<PAGE> 1
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 June 30, 1999
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 August 10, 1999.
Class Outstanding
----------------------------- -----------
Common stock, par value $.001 11,118,583
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PENWEST PHARMACEUTICALS CO.
TABLE OF CONTENTS
PAGE
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
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........................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 14
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders........... 15
Item 6. Exhibits and Reports on Form 8-K.............................. 15
Signature................................................................... 16
Exhibit Index............................................................... 16
2
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PENWEST PHARMACEUTICALS CO.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 467 $ 1,476
Trade accounts receivable, net 5,440 4,381
Inventories:
Raw materials and other 1,225 1,365
Finished goods 5,973 7,439
-------- --------
7,198 8,804
Prepaid expenses and other current assets 496 572
Deferred income taxes 356 356
-------- --------
Total current assets 13,957 15,589
Fixed assets, net 19,514 20,822
Other assets 4,738 4,671
-------- --------
Total assets $ 38,209 $ 41,082
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 5,269 $ 5,405
Taxes payable 351 336
Loans payable 3,400 2,200
-------- --------
Total current liabilities 9,020 7,941
Deferred income taxes 747 932
Other long-term liabilities 2,245 2,177
-------- --------
Total liabilities 12,012 11,050
Shareholders' equity:
Preferred stock, par value $.001, authorized
1,000,000 shares, none outstanding
Common stock, par value $.001, authorized 39,000,000
shares, issued and outstanding 11,104,816 shares and
11,043,331 shares 11 11
Additional paid-in capital 59,431 59,025
Accumulated deficit (32,279) (28,478)
Accumulated other comprehensive loss (966) (526)
-------- --------
Total shareholders' equity 26,197 30,032
-------- --------
Total liabilities and shareholders' equity $ 38,209 $ 41,082
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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PENWEST PHARMACEUTICALS CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS
ENDED JUNE 30,
---------------------
1999 1998
------- -------
(UNAUDITED)
Revenues
Product sales $ 8,274 $ 7,488
Royalties and licensing fees 70 68
------- -------
Total revenues 8,344 7,556
Cost of product sales 5,853 5,348
------- -------
Gross profit 2,491 2,208
Operating expenses
Selling, general and administrative 2,955 2,670
Research and product development 1,762 1,458
------- -------
Total operating expenses 4,717 4,128
------- -------
Loss from operations (2,226) (1,920)
Interest expense 70 --
------- -------
Loss before income taxes (2,296) (1,920)
Income tax expense (benefit) (36) 66
------- -------
Net loss $(2,260) $(1,986)
======= =======
Basic and diluted net loss per share $ (0.20) $ (0.18)
======= =======
Weighted average shares of common stock outstanding 11,104 11,037
======= =======
SIX MONTHS
ENDED JUNE 30,
---------------------
1999 1998
------- -------
(UNAUDITED)
Revenues
Product sales $18,011 $15,249
Royalties and licensing fees 150 93
------- -------
Total revenues 18,161 15,342
Cost of product sales 12,797 11,264
------- -------
Gross profit 5,364 4,078
Operating expenses
Selling, general and administrative 5,551 5,027
Research and product development 3,499 2,663
------- -------
Total operating expenses 9,050 7,690
------- -------
Loss from operations (3,686) (3,612)
Interest expense 134 --
------- -------
Loss before income taxes (3,820) (3,612)
Income tax expense (benefit) (19) 404
------- -------
Net loss $(3,801) $(4,016)
======= =======
Basic and diluted net loss per share $ (0.34) $ (0.36)
======= =======
Weighted average shares of common stock outstanding 11,079 11,037
======= =======
See accompanying notes to condensed consolidated financial statements.
4
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PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
SIX MONTHS
ENDED JUNE 30,
---------------------
1999 1998
------- -------
(UNAUDITED)
Net cash used in operating activities $(2,124) $(3,634)
Investing activities:
Acquisitions of fixed assets, net (246) (951)
Other (145) (125)
------- -------
Net cash used in investing activities (391) (1,076)
Financing activities:
Borrowings from credit facility 4,800 --
Repayments of credit facility (3,600) --
Issuance of common stock 407 --
Increase in payable to Penford -- 4,676
------- -------
Net cash provided by financing activities 1,607 4,676
Effect of exchange rate changes on cash and cash
equivalents (101) (4)
------- -------
Net decrease in cash and cash equivalents (1,009) (38)
Cash and cash equivalents at beginning of period 1,476 938
------- -------
Cash and cash equivalents at end of period $ 467 $ 900
======= =======
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 oral drug
delivery products and technologies. Based on its extensive expertise in
developing and manufacturing tableting ingredients for the pharmaceutical
industry, the Company has developed TIMERx, a proprietary controlled
release drug delivery technology and PROSOLV SMCC(TM), another drug
delivery technology which improves the performance characteristics of
tablets. The Company's product portfolio ranges from excipients that are
sold in bulk to more technically advanced and patented excipients that are
licensed to customers. 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 actively engaged in research and development. These
risks and uncertainties include, but are not limited to, a history of net
losses, technological changes, dependence on collaborators and key
personnel, the successful completion of development efforts and of
obtaining regulatory approval, the successful commercialization of TIMERx
controlled release products, 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 six month period ended June 30, 1999 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1999. For
further information, refer to the consolidated financial statements and
footnotes thereto included in Penwest Pharmaceuticals Co.'s Annual Report
on Form 10-K for the year ended December 31, 1998.
Certain prior year amounts have been reclassified to conform with the
current year's presentation. These reclassifications had no effect on
previously reported results of operations.
3. INCOME TAXES
The effective tax rates for the three month and six month periods
ended June 30, 1999 were a benefit of 2% and 1%, respectively. The
effective rates are lower than the federal statutory rate of a 34% benefit
due primarily to a valuation allowance on deferred tax assets relating to
the Company's net operating loss as well as state and foreign income taxes.
The effective tax rates for the three month and six month periods ended
June 30, 1998 were expenses of 3% and 11%, 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) for which Penwest was not reimbursed,
temporary differences resulting from accelerated depreciation reversing
when losses are not expected to be available and foreign income taxes.
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4. COMPREHENSIVE LOSS
As of January 1, 1998, the Company adopted Financial Accounting
Standards Board Statement No. 130 "Reporting Comprehensive Income".
Statement No. 130 establishes new rules for the reporting and display of
comprehensive income (loss) and its components; however, the adoption of
this Statement had no impact on the Company's Net loss or Shareholders'
equity.
The components of comprehensive loss, for the three-month and six-month
periods ended June 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
1999 1998 1999 1998
------- ------- ------- -------
(IN THOUSANDS OF DOLLARS) (IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
Net loss $(2,260) $(1,986) $(3,801) $(4,016)
Foreign currency translation adjustments (157) 147 (440) 71
------- ------- ------- -------
Comprehensive loss $(2,417) $(1,839) $(4,241) $(3,945)
======= ======= ======= =======
</TABLE>
Accumulated other comprehensive loss equals the cumulative
translation adjustment which is the only component of other comprehensive
loss included in the Company's financial statements.
5. 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). 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. 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 although
the FDA granted tentative approval, it will not grant final marketing
approval of Nifedipine XL until a final judgment on the patent suit is
rendered in favor of Mylan by the district court, or in the event of an
appeal, by the court of appeals, or until 30 months (or such longer or
shorter period as the court may determine) have elapsed from the date of
Mylan's certification, whichever is sooner.
In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming
that its Procardia XL formulation constituted a unique delivery system and
that a drug with a different release mechanism such as the TIMERx
controlled release system cannot be considered the same dosage form and
approved in an ANDA as bioequivalent to Procardia XL. In August 1997, the
FDA rejected Pfizer's citizen's petition. In July 1997, Pfizer also sued
the FDA in the District Court of the District of Columbia, claiming that
the FDA's acceptance of Mylan's ANDA filing for Nifedipine XL was contrary
to law, based primarily on the arguments stated in its citizen's petition.
Mylan and the Company intervened as defendants in this suit. In April 1998
the District Court of the District of Columbia rejected Pfizer's claim, and
in May 1998, Pfizer appealed the District Court's decision. In July 1999,
the US Court of Appeals for the District of Columbia ruled that the lawsuit
was premature and that the courts won't consider lawsuits against an
administrative agency until the FDA gives final clearance to the product.
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
7
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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 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 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 $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 $25.0 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.
6. 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.
7. DISTRIBUTION AND CAPITAL CONTRIBUTION
On August 31, 1998, Penford Corporation ("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 Nasdaq 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
8
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business from its specialty carbohydrate-based chemical business and the
Distribution, including without limitation Penford's agreement to guarantee
the Company's indebtedness under its credit facility; (ii) a Services
Agreement pursuant to which Penford will continue on an interim basis to
provide specified services to the Company until June 30, 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 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 inter-company indebtedness of the Company which approximated
$50.9 million.
8. STOCK OPTIONS
During the six months ended June 30, 1999, options to purchase 61,485
shares were exercised, options to purchase 70,000 shares were granted and
options to purchase 393,375 shares were canceled under the Company's stock
option plans.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Penwest Pharmaceuticals Co. ("Penwest" or the "Company"), is engaged in
the research, development and commercialization of novel oral drug delivery
technologies. The Company has extensive experience in developing and
manufacturing tableting ingredients for the pharmaceutical industry. The
Company's product portfolio ranges from excipients that are sold in bulk, to
more technically advanced and patented excipients that are licensed to
customers. On August 31, 1998 (the "Distribution Date"), Penwest became an
independent, publicly owned company when Penford Corporation ("Penford"), the
Company's former parent, 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, the Company's collaborator, Sanofi Winthrop
International S.A. ("Sanofi"), received marketing approval in the United Kingdom
in November 1998 for Slofedipine XL, a controlled release version of nifedipine
utilizing Penwest's TIMERx technology for the treatment of angina. In May 1997,
the Company's collaborator, Mylan Laboratories ("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 AG ("Bayer") and
Pfizer, Inc. ("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. In July
1999, the US Court of Appeals for the District of Columbia ruled that the
lawsuit was premature and that the courts wouldn't consider the lawsuit until
the FDA gives final clearance to the product. In March 1999, Mylan was notified
by the FDA that the ANDA for 30 mg dosage strength of Nifedipine XL had received
tentative approval. However, the Company does not expect that final marketing
approval will be granted until certain legal issues surrounding the patent
dispute between Mylan and Bayer and Pfizer have been resolved. 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.
9
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The Company is a party to collaborative agreements with Mylan, Leiras,
Sanofi 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. 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 Company has little
control over the timing and the amount of each of these payments which are
dependent on the continued development and commercialization of the products
covered by such agreements, 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.
The Company has incurred net losses since 1994. As of June 30, 1999, the
Company's accumulated deficit was approximately $32.3 million. The Company
expects net losses to continue at least into early 2000. 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, 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 June 30, 1999 and 1998
Total revenues increased 10.4% for the three months ended June 30, 1999 to
$8.3 million from $7.6 million for the three months ended June 30, 1998. Product
sales increased to $8.3 million for the three months ended June 30, 1999
compared to $7.5 million for the three months ended June 30, 1998, representing
an increase of 10.5%. The increase in product sales was primarily due to
increased sales volumes of Emcocel(R). This increase in sales of Emcocel was due
to two new large pharmaceutical customers which came on line throughout the
first quarter of 1999 as well as increased sales to existing customers.
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Gross profit increased to $2.5 million, or 29.9% of total revenues for the
three months ended June 30, 1999 from $2.2 million, or 29.2% of total revenues
for the three months ended June 30, 1998. The increase in gross profit
percentage was primarily due to increasing margins on Emcocel products due to
volume manufacturing efficiencies.
Selling, general and administrative expenses increased by 10.7% for the
three months ended June 30, 1999 to $3.0 million from $2.7 million for the three
months ended June 30, 1998. The increase in 1999 was primarily due to
compensation expenses related to the employment of additional personnel and
additional costs including professional fees associated with being a
publicly-held Company.
Research and development expenses increased by 20.9% for the three months
ended June 30, 1999 to $1.8 million from $1.5 million for the three months ended
June 30, 1998. This increase was primarily due to increased spending under the
Company's collaborative agreement with Endo.
The effective tax rate for the three month period ended June 30, 1999 was a
benefit of 2%. The effective rate is lower than the federal statutory rate of a
34% benefit due primarily to a valuation allowance on deferred tax assets
relating to the Company's net operating loss as well as state and foreign income
taxes. The effective tax rate for the three month period ended June 30, 1998 was
3% (expense) which is 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) for which Penwest was not reimbursed, temporary
differences resulting from accelerated depreciation reversing when losses are
not expected to be available and foreign income taxes.
Six months ended June 30, 1999 and 1998
Total revenues increased 18.4% for the six months ended June 30, 1999 to $18.2
million from $15.3 million for the six months ended June 30, 1998. Product sales
increased to $18.0 million for the six months ended June 30, 1999 compared to
$15.2 million for the six months ended June 30, 1998, representing an increase
of 18.1%. The increase in product sales was primarily due to increased sales
volumes of Emcocel. This increase in sales of Emcocel was primarily due to two
new large pharmaceutical customers which came on line throughout the first
quarter.
Gross profit increased to $5.4 million or 29.5% of total revenues for the
six months ended June 30, 1999 from $4.1 million, or 26.6% of total revenues for
the six months ended June 30, 1998. The increase in gross profit percentage was
partly due to increasing margins on Emcocel products due to volume manufacturing
efficiencies, as well as increased sales of formulated TIMERx, which have
overall higher margins.
Selling, general and administrative expenses increased by 10.4% for the six
months ended June 30, 1999 to $5.6 million from $5.0 million for the six months
ended June 30, 1998. The increase in 1999 was primarily due to compensation
expenses related to the employment of additional personnel and additional costs
including professional fees associated with being a publicly-held Company.
Research and development expenses increased by 31.4% for the six months
ended June 30, 1999 to $3.5 million from $2.7 million for the six months ended
June 30, 1998. This increase was primarily due to increased spending under the
Company's collaborative agreement with Endo.
The effective tax rate for the six month period ended June 30, 1999 was a
benefit of 1%. The effective rate is lower than the federal statutory rate of a
34% benefit due primarily to a valuation allowance on deferred tax assets
relating to the Company's net operating loss as well as state and foreign income
taxes. The effective tax rate for the six month period ended June 30, 1998 was
11% (expense) which is 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) for which Penwest was not reimbursed, temporary
differences resulting from accelerated depreciation reversing when losses are
not expected to be available and foreign income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the Distribution Date, the Company received intercompany advances
from Penford to fund the Company's operations, capital expenditures and the
original acquisition of the Company's predecessor, which aggregated to $50.9
million. On the Distribution Date, Penford contributed the outstanding
intercompany indebtedness and certain other assets and liabilities to the
capital of the Company. Since the Distribution Date, the Company funded its
operations and capital expenditures from cash from operations
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<PAGE> 12
and advances under a credit facility. The Company has an available credit
facility which is a revolving loan facility of $15.0 million of unsecured
financing (the "Credit Facility"). On August 31, 2000, all outstanding amounts
under the Credit Facility will become automatically due and payable. Penford has
agreed that, through the period ending August 31, 2000, it will guarantee the
Company indebtedness under the Credit Facility. LIBOR Advances (available in
multiples of $1,000,000 for 1, 2 or 3 month LIBOR periods) under the Credit
Facility bear interest at a rate equal to LIBOR, plus 1.25%. Base Rate Advances
(as defined under the Credit Facility) (available in minimum amounts of
$100,000) bear interest at the Bank's Alternate Base Rate (as defined under the
Credit Facility). The Credit Facility also requires commitment fees to be paid
at .325% on unused portions of the commitment amount.
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 is 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. Although
Penford has guaranteed the Company's indebtedness under the Credit Facility, in
no other respects is Penford providing financial support to the Company.
As of June 30, 1999, the Company had cash and cash equivalents of $467,000
and $3.4 million of outstanding borrowings under the Credit Facility. 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 June 30, 1999, the Company did not have any material commitments
for capital expenditures. The Company has entered into a strategic alliance
agreement with Endo and the Company expects to expend approximately $7 million,
primarily in 1999, 2000 and early 2001 on the development of a drug. The Company
expects to rely on funds available under the Credit Facility and cash from
operations to fund expenditures. However, the Company may be required to raise
additional funds to continue its development 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 Company had negative cash flow from operations in each of the periods
presented primarily due to net losses for the periods as well as significantly
higher trade receivables over December 31, 1998. Funds expended for the
acquisition of fixed assets were primarily related to efforts at the Company's
manufacturing facility in Iowa to increase capacity. 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 early
2000. 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 (i) the timing and amount of payments received under existing and
possible future collaborative agreements; (ii) the structure of any future
collaborative or development agreements; (iii) the progress of the Company's
collaborative and independent development projects; (iv) revenues from the
Company's traditional excipients; (v) the costs to the Company of bioequivalence
studies for the Company's products; (vi) the prosecution, defense and
enforcement of patent claims and other intellectual property rights; and (vii)
the development of manufacturing, marketing and sales capabilities. 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
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<PAGE> 13
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.
YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four digits 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.
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 100% of its overall assessment of programs, hardware or
other equipment that could be significantly affected by the Year 2000. The
assessment indicates 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 assessment of the Company's North American
manufacturing facility is complete, and the required remediation was completed
in July 1999. The Company's international information technology system
primarily consists of personal computers, some of which required replacement,
which was completed in May 1999. The assessment also indicated that software and
hardware (embedded chips) used in production and manufacturing systems
(hereafter also referred to as operating equipment) in Nastola, Finland, which
produce the Company's European Emcocel products, are Year 2000 non-compliant.
However, the software that is expected to correct this problem will be installed
by December 1999. A failure in this plant could cause disruption to the
operations at the Finnish plant, which could have a material adverse effect on
the Company's business, financial position, results of operations or cash flows.
The Company has also begun the remediation and testing phases with respect
to the Year 2000 issues it has identified relating to its information technology
systems. The Company has completed approximately 90% of the required remediation
and expects to complete replacement of all non-compliant equipment no later than
September 1999. The Company also must complete testing of its software and
hardware systems to ensure compliance. The Company estimates that it has tested
approximately 60% of such systems and expects completion of the testing phase
for all significant systems by September 1999.
The Company does not have any system interfaces with third party vendors,
manufacturers or customers. The Company is in the process of identifying and
obtaining documentation from its significant suppliers and subcontractors who do
not 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 estimates that it is 90% complete with this process. The
Company is also in the process of communicating with its significant customers.
To date, the Company is not aware of any supplier, manufacturer, subcontractor
or significant 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. The Company has sent correspondence to all of its
major suppliers, subcontractors and manufacturers and has received approximately
90% of the responses back.
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 worldwide Year 2000 compliance efforts are being
funded with cash flows from operations as well as the Company's Credit Facility.
Based upon the near-complete 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 compliance
and cost approximately $4.0 million. The Company expects to incur total
worldwide costs of less than $100,000 to become Year 2000 compliant on its
hardware, software and operating equipment.
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<PAGE> 14
The Company does not presently believe that the Year 2000 issue will pose
significant operational problems. However, if all Year 2000 issues are not
properly identified, or assessment, remediation and testing are not affected on
a timely basis 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 or 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 October 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 on Form 10-Q, 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK AND RISK MANAGEMENT POLICIES
The operations of the Company are exposed to financial market risks,
including changes in interest rates and foreign currency exchange rates. The
Company's interest rate risk consists of cash flow risk associated with
borrowing under its variable rate Credit Facility. 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 or interest rates. The Company does not believe that the potential
exposure is significant in light of the size of the Company and its business.
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 Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations and the matters set forth under "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors" in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998.
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<PAGE> 15
PART II. -- OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Shareholders held on June 2, 1999, the
following proposals were adopted by the vote specified below:
a. Election of Class II directors for a term of three years:
FOR FOR % WITHHOLD WITHHOLD %
--------- ----- -------- ----------
Jere E. Goyan 9,887,687 89.05% 16,570 .15%
Anne M. VanLent 9,887,540 89.05% 16,717 .15%
The following directors did not stand for reelection as their
terms in office continued after the Annual Meeting: Tod R.
Hamachek, Robert Hennessey, John N. Staniforth, Paul E. Freiman,
Rolf H. Henel and N. Stewart Rogers.
b. Ratification of selection of Ernst & Young LLP as independent
auditors of the Company for the current year:
FOR AGAINST ABSTAIN
--------- ------- -------
9,879,258 12,774 12,225
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.
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<PAGE> 16
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: August 13, 1999 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 34 through 44 of the Company's Annual Report on
Form 10-K for the year ended December 31, 1998 as
filed with the Securities and Exchange Commission on
March 31, 1999 (which is not deemed filed except to
the extent that portions thereof are expressly
incorporated by reference herein).
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<PAGE> 1
RISK FACTORS
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 March 1999, Mylan was
notified that the ANDA had received tentative approval from the FDA. The Company
expects that final marketing approval will not be granted until the legal issues
surrounding the patent dispute have been resolved.
In an ANDA filing, the FDA generally requires data demonstrating that the
drug formulation is bioequivalent to the branded drug. In addition, under 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 NDA
for the brand name product.
Bayer and ALZA own patents listed for Procardia XL, and 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
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<PAGE> 2
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. In February 1999, the case was heard in appeals court but no
decision has been rendered. 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 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,
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<PAGE> 3
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 has filed an ANDA with respect to a 30 mg and
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.
DEPENDENCE ON COLLABORATIVE AGREEMENTS
The Company intends to develop and commercialize its TIMERx controlled
release products in collaboration with pharmaceutical companies. The Company is
a party to collaborative agreements with Mylan, Leiras, Sanofi and Endo, among
others. 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 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
36
<PAGE> 4
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.
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, and Slofedipine XL which is being marketed in the U.K., none of the
Company's other 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 March 1999, Mylan
received a tentative approval on an ANDA filed 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. Substantially all the revenues from controlled
release products generated to date have been milestone fees received for
products under development as well as some sales of formulated TIMERx. 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.
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
The Company incurred net losses of approximately $3.9 million, $7.3
million and $8.8 million during 1996, 1997 and 1998, respectively. As of
December 31, 1998, the Company's accumulated deficit was approximately $28.5
million. The Company expects net losses to continue at least into early 2000. 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 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.
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<PAGE> 5
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 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 has concentrated 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.
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.
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 early 2000.
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
38
<PAGE> 6
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, 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. 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.
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.
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 24 U.S. and 48
foreign patents and one U.S. patent application has been allowed relating
principally 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
39
<PAGE> 7
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
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 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.
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
40
<PAGE> 8
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.
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. In March 1999, Mylan received tentative approval of this
application. There can be no assurance that final approval 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.
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. The Company has identified another
third-party manufacturer to manufacture TIMERx
41
<PAGE> 9
material and is currently validating such manufacturer's facility and
negotiating the terms under which such manufacturer will manufacture TIMERx
material for the Company. During the fourth quarter of 1998, experimental
batches of TIMERx were run in the facility, and commercial terms were agreed
upon. However, there can be no assurance that the Company will finalize 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 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 a specialty
grade of 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.
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
42
<PAGE> 10
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.
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 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 $25 million which can also be used
for product liability insurance. 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.
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.
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. 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
43
<PAGE> 11
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 (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.
44
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