ITEM 1: BUSINESS
GENERAL
Penwest Pharmaceuticals Co. ("Penwest" or "the Company") is engaged in the research, development and commercialization of novel drug delivery technologies and has extensive expertise in developing, manufacturing and selling excipient ingredients for the pharmaceutical industry. Based on this fundamental expertise in tabletting ingredients, the Company has developed its proprietary TIMERx(R) controlled release drug delivery technology, which is applicable to a broad range of orally administered drugs, and ProSolv(R) a co-processing drug delivery technology platform. The Company had revenues, primarily from the sale of excipients, in 2000, 1999, and 1998 of $42.1, $37.3 million, and $29.1 million, respectively.
TIMERX CONTROLLED RELEASE TECHNOLOGY
The Company has developed the TIMERx delivery system, a novel drug delivery technology, to address the limitations of currently available oral controlled release delivery systems. The Company believes that the TIMERx system is a major advancement in oral drug delivery that represents the first easily-manufactured oral controlled release drug delivery system that is applicable to a wide variety of drug classes, including soluble drugs, insoluble drugs and drugs with a narrow therapeutic index. The Company is utilizing the TIMERx system to formulate generic versions of branded controlled release drugs, controlled release formulations of currently-marketed immediate release drugs and New Chemical Entities ("NCE's").
The TIMERx drug delivery system is a hydrophilic matrix combining primarily a heterodispersed mixture, usually polysaccharides xanthan and locust bean gums, in the presence of dextrose. The physical interaction between these components works to form a strong, binding gel in the presence of water. Drug release is controlled by the rate of water penetration from the gastrointestinal tract into the TIMERx gum matrix, which expands to form a gel and subsequently releases the active drug substance. The TIMERx system can precisely control the release of the active drug substance in a tablet by varying the proportion of the gums, together with the third component, the tablet coating and the tablet manufacturing process. Drugs using TIMERx technology are formulated by combining the active drug substance, the TIMERx drug delivery system and additional excipients and compressing such materials into a tablet.
The Company has developed several drug formulations under collaborative arrangements with pharmaceutical companies. The Company's collaborator, Leiras OY, a Finnish subsidiary of Schering AG ("Leiras"), received marketing approval in Finland for Cystrin CR(R) , a controlled release version of oxybutynin utilizing Penwest's TIMERx technology for the treatment of urge urinary incontinence and began marketing the product in Finland in January 1998. The Company's collaborator, Sanofi-Synthelabo S.A. ("Sanofi"), received marketing approval in the United Kingdom for Slofedipine XL, a controlled release version of nifedipine utilizing Penwest's TIMERx technology for the treatment of angina, and began marketing the product in November, 1998.
The Company's collaborator, Mylan Pharmaceuticals Inc. ("Mylan"), received final marketing approval in December 1999 of an Abbreviated New Drug Application ("ANDA") from the U.S. Food
and Drug Administration (the "FDA") for Nifedipine XL, the first generic version of the 30 mg dosage strength of Procardia(R) XL (nifedipine), a leading cardiovascular drug for angina and hypertension, which was formulated using the TIMERx technology. On March 2, 2000, Mylan announced that it had signed a supply and distribution agreement with Pfizer, Inc. to market a generic version of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer's Procardia XL. As a result of the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In connection with that agreement, Mylan agreed to pay Penwest a royalty on net sales of Pfizer's 30 mg strength of generic Procardia XL. The royalties are comparable to those called for in Penwest's original agreement with Mylan for Nifedipine XL but is not marketing the product. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL. Mylan also agreed to purchase from the Company formulated bulk TIMERx manufactured for Nifedipine XL, and the bulk TIMERx was shipped in the third quarter of 2000.
The Company also has a strategic alliance with Endo Pharmaceuticals, Inc. ("Endo") to jointly develop an extended release oral version of oxymorphone. The Company and Endo have agreed to share the costs involved in the development and commercialization of this product, and share in the net profits from the sale of this product once it is marketed.
The Company believes that the TIMERx controlled release system has several advantages over other oral controlled release systems.
- Broad Applicability as a Drug Delivery System. The TIMERx system is adaptable to a wide range of drugs with different physical and chemical properties. For instance, the TIMERx system can be used to deliver both low dose (less than 5 mg) and high dose (greater than 700 mg) drugs as well as water soluble and insoluble drugs. Because of the high affinity of xanthan and locust bean gums, the TIMERx system permits a formulation with a high drug-to-gum ratio, which permits tablets to include a higher dosage of the active drug substance.
- Flexible Pharmacokinetic Profile. The Company formulates the TIMERx material to optimize the desired kinetic profile of the active drug substance. In this manner, the TIMERx system can be designed to enhance the therapeutic effect of the active drug substance. Depending on the desired release profile, the Company can formulate the drug to be released in the body (i) at a constant amount or linear rate over time, (ii) at a decreasing amount over time where the rate is dependent on drug concentration, or (iii) at a varied release rate.
- Ease of Manufacture. Drugs formulated using the TIMERx system are designed for production on standard pharmaceutical processing equipment. The TIMERx technology is easily and reproducibly scaled-up in a commercial manufacturing environment often utilizing the cost-effective direct compression tabletting process.
- Cost-Effective System. The TIMERx system is a cost-effective drug delivery system. It involves fewer and less complex ingredients than other systems and does not require the manufacturer to purchase specialized equipment. The Company believes that drug formulations using the TIMERx system can be developed more rapidly than drugs formulated with alternative controlled delivery systems and that the time to scale up to commercial quantities is minimized.
PROSOLV(R)
Prosolv, a high-functionality binder for tablets, is a patented combination of microcrystalline cellulose and colloidal silicon dioxide. These two ingredients work together synergistically for optimal tabletting performance. The Company has developed three products from this technology platform: ProSolv SMCC(R) 50, ProSolv SMCC(R) 90, and ProSolv HD(R) and has recently launched customized grades of ProSolv. ProSolv SMCC(R) can be used by manufacturers to produce harder tablets and can enable manufacturers to reduce the amount of binders used in the tablet, thereby reducing the size and cost of the tablet. Additionally, it can be used to manufacture tablets with difficult active ingredients which otherwise may not have been manufactured. ProSolv HD improves flow and compaction, and can increase throughput by increasing production speeds. Custom grades of ProSolv are designed to address specific formulation or manufacturing problems. These grades will be exclusively licensed to pharmaceutical and nutritional partners.
EXCIPIENTS
The Company is also an established leader in the development, production and distribution of branded pharmaceutical excipients, which are the inactive components included in tablets and capsules. Over the past 50 years, the Company has consistently been innovative and has delivered novel products such as Emcompress(R), Explotab(R) and ProSolv(TM) to the pharmaceutical industry. Each of the excipient products carries significant brand value, representing quality, service and performance. The Company sells 31 excipient products, which are used in the formulation and manufacture of tablets by pharmaceutical and nutritional companies worldwide. The excipients business' product line is broadly classified into three categories; binders, disintegrants and lubricants.
These products are sold to the branded prescription, generic prescription, over-the-counter and nutritional supplement markets. In 2000, bulk excipients were sold to more than 250 customers in more than forty countries worldwide, including some of the leading pharmaceutical companies in the world.
PENWEST STRATEGY
The Company's strategy is to become the premier oral drug delivery company for the pharmaceutical industry. The Company's strategy consists of the following principal elements:
Leverage the TIMERx technology through the following:
- - Create Innovative Branded Controlled Release Versions of Immediate Release Pharmaceuticals. The Company is focused on the application of its TIMERx technology to the development of controlled release formulations of immediate release drugs, which will be marketed as brand name pharmaceuticals. In developing these controlled release formulations, the Company will either complete the drug development itself, or in some cases will seek to develop products in collaboration with pharmaceutical companies having a market presence in the applicable therapeutic area. In all cases, the Company will seek to out-license the product at varying stages to a partner for manufacturing and marketing. The development of these controlled release drugs is subject to the New Drug Application ("NDA") approval process, although the Company and its collaborators may be permitted to rely on existing safety and efficacy data with respect to the immediate release drug in submitting the NDA.
- - Apply TIMERx Technology to Generic Versions of Branded Controlled Release Pharmaceuticals. The Company also applies its TIMERx technology to the development of generic versions of branded controlled release drugs. In selecting generic controlled release pharmaceutical candidates to develop, the Company targets high sales volume, technically-complex controlled release pharmaceuticals. The Company believes these drug candidates may be difficult to replicate and, as a result, TIMERx versions may have limited competition from other formulations.
- - Apply TIMERx Technology to the Development of New Chemical Entities. The Company believes that its TIMERx technology may be applicable to the development of products containing NCEs by pharmaceutical companies. The development of such NCEs is subject to the full NDA approval process, including conducting preclinical studies, filing an Investigational New Drug ("IND") application, conducting clinical trials and submitting a NDA. These are long-term in nature, but the Company maintains a portfolio of these feasibility projects.
Establish Collaborations for Development, Manufacture and Marketing
The Company maintains a portfolio of drug candidates utilizing the TIMERx technology in which it will either complete the development work itself, or in some cases will selectively look for development partners. At varying stages during the clinical development program, the Company will seek a partner for the manufacturing and marketing of the drug. The Company's principal collaborative agreements are with Mylan, Endo, Celltech, First Horizon, and Sanofi.
The Company is seeking to enter into additional collaborations for TIMERx. The Company's existing and potential future collaborations enable the Company to secure additional financial support for its research and development activities, to obtain access to the clinical, manufacturing and regulatory resources and expertise of its collaborators and to rely on them for the sales and marketing, distribution and promotion.
Continue Research in ProSolv Technology to Add Additional Products to the Company's Portfolio and to Fully Commercialize ProSolv
The Company continues its research to develop additional ProSolv products from its ProSolv co-processing technology platform. The Company intends to focus on customized grades of ProSolv products which it believes addresses formulation issues specific to active drug substances.
The achievement of the Company's strategy is subject to various risks and uncertainties. In particular, there can be no assurance that the Company's capital resources will be sufficient to fully implement its strategy. The costs of implementing the Company's strategy are difficult to predict and will depend on numerous factors. If the Company's capital resources are insufficient to fully implement its strategy, the Company may be required to modify its strategy. See risk factors following.
TIMERx PRODUCT DEVELOPMENT
The following table provides information by therapeutic area, development status and collaborator for each of the principal products being marketed or under development utilizing the Company's TIMERx technology. The Company is also conducting development activities with respect to various additional controlled release formulations.
(1) The Company's collaborators typically provide research and development support and are responsible for conducting full scale bioequivalence studies or clinical trials, obtaining regulatory approvals and manufacturing, marketing and selling the product. There can be no assurance that the results obtained in bioequivalence studies or preclinical studies will be obtained in full scale bioequivalence studies and other late stage clinical studies or that the Company or its collaborators will receive regulatory approvals to continue clinical studies of such products or to market any such products.
(2) Controlled release formulations of immediate release products are subject to the NDA regulatory process. To the extent that the controlled release product is an extension of an FDA-approved immediate release version of the same chemical entity, the Company's collaborators may be permitted to rely on existing clinical data as to the safety and efficacy of the chemical entity in filing NDAs.
(3) Leiras received marketing approval for Cystrin CR in Finland in October 1997 and began marketing the product in Finland in January 1998.
(4) Generic versions of controlled release products are developed in three basic stages:
FORMULATION. Involves the utilization or adaptation of drug delivery technologies to the product candidate and evaluation in in-vitro dissolution studies.
BIOEQUIVALENCE STUDIES. (a) Pilot bioequivalence studies involve testing in 10 to 15 human subjects to determine if the formulation yields a blood level comparable to the existing controlled release drug; (b) Full scale bioequivalence studies involve the manufacture of at least 10% of the intended commercial lot size and the analysis of plasma concentrations of the drug in 24 or more human subjects under fasting conditions and multiple dose conditions and 18 or more human subjects under fed conditions to determine whether the rate and extent of the absorption of the drug are substantially equivalent to that of the existing drug.
ANDA FILING. An ANDA is submitted to the FDA with results of bioequivalence studies and other data such as in-vitro specifications for the formulation,
stability data, analytical data, methods validation and manufacturing procedures and controls.
(5) Mylan received marketing approval for Nifedipine XL on December 17, 2000. On March 2, 2001, the Company announced Mylan had signed a supply and distribution agreement with Pfizer, Inc. to market a generic version of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer's Procardia XL. In connection with that agreement, Mylan has agreed to pay Penwest a royalty on all future net sales of Pfizer's 30 mg strength of generic Procardia XL. The royalty percentage was comparable to those called for in Penwest's original agreement with Mylan for Nifedipine XL.
(6) Sanofi received marketing approval for and began marketing Slofedipine XL in the United Kingdom in November 1998.
Branded Controlled Release Pharmaceuticals
The Company applies its TIMERx technology to the development of controlled release formulations of immediate release pharmaceuticals. The Company's principal branded controlled release pharmaceuticals being marketed or in development are as follows:
CYSTRIN CR. The Company and Leiras have developed a controlled release formulation of Cystrin(R) incorporating TIMERx technology, which is being marketed in Finland by Leiras under the tradename Cystrin CR. Leiras received marketing approval in Finland for Cystrin CR, a once-a-day version of Cystrin, in October 1997 and began marketing the product in Finland in January 1998. Cystrin is a two to three times-a-day immediate release version of the anticholinergic drug oxybutynin indicated for the treatment of urge urinary incontinence. Oxybutynin is marketed in Finland by Leiras under the trademark Cystrin.
OXYMORPHONE. The Company and Endo are currently developing an extended release formulation of oxymorphone(R) incorporating TIMERx technology. Oxymorphone is a narcotic analgesic for the treatment of moderate to severe pain which is currently given in the parenteral and suppository dosage form. Oxymorphone is marketed by Endo and had sales in the United States in 2000 of approximately $1 million. Extended release oxymorphone, if successfully developed, would represent the first oral extended release version of oxymorphone and would compete in the severe analgesic market with products such as MS Contin and Oxycontin, which had aggregate sales in the United States in 2000 of approximately $1.2 billion. In December 2000, the Company announced the results of a randomized, double-blind, placebo-controlled pivotal trial conducted in approximately 400 evaluable patients with chronic pain resulting from osteoarthritis. The results of the primary outcome variable of this study show patients taking an extended release version of oxymorphone formulated with TIMERx demonstrated a statistically significant reduction in pain intensity compared to placebo (p=0.0047). The product has commenced additional Phase II/III clinical studies.
ISOMERIC TRAMADOL - D6428. The Company and its collaborator Celltech are currently developing a patented formulation designed to release chiral isomers at differential rates based on the Company's knowledge of excipient technology and its TIMERx technology. D6428 is a centrally acting synthetic analgesic and the Company believes represents the next generation of pain medications. This product, if developed successfully, will compete with Ultram(R), which currently has sales in the U.S. in 2000 of $554 million, as well as other controlled release versions of Tramadol which are currently in development. The product has recently completed Phase Ib trials that were designed to confirm the therapeutic benefits of the product while minimizing side effects such as nausea that are commonly associated with pain medications. Additional studies will commence once a market assessment has been completed.
Generic Controlled Release Pharmaceuticals
Generic controlled release pharmaceuticals are therapeutic equivalents of brand name drugs for which patents or marketing exclusivity rights have expired. Generic controlled release pharmaceuticals are typically difficult to replicate because of: (i) formulation complexity; (ii) analytical complexity; and/or (iii) manufacturing complexity. The Company believes that such generic controlled release pharmaceuticals are less likely to suffer the same price erosion as other generic pharmaceuticals because of the difficulty in replicating controlled release pharmaceuticals and the resulting limits on competition.
When developing generic pharmaceuticals, the drug developer is required to demonstrate that the generic product candidate will exhibit in-vivo release and absorption characteristics equivalent to those of the branded pharmaceutical without infringing on any unexpired patents. During the formulation of generic pharmaceuticals, drug developers create their own version of the branded drug by using or adapting drug delivery technologies to the product candidate.
The Company's principal generic controlled release pharmaceuticals are as follows:
NIFEDIPINE XL. The Company and Mylan developed Nifedipine XL as the first generic equivalent to the 30 mg strength of Procardia XL. Procardia XL is a once-a-day controlled release formulation of nifedipine, a calcium channel blocking agent indicated for hypertension, vasospastic angina and chronic stable angina, which uses the OROS delivery system. Procardia XL is marketed in three dosage strengths (30 mg, 60 mg and 90 mg) by the Pratt Pharmaceuticals division of Pfizer and had sales in the United States in 2000 of approximately $409 million. The sales of the 30 mg dosage strength in 2000 were $138 million.
In December 1999, Mylan's ANDA for Nifedipine XL (30 mg) was approved by the FDA. Mylan's ANDA was the first ANDA for a generic version of Procardia XL filed with the FDA for the 30 mg strength. On March 2, 2001 Mylan announced that it had signed a supply and distribution agreement with Pfizer, Inc. to market a generic version of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer's Procardia XL. As a result of the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In connection with that agreement, Mylan has agreed to pay Penwest a royalty on all future net sales of Pfizer's 30 mg strength of generic Procardia XL. The royalty percentage was comparable to those called for in Penwest's original agreement with Mylan for Nifedipine XL. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL.
SLOFEDIPINE XL. The Company and Sanofi received approval for and began marketing in the United Kingdom in November 1998 Slofedipine XL, a generic version of Adalat LA(R) (a drug marketed in Europe by Bayer) incorporating TIMERx technology. Adalat LA is a once-a-day controlled release formulation of nifedipine, a calcium channel blocking agent indicated for hypertension, vasospastic angina and chronic stable angina, which uses the OROS delivery system. Adalat LA is marketed in two dosage strengths (30 mg and 60 mg) by Bayer in Europe and had sales in the UK in 2000 of approximately $60 million. Sanofi has also received marketing approval in Italy for this product.
PHARMACEUTICAL EXCIPIENTS
The Company sells 31 excipient products which are used in the manufacture of tablets by pharmaceutical and nutritional companies worldwide. The Company's product line is broadly classified into three distinct categories: binders, disintegrants and lubricants. Binders, working in conjunction with other products, are the primary tablet-forming component of excipients. Disintegrants function helps a tablet fall apart when consumed by drawing water into the dosage form, a necessary precursor to dissolution and ultimately absorption of the drug. Lubricants help facilitate the ease of manufacture of drugs so that they emerge from a tabletting machine with the desired physical characteristics.
The Company's excipients are sold to the prescription, over-the-counter and nutritional markets. In 2000, the Company sold bulk excipients to more than 250 customers, including some of the leading pharmaceutical companies in the world, in more than 40 countries.
The following is a list of excipient products currently being marketed in bulk by the Company:
PROSOLV SMCC(R) was introduced in late 1996 and the Company sells it both in bulk and through licensing arrangements when exclusivity is offered. The Company believes that Prosolv SMCC offers numerous advantages over traditional microcrystalline cellulose such as enhanced drug loading capability, production of elegant, robust tablets, and has excellent disintegration properties.
PROSOLV HD(TM) was introduced in late 1999 and provides superior flow without losing compactibility in the manufacturing process. The addition of ProSolv HD in some formulations can increase throughput and capacity in a production line.
EMCOCEL(R), or microcrystalline cellulose ("MCC"), the Company's largest selling product, is a tabletting binder used in pharmaceutical formulations worldwide. EMCOCEL is utilized in a number of products including ethical and over-the-counter brands.
EMCOMPRESS(R), or dicalcium phosphate, is a binder marketed by the Company under an exclusive worldwide distribution agreement with the manufacturer Rhodia. The distribution agreement is subject to automatic extension on an annual basis unless either party gives the other party 12 months notice of its desire to terminate the agreement. EMCOMPRESS is frequently used in vitamin formulations as it serves as an additional source of dietary calcium.
EMDEX(R) AND CANDEX(R), or dextrates, are binders that are used as directly compressible excipients in both chewable and non-chewable tablets. They are odorless with a sweet taste caused by its sugar composition. EMDEX and CANDEX are used in, among other things, chewable antacid tablets and vitamins.
EXPLOTAB(R), or sodium starch glycolate, is the principal disintegrant marketed by the Company. EXPLOTAB is distributed by the Company under an exclusive worldwide distribution agreement with the manufacturer, Roquette America, Inc. The distribution agreement is automatically renewable on an annual basis unless either party gives the other party 12 months notice of its desire to terminate the agreement. EXPLOTAB is used in a number of products and is an essential component of the Tylenol family of products.
PRUV(R), or sodium stearyl fumarate, is the principal lubricant marketed by the Company. PRUV is marketed under an exclusive worldwide distribution agreement with Astra-Zeneca. PRUV is used in
several prescription pharmaceuticals. The Company is negotiating an agreement with Astra-Zeneca to purchase the trademark and manufacturing know-how associated with this product.
The Company had revenues from the sale of pharmaceutical excipients, including formulated bulk TIMERx, in 2000, 1999, and 1998 of $37.1 million, $36.8 million, and $28.8 million, respectively.
COLLABORATIVE ARRANGEMENTS
The Company enters into collaborative arrangements with pharmaceutical companies to facilitate and expedite the commercialization of its TIMERx drug delivery technology.
The company has two primary types of collaborative agreements. The first is jointly funded R&D with no up-front licensing fees or milestone payments. In these arrangements, the Company will share in a pre-determined percentage of the royalties. The second type of agreement is the straight licensing of the Company's technology, with no sharing in the R&D development costs. Under these collaborative agreements, the Company has received up-front fees and milestone payments and is entitled to receive additional milestone payments. In addition, under all its current collaborative arrangements, the Company is entitled to receive royalties on the sale of the products covered by such collaborative arrangements and payments for the purchase of formulated TIMERx material. There can be no assurance that future milestone payments will be received. The Company's principal collaborative arrangements are described below.
MYLAN PHARMACEUTICALS, INC.
In August 1994 and March 1996, the Company entered into product development and supply agreements with Mylan with respect to the development of generic versions of Procardia XL (nifedipine) and Glucotrol XL (glipizide), based on the Company's TIMERx technologies (the "Mylan Products"). In December 2000, Mylan cancelled the Glucotrol XL contract and all rights with respect to Glucotrol XL reverted back to the Company. Mylan is one of the leading generic pharmaceutical companies in the United States.
The Company received milestone payments under each of the product development and supply agreements. The Company is also entitled to royalties on the sale of generic Procardia XL. In addition, Mylan has agreed that during the term of the product development and supply agreements it will purchase formulated TIMERx material for use in Nifedipine XL exclusively from the Company at specified prices.
On March 2, 2000 Mylan announced that it had signed a supply and distribution agreement with Pfizer, Inc. to market a generic version of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer's Procardia XL. As a result of the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In connection with that agreement, Mylan is paying Penwest a royalty on net sales of Pfizer's 30 mg strengthof generic Procardia XL. The royalty rates are comparable to those called for in Penwest's original agreement with Mylan for Nifedipine XL. Mylan will not, however, be purchasing formulated bulk TIMERx from the Company as they will not be manufacturing the finished product. As part of Mylan's new agreement with Penwest, Mylan agreed to purchase the remaining formulated bulk TIMERx manufactured for Nifedipine. This inventory was shipped in the third quarter of 2000. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL. The term of this agreement shall continue until such time as Mylan permanently ceases to market generic Procardia XL. In 2000, Mylan accounted for approximately 19% of the Company's total revenues.
SANOFI-SYNTHELABO
In February 1997, the Company entered into a product development and supply agreement with Sanofi-Synthelabo with respect to the development of a generic version of Adalat LA based on the Company's TIMERx technology (the "Sanofi Product"), a drug that utilizes the same controlled release technology as Procardia XL. Sanofi is a research-based international pharmaceutical company, based in Paris, France, which has a European infrastructure from which to develop, register and market prescription pharmaceuticals.
Under the product development and supply agreement, the Company was responsible for conducting pilot bioequivalence studies of the Sanofi Product and for manufacturing and supplying TIMERx material to Sanofi, and Sanofi was responsible for conducting all full scale bioequivalence and clinical studies, preparing all regulatory applications and submissions and manufacturing and marketing the Sanofi Product in specified countries in Europe and in South Korea. This drug was approved and Sanofi began marketing the drug in the United Kingdom in November 1998. Sanofi has also received regulatory approval in Italy.
The product development and supply agreement expires with respect to each specified country on the 10th, 13th, 16th or 19th anniversary of the date on which the Sanofi Product is approved by the relevant regulatory authority in such country for commercial sale if notice is provided by either party prior to any of such anniversary dates that the agreement will expire with respect to such country on such anniversary date. The agreement is also subject to earlier termination by either party under specified circumstances, including termination by the Company if Sanofi fails to meet minimum sales volume requirements and termination by either party upon a material breach of the agreement by the other party. If the Company does not satisfy its obligations under the agreement, the Company will be in breach of the agreement and Sanofi will be entitled to terminate the agreement.
The Company received milestone payments under the product development and supply agreement. The Company is receiving royalties upon the sale of the Sanofi Product. One-half of such payments will be paid to Mylan in accordance with a distribution agreement signed with Mylan. In addition, Sanofi has agreed that, during the term of the product development and supply agreement, it will purchase formulated TIMERx material for use in the Sanofi Product exclusively from the Company at specified prices.
LEIRAS OY
In July 1992, the Company entered into an agreement with Leiras with respect to the development and commercialization of Cystrin CR, a controlled release formulation of Cystrin based on the Company's TIMERx technology. In May 1995, the Company entered into a second agreement with Leiras clarifying certain matters with respect to the collaboration. Also, in 2001, the Company reacquired the North American rights to this product. Leiras is a Finnish subsidiary of Schering AG.
Under the agreements, the Company was responsible for the development and formulation of Cystrin CR and for manufacturing and supplying TIMERx material to Leiras for use in the manufacture of Cystrin CR, and Leiras was responsible for preparing all regulatory applications and submissions and manufacturing and marketing Cystrin CR on a worldwide basis except for in North America. Leiras has the right to transfer its rights and responsibilities under the agreements and its related product rights for specified territories, subject in certain circumstances to the approval of the
Company. Leiras transferred the European rights to Sanofi-Synthelabo who is currently not marketing the product.
The agreements terminate upon the expiration of the TIMERx patents licensed to Leiras (which will occur in 2014), subject to earlier termination by either party under specified circumstances, including upon a material breach of the agreement by a party or upon the bankruptcy of a party. If the Company does not satisfy its obligations under either of these agreements, the Company will be in breach of such agreement and Leiras will be entitled to terminate such agreement. Leiras has also agreed to pay the Company royalties on the sale of Cystrin CR and to purchase formulated TIMERx material exclusively from the Company at specified prices.
ENDO PHARMACEUTICALS INC.
In September 1997, the Company entered into a strategic alliance agreement with Endo with respect to the development of an extended release formulation of oxymorphone based on the Company's TIMERx technology (the "Endo Product"). Endo is a fully integrated specialty pharmaceutical company with a market leadership in pain management. Endo has a broad product line including 14 branded products that include the established brands such as Percodan(R) and Percocet(R). Endo is registered with the U.S. Drug Enforcement Administration as a developer, manufacturer and marketer of controlled narcotic substances.
Under the strategic alliance agreement, the responsibilities of the Company and Endo with respect to any Endo Product are determined by a committee comprised of an equal number of members from each of the Company and Endo (the "Alliance Committee"). However, the Company expects that it will formulate each drug candidate and that Endo will conduct all clinical studies and prepare and file all regulatory applications and submissions. In addition, under the agreement, the Company has agreed to manufacture and supply TIMERx material to Endo, and Endo has agreed to manufacture and market the Endo Products in the United States. The manufacture and marketing of Endo Products outside of the United States may be conducted by the Company, Endo or a third party, as determined by the Alliance Committee.
The strategic alliance agreement is terminable with respect to an Endo Product by either party upon 30 days prior written notice at any time (i) prior to the completion of development activities with respect to such Endo Product if such party determines that further development efforts are not likely to lead to the successful development of such Endo Product and (ii) prior to obtaining approval by the FDA (or equivalent regulatory authority) of an NDA (or equivalent regulatory filing) with respect to such Endo Product if such party determines that further efforts are not likely to lead to such approval, although the non-terminating party would have the right to continue the agreement with respect to such Endo Product for a specified period and the royalties that might otherwise have been payable to the terminating party would be reduced. Following regulatory approval of the marketing and sale of such Endo Product, the term of the strategic alliance agreement will extend for up to 20 years from the date of such regulatory approval, subject to earlier termination under specified circumstances, including failure to launch full-scale marketing of such Endo Product when required or material breach of the agreement by a party.
The Company and Endo have agreed to share the costs involved in the development and commercialization of the Endo Products and that the party marketing the Endo Products (which the Company expects will be Endo) will pay the other party royalties equal to 50% of net marketing revenues after fully-burdened costs (although this percentage will decrease as the total U.S. marketing revenues from an Endo Product increase), subject to each party's right to terminate its participation
with respect to any Endo Product described above. Endo will purchase formulated TIMERx material for use in the Endo Products exclusively from the Company at specified prices. Such prices will be reflected in the determination of fully-burdened costs.
CELLTECH
In December 1998 the Company entered into a strategic alliance agreement with Celltech with respect to the development of products utilizing the differential release of chiral isomers based on the Company's knowledge of excipient technology and its TIMERx technology. The lead candidate, D6428, a centrally-acting synthetic analgesic, is utilized in the treatment of pain. Celltech is a fully-integrated global biopharmaceutical company located in the U.K.
Under the strategic alliance agreement the projects are governed by a committee comprised of an equal number of members from both companies (the "Alliance Committee"). The Company is responsible for formulating each drug candidate, and Celltech is responsible for conducting all clinical studies and preparing and filing all regulatory applications ad submissions. In addition, under the agreement, the Company has agreed to manufacture and supply TIMERx material to Celltech, and Celltech has agreed to manufacture the isomeric active drug substance. The marketing of these products will be determined by the Alliance Committee.
The Company and Celltech have agreed to share the costs involved in the development and commercialization of the Celltech Products and that the party marketing the Celltech Products (which the Company expects will be Celltech) will pay the other party royalties equal to 50% of net marketing revenues after fully-burdened costs (although this percentage will decrease as the total U.S. marketing revenues from an Celltech Product increase), subject to each party's right to terminate its participation with respect to any Celltech Product described above. If the Company does not satisfy its funding and other obligations under the agreement, the Company will be in breach of the agreement and Celltech will be entitled to terminate the agreement. Celltech will purchase formulated TIMERx material for use in the Celltech Products exclusively from the Company at specified prices. Such prices will be reflected in the determination of fully-burdened costs.
The product has currently completed Phase Ib studies and further studies will commence once a marketing assessment has been completed.
RESEARCH AND DEVELOPMENT
The Company conducts research and development activities with respect to additional applications of TIMERx technology, advances in the TIMERx technology, funding of product development, and additional novel excipients such as Prosolv. The Company's research and development expenses in 2000, 1999, and 1998 were $12.8 million, $7.4 million, and , $6.1 million, respectively. These expenses do not include amounts incurred by the Company's collaborators in connection with the development of products under the collaboration agreements such as expenses for full scale bioequivalence studies or clinical trials performed by the collaborators.
MANUFACTURING
The Company currently has a laboratory and pilot manufacturing facility covering approximately 55,000 square feet contiguous to its executive offices in Patterson, New York. However, the
Company does not have commercial-scale facilities to manufacture its TIMERx material in accordance with cGMP requirements prescribed by the FDA. As a result, the Company has contracted with a large third-party pharmaceutical company, Draxis Pharmaceuticals, Inc. ("Draxis"), for the bulk manufacture of its TIMERx material for delivery to its collaborators under an agreement that expires in September 2004.
The Company believes that there are a limited number of manufacturers that operate under cGMP regulations capable of manufacturing the Company's products. There can be no assurance that third parties upon which the Company relies for supply of its TIMERx material will perform and any failures by third parties may delay development or the submission of products for regulatory approval, impair the Company's collaborators' ability to commercialize products as planned and deliver products on a timely basis, or otherwise impair the Company's competitive position, which could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company's TIMERx drug delivery system is a hydrophilic matrix combining primarily a heterodispersed mixture, usually polysaccharides, xanthan and locust bean gums, in the presence of dextrose. The Company purchases these gums from a sole source supplier. Although the Company has qualified alternate suppliers with respect to these gums and to date the Company has not experienced difficulty acquiring these materials, there can be no assurance that interruptions in supplies will not occur in the future or that the Company will not have to obtain substitute suppliers. Any of these events could have a material adverse effect on the Company's ability to manufacture bulk TIMERx for delivery to its collaborators, which could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company currently operates two cGMP-approved manufacturing facilities for its MCC products, including EMCOCEL and ProSolv. These facilities are located in Cedar Rapids, Iowa and Nastola, Finland and cover approximately 35,000 square feet and 15,000 square feet, respectively. The Company's MCC products are primarily made from a specialty grade of wood pulp. Although the Company obtains wood pulp primarily from two suppliers, however, wood pulp is widely available from a number of suppliers.
All manufacturing operations of the Company are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of certain materials and waste products.
MARKETING AND DISTRIBUTION
Pursuant to the Company's collaborative agreements, the Company's collaborators have responsibility for the marketing and distribution of any controlled release pharmaceuticals developed based on the Company's TIMERx technology. Because the Company does not plan on marketing any such pharmaceuticals without a collaborator, the Company has not developed any sales force with respect to such products. As a result, the Company is substantially dependent on the efforts of its collaborators to market the products. In selecting a collaborator for a drug candidate, some of the factors the Company considers include the collaborator's market presence in the therapeutic area targeted by the drug candidate and the collaborator's sales force and distribution network.
The Company has an in-house sales force of eleven employees who market the Company's excipient products in the United States and in Europe. This sales force focuses primarily on pharmaceutical and nutritional companies. The Company also markets excipients worldwide through the use of distributors located in over 40 countries. The Company typically sells its excipients to its largest customers under multi-year supply agreements.
PATENTS AND PROPRIETARY RIGHTS
The Company believes that patent and trade secret protection, particularly of its drug delivery technology, is important to its business and that its success will depend in part on its ability to maintain existing patent protection, obtain additional patents, maintain trade secret protection and operate without infringing the proprietary rights of others.
The Company has been issued 26 U.S. and 71 foreign patents, relating to the Company's controlled release drug delivery technology. The U.S. patents issued to the Company principally cover the Company's TIMERx technology, including the combination of the xanthan and locust bean gums, the oral solid dosage form of TIMERx and the method of preparation, as well as the application (and combination) of TIMERx technology to various active drug substances, including both method of treatment and methods of preparation. All these patents will expire between 2008 and 2020. The Company also has been issued an additional twelve U.S. patents and 14 foreign patents covering its ProSolv technology. These patents will expire between 2017 and 2020.
The issuance of a patent is not conclusive as to its validity or as to the enforceable scope of the claims of the patent. There is no assurance that the Company's patents or any future patents will prevent other companies from developing non-infringing similar or functionally equivalent products or from successfully challenging the validity of the Company's patents. Furthermore, there is no assurance that (i) any of the Company's future processes or products will be patentable; (ii) any pending or additional patents will be issued in any or all appropriate jurisdictions; (iii) the Company's processes or products will not infringe upon the patents of third parties; or (iv) the Company will have the resources to defend against charges of infringement by or protect its own patent rights against third parties. The inability of the Company to protect its patent rights or infringement by the Company of the patent or proprietary rights of others could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company also relies on trade secrets and proprietary knowledge, which it generally seeks to protect by confidentiality and non-disclosure agreements with employees, consultants, licensees and pharmaceutical companies. There can be no assurance, however, that these agreements have or in all cases will be obtained, that these agreements will not be breached, that the Company will have adequate remedies for any breach or that the Company's trade secrets will not otherwise become known by competitors.
There has been substantial litigation in the pharmaceutical industry with respect to the manufacture, use and sale of new products that are the subject of conflicting patent rights. Some of the controlled release products that the Company is developing with its collaborators are generic versions of brand name controlled release products that are covered by one or more patents. Under the Waxman-Hatch Act when an applicant files an ANDA with the FDA for a generic version of a brand name product covered by an unexpired patent listed with the FDA, the applicant must certify to the FDA that such patent will not be infringed by the applicant's product or that such patent is invalid or unenforceable. Notice of such certification must be given to the patent owner and the sponsor of the NDA for the brand name product. If a patent infringement lawsuit is filed within 45 days of the receipt of such notice, the FDA will conduct a substantive review of the ANDA, but will not grant final marketing approval of the generic product until a final judgment on the patent suit is rendered in favor of the applicant or until 30 months (or such longer or shorter period as a court may determine) have elapsed from the date of the certification, whichever is sooner. Should a patent owner commence a lawsuit with respect to alleged patent infringement by the Company or its collaborators, the
uncertainties inherent in patent litigation make the outcome of such litigation difficult to predict. The Company's collaborators are responsible for all legal costs under Waxman-Hatch lawsuits. The Company evaluates the probability of patent infringement litigation with respect to its collaborators' ANDA submissions on a case by case basis. The delay in obtaining FDA approval to market the Company's product candidates as a result of litigation, whether or not the Company is successful could have a material adverse effect on the Company's business, financial condition and results of operations.
In 1994, Boots Company PLC ("Boots") filed in the European Patent Office, or the EPO, an opposition to a patent granted by the EPO to the Company relating to its TIMERx technology. In June 1996, the EPO dismissed Boots' opposition, leaving intact all claims included in the patent. Boots has appealed this decision to the EPO Board of Appeals, and a hearing date has been set for June 2001. We can provide no assurance we will prevail in this matter.
TIMERx, Emcocel, Multicel, Celpac, ProSolv, Explotab, Emdex, Emcompress and Candex are registered trademarks of the Company. Other tradenames and trademarks appearing in this Annual Report on Form 10-K are the property of their respective owners.
GOVERNMENT REGULATION
FDA REGULATION OF PHARMACEUTICAL PRODUCTS
All pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally the FDA, and, to a lesser extent, by state and local governments. The Federal Food, Drug and Cosmetic Act (the "FDCA") and other federal statutes and regulations govern or influence the development, testing, manufacture, safety, labeling, storage, record keeping, approval, advertising, promotion, sale and distribution of prescription products. Pharmaceutical manufacturers are also subject to certain record keeping and reporting requirements, establishment registration, product listing and FDA inspections.
Drugs can be approved by the FDA based on three types of marketing applications: an NDA, an ANDA or a license application under the Public Health Service Act. A full NDA must include complete reports of preclinical, clinical and other studies to prove adequately that the product is safe and effective for its intended use. The FDCA also provides for NDA submissions that may rely in whole or in part on publicly available clinical and other data on safety and efficacy under section 505(b)(2) of the FDCA. These types of NDAs may be appropriate for certain drugs containing previously approved active ingredients but differing with regard to other characteristics such as indications for use, dosage form or method of delivery.
As an initial step in the FDA regulatory approval process for an NDA, preclinical studies are typically conducted in animal models to assess the drug's efficacy and to identify potential safety problems. The results of these studies must be submitted to the FDA as part of an IND application, which must be reviewed by the FDA before proposed clinical testing can begin. Typically clinical testing involves a three-phase process. Phase I trials are conducted with a small number of subjects and are designed to provide information about both product safety and the expected dose of the drug. Phase II trials are designed to provide additional information on dosing and preliminary evidence of product efficacy. Phase III trials are large scale studies designed to provide statistical evidence of efficacy and safety in humans. The results of the preclinical testing and clinical trials of a pharmaceutical product are then submitted to the FDA in the form of an NDA for approval to commence commercial sales. Preparing such applications involves considerable data collection,
verification, analysis and expense. In responding to an NDA, the FDA may grant marketing approval, request additional information or deny the application if it determines that the application does not satisfy its regulatory approval criteria.
This regulatory process can require many years and the expenditure of substantial resources. Data obtained from preclinical testing and clinical trials are subject to varying interpretations, which can delay, limit or prevent FDA approval. In addition, changes in FDA approval policies or requirements may occur or new regulations may be promulgated which may result in delay or failure to receive FDA approval.
ANDAs may be submitted for generic versions of brand name drugs ("Listed Drugs") where the generic drug is the "same" as the Listed Drug with respect to active ingredient(s) and route of administration, dosage form, strength, and conditions of use recommended in the labeling. ANDAs may also be submitted for generic drugs that differ with regard to certain changes from a Listed Drug if the FDA has approved a petition from a prospective applicant permitting the submission of an ANDA for the changed product.
Rather than safety and efficacy studies, the FDA requires data demonstrating that the ANDA drug formulation is bioequivalent to the Listed Drug. The FDA also requires labeling, chemistry and manufacturing information. FDA regulations define bioequivalence as the absence of a significant difference in the rate and the extent to which the active ingredient becomes available at the site of drug action when administered at the same molar dose under similar conditions in an appropriately designed study. If the approved generic drug is both bioequivalent and pharmaceutically equivalent to the Listed Drug, the agency will assign a code to the product in an FDA publication entitled "Approved Drug Products With Therapeutic Equivalence Evaluation." These codes will indicate whether the FDA considers the product to be therapeutically equivalent to the Listed Drug. The codes will be considered by third parties in determining whether the generic drug is therapeutically equivalent and fully substitutable for the Listed Drug and are relied upon by Medicaid and Medicare formularies for reimbursement.
Although the FDA has approved the ANDA filed by the Company's collaborator Mylan for the 30 mg dosage strength of a generic version of Procardia XL, there can be no assurance that applications filed by the Company's collaborators with respect to other products will be suitable or available for such products, or that such products will receive FDA approval on a timely basis.
Certain ANDA procedures for generic versions of controlled release products are the subject of petitions filed by brand name drug manufacturers, which seek changes from the FDA in the approval process for generic drugs. These requested changes include, among other things, tighter standards for certain bioequivalence studies and disallowance of the use by a generic drug manufacturer in its ANDA of proprietary data submitted by the original manufacturer as part of an original new drug application. The Company is unable to predict at this time whether the FDA will make any changes to its ANDA procedures as a result of such petitions or any future petitions filed by brand name drug manufacturers or the effect that such changes may have on the Company. Any changes in FDA regulations which make ANDA approvals more difficult could have a material adverse effect on the Company's business, financial condition and results of operations.
Some products containing the Company's TIMERx formulation, such as controlled release formulations of approved immediate release drugs, will require the filing of an NDA. The FDA will not accept ANDAs when the delivery system or duration of drug availability differs significantly from the Listed Drug. However, the Company may be able to rely on existing publicly available
safety and efficacy data to support section 505(b)(2) NDAs for controlled release products when such data exists for an approved immediate release version of the same chemical entity. However, there can be no assurance that the FDA will accept such section 505(b)(2) NDAs, or that the Company will be able to obtain publicly available data that is useful. The section 505(b)(2) NDA process is a highly uncertain avenue to approval because the FDA's policies on section 505(b)(2) NDAs have not yet been fully developed. There can be no assurance that an application submitted under section 505(b)(2) will be approved, or will be approved in a timely manner.
Sponsors of ANDAs and section 505(b)(2) NDAs, with the exception of applications for certain antibiotic drugs, must include, as part of their applications, certifications with respect to certain patents on Listed Drugs that may result in significant delays in obtaining FDA approvals. Sponsors who believe that patents that are listed in an FDA publication entitled "Approved Drug Products With Therapeutic Equivalence Evaluations" are invalid, unenforceable, or not infringed, must notify the patent owner. If the patent owner initiates an infringement lawsuit against the sponsor within 45 days of the notice, the FDA's final approval of the ANDA or section 505(b)(2) NDA may be delayed for a period of thirty months or longer. This delay may also apply to other ANDAs or 505(b)(2) NDAs for the same Listed Drug. Moreover, the approval of an ANDA involved in such a patent lawsuit may under certain circumstances require a further delay in the final approval of other ANDAs for the same Listed Drug for an additional 180 days. In addition, recent court decisions have raised the possibility that, under some circumstances, ANDAs other than the first ANDA for a Listed Drug may be delayed indefinitely and thereby effectively denied approval if the drug that is the subject of the first ANDA is not brought to market.
Under the Waxman-Hatch Act, an applicant who files the first ANDA with a certification of patent invalidity or non-infringement with respect to a product may be entitled to receive, if such ANDA is approved by the FDA, 180-day marketing exclusivity (a 180-day delay in approval of other ANDAs for the same drug) from the FDA. However, there can be no assurance that the FDA will not approve an ANDA filed by another applicant with respect to a different dosage strength prior to or during such 180-day marketing exclusivity period.
ANDAs and section 505(b)(2) NDAs are also subject to so-called market exclusivity provisions that delay the submission or final approval of the applications. The submission of ANDAs and section 505(b)(2) NDAs may be delayed for five years after approval of the Listed Drug if the Listed Drug contains a new active molecular entity. The final approval of ANDAs and section 505(b)(2) NDAs may also be delayed for three years where the Listed Drug or a modification of the Listed Drug was approved based on new clinical investigations. The three-year marketing exclusivity period would potentially be applicable to Listed Drugs with novel drug delivery systems.
Sponsors of drug applications affected by patents may also be adversely affected by patent term extensions provided under the FDCA to compensate for patent protection lost due to time taken in conducting FDA required clinical studies or during FDA review of data submissions. Patent term extensions may not exceed five additional years nor may the total period of patent protection following FDA marketing approval be extended beyond 14 years. In addition, by virtue of the Uruguay Round Agreements Act of 1994 that ratified the General Agreement on Tariffs and Trade ("GATT"), certain brand name drug patent terms have been extended to 20 years from the date of filing of the pertinent patent applications (which can be longer than the former 17-year patent term starting from the date of patent issuance). Patent term extensions may delay the ability of the Company and its collaborators to use the Company's proprietary technology in the future, market new controlled release products, file section 505(b)(2) NDAs referencing approved products, or file
ANDAs based on Listed Drugs when those approved products or Listed Drugs have acquired patent term extensions.
Manufacturers of marketed drugs must conform to the FDA's cGMP standard or risk sanctions such as the suspension of manufacturing or the seizure of drug products and the refusal to approve additional marketing applications. The FDA conducts periodic inspections to implement these rules. There can be no assurance that a manufacturer's facility will be found to be in compliance with cGMP or other regulatory requirements. Failure to comply could result in significant delays in the development, testing and approval of products manufactured at such facility, as well as increased costs.
Noncompliance with applicable requirements can also result in total or partial injunctions against production and/or distribution, refusal of the government to enter into supply contracts or to approve NDAs, ANDAs or biologics applications, criminal prosecution and product recalls. The FDA also has the authority to revoke for cause drug or biological approvals previously granted.
FDA REGULATION OF EXCIPIENTS
Products sold for use as excipients in finished drug products are subject to regulation by the FDA with regard to labeling, product integrity and manufacturing. The FDA will not approve a drug for marketing without adequate assurances that the excipients are safe for use in the product. The FDA presumes certain excipients that are present in approved drug products currently marketed for human use to be safe. These excipients are listed by the FDA in a document known as the Inactive Ingredient Guide, or "IIG." All of the Company's pharmaceutical excipients other than ProSolv are listed in the IIG. While the FDA does not ordinarily require applicants for NDAs or ANDAs to submit data demonstrating the safety of excipients listed in the IIG, it may require evidence of safety in certain circumstances, such as when evidence is required to demonstrate that such excipients interact safely with other components of a drug product. For excipients not listed in the IIG, the FDA will generally require data, which may include clinical data, demonstrating the safety of the excipient for use in the product at issue. In the case of generic drug products approved based on bioequivalence to a reference drug, the FDA may in some cases (e.g., products for parenteral, ophthalmic, otic or topical use) require excipients that are identical to the excipients in the reference drug. There can be no assurance that the FDA will not require new clinical safety data to approve an application for a product with a Penwest excipient or that the FDA will approve such an application even if such clinical data are submitted.
FOREIGN REGULATORY APPROVAL
Whether or not FDA approval has been obtained, approval of a pharmaceutical product by comparable governmental regulatory authorities in foreign countries must be obtained prior to the commencement of clinical trials and subsequent marketing of such product in such countries. The approval procedure varies from country to country, and the time required may be longer or shorter than that required for FDA approval.
Under European Union ("EU") law, either of two approval procedures may apply to the Company's products: a centralized procedure, administered by the EMEA (the European Medicines Evaluation Agency); or a decentralized procedure, which requires approval by the medicines agency in each EU Member State where the Company's products will be marketed. The centralized procedure is mandatory for certain biotechnology products and available at the applicant's option for certain other products. Although the decentralized procedure requires approval by the medicines agency in
each EU Member State where the products will be marketed, there is a mutual recognition procedure under which the holder of marketing approval from one EU Member State may submit an application to one or more other EU Member States, including a certification to the effect that the application is identical to the application which was originally approved or setting forth the differences between the two applications. Within 90 days of such application, each EU Member State will be required to determine whether to recognize the prior approval.
Whichever procedure is used, the safety, efficacy and quality of the Company's products must be demonstrated according to demanding criteria under EU law and extensive nonclinical tests and clinical trials are likely to be required. In addition to premarket approval requirements, national laws in EU Member States will govern clinical trials of the Company's products, adherence to good manufacturing practice, advertising and promotion and other matters. In certain EU Member States, pricing or reimbursement approval may be a legal or practical precondition to marketing.
A procedure for abridged applications for generic products also exists in the EU. The general effect of the abridged application procedure is to give scope for the emergence of generic competition once patent protection has expired and the original product has been on the market for at least six or ten years. Independent of any patent protection, under the abridged procedure, new products benefit in principle from a basic six or ten year period of protection (commencing with the date of first authorization in the EU) from abridged applications for a marketing authorization. The period of protection in respect of products derived from certain biotechnological processes or other high-technology medicinal products viewed by the competent authorities as representing a significant innovation is ten years. Further, each EU Member State has discretion to extend the basic six-year period of protection to a ten-year period to all products marketed in its territory. Certain EU Member States have exercised such discretion. The protection does not prevent another company from making a full application supported by all necessary pharmacological, toxicological and clinical data within the period of protection. Abridged applications can be made principally for medicinal products which are essentially similar to medicinal products which have been authorized for either six or ten years. Under the abridged application procedure, the applicant is not required to provide the results of pharmacological and toxicological tests or the results of clinical trials. For such abridged applications, all data concerning manufacturing quality and bioavailability are required. The applicant submitting the abridged application generally must provide evidence or information that the drug product subject to this application is essentially similar to that of the referenced product in that it has the same qualitative and quantitative composition with respect to the active ingredient and the same dosage form, and is similar in bioavailability as the referenced drug.
The Company's European excipients manufacturing operations are subject to a variety of laws and regulations, including environmental and good manufacturing practices regulations.
OTHER REGULATIONS
The Company is governed by federal, state and local laws of general applicability, such as laws regulating working conditions and environmental protection. Certain drugs that the Company is developing are subject to regulations under the Controlled Substances Act and related statutes.
COMPETITION
The pharmaceutical industry is highly competitive and is affected by new technologies, governmental regulations, health care legislation, availability of financing, litigation and other factors. Many of the Company's competitors have longer operating histories and greater financial, marketing,
legal and other resources than the Company and certain of its collaborators. The Company expects that it will be subject to competition from numerous other entities that currently operate or intend to operate in the pharmaceutical industry, including companies that engage in the development of controlled release technologies. The Company's TIMERx business faces competition from numerous public and private companies and their controlled release technologies, including Alza Corporation's ("Alza") Oros technology, multiparticulate systems marketed by Elan Corporation PLC ("Elan") and Biovail, traditional matrix systems marketed by SkyePharma, plc and other controlled release technologies marketed or under development by Andrx Corporation, among others.
The Company's entry strategy in drug delivery was to concentrate development efforts on generic versions of branded controlled release pharmaceuticals. Typically, selling prices of immediate release drugs have declined and profit margins have narrowed after generic equivalents of such drugs are first introduced and the number of competitive products has increased. Similarly, the success of generic versions of controlled release products based on the Company's TIMERx technology will depend, in large part, on the intensity of competition from currently marketed drugs and technologies that compete with the branded pharmaceutical, as well as the timing of product approvals. However, the Company believes that generic versions of controlled release pharmaceuticals based on TIMERx technology are less likely to suffer the same degree of price erosion as other generic pharmaceuticals because of formulation, analytical and manufacturing complexity of the generic versions may be difficult for other companies to replicate, which could limit competition. Competition may also arise from therapeutic products that are functionally equivalent but produced by other methods. In addition, under several of the Company's collaborative arrangements, the payments due to the Company with respect to the controlled release products covered by such collaborative arrangements will be reduced in the event that there are competing generic controlled release versions of such products. The Company is now focusing its business development efforts and new research and development projects on controlled release versions of existing immediate release drugs. These drugs will be filed as NDAs.
In its excipients business, the Company competes with a number of large manufacturers and other distributors of excipient products, many of which have substantially greater financial, marketing and other resources than the Company. The Company's principal competitor in this market is FMC Corporation, which markets its own line of MCC excipient products, and J. Rettenmaier & Sohne GmbH which also competes with the Company's MCC and sodium starch glycolate products.
EMPLOYEES
As of December 31, 2000, the Company employed 137 persons, of which 87 were involved in research and development, administration and sales and marketing activities in Patterson, New York; 20 were involved in manufacturing operations at the Company's facility in Nastola, Finland; 30 were involved in manufacturing operations at the Company's facility in Cedar Rapids, Iowa; and six were involved in sales activities in the Company's European sales offices.
None of the Company's employees are covered by collective bargaining agreements other than the Company's employees in Finland who are covered by a national collective bargaining agreement. The Company considers its employee relations to be good.
ITEM 2:
ITEM 2: PROPERTIES
The Company's executive, administrative, research, small-scale production and warehouse facilities, comprising approximately 55,000 square feet, currently are located in a single facility on a 15 acre site owned by the Company in Patterson, New York.
The Company owns a facility in Cedar Rapids, Iowa where it manufactures and packages pharmaceutical excipients. The facility is a 35,000 square foot building containing manufacturing and administrative space. The Company also manufactures pharmaceutical excipients in a 15,000 square foot facility leased by the Company in Nastola, Finland, which lease renews annually with a two year notification of termination period for either party.
The Company believes that all its present facilities are well maintained and in good operating condition.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
None.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of shareholders during the fourth quarter of fiscal 2000.
ITEM 4A: EXECUTIVE OFFICERS OF THE REGISTRANT
PART II
ITEM 5:
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Penwest's common stock, $.001 par value, is listed with and trades on the Nasdaq National Market under the symbol "PPCO." The high and low closing prices of the Company's common stock during 2000 and 1999 are set forth below. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
On March 27, 2001 there were 939 shareholders of record.
The Company has never paid cash dividends on its common stock. The Company presently intends to retain earnings, if any, for use in the operation of its business, and therefore does not anticipate paying any cash dividends in the foreseeable future. The Company is prohibited from paying dividends on its common stock under its existing credit facility with the CIT Group/Business Credit, Inc.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following selected financial data are derived from consolidated financial statements of Penwest Pharmaceuticals Co. which have been audited by Ernst & Young LLP, independent auditors. Ernst & Young LLP's report on the consolidated financial statements for the year ended December 31, 2000, which appears elsewhere herein, includes an explanatory paragraph which describes an uncertainty about Penwest Pharmaceuticals Co.'s ability to continue as a going concern. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.
(a) Reclassification recorded of amounts prior to 2000 for the adoption of EITF No. 00-10 "Accounting for Shipping and Handling Fees and Costs."
(b) Represents a one time charge relating to the write-off of costs associated with the decision to outsource certain manufacturing as opposed to constructing a new facility.
(c) Represents a write-off of transaction costs associated with an abandoned initial public offering.
(d) Cumulative effect of adopting Staff Accounting Bulletin No. 101 ("SAB 101").
(e) In conjunction with the August 31, 1998 distribution, in which the Company's former parent, Penford Corporation, distributed to the shareholders of record of Penford common stock on August 10, 1998 all of the shares of the Company's common stock (the "Distribution), Penford contributed to the Company's capital, all existing intercompany indebtedness.
(f) In connection with the repayment of loans payable with proceeds from the Company's private placement of common stock in March 2000, loans payable have been classified as non-current at December 31, 1999.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below under "Risk Factors."
OVERVIEW
Penwest Pharmaceuticals Co. ("Penwest" or the "Company"), is engaged in the research, development and commercialization of novel drug delivery technologies. The Company has extensive experience in developing and manufacturing tabletting ingredients for the pharmaceutical industry. The Company's product portfolio ranges from excipients that are sold in bulk, to more technically advanced and patented excipients that are licensed to customers. On August 31, 1998 (the "Distribution Date"), Penwest became an independent, publicly owned company when Penford Corporation ("Penford"), the Company's former parent, distributed (the "Distribution") to the shareholders of record of Penford common stock on August 10, 1998 all of the shares of the Company's common stock. Pursuant to the Distribution, each Penford shareholder of record received three shares of the Company's Common Stock for every two shares of Penford common stock held by them.
The Company has incurred net losses since 1994. As of December 31, 2000, the Company's accumulated deficit was approximately $44.9 million. Management expects operating losses and negative cash flows during 2001. Management anticipates that its existing capital resources, as well as internally generated funds, will not enable the Company to maintain currently planned operations. A substantial portion of the Company's revenues to date have been generated from the sales of the Company's pharmaceutical excipients. The Company's future profitability will depend on several factors, including the successful commercialization of TIMERx controlled release products, Mylan's sales of Pfizer's 30 mg generic version of Procardia XL, sales growth of the Company's other pharmaceutical excipients products, as well as the level of investment in research and development activities. There can be no assurance that the Company will achieve profitability or that it will be able to sustain profitability on a quarterly basis, if at all. Continuation of the Company as a going concern and the realization of its assets and the satisfaction of its liabilities are dependent upon the Company's ability to obtain additional funding sources. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. See Note 1 to the consolidated financial statements.
On March 2, 2000, Mylan announced that it had signed a supply and distribution agreement with Pfizer to market a generic version of all three strengths ( 30 mg, 60 mg, 90 mg) of Pfizer's Procardia XL. As a result of the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In connection with that agreement, Mylan agreed to pay Penwest a royalty on all future net sales of Pfizer's 30 mg strength of generic Procardia XL, which Mylan launched at the end of March 2000. The royalty percentage is comparable to those called for in Penwest's original agreement with Mylan for Nifedipine XL, the TIMERx-based generic equivalent to Procardia XL. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL.
The Company's collaborative agreements include licensing arrangements in which the Company is entitled to receive milestone payments, royalties on the sale of the products covered by such collaborative agreements and payments for the purchase of formulated TIMERx material, as well as licensing arrangements which include revenue and cost sharing components in which the Company shares in the costs and profitability in predetermined percentages, but does not generally receive milestone payments. There can be no assurance that the Company's controlled release product development efforts will be successfully completed, that required regulatory approvals will be obtained or that approved products will be successfully manufactured or marketed.
The Company's business is conducted internationally and may be affected by fluctuations in currency exchange rates, as well as by governmental controls and other risks associated with international sales (such as export licenses, collectibility of accounts receivable, trade restrictions, and changes in tariffs). The Company's international subsidiaries transact a substantial portion of their sales and purchases in European currencies other than their functional currency, which can result in the Company having gains or losses from currency exchange rate fluctuations. The Company does not use derivatives to hedge the impact of fluctuations in foreign currencies.
The Company's results of operations may fluctuate from quarter to quarter depending on the volume and timing of orders of the Company's pharmaceutical excipients, Mylan's sales of the 30 mg strength of generic Procardia XL, and on variations in payments under the Company's collaborative agreements including payments upon the achievement of specified milestones. The Company's quarterly operating results may also fluctuate depending on other factors, including variations in gross margins of the Company's products, the mix of products sold, competition, regulatory actions, litigation and currency exchange rate fluctuations.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000 AND 1999
Total revenues increased 12.7% for the year ended December 31, 2000 to $42.1 million from $37.3 million for the year ended December 31, 1999. Product sales increased to $37.1 million for the year ended December 31, 2000 compared to $36.8 million for the year ended December 31, 1999. The increase in product sales was primarily due to shipments of formulated bulk TIMERx to Mylan in the first and third quarters of 2000. The first quarter's shipments to Mylan were in anticipation of their launch of Nifedipine XL, and prior to Mylan signing the supply and distribution agreement with Pfizer. The third quarter's shipments to Mylan were made pursuant to Penwest's March 2000 agreement with Mylan noted above. The Company does not expect to sell any bulk TIMERx to Mylan in 2001. Partially offsetting the increased sales of formulated bulk TIMERx included in product sales was a decrease in excipients revenues during the year ended December 31, 2000. This decrease in excipient revenues was due to a milder-than-expected cough/cold season resulting in reduced orders from customers, a decrease in sales volumes to two primary customers, as well as pricing pressure on Emcocel products, primarily in Europe. Royalties and licensing fees increased to $4.9 million for the year ended December 31, 2000 compared to $0.5 million for the year ended December 31, 1999. This increase was due primarily to royalties from Mylan on its sales of Pfizer's 30 mg generic version of Procardia XL.
Gross profit increased to $16.7 million or 39.8% of total revenues for the year ended December 31, 2000 from $11.4 million, or 30.6% of total revenues for the year ended December 31, 1999. The increase in gross profit was primarily due to increased royalties and licensing fees noted above. Gross profit percentage on product sales increased to 31.9% from 29.6% for the year ended December 31, 2000 and 1999, respectively, primarily due to increased sales of formulated bulk TIMERx and ProSolv, which have higher overall margins than the Company's other excipient products.
Selling, general and administrative expenses increased 5.5% for the year ended December 31, 2000 to $12.1 million from $11.4 million for the year ended December 31, 1999. This increase was primarily due to additional personnel hired in sales and marketing and increased professional fees.
Research and product development expenses increased 73.9% for the year ended December 31, 2000 to $12.8 million from $7.4 million for the year ended December 31, 1999. This increase was primarily due to the Company's share of increased expenses associated with the recently completed Phase II clinical trials, as well as other studies being conducted for the development of extended release oxymorphone under the Company's collaboration with Endo, as well as increased activity in the Company's drug development pipeline.
The effective tax rates for the year ended December 30, 2000 and 1999, were an expense of 4% and a benefit of 1%, respectively. The effective rates are higher than the federal statutory rate of a
]34% benefit, due primarily to the valuation allowance recorded to offset deferred tax assets relating to the Company's net operating losses, and state and foreign income taxes.
YEARS ENDED DECEMBER 31, 1999 AND 1998
Total revenues increased by 28.0% in 1999 to $37.3 million from $29.1 million in 1998. Product sales increased to $36.8 million in 1999 from $28.8 million in 1998 representing an increase of 27.5%. The increase in product sales was primarily due to increased sales volumes of Emcocel, as well as increased sales volumes of formulated bulk TIMERx in anticipation of Mylan's launch of Nifedipine XL. The Company added two new Emcocel customers in December 1998, which contributed to most of the volume increase in 1999. Royalties and licensing fees relating to the TIMERx drug delivery system increased to $0.5 million for the year ended December 31, 1999 from $0.3 million for the year ended December 31, 1998 due to the timing of when development milestones were earned.
Gross profit increased to $11.4 million or 30.6% of total revenues in 1999 from $8.0 million or 27.6% of total revenues in 1998. Gross profit percentage on product sales increased to 29.6% in 1999 from 26.6% in 1998. The increase in gross profit percentage was partly due to increasing margins on Emcocel products due to volume-based manufacturing efficiencies, increased sales of ProSolv and formulated TIMERx, which have higher margins, as well as increased development revenues under collaborative agreements utilizing the TIMERx technology.
Selling, general, and administrative expenses were comparable from year-to-year at $11.4 million. The 1998 expenses included a one-time charge of $1.3 million relating to the write-off of costs associated with the decision to outsource certain manufacturing as opposed to constructing a new manufacturing facility.
Research and development expenses increased by 21.8% in 1999 to $7.4 million from $6.1 million in 1998. The increased spending in 1999 relates primarily to increased funding of clinical development programs under the Company's collaborative agreement with Endo.
For 1999 the Company recorded an income tax benefit of 1% principally as a result of valuation allowances recorded for deferred tax assets primarily attributable to the net operating loss for the year. For 1998 the Company recorded an income tax benefit of 19% principally as a result of operating losses generated by the Company in the period prior to August 31, 1998 that were utilized by Penford.
LIQUIDITY AND CAPITAL RESOURCES
Subsequent to the Distribution, the Company has funded its operations and capital expenditures with cash from operations, advances under credit facilities and the issuance of additional shares of common stock.
As of December 31, 2000, the Company had cash and cash equivalents of $2.2 million. The Company had no committed sources of capital at year end. On January 17, 2001, the Company secured a revolving line of credit ("Revolver") with CIT Group/Business Credit, Inc. Under the terms of the Revolver, the Company may borrow up to $10.0 million ("Line of Credit") as determined by a formula based on the Company's Eligible Accounts Receivable and Eligible Saleable Inventory, as defined in the agreement. The Company has drawn approximately $3.0 million to date, but also currently has approximately $4.8 million in cash and cash equivalents. Under the Revolver, generally
85% of the Company's U.S. and Canadian receivables, as well as generally 60% of the Company's U.S. saleable inventories, are included in the borrowing base. Amounts outstanding under the Revolver are collateralized by the Company's U.S. and Canadian accounts receivable, and its inventory and general intangibles. The Revolver has an initial term of three years, and provides for annual renewals thereafter. The Revolver bears interest at a specified bank's prime rate plus 1% per annum, on the greater of $3.0 million or on the average outstanding balance. The Revolver also requires fees be paid of .5% per annum on unused portions of the Line of Credit. It also provides for early termination fees of up to .75%, in the event the Company terminates the Revolver prior to the end of the initial term. The Revolver contains covenants, including the requirement that the Company maintain at all times, certain minimum levels of tangible net worth as defined, at varying specified amounts during the initial term of the agreement, and restrictions on the incurrence of additional indebtedness.
As of December 31, 2000, the Company did not have any material commitments for capital expenditures. At December 31, 2000, the Company's trade receivables were $8.2 million, an increase of $3.2 million from the December 31, 1999 balance of $5.0 million. This increase was primarily due to amounts due from Mylan, including royalties for the fourth quarter of 2000 and additional amounts due relating to sales of bulk TIMERx to Mylan as previously discussed. At December 31, 2000, the Company's accrued expenses and accounts payable totaled $7.9 million, an increase of $1.9 million from the December 31, 1999 balance of $6.0 million. This increase is due to the Company's funding obligation under its strategic alliance agreement with Endo. In connection with its agreement with Endo, the Company expects to expend approximately an additional $12 million in 2001 and 2002 on the development of extended release oxymorphone, subject to the receipt by the Company of additional funding. The Company intends to utilize available cash and cash from operations, and funds available under the Revolver, and is also evaluating other funding alternatives. If the Company is unable to secure adequate funding, the Company has the option to terminate the agreement upon 30 days' prior written notice, at which time the Company's funding obligations would cease. This would reduce the Company's future net royalties on this product once it is marketed.
The Company had negative cash flow from operations in each of the periods presented, primarily due to net losses for the periods, as well as significantly higher trade receivables. Funds expended for the acquisition of fixed assets were primarily related to efforts at the Company's manufacturing facility in Iowa to increase capacity, and to a lesser extent, to procure equipment used in research and product development. Funds expended for intangible assets include costs to secure and defend patents on technology developed by the Company and to secure trademarks.
The Company's requirements for additional capital are substantial and will depend on many factors, including (i) the timing and amount of payments received under existing and possible future collaborative agreements; (ii) the structure of any future collaborative or development agreements; (iii) the progress of the Company's collaborative and independent development projects; (iv) revenues from the Company's sales of excipients; (v) the costs to the Company of bioequivalence studies for the Company's products; (vi) the prosecution, defense and enforcement of patent claims and other intellectual property rights; and (vii) the timing of adding drug development capabilities.
The Company anticipates that its existing capital resources, including funds available under the Revolver, as well as internally generated funds, will not enable the Company to maintain currently planned operations during 2001 and thereafter. Penwest will need to raise additional funds. Penwest is currently seeking additional funds through transactions relating to its
business lines and/or private financings. The additional financing may not be available to Penwest on acceptable terms, if at all.
If adequate funds are not available, Penwest may be required to (i) significantly curtail its product commercialization efforts, including terminating existing collaborative agreements; (ii) obtain funds through arrangements with collaborative partners or others on favorable terms that may require Penwest to relinquish rights to certain of its technologies, product candidates, or products which Penwest would otherwise pursue on its own or that would significantly dilute the Company's stockholders; (iii) significantly scale back or terminate operations and/or; (iv) seek relief under applicable bankruptcy laws.
MARKET RISK AND RISK MANAGEMENT POLICIES
The operations of the Company are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. The Company's interest rate risk consists of cash flow risk associated with borrowing under its variable rate Credit Facility. The Company's international subsidiaries transact a substantial portion of their sales and purchases in European currencies other than their functional currency, which can result in the Company having gains or losses from currency exchange rate fluctuations. The Company does not use derivatives to hedge the impact of fluctuations in foreign currencies or interest rates. The Company does not believe that the potential exposure is significant in light of the size of the Company and its business. The effect of an immediate 10% change in exchange rates would not have a material impact on the Company's future operating results or cash flows.
RECENT ACCOUNTING DEVELOPMENTS
On January 1, 2000 the Company changed its method of accounting for revenue recognition to conform with guidance provided by Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements ("SAB 101"). SAB 101 requires a company to conform with its guidance no later than the first quarter of its fiscal year beginning after December 15, 2000 through a cumulative effect of a change in accounting principle. The cumulative effect of the change in accounting principle was initially to record certain up-front license and milestone fees as deferred revenue that will be recognized as revenue over the remaining related collaboration or supply agreement. For the year ended December 31, 2000, the cumulative effect of the change on prior years was to increase the net loss by $410,000 or $0.03 per share.
In the fourth quarter of 2000, the Company adopted Emerging Issues Task Force No. 00-10, "Accounting for Shipping and Handling Fees and Costs" ("EITF 00-10"). Upon adoption, the Company reclassified amounts billed to customers for shipping and handling costs from a reduction of cost of product sales to product sales revenues. Accordingly, the Company retroactively reclassified prior quarter and year-end amounts. There are a number of recently issued accounting standards including Statement of Financial Accounting Standard No. 133 ("SFAS 133"), which are required to be adopted in future periods. Management believes that the future adoption of these accounting standards, if applicable, will not have a material effect on the Company's future financial statements.
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words
"believes", "anticipates", "plans", "expects", "intends", "may", and other similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company's actual results to differ materially from those indicated by forward-looking statements contained in this report and presented elsewhere by management from time to time. These factors include the risk factors listed below.
RISK FACTORS
WE HAVE NOT BEEN PROFITABLE
We have incurred net losses since 1994, including net losses of approximately $8.8 million, $7.7 million, and $8.8 million during 2000, 1999, and 1998, respectively. As of December 31, 2000, our accumulated deficit was approximately $44.9 million. The Company expects net losses to continue at least into mid 2003. A substantial portion of our revenues have been generated from the sales of our pharmaceutical excipients. Our future profitability will depend on several factors, including:
- the completion of the development of and successful commercialization of pharmaceutical products using our TIMERx controlled release technology;
- the addition of new product development collaborations;
- an increase in sales of our pharmaceutical excipient products; and
- the amount of our funding obligations under certain of our collaborations.
OUR CONTROLLED RELEASE PRODUCTS THAT ARE GENERIC VERSIONS OF BRANDED CONTROLLED RELEASE PRODUCTS THAT ARE COVERED BY ONE OR MORE PATENTS MAY BE SUBJECT TO LITIGATION
We expect that our collaborators will file ANDAs for our controlled release products that are generic versions of branded controlled release products that are covered by one or more patents. It is likely that the owners of the patents covering the brand name product or the sponsors of the NDA with respect to the branded product will sue or undertake regulatory initiatives to preserve marketing exclusivity, as Pfizer did with respect to Nifedipine XL. Any significant delay in obtaining FDA approval to market our product candidates as a result of litigation, as well as the expense of such litigation, whether or not we or our collaborators are successful, could have a material adverse effect on our business, financial condition and results of operations.
WE ARE DEPENDENT ON COLLABORATORS TO CONDUCT FULL-SCALE BIOEQUIVALENCE STUDIES AND CLINICAL TRIALS, OBTAIN REGULATORY APPROVALS FOR, AND MANUFACTURE, MARKET, AND SELL OUR TIMERx CONTROLLED RELEASE PRODUCTS
We develop and commercialize our TIMERx controlled release products in collaboration with pharmaceutical companies. We are parties to collaborative agreements with third parties relating to certain of our principal products, for instance, we are relying on Ivax to conduct full-scale bioequivalence studies and clinical trials, obtain regulatory approvals for, and manufacture, market and sell one of our TIMERx controlled release products and Endo to develop and commercialize an extended release version of oxymorphone and Celltech to develop D6428. We are also dependent on Mylan with respect to the marketing and sale of the 30 mg strength of Pfizer's generic version of Procardia XL. Our collaborators may not devote the resources necessary or may otherwise be unable
to complete development and commercialization of these potential products. Our existing collaborations are subject to termination without cause on short notice under certain circumstances.
If we cannot maintain our existing collaborations or establish new collaborations, we would be required to terminate the development and commercialization of products or undertake product development and commercialization activities at our own expense. Moreover, we have limited experience in conducting full-scale bioequivalence studies and clinical trials, preparing and submitting regulatory applications and manufacturing, marketing and selling our TIMERx controlled release products. We may not be successful in performing these activities.
Our existing collaborations and any future collaborations with third parties may not be scientifically or commercially successful. Factors that may affect the success of our collaborations include the following:
- our collaborators may be pursuing alternative technologies or developing alternative products, either on their own or in collaboration with others, that may be competitive with the product as to which they are collaborating with us, which could affect our collaborator's commitment to the collaboration with us;
- reductions in marketing or sales efforts or a discontinuation of marketing or sales of our products by our collaborators would reduce our revenues, which will be based on a percentage of net sales by the collaborator;
- our collaborators may terminate their collaborations with us, which could make it difficult for us to attract new collaborators or adversely affect our perception in the business and financial communities; and
- our collaborators may pursue higher priority programs or change the focus of their development programs, which could affect the collaborator's commitment to us.
WE FACE SIGNIFICANT COMPETITION, WHICH MAY RESULT IN OTHERS DISCOVERING, DEVELOPING OR COMMERCIALIZING PRODUCTS BEFORE OR MORE SUCCESSFULLY THAN WE DO
The pharmaceutical industry is highly competitive and is affected by new technologies, governmental regulations, health care legislation, availability of financing, litigation and other factors. Many of our competitors have longer operating histories and greater financial, marketing, legal and other resources than we do and than certain of our collaborators do.
Our TIMERx business faces competition from numerous public and private companies and their controlled release technologies, including ALZA's oral osmotic pump (OROS(R)) technology, multiparticulate systems marketed by Elan and Biovail, traditional matrix systems marketed by SkyePharma, plc and other controlled release technologies marketed or under development by Andrx Corporation, among others.
In addition to developing controlled release versions of immediate release products, we have concentrated a significant portion of our initial development efforts on generic versions of branded controlled release products. The success of generic versions of branded controlled release products based on our TIMERx technology will depend, in large part, on the intensity of competition from the branded controlled release product, other generic versions of the branded controlled release product
and other drugs and technologies that compete with the branded controlled release product, as well as the timing of product approval. Competition from other generic versions of branded controlled release products will also reduce the royalty rate to be paid to us under several of our collaborations.
The generic drug industry is characterized by frequent litigation between generic drug companies and branded drug companies. Those companies with significant financial resources will be better able to bring and defend any such litigation.
In our excipients business, we compete with a number of large manufacturers and other distributors of excipient products, many of which have substantially greater financial, marketing and other resources than the Company. Our principal competitor in this market is FMC Corporation, which markets its own line of MCC excipient products and J. Rettenmaier & Sohne GmbH, a European manufacturer and marketer of MCC and sodium starch glycolate products.
WE REQUIRE ADDITIONAL FUNDING
Our requirements for additional capital are substantial and will depend on many factors, including:
- the timing and amount of payments received under existing and possible future collaborative agreements;
- the structure of any future collaborative or development agreements;
- the progress of our collaborative and independent development projects;
- revenues from our excipients business;
- the costs to us of clinical studies for our products; and
- the prosecution, defense and enforcement of patent claims and other intellectual property rights.
The Company has no committed sources of capital except for the CIT credit facility. The Company anticipates its existing capital resources, including the amount available under the $10 million financing arrangement with CIT Credit will not be sufficient to fund operations through 2001, and believes Penwest will need to raise additional funds. Penwest is currently seeking additional funds through transactions relating to its business lines and/or private financings. The additional financing may not be available to Penwest on acceptable terms, if it all.
If adequate funds are not available, Penwest may able required to (i) significantly curtail its product commercialization efforts, including terminating existing collaborative agreements; (ii) obtain funds through arrangements with collaborative partners or others on favorable terms that may require Penwest to relinquish rights to certain of its technologies, product candidates, or products which Penwest would otherwise pursue on its own or that would significantly dilute the Company's stockholders; (iii) significantly scale back or terminate operations and/or; (iv) seek relief under applicable bankruptcy laws.
IF OUR CLINICAL TRIALS ARE NOT SUCCESSFUL OR TAKE LONGER TO COMPLETE THAN WE EXPECT, WE MAY NOT BE ABLE TO DEVELOP AND COMMERCIALIZE CERTAIN OF OUR PRODUCTS
In order to obtain regulatory approvals for the commercial sale of certain of our potential products, including controlled release versions of immediate release drugs such as the and new chemical entities, our collaborators will be required to complete clinical trials in humans to demonstrate the
safety and efficacy of the products. Our collaborators may not be able to obtain authority from the FDA or other regulatory agencies to commence or complete these clinical trails.
The results from preclinical testing of a product that is under development may not be predictive of results that will be obtained in human clinical trials. In addition, the results of early human clinical trials may not be predictive of results that will be obtained in larger scale advanced stage clinical trials. Furthermore, we, one of our collaborators, or the FDA may suspend clinical trails at any time if the subjects or patients participating in such trails are being exposed to unacceptable health risks, or for other reasons.
The rate of completion of clinical trials is dependent in part upon the rate of enrollment of patients. Patient accrual is a function of many factors including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the study and the existence of competitive clinical trials. Delays in planned patient enrollment may result in increased costs and program delays.
We and our collaborators may not be able to successfully complete any clinical trial of a potential product within any specified time period. In some cases, we may not be able to complete the trial at all. Moreover, clinical trials may not show any potential product to be safe or efficacious. Thus, the FDA and other regulatory authorities may not approve any of our potential products for any indication.
Our business, financial condition, or results of operations could be materially adversely affected if:
- we or our collaborators are unable to complete a clinical trial of one of our potential products;
- the results of any clinical trial are unfavorable; or
- the time or cost of completing the trial exceeds our expectations.
WE MAY NOT OBTAIN REGULATORY APPROVAL; THE APPROVAL PROCESS CAN BE TIME-CONSUMING AND EXPENSIVE
The development, clinical testing, manufacture, marketing and sale of pharmaceutical products are subject to extensive federal, state and local regulation in the United States and other countries. This regulatory approval process can be time-consuming and expensive.
We may encounter delays or rejections during any stage of the regulatory approval process based upon the failure of clinical data to demonstrate compliance with, or upon the failure of the product to meet, the FDA's requirements for safety, efficacy and quality; and those requirements may become more stringent due to changes in regulatory agency policy or the adoption of new regulations. After submission of a marketing application, in the form of an NDA or an ANDA, the FDA may deny the application, may require additional testing or data and/or may require postmarketing testing and surveillance to monitor the safety or efficacy of a product. While the U.S. Food, Drug and Cosmetic Act, or FDCA, provides for a 180-day review period, the FDA commonly takes one to two years to grant final approval to a marketing application (NDA or ANDA). Further, the terms of approval of any marketing application, including the labeling content, may be more restrictive than we desire and could affect the marketability of products incorporating our controlled release technology.
Some of the controlled release products that we are developing with our collaborators are generic versions of branded controlled release products, which require the filing of ANDAs. Certain ANDA procedures for generic versions of controlled release products are the subject of petitions filed by brand name drug manufacturers, which seek changes from the FDA in the approval process for generic drugs. These requested changes include, among other things, tighter standards for certain bioequivalence studies and disallowance of the use by a generic drug manufacturer in its ANDA of proprietary data submitted by the original manufacturer as part of an original new drug application. Any changes in FDA regulations that make ANDA approvals more difficult may have a material adverse effect on our business, financial condition and results of operations.
Other products containing our TIMERx controlled release technology require the filing of an NDA. A full NDA must include complete reports of preclinical, clinical and other studies to prove adequately that the product is safe and effective, which involves, among other things, full clinical testing, and as a result requires the expenditure of substantial resources. In certain cases involving controlled release versions of FDA-approved immediate release drugs, we may be able to rely on existing publicly available safety and efficacy data to support an NDA for controlled release products under Section 505(b)(2) of the FDCA when such data exists for an approved immediate release version of the same chemical entity. However, we can provide no assurance that the FDA will accept such section 505(b)(2) NDA, or that we will be able to obtain publicly available data that is useful. The section 505(b)(2) NDA process is a highly uncertain avenue to approval because the FDA's policies on section 505(b)(2) NDAs have not yet been fully developed. There can be no assurance that the FDA will approve an application submitted under section 505(b)(2) in a timely manner or at all.
The FDA also has the authority to revoke or suspend approvals of previously approved products for cause, to debar companies and individuals from participating in the drug-approval process, to request recalls of allegedly violative products, to seize allegedly violative products, to obtain injunctions to close manufacturing plants allegedly not operating in conformity with current Good Manufacturing Practices (GMP) and to stop shipments of allegedly violative products. The FDA may seek to impose pre-clearance requirements on products currently being marketed without FDA approval, and there can be no assurance that the Company or its third-party manufacturers or collaborators will be able to obtain approval for such products within the time period specified by the FDA.
EVEN IF WE OBTAIN MARKETING APPROVAL, OUR PRODUCTS WILL BE SUBJECT TO ONGOING REGULATORY REVIEW
If regulatory approval of a product is granted, such approval may be subject to limitations on the indicated uses for which the product may be marketed or contain requirements for costly post-marketing follow-up studies. As to products for which marketing approval is obtained, the manufacturer of the product and the manufacturing facilities will be subject to continual review and periodic inspections by the FDA and other regulatory authorities. The subsequent discovery of previously unknown problems with the product, manufacturer or facility may result in restrictions on the product or manufacturer, including withdrawal of the product from the market.
If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.
THE MARKET MAY NOT BE RECEPTIVE TO PRODUCTS INCORPORATING OUR TIMERx CONTROLLED RELEASE TECHNOLOGY
The commercial success of products incorporating our controlled release technology that are approved for marketing by the FDA and other regulatory authorities will depend upon their acceptance by the medical community and third party payors as clinically useful, cost-effective and safe.
Other factors that we believe could materially affect market acceptance of these products include:
- the timing of the receipt of marketing approvals and the countries in which such approvals are obtained;
- the safety and efficacy of the product as compared to competitive products; and
- the cost-effectiveness of the product and the ability to receive third party reimbursement.
OUR SUCCESS DEPENDS ON OUR PROTECTING OUR PATENTS AND PATENTED RIGHTS
Our success depends in significant part on our ability to develop patentable products, to obtain patent protection for our products, both in the United States and in other countries, and to enforce these patents. The patent positions of pharmaceutical firms, including us, are generally uncertain and involve complex legal and factual questions. As a result, patents may not issue from any patent applications that we own or license. If patents do issue, the claims allowed may not be sufficiently broad to protect our technology. In addition, issued patents that we own or license may be challenged, invalidated or circumvented. Our patents also may not afford us protection against competitors with similar technology.
Our success also depends on our not infringing patents issued to competitors or others. We are aware of patents and patent applications belonging to competitors and others that may require us to alter our products or processes, pay licensing fees or cease certain activities.
We may not be able to obtain a license to any technology owned by a third party that we require to manufacture or market one or more products. Even if we can obtain a license, the financial and other terms may be disadvantageous.
Our success also depends on our maintaining the confidentiality of our trade secrets and patented know-how. We seek to protect such information by entering into confidentiality agreements with employees, consultants, licensees and pharmaceutical companies. These agreements may be breached by such parties. We may not be able to obtain an adequate, or perhaps, any remedy to such a breach. In addition, our trade secrets may otherwise become known or be independently developed by our competitors.
WE ARE INVOLVED IN AND MAY BECOME INVOLVED IN ADDITIONAL PATENT LITIGATION OR OTHER INTELLECTUAL PROPERTY PROCEEDINGS RELATING TO OUR PRODUCTS OR PROCESSES WHICH COULD RESULT IN LIABILITY FOR DAMAGE OR STOP OUR DEVELOPMENT AND COMMERCIALIZATION EFFORTS
The pharmaceutical industry has been characterized by significant litigation and interference and other proceedings regarding patents, patent applications and other intellectual property rights. The types of situations in which we may become parties to such litigation or proceedings include:
- We or our collaborators may initiate litigation or other proceedings against third parties to enforce our patent rights.
- We or our collaborators may initiate litigation or other proceedings against third parties to seek to invalidate the patents held by such third parties or to obtain a judgment that our products or processes do not infringe such third parties' patents.
- If our competitors file patent applications that claim technology also claimed by us, we or our collaborators may participate in interference or opposition proceedings to determine the priority of invention.
- If third parties initiate litigation claiming that our processes or products infringe their patent or other intellectual property rights, we and our collaborators will need to defend against such proceedings.
An adverse outcome in any litigation or other proceeding could subject us to significant liabilities to third parties and require us to cease using the technology that is at issue or to license the technology from third parties. We may not be able to obtain any required licenses on commercially acceptable terms or at all.
The cost of any patent litigation or other proceeding, even if resolved in our favor, could be substantial. Although the legal costs of defending litigation relating to a patent infringement claim (unless such claim relates to TIMERx in which case such costs are our responsibility) are generally the contractual responsibility of our collaborators, we could nonetheless incur significant unreimbursed costs in participating and assisting in the litigation. Some of our competitors may be able to sustain the cost of such litigation and proceedings more effectively than we can because of their substantially greater resources. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to complete in the marketplace. Patent litigation and other proceedings may also absorb significant management time.
In 1994, the Boots Company PLC filed in the European Patent Office, or the EPO, an opposition to a patent granted by the EPO to us relating to our TIMERx technology. In June 1996, the EPO dismissed Boots' opposition, leaving intact all claims included in the patent. Boots has appealed this decision to the EPO Board of Appeals, and a court date has been set in June 2001 for an appellate hearing and a court date has been set in June 2001 for an appellate hearing. We can provide no assurance that we will prevail in this matter.
WE HAVE ONLY LIMITED MANUFACTURING CAPABILITIES AND WILL BE DEPENDENT ON THIRD PARTY MANUFACTURERS.
We lack commercial scale facilities to manufacture our TIMERx material in accordance with current GMP requirements prescribed by the FDA. We currently rely on a third party pharmaceutical company for the bulk manufacture of our TIMERx material for delivery to our collaborators.
There are a limited number of manufacturers that operate under GMP regulations capable of manufacturing our TIMERx material. We have not yet qualified a second source of supply. In the event that our current manufacturer is unable to manufacture the TIMERx material in the required quantities or at all, we may be unable to obtain alternative contract manufacturing, or obtain such manufacturing on commercially reasonable terms.
If our third party manufacturer fails to perform its obligations, we may be adversely affected in a number of ways, including:
- our collaborators may not be able to meet commercial demands for our products on a timely basis;
- our collaborators may not be able to initiate or continue clinical trials of products that are under development; and
- our collaborators may be delayed in submitting applications for regulatory approvals of our products.
We have limited experience in manufacturing TIMERx material on a commercial scale and no facilities or equipment to do so. If we determine to develop our own manufacturing capabilities, we will need to recruit qualified personnel and build or lease the requisite facilities and equipment. We may not be able to successfully develop our own manufacturing capabilities. Moreover, it may be very costly and time consuming for us to develop such capabilities.
The manufacture of any of our products (both TIMERx material and excipients) is subject to regulation by the FDA and comparable agencies in foreign countries. Any delay in complying or failure to comply with such manufacturing requirements could materially adversely affect the marketing of our products and our business, financial condition and results of operations.
WE ARE DEPENDENT UPON A SOLE SOURCE SUPPLIER FOR THE GUMS USED IN OUR TIMERx MATERIAL AND UPON A LIMITED NUMBER OF SUPPLIERS FOR THE WOOD PULP USED IN THE MANUFACTURE OF OUR EXCIPIENTS
Our TIMERx drug delivery system is a hydrophilic matrix combining primarily two polysaccharides, xanthan and locust bean gums, in the presence of dextrose. We purchase these gums from a sole source supplier. Emcocel and Prosolv, our two largest selling excipients, are manufactured from a specialty grade of wood pulp. We have qualified alternate suppliers with respect to such materials, but we can provide no assurance that interruptions in supplies will not occur in the future or that we will not have to obtain substitute suppliers. Any interruption in these supplies could have a material adverse effect on our ability to manufacture bulk TIMERx for delivery to our collaborators or to manufacture these excipients.
IF OUR COLLABORATORS FAIL TO OBTAIN AN ADEQUATE LEVEL OF REIMBURSEMENT BY THIRD PARTY PAYORS FOR OUR CONTROLLED RELEASE PRODUCTS, THEY MAY NOT BE ABLE TO SUCCESSFULLY COMMERCIALIZE CONTROLLED RELEASE PRODUCTS IN CERTAIN MARKETS
The availability of reimbursement by governmental and other third party payors affects the market for any pharmaceutical product. These third party payors continually attempt to contain or reduce the costs of health care by challenging the prices charged for medical products and services. In certain foreign countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control.
The generic versions of controlled release products being developed by us and our collaborators may be assigned an AB rating if the FDA considers the product to be therapeutically equivalent to the branded controlled release drug. Failure to obtain an AB rating from the FDA would indicate that for certain purposes the drug would not be deemed to be therapeutically equivalent, would not be fully
substitutable for the branded controlled release drug and would not be relied upon by Medicaid and Medicare formularies for reimbursement.
In both the U.S. and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the health care system. Further proposals are likely. The potential for adoption of these proposals may affect our ability to raise capital, obtain additional collaborative partners and market our products.
If we or our collaborators obtain marketing approvals for our products, we expect to experience pricing pressure due to the trend toward managed health care, the increasing influence of health maintenance organizations and additional legislative proposals. We may not be able to sell our products profitably if reimbursement is unavailable or limited in scope or amount.
WE WILL BE EXPOSED TO PRODUCT LIABILITY CLAIMS AND MAY NOT BE ABLE TO OBTAIN ADEQUATE PRODUCT LIABILITY INSURANCE
Our business exposes us to potential product liability risks which are inherent in the testing, manufacturing, marketing and sale of pharmaceutical products. Product liability claims might be made by consumers, health care providers or pharmaceutical companies or others that sell our products. These claims may be made even with respect to those products that are manufactured in licensed and regulated facilities or that otherwise possess regulatory approval for commercial sale.
We are currently covered by primary product liability insurance in the amount of $1 million per occurrence and $2 million annually in the aggregate on a claims-made basis and by umbrella liability insurance in excess of $25 million which can also be used for product liability insurance. This coverage may not be adequate to cover any product liability claims. Product liability coverage is expensive. In the future, we may not be able to maintain or obtain such product liability insurance at a reasonable cost or in sufficient amounts to protect us against losses due to liability claims. Any claims that are not covered by product liability insurance could have a material adverse effect on our business, financial condition and results of operations.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE
The market price of our common stock, like the market prices for securities of pharmaceutical, biopharmaceutical and biotechnology companies, have historically been highly volatile. The market from time to time experiences significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Factors such as fluctuations in our operating results, future sales of our common stock, announcements of technological innovations or new therapeutic products by us or our competitors, announcements regarding collaborative agreements, clinical trial results, government regulation, developments in patent or other proprietary rights, public concern as to the safety of drugs developed by us or others, changes in reimbursement policies, comments made by securities analysts and general market conditions may have a significant effect on the market price of the common stock.
CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND OF WASHINGTON LAW, AS WELL AS THE RIGHTS AGREEMENT TO WHICH WE ARE A PARTY, MAKE A TAKEOVER OF PENWEST MORE DIFFICULT
Provisions of our Certificate of Incorporation, our Bylaws and Washington law, as well as the Rights Agreement to which we are a party, may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of our company, including transactions in which our stockholders might otherwise receive a premium for their shares over then current market
prices. In addition, these provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interest.
ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to the disclosure under the caption "Market Risk and Risk Management Policies" in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations".
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
All financial statements required to be filed hereunder are filed as Appendix A hereto, are listed under Item 14 (a) included herein.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under "Election of Directors" in the Company's definitive Proxy Statement for the 2001 Annual Meeting of Shareholders is incorporated herein by reference.
Information regarding executive officers of the Company is set forth in Part I, Item 4a above and incorporated herein by reference.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
The information set forth under "Executive Compensation" in the Company's definitive Proxy Statement for the 2001 Annual Meeting of Shareholders is incorporated herein by reference.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 2001 Annual Meeting of Shareholders is incorporated herein by reference.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions of the Company set forth under "Certain Relationships and Related Transactions" in the Company's definitive Proxy Statement for the 2001 Annual Meeting of Shareholders is incorporated herein by reference.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements and Financial Statement Schedule
The following documents are filed as Appendix A hereto and are included as part of this Annual Report on Form 10-K.
The consolidated balance sheets as of December 31, 2000 and 1999 and the related statements of operations, cash flows and shareholders' equity (deficit) for each of the three years in the period ended December 31, 2000.
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because they are not applicable or because the information is presented in the financial statements or notes thereto.
(a) (2) Exhibits
The list of Exhibits filed as part of this Annual Report on Form 10-K are set forth on the Exhibit Index immediately preceding such exhibits, and is incorporated herein by this reference. This list includes a subset containing each management contract, compensatory plan, or arrangement required to be filed as an exhibit to this report.
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the three months ended December 31, 2000:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Penwest Pharmaceuticals Co.
Date: April 2, 2001 /s/Tod R. Hamachek ---------------------------------------- Tod R. Hamachek, Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: April 2, 2001 /s/Tod R. Hamachek ---------------------------------------- Tod R. Hamachek, Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
Date: April 2, 2001 /s/ Jennifer L. Good ---------------------------------------- Jennifer L. Good, Vice President, Finance and Chief Financial Officer (Principal Financial Officer)
Directors
Paul E. Freiman* Jere E. Goyan, Ph.D.* Tod R. Hamachek* Rolf H. Henel* By /s/ Jennifer L. Good Robert J. Hennessey* ------------------------------------ N. Stewart Rogers* John N. Staniforth, Ph.D.* Attorney-in-Fact* Anne M. VanLent* Power of Attorney Dated
Date: April 2, 2001
APPENDIX A
PENWEST PHARMACEUTICALS CO. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page Financial Statements Report of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Shareholders' Equity (Deficit) Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Schedule II - Valuation and Qualifying Accounts
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS PENWEST PHARMACEUTICALS CO.
We have audited the accompanying consolidated balance sheets of Penwest Pharmaceuticals Co. as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Penwest Pharmaceuticals Co. at December 31, 2000 and 1999, and the consolidated 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 related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 3 to the consolidated financial statements, Penwest Pharmaceuticals Co. changed its method of accounting for revenue recognition in 2000.
The accompanying financial statements have been prepared assuming that Penwest Pharmaceuticals Co. will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses and has had negative cash flows from operations in each of the three years in the period ended December 31, 2000 and, based on anticipated levels of operations and currently available capital resources, management expects continued operating losses and negative cash flows during 2001. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP Stamford, Connecticut March 15, 2001
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts)
See accompanying notes.
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
See accompanying notes.
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (in thousands)
See accompanying notes.
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
See accompanying notes.
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Penwest Pharmaceuticals Co. ("Penwest" or the "Company"), is engaged in the research, development and commercialization of novel drug delivery technologies. Based on its extensive expertise in developing and manufacturing tabletting ingredients for the pharmaceutical industry, the Company has developed TIMERx, a proprietary controlled release drug delivery technology and ProSolv SMCC(R) ("ProSolv"), another drug delivery technology which improves the performance characteristics of tablets. The Company's product portfolio ranges from excipients that are sold in bulk, to more technically advanced and patented excipients that are licensed to customers. The Company has manufacturing facilities in Iowa and Finland and has customers primarily throughout North America and Europe. The Company was a wholly-owned subsidiary of Penford Corporation ("Penford") prior to August 31, 1998 ("Distribution Date"). On August 31, 1998, Penford distributed to the stockholders of record of Penford's common stock on August 10, 1998, all of the shares of the Company's common stock (see Note 8).
The Company is subject to the risks and uncertainties associated with a drug delivery company actively engaged in research and development. These risks and uncertainties include, but are not limited to, a history of net losses, technological changes, dependence on collaborators and key personnel, the successful completion of development efforts and of obtaining regulatory approval, the successful commercialization of TIMERx controlled release products, compliance with government regulations, patent infringement litigation and competition from current and potential competitors, some with greater resources than the Company.
Future Operations
The Company has incurred recurring operating losses and has had negative cash flows from operations for each of the three years in the period ended December 31, 2000 and, based on anticipated levels of operations and currently available capital resources, management expects operating losses and negative cash flows during 2001. Management anticipates that its existing capital resources, as well as internally generated funds, will not enable the Company to maintain currently planned operations through 2001. Management's plans in regard to these matters include various available business and financing alternatives. On January 17, 2001, the Company entered into a revolving credit facility, up to $10 million (See Note 7). Continuation of the Company as a going concern and the realization of its assets and the satisfaction of its liabilities are dependent upon the Company's ability to obtain additional funding sources. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Penwest and its wholly owned subsidiaries. Material intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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. In addition, the consolidated financial statements include various costs allocated by Penford prior to the Distribution Date. Management believes the amounts allocated are reasonable and approximate the cost of obtaining the service from an unrelated third party.
In September 2000, the Emerging Issues Task Force reached a consensus on EITF Issue No. 00-10 "Accounting for Shipping and Handling Fees and Costs" and concluded that all amounts billed to a customer in a sale transaction related to shipping and handling represent revenues earned and should be classified as revenue. The Company adopted EITF No. 00-10 in the fourth quarter of 2000, and has reclassified its financial statements for all periods presented to comply with the guidelines of the EITF.
Certain other amounts in the financial statements for prior years have been reclassified to conform with the current year presentation. These reclassifications had no effect on previously reported results of operations or financial position.
Cash and Cash Equivalents
All highly liquid investments with a maturity of three months or less when purchased are considered cash equivalents.
Credit Risk and Fair Value of Financial Instruments
The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Revenues from product sales and licensing fees are primarily derived from major pharmaceutical companies that have significant cash resources. The Company maintains an allowance for doubtful accounts which management believes is sufficient to cover potential credit losses. One customer of the Company accounted for approximately 19% of total revenues in 2000. No customers of the Company accounted for 10% or more of total revenues in 1999. One customer accounted for approximately 11% of total revenues in 1998.
The carrying value of financial instruments, which includes cash, receivables, obligations under the Company's credit facility (see Note 7) and accounts payable, approximates market value due to their short term nature and the fact that all borrowings are at floating interest rates.
Long Lived Assets
Property and equipment are recorded at cost and depreciated by the straight-line method over their estimated useful lives. Estimated useful lives by class of assets are substantially as follows:
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company recognizes impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts.
Foreign Currencies
Assets and liabilities of the Company's foreign operations are translated into U.S. dollars at year-end exchange rates and revenue and expenses are translated at average exchange rates. For each of the foreign operations, the functional currency is the local currency. Accumulated other comprehensive loss equals the cumulative translation adjustment, which is the only component of other comprehensive loss included in the Company's financial statements. Realized gains and losses from foreign currency transactions are reflected in the consolidated statements of operations. Foreign currency transaction gains and losses were not significant in each year in the three year period ended December 31, 2000.
Income Taxes
The Company's results of operations were included in the tax returns of Penford through the Distribution Date. Effective September 1, 1998, the Company filed its income taxes on a stand-alone basis. Deferred income tax benefits and related income tax assets and liabilities are reflected as if the Company were an independent entity for all periods presented, in accordance with SFAS No. 109, "Accounting for Income Taxes", except that the Company was not compensated for tax losses utilized by Penford (see Note 12).
A valuation allowance has been established against the recorded deferred income tax assets to the extent that management believes it is more likely than not that a portion of the deferred income tax assets are not realizable.
Revenue Recognition
Revenues from product sales are recognized when title transfers and customer acceptance provisions have lapsed, provided collections of the related accounts receivable are probable. Revenue received from non-refundable upfront licensing fees are recognized ratably over the development period of the collaboration agreement, when this period involves development risk associated with the incomplete stage of a product's development or over the estimated or contractual licensing and supply term when the Company is obligated to supply inventory for manufacture when the development risk has substantially ended. Non-refundable milestone fees received for the development funding of a product are partially recognized upon receipt based on the Company's proportionate development efforts achieved to date relative to the total expected development efforts and the remainder is generally recognized ratably over the remaining expected development period. Other contractual fees received in connection with a collaborator's launch of a product are also recognized ratably over the estimated or contractual licensing and supply term. Product royalty fees are recognized when earned.
Advertising Costs
Advertising costs are accounted for as expenses in the period in which they are incurred.
Research and Development
Research and development expenses consist of costs related to products being developed internally as well as costs related to products subject to licensing agreements. Research and development costs are charged to expense as incurred. Certain reimbursements of costs related to drug formulation on feasibility studies are netted against research and development expense.
Per Share Data
Loss per common share is computed based on the weighted average number of common shares outstanding during the period after giving effect to the 0.76-for-1 reverse stock split and the 2,907.66-for-1 stock split of the common stock of the Company (see Note 10).
Stock Based Compensation
The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for stock options granted for which the exercise price of the options was the same as the market price of the Company's common stock on the date of grant. The Company has elected to continue to account for its employee stock compensation plans under APB No. 25. As prescribed under SFAS No. 123, "Accounting for Stock Based Compensation," the Company has disclosed in Note 10, the pro forma effects on net loss and loss per share of recording compensation expense for the fair value of the options granted.
3. ACCOUNTING CHANGES
Previously, the Company recognized revenue for upfront non-refundable fees when received and when all contractual obligations of the Company relating to the fees had been fulfilled. In addition, the Company previously recognized revenue relating to development milestones and other contractual fees as achieved, in accordance with the terms of the collaboration agreements. Effective January 1, 2000, the Company changed its method of accounting for upfront non-refundable fees and milestone fees. Revenue received from non-refundable upfront licensing fees are recognized ratably over the development period of the collaboration agreement, when this period involves development risk associated with the incomplete stage of a product's development or over the estimated or contractual licensing and supply term when the Company is obligated to supply inventory for manufacture, when the development risk has substantially ended. Non-refundable milestone fees received for the development funding of a product are partially recognized upon receipt based on the Company's proportionate development efforts achieved to date relative to the total expected development efforts and the remainder is generally recognized ratably over the remaining expected development period. Other contractual fees received in connection with a collaborator's launch of a product are also recognized ratably over the estimated or contractual licensing and supply term. The Company believes the change in accounting principle is preferable based on guidance provided in SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements.
The cumulative effect of the change in accounting principle was reported as a change in the year ended December 31, 2000. The cumulative effect was initially recorded as deferred revenue that will be recognized as revenue over the remaining related collaborative or licensing and supply agreements, as appropriate. For the year ended December 31, 2000, the cumulative effect of the change on prior years was to increase the net loss by $410,000 or $0.03 per share. The effect of the change on loss before cumulative effect of the change for the year ended December 31, 2000 was to decrease the net loss by $32,000 (see Note 17). The pro forma amounts presented on the statement of operations were calculated assuming the accounting change was made retroactively to prior years. During the year ended December 31, 2000, the Company recognized $204,000 of revenue that is included in its cumulative effect adjustment as of January 1, 2000.
4. INVENTORIES
Inventories, which consist of raw materials, pharmaceutical excipients manufactured by the Company, pharmaceutical excipients held for distribution, including manufactured bulk TIMERx, are stated at the lower of cost (first-in, first-out) or market. Cost includes material, labor and manufacturing overhead costs.
Inventories are summarized as follows:
Included in inventories are approximately $466,000 and $2,882,000 of TIMERx raw materials and bulk TIMERx as of December 31, 2000 and 1999, respectively. The ability to continue to sell TIMERx related inventory is dependent, in part, upon the commercialization of products by third parties utilizing bulk TIMERx and the continued use by the Company and third parties of the TIMERx related inventory in existing and new research efforts.
The Company periodically reviews and quality tests its inventory to identify obsolete, slow moving or otherwise unsaleable inventories. Inventories at December 31, 2000 and 1999, are net of allowances of $26,000 and $277,000, respectively.
Through most of 1999, the Company primarily relied on a large third-party pharmaceutical company for the manufacture of its TIMERx products. In September 1999, the Company entered into a five-year contract (plus automatic renewals of one year each) for the manufacturing of TIMERx material with another large third party pharmaceutical company. There are a limited number of third party manufacturers capable of producing the TIMERx material. There can be no assurance that third parties upon which the Company relies for supply of its TIMERx materials will perform and any failures by third parties may delay development, or the submission of products for regulatory approval, impair the Company's collaborators' ability to commercialize products as planned and deliver products on a timely basis or otherwise impair the Company's competitive position, which could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations.
The Company's TIMERx drug delivery system is a hydrophilic matrix combining primarily two natural polysaccharides, xanthan and locust bean gums, in the presence of dextrose. The Company purchases these gums from a sole source supplier. Most of the Company's other excipients are manufactured from a specialty grade of wood pulp, which the Company also purchases from a sole source supplier. Although the Company has qualified alternate suppliers with respect to these materials, there can be no assurance that interruptions in supplies will not occur in the future or that the Company will not have to obtain substitute suppliers. Any of these events could have a material adverse effect on the Company's ability to manufacture bulk TIMERx for delivery to its collaborators or manufacture its other excipients, which could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations.
5. FIXED ASSETS
Fixed assets, at cost, summarized by major categories, consist of the following:
6. OTHER ASSETS
Other assets, net of accumulated amortization, consist of the following:
Patents include costs to secure patents on technology developed by the Company and secure trademarks. Patents are amortized on a straight-line basis over their useful lives of 17 to 20 years. Amortization expense of $155,000, $131,000, and $105,000 was recorded in the years ended December 31, 2000, 1999, and 1998, respectively.
Goodwill is being amortized on a straight-line basis over ten years and was recorded upon the acquisition of the Company by Penford. Amortization expense approximated $58,000 for each of the years ended December 31, 2000, 1999, and 1998.
Recorded intangibles are evaluated for potential impairment whenever events or circumstances indicate that the undiscounted cash flows are not sufficient to recover their carrying amounts. An impairment loss is recorded to the extent the asset's carrying value is in excess of related discounted cash flows.
Cash surrender value of officer's life insurance policies approximating $2,364,000 was contributed to the Company by Penford on the Distribution Date (see Note 8).
7. CREDIT FACILITIES
On July 2, 1998 the Company obtained a $15 million unsecured revolving credit facility (the "Credit Facility") which was guaranteed by Penford. Proceeds from the Credit Facility were used to fund working capital and for general corporate purposes, including capital expenditures. On August 31, 2000, all outstanding amounts under the Credit Facility were to become automatically due and payable. Penford agreed that, for a period ended August 31, 2000, it would guarantee the Company's indebtedness under the Credit Facility. LIBOR Advances (available in multiples of $1,000,000 for 1, 2 or 3 month LIBOR periods) under the Credit Facility bore interest at a rate equal to LIBOR, plus 1.25%. Base Rate Advances (available in minimum amounts of $100,000) bore interest at the Bank's Alternate Base Rate. The Credit Facility also required commitment fees be paid of .325% on unused portions of the commitment amount.
In March 2000, in connection with its private placement of common stock (see Note 10), the Company repaid its outstanding obligations under the Credit Facility and, accordingly, the amount outstanding at December 31, 1999 of $6.7 million, was excluded from current liabilities. Pursuant to the terms of the Credit Facility, amounts available to the Company are reduced by any net proceeds from financings conducted by the Company, thereby terminating the Credit Facility.
Amounts outstanding under the Credit Facility are as follows:
Approximately $147,000, $303,000, and $52,000 of interest was paid in 2000, 1999, and 1998, respectively.
On January 17, 2001, the Company completed arrangements for a revolving line of credit ("Revolver") with a financial institution. Under the terms of the Revolver, the Company may borrow up to $10 million ("Line of Credit") as determined by a formula based on the Company's Eligible Accounts Receivable and Eligible Saleable Inventory, as defined in the agreement. Under the formula, generally 85% of the Company's U.S. and Canadian receivables, as well as generally 60% of the Company's U.S. saleable inventories, are included in the borrowing base. Amounts outstanding under the Revolver are collateralized by the Company's U.S. and Canadian accounts receivable, and
its inventory and general intangibles. The Revolver has an initial term of three years, and provides for annual renewals thereafter.
The Revolver bears interest at a specified bank's prime rate plus 1% per annum, on the greater of $3.0 million or on the average outstanding balance. The Revolver also requires fees be paid of .5% per annum on unused portions of the Line of Credit. It also provides for early termination fees of up to .75%, in the event the Company terminates the Revolver prior to the end of the initial term.
The Revolver contains covenants, including the requirement that the Company maintain at all times, certain minimum levels of tangible net worth as defined, at varying specified amounts during the initial term of the agreement, and restrictions on the incurrence of additional indebtedness.
As of March 15, 2001, there was $3.0 million outstanding under the terms of the Revolver.
8. DISTRIBUTION AND CAPITAL CONTRIBUTION
On August 31, 1998, Penford distributed to the shareholders of record of Penford common stock on August 10, 1998, all of the shares of the Company's Common Stock (the "Distribution"). Pursuant to the Distribution, each Penford shareholder of record received three shares of the Company's Common Stock for every two shares of Penford common stock held by them. In connection with the Distribution (i) the Company's Common Stock was registered under the Securities Exchange Act of 1934, as amended, pursuant to the registration statement on Form 10 which was declared effective on July 31, 1998, (ii) the Company's Common Stock was listed with and began trading on the National Market on August 10, 1998 and (iii) Penford obtained a private letter ruling from the Internal Revenue Service to the effect that, among other things, the Distribution qualified as tax-free under Sections 355 and 368 of the Internal Revenue Code of 1986, as amended, and that the receipt of shares of the Company's Common Stock in the Distribution would not result in the recognition of income, gain or loss to Penford's shareholders for federal income tax purposes.
In connection with the Distribution, the Company and Penford have entered into agreements that govern various interim and ongoing relationships. These agreements include (i) a Separation and Distribution Agreement setting forth the agreement of the parties with respect to the principal corporate transactions which were required to effect the separation of Penford's pharmaceutical business from its specialty carbohydrate-based chemical business and the Distribution, including without limitation Penford's agreement to guarantee the Company's indebtedness under its credit facility (see Note 7); (ii) a Services Agreement pursuant to which Penford continued on an interim basis to provide specified services to the Company until June 30, 2000 or until Penwest no longer needed the services, of which costs were charged to the Company on an actual or allocated basis, plus a specified profit percentage (as of August 31, 1998, significant services were no longer provided to the Company by Penford).; (iii) a Tax Allocation Agreement relating to, among other things, the allocation of tax liability between the Company and Penford in connection with the Distribution, all pre-distribution liabilities are the responsibility of Penford and all post distribution liabilities are those of the respective entities; (iv) an Excipient Supply Agreement pursuant to which Penford will manufacture and supply exclusively to the Company, and the Company will purchase exclusively from Penford, subject to certain exceptions, all the Company's requirements for two excipients marketed by the Company under quantity and pricing terms that the Company believes approximate
fair market value; and (v) an Employee Benefits Agreement setting forth the parties' agreements as to the continuation of certain Penford benefit arrangements for the employees of the Company. Subsequent to the Distribution, no terminating liabilities were incurred by Penwest related to the Penford defined benefit plan.
On August 31, 1998, in connection with the separation of its pharmaceutical business, Penford contributed to the capital of the Company all existing intercompany indebtedness of the Company (the "Contribution") which approximated $50.9 million.
9. TRANSACTIONS WITH PENFORD
The amount payable to Penford that was contributed upon the Distribution consisted solely of advances. These advances were generated primarily from the initial acquisition of the Company, the addition of a microcrystalline cellulose plant and the funding of operations. The amounts payable to Penford were non-interest-bearing obligations. Average balances for the 1998 period prior to the Distribution were $46,784,000. The Company also participated in pension and other employee benefit plans sponsored by Penford and purchases inventory from a wholly-owned subsidiary of Penford. The inventory purchases amounted to approximately $951,000, $469,000, and $438,000 for the years ended December 31, 2000, 1999, and 1998, respectively. The Company believes the terms of its employee benefit and inventory purchase transactions approximate those that would have been reached with a third party in an arms length transaction and represent the approximate costs the Company would have incurred on a stand-alone basis. Penford allocated executive office salaries, bonuses and legal fees to the Company in the form of a management fee prior to the Distribution Date. The costs making up the management fee were allocated to the Company based upon its pro rata portion of Penford's consolidated revenue. The Company believes the management fees approximate the actual costs of services provided and represent the approximate costs the Company would have incurred on a stand-alone-basis. Included in selling, general and administrative expenses is a management fee of $219,000 for the year ended December 31, 1998.
10. EQUITY
On March 6, 2000, the Company completed a private placement of its common stock to selected institutional and other accredited investors, resulting in the sale of 1,399,232 shares for approximately $18.2 million, less expenses. Approximately $7.7 million was used to repay the existing outstanding balance under the Credit Facility as required by its terms. The Credit Facility is no longer available to the Company.
Penford Stock Option Plan
Certain of the Company's employees participated in Penford's 1994 Stock Option Plan (the "1994 Plan") for which 1,000,000 shares of common stock had been authorized for grants of options by Penford. The 1994 Plan provided for the granting of stock options at the fair market value of the common stock on the date of grant. Either incentive stock options or non-qualified stock options were granted under the 1994 Plan. The incentive stock options generally vest over five years at the rate of 20% each year and expire 10 years from the date of grant. The non-qualified stock options generally vest over four years at the rate of 25% each year and expire 10 years and 10 days from the
date of grant. Changes in Penford stock options granted to employees of Penwest for the year ended December 31, 1998 (through the Distribution) are as follows:
Penwest Stock Option Plans
As of December 31, 2000 the Company had two stock option plans: the 1997 Equity Incentive Plan (the "1997 Plan"), and the 1998 Spin-off Option Plan (the "Spin-off Plan"). The 1997 Plan provides for the grant of incentive stock options, nonstatutory stock options, restricted stock awards and other stock-based awards, including the grant of securities convertible into Common Stock and the grant of stock appreciation rights (collectively "Awards"). A total of 2,660,000 shares of Common Stock may be issued pursuant to Awards granted under the 1997 Plan. Awards may be granted at an exercise price which may be less than, equal to or greater than the fair market value of the Common Stock on the date of grant subject to certain limitations. Restricted stock awards entitle recipients to acquire shares of Common Stock, subject to the right of the Company to purchase all or part of such shares from the recipient in the event that the conditions specified in the applicable Award are not satisfied prior to the end of the applicable restriction period established for such Award. During 1998, there were 52,500 restricted shares granted. There were no such shares granted in 1999 or 2000.
The Company's 1998 Spin-off Option Plan was adopted by the Company in June 1998 to provide for the grant of stock options to employees of Penwest and non-employee directors of Penford who held options to purchase Penford Common Stock as of the Distribution Date and who cease to be employees of Penford under the terms of Penford's stock option plans. As of the Distribution Date, options to purchase 1,000,722 shares of Common Stock were granted to the Company's employees and non-employee directors of Penford under the Spin-off Plan. The exercise price and number of options was calculated so as to preserve the Penford options' approximate value as of the Distribution Date. The Board may not grant any additional options under the Spin-off Plan. If any option expires or is terminated, surrendered, canceled or forfeited, the unused Common Stock covered by such option will cease to be available for grant under the Spin-off Plan.
Stock Compensation
Statement of Financial Accounting Standard No. 123 "Accounting for Stock Based Compensation" requires the Company to disclose the pro forma impact on net loss and loss per basic and diluted share as if compensation expense associated with employee stock options granted to employees of Penwest had been calculated under the fair value method of Statement No. 123 as follows:
The fair value of each option grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:
The weighted average fair value of options granted during the years ended December 31, 2000, 1999, and 1998 was $11.92, $5.73, and $6.17, respectively. The weighted average remaining contractual life of options outstanding at December 31, 2000 is 8.0 years. The weighted effect of applying Statement No. 123 for providing pro forma disclosures for the years ended December 31, 2000, 1999, and 1998 is not likely to be representative of the effects in future years because the amounts above reflect only the options granted before 1995 that vest over four to five years. No additional Penford shares were granted to the Company employees subsequent to December 31, 1997.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan was approved in October 1997 and enables all employees to subscribe "during specified offering periods" to purchase shares of common stock at the lower of 85% of the fair market value of the shares on the first or last day of such offering period. A maximum of 228,000 shares are authorized for issuance under the Plan. There were 20,415 shares, 25,930 shares, and 6,509 shares issued under the Plan during 2000, 1999, and 1998, respectively.
Rights Agreement
On June 25, 1998, the Company's Board of Directors declared a dividend of one right for each outstanding share of the Company's Common Stock (the "Right") to shareholders of record at the close of business on July 28, 1998. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of the Series A Preferred Stock, at a purchase price of $60 in cash, subject to adjustment.
The Rights are not currently exercisable and will not be exercisable until the earlier of (i) 10 business days (or such later date as may be determined by the Board) following the later of (a) a public announcement that a person or group of affiliated or associated persons (a "Rights Acquiring Person") has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of Common Stock or (b) the first date on which an executive officer of the Company has actual knowledge that a Rights Acquiring Person has become such, or (ii) 10 business days (or such later date as may be determined by the Board) following the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 15% or more of such outstanding shares of Common Stock. The Rights will expire upon the close of business on July 27, 2008 unless earlier redeemed or exchanged.
Stock Splits
On June 19, 1998, the Company effected a 0.76-for-1 reverse stock split, reducing the outstanding shares to 11,036,822 shares of common stock. Accordingly, all share and per share data have been retroactively adjusted to give effect to the stock split and reverse stock split.
11. COMMITMENTS
Leases
The Company's manufacturing facility in Finland is leased under a three-year operating lease which includes renewal options with annual rental expense of approximately $225,000 plus additional charges determined on a month-to-month basis for equipment and warehouse usage. In addition, certain of the Company's property, plant and equipment is leased under operating leases ranging from one to fifteen years and includes periodic escalation clauses based on rental market conditions as well as insurance rent payments. Rental expense under operating leases was $583,000, $343,000, and $316,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
Future minimum lease payments as of December 31, 2000 for noncancellable operating leases having initial lease terms of more than one year are as follows:
12. INCOME TAXES
The provision (benefit) for federal, state and foreign income taxes consists of the following:
The reconciliation between the statutory tax rate and those reflected in the Company's income tax provision (benefit) is as follows:
The components of deferred income tax (assets) and liabilities at December 31 are as follows:
The Company's income tax payments, primarily comprised of foreign income taxes, approximated $371,000, $243,000, and $151,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
Through August 31, 1998 the Company was included in the consolidated federal and state tax returns of Penford. In accordance with the Company's tax sharing agreement, the Company was not compensated for tax losses that were utilized by Penford. As a result of Penford fully utilizing all of the Company's tax losses through the Distribution Date, the Company does not possess net operating loss carryforwards attributable to such periods. Through August 31, 1998, Penford had utilized approximately $26,693,000 of federal net operating loss carryforwards that the Company would have had outstanding were it a stand-alone entity through such date, of which approximately $3,393,000, $4,503,000, $5,084,000, $7,643,000 and $6,070,000 would have expired in 2009, 2010, 2011, 2012 and 2013, respectively. In addition, Penford is liable for any federal, state or foreign tax adjustments assessed against the Company for periods through the Distribution Date. The valuation allowance and the deferred tax assets at December 31, 1998 related to deferred compensation and the SERP liability, were recorded in conjunction with the Contribution (see Note 8).
At December 31, 2000, the Company has federal net operating loss ("NOL") carryforwards of $23,302,000 for income tax purposes, of which approximately $6,187,000 and $8,405,000 and $8,710,000 expire in 2018, 2019, and 2020, respectively. The use of the NOLs is limited to future taxable earnings of the Company. For financial reporting purposes, a valuation allowance of $7.3 million has been recognized to offset net deferred tax assets, primarily attributable to the NOL carry-forward.
The Company's policy is to permanently reinvest foreign earnings. Accumulated foreign earnings, for which no deferred taxes have been provided, amounted to $3,794,000, $3,372,000 and $2,580,000 as of December 31, 2000, 1999, and 1998, respectively. If such earnings were to be repatriated, the income tax effect would not be significant.
Included in the loss before income taxes is foreign income of $977,000, $971,000, and $476,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
13. PENSION AND OTHER EMPLOYEE BENEFITS
Savings and Stock Ownership Plans
The Company's employees participated, prior to the Distribution, in Penford's Savings and Stock Ownership Plan and costs were charged to the Company based upon actual costs incurred for the Company's employees. Seventy-five percent (75%) of employee's contributions were matched up to 6% of the employee's pay, in the form of Penford common stock. A similar plan was adopted by the Company upon the Distribution. The primary changes in the new plan include the shortening of the vesting period from five years to four years and the Company's match is now in the form of cash. The Company's expense under the Plans was $237,000, $212,000, and $217,000 for 2000, 1999, and 1998, respectively.
The Plans also include a discretionary annual profit-sharing component that is awarded by Penford's Board of Directors prior to the spin-off and Penwest's Board of Directors subsequent to the spin-off, generally based on achievement of predetermined corporate goals. This feature is available to all employees who meet the eligibility requirements of the Plans. The profit sharing expense related to the Company's employees was $125,000 for 1998. There was no profit sharing expense in 1999 or 2000.
Supplemental Executive Retirement Plan
The Company has a Supplemental Executive Retirement Plan (SERP), a nonqualified plan, which covers the Chairman and Chief Executive Officer of Penwest. For 2000, 1999, and 1998, the net expense for the SERP incurred by Penwest was $122,000, $141,000, and $56,000, respectively. The allocated costs represent the costs attributable to the Company's employees. As part of the Distribution, the SERP liability was assumed by the Company. The Company does not fund this liability and no assets are held by the Plan. The following disclosures represent information subsequent to the Distribution.
Change in benefit obligation (in thousands):
Funded status (in thousands):
Components of net periodic benefit cost (in thousands):
The plan's accumulated benefit obligation at December 31, 2000 and 1999 was $1,216,900, and $1,066,000, respectively. The Company's benefit obligation was measured using a weighted average discount rate of 7.5% in 2000 and 1999 and a compensation increase of 3% in 2000 and 1999. The amortization of prior service cost is determined using a straight-line amortization of the cost over the average remaining service period of the employee expected to receive benefits under the Plan.
Health Care and Life Insurance Benefits
The Company offers health care and life insurance benefits to most active employees. Costs incurred for these benefits were $682,000, $491,000, and $496,000 in 2000, 1999, and 1998, respectively.
Pension Plan
Prior to the Distribution, Penwest participated in a noncontributory defined benefit pension plan (the "Plan") that covered substantially all employees. The Plan was sponsored by Penford and costs were allocated based upon actual costs incurred for the Company's employees. In addition to the employees of the Company, employees of Penford and its other subsidiaries participated in the Plan. The Company has accounted for its involvement in the overall Plan as a participant in a multi-employer pension plan. Under this method, the Company recognized as net periodic pension costs its allocated contribution for the period. The Company recognized a liability to Penford for any contributions due and unpaid.
Under the terms of the Employee Benefits Agreement between Penford and Penwest, Penford froze all benefits to employees of Penwest under the Plan as of the Distribution and distributed to each employee his or her fully vested interest in the form of a lump sum payment or an annuity. Based upon the terms of the agreement, there were no termination gains or losses as a result of the freezing of Plan benefits, the termination of the right of employees of the Company to participate in the Plan or the subsequent distribution.
Benefits for employees are primarily related to years of credited service and final average five-year earnings. Employees generally become eligible to participate in the Plan after attaining age 21 and benefits become vested after five years of credited service.
Pension expense of $50,000 was recorded for the year ended December 31, 1998 for this Plan. There was no pension expense for 1999 or 2000 as the plan has been terminated.
14. LICENSING AGREEMENTS
The Company enters into collaborative arrangements with pharmaceutical companies to facilitate and expedite the commercialization of its TIMERx drug delivery technology.
In September 1997, the Company entered into a strategic alliance agreement with Endo Pharmaceuticals Inc. ("Endo") with respect to the development of an extended release formulation of oxymorphone based on the Company's TIMERx technology (the "Endo Product"). Under the agreement, the Company has agreed to manufacture and supply TIMERx material to Endo, and Endo has agreed to manufacture and market the Endo Product in the United States. The manufacture and marketing of the Endo Product outside of the United States may be conducted by the Company, Endo or a third party, as determined by a committee comprised of an equal number of members from each of the Company and Endo. The Company and Endo have agreed to share the costs involved in the development and commercialization of the Endo Products and that the party marketing the Endo Products (which the Company expects will be Endo) will pay the other party royalties equal to 50% of their respective net marketing revenues after fully-burdened costs (although this percentage will decrease as the total U.S. marketing revenues from an Endo Product increase), subject to each party's right to terminate its participation with respect to any Endo Product described above. Endo will purchase formulated TIMERx material for use in the Endo Products exclusively from the Company at specified prices. Such prices will be reflected in the determination of fully-burdened costs. Under the Company's strategic alliance agreement with Endo, the Company is no longer contractually obligated to spend additional funds, but intends to fund the full 50% of the development costs.
On March 2, 2000, Mylan Pharmaceuticals Inc. ("Mylan") announced that it had signed a supply and distribution agreement with Pfizer, Inc. ("Pfizer") to market a generic version of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer's Procardia XL. As a result of the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In connection with that agreement, Mylan agreed to pay Penwest a royalty on all future net sales of Pfizer's 30 mg strength of generic Procardia XL, which Mylan launched at the end of March 2000. The royalty percentage is comparable to those called for in Penwest's original agreement with Mylan for Nifedipine XL, a generic equivalent to Procardia XL. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL. During the year ended December 31, 2000 and in connection with its March 2000 agreement with Mylan, the Company recognized approximately $2.2 million in revenue from a final shipment of formulated bulk TIMERx manufactured for Nifedipine XL, as well as royalty revenue that was recorded on Mylan's sales of the 30mg strength of generic Procardia XL.
Approximately $12,102,000, $6,429,000, and $5,084,000 for the years ended December 31, 2000, 1999, and 1998, respectively, of research and development expense principally related to applications of TIMERx technology to products covered by the Company's collaborative agreements. Since the collaborative agreements can be terminated by either party, the costs associated with such agreements could be discontinued by the Company. Such costs are typically incurred prior to the receipt of milestones, royalties and other payments.
15. CONTINGENCIES
In 1994, the Boots Company PLC ("Boots") filed an opposition to a patent granted by the European Patent Office (the "EPO") to the Company relating to its TIMERx technology. In June 1996, the EPO dismissed Boots' opposition, leaving intact all claims included in the patent. Boots has appealed this decision to the EPO Board of Appeals and a hearing date for this case has been set for June 2001. There can be no assurance that the Company will prevail in this matter. Management believes that an estimate of the possible loss or range of loss relating to this matter cannot be made at this time. An unfavorable
outcome could materially adversely affect the Company's business, financial condition, cash flows and results of operations.
Substantial patent litigation exists in the pharmaceutical industry. Patent litigation generally involves complex legal and factual questions, and the outcome frequently is difficult to predict. An unfavorable outcome in any patent litigation affecting the Company could cause the Company to pay substantial damages, alter its products or processes, obtain licenses and/or cease certain activities. Even if the outcome is favorable to the Company, the Company could incur substantial litigation costs. Although the legal costs of defending litigation relating to a patent infringement claim (unless such claim relates to TIMERx) are generally the contractual responsibility of the Company's collaborators, the Company could nonetheless incur significant unreimbursed costs in participating and assisting in the litigation.
16. SEGMENT INFORMATION
The Company is engaged in the research, development and commercialization of novel drug delivery technologies. The Company has extensive experience in developing and manufacturing tabletting ingredients for the pharmaceutical industry. The Company's product portfolio ranges from excipients that are sold in bulk, to more technically advanced and patented excipients that are licensed to customers and conducts its business primarily in North America and Europe. The European operations consist of a manufacturing facility in Nastola, Finland and sales offices in Reigate, England and Bodenheim, Germany. None of the European locations, other than Finland, is individually significant. Intercompany sales include a profit component for the selling company. Intercompany sales and profits are eliminated in consolidation. Corporate operating expenses are not allocated to the European operations. Operating profit represents gross profit less selling, general and administrative expenses and, for North America, research and development expense.
Neither the revenues nor long-lived assets in Germany or the United Kingdom, individually or in the aggregate, exceed 10% of total revenues or long-lived assets, respectively, of the Company.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for the years ended December 31, 2000 and 1999 is as follows:
a) Amounts restated for the adoption of EITF No. 00-10 "Accounting for Shipping and Handling Fees and Costs."
b) Amounts restated for the adoption of Staff Accounting Bulletin No. 101 ("SAB 101").
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
PENWEST PHARMACEUTICALS CO. DECEMBER 31, 2000
(IN THOUSANDS)
(a) Uncollectible accounts written off, net of recoveries.
(b) Disposals of unrecoverable inventory costs.
INDEX TO EXHIBITS
*Incorporated by reference to Exhibits to the Registrant's Registration Statement on Form S-1 (File No. 333-38389).
**Incorporated by reference to Exhibits to the Company's Registration Statement on Form 10 filed with the Commission on June 22, 1998 and July 31, 1998.
***Incorporated by reference to Exhibits to the Company's Quarterly Report on Form 10Q (No.000-23467) for the quarterly period ended September 30, 2000.
+Confidential treatment granted as to certain portions, which portions are omitted and filed separately with the Commission.
++Management contract or compensatory plan or arrangement required to be filed as an exhibit to this annual report on Form 10-K.