ITEM 1. BUSINESS
OVERVIEW
Orphan Medical, Inc. (the "Company") acquires, develops and markets products of high medical value for patients within selected strategic therapeutic market segments ("STMS"). A drug has high medical value if it offers a major improvement in the safety or efficacy of patient treatment. The Company currently concentrates its efforts on drugs with high medical value that may be marketed within three selected STMS: Antidotes, Oncology Support, and Sleep Disorders. Antizol and Busulfex are commercially available and are the Company's lead products in its Antidote and Oncology Support STMS, respectively. Xyrem is an investigational drug and is expected to be the Company's lead product in its Sleep Disorders STMS. In addition, the Company manufactures and distributes Cystadane and Sucraid that treat two rare congenital diseases. Antizol-Vet is marketed through separate channels to the veterinary community although these products do not fall into any of the three selected STMS. However, the Company expects to continue offering Cystadane, Antizol-Vet, and Sucraid because these products have high medical value and require limited resources to market and distribute.
Each STMS defined by the Company is characterized by a well-defined patient population and treated by a well-defined group of medical specialists. The Company believes this approach makes a large sales force unnecessary to market the Company's products because marketing efforts can be focused on a limited number of medical specialists or patients. The high medical value of the Company's products is expected to facilitate marketing efforts directed toward users and prescribers. Through its sales force supported by marketing and sales methods available through the use of computer systems and the Internet, the Company intends to promote awareness of the key advantages of Orphan Medical branded products within the Antidote, Oncology Support, and Sleep Disorders STMS. The Company's marketing and sales efforts will differentiate products on the basis of quality, potentially improved medical outcomes, and cost effectiveness. The Company uses established distributors of pharmaceutical products for its products in a manner similar to that of most other pharmaceutical companies.
The Company believes its approach to pharmaceutical product development reduces the time, costs and risks traditionally involved in bringing pharmaceutical products to market. The Company does not conduct basic research and does not attempt to discover new drugs. Instead, the Company's strategy is to acquire licenses to develop, or develop existing known therapeutic substances for new indications, and market products that preferably have some existing clinical data that indicate therapeutic value and safety. In addition, the Company considers acquiring products that have already received marketing approval from the FDA. The Company uses contract development, manufacturing, and consulting companies to assist it in its product development activities. This approach avoids the costs and financial risks associated with developing these capabilities internally.
The Company operates within a single industry segment: pharmaceutical product marketing, sales and development. To date, the Company has obtained marketing approval from the U. S. Food and Drug Administration (the "FDA") on six of its New Drug Applications ("NDA"). The Company's products are commercially available in the United
States and several foreign countries. Revenues from the Company's approved products outside the United States were approximately 17.5% of total 2000 revenues.
A Treatment Investigational New Drug ("IND") application for Xyrem was approved by the FDA in December 1998 and the Company began shipping Xyrem in February 1999 for use in its Treatment IND clinical trials. The Treatment IND allows the Company to seek payments for Xyrem used by patients enrolled in the Treatment IND clinical trials and to obtain additional clinical safety data for Xyrem. The Company submitted its NDA for Xyrem on October 2, 2000. The NDA was granted priority review status by the FDA, meaning the FDA has a goal of reaching a decision to either approve or disapprove or delay a decision regarding the NDA within 180 days of submission. The FDA canceled a March 15, 2001 Peripheral and Central Nervous System Advisory Committee review. This meeting had been scheduled to review and discuss the efficacy, safety and risk management of the Xyrem. The FDA took this action in conjunction with its request for clarification of supplemental data outside of Orphan sponsored trials. The Company has submitted additional data in response to FDA's request. On March 29, 2001, the FDA extended by 90 days its priority review of the Xyrem NDA. The decision was taken in order to review the additional data recently submitted to the FDA by the Company. The FDA will continue its review and reschedule a meeting of the Peripheral and Central Nervous System Advisory Committee in early June. The FDA's new action deadline for this NDA is now early July.
As an emerging and growing specialty pharmaceutical company, the Company did not achieve profitability in 2000 and does not expect to do so in 2001. The Company has significant capital requirements to support product development and marketing efforts until profitability is achieved to support these activities. In February 2000, the Company completed the sale of 1,365,000 newly issued shares of common stock for net proceeds of $10.7 million.
STRATEGIC BACKGROUND
In the 1950s and early 1960s, drug development was relatively inexpensive and regulatory approval was straightforward. Pharmaceutical companies marketed their products through sales forces directly to physicians who generally had independent responsibility for prescription and purchase decisions. In the 1970s, however, regulatory standards and competition increased and the price of research and development and manufacturing rose dramatically. In the 1980s and 1990s, prescription decisions by physicians were constrained on their by managed care entities and drug companies revised their targeted rates-of-return or financial "hurdle rates", as well as other selection criteria, to avoid developing drugs whose incremental profit contributions were considered insufficient to provide acceptable returns on investment. Many of the drugs that did not meet these criteria were drugs for smaller patient populations. As a consequence, new drugs for such patient populations were less likely to be developed by larger companies. Some research institutions, universities and small companies, however, have continued to develop and conduct clinical trials on these types of drugs.
The Company's strategy is based on several factors relating to these and other changes in the health care and pharmaceutical industries:
o Larger pharmaceutical companies generally have increased their financial return rates, seek new products with annual revenues greater than $200 million and avoid developing new products that address diseases outside their therapeutic areas of focus. As a result, the Company believes many developmental products of high medical value are available for licensing on favorable terms. If these products are intended to address smaller markets, they may be eligible for orphan drug designation. Many of these products have already been developed to the point where the time and cost required bringing the product to market can be reasonably estimated.
o Skilled employees experienced in the research, development, manufacturing or commercialization of new medicines are available on a contract basis. These individuals have often formed or joined contract clinical research organizations ("CROs"), contract manufacturing companies or drug development and marketing consulting firms. Thus, the knowledge and skills required to address many aspects of drug development are available on a contract basis from outside companies or individuals.
o To address rapidly changing market forces, alternative means of marketing and distributing pharmaceuticals have been created. The advent of the Internet has dramatically increased the availability of information, including information related to health and health care products. Many products, particularly those targeted to smaller, well-defined markets, do not require a large, specialized sales force and can be marketed through direct means such as exhibits at professional meetings, direct mailings, telemarketing, continuing medical education programs, and the Internet. In addition, these products can be effectively distributed through companies proficient in distribution of pharmaceutical products to smaller patient populations.
In response to these changes, the Company has adopted a business strategy that is centered on products of high medical value within well-defined strategic therapeutic market segments, uses the knowledge and skills available on a contract basis from outside sources, and uses alternative marketing and distribution channels.
BUSINESS STRATEGY
The Company focuses on products of high medical value intended to address inadequately treated or uncommon diseases within a selected STMS. A drug has high medical value if it offers a major improvement in the safety or efficacy of patient treatment. In addition to products with high medical value, the Company seeks pharmaceuticals that have readily measured clinical endpoints, existing positive clinical data, proprietary attributes, will likely be eligible for insurance reimbursement, and offer attractive financial returns. The Company does not conduct basic research to discover new drugs, but instead seeks to acquire and further develop products that already have some data that indicate the presence of therapeutic value and safety. The Company's strategy of developing and marketing high medical value drugs with these clinical characteristics is intended to achieve the following benefits.
o REGULATORY REQUIREMENTS AND REVIEW - Drugs of high medical value have a greater likelihood of receiving expedited review by the FDA. If such drugs also have smaller patient populations, the number of patients required for clinical trials is generally reduced.
o REDUCTION OF PRODUCT DEVELOPMENT TIME AND COST - While the safety and efficacy of every drug must be established to the satisfaction of the FDA, the amount of data required to bring a new drug of high medical value not served by existing therapies to market is generally less than for a drug that is available in similar dosage forms or formulations and that is intended for very large markets. Furthermore, the Company generally attempts to concentrate resources and project management attention on a single medical indication in order to limit the amount of clinical information required by the FDA to clear a product for marketing. The time and cost of development is directly related to the amount of clinical information required for regulatory approval.
o LIMITED INFRASTRUCTURE - The Company believes that high quality pharmaceutical products can be developed efficiently and economically using well established independent contractors to assist its experienced staff. Accordingly, the Company uses the available pool of contract development, manufacturing, distribution and consulting companies to assist in product development and marketing activities. This approach allows the Company to avoid the costs, time and financial risks associated with developing an extensive infrastructure in support of these capabilities internally.
o MARKETING STRATEGY - The Company focuses on products of high medical value intended to address inadequately treated or uncommon diseases within selected STMS. An STMS is a subset of a therapeutic area where one or more products can be grouped to satisfy unmet needs. To assess the viability of an STMS, the Company considers the following questions:
o Are there unmet therapeutic needs as defined by the customer (the patient or the health care practitioner)?
o Do additional product development or product acquisition opportunities exist in order to build a profitable business in a particular STMS?
o Can the Company build brand recognition and command significant market share in a particular STMS?
o DIRECT SALES - The Company has built a small, specialized sales force to promote Antizol and Busulfex. The sales force has extensive knowledge of the Antidote and Oncology Support STMS, as well as extensive marketing and business experience. The Company's sales force utilizes a consultative, customer-oriented approach to selling, which is aided by high quality information systems. The Company expects to utilize a similar sales force approach with the Sleep Disorders STMS, initially using a contract sales organization.
o ALLIANCES - The high medical value of the Company's products has interested other companies seeking to market the Company's products outside the U.S. To date, the Company has agreements with nine distributors relating to five of the Company's products. The Company also believes that its relationships with these distribution partners, among others, may provide strategic benefits, possibly in the area of product acquisition opportunities or in market share penetration programs.
o ATTRACTION OF POTENTIAL NEW PRODUCTS - As the Company's strategy and focus on pharmaceutical products of high medical value within a selected STMS becomes better known and understood by others in the research and development community and as the Company proves its ability to market and sell into an STMS, the Company expects more product development or acquisition opportunities will be presented to it in the future.
RISK MANAGEMENT
The Company's strategy is designed, in part, to manage its overall business risk. The Company is pursuing three distinct STMS rather than concentrating financial, development and marketing resources on a single STMS or a single platform technology. To reduce its product development risk, the Company generally seeks to develop products that (1) are known to the medical community and to the FDA, (2) have a straightforward formulation that can be readily manufactured with established technologies, and (3) do not require excessive specialized processes for development or manufacture. In addition, the Company generally seeks to acquire products that are already in Phase II or Phase III clinical trials, or in an earlier stage of development with proof of concept established. When a product is licensed without the equivalent of Phase II or III data, the Company may conduct one or more "pilot clinical trials" to better assess this likelihood. Each such pilot trial is narrowly defined and has a separate budget that to date has not exceeded $500,000. Upon the completion of such a pilot clinical trial, management seeks the approval of the Board of Directors for authority to proceed to full development of the product. The Company does not conduct basic research to discover new chemical entities. The Company may also purchase rights to existing products in order to reduce development risk. To reduce its marketing risk, the Company generally attempts to obtain some form of proprietary protection, such as orphan drug status, patent protection, exclusive licensing agreements, predominant market penetration or sole supplier agreements.
PROPRIETARY RIGHTS
To encourage the continued development of drugs for smaller patient populations, the federal government enacted the Orphan Drug Act of 1983. This Act provides incentives to companies to develop and market drugs for rare diseases or conditions that are known to affect fewer than 200,000 people in the United States. A company must request orphan drug designation before an NDA is approved, and after the FDA grants orphan drug designation, the generic identity of the therapeutic agent (drug) and its potential orphan use (market) are published by the FDA. Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory approval process. The FDA may grant orphan drug designation to more than one company of an identical drug for the same designated indication, however under current law, orphan drug status is granted to the first company receiving FDA marketing approval for a specific indication of a drug with orphan drug designation. A company receiving orphan drug status for a designated indication is entitled to a seven-year exclusive marketing period in the United States for the drug with the approved indication, subject to certain limitations. Orphan drug status, however does not prevent subsequent approval of a different drug for the same designated indication, nor subsequent approval of the same drug for a different designated indication, nor provide any marketing exclusivity in foreign markets.
Since 1983, the FDA has assigned orphan drug designation to more than 650 potential products. Although the Company believes the size of the aggregated markets for orphan and small market drugs may be large, the total annual market for any particular orphan drug indication rarely exceeds $100 million and most have potential markets of less than $25 million annually.
Orphan Drug protection is available in Japan under requirements such as those in the United States. The European Union approved orphan drug regulations in 2000 granting 10 years marketing exclusivity to those products meeting the qualifications.
The Company believes it is important that its proposed products receive patent protection or orphan drug status or have other factors that limit potential competition. A drug that has orphan drug designation and which is the first product to receive marketing approval for its product claim, indication or application, receives orphan drug status and is entitled to a seven-year exclusive marketing period in the United States for that product claim, indication or application, subject to certain limitations. The Company has five products with orphan drug status. Applications for Orphan Drug designation will be made where appropriate and available for any additional indications or products that may be licensed in the future.
The license agreement pursuant to which the Company has acquired rights to develop and market Busulfex provide for an assignment of the licensor's proprietary rights, including patent and technology rights. With respect to additional products it may license in the future, if any, the Company expects that such licenses will include, if such rights are available, an assignment of the licensor's proprietary rights with respect to the licensed product. Foreign patent applications have been filed for Busulfex and Xyrem. The Company evaluates the desirability of registering approved patents or other forms of protection for its products in individual foreign markets based on the expected costs and relative benefits of attaining such protection.
THE REGULATORY PROCESS
Pharmaceutical products intended for therapeutic use in humans are governed by extensive FDA regulations in the United States and by comparable regulations in foreign countries. The process of seeking and obtaining FDA approval for a previously unapproved new human pharmaceutical product generally requires a number of years and involves the expenditure of substantial resources and considerable risk.
Following drug discovery, the process required before a drug product may be marketed in the United States includes (i) pre-clinical laboratory and animal safety tests, (ii) the submission to the FDA of an IND application, (iii) clinical and other studies to assess safety and parameters of use, (iv) adequate and well-controlled clinical trials to establish the safety and effectiveness of the drug product, (v) the submission to the FDA of an NDA, (vi) FDA approval of the NDA prior to any commercial sale or shipment of the product and (vii) finally, marketing of the drug.
Typically, pre-clinical studies are conducted in the laboratory and in animal model systems to gain preliminary information on the product's pharmacology and toxicology and to identify any potential safety problems that would preclude testing in humans. The results of these studies, together with the general investigative plan, protocols for specific human studies and other information, are submitted to the FDA as part of the IND application. The FDA regulations do not, by their terms, require FDA approval of an IND. Rather, if the FDA does not notify the sponsor to the contrary within 30 days of receipt of the IND, a clinical investigation is allowed to commence. As a practical matter, however, FDA approval is often sought before a company commences clinical investigations. That approval may come within 30 days of IND receipt, but may involve substantial delays if the FDA requests additional information.
The initial phase of clinical testing (Phase I) is conducted to evaluate the metabolism and pharmacological actions of the experimental product in humans, as well as the side effects associated with increasing doses, and, if possible, to gain early evidence of possible effectiveness. Phase I studies can also evaluate various dosages, methods and schedules of product administration. These studies generally involve a small number of healthy volunteer subjects, but may be conducted in people with the disease that the product is intended to treat. A demonstration of therapeutic benefit is not required in order to complete Phase I trials successfully. If acceptable product safety is demonstrated, Phase II trials may be initiated.
Phase II trials are designed to evaluate the effectiveness of the product in the treatment of a given disease and involve patients with the disease under study. These trials are well-controlled, closely monitored and involve a relatively small number of subjects. The optimal dosages, methods and schedules of administration are determined in these clinical trials. If Phase II trials are successfully completed, Phase III trials are often commenced, although separate Phase III trials are not always required, particularly for drugs of high medical value intended for smaller patient populations, if efficacy and safety have been validated in the Phase II trials.
Phase III trials are expanded, controlled trials that are performed after preliminary evidence of the effectiveness of the experimental product has been obtained. These trials are intended to gather the additional information about safety and effectiveness needed to evaluate the overall risk/benefit relationship of the experimental product. In addition, these trials provide the confirmatory evidence of both effectiveness and safety necessary for product approval. Phase III trials may involve several hundred to several thousand subjects.
A clinical trial may combine the elements of more than one phase (i.e., a Phase I/II or II/III trial) and typically two or more Phase III studies are required for FDA approval. A company's designation of a clinical trial as being of a particular Phase is not necessarily indicative that such a trial will be sufficient to satisfy the FDA requirements of that Phase because this determination cannot be made until the protocol and data have been submitted to and reviewed by the FDA. In addition, a clinical trial may contain elements of more than one Phase notwithstanding the designation of the trial as being of a particular Phase. The FDA closely monitors the progress of the Phases of clinical testing and may, at its discretion, re-evaluate, alter, suspend or terminate the testing based on the data accumulated and its assessment of the risk/benefit ratio to patients. It is not possible to predict with certainty the time required to complete Phase I, II and III studies with respect to a given product. Likewise, it is difficult to predict with any certainty the requirements of the FDA, which can be subject to new laws and regulations.
Upon the successful completion of clinical testing, a marketing application (e.g., NDA) is submitted to the FDA for approval. This application requires detailed data on the results of pre-clinical testing, clinical testing and the composition of the product; specimen labeling to be used with the drug; information on manufacturing methods; and samples of the product. Following the passage of the Prescription Drug User Fee Act ("PDUFA"), the FDA typically takes from six to eighteen months to review an NDA after it has been accepted for filing. Following its
review of a marketing application, the FDA invariably raises questions or requests additional information. The NDA approval process can, accordingly, be very lengthy. Further, there is no assurance that the FDA will ultimately approve an NDA. The FDA can also determine that a drug is "approvable" contingent on satisfactory review of additional information requested by the FDA. We cannot assure you that such requests by the FDA for additional information can be fulfilled in a timely manner, if at all. If the FDA approves the NDA, the new product may be marketed for the applications or treatments that have been approved by the FDA. The claims with which a product can be marketed are also subject to review and approval by the Division of Drug Marketing, Advertising and Communications ("DDMAC"), the FDA's marketing surveillance department within the Center for Drugs. The FDA often clears a product for marketing with a modification, or restriction to the proposed label claims or requires that post-marketing surveillance, or Phase IV testing, to be conducted.
OPERATING FUNCTIONS
The Company has structured each of its operating functions to support its strategy. Following is a general explanation of the typical steps in the Company's processes of product acquisition, development and marketing.
PRODUCT ACQUISITION
The Company is actively searching for product licensing opportunities. The continual acquisition of products for development and/or commercialization is a key element of the Company's growth strategy. The Company attracts product acquisition proposals through a network of customer and industry contacts, licensing brokers and a growing awareness of its activities by governmental, academic and industry sources. Since its inception, the Company has evaluated many product opportunities. To date, sixteen products have been acquired and, of these, seven products are currently under development or being marketed.
The Company seeks to acquire pharmaceutical products within selected STMS that, in the Company's opinion, generally:
o Are of high medical value as defined by the customer (physician or patient) within a STMS;
o Are targeted at distinct patient populations;
o Are prescribed by physician specialists;
o Can be marketed with a small, specialized sales team to health care specialists, health care institutions, and patients;
o Are likely to be eligible for reimbursement by third-party payors;
o Have or are candidates for patent protection, orphan drug designation or have other characteristics that enhance the Company's competitive position;
o Treat diseases that have clinical endpoints (i.e., signs or symptoms) that are readily measured;
o Are conventional pharmaceutical products that are relatively straightforward in formulation and development, and do not involve the application of new technologies;
o Are in Phase II or Phase III clinical trials and have a relatively high likelihood of obtaining the approval of the FDA within three years of their acquisition;
o Offer attractive potential financial returns with relatively inexpensive development costs;
o Compliment other products in an existing STMS or can be grouped with other products to build a new STMS.
In selecting additional products for potential inclusion in its portfolio, the Company generally focuses on acquiring rights to medicines that serve small, defined patient populations. Many major drug companies and generic manufacturers are less likely to address these orphan drug and niche markets because they do not believe that these markets are capable of producing acceptable revenues and returns on their product development investments. This reluctance limits the number of potential sources of competition. In addition, a product designed for smaller patient populations is often eligible for orphan drug designation. By obtaining orphan drug designation, the Company is granted exclusive marketing rights or status in the United States for seven years, subject to certain limitations, after an NDA for a product is approved, if the Company is the first to receive approval for the designated drug and indication.
The Company seeks to acquire potential products that already have, or will not require, a substantial quantity of clinical data to demonstrate their relative efficacy and safety. The Company also searches for product candidates that represent new dosage forms of previously approved or known compounds because the Company believes these types of products are more likely to be quickly approved by the FDA and accepted by the medical community. In addition, the Company attempts to develop medicines where there are clear clinical endpoints that demonstrate their effectiveness. Generally, the Company seeks to acquire products that can be developed to the point of FDA approval
within three years of their acquisition with expected development costs in the range of $5.0 to $15.0 million. Contrast this approach to the development of therapies for complex diseases (e.g., AIDS, psychoses or complex cancers) that can require a decade or more of development and involve the expenditure of tens of millions of dollars or more. Typically, the Company also focuses its development efforts on one indication and, when possible, one dosage form to minimize development costs. Additional indications or dosage forms will only be evaluated after the primary NDA is submitted or approved.
An additional element of the Company's product development strategy is to acquire products that have or can have a degree of proprietary protection. Generally, this goal is accomplished by selecting products that are eligible for orphan drug designation, are covered by patents or are the subject of an exclusive license from a sole supplier or a manufacturer with specialized or proprietary processes. The likely availability of adequate levels of reimbursement from third-party payors is also an important factor in product acquisition decisions.
The Company's management reviews new product opportunities and makes recommendations to the Board of Directors of the Company regarding the license or acquisition of any proposed additional products. The product review process generally involves discussions with customers (physicians and patients) within a given STMS to identify unmet needs, and with the initial product developer and experts in the disease treated by the drug; a review of research publications and other databases to gauge competitive activities; market research aimed at identifying potential acceptance by the end user; technical evaluations to determine manufacturability and cost; expected FDA regulatory requirements to obtain acceptable marketing or promotional claims; and a legal review of any relevant proprietary rights. If this review indicates that the proposed product meets the Company's selection criteria, efforts to negotiate a license are initiated. Generally, the Company seeks to obtain licenses that require a minimal signing fee, are subject to commercially acceptable royalty levels and, where appropriate, provide for the continued involvement of the original developer in the development process through a consulting or similar arrangement.
The Company is continually seeking and evaluating additional proposed products within the selected STMS. Although the Company generally is actively discussing product licensing or acquisition possibilities with other parties, it currently does not have any binding agreements or arrangements for the acquisition of any additional products. Should the Company be unsuccessful in acquiring additional proposed products for development and commercialization within a selected STMS, the Company may reassess the viability of the selected STMS and redefine the selected STMS to expand the number of potential products that might satisfy the Company's acquisition criteria for a viable STMS to ensure adequate future growth of the Company.
PRODUCT DEVELOPMENT
Pharmaceutical product development is one of the Company's principal activities. The Company has incurred $36.6 million in research and development expense through December 31, 2000. In addition, the Company estimates that it will need to incur at least an additional $8.0 million in research and development expense relating to the products it currently markets and to obtain FDA approval for marketing Xyrem as expeditiously as possible.
A major element of the Company's product development strategy is to use third-parties or contract research organizations (CROs) to assist in the conduct of safety and efficacy testing and clinical studies, to assist the Company in guiding products through the FDA review and approval process, and to manufacture and distribute any FDA approved products. The Company believes that maintaining a minimal infrastructure will enable it to develop products efficiently and cost effectively. To facilitate this strategy, the Company utilizes a team approach to develop its proposed products. A development team is organized and managed by senior staff. The development team is cross-functional and includes in-house experts, as well as appropriate outside consultants, to manage all development activities and market planning with respect to a proposed product. A development team designs a development plan, which will support the proposed indication and marketing claims, and creates and manages a financial budget for the proposed product and contracts with outside development agents and consultants to arrange for the necessary clinical and toxicology studies, manufacturing arrangements and FDA filings. Upon approval of the NDA by the FDA, the Company's marketing and sales staff manages marketing and sales of the proposed product.
The Company believes the use of third parties to develop and manufacture its products has several advantages. This approach generally allows a greater pool of resources to be concentrated on a product than if these functions were performed by internal personnel who were required to support all of the Company's products. Although this approach will allow the Company to avoid the expense associated with developing a large internal infrastructure to support its product development efforts, it will result in the Company being dependent on the ability of outside parties to perform critical functions for the Company.
This contract approach to product development requires project management by professionals with substantial industry experience. The Company believes it has in-house experts in areas of critical importance to all of its proposed products who can be consulted by the development teams. These areas include regulatory affairs, marketing and sales, quality assurance, manufacturing, clinical trials management, finance, information systems and general management.
The product development process is designed to identify any problems associated with a proposed product's clinical aspects. The Company attempts to reduce the risk that a proposed product will not be accepted in the marketplace by conducting the market research and planning process concurrently with a product's development. A drug development portfolio cannot be completely insulated from potential failures and it is likely that some proposed products selected for development by the Company will not produce the clinical or revenue results expected. To date, the Company has discontinued development activities with respect to eleven proposed products because the estimated financial returns of these proposed products were deemed unacceptable by management.
MANUFACTURING
The Company does not have and does not intend to establish any internal product testing, drug or chemical synthesis of bulk drug substance, and manufacturing capability for drug product. Manufacturers of the Company's products are subject to applicable Good Manufacturing Processes ("GMP") as required by FDA regulations, or other rules and regulations prescribed by foreign regulatory authorities. The Company is negotiating or has entered into bulk drug supply and drug product manufacturing agreements with third parties for all of its FDA approved products and is dependent on such third parties for continued compliance with GMP and applicable foreign standards. The Company believes that qualified manufacturers will continue to be available in the future, at a reasonable cost to the Company, although there can be no assurance that this will be the case.
Due to FDA mandated dating requirements and the limited market size for each of the Company's approved products, the Company may be subject to complex manufacturing logistics, minimum order quantities that could result in excess inventory as determined under the Company's accounting policy, unsalable inventory as a result of product expiring prior to use, and competition with others for manufacturing services when needed or expected. The Company has a production planning program to assess and manage the manufacturing logistics amongst the vendors supplying the required finished product components of bulk drug substance, drug product and packaging.
The Company is substantially dependent on its contract drug product manufacturers. These manufacturers have been approved by the FDA for the production of the Company's approved products. Following is a listing of the Company's contract drug product manufacturers:
In addition to the contract drug product manufacturers, the Company is substantially dependent on Ash Stevens, Inc. ("Ash Stevens") and Lonza, Inc. ("Lonza"). Ash Stevens is the Company's sole supplier of bulk drug substance for the manufacture of Antizol, Antizol-Vet, and Busulfex; while Lonza is the Company's sole supplier of bulk drug substance for the manufacture of Xyrem for use in clinical trials and is anticipated to be the sole supplier of any approved product.
MARKETING - UNITED STATES
The Company has designed its product selection strategy to maximize the success of its marketing efforts. By having products that current and potential customers have identified as having "high medical value", the Company believes it should be able to more easily attract the attention of targeted segments of the medical community. The Company also believes that its focus on well-defined physician and patient populations will allow the use of a small, focused sales force instead of a large, generalized sales force. Because of the distinct nature of most of its potential markets, the Company expects to be able to concentrate its marketing efforts on a limited number of medical specialists, or on patients themselves.
As part of its marketing efforts, the Company identifies and defines appropriate STMS, identifies customer needs within each STMS, identifies specific product acquisition candidates within each STMS, works with the development team to insure clinical data are collected that supports the desired indication and marketing claims, and if FDA approval is obtained, designs and implements marketing plans for each of its approved products. Market research is conducted to analyze the potential of products prior to their acquisition. Once a product is acquired and is being developed, further market research is completed and, based on this analysis, the product's marketing plan is developed. Upon submission of the NDA to the FDA, the product management responsibilities transition from the development team to the Company's marketing and sales staff. The development group continues to provide support where needed to enhance marketing and sales efforts. This group is responsible for all aspects of a product's marketing and sales, including product forecasting, positioning, price, promotion and physical distribution to successfully launch and commercialize the product. Senior sales and marketing employees lead a cross functional team of internal and external personnel to implement a product's marketing and commercialization plan. In addition, marketing and sales staff also supports the Company's international sales efforts through support of and interfacing with international partners.
MARKETING - FOREIGN
In general, the Company expects to out-license foreign marketing, sales and distribution rights after an NDA is submitted in the United States. The Company contracts with foreign companies (usually pharmaceutical companies) to market and distribute its products. The Company considers Europe, Japan and Canada to be its most attractive foreign markets. The Company has entered into marketing, sales and distribution agreements for Antizol, Cystadane and Sucraid in Europe, Cystadane and Sucraid in Australia and New Zealand, Busulfex, Cystadane, Elliots B Solution and Sucraid in Israel, Antizol and Cystadane in Canada, and Elliotts B Solution in Central America. In October 1999, the Company signed a definitive agreement with Pierre Fabre Medicament, granting the French company exclusive rights to market and distribute Busulfex in 21 European countries, as well as Argentina and South Africa. Upon approval, Pierre Fabre, a private company with 1998 sales in excess of $1 billion and approximately 8,300 employees, will market Busulfex to transplant centers through its 75 oncology marketing and sales personnel. The Company has an agreement with IDIS World Medicine to distribute Busulfex on a "named patient basis" to requesting physicians outside of the United States, Canada and Israel, and other approved products in territories where the Company's other products are not approved and where the Company does not have a distribution partner. The Company began shipments to IDIS in January 2000.
In December 2000, the Company signed a definitive agreement with Kirin Brewing Co., LTD to market and distribute Busulfex in Asia including Japan, the Peoples Republic of China, South Korea and Taiwan. Kirin is a diversified company with more than $14 billion worldwide revenues in the food and beverage industry. Kirin expanded into the pharmaceutical business in 1982 and has established a strong presence in the fields of nephrology, cancer and cell production, immunology and allergy.
The Company's practice is to negotiate contracts with foreign distributors that generally provide for minimum order and sales performance. Minimum fees negotiated with foreign parties to date are not material and are not refundable, nor subject to future performance criteria. The foreign contracting party is responsible for obtaining marketing approval for the Company's product to which the agreement relates and the Company is responsible for providing selected U.S regulatory information to the foreign party on request. The Company cannot unilaterally terminate these agreements without established evidence of default, but these agreements do expire over a defined period of time and the Company may seek other foreign parties to provide comparable services upon expiration if not satisfied with the performance of its partners. The principal benefit a foreign party receives from entering into these agreements with the Company and paying the minimum fees, if any, is a contracted price for acquisition of product from the Company because the Company is the sole supplier of its approved products on a worldwide basis.
DISTRIBUTION
The Company does not intend to develop internal physical distribution capabilities because the Company believes its relatively low-volume products can be more economically and efficiently distributed through third party distribution organizations. The physical distribution of the Company's products through third parties allows the Company to avoid some of the costs associated with developing internal information systems that comply with regulatory requirements and satisfy customer service demands. Cystadane is principally distributed directly to patients through a third party mail order pharmacy. Chronimed is the principal third party distributor of Cystadane. Elliotts B Solution, Antizol and Busulfex are primarily used in a hospital setting and are distributed by an affiliate of Cardinal Health. This distribution of Antizol and facilitates the sale of these products directly into hospitals or, if customers
prefer, through their primary wholesaler. Antizol-Vet is a product used in veterinary clinics and is distributed by an affiliate of Cardinal Health to individual veterinary clinics and a network of veterinary wholesalers.
COMPETITION
Potential competitors in the United States are numerous and include pharmaceutical, chemical and biotechnology companies. The Company will experience competition in several specific areas, including those described below.
o PRODUCT ACQUISITION - The Company intends to acquire the rights to products with important therapeutic advantages that generally are not of interest to larger pharmaceutical companies. Nevertheless, the Company will compete with other entities in acquiring product rights from universities and other research institutions, as well as from other potential licensors.
o PRODUCT DEVELOPMENT RESOURCES - The Company will compete for certain resources, such as the services of clinical investigators, contract manufacturers, advisors and other consultants. The Company will generally have little or no control over the allocation of such resources.
o ORPHAN DRUG DESIGNATION - The Company is aware of two other companies that have filed for and received orphan drug designation on products similar to two of its products. Sparta Pharmaceutical (acquired by SuperGen in 1999) and Teva (formerly Biocraft) have been granted orphan drug designations for their intravenous busulfan and sodium oxybate, respectively. Intravenous busulfan and sodium oxybate are their equivalent of the Company's Busulfex and Xyrem products, respectively. The Company does not believe SuperGen is developing an intravenous busulfan. In 1999, the Company entered into an agreement with Teva, that, in effect, transfers Teva's development data to the Company. While the Company is not aware of others holding or seeking orphan drug designations for products that would compete with the Company's products for NDA approval, there can be no assurance that the Company's products will not have such competition for the protection conferred by orphan drug status.
o MARKETING AND SALES - Each of the Company's current products will face competition from other products or from other therapeutic alternatives. In general, the Company's products will compete against products whose marketers have substantially greater resources, including large specialized sales forces, than the Company.
GRANTS
The FDA Office of Orphan Drug Products (Orphan Drug grants) and the Small Business Administration (SBIR grants) offer grants to companies whose efforts meet certain requirements. Orphan Drug grants were made available for Busulfex, Antizol and Colomed and an SBIR grant was made available for Intrachol. From July 1, 1995 through December 31, 1998, the Company collected approximately $1,567,000 in grant proceeds with respect to approximately $1,567,000 in grant related disbursements. The grant proceeds collected by the Company are non-refundable. There can be no assurance that Orphan Drug or SBIR grants will be made available to the Company in subsequent periods. The Company currently has no active grants.
GOVERNMENT REGULATION
GENERAL
Political, economic and regulatory influences are subjecting the health care industry in the United States to fundamental change. Several potential approaches are under consideration, including mandated basic health care benefits, controls on health care spending through limitations on the growth of private health insurance premiums and Medicare and Medicaid spending, price discounts from drug manufacturers, the creation of large purchasing groups and other significant changes to the health care delivery system. In addition, some states have adopted or are considering various health care reform proposals. The Company anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery systems and payment methods and that public debate of these issues will likely continue in the future. Because of uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, the Company cannot predict which, if any, of such reform proposals will be adopted, when they may be adopted or what impact they may have on the Company or its prospects.
REIMBURSEMENT
Employers, through payments to their employee benefit plans, bear a significant share of the health care costs of their employees. These plans are typically administered by insurance companies, health maintenance organizations, preferred provider organizations and other third-party payors. Health care services and products, including pharmaceutical products, are also paid for by government agencies, such as Medicaid. Employers and the payors involved in providing or administering health care benefits are increasingly turning to "managed care" systems to control health care costs. Under these systems, the administrative requirements and standards of care are established
by the health care purchasers and providers and the benefit level depends on the negotiated price. Managed care systems usually limit treatment options to approved therapeutic regimens and "formularies," or lists of approved drugs and medical products.
Being included on the formularies of managed care groups is important to the commercial success of a prescription medicine. A pharmaceutical must be included on a third-party payor's formulary or must be deemed "medically necessary" to be eligible for reimbursement by that payor. In deciding whether a drug is to be included on a formulary, payors will generally consider its therapeutic value and cost in comparison to other available treatments. The Company believes that the proprietary nature and medical usefulness of its products should assist it in its efforts to have its products approved for reimbursement. No assurance can be given, however, that the Company's products will be approved for reimbursement by third-party payors at acceptable levels, or at all.
PRODUCT APPROVALS
The Company's products require FDA approval in the United States and comparable approvals in foreign markets before they can be marketed. The development of investigational products and the marketing and supply of approved products require continuing compliance with FDA regulations.
SCHEDULED PRODUCTS
Products that are designated "controlled" substances also require compliance with regulations administered by the U.S. Drug Enforcement Agency ("DEA"), and similar regulations administered by state regulatory agencies. On February 18, 2000, the President signed PL 106-172, a public law which makes gamma hydroxybutyrate (GHB) a Schedule I substance. Schedule I is the designation by which illegal and non-approved drugs are controlled. The bill further delineates GHB products being studied under Food and Drug Administration (FDA) approved protocols or approved for commercial sale as Schedule III substances.
Each state has the ability to schedule products more strictly or equivalent to the Federally designated schedule. Most states have adopted, either administratively or legislatively, the I/III schedule as described above. The Company continues its efforts to ensure consistency across all states by the time of commercial launch.
MANUFACTURING REGULATION
All facilities and manufacturing processes used to manufacture products for clinical use or sale in the United States must be operated in conformity with GMP, the FDA requirements governing the production of pharmaceutical products. FDA approval is required before a contract manufacturer can implement most changes in manufacturing procedures for any of the Company's approved products. The Company has established a quality assurance program to monitor third-party manufacturers of its products to promote compliance by such manufacturers with domestic and foreign regulations (based on country of use). In addition, FDA approval is required for changing contract manufacturers of approved products. Obtaining the FDA's approval for a change in manufacturing procedures or change in manufacturers could cause production delays and loss of revenue.
FOREIGN REGULATION
Products marketed outside of the United States are subject to regulatory approval requirements similar to those required in the United States, although the requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country. No action can be taken to market any product in a country until an appropriate application has been approved by the regulatory authorities in that country. The current approval process varies from country to country, and the time spent in gaining approval varies from that required for FDA approval. In certain European countries, the sales price of a product must also be approved. The pricing review period often begins after market approval is granted. The Company intends to utilize foreign partners to apply for foreign marketing approvals.
INSURANCE
Providing health care products entails an inherent risk of liability. In recent years, participants in the health care industry have been subject to a large number of lawsuits alleging malpractice, product liability or related legal theories, many of which involve large claims and significant defense costs. The Company may from time to time be subject to such suits as a result of the nature of its business. The Company carries product liability insurance coverage in the aggregate amount of $10 million. The Company also carries a $2 million general business insurance policy. The Company does not carry any insurance to cover the financial risks associated with a potential FDA mandated recall of an approved product. There can be no assurance, however, that such insurance policies will be sufficient to fully indemnify the Company against any asserted claims or that such insurance will continue to be available.
HUMAN RESOURCES
The Company has fifty-seven full-time and three part-time employees. The Company believes that its relationship with its employees is good. None of the Company's employees is represented by a labor union.
TRADE SECRETS
The Company also relies on trade secrets and proprietary know-how to protect certain of its technologies and potential products. The Company requires employees, consultants and advisors to enter into confidentiality agreements that prohibit disclosure to any third party or use of such secrets and know-how for commercial purposes. Company employees also agree to disclose and assign to the Company all methods, improvements, modifications, developments, discoveries and inventions conceived during their employment that relate to the Company's business. We cannot assure, however, that these agreements will be observed to prevent disclosure or that they will provide adequate protection for the Company's confidential information and inventions.
DISCONTINUED DEVELOPMENT PRODUCTS
Through December 31, 2000, the Company discontinued development activities on a total of eleven proposed products. During 1997, the Company discontinued development activities on the following proposed products: Colomed, Caprogel, Clonidine, alpha-galactosidase A, colloidal bismuth subcitrate, Intrachol, Repliderm, 5FU (5-fluorouracil), and other indications of Cystadane. In December 1998, the Company sold its rights to colloidal bismuth subcitrate for $750,000, and is evaluating the potential value of its rights to one or more of the other proposed products that were discontinued in 1997. Depending on the availability of financing in subsequent periods, the Company may continue development of one or more of the proposed products that have been discontinued based on the criteria described under the Product Acquisition section. In addition, prior to 1997, the Company discontinued development activities on two proposed products, which proved to have little potential future value. There can be no assurance that the Company's license rights and/or any clinical data related to a discontinued product have any value to a third party and, if such rights or clinical data have value, there can be no assurance that the Company can come to terms with a third party for the sale of such rights or clinical data.
PRODUCTS
The following tables summarize certain information relating to the Company's products:
* Development Phases are discussed under "Business - The Regulatory Process". ** Orphan Drug Designation and Status are discussed under "Business - Proprietary Rights" (1) New Drug Application submitted October 2, 2000.
ANTIDOTE STMS - APPROVED PRODUCT
ANTIZOL (FOMEPIZOLE) INJECTION
Antizol, the first of the Company's products in the Antidote STMS, received marketing clearance from the FDA on December 1997 for ethylene glycol and December 2000 for methanol. The Company commenced shipping Antizol in December 1997. Antizol is primarily used in a hospital setting and is distributed for the Company by an affiliate of Cardinal Health. When ingested by humans, ethylene glycol (found in antifreeze) and methanol (found in windshield wiper fluid) can lead to death or permanent and serious physical damage. In a survey conducted in 1999 by the American Association of Poison Control Centers, over 6,300 cases of ethylene glycol poisoning were reported to United States poison control centers. In the same year, there were approximately 600 treatments for such poisonings. The Company believes that hospital pharmacies will continue to stock Antizol because it is important to treat poisoned patients very quickly in order to improve the chances of successful recovery. For 2000, Antizol contributed approximately 43% of the Company's total revenues. The Company expects to see limited incremental stocking by hospitals in 2001. Future sales will be based more on usage as stocking levels are expected to plateau. The Company has also received marketing approval for Antizol in Canada for the treatment of suspected or confirmed ethylene glycol poisonings.
The Company has obtained orphan drug status for Antizol as an antidote to treat ethylene glycol and methanol poisonings, which provides marketing exclusivity to the Company through December 2004 for ethylene glycol and December 2007 for methanol. Fomepizole, the active ingredient in Antizol, is a known compound and is not patentable. The Company has contracted with a third party for the production of Antizol under GMP conditions. The Company, through a sublicense agreement with Mericon Investment Group, Inc. ("MIG"), has an exclusive, worldwide license to develop and market Antizol, which expires in July 2013, subject to a five year renewal through July 2018 exercisable by MIG at the request of the Company.
ONCOLOLOGY SUPPORT STMS - APPROVED PRODUCTS
BUSULFEX (BUSULFAN) INJECTION
Busulfex is the Company's lead product in its Oncology Support STMS. Following an accelerated six-month priority review, the Company received regulatory approval from the FDA in February 1999 to market Busulfex in the United States. The FDA approved Busulfex for use in combination with cyclophosphamide as a conditioning regimen prior to allogeneic hematopoietic progenitor cell transplantation for chronic myelogenous leukemia ("CML"). The first commercial sales of Busulfex occurred in February 1999, within two weeks of FDA approval. Busulfex also received marketing approval in Canada in September 1999, and in Israel in February 2000. The indications approved in Canada and Israel provide for use of Busulfex as a conditioning regimen prior to bone marrow or hematopoietic progenitor cell transplantation, when used in combination with other chemotherapeutic agents and/or radiotherapy. Included in the Canadian indication are acute lymphocytic leukemia, non-lymphocytic leukemia, acute myeloid leukemia, non-Hodgkin's lymphoma, Hodgkin's disease, multiple myeloma, myelodysplastic syndrome, breast cancer, ovarian cancer and several genetic diseases.
In December 2000, the Company signed a definitive agreement granting Kirin Brewery Co., LTD exclusive rights to market and distribute Busulfex in Asia. Kirin is a diversified company with annual sales of more than $14 billion worldwide in the food and beverage industry. Kirin expanded into the pharmaceutical industry in 1982 and has established a strong presence in the fields of nephrology, cancer and cell production, immunology and allergy.
In October 1999, the Company signed a definitive agreement with Pierre Fabre Medicament, granting the French company exclusive rights to market and distribute Busulfex in 21 European countries, Argentina, and South Africa.
Pierre Fabre will market Busulfex to transplant centers through 75 oncology marketing and sales personnel. The Company signed an agreement with IDIS World Medicine in December 1999 to distribute Busulfex on a named patient basis to requesting physicians outside of the United States, Canada and Israel. The Company began shipments to IDIS in January 2000.
Bone marrow and peripheral stem cell transplants are collectively known as hematopoietic progenitor cell transplants, but are more commonly referred to as stem cell or bone marrow transplants. This year approximately 20,000 stem cell transplants are expected to be performed in the United States, with another 20,000 expected to be performed outside the United States. One of the many complex steps in performing a stem cell transplant includes using high doses of chemotherapeutic drugs, such as Busulfex, and/or radiation as a "conditioning regimen" to destroy the abnormal cancer cells in the bone marrow and to create "space" for the engraftment of transplanted stem cells. The stem cell transplant then replaces the diseased or damaged marrow to grow into healthy marrow.
An oral form of busulfan has been used in the transplant setting for a number of years. However, there are difficulties associated with its use. A patient undergoing a transplant may be required to take up to 35 busulfan pills every six hours, or up to 140 pills each day, over four days, often while nauseated. If the patient vomits any of the pills, they are often given additional pills to ensure they receive the administered dose. Unfortunately, because the absorption of the pills through the gastrointestinal system is erratic, it is difficult to determine how much of the administered dose has actually been absorbed. This variation in drug exposure can cause underdosing, possibly leading to an ineffective conditioning regimen. Conversely, the variation can lead to overdosing, causing an excessive amount of toxicity to the patient. Because of these variations, many authors have cited the need for an intravenous form of busulfan. The Company is the first to bring an intravenous form of busulfan to the market.
Of the 20,000 procedures expected to be performed in the United States, more than 4,000 of these may receive some form of busulfan, as part of the pre-transplantation conditioning regimen. The Company is marketing Busulfex to hematologists and oncologists who perform stem cell transplants at cancer treatment centers.
As clinicians review the clinical study data, they have responded positively to the results seen in the Busulfex trials. The pharmacokinetics seen with Busulfex, meaning the level of drug exposure, demonstrate the consistency that would be expected with an intravenous drug. This consistency has influenced the outcomes seen with Busulfex, which show a low rate of liver toxicity as well as an acceptable rate of early mortality within the first 100 days, the most critical period for treatment related morbidities. These factors may lead to improved safety and an improved likelihood that a BMT will be successful.
Adoption of Busulfex into standard busulfan-based regimens has been steady, and several clinicians in leading institutions have initiated new research protocols using Busulfex to enhance the conditioning regimen, based on clinical data and experience with Busulfex. Several leading United States research centers have indicated to the Company that they have initiated or intend to initiate new study protocols specifying the use of Busulfex.
Many other drugs are currently being developed for use in the BMT area. Although most of these new drugs are used for a different purpose during the bone marrow transplant and not in the conditioning regimen, some of them may compete with Busulfex. In addition, the Company is aware that SuperGen Inc., which acquired Sparta Pharmaceutical in 1999, now owns rights to another form of intravenous busulfan which was in development by Sparta prior to its acquisition. SuperGen holds orphan drug designation for its intravenous busulfan and could seek orphan drug status for a similar or different indication, if SuperGen were to proceed with development of its intravenous formulation and if the FDA approves an NDA for such a product.
The Company has obtained orphan drug status for Busulfex for the approved indication, which provides marketing exclusivity for that indication to the Company through February 2006. The Company has contracted with a third party for the production of Busulfex under GMP conditions. In addition, the Company has an exclusive, worldwide license from M.D. Anderson Cancer Center, The University of Texas, and The University of Houston (collectively, the "busulfan licensors") to develop and market this intravenous form of busulfan, which is effective for the term of busulfan licensors' patent rights. The busulfan licensors have been granted two U.S. patents covering the licensed product's formulation and its use in bone marrow transplants and other conditions, which expire in September 2016 and July 2015, respectively. The product is distributed for the Company by an affiliate of Cardinal Health
ELLIOTTS B SOLUTION (BUFFERED INTRATHECAL ELECTROLYTE/DEXTROSE INJECTION)
Elliotts B Solution, the first of the Company's products in the Oncology Support STMS, received marketing clearance from the FDA in September 1996. The first commercial sales of Elliotts B Solution occurred in December
1996. Elliotts B Solution is primarily used in a hospital setting and is distributed for the Company by an affiliate of Cardinal Health. Elliotts B Solution is a buffered diluent for the intrathecal administration (injection into the fluid space surrounding the central nervous system) of chemotherapeutic agents. Intrathecal injections are most commonly made in treating acute lymphoblastic leukemia ("ALL"). ALL is the most prevalent form of leukemia in children. Due to advances in chemotherapy, the cure rate for ALL has improved dramatically in the past 30 years, going from almost zero to nearly 75% today. As a part of modern chemotherapy, doctors often administer a series of up to 20 injections of methotrexate sodium into the cerebrospinal fluid of patients. Elliotts B Solution is comparable in pH, electrolyte composition, glucose content and osmolarity to cerebrospinal fluid. It is estimated that cerebrospinal injections of methotrexate sodium are administered to about 6,000 people in the United States on an annual basis. Elliotts B Solution revenues through December 2000 have not been material nor does the Company expect that revenues to be material in future periods.
The Company has obtained orphan drug status for the use of Elliotts B Solution as a diluent for methotrexate sodium or cytarabine, which provides marketing exclusivity through September 2003. Elliotts B Solution is a known compound that has been used previously for the intrathecal administration of chemotherapeutic agents and is, therefore, not patentable. The Company has contracted with a third party for the production of Elliotts B Solution under GMP conditions. No license was required for the Company to develop and market Elliotts B Solution.
SLEEP DISORDERS STMS - INVESTIGATIONAL PRODUCT
XYREM (SODIUM OXYBATE) ORAL SOLUTION
Narcolepsy is a chronic neurologic sleep disorder in which sleep is "fragmented", that is, does not occur in an integrated and cohesive manner. This fragmentation results in excessive daytime sleepiness, unavoidable daytime sleep attacks, cataplexy or sudden loss of muscle control provoked by emotions, sleep paralysis or brief periods of muscle paralysis and hallucinations, or vivid and sometimes frightening dreaming when falling asleep or waking up. Other related symptoms include broken night-time sleep, disturbances of auditory and visual perception, and lapses of consciousness and memory problems. These symptoms can lead to a variety of complications, such as limitations on education and employment opportunities, driving or machine accidents, difficulties at work resulting in disability, forced retirement or job dismissal, and depression. Narcolepsy is thought to affect as many as 125,000 patients in the United States and approximately 80,000 to 100,000 of these patients are thought to be diagnosed. Narcolepsy patients usually begin to develop symptoms between the ages of 15-25, with a smaller number developing symptoms between the ages of 35-45. Symptoms have been reported in patients as young as five years of age.
The usual treatment for narcolepsy includes symptomatic treatment of excessive daytime sleepiness and sleep attacks with stimulants or wakefulness promoting agents. The symptoms of cataplexy, sleep paralysis and hypnagogic hallucinations are typically treated with tricyclic antidepressants ("TCAs") or selective serotonin reuptake inhibitors ("SSRIs"). These treatment regimens, in addition to limited efficacy, are often unsatisfactory for a number of other reasons. Amphetamines and other stimulants often cause undesirable side effects such as insomnia, hypertension, palpitations, irritability and, at higher doses, may mimic the symptoms of schizophrenia. Patients often build tolerance to the TCAs and SSRIs and doses are increased to obtain clinical effectiveness at high doses. These medications can cause the side effects of dry mouth, impotence, loss of libido, and increased heart rate. Clinical results with Xyrem suggest that it is effective in the treatment of narcolepsy symptoms. When administered at night, it is believed to consolidate sleep and has been shown to improve cataplexy, and to reduce the severity of daytime sleepiness. More than 300 narcolepsy patients have been exposed to clinical doses with a satisfactory side effect profile, some of these patients for up to 15 years of treatment. Xyrem does not appear to have the side effects associated with TCAs and SSRIs. Narcoleptic patients could be treated with Xyrem at night and, if needed, with stimulants during waking hours.
Provigil(R) (modafinil), a product marketed by Cephalon, Inc., was approved by the FDA in late 1998 for the treatment of excessive daytime sleepiness associated with narcolepsy. The Company believes that Provigil and the proposed use for Xyrem focus on different symptoms of narcolepsy, which could mean that some patients may benefit from both modafinil and Xyrem. Provigil(R) is a registered trademark of Cephalon, Inc.
During 1998, the Company completed a clinical trial with over 130 patients at 18 sleep centers, which assessed Xyrem at different dose levels against placebo. When compared against placebo, higher doses of Xyrem demonstrated a reduction in the number and severity of cataplexy attacks per week, the primary measure of efficacy in this clinical trial. The secondary measure of efficacy was the reduction of excessive daytime sleepiness, as measured by the Epworth Sleepiness Scale, a subjective, but validated measure of EDS. At higher doses, Xyrem appeared to reduce EDS beyond the improvement provided by stimulants which patients continued to take during the trial.
During the first quarter of 1999, the Company commenced a Treatment IND program, which is a clinical trial, to collect additional clinical safety data necessary for the submission of an NDA. The FDA permits an investigational drug, like Xyrem, to be used under a Treatment IND if there is sufficient evidence of safety and effectiveness and the drug is intended to treat a serious disease. The FDA also authorized the Company to seek reimbursement from patients and their insurance providers for the use of Xyrem in this trial, which has allowed the education of certain third party payors regarding Xyrem.
Gamma hydroxybutyrate (GHB) is the active ingredient in Xyrem. Illicitly produced GHB has been reported to be a drug of abuse. On February 18, 2000, the President signed PL 106-172, a public law which makes GHB a Schedule I substance. Schedule I is the designation by which illegal drugs are controlled. The bill further delineates GHB products being studied under Food and Drug Administration (FDA) approved protocols or approved for commercial sale as Schedule III substances.
Each state has the ability to schedule products more strictly or equivalent to the Federally designated schedule. Most states have adopted, either administratively or legislatively, the I/III schedule as described above. The Company continues its efforts to ensure consistency across all states by the time of commercial launch.
Sodium oxybate (GHB), the active ingredient in Xyrem, is a known compound and is not patentable. The Company has received an orphan drug designation for its proposed use of Xyrem. No license was required for the Company to develop Xyrem nor will a license be required to market Xyrem, if approved by the FDA. The Company has contracted with third party bulk drug and drug product manufacturers for the production of Xyrem.
The Company submitted its NDA for Xyrem on October 2, 2000. The NDA was granted priority review status by the FDA, meaning the FDA has a goal of reaching a decision to either approve or disapprove or delay a decision regarding the NDA within 180 days of submission. The FDA canceled a March 15, 2001 Peripheral and Central Nervous System Advisory Committee review. This meeting had been scheduled to review and discuss the efficacy, safety and risk management of the Xyrem. The FDA took this action in conjunction with its request for clarification of supplemental data outside of Orphan sponsored trials. The Company has submitted additional data in response to FDA's request. On March 29, 2001, the FDA extended by 90 days its priority review of the Xyrem NDA. The decision was taken in order to review the additional data recently submitted to the FDA by the Company. The FDA will continue its review and reschedule a meeting of the Peripheral and Central Nervous System Advisory Committee in early June. The FDA's new action deadline for this NDA is now early July.
The Company is continuing a Phase III (b) third clinical trial for Xyrem, which the FDA has previously indicated is not required for the Company's NDA submission. This controlled clinical trial assesses the efficacy of Xyrem for treating excessive daytime sleepiness (EDS) related to narcolepsy as its primary endpoint. This trial continues to move forward toward completion late in 2001.
OTHER APPROVED PRODUCTS
CYSTADANE (BETAINE ANHYDROUS FOR ORAL SOLUTION)
Cystadane received marketing clearance from the FDA in October 1996. The first commercial sales of Cystadane occurred in December 1996. Cystadane is principally distributed on a non exclusive basis by Chronimed Inc. directly to patients in the United States through its mail order pharmacy. Although Cystadane does not fit into one of the Company's three STMS, the Company believes that the small size of the market and the high medical value of Cystadane justify the limited resources required by the Company to continue making this product available to patients. It is the first agent approved by the FDA for the treatment of homocystinuria, an inherited metabolic disease. The clinical consequences are wide-ranging and include dislocation of the ocular lens, early (under age 30) thromboembolism, developmental and mental retardation and reduced life span related to elevated plasma homocysteine levels. It has been estimated that homocystinuria occurs about once in every 200,000 live births worldwide. There are estimated to be 1,000 patients with homocystinuria in the United States. The annual market potential for Cystadane is expected to be under $500,000 in the United States. The Company does have some sales revenue generated outside of the United States. Cystadane revenues met the Company's expectations in 2000 and are expected to grow slightly in subsequent periods.
The Company has obtained orphan drug status for Cystadane for the treatment of homocystinuria, which provides marketing exclusivity to the Company through October 2003. Betaine anhydrous, the active ingredient in Cystadane, is a known compound and is not patentable. The Company has contracted with a third party for the production of Cystadane under GMP conditions. No license was required for the Company to develop and market Cystadane.
The Company is not currently sponsoring any clinical trials with/for Cystadane. The Company is aware, however, of clinical trials being conducted by independent investigators to assess the safety and efficacy of Cystadane as a stand alone or adjunctive therapy for the following indications: Non-alcoholic steatohepatitis, Rett syndrome, rheumatoid arthritis and hyperhomocystinemia. The Company does not expect that the results of any of these clinical trials to significantly enhance or decrease the current limited market potential for Cystadane.
ANTIZOL-VET (FOMEPIZOLE) FOR INJECTION
In November 1996, the Center for Veterinary Medicine of the FDA approved Antizol-Vet as a treatment for dogs that have ingested or are suspected of having ingested ethylene glycol. The first commercial sales of Antizol-Vet occurred in January 1997. It is estimated that at least 10,000 cases of ethylene glycol poisoning occur in dogs each year. The earlier an ethylene glycol poisoned dog is treated with Antizol-Vet, the more likely that there will be a positive outcome. The annual market potential for Antizol-Vet is expected to be under $300,000. Although Antizol-Vet is not included in one of the Company's three STMS, the Company will continue making Antizol-Vet available to veterinarians justifying the limited resources required by the Company to market and distribute the product. The Company has found that stocking of this product has been limited due to its high cost, but it is ordered when a poisoning occurs. Antizol-Vet revenues met the Company's expectations in 2000 and are expected to remain constant or decline in subsequent periods.
Federal law provides the Company with a marketing exclusivity period through November 2001 for the use of Antizol-Vet in dogs for the approved indication. Fomepizole, the active ingredient in Antizol, is a known compound and is not patentable. The Company has contracted with a third party for the production of Antizol-Vet under GMP conditions.
The Company has partnered with seven leading regional and national veterinary wholesalers to distribute Antizol-Vet to veterinary clinics. It is believed that the current partners effectively and efficiently encompass the entire country with limited sales territory overlap, thus helping prevent downward retail pricing pressures. The Company does not anticipate adding additional distribution partners.
SUCRAID (SACROSIDASE) ORAL SOLUTION
Sucraid received marketing clearance from the FDA in April 1998. The first commercial sales of Sucraid occurred in July 1998. Sucraid is principally distributed by an affiliate of Cardinal Health directly to patients in the United States. The FDA approved Sucraid to be used for oral replacement therapy of genetically determined sucrase deficiency, which is part of congenital sucrase isomaltase deficiency (CSID). Sucraid is used as a replacement for an enzyme in the small intestine that is necessary for the digestion of sucrose, which is common table sugar. Although Sucraid does not fit into one of the Company's three STMS, the Company believes that the small size of the market and the high medical value of Sucraid justify the limited resources required by the Company for making this product available to patients. The annual market potential for Sucraid is expected to be approximately $500,000 in the United States. Sucraid revenues met the Company's expectations and are expected to grow slightly in 2001.
The primary symptoms of CSID include severe watery diarrhea, chronic malabsorption and, in infants and toddlers, failure to thrive. Other common symptoms include nausea, vomiting, abdominal cramps and abdominal pain following the consumption of foods containing sucrose. Prior to the approval of Sucraid, the only specific treatment of CSID available to patients was the life-long adherence to a sucrose-free diet. Compliance with a sucrose-free diet is very difficult because sucrose is found in many foods in the typical American diet. Nonspecific symptomatic treatments include antidiarrheal, antispasmodic and antiflatulence drugs, all of which are limited in their efficacy. Sucraid is a specific replacement of the missing enzyme responsible for CSID.
Sacrosidase, the active ingredient in Sucraid, is a known compound and is not patentable. The Company has obtained orphan drug status for Sucraid for the approved indication, which provides marketing exclusivity to the Company through April 2005. The Company has contracted with a third party for the production of Sucraid under GMP conditions. In addition, the Company has an exclusive, worldwide license from Hartford Hospital to develop and market Sucraid, which expires in April 2005. The license provides for two five year extension options, the first through April 2010 and the second through April 2015, unless either party decides to terminate the license within 90 days prior to April 2005 or April 2010.
RISK FACTORS
An investment in our common stock involves a number of risks, including among others, risks associated with companies that operate in the pharmaceutical industry. These risks are substantial and inherent in our operations and industry. Any investor or potential investor should carefully consider the following information about these risks before buying shares of common stock.
WE HAVE A HISTORY OF LOSSES, WHICH WE EXPECT TO CONTINUE.
We have been unprofitable since our inception in January 1993. We expect operating losses in 2001 and 2002 because anticipated gross profits from product revenues will not offset our operating expenses and additional spending to continue drug development activities. The amount of these losses may vary significantly from year-to-year and quarter-to-quarter. Our actual losses will depend on, among other factors, the timing of product development, regulatory approval, and market demand for our Food and Drug Administration ("FDA") approved products. We cannot assure you that we will ever generate sufficient product revenues to achieve profitability.
LIMITATIONS TO SOURCES OF ADDITIONAL CAPITAL - RESTRICTIONS, COVENANTS AND RIGHTS RELATED TO SENIOR CONVERTIBLE PREFERRED STOCK AND SERIES B CONVERTIBLE PREFERRED STOCK.
On July 23, 1998, we completed the private sale to UBS Capital of $7.5 million of Senior Convertible Preferred Stock. On August 2, 1999, we completed another private sale to UBS Capital of $2.95 million of Series B Convertible Preferred Stock. In conjunction with the issuance of the preferred shares, we agreed to several restrictions and covenants, and granted certain voting and other rights to the holders of the preferred shares. One of the most important of these restrictions is that we cannot incur additional indebtedness, except for indebtedness secured solely by our trade receivables, until we have profitable operations, subject to certain limitations. Another important restriction is that, without the approval of a majority of the preferred stockholders, we cannot issue additional equity securities unless the selling price per share exceeds the then conversion price of the outstanding convertible preferred stock or the sale of equity is accomplished in a public offering. The present conversion price is $8.14 per share for the Senior Convertible Preferred Stock and $6.50 for the Series B Convertible Preferred Stock. These restrictions could make it more difficult and more costly for us to obtain additional capital. We cannot assure you that additional sources of capital will be available to us or, if available, on terms acceptable to us.
POSSIBLE PRICE VOLATILITY AND LIMITED LIQUIDITY OF STOCK.
There is generally significant volatility in the market prices and limited liquidity of securities of early stage companies, and particularly of early stage pharmaceutical companies. Contributing to this volatility are various factors and events that can affect our stock price in a positive or negative manner. These factors and events include, but are not limited to:
o announcements by us or our competitors of new product developments or clinical testing results;
o governmental approvals, refusals to approve, regulations or actions;
o developments or disputes relating to patents or proprietary rights;
o public concern over the safety of therapies;
o financial performance;
o fluctuations in financial performance from period to period; and
o small float or number of shares of our stock available for sale and trade.
These and other factors and events may have a significant impact on our business and on the market price of the common stock.
WE CANNOT BE SURE THAT FUTURE CAPITAL WILL BE AVAILABLE TO MEET OUR EXPECTED CAPITAL REQUIREMENTS.
Although we believe that we have sufficient capital to meet out current business objectives, if we expand our business plans, we may need additional capital. Adequate funds for our operations, continued development, and expansion of our business plans, whether from financial markets or from other sources, may not be available when needed on acceptable terms, or at all. If we issue additional securities your holding may be diluted.
POSSIBLE VOLATILITY OF STOCK PRICE AND REDUCED LIQUIDITY OF THE MARKET FOR THE STOCK - POSSIBLE LOSS OF NASDAQ NATIONAL MARKET LISTING AND FAILURE TO QUALIFY FOR NASDAQ SMALL CAP MARKET LISTING.
There is a risk that the market value and the liquidity of the public float for our common stock could be adversely affected in the event we no longer meet the Nasdaq's requirements for continued listing on the National Market. For continued listing on the Nasdaq National Market, a company must satisfy a number of requirements, which in our case includes either: (1) net tangible assets in excess of $4.0 million as reported on Form 10-Q or Form 10-K or (2) a market capitalization of at least $50.0 million. Net tangible assets are defined as total assets less the sum of total liabilities and intangible assets. Market capitalization is defined as total outstanding shares multiplied by the last sales price quoted by Nasdaq. We met both of these criteria as of December 31, 2000, however, we cannot assure you that the market capitalization threshold will continue to be met or that we will continue to have adequate capital to meet the net tangible asset requirement.
THERE IS A LIMITED MARKET FOR OUR PRODUCTS.
Most orphan drugs have a potential United States market of less than $25 million annually and many address annual markets of less than $1 million. We cannot assure you that sales of our products will be adequate to make us profitable even if the products are accepted by medical specialists and used by patients.
WE RELY ON THE LIMITED PROTECTION OF THE ORPHAN DRUG ACT.
UNITED STATES
Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs intended to treat a "rare disease or condition." The Orphan Drug Act generally defines "rare disease or condition" as one that affects populations of fewer than 200,000 people in the United States. The Orphan Drug Act provides us with certain limited protections for our products.
The first step in obtaining the limited protection under the Orphan Drug Act is acquiring the FDA's approval of "orphan drug designation," which must be requested before submitting a New Drug Application ("NDA"). After the FDA grants orphan drug designation, it publishes the generic identity of the therapeutic agent and the potential orphan use specified in the request. Orphan drug designation does not constitute FDA approval. In addition, orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory approval process.
The second step in obtaining the limited protection under the Orphan Drug Act is acquiring the FDA's recognition of "orphan drug status." The Orphan Drug Act confers orphan drug status upon the first company to receive FDA approval to market a drug with "orphan drug designation" for a specific designated indication. Orphan drug status does not protect against another formulation or drug of materially different composition from being approved, with or without orphan drug status, for the same indication. FDA approval also results in United States marketing exclusivity for a period of seven years, subject to certain limitations. Although obtaining FDA approval to market a product with orphan drug status can be advantageous, we cannot assure you that the scope of protection or the level of marketing exclusivity will remain in effect in the future. In addition, United States orphan drug status does not provide any marketing exclusivity in foreign markets. Although certain foreign countries provide development and marketing benefits to orphan drugs, we cannot assure you that such benefits can be obtained or, if obtained, will be of material value to us. The FDA has granted us orphan drug status for Antizol, Elliotts B Solution, Cystadane, Sucraid, and Busulfex.
We have obtained orphan drug designation for Xyrem and, on October 2, 2000, we submitted an NDA for approval. Sodium oxybate is the generic identity of the therapeutic agent for Xyrem. Despite orphan drug designation for Xyrem, another pharmaceutical company could attempt to develop sodium oxybate for the same designated indication as Xyrem or may seek approval of an NDA for their drug prior to the approval of an NDA for Xyrem. If the FDA first approves another sponsor's NDA for sodium oxybate and for the same indication as Xyrem, that sponsor will be entitled to exclusive marketing rights. In that case, the FDA would not approve our application to market Xyrem for seven years, if at all. We are aware that the FDA has granted Teva (formerly Biocraft) orphan drug designation for the use of sodium oxybate to treat the symptoms of narcolepsy, however, we have obtained the exclusive right to use Teva's data for one controlled study in our NDA submission. We cannot assure you that the FDA will approve Xyrem first for the designated indication. We also cannot assure you that the FDA will not grant orphan drug designation and marketing approval to other competing products prior to approving our NDA for Xyrem.
Even if the FDA approves an NDA for a drug with an orphan drug designation, the FDA may still approve the same drug for a different indication, or a molecular variation of the same drug for the same indication. We are aware that the FDA granted to Sparta Pharmaceutical, which has been acquired by SuperGen Inc., orphan drug designation for an intravenous busulfan for a closely related indication. If the FDA approves an NDA for SuperGen drug for a different indication, SuperGen could seek orphan drug status. In addition, the FDA does not restrict doctors from prescribing an approved drug for uses not approved by the FDA for that drug. Thus, a doctor could prescribe another company's drug for indications for which our product has received FDA approval and orphan drug status. Significant "off label" use, that is, prescribing approved drugs for unapproved uses, could adversely affect the marketing potential of any of our products that have received orphan drug status and NDA approval by FDA.
The possible amendment of the Orphan Drug Act by Congress has been the subject of congressional discussion from time to time over the last ten years. Although Congress has made no significant changes to the Orphan Drug Act for a number of years, members of Congress have from time to time proposed legislation that would limit the application of the Orphan Drug Act. We cannot assure you that the Orphan Drug Act will remain in effect or that it will remain in effect in its current form. The precise scope of protection that orphan drug designation and marketing approval may afford in the future is unknown. We cannot assure you that the current level of exclusivity will remain in effect.
EUROPE
An orphan drug act was enacted in Europe that provides up to ten years of market exclusivity for a drug that meets the requirements of the act. For a pharmaceutical product to qualify for the benefits of the act, the prevalence or incidence (whichever is greater) must not exceed five patients per 10,000 population. Our European partners have submitted both Busulfex and Cystadane for designation as orphan drugs in Europe. The Company has also submitted Xyrem and Antizol, for use in methanol poisonings, for designation as orphan drugs in Europe. We cannot provide assurance that any of our pharmaceutical products will qualify for orphan drug protection in Europe or that another company will not obtain an approval which would block us from marketing our product in Europe.
THE FDA AND FOREIGN REGULATORY AUTHORITIES MUST APPROVE OUR PRODUCTS FOR SALE.
Government regulation in the United States and abroad is a significant factor in the testing, production and marketing of our current and future products. Each product must undergo an extensive regulatory review process conducted by the United States Food and Drug Administration and by comparable agencies in other countries. We cannot market any medicine we may develop or license as a prescription product in any jurisdiction, including foreign countries, in which the product does not receive regulatory approval. The approval process can take many years and requires the expenditure of substantial resources.
We depend on external laboratories and medical institutions to conduct our pre-clinical and clinical analytical testing in compliance with clinical and laboratory practices established by the FDA. The data obtained from pre-clinical and clinical testing is subject to varying interpretations that could delay, limit or prevent regulatory approval. In addition, changes in FDA policy for drug approval during the period of development and in the requirements for regulatory review of each submitted NDA could result in additional delays or outright rejection.
We cannot assure you that the FDA or any foreign regulatory authority will approve in a timely manner, if at all, any product we develop. Generally, the FDA and foreign regulatory authorities approve only a very small percentage of newly discovered pharmaceutical compounds that enter pre-clinical development. Moreover, even if the FDA approves a product, it may place commercially unacceptable limitations on the uses, or "indications," for which a product may be marketed. This would result in additional cost and delay for further studies to provide additional data on safety or effectiveness.
FDA APPROVAL DOES NOT GUARANTEE FINANCIAL SUCCESS.
Six of our products have been approved for marketing by regulatory authorities in the United States or elsewhere. Even if we obtain FDA approval to market Xyrem, we cannot assure you that Xyrem or our other products will be commercially successful or achieve the expected financial results. We may encounter unanticipated problems relating to the development, manufacturing, distribution and marketing of our products. Some of these problems may be beyond our financial and technical capacity to solve. The failure to adequately address any such problems could have a material adverse effect on our business and our prospects. In addition, the efforts of government
entities and third party payors to contain or reduce the costs of health care may adversely affect our sales and limit the commercial success of our products.
We cannot completely insulate our drug development portfolio from the possibility of clinical or commercial failures. Some products that we have selected for development may not produce the results expected during clinical trials or receive FDA approval. Drugs approved by the FDA may not generate product sales of an acceptable level. We have discontinued the development of eleven products from our portfolio since inception.
SIGNIFICANT GOVERNMENT REGULATION CONTINUES ONCE A PRODUCT IS APPROVED FOR SALE.
After a reviewing division of the FDA approves a drug, the FDA's Division of Drug Marketing, Advertising and Communication must accept such drug's marketing claims, which are the basis for the drug's labeling, advertising and promotion. We cannot be sure that the Division of Drug Marketing, Advertising and Communication will accept our proposed marketing claims. The failure of the Division of Drug Marketing, Advertising and Communication to accept our proposed marketing claims could have a material adverse effect on our business and prospects.
The FDA requires that a company conduct "post-marketing adverse event surveillance programs" to monitor any side effects that occur after the company's drug is approved for marketing. If the surveillance program indicates unsafe side effects, the FDA may recall the product, and suspend or terminate a company's authorization to market the product. The FDA also regulates the manufacturing process for an approved drug. The FDA may impose restrictions or sanctions upon the subsequent discovery of previously unknown problems with a product or manufacturer. One possible sanction is requiring the withdrawal of such product from the market. The FDA must approve any change in manufacturer as well as most changes in the manufacturing process prior to implementation. Obtaining the FDA's approval for a change in manufacturing procedures or change in manufacturers is a lengthy process and could cause production delays and loss of sales, which would have a material adverse effect on our business and our prospects.
Certain foreign countries regulate the sales price of a product after marketing approval is granted. We cannot be sure that we can sell our products at satisfactory prices in foreign markets even if foreign regulatory authorities grant marketing approval.
WE RELY ON OTHERS FOR PRODUCT DEVELOPMENT OPPORTUNITIES.
We engage only in limited research to identify new pharmaceutical compounds. To build our product portfolio, we have adopted a license and acquisition strategy. This strategy for growth requires us to identify and acquire pharmaceutical products targeted at niche markets within selected strategic therapeutic market segments. These products usually require further development and approval by regulatory bodies before they can be marketed. We cannot assure you that any such products can be successfully developed, approved or marketed. We must rely upon the willingness of others to sell or license pharmaceutical product opportunities to us. Other companies, including those with substantially greater resources, compete with us to acquire such products. We cannot assure you that we will be able to acquire rights to additional products on acceptable terms, if at all. Our failure to acquire or license any new pharmaceutical products or products that fit within one of our strategic therapeutic market segment, or our failure to promote and market any products successfully or products within an existing strategic therapeutic market segment, could have a material adverse effect on our business and our prospects.
We have contractual development rights to certain compounds through various license agreements. Generally, the licensor can unilaterally terminate these agreements for several reasons, including, but not limited to the following reasons:
o for cause if we breach the contract;
o if we become insolvent or bankrupt;
o if we do not apply specified minimum resources and efforts to develop the compound under license; or
o if we do not achieve certain minimum royalty payments, or in some cases, minimum sales levels.
We cannot assure you that we can meet all specified requirements and avoid termination of any license agreements. We cannot assure you that if any agreement is terminated, we will be able to enter into similar agreements on terms as favorable as those contained in our existing license agreements.
WE DEPEND ON OTHERS TO MANUFACTURE AND SUPPLY THE PRODUCTS WE MARKET.
We do not have and do not intend to establish any internal product testing, synthesis of bulk drug substance, or manufacturing capability for drug product. Accordingly, we depend on others to supply and manufacture the components incorporated into all of our finished drug products. The inability to contract for these purposes on acceptable terms could adversely affect our ability to develop and market our products. Failure by parties with whom we contract to adequately perform their responsibilities may delay the submission of products for regulatory approval, impair our ability to deliver our products on a timely basis or otherwise adversely affect our business and our prospects. The loss of a supply or manufacturing contractor could materially adversely affect our business and our prospects.
The loss of either a bulk drug supplier or drug product manufacturer would require us to obtain regulatory clearance in the form of a "pre-approval submission" and incur validation and other costs associated with the transfer of the bulk drug or drug product manufacturing process. We believe that it could take as long as one year for the FDA to approve such a submission. Because our products are targeted to relatively small markets and our manufacturing production runs are small by industry standards, we have not incurred the added costs to certify and maintain secondary sources of supply for bulk drug substance or backup drug product manufacturers for some products. Should we lose either a bulk drug supplier or a drug product manufacturer, we could run out of salable product to meet market demands or investigational product for use in clinical trials, while we wait for the FDA approval of a new bulk drug supplier or drug product manufacturer. We cannot assure you that the change of a bulk drug supplier or drug product manufacturer and the transfer of the processes to another third party will be approved by the FDA, and if approved, in a timely manner. The loss of or the change of a bulk drug supplier or a drug product manufacturer could have a material adverse effect on our business and prospects.
Bulk Drug Supply
Bulk drug substance is the active chemical compound used in the manufacture of our drug products. We depend substantially on Ash Stevens, Inc. for the supply of bulk drug substance used in Busulfex, Antizol, and Antizol-Vet. If we were to lose Ash Stevens as a supplier, we would be required to identify a new supplier for the bulk drug substance used in products that provided approximately 88% of 2000 and 90% of 1999 revenues and are expected to generate approximately 85% of 2001 total revenues. We depend substantially on Lonza, Inc. for the supply of bulk drug substance used in Xyrem. If we were to lose Lonza as a supplier, we would be required to identify a new supplier before an NDA is submitted for Xyrem. We also cannot assure you that our bulk drug supply arrangements with Ash Stevens and Lonza, or any other future such supplier, might not change in the future. We cannot assure you that any change would not adversely affect production of Busulfex, Antizol, Antizol-Vet, Xyrem, or any other drug the Company might attempt to develop or market.
Drug Product Manufacture
From bulk drug substance, drug product manufacturers formulate a finished drug product and package the product for sale or for use in clinical trials. We depend substantially on an affiliate of Boehringer Ingelheim for drug product manufacturing of Busulfex, Antizol, and Antizol-Vet. If we were to lose Boehringer as a manufacturer, we would be required to identify a new manufacturer for drug products that provided approximately 88% of 2000 and 90% of 1999 and are expected to generate approximately 85% of 2001 total revenues. We have identified Catalytica Pharmaceuticals, Inc. as drug product manufacturer for Xyrem and have contracted with them for its manufacture. Currently, however, we do not have a contract with. We cannot assure you that our drug product manufacturing arrangements with Boehringer and Catalytica will not change in the future. We cannot assure you that any change would not adversely affect production of Busulfex, Antizol, Antizol-Vet, or Xyrem, or any other drug that we might attempt to develop or market.
WE CANNOT CONTROL OUR CONTRACTORS' COMPLIANCE WITH APPLICABLE REGULATIONS.
The FDA defines and regulates good manufacturing practices to which bulk drug suppliers and drug product manufacturers are subject. The Drug Enforcement Agency (DEA) defines and regulates the handling and reporting requirements for certain drugs which have abuse potential, known as "scheduled drugs". Foreign regulatory authorities prescribe similar rules and regulations. Our supply and manufacturing contractors must comply with these regulatory requirements. Failure by our contractors to comply with FDA or DEA requirements or applicable foreign requirements could result in significant time delays or in our inability to commercialize or continue to market a
product. Either result could have a material adverse effect on our business and prospects. Failure to comply with good manufacturing practices or other applicable legal requirements can lead to federal seizure of violative products, injunctive actions brought by the federal government, or potential criminal and civil liability for Orphan, our officers, or our employees. We cannot assure you that we will be able to maintain relationships either domestically or abroad with contractors whose facilities and procedures comply or will continue to comply with FDA or DEA requirements or applicable foreign requirements.
WE DEPEND UPON OTHERS FOR DISTRIBUTION.
We have an agreement with Cardinal Health, Inc. to provide a variety of services to support the effective distribution of our currently approved products. Cardinal will provide integrated distribution and operations services to process and support transactions between us and our wholesalers, specialty distributors, and direct customers. Cardinal will also provide patient assistance and information hotline services, and specialty distribution and marketing services to physician practices. Cardinal currently distributes Busulfex, Elliotts B Solution, Antizol, Antizol-Vet, and Sucraid. Cardinal may also distribute our proposed products should those products receive marketing clearance from the FDA. We will substantially depend upon Cardinal's ability to successfully distribute Busulfex, Elliotts B Solution, Antizol, Antizol-Vet, and Sucraid and potentially any other of our products that may receive marketing clearance from the FDA in the future.
Chronimed Inc. is the principal distributor, on a non-exclusive basis, in the United States for Cystadane. Chronimed distributes this product directly to patients through its mail order pharmacy. We substantially depend upon Chronimed's ability to successfully distribute Cystadane directly to patients in the United States.
We cannot assure you that other distribution companies would be available or continue to be available on commercially acceptable terms. The loss of a distributor or failure to renew agreements with an existing distributor could have a material adverse effect on our business and prospects.
WE RELY ON FOREIGN MARKETING ALLIANCES AND HAVE NO ASSURANCE OF FOREIGN LICENSEES.
Our strategy to sell our products in foreign markets is to license foreign marketing and distribution rights to a foreign company after a new drug application (referred to in the industry as an "NDA") is submitted or approved in the United States. We consider Europe, Asia, and Canada our most attractive foreign markets. Our current foreign developments are:
o Europe. We have licensed the marketing and distribution rights for Busulfex, Antizol, Cystadane and Sucraid in Europe. If our licensees are unsuccessful in their registration and distribution efforts, we may find it difficult to contract with other distributors for these products within Europe. Distribution of all products except Antizol is limited to "named patient" or "emergency use" basis until full regulatory approval is obtained. Antizol has been approved for use in the United Kingdom but is limited to "named patient" basis in other parts of Europe. This "emergency use" distribution of the Company's products is expected to result in a limited contribution to the Company's revenues.
o Australia and New Zealand. We have licensed marketing and distribution rights for Cystadane and Sucraid in Australia and New Zealand, but sales of these products have not been material. We do not expect sales to increase in the near future to the point that they become material.
o Israel. We have licensed marketing and distribution rights for Antizol, Busulfex, Cystadane, Elliotts B Solution and Sucraid in Israel. Full regulatory approval for all products except Antizol was obtained in Israel in February 2000. Antizol has been submitted for approval, however, approval has not yet been received. We do not expect such distribution to result in material revenues.
o Canada. We have licensed marketing and distribution rights for Antizol in Canada. For Cystadane we have only licensed the distribution rights in Canada. We do not expect such distribution to result in material revenues.
o Central America. We have licensed marketing and distribution rights for Elliotts B Solution in Central America, but sales have not been material. We do not expect domestic or foreign sales of Elliotts B Solution to become material.
o Asia. We have licensed marketing and distribution rights for Busulfex in Japan, the Peoples Republic of China, Taiwan and South Korea. Distribution is limited to clinical trial usage until full regulatory approval is achieved. We have also licensed marketing and distribution rights for Busulfex in Turkey.
We depend on our foreign licensees for the regulatory registration of our products in foreign countries. We cannot be sure that our licensees can obtain such registration. In addition, we cannot be sure that we will be able to negotiate commercially acceptable license agreements for our other products or in additional foreign countries. Furthermore, we cannot assure you that these companies will be successful in marketing and selling our products in their respective territories.
OUR PRODUCTS MIGHT BE RECALLED.
A product can be recalled at our discretion or at the discretion of the FDA, the U.S. Federal Trade Commission, or other government agencies having regulatory authority for marketed products. A recall may occur due to disputed labeling claims, manufacturing issues, quality defects, or other reasons. We cannot assure you that a product recall will not occur. We do not carry any insurance to cover the risk of a potential product recall. Any product recall could have a material adverse effect on our business and prospects. To date, no recall of products marketed by the Company has occurred.
WE FACE LIMITS ON PRICE FLEXIBILITY AND THIRD-PARTY REIMBURSEMENT.
The flexibility of prices that we can charge for our products depends on government regulation, both in the United States and abroad, and on other third parties. One important factor is the extent to which reimbursement for our products will be available to patients from government health administration authorities, private health insurers and other third-party payors. Government officials and private health insurers are increasingly challenging the price of medical products and services. We are uncertain as to the pricing flexibility we will have with respect to, and if we will be reimbursed for, newly approved health care products.
In the United States, we expect continuing federal and state proposals to implement government control of the pricing and profitability of prescription pharmaceuticals. Cost controls, if mandated by a government agency, could decrease, or limit, the price we receive for our products or products we may develop in the future. We may not be able to recover our development costs, which could be substantial. We may not be able to realize an appropriate profit margin. This could have a material adverse effect on our business. Furthermore, federal and state regulations govern or influence reimbursement of health care providers for medical treatment of certain patients. We cannot assure you that actions taken by federal and/or state governments, if any, with regard to health care reform will not have a material adverse effect on our business and prospects.
Certain private health insurers and third-party payors may attempt to control costs further by selecting exclusive providers of pharmaceuticals. If such arrangements are made with our competitors, these insurers and third-party payors would not reimburse patients who purchase our competing products. This would diminish the market for our products and could have a material adverse effect on our business and prospects.
PATENTS AND OTHER PROPRIETARY RIGHTS ARE SIGNIFICANT FACTORS IN THE PHARMACEUTICAL INDUSTRY.
The pharmaceutical industry and the investment community places considerable importance and value on obtaining patent and trade secret protection for new technologies, products and processes. The patent position of pharmaceutical firms is often highly uncertain and generally involves complex legal, technical and factual questions. Our success depends on several issues, including, but not limited to our ability:
o to obtain, and enforce proprietary protection for our products under United States and foreign patent laws and other intellectual property laws;
o to preserve the confidentiality of our trade secrets; and
o to operate without infringing the proprietary rights of third parties.
We evaluate the desirability of seeking patent or other forms of protection for our products in foreign markets based on the expected costs and relative benefits of attaining such protection. We cannot assure you that any patents will be issued from any applications or that any issued patents will afford us adequate protection or competitive advantage. Also, we cannot assure you that any issued patents will not be challenged, invalidated, infringed or circumvented. Parties not affiliated with us have obtained or may obtain United States or foreign patents or possess or may possess proprietary rights relating to our products. We cannot assure you that patents now in existence or later issued to others will not adversely affect the development or commercialization of our products.
We believe that the active ingredients or compounds in our FDA approved and proposed products, Cystadane, Elliotts B Solution, Antizol, Antizol-Vet, Xyrem and Sucraid, are in the public domain and presently are not subject to patent protection in the United States. However, we have filed a patent application with respect to our formulation of Xyrem oral solution. United States patents issued to the licensor covers our formulation and use of Busulfex. We could, however, incur substantial costs asserting any infringement claims that we may have against others.
We seek to protect our proprietary information and technology, in part, through confidentiality agreements and inventors' rights agreements with our employees. We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise be disclosed to or discovered by our competitors. We also cannot assure you that our planned activities will not infringe patents owned by others. We could incur substantial costs in defending infringement suits brought against us. We also could incur substantial costs in connection with any suits relating to matters for which we have agreed to indemnify our licensors or distributors. An adverse outcome in any such litigation could have a material adverse effect on our business and prospects. In addition, we often must obtain licenses under patents or other proprietary rights of third parties. We cannot assure you that we can obtain any such licenses on acceptable terms, if at all. If we cannot obtain required licenses on acceptable terms, we could encounter substantial difficulties in developing, manufacturing or marketing one or more of our products.
WE FACE INTENSE COMPETITION IN OUR INDUSTRY.
Competition in the pharmaceutical industry is intense. Potential competitors in the United States are numerous and include pharmaceutical, chemical and biotechnology companies. Many of these companies have substantially greater capital resources, marketing experience, research and development staffs and facilities than we do. We seek to limit potential sources of competition by developing products that are eligible for orphan drug status at NDA approval or other forms of protection. We cannot assure you, however, that our competitors will not succeed in developing similar technologies and products more rapidly than we can. Similarly, we cannot assure you that these competing technologies and products will not be more effective than any of those that we have developed or are currently developing.
WE EXPECT RAPID TECHNOLOGICAL AND OTHER CHANGE TO BE CONSTANT IN OUR INDUSTRY.
The pharmaceutical industry has experienced rapid and significant technological change as well as structural changes, such as those brought about by changes in heath care delivery or in product distribution. We expect that pharmaceutical technology will continue to develop and change rapidly, and our future success will depend, in large part, on our ability to develop and maintain a competitive position. Technological development by others may result in our products becoming obsolete before they are marketed or before we recover a significant portion of the development and commercialization expenses incurred with respect to such products. In addition, alternative therapies, new medical treatments, or changes in the manner in which health care is delivered or products provided could alter existing treatment regimes or health care practices, and thereby reduce the need for one or more of our products, which would adversely affect our business and our prospects.
WE FACE SUBSTANTIAL PRODUCT LIABILITY AND INSURANCE RISKS.
Testing and selling health care products entails the inherent risk of product liability claims. The cost of product liability insurance coverage has increased and is likely to continue to increase in the future. Substantial increases in insurance premium costs in many cases have rendered coverage economically impractical. We currently carry product liability coverage in the aggregate amount of $10 million for all claims made in any policy year. Although to date we have not been the subject of any product liability or other claims, we cannot assure you that we will be able to maintain product liability insurance on acceptable terms or that our insurance will provide adequate coverage against potential claims. A successful uninsured product liability or other claim against us could have a material adverse effect on our business and prospects.
ITEM 2.
ITEM 2. PROPERTIES
The Company currently occupies approximately 15,000 square feet of leased office space at a monthly rent of approximately $22,000, including operating expenses. This lease expires on October 31, 2003.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the National Market tier of The Nasdaq Stock Market under the Symbol: ORPH. The following table sets forth the quarterly high and low sales prices for the Company's Common Stock for the years ended December 31, 2000 and December 31, 1999.
As of March 20, 2001, the Company's Common Stock was held by 275 shareholders of record and the Company estimates that there were approximately 3,600 beneficial owners of its Common Stock on such date.
The Company has never declared or paid any dividends and does not anticipate paying dividends on its Common Stock in the foreseeable future. The Company currently intends to retain future earnings, if any, for use in the Company's business. The payment of any future dividends on its Common Stock will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial condition and requirements, restrictions in financing agreements, business conditions and other factors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company as of December 31, 2000 and 1999 and for the three years ended December 31, 2000, 1999 and 1998, are derived from, and are qualified by reference to, the financial statements of the Company audited by Ernst & Young LLP, independent auditors, included elsewhere in this Form 10-K. The selected financial data as of December 31, 1998, 1997 and 1996 and for each of the two years ending December 31, 1997 and 1996 are derived from financial statements which are not included herein. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Financial Statements and Notes thereto and other financial information included elsewhere in this Form 10-K.
FINANCIAL POSITION
FINANCIAL RESULTS
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company incorporated in Minnesota in June 1994 to carry on the business previously conducted by the Orphan Medical Division of Chronimed. In September 2000, the Company reincorporated in Delaware. Since its inception in January 1993, the activities of the Orphan Medical Division and the Company have consisted primarily of obtaining the rights for developing and marketing proposed pharmaceutical products, managing the development of these products and preparing for the commercial introduction of six products. The Company operates in a single business segment: pharmaceutical products. The Company has experienced recurring losses from operations and has generated an accumulated deficit through December 31, 2000 of $47.2 million. In addition, the Company expects to incur additional losses from operations in 2001.
RECENT DEVELOPMENTS
On October 2, 2000 the Company announced the submission to the FDA of a new drug application (NDA) for Xyrem(R) (sodium oxybate) oral solution as a treatment for symptoms in narcolepsy. The FDA had 60 days after submission of the NDA to accept or reject the application for review. On October 17, 2000, the Company announced that the FDA had granted the Company's Xyrem NDA priority review status. This status obligates FDA to a goal of acting on the NDA within six-months from the date of submission. The FDA grants priority review status for new drugs that represent a significant advancement over available therapies.
The NDA requests approval of Xyrem as a treatment for symptoms in narcolepsy, a chronic neurological disorder. In particular, Xyrem is intended to treat cataplexy, and to improve the symptoms of excessive daytime sleepiness. Narcolepsy is accompanied by fragmented nocturnal sleep, with sleepiness and inadvertent naps occurring in daytime hours throughout a 24-hour period whereas persons without the disease usually have more integrated and organized sleep at night. The symptom of excessive daytime sleepiness afflicts all narcolepsy patients. The central activity of Xyrem provides a positive change in sleep architecture. Xyrem increases delta wave sleep, the restorative component of sleep.
Cataplexy is the daytime manifestation of postural muscle weakness that normally occurs during REM sleep. This symptom, which occurs in an estimated 60-75% of narcolepsy patients, is triggered by emotional reactions such as laughter, anger, or surprise. Cataplexy can be very debilitating. In its most severe form, cataplexy causes a person to collapse suddenly and remain unable to move for a few seconds up to several minutes. Clinical trials that are included in this NDA indicate that Xyrem reduces the incidence of cataplexy.
Narcolepsy is estimated to affect approximately 125,000 individuals in the United States. The incidence in Europe is believed to mirror that of the United States.
Stimulants are used to address excessive daytime sleepiness associated with narcolepsy. Because stimulants do not treat cataplexy, tricyclic antidepressants and serotonin selective-reuptake inhibitors are usually prescribed attempting to control this symptom. Long-term treatment with these agents can be problematic due to limited efficacy, tolerance, and adverse side effects such as dry mouth, weight gain, tachycardia, and loss of libido. Because these agents suppress REM, abrupt cessation of treatment can result in "rebound'" cataplexy, a return of cataplexy more severe than pre-treatment levels.
The FDA canceled a March 15, 2001 review of the new drug application for Xyrem for the treatment of narcolepsy. The FDA's Peripheral and Central Nervous System Advisory Committee review had been scheduled to review and discuss the efficacy, safety and risk management of the Xyrem solution. The FDA took this action in conjunction with its request for clarification of supplemental data outside of Orphan sponsored trials. The Company has submitted additional data in response to FDA's request. On March 29, 2001, the FDA extended by 90 days its priority review of the Xyrem NDA. The decision was taken in order to review the additional data recently submitted to the FDA by the Company. The FDA will continue its review and reschedule a meeting of the Peripheral and Central Nervous System Advisory Committee in early June. The FDA's new action deadline for this NDA is now early July.
In early 2001, the Company announced positive preliminary results from pivotal clinical trials of Xyrem that support this NDA submission and indicate that Xyrem reduces serious symptoms in narcolepsy, in particular cataplexy and also have an effect in modifying excessive daytime sleepiness.
The Company is continuing efforts to broaden the proprietary protection relating to Xyrem. In addition to orphan drug designation (which can become orphan drug status with an approval), rights to patents covering the use of GHB
in the treatment of fibromyalgia have been obtained by the Company in the United States and Europe. A patent covering the current formulation in North America, Europe and Japan is also being pursued
In December 2000, the Company also announced that the Food and Drug Administration (FDA) approved its supplemental new drug application (NDA) for Antizol(R) (fomepizole) Injection for the treatment of methanol poisoning and was granted priority review status for the application. Methanol is a common toxic chemical that is found in many household substances such as windshield wiper fluid and cleaning solutions. Methanol poisoning may cause severe morbidity, including blindness or death. According to 1998 Annual Report of the American Association of Poison Control Centers Toxic Exposure Surveillance System, 585 patients were treated for methanol poisoning in 1998. Given the number of poisonings and that awareness of Antizol is high in hospitals with emergency facilities, the Company does not expect approval of the methanol indication to increase sales materially. A marketing application (NDS) was approved in Canada for Antizol to treat ethylene glycol poisonings in December 2000.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 2000 VS. TWELVE MONTHS ENDED DECEMBER 31, 1999
Revenues increased from $6.5 million for the twelve months ended December 31, 1999 to $11.2 million for the twelve months ended December 31, 2000, an increase of $4.7 million or 73%. Sales of both Antizol and Busulfex exceeded expectations in 2000. Busulfex continues to gain acceptance in the major cancer treatment centers and Antizol has become a standard of care in the treatment of ethylene glycol and methanol poisonings. The Company expects Antizol revenues to decline slightly in 2001 because most hospitals that were expected to stock Antizol have done so, and future orders will most likely be based on use. International sales of the Company's products increased in 2000. The sales of Cystadane, Sucraid Antizol-Vet and Elliotts B met the Company's expectations in 2000 and are not expected to increase significantly in 2001. Revenues will fluctuate from quarter to quarter and from year to year depending on, among other factors, demand for the Company's products, new product introductions and the Company's ability to optimize distribution of its approved products.
Cost of sales increased from $0.8 million or 12% of revenues for the twelve months ended December 31, 1999 to $1.5 million or 14% of revenues for the twelve months ended December 31, 2000, an increase of $0.7 million or 88%. The increase is primarily attributable to the increase in sales in 2000. Cost of sales as a percentage of revenues will fluctuate from quarter to quarter and from year to year depending on, among other factors, demand for the Company's products, new product introductions and the mix of approved products shipped.
Research and development expense increased from $5.0 million for the twelve months ended December 31, 1999 to $6.8 million for the twelve months ended December 31, 2000, an increase of $1.8 million or 36%. Development activities for Xyrem, principally clinical and toxicology spending, increased significantly over 1999 levels due to the commencement in 2000 of additional Xyrem clinical trials supporting additional future Xyrem claims and the completion of the submission of the NDA for Xyrem on October 2, 2000.
Sales and marketing expense increased from $3.4 million for the twelve months ended December 31, 1999 to $5.6 million for the twelve months ended December 31, 2000, an increase of $2.2 million or 65%. This increase is largely attributable to significantly higher spending related to the pre-approval market activities related to Xyrem and on-going marketing activities for Busulfex. The Company expects sales and marketing expenses to increase further in 2001 because of the anticipated commercialization of Xyrem in 2001 and additional support for the currently approved products.
General and administrative expense increased from $2.8 million for the twelve months ended December 31, 1999 to $4.1 million for the twelve months ended December 31, 2000, an increase of $1.3 million or 46%. This increase related to building infrastructure, including the addition of staff to prepare for the anticipated launch of Xyrem. General and administrative expenses are not expected to increase significantly above current levels in subsequent quarters.
Other income is interest income from investment activities. Other income increased from $0.3 million for the twelve months ended December 31, 1999 to $0.8 million for the twelve months ended December 31, 2000. As a result of higher levels of invested funds from the proceeds of the private placement in February 2000, interest income has increased during 2000. Other income is expected to decrease during 2001 as invested funds are used to fund operations during the year.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were $0.9 million for the twelve months ended December 31, 2000 compared to $0.7 million for the twelve months ended December 31, 1999. Preferred stock dividends, which commenced on February 1, 1999, are payable in arrears on August 1 and February 1 of each year. The Company previously satisfied its dividend payment obligation by issuing additional preferred stock, as permitted by the terms of the Senior Convertible Stock. The Company intends to continue to satisfy its future dividend payment obligations by the issuance of unregistered common shares of stock for the Senior Convertible Preferred Stock and additional preferred stock for the Series B Convertible Preferred Stock, which will cause preferred stock dividends to increase in subsequent quarters.
Net loss applicable to common shareholders was $(7.0) million for the twelve months ended December 31, 2000 compared to a net loss of $(5.9) million for the twelve months ended December 31, 1999. Basic and diluted loss per common share for these respective periods were $(0.86) and $(0.90), based on weighted average number of common shares outstanding of 8,135,224 and 6,587,790, respectively.
TWELVE MONTHS ENDED DECEMBER 31, 1999 VS. TWELVE MONTHS ENDED DECEMBER 31, 1998
Revenues increased from $5.0 for the twelve months ended December 31, 1998 to $6.5 million for the twelve months ended December 31, 1999, an increase of $1.5 million or 28%. The Company received approval for Busulfex in February 1999 and began shipping product within two weeks. Antizol revenue in 1999 declined compared to 1998 reflecting the initial stocking of this product by hospitals during 1998. The sales of Cystadane, Sucraid, Antizol-Vet and Elliotts B met the Company's expectations in 1999.
Cost of sales decreased from $1.1 million or 22% of revenues for the twelve months ended December 31, 1998 to $0.8 million or 12% of revenues for the twelve months ended December 31, 1999, a decrease of $0.3 million or 28%. The decrease is primarily attributable to a $0.1 million reduction in the allowance for product returns in 1999 and a $0.1 million write off of inventory in the prior year related to Antizol and Antizol-Vet inventories.
Research and development expense decreased from $6.6 million for the twelve months ended December 31, 1998 to $5.0 million for the twelve months ended December 31, 1999, a decrease of $1.6 million or 25%. In February 1999, the Food and Drug Administration ("FDA") approved the Company's NDA for Busulfex and, as a result, Busulfex development spending decreased from 1998 levels. Development activities for Xyrem were slowed until the results of a September meeting with the FDA were known.
Sales and marketing expense increased from $2.7 million for the twelve months ended December 31, 1998 to $3.4 million for the twelve months ended December 31, 1999, an increase of $0.7 million or 25%. This increase is largely attributable to significantly higher spending related to the addition of an Antizol and Busulfex sales force, sales and marketing program costs for Antizol and Busulfex, and an incentive program for employees.
General and administrative expense decreased from $3.0 million for the twelve months ended December 31, 1998 to $2.8 million for the twelve months ended December 31, 1999, a decrease of $0.2 million or 7%. This decrease is principally related to management consulting expenses for regulatory and product development assistance incurred in 1998 resulting from the 1997 departure of the Company's former President and Chief Operating Officer, and a 1998 charge to compensation expense related to stock options.
Other income is the sum of interest income from investment activities less interest expense from financing activities. Other income increased from $0.2 million for the twelve months ended December 31, 1998 to $0.3 million for the twelve months ended December 31, 1999. This increase is due to $0.2 million of interest expense recorded in 1998 that was attributable to the Company's obligation to Chronimed resulting from the 1997 contract termination fee.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were $0.7 million for the twelve months ended December 31, 1999 compared to $0.2 million for the twelve months ended December 31, 1998. Preferred stock dividends, which commenced on February 1, 1999, are payable in arrears on August 1 and February 1 of each year.
Net loss applicable to common shareholders was $(5.9) million for the twelve months ended December 31, 1999 compared to a net loss of $(8.5) million for the twelve months ended December 31, 1998. Basic and diluted loss per common share for these respective periods were $(0.90) and $(1.36), based on weighted average number of common shares outstanding of 6,587,790 and 6,236,897, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Since July 2, 1994, the effective date the Company was spun-off from Chronimed, it has financed its operations principally from net proceeds from several public and private financings, interest income and product sales. The 1999 private placement of convertible preferred stock resulted in net proceeds of $2.9 million. In February 2000, the Company completed a private placement of 1.365 million shares of newly issued common stock, resulting in net proceeds of $10.7 million. The various public and private placement transactions since inception resulted in aggregate net proceeds, after commissions and expenses, of $47.5 million.
Net working capital (current assets less current liabilities) increased from $3.2 million at December 31, 1999 to $10.3 million at December 31, 2000. Cash, cash equivalents, and available-for-sale securities increased from $4.0 million at December 31, 1999 to $11.4 million at December 31, 2000. The Company invests excess cash in short-term, interest-bearing, investment grade securities.
The Company has a commercial revolving line of credit with a bank, which expires on May 15, 2001. The maximum amount available to the Company under this arrangement is $500,000, subject to certain limitations based on the Company's trade accounts receivable. The Company intends to renew this line of credit facility. However the Company cannot assure that the bank will do so, or that it would do so on terms acceptable to the Company. In connection with the financing transaction in August 1999, the Company received a $2.05 million commitment in the form of a line of credit from UBS Capital. Amounts outstanding under this line of credit bear an interest rate of 7.5% and mature on August 2, 2002. To date, the Company has not borrowed under either of these arrangements.
The Company's commitments for outside development spending increased from $1.6 million at December 31, 1999 to $3.9 million at December 31, 2000. The increase is principally attributable to the timing of the initiation of clinical trials for Xyrem development activities. The Company expects development spending to not increase significantly over current levels unless additional products are licensed for development.
The Company expects spending during 2001 for research and development, and sales and marketing to increase significantly over 2000 levels. Management believes the Company's current working capital and anticipated operating cash flows from product sales will be sufficient to fund its operations at least through December 31, 2001.
For continued listing on the Nasdaq National Market, a company must satisfy a number of requirements, which in the Company's case include either: (1) net tangible assets in excess of $4.0 million or (2) a market capitalization of at least $50.0 million. Net tangible assets are defined as total assets less the sum of total liabilities and intangible assets. The Company met both of the thresholds at December 31, 2000. The Company's net tangible assets at December 31, 2000 equaled approximately $10.7 million and the Company's market capitalization was approximately $119.3 million (based on the last sale price of $14.125 and 8,442,759 shares outstanding as of December 31, 2000). Although the Company does not expect to be profitable in fiscal 2001, the Company nevertheless expects to meet the net tangible asset requirement for listing on the Nasdaq National Market. However there can be no assurance that the Company will continue to have adequate capital to meet the net tangible asset requirement through the year 2001 and thereafter.
In connection with the 1998 and 1999 private placements of convertible preferred stock, the Company agreed to certain restrictions and covenants, which could limit its ability to obtain additional financing. The most important of the restrictions are: (1) the Company cannot incur additional indebtedness, except for indebtedness secured solely by the Company's trade receivables, until it has profitable operations, subject to certain limitations and (2) the Company cannot, without the approval of a majority of the preferred stockholders, issue additional equity securities unless the selling price per share exceeds the then conversion price of the outstanding convertible preferred stock or the sale of equity is accomplished in a public offering. The present conversion price is $8.14 for the Senior Convertible Preferred Stock and $6.50 for the Series B Convertible Preferred Stock. Even without these restrictions, the Company can make no assurances that additional financing opportunities will be available or, if available, on acceptable terms.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's investments consist of debt securities with contractual maturities of less than one year. Therefore, the Company does not believe its operations are exposed to significant market risk relating to interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The financial statements of the Company as of and for the year ended December 31, 2000 begin on page of this Annual Report.
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors of the Registrant.
The information required by this item is incorporated by reference from the information under the caption "Election of Directors" contained in the Company's Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Company's Annual Meeting of Shareholders to be held on May 24, 2001 (the "Proxy Statement").
(b) Executive Officers of the Registrant.
The executive officers of the Company and their ages as of March 1, 2001.
Executive officers of the Company serve at the discretion of the Board of Directors with no fixed term. There are no family relationships between or among any of the executive officers or directors of the Company.
Mr. Bullion has been Chief Executive Officer of the Company since June 24, 1994 and Chairman of the Board of Directors since December 30, 1998. Mr. Bullion is a co-founder of Chronimed Inc., the company from which Orphan Medical, Inc. was spun-off in 1994. He has been a director of Chronimed since 1985. Prior to joining Orphan Medical, Mr. Bullion served as President of Bluestem Partners, an investment and consulting company; Dahl & Associates, a soil and ground water remediation company; and Concurrent Knowledge Systems, Inc., a software development company. Mr. Bullion also served as partner and Vice President with First Bank System Venture Capital Company for seven years.
Dr. Houghton has been the Company's Chief Operating Officer since August 1998. Dr. Houghton's most recent position was Chief Scientific Officer and Vice President of Clinical and Regulatory Affairs at Iotek, Inc. from April 1995 to August 1998. At Iotek, Dr. Houghton was responsible for all research activities, regulatory and clinical research, and served as the medical liaison with Iotek's Medical advisory Board. From February 1984 to March 1995, Dr. Houghton also held a variety of management positions with Abbott Australasia and Abbott Laboratories in the United States.
Dr. Reardan has been the Company's Vice President of Regulatory Affairs since May 1995 and had been the Director of Regulatory Affairs since joining the Company in 1994. From 1993 to 1994, he was Director of Development at CV Therapeutics. From 1984 to 1993, he held a variety of management positions at Xoma Corporation.
Ms. Engel has been the Company's Vice President of Marketing & Sales since May 1995 and had been Director of Marketing for the Company since joining the Company in 1994. From 1984 to 1994, Ms. Engel held a variety of sales and marketing management positions with 3M Pharmaceuticals, a division of the 3M Company. Prior to joining 3M, Ms. Engel was a practicing nurse in the field of pediatric oncology.
Mr. McGrath has been the Company's Vice President and Chief Financial Officer since October 1999. Mr. McGrath has most recently worked as consultant providing financial services to growing companies in the Minneapolis and Saint Paul area. From 1994 to 1998, he was Vice President of Finance at E. W. Blanch Holdings, Inc., a publicly traded provider of integrated risk management and distribution services. Prior to joining E.W. Blanch Holdings, Mr. McGrath was with Ernst & Young LLP in Minneapolis.
(c) Compliance with 16(a) of the Securities Exchange Act of 1934.
The information required by this item is incorporated by reference from the information under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" contained in the Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the information under the caption "Executive Compensation" contained in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the information under the caption "Security Ownership of Certain Beneficial Owners and Management " contained in the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the information contained under the caption "Certain Relationships and Related Transactions" contained in the Proxy Statement.
PART IV
ITEM 14.
ITEM 14. FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1). Financial Statements
(a)(2). Financial Statement Schedules
The following financial statement schedule should be read in conjunction with the Audited Financial Statements referred to under Item 14(a)(1) above. Financial statement schedules other than those provided have been omitted since they are not required or are not applicable or the required information is shown in the financial statements or related notes.
The Financial Statement Schedule, Schedule II - Valuation and Qualifying Accounts, to this Annual Report has been omitted.
(a)(3). Listing of Exhibits
(1) Incorporated by reference to the corresponding exhibit numbers in OMI's Registration Statement on Form 10 filed on August 31, 1994, Commission File No. 0-24760.
(2) Incorporated by reference to the corresponding exhibit numbers in OMI's Registration Statement on Form S-1 filed on March 3, 1995, Commission File No. 0-24760.
(3) Incorporated by reference to the corresponding exhibit number in OMI's Quarterly Report on Form 10-Q for the quarter ended December 30, 1994, Commission File No. 0-24760.
(4) Incorporated by reference to the corresponding exhibit numbers in OMI's Annual Report on Form 10-K filed for the year ended June 30, 1995, Commission File No. 0-24760.
(5) Incorporated by reference to the corresponding exhibit numbers in OMI's Registration Statement on Form S-1 filed on March 11, 1996, Commission File No. 0-24760.
(6) Incorporated by reference to the corresponding exhibit number in OMI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, Commission File No. 0-24760.
(7) Incorporated by reference to the corresponding exhibit number in OMI's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, Commission File No. 0-24760.
(8) Incorporated by reference to the corresponding exhibit numbers in OMI's Annual Report on Form 10-K filed for the year ended December 31, 1996, Commission File No. 0-24760.
(9) Incorporated by reference to the corresponding exhibit number in OMI's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, Commission File No. 0-24760.
(10) Incorporated by reference to the corresponding exhibit numbers in OMI's Annual Report on Form 10-K filed for the year ended December 31, 1997, Commission File No. 0-24760.
(11) Incorporated by reference to the corresponding exhibit numbers in OMI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, Commission File No. 0-24760.
(12) Incorporated by reference to the similarly described exhibit included with OMI's Current Report on Form 8-K dated December 7, 1998, Commission File No. 0-24760.
(13) Incorporated by reference to the similarly described exhibit included with OMI's Current Report on Form 8-K dated February 9, 1999, Commission File No. 0-24760.
(14) Incorporated by reference to the similarly described exhibit included with OMI's Annual Report on Form 10-K for the year ended December 31, 1998, Commission File No. 0-24760.
(15) Incorporated by reference to the similarly described exhibit included with OMI's Current Report on Form 10-Q for the quarter ended June 30, 1999, Commission File No. 0-24760.
(16) Incorporated by reference to the similarly described exhibit included with OMI's Annual Report on Form 10-K for the year ended December 31, 1999, Commission File No. 0-24760.
(b). Reports on Form 8-K
None.
(c). Exhibits
See Item 14(a)(3) above.
(d). Financial Statement Schedules
See Item 14(a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Minnetonka, Minnesota, on the 30th day of March, 2001.
ORPHAN MEDICAL, INC.
By: /s/ John Howell Bullion -------------------------------------- John Howell Bullion Chief Executive Officer
/s/ Timothy G. McGrath -------------------------------------- Timothy G. McGrath Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1934 this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated as of March 30, 2001.
* John Howell Bullion, pursuant to the Powers of Attorney executed by each of the officers and directors above whose name is marked by a "*", by signing his name hereto, does hereby sign and execute this Annual Report on behalf of each of the officers and directors in the capacities in which the name of each appears above.
REPORT OF INDEPENDENT AUDITORS
Board of Directors Orphan Medical, Inc.
We have audited the accompanying balance sheets of Orphan Medical, Inc. as of December 31, 2000 and 1999, and the related statements of operations, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 Orphan Medical, Inc. at December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Minneapolis, Minnesota February 23, 2001
ORPHAN MEDICAL, INC. BALANCE SHEETS
See accompanying notes.
ORPHAN MEDICAL, INC. STATEMENTS OF OPERATIONS
See accompanying notes.
ORPHAN MEDICAL, INC. STATEMENTS OF CASH FLOWS
See accompanying notes.
ORPHAN MEDICAL, INC. STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
See accompanying notes.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000
1. BUSINESS ACTIVITY
Orphan Medical, Inc. (the "Company") acquires, develops, and markets products of high medical value intended to address inadequately treated or uncommon diseases within selected strategic therapeutic market segments. A drug has high medical value if it offers a major improvement in the safety or efficacy of patient treatment and has no substantially equivalent substitute. The Company operated within a single segment, pharmaceutical product development, and had six approved products commercially available in the United States and several foreign countries.
As of December 31, 2000, the Company had not completed product development, obtained required regulatory approvals or verified the market acceptance and demand for Xyrem(R) (sodium oxybate) oral solution, one of its three principal products. Antizol(R) (fomepizole) Injection, Busulfex(R) (busulfan) Injection and Xyrem are the Company's principal products. In February 1999, the U.S. Food and Drug Administration (the "FDA") approved the Company's New Drug Application ("NDA") for Busulfex and the Company began commercial shipments of Busulfex to distributors and wholesalers during the same month. In addition, a Treatment Investigational New Drug ("IND") application for Xyrem was approved by the FDA in December 1998 and the Company began shipping Xyrem in February 1999, for use in its Treatment IND clinical trials which continue at December 31, 2000. The Treatment IND allows the Company to seek payments for Xyrem used by patients enrolled in the Treatment IND clinical trials, as well as gain additional clinical safety data that are expected to support the Company's NDA filing for Xyrem. The Company submitted its NDA for Xyrem on October 2, 2000. The FDA granted the application priority review status giving the FDA a goal of completing its review within 180 days.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
REVENUE RECOGNITION
Sales are recognized at the time a product is shipped to the Company's customers and are recorded net of reserves for estimated returns of outdated product and for discounts for prompt payment. The Company is obligated to accept from all domestic customers the return of products that have reached their expiration date. The Company monitors the return of product and modifies its accrual for outdated product returns as necessary. Management bases the reserve on historical experience and these estimates are subject to change.
Deferred revenue represents prepayment from customers for products not yet shipped.
CASH EQUIVALENTS AND AVAILABLE-FOR-SALE SECURITIES
The Company considers all highly liquid investments with remaining maturities of 90 days or less when purchased to be cash equivalents. The Company considers all highly liquid investments with remaining maturities of more than 90 days when purchased to be available-for-sale securities. Cash equivalents are carried at cost plus accrued interest, which approximates market value. The Company records unrealized gain or loss, if any, on available-for-sale securities as a separate component of shareholders' equity.
CONCENTRATION OF CREDIT RISK
The Company invests its excess cash in U.S. government agency securities, investment grade commercial paper, and other money market instruments and has established guidelines relative to diversification and maturities in an effort to maintain safety and liquidity. These guidelines are periodically reviewed to take advantage of trends in yields and interest rates. The Company has not experienced any significant losses on its cash equivalents or available-for-sale securities.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLE ALLOWANCE
The Company determines an allowance amount based upon an analysis of the collectibility of specific accounts and the aging of the accounts receivable. There is a concentration of sales to larger medical wholesalers and distributors. The Company performs periodic credit evaluations of its customers' financial condition. Receivables are generally due within 30 days of the invoice date. Credit losses relating to customers have not been material since the Company's inception.
INVENTORIES
Inventories are valued at the lower of cost or market determined using the first-in, first-out (FIFO) method. The Company's policy is to establish an excess and obsolete reserve for its products in excess of the expected demand for such products.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Maintenance and repairs are expensed as incurred. Depreciation is computed using the straight-line method over the assets' estimated useful lives of five to seven years.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to operations as incurred. Research and development costs consist principally of preclinical and clinical testing costs, certain salary and related expenses, bulk drug and drug product costs incurred in support of clinical testing and for validation lots required by the FDA, toxicology studies and various technical consulting costs.
GRANT AWARDS
The FDA Office of Orphan Drug Products and the Small Business Administration provide, upon application and approval, non-refundable grant awards in support of certain research and development activities. Cash proceeds collected pursuant to the terms of such grant awards are accounted for on a reimbursement basis. The Company has no such grants as of December 31, 2000.
INCOME TAXES
The Company accounts for income taxes using the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities.
STOCK BASED COMPENSATION
The Company accounts for its stock option plans under the intrinsic-value-based method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has adopted the disclosure only provision of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation."
LOSS PER SHARE
Basic and diluted loss per common share applicable to common shareholders are based upon the weighted average number of Common Stock shares outstanding during the respective period. Basic loss per share excludes any dilutive effects of options, convertible senior preferred stock and warrants. Basic and diluted loss per share are the same for the reported periods because the effect of stock options, warrants, and convertible securities is anti-dilutive.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
RECLASSIFICATIONS
Certain prior year balances have been reclassified in order to conform with the current year presentation. These reclassifications have no impact on net loss or shareholders' equity as previously reported.
3. AVAILABLE-FOR-SALE SECURITIES
The amortized cost and estimated market value of available-for-sale securities, all of which have contractual maturities of one year or less, are as follows:
4. OPERATING LEASES
The Company has a non-cancelable operating lease for office space that expires on October 31, 2003. The Company also has an operating lease for certain office equipment expiring April 2003. Future minimum lease payments, including current real estate taxes and operating expenses under the facility lease and the equipment lease are $297,000, $299,000, and $245,000 for the years ended December 31, 2001, 2002, and 2003 respectively. Total rent expense was approximately $239,100, $142,600, and $125,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
5. BORROWINGS
The Company has a commercial revolving line of credit with a bank, which expires on May 15, 2001. The maximum amount available to the Company under this arrangement is $500,000, subject to certain limitations. The Company's indebtedness to the bank may not exceed the lesser of (1) 75 percent of the Company's trade accounts receivable that have been outstanding for 90 days or less or (2) $500,000. Advances are charged a variable rate of interest equal to the prime rate plus one half of a percent. Through December 31, 2000, the Company has not borrowed under this arrangement. The Company has an additional line of credit discussed further in Note 9.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
As of December 31, 2000, the Company had net operating loss (NOL) carryforwards of approximately $37,460,000, credit for increasing research activities (the "R&D credit") carryforwards of approximately $359,000 and orphan drug credit carryforwards of approximately $8,046,000, available to reduce its future tax liabilities. These carryforwards will begin expiring after 2010. For the years ended December 31, 2000 and 1999, a valuation allowance of $21,418,000 and $17,611,000, respectively, has been recognized to offset the deferred tax assets related to these carryforwards.
No current income taxes have been provided for the years ended December 31, 2000, 1999 and 1998 as the Company had a loss for both financial reporting and tax purposes.
Significant components of the Company's net deferred tax assets are as follows:
As a result of the 1995 public stock offering, the Company exceeded the limits allowable under Section 382 of the Internal Revenue Code related to changes in ownership percentage which governs future utilization of NOL, R&D credit, and orphan drug credit carryforwards (collectively, "tax benefit carryforwards"). The effect of this occurrence is to limit the annual utilization of a portion of the Company's tax benefit carryforwards attributable to the period prior to the change in ownership. Should another change in ownership occur, future utilization of the Company's tax benefit carryforwards may be subject to additional limitations under Section 382.
7. EMPLOYEE BENEFIT PLANS
The Company maintains a 401(k) Savings Plan, which is funded by elective salary deferrals by employees. The Plan covers substantially all employees meeting minimum eligibility requirements. The Plan does not require mandatory contributions by the Company, but discretionary contributions may be made at the election of the Company. The Company has not made any provision for discretionary contributions to the Plan.
On January 4, 2000, shareholders approved the Orphan Medical, Inc. Employee Stock Purchase Plan to be funded by employee contributions, generally through payroll deductions. All employees are eligible subject to certain requirements. The purchase price is 85% of the lower of the average of the high and the low trade on the first and last trading day of each purchase period, defined as each calendar quarter. The Company reserved 200,000 shares of its common stock for future issuance at the Plan's inception. In 2000, there were 86,806 shares issued under this plan.
8. STOCK OPTIONS
The Company has one stock option plan for employees and non-employees, the 1994 Stock Option Plan (the "Plan"). The Plan provides the Company may grant employee incentive stock options and non-qualified stock options at a price of not less than 100% of fair market value. Options are exercisable as prescribed by the Plan and expire up to fifteen years from the grant date for non-qualified stock options and up to ten years from the grant date for employee incentive stock options. At December 31, 2000, the Plan has 1,925,000 shares of Common Stock reserved for issuance.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED)
Options outstanding were granted as follows:
The following table summarizes information about the stock options outstanding at December 31, 2000:
Fully vested and exercisable options were 1,098,258, 1,107,518, and 1,101,960 as of December 31, 2000, 1999, and 1998, respectively. The weighted average exercise prices for the fully vested and exercisable options as of December 31, 2000, 1999, and 1998 were $5.85, $5.57, and $5.31 respectively.
PRO FORMA INFORMATION:
The Company applies the intrinsic-value method in accounting for stock issued to employees and directors. Accordingly, compensation expense is recognized only when options are granted with a discounted exercise price. Any such compensation expense is recognized ratably over the associated service period, which is generally the option vesting period.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED)
PRO FORMA INFORMATION:
Pro forma net loss and loss per share information, as required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123), has been determined as if the Company had accounted for employee stock options under the fair value method. The fair value of these options was estimated at grant date using a Black-Scholes option pricing model with the following assumptions for 2000, 1999, and 1998, respectively
The weighted average fair value of the options granted in 2000, 1999, and 1998 was $9.13, $3.55, and $4.79, respectively, as computed as described above.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over a four year average vesting period. The Company's pro forma net loss for 2000, 1999 and 1998 was $(7,687,948), $(6,014,176), and $(9,015,936), and pro forma net loss per share was $(0.95), $(0.91), and $(1.45), respectively.
The Company granted 15,000 options to purchase unregistered common stock to a consultant in December 2000. These options were granted at $13.6875, the closing price of the Company's common stock on the date of grant. The options vest under certain conditions. The fair value of these options is being charged to expense over the vesting period of the options.
9. SHAREHOLDERS' EQUITY
On July 23, 1998 the Company issued $7.5 million of Senior Convertible Preferred Stock (the "Preferred Shares") in a private placement. The Company realized net cash proceeds of $7.1 million from the sale of the Preferred Shares after the payment of related offering expenses. The Preferred Shares were initially convertible, at the option of the holders, into shares of the Company's Common Stock at a price equal to $8.50 per share. The August 1999 financing, as discussed in the following paragraph, triggered antidilution provisions relating to the $8.1 million of the Senior Preferred Stock held as of August 1 (after giving effect to the semi-annual in-kind dividend distributions), which resulted in a decrease in the conversion price of those shares from $8.50 to $8.14 per share. The Preferred Shares have anti-dilution protection and bear a dividend of 7.5% per annum, payable semi annually, which during the first two years may by paid either in cash or by issuing additional Preferred Shares. In the third year and thereafter, the dividend may be paid either in cash or by issuing Common Stock valued at the then current market price. At the Company's option upon their maturity in July 2008, the Preferred Shares must be (a) converted into Common Stock, subject to a $3.0 million conversion fee payable in cash or by issuing additional Common Shares, or (b) redeemed for cash at $1,000 per share plus accrued dividends. The holders of the Preferred Shares are entitled to and have exercised their right to designate an individual to serve on the Company's Board of Directors.
On August 2, 1999, the Company completed a $5.0 million financing transaction in a private placement. The funding consisted of a purchase of 2,950 shares of the Company's Series B Convertible Preferred Stock for an aggregate purchase price of $2.95 million and a commitment of $2.05 million of debt in the form of a line of credit. The Series B Convertible Preferred Stock ("Series B Preferred Shares") may be converted prior to August 2, 2009 into shares of the Company's Common Stock at a price of $6.50 per share. Amounts outstanding under this line of credit bear an interest rate of 7.5% and mature on August 2, 2002. The Company has not borrowed under this arrangement as of December 31, 2000. The Series B Preferred Shares have anti-dilution protection and bear a dividend of 7.5% per annum, payable semi annually, which during the first two years may by paid either in cash or by issuing additional Series B Preferred Shares. In the third year and thereafter, the dividend may be paid either in cash or by issuing Common Stock valued at the then current market price. At the Company's option upon their maturity in August 2009, the Series B Preferred Shares must be (a) converted into Common Stock, subject to a $1.2 million conversion fee payable in cash or by issuing additional Common Shares, or (b) redeemed for cash at $1,000 per share plus accrued dividends.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
On February 23, 2000, the Company completed the sale of 1,265,000 shares of its Common Stock at a price of $8.00 per share. The Company received net proceeds of $9.7 million from the transaction and registered the shares under the Securities Act of 1933, as amended.
On February 25, 2000, the Company completed the sale of 100,000 shares of its Common Stock at a price of $10.00 per share. The Company received proceeds of $1.0 million from the transaction and registered the shares under the Securities Act of 1933, as amended.
10. STOCK WARRANTS
The Company issued warrants to the underwriter related to the Company's 1995 public stock offering to purchase 222,500 shares of Common Stock at a price of $5.20 per share. These warrants were exercised in 2000. In 1999, the Company issued warrants to the underwriter related to the Company's 1995 public offering to purchase 10,000 shares of Common Stock at $8.50 per share. At December 31, 2000, the Company had warrants outstanding to purchase 5,000 shares of Common Stock, all of which are currently exercisable.
In connection with the August 1999 financing, the Company issued two seven-year warrants. One of the warrants entitles the holder to receive, upon payment of the $2.05 million exercise price, either 2,050 shares of Series C Convertible Preferred Stock (which is similar to the Series B Convertible Preferred Stock and which is convertible to shares of the Company's Series D Non-Voting Preferred Stock at a conversion price of $6.50 per share) or 315,385 shares of Series D Non-Voting Preferred Stock (which is equivalent to common stock except that it has no voting rights) or a combination of Series C Convertible Preferred Stock and Series D Non-Voting Preferred Stock, so long as the combined purchase price for the shares does not exceed $2.05 million. The second warrant, issued in relation to the line of credit, entitled the holder to purchase 282,353 shares of Series D Non-Voting Preferred Stock at an exercise price of $4.25 per share. The Company can require the exercise of the warrants under certain conditions. The value of the warrants was $82,000 and is amortized over the term of the line of credit to interest expense. All of these warrants are outstanding at December 31, 2000. These warrants are not exercisable until July 23, 2002.
11. RESEARCH AND DEVELOPMENT COMMITMENTS
The Company has various commitments under agreements with outside consultants, contract drug developers and manufacturers, technical service companies, and drug distributors. In addition, the Company has commitments under license and research agreements. The Company does not have any joint venture agreements nor does it have any arrangements to perform research and development for other parties. The Company recognizes the costs associated with these commitments as incurred based on the accrual method of accounting. Expenditures associated with these commitments totaled approximately $4,900,000, $3,600,000, and $5,200,000 for the years ended December 31, 2000, 1999, and 1998, respectively. The Company's commitment to incur additional expenditures in subsequent periods for development activities totaled approximately $3,907,000 $1,602,000, and $3,350,000 at December 31, 2000, 1999, and 1998, respectively. Commitments for research and development expenditures will likely fluctuate from year to year depending on, among other factors, the timing of new product development, if any, and clinical trial activity.
The Company collected cash proceeds of approximately $511,000 for the year ended December 31, 1998 relating to certain research and development expenditures that qualified for reimbursement under the terms of several grant awards provided by the FDA Office of Orphan Drug Products.
ORPHAN MEDICAL, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. CONTRACT TERMINATION FEE
The Company and Chronimed Inc. ("Chronimed") entered into an Agreement dated June 27, 1997, in which Chronimed agreed to terminate certain agreements that had been in existence since the spin-off of the Company from Chronimed in 1994. Among the terminated agreements was the Marketing and Distribution Agreement dated July 2, 1994, as amended, under which Chronimed had the exclusive right to market and distribute certain of Orphan Medical's products, including Busulfex and Antizol. In consideration for terminating these agreements, the Company agreed to pay Chronimed compensation equal to $2,500,000, consisting of cash and shares of the Company's Common Stock. Chronimed was paid $250,000 in cash on June 27, 1997, with the remaining balance of $2,250,000 payable in quarterly installments based on a temporary royalty arrangement equal to 3 percent of the Company's sales and the issuance of Common Stock equal to 1 percent of the Company's issued and outstanding Common Stock at each quarter end. As provided by the Agreement, the Company paid Chronimed approximately $131,000 and $9,400 in royalties for the years ended December 31, 1998 and 1997, respectively. In addition, the Company issued to Chronimed 313,694 of Common Stock through December 31, 1998, of which 185,971 have been sold by Chronimed in market transactions for net cash proceeds of $1,433,061 as of that date.
On February 9, 1999, the Company completed the acquisition from Chronimed of the remaining 127,723 unregistered shares of the Company's Common Stock. The Company paid Chronimed $338,281 on February 9, 1999 and $338,282 on March 31, 1999 to satisfy all of its obligations under the June 1997 Termination Agreement.
13. GEOGRAPHIC INFORMATION
The Company operates in two geographic regions, domestic and international. The Company's international sales are primarily in Europe and Canada. The Company has no assets outside of the United States. The following is a summary of net sales by geographic region for the years ended December 31, 2000, 1999 and 1998, respectively.
14. QUARTERLY FINANCIAL INFORMATION
The following are unaudited quarterly results of operations for the years ended December 31, 2000 and 1999.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
ORPHAN MEDICAL, INC.
(1) Recovery of amounts previously reserved.