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Previous: GUNTHER INTERNATIONAL LTD, 10-Q, EX-27.1, 2000-08-14 |
Next: ADVANCED NUTRACEUTICALS INC/TX, NT 10-Q, 2000-08-14 |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 0-22890
SANGSTAT MEDICAL CORPORATION (Exact name of Registrant as specified in its charter)
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6300 Dumbarton Circle
Fremont, California 94555
(Address of principal executive offices)
510-789-4300
(Registrant's telephone number, including area code)
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 reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
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SANGSTAT MEDICAL CORPORATION
FORM 10-Q
For the Quarterly Period Ended June 30, 2000
Table of Contents
PART I. FINANCIAL INFORMATION
| ITEM 1. Financial Statements |
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Condensed Consolidated Balance Sheets June 30, 2000 and December 31, 1999 |
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Condensed Consolidated Statements of Operations Three and Six Months Ended June 30, 2000 and 1999 |
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Condensed Consolidated Statements of Comprehensive Loss Three and Six Months Ended June 30, 2000 and 1999 |
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Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2000 and 1999 |
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| Notes to Condensed Consolidated Financial Statements |
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| ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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| ITEM 3. Quantitative and Qualitative Disclosures About Market Risk |
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PART II. OTHER INFORMATION
| ITEM 1. Legal Proceedings |
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| ITEM 2. Changes in Securities and Use of Proceeds |
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| ITEM 3. Defaults Upon Senior Securities |
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| ITEM 4. Submission of Matters to a Vote of Security Holders |
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| ITEM 5. Other Information |
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| ITEM 6. Exhibits and Reports on Form 8-K |
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| SIGNATURES |
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
SANGSTAT MEDICAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
2000 1999
------------ ------------
(unaudited) (1)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................... $ 24,586 $ 16,862
Short-term investments ............................ 5,096 9,657
Accounts receivable (net of allowance for doubtful 17,518 12,782
accounts of $1,886 in 2000 and $1,469 in 1999)...
Other receivables.................................. 2,128 2,906
Inventories........................................ 36,687 46,270
Prepaid expenses................................... 2,686 2,306
------------ ------------
Total current assets............................. 88,701 90,783
PROPERTY AND EQUIPMENT -- net........................ 6,741 5,574
INTANGIBLE ASSETS (net of accumulated amortization
of $2,450 in 2000 and $1,749 in 1999).............. 11,833 12,534
OTHER ASSETS......................................... 15,327 8,406
------------ ------------
TOTAL............................................ $ 122,602 $ 117,297
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................... $ 16,770 $ 11,851
Accrued liabilities................................ 9,805 5,511
Capital lease obligations -- current portion....... 604 700
Deferred revenue -- current portion................ 5,042 4,426
Notes payable -- current portion................... 6,922 4,304
------------ ------------
Total current liabilities........................ 39,143 26,792
------------ ------------
CAPITAL LEASE OBLIGATIONS............................ 1,112 125
DEFERRED REVENUE..................................... 10,372 9,304
NOTES PAYABLE........................................ 41,838 40,067
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value 5,000 shares
authorized; none outstanding..................... -- --
Common stock. $.001 par value, 25,000 shares
authorized; outstanding: 2000 - 17,986
shares; 1999 - 17,354 shares..................... 193,026 174,990
Accumulated deficit................................ (161,284) (133,277)
Accumulated other comprehensive loss............... (1,605) (704)
------------ ------------
Total stockholders' equity....................... 30,137 41,009
------------ ------------
TOTAL............................................ $ 122,602 $ 117,297
============ ============
(1) Derived from the Company's audited consolidated financial statements at December 31, 1999.
See Notes to Condensed Consolidated Financial Statements.
SANGSTAT MEDICAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
REVENUES:
Net product sales................... $ 20,384 $ 13,887 $ 35,742 $ 23,990
Product recall returns.............. (722) -- (722) --
Revenue from collaborative
agreements........................ 634 498 1,216 923
---------- ---------- ---------- ----------
Total revenues................... 20,296 14,385 36,236 24,913
---------- ---------- ---------- ----------
COSTS AND OPERATING EXPENSES:
Cost of sales:
Cost of sales and manufacturing... 11,783 7,503 19,640 13,343
Product recall reserve............ 11,561 -- 11,561 --
Research and development (including
product recall reserve of
$50 in 2000)...................... 4,017 3,558 7,995 7,790
Selling, general and administrative
(including product recall reserve
of $375 in 2000).................. 12,530 11,149 23,694 21,119
Amortization of intangible assets... 353 336 701 693
---------- ---------- ---------- ----------
Total costs and operating
expenses....................... 40,244 22,546 63,591 42,945
---------- ---------- ---------- ----------
Loss from operations............. (19,948) (8,161) (27,355) (18,032)
INTEREST INCOME (EXPENSE) - NET....... (411) (390) (732) (368)
---------- ---------- ---------- ----------
LOSS BEFORE INCOME TAXES.............. (20,359) (8,551) (28,087) (18,400)
INCOME TAX (PROVISION) BENEFIT........ 141 (32) 80 94
---------- ---------- ---------- ----------
NET LOSS.............................. $ (20,218) $ (8,583) $ (28,007) $ (18,306)
========== ========== ========== ==========
Net loss per share - basic and
diluted (Note 2).................... $ (1.13) $ (0.51) $ (1.59) $ (1.11)
========== ========== ========== ==========
Shares used in per share
computations - basic and diluted.... 17,932 16,719 17,660 16,516
========== ========== ========== ==========
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Three Months Ended Three Months Ended
June 30, June 30,
--------------------- ---------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
Net loss.............................. $ (20,218) $ (8,583) $ (28,007) $ (18,306)
Reversal of unrealized gains and
(losses) on marketable securities
sold during the current period...... -- 745 (644) (122)
Unrealized gains and (losses) on
marketable securities classified
as available for sale in the
current period...................... 22 (146) 22 (52)
Foreign currency translation
adjustments......................... 66 446 (279) (542)
---------- ---------- ---------- ----------
Total comprehensive loss........... $ (20,130) $ (7,538) $ (28,908) $ (19,022)
========== ========== ========== ==========
See Notes to Condensed Consolidated Financial Statements.
SANGSTAT MEDICAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
June 30
-----------------------
2000 1999
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................... $ (28,007) $ (18,306)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization................... 1,793 2,297
Non-cash interest expense....................... 701 --
Loss on disposal of property and equipment...... 114 174
Deferred revenue................................ 1,684 7,084
Stock compensation expense...................... -- 57
Changes in assets and liabilities:
Accounts receivable........................... (4,736) (4,727)
Other receivables............................. 778 1,462
Inventories................................... 9,583 (7,109)
Prepaid expenses.............................. (380) 490
Accounts payable.............................. 4,919 (7,352)
Accrued liabilities........................... 4,294 1,067
----------- -----------
Net cash used in operating activities.......... (9,257) (24,863)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............... (1,208) (1,799)
Maturities of short-term investments.............. 3,989 9,749
Purchases of short-term investments............... (51) (1,375)
Other assets...................................... (6,177) 1,458
----------- -----------
Net cash provided by (used in)
investing activities....................... (3,447) 8,033
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock.............................. 17,292 7,829
Note payable borrowings........................... 5,986 25,520
Note payable repayments........................... (2,298) (1,529)
Repayment of capital lease obligations............ (273) (233)
----------- -----------
Net cash provided by financing activities..... 20,707 31,587
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH............. (279) (542)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS....................................... 7,724 14,215
CASH AND CASH EQUIVALENTS, Beginning of period...... 16,862 16,286
----------- -----------
CASH AND CASH EQUIVALENTS, End of period............ $ 24,586 $ 30,501
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest,
net of interest capitalized.................... $ 424 $ 96
=========== ===========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Property acquired under capital leases............ $ 1,164 $ 27
=========== ===========
Warrants issued in connection with financing...... $ 744 $ --
=========== ===========
Unrealized loss on investments.................... $ (622) $ (174)
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
SANGSTAT MEDICAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated financial statements include the accounts of SangStat Medical Corporation and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated.
The condensed consolidated financial statements presented are unaudited and in the opinion of management reflect all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial condition and results of operations as of and for the interim periods presented. The results for interim periods are not necessarily indicative of the results to be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's 1999 Annual Report on Form 10-K.
2. Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. Common share equivalents including stock options, warrants and convertible notes payable, aggregating 1,281,009 shares and 814,756 shares as of June 30, 2000 and 1999, respectively, have been excluded from diluted net loss per share, as their effect would be antidilutive.
The following is a reconciliation of the numerators and denominators of the basic and diluted net loss per share computations (amounts in thousands, except per share figures):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ---------------------
2000 1999 2000 1999
----------- ----------- ---------- ----------
Net loss (numerator):
Net loss - basic and diluted..... $ (20,218) $ (8,583) $ (28,007) $ (18,306)
=========== =========== ========== ==========
Shares (denominator):
Weighted average common shares
outstanding - basic and diluted. 17,932 16,719 17,660 16,516
=========== =========== ========== ==========
Net loss per share, basic and
diluted......................... $ (1.13) $ (0.51) $ (1.59) $ (1.11)
=========== =========== ========== ==========
3. Comprehensive Income (Loss)
The following are the components of accumulated other comprehensive loss (in thousands):
June 30, December 31,
2000 1999
----------- -----------
2000 1999
----------- -----------
Unrealized gain (loss) on
investments .................... $ (13) $ 609
Accumulated translation
adjustments .................... (1,592) (1,313)
----------- -----------
Total......................... $ (1,605) $ (704)
=========== ===========
4. Inventories
Inventories, valued at the lower of cost (first-in, first-out) or market consist of (in thousands):
June 30, December 31,
2000 1999
----------- -----------
2000 1999
----------- -----------
Raw materials..................... $ 13,257 $ 26,710
Work-in-progress.................. 14,712 9,498
Finished goods.................... 8,718 10,062
----------- -----------
Total......................... $ 36,687 $ 46,270
=========== ===========
5. Notes Payable
Notes payable consist of (in thousands):
March 31, December 31,
2000 1999
----------- ----------
2000 1999
----------- ----------
Note payable to Aventis....................... $ 16,750 $ 18,000
Discount on note payable to Aventis........... (2,329) (2,989)
Note payable to Abbott Laboratories........... 16,000 16,000
Convertible note.............................. 9,650 9,609
Other debt.................................... 8,689 3,751
----------- ----------
Total..................................... 48,760 44,371
Less current portion.......................... (6,922) (4,304)
----------- ----------
Long-term..................................... $ 41,838 $ 40,067
=========== ==========
On April 21, 2000 the Company signed an agreement with Finova Capital Corporation to provide a line of credit of up to $30 million. The agreement lasts for three years and may be renewed annually thereafter if both parties agree. The line of credit consists of two elements: a $15 million line of credit bearing interest at the prime rate (9.5% at June 30, 2000) and secured by a matching compensating cash balance, and a $15 million line of credit bearing interest at the prime rate plus 1.5% and based on eligible domestic accounts receivable and inventory, as defined in the agreement. Under the terms of the agreement, the Company is required to maintain a loan balance of at least $5 million. As security for the line of credit, the Company has granted Finova a first priority security interest in certain of its tangible and intangible assets and has pledged the stock of its two French subsidiaries, Imtix-SangStat SAS and SangStat Atlantique SA. In addition, the Company is required to meet certain financial covenants. At June 30, 2000 the Company had drawn down $5.0 million under the line of credit and had set aside a corresponding compensating balance which is included in Other Assets on the Condensed Consolidated Balance Sheet. In connection with this financing, the Company issued 50,000 warrants at an exercise price of $23.438. These warrants have been valued using the Black-Scholes pricing model with the following weighted average assumptions: expected life, five years; stock volatility, 72%; risk free interest rate, 6.0%; and no dividend payments during the expected term. The calculated value of the warrants of $744,000, plus additional financing fees of $750,000, have been included in Other Assets and are being amortized over the three year life of the loan agreement.
6. Issuance of Common Stock
On February 15, 2000, the Company completed a private placement of 451,128 shares of common stock with an institutional investor. The stock was issued at $33.25, the closing price of the stock on February 14, 2000, for aggregate cash proceeds of $15,000,006.
7. Co-promotion, Distribution and Research Agreement
In May 1999, the Company and Abbott Laboratories ("Abbott") signed a multi-year co- promotion, distribution and research agreement for SangCya and cyclosporine capsules in the United States. The Company is the exclusive distributor for the products and shares marketing, promotional and development expenses as well as the profits from the co-promotion of the products with Abbott. The agreement ends December 31, 2004 unless both companies agree to extend it. Pursuant to this agreement, Abbott made an equity investment of $14 million during 1999 in exchange for approximately 894,000 shares of common stock, representing a premium to fair market value aggregating to $1.3 million. In addition, Abbott made a series of up-front and milestone payments totaling $20.8 million, including $1.9 million received in January 2000 and $5.0 million received in May 2000, and a long-term loan of $16 million to the Company received during 1999. Also, in January 2000, the Company made a milestone payment of $4.0 million to Abbott. No further milestone payments are required from either company. All up-front and milestone payments received, net of milestone payments made, and the premium received on the sale of common stock to Abbott are recorded as deferred revenue and recognized ratably over the term of the agreement as revenue from collaborative agreements. In May 2000 SangStat and Abbott launched the cyclosporine capsule developed by Abbott under the brand name Gengraf. In connection with the equity investment, Abbott and SangStat entered into a Right of First Refusal Agreement and a Registration Rights Agreement, and amended and restated their existing Supply Agreement.
8. Business Segment Data
The Company is organized and operates in two business segments: transplantation products and transplantation services. Transplantation products consist primarily of products for patient monitoring and therapeutic products for preventing and treating organ rejection. Transplantation services consist principally of mail order pharmaceutical and patient management services. The accounting policies of the segments are the same as those described in Note 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1999. The following information is presented in accordance with the requirements of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information."
Business segment data consists of (in thousands):
Three
Months
ended Transplantation Transplantation
June 30, Products Services Total
--------- ----------------- ----------------- ----------
Net revenues 2000 $ 15,991 $ 4,305 $ 20,296
1999 11,108 3,277 14,385
Interest income 2000 (411) -- (411)
(expense) - net 1999 (390) -- (390)
Depreciation and 2000 856 42 898
amortization 1999 591 30 621
Segment loss 2000 (19,836) (382) (20,218)
1999 (8,199) (384) (8,583)
Six
Months
ended Transplantation Transplantation
June 30, Products Services Total
--------- ----------------- ----------------- ----------
Net revenues 2000 $ 27,789 $ 8,447 $ 36,236
1999 18,583 6,330 24,913
Interest income 2000 (732) -- (732)
(expense) - net 1999 (368) -- (368)
Depreciation and 2000 1,725 68 1,793
amortization 1999 2,236 61 2,297
Segment loss 2000 (26,930) (1,077) (28,007)
1999 (17,410) (896) (18,306)
Segment assets 2000 117,401 5,201 122,602
1999 117,225 4,302 121,527
9. Recently Issued Accounting Standards
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements. This bulletin will be effective in the fourth quarter of the Company's fiscal year ending December 31, 2000. Management is in the process of determining the impact, if any, that this bulletin will have on its consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 will be effective for the Company's fiscal year ending December 31, 2001. Management believes that this statement will not have a significant impact on the Company.
10. Recall of SangCya Oral Solution
On June 29, 2000, the Company in discussions with the FDA, which began on June 24, 2000, concluded that a recall of SangCya from the United States market would be required. Following further discussions with the FDA as to the type of recall and mechanism for conducting it, this decision was announced on July 10, 2000. The recall was a Class II recall and was limited to the wholesale level and not extended to the pharmacy or the patient. A study in healthy volunteers had found that when SangCya Oral Solution is mixed with apple juice as recommended in its labeling it is not bioequivalent to Neoral® oral solution. The Company also announced at the same time its decision to voluntarily withdraw SangCya Oral Solution from the U.S. market.
In the U.K., the Company is selling SangCya on a named patient only basis subject to an amendment to the labeling. The Company is working with the Medicines Control Agency ("MCA") to complete a labeling change that must be approved by the other member states to permit the Company to obtain authorization to sell SangCya Oral Solution in these other countries.
The Company has included in its financial results for this quarter reserves to cover the expected losses resulting from the recall. These reserves, which are reported in the Condensed Consolidated Statements of Operations under revenues, cost of sales, research and development expenses and selling, general and administrative expenses, include $722,000 for sales returns expected from customers, $11,561,000 for the write-off of all SangCya and CycloTech finished goods and components and a partial write-down of bulk cyclosporine inventories, and $425,000 for costs to terminate ongoing marketing and clinical programs, and to administer the recall. The inventory reserves are non-cash in nature since the inventories in question have already been paid for.
11. Litigation
Patent Litigation
On July 27, 2000, the Company entered into a global settlement agreement with Novartis AG and Novartis Pharmaceuticals Corporation with respect to the patent infringement lawsuits filed against the Company in the US and UK regarding SangCya® Oral Solution, USP [MODIFIED] as well as the counterclaim the Company filed against Novartis Pharmaceuticals Corporation in the US. As part of the settlement, the parties have entered into a global license agreement pursuant to which Novartis shall license United States patent #5,389,382 and its foreign counterparts to the Company and the Company shall pay Novartis a royalty on sales of SangCya Oral Solution. The settlement and license applies only to SangCya Oral Solution and does not apply to cyclosporine capsule products. The Company does not expect the terms of the settlement to have a material financial impact on the Company in the foreseeable future.
Regulatory Litigation
US Regulatory Litigation
Novartis US sued the FDA on February 11, 1999 in the United States District Court for the District of Columbia (case number 1: 99CV-00323) alleging that the FDA did not follow its own regulations in approving SangCya Oral Solution in October 1998. The lawsuit alleges that because Neoral oral solution and SangCya Oral Solution are based on different formulation technologies, they should be classified as different dosage forms. Novartis asks that the court (i) allow Novartis to keep its microemulsion labeling; (ii) declare microemulsion to be a separate dosage form; and (iii) rescind the AB rating that was given to SangCya Oral Solution. The Company intervened in this lawsuit.
The parties have all filed motions for summary judgment with the Court and are awaiting a final ruling. Because the Company permanently withdrew SangCya Oral Solution from the U.S. market in July 2000, the Company does not believe that this lawsuit will have any material impact on the Company.
UK Regulatory Litigation - SangCya Oral Solution
On October 18, 1999, Novartis UK was granted leave to seek judicial review of the decision by the Medicines Control Agency (the "MCA") to approve SangCya Oral Solution (Case No. HC- 1969/99). On March 30, 2000, the High Court in London dismissed Novartis' application for judicial review, ruled that the MCA acted properly in granting the SangCya Oral Solution marketing authorization, ordered Novartis to pay MCA's costs incurred in defending the action, and refused Novartis' request to appeal the decision. The High Court ordered that Novartis did not have to pay SangStat its costs. Novartis has appealed the High Court's decision and the hearing has been scheduled for November 2000. The Court of Appeals could uphold the High Court's ruling, reverse the High Court's ruling, or refer the case to the European Court of Justice. If the Court of Appeals reverses the High Court's ruling, the SangCya Oral Solution marketing authorization would be revoked or suspended until the expiration of the ten year data exclusivity period for Neoral Oral Solution (approximately 2004).
UK Regulatory Litigation - Sang-2000 (SangCya Capsules)
In November 1999, Novartis filed a request for judicial review of the refusal by MCA to state that it would not reference Neoral data in approving any cyclosporine capsule application. An agreement was reached between the parties in which Novartis agreed to stay the judicial review until the earlier of (i) the decision on the judicial review of SangCya Oral Solution or (ii) MCA's approval of a marketing authorization for Sang-2000, and in return, SangStat agreed that SangStat would not launch or commence mutual recognition procedures in relation to the Sang-2000 marketing authorization (including a request to MCA to prepare an assessment report) for a period of 28 days commencing on the day on which SangStat notifies Novartis' solicitors of capsule approval. The parties have agreed to continue the stay until the appeal of the High Court decision with respect to the judicial review of SangCya Oral Solution.
SangStat assumes that Novartis will seek a judicial review hearing with respect to our Sang-2000 marketing authorization within this 28-day period to rescind it or to obtain a preliminary injunction to prevent sale of Sang-2000 until final resolution of the matter. SangStat believes that if Novartis seeks a judicial review, it will be stayed until final resolution of the judicial review of the SangCya Oral Solution marketing authorization.
Novartis has also indicated that it will seek an injunction to prevent Sang-2000 from being sold in the United Kingdom until final resolution of the judicial review relating to Sang-2000. Because the High Court ruled in favor of the MCA with respect to the SangCya Oral Solution marketing authorization, the Company believes that it is unlikely that a court would grant Novartis a preliminary injunction with respect to the Sang-2000 marketing authorization absent a reversal of the High Court's decision by the Court of Appeals. If the Court of Appeals reverses the High Court's ruling, the Sang-2000 marketing authorization could not be approved until the expiration of the ten year data exclusivity period for Neoral capsules (approximately 2004).
Italian Litigation
On May 5, 2000, Novartis Farma S.p.A. ("Novartis Italy") served IMTIX SangStat s.r.l., our Italian subsidiary, and IMTIX SangStat Ltd. with a summons to the Milan Tribunal. Novartis Italy alleges that by requesting mutual recognition from the Italian Health Authorities of the SangCya Oral Solution dossier approved by the MCA, SangStat implicitly requested that the Italian Health Authorities review the Neoral dossier. Novartis alleges that this request is an act of unfair competition in that (i) the Neoral data has ten year exclusivity and (ii) the data is secret and by requesting mutual recognition, SangStat is responsible for the Health Authorities act of unfair competition following use of the Neoral dossier in reviewing the SangCya dossier. The summons acknowledges that the UK High Court did not invalidate the SangCya marketing authorization. It does not acknowledge that the High Court indicated that the MCA could review the Neoral data. SangStat does not know whether or not Novartis Italy has also filed suit against the Italian Health Authorities. Novartis Italy has requested that the initial appearance of the parties before the Milan Tribunal occur November 20, 2000. SangStat does not have marketing approval for SangCya Oral Solution in Italy. Novartis Italy is seeking damages and an injunction to prevent the sale by SangStat of SangCya Oral Solution, or any other product for which SangStat may obtain approval based upon a reference to the Neoral dossier, which the Company believes is intended to block Sang-2000 from sale in Italy.
SangStat believes that these lawsuits are without merit and that SangStat will prevail in these matters. Although SangStat is optimistic that these disputes will ultimately be resolved favorably to SangStat, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. Novartis' requested relief, if granted, could have a significant negative economic impact on SangStat. As a result of the UK judicial review, SangStat could be enjoined from selling SangCya Oral Solution and/or Sang-2000 until approximately 2004 in the United Kingdom and other European countries. The litigation, whether or not resolved favorably to the Company, is likely to be expensive, lengthy and time consuming, will divert management's attention and could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations.
12. Subsequent Events
Abgenix Co-development, Supply and License Agreement
On August 8, 2000, the Company announced that it had entered into a global co- development, supply and license agreement with Abgenix, Inc. for ABX-CBL, an antibody developed by Abgenix. SangStat will have an exclusive worldwide license for the marketing and sale of ABX-CBL. ABX-CBL is an anti-CD147 monoclonal antibody for the treatment of steroid resistant graft versus host disease (GVHD) and is currently in a multicenter, randomized, and controlled Phase II/III study. SangStat will make an initial license fee payment and additional milestone payments to Abgenix. Development costs will be shared equally, as would any potential profits from sales of collaboration products. SangStat and Abgenix will share responsibility for product development, including the ongoing trial. Abgenix will be responsible for manufacturing ABX-CBL. SangStat also has the right, subject to the terms and conditions of the Agreement, to commercialize other anti- CD147 antibodies developed by Abgenix.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto included elsewhere in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the fiscal year ended December 31, 1999. Except for the historical information contained herein, the discussion in this Quarterly Report on Form 10-Q contains certain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this Quarterly Report on Form 10-Q should be read as being applicable to all related forward-looking statements wherever they appear in this Quarterly Report on Form 10-Q. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include those discussed in "Risk Factors," as well as those discussed elsewhere herein. In particular, we have included forward-looking statements regarding the following: (i) the effects of the SangCya Oral Solution recall on future revenues; (ii) expected reductions in litigation expenses; (iii) the conversion of our European subsidiaries to the Euro; (iv) our product development and collaborative efforts; (v) the results of our settlement agreements and litigation with Novartis; and (vi) our future revenue and expenses, including our expectations regarding liquidity.
Results of Operations - Three and Six Months Ended June 30, 2000 and 1999
SangStat, The Transplant Company®, is a global bio-pharmaceutical company applying a disease management approach to improving the outcome of organ, bone marrow, and stem cell transplantation. Since 1988, we have built a family of products and services to address the pre-transplant, acute care and chronic phases of transplant in the worldwide market. Our business is currently organized into two segments: Transplantation Products and Transplantation Services. The Transplantation Products segment consists of six marketed products, one principal product candidate and additional product candidates in various stages of research and development. We plan to capitalize on our products and product pipeline by developing relationships with key providers and managed care organizations to better integrate the management of transplant recipients' care to improve outcomes and lower the costs of transplants. During the first half of fiscal 2000, we continued to market and sell our lead product, Thymoglobulin, launched Gengraf, a cyclosporine capsule product that is distributed by SangStat under a co-promotion agreement with Abbott Laboratories, conducted clinical studies on Thymoglobulin and other products and continued the development of The Transplant Pharmacy. We also initiated the recall of our SangCya Oral Solution product in the United States following the discovery of some clinical data that indicated a lack of bioequivalence versus Neoral when taken with apple juice. The Transplantation Services segment consists of the Transplant Pharmacy®, which provides mail order distribution of drugs and transplant patient management services, and TransplantRx.com™, the first online pharmacy dedicated to organ transplantation.
Total revenues. Total revenues consist of net sales of transplantation products and transplantation services. Total revenues were $20,296,000 for the quarter ended June 30, 2000, an increase of $5,911,000 or 41% over total revenues of $14,385,000 for the quarter ended June 30, 1999. Total revenues were $36,236,000 for the six months ended June 30, 2000, an increase of $11,323,000 or 45% over total revenues of $24,913,000 for the six months ended June 30, 1999.
Net sales of transplantation products for the quarter ended June 30, 2000 were $15,991,000, an increase of $4,883,000 or 44% over net sales of $11,108,000 for the quarter ended June 30, 1999. Net sales of transplantation products for the six months ended June 30, 2000 were $27,789,000, an increase of $9,206,000 or 50% over net sales of $18,583,000 for the six months ended June 30, 1999. The increases for both the three and six month periods were due primarily to sales of Gengraf, which was launched in the US in May 2000, and increased sales of Thymoglobulin in the United States. Sales of transplantation products in Europe for the six months ended June 30, 2000 were slightly lower than sales for the six months ended June 30, 1999. Although sales measured in local currencies increased compared to the corresponding prior period, the increase was more than offset by the effect of the fall in the value of European currencies versus the US dollar during the past year. On June 29, 2000, the Company in discussions with the FDA, which began on June 24, 2000, concluded that a recall of SangCya from the United States market would be required. Following further discussions with the FDA as to the type of recall and mechanism for conducting it, we announced this decision on July 10, 2000. As a result, net sales for both the quarter and six months ended June 30, 2000 have been reduced by a provision of $722,000 to cover anticipated returns of SangCya Oral Solution from customers following the product recall.
Net sales of transplantation services for the quarter ended June 30, 2000 were $4,305,000, an increase of $1,028,000 or 31% over net sales of $3,277,000 for the quarter ended June 30, 1999. Net sales of transplantation services for the six months ended June 30, 2000 were $8,447,000, an increase of $2,117,000 or 33% over sales of $6,330,000 for the six months ended June 30, 1999. The increases in net sales for both the quarter and six months ended June 30, 2000 were due primarily to an increase in the number of patients serviced by The Transplant Pharmacy. Net sales of transplantation services for all periods consisted entirely of drug sales to transplant patients.
Cost of sales. Total cost of sales consist of cost of sales and manufacturing expenses of transplantation products and transplantation services, and a product recall reserve. Total cost of sales were $23,344,000 for the quarter ended June 30, 2000, an increase of $15,841,000 or 211% over cost of sales of $7,503,000 for the quarter ended June 30, 1999. Total cost of sales for the six months ended June 30, 2000 were $31,201,000, an increase of $17,858,000 or 134% over total cost of sales of $13,343,000 for the six months ended June 30, 1999.
Cost of sales for transplantation products were $19,512,000 for the quarter ended June 30, 2000, an increase of $14,924,000 or 325% over cost of sales of $4,588,000 for the quarter ended June 30, 1999. Cost of sales for transplantation products were $23,800,000 for the six months ended June 30, 2000, an increase of $16,011,000 or 206% over cost of sales of $7,789,000 for the six months ended June 30, 1999. The increases in both the quarter and six months were primarily due to the establishment of inventory reserves related to the US recall of SangCya Oral Solution. These reserves, which totaled $11,561,000, include a 100 percent reserve for all SangCya and CycloTech finished goods and components, as well as a partial reserve against our bulk cyclosporine inventories. The remainder of the increase in cost of sales was due to the overall increase in sales and the higher cost of Gengraf compared to our other products.
Cost of sales for transplantation services for the quarter ended June 30, 2000 were $3,832,000, an increase of $917,000 or 31% over cost of sales of $2,915,000 for the quarter ended June 30, 1999. Cost of sales for transplantation services for the six months ended June 30, 2000 were $7,401,000, an increase of $1,847,000 or 33% over cost of sales of $5,554,000 for the six months ended June 30, 1999. The increases in cost of sales for both the quarter and six months were due to the increase in sales of The Transplant Pharmacy. Cost of sales of transplantation services for all periods consisted entirely of the cost of drugs purchased from wholesalers and sold to transplant patients.
Research and development. Research and development expenses for the quarter ended June 30, 2000 were $4,017,000, an increase of $459,000 or 13% over expenses of $3,558,000 for the quarter ended June 30, 1999. Research and development expenses for the six months ended June 30, 2000 were $7,995,000, an increase of $205,000 or 3% over research and development expenses of $7,790,000 for the six months ended June 30, 1999. Spending on research and development in the second quarter increased compared to the prior period as we conducted clinical trials to pursue label expansion of Thymoglobulin and continued pre-clinical work on RDP58, a product in development that inhibits synthesis of TNF-alpha. Expenses for both the three and six month periods ended June 30, 2000 include a reserve of $50,000 to cover the expected cost of terminating SangCya clinical trials following the recently announced product recall. We expect research and development expenses to increase in future quarters as a result of the co-development, supply and license agreement with Abgenix.
Selling, general and administrative. Selling, general and administrative expenses for the quarter ended June 30, 2000 were $12,530,000, an increase of $1,381,000 or 12% over expenses of $11,149,000 for the quarter ended June 30, 1999. Selling, general and administrative expenses for the six months ended June 30, 2000 were $23,694,000, an increase of $2,575,000 or 12% over selling, general and administrative expenses of $21,119,000 for the six months ended June 30, 1999. The increases in expenses for both the quarter and six months were due primarily to higher legal expenses associated with the Novartis lawsuit and marketing expenses associated with the launch of Gengraf. Due to the settlement of the lawsuit with Novartis which was announced on July 27, we expect legal expenses to decrease in subsequent quarters. Expenses for both the three and six month periods ended June 30, 2000 include a reserve of $375,000 to cover the expected cost of managing the recently announced product recall of SangCya and terminating ongoing marketing programs.
Interest income (expense) - net. Interest income (expense) - net for the quarter ended June 30, 2000 was an expense of $411,000, an increase of $21,000 or 5% over expense of $390,000 for the quarter ended June 30, 1999. Interest income (expense) - net for the six months ended June 30, 2000 was an expense of $732,000, an increase of $364,000 or 99% compared to an expense of $368,000 for the six months ended June 30, 1999. The increase in expense in the first six months of 2000 reflected additional interest expense on the note payable to Abbott Laboratories, the loan with Finova and the convertible note.
Income taxes. For the six months ended June 30, 2000, we recorded a tax benefit of $80,000 for European income taxes based upon the results of our European affiliates for the first six months of 2000. For the six months ended June 30, 1999, we recorded a tax benefit of $94,000 based on the results of our European affiliates for the first half year of fiscal 1999.
Net loss. Net loss consists of net loss of transplantation products and transplantation services. Net loss for the quarter ended June 30, 2000 was $20,218,000, an increase of $11,635,000 or 136% over the net loss of $8,583,000 for the quarter ended June 30, 1999. Net loss for the six months ended June 30, 2000 was $28,007,000, an increase of $9,701,000 or 53% compared to net loss of $18,306,000 for the six months ended June 30, 1999. The net loss for both the three and six month periods ended June 30, 2000 includes product recall reserves aggregating $12,708,000. Without these product recall reserves, net loss for the six months ended June 30, 2000 would have been $15,299,000, a decrease of $3,007,000 or 16% compared to the net loss for the six months ended June 30, 1999.
Net loss for transplantation products for the quarter ended June 30, 2000 was $19,836,000, an increase of $11,637,000 or 142% over the net loss of $8,199,000 for the quarter ended June 30, 1999. Net loss for transplantation products for the six months ended June 30, 2000 was $26,930,000, an increase of $9,520,000 or 55% over the net loss of $17,410,000 for the six months ended June 30, 1999. The increase in net loss for both the quarter and six months was due primarily to the product recall reserves of $12,708,000 and the increases in research and development and selling, general and administrative expenses, partially offset by the increase in sales, net of related cost of sales.
Net loss for transplantation services for the quarter ended June 30, 2000 was $382,000, a decrease of $2,000 or 1% compared to the net loss of $384,000 for the quarter ended June 30, 1999. Net loss for transplantation services for the six months ended June 30, 2000 was $1,077,000, an increase of $181,000 or 20% over the net loss of $896,000 for the six months ended June 30, 1999. The increase in net loss was due primarily to an increase in selling, general and administrative expenses, partially offset by the increase in sales, net of related cost of sales, of The Transplant Pharmacy.
Liquidity and Capital Resources
During the first six months of 2000 and 1999, the net cash used in operating activities was approximately $9,257,000 and $24,863,000, respectively. The decrease in net cash used in operating activities in the first six months of fiscal 2000 was substantially due to a reduction in net inventories and increases in accounts payable and accrued liabilities, partially offset by an increase in net loss. The reduction in inventories is primarily due to provisions of $11,561,000 relating to the product recall, which resulted in a corresponding increase in net loss for the period. As of June 30, 2000, we had cash, cash equivalents and short-term investments of $29,682,000 and total assets of $122,602,000.
Net cash used in investing activities for the six months ended June 30, 2000 was $3,447,000 as compared to cash provided of $8,033,000 for the same period in 1999. Net cash used in 2000 is primarily due to an increase in other assets reflecting $5,000,000 cash used as collateral for the note payable to Finova Capital ("Finova"), and the purchase of property and equipment. In 1999, cash was provided by maturing short-term investments and a reduction in other assets, partially offset by purchases of property and equipment.
Net cash provided by financing activities for the six months ended June 30, 2000 was $20,707,000, compared to net cash provided of $31,587,000 for the same period in 1999. In February 2000, we completed a private placement of 451,128 shares of common stock with an institutional investor. The stock was issued at $33.25, the closing price of the stock on February 14, 2000, for aggregate proceeds of $15,000,006. We intend to use the proceeds to fund future working capital requirements. In addition, our borrowings under notes payable increased by $5,986,000, primarily with Finova, partially offset by payments on existing notes. For the six months ended June 30, 1999, net cash provided by financing activities came primarily from the issuance of a $10.0 million convertible note, a $16.0 million loan from Abbott Laboratories ("Abbott") and the sale of common stock, mainly to Abbott.
In May 1999, the Company and Abbott Laboratories ("Abbott") signed a multi-year co-promotion, distribution and research agreement for SangCya and cyclosporine capsules in the United States. The Company is the exclusive distributor for the products and shares marketing, promotional and development expenses as well as the profits from the co-promotion of the products with Abbott. The agreement ends December 31, 2004 unless both companies agree to extend it. Pursuant to this agreement, Abbott made an equity investment of $14 million during 1999 in exchange for approximately 894,000 shares of common stock, representing a premium to fair market value aggregating to $1.3 million. In addition, Abbott made a series of up-front and milestone payments totaling $20.8 million, including $1.9 million received in January 2000 and $5.0 million received in May 2000, and a long-term loan of $16 million to the Company received during 1999. Also, in January 2000, the Company made a milestone payment of $4.0 million to Abbott. No further milestone payments are required from either company. All up-front and milestone payments received, net of milestone payments made, and the premium received on the sale of common stock to Abbott are recorded as deferred revenue and recognized ratably over the term of the agreement as revenue from collaborative agreements. In May 2000 SangStat and Abbott launched the cyclosporine capsule developed by Abbott under the brand name Gengraf. In connection with the equity investment, Abbott and SangStat entered into a Right of First Refusal Agreement and a Registration Rights Agreement, and amended and restated their existing Supply Agreement.
On June 29, 2000, the Company in discussions with the FDA, which began on June 24, 2000, concluded that a recall of SangCya from the United States market would be required. Following further discussions with the FDA as to the type of recall and mechanism for conducting it, we announced this decision on July 10, 2000. We have recorded one-time charges aggregating $12.7 million to cover the financial effect of this recall. On a going forward basis, the Company does not expect the loss of SangCya revenues in the U.S. to have a material effect on future earnings and cash flow.
On July 27, 2000, the Company entered into a global settlement agreement with Novartis AG and Novartis Pharmaceuticals Corporation with respect to the patent infringement lawsuits filed against the Company in the US and UK regarding SangCya® Oral Solution, USP [MODIFIED] as well as the counterclaim the Company filed against Novartis Pharmaceuticals Corporation in the US. As part of the settlement, the parties have entered into a global license agreement pursuant to which Novartis shall license United States patent #5,389,382 and its foreign counterparts to the Company and the Company shall pay Novartis a royalty on sales of SangCya Oral Solution. The Company does not expect the terms of the settlement to have a material financial impact on the Company in the foreseeable future. The settlement and license applies only to SangCya Oral Solution and does not apply to cyclosporine capsule products.
On August 8, 2000, the Company announced that it had entered into a global co-development, supply and license agreement with Abgenix, Inc. for ABX-CBL, an antibody developed by Abgenix. SangStat will have an exclusive worldwide license for the marketing and sale of ABX-CBL. ABX-CBL is an anti- CD147 monoclonal antibody for the treatment of steroid resistant graft versus host disease (GVHD) and is currently in a multicenter, randomized, and controlled Phase II/III study. SangStat will make an initial license fee payment and additional milestone payments to Abgenix. Development costs will be shared equally, as would any potential profits from sales of collaboration products. SangStat and Abgenix will share responsibility for product development, including the ongoing trial. Abgenix will be responsible for manufacturing ABX-CBL. SangStat also has the right, subject to the terms and conditions of the Agreement, to commercialize other anti-CD147 antibodies developed by Abgenix.
In April 2000, we signed an agreement with Finova Capital Corporation ("Finova") to provide a line of credit of up to $30 million. The agreement is for three years and may be renewed annually thereafter if both parties agree. The line of credit consists of two elements: a $15 million line of credit bearing interest at the prime rate and secured by a matching compensating cash balance, and a $15 million line of credit bearing interest at the prime rate plus 1.5% and based on eligible domestic accounts receivable and inventory. As additional security for the line of credit, we have granted Finova a first priority security interest in certain of our tangible and intangible assets and have pledged the stock of our two French subsidiaries, Imtix-SangStat SAS and SangStat Atlantique SA. At June 30, 2000 we had drawn down $5.0 million under the line of credit and had set aside a corresponding compensating balance.
In the opinion of management, SangStat has sufficient funds to continue operations for at least the next twelve months.
Euro-Currency
The Single European Currency (Euro) was introduced on January 1, 1999 with complete transition to this new currency required by January 2002. We are currently assessing the issues raised by the introduction of the Euro. We have made and expect to continue to make changes to our internal systems in preparation for the transition to the Euro. Changes made to date include changing the operating currency of our two French subsidiaries from the French franc to the Euro, which became effective during the second quarter. We expect to convert the other European subsidiaries that are affected by the Euro within the next twelve months.
We further expect that use of the Euro may affect our foreign exchange activities and may result in increased fluctuations in foreign currency results. Any delays in our ability to be Euro- compliant could have an adverse impact on our results of operations or financial position.
Risk Factors
We have a history of operating losses and our future profitability is uncertain. We were incorporated in 1988 and have experienced significant operating losses since that date. As of June 30, 2000, our accumulated deficit was $161,284,000. Our operating expenses have increased from approximately $31.0 million to $60.9 million to $89.9 million over the three year period ended December 31, 1999, and were approximately $63.6 million for the six months ended June 30, 2000. Total revenues increased from approximately $4.5 million to $19.7 million to $58.2 million, and were approximately $36.2 million for the six months ended June 30, 2000, while losses from operations increased from approximately $26.5 million to $41.3 million and decreased to $31.7 million over the three year period ended December 31, 1999, and were approximately $27.4 million for the six months ended June 30, 2000. We cannot guarantee that we will ever achieve significant revenues from product sales or that we will achieve profitable operations. To date, our product revenues have been primarily derived from sales of Thymoglobulin, Lymphoglobuline, and Gengraf.
We may elect to raise additional funds within the next 12 months. Within the next twelve months, we may need to raise additional funds through financings and collaborative research and development arrangements with corporate partners. We may not be able to raise funds on favorable terms, if at all, and our discussions with potential collaborative partners may not result in any agreements. If adequate funds are not available, we may be required to delay, scale back or eliminate one or more of our development programs or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain technologies, product candidates or products that we would not otherwise relinquish.
Our future growth depends on sales of key products. We expect to derive most of our future revenues from sales of Gengraf (cyclosporine capsule, USP, MODIFIED), a cyclosporine capsule product, and Thymoglobulin. We have limited experience selling our products. Our sales of Thymoglobulin began in the U.S. in 1999. We began distributing Gengraf in May 2000. We are marketing Gengraf in the United States under a co-promotion agreement with Abbott Laboratories ("Abbott"). We cannot guarantee that Abbott will be able to effectively market Gengraf pursuant to the agreement, and its failure to do so may impact sales of these products. We recalled all lots of SangCya Oral solution from the US wholesalers in July 2000 and at the same time announced its withdrawal from the U.S. market.
Any factor adversely affecting the regulatory approval or sale of our key products, individually or collectively, would harm our business and results of operations. Sales of these key products could be adversely affected by the following:
In particular, with respect to Gengraf, sales may be affected by the following:
Failure of sales to meet forecasts may also cause excessive inventory build- up, which, if not sold prior to lot expiration, may be required to be taken as a charge against earnings.
The Recall of SangCya Oral Solution in the U.S. could have negative repercussions beyond loss of revenues. The FDA may conduct an investigation into the circumstances that led to the SangCya recall. The FDA or other regulatory authorities may review our future drug approval applications more carefully, which may result in slower approval times. Our sales of Gengraf and Thymoglobulin in the US may be impacted by the recall as competitors attempt to use the recall in marketing against us and our products. The occurrence of any of these events could substantially harm our business.
Our business exposes us to the risk of product liability claims for which we may not be adequately insured. We face an inherent business risk of exposure to product liability claims in the event that the use of our products results in adverse effects during research, clinical development or commercial use. We cannot guarantee we will avoid significant product liability exposure. Our product liability insurance coverage is currently limited to $10,000,000, which may not be adequate to cover potential liability exposures. Moreover, we cannot assure you adequate insurance coverage will be available at acceptable cost, if at all, or that a product liability claim would not harm our results of operations.
Our litigation with Novartis may be resolved adversely and will be a drain on time and resources. While we have settled the patent litigation with Novartis regarding SangCya Oral Solution, we are involved in litigation with Novartis in the U.S. and the U.K. which could potentially harm sales of SangCya Oral Solution and Sang-2000 in Europe. See "Part II, Item 2 - Legal Proceedings. The course of litigation is inherently uncertain and we may not achieve a favorable outcome. The litigation, whether or not resolved favorably to us, is likely to be expensive, lengthy and time consuming, and divert management's attention.
A change in marketing strategy and a delay in product approval have created excess perishable inventories. We have significant amounts of bulk cyclosporine active ingredient inventory which we are not using to manufacture finished product in the amount anticipated. This inventory was originally purchased for use in cyclosporine finished products to be sold in the United States and Europe However, since we are now distributing Gengraf, a cyclosporine product manufactured by Abbott, in the United States and we have withdrawn SangCya from the United States market, we are dependent on the European market to use this inventory. Although we plan to obtain marketing approval for a cyclosporine capsule in Europe, the inherent uncertainty of the approval process makes it very difficult to forecast a launch date for this product. If the approval and product launch are delayed, we may not be able to convert all the inventory into finished product and sell it before its expiration date. As a result, we could write off portions of our bulk active ingredient in the future, which could significantly reduce the gross margin reported for that future period.
If we do not develop and market new products, our business will be harmed. To achieve profitable operations, we must successfully develop, obtain regulatory approval for, manufacture, introduce and market products and product candidates. We cannot guarantee that we will successfully do this. Our product candidates will require extensive development and testing, as well as regulatory approval prior to commercialization. Cost overruns could occur due to the following:
These events would prevent or substantially slow down the development effort and ultimately would harm our business. Furthermore, there can be no assurance that any product candidate under development will be safe, effective or capable of being manufactured in commercial quantities at an economical cost, or that any product will not infringe the proprietary rights of others or will achieve market acceptance.
We may not be able to manufacture or obtain sufficient quantities of our products. We have contracted for commercial scale production of cyclosporine bulk material, the active ingredient of cyclosporine, for SangCya Oral Solution (to be sold outside the U.S.) and SangCya cyclosporine capsule ("Sang-2000"), from Gensia Sicor ("Sicor") and Abbott. Sicor is a qualified supplier of cyclosporine bulk material in the SangCya Oral Solution and Sang-2000 regulatory applications. We have applied to qualify Abbott as an alternative cyclosporine raw material supplier, but this supplemental application has not yet been approved outside of the US. We have also contracted with Lilly for the manufacture of SangCya Oral Solution and Sang-2000. We cannot control these suppliers, and they may fail to timely deliver adequate supplies of a sufficiently high quality product, and any such failure may delay product launch, impair our ability to deliver our products on a timely basis, or otherwise impair our competitive position, which would harm our business and results of operations.
Thymoglobulin is also difficult to manufacture and there can be no assurance that we will be able to manufacture commercial quantities at an economical cost. We acquired the IMTIX division of Aventis in 1998, including certain manufacturing capabilities with respect to Thymoglobulin. From time to time prior to the acquisition, certain batches of Thymoglobulin did not meet manufacturing specifications, resulting in a shortage of Thymoglobulin for commercial sale. We still rely on Aventis for certain important manufacturing services, including quality assurance, quality control, and lyophilization. We cannot guarantee that Aventis will continue to effectively and continuously provide us these critical manufacturing services. We cannot guarantee we will not experience manufacturing difficulties with respect to Thymoglobulin in the future which may impair our ability to deliver products on a timely basis, or otherwise impair our competitive position, which would harm our business.
We rely on third parties for manufacturing. We generally rely on third parties to manufacture compounds (other than Thymoglobulin and Lymphoglobuline) and devices for commercial sales and clinical trials. We cannot guarantee manufacturers will meet FDA standards governing GMP or other regulatory guidelines, that any Biologics License Applications, or BLA, required for manufacturing will be filed, reviewed and approved, or that any third-party manufacturer will pass a pre-approval inspection. We cannot guarantee we will be able to enter into additional commercial scale manufacturing contracts or that any other third-party arrangements can be established on a timely or commercially reasonable basis, or at all. We will depend on all such third parties to perform their obligations effectively and on a timely basis. We cannot guarantee that such parties will perform and any failures by third parties may delay clinical development or submission of products for regulatory approval, or otherwise impair our competitive position, which could harm our business. In addition, the manufacturing of drug candidates involves a number of technical steps and requires meeting stringent quality control specifications imposed by regulatory authorities and by us. Additionally, such products can only be manufactured in facilities approved by the applicable regulatory authorities. Because of these and other factors, we may not be able to replace our manufacturing capacity quickly or efficiently in the event that our manufacturers are unable to manufacture their products at one or more of their facilities. For certain of our potential products, we will need to develop our production technologies further for use on a larger scale in order to conduct human clinical trials and produce such products for commercial scale at an acceptable cost.
Failure of the market to adopt our products will harm our business. Whether or not our products receive regulatory approval the market may not accept our products. We cannot guarantee patients, physicians, pharmacists, or third-party payers will accept our products. Accordingly, we cannot guarantee our products and product candidates will obtain significant market share. Factors that may affect the willingness of patients, physicians, pharmacists and third-party payers to convert to SangStat products, if approved, include price, perception of bioequivalence, perceived clinical benefits and risks, ease of use, other product features and brand loyalty. In addition, other factors may limit the market acceptance of products we develop, including the timing of regulatory approval and market entry relative to competitive products, the availability of alternative therapies, the price of our products relative to alternative therapies, the availability of third-party reimbursement and the extent of our or third party distributor's or agents' marketing efforts. In particular, with respect to SangCya Oral Solution (outside the U.S.) and cyclosporine capsules we cannot guarantee we will be successful in taking significant market share away from Novartis, even if product approval is granted.
Fluctuations in quarterly and annual operating results may adversely affect our stock price. Our quarterly and annual operating results may fluctuate due to a variety of factors. We therefore believe that quarter-to-quarter comparisons of our operating results may not be a good indication of our future performance, and you should not rely on them to predict our future performance or the future performance of our stock. Our operating losses have been substantial each year since inception. We also expect losses to continue in the near future as a result of a number of factors, including:
Our operating results may also fluctuate significantly as a result of other factors, including:
Fluctuations in our operating results have affected our stock price in the past and are likely to continue to do so in the future. In particular, the realization of any of the risks described in this registration statement could have a significant and adverse impact on the market price for our stock.
Our stock price as well as the stock prices for competitors in our industry have historically been volatile. The market prices for securities of pharmaceutical and biotechnology companies, including ours, are highly volatile. The stock market has from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. The market price for our common stock may fluctuate as a result of factors such as:
Our future success depends on our ability to successfully manage growth. We continue to expand our operations, which places a strain upon our management, systems and resources. Our ability to compete effectively and to manage future growth, if any, will require us to continue to, on a timely basis, improve our financial and management controls, reporting systems and procedures and expand, train and manage an increasing number of employees. Our failure to do so would harm our results of operations.
Failure to protect our intellectual property would adversely affect our business. Our success depends in part on our ability to obtain and enforce patent protection for our products and to preserve our trade secrets. We hold patents and pending patent applications in the United States and abroad. Some of our patents involve specific claims and thus do not provide broad coverage. There can be no assurance that our patent applications or any claims of these patent applications will be allowed, or found to be valid or enforceable, that any patents or any claims of these patents will provide us with competitive advantages for our products or that such issued patents and any patents issued under pending patent applications will not be successfully challenged or circumvented by our competitors. We have not conducted extensive patent and prior art searches with respect to our product candidates and technologies, and we cannot guarantee that third-party patents or patent applications do not exist or could not be filed in the United States, Europe or other countries which would have an adverse effect on our ability to market our products. We cannot guarantee claims in our patent applications would be allowed, or found to be valid or enforceable, or that any of our products would not infringe on others' patents or proprietary rights in the United States or abroad. We also have patent licenses from third parties whose patents and patent applications are subject to the same risk as ours are.
We cannot guarantee we will be able to manufacture, or that we have manufactured, formulated or commercialized our cyclosporine capsules without infringing patent or other proprietary rights of Novartis or other third parties.
Patent applications in the United States are maintained in secrecy until patents issue. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we were the first to discover compositions covered by our pending patent applications or the first to file patent applications on such compositions. Our pending patent applications may not result in issued patents and any of our issued patents may not afford protection against a competitor.
We also rely on trade secrets and proprietary know-how that we seek to protect, in part, by confidentiality agreements with our employees and consultants. We cannot guarantee these agreements will not be breached, that we would have adequate remedies for any such breach or that our trade secrets will not otherwise become known or independently developed by competitors.
We have registered or applied for trademark registration of the names of all of our marketed products and plan to register the names of our products under development once a name has been selected for the product candidate. We have registered or applied for trademark registration of the names of most of our products under development or commercialized for research and development use. However, these trademark registrations may not be granted to us or may be challenged by competitors.
We face substantial competition. The drugs we develop compete with existing and new drugs being created by pharmaceutical, biopharmaceutical, biotechnology and diagnostics companies and universities. Many of these entities have significantly greater research and development capabilities, as well as substantial marketing, manufacturing, financial and managerial resources and represent significant competition. The principal factors upon which our products compete are product utility, therapeutic benefits, ease of use, effectiveness, marketing, distribution and price. With respect to Thymoglobulin, SangCya Oral Solution and cyclosporine capsules, we are competing against large companies that have significantly greater financial resources and established marketing and distribution channels for competing products. For example, Novartis currently controls virtually 100% of the worldwide cyclosporine markets and has significantly greater resources than we do. We cannot guarantee we will be able to compete successfully against Novartis. To date, we have a limited number of contracts with managed care providers and group purchasing organizations. Our future sales will be dependent on our ability to enter into contracts with these entities. The drug industry is characterized by intense price competition and we expect we will face this and other forms of competition. We cannot guarantee that developments by others will not render our products or technologies obsolete or noncompetitive, or that we will be able to keep pace with technological developments. Many of our competitors have developed or are in the process of developing technologies that are, or in the future may be, the basis for products that compete with our own. Some of these products may have an entirely different approach or means of accomplishing the desired therapeutic effect than our products and may be more effective and less costly. In addition, many of these competitors have significantly greater experience than we do in undertaking preclinical testing and human clinical trials of pharmaceutical products and obtaining regulatory approvals of such products. Accordingly, our competitors may succeed in commercializing products more rapidly than we can. For example, we believe that the degree of market penetration of a cyclosporine capsule is dependent in part on whether we are the first company to market a bioequivalent formulation of cyclosporine. We believe that other companies may be developing cyclosporine formulations that may be marketed as generic equivalents. Were these competitors to develop their products more rapidly and complete the regulatory process sooner, that would harm our business.
Other treatments for the problems associated with transplantation that our products seek to address are currently available and under development. To the extent these therapeutics or monitoring products address the problems associated with transplantation on which we have focused, they may represent significant competition.
The Transplant Pharmacy may not become a viable distributor. Establishing The Transplant Pharmacy as a viable distributor of pharmaceutical products and services entails a number of risks, including our ability to enter into agreements with transplant centers to utilize The Transplant Pharmacy's services, compliance with state regulations regarding pharmacy licensing and compliance with federal and state laws regulating payments for referrals for health care services. On November 11, 1998, the Office of the Inspector General, or OIG, of the Department of Health & Human Services issued an Advisory Opinion which stated that the placement by a pharmacy of a licensed pharmacist at a hospital transplant center might constitute prohibited remuneration under the anti-kickback statute section of the Social Security Act. This Advisory Opinion was not addressed at us, and the Advisory Opinion only applies to the party to whom it was addressed. We believe the Advisory Opinion does not apply to an operation like The Transplant Pharmacy and our operation does not make prohibited remuneration. We cannot guarantee that the OIG will agree with this analysis, in which case we may reorganizeThe Transplant Pharmacy so that it would no longer include an on-site pharmacist at transplant centers. We cannot guarantee that we will be successful in establishing The Transplant Pharmacy as a viable distributor of pharmaceutical products and services.
If our products do not receive regulatory approvals, or if we do not otherwise comply with government regulations, our business would be harmed. Our research, preclinical development, clinical trials, manufacturing, marketing and distribution of our products in the United States and other countries are subject to extensive regulation by numerous governmental authorities including, but not limited to, the FDA. In order to obtain regulatory approval of a drug product, we must demonstrate to the satisfaction of the applicable regulatory agency, among other things, that such product is safe and effective for its intended uses and that the manufacturing facilities are in compliance with GMP requirements. We must also demonstrate the approvability of a BLA for our biological products. The approval of our generic product candidates is dependent on demonstrating bioequivalence with reference products in addition to assurance of compliance with GMP regulations.
The process of obtaining FDA and other required regulatory approvals is lengthy and will require the expenditure of substantial resources, and we cannot guarantee that we will be able to obtain the necessary approvals. Moreover, if and when such approval is obtained, the marketing, distribution and manufacture of our products would remain subject to extensive regulatory requirements administered by the FDA and other regulatory bodies. Failure to comply with applicable regulatory requirements can result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government to grant pre-market clearance or pre-market approval, withdrawal of approvals and criminal prosecution of SangStat and our employees.
Our therapeutic products are subject to foreign regulatory requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement, which vary from country to country. The process of obtaining foreign regulatory approvals can be lengthy and require the expenditure of substantial resources, and we cannot guarantee we will be able to obtain the necessary approvals or the approvals for the proposed indications.
We depend on collaborative relationships. We have a number of strategic relationships for the development and distribution of our products. In particular, we have entered into a multi- year co-promotion, distribution and research agreement for Gengraf in the U.S. with Abbott. We are dependent upon Abbott for certain regulatory, manufacturing, marketing, and sales activities under the agreement. Abbott may not perform satisfactorily and any such failure may delay regulatory approval, product launch, impair our ability to deliver products on a timely basis, or otherwise impair our competitive position, which would harm our business. We may enter into additional collaborative relationships with corporate and other partners to develop and commercialize certain of our potential products. We cannot assure you that we will be able to negotiate acceptable collaborative arrangements in the future, that such collaborations will be available to us on acceptable terms or that any such relationships, if established, will be scientifically or commercially successful.
We depend upon key personnel. Our ability to develop our business depends in part upon our attracting and retaining qualified management and scientific personnel. As the number of qualified personnel is limited, competition for such personnel is intense. We cannot assure you that we will be able to continue to attract or retain such people. The loss of our key personnel or the failure to recruit additional key personnel could significantly impede attainment of our objectives and harm our financial condition and results of operations. Our planned activities will require the addition of new personnel, including management, and the development of additional expertise by existing management personnel, in areas such as research, product development, preclinical testing, clinical trial management, regulatory affairs, finance, manufacturing, pharmacy affairs and marketing and sales. The inability to acquire such services or to develop such expertise could harm our business.
Pharmaceutical pricing and reimbursement is uncertain. Our ability to commercialize our products may depend in part on the extent to which reimbursement for the cost of such products and related treatment will be available from government health administration authorities, private health coverage insurers and other organizations. The pricing, availability of distribution channels and reimbursement status of newly approved healthcare products is highly uncertain and we cannot assure you that adequate third-party coverage will be available for us to maintain price levels sufficient for realization of an appropriate return on our investment in product development. In certain foreign markets, pricing or profitability of healthcare products is subject to government control. In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental control. In addition, an increasing emphasis on managed care in the United States has and will continue to increase the pressure on pharmaceutical pricing. While we cannot predict whether any such legislative or regulatory proposals will be adopted or the effect such proposals or managed care efforts may have on our business, the announcement of such proposals or efforts could harm our ability to raise capital, and the adoption of such proposals or efforts could harm our results of operations. Further, to the extent that such proposals or efforts harm other pharmaceutical companies that are our prospective corporate partners, our ability to establish corporate collaborations may be adversely affected. In addition, third-party payers are increasingly challenging the prices charged for medical products and services. We cannot guarantee that our products and product candidates, if approved, will be considered cost effective or that reimbursement to the consumer will be available or will be sufficient to allow us to sell our products on a competitive basis.
We deal with hazardous materials. In connection with our research and development activities and operations, we are subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials, biological specimens and wastes. We cannot assure you that we will not incur significant costs to comply with environmental and health and safety regulations. Our research and development involves the controlled use of hazardous materials, including but not limited to certain hazardous chemicals and infectious biological specimens. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, we could be held liable for any damages that result and any such liability could exceed our ability to pay.
Our charter documents, stockholder rights plan and Delaware law may serve to deter a takeover. Certain provisions of our Certificate of Incorporation and our recently amended Bylaws could delay or make more difficult a merger, tender offer or proxy contest, which could adversely affect the market price of our common stock. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Further, we have adopted a stockholder rights plan. The plan allows for the issuance of a dividend to stockholders of rights to acquire our shares or, under certain circumstances, an acquiring corporation, at less than half their fair market value. The plan could have the effect of delaying, deferring or preventing a change in control. In addition, we are subject to the antitakeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change of control.
ITEM 3. Quantitative And Qualitative Disclosures About Market Risk
Reference is made to part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 1999.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Patent Litigation
On July 27, 2000, the Company entered into a global settlement agreement with Novartis AG and Novartis Pharmaceuticals Corporation with respect to the patent infringement lawsuits filed against the Company in the US and UK regarding SangCya® Oral Solution, USP [MODIFIED] as well as the counterclaim the Company filed against Novartis Pharmaceuticals Corporation in the US. As part of the settlement, the parties have entered into a global license agreement pursuant to which Novartis shall license United States patent #5,389,382 and its foreign counterparts to the Company and the Company shall pay Novartis a royalty on sales of SangCya Oral Solution. The settlement and license applies only to SangCya Oral Solution and does not apply to cyclosporine capsule products. The Company does not expect the terms of the settlement to have a material financial impact on the Company in the foreseeable future.
Regulatory Litigation
US Regulatory Litigation
Novartis US sued the FDA on February 11, 1999 in the United States District Court for the District of Columbia (case number 1: 99CV-00323) alleging that the FDA did not follow its own regulations in approving SangCya Oral Solution in October 1998. The lawsuit alleges that because Neoral oral solution and SangCya Oral Solution are based on different formulation technologies, they should be classified as different dosage forms. Novartis asks that the court (i) allow Novartis to keep its microemulsion labeling; (ii) declare microemulsion to be a separate dosage form; and (iii) rescind the AB rating that was given to SangCya Oral Solution. The Company intervened in this lawsuit.
The parties have all filed motions for summary judgment with the Court and are awaiting a final ruling. Because the Company permanently withdrew SangCya Oral Solution from the U.S. market in July 2000, the Company does not believe that this lawsuit will have any material impact on the Company.
UK Regulatory Litigation - SangCya Oral Solution
On October 18, 1999, Novartis UK was granted leave to seek judicial review of the decision by the Medicines Control Agency (the "MCA") to approve SangCya Oral Solution (Case No. HC- 1969/99). On March 30, 2000, the High Court in London dismissed Novartis' application for judicial review, ruled that the MCA acted properly in granting the SangCya Oral Solution marketing authorization, ordered Novartis to pay MCA's costs incurred in defending the action, and refused Novartis' request to appeal the decision. The High Court ordered that Novartis did not have to pay SangStat its costs. Novartis has appealed the High Court's decision and the hearing has been scheduled for November 2000. The Court of Appeals could uphold the High Court's ruling, reverse the High Court's ruling, or refer the case to the European Court of Justice. If the Court of Appeals reverses the High Court's ruling, the SangCya Oral Solution marketing authorization would be revoked or suspended until the expiration of the ten year data exclusivity period for Neoral Oral Solution (approximately 2004).
UK Regulatory Litigation - Sang-2000 (SangCya Capsules)
In November 1999, Novartis filed a request for judicial review of the refusal by MCA to state that it would not reference Neoral data in approving any cyclosporine capsule application. An agreement was reached between the parties in which Novartis agreed to stay the judicial review until the earlier of (i) the decision on the judicial review of SangCya Oral Solution or (ii) MCA's approval of a marketing authorization for Sang-2000, and in return, SangStat agreed that SangStat would not launch or commence mutual recognition procedures in relation to the Sang-2000 marketing authorization (including a request to MCA to prepare an assessment report) for a period of 28 days commencing on the day on which SangStat notifies Novartis' solicitors of capsule approval. The parties have agreed to continue the stay until the appeal of the High Court decision with respect to the judicial review of SangCya Oral Solution.
SangStat assumes that Novartis will seek a judicial review hearing with respect to our Sang-2000 marketing authorization within this 28-day period to rescind it or to obtain a preliminary injunction to prevent sale of Sang-2000 until final resolution of the matter. SangStat believes that if Novartis seeks a judicial review, it will be stayed until final resolution of the judicial review of the SangCya Oral Solution marketing authorization.
Novartis has also indicated that it will seek an injunction to prevent Sang-2000 from being sold in the United Kingdom until final resolution of the judicial review relating to Sang-2000. Because the High Court ruled in favor of the MCA with respect to the SangCya Oral Solution marketing authorization, the Company believes that it is unlikely that a court would grant Novartis a preliminary injunction with respect to the Sang-2000 marketing authorization absent a reversal of the High Court's decision by the Court of Appeals. If the Court of Appeals reverses the High Court's ruling, the Sang-2000 marketing authorization could not be approved until the expiration of the ten year data exclusivity period for Neoral capsules (approximately 2004).
Italian Litigation
On May 5, 2000, Novartis Farma S.p.A. ("Novartis Italy") served IMTIX SangStat s.r.l., our Italian subsidiary, and IMTIX SangStat Ltd. with a summons to the Milan Tribunal. Novartis Italy alleges that by requesting mutual recognition from the Italian Health Authorities of the SangCya Oral Solution dossier approved by the MCA, SangStat implicitly requested that the Italian Health Authorities review the Neoral dossier. Novartis alleges that this request is an act of unfair competition in that (i) the Neoral data has ten year exclusivity and (ii) the data is secret and by requesting mutual recognition, SangStat is responsible for the Health Authorities act of unfair competition following use of the Neoral dossier in reviewing the SangCya dossier. The summons acknowledges that the UK High Court did not invalidate the SangCya marketing authorization. It does not acknowledge that the High Court indicated that the MCA could review the Neoral data. SangStat does not know whether or not Novartis Italy has also filed suit against the Italian Health Authorities. Novartis Italy has requested that the initial appearance of the parties before the Milan Tribunal occur November 20, 2000. SangStat does not have marketing approval for SangCya Oral Solution in Italy. Novartis Italy is seeking damages and an injunction to prevent the sale by SangStat of SangCya Oral Solution, or any other product for which SangStat may obtain approval based upon a reference to the Neoral dossier, which the Company believes is intended to block Sang-2000 from sale in Italy.
SangStat believes that these lawsuits are without merit and that SangStat will prevail in these matters. Although SangStat is optimistic that these disputes will ultimately be resolved favorably to SangStat, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. Novartis' requested relief, if granted, could have a significant negative economic impact on SangStat. As a result of the UK judicial review, SangStat could be enjoined from selling SangCya Oral Solution and/or Sang-2000 until approximately 2004 in the United Kingdom and other European countries. The litigation, whether or not resolved favorably to the Company, is likely to be expensive, lengthy and time consuming, will divert management's attention and could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations.
ITEM 2. Changes In Securities And Use Of Proceeds
None
ITEM 3. Defaults Upon Senior Securities
None
ITEM 4. Submission Of Matters To A Vote Of Security Holders
None
ITEM 5. Other Information
None
ITEM 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS - The following exhibits are attached hereto and filed herewith:
| Exhibit Number | Description of Document |
| 27.1 | Financial Data Schedule |
(b) We filed a Current Report on Form 8-K on May 17, 2000.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused This report to be signed on its behalf by the undersigned thereunto duly authorized.
| SangStat Medical Corporation |
| (Registrant) |
Dated: August 14, 2000
| By: | /s/ STEPHEN G. DANCE |
|
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| Stephen G. Dance | |
| Senior Vice President, Finance | |
| (Principal Financial Officer) |
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