UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 000-22171
KOS PHARMACEUTICALS, INC.
(Exact Name of Company as Specified in Its Charter)
FLORIDA 65-0670898
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1001 BRICKELL BAY DRIVE, 25TH FLOOR, MIAMI, FLORIDA 33131
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(Address of Principal Executive Offices, Zip Code)
Company's Telephone Number, Including Area Code: (305) 577-3464
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value
Indicate by check mark whether the Company (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 Company
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [checkmark] No [ ]
Indicate by check mark if disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. [checkmark]
The aggregate market value of Kos Pharmaceuticals, Inc. Common Stock, $.01
par value, held by non-affiliates, computed by reference to the price at which
the stock was sold as of February 19, 1999: $44,702,275.
Number of shares of Common Stock of Kos Pharmaceuticals, Inc. issued and
outstanding as of February 19, 1999: 17,731,504
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement for the Company's 1999 Annual Meeting of Shareholders
(incorporated in Part III to the extent provided in
Items 10, 11, 12 and 13 hereof).
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TABLE OF CONTENTS
PART I PAGE
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Item 1. Business........................................................ 1
Item 2. Properties...................................................... 10
Item 3. Legal Proceedings............................................... 10
Item 4. Submission of Matters to a Vote of Securities Holders........... 10
PART II
Item 5. Market for the Company's Common Stock and Related Shareholder
Matters......................................................... 11
Item 6. Selected Consolidated Financial Data............................ 12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 13
Forward-Looking Information: Certain Cautionary Statements...... 19
Item 7A. Quantitative and Qualitative Disclosures about Market Risk...... 28
Item 8. Consolidated Financial Statements and Supplementary Data........ 28
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures........................................... 50
PART III ................................................................ 51
PART IV
Item 14. Exhibits, Financial Schedules and Reports on Form 8-K........... 52
Signatures ................................................................ 54
NIASPAN/registered trademark/ and NICOSTATIN/trademark/ are trademarks of
Kos Pharmaceuticals, Inc.
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PART I
ITEM 1. BUSINESS
Kos Pharmaceuticals, Inc. ("Kos" or the "Company") is a fully-integrated
specialty pharmaceutical company engaged in the development of proprietary
prescription products for the treatment of certain chronic cardiovascular and
respiratory diseases. The Company manufactures its lead product, NIASPAN, and
markets such product directly through its own specialty sales force. The
Company's cardiovascular products under development consist of
controlled-release, once-a-day, oral dosage formulations. The Company's
respiratory products under development consist of aerosolized inhalation
formulations to be used primarily with the Company's proprietary inhalation
devices.
The Company believes that substantial market opportunities exist for
developing drugs that are reformulations of existing approved prescription
pharmaceutical products, but which offer certain safety advantages (such as
reduced harmful side effects) or patient compliance advantages (such as
once-a-day rather than multiple daily dosing regimens) over such currently
existing products. Kos believes that developing proprietary products based on
currently approved drugs, rather than new chemical entities ("NCEs"), may reduce
regulatory and development risks and, in addition, may facilitate the marketing
of such products because physicians are generally familiar with the safety and
efficacy of such products. With the exception of one product, all of Kos'
products under development require new drug application ("NDA") filings with the
U.S. Food and Drug Administration ("FDA"). Although such NDA filings are more
expensive and time consuming, developing products that require NDA approval
offers several advantages compared with generic products, including the
potential for higher gross margins, limited competition resulting from
significant clinical and formulation development challenges, and a three-year
statutory barrier to generic competition.
The principal elements of the Company's business strategy are as follows:
(i) select products with unrealized commercial potential where safety or patient
compliance may be improved; (ii) focus initially on the large, rapidly growing
cardiovascular and respiratory markets, which include many chronic diseases
requiring long-term therapy; (iii) develop proprietary formulations of currently
approved pharmaceutical compounds, which can reduce regulatory and development
risks typically associated with the development of new chemical entities; (iv)
manage internally the clinical development of its products; (v) manufacture its
products internally; (vi) market its products directly through the Company's
specialty sales force; and (vii) leverage its core competencies through
corporate and academic alliances.
The Company's predecessor, Kos Holdings, Inc. ("Holdings"), which was
previously named Kos Pharmaceuticals, Inc., was incorporated in Florida on July
1, 1988. On June 25, 1996, Kos (named for the Greek island where Hippocrates
founded the science of medicine) was incorporated in Florida as the successor to
the business of Holdings. On June 30, 1996, all of the assets (except for
certain net operating loss carryforwards) and all of the liabilities of Holdings
were transferred to the Company in exchange for shares of Common Stock of the
Company (the "Reorganization"). The Reorganization was accomplished in order to
transfer the assets and operations of Holdings to the Company while preserving
Holdings' net operating loss carryforwards and related tax benefits for
Holdings. As a result, the Company had no tax assets or liabilities as of June
30, 1996. Kos Investments, Inc. ("Investments") is the sole shareholder of
Holdings. Investments is controlled by, and serves as an investment vehicle for,
Michael Jaharis, one of the Company's founders and its Chairman. All references
in this 10-K to the Company include its wholly-owned subsidiary, Aeropharm
Technology, Inc. ("Aeropharm"), and the business and operations of Holdings
until June 30, 1996. The Company's principal executive offices are located at
1001 Brickell Bay Drive, 25th Floor, Miami, Florida 33131, and its telephone
number is (305) 577-3464.
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NIASPAN
On July 28, 1997, the Company received clearance from the FDA to market
NIASPAN for the treatment of mixed lipid disorders. NIASPAN is the only
once-a-day and the first extended-release formulation of any type of niacin
product ever approved by the FDA for the treatment of mixed lipid disorders. The
Company began shipping NIASPAN to wholesalers in mid-August 1997 and began
detailing NIASPAN to physicians during September 1997.
Niacin, the active ingredient in NIASPAN, is a water soluble vitamin long
recognized by the National Institutes of Health ("NIH") and the American Heart
Association ("AHA") as an effective pharmacological agent for the treatment of
multiple lipid disorders, including elevated low-density lipoprotein ("LDL") or
"bad" cholesterol, total cholesterol, and triglycerides and depressed
high-density lipoprotein ("HDL") or "good" cholesterol. Based principally on the
results of Kos' clinical studies evaluating NIASPAN, as well as other long-term
interventional studies evaluating niacin for the reduction of coronary events,
Niaspan is indicated for the following: (i) reduce elevated total cholesterol,
LDL cholesterol, and apolipoprotein B; (ii) reduce very high serum
triglycerides; (iii) reduce elevated total and LDL cholesterol when used in
combination with a bile-acid binding resin; (iv) reduce recurrent nonfatal
myocardial infarction; and (v) promote the regression or slow the progression of
atherosclerosis when combined with bile-binding resins. In addition, NIASPAN'S
prescribing information references NIASPAN'S ability to significantly improve
HDL cholesterol and lipoprotein (a) ["Lp(a)"], both of which are independent
risk factors for coronary heart disease ("CHD").
During the past five years, researchers have established through several
long-term clinical outcome studies that reducing LDL cholesterol results in
about a 30% reduction in nonfatal heart attacks and cardiac death. Such studies,
however, also have revealed that despite the significant reduction in LDL
cholesterol levels, about 70% of cardiac events were not avoided when compared
with placebo -- suggesting that there may be other lipid risk factors that
contribute to morbidity and mortality in such patients. Recently, a landmark
long-term clinical outcome study known as the HDL Intervention Trial ("HIT")
showed that raising HDL cholesterol reduced significantly the incidence of
morbidity and mortality. Specifically, the HIT results showed that even an 8%
increase in HDL resulted in a 22% reduction in the incidence of CHD-death and
nonfatal heart attacks in patients with CHD who had depressed levels of HDL, but
normal levels of LDL and triglycerides.
The results from HIT are consistent with conclusions from previous
epidemiological studies demonstrating that for each 1% increase in HDL
cholesterol, the risk of developing CHD decreases by 2% to 3%, whereas a 1%
decrease in LDL cholesterol results in only a 1% decrease in CHD risk.
Consequently, agents that further increase HDL cholesterol could potentially
improve the benefits with respect to morbidity and mortality. NIASPAN is the
most potent clinically-tested drug on the market for raising HDL cholesterol.
The Company markets NIASPAN directly to specialist physicians within the
cardiovascular market who treat most of the CHD patients and who are among the
leading prescribers of lipid-altering medications. Specifically, the Company
believes that there are approximately 20,000 such "lipid-management
specialists", consisting of cardiologists, endocrinologists, and internists, who
treat patients with CHD. Of the 14 million Americans who are estimated by the
AHA to have CHD, about 40% have low levels of HDL cholesterol as their primary
lipid abnormality. About 60% of patients with CHD have mixed lipid disorders,
consisting of two or more lipid disorders. The Company believes such patients
would benefit from NIASPAN therapy. Many such patients are candidates for
combination therapy using principally a HMG-CoA reductase inhibitor, or
"statin", to reduce LDL combined with NIASPAN to raise HDL and lower
triglycerides. Since the launch of NIASPAN, Kos has found that many such lipid
specialists are
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receptive to using combination therapy to treat their refractory patients in
order to address all of the lipids that may contribute to a coronary event. For
example, more than half of the 8,000 cardiologists who have been detailed on
NIASPAN since its launch have begun to prescribe NIASPAN, and more than 25,000
physicians have prescribed NIASPAN at least once.
As part of the Company's detailing effort, three-week NIASPAN titration
starter packs are given to physicians as a promotional item to start their
patients on NIASPAN. These titration packs are generally dispensed without a
prescription. Further, physicians being detailed by the Company may have had
unsatisfactory experiences with currently available generic formulations of
niacin, the active ingredient in NIASPAN. The Company believes, therefore, that
since the launch of NIASPAN, many physicians have started only a limited number
of selected patients on NIASPAN in order to confirm its efficacy, safety, and
tolerability (i.e., employing a "trial use" strategy). Consequently, the Company
believes that such a "trial use" strategy has limited the growth of NIASPAN
prescriptions. In general, the "trial use" period for cardiologists/specialists
is shorter than for the general practitioner. Since the launch of NIASPAN,
physicians have increased fourfold the number of NIASPAN prescriptions per
month. The Company anticipates that many physicians will continue to gradually
broaden their usage of NIASPAN as they confirm its efficacy, safety and
tolerability.
The Company's marketing efforts emphasize that NIASPAN alone or in
combination with a statin is the ideal therapy to treat all of the major lipids
that contribute to coronary heart disease. Additionally, the Company informs
physicians as to the manner in which NIASPAN achieves its safety and efficacy
profile. This marketing program is implemented through direct office visits with
selected physicians, medical journal reprints, medical seminars, and clinical
discussion groups. The Company also educates patients on the benefits and proper
use of NIASPAN through brochures and product sample "starter packs" to encourage
proper dose titration. Information delivered by the Company to physicians and
patients includes a discussion about the flushing side effects of NIASPAN,
including the importance of proper dose titration and adherence to the
prescribed dosing regimen to reduce this side effect. Although most patients
taking NIASPAN will flush occasionally, the Company believes that the
combination of NIASPAN'S formulation, its dosing regimen, and proper dose
titration should result in an incidence of flushing episodes that are tolerable
for most patients. NIASPAN'S dosing regimen provides for the drug to be taken
once-a-day at night; therefore, any flushing episodes will normally occur while
the patient is sleeping. The Company believes that flushing during the night
will not cause the discomfort or embarrassment that often accompanies the
multiple daytime flushing episodes that occur with immediate-release ("IR")
niacin. Since the launch of NIASPAN, the Company believes that the experience of
patients taking NIASPAN has been superior to that experienced by patients with
other niacin products in regard to liver function tests and flushing for the
approved treatment of mixed lipid disorders.
PRODUCTS UNDER DEVELOPMENT
Although the Company has obtained clearance from the FDA to market NIASPAN,
each of its other products under development is at an earlier stage of
development. The drug development and approval process takes many years and
requires the expenditure of substantial resources. There can be no assurance
that the Company will be able to successfully formulate any of its products
under development as planned, or that the Company will be successful in
demonstrating the safety and efficacy of such products under development in
human clinical trials. These trials may be costly and time-consuming. The
Company may not be able to obtain the regulatory approvals necessary to continue
testing or to market any or all of the Company's products under development.
Thus, there can be no assurances that any of the Company's products under
development will be developed and commercialized in a timely manner, or in
accordance with the Company's plans or projections, or at all. The Company may
determine to discontinue the development of any or all of its products under
development at any time.
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NICOSTATIN
In addition to NIASPAN, Kos is developing NICOSTATIN, a product that
consists of a combination of NIASPAN and a currently marketed statin; it will be
used to treat mixed lipid disorders. The NICOSTATIN product will require an NDA.
The Company believes that a once-a-night tablet with the combined complementary
properties of its NIASPAN product and a statin represents an effective modality
for treating patients with mixed lipid disorders. The Company also believes that
such a once-a-night product should offer significant improvement in patient
compliance compared with taking each product independently under its recommended
dosing regimen. The target market for the NICOSTATIN product consists of
patients with mixed lipid disorders, including high total and LDL cholesterol
with high triglycerides or low HDL cholesterol or both. The Company has
completed formulation development of the product and commenced a long-term open
label safety study during the second half of 1998. The Company plans to commence
pivotal clinical studies during 1999.
ISOSORBIDE-5-MONONITRATE
Kos, in collaboration with Fuisz Technologies, Ltd. ("Fuisz"), has
developed a once-a-day, controlled-release, oral, generic version of
isosorbide-5-mononitrate ("IS-5-MN") for the prophylactic treatment of angina
pectoris. During the first half of 1998, the Company submitted an abbreviated
new drug application ("ANDA") to the FDA and currently is awaiting clearance to
market the product. Depending on the FDA review period, which has been ranging
between 18 and 24 months for ANDA approvals, the Company anticipates receiving
clearance to market IS-5-MN during late 1999 or early 2000. Upon approval,
depending on the number of other approved generic equivalents of IS-5-MN on the
market at the time, Kos may elect to sell IS-5-MN through generic distribution
channels rather than promote the product itself as a branded generic. Kos is
aware of three other general IS-5-MN products that have been approved by the
FDA.
CAPTOPRIL
The Company, also in collaboration with Fuisz, had been developing a
once-a-day, controlled-release version of captopril, an angiotensin converting
enzyme ("ACE") inhibitor for the treatment of hypertension, for which an NDA is
required. In collaboration with Fuisz, the Company had made two formulations of
captopril that did not satisfactorily meet the required specifications. On this
basis, the Company has decided not to pursue further the development of the
compound because of the high costs and uncertainty associated with attempting to
overcome the unique formulation challenges of captopril.
TRIAMCINOLONE AND BUDESONIDE
Kos is developing a proprietary non-CFC, or environmentally friendly,
formulation of triamcinolone to be used with the Company's proprietary breath
coordinated inhaler ("BCI"). Triamcinolone is a corticosteroid that is used to
treat the underlying inflammation of asthma. This product will require the
submission of an NDA. The Company believes that its BCI may improve the
coordination of inhalation with actuation of medication, thereby offering
possible benefits in patient compliance and uniform dose administration. During
1998, the Company completed the formulation development of triamcinolone.
Kos is also developing a non-CFC formulation of budesonide to be used with
one of its two proprietary inhalation devices. Budesonide is a long-acting
inhaled steroid for the treatment of asthma. The Kos formulation of budesonide,
for which an NDA is required, is currently in development. The Company has
decided to pursue the development of budesonide because of its potency and
because of favorable market conditions.
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For all of the respiratory products currently in development, Kos intends
to establish strategic alliances to fund and complete the clinical programs
necessary for drug approval. The Company believes that the features and benefits
of its improved formulations, combined with Kos' novel proprietary delivery
devices, should be attractive to established pharmaceutical companies either
currently in the respiratory market or wishing to enter such market.
The Company is no longer actively developing non-CFC formulations of
flunisolide and albuterol for the treatment of asthma because of market
conditions for each of these compounds and because of the expense and other
resources required to complete their development and obtain regulatory
approvals. The Company, however, may elect to re-initiate the development of
these non-CFC formulations or other aerosolized formulations under a contract
formulation arrangement.
METERED-DOSE INHALATION ("MDI") DEVICES AND OTHER DEVICE PRODUCTS
The Company's second proprietary MDI device, a breath actuated inhaler
("BAI"), operates automatically and is being developed principally to address
the difficulties often faced by children and the elderly in taking inhaled
medication. The Company also is developing a proprietary inhalation dose counter
designed to indicate when sufficient doses no longer remain in the aerosol
canister, thereby alerting the patient to obtain a refill prescription. At
present, the Company intends to use the inhalation dose counter on all of its
proprietary inhalation devices.
COLLABORATIONS
The Company collaborates with Fuisz, a company engaged in the development
and commercialization of drug delivery and food applications, on the development
of IS-5-MN. In connection with this collaboration, Fuisz is responsible for
formulating the product, Kos is responsible for the remainder of the development
program and, Kos retains exclusive U.S. marketing rights. Kos is obligated to
pay the development costs and pay license and development fees based on
milestone achievements. In addition, Kos will pay royalties to Fuisz based on
product sales by Kos. The Company is collaborating with certain other firms in
the development of its proprietary inhalation devices.
LICENSING AND OTHER ACTIVITIES
The Company is aggressively pursuing collaborative opportunities, including
licensing the use of selected products and technologies from third parties
("in-licensing"); acquisition of complementary technologies, products or
companies; product co-marketing arrangements; joint ventures; and strategic
alliances. Many existing pharmaceutical products, or products currently under
development, may be suitable candidates for specialty promotional or
co-marketing campaigns. Accordingly, Kos intends to attempt to identify
licensing, co-marketing and product acquisition opportunities that can
complement the Company's future product portfolio. In situations where
third-party drug delivery technologies are complementary to the Company's drug
development formulation capabilities, the Company may pursue licensing rights
for such technology. The Company is also pursuing strategic alliances to license
certain of its products and technologies to third parties ("out-licensing").
Specifically, the Company is seeking a suitable co-promotion partner for NIASPAN
in the United States and a licensee to market NIASPAN for international markets.
The Company is also willing to establish a corporate alliance to co-develop
NICOSTATIN for the U.S. and international markets. Lastly, Kos currently intends
to establish strategic alliances with corporate partners with respect to its
respiratory products. There can be no assurance, however, that any of the
collaborative opportunities can be established on terms acceptable to the
Company or at all. Further, the Company's inability to enter into any strategic
alliance or other collaborative opportunity may have a material adverse effect
on the Company's financial position.
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PATENTS AND PROPRIETARY RIGHTS
The Company actively seeks, when appropriate and available, protection for
its products and proprietary information by means of United States and foreign
patents, trademarks, trade secrets and contractual arrangements. Patent
protection in the pharmaceutical field, however, can involve complex legal and
factual issues. Moreover, broad patent protection for new formulations or new
methods of use of existing chemical entities is sometimes difficult to obtain
and often of limited usefulness, primarily because the active ingredient and
many of the formulation techniques have been known for some time. Consequently,
some patents claiming new formulations or new methods of use for old drugs may
not provide meaningful protection against competition. Nevertheless, the Company
intends to seek patent protection when appropriate and available and otherwise
to rely on regulatory-related exclusivity and trade secrets to protect certain
of its products, technologies and other scientific information. There can be no
assurance, however, that any steps taken to protect such proprietary information
will be effective.
The Company has a patent application pending in the U.S. Patent and
Trademark Office ("PTO") with claims covering NIASPAN's method of use consistent
with its recommended once-a-day dosing regimen. The Company has been advised by
the patent examiner that certain of these claims are allowable, but none of
these claims have yet been issued as a patent by the PTO. The patent examiner
has, however, indicated that it may submit Kos' patent application to the PTO's
Board of Interference to determine whether it should declare an interference
between such Kos application and a method-of-use patent issued to a privately
owned generic manufacturer allegedly claiming the same dosing regimen invention.
On February 7, 1997, the Company and such generic manufacturer entered into
an agreement pursuant to which the parties agreed to resolve, as between
themselves, the effects of such potential interference by granting each other
licenses under their respective patent application and patent, regardless of
whether such licenses would be required. Accordingly, under the agreement, the
generic manufacturer granted the Company a license to sell products under the
generic manufacturer's above referenced patent, under a formulation patent owned
by such generic manufacturer, and under corresponding foreign patents owned by
such generic manufacturer, and the Company granted the generic manufacturer the
right to sell such generic manufacturer's products that are covered by the
claims in the Company's patent application and corresponding foreign
applications owned by the Company. As consideration for entering into the
agreement, the Company agreed to pay the generic manufacturer certain license
fees and royalties on the net sales of NIASPAN subject to a cap on such royalty
payments in the United States and a separate cap on such payments outside the
United States. Neither the license fees nor the royalty payments are material to
the financial condition of the Company. The Company may sublicense its rights
under the agreement to third parties to make, use, or sell products developed by
or for the Company. The generic manufacturer may not sublicense or transfer the
license granted to it by the Company, although the generic manufacturer may
sublicense to third parties the right to supply to the generic manufacturer or
market with or on behalf of the generic manufacturer, products that are covered
by the generic manufacturer's patents but which are not covered by the Company's
patent application. The Company may terminate the agreement after February 7,
2001.
Various inhalation devices, technologies, and methods of use licensed from,
or assigned to Kos by, researchers and engineers engaged in development projects
or sponsored research on behalf of Kos are the subject of issued or allowed U.S.
patents, as well as various foreign patents or patent applications. In addition,
patent applications on certain of the Company's products under development or
relating to certain sponsored research activities are pending at the PTO.
There can be no assurance that the patents owned and licensed by the
Company, or any future patents, will prevent other companies from developing
similar or therapeutically equivalent products or that others will not be issued
patents that may prevent the sale of Company products or require licensing
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and the payment of significant fees or royalties by the Company. Furthermore,
there can be no assurance that any of the Company's future products or methods
will be patentable, that such products or methods will not infringe upon the
patents of third parties, or that the Company's patents or future patents will
give the Company an exclusive position in the subject matter claimed by those
patents.
The Company is aware that certain European and U.S. patents have been
issued with claims covering products that contain certain propellant-driven
aerosol formulations. The European patents are currently subject to an
opposition proceeding in Europe, and certain claims in such patents have been
held invalid in the United Kingdom. In the event that the Company develops
aerosol products that use a formulation covered by such European or U.S.
patents, the Company may be prevented from making, using or selling such
products unless the Company obtains a license under such patents, which license
may not be available on commercially reasonable terms, or at all, or unless such
patents are determined to be invalid or unenforceable in Europe or the United
States, respectively. The Company's development of products that are covered by
such patents and its failure to obtain licenses under such patents in the event
such patents are determined to be valid and enforceable could have an adverse
effect on the Company's business.
NIASPAN and "Kos" are the Company's principal registered trademarks,
although other applications for registration of trademarks and service marks are
currently pending in the PTO and additional applications are in the process of
being filed.
MARKETING
Kos intends to market its branded proprietary products through its own
specialty sales force. A fundamental element of the Company's product selection
strategy is to focus on products where a relatively concentrated group of
specialist physicians account for a significant portion of the prescriptions for
the therapeutic indication addressed by the Company's products. The Company
believes that such specialist physicians will be the most receptive to the
patient compliance, safety, or other therapeutic advantages that the Company's
products will seek to offer. Accordingly, the Company believes that significant
market gains can be achieved with such products through the use of a relatively
small, well trained sales force concentrating its detailing efforts on informing
such specialist physicians about the scientific basis for the therapeutic
advantages of the Company's products.
As of February 12, 1999, the Company had a 259-person sales and marketing
organization, including 220 field sales representatives. The majority of the
sales and marketing personnel have considerable previous experience with major
pharmaceutical companies detailing products to cardiovascular physicians. Kos
began actively detailing NIASPAN during September 1997. During 1998, Kos nearly
doubled the size of its field force. The Company does not intend to grow the
size of its field force during 1999. The Company intends to leverage its initial
NIASPAN sales force by marketing its future cardiovascular products, if and as
they are approved, simultaneously with NIASPAN.
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MANUFACTURING
In order to maximize the quality of developed products, assure compliance
with regulatory requirements, and minimize costs, the Company intends to
manufacture all of its products internally. The Company currently produces
NIASPAN at its Hollywood, Florida facility. The Company's Edison, New Jersey,
facility may be used to produce both NIASPAN and NICOSTATIN and is currently
configured, and largely equipped, to manufacture both solid-dose and aerosol
inhalation products. Although the Company believes that its Edison facility
currently operates using current good manufacturing practices as required by the
FDA for the manufacture of product to be used in clinical trials, the facility
requires inspection and approval by the FDA before the commercial sale of
product manufactured at Edison can commence. The Company believes that it has
sufficient capacity, with limited additional capital outlays, to accommodate
sales volume for both solid-dose and aerosol products for the foreseeable
future.
The Company intends to continue to contract the packaging of its solid-dose
and aerosol products to third parties. The Company intends to begin in-house
packaging operations once product sales volumes justify the capital expenditures
required to establish such capabilities. Certain of the Company's raw materials,
including the active ingredient in NIASPAN, are currently obtained from single
sources of supply. The Company does not have a contractual supply arrangement
with the sole supplier of the active ingredient in NIASPAN. The Company intends,
to the extent possible, to identify multiple sources for all of its key raw
materials, including the active ingredient in NIASPAN, although an alternate
source for at least one such material will not be available because of the
supplier's patent rights.
COMPETITION
The Company's product competes with currently existing or future
prescription pharmaceuticals and vitamins in the United States, Europe and
elsewhere. The Company estimates that its existing NIASPAN prescriptions account
for less than 1% of the total prescriptions currently being written for
cholesterol-lowering pharmaceutical compounds. Competition among these products
is based on, among other things, efficacy, safety, reliability, availability,
price and patent position. In addition, academic institutions, government
agencies and other public and private organizations conducting research may seek
patent protection, discover new drugs or establish collaborative arrangements
for drug research. Most of the Company's competitors have substantially greater
financial, technical and human resources than the Company, including a combined
field sales force exceeding 12,000 representatives compared with the Company's
220 field sales representatives as of February 12, 1999, and may be better
equipped to develop, manufacture and market products.
The Company's cardiovascular and respiratory products, when developed and
marketed, will compete in most cases with well established products containing
the same active ingredient already being marketed by medium-sized and large
pharmaceutical companies in the United States. For example, the Company's
triamcinolone and budesonide formulations, if successfully commercialized, each
will compete with another triamcinolone and budesonide product, respectively,
already being marketed in the United States.
Moreover, there are numerous manufacturers of niacin preparations indicated
for use as vitamin supplements or, in IR form, for treatment of hyperlipidemia.
The Company believes that a generic manufacturer has performed at least one
early-stage clinical study using niacin as a once-a-day treatment for
lipid-altering, and such manufacturer may be pursuing an NDA for such product.
Further, the Company's NIASPAN product will compete with many existing
lipid-altering medications, which currently account for more than 80% of the
lipid-altering market.
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GOVERNMENT REGULATION
The development, manufacture and potential sales of prescription
pharmaceutical products is subject to extensive regulation by U.S. and foreign
governmental authorities. In particular, pharmaceutical products are subject to
rigorous preclinical and clinical testing and to other approval and
post-approval requirements by the FDA in the United States under the Federal
Food, Drug and Cosmetic Act and the Public Health Service Act and by comparable
agencies in most foreign countries. The FDA regulates all aspects of a product's
testing, labeling, promotion, and manufacture, and can impose substantial
restrictions on these activities before or after approval of such product.
Whether or not FDA approval has been obtained, approval of a product by
regulatory authorities in foreign countries must be obtained prior to the
commencement of commercial sales of the product in such countries. The
requirements governing the conduct of clinical trials and product approvals vary
widely from country to country, and the time required for approval may be longer
or shorter than that required for FDA approval. Although there are some
procedures for unified filings for certain European countries, in general, each
country at this time has its own procedures and requirements. Further, the FDA
regulates the export of products produced in the United States and may prohibit
their export even if such products are approved for sale in other countries.
The Company's research and development involves the controlled use of
hazardous materials, chemicals, and various radioactive compounds. Although the
Company believes that its procedures for handling and disposing of those
materials comply with state and federal regulations, the risk of contamination
or injury from these materials cannot be eliminated. In the event of such
contamination or injury, the Company could be held liable for resulting damages,
which could be material to the Company's business, financial condition and
results of operations. The Company is also subject to numerous environmental,
health and workplace safety laws and regulations, including those governing
laboratory procedures, exposure to blood-borne pathogens, and the handling of
biohazardous materials. Additional federal, state and local laws and regulations
affecting the Company may be adopted in the future. Any violation of, and the
cost of compliance with, these laws and regulations could materially and
adversely affect the Company.
Completing the multitude of steps necessary prior to the commencement of
marketing requires the expenditure of considerable resources and a lengthy
period of time. There can be no assurance of approval within any particular
period, or ever, or if approval is granted, of continued approval thereafter.
Delay or failure in obtaining, or the withdrawal of, the required approvals,
clearances, permits or inclusions by the Company or its future corporate
partners or licensees, if any, would have a material adverse effect on the
ability of the Company to generate sales or royalty revenue. Further, the
passage and implementation of new or changed laws or regulations or the
potential impact on the Company of such actions cannot be anticipated.
EMPLOYEES
As of February 12, 1999, the Company had 447 full-time employees. No
employee is represented by a union. The Company believes its employee relations
are good. The Company also regularly employs the services of outside consultants
with respect to regulatory, scientific, and certain administrative and
commercial matters. The Company expects to continue to require the services of
such outside consultants.
9
<PAGE>
ITEM 2. PROPERTIES
The Company leased the following properties as of December 31, 1998:
<TABLE>
<CAPTION>
LEASE EXPIRATION MINIMUM
(INCLUDING RENEWAL ANNUAL
LOCATION USE SQUARE FEET OPTIONS) RENT
- --------------- ---------------------------- ----------- ----------------- --------
<S> <C> <C> <C> <C>
Miami, FL Corporate offices 13,000 December 2000 $218,000
Miami Lakes, FL Research and admin. offices 13,000 December 2001 218,000
Hollywood, FL Manufacturing, research and
admin. offices 23,500 November 2002 294,000
Edison, NJ Manufacturing, research, and
admin. offices 32,500 October 2003 193,000
</TABLE>
The Company believes that its existing facilities are adequate to meet its
current needs and that there is sufficient additional space at or in close
proximity to its present facilities to accommodate its near-term requirements.
ITEM 3. LEGAL PROCEEDINGS
On August 5, 1998, a purported class action lawsuit was filed in the United
States District Court for the Northern District of Illinois, Eastern Division,
against the Company, the members of the Company's Board of Directors, certain
officers of the Company, and the underwriters of the Company's October 1997
offering of shares of Common Stock. In its complaint, the plaintiff asserts, on
behalf of itself and a putative class of purchasers of the Company's Common
Stock during the period from July 29, 1997, through November 13, 1997, claims
under : (i) sections 11, 12(a)(2) and 15 of the Securities Act of 1933; (ii)
sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder; and (iii) for common law fraud, negligent
misrepresentation and breach of fiduciary duty. The claims in the lawsuit relate
principally to certain statements made by the Company, or certain of its
representatives, concerning the efficacy, safety, sales volume and commercial
viability of the Company's NIASPAN product. The complaint seeks unspecified
damages and costs, including attorneys' fees and costs and expenses. Upon motion
by the Company, the case was transferred to the United States District Court for
the Southern District of Florida. The Company and the individual Kos defendants
filed a motion to dismiss the complaint on January 7, 1999. The outcome of the
litigation cannot yet be determined. Accordingly, no provision for any liability
that may result from these matters has been recognized in the accompanying
consolidated financial statements. There can be no assurance, however, that the
outcome of this litigation will not have a material adverse effect on the
Company's business, results of operations, and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1998.
10
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
The Company's common stock, par value $.01 per share (the "Common Stock"),
commenced trading on March 7, 1997, on the Nasdaq National Market under the
symbol "KOSP". As of March 1, 1999, there were 384 registered shareholders of
record of the Company's Common Stock.
The following table sets forth, for the fiscal periods indicated, the range
of high and low prices for trades of the Company's Common Stock on the Nasdaq
National Market System.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 HIGH LOW
- ---------------------------- ---- ---
<S> <C> <C>
First Quarter................................... $15.56 $ 7.50
Second Quarter.................................. 13.94 8.38
Third Quarter................................... 12.69 4.31
Fourth Quarter.................................. 8.00 3.50
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
- ----------------------------
First Quarter (commencing March 7, 1997)........ $25.00 $19.25
Second Quarter.................................. 30.50 19.75
Third Quarter................................... 42.00 27.00
Fourth Quarter.................................. 44.88 13.50
</TABLE>
The Company has not declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain future earnings, if
any, to fund the development and growth of its business and does not intend to
pay dividends on its Common Stock in the foreseeable future.
11
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following consolidated selected financial data of the Company for the
five years ended December 31, 1998, should be read in conjunction with
"Management's Discussions and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and related notes thereto.
See "Item 8. Consolidated Financial Statements and Supplementary Data."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
Net sales .................................... $ 13,038 $ 2,892 $ -- $ 3 $ 34
Cost of sales ................................ 3,276 792 -- -- --
-------- -------- -------- -------- -------
Gross profit .......................... 9,762 2,100 -- 3 34
-------- -------- -------- -------- -------
Operating expenses:
Research and development .................. 29,144 24,130 13,679 11,681 6,248
Selling, general and administrative ....... 61,519 20,509 2,881 1,655 1,778
Expense recognized on modification of stock
option grants(1) ..................... -- -- 5,436 -- --
-------- -------- -------- -------- -------
Total operating expenses .............. 90,663 44,639 21,996 13,336 8,026
-------- -------- -------- -------- -------
Loss from operations ......................... (80,901) (42,539) (21,996) (13,333) (7,992)
Other:
Interest income (expense), net ............ 1,793 2,787 11 6 (1,647)
Interest expense-related parties .......... (68) (868) (136) -- (55)
Other income (expense) .................... 15 (10) -- -- 2
-------- -------- -------- -------- -------
Loss before minority interest ........... (79,161) (40,630) (22,121) (13,327) (9,692)
Minority interest(2) ......................... -- -- 15 4 (3)
-------- -------- -------- -------- -------
Net loss ................................ $(79,161) $(40,630) $(22,106) $(13,323) $(9,695)
======== ======== ======== ======== =======
Net loss per share, basic and diluted(3) ..... $ (4,50) $ (2.79) $ (1.95) $ (1.17) $ (0.85)
Weighted average common shares in computing
net loss per share(3)..................... 17,589,767 14,569,474 11,340,000 11,340,000 11,340,000
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET:
Cash and marketable securities................ $ 4,879 $ 70,396 $ 358 $ 229 $ 78
Working capital (deficit)(4).................. (3,136) 70,939 (9,355) (445) (30,763)
Total assets.................................. 21,570 84,403 3,197 2,380 1,698
Total debt.................................... 9,239 -- 8,355 -- 30,372
Accumulated deficit(5)........................ (185,114) (105,952) (65,322) (43,217) (29,894)
Shareholders' equity (deficit)(4)............. (338) 77,870 (6,750) 1,390 (29,404)
</TABLE>
- ------------
(1) Reflects a non-cash charge associated with an extension of the exercise
period for stock options granted during 1988 to 1990 to the Company's Chief
Executive Officer and two independent consultants; no other material
economic terms of these options were changed.
(2) Represents the minority shareholder's interest in Aeropharm Technology,
Inc., which interest was acquired by the Company in June 1996.
(3) See Note 2. of Notes to Consolidated Financial Statements for information
concerning the computation of net loss per share.
(4) In March 1995, Kos Investments, Inc. assumed repayment of a note payable to
a bank in the principal amount of $30,372,000. This assumption was accounted
for as a transfer to Kos Investments, Inc. and as an increase in additional
paid-in capital for the Company. See Note 8. of Notes to Consolidated
Financial Statements.
(5) In connection with the transfer on June 30, 1996, of assets and liabilities
from Kos Holdings, Inc. to the Company, net operating loss carryforwards
amounting to approximately $51.0 million and related tax benefits, were not
transferred to the Company. The Company can only utilize net operating loss
carryforwards sustained subsequent to June 30, 1996 (amounting to $138.7
million as of December 31, 1998), to offset future taxable net income, if
any. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
12
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
A predecessor corporation to the Company was formed in July 1988 under the
name of Kos Pharmaceuticals, Inc. principally to conduct research and
development on new formulations of existing prescription pharmaceutical
products. In June 1993, Aeropharm Technology, Inc. ("Aeropharm"), a then
majority-owned subsidiary of the Company, was formed to conduct research and
development activities on aerosolized products for the treatment of respiratory
diseases. During June 1996, this predecessor corporation acquired the
outstanding minority interest in Aeropharm; changed its name to Kos Holdings,
Inc. ("Holdings"); established the Company as a wholly-owned subsidiary under
the name of Kos Pharmaceuticals, Inc.; and, effective as of June 30, 1996,
transferred all of its existing assets, liabilities and intellectual property,
other than certain net operating loss carryforwards, to the Company.
Accordingly, all references in this 10-K filing to the Company's business
include the business and operations of Holdings until June 30, 1996.
On March 12, 1997, the Company completed an initial public offering ("IPO")
of its Common Stock. From inception through the IPO, the Company had not
recorded any significant sales and had funded its operations exclusively through
equity contributions and a loan from its majority shareholder. Through December
31, 1998, the Company had accumulated a deficit from operations of approximately
$185.1 million. In connection with the transfer of operations from Holdings to
the Company on June 30, 1996, net operating loss carryforwards amounting to
approximately $51.0 million and related tax benefits were retained by Holdings
and not transferred to the Company. Consequently, the Company may utilize net
operating losses sustained subsequent to June 30, 1996, amounting to
approximately $138.7 million as of December 31, 1998, to offset future taxable
net income, if any.
From inception through its June 30, 1997, reporting period, the Company was
a development stage company engaged primarily in the development of
cardiovascular and respiratory pharmaceutical products. On July 28, 1997, the
Company was granted clearance by the FDA to market its lead product, NIASPAN.
The Company began shipping NIASPAN to wholesalers in mid-August 1997 and began
detailing NIASPAN to physicians in September 1997. The Company's Board of
Directors changed the end of the Company's fiscal year from June 30 to December
31 effective with its December 31, 1997, reporting period. Fiscal years
presented and referred to in the Company's consolidated financial statements,
along with all other financial data, have been restated to conform with a
December 31 fiscal year basis.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 AND 1997
The Company recorded net sales of $13 million for the year ended December
31, 1998, compared with $2.9 million for the year ended December 31, 1997. The
Company began sales of its NIASPAN product during August 1997. Cost of sales was
$3.3 million and $0.8 million for the years ended December 31, 1998 and 1997,
respectively, resulting in 74.9% and 72.6% gross margins for the respective
periods.
The Company's research and development expenses increased to $29.1 million
for the year ended December 31, 1998, from $24.1 million for the same period in
1997. The change related primarily to increases of $5.4 million during the 1998
period in connection with formulation development of the
13
<PAGE>
Company's Nicostatin/trademark/ product and other products under development,
$4.6 million in medical education programs in support of NIASPAN, and $2.1
million in personnel and personnel-related costs in support of the Company's
expanded research and development activities. These increases in research and
development expenses were partially offset by a $1 million fee received by the
Company in 1998 related to the exchange of certain technology rights with
another unaffiliated company. The 1998 increases were also partially offset by
the absence of a $3 million charge attributable to entering into an agreement,
in February 1997, with an unaffiliated generic drug manufacturer to resolve, as
between themselves, the effects of a potential patent interference proceeding;
$1.7 million of licensing fees associated with obtaining access to certain
aerosol safety and toxicology data; and $1.2 million of development costs paid
to third parties in 1997.
Selling, general and administrative expenses increased to $61.5 million for
the year ended December 31, 1998, from $20.5 million for the year ended December
31, 1997. Selling expenses increased $36 million as a result of the full impact
of the presence of the Company's sales and marketing organization during the
1998 period, including the continued expansion of the Company's field sales
force and the initiation of a variety of marketing programs in connection with
the NIASPAN product. General and administrative costs also increased during the
1998 period, mostly as a result of increases of $2.2 million in personnel and
personnel-related costs, $0.6 million in royalty expenses for the Company's
NIASPAN product, and other expenses associated with the expanded activities of
the Company.
From July 1, 1996, to the completion of its IPO on March 12, 1997, the
Company funded its operations from the proceeds of a loan from Kos Investments,
Inc. (the "Convertible Note"), the sole shareholder of Holdings. The Convertible
Note and its accrued interest were convertible into shares of the Company's
Common Stock at a conversion price per share equal to the IPO price per share
($15.00). Interest expense under the Convertible Note totaled $0.9 million for
the year ended December 31, 1997. On October 25, 1997, the outstanding principal
and interest of the Convertible Note was converted into 960,069 shares of Common
Stock. At the time of conversion, the Convertible Note accrued interest at a
rate of 8.50% per year and had outstanding principal and interest of $13.4
million and $1.0 million, respectively.
The Company received $65.9 million in net proceeds from its IPO and $43.3
million in net proceeds from a follow-on offering of its Common Stock, completed
in October 1997, after deducting expenses of both offerings. The net proceeds
from these offerings were invested primarily in U.S. Treasury and highly-rated
corporate debt securities. The Company recorded $1.8 million of interest income
for the year ended December 31, 1998, compared with $2.8 million of interest
income for the same period in 1997.
On July 1, 1998, the Company entered into a $30 million credit facility
(the "Credit Facility") with Michael Jaharis, Chairman of the Company's Board of
Directors. The Company may draw against the Credit Facility during the period
from July 1, 1998 to June 30, 1999. Borrowings under the Credit Facility, which
totaled $9 million as of December 31, 1998, bear interest at the prime rate
(7.75% as of December 31, 1998) and will be due December 31, 2000. Interest
expense under the Credit Facility totaled $68,000 for the year ended December
31, 1998.
The Company incurred a net loss of $79.2 million for the year ended
December 31, 1998, compared with a net loss of $40.6 million for the year ended
December 31, 1997.
14
<PAGE>
YEARS ENDED DECEMBER 31, 1997 AND 1996
The Company, which began sales of its NIASPAN product during August 1997,
recorded net sales of the NIASPAN product of $2.9 million for the year ended
December 31, 1997. Cost of sales for the year ended December 31, 1997, totaled
$0.8 million, resulting in 72.6% gross margin for this period.
The Company's research and development expenses increased to $24.1 million
for the year ended December 31, 1997, from $13.7 million for the year ended
December 31, 1996. The change related primarily to increases of $4.2 million in
licensing costs, including $3.0 million attributable to the cost of entering
into an agreement, during February 1997, with an unaffiliated generic drug
manufacturer to resolve, as between themselves, the effects of a potential
patent interference proceeding, $2.2 million in clinical trial costs associated
with the completion of a long-term safety study evaluating the NIASPAN product
and other products under development, $1.5 million in development costs paid to
third parties, and $1.5 million in personnel costs and personnel-related costs
in support of the Company's expanded research and development activities.
Selling, general and administrative expenses increased to $20.5 million for
the year ended December 31, 1997, from $8.3 million for the year ended December
31, 1996. The increase reflected primarily the commencement of the Company's
sales and marketing activities, including the recruitment of the Company's field
sales organization and the launching of a variety of promotional programs in
connection with the introduction of the NIASPAN product. General and
administrative costs also increased during the 1997 period, mostly as a result
of a $1.6 million increase in personnel and personnel-related costs, $0.7
million in other expenses associated with the expanded activities of the
Company, and $0.1 million in royalty expenses for the Company's NIASPAN product.
The increase in selling, general and administrative expenses was offset in part
by the absence during the year ended December 31, 1997, of a $5.4 million
non-cash charge in 1996 for compensation expense associated with an adjustment
of the exercise period on certain stock options granted during 1988 to 1990 to
an officer and two independent consultants of the Company.
The Company recorded $2.8 million of interest income for the year ended
December 31, 1997, as a result of its investment in marketable securities from
the net proceeds of the IPO and the follow-on offering, compared with $11,000
for the year ended December 31, 1996. The Company also recorded, mostly as a
result of the Convertible Note, $0.9 million and $0.1 million of interest
expense for the years ended December 31, 1997, and 1996, respectively.
The Company incurred a net loss of $40.6 million for the year ended
December 31, 1997, compared with a net loss of $22.1 million for the year ended
December 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had cash and cash equivalents totaling
$4.9 million and negative working capital of $3.1 million. The Company's primary
uses of cash to date have been in operating activities to fund research and
development, including clinical trials, and selling, general and administrative
expenses. As of December 31, 1998, the Company's investment in equipment and
leasehold improvements, net of depreciation and amortization, was $12 million.
During the year ended December 31, 1998, the Company spent $6.9 million in
capital expenditures. The Company expects 1999 capital expenditures to be less
than those incurred during the year ended December 31, 1998.
15
<PAGE>
On July 1, 1998, the Company entered into a $30 million credit facility
(the "Credit Facility") with Michael Jaharis, Chairman of the Company's Board of
Directors. The Company may draw against the Credit Facility during the period
from July 1, 1998 to June 30, 1999. Borrowings under the Credit Facility, which
totaled $9 million at December 31, 1998, bear interest at the prime rate and
will be due December 31, 2000.
On October 7, 1998, the Company entered into an additional $25 million
funding arrangement with Michael Jaharis. Effective March 1, 1999, Mr. Jaharis
agreed to increase the amount available to the Company under the October 7,
1998, funding arrangement to an aggregate of $50 million (as amended, the
"Supplemental Funding Arrangement"). Under the terms of the Supplemental Funding
Arrangement, Mr. Jaharis will make available to the Company, as requested,
additional debt or equity capital in excess of the capital available to the
Company under the Credit Facility. Funds will be provided to the Company under
the Supplemental Funding Arrangement at prevailing rates and on prevailing terms
for companies situated similar to the Company. Although the terms pursuant to
which funds will be provided to the Company under the Supplemental Funding
Arrangement have not been determined, the Company expects that it will be
required to pledge all of its assets to secure any borrowings from Mr. Jaharis
and that any amounts borrowed from Mr. Jaharis will be convertible, at his
option, into shares of the Company's common stock. The conversion of amounts
borrowed from Mr. Jaharis under the Supplemental Funding Arrangement into shares
of the Company's common stock will result in dilution to existing shareholders
of the Company. The Supplemental Funding Arrangement is subject to certain
conditions, including (i) the parties' entering into appropriate documentation
containing standard terms and conditions, (ii) at the time of funding, there
shall not have been any material adverse change in the business or financial
operations or condition of the Company or in its management, (iii) for any
funding requested by the Company after January 1, 2000, the Company's then
current financial projections shall indicate that the Company shall have
sufficient funds, with the funding to be provided under the Supplemental Funding
Arrangement, to achieve positive cash flow no later than December 31, 2000, (iv)
at the time of funding, there shall not be any litigation pending or threatened
involving the Company that is likely to have a material adverse effect on the
Company, and (v) at the time of funding, Michael Jaharis or his affiliates shall
continue to hold a controlling interest in the Company's Common Stock. The
Supplemental Funding Arrangement will terminate on the earlier to occur of (x)
December 31, 2000, (y) the Company's receiving third party financing for an
amount in excess of 50% of the amount available under the Supplemental Funding
Arrangement and (z) a change in control, merger or sale of substantially all of
the assets of the Company. There can be no assurance, however, that the Company
will be able to satisfy all of the conditions of the Supplemental Funding
Arrangement at the time that any funding request is made.
Although the Company currently anticipates that, including the capital
available to the Company under the Credit Facility and the Supplemental Funding
Arrangement, it has or has access to an amount of working capital that will be
sufficient to fund the Company's operations until it has positive cash flows,
the Company's cash requirements during this period will be substantial and may
exceed the amount of working capital available to the Company. The Company's
ability to fund its operating requirements and maintain an adequate level of
working capital until it achieves positive cash flows will depend primarily on
its ability to generate substantial growth in sales of its NIASPAN product.
Further, during this period, the Company's ability to fund its operating
requirements may be affected by its ability to reduce its operating expenses and
license or co-market NIASPAN and other cardiovascular products. The Company's
failure to generate substantial growth in the sales of NIASPAN, reduce operating
expenses, enter into a license or co-marketing agreement, or meet the conditions
necessary for the Company to obtain funding under the Supplemental Funding
Arrangement, and other events --including the progress of the Company's research
and development programs; the costs and timing of seeking regulatory approvals
of the Company's products under development; the Company's ability to obtain
regulatory approvals; the Company's ability to manufacture products at an
economically feasible cost; costs in filing, prosecuting, defending, and
enforcing patent claims and other intellectual property rights; the extent and
terms of any collaborative research, manufacturing, marketing, joint venture, or
other
16
<PAGE>
arrangements; and changes in economic, regulatory, or competitive conditions or
the Company's planned business -- could cause the Company to require additional
capital prior to achieving positive cash flows. In the event that the Company
must raise additional capital to fund its working capital needs, it may seek to
raise such capital through loans or the issuance of debt securities that would
require the consent of the Company's current lender, or through the issuance of
equity securities. To the extent the Company raises additional capital by
issuing equity securities or obtaining borrowings convertible into equity,
ownership dilution to existing shareholders will result, and future investors
may be granted rights superior to those of existing shareholders. Moreover,
there can be no assurance that any additional capital will be available to the
Company on acceptable terms, or at all.
NIASPAN SALES GROWTH
The Company's success, including its ability to fund its operating
requirements, currently depends primarily on its ability to sell increasing
quantities of its NIASPAN product. The Company's ability to successfully market
and sell increasing quantities of its NIASPAN product depends significantly on
the acceptance of the NIASPAN product by physicians and their patients and on
its ability and willingness to devote the financial and employee resources to
adequately market NIASPAN. There can be no assurance, however, that the Company
will be able to devote sufficient resources to continue to increase the market
acceptance of NIASPAN. The failure of physicians to prescribe NIASPAN or the
failure of patients to continue taking NIASPAN would have a material adverse
effect on the Company. Among other factors, adverse side effects or unfavorable
publicity concerning the NIASPAN product or any other product incorporating
technology similar to that used in the NIASPAN product could have an adverse
effect on the Company's ability to obtain regulatory approvals, or to increase
the market acceptance of Niaspan by prescribing physicians, managed care
providers, or patients; any of which would have a material adverse effect on the
Company.
CONTINGENCIES
The Company has performed an assessment of the impact of the "Year 2000
Issue" on its reporting systems and operations. The "Year 2000 Issue" exists
because many computer systems and applications currently use two-digit fields to
designate a year. As the century date occurs, date sensitive systems will
recognize the year 2000 as 1900, or not at all. To date, the Company has
incurred minimal costs related with its assessment of the "Year 2000 Issue" and
with the modification of affected internal systems. Based on the Company's
assessment, it believes that its accounting and other critical operational
systems substantially avoid the "Year 2000 Issue", thereby enabling it to
properly process vital financial and operational information.
The Company has implemented a Year 2000 readiness program with the
objective of having all of the Company's systems functioning properly with
respect to the "Year 2000 Issue" before September 30, 1999. The first component
of the Company's readiness program was to identify the internal systems of the
Company that are susceptible to system failures or processing errors as a result
of the "Year 2000 Issue". This effort is substantially complete. The Company
believes that it has identified the systems that may require remediation or
replacement, and it has established priorities for repair or replacement. Those
systems considered most critical to continuing operations are being given the
highest priority.
The second component of the Company's Year 2000 readiness program involves
the actual remediation and replacement of affected systems. The Company is using
both internal and external resources to complete this process. Systems ranked
highest in priority, such as the Company's corporate
17
<PAGE>
accounting software, have been remediated or replaced. Other systems identified
by the Company as being susceptible to failure as a result of the "Year 2000
Issue" have been either remediated or replaced or scheduled for remediation or
replacement.
The "Year 2000 Issue" concerns not only systems used solely by the Company,
but also concerns third parties, such as customers, suppliers, vendors,
distributors, research partners and other entities, using systems that may
interact with or affect the Company's operations. Accordingly, the Company has
identified its significant customers, vendors and creditors that are believed,
at this time, to be critical to the Company's business operations subsequent to
January 1, 2000. The Company has attempted to ascertain the Year 2000 readiness
of such significant third parties through the use of questionnaires, interviews,
and on-site visits. The Company has taken and will continue to take appropriate
action based on responses that it receives to ensure that Year 2000 issues
experienced by third parties with whom the Company conducts business will not
have a material impact on the Company. There can be no assurance, however, that
the systems provided by or utilized by third parties will be timely converted in
such a way as to allow them to continue normal business operations or furnish
products, services or data to the Company without disruption.
If needed remediations and conversions to the Company's systems are not
made on a timely basis by the Company or its significant customers or vendors,
the Company could experience business disruption, operational difficulties,
financial loss, legal liability to third parties and similar risks, any of which
could have a material adverse effect on the Company's operations, liquidity or
financial condition. Although the Company cannot determine the severity with
which the "Year 2000 Issue" will affect, either directly or indirectly, the
Company's operations and financial condition, the Company believes the most
reasonably likely worst case scenario in the event the Company or its
significant customers or vendors fail to resolve the "Year 2000 Issue" would be
an inability on the part of the Company to adequately distribute its NIASPAN
product and receive revenues from the sale of such product for some period of
time following the commencement of the year 2000. Factors that could cause
material differences in results, many of which are outside the control of the
Company, include, but are not limited to, the Company's ability to identify and
correct all relevant computer software, the accuracy of representations by
manufacturers of the Company's systems that their products are Year 2000
compliant, the ability of the Company's customers and vendors to identify and
resolve their own Year 2000 issues and the Company's ability to respond to and
dedicate adequate resources to resolve unforeseen complications arising as a
result of the "Year 2000 Issue".
Consequently, despite the Company's continuing focus on solutions for Year
2000 issues and its current expectations that it will be Year 2000 compliant in
a timely manner, there can be no assurance that the Company will not experience
material disruptions in its business operations resulting from the "Year 2000
Issue." Accordingly, the Company has established, concurrently with the Year
2000 readiness measures described above, an internal Year 2000 project team
whose mission is to develop contingency plans intended to mitigate the possible
disruption in business operations that may result from the "Year 2000 Issue".
The Company's Year 2000 project team is in the process of attempting to develop
such plans and the cost estimates to implement them. The Company's Year 2000
contingency plans, once developed, will be focused primarily on resolving Year
2000 issues encountered in the Company's business dealings with customers and
significant vendors. In the event the Company's suppliers or customers
experience system failures due to the "Year 2000 Issue", the Company may, if
necessary, attempt to resource its materials and redirect its sales to Year 2000
compliant third parties. Notwithstanding the Company's efforts to mitigate the
impact of potential Year 2000 issues, including the development of contingency
plans, there can be no assurance that the Company will be able to successfully
identify and remedy all such issues and, further, that its contingency plans,
once developed, will be able to materially diminish the impact of such possible
disruption of the Company's business operations.
The total cost to the Company of its Year 2000 compliance activities has
not been and is not presently anticipated to be material to the Company's
business, results of operations or financial condition. The Company has
capitalized and will continue to capitalize the costs of purchasing and
developing new Year 2000 compliant systems. The Company presently believes that
it will be required to spend less than an additional $500,000 in order to
remediate or replace its remaining systems susceptible to the "Year 2000 Issue".
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FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report that
are not related to historical results are forward-looking statements. Actual
results may differ materially from those projected or implied in the
forward-looking statements. Further, certain forward-looking statements are
based upon assumptions of future events, which may not prove to be accurate.
Subsequent written and oral forward-looking statements attributable to the
Company or to persons acting on its behalf are expressly qualified in their
entirety by the cautionary statements set forth below and elsewhere in this
report and in other reports filed by the Company with the Securities and
Exchange Commission.
MARKET ACCEPTANCE OF NIASPAN
The Company's success currently depends primarily upon its ability to
successfully market and sell increasing quantities of its NIASPAN product. The
Company's ability to successfully sell increasing quantities of the NIASPAN
product will depend significantly on the increasing acceptance of the NIASPAN
product by physicians and their patients. The Company believes that intolerable
flushing and potential liver toxicity associated with currently available
formulations of niacin are the principal reasons why physicians generally have
been reluctant to prescribe or recommend such currently available formulations.
Flushing episodes are often characterized by facial redness, tingling or rash.
Although most patients taking NIASPAN will sometimes flush, the formulation and
dosing regimen for NIASPAN have been designed to maximize patient acceptance and
minimize the occurrence of flushing. There can be no assurance, however, that
patients using NIASPAN will not suffer episodes of flushing that they consider
intolerable. The failure of physicians to prescribe NIASPAN or the failure of
patients to continue taking NIASPAN due to intolerable flushing or to other side
effects would have a material adverse effect on the Company.
Unanticipated side effects or unfavorable publicity concerning the NIASPAN
product or any other product incorporating technology similar to that used in
the NIASPAN product also could have an adverse effect on the Company's ability
to obtain regulatory approvals, to achieve acceptance by prescribing physicians,
managed care providers, or patients; any of which would have a material adverse
effect on the Company.
HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
To date, the Company has dedicated most of its financial resources to the
development and commercialization of its NIASPAN product, the development of
other products, and general and administrative expenses. The Company expects to
incur significant operating losses for at least the next twelve months, due
primarily to continued manufacturing and marketing, sales and administrative
expenses associated with the commercial launch of the NIASPAN product and for
investments in its research and development programs. No assurance can be given
that additional significant losses will not continue thereafter. The Company's
ability to achieve and maintain profitability will depend, among other things,
on the commercial success of the NIASPAN product; on the Company's ability to
successfully exploit its manufacturing and sales and marketing capabilities; to
complete the development of, and obtain regulatory approvals for, and achieve
market acceptance for its products under development; and on its ability to
maintain sufficient funds to finance its activities. As of December 31, 1998,
the Company's accumulated deficit was $185.1 million. In connection with the
transfer of operations from Holdings to the Company on June 30, 1996, net
operating loss carryforwards amounting to approximately $51.0 million and
related tax benefits remained with Holdings and were not transferred to
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the Company. Consequently, the Company may utilize net operating loss
carryforwards sustained subsequent to June 30, 1996, amounting to $138.7 million
as of December 31, 1998, to offset future taxable net income, if any. There can
be no assurance, however, that the Company will be able to achieve profitability
to utilize such carryforwards or that profitability, if any, can be sustained.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING
The Company has experienced negative cash flows from operations since its
inception. The Company has spent and will continue to be required to spend
substantial funds to continue research and development, including clinical
trials of its products under development, and to commercialize NIASPAN and its
products under development if regulatory approvals are obtained for such
products under development. The Company believes that it has sufficient
resources, including funds available to the Company under certain funding
arrangements, to fund the operations of the Company until the Company achieves
positive cash flows. The Company, however, may need or elect to raise additional
capital prior to such date. The Company's capital requirements will depend on
many factors, primarily relating to the near-term commercial success of NIASPAN;
the Company's ability to meet the conditions necessary to obtain funding under
the Supplemental Funding Arrangement; the problems, delays, expenses and
complications frequently encountered by companies at this stage of development;
the progress of the Company's research, development, and clinical trial
programs; the costs and timing of seeking regulatory approvals of the Company's
products under development; the Company's ability to obtain such regulatory
approvals; costs in filing, prosecuting, defending, and enforcing patent claims
and other intellectual property rights; the extent and terms of any
collaborative research, manufacturing, marketing, or other arrangements; and
changes in economic, regulatory, or competitive conditions or the Company's
planned business. Estimates about the adequacy of funding for the Company's
activities are based on certain assumptions, including assumptions regarding the
marketing and sales success of the Company's NIASPAN product, and that testing
and regulatory procedures relating to the Company's products under development
can be conducted at projected costs and within projected time frames. There can
be no assurances that any of these assumptions will prove to be accurate.
To satisfy its capital requirements, the Company may seek to raise funds in
the public or private capital markets. The Company's ability to raise additional
funds in the public markets may be adversely affected if the Company's sales of
its NIASPAN product do not increase rapidly, if the results of the Company's
clinical trials for its products under development are not favorable, or if
regulatory approval for any of the Company's products under development is not
obtained. The Company may seek additional funding through corporate
collaborations and other financing vehicles. There can be no assurance that any
such funding will be available to the Company, or if available, that it will be
available on acceptable terms. If adequate funds are not available, the Company
may be required to curtail significantly one or more of its research or
development programs or it may be required to obtain funds through arrangements
with future collaborative partners or others that may require the Company to
relinquish rights to NIASPAN or to some or all of its technologies or products
under development or take significant cost-reducing actions or both. If the
Company is successful in obtaining additional financing, the terms of the
financing may have the effect of diluting or adversely affecting the holdings or
the rights of the holders of Common Stock.
LIMITED SALES AND MARKETING EXPERIENCE AND RESOURCES
Although the Company markets its NIASPAN product and intends to market its
other products under development through its own specialty sales force, its
marketing experience to date is limited. Substantial resources will continue to
be required for the Company to promote the sale of the NIASPAN product and
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its products under development. There can be no assurance that the Company will
be able to devote resources to NIASPAN or to its other products under
development sufficient to achieve increasing market acceptance. The Company's
failure to expend the resources to adequately promote the NIASPAN product or its
products under development would have a material adverse effect on the Company.
Moreover, the Company has fewer sales persons than many of its competitors
and there can be no assurance that the Company's sales force will be able to
detail successfully physicians who prescribe lipid-altering medications. There
can be no assurance that the Company will be able to retain its current sales
representatives, that any additional representatives hired by the Company will
be immediately effective in promoting the sale of the NIASPAN product, or that
the Company's sales representatives will be able to generate significantly
increased sales of the NIASPAN product. The failure of the Company's sales
representatives to generate increased sales of the NIASPAN product could have a
material adverse effect on the Company.
CONTROL BY EXISTING SHAREHOLDER
Michael Jaharis, the Chairman of the Board of Directors of the Company and
one of its founders, beneficially owns approximately 50.8% of the Common Stock
outstanding as of December 31, 1998. Accordingly, this shareholder can control
the outcome of certain shareholder votes, including votes concerning the
election of directors, the adoption or amendment of provisions in the Company's
Articles of Incorporation, and the approval of mergers and other significant
corporate transactions. This level of concentrated ownership by one person,
along with the factors described in a subsequent section, "Anti-Takeover
Provisions," may have the effect of delaying or preventing a change in the
management or voting control of the Company. In addition, in connection with the
Supplemental Funding Arrangement, Mr. Jaharis will have the right to convert
amounts owed to Mr. Jaharis by the Company into shares of the Company's Common
Stock, which, if so converted, would result in Mr. Jaharis owning a
significantly greater percentage of the Company's outstanding Common Stock and
would result in substantial dilution to existing shareholders.
COMPETITION AND TECHNOLOGICAL CHANGE
Many products are commercially available for the treatment of elevated LDL
cholesterol, and the manufacturers of such products, individually and
collectively, have significantly greater financial resources and sales and
manufacturing capabilities than the Company, including a combined field sales
force exceeding 12,000 representatives compared with the Company's 220 field
sales representatives as of February 12, 1999. The Company estimates that its
existing NIASPAN prescriptions account for less than 1% of the total
prescriptions currently being written for cholesterol-lowering pharmaceutical
compounds. There can be no assurance that NIASPAN or any other product developed
by the Company will be able to compete successfully with any of those products
or that the Company will be able to overcome such competition and achieve
increasing sales of its NIASPAN product. Moreover, the active ingredient in
NIASPAN, niacin, is available in several other formulations, most of which do
not require a prescription. Although the Company believes that there are no
other currently available niacin formulations that have been approved by the FDA
specifically for once-a-day dosing, there can be no assurance that physicians
will not prescribe or recommend some of these unapproved niacin formulations,
using the NIASPAN dosing regimen, to try to achieve the same results as NIASPAN.
Substitution of other niacin formulations for NIASPAN could have a material
adverse effect on the Company. Moreover, manufacturers of other niacin
formulations could promote their products using the NIASPAN dosing regimen and
could promote the sale of their products to treat the indications for which the
Company has received clearance to market NIASPAN. Although such promotion would
be a violation of FDA regulations, the occurrence of such practices would have a
material adverse effect on the Company.
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Moreover, many established pharmaceutical and biotechnology companies,
universities, and other research institutions with resources significantly
greater than the Company's may develop products that directly compete with the
Company's products. Even if the Company's products under development prove to be
more effective than those developed by other entities, such other entities may
be more successful in marketing their products than the Company because of
greater financial resources, stronger sales and marketing efforts, and other
factors. These entities may succeed in developing products that are safer, more
effective or less costly than the products developed by the Company. There can
be no assurance that any products developed by the Company will be able to
compete successfully with any of those products.
NO ASSURANCE OF ADEQUATE THIRD-PARTY REIMBURSEMENT
The Company's ability to commercialize successfully its products under
development is dependent in part on the extent to which appropriate levels of
reimbursement for NIASPAN or the Company's products under development are
obtained from government authorities, private health insurers, and managed care
organizations such as health maintenance organizations ("HMOs"). Managed care
organizations and other third-party payors are increasingly challenging the
pricing of pharmaceutical products. The trend toward managed healthcare in the
United States, the growth of organizations such as HMOs, and legislative
proposals to reform healthcare and government insurance programs could
significantly influence the purchase of pharmaceutical products, resulting in
lower prices and reduced demand for NIASPAN or the Company's products under
development. Such cost containment measures and potential legislative reform
could affect the Company's ability to sell NIASPAN or its products under
development and may have a material adverse effect on the Company. Significant
uncertainty exists about the reimbursement status of newly approved
pharmaceutical products. Although the Company has obtained approvals for
reimbursement for the cost of NIASPAN from many third-party payers, there can be
no assurance that the Company will be able to maintain such approvals. There can
be no assurance that reimbursement in the United States or foreign countries
will be available for NIASPAN or any of the Company's products under
development, that any reimbursement granted will be maintained, or that limits
on reimbursement available from third-party payors will not reduce the demand
for, or negatively affect the price of, NIASPAN or the Company's products under
development. The unavailability or inadequacy of third-party reimbursement for
NIASPAN or the Company's products under development would have a material
adverse effect on the Company.
DEPENDENCE ON KEY PERSONNEL
The success of the Company is dependent on its ability to attract and
retain highly qualified scientific, management and sales personnel. The Company
faces intense competition for personnel from other companies, academic
institutions, government entities, and other organizations. There can be no
assurance that the Company will be successful in attracting and retaining key
personnel. The loss of key personnel, or the inability to attract and retain the
additional, highly-skilled employees required for the expansion of the Company's
activities, could adversely affect the Company's results of operations and its
business.
YEAR 2000
The Company has performed an assessment of the impact of the "Year 2000
Issue" on its reporting systems and operations. The "Year 2000 Issue" exists
because many computer systems and applications currently use two-digit fields to
designate a year. As the century date occurs, date sensitive systems will
recognize the year 2000 as 1900, or not at all. The "Year 2000 Issue" concerns
not only systems used solely by the Company, but also concerns third parties,
such as customers, suppliers, vendors, distributors, research partners and other
entities, using systems that may interact with or affect the Company's
operations. If needed remediations and conversions to the Company's systems are
not made on a timely basis by the Company or its significant customers or
vendors, the Company could experience business disruption, operational
difficulties, financial loss, legal liability to third parties and similar
risks, any of which could have a material adverse effect on the Company's
operations, liquidity or financial condition. Although the Company cannot
determine the severity with which the "Year 2000 Issue" will affect, either
directly or indirectly, the Company's operations and financial condition, the
Company believes the most reasonably likely worst case scenario in the event the
Company or its significant customers or vendors fail to resolve the "Year 2000
Issue" would be an inability on the part of the Company to adequately distribute
its NIASPAN product and receive revenues from the sale of such product for some
period of time following the commencement of the year 2000. Factors that could
cause material differences in results, many of which are outside the control of
the Company, include, but are not limited to, the Company's ability to identify
and correct all relevant computer software, the accuracy of representations by
manufacturers of the Company's systems that their products are Year 2000
compliant, the ability of the Company's customers and vendors to identify and
resolve their own Year 2000 issues and the Company's ability to respond to and
dedicate adequate resources to resolve unforseen complications arising as a
result of the "Year 2000 Issue". See "Contingencies" under "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section above for further discussion of the "Year 2000 Issue".
PRODUCTS UNDER DEVELOPMENT
Although the Company obtained clearance from the FDA to market NIASPAN,
there can be no assurance that the Company will be able to successfully
formulate any of its other products as planned, or that the Company will be
successful in demonstrating the safety and efficacy of such products in human
clinical trials. These trials may be costly and time-consuming. The
administration of any product the Company develops may produce undesirable side
effects that could result in the interruption, delay or
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suspension of clinical trials, or the failure to obtain FDA or other regulatory
approval for any or all targeted indications. Even if regulatory approval is
secured, the Company's products under development may later produce adverse
effects that limit or prevent their widespread use or that necessitate their
withdrawal from the market. The Company may discontinue the development of any
of its products under development at any time.
PATENTS AND TRADEMARKS; INTERFERENCE
The Company's ability to commercialize any of its products under
development will depend, in part, on its or its licensors' ability to obtain
patents, enforce those patents, preserve trade secrets, and operate without
infringing on the proprietary rights of third parties. In addition, the patents
for which the Company has applied relating to NIASPAN and certain other of the
Company's products under development are based on, among other things, the timed
administration of NIASPAN. If the indications treated by NIASPAN and such other
products under development could be treated using drugs without such timed
administration, the Company's patents, if issued, would not prevent the use of
such drugs for the treatment of such indications, which would have a material
adverse effect on the Company. There can be no assurance that the patent
applications licensed to or owned by the Company will result in issued patents,
that patent protection will be secured for any particular technology, that any
patents that have been or may be issued to the Company or its licensors will be
valid or enforceable or that any patents will provide meaningful protection to
the Company.
In general, the U.S. patents and patent applications owned by or licensed
to the Company are method-of-use patents that cover the timed use of certain
compounds to treat specified conditions. Composition-of-matter protection is not
available for the active ingredient in NIASPAN. The active ingredient in
NIASPAN, niacin, is currently sold in the United States and other markets for
lipid altering and for other uses. Even in jurisdictions where the use of the
active ingredient in NIASPAN for lipid altering and other indications may be
covered by the claims of a use patent licensed to the Company, off-label sales
might occur, especially if another company markets the active ingredient at a
price that is less than the price of Niaspan, thereby potentially reducing the
sales of NIASPAN.
The Company has a patent application pending in the U.S. Patent and
Trademark Office ("PTO") with claims covering NIASPAN's method-of-use consistent
with its recommended once-a-day dosing regimen. The Company has been advised by
the patent examiner that certain of these claims are allowable, but none of the
claims have yet been issued as a patent. The patent examiner has, however,
indicated that it may submit Kos' patent application to the PTO's Board of
Interference to determine whether it should declare an interference between such
Kos application and a method-of-use patent issued to a privately owned generic
manufacturer allegedly claiming the same dosing regimen invention. On February
7, 1997, the Company and such generic manufacturer entered into a
cross-licensing agreement (the "License Agreement") pursuant to which the
parties agreed to resolve, as between themselves, the effects of such potential
interference by granting licenses under their respective patent application and
patent.
The Company is aware that certain European and U.S. patents have been
issued with claims covering products that contain certain non-CFC
propellant-driven aerosol formulations. The European patents are currently
subject to an opposition proceeding in Europe, and certain claims in such
patents have been held invalid in the United Kingdom. Certain or all of the
Company's aerosol products under development may use a formulation covered by
such European or U.S. patents. In such event, the Company would be prevented
from making, using or selling such products unless the Company obtains a license
under such patents, which license may not be available on commercially
reasonable terms, or at all, or unless such patents are determined to be invalid
or unenforceable in Europe or the United States, respectively.
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The Company's development of products that are covered by such patents and its
failure to obtain licenses under such patents in the event such patents are
determined to be valid and enforceable could have an adverse effect on the
Company's business.
The patent positions of pharmaceutical and biotechnology companies are
highly uncertain and involve complex legal and factual questions. There can be
no assurance that the patents owned and licensed by the Company, or any future
patents, will prevent other companies from developing similar or therapeutically
equivalent products or that others will not be issued patents that may prevent
the sale of Company products or require licensing and the payment of significant
fees or royalties by the Company. Furthermore, there can be no assurance that
any of the Company's future products or methods will be patentable, that such
products or methods will not infringe upon the patents of third parties, or that
the Company's patents or future patents will give the Company an exclusive
position in the subject matter claimed by those patents. The Company may be
unable to avoid infringement of third party patents and may have to obtain a
license, defend an infringement action, or challenge the validity of the patents
in court. There can be no assurance that a license will be available to the
Company, if at all, on terms and conditions acceptable to the Company, or that
the Company will prevail in any patent litigation. Patent litigation is costly
and time consuming, and there can be no assurance that the Company will have or
will devote sufficient resources to pursue such litigation. If the Company does
not obtain a license under such patents, is found liable for infringement or is
not able to have such patents declared invalid, the Company may be liable for
significant money damages, may encounter significant delays in bringing products
to market, or may be precluded from participating in the manufacture, use, or
sale of products or methods of treatment requiring such licenses.
The Company also relies on trade secrets and other unpatented proprietary
information in its product development activities. To the extent that the
Company relies on trade secrets and unpatented know-how to maintain its
competitive technological position, there can be no assurance that others may
not independently develop the same or similar technologies. The Company seeks to
protect trade secrets and proprietary knowledge in part through confidentiality
agreements with its employees, consultants, advisors and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of the
Company's confidential information and may not provide the Company with an
adequate remedy in the event of unauthorized disclosure of such information. If
the Company's employees, scientific consultants or collaborators develop
inventions or processes independently that may be applicable to the Company's
products under development, disputes may arise about ownership of proprietary
rights to those inventions and processes. Such inventions and processes will not
necessarily become the Company's property, but may remain the property of those
persons or their employers. Protracted and costly litigation could be necessary
to enforce and determine the scope of the Company's proprietary rights. Failure
to obtain or maintain patent and trade secret protection, for any reason, would
have a material adverse effect on the Company.
The Company engages in collaborations, sponsored research agreements, and
other arrangements with academic researchers and institutions that have received
and may receive funding from U.S. government agencies. As a result of these
arrangements, the U.S. government or certain third parties may have rights in
certain inventions developed during the course of the performance of such
collaborations and agreements as required by law or such agreements. Several
legislative bills affecting patent rights have been introduced in the United
States Congress. These bills address various aspects of patent law, including
publication, patent term, re-examination subject matter and enforceability. It
is not certain whether any of these bills will be enacted into law or what form
such new laws may take. Accordingly, the effect of such potential legislative
changes on the Company's intellectual property estate is uncertain.
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GOVERNMENT REGULATION; NO ASSURANCES OF REGULATORY APPROVAL
The Company's research and development activities, preclinical studies,
clinical trials, and the manufacturing and marketing of its products are
currently subject to extensive regulation by the FDA and may in the future be
subject to foreign regulations. The drug approval process takes many years and
requires the expenditure of substantial resources. Data obtained from
preclinical and clinical activities are susceptible to varying interpretations
that could delay, limit, or prevent regulatory approval. Although the Company
may consult the FDA for guidance in developing protocols for clinical trials,
that consultation provides no assurance that the FDA will accept the clinical
trials as adequate or well-controlled or accept the results of those trials. In
addition, delays or rejections of applications for regulatory approval may
result from changes in or additions to FDA regulations concerning the drug
approval process. Similar delays may also be encountered in foreign countries.
There can be no assurance that any regulatory review will be conducted in a
timely manner or that regulatory approvals will be obtained for any products
developed by the Company. Even if regulatory approval of a product is obtained,
the approval may be limited as to the indicated uses for which it may be
promoted or marketed. In addition, a marketed drug, its bulk chemical supplier,
its manufacturer and its manufacturing facilities are subject to continual
regulatory review and periodic inspections, and later discovery of previously
unknown problems with a product, supplier, manufacturer or facility may result
in restrictions on such products or manufacturers, which may require a
withdrawal of the product from the market. Failure to comply with the applicable
regulatory requirements can, among other things, result in fines, suspensions of
regulatory approvals, product recalls, operating restrictions and criminal
prosecution, any of which could have a material adverse effect on the Company.
The Company's business is also subject to regulation under state, federal
and local laws, rules, regulations and policies relating to the protection of
the environment and health and safety, including those governing the use,
generation, manufacture, storage, air emission, effluent discharge, handling and
disposal of certain materials. The Company believes that it is in compliance in
all material respects with all such laws, rules, regulations and policies
applicable to the Company. There can be no assurance that the Company will not
be required to incur significant costs to comply with such environmental and
health and safety laws and regulations in the future. The Company's research and
development involves the controlled use of hazardous materials. Although the
Company believes that its safety procedures for handling and disposing of such
materials comply with the standards prescribed by applicable state, federal and
local regulations, the risk of contamination or injury from these materials
cannot be completely eliminated. In the event of such contamination or injury,
the Company could be held liable for any damages that result and any such
liability could exceed the resources of the Company and materially adversely
affect the Company's business, financial condition and results of operations.
DEPENDENCE ON CERTAIN COLLABORATORS
The Company relies on third parties for certain aspects of the development
of certain of its products under development. The Company is collaborating with
Fuisz on the development of IS-5-MN. Pursuant to this collaboration, Kos is
responsible for conducting pharmacokinetic studies and clinical trials and Fuisz
is responsible for the formulation of such product. The Company's ability to
commercialize this product may depend to a significant extent on the efforts of
Fuisz, over which the Company has no control. The Company also relies on other
third parties for certain aspects of the development of the Company's presently
planned or future products. There can be no assurance that the Company will be
able to enter into future collaborative arrangements on favorable terms, or at
all. Even if the Company is successful in entering into such collaborative
agreements, there can be no assurance that any such
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arrangement will be successful. The success of any such arrangement is dependent
on, among other things, the skills, experience and efforts of the third party's
employees responsible for the project, the third party's commitment to the
arrangement, and the financial condition of the third party, all of which are
beyond the control of the Company.
LIMITED MANUFACTURING EXPERIENCE; RISK OF SCALE-UP
The Company currently manufactures NIASPAN in one manufacturing plant that
has been inspected and approved by the FDA, and it manufactures clinical
materials for its products under development in another manufacturing plant. The
Company believes both plants operate in substantial compliance with current Good
Manufacturing Practices ("cGMP") regulations for the manufacture of
pharmaceutical products. The Company may need to further scale-up certain of its
current manufacturing processes to achieve production levels consistent with the
commercial sale of its products. Further, modifications to the facilities,
systems and procedures may be necessary to maintain capacity at a level
sufficient to meet market demand or to maintain compliance with cGMP regulations
and other regulations prescribed by various regulatory agencies including the
Occupational Safety and Health Administration and the Environmental Protection
Agency. Failure by the Company to successfully further scale-up, expand in
connection with manufacture for commercial sale, or modify its manufacturing
process or to comply with cGMP regulations and other regulations could delay the
approval of the Company's products under development or limit the Company's
ability to meet the demand for its products, either of which would have a
material adverse effect on the Company. Such occurrences may require the Company
to acquire alternative means of manufacturing its products, which may not be
available to the Company on a timely basis, on commercially practicable terms,
or at all.
DEPENDENCE ON SINGLE SOURCES OF SUPPLY
Some materials used in the Company's products, including niacin, the active
ingredient in NIASPAN, are currently sourced from a single qualified supplier.
The Company does not have a contractual arrangement with its sole supplier of
niacin. Although the Company has not experienced difficulty to date in acquiring
niacin, or other materials for product development, no assurance can be given
that supply interruptions will not occur in the future or that the Company will
not have to obtain substitute materials, which would require additional product
validations and regulatory submissions. Any such interruption of supply could
have a material adverse effect on the Company's ability to manufacture its
products or to obtain or maintain regulatory approval of such products.
RISK OF PRODUCT LIABILITY CLAIMS; NO ASSURANCE OF ADEQUATE INSURANCE
Manufacturing, marketing, selling, and testing NIASPAN and the Company's
products under development entails a risk of product liability. The Company
could be subject to product liability claims in the event the Company's products
or products under development fail to perform as intended. Even unsuccessful
claims could result in the expenditure of funds in litigation and the diversion
of management time and resources and could damage the Company's reputation and
impair the marketability of the Company's products. While the Company maintains
liability insurance, there can be no assurance that a successful claim could not
be made against the Company, that the amount of indemnification payments or
insurance would be adequate to cover the costs of defending against or paying
such a claim, or that damages payable by the Company would not have a material
adverse effect on the Company's business, financial condition, and results of
operations and on the price of the Company's Common Stock.
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SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
The Company has granted certain registration rights to the Company's
controlling shareholder and to Kos Investments, which entitle such entities to
cause the Company to effect three registrations under the Securities Act of
sales of shares of the Company's Common Stock owned by such entities. These
registration rights generally would also permit the holders of such rights to
include shares in any registration statement otherwise filed by the Company. By
exercising these registration rights, these entities could cause a large number
of shares to be registered and become freely tradeable without restrictions
under the Securities Act (except for those purchased in the offering by
affiliates of the Company) immediately upon the effectiveness of such
registration. Such sales may have an adverse effect on the market price of the
Common Stock and could impair the Company's ability to raise additional capital.
POSSIBLE STOCK PRICE VOLATILITY
The stock market, including the Nasdaq National Market, on which the
Company's shares are listed, has 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 price of the Company's Common
Stock, like the stock prices of many publicly traded pharmaceutical and
biotechnology companies, has been and may continue to be highly volatile. The
sale by the Company's controlling shareholder or members of the Company's
management of shares of Common Stock, announcements of technological innovations
or new commercial products by the Company or its competitors, developments or
disputes concerning patent or proprietary rights, publicity regarding actual or
potential medical results relating to the NIASPAN product or to products under
development by the Company or its competitors, regulatory developments in either
the United States or foreign countries, public concern as to the safety of
pharmaceutical and biotechnology products and economic and other external
factors, as well as the trend of prescriptions for the NIASPAN product and the
period-to-period fluctuations in sales or other financial results, among other
factors, may have a significant impact on the market price of the Common Stock.
ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Articles of Incorporation and Bylaws,
as well as the Florida Business Corporation Act, could discourage a third party
from attempting to acquire, or make it more difficult for a third party to
acquire, control of the Company without approval of the Company's Board of
Directors. Such provisions could also limit the price that certain investors
might be willing to pay in the future for shares of the Common Stock. Certain of
such provisions allow the Board of Directors to authorize the issuance of
preferred stock with rights superior to those of the Common Stock. Moreover,
certain provisions of the Company's Articles of Incorporation or Bylaws
generally permit removal of directors only for cause by a 60% vote of the
shareholders of the Company, require a 60% vote of the shareholders to amend the
Company's Articles of Incorporation or Bylaws, require a demand of at least 50%
of the Company's shareholders to call a special meeting of shareholders, and
prohibit shareholder actions by written consent.
27
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated financial statements and supplementary data required by this
item can be found at the pages listed in the following index.
PAGE
----
FINANCIAL STATEMENTS:
Report of Independent Certified Public Accountants................ 29
Consolidated Balance Sheets at December 31, 1998 and 1997......... 30
Consolidated Statements of Operations for the year ended
December 31, 1998, 1997 and 1996.............................. 31
Consolidated Statements of Shareholders' Equity (Deficit) for
the period December 31, 1995 to December 31, 1998............. 32
Consolidated Statements of Cash Flows for the year ended
December 31, 1998, 1997 and 1996.............................. 33
Notes to Consolidated Financial Statements........................ 34
FINANCIAL STATEMENT SCHEDULE:*
Report of Independent Certified Public Accountants on Schedule.... 48
II. Valuation and Qualifying Accounts........................... 49
------------
*All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and
therefore not included herein.
28
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
Kos Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Kos
Pharmaceuticals, Inc. (a Florida corporation) and subsidiary as of December 31,
1998 and 1997, and the related consolidated statements of operations,
shareholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Kos Pharmaceuticals, Inc.
and subsidiary as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Miami, Florida,
February 12, 1999
(except with respect to the
matter discussed in Note 14. as
to which the date is March 1, 1999).
29
<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------------
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents .................................... $ 4,878,641 $ 39,502,484
Marketable securities ........................................ -- 30,894,009
Trade accounts receivable, net ............................... 2,017,151 1,820,011
Inventories .................................................. 1,312,556 3,382,868
Prepaid expenses and other current assets .................... 1,325,689 1,872,862
------------- -------------
Total current assets ..................................... 9,534,037 77,472,234
Fixed Assets, net ............................................... 12,019,579 6,900,160
Other Assets .................................................... 16,747 31,036
------------- -------------
Total assets ............................................. $ 21,570,363 $ 84,403,430
============= =============
LIABILITIES AND SHAREHOLDERS'
EQUITY (DEFICIT)
Current Liabilities:
Accounts payable ............................................. $ 4,333,003 $ 3,159,685
Accrued expenses ............................................. 8,195,586 3,373,887
Capital lease obligations .................................... 141,028 --
------------- -------------
Total current liabilities ................................ 12,669,617 6,533,572
------------- -------------
Notes Payable to Shareholder .................................... 9,000,000 --
Capital Lease Obligations, net of current portion ............... 238,503 --
Commitments and Contingencies (Note 11)
Shareholders' Equity (Deficit):
Preferred stock, $.01 par value, 10,000,000 shares authorized,
none issued and outstanding .............................. -- --
Common stock, $.01 par value, 50,000,000 shares authorized,
17,720,270 and 17,165,695 shares issued and outstanding
as of December 31, 1998 and 1997, respectively ............ 177,203 171,657
Additional paid-in capital ................................... 184,598,845 183,650,564
Accumulated deficit .......................................... (185,113,805) (105,952,363)
------------- -------------
Total shareholders' equity (deficit) ..................... (337,757) 77,869,858
------------- -------------
Total liabilities and shareholders' equity (deficit) ..... $ 21,570,363 $ 84,403,430
============= =============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
30
<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales .............................. $ 13,038,241 $ 2,892,065 $ --
Cost of sales .......................... 3,276,153 792,230 --
------------ ------------ ------------
Gross profit ..................... 9,762,088 2,099,835 --
------------ ------------ ------------
Operating expenses:
Research and development ............ 29,143,527 24,130,216 13,679,009
Selling, general and administrative . 61,519,514 20,508,654 2,880,776
Expense recognized on modification of
stock option grants ............... -- -- 5,436,000
------------ ------------ ------------
Total operating expenses ......... 90,663,041 44,638,870 21,995,785
------------ ------------ ------------
Loss from operations ................... (80,900,953) (42,539,035) (21,995,785)
------------ ------------ ------------
Other:
Interest income, net ................ 1,792,796 2,786,946 11,324
Interest expense-related parties .... (68,466) (867,652) (136,282)
Other income (expense) .............. 15,181 (10,240) --
------------ ------------ ------------
Total other income (expense) .... 1,739,511 1,909,054 (124,958)
------------ ------------ ------------
Loss before minority interest ... (79,161,442) (40,629,981) (22,120,743)
Minority interest ..................... -- -- 15,341
------------ ------------ ------------
Net loss ........................ $(79,161,442) $(40,629,981) $(22,105,402)
============ ============ ============
Net loss per share, basic and diluted .. $ (4.50) $ (2.79) $ (1.95)
Weighted average shares of common
stock outstanding .................... 17,589,767 14,569,474 11,340,000
Common stock options outstanding
(not included in the calculation
of diluted loss per share as their
impact would be antidilutive) ........ 2,857,215 2,446,790 2,295,500
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
31
<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
ADDITIONAL
COMMON PAID-IN ACCUMULATED
STOCK CAPITAL DEFICIT TOTAL
-------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 ................... $100,000 $ 44,507,000 $ (43,216,980) $ 1,390,020
Capital contributions from Kos Investments, Inc. -- 8,381,633 -- 8,381,633
Modification of stock options .................. -- 5,436,000 -- 5,436,000
Contribution of minority interest .............. -- 147,690 -- 147,690
Net loss ....................................... -- -- (22,105,402) (22,105,402)
-------- ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1996 ................... 100,000 58,472,323 (65,322,382) (6,750,059)
Issuance of Common Stock ....................... 58,577 109,167,409 -- 109,225,986
Exercise of stock options ...................... 3,479 1,226,562 -- 1,230,041
Conversion of Convertible Note and accrued
interest to Common Stock..................... 9,601 14,391,435 -- 14,401,036
Stock options issued to non-employees .......... -- 392,835 -- 392,835
Net loss ....................................... -- -- (40,629,981) (40,629,981)
-------- ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1997 ................... 171,657 183,650,564 (105,952,363) 77,869,858
Issuance of Common Stock ....................... 29 33,872 -- 33,901
Exercise of stock options ...................... 5,517 533,594 -- 539,111
Stock options issued to non-employees .......... -- 380,815 -- 380,815
Net loss ....................................... -- -- (79,161,442) (79,161,442)
-------- ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1998 ................... $177,203 $184,598,845 $(185,113,805) $ (337,757)
======== ============ ============= =============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
32
<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996
------------ ------------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................... $(79,161,442) $ (40,629,981) $(22,105,402)
Adjustments to reconcile net loss to net cash used
in operating activities-
Provision for doubtful accounts .......................... 20,000 80,000 --
Depreciation and amortization ............................ 2,202,251 921,271 539,661
Provision for inventory obsolescence ..................... 259,500 246,987 --
Minority interest ........................................ -- -- (15,341)
Expense recognized on modification of
stock option grants .................................... -- -- 5,436,000
Gains from disposals of fixed assets ..................... 15,181 -- --
Common stock issued to employees ......................... 33,901 -- --
Stock options issued to non-employees .................... 380,815 392,835 --
Changes in operating assets and liabilities:
Trade accounts receivable .............................. (217,140) (1,900,011) --
Prepaid expenses and other current assets .............. 547,173 (1,639,021) (81,531)
Inventories ............................................ 1,810,812 (3,629,855) --
Other assets ........................................... 14,289 (31,036) --
Accounts payable ....................................... 1,173,318 2,104,270 336,134
Accrued expenses ....................................... 4,821,699 3,843,514 429,002
------------ ------------- ------------
Net cash used in operating activities ................. (68,099,643) (40,241,027) (15,461,477)
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales (Purchases) of Marketable Securities ................. 30,894,009 (30,894,009) --
Capital expenditures ....................................... (6,906,703) (5,216,027) (1,147,067)
------------ ------------- ------------
Net cash provided by (used in) investing activities ... 23,987,306 (36,110,036) (1,147,067)
------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Common Stock ................. -- 109,225,986 --
Net proceeds from exercise of stock options ................ 539,111 1,230,041 --
Capital contributions received
from Kos Investments, Inc. .............................. -- -- 8,381,633
Borrowings under Convertible Note .......................... -- 5,040,000 8,355,000
Borrowings under Notes Payable to Shareholder .............. 9,000,000 -- --
Payments under capital lease obligations ................... (50,617) -- --
------------ ------------- ------------
Net cash provided by financing activities ............. 9,488,494 115,496,027 16,736,633
------------ ------------- ------------
Net (decrease) increase in cash and cash equivalents (34,623,843) 39,144,964 128,089
Cash and Cash Equivalents, beginning of period ............... 39,502,484 357,520 229,431
------------ ------------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ..................... $ 4,878,641 $ 39,502,484 $ 357,520
============ ============= ============
Supplemental Disclosure of Cash Flow Information:
Interest paid .............................................. $ 14,819 $ -- $ --
Supplemental Disclosure of Non-cash Information:
Acquisition of equipment under capital lease obligations.... $ 430,148 $ -- $ --
Contribution of minority interest to paid-in capital........ $ -- $ -- $ 147,690
Conversion of Convertible Note and accrued interest
payable to Common Stock.................................... $ -- $ 14,401,036 $ --
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
33
<PAGE>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The predecessor to Kos Pharmaceuticals, Inc. (the "Company"), Kos Holdings,
Inc. ("Holdings"), was incorporated in Florida on July 1, 1988, to develop
prescription pharmaceutical products principally for the cardiovascular and
respiratory markets. On June 25, 1996, the Company was incorporated in Florida
as the successor to the business of Holdings. On June 30, 1996, all of the
assets and liabilities of Holdings, other than its net operating loss
carryforwards, were transferred to the Company in exchange for shares of Common
Stock of the Company (the "Reorganization"). The Reorganization was accomplished
in order to transfer the assets and operations of Holdings to the Company while
preserving Holdings' net operating losses and related federal tax benefits for
Holdings and its sole shareholder and one of its founders. Kos Investments, Inc.
("Investments") is the sole shareholder of Holdings. As this transaction was
between entities under common control, the transaction was accounted for on a
historical cost basis, in a manner similar to a pooling of interests.
On June 22, 1993, Holdings and Aeropharm Technology, Inc. ("Aeropharm")
entered into a letter of intent for Holdings' purchase of a controlling interest
in Aeropharm. On February 14, 1995, the transaction was completed through a
stock purchase agreement that gave control (80% ownership) of Aeropharm to
Holdings. Holdings accounted for its investment in Aeropharm as a consolidated
subsidiary from June 22, 1993. On June 20, 1996, Holdings acquired the minority
interest in Aeropharm, held by an employee of Aeropharm, in exchange for options
to purchase 50,000 shares of Holdings' common stock at $7.00 per share, the
estimated fair value of the underlying shares at the date of grant. The
acquisition of the minority interest in Aeropharm was accounted for under the
purchase method and the fair value of the options granted approximated the
carrying value ($147,690) of the minority interest.
On July 28, 1997, the Company obtained clearance from the U.S. Food and
Drug Administration ("FDA") to market NIASPAN, its first product
(NIASPAN/registered trademark/ is a registered trademark of the Company). The
Company began sales of the NIASPAN product during August 1997. NIASPAN is a
once-a-day, oral, solid dose extended-release formulation of niacin for the
treatment of hyperlipidemia, a multiple lipid disorder that is a primary risk
factor for coronary heart disease. Niacin is a water soluble vitamin that has
long been recognized as an effective pharmacological agent for the treatment of
multiple lipid disorders including elevated LDL and low HDL cholesterol.
The Company expects to incur additional losses in the near-term due
primarily to its sales and marketing efforts associated with NIASPAN and to
research and development activities in connection with its products under
development. No assurance can be given that the Company's products can be
successfully marketed, that products under development can be successfully
formulated or manufactured at acceptable cost and with appropriate quality, or
that required regulatory approvals will be obtained. The Company is subject to a
number of other risks including, but not limited to, uncertainties related to
market acceptance, future capital needs and uncertainty of additional funding,
uncertainties related to limited sales and marketing experience, uncertainties
related to patents and trademarks, interference and risk of infringement,
uncertainties related to competition and technological changes, government
regulation, dependence on product development collaborators, limited
manufacturing experience and risk of scale-up, dependence on single sources of
supply, and no assurances of adequate third party reimbursement. The likelihood
of the success of the Company must be considered in light of the uncertainty
caused by problems, expenses, complications and delays frequently encountered in
connection with the development of new business ventures.
34
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the results of Holdings
(prior to July 1, 1996), the Company and its subsidiary, Aeropharm. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of 90 days or less to be cash equivalents.
MARKETABLE SECURITIES
All of the Company's marketable securities are considered
available-for-sale securities. The Company accounts for marketable securities in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities".
Available-for-sale securities represent debt securities that are stated at fair
value. Amortization of premiums and accretion of discounts are recognized as
adjustments to interest income. Gains or losses on disposition are based on the
net proceeds and the adjusted carrying amount of the securities sold, using the
specific identification method.
LONG-LIVED ASSETS
During 1995, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
Under the provisions of this statement, the Company has evaluated its long-lived
assets for financial impairment, and will continue to evaluate them as events or
changes in circumstances indicate that the carrying amount of such assets may
not be fully recoverable.
The Company evaluates the recoverability of long-lived assets not held for
sale by measuring the carrying amount of the assets against the estimated
undiscounted future cash flows associated with them. At the time such
evaluations indicate that the future undiscounted cash flows of certain
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are adjusted to their fair values. Based on these
evaluations, there were no adjustments to the carrying value of long-lived
assets in 1998 or 1997.
The Company evaluates the recoverability of long-lived assets held for sale
by comparing the asset's carrying amount with its fair value less cost to sell.
No assets were held for sale as of December 31, 1998 or 1997.
MINORITY INTEREST
Minority interest for the year ended December 31, 1996, represents the
minority shareholder's interest in the net loss of Aeropharm. As of December 31,
1998 and 1997, the Company owned 100% of Aeropharm; therefore, no minority
interest is reflected.
FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 1998 and 1997, the carrying amount of cash and cash
equivalents, trade accounts receivable, and notes payable approximates fair
value due to the short term nature of these accounts. See Note 3. for
information regarding the fair value of marketable securities.
35
<PAGE>
CONCENTRATION OF CREDIT RISK
The Company has no significant off-balance-sheet concentrations of credit
risk.
REVENUE RECOGNITION
Sales and the related cost of sales are recognized at the time product is
shipped. Net sales consist of gross sales less provisions for expected rebates
and chargebacks, discounts, and customer returns. These provisions totaled
$1,347,000 and $76,000 in the years ended December 31, 1998 and 1997,
respectively. Included in "Accrued expenses" in the accompanying consolidated
balance sheets are $722,000 and $88,000 at December 31, 1998 and 1997,
respectively, related to these provisions.
DEPRECIATION AND AMORTIZATION
Fixed assets are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of the assets or lease term as follows:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and equipment........................... 3-7
Computer software and hardware.................... 3-5
Laboratory and manufacturing equipment............ 3-5
Leasehold improvements............................ Life of lease
</TABLE>
RESEARCH AND DEVELOPMENT EXPENSES
All research and development expenses are reflected in the Company's
consolidated statements of operations as incurred.
NET LOSS PER SHARE
Basic loss per share is determined by dividing the Company's net loss by
the weighted average number of shares of Common Stock outstanding. Diluted loss
per share also includes dilutive Common Stock equivalents outstanding after
applying the "treasury stock" method.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings per Share". SFAS No. 128 simplifies the methodology of
computing earnings per share and requires the presentation of basic and diluted
earnings per share. The Company's basic and diluted earnings per share are the
same, because the Company's Common Stock equivalents are antidilutive.
INCOME TAXES
The Company follows SFAS No. 109, "Accounting for Income Taxes," which
requires, among other things, recognition of future tax benefits measured at
enacted rates attributable to deductible temporary differences between financial
statement and income tax bases of assets and liabilities and to tax net
operating loss carryforwards to the extent that realization of said benefits is
more likely than not. The net operating loss carryforwards as of the
Reorganization, amounting to approximately $51 million, were not transferred to
the Company. As of December 31, 1998, the Company had available $138.7 million
of net operating loss carryforwards. Due to the uncertainty of the Company's
ability to generate sufficient taxable income in the future to utilize such loss
carryforwards, the net deferred tax asset has been fully reserved.
36
<PAGE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FISCAL-YEAR CHANGE
The Company's Board of Directors changed the end of the Company's fiscal
year from June 30 to December 31 effective with the December 31, 1997, reporting
period. Fiscal years presented and referred to in these consolidated financial
statements and notes thereto are on a December 31 fiscal-year basis.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". Comprehensive income is defined as the change in equity during the
financial reporting period of a business enterprise resulting from non-owner
sources. The Company does not have any material comprehensive income recorded
for the years ended December 31, 1998, 1997 and 1996.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", was also issued by FASB in June 1997. This statement establishes
standards for reporting information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The Company believes that it operates
within one segment. See Note 10. for information regarding major customers.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", is effective for fiscal years ended after June 15, 1999. This
statement establishes accounting and reporting standards that require every
derivative instrument be recorded in the balance sheet as either an asset or
liability at its fair value. The Company adopted SFAS 133 effective June 30,
1998. The adoption of this statement did not have an impact on the Company's
consolidated financial position because the Company does not presently have any
derivative or hedging-type investment as defined by SFAS 133.
3. MARKETABLE SECURITIES
As of December 31, 1997, marketable securities consisted of U.S. government
securities for which fair values approximated unamortized cost. The contractual
maturities of these securities were less than one year. Fair values were based
on quoted market prices obtained from an independent broker. No marketable
securities were held by the Company as of December 31, 1998.
37
<PAGE>
4. TRADE ACCOUNTS RECEIVABLE, NET
Trade accounts receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Trade accounts receivable........................................ $2,117,151 $1,900,011
Less allowance for doubtful accounts............................. (100,000) (80,000)
---------- ----------
Trade accounts receivable, net................................ $2,017,151 $1,820,011
========== ==========
</TABLE>
5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Raw materials..................................................... $ 251,039 $ 218,363
Work in process................................................... 847,024 1,916,865
Finished goods.................................................... 214,493 1,247,640
---------- ----------
Total inventories............................................... $1,312,556 $3,382,868
========== ==========
</TABLE>
6. FIXED ASSETS, NET
Fixed assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997
----------- ----------
<S> <C> <C>
Furniture and equipment........................................... $ 1,581,573 $1,238,853
Computer software and hardware.................................... 2,596,069 1,314,214
Laboratory and manufacturing equipment............................ 7,674,443 5,101,992
Leasehold improvements............................................ 5,160,043 2,035,399
----------- ----------
Fixed assets, gross............................................. 17,012,128 9,690,458
Less accumulated depreciation and amortization.................... (4,992,549) (2,790,298)
----------- ----------
Fixed assets, net............................................... $12,019,579 $6,900,160
=========== ==========
</TABLE>
38
<PAGE>
7. ACCRUED EXPENSES
Major components of accrued expenses were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Employee bonuses and commissions.................................. $1,956,986 $ 415,621
Employee vacations................................................ 1,094,609 370,625
Clinical studies.................................................. 646,118 335,994
License fee....................................................... -- 1,000,000
All other......................................................... 4,497,873 1,251,647
---------- ----------
Total accrued expenses.......................................... $8,195,586 $3,373,887
========== ==========
</TABLE>
8. CONVERSION OF NOTES PAYABLE
Michael Jaharis, Chairman of the Company's Board of Directors and the
controlling shareholder of Investments, personally guaranteed the repayment of a
loan to Investments from certain financial institutions. Prior to March 21,
1995, the Company was the primary borrower under this loan and, therefore,
received the benefit of the personal guaranty extended by Mr. Jaharis. As
consideration for Mr. Jaharis' personal guaranty, the Company agreed to pay Mr.
Jaharis an annual fee of 0.25% of the average amount outstanding under the loan
during the Company's fiscal year. In March 1995, the Company was released as a
borrower under the loan. The assumption of the note payable to the bank resulted
in an increase in the Company's "Additional paid-in capital" to reflect this
transfer to Investments.
On July 1, 1996, the Company executed a loan in favor of Kos Investments,
Inc. (the "Convertible Note") in the aggregate principal amount of up to $15.0
million, the proceeds of which were used to fund the Company's operations until
the consummation of its Initial Public Offering ("IPO"). Under the terms of the
Convertible Note, interest accrued on the outstanding principal amount at First
Union National Bank of Florida's prime rate commencing July 1, 1996, escalating
to a rate of 1% over such prime rate during calendar year 1997. The Convertible
Note was convertible into Common Stock at a conversion price per share equal to
the IPO price per share ($15.00). On October 25, 1997, the outstanding principal
and interest of the Convertible Note were converted into 960,069 shares of
Common Stock. At the time of conversion, the Convertible Note accrued interest
at a rate of 8.50% per year and had outstanding principal and interest of
$13,395,000 and $1,006,036, respectively.
9. NOTES PAYABLE TO SHAREHOLDER
On July 1, 1998, the Company entered into a $30 million credit facility
(the "Credit Facility") with Michael Jaharis. The Company may draw against the
Credit Facility during the period from July 1, 1998 to June 30, 1999. Borrowings
under the Credit Facility, which totaled $9 million at December 31, 1998, bear
interest at the prime rate (7.75% as of December 31, 1998) and will be due
December 31, 2000. The Company incurred $68,466 of interest expense under the
Credit Facility for the year ended December 31, 1998.
Effective October 7, 1998, the Company entered into an additional $25
million funding arrangement (the "Supplemental Funding Arrangement") with
Michael Jaharis. Under the terms of the Supplemental Funding Arrangement, Mr.
Jaharis will make available to the Company, as requested, additional debt or
equity capital in excess of the capital available to the Company under the
Credit Facility. Funds will be provided to the Company under the Supplemental
Funding Arrangement at prevailing rates and on prevailing terms for companies
situated similar to the Company. The Supplemental Funding
39
<PAGE>
Arrangement is subject to certain conditions, including (i) the parties'
entering into appropriate documentation containing standard terms and
conditions, (ii) at the time of funding, there shall not have been any material
adverse change in the business or financial operations or condition of the
Company or in its management, (iii) at the time of funding, the Company's then
current financial projections shall indicate that the Company shall have
sufficient funds, with the funding to be provided under the Supplemental Funding
Arrangement, to achieve positive cash flow no later than June 30, 2000, (iv) at
the time of funding, there shall not be any litigation pending or threatened
involving the Company that is likely to have a material adverse effect on the
Company, and (v) at the time of funding, Michael Jaharis or his affiliates shall
continue to hold a controlling interest in the Company's Common Stock. The
Supplemental Funding Arrangement will terminate on the earlier to occur of (x)
June 30, 2000, (y) the Company's receiving third party financing for an amount
in excess of 50% of the amount available under the Supplemental Funding
Arrangement and (z) a change in control, merger or sale of substantially all of
the assets of the Company. The Company had no borrowings outstanding under the
Supplemental Funding Arrangement as of December 31, 1998. (See Note 14.
"Subsequent Event" for increase in funding commitment under the Supplemental
Funding Arrangement).
10. MAJOR CUSTOMERS
Sales to customers that were at least 10% of the Company's gross sales are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
CUSTOMER NAME 1998 1997
------------- ---------- ----------
<S> <C> <C>
McKesson Drug Co...................................................... $4,186,863 $ 649,611
Bergen Brunswig Corp.................................................. 2,610,655 233,297
Cardinal Health, Inc.................................................. 1,860,512 412,929
---------- ----------
Total.............................................................. $8,658,030 $1,295,837
========== ==========
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
LETTER OF CREDIT FACILITY
On July 17, 1998, the Company entered into a $3 million letter of credit
facility with a bank (the "Letter of Credit Facility"). Under the terms of the
Letter of Credit Facility, letters of credit outstanding must not exceed 90% of
the Company's cash balance kept at such bank. As of December 31, 1998, letters
of credit outstanding totaled $1,528,000.
40
<PAGE>
EMPLOYMENT AND ROYALTY AGREEMENTS
As of December 31, 1998, the Company had employment and/or royalty
agreements with three of its officers. Salary and benefits expense recorded
under the employment agreements totaled $833,000, $708,000 and $769,000 during
the years ended December 31, 1998, 1997 and 1996, respectively. The royalty
agreements entitle two of these officers to royalties on sales of the Company's
products, the aggregate amounts of which may not exceed $5,500,000. Royalty
expense from these agreements during the years ended December 31, 1998 and 1997
was approximately $65,000 and $29,000, respectively. Future minimum payments
under the employment agreements are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ----------
<S> <C>
1999................................................................................... $ 515,000
2000................................................................................... 350,000
2001................................................................................... 350,000
2002................................................................................... 175,000
----------
$1,390,000
==========
</TABLE>
LEASE COMMITMENTS
The Company has various operating leases that expire through 2002 for the
rental of office space, laboratory facilities, and sales force vehicles. Future
minimum commitments under these agreements are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ----------
<S> <C>
1999................................................................................... $2,286,000
2000................................................................................... 1,764,000
2001................................................................................... 1,252,000
2002................................................................................... 470,000
----------
$5,772,000
==========
</TABLE>
As of December 31, 1998 and 1997, standby letters of credit of
approximately $1,236,000 and $960,000, respectively, were outstanding under the
Letter of Credit Facility in favor of the lessors as collateral for these leases
provided to the Company.
Rent and other expenses incurred under the operating leases was $3,061,000,
$823,000 and $558,000, during the years ended December 31, 1998, 1997 and 1996,
respectively.
LICENSING AND JOINT VENTURE AGREEMENTS
The Company has several license agreements (the "License Agreements") with
third parties (the "Licensees") for the development of future products. Under
the License Agreements, the Company is required to make payments to the
Licensees upon completion of various milestones of each project in order to
secure exclusive rights to develop, manufacture, sell and/or sublicense future
products developed through the License Agreements. In connection with the
License Agreements, the Company recorded licensing expense of approximately
$490,000, $5,638,000 and $1,671,000 for the years ended December 31, 1998, 1997
and 1996 respectively, which is reflected in "Research and development" in the
accompanying consolidated statements of operations.
41
<PAGE>
In order to maintain its rights under the License Agreements, the Company
is required to pay certain future milestone payments and licensing fees. In the
event that no milestone event occurs, the Company generally would not be
required to make any milestone payment. The Company anticipates, based on the
development efforts that have been conducted to date, that it will be required
to make future milestone payments under the License Agreements as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ --------
<S> <C>
1999................................................................................... $375,000
2000................................................................................... 125,000
--------
$500,000
========
</TABLE>
On February 7, 1997, the Company entered into an agreement with an
unaffiliated generic drug manufacturer pursuant to which the parties agreed to
resolve the effects, as between themselves, of a potential interference
proceeding by the United States Patent and Trademark Office by granting cross
licenses under their respective patent applications and patents, regardless of
whether such licenses would be required. In connection with this licensing
agreement, the Company recognized $3,000,000 as a licensing expense; such
expense is included in "Research and development" in the accompanying
consolidated statement of operations for the year ended December 31, 1997. As
further consideration for entering into the agreement, the Company agreed to pay
the generic manufacturer certain royalties on the net sales of NIASPAN subject
to a cap on such royalty payments in the United States and a separate cap on
such payments for sales outside the United States. The Company recorded $652,000
and $148,000 of royalty expense from this agreement for the years ended December
31, 1998 and 1997, respectively, and are included in "Selling, general and
administrative" in the accompanying consolidated statement of operations.
SPONSORED RESEARCH
The Company has on-going research agreements with two universities and a
research center. The Company is primarily responsible for funding the projects,
and the university or research center is responsible for providing personnel,
equipment, and facilities to conduct the research activities.
Future minimum commitments under these agreements are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ --------
<S> <C>
1999................................................................................. $385,000
2000................................................................................. 87,500
--------
$472,500
========
</TABLE>
The Company also funds, from time to time and at its sole discretion, other
research programs conducted at other universities and research centers. Expenses
recorded under the Company's sponsored research programs totaled approximately
$383,000, $380,000 and $439,000 during the years ended December 31, 1998, 1997
and 1996, respectively, and are reflected in "Research and development" in the
accompanying consolidated statements of operations.
42
<PAGE>
DEVELOPMENT AGREEMENTS
The Company has development agreements with various third parties (the
"Development Agreements"). As dictated by the Development Agreements, the
Company is responsible for funding all required development activities. In order
to maintain its rights under the Development Agreements, the Company is required
to pay certain future milestone payments and development fees. In the event that
no milestone event occurs, the Company generally would not be required to make
any milestone payment. The Company anticipates, based on the development efforts
that have been conducted to date, that it will be required to pay development
fees under the Development Agreements of approximately $67,000 during the year
ended December 31, 1999.
Expenses recorded under these and other development agreements totaled
approximately $1,470,000, $2,688,000 and $1,191,000 during the years ended
December 31, 1998, 1997 and 1996, respectively, and are reflected in "Research
and development" in the accompanying consolidated statements of operations.
EMPLOYEE BENEFIT PLANS
The Company's Internal Revenue Code Section 401(k) Plan, known as the Kos
Savings Plan, became effective on January 1, 1994. Each employee who has
completed at least 90 days of service with the Company and has attained age 21
is eligible to make pre-tax elective deferral contributions each year not
exceeding the lesser of a specified statutory amount or 15% of the employee's
compensation for the year. An employee is always 100% vested in the employee's
elective deferral contributions. On September 24, 1998, the Company's Board of
Directors approved a Company match to employees' contributions to the Kos
Savings Plan, effective January 1, 1999. The Company's matching contribution
will be limited to 50% of an employee's 401(k) contribution, and not to exceed
3% of such employee's compensation or $5,000 per employee for any given year.
On November 19, 1998, subject to shareholder approval at the Company's next
Annual Shareholders' Meeting, the Board of Directors approved the implementation
of the Kos Pharmaceuticals, Inc. 1999 Employee Stock Purchase Plan (the "Stock
Purchase Plan") effective February 15, 1999. Under the Stock Purchase Plan, an
eligible employee may purchase Common Stock at a 15% discount by contributing to
the Stock Purchase Plan, through payroll deductions, up to 10% of such
employee's annual compensation. Each employee's total contributions will be
limited to $25,000 per year. Employee payroll deductions will be accumulated for
six-month periods at the end of which shares of the Company's Common Stock will
be purchased under the Stock Purchase Plan. All employees of the Company with at
least 90 days of continuous service at the beginning of each six-month offering
period are eligible to participate in that offering period. Subject to
shareholder approval, 1,000,000 shares of Common Stock will be made available
for purchase under the Stock Purchase Plan.
12. SHAREHOLDERS' EQUITY (DEFICIT)
COMMON STOCK
In March 1997, the Company completed an initial public offering of
4,772,500 shares of Common Stock. Net proceeds to the Company were approximately
$65,900,000 after deducting expenses of the offering.
In October 1997, the Company completed a follow-on public offering of
1,085,000 shares of Common Stock. Net proceeds to the Company were approximately
$43,330,000 after deducting expenses of the offering.
43
<PAGE>
PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of undesignated
preferred stock. Such shares of preferred stock may be issued by the Company in
the future, without shareholder approval, upon such terms as the Company's Board
of Directors may determine.
STOCK OPTION PLAN
During 1996, the Board of Directors of the Company adopted the Kos
Pharmaceuticals, Inc. 1996 Stock Option Plan (the "Plan"). As of December 31,
1998, a maximum of 4,000,000 shares of Common Stock may be issued pursuant to
stock options granted or to be granted under the Plan. All directors, officers,
employees and certain related parties of the Company designated by the Board are
eligible to receive options under the Plan. The maximum term of any option is
ten years from the date of grant. All options expire within 30 days of
termination of employment. The Plan is administered by a committee appointed by
the Board of Directors of the Company.
On February 19, 1998, the Company's Board of Directors authorized the
re-pricing of options to acquire shares of Common Stock granted to employees at
exercise prices ranging from $15.00 to $43.44 per share (the "February
Re-Pricing"). As a result of the February Re-Pricing, the exercise price for
these options was reduced to $11.16 per share, the average of the high and low
price of the Company's Common Stock on February 19, 1998. No options granted to
members of the Board of Directors were re-priced under the February Re-Pricing.
Effective October 1, 1998, the Board of Directors authorized a second
re-pricing of options to acquire shares of Common Stock granted to employees at
exercise prices ranging from $7.00 to $13.28 (the "October Re-Pricing"). As a
result of the October Re-Pricing, the exercise price of certain options was
reduced to $5.06 per share, the closing price of the Company's Common Stock on
October 1, 1998. No options granted to members of the Board of Directors or to
the Company's officers were re-priced under the October Re-Pricing.
Each outside director of the Company is granted an option to purchase
15,000 shares of Common Stock upon election to the Board, receives options to
purchase 15,000 shares effective on each director's anniversary date and 3,000
shares effective on the date of the Company's Annual Shareholders' Meeting. The
exercise price of such options will be the fair market value of the underlying
Common Stock on the date the option is granted. The Company considered the
provisions of SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") using the Black Scholes method to approximate the related charge to
expense. Assumptions for the calculation of charges associated with SFAS 123
include:
<TABLE>
<CAPTION>
RISK-FREE EXPECTED
GRANT VOLATILITY INTEREST EXPECTED TERM
DATE RATE RATE DIVIDENDS (YEARS)
-------------- ---------- --------- --------- --------
<S> <C> <C> <C> <C>
1996 and prior 0% 6.63% $ -- 5
1997 57.6 6.25 -- 5
1998 66.4 4.77 -- 5
</TABLE>
44
<PAGE>
As of December 31, 1998, the Company had granted options to purchase
3,909,900 shares of Common Stock to employees, consultants, management and
directors, including options granted prior to the implementation of the Plan.
Detail of option activity is as follows:
<TABLE>
<CAPTION>
EXERCISE PRICES
--------------------------------
NUMBER OF WEIGHTED
SHARES RANGE AVERAGE
---------- ------------------- --------
<S> <C> <C> <C>
Outstanding, December 31, 1995........... 1,185,000 $ 0.60 - $ 3.33 $ 0.81
Granted.................................. 1,110,500 7.00 - 15.00 7.99
----------
Outstanding, December 31, 1996........... 2,295,500 0.60 - 15.00 4.28
Granted.................................. 539,700 15.00 - 43.44 33.14
Exercised................................ (347,910) 0.60 - 15.00 3.52
Canceled................................. (40,500) 7.00 - 38.69 11.11
----------
Outstanding, December 31, 1997........... 2,446,790 0.60 - 43.44 10.64
Granted(*)............................... 2,955,265 5.06 - 13.28 8.15
Exercised................................ (551,675) 0.60 - 7.00 0.98
Canceled(*).............................. (1,993,165) 5.06 - 43.44 16.67
----------
Outstanding December 31, 1998............ 2,857,215 $ 0.60 - $27.25 $ 5.93
==========
</TABLE>
- ------------
(*) Includes effect of re-priced options (1,880,565 options, which had original
exercise prices ranging from $7.00 to $43.44, and an original weighted
average exercise price of $16.94, were re-priced in February and October
1998).
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ------------------------------------------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AVERAGE
RANGE OF DECEMBER 31, REMAINING EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1998 CONTRACTUAL LIFE PRICE 1998 PRICE
---------------- -------------- ---------------- --------- ------------ --------
<S> <C> <C> <C> <C> <C>
$ 0.60 to $ 0.75 425,000 6.4 years $ 0.64 425,000 $ 0.64
3.33 to 3.33 25,000 4.5 years 3.33 25,000 3.33
5.06 to 7.16 1,911,390 8.5 years 5.63 660,822 5.88
7.75 to 11.16 472,825 8.8 years 11.07 79,925 11.16
24.69 to 27.25 23,000 8.2 years 25.02 23,000 25.02
--------- ---------
2,857,215 1,213,747
========= =========
</TABLE>
At December 31, 1998, 568,200 shares remain authorized and unissued and
options to purchase 1,213,747 shares of Common Stock were exercisable, including
options granted outside the Plan. During 1998, options to purchase 2,955,265
shares of Common Stock were granted at exercise prices ranging from $5.06 to
$13.28 (including options to purchase 1,880,565 shares of Common Stock, which
had original exercise prices ranging from $7.00 to $43.44, and an original
weighted average exercise price of $16.94, that were re-priced in February and
October 1998).
As permitted by SFAS No. 123, the Company accounts for options issued to
employees under Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees". Consequently, except for options issued to non-employees,
no compensation cost has been recognized on options issued to employees because
the exercise price of such options was not less than the market value of the
Common Stock on the date of grant. Compensation costs of $380,815 and $392,835
were recorded for the years ended December 31, 1998 and 1997, respectively, to
reflect the cost associated with stock options granted to non-employees.
45
<PAGE>
Had compensation cost for options issued to employees been determined
consistent with SFAS No. 123, the Company's net loss and net loss per share
would have been the "Pro Forma" amounts shown in the following table:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net loss:
As reported................................ $(79,161,442) $(40,629,981) $(22,105,402)
Pro Forma.................................. $(81,638,296) $(43,113,692) $(22,105,402)
Net loss per share, basic and diluted:
As reported................................ $ (4.50) $ (2.79) $ (1.95)
Pro Forma.................................. $ (4.64) $ (2.96) $ (1.95)
</TABLE>
13. LEGAL PROCEEDING
On August 5, 1998, a purported class action lawsuit was filed in the United
States District Court for the Northern District of Illinois, Eastern Division,
against the Company, the members of the Company's Board of Directors, certain
officers of the Company, and the underwriters of the Company's October 1997
offering of shares of Common Stock. In its complaint, the plaintiff asserts, on
behalf of itself and a putative class of purchasers of the Company's Common
Stock during the period from July 29, 1997, through November 13, 1997, claims
under: (i) sections 11, 12(a)(2) and 15 of the Securities Act of 1933; (ii)
sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder; and (iii) for common law fraud, negligent
misrepresentation and breach of fiduciary duty. The claims in the lawsuit relate
principally to certain statements made by the Company, or certain of its
representatives, concerning the efficacy, safety, sales volume and commercial
viability of the Company's NIASPAN product. The complaint seeks unspecified
damages and costs, including attorneys' fees and costs and expenses. Upon motion
by the Company, the case was transferred to the United States District Court for
the Southern District of Florida. The Company and the individual Kos defendants
filed a motion to dismiss the complaint on January 7, 1999. The outcome of the
litigation cannot yet be determined. Accordingly, no provision for any liability
that may result from these matters has been recognized in the accompanying
consolidated financial statements. There can be no assurance, however, that the
outcome of this litigation will not have a material adverse effect on the
Company's business, results of operations, and financial condition.
14. SUBSEQUENT EVENT
Effective March 1, 1999, Michael Jaharis agreed to increase the amount
available to the Company under the October 7, 1998, funding arrangement to an
aggregate of $50 million (as amended, the "Supplemental Funding Arrangement").
Under the terms of the Supplemental Funding Arrangement, Mr. Jaharis will make
available to the Company, as requested, additional debt or equity capital in
excess of the capital available to the Company under the Credit Facility. Funds
will be provided to the Company under the Supplemental Funding Arrangement at
prevailing rates and on prevailing terms for companies situated similar to the
Company. Although the terms pursuant to which funds will be provided to the
Company under the Supplemental Funding Arrangement have not been determined, the
Company expects that it will be required to pledge all of its assets to secure
any borrowings from Mr. Jaharis and that any amounts borrowed from Mr. Jaharis
will be convertible, at his option, into shares of the Company's Common Stock.
The conversion of amounts borrowed from Mr. Jaharis under the Supplemental
Funding Arrangement into shares of the Company's Common Stock will result in
dilution to existing shareholders
46
<PAGE>
of the Company. The Supplemental Funding Arrangement is subject to certain
conditions, including (i) the parties' entering into appropriate documentation
containing standard terms and conditions, (ii) at the time of funding, there
shall not have been any material adverse change in the business or financial
operations or condition of the Company or in its management, (iii) for any
funding requested by the Company after January 1, 2000, the Company's then
current financial projections shall indicate that the Company shall have
sufficient funds, with the funding to be provided under the Supplemental Funding
Arrangement, to achieve positive cash flow no later than December 31, 2000, (iv)
at the time of funding, there shall not be any litigation pending or threatened
involving the Company that is likely to have a material adverse effect on the
Company, and (v) at the time of funding, Michael Jaharis or his affiliates shall
continue to hold a controlling interest in the Company's Common Stock. The
Supplemental Funding Arrangement will terminate on the earlier to occur of (x)
December 31, 2000, (y) the Company's receiving third party financing for an
amount in excess of 50% of the amount available under the Supplemental Funding
Arrangement and (z) a change in control, merger or sale of substantially all of
the assets of the Company. There can be no assurance, however, that the Company
will be able to satisfy all of the conditions of the Supplemental Funding
Arrangement at the time that any funding request is made.
47
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULE
To the Board of Directors of
Kos Pharmaceuticals, Inc.:
We have audited in accordance with generally accepted auditing standards,
the financial statements included in this Form 10-K, and have issued our report
thereon dated February 12, 1999. Our audits were made for the purpose of forming
an opinion on the basic financial statements taken as a whole. The accompanying
Schedule II is the responsibility of the Company's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly states, in all material
respects, the financial data required to be set forth therein in relation to the
basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Miami, Florida,
February 12, 1999.
48
<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END
DESCRIPTION PERIOD EXPENSES DEDUCTIONS OF PERIOD
----------- ------------ ----------- ---------- -----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Fiscal year ended December 31, 1997............... $ -- $ 80 $ -- $ 80
Fiscal year ended December 31, 1998............... $ 80 $ 20 $ -- $ 100
ALLOWANCE FOR SALES RETURNS:
Fiscal year ended December 31, 1997............... $ -- $ -- $ -- $ --
Fiscal year ended December 31, 1998............... $ -- $ 135 $ 110 $ 25
</TABLE>
49
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
None.
50
<PAGE>
PART III
The information required in Item 10 (Directors and Executive Officers of
the Registrant), Item 11 (Executive Compensation), Item 12 (Security Ownership
of Certain Beneficial Owners and Management) and Item 13 (Certain Relationships
and Related Transactions) is incorporated by reference to the Company's
definitive proxy statement for the 1998 Annual Meeting of Shareholders to be
filed with the Securities and Exchange Commission within 120 days following
December 31, 1998.
51
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. The Financial Statements filed as part of this report are listed
separately in the index to Financial Statements beginning on page 27
of this report.
2. The following Financial Statement Schedules are filed herewith:
SCHEDULE DESCRIPTION
-------- -----------
II Valuation and Qualifying Accounts for the Year Ended December 31,
1998.
3. The following exhibits are filed herewith:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
3.1* Amended and Restated Articles of Incorporation of the Company
3.2* Amended and Restated Bylaws of the Company
4.1 See Exhibits 3.1 and 3.2 for provisions of the Amended and
Restated Articles of Incorporation and Amended and Restated
Bylaws of the Company defining the rights of holders of Common
Stock of the Company
4.2** Form of Common Stock certificate of the Company
10.1* Employment Agreement dated as of July 1, 1996, between
Daniel M. Bell and the Company
10.2* Nonqualified Stock Option Agreement by and between the
Company and Daniel M. Bell dated as of June 20, 1996.
10.3* Employment Agreement dated as of June 15, 1996, between
David Bova and the Company
10.4* Kos Pharmaceuticals, Inc. 1996 Stock Option Plan
10.5*** Employment Agreement dated June 20, 1996 by and between
Aeropharm Technology, Inc. and Anthony J. Cutie
10.6*** Option Agreement dated June 20, 1996 between Anthony J.
Cutie and the Company.
10.7*+ Development Agreement by and between the Company and Fuisz
Technologies, Ltd.
10.8*+ Option/Licensing Agreement by and between the Company and
Fuisz Technologies, Ltd.
10.9*+ Development Agreement by and between the Company and
Fuisz Technologies, Ltd.
52
<PAGE>
10.10*+ Option/Licensing Agreement by and between the Company and
Fuisz Technologies, Ltd.
10.11*+ License Agreement by and between the Company and Upsher-Smith
Laboratories, Inc., dated February 7, 1997.
10.12* Promissory Note, dated July 1, 1996, in favor of Kos
Investments, Inc.
10.13* Registration Rights Agreement dated as of June 30, 1996, by
and between the Company, Kos Holdings, Inc., and Kos
Investments, Inc.
10.14**** Revolving Credit and Loan Agreement dated July 1, 1998,
between Kos Pharmaceuticals, Inc. and Michael Jaharis.
10.15**** Promissory Note dated July 1, 1998, in favor of Michael
Jaharis.
10.16 Supplemental Commitment Letter dated October 7, 1998, between
Kos Pharmaceuticals, Inc. and Michael Jaharis.
21* Subsidiaries of the Company
23 Consent of Arthur Andersen LLP
24 Powers of Attorney (included on signature page hereto)
27 Financial Data Schedule
* Filed with the Company's Registration Statement on Form S-1 (File
No. 333-17991), as amended, filed with the Securities and Exchange
Commission on December 17, 1996, and incorporated herein by
reference.
** Filed with the Company's Registration Statement on Form 8-A filed
with the Securities and Exchange Commission on February 25, 1997,
and incorporated herein by reference.
*** Filed with the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission for the Company's fiscal year
ending June 30, 1997, and incorporated herein by reference.
**** Filed with the Company's Quarterly Report on Form 10-Q filed with
the Securities and Exchange Commission for the Company's three-month
period ended September 30, 1998, and incorporated herein by
reference.
+ Certain confidential material contained in the document has been
omitted and filed separately with the Securities and Exchange
Commission pursuant to Rule 406 of the Securities Act of 1933, as
amended.
(b) The Company did not file any Reports on Form 8-K during its last
fiscal quarter.
53
<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
behalf of the undersigned, thereunto duly authorized.
KOS PHARMACEUTICALS, INC.
By: /S/ DANIEL M. BELL
------------------------------
Daniel M. Bell
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Daniel M. Bell and Duncan H. Cocroft and each of
them, his true and lawful attorney-in-fact and agents, with full power of
substitution and resubstitution for him and in his name, place and stead, 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, granting unto
said attorneys-in-fact and agents full power and authority to do and perform
each and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that each of said attorneys-in-fact
or his substitute or substitutes, any lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/S/ MICHAEL JAHARIS Chairman of the Board March 23, 1999
- --------------------------- of Directors
Michael Jaharis
/S/ DANIEL M. BELL President, Chief Executive March 23, 1999
- --------------------------- Officer, and Director
Daniel M. Bell (Principal Executive Officer)
/S/ ROBERT E. BALDINI Vice Chairman of the Board and March 23, 1999
- --------------------------- Chief Sales and Marketing Officer
Robert E. Baldini
/S/ DUNCAN H. COCROFT Senior Vice President, Chief March 23, 1999
- --------------------------- Administrative Officer
Duncan H. Cocroft (Principal Financial Officer)
/S/ JUAN F. RODRIGUEZ Controller March 23, 1999
- --------------------------- (Principal Accounting Officer)
Juan F. Rodriguez
/S/ JOHN BRADEMAS
- --------------------------- Director March 23, 1999
John Brademas
/S/ STEVEN JAHARIS
- --------------------------- Director March 23, 1999
Steven Jaharis
/S/ LOUIS C. LASAGNA
- --------------------------- Director March 23, 1999
Louis C. Lasagna
/S/ MARK NOVITCH
- --------------------------- Director March 23, 1999
Mark Novitch
/S/ FREDERICK B. WHITTEMORE
- --------------------------- Director March 23, 1999
Frederick B. Whittemore
54
<PAGE>
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.16 Supplemental Commitment Letter dated October 7, 1998, between Kos
Pharmaceuticals, Inc. and Michael Jaharis.
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
55
EXHIBIT 10.16
October 7, 1998
Kos Pharmaceuticals, Inc.
1001 Brickell Bay Drive
25th Floor
Miami, Florida 33131
Attention: President
Ladies and Gentlemen:
This letter sets forth the understanding between the undersigned and Kos
Pharmaceuticals, Inc. ("Kos") regarding funding to Kos through June 30, 2000.
The funding that is referenced in this letter is in addition to the amount
available to Kos under the terms of that certain Revolving Credit and Loan
Agreement dated as of July 1, 1998 between the undersigned and Kos (the
"Revolving Credit Agreement").
The undersigned will make available to Kos as requested additional
capital, in excess of the capital available to Kos under the Revolving Credit
Agreement, in an amount up to $25 million (the "Commitment Amount") of debt or
equity. The terms of such debt or equity would be at prevailing rates and on
prevailing terms for companies similarly situated, as mutually agreed by the
parties, taking into account Kos' financial condition and any lack of liquidity
existing at that time, whether any other sources of funding exist at that time,
and the types of any such funding sources. If such financing is in the form of
debt, the undersigned reserves the right to require such debt financing to be
secured by appropriate collateral. The undersigned shall have the right, but not
the obligation, to participate up to the Commitment Amount in any third party
financing that is obtained by Kos through June 30, 2000.
The undersigned's willingness to provide funding on the terms set forth
in this letter is conditioned on the satisfaction of the following: (i) at the
time of funding, Kos shall not then be in default under any outstanding loan or
material agreement to which it is a party, (ii) Kos and the undersigned, or the
undersigned's designee, shall have entered into such documents as may be
required or determined to be appropriate by the undersigned, (iii) at the time
of funding, there shall not have been any material adverse change in the
business or financial operations or condition of Kos or in its management, (iv)
at the time of funding, Kos' then current financial projections shall indicate
that, with the funding to be provided by the undersigned hereunder, Kos shall
have sufficient funds to achieve positive cash flow no later than June 30, 2000,
and achieve the criteria on which such financial projections are based, (v) at
the time of funding, there shall not be any litigation pending or threatened
involving Kos which is
<PAGE>
Kos Pharmaceuticals, Inc.
October 7, 1998
Page -2-
likely to have a material adverse effect on Kos, (vi) at the time of funding,
the undersigned or his affiliates shall continue to hold a controlling interest
in Kos common stock, and (vii) such other customary conditions as the
undersigned may reasonably require.
This letter will terminate on the earlier to occur of (i) June 30, 2000,
(ii) the mutual agreement of the undersigned and Kos, (iii) at the option of the
undersigned, upon Kos receiving third party financing for an amount in excess of
50 percent of the Commitment Amount, (iv) upon the transfer of a controlling
interest in Kos, (v) upon the merger of Kos with any other entity resulting in
the loss of a controlling interest in Kos by the undersigned or his affiliates,
or (vi) upon the sale of all or substantially all of the assets of Kos.
This letter is intended solely for the benefit of Kos and shall not be
relied upon or assigned to any other person or entity.
Yours truly,
/s/ MICHAEL JAHARIS
- ------------------------------------
Michael Jaharis
Agreed to and Accepted:
Kos Pharmaceuticals, Inc., a Florida corporation
By: /s/ DANIEL M. BELL
---------------------------------
Daniel M. Bell
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
As independent certified public accountants, we hereby consent to the
incorporation of our reports included in this Form 10-K, into the Company's
previously filed Form S-8 Registration Statement File Nos. 333-34121, 333-35533
and 333-70317.
ARTHUR ANDERSEN LLP
Miami, Florida,
March 22, 1999.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM KOS
PHARMACEUTICALS, INC.'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998, 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-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,879
<SECURITIES> 0
<RECEIVABLES> 2,117
<ALLOWANCES> (100)
<INVENTORY> 1,313
<CURRENT-ASSETS> 9,534
<PP&E> 17,012
<DEPRECIATION> (4,993)
<TOTAL-ASSETS> 21,570
<CURRENT-LIABILITIES> 12,670
<BONDS> 0
0
0
<COMMON> 177
<OTHER-SE> (515)
<TOTAL-LIABILITY-AND-EQUITY> 21,570
<SALES> 13,038
<TOTAL-REVENUES> 13,038
<CGS> 3,276
<TOTAL-COSTS> 93,939
<OTHER-EXPENSES> (15)
<LOSS-PROVISION> 20
<INTEREST-EXPENSE> (1,724)
<INCOME-PRETAX> (79,161)
<INCOME-TAX> 0
<INCOME-CONTINUING> (79,161)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (79,161)
<EPS-PRIMARY> (4.50)
<EPS-DILUTED> (4.50)
</TABLE>
