SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
XX Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1996.
Transition report pursuant to Section 13 of 15(d) of the Securities
Exchange Act of 1934 for transition period from _______ to ________.
Commission File No. 0-27150
PATHOGENESIS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 91-1542150
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 Elliott Avenue West, Seattle, Washington 98119
(Address of principal executive offices)
Registrant's telephone number, including area code: (206) 467-8100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class
-------------------
Common Stock, $.001 par value per share
Indicate by check mark whether the Registrant has (1) filed all reports
required to be filed by Section 12 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) been subject to such
filing requirements for the past 90 days.
Yes X No ______
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. X
As of March 26, 1997, there were 16,049,685 shares of common stock, $.001
par value, outstanding. The aggregate market value of the voting stock held by
non-affiliates of the Registrant,
<PAGE>
based on the closing bid price of the Registrant's common stock quoted on the
NASDAQ National Market on March 26, 1997 of $25.50 per share was approximately
$364,334,718.00.
Document Incorporated by Reference: portions of the Registrant's
definitive Proxy Statement to be filed pursuant to Regulation 14A relating to
its Annual Meeting of Stockholders to be held on or about June 25, 1997 (the
"Proxy Statement") that are specifically identified herein are incorporated by
reference into Part III of this report.
- --------
1 For purposes of this report, the number of shares held by non-affiliates was
determined by aggregating the number of shares held by Officers and Directors of
Registrant, and by others who, to Registrant's knowledge, own 10% or more of the
Registrant's Common Stock, and subtracting those shares from the total number of
shares outstanding.
- 2 -
<PAGE>
PART I
This Annual Report of Form 10-K contains forward looking statements that
involve certain risks and uncertainties. The Registrant's actual results
could differ materially from the results discussed in the forward looking
statements. See "Cautionary Statements Regarding Forward-Looking
Statements."
Item 1. Business
Summary
PathoGenesis Corporation ("PathoGenesis" or the "Registrant") develops
novel drugs to treat serious, chronic human infectious diseases where there is a
significant need for improved therapy. The Registrant's lead drug candidate,
TOBI(TM) (tobramycin for inhalation), is a stable, premixed, proprietary
formulation of the antibiotic tobramycin for delivery by inhalation using a
nebulizer. In January 1997, PathoGenesis announced results from its two pivotal
Phase III clinical trials of TOBI for treatment of chronic Pseudomonas
aeruginosa ("P. aeruginosa") lung infections in people with cystic fibrosis. The
Registrant intends to file a New Drug Application (an "NDA") for TOBI in cystic
fibrosis patients with the United States Food and Drug Administration (the
"FDA") in the second quarter of 1997. The FDA has agreed to an expedited review
of such NDA, which may accelerate the application review process. Based on the
potential efficacy of delivering a high concentration of tobramycin directly to
the site of infection in the lungs, the Registrant also intends to commence
Phase II clinical trials of TOBI in patients suffering from bronchiectasis (a
form of severe chronic bronchitis) and tuberculosis during 1997. The
Registrant's second drug candidate, PA-1648, a derivative of the antibiotic
rifampin, is being developed for the treatment of tuberculosis. The Registrant
intends to commence Phase II clinical trials of PA-1648 in tuberculosis patients
during 1997. The Registrant is also developing PA-824, a proprietary antibiotic,
to treat tuberculosis.
While the Registrant currently intends to file an NDA for TOBI in cystic
fibrosis patients in the second quarter of 1997 and the FDA has agreed to an
expedited review of such NDA, there can be no assurance as to the timing of such
filing or the outcome or timing of the FDA's review of such filing.
Additionally, there can be no assurance that TOBI, if approved by the FDA, will
achieve market acceptance. Furthermore, no assurance can be given that the
results of any of the anticipated additional clinical trials to be conducted by
the Registrant will be consistent with results obtained in the clinical trials
for TOBI in cystic fibrosis patients or that such trials will be completed
within anticipated time frames, if at all.
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Products Under Development
The following table summarizes the indication, development status,
estimated length of therapy and approximate number of U.S. patients for the drug
candidates under development by the Registrant.
<TABLE>
<CAPTION>
Approximate
Drug Estimated Number of
Indication Candidate Development Status* Length of Therapy U.S. Patients
- ---------- --------- ------------------- ----------------- -------------
<S> <C> <C> <C> <C>
Cystic fibrosis lung TOBI Phase III clinical trials 10-15 years 30,000
infections.................... completed; intended
NDA filing in second
quarter of 1997
Bronchiectasis (a form TOBI Phase II clinical trials 5-10 years 100,000
of severe chronic intended to commence in
bronchitis)................ 1997
Tuberculosis (adjunct TOBI Phase II clinical trials Less than 1 month 25,000
therapy for patients intended to commence in
with contagious 1997
pulmonary
tuberculosis)..............
Tuberculosis.................. PA-1648 Phase II clinical trials 4-6 months 25,000
intended to commence in
1997
Tuberculosis.................. PA-824 Preclinical development 4-6 months 25,000
</TABLE>
- -----------
*See "Business-Government Regulation and Product Testing" for a description of
the various phases of clinical testing.
TOBI for Cystic Fibrosis Lung Infections
TOBI is a stable, premixed, proprietary formulation of the antibiotic
tobramycin for delivery by inhalation. Intravenous tobramycin has been approved
for marketing for over 20 years. Tobramycin is a member of an antibiotic complex
called nebramycin, a fermentation product which was isolated in 1967 from
Streptomyces tenebrarius by scientists at Eli Lilly and Company. This
fermentation product was designated tobramycin, a water-soluble compound
belonging to the group of antibiotics called aminoglycosides. Like other
aminoglycosides, tobramycin inhibits bacterial protein synthesis and is most
active against gram-negative bacteria.
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The Registrant is initially seeking to develop TOBI for the treatment of
chronic pseudomonal lung infections in cystic fibrosis patients. The Registrant
also intends to develop TOBI as a primary therapy for bronchiectasis, a form of
severe chronic bronchitis, and as an adjunct therapy for tuberculosis.
Cystic Fibrosis
Cystic fibrosis is a genetic disease that occurs in one out of every 3,000
births in the United States and Europe. The genetic defect results in the
accumulation of thick, tenacious mucus in the lungs. Early in life, cystic
fibrosis patients typically have bacterial infections comparable to other
children. While the majority of these infections are treated effectively in
these patients, the accumulation of mucus in the lungs usually leads to
life-long infections predominantly with a bacterium known as P. aeruginosa.
Once established, persistent pseudomonal infection becomes the predominant
factor in the progression of the lung disease. The persistent local infection
causes a strong inflammatory response in the patient resulting in progressive
destruction of lung tissue. In addition, periodic flare-ups of pseudomonal
infection cause life-threatening episodes and hospitalization. Over a period of
decades, the persistent infection and acute flare-ups lead to death, occurring
at an average age of 30 years. Treatment of pseudomonal infection using TOBI
would be expected to begin at the first detection of pseudomonal bacteria and
then to continue throughout the patient's lifetime.
For over 20 years, intravenous delivery of tobramycin for short periods
(typically 10-14 days) has been available to treat acute flare-ups of
pseudomonal infection common in patients with cystic fibrosis. Compared to other
aminoglycosides, tobramycin is more active against P. aeruginosa by at least
two- to four-fold and is generally less toxic. However, high doses of
intravenous tobramycin are required in the blood, which increases the risk of
adverse side effects such as significant kidney damage and hearing loss.
Furthermore, P. aeruginosa is rarely permanently eradicated following therapy
for acute flare-ups. Thus, cystic fibrosis patients are subjected to frequent
periods of hospitalization for intravenous therapy with tobramycin. As the
cumulative systemic exposure increases, so does the risk of potential adverse
side effects. Intravenous therapy also increases the hardship on the patient
because it normally requires hospitalization, which increases treatment costs,
exposes the patient to potential hospital-acquired infections and disrupts
education and family life.
The Registrant believes that inhalation of TOBI will prove to be superior
to intravenous tobramycin therapy for cystic fibrosis patients, since on average
100-fold greater concentrations of the antibiotic can be delivered to the actual
site of infection by directly depositing the antibiotic on the airway lining.
The Registrant believes that such concentrations of TOBI should suppress the
growth of P. aeruginosa in the lungs of cystic fibrosis patients. Aerosol
delivery should also reduce the risk of toxicity because the airway lining
restricts the absorption of tobramycin into the bloodstream, thereby preventing
tobramycin from reaching toxic systemic levels. Thus, the improved safety
profile of tobramycin by inhalation may allow long-term therapy. See
"Business--PathoGenesis' Development of TOBI for Cystic Fibrosis."
The Registrant believes that the market opportunity for TOBI as a treatment
for chronic pseudomonal lung infections in cystic fibrosis patients is
significant and growing. There are approximately 30,000 cystic fibrosis patients
in the United States, according to the Cystic Fibrosis Foundation, and a
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comparable number in Europe. Pseudomonal bacteria infect the lungs of
approximately 60% of all patients with the disease, according to data gathered
during 1995 by the Cystic Fibrosis Foundation. Infection with pseudomonal
bacteria occurs increasingly as the patient ages, resulting in over 70% of
cystic fibrosis patients above the age of 15 being infected.
Historical Development of Inhaled Tobramycin for Cystic Fibrosis
Inhaled tobramycin has been used experimentally by various clinical
investigators and physicians to treat pseudomonal infection in cystic fibrosis
patients for approximately 20 years. Various solutions of tobramycin for
inhalation have been formulated by pharmacists and physicians from commercially
available sources; however, the use of these formulations for inhalation has not
been approved by the FDA. Because physicians using inhaled tobramycin used
different formulations and reported conflicting results, the Cystic Fibrosis
Foundation financed a long-term program to develop a more complete understanding
of aerosol administration. In conjunction with this program, investigators at
Children's Hospital and Medical Center in Seattle found that not all nebulizers
(devices used to produce the aerosol) studied delivered the tobramycin to the
affected area of the lung. In addition, the doses used were frequently
insufficient. Higher doses are required in inhaled therapy than in intravenous
therapy, since inhaled therapy has to pass through the sputum (phlegm), which
partially binds and inactivates tobramycin. In a series of Phase I and Phase II
trials between 1983 and 1988, the Children's Hospital investigators arrived at a
safe and potentially therapeutic dosage, solution and nebulizer combination.
Subsequently, the investigators tested their method in a multi-center randomized
controlled trial. The results of this study were published in the New England
Journal of Medicine ("NEJM") in June 1993. The study population consisted of 71
clinically stable cystic fibrosis patients who had persistent infection with P.
aeruginosa in their lung air passages. The study design was a cross-over, with
half the patients starting on inhaled tobramycin and the other half on a placebo
aerosol. After one month the groups were switched and the study continued for an
additional two months.
The goals of the multi-center study were to show that inhaled tobramycin
reduces pseudomonal bacteria in the lungs of cystic fibrosis patients, mitigates
the inflammatory response to the bacteria (the cause of progressive lung
destruction), improves lung function and demonstrates safety. The study was
successful in all four areas. While on inhaled tobramycin therapy, patients
maintained on average a 100-fold decrease in their pseudomonal bacteria counts.
One month after the cessation of treatment with inhaled tobramycin, the levels
of bacteria returned to the baseline prior to treatment. Inflammation, the cause
of progressive lung destruction in cystic fibrosis patients, was diminished
during therapy. This was measured by the white blood cell count that dropped on
average 15% during treatment. After one month, lung function compared to placebo
was on average 10% better in the inhaled tobramycin-treated group. Toxicities
associated with intravenous administration of tobramycin, such as significant
kidney damage or hearing loss, were not found.
The Registrant believes that these study results indicate that tobramycin
for inhalation could represent a significant advance in the care of patients
with cystic fibrosis. A cystic fibrosis patient's pulmonary function on average
declines two to three percent per year with the median age of death currently at
30 years. Thus, a 10% improvement in lung function typically represents a return
to what a
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cystic fibrosis patient's lung function was three to four years earlier. In
addition, since physical activity is largely determined by level of lung
function, exercise tolerance could improve in patients.
One concern with long-term administration of any antibiotic is the
emergence of drug-resistant bacteria. However, intravenous tobramycin therapy
for acute flare-ups of pseudomonal infection in cystic fibrosis patients is
usually efficacious even though resistant pseudomonal bacteria are frequently
found. The Registrant does not believe that resistant pseudomonal bacteria will
significantly limit the potential efficacy of TOBI for cystic fibrosis patients
because on average 100-fold greater concentrations of tobramycin can be
delivered by inhalation to affected areas of the lung, while limiting the
concentration of the antibiotic in the bloodstream.
The Registrant obtained exclusive worldwide licenses from each of the
Cystic Fibrosis Foundation and Children's Hospital and Medical Center in Seattle
for patents, research and technology relating to the use of an aerosol
tobramycin solution or any other aerosol aminoglycoside solution for the
treatment of bronchopulmonary infections. See "Business-Licenses and Other
Agreements." The Registrant will submit the clinical data from the Cystic
Fibrosis Foundation-sponsored study in support of its anticipated NDA for TOBI
for cystic fibrosis.
PathoGenesis' Development of TOBI for Cystic Fibrosis
In order to provide a more economical and convenient form of therapy, the
Registrant developed a number of modifications to the initial treatment protocol
published in the NEJM, including a new concentrated, preservative-free
formulation of tobramycin solution for inhalation in jet nebulizers. The
Registrant has also developed an easy-to-use, disposable plastic vial that
contains premixed tobramycin solution. These improvements have resulted in a
substantial reduction of set-up and treatment time. The new hand-held jet
nebulizers are commercially available, are powered by a portable air compressor,
and are convenient to use and to clean. In March 1996, the Registrant was
awarded a competitive $470,000 grant by the FDA Office of Orphan Products
Development to support its Phase III clinical trials of TOBI for the treatment
of chronic lung infections in cystic fibrosis patients.
In January 1997, PathoGenesis announced results from its two pivotal
double-blind, placebo-controlled Phase III clinical trials of TOBI in patients
with cystic fibrosis. A total of 468 patients in 69 cystic fibrosis care centers
in the United States completed the trials. Treatment with the drug or a placebo
was intermittent for six months, with patients on aerosolized treatment twice
daily for four weeks, then off therapy for four weeks. During the trials,
patients continued to be treated with standard therapies as symptoms warranted.
TOBI improved lung function, the primary end point of the study, in the two
pivotal trials, resulting in an improvement of more than 11% compared with
placebo by the end of the six-month study period. In addition, the mean number
of hospitalization days (the secondary end point) across both studies declined
36% to 5.2 days for the TOBI group versus 8.2 days for the placebo group.
Observed bacterial counts in the sputum of patients taking TOBI declined, while
observed bacterial counts increased in the placebo group. Over the six-month
study period, the difference in observed bacterial density between the
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two groups was 10-fold. The foregoing data were statistically significant when
analyzed on an "intent to treat" basis.
Reported adverse events were comparable between the groups taking TOBI and
the placebo. In TOBI patients, the presence of pseudomonal bacteria potentially
resistant to levels of tobramycin in the lungs achieved by aerosol
administration was low: 4.0% at the beginning and 5.4% at the end of the trials.
All patients who completed the Phase III clinical trials were eligible for
a follow-on program, allowing them to receive TOBI treatment for another
12-month period. More than 85% of the patients chose to participate. This
program is designed to allow PathoGenesis to gather longer-term safety and
efficacy data, and will be part of the NDA for TOBI for cystic fibrosis that the
Registrant intends to file with the FDA. PathoGenesis also completed a long-term
(180-day) animal toxicology study in 1996, which showed no safety problems at
clinically relevant doses.
The Registrant intends to file an NDA for TOBI in cystic fibrosis patients
with the FDA in the second quarter of 1997. In February 1997, the FDA notified
the Registrant that it has agreed to an expedited review of the Registrant's
anticipated NDA for TOBI for cystic fibrosis. The FDA has agreed that in order
to facilitate an expedited review, the Registrant may pre-submit chemistry,
stability and other non-clinical data as addenda to its previously filed
investigational new drug ("IND") application. See "Business--Government
Regulation and Product Testing."
The Registrant is currently working with a nine-member advisory board
comprised of European clinicians to initiate open-label clinical trials of TOBI
for cystic fibrosis in 1997. The studies will be conducted in several European
countries to seek to validate TOBI's safety and efficacy given the differences
in standard therapy between the United States and Europe. For example, the
trials would evaluate nebulizers commonly in use in Europe, but not in use in
the United States. PathoGenesis expects to use this data to supplement its U.S.
data on TOBI in filings with European regulatory authorities in 1998.
There can be no assurances that the Registrant's planned drug development
efforts for TOBI, or any other compound, will be successful or completed within
anticipated time frames, or at all, or that regulatory approvals will be
obtained.
Orphan Drug Designation; Patent Filings
In October 1994, the Registrant received an Orphan Drug designation from
the FDA for the use of tobramycin for inhalation in the treatment of pseudomonal
pulmonary infections in cystic fibrosis patients. The Orphan Drug designation
would provide the Registrant with a seven-year marketing exclusivity in the
United States if the Registrant is the first FDA-approved applicant for the drug
in the specified indication. While the Registrant is not aware of any other
companies that have sought an Orphan Drug designation for tobramycin for
inhalation for this indication, there can be no assurance that other companies
will not seek such a designation in the future and obtain FDA marketing approval
before the Registrant obtains such approval. If another company obtains
marketing approval for the use of tobramycin for inhalation in the treatment of
pseudomonal pulmonary infections in cystic fibrosis patients and receives
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seven-year marketing exclusivity, the Registrant would not be permitted by the
FDA to market TOBI in the United States during the exclusivity period. In
addition, in April 1996, the Registrant received a United States patent on the
TOBI formulation and has filed patent applications in major foreign markets.
TOBI for Bronchiectasis
Bronchiectasis is a lung disease in which previous bouts of viral or
bacterial infection have damaged the air passages and compromised the lungs'
normal defenses against airway infection. In bronchiectasis, persistent
bacterial infection is present in air passages of the lungs and causes
inflammation, which leads to progressive lung damage. The late-stage clinical
manifestations are similar to cystic fibrosis lung disease, except the age group
is usually older (in the age range of 50 to 70 years). There are approximately
100,000 people afflicted with bronchiectasis in the United States. These
patients are often diagnosed as having a form of severe chronic bronchitis and
require a significant number of hospitalizations to treat complications of the
condition.
Due to certain clinical similarities between cystic fibrosis and
bronchiectasis, the Registrant believes TOBI should suppress bacterial growth in
the lungs of bronchiectasis patients and thereby decrease inflammation and
progressive lung damage. The Registrant intends to commence Phase II clinical
trials of TOBI for bronchiectasis in 1997. The Registrant has prepared protocols
and selected clinical investigators for the proposed trials. The Registrant
intends to commence these trials upon receipt of all applicable regulatory and
independent institutional review board ("IRB") approvals. There can be no
assurance, however, that the Registrant will be successful in its efforts to
develop TOBI for this indication, or, that the Registrant's Phase II clinical
trials will be commenced or completed within the anticipated time frames, if at
all.
Tuberculosis Drug Development Program
For the past 25 years, there has been limited development of drugs to treat
tuberculosis, which ranks as one of the most serious infectious diseases
worldwide because of its highly contagious nature, worldwide prevalence and
increasing levels of drug resistance. For these reasons, as well as its
experience in respiratory infections, PathoGenesis has identified tuberculosis
as a target for three drug candidates: TOBI, PA-1648 and PA-824.
The goal of PathoGenesis' tuberculosis drug development program is to
develop drug candidates that can provide significant benefit to tuberculosis
patients, either as an adjunct (supplemental) therapy or as a replacement for
one of the four drugs in the current standard primary regimen of therapy
(isoniazid, rifampin, ethambutol and pyrazinamide). For example, the Registrant
intends to research whether TOBI can shorten the contagious period, reducing the
risk that tuberculosis patients might infect family members or medical
personnel. The Registrant believes PA-1648 may be a candidate to replace
rifampin and may require less frequent dosing. Additionally, in preclinical
development, PA-824 has shown action against multi-drug-resistant strains of
tuberculosis and may be a candidate to replace or supplement isoniazid.
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Tuberculosis
A century after the discovery of Mycobacterium tuberculosis (M.
tuberculosis), the bacterium causing tuberculosis, this disease continues to be
one of the most serious infectious diseases outside of developed countries, with
over one billion people infected worldwide. The vast majority of these
infections are latent (inactive) cases, which may typically exist for decades
prior to activation and manifestation of lung disease. The worldwide infection
rate results in approximately eight million active tuberculosis cases annually
and over two million deaths per year.
In the United States, an average of 25,000 new cases of active tuberculosis
has been reported annually for the past five years. Active cases are increasing
due to the susceptibility of AIDS patients, who have a shortened or non-existent
latent phase, and to increased immigration from developing countries that have a
high prevalence of latent infection. The Centers for Disease Control and
Prevention ("CDC") estimate that over 10 million people in the United States
have latent infections.
Initial exposure to M. tuberculosis from an active case results in a latent
infection of the lung, which can usually be diagnosed using a tuberculosis skin
test. After a latent phase ranging from months to decades, the bacteria may
resume active growth. If untreated, the patient then typically develops
progressive tuberculosis pneumonia with loss of lung function, severe weight
loss and eventual death. Patients with active tuberculosis are extremely
infectious. Those in close contact with such patients are at risk of becoming
infected by exposure to airborne droplets produced from coughing. The most
effective way to control the spread of tuberculosis is through early
identification and thorough treatment of active cases.
For the past 25 years, there has been limited development of
anti-tuberculosis drugs. Patents on all four of the drugs in the current
standard regimen of therapy to treat tuberculosis have expired. Currently,
active tuberculosis is treated with a regimen of at least three different drugs
taken daily for a minimum of six months. Multi-drug therapy is used in order to
reduce the emergence of drug-resistant bacteria and shorten the treatment
duration. Failure to fully comply with this complicated, long-term therapy can
result in relapse. In addition, the therapy can be toxic, often causing side
effects including severe gastrointestinal upset and hepatitis. Overall the
mortality rate of drug-related adverse effects is approximately one in two
thousand. While studies have shown that current therapies are effective if the
patient adheres to and completes the treatment course, up to 30% of these
patients relapse due to non-compliance.
Partial or incomplete treatment of active tuberculosis is the primary cause
of the development of drug-resistant tuberculosis. Almost 20% of recent active
tuberculosis cases in New York City have shown resistance to two or more of the
components of the standard regimen of therapy. At present, the pharmaceutical
component of tuberculosis therapy is relatively inexpensive. However, a number
of cities have instituted, at a very high cost, directly observed therapy
programs in which administration of every oral dose is observed by a health care
worker. The growth of directly observed treatment procedures, while intended to
reduce non-compliance, has greatly increased the overall cost of therapy.
Consequently, the Registrant believes that a significant market opportunity
exists for a tuberculosis drug regimen which could decrease the frequency of
administration and shorten the course of multi-drug treatment. This could result
in improved compliance levels and diminished risk of relapse.
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TOBI for Tuberculosis
The increasing incidence of multi-drug-resistant strains of tuberculosis
has compromised the ability of the health care system to treat active cases in
order to prevent the transmission of the infection by coughing. In in vitro
testing, tuberculosis bacteria, including multi-drug-resistant strains, have
been killed by high concentrations of TOBI. The Registrant believes that TOBI
therapy may potentially be most useful in patients with multi-drug-resistant
tuberculosis who respond slowly to primary therapy and require expensive
isolation until they are no longer infectious. Generally, patients are
contagious for a period of up to two weeks.
The Registrant intends to commence Phase II clinical trials of TOBI in 1997
as an adjunct therapy for patients with contagious pulmonary tuberculosis to
shorten the infectious period after systemic anti-tuberculosis therapy has been
started. The Registrant believes that this adjunct therapy may benefit the
patient as well as prevent secondary transmission to family members and health
care workers.
In April 1996, the Registrant filed a provisional patent application with
the PTO for use of the TOBI formulation for the treatment of tuberculosis. There
can be no assurance that the Registrant will be successful in its efforts to
develop TOBI for this indication, or that the Registrant's Phase II clinical
trials will be commenced or completed within the anticipated time frames, if at
all.
PA-1648
PA-1648 is one of the Registrant's drug candidates to be included in the
standard regimen of therapy for the treatment of tuberculosis. PA-1648 is a
novel derivative of the generic drug rifampin, one of the antibiotics in the
current standard regimen of therapy used to treat tuberculosis. PA-1648 was
synthesized, tested for anti-mycobacterial activity and patented in the United
States and major foreign markets by Kaneka Coporation ("Kaneka") under the name
KRM-1648. Kaneka has granted exclusive rights to the Registrant for the
development, marketing and sale of PA-1648 in the United States, Canada and
Mexico.
More than 20 peer-reviewed articles have reported the in vitro and in vivo
(animal) efficacy of PA-1648 against both tuberculosis and disseminated
Mycobacterium avium complex (MAC) infections, a tuberculosis-like disease
affecting AIDS patients. The Registrant has also conducted confirmatory in vitro
and in vivo studies. In preclinical studies, PA-1648 has demonstrated several
characteristics suggesting that it could be superior to rifampin for use in
treating tuberculosis and MAC. In in vitro studies, PA-1648 has been shown to be
(i) eight- to 80-fold more potent than rifampin against M. tuberculosis and MAC;
(ii) active against multiple strains of M. tuberculosis and MAC; and (iii)
potent against other intracellular pathogens, particularly chlamydia. PA-1648
has also shown efficacy in animal models of tuberculosis and disseminated MAC
infections that are generally believed to have been predictive of the clinical
efficacy of other antibiotics. With the advent of new therapies to treat HIV
infections, the incidence of MAC has declined significantly. Because of MAC's
declining frequency, the Registrant has decided to focus on the clinical
development of PA-1648 for tuberculosis and to conduct studies of PA-1648 to
treat MAC infections at a later date only if the market warrants further
development for this indication.
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In December 1996, PathoGenesis completed a series of Phase I clinical
trials of PA-1648 in healthy volunteers under an FDA-approved investigational
new drug ("IND") application. The Phase I data suggest that PA-1648 has a longer
half-life in humans than rifampin. The half-life for rifampin in humans averages
two to three hours, while the Registrant's Phase I results indicate PA-1648 has
an average half-life of at least 48 hours. In addition, PathoGenesis' data
indicates that the ratio of intracellular drug concentrations to extracellular
drug concentrations is much higher for PA-1648 compared with other rifampins.
PathoGenesis believes this may allow a 25 mg dose to be taken once a week to
treat rifampin-sensitive tuberculosis bacteria. Rifampin is typically dosed at
approximately 300 mg once a day.
PA-1648 and rifampin can produce flu-like symptoms and transient reductions
in white blood cell counts in some individuals. The Registrant believes that
lower dosage levels of PA-1648, such as 25 mg or 50 mg once a week, may be
efficacious and less likely to produce these side effects.
Based on its preclinical and human pharmacokinetic data, the Registrant
believes that PA-1648 may be a component of a more efficacious standard regimen
of therapy for the treatment of patients suffering from tuberculosis. Medical
compliance is a severe problem in the treatment of mycobacterial infection.
Failure to comply with or finish the usual six-month course of antibiotics for
tuberculosis is the principal reason for both development of drug-resistant
strains and relapse, with potential spread of resistant strains to uninfected
individuals by coughing. PA-1648 may potentially increase efficacy to allow
shorter overall treatment periods and offer a longer half-life so fewer
administrations would be needed.
The Registrant intends to commence Phase II clinical trials in 1997 for
PA-1648 as a component of standard therapy for tuberculosis. The Registrant has
prepared a protocol to commence such trials in a facility in Brazil supervised
by a United States university, pending receipt of necessary governmental and IRB
approvals. The Registrant expects to test whether PA-1648 will be safe and
effective when taken once a week and if it has the potential to reduce the
length of treatment from the standard six months. There can be no assurance that
the Registrant's planned drug development efforts for PA-1648, or any other drug
candidate, will be successful or completed within the anticipated time frames,
if at all, or that regulatory and IRB approvals will be obtained.
PA-824
PA-824, the Registrant's second candidate for primary anti-tuberculosis
treatment, is designed to replace or to supplement isoniazid. Isoniazid is
currently one of the four components of the standard regimen of therapy to treat
tuberculosis. PA-824 was developed by PathoGenesis, possesses a simple chemical
structure and is readily prepared in the laboratory. The Registrant has filed a
patent application in the United States and plans to file patent applications in
significant foreign markets for PA-824 and a series of related compounds
synthesized to date. PA-824 studies show in vitro activity against
non-drug-resistant and drug-resistant strains of tuberculosis. Furthermore, in
vivo studies indicate that PA-824 has activity against tuberculosis organisms in
the lung and spleen. The Registrant's in vitro studies indicate that PA-824 is
killing tuberculosis bacteria by mechanisms that appear to differ from those of
the current standard therapies, since PA-824 demonstrates activity on
multiple-drug-resistant strains. In addition, a novel formulation for PA-824 was
developed by the Registrant to improve the oral bioavailability of this drug
candidate.
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Research and Development
PathoGenesis has focused its research and development efforts on drug
candidates characterized by potentially unique therapeutic profiles and
accelerated development processes. The Registrant seeks to shorten drug
discovery and development processes through the integration of technical
programs for drug discovery and development with the Registrant's clinical and
regulatory strategy. The Registrant's three major technical programs are: (i) a
molecular genetics program for the discovery of new approaches to the treatment
of pathogens; (ii) a molecular microbiology program that focuses on the
discovery of new approaches to the treatment of pathogens and on developing
"smart screens" using reporter gene technology to facilitate the testing of drug
candidates; and (iii) a pharmaceutical chemistry program that uses combinatorial
chemistry to create new drug candidates. PathoGenesis also has internal
capabilities in microbiology, analytical chemistry and pharmacokinetics to
support drug development. The Registrant involves its clinical and regulatory
personnel in the early stages of the drug discovery and development processes to
select drug candidates which the Registrant believes can be developed on an
accelerated basis due to their significant interest to both physicians and
regulators and outcomes that can be readily measured in clinical trials. The
Registrant intends to focus on developing those drug candidates it believes it
can best exploit through its own resources. In other instances, the Registrant
intends to sell, license, joint venture or otherwise collaborate where such an
approach is determined to be preferable.
Manufacturing
The Registrant does not currently intend to establish internal
manufacturing capabilities. Instead, the Registrant has contracted and intends
to contract with third parties for the production of compounds in bulk
quantities and for the subsequent manufacturing and packaging of products. The
Registrant has an agreement with an FDA-inspected supplier of bulk powdered
tobramycin and also purchases bulk powdered tobramycin from another
FDA-inspected supplier. The Registrant has used an FDA-inspected manufacturer to
formulate and package TOBI utilizing a form-fill-seal technology to manufacture
and fill a plastic vial in a sterile environment. The resulting vials have a
snap-top access port for delivering TOBI directly into a jet nebulizer. Another
contract manufacturer has been used to package the plastic vials in aluminum
foil pouches. No assurance can be made that the Registrant will be able to
obtain future supplies of TOBI on favorable terms, if and when it receives
marketing approval from the FDA.
The Registrant intends to designate the Pari LC Plus Nebulizer,
manufactured and distributed in the United States by Pari Corporation of
Germany, to deliver TOBI. The Registrant intends to test other nebulizers for
use with TOBI.
The Registrant obtains bulk powdered PA-1648 from Kaneka. Pursuant to the
Registrant's license and supply agreements with Kaneka, Kaneka is supplying the
Registrant with PA-1648 for clinical development at no additional charge. The
powdered drug is then formulated into single dose capsules at a contract
manufacturer. In addition, the Registrant and Kaneka are parties to a supply
agreement pursuant to which Kaneka is obligated to supply, and the Registrant is
obligated to purchase at specified prices, all bulk powdered drug if and when
the Registrant receives marketing approval of PA-1648 from the FDA. Such
obligations will remain for the duration of the license agreement. The
Registrant believes that it has
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obtained a sufficient supply of PA-1648 to complete Phase II clinical testing.
However, Kaneka is currently the only known manufacturer of the bulk powdered
drug. Should Kaneka be unable to satisfy the Registrant's needs, the Registrant
has the right to seek alternative supply sources. There can be no assurance that
the Registrant will be able to obtain sufficient quantities of PA-1648 to
satisfy its needs.
All contractors utilized by the Registrant have FDA-inspected facilities
that operate under cGMP. In the event the Registrant decides to establish a
manufacturing facility, the Registrant will require substantial additional
funds, will be required to hire and train significant additional personnel and
comply with the extensive current Good Manufacturing Practices ("cGMP")
regulations applicable to such a facility.
Marketing
The Registrant currently has limited internal marketing and no sales
resources and personnel. The Registrant intends to market TOBI for cystic
fibrosis directly to physicians, hospitals and cystic fibrosis treatment
centers. Cystic fibrosis represents a niche market, involving a small group of
physicians or treating institutions both in the United States and abroad.
Currently, more than 65% of cystic fibrosis patients in the United States are
treated by institutions or physicians associated with the 113 cystic fibrosis
care centers sponsored by the Cystic Fibrosis Foundation. Of those 113 cystic
fibrosis centers, 69 centers participated in the Registrant's Phase III clinical
trials for TOBI. Consequently, the Registrant intends to hire a sales force of
15 to 20 persons and believes that this sales force will provide sufficient
coverage for the United States. The Registrant intends to take a similar
approach with respect to marketing PA-1648 and subsequent product candidates.
In addition, PathoGenesis intends to establish a European office in 1997 as
part of the process of registering TOBI for cystic fibrosis in the European
Union. PathoGenesis expects to file for approval of TOBI for cystic fibrosis
with European regulatory authorities in 1998, and, if and when it obtains such
approval, to market TOBI for cystic fibrosis directly in major European
countries. However, there can be no assurances that the Registrant's planned
drug development efforts for TOBI for cystic fibrosis, or any other compound,
will be successful or completed within anticipated time frames, or at all, or
that regulatory approvals will be obtained.
Licenses and Other Agreements
The Registrant has entered into several key license agreements and research
collaboration arrangements. In addition to those mentioned below, the Registrant
is pursuing additional licensing agreements and collaborations.
PathoGenesis has licensed from the Cystic Fibrosis Foundation and
Children's Hospital and Medical Center in Seattle exclusive worldwide rights to
patents, research and technology relating to the use of an aerosolized
tobramycin solution or any other aerosolized aminoglycoside solution for the
treatment of bronchopulmonary infections. The Registrant has agreed under each
of these licensing agreements to make a substantial one-time payment to each
licensor in the event the Registrant receives marketing approval of TOBI or any
other aerosolized aminoglycoside from the FDA and to pay a royalty
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based on net sales. The term of each licensing agreement continues until the
expiration of any patent rights under the license and may be terminated earlier
upon a material breach by either party.
The Registrant has licensed from Kaneka exclusive rights for the United
States, Canada and Mexico to develop, market and sell PA-1648 for use in the
treatment of tuberculosis, MAC and other infections. Pursuant to the license
agreement, the Registrant is responsible for the clinical development,
regulatory affairs, marketing and sales of PA-1648. The Registrant has agreed to
pay Kaneka certain clinical and regulatory milestone payments of substantial
amounts. In addition, the Registrant has agreed to pay Kaneka a royalty based
upon net sales for 15 years from the date of commercial production of PA-1648.
After such 15-year period, the license is fully paid and remains in effect as a
non-exclusive license. Kaneka has the option to convert this license to a
non-exclusive license should the Registrant fail to achieve certain milestones.
In addition, the license may terminate should the Registrant fail to achieve
certain other milestones. As partial consideration for this license, the
Registrant paid $500,000 in cash and issued 50,000 shares of Common Stock to
Kaneka. In addition, in lieu of a cash milestone payment, the Registrant issued
Kaneka an additional 50,000 shares of Common Stock in March 1995. Pursuant to a
related supply agreement between the Registrant and Kaneka, Kaneka is
responsible for manufacturing the bulk powdered PA-1648 in Japan for final
dosage form preparation in the United States. To date, the Registrant believes
that Kaneka has supplied sufficient quantities of PA-1648 to enable the
Registrant to complete Phase II clinical testing. See "Business--Manufacturing."
PathoGenesis is engaged in research and development collaborations and
licensing arrangements with various academic institutions and government and
commercial research groups. The Registrant has exclusive, worldwide license
rights from Cold Spring Harbor Laboratory for the use of RDA to discover
pathogens in infectious diseases. This license extends until the expiration of
the patent covered by the license. However, the license becomes non-exclusive
commencing in May 1997. The Registrant also intends to enter into a contract
with the Cystic Fibrosis Foundation and the University of Washington to sequence
the P. aeruginosa genome (DNA or genetic code) to assist in the drug discovery
process.
In general, the Registrant's research and development agreements and
licensing arrangements with academic institutions and government research groups
provide for sponsorship of research and development by the Registrant in
exchange for exclusive, royalty-bearing licenses or rights of first refusal
during the course of the sponsored research. In general, the license agreements
grant the Registrant exclusive licenses in exchange for varying combinations of
license fees, milestone payments, royalties and minimum royalties. In addition,
the license agreements typically place commercialization obligations on the
Registrant which, if not satisfied, may result in the licensor having the right
to render the license non-exclusive or to terminate the agreement. Typically,
the agreements are terminable by either party for breach.
In May 1996, PathoGenesis entered into a license and distribution agreement
with Bohdan Automation, Inc. ("Bohdan"). Under this agreement, Bohdan
manufactures and sells the Rapid Analog Matrix ("RAM") Synthesizer, a
proprietary combinatorial chemistry system invented by the Registrant's
scientists. Bohdan is obligated to pay the Registrant royalties based on its
sales, if any, of RAM Synthesizers.
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Patents
The Registrant's success will depend in part on its ability to develop
patentable products and technologies and obtain patent protections for its
products and technologies both in the United States and other countries.
PathoGenesis generally applies for patents for its proprietary compounds,
formulations or technologies.
In April 1996, the Registrant obtained a formulation patent for TOBI in the
United States. A corresponding international patent application was filed in
1995 under the Patent Cooperation Treaty designating Europe, Canada, Japan and
other countries.
The Registrant is the exclusive licensee in the United States, Canada and
Mexico of rights under three issued patents relating to PA-1648. The Registrant
has been issued three United States patents and has 13 United States patent
applications pending that cover several different compounds. The Registrant has
also filed patent applications with respect to several product candidates in
many other countries, including Europe and Canada.
There can be no assurance that any of the Registrant's pending patent
applications will result in the issuance of patents or that competitors will not
successfully challenge the Registrant's patents, if issued, or circumvent the
Registrant's patent position. The failure of patents to issue on pending
applications could result in increased competition.
The patent positions of companies in the pharmaceutical industry are highly
uncertain, involve complex legal and factual questions and have been and
continue to be the subject of much litigation. A significant number of patents
have been applied for by and issued to other companies in PathoGenesis'
industry, and other companies may have filed applications for, may have been
issued patents or may obtain, additional patents and proprietary rights relating
to products competitive with those of the Registrant.
In addition, the Registrant's drug candidates may give rise to claims that
they infringe on the products or proprietary rights of others. There can be no
assurance that any license required under any such patents or rights would be
made available on terms acceptable to the Registrant, if at all. If the
Registrant does not obtain such licenses, it may encounter delays in product
market introductions while it attempts to design around such patents, or may
find that the development, manufacture or sale of products requiring such
licenses may be precluded. The Registrant could also incur substantial costs in
defending any patent infringement suits or in asserting any patent rights,
including those granted by third parties.
Government Regulation and Product Testing
Regulation by governmental authorities in the United States and foreign
countries is a significant factor in the Registrant's ongoing research and
product development activities and in the manufacturing and marketing of the
Registrant's drug candidates. Virtually all the Registrant's products will
require regulatory approval by governmental agencies, principally the FDA, prior
to commercialization. In particular, therapeutic products for human use are
subject to rigorous preclinical and clinical testing and
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other approval procedures by the FDA and similar health authorities in foreign
countries. Various federal statutes and regulations also govern or influence the
manufacturing, safety, effectiveness, labeling, storage, record keeping,
approval, advertising, promotion, distribution and marketing of such products.
The process of obtaining these approvals and the subsequent compliance with
appropriate federal statutes and regulations require the expenditure of
substantial resources. Any failure by the Registrant or its collaborators,
licensors or licensees to obtain, or any delay in obtaining, regulatory approval
could adversely affect the marketing of products then being developed by the
Registrant and its ability to receive product or royalty revenues. In addition,
noncompliance with applicable regulatory requirements can result in, among other
things, fines, injunctions, seizures of products, total or partial suspension of
product marketing, failure of the government to grant premarket approval,
withdrawal of marketing approvals and criminal prosecution.
Upon approval in the United States, a drug may only be marketed for the
approved indications in the approved dosage forms and dosages. The FDA also may
require post-marketing testing and surveillance to monitor safety and efficacy
history of the approved product and continued compliance with regulatory
requirements. The FDA also mandates that drugs be manufactured in conformity
with cGMP regulations. In complying with the cGMP regulations, manufacturers
must continue to expend time, money and effort in production, record keeping and
quality control to ensure that the product meets applicable specifications and
other requirements. The FDA periodically inspects drug manufacturing facilities
to ensure compliance with applicable cGMP requirements. Failure to comply
subjects the manufacturer to possible FDA action, such as suspension of
manufacturing, seizure of the product or voluntary recall of a product. Adverse
experiences with the product must be reported to the FDA. Product approvals may
be withdrawn if compliance with regulatory requirements is not maintained or if
problems concerning safety or efficacy of the product occur following approval.
Full Clinical Testing Requirements
The steps required before a new drug may be commercially distributed in the
United States, include: (i) conducting appropriate preclinical laboratory and
animal tests; (ii) submitting to the FDA an application for an IND which must be
approved before clinical trials may commence; (iii) conducting controlled human
clinical trials that establish the safety and efficacy of the drug product; (iv)
filing with the FDA an NDA; and (v) obtaining FDA approval of the NDA prior to
any commercial sale or shipment of the drug. In addition to obtaining FDA
approval for each indication to be treated with each product, each domestic drug
manufacturing establishment must register with the FDA, list its drug products
with the FDA, comply with cGMP requirements and be subject to inspection by the
FDA. Foreign manufacturing establishments distributing drugs in the United
States also must comply with cGMP requirements and list their products and are
subject to periodic inspection by the FDA.
With respect to any non-biological drug product with an active ingredient
not previously approved by the FDA, a prospective manufacturer must usually
submit a full NDA, including complete reports of preclinical, clinical and
laboratory studies, to prove that the product is safe and effective. A full NDA
may also need to be submitted for a drug product with a previously approved
active ingredient if studies are required to demonstrate safety and efficacy,
such as when the drug will be used to treat an indication for which the drug was
not previously approved, or where the method of drug delivery is changed. A
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manufacturer intending to conduct clinical trials will usually first be required
to submit an IND to the FDA containing information relating to previously
conducted preclinical studies.
Preclinical testing includes formulation development, laboratory evaluation
of product chemistry and animal studies to assess the potential safety and
efficacy of the product formulation. Preclinical trials usually must be
conducted in accordance with the FDA regulations concerning Good Laboratory
Practices ("GLPs"). The results of the preclinical trials are submitted to the
FDA as part of the IND and are reviewed by the FDA prior to authorizing the
sponsor to conduct clinical trials in human subjects. Unless the FDA objects to
an IND, the IND will become effective 30 days following its receipt by the FDA.
There is no certainty that submission of an IND will result in FDA authorization
to commence clinical trials or that authorization of one phase of clinical
trials will result in authorization of other phases or that the performance of
any clinical trials will result in FDA approval. See "Risk Factors-Government
Regulation; No Assurance of Regulatory Approvals."
Clinical trials for newly marketed drugs typically are conducted in three
phases and are subject to detailed protocols. Clinical trials involve the
administration of the investigational drug product to human subjects. Each
protocol indicating how the clinical trial will be conducted must be submitted
for review to the FDA. The FDA's review of a study protocol does not necessarily
mean that, if the study is successful, it will constitute proof of efficacy or
safety. Further, each clinical trial must be conducted under the auspices of an
IRB, which must be constituted and operated in conformance with the FDA
regulations. The IRB considers, among other factors, ethical concerns and
informed consent requirements. The FDA or the IRB may require changes in a
protocol both prior to and after the commencement of a trial. There is no
assurance that the IRB or the FDA will permit a study to go forward or, once
started, to be completed. Clinical trials may be placed on hold at any time for
a variety of reasons, particularly if safety concerns exist.
The three phases of clinical trials are generally conducted sequentially,
but they may overlap. In Phase I, the initial introduction of the drug into
humans, the drug is tested for safety, side effects, dosage tolerance,
metabolism and clinical pharmacology. Phase II involves controlled tests in a
larger but still limited patient population to determine the efficacy of the
drug for specific indications, to determine optimal dosage and to identify
possible side effects and safety risks. Phase II testing for an indication
typically takes from one-and-one-half to two-and-one-half years to complete. If
preliminary evidence suggesting effectiveness has been obtained during Phase II
evaluations, expanded Phase III trials are undertaken to gather additional
information about effectiveness and safety that is needed to evaluate the
overall risk-benefit relationship of the drug and to provide an adequate basis
for product labeling. There can be no assurance that Phase I, Phase II or Phase
III testing will be completed successfully within any specified time period, if
at all, with respect to any of the Registrant's drug candidates.
Reports of results of the preclinical trials and clinical trials for
non-biological drugs are submitted to the FDA in the form of an NDA for approval
of marketing and commercial shipment. The NDA also includes information
pertaining to the preparation of drug substances, analytical methods, drug
product formulation, details on the manufacture of finished product and proposed
product packaging and labeling. Submission of an NDA does not assure FDA
approval for marketing. The application review process generally takes two to
three years to complete, although reviews of treatments for AIDS, cancer and
other
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serious diseases may be accelerated. The FDA may grant expedited review to new
drug applications for therapies intended to treat people with life-threatening
and severely debilitating illnesses, especially where no satisfactory
alternative therapy exists. The granting of an expedited review may accelerate
the application review process; however, there can be no assurance that any
approval will be granted on a timely basis, or at all. The approval process may
take substantially longer if, among other things, the FDA has questions or
concerns about the safety and/or efficacy of a product.
In general, the FDA requires at least two properly conducted, adequate and
well-controlled clinical trials demonstrating efficacy with sufficient levels of
statistical assurance. While a second study may be needed to replicate results
demonstrated in a first study, in some instances, it is possible to replicate
results within one large, well-designed, multicenter study; however, the FDA has
emphasized that this approach can be successful only when the study results are
strong. The FDA also may request long-term toxicity studies or other studies
relating to product safety or efficacy. For example, the FDA may require
additional clinical tests following NDA approval to confirm product safety and
efficacy (Phase IV clinical tests). Notwithstanding the submission of such data,
the FDA ultimately may decide that the application does not satisfy its
regulatory criteria for approval. The full NDA process for newly marketed
non-biological drugs takes a number of years and involves the expenditure of
substantial resources.
The FDA has issued regulations to expedite the review of new non-biological
drug products for life-threatening or severely-debilitating illnesses that
provide meaningful therapeutic benefit to patients over existing treatments
(e.g., the ability to treat patients unresponsive to, or intolerant of,
available therapy, or improved patient response over available therapy). Under
the expedited review program, the FDA has established procedures designed to
expedite the development, evaluation and marketing of therapies intended to
treat persons with life-threatening and severely-debilitating illnesses,
especially when no satisfactory alternative therapy exists. The term
"life-threatening" is defined by the FDA to mean: (1) diseases or conditions
where the likelihood of death is high unless the course of the disease is
interrupted; and (2) diseases or conditions with potentially fatal outcomes,
where the endpoint of clinical trial analysis is survival. "Severely
debilitating" is defined by the FDA to mean diseases or conditions that cause
major irreversible morbidity. As a condition of approval, the FDA may require
the sponsor to conduct certain postmarketing studies to delineate additional
information about the drug's risks, benefits and optimal use. The Registrant has
been notified by the FDA that the Registrant's NDA for the use of TOBI to treat
pseudomonal pulmonary infections in patients with cystic fibrosis will receive
expedited review. However, there can be no assurance as to the timing of such
NDA filing or the outcome or timing of the FDA's review of such filing.
Treatment of patients with an experimental drug not in clinical trials may
also be allowed under a Treatment IND before general marketing begins and
pending FDA approval. Charging for an investigational drug also may be allowed
under a Treatment IND to recover certain costs of development if various
requirements are met. These expedited review and Treatment IND regulations are
limited, for example, to drug products intended to treat AIDS, cancer or other
life-threatening or severely-debilitating diseases and which provide either
meaningful therapeutic benefit to patients over existing treatments or that are
for diseases for which no satisfactory alternative therapy exists. Although the
FDA has agreed to an expedited review of the NDA for the use of TOBI to treat
pseudomonal pulmonary infections in patients
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with cystic fibrosis, there can be no assurance that any of the Registrant's
other drug candidates will qualify for expedited review or treatment use.
Foreign Regulations
To market its products abroad, the Registrant is also subject to numerous
and varying foreign regulatory requirements, governing, among other things, the
design and conduct of human clinical trials, pricing regulations and marketing
approval. The approval procedure may vary among countries and can involve
additional testing, and the time required to obtain approval may differ from
that required to obtain FDA approval. At present, foreign marketing
authorizations are applied for at a national level, although within the EU
certain registration procedures are available to companies wishing to market a
product in more than one EU member country. If a regulatory authority is
satisfied that adequate evidence of safety, quality and efficacy has been
presented, marketing authorization is usually granted. The foreign regulatory
approval process includes all of the risks associated with obtaining FDA
approval. Approval by the FDA does not ensure approval by other countries.
Other Regulations
The Registrant is also subject to various federal, state and local laws,
regulations and recommendations relating to safe working conditions, laboratory
and manufacturing practices, the experimental use of animals and the use and
disposal of hazardous or potentially hazardous substances, including radioactive
compounds and infectious disease agents, used in connection with the
Registrant's research work. The extent of government regulation which might
result from future legislation or administrative action cannot be accurately
predicted.
Competition
The Registrant competes with pharmaceutical companies and specialized
biotechnology firms that produce and market products in the United States,
Europe and elsewhere. Many pharmaceutical companies have focused their
development efforts in the therapeutics areas described herein and many
healthcare companies have existing supply arrangements with other pharmaceutical
companies.
The Registrant expects to encounter significant competition for the
principal products it plans to develop. Companies that complete clinical trials,
obtain required regulatory approvals and commence commercial sales of their
products before PathoGenesis may achieve a significant competitive advantage.
The use of antibiotics to treat pseudomonal, mycobacterial and other
bacterial infections is well established. The most commonly used intravenous
antibiotic is Nebcin(R) (Tobramycin Sulfate Injection, USP) manufactured by Eli
Lilly and Company. Medical therapies for patients with cystic fibrosis include
antibiotics, anti-inflammatory drugs, oral replacement enzymes to maintain
nutrition, physical therapy to the chest to loosen lung secretions and
mucolytics to clear pulmonary secretions such as Pulmozyme(R) (dornase alpha)
manufactured by Genentech, Inc. The Registrant believes that these therapies are
complementary with TOBI for the treatment of chronic pseudomonal lung infections
in cystic fibrosis patients. However, the optimal combination may vary between
patients. In addition, the potential high cost
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of combination therapy may limit the use of TOBI in conjunction with other
therapies. Accordingly, there can be no assurance that alternative formulations
of tobramycin, other antibiotics or different approaches to therapy will not
prove to be more efficacious, safer or more cost-effective than TOBI for the
treatment of pseudomonal lung infections in cystic fibrosis patients.
Antibiotic therapies are currently used to treat tuberculosis. The
Registrant believes that PA-1648 could be used in combination with certain
existing therapies as part of multi-drug therapy regimens and that TOBI could be
used as an adjunct therapy for patients with contagious pulmonary tuberculosis.
However, optimal combination therapies may vary between patients. Furthermore,
there can be no assurance that alternative antibiotics or other therapies will
not prove to be more efficacious, safer or more cost-effective than PA-1648 or
TOBI.
Significant levels of research in chemistry and biotechnology occur in
universities and other nonprofit research institutions. These entities have
become increasingly active in seeking patent protection and licensing revenues
for their research results. They also compete with the Registrant in recruiting
skilled scientific talent.
The Registrant believes that its ability to compete successfully will be
based on its ability to create and maintain scientifically advanced technology,
develop proprietary products, attract and retain scientific personnel, obtain
patent or other protection for its products, obtain required regulatory
approvals and manufacture and successfully market its products either alone or
through outside parties. Many of the Registrant's competitors have substantially
greater financial, research and development, manufacturing, marketing and human
resources than PathoGenesis.
Human Resources
As of January 31, 1997, PathoGenesis had 115 full-time employees, 90 of
whom are engaged in research and development activities at its laboratory
facility in Seattle, Washington. A significant number of the Registrant's
management and professional employees have had prior experience with
pharmaceutical, biotechnology or medical products companies. None of the
Registrant's employees is covered by collective bargaining agreements.
Cautionary Statements Regarding Forward-Looking Statements
Statements in this Annual Report on Form 10-K under the captions
"Business"and "Management's Discussion and Analysis of Financial Condition and
Results of Operations", as well as statements made in press releases and oral
statements that may be made by the Registrant or by officers, directors or
employees of the Registrant acting on the Registrant's behalf, that are not
statements of historical fact constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors that could cause the actual results of the Registrant to be
materially different from the historical results or from any results express or
implied by such forward-looking statements. In addition to statements which
explicitly describe such risks and uncertainties, readers are urged to consider
statements labeled with the terms "believes," "belief," "expects," plans,"
"anticipates," or "intends" to be uncertain
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and forward-looking. All cautionary statements made in this Annual Report on
Form 10-K should be read as being applicable to all related forward-looking
statements wherever they appear.
Early Stage of Development; Continuing Operating Losses; Uncertainty of Future
Profitability
PathoGenesis is in a development stage and currently has no sources of
operating revenues from any of its drug candidates and has limited sources of
revenue from grants and royalties. The Registrant has incurred net operating
losses since its inception in December 1991. At December 31, 1996, the
Registrant had a deficit accumulated during the development stage of
$67,785,433. Such losses have resulted principally from costs incurred in
research and development and clinical trials and from general and administrative
costs associated with the Registrant's operations. The Registrant expects that
operating losses will continue and increase for at least the next year as its
research and development, clinical testing and marketing activities expand. The
Registrant's ability to achieve profitability will depend in part on its ability
to obtain regulatory approvals for its drug candidates and to develop the
capability to manufacture and market any approved products either by itself or
in collaboration with third parties. There can be no assurance if or when the
Registrant will receive any regulatory approvals required for the clinical
development, commercial manufacturing or marketing of its proposed products, or
achieve profitability. Accordingly, the extent of future losses and the time
required to achieve profitability are highly uncertain.
Absence of Products
The Registrant does not currently have regulatory approval to market or
generate revenues from any of its drug candidates. The Registrant's drug
candidates, other than TOBI for cystic fibrosis, are not expected to be
commercially available for at least several years, and TOBI for cystic fibrosis
is not expected to be commercially available until at least 1998, if ever. The
Registrant's drug candidates require significant research and development and
laboratory testing, significant clinical testing and regulatory approval prior
to commercialization. Although the Registrant is currently seeking to identify
other drug candidates, to expand the number of drug candidates it has under
development and to expand the potential indications for which its drug
candidates under development may be used, there can be no assurance that it will
be successful in such development or expansion.
Dependence on TOBI
The Registrant is dependent on its ability to obtain regulatory approvals
of TOBI for pseudomonal lung infections in cystic fibrosis patients and thus,
generate revenues while it continues the research, development and regulatory
approval processes for other drug candidates and potential uses of TOBI for
other indications. Although the Registrant completed its Phase III clinical
trials for TOBI in cystic fibrosis patients in October 1996, the Registrant must
apply for and obtain the approval of the FDA prior to commercially marketing
TOBI in the United States. While the Registrant currently expects to file an NDA
for TOBI in cystic fibrosis patients in the second quarter of 1997 and the FDA
has agreed to an expedited review, there can be no assurance as to the timing of
such filing or the outcome or timing of the FDA's review of such filing.
Furthermore, there can be no assurance that TOBI for cystic fibrosis, if
approved by the FDA, will achieve market acceptance. The Registrant has not yet
commenced clinical trials of TOBI for any other indications. No assurance can be
given that the results of such trials, when commenced, will
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be consistent with results obtained in the clinical trials for TOBI in cystic
fibrosis patients or that the Registrant will be successful in developing TOBI
for other indications.
Government Regulation; No Assurance of Regulatory Approvals
The production and marketing of the Registrant's products, as well as its
ongoing research and development activities, are subject to regulation by
governmental agencies, including the FDA in the United States and regulatory
authorities in other countries. Any potential therapeutic product developed by
the Registrant will be subject to rigorous preclinical and clinical testing and
approval pursuant to regulations administered by the FDA, comparable agencies in
other countries and, to a lesser extent, state regulatory authorities. The
approval process for the Registrant's drug candidates is likely to involve
significant expenditures. In October 1996, the Registrant completed its Phase
III clinical trials of its most advanced drug candidate, TOBI for pseudomonal
lung infections in cystic fibrosis patients. The Registrant expects to file an
NDA for TOBI for cystic fibrosis with the FDA in the second quarter of 1997 and
the FDA has agreed to an expedited review of such NDA. No assurance can be made
that the Registrant will be able to file its NDA in the foregoing time frame, or
at all, or that such filing will result in FDA approval of TOBI for cystic
fibrosis. Furthermore, the Registrant cannot predict with any degree of
certainty when it might be in a position to file any NDA with respect to any
other drug candidate or the length of time involved between the filing of any
NDA and obtaining any FDA approval, if at all. The cost to the Registrant of
conducting human clinical trials for any potential product can vary dramatically
based on a number of factors, including the order and timing of clinical
indications pursued and the extent of development and financial support, if any,
from corporate partners. The Registrant may have difficulty obtaining sufficient
patient populations, clinicians or support to conduct its clinical trials as
planned and may have to expend substantial additional funds to obtain access to
such resources, or delay or modify its plans significantly.
The effect of government regulation may be to delay marketing of the
Registrant's proposed products for a considerable period of time, to impose
costly procedures upon the Registrant's activities and to furnish a competitive
advantage to other companies that compete with the Registrant. There can be no
assurance that FDA or other regulatory authority approval for any product
candidates developed by the Registrant will be granted on a timely basis or at
all. Any delay in obtaining or any failure to obtain such approvals would
materially and adversely affect the marketing of the Registrant's drug
candidates and the Registrant's business, financial position and results of
operations. In addition, legislation may be enacted in the future which might
adversely affect the Registrant's ability to develop, manufacture or market its
drug candidates. Any FDA approvals that may be granted will be subject to
continual review, and later discovery of previously unknown problems may result
in withdrawal of products from marketing.
The Registrant intends, either on its own or in collaboration with others,
to market its products in major markets outside of the United States. There can
be no assurance that the Registrant will be successful in establishing marketing
relationships, conducting clinical testing in foreign countries or obtaining
required foreign regulatory approvals in a timely manner, if at all. To market
its products abroad, the Registrant must comply with numerous and varying
foreign regulatory requirements implemented by foreign health authorities,
governing, among other things, the design and conduct of clinical trials,
pricing regulations and marketing approval. The approval procedure may vary
among countries and can involve, for example,
Page 23
<PAGE>
additional testing, and the time required to obtain approval may differ from the
time required to obtain FDA approval. The foreign regulatory approval process
includes all of the risks associated with obtaining FDA approval. Approval by
the FDA of any drug candidate does not ensure approval by the regulatory
agencies of other countries.
Uncertain Ability to Protect Patents and Proprietary Technology and Information
Because of the substantial length of time and expense associated with
bringing new products through development and regulatory approval to the
marketplace, the pharmaceutical industry places considerable importance on
obtaining patent and trade secret protection for new technologies, products and
processes. The Registrant's ability to compete effectively depends on its
success in protecting its proprietary technology, both in the United States and
abroad. The patent positions of pharmaceutical firms generally are highly
uncertain and involve complex legal and factual questions. The Registrant
intends to file applications as appropriate for patents covering formulation,
composition of matter, or uses of its drug candidates, its proprietary processes
and any gene sequences that it discovers. The Registrant has 13 patent
applications pending with the United States Patent and Trademark Office ("PTO"),
and the Registrant has been issued three United States patents. The Registrant
has filed, and intends to continue to file, patent applications in certain
foreign jurisdictions. There can be no assurance that the PTO will grant the
Registrant's pending patent applications or that the Registrant will obtain any
patents for which it applies. No assurance can be given that patents issued to
or licensed by or to the Registrant will not be challenged, invalidated or
circumvented, or that the rights granted thereunder will provide any competitive
advantage.
The Registrant also relies on trade secrets, know-how and continuing
technological advancement to maintain its competitive position. Although the
Registrant has entered into confidentiality and invention agreements with its
employees and consultants, no assurance can be given that such agreements will
be honored or that the Registrant will be able to effectively protect its rights
to its unpatented trade secrets and know-how. Moreover, no assurance can be
given that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the
Registrant's trade secrets, know-how and proprietary technology.
In addition to protecting its trade secrets, know-how and proprietary
technology, the Registrant may be required to obtain licenses to patents or
other proprietary rights from third parties. No assurance can be given that any
licenses required under any patents or proprietary rights would be made
available on acceptable terms, if at all. If the Registrant does not obtain
required licenses, it could encounter delays in product development while it
attempts to design around blocking patents, or it could find that the
development, manufacture or sale of products requiring such licenses could be
foreclosed.
The Registrant may, from time to time, support and collaborate in research
conducted by universities and by governmental research organizations. There can
be no assurance that the Registrant will have or be able to acquire exclusive
rights to the inventions or technical information derived from such
collaborations or that disputes will not arise as to rights in derivative or
related research programs conducted by the Registrant or such collaborators.
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<PAGE>
In addition, the Registrant could incur substantial costs in defending any
patent infringement suits or in asserting any patent rights, including those
granted by third parties. The PTO could institute interference proceedings
against the Registrant in connection with one or more of the Registrant's patent
applications, and such proceedings could result in an adverse decision as to
priority of invention. The PTO could also institute reexamination proceedings
against the Registrant in connection with one or more of the Registrant's
patents and such proceedings could result in an adverse decision as to the
validity or scope of the patents.
Uncertainties Regarding Development of Drug Candidates; Clinical Trials
Before obtaining regulatory approvals for the commercial sale of any of the
Registrant's proposed products, such products will be subjected to extensive
preclinical and clinical testing to demonstrate their safety and efficacy in
humans. Results of initial preclinical and clinical testing of drug candidates
under development by the Registrant are not necessarily indicative of results
that will be obtained from subsequent or more extensive preclinical and clinical
testing or long-term efficacy studies. Adverse or inconclusive clinical trial
results concerning any of the Registrant's drug candidates could significantly
delay the filing for marketing approval for such drug candidate with the FDA or
result in a filing for a narrower indication. In such event, further studies
would have to be conducted with respect to the excluded indications to support
any filing of a supplemental application covering such indications. There can be
no assurance that the Registrant's research and development, preclinical
testing, clinical trials or long-term safety and efficacy studies will be
successfully completed, that regulatory approvals will be obtained or will be as
broad as sought, that the Registrant's drug candidates will be capable of being
produced in commercial quantities at reasonable costs or that any products, if
introduced, will achieve market acceptance.
The Registrant's drug candidates under development and future product
development efforts are subject to the risks of failure inherent in the
development of pharmaceutical products. These risks include the possibilities
that any or all of the Registrant's drug candidates will be found to be
ineffective, unsafe, toxic or otherwise fail to meet applicable regulatory
standards or receive necessary regulatory clearances; that the drug candidates,
if safe and effective, will be difficult to develop into commercially viable
products, to manufacture on a large scale or be uneconomical to market; or that
proprietary rights of third parties will preclude the Registrant from marketing
such drug candidates. There is, therefore, substantial risk that the
Registrant's product development efforts will not prove to be successful.
Moreover, the Registrant is seeking to develop new treatments for conditions
that are also the subject of research and development efforts by other companies
and entities. The Registrant's competitors may succeed in developing
technologies or products that are more effective or cost-effective than those of
the Registrant. Rapid technological changes or developments by others may result
in the Registrant's drug candidates becoming obsolete or noncompetitive.
Dependence on Licenses; Potential Need for Additional Partners or Collaborators
The Registrant has obtained, and intends to obtain in the future, licensed
rights to certain proprietary technologies from other entities, individuals and
research institutions to which it will be obligated to pay royalties and
milestone payments if it develops products based upon the licensed technology.
Furthermore, the Registrant's strategy for the research, development and
commercialization
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of its drug candidates and proprietary technologies may require the Registrant
to enter into various arrangements with corporate and academic collaborators,
licensors, licensees and others, and the Registrant may, therefore, be dependent
upon the subsequent success of these third parties in performing their
responsibilities. There can be no assurance that the Registrant will be able to
enter into collaborative, license or other arrangements that the Registrant
deems necessary or appropriate to develop and commercialize its drug candidates
or proprietary technologies, or that any or all of the contemplated benefits
from such collaborative, license or other arrangements will be realized. Certain
of the collaborative, license or other arrangements that the Registrant may
enter into in the future may place responsibility on the Registrant's
collaborative partners for preclinical testing and human clinical trials and for
the preparation and submission of applications for regulatory approval for
potential pharmaceutical or other products. Should any collaborative partner
fail to develop or commercialize successfully any drug candidate or proprietary
technology to which it has rights, the Registrant's business, financial position
and results of operations may be materially adversely affected. There can be no
assurance that collaborators will not pursue alternative technologies or drug
candidates either on their own or in collaboration with others, including the
Registrant's competitors, as a means for developing treatments for the diseases
sought to be addressed by the Registrant's programs.
Uncertainty of Orphan Drug Status
In October 1994, the Registrant received an Orphan Drug designation from
the FDA for the use of tobramycin for inhalation in the treatment of pulmonary
infections in cystic fibrosis patients. The Orphan Drug designation would
provide the Registrant with a seven-year marketing exclusivity in the United
States if the Registrant is the first FDA-approved applicant for the drug for
the specified indication. In October 1996, the Registrant completed its Phase
III clinical trials of TOBI for the treatment of chronic lung infections in
cystic fibrosis patients. While the Registrant is not aware of any other
companies that have sought Orphan Drug designation for this drug for this
indication, there can be no assurance that other companies will not seek such
designation in the future and obtain FDA marketing approval before the
Registrant obtains such approval. If another company obtains marketing approval
for the use of tobramycin for inhalation in the treatment of pseudomonal
pulmonary infections in cystic fibrosis patients and receives seven-year
marketing exclusivity, the Registrant would not be permitted by the FDA to
market TOBI in the United States during the exclusivity period. In addition, the
Registrant could incur substantial costs in asserting any rights to prevent such
uses it may have under the Orphan Drug Act.
Uncertainty of Pharmaceutical Pricing and Related Matters; Need for
Reimbursement
The future revenues and profitability of, and availability of capital for,
pharmaceutical companies such as the Registrant may be affected by the
continuing efforts of governmental and private third-party payors to contain or
reduce the costs of health care through various means. For example, in certain
foreign markets the pricing and profitability of prescription drugs is subject
to government control. There have been, and the Registrant expects there will
continue to be, a number of federal and state proposals to control the cost of
drugs through governmental regulation. It is uncertain what form any health care
reform legislation may take or what actions the federal, state and private
payors may take in response to the proposed reforms. The Registrant cannot
predict when any suggested reforms will be implemented, if ever, or the effect
of any implemented reform on the Registrant's business. There can be no
assurance, however,
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<PAGE>
that any implemented reform will not have a material adverse effect on the
Registrant's business, financial position or results of operations.
The Registrant's ability to commercialize its products successfully may
depend, in part, on the extent to which reimbursement for the cost of such
products and related treatments will be available from government health
administration authorities, such as Medicare and Medicaid in the United States,
private health insurers and other organizations. Significant uncertainty exists
as to the reimbursement status of newly approved health care products, and there
can be no assurance that adequate third-party coverage will be available to
enable the Registrant to maintain price levels sufficient to realize an
appropriate return on its investment in product research and development. If
adequate coverage and reimbursement levels are not provided by government and
third-party payors for use of the Registrant's products, the market acceptance
of those products would be adversely affected.
Limited Marketing and No Sales Capability
The Registrant has limited internal marketing and no sales resources and
personnel. In order to market TOBI, or any other products that it may develop,
the Registrant will have to substantially increase its marketing staff and
establish a sales force by hiring personnel with technical expertise. There can
be no assurance that the Registrant will be able to establish sales and
distribution capabilities or that the Registrant or its collaborators will be
successful in gaining market acceptance for any products that may be developed
by the Registrant.
No Assurance of Market Acceptance
There can be no assurance that TOBI, or any other product developed by the
Registrant, will achieve market acceptance, if approved by the FDA. The degree
of market acceptance will depend upon a number of factors, including the receipt
and timing of regulatory approvals, and the establishment and demonstration in
the medical community of the clinical safety, efficacy and cost-effectiveness of
the Registrant's drug candidates and their advantages over existing technologies
and therapeutics. There can be no assurance that the Registrant will be able to
manufacture and market successfully its drug candidates even if they perform
successfully in clinical applications. Furthermore, there is no assurance that
physicians or the medical community in general will accept and utilize any
therapeutic products that may be developed by the Registrant.
Limited Manufacturing Capabilities; Dependence on Suppliers
The Registrant presently does not have the internal capability to
manufacture pharmaceutical products under the current cGMP regulations
prescribed by the FDA. The Registrant has an agreement with an FDA-inspected
supplier of bulk powdered tobramycin and also purchases bulk powdered tobramycin
from another FDA-inspected supplier. Other contract manufacturers are used for
formulating and packaging of TOBI. No assurance can be made that the Registrant
will be able to obtain future supplies of TOBI on favorable terms, if at all.
The Registrant obtains bulk powdered PA-1648 from Kaneka. Pursuant to the
Registrant's license and supply agreements with Kaneka, Kaneka is supplying the
Registrant with PA-1648 for clinical development at no additional charge. The
Registrant has an agreement with
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<PAGE>
Kaneka for the supply of commercial quantities of such product at specified
prices if and when the Registrant receives marketing approval for PA-1648 from
the FDA. Kaneka is currently the only known manufacturer of the bulk powdered
drug and the Registrant has no alternative supply source. The Registrant
believes that it has sufficient quantities of PA-1648 to complete Phase II
testing.
The Registrant's dependence upon third parties for the manufacture of its
proposed products may adversely affect the Registrant's profit margins and its
ability to develop and deliver its proposed products on a timely and competitive
basis. If for any reason the Registrant is unable to obtain sufficient
quantities of any materials required to produce its proposed products or the
Registrant is unable to obtain or retain third-party manufacturers on
commercially acceptable terms, it may not be able to commercialize its proposed
products as planned. If the Registrant should encounter delays or difficulties
with contract manufacturers in producing, packaging or distributing its proposed
products, market introduction and subsequent sales of such products would be
adversely affected and the Registrant may have to seek alternative sources of
supply. No assurance can be made that the Registrant will be able to enter into
alternative supply arrangements at commercially acceptable rates, if at all. No
assurance can be made that the manufacturers utilized by the Registrant will be
able to provide the Registrant with sufficient quantities of its products or
that the products supplied to the Registrant will meet the Registrant's
specifications or delivery and other requirements.
Moreover, contract manufacturers that the Registrant may use must adhere to
cGMP regulations enforced by the FDA through its facilities inspection program.
These facilities must pass a pre-approval plant inspection before the FDA will
issue a pre-market approval of the product. While the Registrant does not
currently intend to manufacture any pharmaceutical products itself, it may
choose to do so in the future. The Registrant has no experience in the
manufacture of pharmaceutical products for clinical trials or commercial
purposes. Should the Registrant decide to manufacture products itself, the
Registrant would be subject to the regulatory requirements described above,
would be subject to similar risks regarding delays or difficulties encountered
in manufacturing any such pharmaceutical products and would require substantial
additional capital. In addition, there can be no assurance that the Registrant
will be able to manufacture any such products successfully or in a
cost-effective manner.
Competition
There are many companies, both public and private, including well-known
pharmaceutical companies, chemical companies and specialized genetic engineering
companies, engaged in developing pharmaceuticals, including biotechnological
products, for human therapeutic applications. Many of these companies have
substantially greater financial, research and development, manufacturing,
marketing and human resources and experience than the Registrant and represent
significant competition for the Registrant. Such companies may succeed in
developing products that are more effective or less costly than any that may be
developed by the Registrant and may also prove to be more successful than the
Registrant in manufacturing and marketing.
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Technological Changes and Uncertainty
The Registrant is engaged in the pharmaceutical business, which is
characterized by extensive research efforts and rapid technological progress.
New developments in molecular biology, medicinal pharmacology, recombinant DNA
technology and other fields of biology and pharmaceutical chemistry are expected
to continue at a rapid pace in both industry and academia. There can be no
assurance that research and discoveries by others will not render some or all of
the Registrant's programs or drug candidates non-competitive or obsolete.
The Registrant's business strategy is based, in part, upon the application
of the Registrant's technology platform, which encompasses various elements from
the fields of biotechnology and pharmaceutical chemistry, and the application of
these technologies to the discovery and development of pharmaceutical products.
This strategy is subject to the risks inherent in the development of new
products using new and emerging technologies and approaches. There can be no
assurance that unforeseen problems will not develop with these technologies or
applications, that the Registrant will be able to overcome technological
challenges it encounters in its research and development programs or that
commercially feasible products will ultimately be developed by the Registrant.
Substantial Capital Requirements
The Registrant will require substantial funds for its research and
development programs, preclinical and clinical testing, operating expenses,
regulatory processes and manufacturing and marketing programs. The Registrant's
capital requirements will depend on numerous factors, including the progress of
its research and development programs; the progress of preclinical and clinical
testing; the time and cost involved in obtaining regulatory approvals; the cost
of filing, prosecuting, defending and enforcing any patent claims and other
intellectual property rights; competing technological and market developments;
changes and developments in the Registrant's existing collaborative, licensing
and other relationships and the terms of any new collaborative, licensing and
other arrangements that the Registrant may establish; and the development of
commercialization activities and arrangements. Moreover, the Registrant's fixed
commitments, including salaries and fees for current employees and consultants,
rent, payments under license agreements and other contractual commitments, are
substantial and are likely to increase as additional agreements are entered into
and additional personnel are retained.
The Registrant may need to raise substantial additional capital to fund its
future operations. The Registrant may seek such additional funding through
public or private financings or collaborative, licensing and other arrangements
with corporate partners. If additional funds are raised by issuing equity
securities, further dilution to existing stockholders will result and future
investors may be granted rights superior to those of existing stockholders.
There can be no assurance, however, that additional financing will be available
when needed, or if available, will be available on acceptable or affordable
terms. Insufficient funds may prevent the Registrant from implementing its
business strategy or may require the Registrant to delay, scale back or
eliminate certain of its research and development programs or to license to
third parties rights to commercialize products or technologies that the
Registrant would otherwise seek to develop itself.
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<PAGE>
Dependence on Qualified Personnel
Because of the specialized scientific nature of the Registrant's business,
the Registrant is highly dependent upon its ability to attract and retain
qualified scientific, technical and managerial personnel. The loss of Wilbur H.
Gantz, Chief Executive Officer and President, A. Bruce Montgomery, M.D., Senior
Vice President, Research and Development, or Alan R. Meyer, Senior Vice
President and Chief Financial Officer, would be detrimental to the Registrant.
The Registrant's current employment agreements with Mr. Gantz and Dr. Montgomery
expire by their terms in March and May 1997, respectively. The Registrant does
not maintain insurance on the lives of any of Mr. Gantz, Mr. Meyer or Dr.
Montgomery.
There is intense competition for qualified personnel in the pharmaceutical
field, and there can be no assurance that the Registrant will be able to
continue to attract and retain qualified personnel necessary for the development
of its business. The loss of the services of existing personnel as well as the
failure to recruit additional key scientific, technical and managerial personnel
in a timely manner would be detrimental to the Registrant's research and
development programs and to its business. In addition, the Registrant's
anticipated growth and expansion into areas and activities requiring additional
expertise, such as marketing, will require the addition of new management
personnel. The failure to attract and retain such personnel could adversely
affect the Registrant's business.
Environmental Matters and Hazardous Materials
The Registrant's research and development processes involve the controlled
use of hazardous, infectious and radioactive materials. The Registrant is
subject to stringent federal, state and local laws, rules, regulations and
policies governing the use, generation, manufacture, storage, air emission,
effluent discharge, handling and disposal of certain materials and wastes. There
can be no assurance that the Registrant will not be required to incur
significant costs to comply with environmental laws, rules, regulations and
policies, or that the business, financial position or results of operations of
the Registrant will not be materially and adversely affected by current or
future environmental laws, rules, regulations and policies or by any releases or
discharges of materials which could be hazardous.
In its research activities, the Registrant utilizes radioactive and other
materials that could be hazardous to human health, safety or the environment.
These materials and various wastes resulting from their use are stored at the
Registrant's facility pending ultimate use and disposal. Although the Registrant
believes that its safety procedures for handling and disposing of such materials
comply with federal, state and local laws, rules, regulations and policies, the
risk of accidental injury or contamination from these materials cannot be
entirely eliminated. In the event of such an accident, the Registrant could be
held liable for any resulting damages, and any such liability could exceed the
Registrant's resources. The Registrant does not maintain a separate insurance
policy for these types of risks.
Product Liability
The Registrant's business exposes it to potential product liability risks
which are inherent in the testing, manufacturing and marketing of human
therapeutic products. The Registrant maintains insurance against product
liability and defense costs in the amount of $5 million per occurrence and $5
million in the
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aggregate. There can be no assurance that claims against the Registrant arising
with respect to products will be successfully defended, that the insurance
carried by the Registrant will be sufficient or that the Registrant will be able
to obtain additional, or maintain its current level of, product liability
insurance on acceptable terms. A successful claim against the Registrant in
excess of the Registrant's insurance coverage could have a material adverse
effect on the Registrant.
Possible Volatility of Stock Price
The market price of the Common Stock has been, and is likely to be, highly
volatile as frequently occurs with publicly traded emerging growth companies and
biopharmaceutical companies. Factors such as results of clinical trials,
announcements of technological innovations or new products by the Registrant or
its competitors, government regulatory action affecting the Registrant's or its
competitors' drug candidates in both the United States and foreign countries,
developments or disputes concerning patent or proprietary rights and market
conditions for emerging growth and biopharmaceutical companies in general, as
well as period-to-period fluctuations in financial results, could have a
significant impact on the Registrant's business and the market price of the
Common Stock.
Item 2. Properties
The Registrant's principal facility consists of approximately 70,000 square
feet of leased laboratory and office space in Seattle, Washington. A portion of
this space has been subleased by the Registrant to a third party. The lease
expires in March 2003.
The Registrant also leases an administrative and marketing office of
approximately 7,600 square feet in Skokie, Illinois. This lease expires in March
2003. A third leased office in Annandale, New Jersey consists of 18,000 square
feet and houses manufacturing support and distribution support operations. The
lease expires in December 2001. In addition, PathoGenesis rents office space in
New York City, which is subject to an oral, month-to-month lease agreement
between the Registrant and the lessor. See Part III, Item 13. Certain
Relationships and Related Transactions.
Item 3. Legal Proceedings
The Registrant has no material pending legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
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PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
Market Information
The Registrant's Common Stock began trading on the NASDAQ National Market
on November 21, 1995 under the trading symbol PGNS.
The following table sets forth the range of high and low bid prices of the
Common Stock for the periods indicated, as quoted by the NASDAQ National Market.
These quotations represent prices between dealers in securities, do not include
retail mark-ups, mark-downs or commissions, and do not necessarily represent
actual transactions.
High Low
1995:
Fourth Quarter (from November 21, 1995) ..... $11.00 $9.25
1996:
First Quarter ............................... 17.50 10.88
Second Quarter .............................. 18.75 13.50
Third Quarter ............................... 17.75 11.50
Fourth Quarter .............................. 26.13 17.00
1997:
First Quarter (through March 26, 1997) ...... 32.50 21.00
As of January 31, 1997, there were approximately 370 holders of record of
the Common Stock; however, the Registrant believes the actual number of
beneficial owners is substantially greater. On March 26, 1997, the last reported
sale price for the Common Stock on the Nasdaq National Market was $25.50.
The Registrant has never declared or paid cash dividends on its capital
stock and does not anticipate declaring or paying cash dividends in the
foreseeable future. The Registrant expects that any earnings which it may
realize will be retained to finance the development and growth of its business.
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Item 6. Selected Financial Data
The following selected financial data for the period from December 10, 1991
(incorporation) through December 31, 1992 and each of the four years ended
December 31, 1993, 1994, 1995 and 1996 were derived from audited financial
statements of the Registrant. The data set forth below should be read in
conjunction with the audited financial statements, related notes and the other
financial information included elsewhere herein.
<TABLE>
<CAPTION>
Period from
December 10,
1991
(incorporation)
Years ended December 31 through
----------------------- December 31,
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(in thousands, except per share Data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue-grants and royalties .. $ 440 $- $- $- $-
-------- -------- -------- -------- --------
Operating expenses:
Research and development .. 20,673 15,668 12,789 8,213 758
General and administrative 4,241 3,609 3,215 3,615 2,698
-------- -------- -------- -------- --------
Total operating expenses ...... 24,914 19,277 16,004 11,828 3,456
-------- -------- -------- -------- --------
Operating loss ................ (24,474) (19,277) (16,004) (11,828) (3,456)
-------- -------- -------- -------- --------
Other income (expense):
Investment income, net .... 3,294 1,287 1,285 1,064 545
Other expense ............. (84) (34) (43) (41) (19)
-------- -------- -------- -------- --------
Net other income ........ 3,210 1,253 1,242 1,023 526
-------- -------- -------- -------- --------
Net loss ................ $(21,264) $(18,024) $(14,762) $(10,805) $ (2,930)
======== ======== ======== ======== ========
Net loss per common share ..... $ (1.66) $ (2.20) $ (1.95) $ (1.77) $ (0.87)
======== ======== ======== ======== ========
Weighted average common shares
outstanding ................. 12,829 8,210 7,585 6,111 3,367
======== ======== ======== ======== ========
</TABLE>
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December 31,
---------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
Balance Sheet Data:
Cash, cash equivalents and
investment securities ...... $60,688 $37,447 $25,994 $20,421 $38,458
Total current assets ......... 61,809 38,884 26,694 20,862 38,559
Total assets ................. 69,999 46,963 36,086 30,301 41,992
Total current liabilities .... 2,974 3,453 2,925 1,300 2,686
Long-term liability .......... 98 462 -- -- --
Total stockholders' equity ... 66,926 43,048 33,161 29,001 39,306
Item 7. Management's Discussion and Analysis of Financial Conditions and Results
of Operations
Overview
Since its incorporation in December 1991, the Registrant has been engaged
in research and development, clinical trials and administrative activities.
During 1992, the Registrant focused its efforts primarily on corporate
organization, recruiting key scientific and administrative staff, raising
capital through private sales of Common Stock and commencing the construction of
the Registrant's laboratory in Seattle, Washington. During 1992, the Registrant
received net proceeds of $42,340,034 from a private offering of Common Stock at
$10.00 per share (the "1992 Private Placement").
In March 1993, the Registrant completed construction of its laboratory and
commenced research and development operations. By the end of 1993, the
Registrant had recruited scientific research staff and had entered into a
research collaboration agreement with the Public Health Research Institute of
New York for the diagnosis and treatment of tuberculosis, a licensing agreement
with Kaneka for development of PA-1648 and a licensing and development agreement
with Baxter Healthcare Corporation for a monoclinal antibody targeted against
pseudomonal bacteria.
During 1994, the Registrant received net proceeds of $19,095,384 from a
private offering of Common Stock at $12.00 per share (the "1994 Private
Placement"). During 1994, the Registrant entered into a license agreement with
the Cystic Fibrosis Foundation and Children's Hospital and Medical Center in
Seattle to obtain worldwide, exclusive rights to patents, research and
technology relating to the use of an aerosolized tobramycin solution or any
other aerosolized aminoglycoside solution for the treatment of bronchopulmonary
infections.
During 1995, the Registrant commenced its Phase III clinical trials of TOBI
in cystic fibrosis patients and Phase I clinical trials of PA-1648. In November
1995, the Registrant completed an initial public offering of 3,000,000 shares of
Common Stock at $10.00 per share, resulting in net proceeds to the Registrant of
$27,095,726.
Page 34
<PAGE>
In April 1996, the Registrant completed a public offering of 2,875,000
shares of Common Stock at $16.25 per share, resulting in net proceeds to the
Registrant of $43,505,340. In October 1996, the Registrant completed its Phase
III clinical trials of TOBI for the treatment of chronic pseudomonal lung
infections in patients with cystic fibrosis, the results of which were announced
in January 1997. In addition, in December 1996, the Registrant completed its
Phase I clinical trials of PA-1648.
In March 1997, the Registrant completed a public offering of 2,100,000
shares of Common Stock at $27.00 per share, resulting in net proceeds to the
Registrant of approximately $53,000,000. The Underwriters of such public
offering have been granted a 30-day option to purchase an additional 315,000
shares to cover over-allotments, if any.
The Registrant has incurred losses since inception and had an accumulated
deficit through December 31, 1996 of $67,785,433. Such losses have resulted
principally from costs incurred in research and development and clinical trials
and from general and administrative costs associated with the Registrant's
operations. The Registrant expects that operating losses will continue and
increase for at least the next year as its research and development, clinical
testing and marketing activities expand.
To date, the Registrant has not marketed or generated revenues from the
commercialization of any of its drug candidates. The Registrant's current drug
candidates, other than TOBI for cystic fibrosis, are not expected to be
commercially available for at least several years, and TOBI for cystic fibrosis
is not expected to be available commercially until at least 1998, if ever.
The Registrant's results may vary significantly from period to period
depending on several factors, such as the timing of certain expenses and the
progress of the Registrant's research and development efforts.
Results of Operations
Years Ended December 31, 1996 and 1995
Revenue from grants and royalties was $439,880 in 1996. The Registrant did
not have any revenue in 1995. Revenues in 1996 represented income received from
a two-year competitive grant from the FDA and royalties from sales of a
proprietary combinatorial chemistry system invented by the Registrant.
Research and development expense increased by $5,004,632 to $20,673,049 in
1996 from $15,668,417 in 1995. This increase was primarily due to increases in
clinical development activity. General and administrative expense increased by
$632,264 to $4,241,339 in 1996 from $3,609,075 in 1995. Such increase was due
primarily to an increase in costs related to operation as a public Registrant,
such as personnel, investor relations and insurance. The Registrant expects
total costs and expenses to continue to increase in the future due principally
to the advancement of the Registrant's clinical development programs through
various phases of clinical trials and, if successful, the cost of
commercializing its first product.
Investment income, net increased by $2,006,325 to $3,293,782 in 1996 from
$1,287,457 in 1995. This increase was due to higher invested balances.
Years Ended December 31, 1995 and 1994
Research and development expense increased by $2,879,536 to $15,668,417 in
1995 from $12,788,881 in 1994. This increase was primarily due to increases in
clinical development activity. General
Page 35
<PAGE>
and administrative expense increased by $394,245 to $3,609,075 in 1995 from
$3,214,830 in 1994. Such increase was due primarily to an increase in
compensation expense resulting from a new agreement with the Registrant's former
Chairman of the Board, which was partially offset by the reversal in 1995 of a
portion of the discretionary bonuses accrued in 1994, but not awarded by the
Board in 1995. Excluding these compensation-related items, general and
administrative expense would have increased by $196,987 to $3,052,405 in 1995
from $2,855,418 in 1994. The Registrant expects total costs and expenses to
continue to increase in the future due principally to the advancement of the
Registrant's clinical development programs through various phases of clinical
trials and, if successful, the cost of commercializing its first product.
Investment income, net increased marginally to $1,287,457 in 1995 from
$1,284,399 in 1994. Decreases in investment income relating to lower invested
balances were offset by higher effective interest rates earned on invested
funds.
Liquidity and Capital Resources
From the Registrant's inception through December 31, 1996, the Registrant
has financed its operations primarily by the issuance of equity securities with
aggregate net proceeds of approximately $135,000,000 and investment income of
approximately $7,500,000.
The Registrant's combined cash, cash equivalents and investment securities
totaled $60,687,796 at December 31, 1996, an increase of $23,240,962 from the
balance at December 31, 1995. The primary uses of cash during 1996 were to
finance the Registrant's operations. Until such time as the Registrant can
generate sufficient levels of cash from operations, the Registrant will have to
continue to finance future cash needs through some or all of the sources
previously used or through other means. The Registrant does not expect to
generate a positive internal cash flow for at least the next two years due to
the expected increase of spending for research and development programs and the
expected cost of commercializing its first product. The Registrant may need to
arrange additional financing for the future operation of its business, including
the commercialization of its drug candidates currently under development. There
can be no assurances that such additional financing can be obtained and, if
obtained, at reasonable terms. However, the Registrant expects that the net
proceeds of its recently completed public offering, together with its available
cash, cash equivalents and investment securities and investment income, should
be sufficient to meet its operating expenses and capital requirements through at
least the next 24 months.
From the Registrant's inception through December 31, 1996, the Registrant
purchased approximately $13,000,000 of property and equipment. The Registrant's
future capital requirements will depend on many factors, including the progress
of its research and development programs; the progress of preclinical and
clinical testing; the time and cost involved in obtaining regulatory approvals;
the cost of filing, prosecuting, defending and enforcing any patent claims and
other intellectual property rights; competing technological and market
developments; changes and developments in the Registrant's existing
collaborative, licensing and other relationships and the terms of any new
collaborative, licensing and other arrangements that the Registrant may
establish; the development of commercialization activities and arrangements; and
the purchase of additional facilities and capital equipment.
The Registrant plans to continue its policy of investing excess funds in
government securities and investment grade, interest-bearing securities,
primarily with expected maturities of one-and-one-half years
Page 36
<PAGE>
or less. The Registrant does not invest in derivative financial instruments, as
defined by SFAS 119, Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments.
At December 31, 1996, the Registrant had tax net operating loss
carryforwards of approximately $65,175,000 and research tax credits of
approximately $747,000, which will begin to expire in the year 2007. In
conjunction with its current proposed public offering, the Registrant does not
anticipate a change in ownership under Section 382 of the Internal Revenue Code
of 1986, as amended, that would result in limitations on the use of the tax net
operating losses, or tax credits. However, there can be no assurance that future
issuances of the Registrant's securities will not trigger limitations under
Section 382.
Item 8. Financial Statements
The Financial Statements for the fiscal year ended December 31, 1996 may be
found beginning on page F-1 hereof.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of Registrant
The information set forth under the caption "Directors and Officers of the
Registrant" in the Proxy Statement is hereby incorporated by this reference.
Item 11. Executive Compensation
The Information set forth under the caption "Executive Compensation" in the
Proxy Statement is hereby incorporated by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is hereby incorporated
by this reference.
Item 13. Certain Relationships and Related Transactions
The information set forth under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement is hereby incorporated by this
reference.
Page 37
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents Filed As a part of This Report
(1) Financial Statements. The financial statements of PathoGenesis
Corporation for the year ended December 31, 1996, together with the
report of the Independent Certified Public Accountants, are set forth
beginning on page F-1 hereof.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of the fiscal
year ended December 31, 1996.
(c) Exhibits
No. Description of Exhibit
--- ----------------------
3.1 Amended and Restated Certificate of Incorporation, as amended.
(1)
3.2 Amended and Restated By-Laws. (1)
4.1 Form of Stock Certificate. (2)
4.2 1992 Stock Option Plan. (2)
4.3 1996 Non-Employee Director Plan. (3)
4.4 Form of 1997 Stock Option Plan. (1)
10.1 Employment Agreement between the Registrant and Wilbur H. Gantz,
dated March 23, 1992. (2)
10.2 Employment Agreement between the Registrant and Alan R. Meyer,
dated October 12, 1992. (3)
10.3 Form of Employment Agreement between the Registrant and A. Bruce
Montgomery, dated September 19, 1995. (2)
10.4 Employment Agreement between the Registrant and Marc C.
Wipperman, effective as of July 1, 1996. (1)
10.5 Agreement between the Registrant and Robert C. Nowinski, dated
June 6, 1995. (2)
10.6 Consulting Agreement between the Registrant and Sidney Altman,
dated March 10, 1992. (4)
10.7 Consulting Agreement between the Registrant and Stephen Benkovic,
dated March 26, 1992. (2)
10.8 Consulting Agreement between the Registrant and Lucy Shapiro,
dated as of August 1, 1995. (2)
10.9 Consulting Agreement between the Registrant and Michael Wigler,
dated March 23, 1992 as amended, dated May 13, 1994. (2)
10.10 Consulting Agreement between the Registrant and Arnold Smith,
dated October 1, 1996. (1)
10.11 Licensing Agreement between the Registrant and Kaneka
Corporation, dated October 25, 1993 and amendment thereto, dated
March 3, 1995. (2)(5)
Page 38
<PAGE>
10.12 Supply Agreement between the Registrant and Kaneka Corporation,
dated as of October 25, 1993. (2)(5)
10.13 Stock Purchase Agreement between the Registrant and Kaneka
Corporation, dated October 25, 1993. (2)(5)
10.14 Development Agreement between the Registrant and Baxter
Healthcare Corporation, dated December 1, 1993. (2)(5)
10.15 Product Development Agreement between the Registrant and Baxter
Healthcare Corporation, dated August 15, 1994. (2)(5)
10.16 License Agreement between the Registrant and Children's Hospital
and Medical Center, dated January 1, 1994. (2)(5)
10.17 License Agreement between the Registrant and the Cystic Fibrosis
Foundation, dated January 1, 1994. (2)(5)
10.18 Agreement between the Registrant and Cold Spring Harbor
Laboratory, dated as of March 11, 1993 (2) and amendments
thereto, dated May 13, 1994 (2) and December 8, 1995. (5)(3)
10.19 Stock Purchase Agreement between the Registrant and Cold Spring
Harbor Laboratory, dated December 8, 1995. (5)(3)
10.20 Research Agreement between the Registrant and the Public Health
Research Institute, dated February 26, 1993. (2)
10.21 Lease for laboratory in Seattle, Washington, between David A.
Sabey and Sandra L. Sabey and the Registrant, dated June 8, 1992,
as amended by the Second Amendment, dated November 16, 1992 (2),
and as amended by the Third Amendment, dated August 1, 1996. (1)
10.22 Lease for principal executive office in Seattle, Washington,
between PFC Holdings and the Registrant, dated December 15, 1991,
as amended May 26, 1992 and as further amended, effective as of
February 23, 1995. (2)
10.23 Lease for the Skokie, Illinois facility, between The Equitable
Life Assurance Society of the United States and the Registrant,
dated October 1992, as amended, dated March 31, 1995 (2), as
amended, dated April 30, 1996 (1) and as amended, dated February
1, 1997 (6).
10.24 Lease for Annandale, New Jersey facility, between Exxon Research
and Engineering Registrant and the Registrant, dated November 25,
1996. (1)
23.1 Consent of KPMG Peat Marwick LLP. (6)
24.1 Power of Attorney (included on the signature page hereof).
27.1 Financial Data Schedule. (1)
- -----------
(1) Filed as an Exhibit to the Registrant's Registration Statement on Form S-1
(Registration No. 333-22297).
(2) Filed as an Exhibit to the Registrant's Registration Statement on Form S-1
(Registration No. 33-97070).
(3) Filed as an Exhibit to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995.
(4) Filed as an Exhibit to the Registrant's Registration Statement on Form S-1
(Registration No. 333-2956).
(5) Contains confidential material omitted and filed separately with the
Securities and Exchange Commission. Brackets denote such omissions.
(6) Filed herewith.
Page 39
<PAGE>
PATHOGENESIS CORPORATION
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page No.
- -------------------- --------
Independent Auditors' Report ............................................. F-2
Balance Sheets as of December 31, 1996 and 1995 .......................... F-3
Statements of Operations for the years ended December 31, 1996,
1995, 1994 and the period from December 10, 1991
(incorporation) through December 31, 1996 ........................... F-4
Statements of Stockholders' Equity for the years ended December
31, 1996, 1995 and 1994 and the period from December 10,
1991 (incorporation) through December 31, 1996 ...................... F-5
Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994 and the period from December 10, 1991
(incorporation) through December 31, 1996 ........................... F-7
Notes to Financial Statements ............................................ F-9
All financial statement schedules have been omitted since the information
is not required or because the information required is included in the financial
statements or the notes thereto.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
PathoGenesis Corporation:
We have audited the accompanying balance sheets of PathoGenesis Corporation
(a development stage enterprise) as of December 31, 1996 and 1995, and the
related statements of operations, stockholders' equity and cash flows for each
of the years in the three-year period ended December 31, 1996 and for the period
from December 10, 1991 (incorporation) through December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of PathoGenesis Corporation (a
development stage enterprise) as of December 31, 1996 and 1995, and the results
of its operations and its cash flows for each of the years in the three-year
period ended December 31, 1996 and for the period from December 10, 1991
(incorporation) through December 31, 1996, in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
Seattle, Washington
January 17, 1997, except as to note 8 to the financial statements,
which is as of January 30, 1997
Page F-2
<PAGE>
PATHOGENESIS CORPORATION
(A Development Stage Enterprise)
Balance Sheets
December 31,
------------
1996 1995
---- ----
Assets
Current assets:
Cash and cash equivalents ...................... $ 14,785,818 575,297
Investment securities .......................... 45,901,978 36,871,537
Interest receivable ............................ 298,437 765,216
Other current assets ........................... 823,092 671,711
------------ ------------
Total current assets ................ 61,809,325 38,883,761
------------ ------------
Restricted investment .......................... 675,000 --
Property and equipment, at cost:
Leasehold improvements ......................... 6,766,935 6,435,336
Furniture and equipment ........................ 5,967,110 5,338,435
------------ ------------
12,734,045 11,773,771
Less accumulated depreciation and amortization . 5,320,039 3,702,152
------------ ------------
Net property and equipment .......... 7,414,006 8,071,619
------------ ------------
Other assets, net .............................. 100,370 7,758
------------ ------------
$ 69,998,701 46,963,138
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ............................... $ 812,259 1,635,711
Compensation and benefits ...................... 774,258 859,462
Clinical development costs ..................... 818,629 876,132
Other accrued expenses ......................... 569,068 81,473
------------ ------------
Total current liabilities ........... 2,974,214 3,452,778
------------ ------------
Long-term liability ............................ 98,273 461,986
Commitments and subsequent events
Stockholders' equity:
Preferred stock, $.01 par value. Authorized
1,000,000 shares; none issued and outstanding -- --
Common stock, $.001 par value. Authorized
20,000,000 shares; 13,930,760 shares and
10,897,715 shares issued and outstanding at
December 31, 1996 and 1995, respectively .... 13,931 10,898
Additional paid-in capital ..................... 134,727,920 89,520,221
Unrealized gain (loss) on investment securities (30,204) 38,458
Deficit accumulated during the development stage (67,785,433) (46,521,203)
------------ ------------
Total stockholders' equity .......... 66,926,214 43,048,374
------------ ------------
$ 69,998,701 46,963,138
============ ============
See accompanying notes to financial statements.
Page F-3
<PAGE>
PATHOGENESIS CORPORATION
(A Development Stage Enterprise)
Statements of Operations
<TABLE>
<CAPTION>
December 10,
1991
Years ended December 31, (incorporation)
------------------------ through
December 31,
1996 1995 1994 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue-grants and royalties ... $ 439,880 -- -- 439,880
------------ ------------ ------------ ------------
Operating expenses:
Research and development . 20,673,049 15,668,417 12,788,881 58,101,538
General and administrative 4,241,339 3,609,075 3,214,830 17,377,525
------------ ------------ ------------ ------------
Total operating expenses 24,914,388 19,277,492 16,003,711 75,479,063
------------ ------------ ------------ ------------
Operating loss ......... (24,474,508) (19,277,492) (16,003,711) (75,039,183)
------------ ------------ ------------ ------------
Other income (expense):
Investment income, net ... 3,293,782 1,287,457 1,284,399 7,475,047
Other expense ............ (83,504) (33,888) (42,805) (221,297)
------------ ------------ ------------ ------------
Net other income ....... 3,210,278 1,253,569 1,241,594 7,253,750
------------ ------------ ------------ ------------
Net loss ............... $(21,264,230) (18,023,923) (14,762,117) (67,785,433)
============ ============ ============ ============
Net loss per common share ...... $ (1.66) (2.20) (1.95)
============ ============ ============
Weighted average common shares
outstanding ................. 12,829,386 8,209,643 7,585,390
============ ============ ============
</TABLE>
See accompanying notes to financial statements.
Page F-4
<PAGE>
PATHOGENESIS CORPORATION
(A Development Stage Enterprise)
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Unrealized Deficit
Number of gain (loss) accumulated
common Price Additional on during the Total
shares per Common paid-in investment development stockholders'
Date Description outstanding share stock capital securities stage equity
------------ ----- --------- ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
February to Shares issued for
March 1992 cash ................. 1,870,000 $ .08 1,870 147,730 -- -- 149,600
June to Shares issued for
December cash, net of issue
1992 costs of $744,966 .... 4,308,500 10.00 4,309 42,335,725 -- -- 42,340,034
November 1992 Repurchase of
common stock
through forgiveness of
note receivable....... (25,000) 10.00 (25) (249,975) -- -- (250,000)
November 1992 Repurchase of
common stock for
cash.................. (46,875) .08 (47) (3,703) -- -- (3,750)
Net loss for the period
ended December 31,
1992.................. -- -- -- -- -- (2,930,285) (2,930,285)
------------ --------- ----------- ------------ ------------ -----------
Balances at December
31, 1992.............. 6,106,625 6,107 42,229,777 -- (2,930,285) 39,305,599
October 1993 Shares issued in
payment of license
fees.................. 50,000 10.00 50 499,950 -- -- 500,000
Net loss for the year
ended December 31,
1993.................. -- -- -- -- -- (10,804,878) (10,804,878)
------------ --------- ----------- ------------ ------------ -----------
Balances at December
31, 1993.............. 6,156,625 6,157 42,729,727 -- (13,735,163) 29,000,721
March 1994 Shares issued for
cash, net of issue
costs of $1,251,739... 1,690,677 12.00 1,690 19,093,694 -- -- 19,095,384
Unrealized loss on
investment securities -- -- -- -- (172,809) -- (172,809)
Net loss for the year
ended December 31,
1994.................. -- -- -- -- -- (14,762,117) (14,762,117)
------------ --------- ----------- ------------ ------------ -----------
Balances at December
31, 1994.............. 7,847,302 7,847 61,823,421 (172,809) (28,497,280) 33,161,179
</TABLE>
Page F-5
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
March 1995 Shares issued in
payment of license
fees.................. 50,000 12.00 50 599,950 -- -- 600,000
April to August Exercise of stock
1995 options for cash...... 413 10.00 1 4,124 -- -- 4,125
November 22, Shares issued for
1995 cash, net of issue
costs of $2,904,274... 3,000,000 10.00 3,000 27,092,726 -- -- 27,095,726
Unrealized gain on
investment securities -- -- -- -- 211,267 -- 211,267
Net loss for the year
ended December 31,
1995.................. -- -- -- -- -- (18,023,923) (18,023,923)
------------ --------- ----------- ------------ ------------ -----------
Balances at December
31, 1995.............. 10,897,715 10,898 89,520,221 38,458 (46,521,203) 43,048,374
Redemption of
fractional shares for
cash.................. (48) 12.00 -- (576) -- -- (576)
February 1996 Shares issued in
payment of license
fees.................. 6,250 10.00 6 62,494 -- -- 62,500
February 1996 Repurchase of
common stock for
cash.................. (45,000) .08 (45) (3,555) -- -- (3,600)
May 1996 Shares issued for
cash, net of issue
costs of $3,213,410... 2,875,000 16.25 2,875 43,502,465 -- -- 43,505,340
Exercise of options
and warrants for cash
and cancellation of 10.00-
warrants.............. 196,843 14.40 197 1,646,871 -- -- 1,647,068
Unrealized loss on
investment securities. -- -- -- -- (68,662) -- (68,662)
Net loss for the year
ended December 31,
1996.................. -- -- -- -- -- (21,264,230) (21,264,230)
------------ --------- ----------- ------------ ------------ -----------
Balances at December
31, 1996.............. 13,930,760 $ 13,931 134,727,920 (30,204) (67,785,433) 66,926,214
============ ========= =========== ============ ============ ===========
</TABLE>
See accompanying notes to financial statements.
Page F-6
<PAGE>
PATHOGENESIS CORPORATION
(A Development Stage Enterprise)
Statements of Cash Flows
<TABLE>
<CAPTION>
December 10,
1991
Years ended December 31, (incorporation)
------------------------ through
December 31,
1996 1995 1994 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss .................................................. $ (21,264,230) (18,023,923) (14,762,117) (67,785,433)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization ........................ 1,618,982 1,557,195 1,436,570 5,435,563
Amortization of investment premiums
(discounts) ....................................... (33,083) 110,855 190,181 339,267
Common stock issued in payment of
license fees ...................................... 62,500 600,000 59,000 1,159,000
Loss on sale of property and
equipment ......................................... 315 62,859 -- 63,174
Changes in certain assets and
liabilities:
Interest receivable ............................... 466,779 (485,430) (120,647) (298,437)
Other current assets .............................. (151,381) (251,102) (139,057) (823,092)
Other assets ...................................... (92,612) 40,926 195,373 (100,370)
Accounts payable .................................. (823,452) 1,209,078 328,141 812,259
Compensation and benefits ......................... (85,204) 160,682 121,378 834,258
Clinical development costs ........................ (57,503) (737,618) 1,613,750 818,629
Other accrued expenses ............................ 487,595 (44,519) (69,666) 569,068
Long-term liability ............................... (363,713) 461,986 -- 98,273
------------- ------------- ------------- -------------
Net cash used in operating
activities ................................... (20,235,007) (15,339,011) (11,147,094) (58,877,841)
------------- ------------- ------------- -------------
Cash flows from investing activities:
Purchases of investment securities ........................ (116,498,821) (72,862,897) (30,753,408) (251,004,472)
Sales of investment securities ............................ 106,757,801 59,211,912 20,393,561 204,058,023
Purchases of property and equipment ....................... (961,784) (448,350) (1,953,362) (13,012,843)
Proceeds from sale of property and
equipment .............................................. 100 40,000 -- 40,100
Issuance of note receivable ............................... -- -- -- (250,000)
------------- ------------- ------------- -------------
Net cash used in investing
activities ................................... (10,702,704) (14,059,335) (12,313,209) (60,169,192)
------------- ------------- ------------- -------------
Cash flows from financing activities:
Net proceeds from issuance of common
stock .................................................. 43,505,340 27,095,726 19,036,384 132,185,834
Repurchase of common stock ................................ (4,176) -- -- (4,176)
Stock option and warrant exercises ........................ 1,647,068 4,125 -- 1,651,193
------------- ------------- ------------- -------------
Net cash provided by financing
activities ................................... 45,148,232 27,099,851 19,036,384 133,832,851
------------- ------------- ------------- -------------
Net increase (decrease) in cash
and cash equivalents ......................... 14,210,521 (2,298,495) (4,423,919) 14,785,818
</TABLE>
Page F-7
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Cash and cash equivalents at beginning of
period .................................................... 575,297 2,873,792 7,297,711 --
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period ................... $ 14,785,818 575,297 2,873,792 14,785,818
============= ============= ============= =============
Supplemental disclosure of noncash investing and
financing activities - repurchase of common
stock through forgiveness of note receivable .............. $ -- -- -- 250,000
============= ============= ============= =============
</TABLE>
See accompanying notes to financial statements.
Page F-8
<PAGE>
PATHOGENESIS CORPORATION
(A Development Stage Enterprise)
Notes to Financial Statements December 31, 1996 and 1995
(1) Organization and Summary of Significant Accounting Policies
(a) Nature of Development Stage Activities
PathoGenesis Corporation (the Company) is a development stage, health care
company focused on developing drugs for the treatment of serious infectious
diseases where there is a significant need for improved therapy. The Company was
incorporated on December 10, 1991. Principal activities to date include
conducting human clinical trials, defining and conducting research programs,
entering into collaborative licensing agreements, raising capital, recruiting
scientific and management personnel, and construction of a research facility.
(b) Depreciation and Amortization
Furniture and equipment are depreciated using the straight-line method over
the assets' estimated useful lives of five to ten years. Leasehold improvements
are amortized using the straight-line method over the shorter of the assets'
estimated useful lives or the remaining term of the lease.
(c) Research and Development Costs
Research and development costs are charged to expense as incurred.
(d) Income Taxes
Deferred income taxes are provided based on the estimated future tax
effects of temporary differences between financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
that are expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(e) Investment Securities
The Company's investment securities are classified as available-for-sale
and carried at market value, with unrealized gains and losses excluded from the
statement of operations and reported as a separate component of stockholders
equity. Realized gains and losses on the sales of investment securities are
determined on the specific identification method and included in investment
income, net.
(f) Fair Value of Financial Instruments
The Company has financial instruments other than investments consisting of
cash, accounts payable and a long-term liability. The Company has determined the
fair value of the above financial instruments using available market information
and appropriate valuation methodologies. The fair value of the Company's
financial instruments approximates their carrying amount.
Page F-9
<PAGE>
(g) Cash Equivalents
All investments with a maturity of three months or less at the date of
purchase are considered to be cash equivalents.
(h) Net Loss Per Share
Net loss per common share is computed using the weighted average number of
common shares outstanding during the periods using the treasury stock method.
Net loss per common share does not include the effect of common share
equivalents, which include stock options and warrants, as their impact is
antidilutive.
(i) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Page F-10
<PAGE>
(2) Investment Securities
The following summarizes the Company's investment securities:
<TABLE>
<CAPTION>
Gross Gross
unrealized unrealized
Amortized cost gains losses Market value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1996:
U.S. Treasury notes ....... $10,641,041 3,823 (11,272) 10,633,592
Federal mortgage notes .... 6,719,925 7,430 (4,276) 6,723,079
Corporate obligations ..... 28,571,216 48,441 (74,350) 28,545,307
----------- ----------- ----------- -----------
$45,932,182 59,694 (89,898) 45,901,978
=========== =========== =========== ===========
1995:
U.S. Treasury notes ....... $19,609,492 44,743 -- 19,654,235
Federal mortgage notes .... 2,261,791 4,189 -- 2,265,980
Corporate obligations ..... 13,547,425 25,322 -- 13,572,747
Foreign obligations ....... 1,414,371 -- (35,796) 1,378,575
----------- ----------- ----------- -----------
$36,833,079 74,254 (35,796) 36,871,537
=========== =========== =========== ===========
</TABLE>
Amortized cost and market value of investment securities at December 31,
1996, by contractual maturity are shown below. Actual maturities may be
different than the contractual maturities because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties.
Contractual maturities are as follows:
Maturities Amortized cost Market value
- ---------- -------------- ------------
Due in one year or less ................ $15,290,665 15,278,842
Due between one year through five years 17,396,480 17,369,280
Due between five years through ten years 9,560,809 9,572,170
Due after ten years .................... 3,684,228 3,681,686
----------- -----------
$45,932,182 45,901,978
=========== ===========
Investment income, net includes interest of $3,412,097, $1,308,127 and
$1,766,953 earned on investments and losses of $118,315, $20,669 and $325,902
realized upon the sale of investments for 1996, 1995 and 1994, respectively.
The Company does not invest in derivative financial instruments, as defined
by SFAS 119, Disclosure about Derivative Financial Instruments and Fair Value of
Financial Instruments.
(3) Long-Term Liability
In the second quarter of 1995, the Board of Directors reached an agreement
with the Company's former chairman of the board which obligated the Company to
pay $944,958 over three years which is included in 1995 general and
Page F-11
<PAGE>
administrative expenses. The portion of this obligation payable within the next
year is included in current liabilities under compensation and benefits.
(4) Stockholders' Equity
(a) Common and Preferred Stock
Effective October 17, 1995, the Company's stockholders approved a
one-for-eight reverse split of the Company's issued and outstanding common
stock, a change to the authorized number of shares of the Company's $.001 par
value common stock to 20,000,000 shares, and an authorization of 1,000,000
shares of preferred stock, par value $.01. The accompanying financial statements
and related notes to the financial statements have been restated to reflect
these changes for all periods presented.
(b) Stock Option Plans
The Company's 1992 Stock Option Plan (Stock Plan) has 1,500,000 shares of
common stock which have been authorized to be reserved for grants. At December
31, 1996, 110,048 shares remain available for future awards. Options granted
under this plan may be designated as qualified or nonqualified at the discretion
of the compensation committee of the Board of Directors.
Generally, options vest and may be exercised over a four-year period in
increments of 25% each year beginning one year from the date of grant; however,
options can vest upon granting. All options expire not later than ten years from
the date of grant. Qualified stock options are exercisable at not less than the
fair market value of the stock at the date of grant and nonqualified stock
options are exercisable at prices determined at the discretion of the Board of
Directors, but not less than 85% of the fair market value of the stock at the
date of grant.
In 1996, the Company adopted the 1996 Stock Option Plan for Non-Employee
Directors (Directors Plan), under which 300,000 shares of common stock are
reserved for grants. At December 31, 1996, 258,000 shares remain available for
future awards. Nonemployee directors are granted between 4,000 and 8,000 options
immediately following each Annual Stockholders Meeting. Options are exercisable
from the date of grant for a period of ten years or one year after termination
as a director. Options are granted at the fair market of the Company's common
stock on the date of grant.
A summary of stock options follows:
Directors Weighted average
Stock Plan Plan exercise price
---------- ---- --------------
Balances at December 31, 1993 695,375 -- $ 10.00
Granted ..................... 132,500 -- 12.00
Canceled .................... (30,813) -- 10.00
---------- ----------
Balances at December 31, 1994 797,062 -- 10.33
Granted ..................... 303,125 -- 12.00
Canceled .................... (74,121) -- 10.00
Exercised ................... (413) -- 10.28
---------- ----------
Balances at December 31, 1995 1,025,653 -- 10.83
Granted ..................... 438,850 42,000 16.18
Canceled .................... (69,941) -- 11.17
Exercised ................... (169,787) -- 10.11
---------- ----------
Balances at December 31, 1996 1,224,775 42,000 $ 12.90
========== ==========
Page F-12
<PAGE>
The weighted average fair value of options granted was $8.87 and $4.97 in
1996 and 1995, respectively.
An additional 44,000 shares of common stock were granted under the Stock
Plan to the Board of Directors in January 1997.
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its plans. Accordingly, no compensation cost has been recognized
for its fixed stock option plans. Had compensation cost for the Company's two
stock-based compensation plans been determined consistent with FASB Statement
No. 123, the Company's net loss and loss per share would have been increased to
the pro forma amounts indicated below:
1996 1995
---- ----
Net loss-as reported ................... $ 21,264,230 18,023,923
Net loss-pro forma ..................... 23,930,975 19,131,780
Loss per share-as reported ............. 1.66 2.20
Loss per share-pro forma ............... 1.87 2.33
The fair value of each option grant is estimated on the date of grant using
the Black-Sholes option-pricing model with the following assumptions used for
grants in 1995 and 1996: dividend yield of 0.0% for both years; expected
volatility of 46% for 1995 and 57% to 67% for 1996; risk-free interest rate of
5.46% to 7.15% for 1995 and 5.18% to 6.85% for 1996; expected lives from three
to six years for both years.
The following table summarizes information about fixed-price stock options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Weighted Weighted Weighted
Number average average Number average
Range of outstanding remaining exercise exercisable exercise
exercise prices at 12/31/96 contractual life price at 12/31/96 price
--------------- ----------- ---------------- ----- ----------- -----
<S> <C> <C> <C> <C> <C>
$10.00 396,700 6.2 years $10.00 336,686 $10.00
12.00 416,975 8.2 years 12.00 250,085 12.00
13.75 to 14.75 141,150 9.5 years 14.51 -- --
16.13 to 16.75 268,550 9.2 years 16.25 101,000 16.25
22 43,400 9.9 years 22.00 20,000 22.00
--------- -------
$10.00 to 22.00 1,266,775 8.0 years $12.90 707,771 $11.94
========= =======
</TABLE>
(c) Common Stock Warrants
As of December 31, 1996, the Company had outstanding warrants, with
expiration terms ranging from September 20, 1998 to February 6, 2001, to
purchase 111,660 shares of common stock which are fully exercisable at the
following per share prices:
Per share
Shares price
------ -----
28,325............................................... $12.00
83,335............................................... 14.40
-------
Page F-13
<PAGE>
111,660.............................................. $12.00-14.40
-------
(5) Income Taxes
Federal income taxes reported by the Company differ from the amount
computed by applying the U.S. Federal income tax rate of 34% to pretax losses
due to limitations on utilizing net operating losses.
The tax effects of temporary differences that give rise to deferred tax
assets at December 31 are as follows:
1996 1995
---- ----
Deferred tax assets:
Start-up costs deferred for tax purposes ........ $ 5,817 29,087
Orphan Drug credit .............................. 100,000 100,000
Deferred compensation ........................... 116,080 333,247
License agreements .............................. 446,068 484,427
Research and experimentation credit carryforwards 747,456 633,961
Net operating loss carryforwards ................ 22,159,516 14,663,765
Depreciation .................................... 310,432 95,204
Other ........................................... 212,701 304,757
----------- -----------
Total gross deferred tax assets ......... 24,098,070 16,644,448
Less valuation allowance ........................ 24,098,070 16,644,448
----------- -----------
Net deferred tax assets ................. $ -- --
=========== ===========
The increases in the valuation allowance for deferred tax assets of
$7,453,622, $6,388,860 and $5,266,640 in 1996, 1995 and 1994, respectively, are
primarily attributable to increases in net operating loss carryforwards whose
utilization cannot reasonably be assured.
At December 31, 1996, the Company has net operating loss carryforwards of
approximately $65,175,000 and research and experimentation credit carryforwards
of approximately $747,000, which are available to offset future Federal taxable
income and income taxes, respectively, if any, and expire beginning in 2007.
(6) Commitments
(a) Leases
The Company leases various office and research facilities under
noncancelable operating leases which expire between 1998 and 2003. With respect
to one of the leases, the Company is required to maintain collateral on a letter
of credit in the amount of a $675,000 certificate of deposit which is recorded
as a restricted investment.
Minimum lease payments under noncancelable operating leases (with initial
or remaining lease terms in excess of one year) and related sublease income as
of December 31, 1996 are as follows:
Lease payments Sublease income
-------------- ---------------
1997...................................... $1,692,000 333,000
1998...................................... 1,810,000 333,000
1999...................................... 1,757,000 333,000
Page F-14
<PAGE>
2000...................................... 1,757,000 333,000
2001...................................... 1,717,000 --
Thereafter................................ 884,000 --
---------- ---------
$9,617,000 1,332,000
========== =========
Rent expense for operating leases was approximately $1,026,000, $746,000
and $644,000 for 1996, 1995 and 1994, respectively, and $3,298,000 for the
period December 10, 1991 (incorporation) through December 31, 1996.
Included in rent expense are payments to a partnership in which a member of
the Board of Directors and an officer of the Company are partners of
approximately $36,200, $35,500 and $49,500 for 1996, 1995 and 1994,
respectively.
(b) Employment and Consulting Agreements
The Company has employment and consulting agreements with certain key
executives, research scientists and advisors. The terms of these agreements
range from two to five years, provide for discretionary bonuses, as determined
by the Company's Board of Directors and provide for annual increases in
compensation to be determined at the discretion of the Board of Directors.
Approximate minimum compensation payments due pursuant to these employment
and consulting agreements are as follows:
1997................................ $ 959,000
1998................................ 517,000
1999................................ 294,000
2000................................ 151,000
----------
$1,921,000
==========
(7) Collaboration Agreements
In May 1996, the Company entered into a distribution agreement with Bohdan
Automation, Inc. (Bohdan), pursuant to which Bohdan has agreed to manufacture
and sell a proprietary combinatorial chemistry system invented by the Company.
Royalties of $238,000 were earned from this arrangement during 1996.
In 1994, the Company entered into a license agreement with two U.S.
institutions to obtain worldwide rights to a product currently in clinical
trials. A $1.5 million milestone payment will be payable by the Company if the
product receives approval for marketing by the FDA. The Company is responsible
for clinical trials, sales, marketing, manufacturing and regulatory affairs
related to the product. The Company will pay a royalty on net product sales.
In 1993, the Company entered into a license agreement with a Japanese
company to obtain rights for North America to a product in preclinical trials.
The initial payment for these rights was $500,000 cash and 50,000 shares of
common stock. A second milestone payment of 50,000 shares of common stock was
paid in 1995 when the Investigational New Drug application was filed. Subsequent
payments will be made upon accomplishment of certain milestones. The Company is
Page F-15
<PAGE>
responsible for clinical trials, sales, marketing and regulatory affairs related
to the product. The Japanese company is responsible for manufacturing the bulk
form of the product. The Company will pay a royalty on net product sales.
In 1993, the Company entered into a collaborative research agreement with a
research institution. The agreement calls for payments to the research
institution of up to $1.5 million over three years, not to exceed $500,000 in
any one year. In addition, the Company was committed to spend $1 million per
year in research and development to support this collaborative research. As of
December 31, 1996, the Company has fulfilled its obligation under this
commitment to the research institution.
In 1993, the Company entered into a license and manufacturing agreement
with a then significant shareholder to obtain worldwide rights to a product in
clinical trials. Under the agreement, the Company was to make certain fixed
payments to the licensor upon accomplishment of certain milestones. Initial
payment for these rights was $550,000 and the Company was responsible for
clinical trials, sales, marketing and regulatory affairs related to the product.
In 1994, the Company decided to cease development of this product and has
fulfilled its obligation under this agreement.
In 1993, the Company also entered into a development agreement with a then
significant shareholder pursuant to which the Company was assisted with its
research and development activities relating to a product currently in clinical
trials. The Company paid research and development fees of $923,100 related to
this agreement. The Company has entered into an additional development agreement
dated as of August 15, 1994 with this shareholder pursuant to which the Company
will continue to receive assistance in developing this product. As of December
31, 1996, the Company has paid $1,265,000 under this agreement.
(8) Subsequent Events
On January 30, 1997, the Board of Directors adopted the 1997 Stock Option
Plan (1997 Plan) subject to stockholder approval. The 1997 Plan provides for the
grant of options to acquire a maximum of 2,000,000 shares of common stock of
which 378,800 shares were granted as of January 30, 1997. Additionally, the
Board of Directors approved an increase in the authorized number of shares of
common stock to 60,000,000 shares subject to stockholder approval.
s -----------
Page F-16
<PAGE>
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, in the City of
Seattle, State of Washington, on March 27, 1997.
PATHOGENESIS CORPORATION
By: /s/ Wilbur H. Gantz
------------------------------
Wilbur H. Gantz
President
In accordance with the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates stated.
Signature Title Date
--------- ----- ----
/s/ Wilbur H. Gantz Chief Executive Officer, March 27, 1997
- ------------------------------ President and Director
Wilbur H. Gantz (Principal Executive Officer)
/s/ Alan R. Meyer Senior Vice President, March 27, 1997
- ------------------------------ Chief Financial Officer
Alan R. Meyer and Director(Principal
Financial and Accounting
Officer)
/s/ Elizabeth M. Greetham Director March 27, 1997
- ------------------------------
Elizabeth M. Greetham
/s/ Lawrence C. Hoff Director March 27, 1997
- ------------------------------
Lawrence C. Hoff
/s/ Edward Mathias Director March 27, 1997
- ------------------------------
Edward Mathias
/s/ Michael J. Motgomery Director March 27, 1997
- ------------------------------
Michael J. Montgomery
/s/ Talat M. Othman Director March 27, 1997
- ------------------------------
Talat M. Othman
/s/ Eugene L. Step Director March 27, 1997
- ------------------------------
Eugene L. Step
/s/ Fred Wilpon Director March 27, 1997
- ------------------------------
Fred Wilpon
Page F-17
THIRD AMENDMENT TO LEASE
THIS THIRD AMENDMENT TO LEASE, ("Amendment") dated this lst day of
February, 1997, is entered into by and between KNICKERBOCKER PROPERTIES, INC.
XVII, a Delaware corporation ("Landlord") and PATHOGENESIS CORPORATION, a
Delaware corporation ("Tenant").
W I T N E S S E T H:
WHEREAS, Landlord is successor in interest to The Equitable Life
Assurance Society of the United States ("Original Landlord");
WHEREAS, Old Orchard Office Venture, the predecessor to Original
Landlord and Tenant entered into that certain Lease dated October ____, 1992
(the "Original Lease") for Suite 910 (the "Original Premises") in that certain
building located at 5215 Old Orchard Road, Smoke, Illinois (the"Building"); and
WHEREAS, Landlord and Tenant entered into that certain First Amendment
to Lease, dated March, 1995 (the"First Amendment") and that certain Second
Amendment to Lease, dated April 3, 1996 (the "Second Amendment"), the Original
Lease as amended by the First Amendment and the Second Amendment is hereinafter
referred to as the "Amended Lease");
WHEREAS, Landlord and Tenant now desire to add approximately 3,134
square feet of net rentable area, as shown on Exhibit A attached hereto and
hereby made a part hereof (the "New Premises") to the Original Premises to
extend the term of the Amended Lease until March 31, 2003 and to amend certain
other provisions of the Amended Lease;
NOW THEREFORE, for and in consideration of the mutual covenants and
conditions contained herein, and for other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, Landlord and Tenant
hereby agree as follows:
1. Landlord hereby leases to Tenant, and Tenant accepts and
leases from Landlord, in accordance with the provisions, terms and conditions of
the Amended Lease as amended by this Amendment (the "Lease"), the New Premises,
which New Premises contains approximately 3,134 square feet of net rentable
area. From and after the date hereof, the term "Leased Premises" in the Lease
shall mean the Original Premises as expanded by the New Premises. Landlord
hereby demises and leases the New Premises on an "as-is" "where-is" basis. The
pa[parties hereto acknowledge and agree that the taking of possession by Tenant
shall be conclusive evidence that the New Premises are in good order and repair
and are in satisfactory condition as of the date of the taking of possession.
Landlord and Landlord's agents have made no representations, warranties or
promises, express or implied with respect to the condition of the Building, the
New Premises, the existing fixtures or the building systems serving the New
premises or as to any other thing or fact related thereto, and no rights,
easements or licenses are acquired by Tenant by implication or otherwise except
as expressly set forth herein.
2. Landlord agrees to deliver the New Premises to Tenant on or
before March 10, 1997. From and after the earlier to occur of occupancy of the
New Premises by Tenant (other
<PAGE>
than for purposes of constructing improvements therein) and May 1, 1997 (the
"Rent Effective Date"), Landlord shall return any security deposit currently
held by Landlord. If Landlord shall be unable to deliver possession of the New
Premises on or before March 10, 1997 for any reason, Landlord shall not be
subject to any liability for such failure. Under such circumstances, the Rent
Commencement Date shall be extended one day for every day after March 10, 1997
until the date possession is actually delivered (or would have been delivered
but for the delay or default of Tenant). Notwithstanding the foregoing, Tenant
shall have the right to terminate this Lease if possession of the New Premises
is not delivered to Tenant on or before June 1, 1997; provided Tenant shall have
delivered written notice to Landlord of such termination on or before June 10,
1997.
3. From and after the Rent Effective Date, the Schedule set
forth on pages 1 and 2 of the Lease shall be deterred in its entirety and
replaced with the following:
SCHEDULE
A. Description of Leased Premises: Suite 910, located on the ninth (9th)
floor of the Building, consisting of 7,620 square feet of net rentable
area, more or less.
B. Tenant's type of business: sales and administrative office for
pharmaceutical company.
C. Base Rent: Annual Monthly RSF
From the Rent Effective Date through 3/31/98 97,155.0 8,096.2 12.75
From 4/1/98 through 3/31/99: 100,050.6 8,337.5 13.13
From 4/1/99 through 3/31/00: 103,098.6 8,591.5 13.53
From 4/1/00 through 3/31/01: 106,146.6 8,845.5 13.93
From 4/1/01 through 3/31/02: 109,347.0 9,112.2 14.35
From l4/1/02 through 3/31/03: 112,623.6 9,385.3 14.78
Notwithstanding anything contained in the Lease to the contrary. Base Rent
shall be determined on a monthly basis as set forth in this Schedule.
D. Tenant's Share: 3.635% (the percentage of the number of square feet of
net rentable area in the Leased Premises to 209,616, the number of
square feet of net rentable area in the Building).
E. Term: A term commencing on the date specified in Paragraph 2A
(hereinafter referred to as the "Commencement Date") and ending on
March 31, 2003 (hereinafter referred to as the "Termination Date")
unless otherwise terminated as provided in this Lease.
F. Security Deposit: 5 -0-
2
<PAGE>
G. Broker: CB Commercial
H. Addresses for Notices:
If to Landlord:
Knickerbocker Properties, Inc. XVII
c/o O'Connor Realty Advisors Incorporated
399 Park Avenue
New York, NY 10022
Attn: Asset Manager
with a copy to:
Hines Interests Limited partnership
5215 Old Orchard Road
Skokie, Illinois 60077
Attn: Property Manager
If to Tenant:
Pathogenesis Corporation
Suite 910
5215 Old Orchard
Skokie, Illinois 60077
This lease is subject to the Terms and Conditions and the provisions
of any riders attached hereto, which Terms and Conditions and riders
are hereby made a part of this Lease."
4. Landlord shall: (a) at Landlord's option, either install
new vinyl wall covering or paint the existing vinyl wall covering in the common
areas of the ninth (9th) floor of the Building and (b) install now carpeting in
the common areas of the ninth (9th) floor of the Building. Landlord shall inform
Tenant of Landlord's choice of carpet prior to its installation. The work
described in this Section 4 shall be completed on or prior to December 31, 1997.
5. Tenant shall have the right in common with all other
tenants of the Building, to park up to twenty-seven (27) vehicles, on an
unreserved basis and at no charge, in the parking garage located adjacent to the
building or on the surface parking lot.
6. Landlord shall pay to Tenant, upon or after the occurrence
of the Rent Effective Date, an amount not in excess of $121,920.00, as
reimbursement for Tenant's actual cost of designing and constructing tenant
improvements in, and moving to, the New premises (the "Allowance"). The
Allowance shall be paid to Tenant upon Tenant's delivery of reasonable evidence
showing that such cost were incurred and that all construction was performed in
3
<PAGE>
accordance with the terms of the Amended Lease (including, without limitation,
delivery of sworn statements and lien waivers). Landlord shall be entitled to
deduct $525.00 from the Allowances, as reimbursement for architectural fees
incurred by Landlord. Tenant may construct the initial tenant improvements in
the New Premises using contractors reasonably approved by Landlord, provided
such contractors construct such improvements in accordance with the terms of the
Amended Lease and in accordance with Landlord's reasonable rules and
regulations. In the event Tenant uses contractors for such initial construction
other than those contracted by Landlord, Landlord shall not be entitled to
charge a supervisory fee in connection with such initial tenant improvement
construction.
7. Provided that Tenant is not in default hereunder, Tenant
shall have a continuing right of offer on the terms and conditions set forth in
this paragraph ("Right of Offer") with respect to (a) that space on the ninth
(9th) floor of the Building shown on Exhibit B attached hereto and hereby made
part hereof, which is contiguous to the Leased Premises and contains
approximately 3,067 square feet (the "Contiguous Offer Space"), (b) all space
located on the eight (8th) floor of the Building (the "Eight Floor Offer Space")
and (c) all space located on the ninth (9th) floor of the Building other than
the Contiguous Offer Space (the "Other Ninth Floor Offer Space") (the Eight
Floor Offer Space and the Other Ninth Floor Offer Space are herein collectively
referred to as the "Other Offer Space." The Other Offer Space and the Contiguous
Offer Space, are herein collectively referred to as the "Offer Space"). If at
any time during the Term any portion of the Offer Space is available for the
lease of such Offer Space, then Landlord shall notify Tenant in writing
("Landlord's Leasing Notice") identifying the Offer Space to be leased, the
proposed term of such lease and, in the case of Other Offer Space, setting forth
the economic terms (including base rent, additional rent, abatements,
construction allowances and pass through) upon which Landlord intends to lease
such Offer Space. Tenant shall have a period of seven (7) business days from the
date of delivery of Landlord's Leasing Notice to notify Landlord in writing
whether Tenant elects to exercise its Right of Offer as herein granted. If
Tenant elects to exercise its Right of Offer, then (1) such exercise must be for
the entire Offer Space as to which Landlord was participating in serious
discussions and for the entire term of such proposed lease, (2) if the Offer
Space consists of Contiguous Offer Space, then (aa) the base Rent payable for
such Contiguous Offer Space shall be equal to the Base Rent then payable for the
remainder of the Leased Premises, (bb) if the Contiguous Offer Space is to be
leased commencing prior to October 2, 1998, Landlord shall provide a tenant
improvement allowance to Tenant in an amount per square foot of such Contiguous
Offer Space to be leased, equal to the then unmortized portion of $16.00 per
square foot amortized over seventy-one (71) months, as more particularly shown
on Exhibit C attached hereto and hereby made a part hereof (by way of example,
if the lease of such Contiguous Offer Space is to commence on October 1, 1997,
the tenant improvement allowance to be paid to Tenant would equal $15.16 per
square foot) and (cc) all other terms of the Lease (including the payment of
Additional Rent, all other economic term and all non-economic terms of the
Lease) shall apply to the Contiguous Offer Space and (3) if the Offer Space
consists of Other Offer Space, then the Base Rent and Additional Rent payable
for such Offer Space (together with all other economic terms applicable to such
Offer Space) shall be as set forth in Landlord's Leasing Notice and all
non-economic terms of the Lease shall apply to such Offer Space. Landlord and
Tenant (negotiating in good faith) shall execute an amendment to
4
<PAGE>
this Lease for such Offer Space within thirty (3)0 days after Tenant notifies
Landlord of its exercise of its Right of Offer. If Tenant (AA) rejects its Right
of Offer, (BB) has not responded to Landlord's Leasing Notice within the
aforementioned seven (7) business days or (CC) is unable to reach an agreement
with Landlord on the form amendment reasonably acceptable to Landlord within the
aforementioned thirty (30) days, then in all such events Tenant shall be deemed
to have rejected and waived its Right of Offer with respect to the particular
Offer Space and Landlord may lease such Offer Space to any other person or
entity. If Tenant rejects (or is deemed to have rejected) its Right of Offer
then, (I) if Landlord enters into a lease for the Offer Space ("Offer Space
Lease") within one year after the date of Landlord's Leasing Notice, Landlord
shall have no obligation to offer to lease the Offer Space to Tenant until the
Offer Space Lease expires or terminates and Landlord is thereafter participating
in serious discussion with a current or potential tenant with respect to the
leasing of such Offer Space or (II) if Landlord does not enter into an Offer
Space Lease, Landlord shall have no obligation to offer to lease the Offer Space
to Tenant until the date that is one year after the date of Landlord's Leasing
Notice (provided Landlord is then participating in serious discussion with a
current or potential tenant to lease the Offer Space). Tenant acknowledges that
the Right of Offer granted herein with respect to the Eight Floor Offer Space is
subject and subordinate to certain rights of offer, expansion options and rights
of refusal granted to PrimeCare International, Inc. Landlord shall not be
required to offer the Eight Floor Offer Space in accordance with the terms of
its lease. Tenant's exercise of the Right of Offer shall not operate to cure any
default by Tenant of any of the terms or provisions in the Lease, nor to
extinguish or impair any portion of the Premises, then immediately upon such
termination, sublease or assignment, the Right of Offer herein granted shall
simultaneously terminate and become null and void.
8. Tenant is hereby given the option to extend the Term of
this Lease for one (1) additional term of three (3) years (all such additional
years beyond the expiration of the original Term shall be collectively referred
to as the "Renewal Term"); provided, however, that such option to extend shall
be conditioned upon the subject to the following:
(a) Tenant shall notify Landlord in writing (the "Renewal
Notice") of its intent to exercise its option to renew on or before July 1,
2002. In the event that Tenant fails to deliver to Landlord the Renewal Notice
on or before July 1, 2002, the option to renew this Lease as set forth in this
paragraph shall be deemed waived by Tenant.
(b) At the time Landlord received the Renewal Notice and at
the expiration of the original Term, Tenant shall not be in default under any of
the terms or provision of this Lease.
(c) The Renewal Term shall be on the same terms and conditions
as set forth in this Lease, except: (i) the Base Rent shall be the then current
Market Base Rent (as hereinafter defined); (ii) the term "Term" as used in this
Lease, shall mean the initial Term and the Renewal
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Term: (iii) the Right of Offer set forth in paragraph 7 of this Amendment shall
not apply during the Renewal Term; and (iv) Tenant shall have no further options
to renew the Term of this Lease. The term "Market Base Rent" for the purposes of
this paragraph 8 shall mean the then current market base rental rate (taking
into consideration market concessions, inducements and allowances) for
comparable space for comparable terms in comparable condition in office building
comparable to the Building in the North Suburban Chicago Market (in the vicinity
of the Edens Expressway), as reasonably determined by Landlord. Landlord shall
deliver its estimated Market Base Rent to Tenant within thirty (30) days after
Landlord's receipt of Renewal Notice. In the event that Tenant disagrees with
Landlord's estimate of such Market Base Rent, then Tenant may rescind its
Renewal Notice, by written notice to Landlord within ten (10) days after receipt
for Landlord's estimate.
(d) If the Lease or Tenant's right of possession of the Leased
Premises hall terminate in any manner whatsoever before Tenant shall exercise
the right herein provided, or if Tenant shall have subleased or assigned all or
any portion of the Leased Premises, then immediately upon such termination,
sublease or assignment, the right to renew the Lease herein granted shall
simultaneously terminates and become null and void, it being acknowledged and
agreed that such right is personal to pathogenesis Corporation.
9. It is expressly understood and agreed that this Amendment
is intended to modify and amend the Amended Lease only to the extent set forth
herein and that all other provisions, terms and conditions of said Amended Lease
(including all riders, exhibits and other attachments thereto), as hereby
modified and amended, shall remain in full force and effect and are hereby
ratified and confirmed.
10. It is expressly understood and agreed that none of
Landlord's covenants, undertakings or agreements made in this Amendment or the
Amended Lease are made or intended as personal covenants, undertakings or
agreements by Landlord, and any liability of Landlord for damages for breach or
nonperformance by Landlord or otherwise arising under or in connection with this
Amendment or the Amended Lease or the relationship of Landlord and Tenant
hereunder, shall be collectible only out of Landlord's interest in the Land and
Building, in each case as the same may then be encumbered, and no personal
liability is assumed by, nor at any time may be asserted against, Landlord, or
its shareholders, officers, directors, employees, agents, legal representatives,
successor or assigns, all such liability, if any, being expressly waived and
released by Tenant.
11. All capitalized terms used herein shall have the same
meanings as in the Amended Lease, unless otherwise defined herein. In the event
of any conflict between the terms and provisions of this Amendment and the terms
and provisions of the Amended Lease, the terms and provisions of this Amendment
shall control.
12. This Amendment may be executed in counterparts.
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IN WITNESS WHEREOF, the parties have set their hands hereto as of the day
and year first above written.
LANDLORD:
KNICKERBOCKER PROPERTIES, INC. XVII
Delaware corporation
By: /s/ ________________________________
Its:____________________________________
TENANT:
PATHOGENESIS CORPORATION, a Delaware
corporation
By: /s/ ________________________________
Its:____________________________________
Exhibit 23.1
Consent of Independent Certified Public Accountants
The Board of Directors
Pathogenesis Corporation
We consent to incorporation by reference in the registration statement (No.
333-05095) on Form S-8 of Pathogenesis Corporation (a development stage
enterprise) of our report dated January 17, 1997, except as to note 8 to the
financial statements, which is as of January 30, 1997, relating to the
consolidated balance sheets of Pathogenesis Corporation as of December 31, 1996
and 1995, and the related statements of operations, stockholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1996, and for the period from December 10, 1991 (incorporation) through December
31, 1995, which report appears in the December 31, 1996, annual report on Form
10-K of Pathogenesis Corporation.
KPMG Peat Marwick LLP
Seattle, Washington
March 27, 1997
