<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 28, 1998
REGISTRATION NO.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10/A
AMENDMENT NO. 2
TO REGISTRATION STATEMENT ON FORM 10
------------------------
GENERAL FORM FOR REGISTRATION OF
SECURITIES PURSUANT TO SECTION 12(B) OR 12(G) OF
THE SECURITIES EXCHANGE ACT OF 1934
------------------------
PENWEST PHARMACEUTICALS CO.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C>
WASHINGTON 91-1513032
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
</TABLE>
<TABLE>
<S> <C>
2981 ROUTE 22, 12563-9970
PATTERSON, NY (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(914) 878-3414
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
PREFERRED STOCK PURCHASE RIGHTS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
PENWEST PHARMACEUTICALS CO.
PART I
INFORMATION INCLUDED IN INFORMATION STATEMENT
CROSS-REFERENCE SHEET BETWEEN INFORMATION STATEMENT
AND ITEMS OF FORM 10
<TABLE>
<CAPTION>
FORM 10
ITEM ITEM CAPTION CAPTION IN INFORMATION STATEMENT
- ---- ------------ --------------------------------
<C> <S> <C>
1. Business.................................. Summary -- The Company and -- Summary Financial
Data; Risk Factors; Selected Financial Data;
Management's Discussion and Analysis of Financial
Condition and Results of Operations; Business;
Index to Financial Statements
2. Financial Information..................... Summary -- Summary Financial Data;
Capitalization; Selected Financial Data;
Management's Discussion and Analysis of Financial
Condition and Results of Operations; Index to
Financial Statements
3. Properties................................ Business -- Facilities
4. Security Ownership of Certain Beneficial
Owners and Management..................... Security Ownership of Certain Beneficial Owners
and Management
5. Directors and Executive Officers.......... Management
6. Executive Compensation.................... Management -- Executive Compensation and --
Employee Benefit Plans
7. Certain Relationship and Related
Transactions.............................. Summary -- The Distribution; Risk Factors --
Relationship with Penford; Conflicts of Interest;
Management's Discussion and Analysis of Financial
Condition and Results of Operations; Certain
Transactions; Arrangements between the Company
and Penford.
8. Legal Proceedings......................... Risk Factors -- Certain Risks and Litigation
Relating to Nifedipine XL; Business -- Litigation
9. Market Price of and Dividends on the
Registrant's Common Equity and Related
Shareholder Matters....................... The Distribution -- Listing and Trading of
Penwest Common Stock; Risk Factors -- No Prior
Public Market; Potential Volatility of Stock
Price and -- Absence of Dividends; Dividend
Policy; Description of Capital Stock
10. Recent Sales of Unregistered Securities... None
11. Description of Registrant's Securities to
be Registered............................. Description of Capital Stock
12. Indemnification of Directors and
Officers.................................. Indemnification of Directors and Officers
13. Financial Statements and Supplementary
Data...................................... Index to Financial Statements
14. Changes in and Disagreements With
Accountants on Accounting and Financial
Disclosure................................ Not Applicable
</TABLE>
<PAGE> 3
[PENFORD LETTERHEAD] [PENWEST LETTERHEAD]
AUGUST [ ], 1998
Dear Penford Corporation Shareholders:
We are pleased to announce that the Board of Directors of Penford
Corporation ("Penford") has authorized the distribution (the "Distribution") by
Penford of all the shares of common stock of Penwest Pharmaceuticals Co.
("Penwest"), a wholly-owned subsidiary of Penford, to the holders of Penford
common stock.
If you are a shareholder of record of Penford common stock at the close of
business on August 10, 1998, you will receive three shares of Penwest common
stock for every two shares of Penford common stock you own (and a cash payment
for any fractional share of Penwest common stock you are entitled to receive).
You will receive your Penwest stock certificates (and cash payment for
fractional shares, if any) in a separate mailing shortly after August 31, 1998.
Penwest's common stock will be listed and traded on the Nasdaq National
Market, and its stock symbol will be "PPCO".
Penwest is engaged in the research, development and commercialization of
novel drug delivery technologies and is an established manufacturer and
distributor of excipients, the inactive ingredients used in binding,
disintegrating and lubricating tabletted pharmaceutical and nutritional
products. By effecting the Distribution, Penford will separate Penwest's
pharmaceutical business from Penford's specialty carbohydrate-based chemical
business for the paper and food industries. The Penford Board of Directors
believes that the Distribution is in the best interests of Penford and Penford's
shareholders because the Distribution, among other things, will: (i) permit the
managements of Penford and Penwest to focus on their respective core businesses
without regard to the corporate objectives and policies of the other company;
(ii) improve the near-term earnings of Penford by eliminating from Penford's
results of operations the expenses associated with developing Penwest's
technologies; (iii) permit the financial community to focus separately on
Penford and Penwest and their respective business opportunities; (iv) provide
Penwest with the opportunity to obtain greater access to capital to finance its
business; and (v) enhance the ability of Penwest to attract, retain and motivate
its employees by offering economic incentives and rewards tied more directly to
Penwest's performance.
As discussed in more detail in the accompanying Information Statement,
Penford has obtained a private letter ruling from the Internal Revenue Service
to the effect that, among other things, the Distribution qualifies as tax-free
under Sections 355 and 368 of the Internal Revenue Code of 1986, as amended, and
the receipt of shares of Penwest common stock in the Distribution will not
result in the recognition of income, gain or loss to Penford's shareholders for
federal income tax purposes. In addition, the aggregate basis of your Penford
common stock and Penwest common stock (including the fractional shares, if any)
will be the same as the aggregate basis in your Penford common stock before the
Distribution, and will be allocated in proportion to the fair market value of
each. We will send you additional information to help you allocate your tax
basis between your Penford and Penwest common stock.
The Information Statement, which is being distributed to all owners of
Penford common stock in connection with the Distribution, describes the
transaction in detail and contains important information about Penwest,
including financial statements and other financial information. Shareholders are
encouraged to read this material carefully.
Holders of Penford common stock are not required to take any action to
participate in the Distribution. Penford is not soliciting your proxy because
shareholder approval of the Distribution is not required.
Very truly yours,
N. Stewart Rogers Tod R. Hamachek
Chairman of the Board of Directors Chairman of the Board of Directors
Penford Corporation and Chief Executive Officer
Penwest Pharmaceuticals Co.
<PAGE> 4
SUBJECT TO COMPLETION, DATED JULY 28, 1998
INFORMATION STATEMENT
PENWEST PHARMACEUTICALS CO.
COMMON STOCK
(PAR VALUE, $.001 PER SHARE)
------------------------
This Information Statement is being furnished to the shareholders of
Penford Corporation, a Washington corporation ("Penford"), in connection with
the distribution (the "Distribution") by Penford to holders of record of Penford
common stock on August 10, 1998 (the "Record Date"), of all the outstanding
shares of common stock, par value $.001 per share (including the associated
preferred stock purchase rights, "Common Stock"), of its wholly-owned
subsidiary, Penwest Pharmaceuticals Co., a Washington corporation ("Penwest" or
the "Company"). Such shares of Common Stock will be distributed by Penford to
its shareholders of record on the basis of three shares of Common Stock for
every two shares of Penford common stock owned on the Record Date. Following the
Distribution, Penford will own no shares of Common Stock. The Distribution will
be effected on August 31, 1998 (the "Distribution Date"). Certificates
representing the shares of Common Stock will be mailed to shareholders on the
Distribution Date or as soon thereafter as practicable.
No consideration will be required to be paid by Penford shareholders for
the shares of Common Stock to be received by them in the Distribution, nor will
they be required to surrender or exchange shares of Penford common stock in
order to receive Penwest Common Stock. Penford has obtained a private letter
ruling from the Internal Revenue Service (the "IRS") to the effect that, among
other things, the Distribution qualifies as tax-free under Sections 355 and 368
of the Internal Revenue Code of 1986, as amended, and the receipt of shares of
Common Stock in the Distribution will not result in the recognition of income,
gain, or loss to Penford shareholders for federal income tax purposes. See "The
Distribution -- Federal Income Tax Considerations of the Distribution." Neither
Penford nor Penwest will receive any cash or other proceeds from the
distribution of the Common Stock.
There is no current public trading market for the Common Stock, although it
is expected that a "when-issued" trading market will develop on or about the
Record Date. The Common Stock will be listed on the Nasdaq National Market under
the symbol "PPCO."
IN REVIEWING THIS INFORMATION STATEMENT, YOU SHOULD CAREFULLY CONSIDER THE
MATTERS DESCRIBED UNDER THE CAPTION "RISK FACTORS" BEGINNING ON PAGE 12.
------------------------
NO VOTE OF SHAREHOLDERS IS REQUIRED IN CONNECTION WITH THE DISTRIBUTION. NO
PROXIES ARE BEING SOLICITED AND YOU ARE NOT REQUESTED TO TAKE ANY ACTION WITH
RESPECT TO YOUR SHARES.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS INFORMATION
STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS INFORMATION STATEMENT IS , 1998.
<PAGE> 5
ADDITIONAL INFORMATION
Penwest has filed a registration statement on Form 10 with the Securities
and Exchange Commission (the "Commission") to register the shares of Common
Stock to be issued on the Distribution Date under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). This Information Statement does not
contain all the information set forth in the registration statement and the
exhibits and schedules thereto, as certain items are omitted in accordance with
the rules and regulations of the Commission. Reference is made to such
registration statement and the exhibits and schedules thereto, which may be
inspected and copied, at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
the Commission's Regional Offices located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. Copies of such material also can be obtained at prescribed rates
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549. In addition, Penwest is required to file electronic
versions of such material with the Commission through the Commission's
Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. The Commission
maintains a World Wide Web site at http://www.sec.gov that contains reports,
proxy and information statements, and other information regarding registrants
that file electronically with the Commission. Statements contained herein
concerning the provisions of any document are not necessarily complete and, in
each instance, reference is made to the copy of such document filed as an
exhibit to the registration statement or otherwise filed with the Commission.
Each such statement is qualified in its entirety by such reference.
Following the Distribution, Penwest will be required to comply with the
reporting requirements of the Exchange Act and will file annual, quarterly and
other reports with the Commission. Penwest will also be subject to the proxy
solicitation requirements of the Exchange Act and will furnish holders of Common
Stock annual reports containing consolidated financial statements prepared in
accordance with generally accepted accounting principles and audited and
reported on, with an opinion expressed, by an independent public accounting
firm.
2
<PAGE> 6
No person is authorized to give any information or to make any
representations other than those contained in this Information Statement, and if
given or made, such information or representations must not be relied upon as
having been authorized. This Information Statement does not constitute an offer
to sell or a solicitation of any offer to buy any securities. This Information
Statement presents information concerning Penwest believed by Penwest to be
accurate as of the date set forth on the cover hereof. This Information
Statement presents information concerning Penford believed by Penford to be
accurate as of the date set forth on the cover hereof. Changes may occur in the
presented information after that date. Neither Penwest nor Penford plans to
update said information except in the course of fulfilling their respective
normal public reporting and disclosure obligations.
This Information Statement contains forward-looking statements that involve
risks and uncertainties. For this purpose, any statements contained herein that
are not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words "believes," "anticipates,"
"plans," "expects," "intends" and similar expressions are intended to identify
forward-looking statements. There are a number of important factors that could
cause the Company's actual results to differ materially from those indicated by
such forward-looking statements. The factors that could cause or contribute to
such differences include without limitation those discussed in "Risk Factors"
herein, as well as those discussed elsewhere in this Information Statement.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Additional Information...................................... 2
Summary..................................................... 4
The Distribution............................................ 9
Risk Factors................................................ 12
Dividend Policy............................................. 22
Selected Financial Data..................................... 23
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 24
Business.................................................... 30
Management.................................................. 53
Certain Transactions........................................ 62
Security Ownership of Certain Beneficial Owners and
Management................................................ 63
Arrangements Between the Company and Penford................ 65
Description of Capital Stock................................ 68
Indemnification of Directors and Officers................... 72
Index to Financial Statements............................... F-1
</TABLE>
------------------------
The Company was incorporated under the name Edward Mendell Co., Inc. in the
State of Washington in February 1991 as a wholly-owned subsidiary of Penford
(formerly known as PENWEST, LTD.) and has changed its name to Penwest
Pharmaceuticals Co. The Company's executive offices are located at 2981 Route
22, Patterson, NY 12563-9970. The Company's telephone number is (914) 878-3414.
TIMERx(R), EMCOCEL(R), EXPLOTAB(R), EMDEX(R), EMCOMPRESS(R) and CANDEX(R)
are registered trademarks of the Company, and PROSOLV SMCC(TM) is a trademark of
the Company. Other tradenames and trademarks appearing in this Information
Statement are the property of their respective owners.
3
<PAGE> 7
- --------------------------------------------------------------------------------
SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors," and the Financial Statements and the
Notes thereto, appearing elsewhere in this Information Statement.
Unless otherwise indicated, all information contained in this Information
Statement reflects a 0.76-for-1 reverse stock split of the shares of Common
Stock effected on June 19, 1998.
THE COMPANY
Penwest is engaged in the research, development and commercialization of
novel drug delivery technologies. Based on its extensive experience in
developing and manufacturing tabletting ingredients for the pharmaceutical
industry, the Company has developed its proprietary TIMERx(R) controlled release
drug delivery technology, which is applicable to a broad range of orally
administered drugs. The Company is applying its TIMERx technology to the
development of oral formulations of branded controlled release versions of
immediate release drugs and generic versions of controlled release drugs. Each
of the formulations developed to date has been developed under a collaborative
arrangement with a pharmaceutical company. The Company's collaborator, Leiras
OY, a Finnish subsidiary of Schering AG ("Leiras"), received marketing approval
in Finland for Cystrin CR(R) (oxybutynin) for the treatment of urge urinary
incontinence in October 1997 and began marketing the product in Finland in
January 1998. In May 1997, the Company's collaborator, Mylan Pharmaceuticals
Inc. ("Mylan"), filed an Abbreviated New Drug Application ("ANDA") with the U.S.
Food and Drug Administration (the "FDA") for the first generic version of the 30
mg dosage strength of Procardia XL(R) (nifedipine), a leading cardiovascular
drug for angina and hypertension.
The TIMERx drug delivery system is a hydrophilic matrix combining primarily
two natural polysaccharides, xanthan and locust bean gums, in the presence of
dextrose. The TIMERx system can precisely control the release of the active drug
ingredient in a tablet by varying the relative proportion of the gums, the
tablet coating and the tablet manufacturing process. The Company believes that
the TIMERx controlled release system is a major advancement in oral drug
delivery because it is applicable to a wide range of soluble and insoluble drugs
of varying dosages, it offers drug developers a flexible pharmacokinetic
profile, it is easy to scale up to commercial batch levels with consistent
reproducibility, and controlled release drugs based on the TIMERx controlled
release system can be manufactured cost effectively using existing
pharmaceutical manufacturing equipment.
The Company's strategy is to establish collaborations with leading
pharmaceutical companies to develop oral controlled release drugs. The Company
believes that this strategy will create significant operating, marketing and
financial advantages for the Company and will accelerate product development and
commercialization. The Company currently has five generic controlled release
products under development with three collaborators, Mylan, Kremers Urban
Development Company, the generics division of Schwarz Pharma, Inc. ("Kremers"),
and Sanofi Winthrop International S.A. ("Sanofi"). All these products are
currently in full-scale bioequivalence studies or clinical trials, and none of
these products has received regulatory approval for commercial sale.
Additionally, the Company has entered into a strategic alliance with Endo
Pharmaceuticals Inc., formerly a division of Dupont Merck Pharmaceuticals
("Endo"), to develop jointly Numorphan TRx, a branded oral controlled release
version of the narcotic analgesic oxymorphone, and a license agreement with
Synthelabo Groupe ("Synthelabo") covering a branded oral controlled release
version of oxybutynin intended to be marketed in Europe under the tradename
Ditropan CR, Ditropan XL or Dridase. The Company is also conducting early stage
development activities with respect to various additional controlled release
formulations.
The Company is also an established manufacturer and distributor of
excipients to the pharmaceutical and nutritional industries. Excipients are the
inactive ingredients in tablets and capsules that enable tabletting of active
drug ingredients by enhancing binding, lubrication and disintegration
properties. The Company recently introduced ProSolv, a patented combination of
microcrystalline cellulose ("MCC") and colloidal silicon
- --------------------------------------------------------------------------------
4
<PAGE> 8
- --------------------------------------------------------------------------------
dioxide, which the Company believes offers improvements over competing
excipients in wet granulation and direct compression, the most common processes
of manufacturing tabletted products in the pharmaceutical industry. In addition
to ProSolv, the Company markets a broad line of 27 other excipient products.
Revenues from the Company's excipients business were $26.0 million for the year
ended December 31, 1997 and $7.8 million for the three months ended March 31,
1998.
- --------------------------------------------------------------------------------
5
<PAGE> 9
- --------------------------------------------------------------------------------
THE DISTRIBUTION
Distributing Company.......... Penford Corporation. As used in this
Information Statement, the term "Penford"
refers to Penford Corporation and its
subsidiaries (other then Penwest), unless the
context requires otherwise.
Distributed Company........... Penwest Pharmaceuticals Co. As used in this
Information Statement, the term "the Company"
or "Penwest" refers to Penwest Pharmaceuticals
Co. and its subsidiaries, unless the context
requires otherwise.
Common Stock to be
Distributed................... Approximately 11.05 million shares, which
constitutes 100% of the Common Stock
outstanding on the Record Date. Immediately
after the Distribution, Penford will own no
shares of Common Stock.
Distribution.................. On the Distribution Date or as soon thereafter
as practicable, the Distribution Agent (as
defined below) will begin distributing
certificates representing Common Stock to the
shareholders of Penford. Penford shareholders
will not be required to make any payment or to
take any other action to receive Common Stock.
Distribution Ratio............ Three shares of Common Stock for every two
shares of Penford common stock.
Record Date................... August 10, 1998.
Distribution Date............. August 31, 1998.
Distribution Agent............ ChaseMellon Shareholder Services.
Fractional Share Interests.... No certificates representing fractional shares
of Common Stock will be issued. Penford
shareholders entitled to receive less than a
full share of Common Stock will receive cash in
lieu of such fractional share. See "The
Distribution -- Manner of Effecting the
Distribution."
Trading Market and Symbol..... The Common Stock will be listed on the Nasdaq
National Market under the symbol "PPCO." There
is no current public trading market for the
Common Stock, although it is expected that a
"when-issued" trading market will develop on or
about the Record Date.
Reasons for the
Distribution.................. The Penford Board of Directors believes that
the Distribution is in the best interests of
Penford and Penford's shareholders because the
Distribution, among other things, will: (i)
permit the managements of Penford and the
Company to focus on their respective core
businesses without regard to the corporate
objectives and policies of the other company;
(ii) improve the near-term earnings of Penford
by eliminating from Penford's results of
operations the expenses associated with
developing the Company's technologies; (iii)
permit the financial community to focus
separately on Penford and the Company and their
respective business opportunities; (iv) provide
the Company with the opportunity to obtain
greater access to capital to finance its
business; and (v) enhance the ability of the
Company to attract, retain and motivate its
employees by offering economic incentives and
rewards tied more directly to the
- --------------------------------------------------------------------------------
6
<PAGE> 10
Company's performance. See "The
Distribution -- Background of the
Distribution."
Tax Consequences.............. Penford has obtained a private letter ruling
from the IRS to the effect that, among other
things, the Distribution qualifies as tax-free
under Sections 355 and 368 of the Internal
Revenue Code of 1986, as amended (the "Code"),
and the receipt of shares of Common Stock in
the Distribution will not result in the
recognition of income, gain or loss to Penford
shareholders for federal income tax purposes.
Any cash payment received by a Penford
shareholder in lieu of fractional shares will
not be tax-free to the Penford shareholder. See
"The Distribution -- Federal Income Tax
Consequences of the Distribution."
Relationship with Penford
after the Distribution........ As a result of the Distribution, the Company
will cease to be a subsidiary of or otherwise
affiliated with Penford and will thereafter
operate as an independent, publicly held
company. In connection with the Distribution,
Penford and the Company have entered into or
will enter into certain agreements, including
but not limited to, the Separation and
Distribution Agreement, the Tax Allocation
Agreement, the Services Agreement, the Employee
Benefits Agreement and the Excipient Supply
Agreement. In addition, Penford has agreed to
guarantee the Company's indebtedness under a
$15.0 million credit facility to which the
Company is a party (the "Credit Facility") for
a period ending August 31, 2000. See "The
Distribution -- Background of the Distribution"
and "Arrangements Between The Company and
Penford."
Anti-Takeover Effects of
Washington Law, Certain
Charter Provisions and
Rights Agreement............ Certain provisions under the Washington
Business Corporation Act, the Amended and
Restated Articles of Incorporation of the
Company, as amended, the Amended and Restated
Bylaws of the Company and the Rights Agreement
(the "Rights Agreement") dated as of July 27,
1998 between the Company and ChaseMellon
Shareholder Services, as Rights Agent (the
"Rights Agent") could make more difficult the
acquisition and control of the Company by means
of a tender offer, open market purchase, a
proxy contest or otherwise.
Dividend Policy............... The Company currently does not intend to pay
cash dividends on the Common Stock. The Company
is prohibited from paying dividends on the
Common Stock under the Credit Facility. See
"Risk Factors -- Absence of Dividends."
Risk Factors.................. The shares of Common Stock to be issued in the
Distribution involve a high degree of risk.
Shareholders should carefully consider the
matters discussed under the section entitled
"Risk Factors."
7
<PAGE> 11
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------- -----------------
1995 1996 1997 1997 1998
------- ------- ------- ------ -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................. $25,089 $26,089 $26,941 $6,970 $ 7,786
Cost of product sales..................... 17,267 18,690 19,929 4,891 5,836
------- ------- ------- ------ -------
Gross profit......................... 7,822 7,399 7,012 2,079 1,950
Selling, general and administrative....... 7,676 6,776 8,708 2,044 2,357
IPO transaction costs..................... -- -- 1,367 -- --
Research and product development.......... 2,719 3,723 4,109 851 1,285
Net loss.................................. $(3,252) $(3,864) $(7,316) $ (832) (2,030)
======= ======= ======= ====== =======
Basic and diluted net loss per share...... $(0.29) $(0.35) $(0.66) $(0.08) $(0.18)
======= ======= ======= ====== =======
Weighted average shares of common stock
outstanding............................. 11,055 11,055 11,055 11,055 11,055
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
--------------------------
ACTUAL AS ADJUSTED(1)
-------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 723 $ 723
Working capital............................................. (35,545) 9,072
Total assets................................................ 37,695 37,695
Accumulated deficit......................................... (21,679) (21,679)
Shareholders' equity (deficit).............................. (14,403) 30,214
</TABLE>
- ---------------
(1) As adjusted to reflect the contribution by Penford to the capital of the
Company, effective immediately prior to the Distribution Date, of the
outstanding intercompany indebtedness of the Company to Penford (the
"Penford Capital Contribution"). The intercompany indebtedness was
$44,617,000 as of March 31, 1998. See Note 6 of Notes to Consolidated
Financial Statements.
8
<PAGE> 12
THE DISTRIBUTION
BACKGROUND OF THE DISTRIBUTION
In May 1998, Penford announced its intent, subject to the satisfaction of
certain conditions, to divest its ownership interest in the Company by means of
the Distribution. By effecting the Distribution, Penford would separate its
pharmaceutical business from its specialty carbohydrate-based chemical business
for the paper and food industries. The Board of Directors of Penford (the
"Penford Board") believes that the Distribution is in the best interests of
Penford and Penford's shareholders because the Distribution, among other things,
will: (i) permit the managements of Penford and the Company to focus on their
respective core businesses without regard to the corporate objectives and
policies of the other company; (ii) improve the near-term earnings of Penford by
eliminating from Penford's results of operations the expenses associated with
developing the Company's technologies; (iii) permit the financial community to
focus separately on Penford and the Company and their respective business
opportunities; (iv) provide the Company with the opportunity to obtain greater
access to capital to finance its business; and (v) enhance the ability of the
Company to attract, retain and motivate its employees by offering economic
incentives and rewards tied more directly to Penwest's performance.
The Company believes that there are a number of risks and uncertainties
associated with the Distribution, including risks related to the Company's
inability to access the resources of Penford following the Distribution. For a
discussion of these risks and uncertainties, see "Risk Factors -- Possibility of
Substantial Sales of Common Stock," "-- History of Losses; Uncertainty of Future
Profitability," "-- Need for Additional Funding; Uncertainty of Access to
Capital," "-- Relationship with Penford; Conflicts of Interest" and "-- Risk of
Product Liability Claims; No Assurance of Adequate Insurance."
The Company and Penford have entered into or will, on or prior to the
completion of this Distribution, enter into agreements that govern various
interim and ongoing relationships. These agreements include (i) a Separation and
Distribution Agreement setting forth the agreement of the parties with respect
to the principal corporate transactions required to effect the separation of
Penford's pharmaceutical business from its specialty carbohydrate-based chemical
business and the Distribution, including without limitation Penford's agreement
to guarantee the Company's indebtedness under the Credit Facility for a period
ending August 31, 2000, (ii) a Services Agreement pursuant to which Penford will
continue on an interim basis to provide specified services to the Company, (iii)
a Tax Allocation Agreement relating to, among other things, the allocation of
tax liability between the Company and Penford in connection with the
Distribution, (iv) an Excipient Supply Agreement pursuant to which Penford will
manufacture and supply exclusively to the Company, and the Company will purchase
exclusively from Penford, subject to certain exceptions, all the Company's
requirements for two excipients marketed by the Company, and (v) an Employee
Benefits Agreement setting forth the parties' agreements as to the continuation
of certain Penford benefits arrangements for the employees of the Company.
MANNER OF EFFECTING THE DISTRIBUTION
The general terms and conditions relating to the Distribution will be set
forth in the Separation and Distribution Agreement and the Tax Allocation
Agreement.
Under the terms and conditions of the Separation and Distribution
Agreement, Penford will effect the Distribution on the Distribution Date by
providing for the delivery of the Common Stock held by Penford to the
Distribution Agent for distribution to the owners of record of Penford common
stock on the Record Date. The Distribution will be made on the basis of three
shares of Common Stock for every two shares of Penford Common Stock outstanding
on the Record Date. The shares of Common Stock will be fully paid and
nonassessable, and the owners thereof will not be entitled to preemptive rights.
See "Description of Capital Stock." Certificates representing Common Stock will
be mailed to Penford shareholders on the Distribution Date or as soon thereafter
as practicable.
No certificates or scrip representing fractional shares of Penwest Common
Stock will be issued to Penford shareholders as part of the Distribution. The
Distribution Agent will aggregate fractional shares into whole shares and sell
them in the open market at then prevailing prices on behalf of shareholders who
otherwise
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<PAGE> 13
would be entitled to receive fractional shares, and such shareholders will
receive instead a cash payment in the amount of their pro rata share of the
total proceeds, net of selling expenses. See "The Distribution -- Federal Income
Tax Consequences of the Distribution." Such sales are expected to be made as
soon as practicable after the Record Date. NONE OF PENFORD, PENWEST OR THE
DISTRIBUTION AGENT WILL GUARANTEE ANY MINIMUM SALE PRICE FOR THE SHARES OF
COMMON STOCK, AND NO INTEREST WILL BE PAID ON THE PROCEEDS.
After the Distribution, holders of Penford common stock will continue to
hold their shares of Penford common stock and, if such shareholders were
shareholders of record on the Record Date, they will have also received shares
of Penwest Common Stock. No holder of Penford common stock will be required to
pay any cash or other consideration for the shares of Common Stock received in
the Distribution or to surrender or exchange shares of Penford common stock in
order to receive shares of Common Stock. The Distribution will not affect the
number of, or the rights attached to, outstanding shares of Penford common
stock.
After the Distribution, Penford will own no shares of Common Stock and the
Company will operate as an independent, publicly owned corporation.
FEDERAL INCOME TAX CONSEQUENCES OF THE DISTRIBUTION
Penford has obtained a private letter ruling from the IRS to the effect
that, among other things, the Distribution will qualify as tax-free under
Sections 355 and 368 of the Code, and, in general, that for federal income tax
purposes:
(1) No gain or loss will be recognized by or be includable in the
income of a holder of Penford common stock solely as a result of the
receipt of Common Stock in the Distribution.
(2) No gain or loss will be recognized by Penford or its subsidiaries
upon the Distribution.
(3) The aggregate tax basis of the Penford common stock and the Common
Stock held by a shareholder immediately after the Distribution will be the
same as the tax basis of Penford common stock held by such shareholder
immediately prior to the Distribution and will be allocated (based upon
relative market values on the Distribution Date) between such Penford
common stock and the Common Stock received by such shareholder in the
Distribution.
(4) Assuming that the Penford common stock is held as a capital asset,
the holding period for the Common Stock received in the Distribution by a
holder of Penford common stock will include the period during which such
Penford common stock was held.
(5) A holder of Penford common stock who receives cash in lieu of a
fractional share of Common Stock will be treated as if such fractional
share had been received by the shareholder as part of the Distribution and
then redeemed from the shareholder by the Company. Such shareholder will
recognize gain or loss equal to the difference between the cash so received
and the portion of the tax basis in the Penford common stock that is
allocable to such fractional share. Such gain or loss will be capital gain
or loss, provided that such fractional share was held by the shareholder as
a capital asset at the time of the Distribution.
The Distribution, although tax-free as of the Distribution Date, like other
tax-free distributions, could be rendered taxable as a result of subsequent
actions or events. For a description of subsequent actions or events that could
render the Distribution taxable, see "Risk Factors -- Risk of Loss of "Tax-Free"
Treatment of Distribution." If the Distribution were rendered taxable as a
result of subsequent actions or events (i) a corporate-level taxable gain would
be recognized by the group of corporations of which Penford is the parent,
generally equal to the amount by which the fair market value of the Common Stock
distributed in the Distribution exceeded Penford's basis therein, (ii) both
Penford, as parent of that group, and Penwest, as a former member of that group,
would be severally liable for the corporate-level tax on such gain and (iii)
each holder of Penford common stock who receives shares of Common Stock in the
Distribution would be treated as having received a taxable dividend in an amount
equal to the fair market value of the Common Stock received (assuming that
Penford had sufficient current or accumulated "earnings and profits"). Under the
Tax
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<PAGE> 14
Allocation Agreement, each of Penford and Penwest has agreed to indemnify the
other for certain taxes incurred with respect to the Distribution (and related
transactions) as a result of certain post-Distribution actions. These
indemnification obligations do not extend to shareholders of Penford.
THE SUMMARY OF FEDERAL INCOME TAX CONSEQUENCES SET FORTH ABOVE IS FOR GENERAL
INFORMATION ONLY AND DOES NOT PURPORT TO COVER ALL FEDERAL INCOME TAX
CONSEQUENCES THAT MAY APPLY TO ALL CATEGORIES OF SHAREHOLDERS. ALL SHAREHOLDERS
SHOULD CONSULT THEIR TAX ADVISORS AS THE PARTICULAR TAX CONSEQUENCES OF THE
DISTRIBUTION TO THEM, INCLUDING THE APPLICABILITY AND EFFECT OF STATE, LOCAL AND
FOREIGN LAWS.
LISTING AND TRADING OF PENWEST COMMON STOCK
Prior to the Distribution, there has been no public market for the Common
Stock. There can be no assurance regarding the prices at which the Common Stock
will trade before or after the Distribution Date.
The Common Stock will be listed on the Nasdaq National Market under the
symbol "PPCO." Based on the number of holders of record of Penford common stock
as of July 27, 1998, Penwest is expected to initially have approximately 1,077
shareholders of record on the Distribution Date. The transfer agent and
registrar for the Common Stock will be ChaseMellon Shareholder Services.
The Company expects that a "when-issued" trading market will develop on or
about the Record Date. A "when-issued" trading market occurs when trading of
shares begins prior to the time stock certificates are actually available or
issued.
Shares of Common Stock distributed to Penford's shareholders will be freely
transferable except for shares received by persons who may be deemed to be
"affiliates" of Penwest under the Securities Act of 1933, as amended (the
"Securities Act"). Persons who may be deemed to be affiliates of Penwest after
the Distribution generally include individuals or entities that control, are
controlled by, or are under common control with Penwest, and include the
directors and executive officers of Penwest. All the shares of Common Stock held
by affiliates of Penwest may generally only be resold (i) in compliance with the
applicable provisions of Rule 144 under the Securities Act, (ii) under an
effective registration statement under the Securities Act, or (iii) pursuant to
an exemption from the registration requirements of the Securities Act. Under
Rule 144, an affiliate is entitled to sell, within any three-month period, a
number of shares of Common Stock that does not exceed the greater of 1% of the
then outstanding shares of Common Stock or the average weekly trading volume of
the Common Stock during the four calendar weeks preceding the date on which
notice of such sale was filed under Rule 144, provided certain requirements
concerning availability of public information, manner of sale and notice of sale
are satisfied.
After the Distribution, the approximate number of shares of Penwest Common
Stock issued and outstanding will be 11.05 million of which approximately
704,152 shares will be held by affiliates and subject to the resale requirements
of Rule 144 of the Securities Act. It is anticipated that prior to the
Distribution Date, Penwest will file with the Commission Registration Statements
on Form S-8 to register under the Securities Act shares of Common Stock which
are issuable pursuant to the Company's 1997 Equity Incentive Plan, 1997 Employee
Stock Purchase Plan and 1998 Spinoff Option Plan. See "Management -- Employee
Benefit Plans."
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<PAGE> 15
RISK FACTORS
Holders of Penford common stock should be aware that the Distribution and
ownership of Common Stock involve certain risks, including those described
below, which could adversely affect the value of their holdings. Neither Penford
nor the Company makes, nor is any other person authorized to make, any
representations as to the future market value of the Common Stock.
CERTAIN RISKS AND LITIGATION RELATING TO NIFEDIPINE XL
In May 1997, one of the Company's collaborators, Mylan, filed an ANDA with
the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of
Procardia XL, a controlled release formulation of nifedipine. Nifedipine XL is
the first product using the Company's TIMERx controlled release technology for
which an ANDA has been filed in the United States.
In an ANDA filing, the FDA generally requires data demonstrating that the
drug formulation is bioequivalent to the branded drug. In addition, under the
Drug Price Competition and Patent Restoration Act of 1984 (the "Waxman-Hatch
Act"), when an applicant files an ANDA for a generic version of a brand name
product covered by an unexpired patent listed with the FDA, the applicant must
certify to the FDA that such patent will not be infringed by the applicant's
product or that such patent is invalid or unenforceable. Notice of such
certification must be given to the patent owner and the sponsor of the New Drug
Application ("NDA") for the brand name product.
Bayer AG ("Bayer") and ALZA Corporation ("ALZA") own patents listed for
Procardia XL, and Pfizer Inc. ("Pfizer") is the sponsor of the NDA and markets
the product. In connection with the ANDA filing, Mylan certified in May 1997 to
the FDA that Nifedipine XL does not infringe these Bayer or ALZA patents and
notified Bayer, ALZA and Pfizer of such certification. Bayer and Pfizer sued
Mylan in the United States District Court for the Western District of
Pennsylvania, alleging that Nifedipine XL infringes Bayer's patent. The Company
has been informed by Mylan that ALZA does not believe that the notice given to
it complied with the requirements of the Waxman-Hatch Act, and there can be no
assurance that ALZA will not sue Mylan for patent infringement or take any other
actions with respect to such notice. Mylan has advised the Company that it
intends to contest vigorously the allegations made in the lawsuit. However,
there can be no assurance that Mylan will prevail in this litigation or that it
will continue to contest the lawsuit. If the litigation results in a
determination that Nifedipine XL infringes Bayer's patent, Nifedipine XL could
not be marketed in the United States until such patent expired. An unfavorable
outcome or protracted litigation for Mylan would materially adversely affect the
Company's business, financial condition and results of operations. Delays in the
commercialization of Nifedipine XL could also occur because the FDA will not
grant final marketing approval of Nifedipine XL until a final judgment on the
patent suit is rendered in favor of Mylan by the district court, or in the event
of an appeal, by the court of appeals, or until 30 months (or such longer or
shorter period as the court may determine) have elapsed from the date of Mylan's
certification, whichever is sooner.
In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming that
its Procardia XL formulation constituted a unique delivery system and that a
drug with a different release mechanism such as the TIMERx controlled release
system cannot be considered the same dosage form and approved in an ANDA as
bioequivalent to Procardia XL. In August 1997, the FDA rejected Pfizer's
citizen's petition. In July 1997, Pfizer also sued the FDA in the District Court
of the District of Columbia, claiming that the FDA's acceptance of Mylan's ANDA
filing for Nifedipine XL was contrary to the law, based primarily on the
arguments stated in its citizen's petition. Mylan and the Company intervened as
defendants in this suit. In April 1998, the District Court of the District of
Columbia rejected Pfizer's claim, and in May 1998, Pfizer appealed the District
Court's decision. There can be no assurance that the FDA, Mylan and the Company
will prevail in this litigation. An outcome in this litigation adverse to Mylan
and the Company would result in Mylan being required to file a suitability
petition in order to continue the ANDA or to file an NDA with respect to
Nifedipine XL, each of which would be expensive and time consuming. An adverse
outcome also would result in Nifedipine XL becoming ineligible for an "AB"
rating from the FDA. Failure to obtain an AB rating from the FDA would indicate
that for certain purposes Nifedipine XL would not be deemed to be
therapeutically equivalent to the referenced branded drug, would not be fully
substitutable for the referenced
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<PAGE> 16
branded drug and would not be relied upon by Medicaid and Medicare formularies
for reimbursement. Any such failure would have a material adverse effect on the
Company's business, financial condition and results of operations. If any of
such events occur, Mylan may terminate its efforts with respect to Nifedipine
XL, which would have a material adverse effect on the Company's business,
financial condition and results of operations.
There can be no assurance that Pfizer will not pursue additional regulatory
initiatives and lawsuits with respect to Procardia XL and Nifedipine XL.
Most of the controlled release products that the Company is developing with
its collaborators are generic versions of brand name controlled release products
that are covered by one or more patents. The Company expects its collaborators
will file ANDAs for such product candidates. There can be no assurance that if
ANDAs are filed for any of such products, the owners of the patents covering the
brand name product or the sponsors of the NDA with respect to the brand name
product will not sue or undertake regulatory initiatives to preserve marketing
exclusivity. Any significant delay in obtaining FDA approval to market the
Company's product candidates as a result of litigation, as well as the expense
of such litigation, whether or not the Company or its collaborators are
successful, could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition to filing an ANDA with respect to the 30 mg dosage strength of
Nifedipine XL, Mylan is conducting full scale bioequivalence studies of the 60
mg and 90 mg dosage strengths of Nifedipine XL. There can be no assurance,
however, that Mylan will file ANDAs with respect to the 60 mg and 90 mg dosage
strengths or that these formulations would be otherwise approvable by the FDA.
The Company is aware that Biovail Corporation International ("Biovail") has
filed an ANDA with respect to a 60 mg dosage strength generic version of
Procardia XL. Under the Waxman-Hatch Act, an applicant who files the first ANDA
with a certification of patent invalidity or non-infringement with respect to a
product may be entitled to receive, if such ANDA is approved by the FDA, a
180-day marketing exclusivity (a 180-day delay in approval of other ANDAs for
the same drug) from the FDA. There can be no assurance that the FDA will not
approve Biovail's ANDA or another ANDA filed by another applicant with respect
to a different dosage strength prior to or during Mylan's 180-day marketing
exclusivity period, if obtained, for the 30 mg dosage strength of Nifedipine XL.
See "Business -- Government Regulation" and "-- Litigation."
DEPENDENCE ON COLLABORATIVE AGREEMENTS
The Company intends to develop and commercialize its TIMERx controlled
release products in collaboration with pharmaceutical companies. To date, the
Company has entered into collaborative agreements with Mylan, Leiras, Kremers,
Sanofi, Synthelabo and Endo. The Company is particularly dependent on its
collaboration with Mylan, which covers three of the Company's products under
development. Under its current collaborative agreements, the Company's
collaborators are generally responsible for conducting full scale bioequivalence
studies and clinical trials, preparing and submitting all regulatory
applications and submissions and manufacturing, marketing and selling the TIMERx
controlled release products.
There can be no assurance that the Company will be able to maintain
existing collaborative arrangements or establish new collaborative arrangements
on acceptable terms, if at all, or that any collaborative arrangements will be
commercially successful. To the extent that the Company is not able to maintain
or establish such arrangements, the Company would be required to undertake
product development and commercialization activities at its own expense, which
would increase the Company's capital requirements or require the Company to
limit the scope of its development and commercialization activities. Moreover,
the Company has limited or no experience in conducting full scale bioequivalence
studies and clinical trials, preparing and submitting regulatory applications
and manufacturing and marketing controlled release products. There can be no
assurance that it could be successful in performing these activities and any
failure to perform such activities could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company cannot control the amount and timing of resources that its
collaborative partners devote to the Company's programs or potential products,
which may vary because of factors unrelated to the potential products. If any of
the Company's collaborators breach or terminate their agreements with the
Company or
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otherwise fail to conduct their collaborative activities in a timely manner, the
preclinical and/or clinical development and/or commercialization of product
candidates will be delayed, and the Company would be required to devote
additional resources to product development and commercialization or terminate
certain development programs. Also, these relationships generally may be
terminated at the discretion of the Company's collaborators, in some cases with
only limited notice to the Company. For instance, Mylan may terminate its
agreements with the Company at any time upon 90 days prior written notice under
specified circumstances. The termination of collaborative arrangements could
have a material adverse effect on the Company's business, financial condition
and results of operations. There also can be no assurance that disputes will not
arise with respect to the ownership of rights to any technology developed with
third parties. These and other possible disagreements with collaborators could
lead to delays in the development or commercialization of product candidates or
could result in litigation or arbitration, which could be time consuming and
expensive and could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the Company's collaborators may develop, either alone or with
others, products that compete with the development and marketing of the
Company's potential products. Competing products of the Company's collaborators
may result in their withdrawal of support with respect to their products under
development using the Company's controlled release technology, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Collaborative Arrangements."
UNCERTAINTY OF COMMERCIALIZATION OF TIMERX CONTROLLED RELEASE PRODUCTS
Products using the Company's TIMERx controlled release technology are in
various stages of development. Except for Cystrin CR, which is being marketed in
Finland, none of the Company's TIMERx controlled release products have been
commercialized, and the period required to achieve commercialization is
uncertain and may be lengthy, if commercialization is achieved at all. Although
in May 1997, Mylan filed an ANDA with the FDA for the 30 mg dosage strength of
Nifedipine XL, no regulatory approval to market Nifedipine XL has been received,
and there can be no assurance as to when or if regulatory approval will be
received. Moreover, other than Cystrin CR and Ditropan CR which received
regulatory approval for commercial sale in the Netherlands, Austria and Ireland
in June 1998, no product based on TIMERx technology has ever received regulatory
approval for commercial sale, and there can be no assurance that the results
from bioequivalence studies or clinical trials will justify such regulatory
approval. Substantially all the revenues from controlled release products
generated to date have been milestone fees received for products under
development. There can be no assurance that the Company's controlled release
product development efforts will be successfully completed, that required
regulatory approvals will be obtained or that approved products will be
successfully manufactured or marketed. See "Business -- TIMERx Product
Development," "-- Collaborative Arrangements" and "-- Government Regulation."
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
The Company incurred net losses of approximately $3.3 million, $3.9 million
and $7.3 million during 1995, 1996 and 1997, respectively, and $832,000 and $2.0
million during the three months ended March 31, 1997 and 1998, respectively. As
of March 31, 1998, the Company's accumulated deficit was approximately $21.7
million. The Company expects net losses to continue at least into late 1999. A
substantial portion of the Company's revenues have been generated from the sales
of the Company's pharmaceutical excipients. The Company's future profitability
will depend on several factors, including the successful commercialization by
the Company and its collaborators of the controlled release products for which
regulatory approval currently is pending or has recently been obtained, the
completion of the development of other pharmaceuticals using the Company's
TIMERx controlled release technology and, to a lesser extent, an increase in
sales of its pharmaceutical excipient products. There can be no assurance that
the Company will achieve profitability or that it will be able to sustain any
profitability on a quarterly basis, if at all. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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INTENSE COMPETITION; RISK OF TECHNOLOGICAL CHANGE
The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability of
financing, litigation and other factors. Many of the Company's competitors have
longer operating histories and greater financial, marketing, legal and other
resources than the Company and certain of its collaborators. The Company expects
that it will be subject to competition from numerous other entities that
currently operate or intend to operate in the pharmaceutical industry, including
companies that engage in the development of controlled release technologies. The
Company's TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including ALZA's oral
osmotic pump (OROS(R)) technology, multiparticulate systems marketed by Elan
Corporation, plc ("Elan") and Biovail, traditional matrix systems marketed by
SkyePharma, plc and other controlled release technologies marketed and under
development by Andrx Corporation, among others.
The Company initially is concentrating a significant portion of its
development efforts on generic versions of controlled release pharmaceuticals.
Typically, selling prices of immediate release drugs have declined and profit
margins have narrowed after generic equivalents of such drugs are first
introduced and the number of competitive products has increased. Similarly, the
success of generic versions of controlled release products based on the
Company's TIMERx technology will depend, in large part, on the intensity of
competition from currently marketed drugs and technologies that compete with the
branded controlled release pharmaceuticals, as well as the timing of product
approvals. Competition may also arise from therapeutic products that are
functionally equivalent but produced by other methods. In addition, under
several of the Company's collaborative arrangements, the payments due to the
Company with respect to the controlled release products covered by such
collaborative arrangements will be reduced in the event that there are competing
generic controlled release versions of such products.
The generic drug industry is characterized by frequent litigation between
generic drug companies and branded drug companies. Those companies with
significant financial resources will be more able to bring and defend any such
litigation. See "Business -- Litigation."
In its excipients business, the Company competes with a number of large
manufacturers and other distributors of excipient products, many of which have
substantially greater financial, marketing and other resources than the Company.
The Company's principal competitor in this market is FMC Corporation, which
markets its own line of MCC excipient products.
The pharmaceutical industry is characterized by rapid and substantial
technological change. There can be no assurance that any products incorporating
TIMERx technology will not be rendered obsolete or non-competitive by new drugs,
treatments or cures for the medical conditions the TIMERx-based products are
addressing. Any of the foregoing could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Business
- -- Competition."
NEED FOR ADDITIONAL FUNDING; UNCERTAINTY OF ACCESS TO CAPITAL
The Company anticipates that its existing capital resources, together with
the funds available under the Credit Facility and internally generated funds,
will enable it to maintain currently planned operations through at least 1999.
However, this expectation is based on the Company's current operating plan,
which could change as a result of many factors, and the Company could require
additional funding sooner than anticipated. The Company's requirements for
additional capital could be substantial and will depend on many factors,
including the timing and amount of payments received under existing and possible
future collaborative agreements; the structure of any future collaborative or
development agreements; the progress of the Company's collaborative and
independent development projects; revenues from the Company's excipients
business, including from the introduction of ProSolv; the costs to the Company
of bioequivalence studies for the Company's products; the prosecution, defense
and enforcement of patent claims and other intellectual property rights; and the
development of manufacturing, marketing and sales capabilities. Upon the
Distribution Date, the Company will have no committed sources of capital other
than the Credit Facility. There can be no assurance that the Company will be
able to access the Credit Facility at such times as it desires or needs
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capital. The Credit Facility contains a number of non-financial covenants that
are applicable to Penwest. Any breach of these covenants by the Company would
constitute a default by the Company under the Credit Facility. In addition, the
Credit Facility provides that a breach by Penford of its guarantee of the
Company's indebtedness under the Credit Facility (which will continue for a
period ending August 31, 2000) or the occurrence of an event of default under
any credit agreement with Penford under which the lender is either the sole or a
participating lender would constitute a default by the Company under the Credit
Facility. Accordingly, the Company will be substantially dependent on Penford in
order to access and maintain the Credit Facility. Any default under the Credit
Facility would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation -- Liquidity and
Capital Resources."
To the extent capital resources are insufficient to meet future
requirements, the Company will have to raise additional funds to continue the
development of its technologies. There can be no assurance that such funds will
be available on favorable terms, if at all. The Credit Facility restricts the
incurrence of additional indebtedness by the Company and provides that the
maximum amount available to Penwest under the Credit Facility (initially $15.0
million) will be reduced by the amount of any net proceeds from any financing
conducted by the Company and that the Company will repay any outstanding amounts
under the Credit Facility in excess of the new maximum amount. To the extent
that additional capital is raised through the sale of equity or convertible debt
securities, the issuance of such securities could result in dilution to the
Company's shareholders. If adequate funds are not available, the Company may be
unable to comply with its obligations under its collaborative agreements, which
could result in the termination of such collaborative agreements. In addition,
the Company may be required to curtail operations significantly or to obtain
funds through entering into collaboration agreements on unfavorable terms. The
Company's inability to raise capital would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
UNCERTAINTIES RELATING TO PATENTS AND PROPRIETARY RIGHTS
The Company believes that patent and trade secret protection of its drug
delivery technologies is important to its business and that its success will
depend, in part, on its ability to maintain existing patent protection, obtain
additional patents, maintain trade secret protection and operate without
infringing on the rights of others. The Company has been issued 23 U.S. patents
and 42 foreign patents and three U.S. patent applications have been allowed
relating to its controlled release drug delivery and excipient technologies. In
addition, the Company has filed 11 U.S. patent applications and corresponding
foreign patent applications relating to its controlled release drug delivery
technology. The issuance of a patent is not conclusive as to its validity or as
to the enforceable scope of the claims of the patent. There can be no assurance
that the Company's patents or any future patents will prevent other companies
from developing similar or functionally equivalent products or from successfully
challenging the validity of the Company's patents. Furthermore, there can be no
assurance that (i) any of the Company's future processes or products will be
patentable; (ii) any pending or additional patents will be issued in any or all
appropriate jurisdictions; (iii) the Company's processes or products will not
infringe upon the patents of third parties; or (iv) the Company will have the
resources to defend against charges of patent infringement or protect its own
patent rights against third parties. The inability of the Company to protect its
patent rights or infringement by the Company of the patent or proprietary rights
of others could have a material adverse effect on the Company's business,
financial condition and results of operations.
Substantial patent litigation exists in the pharmaceutical industry. Patent
litigation generally involves complex legal and factual questions, and the
outcome frequently is difficult to predict. An unfavorable outcome in any patent
litigation affecting the Company could cause the Company to pay substantial
damages, alter its products or processes, obtain licenses and/or cease certain
activities. Even if the outcome is favorable to the Company, the Company could
incur substantial litigation costs. Although the legal costs of defending
litigation relating to a patent infringement claim (unless such claim relates to
TIMERx in which case such costs are the responsibility of the Company) are
generally the contractual responsibility of the Company's
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<PAGE> 20
collaborators, the Company could nonetheless incur significant unreimbursed
costs in participating and assisting in the litigation.
In 1994, the Boots Company PLC ("Boots") filed in the European Patent
Office (the "EPO") an opposition to a patent granted by the EPO to the Company
relating to its TIMERx technology. In June 1996, the EPO dismissed Boots'
opposition, leaving intact all claims included in the patent. Boots has appealed
this decision to the EPO Board of Appeals. There can be no assurance that the
Company will prevail in this matter. An unfavorable outcome could materially
adversely affect the Company's business, financial condition and results of
operations.
The Company's collaborator Mylan is involved in patent litigation with
respect to Nifedipine XL. For a discussion of such patent litigation, see
"Business -- Litigation."
The Company also relies on trade secrets and proprietary knowledge, which
it generally seeks to protect by confidentiality and non- disclosure agreements
with employees, consultants, licensees and pharmaceutical companies. There can
be no assurance, however, that these agreements have or in all cases will be
obtained, that these agreements will not be breached, that the Company will have
adequate remedies for any breach or that the Company's trade secrets will not
otherwise become known by others, any of which could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Business -- Patents and Proprietary Rights."
GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVAL
The development, clinical testing, manufacture, marketing and sale of
pharmaceutical products are subject to extensive federal, state and local
regulation in the United States. The Company cannot predict the extent to which
it may be affected by legislative and regulatory actions and developments
concerning various aspects of its operations, its products and the health care
field generally. All new prescription drugs must be approved by the FDA before
they can be introduced into the market in the United States. These approvals are
based on manufacturing, chemistry and control data, as well as safety and
efficacy studies and/or bioequivalence studies. The generation of the required
data is regulated by the FDA and can be time-consuming and expensive without
assurance that the results will be adequate to justify approval.
After submission of a marketing application, in the form of an NDA or an
ANDA, there can be substantial delays in obtaining FDA approval, including the
need to generate and submit additional data. Data submitted to the FDA is often
susceptible to varying interpretations that could delay, limit or prevent
regulatory approval. Also, delays or rejections may be encountered during any
stage of the regulatory approval process based upon the failure of clinical data
to demonstrate compliance with, or upon the failure of the product to meet, the
FDA's requirements for safety, efficacy and quality; and those requirements may
become more stringent due to changes in regulatory agency policy or the adoption
of new regulations. While the U.S. Food, Drug and Cosmetic Act provides for a
180-day review period, the FDA commonly takes one to two years to grant final
approval to a marketing application (NDA or ANDA). Further, the terms of
approval of any marketing application, including the labeling content, may be
more restrictive than the Company desires and could affect the marketability of
products incorporating the Company's controlled release technology.
Most of the controlled release products that the Company is developing with
its collaborators are generic versions of brand name controlled release
products, which require the filing of ANDAs. Certain ANDA procedures for generic
versions of controlled release products are the subject of petitions filed by
brand name drug manufacturers, which seek changes from the FDA in the approval
process for generic drugs. These requested changes include, among other things,
tighter standards for certain bioequivalence studies and disallowance of the use
by a generic drug manufacturer in its ANDA of proprietary data submitted by the
original manufacturer as part of an original new drug application. The Company
is unable to predict at this time whether the FDA will make any changes to its
ANDA procedures as a result of such petitions or any future petitions filed by
brand name drug manufacturers or the effect that such changes may have on the
Company. Any changes in FDA regulations that make ANDA approvals more difficult
could have a material adverse effect on the Company's business, financial
condition and results of operations.
17
<PAGE> 21
The FDA also has the authority to revoke or suspend approvals of previously
approved products for cause, to debar companies and individuals from
participating in the drug-approval process, to request recalls of allegedly
violative products, to seize allegedly violative products, to obtain injunctions
to close manufacturing plants allegedly not operating in conformity with current
Good Manufacturing Practices ("cGMPs") and to stop shipments of allegedly
violative products. Such delays or FDA actions could have a material adverse
effect on the Company's business, financial condition and results of operations.
The FDA may seek to subject to pre-clearance requirements products currently
being marketed without FDA approval, and there can be no assurance that the
Company or its third-party manufacturers or collaborators will be able to obtain
approval for such products within the time period specified by the FDA.
In May 1997, one of the Company's collaborators, Mylan, filed an ANDA with
the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of
Procardia XL. There can be no assurance that approvals can be obtained, or be
obtained in a timely manner, for such ANDA or for any other applications for
regulatory approval that may be filed. See "Business -- Government Regulation."
LIMITED MANUFACTURING CAPABILITY; DEPENDENCE ON SOLE SOURCE SUPPLIERS
The Company does not have commercial-scale facilities to manufacture its
TIMERx material in accordance with cGMP requirements prescribed by the FDA. To
date, the Company has relied on a large third-party pharmaceutical company,
Boehringer Ingelheim Pharmaceuticals, Inc. ("Boehringer Ingelheim"), for the
bulk manufacture of its TIMERx material for delivery to its collaborators under
an agreement that expired in June 1998. The Company believes that there are a
limited number of manufacturers that operate under cGMP regulations capable of
manufacturing the Company's products. Boehringer Ingelheim has advised the
Company that it will continue to manufacture TIMERx material for the Company on
the terms set forth in the current agreement until such time as the Company
contracts with another manufacturer, but Boehringer Ingelheim is not obligated
to continue to manufacture TIMERx material, and there can be no assurance as to
how long Boehringer Ingelheim will continue to manufacture TIMERx material. The
Company has identified another third-party manufacturer to manufacture TIMERx
material and is currently validating such manufacturer's facility and
negotiating the terms under which such manufacturer will manufacture TIMERx
material for the Company. However, there can be no assurance that the Company
will enter into a manufacturing agreement with such manufacturer or as to the
terms of such manufacturing agreement. In the event that the Company is unable
to obtain contract manufacturing, or obtain such manufacturing on commercially
reasonable terms, it may not be able to commercialize its products as planned.
There can be no assurance that third parties upon which the Company relies for
supply of its TIMERx materials will perform, and any failures by third parties
may delay development or the submission of products for regulatory approval,
impair the Company's collaborators' ability to commercialize products as planned
and deliver products on a timely basis, or otherwise impair the Company's
competitive position, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
The manufacture of any products by the Company (both TIMERx material and
excipients) is subject to regulation by the FDA and comparable agencies in
foreign countries. Delay in complying or failure to comply with such
manufacturing requirements could materially adversely affect the marketing of
the Company's products and the Company's business, financial condition and
results of operations.
The Company's TIMERx drug delivery system is a hydrophilic matrix combining
primarily two natural polysaccharides, xanthan and locust bean gums, in the
presence of dextrose. The Company purchases these gums from a sole source
supplier. Most of the Company's excipients are manufactured from wood pulp.
Although the Company has qualified alternate suppliers with respect to these
materials, there can be no assurance that interruptions in supplies will not
occur in the future or that the Company will not have to obtain substitute
suppliers. Any of these events could have a material adverse effect on the
Company's ability to manufacture bulk TIMERx for delivery to its collaborators
or to manufacture its excipients, which could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Business -- Manufacturing."
18
<PAGE> 22
RELATIONSHIP WITH PENFORD; CONFLICTS OF INTEREST
Conflicts of interest may arise between the Company and Penford in a number
of areas relating to their past and ongoing relationships, including the
manufacture of certain excipients, tax and employee benefit matters, indemnity
arrangements and the guaranty by Penford of the Company's indebtedness under the
Credit Facility. Although Penford has advised the Company that it does not
currently intend to engage in the business of developing, marketing and
commercializing drug delivery products except through contractual relationships
with the Company, other than the agreement by Penford not to distribute certain
products to the pharmaceutical and nutritional industries (excluding food
products), there are no contractual or other restrictions on Penford's ability
to engage in such activities. Accordingly, circumstances could arise in which
Penford would compete with the Company.
In anticipation of this Distribution, the Company and Penford have entered
into a number of agreements, which will become effective on or before the
Distribution Date, for the purpose of defining certain relationships between
them. As a result of Penford's ownership interest in the Company, the terms of
such agreements were not the result of arm's-length negotiations.
Notwithstanding the Tax Allocation Agreement entered into between the Company
and Penford, under federal income tax law, each member of a consolidated group
for federal income tax purposes is also jointly and severally liable for the
federal income tax liability of each other member of the consolidated group.
Similar rules may apply under state income tax laws. If Penford or members of
its consolidated tax group (other than the Company and its subsidiaries) do not
comply with the provisions of the Tax Allocation Agreement and the Company is
required to make payments in respect of the tax liabilities allocated to Penford
thereunder, such payments could adversely affect the business, financial
condition and results of operations of the Company.
The Credit Facility contains a number of non-financial covenants that are
applicable to Penwest, including without limitation, restrictions on the
incurrence of additional debt and on the payment of dividends. Any breach of
these covenants by the Company would constitute a default by the Company under
the Credit Facility. In addition, the Credit Facility provides that a breach by
Penford of its guarantee of the Company's indebtedness under the Credit Facility
(which will continue for a period ending August 31, 2000) or the occurrence of
an event of default under any credit agreement with Penford under which the
lender is either the sole or a participating lender, including without
limitation, an event of default arising from the failure of Penford to satisfy
certain financial covenants requiring, among other things, the maintenance of a
minimum net worth and of certain financial ratios, would constitute a default by
the Company under the Credit Facility. Accordingly, the Company will be
substantially dependent on Penford in order to access and maintain the Credit
Facility. Any default by the Company under the Credit Facility would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Three of the seven current directors of the Company are also directors of
Penford. Tod R. Hamachek, the Company's Chairman and Chief Executive Officer,
has informed the Company that he intends to resign from the Penford Board upon
completion of the Distribution, and Paul E. Freiman has informed the Company
that he intends to resign from the Penford Board at its next annual meeting of
shareholders. N. Stewart Rogers, the Chairman of Penford, will remain on the
Penwest Board pursuant to Penford's rights under the Separation and Distribution
Agreement. Any directors of the Company who are also directors of Penford may
have conflicts of interest with respect to matters potentially or actually
involving or affecting the Company and Penford such as acquisitions, financings
and other corporate opportunities that may be suitable for the Company and
Penford. To the extent that such opportunities arise, such directors may consult
with their legal advisors and make a determination after consideration of a
number of factors, including whether such opportunity is presented to either of
such directors in his capacity as a director of the Company, whether such
opportunity is within the Company's line of business or consistent with its
strategic objectives and whether the Company will be able to undertake or
benefit from such opportunity. Mr. Hamachek may also have a conflict of interest
as a result of a loan extended to him by Penford. See "Management -- Executive
Compensation." In addition, determinations may be made by the Company's Board of
Directors, when appropriate, by the vote of the disinterested directors only.
Notwithstanding the foregoing, there can be no assurance that conflicts will be
resolved in favor of the Company. See "Arrangements Between the Company and
Penford."
19
<PAGE> 23
NO ASSURANCE OF ADEQUATE THIRD-PARTY REIMBURSEMENT
The commercialization of the controlled release product candidates under
development by the Company and its collaborators depends in part on the extent
to which reimbursement for the cost of such products will be available from
government health administration authorities, private health insurers and other
third party payors, such as health maintenance organizations and managed care
organizations. The generic versions of controlled release products being
developed by the Company and its collaborators may be assigned an AB rating if
the FDA considers the product to be therapeutically equivalent to the branded
controlled release drug. Failure to obtain an AB rating from the FDA would
indicate that for certain purposes the drug would not be deemed to be
therapeutically equivalent, would not be fully substitutable for the branded
controlled release drug and would not be relied upon by Medicaid and Medicare
formularies for reimbursement.
Third party payors are attempting to control costs by limiting the level of
reimbursement for medical products, including pharmaceuticals. Cost control
initiatives could decrease the price that the Company or any of its
collaborators receive for their drugs and have a material adverse effect on the
Company's business, financial condition and results of operations. Further, to
the extent that cost control initiatives have a material adverse effect on the
Company's collaborators, the Company's ability to commercialize its products and
to realize royalties may be adversely affected. Moreover, health care reform has
been, and may continue to be, an area of national and state focus, which could
result in the adoption of measures that adversely affect the pricing of
pharmaceuticals or the amount of reimbursement available from third party
payors. There can be no assurance that changes in health care reimbursement laws
or policies will not have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Pricing and
Third-Party Reimbursement."
RISK OF PRODUCT LIABILITY CLAIMS; NO ASSURANCE OF ADEQUATE INSURANCE
Testing, manufacturing, marketing and selling pharmaceutical products
entail a risk of product liability. The Company faces the risk of product
liability claims in the event that the use of its products is alleged to have
resulted in harm to a patient or subject. Such risks exist even with respect to
those products that are manufactured in licensed and regulated facilities or
that otherwise possess regulatory approval for commercial sale. Product
liability insurance coverage is expensive, difficult to obtain and may not be
available in the future on acceptable terms, if at all. The Company is currently
covered by primary product liability insurance maintained by Penford in the
amount of $1.0 million per occurrence and $2.0 million annually in the aggregate
on a claims-made basis and by umbrella liability insurance in excess of $5.0
million which can also be used for product liability insurance. The Company is
currently seeking to obtain comparable coverage immediately following the
Distribution. However, there can be no assurance that the Company will be able
to obtain comparable coverage following the Distribution at a similar cost to
the Company. Furthermore, this coverage may not be adequate as the Company
develops additional products. As the Company receives regulatory approvals for
products under development, there can be no assurance that additional liability
insurance coverage for any such products will be available in the future on
acceptable terms, if at all. The Company's business, financial condition and
results of operations could be materially adversely affected by the assertion of
a product liability claim. See "Business -- Product Liability Insurance."
HAZARDOUS MATERIALS
The Company's research and development and manufacturing activities involve
the controlled use of chemicals and solvents. Although the Company believes that
its safety procedures for handling, storing and disposing of such materials and
the safety procedures of the third parties who ship such materials for the
Company comply with the standards prescribed by federal, state and local
regulations, the risk of accidental contamination or injury from these materials
cannot be completely eliminated. In the event of such an accident, the Company
could be held liable for significant damages and any such liability could have a
material adverse effect on the Company's business, financial condition and
results of operations.
20
<PAGE> 24
NO PRIOR PUBLIC MARKET; POTENTIAL VOLATILITY OF STOCK PRICE
Prior to the Distribution, there has been no public market for the Penwest
Common Stock, although it is expected that a "when-issued" trading market will
develop on or about the Record Date. There can be no assurance regarding the
prices at which the Common Stock will trade before or after the Distribution
Date.
As a result of the Distribution, all the shares of Common Stock outstanding
will be distributed to the shareholders of Penford. Substantially all such
shares will be eligible for immediate resale in the public market. The Company
is unable to predict whether substantial amounts of Common Stock will be sold in
the open market following the Distribution. Sales of substantial amounts of
Common Stock in the public market, or the perception that such sales might
occur, whether as a result of the Distribution or otherwise, could materially
adversely affect the market price of the Common Stock.
The market prices for securities of pharmaceutical, biopharmaceutical and
biotechnology companies have historically been highly volatile. The market from
time to time experiences significant price and volume fluctuations that are
unrelated to the operating performance of particular companies. In addition,
factors such as fluctuations in the Company's operating results, future sales of
Common Stock, announcements of technological innovations or new therapeutic
products by the Company or its competitors, announcements regarding
collaborative agreements, clinical trial results, government regulation,
developments in patent or other proprietary rights, public concern as to the
safety of drugs developed by the Company or others, changes in reimbursement
policies, comments made by securities analysts and general market conditions can
have an adverse effect on the market price of the Common Stock. In particular,
the realization of any of the risks described in these "Risk Factors" could have
a significant and adverse impact on such market price.
ABSENCE OF DIVIDENDS
The Company has not paid any dividends on its Common Stock since inception
and does not anticipate paying any cash dividends in the foreseeable future. The
Company is prohibited from paying dividends on the Common Stock under the Credit
Facility. See "Dividend Policy."
ANTI-TAKEOVER EFFECTS OF WASHINGTON LAW, CERTAIN CHARTER PROVISIONS AND RIGHTS
AGREEMENT
The Company's Amended and Restated Articles of Incorporation, as amended,
the Company's Amended and Restated Bylaws, certain provisions of the Washington
Business Corporation Act and the Rights Agreement contain several provisions
that could make more difficult a change of control of Penwest in a transaction
not approved by the Board. The Board has the authority to issue up to 1,000,000
shares of Preferred Stock and to determine the price, rights, preferences and
privileges of those shares without any further vote or action by the Company's
shareholders. The rights of the holders of Common Stock will be subject to, and
may be adversely affected by, the rights of the holders of any Preferred Stock
that may be issued in the future. While the Company has no present intention to
issue shares of Preferred Stock other than in connection with the Rights
Agreement, such issuance, while providing desirable flexibility in connection
with possible acquisitions and other corporate purposes, could have the effect
of making it more difficult for a third party to acquire a majority of the
outstanding voting stock of the Company. In addition, the Company is subject to
the anti-takeover provisions of Chapter 23B.19 of the Washington Business
Corporation Act, which prohibit the Company from engaging in a "business
combination" with an "interested shareholder" for a period of three years after
the date of the transaction in which the person became an interested
shareholder, unless the business combination is approved in a prescribed manner.
The application of Chapter 23B.19 could have the effect of delaying or
preventing a change of control of the Company. The Company's Amended and
Restated Articles of Incorporation provide for staggered terms for the members
of the Board. The staggered Board and certain other provisions of the Company's
Amended and Restated Articles of Incorporation and Amended and Restated Bylaws
may have the effect of delaying or preventing a change of control of the
Company, which could adversely affect the market price of the Company's Common
Stock. See "Description of Capital Stock -- Washington Law and Certain Charter
and Bylaw Provisions."
21
<PAGE> 25
RISK OF LOSS OF "TAX-FREE" TREATMENT OF DISTRIBUTION
Penwest has received a private letter ruling from the IRS to the effect
that, among other things, the Distribution qualifies as tax-free under Sections
355 and 368 of the Code and that the receipt of shares of Common Stock in the
Distribution will not result in the recognition of income, gain or loss to
Penford's shareholders for federal income tax purposes. See "The
Distribution -- Certain Federal Income Tax Consequences of the Distribution."
The continuing validity of any such ruling is subject to certain factual
representations and assumptions. Neither Penford nor Penwest is aware of any
facts or circumstances which should cause such representations and assumptions
to be untrue. Although the Tax Allocation Agreement provides that neither
Penford nor Penwest is to take any action inconsistent with, nor fail to take
any action required by, the private letter ruling unless required to do so by
law or the other party has given its prior written consent or, in certain
circumstances, a supplemental ruling permitting such action is obtained, any of
the following acts potentially could render the Distribution taxable: (i) the
transfer by Penford or Penwest of a material portion of its assets (other than a
transfer of assets in the ordinary course of business); (ii) the merger of
Penford or Penwest with or into another corporation in a transaction that does
not qualify as a tax-free reorganization under Section 368 of the Code; (iii)
the discontinuance by Penford or Penwest or a material portion of its historical
business activities; (iv) the conversion (or redemption or exchange) of the
Common Stock distributed in the Distribution into or for any other stock,
security, property, or cash; (v) the issuance of additional shares of stock by
Penwest pursuant to negotiations, agreements, plans, or arrangements entered
into before the Distribution; (vi) transfers of stock of Penford and/or Penwest
by shareholders of sufficient quantity to cause the historic shareholders of
Penford not to be considered to have maintained sufficient "continuity of
proprietary interest" in one or both of the companies; and (vii) the acquisition
of a 50% or greater interest in Penford and/or Penwest pursuant to a plan (or
deemed to be pursuant to a plan) in existence on the Distribution Date. If the
Distribution were rendered taxable as a result of such an act, then (x) the
corporate-level taxable gain would be recognized by the consolidated group of
which Penford is the parent (see "The Distribution -- Federal Income Tax
Consequences of the Distribution"), (y) each of Penford and Penwest, as a former
member of that group, would be severally liable for the corporate-level tax on
such gain when such gain becomes taxable under the consolidated return
regulations, and (z) except in the case of an acquisition described in clause
(vii) of the preceding sentence, each holder of common stock who received shares
of Common Stock in the Distribution would be treated as having received a
taxable dividend in an amount equal to the fair market value of the Common Stock
received (assuming that Penford had sufficient current or accumulated "earnings
and profits"). Penford and Penwest have agreed to indemnify each other with
respect to any tax liability resulting from their respective failures to comply
with such provisions. These indemnification obligations do not extend to
shareholders of Penford. See "Arrangements Between the Company and
Penford -- Tax Allocation Agreement."
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock. The Company
presently intends to retain earnings, if any, for use in the operation of its
business, and therefore does not anticipate paying any cash dividends in the
foreseeable future. The Company is prohibited from paying dividends on its
Common Stock under the Credit Facility.
22
<PAGE> 26
SELECTED FINANCIAL DATA
The statement of operations data for the years ended December 31, 1994,
1995, 1996 and 1997 and the balance sheet data as of December 31, 1995, 1996 and
1997 are derived from the consolidated financial statements of the Company which
have been audited by Ernst & Young LLP, independent auditors. The statement of
operations data for the year ended December 31, 1993 and the three month periods
ended March 31, 1997 and 1998 and the balance sheet data as of December 31, 1993
and 1994 and March 31, 1998 are derived from unaudited consolidated financial
statements. The unaudited consolidated financial statements include all
adjustments, consisting of normal recurring accruals, which the Company
considers necessary for a fair presentation of the financial position and
results of operations for these periods. Operating results for the three-month
period ended March 31, 1998 are not necessarily indicative of the results that
may be expected for the entire year ending December 31, 1998. The data set forth
below should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Consolidated Financial
Statements, related Notes thereto, and other financial information included
elsewhere in this Information Statement.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------------------- -----------------
1993 1994 1995 1996 1997 1997 1998
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................ $21,355 $23,146 $25,089 $26,089 $26,941 $ 6,970 $ 7,786
Cost of product sales............... 13,708 15,910 17,267 $18,690 $19,929 4,891 5,836
------- ------- ------- ------- ------- ------- -------
Gross profit........................ 7,647 7,236 7,822 7,399 7,012 2,079 1,950
Selling, general and
administrative.................... 6,383 7,021 7,676 6,776 8,708 2,044 2,357
IPO transaction costs............... -- -- -- -- 1,367 -- --
Research and product development.... 1,255 2,322 2,719 3,723 4,109 851 1,285
Net income (loss)................... $ 8 $(2,629) $(3,252) $(3,864) $(7,316) $ (832) $(2,030)
======= ======= ======= ======= ======= ======= =======
Basic and diluted net income (loss)
per share......................... $ 0.00 $ (0.24) $ (0.29) $ (0.35) $ (0.66) $ (0.08) $ (0.18)
======= ======= ======= ======= ======= ======= =======
Weighted average shares of Common
Stock outstanding................. 11,055 11,055 11,055 11,055 11,055 11,055 11,055
======= ======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, 1998
---------------------------------------------------- ----------------------
AS
1993 1994 1995 1996 1997 ACTUAL ADJUSTED(1)
-------- -------- -------- -------- -------- -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents.............. $ 347 $ 668 $ 290 $ 695 $ 938 $ 723 $ 723
Working capital............ (12,321) (14,592) (19,461) (23,362) (33,433) (35,545) 9,072
Total assets............... 25,430 27,000 31,671 35,083 37,436 37,695 37,695
Accumulated deficit........ (2,588) (5,217) (8,469) (12,333) (19,649) (21,679) (21,679)
Total shareholder's equity
(deficit)................ 5,011 2,641 (477) (4,412) (12,297) (14,403) 30,214
</TABLE>
- ---------------
(1) As adjusted to reflect the Penford Capital Contribution. See Note 6 of Notes
to Consolidated Financial Statements.
23
<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth under "Risk Factors" and elsewhere in
this Information Statement.
OVERVIEW
Since 1991, the Company has been engaged in the research, development and
commercialization of novel drug delivery technologies, including the development
of its TIMERx controlled release drug delivery technology. The Company also
develops, manufactures, distributes and markets excipients to the pharmaceutical
and nutritional industries. The Company was incorporated under the name Edward
Mendell Co., Inc. in the State of Washington in 1991 following Penford's
acquisition of substantially all the assets of its predecessor company.
The Company's principal development focus to date has been the development
of controlled release drugs based on the TIMERx technology. The Company's
collaborator, Leiras, received marketing approval in Finland for Cystrin CR, a
TIMERx formulation for the treatment of urge urinary incontinence, in October
1997 and began marketing the product in Finland in January 1998. In May 1997,
the Company's collaborator, Mylan, filed an ANDA with the FDA for the 30 mg
dosage strength of Nifedipine XL, the first generic version of Procardia XL.
Subsequent to the filing of Mylan's ANDA, Bayer and Pfizer sued Mylan alleging
patent infringement and Pfizer sued the FDA claiming that the FDA's acceptance
of Mylan's ANDA filing was contrary to law. Pfizer's claim against the FDA was
rejected by a district court in April 1998 and in May 1998 Pfizer appealed the
district court's decision. There can be no assurance that Mylan or the FDA will
prevail in these matters or that they will continue to contest these matters. An
unfavorable outcome or protracted litigation with respect to either of these
matters would have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company is a party to collaborative agreements with Mylan, Leiras,
Kremers, Sanofi, Synthelabo and Endo with respect to the development and
commercialization of TIMERx controlled release products. Under these
collaborative agreements, the Company's collaborators are generally responsible
for conducting full scale bioequivalence studies and clinical trials, preparing
and submitting all regulatory applications and submissions and manufacturing,
marketing and selling the TIMERx controlled release products. There can be no
assurance that the Company's collaborations will be commercially successful. The
Company cannot control the amount and timing of resources which its
collaborators devote to the Company's programs or potential products. If any of
the Company's collaborators breach or terminate their agreements with the
Company or otherwise fail to conduct their collaborative activities in a timely
manner, the development and commercialization of product candidates would either
be terminated or delayed, or the Company would be required to undertake product
development and commercialization activities on its own and at its own expense,
which would increase the Company's capital requirements or require the Company
to limit the scope of its development and commercialization activities.
Under most of these collaborative agreements, the Company has received
upfront fees and milestone payments. In connection with the receipt of certain
upfront fees, the Company was required to perform pilot bioequivalence studies
and only recognized such fees upon delivery of the results of such studies to
the collaborators. In addition, under most of these collaborative agreements,
the Company is entitled to receive additional milestone payments, royalties on
the sale of the products covered by such collaborative agreements and payments
for the purchase of formulated TIMERx material. Because the timing and the
amount of each of these payments are dependent on the continued development and
commercialization of the products covered by such agreements, as to which the
Company has limited control, there can be no assurance as to the timing of
receipt of some or all of these payments or as to the amount of payments to be
received by the Company.
24
<PAGE> 28
Except for Cystrin CR, which received marketing approval in Finland in
October 1997, and Ditropan CR, which received marketing approval in the
Netherlands, Austria and Ireland in June 1998, no product based on TIMERx
technology has ever received regulatory approval for commercial sale.
Substantially all the TIMERx revenues generated to date have been milestone fees
received for products under development. There can be no assurance that the
Company's controlled release product development efforts will be successfully
completed, that required regulatory approvals will be obtained or that approved
products will be successfully manufactured or marketed.
The Company has incurred net losses since 1994. As of March 31, 1998, the
Company's accumulated deficit was approximately $21.7 million. The Company
expects net losses to continue at least into late 1999. A substantial portion of
the Company's revenues to date have been generated from the sales of the
Company's pharmaceutical excipients. The Company's future profitability will
depend on several factors, including the successful commercialization of TIMERx
controlled release products, and, to a lesser extent, an increase in sales of
its pharmaceutical excipients products. There can be no assurance that the
Company will achieve profitability or that it will be able to sustain any
profitability on a quarterly basis, if at all.
The Company's results of operations may fluctuate from quarter to quarter
depending on the volume and timing of orders of the Company's pharmaceutical
excipients and on variations in payments under the Company's collaborative
agreements including payments upon the achievement of specified milestones. The
Company's quarterly operating results may also fluctuate depending on other
factors, including variations in gross margins of the Company's products, the
mix of products sold, competition, regulatory actions, litigation and currency
exchange rate fluctuations.
The Company's business is conducted internationally and may be affected by
fluctuations in currency exchange rates, as well as by governmental controls and
other risks associated with international sales (such as export licenses,
collectibility of accounts receivable, trade restrictions and changes in
tariffs). The Company's international subsidiaries transact a substantial
portion of their sales and purchases in European currencies other than their
functional currency, which can result in the Company having gains or losses from
currency exchange rate fluctuations. The Company does not use derivatives to
hedge the impact of fluctuations in foreign currencies.
RESULTS OF OPERATIONS
Three Months Ended March 31, 1998 and 1997
Total revenues increased by 11.7% for the three months ended March 31, 1998
to $7.8 million from $7.0 million for the three months ended March 31, 1997.
Product sales increased to $7.8 million for the three months ended March 31,
1998 from $6.6 million for the three months ended March 31, 1997 representing an
increase of 16.8%. The increase in product sales was primarily due to increased
sales in North America of EMCOCEL, one of the Company's principal excipient
products. Royalties and licensing fees relating to the TIMERx drug delivery
system decreased to $25,000 for the three months ended March 31, 1998 from
$325,000 for the three months ended March 31, 1997 due to the timing of when
development milestones were earned.
Gross profit decreased to $2.0 million or 25.0% of total revenues for the
three months ended March 31, 1998 from $2.1 million or 29.8% of total revenues
for the three months ended March 31, 1997. The decrease in gross profit
percentage was primarily due to the decrease in licensing fees for the period
and, to a lesser extent, a change in product mix.
Selling, general and administrative expenses increased by 15.3% for the
three months ended March 31, 1998 to $2.4 million from $2.0 million for the
three months ended March 31, 1997. This increase was primarily due to relocation
expenses associated with the hiring of additional employees required for the
Company to operate as a stand-alone entity, depreciation on a new computer
system and higher compensation expenses related to the employment of additional
employees in 1998.
Research and development expenses increased by 51.0% for the three months
ended March 31, 1998 to $1.3 million from $851,000 for the three months ended
March 31, 1997. This increase was due to increased
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spending under the Company's collaboration with Endo and increased spending
related to the development of other TIMERx controlled release products.
For the three months ended March 31, 1998 and 1997, respectively, the
Company did not record a benefit for federal or state taxes because net
operating losses were utilized by Penford in the year they were generated, and
the Company was not compensated by Penford for these losses. In addition, the
Company's provision for income taxes includes foreign taxes and federal and
state deferred tax liabilities that exceed deferred tax assets, which will
reverse when losses are not expected to be available.
Years Ended December 31, 1997 and 1996
Total revenues increased by 3.3% in 1997 to $26.9 million from $26.1
million in 1996. Product sales increased to $26.0 million in 1997 from $25.0
million in 1996, primarily due to an increase in the second half of 1997 in
North American sales of EMCOCEL. These increased sales were partially offset by
a decrease in average selling price for some excipients in Europe due to
competitive pricing pressures. Royalties and licensing fees relating to the
TIMERx drug delivery system decreased to $911,000 in 1997 from $1.1 million in
1996 due to the timing of when development milestones were earned.
Gross profit decreased to $7.0 million or 26.0% of total revenues in 1997
from $7.4 million or 28.4% of total revenues in 1996. This decrease in gross
profit was primarily attributable to an increase in sales of EMCOCEL products,
which have lower overall gross margins than the Company's other excipients. The
Company expects sales of EMCOCEL products to continue to increase. However, the
Company also expects margins on these products to improve as manufacturing
economies of scale are achieved. The decrease is also attributable to inventory
write-offs of excipient products in the fourth quarter of 1997 and the decrease
in royalties and licensing fees in 1997. Excipient product write-offs of
approximately $100,000 were primarily due to quality reasons. Future write-offs
are not expected to materially affect results of operations, liquidity or
capital resources.
Selling, general and administrative expenses increased by 28.5% in 1997 to
$8.7 million from $6.8 million in 1996. This increase reflected additional
business development expenses of $327,000, employee benefit consulting
associated with the Distribution of $311,000, additional incentive compensation
expenses of $222,000, an increase in management fees of $210,000 and a property
tax refund recorded in 1996 of $150,000. The balance of the increase is
primarily attributable to increases in administrative staff in anticipation of
planned business growth. Business development expenses are primarily comprised
of payroll and related benefits and staff recruiting, relocation, travel,
professional and promotional expenses.
In October 1997, Penford's Board of Directors approved the sale of
approximately 20% of the Company's Common Stock in an initial public offering
(the "IPO"). The IPO was initially intended to be completed during December
1997. Due to market conditions, the IPO was initially postponed and during May
1998, after further evaluation of the market opportunities, Penford's Board of
Directors decided to distribute 100% of the Common Stock to Penford's
shareholders and forego the IPO at such time. Based on this decision, the
Company wrote-off approximately $1.4 million of transaction costs, principally
legal, accounting and printing, associated with the preparation for the IPO
during the year ended December 31, 1997.
Research and development expenses increased by 10.4% in 1997 to $4.1
million from $3.7 million in 1996. This increase was due to increased spending
in the development of the TIMERx drug delivery system and its applications as
well as increased spending on developing high performance excipients such as
ProSolv.
For 1997 and 1996, the Company did not record a benefit for federal or
state taxes because net operating losses were utilized by Penford in the year
they were generated, and the Company was not compensated for these losses. In
addition, the Company's provision for income taxes includes foreign taxes and
federal and state deferred tax liabilities that exceed deferred tax assets,
which will reverse when losses are not expected to be available.
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Years Ended December 31, 1996 and 1995
Total revenues increased by 4.0% in 1996 to $26.1 million from $25.1
million in 1995. Product sales equalled $25.0 million in 1996 and in 1995.
Licensing revenues relating to the TIMERx drug delivery system increased to $1.1
million in 1996 from $100,000 in 1995 due to the achievement of additional
development milestones during the 1996 period.
Gross profit decreased to $7.4 million or 28.4% of total revenues in 1996
from $7.8 million or 31.2% of total revenues in 1995. Gross margins in 1996
decreased due to higher unit costs with respect to EMCOCEL, which were partially
offset by an increase in licensing revenues. These higher unit costs resulted
from the underutilization of a new manufacturing plant opened in late 1993 to
produce EMCOCEL.
Selling, general and administrative expenses decreased by 11.7% in 1996 to
$6.8 million from $7.7 million in 1995. This decrease was due to a property tax
refund recorded on the Patterson facility and a reduction in professional
services.
Research and development expenses increased by 36.9% in 1996 to $3.7
million from $2.7 million in 1995. This increase was attributable primarily to
the hiring of additional research and development personnel in connection with
the development of the TIMERx drug delivery system and its applications.
For 1996 and 1995, the Company did not record a benefit for federal or
state taxes because net operating losses were utilized by Penford in the year
they were generated, and the Company was not compensated for these losses. In
addition, the Company's provision for income taxes includes foreign taxes and
federal and state deferred tax liabilities that exceed deferred tax assets,
which will reverse when losses are not expected to be available.
LIQUIDITY AND CAPITAL RESOURCES
Since its incorporation, the Company has received intercompany advances
from Penford to fund the Company's operations, capital expenditures and the
original acquisition of the Company's predecessor, which equalled $44.6 million
as of March 31, 1998. Penford intends to continue to provide advances to the
Company until the Distribution Date. Penford has agreed that it will contribute
the outstanding intercompany indebtedness to the capital of the Company as of
the Distribution Date. In addition, Penford has agreed to guarantee the
Company's indebtedness under the Credit Facility. In no other respects will
Penford provide financial support to the Company after the Distribution.
As of March 31, 1998, the Company had cash and cash equivalents of
$723,000. Following the Distribution Date, the Company will have no committed
sources of capital other than the Credit Facility and no indebtedness to any
third or related parties other than under the Credit Facility. The Company does
not anticipate any borrowings under the Credit Facility immediately following
the Distribution. The Company intends to borrow under the Credit Facility from
time to time following the Distribution in order to fund its working capital
needs as required. As of March 31, 1998, the Company did not have any material
commitments for capital expenditures.
The Company had negative cash flow from operations in each of the periods
presented primarily due to net losses for the period as well as increasing
inventory levels. Inventory has increased as the Company began manufacturing
TIMERx inventory in 1995 for a variety of uses. These uses include the supply of
the drug delivery system for use in connection with products that are complete
and awaiting regulatory approval or completion of the commercialization efforts
where regulatory approval has been obtained, and the supply of the drug delivery
system to pharmaceutical companies for use in their development efforts or in
connection with new or existing collaborative arrangements. In all these cases,
the Company receives revenue from the supply of the TIMERx inventory.
Additionally, the Company has alternative uses of the TIMERx inventory for other
drugs which the Company may research and formulate for commercialization. The
Company will continue to build inventories until the drugs under development are
commercialized. As of December 31, 1997, there was a temporary decrease in
accounts receivable due primarily to the timing of customer purchases and
improved collection efforts. However, accounts receivable as of March 31, 1998
increased by 24% from December 31, 1997. This increase was due primarily to the
timing of customer purchases.
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Customers purchase inventory as needed and the timing of such purchases are not
typically influenced by the time of the year. Funds expended for the acquisition
of fixed assets were primarily related to the expansion of the Company's
manufacturing facilities and laboratory space as well as the purchase of
equipment used principally for research and development efforts. The payable to
Penford increased to fund the operations and capital needs of the Company.
The Company anticipates that its existing capital resources, together with
the funds available under the Credit Facility and internally generated funds,
will enable it to maintain currently planned operations through at least 1999.
However, this expectation is based on the Company's current operating plan,
which could change as a result of many factors, and the Company could require
additional funding sooner than anticipated. The Company's requirements for
additional capital could be substantial and will depend on many factors,
including the timing and amount of payments received under existing and possible
future collaborative agreements; the structure of any future collaborative or
development agreements; the progress of the Company's collaborative and
independent development projects; revenues from the Company's excipients
business, including from the introduction of ProSolv; the costs to the Company
of bioequivalence studies for the Company's products; the prosecution, defense
and enforcement of patent claims and other intellectual property rights; and the
development of manufacturing, marketing and sales capabilities. Upon the
Distribution Date, the Company will have no committed sources of capital other
than the Credit Facility. There can be no assurance that the Company will be
able to access the Credit Facility at such times as it desires or needs capital.
To the extent capital resources are insufficient to meet future
requirements, the Company will have to raise additional funds to continue the
development of its technologies. There can be no assurance that such funds will
be available on favorable terms, if at all. The Credit Facility restricts the
incurrence of additional indebtedness by the Company and provides that the
maximum amount available to Penwest under the Credit Facility (initially $15.0
million) will be reduced by the amount of any net proceeds from any financing
conducted by the Company and that the Company will repay any outstanding amounts
under the Credit Facility in excess of the new maximum amount. To the extent
that additional capital is raised through the sale of equity or convertible debt
securities, the issuance of such securities could result in dilution to the
Company's shareholders. If adequate funds are not available, the Company may be
unable to comply with its obligations under its collaborative agreements, which
could result in the termination of such collaborative agreements. In addition,
the Company may be required to curtail operations significantly or to obtain
funds through entering into collaboration agreements on unfavorable terms. The
Company's inability to raise capital would have a material adverse effect on the
Company's business, financial condition and results of operations.
Under the Company's strategic alliance agreement with Endo, the Company
expects to expend through development approximately $12.0 million, primarily in
1999 and 2000. The Company expects to rely on funds available under the Credit
Facility and cash from operations to fund expenditures. However, as noted above,
the Company may be required to raise additional funds to continue its
development activities, including its activities under the Endo agreement.
However, either the Company or Endo may terminate the agreement upon 30 days
prior written notice, at which time the Company's funding obligations would
cease. See "Business -- Collaborative Arrangements -- Endo Pharmaceuticals Inc."
The Credit Facility is a revolving loan facility with a maximum principal
amount of $15.0 million of unsecured financing. On August 31, 2000, all
outstanding amounts under the Credit Facility will become automatically due and
payable. Penford has agreed that, for a period ending August 31, 2000, it will
guarantee the Company's indebtedness under the Credit Facility. Borrowings under
the Credit Facility bear interest at a rate equal to LIBOR, plus 1.25%. The
Credit Facility contains a number of non-financial covenants that are applicable
to Penwest, including without limitation, restrictions on the incurrence of
additional debt and on the payment of dividends. Any breach of these covenants
by the Company would constitute a default by the Company under the Credit
Facility. In addition, the Credit Facility provides that a breach by Penford of
its guarantee of the Company's indebtedness under the Credit Facility or the
occurrence of a default under any credit agreement with Penford under which the
lender is either the sole or a participating lender, including without
limitation, an event of default arising from the failure of Penford to satisfy
certain financial conditions requiring, among other things, the maintenance of a
minimum net worth and of certain financial ratios, would
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constitute a default by the Company under the Credit Facility. Accordingly, the
Company will be substantially dependent on Penford in order to access and
maintain the Credit Facility. Any default under the Credit Facility would have a
material adverse effect on the Company's business, financial condition and
results of operations.
YEAR 2000
The Company has undergone a review of its domestic information systems,
including consideration of issues associated with the Year 2000. Due to the
recent addition of a new integrated computer system (at a cost of approximately
$2.9 million) that is Year 2000 compliant, other domestic Year 2000 expenditures
have not been and are not expected to be material. Also, the Company has
initiated a review of potential Year 2000 matters at its European manufacturing
facility and communications with its significant suppliers and customers (which
it expects to complete by the end of 1998) to determine the extent to which the
Company is vulnerable to those third parties' failure to remediate their own
Year 2000 issues. Although the actual costs of such review and any corrective
actions required are not expected to be significant, actual costs cannot be
determined until the review is completed. There can be no assurance that the
systems of other companies or the Company's European manufacturing facility will
be converted on a timely basis and will not have a corresponding adverse effect
on the Company's results of operations or cash flows.
COMMON EUROPEAN CURRENCY
The Treaty on European Economic and Monetary Union (the "Maastricht
Treaty") provides for the introduction of a single European currency, the Euro,
in substitution for the national currencies of the member states of the European
Union that adopt the Euro. In May 1998, the European Council determined (i) the
11 member states that met the requirement for the Monetary Union, and (ii) the
currency exchange rates among the currencies for the member states joining the
Monetary Union. The transitory period for the Monetary Union starts on January
1, 1999. According to Council Resolution of July 7, 1997, the introduction of
the Euro will be made in three steps: (i) a transitory period from January 1,
1999 to December 31, 2001, in which current accounts may be opened and financial
statements may be drawn in Euros, and local currencies and Euros will coexist;
(ii) from January 1, 2002 to June 30, 2002, in which local currencies will be
exchanged for Euros; and (iii) from July 1, 2002 in which local currencies will
disappear. Although there can be no assurance that a single European currency
will be adopted or, if adopted, on what time schedule and with what success,
substantial transitional costs could result as the Company redesigns its
software systems to reflect the adoption of the new currency. In addition, there
can be no assurance as to the effect of the adoption of the Euro on the
Company's payment obligations under commercial agreements in such currencies.
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BUSINESS
The Company is engaged in the research, development and commercialization
of novel drug delivery technologies. Based on its extensive experience in
developing and manufacturing tabletting ingredients for the pharmaceutical
industry, the Company has developed its proprietary TIMERx controlled release
drug delivery technology, which is applicable to a broad range of orally
administered drugs. The Company is applying its TIMERx technology to the
development of oral formulations of branded controlled release versions of
immediate release drugs and generic versions of controlled release drugs. Each
of the formulations developed to date has been developed under a collaborative
arrangement with a pharmaceutical company. The Company's collaborator, Leiras,
received marketing approval in Finland for Cystrin CR (oxybutynin) for the
treatment of urge urinary incontinence in October 1997 and began marketing the
product in Finland in January 1998. In May 1997, the Company's collaborator,
Mylan, filed an ANDA with the FDA for the first generic version of the 30 mg
dosage strength of Procardia XL (nifedipine), a leading cardiovascular drug for
angina and hypertension. The Company is also an established manufacturer and
distributor of excipients to the pharmaceutical and nutritional industries.
DRUG DELIVERY OVERVIEW
Drug delivery technology is a critical component in the formulation of
pharmaceutical products. The formulation of a pharmaceutical product involves
selecting, combining and processing active and inactive ingredients. Drug
delivery technology is used to create or design a system that delivers a drug to
the body in a safe and efficacious manner. These drug delivery systems control
the dissolution, absorption and stability of the finished dosage form and
thereby enhance its safety and therapeutic effectiveness. Although there are
several routes of drug administration used in pharmaceutical products, oral
delivery (principally tablets and capsules) is the preferred delivery route due
to ease of manufacture and administration, as well as enhanced patient
compliance.
Oral Immediate Release Formulations
Oral drugs have traditionally been delivered through "immediate release"
formulations, which release all the active drug substance into the bloodstream
shortly after the patient takes the medication. Immediate release formulations
are beneficial for certain conditions where rapid concentration of the active
ingredient in the bloodstream is required, such as in acute pain relief.
However, immediate release formulations of certain drugs can cause side effects
due to toxicity associated with excessively high concentrations of the active
substance in the bloodstream. In addition, certain immediate release
pharmaceuticals have relatively short half-lives (the time required for half of
the drug to be eliminated from the body), requiring frequent dosing and rigorous
patient compliance in order to achieve successful outcomes.
Oral Controlled Release Formulations
Oral controlled release formulations are designed to alleviate the problems
associated with certain immediate release formulations by extending the period
over which the active ingredient is released into the bloodstream. This permits
the drug to be administered less frequently, enhancing patient compliance.
Controlled release drug delivery systems are typically designed to modulate peak
drug levels in order to reduce side effects such as toxicity associated with
immediate release pharmaceuticals.
In certain cases, a controlled release drug can reduce the total amount of
drug required because it is delivered over an extended period or at the
therapeutically beneficial time or site. The reduction in the total amount of
the active drug substance administered can result in diminished acute toxicity
or toxicity associated with chronic dosing and decrease or eliminate systemic
side effects. Controlled release systems can also improve drug bioavailability
(the relative amount of the active drug substance in the bloodstream). For
example, in drugs that have a narrow window for absorption, these systems can
enhance bioavailability by localizing the release of the active drug substance
in certain regions of the gastrointestinal tract. In addition, controlled
release systems can be designed to coordinate the release of the active drug
substance to coincide
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with the body's natural (circadian) rhythms when they are associated with
certain disease states, such as diabetes and myocardial infarction.
The following chart compares the concentration of the active drug substance
in the bloodstream for a hypothetical drug over a period of time delivered with
an immediate release delivery system and a controlled release delivery system.
[Chart comparing the concentration of the active drug substance in the
bloodstream (x axis) over a period of 30 hours (y axis) delivered with an
immediate release delivery system and a controlled release delivery system]
The controlled release system represented in the chart modulates the
release of the active drug substance which prevents the concentration of the
active drug substance at toxic levels and extends the period during which an
effective dose is provided to the body.
The usefulness of a number of types of drugs can be improved by a
controlled release delivery system. Drugs with short half-lives often require
frequent administration and are therefore candidates for controlled release
formulation. In addition, controlled release systems can be used for drugs with
a long half-life but with a narrow therapeutic index (the median toxic dose
divided by the median therapeutic dose).
The utilization of controlled release technologies also offers potential
benefits to the developers of pharmaceutical products. For instance, a drug
developer can continue to benefit from an established immediate release product
that is losing patent protection, by creating a controlled release version of
the immediate release product and then seeking patent protection for the
reformulated product based on the delivery system. By reformulating a product, a
drug developer can, in effect, develop a new product without many of the risks
and costs typically associated with the discovery and development of new drugs
such as new chemical entities ("NCEs"). While the development of a new drug
based on an NCE generally takes approximately 15 years from discovery to
regulatory approval and costs approximately $300 to $600 million, the
development and regulatory approval of a controlled release version of an
immediate release product generally takes between approximately five to seven
years and costs less than $50 million. Furthermore, under the Waxman-Hatch Act,
a drug developer can under certain circumstances obtain a three-year or
five-year period of marketing exclusivity for a controlled released product
approved under an NDA by the FDA.
Despite these benefits, the development of a controlled release formulation
of a drug is inherently more difficult than the development of an immediate
release formulation of a drug. In developing an immediate release formulation, a
developer need only develop a stable tablet which provides for the immediate
release and the absorption of the active drug ingredient. In developing a
controlled release formulation, a developer
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must also develop a system to control the rate and the extent of the absorption
of the active drug ingredient over an extended period of time.
Oral Controlled Release Delivery Systems
To date, drug developers have principally applied controlled release
technologies to oral and transdermal (across the skin) routes of administration.
The transdermal route of administration has not been widely commercialized
because most drugs cannot be absorbed through the skin in a sufficient
therapeutic dose. Due to the limited applicability of this technology and
because oral delivery is the most prevalent and preferred route for delivery of
drugs to patients, most of the recent advances in controlled release drug
delivery technologies have focused on oral delivery. Three principal types of
oral controlled release systems are currently utilized.
Oral Osmotic Pump (OROS). The OROS drug delivery system was developed by
ALZA in the early 1980s. It consists of the active drug substance housed in a
reservoir, surrounded by a semi-permeable membrane and formulated into a tablet.
A drug portal for release of the active drug substance is created by a
laser-drilled hole in the tablet. Water from the gastrointestinal tract
permeates the semi-permeable membrane at a controlled rate, and the osmotic
pressure of this water forces the release of the active drug substance through
the drug portal.
The Company believes that each new drug which utilizes the OROS system
requires extensive and time consuming development. In addition, specialized
manufacturing equipment may be required to produce OROS-based products. Because
of the complexities inherent in the manufacturing process, the Company believes
that products formulated with the OROS system are more likely to suffer from
batch variability and validation difficulties, and the scale-up from the
laboratory to production can be difficult and expensive. Despite these
disadvantages, the OROS system has been used in several commercially successful
pharmaceutical products, including Procardia XL.
Multiparticulate Systems. Multiparticulate systems have been used in
commercially successful drugs since the 1960s. These systems consist of small
particles containing active drug substance and excipients that are coated with a
polymer to control the rate of release of the active drug substance. These small
particles are either compressed into tablets or packed into a capsule. The
active drug substance is released over time by diffusion from the particles.
The Company believes that scale-up from the laboratory to commercial-scale
production of formulations using a multiparticulate system can be lengthy,
costly and difficult. Multiparticulate systems require investment in specialized
equipment and the development of specialized solvents and solvent recovery
systems for the coatings of each small particle. The Company believes that the
major difficulty encountered in the production of multiparticulate systems is
that the size and thickness of the coating of each particle often differ, which
results in undesired variability in the release of the drug. Consequently, the
Company believes the manufacturers of drugs using multiparticulate systems often
have difficulties with reproducibility and content uniformity and experience
high batch failure rates. Multiparticulate systems have also demonstrated
limited applicability with insoluble active drug substances.
Traditional Matrix Systems. Traditional matrix systems consist of an
active drug substance, rate-controlling polymers and gel-forming excipients
mixed together and compressed in a manner similar to conventional immediate
release tablets. The matrix forms a gel after ingestion, and the active drug
substance is released over time by diffusion through the matrix.
Products using traditional matrix systems generally have low manufacturing
costs as they are manufactured in the same manner as conventional tablets.
However, the rate-controlling polymers used in such systems are not compatible
with the physical and chemical properties of a wide range of drugs. The
inconsistency of these polymers, as well as their limited drug carrying
capacity, often limits their duration to 12 hours or less, such that more
frequent dosing is often required to obtain efficacy. The usefulness of the
traditional matrix systems is also limited because these systems are difficult
to use with insoluble active drug substances.
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Notwithstanding the shortcomings of existing controlled release
technologies, approximately 60 oral controlled release prescription drugs are
marketed currently. Sales of these products in the United States in 1997 were
approximately $7.0 billion.
TIMERX CONTROLLED RELEASE TECHNOLOGY
The Company has developed the TIMERx delivery system, a novel drug delivery
technology, to address the limitations of currently available oral controlled
release delivery systems. The TIMERx system has evolved from the Company's
extensive experience in developing, manufacturing and marketing tabletting
ingredients for use in the pharmaceutical industry. The Company believes that
the TIMERx system is a major advancement in oral drug delivery that represents
the first easily-manufactured oral controlled release drug delivery system that
is applicable to a wide variety of drug classes, including soluble drugs,
insoluble drugs and drugs with a narrow therapeutic index. The Company intends
to utilize the TIMERx system to formulate generic versions of controlled release
drugs, controlled release formulations of currently-marketed immediate release
drugs and NCEs.
The TIMERx drug delivery system is a hydrophilic matrix combining primarily
two natural polysaccharides, xanthan and locust bean gums, in the presence of
dextrose. The physical interaction between these components works to form a
strong, binding gel in the presence of water. Drug release is controlled by the
rate of water penetration from the gastrointestinal tract into the TIMERx gum
matrix, which expands to form a gel and subsequently releases the active drug
substance. The TIMERx system can precisely control the release of the active
drug substance in a tablet by varying the proportion of the gums, the tablet
coating and the tablet manufacturing process. Drugs using TIMERx technology are
formulated by combining the active drug substance, the TIMERx drug delivery
system and additional excipients and compressing such materials into a tablet.
The Company believes that the TIMERx controlled release system has several
advantages over other oral controlled release systems.
- Broad Applicability as a Drug Delivery System. The TIMERx system is
adaptable to a wide range of drugs with different physical and chemical
properties. For instance, the TIMERx system can be used to deliver both
low dose (less than 5 mg) and high dose (greater than 500 mg) drugs as
well as water soluble and insoluble drugs. Because of the high affinity
of xanthan and locust bean gums, the TIMERx system permits a formulation
with a high drug to gum ratio, which permits tablets to include a higher
dosage of the active drug substance.
- Flexible Pharmacokinetic Profile. The Company formulates the TIMERx
material to optimize the desired kinetic profile of the active drug
substance. In this manner, the TIMERx system can be designed to enhance
the therapeutic effect of the active drug substance. Depending on the
desired release profile, the Company can formulate the drug to be
released in the body (i) at a constant amount or linear rate over time,
(ii) at a decreasing amount over time where the rate is dependent on drug
concentration, or (iii) at a varied release rate.
- Ease of Manufacture. Drugs formulated using the TIMERx system are
designed for production on standard pharmaceutical processing equipment.
The TIMERx technology is easily and reproducibly scaled-up in a
commercial manufacturing environment often utilizing the cost-effective
direct compression tabletting process.
- Cost-Effective System. The TIMERx system is a cost-effective drug
delivery system. It involves fewer and less complex ingredients than
other systems and does not require the manufacturer to purchase
specialized equipment. The Company believes that drug formulations using
the TIMERx system can be developed more rapidly than drugs formulated
with alternative controlled delivery systems and that the time to scale
up to commercial quantities is minimized.
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PENWEST STRATEGY
The Company's objective is to become a leader in the discovery, development
and commercialization of innovative drug delivery technologies for the
pharmaceutical industry. The Company's strategy consists of the following
principal elements:
Create Innovative Branded Controlled Release Versions of Immediate Release
Pharmaceuticals. The Company is focused on the application of its TIMERx
technology to the development of controlled release formulations of immediate
release drugs, which will be marketed as brand name pharmaceuticals. In
developing these controlled release formulations, the Company intends to seek
collaborations with developers of the immediate release drugs or with
pharmaceutical companies having a market presence in the applicable therapeutic
area. The development of these controlled release drugs is subject to the NDA
approval process, although the Company and its collaborators may be permitted to
rely on existing safety and efficacy data with respect to the immediate release
drug in submitting the NDA.
Apply TIMERx Technology to Generic Versions of Controlled Release
Pharmaceuticals. The Company is also focused on the application of its TIMERx
technology to the development of generic versions of controlled release drugs.
The Company has focused its development efforts on these drugs in order to
accelerate the commercialization of the TIMERx delivery system, since generic
drugs are regulated through the less expensive and abbreviated ANDA regulatory
process applicable to generic drugs. In selecting generic controlled release
pharmaceutical candidates to develop, the Company targets high sales volume,
technically-complex controlled release pharmaceuticals. The Company believes
these drug candidates are difficult to replicate and, as a result, TIMERx
versions may have limited competition from other formulations.
Apply TIMERx Technology to the Development of New Chemical Entities. The
Company believes that its TIMERx technology may be applicable to the development
of products containing NCEs by pharmaceutical companies. The development of such
NCEs is subject to the full NDA approval process, including conducting
preclinical studies, filing an Investigational New Drug ("IND") application,
conducting clinical trials and submitting an NDA.
Establish Collaborations for Development, Manufacture and Marketing. The
Company has existing collaborative agreements with Mylan, Leiras, Kremers,
Sanofi, Synthelabo and Endo and intends to enter into additional collaborative
agreements with respect to other pharmaceuticals. The Company's existing and
potential future collaborations enable the Company to secure additional
financial support for its research and development activities, to obtain access
to the clinical, manufacturing and regulatory resources and expertise of its
collaborators and to rely on them for the sales and marketing, distribution and
promotion of TIMERx-based controlled release drugs on a worldwide basis.
Expand Pharmaceutical Excipients Business. The Company's excipients
business provides financial support for the development of the Company's TIMERx
drug delivery system. In order to expand the Company's excipients business, the
Company intends to develop new excipients, such as ProSolv, its recently
introduced MCC excipient for pharmaceutical and nutritional companies. In
addition to selling ProSolv as a bulk excipient, the Company is pursuing
selected licensing opportunities for ProSolv with pharmaceutical companies that
are developing new drug candidates.
The achievement of the Company's strategy is subject to various risks and
uncertainties. In particular, there can be no assurance that the Company's
capital resources will be sufficient to fully implement its strategy. The costs
of implementing the Company's strategy are difficult to predict and will depend
on numerous factors. If the Company's capital resources are insufficient to
fully implement its strategy, the Company may be required to modify its
strategy. See "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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TIMERX PRODUCT DEVELOPMENT
The following table provides information relating to the therapeutic area,
the development status and the collaborator for each of the principal products
under development utilizing the Company's TIMERx technology and is qualified by
reference to the more detailed descriptions included elsewhere in this
Information Statement. The Company is also conducting early stage development
activities with respect to various additional controlled release formulations.
<TABLE>
<CAPTION>
BRAND NAME THERAPEUTIC DEVELOPMENT
(COMPOUND) AREA STATUS COLLABORATOR(1)
---------- ----------- ----------- ---------------
<S> <C> <C> <C>
BRANDED CONTROLLED RELEASE(2)
Cystrin CR Urge Urinary Approved(3) Leiras
(oxybutynin) Incontinence
Ditropan CR Urge Urinary Approved/Registration/ Synthelabo
(oxybutynin) Incontinence Clinical Studies(3)(4)
Numorphan TRx Pain Relief Formulation Endo
(oxymorphone)
GENERIC CONTROLLED RELEASE(5)
Procardia XL Hypertension, ANDA filed(6) Mylan
(nifedipine) Angina
Adalat CC Hypertension Bioequivalence Mylan
(nifedipine) Studies
Adalat LA Hypertension, Registration/Clinical Sanofi
(nifedipine) Angina Studies(4)
Glucotrol XL Diabetes Bioequivalence Mylan
(glipizide) Studies
Covera HS Hypertension, Bioequivalence Kremers
(verapamil hydrochloride) Angina Studies
</TABLE>
- ---------------
(1) The Company's collaborators typically provide research and development
support and are responsible for conducting full scale bioequivalence studies
or clinical trials, obtaining regulatory approvals and manufacturing,
marketing and selling the product. There can be no assurance that the
results obtained in bioequivalence studies or preclinical studies will be
obtained in full scale bioequivalence studies and other late stage clinical
studies or that the Company or its collaborators will receive regulatory
approvals to continue clinical studies of such products or to market any
such products. See "Business -- Collaborative Arrangements."
(2) Controlled release formulations of immediate release products are subject to
the NDA regulatory process. To the extent that the controlled release
product is an extension of an FDA-approved immediate release version of the
same chemical entity, the Company's collaborators may be permitted to rely
on existing clinical data as to the safety and efficacy of the chemical
entity in filing NDAs. See "Business -- Government Regulation."
(3) Leiras received marketing approval for Cystrin CR in Finland in October 1997
and began marketing the product in January 1998. Synthelabo received
marketing approval for Ditropan CR in the Netherlands, Austria and Ireland
in June 1998.
(4) Registration/Clinical Studies indicates that application for marketing
approval has been made to the appropriate regulatory authority in specific
countries and the Company's collaborator may be continuing to conduct
clinical studies of the product.
(5) Generic versions of controlled release products are developed in three basic
stages:
Formulation. Involves the utilization or adaptation of drug delivery
technologies to the product candidate and evaluation in in vitro dissolution
studies.
Bioequivalence Studies. (a) Pilot bioequivalence studies involve testing in
10 to 15 human subjects to determine if the formulation yields a blood level
comparable to the existing controlled release drug; (b) Full scale
bioequivalence studies involve the manufacture of at least 10% of the
intended commercial lot size and the analysis of plasma concentrations of
the drug in 24 or more human subjects under fasting conditions and multiple
dose conditions and 18 or more human subjects under fed conditions to
determine whether the rate and extent of the absorption of the drug are
substantially equivalent to that of the existing drug.
ANDA Filing. An ANDA is submitted to the FDA with results of bioequivalence
studies and other data such as in vitro specifications for the formulation,
stability data, analytical data, methods validation and manufacturing
procedures and controls. See "Business -- Government Regulation."
(6) Mylan has filed an ANDA for the 30 mg dosage strength of Nifedipine XL and
is conducting full scale bioequivalence studies of the 60 and 90 mg dosage
strengths of Nifedipine XL.
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<PAGE> 39
Branded Controlled Release Pharmaceuticals
The Company is applying its TIMERx technology to the development of
controlled release formulations of immediate release pharmaceuticals. The
Company's principal branded controlled release pharmaceuticals in development
are as follows:
Cystrin CR. The Company and Leiras have developed a controlled release
formulation of Cystrin(R) incorporating TIMERx technology, which is being
marketed in Finland by Leiras under the tradename Cystrin CR. Leiras received
marketing approval in Finland for Cystrin CR in October 1997 and began marketing
the product in Finland in January 1998. Cystrin is a two to three times-a-day
immediate release version of the anticholinergic drug oxybutynin indicated for
the treatment of urge urinary incontinence. Oxybutynin is marketed in Europe by
Leiras under the trademark Cystrin and by Synthelabo under the tradename
Ditropan(R). These products had worldwide sales in 1997 of approximately $100
million.
Ditropan CR. The Company and Leiras licensed the marketing rights to a
controlled release formulation of Cystrin incorporating TIMERx technology to
Synthelabo in December 1997. Subject to regulatory approval, Synthelabo will
market the product throughout Europe under the tradename Ditropan CR. Synthelabo
received marketing approval in the Netherlands, Austria and Ireland for Ditropan
CR in June 1998.
Numorphan TRx. The Company and Endo are currently developing a controlled
release formulation of Numorphan(R) incorporating TIMERx technology. Numorphan
is a parenteral and suppository dosage form of oxymorphone, a narcotic analgesic
for the treatment of moderate to severe pain. Numorphan is marketed by Endo and
had sales in the United States in 1996 of approximately $10 million. Numorphan
TRx, if successfully developed, would represent the first oral controlled
release version of Numorphan and would compete in the severe analgesic market
with products such as MS Contin and Oxycontin, which had sales in the United
States in 1997 of approximately $300 million. The Company is currently in the
process of developing TIMERx-based formulations and no clinical studies on such
formulations have been conducted to date.
Generic Controlled Release Pharmaceuticals
Generic controlled release pharmaceuticals are therapeutic equivalents of
brand name drugs for which patents or marketing exclusivity rights have expired.
Generic controlled release pharmaceuticals are typically difficult to replicate
because of: (i) formulation complexity; (ii) analytical complexity; and/or (iii)
manufacturing complexity. The Company believes that such generic controlled
release pharmaceuticals are less likely to suffer the same price erosion as
other generic pharmaceuticals because of the difficulty in replicating
controlled release pharmaceuticals and the resulting limits on competition.
When developing generic pharmaceuticals, the drug developer is required to
demonstrate that the generic product candidate will exhibit in vivo release and
absorption characteristics equivalent to those of the branded pharmaceutical
without infringing on any unexpired patents. During the formulation of generic
pharmaceuticals, drug developers create their own version of the branded drug by
using or adapting drug delivery technologies to the product candidate.
The Company's principal generic controlled release pharmaceuticals in
development are as follows:
Nifedipine XL. The Company and Mylan are currently developing Nifedipine
XL, a generic version of Procardia XL incorporating TIMERx technology. Procardia
XL is a once-a-day controlled release formulation of nifedipine, a calcium
channel blocking agent indicated for hypertension, vasospastic angina and
chronic stable angina, which uses the OROS delivery system. Procardia XL is
marketed in three dosage strengths (30 mg, 60 mg and 90 mg) by the Pratt
Pharmaceuticals division of Pfizer and had sales in the United States in 1997 of
approximately $785 million.
In May 1997, Mylan's ANDA for Nifedipine XL (30 mg) was accepted by the FDA
for review. This was the first generic version of Procardia XL accepted by the
FDA for review. Mylan is currently conducting full scale bioequivalence studies
of the 60 mg and 90 mg dosage strengths of Nifedipine XL. The Company is
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<PAGE> 40
aware that Biovail filed an ANDA for the 60 mg dosage strength of a generic
version of Procardia XL and is aware of a number of other companies that are
developing generic versions of Procardia XL. For a description of certain
litigation regarding the Mylan ANDA filing, see "Business -- Litigation."
Nifedipine CC. The Company and Mylan are currently developing Nifedipine
CC, a generic version of Adalat CC(R) incorporating TIMERx technology. Adalat CC
is a once-a-day controlled release formulation of nifedipine, a calcium channel
blocking agent indicated for hypertension. Adalat CC is marketed in three dosage
strengths (30 mg, 60 mg and 90 mg) by Bayer and had sales in the United States
in 1997 of approximately $366 million. Mylan is conducting full scale
bioequivalence studies of the 30 mg dosage strength of Nifedipine CC. Warner
Chilcott and Biovail have filed ANDAs for generic versions of Adalat CC.
Nifedipine LA. The Company and Sanofi are currently developing Nifedipine
LA, a generic version of Adalat LA(R) (a drug marketed in Europe that utilizes
the same controlled release technology as Procardia XL) incorporating TIMERx
technology. Adalat LA is a once-a-day controlled release formulation of
nifedipine, a calcium channel blocking agent indicated for hypertension,
vasospastic angina and chronic stable angina, which uses the OROS delivery
system. Adalat LA is marketed in two dosage strengths (30 mg and 60 mg) by Bayer
in Europe and had sales in Europe in 1997 of approximately $340 million. Sanofi
is conducting certain confirmatory clinical trials of Nifedipine LA in the
United Kingdom and is analyzing the results of such trials.
Glipizide XL. The Company and Mylan are currently developing Glipizide XL,
a generic version of Glucotrol XL(R) incorporating TIMERx technology. Glucotrol
XL is a once-a-day controlled release formulation of glipizide, a blood-glucose
lowering agent indicated as an adjunct to diet for the control of hyperglycemia
in diabetes patients, which uses the OROS delivery system. Glucotrol XL is
marketed in 5 mg and 10 mg dosage strengths by the Pratt Pharmaceuticals
division of Pfizer and had sales in the United States in 1997 of approximately
$165 million. Mylan is conducting full scale bioequivalence studies of the 5 mg
and 10 mg dosage strengths of Glipizide XL. The Company is aware of a number of
other companies that are developing generic formulations of Glucotrol XL.
Verapamil HS. The Company and Kremers are currently developing Verapamil
HS, a generic version of Covera HS(R) incorporating TIMERx technology. Covera HS
is a once-a-day controlled release formulation of verapamil hydrochloride, a
calcium channel blocking agent indicated for the management of hypertension and
angina, which uses the OROS delivery system. Covera HS is marketed in two dosage
strengths (180 mg and 240 mg) by G. D. Searle & Co. and had sales in the United
States in 1997 of approximately $17 million. Kremers is conducting full scale
bioequivalence studies of the 180 mg and 240 mg dosage strengths of Verapamil
HS. The Company is aware of a number of other companies that are developing
generic formulations of Covera HS.
PHARMACEUTICAL EXCIPIENTS
The Company sells 28 excipient products which are used in the manufacture
of tablets by pharmaceutical and nutritional companies worldwide. The Company's
product line is broadly classified into three distinct categories: binders,
disintegrants and lubricants. Binders, working in conjunction with other
products, are the primary tablet-forming component of excipients. Disintegrants
function to help make a tablet fall apart when consumed by drawing water into
the dosage form, a necessary precursor to dissolution and ultimately absorption
of the drug. Lubricants help facilitate the ease of manufacture of drugs so that
they emerge from a tabletting machine with the desired physical characteristics.
The Company's excipients are sold to the prescription, over-the-counter and
nutritional markets. In 1997, the Company sold bulk excipients to more than 300
customers, including some of the leading pharmaceutical companies in the world
such as the Perrigo Company, Bristol-Meyers Squibb Company, McNeil Consumer
Products Company and SmithKline Beecham, plc ("SmithKline"), in more than 40
countries.
The Company engages in innovative product development to develop new high
performance excipients. In October 1996, the Company introduced ProSolv, which
the Company believes represents a new class of high functionality binders.
ProSolv, the first new MCC product in the pharmaceutical industry in 35 years,
is a
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<PAGE> 41
patented product that combines MCC and colloidal silicon dioxide. MCC has
historically been one of the most popular excipients used in tabletting
operations. However, MCC has demonstrated certain disadvantages with respect to
the manufacture of tablets using the wet granulation method, a widely used
method of tablet preparation. One of the disadvantages of this method is that
when MCC is wetted or comes in contact with moisture during tablet
manufacturing, MCC loses 30-50% of its compactability. To counteract this loss,
additional MCC is required to be added to the formulation, which increases the
size and the cost of the tablet. In contrast, ProSolv's properties enable it to
be used without losing compactability when wetted or placed in contact with
moisture.
The benefits of ProSolv are maintained irrespective of the method of tablet
manufacture. ProSolv can be used by manufacturers to produce harder tablets and
can enable manufacturers to reduce the amount of binders used in the tablet,
thereby reducing the size and cost of the tablet. Additionally, ProSolv can be
used to manufacture tablets with difficult active ingredients which otherwise
may not have been manufactured.
In addition to ProSolv, the principal excipient product lines currently
marketed by the Company include the following:
EMCOCEL(R), or microcrystalline cellulose (MCC), the Company's largest
selling product, is a tabletting binder used in pharmaceutical formulations
worldwide. EMCOCEL is utilized in a number of products including Centrum
vitamins, several store brand ibuprofen products and many prescription
pharmaceuticals.
EMCOMPRESS(R), or dicalcium phosphate, is a binder marketed by the Company
under an exclusive worldwide distribution agreement with the manufacturer
Albright and Wilson Americas Inc. The distribution agreement expires on December
31, 1999, subject to automatic extension on an annual basis unless either party
gives the other party 12 months notice of its desire to terminate the agreement.
EMCOMPRESS is frequently used in vitamin formulations as it serves as an
additional source of dietary calcium.
EMDEX(R), or dextrates, is a binder that is used as a directly compressible
excipient in both chewable and non-chewable tablets. EMDEX is odorless with a
sweet taste caused by its sugar composition. EMDEX is used in, among other
things, chewable antacid tablets and vitamins. EMDEX is manufactured by Penford
and will continue to be supplied by Penford to the Company following the
completion of this Distribution. See "Arrangements Between the Company and
Penford."
EXPLOTAB(R), or sodium starch glycolate, is the principal disintegrant
marketed by the Company. EXPLOTAB is distributed by the Company under an
exclusive worldwide distribution agreement with the manufacturer, Roquette
America, Inc. The distribution agreement is automatically renewable on an annual
basis unless either party gives the other party 12 months notice of its desire
to terminate the agreement. EXPLOTAB is used in a number of products and is an
essential component of the Tylenol family of products.
PRUV(R), or sodium stearyl fumarate, is the principal lubricant marketed by
the Company. PRUV is marketed under an exclusive worldwide distribution
agreement with the manufacturer, Astra Pharmaceutical Production AB. The
distribution agreement is automatically renewable on an annual basis unless
either party gives the other party 12 months notice of its desire to terminate
the agreement. PRUV is used in several prescription pharmaceuticals.
The Company had revenues from the sale of pharmaceutical excipients in
1995, 1996 and 1997 of $25.0 million, $25.0 million and $26.0 million,
respectively, and in the three months ended March 31, 1997 of $7.8 million.
COLLABORATIVE ARRANGEMENTS
The Company has entered into collaborative arrangements with six
pharmaceutical companies to facilitate and expedite the commercialization of its
TIMERx drug delivery technology.
Under most of these collaborative arrangements, the Company has received
upfront fees and milestone payments and is entitled to receive additional
milestone payments. In addition, under all the collaborative arrangements, the
Company is entitled to receive royalties on the sale of the products covered by
such collaborative arrangements and payments for the purchase of formulated
TIMERx material. Assuming that
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<PAGE> 42
all milestones are achieved under its collaborative arrangements, the Company
would be entitled to receive up to an aggregate of $10.4 million in upfront fees
and milestone payments under its collaborative arrangements, of which $2.1
million have been received to date. There can be no assurance that future
milestone payments will be received.
Mylan Pharmaceuticals Inc.
In August 1994, August 1995 and March 1996, the Company entered into
product development and supply agreements with Mylan with respect to the
development of generic versions of Procardia XL (nifedipine), Adalat CC
(nifedipine) and Glucotrol XL (glipizide), based on the Company's TIMERx
technologies (the "Mylan Products"). Mylan is one of the leading generic
pharmaceutical companies in the United States.
Under these product development and supply agreements, the Company is
responsible for the formulation, manufacture and supply of TIMERx material for
use in the Mylan Products, and Mylan is responsible for conducting all
bioequivalence studies, preparing all regulatory applications and submissions
and manufacturing and marketing the Mylan Products in the United States, Canada
and Mexico. Each product development and supply agreement is terminable by
either party upon 90 days prior written notice at any time (i) prior to the
submission of the ANDA for the product covered by such agreement if such party
reasonably determines that no further development efforts are likely to lead to
the successful development of such product and (ii) prior to approval by the FDA
of such ANDA if such party reasonably determines that such ANDA is not likely to
be approved. Following approval of the ANDA, the product development and supply
agreement will extend for a term of 20 years from the date on which the ANDA is
approved, subject to earlier termination by either party upon specified
circumstances, including termination by the Company if Mylan fails to meet
minimum sales volume requirements and termination by either party upon a
material breach by the other party of the agreement. If the Company does not
satisfy its obligations under any of these agreements, the Company will be in
breach of such agreement and Mylan will be entitled to terminate such agreement.
The Company has received milestone payments under each of the product
development and supply agreements and is entitled to additional milestone
payments under such agreements upon the continued development of the Mylan
Products. The Company is also entitled to royalties on the sale of each Mylan
Product, which royalties will be reduced with respect to such Mylan Product if
there are on the market and available for retail sale any other generic
controlled release formulations of the drug of which such Mylan Product is a
generic controlled release formulation. The Company is aware of one ANDA filed
for the 60 mg dosage strength of a generic version of Procardia XL and two ANDAs
filed for the 30 mg dosage strength of a generic version of Adalat CC. In
addition, Mylan has agreed that during the term of the product development and
supply agreements it will purchase formulated TIMERx material for use in the
Mylan Products exclusively from the Company at specified prices.
The Company and Mylan also entered into a sales and distribution agreement
in January 1997 (the "Mylan Distribution Agreement") with respect to Nifedipine
XL pursuant to which Mylan agreed to manufacture and supply Nifedipine XL to the
Company for distribution by the Company and one or more distributors (as to
which the Company and Mylan must mutually agree) in certain specified European
and Latin American countries. This agreement expires in January 2007, subject to
automatic extension on an annual basis. Under this agreement, the Company has
agreed to purchase Nifedipine XL exclusively from Mylan at specified prices or
to pay Mylan 50% of any royalties received by the Company from its distributors
if Mylan licenses its manufacturing technology to the Company for use by the
Company's distributors instead of manufacturing the product for distribution.
Under this agreement, Mylan is entitled to 50% of any royalties or milestone
payments received by the Company under the Company's product development and
supply agreement with Sanofi described below.
Kremers Urban Development Company
In August 1996, the Company entered into a product development and supply
agreement with Kremers with respect to the development of a generic version of
Covera HS (verapamil hydrochloride), based on the
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Company's TIMERx technologies. Kremers is the generics division of the
research-based pharmaceutical company, Schwarz Pharma Inc.
Under the product development and supply agreement, the Company is
responsible for formulating Covera HS and for manufacturing and supplying TIMERx
material to Kremers for use in Covera HS, and Kremers is responsible for
conducting bioequivalence studies, preparing all regulatory applications and
submissions and manufacturing and marketing Covera HS in the United States,
Canada and Mexico.
The product development and supply agreement is terminable by either party
upon 30 days prior written notice at any time (i) prior to the successful
completion of specified bioequivalence studies if such party reasonably
determines that no further development efforts are likely to lead to the
successful development of the product covered by such product development and
supply agreement and (ii) prior to the approval by the FDA (or equivalent
regulatory authority) of the ANDA (or equivalent regulatory filing) for such
product if such party reasonably determines that the ANDA or equivalent filing
is not likely to be approved by the FDA (or equivalent regulatory authority). In
addition, Kremers may terminate the product development and supply agreement if,
due to changed circumstances, Kremers reasonably determines that the potential
commercial viability of Covera HS will not justify the use of best efforts by
Kremers. Following approval of the ANDA (or other regulatory filing), the
product development and supply agreement will extend with respect to each
country covered by such agreement for a term of 20 years from the date (the
"Kremers Approval Date") on which Covera HS is approved for commercial sale by
the FDA (or equivalent regulatory authority) pursuant to an ANDA (or equivalent
regulatory filing) in such country, subject to earlier termination by either
party upon specified circumstances, including upon a material breach of the
agreement by a party or upon the bankruptcy of a party. In addition, at any time
following the Kremers Approval Date for commercial sale of Covera HS in the
United States, Kremers may terminate the product development and supply
agreement for any reason upon at least 120 days prior written notice, whereupon
the Company would have a paid-up license to Kremers's rights in Covera HS and
related data and regulatory filings. If the Company does not satisfy its
obligations under either of these agreements, the Company will be in breach of
such agreement and Kremers will be entitled to terminate such agreement.
The Company has received milestone payments under the product development
and supply agreement and is entitled to additional milestone payments upon the
continued development of Covera HS. The Company also is entitled to royalties on
the sale of Covera HS. However, both milestone payments and the royalties
otherwise due under the product development and supply agreement may be reduced
in the event that there are competing generic controlled release formulations of
Covera HS on the market and available for retail sale.
In addition, Kremers has agreed that, during the term of the product
development and supply agreement, it will purchase formulated TIMERx material
for use in Covera HS exclusively from the Company at specified prices. These
prices will be reduced in the event that there are competing generic versions of
Covera HS on the market and available for retail sale.
The Company is also a party to a product development and supply agreement
with Kremers with respect to the development of a generic version of Cardizem CD
(diltiazem) based on the Company's TIMERx technologies. The terms of this
agreement are substantially similar to the product development and supply
agreement entered into by the Company with respect to Covera HS. On July 9,
1998, Kremers notified the Company that it was exercising its right to terminate
the Cardizem CD product development and supply agreement effective as of August
20, 1998. Kremers based this termination on its determination that, due to a
significant change of circumstances since the execution of the product
development and supply agreement, including without limitation the filing of
competing ANDAs with respect to three different generic versions of Cardizem CD,
the potential commercial viability of the product did not justify the use of
best efforts by Kremers under the agreement.
Sanofi Winthrop International S.A.
In February 1997, the Company entered into a product development and supply
agreement with Sanofi with respect to the development of a generic version of
Adalat LA based on the Company's TIMERx
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technology (the "Sanofi Product"), a drug that utilizes the same controlled
release technology as Procardia XL. Sanofi is a research-based international
pharmaceutical company, based in Paris, France, which has a European
infrastructure from which to develop, register and market prescription
pharmaceuticals.
Under the product development and supply agreement, the Company is
responsible for conducting pilot bioequivalence studies of the Sanofi Product
and for manufacturing and supplying TIMERx material to Sanofi, and Sanofi is
responsible for conducting all full scale bioequivalence and clinical studies,
preparing all regulatory applications and submissions and manufacturing and
marketing the Sanofi Product in specified countries in Europe and in South
Korea.
The product development and supply agreement expires with respect to each
specified country on the 10th, 13th, 16th or 19th anniversary of the date on
which the Sanofi Product is approved by the relevant regulatory authority in
such country for commercial sale if notice is provided by either party prior to
any of such anniversary dates that the agreement will expire with respect to
such country on such anniversary date. The agreement is also subject to earlier
termination by either party under specified circumstances, including termination
by the Company if Sanofi fails to meet minimum sales volume requirements and
termination by either party upon a material breach of the agreement by the other
party. If the Company does not satisfy its obligations under the agreement, the
Company will be in breach of the agreement and Sanofi will be entitled to
terminate the agreement.
The Company is entitled to milestone payments under the product development
and supply agreement upon the continued development of the Sanofi Product. The
Company is also entitled to royalties upon the sale of the Sanofi Product. One
half of such payments will be paid to Mylan in accordance with the Mylan
Distribution Agreement. In addition, Sanofi has agreed that, during the term of
the product development and supply agreement, it will purchase formulated TIMERx
material for use in the Sanofi Product exclusively from the Company at specified
prices.
Leiras OY
In July 1992, the Company entered into an agreement with Leiras with
respect to the development and commercialization of Cystrin CR, a controlled
release formulation of Cystrin based on the Company's TIMERx technology. In May
1995, the Company entered into a second agreement with Leiras clarifying certain
matters with respect to the collaboration. Leiras is a Finnish subsidiary of
Schering AG. Leiras is developing products focused in the areas of reproductive
health care, urology, oncology and inhalation technology.
Under the agreements, the Company is responsible for the development and
formulation of Cystrin CR and for manufacturing and supplying TIMERx material to
Leiras for use in the manufacture of Cystrin CR, and Leiras is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Cystrin CR on a worldwide basis. Leiras has the right to transfer its
rights and responsibilities under the agreements and its related product rights
for specified territories, subject in certain circumstances to the approval of
the Company. Pursuant to this right, Leiras, with the Company's consent,
transferred to Synthelabo its marketing rights to this controlled release
formulation for Europe.
The agreements terminate upon the expiration of the TIMERx patents licensed
to Leiras (which will occur in the year 2014), subject to earlier termination by
either party under specified circumstances, including upon a material breach of
the agreement by a party or upon the bankruptcy of a party. If the Company does
not satisfy its obligations under either of these agreements, the Company will
be in breach of such agreement and Leiras will be entitled to terminate such
agreement. Leiras has also agreed to pay the Company royalties on the sale of
Cystrin CR and to purchase formulated TIMERx material exclusively from the
Company at specified prices.
Synthelabo Groupe
In December 1997, pursuant to a related transfer by Leiras to Synthelabo of
Leiras' rights and responsibilities under Leiras' agreements with the Company,
the Company entered into a license agreement
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and a supply agreement with Synthelabo with respect to the manufacturing and
marketing in Europe of the controlled release formulation of oxybutynin
developed by the Company and Leiras, which is expected to be marketed under the
tradename Ditropan CR. Synthelabo is one of the largest pharmaceutical companies
in France and focuses primarily in three core therapeutic fields: central
nervous system, cardiovascular and internal medicine.
Under the agreements, the Company is responsible for manufacturing and
supplying TIMERx material to Synthelabo for use in the manufacture of Ditropan
CR, and Synthelabo is responsible for preparing all regulatory applications and
submissions and manufacturing and marketing Ditropan CR for sale in Europe
(although Synthelabo may contract initially with Leiras for the manufacture of
the product until it receives regulatory approval to manufacture the product).
The agreements terminate upon the expiration of the TIMERx patents licensed
to Synthelabo (which will occur in the year 2014), subject to earlier
termination by either party under specified circumstances, including upon a
material breach of the agreement by a party or upon the bankruptcy of a party.
If the Company does not satisfy its obligations under either of these
agreements, the Company will be in breach of such agreement and Synthelabo will
be entitled to terminate such agreement. Synthelabo has agreed to pay the
Company royalties on the sale of the product and to purchase formulated TIMERx
material exclusively from the Company at specified prices.
Endo Pharmaceuticals Inc.
In September 1997, the Company entered into a strategic alliance agreement
with Endo with respect to the development of controlled release formulations of
oxymorphone based on the Company's TIMERx technology (the "Endo Products"). Endo
is a research-based and generic pharmaceutical company formed from a management
buyout of a division of DuPont Merck Pharmaceuticals ("DuPont Merck"). Endo has
a broad product line including 25 drugs in the generic product division and 12
established (formerly DuPont Merck) brand products, including Percodan and
Percocet. Endo is registered with the U.S. Drug Enforcement Administration as a
developer, manufacturer and marketer of controlled narcotic substances.
Under the strategic alliance agreement, the responsibilities of the Company
and Endo with respect to any Endo Product will be determined by a committee
comprised of an equal number of members from each of the Company and Endo (the
"Alliance Committee"). However, the Company expects that it will formulate each
drug candidate and that Endo will conduct all clinical studies and prepare and
file all regulatory applications and submissions. In addition, under the
agreement, the Company has agreed to manufacture and supply TIMERx material to
Endo, and Endo has agreed to manufacture and market the Endo Products in the
United States. The manufacture and marketing of Endo Products outside of the
United States may be conducted by the Company, Endo or a third party, as
determined by the Alliance Committee.
The strategic alliance agreement is terminable with respect to an Endo
Product by either party upon 30 days prior written notice at any time (i) prior
to the completion of development activities with respect to such Endo Product if
such party determines that further development efforts are not likely to lead to
the successful development of such Endo Product and (ii) prior to obtaining
approval by the FDA (or equivalent regulatory authority) of an NDA (or
equivalent regulatory filing) with respect to such Endo Product if such party
determines that further efforts are not likely to lead to such approval,
although the non-terminating party would have the right to continue the
agreement with respect to such Endo Product for a specified period and the
royalties that might otherwise have been payable to the terminating party would
be reduced. Following regulatory approval of the marketing and sale of such Endo
Product, the term of the strategic alliance agreement will extend for up to 20
years from the date of such regulatory approval, subject to earlier termination
under specified circumstances, including failure to launch full-scale marketing
of such Endo Product when required or material breach of the agreement by a
party.
The Company and Endo have agreed to share the costs involved in the
development and commercialization of the Endo Products and that the party
marketing the Endo Products (which the Company expects will be Endo) will pay
the other party royalties equal to 50% of net marketing revenues after
fully-burdened costs (although this percentage will decrease as the total U.S.
marketing revenues from an Endo Product increase),
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subject to each party's right to terminate its participation with respect to any
Endo Product described above. If the Company does not satisfy its funding and
other obligations under the agreement, the Company will be in breach of the
agreement and Endo will be entitled to terminate the agreement. Endo will
purchase formulated TIMERx material for use in the Endo Products exclusively
from the Company at specified prices. Such prices will be reflected in the
determination of fully-burdened costs.
RESEARCH AND DEVELOPMENT
The Company conducts research and development activities with respect to
additional applications of TIMERx technology, advances in the TIMERx technology
and additional novel excipients such as ProSolv. The Company is also conducting
research and development with respect to controlled release delivery of
therapeutic substances to the respiratory tract through the use of dry powder
aerosol delivery systems and has recently received a U.S. patent relating to
such technology. The Company believes that this technology, which utilizes the
same polysaccharide materials as the Company's TIMERx technology, may be
appropriate for the delivery of peptide and protein drugs, which are often
poorly absorbed from the gastrointestinal tract. The Company expects that it
will seek to enter into collaborations to develop such new TIMERx applications
or technologies.
The Company's research and development expenses in 1995, 1996, 1997 and the
three months ended March 31, 1998 were $2.7 million, $3.7 million, $4.1 million
and $1.3 million, respectively. These expenses do not include amounts incurred
by the Company's collaborators in connection with the development of products
under the collaboration agreements such as expenses for full scale
bioequivalence studies performed by the collaborators.
MANUFACTURING
The Company currently has a laboratory and pilot manufacturing facility
covering approximately 55,000 square feet contiguous to its executive offices in
Patterson, New York. However, the Company does not have commercial-scale
facilities to manufacture its TIMERx material in accordance with cGMP
requirements prescribed by the FDA. As a result, to date, the Company has relied
on a large third-party pharmaceutical company, Boehringer Ingelheim
Pharmaceuticals, Inc. ("Boehringer Ingelheim"), for the bulk manufacture of its
TIMERx material for delivery to its collaborators under an agreement that
expired in June 1998.
The Company believes that there are a limited number of manufacturers that
operate under cGMP regulations capable of manufacturing the Company's products.
Boehringer Ingelheim has advised the Company that it will continue to
manufacture TIMERx material for the Company on the terms set forth in the
current agreement until such time as the Company contracts with another
manufacturer, but Boehringer Ingelheim is not obligated to continue to
manufacture TIMERx material and there can be no assurance as to how long
Boehringer Ingelheim will continue to manufacture TIMERx material. The Company
has identified another third-party manufacturer to manufacture TIMERx material
and is currently validating such manufacturer's facility and negotiating the
terms under which such manufacturer will manufacture TIMERx material for the
Company. However, there can be no assurance that the Company will enter into a
manufacturing agreement with such manufacturer or as to the terms of such
manufacturing agreement. In the event that the Company is unable to obtain
contract manufacturing, or obtain such manufacturing on commercially reasonable
terms, it may not be able to commercialize its products as planned. There can be
no assurance that third parties upon which the Company relies for supply of its
TIMERx material will perform and any failures by third parties may delay
development or the submission of products for regulatory approval, impair the
Company's collaborators' ability to commercialize products as planned and
deliver products on a timely basis, or otherwise impair the Company's
competitive position, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company's TIMERx drug delivery system is a hydrophilic matrix combining
primarily two natural polysaccharides, xanthan and locust bean gums, in the
presence of dextrose. The Company purchases these gums from a sole source
supplier. Although the Company has qualified alternate suppliers with respect to
these gums and to date the Company has not experienced difficulty acquiring
these materials, there can be no
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assurance that interruptions in supplies will not occur in the future or that
the Company will not have to obtain substitute suppliers. Any of these events
could have a material adverse effect on the Company's ability to manufacture
bulk TIMERx for delivery to its collaborators, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company currently has two cGMP-approved manufacturing facilities for
its MCC products, including EMCOCEL and ProSolv. These facilities are located in
Cedar Rapids, Iowa and Nastola, Finland and cover approximately 35,000 square
feet and 15,000 square feet, respectively. The Company's MCC products are
primarily made from wood pulp. Although the Company obtains wood pulp primarily
from two suppliers, wood pulp is widely available from a number of suppliers.
All manufacturing operations of the Company are subject to federal, state
and local laws and regulations governing the use, manufacture, storage, handling
and disposal of certain materials and waste products.
MARKETING AND DISTRIBUTION
Pursuant to the Company's collaborative agreements, the Company's
collaborators have responsibility for the marketing and distribution of any
controlled release pharmaceuticals developed based on the Company's TIMERx
technology. Because the Company does not plan on developing any of such
pharmaceuticals without a collaborator, the Company has not developed and does
not intend to develop any sales force with respect to such products. As a
result, the Company is substantially dependent on the efforts of its
collaborators to market the products. In selecting a collaborator for a drug
candidate, some of the factors the Company considers include the collaborator's
market presence in the therapeutic area targeted by the drug candidate and the
collaborator's sales force and distribution network.
The Company has an in-house sales force of nine employees who market the
Company's excipients in the United States. This sales force focuses primarily on
pharmaceutical and nutritional companies. The Company also markets its
excipients worldwide through the use of distributors located in over 40
countries. The Company typically sells its excipients to its largest customers
under multi-year supply agreements.
COMPETITION
The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability of
financing, litigation and other factors. Many of the Company's competitors have
longer operating histories and greater financial, marketing, legal and other
resources than the Company and certain of its collaborators. The Company expects
that it will be subject to competition from numerous other entities that
currently operate or intend to operate in the pharmaceutical industry, including
companies that engage in the development of controlled release technologies. The
Company's TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including ALZA's OROS
technology, multiparticulate systems marketed by Elan and Biovail, traditional
matrix systems marketed by SkyePharma, plc and other controlled release
technologies marketed and under development by Andrx Corporation, among others.
The Company initially is concentrating a significant portion of its
development efforts on generic versions of controlled release pharmaceuticals.
Typically, selling prices of immediate release drugs have declined and profit
margins have narrowed after generic equivalents of such drugs are first
introduced and the number of competitive products has increased. Similarly, the
success of generic versions of controlled release products based on the
Company's TIMERx technology will depend, in large part, on the intensity of
competition from currently marketed drugs and technologies that compete with the
branded pharmaceutical, as well as the timing of product approvals. However, the
Company believes that generic versions of controlled release pharmaceuticals
based on TIMERx technology are less likely to suffer the same degree of price
erosion as other generic pharmaceuticals because the formulation, analytical and
manufacturing complexity of the generic versions may be difficult for other
companies to replicate, which could limit competition. Competition may also
arise from therapeutic products that are functionally equivalent but produced by
other methods. In addition, under several of the Company's collaborative
arrangements, the payments due to the Company with
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respect to the controlled release products covered by such collaborative
arrangements will be reduced in the event that there are competing generic
controlled release versions of such products.
The generic drug industry is characterized by frequent litigation between
generic drug companies and branded drug companies. Those companies with
significant financial resources will be more able to bring and to defend any
such litigation. See "Business -- Litigation."
In its excipients business, the Company competes with a number of large
manufacturers and other distributors of excipient products, many of which have
substantially greater financial, marketing and other resources than the Company.
The Company's principal competitor in this market is FMC Corporation, which
markets its own line of MCC excipient products.
The pharmaceutical industry is characterized by rapid and substantial
technological change. There can be no assurance that any products incorporating
TIMERx technology will not be rendered obsolete or non-competitive by new drugs,
treatments or cures for the medical conditions the TIMERx-based products are
addressing. Any of the foregoing could have a material adverse effect on the
Company's business, financial condition and results of operations.
PATENTS AND PROPRIETARY RIGHTS
The Company believes that patent and trade secret protection, particularly
of its drug delivery technology, is important to its business and that its
success will depend in part on its ability to maintain existing patent
protection, obtain additional patents, maintain trade secret protection and
operate without infringing the proprietary rights of others.
The Company has been issued 18 U.S. patents and 42 foreign patents and one
U.S. patent application has been allowed relating to its controlled release drug
delivery technology. In addition, the Company has filed nine U.S. patent
applications and various corresponding foreign patent applications relating to
its controlled release drug delivery technology. The U.S. patents issued to the
Company and the allowed U.S. patent application cover the Company's TIMERx
technology, including the combination of the xanthan and locust bean gums, the
oral solid dosage form of TIMERx and the method of preparation, as well as the
application (and combination) of TIMERx technology to various active drug
substances, including both method of treatment and methods of preparation. All
these patents and the allowed U.S. patent application, if issued, will expire
between 2008 and 2015.
The Company has also been issued five U.S. patents and two U.S. patent
applications have been allowed relating to its excipient technology. In
addition, the Company has filed two U.S. patent applications relating to its
excipient technology. The U.S. patents and the two allowed U.S. patent
applications cover ProSolv and other augmented MCC excipient products. The U.S.
patents and the two allowed U.S. patent applications, if issued, will expire no
later than January 9, 2015.
The issuance of a patent is not conclusive as to its validity or as to the
enforceable scope of the claims of the patent. There is no assurance that the
Company's patents or any future patents will prevent other companies from
developing non-infringing similar or functionally equivalent products or from
successfully challenging the validity of the Company's patents. Furthermore,
there is no assurance that (i) any of the Company's future processes or products
will be patentable; (ii) any pending or additional patents will be issued in any
or all appropriate jurisdictions; (iii) the Company's processes or products will
not infringe upon the patents of third parties; or (iv) the Company will have
the resources to defend against charges of infringement by or protect its own
patent rights against third parties. The inability of the Company to protect its
patent rights or infringement by the Company of the patent or proprietary rights
of others could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company also relies on trade secrets and proprietary knowledge, which
it generally seeks to protect by confidentiality and non-disclosure agreements
with employees, consultants, licensees and pharmaceutical companies. There can
be no assurance, however, that these agreements have or in all cases will be
obtained, that these agreements will not be breached, that the Company will have
adequate remedies for any breach or that the Company's trade secrets will not
otherwise become known by competitors.
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There has been substantial litigation in the pharmaceutical industry with
respect to the manufacture, use and sale of new products that are the subject of
conflicting patent rights. Most of the controlled release products that the
Company is developing with its collaborators are generic versions of brand name
controlled release products that are covered by one or more patents. Under the
Waxman-Hatch Act when an applicant files an ANDA with the FDA for a generic
version of a brand name product covered by an unexpired patent listed with the
FDA, the applicant must certify to the FDA that such patent will not be
infringed by the applicant's product or that such patent is invalid or
unenforceable. Notice of such certification must be given to the patent owner
and the sponsor of the NDA for the brand name product. If a patent infringement
lawsuit is filed within 45 days of the receipt of such notice, the FDA will
conduct a substantive review of the ANDA, but will not grant final marketing
approval of the generic product until a final judgment on the patent suit is
rendered in favor of the applicant or until 30 months (or such longer or shorter
period as a court may determine) have elapsed from the date of the
certification, whichever is sooner. Should a patent owner commence a lawsuit
with respect to alleged patent infringement by the Company or its collaborators,
the uncertainties inherent in patent litigation make the outcome of such
litigation difficult to predict. To date, one such action has been commenced
against one of the Company's collaborators and it is anticipated that additional
actions will be filed as the Company's collaborators file additional ANDAs. The
Company evaluates the probability of patent infringement litigation with respect
to its collaborators' ANDA submissions on a case by case basis. The delay in
obtaining FDA approval to market the Company's product candidates as a result of
litigation, as well as the expense of such litigation, whether or not the
Company is successful could have a material adverse effect on the Company's
business, financial condition and results of operations.
In May 1997, the Company's collaborator, Mylan, filed an ANDA with the FDA
for a generic version of Procardia XL, a controlled release formulation of
nifedipine. For a discussion of the litigation resulting from such filing, see
"Business -- Litigation."
In 1994, Boots filed in the European Patent Office ("EPO") an opposition to
a patent granted by the EPO to the Company relating to its TIMERx technology. In
June 1996, the EPO dismissed Boots' opposition, leaving intact all claims
included in the patent. Boots has appealed this decision to the EPO Board of
Appeals. There can be no assurance that the Company will prevail in this matter.
An unfavorable outcome could have a material adverse effect on the Company's
business, financial condition and results of operations.
GOVERNMENT REGULATION
FDA Regulation of Pharmaceutical Products
All pharmaceutical manufacturers are subject to extensive regulation by the
federal government, principally the FDA, and, to a lesser extent, by state and
local governments. The Federal Food, Drug and Cosmetic Act (the "FDCA") and
other federal statutes and regulations govern or influence the development,
testing, manufacture, safety, labeling, storage, record keeping, approval,
advertising, promotion, sale and distribution of prescription products.
Pharmaceutical manufacturers are also subject to certain record keeping and
reporting requirements, establishment registration, product listing and FDA
inspections.
Drugs can be approved by the FDA based on three types of marketing
applications: a new drug application ("NDA"), an abbreviated new drug
application ("ANDA") or a license application under the Public Health Service
Act. A full NDA must include complete reports of preclinical, clinical and other
studies to prove adequately that the product is safe and effective for its
intended use. The FDCA also provides for NDA submissions that may rely in whole
or in part on publicly available clinical and other data on safety and efficacy
under section 505(b)(2) of the FDCA. These types of NDAs may be appropriate for
certain drugs containing previously approved active ingredients but differing
with regard to other characteristics such as indications for use, dosage form or
method of delivery.
As an initial step in the FDA regulatory approval process for an NDA,
preclinical studies are typically conducted in animal models to assess the
drug's efficacy and to identify potential safety problems. The results of these
studies must be submitted to the FDA as part of an Investigational New Drug
("IND") application, which must be reviewed by the FDA before proposed clinical
testing can begin. Typically clinical testing involves a three-phase process.
Phase I trials are conducted with a small number of subjects and are designed
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to provide information about both product safety and the expected dose of the
drug. Phase II trials are designed to provide additional information on dosing
and preliminary evidence of product efficacy. Phase III trials are large scale
studies designed to provide statistical evidence of efficacy and safety in
humans. The results of the preclinical testing and clinical trials of a
pharmaceutical product are then submitted to the FDA in the form of an NDA for
approval to commence commercial sales. Preparing such applications involves
considerable data collection, verification, analysis and expense. In responding
to an NDA, the FDA may grant marketing approval, request additional information
or deny the application if it determines that the application does not satisfy
its regulatory approval criteria.
This regulatory process can require many years and the expenditure of
substantial resources. Data obtained from preclinical testing and clinical
trials are subject to varying interpretations, which can delay, limit or prevent
FDA approval. In addition, changes in FDA approval policies or requirements may
occur or new regulations may be promulgated which may result in delay or failure
to receive FDA approval.
ANDAs may be submitted for generic versions of brand name drugs ("Listed
Drugs") where the generic drug is the "same" as the Listed Drug with respect to
active ingredient(s) and route of administration, dosage form, strength, and
conditions of use recommended in the labeling. ANDAs may also be submitted for
generic drugs that differ with regard to certain changes from a Listed Drug if
the FDA has approved a petition from a prospective applicant permitting the
submission of an ANDA for the changed product.
Rather than safety and efficacy studies, the FDA requires data
demonstrating that the ANDA drug formulation is bioequivalent to the Listed
Drug. The FDA also requires labeling, chemistry and manufacturing information.
FDA regulations define bioequivalence as the absence of a significant difference
in the rate and the extent to which the active ingredient becomes available at
the site of drug action when administered at the same molar dose under similar
conditions in an appropriately designed study. If the approved generic drug is
both bioequivalent and pharmaceutically equivalent to the Listed Drug, the
agency will assign a code to the product in an FDA publication entitled
"Approved Drug Products With Therapeutic Equivalence Evaluation." These codes
will indicate whether the FDA considers the product to be therapeutically
equivalent to the Listed Drug. The codes will be considered by third parties in
determining whether the generic drug is therapeutically equivalent and fully
substitutable for the Listed Drug and are relied upon by Medicaid and Medicare
formularies for reimbursement.
The Company's collaborator, Mylan, has filed an ANDA with the FDA for the
30 mg dosage strength of a generic version of Procardia XL, and the Company
expects that its collaborators will file additional ANDAs to obtain approval to
market other generic controlled release products. There can be no assurance that
ANDAs will be suitable or available for such products, or that such products
will receive FDA approval on a timely basis.
Certain ANDA procedures for generic versions of controlled release products
are the subject of petitions filed by brand name drug manufacturers, which seek
changes from the FDA in the approval process for generic drugs. These requested
changes include, among other things, tighter standards for certain
bioequivalence studies and disallowance of the use by a generic drug
manufacturer in its ANDA of proprietary data submitted by the original
manufacturer as part of an original new drug application. The Company is unable
to predict at this time whether the FDA will make any changes to its ANDA
procedures as a result of such petitions or any future petitions filed by brand
name drug manufacturers or the effect that such changes may have on the Company.
Any changes in FDA regulations which make ANDA approvals more difficult could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Some products containing the Company's TIMERx formulation, such as
controlled release formulations of approved immediate release drugs, will
require the filing of an NDA. The FDA will not accept ANDAs when the delivery
system or duration of drug availability differs significantly from the Listed
Drug. However, the Company may be able to rely on existing publicly available
safety and efficacy data to support section 505(b)(2) NDAs for controlled
release products when such data exists for an approved immediate release version
of the same chemical entity. However, there can be no assurance that the FDA
will accept such section 505(b)(2) NDAs, or that the Company will be able to
obtain publicly available data that is useful. The section 505(b)(2) NDA process
is a highly uncertain avenue to approval because the FDA's policies on
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section 505(b)(2) NDAs have not yet been fully developed. There can be no
assurance that an application submitted under section 505(b)(2) will be
approved, or will be approved in a timely manner.
Sponsors of ANDAs and section 505(b)(2) NDAs, with the exception of
applications for certain antibiotic drugs, must include, as part of their
applications, certifications with respect to certain patents on Listed Drugs
that may result in significant delays in obtaining FDA approvals. Sponsors who
believe that patents that are listed in an FDA publication entitled "Approved
Drug Products With Therapeutic Equivalence Evaluations" are invalid,
unenforceable, or not infringed, must notify the patent owner. If the patent
owner initiates an infringement lawsuit against the sponsor within 45 days of
the notice, the FDA's final approval of the ANDA or section 505(b)(2) NDA may be
delayed for a period of thirty months or longer. This delay may also apply to
other ANDAs or 505(b)(2) NDAs for the same Listed Drug. Moreover, the approval
of an ANDA involved in such a patent lawsuit may under certain circumstances
require a further delay in the final approval of other ANDAs for the same Listed
Drug for an additional 180 days. In addition, recent court decisions have raised
the possibility that, under some circumstances, ANDAs other than the first ANDA
for a Listed Drug may be delayed indefinitely and thereby effectively denied
approval if the drug that is the subject of the first ANDA is not brought to
market.
Under the Waxman-Hatch Act, an applicant who files the first ANDA with a
certification of patent invalidity or non-infringement with respect to a product
may be entitled to receive, if such ANDA is approved by the FDA, 180-day
marketing exclusivity (a 180-day delay in approval of other ANDAs for the same
drug) from the FDA. However, there can be no assurance that the FDA will not
approve an ANDA filed by another applicant with respect to a different dosage
strength prior to or during such 180-day marketing exclusivity period. For
example, although Mylan has filed an ANDA for the 30 mg dosage strength of a
generic version of Procardia XL, there can be no assurance that the ANDA filing
by Biovail for the 60 mg dosage strength of a generic version of Procardia XL
will not be approved prior to or during Mylan's 180-day marketing exclusivity
period, if obtained for its ANDA.
ANDAs and section 505(b)(2) NDAs are also subject to so-called market
exclusivity provisions that delay the submission or final approval of the
applications. The submission of ANDAs and section 505(b)(2) NDAs may be delayed
for five years after approval of the Listed Drug if the Listed Drug contains a
new active molecular entity. The final approval of ANDAs and section 505(b)(2)
NDAs may also be delayed for three years where the Listed Drug or a modification
of the Listed Drug was approved based on new clinical investigations. The
three-year marketing exclusivity period would potentially be applicable to
Listed Drugs with novel drug delivery systems.
Sponsors of drug applications affected by patents may also be adversely
affected by patent term extensions provided under the FDCA to compensate for
patent protection lost due to time taken in conducting FDA required clinical
studies or during FDA review of data submissions. Patent term extensions may not
exceed five additional years nor may the total period of patent protection
following FDA marketing approval be extended beyond 14 years. In addition, by
virtue of the Uruguay Round Agreements Act of 1994 that ratified the General
Agreement on Tariffs and Trade ("GATT"), certain brand name drug patent terms
have been extended to 20 years from the date of filing of the pertinent patent
applications (which can be longer than the former 17-year patent term starting
from the date of patent issuance). Patent term extensions may delay the ability
of the Company and its collaborators to use the Company's proprietary technology
in the future, market new controlled release products, file section 505(b)(2)
NDAs referencing approved products, or file ANDAs based on Listed Drugs when
those approved products or Listed Drugs have acquired patent term extensions.
Manufacturers of marketed drugs must conform to the FDA's cGMP standard or
risk sanctions such as the suspension of manufacturing or the seizure of drug
products and the refusal to approve additional marketing applications. The FDA
conducts periodic inspections to implement these rules. There can be no
assurance that a manufacturer's facility will be found to be in compliance with
cGMP or other regulatory requirements. Failure to comply could result in
significant delays in the development, testing and approval of products
manufactured at such facility, as well as increased costs.
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Noncompliance with applicable requirements can also result in total or
partial injunctions against production and/or distribution, refusal of the
government to enter into supply contracts or to approve NDAs, ANDAs or biologics
applications, criminal prosecution and product recalls. The FDA also has the
authority to revoke for cause drug or biological approvals previously granted.
FDA Regulation of Excipients
Products sold for use as excipients in finished drug products are subject
to regulation by the FDA with regard to labeling, product integrity and
manufacturing. The FDA will not approve a drug for marketing without adequate
assurances that the excipients are safe for use in the product. The FDA presumes
certain excipients that are present in approved drug products currently marketed
for human use to be safe. These excipients are listed by the FDA in a document
known as the Inactive Ingredient Guide, or "IIG." All of the Company's
pharmaceutical excipients other than ProSolv are listed in the IIG. While the
FDA does not ordinarily require applicants for NDAs or ANDAs to submit data
demonstrating the safety of excipients listed in the IIG, it may require
evidence of safety in certain circumstances, such as when evidence is required
to demonstrate that such excipients interact safely with other components of a
drug product. For excipients not listed in the IIG, the FDA will generally
require data, which may include clinical data, demonstrating the safety of the
excipient for use in the product at issue. In the case of generic drug products
approved based on bioequivalence to a reference drug, the FDA may in some cases
(e.g., products for parenteral, ophthalmic, otic or topical use) require
excipients that are identical to the excipients in the reference drug. There can
be no assurance that the FDA will not require new clinical safety data to
approve an application for a product with a Penwest excipient or that the FDA
will approve such an application even if such clinical data are submitted.
Foreign Regulatory Approval
Whether or not FDA approval has been obtained, approval of a pharmaceutical
product by comparable governmental regulatory authorities in foreign countries
must be obtained prior to the commencement of clinical trials and subsequent
marketing of such product in such countries. The approval procedure varies from
country to country, and the time required may be longer or shorter than that
required for FDA approval.
Under European Union ("EU") law, either of two approval procedures may
apply to the Company's products: a centralized procedure, administered by the
EMEA (the European Medicines Evaluation Agency); or a decentralized procedure,
which requires approval by the medicines agency in each EU Member State where
the Company's products will be marketed. The centralized procedure is mandatory
for certain biotechnology products and available at the applicant's option for
certain other products. Although the decentralized procedure requires approval
by the medicines agency in each EU Member State where the products will be
marketed, there is a mutual recognition procedure under which the holder of
marketing approval from one EU Member State may submit an application to one or
more other EU Member States, including a certification to the effect that the
application is identical to the application which was originally approved or
setting forth the differences between the two applications. Within 90 days of
such application, each EU Member State will be required to determine whether to
recognize the prior approval.
Whichever procedure is used, the safety, efficacy and quality of the
Company's products must be demonstrated according to demanding criteria under EU
law and extensive nonclinical tests and clinical trials are likely to be
required. In addition to premarket approval requirements, national laws in EU
Member States will govern clinical trials of the Company's products, adherence
to good manufacturing practice, advertising and promotion and other matters. In
certain EU Member States, pricing or reimbursement approval may be a legal or
practical precondition to marketing.
A procedure for abridged applications for generic products also exists in
the EU. The general effect of the abridged application procedure is to give
scope for the emergence of generic competition once patent protection has
expired and the original product has been on the market for at least six or ten
years. Independent of any patent protection, under the abridged procedure, new
products benefit in principle from a basic six or ten year period of protection
(commencing with the date of first authorization in the EU) from abridged
applications for a marketing authorization. The period of protection in respect
of products derived
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from certain biotechnological processes or other high-technology medicinal
products viewed by the competent authorities as representing a significant
innovation is ten years. Further, each EU Member State has discretion to extend
the basic six-year period of protection to a ten-year period to all products
marketed in its territory. Certain EU Member States have exercised such
discretion. The protection does not prevent another company from making a full
application supported by all necessary pharmacological, toxicological and
clinical data within the period of protection. Abridged applications can be made
principally for medicinal products which are essentially similar to medicinal
products which have been authorized for either six or ten years. Under the
abridged application procedure, the applicant is not required to provide the
results of pharmacological and toxicological tests or the results of clinical
trials. For such abridged applications, all data concerning manufacturing
quality and bioavailability are required. The applicant submitting the abridged
application generally must provide evidence or information that the drug product
subject to this application is essentially similar to that of the referenced
product in that it has the same qualitative and quantitative composition with
respect to the active ingredient and the same dosage form, and is similar in
bioavailability as the referenced drug.
The Company's European excipients manufacturing operations are subject to a
variety of laws and regulations, including environmental and good manufacturing
practices regulations.
Other Regulations
The Company is governed by federal, state and local laws of general
applicability, such as laws regulating working conditions and environmental
protection. Certain drugs that the Company is developing are subject to
regulations under the Controlled Substances Act and related statutes.
PRICING AND THIRD-PARTY REIMBURSEMENT
The commercialization of the controlled release product candidates under
development by the Company and its collaborators depends in part on the extent
to which reimbursement for the cost of such products will be available from
government health administration authorities, private health insurers and other
third party payors, such as health maintenance organizations and managed care
organizations. The generic versions of controlled release products being
developed by the Company and its collaborators may be assigned an AB rating if
the FDA considers the product to be therapeutically equivalent to the branded
controlled release drug. Failure to obtain an AB rating from the FDA would
indicate that for certain purposes the drug would not be deemed to be
therapeutically equivalent, would not be fully substitutable for the branded
controlled release drug and would not be relied upon by Medicaid and Medicare
formularies for reimbursement.
Third-party payors are attempting to control costs by limiting the level of
reimbursement for medical products, including pharmaceuticals. Cost control
initiatives could decrease the price that the Company or any of its
collaborators receives for their drugs and have a material adverse effect on the
Company's business, financial condition and results of operations. Further, to
the extent that cost control initiatives have a material adverse effect on the
Company's collaborators, the Company's ability to commercialize its products and
to realize royalties may be adversely affected. Moreover, health care reform has
been, and may continue to be, an area of national and state focus, which could
result in the adoption of measures that adversely affect the pricing of
pharmaceuticals or the amount of reimbursement available from third party
payors. The Company's business, financial condition and results of operations
could be materially adversely affected if adequate coverage and reimbursement
levels are not provided by government and other third-party payors for the
products of the Company and its collaborators.
PRODUCT LIABILITY INSURANCE
The design, development, and manufacture of the Company's products involve
an inherent risk of product liability claims. The Company faces the risk of
product liability claims in the event that the use of its products is alleged to
have resulted in harm to a patient or subject. Such risks exist even with
respect to those products that are manufactured in licensed and regulated
facilities or that otherwise possess regulatory approval for commercial sale.
The Company is currently covered by primary product liability insurance
maintained by
50
<PAGE> 54
Penford in the amount of $1.0 million per occurrence and $2.0 million annually
in the aggregate on a claims-made basis and by umbrella liability insurance in
excess of $5.0 million which can also be used for product liability insurance.
The Company is currently seeking to obtain comparable coverage immediately
following the Distribution. The Company believes that such coverage is adequate
for its current operations, and will seek to increase its coverage prior to the
commercial introduction of its controlled release product candidates. There can
be no assurance that the coverage limits of the Company's insurance will be
sufficient to offset potential claims or that the Company will be able to obtain
comparable coverage following the Distribution at a similar cost to the Company.
Product liability insurance is expensive and difficult to procure and may not be
available in the future on acceptable terms or in sufficient amounts, if
available at all. However, since some of the Company's collaborators require the
Company to maintain product liability insurance coverage as a condition to doing
business with the Company, the Company intends to take all reasonable steps
necessary to maintain such insurance coverage. A successful claim against the
Company in excess of its insurance coverage could have a material adverse effect
upon the Company's business, financial condition and results of operations.
LITIGATION
In May 1997, one of the Company's collaborators, Mylan, filed an ANDA with
the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of
Procardia XL, a controlled release formulation of nifedipine. Bayer and ALZA own
patents listed for Procardia XL (the last of which expires in 2010), and Pfizer
is the sponsor of the NDA and markets the product. In connection with the ANDA
filing, Mylan certified to the FDA that Nifedipine XL does not infringe these
Bayer or ALZA patents and notified Bayer, ALZA and Pfizer of such certification.
Bayer and Pfizer sued Mylan in the United States District Court for the Western
District of Pennsylvania, alleging that Mylan's product infringes Bayer's
patent. The Company has been informed by Mylan that ALZA does not believe that
the notice given to it complied with the requirements of the Waxman-Hatch Act,
and there can be no assurance that ALZA will not sue Mylan for patent
infringement or take any other actions with respect to such notice. Mylan has
advised the Company that it intends to contest vigorously the allegations made
in the lawsuit. However, there can be no assurance that Mylan will prevail in
this litigation or that it will continue to contest the lawsuit. If the
litigation results in a determination that Nifedipine XL infringes Bayer's
patent, Nifedipine could not be marketed in the United States until such patent
expired. An unfavorable outcome or protracted litigation for Mylan would
materially adversely affect the Company's business, financial condition and
results of operations. Delays in the commercialization of Nifedipine XL could
occur because the FDA will not grant final marketing approval of Nifedipine XL
until a final judgment on the patent suit is rendered in favor of Mylan by the
district court, or in the event of an appeal, by the court of appeals, or until
30 months (or such longer or shorter period as the court may determine) have
elapsed from the date of Mylan's certification, whichever is sooner.
In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming that
its Procardia XL formulation constituted a unique delivery system and that a
drug with a different release mechanism such as the TIMERx controlled release
system cannot be considered the same dosage form and approved in an ANDA as
bioequivalent to Procardia XL. In August 1997, the FDA rejected Pfizer's
citizen's petition. In July 1997, Pfizer also sued the FDA in the District Court
of the District of Columbia, claiming that the FDA's acceptance of Mylan's ANDA
filing for Nifedipine XL was contrary to law, based primarily on the arguments
stated in its citizen's petition. Mylan and the Company intervened as defendants
in this suit. In April 1998 the District Court of the District of Columbia
rejected Pfizer's claim, and in May 1998, Pfizer appealed the District Court's
decision. There can be no assurance that the FDA, Mylan and the Company will
prevail in this litigation. An outcome in this litigation adverse to Mylan and
the Company would result in Mylan being required to file a suitability petition
in order to maintain the ANDA filing or to file an NDA with respect to
Nifedipine XL, each of which would be expensive and time consuming. An adverse
outcome also would result in Nifedipine XL becoming ineligible for an "AB"
rating from the FDA. Failure to obtain an AB rating from the FDA would indicate
that for certain purposes Nifedipine XL would not be deemed to be
therapeutically equivalent to the referenced branded drug, would not be fully
substitutable for the referenced branded drug and would not be relied upon by
Medicaid and Medicare formularies for reimbursement. Any such failure would have
a material adverse effect on the Company's business, financial condition and
results of operations. If any of such events occur, Mylan may terminate its
efforts with respect to Nifedipine XL, which would have a material adverse
effect on the Company's business, financial condition and results of operations.
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<PAGE> 55
There can be no assurance that Pfizer or others will not pursue additional
regulatory initiatives and lawsuits with respect to Procardia XL and Nifedipine
XL.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
For financial information about the Company's foreign and domestic
operations and export sales, see Note 12 of Notes to Consolidated Financial
Statements.
FACILITIES
The Company's executive, administrative, research, small-scale production
and warehouse facilities, comprising approximately 55,000 square feet, currently
are located in a single facility on a 15 acre site owned by the Company in
Patterson, New York.
The Company owns a facility in Cedar Rapids, Iowa where it manufactures and
packages pharmaceutical excipients. The facility is a 35,000 square foot
building containing manufacturing and administrative space. The Company also
manufactures pharmaceutical excipients in a 15,000 square foot facility leased
by the Company in Nastola, Finland, which lease renews annually with a two-year
notification of termination period for either party.
The Company believes that all its present facilities are well maintained
and in good operating condition.
EMPLOYEES
As of March 31, 1998, the Company employed 120 persons, of which 75 were
involved in research and development, administration and sales and marketing
activities in Patterson, New York, 20 were involved in manufacturing operations
at the Company's facility in Nastola, Finland, 19 were involved in manufacturing
operations at the Company's facility in Cedar Rapids, Iowa and six were involved
in sales activities in the Company's European sales offices.
Other than the Company's employees in Finland who are covered by a national
collective bargaining agreement, none of the Company's employees are covered by
collective bargaining agreements. The Company considers its employee relations
to be good.
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<PAGE> 56
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, and their ages as of
the Distribution Date will be as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Tod R. Hamachek(1)........................ 52 Chairman of the Board and Chief Executive Officer
John V. Talley, Jr. ...................... 42 President, Chief Operating Officer and Director
Anand R. Baichwal, Ph.D. ................. 43 Senior Vice President, Research and Development
Stephen J. Berte, Jr. .................... 43 Vice President, Marketing and Sales
Jennifer L. Good.......................... 33 Vice President, Finance, Chief Financial Officer and
Secretary
Paul K. Wotton, Ph.D. .................... 37 Vice President, Business Development
Paul E. Freiman(1)(3)..................... 63 Director
Jere E. Goyan, Ph.D.(2)................... 67 Director
Rolf H. Henel(2).......................... 60 Director
Robert J. Hennessey(1)(3)................. 56 Director
N. Stewart Rogers(2)(3)................... 68 Director
</TABLE>
- ---------------
(1) Member of Executive Committee.
(2) Member of Audit Committee.
(3) Member of Compensation Committee.
Tod R. Hamachek has served as Chairman of the Board and Chief Executive
Officer of the Company since October 1997. Mr. Hamachek has served as President
and Chief Executive Officer of Penford since 1985 and as director of Penford
since 1983, but will resign from these positions effective upon the Distribution
Date. Mr. Hamachek is a director of DEKALB Genetics Corporation and Northwest
Natural Gas Company.
John V. Talley, Jr. has served as President of the Company since December
1993 and was named Chief Operating Officer and a director of the Company on
October 8, 1997. Mr. Talley has served as a Vice President of Penford since 1993
but will resign from that position effective upon the Distribution Date. Prior
to joining the Company, Mr. Talley served in a variety of positions at Sanofi
from 1989 to 1993, including Vice President of Marketing from 1992 to 1993 and
Vice President, Marketing of the Hospital Products Division from 1989 to 1992.
From 1979 to 1989, Mr. Talley served in the New Product Development and
Marketing Department of Sterling Drug where he was responsible for the marketing
of prescription drugs in the United States.
Dr. Anand R. Baichwal has served as Senior Vice President, Research and
Development of the Company since January 1997, after serving in a variety of
positions for the Company since 1987, including Vice President, Technology from
1994 to 1997, Vice President, Research and Development from 1993 to 1994,
Director of Commercial Development from 1991 to 1993 and Director of Research
and Development and Technical Affairs from 1987 to 1991. Dr. Baichwal is a
co-inventor of the TIMERx technology. See "Certain Transactions."
Stephen J. Berte, Jr. has served as Vice President, Marketing and Sales of
the Company since January 1995. Prior to joining the Company, Mr. Berte served
in a variety of positions at Sanofi, including Senior Director of New Product
Development from 1992 to 1995, Director of Marketing from 1990 to 1992, Senior
Product Manager from 1989 to 1990, Product Manager from 1988 to 1989 and
Assistant Project Manager for injectable drugs from 1987 to 1988.
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<PAGE> 57
Jennifer L. Good has served as Vice President, Finance of the Company since
March 1997 and was named Chief Financial Officer of the Company on October 8,
1997. Prior to joining the Company, Ms. Good served as Corporate Director of
Finance and Secretary of Penford from 1996 to March 1997 and as Corporate
Controller of Penford from 1993 to 1996. From 1987 to 1993, Ms. Good was
employed by Ernst & Young LLP as an audit manager.
Dr. Paul K. Wotton has served as Vice President, Business Development of
the Company, since November 1994, after serving in a variety of positions for
the Company since 1989, including Director of Business Development from 1993 to
1994 and Product Manager (Europe) from 1991 to 1993. Prior to joining the
Company, Dr. Wotton served as a Project Manager at Abbott Laboratories, a
pharmaceutical company ("Abbott"), from 1987 to 1989 and as a Research
Pharmacist at Merck and Co., Inc. ("Merck"), a pharmaceutical company, from 1985
to 1987.
Paul E. Freiman has served as a director of the Company since October 1997
and as a director of Penford since April 1996, but will resign as a director of
Penford at its next annual meeting of shareholders. Mr. Freiman has served as
President of Neurobiological Technologies, Inc., a biotechnology company, since
May 1997 and as Chairman of the Board of Digital Gene Technologies, a
biotechnology company, since February 1995. From 1990 to 1995, Mr. Freiman
served as Chairman and Chief Executive Officer of Syntex Corporation, a
pharmaceutical company. Mr. Freiman is a director of Calypte Biomedical
Corporation, a biotechnology company.
Dr. Jere E. Goyan has served as a director of the Company since October
1997. Dr. Goyan has been the President and Chief Operating Officer of Alteon
Corporation ("Alteon"), a biopharmaceutical company, since April 1993. Dr. Goyan
also served as the Acting Chief Executive Officer of Alteon from June 1993 to
February 1994 and as Senior Vice President, Research and Development of Alteon
from January 1993 through April 1993. Dr. Goyan is Professor Emeritus of
Pharmacy and Pharmaceutical Chemistry and Dean Emeritus of the School of
Pharmacy, University of California, San Francisco ("UCSF"). He has been on the
faculty of the School of Pharmacy at UCSF since 1963. He took a leave of absence
from 1979 to 1981 to serve as Commissioner of Food and Drugs of the United
States (FDA). Dr. Goyan is a director of ATRIX Laboratories, Inc., Emisphere
Technologies, Inc. and SciClone Pharmaceuticals, Inc., each a biopharmaceutical
firm, and Boehringer Ingelheim Pharmaceuticals, Inc., a pharmaceutical company.
Rolf H. Henel has served as a director of the Company since October 1997.
Mr. Henel has served as Executive Director of Performance Effectiveness Corp., a
consulting firm for the pharmaceutical industry, since June 1995 and as a
partner of Naimark & Associates P.C., a consulting firm for the healthcare
industry, since September 1994. From 1978 to 1993, Mr. Henel served in a variety
of positions at American Cyanamid Co., a pharmaceutical company, most recently
as President of Lederle International, a division of American Cyanamid Co. Mr.
Henel is a director of SciClone Pharmaceuticals, Inc.
Robert J. Hennessey has served as a director of the Company since October
1997. Mr. Hennessey has served as Chairman of the Board and Chief Executive
Officer of Genome Therapeutics Corp., a biotechnology company, since March 1993.
From 1990 to 1993, Mr. Hennessey served as the President of Hennessey &
Associates Ltd., a strategic consulting firm to biotechnology and healthcare
companies. Prior to 1990, Mr. Hennessey held a variety of management positions
at Merck, SmithKline, Abbott and Sterling Drug. Mr. Hennessey is also a director
of Virus Research Institute, Inc., a biotechnology company, and Repligen, Inc.,
a biotechnology company.
N. Stewart Rogers has served as a director of the Company since October
1997 and as Chairman of the Penford Board since 1990 and as a director of
Penford since 1983. Mr. Rogers is also a director of Fluke Corporation, an
electronic test instrument manufacturer, Royal Pakhoed N.V. (The Netherlands), a
chemical logistics and distribution company, and VWR Scientific Products
Corporation, a laboratory supply company.
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<PAGE> 58
BOARD OF DIRECTORS' COMMITTEES AND OTHER INFORMATION
Each officer of the Company is elected by the Board on an annual basis and
serves until his or her successor has been duly elected and qualified. There are
no family relationships among any of the executive officers or directors of the
Company.
The Board is divided into three classes, each of whose members serves for a
staggered three-year term. The Board consists of three Class I directors (Mr.
Freiman, Mr. Henel and Mr. Rogers), two Class II directors (Dr. Goyan and Mr.
Talley) and two Class III directors (Mr. Hamachek and Mr. Hennessey). At each
annual meeting of shareholders, a class of directors is elected for a three-year
term to succeed the directors of the same class whose term is then expiring. The
terms of the Class I directors, Class II directors and Class III directors
expire at the annual meeting of shareholders to be held in 2001, 1999 and 2000,
respectively. It is the Company's policy that when the Chairman of the Board and
the Chief Executive Officer is the same person, the Board will appoint one of
its members as a Lead Director to chair meetings of the Board and for certain
other purposes. Mr. Freiman has been appointed Lead Director.
Under the terms of the Separation and Distribution Agreement, the Company
has agreed that during the period during which Penford's guaranty of the Credit
Facility is effective, and subject to the exercise by the Board of Directors of
Penwest of its fiduciary duties, Penwest will use its reasonable best efforts to
assure that at least one person designated by Penford is elected to serve on the
Board of Directors of the Company. The initial director designated by Penford is
Mr. Rogers.
The Board has established a Compensation Committee, an Audit Committee and
an Executive Committee. The Compensation Committee makes recommendations to the
Board with respect to the compensation of directors and executive officers of
the Company. The Compensation Committee also supervises the Company's employee
benefit plans. The Compensation Committee consists of Messrs. Freiman, Hennessey
and Rogers.
The Audit Committee recommends to the Board the selection of the
independent auditors, reviews the proposed scope of the independent audit,
reviews the annual financial statements and the independent auditor's report,
reviews the independent auditor's recommendations relating to accounting,
internal controls and other matters, and reviews internal controls and
accounting procedures with management. The Audit Committee consists of Messrs.
Henel and Rogers and Dr. Goyan.
The Executive Committee exercises all powers and authority of the Board
with certain exceptions as provided under Washington law. The Executive
Committee consists of Messrs. Freiman, Hamachek and Hennessey.
DIRECTOR COMPENSATION
Each non-employee director of the Company is paid an annual retainer of
$7,500 ($14,500 in the case of the Lead Director) and is paid $1,500 for
personal or telephone attendance at a Board or committee meeting. Each director
may elect to receive these fees in the form of stock options under the Company's
1997 Equity Incentive Plan (the "1997 Plan"), which options, if elected, will be
granted as of the date such fees are earned to purchase the number of shares of
Common Stock determined by dividing the amount of the fees earned by 25% of the
fair market value of one share of Common Stock on the grant date. The exercise
price of such options will equal 75% of the fair market value of one share of
Common Stock on the grant date and will be immediately exercisable. In addition,
each non-employee director is reimbursed for expenses in connection with
attendance at Board and committee meetings.
Non-employee directors will also be granted annual options under the 1997
Plan to purchase 7,000 shares of Common Stock on September 1 of each year
commencing in 1998. All such options will vest on the first anniversary of the
date of grant. However, the exercisability of these options will be accelerated
upon the occurrence of a change in control of the Company. The exercise price of
all such options granted will equal the fair market value of one share of Common
Stock on the grant date.
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<PAGE> 59
Upon the Distribution Date with respect to the Company's then non-employee
directors and upon the date of the initial election of any non-employee director
thereafter, each non-employee director will receive the right to receive up to
7,500 shares of Common Stock under the 1997 Plan on the earlier of (i) the date
four years from the date of grant or (ii) the date upon which such director
ceases to be a director by reason of death, permanent disability, resignation or
retirement. The right to receive these shares will vest in four equal annual
installments commencing upon the first anniversary of the date of grant.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Company's Compensation Committee are Messrs.
Freiman, Hennessey and Rogers, none of whom are employees of the Company.
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company or
Penford in the years ended December 31, 1997 and December 31, 1996 to the
Company's Chief Executive Officer and to the Company's other executive officers
whose annual salary and bonus exceeded $100,000 in the year ended December 31,
1997 (collectively, the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
SECURITIES
ANNUAL COMPENSATION OF PENFORD
---------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION(1) YEAR SALARY BONUS OPTIONS(2) COMPENSATION(3)
- ------------------------------ ---- -------- -------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Tod R. Hamachek(4)(5)................. 1997 $340,000 $453,934 0 $19,352
Chairman of the Board and 1996 340,006 123,636 96,000 19,702
Chief Executive Officer
Edmund O. Belsheim, Jr.(4)(6)......... 1997 190,000 156,104 0 10,768
Senior Vice President, Corporate 1996 40,923 0 53,000 0
Development and General Counsel
John V. Talley, Jr. .................. 1997 188,846 103,896 0 10,611
President and Chief Operating 1996 180,000 58,183 19,000 8,403
Officer
Anand R. Baichwal, Ph.D.(7)........... 1997 114,269 39,827 0 8,642
Senior Vice President, 1996 96,000 19,000 6,000 6,101
Research and Development
Stephen J. Berte, Jr. ................ 1997 122,076 31,481 0 7,062
Vice President, Marketing and Sales 1996 119,000 17,927 10,000 4,745
</TABLE>
- ---------------
(1) In accordance with the rules of the Commission, this table and the stock
option grant table and the stock option exercise table which follow present
information concerning the Company's Chief Executive Officer and its four
other most highly compensated executive officers whose total annual salary
and bonus exceeded $100,000 (determined by reference to total annual salary
and bonus earned by such officers) for the year ended December 31, 1997.
(2) Represents options to purchase common stock of Penford granted to the Named
Executive Officers in 1996.
(3) Represents Penford's matching and profit sharing contributions under the
Penford Savings and Stock Ownership Plan and premiums paid on behalf of the
Named Executive Officers for supplemental life and disability insurance
plans.
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<PAGE> 60
(4) Messrs. Hamachek and Belsheim earned the compensation set forth above for
services rendered to Penford in their capacities as President and Chief
Executive Officer of Penford and Vice President, Corporate Development and
General Counsel of Penford, respectively.
(5) In February 1998, Penford loaned $1,215,000 to Mr. Hamachek, which loan was
secured by Mr. Hamachek's homes in Washington and Connecticut. Such loan
bears interest at a rate equal to Penford's then current borrowing rate. All
outstanding principal and accrued interest under such loan must be repaid by
Mr. Hamachek on August 31, 1998. As of May 31, 1998, existing indebtedness
under the loan equalled $1,234,399. This loan will not be assumed by the
Company following the Distribution and will remain with Penford.
(6) Mr. Belsheim, who joined Penford in September 1996, has advised the Company
that he will resign as Senior Vice President, Corporate Development and
General Counsel as of the Distribution Date.
(7) For a discussion of certain other amounts payable to Dr. Baichwal, see
"Certain Transactions."
Option Grants
No options to purchase shares of common stock of Penford or Penwest Common
Stock were granted to the Named Executive Officers during the fiscal year ended
December 31, 1997. In addition, no options to purchase shares of Penford common
stock have been granted to the Named Executive Officers since December 31, 1997.
The Company intends to grant stock options under the 1997 Plan to purchase
an aggregate of 1,010,000 shares of Common Stock to its employees and officers,
following the Distribution Date, at an exercise price equal to the fair market
value of the Common Stock as of the date of grant, of which it is expected
options to purchase 300,000 shares, 175,000 shares, 75,000 shares and 130,000
shares would be granted to Mr. Hamachek, Mr. Talley, Mr. Berte and Dr. Baichwal,
respectively. These options will be exercisable in four equal annual
installments commencing on the first anniversary of the Distribution Date and
will become exercisable in full upon a change in control of the Company (as
defined).
Stock options will also be granted to employees of the Company, including
Mr. Hamachek, Mr. Talley, Mr. Berte and Dr. Baichwal, under the Company's 1998
Spinoff Option Plan. See "Employee Benefit Plans -- 1998 Spinoff Option Plan,"
and "Arrangements between the Company and Penford -- Separation and Distribution
Agreement -- Treatment of Options."
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<PAGE> 61
Stock Options Held as of Year-End
The following table sets forth certain information concerning each exercise
of a stock option to purchase common stock of Penford during the year ended
December 31, 1997 by a Named Executive Officer, and the number and value of
unexercised stock options to purchase shares of common stock of Penford held by
each of the Named Executive Officers as of December 31, 1997. No Named Executive
Officer held any stock options to purchase shares of the Company's Common Stock
as of December 31, 1997.
AGGREGATE OPTION EXERCISES IN 1997
AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES
OF PENFORD
--------------------------- VALUE OF UNEXERCISED
NUMBER OF UNDERLYING UNEXERCISED IN-THE-MONEY
SHARES OF OPTIONS AS OF OPTIONS AS OF
PENFORD DECEMBER 31, 1997(#) DECEMBER 31, 1997($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ---------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Tod R. Hamachek............. 225,000 $2,118,825 34,000 62,000 $583,500 $1,250,500
Edmund O. Belsheim, Jr. .... -- -- 13,250 39,750 220,813 662,437
John V. Talley, Jr. ........ -- -- 12,750 56,250 176,375 819,625
Anand R. Baichwal........... -- -- 5,200 10,800 77,350 169,400
Stephen J. Berte, Jr. ...... -- -- 2,000 8,000 34,750 139,000
</TABLE>
- ---------------
(1) Value is based on the difference between the option exercise price and the
fair market value of shares of common stock of Penford as of December 31,
1997 ($35 per share as quoted on the Nasdaq National Market).
Penford Retirement Plan
Penford has a defined benefit retirement plan (the "Retirement Plan"). The
table below shows the estimated annual benefits payable on retirement under the
Retirement Plan to persons in the specified compensation and years of service
classifications. The retirement benefits shown are based upon retirement at age
65 and the payments of a single-life annuity to the employee using current
average Social Security wage base amounts and are not subject to any deduction
for Social Security or other offset amounts. With certain exceptions, the Code
restricts to an aggregate amount of $120,000 (subject to cost of living
adjustments) the annual pension that may be paid by an employer from a plan
which is qualified under the Code. The Code also limits the covered compensation
which may be used to determine benefits to $150,000. The Penford Board has
established supplemental benefits for certain highly compensated employees to
whom this limit applies or will apply in the future, so that these employees
will obtain the benefit of the formula that would have applied in the absence of
the limitation. Named Executive Officers entitled to receive supplemental
benefits as of December 31, 1997 were Messrs. Hamachek and Talley.
RETIREMENT BENEFITS
<TABLE>
<CAPTION>
YEARS OF SERVICE
-----------------------------------------
COVERED COMPENSATION(1) 20 25 30 35
- ----------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
$200,000................................... $ 57,569 $ 71,961 $ 86,353 $100,745
300,000................................... 87,569 109,461 131,353 153,245
400,000................................... 117,569 146,961 176,353 205,745
500,000................................... 147,569 184,461 221,353 258,245
600,000................................... 177,569 221,961 266,353 310,745
700,000................................... 207,569 259,461 311,353 363,245
800,000................................... 237,569 296,961 356,353 415,745
900,000................................... 267,569 334,461 401,353 468,245
</TABLE>
- ---------------
(1) Represents the highest average annual earnings during five consecutive
calendar years of service.
58
<PAGE> 62
Compensation of Named Executive Officers covered by the Retirement Plan
includes salaries and bonuses as shown in the salary and bonus columns of the
Summary Compensation Table.
As of December 31, 1997, the approximate years of credited service (rounded
to the nearest year) under the Retirement Plan of the Named Executive Officers
were: Mr. Hamachek, 14, Mr. Belsheim, 1, Mr. Talley, 4, Dr. Baichwal, 10, and
Mr. Berte, 3.
Under the Employee Benefits Agreement between Penford and the Company,
Penford will freeze all benefit accruals of employees of the Company under this
plan as of the Distribution Date and will thereafter distribute to each employee
his or her fully vested interest in the form of a lump sum payment or an
annuity. See "Arrangements Between the Company and Penford."
EMPLOYEE BENEFIT PLANS
1997 Equity Incentive Plan
The Company's 1997 Plan was adopted by the Company in October 1997. The
1997 Plan provides for the grant of incentive stock options, nonstatutory stock
options, restricted stock awards and other stock-based awards, including the
grant of securities convertible into Common Stock and the grant of stock
appreciation rights (collectively "Awards"). A total of 2,660,000 shares of
Common Stock may be issued pursuant to Awards granted under the 1997 Plan.
Optionees receive the right to purchase a specified number of shares of
Common Stock at a specified option price and subject to such other terms and
conditions as are specified in connection with the option grant. Awards may be
granted at an exercise price which may be less than, equal to or greater than
the fair market value of the Common Stock on the date of grant subject to the
limitations described below. Incentive stock options may not be granted at an
exercise price less than the fair market value of the Common Stock on the date
of grant (or less than 110% of the fair market value in the case of incentive
stock options granted to optionees holding more than 10% of the voting power of
the Company). Options may not be granted for a term in excess of ten years. The
1997 Plan permits the Board to determine the manner of payment of the exercise
price of options, including through payment by cash, check or in connection with
a "cashless exercise" through a broker, by surrender to the Company of shares of
Common Stock, by delivery to the Company of a promissory note, or any
combination of the foregoing.
Restricted stock Awards entitle recipients to acquire shares of Common
Stock, subject to the right of the Company to repurchase all or part of such
shares from the recipient in the event that the conditions specified in the
applicable Award are not satisfied prior to the end of the applicable
restriction period established for such Award.
Under the 1997 Plan, the Board has the right to grant other Awards based
upon the Common Stock having such terms and conditions as the Board may
determine, including the grant of securities convertible into Common Stock and
the grant of stock appreciation rights.
Officers, employees, directors, consultants and advisors of the Company and
its subsidiaries are eligible to be granted Awards under the 1997 Plan. However,
incentive stock options may only be granted to employees. The maximum number of
shares with respect to which an Award may be granted to any participant under
the 1997 Plan may not exceed 380,000 shares per calendar year.
As of the date of adoption of the 1997 Plan, all the Company's employees
were eligible to receive Awards under the 1997 Plan. The granting of Awards
under the 1997 Plan is discretionary, and the Company cannot now determine the
number or type of Awards to be granted in the future to any particular person or
group.
The 1997 Plan is administered by the Board. The Board has the authority to
adopt, amend and repeal the administrative rules, guidelines and practices
relating to the 1997 Plan and to interpret the provisions of the 1997 Plan.
Pursuant to the terms of the 1997 Plan, the Board may delegate authority under
the 1997 Plan to one or more committees of the Board, and subject to certain
limitations, to one or more executive officers of the Company. The Board has
authorized the Compensation Committee to administer certain aspects of the 1997
Plan, including the granting of options to executive officers. Subject to any
applicable limitations
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<PAGE> 63
contained in the 1997 Plan, the Board, the Compensation Committee or any other
committee or executive officer to whom the Board delegates authority, as the
case may be, selects the recipients of Awards and determines (i) the number of
shares of Common Stock covered by options and the dates upon which such options
become exercisable, (ii) the exercise price of options, (iii) the duration of
options, and (iv) the number of shares of Common Stock subject to any restricted
stock or other stock-based Awards and the terms and conditions of such Awards,
including conditions for repurchase, issue price and repurchase price.
The Board is required to make appropriate adjustments in connection with
the 1997 Plan and any outstanding Awards to reflect stock dividends, stock
splits and certain other events. In the event of a merger, liquidation or other
Acquisition Event (as defined in the 1997 Plan), the Board is authorized to
provide for outstanding options or other stock-based Awards to be assumed or
substituted for, to accelerate the Awards to make them fully exercisable prior
to consummation of the Acquisition Event or to provide for a cash out of the
value of any outstanding options. If any Award expires or is terminated,
surrendered, canceled or forfeited, the unused shares of Common Stock covered by
such Award will again be available for grant under the 1997 Plan.
The Company intends to grant stock options under the 1997 Plan to purchase
an aggregate of 1,010,000 shares of Common Stock to its employees and officers
following the Distribution Date, at an exercise price equal to the fair market
value of the Common Stock as of the date of grant. See "Management -- Executive
Compensation -- Option Grants."
1997 Employee Stock Purchase Plan
The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Company in October 1997. The Purchase Plan authorizes the
issuance of up to a total of 228,000 shares of Common Stock to participating
employees at a discount from fair market value. The Purchase Plan is intended to
qualify as an employee stock purchase plan within Section 423 of the Code.
All employees of the Company, including directors of the Company who are
employees and all employees of any designated subsidiaries, whose customary
employment is more than 20 hours per week and for more than five months in any
calendar year, are eligible to participate in the Purchase Plan. Employees who
would immediately after the grant own 5% or more of the total combined voting
power or value of the stock of the Company or any subsidiary are not eligible to
participate. Following this Distribution, all the Company's full-time employees
as of the date of adoption of the Purchase Plan will be eligible to participate
in the Purchase Plan.
On the first day of a designated payroll deduction period (the "Offering
Period"), the Company will grant to each eligible employee who has elected to
participate in the Purchase Plan an option to purchase shares of Common Stock as
follows: the employee may authorize an amount (a whole percentage from 1% to 10%
of such employee's regular pay) to be deducted by the Company from such pay
during an Offering Period. On the last day of such Offering Period, the employee
is deemed to have exercised the option, at the option exercise price, to the
extent of accumulated payroll deductions. Under the terms of the Purchase Plan,
the option price is an amount equal to 85% of the fair market value per share of
the Common Stock on either the first day or the last day of each Offering
Period, whichever is lower. In no event may an employee purchase in any one
Offering Period a number of shares which is more than the number determined by
dividing $12,500 by the closing price of a share of Common Stock on the
commencement date of each Offering Period. The Compensation Committee may, at
its discretion, choose an Offering Period of 12 months or less for each of the
offerings and choose a different Offering Period for each offering.
If an employee is not a participant on the last day of an Offering Period,
such employee is not entitled to exercise any option, and the amount of such
employee's accumulated payroll deductions will be refunded without interest. An
employee's rights under the Purchase Plan terminate upon voluntary withdrawal
from the Purchase Plan at any time, or when such employee ceases employment for
any reason.
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1998 Spinoff Option Plan
The Company's 1998 Spinoff Option Plan (the "Spinoff Plan") was adopted by
the Company in June 1998. The Spinoff Plan provides for the grant of stock
options to employees of Penwest and non-employee directors of Penford who hold
options to purchase Penford common stock as of the Distribution Date. Such
Penwest employees and Penford directors held, as of May 31, 1998, options to
purchase an aggregate of 370,864 shares of Penford common stock under Penford's
stock option plans (the "Penford Options").
Generally, under such plans, outstanding vested options may be exercised
during the 90-day or one-year period following termination of employment and
unvested options lapse upon termination of employment. As of the Distribution
Date, the Penwest employees will cease to be deemed employees of Penford under
the terms of Penford's stock option plans. As a result, as of the Distribution
Date, options to purchase shares of Common Stock will be granted to the
Company's employees under the Spinoff Plan in replacement of the outstanding
Penford Options. The exercise price and the number of replacement options will
be calculated so as to preserve the Penford Options' approximate value as of the
Distribution Date. To accomplish this, (i) the number of shares of Common Stock
covered by options under the Spinoff Plan will be determined by multiplying the
number of shares of Penford common stock subject to each outstanding Penford
Option by the average of the high and low trading prices of the Penford common
stock on the Nasdaq National Market on the Distribution Date and then dividing
the result by the average of the high and low trading prices of the Common Stock
on the Nasdaq National Market on the trading day immediately following the
Distribution Date, and (ii) the exercise price of such options will be
determined by multiplying the exercise price of the Penford Option by the
average of the high and low trading prices of the Common Stock on the Nasdaq
National Market on the trading day immediately following the Distribution Date
and then dividing the result by the average of the high and low trading prices
of the Penford common stock on the Nasdaq National Market on the Distribution
Date. Fractions will be rounded to the next highest share and next lowest cent,
respectively. Substantially all other terms and conditions of the Penford
Options will be reflected in the replacement options, including the continuation
of the remaining portions of their original vesting schedules and their ten-year
terms.
Non-employee directors will retain their existing Penford Options, but will
also receive options to purchase Common Stock under the Spinoff Plan
corresponding to such Penford Options. The exercise price and the number of
options to be granted will be calculated in conjunction with adjustments to such
directors' Penford Options so as to preserve the Penford Options' approximate
value as of the Distribution Date.
The Spinoff Plan will be administered by the Board. The Board has the
authority to adopt, amend and repeal the administrative rules, guidelines and
practices relating to the Spinoff Plan and to interpret the provisions of the
Spinoff Plan. The Board is required to make appropriate adjustments in
connection with the Spinoff Plan and any outstanding options to reflect stock
dividends, stock splits and certain other events. In the event of a merger,
liquidation or other Acquisition Event (as defined in the Spinoff Plan), the
Board is authorized to provide for outstanding options to be assumed or
substituted for, to accelerate the vesting of the options to make them fully
exercisable prior to consummation of the Acquisition Event or to provide for a
cash out of the value of any outstanding options. The Board may not grant any
additional options under the Spinoff Plan. If any option expires or is
terminated, surrendered, canceled or forfeited, the unused shares of Common
Stock covered by such option will cease to again be available for grant under
the Spinoff Plan.
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<PAGE> 65
CERTAIN TRANSACTIONS
Since January 1, 1995, the Company has not engaged in any transactions with
the directors or officers of the Company or Penford except as described below.
Under a Recognition and Incentive Agreement (as amended, the "Baichwal
Agreement") with Anand Baichwal, the Company's Senior Vice President, Research
and Development, the Company is obligated to pay to Dr. Baichwal on an annual
basis in arrears (i) one-half of one percent of the Company's Net Sales (as
defined in the Baichwal Agreement) of TIMERx Material (as defined in the
Baichwal Agreement) to third parties, (ii) one-half of one percent of royalties
received by the Company under licenses, collaborations or other exploitation
agreements with third parties with respect to the sale, license, use or
exploitation by such third parties of products based on or incorporating the
TIMERx Material, and (iii) one-half of one percent of payments made in lieu of
such Net Sales or royalties and received by the Company. Such payments cease in
the event that Dr. Baichwal's employment is terminated for cause. The Baichwal
Agreement also contains non-competition and non-solicitation provisions which
expire two years after the termination of his employment.
For a description of the stock options granted and other securities to the
directors and officers of the Company, see "Management -- Director Compensation"
and "Management -- Executive Compensation."
For a description of the Company's arrangements with Penford, see
"Arrangements between the Company and Penford."
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<PAGE> 66
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Penford will own all of the outstanding shares of Common Stock until the
Distribution. Following the completion of the Distribution, Penford will own no
shares of Common Stock.
The following table sets forth certain information regarding the Penford
beneficial ownership of the Common Stock expected to be received on the
Distribution Date by (i) each person who is expected by the Company to
beneficially own five percent or more shares of Common Stock, (ii) each director
and Named Executive Officer of the Company and (iii) all directors and executive
officers of the Company as a group. The information set forth below is based on
certain information known to the Company with respect to such person's
beneficial ownership of shares of common stock of Penford as of May 31, 1998.
The table assumes the beneficial ownership of common stock of Penford as of May
31, 1998 will not change before the Record Date.
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OUTSTANDING SHARES
NAME(1) OF SHARES BENEFICIALLY OWNED
- ------- --------- ------------------
<S> <C> <C>
5% Stockholders
David L. Babson & Co., Inc.................................. 747,750(2) 6.76%
One Memorial Drive
Cambridge, MA 02142
Wellington Management....................................... 732,180(3) 6.66
75 State Street
Boston, MA 02109
Tod R. Hamachek............................................. 554,776(4) 5.01
2981 Route 22
Patterson, NY 12563-9970
Other Directors
Paul E. Freiman............................................. 6,621 *
Jere E. Goyan............................................... -- *
Rolf H. Henel............................................... 3,000 *
Robert J. Hennessey......................................... -- *
N. Stewart Rogers........................................... 223,420(6) 2.02
John V. Talley, Jr.......................................... 23,053(7) *
Other Named Executive Officers
Anand R. Baichwal........................................... 14,934(8) *
Edmund O. Belsheim, Jr. .................................... 33,654(9) *
Steven J. Berte, Jr. ....................................... 4,712(10) *
All directors and executive officers as a group (12
persons).................................................. 877,621(11) 7.50
</TABLE>
- ---------------
* Less than 1%.
(1) Except as reflected in the footnotes to this table, shares of Common Stock
beneficially owned consist of shares owned by the indicated person, and all
share ownership involves sole voting and investment power. Amounts shown in
the above table and the following notes include shares issuable within the
60-day period following May 31, 1998 pursuant to the exercise of options to
purchase shares of Penford common stock, which for purposes of this table,
have been assumed to be exercised prior to the Record Date.
(2) Share ownership based on Schedule 13G filed with the Commission on January
20, 1998.
(3) Share ownership based on Schedule 13G/A filed with the Commission on
February 10, 1998.
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<PAGE> 67
(4) Includes 51,000 shares subject to outstanding options held by Mr. Hamachek,
which are exercisable within the 60-day period following May 31, 1998.
(5) Includes 5,142 shares subject to outstanding stock options held by Mr.
Freiman, which are exercisable within the 60-day period following May 31,
1998.
(6) Includes 180,000 shares held in a Grantor Annuity Trust for which Mr.
Rogers has sole voting power, as well as 40,501 shares subject to
outstanding stock options held by Mr. Rogers, which are exercisable within
the 60-day period following May 31, 1998.
(7) Includes 19,125 shares subject to outstanding stock options held by Mr.
Talley, which are exercisable within the 60-day period following May 31,
1998.
(8) Includes 11,100 shares subject to outstanding stock options held by Dr.
Baichwal, which are exercisable within the 60-day period following May 31,
1998.
(9) Includes 33,000 shares subject to outstanding stock options held by Mr.
Belsheim, which are exercisable within the 60-day period following May 31,
1998.
(10) Includes 3,000 shares subject to outstanding stock options held by Mr.
Berte which are exercisable within the 60-day period following May 31,
1998.
(11) Includes an aggregate of 173,519 shares subject to outstanding stock
options which are exercisable within the 60-day period following May 31,
1998.
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ARRANGEMENTS BETWEEN THE COMPANY AND PENFORD
In anticipation of the Distribution, the Company and Penford have entered
or will enter into a number of agreements, which will become effective on or
before the Distribution Date, for the purpose of defining certain relationships
between them. As a result of Penford's ownership interest in the Company, the
terms of such agreements were not the result of arm's-length negotiation.
However, the Company believes the terms of these agreements approximate fair
market value. See "Risk Factors -- Relationship with Penford; Conflicts of
Interest."
The following discussion of agreements between the Company and Penford
summarizes the material items of the agreements and is qualified in its entirety
by reference to the forms of such agreements, which have been filed as exhibits
to the Registration Statement of which this Information Statement is a part.
Separation and Distribution Agreement
The Company and Penford have entered into a Separation and Distribution
Agreement (the "Separation and Distribution Agreement") setting forth the
agreement of the parties with respect to the principal corporate transactions
required to effect the separation of Penford's pharmaceutical business from its
food and paper businesses, the Distribution, and certain other agreements
governing the relationship of the parties both prior to and after the
Distribution.
Asset Transfer. In connection with the separation of the pharmaceutical
business, Penford has agreed to assign to the Company, to the extent not
previously assigned, its rights, title and interest in any assets related to the
pharmaceutical business, and the Company has agreed to assume, to the extent not
previously assumed, all of Penford's liabilities relating to the pharmaceutical
business. Penford will assign to the Company its rights in the agreements
entered into with the Company's collaborators. Penford also has agreed to
contribute to the capital of the Company all existing remaining intercompany
indebtedness of the Company ($44.6 million as of March 31, 1998).
Treatment of Options. Penford and the Company have also agreed that at the
time of the Distribution the stock options to purchase the common stock of
Penford will be adjusted to reflect the Distribution. Options to purchase
Penford common stock not held by employees of the Company will be adjusted so
that the number of shares subject to such options and the exercise price of such
options will preserve the approximate value of such options immediately prior to
the Distribution Date. To accomplish this, (i) the number of shares of Common
Stock covered by options under the Spinoff Plan will be determined by
multiplying the number of shares of Penford common stock subject to each
outstanding Penford Option by the average of the high and low trading prices of
the Penford common stock on the Nasdaq National Market on the Distribution Date
and then dividing the result by the average of the high and low trading prices
of the Common Stock on the Nasdaq National Market on the trading day immediately
following the Distribution Date, and (ii) the exercise price of such options
will be determined by multiplying the exercise price of the Penford Option by
the average of the high and low trading prices of the Common Stock on the Nasdaq
National Market on the trading day immediately following the Distribution Date
and then dividing the result by the average of the high and low trading prices
of the Penford common stock on the Nasdaq National Market on the Distribution
Date. Options to purchase Penford common stock held by non-employee directors
will be further adjusted to reflect the grant of corresponding options under the
Spinoff Plan.
Options to purchase Penford common stock held by employees of the Company
will also be adjusted through the grant of replacement options under the Spinoff
Plan. See "Management -- Employee Benefit Plans -- 1998 Spinoff Option Plan" for
the terms of such replacement options and the method by which the number of
shares of Common Stock covered by such options and the exercise price of such
options will be adjusted in the replacement options.
Indemnification. The Company has agreed to indemnify Penford from and
against any liabilities arising out of (i) the employment of individuals by the
Company, (ii) the pharmaceutical business and the use of the assets transferred
to the Company, (iii) purchase orders, accounts payable, accrued compensation
and other liabilities which relate to the pharmaceutical business and the assets
transferred to the Company, and (iv) any misstatement or omission of a material
fact in any documents or filings prepared by the Company for purposes of
compliance or qualification under applicable securities laws in connection with
this Distribution, including
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<PAGE> 69
this Information Statement (the "SEC filings"). Penford has agreed to indemnify
the Company from and against all liabilities arising out of (i) the business of
Penford and the liabilities not assumed by the Company and (ii) any misstatement
or omission of a material fact with respect to Penford based on information
supplied by Penford in the SEC filings.
Sharing of Utilities. Penford has agreed that the Company will be entitled
to use and consume at the Company's Cedar Rapids facility certain utilities
consisting of natural gas, electricity and steam from Penford's Cedar Rapids
facility. The Company will reimburse Penford for such consumption based on
Penford's total cost for such utilities and the Company's fraction of the total
consumption.
Non-Competition and Non-Solicitation. Penford has agreed that, during the
period ending upon the later of (a) November 3, 2002 or (b) the expiration or
termination of the Excipient Supply Agreement to be entered into between Penford
and the Company, it shall not (i) manufacture, market, sell or distribute for
inclusion in any pharmaceutical or nutritional product (excluding any food
product) any product having the same or substantially the same form, composition
or application as EMDEX or CANDEX or any similar sugar-based product or (ii)
recruit or solicit any employee of the Company, without the consent of the
Company. The Company has agreed that during the same period, it will not (i)
manufacture, market, sell or distribute for inclusion in any foods product any
product having the same or substantially the same form, composition or
applications as EMDEX or CANDEX or any similar sugar-based product or (ii)
recruit or solicit any employee of Penford, without the consent of Penford.
Guaranty of Credit Facility. Penford has agreed that, for a period ending
August 31, 2000, it will guarantee the Company's indebtedness under the Credit
Facility. In connection with such guaranty, the Company has agreed that during
the effectiveness of such guaranty, and subject to the exercise by the Board of
Directors of Penwest of its fiduciary duties, Penwest will use its reasonable
best efforts to assure that at least one person designated by Penford is elected
to serve on the Penwest Board.
Services Agreement
The Company and Penford have entered into a services agreement (the
"Services Agreement") pursuant to which Penford will continue on an interim
basis to provide or otherwise make available to the Company, upon the Company's
reasonable request, certain accounting and audit, finance and treasury, tax,
financial and human resources services, provide for certain insurance coverage
and arrange for administration of insurance and risk management and employee
benefit programs. The Company will pay 110% of the direct costs of these
services. To the extent that such direct costs cannot be separately measured,
the Company will pay a portion of the total cost determined on a reasonable
basis selected by Penford and approved by the Company. The initial term of the
Services Agreement will expire on the first anniversary of the Distribution Date
and will be extended automatically for successive one-year terms unless either
party provides written notice of its election not to renew the Services
Agreement at least 90 days prior to the expiration of the initial or any renewal
term.
Tax Allocation Agreement
The Company and Penford have entered into a tax allocation agreement (the
"Tax Allocation Agreement") providing for (i) the allocation of any taxes
payable if the Distribution fails to qualify as tax-free under Sections 355 and
368 of the Code, and (ii) various related matters. Under the Tax Allocation
Agreement, the Company will be responsible for any tax liabilities (including
interest and penalties) imposed on it and will indemnify Penford for any tax
liabilities (including interest and penalties) imposed on Penford that are
directly related to the failure of the Distribution to qualify as tax-free under
Sections 355 and 368 of the Code as a result of (i) the inaccuracy of certain
representations and covenants made by the Company in the Tax Allocation
Agreement or (ii) the participation by the Company in certain acts set forth in
the Tax Allocation Agreement that occur after the Distribution.
Excipient Supply Agreement
The Company and Penford have entered into a supply agreement (the "Supply
Agreement") pursuant to which Penford will manufacture and supply exclusively to
the Company, and the Company will purchase exclusively from Penford, subject to
certain exceptions, all the Company's requirements for EMDEX and
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<PAGE> 70
CANDEX, two sugar-based excipients marketed by the Company. The Company will
purchase such excipients at specified prices, which will be subject to
adjustment on an annual basis. The initial term of the Supply Agreement will
expire on December 31, 2003, unless earlier terminated by the Company or Penford
upon one year's prior written notice, and will be extended automatically for
successive one-year terms unless either party provides written notice of its
election not to renew the Supply Agreement at least 90 days prior to the
expiration of the initial or any renewal term. Revenues from the sale of EMDEX
and CANDEX represented less than 10% of the Company's total revenues for the
three months ended March 31, 1998 and each of the three years ended December 31,
1997.
Employee Benefits Agreement
The Company and Penford have entered into an employee benefits agreement
(the "Benefits Agreement") setting forth the parties' agreements as to the
termination, as of the Distribution Date, of participation of the Company
employees under certain of Penford's welfare, retirement and other benefit plans
and sets forth the manner in which the assets and liabilities under certain of
such plans will be transferred to the Company. Under the Benefits Agreement, the
Company has agreed to establish for its employees a set of benefit plans similar
to those provided by Penford with the exception of Penford's defined benefit
plan.
Conflicts of interest may arise between the Company and Penford in a number
of areas relating to their past and ongoing relationships, including the
manufacture of certain excipients, tax and employee benefit matters, indemnity
arrangements and the guaranty by Penford of the Company's indebtedness under the
Credit Facility.
In connection with Penford's guaranty of the Company's indebtedness under
the Credit Facility, the Credit Facility provides that the breach by Penford of
its guarantee of the Company's indebtedness under the Credit Facility or the
occurrence of an event of default under any credit agreement with Penford under
which the lender is either the sole or participating lender, including without
limitation, an event or default arising from the failure of Penford to satisfy
certain financial covenants requiring, among other things, the maintenance of a
minimum net worth and of certain financial ratios, would constitute a default by
the Company under the Credit Facility. Accordingly, the Company will be
substantially dependent on Penford in order to access and maintain the Credit
Facility. Any default by the Company under the Credit Facility would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company and Penford may enter into amendments to the terms of the
foregoing agreements or new material transactions and agreements in the future.
The Company has been advised by Penford that it intends that the terms of any
future amendments, transactions and agreements between the Company and Penford
or its affiliates will approximate fair market value. The Board will utilize
such procedures in evaluating the terms and provisions of any material
transactions between the Company and Penford or its affiliates as the Board may
deem appropriate in light of its fiduciary duties under state law. Depending on
the nature and size of the particular transaction, in any such evaluation, the
Board may rely on management's statements and opinions and may or may not
utilize outside experts or consultants or obtain independent appraisals or
opinions.
Directors of the Company who are also directors of Penford may have
conflicts of interest with respect to matters potentially or actually involving
or affecting the Company and Penford, such as acquisitions, financings and other
corporate opportunities that may be suitable for the Company and Penford. To the
extent that such opportunities arise, such directors may consult with their
legal advisors and make a determination after consideration of a number of
factors, including whether such opportunity is presented to any such director in
his or her capacity as a director of the Company, whether such opportunity is
within the Company's line of business or consistent with its strategic
objectives and whether the Company will be able to undertake or benefit from
such opportunity. Mr. Hamachek may have a conflict of interest as a result of a
loan advanced to him by Penford. See "Management -- Executive Compensation." In
addition, determinations may be made by the Board, when appropriate, by the vote
of the disinterested directors only. Notwithstanding the foregoing, there can be
no assurance that conflicts will be resolved in favor of the Company. See "Risk
Factors -- Relationship with Penford; Conflicts of Interest."
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company immediately prior to the
Distribution will consist of 39,000,000 shares of Common Stock, $0.001 par value
per share, and 1,000,000 shares of Preferred Stock, $0.001 par value per share
("Preferred Stock").
The following summary of certain provisions of the Common Stock and the
Preferred Stock does not purport to be complete and is subject to, and qualified
in its entirety by, the provisions of the Company's Amended and Restated
Articles of Incorporation (the "Restated Articles"), which are included as an
exhibit to the Registration Statement of which this Information Statement is a
part, and by the provisions of applicable law.
COMMON STOCK
Holders of Common Stock are entitled to receive dividends as may from time
to time be declared by the Board out of funds legally available therefor,
subject to any preferential dividend rights of any outstanding class or series
of Preferred Stock and to one vote per share on all matters on which the holders
of Common Stock are entitled to vote. Such holders do not have any cumulative
voting rights or preemptive, conversion, redemption or sinking fund rights. In
the event of a liquidation, dissolution or winding up of the Company, holders of
Common Stock are entitled to share equally and ratably in the Company's assets,
if any, remaining after the payment of all liabilities of the Company and the
liquidation preference of any outstanding class or series of Preferred Stock.
The outstanding shares of Common Stock are, and the shares of Common Stock
offered hereby will be, when issued and paid for, fully paid and nonassessable.
The rights, preferences and privileges of holders of Common Stock are subject
to, and may be adversely affected by, the rights of the holders of shares of any
series of Preferred Stock that the Company may issue in the future.
PREFERRED STOCK
The Board has the authority to issue up to 1,000,000 shares of Preferred
Stock in one or more series and to fix the number of shares constituting any
such series and the preferences, limitations and relative rights, including
dividend rights, dividend rate, voting rights, terms of redemption, redemption
price or prices, conversion rights and liquidation preferences of the shares
constituting any series, without any further vote or action by the Company's
shareholders. The issuance of Preferred Stock by the Board could adversely
affect the rights of holders of Common Stock. The potential issuance of
Preferred Stock may have the effect of delaying, deferring or preventing a
change in control of the Company, may discourage bids for the Common Stock at a
premium over the market price of the Common Stock and may adversely affect the
market price of, and the voting and other rights of the holders of, the Common
Stock. The Company has no current plans to issue any shares of Preferred Stock
other than in connection with the adoption of a shareholder rights plan, which
the Company may consider adopting.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services.
WASHINGTON LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS
The laws of Washington, where the Company is incorporated, restrict certain
transactions between Washington corporations and certain significant
shareholders. Chapter 23B.19 of the Washington Business Corporation Act
prohibits a "target corporation," with certain exceptions, from engaging in any
"significant business transaction" with a person or group of persons which has
acquired 10% or more of the voting securities of the target corporation (an
"acquiring person") for five years after such acquisition unless the transaction
or such acquisition is approved by a majority of the members of the target
corporation's board of directors prior to acquisition. Significant business
transactions include, among others, a merger, share exchange or consolidation
with, disposition of assets to, or issuance or redemption of stock to or from,
the acquiring person, or a reclassification of securities that has the effect of
increasing the proportionate share of the outstanding securities held by the
acquiring person. After the five-year period, a significant business
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transaction may take place if it complies with certain fair price provisions of
the statute. A target corporation includes every Washington corporation that has
a class of voting stock registered pursuant to Section 12 or 15 of the Exchange
Act.
The Restated Articles provide for the division of the Board into three
classes as nearly equal in size as possible with staggered three-year terms. In
addition, the Restated Articles provide that directors may be removed only for
cause by the affirmative vote of the holders of two-thirds of the shares of
capital stock of the Company entitled to vote. Under the Restated Articles, any
vacancy on the Board, however occurring, including a vacancy resulting from an
enlargement of the Board, may only be filled by vote of a majority of the
directors then in office. The classification of the Board and the limitations on
the removal of directors and filling of vacancies could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from acquiring, control of the Company.
The Company's Amended and Restated Bylaws (the "Restated Bylaws") provide
that any action required or permitted to be taken by the shareholders of the
Company at an annual meeting or special meeting of shareholders may only be
taken if it is properly brought before such meeting and that any such action may
also be taken without a meeting by written consent if all the shareholders
entitled to vote with respect to such action so consent. The Restated Articles
provide that special meetings of the shareholders may be called by the President
of the Company, the Chairman of the Board or the Board. Under the Restated
Bylaws, in order for any matter to be considered "properly brought" before a
meeting, a shareholder must comply with certain requirements regarding advance
notice to the Company. The foregoing provisions could have the effect of
delaying until the next shareholders meeting shareholder actions which are
favored by the holders of a majority of the outstanding voting securities of the
Company. These provisions may also discourage another person or entity from
making a tender offer for the Company's Common Stock, because such person or
entity, even if it acquired a majority of the outstanding voting securities of
the Company, would be able to take action as a shareholder (such as electing new
directors or approving a merger) only at a duly called shareholders meeting, and
not by written consent.
The laws of Washington provide generally that the affirmative vote of a
majority of the shares entitled to vote on any matter is required to amend a
corporation's articles of incorporation or bylaws, unless a corporation's
articles of incorporation or bylaws, as the case may be, require a greater
percentage. The Restated Articles and the Restated Bylaws require the
affirmative vote of the holders of at least two-thirds of the shares of capital
stock of the Company issued and outstanding and entitled to vote to amend or
repeal any of the provisions described in the prior two paragraphs.
The Restated Articles contain certain provisions relating to the
elimination of personal liability of directors to the Company or its
shareholders for monetary damages to the full extent permitted by Washington
law. In addition, the Restated Bylaws contain provisions to indemnify the
Company's directors and officers to the fullest extent permitted by Washington
law.
RIGHTS AGREEMENT
On June 25, 1998, the Board declared a dividend of one right for each
outstanding share of the Common Stock (the "Right") to shareholders of record at
the close of business on July 28, 1998 (the "Record Date"). Each Right entitles
the registered holder to purchase from the Company one one-thousandth of a share
of Series A Junior Participating Preferred Stock, $.001 par value per share (the
"Series A Preferred Stock"), at a purchase price of $60 in cash ("Purchase
Price"), subject to adjustment. The description and terms of the Rights are set
forth in a Rights Agreement, and the following description of the Rights does
not purport to be complete and is qualified in its entirety by reference to the
Rights Agreement.
Initially, the Rights will be attached to all Common Stock certificates
representing shares then outstanding, and no separate Rights Certificates will
be distributed. The Rights will separate from the Common Stock and a "Rights
Distribution Date" will occur upon the earlier of (i) 10 business days (or such
later date as may be determined by the Board) following the later of (a) a
public announcement that a person or group of affiliated or associated persons
(a "Rights Acquiring Person") has acquired, or obtained the right to acquire,
beneficial ownership of 15% or more of the outstanding shares of Common Stock or
(b) the first
69
<PAGE> 73
date on which an executive officer of the Company has actual knowledge that a
Rights Acquiring Person has become such (the "Stock Acquisition Date"), or (ii)
10 business days (or such later date as may be determined by the Board)
following the commencement of a tender offer or exchange offer that would result
in a person or group beneficially owning 15% or more of such outstanding shares
of Common Stock. Until the Rights Distribution Date (or earlier redemption or
expiration of the Rights), (i) the Rights will be evidenced by the Common Stock
certificates and will be transferred only with such Common Stock certificates,
(ii) new Common Stock certificates issued after the Record Date will contain a
notation incorporating the Rights Agreement by reference and (iii) the surrender
for transfer of any certificates for Common Stock outstanding, even without such
notation, will also constitute the transfer of the Rights associated with the
Common Stock represented by such certificate.
The Rights are not exercisable until the Rights Distribution Date and will
expire upon the close of business on July 27, 2008 (the "Final Expiration Date")
unless earlier redeemed or exchanged as described below. As soon as practicable
after the Rights Distribution Date, separate Rights Certificates will be mailed
to holders of record of the Common Stock as of the close of business on the
Rights Distribution Date and, thereafter, the separate Rights Certificates alone
will represent the Rights. Except as otherwise determined by the Board, and
except for shares of Common Stock issued upon exercise, conversion or exchange
of then outstanding options, convertible or exchangeable securities or other
contingent obligations to issue shares, only shares of Common Stock issued prior
to the Rights Distribution Date will be issued with Rights.
In the event that any Person becomes a Rights Acquiring Person, unless the
event causing the 15% threshold to be crossed is a Permitted Offer (as defined
in the Rights Agreement), then, promptly following the first occurrence of such
event, each holder of a Right (except as provided below and in Section 7(e) of
the Rights Agreement) shall thereafter have the right to receive, upon exercise,
that number of shares of Common Stock of the Company (or, in certain
circumstances, cash, property or other securities of the Company) which equals
the exercise price of the Right divided by 50% of the current market price (as
defined in the Rights Agreement) per share of Common Stock at the date of the
occurrence of such event. However, Rights are not exercisable following such
event until such time as the Rights are no longer redeemable by the Company as
described below. Notwithstanding any of the foregoing, following the occurrence
of such event, all Rights that are, or (under certain circumstances specified in
the Rights Agreement) were, beneficially owned by any Rights Acquiring Person
will be null and void. The event summarized in this paragraph is referred to as
a "Section 11(a)(ii) Event."
In the event that, at any time after any Person becomes a Rights Acquiring
Person, (i) the Company is consolidated with, or merged with and into, another
entity and the Company is not the surviving entity of such consolidation or
merger (other than a consolidation or merger which follows a Permitted Offer) or
if the Company is the surviving entity, but shares of its outstanding Common
Stock are changed or exchanged for stock or securities (of any other person) or
cash or any other property, or (ii) 50% or more of the Company's assets or
earning power is sold or transferred, each holder of a Right (except Rights
which previously have been voided as set forth above) shall thereafter have the
right to receive, upon exercise, that number of shares of common stock of the
acquiring company which equals the exercise price of the Right divided by 50% of
the current market price of such common stock at the date of the occurrence of
the event. The events summarized in this paragraph are referred to as "Section
13 Events." A Section 11(a)(ii) Event and Section 13 Events are collectively
referred to as "Triggering Events."
At any time after the occurrence of a Section 11(a)(ii) Event, subject to
certain conditions, the Board may exchange the Rights (other than Rights owned
by such Rights Acquiring Person which have become void), in whole or in part, at
an exchange ratio of one share of Common Stock, or one one-thousandth of a share
of Series A Preferred Stock (or of a share of a class or series of the Company's
preferred stock having equivalent rights, preferences and privileges), per Right
(subject to adjustment).
The Purchase Price payable, and the number of units of Series A Preferred
Stock or other securities or property issuable, upon exercise of the Rights are
subject to adjustment from time to time to prevent dilution (i) in the event of
a stock dividend on, or a subdivision, combination or reclassification of, the
Series A Preferred Stock, (ii) if holders of the Series A Preferred Stock are
granted certain rights or warrants to
70
<PAGE> 74
subscribe for Series A Preferred Stock or convertible securities at less than
the then-current market price of the Series A Preferred Stock, or (iii) upon the
distribution to holders of the Series A Preferred Stock of evidences of
indebtedness or assets (excluding regular periodic cash dividends paid out of
earnings or retained earnings) or of subscription rights or warrants (other than
those referred to above). The number of Rights associated with each share of
Common Stock is also subject to adjustment in the event of a stock split of the
Common Stock or a stock dividend on the Common Stock payable in Common Stock or
subdivisions, consolidations or combinations of the Common Stock occurring, in
any such case, prior to the Rights Distribution Date.
With certain exceptions, no adjustment in the Purchase Price will be
required until cumulative adjustments amount to at least 1% of the Purchase
Price. No fractional shares of Series A Preferred Stock (other than fractions
which are integral multiples of one one-thousandth of a share of Series A
Preferred Stock) will be issued and, in lieu thereof, an adjustment in cash will
be made based on the market price of the Series A Preferred Stock on the last
trading date prior to the date of exercise.
Series A Preferred Stock purchasable upon exercise of the Rights will not
be redeemable. Each share of Series A Preferred Stock will be entitled to
receive, when, as and if declared by the Board, a minimum preferential quarterly
dividend payment of $10 per share or, if greater, an aggregate dividend of 1,000
times the dividend declared per share of Common Stock. In the event of
liquidation, the holders of the Series A Preferred Stock will be entitled to a
minimum preferential liquidation payment of $1,000 per share and will be
entitled to an aggregate payment of 1,000 times the payment made per share of
Common Stock. Each share of Series A Preferred Stock will have 1,000 votes,
voting together with the Common Stock. In the event of any merger, consolidation
or other transaction in which Common Stock is changed or exchanged, each share
of Series A Preferred Stock will be entitled to receive 1,000 times the amount
received per share of Common Stock. These rights are protected by customary
antidilution provisions. Because of the nature of the Series A Preferred Stock's
dividend, liquidation and voting rights, the value of one one-thousandth of a
share of Series A Preferred Stock purchasable upon exercise of each Right should
approximate the value of one share of Common Stock.
At any time prior to the earlier of (i) the tenth Business Day (or such
later date as may be determined by the Board) after the Stock Acquisition Date,
or (ii) the Final Expiration Date, the Company may redeem the Rights in whole,
but not in part, at a price of $.001 per Right (the "Redemption Price"), payable
in cash or stock, provided, however, that if a majority of the Board is
comprised of persons elected at a meeting of shareholders who were not nominated
by the Board in office immediately prior to such meeting, then the Rights may
not be redeemed for a period of 90 days after such election if such redemption
is reasonably likely to have the purpose or effect of allowing any person to
become a Rights Acquiring Person or otherwise facilitating the occurrence of a
Triggering Event or a transaction with a Rights Acquiring Person. Immediately
upon the action of the Board ordering redemption of the Rights, the Rights will
terminate and the only right of the holders of Rights will be to receive the
Redemption Price. The Rights may also be redeemable following certain other
circumstances specified in the Rights Agreement.
Until a Right is exercised, the holder thereof, as such, will have no
rights as a shareholder of the Company, including, without limitation, the right
to vote or to receive dividends. While the distribution of the Rights will not
be taxable to shareholders or to the Company, shareholders may, depending upon
the circumstances, recognize taxable income in the event that the Rights become
exercisable for Common Stock (or other consideration) of the Company or for
common stock of the acquiring company as set forth above.
Subject to certain exceptions, any of the provisions of the Rights
Agreement may be amended by the Board prior to such time as the Rights are no
longer redeemable.
71
<PAGE> 75
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Washington Business Corporation Act and the Company's Amended and
Restated Bylaws provide for indemnification of the Company's directors and
officers for liabilities and expenses that they may incur in such capacities. In
general, under the Company's Amended and Restated Bylaws, directors and officers
are indemnified with respect to actions taken in good faith in a manner
reasonably believed to be in, or not opposed to, the best interests of the
Company, and with respect to any criminal action or proceeding, actions that the
indemnitee had no reasonable cause to believe were unlawful. The officers and
directors of the Company are currently covered under director and officer
liability insurance maintained by Penford. The Company expects to obtain its own
director and officer liability insurance prior to or effective on the
Distribution.
72
<PAGE> 76
PENWEST PHARMACEUTICALS CO.
INDEX TO FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 1998 (UNAUDITED) AND DECEMBER 31, 1997 AND
FOR THE THREE MONTHS ENDED MARCH 31, 1997 (UNAUDITED) AND
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Statements
Consolidated Balance Sheets............................... F-2
Consolidated Statements of Operations..................... F-3
Condensed Consolidated Statements of Cash Flows........... F-4
Notes to Condensed Consolidated Financial Statements...... F-5
</TABLE>
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<S> <C>
Report of Ernst & Young LLP................................. F-10
Financial Statements
Consolidated Balance Sheets............................... F-11
Consolidated Statements of Operations..................... F-12
Consolidated Statements of Shareholder's Equity
(Deficit).............................................. F-13
Consolidated Statements of Cash Flows..................... F-14
Notes to Consolidated Financial Statements................ F-15
</TABLE>
F-1
<PAGE> 77
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1997 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 938 $ 723
Trade accounts receivable, net............................ 3,005 3,713
Inventories:
Raw materials and other................................ 1,545 1,091
Finished goods......................................... 7,146 6,246
------- -------
8,691 7,337
Prepaid expenses and other current assets................... 358 1,319
------- -------
Total current assets.............................. 12,992 13,092
Fixed assets, net........................................... 22,311 22,363
Other assets................................................ 2,133 2,240
------- -------
Total assets...................................... $37,436 $37,695
======= =======
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Accounts payable and accrued expenses..................... $ 3,410 $ 3,440
Taxes payable............................................. 361 580
Payable to Penford........................................ 42,654 44,617
------- -------
Total current liabilities......................... 46,425 48,637
Deferred taxes.............................................. 2,967 3,175
Other long-term liabilities................................. 341 286
------- -------
Total liabilities................................. 49,733 52,098
Shareholder's deficit:
Common stock, par value $.001, authorized 39,000,000
shares, issued and outstanding 11,055,462 shares....... 11 11
Additional paid-in capital................................ 8,079 8,079
Accumulated deficit....................................... (19,649) (21,679)
Cumulative translation adjustment......................... (738) (814)
------- -------
Total shareholder's deficit....................... (12,297) (14,403)
------- -------
Total liabilities and shareholder's deficit....... $37,436 $37,695
======= =======
</TABLE>
- ---------------
Note: The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.
See accompanying notes to condensed consolidated financial statements.
F-2
<PAGE> 78
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
-----------------
1997 1998
------ -------
(UNAUDITED)
<S> <C> <C>
Revenues
Product sales............................................. $6,645 $ 7,761
Royalties and licensing fees.............................. 325 25
------ -------
Total revenues.................................... 6,970 7,786
Cost of product sales....................................... 4,891 5,836
------ -------
Gross profit.............................................. 2,079 1,950
Operating expenses
Selling, general and administrative....................... 2,044 2,357
Research and product development.......................... 851 1,285
------ -------
Total operating expenses.......................... 2,895 3,642
------ -------
Loss before income taxes.................................. (816) (1,692)
Income tax expense........................................ 16 338
------ -------
Net loss.................................................. $ (832) $(2,030)
====== =======
Basic and diluted loss per share.......................... $(0.08) $ (0.18)
====== =======
Weighted average shares of common stock outstanding....... 11,055 11,055
====== =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
F-3
<PAGE> 79
PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
------------------
1997 1998
------- -------
<S> <C> <C>
Net cash used in operating activities....................... $(1,738) $(1,184)
Net cash used in investing activities:
Acquisitions of fixed assets, net......................... (78) (668)
Other..................................................... (301) (282)
------- -------
Net cash used in investing activities....................... (379) (950)
Cash provided by financing activities:
Increase in payable to Penford............................ 2,550 1,934
Effect of exchange rate changes on cash..................... (71) (15)
------- -------
Net increase (decrease) in cash and cash equivalents........ 362 (215)
Cash and cash equivalents at beginning of period............ 695 938
------- -------
Cash and cash equivalents at end of period.................. $ 1,057 $ 723
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
F-4
<PAGE> 80
PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation for
the interim periods presented have been included. Operating results for the
three month period ended March 31, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998. For further
information, refer to the consolidated financial statements and footnotes
thereto included elsewhere in this report on Form 10.
2. INCOME TAXES
The effective tax rate for the quarter ended March 31, 1998 was 20%. The
effective rate is higher than the federal statutory rate of a 34% benefit due
primarily to the effect of tax benefits utilized by Penford Corporation for
which Penwest is not reimbursed, temporary differences resulting from
accelerated depreciation reversing when losses are not expected to be available
and foreign income taxes.
3. EARNINGS PER COMMON SHARE
During the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." Statement
No. 128 replaced the previous requirement to report primary and fully diluted
earnings per share with basic and diluted earnings per share. Basic earnings per
share reflects only the weighted average common shares outstanding. Diluted
earnings per share reflects weighted average common shares outstanding and the
effect, if any, of dilutive common stock equivalent shares. SFAS No. 128 does
not impact the Company's net loss per share.
4. COMPREHENSIVE LOSS
As of January 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130 "Reporting Comprehensive Income". Statement No. 130
establishes new rules for the reporting and display of comprehensive income
(loss) and its components; however, the adoption of this Statement had no impact
on the Company's net loss or shareholder's deficit.
The components of comprehensive loss, for the three-month periods ended
March 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1997 1998
---------- ----------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C>
Net loss.................................................... $ (832) $(2,030)
Foreign currency translation adjustments.................... (268) (76)
------- -------
Comprehensive loss.......................................... $(1,100) $(2,106)
======= =======
</TABLE>
Accumulated other comprehensive loss equals the amount included in
shareholder's deficit for cumulative translation adjustment which is the only
component of other comprehensive loss included in the Company's financial
statements.
F-5
<PAGE> 81
PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. CONTINGENCIES
In May 1997, one of the Company's collaborators, Mylan, filed an
Abbreviated New Drug Application ("ANDA") with the U.S. Food and Drug
Administration ("FDA") for the 30 mg dosage strength of Nifedipine XL, a generic
version of Procardia XL, a controlled release formulation of nifedipine. Bayer
AG ("Bayer") and ALZA Corporation ("ALZA") own patents listed for Procardia XL
(the last of which expires in 2010), and Pfizer Inc. ("Pfizer") is the sponsor
of the New Drug Application ("NDA") and markets the product. In connection with
the ANDA filing, Mylan certified to the FDA that Nifedipine XL does not infringe
these Bayer or ALZA patents and notified Bayer, ALZA and Pfizer of such
certification. Bayer and Pfizer sued Mylan in the United States District Court
for the Western District of Pennsylvania, alleging that Mylan's product
infringes Bayer's patent. The Company has been informed by Mylan that ALZA does
not believe that the notice given to it complied with the requirements of the
Waxman-Hatch Act, and there can be no assurance that ALZA will not sue Mylan for
patent infringement or take any other actions with respect to such notice. Mylan
has advised the Company that it intends to contest vigorously the allegations
made in the lawsuit. However, there can be no assurance that Mylan will prevail
in this litigation or that it will continue to contest the lawsuit. If the
litigation results in a determination that Nifedipine XL infringes Bayer's
patent, Nifedipine XL could not be marketed in the United States until such
patent expired. An unfavorable outcome or protracted litigation for Mylan would
materially adversely affect the Company's business, financial condition, cash
flows and results of operations. Delays in the commercialization of Nifedipine
XL could also occur because the FDA will not grant final marketing approval of
Nifedipine XL until a final judgment on the patent suit is rendered in favor of
Mylan by the district court, or in the event of an appeal, by the court of
appeals, or until 30 months (or such longer or shorter period as the court may
determine) have elapsed from the date of Mylan's certification, whichever is
sooner.
In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming that
its Procardia XL formulation constituted a unique delivery system and that a
drug with a different release mechanism such as the TIMERx controlled release
system cannot be considered the same dosage form and approved in an ANDA as
bioequivalent to Procardia XL. In August 1997, the FDA rejected Pfizer's
citizen's petition. In July 1997, Pfizer also sued the FDA in the District Court
of the District of Columbia, claiming that the FDA's acceptance of Mylan's ANDA
filing for Nifedipine XL was contrary to law, based primarily on the arguments
stated in its citizen's petition. Mylan and the Company intervened as defendants
in this suit. In April 1998 the District Court of the District of Columbia
rejected Pfizer's claim, and in May 1998, Pfizer appealed the District Court's
decision. There can be no assurance that the FDA, Mylan and the Company will
prevail in this litigation. An outcome in this litigation adverse to Mylan and
the Company would result in Mylan being required to file a suitability petition
in order to maintain the ANDA filing or to file an NDA with respect to
Nifedipine XL, each of which would be expensive and time consuming. An adverse
outcome also would result in Nifedipine XL becoming ineligible for an "AB"
rating from the FDA. Failure to obtain an AB rating from the FDA would indicate
that for certain purposes Nifedipine XL would not be deemed to be
therapeutically equivalent to the referenced branded drug, would not be fully
substitutable for the referenced branded drug and would not be relied upon by
Medicaid and Medicare formularies for reimbursement. Any such failure would have
a material adverse effect on the Company's business, financial condition, cash
flows and results of operations. If any of such events occur, Mylan may
terminate its efforts with respect to Nifedipine XL, which would have a material
adverse effect on the Company's business, financial condition, cash flows and
results of operations.
In 1994, the Boots Company PLC ("Boots") filed in the European Patent
Office (the "EPO") an opposition to a patent granted by the EPO to the Company
relating to its TIMERx technology. In June 1996, the EPO dismissed Boots'
opposition, leaving intact all claims included in the patent. Boots has appealed
this decision to the EPO Board of Appeals. There can be no assurance that the
Company will prevail in this matter. An unfavorable outcome could materially
adversely affect the Company's business, financial condition, cash flows and
results of operations.
F-6
<PAGE> 82
PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Substantial patent litigation exists in the pharmaceutical industry. Patent
litigation generally involves complex legal and factual questions, and the
outcome frequently is difficult to predict. An unfavorable outcome in any patent
litigation affecting the Company could cause the Company to pay substantial
damages, alter its products or processes, obtain licenses and/or cease certain
activities. Even if the outcome is favorable to the Company, the Company could
incur substantial litigation costs. Although the legal costs of defending
litigation relating to a patent infringement claim (unless such claim relates to
TIMERx) are generally the contractual responsibility of the Company's
collaborators, the Company could nonetheless incur significant unreimbursed
costs in participating and assisting in the litigation.
Testing, manufacturing, marketing and selling pharmaceutical products
entail a risk of product liability. The Company faces the risk of product
liability claims in the event that the use of its products is alleged to have
resulted in harm to a patient or subject. Such risks exist even with respect to
those products that are manufactured in licensed and regulated facilities or
that otherwise possess regulatory approval for commercial sale. Product
liability insurance coverage is expensive, difficult to obtain and may not be
available in the future on acceptable terms, if at all. Until the Distribution,
the Company will be covered by primary product liability insurance maintained by
Penford in the amount of $1.0 million per occurrence and $2.0 million annually
in the aggregate on a claims-made basis and by umbrella liability insurance in
excess of $5.0 million which can also be used for product liability insurance.
There can be no assurance that this coverage is adequate to cover potential
liability claims or that Penwest will be able to obtain comparable coverage
following the Distribution. Furthermore, this coverage may not be adequate as
the Company develops additional products. As the Company receives regulatory
approvals for products under development, there can be no assurance that
additional liability insurance coverage for any such products will be available
in the future on acceptable terms, if at all. The Company's business, financial
condition, cash flows and results of operations could be materially adversely
affected by the assertion of a product liability claim.
6. SUBSEQUENT EVENTS
Distribution
On May 19, 1998, the Board of Directors of Penford announced a plan to
effect a tax-free Distribution to its shareholders of 100% of Penwest's common
stock. The Distribution is subject to the satisfaction of certain conditions,
including receipt of a favorable tax ruling from the Internal Revenue Service or
a written opinion from Ernst & Young LLP. As a condition to the Distribution,
the Company will obtain a $15 million credit facility ("Credit Facility") which
Penford has agreed to guarantee. The Credit Facility is expected to be a
revolving loan facility with a maximum principal amount of $15 million of
unsecured financing. The proceeds may be used to fund working capital and for
general corporate purposes, including capital expenditures. On the second
anniversary of the execution of the Credit Facility all outstanding amounts
under the Credit Facility will become automatically due and payable, although
the Company will be required to use the proceeds of any financing conducted by
the Company prior to such date to pay down any outstanding amounts under the
Credit Facility at such time. Borrowings under the Credit Facility are expected
to bear interest at a rate equal to LIBOR, plus 1.25%. The Credit Facility is
expected to contain a number of financial covenants that relate to Penford (and
not Penwest), including requirements that Penford maintain certain levels of
financial performance and maintain certain financial ratios. The Credit Facility
is also expected to contain certain covenants applicable to both Penford and
Penwest including restrictions on the incurrence of additional debt and the
payment of dividends. Any breach of these covenants by Penford or the Company,
or a default by Penford with respect to any material indebtedness or a change of
control of Penford without the lender's consent, would constitute a default by
the Company under the Credit Facility. Accordingly, the Company will be
substantially dependent on Penford in order to access and maintain the Credit
Facility. Any default under the Credit Facility would have a material adverse
effect on the Company's business, financial condition and results of operation.
F-7
<PAGE> 83
PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On June 19, 1998, the Company effected a 0.76-for-1 reverse stock split of
its common stock. Accordingly, all share and per share data have been
retroactively adjusted to give effect to the reverse stock split.
The Company and Penford have entered into or will, on or prior to the
completion of this Distribution, enter into agreements that govern various
interim and ongoing relationships. These agreements include (i) a Separation and
Distribution Agreement setting forth the agreement of the parties with respect
to the principal corporate transactions required to effect the separation of
Penford's pharmaceutical business from its specialty carbohydrate-based chemical
business and the Distribution, including without limitation Penford's agreement
to guarantee the Company's indebtedness under the Credit Facility; (ii) a
Services Agreement pursuant to which Penford will continue on an interim basis
to provide specified services to the Company until June 30, 1998 or until
Penwest does not need the services, of which costs will be charged to the
Company on an actual or allocated basis, plus a specified profit percentage;
(iii) a Tax Allocation Agreement relating to, among other things, the allocation
of tax liability between the Company and Penford in connection with the
Distribution all pre-distribution liabilities are the responsibility of Penford
and all post distribution liabilities are those of the respective entities; (iv)
an Excipient Supply Agreement pursuant to which Penford will manufacture and
supply exclusively to the Company, and the Company will purchase exclusively
from Penford, subject to certain exceptions, all the Company's requirements for
two excipients marketed by the Company under pricing and quantity terms that the
Company believes approximate fair market value; and (v) an Employee Benefits
Agreement setting forth the parties' agreements as to the continuation of
certain Penford benefits arrangements for the employees of the Company.
Subsequent to the Distribution, no terminating liabilities will be incurred by
Penwest related to the Penford defined benefit plan.
Rights Agreement
On June 25, 1998, the Board of Directors declared a dividend of one right
for each outstanding share of the Common Stock (the "Right") to shareholders of
record at the close of business on July 28, 1998. Each Right entitles the
registered holder to purchase from the Company one one-thousandth of a share of
the Series A Preferred Stock, at a purchase price of $60 in cash, subject to
adjustment.
The rights are not currently exercisable and will not be exercisable until
the earlier of (i) 10 business days (or such later date as may be determined by
the Board) following the later of (a) a public announcement that a person or
group of affiliated or associated persons (a "Rights Acquiring Person") has
acquired, or obtained the right to acquire, beneficial ownership of 15% or more
of the outstanding shares of Common Stock or (b) the first date on which an
executive officer of the Company has actual knowledge that a Rights Acquiring
Person has become such, or (ii) 10 business days (or such later date as may be
determined by the Board) following the commencement of a tender offer or
exchange offer that would result in a person or group beneficially owning 15% or
more of such outstanding shares of Common Stock. The Rights will expire upon the
close of business on July 27, 2008 unless earlier redeemed or exchanged.
In the event that any Person becomes a Rights Acquiring Person, unless the
event causing the 15% threshold to be crossed is a permitted offer, then,
promptly following the first occurrence of such event, each holder of a Right
(except as provided below and under certain circumstances) shall thereafter have
the right to receive, upon exercise, that number of shares of Common Stock of
the Company (or, in certain circumstances, cash, property or other securities of
the Company) which equals the exercise price of the Right divided by 50% of the
current market price per share of Common Stock at the date of the occurrence of
such event. However, Rights are not exercisable following such event until such
time as the Rights are no longer redeemable by the Company. Notwithstanding any
of the foregoing, following the occurrence of such event, all Rights that are,
or (under certain circumstances) were, beneficially owned by any Rights
Acquiring Person will be null and void.
F-8
<PAGE> 84
PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the event that, at any time after any Person becomes a Rights Acquiring
Person, (i) the Company is consolidated with, or merged with and into, another
entity and the Company is not the surviving entity of such consolidation or
merger (other than a consolidation or merger which follows a Permitted Offer) or
if the Company is the surviving entity, but shares of its outstanding Common
Stock are changed or exchanged for stock or securities (of any other person) or
cash or any other property, or (ii) 50% or more of the Company's assets or
earning power is sold or transferred, each holder of a Right (except Rights
which previously have been voided as set forth above) shall thereafter have the
right to receive, upon exercise, that number of shares of common stock of the
acquiring company which equals the exercise price of the Right divided by 50% of
the current market price of such common stock at the date of the occurrence of
the event.
F-9
<PAGE> 85
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Penwest Pharmaceuticals Co.
We have audited the accompanying consolidated balance sheets of Penwest
Pharmaceuticals Co., (formerly known as Edward Mendell Co., Inc.), as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, shareholder's equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 consolidated financial position of Penwest
Pharmaceuticals Co. at December 31, 1997 and 1996, and the consolidated results
of its operations and its cash flows for the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Stamford, Connecticut
June 5, 1998,
except for the information describing
the 0.76-for-1 reverse stock split
in Note 13, as to which the date is
June 19, 1998.
F-10
<PAGE> 86
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 695 $ 938
Trade accounts receivable, net of allowance for doubtful
accounts of $237 and $337.............................. 4,680 3,005
Inventories............................................... 7,555 8,691
Prepaid expenses and other current assets................. 72 358
------- -------
Total current assets.............................. 13,002 12,992
Fixed assets, net........................................... 20,336 22,311
Other assets................................................ 1,745 2,133
------- -------
Total assets...................................... $35,083 $37,436
======= =======
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Accounts payable and accrued expenses..................... $ 3,376 $ 3,410
Taxes payable............................................. 454 361
Payable to Penford........................................ 32,534 42,654
------- -------
Total current liabilities......................... 36,364 46,425
Deferred taxes.............................................. 3,071 2,967
Other long-term liabilities................................. 60 341
------- -------
Total liabilities................................. 39,495 49,733
Shareholder's deficit
Common stock, par value $.001, authorized 39,000,000
shares, issued and outstanding 11,055,462 shares....... 11 11
Additional paid in capital................................ 8,079 8,079
Accumulated deficit....................................... (12,333) (19,649)
Cumulative translation adjustment......................... (169) (738)
------- -------
Total shareholder's deficit....................... (4,412) (12,297)
------- -------
Total liabilities and shareholder's deficit....... $35,083 $37,436
======= =======
</TABLE>
See accompanying notes.
F-11
<PAGE> 87
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Revenues
Product sales............................................. $24,989 $25,007 $26,030
Royalties and licensing fees.............................. 100 1,082 911
------- ------- -------
Total revenues.................................... 25,089 26,089 26,941
Cost of product sales....................................... 17,267 18,690 19,929
------- ------- -------
Gross profit........................................... 7,822 7,399 7,012
Operating expenses
Selling, general and administrative....................... 7,676 6,776 8,708
IPO transaction costs..................................... 1,367
Research and product development.......................... 2,719 3,723 4,109
------- ------- -------
Total operating expenses.......................... 10,395 10,499 14,184
------- ------- -------
Loss before income taxes.................................... (2,573) (3,100) (7,172)
Income tax expense.......................................... 679 764 144
------- ------- -------
Net loss.................................................... $(3,252) $(3,864) $(7,316)
======= ======= =======
Basic and diluted net loss per share........................ $(0.29) $(0.35) $(0.66)
======= ======= =======
Weighted average shares of common stock outstanding......... 11,055 11,055 11,055
======= ======= =======
</TABLE>
See accompanying notes.
F-12
<PAGE> 88
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK CUMULATIVE
--------------- PAID-IN ACCUMULATED TRANSLATION
SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT TOTAL
------ ------ ------- ----------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1995 before
stock splits...................... 5 $ 5 $8,085 $ (5,217) $(232) $ 2,641
Stock splits........................ 11,050 6 (6)
------ --- ------ -------- ----- --------
Balances, January 1, 1995 after
stock splits...................... 11,055 11 8,079 (5,217) (232) 2,641
Net loss............................ (3,252) (3,252)
Translation adjustment.............. 134 134
------ --- ------ -------- ----- --------
Balances, December 31, 1995......... 11,055 11 8,079 (8,469) (98) (477)
Net loss............................ (3,864) (3,864)
Translation adjustment.............. (71) (71)
------ --- ------ -------- ----- --------
Balances, December 31, 1996......... 11,055 11 8,079 (12,333) (169) (4,412)
Net loss............................ (7,316) (7,316)
Translation adjustment.............. (569) (569)
------ --- ------ -------- ----- --------
Balances, December 31, 1997......... 11,055 $11 $8,079 $(19,649) $(738) $(12,297)
====== === ====== ======== ===== ========
</TABLE>
See accompanying notes.
F-13
<PAGE> 89
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
CASH USED IN OPERATING ACTIVITIES:
Net loss.................................................... $(3,252) $(3,864) $(7,316)
Adjustments to reconcile net loss to Net cash used in
operating activities:
Depreciation.............................................. 1,724 2,190 2,047
Amortization.............................................. 282 207 157
Deferred income taxes..................................... 455 546 (104)
Changes in operating assets:
Accounts receivable....................................... (1,647) 470 1,805
Inventories............................................... (1,079) (3,218) (1,135)
Accounts payable and other................................ 396 224 (345)
------- ------- -------
Net cash used in operating Activities....................... (3,121) (3,445) (4,891)
NET CASH USED IN INVESTING ACTIVITIES:
Acquisitions of fixed assets, net......................... (3,990) (2,322) (4,023)
Other..................................................... (87) (657) (833)
------- ------- -------
Net cash used in investing Activities....................... (4,077) (2,979) (4,856)
CASH PROVIDED BY FINANCING ACTIVITIES:
Increase in payable to Penford............................ 6,787 6,823 10,120
Effect of exchange rate changes on Cash..................... 33 6 (130)
------- ------- -------
Net increase (decrease) in cash and cash equivalents........ (378) 405 243
Cash and cash equivalents at beginning of year.............. 668 290 695
------- ------- -------
Cash and cash equivalents at end of year.................... $ 290 $ 695 $ 938
======= ======= =======
</TABLE>
See accompanying notes.
F-14
<PAGE> 90
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Penwest Pharmaceuticals Co. and subsidiaries ("Penwest" or the "Company"),
formerly known as Edward Mendell Co., Inc. is a wholly-owned subsidiary of
Penford Corporation ("Penford"). The Company is engaged in the research,
development, and commercialization of novel drug delivery products and
technologies. The Company has developed TIMERx proprietary controlled release
drug delivery technology. The Company also manufactures and distributes
pharmaceutical excipients, the inactive ingredients in tablets and capsules. The
Company has manufacturing facilities in Iowa and Finland and has customers
primarily throughout North America and Europe.
The Company is subject to the risks and uncertainties associated with a
drug delivery company. These risks and uncertainties include, but are not
limited to, a history of net losses, technological changes, dependence on
collaborators and key personnel, no assurance of successful completion of
development efforts and of obtaining regulatory approval, compliance with
government regulations, patent infringement litigation and competition from
current and potential competitors, some with greater resources than the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Penwest and its wholly owned subsidiaries. Material intercompany balances and
transactions have been eliminated. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. In addition, the consolidated financial statements include various
costs allocated by Penford (see Notes 6 and 9). Management believes the amounts
allocated are reasonable and approximate the cost of obtaining the service from
an unrelated third party.
Certain amounts in the financial statements for prior years have been
reclassified to conform with the current year presentation. These
reclassifications had no effect on previously reported results of operations.
Cash and Cash Equivalents
All highly liquid investments with a maturity of three months or less when
purchased are considered cash equivalents.
Credit Risk and Fair Value of Financial Instruments
The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company's excipient revenues and its
licensing fees are derived from major pharmaceutical companies that have
significant cash resources. The Company maintains an allowance for doubtful
accounts which management believes is sufficient to cover potential credit
losses.
The carrying value of financial instruments, which includes cash,
receivables and payables, approximates market value.
Fixed Assets
Property and equipment are recorded at cost and depreciated by the
straight-line method over their estimated useful lives. Estimated useful lives
by class of assets are as follows:
<TABLE>
<S> <C>
Buildings................................................... 20-25 years
Machinery and equipment..................................... 10-12 years
Office furniture and equipment.............................. 5-10 years
</TABLE>
F-15
<PAGE> 91
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property and equipment of the Company are reviewed for impairment whenever
events or circumstances indicate that the asset's undiscounted expected cash
flows are not sufficient to recover its carrying amount. The Company measures an
impairment loss by comparing the fair value of the asset to its carrying amount.
Fair value of an asset is calculated as the present value of expected future
cash flows.
Foreign Currencies
Assets and liabilities of the Company's foreign operations are translated
into U.S. dollars at year-end exchange rates and revenue and expenses are
translated at average exchange rates. For each of the foreign operations, the
functional currency is the local currency. Translation adjustments are disclosed
and accumulated in a separate component of consolidated shareholder's deficit.
Realized gains and losses from foreign currency transactions are reflected in
the consolidated statement of operations. Foreign transaction gains and losses
were not significant in each of the years in the three year period ended
December 31, 1997.
Income Taxes
The Company's results of operations are included in the tax returns of
Penford. Deferred income tax expense and related income tax assets and
liabilities are reflected as if the Company were an independent entity, in
accordance with FAS 109, except that the Company is not compensated for tax
losses that are utilized by Penford. See Note 8.
Revenue Recognition
Royalties and licensing fees include milestone fees related to licensing
agreements for TIMERx with various collaborators and will include royalties when
earned. To date there have been no royalties recognized as the first
commercialized product using the TIMERx technology was launched for sale in
Finland in January 1998. Milestone payments are derived from reaching
development milestones with collaborators and are recognized as achieved in
accordance with the contract terms. These milestone payments are not subject to
forfeiture.
The Company receives certain nonrefundable payments upon the signing of
collaborative agreements. Up-front payments related specifically to the
achievement of certain milestones are recognized as those milestones are
achieved in accordance with the agreement. Up-front payments related solely to
the signing of agreements where additional services are not required are
recognized upon signing. Up-front payments that obligate the Company to perform
specific functions or services over the licensing term are recognized over the
term of the agreement.
Product sales revenues are recognized when goods are shipped.
Advertising Costs
Advertising costs are accounted for as expenses in the period in which they
are incurred.
Research and Development
Research and development expenses consist of costs related to products
being developed internally as well as costs related to products subject to
licensing agreements. Research and development costs are charged to expense as
incurred.
F-16
<PAGE> 92
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Per Share Data
Earnings per common share are computed based on the weighted average number
of common shares and dilutive common stock equivalents outstanding during the
period after giving effect to the 0.76-for-1 reverse stock split and the
2,907.66-for-1 stock split of the common stock of the Company (see Note 13).
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share. Statement 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where appropriate, restated to conform to the Statement 128 requirements. The
Company does not have any common stock equivalents. Therefore, there is no
difference between basic and diluted loss per share.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income". Statement 130 establishes new rules for
the reporting and display of comprehensive income and its components; however,
adoption in 1998 will have no impact on the Company's net loss or shareholder's
deficit. Statement 130 requires unrealized gains or losses on the Company's
foreign currency translation adjustments, which currently are reported in
shareholder's deficit, to be included in other comprehensive income and the
disclosure of total comprehensive income. If the Company adopted Statement 130
for the year ended December 31, 1997, the total of other comprehensive income
items and total comprehensive loss (which includes the net loss) would be
$569,000 and $7,885,000, respectively, and would be displayed separately.
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information", which is effective for years beginning
after December 15, 1997. Statement 131 establishes standards for the way that
public business enterprises report information about operating segments in
interim and annual financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Statement is effective for financial statements for fiscal years beginning
after December 15, 1997, and therefore the Company will adopt the new
requirements retroactively in 1998. Management has not completed its review of
Statement 131, but does not anticipate that the adoption of this statement will
have a significant effect on the Company's reported segments.
Long-Lived Assets
In March 1995, the Financial Accounting Standards Board issued Statement
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," which requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount. Statement 121 also addresses the
accounting for long-lived assets that are expected to be disposed. The Company
adopted Statement 121 in the first quarter of 1996 with no impact on financial
position or results of operations.
F-17
<PAGE> 93
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVENTORIES
Inventories, which consist of raw materials, pharmaceutical excipients
manufactured by the Company, pharmaceutical excipients held for distribution,
and manufactured bulk TIMERx, are stated at the lower of cost (first-in,
first-out) or market. Cost includes material, labor and manufacturing overhead
costs.
Inventories are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------ ------
(IN THOUSANDS)
<S> <C> <C>
Raw materials............................................... $1,745 $1,545
Finished products........................................... 5,810 7,146
------ ------
Total inventories................................. $7,555 $8,691
====== ======
</TABLE>
Included in inventories are approximately $1,742,000 and $3,096,000 of
TIMERx raw materials and bulk TIMERx as of December 31, 1996 and 1997,
respectively. The ability to continue to sell TIMERx related inventory is
dependent, in part, upon the commercialization of products by third parties
utilizing bulk TIMERx and the continued use by the Company and third parties of
the TIMERx related inventory in existing and new research efforts. Although
third parties have products in various stages of development, and the first
commercial product was launched for sale in Finland in January 1998, the period
required to achieve commercialization of other products is uncertain if achieved
at all. The manufactured bulk TIMERx does not have a predetermined shelf life.
The Company's inventories have no predetermined shelf life. The Company
periodically reviews and quality tests its inventory to identify obsolete,
slow-moving or otherwise unsaleable inventories.
The Company has relied on a large third-party pharmaceutical company for
the bulk manufacture of TIMERx material for delivery to its collaborators under
an agreement that expired in June 1998. The Company is seeking to contract with
another third-party manufacturer to manufacture TIMERx material. There are a
limited number of third party manufacturers capable of producing the TIMERx
material. The Company's current third-party manufacturer has advised the Company
that it will continue to manufacture TIMERx material on the terms set forth in
the current agreement until such time as the Company contracts with another
manufacturer, but it is not obligated to continue to manufacture TIMERx material
and there can be no assurance as to how long it will continue to manufacture
TIMERx material. There can be no assurance that third parties upon which the
Company relies for supply of its TIMERx materials will perform, and any failures
by third parties may delay development or the submission of products for
regulatory approval, impair the Company's collaborators' ability to
commercialize products as planned and deliver products on a timely basis or
otherwise impair the Company's competitive position, which could have a material
adverse effect on the Company's business, financial condition, cash flows and
results of operations.
The Company's TIMERx drug delivery system is a hydrophilic matrix combining
primarily two natural polysaccharides, xanthan and locust bean gums, in the
presence of dextrose. The Company purchases these gums from a sole source
supplier. Most of the Company's excipients are manufactured from wood pulp,
which the Company also purchases from a sole source supplier. Although the
Company has qualified alternate suppliers with respect to these materials, there
can be no assurance that interruptions in supplies will not occur in the future
or that the Company will not have to obtain substitute suppliers. Any of these
events could have a material adverse effect on the Company's ability to
manufacture bulk TIMERx for delivery to its collaborators or manufacture its
excipients, which could have a material adverse effect on the Company's results
of operations, cash flows and financial position.
F-18
<PAGE> 94
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. FIXED ASSETS
Fixed assets, at cost, summarized by major categories, consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Buildings and equipment..................................... $26,513 $27,787
Land........................................................ 696 696
Construction in progress.................................... 1,160 3,750
------- -------
28,369 32,233
Less: accumulated depreciation.............................. 8,033 9,922
------- -------
$20,336 $22,311
======= =======
</TABLE>
5. OTHER ASSETS
Other assets, net of accumulated amortization, consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------ ------
(IN THOUSANDS)
<S> <C> <C>
Patents, net of accumulated amortization of $162 and $249... $1,443 $1,888
Goodwill, net of accumulated amortization of $238 and
$295...................................................... 302 245
------ ------
$1,745 $2,133
====== ======
</TABLE>
Goodwill is being amortized over ten years and was recorded upon the
acquisition of the Company by Penford. Amortization expense approximated $57,000
for each of the years ended December 31, 1995, 1996 and 1997.
Patents include costs to secure and defend patents on technology developed
by the Company and secure trademarks. Patents are amortized over their useful
lives of 17 to 20 years. Amortization expense of $48,000, $66,000 and $87,000
was recorded in the years ended December 31, 1995, 1996 and 1997, respectively.
Recorded intangibles are evaluated for potential impairment whenever events
or circumstances indicate that the undiscounted cash flows are not sufficient to
recover their carrying amounts. An impairment loss is recorded to the extent the
asset's carrying value is in excess of related discounted cash flows.
6. TRANSACTIONS WITH PENFORD
The Payable to Penford consists solely of advances. These advances were
generated primarily from the initial acquisition of the Company, the addition of
a microcrystalline cellulose plant and the funding of operations. The Payable to
Penford is a non-interest-bearing obligation. Average balances for the years
ended December 31, 1995, 1996 and 1997 were $22,100,000, $29,123,000 and
$37,594,000, respectively. Penford has indicated that it intends to continue to
provide advances until the Distribution is completed and the Company has a
credit facility, at which time Penford intends to contribute the outstanding
payable to Penford to the Company (see Note 13). The Company also participates
in pension and other employee benefit plans sponsored by Penford and purchases
inventory from a wholly-owned subsidiary of Penford. The inventory purchases
amounted to approximately $609,000, $634,000, and $367,000 for the years ended
December 31, 1995, 1996 and 1997, respectively. The Company believes the terms
of its employee benefit and inventory purchase transactions approximate those
that would be reached with a third party in an arms length transaction and
represent the approximate costs the Company would have incurred on a stand-alone
basis.
F-19
<PAGE> 95
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Penford allocates executive office salaries, bonuses and legal fees to the
Company in the form of a management fee. The costs making up the management fee
are allocated to the Company based upon its pro-rata portion of Penford's
consolidated revenue. The Company believes the management fees approximate the
actual costs of services provided and represent the approximate costs the
Company would have incurred on a stand-alone basis. Included in selling, general
and administrative expenses is a management fee of $404,000, $391,000 and
$601,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
Penford Stock Option Plan
Certain of the Company's employees participate in Penford's 1994 Stock
Option Plan (the "1994 Plan") for which 1,000,000 shares of common stock have
been authorized for grants of options by Penford. The 1994 Plan provides for the
granting of stock options at the fair market value of the common stock on the
date of grant. Either incentive stock options or non-qualified stock options may
be granted under the 1994 Plan. The incentive stock options generally vest over
five years at the rate of 20% each year and expire 10 years from the date of
grant. The non-qualified stock options generally vest over four years at the
rate of 25% each year and expire 10 years and 10 days from the date of grant.
The Company has elected to follow Accounting Principals Board Opinion (APB)
No. 25 "Accounting for Stock Issued to Employees" and related Interpretations in
accounting for its employee stock options. Under APB No. 25, the Company does
not recognize compensation expense for Penford options granted to employees of
Penwest, since the exercise price of the options granted is equal to the market
value of the Parent's common stock at the date of grant. Statement of Financial
Accounting Standard No. 123 "Accounting for Stock Based Compensation" requires
the Company to disclose the pro forma impact on net loss and loss per share as
if compensation expense associated with employee stock options granted to
employees of Penwest had been calculated under the fair value method of
Statement No. 123 for employee stock options granted to employees of Penwest
subsequent to December 31, 1994.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
--------- --------- ---------
IN THOUSANDS, EXCEPT PER SHARE DATA
<S> <C> <C> <C>
Net loss -- as reported............................... $(3,252) $(3,864) $(7,316)
Net loss -- pro forma................................. (3,396) (4,123) (7,766)
Net loss per share, basic and diluted -- as
reported............................................ (0.29) (0.35) (0.66)
Net loss per share, basic and diluted -- pro forma.... $ (0.31) $ (0.37) $ (0.70)
</TABLE>
The fair value of each option grant was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions: risk-free
interest rates of 5.6% to 6.1%; expected option life of each vesting increment
of 2.8 years; expected volatility of 49%; and expected dividends of $0.20 per
share. The weighted average fair value of options granted under the 1994 Plan
during the years ended December 31, 1995, 1996 and 1997 was $13.02, $9.30, and
$9.67, respectively. The effect of applying Statement No. 123 for providing pro
forma disclosures for the years ended December 31, 1995, 1996 and 1997, is not
likely to be representative of the effects in future years because the amounts
above reflect only the options granted in 1995, 1996 and 1997 that vest over
four to five years. No additional Penford shares were granted to Company
employees subsequent to December 31, 1997.
F-20
<PAGE> 96
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in Penford stock options granted to employees of Penwest for the
three years ended December 31, 1995, 1996, and 1997 are as follows:
<TABLE>
<CAPTION>
OPTION PRICE WTD. AVERAGE
SHARES RANGE EXERCISE PRICE
------- --------------- --------------
<S> <C> <C> <C>
1995
Balance, January 1, 1995............................. 14,000 $20.13 - $22.75 $22.00
Granted.............................................. 71,000 21.00 - 24.50 21.30
Exercised............................................ --
Cancelled............................................ --
-------
Balance, December 31, 1995........................... 85,000 20.13 - 24.50 21.41
=======
Options Exercisable.................................. 5,000 20.13 - 24.50 22.00
1996
Granted.............................................. 80,500 17.00 - 18.25 17.71
Exercised............................................ --
Cancelled............................................ --
-------
Balance, December 31, 1996........................... 165,500 17.00 - 24.50 19.61
=======
Option Exercisable................................... 14,600 20.13 - 24.50 21.86
1997
Granted.............................................. 1,000 18.25 18.25
Exercised............................................ (600) 18.25 18.25
Cancelled............................................ (1,800) 18.25 18.25
-------
Balance, September 30, 1997.......................... 164,100 17.00 - 24.50 19.62
=======
Options Exercisable.................................. 40,050 $17.00 - $24.50 $20.15
</TABLE>
At December 31, 1997, the weighted average remaining contractual life of
options outstanding approximates 7.9 years.
7. COMMITMENTS
Leases
The Company's manufacturing facility in Finland is leased under a two-year
operating lease which includes renewal options with annual rental expense of
$188,000 plus additional charges determined on a month-to-month basis for
equipment and warehouse usage. In addition, certain of the Company's property,
plant and equipment is leased under operating leases ranging from one to fifteen
years and includes periodic escalation clauses based on rental market conditions
as well as insurance rent payments. Rental expense under operating leases was
$210,000, $216,000 and $283,000 for the years ended December 31, 1995, 1996 and
1997,
F-21
<PAGE> 97
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
respectively. Future minimum lease payments as of December 31, 1997 for
noncancellable operating leases having initial lease terms of more than one year
are as follows:
<TABLE>
<CAPTION>
OPERATING LEASES
----------------
(IN THOUSANDS)
<S> <C>
1998........................................ $ 264
1999........................................ 260
2000........................................ 69
2001........................................ 61
2002........................................ 58
Thereafter.................................. 532
------
Total minimum lease payments...... $1,244
======
</TABLE>
8. INCOME TAXES
The provision (benefit) for federal, state and foreign income taxes
consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Federal:
Deferred.................................................. $386 $423 $(81)
Foreign:
Current................................................... 223 217 247
State:
Current................................................... 1 1 1
Deferred.................................................. 69 123 (23)
---- ---- ----
$679 $764 $144
==== ==== ====
</TABLE>
The reconciliation between the statutory tax rate and those reflected in
the Company's income tax provision is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Statutory tax rate.......................................... (34)% (34)% (34)%
Tax benefit utilized by Penford............................. 56 55 36
Foreign taxes............................................... 1 2 --
State taxes, net of federal benefit......................... 2 2 --
Other....................................................... 1 -- --
---- ---- ----
26% 25% 2%
==== ==== ====
</TABLE>
F-22
<PAGE> 98
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of deferred federal and state income tax assets and
liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------ ------
<S> <C> <C>
Receivable allowance........................................ $ (107) $ (135)
Inventory reserves and basis differences.................... (115) (249)
------ ------
(222) (384)
Accelerated depreciation and amortization................... 3,293 3,351
------ ------
Deferred tax liability...................................... $3,071 $2,967
====== ======
</TABLE>
The Company has made payments for foreign income taxes of approximately
$223,000, $217,000, and $181,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
The Company is included in the consolidated federal and state tax returns
of Penford. In accordance with the Company's tax sharing agreement, the Company
is not compensated for tax losses that are utilized by Penford. As a result of
Penford fully utilizing all of the Company's tax losses, the Company does not
possess any net operating loss carryforwards. Although the Company is not
compensated for tax losses that are utilized by Penford, if such tax losses
remained with the Company they would have been fully offset by a valuation
allowance due to the Company's history of operating losses and the Company's
inability to offset the losses against recorded deferred tax liabilities due to
uncertainties related to the availability of the losses when the temporary
differences are expected to reverse. As a result, the provision as calculated
approximates that which would have been recorded if calculated on a stand-alone
basis. Through December 31, 1997, Penford has utilized approximately $20,623,000
of federal net operating loss carryforwards that the Company would have had
outstanding were it a stand-alone entity of which approximately $3,393,000,
$4,503,000, $5,084,000 and $7,643,000 would have expired in 2009, 2010, 2011 and
2012, respectively. In addition, Penford is liable for any federal, state or
foreign tax adjustments assessed against the Company for periods through the
date of the Distribution.
The Company's policy is to permanently reinvest foreign earnings.
Accumulated foreign earnings, for which no deferred taxes have been provided,
amounted to $1,499,000, $1,793,000 and $2,230,000 as of December 31, 1995, 1996
and 1997, respectively. If such earnings were to be repatriated, the income tax
effect would not be significant.
Included in the loss before income taxes is foreign income of $606,000,
$801,000, and $757,000 for the years ended December 31, 1995, 1996 and 1997,
respectively.
9. PENSION AND OTHER EMPLOYEE BENEFITS
Pension Plan
Penwest participates in a noncontributory defined benefit pension plan (the
Plan) that covers substantially all employees. The Plan is sponsored by its
Parent and costs are allocated based upon actual costs incurred for the
Company's employees. In addition to the employees of the Company, employees of
Penford and its other subsidiaries participate in the Plan. The Company has
accounted for its involvement in the overall Plan as a participant in a
multiemployer pension plan. Under this method, the Company recognizes as net
periodic pension cost its allocated contribution for the period. The Company
recognizes a liability to the Parent for any contributions due and unpaid.
Under the terms of the Employee Benefits Agreement between Penford and
Penwest, Penford will freeze all benefits of employees of Penwest under the Plan
as of the Distribution and will distribute to each employee his or her fully
vested interest in the form of a lump sum payment or an annuity (see Note 13).
Based upon
F-23
<PAGE> 99
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the terms of the agreement there will be no termination gains or losses as a
result of the freezing of Plan benefits, the termination of the right of
employees of the Company to participate in the Plan or the subsequent
distribution. The Company plans to adopt a defined contribution plan and
employees of Penwest will be eligible to participate in such defined
contribution plan.
Benefits for employees are primarily related to years of credited service
and final average five-year earnings. Employees generally become eligible to
participate in the plans after attaining age 21 and benefits become vested after
five years of credited service.
Pension expense of $73,000, $74,000 and $66,000 was recorded for the years
ended December 31, 1995, 1996 and 1997, respectively.
Savings and Stock Ownership Plan
The Company's employees participate in Penford's Savings and Stock
Ownership Plan and costs are charged to the Company based upon actual costs
incurred for the Company's employees. Seventy-five percent (75%) of employee's
contributions are matched up to 6% of the employee's pay, in the form of Penford
common stock. The Company's expense under the plan was $110,000, $147,000 and
$161,000 for 1995, 1996, and 1997, respectively.
The Plan also includes an annual profit-sharing component that is awarded
by Penford's Board of Directors based on achievement of predetermined corporate
goals. This feature of the plan is available to all employees who meet the
eligibility requirements of the Plan. The profit sharing expense related to the
Company's employees was $80,000, $38,000 and $95,000 for 1995, 1996 and 1997,
respectively.
Supplemental Executive Retirement Plan
Penford sponsors a Supplemental Executive Retirement Plan (SERP), a
nonqualified plan, which covers certain key employees including certain
employees of Penwest. For 1995, 1996 and 1997, the net expense for the SERP
incurred by Penwest was $32,000, $35,000 and $22,000, respectively. The
allocated costs represent the costs attributable to the Company's employees.
Health Care and Life Insurance Benefits
The Company offers health care and life insurance benefits to most active
employees. Costs incurred to provide these benefits are charged to expense when
incurred. Health care and life insurance expense was $244,000, $212,000, and
$343,000 in 1995, 1996 and 1997, respectively.
10. LICENSING AGREEMENTS
The Company has entered into collaborative arrangements with six
pharmaceutical companies to facilitate and expedite the commercialization of its
TIMERx drug delivery technology.
In August 1994, August 1995 and March 1996, the Company entered into
product development and supply agreements with Mylan Pharmaceuticals, Inc.
("Mylan") with respect to the development of generic versions of Procardia XL
(nifedipine), Adalat CC (nifedipine) and Glucotrol XL (glipizide), based on the
Company's TIMERx technologies (the "Mylan Products"). Under these product
development and supply agreements, the Company is responsible for the
formulation, manufacture and supply of TIMERx material for use in the Mylan
Products, and Mylan is responsible for conducting all bioequivalence studies,
preparing all regulatory applications and submissions and manufacturing and
marketing the Mylan Products in the United States, Canada and Mexico. The
Company has received non-refundable milestone payments under each of the product
development and supply agreements and is entitled to additional milestone
payments under such agreements upon the continued development of the Mylan
Products. The Company is also entitled to royalties
F-24
<PAGE> 100
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on the sale of each Mylan Product, which royalties will be reduced with respect
to such Mylan Product if there are on the market and available for retail sale
any other generic controlled release formulations of the drug of which such
Mylan Product is a generic controlled release formulation. In addition, Mylan
has agreed that during the term of the product development and supply agreements
it will purchase formulated TIMERx material for use in the Mylan Products
exclusively from the Company at specified prices.
Penwest and Mylan also entered into a sales and distribution agreement in
January 1997 (the "Mylan Distribution Agreement") with respect to Nifedipine XL
pursuant to which Mylan agreed to manufacture and supply Nifedipine XL to
Penwest for distribution by Penwest and one or more distributors (as to which
the Company and Mylan must mutually agree) in certain specified European and
Latin American countries. Under this agreement, the Company has agreed to
purchase Nifedipine XL exclusively from Mylan at specified prices or to pay
Mylan 50% of any royalties received by the Company from its distributors if
Mylan licenses its manufacturing technology to the Company for use by the
Company's distributors instead of manufacturing the product for distribution.
Under this agreement, Mylan is entitled to 50% of any royalties or milestone
payments received by the Company under the Company's product development and
supply agreement with Sanofi described below.
In August 1996, the Company entered into a product development and supply
agreement with Kremers Urban Development Company ("Kremers") with respect to the
development of a generic version of Covera HS (verapamil hydrochloride), based
on the Company's TIMERx technology. Under the product development and supply
agreement, the Company is responsible for formulating Covera HS and for
manufacturing and supplying TIMERx material to Kremers for use in Covera HS, and
Kremers is responsible for conducting bioequivalence studies, preparing all
regulatory applications and submissions and manufacturing and marketing Covera
HS in the United States, Canada and Mexico. The Company has received
non-refundable milestone payments under the product development and supply
agreement and is entitled to additional milestone payments upon the continued
development of Covera HS. The Company also is entitled to royalties on the sale
of Covera HS. However, both milestone payments and the royalties otherwise due
under the product development and supply agreement may be reduced in the event
that there are competing generic controlled release formulations of Covera HS on
the market and available for retail sale. In addition, Kremers has agreed that,
during the term of the product development and supply agreement, it will
purchase formulated TIMERx material for use in Covera HS exclusively from the
Company at specified prices. These prices will be reduced in the event that
there are competing generic versions of Covera HS on the market and available
for retail sale.
In February 1997, the Company entered into a product development and supply
agreement with Sanofi Winthrop International S.A. ("Sanofi") with respect to the
development of a generic version of Adalat LA based on the Company's TIMERx
technology (the "Sanofi Product"), a drug that utilizes the same controlled
release technology as Nifedipine XL. Under the product development and supply
agreement, the Company is responsible for conducting pilot bioequivalence
studies of the Sanofi Product and for manufacturing and supplying TIMERx
material to Sanofi, and Sanofi is responsible for conducting all full scale
bioequivalence studies, preparing all regulatory applications and submissions
and manufacturing and marketing the Sanofi Product in specified countries in
Europe and in South Korea. The Company is entitled to non-refundable milestone
payments under the product development and supply agreement upon the continued
development of the Sanofi Product. The Company is also entitled to royalties
upon the sale of the Sanofi Product. One half of such payments will be paid to
Mylan in accordance with the Mylan Distribution Agreement. In addition, Sanofi
has agreed that, during the term of the product development and supply
agreement, it will purchase formulated TIMERx material for use in the Sanofi
Product exclusively from the Company at specified prices.
In July 1992, the Company entered into an agreement with Leiras Oy
("Leiras") with respect to the development and commercialization of Cystrin CR,
a controlled release formulation of oxybutynin based on the Company's TIMERx
technology. In May 1995, the Company entered into a second agreement with Leiras
F-25
<PAGE> 101
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
clarifying certain matters with respect to the collaboration. Leiras is a
Finnish subsidiary of Schering AG. Leiras is developing products focused in the
areas of reproductive health care, urology, oncology and inhalation technology.
Under the agreements, the Company is responsible for the development and
formulation of Cystrin CR and for manufacturing and supplying TIMERx material to
Leiras for use in the manufacture of Cystrin CR, and Leiras is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Cystrin CR on a worldwide basis. Leiras has the right to transfer its
rights and responsibilities under the agreements and its related product rights
for specified territories, subject in certain circumstances to the approval of
the Company. Pursuant to this right, Leiras, with the Company's consent,
transferred to Synthelabo its marketing rights to this controlled release
formulation for Europe. Leiras has also agreed to pay the Company royalties on
the sale of Cystrin CR and to purchase formulated TIMERx material exclusively
from the Company at specified prices.
In December 1997, pursuant to a related transfer by Leiras to Synthelabo
Groupe ("Synthelabo") of Leiras' rights and responsibilities under Leiras'
agreements with the Company, the Company entered into a license agreement and a
supply agreement with Synthelabo with respect to the manufacturing and marketing
in Europe of the controlled release formulation of oxybutynin developed by the
Company and Leiras, which is expected to be marketed under the tradename
Ditropan CR. Synthelabo is one of the largest pharmaceutical companies in France
and focuses primarily in three core therapeutic fields: central nervous system,
cardiovascular and internal medicine. Under the agreements, the Company is
responsible for manufacturing and supplying TIMERx material to Synthelabo for
use in the manufacture of Ditropan CR, and Synthelabo is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Ditropan CR for sale in Europe (although Synthelabo may contract
initially with Leiras for the manufacture of the product until it receives
regulatory approval to manufacture the product). Synthelabo has agreed to pay
the Company royalties on the sale of the product and to purchase formulated
TIMERx material exclusively from the Company at specified prices.
In September 1997, the Company entered into a strategic alliance agreement
with Endo Pharmaceuticals, Inc. ("Endo") with respect to the development of
controlled release formulations of oxymorphone based on the Company's TIMERx
technology (the "Endo Products"). Under the agreement, the Company has agreed to
manufacture and supply TIMERx material to Endo, and Endo has agreed to
manufacture and market the Endo Products in the United States. The manufacture
and marketing of Endo Products outside of the United States may be conducted by
the Company, Endo or a third party, as determined by a committee comprised of an
equal number of members from each of the Company and Endo. The Company and Endo
have agreed to share the costs involved in the development and commercialization
of the Endo Products and that the party marketing the Endo Products (which the
Company expects will be Endo) will pay the other party royalties equal to 50% of
their respective net marketing revenues after fully-burdened costs (although
this percentage will decrease as the total U.S. marketing revenues from an Endo
Product increase), subject to each party's right to terminate its participation
with respect to any Endo Product described above. Endo will purchase formulated
TIMERx material for use in the Endo Products exclusively from the Company at
specified prices. Such prices will be reflected in the determination of
fully-burdened costs. Under the Company's strategic alliance agreement with
Endo, the Company expects to incur expenses of approximately $12.0 million,
primarily in 1999 and 2000.
Royalties and licensing fees revenue consist solely of payments received
under TIMERx collaborative agreements. Included in royalties and licensing
revenue are approximately $100,000, $1,082,000, and $50,000 for the years ended
December 31, 1995, 1996 and 1997, respectively, of payments received upon the
signing of collaborative agreements. These up-front payments relate principally
to the performance of pilot bioequivalence studies and have been recognized upon
the delivery of the results of such studies to the collaborators. In addition,
approximately $861,000 of non-refundable milestone payments were recognized as
the milestones were achieved during the year ended December 31, 1997.
Approximately $1,844,000, $2,819,000 and $3,075,000 for the years ended December
31, 1995, 1996 and 1997, respectively, of research
F-26
<PAGE> 102
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and development expense principally related to applications of TIMERx technology
to products covered by the Company's collaborative agreements. Since the
collaborative agreements can be terminated by either party, the costs associated
with such agreements could be discontinued by the Company. Such costs are
typically incurred prior to the receipt of milestones, royalties and other
payments.
11. CONTINGENCIES
In May 1997, one of the Company's collaborators, Mylan, filed an
Abbreviated New Drug Application ("ANDA") with the U.S. Food and Drug
Administration ("FDA") for the 30 mg dosage strength of Nifedipine XL, a generic
version of Procardia XL, a controlled release formulation of nifedipine. See
Note 10 for a description of the Company's collaborative agreements with Mylan.
Bayer AG ("Bayer") and ALZA Corporation ("ALZA") own patents listed for
Procardia XL (the last of which expires in 2010), and Pfizer Inc. ("Pfizer") is
the sponsor of the New Drug Application ("NDA") and markets the product. In
connection with the ANDA filing, Mylan certified to the FDA that Nifedipine XL
does not infringe these Bayer or ALZA patents and notified Bayer, ALZA and
Pfizer of such certification. Bayer and Pfizer sued Mylan in the United States
District Court for the Western District of Pennsylvania, alleging that Mylan's
product infringes Bayer's patent. The Company has been informed by Mylan that
ALZA does not believe that the notice given to it complied with the requirements
of the Waxman-Hatch Act, and there can be no assurance that ALZA will not sue
Mylan for patent infringement or take any other actions with respect to such
notice. Mylan has advised the Company that it intends to contest vigorously the
allegations made in the lawsuit. However, there can be no assurance that Mylan
will prevail in this litigation or that it will continue to contest the lawsuit.
If the litigation results in a determination that Nifedipine XL infringes
Bayer's patent, Nifedipine XL could not be marketed in the United States until
such patent expired. An unfavorable outcome or protracted litigation for Mylan
would materially adversely affect the Company's business, financial condition,
cash flows and results of operations. Delays in the commercialization of
Nifedipine XL could also occur because the FDA will not grant final marketing
approval of Nifedipine XL until a final judgment on the patent suit is rendered
in favor of Mylan by the district court, or in the event of an appeal, by the
court of appeals, or until 30 months (or such longer or shorter period as the
court may determine) have elapsed from the date of Mylan's certification,
whichever is sooner.
In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming that
its Procardia XL formulation constituted a unique delivery system and that a
drug with a different release mechanism such as the TIMERx controlled release
system cannot be considered the same dosage form and approved in an ANDA as
bioequivalent to Procardia XL. In August 1997, the FDA rejected Pfizer's
citizen's petition. In July 1997, Pfizer also sued the FDA in the District Court
of the District of Columbia, claiming that the FDA's acceptance of Mylan's ANDA
filing for Nifedipine XL was contrary to law, based primarily on the arguments
stated in its citizen's petition. Mylan and the Company intervened as defendants
in this suit. In April 1998 the District Court of the District of Columbia
rejected Pfizer's claim, and in May 1998, Pfizer appealed the District Court's
decision. There can be no assurance that the FDA, Mylan and the Company will
prevail in this litigation. An outcome in this litigation adverse to Mylan and
the Company would result in Mylan being required to file a suitability petition
in order to maintain the ANDA filing or to file an NDA with respect to
Nifedipine XL, each of which would be expensive and time consuming. An adverse
outcome also would result in Nifedipine XL becoming ineligible for an "AB"
rating from the FDA. Failure to obtain an AB rating from the FDA would indicate
that for certain purposes Nifedipine XL would not be deemed to be
therapeutically equivalent to the referenced branded drug, would not be fully
substitutable for the referenced branded drug and would not be relied upon by
Medicaid and Medicare formularies for reimbursement. Any such failure would have
a material adverse effect on the Company's business, financial condition, cash
flows and results of operations. If any of such events occur, Mylan may
terminate its efforts with respect to Nifedipine XL, which would have a material
adverse effect on the Company's business, financial condition, cash flows and
results of operations.
F-27
<PAGE> 103
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1994, the Boots Company PLC ("Boots") filed in the European Patent
Office (the "EPO") an opposition to a patent granted by the EPO to the Company
relating to its TIMERx technology. In June 1996, the EPO dismissed Boots'
opposition, leaving intact all claims included in the patent. Boots has appealed
this decision to the EPO Board of Appeals. There can be no assurance that the
Company will prevail in this matter. An unfavorable outcome could materially
adversely affect the Company's business, financial condition, cash flows and
results of operations.
Substantial patent litigation exists in the pharmaceutical industry. Patent
litigation generally involves complex legal and factual questions, and the
outcome frequently is difficult to predict. An unfavorable outcome in any patent
litigation affecting the Company could cause the Company to pay substantial
damages, alter its products or processes, obtain licenses and/or cease certain
activities. Even if the outcome is favorable to the Company, the Company could
incur substantial litigation costs. Although the legal costs of defending
litigation relating to a patent infringement claim (unless such claim relates to
TIMERx) are generally the contractual responsibility of the Company's
collaborators, the Company could nonetheless incur significant unreimbursed
costs in participating and assisting in the litigation.
Testing, manufacturing, marketing and selling pharmaceutical products
entail a risk of product liability. The Company faces the risk of product
liability claims in the event that the use of its products is alleged to have
resulted in harm to a patient or subject. Such risks exist even with respect to
those products that are manufactured in licensed and regulated facilities or
that otherwise possess regulatory approval for commercial sale. Product
liability insurance coverage is expensive, difficult to obtain and may not be
available in the future on acceptable terms, if at all. Until the Distribution,
the Company will be covered by primary product liability insurance maintained by
Penford in the amount of $1.0 million per occurrence and $2.0 million annually
in the aggregate on a claims-made basis and by umbrella liability insurance in
excess of $5.0 million which can also be used for product liability insurance.
There can be no assurance that this coverage is adequate to cover potential
liability claims or that Penwest will be able to obtain comparable coverage
following the Distribution. Furthermore, this coverage may not be adequate as
the Company develops additional products. As the Company receives regulatory
approvals for products under development, there can be no assurance that
additional liability insurance coverage for any such products will be available
in the future on acceptable terms, if at all. The Company's business, financial
condition, cash flows and results of operations could be materially adversely
affected by the assertion of a product liability claim.
12. GEOGRAPHIC INFORMATION
The Company, which operates in one business segment as a drug delivery
company, conducts its business primarily in North America and Europe. The
European operations consist of a manufacturing facility in Nastola, Finland and
sales offices in Reigate, England and Bodenheim, Germany. None of the European
locations, other than Finland, is individually significant. Intercompany sales
include a profit component for the selling company. Intercompany sales and
profits are eliminated in consolidation. Corporate operating expenses are not
allocated to the European operations. Operating profit represents gross profit
less selling, general and administrative expenses and, for North America,
research and development expense.
F-28
<PAGE> 104
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE ELIMINATIONS TOTAL
------- ------ ------------ -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Total Revenues............................ $24,818 $6,463 $(4,340) $26,941
Operating Profit (Loss)................... (7,929) 757 (7,172)
Identifiable Assets....................... 32,813 5,967 (1,344) 37,436
Export Sales.............................. 1,616 286 1,902
DECEMBER 31, 1996
Total Revenues............................ 25,400 6,917 (6,228) 26,089
Operating Profit (Loss)................... (2,985) 488 (603) (3,100)
Identifiable Assets....................... 30,014 6,611 (1,542) 35,083
Export Sales.............................. 1,473 283 1,756
DECEMBER 31, 1995
Total Revenues............................ 22,253 7,509 (4,673) 25,089
Operating Profit (Loss)................... (2,695) 180 (58) (2,573)
Identifiable Assets....................... 29,420 4,108 (1,857) 31,671
Export Sales.............................. 1,602 263 1,865
</TABLE>
Segment information for operations in Finland, Germany and the United
Kingdom are included under the caption "Europe." Total revenues, operating
profit (loss) and identifiable assets in Europe are principally from the Finnish
operations. None of the revenues, operating profit (loss) or identifiable assets
of the operations in Germany or the United Kingdom, individually or in the
aggregate, exceed 10% of total revenues, operating profit (loss) or identifiable
assets of the Company. North American export sales consist principally of sales
to Europe and South America. European export sales consist principally of sales
from Europe to other international countries.
13. SUBSEQUENT EVENTS
Distribution
On May 19, 1998, the Board of Directors of Penford announced a plan to
effect a tax-free Distribution to its shareholders of 100% of Penwest's common
stock. The Distribution is subject to the satisfaction of certain conditions,
including receipt of a favorable tax ruling from the Internal Revenue Service or
a written opinion from Ernst & Young LLP. As a condition to the Distribution,
the Company will obtain a $15 million credit facility ("Credit Facility") which
Penford has agreed to guarantee through August 31, 2000. The Credit Facility is
expected to be a revolving loan facility with a maximum principal amount of $15
million of unsecured financing. The proceeds may be used to fund working capital
and for general corporate purposes, including capital expenditures. On the
second anniversary of the execution of the Credit Facility all outstanding
amounts under the Credit Facility will become automatically due and payable,
although the Company will be required to use the proceeds of any financing
conducted by the Company prior to such date to pay down, any outstanding amounts
under the Credit Facility at such time. Borrowing under the Credit Facility are
expected to bear interest at a rate equal to LIBOR, plus 1.25%. The Credit
Facility is expected to contain a number of financial covenants that relate to
Penford (and not Penwest), including requirements that Penford maintain certain
levels of financial performance and maintain certain financial ratios. The
Credit Facility is also expected to contain certain covenants applicable to both
Penford and Penwest including restrictions on the incurrence of additional debt
and the payment of dividends. Any breach of the covenants by Penford or the
Company, or a default by Penford with respect to any material indebtedness or a
change of control of Penford without the lender's consent, would constitute a
default by the Company under the Credit Facility. Accordingly, the Company will
be substantially dependent on Penford in order to access and maintain
F-29
<PAGE> 105
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Credit Facility. Any default under the Credit Facility would have a material
adverse effect on the Company's business, financial condition and results of
operation.
Prior to deciding to distribute 100% of the Company's common stock to
Penford's shareholders, in October 1997, Penford's Board of Directors approved
the sale of approximately 20% of the Company's Common Stock in an initial public
offering ("IPO"). The IPO was initially intended to be completed during December
1997. Due to market conditions, the IPO was initially postponed and during May
1998, after further evaluation of the market opportunities, Penford's Board of
Directors decided to distribute 100% of the Company's common stock to Penford's
shareholders and forego the IPO at such time. Based on this decision, the
Company wrote-off approximately $1.4 million of transaction costs, principally
legal, accounting and printing, associated with the IPO during the year ended
December 31, 1997.
On October 20, 1997, the Company effected a 2,907.66-for-1 stock split
transforming the Company's capital structure from 50,000 shares, $1.00 par value
per share, of common stock authorized and 5,000 shares of common stock
outstanding to 39,000,000 shares, $.001 par value per share, of common stock
authorized and 14,538,282 shares of Common Stock outstanding and 1,000,000
shares of preferred stock, $.001 par value per share, authorized, that may be
issued by the Board in one or more series. On June 19, 1998, the Company
effected a 0.76-for-1 reverse stock split, reducing the outstanding shares to
11,055,462 shares of common stock. Accordingly, all share and per share data
have been retroactively adjusted to give effect to the stock split and reverse
stock split.
The Company and Penford have entered into or will, on or prior to the
completion of this Distribution, enter into agreements that govern various
interim and ongoing relationships. These agreements include (i) a Separation and
Distribution Agreement setting forth the agreement of the parties with respect
to the principal corporate transactions required to effect the separation of
Penford's pharmaceutical business from its specialty carbohydrate-based chemical
business and the Distribution, including without limitation Penford's agreement
to guarantee the Company's indebtedness under the Credit Facility; (ii) a
Services Agreement pursuant to which Penford will continue on an interim basis
to provide specified services to the Company until June 30, 1998 or until
Penwest does not need the services, of which costs will be charged to the
Company on an actual or allocated basis, at 110% of the cost; (iii) a Tax
Allocation Agreement relating to, among other things, the allocation of tax
liability between the Company and Penford in connection with the Distribution
and that all pre-distribution liabilities are the responsibility of Penford and
all post distribution liabilities are those of the respective entities; (iv) an
Excipient Supply Agreement pursuant to which Penford will manufacture and supply
exclusively to the Company, and the Company will purchase exclusively from
Penford, subject to certain exceptions, all the Company's requirements for two
excipients marketed by the Company under pricing and quantity terms that the
Company believes approximate fair market value; and (v) an Employee Benefits
Agreement setting forth the parties' agreements as to the continuation of
certain Penford benefits arrangements for the employees of the Company.
Subsequent to the Distribution, no terminating liabilities will be incurred by
Penwest related to the Penford defined benefit plan.
Stock Plans
In October 1997, the Company adopted the 1997 Equity Incentive Plan (the
"Plan") under which the Board of Directors or its compensation committee is
authorized to grant stock options, stock appreciation rights, restricted stock,
deferred stock, performance units, or any combination thereof, to employees,
directors, officers, consultants or advisors of the Company. There are 2,660,000
shares available for grant under the terms of the Plan. These options are to be
granted at prices equal to the fair market value of the Company's common stock
at the date of grant and vest over a period not to exceed four years. Options
granted under the Plan must be exercised within ten years of grant, unless a
shorter period is designated at the time of grant. No options can be awarded
under the Plan after ten years. The Company intends to grant stock options under
the 1997 Plan to purchase an aggregate of 1,010,000 shares of Common Stock to
its employees and officers
F-30
<PAGE> 106
PENWEST PHARMACEUTICALS CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
following the Distribution date at an exercise price equal to the fair market
value on the date of grant. In addition, the Company adopted the 1997 Employee
Stock Purchase Plan which will enable employees of the Company to purchase stock
at 85% of market value as defined in the Plan. There are 228,000 shares
available under the Employee Stock Purchase Plan.
At the time of the Distribution the outstanding stock options held by
employees of the Company to purchase the common stock of Penford will be
replaced by Penwest options. The Company adopted a 1998 Spin-off Option Plan
effective upon the Distribution under which employees of Penwest will be granted
these options. There will be no additional grants under this Plan. The exercise
price and the number of shares subject to the Penwest options will be calculated
so as to preserve the approximate value of the Penford options by ensuring that
the ratio of exercise price per option to the market value per share remains
unchanged and that the aggregate intrinsic value of the Penwest options is not
greater than the aggregate intrinsic value of the Penford options. The changes
in the stock options to purchase the common stock of Penwest will not result in
additional compensation expense. Substantially all other terms and conditions of
the Penford options will be reflected in the Penwest options, including the
continuation of the remaining portions of their original vesting schedules and
their 10-year terms.
F-31
<PAGE> 107
PART II
INFORMATION NOT REQUIRED IN INFORMATION STATEMENT
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS.
(a) Financial Statements Schedules:
Schedule II -- Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.
(b) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C> <C>
2.1** -- Form of Separation and Distribution Agreement to be entered
into between Registrant and Penford Corporation ("Penford").
3.1* -- Amended and Restated Articles of Incorporation.
3.2** -- Articles of Amendment to the Amended and Restated Articles
of Incorporation filed on June 19, 1998.
3.3* -- Amended and Restated Bylaws of the Registrant.
3.4** -- Designation of Rights and Preference of Series A Junior
Participating Preferred Stock of the Company filed on July
17, 1998.
4.1* -- Specimen certificate representing the Common Stock.
4.2** -- Form of Rights Agreement dated as of July 27, 1998 between
the Company and the Rights Agent.
8.1 -- Tax Private Letter Revenue Ruling dated April 15, 1998
issued by the Internal Revenue Service, as supplemented on
July 13, 1998.
+10.1* -- Product Development and Supply Agreement dated August 17,
1994 by and between the Registrant and Mylan Pharmaceuticals
Inc. ("Mylan").
+10.2* -- Product Development and Supply Agreement dated August 3,
1995 by and between the Registrant and Mylan.
+10.3* -- Product Development and Supply Agreement dated March 22,
1996 by and between the Registrant and Mylan.
+10.4* -- Sales and Distribution Agreement dated January 3, 1997 by
and between the Registrant and Mylan.
10.5 -- [Intentionally Omitted]
+10.6* -- Product Development and Supply Agreement dated August 30,
1996 by and between the Registrant and Kremers Urban
Development Company.
+10.7* -- Product Development, License and Supply Agreement dated
February 28, 1997 by and between the Registrant and Sanofi
Winthrop International S.A., as amended.
+10.8* -- Agreement dated May 26, 1995 by and between the Registrant
and Leiras OY.
+10.9* -- Agreement dated July 27, 1992 by and between the Registrant
and Leiras OY.
+10.10* -- Strategic Alliance Agreement dated as of September 17, 1997
by and between the Registrant and Endo Pharmaceuticals Inc.
10.11* -- 1997 Equity Incentive Plan.
10.12* -- 1997 Employee Stock Purchase Plan.
10.13** -- 1998 Spinoff Option Plan.
10.14** -- Form of Excipient Supply Agreement to be entered into
between the Registrant and Penford.
10.15** -- Form of Services Agreement to be entered into between the
Registrant and Penford.
10.16** -- Form of Tax Allocation Agreement to be entered into between
the Registrant and Penford.
</TABLE>
II-1
<PAGE> 108
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <C> <S>
10.17** -- Form of Employee Benefits Agreement to be entered into
between the Registrant and Penford.
10.18* -- Recognition and Incentive Agreement dated as of May 14, 1990
between the Registrant and Anand Baichwal, as amended.
+10.19** -- License Agreement dated December 17, 1997 between Synthelabo
and the Registrant.
+10.20** -- Supply Agreement dated December 17, 1997 by and between
Synthelabo and the Registrant.
10.21** -- Revolving Term Credit Facility dated July 2, 1998 by and
between the Company and the Bank of Nova Scotia.
21.1* -- Subsidiaries.
27.1** -- Financial Data Schedule (December 31, 1997).
27.2** -- Financial Data Schedule (March 31, 1998).
</TABLE>
- ---------------
* Incorporated by reference to Exhibits to the Registrant's Registration
Statement on Form S-1 (File No. 333-38389).
** Previously filed.
+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.
II-2
<PAGE> 109
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the Registrant has duly caused this Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized.
PENWEST PHARMACEUTICALS CO.
By: /s/ TOD R. HAMACHEK
------------------------------------
Tod R. Hamachek
Chairman of the Board and
Chief Executive Officer
Date: July 27, 1998
II-3
<PAGE> 110
REPORT OF INDEPENDENT AUDITORS ON SCHEDULE
We have audited the consolidated financial statements of Penwest
Pharmaceuticals Co. as of December 31, 1997 and 1996, and for each of the three
years in the period ended December 31, 1997, and have issued our report thereon
dated June 5, 1998, except for information describing the 0.76-for-1 reverse
stock split in Note 13, as to which the date is June 19, 1998, included
elsewhere in this Form 10. Our audits also included the financial statement
schedule listed in Item 15(a) of this Form 10. This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Stamford, Connecticut
June 5, 1998
S-1
<PAGE> 111
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
PENWEST PHARMACEUTICALS CO.
DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO OTHER
BEGINNING OF COSTS AND ACCOUNTS DEDUCTIONS BALANCE AT
PERIOD EXPENSES DESCRIBE DESCRIBE END OF PERIOD
------------ ---------- ---------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Allowance for Doubtful Accounts... $237 $100 -- -- $337
==== ==== ==== === ====
Year ended December 31, 1996
Allowance for Doubtful Accounts... $200 $ 37 -- -- $237
==== ==== ==== === ====
Year ended December 31, 1995
Allowance for Doubtful Accounts... $187 $ 28 -- (15)(a) $200
==== ==== ==== === ====
</TABLE>
- ---------------
(a) Write-off of bad debts
S-2
<PAGE> 112
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C> <C>
2.1** -- Form of Separation and Distribution Agreement to be entered
into between Registrant and Penford Corporation ("Penford").
3.1* -- Amended and Restated Articles of Incorporation.
3.2** -- Articles of Amendment to the Amended and Restated Articles
of Incorporation filed on June 19, 1998.
3.3* -- Amended and Restated Bylaws of the Registrant.
3.4** -- Designation of Rights and Preference of Series A Junior
Participating Preferred Stock of the Company filed on July
17, 1998.
4.1* -- Specimen certificate representing the Common Stock.
4.2** -- Form of Rights Agreement dated as of July 27, 1998 between
the Company and the Rights Agent.
8.1 -- Tax Private Letter Revenue Ruling dated April 15, 1998
issued by the Internal Revenue Service, as supplemented on
July 13, 1998.
+10.1* -- Product Development and Supply Agreement dated August 17,
1994 by and between the Registrant and Mylan Pharmaceuticals
Inc. ("Mylan").
+10.2* -- Product Development and Supply Agreement dated August 3,
1995 by and between the Registrant and Mylan.
+10.3* -- Product Development and Supply Agreement dated March 22,
1996 by and between the Registrant and Mylan.
+10.4* -- Sales and Distribution Agreement dated January 3, 1997 by
and between the Registrant and Mylan.
10.5 -- [Intentionally Omitted]
+10.6* -- Product Development and Supply Agreement dated August 30,
1996 by and between the Registrant and Kremers Urban
Development Company.
+10.7* -- Product Development, License and Supply Agreement dated
February 28, 1997 by and between the Registrant and Sanofi
Winthrop International S.A., as amended.
+10.8* -- Agreement dated May 26, 1995 by and between the Registrant
and Leiras OY.
+10.9* -- Agreement dated July 27, 1992 by and between the Registrant
and Leiras OY.
+10.10* -- Strategic Alliance Agreement dated as of September 17, 1997
by and between the Registrant and Endo Pharmaceuticals Inc.
10.11* -- 1997 Equity Incentive Plan.
10.12* -- 1997 Employee Stock Purchase Plan.
10.13** -- 1998 Spinoff Option Plan.
10.14** -- Form of Excipient Supply Agreement to be entered into
between the Registrant and Penford.
10.15** -- Form of Services Agreement to be entered into between the
Registrant and Penford.
10.16** -- Form of Tax Allocation Agreement to be entered into between
the Registrant and Penford.
10.17** -- Form of Employee Benefits Agreement to be entered into
between the Registrant and Penford.
10.18* -- Recognition and Incentive Agreement dated as of May 14, 1990
between the Registrant and Anand Baichwal, as amended.
</TABLE>
<PAGE> 113
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C> <C>
+10.19** -- License Agreement dated December 17, 1997 between Synthelabo
and the Registrant.
+10.20** -- Supply Agreement dated December 17, 1997 by and between
Synthelabo and the Registrant.
10.21** -- Revolving Term Credit Facility dated July 2, 1998 by and
between the Company and the Bank of Nova Scotia.
21.1* -- Subsidiaries.
27.1** -- Financial Data Schedule (December 31, 1997).
27.2** -- Financial Data Schedule (March 31, 1998).
</TABLE>
- ---------------
* Incorporated by reference to Exhibits to the Registrant's Registration
Statement on Form S-1 (File No. 333-38389).
** Previously filed.
*** To be filed by amendment.
+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.
<PAGE> 1
Exhibit 8.1
INTERNAL REVENUE SERVICE LETTERHEAD
April 15, 1998
Mr. Victor W. Breed
Corporate Director of Finance
Penwest, Ltd.
P.O. Box 1688
Bellevue, Washington 98009
Distributing = Penford Corporation
a Washington corporation
EIN: 91-1221360
Controlled = Penwest Pharmaceuticals Co.
a Washington corporation
EIN: 91-1513032
Subsidiary = Penford Products Company
Business A = food and paper chemicals
Business B = development of pharmaceutical ingredients and
technology
Advisor C = David L. Babson & Co.
Advisor D = Wellington Management Company, LLP
E = 7,260,316
F = 25,000,000
State X = Washington
Dear Mr. Breed:
This is in reply to your letter dated October 28, 1997, requesting rulings
on the federal income tax consequences of a proposed transaction. Additional
information
<PAGE> 2
was submitted in letters dated February 20, February 27, March 23, and April 3,
1998. The information submitted for consideration is summarized below.
Distributing is an accrual basis State X corporation engaged in Business A
through Subsidiary, a wholly owned subsidiary. Distributing has issued and
outstanding E shares of common stock. The Distributing shares are publicly
traded.
Advisor C and Advisor D are investment advisors and each holds more than 5
percent of the outstanding Distributing common stock on behalf of their clients.
None of the clients of Advisor C or Advisor D own 5 percent or more of the
Distributing stock. Advisor C and Advisor D have each filed Schedule 13G,
indicating they are passive investors in Distributing.
Controlled is an accrual basis State X corporation engaged in Business H.
Controlled has one class of common stock outstanding, all of which is held by
Distributing. Controlled will have outstanding employee stock options that, if
exercised, would represent approximately 15 percent of the Controlled stock.
Financial information has been submitted which indicates that
Distributing's Business A and Controlled's Business B each have had gross
receipts and operating expenses representative of the active conduct of a trade
or business for each of the past five years.
Controlled stated it needs additional capital for Business B. Controlled
proposes to raise the funds through a public offering of Controlled stock.
Controlled's investment banker submitted analysis showing that the proposed
transaction would enhance the stock offering. In addition, the investment banker
described how the proposed transaction would enhance the stock offering in
comparison to alternatives to the proposed transaction.
Accordingly, in order to enhance the offering of the Controlled stock,
Distributing proposed the following transaction:
(i) Distributing will transfer its entire interest in certain Business B
assets, including trademarks and license agreements, and other
miscellaneous assets to Controlled. In addition, Distributing will cancel
the intercompany indebtedness owed by Controlled to Distributing. No ss. 38
property will be transferred to Controlled by Distributing. All of the
assets held by Distributing and Controlled are related to their respective
businesses.
(ii) Controlled will issue up to 20 percent of its stock in the public
offering, raising approximately $F. Controlled will also issue stock
options to its employees (the "Controlled Options").
2
<PAGE> 3
(iii) Distributing will distribute the Controlled stock, pro rata, to its
shareholders. Distributing will provide administrative services to
Controlled and Controlled will sell products to distributing after the
transaction. Except for amounts owed in connection with these continuing
transactions, Controlled will not be indebted to Distributing after the
distribution.
The following representations have been made in connection with the
proposed transaction:
(a) No part of the consideration distributed by the distributing
corporation will be received by a shareholder as a creditor, employee,
or in any capacity other than that of a shareholder of the
corporation.
(b) The five years of financial information submitted on behalf of the
distributing corporation is representative of the corporation's
present operations, and, with regard to such corporation, there have
been no substantial operational changes since the date of the last
financial statements submitted.
(c) Immediately after the distribution, at least 90 percent of the fair
market value of the gross assets the distributing corporation will
consist of the stock and securities of Subsidiary, a corporation that
is engaged in the active conduct of a trade or business as defined in
ss. 355(b)(2) of the Code.
(d) Following the transaction, the controlled corporation will continue
the active conduct of its business, independently and with its
separate employees, and the distributing corporation, through
Subsidiary, will continue the active conduct of its business,
independently and with its separate employees, except that for a
transition period, the controlled corporation will utilize the
services of the distributing corporation for certain administrative
operations. The controlled corporation will pay the distributing
corporation fair market value for such services consistent with
amounts that would be paid to a third party.
(e) The distribution of the stock of the controlled corporation is carried
out for the following corporate business purposes: (i) to permit the
managements the distributing and controlled corporations to focus on
their respective core businesses; (ii) to improve the near term
earnings of the distributing corporation by eliminating from the
distributing corporation's results of operations the expenses
associated with developing the controlled corporation's Business B;
(iii) to permit the financial community to focus separately on the
distributing corporation and the controlled corporation; and (iv) to
enable the controlled
3
<PAGE> 4
corporation to have greater access to capital to finance its business.
The distribution of the stock of the controlled corporation is
motivated, in whole or substantial part, by these corporate business
purposes.
(f) There is no plan or intention by any shareholder who owns 5 percent or
more of the stock of the distributing corporation, and the management
of the distributing corporation, to its best knowledge, is not aware
of any plan or intention on the part of any particular remaining
shareholder of the distributing corporation to sell, exchange,
transfer by gift, or otherwise dispose of any stock in either the
distributing or controlled corporation after the transaction.
(g) There is no plan or intention by either the distributing corporation
or the controlled corporation, directly or through any subsidiary
corporation, to purchase any of its outstanding stock after the
transaction, other than through stock purchases meeting the
requirements of section 4.05(1)(b) of Rev. Proc. 96-30.
(h) There is no plan or intention to liquidate either the distributing or
controlled corporation, to merge either corporation with any other
corporation, or to sell or otherwise dispose of the assets of either
corporation after the transaction, except in the ordinary course of
business.
(i) The total adjusted bases and the fair market value of the assets
transferred to the controlled corporation by the distributing
corporation each equals or exceeds the sum of the liabilities assumed
by the controlled corporation plus any liabilities to which the
transferred assets are subject; and the liabilities assumed in the
transaction and the liabilities to which the transferred assets are
subject were incurred in the ordinary course of business and are
associated with the assets being transferred.
(j) The distributing corporation neither accumulated its receivables nor
made extraordinary payment of its payables in anticipation of the
transaction.
(k) The intercorporate indebtedness owed by the controlled corporation to
the distributing corporation arose in the ordinary course of business
and will be forgiven prior to the distribution of the controlled
corporation stock.
(l) Immediately before the distribution, items or income, gain, loss,
deduction, and credit will be taken into account as required by the
4
<PAGE> 5
applicable intercompany transaction regulations. Further, the
distributing corporation's excess loss account, if any, with respect
to the controlled corporation stock will be included in income
immediately before the distribution.
(m) Payments made in connection with all continuing transactions between
the distributing and controlled corporations, will be for fair market
value based on terms and conditions arrived at by the parties
bargaining at arm's length.
(n) No two parties to the transaction are investment companies as defined
in ss. 368(a)(2)(F)(iii) and (iv).
(o) Taking into account the shares of the controlled corporation to be
issued in the public offering and all options to acquire controlled
corporation stock, treating such options as exercised, the
distributing corporation's shareholders will continue to hold more
than 50 percent of the stock of both the distributing and controlled
corporations after the distribution of the stock of the controlled
corporation.
(p) The distributing corporation will distribute the controlled
corporation stock within 6 months of the public offering or within 3
months of receipt of a favorable ruling letter from the Internal
Revenue Service, whichever is later.
(q) The sum of the shares of the controlled corporation to be issued in
the public offering and the stock issued upon the exercise of
Controlled Options that are issued in the transaction (as described in
step (ii), above) and are exercised prior to the distribution will not
exceed 20 percent of the stock of the controlled corporation.
Based solely on the information submitted and representations set forth
above, we hold as follows:
(1) The transfer by Distributing to Controlled of the Business B assets,
solely in exchange for the stock of Controlled, followed by the
distribution of the Controlled stock to all of the shareholders of
Distributing, as described above, will be a reorganization within the
meaning of ss. 368(a)(1)(D) of the Code. Distributing and Controlled
will each be "a party to a reorganization" within the meaning of ss.
368(b).
(2) No gain or loss will be recognized to Distributing upon the transfer
of assets to Controlled in exchange for Controlled stock, as described
above (ss.ss. 361(a) and 357(a)).
5
<PAGE> 6
(3) No gain or loss will be recognized to Controlled on the receipt of the
assets in exchange for all of the Controlled stock (ss. 1032(a)).
(4) The basis of the assets received by Controlled will be the same as the
basis of such assets in the hands of Distributing immediately prior to
the transfer (ss. 362(b)).
(5) The holding period of each asset received by Controlled from
Distributing will include the period during which that asset was held
by Distributing (ss. 1223(2)).
(6) No gain or loss will be recognized to the shareholders of Distributing
upon the receipt of the Controlled stock (ss. 355(a)(1)).
(7) No gain or loss will be recognized to Distributing upon the
distribution of all of Controlled's stock, as described above (ss.
361(c)(1)).
(8) The aggregate basis of the Distributing stock and the Controlled stock
in the hands of each shareholder of Distributing immediately after the
distribution will be the same as the basis of the Distributing stock
held by such shareholder immediately before the distribution,
allocated in proportion to the fair market value of the shares in
accordance with ss. 1.358-2(a)(2) of the Income Tax Regulations (ss.
358(a)(1) and ss. 358(b)(2)).
(9) The holding period of the Controlled stock received by the
shareholders of Distributing will, in each instance, include the
holding period of the Distributing stock with respect to which the
distribution will be made provided that such Distributing stock is
held as a capital asset on the date of the exchange (ss. 1223(l)).
(10) As provided in ss. 312(h) of the Code, proper allocation of earnings
and profits between Distributing and Controlled will be made in
accordance with ss. 1.312-10(a) of the Regulations.
No opinion is expressed concerning the federal income tax treatment of the
proposed transactions under other provisions of the Code or Regulations or about
the tax treatment of any conditions existing at the time of, or effects
resulting from, the transactions that are not specifically covered by the above
rulings.
This ruling is directed only to the taxpayer who requested it. Section
6110(j)(3) of the Code provides that it may not be used or cited as precedent.
6
<PAGE> 7
A copy of this letter should be attached to the Federal Income Tax Returns
of the taxpayers involved for the taxable year in which the transaction covered
by this ruling letter is consummated.
In accordance with the power of attorney on file in this office, copies of
this letter are being sent to your authorized representatives.
Sincerely yours,
Assistant Chief Counsel (Corporate)
By: /s/ Charles Whedbee
--------------------------------
Charles Whedbee
Senior Technical Reviewer, Branch 5
7
<PAGE> 8
INTERNAL REVENUE SERVICE LETTERHEAD
July 13, 1998
Mr. Victor W. Breed
Corporate Director of Finance
Penwest, Ltd.
P.O. Box 1688
Bellevue, Washington 98009
G = 26
H = 20 to 30 million
Dear Mr. Breed:
This is in reply to a letter from your authorized representative, dated May
22, 1998, requesting that we supplement our letter ruling dated April 15, 1998
(PLR-119958-97) (the "Prior Letter Ruling"). Additional information was
submitted in a letter dated July 9, 1998. The information submitted for
consideration is summarized below. Capitalized terms retain the meaning assigned
to them in the Prior Letter Ruling.
In its request for a supplemental letter ruling, the taxpayer describes a
change in market conditions since the Prior Letter Ruling was issued. The
taxpayer's investment banker analyzed these market conditions and recommended
revising the order of the steps of the proposed transaction in order to enhance
the stock offering.
Accordingly, the taxpayer proposes the following revised transaction:
(i) Distributing will transfer its entire interest in certain Business B
assets, including trademarks and license agreements, and other
miscellaneous assets to Controlled. In addition, Distributing will cancel
the intercompany indebtedness owed by Controlled to Distributing. No ss. 38
property will be transferred to Controlled by Distributing. All of the
assets held by Distributing and Controlled are related to their respective
businesses.
(ii) Controlled will enter into a loan agreement with a bank to borrow
funds as interim financing for Controlled. The funds will be repaid at the
end
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of G months or upon the receipt of proceeds from the stock offering
described in paragraph (iii), whichever occurs first. Distributing will
then distribute the Controlled stock, pro rata, to its shareholders.
Distributing will provide administrative services to Controlled and
Distributing will sell products to Controlled after the transaction. Except
for amounts owed in connection with these continuing transactions,
Controlled will not be indebted to Distributing after the distribution.
(iii) Within 12 months of the date of the distribution of the stock of
Controlled by Distributing, Controlled will issue up to 20 percent of its
stock in the public offering, raising approximately $H. Controlled will
also issue stock options to its employees (the "Controlled Options").
Representations (p) and (q) of the Prior Letter Ruling are deleted.
Based upon the information and representations submitted with the original
and supplemental ruling requests, we reaffirm the rulings set forth in the Prior
Letter Ruling.
No opinion is expressed concerning the federal income tax treatment of the
proposed transactions under other provisions of the Code or Regulations or about
the tax treatment of any conditions existing at the time of, or effects
resulting from, the transactions that are not specifically covered by the above
rulings.
This supplemental letter ruling is directed only to the taxpayer who
requested it. Section 6110(j)(3) of the Code provides that it may not be used or
cited as precedent.
A copy of this letter should be attached to the Federal Income Tax Returns
of the taxpayers involved for the taxable year in which the transaction covered
by this supplemental letter ruling is consummated.
In accordance with the power of attorney on file in this office, copies of
this letter are being sent to your authorized representatives.
Sincerely yours,
Assistant Chief Counsel (Corporate)
By: /s/ Charles Whedbee
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Charles Whedbee
Senior Technical Reviewer, Branch 5
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