Medco Research, Inc.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the year ended December 31, 1998
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from________to________
Commission file number 0-13948
MEDCO RESEARCH, INC.
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(Exact name of registrant as specified in its charter)
Delaware 95-3318451
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7001 Weston Parkway, Suite 300
Cary, North Carolina 27513
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(Address of principal executive offices) (Zip Code)
(919) 653-7001
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock New York Stock Exchange
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(Title of Class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[ X ]
Based on the closing price on March 1, 1999 of $23.125 for the Registrant's
Common Stock as reported on the New York Stock Exchange, the aggregate market
value of Common Stock held by nonaffiliates of Registrant was approximately
$235,844,475.
The number of shares outstanding of the Registrant's Common Stock was 10,333,257
at March 1, 1999.
Documents incorporated by reference:
Part III: Sections entitled "Election of Directors", "Board of Directors and
Executive Officers", "Executive Compensation", "Security Ownership of Certain
Beneficial Owners and Management" and "Certain Transactions" from the
Registrant's Proxy Statement for its 1999 Annual Meeting of Shareholders.
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PART I
ITEM 1. BUSINESS
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COMPANY PROFILE
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Medco Research, Inc. (the "Company") is a pharmaceutical company dedicated to
being a leader in the global commercialization of cardiovascular medicines and
adenosine-receptor technologies leading to superior growth in shareholder value.
The Company was incorporated in California in September 1978 and originally
founded as a contract research organization offering clinical and regulatory
support to the pharmaceutical industry. In 1984, the Company secured its own
product rights, went public, raised approximately $4 million in the initial
offering, and began its transition to a pharmaceutical company. In January 1992,
it raised approximately $48 million in a secondary public offering. In May 1993,
the Company relocated to Research Triangle Park, North Carolina, and in 1995 it
completed its reincorporation in Delaware.
The Company's business approach has been to carefully evaluate and selectively
acquire product candidates, thereby reducing the costs and risks associated with
basic research and drug discovery. These product opportunities and the related
intellectual property rights are typically obtained under license from academic
or corporate sources who have received United States patents which, in the
opinion of the Company's patent counsel, are valid and enforceable. See "Patents
and Proprietary Rights" below. The Company then sponsors and directs any
additional preclinical studies and clinical testing needed for product
registration and marketing approval. These late-stage product development
activities are outsourced to independent clinical research organizations to
maximize efficiency and minimize internal overhead. Historically the Company has
licensed the manufacturing and marketing rights to the product to a corporate
partner in exchange for licensing fees and royalty payments on future product
sales. A portion of formulation development, as well as microbiology, chemistry,
manufacturing and controls information, are typically provided by the Company's
licensed corporate partner, and the Company then submits to the United States
Food and Drug Administration (the "FDA") a New Drug Application ("NDA") to
obtain the FDA's clearance to market the drug. See "Government Regulation of
Pharmaceuticals" below.
Using this royalty-based business model, which is relatively uncommon in the
pharmaceutical industry, the Company has had two out of four NDAs approved,
commercialized two drugs, and has other compounds proceeding through various
stages of development, all with a relatively modest depletion of its cash. The
Company's first product, ADENOCARD(R), was approved by the FDA in October 1989.
Its second product, ADENOSCAN(R), was approved by the FDA in May 1995.
Substantially all of the Company's royalty income in the three-year period ended
December 31, 1998 resulted from sales of ADENOCARD and ADENOSCAN in the United
States by Fujisawa Healthcare, Inc. ("Fujisawa"), the Company's corporate
partner.
Statements contained in Item 1 of this report which are not historical facts are
forward looking statements under the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Although the Company believes the
expectations reflected in such forward looking statements are based upon
reasonable assumptions, it can give no assurance that its expectations will be
attained. Forward looking statements involve known and unknown risks that could
cause the Company's actual results to differ materially from expected results.
Factors that could cause actual results to differ materially include, among
others, the high cost and uncertainty of the research, clinical trials and other
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development activities involving pharmaceutical products; the unpredictability
of the duration and results of regulatory review of New Drug Applications and
Investigational New Drug Applications; the possible impairment of, or inability
to obtain, intellectual property rights and the cost of obtaining such rights
from third parties; intense competition; the uncertainty of obtaining, and the
Company's dependence on, third parties to manufacture and sell its products;
results of pending or future litigation and other risk factors detailed from
time to time in the Company's Securities and Exchange Commission filings.
STRATEGIC PLAN
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Whereas large pharmaceutical companies often diversify into multiple diagnostic
and therapeutic areas, small companies with more limited resources must
concentrate their efforts to be competitive and successful. As such, the Company
focuses primarily on the role of adenosine and its receptors in cardiovascular
disease. The Company's expertise in adenosine drug development is
well-recognized in the medical community.
Over the past two years the Company has conducted a worldwide assessment of
adenosine-receptor technologies and has succeeded in securing commercialization
rights and related intellectual properties to a portfolio of applications of
intravenous adenosine as well as adenosine analogs and allosteric modulators.
Going forward, the Company plans to retain U.S. rights to the compounds which
indicate potential use as hospital-based cardiovascular products and out-license
non-U.S. rights to these compounds as well as worldwide rights to compounds
identified for potential non-cardiovascular use.
PORTFOLIO
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ADENOCARD(R) - a sterile formulation of adenosine for injection - indicated for
the treatment of abnormally rapid heartbeats originating in the upper
chambers of the heart, referred to as paroxysmal supraventricular
tachycardia. Commercially available from Fujisawa in the U.S. and Canada
since 1989 as ADENOCARD, the drug also is sold by the Company's corporate
partner Sanofi Pharma ("Sanofi"), a multinational pharmaceutical company
headquartered in France, in the United Kingdom and 47 other countries of
the world as ADENOCOR(R) and in Switzerland as KRENOSIN(R).
ADENOSCAN(R) - a sterile formulation of adenosine for infusion - indicated as an
adjunct to thallium cardiac imaging for the evaluation of coronary artery
disease in patients unable to exercise adequately, referred to as a
pharmacological stressor. Commercially available from Fujisawa in the
United States and Canada since 1995, the drug also is sold by Sanofi in the
United Kingdom and five other European countries as well as Australia.
During 1997 Sanofi received approval for the drug in 14 additional member
countries of the European Community through the mutual recognition
procedure. Additional markets will be added in 1999 as pricing agreements
are completed.
ADENOSINE FOR CARDIOPROTECTION (formerly designated MEDR-640) - sterile
formulations of adenosine for infusion under development as a
cardioprotective adjunct to early thrombolytic therapy or emergency
angioplasty in the treatment of acute myocardial infarction and as an
additive to standard cardioplegia during open-heart surgery. At the 1998
71st Scientific Sessions of the American Heart Association, positive
clinical results of a Phase II multicenter trial were reviewed, supporting
the Company's belief, although no assurance can be given, that the drug may
prove to be an effective cardioprotective agent during acute myocardial
infarction. A Phase III trial, involving approximately 2,100 patients to be
recruited from 200 to 300 centers in the United States and Canada,
commenced in 1999. The objectives of this trial are to confirm results in a
sizeable population and to provide additional information on clinical
outcomes such as death and rehospitalization.
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ADENOSINE ANALOGS - chemical derivatives of adenosine, or adenosine analogs,
have been developed by chemists to selectively affect a particular
adenosine receptor subtype. These compounds are referred to as
second-generation technology. By means of option agreements and a research
agreement, the Company has rights to a number of adenosine analogs,
including A2a-, and A3- agonists as well as A3- antagonists. The lead
A2a-agonist, designated MRE0470, is under development as a potential
follow-on to the Company's currently marketed product ADENOSCAN. No
assurance can be given that any of the Company's analogs will result in the
filing or approval of any NDA. See "Government Regulation of
Pharmaceuticals" below.
ADENOSINE ALLOSTERIC MODULATORS - a new series of adenosine-based compounds,
designated adenosine allosteric modulators, with a novel mechanism of
action were discovered and synthesized in 1997. The compounds are referred
to as third-generation technology. No assurance can be given that any of
these compounds will result in the filing or approval of any NDA. As of the
end of 1998, the Company had filed patent applications on more than 20
adenosine allosteric modulators. No assurance can be given that any patents
will be issued or, if issued, that they will provide any competitive
protection to the Company. See "Patents and Proprietary Rights" below.
PRODUCT AND COMPOUND SUMMARIES
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ADENOCARD(R)
The Product: ADENOCARD is a sterile formulation of adenosine (3mg/ml) available
in 2ml vials and 2-4ml prefilled syringes for intravenous injection to restore
normal heart rhythm in patients with abnormally rapid heartbeats originating in
the upper chambers of the heart, so-called paroxysmal supraventricular
tachycardia (PSVT). Because of its very short half-life (less than 10 seconds),
ADENOCARD works quickly and typically without prolonged side effects. It has
been adopted by numerous medical organizations as the "drug-of-choice" for the
treatment of PSVT.
Regulatory Status: In October 1988, the Company received FDA approval to market
ADENOCARD in the United States, and the drug is commercially available from
Fujisawa in the United States and Canada. In September 1991, Sanofi received
marketing approval (under the trade name ADENOCOR) in the United Kingdom and, in
May 1992, received marketing approval (under the trade name KRENOSIN) in
Switzerland. Sanofi also sells the drug in Austria, Australia, Belgium,
Bulgaria, Chile, China, Columbia, the Czech Republic, Denmark, the Dominican
Republic, Egypt, Finland, France, French Polynesia, Germany, Greece, Guatemala,
Hong-Kong, Hungary, India, Indonesia, Ireland, Israel, Italy, Kuwait,
Luxembourg, Malaysia, New Zealand, Norway, Oman, Panama, Peru, the Philippines,
Poland, Portugal, Qatar, the Republic of Estonia, the Republic of Lithuania,
Romania, Saudi Arabia, Singapore, Slovakia, South Africa, South Korea, Spain,
Switzerland, Taiwan, Thailand, and Uruguay.
Product License: In March 1985, the University of Virginia Alumni Patents
Foundation ("UVAPF") granted to the Company an exclusive license to exploit in
the United States and Canada the use of adenosine for the treatment of
supraventricular tachycardia that is caused by re-entry in the A-V node or an
accessory pathway of the human heart. (In November 1986, UVAPF received a United
States Patent on such use.) For these rights, the Company paid a one-time,
nonrefundable license fee and agreed to pay 10% of all net sales of ADENOCARD
made directly by the Company and 50% of all royalties received by the Company
from its sublicensees until the expiration of the term of the last applicable
patent rights or until the license is terminated as provided in the agreement.
Competition: Intravenous calcium channel blockers and beta-blockers (generically
available from numerous sources) are principal competitors. In addition,
catheter-based ablation therapy is becoming more common and may compete for
certain patient types.
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Manufacturing and Marketing:
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1. Agreement with Fujisawa. The Company granted Fujisawa an exclusive license to
manufacture and market ADENOCARD in the United States and Canada. Fujisawa
agreed to pay the Company a royalty equal to 25% of its net sales of ADENOCARD
in each country for the duration of patent protection or any other exclusive
marketing rights that may be granted to the Company by governmental agencies,
whichever is longer. Fujisawa also agreed to pay the Company a royalty equal to
7% of Fujisawa's net sales of ADENOCARD during any subsequent term of the
agreement, which will continue after the initial term until either party
terminates the agreement by giving the other party 90 days written notice. In
May 1998, the Company transferred the NDA for ADENOCARD to Fujisawa and engaged
a third party to contract manufacture the drug.
2. Agreement with Sanofi Pharma. The Company granted Sanofi the rights to
exclusively manufacture and market ADENOCARD in Europe and countries other than
the United States and Canada. Sanofi agreed to use its best efforts to
commercialize ADENOCARD in such territories subsequent to receiving governmental
marketing approvals and to pay the Company royalties equal to 5% of its net
sales of ADENOCARD. Royalties will be paid on a country by country basis for the
longer of six years or the period of any marketing exclusivity.
ADENOSCAN(R)
The Product: ADENOSCAN is a sterile formulation of adenosine (3mg/ml) available
in 30ml or 20ml vials for infusion indicated as an adjunct to thallium cardiac
imaging in the evaluation of coronary artery disease in patients unable to
exercise adequately. The procedure is called pharmacological stress, since in
many ways the effects of adenosine simulate those of exercise. ADENOSCAN is
administered by brief intravenous infusion, and thallium (a radioactive agent)
is injected during the procedure. Cardiac images are subsequently acquired (with
gamma cameras) which visually display the presence and severity of underlying
coronary artery disease. Because of its very short half-life, side effects are
generally very brief.
Regulatory Status: In October 1992, the Company received approval to market
ADENOSCAN in Canada; and in May 1995, the Company received from the FDA
marketing clearance for ADENOSCAN in the United States. In June 1995, Sanofi
received marketing approval for ADENOSCAN in the United Kingdom and in February
1997, Sanofi registered ADENOSCAN in 14 additional member countries of the
European Community through the mutual recognition procedure. The final
administrative procedure involving the granting of a National Marketing License
authorizing the sale of the product has been secured from the health authorities
in the majority of the member countries. ADENOSCAN is currently marketed in the
United States, Canada, the United Kingdom, Australia, Finland, Germany, Ireland,
Italy, Norway and Spain. Suntory, the Company's partner for adenosine in Japan,
completed the Phase III trial of Adenoscan in that country. Suntory expects to
file a New Drug Application with the Japanese regulatory authority during the
first half of 1999.
Product License: The Company owns the product as it is the exclusive assignee of
patents issued in the U.S. and Canada, with counterpart applications pending
approval in other countries of the world, covering the use of adenosine as a
pharmacological stressor in cardiac imaging. By means of an agreement signed
during the year, the Company's marketing partner, Fujisawa, secured intellectual
property rights to extend its exclusivity on Adenoscan until 2015. In addition,
in the U.S. the product received three years of exclusivity from the date of NDA
approval under the Hatch-Waxman Act.
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Competition: Intravenous dipyridamole, manufactured and marketed by DuPont
Radiopharmaceuticals under the brand name IV Persantine(R), is the principal
competitor and has been available in the U.S. since 1990. Intravenous
dipyridamole is generically manufactured and marketed by Lederle. In addition,
other drugs and procedures currently available or under development may be
useful in determining the presence or severity of coronary artery disease and
may compete directly with ADENOSCAN.
Manufacturing and Marketing:
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Agreements with Fujisawa. The Company granted Fujisawa an exclusive license in
the United States and Canada to manufacture and market ADENOSCAN. Fujisawa
agreed to pay the Company royalties of 29% of ADENOSCAN net sales for the first
five years after the commencement of commercial sales in each territory, i.e.,
until July 2000 for U.S. sales, and thereafter royalties of 25% of net sales
until the expiration of the last applicable patent rights, at which time
Fujisawa would have a paid-up license. The parties also agreed to share equally
all third party royalties.
Fujisawa also agreed to pay royalties to the Company in respect of periods of
more than thirty days in which it is unable to fulfill ADENOSCAN orders for
reasons other than force majeure and other specified events, such royalties to
be at the then prevailing rate based on the average daily sales of ADENOSCAN
during the preceding 12 months. Fujisawa also agreed generally to maintain an
inventory of at least six months of ADENOSCAN finished product and
work-in-process, to be stored at multiple locations and to use its best efforts
to identify and provide data to the Company to qualify with the FDA an alternate
supplier of the adenosine raw material necessary for the manufacture of
ADENOSCAN. In October 1996, Fujisawa's Melrose Park, Illinois plant was
qualified by the FDA as an alternate manufacturing facility for ADENOSCAN in
30ml. vials. In May 1998, the Company transferred the NDA for ADENOSCAN to
Fujisawa and Fujisawa engaged a third party to contract manufacture the drug.
Agreement with Sanofi. In December 1992, the Company granted Sanofi the
exclusive rights to manufacture and market ADENOSCAN worldwide except in the
United States, Canada, Japan, Korea and Taiwan. In June 1995, Sanofi received
marketing approval for ADENOSCAN in the United Kingdom and in February 1997,
Sanofi registered ADENOSCAN in 14 additional member countries of the European
Community through the mutual recognition procedure. The final administrative
procedure involving the granting of a National Marketing License authorizing the
sale of the product has been secured from the health authorities in the majority
of the member countries. Sanofi pays the Company a royalty of 6 to 8 percent,
based on the level of annual sales, for the longer of ten years or the period of
any marketing exclusivity for ADENOSCAN in each country of the territory.
Agreement with Suntory. The Company signed a development and marketing agreement
with Suntory Limited for cardiovascular uses of adenosine in Japan. During 1997
Suntory initiated a Phase III trial to pursue the use of adenosine for
pharmacologic stress for use with thallium perfusion imaging to detect coronary
artery disease. The Japanese equivalent of an NDA has not been filed for any
product covered by the agreement. The Company received a $1 million license fee
upon signing, a $300,000 fee in 1995 when the FDA granted marketing clearance in
the U.S. for ADENOSCAN and a payment of $400,000 following Suntory's initiation
of a Phase III trial in Japan in 1997. The Phase III study was completed during
1998.
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ADENOSINE FOR CARDIOPROTECTION
The Product: The Company's development program with a sterile formulation of
adenosine (3mg/ml) as an adjunct to early reperfusion with thrombolytic therapy
or emergency angioplasty in the treatment of acute myocardial infarction and as
an additive to standard cardioplegia during open-heart surgery now is referred
to as "ADENOSINE FOR CARDIOPROTECTION" (formerly designated MEDR-640). Each year
in the U.S. over one million patients suffer acute myocardial infarction and,
despite the benefits of early reperfusion, permanent injury and disability are
not uncommon. In addition, over 300,000 patients a year undergo coronary artery
bypass graft (CABG) surgery and, despite standard cardioprotective measures,
significant cardiac support is often required during the early postoperative
period.
Development Background: Substantial preclinical data and limited human testing
suggest, although no assurance can be given, that adenosine may be beneficial in
these acute ischemic settings. The results of a single-center pilot
investigation (i.e., significantly reduced injury measured six weeks after the
procedure compared to measurements made at the time of hospital discharge),
suggest that adenosine, as an adjunct to emergency angioplasty, may further
limit the damage associated with acute myocardial infarction. The preliminary
results from another single-center pilot study (i.e., statistically significant
reductions in the cumulative amount of inotropes such as dopamine and
dobutamine, and vasodilators such as nitroglycerin, required in the 24-hour
period following surgery), suggest that adenosine, as an additive to standard
cold-blood cardioplegia, may also limit the amount of cardiac support required
during the early postoperative period following CABG surgery. These preliminary
findings supported the initiation of three Phase II multicenter trials,
including a placebo-controlled trial in CABG surgery (so-called AB-02 trial), a
placebo-controlled trial using emergency (primary) angioplasty in acute
myocardial infarction (so-called ALIVE trial), and a placebo-controlled trial
using thrombolytic therapy in acute myocardial infarction (so-called AMISTAD I).
Patient enrollment for the AB-02 trial was completed during 1997 and the results
of the study were analyzed during 1998. Due to difficulty in recruiting patients
in a timely manner, the ALIVE trial has been terminated. AMISTAD I (Phase II
multicenter trial) was completed in 1997 and results of the study were presented
by Dr. Kenneth Mahaffey, Duke Clinical Research Institute, at the 70th
Scientific Sessions of the American Heart Association on November 10, 1997.
AMISTAD I revealed that patients with anterior MI who were treated with
adenosine plus thrombolysis experienced median final infarct size of 15.0%
(n=39) as compared to 45.5% (n=38) for patients treated with thrombolysis alone.
For patients with non-anterior MI, infarct size was similar (11.5% (n=72) vs.
11.5% (n=72)) regardless of the addition of adenosine. Statistical analysis of
the primary endpoint was carried out for the intent-to-treat population using
protocol-specified methods and predetermined variables. As expected, MI location
was the most significant variable related to the final infarct size, since
anterior MI is typically much larger than non-anterior MI. But more importantly,
for those patients with anterior MI, i.e., those at greatest risk, the use of
adenosine resulted in significantly smaller final infarct size (p=0.014).
In a subset of patients, cardiac images were obtained at the time of hospital
admission as well as at the time of discharge in order to measure the amount of
heart muscle at risk of irreversible injury prior to treatment. For patients
with anterior MI, the amount of myocardium at risk was similar in the adenosine
and non-adenosine groups, 49.5% (n=12) vs. 51.0% (n=9), respectively. However,
the amount of heart muscle "saved", as a percentage of myocardium at risk, was
greater with adenosine plus thrombolysis (62.3%) vs. thrombolysis alone (15.0%).
Overall, at any time during hospitalization, cardiogenic shock (5.0% vs. 3.4%),
congestive heart failure (10.1% vs. 6.8%), death (8.4% vs. 5.1%), and
reinfarction (5.0% vs. 2.6%) were more common in the adenosine group compared to
placebo. These differences were less apparent in the anterior MI subgroup and,
overall, these event rates were far too low to draw any conclusions about
clinical risk or benefit.
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The study results (i.e., myocardial infarct size, as measured by nuclear
imaging, is reduced by treatment with adenosine), are consistent with the basic
literature describing the cardioprotective effects of adenosine in multiple
animal models from various laboratories around the world.
During fourth quarter 1998, the protocol for AMISTAD-II, the Company's second
multicenter Acute Myocardial Infarction Study of Adenosine was completed. In
January 1999 the Company announced the initiation of this Phase III trial to
further investigate the safety and efficacy of adenosine in combination with
thrombolysis or angioplasty in the treatment of acute myocardial infarction. The
name Pallacor(TM) has been selected for this application of intravenous
adenosine - formerly referenced as part of the MEDR640 program. The study will
involve approximately 2,100 patients and is projected to require approximately
24 months for completion.
Regulatory Status: The original IND for Phase I studies was filed in November
1988. The Company has conducted three multicenter Phase II clinical trials in
the U.S., Canada and Argentina under this Investigational New Drug Application
("IND"). AMISTAD-II (Phase III multicenter trial) was initiated in January 1999
to further investigate the safety and efficacy of adenosine in combination with
thrombolysis or angioplasty in the treatment of acute myocardial infarction.
Product License: As described below, the Company owns the product, including all
worldwide manufacturing and marketing rights. ADENOSINE FOR CARDIOPROTECTION was
included in the Company's 1988 exclusive license agreement with Fujisawa
relating to ADENOSCAN. Pursuant to the May 1995 agreement with Fujisawa settling
the litigation over the manufacturing and marketing of ADENOSCAN, all references
to ADENOSINE FOR CARDIOPROTECTION in such license agreement were eliminated, and
in May 1996, the parties entered into an agreement to jointly develop ADENOSINE
FOR CARDIOPROTECTION. In June 1998 Fujisawa assigned and transferred to the
Company all of its right, title and interest in ADENOSINE FOR CARDIOPROTECTION,
including all of Fujisawa's related scientific data and intellectual properties
in the United States and Canada. In the event that the Company markets an
adenosine-containing cardioprotective product, Fujisawa will receive an 8%
royalty on the Company's net sales. In the event that the Company licenses a
third party to sell such product, Fujisawa will receive 25% of licensing fees,
milestone payments, royalties, and other considerations received by the Company
from such third party after the Company has recouped the $2 million in costs
incurred for the compound through May 1998 plus its substantiated development
costs from such date to the date of NDA approval.
The Company has a patent application pending in the U.S. and abroad for the use
of adenosine to prevent further injury during acute myocardial infarction. (No
assurance can be given that any pending application will result in any issued
patent, or that any issued patent will provide any competitive protection to the
Company.) See "Patent and Proprietary Rights" below.
Competition: A wide variety of agents currently available or under investigation
may be useful in these acute ischemic settings, including antiplatelet and
anticoagulant agents, cardiosuppressants, perfluorochemicals, free radical
scavengers, and adenosine analogs or modulators, which may compete directly with
ADENOSINE FOR CARDIOPROTECTION.
ADENOSINE ANALOGS
The Compounds: Chemical derivatives, or analogs, of adenosine have been
developed in an effort to improve the therapeutic utility of adenosine. The
actions of adenosine are controlled or mediated through receptors, or specific
recognition sites, on the surface of cells. Four adenosine receptor subtypes are
known to exist (A1-, A2a-, A2b-, and A3-) and each is responsible for a
different function. Intravenous adenosine, or first-generation technology
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(commercially available as ADENOCARD or ADENOSCAN), is a non-selective agonist,
i.e., it stimulates all receptor subtypes. Adenosine analogs, or
second-generation technology, theoretically may be selective, i.e., may act
through a specific receptor subtype. In addition, certain analogs may exhibit
activity by oral administration.
Development Background: Theoretical rationale and preclinical data support the
investigation of several A2a-agonists for a variety of applications including:
diagnosis of coronary artery disease, promotion of wound healing, treatment of
coronary artery disease, prevention of restenosis, and treatment of congestive
heart failure. The Company's lead A2a-receptor agonist, MRE0470, should
theoretically produce coronary vasodilation (via stimulation of the
A2a-receptor) while not producing transient heart block and arrhythmias (the
effects of A1-receptor stimulation). Hence, the compound may hold potential as a
second-generation pharmacologic stressor. With respect to MRE0470, on December
28, 1998 the Company filed an IND with the FDA, and in late January 1999 the
Company received clearance from the FDA to initiate a Phase I clinical trial as
a selective coronary vasodilator during myocardial perfusion imaging procedures
to diagnose coronary artery disease. During 1999 the evaluation of several
adenosine A2a-receptor agonists in a wound healing model in animals was
completed with positive results. In addition to these A2a-receptor agonists,
work advanced during 1999 in the early evaluation of additional adenosine
analogs and U.S. patent applications were filed for adenosine A3-receptor
agonists and antagonists synthesized by the University of Ferrara.
Regulatory Status: Work is in progress to file an IND.
Competition: Adenocard, ADENOSCAN, generic dipyridamole
Product License: The Company has an exclusive worldwide license to multiple U.S.
patents and foreign counterparts held by Discovery Therapeutics, Inc. (DTI)
related to A2a-agonists. In March 1998, the Company signed an option to
exclusively license New York University's worldwide rights for the use of
adenosine A2a-receptor agonists for the promotion of wound healing. The Company
has expanded its research agreement with the University of Ferrara to include
agonists and antagonists which exert their actions at the adenosine A1- and A3-
receptor subtypes. A Provisional Patent Application has been filed with the
United States Patent and Trademark office on a lead A3-agonist as well as
additional adenosine A3-receptor agonists and antagonists. (No assurance can be
given that any pending application will result in any issued patent, or that any
issued patent will provide any competitive protection to the Company.)
ADENOSINE ALLOSTERIC MODULATORS
The Compounds: ADENOSINE ALLOSTERIC MODULATORS affect the action of endogenous
adenosine in the form of enhancement or inhibition by binding at sites distinct
from, but functionally linked to, the primary recognition site of a receptor.
Binding site studies and functional assays have shown that the enhancers
"amplify" the effects of adenosine. Research is underway to establish the exact
molecular mechanisms of this class of compounds. Allosteric enhancers may
increase the actual number of adenosine receptors in the "active" or
high-affinity state. Accordingly, although no assurance can be given, allosteric
enhancers may be therapeutically useful when internal adenosine signals are
weak.
Development Background: This new series of compounds was discovered and
synthesized in the laboratories of Professor Giovanni Baraldi at the University
of Ferrara, Italy as part of a basic research collaboration agreement between
the Company and the University of Ferrara. The agreement grants the Company
exclusive ownership of all intellectual properties relating to allosteric
modulators derived from the collaboration.
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Product License: The Company has filed patent applications with the U.S. Patent
and Trademark Office and intends to file companion applications overseas for
compounds synthesized and tested by Dr. Baraldi and colleagues. (No assurance
can be given that any pending application will result in any issued patent, or
that any issued patent will provide any competitive protection to the Company.)
Regulatory Status: The subject compounds are in the research/discovery stage,
and the Company therefore has no need to commence regulatory work.
Competition: The Company has no knowledge of the existence of any additional
adenosine allosteric inhibitors.
GOVERNMENT REGULATION OF PHARMACEUTICALS
The Company is engaged in a business in which strict federal regulation through
the FDA is a significant factor. Such regulations relate primarily to the safety
and efficacy, but also govern manufacturing, labeling, advertising and
marketing, of pharmaceutical products.
In order to test clinically and later market pharmaceutical products, a company
must obtain marketing clearance from the FDA in the United States and comparable
governmental agencies in other countries. The FDA requires substantial evidence
of the safety and efficacy of new drugs and the approval process involves
several steps. Each of these steps can be time consuming and expensive, and
regulatory approval can never be predicted nor assured.
The first step includes the period from the discovery of the compound, including
laboratory and animal experimentation, to the filing of an IND. The IND
submission must contain data from the preclinical drug research, including
biochemistry, animal toxicological and pharmacological studies, and any other
available information on the drug and must also outline a plan of clinical
investigation. INDs must be sought for particular formulations of a drug, such
as oral, injectable and topical, and these formulations must be tested in the
treatment of human disease only in accordance with protocols (specific treatment
regimens) submitted in connection with the IND.
Once an IND has been allowed to become effective by the FDA, clinical trials on
humans may be undertaken in accordance with the approved protocols. During
clinical investigation, the sponsor is required to monitor all studies, to
submit progress reports to the FDA at intervals not exceeding one year, and to
report promptly serious adverse reactions pertinent to the safety of the drug.
There are usually three phases in the clinical development of a new drug. Phase
I concerns the testing of the drug in a small number of healthy subjects to
determine primarily a number of safety parameters and to obtain other basic
experience with the drug in humans. Phase II concerns the testing of the drug
under well-controlled conditions in a larger population to obtain information on
the drug's safety and efficacy in patients for the claim or claims being made by
the sponsor. Phase III concerns the testing of the drug in a still larger
patient population and for a longer period of time under well-controlled
conditions to confirm the safety and efficacy results obtained in Phase II.
Phase III is usually considered the last phase in the clinical testing of the
drug.
10
<PAGE>
If the sponsor elects to proceed beyond clinical development to
commercialization of the drug, it submits to the FDA an NDA which contains a
written summary of all data reflecting the total research experience with the
drug and a section regarding its manufacture. When the FDA has reviewed the NDA
and all additional information which it may have required to be submitted during
the review process, it decides whether, and under what labeling conditions, it
will permit the product to be marketed. The FDA may require post-marketing
testing and surveillance of adverse reactions as a condition of its approval to
monitor the drug's effect during marketing.
Although health registration requirements are generally more rigidly applied in
the United States than elsewhere, the regulatory pattern in the United States is
now being followed by most industrialized countries.
ORPHAN DRUG ACT
- ---------------
As the sponsor of an orphan drug for a particular indication, the Company would
be entitled to receive seven years exclusive marketing rights for this
indication, but only if it proceeds to sponsor the first NDA approved for the
drug for this indication. Thus, unlike patent protection, the designation of a
drug for a particular indication as an orphan drug would not, by itself, prevent
other manufacturers or sponsors from obtaining orphan drug status for the same
drug for the same indication if they obtained a prior NDA, or from obtaining FDA
approval prior to approval of the Company's NDA.
The Company also is entitled to certain federal income tax credits with respect
to certain clinical expenses related to its orphan drugs.
As is the case with FDA approval generally, the grant of orphan drug status for
one or more of the Company's drugs would not prevent the FDA from approving the
same drug or drugs for a different indication, and medical practitioners may
prescribe an approved drug for non-indicated (i.e., off-label) uses. The
marketing potential of the Company's orphan drugs could be adversely affected by
FDA approval of another company's NDA for the same drug for different uses.
The Company intends, where applicable, to obtain orphan drug designation for any
drugs licensed or acquired by it in the future. There can be no assurance,
therefore, that the scope of protection currently afforded by orphan drug status
or the federal income tax credits currently available to sponsors of orphan
drugs will continue to be available in the future.
HATCH-WAXMAN ACT
- ----------------
The Hatch-Waxman Act provides for limited marketing exclusivity for
pharmaceutical products which receive NDA approval from the FDA, independent of
any issued patents which may apply. If a pharmaceutical product receives NDA
approval, and the FDA has not previously approved any other product containing
the same active ingredient, including any salt or ester of the active
ingredient, then the Hatch-Waxman Act does not permit any abbreviated generic
NDA ("ANDA") to be submitted by another company for that drug product for five
years from the date of NDA approval. If an NDA approval is received for a
pharmaceutical product containing an active ingredient or salt or ester of an
active ingredient that has been previously approved by the FDA, and if that NDA
approval was secured in part through the submission to the FDA of new clinical
investigations other than bioavailability studies, then the Hatch-Waxman Act
prohibits the FDA from making effective the approval of an ANDA for that product
by another company for a period of three years from the date of NDA approval.
This limited exclusivity provision is automatically granted upon NDA approval as
applicable and does not require special consideration. Within the Company's
current portfolio of products, ADENOSCAN and ADENOSINE FOR CARDIOPROTECTION
qualify for three years of exclusivity, under this provision.
11
<PAGE>
PATENTS AND PROPRIETARY RIGHTS
- ------------------------------
Patents and other proprietary rights are extremely important to the Company's
business. However, the patent positions of biopharmaceutical firms, including
the Company, are uncertain and involve complex legal and factual questions which
can be difficult to resolve.
The Company's general policy is to license the right to manufacture and sell
pharmaceutical products the use of which for the particular indication is
covered by an issued United States patent which the Company's patent counsel
believes is valid and enforceable. The Company believes that licensing issued
patents represents the best step the Company can take to protect the technology,
inventions, and improvements that it considers important to the development of
its business, and the Company's financial investment therein. However, on
occasion the Company may acquire product opportunities without issued patents or
without patent applications pending, such as, for example, when in Management's
opinion, the invention would expand the Company's adenosine portfolio. The
Company also relies upon trade secrets, know-how, continuing technological
innovations and subsequent licensing opportunities to develop and maintain its
competitive position.
The patent application and issuance process may take several years and involves
considerable expense, and there is no assurance that any patent sought by the
Company or its licensors will issue. The coverage claimed in a patent
application can be significantly reduced before a patent is issued.
Consequently, neither the applicant nor the licensee knows whether any claim
contained in a patent application will be allowed and result in the issuance of
a patent or, if any patent is issued, whether it will provide meaningful
proprietary protection or will be circumvented or invalidated. Since patent
applications in the United States are maintained in secrecy, until foreign
counterparts, if any, are published, and because publication of discoveries in
the scientific or patent literature often lags behind actual discoveries, the
Company cannot be absolutely certain that it or any licensor was the first
inventor of the subject matter covered by the patent application or that it or
such licensor was the first to file a patent application therefor or that it
would obtain the freedom to practice the claimed inventions. Moreover, priority
in filing a patent application for an invention can be overcome by a different
party who first practiced the invention. Accordingly, the Company might have to
participate in extensive proceedings in U.S. and/or foreign patent offices or
courts, including interference proceedings declared by the U.S. Patent and
Trademark Office ("Patent Office"), to determine priority and/or patent
validity. Any such proceeding would be costly and consuming of Management's
time. There can be no assurance either that the Company's owned or licensed
patents would be held valid or that the Company's products would not be found to
infringe patents owned by others. In the event of a determination that the
Company is infringing a third party's patent, the Company likely would be
required to pay royalties, which could be substantial, to such third party. In
order to avoid the cost and risk of a Patent Office proceeding, or otherwise to
obtain the intellectual property rights, the Company may seek to obtain from
third parties patent licenses it believes are necessary or appropriate. However,
it is possible that the third party could refuse a license to the Company in
order to keep the Company's product off the market.
There can be no assurance that any patent rights held by the Company will
provide any actual competitive advantage to the Company. Competitors might be
able to develop similar and competitive products outside the scope of the
Company's patents. For example, should third parties patent or otherwise develop
and receive governmental clearance to commercialize an adenosine product for a
use not covered by the Company's patents, physicians could use those third party
products in place of the Company's adenosine products even though such third
party products were not approved by the FDA for the same indications as the
Company's products. Any such off-label use of third party products could have a
material adverse effect on sales of the Company's products and the amount of
royalty revenues received by the Company.
12
<PAGE>
The Company also relies upon trade secret protection for its confidential and
proprietary information. There can be no assurance that others will not
independently develop substantially equivalent proprietary technology and
techniques or otherwise gain access to the Company's trade secrets or disclose
such technology or that the Company can meaningfully protect its trade secrets.
The Company has registered various trademarks in the Patent Office and has other
trademarks which have acquired both national and international recognition. The
Company has trademark registrations or pending applications in a number of
foreign countries.
PRODUCT AND CLINICAL STUDIES LIABILITY
- --------------------------------------
Administration of any drug to humans involves the risk of allergic or other
adverse reactions in certain individuals. Accordingly, it is possible that
claims might be successfully asserted against the Company for liability with
respect to injuries that may arise from the administration or use of its
products during clinical trials or following marketing. However, no claim
involving a material liability has ever been brought against the Company. The
Company presently carries, and contractually requires its marketing partners and
independent clinical research organizations to carry, what it believes to be
adequate product and clinical studies liability insurance coverage.
RESEARCH AND DEVELOPMENT
- ------------------------
The Company expended $10,347,570, $6,902,092, and $5,839,278, for research and
development during the years ended December 31, 1998, 1997 and 1996,
respectively.
EMPLOYEES
- ---------
As of March 1, 1999 the Company employed twenty-seven persons on a full-time
basis. None of the Company's employees are represented by a labor union, and the
Company considers its employee relations to be good. The Company will need to
hire additional scientific and support personnel as it expands its operations.
ITEM 2. PROPERTIES
- ------- ----------
The Company leases approximately 26,700 square feet of office space, in Cary,
North Carolina, for its corporate offices under a lease that expires in December
2003. This facility is expected to be adequate for the Company's present and
future operations. See Note 4 to the financial statements for a discussion of
future lease payments.
13
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
There are no material legal proceedings pending against the Company. However, on
October 3, 1997, Richard A. Wilson, Debra A. Angello, and Paul S. Angello
("Plaintiffs") filed a complaint against Fujisawa, USA, Inc. in the United
States District Court, District of Oregon, alleging that Fujisawa's sale of
Adenoscan in the United States induces, or contributes to, the infringement of
plaintiffs' U.S. Patent No. 4,824,660 ("the `660 patent"), entitled "Method of
Determining the Viability of Tissue in an Organism" which the Patent Office
issued on April 25, 1989. According to plaintiffs, the `660 patent claims a
specific technique for more reliably locating viable or nonviable regions of
heart tissue, namely using an adenosine triphosphate repleting agent such as
ribose or adenosine as an adjunct to radioactive isotope (e.g., thallium-201)
myocardial perfusion scintigraphy, where regions of heart tissue in which the
scan images show no radioactivity indicate the presence of nonviable heart
tissue. In its Answer and Counterclaim, Fujisawa denied that it infringed any of
the claims of the `660 patent and alleged that the `660 patent was invalid.
Fujisawa further alleged that plaintiffs' claims of patent infringement were
barred by the doctrines of laches and estoppel. In its Counterclaim, Fujisawa
requested a declaratory judgment that it did not infringe the claims of the `660
patent and that such patent is invalid.
On December 31, 1998, Fujisawa filed a motion seeking summary judgement. This
action is in the discovery stage. Fujisawa has advised the Company that Fujisawa
intends to vigorously defend this action and believes it has no merit. Under the
terms of its Adenoscan exclusive license agreement with Fujisawa, the Company
reimburses Fujisawa for 50% of the cost of defending this action.
The Company also believes the action has no merit. The Company has long been
aware of the `660 patent, and as part of its normal operating procedures the
Company has received the written opinions of separate patent counsel that the
manufacture and sale of Adenoscan for use in myocardial imaging does not
infringe any valid claim of the `660 patent. The Company disclosed its receipt
of its patent counsel non-infringement opinion in its 1993 Form 10-K Report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
None.
14
<PAGE>
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------- ------------------------------------------------------------------
The Company's Common Stock traded on the American Stock Exchange under the
symbol MRE during the year ended December 31, 1997 and through December 1, 1998.
On December 2, 1998, the Company transferred to and began trading on the New
York Stock Exchange under the symbol MRE. The following table sets forth the
high and low sales prices of the Company's Common Stock on the American Stock
Exchange and the New York Stock Exchange during the applicable periods.
Quarter Ended High Low
------------- ---- ---
Calendar 1998:
March 31, 1998 $19 5/8 $13 3/16
June 30, 1998 25 1/2 17 1/8
September 30, 1998 26 5/8 15 5/8
December 31, 1998 26 3/16 17 1/2
Calendar 1997:
March 31, 1997 $13 3/8 $ 7 3/4
June 30, 1997 9 13/16 7 3/4
September 30, 1997 14 9 5/8
December 31, 1997 17 1/8 12 3/4
The Company had 233 owners of record and in excess of 4,845 beneficial owners of
its Common Stock as of March 1,1999, based upon information provided by the
Company's transfer agent.
DIVIDENDS
- ---------
The Company has not paid any cash dividends since its inception and presently
anticipates that all earnings, if any, will be retained for development of the
Company's business and that no cash dividends on its Common Stock will be
declared in the foreseeable future. Any future cash dividends will be subject to
the discretion of the Company's Board of Directors and will depend upon, among
other things, future earnings, the operating and financial condition of the
Company, its capital requirements and general business conditions.
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
The selected consolidated financial data set forth below for the Company as of
December 31, 1998 and 1997 and for each of the three years in the period ended
December 31, 1998 are derived from the audited consolidated financial statements
included elsewhere herein. The selected financial data set forth below for the
Company as of December 31, 1996, 1995 and 1994 and for each of the two years in
15
<PAGE>
the period ended December 31, 1995 are derived from the financial statements of
the Company not included elsewhere herein. The data presented below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and with the Company's consolidated
financial statements and related notes thereto included elsewhere in this
report.
Summary Consolidated Statement of Operations Data:
<TABLE>
<CAPTION>
OPERATIONS Years Ended December 31,
-----------------------------------------------------------------------------------
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Revenue $34,277,842 $22,782,306 $15,824,073 $13,007,734 $10,688,619
Costs and Expenses 18,035,640 12,569,177 11,502,428 16,540,176 15,103,087
Net Income (Loss) 16,242,202 10,213,128 4,321,645 (3,532,442) (4,414,468)
Basic Earnings (Loss) per
Common Share $1.54 $0.97 $0.40 $(0.32) $(0.40)
Diluted Earnings (Loss) per
Common Share $1.50 $0.96 $0.40 $(0.32) $(0.40)
Weighted Average Shares
Outstanding 10,530,745 10,545,533 10,917,920 11,023,921 11,144,938
Weighted Average Shares
Outstanding Assuming
Dilution 10,857,004 10,620,785 10,938,357 11,023,921 11,144,938
Cash Dividends Declared
per Common Share - - - - -
Summary Consolidated Balance Sheet Data:
<CAPTION>
December 31,
-----------------------------------------------------------------------------------
1998 1997 1996 1995 1994
Working Capital $29,812,684 $20,158,833 $18,372,970 $27,734,612 $24,883,199
Total Assets 64,285,101 49,612,714 42,628,404 43,121,656 44,680,299
Stockholders' Equity 58,058,941 44,656,284 36,499,005 35,099,683 38,901,572
Accumulated Earnings/(Deficit) 15,061,383 (1,180,819) (11,393,947) (15,715,592) (12,183,150)
Net Book Value
per Share 5.58 4.25 3.40 3.19 3.53
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
- ------- -------------------------------------------------------------------
FINANCIAL CONDITION
-------------------
OVERVIEW
- --------
For calendar 1998, adenosine royalties (ADENOCARD and ADENOSCAN) increased 38%
and operating expenses increased 39% which resulted in a net income of
$16,242,202 for 1998, or $1.54 basic earnings per share, compared to $10,213,128
or $0.97 basic earnings per share, for 1997. Earnings per share on a diluted
basis for 1998 and 1997 were $1.50 and $0.96, respectively. Approximately
two-thirds of all royalty income in the three-year period ended December 31,
1998 resulted from Fujisawa sales of ADENOSCAN in the United States.
In February 1998, the Company expanded its drug discovery collaboration with the
University of Ferrara, to include agonists and antagonists which exert their
action at the adenosine A1- and A3-receptor subtypes. In March 1998, Fujisawa
Healthcare, on behalf of itself and the Company, licensed additional
intellectual property rights for intravenous adenosine in cardiac imaging and
the right to use intravenous adenosine as a cardioprotectant in combination with
thrombolytic therapy, balloon angioplasty and coronary bypass surgery and
extended the exclusivity on ADENOSCAN until 2015. In April 1998, the Company
obtained an option from the University of California at San Francisco to an
exclusive license pertaining to the use of adenosine for the promotion of
angiogenesis. In June 1998, the Company signed an agreement to acquire right,
title, and interest in certain patents relating to the use of intravenous
16
<PAGE>
adenosine as a cardioprotectant in combination with thrombolytic therapy,
balloon angioplasty and coronary bypass surgery and extend the Company's
marketing partner's exclusivity on ADENOSCAN until 2015. In November 1998, the
Company completed the evaluation of several adenosine A2a-receptor agonists in
an animal wound healing model with positive results. In December 1998, the
Company, through its collaboration with the University of Ferrara, advanced
early evaluation of additional ADENOSINE ANALOGS and allosteric modulators. Also
in December, the Company filed an IND for MRE0470 for use as a selective
coronary vasodilator during myocardial perfusion imaging procedures to diagnose
coronary artery disease. In January 1999, the Company initiated AMISTAD II, a
Phase III multi-center trial to further investigate the safety and efficacy of
adenosine in combination with thrombolysis or angioplasty in the current
treatment of acute myocardial infarction.
RESULTS OF OPERATIONS
- ---------------------
The accompanying consolidated financial statements and certain selected
financial data have been presented for the calendar years ended December 31,
1998, 1997 and 1996. The Company's presentation of the Consolidated Statements
of Operations reflect gross margin related to royalty revenues followed by
operating expenses, operating income related to gross margin and other income.
Calendar Year 1998 Compared to Calendar Year 1997
- -------------------------------------------------
Royalty Revenues. The Company's 1998 royalty revenue increased to $27,544,248
from $20,000,366, an increase of 38%, primarily due to continued year-over-year
increases in unit sales of ADENOSCAN by Fujisawa, the Company's North American
licensee, and a 4% increase in the royalty revenue rate recognized as revenue
which began midway through fourth quarter 1997. Fujisawa is the source of
substantially all of the royalties of the Company. See Note 6 to the Company's
Financial Statements included in Item 8 below.
Gross Margin. The Company's 1998 gross margin from adenosine revenues increased
to $22,671,316 from $17,015,292 an increase of 33% due to the continued shift in
the product sales mix to ADENOSCAN and continued year-over-year increases in
unit sales of ADENOSCAN, a drug for which the Company pays a royalty of 3% of
net sales to a third party vis-a-vis ADENOCARD, a drug for which the Company
pays a royalty of 12.5% of net sales to the University of Virginia Alumni
Patents Foundation. Royalty expense increased to $4,872,932 from $2,985,074, an
increase of 63% primarily due to the payment of a royalty of 3% of net sales of
ADENOSCAN to a third party beginning January 1, 1998 relating to the procurement
of additional intellectual property rights for intravenous adenosine from such
third party.
Operating Expenses. Total operating expenses increased to $12,932,088 from
$9,295,693, an increase of 39% due to increases in research and development
expenditures related to ADENOSINE FOR CARDIOPROTECTION and the Company's lead
A2a-receptor agonist MRE0470 for use as a selective coronary vasodilator during
myocardial perfusion imaging procedures to diagnose coronary artery disease.
Research and development costs increased to $10,347,570 from $6,902,092, an
increase of 50%. Research and development expenditures were higher during 1998
primarily due to a one-time charge of $2,361,000 in the second quarter of 1998
pertaining to the purchase of Fujisawa's commercialization rights and related
intellectual properties for the cardioprotection application of intravenous
adenosine. Also, research and development expenditures were higher during 1998
due to a $1 million charge in the fourth quarter 1998 for a milestone payment to
Discovery Therapeutics, Inc. related to the December filing of the IND for
MRE0470.
17
<PAGE>
General and administrative expenses increased to $2,584,518 from $2,393,601, an
increase of 8% primarily due to one-time expenditures related to the Company's
transfer of its common stock listing to the New York Stock Exchange and the
Company's move from Research Triangle Park, North Carolina to Cary, North
Carolina.
Other Income. Interest income increased to $2,730,032 from $2,099,550, an
increase of 30%. Investment income was higher in 1998 mainly due to higher
investment balances. Other income increased to $4,003,562 from $682,389 an
increase of 487%. Other income was higher in 1998 due to the Company's receipt
of a $4 million payment from Fujisawa for the assistance provided by the Company
to Fujisawa in connection with the contract manufacturing of ADENOSCAN and
ADENOCARD by a third party and the transfer of the ADENOSCAN and ADENOCARD NDAs
to Fujisawa. In 1997, the Company recognized a $300,000 licensing fee as income
and also received and recognized a $400,000 payment as other income following
Suntory's, the Company's development and marketing partner for adenosine in
Japan, announcement of the initiation of Phase III clinical trials of ADENOSCAN
in Japan.
Earnings Per Share. Basic earnings per share increased to $1.54 per share in
1998 from $0.97 per share in 1997 on weighted average common shares outstanding
of 10,530,745 and 10,545,533, respectively. The basic earnings per share reflect
net income of $16,242,202 and $10,213,128 in 1998 and 1997, respectively.
Diluted earnings per share increased to $1.50 per share in 1998 from $0.96 per
share in 1997 on weighted average common shares outstanding of 10,857,004 and
10,620,785, respectively.
Calendar Year 1997 Compared to Calendar Year 1996
- -------------------------------------------------
Royalty Revenues. The Company's 1997 royalty revenue increased to $20,000,366
from $13,453,958, an increase of 49%, primarily due to continued
quarter-to-quarter increases in unit sales of ADENOSCAN by Fujisawa, the
Company's North American licensee. Fujisawa is the source of substantially all
of the royalty revenue of the Company.
Gross Margin. The Company's 1997 gross margin from adenosine revenues increased
to $17,015,292 from $10,880,081, an increase of 56% due to the continued shift
in the product sales mix to ADENOSCAN and continued quarter-to-quarter increases
in unit sales of ADENOSCAN, a drug for which the Company owned the underlying
patent and therefore paid no third party royalty in 1996 or 1997. Royalty
expense, which is payable to the University of Virginia Alumni Patents
Foundation from whom the Company acquired exclusive rights to ADENOCARD, and
represents one-half of royalty revenue earned by the Company from ADENOCARD
sales, increased to $2,985,074 from $2,573,877, an increase of 16%.
Operating Expenses. Total operating expenses increased to $9,295,693 from
$8,841,551, an increase of 5% due to an increase in research and development
expenditures for ADENOSINE FOR CARDIOPROTECTION and ADENOSINE ANALOGS.
Research and development costs increased to $6,902,092 from $5,839,278, an
increase of 18%. Research and development expenditures were higher during 1997
primarily due to the Company nearing the completion of the three multi-center
Phase II trials associated with ADENOSINE FOR CARDIOPROTECTION and pursuing the
filing of an IND for MRE0470, an adenosine A2a-receptor agonist for the
diagnosis of coronary artery disease.
General and administrative expenses decreased to $2,393,601 from $3,002,273, a
decrease of 20%. This reduction is primarily the result of lower overall
spending in 1997 and one-time employee related charges incurred in 1996.
18
<PAGE>
Other Income. Interest income increased to $2,099,550 from $2,020,115, an
increase of 4%. Investment income was higher in 1997 mainly due to higher
investment balances. Other income increased to $682,389 from $350,000, an
increase of 95%. This increase is related to non-royalty receipts under
licensing agreements, such as license fees or milestone payments, and the timing
in which these receipts can be recognized as revenues. Such receipts are not
recognized as revenues prior to the completion of the related milestones.
Earnings Per Share. Basic earnings per share increased to $0.97 per share in
1997 from $0.40 per share in 1996 on weighted average common shares outstanding
of 10,545,533 and 10,917,920, respectively. The basic earnings per share reflect
net income of $10,213,128 and $4,321,645 in 1997 and 1996, respectively. Diluted
earnings per share increased to $0.96 per share in 1997 from $0.40 per share in
1996 on weighted average common shares outstanding of 10,620,785 and 10,938,357,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
As of December 31, 1998, the Company had total cash and investments of
$51,250,671 comprised of $4,742,016 of cash and cash equivalents and $46,508,655
of investments in U.S. Treasury Notes, debt securities of various federal
governmental agencies and high quality corporate debt securities. The Company's
working capital as of December 31, 1998 was $29,812,684 compared to $20,158,833
as of December 31, 1997.
The Company generated $14,257,117 in cash flow from operations during the year
ended December 31, 1998 primarily due to increased ADENOSCAN royalty revenues
partially offset by payment of a royalty obligation to Abbott Laboratories, Inc.
This increase in cash and investments was further offset by $4,132,132 in
treasury stock repurchases during 1998.
Included in liabilities at December 31, 1997 is an accrued liability (current
and non-current portion) of $1.5 million relating to the balance of the
Company's guaranteed royalty obligation to Abbott Laboratories pursuant to the
terms of the Company's settlement of a litigation relating to the manufacturing
and marketing rights to ADENOSCAN. At December 31, 1998 the royalty obligation
to Abbott Laboratories was fully paid. See Note 6 to the Company's Financial
Statements included in Item 8 below.
At December 31, 1997, the Company maintained a full valuation allowance against
its deferred tax assets due to uncertainty surrounding timing of partnering
arrangements and uncertainty surrounding the ultimate cost of the research,
clinical trials and development of pharmaceutical products. These uncertainties
could have adversely affected future operations and profit levels. During 1998,
actual profit levels, estimated future research and development spending levels
and the development of certain tax planning strategies made it more likely than
not that the benefits of the Company's deferred tax assets will be realized. As
such, at December 31, 1998, the valuation allowance was eliminated and a
deferred tax asset was recognized on the balance sheet. See Note 10 to the
Company's Financial Statements included in Item 8 below.
ADENOSCAN is currently marketed in the United States, Canada, the United
Kingdom, Australia, Finland, Germany, Ireland, Italy, Norway, and Spain.
ADENOCARD is currently marketed in the United States, Canada, the United
Kingdom, Austria, Australia, Belgium, Bulgaria, Chile, China, Columbia, the
Czech Republic, Denmark, the Dominican Republic, Egypt, Finland, France, French
Polynesia, Germany, Greece, Guatemala, Hong-Kong, Hungary, India, Indonesia,
Ireland, Israel, Italy, Kuwait, Luxembourg, Malaysia, New Zealand, Norway, Oman,
Panama, Peru, the Philippines, Poland, Portugal, Qatar, the Republic of Estonia,
the Republic of Lithuania, Romania, Saudi Arabia, Singapore, Slovakia, South
Africa, South Korea, Spain, Switzerland, Taiwan, Thailand, and Uruguay.
19
<PAGE>
The Company will not generate royalties from the sale of its products until its
licensees receive marketing clearance from the FDA or appropriate governmental
agencies in other countries. The Company cannot predict the timing of any
potential marketing clearance nor can assurances be given that the FDA or such
agencies will approve any of the Company's products. For the short term the
Company expects to receive substantially all of its royalty revenues from sales
of its products, in the U.S. by Fujisawa.
IMPACT OF INFLATION
- -------------------
Although it is difficult to predict the impact of inflation on costs and
revenues of the Company in connection with the Company's products, the Company
does not anticipate that inflation will materially impact its costs of operation
or the profitability of its products when marketed.
IMPACT OF YEAR 2000
- -------------------
Readiness
The Year 2000 ("Y2K") issue results from programmers using two digits to
indicate the century value in date fields. This generally affects older software
and embedded systems of the Company and third parties with which it does
business, thereby threatening data. The team that the Company assembled to
address the Y2K issue brings to bear knowledge from all areas of the Company and
helps minimize the potential impact to the Company.
The Company has categorized the Y2K issue into three parts: internal business
systems software; internal non-business software/embedded systems; and external
vendors. The Company's reliance on an outsourcing philosophy, which encourages
the use of partnering agreements with third parties to accomplish many business
functions, eases the Y2K issue as the Company does not have a large number of
internal business systems applications or embedded systems. However, given that
the Company receives substantially all of its royalty revenues from Fujisawa
Healthcare, Inc., the Y2K issue is still a threat and is being given full
attention by the Company, especially in assessing the Company's third party
relationships.
Internal Business Systems
The Company does not rely on custom developed solutions for its business
systems. The software that it uses is mass-produced and has been inventoried.
The providers have advised the Company that it has been made Y2K compliant
through normal manufacturer upgrades and updates to the software. Accordingly,
all software is either Y2K compliant or is due to be replaced in the normal
course of business by the end of first quarter 1999.
20
<PAGE>
Internal Non-Business Software/Embedded Systems
All internal non-business software and embedded systems have been inventoried.
The providers have been queried regarding Y2K compliance. At this time all
software and systems are either Y2K compliant or due to be replaced in the
normal course of business by the end of first quarter 1999.
External Vendors
A database has been established to track progress the Company's vendors are
making in becoming Y2K compliant. The Company is closely monitoring the progress
and potential impact of vendors that may fail to become Y2K compliant by year
end 1999. The Company has submitted questionnaires to its licensees and material
vendors, including Fujisawa, relative to their Y2K compliance. The Company
expects to complete this phase along with assessing risks and planning for
contingencies relating to third party relationships by April 1, 1999.
Costs
The costs of addressing the Y2K issue are not expected to be material to the
operation of the Company. The costs of software and hardware inventories are
currently being absorbed in the normal course of business. The Company
anticipates incurring less than $2,000 for mailing and reviewing Y2K status
reports for external vendors. The costs anticipated by the Company to replace or
upgrade software or hardware are not being accelerated due to Y2K compliance.
These costs are expected to total $6,000 of which none has been incurred at
December 31, 1998.
Risks
At this stage of its assessment, the Company does not anticipate that Y2K issues
will materially impact any of its operations, including research and
development, manufacturing, supply and distribution and financial control. All
internal systems are expected to be operational at the Century Date Change
(CDC). However, due to the large number of the Company's vendors (including
utility companies and governmental bodies) and their reliance, in turn, on other
vendors (including hospitals and distributors), it is impossible for the impact
of the CDC to be fully known. The Company is unable to determine at this time
whether it will be materially impacted by unknown factors beyond the Company's
control affecting third parties or their vendors including royalties the Company
receives from Fujisawa Healthcare, Inc. The Company's Y2K plan is expected to
significantly reduce the Company's level of uncertainty about Y2K issues and, in
particular, about Y2K compliance and readiness of its material vendors. The
Company believes that, with the completion of the plan as scheduled, the
possibility of significant interruptions of normal operations should be reduced.
Contingency Plans
Contingency planning has begun relative to the Company's material vendors,
banking operations and governmental bodies. Such plans will be updated based on
information received from the vendors on their Y2K readiness. Other contingency
plans will be developed on a vendor-by-vendor basis if deemed necessary
following the Company's assessment of (1) Y2K readiness of other vendors and (2)
the risk of business interruption to the Company. The Company expects to have
formal plans in place by June 1, 1999. The Company's contingency plan takes into
account the fact that the Company's agreements obligate Fujisawa to maintain
inventories of ADENOCARD and ADENOSCAN finished product and work-in-process in
quantities sufficient to satisfy at least six months of projected orders based
on orders received during the prior six month period. In addition, in the event
Fujisawa cannot fulfill orders for such drugs on a timely basis consistent with
U.S. industry practice for any period in excess of 30 calendar days, Fujisawa is
obligated to pay royalties to the Company during such "outage" periods based on
the average daily net sales of the drug during the prior twelve months, except
if such outage results from force majeure and other specified events.
21
<PAGE>
Disclaimer
The discussion of the Company's efforts and management's expectations relating
to the Year 2000 are forward-looking statements. The Company's ability to
achieve Y2K compliance, to verify external vendors' Y2K compliance, and the
costs associated with those activities are subject to change as the Company's
Y2K plan is implemented. Completion of the plan is dependent on the Company's
ability to discover and correct the potential Y2K sensitive problems which could
have a serious impact on operations and the ability of third party vendors to
bring their systems into Y2K compliance.
CAUTIONARY STATEMENT
- --------------------
The Company operates in a highly competitive environment that involves a number
of risks, some of which are beyond the Company's control. The following
statement highlights some of these risks.
Statements contained in Management's Discussion and Analysis of Financial
Conditions and Results of Operations which are not historical facts are forward
looking statements under the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Although the Company believes the expectations
reflected in such forward looking statements are based on reasonable
assumptions, it can give no assurance that its expectations will be attained.
Forward looking statements involve known and unknown risks that could cause the
Company's actual results to differ materially from expected results. Factors
that could cause actual results to differ materially from the Company's
expectations include, among others, the high cost and uncertainty of the
research, clinical trials and other development activities involving
pharmaceutical products; the unpredictability of the duration and results of
regulatory review of New Drug Applications and Investigational New Drug
Applications; the possible impairment of, or inability to obtain, intellectual
property rights and the cost of obtaining such rights from third parties;
intense competition; the uncertainty of obtaining, and the Company's dependence
on, third parties to manufacture and sell its products; results of pending or
future litigation and other risk factors detailed from time to time in the
Company's Securities and Exchange Commission filings.
22
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE ANALYSIS OF MARKET RISK
- -------- --------------------------------------------------
The Company is exposed to various types of market risk in the normal course of
business, including interest rate risk. To manage this exposure, the Company
employs risk management strategies including diversification and a
hold-to-maturity investment policy.
A significant portion of the Company's assets are invested in U.S. Treasury
Notes, debt securities of various federal governmental agencies and high quality
corporate debt securities which are subject to the impact of interest rate
changes. The Company's strategy for managing interest rate risk is to maintain a
balance of U.S. Government and Corporate obligations across a variety of
maturities. Additionally, the Company has adopted a hold-to-maturity policy to
eliminate risk associated with temporary fluctuations in the market value of
securities. All of the Company's investments are in U.S Treasury Notes, debt
securities of various federal governmental agencies and high quality corporate
debt securities, and as such, the Company considers the risk of nonperformance
to be remote.
The following table provides information, by maturity date, about the Company's
interest rate sensitive financial instruments, which consist of marketable debt
securities that are recorded at cost and accounted for as held-to-maturity.
1999 2000 2001
----------- ----------- -----------
Fixed rate marketable debt
securities $21,434,398 $13,069,804 $12,004,453
Average interest rate 5.8% 5.6% 5.8%
23
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
- ------- --------------------
The following consolidated financial statements of Medco Research, Inc. are
included in this report:
Page 24 Report of Independent Accountants
Page 25 Independent Auditors' Report
Page 26 Consolidated Balance Sheets--December 31, 1998 and 1997
Page 27 Consolidated Statements of Operations--Years Ended December
31, 1998, 1997 and 1996
Page 28 Consolidated Statements of Stockholders' Equity--Years Ended
December 31, 1998, 1997 and 1996
Page 29 Consolidated Statements of Cash Flows--Years Ended December
31, 1998, 1997 and 1996
Page 31 Notes to Consolidated Financial Statements
24
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders
Medco Research, Inc. and its Subsidiary:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Medco
Research, Inc. and its subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years then
ended in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Raleigh, North Carolina
January 22, 1999
25
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Medco Research, Inc.:
We have audited the consolidated statements of operations, stockholders' equity
and cash flows of Medco Research, Inc. and subsidiary for the year ended
December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and the cash flows
of Medco Research, Inc. and subsidiary for the year ended December 31, 1996, in
conformity with generally accepted accounting principles.
As discussed in Note 11 to the consolidated financial statements contained in
the 1996 Form 10-K, the Company is party to certain claims and litigation. The
ultimate outcome of these matters cannot presently be determined. Accordingly,
no provisions for liability, if any, that may result from the resolution of such
matters have been recognized in the accompanying consolidated financial
statements.
As discussed in Note 1, the Company adopted Statement of Financial Accounting
Standard No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", on January 1, 1994.
KPMG LLP
Raleigh, North Carolina
January 28, 1997
26
<PAGE>
<TABLE>
Medco Research, Inc.
Consolidated Balance Sheets
December 31,
--------------------------------------------
1998 1997
--------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $4,742,016 $2,726,486
Investments held to maturity (Note 2) 21,434,398 14,272,791
Accounts and notes receivable:
Royalties 8,348,719 6,003,629
Other 84,654 244,486
Accrued interest income 577,691 563,294
Deferred tax asset, current portion (Note 10) 458,497 -
Prepaid expenses and other 242,869 503,568
--------------------------------------------
Total current assets 35,888,844 24,314,254
Investments held to maturity (Note 2) 25,074,257 23,530,192
Deferred tax asset (Note 10) 1,227,503 -
Property and equipment, at cost, net of accumulated
depreciation (Note 3) 465,759 243,996
Patent, trademark and distribution rights, at cost,
net of accumulated amortization (Note 5) 1,628,738 1,524,272
--------------------------------------------
Total assets $64,285,101 $49,612,714
============================================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $3,400,670 $2,378,933
Accrued royalties (Note 5) 2,166,339 1,300,650
Accrued compensation 509,151 475,838
--------------------------------------------
Total current liabilities 6,076,160 4,155,421
Deferred royalty payment (Note 6) - 451,009
Other long-term liabilities 150,000 350,000
Stockholders' equity (Notes 8 and 9):
Common stock, no par value, authorized 40,000,000
shares; shares issued of 11,298,732 and 11,182,832
at December 31, 1998, and 1997, respectively;
shares outstanding of 10,409,332 and 10,513,832 at
December 31, 1998 and 1997, respectively 53,805,722 52,513,135
Retained earnings (accumulated deficit) 15,061,383 (1,180,819)
Cost of stock held in treasury, 889,400 and 669,000
shares at December 31, 1998 and 1997, respectively (10,808,164) (6,676,032)
--------------------------------------------
Total stockholders' equity 58,058,941 44,656,284
--------------------------------------------
Commitments and contingencies (Notes 5, 6 and 12)
============================================
Total liabilities and stockholders' equity $64,285,101 $49,612,714
============================================
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE>
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1998 1997 1996
------------------------------------------------------
<S> <C> <C> <C>
Net Revenues:
Royalty revenue (Note 5) $27,544,248 $20,000,366 $13,453,958
Royalty expense (Note 5) 4,872,932 2,985,074 2,573,877
------------------------------------------------------
Gross margin 22,671,316 17,015,292 10,880,081
------------------------------------------------------
Operating expenses:
Research and development costs 10,347,570 6,902,092 5,839,278
General and administrative expenses 2,584,518 2,393,601 3,002,273
------------------------------------------------------
12,932,088 9,295,693 8,841,551
------------------------------------------------------
Operating income 9,739,228 7,719,599 2,038,530
------------------------------------------------------
Other income:
Interest income 2,730,032 2,099,550 2,020,115
Other income (Note 7) 4,003,562 682,389 350,000
------------------------------------------------------
6,733,594 2,781,939 2,370,115
------------------------------------------------------
Income before income taxes 16,472,822 10,501,538 4,408,645
Provision for income taxes (Note 10) 230,620 288,410 87,000
------------------------------------------------------
Net income $16,242,202 $10,213,128 $ 4,321,645
======================================================
Basic earnings per share $1.54 $0.97 $0.40
======================================================
Diluted earnings per share $1.50 $0.96 $0.40
======================================================
Weighted average shares outstanding 10,530,745 10,545,533 10,917,920
======================================================
Weighted average shares outstanding
assuming dilution 10,857,004 10,620,785 10,938,357
======================================================
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE>
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Common stock
-----------------------------
Accumulated
other Retained
Number of comprehensive earnings/ Cost of stock
shares Amount income (accumulated held in treasury Total
deficit)
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 11,013,732 $52,216,010 $133,972 $(15,715,592) $(1,534,707) $35,099,683
Purchase of stock held in
treasury (273,700) - - - (2,788,351) (2,788,351)
Reclassification adjustment
to other comprehensive
income due to the sale of
an investment - - (133,972) - - (133,972)
Net income - - - 4,321,645 - 4,321,645
--------------------------------------------------------------------------------------------
Balance at December 31, 1996 10,740,032 52,216,010 - (11,393,947) (4,323,058) 36,499,005
Stock options exercised 27,000 297,125 - - - 297,125
Purchase of stock held in
treasury (253,200) - - - (2,352,974) (2,352,974)
Net income - - - 10,213,128 - 10,213,128
--------------------------------------------------------------------------------------------
Balance at December 31, 1997 10,513,832 52,513,135 - (1,180,819) (6,676,032) 44,656,284
Stock options exercised 115,900 1,292,587 - - - 1,292,587
Purchase of stock held in
treasury (220,400) - - - (4,132,132) (4,132,132)
Net income - - - 16,242,202 - 16,242,202
--------------------------------------------------------------------------------------------
Balance at December 31, 1998 10,409,332 $53,805,722 $ - $15,061,383 $(10,808,164) $58,058,941
============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
29
<PAGE>
Medco Research, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------
<S> <C> <C> <C>
Operating activities
Net income $16,242,202 $10,213,128 $4,321,645
Adjustments to reconcile net income to net cash provided by (used
in) operating activities:
Depreciation of property and equipment 99,808 101,965 143,934
Amortization of patent, trademark and other distribution
rights 608,034 573,817 51,403
Deferred tax benefit (1,686,000) - -
Realized gain on investments available for sale - - (49,258)
Net amortization of investment discount (334,539) (101,869) (260,912)
(Gain) loss on disposition of property and equipment
(3,162) 10,852 -
Loss on disposal of patents - 14,759 -
Changes in operating assets and liabilities:
Accounts receivable (1,185,258) (226,490) (2,286,735)
Accrued interest income (14,397) (186,430) (124,644)
Prepaid expenses and other 260,699 109,876 34,427
Deferred asset - 124,212 1,727,703
Accounts payable and accrued expenses 855,050 199,451 (126,659)
Accrued royalties 865,689 121,093 (129,764)
Deferred revenue - (548,202) (751,798)
Deferred royalty payment (1,451,009) (1,265,863) (884,353)
-----------------------------------------------------------
Net cash provided by operating activities 14,257,117 9,140,299 1,664,989
-----------------------------------------------------------
</TABLE>
(Continued)
30
<PAGE>
Consolidated Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------
<S> <C> <C> <C>
Investing activities
Purchase of investment securities (34,293,133) (20,161,540) (45,707,862)
Maturity of investment securities 25,922,000 8,478,579 52,106,334
Purchases of property and equipment (332,769) (51,298) (121,786)
Proceeds from sale of property and equipment 14,360 2,006 -
Purchases of patent, trademark and distribution rights (712,500) (1,732,406) (351,403)
-------------------------------------------------------------
Net cash provided by (used in) investing activities (9,402,042) (13,464,659) 5,925,283
-------------------------------------------------------------
Financing activities
Net proceeds from exercise of stock options 1,292,587 297,125 -
Purchase of stock held in treasury (4,132,132) (2,352,974) (2,788,351)
-------------------------------------------------------------
Net cash used in financing activities (2,839,545) (2,055,849) (2,788,351)
-------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 2,015,530 (6,380,209) 4,801,921
Cash and cash equivalents at beginning of year 2,726,486 9,106,695 4,304,774
-------------------------------------------------------------
Cash and cash equivalents at end of year $ 4,742,016 $ 2,726,486 $ 9,106,695
=============================================================
See accompanying notes to consolidated financial statements.
</TABLE>
31
<PAGE>
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
1. Summary of Significant Accounting Policies
Company Operations
Medco Research, Inc. is an emerging pharmaceutical company engaged in the global
commercialization of cardiovascular medicines and adenosine-based products.
The Company's business approach has been to carefully evaluate and selectively
acquire product candidates, thereby reducing the costs and risks associated with
basic research and drug discovery. These product opportunities and the related
intellectual property rights are typically obtained under license from academic
or corporate sources who have received United States patents which, in the
opinion of the Company's patent counsel, are enforceable. The Company then
sponsors and directs any additional pre clinical studies and clinical testing
needed for product registration and marketing approval. These late-stage product
development activities are outsourced to independent clinical research
organizations to maximize efficiency and minimize internal overhead.
Historically the Company has licensed the manufacturing and marketing rights to
its products to corporate partners in exchange for licensing fees and royalty
payments on future product sales. A portion of formulation development, as well
as microbiology, chemistry, manufacturing and controls information, are
typically provided by the Company's licensed corporate partner, and the Company
then submits to the United States Food and Drug Administration (the "FDA") a New
Drug Application ("NDA") to obtain the FDA's clearance to market the drug.
Principles of Consolidation and Basis of Preparation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary. All significant intercompany balances and
transactions have been eliminated. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly-liquid investments with a maturity of less than
three months when purchased to be cash equivalents.
32
<PAGE>
Summary of Significant Accounting Policies (continued)
Investments
The Company's investments include primarily investments in marketable debt
securities which are recorded at cost, net of amortization of premiums and
discounts. All premiums and/or discounts are amortized over the remaining term
of the related security using the straight-line method which does not differ
significantly from the effective interest rate method. The Company's investments
are accounted for in accordance with SFAS No.115, "Accounting for Certain
Investments in Debt and Equity Securities". This Statement addresses the
accounting and reporting for investments in equity securities that have readily
determinable fair values and for all investments in debt securities. These
investments are classified in three categories and are accounted for as follows:
(1) debt securities that the Company has the positive intent and the ability to
hold to maturity are classified as held-to-maturity and reported at cost; (2)
debt and equity securities that are bought and held principally for the purpose
of selling them in the near term are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings;
(3) debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale securities
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of equity. All of the Company's
investments are accounted for as held-to-maturity securities as of December 31,
1998 and 1997. The classification of investments is determined on the date of
acquisition. The Company reviews its investment portfolio as deemed necessary
and, where appropriate, adjusts individual investments for other-than-temporary
impairments.
Fair Value of Financial Instruments
Statement of Financial Accounting Standard No. 107, "Disclosures about the Fair
Value of Financial Instruments" ("SFAS No. 107") requires the disclosure of fair
value information about financial instruments, whether or not recognized on the
balance sheet, for which it is practicable to estimate the value. In cases where
quoted market prices are not readily available, fair values are based on quoted
market prices of comparable instruments. SFAS No. 107 excludes certain financial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts are not intended to represent the underlying value of the Company.
The carrying amount of cash and equivalents, accounts receivable and payable,
and accrued royalties approximates fair value because of the short maturity of
those instruments. The fair value of investments was based primarily on quoted
market prices (see note 2). If quoted market prices are not readily available,
fair values are based on quoted market prices of comparable instruments.
Property and Equipment
Property and equipment are primarily made up of furniture and equipment and
leasehold improvements and are stated at cost. Depreciation is computed using
the straight-line method over the useful lives of the related assets which is
generally five years.
Trademark and Distribution Rights
The cost of acquiring trademark and distribution rights is amortized over 15
years using the straight-line method. Periodically, these costs are reviewed and
adjusted based on the estimated future financial benefits of the underlying
product.
33
<PAGE>
Summary of Significant Accounting Policies (continued)
Patent Costs
The Company capitalizes certain costs, principally acquisition costs incurred in
connection with the application for and procurement of patents. Costs are
capitalized on a case-by-case basis relating to those territories where the
Company anticipates receiving significant future benefits from the patent, and
are amortized over the life of the patent beginning at the date of grant.
Amortization periods on capitalized patent costs at December 31, 1998 range from
2 to 17 years. Periodically, these costs are reviewed and the amortization
adjusted based on the estimated future benefits remaining. Patent costs are
presented net of accumulated amortization of $885,440 and $277,406 at December
31, 1998 and 1997, respectively.
Concentration of Credit Risk
Statement of Financial Accounting Standard No. 105 requires disclosure of
information about financial instruments with off-balance-sheet risk and
financial instruments with concentrations of credit risk. Financial instruments
which subject the Company to concentrations of credit risk consist principally
of accounts receivable and investments.
The Company invests its excess cash primarily in U.S. Government and
high-quality corporate debt securities and commercial paper. The commercial
paper securities are highly liquid and the governmental securities typically
mature within one to three years (although there is an established secondary
market for sales at any given time). The majority of the accounts receivable
balance at December 31, 1998 and 1997 relates to the Company's corporate
partner, Fujisawa (see Note 5). Based on the nature of the financial instruments
and/or historical realization of these financial instruments, management
believes they bear minimal risk.
Research and Development
All research and development costs are expensed as incurred.
Income Taxes
The Company accounts for income taxes under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
34
<PAGE>
Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), permits entities to recognize as expense over
the vesting period, the fair value on the date of grant of all stock-based
awards. Alternatively, SFAS No. 123 also allows entities to continue to apply
the provisions of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants as if the fair value based method
defined in SFAS No. 123 had been applied. The Company has elected to continue to
apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure
provisions of SFAS No. 123. Accordingly, compensation expense has been
recognized to the extent of employee or director services rendered based on the
intrinsic value of compensatory options or shares granted under the plans.
Earnings Per Share
The Company adopted Statement of Financial Accounting Standards No. 128 ("SFAS
No. 128"), "Earnings Per Share," on December 31, 1997. Basic earnings per share
is computed using the weighted average number of common shares outstanding
during the year. Diluted earnings per share is computed using the weighted
average number of common shares plus the effects of any dilutive common share
equivalents, primarily stock options, outstanding during a period. Earnings per
share for all periods presented conforms to the provisions of SFAS No. 128.
The following is a reconciliation of the weighted average number of common
shares and common share equivalents used to determine diluted earnings per share
for each of the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------- --------------- ---------------
1998 1997 1996
-------------- --------------- ---------------
<S> <C> <C> <C>
Basic weighted average shares outstanding 10,530,745 10,545,533 10,917,920
Net effect of dilutive stock options
based on treasury stock method
using average market price 326,259 75,252 20,437
-------------- --------------- ---------------
Weighted average shares assuming
dilution 10,857,004 10,620,785 10,938,357
============== =============== ===============
</TABLE>
Adoption of New Accounting Pronouncements
The Company adopted Statement of Financial Accounting Standards No. 130
"Reporting Comprehensive Income" ("SFAS No. 130") for its fiscal year ending
December 31, 1998. SFAS No. 130 requires the Company to display an amount
representing the total comprehensive income for the period in a financial
statement which is displayed with the same prominence as other financial
statements. The Company has no items of comprehensive income or loss during the
years ended December 31, 1998 and 1997. The Company has an unrealized loss on
investments in marketable equity securities at December 31, 1995, which was
adjusted due to the sale of an investment during the year ended December 31,
1996.
35
<PAGE>
The Company adopted Statement of Financial Accounting Standards No. 131
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131") for its fiscal year ended December 31, 1998. SFAS No. 131 requires the
Company to report selected information about operating segments in interim and
annual financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. The adoption of this pronouncement did not impact the Company's
disclosures as the Company manages its business as one segment and substantially
all of the Company's revenues come from one source (see note 5).
The Company will adopt Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Investments and Hedging Activities" ("SFAS No. 133")
for its fiscal year ending December 31, 2000. SFAS No. 133 establishes a new
model for accounting for derivatives and hedging activities and supersedes and
amends a number of existing standards. The adoption of this pronouncement is
expected to have no impact on the Company's results of operations or financial
condition.
2. Investments
The aggregate fair values of investment securities at December 31, 1998 and 1997
along with unrealized gains and losses determined on an individual security
basis are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------------ --------------------- ---------------------- -------------------
1998 Held to maturity
- ---------------------
<S> <C> <C> <C> <C>
U.S. Government Obligations $26,046,715 $216,618 $ - $26,263,333
Corporate Obligations 20,461,940 - (99,347) 20,362,593
------------------ --------------------- ---------------------- -------------------
Total securities held to maturity $46,508,655 $216,618 $(99,347) $46,625,926
================== ===================== ====================== ===================
1997 Held to maturity
- ---------------------
U.S. Government Obligations $26,003,402 $40,248 $ - $26,043,650
Corporate Obligations 11,799,581 - (84,645) 11,714,936
------------------ --------------------- ---------------------- -------------------
Total securities held to maturity $37,802,983 $40,248 $(84,645) $37,758,586
================== ===================== ====================== ===================
</TABLE>
There were no realized gains or losses in 1998 or 1997. Net realized gains in
1996 were $49,258 as a result of the sale of an investment in the Pimco Fund.
The following represents the contractual maturities of investments held as of
December 31, 1998.
Less than 1 year $21,434,398
1 to 5 years 25,074,257
==============
Total $46,508,655
==============
36
<PAGE>
3. Property and Equipment
December 31,
1998 1997
-------------------------------
Property and equipment $907,592 $717,675
Leasehold improvements 24,851 -
Accumulated depreciation (466,684) (473,679)
===============================
$465,759 $243,996
===============================
4. Leases
The Company leases office space under an operating lease which expires in
November 2003. Lease expense approximated $208,366, $210,800 and $206,100 in
1998, 1997 and 1996, respectively. Future minimum lease payments under operating
lease agreements at December 31, 1998 are:
Year Ending December 31,
1999 $ 411,663
2000 521,854
2001 537,509
2002 553,635
2003 570,244
===============
$2,594,905
===============
5. Patent, Trademark and Distribution Rights
The Company is engaged in the development of new prescription drugs in pursuit
of obtaining governmental marketing approvals in the United States and other
countries. The Company acquires from third parties exclusive rights to develop
and market various drugs, including related patents and trademarks (where
applicable), and develops drugs and seeks patents and trademarks for its
products on a proprietary basis. Agreements under which the Company acquires
such rights from third parties generally require the Company to finance the
costs of clinical trials and the filing of New Drug Applications ("NDAs") with
the United States Food and Drug Administration ("FDA") and, in some instances,
comparable applications with appropriate regulatory agencies in other countries.
The Company is also typically required to pay royalties to such third parties
based on sales of the applicable approved drugs. The Company also may be
obligated to pay to third parties advance royalties or licensing fees, some of
which may be based on the attainment of specified milestones.
Under present agreements with third parties, the Company has obligations as of
December 31, 1998 to pay $350,000 in nonrefundable payments which are payable in
quarterly installments of $50,000 through July 1, 2000. At December 31, 1998,
approximately $200,000 of this obligation is included in accounts payable and
accrued expenses and the remaining obligation of $150,000 is included in other
long-term obligations in the consolidated balance sheet. The Company may also be
required to pay a maximum of $5,500,000 in nonrefundable payments generally upon
the completion of development milestones and the FDA's approvals of NDAs for
certain compounds.
37
<PAGE>
In October 1989, the Company received FDA approval to market ADENOCARD in the
United States. The Company entered into agreements with Fujisawa USA, Inc.
(Fujisawa) for the manufacture and marketing of ADENOCARD in the United States
and Canada and receives royalties from Fujisawa based on a percentage of
ADENOCARD net sales. The Company has also entered into an agreement with Sanofi
Pharma (France) (Sanofi) for the manufacture and marketing of ADENOCARD in all
countries other than the United States and Canada. In September 1991, Sanofi
received marketing approval (under the trade name ADENOCOR) in the United
Kingdom and, in May 1992, received marketing approval (under the trade name
KRENOSIN) in Switzerland. The Company receives royalties from Sanofi based on a
percentage of ADENOCOR and KRENOSIN sales. One half of all royalties received
from ADENOCARD, ADENOCOR and KRENOSIN sales are payable by the Company to the
University of Virginia Alumni Patents Foundation from which the Company acquired
rights to ADENOCARD.
In 1988, the Company entered into a Development and License Agreement (the
"Agreement") with Fujisawa that provides for Fujisawa to fund one-half of the
development costs (as incurred) of ADENOSCAN, and other products. Under the
agreement, Fujisawa will have manufacturing and marketing rights to these drugs
in the United States and Canada upon the Company's receipt of the required
regulatory approvals, and will pay the Company royalties based on sales of these
drugs. Royalties received by the Company from sales of these drugs outside of
the United States and Canada will be shared equally with Fujisawa. In May 1995,
the FDA granted marketing clearance for ADENOSCAN in the United States. In May
1996, the parties entered into an agreement to jointly develop adenosine-based
products having indications as cardioprotective agents. In March 1998, Fujisawa
on behalf of itself and the Company, licensed additional intellectual property
rights for intravenous adenosine in cardiac imaging and the right to use
intravenous adenosine as a cardioprotectant in combination with thrombolytic
therapy, balloon angioplasty and coronary bypass surgery and secured
intellectual property rights to extend the exclusivity of ADENOSCAN until 2015.
Pursuant to the Agreement and the May 1996 agreement, the Company paid its 50%
share of the one-time up-front fee due to the licensor, which the Company
capitalized and is amortizing over the life of the patents, and is obligated to
pay its 50% share of a 6% royalty on ADENOSCAN net sales to this third party.
In June 1998 Fujisawa assigned and transferred to the Company all of its right,
title and interest in the May 1996 cardioprotective product development
agreement, including all of Fujisawa's related scientific data and intellectual
properties in the United States and Canada. In the event that the Company
markets an adenosine-containing cardioprotective product, Fujisawa will receive
an 8% royalty on the Company's net sales. In the event that the Company licenses
a third party to sell such product, Fujisawa will receive 25% of licensing fees,
milestone payments, royalties, and other considerations received by the Company
from such third party after the Company has recouped $2 million toward its
investment plus its substantiated future development costs. Also in June 1998,
the Company transferred the NDA for ADENOCARD and ADENOSCAN to Fujisawa and
provided assistance to Fujisawa in connection with the contract manufacturing
agreement for both products with a third party.
Two-thirds of all royalty income in the three-year period ended December 31,
1998 resulted from Fujisawa sales of ADENOSCAN in the United States. In December
1992, the Company granted Sanofi the exclusive rights to manufacture and market
ADENOSCAN worldwide except in the United States, Canada, Japan, Korea and
Taiwan. In June 1995, Sanofi received marketing approval for ADENOSCAN in the
United Kingdom and in February 1997, Sanofi registered ADENOSCAN in 14 member
countries of the European Community through the mutual recognition procedure.
The final administrative procedure involving the granting of a National
Marketing License authorizing the sale of the product has been secured from the
health authorities in the majority of the member countries.
38
<PAGE>
In 1997 the Company entered into a Development and Commercialization Agreement
(the "Agreement") with Discovery Therapeutics, Inc. ("DTI") dedicated to the
discovery, development and commercialization of compounds that stimulate the A2a
subfamily of adenosine receptors ("A2a-agonists"). Under the terms of the
Agreement, DTI granted to the Company an exclusive license under certain U.S.
and foreign patents and pending applications relating to DTI's current
intellectual property related to A2a-agonists. The Company has exclusive rights
under certain U.S. and foreign patents and pending applications to market and
sell developed compounds, either directly or through sublicense. In exchange for
these rights, the Company agreed to pay DTI certain licensing fees, development
milestones and royalties on future sales of A2a-agonists. The Company was
required to make a $1 million payment to DTI in the fourth quarter of 1998. This
payment was recorded as research and development expenses in the accompanying
statement of operations.
6. Deferred Royalty Payment
In May 1995, the litigation pending between Fujisawa USA, Inc. (Fujisawa) and
the Company, regarding the rights to manufacture and market ADENOSCAN in the
United States and Canada, was settled and the Company and Abbott Laboratories,
Inc. (Abbott) terminated their manufacturing and marketing agreements regarding
the ADENOSCAN drug and settled Medco's outstanding obligations thereunder.
Pursuant to the settlement agreement with Fujisawa, the December 21, 1988 Joint
Development and License Agreement between the parties remains in full force and
effect except as expressly amended and Fujisawa remains the Company's exclusive
licensee to manufacture and market ADENOSCAN in the United States and Canada.
Fujisawa agreed to pay the Company within fifteen days after FDA marketing
clearance of ADENOSCAN the sum of $2 million, representing certain research and
development expenses incurred by the Company, and to pay the Company royalties
of 29 percent of ADENOSCAN net sales in the United States and Canada for the
first five years after the commencement of commercial sales in each territory.
Thereafter Fujisawa would pay the Company royalties of 25% of sales until the
end of exclusivity on ADENOSCAN.
The Company agreed to pay Abbott a royalty of two percent of net sales of
ADENOSCAN for the first five years of commercial sales, up to a maximum of $5.35
million, of which $2 million was payable within fifteen days after FDA marketing
clearance of ADENOSCAN as an advance royalty payment and the remainder payable
based upon actual sales of ADENOSCAN. The Company also agreed that if at the
conclusion of the five-year period Abbott had not received an aggregate of $5.35
million, including the $2 million advance, Medco would pay Abbott any
deficiency. Abbott relinquished all claims to royalty payments in excess of that
amount. Finally, the Company agreed to pay Abbott $330,560 for the reimbursement
of research and development and other expenses incurred in connection with
ADENOSCAN.
Included in liabilities for the year ended December 31, 1997 was an accrued
liability (current and non-current portion) of approximately $1.5 million
relating to the balance of the Company's guaranteed royalty obligation to
Abbott. At December 31, 1998 the royalty obligation to Abbott Laboratories was
fully paid.
Included in assets at December 31, 1996 was a deferred asset (current and
non-current portion) of $1.7 million relating to royalties to be received by the
Company from Fujisawa and paid by the Company to Abbott. The Company received a
29% royalty from ADENOSCAN net sales of which 4% was applied to the deferred
asset and 25% was recognized as royalty revenue. At such time during the first
five years that the deferred asset is fully recovered, the Company thereafter
will recognize royalty revenue of 29% through the end of the five-year period.
As of December 31, 1997 the deferred asset was fully recovered and the Company
recognized royalty revenue of 29%.
39
<PAGE>
7. Agreement with Fujisawa
In June 1998 the Company received a $4 million payment from Fujisawa for the
transfer of the ADENOSCAN and ADENOCARD NDAs and for the assistance provided by
the Company to Fujisawa in connection with its contract manufacturing agreement
with a third party relating to ADENOSCAN and ADENOCARD. The Company has included
this payment in other income. Additionally, the Company incurred a one-time
charge of $2,361,000 pertaining to the purchase of Fujisawa's commercialization
rights and related intellectual properties for the cardioprotection application
of intravenous adenosine, which is included in research and development
expenses.
8. Equity
The Company adopted a Shareholder Rights Plan on April 2, 1998. The plan
provides for a dividend distribution of rights to purchase shares of the common
stock of the Company, exercisable upon the occurrence of certain events.
9. Employee Benefits Plans
The Company sponsors an IRS-approved 401(K) retirement plan. Employees become
eligible to participate in the plan beginning on the enrollment date coinciding
with or following 90 days of employment. Enrollment periods are limited to
January 1, April 1, July 1 and October 1 of each year. The 401(K) plan allows
employees to contribute a portion of their pre-tax earnings into their own
retirement account. Eligible employees may contribute between 2% and 15% of
their annual income up to the annual limits established by the IRS yearly. The
Board of Directors authorized the Company, for those years in which it achieves
the performance goals established in advance by the Compensation Committee, to
match 50% of each employee's annual plan contribution up to a maximum of 2% of
the salary of such employee, and such Company contributions to vest equally over
the first four years of service. Following the fourth year of service, all
matching contributions are fully vested. In 1998, 1997 and 1996, the Company
accrued approximately $27,000, $28,000 and $22,000, respectively, for the match
of 50% of each employee's annual plan contribution up to a maximum of 2% of the
salary of such employee based on achievement of Company performance goals.
The Company currently has one stock option plan in operation, the 1989 Stock
Option and Stock Appreciation Rights Plan. Options to purchase up to 2,090,000
shares of the Company's common stock may be granted to its officers, directors,
employees and to other persons who provide services to the Company. Under the
Plans, both incentive and non-qualified stock options, as well as stock
appreciation rights under the 1989 Plan, can be granted. No incentive stock
options are currently outstanding and no stock appreciation rights have been
granted. Non-qualified stock options generally can be exercised in part one year
after the date of grant. The exercise price may not be less than 100% of the
fair market value of the common stock on the date of grant (110% with respect to
incentive stock options granted to optionees who are 10% or more stockholders of
the Company). Option holders may pay for the exercise of the options in whole or
in part by tendering shares of common stock of the Company, in lieu of cash.
During the year ended December 31, 1998 115,900 options were exercised. During
the year ended December 31, 1997 27,000 options were exercised. During the year
ended December 31, 1996 there were no options exercised.
40
<PAGE>
<TABLE>
Changes in the status of options are summarized as follows:
<CAPTION>
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
1998 Price 1997 Price 1996 Price
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 983,930 $12 781,982 $11 610,732 $15
Granted 340,936 20 400,080 14 461,000 10
Exercised (115,900) 11 (27,000) 11 - -
Expired or canceled (89,660) 14 (171,132) 14 (289,750) 17
-----------------------------------------------------------------------------------------
Outstanding at end of year 1,119,306 $14 983,930 $12 781,982 $11
=========================================================================================
Available for grant at end of year 395,307 N/A 56,583 N/A 285,531 N/A
Exercisable at end of year 561,618 N/A 394,275 N/A 281,257 N/A
Weighted average fair value of
options granted with exercise
price equal to fair value of
underlying stock $9.04 N/A $6.05 N/A $3.92 N/A
Price range of options outstanding $8.63-$23.88 N/A $8.63-$15.88 N/A $8.63-$17.13 N/A
Price range of options exercised $8.88-$15.88 N/A $10.13-$13.25 N/A N/A N/A
Options outstanding and exercisable as of December 31, 1998 are summarized as
follows:
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------- ------------------------------------
Weighted Average
Remaining Weighted Weighted Average
Range of Exercise Number Contarctual Average Number
Prices Outstanding Life Exercise Price Exercisable Exercise Price
- ---------------------------------------------------------------------------- ----------------- ------------------
$ 8 - $15 629,800 7.3 years $11 488,225 $11
15 - 24 489,506 9.5 19 73,393 16
------------- -------------
$ 8 - $24 1,119,306 8.3 $14 561,618 $12
============= =============
</TABLE>
As of December 31, 1998, the Company had a warrant outstanding allowing the
holder to purchase 40,000 shares of the Company's common stock on or before
November 16, 2000 at an exercise price of $13.50 per share. The Company has
reserved 1,554,613 shares of common stock for future exercise of stock options
and warrants.
41
<PAGE>
For disclosure purposes, the fair value of each option grant is estimated on the
date of grant, in accordance with the requirements of SFAS No. 123, using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 1998, 1997 and 1996: dividend yield zero (all years); expected
volatility of 43% (1998), 37% (1997) and 35% (1996); risk-free interest rate of
5% (1998) 6% (1997 and 1996); and expected life of 5 years for all options. Had
compensation cost for the Company's stock-based compensation plans, as described
above, been determined consistent with SFAS No.123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below. The compensation costs disclosed here may not be representative of the
effects on pro forma net income in future years.
<TABLE>
<CAPTION>
1998 1997 1996
------------------- -------------------- --------------------
<S> <C> <C> <C> <C>
Net income: As reported $16,242,202 $10,213,128 $4,321,645
Pro forma 14,951,394 8,674,702 2,806,507
Basic earnings per share: As reported $1.54 $0.97 $0.40
Pro forma 1.42 0.82 0.26
Diluted earnings per share: As reported $1.50 $0.96 $0.40
Pro forma 1.38 0.82 0.26
</TABLE>
10. Income Taxes
The components of income tax expense consisted of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------
1998 1997 1996
------------------ ------------------- ------------------
<S> <C> <C> <C>
Current expense:
Federal $1,523,232 $208,410 $ 87,000
State 15,130 - -
Foreign taxes 15,272 80,000 -
------------------ ------------------- ------------------
1,553,634 288,410 87,000
------------------ ------------------- ------------------
Deferred benefit:
Federal (1,323,014) - -
State - - -
------------------ ------------------- ------------------
(1,323,014) - -
------------------ ------------------- ------------------
Total $230,620 $288,410 $ 87,000
================== =================== ==================
</TABLE>
42
<PAGE>
The components of deferred tax assets and the deferred tax liabilities as of
December 31, 1998 and December 31, 1997 are as follows:
Years Ended December 31,
------------------ ------------------
1998 1997
------------------ ------------------
Deferred tax assets:
Tax loss carryforwards $ - $3,214,000
Capital loss carryforwards 332,000 381,000
Tax credit carryforwards 1,264,000 1,625,000
Compensation accruals 42,000 33,000
Charitable contributions - 25,000
Deferred revenue - 567,000
Depreciation and Amortization 48,000 24,000
------------------ ------------------
Total gross deferred tax assets 1,686,000 5,869,000
Valuation allowance - (5,869,000)
------------------ ------------------
Net deferred tax assets $1,686,000 $ -
------------------ ------------------
The Company establishes valuation allowances in accordance with the provisions
of FASB Statement No. 109, "Accounting for Income Taxes". Management continually
reviews the adequacy of the valuation allowance and recognizes these benefits
only as reassessment indicates that it is more likely than not that the tax
benefits will be realized.
At December 31, 1997, the Company maintained a full valuation allowance against
its deferred tax assets due to uncertainty surrounding timing of partnering
arrangements and uncertainty surrounding the ultimate cost of the research,
clinical trials and development of the Company's portfolio of pharmaceutical
products. These uncertainties could have adversely affected future operations
and profit levels. During 1998, actual profit levels, estimated future research
and development spending levels based on existing agreements and the development
of certain tax planning strategies made it more likely than not that the
benefits of the Company's deferred tax assets will be realized. As such, at
December 31, 1998, the valuation allowance was eliminated and a deferred tax
asset was recognized on the balance sheet.
43
<PAGE>
The actual income tax expense for 1998, 1997 and 1996 differs from the
"expected" amount (computed by applying the statutory federal income tax rate of
35% for 1998 and 34% for 1997 and 1996 to the earnings before income taxes) as
follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997 December 31, 1996
------------------------------------------------------ ----------------------------
Amount % Amount % Amount %
------------------------------------------------------ ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Tax expense at federal statutory rate $5,765,488 35.0% $3,570,523 34.0% $1,498,940 34.0%
Change in valuation allowance (5,869,000) (35.6) (3,262,000) (31.1) (1,725,000) (39.1)
Write-off of state operating loss
carryforwards 406,074 2.5 - - - -
Tax credits - - - - 8,000 0.2
State tax expense 15,130 0.1 12,366 0.1 325,934 7.4
Write down of marketable securities - - - - (29,469) (0.7)
Stock options (383,600) (2.3) (101,023) (1.0) - -
Foreign taxes 9,927 - 52,940 0.5 - -
Other 286,601 1.7 15,605 0.2 8,595 0.2
================= =========== =============== ========== ================ =========
Tax provision $ 230,620 1.4% $ 288,410 2.7% $ 87,000 2.0%
================= =========== =============== ========== ================ =========
</TABLE>
At December 31, 1998, the Company had available approximately $974,000, $286,000
and $4,000 of research and development credit, alternative minimum tax credit
and investment credit, respectively. Except for the alternative minimum tax
credit, these credits expire in varying amounts from 1999 through 2012.
The Company has a capital loss carryover of $974,000 at December 31, 1998, of
which $47,000 will expire in 1999 and the remainder will expire in 2000.
The Company made income tax payments of $845,000, $528,750 and $87,000 during
the years ended December 31, 1998, 1997 and 1996, respectively.
11. Related Party Transactions
Fees of $108,000, $144,000 and $144,000 as well as related travel expenses were
paid in 1998, 1997 and 1996, respectively, to an individual director for
consulting with the Company on matters such as acquisitions, financial public
relations and pending litigation.
12. Contingencies
There are no material legal proceedings pending against the Company. However, on
October 3, 1997, Richard A. Wilson, Debra A. Angello, and Paul S. Angello
("Plaintiffs") filed a complaint against Fujisawa, USA, Inc. in the United
States District Court, District of Oregon, alleging that Fujisawa's sale of
ADENOSCAN in the United States induces, or contributes to, the infringement of
plaintiffs' U.S. Patent No. 4,824,660 ("the `660 patent"), entitled "Method of
Determining the Viability of Tissue in an Organism" which the Patent Office
issued on April 25, 1989. According to plaintiffs, the `660 patent claims a
specific technique for more reliably locating viable or nonviable regions of
heart tissue, namely using an adenosine triphosphate repleting agent such as
ribose or adenosine as an adjunct to radioactive isotope (e.g., thallium-201)
myocardial perfusion scintigraphy, where regions of heart tissue in which the
44
<PAGE>
scan images show no radioactivity indicate the presence of nonviable heart
tissue. In its Answer and Counterclaim, Fujisawa denied that it infringed any of
the claims of the `660 patent and alleged that the `660 patent was invalid.
Fujisawa further alleged that plaintiffs' claims of patent infringement were
barred by the doctrines of laches and estoppel. In its Counterclaim, Fujisawa
requested a declaratory judgment that it did not infringe the claims of the `660
patent and that such patent is invalid.
On December 31, 1998, Fujisawa filed a motion seeking summary judgement. This
action is in the discovery stage. Fujisawa has advised the Company that Fujisawa
intends to vigorously defend this action and believes it has no merit. Under the
terms of its ADENODSCAN exclusive license agreement with Fujisawa, the Company
reimburses Fujisawa for 50% of the cost of defending this action.
The Company also believes the action has no merit. The Company has long been
aware of the `660 patent, and as part of its normal operating procedures the
Company has received the written opinions of separate patent counsel that the
manufacture and sale of ADENOSCAN for use in myocardial imaging does not
infringe any valid claim of the `660 patent. The Company disclosed its receipt
of its patent counsel non-infringement opinion in its 1993 Form 10-K Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------- ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
45
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
- --------------------------------------------------------
All of the information required by this Item is contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Shareholders under the
captions "Election of Directors," "Board of Directors" and "Executive Officers"
and is incorporated herein by this reference.
ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------
All of the information required by this Item is contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Shareholders under the
caption "Executive Compensation" and is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------ ----------
All of the information required by this Item is contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Shareholders under the
caption "Security Ownership of Certain Beneficial Owners and Management" and is
incorporated herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
All of the information required by this Item is contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Shareholders under the
caption "Certain Transactions" and is incorporated herein by this reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------
(a) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements of Medco Research, Inc. are
included in Item 8:
Independent Accountants' Report
Independent Auditors' Report
Consolidated Balance Sheets--December 31, 1998 and 1997
Consolidated Statements of Operations--Years Ended December 31, 1998,
1997 and 1996
Consolidated Statements of Stockholders' Equity--Years Ended December
31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows--Years Ended December 31, 1998,
1997 and 1996
Notes to Consolidated Financial Statements
46
<PAGE>
All schedules for which provision is made in the applicable accounting
regulation of the Securities Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
(b) No reports on Form 8-K were filed for the quarter ended December 31, 1998.
(c) Exhibits
3.1 Articles of Incorporation of the Registrant for the State of
California, as amended to date. (6)
3.2 Bylaws of the Registrant for the State of California, as amended to
date. (5)
3.3 Articles of Incorporation of the Registrant for the State of Delaware.
(8)
3.4 Bylaws of the Registrant for the State of Delaware. (8)
10.1 1983 Stock Option Plan, as amended to date. (1)
10.2 Form of Indemnity Agreement by and between Registrant and Registrant's
directors and officers. (5)
10.3 Agreement dated March 16, 1988 by and among Registrant, Pharmatec,
Inc. and the University of Florida Research Foundation, Inc. (1)
10.4 Development and License Agreement dated December 21, 1988 by and
between Registrant and LyphoMed, Inc. (2)
10.5 Letter Agreement dated March 3, 1989 by and between Registrant and the
University of Virginia Alumni Patents Foundation. (3)
10.6 First Amendment dated March 17, 1989 to Development and License
Agreement dated November 7, 1985 by and between Registrant and
LyphoMed, Inc. (3)
10.7 1989 Stock Option and Stock Appreciation Rights Plan, as amended to
date. (4)
10.8 Employment Agreement dated January 8, 1992 by and between Registrant
and Archie W. Prestayko. (6)
10.9 Second Amendment to Lease dated February 18, 1992 relative to
Registrant's facilities at 8455 Beverly Boulevard, Los Angeles,
California. (6)
10.10 License Agreement dated April 21, 1992 by and between Registrant and
Nordion International Inc. (6)
10.11 Employment Agreement dated June 9, 1992 by and between Registrant and
Donald B. Siegel. (6)
10.12 Employment Agreement dated June 9, 1992 by and between Registrant and
Sam L. Teichman. (6)
10.13 Third Amendment to Lease dated August 10, 1992 relative to
Registrant's facilities located at 8455 Beverly Boulevard, Los
Angeles, California. (6)
47
<PAGE>
10.14 Consulting Agreement dated September 15, 1992 by and between
Registrant and William M. Bartlett. (6)
10.15 Employment Agreement dated October 16, 1992 by and between Registrant
and Roger D. Blevins. (7)
10.16 Employment Agreement dated January 8, 1993 by and between Registrant
and Archie W. Prestayko. (7)
10.17 Lease Agreement effective June 25, 1993 relative to Registrant's
facilities at 85 T.W. Alexander Drive, Research Triangle Park, North
Carolina. (7)
10.18 Consulting Agreement dated July 1, 1993 by and between Registrant and
Richard C. Williams. (7)
10.19 Employment Agreement dated October 16, 1993 by and between Registrant
and Roger D. Blevins. (7)
10.20 Employment Agreement dated February 24, 1994 by and between Registrant
and Archie W. Prestayko. (7)
10.21 Consulting Agreement dated December 1, 1994 by and between Registrant
and Richard C. Williams. (8)
10.22 Medco Research and Fujisawa, USA Mutual Release and Settlement
Agreement, dated May 22, 1995. (9)
10.23 Amendment to Consulting Agreement dated December 1, 1994 by and
between Registrant and Richard C. Williams. (10)
10.24 Employment Agreement dated September 26, 1996 by and between
Registrant and Roger D. Blevins. (11)
10.25 Amendment to Consulting Agreement dated December 1, 1994 by and
between Richard C. Williams. (11)
10.26 Amendment to Consulting Agreement dated December 1, 1994 by and
between Richard C. Williams. (12)
23.1 Consent of Independent Accountants
23.2 Accountants' Consent
27 Financial Data Schedule
48
<PAGE>
- -------------------------------------------------------------------------------
(1) The referenced exhibits are incorporated herein by reference to Exhibits
10.1 and 10.6 to the Registrant's Form 10-K for the fiscal year ended
August 31, 1988 filed with the Securities and Exchange Commission on
November 29, 1988.
(2) The referenced exhibit is incorporated herein by reference to Exhibit
10.02 to the Registrant's Form 8-K dated December 21, 1988 filed with the
Securities and Exchange Commission.
(3) The referenced exhibits are incorporated herein by reference to Exhibits
10.01 and 10.02 to the Registrant's Form 8-K dated March 3, 1989 filed
with the Securities and Exchange Commission.
(4) The referenced exhibit is incorporated herein by reference to Exhibit
10.20 to the Registrant's Form 10-K for this fiscal year ended August 31,
1989 filed with the Securities and Exchange Commission on November 29,
1989.
(5) The referenced exhibits are incorporated herein by reference to Exhibits
3.2 and 10.4 to the Registrant's Form 10-K for the fiscal year ended
August 31, 1990 filed with the Securities and Exchange Commission on
December 14, 1990.
(6) The referenced exhibits are incorporated herein by reference to Exhibits
10.18, 10.19, 10.20, 10.21, 10.22, 10.23, and 10.24 to the Registrant's
Form 10-K for the fiscal year ended August 31, 1992 filed with the
Securities and Exchange Commission on November 27, 1992.
(7) The referenced exhibits are incorporated herein by reference to Exhibits
10.23, 10.24, 10.25, 10.26, 10.27, and 10.28 to the Registrant's Form
10-K for the Transition period of September 1, 1992 through December 31,
1992 and calendar year ended December 31, 1993 filed with the Securities
and Exchange Commission on March 28, 1994.
(8) The referenced exhibits are incorporated herein by reference to Exhibits
3.3, 3.4, and 10.21 to the Registrant's Form 10-K for the calendar year
ended December 31, 1994 filed with the Securities and Exchange Commission
on March 29, 1996.
(9) The referenced exhibit is incorporated herein by reference to Exhibit
10.01 to the Registrant's Form 10Q for the period ended June 30, 1995
filed with the Securities and Exchange Commission on August 11, 1995.
(10) The referenced exhibit is incorporated herein by reference to Exhibit
10.23 to the Registrant's Form 10-K for the calendar year ended
December 31, 1995 filed with the Securities and Exchange Commission on
March 29, 1996.
(11) The referenced exhibits are incorporated herein by reference to Exhibits
10.24 and 10.25 to the Registrant's Form 10-K for the calendar year ended
December 31, 1996 filed with the Securities and Exchange Commission on
March 27, 1997.
(12) The referenced exhibits are incorporated herein by reference to Exhibit
10.26 to the Registrant's Form 10-K for the calendar year ended December
31, 1997 filed with the Securities and Exchange Commission on March 24,
1998.
49
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MEDCO RESEARCH, INC.
By: /s/ Roger D. Blevins
-------------------------
Roger D. Blevins, Pharm. D.,
President and Chief Executive
Officer
Date: March 16,1999
By: /s/ Glenn C. Andrews
-------------------------
Glenn C. Andrews
Executive Vice President, Finance and
Administration, Chief Financial Officer
and Treasurer
Date: March 16,1999
By: /s/ Adam C. Derbyshire
-------------------------
Adam C. Derbyshire
Corporate Controller and
Secretary
Date: March 16,1999
Pursuant to the requirement of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: /s/ Richard C. Williams Date: March 16,1999
-------------------------------
Richard C. Williams,
Chairman of the Board
By: /s/ William M. Bartlett Date: March 16,1999
-------------------------------
William M. Bartlett, Director
By: /s/ Jay N. Cohn, M.D. Date: March 16,1999
-------------------------------
Jay N. Cohn, M.D., Director
50
<PAGE>
By: /s/ Mark B. Hirsch Date: March 16,1999
-------------------------------
Mark B. Hirsch, Director
By: /s/ Eugene L. Step Date: March 16,1999
-------------------------------
Eugene L. Step, Director
51
EXHIBIT 23.1
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Medco Research, Inc. and its subsidiary on Form S-8 (File No. 33-35675) of our
report dated January 22, 1999, on our audit of the consolidated financial
statements of Medco Research, Inc. and its subsidiary as of December 31, 1998
and 1997 and for each of the years then ended, which report is included in this
Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
Raleigh, North Carolina
March 15,1999
EXHIBIT 23.2
<PAGE>
ACCOUNTANTS' CONSENT
The Board of Directors and Stockholders
Medco Research, Inc.
We consent to the incorporation by reference in the registration statement (No.
33-35675) on Form S-8 of Medco Research, Inc. and subsidiary of our report dated
January 28, 1997, with respect to the consolidated statements of operations,
stockholders' equity, and cash flows for the year ended December 31, 1996, which
report appears in the December 31, 1998 annual report on Form 10-K of Medco
Research, Inc.
Our report dated January 28, 1997, contains an explanatory paragraph that states
that the Company is party to certain claims and litigation, which outcome cannot
presently be determined. No provisions for liability, if any, that may result
from the resolution of such matters have been recognized in the accompanying
consolidated financial statements.
KPMG LLP
Raleigh, North Carolina
March 15,1999
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