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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-15190
OSI PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 13-3159796
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
106 CHARLES LINDBERGH BLVD., UNIONDALE, N.Y. 11553
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (516) 222-0023
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
NONE NONE
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
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 [ ]
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. [ ]
As of November 30, 1998, the aggregate market value of the Registrant's
voting stock held by non-affiliates was $58,502,216. For purposes of this
calculation, shares of Common Stock held by directors, officers and stockholders
whose ownership exceeds five percent of the Common Stock outstanding at November
30, 1998 were excluded. Exclusion of shares held by any person should not be
construed to indicate that such person possesses the power, direct or indirect,
to direct or cause the direction of the management or policies of the
Registrant, or that such person is controlled by or under common control with
the Registrant.
As of November 30, 1998, there were 22,308,833 shares of the Registrant's
Common Stock, par value $.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement for its 1999 annual
meeting of stockholders are incorporated by reference into Part III of this Form
10-K.
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PART I
ITEM 1. BUSINESS
OSI Pharmaceuticals, Inc. ("OSI" or the "Company") discovers and develops
novel, small-molecule pharmaceutical products for commercialization by the
pharmaceutical industry. The Company has innovated, assembled, and reduced to
practice a constellation of drug discovery and development technologies and
other assets that enable it to conduct the full range of drug discovery and
early development activities, from the identification of an attractive
biological target for drug discovery to the development of a drug candidate in
human clinical efficacy studies. These capabilities provide OSI with a sound
base from which to grow and a variety of commercialization opportunities that
can be used to fuel growth.
The Company conducts its drug discovery and development programs
independently and through funded collaborations with major pharmaceutical
companies. The Company's major corporate partners include Pfizer Inc.
("Pfizer"), The Bayer Corporation ("Bayer"), Sankyo Company, Ltd. ("Sankyo") and
Hoechst Marion Roussel, Inc. ("HMRI"). Independently and in collaboration with
its various partners, the Company is involved in the discovery and development
of drugs for 38 targets. These drug discovery efforts are primarily focused in
the areas of cancer, cosmeceuticals, anti-infectives and diabetes. The Company's
research and development capabilities together with its ongoing discovery and
development programs have positioned it as a leader in the field of drug
discovery and development. The Company was incorporated in 1983. Its NASDAQ
stock symbol is OSIP.
BACKGROUND
Historically, drug discovery has been an expensive process of attrition. In
the pharmaceutical industry, only about 1-in-16 research and development
programs involving compounds screened against specific targets actually results
in a successful drug. On average, it costs more than $300 million in research
and development (including failures) to bring a drug from initial lead
identification to market.
During the 1990s, the rising cost of health care and changes in health care
management policies have fundamentally altered the pharmaceutical landscape,
putting increasing competitive pressure on the pharmaceutical industry. This has
resulted in a series of major pharmaceutical company mergers, as organizations
strive to enhance market share and improve profit margins.
At the same time, these new pressures have led to a growing emphasis on
product pipeline enhancement through the cost-effective discovery and
development of novel classes of pharmaceuticals that will meet large, unmet
medical needs, can more rapidly be brought to the marketplace, and have the
potential to command premium prices. Advances in molecular biology, automation,
and computing and the understanding of the human genome have revolutionized the
ways in which drug discovery is conducted, creating the potential for
accelerated discovery and development of new generations of drugs.
Pharmaceutical companies have typically formed collaborations with
biotechnology companies in order to access these types of technologies in
pursuit of novel drug development. OSI believes that the competitive pressures
described above have caused pharmaceutical companies to greatly reduce the
royalty rates they are willing to pay to biotechnology companies for
technological contributions to their product development efforts. On the other
hand, the Company believes that such pressures are making pharmaceutical
companies more willing to pay premiums for high quality drug candidates that
have already undergone some degree of optimization and clinical development.
STRATEGY
OSI's mission is the discovery and early development of novel
pharmaceutical products that improve the human condition. The Company's strategy
is to build and sustain a pipeline of pharmaceutical product
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opportunities for commercialization by its pharmaceutical company partners. The
Company's plan for accomplishing its mission and strategy consists of the
following elements:
Exploit Full Range of Discovery and Early Development Capabilities. OSI
has built a fully integrated drug discovery technology platform. This platform
includes every major aspect of drug discovery and development, from the
identification of a validated drug discovery target to the emergence of a drug
candidate. The integrated management of these technologies is designed to
accelerate the process of identifying and optimizing high quality, small
molecule drug candidates for clinical development and then to progress such
candidates through Phase II clinical trials. OSI believes it will be able to
rapidly and effectively deliver high quality drug candidates in early Phase II
clinical trials and that this will position the Company to recognize enhanced
payments, milestones, royalties, and success fees on OSI funded discovery
programs. The Company seeks to achieve risk diversification as well as breadth
and depth in its product pipeline through fully funded, royalty bearing,
discovery alliances with major pharmaceutical company partners.
Focus Resources on Selected Disease Areas. In order to more rapidly
progress product development opportunities to a clinical stage, the Company
intends to focus its growing resources and energies on a smaller number of
targets in fewer disease areas to provide the critical mass and disease area
expertise to effectively move these programs forward. The Company has begun to
focus primarily on the areas of cancer, cosmeceuticals, anti-infectives and
diabetes. OSI has major collaborations in cancer and cosmeceuticals. The Company
has terminated its existing co-ventures in the area of anti-infectives and plans
to pursue discovery and early development in this area and selected cancer
targets as proprietary programs. Generally, the Company's objectives with
respect to its proprietary programs are to identify lead compounds, advance them
through pre-clinical development, and manage clinical development through early
stage clinical trials. If such efforts are successful, the Company expects to
partner with pharmaceutical companies for clinical and commercial development of
these proprietary products. With respect to the diabetes program, the Company is
currently seeking a funding partner.
Commercialize Certain Technology Assets. OSI is seeking to generate a
revenue stream by licensing pharmaceutical and biotechnology companies to
practice under its gene transcription patent estate. For example, in May 1998
OSI and Aurora Biosciences Corp. ("Aurora") entered into a license agreement
covering OSI's gene transcription patent estate. Under the terms of the
agreement, OSI received Aurora common stock and cash for Aurora's non-exclusive
license and certain sub-licensing rights to OSI's Methods of Modulation patent,
for which the U.S. Patent Office has issued claims. OSI will also receive
revenues from any sub-licenses granted by Aurora to its pharmaceutical partners
to develop small molecule gene transcription modulators encompassed by the
Methods of Modulation claims. The Company is currently in discussions with
several other parties concerning licenses to its gene transcription patent
estate. Additionally, under its collaborative agreement with Bayer for the
development of serum-based diagnostic products, the Company has retained rights
to sell certain types of these products. The Company, through its wholly owned
subsidiary, Oncogene Science Diagnostics, Inc. ("OSDI"), is actively selling
cancer diagnostic tests to the clinical research market and has initiated plans
to expand sales of these products in this market.
PRODUCT DEVELOPMENT AND RESEARCH PROGRAMS
OSI utilizes its broad-based drug discovery capability in multiple drug
discovery programs encompassing a variety of major human diseases. The Company's
major areas of focus in research and development ("R&D") are as follows:
Cancer
During the 1980s, cancer researchers developed a sophisticated
understanding of the role played by certain genes in the transformation of
normal cells into a cancerous state, and thus were able to identify novel
targets for drug intervention. As the decade of the 1990s comes to a close, this
new knowledge of the molecular basis of cancer has started to move from the
laboratory into the clinical arena, promising new hope for patients with many
types of cancers, including breast, colon, head and neck, and ovarian. In the
next decade, novel anticancer therapies and diagnostic tools are expected to be
commercialized, creating a new
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paradigm for cancer treatment, with the potential that cancer can either be
cured or managed safely over the long term. OSI, through its pharmaceutical
collaboration with Pfizer and diagnostic alliances with Bayer and Fujirebio,
Inc. ("Fujirebio"), is positioned at the forefront of this unfolding revolution
in the diagnosis and treatment of cancer.
With its collaborative partner Pfizer, OSI has focused since 1986 on the
discovery and development of novel classes of orally active, molecularly
targeted, small molecule anticancer drugs based on oncogenes and tumor
suppressor genes and the fundamental mechanisms underlying tumor growth. The
first of these programs to yield a clinical candidate, CP-358,774, which targets
a variety of cancers including ovarian, pancreatic, non-small cell lung and head
and neck, achieved a significant milestone with the completion of Phase I safety
trials and the initiation of Phase II clinical trials in the United States in
cancer patients. CP-358,774 is a potent, selective and orally active inhibitor
of the epidermal growth factor receptor, a key oncogene in these cancers. In
addition, two other compounds, CP-564,959 and CP-609,754, have been identified
and are in advanced stages of pre-clinical development. Nine other targets are
in active R&D at OSI. CP-564,959 is being developed as an orally available,
potent and selective inhibitor of a key protein tyrosine kinase receptor
involved in blood vessel growth or angiogenesis. Angiogenesis is induced by
solid tumors which require nutrients that will enable growth. The Company
believes that the ability to safely and effectively inhibit this process
represents one of the most exciting areas of cancer drug development. CP-609,754
is an orally active inhibitor of the ras oncogene, which is another important
target involved in many major tumors including colon and bladder. The types of
novel anticancer drugs being developed in the OSI/Pfizer collaboration are
expected to be safer and more effective than standard chemotherapeutic agents.
In addition to its cancer therapeutics programs, OSI is also a leader in
the development of novel cancer diagnostic products based on oncogenes, tumor
suppressor genes, and other gene targets whose proteins are directly involved in
tumor growth or metastasis. These new diagnostic products are expected to help
guide oncologists in the confirmation, monitoring, staging, screening or
prognosis of cancer and may enable reference labs and physicians to select more
effective types of treatment, to more easily monitor patients during therapy, or
to diagnose cancer at an earlier stage.
Through OSDI, the Company is launching its HER-2/neu serum based diagnostic
product. The OSDI tests are currently being sold directly by OSDI into the
clinical research market. Through the partnership with Bayer, the HER-2/neu
immunoassay is being formatted on the Bayer Immuno-1 automated clinical
analyzer. The Company expects that in 1999 Bayer and OSDI will seek Food and
Drug Administration ("FDA") approval for both the automated and manual HER-2/neu
serum test.
In addition to its HER-2/neu diagnostic product, OSDI is in advanced
development of a test to quantitate complexed Prostate Specific Antigen
("c-PSA") in serum. The Company believes the measurement of c-PSA represents a
significant advancement over current PSA tests. Current clinical tests measure
total PSA, free PSA or the free-to-total PSA ratio. The Company's collaborative
studies with Bayer have demonstrated the improved specificity of the c-PSA
assay. The c-PSA assay is a direct measure of the amount of c-PSA present in the
serum. c-PSA is the component of serum PSA that increases with the progression
of prostate cancer. These new assays will provide oncologists with essential
information necessary to determine which patients will respond best to the newly
developed therapies directed at oncogenes and tumor suppressor genes.
Cosmeceuticals
Every year, consumers in the United States, Europe, and Asia spend billions
of dollars on cosmetic products and services that promise to provide a youthful,
healthy, or culturally desirable appearance. Some of these products are marketed
on the basis of ostensible pharmaceutical effects, such as the reduction of skin
wrinkles and pigmentation or the promotion of hair growth. The Company believes
that most of these products are not optimally effective and may have undesirable
side effects.
In 1996, OSI entered into a joint venture with Pfizer (the majority owner)
and New York University ("NYU") in Anaderm Research Corp. ("Anaderm"), a virtual
company dedicated to the application of modern tools to the discovery and
development of safe, effective, pharmacologically active agents for certain
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cosmetic and quality-of-life indications, such as skin pigmentation, hair loss
and wrinkling. This program has made significant progress, with certain
compounds in the skin pigmentation program already in advanced pre-clinical
development.
To date, all of the targets encompassed in the Anaderm program are in
active R&D, and the program is undergoing expansion in R&D activities. OSI,
which owns a minority equity stake in Anaderm, provides most of the discovery
and early development capabilities for the programs, which are fully funded by
Anaderm. The Company believes that its participation in Anaderm represents a
major validation of its drug discovery and development capabilities.
Anti-infectives
During the 1990s, the overuse and misuse of antibiotics has resulted in the
emergence of antibiotic-resistant microorganisms that represent a growing health
care threat. Already, many of the most effective and widely prescribed
antibiotic drugs used to treat common infections have been rendered useless for
certain drug resistant infections. Within the health care and pharmaceutical
industries, there is a renewed sense of urgency to develop and commercialize
novel drugs for the effective treatment of many viral and fungal diseases,
markets which represent billions of dollars in annual sales.
During 1996 and 1997, OSI entered into co-venture arrangements with BioChem
Pharma (International) Inc. ("BioChem Pharma") in anti-virals and Sepracor, Inc.
("Sepracor") in anti-bacterials. Both ventures were successful in seeding core
drug discovery capabilities in anti-infectives that were of mutual benefit to
both OSI and its co-venture partners. Both programs were also successful in
discovering early leads. During 1998, the Company made the decision that it
could most effectively capitalize on its integrated drug discovery platform by
seeking sole management of its proprietary (OSI funded) discovery programs as
opposed to co-venture agreements. In March 1998, an agreement was reached with
Sepracor to terminate the OSI/Sepracor co-venture. OSI will receive royalties on
the successful development of products arising from the co-venture. The Company
expects the OSI/BioChem Pharma co-venture to be terminated in the near future.
During 1998, anti-infectives became the major lead-seeking effort for OSI's
proprietary drug discovery program. The Company believes that anti-infectives
are an area well suited for drug discovery at OSI. The discovery and development
pathways involved in anti-infectives have well defined end points and relatively
short timelines for pre-clinical and clinical development. In addition, the
Company believes its natural products fungal library is a unique source for
novel anti-bacterial and anti-fungal agents. In an effort to focus the Company's
resources in the anti-infectives area, a number of anti-infectives targets,
including Methicillin Resistant Staphylococcus Aureas ("MRSA"), will be pursued
by OSI for its own account using its own R&D resources.
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TABLE I. CURRENT PRODUCT DEVELOPMENT AND RESEARCH PROGRAMS
The following table summarizes OSI's current product development and
research programs as of December 1, 1998. The table is qualified in its entirety
by reference to the more detailed descriptions elsewhere in this report.
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PRE-CLINICAL
--------------------------------- CLINICAL
DRUG NUMBER LEAD LEAD -------------
DISCOVERY OF LEAD OPTIMI- DEVELOP- PHASE PHASE
DISEASE FIELD PROGRAM TARGETS SEEKING(A) ZATION(B) MENT(C) I(D) II(E)
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CANCER........................... PFIZER 13 6 4 2 1
COSMECEUTICALS................... ANADERM 5 3 1 1
ANTI-INFECTIVES:
INFLUENZA...................... SANKYO 4 4
HIV............................ OSI 1 1
MRSA........................... OSI 1 1
OTHER:
TGF-BETA 3..................... NOVARTIS 1 1
VARIOUS DISEASES............... HMRI 10 8 2
LONG TERM MEMORY............... HELICON 1 1
SICKLE CELL.................... OSI 1 1
DIABETES....................... OSI 1 1
-- -- -- -- -- --
TOTAL............................ 38 25 8 4 0 1
== == == == == ==
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(a) For most of the Company's programs in the "Lead Seeking" phase, the target
proteins are either undergoing high throughput screening or lead compounds
identified in these screens are being evaluated. Multiple lead compounds may
exist for any target protein. These lead compounds may be at different
stages of development, as indicated in the table above.
(b) In the "Lead Optimization" phase, the Company or its collaborative partners
optimize lead compounds and conduct laboratory pharmacology and exploratory
toxicology testing.
(c) In the "Lead Development" phase, the Company or its collaborators conduct
formal pre-clinical toxicology testing on a development candidate and
prepare a regulatory dossier.
(d) "Phase I" clinical trials consist of small scale safety trials typically in
healthy human volunteers.
(e) "Phase II" clinical trials entail testing of compounds in humans for safety
and efficacy in a limited patient population.
OSI'S TECHNOLOGY PLATFORM
OSI's technology platform constitutes an integrated set of drug discovery
technologies covering every aspect of pre-clinical drug development. This
platform includes a variety of cell-free and live-cell assays, high throughput
robotic screening, diverse compound libraries and combinatorial, medicinal and
natural products chemistry capabilities, together with significant pre-clinical
expertise in pharmaceutics, pharmacokinetics and molecular biology. The
Company's technologies are designed to accelerate the process of identifying and
optimizing high quality, small molecule drug candidates for clinical
development. The Company pioneered the development of (i) genetically engineered
live-cell assays targeting gene transcription and (ii) robotic high throughput
screening. The Company has, through acquisition and internal technology
development, added extensively to these core capabilities. The addition of large
diverse libraries of small molecules and a broadened expertise in assay biology
and medicinal, combinatorial and pharmaceutical chemistry capabilities have
created a comprehensive drug discovery platform enabling the Company to progress
leads discovered against novel targets all the way through the discovery and
pre-clinical development stages. The Company's technology platform is widely
applicable to the identification and optimization of small molecule drug
candidates to treat many different diseases. Utilizing its technology platform,
the Company has been able to
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identify and optimize lead compounds that are potent and selective, possess
minimal or no cellular toxicity, have activity in live-cells and animal models,
and have progressed to clinical trials in humans.
Assay Biology
The Company has specialized in the development of drug screens that utilize
genetically engineered human cells to identify compounds that affect
transcription of target genes. These assay systems, which employ reporter gene
technology, can be utilized to discover drugs that affect the expression of
proteins encoded by the target genes. There are multiple sites within a cell
where a drug can act to exert a specific effect. This broadly enabling
technology allows the Company to discover compounds that exert their effects on
receptors, signal transduction proteins, transcription factors and other sites.
The Company's seminal contribution to the development of this technology was
recognized by the issuance of U.S. Patent No. 5,665,543 in September 1997, which
claims a method of identifying compounds that specifically modulate expression
of target genes using cells engineered to include reporter genes, and U.S.
Patent No. 5,776,502, which covers the use of small molecules to modulate gene
transcription in vivo. This technology is used in the biotechnology and
pharmaceutical industry, and the Company believes that the claims covered by
this patent estate can be licensed for certain monetary and technology
considerations. Over the last several years the Company broadened its assay
expertise extensively. Currently, the Company is able to conduct screens on a
wide variety of different assay platforms, including enzyme assays,
immunoassays, scintillation proximity assays, protein-protein interaction assays
and receptor-ligand screens. The Company believes this breadth of expertise
enables it to select the most appropriate assay with which to pursue drug
discovery against a novel biological target.
High Throughput Robotic Screening
OSI has been a pioneer and remains a leader in high throughput screening.
The Company has developed software and automation that enable it to manage large
compound libraries and prepare test substances for screening. The Company has
developed proprietary hardware and software systems to automate the entire drug
screening process, from the addition of the test substances to assay systems to
the analysis of the data generated from the tests. In its proprietary robotic
screening facility, the Company can analyze up to 300,000 different test samples
each week, depending on the complexity of the assays. The Company's robotic
systems are not limited to any particular assay format and can be rapidly
reconfigured to run a wide variety of assays.
Diverse Compound Libraries
Access to large libraries of diverse, small molecule compounds is a key
asset in the Company's drug discovery efforts. Leads discovered from these
libraries become the proprietary starting materials from which drugs are
optimized. The Company manages over 1.5 million compounds in its compound
libraries facility from its own and several of its partners' compound libraries
for high throughput screening. The Company's proprietary libraries include its
natural products library derived from its unique collection of over 70,000
fungal organisms, its focused libraries of small molecule compounds derived from
its high-speed combinatorial analoging, and The Dow Chemical Company's ("Dow")
library of approximately 140,000 small-molecule compounds. In March 1997, the
Company acquired from Dow an exclusive worldwide license to this library for the
purposes of discovery and development of small molecular weight pharmaceuticals
and cosmeceuticals. The duration of this license is coextensive with the life of
the last to expire of the patents related to the licensed compounds (or 20 years
if no patents are filed). In exchange for these rights, the Company issued to
Dow 352,162 shares of its common stock, $.01 par value ("Common Stock"). The
Company will also pay royalties to Dow from sales of products derived from a
small subset of Dow's compound library that is covered by existing Dow patents
or proprietary technology. In addition, certain collaborative partners have made
their compound libraries available for additional research by the Company
outside of their existing collaborative programs. For any compound from the
Company's collaborative partners' libraries that emerges as a lead in a
proprietary program, the partner typically will have the right of first refusal
to develop the compound or terminate its further development or to allow the
Company to commercialize the compound independently or with a third party in
exchange for royalty payments from the Company on product sales.
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Natural Products Discovery
The Company has an extensive program to discover novel and active natural
product compounds found in fungal fermentation extracts. Fungi are a known
source of pharmaceuticals, including penicillin, cephalosporin, lovastatin,
prevastatin and cyclosporin A. Through its MYCOsearch, Inc. subsidiary
("MYCOsearch"), the Company owns a unique and diverse collection of
approximately 70,000 fungal organisms. In the MYCOsearch Natural Products
Discovery Center in North Carolina, the Company has implemented automated
microfermentation technology through which it has generated approximately
110,000 extracts for high throughput screening. This operation is expected to
add between 50,000 and 100,000 new extracts to the Company's natural products
library annually. The Company has invested substantial resources in implementing
a fully integrated fermentation biology and natural products chemistry
capability to provide the infrastructure and expertise necessary to isolate and
identify active natural product compounds that may be present in fungal
abstracts.
Chemistry and Lead Optimization
The pharmaceutical properties of a lead compound must be optimized before
clinical development of that compound begins. In 1996 the Company acquired Aston
Molecules Ltd. ("Aston"), a private British company with expertise in medicinal
and combinatorial chemistry and pharmaceutical development, which are critical
elements in the lead optimization and development process. The Company's Aston
subsidiary has expertise in pharmacokinetics and pharmaceutical chemistry and
the management and generation of Good Manufacturing Practices ("GMP") accredited
data required for regulatory dossier submissions to agencies such as the FDA.
Thus, the Company is able to support the development of a drug candidate for
clinical testing. The Company has invested significant resources in expanding
this capability and in technological enhancements in this area. The Company also
has a strategic alliance with Xenometrix, Inc. which is aimed at the development
of automated live-cell assays that will allow the Company to profile genes that
might be early indicators of the toxicological liability of a lead compound. In
addition, the Company is implementing approaches that allow it to generate
information on the metabolic liability of lead compounds together with their
physical and chemical properties. The Company is in the process of establishing
this integrated platform of automated and semi-automated technologies in an
effort to support decision making regarding the quality of lead candidates
earlier in the drug discovery process.
MAJOR COLLABORATIVE PROGRAMS
OSI pursues collaborations with pharmaceutical companies to combine the
Company's drug discovery and development capabilities with the collaborators'
development and financial resources. The Company's collaborations provide for
its partners to fund the Company's collaborative research programs and to pay
royalties on sales of any resulting products. Certain collaborative programs
involve milestone payments by the Company's partners. The collaborative partners
generally retain manufacturing and marketing rights worldwide. Generally, each
collaborative research agreement prohibits the Company from pursuing with any
third party drug discovery research relating to the drug targets being covered
by research under the collaboration.
Pfizer Inc.
In April 1986, Pfizer and the Company entered into a collaborative research
agreement and several other related agreements. During the first five years of
the collaboration, the Company and Pfizer focused principally on understanding
the molecular biology of oncogenes. In 1991, Pfizer and the Company renewed the
collaboration for a second five-year term and expanded the resources and scope
of the collaboration to focus on the discovery and development of cancer
therapeutic products based on mechanisms-of-action that target oncogenes and
anti-oncogenes and fundamental mechanisms underlying tumor growth. Oncogenes
play a key role in the conversion of normal cells to a cancerous state and can
cause cancer when they mutate or over express. Anti-oncogenes, or tumor
suppressor genes, encode proteins that generally function to block the
proliferative growth of particular cell types. A loss of function of certain
tumor suppressor genes can result in uncontrolled cell growth. Tumor induced
angiogenesis is a process whereby solid tumors develop the blood
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supply necessary to sustain tumor growth. Effective April 1, 1996, the Company
and Pfizer renewed their collaboration for a new five-year term by entering into
new collaborative research and license agreements.
All patent rights and patentable inventions derived from the research under
this collaboration are owned jointly by the Company and Pfizer. The Company has
granted Pfizer an exclusive, worldwide license to make, use, and sell the
therapeutic products resulting from this collaboration in exchange for royalty
payments. This license terminates on the date of the last to expire of the
Company's relevant patent rights.
Pfizer is responsible for the clinical development, regulatory approval,
manufacturing and marketing of any products derived from the collaborative
research program. However, the collaborative research agreement does not
obligate Pfizer to pursue these activities. Generally, the Company and Pfizer
are prohibited during the term of the contract from independently pursuing or
sponsoring research aimed at the compounds or products against specific targets
in the program, except that the Company may conduct research with respect to
human diagnostic products within the area of its collaborative research with
Pfizer. The collaborative research agreement will expire on April 1, 2001.
However, it may be terminated earlier by either party upon the occurrence of
certain defaults by the other party. Any termination of the collaboration
resulting from a Pfizer default will cause a termination of Pfizer's license
rights. Pfizer will retain its license rights if it terminates the agreement in
response to a default by the Company. In addition, between July 1 and September
30, 1999, Pfizer may terminate the collaborative research agreement, with or
without cause, effective March 31, 2000. In the event of such early termination,
Pfizer will retain its license rights.
From 1986 to September 1998, Pfizer paid an aggregate amount of $40.1
million to the Company in research funding. In 1986, Pfizer purchased 587,500
shares of the Company's Common Stock, which constitutes approximately 2.7% of
the Company's outstanding Common Stock, for an aggregate purchase price of
$3,525,000. Under the current collaborative research agreement, Pfizer has
committed to provide research funding to the Company in an aggregate amount of
approximately $18.8 million. Pursuant to a schedule set forth in the
collaborative research agreement, Pfizer will make annual research funding
payments to the Company, which will gradually increase from a maximum of
approximately $3.5 million in the first year of the five-year term to
approximately $4 million in the fifth year.
The Bayer Corporation
The Company is engaged in the development of a series of cancer diagnostic
tests based on oncogenes, tumor suppressor genes and other gene targets whose
proteins are directly involved in tumor growth or metastasis. These tests
utilize immunoassays and monoclonal antibodies to detect these cancer markers in
serum and urine. These tests are designed to aid oncologists in the
confirmation, monitoring, staging, screening or prognosis of human cancer. These
tests may enable reference labs and physicians to select more effective types of
treatment, more easily monitor patients during therapy, or diagnose cancer at an
earlier stage. The current focus of the Company's diagnostic development program
is on breast and colon cancer, but the Company believes that many of the cancer
markers in its program may have clinical utility for other human tumors, such as
lung, prostate, ovarian and stomach cancer. None of these diagnostic tests have
completed clinical development or received FDA clearance to be marketed in the
United States.
The Company entered into a Collaborative Research and License Agreement
with Bayer, effective January 1, 1997, for the development of serum-based cancer
diagnostic products. Under this agreement, the Company has granted to Bayer
licenses to manufacture, use and sell clinical diagnostic products based on the
Company's cancer diagnostic technology for the automated analyzer market in
exchange for royalties on net sales. Bayer will own all technology, and has the
exclusive right to commercialize automated clinical diagnostic products derived
from the collaboration. OSI has retained rights and is actively selling non-
automated, or manual, versions of these tests to the clinical research market
and has retained the right to commercialize the manual versions in the clinical
diagnostic market. Bayer's license is perpetual with respect to non-patented
technology and will terminate with respect to patented technology upon the
expiration of the last to expire of the Company's patents. Bayer will provide
funding for the Company's research under the
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collaboration in the amount of $1.5 million for each of the first two years, and
$1 million for each subsequent year. The Company will be required to provide up
to $500,000 in annual funding for the collaboration to the extent the Company
derives net revenues from out-licensing any cancer diagnostics technology or the
sale of any clinical diagnostic or clinical research products. The agreement
will terminate on December 31, 2002. Bayer has the right to terminate the
agreement at any time upon 12 months notice.
Fujirebio, Inc.
The Company, through OSDI, entered into a Research Collaboration and
License Agreement with Fujirebio effective April 1, 1998, creating a
collaborative program focused on discovering and developing certain proprietary
cancer assays and commercializing cancer diagnostic products. Under the
agreement, Fujirebio is to fund the Company's research and development of cancer
assays over a four-year term. The Company is to provide Fujirebio with
antibodies, antigens and other substances necessary to manufacture the
diagnostic products derived from the collaboration. Further, the Company has
granted to Fujirebio a non-exclusive license to, among other things, develop,
manufacture and sell the products developed pursuant to the collaboration in
Japan in exchange for license fees and royalties on product sales. The duration
of the license is to be coextensive with the lives of the patents related to the
licensed products. Each of the parties has rights and obligations to prosecute
and maintain patent rights related to specified areas of the research under the
agreement. The agreement is subject to early termination by either party in the
event of certain defaults.
Anaderm Research Corp.
On April 23, 1996, in connection with the formation of Anaderm, the Company
entered into a Stockholders' Agreement (the "Stockholders' Agreement") among the
Company, Pfizer, Anaderm, NYU and certain NYU faculty members (the "Faculty
Members"), and a Collaborative Research Agreement (the "Research Agreement")
among the Company, Pfizer and Anaderm for the discovery and development of novel
compounds to treat conditions such as baldness, wrinkles and pigmentation
disorders. Anaderm has issued common stock to Pfizer and the Company and options
to purchase common stock to NYU and the Faculty Members. NYU and the Faculty
Members have exercised their options fully, and Pfizer holds 82%, the Company
holds 14%, and NYU and the Faculty Members collectively hold 4%, of Anaderm's
common stock. In exchange for its 14% of the outstanding shares of Anaderm's
common stock, the Company provided formatting for high throughput screens and
conducted compound screening for 18 months at its own expense under the Research
Agreement.
The term of the Research Agreement is three years. During the initial phase
of the agreement (the first 18 months), the Company was required to provide at
its own cost formatting for high throughput screens and perform screening of its
own compounds and those compounds provided by Pfizer. Upon the termination of
the initial phase, the Board of Directors of Anaderm made a determination that
the initial phase was successfully completed. With Pfizer's approval, the funded
phase commenced as of October 1, 1997 and will continue for the term of the
Research Agreement. During this phase, Anaderm will make payments to the Company
equal to its research costs, including overhead, plus 10%. Anaderm or Pfizer
will pay royalties to the Company on the sales of products resulting from this
collaboration.
In December 1997, the Company and Pfizer entered into an agreement for a
second round of equity financing for Anaderm. The agreement called for an equity
contribution of $14 million, of which the Company will contribute $2 million in
drug discovery resources, including assay biology, high throughput screening,
lead optimization and chemistry, through 1999. Pfizer will contribute $12
million, approximately $7 million of which will be used to support the Company
in its ongoing drug discovery activities. Through September 1998, the Company
had contributed $770,000 of its $2 million contribution in resources.
Sankyo Company, Ltd.
Effective as of February 12, 1997, the Company entered into a Collaborative
Research and License Agreement with Sankyo to be conducted in partnership with
MRC Collaborative Center ("MRC CC"),
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London, U.K. The collaboration is focused on discovering and developing novel
pharmaceutical products to treat influenza.
Under the terms of the agreement, a research committee was formed
consisting of three representatives from Sankyo, two representatives from the
Company and one representative from MRC CC. The committee monitors the progress
of the research program and directs the objectives, tasks and required
activities of the collaboration. The Company is responsible for conducting
research as directed by the research committee, including, without limitation,
compound screening in exchange for research funding from Sankyo. Sankyo has the
responsibility and the exclusive right to conduct pre-clinical and clinical
development of all candidate compounds in exchange for milestone payments to the
Company.
The Company and MRC CC have granted to Sankyo exclusive, worldwide licenses
to, among other things, use, manufacture and sell all products resulting from
the collaboration. In exchange for these licenses, Sankyo will pay to the
Company and MRC CC license fees and royalties on product sales. The duration of
the licenses is coextensive with the lives of the patents related to the
licensed compound. If Sankyo discontinues development of all candidate
compounds, the Company will have the sole and exclusive right to develop, use,
manufacture and sell all products resulting from the collaboration, and it will
pay royalties to Sankyo. Each of the parties has rights and obligations to
prosecute and maintain patent rights related to specified areas of the research
under the agreement.
Generally, the Company, Sankyo and MRC CC are prohibited during the term of
the contract from pursuing or sponsoring research and development of compounds
and products in the anti-influenza area other than pursuant to the agreement.
The agreement is for a term of three years, with the option to extend for an
additional one or two year period upon conditions and terms acceptable to the
Company, Sankyo and MRC CC. The agreement is subject to early termination in the
event of certain defaults by the parties.
Hoechst Marion Roussel, Inc.
Pursuant to the Amended Collaborative Research and License Agreement
effective April 1, 1997, the Company and HMRI are conducting joint research and
development activities, which focus specifically on OSI's expertise in live-cell
assay technology. OSI conducts the lead seeking (screening) phase of the drug
discovery process against a variety of targets in various disease areas. HMRI is
responsible for all lead optimization and development activities. The Company
has identified several compounds, which HMRI is optimizing for further
development. The most advanced of these compounds are in lead optimization for
individual targets in atherosclerosis and arthritis.
Under this collaboration, a research committee, with equal representation
from OSI and HMRI, meets at least three times a year to evaluate the progress of
the research program, make priority and program decisions, and prepare research
plans identifying the drug targets to be pursued. New targets are added to the
program on an ongoing basis by mutual agreement. The Company is responsible for
achieving objectives outlined in the annual research plans. HMRI is responsible
for assisting the Company in the pursuit of such objectives, including advancing
the pharmacological assessment of compounds identified by the Company,
determining the chemical structure of the selected compounds, identifying and
selecting development candidates, pursuing clinical development and regulatory
approval, and developing manufacturing methods and pharmaceutical formulations
for the selected candidates. HMRI is responsible for funding the costs of the
Company's discovery efforts. As of September 30, 1998, the Company had received
or accrued an aggregate of $20.4 million in research funding from HMRI and its
predecessors.
The Company has granted to HMRI an exclusive, worldwide license (and rights
to acquire additional licenses) with respect to, among other things, the use,
manufacture and sale of products resulting from OSI's lead seeking efforts
against these individual drug targets. In exchange for these licenses, HMRI will
pay royalties to the Company on sales of such products. The Company and HMRI
have mutually exclusive rights and obligations to prosecute and maintain certain
patent rights related to various specified areas of the research.
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Generally, the Company is prohibited during the term of the collaboration
from pursuing or sponsoring research independent of HMRI if it relates to the
identified targets in the areas of collaboration with HMRI without the approval
of the research committee. HMRI is generally prohibited from using the gene
transcription method independent of OSI to discover novel human therapeutic
products without the approval of the research committee. The agreement expires
on the later of March 31, 2002 or the last to expire of any obligations of HMRI
to pay royalties. The collaborative research agreement may be terminated early
by either party upon the occurrence of certain defaults by the other party. Any
termination by the Company resulting from an HMRI default will cause a
termination of certain of HMRI's license rights. HMRI will retain its license
rights if it terminates the agreement in response to a default by the Company.
HMRI holds 1,590,909 shares of Common Stock of the Company, which includes a
warrant to purchase 500,000 shares of the Company's Common Stock for $5.50 per
share. This warrant expires in December 1999.
Effective as of January 1, 1997, the Company entered into a Collaborative
Research and License Agreement with HMRI to develop orally active, small
molecule inducers of erythropoietin gene expression for the treatment of anemia
due to chronic renal failure and anemia associated with chemotherapy for AIDS
and cancer. This collaboration identified active lead compounds that were
advanced to a pre-clinical development stage. This research effort, however, did
not achieve sufficient data to warrant further development. Consequently, in
October 1998, this program was terminated.
Helicon Therapeutics, Inc.
In July 1997, the Company, Cold Spring Harbor Laboratory and Hoffman-La
Roche Inc. ("Roche") formed Helicon Therapeutics, Inc., a new Delaware
corporation ("Helicon"). In exchange for approximately 30% of Helicon's
outstanding capital stock, the Company contributed to Helicon molecular
screening services and a nonexclusive license with respect to certain screening
technology. Cold Spring Harbor Laboratory contributed a royalty-free license to
commercialize certain technology relating to genes associated with long-term
memory in exchange for a portion of Helicon's outstanding capital stock. Roche
contributed cash for a portion of Helicon's outstanding capital stock. Certain
individuals associated with Cold Spring Harbor Laboratory hold the remaining
outstanding capital stock of Helicon.
The parties have entered into various collaborative research and license
agreements pursuant to which they will jointly pursue the discovery, development
and commercialization of novel drugs for the treatment of long-term memory
disorders and other central nervous system dysfunctions. The initial term of the
collaborative program is three years, commencing as of July 1, 1997, subject to
extension for successive one-year periods upon agreement of the parties. Roche,
however, will have the right to terminate the program at the end of the second
year, or otherwise if certain milestones identified by the research committee
are not achieved. The Company and Cold Spring Harbor Laboratory are to conduct
research under the program, which is being funded by Helicon (except for the
molecular screening services the Company is contributing to Helicon). Helicon is
to receive funding from Roche for the first two years of the program. If the
program is not previously terminated, Roche is to continue to provide funding
for the third year of the program, with the actual amount to be determined by a
research committee established to oversee the collaborative program. Roche is
obligated to use reasonably diligent efforts to commercialize products derived
from the program.
Helicon has granted to Roche a worldwide license to commercialize
pharmaceutical products resulting from the collaborative program in exchange for
certain milestone payments and royalties on Roche's sales of such products. Each
of Helicon, the Company, Cold Spring Harbor Laboratory and Roche have various
rights and obligations to prosecute and maintain patent rights related to
specified developments and areas of the research under the collaborative
program. Helicon is prohibited from independently conducting or sponsoring
research related to the objectives of this collaborative program.
Novartis Pharma AG
The Company entered into an agreement with Novartis Pharma AG ("Novartis")
in April 1995 for the development of TGF-Beta 3 for various indications.
TGF-Beta 3 is a naturally occurring human growth factor, first isolated by the
Company, that exerts either stimulatory or inhibitory effects depending upon the
particular
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cell type to which it is applied. This agreement granted to Novartis an
exclusive, worldwide license to use and sell TGF-Beta 3 products for wound
healing and oral mucositis, as well as certain other indications, in exchange
for royalty payments to the Company on the sale of TGF-Beta 3 products.
During 1998, Phase II clinical trials being conducted by Novartis for both
wound healing and oral mucositis failed to achieve their primary clinical end
points. Consequently, no further clinical development of TGF-Beta 3 by Novartis
for either wound healing or oral mucositis is anticipated. Novartis has an
option through April 1999 (which it has not yet exercised) to obtain exclusive
rights to all other indications for TGF-Beta 3 by making a $10 million payment
in exchange for the Company's Common Stock at the higher of $5.50 per share or
the then current market price. Novartis is currently conducting pre-clinical
evaluation of TGF-Beta 3 for bone repair. Novartis and the Company are currently
renegotiating this agreement to allow for the continued development of TGF-Beta
3 for this and other indications. The Company's agreement with Novartis ends
upon the expiration of the last of the Company's patents relating to TGF-Beta 3.
PROPRIETARY DRUG DISCOVERY AND DEVELOPMENT
In addition to its proprietary program in anti-infectives, the Company is
pursuing proprietary discovery and development activities in the following
areas:
Sickle Cell Anemia and B-thalassemia
Currently, the Company's proprietary discovery and development efforts are
focused principally in sickle cell anemia and B-thalassemia that are caused by
genetic mutations which result in the mutation, absence or decrease in the adult
chain of hemoglobin (the protein in red blood cells that binds oxygen).
Currently available treatments for both of these diseases are inadequate and
expensive. The cost of treating each sickle cell patient in the United States
has been estimated to be in excess of $60,000 annually. Regular blood
transfusions are the mainstay of current therapy for thalassemia. The Company's
approach to address sickle cell anemia and thalassemia is to discover a small
molecule compound that increases expression of the fetal hemoglobin ("HbF") gene
to compensate for defects in the adult chain of hemoglobin. The Company has
identified lead compounds that induce the production of HbF and has initiated
pre-clinical developments.
Diabetes
The Company has assembled a comprehensive drug discovery capability in
diabetes that it believes can provide a unique opportunity for a major
pharmaceutical company to form a strategic partnership with the Company. In
April 1998, the Company entered into a collaborative agreement with the
Vanderbilt University Diabetes Center ("Vanderbilt") to discover and develop
novel, small molecule drugs for the treatment of non-insulin dependent diabetes
mellitus of Type II diabetes.
Type II diabetes affects a significant proportion of the population, 100
million people worldwide by some estimates. In the United States, over 10
million patients have symptoms associated with Type II diabetes, with
approximately 500,000 new cases diagnosed each year. An estimated 20 million
Americans have impaired glucose tolerance, one of the earliest manifestations of
insulin resistance, which is believed to precede development of Type II
diabetes. Serious complications associated with Type II diabetes cost the U.S.
economy more that $90 billion annually. An orally active, well tolerated,
efficacious drug to modulate blood glucose levels will benefit significant
numbers of diabetic patients, or those designated to develop the disease.
The Company believes that the innovative alliance between the Company and
Vanderbilt provides a comprehensive drug discovery and early clinical testing
capability in the field of diabetes. The Company is actively seeking a
pharmaceutical company to form a funded collaboration in this disease area.
INTELLECTUAL PROPERTY
The Company believes that patents and other proprietary rights are vital to
its business. The Company's policy is to protect its intellectual property
rights in technology developed by its scientific staff by a variety of means,
including applying for patents in the United States and other major
industrialized countries. The
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Company also relies upon trade secrets and improvements, unpatented proprietary
know-how and continuing technological innovations to develop and maintain its
competitive position. In this regard, the Company seeks restrictions in its
agreements with third parties, including research institutions, with respect to
the use and disclosure of the Company's proprietary technology. The Company also
has confidentiality agreements with its employees, consultants and scientific
advisors.
The Company currently controls 23 U.S. patents and 92 foreign patents. In
addition, the Company currently has pending 26 applications for U.S. patents, 7
of which have been allowed, and 30 applications for foreign patents, 3 of which
have been allowed. In addition, other institutions have granted exclusive rights
under their United States and foreign patents and patent applications to the
Company.
In September 1997, the Company was issued U.S. Patent No. 5,665,543, which
claims a method of identifying compounds that specifically modulate expression
of target genes using cells engineered to include reporter genes. In July 1998,
the Company was issued U.S. Patent 5,776,502, which claims a method of
specifically modulating gene transcription in a multicellular organism using a
low molecular weight compound. The Company has additional patent applications
pending, some of which have been allowed, which should enhance the Company's
patent position in the area of gene transcription.
There can be no assurance that patents will issue based upon the Company's
pending patent applications or any applications which it may file in the future,
that any patent issued will adequately protect a commercially marketable product
or process or that any patent issued will not be circumvented or infringed by
others or declared invalid or unenforceable. Moreover, there can be no assurance
that others may not independently develop the same or similar technology or
obtain access to the Company's proprietary technology. The Company is aware of
patents issued to other entities with respect to technology potentially useful
to the Company and, in some cases, related to products and processes being used
or developed by the Company. The Company currently cannot assess the effect, if
any, that these patents may have on its operations in the future. The extent to
which efforts by other researchers resulted or will result in patents and the
extent to which the issuance of patents to other entities would have a material
adverse effect on the Company or would force the Company to seek licenses from
such other entities currently is unknown as is the availability to the Company
of licenses from such other entities, and whether, if available, such licenses
can be obtained on terms acceptable to the Company.
In the cancer diagnostic area the Company has an issued U.S. patent and a
granted European patent relating to an assay the Company, in collaboration with
Bayer, is seeking to develop for the detection of a protein encoded by the neu
oncogene ("neu") in serum. The U.S. Patent Office has declared an interference
between the Company's issued U.S. Patent and a pending patent application owned
by Chiron Diagnostics Inc. ("Chiron"). In addition, Chiron has filed an
opposition against the corresponding granted European patent. These legal
proceedings, if not settled, could result in substantial legal expenses being
incurred by the Company. Also, the Company cannot predict whether it would
prevail in these proceedings. If the Company does not prevail, it may not be
able to commercialize its assay for neu in serum without a license from Chiron,
which may not be available on acceptable terms or at all.
The Company is aware of several U.S. and foreign patents owned by others
who may allege infringement by products, including TGF-Beta 3, which is the
subject of the Company's collaboration with Novartis. Genentech, Inc.
("Genentech") has U.S. patents relating to certain recombinant materials and
procedures for producing members of the TGF-Beta family, including TGF-Beta 3.
In addition, the Company believes that Genentech has license rights under a U.S.
Government patent relating to work done at the National Institute of Health of
the U.S. Department of Health and Human Services involving the identification
and isolation of TGF-Beta 1. Furthermore, Celtrix Pharmaceuticals, Inc.
("Celtrix") had been granted a European patent relating to TGF-Beta 2. This
patent was recently revoked in opposition proceedings, but could be reinstated
on appeal. The Company and Novartis have taken and continue to take such
actions, including the pursuit of opposition proceedings against foreign
patents, as they deem prudent to minimize the possibility of any charge of
patent infringement being validly raised against Novartis or the Company based
on such patents.
The Company has received communications from Sibia Neuroscience, Inc.
("Sibia") in which Sibia has stated the Company's live-cell assay technology may
infringe a patent issued to Sibia covering cell-based
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assays. The Company does not believe that it is infringing any valid claim of
Sibia's patent or of any patents owned by any other third parties. However,
there can be no assurance that a contrary position will not be asserted, or
that, if asserted, such a position would not prevail. If a patent infringement
lawsuit were brought against the Company or its licensees, the Company could
incur substantial costs in defense of such a suit, which could have a material
adverse effect on the Company's business, financial condition and results of
operation, regardless of whether the Company were successful in the defense.
Furthermore, if Sibia (or any other third party) were to establish that the
Company's assays infringe Sibia's patent (or any patent of any other third
party), then the Company would be required to design non-infringing assays or
take a license under Sibia's patent. There can be no assurance the Company would
successfully design such assays or that such a license would be available on
acceptable terms or at all. Moreover, the Company's royalties may be reduced by
up to 50% if its licensees or collaborative partners are required to obtain
licenses from third parties whose patent rights are infringed by the Company's
products, technology or operations.
COMPETITION
The pharmaceutical, biotechnology and diagnostic industries are intensely
competitive. The Company faces, and will continue to face, intense competition
from organizations such as large pharmaceutical companies, biotechnology
companies, diagnostic companies, academic and research institutions and
government agencies. The Company is subject to significant competition from
industry participants who are pursuing the same or similar technologies as those
which constitute the Company's technology platform and from organizations that
are pursuing pharmaceutical products or therapies or diagnostic products that
are competitive with the Company's potential products. Most of the organizations
competing with the Company have greater capital resources, greater research and
development staffs and facilities, and greater experience in drug discovery and
development, obtaining regulatory approval and pharmaceutical product
manufacturing and marketing. The Company's major competitors include fully
integrated pharmaceutical companies, such as Merck & Co., Inc., Glaxo Wellcome
Inc. and SmithKline Beecham plc, that conduct extensive drug discovery efforts
and are developing novel small molecule pharmaceuticals, as well as numerous
smaller companies.
The Company's technology platform consists principally of utilizing
genetically engineered live-cells, gene transcription technologies, high
throughput drug screening, and medicinal, combinatorial and natural product
chemistry. Pharmaceutical and biotechnology companies and others are active in
all of these areas. Ligand Pharmaceuticals Inc. and Aurora, publicly owned
companies, employ live-cell assays, gene transcription, and high throughput
robotics in their drug discovery operations. Numerous other companies use one or
more of these technologies. Several private companies, including Tularik Inc.,
Signal Pharmaceuticals Inc. and Scriptgen Pharmaceuticals, Inc., pursue drug
discovery using gene transcription methods. Other organizations may acquire or
develop technology superior to that of the Company.
Companies pursuing different but related fields also present significant
competition for the Company. For example, research efforts with respect to gene
sequencing and mapping are identifying new and possibly superior target genes.
In addition, alternative drug discovery strategies, such as rational drug
design, may prove more effective than those pursued by the Company. Furthermore,
competing entities may have access to more diverse compounds for testing by
virtue of larger compound libraries or through combinatorial chemistry skills or
other means. These include Pharmacopeia, Inc., CombiChem, Inc., ArQule, Inc. and
AxyS Pharmaceuticals, Inc., all of which have major collaborations with leading
pharmaceutical companies. There can be no assurance that the Company's
competitors will not succeed in developing technologies or products that are
more effective than those of the Company or that would render the Company's
products or technologies obsolete or noncompetitive.
With respect to the Company's small molecule drug discovery programs, other
companies have potential drugs in clinical trials to treat disease areas for
which the Company is seeking to discover and develop drug candidates. These
competing drug candidates may be further advanced in clinical development than
are any of the Company's potential products in its small molecule programs and
may result in effective, commercially successful products. Even if the Company
and its collaborative partners are successful in developing effective drugs,
there can be no assurance that the Company's products will compete effectively
with such products. No assurance can be given that the Company's competitors
will not succeed in developing and marketing products
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that either are more effective than those that may be developed by the Company
and its collaborative partners or are marketed prior to any products developed
by the Company or its collaborative partners.
The Company believes that its ability to compete successfully will be based
on, among other things, its ability to create and maintain scientifically
advanced technology, attract and retain scientific personnel with a broad range
of expertise, obtain patent protection or otherwise develop proprietary products
or processes, enter into collaborative arrangements, and, independently or with
its collaborative partners, conduct clinical trials, obtain required government
approvals on a timely basis, and commercialize its products.
MANUFACTURING
OSDI has developed a GMP capability for the production of immunoassay kits
and monoclonal antibodies at its Cambridge, Massachusetts facility. GMP is
essential for conducting clinical trials for tumor markers like HER-2/neu and
for sale of FDA approved products to the diagnostic market. The Company plans to
expand OSDI's manufacturing capacity by automating several of the current
manufacturing processes. OSDI currently manufactures an FDA approved product
known as Transprobe(R). Transprobe(R) is a nucleic acid based probe that aids in
the diagnosis of chronic myelogenous leukemia by identifying the bcr-abl
translocation.
The Company is, and will remain, dependent on its collaborative partners
and third parties for the manufacture of all products. There can be no assurance
that the Company will be able to manufacture products that will meet the
Company's demands for quality, quantity, cost and timeliness or otherwise
contract for manufacturing capabilities on acceptable terms. The failure of the
Company to successfully contract for the manufacture of products that satisfy
its requirements for quality, quantity, cost and timeliness would prevent the
Company from conducting pre-clinical testing and clinical trials and
commercializing its products.
Novartis has the exclusive right to, and the Company will rely on Novartis
for, the manufacture of TGF-Beta 3 for all of the Company's requirements for
clinical trials and commercial purposes. The Company believes that, if Novartis
should fail to meet its requirements, there are other companies that could
manufacture and supply TGF-Beta 3, although there can be no assurance that this
could be accomplished on a timely basis, or at all.
MARKETING AND SALES
The Company does not expect to develop significant marketing and sales
capabilities. Potential therapeutic products subject to the Company's
collaborative agreements with Pfizer, HMRI, Sankyo, and Novartis, and potential
diagnostic products under the Company's collaboration with Bayer and Fujirebio,
will be marketed by those companies worldwide. The Company will receive
royalties of up to 8% on net sales of products, depending upon the nature of the
product and the ownership of the underlying technology. The Company expects that
products resulting from future collaborations in drug discovery and development
and diagnostic product development will be marketed under arrangements which are
similar to these agreements, although any collaborations established for
products resulting from proprietary programs may vary significantly.
GOVERNMENT REGULATION
The Company and its collaborative partners are, and any potential products
discovered and developed thereto, will be subject to comprehensive regulation by
the FDA in the United States and by comparable authorities in other countries.
These national agencies and other federal, state, and local entities regulate,
among other things, the pre-clinical and clinical testing, safety,
effectiveness, approval, manufacture, labeling, marketing, export, storage,
record keeping, advertising, and promotion of pharmaceutical and diagnostic
products.
The process required by the FDA before pharmaceutical products may be
approved for marketing in the United States generally involves: (i) pre-clinical
laboratory and animal tests, (ii) submission to FDA of an investigational new
drug application ("IND"), which must become effective before clinical trials may
begin,
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(iii) adequate and well controlled human clinical trials to establish the safety
and efficacy of the drug for its intended indication, (iv) submission to the FDA
of a new drug application ("NDA") or, in the case of biological products, such
as TGF-Beta 3, a product license application ("PLA"), and (v) FDA review of the
NDA or PLA in order to determine, among other things, whether the drug is safe
and effective for its intended uses. There is no assurance that FDA review
process will result in product approval on a timely basis, if at all.
Pre-clinical tests include laboratory evaluation of product chemistry and
formulation, as well as animal studies, to assess the potential safety and
efficacy of the product. Certain pre-clinical tests are subject to FDA
regulations regarding current Good Laboratory Practices. The results of the
pre-clinical tests are submitted to the FDA as part of an IND and are reviewed
by the FDA prior to the commencement of clinical trials.
Clinical trials are conducted under protocols that detail such matters as
the objectives of the study, the parameters to be used to monitor safety and the
efficacy criteria to be evaluated. Each protocol must be submitted to the FDA as
part of the IND.
Clinical trials are typically conducted in three sequential phases, which
may overlap. During Phase I, when the drug is initially given to human subjects,
the product is tested for safety, dosage tolerance, absorption, metabolism,
distribution and excretion. Phase II involves studies in a limited patient
population to: (i) evaluate preliminarily the efficacy of the product for
specific, targeted indications, (ii) determine dosage tolerance and optimal
dosage, and (iii) identify possible adverse effects and safety risks. Pivotal or
Phase III trials are undertaken in order to further evaluate clinical efficacy
and to further test for safety within an expanded patient population. The FDA
may suspend or terminate clinical trials at any point in this process if it
concludes that clinical subjects are being exposed to an unacceptable health
risk.
FDA approval of the Company's and its collaborators' products, including a
review of the manufacturing processes and facilities used to produce such
products, will be required before such products may be marketed in the United
States. The process of obtaining approvals from the FDA can be costly, time
consuming and subject to unanticipated delays. There can be no assurance that
approvals of the Company's proposed products, processes or facilities will be
granted on a timely basis, if at all. Any failure to obtain or delay in
obtaining such approvals would have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, even if
regulatory approval is granted, such approval may include significant
limitations on indicated uses for which a product could be marketed.
Among the conditions for NDA approval is the requirement that the
prospective manufacturer's manufacturing procedures conform to GMP requirements,
which must be followed at all times. In complying with those requirements,
manufacturers (including a drug sponsor's third-party contract manufacturers)
must continue to expend time, money and effort in the area of production and
quality control to ensure compliance. Domestic manufacturing establishments are
subject to periodic inspections by the FDA in order to assess, among other
things, GMP compliance. To supply products for use in the United States, foreign
manufacturing establishments must comply with GMP and are subject to periodic
inspection by the FDA or by regulatory authorities in certain countries under
reciprocal agreements with the FDA.
Both before and after approval is obtained, a product, its manufacturer and
the holder of the NDA for the product are subject to comprehensive regulatory
oversight. Violations of regulatory requirements at any stage, including the
pre-clinical and clinical testing process, the approval process, or thereafter
(including after approval) may result in various adverse consequences, including
the FDA's delay in approving or refusal to approve a product, withdrawal of an
approved product from the market, and the imposition of criminal penalties
against the manufacturer and NDA holder. In addition, later discovery of
previously unknown problems may result in restrictions on such product,
manufacturer or NDA holder, including withdrawal of the product from the market.
Furthermore, new government requirements may be established that could delay or
prevent regulatory approval of the Company's products under development.
For marketing outside the United States, the Company and its collaborators
and the drugs developed thereby, if any, will be subject to foreign regulatory
requirements governing human clinical trials and marketing approval for drugs
and diagnostic products. The requirements governing the conduct of clinical
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trials, product licensing, pricing and reimbursement vary widely from country to
country. In addition, before a new drug may be exported from the United States,
it must be the subject of an approved NDA or comply with FDA regulations
pertaining to INDs.
In addition to regulations enforced by the FDA, the Company also is subject
to regulation under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substances Control Act, the Resource Conservation and
Recovery Act and other present and future federal, state or local regulations.
The Company's R&D activities involve the controlled use of hazardous materials,
chemicals and various radioactive compounds. Although the Company believes that
its safety procedures for handling and disposing of such materials comply with
the standards prescribed by state and federal regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result and any such liability could exceed the resources of
the Company.
Diagnostic tests undergo different FDA review processes depending upon
whether they are classified as "biologicals" or "medical devices." For medical
devices, a 510(k) application (for a product substantially equivalent to a
product already on the market) or a premarket approval application (generally, a
new product or method that is not substantially equivalent to an existing
product) must be filed with, and approved by, the FDA prior to
commercialization. Obtaining premarket approval is a costly and time-consuming
process, comparable to that for new drugs. There can be no assurance that the
Company's cancer diagnostic product candidates will be submitted for regulatory
approval, or if submitted, that the Company would not be required to seek
premarket approval as opposed to filing a 510(k) application.
EMPLOYEES
The Company believes that its success is largely dependent upon its ability
to attract and retain qualified personnel in scientific and technical fields. As
of December 1, 1998, the Company employed 164 persons worldwide (126 in the
United States), of whom 134 were primarily involved in research and development
activities, with the remainder engaged in executive and administrative
capacities. Although the Company believes that it has been successful to date in
attracting skilled and experienced scientific personnel, competition for such
personnel is intense and there can be no assurance that the Company will
continue to be able to attract and retain personnel of high scientific caliber.
The Company considers its employee relations to be good.
CAUTIONARY FACTORS FOR CONSIDERATION IN CONNECTION WITH FORWARD LOOKING
STATEMENTS
This report contains forward-looking statements that do not convey
historical information, but relate to predicted or potential future events, such
as statements of the Company's plans, strategies and intentions, or its future
performance or goals for the Company's product development programs. Such
statements can often be identified by the use of forward-looking terminology
such as "believes," "expects," "intends," "may," "will," "should" or
"anticipates" or similar terminology. These statements involve risks and
uncertainties and are based on various assumptions, and investors and
prospective investors are cautioned that such statements are only projections.
The following risks and uncertainties, among others, could cause the Company's
actual results to differ materially from those described in forward looking
statements made in this report or presented elsewhere by management from time to
time:
Uncertainties Related to Clinical Trials
The Company has limited experience in conducting clinical trials and has
relied primarily on the pharmaceutical companies with which it collaborates,
including Pfizer, HMRI, Sankyo and Novartis for clinical development and
regulatory approval of its product candidates. Before obtaining regulatory
approvals for the commercial sale of its products, the Company or its
collaborative partners will be required to demonstrate through pre-clinical
studies and clinical trials that the proposed products are safe and effective
for use in each target indication. The results from pre-clinical studies and
early clinical trials may not be predictive of results that will be obtained in
large-scale testing, and there can be no assurance that the clinical
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trials conducted by the Company or its partners will demonstrate sufficient
safety and efficacy to obtain the required regulatory approvals or will result
in marketable products. In addition, clinical trials are often conducted with
patients having the most advanced stages of disease. During the course of
treatment, these patients can die or suffer other adverse medical effects for
reasons that may not be related to the pharmaceutical agent being tested, but
which can nevertheless affect clinical trial results. Various companies in the
pharmaceutical industry have suffered significant setbacks in advanced clinical
trials, even after promising results in earlier trials. In addition, clinical
trials for the product candidates being developed by the Company and its
collaborators may be delayed by many factors. Any delays in, or termination of,
the clinical trials of any of the Company's product candidates would have a
material adverse effect on the Company's business, financial condition and
results of operations.
To date, in the Company's small molecule drug discovery operations, only
one product candidate has entered clinical trials. Furthermore, thus far only
one of the compounds discovered using the Company's small molecule discovery
technology has been proven safe in humans and none have yet demonstrated
efficacy. Moreover, the Company's drug discovery assays are focused on various
genes and other targets, the functions of many of which have not yet been fully
elucidated. As such, the safety and efficacy of drugs that affect these targets
has not yet been established. No assurance can be given that any lead small
molecule compounds or diagnostic product candidates emerging from the Company's
discovery and development operations will successfully complete clinical trials
or receive marketing approval from FDA or any foreign regulatory authorities on
a timely basis or at all.
Dependence on Collaborative Relationships
The Company does not intend to conduct late-stage clinical trials or
manufacturing or marketing activities with respect to any of its product
candidates in the foreseeable future. The Company has collaborations with
Pfizer, HMRI, Sankyo and Novartis for the development of potential drug
candidates, and currently its most advanced program is in an oncogene inhibitor
with Pfizer for the treatment of certain cancers. The Company is largely
dependent on the pharmaceutical companies with which it collaborates for the
pre-clinical testing, clinical development, regulatory approval, manufacturing
and marketing of its products. The Company's collaborative agreements allow its
collaborative partners significant discretion in electing to pursue or not to
pursue any of these activities. The Company cannot control the amount and timing
of resources its collaborative partners devote to the Company's programs or
potential products. If any of the Company's collaborative partners were to
breach or terminate its agreements with the Company or otherwise fail to conduct
its collaborative activities successfully in a timely manner, the pre-clinical
or clinical development or commercialization of product candidates or research
programs would be delayed or terminated. Any such delay or termination could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The Company relies on its collaborative partners to provide funding in
support of its research operations. As of September 30, 1998, the Company had
received or accrued an aggregate of $97.4 million in research funding and
milestone payments from its collaborative partners. The Company would be
required to devote additional internal resources to product development, or
scale back or terminate certain development programs or seek alternative
collaborative partners, if funding from one or more of its collaborative
programs were reduced or terminated.
Although the Company has worked to expand its proprietary compound
libraries (through acquisition of the fungal collection of MYCOsearch and the
licensing of Dow's library of approximately 140,000 small molecule compounds),
the Company still owns or controls the rights to only a relatively small number
of the compounds that it tests in its drug discovery operations. The Company is
dependent on access to the compound libraries of its collaborative partners and
others in order to enhance the value of its drug discovery platforms. Failure by
the Company to gain access to the compound libraries of its collaborative
partners for its collaborative programs and others would restrict its ability to
exploit fully its high throughput screening capabilities and would have a
material adverse effect on its business, financial condition and results of
operations.
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Disputes may arise in the future with respect to the ownership of rights to
any technology developed with third parties. These and other possible
disagreements between collaborators and the Company could lead to delays in the
collaborative research, development or commercialization of certain product
candidates, or could require or result in litigation or arbitration, which would
be time-consuming and expensive, and would have a material adverse effect on the
Company's business, financial condition and results of operations.
Generally, in its collaborative research agreements, the Company agrees not
to conduct independently, or with any third party, any research that is
competitive with the research conducted under its collaborative programs. The
Company's collaborative relationships may have the effect of limiting the areas
of research the Company may pursue. For example, under its collaborative
research agreements with some of its partners, the Company is prohibited during
the term of the agreements from pursuing or sponsoring research aimed at the
discovery of drugs which are the subject of the collaborations. However, the
Company's collaborative partners may develop, either alone or with others,
products that are similar to or competitive with the products or potential
products that are the subject of the Company's collaborations with such
partners. Competing products, either developed by the collaborative partners or
to which the collaborative partners have rights, may result in their withdrawal
of support for the Company's product candidates, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
All of the Company's collaborative programs with pharmaceutical companies
have terms of six or fewer years, which is generally less than the period
required for the discovery, clinical development and commercialization of most
drugs. The continuation of any of the Company's drug discovery and development
programs is dependent on the periodic renewal of the relevant collaborative
partnership. Furthermore, all of the Company's collaborative research agreements
are subject to termination under various circumstances. Certain of the Company's
collaborative research agreements provide that, upon expiration of a specified
period after commencement of the agreement, its collaborative partners have the
right to terminate the agreement on short notice without cause. The termination
or nonrenewal of any collaborative relationship could have a material adverse
effect on the Company's business, financial condition and results of operations.
There have been a significant number of consolidations among large
pharmaceutical and diagnostic companies. Such consolidations among these
companies with which the Company is engaged in collaborative research can result
in the diminution or termination of, or delays in, one or more of the Company's
collaborative programs. For example, in 1995, the pharmaceutical operations of
three companies with which the Company had collaborative research agreements,
Hoechst AG, Hoechst Roussel Pharmaceuticals, Inc. and Marion Merrell Dow Inc.
were combined in one entity, HMRI. This combination resulted in delays in the
Company's collaborative programs with each of the constituent companies and a
reduction in the aggregate funding received by the Company.
The Company's strategy for the discovery, development, clinical testing,
manufacturing and marketing of certain of its potential products includes
establishing additional collaborations. There can be no assurance that the
Company will be able to negotiate such collaborative arrangements on acceptable
terms, if at all, or that such collaborations will be successful.
Uncertainties Related to the Early Stage of Development; Technological
Uncertainties
To date, the Company has generated no revenue from the sale of
pharmaceutical products. Except for CP-358,774, with respect to which Pfizer has
completed Phase I safety and toxicity studies and has initiated Phase II
clinical trials, all of the lead compounds in the Company's small molecule drug
discovery programs are in either a discovery or pre-clinical evaluation phase.
The Company has commercialized one diagnostic product, which to date has not
generated significant sales and is not expected to generate significant sales in
the future. Any products resulting from the Company's development programs are
not expected to be commercially available for several years, if at all.
All of the Company's potential products will require significant research
and development and are subject to significant risks. Potential products that
appear to be promising at early stages of development may not reach the market
for a number of reasons. Potential products may be found ineffective or cause
harmful side effects during pre-clinical testing or clinical trials, fail to
receive necessary regulatory approvals, be difficult to
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manufacture on a large scale, be uneconomical to produce, fail to achieve market
acceptance or be precluded from commercialization by proprietary rights of third
parties. There can be no assurance that the Company's or its collaborative
partners' product development efforts will be successfully completed, that
required regulatory approvals will be obtained or that any products, if
introduced, will be successfully marketed or achieve customer acceptance.
The Company's live-cell assays are novel as a drug discovery method and
have not yet been shown to be successful in the development of any
commercialized drug. Furthermore, the Company's drug discovery assays are
focused on several target genes and other molecular targets, the functions of
many of which have not yet been fully elucidated. There can be no assurance that
the Company's live-cell assay technology will result in lead compounds that will
be safe and efficacious. Development of new pharmaceutical products is highly
uncertain, and no assurance can be given that the Company's drug discovery
technology will result in any commercially successful products.
Uncertainty of Future Profitability
OSI has had net operating losses since its inception in 1983. At September
30, 1998, the Company's accumulated deficit was approximately $55.8 million. The
Company's losses have resulted principally from costs incurred in research and
development, and from general and administrative costs associated with the
Company's operations. These costs have exceeded the Company's revenues, which to
date have been generated principally from collaborative research agreements. OSI
expects to incur substantial additional operating expenses over the next several
years as a result of increases in its expenses for research and development,
including enhancements in its drug discovery technologies and with respect to
its internal proprietary projects. If the Company does not obtain additional
third party funding for such expenses, the Company expects that such expenses
will result in increased losses from operations. OSI does not expect to generate
revenues from the sale of its small molecule products for several years. The
Company currently has limited sales of only one diagnostic product. The
Company's future profitability depends, in part, on its collaborative partners
obtaining regulatory approval for products derived from its collaborative
research efforts, the Company's collaborative partners successfully producing
and marketing products derived from technology or rights licensed from the
Company, and the Company's entering into agreements for the development,
commercialization, manufacture and marketing of any products derived from the
Company's internal proprietary programs. There can be no assurance that the
Company or its collaborative partners will obtain required regulatory approvals,
or successfully develop, commercialize, manufacture and market product
candidates or that the Company will ever achieve product revenues or
profitability.
Need for Additional Funding; Uncertainty of Access to Capital
The Company will require substantial funding in order to continue its
research, product development, pre-clinical testing and clinical trials of its
product candidates. The Company's internal proprietary programs and operations
will require a significant amount of funding that will not be provided by the
Company's existing collaborative partners. The Company's strategy includes, in
addition to its funded collaborations, developing product candidates in its
internal proprietary programs through early stage clinical development, before
forming collaborations for the further development of such product candidates.
These activities will require investment of significant funds by the Company. No
assurance can be given that the Company will have adequate resources to support
such existing and future activities or that the Company will be able to enter
into collaborative arrangements on acceptable terms, if at all.
The Company's future capital requirements will depend on many factors,
including continued scientific progress in its research and development
programs, the size and complexity of these programs, progress with pre-clinical
testing and early stage clinical trials, the time and costs involved in
obtaining regulatory approvals for its product candidates, the costs involved in
filing, prosecuting and enforcing patent claims, competing technological and
market developments, the establishment of additional collaborative arrangements,
the cost of manufacturing arrangements, commercialization activities, and the
cost of product in-licensing and strategic acquisitions, if any. The Company
evaluates on an ongoing basis potential collaborative arrangements with third
parties and acquisitions of companies or technologies that may complement its
business.
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The Company intends to seek additional funding through arrangements with
corporate collaborators and may seek additional funding through public or
private sales of the Company's securities, including equity securities. There
can be no assurance, however, that additional funding will be available on
reasonable or acceptable terms, if at all. Any additional equity financings
would be dilutive to the Company's stockholders. If adequate funds are not
available, the Company may be required to curtail significantly one or more of
its research and development programs or obtain funds through arrangements with
collaborative partners or others that may require the Company to relinquish
rights to certain of its technologies or product candidates, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Generally, the Company's funding pursuant to any particular collaborative
research agreement is subject to reduction or termination under various
circumstances. There can be no assurance that scheduled payments will be made by
third parties, that current agreements will not be cancelled, that government
research grants will continue to be received at current levels or that
unanticipated events requiring the expenditure of funds will not occur. There
can be no assurance that the Company's cash reserves and other liquid assets
will be adequate to satisfy its capital and operating requirements for the
foreseeable future.
No Assurance of Protection of Patents and Proprietary Technology
The Company's success will depend in part on its ability or the ability of
its collaborative partners to obtain patent protection for product candidates,
to maintain trade secret protection and to operate without infringing on the
proprietary rights of third parties.
The patent positions of pharmaceutical, biopharmaceutical and biotechnology
companies, including OSI, are generally uncertain and involve complex legal and
factual questions. There can be no assurance that any of the Company's pending
patent applications will be approved, that the Company will develop additional
proprietary technologies that are patentable, that any patents issued to the
Company or its licensors will provide a basis for commercially viable products
or will provide the Company with any competitive advantages or will not be
challenged by third parties, or that the patents of others will not have an
adverse effect on the ability of the Company to do business. In addition, patent
law relating to the scope of claims in the technology fields in which the
Company operates is still evolving. The degree of future protection for the
Company's proprietary rights, therefore, is uncertain. Furthermore, there can be
no assurance that others will not independently develop similar or alternative
technologies, duplicate any of the Company's technologies, or, if patents are
issued to the Company, design around the patented technologies developed by the
Company. In addition, the Company could incur substantial costs in litigation if
it is required to defend itself in patent suits brought by third parties or if
it initiates such suits.
In the cancer diagnostics area, the Company has an issued U.S. patent and a
granted European patent relating to an assay which the Company, in collaboration
with Bayer, is seeking to develop for the detection of a protein encoded by neu
in serum. The U.S. Patent Office has declared an interference between the
Company's issued U.S. Patent and a pending patent application owned by Chiron.
In addition, Chiron has filed an opposition against the corresponding granted
European patent. These legal proceedings, if not settled, could result in
substantial legal expenses being incurred by the Company. Also, the Company
cannot predict whether it would prevail in these proceedings. If the Company
does not prevail, it may not be able to commercialize its assay for neu in serum
without a license from Chiron, which may not be available on acceptable terms or
at all.
The Company is aware of several U.S. and foreign patents owned by others
who may allege infringement by TGF-Beta 3, which the Company is seeking to
develop in collaboration within Novartis for bone repair. Genentech, Inc. has
U.S. patents relating to certain recombinant materials and procedures for
producing members of the TGF-Beta family, including TGF-Beta 3. In addition, the
Company believes that Genentech, Inc. has license rights under a U.S. Government
patent relating to work done at the National Institute of Health of the U.S.
Department of Health and Human Services involving the identification and
isolation of TGF-Beta 1. Furthermore, Celtrix has been granted a European patent
relating to TGF-Beta 2. There can be no assurance that the activities or
products of the Company or its collaborative partners do not or will not
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infringe the claims of these or other issued patents held by third parties or
any other patent issued in the future. Furthermore, there can be no assurance
that any license required under any such patents would be made available or, if
available, would be available on acceptable terms. Failure to obtain patent
protection or a required license could prevent the Company and Novartis from
commercializing TGF-Beta 3 products. The inability of the Company and Novartis
to commercialize TGF-Beta 3 products could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company is seeking to license to other companies rights to practice
under the Company's gene transcription patent estate. Technology and practices
covered by these patents are in widespread use in the pharmaceutical and
biotechnology industries. To date, the Company has entered into only one
agreement (with Aurora) to license out this technology. If other pharmaceutical
and biotechnology firms using the Company's patented technology are not willing
to negotiate license arrangements with the Company on reasonable terms, the
Company may have to choose between (i) abandoning its licensing strategy and
(ii) initiating legal proceedings against those firms. Such legal action,
including patent infringement litigation, would be extremely costly. There can
be no assurance that the Company's strategy to commercialize its gene
transcription patent estate through licensing will be successful.
The extent to which efforts by other researchers have resulted or will
result in patents and the extent to which the issuance of patents to others
would have a material adverse effect on the Company or would force the Company
or its collaborative partners or other licensees to obtain licenses from others,
if available, is currently unknown. Generally, the Company's royalties on any
commercialized products could be reduced by up to 50% if its licensees or
collaborative partners are required to obtain such licenses. There can be no
assurance that the Company's products, operations or technology will not
infringe upon the rights of any third party.
The Company relies on trade secrets to protect technology where patent
protection is not believed to be appropriate or obtainable. The Company has
entered, and will continue to enter, into confidentiality agreements with its
employees, consultants, licensors and collaborative partners. There can be no
assurance, however, that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets, that such obligations of confidentiality will be
honored or that the Company will be able to effectively protect its rights to
proprietary information.
Competition and Risk of Technological Obsolescence
The pharmaceutical, biotechnology and diagnostics industries are intensely
competitive, and the Company faces, and will continue to face, intense
competition from organizations such as large pharmaceutical companies,
diagnostic companies, biotechnology companies, academic and research
institutions and government agencies. The Company is subject to significant
competition from industry participants who are pursuing the same or similar
technologies as those which constitute the Company's technology platform and
from organizations that are pursuing pharmaceutical products or therapies or
diagnostic products that are competitive with the Company's potential products.
Most of the organizations competing with the Company have greater capital
resources, greater research and development staffs and facilities, and greater
experience in drug discovery and development, obtaining regulatory approval and
pharmaceutical product manufacturing and marketing. The Company's major
competitors include fully integrated pharmaceutical companies, such as Merck &
Co., Inc., Glaxo Wellcome Inc. and Smith Kline Beecham, that have extensive drug
discovery efforts and are developing novel small molecule pharmaceuticals, as
well as numerous smaller companies.
The Company's technology platform consists principally of a variety of lead
seeking assay methodologies, transcription technologies, chemical libraries,
medical and combinational chemistry and pharmaceutical development technologies.
Pharmaceutical and biotechnology companies and others are active in all of these
areas, and there can be no assurance that other organizations will not acquire
or develop technology superior to that of the Company. Ligand Pharmaceuticals
Inc. and Aurora, publicly owned companies, employ live-cell assays, gene
transcription, and high throughput robotics in its drug discovery operations.
Numerous other companies use one or more of these technologies. Several private
companies, including Tularik Inc., Signal Pharmaceuticals Inc. and Scriptgen
Pharmaceuticals, Inc., pursue drug discovery using gene transcription methods.
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Companies pursuing different but related fields also present significant
competition for the Company. For example, research efforts with respect to gene
sequencing and mapping are identifying new and potentially superior target
genes. In addition, alternative drug discovery strategies, such as rational drug
design, may prove more effective than those pursued by the Company. Furthermore,
competing entities may have access to more diverse compounds for testing by
virtue of larger compound libraries or through combinatorial chemistry skills or
other means. These include Pharmacopeia, Inc., CombiChem, Inc., ArQule, Inc. and
AxyS Pharmaceuticals, Inc., all of which have major collaborations with leading
pharmaceutical companies. There can be no assurance that the Company's
competitors will not succeed in developing technologies or products that are
more effective than those of the Company or that would render the Company's
products or technologies obsolete or noncompetitive.
With respect to the Company's small molecule drug discovery programs, other
companies have potential drugs in clinical trials to treat all the disease areas
for which the Company is seeking to discover and develop drug candidates. These
competing drug candidates are further advanced in clinical development than are
any of the Company's potential products in its small molecule programs and may
result in effective, commercially successful products. Even if the Company and
its collaborative partners are successful in developing effective drugs, there
can be no assurance that the Company's products will compete effectively with
such products. No assurance can be given that the Company's competitors will not
succeed in developing and marketing products either that are more effective than
those that may be developed by the Company and its collaborators or that are
marketed prior to any products developed by the Company or its collaborators.
The Company will, for the foreseeable future, rely on its collaborative
partners for some pre-clinical evaluation and clinical development of its
potential products and manufacturing and marketing of any products. In addition,
the Company relies on its collaborative partners for support in its drug
discovery operations. It is likely that all of the pharmaceutical companies with
which the Company has collaborations are conducting multiple product development
efforts within each disease area. Generally, the Company's collaborative
research agreements do not restrict a party from pursuing competing internal
development efforts based on reasonable commercial judgment and other factors.
Any product candidate of the Company, therefore, may be subject to competition
with a potential product under development by the pharmaceutical company with
which the Company is collaborating in connection with such product candidate.
Biotechnology and related pharmaceutical technology have undergone rapid
and significant change. The Company expects the technology associated with the
Company's research and development will continue to develop rapidly, and the
Company's future success will depend in large part on its ability to maintain a
competitive position with respect to this technology. Rapid technological
development by the Company or others may result in compounds, products or
processes becoming obsolete before the Company recovers any expenses it incurs
in connection with developing such products.
Government Regulation; No Assurance of Regulatory Approval
Prior to marketing by a collaborative partner, any new drug discovered by
the Company must undergo an extensive regulatory approval process in the United
States and other countries. This regulatory process, which includes pre-clinical
testing and clinical trials, and may include post-marketing surveillance, of
each compound to establish its safety and efficacy, can take many years and
require the expenditure of substantial resources. Data obtained from
pre-clinical and clinical activities are susceptible to varying interpretations
that could delay, limit or prevent regulatory approval. In addition, delays or
rejections may be encountered based upon changes in FDA policies for drug
approval during the period of product development and FDA regulatory review of
each submitted an NDA in the case of new pharmaceutical agents, or PLA in the
case of a biologic, such as the Company's TGF-Beta 3 product candidate. Similar
delays may also be encountered in the regulatory approval of any diagnostic
product. Such delays may also be encountered in obtaining regulatory approval in
foreign countries. There can be no assurance that regulatory approval will be
obtained for any drugs discovered, or diagnostic products developed, by the
Company. Furthermore, regulatory approval may entail limitations on the
indicated use of the drug.
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Even if regulatory approval is obtained, a marketed product and its
manufacturer are subject to continuing review. Discovery of previously unknown
problems with a product of the Company or its manufacturer may have adverse
effects on the Company's business, financial condition and results of
operations, including withdrawal of the product from the market. Violations of
regulatory requirements at any stage, including pre-clinical testing and
clinical trials, the approval process or post-approval, may result in various
adverse consequences to the Company, including the FDA's delay in approving or
its refusal to approve a product, withdrawal of an approved product from the
market and the imposition of criminal penalties against the manufacturer and NDA
holder. Although Pfizer submitted an IND to the FDA with respect to the
epidermal growth factor receptor inhibitor CP-358,774, the Company has not
submitted an IND for any product candidate, and no product candidate has been
approved for commercialization in the United States or elsewhere. The Company
intends to file INDs for product candidates in its internal proprietary
programs, but to rely on its partners to file INDs in its collaborative
programs. No assurance can be given that the Company or any of its collaborative
partners will be able to conduct clinical testing or obtain the necessary
approvals from the FDA or other regulatory authorities for any products. Failure
to obtain required governmental approvals will delay or preclude the Company's
partners from marketing drugs discovered, or diagnostic products developed, by
the Company or limit the commercial use of such products and will have a
material adverse effect on the Company's business, financial condition and
results of operations.
No Manufacturing Capacity; Reliance on Third-Party Manufacturing
The Company does not intend to develop or acquire facilities for the
manufacture of drug candidates or diagnostic products for clinical trials or
commercial purposes, and has been, and will remain, dependent on its
collaborative partners or third parties for the manufacture of product
candidates for pre-clinical, clinical and commercialization purposes.
The manufacture of the Company's candidate products for clinical trials and
the manufacture of resulting products for commercialization purposes is subject
to current GMP regulations promulgated by the FDA. The Company will rely on
collaborative partners or outside contractors to manufacture its products in
their FDA approved manufacturing facilities. The Company's products may be in
competition with other products for priority of access to these facilities.
Consequently, the Company's products may be subject to delays in manufacture if
collaborative partners or outside contractors give other products greater
priority than the Company's products. For this and other reasons, there can be
no assurance that the Company's collaborative partners will manufacture such
products in an effective or timely manner. If not performed in a timely manner,
the clinical trial development of the Company's product candidates or their
submission for regulatory approval could be delayed, and the Company's ability
to deliver products on a timely basis could be impaired or precluded. There can
be no assurance that the Company will be able to enter into any necessary third
party manufacturing arrangements on acceptable terms if at all. The Company's
current dependence upon others for the manufacture of its products may adversely
affect its future profit margin, if any, and its ability to commercialize
products on a timely and competitive basis.
Uncertainties Related to Pharmaceutical Pricing and Reimbursement
The Company's business, financial condition and results of operations may
be materially adversely affected by the continuing efforts of government and
third-party payors to contain or reduce the costs of health care through various
means. For example, in certain foreign markets, pricing and profitability of
prescription pharmaceuticals are subject to government control. In the United
States, the Company expects that there will continue to be a number of federal
and state proposals to implement similar government control. In addition,
increasing emphasis on managed care in the United States will continue to put
pressure on the pricing of pharmaceutical products and diagnostic tests. Cost
control initiatives could decrease the price that the Company or any of its
collaborative partners or other licensees receives for any drugs it may discover
or develop or diagnostic products it may develop in the future and have a
material adverse effect on the Company's business, financial condition and
results of operations. Further, to the extent that cost control
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initiatives have a material adverse effect on the Company's collaborative
partners, the Company's ability to commercialize its products and to realize
royalties may be adversely affected.
The Company's or any collaborative partner's or licensee's ability to
commercialize pharmaceutical or diagnostic products may depend in part on the
extent to which reimbursement for the products will be available from government
and health administration authorities, private health insurers and other
third-party payors. Significant uncertainty exists as to the reimbursement
status of newly approved health care products. Third-party payors, including
Medicare, are increasingly challenging the prices charged for medical products
and services. There can be no assurance that any third-party insurance coverage
will be available to patients for any products discovered and developed by the
Company and its collaborative partners. Government and other third-party payors
are increasingly attempting to contain health care costs by limiting both
coverage and the level of reimbursement for new therapeutic products and by
refusing in some cases to provide coverage for uses of approved products for
disease indications for which the FDA has not granted labeling approval. If
adequate coverage and reimbursement levels are not provided by government and
other third-party payors for the Company's products, the market acceptance of
these products would be adversely affected, which would have a material adverse
effect on the Company's business, financial condition and results of operations.
Potential Product Liability
The use of any of the Company's potential products in clinical trials and
the sale of any approved products may expose the Company to liability claims
resulting from the use of products or product candidates. These claims might be
made directly by consumers, pharmaceutical companies, including the Company's
collaborative partners, or others. The Company is currently an additional named
insured under a clinical trials liability insurance policy carried by Novartis
with respect to its TGF-Beta 3 clinical trials in the amount of $3 million. The
Company does not independently maintain product liability insurance coverage for
claims arising from the use of its products in clinical trials. Insurance
coverage is becoming increasingly expensive, and no assurance can be given that
the Company will continue to be a named insured with respect to trials underway
or obtain insurance in the future at a reasonable cost or in sufficient amounts
to protect the Company. The Company's inability to obtain adequate liability
insurance could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will be able to obtain commercially reasonable product liability
insurance for any product approved for marketing in the future or that insurance
coverage and the resources of the Company would be sufficient to satisfy any
liability resulting from product liability claims. A successful product
liability claim or series of claims brought against the Company could have a
material adverse effect on its business, financial condition and results of
operations.
Year 2000
The Company is currently working to resolve the potential impact of the
Year 2000 problem on the processing of date-sensitive information by the
Company's computerized information system. The Company is currently not in a
position to estimate the likelihood of disruption caused by Year 2000 problems
experienced by it or the Company's suppliers, vendors or collaborators. The
Company may be faced with unforeseen difficulties in implementing future Year
2000 compliance plans or contingency plans. Such difficulties and failure of
suppliers, vendors or collaborators to be Year 2000 compliant could result in
risks and uncertainties that may have a material adverse effect on the Company's
business, financial condition and results of operation.
ITEM 2. PROPERTIES
The Company leases two facilities, one located at 106 Charles Lindbergh
Boulevard, Uniondale, New York consisting of 30,000 square feet and the other
located at 50 Charles Lindbergh Boulevard, Uniondale, New York consisting of
4,500 square feet. The larger facility houses the Company's principal executive
offices and drug discovery laboratory. The smaller facility houses the Company's
Finance and Administrative offices. The Company also leases an 11,000 square
foot facility located at 80 Rogers Street/129 Binney Street, Cambridge,
Massachusetts. This facility contains the offices and laboratories of the
Company's diagnostic
25
<PAGE> 27
product operations. The Company also has two wholly-owned subsidiaries, Aston
and MYCOsearch, each of which lease facilities which house their offices and
drug discovery laboratories. Aston leases a 9,689 square foot facility located
at 10 Holt Court South, Aston Science Park, Birmingham, England. MYCOsearch
leases two facilities, one located at Five Oaks Office Park, 4905 Pine Cone
Drive, Durham, North Carolina consisting of 4,280 square feet and the other
located at 4727 University Drive, Durham, North Carolina consisting of 8,000
square feet. The Company expects a modest expansion of space of its Aston
facility in the United Kingdom. Otherwise, the Company believes that its
facilities will be adequate to meet current requirements. If any of the
Company's collaborative programs is expanded, the Company may need to acquire
additional space, which the Company believes it would be able to secure on
reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded in the over-the-counter market and is
included for quotation on the NASDAQ National Market under the symbol OSIP. The
following is the range of high and low sales prices by quarter for the Company's
Common Stock from the first quarter of fiscal 1997 through September 30, 1998 as
reported on the NASDAQ National Market:
<TABLE>
<CAPTION>
1998 FISCAL YEAR HIGH LOW
---------------- ---- ---
<S> <C> <C>
First Quarter............................................... $11 1/2 $5 7/8
Second Quarter.............................................. 8 5 7/8
Third Quarter............................................... 7 7/8 5 1/8
Fourth Quarter.............................................. 6 3/4 2 29/32
</TABLE>
<TABLE>
<CAPTION>
1997 FISCAL YEAR HIGH LOW
---------------- ---- ---
<S> <C> <C>
First Quarter............................................... $ 9 $6 1/4
Second Quarter.............................................. 7 7/8 5 5/8
Third Quarter............................................... 6 15/16 4 3/4
Fourth Quarter.............................................. 11 3/4 5 5/8
</TABLE>
As of November 30, 1998, there were approximately 617 holders of record of
the Company's Common Stock. The Company has not paid any dividends since its
inception and does not intend to pay any dividends in the foreseeable future.
Declaration of dividends will depend, among other things, upon future earnings,
the operating and financial condition of the Company, its capital requirements
and general business conditions.
26
<PAGE> 28
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data with
respect to the Company for each of the years in the five-year period ended
September 30, 1998. The information set forth below should be read in
conjunction with the consolidated financial statements and notes thereto
included elsewhere in this report.
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
----------------------------------------------------------------------
1998(a) 1997(b) 1996(c) 1995(d) 1994(e)
------------ ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................. $ 19,468,337 $ 14,777,323 $ 9,718,437 $15,864,999 $16,299,489
Expenses:
Research and
development......... 20,350,063 16,896,617 13,918,968 13,523,043 12,125,210
Production and service
costs............... 955,464 635,768 134,529 1,252,990 1,427,981
Selling, general and
administrative...... 8,076,662 7,424,265 6,314,697 7,140,208 7,487,090
Amortization of
intangibles......... 1,460,740 1,460,748 1,452,755 1,696,561 1,745,163
Loss from operations..... (11,374,592) (11,640,075) (12,102,512) (7,747,803) (6,485,955)
Other income, net........ 1,190,124 2,053,838 2,160,377 768,744 762,031
Gain on sale of Research
Products Business...... -- -- -- 2,720,389 --
Net loss................. (10,184,468) (9,586,237) (9,942,135) (4,258,670) (5,723,924)
Basic loss per share..... (0.48) (0.44) (0.50) (0.25) (0.35)
Weighted average number
of shares of common
stock outstanding...... 21,372,655 21,604,344 19,712,274 16,757,370 16,335,000
SEPTEMBER 30,
----------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ----------- -----------
Balance Sheet Data:
Cash and short-term
investments............ $ 24,418,281 $ 31,834,669 $ 47,542,745 $26,786,566 $18,157,891
Accounts receivable...... 1,720,737 1,215,672 2,031,950 1,320,015 3,032,839
Working capital.......... 22,268,346 29,612,616 47,181,407 26,127,781 21,208,145
Total assets............. 50,417,980 59,585,565 73,537,054 44,057,421 42,040,900
Stockholders' equity..... 43,059,246 52,944,868 68,286,959 40,549,636 38,656,314
</TABLE>
- ---------------
(a) During fiscal 1998, the Company entered into collaborative agreements with
Fujirebio and Vanderbilt, expanded its co-venture agreement with Anaderm,
and entered into a license agreement with Aurora (See Notes 2, 5(b), 5(c),
and 5(n) to the Consolidated Financial Statements).
(b) During fiscal 1997, the Company entered into collaborative agreements with
Sankyo and Bayer, expanded its collaboration with HMRI, entered into
co-venture agreements with Sepracor and Helicon, entered into a license
agreement with Dow, and repurchased its Common Stock held by Becton,
Dickinson and Company (See Notes 3(d), 5 and 9(a) to the Consolidated
Financial Statements).
(c) During fiscal 1996, the Company acquired MYCOsearch and Aston and completed
an offering of its Common Stock (See Notes 3 and 9(b) to the Consolidated
Financial Statements).
(d) During fiscal 1995, the Company sold its Research Products Business and also
sold shares of its Common Stock to Novartis.
(e) During fiscal 1994, the Company changed its method of accounting for
marketable securities to adopt the provisions of the Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt
and Equity Securities."
27
<PAGE> 29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
REVENUES
Total revenues of $19.5 million in fiscal 1998 increased approximately $4.7
million or 32% compared to fiscal 1997 and total revenues of $14.8 million in
fiscal 1997 increased approximately $5.1 million or 52% compared to fiscal 1996.
Collaborative program revenues increased approximately $4.0 million or 32%, in
fiscal year 1998 due to the commencement on October 1, 1997 of the funded phase
of the collaborative research and license agreement among the Company, Anaderm
and Pfizer as well as an increased level of research in the collaborative
program with Sankyo to discover and develop novel pharmaceutical products to
treat influenza. This increase in revenues was partially offset by a decrease in
revenues related to the Company's collaborative program with HMRI to discover
and develop small molecules that induce gene expression of the protein
erythropoietin. This decrease in revenues attributable to the Company's receipt
of a $1 million initiation fee from HMRI for the erythopoletin program in the
second quarter of fiscal 1997 reduced funding in connection with the extension
of the first phase of this program in April 1998. This program did not achieve
sufficient positive data to warrant further development. Consequently, in
October 1998, this program was terminated. The increase in revenue was also
offset by the completion in fiscal 1997 of the funded discovery phase of the
Company's collaborative program with Wyeth-Ayerst Laboratories ("Wyeth")
relating to the discovery and development of drugs for the treatment of diabetes
and osteoporosis.
Sales revenue, representing primarily service revenue from the
pharmaceutical division of the Company's Aston subsidiary, which the Company
acquired in September 1996, decreased approximately $46,000 or 4% compared to
the prior year. The decrease was primarily due to the Company's decision to
devote certain of Aston's resources to internal programs as opposed to sales
outside the Company. Other research revenues, representing primarily government
grants and other research grants, increased approximately $20,000 or 1% compared
to the prior fiscal year. The Company recognized license revenue of
approximately $752,000 for the year ended September 30, 1998. This revenue is
primarily related to the signing of a license agreement in May 1998 with Aurora
covering the Company's gene transcription patent estate. Under the terms of the
agreement, the Company received 75,000 shares of Aurora common stock with a fair
market value of approximately $400,000 and $300,000 in cash for Aurora's
non-exclusive license and certain sub-licensing rights to the Company's reporter
gene patent, and options to the Company's Methods of Modulation patent. The
Company may enter into additional licensing agreements for these patents in the
future.
The increase in total revenues of approximately $5.1 million in fiscal 1997
compared to fiscal 1996 was attributable to the new collaborative research and
license agreements with each of: (1) HMRI, to develop drugs for the treatment of
chronic anemia; (2) Sankyo to discover and develop novel pharmaceutical products
to treat influenza; and (3) Bayer for the continuing development of serum-based
cancer diagnostics. Also contributing to the increase in total revenues is the
sales revenues related to the inclusion of the Company's Aston subsidiary. The
increase in revenues was partially offset by a decrease in revenues related to
the completion on December 31, 1996 of the funded discovery phase of the
Company's collaborative program with Wyeth relating to the discovery and
development of drugs for the treatment of diabetes and osteoporosis and the
completion on September 30, 1996 of the funded collaboration with Becton,
Dickinson and Company ("Becton") relating to the development of serum-based
cancer diagnostics.
EXPENSES
Research and development expenses increased by approximately $3.5 million
or 20% in fiscal 1998 compared to fiscal 1997 and increased by approximately
$3.0 million or 21% in fiscal 1997 compared to fiscal 1996. The increase in
fiscal 1998 was due to the expansion of the Company's joint venture with Anaderm
for the discovery and development of novel compounds to treat pigmentation
disorders, wrinkles and baldness and the collaborative agreement with Sankyo for
the discovery and development of novel pharmaceutical products
28
<PAGE> 30
to treat influenza, which commenced in February 1997. In addition, research and
development expenses include the amortization of the Company's compound library
assets which increased by approximately $70,000 to $1.8 million in fiscal 1998
reflecting a full year of amortization of the Dow Compound Library License
acquired in March 1997.
The increase in fiscal 1997 was due to the expansion of the Company's joint
ventures with Anaderm and BioChem Pharma, and the new collaborative agreements
with Sankyo and HMRI. Although the Company incurred expense in connection with
its serum-based cancer diagnostic collaboration with Bayer, these expenses
generally were offset by the elimination of expenditures with respect to (i) the
Company's former tissue-based cancer diagnostics collaboration with Becton,
which expired on September 30, 1996 and (ii) the discovery and development of
drugs for the treatment of diabetes and osteoporosis by Wyeth which was competed
December 31, 1996. Also contributing to the increase in expenses were costs
associated with the expansion of the Company's natural products discovery and
medicinal chemistry operations at its MYCOsearch acquired in April 1996 and
Aston subsidiaries. In addition, research and development expenses included the
amortization of the Company's compound library assets which increased by
approximately $600,000 in fiscal 1997 reflecting a full year of amortization of
the fungi cultures acquired upon the acquisition of MYCOsearch.
Production and service costs increased approximately $320,000 and $501,000
in fiscal 1998 and 1997, respectively. The increase in fiscal 1998 is primarily
related to increases in diagnostic costs in preparation for launching the
Company's new serum based cancer diagnostic products. The OSDI division (a
wholly-owned subsidiary of the Company), through a partnership with Bayer,
expects to seek FDA approval for its Her-2/neu serum kits during fiscal 1999. In
addition, other new assays are also being developed that the Company believes
will provide oncologists with essential information necessary to determine which
patients will respond best to the newly developed therapies directed at
oncogenes and tumor suppressor genes. The increase in fiscal 1997 was due to the
acquisition of Aston's pharmaceutical development business.
Selling, general and administrative expenses increased approximately
$652,000 or 9% in fiscal 1998 compared to fiscal 1997. Selling, general and
administrative expenses increased approximately $1.1 million or 18% in fiscal
1997 compared to fiscal 1996. The increase between fiscal 1998 compared to
fiscal 1997 were primarily related to the expenses associated with the expansion
of the Company's Aston and OSDI subsidiaries. The Aston facility has expertise
in pharmacokinetics and pharmaceutical chemistry and the management and
generation of GMP accredited data as generally required for regulatory
submissions to agencies such as the FDA. The Company has invested significant
resources in expanding the drug development capabilities of this division. In
addition, the Company invested in the sales and marketing resources of its OSDI
(Diagnostics division) in preparation for launching its new serum based cancer
diagnostic products. The increases between fiscal 1997 compared to fiscal 1996
were primarily related to the expenses associated with the Company's general and
administrative costs associated with the expansion of the Company's recently
acquired subsidiaries.
Amortization of intangibles in fiscal 1998, 1997, and 1996 represents
amortization of patents and goodwill that resulted from the acquisition of the
cancer diagnostic business of Applied bioTechnology, Inc. in fiscal 1991 and
Aston in fiscal 1996. The goodwill related to Applied bioTechnology, Inc.
approximated $686,000 per annum and was fully amortized as of September 1996.
Amortization expense in fiscal 1997 includes the first year of amortization of
the goodwill from the acquisition of Aston totaling $694,000.
OTHER INCOME AND EXPENSE
Net investment income decreased approximately $625,000 or 30% in fiscal
1998 compared to fiscal 1997 and $70,000 or 3% in fiscal 1997 compared to fiscal
1996. This decrease was a result of the decline in principal balance invested.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, working capital (representing primarily cash, cash
equivalents and short-term investments) aggregated approximately $21.9 million.
The Company is dependent upon collaborative research
29
<PAGE> 31
revenues, government research grants, interest income and cash balances, and
will remain so until products developed from its technology are successfully
commercialized.
The Company believes that with the funding from its collaborative research
programs, government research grants, interest income, and cash balances, its
financial resources are adequate for its operations for approximately the next
four years based on its current business plan even if no milestone payments or
royalties are received during this period. However, the Company's capital
requirements may vary as a result of a number of factors, including, but not
limited to, competitive and technological developments, funds required for
further expansion or enhancement of the Company's technology platform,
(including possible additional joint ventures, collaborations and acquisitions),
potential milestone payments, and the time and expense required to obtain
governmental approval of products, some of which factors are beyond the
Company's control.
One of the Company's strategic objectives is to manage its financial
resources and the growth of its drug discovery and development programs so as to
balance its proprietary efforts and funded collaborations. In pursuing this
objective, the Company in fiscal 1998 has expanded the scope of its discovery
and development activities without significantly increasing its rate of cash
consumption. The Company expects to continue its current level of expenditures
and capital investment over the next several years to enhance its drug discovery
technologies and pursue internal proprietary drug discovery programs.
There can be no assurance that scheduled payments will be made by third
parties, that current agreements will not be canceled, that government research
grants will continue to be received at current levels, that milestone payments
will be made, or that unanticipated events requiring the expenditure of funds
will not occur. Further, there can be no assurance that the Company will be able
to obtain any additional required funds on acceptable terms, if at all. Failure
to obtain additional funds when required would have a material adverse effect on
the Company's business, financial condition and results of operations.
YEAR 2000
The Company is aware of the challenges associated with the inability of
certain systems to properly format information after December 31, 1999. The
Company is currently working to resolve the potential impact of the Year 2000
problem on the processing of date-sensitive information by the Company's
computerized information systems. The Year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define an
applicable year. Substantially all of the Company's biology and chemistry
databases are stored on Oracle tables and ISIS chemical structure databases,
which are Year 2000 compliant, as are its Novell network servers. The Company is
currently converting its financial records to an Oracle based system and is in
the process of implementing a new planning and budgeting package, both of which
are Year 2000 compliant. The Company expects these systems to be operational by
December 31, 1999. The Company believes it will fully remediate any of its Year
2000 programs in advance of the Year 2000 and does not anticipate any material
disruption in its operations as the result of any failure by the Company to
fully remediate such programs. Based on current information, the cost of
addressing remaining potential Year 2000 problems associated with the Company's
internal systems and operations are not expected to have a material adverse
impact to the Company's financial position, results of operations, or cash flows
in future periods.
The Company has not conducted an evaluation of the extent to which the
operations of the material third parties with whom it regularly deals may be
disrupted by any Year 2000 non-compliance of any of their systems. These third
parties include the Company's collaborative partners and its suppliers and
vendors. Disruption of the operations of any of its partners could delay or halt
important research and development programs, cause the loss of data or have
other unforeseen consequences. The Company is currently planning to contact all
significant collaborators, suppliers, vendors and financial institutions in
order to identify potential areas of concern. It is anticipated that this
inquiry will be completed during the second quarter of fiscal 1999. Year 2000
problems experienced by the Company's suppliers and vendors could cause a
disruption of the Company's operations. The Company currently is unable to
estimate the likelihood of any of these risks being realized, or if realized,
the impact they may have on the Company. Any such occurrence could have a
material adverse effect on the Company's business, financial condition and
results of operations.
30
<PAGE> 32
If necessary, the Company intends to create a contingency plan to identify
and document potential business disruptions and continuity planning procedures.
The focus of this activity would be on potential failures of external systems
required to carry out normal business operations including services provided by
the public infrastructure such as, but not limited to, power, electric,
transportation and telecommunications. The Company expects this activity to be
on an on-going process throughout fiscal 1999.
NEW ACCOUNTING PRONOUNCEMENT
In February 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 132 "Employers'
Disclosures about Pensions and Other Postretirement Benefits", which revises
current disclosures about pension and other postretirement benefit plans. It
does not change the measurement or recognition of those plans. SFAS No. 132: (1)
standardizes the disclosure requirements for pension and other postretirement
benefits to the extent practicable; (2) requires additional information on
changes in the benefit obligations and fair values of plan assets that will
facilitate financial analysis; (3) eliminates certain disclosures that are no
longer useful; (4) suggests combined formats for presentation of pension and
other postretirement benefits; and (5) permits reduced disclosures for nonpublic
entities. SFAS No. 132 is effective for fiscal years beginning after December
15, 1997. These standards expand or modify current disclosures and, accordingly,
will have no impact on the Company's reported financial position, results of
operations and cash flows.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative and
Hedging Activities." SFAS No. 133 establishes a comprehensive standard on
accounting for derivatives and hedging activities and is effective for periods
beginning after June 15, 1999. Management does not believe that the future
adoption of SFAS No. 133 will have a material effect on the Company's financial
position and results of operations.
FORWARD LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Item 1 "Business" and elsewhere in this report that are not
historical or current facts deal with potential future circumstances and
developments. The discussion of such matters and subject areas is qualified by
the inherent risks and uncertainties surrounding future expectations generally,
and such discussion may materially differ from the Company's actual future
experience involving any one or more of such matters and subject areas. These
forward looking statements are also subject generally to the other risks and
uncertainties that are described in this report in Item 1
"Business -- Cautionary Factors for Consideration in Connection with Forward
Looking Statements."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company's cash flow and earnings are subject to fluctuations due to
changes in interest rates in its investment portfolio of debt securities, to the
fair value of equity instruments held, and, to an immaterial extent, to foreign
currency exchange rates. The Company maintains an investment portfolio of
various issuers, types and maturities. These securities are generally classified
as available-for-sale and, consequently, are recorded on the balance sheet at
fair value with unrealized gains or losses reported as a separate component of
stockholders' equity. The Company's investments in certain biotechnology
companies are carried on either the equity method of accounting or at cost for
equity securities that do not have readily determinable fair values.
Other-than-temporary losses are recorded against earnings in the same period the
loss was deemed to have occurred. The Company does not currently hedge this
exposure and there can be no assurance that other-than-temporary losses will not
have a material adverse impact on the Company's results of operations in the
future.
31
<PAGE> 33
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
PAGE
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS: NUMBER
<S> <C>
Independent Auditors' Report................................ 33
Consolidated Balance Sheets -- September 30, 1998 and
1997. .................................................... 34
Consolidated Statements of Operations -- Years ended
September 30, 1998, 1997 and 1996. ....................... 35
Consolidated Statements of Stockholders' Equity -- Years
ended September 30, 1998, 1997 and 1996. ................. 36
Consolidated Statements of Cash Flows -- Years ended
September 30, 1998, 1997 and 1996. ....................... 37
Notes to Consolidated Financial Statements.................. 38
</TABLE>
32
<PAGE> 34
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
OSI Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of OSI
Pharmaceuticals, Inc. and subsidiaries (the "Company") as of September 30, 1998
and 1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the years in the three-year period ended
September 30, 1998. 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of OSI
Pharmaceuticals, Inc. and subsidiaries at September 30, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended September 30, 1998 in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
Melville, New York
December 4, 1998
33
<PAGE> 35
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................... $11,315,166 $ 8,636,634
Short-term investments...................................... 13,103,115 23,198,035
Receivables, including trade receivables of $258,905 and
$350,100 at September 30, 1998 and 1997, respectively..... 1,720,737 1,215,672
Interest receivable......................................... 283,908 475,800
Grants receivable........................................... 406,149 179,740
Prepaid expenses and other.................................. 788,496 820,151
----------- -----------
Total current assets.............................. 27,617,571 34,526,032
----------- -----------
Property, equipment and leasehold improvements -- net....... 7,996,555 7,752,286
Compound library assets -- net.............................. 5,515,517 6,800,406
Loans to officers and employees............................. 6,433 34,317
Other assets................................................ 1,557,903 1,287,782
Intangible assets -- net.................................... 7,724,001 9,184,742
----------- -----------
$50,417,980 $59,585,565
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses....................... $ 4,232,540 $ 4,180,039
Current portion of unearned revenue......................... 1,116,685 733,377
----------- -----------
Total current liabilities......................... 5,349,225 4,913,416
----------- -----------
Other liabilities:
Loan payable................................................ 49,326 151,985
Deferred acquisition costs.................................. 670,916 630,796
Accrued postretirement benefit cost......................... 1,289,267 944,500
----------- -----------
Total liabilities................................. 7,358,734 6,640,697
----------- -----------
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares authorized,
22,288,583 shares issued at September 30, 1998 and
22,262,220 shares issued at September 30, 1997............ 222,886 222,622
Additional paid-in capital.................................. 104,963,082 104,864,056
Accumulated deficit......................................... (55,842,181) (45,657,713)
Cumulative translation adjustments.......................... (18,755) (101,531)
Unrealized holding gain (loss) on short-term investments.... 19,080 (97,700)
----------- -----------
49,344,112 59,229,734
Less: treasury stock, at cost; 897,838 shares at September
30, 1998 and 1997......................................... (6,284,866) (6,284,866)
----------- -----------
Total stockholders' equity........................ 43,059,246 52,944,868
----------- -----------
Commitments and contingencies............................... $50,417,980 $59,585,565
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE> 36
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
-------------------------------------------
1998 1997 1996
------------ ----------- ------------
<S> <C> <C> <C>
Revenues:
Collaborative program revenues, principally from
related parties.............................. $ 16,165,613 $12,200,801 $ 8,347,560
Sales........................................... 1,121,449 1,167,604 105,356
Other research revenue.......................... 1,428,853 1,408,918 1,265,521
Patent license fees............................. 752,422 -- --
------------ ----------- ------------
19,468,337 14,777,323 9,718,437
------------ ----------- ------------
Expenses:
Research and development........................ 20,350,063 16,896,617 13,918,968
Production and service costs.................... 955,464 635,768 134,529
Selling, general and administrative............. 8,076,662 7,424,265 6,314,697
Amortization of intangibles..................... 1,460,740 1,460,748 1,452,755
------------ ----------- ------------
30,842,929 26,417,398 21,820,949
------------ ----------- ------------
Loss from operations......................... (11,374,592) (11,640,075) (12,102,512)
------------ ----------- ------------
Other income (expense):
Net investment income........................... 1,467,412 2,092,331 2,162,294
Other expense -- net............................ (277,288) (38,493) (1,917)
------------ ----------- ------------
Net loss.......................................... $(10,184,468) $(9,586,237) $ (9,942,135)
============ =========== ============
Weighted average number of shares of common stock
outstanding..................................... 21,372,655 21,604,344 19,712,274
============ =========== ============
Basic loss per weighted average share of common
stock outstanding............................... $ (.48) $ (.44) $ (.50)
============ =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE> 37
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
UNREALIZED
HOLDING
COMMON STOCK ADDITIONAL CUMULATIVE GAIN (LOSS)
--------------------- PAID-IN ACCUMULATED TRANSLATION ON SHORT-TERM TREASURY
SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT INVESTMENTS STOCK
---------- -------- ------------ ------------ ----------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT SEPTEMBER 30, 1995.... 17,683,047 $176,830 $ 66,735,375 $(26,129,341) $(55,669) $ (35,000) $ (142,559)
Options exercised................ 491,544 4,915 1,640,653 -- -- -- --
Issuance of common stock for
employee purchase plan......... 3,860 39 10,214 -- -- -- --
Unrealized holding loss on short-
term investments............... -- -- -- -- -- (170,193) --
Sale of common stock............. 3,618,750 36,188 30,293,757 -- -- -- --
Issuance of common stock and
treasury stock for
acquisitions................... 378,013 3,780 5,667,232 -- -- -- 142,559
Translation adjustment........... -- -- -- -- 50,314 -- --
Net loss......................... -- -- -- (9,942,135) -- -- --
---------- -------- ------------ ------------ -------- --------- -----------
BALANCE AT SEPTEMBER 30, 1996.... 22,175,214 221,752 104,347,231 (36,071,476) (5,355) (205,193) --
Options exercised................ 74,618 746 407,503 -- -- -- --
Issuance of common stock for
employee purchase plan......... 12,388 124 74,456 -- -- -- --
Unrealized holding gain on short-
term investments............... -- -- -- -- -- 107,493 --
Purchase of treasury stock....... -- -- -- -- -- -- (8,750,000)
Issuance of treasury stock for
Dow Compound Library License... -- -- 34,866 -- -- -- 2,465,134
Translation adjustment........... -- -- -- -- (96,176) -- --
Net loss......................... -- -- -- (9,586,237) -- -- --
---------- -------- ------------ ------------ -------- --------- -----------
BALANCE AT SEPTEMBER 30, 1997.... 22,262,220 222,622 104,864,056 (45,657,713) (101,531) (97,700) (6,284,866)
Options exercised................ 5,699 57 24,007 -- -- -- --
Issuance of common stock for
employee purchase plan......... 20,664 207 75,019 -- -- -- --
Unrealized holding gain on short-
term investments............... -- -- -- -- -- 116,780 --
Translation adjustment........... -- -- -- -- 82,776 -- --
Net loss......................... -- -- -- (10,184,468) -- -- --
---------- -------- ------------ ------------ -------- --------- -----------
BALANCE AT SEPTEMBER 30, 1998.... 22,288,583 $222,886 $104,963,082 $(55,842,181) $(18,755) $ 19,080 $(6,284,866)
========== ======== ============ ============ ======== ========= ===========
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
<S> <C>
BALANCE AT SEPTEMBER 30, 1995.... $ 40,549,636
Options exercised................ 1,645,568
Issuance of common stock for
employee purchase plan......... 10,253
Unrealized holding loss on short-
term investments............... (170,193)
Sale of common stock............. 30,329,945
Issuance of common stock and
treasury stock for
acquisitions................... 5,813,571
Translation adjustment........... 50,314
Net loss......................... (9,942,135)
------------
BALANCE AT SEPTEMBER 30, 1996.... 68,286,959
Options exercised................ 408,249
Issuance of common stock for
employee purchase plan......... 74,580
Unrealized holding gain on short-
term investments............... 107,493
Purchase of treasury stock....... (8,750,000)
Issuance of treasury stock for
Dow Compound Library License... 2,500,000
Translation adjustment........... (96,176)
Net loss......................... (9,586,237)
------------
BALANCE AT SEPTEMBER 30, 1997.... 52,944,868
Options exercised................ 24,064
Issuance of common stock for
employee purchase plan......... 75,226
Unrealized holding gain on short-
term investments............... 116,780
Translation adjustment........... 82,776
Net loss......................... (10,184,468)
------------
BALANCE AT SEPTEMBER 30, 1998.... $ 43,059,246
============
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE> 38
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
-----------------------------------------
1998 1997 1996
------------ ----------- ------------
<S> <C> <C> <C>
Cash flow from operating activities:
Net loss.................................................... $(10,184,468) $(9,586,237) $ (9,942,135)
Adjustments to reconcile net loss to net cash used in
operating activities:
(Gain) loss on sale of investments.......................... 45,847 36,523 (33,305)
Depreciation and amortization............................... 1,944,344 1,518,751 1,837,873
Amortization of library assets.............................. 1,811,583 1,101,509 458,962
Amortization of intangibles................................. 1,460,740 1,460,739 1,452,755
Amortization of deferred acquisition costs.................. 40,120 40,121 --
Cashless exercise of stock options.......................... -- 126,600 --
Common stock received for patent license fee................ (402,422) -- --
Foreign exchange (gain) loss................................ 82,776 (96,176) 50,314
Changes in assets and liabilities, net of the effects of
acquisitions of MYCOsearch and Aston Molecules:
Receivables............................................... (505,065) 816,278 (412,935)
Interest receivable....................................... 191,892 4,250 (434,787)
Grants receivable......................................... (226,409) 151,274 102,516
Prepaid expenses and other................................ 31,655 (196,324) (105,677)
Other receivable.......................................... -- -- 262,703
Other assets.............................................. 6,079 (72,514) (108,949)
Accounts payable and accrued expenses..................... 52,501 493,401 391,857
Unearned revenue.......................................... 383,308 487,339 (69,842)
Accrued postretirement benefit cost....................... 344,767 301,000 277,297
------------ ----------- ------------
Net cash used by operating activities....................... (4,922,752) (3,413,466) (6,273,353)
------------ ----------- ------------
Cash flows from investing activities:
Additions to short-term investments....................... (4,004,770) (4,019,935) (37,216,936)
Maturities and sales of short-term investments............ 14,573,046 15,025,749 11,814,126
Change in other assets.................................... (276,200) (914,319) 150,000
Additions to property, equipment and leasehold
improvements............................................ (2,188,613) (2,775,925) (2,421,040)
Additions to compound library assets...................... (526,694) (353,332) --
Payments for acquisition of MYCOsearch.................... -- -- (1,889,960)
Payments for acquisition of Aston Molecules............... -- -- (635,441)
Net change in loans to officers and employees............. 27,884 3,025 (11,826)
------------ ----------- ------------
Net cash provided by (used in) investing activities....... 7,604,653 6,965,263 (30,211,077)
------------ ----------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net............... -- -- 30,329,945
Purchase of treasury stock................................ -- (8,750,000) --
Proceeds from exercise of stock options and employee stock
purchase plan........................................... 99,290 356,230 1,655,821
Net change in loan payable................................ (102,659) 68,741 (11,079)
------------ ----------- ------------
Net cash provided by (used in) financing activities....... (3,369) (8,325,029) 31,974,687
------------ ----------- ------------
Net increase (decrease) in cash and cash equivalents...... 2,678,532 (4,773,232) (4,509,743)
Cash and cash equivalents at beginning of year.............. 8,636,634 13,409,866 17,919,609
------------ ----------- ------------
Cash and cash equivalents at end of year.................... $ 11,315,166 $ 8,636,634 $ 13,409,866
============ =========== ============
Non-cash activities:
Issuance of common stock, treasury stock and warrants for
acquisition of MYCOsearch and Aston Molecules............. -- -- $ 5,816,736
============ =========== ============
Liabilities assumed from acquisition of MYCOsearch and Aston
Molecules................................................. -- -- $ 563,402
============ =========== ============
Deferred purchase obligation incurred for acquisition of
Aston Molecules........................................... -- -- $ 590,675
============ =========== ============
Issuance of treasury stock for acquisition of Dow Compound
Library License........................................... -- $ 2,500,000 --
============ =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE> 39
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The consolidated financial statements of the Company include the accounts
of OSI Pharmaceuticals, Inc., known as Oncogene Science, Inc. prior to October
1, 1997, and its wholly-owned subsidiaries Applied bioTechnology, Inc. ("Applied
bioTechnology"), MYCOsearch, Inc. ("MYCOsearch"), Oncogene Science Diagnostics,
Inc. and Aston Molecules Ltd. ("Aston"). All intercompany balances and
transactions have been eliminated. The Company utilizes a platform of
proprietary technologies in order to discover and develop novel, small molecule
compounds for the treatment of major human diseases. It conducts the full range
of drug discovery activities, from target identification to drug candidate.
(b) Revenue Recognition
Collaborative research revenues represent funding arrangements for the
conduct of research and development ("R&D") in the field of biotechnology and
are recognized when earned in accordance with the terms of the contracts and the
related development activities undertaken. Other research revenues are
recognized pursuant to the terms of grants which provide reimbursement of
certain expenses related to the Company's other R&D activities. Collaborative
and other research revenues are accrued for expenses incurred in advance of the
reimbursement and deferred for cash payments received in advance of
expenditures. Such deferred revenues are recorded as revenue when earned (See
Note 5). Patent license fee revenues are recognized pursuant to the terms of the
license agreement.
Revenue from the sale of diagnostic and research reagent products is
recognized at time of shipment. Revenues from the performance of chemistry
services provided by Aston are recognized when performed.
(c) Patents and Goodwill
As a result of the Company's research and development programs, including
programs funded pursuant to the research and development funding agreements (See
Note 5), the Company has applied for a number of patents in the United States
and abroad. Such patent rights are of significant importance to the Company to
protect products and processes developed. Costs incurred in connection with
patent applications for the Company's research and development programs have
been expensed as incurred.
Patents and goodwill acquired in connection with the acquisition of Applied
bioTechnology's cancer business in October 1991 have been capitalized and are
being amortized on a straight-line basis over the remaining lives of the
respective patents, and over five years for goodwill. The goodwill acquired in
connection with the acquisition of Aston in September 1996 is being amortized on
a straight-line basis over five years (See Note 3). The Company continually
evaluates the recoverability of its intangible assets by assessing whether the
unamortized value can be recovered through expected future results.
(d) Research and Development Costs
Research and development costs are charged to operations as incurred and
include direct costs of research scientists and equipment and an allocation of
laboratory facility and central service. In fiscal years 1998, 1997, and 1996,
R&D activities include approximately $5,772,000, $5,052,000 and $6,365,000 of
independent R&D, respectively. Independent R&D represents those research and
development activities, including research and development activities funded by
government research grants, substantially all the rights to which the Company
will retain. The balance of research and development represents expenses under
the collaborative agreements and co-ventures with Pfizer Inc. ("Pfizer"), The
Bayer Corporation ("Bayer"), Fujirebio, Inc. ("Fujirebio"), Anaderm Research
Corp. ("Anaderm"), Sankyo Company, Ltd. ("Sankyo"), Hoechst Marion Roussel, Inc.
("HMRI"), Helicon Therapeutics, Inc. ("Helicon"), Novartis Pharma AG
38
<PAGE> 40
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
("Novartis"), Becton, Dickinson and Company ("Becton"), Wyeth-Ayerst, a division
of American Home Products ("Wyeth"), BioChem Pharma (International) Inc.
("BioChem Pharma"), and Sepracor, Inc, ("Sepracor"). HMRI was formed on July 18,
1995 pursuant to the merger of Marion Merrell Dow Inc. ("Marion"), Hoechst AG,
and Hoechst-Roussel Pharmaceuticals, Inc. ("Hoechst Roussel").
(e) Depreciation and Amortization
Depreciation of equipment is provided over the estimated useful lives of
the respective asset groups on a straight-line basis. Leasehold improvements are
amortized on a straight-line basis over the lesser of the estimated useful lives
or the remaining term of their lease.
Amortization of the fungal cultures acquired in connection with the
acquisition of MYCOsearch (See Note 3(a)), and amortization of the Dow Compound
Library License (See Note 3(d)) are on a straight-line basis over five years,
which represents the estimated period over which the fungal cultures and
compounds will be used in the Company's R&D efforts.
(f) Income Taxes
Income taxes are accounted for 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.
(g) Investments
Investment securities at September 30, 1998 and 1997 consist of U.S.
Treasury obligations and corporate debt and equity securities. The Company
classifies its investments as available-for-sale. These securities are recorded
at their fair value. Unrealized holding gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from earnings and are
reported as a separate component of stockholders' equity until realized.
Realized gains and losses from the sale of available-for-sale securities are
determined on a specific identification basis.
A decline in the market value of any available-for-sale security below cost
that is deemed to be other than temporary results in a reduction in carrying
amount to fair value. The impairment is charged to earnings and a new cost basis
for the security is established. Premiums and discounts are amortized or
accreted over the life of the related held-to-maturity security as an adjustment
to yield using the effective interest method. Dividend and interest income are
recognized when earned.
(h) Net Loss Per Share
Effective October 1, 1997, the Company adopted the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share," which
replaced the calculation of primary and fully diluted earnings per share with
basic and diluted earnings per share. Basic loss per share is computed by
dividing the net loss by the weighted average number of common shares
outstanding during the period. Diluted loss per share is not presented because
the inclusion of common share equivalents (stock options and warrants) in the
computation would be anti-dilutive.
39
<PAGE> 41
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
(i) Cash and Cash Equivalents
The Company includes as cash equivalents reverse repurchase agreements,
treasury bills, and other time deposits with original maturities of three months
or less.
(j) Use of Estimates
Management of the Company has made a number of estimates and assumptions
relative to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these consolidated financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
(2) LICENSE AGREEMENT
Pursuant to a License Agreement effective May 26, 1998, the Company granted
to Aurora Biosciences Corporation ("Aurora") a non-exclusive worldwide license
to practice the technology under the Company's patent for live-cell gene
transcription assays utilizing a reporter gene. The Company also granted Aurora
an option to obtain a non-exclusive license to practice the technology under the
Company's patent concerning Methods of Modulation. The duration of each license
is to be coextensive with the life of the last to expire of the underlying
patents. Under the License Agreement, Aurora has the right to grant sublicenses.
The Company received 75,000 shares of Aurora's common stock with an estimated
discounted fair market value of $400,000 and a license fee of $300,000 upon
execution of the agreement. In addition, Aurora will pay the Company an annual
fee of $50,000, milestone payments and royalties on sales of products derived
from the licensed patents, if any. The Company has exclusive control over
prosecution, maintenance and enforcement of the patents subject to the
agreement.
(3) ACQUISITIONS AND COMPOUND LIBRARY LICENSE
(a) MYCOsearch, Inc.
On April 11, 1996, the Company acquired all the outstanding shares of
MYCOsearch, a privately owned company, that specializes in the collection of
fungal cultures and the development of extracts derived therefrom. On the date
of the acquisition, MYCOsearch became a wholly-owned subsidiary of the Company.
Prior to the acquisition, the Company had purchased extracts and certain
services from MYCOsearch. Such expenses totaled $301,000, in fiscal 1996
(through April 11, 1996) which are included in research and development expenses
in the accompanying consolidated statements of operations.
The purchase price paid by the Company to the shareholders of MYCOsearch
consisted of $1.75 million in cash, $2.95 million in common stock of the Company
(316,553 shares at $9.319 per share, of which 222,521 shares represented the
reissuance of shares held in treasury), and warrants to purchase 100,000 shares
of the Company's stock at $9.319 per share, valued at $483,000. The warrants are
exercisable for a three-year period starting on April 11, 1998. The Company also
incurred other direct costs totaling approximately $137,000 in connection with
the acquisition resulting in a total purchase price of $5.3 million.
40
<PAGE> 42
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
The acquisition has been accounted for using the purchase method of
accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based on the fair values at the
date of acquisition. The purchase price was allocated as follows (in thousands):
<TABLE>
<S> <C>
Fungi cultures.............................................. $5,508
Fixed assets................................................ 21
Other assets................................................ 16
Other liabilities........................................... (225)
------
Purchase price.............................................. $5,320
======
</TABLE>
The fungal cultures contain natural chemical structures that will be tested
against target proteins using the Company's drug screens. The Company is
amortizing the fungal cultures on a straight-line basis over a five-year period
and will continually evaluate the recoverability of this asset based on the
results of its testing. Amortization of the fungal cultures totaling $1,102,000,
1,102,000 and $459,000 for the fiscal years ended September 30, 1998, 1997 and
1996, respectively, is reflected as research and development expense in the
accompanying consolidated statement of operations.
(b) Aston Molecules Ltd.
On September 19, 1996, the Company completed the acquisition of all the
outstanding capital stock of Aston, a privately held United Kingdom company. On
the date of the acquisition, Aston became a wholly-owned subsidiary of the
Company. Its operations and personnel will be maintained at its present site in
Birmingham, UK.
The consideration paid for Aston included 283,981 shares of the Company's
common stock having a fair market value of approximately $2.4 million. In
addition, the Company also issued rights exercisable at the end of three and
five years following the closing date (for an aggregate exercise price of
$7,500) to obtain a number of shares of the Company's common stock having an
aggregate value of $750,000 (based on the then current market value). The
present value of this additional consideration of $670,916 and $630,796 is
reflected as deferred acquisition costs in the accompanying consolidated balance
sheet as of September 30, 1998 and 1997, respectively. Other direct costs of the
acquisition approximated $635,000 resulting in a total acquisition cost of $3.6
million.
The acquisition has been accounted for using the purchase method of
accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based on the fair values at the
date of acquisition. The purchase price was allocated as follows (in thousands):
<TABLE>
<S> <C>
Goodwill.................................................... $3,468
Fixed assets................................................ 181
Other assets................................................ 299
Other liabilities........................................... (338)
------
Purchase price.............................................. $3,610
======
</TABLE>
The goodwill resulting from the acquisition is being amortized on a
straight-line basis over a five year period. Prior to the acquisition, the
Company purchased certain chemistry services from Aston. Such expenses totaled
$879,000, in fiscal 1996 (through September 19, 1996) which are included in
research and development expenses in the accompanying consolidated statements of
operations.
Concurrent with the acquisition, the Company entered into employment
agreements with certain of Aston's executives and scientific personnel and
granted stock options covering an aggregate of 125,000 shares
41
<PAGE> 43
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
of its common stock to such persons. The exercise price of $8.51 per share was
based on the fair market value of the Company's stock on the date of the grant.
(c) Pro Forma Information (Unaudited)
The operating results of MYCOsearch and Aston have been included in the
consolidated statements of operations from the respective dates of the
acquisitions. The following unaudited pro forma information presents a summary
of consolidated results of operations for the year ended September 30, 1996
assuming the acquisitions had taken place as of October 1, 1995.
<TABLE>
<CAPTION>
1996
------------
<S> <C>
Revenues............................................... $ 10,566,000
Net loss............................................... (12,108,000)
Net loss per share..................................... (.61)
</TABLE>
The pro forma results give effect to the amortization of the fungi cultures
and goodwill, elimination of intercompany sales, reduction of investment income,
and an increase in the number of common shares outstanding. The pro forma
financial information is not necessarily indicative of the results of operations
as they would have been had the acquisitions been affected on the assumed dates.
(d) Compound Library License
On March 18, 1997, the Company entered into a license agreement with The
Dow Chemical Company ("Dow") giving the Company exclusive worldwide rights to
use more than 140,000 compounds for screening and potential development of small
molecule drugs and cosmeceuticals. The initial payment for the license was
352,162 shares of the Company's common stock with a fair market value of
approximately $2,500,000. Dow is also entitled, in certain instances where
pre-existing Dow patents are in effect, to royalty payments from any new drug
products that may result from the screening of the subset of the compound
library covered by such patents. The common stock issued to Dow was from the
shares held in treasury. The Company will amortize the license agreement cost on
a straight-line basis over a five-year period, which represents the estimated
period over which the compounds will be used in the Company's research and
development efforts. Since the Company did not conduct significant research
utilizing these compounds during fiscal 1997, the Company began amortizing the
license agreement cost in October 1997 and recorded $505,446 of amortization
expense in fiscal 1998.
(4) INVESTMENTS
The Company invests its excess cash in U.S. Government securities and debt
instruments of financial institutions and corporations with strong credit
ratings. The Company has established guidelines relative to diversification of
its investments and their maturities that should maintain safety and liquidity.
These guidelines are periodically reviewed and modified to take advantage of
trends in yields and interest rates. The Company uses the specific
identification method to determine the cost of securities sold.
42
<PAGE> 44
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
The following is a summary of available-for-sale securities as of September
30, 1998 and 1997:
<TABLE>
<CAPTION>
GROSS
UNREALIZED
1998 COST (LOSSES) GAINS FAIR VALUE
- ---- ----------- -------------- -----------
<S> <C> <C> <C>
US Treasury Securities and obligations of
US Government agencies................... $ 9,201,681 $(17,154) $ 9,184,527
Corporate debt securities.................. 3,479,932 36,234 3,516,166
Corporate equity securities................ 402,422 -- 402,422
----------- -------- -----------
Total............................ $13,084,035 $ 19,080 $13,103,115
=========== ======== ===========
</TABLE>
<TABLE>
<CAPTION>
GROSS
UNREALIZED
1997 COST (LOSSES) GAINS FAIR VALUE
- ---- ----------- -------------- -----------
<S> <C> <C> <C>
US Treasury Securities and obligations of
US Government agencies................... $14,869,695 $(126,253) $14,743,442
Corporate debt securities.................. 8,426,040 28,553 8,454,593
----------- --------- -----------
Total............................ $23,295,735 $ (97,700) $23,198,035
=========== ========= ===========
</TABLE>
Net realized losses on sales of investments during fiscal 1998 and 1997
were approximately $46,000 and $37,000 respectively.
The Company also has investments in certain biotechnology companies which
are included in other noncurrent assets in the accompanying balance sheets. The
net investments are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Anaderm Research Corp............................... $ 977,471 $ 677,471
Helicon Therapeutics, Inc........................... 200,000 123,800
Tularik Inc. in 1998; Amplicon Corp. in 1997........ 250,000 250,000
NuGene Technologies, Inc............................ -- 100,000
---------- ----------
$1,427,471 $1,151,271
========== ==========
</TABLE>
As further discussed in Note 5, the Company has collaborative research
agreements with Anaderm and Helicon and the investments are carried based on the
equity method of accounting. The investments in Tularik Inc. ("Tularik"),
Amplicon Corp. ("Amplicon"), and NuGene Technologies, Inc. ("NuGene") are
carried at cost and approximate fair market value. In November 1997, Amplicon
was acquired by Tularik. The Company's Amplicon securities were exchanged for
common shares of Tularik. During fiscal 1998, based on the recurring operating
losses of NuGene, the Company decided to fully reserve its investment in NuGene
in the amount of $125,000.
(5) PRODUCT DEVELOPMENT CONTRACTS
(a) Pfizer
Effective April 1, 1996, the Company and Pfizer renewed their ten-year-old
collaboration for a new five-year term by entering into new Collaborative
Research and License Agreements. Under these agreements, all patent rights and
patentable inventions derived from the research under this collaboration are
owned jointly by the Company and Pfizer. Under the collaborative research
agreement, Pfizer has committed to provide research funding to the Company in an
aggregate amount of approximately $18.8 million. Pursuant to a schedule set
forth in the collaborative research agreement, Pfizer will make maximum annual
research
43
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
funding payments to the Company, which will gradually increase from
approximately $3.5 million in the first year of the five-year term to
approximately $4 million in the fifth year. The collaborative research agreement
will expire on April 1, 2001. However, it may be terminated earlier by either
party upon the occurrence of certain defaults by the other party. Any
termination of the collaboration resulting from a Pfizer default will cause a
termination of Pfizer's license rights. Pfizer will retain its license rights if
it terminates the agreement in response to a default by the Company.
Furthermore, between July 1 and September 30, 1999, Pfizer may terminate the
collaborative research agreement, with or without cause, effective March 31,
2000. Upon such early termination by Pfizer, Pfizer will retain its license
rights. The Company also granted Pfizer an exclusive, worldwide license to make,
use, and sell the therapeutic products resulting from this collaboration in
exchange for royalty payments. This license terminates on the date of the last
to expire of the Company's relevant patent rights.
(b) Bayer
Effective January 1, 1997, the Company and Bayer entered into an agreement
to develop serum-based cancer diagnostic products. Under the agreement, the
Company granted to Bayer licenses to manufacture, use and sell clinical
diagnostic products based on the Company's cancer diagnostic technology in
exchange for royalties on net sales. Bayer will own all technology, and has the
exclusive right to commercialize automated clinical diagnostic products derived
from the collaboration. OSI has retained rights and is actively selling non-
automated, or manual, versions of these tests to the clinical research market
and has retained the right to commercialize automated the manual versions in the
clinical diagnostic market. Bayer's license is perpetual with respect to
non-patented technology and will terminate with respect to patented technology
upon the expiration of the last to expire of the Company's patents. Bayer will
provide funding for the Company's research under the collaboration in the amount
of $1.5 million for each of the first two contract years, and $1 million for
each subsequent year. After the first two contract years, the Company will be
required to provide up to $500,000 in annual funding for the collaboration to
the extent the Company derives net revenues from out-licensing any cancer
diagnostics technology or the sale of any clinical diagnostic or clinical
research products. The agreement will terminate on December 31, 2002. Bayer has
the right to terminate the agreement at any time after December 31, 1997 upon 12
months notice. During fiscal 1998 and 1997, the Company recorded revenue of
approximately $1.5 million and $1.1 million, respectively, from Bayer pursuant
to this agreement.
(c) Fujirebio, Inc.
The Company, through its wholly-owned subsidiary, Oncogene Science
Diagnostics, Inc., entered into a Research Collaboration and License Agreement
with Fujirebio effective April 1, 1998, creating a collaborative program focused
on discovering and developing certain proprietary cancer assays and
commercializing cancer products. Under the agreement, Fujirebio is to fund the
Company's research and development of cancer assays over a four-year term. The
Company is to provide Fujirebio with antibodies, antigens and other substances
necessary to manufacture the diagnostic products derived from the collaboration.
Further, the Company has granted to Fujirebio a non-exclusive license to, among
other things, develop, manufacture and sell the products developed pursuant to
the collaboration in exchange for license fees and royalties on product sales.
The duration of the license is to be coextensive with the lives of the patents
related to the licensed products. Each of the parties has rights and obligations
to prosecute and maintain patent rights related to specified areas of the
research under the agreement. The agreement is subject to early termination by
either party in the event of certain defaults. During fiscal 1998, the Company
recorded $100,000 of revenue under this agreement.
44
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
(d) Anaderm
In April 1996, in connection with the formation of Anaderm, the Company
entered into a Stockholders' Agreement ("Stockholders' Agreement") among the
Company, Pfizer, Anaderm, New York University ("NYU") and certain NYU faculty
members ("Faculty Members"), and a Collaborative Research Agreement ("Research
Agreement") among the Company, Pfizer and Anaderm. Anaderm issued common stock
to Pfizer and the Company and options to purchase common stock to NYU and the
Faculty Members. NYU and the Faculty Members have exercised their options fully,
and Pfizer holds 82%, the Company holds 14%, and NYU and the Faculty Members
collectively hold 4% of Anaderm's common stock. In exchange for its 14% of the
outstanding shares of Anaderm common stock, the Company will provide formatting
for high throughput screens and will conduct compound screening for 18 months at
its own expense under the Research Agreement. The term of the Research Agreement
is three years. During the initial phase of the agreement (the first 18 months),
the Company was required to provide at its own cost formatting for high
throughput screens and perform screening of its own compounds and those
compounds provided by Pfizer. Upon the termination of the initial phase, the
Board of Directors of Anaderm made a determination that the initial phase was
successfully completed. With Pfizer's approval, the funded phase commenced on
October 1, 1997 and will continue for the term of the Research Agreement. During
this phase, Anaderm will make payments to the Company equal to its research
costs, including overhead, plus 10%. Anaderm or Pfizer will pay royalties to the
Company on the sales of products resulting from this collaboration. In December
1997, the Company and Pfizer entered into an agreement for a second round of
equity financing for Anaderm. The agreement called for an equity contribution of
$14 million, of which the Company will contribute $2 million in drug discovery
resources, including assay biology, high throughout screening, lead optimization
and chemistry, through 1999. Pfizer will contribute $12 million, approximately
$7 million of which will be used to support the Company in its ongoing drug
discovery activities. Through September 1998, the Company had contributed
$770,000 of its $2 million contribution in resources.
As of September 30, 1998, the Company has expended approximately $6.2
million, of which, $2.4 million has been capitalized as the cost of the
Company's 14% interest in Anaderm. This capitalized cost has been offset by
approximately $1.4 million which includes the Company's estimated interest in
the loss of Anaderm as of September 30, 1998 of $1.0 million and an additional
reserve of $400,000. The Company's net investment in Anaderm at September 30,
1998 of $977,000 is included in other assets in the accompanying consolidated
balance sheet. During fiscal 1998 and 1997, the Company recorded revenue of
approximately $3.5 million and $388,000, respectively, from Anaderm for
contracted research activities.
(e) Sankyo
Effective as of February 12, 1997, the Company entered into a Collaborative
Research and License Agreement with Sankyo to be conducted in partnership with
MRC Collaborative Center ("MRC CC"), London, U.K. The collaboration is focused
on discovering and developing novel pharmaceutical products to treat influenza.
The Company is responsible for conducting research as directed by a research
committee, including, without limitation, compound screening in exchange for
research funding from Sankyo. Sankyo has the responsibility and the exclusive
right to conduct pre-clinical and clinical development of all candidate
compounds in exchange for milestone payments to the Company. During 1997, the
Company received and recorded $267,000 for a non-refundable technology
disclosure fee upon signing the agreement. During fiscal 1998 and 1997, the
Company recorded revenue of approximately $2.6 million and $1.0 million,
respectively, from Sankyo pursuant to this agreement.
The Company and MRC CC have granted to Sankyo exclusive, worldwide licenses
to, among other things, use, manufacture and sell all products resulting from
the collaboration. In exchange for these licenses, Sankyo will pay to the
Company and MRC CC license fees and royalties on product sales. The duration of
the
45
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
licenses is coextensive with the lives of the patents related to the licensed
compound. If Sankyo discontinues development of all candidate compounds, the
Company will have the sole and exclusive right to develop, use, manufacture and
sell all products resulting from the collaboration, and it will pay royalties to
Sankyo.
(f) Hoechst Marion Roussel
Effective as of April 1, 1997, the Company and HMRI entered into an Amended
Collaborative Research and License Agreement that consolidated and extended
formerly separate collaborative programs between the Company and each of Marion,
Hoechst Roussel and Hoechst AG. This resulted from the corporate reorganization
of HMRI in July 1995 in which the pharmaceutical operations Marion, Hoechst
Roussel and Hoechst AG were combined into HMRI. This Amended Collaborative
Research and License Agreement provides for HMRI and the Company to collaborate
in the discovery and development of drugs for the treatment of various diseases.
Under this collaboration, a research committee, with equal representation
from the Company and HMRI, meets at least three times a year to evaluate the
progress of the research program, make priority and program decisions, and
prepare research plans identifying the drug targets to be pursued. New targets
are added to the program on an ongoing basis by mutual agreement. The Company is
responsible for achieving objectives outlined in the annual research plans. HMRI
is responsible for assisting the Company in the pursuit of such objectives and
for the clinical development and commercialization of drugs resulting from the
program. HMRI is responsible for funding the costs of the Company's discovery
efforts, and as of September 30, 1998, the Company had received or accrued an
aggregate of $20.4 million in research funding from HMRI and its predecessors.
The Company has granted to HMRI an exclusive, worldwide license (and rights
to acquire additional licenses) with respect to, among other things, the use,
manufacture and sale of products resulting from OSI's lead seeking efforts
against individual drug targets. In exchange for these licenses, HMRI will pay
royalties to the Company on sales of such products. The Company and HMRI have
mutually exclusive rights and obligations to prosecute and maintain certain
patent rights related to various specified areas of the research.
Effective as of January 1, 1997, the Company entered into a Collaborative
Research and License Agreement with HMRI to develop orally active, small
molecule inducers of erythropoietin gene expression for the treatment of anemia
due to chronic renal failure and anemia associated with chemotherapy for AIDS
and cancer. This collaboration identified active lead compounds that were
advanced to a pre-clinical development stage. During fiscal 1997, the Company
received and recorded as income a $1.0 million initiation fee from HMRI in
connection with this collaboration. This research effort, however, did not
achieve sufficient data to warrant further development. Consequently, in October
1998, this program was terminated.
(g) Helicon
In July 1997, the Company, Cold Spring Harbor Laboratory and Hoffman-La
Roche Inc. ("Roche") formed Helicon Therapeutics, Inc., a new Delaware
corporation. In exchange for approximately 30% of Helicon's outstanding capital
stock, the Company contributed to Helicon molecular screening services and a
nonexclusive license with respect to certain screening technology. Such services
were completed in fiscal 1998. Cold Spring Harbor Laboratory contributed a
royalty-free license to commercialize certain technology relating to genes
associated with long-term memory in exchange for a portion of Helicon's
outstanding capital stock. Roche contributed cash for a portion of Helicon's
outstanding capital stock. Certain individuals associated with Cold Spring
Harbor Laboratory hold the remaining outstanding capital stock of Helicon.
The parties have entered into various collaborative research and license
agreements pursuant to which they will jointly pursue the discovery, development
and commercialization of novel drugs for the treatment of
46
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
long-term memory disorders and other central nervous system dysfunctions. The
Company and Cold Spring Harbor Laboratory are to conduct research under the
program, which is being funded by Helicon (except for the molecular screening
services that the Company is contributing to Helicon). Helicon is to receive
this funding from Roche for the first two years of the program. Roche, however,
will have the right to terminate the program at the end of the second year, or
otherwise if certain milestones identified by the research committee are not
achieved. If the program is not previously terminated, Roche is to continue to
provide funding for the third year of the program, with the actual amount to be
determined by a research committee established to oversee the collaborative
program. Helicon has granted to Roche a worldwide license to commercialize
pharmaceutical products resulting from the collaborative program in exchange for
certain milestone payments and royalties on Roche's sales of such products.
As of September 30, 1998, the Company has expended approximately $1.2
million of which $1.0 million has been capitalized as the cost of the Company's
30% interest in Helicon. This capitalized cost has been offset by approximately
$800,000 which represents the Company's estimated interest in the loss of
Helicon as of September 30, 1998 of $370,000 and an additional reserve of
$430,000. The Company's net investment in Helicon at September 30, 1998 of
$200,000 is included in other assets in the accompanying consolidated balance
sheet. The Company recorded revenue of $203,000 from Helicon in fiscal 1998.
(h) Novartis
The Company entered into an agreement with Novartis Pharma AG ("Novartis")
in April 1995 for the development of TGF-Beta 3 for various indications.
TGF-Beta 3 is a naturally occurring human growth factor, first isolated by the
Company, that exerts either stimulatory or inhibitory effects depending upon the
particular cell type to which it is applied. This agreement granted to Novartis
an exclusive, worldwide license to use and sell TGF-Beta 3 products for wound
healing and oral mucositis, as well as certain other indications, in exchange
for royalty payments to the Company on the sale of TGF-Beta 3 products.
During 1998, Phase II clinical trials being conducted by Novartis for both
wound healing and oral mucositis failed to achieve their primary clinical end
points. Consequently, no further clinical development of TGF-Beta 3 by Novartis
for either wound healing or oral mucositis is anticipated. Novartis has an
option through April 1999 (which it has not yet exercised) to obtain exclusive
rights to all other indications for TGF-Beta 3 by making a $10 million payment
in exchange for the Company's Common Stock at the higher of $5.50 per share or
the then current market price. Novartis is currently conducting pre-clinical
evaluation of TGF-Beta 3 for bone repair. Novartis and the Company are currently
renegotiating this agreement to allow for the continued development of TGF-Beta
3 for this and other indications. The Company's agreement with Novartis ends
upon the expiration of the last of the Company's patents relating to TGF-Beta 3.
(i) Becton Dickinson
On October 4, 1991, the Company and Becton established a collaborative
research program to develop cancer diagnostic products. The Company and Becton
shared equally the cost of discovery phase and pre-clinical research and
development. This collaborative research program expired on September 30, 1996
and was not renewed. To the extent Becton commercializes any products derived
from this program, it will pay certain royalties to the Company on sales of such
products, if any.
(j) Wyeth-Ayerst
Effective December 31, 1991, the Company entered into a collaborative
research agreement with Wyeth. This agreement was extended and expanded in
January 1994 for an additional three years through December 31, 1996 to provide
for additional funding of approximately $4.3 million. The Company had received
approximately $1.6 million annually in research and development funding from
Wyeth pursuant to
47
<PAGE> 49
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
this collaborative agreement. The funded portions of the research collaboration
expired on December 31, 1996. To the extent Wyeth commercializes any products
derived from this collaboration, it will pay certain royalties to the Company on
sales of such products, if any.
(k) BioChem Pharma
fff Effective May 1, 1996, the Company entered into a Collaborative Research,
Development and Commercialization Agreement with BioChem Pharma. Under this
agreement, the parties were seeking to discover and develop anti-viral drugs for
the treatment of Hepatitis B virus, Hepatitis C virus and HIV. This agreement
provided that the Company and BioChem Pharma would jointly commit resources to
the collaborative program. During fiscal 1998 and 1997, the Company has
recognized $100,000 and $518,000 in revenue, respectively, which represents (i)
a $100,000 annual technology fee for the right to receive all available upgrades
and annual improvements to the equipment, software and license technology and
(ii) reimbursement for all out-of-pocket costs to build, deliver and install
robotic equipment at a BioChem Pharma location. The Company expects this
agreement to be terminated in the near future.
(l) Sepracor
Pursuant to an Amendatory and Collaborative Agreement dated March 31, 1998,
the Company and Sepracor amended their Collaborative Research Development and
Commercialization Agreement dated March 7, 1997, terminating certain provisions
contained therein, including, without limitation, provisions establishing the
research program. Each party will be free to independently pursue the discovery
of new compounds in the anti-infective area without incurring any responsibility
to the other party. To the extent Sepracor commercializes certain compounds
arising out of the joint venture, however, it will pay royalties to the Company.
The Company provided discovery biology and certain other services to Sepracor
until September 1, 1998, in exchange for fees. In fiscal 1998, the Company had
received approximately $197,000 in research and development funding from
Sepracor pursuant to this amended agreement.
(m) Xenometrix
On June 27, 1997, the Company and Xenometrix, Inc. ("Xenometrix") entered
into an agreement pursuant to which they will jointly seek a corporate partner
to fund a technology collaboration for the development of automated systems to
generate and analyze certain data relating to toxicological, metabolic and
undesirable systemic effects of drug candidates. The parties have cross-licensed
certain of their respective assay technologies on a worldwide, royalty-free
nonexclusive basis. The agreement is for a period of nine months, with automatic
successive three-month renewal periods.
(n) Vanderbilt
Effective as of April 28, 1998, the Company entered into a Collaborative
Research, Option and Alliance Agreement with Vanderbilt University
("Vanderbilt") to conduct a collaborative research program and seek a corporate
partner to fund a technology collaboration for the discovery and development of
drugs to treat diabetes. The collaborative research is funded by the Company in
exchange for which the Company has the option to negotiate a commercially
reasonable, worldwide, exclusive license from Vanderbilt to develop, make, use,
and sell, products derived from the research program. The Company and Vanderbilt
will commit equal resources to the program, including, among other things,
access to all their respective laboratory facilities and dedicated teams of
research scientists. The Company has certain rights and obligations to prosecute
and maintain patent rights related to specified areas of the research under the
agreement. The agreement is for a term of one year, but shall be automatically
extended upon the execution of a third-party research
48
<PAGE> 50
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
collaboration agreement for the term of such collaboration. Each party is
prohibited from entering, on its own without the other party, into a funded
collaboration agreement with a third-party for drug discovery in the area of
diabetes using certain targets which are the subject of the collaboration.
(o) Other
Under the terms of aforementioned collaborative research agreements, the
collaborative partners will pay the Company royalties ranging from 2% to 8% of
net sales of products resulting from these research programs. To date, the
Company has not received any royalties pursuant to these agreements. The Company
or its collaborative partners may terminate each of the collaborative research
programs upon the occurrence of certain events.
The Company does not intend to conduct late-stage clinical trials,
manufacturing or marketing activities with respect to any of its product
candidates in the foreseeable future. The Company is dependent on the companies
with which it collaborates for the pre-clinical testing, clinical development,
regulatory approval, manufacturing and marketing of potential products developed
under its collaborative research programs. The Company's collaborative
agreements allow its collaborative partners significant discretion in electing
to pursue or not to pursue any of these activities. The Company cannot control
the amount and timing of resources its collaborative partners devote to the
Company's programs or potential products. If any of the Company's collaborative
partners were to breach or terminate its agreements with the Company or
otherwise fail to conduct its collaborative activities successfully in a timely
manner, the pre-clinical or clinical development or commercialization of product
candidates or research programs could be delayed or terminated. Any such delay
or termination could have a material adverse effect on the Company's business,
financial condition and results of operations.
Total program research revenues under the aforementioned agreements are as
follows:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
----------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Related Parties:
Pfizer....................................... $ 3,682,056 $ 3,622,363 $3,208,077
HMRI......................................... 4,301,263 5,136,257 2,439,358
BioChem Pharma............................... 100,000 517,888 --
Becton....................................... -- -- 1,150,125
Anaderm...................................... 3,467,203 388,254 --
Helicon...................................... 203,437 -- --
----------- ----------- ----------
Total Related Parties.............. 11,753,959 9,664,762 6,797,560
Bayer........................................ 1,500,000 1,125,000 --
Sankyo....................................... 2,614,297 1,011,039 --
Sepracor..................................... 197,357 -- --
Fujirebio.................................... 100,000 -- --
Wyeth........................................ -- 400,000 1,550,000
----------- ----------- ----------
Total.............................. $16,165,613 $12,200,801 $8,347,560
=========== =========== ==========
</TABLE>
49
<PAGE> 51
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
Included in receivables are the following amounts due from related parties:
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------
1998 1997
---------- --------
<S> <C> <C>
Pfizer............................................... $ 125,975 $ 5,020
HMRI................................................. 74,623 178,310
Anaderm.............................................. 803,240 --
Helicon.............................................. 173,137 --
---------- --------
Total...................................... $1,176,975 $183,330
========== ========
</TABLE>
(6) PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements are recorded at cost and
consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
ESTIMATED -------------------------
LIFE (YEARS) 1998 1997
------------- ----------- ----------
<S> <C> <C> <C>
Laboratory equipment................ 5-15 $10,728,319 $9,073,179
Office furniture and equipment...... 5-10 3,945,292 3,587,698
Automobile equipment................ 3 122,775 152,474
Leasehold improvements.............. Life of lease 5,520,703 5,315,125
----------- ----------
20,317,089 18,128,476
Less: accumulated depreciation and
amortization...................... 12,320,534 10,376,190
----------- ----------
Net property, equipment and
leasehold improvements............ $ 7,996,555 $7,752,286
=========== ==========
</TABLE>
(7) INTANGIBLE ASSETS
The components of intangible assets are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Patents............................................. $5,643,401 $6,410,614
Goodwill............................................ 2,080,600 2,774,128
---------- ----------
$7,724,001 $9,184,742
========== ==========
</TABLE>
The above amounts reflect accumulated amortization of $6,757,655 and
$8,721,613 at September 30, 1998 and 1997, respectively. During fiscal 1996,
goodwill increased $3,467,656 in connection with the acquisition of Aston (See
Note 3(b)).
50
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
(8) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at September 30, 1998 and 1997 are
comprised of:
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Accounts payable.................................... $2,393,274 $2,411,133
Accrued future lease escalations.................... 446,137 448,137
Accrued payroll and employee benefits............... 350,831 367,242
Accrued incentive compensation...................... 625,000 615,000
Accrued expenses.................................... 417,298 338,527
---------- ----------
$4,232,540 $4,180,039
========== ==========
</TABLE>
(9) STOCKHOLDERS' EQUITY
(a) Stock Redemption
On February 18, 1997, the Company repurchased all 1.25 million shares of
the Company's common stock held by Becton for an aggregate price of $8.75
million. The Company's collaborative research agreement with Becton had ended on
its scheduled expiration date of September 30, 1996. See Note 5(i).
(b) Stock Offering
In April 1996, the Company completed a public offering for 3,118,750 shares
of common stock. The sale price was $9.125 per share. Concurrent with the public
offering, the Company sold 500,000 shares at $9.125 per share directly to
BioChem Pharma. The proceeds to the Company from these sales, net of
underwriting commissions and other costs, were approximately $30.3 million. The
net proceeds were added to the Company's general funds and are to be used for
research and development expenses, including funds for enhancing the Company's
drug discovery technologies and for general corporate purposes.
(c) Stock Option Plans
The Company has established four stock option plans for its employees,
officers, directors and consultants. The Plans are administered by the
Compensation Committee of the Board of Directors, which may grant either
non-qualified or incentive stock options. The Committee determines the exercise
price and vesting schedule at the time the option is granted. Options vest over
various periods and may expire no later than 10 years from date of grant. The
total authorized shares under these plans is 5,400,000.
51
<PAGE> 53
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
The following table summarizes changes in the number of common shares
subject to options in the stock option plans:
<TABLE>
<CAPTION>
EXERCISE PRICE
---------------------------------------
WEIGHTED
SHARES LOW HIGH AVERAGE
--------- ----- ----- --------
<S> <C> <C> <C> <C>
Balance at September 30, 1995
Unexercised......................................... 2,021,279 $1.75 $5.63 $3.75
Granted............................................. 776,000 7.88 9.32 8.98
Exercised........................................... (491,544) 1.75 4.88 3.35
Forfeited........................................... (87,678) 3.50 5.63 3.98
--------- ----- ----- -----
Balance at September 30, 1996
Unexercised......................................... 2,218,057 $1.75 $9.32 $5.67
Granted............................................. 907,500 6.50 7.09 6.82
Exercised........................................... (84,618) 2.50 9.25 4.32
Forfeited........................................... (55,887) 3.50 9.00 5.19
--------- ----- ----- -----
Balance at September 30, 1997
Unexercised......................................... 2,985,052 $1.75 $9.32 $6.07
Granted............................................. 840,250 3.25 6.75 5.26
Exercised........................................... (5,699) 3.50 9.25 4.22
Forfeited........................................... (37,872) 3.75 9.00 6.66
--------- ----- ----- -----
Balance at September 30, 1998
Unexercised......................................... 3,781,731 $1.75 $9.32 $5.89
========= ===== ===== =====
</TABLE>
At September 30, 1998, the Company has reserved 4,335,593 shares of its
authorized common stock for all shares issuable under options. At September 30,
1998, 1997, and 1996 options exercisable were 2,454,082, 1,290,829, and 872,513,
respectively.
On March 22, 1995, the Company granted the right to current option holders
to surrender their current options in exchange for replacement options on the
basis of three replacement options for four options surrendered. The exercise
price of the replacement options was $3.50 per share, which was greater than the
market price on the date of exchange. The replacement options vested 25% upon
grant with the remaining 75% vesting pro rata on a monthly basis over the
following three years. Option holders surrendered 606,000 options in exchange
for 454,500 replacement options.
Stock option grants are set at the closing price of the Company's common
stock on the date of grant and the related number of shares granted are fixed at
that point in time. Therefore under the principles of APB Opinion No. 25, the
Company does not recognize compensation expense associated with the grant of
stock options. SFAS No. 123, "Accounting for Stock-Based Compensation," requires
the use of option valuation models to provide supplemental information regarding
options granted after 1995. Pro forma information regarding net income and
earnings per share shown below was determined as if the Company had accounted
for its employee stock options and shares sold under its stock purchase plan
under the fair value method of that statement.
The fair value of the options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996 respectively: risk-free interest rates of
4.38%, 5.84% and 6.26%; dividend yields of 0%; volatility factors of the
expected market price of the Company's common stock of 64.9%, 65.8% and 64.8%
and expected life of the options of 3.7 years for all
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
three years. These assumptions resulted in weighted-average fair values of
$2.87, $3.61 and $4.75 per share for stock options granted in 1998, 1997 and
1996, respectively.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. The pro forma effect on
net income for 1998 and 1997 is not representative of the pro forma effect on
net income in future years because it does not take into consideration pro forma
compensation expense related to grants made prior to 1996. Pro forma information
in future years will reflect the amortization of a larger number of stock
options granted in several succeeding years. The Company's pro forma information
is as follows (in thousands, except per share information):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Pro forma net loss......................... $(12,802) $(11,205) $(10,327)
Pro forma net loss per share:
Basic.................................... $ (0.57) $ (0.51) $ (0.52)
</TABLE>
Information regarding stock options outstanding as of September 30, 1998,
is as follows (options in thousands):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS
-------------------------------------- EXERCISABLE
WEIGHTED -----------------------
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
SHARES EXERCISE CONTRACTUAL SHARES EXERCISE
PRICE RANGE (IN THOUS) PRICE LIFE (IN THOUS) PRICE
----------- ---------- --------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Under $4.50.................. 1,424 $3.78 5.44 1,239 $3.87
$4.50 - $7.00................ 1,558 6.26 8.72 589 6.56
Over $7.00................... 800 8.89 6.43 626 8.93
</TABLE>
(d) Sale of Common Stock and Warrant to Marion Merrell Dow
In December 1992, the Company entered into the common stock purchase and
common stock warrant purchase agreements with Marion. The Company issued
1,090,909 shares of common stock at $5.50 per share and a warrant to purchase up
to 500,000 additional shares at $5.50 per share which is exercisable during the
period December 1994 to December 1999. The proceeds to the Company were $6
million.
(e) Employee Stock Purchase Plan
On May 1, 1993, the Company adopted an Employee Stock Purchase Plan under
which eligible employees may contribute up to 10% of their base earnings toward
the quarterly purchase of the Company's common stock. The employees purchase
price is derived from a formula based on the fair market value of the common
stock. No compensation expense is recorded in connection with the plan. During
fiscal 1998, 1997 and 1996, 20,664, 12,388, and 3,860 shares were issued with
52, 48 and 34 employees participating in the plan, respectively.
(10) INCOME TAXES
There is no provision (benefit) for federal or state income taxes, since
the Company has incurred operating losses since inception and has established a
valuation allowance equal to the total deferred tax asset.
53
<PAGE> 55
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
The tax effect of temporary differences, net operating loss carry forwards
and research and development tax credit carry forwards as of September 30, 1998
and 1997 are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carry forwards............... $ 16,942,035 $ 14,170,792
Research and development credits................ 874,246 824,246
Intangible assets............................... 797,137 946,094
Other........................................... 2,041,480 1,750,156
------------ ------------
20,654,898 17,691,288
Valuation allowance............................. (20,654,898) (17,691,288)
------------ ------------
$ -- $ --
============ ============
</TABLE>
As of September 30, 1998, the Company has available federal net operating
loss carry forwards of approximately $50 million which will expire in various
years from 1999 to 2013, and may be subject to certain annual limitations. The
Company's research and development tax credit carry forwards noted above expire
through the year 2013.
(11) COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments
The Company leases office, operating and laboratory space under various
lease agreements.
Rent expense was approximately $1,090,000, $1,081,000 and $727,000 for the
fiscal years ended September 30, 1998, 1997, and 1996, respectively.
The following is a schedule by fiscal years of future minimum rental
payments required as of September 30, 1998, assuming expiration of the leases
for the two Uniondale facilities on July 31, 2003 and June 30, 2006,
respectively, the Cambridge facility on December 31, 2003, the Durham facility
on October 31, 2004, and the Birmingham facility on May 31, 2002.
<TABLE>
<S> <C>
1999..................................................... $1,094,978
2000..................................................... 1,172,662
2001..................................................... 1,184,129
2002..................................................... 1,122,652
2003..................................................... 960,993
2004 and thereafter...................................... 1,567,866
----------
$7,103,280
==========
</TABLE>
(b) Contingencies
The Company has received several letters from other companies and
universities advising the Company that various products being marketed and
research being conducted by the Company may be infringing on existing patents of
such entities. These matters are presently under review by management and
outside counsel for the Company. Where valid patents of other parties are found
by the Company to be in place, management will consider entering into licensing
arrangements with the universities and/or other companies or modify the conduct
of its research. The Company's royalties may be reduced by up to 50% if its
licensees or collaborative
54
<PAGE> 56
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
partners are required to obtain licenses from third parties whose patent rights
are infringed by the Company's products, technology or operations. In addition,
should any infringement claims result in a patent infringement lawsuit, the
Company could incur substantial costs in defense of such a suit, which could
have a material adverse effect on the Company's business financial condition and
results of operations, regardless of whether the Company were successful in the
defense.
(c) Lines of Credit
As of September 30, 1998, the Company has a line of credit with a
commercial bank in the amount of $10 million. This line expires annually on
March 31st, and its current rate of interest is prime plus 3/4. The Company has
had no borrowings under this line of credit.
(12) RELATED PARTY TRANSACTIONS
Effective January 1, 1993, the Company compensates its independent outside
directors on a $1,000 retainer per month. This amount increased to $1,500
effective January 1, 1995. For the years ended September 30, 1998, 1997 and
1996, such fees amounted to $135,000, $126,000 and $108,000, respectively. The
Company also has compensated directors for consulting services performed. For
the years ended September 30, 1998, 1997 and 1996, consulting services in the
amounts of $157,000, $144,000, and $100,000 respectively, were paid by the
Company pursuant to these arrangements.
One director is a partner in a law firm which represents the Company on its
patent and license matters. Fees paid to this firm for the years ended September
30, 1998, 1997 and 1996 were approximately $604,000 $404,000, and $413,000
respectively.
During fiscal 1997, the Board of Directors of the Company approved the
cashless exercise of certain stock options held by a director. The Company
recorded a charge of $126,750, which represents the fair market value of the
common stock issued.
A board member is an officer of Cold Spring Harbor Laboratory which was a
founder of Amplicon (which was recently acquired by Tularik) and Helicon. A
board member is the chief executive officer and director of Helicon and member
of the board of directors of Xenometrix. A board member is the chief executive
officer of NuGene. The Company's chairman is a member of the boards of directors
of NuGene, Anaderm and Helicon, and may become the chairman or co-chairman of
Helicon and vice president of Anaderm. An executive officer of the Company is
vice president of Helicon. The Company has investments in Tularik, Helicon, and
NuGene and collaborative research agreements with Helicon and Xenometrix.
(13) EMPLOYEE SAVINGS AND INVESTMENT PLAN
The Company sponsors an Employee Savings and Investment Plan under Section
401(k) of the Internal Revenue Code. The plan allows employees to defer from 2%
to 10% of their income on a pre-tax basis through contributions into designated
investment funds. For each dollar the employee invests up to 6% of his or her
earnings, the Company will contribute an additional 50 cents into the funds. For
the years ended September 30, 1998, 1997, and 1996, the Company's expenses
related to the plan were approximately $197,000, $233,000 and $164,000,
respectively.
(14) EMPLOYEE RETIREMENT PLAN
On November 10, 1992, the Company adopted a plan which provides
postretirement medical and life insurance benefits to eligible employees, board
members and qualified dependents. Eligibility is determined
55
<PAGE> 57
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
based on age and service requirements. These benefits are subject to
deductibles, co-payment provisions and other limitations.
The Company utilizes SFAS No. 106, "Employer's Accounting for
Postretirement Benefits Other Than Pensions" to account for the benefits to be
provided by the plan. Under SFAS No. 106 the cost of post retirement medical and
life insurance benefits is accrued over the active service periods of employees
to the date they attain full eligibility for such benefits. As permitted by SFAS
No. 106, the Company elected to amortize over a 20 year period the accumulated
postretirement benefit obligation related to prior service costs.
Net postretirement benefit cost for the years ended September 30, 1998,
1997 and 1996 includes the following components:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Service cost for benefits earned during the
Period........................................... $220,785 $194,900 $161,800
Interest cost on accumulated postretirement benefit
obligation....................................... 104,831 99,600 89,300
Amortization of unrecognized net loss.............. 3,327 9,600 18,700
Amortization of initial benefits attributed to past
service.......................................... 17,493 17,500 17,500
-------- -------- --------
Net postretirement benefit cost.................... $346,436 $321,600 $287,300
======== ======== ========
</TABLE>
The accrued postretirement benefit cost at September 30, 1998 and 1997 were
as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Accumulated postretirement benefit
obligation -- fully eligible active plan
participants...................................... $1,721,206 $1,672,500
Unrecognized cumulative net loss.................... (181,832) (460,400)
Unrecognized transition obligation.................. (250,107) (267,600)
---------- ----------
Accrued postretirement benefit cost................. $1,289,267 $ 944,500
========== ==========
</TABLE>
The accumulated postretirement benefit obligation was determined using a
discount rate of 7.5 percent in 1998 and in 1997 and a health care cost trend
rate of approximately 7 percent in 1997, decreasing down to 5 percent in 1999
and thereafter. Increasing the assumed health care cost trend rates by one
percentage point in each year and holding all other assumptions constant would
increase the accumulated postretirement benefit obligation as of September 30,
1998 by approximately $226,000 and the net postretirement benefit cost by
approximately $92,000.
(15) NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS Nos. 130
and 131, "Reporting Comprehensive Income" and "Disclosures about Segments of an
Enterprise and Related Information," respectively (the "Statements"). The
Statements are effective for fiscal years beginning after December 15, 1997.
SFAS No. 130 establishes standards for reporting of comprehensive income and its
components in annual financial statements. SFAS No. 131 establishes standards
for reporting financial and descriptive information about an enterprise's
operating segments in its annual financial statements and selected segment
information in interim financial reports. Reclassification or restatement of
comparative financial statements or financial information for earlier periods is
required upon adoption of SFAS No. 130 and SFAS No. 131, respectively.
Application of the Statements' disclosure requirements will have no impact on
the Company's consolidated financial position, results of operations or earnings
per share data as currently reported.
56
<PAGE> 58
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
In February 1998, the Financial Accounting Standards Board issued SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits"
which revises current disclosures about pension and other postretirement benefit
plans. It does not change the measurement or recognition of those plans. The
Statement: (1) standardizes the disclosure requirements for pension and other
postretirement benefits to the extent practicable; (2) requires additional
information on changes in the benefit obligations and fair values of plan assets
that will facilitate financial analysis; (3) eliminates certain disclosures that
are no longer useful; (4) suggests combined formats for presentation of pension
and other postretirement benefits; and (5) permits reduced disclosures for
nonpublic entities. SFAS No. 132 is effective for fiscal years beginning after
December 15, 1997. These standards expand or modify current disclosures and,
accordingly, will have no impact on the Company's reported financial position,
results of operations and cash flows.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative and Hedging Activities." SFAS No. 133 establishes a
comprehensive standard on accounting for derivatives and hedging activities and
is effective for periods beginning after June 15, 1999. Management does not
believe that the future adoption of SFAS No. 133 will have a material effect on
the Company's financial position and results of operations.
57
<PAGE> 59
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the
similarly named section of the Registrant's Proxy Statement for its 1999 Annual
Meeting to be filed with the Securities and Exchange Commission not later than
120 days after September 30, 1998 (the "1999 Proxy").
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
similarly named section of the Registrant's 1999 Proxy.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
similarly named section of the Registrant's 1999 Proxy.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
similarly named section of the Registrant's 1999 Proxy.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) The following consolidated financial statements are included in
Part II, Item 8 of this report:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(2) All schedules are omitted as the required information is
inapplicable or the information is presented in the financial
statements or related notes.
(3) The exhibits listed in the Index to Exhibits are attached or
incorporated herein by reference and filed as a part of this
report.
(b) Reports on Form 8-K
None.
58
<PAGE> 60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
OSI PHARMACEUTICALS, INC.
By: /s/ COLIN GODDARD, PH.D.
------------------------------------
Colin Goddard, Ph.D.
President and Chief Executive
Officer
Date: December 22, 1998
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Company and in the capacities and on the days indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ COLIN GODDARD, PH.D. President and Chief Executive December 22, 1998
- --------------------------------------------------- Officer and Director
Colin Goddard, Ph.D.
/s/ ROBERT L. VAN NOSTRAND Vice President and Chief December 22, 1998
- --------------------------------------------------- Financial Officer
Robert L. Van Nostrand
/s/ G. MORGAN BROWNE Director December 22, 1998
- ---------------------------------------------------
G. Morgan Browne
/s/ GARY E. FRASHIER Chairman of the Board of December 22, 1998
- --------------------------------------------------- Directors
Gary E. Frashier
/s/ JOHN H. FRENCH, II Director December 22, 1998
- ---------------------------------------------------
John H. French, II
/s/ EDWIN A. GEE, PH.D. Director December 22, 1998
- ---------------------------------------------------
Edwin A. Gee, Ph.D.
/s/ DARYL K. GRANNER, M.D. Director December 22, 1998
- ---------------------------------------------------
Daryl K. Granner, M.D.
/s/ WALTER M. LOVENBERG, PH.D. Director December 22, 1998
- ---------------------------------------------------
Walter M. Lovenberg, Ph.D.
/s/ STEVEN M. PELTZMAN Director December 22, 1998
- ---------------------------------------------------
Steven M. Peltzman
/s/ JOHN P. WHITE Director December 22, 1998
- ---------------------------------------------------
John P. White, Esquire
</TABLE>
59
<PAGE> 61
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBITS
- --------
<C> <S>
3.1 Certificate of Incorporation, as amended(1)
3.2 By-Laws, as amended(2)
10.1 1985 Stock Option Plan (filed as an exhibit to the Company's
registration statement on Form S-1 (file no. 33-3148) and
incorporated herein by reference)
10.2 1989 Incentive and Non-Qualified Stock Option Plan (filed as
an exhibit to the Company's registration statement on Form
S-8 (file no. 33-38443) and incorporated herein by
reference)
10.3 1993 Incentive and Non-Qualified Stock Option Plan, as
amended (filed as an exhibit to the Company's registration
statement on Form S-8 (file no. 33-64713) and incorporated
herein by reference)
10.4 Stock Purchase Plan for Non-Employee Directors (filed as an
exhibit to the Company's registration statement on Form S-8
(file no. 333-06861) and incorporated herein by reference)
10.5 1995 Employee Stock Purchase Plan (filed as an exhibit to
the Company's registration statement on Form S-8 (file no.
333-06861) and incorporated herein by reference)
10.6 1997 Incentive and Non-Qualified Stock Option Plan (filed as
an exhibit to the Company's registration statement on Form
S-8 (file no. 333-39509) and incorporated herein by
reference)
10.7+ Collaborative Research Agreement dated April 1, 1996 between
the Company and Pfizer Inc.(3)
10.8+ License Agreement dated April 1, 1996 between the Company
and Pfizer Inc.(3)
10.9+ Stockholders' Agreement dated April 23, 1996 among Anaderm
Research Corp., the Company, Pfizer Inc., New York
University and certain individuals(3)
10.10+ Collaborative Research Agreement dated April 23, 1996 amount
the Company, Pfizer Inc. and Anaderm Research Corp.(3)
10.11 Form of Warrants issued by the Company to the former
stockholders of MYCOsearch, Inc. and their designees
covering an aggregate of 100,000 shares of common stock(3)
10.12 Employment Agreement dated April 11, 1996 between the
Company and Dr. Barry Katz(3)
10.13 Common Stock Purchase Warrant granted to Marion Merrell Dow,
Inc. dated December 11, 1992(4)
10.14 Collaborative Agreement dated as of April 19, 1995 between
the Company and Novartis Pharma AG(5)
10.15 Letter Agreement dated as of April 19, 1995 between the
Company and Novartis Pharma AG(5)
10.16 Registration Rights Agreement dated as of April 19, 1995
between the Company and Novartis Pharma AG(5)
10.17+ Agreement dated September 27, 1996 between the Company and
Becton, Dickinson and Company(6)
10.18+ Collaborative Research and License Agreement dated as of
January 1, 1997 between the Company and Bayer Corporation(7)
10.19+ Collaborative Research, Development and License Agreement
dated as of February 12, 1997 by and among the Company,
Sankyo Company, Ltd., and MRC Collaborative Center(8)
10.20+ License Agreement dated as of March 18, 1997 between the
Company and The Dow Chemical Company(8)
10.21 Amended and Restated Collaborative Research and License
Agreement effective as of April 1, 1997 by and among the
Company, Hoechst Marion Roussel, Inc. and Hoechst
Aktiengesellschaft(9)
10.22+ Stock Subscription Agreement dated as of July 17, 1997 by
and between the Company and Helicon Therapeutics, Inc.(4)
</TABLE>
60
<PAGE> 62
<TABLE>
<CAPTION>
EXHIBITS
- --------
<C> <S>
10.23+ License and Services Agreement dated as of July 17, 1997 by
and between the Company and Helicon Therapeutics, Inc.(4)
10.24+ Stockholders' Agreement dated as of July 17, 1997 by and
among Helicon Therapeutics, Inc. and certain stockholders of
Helicon Therapeutics, Inc.(4)
10.25+ Convertible Preferred Stock Purchase Agreement dated as of
July 17, 1997 by and among Helicon Therapeutics, Inc., the
Company, Hoffman-La Roche, Inc. and Cold Spring Harbor
Laboratory.(4)
10.26+ Collaborative Research and License Agreement effective as of
July 1, 1997 by and between Hoffman-La Roche, Inc. and
Helicon Therapeutics, Inc.(4)
10.27 Employment Agreement, dated April 30, 1998, between the
Company and Colin Goddard, Ph.D.(10)
10.28+ Amendatory and Collaborative Agreement, dated as of March
31, 1998, by and between the Company and Sepracor, Inc.(10)
10.29+ Research Collaboration and License Agreement, dated as of
April 1, 1998, by and among the Company, Oncogene Science
Diagnostics, Inc. and Fujirebio, Inc.(10)
10.30+ License Agreement, dated as of May 26, 1998, by and between
the Company and Aurora Biosciences Corporation.(10)
21* Subsidiaries of the Company
23* Consent of KPMG Peat Marwick, LLP, independent public
accountants
27* Financial Data Schedule
</TABLE>
- ---------------
* Filed herewith.
+ Portions of this exhibit have been redacted and are subject to a
confidential treatment request filed with the Secretary of the Securities
and Exchange Commission pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
(1) Filed as an exhibit to the Company's quarterly report filed on Form 10-Q
for the quarter ended December 31, 1997, filed on February 27, 1998, and
incorporated herein by reference.
(2) Filed as an exhibit to the Company's registration statement on Form S-3
(file no. 333-937) and incorporated herein by reference.
(3) Filed as an exhibit to the Company's quarterly report on Form 10-Q for the
fiscal quarter ended March 31, 1996, as amended, and incorporated herein by
reference.
(4) Filed as an exhibit to the Company's annual report on Form 10-K for the
fiscal year ended September 30, 1997, and incorporated herein by reference.
(5) Filed as an exhibit to the Company's annual report on Form 10-K for the
fiscal year ended September 30, 1995, as amended, and incorporated herein
by reference.
(6) Filed as an exhibit to the Company's annual report on Form 10-K for the
fiscal year ended September 30, 1996 and incorporated herein by reference.
(7) Filed as an exhibit to the Company's quarterly report on Form 10-Q for the
fiscal quarter ended December 31, 1996 and incorporated herein by
reference.
(8) Filed as an exhibit to the Company's quarterly report on Form 10-Q for the
fiscal quarter ended March 31, 1997 and incorporated herein by reference.
(9) Filed as an exhibit to the Company's quarterly report on Form 10-Q for the
fiscal quarter ended June 30, 1997 and incorporated herein by reference.
(10) Filed as an exhibit to the Company's quarterly report on Form 10-Q for the
fiscal quarter ended June 30, 1998 and incorporated herein by reference.
61
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
Aston Molecules, Inc., organized under the laws of the United Kingdom
MYCOsearch Inc., incorporated under the laws of the State of Delaware
Applied bioTechnology, Inc., incorporated under the laws of the State of
Delaware
Oncogene Science Diagnostics, Inc., incorporated under the laws of the State of
Delaware
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
OSI Pharmaceuticals, Inc.
We consent to incorporation by reference in the registration statements on Forms
S-3 (No. 333-12593 and No. 333-2451) and on Forms S-8 (No. 333-06861, No.
33-64713, No. 33-60182, No. 33-38443, No. 33-8980 and No. 333-39509) of OSI
Pharmaceuticals, Inc. of our report dated December 4, 1998, relating to the
consolidated balance sheets of OSI Pharmaceuticals, Inc. and subsidiaries as of
September 30, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended September 30, 1998, which report appears in the
September 30, 1998 annual report on Form 10-K of OSI Pharmaceuticals, Inc.
/s/ KPMG PEAT MARWICK LLP
Melville, New York
December 21, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 11,315,166
<SECURITIES> 13,103,115
<RECEIVABLES> 1,731,633
<ALLOWANCES> 10,896
<INVENTORY> 0
<CURRENT-ASSETS> 27,617,571
<PP&E> 20,317,089
<DEPRECIATION> 12,320,534
<TOTAL-ASSETS> 50,417,980
<CURRENT-LIABILITIES> 5,349,225
<BONDS> 0
0
0
<COMMON> 222,886
<OTHER-SE> 42,836,360
<TOTAL-LIABILITY-AND-EQUITY> 50,417,980
<SALES> 1,121,449
<TOTAL-REVENUES> 19,468,337
<CGS> 955,464
<TOTAL-COSTS> 30,842,929
<OTHER-EXPENSES> 277,288
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20,148
<INCOME-PRETAX> (10,184,468)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,184,468)
<EPS-PRIMARY> (0.48)
<EPS-DILUTED> (0.48)
</TABLE>
