<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
COMMISSION FILE NO. 0-23556
------------------------
INHALE THERAPEUTIC SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3134940
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
150 INDUSTRIAL ROAD, SAN CARLOS, CA 94070
(Address of principal executive offices and zip code)
(650) 631-3100
(Registrant's telephone number, including area code)
------------------------
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
$0.0001 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The approximate aggregate market value of voting stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock on March 1, 1999 as reported by Nasdaq National Market was approximately
$428,798,342. Determination of affiliate status for this purpose is not a
determination of affiliate status for any other purpose.
16,925,375
(Number of shares of common stock outstanding as of March 1, 1999)
------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive Proxy Statement to be filed for its 1999
Annual Meeting of Shareholders are incorporated by reference into Part III
hereof.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
PART I
Item 1. Business................................................................................... 1
Item 2. Properties................................................................................. 24
Item 3. Legal Proceedings.......................................................................... 25
Item 4. Submission of Matters to a Vote of Security Holders........................................ 25
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters...................... 26
Item 6. Selected Financial Data.................................................................... 27
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 27
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................................. 31
Item 8. Financial Statements and Supplementary Data................................................ 31
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....... 31
PART III
Item 10. Directors and Executive Officers of the Registrant......................................... 32
Item 11. Executive Compensation..................................................................... 32
Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 32
Item 13. Certain Relationships and Related Transactions............................................. 32
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 32
SIGNATURES ................................................................................................ 35
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
OVERVIEW
Inhale Therapeutic Systems, Inc. ("Inhale" or the "Company") is creating an
inhalation drug delivery system to deliver a wide range of drugs, including
peptides, proteins and other macromolecule drugs to the deep lung. Inhale is
using this system principally to enable non-invasive delivery of macromolecule
drugs currently administered by injection. Inhale's lead program is inhaled
insulin sponsored by Pfizer Inc. ("Pfizer") Pfizer initiated Phase III trials
with an investigators meeting held November 7-9, 1998 to be followed with
recruitment, enrollment and dosing of patients. Inhale has a variety of drug
delivery programs in development and has tested six drugs in human clinical
trials.
Currently there are approximately 30 macromolecule drugs marketed in the
United States and about 120 others in human clinical trials. Sales of the top 15
genetically engineered protein drugs which are a subject of macromolecule drugs,
were estimated at $14 billion worldwide in 1997. Most of these drugs are
currently delivered by injection. Injections are undesirable for numerous
reasons including patient discomfort, inconvenience and risk of infection. Poor
patient acceptance of, and compliance with, injectable therapies can lead to
increased incidence of medical complications and higher disease management
costs. Alternatives to injection such as oral, transdermal and nasal delivery
have to date been shown generally to be commercially unattractive due to low
natural bioavailability--the amount of drug absorbed from the delivery site into
the bloodstream. As an alternative to the invasiveness of injection, Inhale
believes a pulmonary delivery system could expand the market for macromolecule
drug therapies and may enable new therapeutic uses of certain macromolecule
drugs.
Inhale is creating a proprietary platform integrating customized
formulation, fine-powder processing and packaging with a novel inhalation device
to enable efficient, reproducible delivery of macromolecule drugs for systemic
and local lung indications. For specific drug products, Inhale formulates and
processes bulk drugs supplied by collaborative partners into fine powders which
are packaged into individual dosing units referred to as blisters. The blisters
are designed to be loaded into Inhale's device, which patients then activate to
inhale the aerosolized drugs. Inhale has developed a prototype inhalation device
that has been used several times per day, for several months in outpatient
trials for insulin. In addition, Inhale has demonstrated room temperature
stability of a year or more for a number of macromolecule drugs, and has
scaled-up its powder processing and packaging for late stage clinical trials and
small-scale production for certain drugs.
As an alternative to invasive delivery techniques, Inhale believes that a
pulmonary delivery system could potentially expand the market for macromolecule
drug therapies by increasing patient acceptance and improving compliance, which
in turn could decrease medical complications and the associated costs of disease
management. Additionally, pulmonary delivery may enable new therapeutic uses of
certain macromolecule drugs. Inhale is focusing development efforts on applying
its pulmonary delivery system primarily to drugs for systemic and local lung
diseases that either have proven efficacy and are approved for delivery by
injection or are in late stage human clinical trials.
Inhale's business strategy is to work with collaborative partners to develop
and commercialize macromolecule drugs for pulmonary delivery. In a typical
collaboration, Inhale's partner provides the drug, funds clinical development,
and will market the resulting commercial product. Inhale supplies the delivery
system and receives research and development and progress payments during
development, and will receive revenue from powder manufacturing, device supply,
and royalties from sales of any commercial products.
In addition to Pfizer's sponsorship of inhaled insulin, Inhale has alliances
with a series of corporate partners. The Company's most recent agreement is with
Biogen, Inc. ("Biogen") for pulmonary delivery of AVONEX-Registered Trademark-,
a drug used in the treatment of multiple sclerosis. Inhale is also engaged in
early stage
1
<PAGE>
feasibility and preclinical research and development collaborations with Centeon
L.L.C. ("Centeon") (a joint venture of Hoechst AG and Rhone-Poulenc Rorer, Inc.)
on alpha-1 proteinase inhibitor for genetic emphysema; Genzyme Corporation on
gene vectors for lung diseases; two projects with Eli Lilly and Company
("Lilly") and projects with Baxter Healthcare Corp. ("Baxter"), a subsidiary of
Baxter International. Inhale anticipates that any product that may be developed
would be commercialized with a collaborative partner and believes its partnering
strategy will enable it to reduce the investment required to develop a large and
diversified potential product portfolio.
While Inhale believes its pulmonary delivery system will provide a unique
delivery alternative for a wide range of drugs, development and testing are
still ongoing and there can be no assurance that Inhale's pulmonary delivery
technology will prove to be technically feasible or commercially applicable to a
range of drugs. Although many of the underlying drug compounds with which Inhale
is working have been tested in humans by others using alternative delivery
routes, Inhale's potential products will require extensive research,
development, pre-clinical and clinical testing, and may involve lengthy
regulatory review. There can be no assurance that any of Inhale's potential
products will prove safe and effective in clinical trials, meet applicable
regulatory standards, be capable of being produced in commercial quantities at
acceptable cost or be successfully marketed to health care providers, payors or
patients. In addition, there can be no assurance that Inhale's strategic
relations with any and all of its partners will continue in the future. Any
failure by Inhale to maintain or continue its partner relations, achieve
technical feasibility, demonstrate safety, achieve clinical efficacy, obtain
regulatory approval or, together with partners, successfully market products,
would have a material adverse effect on Inhale's business, financial condition
and results of operations. See "Risk Factors" beginning on page 19.
OPPORTUNITY FOR PULMONARY DRUG DELIVERY
MACROMOLECULES
Innovations in biotechnology and recombinant techniques have led to a large
increase in the number of macromolecule drugs over the last several years. These
drugs, which are identical or similar to the body's natural molecules, are
enabling new therapies for many previously untreated or poorly treated diseases.
Approximately 30 macromolecule drugs are approved for marketing in the United
States and approximately 120 additional macromolecule drugs are in human
clinical trials, many for chronic and subchronic diseases. Sales of genetically
engineered protein drugs were estimated at $14 billion worldwide in 1997.
Due principally to their large size, most macromolecules typically have been
delivered by injection. Drug injections administered in hospitals or doctors'
offices can be expensive and inconvenient to patients. Many patients find
self-injectable therapies unpleasant. As a result, such therapies for many
chronic and subchronic diseases meet with varying degrees of patient acceptance
and compliance with the prescribed regimens. Poor acceptance and compliance can
lead to increased incidence of medical complications and potentially higher
disease management costs. In addition, some elderly, infirm or pediatric
patients cannot administer their own injections and require assistance, thereby
increasing both inconvenience to these patients and the cost of therapy.
Medical science, health care providers and consumers have been searching for
alternatives to injection as a means of delivery of macromolecules used in the
systemic treatment of chronic and subchronic diseases. Several non-invasive
routes of delivery are being explored for macromolecule drugs, including oral,
transdermal, nasal and pulmonary, such as metered-dose inhalers ("MDIs").
Oral delivery is a common method of delivery for many small molecule drugs.
However, drug delivery scientists generally believe that oral delivery provides
extremely low delivery system efficiency for most macromolecules. In addition,
Inhale believes that dosage reproducibility for oral delivery of macromolecules
may be very poor because of their low oral bioavailability. While several
companies are
2
<PAGE>
working on oral delivery for macromolecule drugs, no commercially viable system
is currently being marketed.
Passive transdermal delivery using "patch" technology has not been
successful to date since the skin is even less naturally permeable to
macromolecules than the gastrointestinal tract. No macromolecule drugs have been
approved for marketing in the United States utilizing patch technology. Certain
peptides and proteins can be transported across the skin barrier into the
bloodstream using high pressure "needle-less" injection devices. The devices,
which inject proteins like insulin through the skin into the body, have been
available for many years. However, Inhale believes these devices have not been
well accepted due to patient discomfort and relatively high cost.
The nasal route has been shown to have low and variable bioavailability for
proteins and peptides, which is a major limitation for the nasal administration
of such drugs. As a result of these limitations, penetration enhancers are often
used with nasal delivery to achieve higher bioavailability; these enhancers may
cause local irritation to the nasal tissue and result in safety concerns with
long-term use. Only four peptides have been approved for marketing in the United
States utilizing nasal delivery.
Pulmonary drug delivery systems, such as MDIs, existing dry powder inhalers
and nebulizers, are used primarily to deliver drugs to the airways of the lung
for local lung applications. Approximately 30 drugs are approved for marketing
by the United States Federal Drug Administration ("FDA") for delivery into the
lung, but none of these delivery devices was designed to optimize drug delivery
to the deep lung for absorption into the bloodstream. Current MDIs, dry powder
inhalers and nebulizers typically deliver only a fraction of the drug to the
deep lung, with most of the drug being lost in the delivery device or in the
mouth and throat. Consequently, Inhale believes that the total efficiency of
such systems is generally not high enough to be commercially feasible for
systemic delivery of most macromolecule drugs.
In addition, current pulmonary drug delivery devices do not provide the
dosage reproducibility and formulation stability generally needed for
commercially viable systemic macromolecule drug delivery. Inhale believes that
many MDI and dry powder systems do not provide the deep lung dosage
reproducibility necessary for many systemic applications because the patient
must coordinate the breathing maneuver with the generation of the aerosol.
Further, Inhale believes that many macromolecules currently cannot be formulated
for use in MDI systems, since macromolecule drugs could be denatured by the MDI
formulating ingredients. In addition, Inhale believes that some macromolecules
may be inactivated by nebulization and that many dry powder systems do not
provide the protection needed for long-term stability that may be needed for
macromolecule formulations.
Inhale believes that an efficient and reproducible pulmonary delivery system
for systemic macromolecule drugs used in the treatment of chronic and subchronic
diseases represents a significant commercial opportunity. Such a system could
improve patient acceptance of systemic macromolecule drug therapy and compliance
with prescribed regimens, thereby improving therapeutic outcomes and reducing
the costs of administration and treatment of disease. Additionally, pulmonary
delivery may enable new therapeutic uses of certain macromolecule drugs.
Inhale also believes that opportunities for a pulmonary delivery system
exist in the delivery of macromolecules for local lung diseases due to the
limitations of current pulmonary devices. Biotechnology and pharmaceutical
companies are developing new macromolecule drugs for pulmonary diseases such as
asthma, cystic fibrosis, emphysema, lung cancer, pneumonia and bronchitis.
Pulmonary delivery is the preferred route for treating most lung diseases since
much smaller amounts of certain drugs generally are needed than for systemic
administration and the drug can be applied directly to the site of action,
thereby potentially reducing systemic side effects.
3
<PAGE>
OTHER MOLECULES
In addition to developing a pulmonary delivery system for macromolecules,
Inhale is investigating opportunities for leveraging its technology for small
molecules where there is a clear, demonstrable need for an alternative drug
delivery system and where Inhale's existing technology can be applied without
significant modification. Examples include molecules that require rapid systemic
absorption for efficacy, i.e., analgesics and antiemetics, molecules that
undergo massive first pass metabolism by the oral route or molecules used for
local lung delivery for diseases such as asthma that are currently delivered by
sub-optimal aerosol systems.
MDIs, existing dry powder inhalers and nebulizers have been used primarily
to deliver drugs to the airways of the lung for local lung applications. Some of
the problems associated with traditional small molecule aerosol delivery systems
include poor reproducibility, low efficiency, low drug payload per puff, poor
moisture barrier and, in the case of wet systems, long dosing time and microbial
growth.
Inhale believes that its technology could be used to address these problems
through the following: efficient dispersion of the drug into the lungs,
reproducible delivery of a consistent and predictable amount of drug into the
bloodstream, and a strong moisture barrier in the blister packs. Inhale further
believes its technology could potentially be applied economically in market
segments where it is essential that significant drug doses reach the lung, such
as severe asthma cases where nebulizers are used today. Large amounts of drugs
taken orally or through inefficient inhalers can result in side effects which
could be avoided or reduced through more efficient pulmonary delivery.
STRATEGY
Inhale's goal is to become the leading drug delivery company in the field of
pulmonary delivery of macromolecules. In addition, Inhale is leveraging its
technology base for other applications where its system can provide significant
market advantages. Inhale's strategy incorporates the following principal
elements:
- DEVELOP A BROADLY APPLICABLE PULMONARY DELIVERY SYSTEM. Inhale is
developing its non-invasive pulmonary drug delivery system to be
applicable to a wide range of peptides, proteins and other molecules
currently delivered by injection or poorly delivered by inhalation or
other routes. Inhale intends to develop an effective non-invasive delivery
alternative that can: (i) expand market penetration for existing
therapeutics currently delivered by injection, infusion or other routes;
(ii) commercialize new indications by using pulmonary delivery as a new
route of administration; and (iii) extend existing patents or seek new
patents to gain important competitive advantages for Inhale and its
partners.
- BUILD COMPETITIVE ADVANTAGE THROUGH AN INTEGRATED SYSTEMS APPROACH. Inhale
is developing a commercially viable pulmonary delivery system through an
integrated systems solution. Inhale combines its expertise in aerosol
engineering, chemical engineering, mechanical engineering, aerosol
science, protein formulations, fine powder processing and powder filling,
and pulmonary physiology and biology to build a proprietary,
fully-integrated system for pulmonary delivery of therapeutic drugs.
Inhale believes that building expertise in technology across several
disciplines provides it with a significant competitive advantage.
- PARTNER WITH PHARMACEUTICAL AND BIOTECHNOLOGY COMPANIES. Inhale's strategy
is to market its proposed products through collaborative partners. Inhale
is seeking to work with partners that have significant clinical
development and marketing resources, and currently has collaborations with
several large pharmaceutical and biotechnology companies. For patented
drug products, Inhale intends to partner with owners or licensees from the
outset of the project. For drugs that are off-patent or licensed-in,
Inhale may perform initial feasibility screening work, formulations
development and early stage human clinical trials before entering into a
partner relationship for further
4
<PAGE>
development. Inhale believes this partnering strategy enables it to reduce
its cash requirements while developing a large and diversified potential
product portfolio.
- FOCUS ON APPROVED OR LATE STAGE DRUGS. To date, Inhale has focused
primarily on drugs that either have proven efficacy and are approved for
marketing or are in late stage clinical trials. Inhale believes that
working primarily with drugs with demonstrated efficacy reduces the
technical risk of its projects. In the future, Inhale anticipates working
on drugs at earlier stages of development.
- EXPAND MANUFACTURING CAPABILITY. Inhale intends to formulate, manufacture
and package dry powders for most of its drugs and to subcontract
manufacturing of its device. Inhale believes that this strategy will
provide manufacturing economies of scale across a range of therapeutic
products and expand capacity for additional partnerships and commercial
scale production.
INHALE'S PULMONARY DELIVERY SYSTEM
Inhale believes that the following criteria are necessary for a commercially
viable non-invasive drug delivery system:
- SYSTEM EFFICIENCY/COST: The system must attain a certain minimum
efficiency in delivering a drug to the bloodstream as compared to
injection. Bioavailability--the percentage of drug absorbed into the
bloodstream from the lungs relative to that absorbed from injection is the
most important element of system efficiency. Total system efficiency is
critical due to the high cost of macromolecule drugs. Total delivery
system efficiency is determined by the amount of drug loss during
manufacture, in the delivery device, in reaching the site of absorption,
and during absorption from that site into the bloodstream. Inhale believes
that for most systemic macromolecule drugs, a non-invasive delivery system
must show total delivery system efficiency of at least 5% to 25% compared
to injection for the system to be commercially viable.
- REPRODUCIBILITY: The system must deliver a consistent and predictable
amount of drug to the lung and into the bloodstream.
- FORMULATION STABILITY: Formulations used in the system must remain
physically and chemically stable over time and under a range of storage
conditions.
- SAFETY: The system should not introduce local toxicity problems during
chronic or subchronic use by a wide patient population.
- CONVENIENCE: The system must be convenient to the patient in terms of
comfort, ease of operation, transportability and required dosage time.
Inhale approaches pulmonary drug delivery with the objective of maximizing
overall delivery system efficiency while addressing commercial requirements for
reproducibility, formulation stability, safety and convenience. To achieve this
goal, Inhale's delivery system integrates customized drug formulations with its
proprietary inhalation device. Inhale combines an understanding of lung biology,
aerosol science, chemical engineering, mechanical engineering and protein
formulations in its system development efforts. Inhale believes that this
interdisciplinary capability provides an important competitive advantage.
Inhale has chosen to base its pulmonary delivery system on dry powders for
several reasons. Many proteins are more stable in dry powders than in liquids.
In addition, dry powder aerosols can carry approximately five times more drug in
a single breath than MDIs and, for many drugs, at least 25 times more than
currently marketed liquid or nebulizer systems. Inhale believes that a dry
powder system for drugs requiring higher doses, such as insulin, alpha-1
antitrypsin and heparin, could decrease dosing time as compared with nebulizers.
Inhale takes bulk drugs supplied by partners and formulates and processes
them into fine powders that are then packaged into individual blisters. The
blisters are designed to be loaded into Inhale's device,
5
<PAGE>
which patients activate to inhale the aerosolized drugs. Once inhaled, the
aerosol particles are deposited in the deep lung, dissolved in the alveolar
fluid and absorbed into the bloodstream. Although Inhale is in the advanced
stages of developing its system technologies, there can be no assurance that
Inhale's products will ever be successfully commercialized.
FORMULATIONS.
Each macromolecule drug poses different formulation challenges due to
varying chemical and physical characteristics and dosing requirements. This
requires significant optimization work for each specific drug. Inhale has
assembled a team with expertise in protein formulations, powder science and
aerosol science and is applying this expertise to develop proprietary techniques
and methods that it believes will produce stable, fillable and dispersible dry
powder drug formulations. Inhale has several protein powders with on-going room
temperature stability (both chemical and physical) of more than one year.
Through its work with numerous macromolecules, Inhale is developing an extensive
body of knowledge on aerosol dry powder formulations, including knowledge
relating to powder flow characteristics and solubility within the lung, as well
as physical and chemical properties of various excipients. The Company has filed
and expects to continue to file patent applications on several of its
formulations. In June 1997, Inhale acquired the intellectual property portfolio
of the BioPreservation Division of Pafra Limited ("Pafra") of Basildon, England.
This portfolio included issued U.S. and foreign Letters Patent and pending
applications relating to the stabilization of macromolecule drugs in dry
formulations.
POWDER PROCESSING.
Inhale is modifying standard powder processing equipment and developing
custom techniques to enable it to produce fine dry powders consistently with
particle diameters of between one and five microns without drug degradation or
significant loss of expensive bulk drug. Inhale has scaled up powder processing
to sufficient levels for producing test powders for late stage clinical trials
and small volume marketed products, if any. Inhale is in the process of scaling
up its powder processing systems in order to produce quantities sufficient for
commercial production of products Inhale believes it will need to supply in high
volumes, such as insulin. However, there can be no assurance that Inhale will be
successful in further scaling up its powder processing on a timely basis or at a
reasonable cost, or that the powder processing system will be applicable for
every drug.
POWDER PACKAGING.
Fine particle powders have special handling requirements that are different
from those for larger particles. Current commercial filling and packaging
systems are designed for filling larger particle powders and therefore must be
modified to dispense finer particles more accurately and in the small quantities
required. Initially, powder filling was performed manually. Inhale has since
developed and qualified a proprietary automated filling system suitable for use
in clinical trials and initial production quantities for certain products.
Inhale is also developing with Pfizer a proprietary, high capacity system for
production use.
INHALATION DEVICE.
Inhale's proprietary pulmonary delivery device is designed to provide deep
lung delivery of therapeutic powders in a reproducible, safe and efficient
manner. The first of a series of patents covering the device was granted in the
United States in October 1995. See "Business--Patents and Proprietary Rights."
To achieve this goal, Inhale has designed a prototype of its pulmonary delivery
device to perform the following:
- EFFECTIVELY DISPERSE FINE PARTICLES INTO AN AEROSOL CLOUD. Fine powders
have different dispersion requirements or characteristics than large
powders. Most current dry powder inhalers use larger
6
<PAGE>
powders and are not efficient in dispersing powders with diameters of one
to five microns. Inhale has developed and is refining its dispersion
system for its prototype device specifically for fine powders. Inhale's
device has been designed to efficiently remove powders from the packaging,
effectively break up the powder particles and create an aerosol cloud
while maintaining the integrity of the macromolecule drug.
- EFFICIENTLY AND REPRODUCIBLY DELIVER THE AEROSOL CLOUD TO THE DEEP LUNG.
Inhale has developed a proprietary aerosol cloud handling system in its
device that facilitates deep lung powder deposition and reproducible
patient dosing. The handling system design is intended to enable the
aerosolized particles to be transported from the device to the deep lung
during a patient's breath, reducing losses in the throat and upper
airways. In addition, the aerosol cloud handling system, in conjunction
with the dispersion mechanism and materials used in the device, is
designed to reduce powder loss in the device itself.
- ELIMINATE THE USE OF PROPELLANTS TO AVOID ASSOCIATED ENVIRONMENTAL
CONCERNS AND FORMULATION DIFFICULTIES. Unlike MDIs, the Inhale device does
not use propellants. The oily surfactants required to stabilize propellant
formulations can cause aggregation of macromolecules. Current
chlorofluorocarbon propellants, which are used in most commercial MDI
systems, are being phased out in many countries due to environmental
concerns.
The success of Inhale's pulmonary drug delivery system for any drug will
depend upon Inhale achieving sufficient formulation stability, safety dosage
reproducibility and system efficiency--measured by the percentage of bulk drug
entering the manufacturing process that eventually is absorbed into the
bloodstream relative to that administered by injection for systemic indications,
or the amount of drug delivered to the lung tissue for local lung indications.
The initial screening factor for the feasibility of pulmonary delivery of any
systemic macromolecule drug is pulmonary bioavailability, which measures the
percentage of the drug absorbed into the bloodstream when delivered directly to
the lungs. In addition, a certain percentage of each drug dose may be lost at
various stages of the manufacturing and pulmonary delivery process in drug
formulation, dry powder processing, packaging, and in moving the drug from a
delivery device into the lungs. Excessive drug loss at any one stage or
cumulatively in the manufacturing and delivery process would render a drug
commercially unfeasible for pulmonary delivery. Formulation stability--the
physical and chemical stability of the formulated drug over time and under
various storage conditions and safety will vary with each macromolecule and the
type and amount of excipients that are used in the formulation. Reproducible
dosing--the ability to deliver a consistent and predictable amount of drug into
the bloodstream over time both for a single patient and across patient groups
requires the development of an inhalation device that consistently delivers
predictable amounts of dry powder formulations to the deep lung, accurate unit
dose packaging of dry powder formulations and moisture resistant packaging.
There can be no assurance that Inhale will be able to successfully develop such
an inhalation device or overcome such other obstacles to reproducible dosing.
CLINICAL STATUS SUMMARY
The following table sets forth the type of product currently in development,
the application(s) for the particular product, its present stage of clinical
development and the identity of Inhale's corporate partner, if any, for such
product application.
7
<PAGE>
<TABLE>
<CAPTION>
DRUG INDICATIONS CLINICAL STATUS PARTNER STATUS
- -------------------------- -------------------------- -------------------------- --------------------------
<S> <C> <C> <C>
Human insulin............. Type 1 and 2 diabetes Phase III (patient Pfizer--active
recruitment)
Non-protein, Not released Phase II Baxter--on hold due to
non-peptide............. Baxter re-focus
Non-protein, Not released Phase I Baxter--minimum work while
non-peptide............. looking for new partner
PTH....................... Osteoporosis Phase I Lilly--minimum work while
Lilly investigates
problem with injectable
version
Calcitonin................ Osteoporosis, bone pain, Phase I Looking for partner
Paget's disease
Interleukin-1 Receptor.... Asthma Phase I/II Immunex--on hold; waiting
for partner activity
Alpha-1 Antitrypsin
proteinase inhibitor.... Genetic emphysema Preclinical Centeon--active
Interferon beta........... Multiple sclerosis Preclinical Biogen--active
Non-protein, Not released Preclinical Baxter--on hold due to
non-peptide............. Baxter re-focus
</TABLE>
Definition of Clinical Status:
Phase III--broad out-patient clinical trials conducted to obtain
information regarding specific patient groups conducted following
encouraging safety and efficacy trials.
Phase II--human clinical trials to establish dosing and efficacy in
patients.
Phase I--human clinical trials to test safety, and for drugs with
systemic applications, also tests bioavailability compared with injection in
healthy subjects.
Preclinical--formulation development and animal testing in preparation
for human clinical trials.
INHALE'S PULMONARY DRUG DELIVERY PROGRAMS IN PROGRESS
Inhale has a variety of programs in development, six of which have been
tested in human clinical trials. In general, Inhale's partnership arrangements
provide funding for development, payments upon the achievement of certain
milestones and royalty and manufacturing revenues upon the commencement of
commercial sales. The arrangements are cancelable by the partner at any time
without significant penalty.
PFIZER PROGRAM.
Insulin is a protein hormone naturally secreted by the pancreas to induce
the removal of glucose from the blood. Diabetes, the inability of the body to
regulate properly blood glucose levels, is caused by insufficient production of
insulin by the pancreas or insufficient use of the insulin that is secreted.
Over time, high blood glucose levels can lead to failure of the microvascular
system, which may lead to blindness, loss of circulation, kidney failure, heart
disease or stroke. Insulin currently is marketed only in injectable form.
Insulin is supplied by various manufacturers, including Eli Lilly, Novo-Nordisk
A/S and Hoechst Marion Roussel AG.
According to the Centers for Disease Control and Prevention, more than 16
million people in the United States have diabetes--10.3 million are diagnosed
with diabetes, another 5.4 million have undiagnosed diabetes, and 798,000 new
cases are diagnosed each year. All Type 1 diabetics, estimated at between 5% and
15% of all diabetics, require insulin therapy. Type 1 diabetics generally
require both a baseline treatment of long-acting insulin and multiple treatments
of regular insulin throughout the day. Type 2
8
<PAGE>
diabetics, depending on the severity of their case, may or may not require
insulin therapy. Type 2 diabetics who use insulin are best treated with regular
insulin and sometimes require long-acting insulin as well. Many Type 2 patients
who do not require insulin to survive but would benefit from it are reluctant to
start treatment because of the inconvenience and unpleasantness of injections.
Regular insulin is generally administered 30 minutes before mealtimes and
generally is given only twice a day. A ten-year study by the National Institutes
of Health ("NIH"), (the DCCT Research Group, published in the New England
Journal of Medicine in Sept. 1993) however, demonstrated that the side effects
of diabetes could be significantly reduced by dosing more frequently. The NIH
study recommended dosing regular insulin three to four times per day, a regimen
which would more closely mirror the action of naturally produced insulin in
non-diabetics. However, many patients are reluctant to increase their number of
doses because they find injections unpleasant and inconvenient.
Inhale and Pfizer are developing a regular insulin that can be administered
in one to three blisters using its pulmonary delivery system. Inhale believes
that its pulmonary delivery system could provide increased user convenience and
result in greater patient compliance by eliminating some injections for Type 1
and Type 2 patients and all injections for some Type II patients. In addition,
Inhale believes that pulmonary delivery could yield medical advantages by
providing a more rapid acting insulin than certain current injectable products.
Through its collaboration with Inhale, Pfizer conducted Phase I and Phase
IIa clinical trials which indicated that pulmonary insulin was absorbed
systemically and reduced glucose levels and provides the same control of
diabetes as does injected insulin. In October 1996, Pfizer initiated a
multi-site Phase IIb outpatient trial to include up to 240 patients with
diabetes mellitus. In June 1998, Pfizer announced the results of Phase IIb
trials. In 70 Type 1 diabetics treated with either inhaled or conventional
injected insulin therapy for three months, the levels of hemoglobin A1c, the
best index of blood glucose control, were statistically equivalent. Virtually
identical results were obtained in a group of Type 2 diabetics. In September
1998 Pfizer released additional Phase IIb data from the inhaled insulin trials
which indicated that results from 56 of 69 patients in a three-month trial
showed that individuals with Type 2 diabetes can markedly improve their glycemic
control without insulin injections by combining Inhale's pulmonary insulin with
oral diabetes agents.
In November 1998, Pfizer and Hoechst Marion Roussel AG announced that they
entered into worldwide agreements to manufacture insulin, co-develop and
co-promote inhaled insulin. Under the terms of the agreement, Pfizer and Hoechst
Marion Roussel said they will construct a jointly owned manufacturing plant--one
of the world's largest insulin production facilities of its kind in Frankfurt,
Germany. Until its completion, Hoechst Marion Roussel will provide biosynthetic
recombinant insulin from its existing plant to Inhale for powder processing.
Inhale will continue to have responsibility for manufacturing powders and
supplying devices and will receive a royalty on inhaled insulin products
marketed jointly by Pfizer and Hoechst. Later in the same month, Pfizer held a
meeting for 117 Phase III sites of the inhaled insulin trials to be followed by
patient recruitment, enrollment and dosing.
Inhale has begun initial research funded by Pfizer on a long-acting inhaled
insulin. Some diabetic patients require a long-acting insulin to maintain
baseline insulin levels. A long-acting, inhalable form of insulin could be used
by these patients as a supplement to short-acting, mealtime inhaled insulin.
This program is part of a broader sustained release program announced by Inhale
in January 1999.
In January 1995 and October 1996, Pfizer made two $5 million equity
investments in Inhale at a 25% premium to the market price of Inhale stock at
the time of each investment. See "Risk Factors" beginning on page 19.
9
<PAGE>
BAXTER PROGRAM.
In March 1996, Inhale entered into a collaboration agreement with Baxter to
use Inhale's dry powder pulmonary delivery system as a technology platform for
developing and launching therapeutic products. In connection with the
collaboration, Baxter made a $20 million equity investment in Inhale at a 25%
premium to the market price of Inhale stock at the time of the investment.
Baxter received worldwide commercialization rights for four non-protein/peptide
drugs in exchange for up to an estimated $60 million in research and development
funding and progress payments. In April 1998 Inhale announced that the first two
compounds from its collaboration with Baxter had successfully completed Phase I
and Phase II trials respectively. In addition, it was announced that the program
would focus on the product that had completed Phase I as it was the product with
the most commercial potential. The technology from one of the three remaining
products was returned to Inhale, leaving the development of the other two
compounds on hold. In October 1998, Inhale announced that it had reached an
agreement with Baxter to amend their collaborative agreement to facilitate
signing a new corporate partner to fund further development and
commercialization of the undisclosed compound that had been their focus since
April 1998. Baxter will continue to provide development funding for this
compound in preparation for Phase II trials while the two companies are seeking
a new partner. See "Risk Factors" beginning on page 19.
ELI LILLY & COMPANY PROGRAMS.
In January 1997 Inhale entered into a collaborative agreement with Lilly to
develop pulmonary delivery for a selected Lilly osteoporosis drug, parathyroid
hormone (PTH 1-34). Osteoporosis is estimated to affect approximately 25 million
Americans, mostly women. If not prevented or left untreated, osteoporosis can
progress painlessly until a bone breaks. As many as 35,000 people die each year
from a cause associated with hip fractures, primarily due to complications that
result from surgery or from being confined to bed.
Under the terms of its agreement with Lilly, Inhale will receive up to an
estimated $20 million in initial fees, funding for research and progress
payments. Lilly will receive global commercialization rights for the pulmonary
deliver of the products, with Inhale receiving royalties on any marketed
products. Inhale will manufacture and package product with bulk drug supplied by
Lilly and supply the inhalation devices.
Independent Phase I inhalation clinical trials of parathyroid hormone,
completed in collaboration with ALZA Corporation ("Alza") indicated that the
drug was systemically absorbed when delivered with Inhale's pulmonary system.
Under an agreement between Alza and Inhale, Alza has agreed not to participate
in the future development and commercialization of the osteoporosis product.
Subsequently, the Company entered into an agreement whereby Lilly has agreed to
conduct future clinical trials and will receive worldwide commercialization
rights.
In late 1998, unexpected observations from a long-term test in rats of the
injectable version of this osteoporosis drug, parathyroid hormone, led Lilly to
suspend further clinical development of the injectable and pulmonary versions of
PTH pending further analysis. Inhale is maintaining a minimum development effort
in its pulmonary program pending further direction from Lilly. Depending on the
continued evaluations by Lilly, this inhalation program could be re-initiated,
suspended for an extended period, or possibly terminated.
In January 1998 Lilly and Inhale entered into a second collaborative
agreement to develop pulmonary delivery for an unspecified protein product based
on Inhale's deep-lung delivery system for macromolecules. Under the terms of the
agreement, Inhale will receive funding of up to $20 million in research,
development and milestone payments. Lilly will receive global commercialization
rights for the pulmonary delivery of the products with Inhale receiving
royalties on any marketed products. Inhale will manufacture packaged powders for
and supply inhalation devices to Lilly. See "Risk Factors" beginning on page 19.
10
<PAGE>
CALCITONIN PROGRAM.
Inhale is funding a proprietary program to develop pulmonary delivery of
calcitonin for the treatment of osteoporosis, bone pain and Paget's disease.
Calcitonin is a peptide hormone secreted by the thyroid gland that inhibits bone
resorption and lowers serum calcium. Calcitonin is available in two forms, fish
and human. Calcitonin is administered daily or every other day by injection in
the United States. In the United States, salmon calcitonin is approved for the
treatment of postmenopausal osteoporosis, Paget's disease, hypercalcemia of
cancer and bone pain. Human calcitonin is approved for Paget's disease and bone
pain. Paget's disease is a chronic disorder of the adult skeleton, in which
localized areas of bone become hyperactive and are replaced by a softened and
enlarged bone structure. About 3% of Caucasians in the United States over age 60
have Paget's disease. Hypercalcemia occurs as a result of excessive serum
calcium levels caused by hyperparathyroidism and malignancy. It occurs in
approximately 10-20% of cancer patients.
In April 1997 Inhale announced the successful completion of Phase I clinical
trials to determine the safety and bioavailability of pulmonary delivery of a
dry powder, aerosolized form of salmon calcitonin as a potential treatment for
osteoporosis, Paget's disease, hypercalcemia and other bone diseases. The
single-dose study conducted in the United Kingdom with a total of 36 fasted
normal volunteers indicated that the drug was systemically absorbed through the
pulmonary route when delivered with Inhale's system. Inhale is seeking a partner
for further clinical development. Inhale is continuing work on this program. See
"Risk Factors" beginning on page 19.
IMMUNEX PROGRAM.
Interleukin-1 is a cytokine that helps initiate the inflammatory response to
foreign pathogens. Inhale collaborated with Immunex to develop pulmonary
delivery of a therapeutic product for asthma. Initial formulation development
and animal toxicology have been completed, and the two companies successfully
completed Phase I/II trials demonstrating pulmonary delivery. This program is
awaiting further work and/or licensing by Immunex. See "Risk Factors" beginning
on page 19.
CENTEON PROGRAM.
In January 1997 Inhale and Centeon entered into a collaboration to develop a
pulmonary formulation of alpha-1 antitrypsin to treat patients with alpha-1
antitrypsin deficiency. Alpha-1 antitrypsin is approved in the United States and
several European countries for augmentation treatment of alpha-1 antitrypsin
deficiency. Current treatment is given by systemic intravenous infusion on a
weekly basis. This "replacement therapy" consists of a concentrated form of
alpha-1 antitrypsin derived from human plasma. Under the terms of the
collaboration, Centeon will receive commercialization rights worldwide excluding
Japan and Inhale will receive royalties on product sales, an up-front signing
fee and up to an estimated $15 million in research and development funding and
milestone payments. Centeon will manufacture the active ingredient for use in
Inhale's delivery device. Inhale will manufacture and package the dry powder and
supply inhalation devices to Centeon for commercialization and marketing.
The two companies have completed pre-clinical work that indicates Inhale's
dry powder formulation of Centeon's alpha-1 antitrypsin has the potential to
significantly improve the efficiency of delivery compared with current infusion
therapy. Inhale believes its pulmonary delivery system could significantly
reduce the amount of drug needed for genetic emphysema therapy since alpha-1
antitrypsin could be delivered directly to the lung. Centeon is currently
negotiating to secure rights under patents that have been granted in Europe
directed to aerosol formulations for the treatment of the lung containing serine
protease inhibitors including alpha-1 antitrypsin. See "Risk Factors" beginning
on page 19.
11
<PAGE>
BIOGEN PROGRAM.
In February 1999 Inhale entered into a collaborative agreement with Biogen
to develop pulmonary delivery for Biogen's AVONEX-Registered Trademark-. Under
the terms of the agreement, Inhale will receive royalties on product sales, an
up front signing fee, and up to an estimated $25 million in research and
development funding and potential progress payments. Biogen will provide bulk
AVONEX-Registered Trademark- to Inhale for formulation into a room-temperature
stable dry powder. Inhale will manufacture and package the dry powder and supply
inhalation devices. Biogen will be responsible for clinical trials, marketing
and commercialization. See "Risk Factors" beginning on page 19.
FOLLICLE STIMULATING HORMONE (FSH) PROGRAM.
FSH, a glycoprotein hormone secreted by the pituitary gland, has been
utilized since the 1960s for treatment of infertility. In female reproduction,
FSH is responsible for ovarian follicular growth and development. Therapeutic
use of FSH has expanded since the 1970s. It is currently administered in a
series of daily injections over one to three weeks to enhance follicle growth
and ovum production. Inhale has demonstrated the feasibility of pulmonary FSH in
an animal model and continues to work on this project.
GENZYME PROGRAM.
In July 1996 Inhale signed an agreement with Genzyme Corporation to examine
the feasibility of developing dry powder formulations of gene vectors for
pulmonary applications. Gene vectors are currently being investigated by several
companies and academic institutions for use in treating lung diseases such as
cystic fibrosis. Inhale believes that its delivery system is well suited for the
delivery of gene therapies to treat lung disease because its system could
provide efficiency, reproducibility, stability and containment advantages
relative to alternative pulmonary delivery methods. Early stage research has
shown that Inhale's dry powder formulations and powder processing technology can
be used to make powders containing active gene vectors. The Company continues to
do research on this project. See "Risk Factors" beginning on page 19.
INTERFERON ALPHA PROGRAM.
Interferon alpha is produced by a number of cell types in the body and
serves to turn on an array of genes in cells for fighting viral infections. It
has been approved for Hepatitis B and C (inflammatory viral diseases of the
liver), hairy cell leukemia (a blood cancer), and AIDS-related Kaposi's sarcoma
(a skin cancer prevalent in AIDS patients). There are at least five companies
competing in the interferon alpha market, including Schering-Plough Corporation,
Hoffmann-La Roche, Inc., Sumitomo Corp. and Otsuka Pharmaceutical Co., Ltd.
Interferon alpha is currently given in all indications three times per week by
subcutaneous injection. Inhale believes that a pulmonary delivery system could
provide a competitive advantage in what is now an exclusively injectable market
and could reduce the cost of treatment by enabling more home therapy. Inhale has
completed feasibility testing, including animal studies, showing that interferon
alpha is well absorbed systemically following pulmonary administration. Inhale
continues to work on this project. See "Risk Factors" beginning on page 19.
There can be no assurance that Inhale will be able to enter into additional
collaborations or that its feasibility agreements will lead to collaborations.
There also can be no assurance that Inhale will be able to maintain any such
collaborative arrangements or feasibility agreements or that any such
collaborative arrangements or feasibility agreements will be successful. The
failure of Inhale to enter into or maintain such collaborative arrangements and
feasibility agreements would have a material adverse effect on Inhale. See "Risk
Factors,", beginning on page 19.
12
<PAGE>
MANUFACTURING
Inhale generally plans to formulate, manufacture and package the powders for
its pulmonary delivery products and to subcontract the manufacture of its
proprietary pulmonary delivery devices. Under its collaborative agreement with
Pfizer to develop insulin powders, Inhale will be the primary manufacturer of
powders and Pfizer will be primarily responsible for filling blisters. Prior to
the commercialization of its first products, Inhale must build and have
validated a powder processing and packaging facility. Inhale must also select
and have validated a device manufacturer. Inhale believes its manufacturing
strategy will enable it to achieve the following: (i) provide economies of scale
by utilizing manufacturing capacity for multiple products; (ii) improve its
ability to retain any manufacturing know-how; and (iii) allow its customers to
bring pulmonary delivery products to market faster.
Inhale has built a powder manufacturing and packaging facility in San
Carlos, California capable of producing powders in quantities sufficient for
human clinical trials and commercial launch. This facility has been inspected
and licensed by the State of California and is used to manufacture and package
powders under Good Manufacturing Practices ("GMP"). Inhale intends to expand the
facility to meet its future commercial manufacturing commitments.
Inhale is working to further scale up its powder processing to a larger
production scale system and to further develop the necessary powder packaging
technologies. Fine particle powders and small quantity powder packaging (such as
those to be used in Inhale's delivery system) require special handling. Current
commercial packaging systems are designed for filling larger quantities of
larger particle powders and therefore must be modified to dispense finer
particles in the small quantities required by Inhale. Inhale has developed and
validated a proprietary small scale prototype automated filling system which
Inhale believes is capable of supporting its requirements through Phase III
trials and into commercial production for some products. Inhale is developing a
higher capacity automated filling unit capable of filling blisters on a
production scale for moderate and large volume products. Inhale faces
significant technical challenges in developing an automated, commercial-scale
filling system that can accurately and economically handle the small dose and
particle sizes of its powders. There can be no assurance that Inhale will be
able to develop or acquire the technology necessary to develop successfully any
such system in a timely manner or at commercially reasonable cost. Any failure
or delay in developing such technology would delay product development or bar
commercialization of Inhale's products and would have a material adverse effect
on Inhale. See "Risk Factors" beginning page 19.
A new prototype inhalation device has been developed for commercial use and
will be used in the Phase III insulin and other trials in 1999. Inhale plans to
subcontract the manufacture of its pulmonary delivery devices before commercial
production of its first product. Inhale has identified contract manufacturers
that it believes have the technical capabilities and production capacity to
manufacture its devices and which can meet the requirements of GMP. There can be
no assurance that Inhale will be able to obtain and maintain satisfactory
contract manufacturing on commercially acceptable terms, if at all. Inhale's
dependence upon third parties for the manufacture of its potential inhalation
device may adversely affect Inhale's cost of goods and its ability to develop
and commercialize products on a timely and competitive basis.
GOVERNMENT REGULATION
The research and development, manufacture and marketing of pulmonary drug
delivery systems are subject to regulation by the FDA in the United States and
by comparable regulatory agencies in other countries. These national agencies
and other federal, state and local entities regulate, among other things,
research and development activities and the testing, manufacture, safety,
effectiveness, labeling, storage, record keeping, approval, advertising and
promotion of Inhale's products.
The process required by the FDA before a pulmonary drug delivery system may
be marketed in the United States depends on whether the compound has existing
approval for use in other dosage forms. If
13
<PAGE>
the drug is a new chemical entity that has not been approved, the process
includes the following: (i) pre-clinical laboratory and animal tests; (ii) the
filing of an Investigational New Drug application ("IND"); (iii) adequate and
well-controlled human clinical trials to establish the safety and efficacy of
the drug in its intended indication; and (iv) submission to the FDA for approval
of a New Drug Application ("NDA") with respect to drugs or a Biological License
Application ("BLA") with respect to biologics. If the drug has been previously
approved, the approval process is similar, except that certain toxicity tests
normally required for the IND and NDA/BLA application may not be necessary.
Pre-clinical tests include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. Pulmonary systems must be formulated according to GMP, and
pre-clinical safety tests must be conducted by laboratories that comply with FDA
Good Laboratory Practices regulations. The results of the pre-clinical tests are
submitted to the FDA as part of an IND application and are reviewed by the FDA
before human clinical trials begin. The IND application becomes effective 30
days after receipt by the FDA, unless the FDA raises objections.
Clinical trials involve the administration of the drug to healthy volunteers
or to patients under the supervision of a qualified principal investigator.
Clinical trials are conducted in accordance with protocols that detail the
objectives of the study, the parameters to be used to monitor safety and the
efficacy criteria to be evaluated. Each protocol is submitted to the FDA as part
of the IND. Each clinical study is conducted under the auspices of an
independent Institutional Review Board ("IRB"). The IRB will consider, among
other things, ethical factors, the safety of human subjects and the possible
liability of the institution.
Clinical trials are typically conducted in three sequential phases, but the
phases may overlap. In Phase I, the initial introduction of the drug into
healthy human subjects, the product generally is tested for safety, dosage
tolerance, pharmacokinetics, absorption, metabolism and excretion. Phase II
involves studies in a limited patient population to (i) determine the efficacy
of the product for specific, targeted indications, (ii) determine dosage
tolerance and optimal dosage, and (iii) identify possible adverse effects and
safety risks. When Phase II evaluations demonstrate that dosing the drug by the
pulmonary system is effective and has an acceptable safety profile, Phase III
trials are undertaken to evaluate further clinical efficacy and safety within an
expanded patient population at geographically dispersed clinical study sites.
The FDA, the clinical trial sponsor, the investigator or the IRB may suspend
clinical trials at any time if it believes that clinical subjects are being
exposed to an unacceptable health risk.
The results of product development, pre-clinical studies and clinical
studies are submitted to the FDA as an NDA/BLA for approval of the marketing and
commercial shipment of the pulmonary system. The FDA may deny an NDA/BLA if
applicable regulatory criteria are not satisfied or may require additional
clinical testing. Even if such data are submitted, the FDA may ultimately decide
that the NDA/BLA does not satisfy the criteria for approval. Product approvals
may be withdrawn if compliance with regulatory standards are not maintained or
if problems occur after the product reaches the market. The FDA may require
testing and surveillance programs to monitor the effect of pulmonary systems
that have been commercialized, and has the power to prevent or limit future
marketing of the product based on the results of these post-marketing programs.
Each domestic drug product manufacturing establishment must be registered
with, and approved by, the FDA. Drug product manufacturing establishments
located in California also must be licensed by the State of California.
Establishments handling controlled substances must be licensed by the United
States Drug Enforcement Administration ("DEA"). Domestic manufacturing
establishments are subject to biennial inspections by the FDA for GMP
compliance. Inhale is also subject to United States federal, state and local
regulations regarding workplace safety, environmental protection and hazardous
and controlled substance controls, among others.
Many of the drugs with which Inhale is working are already approved for
marketing by the FDA. Inhale believes that when working with approved drugs, the
approval process for delivery by pulmonary
14
<PAGE>
delivery may require less time and fewer tests than for new chemical entities.
However, Inhale expects that its formulations often will use excipients not
currently approved for pulmonary use. Use of these excipients will require
additional toxicological testing that may increase the costs of, or lengthen the
time in, gaining regulatory approval. In addition, regulatory procedures
applicable to Inhale's products may change as regulators gain experience in the
area of macromolecules, and any such changes may delay or increase the cost of
regulatory approval.
Inhale's device will not be developed as an independent product but will be
an inseparable part of the pulmonary drug delivery system for each specific
molecule. Prior to or at the time of submission of the IND, the FDA Center and
division within the Center will be identified to be responsible for the review
of the IND and NDA/BLA. In the case of Inhale's products, either the Center for
Drug Evaluation and Research or the Center for Biologics Evaluation and
Research, in consultation with the Center for Devices and Radiological Health,
will be involved in the review. However, one Center is designated as the Center
which has the lead responsibility for regulating the product. The jurisdiction
within the FDA is based on the primary mode of action of the drug and is
identified in the FDA's intercenter agreement.
Inhale expects that its partners generally will be responsible for clinical
and regulatory approval procedures, but Inhale may participate in this process
by submitting to the FDA or to each partner portions of the Drug Master File
being developed and to be maintained by Inhale which contains data concerning
the manufacturing processes for the product. The regulatory review process
generally takes a number of years and requires the expenditure of substantial
resources. Inhale's ability to manufacture and sell products developed under
contract depends upon the partner's completion of satisfactory clinical trials
and obtaining marketing approvals. Inhale may prepare and submit an IND
application and perform initial clinical studies before licensing the product to
a partner. Inhale's business strategy contemplates performing more of these
studies in the future.
Sales of Inhale's products outside the United States are subject to
regulatory requirements governing human clinical trials and marketing approval
for drugs and pulmonary delivery systems. Such requirements vary widely from
country to country.
Prior to marketing a new dosage form of any drug, including one developed
for use with Inhale's pulmonary drug delivery system, whether or not such drug
was already approved for marketing in another dosage form, the product must
undergo rigorous pre-clinical and clinical testing and an extensive review
process mandated by the FDA and equivalent foreign authorities. These processes
generally take a number of years and require the expenditure of substantial
resources. None of Inhale's proposed products has been submitted to the FDA for
marketing approval. Inhale has no experience obtaining such regulatory approval,
does not have the expertise or other resources to do so and intends to rely on
its partners to fund clinical testing and to obtain product approvals.
PATENTS AND PROPRIETARY RIGHTS
Inhale's policy is to apply for patent protection for the technology,
inventions and improvements deemed important to the development of its business.
Inhale also relies upon trade secrets, know-how, continuing technological
innovations and licensing opportunities to maintain and further develop its
competitive position. Inhale plans to defend aggressively its proprietary
technology and any issued patents.
Inhale expects that its integrated system for the development of pulmonary
delivery technology for macromolecule drugs will yield innovations in dry powder
formulations, powder processing, powder packaging and device design. It is
Inhale's strategy to build proprietary positions in each of its technological
areas. Inhale's success will depend in part upon its ability to protect its
proprietary technology from infringement, misappropriation, duplication and
discovery. Inhale has filed patent applications covering certain aspects of its
device and powder processing technology and powder formulations and pulmonary
route of delivery for certain molecules, and plans to file additional patent
applications. On October 17, 1995, Inhale received United States Patent No.
5,458,135 from the United States Patent and Trademark
15
<PAGE>
Office (the "PTO") for certain claims covering the use of its device in a method
for delivering powder formulations of drugs to the lung. On March 4, 1997,
Inhale received United States Patent No. 5,607,915 from the United States Patent
Trademark Office for pulmonary delivery of active fragments of parathyroid
hormone (PTH) 1-34. On October 17, 1997, Inhale was granted United States Patent
No. 5,654,007 covering a system and methods for processing fine dispersible
powders for easier processing. There can be no assurance that any of the patents
applied for by Inhale will issue, or that any patents that issue will be valid
and enforceable. Even if such patents are enforceable, Inhale anticipates that
any attempt to enforce its patents could be time consuming and costly.
In 1998 Inhale was granted an additional six patents by the PTO. United
States Patent No. 5,775,320 issued July 7, 1998, covers the method and means for
dispersing a dry-powder or liquid drug, and transferring the drug in its
aerosolized "cloud" form to a holding chamber where it is held until a patient
is ready to inhale. The patent also covers a way to pull in atmospheric "chase"
air following the initial inhalation to help push the drug into the deep lung.
United States Patent No. 5,740,794, issued April 21, 1998, covers a method and
means to access a packaged drug, to break up a dry powder drug into particles
with compressed air (aerosolize), and to transport the aerosolized drug into a
holding chamber. United States Patent No. 5,785,049, issued July 28, 1998,
contains 50 claims directed to methods and means for aerosolizing dry powders
through use of a high pressure gas stream to draw dry powder from a receptacle
such as a blister. Inhale utilizes the design described in this patent to enable
efficient aerosolization of fine dry powders to enable deep lung delivery for
systemic absorption. United States Patent No. 5,780,014 issued July 14, 1998,
covers methods and means for pulmonary delivery of dry powder alpha-1
antitrypsin for administration to a patient. United States Patent No. 5,814,607,
issued September 29, 1998, extends Inhale's coverage of pulmonary delivery of
active fragments of parathyroid hormone (PTH), a macromolecule being developed
by pharmaceutical companies to treat osteoporosis. United States Patent No.
5,826,633 covers Inhale's powder handling technologies. Included under the
patent is the process of transferring fine powder particles into blister packs
in an un-compacted state so that they can be easily dispersed in Inhale's
pulmonary delivery system.
In April 1998 Inhale and Initiatech Inc. signed an agreement under which
Inhale will license technology, intellectual property, and patents for
protecting biologically active compounds in the dry state. Inhale plans to use
this technology to expand its current technology base in stabilizing dry powder
aerosol formulations for peptides, proteins, and other macromolecules at room
temperature. Inhale's license will be exclusive for the fields of respiratory
delivery of pharmaceutical products and for any delivery form of insulin. The
license includes rights to two issued United States patents and a pending
foreign application covering the protection of biological materials from
degradation. Initiatech has exclusive rights to this technology from the Boyce
Thompson Institute for Plant Research Inc., (BTI) including the right to
sub-license.
It is Inhale's policy to require its employees and consultants, outside
scientific collaborators, sponsored researchers and other advisors who receive
confidential information from Inhale to execute confidentiality agreements upon
the commencement of employment or consulting relationships with Inhale. These
agreements provide that all confidential information developed or made known to
the individual during the course of the individual's relationship with Inhale is
to be kept confidential and not disclosed to third parties except in specific
circumstances. The agreements provide that all inventions conceived by an
employee shall be the property of Inhale. There can be no assurance, however,
that these agreements will provide meaningful protection or adequate remedies
for Inhale's trade secrets in the event of unauthorized use or disclosure of
such information.
In June 1997 Inhale acquired the intellectual property portfolio of the
BioPreservation Division of Pafra. This portfolio includes issued U.S. and
foreign Letters Patent and pending applications relating to the stabilization of
macromolecule drugs in dry formulations. A granted European patent included in
this portfolio is currently the subject of an opposition proceeding before the
European Patent Office and Inhale is continuing the defense of this patent, the
opposition to which was initiated prior to the
16
<PAGE>
acquisition. There can be no assurance that Inhale will be successful in the
defense of this opposition proceeding. In addition, there can be no assurance
that any of the Pafra patent applications will issue, or that any Pafra patents
will be valid and enforceable. The loss of the opposition proceeding or the
inability to obtain or defend the Pafra patents could have a material adverse
effect on Inhale. See "Risk Factors" beginning on page 19.
Inhale has obtained license rights to certain know-how and patent
applications owned by Genentech, Inc. covering formulations and powder
processing and pulmonary delivery of certain molecules, which it believes could
be important to the development of its business. These license rights are
worldwide, nonexclusive, sublicensable and royalty free. Recently, Genentech
successfully defended an opposition proceeding involving a pending European
patent licensed to Inhale. This decision is currently on appeal. The pending
patent covers the pulmonary delivery of cytokines and growth factors.
SCIENTIFIC ADVISORS
Inhale has assembled scientific and development advisors that provide Inhale
expertise in critical scientific, development, engineering, manufacturing and
business issues facing Inhale. The scientific advisory group assists Inhale on
issues related to pulmonary delivery, pulmonary toxicology, aerosol science,
government regulation, product selection and clinical trial design. Its members
are called upon individually as needed and include:
<TABLE>
<CAPTION>
NAME AFFILIATION AREA OF EXPERTISE
- ------------------------------ ------------------------------------------------ ------------------------------
<S> <C> <C>
Joseph Brain, Ph.D............ Professor, Harvard School of Public Health Pulmonary safety
Chairman, Department of Environmental Health
Director, Physiology Program
Peter Byron, Ph.D............. Professor of Pharmacy, Virginia Commonwealth Pharmaceutical aerosols
University, Medical College of Virginia
Carl Grunfeld, M.D............ Professor of Medicine, University of California, Endocrinology
San Francisco
Michael Matthay, M.D.......... Professor of Medicine and Anesthesiology, Pulmonology
University of California, San Francisco
Gerald Smaldone, M.D.......... Professor of Medicine, State University of New Aerosol medicine
York at Stony Brook
</TABLE>
EMPLOYEES AND CONSULTANTS
As of December 31, 1998, Inhale had 205 full time employees, of which 168
were engaged in research and development (including manufacturing) activities
and 37 in general administration and business development. Eighty-nine of the
employees hold advanced degrees, of which 44 are Ph.D.s. Inhale employs
scientists and engineers with expertise in the areas of pulmonary biology,
aerosol science, mechanical engineering, protein chemistry and chemical
engineering. None of Inhale's employees are covered by a collective bargaining
agreement and Inhale has experienced no work stoppages. Inhale believes that it
maintains good relations with its employees.
To complement its own expertise, Inhale utilizes specialists in regulatory
affairs, pulmonary toxicology, process engineering, manufacturing, quality
assurance, device design, clinical trial design and business development. These
individuals include certain of Inhale's scientific advisors as well as
independent consultants.
17
<PAGE>
RESEARCH AND DEVELOPMENT
Research and development expenditures totaled $35.4 million, $23.6 million,
$14.4 million for the years ended December 31, 1998, 1997 and 1996 respectively.
Research and development expenditures funded by partners were approximately
$21.8 million, $16.2 million and $6.9 million for the years ended December 31,
1998, 1997 and 1996 respectively.
THIRD-PARTY REIMBURSEMENT
In both domestic and foreign markets, sales of Inhale's potential products,
if any, will depend in part on the availability of reimbursement from
third-party payors such as government health administration authorities, private
health insurers and other organizations. Third-party payors are increasingly
challenging the price and cost-effectiveness of medical products and services.
Significant uncertainty exists as to the reimbursement status of newly approved
health care products. There can be no assurance that Inhale's proposed products
will be considered cost effective or that adequate third-party reimbursement
will be available to enable Inhale to maintain price levels sufficient to
realize an appropriate return on investment in product development. Legislation
and regulations affecting the pricing of pharmaceuticals may change before
Inhale's proposed products are approved for marketing and any such changes could
further limit reimbursement for medical products and services. See "Risk
Factors" beginning on page 19.
18
<PAGE>
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE READ CAREFULLY IN CONNECTION WITH
EVALUATING INHALE'S BUSINESS. ANY OF THE FOLLOWING RISKS COULD MATERIALLY
ADVERSELY AFFECT INHALE'S BUSINESS, OPERATING RESULTS OF FINANCIAL CONDITION.
WE DO NOT KNOW IF OUR DEEP LUNG DRUG DELIVERY SYSTEM IS TECHNICALLY FEASIBLE.
We are in an early stage of development. There is a risk that our deep lung
delivery technology will not be technically feasible. Even if our deep lung
delivery technology is technically feasible, it may not be commercially accepted
across a range of large and small molecule drugs. We have tested six of our
thirteen deep lung delivery formulations in humans. The deep lung formulations
tested in humans are insulin, interleukin-1 receptor, salmon calcitonin, an
osteoporosis drug and two small molecules.
Many of the underlying drug compounds contained in our deep lung
formulations have been tested in humans by other companies using alternative
delivery routes. Our potential products require extensive research, development
and pre-clinical (animal) and clinical (human) testing. Our potential products
also may involve lengthy regulatory review before they can be sold. We do not
know if and cannot assure that any of our potential products will prove to be
safe and effective or meet regulatory standards. There is a risk that any of our
potential products will not be able to be produced in commercial quantities at
acceptable cost or marketed successfully. Our failure to achieve technical
feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory
approval or, together with partners, successfully market products will seriously
impact the amount of our revenue and our results of operations.
WE DO NOT KNOW IF OUR DEEP LUNG DELIVERY SYSTEM IS EFFICIENT.
We may not be able to achieve the total system efficiency needed to be
competitive with alternative routes of delivery. System efficiency is the
product of the deep lung bioavailability of a potential product and the
percentage of each drug dose lost at various stages of the manufacturing and
deep lung delivery process. Deep lung bioavailability is the percentage of a
drug that is absorbed into the bloodstream when that drug is delivered directly
to the lungs. This is the initial screen for whether deep lung delivery of any
systemic drug is feasible.
WE DO NOT KNOW IF OUR DEEP LUNG DRUG FORMULATIONS ARE STABLE.
We may not be able to identify and produce powdered versions of drugs that
retain the physical and chemical properties needed to work with our delivery
device. Formulation stability is the physical and chemical stability of the drug
over time and under various storage conditions. Formulation stability will vary
with each deep lung formulation and the type and amount of ingredients that are
used in the formulation. We would not consider a drug as a good candidate for
development and commercialization if its dose loss is excessive at any one stage
or cumulatively in the manufacturing and delivery process or if its deep lung
bioavailability is too low. Problems with powdered drug stability would
seriously impact our ability to develop and market our potential products.
WE DO NOT KNOW IF OUR DEEP LUNG SYSTEM IS SAFE.
We may not be able to prove potential products to be safe.
Our products require lengthy laboratory, animal and human testing. For most
of our products we are in the early stage of human testing. If we find that any
product is not safe, we will not be able to commercialize the product. The
safety of our deep lung formulations will vary with each drug and the
ingredients used in its formulation.
19
<PAGE>
WE DO NOT KNOW IF OUR DEEP LUNG SYSTEM PROVIDES CONSISTENT DOSES OF MEDICINE.
We may not be able to provide reproducible dosages of stable formulations
sufficient to achieve clinical success. Reproducible dosing is the ability to
deliver a consistent and predictable amount of drug into the bloodstream over
time both for a single patient and across patient groups. Reproducible dosing
requires the development of:
- an inhalation device that consistently delivers predictable amounts of dry
powder formulations to the deep lung;
- accurate unit dose packaging of dry powder formulations; and
- moisture resistant packaging.
We may not be able to develop reproducible dosing of any potential product.
The failure to do so means that we would not consider it a good candidate for
development and commercialization.
WE DO NOT KNOW IF OUR TECHNOLOGIES CAN BE INTEGRATED IN TIME TO BRING PRODUCT TO
MARKET.
We may not be able to integrate all of the relevant technologies to provide
an integrated deep lung delivery system. Our integrated approach to systems
development relies upon several different but related technologies:
- dry powder formulations;
- dry powder processing technology;
- dry powder packaging technology; and
- deep lung delivery devices.
At the same time we must:
- establish collaborations with partners;
- perform laboratory and clinical testing of potential products; and
- scale-up our manufacturing processes.
We must accomplish all of these steps without delaying any aspect of
technology development. Any delay in one component of product or business
development could delay our ability to develop, obtain approval of or market
therapeutic products using our deep lung delivery technology.
OUR DEEP LUNG DELIVERY SYSTEM MAY NOT BE COMMERCIALLY ACCEPTED.
We may not be able to achieve commercial viability of our deep lung delivery
system. In order to sell any potential product, we must make it commercially
acceptable to the market. This means that we must:
- further refine our device prototype;
- complete scale-up of our powder processing system; and
- complete scale-up of our automated packaging system.
The failure to demonstrate deep lung bioavailability, achieve total system
efficiency, provide safe, reproducible dosages of stable formulations or advance
on a timely basis the numerous aspects of product and business development will
seriously impact the amounts of our revenues and our results of operations.
20
<PAGE>
WE EXPECT TO CONTINUE TO LOSE MONEY FOR THE NEXT SEVERAL YEARS.
We have never been profitable and, through December 31, 1998, have incurred
a cumulative deficit of approximately $56.0 million. We expect to continue to
incur substantial and increasing losses over at least the next several years as
we expand our research and development efforts, testing activities and
manufacturing operations, and as we complete our late stage clinical and early
commercial production facility. All of our potential products are in research or
in the early stages of development except for our insulin collaboration. We have
generated no revenues from approved product sales. Our revenues to date have
consisted primarily of payments under short-term research and feasibility
agreements and development contracts. To achieve and sustain profitable
operations, we must, alone or with others, successfully develop, obtain
regulatory approval for, manufacture, introduce, market and sell products using
our deep lung drug delivery system. There is a risk that we will not generate
sufficient product or contract research revenue to become profitable or to
sustain profitability.
WE DEPEND ON PARTNERS FOR REGULATORY APPROVALS AND COMMERCIALIZATION OF OUR
PRODUCTS.
Since Inhale is in the business of developing technology for delivering
drugs to the lungs and licensing this technology to companies that make and sell
drugs, we do not have the people and other resources to do the following things:
- make bulk drugs to be used as medicines;
- design and carry out large scale clinical studies;
- prepare and file documents necessary to obtain government approval to sell
a given drug product; and
- market and sell our products when and if they are approved.
When Inhale signs a license agreement to develop a product with a drug
company, the drug company agrees to do some or all of the things described
above. If our partner fails to do any of these things, Inhale cannot complete
the development of the product.
WE DO NOT KNOW IF WE WILL BE ABLE TO PRODUCE OUR PRODUCTS IN COMMERCIAL
QUANTITIES.
We must scale-up our current powder processing and filling facilities and
comply with the good manufacturing practice standards prescribed by the United
States Food and Drug Administration and other standards prescribed by other
regulatory agencies to achieve drug production levels that are adequate to
support late stage human clinical testing and early commercial sales.
We have no experience manufacturing products for large scale clinical
testing or commercial purposes. We have only performed powder processing on the
small scale needed for testing formulations and for early stage and larger
clinical trials. We may encounter manufacturing and control problems as we
attempt to scale-up powder processing facilities. We may not be able to achieve
such scale-up in a timely manner or at a commercially reasonable cost, if at
all. Our failure to solve any of these problems could delay or prevent late
stage clinical testing and commercialization of our products and could seriously
impact the amount of our revenues and our results of operations.
To date, we have relied on one particular method of powder processing. There
is a risk that this technology will not work with all drugs or that the drug
losses will prohibit the commercial viability of certain drugs. Additionally,
there is a risk that any alternative powder processing methods we may pursue
will not be commercially practical for aerosol drugs or that we will not have or
be able to acquire the rights to use such alternative methods.
21
<PAGE>
Our fine particle powders and small quantity packaging require special
handling. We have designed and qualified small scale automated filling equipment
for small quantity packaging of fine powders. We face significant technical
challenges in scaling-up an automated filling system that can handle the small
dose and particle sizes of our powders in commercial quantities. There is a risk
that we will not be able to scale-up our automated filling equipment in a timely
manner or at commercially reasonable costs. Any failure or delay in such
scale-up would delay product development or bar commercialization of our
products and will impact the level of our revenues and results of operations.
We face many technical challenges in further developing our inhalation
device to work with a broad range of drugs, to produce such a device in
sufficient quantities and to adapt the device to different powder formulations.
There is a risk that we will not successfully achieve any of these things. Our
failure to overcome any of these challenges will impact our revenues and results
of operations.
For late stage clinical trials and initial commercial production, we intend
to use one or more contract manufacturers to produce our device. There is a risk
that we will not be able to enter into or maintain arrangements with any
potential contract manufacturers, and that the failure to do so will impact our
revenues and results of operations.
WE DO NOT KNOW IF THE MARKET WILL ACCEPT INHALE'S DEEP LUNG DELIVERY SYSTEM.
The commercial success of our potential products depends upon market
acceptance by health care providers, third-party payors, like health insurance
companies and Medicare, and patients. Our products under development use a new
method of drug delivery and there is a risk that our potential products will not
be accepted by the market. Market acceptance will depend on many factors,
including
- the safety and efficacy results of our clinical trials;
- favorable regulatory approval and product labeling;
- the frequency of product use;
- the availability of third-party reimbursement;
- the availability of alternative technologies; and
- the price of our products relative to alternative technologies.
There is a risk that health care providers, patients or third-party payors
will not accept our deep lung drug delivery system. If the market does not
accept our potential products, our revenues and results of operations will be
seriously impacted if our potential products are not accepted by the market.
OUR PATENTS MAY NOT PROTECT OUR PRODUCTS AND OUR PRODUCTS MAY INFRINGE ON THIRD
PARTY PATENT RIGHTS.
Inhale has filed patent applications covering certain aspects of our device,
powder processing technology, and powder formulations and deep lung route of
delivery for certain molecules, and we plan to file additional patent
applications. Currently we have 27 issued U.S. and foreign patents that cover
certain aspects of our technology and we have a number of patent applications
pending. There is a risk that any of the patents applied for will not issue, or
that any patents that issue or have issued will not be valid and enforceable.
Enforcing our patent rights would be time consuming and costly.
We are aware of an alternate dry powder processing technology that we are
not using for our current products under development but may desire to use for
certain products in the future. The ownership of this powder processing
technology is unclear. We are aware that multiple parties, including Inhale,
claim patent, trade secret and other rights in the technology. If we determine
that this alternate powder processing technology is relevant to the development
of future products and further determine that a license to this alternate powder
processing technology is needed, we cannot be certain that we can obtain a
license from the relevant party or parties on commercially reasonable terms, if
at all.
22
<PAGE>
Our access or our partners' access to the drugs to be formulated will affect
our ability to develop and commercialize our technology. Many drugs, including
powder formulations of certain drugs that are presently under development by us,
are subject to issued and pending United States and foreign patents that may be
owned by our competitors. We know that there are issued patents and pending
patent applications relating to the deep lung delivery of large molecule drugs,
including several for which we are developing deep lung delivery formulations.
This situation is highly complex, and the ability of any one company, including
Inhale, to commercialize a particular drug is unpredictable.
We intend generally to rely on the ability of our partners to provide access
to the drugs that are to be formulated by us for deep lung delivery. There is a
risk that our partners will not be able to provide access to such drug
candidates. Even if such access is provided, there is a risk that our partners
or we will be accused of, or determined to be, infringing a third-party's patent
rights and will be prohibited from working with the drug or be found liable for
damages that may not be subject to indemnification. Any such restriction on
access to drug candidates or liability for damages would impact the level of our
revenues and results of operations.
WE MAY NOT OBTAIN REGULATORY APPROVAL.
There is a risk that we will not obtain regulatory approval for our products
on a timely basis, or at all. Our product must undergo rigorous animal and human
testing and an extensive review process mandated by the FDA and equivalent
foreign authorities. This process generally takes a number of years and requires
the expenditure of substantial resources although the time required for
completing such testing and obtaining such approvals is uncertain. We have not
submitted any of our products to the FDA for marketing approval. We have no
experience obtaining such regulatory approval.
In addition, we may encounter delays or rejections based upon changes in the
United States Food and Drug Administration policy, including policy relating to
good manufacturing practice compliance, during the period of product
development. We may encounter similar delays in other countries.
Even if regulatory approval of a product is granted, the approval may limit
the indicated uses for which we may market our product. In addition, our
marketed product, our manufacturing facilities and Inhale, as the manufacturer,
will be subject to continual review and periodic inspections. Later discovery
from such review and inspection of previously unknown problems may result in
restrictions on our product or on us, including withdrawal of our product from
the market. The failure to obtain timely regulatory approval of our products,
any product marketing limitations or a product withdrawal would impact the level
of our revenue and results of operations.
IF OUR PRODUCTS ARE NOT COST EFFECTIVE, GOVERNMENT AND PRIVATE INSURANCE PLANS
WILL NOT PAY FOR OUR PRODUCTS.
In both domestic and foreign markets, sales of our products under
development will depend in part upon the availability of reimbursement from
third-party payors, such as government health administration authorities,
managed care providers, private health insurers and other organizations. In
addition, such third-party payors are increasingly challenging the price and
cost effectiveness of medical products and services. Significant uncertainty
exists as to the reimbursement status of newly approved health care products.
Legislation and regulations affecting the pricing of pharmaceuticals may change
before our proposed products are approved for marketing. Adoption of such
legislation and regulations could further limit reimbursement for medical
products. A government third party payor decision to not provide adequate
coverage and reimbursements for our products would limit market acceptance of
such products.
OUR COMPETITORS MAY DEVELOP AND SELL BETTER DRUG DELIVERY SYSTEMS.
We are aware of other companies engaged in developing and commercializing
pulmonary drug delivery systems and enhanced injectable drug delivery systems.
Many of these companies have greater
23
<PAGE>
research and development capabilities, experience, manufacturing, marketing,
financial and managerial resources than we do and represent significant
competition for us. Acquisitions of competing drug delivery companies by large
pharmaceutical companies could enhance our competitors' financial, marketing and
other resources. Accordingly, our competitors may succeed in developing
competing technologies, obtaining United States Food and Drug Administration
approval for products or gain market acceptance before us. We cannot assure that
developments by others will not make our products or technologies uncompetitive
or obsolete.
WE EXPECT OUR STOCK PRICE TO REMAIN VOLATILE.
Our stock price is volatile. In the last twelve months our stock price
ranged from $20 1/8 to $36 1/2 and we expect it to remain volatile. A variety of
factors may have a significant effect on the market price of our common stock,
including:
- fluctuations in our operating results;
- announcements of technological innovations or new therapeutic products;
- announcement or termination of collaborative relationships by Inhale or
our competitors;
- governmental regulation;
- clinical trial results;
- developments in patent or other proprietary rights;
- public concern as to the safety of drug formulations developed by Inhale
or others; and
- general market conditions.
Any litigation instigated against us as a result of this volatility could
result in substantial costs and a diversion of our management's attention and
resources, which could impact our revenues and results of operations.
INVESTORS SHOULD BE AWARE OF INDUSTRY-WIDE RISKS.
In addition to the risks associated specifically with Inhale described
above, investors should also be aware of general risks associated with drug
development and the pharmaceutical industry. These include but are not limited
to:
- handling of hazardous materials;
- hiring and retaining qualified people; and
- insuring against product liability claims.
ITEM 2. PROPERTIES
Inhale currently leases approximately 140,000 square feet in San Carlos,
California and 20,000 square feet in Palo Alto, California. The Palo Alto
facility is used for research, development and administration. The lease has a
five year term, and expires on May 31, 2003.
The San Carlos facility is leased pursuant to a 15-year lease agreement. The
San Carlos facility serves as the Company's corporate headquarters and is used
for research and development, manufacturing and administration. The lease
provides Inhale with an option to lease approximately 80,000 additional square
feet in the same facility. This manufacturing facility operates under Good
Manufacturing Practices and has been approved and licensed by the State of
California to manufacture clinical supplies for use in human clinical trials.
24
<PAGE>
In October 1998 the Company acquired 4.7 acres of land adjacent to its San
Carlos facility. The Company intends to use this property to expand future
operations.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Inhale's stockholders in the quarter
ended December 31, 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and positions of the
executive officers of Inhale:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------- --- ------------------------------------------------
<S> <C> <C>
Robert B. Chess.......... 42 Co-Chief Executive Officer and Director
Ajit S. Gill............. 50 Co-Chief Executive Officer and Director
Stephen L. Hurst......... 43 General Counsel
John S. Patton, Ph.D..... 52 Vice President, Research and Director
Robert M. Platz.......... 47 Vice President, Technology
</TABLE>
ROBERT B. CHESS has served as Co-Chief Executive Officer since August 1998.
Mr. Chess served as President of Inhale from December 1991 to August 1998 and as
Chief Executive Officer from May 1992 to September 1998. Mr. Chess was also
elected a Director of Inhale in May 1992. From September 1990 until October
1991, he was an Associate Deputy Director in the White House Office of Policy
Development. In March 1987, Mr. Chess co-founded Penederm Incorporated
("Penederm"), a topical dermatological drug delivery company, and served as its
President until February 1989. He left Penederm in October 1989. Prior to
co-founding Penederm, Mr. Chess held management positions at Intel Corp., a
semiconductor manufacturer, and Metaphor, a computer software company (acquired
by International Business Machines). Mr. Chess holds a BS in Engineering from
the California Institute of Technology and an MBA from the Harvard Business
School.
AJIT S. GILL has served as Co-Chief Executive Officer since August 1998. Mr.
Gill served as Chief Operating Officer from October 1996 to August 1998 and,
Chief Financial Officer from January 1993 until October 1996. Before joining
Inhale, Mr. Gill was Vice President and General Manager of Kodak's Interactive
Systems division. Mr. Gill has served as Chief Financial Officer for
TRW-Fujitsu, Director of Business Development for Visicorp, and as start-up
President for three high technology companies. He completed a BTech at the
Indian Institute of Technology, an MS in Electrical Engineering from the
University of Nebraska, and holds an MBA from the University of Western Ontario.
STEPHEN L. HURST has been General Counsel since August 1998. Mr. Hurst
served as Vice President, Intellectual Property and Licensing of Inhale from
March 1994 to August 1998. From July 1990 to February 1994, Mr. Hurst was in
private law practice and consulted with COR Therapeutics, Inc., a biotechnology
company, on intellectual property and business development issues. From November
1987 to June 1990, he was the Campus Patent Coordinator for the University of
California, San Francisco. He also worked as an Associate Counsel at Townsend &
Townsend, the San Francisco area's largest intellectual property law firm. He
received a BS degree in Environmental Science from the University of California
at Berkeley and his JD from Golden Gate University in San Francisco.
JOHN S. PATTON, PH.D., a co-founder of Inhale, has been Vice President,
Research since December 1991 and a Director of Inhale since July 1990. He served
as President of Inhale from its incorporation in July 1990 to December 1991.
From 1985 to 1990, Dr. Patton was a Project Team Leader with Genentech, Inc., a
biotechnology company, where he headed their non-invasive drug delivery
activities.
25
<PAGE>
Dr. Patton was on the faculty of the Marine Science and Microbiology Departments
at the University of Georgia from 1979 through 1985, where he was granted tenure
in 1984. Dr. Patton received a BS in Zoology and Biochemistry from Pennsylvania
State University, an MS from the University of Rhode Island, a Ph.D. in Biology
from the University of California, San Diego and received post doctorate
fellowships from Harvard Medical School and the University of Lund, Sweden both
in biomedicine.
ROBERT M. PLATZ, a co-founder of Inhale, has served as Vice President,
Technology of Inhale since August 1990. He also served as a Director of Inhale
from July 1990 to August 1991. From January 1983 to August 1991, Mr. Platz was
employed by SRI International, a contract research company, most recently as
Senior Chemical Engineer, where he headed the pharmaceutical aerosol group. Mr.
Platz received a BS in biology and an MS in Chemical Engineering from the
University of California, Los Angeles.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Inhale's Common Stock trades on the Nasdaq National Market under the symbol
INHL. The table below sets forth the high and low sales prices for Inhale's
Common Stock (as reported on the Nasdaq National Market) during the periods
indicated.
<TABLE>
<CAPTION>
PRICE RANGE OF
COMMON STOCK
--------------------
<S> <C> <C>
HIGH LOW
--------- ---------
YEAR ENDED DECEMBER 31, 1997:
1st Quarter............................................................. $ 22.625 $ 15.125
2nd Quarter............................................................. 25.000 18.375
3rd Quarter............................................................. 33.625 18.750
4th Quarter............................................................. 36.500 25.000
YEAR ENDED DECEMBER 31, 1998:
1st Quarter............................................................. $ 34.250 $ 25.250
2nd Quarter............................................................. 34.000 23.125
3rd Quarter............................................................. 29.750 21.750
4th Quarter............................................................. 33.375 21.500
</TABLE>
As of December 31, 1998, there were approximately 184 holders of record of
Inhale's Common Stock. Inhale has not paid any cash dividends since its
inception and does not intend to pay any cash dividends in the foreseeable
future.
On December 11, 1998, Inhale sold 1,200,000 shares of its common stock to
funds affiliated with Capital Research and Management Company, an accredited
investor, for aggregate cash consideration of $37,200,000 pursuant to the
exemption from registration provided by Section 4 (2) of the Securities Act of
1933, as amended.
26
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Contract revenue........................... $ 21,795 $ 16,249 $ 6,890 $ 3,445 $ 1,651
Operating costs and expenses:
Research and development................. 35,398 23,645 14,376 9,041 4,934
General and administrative............... 8,387 6,328 4,004 3,232 2,465
--------- --------- --------- --------- ---------
Total operating costs and expenses......... 43,785 29,973 18,380 12,273 7,399
--------- --------- --------- --------- ---------
Loss from operations....................... (21,990) (13,724) (11,490) (8,828) (5,748)
--------- --------- --------- --------- ---------
Net loss................................... $ (18,356) $ (9,983) $ (9,909) $ (7,662) $ (5,279)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net loss per share......................... $ (1.17) $ (0.72) $ (0.88) $ (0.78) $ (0.86)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Shares used in computation of net loss per
share (1)................................ 15,719 13,792 11,207 9,837 6,103
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.......................... $ 71,784 $ 83,811 $ 31,304 $ 17,701 $ 13,451
Total assets............................. 134,496 119,762 41,492 23,248 17,249
Equipment financing obligations, less
current portion........................ 9 135 187 353 460
Tenant improvement loan, less current
portion................................ 4,931 4,967 -- -- --
Accumulated deficit...................... (56,018) (37,662) (27,679) (17,770) (10,108)
Stockholders' equity..................... 115,881 97,093 35,061 20,182 15,427
</TABLE>
- ------------------------
No cash dividends have been paid.
(1) Basic and diluted net loss per share is based upon the weighted average
number of common shares outstanding. All share amounts have been adjusted to
reflect the implementation of FASB Statement No. 128 and Staff Accounting
Bulletin No. 98. See Note 1 of Notes to Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. INHALE'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE DISCUSSED HERE. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THIS SECTION AS WELL AS IN
PART I OF THIS ANNUAL REPORT UNDER THE HEADING "RISK FACTORS".
OVERVIEW
Since its inception in July 1990, Inhale has been engaged in the development
of a pulmonary system for the delivery of macromolecules and other drugs for
systemic and local lung applications. Inhale has been unprofitable since
inception and expects to incur significant and increasing additional operating
27
<PAGE>
losses over the next several years primarily due to increasing research and
development expenditures and expansion of manufacturing facilities. To date,
Inhale has not sold any products and does not anticipate receiving revenue from
product sales or royalties for at least the next several years. For the period
from inception through December 31, 1998, Inhale incurred a cumulative net loss
of approximately $56.0 million. Inhale's sources of working capital have been
equity financings, financings of equipment acquisitions and tenant improvements,
interest earned on investments of cash, and revenues from short term research
and feasibility agreements and development contracts.
Inhale typically has been compensated for research and development expenses
incurred during initial feasibility work as well as for work performed under
collaborative arrangements. Partners that enter into collaborative agreements
generally pay for research and development expenses and make additional payments
to Inhale as Inhale achieves certain key milestones. These additional payments
are intended to fund the continued development of the Company's technology.
Inhale expects to receive royalties from its partners based on revenues received
from product sales, and to receive revenue from the manufacturing of powders and
the supply of devices. In certain cases, Inhale may enter into collaborative
agreements under which Inhale's partners would manufacture powders or supply
inhalation devices, thereby potentially limiting one or more sources of revenue
for Inhale. To achieve and sustain profitable operations, Inhale, alone or with
others, must successfully develop, obtain regulatory approval for, manufacture,
introduce, market and sell products utilizing its pulmonary drug delivery
system. There can be no assurance that Inhale will be able to generate revenue
from commercial products or generate sufficient product or contract research
revenue to become profitable or to sustain profitability.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Contract research revenue was $21.8 million for the year ended December 31,
1998 compared to $16.2 million and $6.9 million for the years ended December 31,
1997 and 1996, respectively. Revenue increased 34% in 1998 from 1997 levels and
136% in 1997 from 1996 levels. Costs of contract research revenue approximate
such revenue and are included in operating costs and expenses.
The 34% increase in revenue for the year ended December 31, 1998 as compared
to December 31, 1997 was primarily due to the increase in activities under
Inhale's existing collaborative agreement with Pfizer. The increase in activity
under the Pfizer collaboration was primarily related to manufacturing scale-up
and clinical supply production. Contract revenues are expected to fluctuate from
year to year, and future contract revenues cannot be predicted accurately. The
level of contract revenues depends in part upon future success in obtaining new
collaborative agreements, timely completion of feasibility studies, the
continuation of existing collaborations and achievement of milestones under
current and future agreements.
Research and development expenses were $35.4 million for the year ended
December 31, 1998, as compared to $23.6 million and $14.4 million for the years
ended December 31, 1997 and 1996, respectively. These expenses represent
proprietary research expenses as well as the costs related to contract research
revenue and include salaries and benefits of scientific and development
personnel, clinical manufacturing costs, laboratory supplies, consulting
services, facilities, costs of obtaining intellectual property protection for
Inhale's technologies and expenses associated with the development of
manufacturing processes. The $11.8 million increase in research and development
expenses in 1998 from 1997 was primarily attributable to the development of
infrastructure necessary to manufacture the Company's products on a late stage
clinical scale. The $9.3 million increase in research and development expenses
in 1997 from 1996 was primarily attributed to continued expansion of research
activities resulting from an increase in the number of projects and the hiring
of additional scientific personnel required to support the increased number of
projects. Inhale expects research and development spending to increase over the
next few years as Inhale
28
<PAGE>
expands its development efforts under collaborative agreements and plans, builds
and scales up a late stage clinical and early commercial manufacturing facility.
General and administrative expenses were $8.4 million for the year ended
December 31, 1998 as compared to $6.3 million and $4.0 million for the years
ended December 31, 1997 and 1996, respectively. The $2.1 million increase in
general and administrative expenses in 1998 from 1997 and the $2.3 million
increase in 1997 from 1996 were due primarily to costs associated with
supporting Inhale's increased research efforts including administrative
staffing, business development activities and marketing activities.
General and administrative expenses are expected to continue to increase over
the next few years as Inhale expands its research, development and manufacturing
activities.
Interest income was $3.9 million for the year ended December 31, 1998 as
compared to $3.8 million and $1.6 million for the years ended December 31, 1997
and 1996, respectively. The 3% increase in interest income in 1998 from 1997 was
due to Inhale maintaining larger cash and investment balances. The 132% increase
in interest income in 1997 from 1996 was primarily a result of Inhale receiving
research funding and milestone payments from collaborative partners, the
completion of a private placement of Inhale's Common Stock in February 1997
which raised net proceeds of $30.5 million as well as the completion of a public
offering of Inhale's Common Stock in November 1997 which raised net proceeds of
$40.0 million.
At December 31, 1998, Inhale had federal net operating loss carryforwards of
approximately $47.2 million. These carryforwards will expire beginning in the
year 2006. Utilization of net operating loss carryforwards may be subject to
substantial annual limitation due to the ownership change limitation provided
for by the Internal Revenue Code of 1986. The annual limitation may result in
the expiration of net operating loss carryforwards before utilization.
LIQUIDITY AND CAPITAL RESOURCES
Inhale has financed its operations primarily through public and private
placements of its equity securities, contract research revenues, interest income
earned on its investments of cash and financing of equipment acquisitions. In
its initial public offering completed May 1994, Inhale raised net proceeds of
approximately $14.4 million and raised additional net proceeds of $7.2 million
in its public offering completed in March 1995. On February 7, 1997 Inhale
completed a private placement of its Common Stock, selling 1.8 million newly
issued shares for net proceeds of $30.5 million. In November 1997 Inhale
completed a public offering of its Common Stock, selling 1.725 million newly
issued shares for net proceeds of $40.0 million. In May 1997, Inhale obtained a
$10 million line of credit which may be drawn upon to finance the purchases of
equipment and facility improvements. As of December 31, 1998, Inhale had not
drawn on this line of credit. The line of credit expires in May 1999. Inhale
secured a $5 million loan in November 1997 to also finance the purchases of
equipment and facility improvements. In December 1998, Inhale completed a
private placement of its Common Stock, selling 1.2 million newly issued shares
for net proceeds of $35.2 million. At December 31, 1998, Inhale had cash, cash
equivalents and short-term investments of approximately $82.9 million.
Inhale's operations used cash of $19.2 million, provided cash of $5.0
million and used cash of $5.8 million in the years ended December 31, 1998, 1997
and 1996, respectively. These amounts differed from Inhale's net operating
losses in these periods principally due to increases in accounts payable and
accrued liabilities, depreciation expenses and deferred revenue. Additionally,
in 1998 Inhale recorded a non-cash transaction of $284,000 in connection with
the completion of two licensing agreements.
Inhale purchased property and equipment of approximately $34.6 million,
$17.3 million and $2.2 million during the years ended December 31, 1998, 1997
and 1996, respectively. The increase for the year ended December 31, 1998 is
primarily due to the build out of Inhale's manufacturing facility and corporate
headquarters located in San Carlos, California. In addition, the Company
acquired land adjacent to the current facility for approximately $7.4 million
which will be used to support future expansion.
29
<PAGE>
Inhale expects its cash requirements to increase due to expected increases
in expenses related to the further research and development of its technologies
resulting from a larger number of projects, development of drug formulations,
process development for the manufacture and filling of powders and devices,
marketing and general and administrative costs. These expenses include, but are
not limited to, increases in personnel and personnel related costs, purchases of
capital equipment, inhalation device prototype construction and facilities
expansion, including the planning and building of a late stage clinical and
early stage commercial manufacturing facility.
Inhale believes that its cash, cash equivalents and short-term investments
as of December 31, 1998 together with interest income and possible additional
equipment financing, will be sufficient to meet its operating expense and
capital expenditure requirements at least through the first half of 2000.
However, Inhale's capital needs will depend on many factors, including continued
scientific progress in its research and development arrangements, progress with
pre-clinical and clinical trials, the time and costs involved in obtaining
regulatory approvals, the costs of developing and the rate of scale-up of
Inhale's powder processing and packaging technologies, the timing and cost of
its late-stage clinical and early commercial production facility, the costs
involved in preparing, filing, prosecuting, maintaining and enforcing patent
claims, the need to acquire licenses to new technologies and the status of
competitive products. To satisfy its long-term needs, Inhale intends to seek
additional funding, as necessary, from corporate partners and from the sale of
securities. There can be no assurance that additional funds, if and when
required, will be available to Inhale on favorable terms, if at all.
YEAR 2000 COMPLIANCE
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (Year 2000) approaches. The Year
2000 ("Y2K") problem is pervasive and complex as virtually every computer
operation may be affected in some way by the rollover of the two digit year
value to "00". The issue is whether systems will properly recognize date
sensitive information when the year changes to 2000. If the Company's software
and firmware with date-sensitive functions are not Y2K compliant, they may
recognize a date with "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, interruptions in manufacturing
operations, a temporary inability to process transactions, or engage in similar
normal business activities.
The Company is utilizing both internal and external resources to conduct a
comprehensive review of its systems to identify those systems that could be
affected by the Y2K problem and has developed an implementation plan to resolve
the issue by the end of 1999. The scope of the Y2K effort includes information
technology ("IT") such as software and hardware, non-IT systems or embedded
technology such as microcontrollers contained in various manufacturing and lab
equipment, environmental and safety systems, facilities and utilities, and the
Y2K readiness of key third parties such as suppliers and financial institutions.
A multi-step Y2K readiness plan has been developed for its internal systems.
This plan includes the following elements: 1) Awareness - raising the Company's
awareness of the Y2K issue; 2) Discovery - keeping an inventory and monitoring
the compliance status of key financial, informational and operations systems
subject to Y2K issues; 3) Assessment - determining both the business impact of
noncompliance and the likelihood of noncompliance from each of the entities in
the inventory; 4) Validation Remediation - the process of validating entities to
ascertain compliance and remediate non-compliant entities. As of December 1998,
the Company had completed the Awareness, Discovery and Assessment phases of the
plan.
The Company has initiated formal communication with significant vendors and
suppliers to determine the extent to which the Company's operations are
vulnerable to those third parties' failure to remediate their own Y2K issues.
Suppliers of hardware, software or other products that might contain embedded
processors were requested to provide information regarding Y2K compliance status
of their products. The Company will continue to seek information from
non-responsive suppliers and plans to contact replacement vendors and suppliers
through the second quarter of 1999 and then implement appropriate
30
<PAGE>
contingency plans. In addition, in order to protect against the acquisition of
additional non-compliant products, the Company now requires suppliers to warrant
that products sold or licensed to the Company are Y2K compliant. In the event
that any of the Company's significant suppliers do not successfully achieve Y2K
compliance in a timely manner, the Company's business or operations could be
adversely affected. There can be no assurance that the systems of other
companies on which the Company's systems rely will be converted on a timely
basis and would not have an adverse effect on the Company's operations.
The Company has not yet fully developed a comprehensive contingency plan to
address situations that may result if the Company is unable to achieve Y2K
readiness of its critical operations. Development of contingency plans are in
progress and will be completed by the end of first quarter of 1999. There can be
no assurance that the Company will be able to develop a contingency plan that
will adequately address issues that may arise in the year 2000. The failure of
the Company to develop and implement, if necessary, an appropriate contingency
plan could have a material impact on the operations of the Company. Finally, the
Company is also vulnerable to external forces that might generally affect
industry and commerce, such as utility and transportation company Y2K compliance
failures and related service interruptions.
The Company anticipates completing the mission critical, high impact Y2K
issues by the first half of 1999, which is prior to any anticipated impact on
its operating systems and expects the Y2K project to continue beyond the year
2000 with respect to the upgrading, replacement and testing of non-critical
systems. These dates are contingent upon the timeliness and accuracy of software
and hardware upgrades from vendors, adequacy and quality of resources available
to work on completion of the project and any other unforeseen factors. The total
expense of the Y2K project is currently estimated at approximately $750,000, of
which approximately $250,000 has been spent through December 31, 1998, which is
not material to the Company's business operations or financial condition. The
expenses of the Y2K project are being funded through operating cash flows.
The costs of the project and the date on which the Company believes it will
complete the Y2K modifications are based on management's best estimates, which
were derived utilizing numerous assumptions of future events, including the
continued availability of certain resources, third-party modification plans and
other factors. There can be no assurance that these estimates will be achieved
and actual results could differ materially from those anticipated.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of the Company's investment activities is to preserve
principal while at the same time maximizing yields without significantly
increasing risk. To achieve this objective, the Company invests in highly liquid
and high quality debt securities. The Company's investments in debt securities
are subject to interest rate risk. To minimize the exposure due to adverse shift
in the interest rates the Company invests in short term securities and maintains
an average maturity of one year or less. A hypothetical 50 basis point increase
in interest rates would result in an approximate $150,000 decrease (less than
0.185% in the fair value of the Company's available-for-sale securities.
The potential change noted above is based on sensitivity analyses performed
on the Company's financial positions at December 31, 1998. Actual results may
differ materially.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements for the years ended December 31, 1998, 1997 and
1996 are submitted as a separate section of this report. See Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
31
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Inhale incorporates by reference the information concerning its directors
set forth under the heading "Election of Directors" in Inhale's definitive Proxy
Statement to be filed for its 1999 Annual Meeting of Stockholders.
Information concerning Inhale's executive officers appears at the end of
Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
Inhale incorporates by reference the information set forth under the heading
"Executive Compensation" in Inhale's definitive Proxy Statement to be filed for
its 1999 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Inhale incorporates by reference the information set forth under the heading
"Security Ownership of Certain Beneficial Owners and Management" in Inhale's
definitive Proxy Statement to be filed for its 1999 Annual Meeting of
Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Inhale incorporates by reference the information set forth under the heading
"Certain Transactions" in Inhale's definitive Proxy Statement to be filed for
its 1998 Annual Meeting for Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
<TABLE>
<C> <S>
(a)(1) Financial Statements
The Financial Statements required by this item, with the report of independent
auditors, are submitted in a separate section beginning on page F-1 of this
report.
(2) Financial Statement Schedules
Schedules have been omitted because the information required to be set forth
therein is not applicable or is shown in the Financial Statements or notes
thereto.
(3) Exhibits
The following exhibits are filed herewith or incorporated by reference:
</TABLE>
<TABLE>
<CAPTION>
EXHIBIT EXHIBIT TITLE
- ------------ -------------------------------------------------------------------------------------------------------
<C> <S>
3.1 (3) Certificate of Incorporation of the Registrant.
3.2 (3) Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.1 through 3.2.
4.2 (1) Restated Investor Rights Agreement among the Registrant and certain other persons named therein, dated
April 29, 1993, as amended October 29, 1993.
4.3 (5) Stock Purchase Agreement between the Registrant and Baxter World Trade Corporation, dated March 1,
1996.
4.9 (2) Stock Purchase Agreement between the Registrant and Pfizer Inc., dated January 18, 1995.
4.10(8) Warrant to purchase 10,000 shares of Common Stock between the Registrant and Thomas J. Peirona, dated
November 1, 1996.
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT EXHIBIT TITLE
- ------------ -------------------------------------------------------------------------------------------------------
<C> <S>
4.11(8) Warrant to purchase 10,000 shares of Common Stock between the Registrant and Kiet Nguyen, dated
November 1, 1996.
4.12(9) Form of Stock Purchase Agreement between the Registrant and the Selling Shareholders dated January 28,
1997.
10.1 (4) Registrant's 1994 Equity Incentive Plan (the "Equity Incentive Plan").
10.2 (1) Form of Incentive Stock Option under the Equity Incentive Plan.
10.3 (1) Form of Nonstatutory Stock Option under the Equity Incentive Plan.
10.4 (7) Registrant's 1994 Non-Employee Directors' Stock Option Plan, as amended.
10.5 (1) Registrant's 1994 Employee Stock Purchase Plan.
10.6 (1) Standard Industrial Lease between the Registrant and W.F. Batton & Co., Inc., dated September 17, 1992,
as amended September 18, 1992.
10.9 (1) Sublicense Agreement between the Registrant and John S. Patton, dated September 13, 1991.
10.11(2) Addendum to Lease dated September 17, 1992, between the Registrant and W.F. Batton & Marie A. Batton.
10.13(6) Addendum Number One to Lease dated September 17, 1992, between the Registrant and W.F. Batton & Marie
A. Batton.
10.14(6) Addendum to Lease dated May 31, 1995 between the Registrant and W.F. Batton & Marie A. Batton.
10.15(6) Addendum Number Two to Lease dated September 17, 1992, between the Registrant and W.F. Batton & Marie
A. Batton.
10.17(8) Sublease and Lease Agreement, dated October 2, 1996 between the Registrant and T.M.T. Associates L.L.C.
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney. Reference is made to the signature page.
27.1 Financial Data Schedule
</TABLE>
- ------------------------
(1) Incorporated by reference to the indicated exhibit in Inhale's Registration
Statement (No. 33-75942), as amended.
(2) Incorporated by reference to the indicated exhibit in Inhale's Registration
Statement (No. 33-89502), as amended.
(3) Incorporated by reference to the indicated exhibit in Inhale's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998
(4) Incorporated by reference to Inhale's Registration Statement on Form S-8
(No. 333-07969).
(5) Incorporated by reference to the indicated exhibit in Inhale's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1996.
(6) Incorporated by reference to the indicated exhibit in Inhale's Annual Report
on Form 10-K for the year ended December 31, 1995.
(7) Incorporated by reference to the indicated exhibit in Inhale's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996.
33
<PAGE>
(8) Incorporated by reference to the indicated exhibit in Inhale's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996.
(9) Incorporated by reference to Inhale's Registration Statement on Form S-3
(No. 333-20787)
(b) Reports on Form 8-K.
No Reports on Form 8-K were filed during the quarter ended December 31,
1998.
(c) See Exhibits listed under Item 14(a)(3).
(d) Not applicable. See Item 14(a)(2).
34
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 29th day of March
1999.
INHALE THERAPEUTIC SYSTEMS, INC.
By: /s/ ROBERT B. CHESS
-----------------------------------------
Robert B. Chess
CO-CHIEF EXECUTIVE OFFICER AND DIRECTOR
By: /s/ AJIT S. GILL
-----------------------------------------
Ajit S. Gill
CO-CHIEF EXECUTIVE OFFICER AND DIRECTOR
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints, Ajit S. Gill and Robert B. Chess, and each of
them, as his attorney-in-fact for him in any and all capacities, to sign any and
all amendments to this report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that the said
attorney-in-fact, or his substitutes, may do or cause to be done by virtue
hereof. Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
Co-Chief Executive Officer
/s/ ROBERT B. CHESS and Director
- ------------------------------ (CO-PRINCIPAL EXECUTIVE March 29, 1999
Robert B. Chess OFFICER)
Co-Chief Executive Officer
/s/ AJIT S. GILL and Director
- ------------------------------ (CO-PRINCIPAL EXECUTIVE March 29, 1999
Ajit S. Gill OFFICER)
/s/ CHRISTIAN O. HENRY Corporate Controller
- ------------------------------ (PRINCIPAL FINANCIAL AND March 29, 1999
Christian O. Henry ACCOUNTING OFFICER)
/s/ JOHN S. PATTON
- ------------------------------ Vice President and March 29, 1999
John S. Patton Director
/s/ MARK J. GABRIELSON
- ------------------------------ Director March 29, 1999
Mark J. Gabrielson
/s/ JAMES B. GLAVIN
- ------------------------------ Director March 29, 1999
James B. Glavin
/s/ MELVIN PERELMAN
- ------------------------------ Director March 29, 1999
Melvin Perelman
/s/ TERRY L. OPDENDYK
- ------------------------------ Chairman of the Board March 29, 1999
Terry L. Opdendyk
</TABLE>
35
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors....................................................................... F-2
Balance Sheets at December 31, 1998 and 1997............................................................................ F-3
Statements of Operations for each of the three years in the period ended December 31, 1998.............................. F-4
Statement of Stockholders' Equity for the three years in the period ended
December 31, 1998..................................................................................................... F-5
Statements of Cash Flows for each of the three years in the period ended December 31, 1998.............................. F-6
Notes to Financial Statements........................................................................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of
Inhale Therapeutic Systems, Inc.
We have audited the accompanying balance sheets of Inhale Therapeutic
Systems, Inc. as of December 31, 1998 and 1997, and the related statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Inhale Therapeutic Systems
at December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Palo Alto, California
January 22, 1999
F-2
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE PER SHARE INFORMATION)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................. $ 24,916 $ 14,104
Short-term investments................................................ 57,946 86,069
Other current assets.................................................. 1,678 752
--------- ---------
Total current assets................................................ 84,540 100,925
Property and equipment, net............................................. 49,863 18,694
Deposits and other assets............................................... 93 143
--------- ---------
$ 134,496 $ 119,762
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................... $ 3,678 $ 5,975
Accrued liabilities................................................... 4,655 4,370
Deferred revenue...................................................... 4,359 6,686
Equipment financing obligations--current portion...................... 30 52
Tenant improvement loan--current portion.............................. 34 31
--------- ---------
Total current liabilities........................................... 12,756 17,114
Equipment financing obligations......................................... 9 135
Tenant improvement loan................................................. 4,931 4,967
Accrued rent............................................................ 919 453
Commitments (See Note 3)
Stockholders' equity:
Preferred stock, $0.0001 par value; 10,000 shares authorized, no
shares issued or outstanding........................................ -- --
Common stock, $0.0001 par value; 50,000 shares authorized; 16,924
shares and 15,542 shares issued and outstanding at December 31, 1998
and 1997, respectively.............................................. 2 2
Capital in excess of par value........................................ 172,847 135,271
Deferred compensation................................................. (931) (538)
Accumulated deficit................................................... (56,018) (37,662)
Accumulated other comprehensive income/(loss)......................... (19) 20
--------- ---------
Total stockholders' equity.......................................... 115,881 97,093
--------- ---------
$ 134,496 $ 119,762
--------- ---------
--------- ---------
</TABLE>
See accompanying notes
F-3
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Contract research revenue....................................... $ 21,795 $ 16,249 $ 6,890
Operating costs and expenses:
Research and development...................................... 35,398 23,645 14,376
General and administrative.................................... 8,387 6,328 4,004
--------- --------- ---------
Total operating costs and expenses............................ 43,785 29,973 18,380
--------- --------- ---------
Loss from operations............................................ (21,990) (13,724) (11,490)
Interest income................................................. 3,904 3,807 1,638
Interest expense................................................ (270) (66) (57)
--------- --------- ---------
Net loss........................................................ $ (18,356) $ (9,983) $ (9,909)
--------- --------- ---------
--------- --------- ---------
Basic and diluted net loss per share............................ $ (1.17) $ (0.72) $ (0.88)
--------- --------- ---------
--------- --------- ---------
Shares used in basic and diluted net loss per share
calculation................................................... 15,719 13,792 11,207
--------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes
F-4
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
ACCUMULATED
--------------- CAPITAL IN OTHER TOTAL
PAR EXCESS OF DEFERRED ACCUMULATED COMPREHENSIVE STOCKHOLDERS'
SHARES VALUE PAR VALUE COMPENSATION DEFICIT INCOME/(LOSS) EQUITY
-------- ----- ---------- ---------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995......... 10,142 $1 $ 38,201 $(250) $(17,770) -- $20,182
Issuance of common stock in
connection with collaborative
agreements, net of issuance costs
of $806............................ 1,608 -- 24,196 -- -- -- 24,196
Amortization of deferred
compensation....................... -- -- -- 162 -- -- 162
Common stock issued upon exercise of
stock options...................... 85 -- 442 -- -- -- 442
Unrealized loss on securities held as
available-for-sale................. -- -- -- -- -- (12) (12)
Net loss for the year ended December
31, 1996........................... -- -- -- -- (9,909) -- (9,909)
-----------
Comprehensive loss................... -- -- -- -- -- -- (9,921)
-------- ----- ---------- ----- ----------- ------------- -----------
Balance at December 31, 1996......... 11,835 1 62,839 (88) (27,679) (12) 35,061
Issuance of common stock in private
placement, net of issuance costs of
$1,940............................. 1,800 1 30,459 -- -- -- 30,460
Issuance of common stock in
connection with licensing
agreement.......................... 28 -- 600 -- -- -- 600
Issuance of common stock in public
offering, net of issuance costs of
$2,885............................. 1,725 -- 40,024 -- -- -- 40,024
Common stock issued upon exercise of
stock options...................... 125 -- 798 -- -- -- 798
Issuance of common stock in
connection with exercise of
warrant............................ 29 -- -- -- -- -- --
Deferred compensation................ -- -- 551 (551) -- -- --
Amortization of deferred
compensation....................... -- -- -- 101 -- -- 101
Unrealized gain on securities held as
available-for-sale................. -- -- -- -- -- 32 32
Net loss for the year ended December
31, 1997........................... -- -- -- -- (9,983) -- (9,983)
-----------
Comprehensive loss................... -- -- -- -- -- -- (9,951)
-------- ----- ---------- ----- ----------- ------------- -----------
Balance at December 31, 1997......... 15,542 2 135,271 (538) (37,662) 20 97,093
Issuance of common stock in private
placement, net of issuance costs of
$1,997............................. 1,200 -- 35,202 -- -- -- 35,202
Issuance of common stock in
connection with licensing
agreement.......................... 6 -- 159 -- -- -- 159
Issuance of stock options in
connection with licensing
agreement.......................... -- -- 125 -- -- -- 125
Common stock issued upon exercise of
stock options...................... 176 -- 1,514 -- -- -- 1,514
Deferred compensation................ -- -- 576 (576) -- -- --
Amortization of deferred
compensation....................... -- -- -- 183 -- -- 183
Unrealized loss on securities held as
available-for-sale................. -- -- -- -- -- (39) (39)
Net loss for the year ended December
31, 1998........................... -- -- -- -- (18,356) -- (18,356)
-----------
Comprehensive loss................... -- -- -- -- -- -- (18,395)
-------- ----- ---------- ----- ----------- ------------- -----------
Balance at December 31, 1998......... 16,924 $2 $172,847 $(931) $(56,018) (19) $115,881
-------- ----- ---------- ----- ----------- ------------- -----------
-------- ----- ---------- ----- ----------- ------------- -----------
</TABLE>
See accompanying notes
F-5
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net loss........................................................ $ (18,356) $ (9,983) $ (9,909)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................. 3,415 2,337 1,071
Amortization of deferred compensation......................... 183 101 162
Issuance of common stock and stock options in connection with
licensing agreements........................................ 284 600 --
Decrease (increase) in other current assets, deposits and
other assets................................................ (876) 518 (752)
Increase (decrease) in accounts payable and accrued
liabilities................................................. (1,546) 7,443 1,465
Increase (decrease) in deferred revenue....................... (2,327) 3,963 2,145
--------- --------- ---------
Net cash (used in) provided by operating activities............. (19,223) 4,979 (5,818)
--------- --------- ---------
CASH FLOWS USED IN INVESTING ACTIVITIES
Purchases of short-term investments............................. (219,414) (483,247) (58,993)
Sales of short-term investments................................. 65,189 80,662 2,020
Maturities of short-term investments............................ 182,309 334,289 55,313
Purchases of property and equipment, net........................ (34,584) (17,261) (2,181)
--------- --------- ---------
Net cash used in investing activities........................... (6,500) (85,557) (3,841)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of equipment financing obligations..................... (150) (83) (52)
Payments of tenant improvement loan obligations................. (31) (2) --
Payments of capital lease obligations........................... -- (83) (193)
Proceeds from tenant improvement loan........................... -- 5,000 --
Issuance of common stock, net of issuance costs................. 36,716 71,282 24,638
--------- --------- ---------
Net cash provided by financing activities....................... 36,535 76,114 24,393
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents............ 10,812 (4,464) 14,734
Cash and cash equivalents at beginning of period................ 14,104 18,568 3,834
--------- --------- ---------
Cash and cash equivalents at end of period...................... $ 24,916 $ 14,104 $ 18,568
--------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes
F-6
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Inhale Therapeutic Systems, Inc. ("Inhale") was incorporated in the State of
California in July 1990 and reincorporated in the State of Delaware in July
1998. Since inception, Inhale has been engaged in the development of a system to
deliver drugs to the bloodstream through the lungs by inhaling a powdered
version of the drug. The system is applicable to a wide range of peptides,
proteins and other molecules.
Inhale expects increasing losses over the next several years as research and
development and manufacturing scale-up efforts continue, and as Inhale expands
its facilities for full-scale commercial manufacturing. Management plans to
continue to finance Inhale primarily through issuances of equity securities,
research and development contract revenue, and in the longer term, revenue from
product sales and royalties. If the financing arrangements contemplated by
management are not completed, Inhale may have to seek other sources of capital
or reevaluate its operating plans.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Inhale considers all highly liquid investments with a maturity from date of
purchase of three months or less to be cash equivalents. Cash and cash
equivalents include demand deposits held in banks and interest bearing money
market funds. All other liquid investments are classified as short-term
investments. Short-term investments consist of federal and municipal government
securities, repurchase agreements or corporate commercial paper with A1 or P1
short-term ratings and A or better long-term ratings with remaining maturities
at date of purchase of greater than 90 days and less than one year. Inhale
limits its concentration of risk by diversifying its investments among a variety
of industries and issuers. Inhale has experienced no material losses on its
investments.
At December 31, 1998, all short-term investments are designated as
available-for-sale and are carried at fair value, with material unrealized gains
and losses, if any, reported in stockholders' equity. The amortized cost of
securities is adjusted for amortization of material premiums and accretion of
discounts to maturity. Such amortization, if any, is included in interest
income. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities, if any, are included in
interest income. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.
F-7
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS (CONTINUED)
The following is a summary of available-for-sale securities as of December
31, 1998:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE SECURITIES
------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Obligations of U.S. government
agencies........................... $ 20,758 $ -- $ -- $ 20,758
U.S. corporate commercial paper...... 42,773 -- (19) 42,754
Repurchase agreements, secured by
U.S. Government securities......... 17,704 -- -- 17,704
Other................................ 105 -- -- 105
--------- ----- --- -----------
$ 81,340 $ -- $ (19) $ 81,321
--------- ----- --- -----------
--------- ----- --- -----------
Amounts included in cash and cash
equivalents........................ $ 23,375 $ -- $ -- $ 23,375
Amounts included in short-term
investments........................ 57,965 -- (19) 57,946
--------- ----- --- -----------
$ 81,340 $ -- $ (19) $ 81,321
--------- ----- --- -----------
--------- ----- --- -----------
</TABLE>
The following is a summary of available-for-sale securities as of December
31, 1997:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE SECURITIES
------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Obligations of U.S. government
agencies........................... $ 19,943 $ -- $ -- $ 19,943
U.S. corporate commercial paper...... 70,584 20 -- 70,604
Repurchase agreements, secured by
U.S. Government securities......... 7,001 -- -- 7,001
Other................................ 57 -- -- 57
--------- ----- ----- -----------
$ 97,585 $ 20 $ -- $ 97,605
--------- ----- ----- -----------
--------- ----- ----- -----------
Amounts included in cash and cash
equivalents........................ $ 11,536 $ -- $ -- $ 11,536
Amounts included in short-term
investments........................ 86,049 20 -- 86,069
--------- ----- ----- -----------
$ 97,585 $ 20 $ -- $ 97,605
--------- ----- ----- -----------
--------- ----- ----- -----------
</TABLE>
The gross realized losses and gains on the sale of securities
available-for-sale during the years ended December 31, 1998 and 1997, were not
material. At December 31, 1998 and 1997, the average portfolio duration was
approximately three months and the contractual maturity of any single investment
did not exceed eleven months (nine months at December 31, 1997).
F-8
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS (CONTINUED)
The estimated fair value amounts have been determined by Inhale using
available market information and appropriate valuation methodologies. However,
market data must be interpreted to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that Inhale could realize in a current market exchange.
PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
(IN THOUSANDS)
Laboratory and other equipment.......................................... $ 15,012 $ 9,145
Leasehold improvements.................................................. 36,003 14,729
Land.................................................................... 7,443 --
--------- ---------
58,458 23,874
Less accumulated depreciation and amortization.......................... (8,595) (5,180)
--------- ---------
$ 49,863 $ 18,694
--------- ---------
--------- ---------
</TABLE>
Property and equipment are stated at cost. Major renewals and improvements
are capitalized, while maintenance and repairs are expensed when incurred. Other
equipment is depreciated using the straight-line method over estimated useful
lives of four to seven years. Manufacturing equipment is depreciated using the
straight-line method over its useful life estimated to be ten years. Leasehold
improvements and assets acquired under capital leases are amortized using the
straight-line method over the shorter of an estimated useful life of fifteen
years or the term of the lease.
Interest is capitalized in connection with the construction of leasehold
improvements to the Company's manufacturing facility in San Carlos, California.
The capitalized interest is recorded as part of the asset to which it relates
and is amortized over the asset's estimated useful life. In 1998, $203,000 of
interest cost was capitalized. No interest was capitalized in 1997.
COMPREHENSIVE LOSS
Effective January 1, 1998, Inhale adopted the Financial Accounting Standards
Board's ("FASB") Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). Other comprehensive income includes only
unrealized gains and losses on securities held as available-for-sale and is
shown in the Statement of Stockholders' Equity.
REVENUE RECOGNITION
Contract revenue from collaborative research agreements is recorded when
earned and as the related costs are incurred. Payments received which are
related to future performance are deferred and recognized as revenue in the
period in which it is earned. In accordance with contract terms, upfront and
progress payments from collaborative research agreements are considered to be
payments to support continued research and development activities under the
agreements. In accordance with the Company's revenue
F-9
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
recognition policy, these payments are included in deferred revenue and are
recognized as the related research and development expenditures are incurred.
STOCK-BASED COMPENSATION
As permitted by the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), Inhale
continues to follow Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations in accounting
for its employee stock option plans. Under APB 25, if the exercise price of
Inhale's employee stock options equals or exceeds the fair market value of the
underlying stock on the date of grant as determined by the closing price of
Inhale's common stock as quoted on the Nasdaq stock market, no compensation
expense is recognized. See Note 3 for pro forma disclosures required by FAS 123.
Stock options and warrants issued to non-employees are accounted for based on
the fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measurable.
NET LOSS PER SHARE
In accordance with Financial Accounting Standard No. 128, basic and diluted
net loss per share has been computed using the weighted average number of shares
of common stock outstanding during the period. Had Inhale been in a net income
position, diluted earnings per share would have included the shares used in
computation of basic net loss per share as well as an additional 1,190,814,
1,098,987 and 715,918 shares for the years ended December 31, 1998, 1997, and
1996, respectively, relating to outstanding options and warrants (after the
application of the treasury stock method) and stock subject to repurchase.
SEGMENT INFORMATION
Effective January 1, 1998, Inhale became subject to the FASB's Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 superseded FASB
Statement No. 14, "Financial Reporting for Segments of a Business Enterprise."
SFAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. SFAS 131 also establishes standards for
related disclosures about products and services, geographic areas, and major
customers.
Management has organized Inhale's business in one operating segment which
includes activities related to the development of systems for the pulmonary
delivery of macromolecule drugs. Inhale's operations are presently located in
the United States and Inhale derives all of its revenues within the United
States.
NOTE 2--COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS
Inhale performs research and development for others pursuant to feasibility
agreements and development and license agreements. Under the feasibility
agreements, Inhale generally is reimbursed for the cost
F-10
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 2--COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS (CONTINUED)
of work performed. Feasibility agreements are designed to evaluate the
applicability of Inhale's technologies to a particular molecule and therefore
are generally completed in less than one year. Under Inhale's development and
license agreements, the partner companies receive an exclusive license to
develop, use and sell a dry powder formulation and a suitable delivery device to
be developed by Inhale for one of the partner's macromolecule drugs. Under these
development agreements, Inhale will be reimbursed for development costs and may
also be entitled to milestone and advance royalty payments when and if certain
development milestones are achieved. All of Inhale's research and development
agreements are generally cancelable by the partner without significant financial
penalty to the partner.
In December 1997, the Company entered into a collaboration agreement with
Eli Lilly and Company ("Lilly") to develop pulmonary delivery for an unspecified
protein based on Inhale's deep-lung delivery system for macromolecules. Under
the terms of the agreement, Inhale will receive funding up to $20 million of
research, development and progress payments. Lilly will receive global
commercialization rights for the pulmonary delivery of the products with Inhale
receiving royalties on any marketed products. Inhale will manufacture packaged
powders for and supply devices to Lilly. Under this agreement the Company
recognized revenue of $0.9 million in 1998. No revenue was recognized under this
agreement in 1997.
In January 1997, the Company executed a collaboration agreement with Lilly
to develop pulmonary delivery for parathyroid hormone ("PTH") based on Inhale's
deep-lung delivery system for macromolecules. Under the terms of the agreement,
Inhale will receive funding up to $20 million of initial fees, research and
development and progress payments. Lilly will receive global commercialization
rights for the pulmonary delivery of the products with Inhale receiving
royalties on any marketed products. Inhale will manufacture packaged powders for
and supply devices to Lilly. Under this agreement the Company recognized revenue
of $3.8 million and $3.4 million in 1998 and 1997, respectively. In late 1998,
unexpected observations from a long-term test in rats of the injectable version
of parathyroid hormone led Lilly to suspend further clinical development of the
injectable and pulmonary versions of PTH pending further analysis. Inhale is
maintaining a minimum development effort in its pulmonary program pending
further direction from Lilly.
In December 1996, the Company executed a collaboration agreement with
Centeon L.L.C. ("Centeon") to develop a pulmonary formulation of alpha-1
proteinase inhibitor to treat patients with alpha-1 antitrypsin deficiency, a
genetic disorder which can lead to emphysema. Under the terms of the agreement,
Inhale will receive funding up to an estimated $15 million of research and
development and progress payments. Centeon will receive global commercialization
rights for the pulmonary delivery of the products with Inhale receiving
royalties on any marketed products. Inhale will manufacture packaged powders for
and supply devices to Centeon. Under this agreement, the Company recognized
revenue of $1.6 million and $0.9 million in 1998 and 1997, respectively. No
revenue was recognized under this agreement in 1996.
In March 1996, Inhale entered into a collaboration agreement with Baxter
Healthcare Corporation ("Baxter") to use Inhale's dry powder pulmonary delivery
system as a technology platform for developing and launching therapeutic
products. In connection with the collaboration, Baxter made a $20 million equity
investment in Inhale at a 25% premium to the market price of Inhale stock at the
time of the investment. Baxter received worldwide commercialization rights in
exchange for up to an estimated
F-11
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 2--COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS (CONTINUED)
$60 million in research and development funding and milestone payments for four
molecules. In October 1998, Inhale announced that it had reached an agreement
with Baxter to amend their collaborative agreement to facilitate signing a new
corporate partner to fund further development and commercialization of the
products. Baxter will continue to provide development funding for this compound
in preparation for Phase II trials while the two companies are seeking a new
partner. The Company recognized revenues associated with this program of $4.0
million, $4.1 million and $0.9 million in 1998, 1997 and 1996, respectively.
In January 1995, the Company entered into a collaborative development and
license agreement with Pfizer Inc. ("Pfizer") to develop pulmonary delivery for
inhaled insulin based on Inhale's deep-lung delivery system for macromolecules.
Under the terms of the agreement, Inhale will receive funding consisting of
initial fees, research and development and progress payments. Upon execution of
the agreement Pfizer purchased $5.0 million of Inhale common stock. In addition,
in October 1996, Pfizer purchased an additional $5.0 million of Inhale common
stock. Pfizer will receive global commercialization rights for the pulmonary
delivery of the products with Inhale receiving royalties on any marketed
products. Inhale will manufacture inhaled insulin for, and supply devices to
Pfizer. Under this agreement the Company recognized revenue of $11.1 million,
$7.6 million and $5.3 million in 1998, 1997 and 1996, respectively.
Costs associated with research and development activities attributable to
these agreements are expected to approximate the revenues recognized.
NOTE 3--COMMITMENTS, EQUIPMENT FINANCING OBLIGATIONS AND TENANT IMPROVEMENT LOAN
Inhale leases its office and laboratory facilities under several
arrangements expiring through the year 2012. Rent expense was approximately
$1,777,000, $1,106,000 and $416,000 for the years ended December 31, 1998, 1997
and 1996, respectively.
In November 1997, Inhale received from the landlord of its facility in San
Carlos, California a loan of $5.0 million to fund a portion of the cost of
improvements made to the facility. The loan bears interest at 9.46% per annum,
and principal and interest payments are payable monthly over the ten-year loan
term with a balloon payment of $4.5 million at the end of the tenth year. The
loan is recorded on the balance sheet at December 31, 1998 as a tenant
improvement loan.
F-12
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 3--COMMITMENTS, EQUIPMENT FINANCING OBLIGATIONS AND TENANT IMPROVEMENT LOAN
(CONTINUED)
Future noncancelable commitments under operating leases and equipment
financing and tenant improvement obligations at December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
EQUIPMENT TENANT
OPERATING FINANCING IMPROVEMENT
LEASES OBLIGATIONS OBLIGATIONS
----------- ------------- ------------
<S> <C> <C> <C>
(IN THOUSANDS)
Years ending December 31,
1999................................................. $ 1,409 $ 33 $ 503
2000................................................. 1,461 8 503
2001................................................. 1,550 -- 503
2002................................................. 1,639 -- 503
2003 and thereafter.................................. 15,224 -- 6,979
----------- --- ------------
Total minimum payments required........................ $ 21,283 $ 41 $ 8,991
----------- --- ------------
Less amount representing interest...................... (2) (4,026)
--- ------------
Present value of future lease payments................. 39 4,965
Less current portion................................... (30) (34)
--- ------------
Non-current portion.................................... $ 9 $ 4,931
--- ------------
--- ------------
</TABLE>
NOTE 4--STOCKHOLDERS' EQUITY
COMMON STOCK
EMPLOYEE STOCK PURCHASE PLAN
In February 1994, Inhale's Board of Directors adopted the Employee Stock
Purchase Plan (the "Purchase Plan"). Under the Purchase Plan, 150,000 shares of
common stock have been reserved for purchase by Inhale's employees pursuant to
section 423(b) of the Internal Revenue Code of 1986. As of December 31, 1998, no
shares of common stock have been issued under the Purchase Plan.
STOCK OPTION PLANS
EQUITY INCENTIVE PLAN
Inhale's 1994 Equity Incentive Plan (the "Equity Incentive Plan") was
adopted by the Board of Directors in February 1994. The Equity Incentive Plan is
an amendment and restatement of Inhale's 1992 Stock Option Plan. The purpose of
the Equity Incentive Plan is to attract and retain qualified personnel, to
provide additional incentives to employees, officers, consultants and employee
directors of Inhale and to promote the success of Inhale's business. Pursuant to
the Equity Incentive Plan, Inhale may grant or issue incentive stock options to
employees and officers and non-qualified stock options, restricted stock
purchase awards, stock bonuses and stock appreciation rights to consultants,
employees, officers and employee directors. Options granted to non-employees
after December 15, 1994 are recorded at fair value based on the fair value
measurement criteria of FAS 123.
F-13
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 4--STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTION PLANS (CONTINUED)
The maximum term of a stock option under the Equity Incentive Plan is ten
years, but if the optionee at the time of grant has voting power of more than
10% of Inhale's outstanding capital stock, the maximum term of an incentive
stock option is five years. The exercise price of incentive stock options
granted under the Equity Incentive Plan must be at least equal to 100% (or 110%
with respect to holders of more than 10% of the voting power of Inhale's
outstanding capital stock) of the fair market value of the stock subject to the
option on the date of the grant. The exercise price of non-qualified stock
options, and the purchase price of restricted stock purchase awards, granted
under the Equity Incentive Plan are determined by the Board of Directors. Stock
appreciation rights authorized for issuance under the Equity Incentive Plan may
be tandem stock appreciation rights, concurrent stock appreciation rights or
independent stock appreciation rights.
The Equity Incentive Plan may be amended at any time by the Board, although
certain amendments would require shareholder approval. The Equity Incentive Plan
will terminate in February 2004 unless earlier terminated by the Board.
NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
In February 1994, Inhale's Board of Directors adopted the Non-employee
Directors' Stock Option Plan under which options to purchase up to 200,000
shares of Inhale's common stock at the then fair market value may be granted to
Inhale's non-employee directors. As of December 31, 1998, options on 6,000
shares had been exercised and options to purchase 124,200 shares were
exercisable.
1998 NON-OFFICER EQUITY INCENTIVE PLAN
Inhale's 1998 Non-officer Equity Incentive Plan ("1998 Plan") was adopted by
the Board of Directors in June 1998. The purpose of the 1998 Plan is to attract
and retain qualified personnel, to provide additional incentives to employees,
consultants and to promote the success of Inhale's business. Pursuant to the
1998 plan, Inhale may grant or issue non-qualified stock options, restricted
stock purchase awards, stock bonuses and stock appreciation rights to employees
and consultants who are neither Officers or Directors of Inhale.
The maximum term of a stock option under the 1998 Plan is ten years. The
exercise price of stock options, and the purchase price of restricted stock
purchase awards, granted under the 1998 Plan is determined by the Board of
Directors. Stock appreciation rights authorized for issuance under the 1998 Plan
may be tandem stock appreciation rights, concurrent stock appreciation rights or
independent stock appreciation rights. The 1998 Non-officer Equity Incentive
Plan may be amended by the Board of Directors at any time.
F-14
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 4--STOCKHOLDERS' EQUITY (CONTINUED)
A summary of activity under the Equity Incentive Plan, the Non-Employee
Directors' Stock Option Plan and the 1998 Non-officer Equity Incentive Plan is
as follows:
<TABLE>
<CAPTION>
WEIGHTED-
OPTIONS AVAILABLE OPTIONS OUTSTANDING AVERAGE
FOR GRANT --------------------------------- EXERCISE PRICE
----------------- EXERCISE PRICE PER
NUMBER OF SHARES NUMBER OF SHARES PER SHARE SHARE
----------------- ---------------- -------------- --------------
<S> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
Balance at December 31, 1995............................ 784 1,233 0.06-15.25 $ 6.32
Shares authorized..................................... 1,500 -- -- --
Options granted....................................... (620) 620 10.13-19.25 14.05
Options exercised..................................... -- (85) 0.06-12.00 5.22
Options canceled...................................... 109 (109) 0.31-15.25 8.33
------ ------ -------------- ------
Balance at December 31, 1996............................ 1,773 1,659 0.06-19.25 9.13
Options granted....................................... (851) 851 0.01-35.25 20.99
Options exercised..................................... -- (125) 0.06-16.13 6.41
Options canceled...................................... 33 (33) 0.56-22.75 15.27
------ ------ -------------- ------
Balance at December 31, 1997............................ 955 2,352 0.01-35.25 13.46
Shares authorized..................................... 1,550 -- -- --
Options granted....................................... (1,070) 1,070 0.01-34.13 28.16
Options exercised..................................... -- (176) 0.06-22.75 8.69
Options canceled...................................... 83 (83) 5.56-35.25 23.26
------ ------ -------------- ------
Balance at December 31, 1998............................ 1,518 3,163 $0.01-35.25 $18.45
------ ------ -------------- ------
------ ------ -------------- ------
</TABLE>
At December 31, 1998, 1997 and 1996, options were exercisable to purchase
approximately 1,077,000, 784,000 and 514,000 at weighted-average exercise prices
of $11.36, $8.17 and $5.83 per share, respectively.
Weighted average fair value of options granted during the year ended
December 31, 1998, 1997 and 1996, was $28.42, $21.89 and $14.24 per share,
respectively. The following table provides information regarding Inhale's stock
option plans.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------------------
WEIGHTED- OPTIONS EXERCISABLE
AVERAGE ---------------------------------
WEIGHTED- REMAINING WEIGHTED-
RANGE OF EXERCISE NUMBER AVERAGE EXERCISE CONTRACTUAL LIFE NUMBER AVERAGE EXERCISE
PRICES OF SHARES PRICE PER SHARE (IN YEARS) OF SHARES PRICE PER SHARE
- ----------------- -------------- ---------------- ---------------- -------------- ----------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
$ 0.01- 9.13 737 $ 5.46 5.68 560 $ 4.97
10.00-17.50 662 13.27 7.32 311 13.79
18.63-22.75 656 19.93 8.28 104 20.31
25.00-29.25 667 27.88 9.40 52 2.95
30.13-35.25 441 31.50 9.47 50 31.75
- ----------------- ----- ------ --- ----- ------
$ 0.01-35.25 3,163 $18.45 7.88 1,077 $11.36
- ----------------- ----- ------ --- ----- ------
- ----------------- ----- ------ --- ----- ------
</TABLE>
F-15
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 4--STOCKHOLDERS' EQUITY (CONTINUED)
Pro forma information regarding net loss and loss per share is required by
FAS 123, which also requires that the information be determined as if Inhale has
accounted for its employee stock options granted subsequent to December 31, 1994
under the fair value method of that Statement. The fair value for these options
was estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Risk-free Interest Rate........................................ 4.8% 5.7% 6.4%
Dividend Yield................................................. 0.0% 0.0% 0.0%
Volatility Factor.............................................. 0.700 0.578 0.620
Weighted Average Expected Life................................. 5 years 6 years 6 years
</TABLE>
The Black-Scholes options valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because Inhale's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options. However, Inhale
has presented the pro forma net loss and pro forma basic and diluted net loss
per common share using the assumptions noted above.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period, generally five
years. Inhale's pro forma information follows (in thousands except for earnings
per share):
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Pro forma net loss........................................ $ (24,325) $ (13,168) $ (11,252)
---------- ---------- ----------
Pro forma basic and fully diluted net loss per common
share................................................... $ (1.55) $ (0.95) $ (1.00)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Because FAS 123 is applicable only to options granted subsequent to December
31, 1994, the pro forma effect of the statement will not be fully reflected
until approximately the year 2000.
WARRANTS
In October 1996 Inhale issued two warrants ("the warrants") to purchase a
total of 20,000 shares of Common Stock (10,000 shares each) at a price of
$13.125 per share in connection with a facility lease. The warrants expire in
October 2006 and were outstanding and exercisable at December 31, 1998.
F-16
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 4--STOCKHOLDERS' EQUITY (CONTINUED)
STOCK COMPENSATION
Inhale recorded deferred compensation of approximately $576,000 during the
year ended December 31, 1998. Deferred compensation of $551,000 had been
recorded in the year ended December 31, 1997. These amounts represent the
difference between the exercise price and the fair market value of certain of
Inhale's stock options granted in these periods. Inhale recorded amortization
expense of approximately $183,000, $101,000, and $162,000 for the years ended
December 31, 1998, 1997, and 1996, respectively.
RESERVED SHARES
A total of 4,684,090 shares of common stock have been reserved for issuance
at December 31, 1998 for Inhale's equity incentive plans and the warrants.
NOTE 5--INCOME TAXES
As of December 31, 1998, Inhale had federal net operating loss carryforwards
of approximately $47,200,000. Inhale also had federal research and development
tax credit carryforwards of approximately $1,400,000. The net operating loss and
credit carryforwards will expire at various dates beginning in 2006 through 2018
if not utilized.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization. Significant components of Inhale's deferred tax assets for
federal and state income taxes as of December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards.................................... $ 16,300 $ 9,400
Research credits.................................................... 2,100 800
Manufacturing & research equipment credits.......................... 100 --
Capitalized research expenses....................................... 1,900 1,300
Deferred revenue.................................................... 1,700 2,700
Other............................................................... 2,500 1,500
---------- ----------
Total deferred tax assets............................................. 24,600 15,700
Valuation allowance for deferred tax assets........................... (24,600) (15,700)
---------- ----------
Net deferred tax assets............................................... $ -- $ --
---------- ----------
---------- ----------
</TABLE>
Because of Inhale's lack of earnings history, the deferred tax assets have
been fully offset by a valuation allowance. The valuation allowance increased by
$8,900,000 and $4,600,000 during the years ended December 31, 1998 and 1997,
respectively.
F-17
<PAGE>
INHALE THERAPEUTIC SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1998
NOTE 6--STATEMENT OF CASH FLOWS DATA (IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Supplemental disclosure of cash flows information:
Interest paid........................................... $ 270 $ 66 $ 57
--------- --------- ---------
--------- --------- ---------
Supplemental schedule of non-cash investing and
financing activities:
Deferred compensation related to the issuance of certain
stock options......................................... $ 576 $ 551 $ --
--------- --------- ---------
--------- --------- ---------
Issuance of common stock in connection with licensing
agreement............................................. $ 159 $ 600 $ --
--------- --------- ---------
--------- --------- ---------
Issuance of stock options in connection with licensing
agreement............................................. $ 125 $ -- $ --
--------- --------- ---------
--------- --------- ---------
</TABLE>
NOTE 7--SUBSEQUENT EVENTS (UNAUDITED)
In February 1999, the Company entered into a collaboration agreement with
Biogen Inc. ("Biogen") to develop pulmonary delivery for
AVONEX-Registered Trademark- (Interferon Beta-1a), a drug used in the treatment
of multiple sclerosis. The product under development will be based on Inhale's
deep-lung delivery system for macromolecules. Under the terms of the agreement,
Inhale will receive funding up to $25 million of research, development and
progress payments. Biogen will receive global commercialization rights for the
pulmonary delivery of the products with Inhale receiving royalties on any
marketed products. Inhale will manufacture packaged powders for and supply
devices to Biogen.
F-18
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 333-07069, Form S-8 No. 333-59735 and Form S-8 No. 333-65919)
pertaining to the Employee Stock Purchase Plan, the 1994 Equity Incentive Stock
Option Plan, the Non-Employee Directors Stock Option Plan, the 1994 Equity
Incentive Plan and the 1998 Non-Officer Equity Incentive Plan of Inhale
Therapeutic Systems, Inc., and the Registration Statement (Form S-3 No.
333-20787) and in the related Prospectus of Inhale Therapeutic Systems, Inc. for
the registration of 1,800,000 shares of its common stock, and the Registration
Statement (Form S-3 No. 333-68897) and in the related Prospectus of Inhale
Therapeutic Systems, Inc. for the registration of 1,200,000 shares of its common
stock of our report dated January 22, 1999, with respect to the financial
statements of Inhale Therapeutic Systems, Inc. included in this Annual Report
(Form 10-K) for the year ended December 31, 1998.
/s/ ERNST & YOUNG LLP
Palo Alto, California
March 29, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS AS FILED ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998,
AND IS QUALIFIED IN ITS ENTIREYT BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 24,916
<SECURITIES> 57,946
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 84,540
<PP&E> 58,458
<DEPRECIATION> (8,595)
<TOTAL-ASSETS> 134,496
<CURRENT-LIABILITIES> 12,756
<BONDS> 0
0
0
<COMMON> 2
<OTHER-SE> 172,847
<TOTAL-LIABILITY-AND-EQUITY> 134,496
<SALES> 0
<TOTAL-REVENUES> 21,795
<CGS> 0
<TOTAL-COSTS> 43,785
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (270)
<INCOME-PRETAX> (18,356)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,356)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,356)
<EPS-PRIMARY> (1.17)
<EPS-DILUTED> 0
</TABLE>
