ITEM 1. BUSINESS
THE TEXT OF THIS FORM 10-K, INCLUDING THIS BUSINESS SECTION, MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, AND NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN THESE FORWARD-LOOKING STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REPORT EVENTS ON CIRCUMSTANCES ARISING AFTER THE DATE OF THIS ANNUAL REPORT. IN ADDITION TO RISKS AND UNCERTAINTIES SPECIFICALLY IDENTIFIED IN THESE SECTIONS, FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THE FAILURE OF OPTISON TO GAIN WIDE MARKET ACCEPTANCE, THE FAILURE OF OPTISON TO GAIN FDA APPROVAL FOR NEW INDICATIONS, ADVERSE RESULTS IN THE COMPANY'S ONGOING PATENT LAWSUITS, THE FAILURE OF THE COMPANY AND MALLINCKRODT TO CONCLUDE THEIR AGREEMENT RELATING TO THE TRANSFER OF OPTISON MANUFACTURING RESPONSIBILITY TO MALLINCKRODT, AND OTHER FACTORS IDENTIFIED IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION AND PRESS RELEASES.
GENERAL
Molecular Biosystems, Inc. ("MBI" or the "Company") is a leader in the development, manufacture and sale of ultrasound contrast imaging agents. These contrast agents are used primarily to improve the real-time images ("moving pictures") of organs and body structures, especially the heart, obtained through ultrasound examinations. MBI's products are designed to increase the diagnostic usefulness of ultrasound examinations through enhanced visualization of structures and vasculature, and to reduce the need for other diagnostic procedures that may be more expensive, time-consuming or invasive. MBI is the first and only company to obtain marketing approval from the United States Food and Drug Administration ("FDA") for ultrasound contrast agents, having gained approvals for ALBUNEX-Registered Trademark- in 1994 and for OPTISON-Registered Trademark- (the Company's second-generation agent) in 1997. OPTISON, a significant improvement over ALBUNEX in terms of efficacy, is used to detect heart disease by assessing blood flow within the heart chambers and by identifying the location of the chamber borders and the movement of the chamber walls ("cardiac function"). OPTISON is the only advanced generation cardiac ultrasound imaging agent commercially available in the United States and Europe.
To increase the potential applications of OPTISON, MBI has conducted Phase 2 clinical trials to evaluate the product's efficacy in determining whether the heart muscle is receiving an adequate blood supply ("myocardial perfusion"). The multiple Phase 2 trials include use of OPTISON in the emergency room for patients with chest pain, and in various forms of stress echocardiography. Results using OPTISON in each of these applications suggest a close agreement with nuclear imaging for the detection of ischemia ("reduced blood supply") by wall motion and perfusion. Furthermore, the results indicate that use of OPTISON could help to "rescue" a large proportion of uninterpretable non-contrast studies, thereby reducing the need for additional, more expensive and time-consuming testing. The Company believes the information regarding perfusion will enable cardiologists to diagnose heart attacks and coronary artery disease more accurately and safely than is currently feasible. MBI is also conducting Phase 2 clinical studies using OPTISON to detect abnormalities in other organs, such as the liver.
Ultrasound imaging is a widely-used and cost-effective technique to examine soft tissues, internal body organs and blood flow. Ultrasound systems use low-power, high-frequency sound waves that are reflected by tissues and fluids to produce real-time images. It is estimated that over 63 million ultrasound imaging procedures are performed in the United States each year, of which approximately 15 million procedures are used to examine the heart ("echocardiograms"). Unlike other imaging modalities, such as magnetic resonance imaging, computed tomography and nuclear imaging, ultrasound imaging procedures could not be performed with contrast agents to enhance images until the approval of ALBUNEX and the subsequent approval of OPTISON. Non-contrast ultrasound, while very good in delineating anatomy, often results in poor image quality and is unable to demonstrate actual blood flow within organ tissue.
MBI's ultrasound contrast agents are designed to enhance existing ultrasound procedures by improving their ability to image blood flow and by providing clearer images of body structures and organs. OPTISON and ALBUNEX consist of human albumin microspheres made using MBI's patented process. The microspheres are injected intravenously into the bloodstream and transported to the heart and other organs. Because the microspheres are highly reflective to the ultrasound beam, organs and structures containing blood will appear more brightly and clearly than they would in the absence of the contrast agent. Albumin is a protein naturally found in human blood and has been used for many years as a blood expander. Both ALBUNEX, which was first marketed in Japan in October 1993, and OPTISON, which has been marketed in the
United States since January 1998, have a strong safety profile as demonstrated in over 80,000 patients with no unexpected adverse events.
OPTISON permits cardiologists to see blood flow in the chambers of the heart and the motion of the heart muscle using ultrasound. Cardiologists are particularly interested in viewing the left ventricle, the chamber of the heart which pumps oxygenated blood arriving from the lungs to all other parts of the body. In approximately 15-20% of patients undergoing an echocardiogram, the wall of the left ventricle (the "endocardial border") cannot be detected or its location appears ambiguous on the ultrasound image depending on the physical and disease condition of the patient. When OPTISON enters the left ventricle, however, the endocardial border can be visualized because of the reflectivity of the OPTISON microspheres in the blood. When the endocardial border is visible, cardiologists can observe its motion and thus are able to interpret cardiac function, which is critical in diagnosing cardiac disease, including damage from a heart attack.
In addition to other indications, OPTISON is designed to permit cardiologists to evaluate myocardial perfusion. Unlike ALBUNEX, which is air-filled, OPTISON microspheres contain an insoluble gas, octafluoropropane. Because of their composition, the contrast effect from OPTISON microspheres lasts up to 5 minutes, as opposed to 35-40 seconds with ALBUNEX microspheres. The Company believes that if its clinical trials for myocardial perfusion are successful, OPTISON will provide important diagnostic benefits, including detecting areas of the heart muscle compromised due to coronary artery stenosis as well as detecting the lack of blood flow in the heart muscle resulting from a complete occlusion of a coronary artery (heart attack). The Company believes that OPTISON may have much greater market potential than ALBUNEX because of the greater diagnostic importance of the indications for which it may be suitable (such as myocardial perfusion) when used in conjunction with new ultrasound imaging modalities.
In June 1998, the Company announced that results from Phase 2 myocardial perfusion clinical trials for OPTISON indicate that it may be a useful contrast agent for the evaluation of myocardial perfusion. The Company believes that the use of OPTISON in routine diagnostic as well as emergency room procedures may significantly reduce the overall cost of patient care by substituting ultrasound for more expensive diagnostic methods, such as nuclear imaging, and by enabling more accurate screening of patients to determine whether follow-up diagnostic or surgical procedures are required. In March 1996, the Company announced that preliminary analysis of Phase 2 myocardial perfusion results indicated a 92% agreement between diagnoses of patients with known or suspected heart disease made using dipyridamole-stress nuclear imaging, the current perfusion "gold standard," and dipyridamole-stress harmonic ultrasound imaging using OPTISON.
In the area of computed tomography imaging ("CT"), MBI is developing a novel contrast agent, MB-840, which employs iodinated triglycerides ("ITG") to target hepatocytes (liver cells), thereby providing a site-specific contrast agent for CT. Current CT imaging is not effective in identifying the very early stages of liver cancer even with the use of traditional iodinated x-ray contrast agents. The Company believes that MB-840 may make possible consistent early identification of liver cancer by CT. At present, the Company is currently conducting pre-clinical trials for MB-840.
MBI is collaborating with Mallinckrodt, Inc. ("Mallinckrodt") to develop and commercialize OPTISON in all territories of the world with the exception of Japan, Taiwan and South Korea. Mallinckrodt is one of the world leaders in the marketing of contrast imaging agents, with 1998 imaging agent sales of approximately $760 million. MBI's relationship with Mallinckrodt began in 1988 with the execution of a distribution agreement for ALBUNEX in North and South America and a related investment agreement pursuant to which Mallinckrodt paid the Company approximately $30 million.
The Company and Mallinckrodt expanded their original agreement in September 1995 when the parties entered into an Amended and Restated Distribution Agreement ("ARDA"). ARDA expanded the geographic scope and extended the duration of Mallinckrodt's exclusive marketing rights. Mallinckrodt at that time also made a $13.0 million equity investment in MBI and committed $20.0 million to the clinical development of OPTISON and related projects. MBI has received $3.0 million and may receive up to an additional $9.5 million upon meeting certain territorial and product development milestones. There can be no assurances, however, that future milestones will be met.
In December 1996, the Company and Mallinckrodt amended ARDA to further expand the geographical scope of Mallinckrodt's exclusive marketing and distribution rights for OPTISON, ALBUNEX and related products. The amendment extended Mallinckrodt's exclusive territory to include the territory that the Company had formerly licensed to Nycomed Imaging AS, consisting of Europe, Africa, India and parts of Asia.
Under ARDA, the Company is responsible for manufacturing all licensed products for sale to Mallinckrodt at a price generally equal to 40% of Mallinckrodt's quarterly average selling price to end users. The Company is also responsible for conducting clinical trials and securing regulatory approvals of the licensed products in the United States for cardiac indications. Mallinckrodt is responsible for conducting clinical trials and securing approvals of the licensed products in the United States for non-cardiac indications ("Radiology") and is responsible for conducting all clinical trials and securing approvals in the other countries in Mallinckrodt's territory.
In April 1999, the Company and Mallinckrodt Inc. agreed to transfer the manufacture of OPTISON from MBI to Mallinckrodt. The parties agreement will be incorporated into an amendment to ARDA. In addition to the transfer of manufacturing, the amended agreement will extend Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology, clinical trials for OPTISON in the United States. MBI will continue to conduct all cardiology trials for OPTISON and will assume responsibility for conducting radiology trials in the United States. Under the amended agreement, Mallinckrodt will reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer and, in exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI will receive a reduced royalty rate on product sales of OPTISON.
In April 1998, the Company and Chugai entered into a strategic alliance to develop and commercialize OPTISON and ORALEX in Japan, Taiwan and South Korea. (Chugai may market OPTISON under a name other than "OPTISON." In the Chugai agreement, OPTISON is referred to as "FS069," MBI's developmental name for OPTISON.) In exchange for granting to Chugai a royalty-based license to market these products in the named countries, MBI received an upfront license fee from Chugai of $14.0 million. In addition, Chugai made an equity investment in MBI common stock of $8.3 million at a premium of 40% over the then-prevailing market price. MBI is eligible to receive milestone payments of up to $20.0 million based on the achievement of certain product development goals in the territory and will receive royalties from Chugai from the sale of commercialized products in the territory.
BUSINESS STRATEGY
The Company's objective is to remain a leader in the development and commercialization of innovative contrast imaging agents. MBI intends to achieve this objective by implementing the following key strategies.
DEVELOP OPTISON FOR MULTIPLE INDICATIONS. MBI's primary clinical developmental objective is to gain additional regulatory approvals in the United States and abroad for OPTISON for the diagnosis of multiple cardiac indications, such as cardiac function and myocardial perfusion. Thereafter, the Company intends to expand the application of OPTISON by seeking approval for non-cardiac (radiology) indications. The Company believes that the extensive knowledge that it and Mallinckrodt have gained through the marketing of ALBUNEX regarding the requirements of the medical and third-party payor communities will assist in the commercialization of OPTISON.
DEMONSTRATE COST-EFFECTIVENESS. The Company and Mallinckrodt will continue to design studies to demonstrate the overall cost-effectiveness of using the Company's ultrasound contrast agents. The Company believes that such studies may establish that use of OPTISON can significantly reduce the overall cost of patient care by substituting ultrasound for more expensive diagnostic modalities, and by enabling more accurate screening of patients to determine whether follow-up diagnostic or therapeutic procedures are required.
NEW PRODUCT DEVELOPMENT. The Company has established significant clinical, regulatory and manufacturing expertise in the development of OPTISON and ALBUNEX. The Company intends to leverage this expertise for the development of new, proprietary imaging products such as ORALEX, MB-840, and other products.
INDUSTRY BACKGROUND
NON-ULTRASOUND IMAGING TECHNIQUES
Since the discovery of x-rays, medical imaging has been used extensively to diagnose and guide the treatment of diseases and injuries to internal organs. Medical imaging can be used to identify high-risk patients, make initial diagnoses, confirm diagnoses based on other information, formulate treatment plans, and evaluate the effectiveness of treatment and detect the recurrence of a medical problem. Generally, imaging improves patient care and lowers health care costs by enabling the detection of disease or abnormal structures not apparent by routine physical examination.
There are a variety of medical imaging methods, or "modalities," available to the physician. The choice of modality by the physician depends on a number of factors, including the part of the body to be imaged, the suspected condition to be investigated, the cost of the procedure, the diagnostic usefulness of the image and the condition of the patient. Other important factors in determining the selection of a modality are the availability of equipment and trained operators and the ability to schedule time on the equipment. The major non-ultrasound modalities are:
COMPUTED TOMOGRAPHY ("CT"). CT employs x-rays aimed into the body from several different angles to create a computerized static "snapshot" image of soft tissue and bones. CT is used extensively to image the head and neck for injury and disease, and is also used to detect liver cancer and other hepatobiliary diseases. CT may employ injectable contrast agents which absorb x-rays and thereby enhance structural imaging. According to published reports, approximately 23 million CT examinations are performed annually in the United States, approximately 44% of which employed a contrast agent. While CT is effective in revealing anatomic detail, it is expensive, does not generally provide real-time images or permit the assessment of blood flow, and exposes patients to radiation. CT is rarely used to image the heart.
CONVENTIONAL X-RAY. Familiar procedures such as chest x-rays and mammograms use x-rays aimed from only a single angle and do not require computer reconstruction to create an image. According to published reports, more than 5 million abdominal x-rays performed annually in the United States employed barium as a contrast agent to examine the gastrointestinal system. Conventional x-ray is not used to assess heart function.
MAGNETIC RESONANCE IMAGING ("MRI"). MRI creates an image by exposing the body to a radio frequency pulse to which the body's hydrogen atoms respond in a way detectable by the MRI equipment. This information is analyzed by computer and a cross-sectional image is produced. MRI is used primarily to image soft tissues in order to detect tumors, lesions, and injuries. An accurate image is produced, but as with CT, the images are not real-time. In addition, MRI does not generally provide information on blood flow or perfusion of blood into organs and tissues, and has not yet been accepted as a primary diagnostic for imaging of the heart. According to published reports, more than 9 million MRI procedures are performed annually in the United States, approximately 29% of which use a contrast imaging agent.
NUCLEAR IMAGING. Nuclear imaging requires the injection of radioactive substances into the body. The radiation is detected by a special camera and analyzed by computer, resulting in a static image that does not depict blood flow in real time. Great care is required in the handling and disposal of radioactive contrast agents. Nuclear imaging is used primarily to detect cardiovascular disease, malignancies and soft-tissue tumors and is typically preceded by a stress echocardiogram exam. Nuclear imaging is also the current "gold standard" used to detect myocardial perfusion. According to published reports, nearly 13 million nuclear imaging procedures are performed annually in the United States, approximately 5 million of which are cardiac perfusion studies.
X-RAY ANGIOGRAPHY. Angiography is used to visualize real-time blood flow in the body's vasculature in order to determine the presence of blockages or occlusions in the vessels leading to the heart prior to performing bypass surgery or balloon angioplasty. A catheter is inserted into a vessel or directly into the heart chamber and a contrast agent that is visible using special x-ray detection equipment is injected. This procedure requires a specially-equipped laboratory. It is effective in locating blockages and occlusions, but it is expensive, invasive, and exposes the patient to x-ray radiation. According to published reports, approximately 1.3 million interventional angiographic examinations and approximately 3 million cardiac catheterization procedures are performed annually in the United States.
ULTRASOUND IMAGING
Ultrasound employs low-power, high-frequency sound waves which are directed at the organ to be imaged by placing a generating instrument called a "transducer" on the body near the organ. The sound waves are reflected off of the organ or tissue back to the ultrasound machine. The ultrasound machine reads the reflected sound waves and produces a cross-sectional real-time "moving picture" image of the targeted organ or tissue. Ultrasound is used to image the heart, liver, kidneys, gall bladder, pancreas, other abdominal structures, blood vessels, and the reproductive system, and is also being investigated for use with brain and breast examinations. Cardiac ultrasound examinations are called "echocardiograms." Non-cardiac diagnostic ultrasound examinations are referred to as "radiology" indications or applications. The advantages of ultrasound include:
- SAFETY. The sound waves employed by ultrasound have no noticeable medical effect on the body. The same organs or sections of the body may be imaged repeatedly for long periods of time with no adverse effects. Ultrasound is routinely used in fetal examinations.
- EASE OF USE. Ultrasound exams are relatively simple to perform and require little patient preparation. Unlike machines used for MRI, CT, nuclear imaging and x-ray angiography, ultrasound machines are compact and portable and do not require specially-equipped facilities or housing.
- REAL-TIME IMAGES. Unlike the other imaging modalities (with the exception of x-ray angiography and, to a less frequent extent, CT), ultrasound creates a "moving picture" of the targeted organ. The organ under study may be safely examined over any period of time selected by the physician. This feature is especially important in heart examinations, where the dynamics of the beating heart are of diagnostic importance to the cardiologist.
- LARGE INSTALLED BASE. There is a large installed base of ultrasound machines throughout the world. According to published reports, there are more than 70,000 machines installed in the United States. Several large manufacturers such as Hewlett-Packard, ATL, Acuson, General Electric and Toshiba compete in the ultrasound hardware market.
- PRICE. Ultrasound is a relatively inexpensive procedure. According to a recent published article on diagnostic costs, an average cost of a cardiac perfusion nuclear exam is $670, a cardiac catherization is $2,048 and an echocardiogram is $319.
Although ultrasound is a widely-used imaging modality, the visual clarity of non-contrast-enhanced ultrasound images is generally inferior to that obtainable using certain of the other modalities. With each of the other modalities, contrast agents are frequently used, and in nuclear imaging and x-ray angiography, an imaging agent is required to create the images. Until the introduction of ALBUNEX, no imaging agents were available in the United States for use with ultrasound.
"Conventional" ultrasound imaging sends and receives sound waves at a single frequency; this is called the "fundamental" frequency. The Company's products are being tested with new ultrasound techniques which, although currently not widely available, may find acceptance in diagnostic imaging over the next several years. The most significant of these new techniques is "harmonic imaging." Researchers have discovered that if the ultrasound machine's transducer is modified to read the sound waves returning from the imaged area at a multiple ("harmonic") of the outgoing fundamental frequency, and if a contrast agent is used, the resulting image can provide more complete information on blood flow and structures in the scanned area than is available with a conventional ultrasound exam. This is because the microspheres generate a harmonic signal significantly stronger than that generated by the tissue, resulting in a significantly enhanced signal-to-noise ratio.
PRODUCTS AND MARKETS
OPTISON AND ALBUNEX MICROSPHERE TECHNOLOGY
Both OPTISON and ALBUNEX are ultrasound contrast imaging agents consisting of gas-filled human albumin microspheres manufactured using MBI's proprietary process and albumin microsphere technology. They are injected into an arm vein and pass through the bloodstream to the right atrium and ventricle of the heart, where they are pumped through the lungs and into the left atrium and ventricle of the heart. The left ventricle is the chamber of the heart that pumps oxygenated blood arriving from the lungs out to the rest of the body and is the portion of the heart that is of the greatest clinical interest in the diagnosis of heart disease.
ALBUNEX microspheres are air-filled, while OPTISON microspheres are filled with an insoluble gas, octafluoropropane. The use of OPTISON and ALBUNEX as ultrasound imaging contrast agents relies on the greater acoustic reflectivity of the microspheres relative to blood, which does not reflect sound waves well and is effectively invisible to ultrasound imaging, and relative to the tissues to which the blood carries the microspheres. Areas where OPTISON and ALBUNEX are present will appear brighter and clearer than areas where no agent is present. The contrast effect between the blood containing the microspheres and the surrounding tissues enhances the ability to detect blood flow using ultrasound imaging and permits the resolution of subtle differences in the density of the target tissue structures.
OPTISON, which uses a 1% albumin solution (in saline), has exhibited a safety profile in clinical studies equivalent to that of ALBUNEX. ALBUNEX consists of a 5% albumin solution in which the air-filled microspheres are suspended.
Human albumin is a protein extracted from blood and has been used as a blood expander for many years. Both ALBUNEX, which was first marketed in Japan in October 1993, and OPTISON, which has been marketed in the United States since January 1998, have a strong safety profile as demonstrated in over 80,000 patients with no unexpected adverse events.
ALBUNEX
ALBUNEX the first ultrasound contrast imaging agent to be approved by the FDA. The FDA approved ALBUNEX for marketing in the United States in August 1994 to assess cardiac function. It has also been approved in Japan and Europe. The Company believes that OPTISON has replaced ALBUNEX in the market because of OPTISON's superior performance characteristics.
OPTISON
OPTISON was the first perfluorocarbon based agent to have been approved for sale in the United States by the FDA. The Company received FDA approval for OPTISON in December 1997. In May 1998, OPTISON became the first perfluorocarbon based agent to receive final marketing authorization by the European Agency for the Evaluation of Medicinal Products for use in patients with suspected or known cardiovascular disease. OPTISON consists of octafluoropropane-filled albumin microspheres of approximately the same size and concentration as ALBUNEX. Because octafluoropropane is insoluble in blood, the microspheres in OPTISON have greater durability and remain intact in the bloodstream for over 5 minutes, versus 35 to 40 seconds for ALBUNEX. This greater durability permits more of the microspheres to pass from the right side of the heart, through the microvasculature of the lungs, and into the left side of the heart. As a result, OPTISON is superior to ALBUNEX in its ability to enhance endocardial border delineation and regional wall motion using ultrasound. More importantly, the durability of the OPTISON microspheres enable them to circulate into the heart muscle and may permit the assessment of myocardial perfusion using ultrasound.
CARDIAC FUNCTION. Clinical studies have demonstrated that OPTISON is effective in visualizing blood flow in the chambers of the heart, including the delineation of endocardial borders and the assessment of regional wall motion. In 15-20% of the echocardiograms performed annually in the United States, the location of the wall of the left ventricle, or "endocardial border," cannot be satisfactorily visualized or its location appears ambiguous. Clinical studies demonstrated a high success rate for this indication in cases of suboptimal chamber wall imaging in both stressed and non-stressed patients. When sufficient numbers of OPTISON microspheres reach the left ventricle, the acoustical reflectivity of OPTISON in the chamber permits the endocardial border to be seen by defining the walls of the chamber, or "endocardial border delineation." This delineation in turn permits visualization of the movement of the walls of the chamber as the heart beats, or "regional wall motion." Information regarding endocardial border delineation and regional wall motion are important for diagnostic purposes. If the chamber walls appear thicker than normal or are not moving normally, it is a potential indicator that the surrounding heart muscle is not receiving sufficient blood or is abnormal in some other way, which, in turn, may indicate an infarction (heart attack), stenosis (partial blockage of an artery) or other abnormal condition. OPTISON has demonstrated efficacy at a much lower dose than ALBUNEX requires, with an equivalent safety profile.
MYOCARDIAL PERFUSION. Clinical studies indicate that the longer circulation time of the octafluoropropane-filled microspheres in OPTISON may allow a physician to assess myocardial perfusion using ultrasound. The Company conducted a Phase 1 safety study which demonstrated a safe dosing range of many times the expected efficacious dose and also showed myocardial perfusion in healthy patients using a dose as low as 0.5 cc. Analysis of Phase 2 results indicated a 92% agreemeny between diagnoses of patients with known or suspected heart disease made using dipyridamole-stress nuclear imaging, the current perfusion "gold standard," and dipyridamole-stress harmonic ultrasound imaging using OPTISON. In June 1998, the Company announced that results from Phase 2 myocardial perfusion clinical trials for OPTISON indicate that it may be a useful contrast agent for the evaluation of myocardial perfusion. The Company will design future Phase 3 studies to evaluate, among other things, myocardial perfusion in cardiac patients using ultrasound at both fundamental and harmonic frequencies.
Myocardial perfusion is important because it provides oxygenated blood to the heart muscle. If OPTISON is not detected in a portion of the heart muscle, or not detected with the expected level of intensity, it means that a portion of the muscle is not receiving enough blood ("ischemia"). This finding may be diagnostic of several conditions, including coronary arterial stenosis and myocardial infarction.
The ability to rapidly assess the condition of the heart using OPTISON may also prove efficacious and cost-effective in the emergency room and in the subsequent treatment of heart attacks. For example, a patient arriving at the emergency room complaining of chest pain may be quickly assessed using ultrasound with OPTISON. If no perfusion defect is seen in the heart, a myocardial infarction may be ruled out. Where a perfusion defect is detected using OPTISON, the Company believes that information regarding its severity, size and location may assist the physician in determining the patient's condition. A patient with an extensive infarction may be sent immediately for an angiogram and even emergency angioplasty. A patient with a less severe infarction may be given a thrombolytic (clot-dissolving) agent. This patient may then undergo an additional OPTISON echocardiogram to see whether the affected area of the heart muscle has reperfused; that is, whether the thrombolytic agent was successful in treating the condition. If the OPTISON echocardiogram shows that the muscle has reperfused, the physician would not have to order any additional emergency procedures and conventional treatment might begin. Subsequent OPTISON echocardiograms may be used to assess the effectiveness of the post-emergency-room treatment; for example, how the heart muscle has responded to different medications, changes in diet, exercise program, weight loss and other therapies.
The Company believes that the assessment of myocardial perfusion may also be important in screening high-risk patients prior to general surgery or other potentially stressful treatment regimens. For example, a surgeon may wish to assess whether an elderly or weakened patient is capable of undergoing a particular surgery or treatment without a cardiac incident. An OPTISON echocardiogram may be safely administered to assist the physician in making this determination.
Commercialization of OPTISON for myocardial perfusion may require the conversion of present ultrasound equipment to harmonic imaging frequencies. Although the Company is aware of the development of commercial harmonic modules for attachment to existing ultrasound machines as well as efforts to develop new harmonic imaging machinery by several hardware manufacturers, there can be no assurance that any of these current efforts will be successfully commercialized. See "Industry Background - Ultrasound Imaging."
RADIOLOGY INDICATIONS. The stability of the OPTISON microspheres renders the product potentially suitable for a much greater range of indications than ALBUNEX. In preclinical studies, OPTISON has been shown to perfuse the liver, which may permit the detection of tumors and lesions using ultrasound. Preliminary animal studies have shown OPTISON is able to perfuse the kidneys, ovaries, prostate, testes and peripheral intracranial vessels. The Company plans clinical studies to evaluate the use of OPTISON in the detection of liver pathology relative to the current imaging "gold standard" for analyzing liver pathology.
OPTISON enjoys several other potential advantages. In clinical studies, OPTISON has achieved greater efficacy at a fraction of the dose of ALBUNEX required for the assessment of cardiac function. The Company expects that this low dosage will make OPTISON attractive to the patient as well as the doctor. In addition, OPTISON uses a 1% albumin solution, compared to a 5% albumin solution required for ALBUNEX. The lower dose required and the lesser amount of albumin used may lower the per-unit manufacturing cost and may allow for the production of more doses of OPTISON than ALBUNEX using equivalent manufacturing capacity.
MB-840
MBI is developing a novel contrast agent, MB-840, which employs iodinated triglycerides ("ITG") to target hepatocytes (liver cells), thereby providing a site-specific contrast agent for CT. Current CT imaging is not effective in identifying the very early stages of liver cancer even with the use of traditional iodinated x-ray contrast agents. The Company believes that MB-840 may make possible consistent early identification of liver cancer by CT.
In 1996, approximately 40% of the 7.25 million CT procedures performed in the US were specific for the abdomen and liver. The evaluation of abdominal pain, primary or metastatic cancer and undefined mass or cyst detection were the most commonly ordered procedures in the multi-billion dollar iodinated contrast market. The Company anticipates that CT
imaging with contrast will not only become routine for existing applications but will also create entirely new markets for CT procedures.
Potential applications of MB-840 include the assessment of gallbladder disorders, liver transplant efficacy, hepatobiliary duct patency, disease-induced hepatic dysfunction associated with diabetes, alcoholism, cirrhosis, fibrosis, and hepatitis hepatobiliary disorders such as cholecystitis, biliary obstruction, hepatobiliary tumors and choledocolithiasis. Even if the enhancement profiles of the ITG contrasts prove to be only as good as those of water-soluble contrast media, the ITG formulations will still bring advantages to the marketplace because of ease of use (administered manually at slow injection rates), reduced dose, lower osmolarity, minimal renal elimination, and positive impact on patient throughput.
Competition to MB-840 comes from three primary sources: 1) commercially available iodinated contrast media; 2) iodinated lipids, emulsions, and lipophilic derivatives of water-soluble compounds currently under development; and 3) liver-specific agents designed for use in magnetic resonance imaging (MRI) or other imaging modalities. A benefit of using CT imaging with ITG contrast is the localization of the contrast agent to a target tissue which reduces systemic toxicity, lowers the doses required for effective enhancement and maximizes diagnostic efficiency in the target organ. In addition, ITG contrast agents have the potential for evaluation of physiological function in the liver. Preliminary safety studies with animals administered ITG have shown no adverse effects.
MBI holds an exclusive license from the University of Michigan for patents relating to the ITG technology which requires the Company to exercise diligence in the development and commercialization of MB-840. If the Company does not enter into a collaborative development relationship with a partner or determines that it will no longer invest its own resources in the development of MB-840, the Company's license from the University of Michigan will terminate at the University's option. At present, the Company continues to develop the product and is currently conducting pre-clinical trials for MB-840.
ORALEX
The Company is developing ORALEX, an oral ultrasound contrast agent intended to enhance images of the abdomen, including the small bowel, stomach lining and structures adjoining the stomach, in particular the pancreas.
MBI has entered into a strategic alliance with Chugai to develop and commercialize ORALEX in Japan, Taiwan and South Korea. See "General." In the United States, the Company is seeking a partner for continued development of ORALEX. Because of the Company's primary commitment to OPTISON and MB-840, it has determined that it will begin Phase 3 clinical trials for ORALEX only when it has found a collaborative partner to fund a significant portion of the necessary clinical and regulatory activities in the United States.
MARKETING AND LICENSE AGREEMENTS
MALLINCKRODT, INC. MBI's distribution agreement with Mallinckrodt forms the basis of its product development and marketing program for products containing albumin microspheres such as OPTISON and ALBUNEX.
In December 1988, the Company entered into a distribution agreement with Mallinckrodt granting it the exclusive marketing and distribution rights for ALBUNEX as defined and gas-filled albumin microspheres in North and South America. Mallinckrodt paid the Company $6.0 million and agreed to pay the Company a further $21.0 million based on the successful completion of certain product development and regulatory milestones. Mallinckrodt also paid the Company $3.0 million for 181,818 unregistered shares of the Company's Common Stock. Under the distribution agreement, the Company was responsible for conducting clinical trials and securing regulatory approvals of the licensed products in the United States for cardiac indications, and Mallinckrodt was responsible for conducting clinical trials and securing regulatory approvals in the United States for non-cardiac indications and was responsible for conducting all clinical trials and securing approvals in the other countries in Mallinckrodt's territory. The Company manufactures all licensed products for sale to Mallinckrodt at a price generally equal to 40% of Mallinckrodt's quarterly average selling price to end users. The Company expects to transfer the manufacturing responsibility to Mallinckrodt pursuant to an agreement announced in April 1999 (see below).
The distribution agreement lasts for the life of the licensed patents and, prior to amendment in September 1995, granted Mallinckrodt exclusive rights for five years following the first commercial sale of ALBUNEX in the United States, after which MBI was granted the assignable right to co-market the licensed products. In accordance with the distribution agreement, the Company undertook to acquire license rights from a third party to a United States patent for certain related
technology. The Company acquired these rights in February 1991, and in connection with this acquisition the Company and Mallinckrodt agreed to pay royalties to the licensor of 0.8% and 1.2%, respectively, on the net sales of ALBUNEX in the United States.
In September 1991, the Company and Mallinckrodt entered into an Amended and Restated Distribution Agreement ("ARDA"), which strengthened and expanded the parties' relationship. ARDA expands the geographic scope of Mallinckrodt's exclusive right to market the licensed products to include all of the countries of the world other than those covered by the Company's then existing license agreements with Shionogi and Nycomed and extends the duration of Mallinckrodt's exclusive rights to the later of July 1, 2003 or three years after the date that the Company obtains approval from the FDA to market OPTISON for an intravenous myocardial perfusion indication. Mallinckrodt agreed to pay the Company $20.0 million over four years beginning in October 1995 to support clinical trials of OPTISON, related regulatory submissions and associated product development and to pay up to an additional $9.5 million upon the satisfaction of certain territorial and product development milestones. ARDA required the Company to spend at least $10.0 million for clinical trials to support regulatory filings with the FDA for cardiac indications of OPTISON. Under a related investment agreement, Mallinckrodt purchased 1,118,761 shares of the Company's Common Stock for $13.0 million at a premium of 40% above the then-prevailing market price. In addition, ARDA grants the Company the option to repurchase all of the shares of the Company's Common Stock that Mallinckrodt purchased under the related investment agreement for $45.0 million, subject to various price adjustments. This option is exercisable from the later of July 1, 2000, or the date that the FDA approves OPTISON for a myocardial perfusion indication, through the later of the third anniversary of such approval or June 30, 2003. If the Company exercises this option, the Company or its assignee may co-market licensed products in all of the countries covered by ARDA.
In December 1996, the Company and Mallinckrodt amended ARDA to expand the geographical scope of Mallinckrodt's exclusive marketing and distribution rights for OPTISON, ALBUNEX and related products. The amendment extended Mallinckrodt's exclusive territory to include the territory that the Company had formerly licensed to Nycomed consisting of Europe, Africa, India and parts of Asia. Under the amendment to ARDA, Mallinckrodt agreed to pay fees of up to $12.9 million plus 40 percent of product sales to cover royalties and manufacturing. Mallinckrodt made an initial payment of $7.1 million, consisting of reimbursement to the Company of $2.7 million that the Company paid to Nycomed to reacquire the exclusive product rights in Nycomed's territory, payment of $3.0 million to the Company under the terms of ARDA upon the extension of Mallinckrodt's exclusive rights to Nycomed's former territory, and payment of $1.4 million to Nycomed in satisfaction of the Company's obligation to pay 45% of any amounts that the Company receives in excess of $2.7 million upon the licensing of the former Nycomed territory to a third party. Of the remaining $5.8 million that may be paid, Mallinckrodt will pay $4.0 million to the Company (upon the achievement of the specified product development milestone) and $1.8 million to Nycomed (representing 45% of the $4.0 million payment to the Company). There can be no assurance, however, that the Company will satisfy this milestone.
In April 1999, the Company and Mallinckrodt agreed to transfer the manufacture of OPTISON from MBI to Mallinckrodt. The parties agreement will be incorporated into an amendment to ARDA. In addition to the transfer of manufacturing, the amended agreement will extend Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology, clinical trials for OPTISON in the United States. MBI will continue to conduct all cardiology trials for OPTISON and will assume responsibility for conducting radiology trials in the United States. Under the amended agreement, Mallinckrodt will reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer and, in exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI will receive a reduced royalty rate on product sales of OPTISON.
CHUGAI PHARMACEUTICAL CO., LTD. In an agreement dated March 31, 1998, the Company entered into a cooperative development and marketing agreement with Chugai Pharmaceutical Co., Ltd. ("Chugai") of Japan. The parties entered into this strategic alliance which covers Japan, Taiwan and South Korea, to develop OPTISON (which Chugai may market under a different name) and ORALEX, as well as related products. The Company granted Chugai an exclusive license to develop, manufacture, and market these products in the subject territory, for which the Company received an upfront license fee of $14.0 million. Chugai will pay the Company a royalty on net sales of licensed products which Chugai manufactures. For licensed products which the Company manufactures, Chugai will pay the Company royalties on net sales, depending upon the sales volume, in addition to a transfer price based on average net sales per unit from the previous quarter. Additionally, Chugai purchased 691,883 shares of the Company's common stock at a premium of 40% over the then-prevailing market price. The equity investment was valued at $8.3 million. The Company is also eligible to receive milestone payments of up to $20.0 million based on Chugai's achievement of certain Japanese product development and regulatory goals.
FEINSTEIN LICENSE. In November 1986, the Company entered into a license agreement under which it acquired the exclusive right to develop, use and sell any products derived from patents and applications which Stephen B. Feinstein, M.D. owned covering sonicated gas-filled albumin microspheres used for imaging and any future related patents and applications. In June 1989, the parties restructured this agreement. The Company paid the licensor $4.5 million as an additional license fee and $2.0 million as a prepayment of royalties on the first $66.7 million of sales of the licensed products in the United States, and the parties agreed to reduce the royalty rate on sales of licensed products from 6% to 3% on worldwide net sales by the Company (and United States sales by a sublicensee) and from 2 1/2% to 1 1/4% on net sales by sublicensees outside of the United States. The restructured agreement, requires the Company to pay minimum royalties each year, increasing from $100,000 in 1994 to $600,000 in 1999 and subsequent years.
ITG AGENT. In November 1991, the Company entered into an exclusive license agreement with the University of Michigan for certain patents relating to the Company's ITG CT agent, MB-840, currently under development. The Company paid a license fee of $20,000 and an annual license maintenance fee of $15,000. The Company agreed to pay a royalty of from 2 1/2% to 6% on net sales of licensed products, depending upon the jurisdiction and status of the particular product, and also agreed to make annual minimum royalty payments increasing from $25,000 to $150,000. Effective June 1998, the Company and the University of Michigan amended their exclusive license agreement. The Company agreed to increase the annual license maintenance fee to $100,000 and to provide support for research projects related to MB-840.
PATENTS AND TRADEMARKS
The Company considers the protection of its proprietary technologies to be material to its business prospects. The Company pursues a comprehensive program of patent and trademark prosecution for its products both in the United States and in other countries where the Company believes that significant market opportunities exist.
The Company has an exclusive license to certain United States and foreign patents relating to gas-filled sonicated albumin microspheres from Steven B. Feinstein, M.D. See "Marketing and License Agreements - Feinstein License." The Company itself owns additional United States and foreign patents covering ALBUNEX and OPTISON that broaden the product coverage of its license. Certain of these additional patents cover the Company's continuous flow sonication manufacturing process. Andaris Ltd. challenged the European equivalents of these manufacturing patents in an opposition proceeding which was decided in the Company's favor in January 1996. Andaris has appealed the decision. Andaris has also filed an opposition against the Company's ALBUNEX composition patent in Europe, and Andaris and two other parties have filed a similar opposition in Japan. No hearing date has been set in these latter two oppositions.
The Company has received patents covering its method of manufacturing gas-filled albumin microspheres using a milling process. The Company believes that this process may be more efficient than the sonication process that the Company currently uses. The Company has also received patents on other perfluorocarbon-based technology relating to ultrasound contrast agents.
The Company owns a United States patent covering ORALEX and has several foreign applications pending. The Company has also filed patent applications relating to several early-stage development products. The Company is uncertain whether these applications will result in issued patents or whether the covered products can or will be commercialized.
The last-to-expire of the Company's key United States patents covering OPTISON and ALBUNEX expires in 2008, and subject to the outcome of the oppositions previously described, the last-to-expire of the Company's key European patents covering OPTISON and ALBUNEX expires in 2009.
The patent position of medical and pharmaceutical companies is highly uncertain and involves complex legal and factual questions. There can be no assurance that the Company will receive patents for all or any of the claims included in its pending or future patent applications, that any issued patents will provide the Company with competitive advantages or that third parties will not challenge any issued patents, or that existing or future patents of third parties will not have an adverse effect on the Company's ability to commercialize its products. Moreover, there can be no assurance that third parties will not independently develop similar products, duplicate one or more of the Company's products or design around the Company's patents.
The Company's commercial success also will depend in part upon the Company not infringing patents issued to third parties. There can be no assurance that patents issued to third parties will not require the Company to alter its products or manufacturing processes, pay licensing fees, or cease development of its current or future products.
Litigation or administrative proceedings may be necessary to enforce the Company's patents, to defend the Company against infringement claims or to determine the priority, scope and validity of the proprietary rights of third parties. See "Legal Proceedings." Any such litigation or administrative proceedings could result in substantial costs to the Company, and an unfavorable outcome could have a material adverse effect on the Company's business, financial condition and results of operation. Moreover, there can be no assurance that, in the event of an unfavorable outcome in any litigation or administrative proceedings involving infringement claims against the Company, the Company would be able to license any proprietary rights that it requires on acceptable terms or at all. The Company's failure to obtain a license that it requires to commercialize one of its products could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company has become aware of several United States patents issued to other companies purportedly covering various attributes of perfluorocarbon-containing imaging agents such as OPTISON. Certain of these companies also are pursuing foreign patent protection. Some of these companies are developing or may be developing ultrasound contrast imaging agents that would compete with OPTISON. The patents and patent applications of these other companies involve a number of complex legal and factual issues that are currently unresolved. The Company believes that there may be a substantial overlap among many of the claims in their patents and is currently involved in various administrative proceedings and litigation in the United States and Europe to adjudicate their conflicting rights. See "Item 3 - Legal Proceedings."
The Company believes that, for a variety of reasons, its commercialization of OPTISON will not infringe any valid patent held by any of these other companies. Depending upon the particular patent claim, these reasons include, but are not limited to (i) differences between OPTISON and the subject of the claim, (ii) the invalidity of the claim due to the existence of prior art, (iii) the inadequacy of the claim's specifications, (iv) lack of enablement, (v) inequitable conduct by patentee, and (vi) various other defenses as allowed by law. The Company intends to challenge the validity of any such patent granted to one of the other companies if the patent is asserted against the Company, and the Company will enforce its own patents if any product of one of the other companies infringes the Company's patent claims. See "Legal Proceedings."
The Company has obtained registered trademarks for "ORALEX" and "ALBUNEX" in the United States and in selected foreign countries. Additionally Mallinckrodt has filed for the trademark for "OPTISON" in various countries throughout the world. There can be no assurance that the Company's registered or unregistered trademarks and trade names will not infringe on the proprietary rights of third parties.
The Company also relies on unpatented trade secrets, proprietary know-how and continuing technological innovation which it seeks to protect by, in part, confidentiality agreements with its employees, consultants, investigators and others. There can be no assurance that these agreements will not be breached, that the Company would have an adequate remedy for any breach or that the Company's trade secrets or know-how will not otherwise become known or independently discovered by third parties.
MANUFACTURING
During the fiscal year ended March 31, 1999, the Company manufactured OPTISON and ALBUNEX for commercial sale in the United States in its aseptic plant at its principal San Diego facility. The plant employed the Company's patented continuous-flow sonication process in which a mixture of sterile albumin solution and gas was subjected to ultrasonic energy. This treatment denatures the albumin protein and facilitates a process known as "cavitation" in which the stable gas-filled microspheres are created. During fiscal year ended March 31, 1999, the Company replaced its first generation product, ALBUNEX, with OPTISON.
The Company was able to meet all orders for OPTISON and ALBUNEX from Mallinckrodt. However, in April 1999, the Company and Mallinckrodt agreed to transfer the manufacture of OPTISON from MBI to Mallinckrodt as part of a multi-phase program by the Company to reduce expenses and preserve capital. The parties agreement will be incorporated into an amendment to ARDA. Under the terms of the amended agreement, which will be retroactive to March 1, 1999, Mallinckrodt will reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer. In exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI
will receive a reduced royalty rate on product sales of OPTISON. The Company expects that it may take up to two years to fully complete the transfer of manufacturing from MBI to Mallinckrodt.
COMPETITION
In general, competition in the field of contrast agents is based on such factors as product performance and safety, product acceptance by physicians, patent protection, manner of delivery, ease of use, price, distribution and marketing. The Company's products compete or may compete with new or improved contrast agents.
The Company anticipates that it will face increased competition in the future as new products enter the market and advanced technologies become available. The Company expects to compete against a number of companies, many of which have substantially greater financial, technical and human resources than the Company and may be better able to develop, manufacture and market products. In addition, many of the Company's existing or potential competitors have extensive experience in research, preclinical testing and human clinical trials, obtaining FDA and other regulatory approvals, and manufacturing and marketing their products, or are allied with major pharmaceutical companies that can afford them these advantages. As a result, competitors may develop and introduce competitive or superior products more rapidly than the Company. While the Company was the first to obtain FDA approval of ultrasound contrast agents, OPTISON and ALBUNEX, the Company expects that one or more of these competitors will develop products that will be approved for an indication or indications covered by OPTISON or ALBUNEX, including the assessment of cardiac function and myocardial perfusion. There can be no assurance that existing products or new products developed by the Company's competitors will not be more effective than any products that may be developed by the Company. Competitive products may render the Company's technology and products obsolete or noncompetitive.
Any product that the Company develops that gains regulatory approval will have to compete for market acceptance and market share. An important factor in such competition may be the timing of market introduction of competitive products. Accordingly, important competitive factors include the relative speed with which the Company can develop products, complete clinical testing and the regulatory approval process, gain reimbursement acceptance and supply commercial quantities of the product for distribution to the market. In addition, the Company believes that the primary competitive factors in the market for ultrasound imaging agents are safety, efficacy, ease of delivery, reliability, innovation and price. The Company also believes that physician relationships and customer support are important competitive factors.
GOVERNMENT REGULATION
The Company's diagnostic products are subject to substantial regulation by the FDA and comparable agencies in foreign countries. Pursuant to the federal Food, Drug and Cosmetic Act, as amended, and the regulations promulgated thereunder, the FDA regulates the research, development, clinical testing, manufacture, labeling, distribution and promotion of medical products. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal by the FDA to review New Drug Applications ("NDA"), withdrawal of marketing approvals, a recommendation by the FDA that the Company not be permitted to enter into government contracts, and criminal prosecution.
The process of obtaining FDA approval of new products like OPTISON, ORALEX and MB-840 involves many steps. The Company must submit the results of laboratory and animal tests to determine efficacy and safety, including potential toxicity, to the FDA as part of an application for an Investigational New Drug ("IND") before the Company may begin clinical trials on humans. After completion of clinical trials, the Company must submit an NDA, in the case of drugs, to the FDA for review and approval before the Company may begin commercial marketing and sale for a new indication.
The FDA classifies OPTISON and ALBUNEX as drugs. As such, the FDA requires these products to undergo the NDA process. An NDA must be supported by valid scientific evidence that typically includes extensive data, including preclinical and human clinical trial data to demonstrate the safety and efficacy of the drug. If human clinical trials of a drug are required, the sponsor of the trial is required to file an IND application with the FDA prior to beginning human clinical trials. The IND application must be supported by data, typically including the results of animal and laboratory testing. If the IND application is approved by the FDA and the appropriate institutional review boards, human clinical trials may begin at a specific site with a specific number of patients, as specified in the approved protocol. An IND supplement must be submitted to and approved by the FDA before a sponsor or an investigator may make any change to the investigational plan that may affect its scientific soundness or the rights, safety or welfare of human subjects.
In addition to the results of clinical trials, the NDA must also contain the results of all relevant bench tests, laboratory and animal studies, a complete description of the drug and its components, and a detailed description of the methods, facilities and controls used to manufacture the drug. In addition, the submission must include the proposed labeling, advertising literature and any relevant training methods. Upon receipt of an NDA application, the FDA makes a threshold determination whether the application is sufficiently complete to permit a substantive review. If the FDA determines that the NDA is sufficiently complete to permit a substantive review, the FDA will accept the application for filing. Once the submission is accepted for filing, the FDA begins an in-depth review of the NDA. An FDA review of an NDA application generally takes one to two years from the date that the NDA application is accepted for filing, but may take significantly longer. The review time is often significantly extended as a result of the FDA asking for more information or for clarification of information already provided in the submission. During the review period, an advisory committee, typically a panel of clinicians, will likely be convened to review and evaluate the application and provide recommendations to the FDA as to whether the drug should be approved. The FDA is not bound by the recommendations of the advisory panel. Toward the end of the review process, the FDA generally will conduct an inspection of the manufacturer's facilities to ensure that the facilities are in compliance with the applicable Good Manufacturing Practices ("GMP") requirements.
If the FDA's evaluations of both the NDA application and the manufacturing facilities are favorable, the FDA will either issue an approval letter or, in some cases, an "approvable letter" containing a number of conditions which must be met in order to obtain final approval of the NDA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue an NDA approval letter authorizing commercial marketing of the drug for the specified indications. If the FDA's evaluation of the NDA applications or manufacturing facilities is not favorable, the FDA will deny approval of the NDA application or issue a "not approvable" letter. The FDA may also determine that additional clinical trials are necessary, in which case NDA approval could be delayed for several years while additional clinical trials are conducted and submitted in an amendment to the NDA. The NDA process can be expensive, uncertain and lengthy, and a number of drugs for which approval has been sought by other companies have never been approved for marketing.
Any drugs manufactured or distributed by the Company pursuant to FDA approvals are subject to pervasive and continuing regulations by the FDA and certain state agencies. The FDA often requires drug manufacturers to conduct post marketing surveillance studies following approval to further evaluate the safety and effectiveness of the drug. Foreign and domestic regulatory approvals, if granted, may include significant limitations on the indicated use for which the product may be marketed. In addition, the FDA and certain foreign regulatory authorities impose numerous other requirements with which medical drug manufacturers must comply. Product approvals could be withdrawn for failure to comply with regulatory standards or as a result of the occurrence of unforeseen safety or effectiveness problems following initial marketing. The Company will also be required to adhere to applicable FDA regulations setting forth current GMP requirements, which include testing, control and documentation requirements. The Company is also required to register with the FDA and with state agencies such as the California Department of Health Services as a drug manufacturer and to list its products with the FDA. Ongoing compliance with GMP and other applicable regulatory requirements is monitored through periodic inspections by state and federal agencies, including the FDA, and by comparable agencies in other countries. Changes in existing regulations or adoption of new regulations could prevent the Company from obtaining, or affect the timing of, future approvals or clearances.
The FDA and equivalent foreign agencies have significant discretion in their conduct of each stage of the regulatory process. Adverse decisions are effectively unappealable, and agency delays are an unfortunate fact of life for the companies they regulate.
The Company also intends to sell OPTISON and ALBUNEX in foreign countries. The time required to obtain approval for sale in foreign countries may be longer or shorter than that required for additional FDA approval, and the requirements may differ.
Labeling, advertising and other promotional activities are subject to scrutiny by the FDA and in certain instances by the Federal Trade Commission. The FDA actively enforces regulations prohibiting marketing of products for unapproved uses, sometimes called "off-label" uses. The Company and its products are also subject to a variety of state laws and regulations in those states or localities where its products are or will be marketed. Any applicable state or local regulations may hinder the Company's ability to market its products in those states or localities.
The Company is also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations now or in the future or that such laws or regulations will not have a material adverse effect upon the Company's ability to do business.
Changes in existing requirements or the adoption of new requirements or policies could adversely affect the ability of the Company to comply with regulatory requirements. Failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will not be required to incur significant costs to comply with laws and regulations in the future or that laws or regulations will not have a material adverse effect on the Company's business, financial condition, or results of operations.
THIRD PARTY REIMBURSEMENT
In the United States, the Company's products will be purchased primarily by medical institutions that will then bill various third-party payors such as Medicare, Medicaid and other government programs and private insurance plans. In considering reimbursement for a new medical product, these payors must decide whether to cover the product and how much to pay for it.
In general, to be covered by Medicare, a health care product or service must be "reasonable and necessary" for the diagnosis or treatment of an illness or injury. This requirement has been interpreted to mean that the product or service must be safe and effective, not experimental or investigational (except under certain limited circumstances involving drugs furnished pursuant to an FDA-approved clinical trial), and appropriate. Medicaid, Blue Cross and Blue Shield plans, commercial insurers and other third-party payors generally have limitations on coverage which are similar to those of Medicare.
Even if a drug has received approval or clearance for marketing by the FDA, there is no assurance that Medicare or other third-party payors will cover the drug or related services. The Company is aware that certain third party payors are providing reimbursement for OPTISON contrast echocardiography procedures. Plans and programs are in place to develop expanded coverage among third party payors. However, the Company also acknowledges that these payors may place certain restrictions on the circumstances in which coverage will be available. In making such coverage determinations, the Health Care Finance Administration ("HCFA"), which administers the Medicare program, and HCFA's contractors consider, among other things, peer-reviewed articles concerning the safety and effectiveness of the drug, the opinions of medical specialty societies, and input from the FDA, the National Institutes of Health, and other government agencies. There is no assurance that the Company's products will be covered by Medicare and other third-party payors.
Failure by hospitals and physicians to receive what they consider to be adequate reimbursement for procedures in which the Company's products are used would have a material adverse effect on the Company's business, financial condition and results of operations.
EMPLOYEES
As of March 31, 1999, the Company had 92 full-time employees, including 4 officers. Approximately 23 of the Company's employees were involved directly in scientific research and development activities. Of these employees, 6 held Ph.D. or M.D. degrees. The Company considers its relations with its employees to be good, and none of its employees is a party to a collective bargaining agreement.
ITEM 2.
ITEM 2. PROPERTIES
The Company's corporate offices and laboratory, manufacturing and warehouse facilities are housed in a Company owned 44,000 square foot building located in San Diego, California. The Company also leases a 30,097 square-foot facility in San Diego. As part of cost reduction measures implemented in fiscal year 1999, the Company moved out of the 30,097 square-foot facility and has no plans to renew this lease when it expires in February 2000. The Company anticipates that its current facilities will be sufficient to meet its needs into the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In July, 1997 the Company and its marketing partner, Mallinckrodt Inc. ("Mallinckrodt") filed suit (the "MBI Case") in United States District Court for the District of Columbia against four potential competitors - Sonus Pharmaceuticals, Inc. ("Sonus"), Nycomed Imaging AS ("Nycomed"), ImaRx Pharmaceutical Corp. ("ImaRx") and its marketing partner DuPont Merck and Bracco - - seeking declarations that certain of their ultrasound contrast agent patents are invalid.
The complaint alleges that each of the defendants' patents is invalid on a variety of independent grounds under U.S. patent law. In addition to requesting that all of the patents in question be declared invalid, the complaint requests a declaration that, contrary to defendants' contentions, the Company and Mallinckrodt do not infringe the defendants' patents, and asks that defendants be enjoined from proceeding against the Company and Mallinckrodt for infringement until the status of defendants' patents has been determined by the court or the U.S. Patent and Trademark Office ("PTO"). The complaint alleges that each defendant has claimed or is likely to claim that its patent or patents cover OPTISON, the Company's advanced generation ultrasound contrast agent, and will attempt to prevent its commercialization.
All of the defendants except Nycomed filed motions to dismiss the complaint on jurisdictional grounds. In January 1998, the court dismissed each of the defendants except Nycomed, ruling that the court lacked jurisdiction over those defendants with respect to the Company's claims of patent invalidity and non infringement. The court's ruling does not purport to rule on the merits of the Company's claims; the dismissal was based solely on jurisdictional grounds.
Following Sonus's dismissal as a defendant in the MBI Case, Sonus activated a patent infringement lawsuit (the "Sonus Case") which it had filed in August 1997 against the Company and Mallinckrodt in the United States District Court for the Western District of Washington. Although the complaint was filed in August 1997, Sonus had agreed not to proceed with the Sonus Case until the jurisdictional motions were decided in the MBI Case. Sonus's complaint alleges that the manufacture and sale of OPTISON by the Company and Mallinckrodt infringe two patents owned by Sonus. As in the MBI Case, MBI counterclaimed for a declaration of invalidity and non-infringement with respect to the Sonus patents. Additionally, MBI filed a counterclaim which alleges that Sonus knowingly made false and misleading public statements regarding its patents and its product, Echogen-Registered Trademark- with the intent to cause damage to MBI and its product OPTISON. Damages, including punitive damages and attorneys fees, are requested. These two patents are the same patents for which the Company was seeking a declaration of invalidity in the MBI Case.
Beginning in July 1997, the Company received the first of five notices from the PTO granting the Company's petitions for reexamination which it had filed with respect to five patents held by three potential competitors, Sonus, Nycomed and ImaRx. Each of the five notices stated there was a substantial new question of patentability raised by the Company's petitions with respect to all claims of the patents. Each of the patents in the reexamination process is related to the use of perfluorocarbon gases in ultrasound contrast agents and is included among the patents for which the Company was seeking a declaration of invalidity in the MBI Case (and for which the Company is continuing to seek a declaration of invalidity in the case of Nycomed's patents).
In late 1997 and early 1998, the PTO issued office actions in connection with the Company's patent reexamination petitions filed against Sonus, Nycomed and ImaRx. The PTO office actions rejected all relevant claims of these patents based on prior art not previously disclosed to the PTO by Sonus, Nycomed or ImaRx during prosecution of their patent applications.
In June 1998, the PTO issued a final rejection of all claims of the two Sonus patents involved in the Sonus Case. In December 1998, the Company received correspondence from the PTO with respect to the two Sonus patents involved in the reexamination proceedings. On the basis of amendments after final rejection, the PTO has indicated that certain claims in Sonus' U.S. Patent No. 5,558,094 (`094) are allowable by the agency. According to the PTO correspondence, none of the original `094 patent claims which Sonus had asserted against MBI will be allowed by the PTO without amendment. The PTO has also indicated that certain claims of Sonus' U.S. Patent 5,573,751 (`751) are allowable by the agency. According to the PTO correspondence, certain of the `751 patent claims which Sonus has asserted against the Company will be allowed in their original form. In January 1999, the PTO issued reexamination certificates for the `094 and `751 patents.
In August 1998, the PTO issued a final rejection of all relevant claims of the Nycomed patent involved in the MBI Case. If the PTO rejection is maintained on any appeal subsequently filed by Nycomed, the patent Nycomed is attempting to assert against the Company and Mallinckrodt to block the manufacture and sale of OPTISON will be invalidated.
In May and June 1999, the Company received correspondence from the PTO with respect to the ImaRx patents involved in the reexamination proceedings. The PTO indicated that all claims of U.S. Patent No. 5,547,656 (`656) and U.S. Patent No. 5,527,521(`521) will be allowed in their original form.
On May 5, 1999, the Company and Mallinckrodt announced that the two companies received notice of a lawsuit filed against them by DuPont Pharmaceuticals Company ("DuPont) and ImaRx in the United States District Court for the District of Delaware (the "DuPont Case"). The lawsuit alleges that the manufacture and sale of OPTISON infringes the `656 patent owned by ImaRx and exclusively licensed to DuPont. MBI counterclaimed for a declaration of invalidity and non-infringement with respect to the `656 patent. In June 1999, DuPont and ImaRx amended their complaint in the DuPont Case to add allegations that the manufacture and sale of OPTISON also infringes the `521 patent owned by ImaRx and exclusively licensed to DuPont.
Litigation or administrative proceedings relating to these matters could result in a substantial cost to the Company; and given the complexity of the legal and factual issues, the inherent vicissitudes and uncertainty of litigation, and other factors, there can be no assurance of a favorable outcome. An unfavorable outcome could have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, there can be no assurance that, in the event of an unfavorable outcome, the Company would be able to obtain a license to any proprietary rights that may be necessary to commercialize OPTISON, either on acceptable terms or at all. If the Company were required to obtain a license necessary to commercialize OPTISON, the Company's failure or inability to do so would have a material adverse effect on the Company's business, financial condition and results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information concerning the names, ages and titles of the Company's executive officers as of the date of this report, is included in accordance with General Instruction G(3) of Form 10-K:
BOBBA VENKATADRI has served as the Company's President and Chief Executive Officer since May 1997. He served as the Company's President and Chief Operating Officer from October 1995 until May 1997. Mr. Venkatadri served as Executive Vice President of the Pharmaceutical Division of Centocor, Inc., from September 1992 until he joined the Company, and as Vice President - Operations of Centocor's Pharmaceutical Division from March 1992 to September 1992. He was employed by Warner-Lambert Company from 1967 until February 1992, most recently serving as Senior Director, Pharmaceutical Operations, at its manufacturing facility in Vegabaja, Puerto Rico.
HOWARD DITTRICH, M.D., has served as the Company's Executive Vice President since December 1998. He served as the Company's Vice President - Research/Medical & Regulatory Affairs from November 1996 to December 1998 and as Executive Director of Medical Affairs from May 1996 to November 1996. He served as a consultant to the Company from
1989 to 1996. Dr. Dittrich was a full-time faculty member of the University of California, San Diego, Department of Medicine from 1984 to May 1996. Currently, Dr. Dittrich practices part-time with the University of California, San Diego where he holds an appointment as Clinical Professor of Medicine.
JONI HARVEY has served as Vice President - Operations since April 1998. She served as the Company's Executive Director of Operations from November 1996 to April 1998. From September 1995 to November 1996, she served as Director of Manufacturing. Ms. Harvey served with Genzyme from February 1995 until rejoining the Company in September 1995. From March 1994 to January 1995, Ms. Harvey was Associate Director of Manufacturing for the Company. She originally joined the Company in October 1988 as Manager of Manufacturing. From 1980 until October 1988, Ms. Harvey held various supervisory positions in Quality and Manufacturing with Baxter Healthcare.
ELIZABETH L. HOUGEN has served as the Company's Executive Director, Finance and Chief Financial Officer since January 1999. She served as the Company's Controller from October 1997 until January 1999. She has been employed at MBI since 1992. Ms. Hougen has more than 15 years of experience in finance and accounting in the biomedical, high technology and professional services industries. Ms. Hougen is a certified management accountant and holds an MBA from the University of San Diego.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange under the symbol "MB." As of June 15, 1999, there were approximately 1,654 holders of record of the Company's Common Stock, representing approximately 8,928 beneficial owners. The Company has not paid dividends on its Common Stock. The following table sets forth the quarterly high and low last sale price for a share of the Company's Common Stock for the three fiscal years ended March 31, 1999, 1998, and 1997, respectively, as reported by the New York Stock Exchange.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth above with respect to the Company's consolidated financial statements has been derived from the audited financial statements. The data set forth above should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and related notes included elsewhere in this filing.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(REFERENCES TO YEARS ARE TO THE COMPANY'S FISCAL YEARS ENDED MARCH 31.)
THIS ANNUAL REPORT ON FORM 10-K MAY CONTAIN PREDICTIONS, ESTIMATES AND OTHER FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. THIS OUTLOOK REPRESENTS THE COMPANY'S CURRENT JUDGMENT ON THE FUTURE DIRECTION OF ITS BUSINESS. ANY RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FUTURE PERFORMANCE SUGGESTED BELOW. THE COMPANY UNDERTAKES NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES ARISING AFTER THE DATE OF THIS ANNUAL REPORT.
OVERVIEW
Molecular Biosystems, Inc. ("MBI" or the "Company") is a leader in the development, manufacture and sale of ultrasound contrast imaging agents. These contrast agents are used primarily to improve the real-time images ("moving pictures") of organs and body structures, especially the heart, obtained through ultrasound examinations. The Company has designed its products to increase the diagnostic usefulness of ultrasound examinations through enhanced visualization of structures and vasculature, and to reduce the need for diagnostic procedures that may be more expensive, time-consuming, or invasive.
The Company made key operational changes during fiscal year 1999. First, as fiscal year 1999 was the first full year of OPTISON-Registered Trademark- sales, the Company made a transition from being a product development company to a commercial enterprise. In making this transition and in carefully evaluating cost reduction measures, the Company announced on November 10, 1998 the initiation of a multi-phase program to reduce expenses and preserve capital. This program included plans to out-source the Company's manufacturing process.
In April 1999, the Company and Mallinckrodt, Inc. ("Mallinckrodt") agreed to transfer the manufacture of OPTISON, the only advanced generation cardiac ultrasound imaging agent commercially available in the United States and Europe, from MBI to Mallinckrodt under an amendment to their existing research support and distribution agreement. In addition to the transfer of manufacturing, the amended agreement will extend Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology, clinical trials for OPTISON in the United States. Under the terms of the agreement, MBI will continue to conduct all cardiology trials for OPTISON and will assume responsibility for conducting radiology trials in the United States. The parties agreement will be incorporated into an amendment to ARDA.
Under the terms of the amended agreement, which will be retroactive to March 1, 1999, Mallinckrodt would reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer. In exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI would receive a reduced royalty rate on product sales of OPTISON.
The out-sourcing of the Company's manufacturing process is not only expected to reduce the Company's expenditures, but also to better enable the Company to focus on key research and development opportunities, including other indications of OPTISON and its liver CT, imaging agent, MB-840.
The Company is the first and only company to obtain marketing approval from the United States Food and Drug Administration ("FDA") for ultrasound contrast agents, having gained approvals for ALBUNEX-Registered Trademark- in 1994 and OPTISON (the Company's second-generation agent) in 1997. In May 1998, OPTISON received final marketing authorization by the European Agency for the Evaluation of Medicinal Products ("EMEA") for use in patients with suspected or known cardiovascular disease. The authorization covers all 15 member states of the European Union.
OPTISON is used to detect heart disease by assessing blood flow within the heart chambers and by identifying the location of the chamber borders and the movement of the chamber walls ("cardiac function"). To increase the potential applications of OPTISON, MBI is conducting Phase 2 clinical trials to evaluate the product's efficacy in determining whether the heart muscle is receiving an adequate blood supply ("myocardial perfusion"). The multiple Phase 2 trials include use of OPTISON in the emergency room for patients presenting with chest pain, and in various forms of stress echocardiography. Results using OPTISON in each of these applications suggest a close agreement with nuclear imaging for the detection of ischemia by wall motion and perfusion. Furthermore, the results indicate that use of OPTISON could help to "rescue" a large proportion of uninterpretable non-contrast studies, thereby reducing the need for additional, more expensive and time consuming testing. The Company believes the information regarding perfusion will enable cardiologists to diagnose heart
attacks and coronary artery disease more accurately and safely than is currently feasible. MBI is also conducting Phase 2 clinical studies using OPTISON to detect abnormalities in other organs, such as the liver.
OPTISON is the Company's second generation contrast agent and is a significant improvement over the Company's first generation contrast agent, ALBUNEX, in terms of efficacy. The Company has replaced ALBUNEX with OPTISON. Accordingly, the Company does not foresee any ALBUNEX product sales in the future.
Operating losses may occur for at least the next few years due to continued requirements for research and development including preclinical testing and clinical trials, regulatory activities and the costs of commercializing new products. The magnitude of the losses and the time required by the Company to achieve profitability are highly dependent on the market acceptance of OPTISON and are therefore uncertain. There can be no assurance that the Company will be able to achieve profitability on a sustained basis or at all. Results of operations may vary significantly from quarter to quarter depending on, among other things, the progress, if any, of the Company's research and development efforts, the timing of milestone payments, the timing of certain expenses and the establishment of collaborative research agreements.
REVENUE RECOGNITION
Historically the Company has earned revenues from three primary sources: revenues under collaborative agreements, product revenues and license fee revenues.
REVENUES UNDER COLLABORATIVE AGREEMENTS. Revenues under collaborative agreements have been the primary source of revenues for the Company in the past. They consist of two types of revenues: (i) milestone payments which are earned on the achievement of certain product development and territorial milestones, and (ii) payments received from Mallinckrodt under the Company's Amended and Restated Distribution Agreement ("ARDA") to support clinical trials, regulatory submissions and product development.
PRODUCT AND ROYALTY REVENUES. Product revenues are based upon the Company's sales to Mallinckrodt and are recognized upon shipment of the product. Product revenues in 1997 also included sales to Shionogi & Co., Ltd. ("Shionogi"). The transfer prices for the Company's sales of ALBUNEX to Mallinckrodt and Shionogi were determined under the respective agreements and were approximately equal to 40% of Mallinckrodt's average net sales price to its end users of the product and 30% of Shionogi's net sales to its end users.
For fiscal year 1998 and fiscal year 1999, the transfer price for the Company's sales of OPTISON to Mallinckrodt was approximately equal to 40% of Mallinckrodt's average net sales price to its end users of the product for the immediately preceding quarter. Pursuant to ARDA, the average net sales price to end users is calculated by dividing the net sales for the preceding quarter by the total number of units shipped to end users whether paid for or shipped as samples. Consistent with industry practice, the Company considers samples a marketing expense and as such the cost of samples is recorded as selling, general and administrative expense.
Under the anticipated final terms of the April 1999 agreement with Mallinckrodt, the Company will receive a reduced royalty rate rather than a transfer price on product sales of OPTISON in exchange for the transfer of manufacturing of and increased financial support for clinical trials of OPTISON.
Royalty revenues during fiscal years 1997, 1998 and 1999 were pursuant to a licensing agreement between the Company and Abbott Laboratories.
LICENSE FEES. The Company recognizes license fees at the time of receipt. The Company generally receives license fees in conjunction with the grant of product development, manufacturing, marketing and/or distribution rights to one of the Company's technologies.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 problem is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations, which could disrupt operations, including product development, manufacturing, the processing of transactions and other normal business
activities. The Year 2000 problem may also create unforeseen risks to the Company from its internal computing systems as well as from computer systems of third parties with which it deals.
The Company has conducted a comprehensive review of its information technology ("IT") and non information technology ("Non-IT") systems to identify the systems that could be affected by the "Year 2000" issue and has developed a plan to assess and resolve Year 2000 problems with its IT and Non-IT systems. The plan includes five phases: inventory, assessment, evaluation, implementation and testing. The Company has completed the inventory phase on its IT systems and has identified all IT systems that the Company believes are at risk. The Company is in the process of inventorying its Non-IT systems and expects to have identified all Non-IT systems that are at risk within the next few months.
The Company completed the assessment phase (in which systems that were inventoried are prioritized) for all systems in March 1999. The Company has begun the evaluation phase which involves testing systems and determining which IT and Non IT systems need to be replaced, repaired or retired. The evaluation phase is expected to take approximately 3 months.
Once the evaluation phase is complete, the Company will begin the implementation phase and repair/replace all noncompliant systems (both IT and Non-IT), convert data as necessary, and obtain compliance statements. The implementation phase is expected to take three months to complete. Finally, the Company will test and validate the repaired noncompliant IT and Non-IT systems for compliance. This final phase of the process should take 1-2 months and should be complete by November 1999.
In addition, the Company is in the process of conducting a comprehensive review of its vendors, service providers (including financial institutions and insurance companies), and collaborative partners. Although this assessment is not yet complete, the Company is not currently aware of any material Year 2000 issues with respect to its dealings with such third parties. However, if the Company discovers Year 2000 problems with such third parties' systems, the Company will be unable to control whether its current and future suppliers', service providers' or collaborative partners' systems are Year 2000 compliant. To the extent that such third parties would be hindered by Year 2000 problems, the Company's operations could be materially adversely affected.
The Company anticipates that its assessment of both internal and third party IT and Non-IT systems will be complete by November 1999. At this time, the Company believes that the Year 2000 problem will not pose significant operational problems for the Company's computer systems. The Company also expects that the total costs required to fix the Year 2000 problem will not be material. To date, the Company has not used, and does not plan to use, any independent verification and validation process to assess the reliability of the Company's risk and cost estimates. Since no significant issues have arisen, the Company does not have a contingency plan to address any material Year 2000 issues. If significant Year 2000 issues arise, the Company may not be able to timely develop and implement a contingency plan and the Company's operations could be adversely affected.
RESULTS OF OPERATIONS
FISCAL YEAR 1999 COMPARED TO FISCAL YEAR 1998. Revenues under collaborative agreements were $5.5 million for the fiscal year ended March 31, 1999, compared to $5.1 million for the fiscal year ended March 31, 1998. This increase is primarily due to an increase in the quarterly payments from Mallinckrodt to $1.5 million for the last two quarters in fiscal year 1999 over $1.25 million in the prior year. These revenues in both years consist of quarterly payments to support clinical trials, regulatory submissions and product development received from Mallinckrodt under ARDA.
Product and royalty revenues were $4.1 million for fiscal year 1999, compared to $1.2 million for the prior year. Product revenues in the current year are based on the Company's sales to Mallinckrodt and are recognized upon shipment of the product. The increase in product revenues for fiscal year 1999 as compared to 1998 results primarily from sales of OPTISON to Mallinckrodt which were launched in the fourth quarter of fiscal year 1998. Royalty revenues are pursuant to a license agreement between the Company and Abbott Laboratories.
License fees were $16.4 million in fiscal year 1999 compared to none in fiscal year 1998. These revenues consist of payments from Chugai Pharmaceutical Co. of Japan pursuant to a strategic alliance which covers Japan, Taiwan and South Korea to develop OPTISON and ORALEX. The Company granted Chugai an exclusive license to develop, manufacture and market these products in exchange for an up-front license fee of $14.0 million plus additional future royalties on net sales. In addition, Chugai purchased 691,883 shares of the Company's common stock at a premium of 40% to the then-prevailing market price. This premium was equal to $2.4 million and was recognized as license revenue.
Costs of products sold totaled $7.8 million for fiscal year 1999, resulting in a negative gross profit margin. This negative gross profit margin was due to the fact that the low levels of production were insufficient to cover the Company's fixed manufacturing overhead expenses. For fiscal year 1998, costs of products sold totaled $5.8 million. The increase over the prior year is primarily due to two factors. First, the Company sold OPTISON throughout the entire fiscal year 1999 as compared to only during the fourth quarter of fiscal year 1998. Second, $1.1 million in inventories were expensed through cost of sales as a result of the planned out-sourcing of manufacturing. The Company anticipates an increase in gross profit margins if and when OPTISON sales volumes increase as OPTISON obtains market acceptance and when the manufacturing process is out-sourced pursuant to the anticipated terms of the April 1999 agreement with Mallinckrodt. During fiscal 1999, manufacturing fixed costs were running at an annual rate of approximately $4.5 million.
The Company's research and development costs totaled $9.1 million for fiscal year 1999 as compared to $11.1 million for fiscal year 1998. The decrease of 18% is due to previously announced cost reduction measures.
Selling, general and administrative expenses totaled $14.2 million in fiscal year 1999 as compared to $11.9 million in fiscal year 1998. This increase of 19% is primarily due to continuing legal expenses, marketing costs associated with the launch of OPTISON, and severance costs. Additionally, a portion of the increase is due to a licensing agreement between the Company and Schering AG ("Schering") in which the Company licensed rights to certain Schering patents.
During fiscal year 1999, the Company incurred nonrecurring charges of $15.5 million. These nonrecurring charges include $8.5 million related to the sale to Chugai of territory rights previously reacquired from Shionogi and $6.1 million of cost reduction measures. The $6.1 million of cost reduction measures included $3.1 million for the write off of fixed assets, capitalized license fees and capitalized patent costs that will no longer be used by the Company as a result of the planned out-sourcing of manufacturing operations and the discontinuation of certain projects, $2.3 million of severance costs, and approximately $700,000 of technology transfer costs and other costs related to the Company's plan to out-source manufacturing. As part of the cost reduction measures, the Company consolidated facilities and no longer occupies the 30,097 square-foot leased facility that had become its corporate headquarters in fiscal year 1998.
Interest expense for fiscal years 1999 and 1998 amounted to $574,000 and $721,000, respectively. Interest expense consists of mortgage interest on the Company's manufacturing building and interest related to a note payable, secured by the tangible assets of the Company, which bears interest at the prime rate and is payable in monthly installments of principal plus interest over five years. The interest rate on the note was 7.75% in March 1999. In September 1998, the Company renegotiated its note payable to reduce the interest rate from prime plus one to the prime rate and to release compensating balance requirements.
Interest income for fiscal year 1999 was $1.4 million compared to $2.0 million in fiscal year 1998. This decrease is due to lower average cash balances and marketable securities balances.
No tax benefit has been recognized for fiscal years 1999 or 1998 as the Company had fully utilized its operating loss carryback ability in 1993. As of March 31, 1999, the Company had federal and state operating loss carryforwards of approximately $121 million and $38.9 million, respectively. Realization of future tax benefits from utilization of net operating loss carryforwards is uncertain.
FISCAL YEAR 1998 COMPARED TO FISCAL YEAR 1997. Revenues under collaborative agreements were $5.1 million for the fiscal year ended March 31, 1998, compared to $4.5 million for the fiscal year ended March 31, 1997. This increase was primarily due to an increase in the quarterly payments from Mallinckrodt to $1.25 million over $1.0 million in the prior year's first two quarters. These revenues in both years consisted of quarterly payments to support clinical trials, regulatory submissions and product development received from Mallinckrodt under ARDA.
Product and royalty revenues were $1.2 million for fiscal year 1998, compared to $626,000 for fiscal year 1997. Product revenues in fiscal year 1998 were based on the Company's sales to Mallinckrodt and were recognized upon shipment of the product. Product revenues in fiscal year 1997 also included sales to Shionogi, also recognized upon shipment of the product. The increase in product revenues for fiscal year 1998 as compared to fiscal year 1997 resulted primarily from the market introduction of OPTISON in the fourth quarter which added revenues of approximately $700,000. Royalty revenues were pursuant to a license agreement between the Company and Abbott Laboratories.
There were no license fees in fiscal year 1998 compared to $5.7 million in fiscal year 1997. The revenues in fiscal year 1997 consist of payments from Mallinckrodt pursuant to an amendment to ARDA that the Company entered into with Mallinckrodt in December 1996. The amendment extended Mallinckrodt's exclusive territory to include the territory that the
Company had formerly licensed to Nycomed Imaging AS ("Nycomed") consisting of Europe, Africa, India and parts of Asia.
Costs of products sold totaled $5.8 million for fiscal year 1998, resulting in a negative gross profit margin. This negative gross profit margin was due to the fact that low levels of production were insufficient to cover the Company's fixed manufacturing overhead expenses. For fiscal year 1997, costs of products sold totaled $4.7 million.
The Company's research and development costs totaled $11.1 million for fiscal year 1998 as compared to $9.9 million for fiscal year 1997. The increase of 12% was due to additional research and development costs associated with the Company's product development efforts.
Selling, general and administrative expenses totaled $11.9 million in fiscal year 1998 as compared to $8.1 million in fiscal year 1997. This increase of 47% was primarily due to increased legal expenses.
During fiscal year 1998, the Company did not incur any nonrecurring charges compared to $3 million in nonrecurring charges for fiscal year 1997 related to the reacquisition of license rights from Nycomed.
Interest expense for fiscal years 1998 and 1997 amounted to $721,000 and $810,000, respectively. Interest expense consisted of mortgage interest on the Company's manufacturing building and interest related to a note payable, secured by the tangible assets of the Company, which bore interest at the prime rate plus 1% and was payable in monthly installments of principal plus interest over five years. The interest rate on the note was 9.5% in March 1998.
Interest income for fiscal year 1998 was $2.0 million compared to $2.4 million in fiscal year 1997. This decrease was due to lower average cash balances and marketable securities balances.
No tax benefit was recognized for fiscal years 1998 or 1997 as the Company had fully utilized its operating loss carryback ability in 1993. As of March 31, 1998, the Company had federal and state operating loss carryforwards of approximately $90.5 million and $27.2 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, the Company had net working capital of $10.7 million compared to $21.1 million at March 31, 1998. Cash, cash equivalents and marketable securities were $18.0 million at March 31, 1999 compared to $21.3 million at March 31, 1998.
For the next several years, the Company expects to incur substantial additional expenditures associated with product development. The Company anticipates that its existing resources, including up-front license fees received from Chugai, and interest thereon, plus payments under its collaborative agreements with Mallinckrodt, will enable the Company to fund its operations for at least the next fifteen months. The Company continually reviews its product development activities in an effort to allocate its resources to those products that the Company believes have the greatest commercial potential. Factors considered by the Company in determining the products to pursue may include, but are not limited to, the projected markets, potential for regulatory approval, technical feasibility and estimated costs to bring the product to the market. Based upon these factors, the Company may from time to time reallocate its resources among its product development activities.
The Company may pursue a number of options to raise additional funds, including borrowings; lease arrangements; collaborative research and development arrangements with pharmaceutical companies; the licensing of product rights to third parties; or additional public and private financing, as capital requirements change as a result of strategic, competitive, technological and regulatory factors. There can be no assurance that funds from these sources will be available on favorable terms, or at all.
During fiscal year 1999, the Company used $11.0 million cash for operating requirements, which was funded primarily by $6.4 million of marketable securities that matured during fiscal 1999 and $8.3 million in net proceeds from the sale of common stock to Chugai. Other significant cash uses included purchases of property and equipment of $791,000, $2.0 million for the reacquisition of license rights from Shionogi and $1.3 million in principal payments on long term debt.
In an agreement dated March 31, 1998, the Company entered into a cooperative development and marketing agreement with Chugai. The parties entered into this strategic alliance which covers Japan, Taiwan and South Korea, to develop
OPTISON (which Chugai may be market under a different name) and ORALEX, as well as related products. The Company granted Chugai an exclusive license to develop, manufacture, and market these products in the subject territory, for which the Company received an upfront license fee of $14.0 million during fiscal year 1999. With respect to licensed products manufactured by Chugai, Chugai will pay the Company a royalty on net sales. For licensed products manufactured by the Company, the Company will receive royalties on net sales, the amount of which will depend upon the sales volume, in addition to a transfer price based on average net sales per unit from the previous quarter. Additionally, Chugai purchased 691,883 shares of the Company's common stock at a premium of 40% over the then-prevailing market price. The equity investment was valued at $8.3 million. The Company is also eligible to receive milestone payments of up to $20.0 million based on Chugai's achievement of certain Japanese product development and regulatory goals.
On September 7, 1995, the Company entered into an Amended and Restated Distribution Agreement ("ARDA") and a related investment agreement with Mallinckrodt which will provide the Company with between $33.0 million and $42.5 million. Under the terms of the agreement, Mallinckrodt is obligated to make payments to the Company totaling $20.0 million over four years to support clinical trials, related regulatory submissions and associated product development of the licensed products, which include, but are not limited to, ALBUNEX and OPTISON. These payments will be made in 16 quarterly installments of $1.0 million for the first four quarters, $1.25 million for the following eight quarters and $1.5 million for the final four quarters. The payments may be accelerated in the event that the Company's cumulative outlays for clinical trials are in excess of the amounts received at any point in time. However, the quarterly payments may not be postponed. The first 14 quarterly payments have been received by the Company as of March 31, 1999.
In April 1999, the Company and Mallinckrodt Inc. entered into an agreement to transfer the manufacture of OPTISON from MBI to Mallinckrodt under an amendment to ARDA. The terms of the agreement also extends Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology, clinical trials for OPTISON in the United States. MBI will continue to conduct all cardiology trials for OPTISON and will assume responsibility for conducting radiology trials in the United States. Under the terms of the agreement, which is retroactive to March 1, 1999, Mallinckrodt will reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer. In exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI will receive a reduced royalty rate on product sales of OPTISON.
In September 1996, the Company entered into an agreement with Shionogi pursuant to which the Company reacquired all rights to manufacture, market and sell its ALBUNEX family of products in the territory, consisting of Japan, Taiwan and South Korea, formerly exclusively licensed to Shionogi. Under the agreement, the Company paid $3.0 million to Shionogi and agreed to pay an additional $5.5 million over the next three years, of which $4.0 million had been paid at March 31, 1999.
Capital expenditures for facilities, laboratory equipment, furniture and fixtures were $791,000, $1.4 million, and $726,000 for fiscal years 1999, 1998 and 1997, respectively. Expenditures in all three fiscal years consisted primarily of building improvements and equipment for aseptic manufacturing facilities being constructed for the manufacture of OPTISON and other products. In June 1997, the Company entered into an equipment leasing agreement with Mellon US Leasing for a lease line of $1.6 million with a term of 48 months. The outstanding balance on this line of credit at March 31, 1999 was $1.0 million.
The Company currently leases one of its facilities in San Diego. The lease requires aggregate payments of approximately $324,000 through February 2000.
The Company invests its excess cash in debt instruments of financial institutions and corporations with strong credit ratings. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.
The Company believes that inflation and changing prices have not had a material effect on operations for fiscal years 1999, 1998 and 1997 and that the impact of government regulation on the Company is not materially different from the impact on other similar enterprises.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants Consolidated Balance Sheets as of March 31, 1998 and 1999 Consolidated Statements of Operations for the Fiscal Years Ended March 31, 1997, 1998 and 1999 Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended March 31, 1997, 1998 and 1999 Consolidated Statements of Cash Flows for the Fiscal Years Ended March 31, 1997, 1998 and 1999 Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Molecular Biosystems, Inc.:
We have audited the accompanying consolidated balance sheets of Molecular Biosystems, Inc. (a Delaware corporation) and subsidiaries as of March 31, 1998 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Molecular Biosystems, Inc. and subsidiaries as of March 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1999, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Diego, California April 30, 1999
MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these consolidated statements.
MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The accompanying notes are an integral part of these consolidated statements.
MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these consolidated statements.
MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these consolidated statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS-
Molecular Biosystems, Inc. ("MBI" or the "Company") discovers, develops and manufactures proprietary diagnostic ultrasound imaging agents. The Company's annual continuing operations have been unprofitable since 1992. The Company believes that operating losses may occur for at least the next several years due to continued requirements for research and development, including preclinical testing and clinical trials, regulatory activities and the high costs of commercialization activities. The magnitude of the losses and the time required by the Company to achieve profitability are highly dependent on the market acceptance of OPTISON-Registered Trademark- and other future products and are therefore uncertain. The Company has replaced its first generation product, ALBUNEX-Registered Trademark-, with OPTISON. There is no assurance that the Company will be able to achieve profitability with sales of OPTISON or other future products on a sustained basis or at all.
PRINCIPLES OF CONSOLIDATION-
The Consolidated Financial Statements include the accounts of Molecular Biosystems, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Certain amounts in the prior years' financial statements and notes have been reclassified to conform with the current year presentation.
USE OF ESTIMATES-
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
RESEARCH AND DEVELOPMENT COSTS-
All research and development costs and related special purpose equipment costs are charged to expense as incurred.
REVENUES UNDER COLLABORATIVE AGREEMENTS-
Revenues under collaborative agreements, which have been the primary source of revenues for the Company, consist of two types of revenues. The first type, milestone payments, is earned in connection with research activities performed under the terms of research and development license agreements. Revenue is recognized on the achievement of certain milestones, some of which relate to obtaining regulatory approvals. Accordingly, the estimated dates of the milestone achievements are subject to revision based on periodic evaluations by the Company and its partners of the attainment of specified milestones, including the status of the regulatory approval process. Advance payments received in excess of amounts earned are classified as deferred contract revenues and the resulting revenues are recognized based on work performed at a predetermined rate or level of expense reimbursement.
Additionally, under the terms of the Amended and Restated Distribution Agreement ("ARDA") entered into in September 1995, as restated in May 1999, Mallinckrodt, Inc. ("Mallinckrodt") will pay the Company $20.0 million over four years to further the development of OPTISON (the Company's second-generation product) and related products. These payments will be made in 16 quarterly installments starting at $1.0 million for the first four quarters, $1.25 million for the following eight quarters and $1.5 million for the final four quarters. Pursuant to the agreement, half of each payment is designated for clinical development expenses and will be recorded as deferred revenue until such expenses are incurred, and the remaining half of each payment will be recognized as research revenue when received.
REVENUE RECOGNITION FOR PRODUCT SOLD-
The Company recognizes revenue when goods are shipped to its customer, Mallinckrodt. For fiscal years 1998 and 1999, the transfer price for the Company's sales of OPTISON to Mallinckrodt was equal to 40% of Mallinckrodt's average net sales price to its end users of the product for the immediately preceding quarter. Pursuant to ARDA, the average net sales price to end users is calculated by dividing the net sales for the preceding quarter by the total number of units shipped to end users whether paid for or shipped as samples. Consistent with industry practice, the Company considers samples a marketing expense and as such the cost of samples is recorded as selling, general and administrative expense.
Under the terms of the May 1999 amended agreement with Mallinckrodt, the Company will receive a receive a reduced royalty rate on product sales of OPTISON in exchange for the transfer of manufacturing of and increased financial support for clinical trials of OPTISON.
REVENUE RECOGNITION FOR LICENSE FEES-
The Company recognizes revenue when license fees are received, provided the Company has no future obligations.
INCOME TAXES-
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting for Income Taxes." SFAS No. 109 is an asset and liability approach that requires the recognition of deferred assets and liabilities for the expected future tax consequences of events that have been recognized differently in the Company's financial statements or tax returns. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
CASH EQUIVALENTS-
Cash equivalents include marketable securities with original maturities of three months or less when acquired. The Company has not realized any losses on its cash equivalents.
MARKETABLE SECURITIES
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company's management has classified its investment securities as available-for-sale and records holding gains or losses as a separate component of stockholders' equity.
CONCENTRATION OF CREDIT RISK-
The Company invests its excess cash in debt instruments of financial institutions and corporations with strong credit ratings. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.
INVENTORIES-
Inventories are stated at lower of cost (first-in, first-out) or market, and consist of the following major classes (in thousands):
Work in process and finished goods include the cost of materials, direct labor and manufacturing overhead.
PROPERTY AND EQUIPMENT-
Property and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method over estimated useful lives of five years for equipment, 31 years for buildings and improvements and the term of the lease for leasehold improvements.
PATENTS AND LICENSE RIGHTS AND OTHER ASSETS-
The Company periodically reevaluates the original assumptions and rationale utilized in the assessment of the carrying value and estimated lives of long-lived assets. The determinants used for this evaluation include management's estimate of the asset's ability to generate positive income and cash flow as well as the strategic significance of the respective assets.
Patents and license rights are amortized on the straight-line method over their estimated useful lives of five to ten years. During fiscal year 1999, the Company reevaluated its patent estate and wrote off approximately $300,000 in capitalized patent and license rights that will no longer be used by the Company as a result of the planned out-sourcing of manufacturing operations and discontinuation of certain products.
In June 1989, the Company prepaid $2.0 million in royalties on the first $66.6 million of sales of ALBUNEX and OPTISON in the United States. Included in other assets at March 31, 1999 is approximately $1.7 million which is the portion of this prepayment which has not yet been expensed. Additionally, other assets at March 31, 1998 and 1999 include $300,000 of real estate investment related to an employment agreement with one of the Company's officers.
IMPAIRMENT OF LONG-LIVED ASSETS-
The Company accounts for long lived assets in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121). The statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.
During fiscal year 1999, the Company wrote off approximately $2.8 million of fixed assets that will no longer be used by the company as a result of the planned out-sourcing of manufacturing operations and discontinuation of certain projects.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES-
Accounts payable and accrued liabilities consist of the following major classes (in thousands):
STOCK BASED COMPENSATION-
The Company has elected to adopt the disclosure only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Accordingly the Company accounts for its stock based compensation plans under the provisions of APB No. 25.
LOSS PER SHARE-
In December 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). The statement specifies the computation, presentation, and disclosure requirements for earnings per share (EPS). SFAS 128 requires companies to compute net income (loss) per share under two different methods, basic and diluted per share data for all periods for which an income statement is presented. Basic earnings per share was computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if net income were divided by the weighted-average number of common shares and potential common shares from outstanding stock options for the period. Potential common shares are calculated using the treasury stock method and represent incremental shares issuable upon exercise of the Company's outstanding options. For the years ended March 31, 1997, 1998, and 1999, the diluted loss per share calculation excludes effects of outstanding stock options as such inclusion would be anti-dilutive.
COMPREHENSIVE LOSS-
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," was issued. The Company has adopted this standard which requires the display of comprehensive income or loss and its components in the financial statements. The Company has chosen to disclose Comprehensive Loss, which encompasses net loss and unrealized gains and losses on available-for-sale securities, in the Consolidated Statements of Stockholders' Equity. Prior years have been restated to conform to the SFAS No. 130 requirements.
2. COST REDUCTION MEASURES
On November 10, 1998, as a result of the slower than planned ramp up of OPTISON sales, the Company announced the initiation of a multi-phase program to reduce expenses and preserve capital. The initial phase of cost reduction affected approximately 40 employees of the Company's 140-person workforce. The next reduction in force, in April 1999, affected an additional 26 employees. The Company will implement a further reduction in force in the future when the out-sourcing of the Company's manufacturing operations is complete.
The impact of the cost reduction measures on the Company's financial results included a one-time charge of $7.2 million for the year ended March 31, 1999. This charge included $6.1 million in nonrecurring charges and $1.1 million in cost of sales. The $6.1 million nonrecurring charge included $3.1 million for the write off of fixed assets, capitalized license fees and capitalized patent costs that will no longer be used by the Company as a result of the planned out-sourcing of manufacturing operations and the discontinuation of certain projects, $2.3 million of severance costs, and approximately $700,000 of technology transfer costs and other costs related to the Company's plan to out-source manufacturing.
Additionally, the Company wrote off $1.2 million in fixed assets through accelerated depreciation during fiscal year 1999 and expects to write off another $1.6 million in fixed assets through accelerated depreciation over the next 12 months as the manufacturing process is out-sourced. As of March 31, 1999, the Company had approximately $1.0 million in accrued liabilities related to the future costs of out-sourcing.
3. THE CHUGAI AGREEMENT
In April, 1998, the Company entered into a cooperative development and marketing agreement with Chugai Pharmaceutical Co., Ltd. ("Chugai") of Japan. The parties entered into this strategic alliance
which covers Japan, Taiwan and South Korea, to develop OPTISON (which may be marketed under a different name) and ORALEX-Registered Trademark-, as well as related products. The Company granted Chugai an exclusive license to develop, manufacture, and market these products in the subject territory, for which the Company received an up-front license fee of $14.0 million in fiscal year 1999. With respect to licensed products manufactured by Chugai, Chugai will pay the Company a royalty on net sales. For licensed products manufactured by the Company, the Company will receive royalties on net sales, the amount of which will depend upon the sales volume, in addition to a transfer price based on average net sales per unit from the previous quarter.
Additionally, Chugai purchased 691,883 shares of the Company's common stock at a premium of 40% over the then-prevailing market price. This premium was equal to $2.4 million and was recognized as revenue in the first quarter of fiscal year 1999. The equity investment was valued at $8.3 million. The Company is also eligible to receive milestone payments of up to $20.0 million based on Chugai's achievement of certain Japanese product development and regulatory goals.
The accompanying consolidated statements of operations incorporate the impact of the Chugai transaction. Proforma unaudited consolidated operating results of the Company for the year ended March 31, 1999, excluding the impact of the Chugai transaction, are summarized below (in thousands, except per share amounts):
4. MARKETABLE SECURITIES
Investments are recorded at estimated fair market value, and consist primarily of treasury securities, government agency securities and corporate obligations. The Company has classified all of its investments as available-for-sale securities. The following table summarizes available-for-sale securities at March 31, 1998 (in thousands):
The following table summarizes available-for-sale securities at March 31, 1999 (in thousands):
There were no gross realized gains or losses on sales of available-for-sale securities for the year ended March 31, 1999.
The amortized cost and estimated fair value of debt and marketable securities at March 31, 1999, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
At March 31, 1998 a $3.0 million certificate of deposit was held as a compensating balance under the Company's debt agreement. In September 1998, this loan was renegotiated and the compensating balance requirement was removed (see note 6). Accordingly, the certificate of deposit was included in the marketable securities balances for the fiscal year March 31, 1999, but not for the fiscal year ended March 31, 1998.
5. INCOME TAXES
As described in Note 1, the Company uses the asset and liability method of computing deferred income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes."
The effective income tax rate on the loss before income taxes differs from the statutory U.S. federal income tax rate as follows (in thousands):
At March 31, 1999, the Company has deferred tax assets of approximately $48.9 million relating to the following tax loss carryforwards for income tax purposes (in thousands):
For financial reporting purposes, a valuation allowance has been recognized to offset the deferred tax assets related to the carryforwards. If realized, approximately $1.1 million of the tax benefit for those items will be applied directly to paid-in capital, related to deductible expenses reported as a reduction of the proceeds from issuing common stock in connection with the exercise of stock options.
The foreign income tax provision of $1.4 million included in the Company's fiscal 1999 net loss represents foreign taxes paid during the year related to the Chugai transaction.
6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
The note payable due in 2004 bears interest at a variable rate based upon the weighted average Eleventh District cost of funds plus 2.35 percent. The interest rate on this note is adjusted semi-annually and was 8 percent at March 31, 1998 and 1999. The note is secured by the Company's manufacturing facility and certain of the equipment contained therein and is payable in monthly installments of principal and interest. As of March 31, 1999, maturities of this note in each of the next five fiscal years are: $79,000, $85,000, $92,000, $100,000 and $3,326,000.
The note payable due in April, 2001 bears interest at the prime rate (7.75 percent at March 31, 1999) and is payable in monthly installments of $100,000 plus accrued interest. The loan contains covenants relating to cashflow coverage and minimum cash balances. In September 1998, the terms of the loan were renegotiated which lowered the interest rate from prime plus one percent to the prime rate and released a compensating balance requirement. The loan is secured by the tangible assets of the Company.
7. COMMITMENTS AND CONTINGENCIES
LEASES
The Company conducts certain of its operations in leased premises and also leases equipment through lease financing. Terms of the leases, including renewal options, vary by lease. Future minimum rental commitments for all noncancelable operating leases that have initial or remaining lease terms in excess of one year are as follows (in thousands):
In fiscal 1998, the Company entered into a lease for its corporate headquarters. The lease expires in February 2000. The Company is obligated to pay real estate taxes, insurance and utilities on its portion of the leased property. Rental expense for the years ended March 31, 1997, 1998 and 1999 was $194,000, $245,000, and $297,000, respectively. As part of the cost reduction measures implemented in fiscal year 1999, the Company consolidated facilities and no longer occupies the building that had become its corporate headquarters in fiscal year 1998. As a result of this move, the Company recognized approximately $370,000 of the remaining rent expense through the end of the lease term as other nonrecurring charges in fiscal year 1999. However, because the Company has not yet paid rent for the period April 1999 through February 2000, the remaining lease payments are included in the schedule above.
In June 1997, the Company entered into an equipment leasing agreement with Mellon US Leasing ("Mellon") for a lease line of $1.6 million with a term of 48 months. The outstanding balance on this line of credit at March 31, 1999 was $1.0 million.
LICENSE AGREEMENTS
The Company has entered into license agreements requiring future royalty payments ranging from 1 1/4% to 3% of specified product sales relating to the licensed technologies. Additionally, there is a minimum royalty payment of $600,000 due to one licensor in each calendar year.
In April 1998, the Company and Chugai Pharmaceutical Co., Ltd. ("Chugai") entered into a strategic alliance to develop and commercialize OPTISON (which may be marketed under a different name) and ORALEX-Registered Trademark- in Japan, Taiwan and South Korea. In exchange for granting to Chugai a royalty-based license to market these products in the named countries, MBI received an upfront license fee from Chugai of $14.0 million. In addition, Chugai made an equity investment in MBI common stock. MBI is eligible to receive milestone payments of up to $20.0 million based on the achievement of certain product development goals and will receive royalties from Chugai from the sale of commercialized products in the territory.
PATENT MATTERS
The Company considers the protection of its proprietary technologies to be material to its business prospects. The Company pursues a comprehensive program of patent and trademark prosecution for its products both in the United States and in other countries where the Company believes that significant market opportunities exist.
The Company has an exclusive license to certain United States and foreign patents relating to gas-filled sonicated albumin microspheres from Steven B. Feinstein, M.D. (see - Business - Marketing and Licensing Agreements - Feinstein License) The Company itself owns additional United States and foreign patents covering ALBUNEX and OPTISON that broaden the product coverage of its license. Certain of these additional patents cover the Company's continuous flow sonication manufacturing process. The European equivalents of these manufacturing patents were challenged in an opposition proceeding brought by Andaris Ltd. which was decided in the Company's favor in January 1996. Andaris has appealed the decision. Andaris has also filed an opposition against the Company's ALBUNEX composition patent in Europe, and Andaris and two other parties have filed a similar opposition in Japan. No hearing date has been set in these latter two oppositions.
The Company has received patents covering its method of manufacturing gas-filled albumin microspheres using a milling process. The Company believes that this process may be more reliable and efficient than the sonication process that the Company currently uses. The Company has also received patents on other perfluorocarbon-based technology relating to ultrasound contrast agents.
The Company owns a United States patent covering ORALEX and has several foreign applications pending. The Company has also filed patent applications relating to several early-stage development products. The Company is uncertain whether these applications will result in issued patents or whether the covered products can or will be commercialized.
The last-to-expire of the Company's key United States patents covering ALBUNEX and OPTISON expires in 2008, and subject to the outcome of the oppositions previously described, the last-to-expire of the Company's key European patents covering ALBUNEX and OPTISON expires in 2009.
The patent position of medical and pharmaceutical companies is highly uncertain and involves complex legal and factual questions. There can be no assurance that the Company will receive patents for all or any of the claims included in its pending or future patent applications, that any issued patents will provide the Company with competitive advantages or will not be challenged by third parties, or that existing or future patents of third parties will not have an adverse effect on the Company's ability to commercialize its products. Moreover, there can be no assurance that third parties will not independently develop similar products, duplicate one or more of the Company's products or design around the Company's patents.
The Company's commercial success also will depend in part upon the Company not infringing patents issued to third parties. There can be no assurance that patents issued to third parties will not require the Company to alter its products or manufacturing processes, pay licensing fees, or cease development of its current or future products.
Litigation or administrative proceedings may be necessary to enforce the Company's patents, to defend the Company against infringement claims or to determine the priority, scope and validity of the
proprietary rights of third parties. Any such litigation or administrative proceedings could result in substantial costs to the Company, and an unfavorable outcome could have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, there can be no assurance that, in the event of an unfavorable outcome in any litigation or administrative proceedings involving infringement claims against the Company, the Company would be able to license any proprietary rights that it requires on acceptable terms or at all. The Company's failure to obtain a license that it requires to commercialize one of its products could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company has become aware of several United States patents issued to other companies purportedly covering various attributes of perfluorocarbon-containing imaging agents such as OPTISON. Certain of these companies also are pursuing foreign patent protection. Some of these companies are developing or may be developing ultrasound contrast imaging agents that would compete with OPTISON. The patents and patent applications of these other companies involve a number of complex legal and factual issues that are currently unresolved. The Company believes that there may be a substantial overlap among many of the claims in their patents and is currently involved in various administrative proceedings and litigation in the United States and Europe to adjudicate their conflicting rights.
The Company believes that, for a variety of reasons, its commercialization of OPTISON will not infringe any valid patent held by any of these other companies. Depending upon the particular patent claim, these reasons include, but are not limited to, (i) differences between OPTISON and the subject of the claim, (ii) the invalidity of the claim due to the existence of prior art, (iii) the inadequacy of the claim's specifications, (iv) lack of enablement, (v) inequitable conduct by patentee, and (vi) various other defenses as allowed by law. The Company intends to challenge the validity of any such patent granted to one of the other companies if the patent is asserted against the Company, and the Company will enforce its own patents if any product of one of the other companies infringes the Company's patent claims.
The Company has obtained registered trademarks for "ALBUNEX" and "ORALEX" in the United States and in selected foreign countries. Additionally Mallinckrodt has filed for the trademark for "OPTISON" in various countries throughout the world. There can be no assurance that the Company's registered or unregistered trademarks and trade names will not infringe on the proprietary rights of third parties.
The Company also relies on unpatented trade secrets, proprietary know-how and continuing technological innovation which it seeks to protect by, in part, confidentiality agreements with its employees, consultants, investigators and others. There can be no assurance that these agreements will not be breached, that the Company would have an adequate remedy for any breach or that the Company's trade secrets or know-how will not otherwise become known or independently discovered by third parties.
OTHER
The Company is periodically a defendant in other legal actions incidental to its business activities. While any litigation has an element of uncertainty, the Company believes that the outcome of any of these actions or all of them combined will not have a materially adverse effect on its financial condition or results of operations.
8. STOCKHOLDERS' EQUITY
Mallinckrodt has certain registration rights with respect to the Common Stock issued and issuable to them.
In April 1998, the Company entered into a Common Stock Purchase Agreement with Chugai. Under this agreement, the Company sold to Chugai 691,883 shares of common stock for $12.00 per share which represented a 40% premium over the then-prevailing market price for a total equity investment
of $8.3 million. These shares are subject to certain covenants and restrictions, including "standstill" rights of the Company, a market stand-off provision and restrictions on transferability.
COMMON SHARES RESERVED
Common shares were reserved for the following purposes (in thousands):
STOCK OPTIONS-
1998 PLAN
In fiscal 1999, the Board of Directors and the shareholders of the Company approved the 1998 Stock Option Plan as the sucessor to the Company's 1993 and 1997 Plans. All outstanding options under the 1993 and 1997 Plans were incorporated into the 1998 Plan plus an additional 2.0 million shares. The 1998 Plan provides for the grant of both qualified incentive stock options and nonstatutory stock options to purchase Common Stock to employees, non-employee directors, independent consultants and advisors of the Company under four separate equity incentive programs. The exercise price per share may be either 85% of the fair value on the date of grant or fair market value of the stock on date of grant depending on the program. Options granted under this plan are exercisable per the terms specified in each individual option, but not before one year (unless the option exercisability is accelerated by the Company's Board of Directors), or later than ten years from the date of grant.
1997 OUTSIDE DIRECTORS' PLAN
In fiscal 1998, the Board of Directors and the shareholders of the Company approved the 1997 Directors' Option Plan and authorized the issuance of options for 300,000 shares pursuant to the plan. The Plan provides for the grant of both qualified incentive stock options and nonstatutory stock options to purchase common stock to non-employee directors of the Company at no less than the fair value of the stock on the date of grant. Options granted under this plan are exercisable per the terms specified in each individual option, but not before one year (unless the option exercisability is accelerated by the Company's Board of Directors), or later than ten years from the date of grant.
1993 PLANS
In 1993 both the Board of Directors and the shareholders of the Company approved the 1993 Stock Option Plan and the 1993 Outside Directors Stock Option Plan (together, the 1993 Plans). The 1993 Plans were intended to replace the Company's 1984 Incentive Stock Option Plan and the 1984 Nonstatutory Stock Option Plan (together, the 1984 Plan), under which all of the options authorized to be granted have been granted. The 1993 Plans provide for the grant of both qualified incentive stock options and nonstatutory stock options to purchase Common Stock to employees (1993 Stock Option Plan) or non-employee directors of the Company (1993 Outside Directors Stock Option Plan) at no less than the fair value of the stock on the date of grant. Options granted under these plans are exercisable per the terms specified in each individual option, but not before one year (unless the option exercisability is accelerated by the Company's Board of Directors), or later than ten years from the date of grant.
During fiscal 1997, the shareholders approved the Company's Board of Directors recommendation to amend the Company's 1993 Stock Option Plan to increase the maximum number of shares from 2,500,000 shares to 3,250,000 shares.
1984 PLAN
The Company had an Incentive Stock Option Plan and Nonstatutory Stock Option Plan (together, the 1984 Plan) which provided for the grant of options to purchase Common Stock to employees or non-employee directors of the Company at no less than the fair value of the stock on the date of grant. Options granted under the 1984 Plan were exercisable per the terms specified in each individual option, but not before one year (unless the option exercisability was accelerated by the Company's Board of Directors) or later than five years from the date of grant. The 1984 Plan expired in July 1994 and there are no shares reserved for future grants.
On May 11, 1995, the Board of Directors voted to offer the Company's non-executive employees the opportunity to reprice certain stock options which were originally granted under the 1984 Plan to the closing price on May 31, 1995. The Board approved this repricing because it believed retaining key employees was in the best interests of the stockholders and the Company. During the fourth quarter of fiscal 1995, following a decline in the stock price and a restructuring which included a twenty-five percent staff reduction, key employees were being contacted by other companies and agencies about employment opportunities elsewhere. The Board believed the repricing of the options was the most effective employment retention tool available.
OTHER OPTION GRANTS
The Company has granted to employees, consultants and scientific advisors options to purchase shares of common stock. These options are exercisable per the terms specified in each individual option and lapse pursuant to the terms in the applicable plan. The options were granted at amounts per share which were not less than the fair market value at the date of grant.
Additional information with respect to the Company's option plans is as follows:
The following table summarizes information about fixed stock options outstanding at March 31, 1999:
As permitted, the Company has adopted the disclosure only provisions of SFAS 123 effective April 1, 1996. Accordingly, no compensation expense has been recognized for the stock option plans. Had compensation cost for the Company's 1999 grants for stock-based compensation plans been determined consistent with SFAS 123, the Company's net loss, net loss applicable to common share owners, and net loss per common share for March 31, 1997, 1998 and 1999 would approximate the pro forma amounts below (in thousands, except per share amounts).
Because the SFAS 123 method of accounting has not been applied to options granted prior to April 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. The fair value of each option grant was estimated on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions used for grants in fiscal year 1999: risk free rate of 4.75%, expected option life of 4 years, expected volatility of 65% and a dividend rate of zero. The weighted average fair value of options granted from the Employee stock option plans during fiscal 1997, 1998 and 1999 was $9.29, $7.85 and $5.43, respectively. The weighted average fair value of options granted from the Outside Director stock option plan during fiscal 1997 and 1998 was $6.88 and $9.19, respectively.
NOTES RECEIVABLE FROM SALE OF COMMON STOCK-
During fiscal year 1997, the Company repurchased 21,500 shares of Common Stock and forgave notes receivable from related parties of approximately $390,000 relating to the exercise of options to purchase common stock of the Company by officers and other employees. Of this amount, approximately $109,000 was included in accounts and notes receivable and represents taxes payable by the individuals at the time of these option exercises plus accrued interest thereon, as well as accrued interest on purchase price notes. The amounts relating to the purchase price of the common stock are recorded as a reduction to stockholders' equity.
9. SIGNIFICANT RESEARCH CONTRACTS
The Company conducts all of its research and development activities on its own behalf. Under the terms of its collaborative research agreements, the Company retains all ownership rights to its proprietary technologies, subject to licensing arrangements made with its licensees.
In December 1987, December 1988 and March 1989, the Company entered into respective agreements (the Original Agreements) with Nycomed A.S. (Nycomed), a Norwegian corporation, Mallinckrodt, Inc. (Mallinckrodt), of St. Louis, Missouri and Shionogi & Co., Ltd. (Shionogi), a Japanese
corporation, under which the Company granted exclusive licenses, restricted to certain geographic areas, to test, evaluate, develop and sell products covered by specified patents of the Company relating directly to the design, manufacture or use of microspheres for ultrasound imaging in vascular applications. The Company also granted rights to sublicense, use, make and sell the licensed products under specified royalty arrangements.
Under the terms of the Original Agreements, as amended, the Company earned and received license fees of $6.5 million. The Original Agreements also provide for total payments to the Company aggregating up to $66.5 million, to continue product development, clinical trials, preproduction and premarketing activities relating to the Company's ultrasound imaging contrast agents for vascular applications. These amounts are to be received in installments based on the achievement of certain milestones by the Company.
In September 1995, the Company entered into an Amended and Restated Distribution Agreement ("ARDA"), as well as a related investment agreement, with Mallinckrodt. Under ARDA, the geographical scope of Mallinckrodt's exclusive right was expanded to include all of the countries of the world other than those covered by the Company's license agreements with Shionogi and Nycomed. Additionally, the duration of Mallinckrodt's exclusive right was also extended from October 1999 until the later of July 1, 2003 or three years after the date that the Company obtains approval from the United States Food and Drug Administration ("FDA") to market OPTISON for an intravenous myocardial perfusion indication.
The agreement provides the Company with between $33.0 million and $42.5 million in financing (including the $13.0 million common stock investment discussed below). Under the terms of the agreement, Mallinckrodt must make guaranteed payments to the Company totaling $20.0 million over four years to support clinical trials, related regulatory submissions and associated product development of the licensed products, which include but are not limited to ALBUNEX and OPTISON. These payments will be made in 16 quarterly installments of $1.0 million for the first four quarters, $1.25 million for the following eight quarters and $1.5 million for the final four quarters. The payments may be accelerated in the event that the Company's cumulative outlays for clinical trials are in excess of the amounts received at any point in time. However, the quarterly payments may not be postponed. As of March 31, 1999 the first 14 quarterly payments had been received by the Company.
ARDA requires the Company to spend at least $10.0 million of the $20.0 million it receives over four years on clinical trials to support regulatory filings with the FDA for cardiac indications of the licensed products. The Company's expenditure of this $10.0 million will be made in accordance with the directions of a joint steering committee which the Company and Mallinckrodt established in order to expedite the development and regulatory approval of OPTISON by enabling the parties to share their expertise relating to clinical trials and the regulatory approval process. The Company and Mallinckrodt have each appointed three of the six members of the joint steering committee.
In connection with ARDA, the Company also entered into an investment agreement whereby the Company sold 1,118,761 unregistered shares of its common stock to Mallinckrodt for $13.0 million, or a price of $11.62 per share before related costs. Combined with the 181,818 shares of the Company's common stock that Mallinckrodt acquired in December 1988, Mallinckrodt currently owns approximately 7.3% of the Company's issued and outstanding shares.
In addition, ARDA grants the Company the option (at its own discretion) to repurchase all of the shares of the Company's common stock that Mallinckrodt purchased under the investment agreement for $45.0 million, subject to various price adjustments. This option is exercisable beginning the later of July 1, 2000 or the date that the Company obtains approval from the FDA to market OPTISON for an intravenous myocardial perfusion indication and ending on the later of June 30, 2003 or three years after the date that the Company obtains approval from the FDA to market OPTISON for an intravenous myocardial perfusion. If the Company exercises this option, the Company may co-market ALBUNEX, OPTISON and related products in all of the countries covered by the amended distribution agreement.
In December 1996, the Company and Mallinckrodt amended ARDA to expand the geographical scope of Mallinckrodt's exclusive marketing and distribution rights for ALBUNEX, OPTISON and related products. The amendment extended Mallinckrodt's exclusive territory to include the territory that the
Company had formerly licensed to Nycomed consisting of Europe, Africa, India and parts of Asia. Under the amendment to ARDA, Mallinckrodt agreed to pay fees up to $12.9 million plus 40 percent of product sales to cover royalties and manufacturing. Mallinckrodt made an initial payment of $7.1 million, consisting of reimbursement to the Company of $2.7 million that the Company paid to Nycomed to reacquire the exclusive product rights in Nycomed's territory, payment of $3.0 million to the Company under the terms of ARDA upon the extension of Mallinckrodt's exclusive rights to Nycomed's former territory, and payment of $1.4 million to Nycomed in satisfaction of the Company's obligation to pay 45 percent of any amounts that the Company receives in excess of $2.7 million upon the licensing of the former Nycomed territory to a third party. Of the remaining $5.8 million that may be paid, Mallinckrodt will pay $4.0 million to the Company (upon the achievement of the specified product development milestone) and $1.8 million to Nycomed (representing 45% of the $4.0 million payment to the Company). There can be no assurance, however, that this milestone will be satisfied. The Company has included all costs related to the reacquisition of its license rights from Nycomed in other nonrecurring charges in the financial statements. Of these costs, approximately $1.0 million was paid in fiscal 1996 and the remainder was paid in fiscal 1997.
In April 1999, the Company and Mallinckrodt agreed to transfer the manufacture of OPTISON from MBI to Mallinckrodt. The parties agreement will be incorporated into an amendment to ARDA. In addition to the transfer of manufacturing, the amended agreement will extend Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology, clinical trials for OPTISON in the United States. MBI will continue to conduct all cardiology trials for OPTISON and will assume responsibility for conducting radiology trials in the United States. Under the amended agreement, which will be retroactive to March 1, 1999, Mallinckrodt will reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer. In exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI will receive a reduced royalty rate on product sales of OPTISON.
Mallinckrodt is the Company's principal strategic marketing partner for its ALBUNEX and OPTISON ultrasound contrast agents for all areas of the world except Japan, Taiwan and South Korea, which are exclusively licensed to Chugai. Under the Company's arrangements with Mallinckrodt, Mallinckrodt has substantial control over all aspects of marketing the Company's product in its territories.
In October 1995, the Company entered into an agreement whereby it reacquired all rights to INFOSON (the European designation for ALBUNEX), OPTISON and related products from Nycomed, the Company's European licensee. The Company agreed to pay Nycomed $2.7 million and 45% of any amounts in excess of $2.7 million that the Company receives in payment for the transfer of marketing rights in the former Nycomed territory to a third party. The Company also agreed to pay Nycomed a royalty based on future sales, as defined in the agreement. As stated above, the license rights were resold to Mallinckrodt for amounts stipulated in the amendment to ARDA.
In September 1996, the Company entered into an agreement with Shionogi pursuant to which the Company reacquired all rights to manufacture, market and sell its ALBUNEX family of products in the territory consisting of Japan, Taiwan and South Korea, formerly exclusively licensed to Shionogi. This agreement settled an outstanding dispute between the two companies concerning the license and distribution agreement for ALBUNEX and resulted in the dismissal of all claims raised by the companies against each other. Under the agreement, the Company paid $3.0 million to Shionogi and agreed to pay an additional $5.5 million over the next three years, of which $4.0 million had been paid at March 31, 1999.
In April 1998, the Company and Chugai entered into a strategic alliance to develop and commercialize OPTISON (which may be marketed under a different name) and ORALEX in Japan, Taiwan and South Korea. In exchange for granting to Chugai a royalty-based license to market these products in the named countries, MBI received an upfront license fee from Chugai of $14.0 million. In addition, Chugai made an equity investment in the Company's common stock. The Company is eligible to receive milestone payments of up to $20 million based on the achievement of certain product development goals and will receive royalties from Chugai from the sale of commercialized products in the territory.
During the years ended March 31, 1997, 1998 and 1999, the Company received contract research payments and earned revenue under the above agreements as follows (in thousands):
10. OTHER NONRECURRING CHARGES
Other nonrecurring charges include the following for the years presented:
As a result of slower than planned OPTISON sales, the Company initiated a cost reduction plan in fiscal 1999 to reduce expenses and preserve capital. The impact of the cost reduction measures, out-sourcing of the Company's manufacturing operations and discontinuation of certain projects resulted in a one-time charge of $6.1 million. The Company wrote off $1.2 million in fixed assets through accelerated depreciation during fiscal year 1999 and expects to write-off another $1.6 million in fixed assets through accelerated depreciation over the next 12 months as the manufacturing process is out-sourced.
In fiscal 1999, the Company wrote off $8.5 million of license rights related to the sale to Chugai of territory rights previously reacquired from Shionogi. In addition, the Company incurred a one-time charge of $878,000 in bankers fees in connection with the Chugai Agreement.
In September 1996, the Company entered into an agreement with Nycomed for the repurchase of the rights to manufacture, market and sell its ALBUNEX family of products in the territory formerly exclusively licensed to Nycomed (see note 9). As a result, during fiscal year 1997 the Company wrote off the license rights of the former Nycomed territory in the amount of $3.0 million.
11. SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following is a summary of the unaudited quarterly results of operations for the years ended March 31, 1999 and 1998 (in thousands, except per share amounts):
12. SUBSEQUENT EVENTS
In April 1999, the Company and Mallinckrodt agreed to transfer the manufacture of OPTISON, the only advanced generation cardiac ultrasound imaging agent commercially available in the United States and Europe, from MBI to Mallinckrodt. The parties agreement will be incorporated into an amendment to ARDA. In addition to the transfer of manufacturing, the amended agreement will extend Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology, clinical trials for OPTISON in the United States. MBI will continue to conduct all cardiology trials for OPTISON and will assume responsibility for conducting radiology trials in the United States. Under the terms of the amended agreement, which will be retroactive to March 1, 1999, Mallinckrodt will reimburse MBI for all manufacturing expenses, including incremental costs related to the technology transfer. In exchange for the transfer of manufacturing and increased financial support of clinical trials for OPTISON, MBI will receive a reduced royalty rate on product sales of OPTISON.
In May and June 1999, the Company received correspondence from the PTO with respect to the ImaRx patents involved in the reexamination proceedings. The PTO indicated that all claims of U.S. Patent No. 5,547,656 (`656) and U.S. Patent No. 5,527,521(`521) will be allowed in their original form.
In May 1999, the Company and Mallinckrodt received notice of a lawsuit filed against them by DuPont Pharmaceuticals Company ("DuPont) and ImaRx in the United States District Court for the District of Delaware (the "DuPont Case"). The lawsuit alleges that the manufacture and sale of OPTISON infringes the `656 patent owned by ImaRx and exclusively licensed to DuPont. MBI has counterclaimed for a declaration of invalidity and non-infringement with respect to the `656 patent. In June 1999, DuPont and ImaRx amended their complaint in the DuPont case to add allegations that the manufacture and sale of OPTISON also infringes the `521 patent owned by ImaRx and exclusively licensed to DuPont.
Litigation or administrative proceedings relating to these matters could result in a substantial cost to the Company; and given the complexity of the legal and factual issues, the inherent vicissitudes and uncertainty of litigation, and other factors, there can be no assurance of a favorable outcome. An unfavorable outcome could have a material adverse effect on the Company's business, financial
condition and results of operations. Moreover, there can be no assurance that, in the event of an unfavorable outcome, the Company would be able to obtain a license to any proprietary rights that may be necessary to commercialize OPTISON, either on acceptable terms or at all. If the Company were required to obtain a license necessary to commercialize OPTISON, the Company's failure or inability to do so would have a material adverse effect on the Company's business, financial condition and results of operations.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors is incorporated in this report by reference to the information contained under the caption "Election of Directors" in the Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders to be held on August 26, 1999 ("1999 Proxy Statement"). Information concerning executive officers is included in Part I of this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated in this report by reference to the information contained under the caption "Executive Compensation" in the Company's 1999 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership is incorporated in this report by reference to the information contained under the caption "Stock Ownership" in the Company's 1999 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is incorporated in this report by reference to the information contained under the caption "Certain Relationships and Related Transactions" in the Company's 1999 Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(b) REPORT ON FORM 8-K
A Current Report on Form 8-K dated November 10, 1998 was filed on January 11, 1999 reporting the following: (1) that as a result of slower than planned ramp up of OPTISON sales, the Company had initiated a multi-phase program to reduce expenses and preserve capital; (2) that changes in management had occurred; and (3) that the U.S. Patents & Trademark Office would allow certain of the `751 patent claims filed by Sonus Pharmaceuticals to be filed against the Company in their original form.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on June 28, 1999.
MOLECULAR BIOSYSTEMS, INC.
By: /s/ Bobba Venkatadri -------------------------------- Bobba Venkatadri President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.