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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 000-23265
SALIX PHARMACEUTICALS, LTD.
(FORMERLY, SALIX HOLDINGS, LTD.)
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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BRITISH VIRGIN ISLANDS 94-3267443
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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3600 WEST BAYSHORE ROAD, SUITE 205
PALO ALTO, CALIFORNIA 94303
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(650) 856-1550
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
Common Shares, No Par Value The Toronto Stock Exchange
</TABLE>
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 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) has 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 IIII of this Form 10-K or any
amendment to this Form 10-K [X]
The aggregate market value of the Registrant's Common Shares held by non-
affiliates of the Registrant on March 20, 1998 (based on the closing sale
price of U.S. 5.25 of the Registrant's Common Shares, as reported on The
Toronto Stock Exchange on such date) was approximately $36,330,284. Common
Shares held by each officer and director and by each person known to the
Company who owns 5% or more of the outstanding Common Shares have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes.
The number of the Registrant's Common Shares outstanding at March 20, 1998
was 10,192,838.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed for its
1998 Annual Meeting of Stockholders to be held May 12, 1998 are incorporated
by reference into Part III of this report.
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SALIX PHARMACEUTICALS, LTD.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
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PAGE
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Item 1. Business....................................................... 1
Item 2. Properties..................................................... 18
Item 3. Legal Proceedings.............................................. 18
Item 4. Submission of Matters to a Vote of Security Holders............ 18
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................ 20
Item 6. Selected Consolidated Financial Data........................... 22
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 23
Item 8. Financial Statements and Supplementary Data.................... 32
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... 32
PART III
Item 10. Directors and Executive Officers of the Registrant............. 33
Item 11. Executive Compensation......................................... 33
Item 12. Security Ownership of Certain Beneficial Owners and Management. 33
Item 13. Certain Relationships and Related Transactions................. 33
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K............................................................ 34
Signatures.............................................................. 36
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<PAGE>
PART I
ITEM 1. BUSINESS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward-looking statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical results or those anticipated in these forward-looking
statements as a result of certain factors, including those set forth under
"Factors That May Affect Future Results" under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in,
or incorporated by reference into, this report.
OVERVIEW
Salix Pharmaceuticals, Ltd. ("the Company") identifies and in-licenses
gastrointestinal products that have near-term commercial potential and applies
its product development expertise to accelerate the commercialization of these
products. The Company's business strategy is to select and in-license
gastrointestinal products that have the potential for rapid regulatory
approval. By in-licensing drugs with late-stage clinical data and developing
these drugs for diseases that are in need of new pharmaceutical treatments,
the Company believes that it can significantly reduce the risk, time and
investment normally associated with the development and commercialization of
pharmaceutical products.
In 1997, the Company's first product, Colazide(R), was approved for
marketing in the United Kingdom for the treatment of acute ulcerative colitis.
The Company's marketing partner, Astra AB, commercially launched Colazide in
the United Kingdom in October 1997 and, subject to regulatory approvals,
Colazide will become commercially available in other countries in Europe
commencing in 1998. In addition, the Company's New Drug Application ("NDA")
for Colazide for the same indication was accepted for filing by the United
States Food and Drug Administration ("FDA") in August 1997 and is currently
under review.
The Company has also in-licensed a second product, rifaximin, and intends to
pursue regulatory approvals for the drug in the treatment of two initial
indications, hepatic encephalopathy and bacterial infections of the lower
gastrointestinal tract including antibiotic associated colitis. The FDA
recently granted the Company Orphan Drug Designation for rifaximin for the
treatment of hepatic encephalopathy. With the Orphan Drug Designation,
rifaximin could receive priority review from the FDA following completion of
clinical trials for the drug and filing of an NDA for marketing approval.
In the course of its transition to a commercial stage company, the Company
has leveraged its resources by establishing strategic alliances with companies
that have significant resources in clinical monitoring and manufacturing. For
the commercial production of Colazide, the Company has entered into
manufacturing arrangements with Courtaulds Chemicals (Holdings) Limited and
Anabolic, Inc.
Colazide will be distributed in all markets except certain countries in
southern Europe and Asia by Astra AB ("Astra"), a Swedish international
pharmaceutical company, under a distribution agreement that provides Astra
with exclusive distribution rights, and in Italy, Spain, Portugal, and Greece
by a division of Menarini Pharmaceutical Industries s.r.l. ("Menarini"), an
Italian manufacturer and distributor of pharmaceutical products. The Company's
distribution arrangements with Astra and Menarini have provided the Company
with funding necessary to complete the late-stage development of Colazide, in-
license other gastrointestinal products and help establish the Company as a
viable gastrointestinal pharmaceutical company.
The Company expects to market and sell rifaximin and other future products
in-licensed and commercialized by the Company through a small, specialized
direct sales force to be established by Salix. The Company believes that a
direct sales model will reflect higher operating margins than the distribution
partner model that the Company is using in connection with sales of Colazide.
In March 1998, the Company changed its name to Salix Pharmaceuticals, Ltd.
Prior to March 1998, the Company operated as Salix Holdings, Ltd. The Company
was incorporated in the British Virgin Islands in
<PAGE>
December 1993. Prior to December 1993, the business of the Company was
conducted by Salix Pharmaceuticals, Inc., a California corporation ("Salix
California"), which was incorporated in California in 1989, and Glycyx
Pharmaceuticals, Ltd., a Bermuda corporation ("Glycyx"), each of which is now
a subsidiary of Salix Pharmaceuticals, Ltd. Unless the context otherwise
requires, references in this report to "Salix" and the "Company" refer to
Salix Pharmaceuticals, Ltd., a corporation organized under the laws of the
British Virgin Islands, and its wholly owned subsidiaries, Salix California
and Glycyx. The Company's executive offices are located at 3600 West Bayshore
Road, Suite 205, Palo Alto, California 94303, and its telephone number at that
address is (650) 856-1550.
BUSINESS STRATEGY
The Company's objective is to become a leading gastrointestinal
pharmaceutical company. The Company believes that by implementing the
strategies summarized below it will reduce significantly the risk, time and
investment normally associated with development and commercialization of
pharmaceuticals.
In-license proprietary gastrointestinal products with near-term commercial
potential. The Company's principal focus is to identify and in-license
gastrointestinal products that have near-term commercial potential and to
apply its product development expertise to commercialize these products. In
pursuing this strategy, the Company evaluates each product based on the
following:
. The product must treat gastrointestinal diseases that are in need of new
pharmaceutical therapies. The Company believes the gastrointestinal
disease market is in need of new or more effective pharmaceutical
treatments and will provide the Company with a significant return on
investment. The Company also believes that by establishing itself as a
recognized leader in the gastrointestinal disease market, it will enhance
its ability to attract future in-licensing product opportunities.
. The product must have a substantial base of positive late-stage clinical
research data in humans and have the potential for rapid regulatory
approval. The Company will carefully evaluate and in-license only
products that have an existing base of positive late-stage data in humans
and that the Company believes demonstrate safety and efficacy. By in-
licensing drugs with a substantial base of late-stage clinical data and
developing these drugs for diseases that are in need of new or more
effective pharmaceutical treatments, the Company believes that it will be
able to minimize the costs and risk associated with inventing a drug and
conducting early-stage clinical trials needed to determine if a drug is
safe and effective in humans. The Company also believes that its strategy
can significantly reduce the time and risk of obtaining regulatory
clearances.
. The product must be available to the Company on acceptable licensing
terms. The Company believes that there are significant opportunities to
in-license or acquire gastrointestinal products from pharmaceutical
companies in the United States and internationally. This includes
products developed by companies that lack either the expertise or
resources to pursue regulatory approvals in the United States and certain
other territories. In addition, the Company believes that large
pharmaceutical companies are willing to out-license or sell products and
technologies that do not fit their product portfolios or fail to meet
their business or market criteria.
Establish a small, specialized sales force to market to a targeted group of
physicians. Of the 738,000 physicians in the United States, gastrointestinal
diseases are treated primarily by approximately 9,700 gastroenterologists. The
Company believes that it can effectively reach this small number of physicians
through a small, specialized sales and marketing group, without the investment
needed to develop and maintain the large sales force typically required in the
pharmaceutical industry. This direct sales force model will be the basis for
the Company's commercialization of rifaximin and future products in the United
States. The Company expects that, once fully established and operational, a
sales and marketing model premised on a domestic direct sales force will
result in higher operating margins than the distribution partner model that
the Company has established for Colazide sales. See "--Marketing and Sales."
2
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In the case of Colazide, the alliances with Astra and Menarini have provided
the Company funding needed to complete late-stage development of Colazide, to
in-license other gastrointestinal products and to help establish the Company
as a viable gastrointestinal pharmaceutical company. The Company received the
necessary funding in exchange for the grant of exclusive distribution rights
in certain territories to Astra and Menarini. The Company plans to implement
future North American product sales and marketing based on the direct sales
force model. See "--Strategic Alliances."
Enhance market potential of products through development of additional
indications. Where appropriate, the Company intends to conduct clinical trials
for multiple indications to expand the approved use of its products. The
Company believes that both balsalazide and rifaximin have potential
applications in other disease indications which, if developed by the Company
and approved by regulatory authorities, will significantly enhance the
commercial potential of such products. In the case of Colazide, which has been
approved in the United Kingdom for the treatment of acute ulcerative colitis
and for which the Company has filed an NDA with the FDA for the same
indication, the Company believes that balsalazide, the active ingredient in
Colazide, may also have therapeutic applications for reduction of colonic
polyps. Similarly, rifaximin may be developed in the future for potential use
in treating infectious diarrhea, diverticular disease and other
gastrointestinal diseases. Currently, Alfa Wassermann, one of the Company's
partners, is conducting a Phase III clinical trial in Spain relating to
rifaximin as a therapy for hepatic encephalopathy. The Company believes that
the strategy of commercializing products for initial indications will enable
it to begin realizing product revenues while completing the development of
multiple indications. See "--Products Under Development."
Enhance research and manufacturing capabilities through strategic
partnerships. The Company has established strategic relationships with
companies it believes have proven expertise in clinical monitoring and
manufacturing. The Company uses clinical research organizations ("CROs") to
manage its clinical trials, thus enabling the Company to reduce its fixed
overhead costs and to leverage its management resources. For the commercial
production of Colazide, the Company has entered into pharmaceutical
manufacturing arrangements with Courtaulds Chemical (Holdings) Limited for
bulk drug substance and Anabolic, Inc. for finished dosage forms. See "--
Manufacturing."
DISEASE BACKGROUND
Gastrointestinal Disease Overview
Gastrointestinal diseases have a major impact in the United States and
across the world. According to the National Institutes of Health, more than 60
million cases of gastrointestinal disease are reported annually in the United
States alone, resulting in more than 200 million days of restricted activity,
50 million visits to physicians, 10 million hospitalizations, and nearly
200,000 deaths. Current treatments for gastrointestinal disease in many
instances either have serious side effects or provide only partial symptomatic
relief. The Company believes there is significant need for new pharmaceutical
therapies to improve treatment of gastrointestinal diseases.
The Company is pursuing product indications for select gastrointestinal
conditions, including ulcerative colitis, hepatic encephalopathy, and
investigating other potential indications including bacterial infections of
the lower gastrointestinal tract including antibiotic associated colitis,
colonic polyps, familial adenomatous polyposis, diverticular disease of the
colon, infectious diarrhea, and ulcers.
Inflammatory Bowel Disease/Ulcerative Colitis
Inflammatory bowel disease ("IBD") is a condition that covers both
ulcerative colitis and Crohn's disease. The cause of IBD is unknown and onset
can occur at any age but is most prevalent between the ages of 15 and 25. The
symptoms of ulcerative colitis and Crohn's disease are similar, but ulcerative
colitis affects the large colon while Crohn's disease can affect any part of
the gastrointestinal tract. These debilitating diseases are usually lifelong,
and there is currently no cure.
3
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The Crohn's and Colitis Foundation of America estimates that IBD afflicts
two million people in the United States. Sales of drugs used to treat IBD
worldwide totaled approximately $620 million in 1997 and have reflected a
compound annual growth rate of approximately 20% between 1987 and 1996.
Ulcerative colitis is a chronic disease which causes ulceration of the inner
lining of the colon and rectum. Symptoms include diarrhea, abdominal pain,
rectal bleeding and fever. Decreased appetite and weight loss are also common.
As with many chronic illnesses, ulcerative colitis also can have serious
emotional side effects, including depression, anxiety and reduced self-esteem,
typically resulting from the painful and embarrassing symptoms caused by the
disease.
Medical treatment of ulcerative colitis over the past 50 years has generally
consisted of corticosteroids, which are typically unsuitable for long-term
treatment because of their significant side effects, and 5-aminosalicylic-acid
("5-ASA") drugs. To be effective, these drugs must travel through the stomach
and small intestine to the colon and be released in the colon without
significant quantities being absorbed in the bloodstream. Sulfasalazine
("SASP"), which is taken orally, is the original 5-ASA drug and is considered
the current "gold standard" treatment (i.e., the most effective available
treatment). SASP is effective in reaching the colon with only low absorption
rates in the bloodstream. However, SASP also contains a carrier molecule
(sulfapyridine) which is toxic and results in a high incidence of side effects
such as nausea, headache, dizziness, anemia or other blood disorders, and skin
rashes. In approximately 30% of IBD patients who attempt treatment with SASP,
these side effects are so severe that the patient cannot tolerate continued
treatment.
In the early 1980s, pharmaceutical companies began developing new drugs
designed to deliver 5-ASA to the colon without the side effect profile of
SASP, and these drugs, including mesalamine, first appeared in the United
States market in the early 1990s. While the new drugs are generally better
tolerated than SASP, they continue to be limited in use because significant
amounts of the drugs may be absorbed in the bloodstream before reaching the
colon. In other cases, the drugs may not dissolve in the body, in which case
they may remain whole when passed through the bowel and are, therefore, not
absorbed in the colon. One of these drugs is mesalamine, the current market
leader when measured by dollar sales of drugs to treat IBD.
An alternative treatment for ulcerative colitis where drug intervention is
ineffective is surgical removal of the large bowel. This procedure effectively
eliminates ulcerative colitis but with substantial physical and emotional
consequences for the patient, who must carry an external bag or have an
internal pouch constructed to collect waste.
Hepatic Encephalopathy
Hepatic encephalopathy, a neuropsychiatric syndrome caused by the build-up
of toxic products, such as ammonia, in the bloodstream, is a common
complication of acute or chronic liver disease. Causes of liver disease
include alcohol abuse and hepatitis due to viruses, drug abuse or toxins. The
liver plays a key role in removing certain toxins found in the digestive tract
from the blood. In severe liver disease, the liver does not effectively remove
ammonia from the blood. As a result, ammonia accumulates in the bloodstream
and travels to the brain, potentially causing personality changes, impaired
consciousness, agitation or mania, and coma. Hepatic encephalopathy affects
approximately 60,000 people in the United States. Approximately 30% of hepatic
encephalopathy patients go into coma, which is fatal in up to 80% of these
patients, despite aggressive intervention.
To date, no product has been approved in the United States to treat hepatic
encephalopathy. Existing non-approved treatment strategies, including
antibiotics, focus on reducing levels of ammonia in the bloodstream. The
Company believes that current antibiotic therapies, including neomycin and
metronidazole, are inadequate treatments, however, due to their limited
antibacterial spectrum and broad side effects. Oral lactulose is also used to
reduce the amount of ammonia accumulated in the intestine by increasing the
number of bowel movements per day.
4
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In spite of the small number of people afflicted with hepatic
encephalopathy, the Company believes that a significant market opportunity
exists for a drug that offers a more effective therapy than currently
available treatments. In addition, because hepatic encephalopathy affects a
relatively small number of patients, the Company has received Orphan Drug
Designation from the FDA for rifaximin to treat hepatic encephalopathy. In
practice, Orphan Drug Designation is available for therapies addressing
indications affecting less than 200,000 people, may allow the drug to receive
a priority review by the FDA, provides the product seven years of market
exclusivity for the orphan indication regardless of the drug's patent status,
and may allow the FDA to rely only on a single pivotal trial in approving an
NDA. See "--Government Regulation."
Antibiotic Associated Colitis
Antibiotic associated colitis ("AAC") can be caused by taking certain
antibiotics to treat a variety of illnesses. These antibiotics can cause a
reduction in the presence of normal bacteria in the colon, a condition which
promotes overgrowth of the bacterium Clostridium difficile ("C. difficile").
C. difficile produces toxins that cause severe diarrhea and inflammation of
the colon. If untreated, these symptoms can lead to toxic megacolon, colonic
perforation and death. Institutionalized patients, such as patients in nursing
homes, have a high risk of developing AAC. Independent research indicates that
up to 2,000,000 people develop AAC each year in North America.
Until recently, oral vancomycin was the preferred treatment for AAC.
However, the widespread use of vancomycin for treating enterococcal infections
has resulted in the development of vancomycin-resistant organisms (organisms
that do not respond to vancomycin therapy). Vancomycin resistant genes may
also be transferred to other microorganisms such as Staphylococcus aureus, an
organism responsible for many common infections. The emergence of these
resistant organisms has led the United States Centers for Disease Control and
Prevention to recommend that vancomycin be used for treatment of AAC only in
cases which fail to respond to metronidazole therapy or are severe and
potentially life-threatening.
Metronidazole, although not approved for AAC, is now the preferred treatment
for AAC. Although metronidazole is less costly than vancomycin, the drug is
absorbed not only in the digestive tract but also in the bloodstream following
drug administration. In addition, the safety and effectiveness of
metronidazole in treating AAC has not been confirmed by the FDA through the
NDA clearance process.
Infectious Diarrhea
Diarrhea is a leading cause of death in most developing countries, with the
greatest impact seen in infants and children. In the United States, children
under 5 years of age average two episodes of diarrhea per year. In developing
countries, the rate is two to three times higher. Overall, physicians in the
United States are consulted annually for 8.2 million diarrhea episodes.
Primary therapy for infectious diarrhea is antibiotics, with the choice of
antibiotic made on the basis of effectiveness against the specific bacterial
cause in each case or in similar local cases. Antibiotic development in recent
years has tended to focus on broad spectrum antibiotics to cover the widest
possible range of bacterial forms. As new bacterial forms mutate and develop
resistance to currently available antibiotics, there is ongoing effort to
develop more effective antibiotic therapies.
Colorectal Cancer/Colonic Polyp
A polyp is a growth that projects, often on a stalk, from the interior
lining of the intestine or rectum. Approximately 30% of individuals in Western
countries have polyps. Based on population indices, this equates to
approximately 80 million persons in the United States and 95 million in
Europe. In addition, the probability of having polyps increases with age. One-
half to two-thirds of individuals over 65 in Western countries have polyps.
When a polyp is diagnosed, it is normally removed surgically through a
procedure known as polypectomy. Polyp recurrence rates following polypectomy
average 45% after 24 months. Currently, no proven pharmaceutical treatment is
available for the common polyp patient.
5
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All colorectal cancer starts as a polyp. Conversion of benign polyps to
neoplastic or metaplastic tissue (cancer) occurs in approximately five percent
of polyp patients. Colorectal cancer includes cancer of the colon and rectum
and is the third most common cancer in men and the fourth most common cancer
in women. Cancers of the colon and rectum may be present for as long as five
years before symptoms appear. Common symptoms include rectal bleeding, anemia,
constipation, abdominal pain, diarrhea, weight loss and fatigue. Patients with
diagnosed colon cancer have a five year survival rate of less than 50%.
Current standard treatment includes surgical removal of the colon combined
with chemotherapy. This treatment regimen has helped improve survival rates
for early and mid-stage cancers but not for late stage, invasive cancers.
The Company believes that managing polyp recurrence will help decrease the
incidence of polyp progression to colorectal cancer.
Familial Adenomatous Polyposis
Familial Adenomatous Polyposis ("FAP") is a hereditary condition that
predisposes patients to a large number of colonic polyps. Studies estimate
that approximately 40,000 people in the United States have the genetic
abnormality that causes FAP. Colorectal cancer is considered an inevitable
consequence in patients with FAP, and most FAP patients develop colorectal
cancer by age 40. Due to the small number of patients with FAP, drugs to treat
FAP may be eligible for Orphan Drug Status by the FDA.
Diverticular Disease of the Colon
Diverticular disease of the colon results from an acquired deformity of the
colon (diverticulosis) that leads to subsequent complications. The deformity
results in a build-up of fecal matter in the colon, which causes symptoms such
as pain and fever. If not treated, these symptoms can progress and result in
additional complications such as intra-abdominal abscess, bowel obstruction
and possible bowel perforation. Because this fecal build-up contains entrapped
bacteria, it creates an environment susceptible to infection, suggesting that
this symptom of diverticulosis can be treated with antibiotic therapy. The
disease is common in Western societies, afflicting more than 25 million people
in the United States and more than 35 million people in Western Europe. Of
those people affected by diverticular disease, approximately 20% will develop
symptoms that require therapy.
Ulcers
Peptic ulcer is a chronic inflammatory condition of the stomach and small
intestine. The bacterium Helicobacter pylori ("H. pylori") is considered to be
the underlying cause of most peptic ulcers, suggesting that antibiotics could
be used to treat infected ulcer patients. It is estimated that at least half
of the world's population and 25% of people in the United States are infected
with the H. pylori organism. Studies have shown that eradication of H pylori
may reduce the rate of ulcer recurrence.
6
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PRODUCTS UNDER DEVELOPMENT
The Company's principal focus is on gastrointestinal products with late-
stage clinical data on human safety and efficacy. The following table
summarizes Salix's current products in development.
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PRODUCT INDICATION STATUS
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Colazide(1) Acute ulcerative colitis . Approved in United Kingdom in July 1997
. NDA accepted for filing by FDA in United
States in August 1997
. European submissions to occur through
mutual recognition procedure of European
Union in 1998
. Additional Phase III/IV clinical study
ongoing
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Colazide(1) Ulcerative colitis . European clinical studies patient
maintenance enrollment completed
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Rifaximin Hepatic encephalopathy . Phase III clinical trial patient
enrollment completed(2)
. Orphan Drug Designation granted by FDA in
February 1998
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Rifaximin Antibiotic associated . IND submitted and cleared
colitis
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Rifaximin Bacterial infections of . Phase II clinical trial scheduled to
the lower gastrointestinal commence in 1998
tract including
antiobiotic associated
colitis
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(1) Astra has exclusive commercial rights in all countries excluding Italy,
Spain, Portugal, Greece, Japan, Taiwan, and Korea. Menarini has
exclusive commercial rights in Italy, Spain, Portugal and Greece. See
"--Strategic Alliances" and "--Marketing and Sales".
(2) This trial is being conducted by Alfa Wassermann in Spain. The data
obtained in this trial may be used in partial support of an NDA filing,
subject to the Company's audit of data collection procedures and
methodology established by Alfa Wassermann as well as the outcome of the
trial.
Additionally, the Company is investigating development of the following
potential indications: colonic polyps, familial adenomatous polyposis,
diverticular disease of the colon, infectious diarrhea, and ulcers.
Colazide
Colazide (balsalazide disodium) is an orally administered, anti-inflammatory
drug designed to act in the gastrointestinal tract and specifically in the
colon. The Company recently obtained authorization to market Colazide in the
United Kingdom for the treatment of acute ulcerative colitis and is pursuing
the maintenance indication. The Company believes that Colazide is also a
potential treatment for other inflammatory bowel disease conditions. Salix
licensed Colazide from Biorex Laboratories Limited ("Biorex") and will sell
Colazide, manufactured by third parties under contract with the Company, to
its distribution partners, Astra and Menarini. Astra launched Colazide in the
United Kingdom in October 1997 and is planning other commercial launches in
Europe in 1998 subject to regulatory approvals. Sales of drugs used to treat
IBD worldwide totaled approximately $620 million in 1997 and have reflected a
compound annual growth rate of approximately 20% between 1987 and 1997. See
"--Strategic Alliances."
Colazide was developed after careful evaluation of the benefits and side
effects of existing therapies. Colazide is an orally administered drug therapy
that the Company believes is superior in delivering drug directly to the
colon. Medical treatment of ulcerative colitis over the past 50 years has
consisted of corticosteroids, which are typically unsuited for long-term
treatments because of their significant side effect profile, and 5-ASA drugs.
To be effective, these drugs must travel through the stomach and small
intestine to the colon and be released in the colon without significant
quantities being absorbed in the bloodstream. SASP, which is taken orally, is
the
7
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original 5-ASA drug and is effective in reaching the colon with only low
absorption rates in the bloodstream. However, SASP also contains a carrier
molecule (sulfapyridine) which is toxic and results in a high incidence of
side effects such as nausea, headache, dizziness, anemia or other blood
disorders, and skin rashes. In approximately 30% of IBD patients who attempt
treatment with SASP, these side effects are so severe that the patient cannot
tolerate continued treatment.
In the early 1980s, pharmaceutical companies began developing new drugs to
deliver 5-ASA to the colon without the side effect profile of SASP. These
drugs first appeared in the United States market in the early 1990s. While the
new drugs, including mesalamine, are generally better tolerated than SASP,
they continue to be limited in use because significant amounts of the drugs
may be absorbed in the bloodstream before reaching the colon. In other cases,
the drugs may not dissolve in the body, in which case they may remain whole
when passed through the bowel and are therefore not absorbed in the colon. See
"--Inflammatory Bowel Disease/Ulcerative Colitis."
Colazide is a new chemical entity that consists of two molecular structures.
The first molecule, 5-ASA, is the active drug and responsible for the actual
therapeutic effect. The second molecule, 4-ABA, is a non-toxic carrier
molecule that enables the 5-ASA molecule to travel to the colon without being
absorbed in the bloodstream. The combination of these two molecules into one
chemical compound is designed to deliver the therapeutic agent to the disease
site and has a favorable side effect profile.
In July 1997, the Company received marketing authorization in the United
Kingdom for acute ulcerative colitis from the Medicines Control Agency (the
"MCA"). Under new mutual recognition procedures of the European Union, the
Company's marketing partners, Astra and Menarini, have informed the Company
that they have filed submissions in 1998, based on the MCA authorization,
seeking marketing approval for Colazide in Germany, France, Italy, Spain and
other member countries of the European Union. The Company believes that
approvals through these mutual recognition procedures will be received
beginning in 1998.
In June 1997, the Company submitted an NDA to the FDA seeking approval in
the United States for Colazide as a treatment for acute ulcerative colitis. In
August 1997, the FDA accepted the NDA for filing. This NDA can be approved
only if the FDA determines that the NDA contains substantial evidence from
clinical trials that the drug is safe and effective for its intended use. The
Company submitted the NDA following completion of five double-blind,
randomized, controlled, safety and efficacy studies evaluating Colazide as a
treatment for acute ulcerative colitis. Two pivotal Phase III studies were
completed in March 1995 and March 1996, respectively.
A multi-center Phase III study conducted in the United States, which
evaluated 150 recently relapsed patients with long-standing disease symptoms,
was completed in March 1996. The proposed marketing dose (6.75 grams per day)
of Colazide was compared to a lower dose of Colazide (2.25 grams per day) and
to mesalamine over an eight week treatment period. The study demonstrated a
statistically significant dose-response between the two Colazide doses for the
primary endpoint of symptom improvement, including stool frequency, rectal
bleeding, sigmoidoscopic score and physician's global assessment. Although the
primary measure of symptom improvement was not statistically significantly
different between Colazide and mesalamine, symptom improvement was noticeably
favorable for Colazide. Secondary measures of study-end symptom scores were
also significantly more favorable for Colazide than mesalamine with respect to
rectal bleeding, sigmoidoscopic score and physician's global assessment.
A trial completed in March 1995 evaluated 100 patients, most of whom had
been recently diagnosed with acute ulcerative colitis, over a 12 week
treatment period at multiple centers in the United Kingdom. The primary study
endpoint measured patient tolerance of Colazide versus mesalamine. While only
one patient in each group withdrew due to intolerance, patients treated with
Colazide had statistically significantly fewer side effects than those treated
with mesalamine. The secondary endpoint of the trial measured the efficacy of
Colazide relative to mesalamine and included primary measures of complete
remission, symptomatic remission, and median time to
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complete relief of symptoms. Colazide proved statistically significantly more
effective than mesalamine for the endpoints of complete remission, symptomatic
remission, and median time to complete relief of symptoms.
In addition to the two pivotal Phase III trials, the Company completed
another trial in February 1996, comparing two doses of Colazide to placebo and
evaluating 180 patients at multiple centers in the United States. Due to
ethical concerns regarding treatment of active-disease patients with placebo,
the Company limited the study to four weeks, which reduced the opportunity for
Colazide to demonstrate its full therapeutic effect and no significant
difference between placebo and Colazide for the primary efficacy endpoint was
found. However, patients treated with Colazide showed statistically
significantly fewer side effects than patients treated with placebo. In
addition, the Company believes the lack of difference in efficacy between the
two treatments is attributable to the nature of the patients enrolled and the
short duration of the trial. Many of the patients enrolled had previously
failed treatment with other therapies, including 5-ASA containing products
such as mesalamine.
In December 1997, the Company initiated a Phase III/IV clinical study of
Colazide in the treatment of acute ulcerative colitis.
Rifaximin
Rifaximin, a new antibiotic, belongs to the rifamycin class of antibiotics
and distinguishes itself from others of analogous structure due to its almost
complete lack of absorption by gastroenteric mucosa, which allows high
concentrations of the active drug to reach and be maintained in the digestive
tract. The Company licensed rights in the United States and Canada to
rifaximin from Alfa Wassermann S.p.A. ("Alfa Wassermann"), which developed and
currently markets the product in Italy for hepatic encephalopathy and chronic
intestinal infections as well as for prophylactic use with infective
complications of gastrointestinal surgery. The Company currently has full
commercial rights for rifaximin for the treatment of gastrointestinal and
respiratory tract diseases in the United States and Canada and intends to
establish an independent sales and marketing organization for the purpose of
fully exploiting these rights. The Company believes that a business model
premised on a direct sales force will result in higher operating margins than
the distribution partner model that the Company has established for Colazide.
The Company intends to pursue regulatory approvals for rifaximin for two
initial indications, hepatic encephalopathy and bacterial infections of the
lower gastrointestinal tract including AAC. In the future, the Company plans
to investigate developing rifaximin for other potential indications, including
infectious diarrhea, diverticular disease, peptic ulcer treatment through H.
pylori eradication, other gastrointestinal infections, and for perioperative
prophylaxis of septic complications of large bowel surgery.
Hepatic encephalopathy is a neuro-psychiatric syndrome caused by the build-
up of ammonia in the blood. When ammonia is not removed from the body, it
travels to the brain and causes the neuropsychiatric syndrome known as hepatic
encephalopathy. The Company believes that antibiotic treatment for hepatic
encephalopathy may prevent the accumulation of ammonia in the bloodstream.
The FDA has recently granted the Company Orphan Drug Designation for
rifaximin to treat hepatic encephalopathy. Orphan Drug Designation is
generally available for indications affecting less than 200,000 patients. In
practice, it may allow an NDA to receive a priority review by the FDA, gives
the product seven years of market exclusivity for the orphan indication
regardless of the drug's patent status, and may allow the FDA to permit
approval of an NDA based on a single pivotal Phase III trial. See "--
Government Regulation." The Company believes that approximately 60,000 persons
currently suffer from hepatic encephalopathy in North America.
As part of its agreement with Alfa Wassermann, the Company obtained clinical
trial data for rifaximin. In addition to previous studies, Alfa Wassermann
recently completed patient enrollment in a study conducted in Spain which may
provide the Company with data in support of an NDA filing in the United States
for hepatic encephalopathy. The validity of this data is subject to the
Company's audit of data collection procedures and
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methodology established by Alfa Wassermann in conducting this study. Previous
studies in patients with hepatic encephalopathy include open-label trials and
randomized, double-blind, comparative trials in patients with hepatic
encephalopathy. In these studies, a total of 237 patients were treated with
rifaximin and 149 patients with comparative agents (other antibiotics and
lactulose). In the comparative studies with lactulose, rifaximin was
comparable to or more effective than lactulose for the improvement of signs
and symptoms of hepatic encephalopathy and had a superior side effect profile.
The Company intends to conduct its own clinical trials using rifaximin to
treat bacterial infections of the lower gastrointestinal tract including AAC
caused by C difficile, a gram negative bacterium for which there are currently
few effective therapies. Based on research conducted by Alfa Wassermann, the
Company believes that rifaximin has broad spectrum activity and may be shown
to be effective against C difficile. Oral vancomycin was until recently the
preferred treatment for AAC. However, the emergence of vancomycin-resistant
bacteria has prompted the United States Centers for Disease Control and
Prevention to recommend limited use of vancomycin. No other therapy has been
approved for the treatment of AAC in the United States. Independent research
indicates that up to 2,000,000 people develop AAC each year in North America.
Given the low gastrointestinal absorption of rifaximin and a promising
cross-resistance profile, the Company believes rifaximin may be more effective
in eradicating H pylori than other more commonly used antibiotics. Alfa
Wassermann has conducted a single non-comparative trial in Italy to assess the
efficacy of rifaximin in treating H. pylori induced peptic ulcers and is
currently organizing a co-operative study to supplement the earlier findings.
BX-661A (Balsalazide)
Based on a preclinical evaluation of BX-661A, the Company believes that the
drug may be shown to be a chemopreventive agent to reduce colonic polyp growth
and believes that the drug may have potential for this indication. All
colorectal cancer starts as a polyp, and eventually all FAP patients develop
colorectal cancer. There are approximately 40,000 people in the United States
that have the genetic abnormality that causes FAP. Because this patient
population is genetically predisposed to polyp growth consistently throughout
life, they are an important subset of the general population who would be
eligible for therapy to retard polyp growth. The Company estimates that
approximately 80 million persons in the United States and 95 million persons
in Europe have colonic polyps, although the number of persons who seek
diagnosis and treatment for the condition is unknown.
The Company believes that balsalazide has anti-inflammatory and antioxidant
properties that are similar to non-steroidal anti-inflammatory drugs
("NSAIDs") but lack NSAIDs' upper gastrointestinal ulcerogenic activity. In
addition, the Company believes that the colonic-specific delivery mechanism
for the drug results in very low systemic absorption significantly reducing
the possibility of renal side effects. In clinical studies evaluating a total
of more than 900 patients treated with balsalazide for a mean duration of 1.5
years, no cases of gastrointestinal ulceration or renal side effects have been
reported.
In collaboration with scientists at the University of California at San
Francisco ("UCSF") and the San Francisco Veterans Administration Medical
Center ("VA Medical Center"), balsalazide and a newly discovered metabolite of
balsalazide were shown in early studies to inhibit human colon cancer cell
proliferation in culture and to inhibit in animals one of the earliest steps
in colon polyp and cancer formation.
Further pre-clinical studies performed by the Company, using a genetic
strain of mice which develop multiple intestinal tumors and die before 5
months of age, showed that balsalazide prevented the formation of greater than
75% of these tumors in the colon. Based on these preliminary results, the
Company and scientists at UCSF and the VA Medical Center in San Francisco have
responded to a request from the National Cancer Institute ("NCI") to submit a
grant proposal to fund a clinical trial to test the effectiveness of
balsalazide in patients who are at increased risk of developing colorectal
cancer. The target patients are those who have had polyps removed and are
undergoing surveillance for polyp occurrence.
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STRATEGIC ALLIANCES
The Company enters into various collaborations with corporate partners,
licensors, licensees and others. To date, the Company has entered into the
following strategic alliances:
Biorex Laboratories Limited
The Company in-licensed balsalazide and all its salts, including the
Company's first product, Colazide (balsalazide disodium), from Biorex, a
private, independent drug company headquartered in England. Biorex developed
Colazide and completed limited Phase III clinical trials. Under its agreements
with the Company, Biorex will participate in future milestone revenues and
profits from Colazide.
Pursuant to an agreement between Biorex and the Company, Biorex granted the
Company the exclusive worldwide right (other than Japan, Taiwan, Korea, and
the United States) to develop, manufacture and sell balsalazide for all
disease indications for a period of 15 years from the date of commercial
launch, subject to early termination in certain circumstances, including upon
the material breach by either party and, in the case of Biorex, in the event
of Salix's bankruptcy or if a sublicensee of the Company terminates or becomes
entitled to terminate such sublicense as a result of actions by the Company.
Under a separate agreement, Biorex granted the Company the exclusive right to
develop, manufacture and sell balsalazide for all disease indications in the
United States for a period of nine years from the date of commercial launch or
the term of the applicable patent, whichever is longer. Under these
agreements, the Company paid Biorex fees upon entering into the agreements and
is obligated to make additional milestone and royalty payments for the drug.
The royalty payments to be made by the Company pursuant to the agreement
governing the United States market are based on net sales, subject to minimum
royalty payments for the first five years following commercial launch. Under
the agreement governing territories other than the United States, the Company
is obligated to pay to Biorex a portion of any gross profit on Colazide sales
to Astra and Menarini outside the United States. Pursuant to such agreements,
the Company is responsible for completion of preclinical testing, clinical
trials and regulatory approvals for balsalazide.
Alfa Wassermann S.p.A.
The Company in-licensed rifaximin from Alfa Wassermann, a privately held
pharmaceutical company headquartered in Italy. Alfa Wassermann has developed
several glycosaminoglycans, rifaximin and alpha-interferon from human
leukocytes. Alfa Wassermann's principal areas of therapeutic focus include
anti-thrombotics, antibiotics, gastrointestinal products, NSAIDs,
immunomodulators, anti-hypertensives, and bronchopulmonary products. During
recent years, Alfa Wassermann has formed alliances with international partners
to expand and strengthen its marketing and research activities.
Pursuant to an agreement with the Company, Alfa Wassermann granted the
Company, in exchange for certain royalties, the exclusive right in the United
States and Canada to develop, make, use and sell or have sold rifaximin for
the treatment of gastrointestinal and respiratory tract diseases. Alfa
Wassermann has agreed separately to supply the Company with bulk active
ingredient rifaximin at a fixed price.
Pursuant to the license agreement, the Company has agreed to pay Alfa
Wassermann a net sales-based royalty as well as certain milestone payments.
The Company's obligation to pay royalties commences upon the commercial launch
of the product and continues until the later of (i) the expiration of the
period in which the manufacture, use or sale of the products by an unlicensed
third party would constitute an infringement on the patent covering the
product or (ii) the expiration of a period of 10 years from commercial launch.
Thereafter, the licenses granted to the Company shall continue as irrevocable
royalty-free paid-up licenses.
The license agreement does not have a set term and continues until
terminated in accordance with its terms. Either party to the agreement may
terminate it following a material breach by the other party and the failure of
such breaching party to remedy such breach within 60 days. In addition, Alfa
Wassermann has the right to
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terminate the agreement on three-months' written notice in the event that the
Company fails to use best efforts to develop the product in a timely manner,
fails to effect commercial launch within six months of receipt of regulatory
approval or fails to sell the product for a period of six consecutive months
after commercial launch. In addition, Alfa Wassermann may terminate the
agreement if the Company becomes involved in bankruptcy, liquidation or
similar proceedings. The Company may terminate the agreement in respect of any
indication or any part of the territory covered on 90 days' notice at which
point its rights with respect to such indiction or territory shall cease.
Astra AB
Astra, an international pharmaceutical company headquartered in Sweden, has
extensive experience developing and marketing therapies for gastrointestinal
diseases. The Company's alliance with Astra partially funded the development
of Colazide. Through December 31, 1997, Salix had received revenues for
milestone payments and product development funding of approximately $12.6
million out of a total of $16.0 million payable upon achievement of certain
milestones under its agreements with Astra. The remaining milestone revenues
relate to European marketing approvals, and FDA approval of the NDA. Under the
terms of agreements between the Company and Astra, the Company will sell
encapsulated Colazide to Astra for marketing and distribution in its
territories at a price based on a percentage of Astra's average ex-factory
sales price. Astra launched Colazide in the United Kingdom in October 1997.
Pursuant to contracts between the Company and Astra, the two companies
agreed to collaborate in developing and obtaining regulatory approval of
Colazide in all the countries of the world excluding Italy, Spain, Portugal,
and Greece (collectively, "Southern Europe") and Japan, Taiwan and Korea
(collectively, "East Asia"). Under these agreements, the Company granted Astra
exclusive distribution rights to Colazide in all markets (except for Southern
Europe and East Asia) for specified indications. In addition, the companies
agreed to collaborate on development and promotional plans for Colazide in the
United States market. Astra is obligated to provide the Company with
milestone, license and development payments, and has agreed to purchase
encapsulated product from the Company at a transfer price based on a
percentage of Astra's selling price. In addition, the Company granted Astra
certain rights of first negotiation with respect to the development and
exploitation of additional indications for balsalazide disodium and a right of
first refusal to obtain marketing rights in the United States for
gastrointestinal products for which Salix chooses not to assume the sole and
exclusive responsibility for marketing. For new indications for Colazide,
including without limitation the cancer and polyp indications, the agreements
provide that the Company cannot market Colazide, either directly or through
third parties, without the prior consent of Astra.
The distribution agreement with Astra (which covers all countries of the
world except Spain, Portugal, Greece, Japan, Korea, Taiwan and the United
States) has a base term of 15 years from the date of initial commercial
launch, unless terminated earlier in accordance with its terms. The agreement
governing the United States market expires, unless terminated earlier in
accordance with its terms, upon the later of (i) the expiration of the
validity of the last of the patents relating to the product or (ii) nine years
from launch of the product, except with respect to provisions governing
trademark license, indemnification and confidential information each of which
have independent termination provisions. Under both agreements, either party
to the agreement is entitled to terminate the agreement upon a material breach
by the other party and the failure to remedy such breach within 30 days in the
case of a payment breach or 90 days in the case of any other material breach
or if the other party enters bankruptcy, liquidation or similar proceedings.
Menarini Pharmaceutical Industries s.r.l.
Menarini, headquartered in Italy, is the largest manufacturer and
distributor of pharmaceuticals in Southern Europe. Menarini also has extensive
experience developing and marketing therapies for gastrointestinal disease in
its markets. Under its agreements with Menarini, the Company granted Menarini
certain manufacturing rights and exclusive distribution rights with respect to
Colazide in Italy, Spain, Portugal and Greece. Through December 31, 1997 the
Company has received revenues as partial contribution to research and
development costs
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borne by the Company of approximately $1.2 million. The agreement calls for
additional milestone revenues of $0.5 million to be paid to Salix relating to
European marketing approvals in the Menarini territories. The funding provided
through this alliance has allowed Salix to fund partially the development of
Colazide. Under the terms of its agreements, Salix will sell bulk active
ingredient Colazide to Menarini for marketing and distribution in its
territories at cost plus a sales-based royalty.
Unless terminated sooner in accordance with its terms, the agreement with
Menarini continues until the earlier of the expiration of (i) the patents
relating to the product or (ii) a period of 15 years from the date of the
agreement, provided however that in any case the agreement shall continue for
a period of 10 years from the date of first launch. Either party may terminate
the agreement upon a material breach by the other party and the failure to
remedy such breach within 30 days in the case of a payment breach or 90 days
in the case of any other material breach or if a party enters liquidation,
bankruptcy or similar proceedings.
MANUFACTURING
The Company has in the past used and will continue to use third party
manufacturers to produce material for use in clinical trials and for
commercial product. This manufacturing strategy enables the Company to direct
its financial resources to product in-licensing and acquisition, product
development, and sales and marketing efforts, without devoting resources to
the time and cost associated with building large manufacturing plants.
Currently, bulk active ingredient Colazide is being manufactured for the
Company by Courtaulds Chemicals (Holdings) Limited in Scotland and is being
encapsulated for the Company by Anabolic, Inc. in Irvine, California.
Under its supply agreement with the Company, Alfa Wassermann is obligated to
supply the Company with bulk active ingredient rifaximin. Currently, Alfa
Wassermann manufactures rifaximin for the Italian and other European markets.
MARKETING AND SALES
The Company has retained marketing rights in the United States and Canada to
rifaximin and plans to establish its own marketing and sales organization for
rifaximin and future products. The Company intends to establish a small,
specialized sales force to market rifaximin to the limited group of
approximately 9,700 gastroenterologists in the United States who are
responsible for treating most gastrointestinal disease. The Company believes
that a domestic direct sales force can effectively reach this small number of
physicians without the investment needed to develop and maintain a large sales
force. This direct sales force model will be the basis for the
commercialization of rifaximin and future products in the United States.
The Company has licensed the exclusive distribution rights for Colazide to
Astra and Menarini. The commercial relationships with Astra and Menarini have
provided the Company money needed to fund the late-stage development of
Colazide, to in-license other gastrointestinal products and to help establish
the Company as a viable gastrointestinal pharmaceutical company. The Company
received the necessary funding in exchange for the grant of exclusive
distribution rights to Astra and Menarini. The Company plans to implement
future North American product sales and marketing based on the direct sales
force model. See "--Strategic Alliances."
PATENTS AND PROPRIETARY RIGHTS
General
As with all pharmaceutical companies, the Company's success will depend on
its ability to maintain patent protection for its products, preserve trade
secrets, prevent third parties from infringing upon its proprietary rights,
and operate without infringing upon the proprietary rights of others, both in
the United States and internationally.
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Colazide
The active ingredient of Colazide, balsalazide, and the method of treating
ulcerative colitis with Colazide are the subject of composition of matter
patents which have been issued to Biorex in the United States (expiring July
2001), the United Kingdom (expiring February 2002), France (expiring May
2002), Italy (expiring July 2001), and Germany (expiring April 2002). The
Company holds exclusive worldwide rights under the issued patents, excluding
Japan, Korea and Taiwan. The patents claim balsalazide disodium as well as
several variant molecules.
Additional patent applications have been filed by the Company in its own
name covering the use of balsalazide or any metabolite thereof for colorectal
cancer chemoprevention. A patent for the method of treating colon cancer was
issued in the United States to the Company in March 1996 and expires in
January 2014. Assuming patents issue for pending applications, patents for the
method of treating colon cancer will expire in January 2015 in various
countries in Europe, Asia, and North America. Claims to additional metabolites
are still pending in subsequent filings worldwide. No assurances can be given
that such additional patents will issue or, if issued, that they will provide
protection against similar or competing products.
Rifaximin
Rifaximin is covered by substance of matter patents which have issued in the
United States and major market territories of Europe. The original United
States composition-of-matter patent, which also covers the process of making
rifaximin and the use of rifaximin for the treatment of gastrointestinal
infectious diseases, expires in May 2001. A related Canadian patent also
expires in May 2001. Additional patents on a manufacturing process and on the
use of rifaximin for the treatment of H. pylori infections have been issued in
the United States to Alfa Wassermann and such patents expire in April 2005 and
June 2013, respectively. Related Canadian patents expire in April 2005 and
February 2014, respectively.
Patent Term Extensions
The Company believes that some of these patents may be eligible for
extensions of up to five years based upon patent term restoration procedures
in Europe and in the United States under the Waxman-Hatch Act. Under the
Waxman-Hatch Act, the United States Patent and Trademark Office is directed to
extend the term of an eligible patent for a time equal to the "regulatory
review period for the approved product". This time period is generally one-
half the length of time between the effective date of the IND and submission
of the NDA, plus the length of time between filing and approval of the NDA, up
to a total possible extension of five years. Periods during which the
applicant did not act with "due diligence" are subtracted from the regulatory
review period. Under this law, the Colazide patent in the United States could
be extended by up to five years, giving the product patent protection until as
late as 2006 if approval in the United States is received before expiration of
the original patent term in 2001. In addition, the Company intends to seek
patent extensions under similar laws in effect in the European Union, which
could give Colazide extended patent protection in these jurisdictions until as
late as 2006.
GOVERNMENT REGULATION
The research, testing, manufacture, marketing and distribution of drug
products are extensively regulated by governmental authorities in the United
States and other countries. In the United States, drugs are subject to
rigorous regulation by the FDA. The Federal Food, Drug and Cosmetic Act, as
amended (the "FDC Act"), and the regulations promulgated thereunder, and other
federal and state statutes and regulations, govern, among other things, the
research, development, testing, manufacture, storage, record keeping,
labeling, promotion and marketing and distribution of pharmaceutical products.
Failure to comply with applicable regulatory requirements may subject a
company to administrative sanctions or judicially imposed sanctions such as
civil penalties, criminal prosecution, injunctions, product seizure or
detention, product recalls, and total or partial suspension of product
marketing and/or approvals. In addition, non-compliance may result in the
FDA's refusal to approve
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pending NDAs or supplements to approved NDAs or in the withdrawal of an NDA.
Any such sanction could result in adverse publicity, which could have a
material adverse effect on the Company's business, financial conditions, and
results of operation.
The steps ordinarily required before a new pharmaceutical product may be
marketed in the United States include: (i) preclinical laboratory tests,
preclinical studies in animals and formulation studies; (ii) the submission to
the FDA of a notice of claimed investigational exemption for a new drug or
antibiotic, which must become effective before clinical testing may commence;
(iii) adequate and well-controlled clinical human trials to establish the
safety and efficacy of the drug for each indication; (iv) the submission of an
NDA to the FDA; and (v) FDA review and approval of the NDA prior to any
commercial sale or shipment of the drug. Preclinical tests include laboratory
evaluation of product chemistry and formulation, as well as animal studies to
assess the potential safety and efficacy of the product. Preclinical tests
must be conducted in compliance with Good Laboratory Practice regulations. The
results of preclinical testing are submitted to the FDA as part of an IND. A
30-day waiting period after the filing of each IND is required prior to the
commencement of clinical testing in humans. In addition, the FDA may, at any
time during this 30-day period or at any time thereafter, impose a clinical
hold on proposed or ongoing clinical trials. If the FDA imposes a clinical
hold, clinical trials cannot commence or recommence without FDA authorization
and then only under terms authorized by the FDA. In some instances, the IND
application process can result in substantial delay and expense.
Clinical trials to support NDAs are typically conducted in three sequential
phases, but the phases may overlap. In Phase I, the initial introduction of
the drug into healthy human subjects or patients, the drug is tested to assess
metabolism, pharmacokinetics and pharmacological actions and safety, including
side effects associated with increasing doses. Phase II usually involves
studies in a limited patient population to (i) assess the efficacy of the drug
in specific, targeted indications, (ii) assess dosage tolerance and optimal
dosage and (iii) identify possible adverse effects and safety risks. If a
compound is found to be potentially effective and to have an acceptable safety
profile in Phase II evaluations, Phase III trials are undertaken to further
demonstrate clinical efficacy and to further test for safety within an
expanded patient population at geographically dispersed clinical study sites.
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 Company's products subject to such testing.
After successful completion of the required clinical testing, generally an
NDA is submitted. FDA approval of the NDA is required before marketing may
begin in the United States. The FDA reviews all NDAs submitted before it
accepts them for filing and may request additional information rather than
accepting an NDA for filing. In such an event, the NDA must be resubmitted
with the additional information and, again, is subject to review before
filing. Once the submission is accepted for filing, the FDA begins an in-depth
review of the NDA. Under the FDC Act, the FDA has 180 days in which to review
the NDA and respond to the applicant. The review process is often
significantly extended by FDA requests for additional information or
clarification regarding information already provided in the submission. The
FDA may refer the application to an appropriate advisory committee, typically
a panel of clinicians, for review, evaluation and a recommendation as to
whether the application should be approved. The FDA is not bound by the
recommendation of an advisory committee. If FDA evaluations of the NDA and the
manufacturing facilities are favorable, the FDA may issue either an approval
letter or an approvable letter, which usually contains a number of conditions
that must be met in order to secure final approval of the NDA. When and if
those conditions have been met to the FDA's satisfaction, the FDA will issue
an approval letter, authorizing commercial marketing of the drug for certain
indications. If the FDA's evaluation of the NDA submission or manufacturing
facilities is not favorable, the FDA may refuse to approve the NDA or issue a
not approvable letter, outlining the deficiencies in the submission and often
requiring additional testing or information. If regulatory approval of
Colazide or any other product is granted, such approval will be limited to
those disease states and conditions for which the product has been found by
the FDA to be safe and effective, as demonstrated through well controlled
clinical studies. Even if such regulatory approval is obtained, a marketed
product, its manufacturer and its manufacturing facilities are subject to
continual review and periodic inspections. In addition, identification of
certain side effects after a drug is on the market or the occurrence of
manufacturing problems could cause subsequent withdrawal of approval,
reformulation of the drug, additional preclinical testing or clinical trials
and changes in labeling of the product.
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For antibiotic drug products such as rifaximin, FDA testing and approval
procedures are analogous to those applicable to non-antibiotic drugs except
that approval also requires the establishment of an antibiotic monograph
setting forth the tests and specifications for the drug, which are published
by the FDA as a regulation and codified in the Code of Federal Regulations.
On June 23, 1997, the Company submitted an NDA to the FDA covering the use
of Colazide as a therapy for acute ulcerative colitis and in August 1997, the
NDA was accepted for filing by the FDA. The NDA can be approved only if the
FDA determines that the NDA contains substantial evidence from clinical trials
that the drug is safe and effective for its intended use. There can be no
assurance that the results of the Company's preclinical or clinical studies,
including its United States Phase III clinical testing in combination with the
results from a European safety and efficacy study, will demonstrate, to the
FDA's satisfaction, substantial evidence that the drug is safe and effective.
If clinical data, in addition to that filed in the NDA, is requested from the
Company to support approval of Colazide, such a request is likely to
significantly delay approval of the product, if approval is granted at all. If
regulatory approval of Colazide or any other product is granted, such approval
will be limited to those disease states and conditions for which the product
has been shown to be safe and effective, as demonstrated to the FDA's
satisfaction through well controlled clinical studies. Furthermore, approval
may entail ongoing requirements for post-marketing studies. Even if such
regulatory approval is obtained, a marketed product, promotional activities
for the product, its manufacturer and its manufacturing facilities are subject
to continual review and periodic inspections. In addition, identification of
certain side effects after a drug is on the market or the occurrence of
manufacturing problems could cause subsequent withdrawal of approval,
reformulation of the drug, additional preclinical testing or clinical trials
and changes in labeling of the product.
Under the Orphan Drug Act, the FDA may designate a product as an orphan drug
if it is a drug intended to treat a "rare disease or condition," which is a
disease or condition that affects populations of fewer than 200,000
individuals in the United States or a disease whose incidence rates number
more than 200,000 where the sponsor establishes that it does not realistically
anticipate that its product sales will be sufficient to recover its costs. The
sponsor that obtains the first marketing approval for a designated orphan drug
for a given rare disease is eligible to receive marketing exclusivity for use
of that drug for the orphan indication for a period of seven years. In
February 1998, the FDA granted the Company Orphan Drug Designation for
rifaximin to treat hepatic encephalopathy. The Company may apply for orphan
drug designation for some of its other products and indications in
development. There is no assurance that the FDA would grant orphan drug
designation or marketing exclusivity for any such additional indications or
products or that, if granted, such exclusivity would effectively protect the
product from competition.
Drug manufacturing establishments are subject to periodic inspection by
regulatory authorities and must comply with Good Manufacturing Practice
regulations. The Company or its third party manufacturer must pass a
preapproval inspection of its manufacturing facilities by the FDA before
obtaining marketing approval of any products for sale in the United States.
These manufacturers are also subject to periodic FDA inspections. In the event
that violations of applicable standards are found, the Company may be required
to cease distribution of some or all products and may be required to recall
products already distributed.
REGULATION OF DRUG COMPOUNDS OUTSIDE OF THE UNITED STATES
Outside the United States, the Company's ability to market a product is
contingent upon receiving marketing authorizations from the appropriate
regulatory authorities. The requirements governing the conduct of clinical
trials and marketing authorization vary widely from country to country. At
present, foreign marketing authorizations are applied for at a national level,
although within the European Union ("EU") procedures are available to
companies wishing to market a product in more than one EU member state. The
foreign regulatory approval process includes all of the risks associated with
FDA approval set forth above.
To market its products in Europe, the Company also must satisfy foreign
regulatory requirements, implemented by foreign health authorities, governing
human clinical trials and marketing approval. In the United Kingdom, the sale
and marketing of new drugs is subject to the approval of the Medicines Control
Agency (the
16
<PAGE>
"MCA"). As in the United States, a company seeking regulatory approval must
submit an application requesting such approval, which is referred to as a
Product Licence Application ("PLA"). The PLA is submitted after completion of
pre-clinical and clinical studies. The MCA may request additional clinical
information on efficacy or safety before formally reviewing the application.
Following a review of the PLA, the MCA makes a determination as to approval of
the new drug compound. The review process in the United Kingdom is subject to
many of the same uncertainties and risks associated with the approval of new
drugs by the FDA in the United States. Furthermore, approval may entail
ongoing requirements for post-marketing studies. Even if such regulatory
approval is obtained, a marketed product and its manufacturer and its
manufacturing facilities are subject to continual review and periodic
inspections by the MCA.
Under a new regulatory system in Europe, marketing authorizations, broadly
speaking, may be submitted at either a centralized, a decentralized or a
national level. The centralized procedure is mandatory for the approval of
biotechnology and high technology products and available at the applicant's
option for other products. The centralized procedure provides for the first
time in the EU for the grant of a single marketing authorization which is
valid in all EU member states.
As of January 1995, a mutual recognition procedure is available at the
request of the applicant for all medicinal products which are not subject to
the centralized procedure under the so called "decentralized procedure". The
decentralized procedure, which became mandatory in January 1998, creates a new
system for mutual recognition of national approval decisions, makes changes in
existing procedures for national approvals and establishes procedures for
coordinated EU actions on products, suspensions and withdrawals. Under this
procedure, the holder of a national marketing authorization for which mutual
recognition is sought may submit an application to one or more EU member
states, certify that the dossier is identical to that on which the first
approval was based or explain any differences and certify that identical
dossiers are being submitted to all member states for which recognition is
sought. Within 90 days of receiving the application and assessment report,
each member state must decide whether to recognize the approval. The procedure
encourages member states to work with applicants and other regulatory
authorities to resolve disputes concerning mutual recognition. Lack of
objection of a given country within 90 days automatically results in approval
of the EU country. If such disputes cannot be resolved within the 90 day
period provided for review, the application will be subject to a binding
arbitration procedure. Notwithstanding these simplified procedures, the
foreign regulatory approval process includes many of the risks associated with
FDA approval set forth above. The PLA that the Company filed with the MCA for
the acute ulcerative colitis indication, which was approved in July 1997, was
filed under these mutual recognition procedures.
The Company will choose the appropriate route of European regulatory filing
to accomplish the most rapid regulatory approvals. However, there can be no
assurance that the chosen regulatory strategy will secure regulatory approvals
or approvals of the Company's chosen product indications.
COMPETITION
Competition in the pharmaceutical industry is intense and characterized by
extensive research efforts and rapid technological progress. The Company
believes that there are numerous pharmaceutical and biotechnology companies,
both public and private and including large well known pharmaceutical
companies, as well as academic research groups that are engaged in research
and development efforts for gastrointestinal diseases and conditions addressed
by the Company's current and potential products. In particular, the Company is
aware of products in research or development by competitors that address the
diseases being targeted by the Company's products. There can be no assurance
that developments by others will not render the Company's current and
potential products obsolete or noncompetitive. Competitors may be able to
complete the development and regulatory approval process sooner and,
therefore, market their products earlier than the Company. Many of the
Company's competitors have substantially greater financial, marketing and
human resources and development capabilities than the Company. For example,
many large, well capitalized companies already offer products in the United
States and Europe that will compete with the Company's proposed therapeutic
applications of Colazide, including mesalamine (SmithKline Beecham plc, Dr.
Falk Pharma GmbH, Pharmacia & Upjohn, Inc.,
17
<PAGE>
Solvay S.A., The Procter & Gamble Company, and Hoechst Marion Roussel, Inc.),
sulfasalazine (Pharmacia & Upjohn, Inc.), and olsalazine (Pharmacia & Upjohn,
Inc.). Technological developments by competitors, earlier regulatory approval
for marketing competitive products, or superior marketing capabilities
possessed by competitors could adversely affect the commercial potential of
the Company's products, including Colazide, and could have a material adverse
effect on the Company's business, financial condition, and results of
operations. In addition, manufacturers of generic drugs may seek to compete
directly with the Company's products in the absence of effective patent
protection or non-patent exclusivity protections.
EMPLOYEES
As of December 31, 1997, the Company had 13 employees. The Company believes
that its future success will depend in part on its continued ability to
attract, hire, and retain qualified personnel. Competition for such personnel
is intense, and there can be no assurance that the Company will be able to
identify, attract, and retain such personnel in the future. None of the
Company's employees is represented by a labor union. The Company has not
experienced any work stoppages and considers its relations with its employees
to be good.
ITEM 2. PROPERTIES
The Company's headquarters is located in Palo Alto, California, where it
occupies approximately 7,500 square feet of office space under a lease
extending through August 31, 2001. The Company considers this space adequate
for its anticipated needs into the foreseeable future. In addition, the
Company leases approximately 200 square feet of office space in Hamilton,
Bermuda and approximately 260 square feet of office space in Dorset, England.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is party to various legal proceedings or
claims, either asserted or unasserted, which arise in the ordinary course of
business. Management has reviewed pending legal matters and believes that the
resolution of such matters will not have a significant adverse effect on the
Company's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's shareholders during the
fourth quarter of the year ended December 31, 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the Company's
executive officers as of March 1, 1997:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Randy W. Hamilton........... 43 Chairman, President and Chief Executive Officer
David Boyle................. 44 Vice President, Finance & Administration, and
Chief Financial Officer
John Brough................. 44 President, Glycyx Pharmaceuticals, Ltd.
Alvaro E. Carvajal.......... 53 Vice President, Information Systems (Salix
California)
Lorin K. Johnson, Ph.D...... 45 Vice President, Research (Salix California),
and Director
Robert P. Ruscher........... 37 Vice President, Corporate Development
James G. Shook, Ph.D........ 58 Senior Vice President, Development (Salix
California)
</TABLE>
18
<PAGE>
Randy W. Hamilton is a co-founder of the Company and has served as Chairman
of its Board of Directors and President and Chief Executive Officer since
December 1993. From November 1989 to December 1993, Mr. Hamilton served as
President and Chief Executive Officer and as a director of Salix
Pharmaceuticals, Inc. ("Salix California") Prior to 1989, Mr. Hamilton served
as Director of Planning and Business Development with SmithKline Diagnostics,
Inc., a medical diagnostic subsidiary of SmithKline Beecham plc, a
pharmaceutical company, and as head of Asian business development for
California Biotechnology Inc. (now Scios, Inc.), a biotechnology company.
David Boyle has served as the Company's Vice President, Finance and
Administration, and Chief Financial Officer since November 1996. From May 1992
to October 1996, Mr. Boyle was employed by Ares Serono Group, a Swiss
pharmaceutical company, most recently as Vice President, Finance and
Administration (North America), and previously as Director, Business Analysis
Group. Prior to joining Ares Serono, Mr. Boyle held various accounting and
finance positions with Ernst & Young LLP.
John Brough has served as President of Glycyx Pharmaceuticals, Ltd. since
July 1996. From April 1995 to April 1996, he served as President, and from May
1989 to April 1995 as Director, Finance and Administration, of Syntex
Pharmaceuticals International Ltd., a subsidiary of Syntex Corporation
("Syntex"), a pharmaceutical company acquired in 1994 by The Roche Group.
Alvaro E. Carvajal has served as the Vice President, Information Systems of
Salix California since August 1997. From January 1994 to August 1997, Mr.
Carvajal served as the Director, Information Systems of Salix California. From
1989 to January 1994, he served as an international systems consultant for
Syntex.
Lorin K. Johnson, Ph.D. is a co-founder of the Company and has served as the
Company's Vice President, Research, and as a member of its Board of Directors
since December 1993. From November 1989 to December 1993, Dr. Johnson held the
same positions at Salix California. Prior to co-founding Salix, Dr. Johnson
served as Director of Scientific Operations at California Biotechnology Inc.
Prior to joining California Biotechnology, Dr. Johnson was assistant Professor
of Pathology at Stanford University Medical Center.
Robert P. Ruscher has served as the Company's Vice President, Corporate
Development since February 1996. From May 1996 to November 1996, he also
served as the Company's Chief Financial Officer. From April 1995 to February
1996, Mr. Ruscher served as Director of Corporate Affairs. Since April 1994,
Mr. Ruscher has been associated with the law firm of Wyrick, Robbins, Yates &
Ponton, L.L.P. in Raleigh, North Carolina. From February 1993 to April 1994,
Mr. Ruscher was an associate at the law firm Venture Law Group in Menlo Park,
California, and from August 1989 to February 1993, he was an associate at the
law firm Wilson Sonsini Goodrich & Rosati in Palo Alto, California.
James G. Shook, Ph. D. has served as the Senior Vice President, Development
of Salix California, since April 1997. From August 1994 to April 1997, Dr.
Shook served as Vice President, Research and Development of Fujisawa
Pharmaceuticals U.S.A., a pharmaceutical company. From September 1993 to
August 1994, Dr. Shook served as Acting Vice President, Research and
Development, and Vice President, Research and Development Operations at
Fujisawa and from June 1992 to September 1993 as Vice President, Research and
Development Operations and Project Director, Immunology.
19
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Shares have been traded on The Toronto Stock Exchange
under the symbol "SLX.s" since the Company's initial public offering in Canada
in May 1996. The suffix "s" on the trading symbol reflects the Company's
reliance, in connection with such offering, on the exemption from the
registration requirements of the United States Securities Act of 1933, as
amended (the "Securities Act"), set forth in Regulation S thereunder. In
October 1997, the Company completed a follow-on public offering in Canada and
an initial public offering in the United States, and the Common Shares issued
in that offering have since traded and been quoted separately under the symbol
"SLX." Beginning on May 28, 1998, all the Company's Common Shares available
for resale on The Toronto Stock Exchange will trade under the symbol "SLX."
The following is a summary of the market price range in Canadian dollars and
the aggregate volume for the Common Shares as reported on The Toronto Stock
Exchange for the periods indicated. On December 31, 1997, The Bank of Canada
noon rate of exchange for United States Dollars into Canadian Dollars was Cdn.
$1.4296 = U.S. $1.00.
<TABLE>
<CAPTION>
SHARES TRADED UNDER SHARES TRADED UNDER
SYMBOL "SLX.S" SYMBOL "SLX"
------------------------- -----------------------
HIGH LOW SHARE HIGH LOW SHARE
(CDN.$) (CDN.$) VOLUME (CDN.$) (CDN.$) VOLUME
------- ------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Fiscal Year ended December
31, 1997
Fourth Quarter 1997(1)..... 7.90 5.00 295,938 7.05 5.00 445,354
Third Quarter 1997......... 9.00 6.50 235,200 -- -- --
Second Quarter 1997........ 9.95 7.60 640,283 -- -- --
First Quarter 1997......... 9.35 4.25 1,016,263 -- -- --
Fiscal Year ended December
31, 1996 -- -- --
Fourth Quarter............. 5.95 4.50 625,388 -- -- --
Third Quarter.............. 6.60 5.00 428,425 -- -- --
Second Quarter (from May
27, 1996)................. 7.50 6.20 241,800 -- -- --
</TABLE>
- --------
(1) Shares traded under the symbol "SLX" commenced trading on The Toronto
Stock Exchange on October 16, 1997.
On December 31, 1997, the closing prices for the Common Shares as reported
on The Toronto Stock Exchange were Cdn. $6.00 for the Common Shares traded
under the symbol "SLX.s" and Cdn. $6.25 for the Common Shares traded under the
symbol "SLX." As of March 20, 1998, there were approximately 83 shareholders
of record.
The securities markets have from time to time experienced significant price
and volume fluctuations that may be unrelated to the operating performance of
particular companies. In addition, the market prices of the common stock of
many publicly traded pharmaceutical and biotechnology companies have in the
past and can in the future be expected to be especially volatile.
Announcements of technological innovations or new products by the Company or
its competitors, developments or disputes concerning proprietary rights,
publicity regarding actual or potential medical results relating to products
under development by the Company or its competitors, regulatory developments
in both the United States and other countries, public concern as to the safety
of pharmaceutical products and economic and other external factors, as well as
period-to-period fluctuations in the Company's financial results may have a
significant impact on the market price of the Company's Common Shares. The
Company's Common Shares have been traded on The Toronto Stock Exchange since
May 1996, were not freely tradable in the United States until October 1997,
and no public trading market currently exists for the Common Shares in the
United States. Trading volume in the Common Shares on The Toronto Stock
Exchange has been low, and there can be no assurances that an active trading
market will develop or be sustained on The Toronto Stock Exchange, or any
other exchange or dealer quotation system.
20
<PAGE>
The Common Shares trade on The Toronto Stock Exchange in Canadian dollars.
In addition to the general market risks associated with ownership of equity
securities and the more specific risks of ownership of the Common Shares of
the Company, U.S. holders of the Common Shares also bear exchange rate risks
resulting from fluctuations in the relative values of the Canadian dollar and
the U.S. dollar. The value of the Canadian dollar has fluctuated substantially
in the past relative to the United States dollar and other currencies and may
continue to do so in the future. As a result, for U.S. investors and other
non-Canadian investors, the value of the Common Shares in United States
dollars or other currencies may vary independently of changes in the trading
price of the Common Shares on The Toronto Stock Exchange and for reasons
unrelated to the Company or its business, results of operations, or financial
condition.
For a more thorough discussion of risks associated with purchasing or
holding the Common Shares, see the section captioned "Factors Affecting Future
Results" under Management's Discussion and Analysis of Financial Condition and
Results of Operations.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain future earnings, if any, for use in
the operation and expansion of business and does not anticipate paying any
cash dividends in the foreseeable future.
USE OF PROCEEDS
In October 1997, the Company completed the sale of 3,000,000 Common Shares
at a per share price of Cdn. $7.00 in a firm commitment underwritten public
offering. The offering was effected in Canada pursuant to final receipts
issued by each of the provincial securities commissions and in the United
States pursuant to a Registration Statement on Form S-1 (Registration No. 333-
33781), which the United States Securities and Exchange Commission declared
effective on October 14, 1997. The offering was underwritten by Levesque
Beaubien Geoffrion Inc., Yorkton Securities Inc., Marleau, Lemire Securities
Inc., and Midland Walwyn Capital Inc. In the United States, the offering was
made by the United States broker-dealer affiliates of the underwriters, NBC
Levesque International Ltd., Yorkton Capital Inc., Marleau Lemire (USA), Inc.,
and Midland Walwyn Capital Corporation, respectively. On October 16, 1997, the
date of the effectiveness of the Registration Statement covering the public
offering, the Bank of Canada noon rate of exchange for United States dollars
into Canadian dollars was Cdn $1.3866 per U.S. $1.00.
Of the Cdn. $21,000,000 in aggregate proceeds raised in connection with the
October 1997 offering, (i) approximately Cdn. $1,365,000 was paid to the
underwriters in connection with underwriting discounts, and (ii) approximately
Cdn. $1,403,000 was paid by the Company in connection with offering expenses,
including legal, printing, and filing fees. There were no direct or indirect
payments to directors or officers of the Company or any other person or
entity. None of the offering proceeds have been used for the construction of
plant, building or facilities or the purchase or installation of machinery or
equipment or for purchases of real estate or the acquisition of other
businesses. The Company is currently investing the net offering proceeds for
future use as additional working capital. Such remaining net proceeds have
been invested in short-term, interest-bearing, investment grade securities. A
portion of the net proceeds may be used for the acquisition of technologies,
businesses or products that are complementary to those of the Company.
21
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and the
Notes thereto included elsewhere in this report. The statement of operations
data for each of the three years in the period ended December 31, 1997, and
the balance sheet data as of December 31, 1997 and 1996, are derived from
financial statements of the Company that have been audited by Ernst & Young
LLP, independent auditors, and are included elsewhere in this report. The
statement of operations data for the years ended December 31, 1993 and 1994
and the balance sheet data as of December 31, 1995, 1994 and 1993 are derived
from audited financial statements of the Company that are not included in this
report. The Company has paid no cash dividends.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Product revenue................ $ 245 $ -- $ -- $ -- $ --
Revenues from collaborative
agreements and other.......... 1,821 1,820 1,990 2,827 4,439
-------- ------- ------- ------- -------
Total revenues............... 2,066 1,820 1,990 2,827 4,439
Expenses:
Cost of products sold.......... 827 -- -- -- --
License fees................... 461 605 100 -- --
Research and development....... 3,516 2,053 2,888 3,199 4,321
General and administrative..... 2,430 1,731 1,334 1,125 873
-------- ------- ------- ------- -------
Total expenses............... 7,234 4,389 4,322 4,324 5,194
-------- ------- ------- ------- -------
Loss from operations............. (5,168) (2,569) (2,332) (1,497) (755)
Interest income.................. 400 290 18 48 48
Interest and other expense....... (22) (172) (106) (3) (7)
-------- ------- ------- ------- -------
Net loss......................... $ (4,790) $(2,451) $(2,420) $(1,452) $ (714)
======== ======= ======= ======= =======
Net loss per share, basic and
diluted (1)..................... $ (0.63) $ (0.46) $ (0.77) $ (0.46) $ (0.23)
======== ======= ======= ======= =======
Shares used in computing net loss
per share(1).................... 7,613 5,365 3,149 3,144 3,144
======== ======= ======= ======= =======
<CAPTION>
DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents........ $ 15,173 $ 5,624 $ 188 $ 329 $ 1,552
Working capital (deficit)........ 13,884 4,438 (3,432) (3,061) (1,570)
Total assets..................... 15,878 5,858 433 593 1,967
Long-term liabilities............ -- -- 2,005 -- --
Accumulated deficit.............. (13,391) (8,601) (6,150) (3,729) (2,278)
Shareholders' equity (net capital
deficiency)..................... 14,129 4,593 (5,226) (2,813) (1,372)
</TABLE>
- --------
(1) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of shares used in computing net loss per share.
22
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward looking statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical results or anticipated results, including those set forth
under "Factors that May Affect Future Results" under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and elsewhere
in, or incorporated by reference into, this report.
Unless otherwise indicated, all references to "dollars" or "$" refer to
United States dollars. The Company's Common Shares trade on The Toronto Stock
Exchange and are quoted in Canadian dollars.
OVERVIEW
The Company's principal focus is to identify and acquire gastrointestinal
products that have near-term commercial potential and to apply its product
development expertise to commercialize these products. The Company selects
products that it believes serve a gastrointestinal disease in need of new
treatments, have the potential for rapid regulatory approval, and are
marketable to a small group of specialized physicians. The Company believes
this strategy will reduce the expense, time and risk normally associated with
pharmaceutical development. The Company believes that its first two products,
Colazide and rifaximin, will demonstrate the Company's ability to execute this
strategy.
The Company has generated limited revenues to date from the sales of
products, and it has been unprofitable since inception. The Company expects to
continue to incur substantial and increasing losses and expects its operating
expenses to increase as the Company commences its Colazide commercialization
efforts in the United Kingdom and, subject to regulatory approval, elsewhere
in Europe and continues its product development and clinical programs for
other products. The Company does not expect to achieve substantial
profitability on an annual basis before 2001 at the earliest. As of December
31, 1997, the Company had accumulated losses of approximately $13.4 million.
Since 1992, the Company has financed its operations principally through
reimbursement payments, license fees and milestone revenues, totaling
approximately $15.8 million under collaborative research and licensing
agreements, and sales of equity and convertible debt securities totaling
approximately $27.5 million. Over the same period, the Company has recorded
expenses totaling $20.3 million, of which $11.7 million were in research and
development expenses and $1.2 million in license fees to licensors. The
Company's alliances with Astra AB ("Astra") and a division of Menarini
Pharmaceutical Industries s.r.l. ("Menarini") have allowed Salix to fund the
development of Colazide, to in-license other gastrointestinal products, and to
help establish itself with a relatively small amount of outside capital.
The Company's collaborative research and licensing agreements provide for
payments in support of the Company's research activities, as well as
additional payments for licensing fees and upon the attainment of specified
milestones. Research reimbursements under these agreements are recorded when
earned based on contract costs incurred to date compared with total estimated
contract costs. License fees and milestone revenues are recognized according
to contract terms. Amounts received in advance of the applicable research
activities are deferred as unearned revenue. Amounts received which are
refundable until the milestones are achieved are deferred as advances from
licensees until earned.
The Company licensed balsalazide from Biorex Laboratories Limited ("Biorex")
in exchange for participation in future milestone revenues and profits. The
Company will sell Colazide, the disodium salt of balsalazide, which is
manufactured by third parties under contract with the Company, to its
distribution partners, Astra and Menarini, at a formula price. The Company
received approval in July 1997 to market Colazide in the United Kingdom for
the treatment of acute ulcerative colitis. Astra launched Colazide
commercially in October 1997 in the United Kingdom. Commercial launches of
Colazide are expected in other European countries by Astra and Menarini
beginning in 1998, subject to receipt of necessary regulatory approvals. The
Company recognized its initial product revenues from Astra's sales of Colazide
in 1997 and expects to recognize product
23
<PAGE>
revenues from sales of Colazide by Menarini in 1998. The selling price of
Colazide to Astra outside the United Kingdom has not been determined, and the
Company will be obligated to pay to Biorex, the original licensor of the
product, a portion of any gross profit on Colazide sales to Astra and Menarini
outside the United States. In addition, the Company anticipates high initial
product launch costs due to the cost of scaling up manufacturing processes for
commercial distribution.
The Company's second product, rifaximin, is currently under development. The
Company obtained the rights to develop, make, use and sell rifaximin in Canada
and the United States from Alfa Wassermann S.p.A. ("Alfa Wassermann") in
exchange for future royalties and milestone payments. Under a separate
agreement, Alfa Wassermann will supply Salix with bulk active ingredient
rifaximin at a fixed price. If regulatory approvals are obtained, the Company
intends to establish its own direct sales force to market rifaximin. This
strategy for rifaximin represents the business model that the Company intends
to adopt for future product development and commercialization. Although the
creation of an independent sales organization will require a substantial
investment by the Company, the Company anticipates that the financial results
from rifaximin and future products will be more favorable to the Company than
those anticipated from the sale of Colazide by Astra and Menarini since the
Company has retained the distribution rights to rifaximin, whereas Astra and
Menarini have the distribution rights for Colazide. In the case of Colazide,
the Company granted exclusive distribution rights in certain territories in
exchange for funding needed to complete late-stage development of Colazide, to
in-license other gastrointestinal products and to help establish the Company
as a viable gastrointestinal pharmaceutical company. The Company is currently
unable to provide a meaningful estimate of the investment required to create
an independent sales organization because such investment is dependent on a
number of contingencies, including receipt of necessary regulatory approvals
and developments with current and future strategic partners.
The Company intends to pursue regulatory approvals for two initial
indications for rifaximin, hepatic encephalopathy and bacterial infections of
the lower gastrointestinal tract including antibiotic associated colitis with
the cost of the clinical trials being borne by Salix. The Company plans
further development of rifaximin for several other possible indications. In
February 1998, the Company received Orphan Drug Designation from the FDA for
rifaximin to treat hepatic encephalopathy. Orphan Drug Designation can entail
certain possible advantages in the testing and approval process for the drug.
See "Factors That May Affect Future Results." Having obtained Orphan Drug
Designation for rifaximin, costs incurred through submission of an NDA for the
hepatic encephalopathy indication may be expected to be significantly reduced.
RESULTS OF OPERATIONS
Years Ended December 31, 1997, 1996 and 1995
Revenues for the year ended December 31, 1997 included the Company's initial
revenues from Colazide product sales of $245,000 and milestone revenues of
$1.8 million relating to the approval of Colazide in the United Kingdom and
the filing of the NDA for Colazide in the United States. Revenues totaled $2.1
million, $1.8 million, and $2.0 million for 1997, 1996 and 1995, respectively.
For 1996, license revenues were $1.2 million and revenue from collaborative
agreements for product development was $0.6 million. In 1996, revenues from
collaborative agreements for product development decreased as certain clinical
trials for Colazide were completed. Revenues in 1995 were comprised primarily
of revenue recognized from collaborative agreements for product development.
Operating expenses were $7.2 million, $4.4 million and $4.3 million for
1997, 1996 and 1995, respectively. The increase in operating expenses is a
result of increases in all expense categories as noted below.
The Company recognized its first cost of products sold related to initial
product sales of Colazide in the year ended December 31, 1997 of $0.8 million.
Prior to this year, the Company had no product revenues. Initial costs of
products are expected to remain high due to the cost of scaling up
manufacturing processes for commercial distribution.
24
<PAGE>
License fee expenses of $0.5 million, $0.6 million and $0.1 million and in
1997, 1996 and 1995, respectively relate primarily to payments made to Biorex
under the terms of the Colazide license agreement.
Research and development expense was $3.5 million, $2.1 million and $2.9
million for 1997, 1996 and 1995, respectively. The increase in research and
development expenses in 1997 is due primarily to increased regulatory affairs
activities for the preparation of the NDA filing in the United States and to a
one time non-cash charge recognized in the third quarter of 1997 of $0.3
million relating to modification of the terms of an existing employee stock
option arrangement. Research and development expense is expected to increase
significantly as additional clinical trials for Colazide and rifaximin are
initiated. Research and development expenses through 1996 were primarily for
clinical trials and both domestic and foreign regulatory affairs activities
related to the development of Colazide. The decrease in research and
development expenses of $0.8 million from 1995 to 1996 is due to the
completion of certain clinical trials for Colazide in 1996, partially offset
by increased regulatory affairs activities for the preparation of the NDA
filing in the United States.
General and administrative expenses were $2.4 million, $1.7 million and $1.3
million for 1997, 1996 and 1995, respectively. The increases are due mainly to
additions of key personnel and the increased administrative costs related to
becoming a public company in Canada in May 1996 and a public reporting company
in the United States in October.
Interest income for 1997 increased from 1996 by $0.1 million due to larger
average cash reserves in 1997 after completion of the follow-on public
offering in October 1997. From 1995 to 1996, interest income increased by $0.3
million due primarily to interest income derived from proceeds of the
Company's initial public offering in Canada and the conversion of outstanding
debentures as a result of the initial public offering. See "Liquidity and
Capital Resources."
The Company has experienced net losses of $4.8 million, $2.5 million, and
$2.4 million for 1997, 1996 and 1995, respectively.
At December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $8.8 million for United States income tax
purposes. These carryforwards will expire in varying amounts through 2012. As
the Company adds new investors, utilization of the current loss carryforwards
may be substantially limited if, under United States Internal Revenue Code
Section 382, a change in ownership is deemed to have occurred within the three
most recent fiscal years.
Year 2000 Compliance
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. The Company's internal
operating systems rely exclusively on software products of third party
vendors, who have provided assurance to the Company that such products are
year 2000 compliant. As a result, the Company does not believe that issues
relating to year 2000 compliance will result in a material adverse effect on
its financial condition or results of operations. If the information provided
by such software vendors were to prove incorrect, however, there can be no
assurance that the costs and disruption associated with implementing new or
corrected software would not have an adverse effect on the Company's business,
financial condition or results of operations.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, Reporting Comprehensive Income (SFAS No. 130) and Statement No. 131,
Disclosures About Segments of An Enterprise and Related Information (SFAS No.
131). SFAS No. 130 establishes rules for reporting and displaying
comprehensive income. SFAS No. 131 will require the Company to use the
"management approach" in disclosing segment information. Both Statements are
effective for the Company during 1998. The Company does not believe that the
adoption of either SFAS No. 130 or SFAS No. 131 will have a material impact on
the Company's results of operations, cash flows, financial position or
prospects.
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LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed product development, operations
and capital expenditures primarily from funding arrangements with
collaborative partners and from public and private sales of debt and equity
securities.
As of December 31, 1997, the Company had approximately $15.2 million in cash
and cash equivalents. The increase of $9.5 million from December 31, 1996 was
due primarily to cash provided by financing activities of $14.3 million from
issuance of Common Shares upon exercise of warrants and from its October 1997
underwritten public offering of securities in Canada, offset by cash used in
operations of $4.7 million.
In October 1997, the Company offered and sold 3,000,000 Common Shares in an
underwritten public offering of securities in Canada and the United States at
a price of Cdn $7.00 (U.S. $ 4.98), raising Cdn $19,635,000 (U.S. $13,973,000)
net of underwriting discounts and commissions. The offering in the United
States was made pursuant to a Registration Statement on Form S-1 (File No.
333-33781) that was declared effective by the Securities and Exchange
Commission on October 16, 1997.
As of December 31, 1997, the Company had no long term obligations. The
Company has non-cancelable purchase order commitments for inventory purchases
of $0.5 million. The Company anticipates capital expenditures in 1998 of
approximately $0.3 million.
The Company's purchases of raw materials and its product sales to its
European distribution partners are denominated in Pounds Sterling. Translation
into the Company's reporting currency, the United States dollar, has not
historically had a material impact on the Company's financial position.
Additionally, the Company's net assets denominated in currencies other than
the functional currency have not exposed the Company to material risk
associated with fluctuations in currency rates. Given these facts, the Company
has not considered it necessary to use foreign currency contracts or other
derivative instruments to manage changes in currency rates.
The Company has sustained continuing operating losses and expects to incur
substantial and increasing losses until product approvals are obtained and
product revenues reach a sufficient level to support ongoing operations. The
Company believes that the net proceeds from the recently completed offering of
Common Shares, together with the Company's cash reserves at December 31, 1997
and the cash flow from operations, should be sufficient to satisfy the cash
requirements of the Company's product development programs through at least
1998. The Company's actual cash requirements may vary materially from those
now planned because of a number of factors, including the results of research
and development activities, FDA and foreign regulatory processes,
establishment of and change in relationships with strategic partners,
technological advances by the Company and other pharmaceutical companies, the
terms of the Company's collaboration arrangements with strategic partners, and
the status of competitive products. The Company anticipates that it will need
to raise additional funds in the form of debt or equity financing to fund
future licensing, development, and commercialization of rifaximin and new
products. The Company may also enter into collaborative arrangements with
corporate partners that could provide the Company with additional funding in
the form of equity, debt, licensing, milestone and/or royalty payments. There
can be no assurance that the Company will be able to enter into such
arrangements or raise any additional funds on terms favorable to the Company.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report, including this Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements and other prospective information relating to future events. These
forward-looking statements and other information are subject to certain risks
and uncertainties that could cause actual results to differ materially from
historical results on anticipated results, including the following:
Dependence on Currently Licensed Products; Uncertainty of Regulatory
Approval of Company's Products. The Company's future success will depend,
among other factors, on its ability to in-license, develop, and commercialize
new pharmaceutical products. The Company currently licenses two pharmaceutical
products, balsalazide and rifaximin, and the Company's prospects over the next
three to five years are substantially dependent
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on regulatory approval and successful commercialization of these products. The
Company has in-licensed certain rights to balsalazide and rifaximin in certain
markets from Biorex and Alfa Wassermann, respectively. In addition, the
Company has entered into agreements relating to the development,
commercialization, manufacture, and marketing of Colazide, the disodium salt
of balsalazide, with Astra and Menarini.
Development, manufacture, and marketing of both balsalazide and rifaximin
are subject to extensive regulation by governmental authorities in the United
States and other countries. Neither drug has been approved by the FDA for use
in the United States. In June 1997, the Company submitted a NDA to the FDA
relating to Colazide as a therapy for acute ulcerative colitis. The NDA was
accepted for filing by the FDA in August 1997 and is subject to a detailed
substantive review. The Company believes that the FDA approval to market
Colazide will not be obtained before mid-1998, if at all. The NDA can be
approved only if the FDA determines that the NDA contains substantial evidence
from clinical trials that the drug is safe and effective for its intended use.
There can be no assurance that the results of the Company's preclinical or
clinical studies, including its United States Phase III clinical testing in
combination with the results from a European Phase III safety and efficacy
study, will demonstrate, to the FDA's satisfaction, substantial evidence that
the drug is safe and effective. If clinical data, in addition to that filed in
the NDA, is requested from the Company to support approval of Colazide, such a
request is likely to delay significantly any pending review and approval of
the product, if approval is granted at all. If regulatory approval of Colazide
or any other product is granted, such approval will be limited to those
disease states and conditions for which the product has been shown to be safe
and effective, as demonstrated to the FDA's satisfaction through well
controlled clinical studies. Furthermore, approval may entail ongoing
requirements for post-marketing studies. Even if such regulatory approval is
obtained, a marketed product, promotional activities for the product, its
manufacturer and its manufacturing facilities are subject to continual review
and periodic inspections. In addition, identification of certain side effects
after a drug is on the market or the occurrence of manufacturing problems
could cause subsequent withdrawal of approval, reformulation of the drug,
additional preclinical testing or clinical trials and changes in labeling of
the product.
In July 1997, the Medicines Control Agency in the United Kingdom approved
Colazide as a treatment for acute ulcerative colitis in the United Kingdom,
and the Company and its partners, Astra and Menarini, are in the process of
seeking approvals in other member countries of the European Union through a
mutual recognition procedure. There can be no assurance that Colazide will
receive approval from the FDA or from regulatory agencies in any member
country of the European Union other than the United Kingdom. Even if such
approvals are ultimately received, there can be no assurance as to the timing
of such approvals or market acceptance of Colazide for the approved
indications.
With respect to rifaximin, Alfa Wassermann has recently completed patient
enrollment in a clinical trial in Spain relating to the drug as a therapy for
hepatic encephalopathy. The Company has not yet audited the data collection
procedures and has not determined that such study is being conducted in
accordance with Good Clinical Procedures. There can be no assurance that the
clinical trial for rifaximin currently being performed by Alfa Wassermann will
demonstrate that the drug is safe and effective for the indication tested,
that such clinical trial will support the filing of an NDA for rifaximin as a
therapy for hepatic encephalopathy, that in the event an NDA is filed with the
FDA, the Company will be successful in obtaining regulatory approval in the
United States, or that the Company will obtain regulatory approval for
rifaximin from authorities in any other jurisdiction.
The Company expects that a significant portion of its potential revenues for
the next few years will depend on regulatory approval and sales of these
products. Failure to obtain regulatory approvals, delays in obtaining
regulatory approvals, obtaining regulatory approvals for Colazide or rifaximin
in only limited markets or for limited uses, or lack of market acceptance for
either product, to the extent regulatory approvals are obtained, would have a
material adverse effect on the Company's business, financial condition, and
results of operations.
Limited Operating History; History of Operating Losses; Expectation of
Future Losses. The Company has only a limited history of operations consisting
primarily of development of its products and sponsorship with third parties of
research and clinical trials. The Company has had no earnings to date and has
not realized any material operating revenues from product sales, either
directly by the Company or indirectly through its
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development and distribution partners. Substantially all of the Company's
revenues to date have been derived from milestone payments from the Company's
collaborative partners related to the development of Colazide. As of December
31, 1997, the Company had incurred cumulative losses since inception of
approximately $13.4 million. Furthermore, the Company currently expects
operating losses to continue at least through 2000 and to increase from
current levels prior to 2000 as the Company continues to develop Colazide and
rifaximin. The Company's future operating performance will depend on the
timing of regulatory approvals of Colazide and rifaximin, particularly the
timing of FDA approval, and, if such approvals can be obtained, will also
depend on market acceptance.
Dependence on Collaborative Partners. The initial commercialization of
Colazide in the United Kingdom and, to the extent regulatory approval is
obtained, in other countries in which the Company has commercial rights to
Colazide is entirely dependent on Astra and Menarini, in their respective
territories. Under its agreements with Astra, the Company has granted Astra
exclusive rights to distribute and sell Colazide on a worldwide basis with the
exception of Italy, Spain, Portugal, and Greece, where the Company has granted
exclusive distribution rights to Menarini, and with the exception of Japan,
Taiwan, and Korea, where the Company does not have rights to Colazide.
Although Astra has agreed to use its best endeavors to promote, market, and
sell Colazide in its exclusive markets, there are no specified financial
thresholds that must be achieved for Astra to maintain its exclusivity. The
Company's agreements with Astra provide for, with respect to Europe, a term of
15 years and, with respect to the United States, a term ending on the later to
occur of the expiration date of the last expiring patent and the date 9 years
from the first commercial launch date of Colazide but, in either event, the
agreements may be terminated earlier by either party upon the occurrence of
specified events, including a material breach.
The Company's agreements with Astra require Astra to accomplish the
commercial launch of Colazide in any jurisdiction within 90 days of receipt of
regulatory approval in that jurisdiction, subject to a 90 day cure period
during which period Astra has the opportunity to accomplish the commercial
launch without triggering Salix's rights to terminate the agreement or amend
it to make Astra's right non-exclusive. The Company received marketing
approval for Colazide in the United Kingdom from the Medicine Controls Agency
in July 1997 and Astra has launched Colazide commercially in the United
Kingdom in October 1997, based on a selling price set by Astra. Following
regulatory approval of Colazide in each country in Europe where Astra has
exclusive distribution rights, the Company and Astra must agree on the
Colazide sales price for such country, which may be less than the selling
price in the United Kingdom. The agreed sales price for Colazide will directly
affect the Company's revenues because the parties' agreement obligates Astra
to purchase Colazide from the Company, and the Company to supply Colazide to
Astra, at a transfer price equal to a percentage of Astra's selling price. The
Company does not anticipate significant margins from Colazide sales to Astra
in the United Kingdom or in continental Europe, where pricing has not yet been
determined. In addition, while the Company has been advised by both Astra and
Menarini that they intend to seek approval in other European countries through
the mutual recognition procedures of the European Union, the decision as to
which approvals to seek, the order in which to seek them and the
responsibility to complete the approval process lies with Astra and Menarini.
There can be no assurance that the Company will be able to negotiate
acceptable collaborative arrangements in the future, or that its current or
future collaborative arrangements, including the agreements with Astra or
Menarini, will be successful or will not be terminated by the other party.
Although the Company believes that parties to any collaborative arrangements
would have an economic motivation to succeed in performing their contractual
responsibilities, the amount and timing of resources to be devoted to these
activities in most instances will not be within the control of the Company.
Failure of the Company and its collaborative partners to develop,
commercialize, manufacture or market products, including Colazide, would have
a material adverse effect on the Company's business, financial condition, and
results of operations.
Dependence on Third Parties for Manufacturing. The Company currently does
not manufacture its potential pharmaceutical products, including Colazide and
rifaximin, and, therefore, is dependent on contract manufacturers for the
production of such products for development and commercial purposes. In the
event that the Company is unsuccessful in obtaining or retaining third-party
manufacturing or if the Company's manufacturers experience production
difficulties, delays or disruptions or fail to comply with regulatory
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requirements, the Company may not be able to obtain adequate supplies of
products in a timely fashion or at acceptable quality, quantity, timing or
prices, or to commercialize its potential products as planned. The Company's
initial product, Colazide, has never been manufactured in commercial
quantities. No assurances can be given that the Company, or its manufacturing
partners, will be able to manufacture Colazide (or other future developed
products) in commercial quantities that would enable the Company to meet its
business objectives. Under the terms of the Company's distribution agreements
with Astra and Menarini, the obligations of such companies to purchase product
will terminate under certain circumstances in which the Company is unable or
unwilling to adequately supply them with product. In such circumstances, Astra
or Menarini, as the case may be, is granted a temporary license to manufacture
Colazide. Under certain situations, such manufacturing licenses may become
permanent, in which case the Company's revenues from the arrangements could
be, depending on the circumstances, severely reduced or eliminated. Moreover,
contract manufacturers that the Company may use must adhere to current Good
Manufacturing Practices, which are regulations strictly enforced by the FDA
through its facilities inspection program. If these facilities cannot pass a
pre-approval plant inspection, the likelihood of the FDA's pre-market approval
of Colazide will be adversely affected. Certain material manufacturing changes
that may occur after approval are also subject to FDA review and approval.
There can be no assurance that the FDA or other regulatory agencies will
approve the processes or the facilities by which any of the Company's products
may be manufactured. In addition, if the facilities cannot pass regular post-
approval inspections, manufacturing and distribution may be disrupted, recalls
of distributed products may be necessary, and other sanctions could be
applied. Any disruption in the supply in manufacturing and marketing of the
Company's proposed products would have a material adverse effect on the
Company's business, financial condition, and results of operations.
Dependence on In-Licensing and Acquisition of New Products for Future
Growth. Whether or not Colazide or rifaximin receives regulatory approvals and
is successfully marketed, the Company's ability to grow in the future will
depend on its success in in-licensing or acquiring additional pharmaceutical
products. The Company seeks to in-license or acquire pharmaceutical products
that have been developed beyond the initial discovery phase and for which
late-stage human clinical data is already available. There can be no assurance
that such pharmaceutical products will be available on attractive terms for
in-licensing or acquisition by the Company.
Uncertainty of Market Acceptance. The Company's future success will depend
in part on its ability to develop and commercialize new products, including
Colazide and rifaximin, or new formulations of or indications for current
products. Assuming the Company can successfully develop such products and
obtain regulatory approvals, their future success will depend upon their
acceptance by the medical community and third-party payors as useful and cost-
effective. Market acceptance will depend upon several factors, including the
establishment of the safety, effectiveness, patient tolerance, and cost of the
Company's products relative to those of competitors. The Company and its
collaborative partners may be required to engage in extensive advertising,
educational programs or other means to market its products. Failure of any of
the Company's products to achieve market acceptance would have a material
adverse effect on the Company's business, financial condition, and results of
operations.
Lack of Sales and Marketing Experience. The Company has no experience
marketing and selling its products either directly or through distributors.
The Company's sales and marketing strategy for Colazide relies on its third-
party distributors, Astra and Menarini, to whom the Company has granted
exclusive marketing rights. There can be no assurance that either Astra or
Menarini will market Colazide successfully in any country in which they have
exclusive rights. The Company intends to establish its own direct sales force
for the purpose of achieving direct sales of rifaximin and other future
products. There can be no assurance that the Company's marketing and direct
sales efforts will be successful.
Dependence on Exclusive Licenses. The Company's rights to balsalazide and
rifaximin are derived from its license agreements with Biorex and Alfa
Wassermann, respectively. The Company's rights under these licenses are
subject to early termination by Biorex or Alfa Wassermann, as the case may be,
under certain circumstances, including material breach by the Company, the
bankruptcy or insolvency of the Company, or the Company's failure to satisfy
its manufacturing obligations under its agreements with distribution partners.
In the
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event that Biorex or Alfa Wassermann terminate their respective license
agreements, the Company would have no further rights to utilize their
respective patents or trade secrets to manufacture and market products based
on balsalazide or rifaximin, as the case may be. The Company's licenses for
balsalazide and rifaximin provide that the Company's royalty obligations may
extend beyond the expiration date of the underlying patents, which could have
a material adverse effect on the Company's business, financial condition, and
results of operations in the event a generic version of balsalazide or
rifaximin, as the case may be, were introduced. In addition, the Company's
license agreement with Alfa Wassermann also provides that the Company may not
promote, distribute or sell any antibiotic products that compete with
rifaximin in its licensed territory (the United States and Canada) for a
period of five years after the first commercial sale of rifaximin under the
agreement, thereby limiting the Company's ability to in-license, develop, or
market such products.
Patents and Proprietary Rights; Expiration of Patents. 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. Because
the Company's strategy is to in-license or acquire pharmaceutical products
which typically have been discovered and initially researched by others, such
products may have limited or no remaining patent protection due to the time
elapsed since their discovery. The patents for the Colazide composition of
matter and method of treating ulcerative colitis with Colazide expire in July
2001 in the United States, February 2002 in the United Kingdom, May 2002 in
France, July 2001 in Italy, and April 2002 in Germany. The patents for the
method of treating colon cancer using balsalazide expire in January 2014 in
the United States and, assuming patents issue from pending applications, in
January 2015 in various countries in Europe, Asia, and North America. The
patents for the rifaximin composition of matter (also covering a process of
making rifaximin and using rifaximin to treat gastrointestinal infectious
diseases) expire in May 2001 in the United States and Canada. The patents for
another process of making rifaximin expire in April 2005 in both the United
States and Canada. Patents for the use of rifaximin for H. pylori infections
expire in June 2013 in the United States and February 2014 in Canada. Although
the Company believes it may be granted extensions of up to five years in
certain circumstances, based on patent term restoration procedures established
in Europe and in the United States under the Waxman-Hatch Act for products
that have received regulatory approval, there is no assurance that such
extensions will be granted. The Company has filed applications for use patents
for additional indications using balsalazide and related chemical substances.
There can be no assurance that any patents will be issued. There can be no
assurance that competitors will not develop products based on the same active
ingredients for marketing as soon as the applicable patents expire or at any
time thereafter or that competitors will not design around existing patents.
Sales of such generic versions could have an adverse effect on the Company's
business, financial condition, and results of operations. The Company's
success will depend in part on its ability to obtain United States and foreign
patent protection for its products and processes, preserve its trade secrets,
and operate without infringing on the proprietary rights of third parties.
There can be no assurance that patents will issue with respect to, or that the
claims allowed will provide sufficient protection to, the Company's present or
future technology.
There can be no assurance that any other patents will be issued on any of
the Company's patent applications or on patent applications licensed from
third parties. Moreover, there can be no assurance that claims allowed in the
patents or patent applications are or will be sufficiently broad to protect
the Company's technology or that the patents will provide protection against
competitive products or otherwise be commercially valuable.
Furthermore, as with any pharmaceutical company, the Company's patent and
other proprietary rights are subject to uncertainty. The Company's patent or
other proprietary rights related to its products might conflict with current
or future rights of others. For instance, there is no assurance that the use
of the Company's technology will not infringe the patent rights of others. For
the same reasons, the products of others could infringe the patent or other
proprietary rights of the Company. Litigation or patent interference
proceedings, either of which could result in substantial cost to the Company,
may be necessary to enforce any patents issued to and other proprietary rights
of the Company or to determine the scope and validity of other parties'
proprietary rights. The defense and prosecution of patent and intellectual
property claims are both costly and time-consuming, even if the outcome is
favorable to the Company. Any adverse outcome could subject the Company
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to significant liabilities to third parties, require disputed rights to be
licensed from third parties, or require the Company to cease selling its
products.
In addition to patent protection, the Company also relies on trade secrets,
proprietary know-how and technological advances which it seeks to protect, in
part, through confidentiality agreements with its collaborative partners,
employees and consultants. There can be no assurance that these agreements
will not be breached, that the Company will have adequate remedies for any
breach, or that the Company's trade secrets and proprietary know-how will not
otherwise become known or be independently developed by others.
There can be no assurance that the Company will be able to obtain a license
to any third-party technology that it may require to conduct its business or
that, if obtainable, such technology can be licensed at a reasonable cost.
Failure by the Company to obtain a license to any technology that it may
require to commercialize its technologies or products will have a material
adverse effect on the Company. In addition, there can be no assurance that
others will not independently develop substantially equivalent proprietary
information or obtain access to the Company's know-how, or that others will
not be issued patents which prevent the manufacture or sale of Company
products or require licensing and the payment of significant fees or royalties
by the Company in order for it to be able to carry on its business.
Litigation, which could result in substantial cost to the Company, may be
necessary to enforce or defend the Company's patents or proprietary rights.
Intense Competition. Competition in the pharmaceutical industry is intense
and characterized by extensive research efforts and rapid technological
progress. The Company believes that there are numerous pharmaceutical and
biotechnology companies, both public and private and including large well-
known pharmaceutical companies, as well as academic research groups throughout
the world engaged in research and development efforts with respect to
pharmaceutical products targeted at gastrointestinal diseases and conditions
addressed by the Company's current and potential products. In particular, the
Company is aware of products in research or development by competitors that
address the diseases being targeted by the Company's products. There can be no
assurance that developments by others will not render the Company's current
and potential products obsolete or non-competitive. Competitors may be able to
complete the development and regulatory approval process sooner and,
therefore, market their products earlier than the Company. Many of the
Company's competitors have substantially greater financial, marketing and
personnel resources and development capabilities than the Company. For
example, many large, well capitalized companies already offer products in the
United States and Europe that target the proposed indications for Colazide,
including mesalamine (SmithKline Beecham plc, Dr. Falk Pharma GmbH, Pharmacia
& Upjohn, Inc., Solvay S.A., The Procter & Gamble Company, and Hoechst Marion
Roussel, Inc.), sulfasalazine (Pharmacia & Upjohn, Inc.), and olsalazine
(Pharmacia & Upjohn, Inc.). Technological developments by competitors, earlier
regulatory approval for marketing competitive products, or superior marketing
capabilities possessed by competitors could adversely affect the commercial
potential of the Company's products, including Colazide, and could have a
material adverse effect on the Company's business, financial condition, and
results of operations. In addition, manufacturers of generic drugs may seek to
compete directly with the Company's products in the absence of effective
patent protection or non-patent exclusivity protection.
Currency Fluctuations. A significant portion of the company's business is
conducted in currencies other than the United States dollar. Foreign currency
transaction gains and losses arising from normal business operations are
credited to or charged against earnings in the period incurred. As a result,
fluctuations in the value of the currencies in which the Company conducts its
business relative to the United States dollar have caused and will continue to
cause currency transaction gains and losses. Although translation into the
Company's reporting currency has not historically had a material impact on the
Company's financial position, due to the substantial volatility of currency
exchange rates, among other factors, the Company cannot predict the effect of
exchange rate fluctuations upon future operating results. There can be no
assurance that the Company will not experience currency losses in the future.
The Company has not previously undertaken hedging transactions to cover its
currency exposure but may hedge a portion of its currency exposure in the
future as management deems appropriate.
Management of Growth. The Company expects to experience significant growth
in the number of its employees and the scope of its operations. This growth is
expected to place a significant strain on the Company's management and
operations. The Company's ability to manage such growth effectively will
depend upon its
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ability to broaden its management team and its ability to attract, hire, and
retain skilled employees. The Company's success will also depend on the
ability of its officers and key employees to continue to implement and improve
its operational, management information and financial control systems and to
expand, train and manage its employee base. The Company's inability to manage
growth effectively could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Key Personnel; Ability to Recruit Personnel. The Company is
dependent upon a number of key management and technical personnel, none of
whom is bound by an employment agreement with the Company, including Randy
Hamilton, chairman, Chief Executive Officer and President, Lorin Johnson, Vice
President, Research (Salix Pharmaceuticals), and James Shook, Senior Vice
President, Development (Salix Pharmaceuticals). The loss of the services of
one or more key employees could have a material adverse effect on the Company.
The Company's success will also depend on its ability to attract and retain
additional highly qualified management and technical personnel. The Company
faces intense competition for qualified personnel, many of whom are often
subject to competing employment offers. In the event the Company obtains
regulatory approvals for rifaximin, it intends to sell rifaximin through a
small direct sales force. New employees, particularly new sales and marketing
employees, will require substantial training and education concerning the
Company's products. There can be no assurance that the Company will be
successful in attracting and retaining qualified personnel as necessary, and
the failure to do so could have a material adverse effect on the Company's
business, operating results, and financial condition.
Price Volatility; Limited Trading Volume; Foreign Exchange Risk. The
securities markets have from time to time experienced significant price and
volume fluctuations that may be unrelated to the operating performance of
particular companies. In addition, the market prices of the common stock of
many publicly traded pharmaceutical and biotechnology companies have in the
past and can in the future be expected to be especially volatile.
Announcements of technological innovations or new products by the Company or
its competitors, developments or disputes concerning proprietary rights,
publicity regarding actual or potential medical results relating to products
under development by the Company or its competitors, regulatory developments
in both the United States and other countries, public concern as to the safety
of pharmaceutical products and economic and other external factors, as well as
period-to-period fluctuations in the Company's financial results, may have a
significant impact on the market price of the Company's Common Shares. The
Company's Common Shares have been traded on The Toronto Stock Exchange since
May 1996 were not freely tradeable in the United States until October 1997,
and no public trading market exists for the Common Shares in the United
States. In addition, trading volume in the Common Shares on The Toronto Stock
Exchange has been low, and there can be no assurances that an active trading
market will develop or be sustained on The Toronto Stock Exchange, or any
other exchange or dealer quotation system.
The Common Shares trade on The Toronto Stock Exchange in Canadian dollars.
In addition to the general market risks associated with ownership of equity
securities and the more specific risks of ownership of the Common Shares of
the Company, U.S. holders of the Common Shares also bear exchange rate risks
resulting from fluctuations in the relative values of the Canadian dollar and
the U.S. dollar. The value of the Canadian dollar has fluctuated substantially
in the past relative to the United States dollar and other currencies and may
continue to do so in the future. As a result, for U.S. investors and other
non-Canadian investors, the value of the Common Shares in United States
dollars or other currencies may vary independently of changes in the trading
price of the Common Shares on The Toronto Stock Exchange and for reasons
unrelated to the Company or its business, results of operations, or financial
condition.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in the Company's
Consolidated Financial Statements and Notes thereto beginning at page F-1 of
this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
32
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item concerning the Company's directors is
incorporated by reference from the section captioned "Election of Directors"
contained in the Company's Proxy Statement related to the 1998 Annual Meeting
of Shareholder scheduled to be held on May 12, 1998, which will be filed by
the Company with the United States Securities and Exchange Commission within
120 days of the end of the Company's fiscal year pursuant to General
Instruction G(3) of Form 10-K (the "Proxy Statement"). The information
required by this Item concerning executive officers of the Registrant is set
forth in Part I of this report. The information required by this Item
concerning compliance with Section 16(a) of the United States Securities
Exchange Act of 1934, as amended, is incorporated by reference from the
section of the Proxy Statement captioned "Section 16(a) Beneficial Ownership
Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
information under the section captioned "Executive Compensation and Other
Matters" contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information under the section captioned "Security Ownership of Management and
Certain Beneficial Owners" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information under the sections captioned "Compensation Committee Interlocks
and Insider Participation" and "Certain Transactions" contained in the Proxy
Statement.
33
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)1. FINANCIAL STATEMENTS
The following statements are filed as part of this report:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Public Auditors............... F-2
Consolidated Balance Sheets............................................ F-3
Consolidated Statements of Operations.................................. F-4
Consolidated Statements of Shareholders' Equity (Net Capital
Deficiency)........................................................... F-5
Consolidated Statements of Cash Flows.................................. F-6
Notes to Consolidated Financial Statements............................. F-7
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in
the financial statements or notes thereto.
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
----------- -------------
<C> <S>
3.1(a) Memorandum of Association of Salix Holdings, Ltd.
3.2(a) Articles of Association of Salix Holdings, Ltd.
3.3(c) Notice of Amendment to Memorandum and Articles of
Association dated March 3, 1998
4.1(a) Form of Common Share Certificate.
4.2(a) Form of Warrant to purchase Common Shares.
4.3(a) Form of Warrant to purchase Common Shares.
10.1(a) Form of Indemnification Agreement between the Registrant
and each of its officers and directors.
10.2(a) Form of 1994 Stock Plan for Salix Holdings, Ltd. and form
of Stock Option and Restricted Stock Purchase Agreements
thereunder.
10.3(a) Form of 1996 Stock Option Plan for Salix Holdings, Ltd. and
form of Notice of Stock Option Grant and Stock Option
Agreement thereunder.
10.4(b) Amendment Agreement effective as of September 17, 1992 by
and among Glycyx Pharmaceuticals, Ltd., Salix
Pharmaceuticals, Inc. and Biorex Laboratories, Inc.
10.5(b) License Agreement, dated September 17, 1992 between Biorex
Laboratories Limited and Glycyx Pharmaceuticals Limited and
letter agreement amendments thereto.
10.6(b) Research and Development Agreement dated September 21, 1992
between Glycyx Pharmaceuticals, ltd. and AB Astra and
letter agreement amendments thereto.
10.7(b) Distribution Agreement dated September 21, 1992 between
Glycyx Pharmaceuticals, Ltd. and AB Astra.
10.8(b) Amended and Restated License Agreement by and between Salix
Pharmaceuticals, Inc. and Biorex Laboratories, Limited,
dated April 16, 1993.
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE
----------- -------------
<C> <S>
10.9(b) Co-Participation Agreement, dated April 30, 1993 between
Salix Pharmaceuticals, Inc. and AB Astra as amended by
Amendment No. 1 thereto effective September 30, 1993.
10.10(b) Manufacturing Agreement, dated September 15, 1993 between
Courtaulds Chemicals Limited and Glycyx Pharmaceuticals,
Limited.
10.11(b) Distribution Agreement, dated September 23, 1994 between
Glycyx Pharmaceuticals, Ltd. and Menarini International
Operations Luxembourg SA and amendments thereto.
10.12(b) License Agreement, dated June 24, 1996, between Alfa
Wassermann S.p.A. and Salix Pharmaceuticals, Ltd.
10.13(b) Supply Agreement, dated June 24, 1996, between Alfa
Wassermann S.p.A. and Salix Pharmaceuticals, Ltd.
10.14(a) Lease dated January 1, 1992 by and between Kontrabecki
Mason Developers and Salix Pharmaceuticals, Inc., as
amended.
21.1(a) Subsidiaries of the Registrant.
23.1(d) Consent of Ernst & Young LLP.
24.1(d) Power of Attorney (see page 36).
27.1(d) Financial Data Schedule
</TABLE>
- --------
(a) Incorporated by reference to the exhibit bearing the same number filed
with the Registrant's Registration Statement on Form S-1 (Registration No.
333-33781), which the United States Securities and Exchange Commission
declared effective on October 16, 1997.
(b) Incorporated by reference to the exhibit bearing the same number filed
with the Registrant's Registration Statement on Form S-1 (Registration No.
333-33781), which the United States Securities and Exchange Commission
declared effective on October 16, 1997. The Registrant has received
confidential treatment with respect to certain portions of this exhibit.
Such portions have been omitted from this exhibit and have been filed
separately with the United States Securities and Exchange Commission.
(c) Incorporated by reference to the exhibit bearing the same number filed
with the Registrant's Current Report on Form 8-K, which was filed with the
United States Securities and Exchange Commission on March 24, 1998.
(d) Filed herewith.
(B)REPORTS ON FORM 8-K.
The Registrant filed no Current Reports on Form 8-K during the year
ended December 31, 1997.
(C)EXHIBITS
See Item 14(a)(3) above.
(D)FINANCIAL STATEMENT SCHEDULES
See Item 14(a)(2) above.
35
<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
PALO ALTO, CALIFORNIA.
SALIX PHARMACEUTICALS, LTD.
Date: March 30, 1998 /s/ Randy W. Hamilton
By: _________________________________
Randy W. Hamilton,
Chairman of the Board, President
and Chief Executive Officer
Date: March 30, 1998 /s/ David Boyle
By: _________________________________
David Boyle,
Vice President, Finance &
Administration,
and Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Randy W. Hamilton and David Boyle and
each of them acting individually, as his or her attorney-in-fact, each with
full power of substitution, for him or her in any and all capacities, to sign
any and all amendments to this Report on Form 10-K, and to file the same, with
all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Randy W. Hamilton Chairman of the Board, March 30, 1998
____________________________________ President and Chief
Randy Hamilton Executive Officer (Principal
Executive Officer)
/s/ David Boyle Vice President, Finance & March 30, 1998
____________________________________ Administration, Chief
David Boyle Financial Officer (Principal
Financial and Accounting
Officer)
/s/ Lily Baxendale Director March 30, 1998
____________________________________
Lily Baxendale
/s/ Lawrance A. Brown, Jr. Director March 30, 1998
____________________________________
Lawrance A. Brown, Jr.
/s/ John F. Chappell Director March 30, 1998
____________________________________
John F. Chappell
/s/ Nicholas M. Ediger Director March 30, 1998
____________________________________
Nicholas M. Ediger
/s/ Lorin K. Johnson Director March 30, 1998
____________________________________
Lorin K. Johnson
/s/ David E. Lauck Director March 30, 1998
____________________________________
David E. Lauck
</TABLE>
36
<PAGE>
SALIX PHARMACEUTICALS, LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations...................................... F-4
Consolidated Statement of Shareholders' Equity (Net Capital Deficiency).... F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Salix Pharmaceuticals, Ltd.
We have audited the accompanying consolidated balance sheets of Salix
Pharmaceuticals, Ltd. as of December 31, 1997 and 1996 and the related
consolidated statements of operations, shareholders' equity (net capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1997. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Salix
Pharmaceuticals, Ltd. at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1997, in conformity with accounting principles
generally accepted in the United States.
(Signed) Ernst & Young LLP
Palo Alto, California
March 4, 1998
F-2
<PAGE>
SALIX PHARMACEUTICALS, LTD.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
-------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Note 2)........................ $ 15,173 $ 5,624
Other current assets...................................... 460 79
-------- -------
Total current assets.................................... 15,633 5,703
Property and equipment, net (Note 2)........................ 194 145
Other assets................................................ 51 10
-------- -------
$ 15,878 $ 5,858
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,749 $ 667
Other current liabilities................................. -- 43
Amount due licensor (Note 5).............................. -- 555
-------- -------
Total current liabilities............................... 1,749 1,265
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized, issuable in series, none outstanding......... -- --
Common stock, no par value; 20,000,000 shares authorized;
10,120,573 and 6,858,173 shares issued and outstanding at
December 31, 1997 and 1996, respectively................. 27,520 13,194
Accumulated deficit....................................... (13,391) (8,601)
-------- -------
Shareholders' equity.................................... 14,129 4,593
-------- -------
$ 15,878 $ 5,858
======== =======
</TABLE>
ON BEHALF OF THE BOARD:
<TABLE>
<S> <C>
/s/ RANDY W. HAMILTON /s/ LORIN K. JOHNSON
RANDY W. HAMILTON LORIN K. JOHNSON
Director Director
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
SALIX PHARMACEUTICALS, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Product revenue (Note 11)...................... $ 245 $ -- $ --
Revenue from collaborative agreements and other
(Note 6)...................................... 1,821 1,820 1,990
-------- -------- --------
Total revenues............................... 2,066 1,820 1,990
-------- -------- --------
Expenses:
Cost of products sold.......................... 827 -- --
License fees (Note 5).......................... 461 605 100
Research and development (Note 2).............. 3,516 2,053 2,888
General and administrative..................... 2,430 1,731 1,334
-------- -------- --------
Total expenses............................... 7,234 4,389 4,322
-------- -------- --------
Loss from operations............................. (5,168) (2,569) (2,332)
Interest income.................................. 400 290 18
Interest expense and other....................... (22) (172) (106)
-------- -------- --------
Net loss..................................... $ (4,790) $ (2,451) $ (2,420)
======== ======== ========
Net loss per share, basic and diluted............ $ (0.63) $ (0.46) $ (0.77)
======== ======== ========
Shares used in computing net loss per share,
basic and diluted............................... 7,613 5,365 3,149
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SALIX PHARMACEUTICALS, LTD.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
SHAREHOLDERS'
PREFERRED COMMON STOCK EQUITY
STOCK ------------------ ACCUMULATED (NET CAPITAL
AMOUNTS SHARES AMOUNTS DEFICIT DEFICIENCY)
--------- ---------- ------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... $845 3,150,965 $ 79 $ (6,150) $(5,226)
Issuance of common
stock for conversion
of debentures,
including accrued
interest............. -- 1,167,625 3,503 -- 3,503
Issuance of common
stock for conversion
of Series A, B and C
convertible preferred
stock................ (845) 466,445 845 -- --
Issuance of common
stock in connection
with the Company's
initial public
offering of
securities, net of
issuance costs of
$1,473............... -- 2,000,000 8,694 -- 8,694
Issuance of common
stock upon exercise
of stock options..... -- 73,138 73 -- 73
Net loss................ -- -- -- (2,451) (2,451)
---- ---------- ------- -------- -------
Balance at December 31,
1996................... -- 6,858,173 13,194 (8,601) 4,593
Issuance of common
stock for exercise of
warrants............. -- 200,000 1,004 -- 1,004
Issuance of common
stock in connection
with the Company's
public offering of
securities, net of
issuance costs of
$1,977............... -- 3,000,000 12,973 -- 12,973
Issuance of common
stock upon exercise
of stock options..... -- 62,400 62 -- 62
Expense recognized
upon extension of the
exercise period of
common stock options. -- -- 287 -- 287
Net loss................ -- -- -- (4,790) (4,790)
---- ---------- ------- -------- -------
Balance at December 31,
1997................... $ -- 10,120,573 $27,520 $(13,391) $14,129
==== ========== ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
SALIX PHARMACEUTICALS, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss........................................ $ (4,790) $ (2,451) $ (2,420)
Adjustments to reconcile net loss to cash used
in operating activities:
Depreciation and amortization.................. 70 55 59
Changes in assets and liabilities:
Other current assets and other assets......... (422) (22) (37)
Accounts payable and other current
liabilities.................................. 1,039 (673) 1,223
Advances from licensees....................... -- (1,186) 910
Unearned revenue.............................. -- (599) (1,687)
Amount due licensor........................... (555) 555 --
-------- -------- --------
Net cash used in operating activities........ (4,658) (4,321) (1,952)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment............. (119) (21) (3)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of convertible promissory
notes.......................................... -- -- 607
Proceeds from issuance of promissory notes...... -- -- 1,200
Proceeds from issuance of convertible
debentures..................................... -- 1,375 --
Proceeds from issuance of common stock.......... 14,326 8,767 7
Payments of principal on secured promissory
note........................................... -- (364) --
-------- -------- --------
Net cash provided by financing activities.... 14,326 9,778 1,814
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents..................................... 9,549 5,436 (141)
Cash and cash equivalents at beginning of year... 5,624 188 329
-------- -------- --------
Cash and cash equivalents at end of year......... $ 15,173 $ 5,624 $ 188
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest.......................... $ -- $ 13 $ 5
======== ======== ========
NONCASH FINANCING ACTIVITIES
Issuance of convertible debentures for
promissory notes and related interest.......... $ -- $ 1,905 $ --
======== ======== ========
Issuance of convertible debentures for amount
due licensor................................... $ -- $ 100 $ --
======== ======== ========
Issuance of common stock for convertible
debentures and related interest................ $ -- $ 3,503 $ --
======== ======== ========
Issuance of common stock for preferred stock.... $ -- $ 845 $ --
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
1. ORGANIZATION AND BASIS OF PRESENTATION
Salix Pharmaceuticals, Ltd., formerly Salix Holdings, Ltd. (the "Company"),
was incorporated in the British Virgin Islands in December 1993 for the
purpose of acquiring all of the outstanding capital stock of Salix
Pharmaceuticals, Inc., a California corporation ("Salix California"), and
Glycyx Pharmaceuticals, Ltd., a Bermuda corporation ("Glycyx"). Salix
California was incorporated in California in 1989 and Glycyx was incorporated
in Bermuda in 1992. Salix and Glycyx had identical shareholder ownership
interests in the period from the inception of Glycyx through March 1994. The
Company is developing new pharmaceuticals, primarily focused in the area of
gastrointestinal disease. The Company received its first product approval in
fiscal 1997 and commenced product shipments in the third quarter of this year.
In March 1994, Salix Pharmaceuticals, Ltd. entered into an agreement with
the shareholders of Salix California and Glycyx, whereby it issued shares in
exchange for the shareholders' interests in Salix California and Glycyx. As a
result of the exchange, Salix California and Glycyx became wholly owned
subsidiaries of the Company.
These statements are stated in United States dollars and are prepared under
accounting principles generally accepted in the United States. All significant
intercompany balances and transactions have been eliminated.
The Company has sustained continuing operating losses and expects such
losses to continue until additional product approvals are obtained and product
revenues reach a sufficient level to support ongoing operations. There can be
no assurance that such product approvals and revenues will be obtained on a
timely basis, if at all. The Company believes that its current cash reserves
should be sufficient to satisfy the cash requirements of product development
programs for at least the next year. The Company's actual cash requirements
may vary materially from those now planned because of results of research and
development activities, establishment of and changes in relationships with
strategic partners, changes in focus and direction of the Company's research
and development programs, the FDA regulatory process, and other factors. To
the extent that the Company proceeds with the development and in-licensing of
new products, the Company anticipates that it will need to raise additional
funds in the form of debt or equity financing to fund its future operations.
The Company may also enter into collaborative arrangements with corporate
partners that could provide the Company with additional funding in the form of
equity, debt, licensing, milestone and/or royalty payments. There can be no
assurance that the Company will be able to enter into such arrangements or
raise any additional funds on terms favorable to the Company, if at all. If
adequate capital is unavailable, the Company may have to reduce substantially
or eliminate expenditures for research and development of new products and
indications.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These statements have been prepared in accordance with accounting principles
generally accepted in the United States. The application of these principles
conforms in all material respects with financial statements prepared using
accounting principles generally accepted in Canada.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB"), issued
Statement of Financial Accounting Standard ("FAS") No. 130, "Reporting
Comprehensive Income," which requires the reporting of comprehensive income
and its components in a full set of general-purpose financial statements. FAS
No. 130 is effective for annual and interim reporting periods beginning after
December 15, 1997. The adoption of FAS No. 130 will not have a material impact
upon the Company.
F-7
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
Also, in June 1997, the FASB issued FAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information." FAS No. 131 establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to shareholders. This Statement is effective for
fiscal years beginning after December 15, 1997. The Company conducts its
business in one industry segment.
Uses of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
Product sales are recorded upon shipment of order, net of estimated returns
(which have been minimal). Product sales in 1997 were limited to shipments
made to one of the Company's licensees.
The Company's collaborative research and licensing agreements with its
license partners provide for payments in support of the Company's research
activities and additional payments upon the attainment of specific milestones.
Research reimbursements under these agreements are recorded when earned based
on contract costs incurred to date compared with total estimated contract
costs. License fees and milestone revenues are recognized according to
contract terms, to the extent that no performance obligations remain and
collection of the receivable amount is deemed probable. Amounts received in
advance of the applicable research activities are deferred as unearned
revenue. Amounts received which are subject to refundability until the point
at which milestones are achieved are deferred as advances from licensees,
until earned.
Research and Development
Research and development costs are expensed as incurred.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities from
date of purchase of three months or less to be cash equivalents. The Company
maintains its cash and cash equivalents in several different instruments with
various banks and brokerage houses. This diversification of risk is consistent
with Company policy to maintain liquidity and ensure the safety of principal.
For these short-term instruments, the carrying value approximates fair value
at December 31, 1997 and 1996, respectively.
F-8
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
Property and Equipment
Property and equipment are stated at cost and depreciated over the estimated
useful lives of the assets, generally five years, using the straight-line
method. Property and equipment consisted of the following at December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Cost:
Furniture and equipment....................................... $133 $105
Computer equipment............................................ 212 122
Laboratory equipment.......................................... 107 106
---- ----
452 333
Accumulated depreciation:
Furniture and equipment....................................... 84 64
Computer equipment............................................ 117 67
Laboratory equipment.......................................... 57 57
---- ----
258 188
---- ----
Net property and equipment...................................... $194 $145
==== ====
</TABLE>
Foreign Currency Translation
The functional currency for the Company is the United States dollar. The
adjustment resulting from translating the financial statements of the Company
and its foreign subsidiaries is reflected in the results of operations.
Foreign currency transaction gains of approximately $20,000 and $79,000 were
recorded in the years ended December 31, 1997 and 1996, respectively. A
foreign currency transaction loss of approximately $7,000 was incurred in the
year ended December 31, 1995. These gains and losses are included in the
results of operations.
Net Loss Per Common Share
In February, 1997, the FASB issued FAS No. 128 "Earnings Per Share." Basic
and diluted net loss per common share have been computed using the weighted-
average number of common shares outstanding during each year. Common
equivalent shares are excluded from the computation as their effect is anti-
dilutive in all periods.
3. INITIAL PUBLIC OFFERING AND FOLLOW-ON OFFERING
In May 1996, the Company completed its initial public offering, listed on
The Toronto Stock Exchange, and issued 2,000,000 shares of its common stock at
a price of Cdn. $7.00 (U.S. $5.25) per share. The Company received
approximately $8.7 million in cash, net of underwriting discounts, commissions
and other offering costs. Simultaneously with the closing of the initial
public offering, each outstanding share of convertible preferred stock was
automatically converted into one share of common stock, and $3.5 million
principal and accrued interest of convertible debentures issued in January and
February 1996 were converted into 1,167,625 "units" consisting of one common
share and one-half of one common share purchase warrant (see Note 10).
In October 1997, the Company completed a follow-on public offering, issuing
3,000,000 shares of its common stock at price of Cdn. $7.00 (U.S. $4.98). The
Company received approximately $13 million in cash, net of underwriting
discounts, commissions and other offering costs.
F-9
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
4. FOREIGN SUBSIDIARIES
Glycyx, a wholly owned subsidiary incorporated in Bermuda, recognized net
losses of approximately $1,031,000, $39,000 and $1,617,000 in the years ended
December 31, 1997, 1996 and 1995, respectively. Salix, a wholly owned
subsidiary incorporated in the United States, recognized net losses of
approximately $3,119,000, $2,054,000 and $499,000 in the years ended December
31, 1997, 1996 and 1995, respectively.
5. TECHNOLOGY LICENSING
In January 1991 and March 1992, the Company entered into license agreements
with a company possessing certain patents relating to balsalazide, a
therapeutic agent with potential use in the treatment of ulcerative colitis
and other diseases. Under the agreements, the Company will pay the licensor,
which is also a shareholder in the Company, a royalty based on a percentage of
gross profit on the drug in one defined territory and a sales-based royalty in
other territories. In addition, milestone payments from the Company to the
licensor will be paid to the licensor based upon development efforts. In the
January 1991 agreement, as amended, the Company obtained the exclusive right
to develop and market balsalazide in the United States. In the March 1992
agreement, as amended, the Company licensed the exclusive right to develop,
manufacture and market the same drug in the rest of the world excluding Japan,
Taiwan and Korea. The first product under development pursuant to these
licenses is Colazide(R), a form of balsalazide proposed for the treatment of
ulcerative colitis. At December 31, 1996, a total of $555,000 was due the
licensor. Such amount was paid in February 1997. At December 31, 1997, no
amounts were due the licensor.
6. LICENSE REVENUE AND REVENUE FROM COLLABORATIVE AGREEMENTS
In September 1992, the Company entered into research, development and
distribution agreements whereby the Company granted its partner an exclusive
right to promote, market, distribute and sell Colazide in certain territories
outside of the United States. The research under this agreement took place
through December 1993 and revenue from research funding was recognized as
earned.
In 1992, the Company received a portion of the license fees payable under
the agreement, with the remaining payments due upon the receipt of approval to
market the product by the relevant regulatory authorities in five principal
territories. Under the distribution agreement, the partner will purchase
product from the Company at an agreed upon price based on a percentage of the
partner's selling price of the product. The licensee has the right to offset
(Pounds)750,000 (approximately $1,207,500 at December 31, 1997 exchange rates)
previously paid to the Company in the form of a 20% discount against the price
of Colazide purchased by the licensee.
In April 1993, Salix entered into a collaborative agreement with the above-
mentioned partner covering pharmaceutical product development and marketing of
Colazide in the United States. In consideration for the rights granted, the
partner agreed to pay the Company a specified licensing fee and to fund
development up to a specified amount. The Company recognized development
revenue of $599,000 and $1,687,000 in 1996 and 1995, respectively, under these
agreements. License fee revenue of $1,821,000 was recognized in 1997, of which
$821,000 occurred upon the attainment of marketing approval for Colazide in
the United Kingdom and of which $1,000,000 occurred upon the filing of a NDA
with the United States Food and Drug Administration.
In October 1992, the Company entered into a distribution agreement with a
second licensee for Colazide in southern Europe. This agreement calls for
payments to the Company in support of clinical trials and upon the achievement
of certain milestones. Under this agreement, the partner will purchase product
when approved from
F-10
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
the Company at an agreed upon price. Such milestones were achieved and
accepted by the licensee in 1996 and revenue of approximately $1,186,000 was
recognized.
7. COMMITMENTS
The Company leases an office facility. Rent expense was approximately
$167,000, $112,000 and $81,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
In July 1997, the Company amended the lease related to its office facility
to extend through August 2001. Future payments for operating leases at
December 31, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
OPERATING
LEASE
---------
<S> <C>
Years ending December 31,
1998......................................................... $ 256
1999......................................................... 296
2000......................................................... 353
2001......................................................... 357
------
Total minimum payments required................................ $1,262
======
</TABLE>
At December 31, 1997, the Company had a binding purchase order commitment
for inventory purchases aggregating $540,000 to be delivered in 1998.
8. SHAREHOLDERS' EQUITY
Preferred Stock
In May 1996, the Company closed its initial public offering of its common
stock. At that time, all issued and outstanding shares of the Company's Series
A, B and C convertible preferred stock were converted into 466,445 shares of
the Company's common stock. A total of 5,000,000 shares of preferred stock are
authorized and issuable in series. No shares of preferred stock were issued as
of December 31, 1997.
Stock Option Plans
The Company's 1994 Stock Plan (the "Plan") was adopted by the board of
directors in March 1994 and approved by the shareholders in March 1995. The
Company's 1996 Stock Option Plan (the "1996 Plan") was adopted by the board of
directors and approved by the Company's shareholders in February 1996. The
options granted under the Plan and the 1996 Plan may be either incentive stock
options or nonstatutory stock options. Options granted expire no later than
ten years from the date of grant.
For incentive stock options, the option price shall be at least 100% of the
fair market value on the date of grant, and no less than 85% of the fair
market value for nonqualified stock options. If, at the time the Company
grants an option, the optionee directly or by attribution owns stock
possessing more than 10% of the total combined voting power of all classes of
stock of the Company, the option price shall be at least 110% of the fair
market value and shall not be exercisable more than five years after the date
of grant. The options generally become exercisable in increments of 1/48th per
month over a period of 48 months from the date of grant. Options may be
granted with different vesting terms as determined by the board of directors.
F-11
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
At December 31, 1997, the Company has reserved 1,014,462 shares of common
stock for issuance to eligible participants under the two plans.
Aggregate option activity is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
------------------------
SHARES WEIGHTED-
AVAILABLE NUMBER OF AVERAGE
FOR GRANT SHARES EXERCISE PRICE
--------- --------- --------------
<S> <C> <C> <C>
Balance at December 31, 1995................ 74,175 425,825 $1.00
Additional shares authorized.............. 650,000 -- --
Options granted........................... (133,000) 133,000 $3.82
Options exercised......................... -- (73,138) $1.00
Options canceled.......................... 4,687 (4,687) $1.00
-------- ------- -----
Balance at December 31, 1996................ 595,862 481,000 $1.78
Options granted........................... (480,500) 480,500 $5.81
Options exercised......................... -- (62,400) $1.00
Options canceled.......................... 15,989 (15,989) $3.40
-------- ------- -----
Balance at December 31, 1997................ 131,351 883,111 $4.00
======== ======= =====
</TABLE>
At December 31, 1996, options were exercisable to purchase 272,167 shares at
a weighted-average exercise price of $1.21 per share. At December 31, 1997,
options were exercisable to purchase 445,805 shares at a weighted-average
exercise price of $2.85 per share.
Exercise prices for options outstanding as of December 31, 1997 ranged from
$1.00 to $7.00 per share. The weighted-average remaining contractual life of
those options is 8.5 years.
The weighted-average exercise price of options granted in fiscal 1997 and
1996 was $5.81 and $3.82, respectively.
Stock-Based Compensation
As permitted under FAS Statement No. 123, "Accounting for Stock-Based
Compensation" ("FAS No. 123"), the Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25") in accounting for stock-based awards to employees. Under APB
No. 25, the Company generally recognizes no compensation expense with respect
to such awards.
Pro forma information regarding net loss and net loss per share is required
under FAS No. 123 for awards granted after December 31, 1994 as if the Company
had accounted for its stock-based awards to employees under the fair value
method of FAS No. 123. The fair value of the Company stock-based awards to
employees was estimated using a Black-Scholes option pricing model (minimum
value model for awards prior to the Company's initial public offering). The
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, the Black-Scholes model requires the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's stock-based awards to employees have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of
F-12
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
the fair value of its stock-based awards to employees. The fair value of the
Company's stock-based awards to employees was estimated assuming no expected
dividends and the following weighted-average assumptions:
<TABLE>
<CAPTION>
OPTIONS OPTIONS OPTIONS
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Expected life (years)............................ 5 5 5
Expected volatility.............................. 0.6 0.6 --
Risk-free interest rate.......................... 5.74% 6.13% 7.00%
</TABLE>
Had compensation cost for the Company's stock-based compensation plan been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of FAS No. 123, the Company's net loss and
loss per share would have been increased to the pro forma amounts indicated
below for the year ended December 31, 1997. For years ended December 31, 1996
and 1995, the effect of applying the FAS No. 123 Black-Scholes option
valuation model to the Company's stock option grants did not result in pro
forma net loss and loss per share amounts that are materially different from
historical amounts reported. Therefore, such pro forma information is not
separately presented for those years.
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Pro forma net loss (in thousands)... $(5,011)
Pro forma loss per share
Basic and diluted................. $ (0.66)
</TABLE>
FAS No. 123 is applicable only to awards granted subsequent to December 31,
1994, its pro forma effect will not be fully reflected until approximately
1998. Future pro forma net income (loss) and earnings (loss) per share results
may be materially different from actual amounts reported.
401(k) Plan
In 1996, the Company adopted the Salix Pharmaceuticals, Inc. 401(k)
Retirement Plan. Eligible participants may elect to defer a percentage of
their compensation. The Company matches up to 25% of such participant
deferrals, provided that such deferrals do not exceed 6% of the participant's
compensation. The Company's total matching contribution for all participants
in fiscal 1997 was approximately $10,000.00. Additional discretionary employer
contributions may be made on an annual basis.
F-13
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
9. INCOME TAXES
As of December 31, 1997, the Company has a U.S. federal net operating loss
carryforward of approximately $8,800,000 related to its U.S. subsidiary, Salix
California. This will expire on various dates beginning in 2004 through 2012,
if not utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................... $ 3,150 $ 2,000
Capitalized research and development expenses.......... 290 100
Other.................................................. 100 200
------- -------
Total deferred tax assets................................ 3,540 2,300
Valuation allowance...................................... (3,540) (2,300)
------- -------
Net deferred taxes....................................... -- --
======= =======
</TABLE>
Because of the Company's lack of earnings history, the deferred tax asset
has been fully offset by a valuation allowance. The valuation allowance
increased by $850,000 during the year ended December 31, 1996.
Utilization of the federal net operating loss and credit carryforwards may
be subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986. The annual limitation may
result in the expiration of net operating losses and credits before
utilization.
The Company's Bermuda subsidiary, Glycyx, has a cumulative loss of
approximately $3,000,000. Because Glycyx is domiciled in Bermuda where the
effective tax rate is zero, the Company expects to receive no future tax
benefit from these net operating losses.
10. PROMISSORY NOTES AND WARRANTS
On January 12, 1996 and February 2, 1996, the Company completed the private
placement of an aggregate principal amount of $3,379,500 of 10% convertible
secured debentures maturing on December 31, 1998 to certain new and existing
investors. As part of the financing, holders of outstanding convertible
promissory notes and other promissory notes converted the principal and
accrued interest on such notes into debentures. In addition, $100,000 owed by
the Company to a licensor as of December 31, 1995 was converted into
debentures as part of this financing.
Upon the completion of the initial public offering in May 1996, the
debentures were converted at the option of the holder into units comprised of
one share of common stock and one-half of one common stock purchase warrant,
as referred to in Note 3. The conversion price for such units was Cdn. $4.00
(U.S. $3.00 at the May 15, 1996 exchange rate). Also, in connection with the
initial public offering, the Company issued to the underwriters common share
purchase warrants, exercisable into 200,000 common shares at a price of Cdn
$7.00 (U.S. $5.25). Such purchase warrants were exercised in 1997, raising
proceeds to the Company of approximately Cdn. $1,400,000 (U.S. $1,004,000).
F-14
<PAGE>
SALIX PHARMACEUTICALS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
At December 31, 1997, 602,331 shares of common stock were reserved for
issuance upon the exercise of the warrants at exercise price of $3.00 per
share. Warrants to purchase 202,332 shares of Common Stock expire in 2000 and
warrants to purchase 399,999 shares of Common Stock expire in 2003.
11. REVENUES FROM SIGNIFICANT CUSTOMERS
Revenues from three customers represented the following percentages of total
revenues during fiscal 1997, 1996 and 1995:
<TABLE>
<CAPTION>
CUSTOMER 1997 1996 1995
-------- ------ ----- -----
<S> <C> <C> <C>
A....................... 100.0% 32.8% 85.5%
B....................... -- % -- % 10.1%
C....................... -- % 65.2% 1.1%
</TABLE>
All revenue is associated with the development of a single product,
Colazide.
12. YEAR 2000 COMPLIANCE (UNAUDITED)
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. The Company's internal
operating systems rely exclusively on software products of third party
vendors, who have provided assurance to the Company that such products are
year 2000 compliant. As a result, the Company does not believe that issues
relating to year 2000 compliance will result in a material adverse effect on
its financial condition or results of operations. If the information provided
by such software vendors were to prove incorrect, however, there can be no
assurance that the costs and disruption associated with implementing new or
corrected software would not have an adverse effect on the Company's business,
financial condition or results of operations.
13. EVENT SUBSEQUENT TO DATE OF AUDITOR'S REPORT
In March 1998, the Board of Directors approved an increase to the 1996 Plan
of 600,000 additional shares to be issued in the form of stock options.
F-15
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under "Selected Consolidated
Financial Data" and to the incorporation by reference in the Registration
Statement on Form S-8 No. 333-41801 pertaining to the 1994 Stock Plan and the
1996 Stock Option Plan of our report dated March 4, 1998, with respect to the
consolidated financial statements of Salix Pharmaceuticals, Ltd. (formerly,
Salix Holdings, Ltd.) included in the Annual Report (Form 10-K) for the year
ended December 31, 1997.
/s/ ERNST & YOUNG LLP
Palo Alto, California
March 26, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K
FISCAL 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS. </LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 15,173
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 284
<CURRENT-ASSETS> 227
<PP&E> 452
<DEPRECIATION> 258
<TOTAL-ASSETS> 15,878
<CURRENT-LIABILITIES> 1,749
<BONDS> 0
0
0
<COMMON> 27,520
<OTHER-SE> (13,391)
<TOTAL-LIABILITY-AND-EQUITY> 15,878
<SALES> 245
<TOTAL-REVENUES> 2,066
<CGS> 827
<TOTAL-COSTS> 7,234
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 22
<INCOME-PRETAX> (4,790)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,790)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,790)
<EPS-PRIMARY> (00.63)
<EPS-DILUTED> (00.63)
<FN>
INTEREST EXPENSE INCLUDES INTEREST AND OTHER EXPENSE FOR THE PURPOSE OF THIS
FINANCIAL DATA SCHEDULE. </FN>
</TABLE>
