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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______________________ to ______________________
Commission File No. 000-23467
PENWEST PHARMACEUTICALS CO.
(Exact name of registrant as specified in its charter)
Washington 91-1513032
------------------------ -------------------
(State of Incorporation) (I.R.S. Employer
Identification No.)
2981 Route 22, Patterson, NY 12563-9970
- - ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(914)878-3414
-----------------------------------------------------
(Registrant's telephone number, including area code.)
Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of October 31, 1998.
Class Outstanding
- - ----------------------------- -----------
Common stock, par value $.001 11,055,462
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PENWEST PHARMACEUTICALS CO.
TABLE OF CONTENTS
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PAGE
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Part I. Financial Information
Item 1-- Financial Statements
Consolidated Balance Sheets.............................................................. 3
Consolidated Statements of Operations.................................................... 4
Condensed Consolidated Statements of Cash Flows.......................................... 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2-- Management's Discussion and Analysis of Financial Condition and Results of Operations.... 10
Part II. Other Information
Item 6-- Exhibits and Reports on Form 8-K......................................................... 15
Signature................................................................................................. 16
Exhibit Index............................................................................................. 16
</TABLE>
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
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<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
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ASSETS
Current assets:
Cash and cash equivalents $ 938 $ 1,137
Trade accounts receivable, net 3,005 4,066
Inventories:
Raw materials and other 1,545 1,207
Finished goods 7,146 7,724
-------- --------
8,691 8,931
Prepaid expenses and other current assets 358 684
-------- --------
Total current assets 12,992 14,818
Fixed assets, net 22,311 22,537
Other assets 2,133 4,591
-------- --------
Total assets $ 37,436 $ 41,946
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 3,410 $ 4,134
Taxes payable 361 448
Payable to Penford 42,654 ---
-------- --------
Total current liabilities 46,425 4,582
Deferred taxes 2,967 2,900
Other long-term liabilities 341 2,321
-------- --------
Total liabilities 49,733 9,803
Shareholders' equity (deficit)
Common stock, par value $.001, authorized 39,000,000
shares, issued and outstanding 11,055,462 shares 11 11
Preferred stock, par value $.001, authorized
1,000,000 shares, none outstanding
Additional paid-in capital 8,079 58,536
Accumulated deficit (19,649) (25,937)
Accumulated other comprehensive income (738) (467)
-------- --------
Total Shareholders' equity (deficit) (12,297) 32,143
-------- --------
Total liabilities and Shareholders' equity (deficit) $ 37,436 $ 41,946
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED SEPTEMBER 30
---------------------
1997 1998
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(UNAUDITED)
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Revenues
Product sales $ 6,645 $ 6,180
Royalties and licensing fees 325 50
-------- --------
Total revenues 6,970 6,230
Cost of product sales 4,891 4,511
-------- --------
Gross profit 2,079 1,719
Operating expenses
Selling, general and administrative 2,044 2,865
Research and product development 851 1,455
-------- --------
Total operating expenses 2,895 4,320
-------- --------
Loss before income taxes (816) (2,601)
Income tax expense (benefit) 525 (329)
-------- --------
Net loss $ (1,341) $ (2,272)
======== ========
Basic and diluted net loss per share $ (0.12) $ (0.21)
======== ========
Weighted average shares of common stock outstanding 11,055 11,055
======== ========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30
---------------------
1997 1998
-------- --------
(UNAUDITED)
<S> <C> <C>
Revenues
Product sales $ 19,876 $ 21,429
Royalties and licensing fees 911 143
-------- --------
Total revenues 20,787 21,572
Cost of product sales 14,660 15,615
-------- --------
Gross profit 6,127 5,957
Operating expenses
Selling, general and administrative 5,747 7,892
Research and product development 2,994 4,278
-------- --------
Total operating expenses 8,741 12,170
-------- --------
Loss before income taxes (2,614) (6,213)
Income tax expense 561 75
-------- --------
Net loss $ (3,175) $ (6,288)
======== ========
Basic and diluted net loss per share $ (0.29) $ (0.57)
======== ========
Weighted average shares of common stock outstanding 11,055 11,055
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30
--------------------
1997 1998
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(UNAUDITED)
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Net cash used in operating activities $(1,322) $(3,966)
Investing activities:
Acquisitions of fixed assets, net (2,953) (2,015)
Other (625) 29
------- -------
Net cash used in investing activities (3,578) (1,986)
Financing activities:
Increase (decrease) in payable to Penford 5,403 6,105
Effect of exchange rate changes on cash and cash equivalents (110) 46
------- -------
Net increase in cash and cash equivalents 393 199
Cash and cash equivalents at beginning of period 695 938
------- -------
Cash and cash equivalents at end of period $ 1,088 $ 1,137
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Penwest Pharmaceuticals Co. (the "Company" or "Penwest") 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. 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 considered necessary for a fair presentation for the
interim periods presented have been included. All such adjustments are of a
normal recurring nature. Operating results for the three month period and
nine month period ended September 30, 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 in Penwest Pharmaceuticals Co.'s Registration
Statement on Form 10 (declared effective on July 31, 1998).
Certain prior year amounts have been reclassified to conform with the
current year presentation. These reclassifications had no effect on
previously reported results of operations.
3. INCOME TAXES
The effective tax rates for the three month period and the nine month
period ended September 30, 1998 were a 13% benefit and a 1% expense,
respectively. The effective rates are higher than the federal statutory
rate of a 34% benefit due primarily to the effect of tax benefits utilized
by Penford Corporation (the Company's former parent company) through August
31, 1998 for which Penwest was not reimbursed and state and foreign income
taxes.
4. EARNINGS PER COMMON SHARE
The Company follows the provisions of 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.
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5. 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 Shareholders' equity (deficit).
The components of comprehensive loss, for the three and nine month periods
ended September 30, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
1997 1998 1997 1998
-------- -------- -------- --------
(IN THOUSANDS OF DOLLARS) (IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
Net loss $(1,341) $(2,272) $(3,175) $(6,288)
Foreign currency translation adjustments 157 200 (491) 271
------- ------- ------- -------
Comprehensive loss $(1,184) $(2,072) $(3,666) $(6,017)
======= ======= ======= =======
</TABLE>
Accumulated other comprehensive income equals the cumulative translation
adjustment which is the only component of other comprehensive income
included in the Company's financial statements.
6. CREDIT FACILITY
On July 2, 1998 the Company obtained a $15 million unsecured revolving
credit facility (the "Credit Facility") which is guaranteed by Penford
Corporation, the Company's former parent corporation ("Penford"). The
proceeds may be used to fund working capital and for general corporate
purposes, including capital expenditures. 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 provides that the maximum amount
available to the Company under the Credit Facility will be reduced by the
amount of any net proceeds from any financing conducted by the Company, and
that the Company will be required to repay any outstanding amounts under
the Credit Facility in excess of the new maximum amount. The Credit
Facility contains a number of financial covenants that relate to Penford
(and not Penwest), including requirements that Penford maintain certain
levels of financial performance and capital structure. The Credit Facility
also contains certain covenants applicable to both Penford and Penwest
including restrictions on the incurrence of additional debt and the payment
of dividends. Accordingly, the Company is substantially dependent on
Penford's compliance with such covenants in order to access and maintain
the Credit Facility. Any breach by Penford of these covenants would
constitute a default by the Company under the Credit Facility, which would
have a material adverse effect on the Company's business, financial
condition and results of operation.
As of September 30, 1998, the Company had no outstanding borrowings under
the Credit Facility.
7. CONTINGENCIES
In May 1997, one of the Company's collaborators, Mylan Pharmaceuticals,
Inc. ("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
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event of an appeal, by the court of appeals, or until 30 months 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.
Substantial patent litigation exist 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 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. The Company is covered by primary product liability insurance in the
amount of $2.0 million in the aggregate on a claims-made basis and by
umbrella liability insurance in excess of $20.0 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 and 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.
8. RIGHTS AGREEMENT
On June 25, 1998, the Board of Directors declared a dividend of one right
for each outstanding share of the Company's Common Stock (the "Right") to
shareholders of record at the close of business on July 28, 1998. Each
Right entitles the registered holder to purchase from the Company one
one-thousandth of a share of the Series A Preferred Stock, at a purchase
price of $60 in cash, subject to adjustment.
The Rights are not currently exercisable and will not be exercisable until
the earlier of (I) 10 business days (or such later date as
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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, as
defined in the agreement, 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.
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.
9. REVERSE STOCK SPLIT
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.
10. DISTRIBUTION AND CAPITAL CONTRIBUTION
On August 31, 1998, Penford distributed to the shareholders of record of
Penford common stock on August 10, 1998 all of the shares of the Company's
Common Stock (the "Distribution"). Pursuant to the Distribution, each
Penford shareholder of record received three shares of the Company's
Common Stock for every two shares of Penford common stock held by them. In
connection with the Distribution (i) the Company's Common Stock was
registered under the Securities Exchange Act of 1934, as amended, pursuant
to the registration statement on Form 10 which was declared effective on
July 31, 1998, (ii) the Company's Common Stock was listed with and began
trading on the National Market on August 10, 1998 and (iii) Penford
obtained a private letter ruling from the Internal Revenue Service to the
effect that, among other things, the Distribution qualified as tax-free
under Sections 355 and 368 of the Internal Revenue Code of 1986, as
amended, and that the receipt of shares of the Company's Common Stock in
the Distribution would not result in the recognition of income, gain or
loss to Penford's shareholders for federal income tax purposes.
In connection with the Distribution, the Company and Penford have entered
into agreements that govern various interim and ongoing relationships.
These agreements include (i) a Separation and Distribution Agreement
setting forth the agreement of the parties with respect to the principal
corporate transactions which were required to effect the separation of
Penford's pharmaceutical business from its specialty carbohydrate-based
chemical business and the Distribution, including without limitation
Penford's agreement to guarantee the Company's indebtedness under the
Credit Facility referred to above; (ii) a Services Agreement pursuant to
which Penford will continue on an interim basis to provide specified
services to the Company until June 30, 1999 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
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Penford, subject to certain exceptions, all the Company's requirements for
two excipients marketed by the Company under quantity and pricing terms
that the Company believes approximate fair market value; and (v) an
Employee Benefits Agreement setting forth the parties' agreements as to the
continuation of certain Penford benefit arrangements for the employees of
the Company. Subsequent to the Distribution, no terminating liabilities
were incurred by Penwest related to the Penford defined benefit plan.
On August 31, 1998, in connection with the separation of its pharmaceutical
business, Penford contributed to the capital of the Company all existing
intercompany indebtedness of the Company which approximated $50.5 million.
11. STOCK OPTIONS
On September 4, 1998 there were 1,010,000 options to purchase common stock
granted to management. These options were priced at market and will vest
over a four-year period.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Since 1991, Penwest 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 sells excipients to the pharmaceutical
and nutritional industries. Penwest 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. On
August 31, 1998, Penford distributed (the "Distribution") to the shareholders of
record of Penford common stock on August 10, 1998 all of the shares of the
Company's Common Stock. Pursuant to the Distribution, each Penford shareholder
of record received three shares of the Company's Common Stock for every two
shares of Penford common stock held by them.
The Company's principal development focus to date has been the development
of controlled release drugs based on the TIMERx technology. The Company's
collaborator, Leiras Oy ("Leiras"), received marketing approval in Finland for
Cystrin CR (oxybutynin), a TIMERx formulation for the treatment of urge urinary
incontinence in October 1997 and began marketing the product in Finland in
January 1998. In addition, Synthelabo Groupe ("Synthelabo") has received
marketing approval in the Netherlands, Austria and Ireland for Ditropan CR, a
controlled release formulation of Cystrin CR, which Synthelabo licensed from the
Company and Leiras. Synthelabo has not yet begun marketing this product. 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,
Sanofi Winthrop International S.A. ("Sanofi"), Synthelabo and Endo
Pharmaceuticals, Inc. ("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.
During the third quarter, the Company was notified by Kremers Urban Development
Company that it was terminating the Covera HS (Verapamil) collaboration due to
market considerations. The Company intends to seek to license this product to
another collaborator. 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
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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.
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 September 30, 1998,
the Company's accumulated deficit was approximately $25.9 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 September 30, 1998 and 1997
Total revenues decreased 10.6% for the three months ended September 30,
1998 to $6.2 million from $7.0 million for the three months ended September 30,
1997. Product sales decreased to $6.2 million for the three months ended
September 30, 1998 from $6.6 million for the three months ended September 30,
1997 representing a decrease of 7.0%. The decrease in product sales was
primarily due to lower sales in North America of EMCOCEL, one of the Company's
principal excipient products, which occurred in part because the Company
declined to continue serving a high volume, low margin account due to pricing
pressures. Royalties and licensing fees relating to the TIMERx drug delivery
system decreased to $50,000 for the three months ended September 30, 1998 from
$325,000 for the three months ended September 30, 1997 due to the timing of
when development milestones were earned.
Gross profit decreased to $1.7 million or 27.6% of total revenues for the
three months ended September 30, 1998 from $2.1 million or 29.8% of total
revenues for the three months ended September 30, 1997. The decrease in gross
profit percentage was primarily due to the decrease in royalty and licensing
fees for the period. This decrease however, was partially offset by an overall
improvement in the gross profit percentage on product sales from 26.4% for the
three months ended September 30, 1997 to 27.0% for the three months ended
September 30, 1998 due to improving margins on Emcocel products from volume
manufacturing efficiencies, as well as product mix.
Selling, general and administrative expenses increased by 40.2% for the
three months ended September 30, 1998 to $2.9 million from $2.0 million for the
three months ended September 30, 1997. The increase in 1998 was primarily due to
higher compensation expenses related to the employment of additional employees
in 1998 and depreciation on a new computer system.
Research and development expenses increased by 71.0% for the three months
ended September 30, 1998 to $1.5 million from $850,000 for the three months
ended September 30, 1997. This increase was due to increased spending under the
Company's
11
<PAGE> 12
collaborative agreement with Endo and increased spending related to the
development of TIMERx controlled release products.
For the three months ended September 30, 1998 the Company recorded an
income tax benefit of 12.7%. This tax benefit was less than the statutory rate
because operating losses generated by the Company in such period prior to
August 31, 1998 were utilized by Penford, without any compensation being paid to
the Company by Penford for these tax benefits. In addition, the Company's
provision for income taxes includes state and foreign income taxes.
Nine Months Ended September 30, 1998 and 1997
Total revenues increased 3.8% for the nine months ended September 30, 1998
to $21.6 million from $20.8 million for the nine months ended September 30,
1997. Product sales increased to $21.4 million for the nine months ended
September 30, 1998 from $19.9 million for the nine months ended September 30,
1997 representing an increase of 7.8%. The increase in product sales was
primarily due to increased sales volumes of EMCOCEL. Royalties and licensing
fees relating to the TIMERx drug delivery system decreased to $143,000 for the
nine months ended September 30, 1998 from $911,000 for the nine months ended
September 30, 1997 due to the timing of when development milestones were earned.
Gross profit decreased to $6.0 million or 27.6% of total revenues for the
nine months ended September 30, 1998 from $6.1 million or 29.5% of total
revenues for the nine months ended September 30, 1997. The decrease in gross
profit percentage was primarily due to the decrease in royalty and licensing
fees for the period. This decrease, however, was partially offset by an overall
improvement in the gross profit percentage on product sales from 26.2% for the
nine months ended September 30, 1997 to 27.1% for the nine months ended
September 30, 1998 due to improving margins on EMCOCEL products from volume
manufacturing efficiencies as well as product mix.
Selling, general and administrative expenses increased by 37.3% for the
nine months ended September 30, 1998 to $7.9 million from $5.7 million for the
nine months ended September 30, 1997. These lower expenses in the 1997 period
reflected unusually low general and administrative expenses as a result of a
property tax refund recorded in the second quarter of 1997 on the Patterson
facility. The higher expense in 1998 was also due to higher compensation
expenses and relocation expenses associated with the hiring of additional
employees, and higher depreciation on a new computer system.
Research and development expenses increased by 42.9% for the nine months
ended September 30, 1998 to $4.3 million from $3.0 million for the nine months
ended September 30, 1997. This increase was due to increased spending related to
the development of TIMERx controlled release products including the Company's
collaborative agreement with Endo.
For the nine months ended September 30, 1998 the Company recorded an income
tax expense of 1%, higher than the statutory rate of a 34% benefit because
operating losses generated by the Company in such period prior to August 31,
1998 were utilized by Penford, without any compensation being paid to the
Company by Penford for these tax benefits. In addition, the Company's provisions
for income taxes includes state and foreign income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Through August 31, 1998 (the "Distribution Date"), the Company received
inter-company advances from Penford to fund the Company's operations, capital
expenditures and the original acquisition of the Company's predecessor, which
aggregated to $50.5 million. On the Distribution Date Penford contributed the
outstanding inter-company indebtedness to the capital of the Company. Although
Penford has guaranteed the Company's indebtedness under the Credit Facility, in
no other respects has Penford or will Penford provide financial support to the
Company after the Distribution. Subsequent to the Distribution through
September 30, 1998 the Company has funded its operations with cash from
operations.
As of September 30, 1998, the Company had cash and cash equivalents of $1.1
million, and no outstanding borrowings under the Credit Facility. The Company
did begin drawing on the Credit Facility in October 1998. The Company has 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. As of
September 30, 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 trade
receivables. 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 September 30, 1998
increased by 35% from December 31, 1997 primarily due to the increase and the
timing of customer purchases.
12
<PAGE> 13
Funds expended for the acquisition of fixed assets were primarily related
to the expansion and improvement of the Company's manufacturing facilities and
laboratory space as well as the purchase of equipment used principally for
research and development efforts. Funds expended for intangible assets include
costs to secure and defend patents on technology developed by the Company and
secure trademarks.
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, an excipient marketed by
the Company; 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. The Company has 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, $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 obtain funds
through entering into collaborative 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 approximately $9 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.
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 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 result of operations.
YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware or other equipment that have date-sensitive
software or embedded chips may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
13
<PAGE> 14
The Company's plan to resolve the Year 2000 Issue involves the following four
phases: assessment, remediation, testing and contingency planning. The Company
has completed approximately 75% of its overall anticipated assessment of
programs, hardware or other equipment that could be significantly affected by
the Year 2000. The completed assessment indicated that most of the Company's
significant information technology systems will not be affected. The Company
recently installed a new integrated computer system for all domestic operations
that is Year 2000 compliant. The underlying hardware is also Year 2000
compliant according to vendor certification. The international information
technology system primarily consists of personal computers, the majority of
which will require replacement. The assessment also indicated that software and
hardware (embedded chips) used in production and manufacturing systems
(hereafter also referred to as operating equipment) may be Year 2000
non-compliant. Affected systems include process control software used at the
Company's two manufacturing plants, which produce the Company's Emcocel
products, which account for approximately 50% of the Company's revenues. A
failure in either of the plants could cause significant disruption to such
operations, which would have a material adverse effect on the Company's
business, financial position, results of operations or cash flows.
Although the Company has not completed its Year 2000 assessment, it has begun
the remediation and testing phases with respect to the Year 2000 issues it has
identified with respect to its information technology systems. The Company has
completed approximately 75% of the required remediation and expects to complete
replacement of personal computers no later than June 30, 1999. The Company also
needs to complete testing of its software and hardware systems to ensure
compliance. The Company estimates that it has tested approximately 25% of such
systems. The Company expects completion of the testing phase for all significant
systems by February 1999.
The required remediation of operating equipment primarily relates to
manufacturing and laboratory equipment. The Company is currently assessing the
laboratory equipment, and to date, has not identified any material remediation
issues. The Company estimates that it is approximately 60% complete with this
assessment, that the assessment will be completed by December 1998 and that any
required remediation will be completed by June 1999.
The Company has not yet completed the assessment of the process control system
in its two manufacturing facilities, but anticipates that such assessment will
be completed by March 1999 and that any remediation and testing will be
completed by September 1999.
The Company does not have any system interfaces with third party vendors or
customers. The Company is in the process of identifying and obtaining
documentation from its significant suppliers and subcontractors none of which
share information systems with the Company to determine the extent to which such
suppliers and subcontractors will be affected by any significant Year 2000
issues. The Company has not sought to obtain such documentation from its
strategic customers. To date, the Company is not aware of any supplier,
subcontractor or strategic customers with a Year 2000 issue that could have a
material adverse effect on the Company's business, financial position, results
of operations or cash flows. However, as of November 1, 1998 the Company has
only received responses from approximately 25% of the third parties to whom
such communications were made.
<PAGE> 15
There can be no guarantee, however, that third parties of business importance to
the Company will successfully and timely evaluate and address their own Year
2000 issues. The failure of any of these third parties to achieve Year 2000
compliance in a timely fashion could have a material adverse effect on the
Company's business, financial position, results of operations or cash flows.
The costs of the Company's Year 2000 compliance efforts are being funded by
Penford, through August 31, 1998 and thereafter with cash flows from operations
as well as the Company's Credit Facility. Although the Company has not completed
the Year 2000 assessment of its computer systems and software, based upon its
assessment efforts to date, the Company does not anticipate that the costs of
becoming Year 2000 compliant will have a material adverse effect upon the
Company's business, financial position, results of operations or cash flows. The
Company does not expect that the costs of replacing or modifying the computer
equipment and software will be substantially different, in the aggregate, from
the normal, recurring costs incurred by the Company for systems development,
implementation and maintenance in the ordinary course of business. In this
regard, in the ordinary course of replacing computer equipment and software, the
Company attempts to obtain replacements that are Year 2000 compliant. For
example, the Company recently installed a computer system, which was purchased
and installed irrespective of Year 2000 and cost approximately $4.0 million. As
of November 1, 1998, additional costs incurred by the Company for the
replacement of computer equipment and software that was not Year 2000 compliant
(i.e. the costs incurred in excess of the costs that would have been incurred by
the Company in the ordinary course of replacing computer equipment and software)
have not been material. The Company expects to incur total costs of less than
$100,000 to become Year 2000 compliant.
The Company does not presently believe that the Year 2000 issue will pose
significant operational problems for the Company. However, if all Year 2000
issues are not properly identified, or assessment, remediation and testing are
not effected timely with respect to Year 2000 problems that are identified,
there can be no assurance that the Year 2000 issue will not have a material
adverse effect on the Company's business, financial position, results of
operations or cash flows or adversely affect the Company's relationships with
customers, suppliers or others.
The Company has not yet developed a contingency plan for dealing with
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from failure by the Company and certain third
parties to achieve Year 2000 compliance on a timely basis. The Company currently
plans to complete its analysis of the problems and costs associated with the
failure to achieve Year 2000 compliance and to establish a contingency plan in
the event of such failure by December 31, 1999.
The foregoing assessment of the impact of the Year 2000 issue on the Company
is based on management's best estimates as of the date of this Quarterly Report,
which are based on numerous assumptions as to future events. There can be no
assurance that these estimates will prove accurate and actual results could
differ materially from those estimated if these assumptions prove inaccurate.
<PAGE> 16
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 members 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.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects", "intends", "may", and other
similar expressions are intended to identify forward-looking statements. There
are a number of important factors that could cause the Company's actual results
to differ materially from those indicated by forward-looking statements
contained in this report and presented elsewhere by management from time to
time. These factors include the matters discussed in the Overview to this Item
7. Management's Discussion and Analysis of Results of Operations and Financial
Conditions and the matters set forth under the heading "Risk Factors" in the
Company's Registration Statement on Form 10 (declared effective on July 31,
1998), which matters are incorporated herein by reference.
14
<PAGE> 17
PART II. -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
See exhibit index below for a list of the exhibits filed as part of
this Quarterly Report on Form 10-Q, which exhibit index is incorporated
herein by reference.
b. Reports on Form 8-K.
None.
15
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PENWEST PHARMACEUTICALS CO.
Date: November 16, 1998 By: /s/ Tod R. Hamachek
-------------------------------
Tod R. Hamachek
Chairman of the Board and
Chief Executive Officer
EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
27 Financial Data Schedule
99 Pages 12 through 22 of Amendment No. 2 to the
Company's Registration Statement on Form 10/A as
filed with the Securities and Exchange Commission
on July 28, 1998 (which is not deemed filed
except to the extent that portions thereof are
expressly incorporated by reference herein).
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30, 1998 THE CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND THE CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 1,137
<SECURITIES> 0
<RECEIVABLES> 4,403
<ALLOWANCES> 337
<INVENTORY> 8,931
<CURRENT-ASSETS> 14,818
<PP&E> 34,720
<DEPRECIATION> 12,183
<TOTAL-ASSETS> 41,946
<CURRENT-LIABILITIES> 4,582
<BONDS> 0
0
0
<COMMON> 11
<OTHER-SE> 32,132
<TOTAL-LIABILITY-AND-EQUITY> 41,946
<SALES> 6,180
<TOTAL-REVENUES> 6,230
<CGS> 4,511
<TOTAL-COSTS> 4,511
<OTHER-EXPENSES> 4,305
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15
<INCOME-PRETAX> (2,601)
<INCOME-TAX> (329)
<INCOME-CONTINUING> (2,272)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,272)
<EPS-PRIMARY> (.21)
<EPS-DILUTED> (.21)
</TABLE>
<PAGE> 1
EXHIBIT 99
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
12
<PAGE> 2
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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<PAGE> 3
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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<PAGE> 4
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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<PAGE> 5
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> 6
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.
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<PAGE> 7
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."
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<PAGE> 8
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."
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<PAGE> 9
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.
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<PAGE> 10
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."
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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.
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