VIVUS INC
10-Q, 1998-08-14
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS
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<PAGE>   1
 
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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-Q
 
[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934
 
                  FOR THE QUARTERLY PERIOD ENDED JUNE 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: 0-23490
 
                            ------------------------
 
                                  VIVUS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      94-3136179
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NUMBER)
           605 EAST FAIRCHILD DRIVE                       MOUNTAIN VIEW, CA 94043
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>
 
                                 (650) 934-5200
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
                                      N/A
   (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
                                    REPORT)
 
                            ------------------------
 
     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 [ ]
 
     At June 30, 1998, 31,766,979 shares of common stock were outstanding.
 
                          Exhibit index on page [20].
 
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<PAGE>   2
 
                         PART I: FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
                                  VIVUS, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                  THREE MONTHS ENDED             SIX MONTHS ENDED
                                                       JUNE 30,                      JUNE 30,
                                              --------------------------    --------------------------
                                                 1998           1997           1998           1997
                                              -----------    -----------    -----------    -----------
                                              (UNAUDITED)    (UNAUDITED)    (UNAUDITED)    (UNAUDITED)
<S>                                           <C>            <C>            <C>            <C>
Revenue
  US Product................................   $  6,142        $33,458       $ 30,693        $61,249
  International Product.....................      9,841             --         11,812             --
  Milestone.................................         --             --          1,000          5,000
                                               --------        -------       --------        -------
          Total revenue.....................     15,983         33,458         43,505         66,249
Cost of goods sold..........................     10,704          9,584         21,186         17,650
                                               --------        -------       --------        -------
Gross margin................................      5,279         23,874         22,319         48,599
                                               --------        -------       --------        -------
Operating expenses:
  Research and development..................      5,359          1,940          9,239          3,967
  Selling, general and administrative.......     17,576         11,258         34,634         23,067
  Restructuring costs.......................      6,522             --          6,522             --
                                               --------        -------       --------        -------
          Total operating expenses..........     29,457         13,198         50,395         27,034
                                               --------        -------       --------        -------
Income (loss) from operations...............    (24,178)        10,676        (28,076)        21,565
Interest and other income...................        597          1,264          1,508          2,385
                                               --------        -------       --------        -------
  Income (loss) before taxes................    (23,581)        11,940        (26,568)        23,950
Income tax (provision) benefit..............       (597)        (1,982)            --         (4,438)
                                               --------        -------       --------        -------
          Net income (loss).................   $(24,178)       $ 9,958       $(26,568)       $19,512
                                               ========        =======       ========        =======
Net income (loss) per share:
  Basic.....................................   $  (0.76)       $  0.30       $  (0.83)       $  0.59
  Diluted...................................   $  (0.76)       $  0.28       $  (0.83)       $  0.55
Shares used in the computation of net income
  (loss) per share:
  Basic.....................................     31,752         32,990         31,938         32,846
  Diluted...................................     31,752         35,579         31,938         35,626
</TABLE>
 
                                        2
<PAGE>   3
 
                                  VIVUS, INC.
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                               JUNE 30,      DECEMBER 31,
                                                                 1998            1997
                                                              -----------    ------------
                                                              (UNAUDITED)
<S>                                                           <C>            <C>
Current assets:
  Cash......................................................   $  1,420        $  6,161
  Available-for-sale securities.............................      8,913          52,955
  Accounts receivable.......................................      8,170          11,791
  Inventories...............................................     16,772           9,084
  Prepaid expenses and other assets.........................      2,458           1,636
                                                               --------        --------
          Total current assets..............................     37,733          81,627
Property and equipment......................................     46,878          36,462
Available-for-sale securities, non-current..................     15,073          32,580
                                                               --------        --------
          Total.............................................   $ 99,684        $150,669
                                                               ========        ========
Current liabilities:
  Accounts payable..........................................   $  7,370        $  6,574
  Accrued and other liabilities.............................     17,681          20,165
                                                               --------        --------
          Total current liabilities.........................     25,051          26,739
Stockholders' equity:
  Common stock; $.001 par value; shares authorized 200,000;
     shares outstanding -- June 30, 1998, 31,767; December
     31, 1997, 33,168.......................................         32              33
  Paid in capital...........................................    130,699         153,336
  Accumulated other comprehensive income....................          7              98
  Accumulated deficit.......................................    (56,105)        (29,537)
                                                               --------        --------
          Total stockholders' equity........................     74,633         123,930
                                                               --------        --------
          Total.............................................   $ 99,684        $150,669
                                                               ========        ========
</TABLE>
 
                                        3
<PAGE>   4
 
                                  VIVUS, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                   SIX MONTHS ENDED
                                                                       JUNE 30,
                                                              --------------------------
                                                                 1998           1997
                                                              -----------    -----------
                                                              (UNAUDITED)    (UNAUDITED)
<S>                                                           <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss).........................................   $(26,568)      $  19,512
  Adjustments to reconcile net income (loss) to net cash
     provided by (used for) operating activities:
     Depreciation and amortization..........................      1,656             892
     Stock compensation costs...............................        256             201
  Changes in assets and liabilities:
     Accounts receivable....................................      3,621         (13,663)
     Inventories............................................     (7,688)           (640)
     Prepaid expenses and other assets......................       (822)           (170)
     Accounts payable.......................................        796           3,020
     Accrued and other liabilities..........................     (2,484)         14,003
                                                               --------       ---------
          Net cash provided by (used for) operating
            activities......................................    (31,233)         23,155
                                                               --------       ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Property and equipment purchases..........................    (12,072)        (10,839)
  Investment purchases......................................    (67,743)       (133,303)
  Proceeds from sale/maturity of securities.................    129,201         123,707
                                                               --------       ---------
          Net cash provided by (used for) investing
            activities......................................     49,386         (20,435)
                                                               --------       ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Exercise of common stock options..........................        277           2,029
  Sale of common stock through employee stock purchase
     plan...................................................        413             173
  Repurchase of common stock................................    (23,584)         (3,401)
                                                               --------       ---------
          Net cash (used for) financing activities..........    (22,894)         (1,199)
                                                               --------       ---------
Net increase (decrease) in cash.............................     (4,741)          1,521
CASH:
  Beginning of period.......................................      6,161             555
                                                               --------       ---------
  End of period.............................................   $  1,420       $   2,076
                                                               ========       =========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
  Unrealized loss on securities.............................   $    (91)      $     (92)
SUPPLEMENTAL CASH FLOW DISCLOSURE:
  Income taxes paid.........................................   $     71       $      --
</TABLE>
 
                                        4
<PAGE>   5
 
                                  VIVUS, INC.
 
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 JUNE 30, 1998
 
 1. BASIS OF PRESENTATION
 
     The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulations S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three and six month periods ended
June 30, 1998 are not necessarily indicative of the results that may be expected
for the year ending December 31, 1998. For further information, refer to the
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
 
 2. COMPREHENSIVE INCOME
 
     The Company has adopted the Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income", which establishes standards
for the reporting and display of comprehensive income and its components in
general purpose financial statements for the year ended December 31, 1998. The
table below sets forth "comprehensive income" as defined by SFAS No. 130 for the
three and six month periods ended June 30, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                          THREE MONTHS ENDED             SIX MONTHS ENDED
                                               JUNE 30,                      JUNE 30,
                                      --------------------------    --------------------------
                                         1998           1997           1998           1997
                                      -----------    -----------    -----------    -----------
(IN THOUSANDS)                        (UNAUDITED)    (UNAUDITED)    (UNAUDITED)    (UNAUDITED)
<S>                                   <C>            <C>            <C>            <C>
Net income (loss)...................   $(24,178)       $ 9,958       $(26,568)       $19,512
Other comprehensive income:
Unrealized gain (loss) on
  securities........................         31            209            (91)           (92)
Income tax benefit..................         --            (41)            --             18
                                       --------        -------       --------        -------
                                             31            168            (91)           (74)
                                       --------        -------       --------        -------
Comprehensive income (loss).........   $(24,147)       $10,126       $(26,659)       $19,438
                                       ========        =======       ========        =======
</TABLE>
 
 3. NET INCOME (LOSS) PER SHARE
 
     The Company has adopted Statement of Financial Accounting Standards No. 128
("SFAS 128"), "Earnings per Share", which replaced Accounting Principles Board
Opinion No. 15 ("APB 15"). SFAS 128 requires a dual presentation of basic and
diluted earnings per share. Basic earnings per share is based on the weighted
average number of common shares outstanding during the periods. Diluted earnings
per share is based on the weighted average number of common and common
equivalent shares, which represent shares that may be issued in the future upon
the exercise of outstanding stock options and warrants. Such options and
warrants are excluded from the net loss per common and equivalent shares for the
three and six months ended June 30, 1998 because they are anti-dilutive. Diluted
earnings per share is computed similarly to earnings per share previously
reported pursuant to APB 15 and for the Company, diluted earnings per share
amounts are the same as amounts previously reported under APB 15. Share and per
share amounts have been calculated based on post-split shares resulting from the
two-for-one stock split effective June 23, 1997.
 
 4. RESTRUCTURING COSTS
 
     During June of 1998, the company decided to seek a major pharmaceutical
partner to market MUSE (alprostadil) in the United States. Expenses of $6.5
million were incurred, primarily associated with the Company's agreement to
facilitate the transition of its direct U.S. sales force to ALZA Corporation, as
well as terminating the contract sales force agreement with Innovex, and
personnel reductions in administration, research and development, clinical and
marketing departments.
 
                                        5
<PAGE>   6
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
DESCRIPTION OF BUSINESS
 
     VIVUS, Inc. ("VIVUS" or the "Company") is a leader in the development of
advanced therapeutic systems for the treatment of erectile dysfunction. Erectile
dysfunction, commonly referred to as impotence, is the inability to achieve and
maintain an erection of sufficient rigidity for sexual intercourse. The
Company's transurethral system for erection is a minimally invasive, easy to use
system that delivers pharmacologic agents topically to the urethral lining. In
November 1996, the Company obtained marketing clearance by the U.S. Food and
Drug Administration (the "FDA") to manufacture and market its first product,
MUSE(R) (alprostadil). The Company commenced product shipments to wholesalers in
December 1996 and commercially introduced MUSE (alprostadil) in the United
States through its direct sales force beginning in January 1997. Furthermore,
the Company received FDA clearance in December 1996 for ACTIS(R), an adjustable
elastomeric venous flow control device designed for those patients who suffer
from veno-occlusive dysfunction (commonly referred to as venous leak syndrome).
The Company commenced commercial sales of ACTIS in the United States through its
direct sales force in July 1997. ACTIS is currently being studied for adjunctive
use with MUSE (alprostadil); however, there can be no assurance that such
studies will be completed and if completed that such studies will demonstrate
that adjunctive use of ACTIS with MUSE (alprostadil) is a safe and effective
treatment for erectile dysfunction.
 
     The Company has entered into international marketing agreements with
Astra AB ("Astra") and Janssen Pharmaceutica International ("Janssen") under
which Astra and Janssen will purchase MUSE (alprostadil) for resale in various
international markets. In November 1997, the Company obtained regulatory
marketing clearance by the Medicines Control Agency ("MCA") to market MUSE
(alprostadil) in the United Kingdom. The Company began selling MUSE
(alprostadil) to Astra in the fourth quarter of 1997. Astra began selling MUSE
(alprostadil) in the United Kingdom in February 1998. MUSE (alprostadil) has
also been approved in Argentina, Brazil, Canada, Hong Kong, Korea, Mexico, New
Zealand, Philippines, Singapore, South Africa, Sweden, Switzerland and Thailand.
In addition, applications for regulatory approval to market MUSE (alprostadil)
have been submitted in several other countries, including China, Australia and
certain Middle Eastern countries. These applications will be subject to rigorous
approval processes, and there can be no assurance such approval will be granted
in a timely manner, if at all. The Company has received indications from one of
its international marketing partners that regulatory approvals in certain Middle
Eastern countries will be granted later than initially anticipated.
 
     On March 27, 1998, the FDA approved Viagra (sildenafil), an oral pill
produced by Pfizer Inc. ("Pfizer") for the treatment of male impotence. Pfizer
commercially introduced sildenafil in the U.S. in April 1998. The introduction
of sildenafil dramatically increased the number of men seeking treatment for
impotence and significantly decreased demand for MUSE (alprostadil). Since the
launch of sildenafil, MUSE (alprostadil) prescriptions have declined
approximately 70%. As a result of this and other factors, including higher costs
of goods sold related to the Company's ramp up of its new manufacturing
facility, and higher marketing and sales costs primarily related to the sales
force expansion via the Innovex contract pharmaceutical sales organization, the
Company experienced an operating loss of $24.2 million, or $0.76 per share, in
the second quarter of 1998. Included in the second quarter 1998 results is a
one-time charge of $6.5 million related to restructuring the Company's
operations. The goal of this restructuring announced on July 8, 1998 is to
reduce expenses in order to facilitate a return to profitability. However, there
can be no assurance that the restructuring will result in a return to
profitability. The Company does not believe that it will return to profitability
in 1998 due to a number of factors including costs associated with the
restructuring, domestic and international competition from Pfizer and
manufacturing difficulties. In connection with the restructuring on July 8,
1998, the Company announced its decision to seek a major pharmaceutical partner
to market, distribute and sell MUSE (alprostadil) in the U.S. As a first step,
the Company agreed to facilitate the transition of its direct sales force to
ALZA Corporation. Sales personnel joining ALZA will continue to sell MUSE on a
limited basis until December 31, 1998. Accordingly, the Company is highly
dependent upon the efforts of ALZA during this period, and there can be no
assurance that ALZA's sales efforts will be successful. In addition, VIVUS also
terminated its sales force services agreement with Innovex and reduced personnel
in administration, research and development, clinical and marketing departments.
As a result of the restructuring, the Company expects its quarterly operating
expenses to decrease. There can be no assurance that the Company will partner
with a major pharmaceutical company to market, distribute and sell MUSE, or that
such a partnership would be on reasonable terms. Further, there can be no
assurance that such a partner will be able to successfully market,
 
                                        6
<PAGE>   7
 
distribute and sell MUSE. Should the Company establish such a relationship, the
Company's U.S. marketing efforts will depend substantially on the partner's
efforts. The partner may have other commitments and may not commit the necessary
resources to effectively market, distribute and sell the Company's products. If
the Company cannot establish such a relationship, it will have to develop an
alternative strategy for marketing, distribution and selling its products in the
U.S.
 
     The Company has limited experience in manufacturing and selling MUSE
(alprostadil) in commercial quantities. Up until the commercial launch of
sildenafil, the Company had initially experienced product shortages due to
higher than expected demand and difficulties encountered in scaling up
production of MUSE (alprostadil). The Company leased 90,000 square feet of space
in New Jersey in which it has constructed additional manufacturing and testing
facilities. The FDA and MCA authorized the Company to begin commercial
production and shipment of MUSE (alprostadil) from its new facility in June and
March 1998, respectively. With the added capacity, the Company does not
anticipate capacity constraints in the foreseeable future. However, if the
Company encounters further difficulties with its current manufacturing facility,
capacity issues could arise, which would have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
has recently experienced various manufacturing difficulties that have resulted
in production and shipment delays and higher costs. In turn, revenues from the
sale of MUSE (alprostadil) will be delayed, which will have a material adverse
affect on the Company's business, financial condition and results of operations.
 
     The Company has sought and will continue to seek pharmacologic agents
suitable for transurethral delivery for which significant safety data already
exists. The Company believes that such agents may progress more rapidly through
clinical development and the regulatory process than agents without preexisting
safety data. The Company expects to begin a Phase III multi-center trial in 1998
for its second product candidate, a combination of alprostadil and prazosin
delivered via the Company's transurethral system for erection. The Company has
several other product candidates in pre-clinical development. There can be no
assurance at this point that the Company will be able to fully develop and bring
these products to the market.
 
RESULTS OF OPERATIONS
 
     THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997
 
     Product revenues for the quarter ended June 30, 1998 were $6.1 million in
the United States and $9.8 million internationally compared to $33.5 million in
the Unites States and zero internationally for the same period in 1997. Product
revenues for the six months ended June 30, 1998 were $30.7 million in the U.S.
and $11.8 million internationally compared to $61.2 million domestically and
zero internationally for the same period in 1997. The decline in domestic
revenue is attributable to the U.S. launch of sildenafil, a competitive oral
treatment for erectile dysfunction. Underlying demand for MUSE (alprostadil)
domestically, as measured by retail prescriptions, has declined approximately
70% since the commercial launch of sildenafil. Internationally, revenues
increased from $2.0 million in the first quarter of 1998 to $9.8 million in the
second quarter of 1998 as the Company's international marketing partners,
Janssen and Astra, launched in various countries. Pfizer has commenced selling
sildenafil on a limited basis outside the U.S. As sildenafil is offered in other
countries, it is likely that a large number of current and future impotence
patients will want to try this new oral therapy. The Company anticipates that
the launch of sildenafil in other countries may significantly reduce
international demand for MUSE (alprostadil). Such a reduction would have a
material adverse effect on the Company's business, financial condition and
results of operations.
 
     Total revenues for the six months ended June 30, 1998 also included a $1
million milestone payment from Janssen related to regulatory approval of MUSE
(alprostadil) in South Korea, compared to the six months ended June 30, 1997
which included a $5 million milestone payment related to signing the initial
distribution agreement with Janssen.
 
     The gross margin for the quarter and six months ended June 30, 1998 was 33%
and 50% of net product revenues, respectively, compared with 71% and 73%,
respectively, in the same periods in 1997. The lower margins in 1998 were
primarily the result of the lower per unit price on international shipments due
to the revenue sharing arrangements with international partners, as well as
higher cost of goods primarily related to start up costs associated with the new
manufacturing facility. The gross margins include the effect of reduced cost of
sales related to previously expensed materials of $0.8 million and $1.8 million
in the second quarter of
 
                                        7
<PAGE>   8
 
1998 and 1997, respectively, and $1.6 million and $2.9 million in the six months
ended June 30, 1998 and 1997, respectively. The Company anticipates that the raw
materials, which had been previously expensed prior to FDA approval, will be
fully utilized in 1999. The Company also expects international revenues to
continue to increase as a proportion of total revenues. These factors will have
the effect of reducing the gross margin but may be offset in part by production
efficiencies at the new manufacturing facility.
 
     Research and development expenses for the quarter ended June 30, 1998 were
$5.4 million compared to $1.9 million in the quarter ended June 30, 1997. For
the six months ended June 30, 1998 and 1997, research and development expenses
were $9.2 million and $4.0 million, respectively. The increase was mainly due to
new product development. As a result of the Company's recent restructuring, it
expects that research and development expenses will decrease from current
levels.
 
     Selling, general and administrative expenses for the quarter ended June 30,
1998 were $17.6 million, $6.3 million higher than the quarter ended June 30,
1997. The increase primarily related to higher selling and marketing expenses
associated with the Innovex contract sales organization and expanding the
Company's direct sales force from 50 to 74 sales representatives. For the six
months ended June 30, 1998, selling, general and administrative expenses were
$34.6 million, $11.5 million higher than the same period in 1997. The increase
was almost entirely due to spending on a direct-to-consumer advertising campaign
and costs associated with expanding the direct sales force and adding the
Innovex contract sales force. The Company also discontinued its
direct-to-consumer advertising program designed to create patient awareness. In
addition, on July 8, 1998, the Company announced its decision to seek a major
pharmaceutical partner to market, distribute and sell MUSE (alprostadil) in the
U.S. and its comprehensive effort to reduce expenses. As a first step, the
Company agreed to facilitate the transition of its direct sales force to ALZA.
Sales personnel joining ALZA will continue to sell MUSE on a limited basis until
December 31, 1998. VIVUS also terminated its sales force services agreement with
Innovex and reduced personnel in administration, research and development,
clinical and marketing departments. As a result of the restructuring, the
Company expects its selling, general and administrative expenses to decrease
from the current level.
 
     Interest and other income for the three and six months ended June 30, 1998
were $0.6 million and $1.5 million, respectively, compared with $1.3 million and
$2.4 million for the same periods in 1997. The decrease was primarily the result
of lower average invested cash balances. The Company expects lower interest
income for the remainder of 1998 due to lower average invested cash balances.
 
     Because of the first quarter loss in 1998, the Company recorded a tax
benefit of $0.6 million. The Company reversed this tax benefit because of
continued losses in the second quarter, resulting in no provision for income
taxes for the six months ended June 30, 1998. The Company's effective tax rate
was 17% and 19% of income before taxes for the three and six months ended June
30, 1997.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since inception, the Company has financed operations primarily from the
sale of preferred and common stock. Through June 30, 1998, VIVUS has raised
$153.0 million from financing activities. Cash, cash equivalents and
available-for-sale securities totaled $25.4 million at June 30, 1998 compared
with $44.2 million at March 31, 1998 and $91.7 million at December 31, 1997. The
$66.3 million decrease in cash resulted from several factors, including the
Company's repurchase of its common stock during the first quarter of 1998 ($23.6
million), net losses for the first six months of 1998, capital spending
associated with the new manufacturing facility in New Jersey, payments in the
first quarter of 1998 for 1997 sales commissions and a lawsuit settlement
payment.
 
     Accounts receivable at June 30, 1998 were $8.2 million compared with $11.8
million at December 31, 1997, a decrease of $3.6 million. The decrease was
primarily due to lower sales.
 
     Current liabilities were $25.1 million at June 30, 1998, compared with
$26.7 million at December 31, 1997, a reduction of $1.6 million. The reduction
primarily relates to a lawsuit settlement payment and payment of 1997 sales
commissions, partially offset by accruals associated with the restructuring
charges.
 
                                        8
<PAGE>   9
 
     Capital expenditures in the six months ended June 30, 1998 were $12.1
million compared with $10.8 million for the same period in 1997, an increase of
$1.4 million. This increase primarily resulted from additional costs associated
with the Company's new 90,000 square foot production facility in New Jersey.
 
     The Company expects to incur substantial additional costs, including
expenses related to its manufacturing facilities in New Jersey and a new
manufacturing facility in Europe, new product pre-clinical and clinical costs,
ongoing research and development activities, and general corporate purposes. The
Company anticipates that its existing capital resources will not be sufficient
to support the Company's operations through the commercial introduction of MUSE
(alprostadil) in all international markets or for the introduction of any
additional future products. The Company is currently seeking other sources of
financing to support its operations. In August 1998, the Company received a
nonbinding commitment letter for a proposed $10 million lease under an equipment
leasing program. Initially, the Company would receive $7.5 million of the total
lease balance upon execution of mutually agreeable documentation. The remaining
$2.5 million would become available upon the Company successfully meeting
certain financial milestones for the third and fourth quarters of 1998. The
proposed lease term would be five years, and as collateral, the lender would
have a claim on the equipment being financed, and a security interest to certain
other assets of the Company that is junior to the security interest of a working
capital lender. The Company is currently negotiating the documentation for the
proposed $10 million lease. There can be no assurance that the proposed lease
will be completed, if at all. Failure to successfully negotiate the proposed
lease will have a material adverse affect on the Company's business, financial
condition and results of operations. The Company is also seeking other financing
sources, such as receivables financing and credit lines, to provide additional
capital resources. There can be no assurance that the Company will be able to
secure financing from other sources. Furthermore, the Company may also be
required to issue additional equity or debt securities and may use other
financing sources including, but not limited to corporate alliances and lease
financing to fund the future development and possible commercial launch of its
future products. The sale of additional equity securities would result in
additional dilution to the Company's stockholders. The Company's working capital
and additional funding requirements will depend upon numerous factors,
including: (i) results of operations; (ii) the level of resources that the
Company devotes to expanding manufacturing capacity; (iii) the activities of
competitors; (iv) the progress of the Company's research and development
programs; (v) the timing and results of pre-clinical testing and clinical
trials; (vi) technological advances; and (vii) the level of resources that the
Company devotes to sales and marketing capabilities.
 
     The Management's Discussion and Analysis of Financial Condition and Results
of Operations section contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the factors set forth in this Liquidity and Capital Resources section, the Risk
Factors section, the Results of Operations section and the Description of
Business section. The discussion of those factors is incorporated herein by this
reference as if said discussion was fully set forth at this point.
 
                                        9
<PAGE>   10
 
     This Quarterly Report on Form 10-Q contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ from
those set forth in such forward-looking statements as a result of certain
factors, including those set forth in this Risk Factors section.
 
                                  RISK FACTORS
 
LIMITED SALES AND MARKETING EXPERIENCE; DEPENDENCE ON THIRD PARTIES
 
     Before commercially launching its first product, MUSE (alprostadil), in
January 1997, the Company had no experience in the sale, marketing and
distribution of pharmaceutical products. In the United States, the Company
initially marketed and sold its products through a direct sales force of
approximately 74 sales representatives. Effective February 1998, the Company
entered into a sales force services agreement with Innovex Inc. ("Innovex")
under which it added approximately 150 contract sales representatives, the
substantial majority of whom called upon primary care physicians ("PCPs"). On
March 27, 1998, the FDA approved Viagra (sildenafil), an oral pill produced by
Pfizer for the treatment of male impotence. Pfizer commercially introduced
sildenafil in the U.S. in April 1998. The introduction of sildenafil
dramatically increased the number of men seeking treatment for impotence and
significantly decreased demand for MUSE (alprostadil). Since the launch of
sildenafil, MUSE (alprostadil) prescriptions have declined approximately 70%.
The Company believes that the launch of sildenafil has dramatically increased
the role of the PCP in the treatment of erectile dysfunction patients. Under the
new erectile dysfunction market dynamics, the Company recognized that the
infrastructure of a major pharmaceutical company was needed to support a sales
force large enough to effectively address the needs of the PCP. Therefore, on
July 8, 1998, the Company announced a strategic decision to seek a major
pharmaceutical partner to market, distribute and sell MUSE (alprostadil) in the
U.S. As the first step in the implementation of the Company's new strategy and
to immediately reduce expenses, the Company terminated its agreement with
Innovex and agreed to facilitate the transition of its direct sales
representatives to ALZA. Sales personnel joining ALZA will continue to sell MUSE
(alprostadil) on a limited basis until December 31, 1998. Accordingly, the
Company is highly dependent upon the efforts of ALZA during this period, and
there can be no assurance that ALZA's sales efforts will be successful. There
can be no assurance that the Company will partner with a major pharmaceutical
company to market, distribute and sell MUSE, or that such a partnership would be
on reasonable terms. Further, there can be no assurance that such a partner will
be able to successfully market, distribute and sell MUSE. Should the Company
establish such a relationship, the Company's U.S. marketing efforts will depend
substantially on the partner's efforts. The partner may have other commitments
and may not commit the necessary resources to effectively market, distribute and
sell the Company's products. If the Company cannot establish such a
relationship, it will have to develop an alternative strategy for marketing,
distributing and selling its products in the U.S.
 
     In February 1996, the Company entered into a distribution agreement with
CORD Logistics, Inc. ("CORD"), a wholly-owned subsidiary of Cardinal Health,
Inc. Under this agreement, CORD warehouses the Company's finished goods, takes
customer orders, picks, packs and ships its product, invoices customers and
collects related receivables. The Company also has access to CORD's information
systems that support these functions. As a result of this distribution agreement
with CORD, the Company is heavily dependent on CORD's efforts to fulfill orders
and warehouse its products effectively. There can be no assurance such efforts
will be successful.
 
     In May 1996, the Company entered into an international marketing agreement
with Astra to purchase the Company's products for resale in Europe, South
America, Central America, Australia and New Zealand. As consideration for
execution of the international marketing agreement, Astra paid the Company $10
million in June 1996. In September 1996, the Company received a $10 million
milestone payment from Astra upon filing an application for marketing
authorization for MUSE (alprostadil) in the United Kingdom, and, in December
1997, received a $2 million milestone payment upon receiving approval of this
application by the MCA. The Company will be paid up to an additional $8 million
in the event certain other milestones are achieved. However, there can be no
assurance that such milestones will be achieved. The marketing agreement does
not have minimum purchase commitments, and Astra may take up to twelve months to
introduce a product in a
                                       10
<PAGE>   11
 
given country following regulatory approval in such country. As a result of this
marketing agreement with Astra, the Company is dependent on Astra's efforts to
market, distribute and sell the Company's products effectively in the above
mentioned markets. There can be no assurance that such efforts will be
successful.
 
     In July 1996, the Company entered into a distribution agreement with ASD, a
subsidiary of Bergen Brunswig Corporation. ASD provides "direct-to-physician"
distribution, telemarketing and customer service capabilities in support of the
U.S. marketing and sales efforts. As a result of this distribution agreement
with ASD, the Company is dependent on ASD's efforts to distribute, telemarket,
and provide customer service effectively. There can be no assurance that such
efforts will be successful.
 
     In January 1997, the Company signed an international marketing agreement
with Janssen, a subsidiary of Johnson & Johnson. Janssen will purchase the
Company's products for resale in China, multiple Pacific Rim countries
(excluding Japan), Canada, Mexico and South Africa. As consideration for
execution of the international marketing agreement, Janssen paid the Company $5
million. In October 1997, the Company signed an international marketing
agreement, amending the earlier agreement with Janssen, that expanded Janssen's
territories to include the Middle East, Russia, the Indian sub-continent, and
Africa. As consideration for execution of the expanded international territory
marketing agreement, Janssen paid the Company $2 million. The Company will
receive additional payments in the event certain other milestones are achieved.
However, there can be no assurance that such milestones will be achieved. As a
result of this distribution agreement with Janssen, the Company is dependent on
Janssen's efforts to distribute and sell the Company's products effectively in
the above mentioned markets. There can be no assurance that such efforts will be
successful. The Company has received indications from Janssen that regulatory
approvals in certain Middle Eastern countries will be granted later than
initially anticipated.

     The Company intends to market and sell its products in other foreign
markets through distribution, co-promotion or license agreements with corporate
partners. To date, the Company has entered into international marketing
agreements with Astra and Janssen. There can be no assurance that the Company
will be able to successfully enter into additional agreements with corporate
partners upon reasonable terms, if at all. To the extent that the Company enters
into distribution, co-promotion or license agreements for the sale of its
products, the Company will be dependent upon the efforts of third parties. These
third parties may have other commitments, and there can be no assurance that
they will commit the necessary resources to effectively market, distribute and
sell the Company's product.
 
INTENSE COMPETITION
 
     Competition in the pharmaceutical and medical products industries is
intense and is characterized by extensive research efforts and rapid
technological progress. Certain treatments for erectile dysfunction exist, such
as oral medications, needle injection therapy, vacuum constriction devices and
penile implants, and the manufacturers of these products will continue to
improve these therapies. The most significant competitive therapy is Viagra
(sildenafil), an oral medication by Pfizer, for which it received regulatory
approval in the United States in March 1998 and has filed for regulatory
approval in Europe. The commercial launch of sildenafil in the U.S. in April,
1998 dramatically increased the number of men seeking treatment for impotence
and significantly decreased demand for MUSE (alprostadil). Since the launch of
sildenafil, MUSE (alprostadil) prescriptions have declined approximately 70%.
The Company anticipates that the commercial launch of sildenafil in Europe and
other international countries may decrease the international demand for
MUSE (alprostadil). Such a decrease would have a material adverse effect on the
Company's business, financial condition, and results of operations. As a result
of this and other factors, including higher costs of goods sold related to the
Company's ramp up of its new manufacturing facility, and higher marketing and
sales costs primarily related to the sales force expansion via the Innovex
contract pharmaceutical sales organization, the Company experienced an operating
loss of $24.2 million, or $0.76 per share, in the second quarter of 1998. The
Company is currently seeking a major pharmaceutical partner to market,
distribute and sell MUSE (alprostadil) in the U.S. There can be no assurance
that this strategy will be successful in increasing domestic demand for MUSE
(alprostadil).
 
     Additional competitive products in the erectile dysfunction market include
needle injection therapy products from The Upjohn Company and Schwartz Pharma,
which were approved by the FDA in July 1995
 
                                       11
<PAGE>   12
 
and June 1997, respectively. Other large pharmaceutical companies are also
actively engaged in the development of therapies for the treatment of erectile
dysfunction. These companies have substantially greater research and development
capabilities as well as substantially greater marketing, financial and human
resources than the Company. In addition, these companies have significantly
greater experience than the Company in undertaking pre-clinical testing, human
clinical trials and other regulatory approval procedures. There are also small
companies, academic institutions, governmental agencies and other research
organizations that are conducting research in the area of erectile dysfunction.
For instance, Zonagen, Inc. has filed for FDA approval of its oral treatment and
has recently received approval in Mexico; Pentech Pharmaceutical, Inc. has an
oral medication in Phase III clinical trials; and Senetek has a needle injection
therapy product approved recently in Denmark and has filed for approval in other
countries. These entities may market commercial products either on their own or
through collaborative efforts. For example, Zonagen, Inc. announced a worldwide
marketing agreement with Schering-Plough in November 1997. The Company's
competitors may develop technologies and products that are more effective than
those currently marketed or being developed by the Company. Such developments
would render the Company's products less competitive or possibly obsolete. The
Company is also competing with respect to marketing capabilities and
manufacturing efficiency, areas in which it has limited experience.
 
LIMITED MANUFACTURING EXPERIENCE; CAPACITY CONSTRAINTS
 
     The Company has limited experience in manufacturing MUSE (alprostadil) in
commercial quantities. Up until the commercial launch of sildenafil, the Company
had experienced product shortages due to higher than expected demand and
difficulties encountered in scaling up production of MUSE (alprostadil). The
Company leased 90,000 square feet of space in New Jersey in which it has
constructed additional manufacturing and testing facilities . The FDA and MCA
authorized the Company to begin commercial production and shipment of MUSE
(alprostadil) from its new facility in June 1998 and March 1998, respectively.
With the added capacity, the Company does not anticipate capacity constraints in
the foreseeable future. However, if the Company encounters further difficulties
with either of its current manufacturing facilities, capacity issues could
arise. Such capacity constraints could strain relationships with distribution
partners due to the need to allocate product between domestic and international
markets, and possibly cause patients to seek alternative therapies. Such events
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company has recently experienced
various manufacturing difficulties that have resulted in production and shipment
delays and higher costs. In turn, revenues from the sale of MUSE (alprostadil)
will be delayed, which will have a material adverse effect on the Company's
business, financial condition and results of operations. 
 
     The Company and certain of its suppliers and service providers are subject
to routine periodic inspections by the FDA and certain state and foreign
regulatory agencies for compliance with current Good Manufacturing Practices
(cGMP) and other applicable regulations. Certain of the Company's suppliers were
inspected for compliance with cGMP requirements as part of the approval process.
However, upon routine re-inspection of these facilities, there can be no
assurance that the FDA will find the manufacturing process or facilities to be
in compliance with cGMP and other regulations. A routine re-inspection of
Chinoin, one of the Company's two sources of alprostadil, resulted in the
issuance of an FDA Form 483 which set forth areas where Chinoin was not in
compliance with cGMP requirements. Chinoin has successfully responded to the FDA
report, and is in compliance with cGMP requirements. Failure to achieve
satisfactory cGMP compliance as confirmed by routine regulatory inspections
could have a significant adverse effect on the Company's ability to continue to
manufacture and distribute its products and, in the most serious cases, result
in the issuance of a regulatory warning letter or seizure or recall of products,
injunction and/or civil fines.
 
     In connection with post-approval inspections of the Company's New Jersey
manufacturing facility at Paco, the FDA issued the Company FDA Forms 483 and a
Warning Letter, which detailed specific areas where the FDA observed that the
Company's operations were not in full compliance with some areas of cGMP
requirements. On November 19, 1997, after taking corrective action and providing
the FDA a written response to the FDA observations, the Company received a
letter from the FDA affirming that the Company's facility at Paco is in
substantial compliance with cGMP requirements. Failure to maintain satisfactory
cGMP compliance could have a material adverse effect on the Company's ability to
continue to market and distribute its products and, in the most serious cases,
could result in the issuance of additional Warning Letters, seizure
 
                                       12
<PAGE>   13
 
or recall of products, civil fines or closure of the Company's manufacturing
facility until cGMP compliance is achieved.
 
DEPENDENCE ON THE COMPANY'S TRANSURETHRAL SYSTEM FOR ERECTION
 
     The Company currently relies upon a single therapeutic approach to treat
erectile dysfunction, its transurethral system for erection. Certain side
effects have been found to occur with the use of MUSE (alprostadil). Mild to
moderate transient penile/perineal pain was experienced by 21 percent to 42
percent of patients (depending on dosage) treated with MUSE (alprostadil) in the
Company's Phase II/III Dose Ranging study. Moderate to severe decreases in blood
pressure were experienced by 1 percent to 4 percent of patients (depending on
dosage) treated with MUSE (alprostadil) in such study and in a few instances
(0.4 percent), patients experienced syncope (fainting). During 1997, the first
year of commercial use of MUSE (alprostadil), the incidence of adverse side
effects was consistent with that experienced in clinical trials.
 
     The existence of side effects or dissatisfaction with product results may
impact a patient's decision to use or continue to use, or a physician's decision
to recommend, MUSE (alprostadil) as a therapy for the treatment of erectile
dysfunction thereby affecting the commercial viability of MUSE (alprostadil). In
addition, technological changes or medical advancements could diminish or
eliminate the commercial viability of the Company's products. As a result of the
Company's single therapeutic approach and its current focus on MUSE
(alprostadil), the failure to successfully commercialize such product would have
an adverse effect on the Company and could threaten the Company's ability to
continue as a viable entity.
 
FUTURE CAPITAL NEEDS AND UNCERTAINTY OF ADDITIONAL FINANCING
 
     The Company expects to incur substantial additional costs, including
expenses related to its manufacturing facilities in New Jersey and a new
manufacturing facility in Europe, new product pre-clinical and clinical costs,
ongoing research and development activities, and general corporate purposes. The
Company anticipates that its existing capital resources will not be sufficient
to support the Company's operations through the commercial introduction of MUSE
(alprostadil) in all international markets or for the introduction of any
additional future products. The Company is currently seeking other sources of
financing to support its operations. In August 1998, the Company received a
nonbinding commitment letter for a proposed $10 million lease under an equipment
leasing program. Initially, the Company would receive $7.5 million of the total
lease balance upon execution of mutually agreeable documentation. The remaining
$2.5 million would become available upon the Company successfully meeting
certain financial milestones for the third and fourth quarters of 1998. The
proposed lease term would be five years, and as collateral, the lender would
have a claim on the equipment being financed, and a security interest to certain
other assets of the Company that is junior to the security interest of a working
capital lender. The Company is currently negotiating the documentation for the
proposed $10 million lease. There can be no assurance that the proposed lease
will be completed, if at all. Failure to successfully negotiate the proposed
lease will have a material adverse affect on the Company's business financial
condition and results of operations. The Company is also seeking other financing
sources, such as receivables financing and credit lines, to provide additional
capital resources. There can be no assurance that the Company will be able to
secure financing from other sources. The Company may also be required to issue
additional equity or debt securities and may use other financing sources
including, but not limited to corporate alliances and lease financing to fund
the future development and possible commercial launch of its future products.
The sale of additional equity securities would result in additional dilution to
the Company's stockholders. The Company's working capital and additional funding
requirements will depend upon numerous factors, including: (i) results of
operations; (ii) the level of resources that the Company devotes to expanding
manufacturing capacity; (iii) the activities of competitors; (iv) the progress
of the Company's research and development programs; (v) the timing and results
of pre-clinical testing and clinical trials; (vi) technological advances; and
(vii) the level of resources that the Company devotes to sales and marketing
capabilities.
 
HISTORY OF LOSSES AND LIMITED OPERATING HISTORY
 
     The Company has generated a cumulative net loss of $56.1 million for the
period from its inception through June 30, 1998. In order to return to
profitability, the Company must successfully manufacture and market MUSE
(alprostadil) and adjust its expenditures in conjunction with lower product
revenues. The Company is subject to a number of risks including its ability to
successfully market, distribute and sell its product, intense competition, its
ability to scale-up manufacturing capabilities, its reliance on a single
therapeutic approach to erectile dysfunction and its ability to secure
additional operating capital. There can be
                                       13
<PAGE>   14
no assurance that the Company will be able to achieve profitability on a
sustained basis. Accordingly, there can be no assurance of the Company's future
success. Since the launch of sildenafil, a competitive oral product, MUSE
(alprostadil) prescriptions have declined approximately 70%. As a result of this
and other factors, including higher costs of good sold related to the Company's
ramp up its new manufacturing facility, and higher marketing and sales costs
primarily related to the sales force expansion via the Innovex contract
pharmaceutical sales organization, the Company experienced an operating loss of
$24.2 million, or $0.76 per share, in the second quarter of 1998. Included in
the second quarter 1998 results is a one-time charge of $6.5 million related to
the Company restructuring its operations. The goal of this restructuring is to
reduce expenses in order to facilitate a return to profitability. The Company
does not believe that it will return to profitability in 1998 due to a number of
factors, including costs associated with the restructuring, domestic and
international competition from Pfizer and manufacturing difficulties.
 
     The Company began generating revenues from product sales in January 1997.
The Company has limited experience in manufacturing and selling MUSE
(alprostadil) in commercial quantities. If international sales increase as
anticipated, gross margins will be adversely impacted and will only improve if
the Company is successful in lowering its cost of goods sold. If the Company
encounters further difficulties with its current manufacturing facility,
capacity issues could arise. Such capacity constraints could strain
relationships with distribution partners due to the need to allocate product
between domestic and international markets, and possibly cause patients to seek
alternative therapies. Such events could have a material adverse effect on the
Company's business, financial condition and results of operations. Whether the
Company can successfully manage the transition to a large scale commercial
enterprise will depend upon its ability to successfully market, distribute and
sell its product, further develop its manufacturing capability and attain
foreign regulatory approvals for MUSE (alprostadil). Failure to make such a
transition successfully would have a material adverse effect on the Company's
business, financial condition and results of operations. The Company has
recently experienced various manufacturing difficulties that have resulted in
production and shipment delays and higher costs. In turn, revenues from the sale
of MUSE (alprostadil) will be delayed which will have a material adverse effect
on the Company's business, financial condition and results of operations.
 
DEPENDENCE ON KEY PERSONNEL
 
     The Company's progress to date has been highly dependent upon the skills of
a limited number of key management personnel. To reach its future business
objectives, the Company will need to hire and retain numerous qualified
personnel in the areas of research and development, manufacturing, clinical
trial management and pre-clinical testing. Due to recent decreases in the
Company's stock price and demand for MUSE (alprostadil), there can be no
assurance that the Company will be able to hire and retain such personnel, as
the Company must compete with other companies, academic institutions, government
entities and other agencies. The loss of any of the Company's key personnel or
the failure to attract or retain necessary new employees could have an adverse
effect on the Company's research, product development and business operations.
 
RISKS RELATING TO INTERNATIONAL OPERATIONS
 
     The Company's products are currently marketed internationally. Changes in
overseas economic and political conditions, currency exchange rates, foreign tax
laws or tariffs or other trade regulations could have a material adverse effect
on the Company's business, financial condition and results of operations. The
current economic instability in Asia has resulted in weaker than expected sales
of MUSE (alprostadil) in the Asian markets. The international nature of the
Company's business is also expected to subject it and its representatives,
agents and distributors to laws and regulations of the foreign jurisdictions in
which they operate or the Company's products are sold. The regulation of drug
therapies in a number of such jurisdictions, particularly in the European Union,
continues to develop, and there can be no assurance that new laws or regulations
will not have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the laws of certain foreign
countries do not protect the Company's intellectual property rights to the same
extent as do the laws of the United States.
 
GOVERNMENT REGULATION AND UNCERTAINTY OF PRODUCT APPROVALS
 
     The Company's research, pre-clinical development, clinical trials,
manufacturing and marketing of its products are subject to extensive regulation
by numerous governmental authorities in the United States and other countries.
Clinical trials, manufacturing and marketing of the Company's products will be
subject to the rigorous testing and approval processes of the FDA and equivalent
foreign regulatory agencies. The process of
                                       14
<PAGE>   15
 
obtaining FDA and other required regulatory approvals is lengthy and expensive.
The Company completed pivotal clinical trials in 1995 and submitted an NDA for
its first product, MUSE (alprostadil), to the FDA in March 1996. In November
1996, the Company received final marketing clearance from the FDA for MUSE
(alprostadil). In November 1997, the Company obtained regulatory marketing
clearance by the MCA to market MUSE (alprostadil) in the United Kingdom. MUSE
(alprostadil) has also been approved in Argentina, Brazil, Canada, Hong Kong,
Mexico, New Zealand, Philippines, Singapore, South Africa, Sweden, Switzerland
and Thailand.
 
     After regulatory approval is obtained, the Company's products are subject
to continual review. Manufacturing, labeling and promotional activities are
continually regulated by the FDA, and the Company must also report certain
adverse events involving its drugs to the Agency under regulations issued by the
FDA. Additionally, previously unidentified adverse events or an increased
frequency of adverse events that occur post-approval could result in labeling
modifications of approved products, which could adversely effect future
marketing of a drug. Finally, approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems occur following initial
marketing. The restriction, suspension or revocation of regulatory approvals or
any other failure to comply with regulatory requirements would have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     The Company has submitted applications for approval of MUSE (alprostadil)
in several other countries, including China and Australia. These applications
will be subject to rigorous approval processes. There can be no assurance that
approval in these or other countries will be granted on a timely basis, if at
all, or if granted, that such approval will not contain significant limitations
in the form of warnings, precautions or contraindications with respect to
condition of use. Any delay in obtaining, or failure to obtain such approval
would adversely affect the Company's ability to generate product revenue. The
Company has received indications from one of its international marketing
partners that regulatory approvals in certain Middle Eastern countries will be
granted later than initially anticipated.
 
     The Company's clinical trials for future products will generate safety data
as well as efficacy data and will require substantial time and significant
funding. There is no assurance that clinical trials related to future products
will be completed successfully within any specified time period, if at all.
Furthermore, the FDA may suspend clinical trials at any time if it is believed
that the subjects participating in such trials are being exposed to unacceptable
health risks. There can be no assurance that FDA or other regulatory approvals
for any products developed by the Company will be granted on a timely basis, if
at all, or if granted, that such approval will not contain significant
limitations in the form of warnings, precautions or contraindications with
respect to conditions of use. Any delay in obtaining, or failure to obtain, such
approvals would adversely affect the Company's ability to generate product
revenue. Failure to comply with the applicable regulatory requirements can,
among other things, result in fines, suspensions of regulatory approvals,
product recalls, operating restrictions and criminal prosecution. In addition,
the marketing and manufacturing of pharmaceutical products are subject to
continuing FDA review, and later discovery of previously unknown problems with a
product, manufacturer or facility may result in the FDA requiring further
clinical research or restrictions on the product or the manufacturer, including
withdrawal of the product from the market. The restriction, suspension or
revocation of regulatory approvals or any other failure to comply with
regulatory requirements would have a material adverse effect on the Company's
business, financial condition and results of operations.
 
     The Company obtains the necessary raw materials and components for the
manufacture of MUSE (alprostadil) as well as certain services, such as testing
and sterilization, from third parties. The Company currently contracts with
suppliers and service providers, including foreign manufacturers, that are
required to comply with strict standards established by the Company. Certain
suppliers and service providers are required by the Federal Food, Drug, and
Cosmetic Act, as amended, and by FDA regulations to follow cGMP requirements and
are subject to routine periodic inspections by the FDA and certain state and
foreign regulatory agencies for compliance with cGMP and other applicable
regulations. Certain of the Company's suppliers were inspected for cGMP
compliance as part of the approval process. However, upon routine re-inspection
of these facilities, there can be no assurance that the FDA will find the
manufacturing process or facilities to be in compliance with cGMP and other
regulations. A routine re-inspection of Chinoin, one of the Company's two
sources of alprostadil, resulted in the issuance of an FDA Form 483 which set
forth areas where Chinoin was not in compliance with cGMP requirements. Chinoin
has successfully responded to the FDA report, and is in compliance with cGMP
requirements. Failure to achieve satisfactory cGMP compliance as confirmed by
routine inspections could have a material adverse effect on the Company's
ability to continue
 
                                       15
<PAGE>   16
 
to manufacture and distribute its products and, in the most serious case, result
in the issuance of a regulatory Warning Letter or seizure or recall of products,
injunction and/or civil fines.
 
     In connection with post-approval inspections of the Company's New Jersey
manufacturing facility at Paco, the FDA issued the Company FDA Forms 483 and a
Warning Letter, which detailed specific areas where the FDA observed that the
Company's operations were not in full compliance with some areas of cGMP
requirements. On November 19, 1997, after taking corrective action and providing
the FDA a written response to the FDA observations, the Company received a
letter from the FDA affirming that the Company's facility at Paco is in
substantial compliance with cGMP requirements. Failure to maintain satisfactory
cGMP compliance could have a material adverse effect on the Company's ability to
continue to market and distribute its products and, in the most serious cases,
could result in the issuance of additional Warning Letters, seizure or recall of
products, civil fines or closure of the Company's manufacturing facility until
cGMP compliance is achieved.
 
PROPRIETARY RIGHTS AND RISK OF PATENT LITIGATION
 
     The Company's success will depend, in large part, on the strength of its
current and future patent position relating to the administration of
pharmacologic agents for the treatment of erectile dysfunction. The Company's
patent position, like that of other pharmaceutical companies, is highly
uncertain and involves complex legal and factual questions. The claims of any
patent applications may be denied or significantly narrowed and issued patents
may not provide significant commercial protection to the Company. The Company
could incur substantial costs in proceedings before the United States Patent and
Trademark Office, including interference and reexamination proceedings.
Interference proceedings could also result in adverse decisions as to the
priority of the Company's licensed or assigned inventions. There is no assurance
that the Company's patents will not be successfully challenged or designed
around by others.
 
     The Company is presently involved in an opposition proceeding that was
instigated by the Pharmedic Company against a European patent that is
exclusively licensed to VIVUS. As a result of the opposition proceeding, certain
claims in the European patent were held to be unpatentable by the Opposition
Division of the European Patent Office ("EPO"). These claims all related to
pharmaceutical compositions that include prostaglandin E1. The patentability of
all other claims in the patent was confirmed (i.e., claims directed to the use
of active agents in the treatment of erectile dysfunction by administration via
the urethra to the corpora cavernosa, and to a pharmaceutical composition claim
for prazosin). The Company appealed the EPO's decision with respect to the
pharmaceutical composition claims that were held unpatentable and the Pharmedic
Company appealed the EPO's decision with respect to the claims that were held
patentable, but Pharmedic's appeal has since withdrawn. Despite the withdrawal
of the Pharmedic Company from the appeal process, the Company has continued with
its own appeal in an attempt to reinstate the composition claims. The EPO
Appeals Board must make its own finding whether the claims that were deemed
unpatentable by the Opposition Division are indeed patentable before it can
reverse the Opposition Division's decision. There can be no assurance that the
appeal will be successful or that further challenges to the Company's European
patent will not occur should the Company try to enforce the patent in the
various European courts.
 
     There can be no assurance that the Company's products do not or will not
infringe on the patent or proprietary rights of others. The Company may be
required to obtain additional licenses to the patents, patent applications or
other proprietary rights of others. There can be no assurance that any such
licenses would be made available on terms acceptable to the Company, if at all.
If the Company does not obtain such licenses, it could encounter delays in
product introductions while it attempts to design around such patents, or the
development, manufacture or sale of products requiring such licenses could be
precluded. The Company believes there will continue to be significant litigation
in the pharmaceutical industry regarding patent and other intellectual property
rights.
 
     The Company also relies on trade secrets and other unpatented proprietary
technology. No assurance can be given that the Company can meaningfully protect
its rights in such unpatented proprietary technology or that others will not
independently develop substantially equivalent proprietary products and
processes or otherwise gain access to the Company's proprietary technology. The
Company seeks to protect its trade
 
                                       16
<PAGE>   17
 
secrets and proprietary know-how, in part, with confidentiality agreements with
employees and consultants. There can be no assurance that these agreements will
not be breached, that the Company will have adequate remedies for any breach or
that the Company's trade secrets will not otherwise become known or be
independently developed by competitors. In addition, protracted and costly
litigation may be necessary to enforce and determine the scope and validity of
the Company's proprietary rights.
 
UNCERTAINTY OF PHARMACEUTICAL PRICING AND REIMBURSEMENT
 
     In the United States and elsewhere, sales of pharmaceutical products are
dependent, in part, on the availability of reimbursement to the consumer from
third party payors, such as government and private insurance plans. Third party
payors are increasingly challenging the prices charged for medical products and
services. With the introduction of sildenafil, third party payors have begun to
restrict or eliminate reimbursement for patients for erectile dysfunction
treatments. While more than 70 percent of prescriptions for MUSE (alprostadil)
were reimbursed by third party payors during 1997 and the first half of 1998
there can be no assurance that the Company's products will be considered cost
effective and that reimbursement to the consumer will continue to be available
or sufficient to allow the Company to sell its products on a competitive basis.
 
     In addition, certain health care providers are moving towards a managed
care system in which such providers contract to provide comprehensive health
care services, including prescription drugs, for a fixed cost per person. The
Company hopes to further qualify its transurethral system for erection for
reimbursement in the managed care environment. However, the Company is unable to
predict the reimbursement policies employed by third-party health care payors.
Furthermore, attempts at qualifying its transurethral system for erection for
reimbursement could be adversely affected by changes in reimbursement policies
of governmental or private health care payors.
 
DEPENDENCE ON DUAL AND SINGLE SOURCE OF SUPPLY
 
     The Company obtains its supply of alprostadil from two sources. The first
is Spolana Chemical Works a.s. in Neratovice, Czech Republic ("Spolana")
pursuant to a supply agreement that was executed in May 1997. In January 1996,
the Company entered into an alprostadil supply agreement with CHINOIN
Pharmaceutical and Chemical Works Co., Ltd. ("Chinoin"). Chinoin is the
Hungarian subsidiary of the French pharmaceutical company Sanofi Winthrop.
Alprostadil, a generic drug, is extremely difficult to manufacture and is only
available to the Company from a limited number of other suppliers, none of which
currently produce it in commercial quantities. The Company is seeking additional
sources of alprostadil. In addition, the Company relies on a single injection
molding company, The Kipp Group ("Kipp"), for its supply of plastic applicator
components. In turn, Kipp obtains its supply of resin, a key ingredient of the
applicator, from a single source, Huntsman Corporation. The Company also relies
on a single source, E-Beam Services, Inc. ("E-Beam"), for sterilization of its
product. There can be no assurance that the Company will be able to identify and
qualify additional sources of alprostadil and plastic components and an
additional sterilization facility. The Company is required to receive FDA
approval for suppliers. The FDA may require additional clinical trials or other
studies prior to accepting a new supplier. Unless the Company secures and
qualifies additional sources of alprostadil and plastic components and an
additional sterilization facility, it will be entirely dependent upon the
existing suppliers and E-Beam. If interruptions in these supplies or services
were to occur for any reason, including a decision by existing suppliers and/or
E-Beam to discontinue manufacturing or services, political unrest, labor
disputes or a failure of the existing suppliers and/or E-Beam to follow
regulatory guidelines, the development and commercial marketing of MUSE
(alprostadil) and other potential products could be delayed or prevented. An
interruption in sterilization services or the Company's supply of alprostadil or
plastic components would have a material adverse effect on the Company's
business, financial condition and results of operations.
 
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE
 
     The commercial launch of MUSE (alprostadil) exposes the Company to a
significant risk of product liability claims due to its availability to a large
population of patients. In addition, pharmaceutical products are
                                       17
<PAGE>   18
 
subject to heightened risk for product liability claims due to inherent side
effects. The Company details potential side effects in the patient package
insert and the physician package insert, both of which are included with MUSE
(alprostadil), and the Company maintains product liability insurance coverage.
However, the Company's product liability coverage is limited and may not be
adequate to cover potential product liability exposure. Product liability
insurance is expensive, difficult to maintain and current or increased coverage
may not be available on acceptable terms, if at all. Product liability claims
brought against the Company in excess of its insurance coverage, if any, could
have a material adverse effect upon the Company's business, financial condition
and results of operations.
 
UNCERTAINTY AND POSSIBLE NEGATIVE EFFECTS OF HEALTHCARE REFORM
 
     The healthcare industry is undergoing fundamental changes that are the
result of political, economic and regulatory influences. The levels of revenue
and profitability of pharmaceutical companies may be affected by the continuing
efforts of governmental and third party payors to contain or reduce healthcare
costs through various means. Reforms that have been and may be considered
include mandated basic healthcare benefits, controls on healthcare spending
through limitations on the increase in private health insurance premiums and
Medicare and Medicaid spending, the creation of large insurance purchasing
groups and fundamental changes to the healthcare delivery system. Due to
uncertainties regarding the outcome of healthcare reform initiatives and their
enactment and implementation, the Company cannot predict which, if any, of the
reform proposals will be adopted or the effect such adoption may have on the
Company. There can be no assurance that future healthcare legislation or other
changes in the administration or interpretation of government healthcare or
third-party reimbursement programs will not have a material adverse effect on
the Company. Healthcare reform is also under consideration in some other
countries.
 
POTENTIAL VOLATILITY OF STOCK PRICE
 
     The stock market has recently experienced significant price and volume
fluctuations unrelated to the operating performance of particular companies. In
addition, the market price of the Company's Common Stock has been highly
volatile and is likely to continue to be so. Factors such as the Company's
ability to increase demand for its product in the United States, the Company's
ability to successfully sell its product in the United States and
internationally, variations in the Company's financial results and its ability
to obtain needed financing, announcements of technological innovations or new
products by the Company or its competition, comments by security analysts,
adverse regulatory actions or decisions, any loss of key management, the results
of the Company's clinical trials or those of its competition, changing
governmental regulations, patents or other proprietary rights, product or patent
litigation or public concern as to the safety of products developed by the
Company, may have a significant effect on the market price of the Company's
Common Stock.
 
ANTI-TAKEOVER EFFECT OF PREFERRED SHARES RIGHTS PLAN AND CERTAIN CHARTER AND
BYLAW PROVISIONS
 
     In February 1996, the Company's Board of Directors authorized its
reincorporation in the State of Delaware (the "Reincorporation") and adopted a
Preferred Shares Rights Plan. The Company's reincorporation into the State of
Delaware was approved by its stockholders and effective in May 1996. The
Preferred Shares Rights Plan provides for a dividend distribution of one
Preferred Shares Purchase Right (a "Right") on each outstanding share of the
Company's Common Stock. The Rights will become exercisable following the tenth
day after a person or group announces acquisition of 20 percent or more of the
Company's Common Stock, or announces commencement of a tender offer, the
consummation of which would result in ownership by the person or group of 20
percent or more of the Company's Common Stock. The Company will be entitled to
redeem the Rights at $0.01 per Right at any time on or before the tenth day
following acquisition by a person or group of 20 percent or more of the
Company's Common Stock.
 
     The Preferred Shares Rights Plan and certain provisions of the Company's
Certificate of Incorporation and Bylaws may have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, control of the Company. The Company's Certificate of
Incorporation allows the Company to issue Preferred Stock without any vote or
further action by the stockholders, and
                                       18
<PAGE>   19
 
certain provisions of the Company's Certificate of Incorporation and Bylaws
eliminate the right of stockholders to act by written consent without a meeting,
specify procedures for director nominations by stockholders and submission of
other proposals for consideration at stockholder meetings, and eliminate
cumulative voting in the election of directors. Certain provisions of Delaware
law could also delay or make more difficult a merger, tender offer or proxy
contest involving the Company, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years unless certain conditions are met. The
Preferred Shares Rights Plan, the possible issuance of Preferred Stock, the
procedures required for director nominations and stockholder proposals and
Delaware law could have the effect of delaying, deferring or preventing a change
in control of the Company, including without limitation, discouraging a proxy
contest or making more difficult the acquisition of a substantial block of the
Company's Common Stock. These provisions could also limit the price that
investors might be willing to pay in the future for shares of the Company's
Common Stock.
 
                           PART II: OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
     On February 18, 1998, a purported shareholder class action entitled Crain
et al. v Vivus, Inc. et al., was filed in Superior Court of the State of
California for the County of San Mateo. Five identical complaints were
subsequently filed in the same court. These complaints were filed on behalf of a
purported class of persons who purchased stock between May 15 and December 9,
1997. The complaints allege that the Company and certain current and former
officers or directors artificially inflated the Company's stock price by issuing
false and misleading statements concerning the Company's prospects and issuing
false financial statements. The complaints do not specify the damages resulting
from the alleged conduct. The state court cases have been consolidated, and the
Company anticipates that the plaintiffs will file a consolidated and amended
complaint. On March 16, 1998, a purported shareholder class action entitled
Cramblit et al. v. Vivus, Inc. et al. was filed in the United States District
Court for the Northern District of California. Five additional complaints were
subsequently filed in the same court. The federal complaints were filed on
behalf of a purported class of persons who purchased stock between May 2 and
December 9, 1997. The federal complaints assert the same factual allegations as
the state court complaints, but asserts legal claims under the Federal
Securities Laws. The federal court cases have been consolidated and a lead
plaintiff has been appointed. The Company anticipates that the plaintiffs will
file a consolidated and amended complaint. The Company believes the complaints
lack merit and the Company will vigorously defend itself in the pending actions.
 
     In the normal course of business, the Company receives and makes inquiries
regarding patent infringement and other legal matters. The Company believes that
it has meritorious claims and defenses and intends to pursue any such matters
vigorously. The Company is not aware of any asserted or unasserted claims
against it where the resolution would have an adverse material impact on the
operations or financial position of the Company.
 
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
 
     None.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
     None.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     The annual meeting of stockholders was held May 21, 1998. Matters voted on
at that meeting were: (i) the election of seven directors and (ii) the
confirmation of the appointment of Arthur Andersen LLP as
 
                                       19
<PAGE>   20
 
independent public accountants for the fiscal year ended December 31, 1998.
Tabulation for each proposal and individual director were as follows:
 
                       PROPOSAL I. ELECTION OF DIRECTORS
 
<TABLE>
<CAPTION>
                       DIRECTOR                            FOR        WITHHELD
                       --------                            ---        --------
<S>                                                     <C>           <C>
Virgil A. Place, MD...................................  26,099,480    250,391
Leland F. Wilson......................................  26,099,480    250,391
Richard L. Casey......................................  26,099,480    250,391
Brian H. Dovey........................................  26,099,480    250,391
Elizabeth A. Fetter...................................  26,098,180    251,691
Linda Jenckes.........................................  26,099,480    250,391
Joseph E. Smith.......................................  26,099,480    250,391
</TABLE>
 
      PROPOSAL II. CONFIRMATION OF THE APPOINTMENT OF ARTHUR ANDERSEN LLP
 
<TABLE>
<CAPTION>
   FOR      AGAINST   ABSTAIN   NO VOTE
   ---      -------   -------   -------
<S>         <C>       <C>       <C>
26,230,785  69,955    50,131      --
</TABLE>
 
ITEM 5. OTHER INFORMATION

     With respect to stockholder proposals not included in the Company's proxy
statement for the 1999 Annual Meeting of Stockholders, the persons named in
management's proxy for the 1999 Annual Meeting of Stockholders will be entitled
to exercise the discretionary voting power conferred by such proxy under the
circumstances specified in Rule 14a-4(c) under the Securities Exchange Act of
1934, of the date of mailing of the proxy statement for the 1999 Annual Meeting
of Stockholders.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
(a) EXHIBITS (in accordance with Item 601 of Regulation S-K)
 
<TABLE>
<CAPTION>
      EXHIBIT
      NUMBER
      -------
    <S>          <C>
       (7)3.2    Amended and Restated Certificate of Incorporation of the
                 Company
       (4)3.3    Bylaws of the Registrant, as amended
       (8)3.4    Certificate of Designations of Rights, Preferences and
                 Privileges of Series A Participating Preferred Stock
       (7)4.1    Specimen Common Stock Certificate of the Registrant
       (1)4.2    Registration Rights, as amended
       (1)4.4    Form of Preferred Stock Purchase Warrant issued by the
                 Registrant to Invemed Associates, Inc., Frazier Investment
                 Securities, L.P., and Cristina H. Kepner
</TABLE>
 
                                       20
<PAGE>   21
 
<TABLE>
<CAPTION>
      EXHIBIT
      NUMBER
      -------
    <S>          <C>
       (8)4.5    Second Amended and Restated Preferred Shares Rights
                 Agreement, dated as of April 15, 1997 by and between the
                 Registrant and Harris Trust Company of California, including
                 the Certificate of Determination, the form of Rights
                 Certificate and the Summary of Rights attached thereto as
                 Exhibits A, B, and C, respectively
     (1)+10.1    Assignment Agreement by and between Alza Corporation and the
                 Registrant dated December 31, 1993
     (1)+10.2    Memorandum of Understanding by and between Ortho
                 Pharmaceutical Corporation and the Registrant dated February
                 25, 1992
      (1)10.3    Assignment Agreement by and between Ortho Pharmaceutical
                 Corporation and the Registrant dated June 9, 1992
     (1)+10.4    License Agreement by and between Gene A. Voss, MD, Allen C.
                 Eichler, MD, and the Registrant dated December 28, 1992
     (1)+10.5A   License Agreement by and between Ortho Pharmaceutical
                 Corporation and Kjell Holmquist AB dated June 23, 1989
     (1)+10.5B   Amendment by and between Kjell Holmquist AB and the
                 Registrant dated July 3, 1992
      (1)10.5C   Amendment by and between Kjell Holmquist AB and the
                 Registrant dated April 22, 1992
     (1)+10.5D   Stock Purchase Agreement by and between Kjell Holmquist AB
                 and the Registrant dated April 22, 1992
     (1)+10.6A   License Agreement by and between Amsu, Ltd., and Ortho
                 Pharmaceutical Corporation dated June 23, 1989
     (1)+10.6B   Amendment by and between Amsu, Ltd., and the Registrant
                 dated July 3, 1992
      (1)10.6C   Amendment by and between Amsu, Ltd., and the Registrant
                 dated April 22, 1992
     (1)+10.6D   Stock Purchase Agreement by and between Amsu, Ltd., and the
                 Registrant dated July 10, 1992
      (1)10.7    Supply Agreement by and between Paco Pharmaceutical
                 Services, Inc., and the Registrant dated November 10, 1993
      (1)10.10   Lease by and between McCandless-Triad and the Registrant
                 dated November 23, 1992, as amended
      (4)10.11   Form of Indemnification Agreements by and among the
                 Registrant and the Directors and Officers of the Registrant
      (2)10.12   1991 Incentive Stock Plan and Form of Agreement, as amended
      (1)10.13   1994 Director Option Plan and Form of Agreement
      (1)10.14   Form of 1994 Employee Stock Purchase Plan and Form of
                 Subscription Agreement
      (1)10.17   Letter Agreement between the Registrant and Leland F. Wilson
                 dated June 14, 1991 concerning severance pay
     (3)+10.21   Distribution Services Agreement between the Registrant and
                 Synergy Logistics, Inc. (a wholly-owned subsidiary of
                 Cardinal Health, Inc.) dated February 9, 1996
     (3)+10.22   Manufacturing Agreement between the Registrant and CHINOIN
                 Pharmaceutical and Chemical Works Co., Ltd. dated December
                 20, 1995
    (11)+10.22A  Amendment One, dated as of December 11, 1997, to the
                 Manufacturing Agreement by and between VIVUS and CHINOIN
                 Pharmaceutical and Chemical Works Co., Ltd. dated December
                 20, 1995
</TABLE>
 
                                       21
<PAGE>   22
 
<TABLE>
<CAPTION>
      EXHIBIT
      NUMBER
      -------
    <S>          <C>
     (6)+10.23   Distribution and Services Agreement between the Registrant
                 and Alternate Site Distributors, Inc. dated July 17, 1996
     (5)+10.24   Distribution Agreement made as of May 29, 1996 between the
                 Registrant and Astra AB
     (7)+10.27   Distribution Agreement made as of January 22, 1997 between
                 the Registrant and Janssen Pharmaceutica International, a
                 division of Cilag AG International
    (11)+10.27A  Amended and Restated Addendum 1091, dated as of October 29,
                 1997, between VIVUS International Limited and Janssen
                 Pharmaceutica International
      (7)10.28   Lease Agreement made as of January 1, 1997 between the
                 Registrant and Airport Associates
      (7)10.29   Lease Amendment No. 1 as of February 15, 1997 between
                 Registrant and Airport Associates
     (10)10.29A  Lease Amendment No. 2 dated July 24, 1997 by and between the
                 Registrant and Airport Associates
     (10)10.29B  Lease Amendment No. 3 dated July 24, 1997 by and between the
                 Registrant and Airport Associates
      (7)10.30   Lease agreement by and between 605 East Fairchild
                 Associates, L.P. and Registrant dated as of March 5, 1997
     (9)+10.31   Manufacture and Supply Agreement between Registrant and
                 Spolana Chemical Works, A.S. dated May 30, 1997
     (11)10.32A  Agreement between ADP Marshall, Inc. and the Registrant
                 dated December 19, 1997
     (11)10.32B  General Conditions of the Contract for Construction
     (11)10.32C  Addendum to General Conditions of the Contract for
                 Construction
      ++10.34    Agreement dated as of June 30, 1998 between Registrant and
                 Alza Corporation
      ++10.35    Sales Force Transition Agreement dated July 6, 1998 between
                 Registrant and Alza Corporation
          27.1   Financial Data Schedule
</TABLE>
 
- ---------------
 (1) Incorporated by reference to the same-numbered exhibit filed with the
     Registrant's Registration Statement on Form S-1 No. 33-75698, as amended.
 
 (2) Incorporated by reference to the same numbered exhibit filed with the
     Registrant's Registration Statement on Form S-1 No. 33-90390, as amended.
 
 (3) Incorporated by reference to the same-numbered exhibit filed with the
     Registrant's Annual Report on Form 10-K for the year ended December 31,
     1995, as amended.
 
 (4) Incorporated by reference to the same numbered exhibit filed with the
     Registrant's Form 8-B filed with the Commission on June 24, 1996.
 
 (5) Incorporated by reference to the same numbered exhibit filed with the
     Registrant's Current Report on Form 8-K/A filed with the Commission on June
     21, 1996.
 
 (6) Incorporated by reference to the same-numbered exhibit filed with the
     Registrant's Quarterly Report on Form 10-Q for the quarter ended September
     30, 1996.
 
 (7) Incorporated by reference to the same-numbered exhibit filed with the
     Registrant's Annual Report on Form 10-K for the year ended December
     31,1996, as amended.
 
 (8) Incorporated by reference to exhibit 99.1 filed with Registrant's Amendment
     Number 2 to the Registration Statement of Form 8-A (File No. 0-23490) filed
     with the Commission on April 23, 1997.
 
                                       22
<PAGE>   23
 
 (9) Incorporated by reference to the same-numbered exhibit filed with the
     Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
     1997
 
(10) Incorporated by reference to the same numbered exhibit filed with the
     Registrant's Quarterly Report on Form 10-Q for the quarter ended September
     30, 1997.
 
(11) Incorporated by reference to the same-numbered exhibit filed with the
     Registrant's Annual Report on Form 10-K for the year ended December 31,
     1997.
 
   + Confidential treatment granted.
 
   ++ Confidential treatment requested.
 
(b) REPORTS ON FORM 8-K
 
     None.
 
                                       23
<PAGE>   24
 
                                   SIGNATURES
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
 
<TABLE>
<S>                                       <C>
Date: August 14, 1998                     VIVUS, Inc.
</TABLE>
                                                   /s/ David C. Yntema
                                          --------------------------------------
                                                     David C. Yntema
                                                 Chief Financial Officer

                                                   /s/ Leland F. Wilson
                                          --------------------------------------
                                                     Leland F. Wilson
                                          President and Chief Executive Officer
 
                                       24
<PAGE>   25
 
                                  VIVUS, INC.
 
                               INDEX TO EXHIBITS*
 
<TABLE>
<CAPTION>
EXHIBIT                            DESCRIPTION
- -------                            -----------
<S>        <C>
++10.34    Agreement dated as of June 30, 1998 between Registrant and
           Alza Corporation
++10.35    Sales Force Transition Agreement dated July 6, 1998, between
           Registrant and Alza Corporation.
 27.1      Financial Data Schedule
</TABLE>
 
- ---------------
* Only exhibits actually filed are listed. Exhibits incorporated by reference
  are set forth in the exhibit listing included in Item 6 of the Quarterly
  Report on Form 10-Q.
 
++ Confidential treatment requested.

<PAGE>   1
                                                                   EXHIBIT 10.34


                                    AGREEMENT


         This Agreement is made and entered into as of the 30th day of June,
1998, between Vivus, Inc., a Delaware corporation ("Vivus") and ALZA
Corporation, a Delaware corporation ("ALZA").
Vivus and ALZA hereby agree as follows:

         ALZA is entering into a Sales Force Services Agreement with Innovex
Inc. on or about the date of this Agreement (the "Innovex Agreement"). Vivus
shall pay ALZA [ * ] of the amounts payable to Innovex Inc. for (i) the Daily
Fees (as defined in the Innovex Agreement) of up to [*] Territory
Representatives (as defined in the Innovex Agreement) and up to[*] Field
Coordinators (as defined in the Innovex Agreement) and (ii) related expenses for
such personnel (excluding initial training costs and travel expenses associated
with initial training) under the Innovex Agreement; during the period of July 1,
1998 to September 30, 1998, but in no event shall the Daily Fees for Territory
Representatives and Field Coordinators exceed an amount per day of [ * ],
respectively. In addition, in no event shall total amounts paid pursuant to this
Agreement exceed [ * ]. Vivus shall make payments under this Agreement within
thirty (30) days of receiving a copy of the invoices delivered to ALZA from
Innovex Inc. Vivus shall indemnify and hold harmless ALZA and its affiliates,
employees, officers, directors, successors and assignees from and against any
and all liabilities that such person may incur, suffer or be required to pay in
connection with or arising out of Vivus' execution, performance or obligations
under the Sales Force Services Agreement between Vivus and Innovex Inc. dated
February 1, 1998. Subject to the reimbursement provisions hereof, ALZA shall
indemnify and hold harmless Vivus and its affiliates, employees, officers,
directors, successors and assignees from and against any and all liability that
such person may incur, suffer or be required to pay in connection with or
arising out of ALZA's execution, performance or obligations under the Innovex
Agreement.

         ALZA shall use reasonable efforts to minimize the amounts payable by
Vivus under this Agreement. It is anticipated that at least [*] former District
Managers (as defined in the Sales Forces Services Agreement by Vivus and Innovex
Inc., dated February 1, 1998) shall become Innovex Personnel (as defined in the
Innovex Agreement).

         Vivus shall permit Innovex Personnel to continue promotion of the MUSE
product for an interim period, not to extend beyond July 9, 1998. The parties
shall draft mutually agreeable press releases regarding the subject matter of
this Agreement, which releases shall be made at a time to be agreed upon by the
parties, not to be later than July 9, 1998. Except for such press releases or to
the extent otherwise required by law, neither party shall make any disclosure or
public statement concerning this Agreement without the prior written consent of
the other.

[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.





<PAGE>   2


         Except as expressly set forth in the indemnification provisions above,
there are no third party beneficiaries to this Agreement. This Agreement may not
be amended except by an instrument in writing signed by both parties that
specifically refers to this Agreement. This Agreement constitutes the entire
agreement between the parties relating to the subject matter hereof and
supersedes all previous writings and understandings, whether oral or written,
relating to the subject matter of this Agreement.

         This Agreement may be executed in several counterparts, each of which
shall be deemed an original but all of which shall constitute one and the same
instrument. ALZA and Vivus have executed this Agreement, effective as of the
date first above written.

ALZA CORPORATION                           VIVUS, INC.


By: /s/ Peter D. Staple                    By: /s/ David C. Yntema
    ----------------------------               ----------------------------
    Name: Peter D. Staple                      David Yntema
    Title: Senior Vice President               Chief Financial Officer






<PAGE>   1
                                                                  EXHIBIT 610.35

                        SALES FORCE TRANSITION AGREEMENT

         This Sales Force Transition Agreement (the "Agreement") is made and
entered into as of the 6th day of July, 1998, between Vivus, Inc., a Delaware
corporation ("Vivus") and ALZA Corporation, a Delaware corporation ("ALZA").

                                 R E C I T A L S

         A.       Vivus has created a sales force to promote products to 
urology specialists in the United States.

         B. Due to business considerations, Vivus is considering a decrease in
the size of its total sales organization.

         C. ALZA desires to increase the size of its sales force by adding sales
representatives experienced in promoting products to the urology and primary
care markets.

         D. The parties desire to effect an orderly transition of the Vivus
sales force to ALZA in accordance with the terms and conditions of this
Agreement.

         NOW THEREFORE, in consideration of the following covenants, promises
and obligations, Vivus and ALZA agree as follows:

         1.       Definitions

                  1.1 "Affiliate" shall mean any corporation, firm, partnership
or other entity which, at the time in question, is directly or indirectly owned
or controlled by or under common control with, Vivus or ALZA, as the case may
be. For the purposes of this definition "control" shall mean the ownership,
directly or indirectly, of more than 50% of the voting stock or stockholders'
equity of a corporation or, in the case of a non-corporate entity, the right to
receive more than 50% of the profits or of the assets upon dissolution.

                  1.2 "Confidential Information" shall mean (i) in the case of
Vivus, employeespecific information (such as performance and compensation
information) disclosed by Vivus to ALZA concerning the Vivus Sales Employees and
information included in training materials relating to the MUSE product, and
(ii) in the case of ALZA information disclosed by ALZA to Vivus concerning
ALZA's products and training and promotional materials relating thereto, and
ALZA employment and compensation practices. Confidential Information shall not
include any information which is (i) now in the public domain or subsequently
enters the public domain without fault on the part of the receiving party; (ii)
known by the receiving party from its own sources, as evidenced by the receiving
party's written records; or (iii) received from any third party not under any
obligation to keep such information confidential.

                  1.3 "Liabilities" shall mean any and all liabilities, claims,
demands, losses or judgments of any kind or nature, primary or secondary,
including without limitation any liability for

                                       -1-

<PAGE>   2



claims of personal injury or death, and all reasonable attorneys' fees incurred
in connection with the defense of any such claims.

                  1.4 "MUSE" shall mean the MUSE(R) (alprostadil) transurethral
delivery product for erectile dysfunction in the form being marketed by Vivus in
the United States as of the Effective Date of this Agreement.

                  1.5      "Transition Date" shall mean July 1, 1998.

         2.       Vivus Sales Personnel

                  2.1 Reimbursement for Interim Period. During the period from
the Transition Date through July 31, 1998, Vivus shall cause each of the Vivus
Sales Employees who remain in Vivus' employ during such period to perform sales
and promotion services on behalf of ALZA as requested by ALZA and to undergo
training as requested by ALZA. Such services shall be performed in accordance
with ALZA's training and instructions and in compliance with applicable laws and
regulations. ALZA shall reimburse Vivus for Vivus' out-of-pocket costs incurred
in paying salaries and other benefits (to the extent specifically quantified in
Exhibit C) incurred for services actually performed for ALZA by Vivus Sales
Employees from the Transition Date through July 31, 1998. Such reimbursement
will be made within 30 days after receipt of Vivus' invoice for such amounts. To
be eligible for such reimbursement to Vivus such employees must perform sales
and promotion services on behalf of ALZA as requested by ALZA and undergo
training as requested by ALZA. During such interim period Vivus shall not
increase the salary, bonus, benefits, perquisites or other incentives to the
Vivus Sales Employees (other than the adoption of severance arrangements
pursuant to layoffs, for which Vivus shall bear the cost without reimbursement
by ALZA) without ALZA's prior written consent. At the conclusion of such interim
period Vivus shall promptly return to ALZA any and all promotional or training
materials, samples and other items provided by ALZA hereunder, other than those
that are in the possession of Vivus Sales Employees who become employees of ALZA
hereunder.

                  2.2      Offers of Employment.

                           (a) Promptly after execution of this Agreement, Vivus
will review with ALZA the employment history of each of the employees listed on
Exhibits A-1 and A-2 (the "Vivus Sales Employees"), including, without
limitation, salary, benefits, bonuses, defined compensation, options,
performance reviews and such other information as ALZA may reasonably request.
Vivus shall have obtained the written consent of each of such employees to the
provision of information to ALZA. Vivus shall also make such persons available
to meet with ALZA, if ALZA so requests.

                           (b) As soon as reasonably possible, but in any event
by July 31, 1998, ALZA shall notify each of the Vivus Sales Employees of ALZA's
determination of whether or not to offer employment to each such person and
shall make an offer of employment to each person for whom a positive
determination is made, such employment to be effective August 3, 1998. ALZA's

                                       -2-

<PAGE>   3



determination as to individual employees may be made based upon factors to be
determined by ALZA which may include, without limitation, the overall fit with
ALZA's sales and marketing organization, experience, motivation, geographic
location, compensation and performance. Offers of employment made to such
persons by ALZA would be in accordance with the terms and conditions described
in Exhibit B. Vivus shall not request or encourage any such persons to remain in
the employ of Vivus or to accept employment with a company other than ALZA.

                  2.3 Communications; Notice. Vivus shall provide to the Vivus
Sales Employees any notices required by applicable law or regulation in
connection with the prospective termination of their employment with Vivus.
Vivus shall provide ALZA with drafts of all proposed notices and communications
to the Vivus Sales Employees, and provide ALZA a reasonable opportunity to
review and comment on such materials, provided that any notice or communication
that relates to ALZA or potential employment with ALZA shall be subject to
ALZA's prior approval. Vivus and ALZA's human resource personnel shall meet on a
weekly basis to communicate the status of employment offers and other personnel
matters.

                  2.4 Other Costs and Expenses. Except for the reimbursement
provided for in Section 2.1, with respect to each Vivus Sales Employee, whether
or not subsequently employed by ALZA, Vivus shall bear and discharge, and
indemnify and hold harmless ALZA and its Affiliates, employees, officers,
directors, successors and assignees from and against all obligations and
Liabilities (excluding such obligations and Liabilities resulting from the gross
negligence or willful misconduct of ALZA), including but not limited to
obligations and Liabilities for wages, compensation, vacation pay, benefits,
termination or severance pay (including notice of termination or pay in lieu of
notice, damages for wrongful dismissal or similar claims), which relate to such
person's employment by Vivus (including without limitation the interim period
referred to in Section 2.1) or the termination thereof; including any interest,
award, judgment or penalty relating thereto and any costs and expenses
(including attorneys' fees) incurred by ALZA in such matters.

                  2.5 Non-solicitation. Neither Vivus nor its Affiliates shall,
without ALZA's prior written consent, prior to [ * ], directly or indirectly
solicit for employment or hire any of the Vivus Sales Employees who become
employed by ALZA (except for such employees whose employment is terminated by
ALZA).

                  2.6 ALZA Costs. Except for the compensation provided to ALZA
in Section 3.2, with respect only to each Vivus Sales Employee who becomes an
employee of ALZA under Section 2.2(b), ALZA shall bear and discharge, and
indemnify and hold harmless Vivus and its Affiliates, employees, officers,
directors, successors and assignees from and against, all obligations and
Liabilities (excluding such obligations and Liabilities resulting from the gross
negligence or willful misconduct of Vivus), including but not limited to
obligations and Liabilities for wages,

[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.


                                       -3-

<PAGE>   4



compensation, vacation pay, benefits, termination or severance pay (including
notice of termination or pay in lieu of notice, damages for wrongful dismissal
or similar claims), which relate to such person's employment by ALZA or any
termination thereof; including any interest, award, judgment or penalty relating
thereto and any costs and expenses (including attorneys' fees) incurred by Vivus
in such matters.

         3.       Promotion of MUSE

                  3.1 Promotion Activity. With respect to the period from the
Transition Date through December 31, 1998 (the "MUSE Promotion Period"), ALZA
shall devote at least [*]% of the aggregate sales call time, measured on a
calendar quarter basis, of ALZA's urology sales force to promotional
presentations of the MUSE(R) product on behalf of Vivus. For such purposes the
ALZA urology sales force will include approximately [*] of ALZA's current sales
representatives who will be assigned to promotion of urology products and those
Vivus Sales Employees listed in Exhibit A-1 who provide services to ALZA in
urology on an interim basis under Section 2.1, or who are subsequently employed
by ALZA pursuant to Section 2.2. ALZA shall provide a written report to Vivus
within 10 days after the end of each calendar month which [ * ]. [ * ] Vivus
shall provide to ALZA a report by August 10, 1998, providing all such
information for calls made by Vivus sales representatives under Section 2.1.
ALZA's promotion activity shall be performed in accordance with instruction and
training provided by Vivus and in compliance with applicable laws and
regulations. ALZA will not be required to present MUSE in "primary position"
during sales calls. ALZA's obligations under this Section 3.1 will be subject to
(i) prompt provision of materials and training by Vivus in accordance with
Section 3.3; and (ii) continued supply, distribution and customer support for
MUSE by Vivus in accordance with applicable laws and regulations. In addition,
if there is a substantial adverse medical development relating to MUSE which
ALZA, in its reasonable judgment, believes would be likely to result in material
harm to the reputation of ALZA or its sales force, then ALZA may notify Vivus of
such concern and the parties will agree on appropriate steps for an orderly
winding down of promotional activities while complying with applicable
regulatory requirements.

                  3.2 Incentives. During the MUSE Promotion Period, ALZA will
provide sales incentives for its urology sales force in which [*]% of the total
incentive package is based on sales of MUSE. Vivus shall reimburse ALZA for such
portion of the sales incentives that are based on sales of MUSE, within 30 days
after ALZA's invoice for such amounts.

                  3.3 Training, Materials. As a condition to ALZA's obligations
under Section 3.1, Vivus shall provide to ALZA at Vivus' cost and expense,
promptly after the Transition Date but in any event by July 15, 1998, such
promotional materials and training relating to MUSE as are necessary and
appropriate for ALZA to provide the promotional services contemplated in this

[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.


                                       -4-

<PAGE>   5



Article 3. Vivus shall ensure that all such training and promotional materials
are in compliance with applicable laws and regulations, including those
promulgated by the U.S. Food and Drug Administration.

                  3.4 Indemnity. Vivus shall indemnify and hold harmless ALZA
and its Affiliates, employees, officers, directors, successors and assignees
from and against any and all Liabilities which such person may incur, suffer or
be required to pay arising out of: (i) any claim relating to or arising out of
the manufacture, use, promotion or sale of Vivus' products; (ii) Vivus' breach
of any of its obligations under this Agreement; (iii) Vivus' or Vivus
personnel's negligence or willful misconduct; (iv) any advertising, training or
promotional material furnished by or on behalf of Vivus; or (v) Vivus' or Vivus
personnel's failure to materially comply with any applicable law, rule,
regulation or order of any governmental authority having jurisdiction.
Notwithstanding the foregoing, Vivus shall not be required to indemnify ALZA for
any losses to the extent they arise from; (i) the failure by ALZA to promote the
Products in accordance with approved labeling and the terms of this Agreement,
(ii) the gross negligence or willful misconduct of ALZA, or (iii) any breach by
ALZA of its material obligations under this Agreement.

         4.       Representations and Warranties

                  4.1 The Parties. Each of Vivus and ALZA represents and
warrants to the other that (i) it has the authority and right to enter into this
Agreement and to perform its obligations hereunder, and (ii) its execution,
delivery and performance of this Agreement will not conflict with the terms of
any other agreement or obligation to which it is a party or is bound; (iii)
neither it, nor any of its employees who will be undertaking activities related
to this Agreement, have been debarred or the subject of debarment proceedings by
the U.S. Food and Drug Administration.

                  4.2 Vivus. Vivus represents and warrants to ALZA that, (i)
Vivus has provided to ALZA a true and complete copy of the Innovex Agreement,
and the Innovex Agreement has been terminated by mutual agreement of Vivus and
Innovex; (ii) Vivus has made all payments due as of the Transition Date under
the Innovex Agreement and shall make timely payments of any amounts incurred
prior to the Transition Date but not yet paid; (iii) each of the Vivus Sales
Employees is employed by and in good standing with Vivus, and none of such
employees has made any claim or demand against Vivus for any reason; and (v) the
Vivus Sales Employees are not entitled to any payments or benefits relating to
their employment by Vivus or the termination thereof, except as specified in
Schedule 4.2 of this Agreement.

         5.       Confidentiality

                  5.1 Confidential Information. Except as specifically
authorized by this Agreement, each party shall, for a period of five years from
the date of this Agreement, keep confidential, not disclose to others and use
only for the purposes provided for or permitted under this Agreement, all of the
other party's Confidential Information, except as provided for or permitted by
this Agreement. Notwithstanding the foregoing, such information may be (i)
disclosed to

                                       -5-

<PAGE>   6



governmental agencies and to others where such information may be required to be
included in regulatory filings; (ii) provided to third parties under appropriate
terms and conditions including confidentiality provisions substantially
equivalent to those in this Agreement for consulting or marketing arrangements;
(iii) disclosed to the extent required by applicable laws or regulations or as
ordered by a court or other regulatory body having competent jurisdiction. In
each of the foregoing cases, the recipient will use its reasonable efforts to
limit the disclosure and maintain confidentiality to the extent possible.

                  5.2      Public Disclosure.

                           (a) The parties shall draft mutually agreeable
separate press releases regarding this Agreement. Such press releases shall be
made as agreed upon by the parties following execution of this Agreement.

                           (b) Except for the press releases described in
Section 5.2(a), neither party shall, without the prior written consent of the
other party, disclose to third parties, nor originate any publicity, news
release or public announcement, written or oral, whether to the public, the
press, stockholders or otherwise, referring to the existence or terms of this
Agreement, including its existence, the subject matter to which it relates, the
performance under it or any of its specific terms and conditions, except such
announcements or disclosures as, in the opinion of the counsel for the party
making such announcement, are required by law, including United States
securities laws, and each party may disclose the existence of this Agreement and
the material terms and conditions hereof under circumstances that reasonably
ensure the confidentiality thereof to any government or regulatory authorities,
including without limitation the United States Securities and Exchange
Commission to the extent required by applicable law. If a party decides to make
an announcement it believes to be required by law with respect to this
Agreement, it will give the other party such notice as is reasonably practicable
and an opportunity to comment upon the announcement.

         6.       Term and Termination

                  6.1 Term. The term of this Agreement shall continue unless or
until otherwise earlier terminated pursuant to this Section 6.

                  6.2 Termination by Either Party. ALZA may terminate its
obligations under Sections 3.1 and 3.2, and Vivus may terminate its obligations
under Section 3.2, upon written notice to the other party in the event of any of
the following:

                           (a) a breach by the other party of any material
provision herein that is continuing 60 days after the nonbreaching party gives
the breaching party notice of such breach, specifying in reasonable detail the
particulars of the alleged breach, and such breach has not been cured within
such 60 day period (or if such breach cannot by its nature be cured within 60
days, if reasonable progress has not been made by the breaching party during
such 60 day period toward curing such breach) or

                                       -6-

<PAGE>   7



                           (b) the other party becomes insolvent, or voluntary
or involuntary proceedings are instituted by or against the other party, or a
receiver or custodian is appointed for such other party's business, or a
substantial portion of such other party's business is subject to attachment or
similar process, or the other party is unable to satisfy its financial
obligations as they become due, enters into any composition or arrangement with
its creditors or enters into liquidation.

                  6.3 Effect. Any termination pursuant to Section 6.2 shall not
effect any other provisions than those set forth in Section 6.2, and such other
provisions shall remain in effect.

         7.       Insurance

                  7.1 Insurance Policies. Each party shall maintain in effect
for at least three years from the date of this Agreement a policy of liability
insurance, in an amount not less than $5,000,000, that provides coverage for
such party's indemnity obligations hereunder.

         8.       Miscellaneous

                  8.1 Force Majeure. If the performance by either party of any
obligation under this Agreement is prevented, restricted, interfered with or
delayed by reason of any cause beyond the reasonable control of the party liable
to perform, unless conclusive evidence to the contrary is provided, the party so
affected shall, upon giving written notice to the other party, be excused from
such performance to the extent of such prevention, restriction, interference or
delay, provided that the affected party shall use its reasonable efforts to
avoid or remove such causes of non-performance and shall continue performance
with the utmost dispatch whenever such causes are removed. When such
circumstances arise, the parties shall discuss what, if any, modification of the
terms of this Agreement may be required in order to arrive at an equitable
solution.

                  8.2 Governing Law. This Agreement shall be deemed to have been
made in the State of California and its form, execution, validity, construction
and effect shall be determined in accordance with the laws of the State of
California, without giving effect to the principles of conflicts of law thereof.

                  8.3 Headings and References. All section headings contained in
this Agreement are for convenience of reference only and shall not affect the
meaning or interpretation of this Agreement. Unless the context requires
otherwise, all references in this Agreement to any article, section, schedule or
exhibit shall be deemed and construed as references to an article or section of,
or an exhibit to, this Agreement, and any such exhibits are hereby incorporated
in this Agreement by such reference.






                                       -7-

<PAGE>   8



                  8.4      Dispute Resolution.

                           (a) Any dispute, controversy or claim arising out of
or relating to this Agreement, or the breach, termination, or invalidity of this
Agreement, shall be submitted in the first instance to the Chief Executive
Officer of Vivus and the Chief Executive Officer of ALZA.

                           (b) If the matter or dispute cannot be resolved by
the individuals designated in Section 8.4 (a) within 30 days after such
submission, either party shall be entitled to submit the dispute to the next
step in the dispute resolution process set forth in subsection (c).

                           (c) If any dispute is not resolved in accordance with
subsection (a) and (b), then either party may submit such matter for binding
resolution by arbitration conducted in Santa Clara County, California, in
accordance with the then existing rules of the American Arbitration Association,
and judgment upon the award rendered by the arbitrators may be entered in any
court having jurisdiction thereof. The parties hereby agree that service of any
notices in the course of such arbitration at their respective addresses as
provided for in Section 8.8 of this Agreement shall be valid and sufficient.

                           (d) In any arbitration pursuant to this Section 8.4,
the award shall be rendered by a majority of the members of a board of
arbitration consisting of three members who shall be appointed by the parties
jointly, or if the parties cannot agree as to three arbitrators within 30 days
after the commencement of the arbitration proceeding, then one arbitrator shall
be appointed by ALZA and one arbitrator shall be appointed by Vivus within 60
days after the commencement of the arbitration proceeding. The third arbitrator
shall be appointed by mutual agreement of such two arbitrators. In the event of
failure of the two arbitrators to agree within 75 days after commencement of the
arbitration proceeding upon the appointment of the third arbitrator, the third
arbitrator shall be appointed by the American Arbitration Association in
accordance with its then existing rules. Notwithstanding the foregoing, in the
event that any party shall fail to appoint an arbitrator it is required to
appoint within the specified time period, such arbitrator and the third
arbitrator shall be appointed by the American Arbitration Association in
accordance with its then existing rules. For purposes of this Section 8.4, the
"commencement of the arbitration proceeding" shall be deemed to be the date upon
which a written demand for arbitration is received by the American Arbitration
Association from one of the parties.

                  8.5 Severability. If any provision of this Agreement is held
by a court of competent jurisdiction to be invalid or unenforceable, it shall be
modified, if possible, to the minimum extent necessary to make it valid and
enforceable or, if such modification is not possible, it shall be stricken and
the remaining provisions shall remain in full force and effect; provided,
however, that if a provision is stricken so as to significantly alter the
economic arrangements of this Agreement, the party adversely affected may
terminate this Agreement upon 60 days' prior written notice to the other party.
If any of the terms or provisions of this Agreement is in conflict with any
applicable statute or rule of law in any jurisdiction, then such term or
provision shall be deemed

                                       -8-

<PAGE>   9



inoperative in such jurisdiction to the extent of such conflict and the parties
will renegotiate the affected terms and conditions of this Agreement to resolve
any inequities.

                  8.6 Entire Agreement. This Agreement, including the exhibits
hereto, constitutes the entire agreement between the parties relating to the
subject matter hereof and supersedes all previous writings and understandings,
whether oral or written, relating to the subject matter of this Agreement. In
the event of any inconsistency between this Agreement and any exhibit, standard
operating procedure or other ancillary agreement or document contemplated by
this Agreement, the terms of this Agreement shall govern.

                  8.7 Amendment. This Agreement may not be amended, supplemented
or otherwise modified except by an instrument in writing signed by both parties
that specifically refers to this Agreement.

                  8.8 Notices. Any notice required or permitted under this
Agreement shall be sent by certified mail or courier service, charges prepaid,
or by facsimile transmission, to the address or facsimile number specified
below:

                  If to Vivus:      Vivus, Inc.
                                    605 East Fairchild
                                    Mountain View, CA 94043
                                    Fax Number: (650) 934-5357
                                    Attention: Chief Financial Officer

                  If to ALZA:       ALZA Corporation
                                    950 Page Mill Road
                                    PO Box 10950
                                    Palo Alto, CA 94303-0802
                                    Fax Number: (650) 496-8048
                                    Attention: Senior Vice President and
                                    General Counsel

Notices will be deemed delivered five days after mailing, if sent by certified
mail, or upon delivery, if sent by facsimile or courier.

                  8.9 Assignment and Binding Effect. This Agreement shall be
binding upon and inure to the benefit of the successors and assigns of the
parties hereto. Neither party may assign any of its rights, or delegate any of
its obligations, under this Agreement without the written consent of the other
party, except that either party may assign this Agreement to any Affiliate or to
any corporation with which it may merge or consolidate, or to which it may
transfer all or substantially all of its assets to which this Agreement relates.
Such consent will not be unreasonably withheld if the proposed assignee has
capabilities at least comparable to those of the assigning party to carry out
its obligations hereunder.

                                       -9-

<PAGE>   10


                  8.10 No Agency. It is understood and agreed that each party
shall have the status of an independent contractor under this Agreement and that
nothing in this Agreement shall be construed as authorization for either party
to act as agent for the other. Neither party shall incur any liability for any
act or failure to act by employees of the other party.

                  8.11 No Third Party Beneficiaries. Except as expressly set
forth in the indemnification provisions of this Agreement, nothing contained in
this Agreement shall be deemed to create any third party beneficiaries or confer
any benefit or rights on or to any person not a party to this Agreement, and no
person not a party to this Agreement shall be entitled to enforce any provisions
hereof or exercise any rights hereunder.

                  8.12 No Strict Construction. This Agreement has been
prepared jointly and shall not be strictly construed against either party.

                  8.13 Counterparts. This Agreement may be executed in two
counterparts, each of which shall be an original as against any party whose
signature appears thereon but both of which together shall constitute one and
the same instrument. A facsimile transmission of the signed Agreement shall be
legal and binding on both parties.

         IN WITNESS WHEREOF, the parties, through their authorized officers,
have duly executed this as of the date first written above.

VIVUS, INC.                                 ALZA CORPORATION

By: /s/ David C. Yntema                     By: /s/ Peter D. Staple
     ------------------------------            -------------------------------
                  (signature)                                 (signature)

Name: David C. Yntema                       Name: Peter D. Staple
     ------------------------------            -------------------------------
                  (print)                                     (print)

Title:                                      Title: Senior Vice President
     ------------------------------            -------------------------------  


                                      -10-

<PAGE>   11



                             C O N F I D E N T I A L

                             EXHIBITS AND SCHEDULES


                Exhibit A         Vivus Sales Employees

                        A-1       (Sales Representatives)

                        A-2       (Other Sales Personnel)

                        B         Terms of Employment

                        C         Existing Salaries and Benefits

                Schedule 4.2      Exceptions to Representations and Warranties



                                      -11-

<PAGE>   12



                                    EXHIBIT A

                              VIVUS SALES EMPLOYEES

                                   EXHIBIT A-1


[  *  ]

























[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.


                                       A-1

<PAGE>   13



                                   EXHIBIT A-2



[  *  ]




























[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.


                                       A-2

<PAGE>   14



                                    EXHIBIT B

Proposal for Vivus Sales Force

         ALZA will review all relevant employee information which may include
employee files, performance reviews and discussions with management. By July 31,
1998, ALZA will offer regular ALZA employment at will (the same as other regular
ALZA employees) to such Vivus employees as ALZA believes would fit with ALZA's
sales force in terms of experience, performance, motivation, geographic location
and other considerations.

         [  *  ]

         In very rare cases, it is possible that some employees would need to
relocate as a condition of the offer or to accept different positions.

         [  *  ]

         If ALZA's offer of employment is accepted, the start date will be
Monday, August 3, 1998.

         ALZA will endeavor to act as quickly as possible, but no later than
July 31, 1998 to determine which Vivus employees will be offered ALZA
employment.




















[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.

                                       B-1

<PAGE>   15



                                    EXHIBIT C

                         EXISTING SALARIES AND BENEFITS



         Attachment C-1 to this Exhibit C contains the salaries of Vivus Sales
Employees. In addition to these salaries Vivus compensates the Vivus Sales
Employees with the following non-salary benefits:

         -        [  *  ]

         In no event shall the total expense for the above listed non-salary
benefits exceed [*]% of the total salaries paid to the Vivus Sales Employees.

         Vivus Sales Employees also receive payments for the following sales
related expenses:

         -        [  *  ]
         Vivus will provide ALZA with backup documentation of actual costs
during July 1998, and (at ALZA's request) of historical costs for comparison and
planning purposes.


















[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.




                                       C-1

<PAGE>   16


                                 ATTACHMENT C-1



[ * ]























[*] Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to the
omitted portions.



                                       C-2


<TABLE> <S> <C>

<ARTICLE> 5
<MULTIPLIER> 1,000
       
<S>                             <C>
<PERIOD-TYPE>                   3-MOS
<FISCAL-YEAR-END>                          DEC-31-1998
<PERIOD-START>                             APR-01-1998
<PERIOD-END>                               JUN-30-1998
<CASH>                                           1,420
<SECURITIES>                                     8,913
<RECEIVABLES>                                    8,221
<ALLOWANCES>                                      (51)
<INVENTORY>                                     16,772
<CURRENT-ASSETS>                                37,733
<PP&E>                                          52,750
<DEPRECIATION>                                 (5,872)
<TOTAL-ASSETS>                                  99,684
<CURRENT-LIABILITIES>                           25,051
<BONDS>                                              0
                                0
                                          0
<COMMON>                                            32
<OTHER-SE>                                      74,601
<TOTAL-LIABILITY-AND-EQUITY>                    99,684
<SALES>                                         15,983
<TOTAL-REVENUES>                                15,983
<CGS>                                           10,704
<TOTAL-COSTS>                                   10,704
<OTHER-EXPENSES>                                29,457
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                                   0
<INCOME-PRETAX>                               (23,581)
<INCOME-TAX>                                       597
<INCOME-CONTINUING>                           (24,178)
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                  (24,178)
<EPS-PRIMARY>                                   (0.76)<F1>
<EPS-DILUTED>                                   (0.76)
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
        

</TABLE>


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