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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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 [ ]
The number of shares outstanding of the registrant's common stock, par value $.001 per share, as of March 31, 2000, was 17,907,372.
SANGSTAT MEDICAL CORPORATION
FORM 10-Q
For the Quarterly Period Ended March 31, 2000
Table of Contents
PART I. FINANCIAL INFORMATION
| ITEM 1. Financial Statements |
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Condensed Consolidated Balance Sheets March 31, 2000 and December 31, 1999 |
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Condensed Consolidated Statements of Operations Three Months Ended March 31, 2000 and 1999 |
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Condensed Consolidated Statements of Cash Flows Three months ended March 31, 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)
(unaudited)
March 31, December 31,
2000 1999
------------ ------------
(1)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................... $ 26,054 $ 16,862
Short-term investments ............................ 8,033 9,657
Accounts receivable (net of allowance for doubtful
accounts of $1,721 in 2000 and $1,469 in 1999)... 12,562 12,782
Other receivables.................................. 1,348 2,906
Inventories........................................ 45,751 46,270
Prepaid expenses................................... 2,567 2,306
------------ ------------
Total current assets............................. 96,315 90,783
PROPERTY AND EQUIPMENT -- net........................ 6,097 5,574
INTANGIBLE ASSETS (net of accumulated amortization
of $2,097 in 2000 and $1,749 in 1999).............. 12,186 12,534
OTHER ASSETS......................................... 8,695 8,406
------------ ------------
TOTAL............................................ $ 123,293 $ 117,297
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................... $ 12,260 $ 11,851
Accrued liabilities................................ 6,833 5,511
Capital lease obligations -- current portion....... 645 700
Deferred revenue -- current portion................ 2,326 4,426
Notes payable -- current portion................... 6,145 4,304
------------ ------------
Total current liabilities........................ 28,209 26,792
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CAPITAL LEASE OBLIGATIONS............................ 659 125
DEFERRED REVENUE..................................... 8,722 9,304
NOTES PAYABLE........................................ 36,850 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 - 17,907
shares; 1999 - 17,354 shares..................... 191,612 174,990
Accumulated deficit................................ (141,066) (133,277)
Accumulated other comprehensive loss............... (1,693) (704)
------------ ------------
Total stockholders' equity....................... 48,853 41,009
------------ ------------
TOTAL............................................ $ 123,293 $ 117,297
============ ============
(1) Derived from the Company's audited consolidated financial statements.
See Notes to Condensed Consolidated Financial Statements.
SANGSTAT MEDICAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
(unaudited)
Three Months Ended
March 31,
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2000 1999
----------- -----------
REVENUES:
Net product sales................... $ 15,358 $ 10,103
Revenue from collaborative
agreements........................ 582 425
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Total revenues................... 15,940 10,528
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COSTS AND OPERATING EXPENSES:
Cost of sales and manufacturing
expenses.......................... 7,857 5,841
Research and development............ 3,978 4,232
Selling, general and administrative. 11,164 9,970
Amortization of intangible assets... 348 357
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Total costs and operating
expenses....................... 23,347 20,400
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Loss from operations............. (7,407) (9,872)
INTEREST INCOME (EXPENSE) - NET....... (321) 23
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LOSS BEFORE INCOME TAXES.............. (7,728) (9,849)
INCOME TAXES.......................... (61) 126
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NET LOSS.............................. $ (7,789) $ (9,723)
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Net loss per share - basic and
diluted (Note 2).................... $ (0.44) $ (0.60)
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Shares used in per share
computations........................ 17,635 16,308
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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended
March 31,
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2000 1999
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Net loss.............................. $ (7,789) $ (9,723)
Unrealized gains and (losses) on
marketable securities classified
as available for sale............... (642) (773)
Foreign currency translation
adjustments......................... (347) (988)
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Total comprehensive loss........... $ (8,778) $ (11,484)
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See Notes to Condensed Consolidated Financial Statements.
SANGSTAT MEDICAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
March 31,
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2000 1999
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................... $ (7,789) $ (9,723)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization................... 895 1,297
Non-cash interest expense....................... 398 --
Stock compensation expense...................... -- 28
Deferred income taxes........................... 94 --
Changes in assets and liabilities:
Accounts receivable........................... 220 171
Other receivables............................. 1,558 1,725
Inventories................................... 519 (6,188)
Prepaid expenses.............................. (261) (424)
Accounts payable.............................. 409 346
Accrued liabilities........................... 1,228 (1,087)
Deferred revenue.............................. (2,682) --
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Net cash used in operating activities.......... (5,411) (13,855)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............... (437) 34
Maturities of short-term investments.............. 1,893 2,385
Purchase of short-term investments................ (913) (1,375)
Other assets...................................... (289) 2,408
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Net cash provided by
investing activities....................... 254 3,452
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CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock.............................. 16,622 1,226
Sale of convertible note payable.................. -- 9,550
Note payable borrowings........................... 177 --
Note payable repayments........................... (1,951) (187)
Repayment of capital lease obligations............ (152) (93)
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Net cash provided by financing activities..... 14,696 10,496
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EFFECT OF EXCHANGE RATE CHANGES ON CASH............. (347) (987)
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NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS....................................... 9,192 (894)
CASH AND CASH EQUIVALENTS, Beginning of period...... 16,862 16,286
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CASH AND CASH EQUIVALENTS, End of period............ $ 26,054 $ 15,392
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest,
net of interest capitalized.................... $ 305 $ 103
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NONCASH INVESTING AND FINANCING ACTIVITIES:
Property acquired under capital leases............ $ 661 $ --
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Unrealized loss on investments.................... $ (642) $ (773)
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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. Loss Per Share
Basic EPS is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted EPS 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 and convertible notes payable, aggregating 1,757,194 shares and 849,567 shares as of March 31, 2000 and 1999, respectively, have been excluded from diluted EPS 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
March 31,
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2000 1999
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Net loss (numerator):
Net loss - basic and diluted....................... $ (7,789) $ (9,723)
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Shares (denominator):
Weighted average common shares outstanding - basic
and diluted....................................... 17,635 16,308
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Net loss per share, basic and diluted............... $ (0.44) $ (0.60)
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3. Comprehensive Income (Loss)
The following are the components of accumulated other comprehensive loss (in thousands):
March 31, December 31,
2000 1999
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2000 1999
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Unrealized gain (loss) on investments .............. $ (35) $ 609
Accumulated translation adjustments ................ (1,658) (1,313)
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Total........................................... $ (1,693) $ (704)
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4. Inventories
Inventories, valued at the lower of cost (first-in, first-out) or market consist of (in thousands):
March 31, December 31,
2000 1999
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2000 1999
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Raw materials....................................... $ 27,430 $ 26,710
Work-in-progress.................................... 8,942 9,498
Finished goods...................................... 9,379 10,062
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Total........................................... $ 45,751 $ 46,270
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5. Notes Payable
Notes payable consist of (in thousands):
March 31, December 31,
2000 1999
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2000 1999
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Note payable to Aventis............................. $ 16,750 $ 18,000
Discount on note payable to Aventis................. (2,646) (2,989)
Note payable to Abbott Laboratories................. 16,000 16,000
Convertible note.................................... 9,713 9,609
Other debt.......................................... 3,178 3,751
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Total........................................... 42,995 44,371
Less current portion................................ (6,145) (4,304)
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Long-term........................................... $ 36,850 $ 40,067
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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 and Abbott will share marketing, promotional and development expenses as well as the profits from the co-promotion of these two products. 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 $15.8 million, including $1.9 million received in January 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. 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. Under the terms of the agreement, the Company may also receive an additional $5 million in milestone payments, contingent upon receiving regulatory approval for the cyclosporine capsule. 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. 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
March 31, Products Services Total
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Net revenues 2000 $ 11,798 $ 4,142 $ 15,940
1999 7,475 3,053 10,528
Interest income 2000 (321) -- (321)
(expense) - net 1999 23 -- 23
Depreciation and 2000 869 26 895
amortization 1999 1,232 65 1,297
Income taxes 2000 (61) -- (61)
1999 126 -- 126
Segment loss 2000 (7,094) (695) (7,789)
1999 (9,211) (512) (9,723)
Segment assets 2000 118,283 5,010 123,293
1999 102,453 3,679 106,132
9. Recently Issued Accounting Standards
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. Litigation
Patent Litigation
US Patent Litigation
On February 11, 1999, Novartis Pharmaceuticals Corporation ("Novartis US") filed a lawsuit (case number 99-065) in Federal District Court for the District of Delaware against the Company alleging infringement of United States patent #5,389,382, a cyclosporine technology patented by Novartis A.G. (the "US Patent"). The Novartis A.G. patent does not cover Novartis' Neoral product but rather a separate delivery system not used in the Neoral formulation. Novartis US seeks the following relief: (i) a finding that SangStat willfully infringed the patent; (ii) to permanently enjoin SangStat from infringing the US Patent; (iii) treble damages; and (iv) reasonable attorneys' fees, costs and expenses.
On April 15, 1999, the Company filed its answer in this case and also filed a counterclaim against Novartis alleging that Novartis violated the anti-trust laws by engaging in a series of anti-competitive acts designed and intended to exclude the Company from the market. Novartis filed a motion to separate the anti-trust counterclaim and to stay discovery relating to that counterclaim. On March 30, 2000 the Court denied Novartis' motion, which means that both the patent and the anti-trust claims will be tried at the same time and the same jury will decide both claims. The trial date is October 23, 2000 and discovery is continuing.
UK Patent Litigation
On July 9, 1999, Novartis AG and Novartis Pharmaceuticals UK Limited ("Novartis UK") filed an action against IMTIX- SangStat (UK) Limited; SangStat UK, Limited, and SangStat Medical Corporation (collectively, the "UK Defendants") in the High Court of Justice, Chancery Division, Patents Court, London (HC-1999-02988) alleging infringement of United Kingdom Patent No 2 200 048 (the "UK Patent"), the counterpart to the US Patent. The lawsuit mirrors the US patent infringement lawsuit. Novartis AG and Novartis UK seek the following relief: (i) an injunction to restrain the UK Defendants from infringing the UK Patent; (ii) the delivery up or destruction of all material that would infringe such injunction; (iii) damages; (iv) a declaration that the UK Patent is valid, and has been infringed by the UK Defendants; and (v) costs. No trial date has been set at this time though the parties have agreed that the trial will not be scheduled before March 31, 2001.
Germany Patent Litigation
In January 2000, SangStat filed a Nullity Action in the German Federal Patents Court in Munich Germany seeking to invalidate German Patent 37 42 473, which is the German counter-part to the patent that Novartis is suing the Company on in the United States and the United Kingdom. If SangStat prevails in this nullity action, the patent would be invalidated, which would render any infringement action that Novartis might bring in Germany moot.
Regulatory Litigation
US Regulatory Litigation
Novartis US also 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. Loss of the AB rating would prevent SangCya Oral Solution from being automatically substitutable for Neoral oral solution, which would impede the marketing of SangCya Oral Solution. SangStat does not believe that this lawsuit will impact the regulatory approval of Sang-2000 in the US.
In November 1999, Novartis filed a motion with the court requesting a preliminary injunction to block the FDA from enforcing its order requiring Novartis to change the labeling of its Neoral product line to make it consistent with the established name and descriptor for the product class: Cyclosporine Oral Solution, USP [MODIFIED]). At a hearing on December 7, 1999, the court rejected Novartis' motion for a preliminary injunction and ordered that the FDA may proceed to require Novartis to change its labeling. SangStat does not know if and when the FDA will require Novartis to change the Neoral labeling on the products, but recent advertising for Neoral has used the new labeling. FDA and SangStat have filed a motion for summary judgment but the court has not yet ruled on the motion.
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 requested permission from the Court of Appeals to appeal the High Court's decision. If such request is granted, then a hearing will take place before the Court of Appeals in late 2000 or early 2001. 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.
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. If Novartis does not seek permission to appeal the High Court's decision on SangCya Oral Solution or if Novartis seeks such permission and it is not granted, then there has been a final resolution of the judicial review of the SangCya Oral Solution marketing authorization. In such event, the judicial review with respect to the granting of the Sang-2000 marketing authorization will progress.
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 because Novartis would not, based on the facts known to date, be able to demonstrate a substantial likelihood of success on the merits of its claim. If the Court of Appeals agrees to hear Novartis' appeal and subsequently rules in Novartis' favor, Novartis may be more likely to obtain an injunction with respect to Sang-2000.
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 the MRP, 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.
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 Novartis patent suits and the UK judicial review, SangStat could be enjoined from selling SangCya Oral Solution for a significant period of time or ultimately be prevented from selling SangCya Oral Solution in the United States, the United Kingdom or any country in which SangStat attempts to launch SangCya Oral Solution. Should this happen, SangStat does not believe that it would be able to obtain a license from Novartis on acceptable terms for either jurisdiction because SangStat believes cyclosporine is an important product for Novartis and that Novartis would not want to diminish its profits from this product by licensing it to SangStat on acceptable terms. Failure to obtain any such required license could prevent SangStat from selling SangCya Oral Solution entirely in the United States, the United Kingdom, or any country in which SangStat attempts to launch SangCya Oral Solution, which would harm SangStat's future revenues. With respect to the FDA lawsuit, SangStat would retain its approval but lose its AB rating. If SangCya Oral Solution was no longer AB-rated to Neoral, pharmacists could not automatically substitute SangCya Oral Solution for Neoral and this would harm revenues. 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.
11. Subsequent Event
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 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.
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 the Management's Discussion and Analysis of Financial Condition and Results of Operations included in 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) our strategy; (ii) the anticipated timing of our regulatory filings; (iii) other product development efforts that we intend to undertake; (iv) the growth of our product sales and markets; (v) the results of our litigation with Novartis; (vi) our future revenue and expenses, including our expectations regarding liquidity; and (vii) changes in our internal systems.
Results of Operations - Three Months Ended March 31, 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, two principal product candidates 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 the outcomes and lower the costs of transplants. 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. During the first quarter of fiscal 2000, we continued to market and sell our two lead products, prepared for the launch of a cyclosporine capsule product, conducted clinical studies on these and other products and continued the development of The Transplant Pharmacy.
Total revenues. Total revenues consist of net sales of transplantation products and transplantation services. Total revenues were $15,940,000 for the three months ended March 31, 2000, an increase of $5,412,000 or 51% over total revenues of $10,528,000 for the three months ended March 31, 1999.
Net sales of transplantation products for the three months ended March 31, 2000 were $11,798,000, an increase of $4,323,000 or 58% over net sales of $7,475,000 for the three months ended March 31, 1999. The increase was due primarily to increased sales of Thymoglobulin and SangCya in the United States. Sales of transplantation products in Europe for the quarter ended March 31, 2000 were slightly lower than sales for the quarter ended March 31, 1999. Although sales measured in local currencies increased compared to the prior year quarter, 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.
Net sales of transplantation services for the three months ended March 31, 2000 were $4,142,000, an increase of $1,089,000 or 36% over sales of $3,053,000 for the three months ended March 31, 1999. The increase in net sales was due primarily to an increase in the number of patients serviced by The Transplant Pharmacy. Net sales for all periods consisted entirely of drug sales to transplant patients.
Cost of sales and manufacturing. Total cost of sales and manufacturing expenses consist of cost of sales and manufacturing expenses of transplantation products and transplantation services. Total cost of sales were $7,857,000 for the three months ended March 31, 2000, an increase of $2,016,000 or 35% over total cost of sales of $5,841,000 for the three months ended March 31, 1999.
Cost of sales and manufacturing expenses for transplantation products were $4,288,000 for the three months ended March 31, 2000, an increase of $1,086,000 or 34% over cost of sales and manufacturing expenses of $3,202,000 for the three months ended March 31, 1999. The increase was primarily due to the increase in sales of transplantation products, especially Thymoglobulin.
Cost of sales for transplantation services for the three months ended March 31, 2000 were $3,569,000, an increase of $930,000 or 35% over cost of sales of $2,639,000 for the three months ended March 31, 1999. The increase in cost of sales was due primarily to the increase in sales of The Transplant Pharmacy. Cost of sales 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 were $3,978,000 for the three months ended March 31, 2000, a decrease of $254,000 or 6% over research and development expenses of $4,232,000 for the three months ended March 31, 1999. Although spending declined slightly from the prior year quarter as clinical trials on SangCya and Thymoglobulin were completed, we started several new development programs, including pursuing label expansion of Thymoglobulin and pre-clinical work on RDP58, a product in development that inhibits synthesis of TNF-alpha.
Selling, general and administrative. Selling, general and administrative expenses for the three months ended March 31, 2000 were $11,164,000, an increase of $1,194,000 or 12% over selling, general and administrative expenses of $9,970,000 for the three months ended March 31, 1999. The increase in expenses is due primarily to higher legal expenses associated with the Novartis lawsuit. These expenses are expected to continue throughout fiscal 2000.
Interest income (expense) - net. Interest income (expense) - net for the three months ended March 31, 2000 was an expense of $321,000, net of interest capitalized of $50,000, compared to income of $23,000 for the three months ended March 31, 1999. The increase in expense in the first quarter of 2000 reflected additional interest on the notes payable to Aventis and Abbott Laboratories, and the convertible debt issued in March 1999.
Income taxes. For the three months ended March 31, 2000, we recorded a provision of $61,000 for European income taxes based upon taxable income of our European affiliates in the first quarter of 2000. For the three months ended March 31, 1999, we recorded a tax benefit of $126,000 based on losses of our European affiliates for the first quarter of fiscal 1999.
Net loss. Net loss consists of net loss of transplantation products and transplantation services. Net loss was $7,789,000 for the three months ended March 31, 2000, a decrease of $1,934,000 or 20% compared to net loss of $9,723,000 for the three months ended March 31, 1999.
Net loss for transplantation products for the three months ended March 31, 2000 was $7,094,000, a decrease of $2,117,000 or 23% compared to the net loss of $9,211,000 for the three months ended March 31, 1999. The decrease in net loss was due primarily to the increase in sales net of related cost of sales, partially offset by increases in selling, general and administrative expenses.
Net loss for transplantation services for the three months ended March 31, 2000 was $695,000, an increase of $183,000 or 36% compared to the net loss of $512,000 for the three months ended March 31, 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 three months of 2000 and 1999, the net cash used in operating activities was approximately $5,411,000 and $13,855,000, respectively. The decrease in net cash used in operating activities in the first three months of fiscal 2000 was due substantially to more stable inventory levels and an increase in accrued liabilities, partially offset by net milestone payments to Abbott under the cyclosporine co-promotion agreement. As of March 31, 2000, the Company had cash, cash equivalents and short-term investments of $34,087,000 and total assets of $123,293,000.
Net cash provided by investing activities for the three months ended March 31, 2000 was $254,000 as compared to $3,452,000 for the comparable quarter in 1999. The amount in 2000 is primarily the result of the maturity of short-term investments, partially offset by purchases of property and equipment and other assets. In 1999, cash was provided by maturing short-term investments and a reduction in other assets.
Net cash provided by financing activities for the three months ended March 31, 2000 was $14,696,000 as compared to net cash provided of $10,496,000 for the same period in 1999. In February 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 proceeds of $15,000,006. The Company intends to use the proceeds to fund future working capital requirements. In March 1999, net cash provided by financing activities came primarily from the issuance of a $10 million convertible note due March 30, 2004.
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 and Abbott will share marketing, promotional and development expenses as well as the profits from the co-promotion of these two products. 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 $15.8 million, including $1.9 million received in January 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. 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. Under the terms of the agreement, the Company may also receive an additional $5 million in milestone payments, contingent upon receiving regulatory approval for the cyclosporine capsule. 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.
In April 2000, the Company signed an agreement with FINOVA Capital Corporation 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, 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 the opinion of management, the Company 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. The Company is currently assessing the issues raised by the introduction of the Euro. The Company has made and expects to continue to make changes to its internal systems in preparation for the transition to the Euro. The Company further expects that use of the Euro may affect the Company's foreign exchange activities and may result in increased fluctuations in foreign currency results. Any delays in the Company's ability to be Euro-compliant could have an adverse impact on the Company's 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 March 31, 2000, our accumulated deficit was $141,066,000. 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 23.3 million for the three months ended March 31, 2000. Total revenues increased from approximately $4.5 million to $19.7 million to $58.2 million over the three year period ended December 31, 1999 and were $15.9 million for the three months ended March 31, 2000. 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. Losses from operations for the three months ended March 31, 2000 were $7.4 million. 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 SangCya Oral Solution.
We may elect to raise additional funds within the next 12 months. Within the next twelve months, we may elect 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. To raise funds, we may also be required to sell shares of our common stock, which may be at prices below the price at which you may have purchased shares. Such sales would also constitute a dilution of your percent ownership of SangStat.
Our future growth depends on sales of key products. We expect to derive most of our future revenues from sales of the cyclosporine capsule, Thymoglobulin and SangCya Oral Solution. We have limited experience selling our products. Our sales of SangCya Oral Solution and Thymoglobulin began in 1998 and 1999, respectively. We have not yet begun selling our cyclosporine capsules. We will be marketing cyclosporine capsules in the United States under a co-promotion agreement with Abbott Laboratories. We cannot guarantee that Abbott will effectively perform under the agreement, and their failure to do so may delay regulatory approval and product launch. We also will not be the first generic cyclosporine capsule approved; Eon's generic cyclosporine capsule was approved in February 2000, but to the best of our knowledge, Eon has not yet launched its product.
Any factor adversely affecting the regulatory approval or sale of these 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 SangCya Oral Solution and cyclosporine capsules, 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.
Our litigation with Novartis may be resolved adversely and will be a drain on time and resources. We are involved in significant litigation with Novartis regarding our SangCya Oral Solution. See "Part II, Item 1 - Legal Proceedings." The course of litigation is inherently uncertain and we may not achieve a favorable outcome. As a result of the Novartis suits, we could be enjoined from selling SangCya Oral Solution for a significant period of time or ultimately be prevented from selling SangCya Oral Solution in the United States, the United Kingdom or any country in which we attempt to launch SangCya Oral Solution. Should this happen, we do not believe we would be able to obtain a license from Novartis on acceptable terms in any country because we believe cyclosporine is an important product for Novartis and that Novartis would not want to diminish its profits from this product by licensing it to us on acceptable terms. Failure to obtain any such required license could prevent us from selling SangCya Oral Solution entirely in the United States, the United Kingdom, or any country in which we attempt to launch SangCya Oral Solution, which would harm our future revenues. The litigation, whether or not resolved favorably to us, is likely to be expensive, lengthy and time consuming, and divert management's attention.
A slower product launch has created excess perishable inventories. Due to the inherent uncertainty of the timing of the SangCya Oral Solution approval and the concern over having insufficient inventory for the launch of SangCya Oral Solution, we manufactured large quantities of SangCya Oral Solution well in advance of the approval date. In the third and fourth quarters of 1999, we have written off $1.9 million. While demand for SangCya Oral Solution is growing, we may not sell this entire inventory prior to lot expiration. In addition, we also have significant amounts of bulk cyclosporine active ingredient, which we are not using for manufacturing finished product in the amount anticipated. We could write off portions of both our finished product and bulk active ingredient inventory 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 SangCya, Sang- 2000, or Thymoglobulin. We have contracted for commercial scale production of cyclosporine bulk material, the active ingredient of cyclosporine, for SangCya Oral Solution and Sang-2000, from Gensia Sicor and Abbott Laboratories. Gensia 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. Since the acquisition, all batches of Thymoglobulin have met manufacturing specifications; however even after the acquisition, 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 approvals, 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 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 SangCya Oral Solution and capsules without infringing patent or other proprietary rights of Novartis or other third parties. We have been sued by Novartis for patent infringement. See "Part II, Item 1 - Legal Proceedings."
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 will be 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 modify The 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 SangCya Oral Solution and cyclosporine capsules 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.
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.
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
US Patent Litigation
On February 11, 1999, Novartis Pharmaceuticals Corporation ("Novartis US") filed a lawsuit (case number 99-065) in Federal District Court for the District of Delaware against the Company alleging infringement of United States patent #5,389,382, a cyclosporine technology patented by Novartis A.G. (the "US Patent"). The Novartis A.G. patent does not cover Novartis' Neoral product but rather a separate delivery system not used in the Neoral formulation. Novartis US seeks the following relief: (i) a finding that SangStat willfully infringed the patent; (ii) to permanently enjoin Sangstat from infringing the US Patent; (iii) treble damages; and (iv) reasonable attorneys' fees, costs and expenses.
On April 15, 1999, the Company filed its answer in this case and also filed a counterclaim against Novartis alleging that Novartis violated the anti-trust laws by engaging in a series of anti-competitive acts designed and intended to exclude the Company from the market. Novartis filed a motion to separate the anti-trust counterclaim and to stay discovery relating to that counterclaim. On March 30, 2000 the Court denied Novartis' motion, which means that both the patent and the anti-trust claims will be tried at the same time and the same jury will decide both claims. The trial date is October 23, 2000 and discovery is continuing.
UK Patent Litigation
On July 9, 1999, Novartis AG and Novartis Pharmaceuticals UK Limited ("Novartis UK") filed an action against IMTIX- SangStat (UK) Limited; SangStat UK, Limited, and SangStat Medical Corporation (collectively, the "UK Defendants") in the High Court of Justice, Chancery Division, Patents Court, London (HC-1999-02988) alleging infringement of United Kingdom Patent No 2 200 048 (the "UK Patent"), the counterpart to the US Patent. The lawsuit mirrors the US patent infringement lawsuit. Novartis AG and Novartis UK seek the following relief: (i) an injunction to restrain the UK Defendants from infringing the UK Patent; (ii) the delivery up or destruction of all material that would infringe such injunction; (iii) damages; (iv) a declaration that the UK Patent is valid, and has been infringed by the UK Defendants; and (v) costs. No trial date has been set at this time though the parties have agreed that the trial will not be scheduled before March 31, 2001.
Germany Patent Litigation
In January 2000, SangStat filed a Nullity Action in the German Federal Patents Court in Munich Germany seeking to invalidate German Patent 37 42 473, which is the German counterpart to the patent that Novartis is suing us on in the United States and the United Kingdom. If SangStat prevails in this nullity action, the patent would be invalidated, which would render any infringement action that Novartis might bring in Germany moot.
Regulatory Litigation
US Regulatory Litigation
Novartis US also 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. Loss of the AB rating would prevent SangCya Oral Solution from being automatically substitutable for Neoral oral solution, which would impede the marketing of SangCya Oral Solution. SangStat does not believe that this lawsuit will impact the regulatory approval of Sang-2000 in the US.
In November 1999, Novartis filed a motion with the court requesting a preliminary injunction to block the FDA from enforcing its order requiring Novartis to change the labeling of its Neoral product line to make it consistent with the established name and descriptor for the product class: Cyclosporine Oral Solution, USP [MODIFIED]). At a hearing on December 7, 1999, the court rejected Novartis' motion for a preliminary injunction and ordered that the FDA may proceed to require Novartis to change its labeling. SangStat does not know if and when the FDA will require Novartis to change the Neoral labeling on the products, but recent advertising for Neoral has used the new labeling. FDA and SangStat have filed a motion for summary judgment but the court has not yet ruled on the motion.
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 requested permission from the Court of Appeals to appeal the High Court's decision. If such request is granted, then a hearing will take place before the Court of Appeals in late 2000 or early 2001. 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.
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. If Novartis does not seek permission to appeal the High Court's decision on SangCya Oral Solution or if Novartis seeks such permission and it is not granted, then there has been a final resolution of the judicial review of the SangCya Oral Solution marketing authorization. In such event, the judicial review with respect to the granting of the Sang-2000 marketing authorization will progress.
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 because Novartis would not, based on the facts known to date, be able to demonstrate a substantial likelihood of success on the merits of its claim. If the Court of Appeals agrees to hear Novartis' appeal and subsequently rules in Novartis' favor, Novartis may be more likely to obtain an injunction with respect to Sang-2000.
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 the MRP, 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.
SangStat believes that these lawsuits are without merit and that the 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 Novartis patent suits and the UK judicial review, SangStat could be enjoined from selling SangCya Oral Solution for a significant period of time or ultimately be prevented from selling SangCya Oral Solution in the United States, the United Kingdom or any country in which SangStat attempts to launch SangCya Oral Solution. Should this happen, SangStat does not believe that it would be able to obtain a license from Novartis on acceptable terms for either jurisdiction because SangStat believes cyclosporine is an important product for Novartis and that Novartis would not want to diminish its profits from this product by licensing it to SangStat on acceptable terms. Failure to obtain any such required license could prevent SangStat from selling SangCya Oral Solution entirely in the United States, the United Kingdom, or any country in which SangStat attempts to launch SangCya Oral Solution, which would harm SangStat's future revenues. With respect to the FDA lawsuit, SangStat would retain its approval but lose its AB rating. If SangCya Oral Solution was no longer AB-rated to Neoral, pharmacists could not automatically substitute SangCya Oral Solution for Neoral and this would harm revenues. 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
(c) On February 15, 2000 we sold 451,128 shares of our common stock to BioPharma Equities Holdings NV at a price of $33.25 per share. The aggregate offering price was $15,000,006 and was paid in cash. This sale was made pursuant to the exemption from registration set forth in Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), as this sale was to one private party, and the purchaser represented their intention to acquire these shares for their own account and not with a view to any distribution thereof to the public. The certificate evidencing these shares bears a legend stating that the shares are not to be offered, sold or transferred other than pursuant to an effective registration statement under the Securities Act or an exemption from its registration requirements. This transaction did not involve an underwriter, underwriter's discount or commissions.
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 |
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| 3.5 | Second Amended and Restated Bylaws |
| 10.33 | Loan and Security Agreement between us and Finova Capital Corporation dated as of April 21, 2000 |
| 27.1 | Financial Data Schedule |
(b) We filed a Current Report on Form 8-K on February 28, 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: May 15, 2000
| By: | /s/ STEPHEN G. DANCE |
|
| |
| Stephen G. Dance | |
| Senior Vice President,Finance | |
| (Principal Financial Officer) |
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