SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended March 31, 1999
[ ] 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 0-24760
Orphan Medical, Inc.
--------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-1784594
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
13911 Ridgedale Drive, Suite 475,
Minnetonka, MN 55305 (612) 513-6900
-------------------- --------------
(Address of principal executive offices (Registrant's telephone number,
and zip code) 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, 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 practical date.
Common Stock, $.01 par value 6,562,707
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(Class) (Outstanding at April 30, 1999)
<PAGE>
INDEX
ORPHAN MEDICAL, INC.(R)
(A Development Stage Company)
Page No.
--------
PART I. FINANCIAL INFORMATION
- -----------------------------
Item 1. Financial Statements (Unaudited)
Balance Sheets - March 31, 1999 and December 31, 1998. 3
Statements of Operations - Three months ended March 31, 1999 and
March 31, 1998. 4
Statements of Cash Flows - Three months ended March 31, 1999 and
March 31, 1998. 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 8
Item 3. Quantitative and Qualitative Disclosures about Market Risks 12
PART II. OTHER INFORMATION
- --------------------------
Items 1 through 4 have been omitted since all items are inapplicable
or answers negative.
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 13
Signature 14
Antizol(R), Antizol-Vet(R), Caprogel(TM), Busulfex(TM), Intrachol(TM),
Colomed(TM), Cystadane(R), Elliotts B(R) Solution, Sucraid(R), Xyrem(TM), "The"
Orphan Drug Company(TM), Orphan Medical(R), Inc. and Dedicated to Patients with
Uncommon Diseases(R) are trademarks of the Company.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BALANCE SHEETS
ORPHAN MEDICAL, INC.
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
ASSETS (Unaudited) (Note)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,154,069 $ 2,980,342
Available-for-sale securities 4,031,557 4,541,141
Accounts receivable, less allowance for doubtful
accounts and returns of $96,167 and $48,620 596,990 989,339
Other receivables 29,348 6,925
Inventories 128,270 112,725
Prepaid expenses 91,622 115,231
------------ ------------
Total current assets 7,031,856 8,745,703
Property and equipment:
Property and equipment 576,013 556,358
Accumulated depreciation (282,101) (255,331)
------------ ------------
293,912 301,027
------------ ------------
Total assets $ 7,325,968 $ 9,046,730
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 708,291 $ 586,816
Accrued outdated product return allowance 370,203 304,582
Accrued expenses 2,164,954 2,579,755
------------ ------------
Total current liabilities 3,243,448 3,471,153
Commitments
Shareholders' equity:
Senior Convertible Preferred Stock, $.01 par value; 14,400
shares authorized; 7,798 and 7,500 shares issued and
outstanding, respectively 78 75
Common Stock, $.01 par value; 25,000,000 shares
authorized; 6,562,707 and 6,560,096 shares issued and
outstanding, respectively 65,627 65,601
Additional paid-in capital 40,270,387 39,946,113
Deficit accumulated during the development stage (36,253,552) (34,433,640)
------------ ------------
4,082,540 5,578,149
Unrealized gain (loss) on available-for-sale securities (20) (2,572)
------------ ------------
Total shareholders' equity 4,082,520 5,575,577
------------ ------------
Total liabilities and shareholders' equity $ 7,325,968 $ 9,046,730
============ ============
</TABLE>
NOTE: THE BALANCE SHEET AT DECEMBER 31, 1998 HAS BEEN DERIVED FROM THE AUDITED
FINANCIAL STATEMENTS AT THAT DATE BUT DOES NOT INCLUDE ALL OF THE INFORMATION
AND FOOTNOTES REQUIRED BY GENERALLY ACCEPTED ACCOUNTING PRINCIPLES FOR COMPLETE
FINANCIAL STATEMENTS.
SEE ACCOMPANYING NOTES.
3
<PAGE>
STATEMENTS OF OPERATIONS
ORPHAN MEDICAL, INC.
(Unaudited)
For the Three Months Ended
------------------------------
March 31, March 31,
1999 1998
------------ ------------
Revenues $ 1,401,839 $ 1,613,079
Cost of sales 248,925 308,540
------------ ------------
Gross Profit 1,152,914 1,304,539
Operating expenses:
Research and development 1,308,763 1,795,678
Sales and marketing 737,985 611,288
General and administrative 713,025 569,074
------------ ------------
Total operating expenses 2,759,773 2,976,040
------------ ------------
Loss from operations (1,606,859) (1,671,501)
Other income:
Interest, net 85,920 20,142
------------ ------------
Net loss (1,520,939) (1,651,359)
Less: Preferred stock dividends 142,250 --
------------ ------------
Net loss attributable to common
shareholders $ (1,663,189) $ (1,651,359)
============ ============
Basic and diluted loss per
common share $ (0.25) $ (0.27)
============ ============
Weighted average number of
shares outstanding 6,597,995 6,107,496
============ ============
SEE ACCOMPANYING NOTES.
4
<PAGE>
STATEMENTS OF CASH FLOWS
ORPHAN MEDICAL, INC.
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended
------------------------------
March 31, March 31,
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (1,520,939) $ (1,651,359)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 26,770 22,986
Compensatory options 51,196 --
Changes in operating assets and liabilities:
Accounts payable and accrued expenses (227,705) 54,003
Inventories (15,545) 49,552
Accounts receivable and current assets 393,345 (331,538)
------------ ------------
Net cash used in operating activities (1,292,878) (1,856,356)
INVESTING ACTIVITIES
Purchase of office equipment (19,665) (23,713)
Purchases of short-term investments (2,487,558) (2,046,395)
Maturities of short-term investments 2,999,694 5,057,000
------------ ------------
Net cash provided by (used in) investing activities 492,471 2,986,892
FINANCING ACTIVITIES:
Chronimed Inc. obligation -- (344,227)
Stock option exercise proceeds 651,670 108,312
Stock issued to Chronimed -- 367,068
Common stock redeemed (676,563) --
Cash dividends (973) --
------------ ------------
Net cash provided by financing activities (25,866) 131,153
------------ ------------
Increase (decrease) in cash and cash equivalents (826,273) 1,261,689
Cash and cash equivalents at beginning of
period 2,980,342 2,150,877
------------ ------------
Cash and cash equivalents at end of
period $ 2,154,069 $ 3,412,566
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest received $ 74,210 $ 192,039
============ ============
</TABLE>
SEE ACCOMPANYING NOTES
5
<PAGE>
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
Orphan Medical, Inc. (the "Company") acquires, develops, and markets products of
high medical value intended to address inadequately treated or uncommon diseases
within selected strategic therapeutic market segments. A drug has high medical
value if it offers a major improvement in the safety or efficacy of patient
treatment and has no substantial equivalent substitute. The Company has six
products that have been approved for marketing by the Food and Drug
Administration (the "FDA") and is currently developing one potential product.
The Company expects to seek additional products for development. In the first
quarter of 1999, the Company considered itself to no longer be in the
development stage.
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, these financial statements do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal, recurring accruals) considered necessary for fair presentation have
been included. Operating results for the three month period ended March 31, 1999
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1999. For further information, refer to the audited financial
statements and accompanying notes contained in the Company's Annual Report filed
on Form 10-K for the year ended December 31, 1998.
2. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
3. COMMITMENTS
The Company has various commitments under agreements with outside consultants,
contract drug development companies, manufacturers, technical service companies,
license and research agreements, and agreements with drug distributors.
Expenditures incurred under these commitments and reported as research and
development expense totaled approximately $464,000 for the three month period
ended March 31, 1999. At March 31, 1999, the Company estimates that it could
incur approximately $1,502,000 of additional expenditures in subsequent periods
under existing commitments. Commitments for research and development
expenditures will likely fluctuate from quarter to quarter and from year to year
depending on, among other factors, the timing of product development and the
progress of clinical development programs.
6
<PAGE>
4. BORROWINGS
The Company has a commercial revolving line of credit with a bank, which expires
on May 15, 1999. The maximum amount available to the Company under this
arrangement is $500,000, subject to certain limitations. The Company's
indebtedness to the bank may not exceed the lesser of (1) 75 percent of the
Company's trade accounts receivable that have been outstanding for 90 days or
less or (2) $500,000. In addition, the Company must maintain a minimum balance
of at least $250,000 in accounts which the bank controls. Advances are charged a
variable rate of interest equal to the prime rate plus one half of a percent.
Through March 31, 1999, the Company has not borrowed under this arrangement.
5. RECLASSIFICATIONS
Certain prior period balances have been reclassified in order to conform with
the presentation for the three ended March 31, 1999. These reclassifications
have no impact on the net loss or shareholders' equity as previously reported.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
THREE MONTHS ENDED MARCH 31, 1999 VS. THREE MONTHS ENDED MARCH 31, 1998
CAUTIONARY STATEMENT
This Quarterly Report on Form 10-Q contains statements that are not descriptions
of historical facts. The words or phrases "will likely result", "look for", "may
result", "will continue", "is anticipated", "expect", "project", or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
may be forward-looking statements that are subject to risks and uncertainties.
Actual results could differ materially from those currently anticipated due to a
number of factors, including those identified in the Company's "Cautionary
Statements" on Exhibit 99 to this Quarterly Report filed on Form 10-Q for the
quarterly period ended March 31, 1999.
GENERAL
Orphan Medical, Inc. was incorporated on June 17, 1994 in order to carry on the
business previously conducted by the Orphan Medical Division of Chronimed, Inc.
("Chronimed"). The Company's activities have consisted primarily of obtaining
the rights for pharmaceutical products, hiring the personnel required to
implement the Company's business plan, managing the development of these
products, preparing for the commercial introduction of six products and fund
raising. At March 31, 1999, six of the Company's products have been approved by
the Food and Drug Administration ("FDA") for marketing and are commercially
available and one product was in active development. The Company has not
generated sufficient levels of revenue from its approved products to date to
fund its operating activities and has sustained significant operating losses
each year since inception. In addition, the Company expects operating losses to
continue through 1999.
Net loss applicable to common shareholders of $1,663,189 in the 1999 first
quarter compares with a net loss of $1,651,359 in the 1998 first quarter. The
slight increase in the loss results principally from lower research and
development spending for Busulfex, which was offset by higher research and
development spending for Xyrem. In addition, the Company had higher sales and
marketing spending for Busulfex as a result of the commercialization of the
product in February 1999. The Company also had increased general and
administrative expense resulting from compensation expense associated with
staffing increases. A preferred stock dividend, which did not exist in the
comparable period of 1998, increased the net loss applicable to common
shareholders in the current quarter.
Net sales decreased 13% from $1,613,079 in the 1998 first quarter to $1,401,839
in the 1999 first quarter. The decline in net sales reflects the end of the
initial stocking period for Antizol. During the quarter the Company began the
commercialization of Busulfex. Sales of Busulfex in the quarter are consistent
with the Companies expectations. The
8
<PAGE>
Company expects sales of Busulfex to increase in future periods, because more
hospitals will include Busulfex in the treatment protocol. The sales of Antizol
will be at lower levels on an annualized basis because future orders will most
likely be based on use or as poisonings occur. Sales of Elliotts B Solution,
Cystadane, Antizol-Vet, Antizol, and Sucraid are consistent with the Company's
expectations for 1999.
Gross profit margins increased slightly to 82% for the 1999 quarter compared to
81% for the 1998 quarter. Cost of sales decreased 19% from $308,540 in the 1998
first quarter to $248,925 in the 1999 first quarter. The decrease in cost of
sales compared to the prior year is primarily the result of a decline in net
sales in the first quarter 1999 and also the write-off of excess inventories in
the prior year. Cost of sales as a percentage of net sales will fluctuate from
quarter to quarter and from year to year depending on, among other factors,
demand for the Company's products, new product introductions and the mix of
approved products shipped.
Research and development expense decreased by 27% from $1,795,678 in the 1998
first quarter to $1,308,763 in the 1999 first quarter. The decrease is the
result of lower research and development spending for Busulfex offset by
increased spending for Xyrem. In addition, the prior year's quarter included
research and development spending on products whose clinical trials have been
concluded. The Company expects research and development expense to increase
significantly over current levels in subsequent quarters due to an acceleration
of the development plans for Xyrem. In February 1999, the Company began shipping
Xyrem for use in its Treatment IND trial and expects to charge enrolled patients
for the drug utilized in the trial. Any income generated by the Treatment IND,
which is not expected to be material, will be used to offset development
expense. Clinical spending for Xyrem will continue to be dependent on a number
of factors, including among others: the number of human subjects required for a
trial, the number of human subjects screened and enrolled in a trial, and the
number of active clinical sites.
Sales and marketing expense increased by 21% from $611,288 in the 1998 first
quarter to $737,985 in the 1999 first quarter. This increase is largely
attributable to significantly higher spending related to the commercialization
of Busulfex in February 1999. Sales and marketing expenses will likely increase
in subsequent quarters.
General and administrative expense increased by 25% from $569,075 in the 1998
first quarter to $713,025 in the 1999 first quarter. This increase is
principally related to increased salary expense resulting from staffing
increases and salary adjustments. General and administrative expenses are not
expected to increase significantly in subsequent quarters.
Other income is the sum of interest income from investment activities less
interest expense from financing activities. Other income increased 327% from
$20,142 in the 1998 first quarter to $85,920 in the 1999 first quarter. This
increase is the result of additional invested funds from the successful
preferred stock offering in the third quarter of 1998 and the settlement of the
Company's obligation to Chronimed in December 1998. Other
9
<PAGE>
income is expected to decline in subsequent quarters as currently invested funds
are used to fund Xyrem development activities, and for working capital
requirements.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that
was issued on July 23, 1998 and has a dividend rate of 7.5%. Preferred stock
dividends commenced on February 1, 1999 and were $142,250 in the 1999 first
quarter. Preferred stock dividends are payable in arrears, when and as declared
by the Company's Board of Directors on August 1 and February 1 of each year. The
Company intends to satisfy its dividend payment obligations by the issuance of
additional preferred stock through August 1, 2000, which will cause preferred
stock dividends to increase in subsequent quarters.
LIQUIDITY AND CAPITAL RESOURCES
Since July 2, 1994, the effective date the Company was spun-off from Chronimed,
it has financed its operations principally from initial working capital
balances, the net proceeds from the 1995 and 1996 public offerings, the net
proceeds from the 1998 private placement, interest income and product sales. The
1995 and 1996 public offerings, and the 1998 private placement, resulted in
aggregate net proceeds, after commissions and expenses, of $30,714,701.
Net working capital (current assets less current liabilities) decreased from
$5,274,549 at December 31, 1998 to $3,788,608 at March 31, 1999. Cash and cash
equivalents, and available-for-sale securities decreased from $7,521,483 at
December 31, 1998 to $6,185,627 at March 31, 1999. The Company continues to
invest its excess cash in interest-bearing, investment grade securities. The
Company has a $500,000 commercial revolving line of credit with a bank, expiring
on May 15, 1999. The Company expects to renew this facility on substantially
similar terms.
The Company's commitments for outside development spending decreased from
approximately $3,350,000 at December 31, 1998 to approximately $1,502,000 at
March 31, 1999. The $1,848,000 decrease resulted principally from the
commercialization of Busulfex. The Company expects future commitments for Xyrem
to increase significantly over current levels.
The Company has experienced recurring losses from operations since inception,
with continuing losses expected through at least the end of fiscal 1999. The
Company believes that its current working capital and anticipated gross profits
from product sales will be sufficient to fund its operations through December
31, 1999. These assumptions are based upon the Company substantially increasing
development expenses and revenues from the sale of its six marketed products.
These conditions give rise to the question about the Company's ability to
generate positive cash flow and fund operations. Any material reduction in
projected revenues will require the Company to seek additional equity or debt
financing or substantially reduce the Company's expense structure through
reductions in personnel and development.
10
<PAGE>
The Company's ability to raise additional capital and/or raise capital on
acceptable terms could be negatively affected in the event it no longer meets
the Nasdaq's requirements for continued listing on the NASDAQ National Market.
For continued listing on the Nasdaq National Market, a company must satisfy a
number of requirements, which in the Company's case includes either: (1) net
tangible assets in excess of $4,000,000 as reported on Form 10-Q or Form 10-K or
(2) a market capitalization of at least $50,000,000. At March 31, 1999, the
Company's net tangible assets equaled $4,082,520 and its market capitalization
was approximately $47.6 million (based on the last sale price of $7.25 and
6,562,707 shares outstanding). Net tangible assets are defined as total assets,
less any intangible assets, less total liabilities. The Company estimates that
it will have net tangible assets less than $4.0 million, but exceed $2.0 million
on or around June 30, 1999. The Company is currently seeking additional capital
to ensure compliance with the Nasdaq requirements and maintain its Nasdaq
listing. As long as the Company meets at least one of the aforementioned Nasdaq
listing requirements, the Company's Common Stock would qualify for listing on
the Nasdaq National Market. If the Company did not meet either of the Nasdaq
requirements, the Company would qualify for quotation on the Nasdaq Small Cap
Market provided it had net tangible assets in excess of $2.0 million.
IMPACT OF YEAR 2000 READINESS ISSUE
The Company has assessed and continues to assess the impact of the so called
"Year 2000 Readiness Issue" on its reporting systems and operations. The Year
2000 Readiness Issue relates to the ability of computer hardware, software, and
firmware products to accurately process date/time data (including calculating,
comparing, and sequencing) from, into, and between the twentieth and
twenty-first centuries, and the years 1999 and 2000 and leap year calculations.
The Year 2000 Readiness Issue also relates to the ability to properly exchange
time/date data between such products. When the year 2000 occurs, systems that
are not year 2000 compliant might recognize the year 2000 as the year 1900, or
not at all. This inability to recognize or properly treat the year 2000 may
cause the Company's systems, or the systems used by its suppliers, distributors,
customers or regulatory agencies (i.e., FDA) to process critical financial and
operational information incorrectly, or not at all.
The Company's information technology ("IT") systems consist of computer hardware
systems and software applications supplied by third parties. The Company's
strategy has been to replace its IT systems with current technology, which is
both year 2000 compliant and more efficient. The Company has also purchased and
implemented financial and operational software upgrades that are year 2000
compliant. For the three months ended March 31, 1999, the Company IT system
purchases have not been material. The Company's IT systems are year 2000
compliant.
The Company's assessment of internal systems includes a review of
non-information technology ("non IT") systems. This assessment includes a review
of the Company's internal equipment and facilities. Based upon this review, the
Company believes that its processes and equipment are year 2000 compliant.
11
<PAGE>
The Company has identified third parties with which it has material
relationships, including suppliers, distributors and other key vendors of
materials and services. The Company has confirmed with these parties or
organizations that they have implemented Year 2000 Readiness Programs. The
Company has not developed a contingency plan to provide for continuity of
business operations in the event material third parties experience a disruption
of service due to the Year 2000 Readiness Issue, which could include, but not
limited to, loss of electricity, loss of communications (data and voice), and
loss of transportation services. However, even if all material third parties
confirm that they are or expect to be year 2000 compliant by December 31, 1999,
it is not possible to state with certainty that such parties will be compliant.
If the Company's remediation plan is not successful, or if third party systems
on which the Company relies should fail, there could be a significant disruption
of the Company's ability to transact business with its customers and suppliers.
It is impossible to fully assess the potential consequences in the event service
interruptions from suppliers occur or in the event that there are disruptions in
such infrastructure areas as utilities, communications, transportation, banking
and government.
Item 3. Quantitative and Qualitative Disclosures about Market Risks
Not Applicable
12
<PAGE>
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 5. Other Information
On February 22, 1999, the Company announced that it received permission from the
Food and Drug Administration (FDA) for commercial shipment of Busulfex. The
Company began shipments 18 days after receiving approval from the FDA.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT INDEX
- ---------------- ------------------------------------------------- -------------
Exhibit Sequentially
Number Description Numbered Page
- ---------------- ------------------------------------------------- -------------
27 Financial Data Schedule - For SEC EDGAR filing 16
- ---------------- ------------------------------------------------- -------------
99 Cautionary Statements 15
- ---------------- ------------------------------------------------- -------------
(b) Reports on Form 8-K
Not applicable
13
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Orphan Medical, Inc.
--------------------
Registrant
Date May 14, 1999 By /s/ John H. Bullion
---------------- -------------------
John H. Bullion
Chief Executive Officer
(principal executive officer)
14
EXHIBIT 99
Page 1 of 9
ORPHAN MEDICAL, INC.
CAUTIONARY STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements to encourage companies to provide prospective
information without fear of litigation so long as statements are identified as
forward-looking and are accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those projected. The Company desires to take advantage of these
"safe harbor" provisions and is filing this Exhibit 99 in order to do so. The
words or phrases "will likely result", "look for", "may result", "will
continue", "is anticipated", "expect", "project", or similar expressions are
intended to identify forward-looking statements, and are subject to numerous
known and unknown risks and uncertainties. Actual results could differ
materially from those currently anticipated due to a number of factors,
including those identified in this Exhibit 99, and in the Company's other
filings with the Securities and Exchange Commission. The Company undertakes no
obligation to update or publicly announce revisions to any forward-looking
statements to reflect future events or developments.
LACK OF PROFITABLE OPERATIONS - OPERATING LOSSES WILL CONTINUE.
The Company has been unprofitable since its inception in January 1993. The
Company expects operating losses in 1999 because anticipated gross profits from
product revenues will not offset additional 1999 spending to advance the
development of Xyrem, and other operating expenses. The amount of these losses
may vary significantly from year-to-year and quarter-to-quarter and will depend
on, among other factors, the timing of product development, regulatory approval,
and market demand for its FDA approved products. There can be no assurance that
the Company will ever generate sufficient product revenues or achieve
profitability.
FUTURE CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE.
Research and development, and sales and marketing spending are expected to
increase significantly. The Company estimates that it will need to incur at
least an additional $8.0 million during the next two fiscal years in research
and development expense relating to the products it currently markets and to
advance the development of Xyrem. In addition, the Company commenced shipping
Busulfex to customers in February 1999 and, as a result, sales and marketing
spending is expected to increase significantly in subsequent quarters. However,
the Company has estimated that it would need to raise up to an additional $7.0
million of capital during 1999 to fully implement its current business plan,
including the Xyrem development plan, and to maintain its Nasdaq National Market
listing. Adequate funds for the Company's operations, whether from financial
markets or from other sources, may not be available when needed on terms
acceptable to the Company, or at all. Lack of funding would cause the Company to
delay or scale back some or all of its development plans for Xyrem, reduce
personnel and general office support spending, and sell or license of one or
more of its approved products.
DEPENDENCE ON LICENSE AND ACQUISITION STRATEGY.
The Company has adopted a license and acquisition strategy to build its product
portfolio. The Company's strategy for growth is dependent upon its continued
ability to identify and acquire new pharmaceutical products targeted at niche
markets within selected strategic therapeutic market segments ("STMS"). Because
the Company does not engage in proprietary research and development of new
pharmaceutical products, it must rely upon the willingness of others to sell or
license pharmaceutical product opportunities to the Company. Other companies,
including those with substantially greater resources, are competing with the
Company to acquire such products. There can be no assurance that the Company
will be able to acquire rights to additional products on acceptable terms, if at
all. The failure of the Company to acquire or license new pharmaceutical
products within a selected STMS or to promote and market commercially successful
products within an existing STMS could have a material adverse effect on the
Company's business and its prospects.
The Company has contractual production rights to certain compounds through
various license agreements. These agreements are generally terminable by the
licensor for cause upon short notice or in the event the Company is insolvent or
bankrupt, does not apply minimum resources and efforts to develop the compound
under license or does
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Page 2 of 9
not achieve certain minimum royalty payments. There can be no assurance that the
agreements will not be so terminated and, if terminated, that the Company will
be able to enter into similar agreements on terms as favorable to the Company as
those contained in its existing license agreements.
FOREIGN MARKETING ALLIANCES; NO ASSURANCE OF FOREIGN LICENSEES.
The Company's strategy for the exploitation of foreign markets is to license
foreign marketing and distribution rights after an NDA is submitted in the
United States. The Company considers Europe, Japan, and Canada its most
attractive foreign markets. The Company has licensed marketing and distribution
rights for Antizol, Cystadane and Sucraid in Europe; Cystadane and Sucraid in
Australia and New Zealand; Busulfex, Cystadane, Elliotts B Solution and Sucraid
in Israel; and Elliotts B Solution in Central America. Sales of Cystadane and
Sucraid in Australia and New Zealand and Elliotts B Solution in Central America
have not been nor are they expected to be material. Distribution of Antizol in
Europe and Busulfex in Israel will initially be done on a "named patient" or
"emergency use" basis until full regulatory approval is obtained, and the
Company does not expect such "emergency use" distribution to result in material
revenues. Distribution of Antizol in Europe and Busulfex in Israel through
normal or the usual distribution channels is expected to commence after the
first half of 1999. However, there can be no assurance that the Company will be
able to negotiate commercially acceptable license agreements for its other
products or in additional foreign countries, if at all, or that such
arrangements will be successful. The Company will be substantially dependent
upon the companies it has contracted with to date for the successful
distribution of Cystadane, Antizol, and Sucraid in Europe and, if these
companies are unsuccessful in their distribution efforts, it may be difficult
for the Company to contract with other distributors for these products within
Europe. The Company is also dependent on its foreign partners for the regulatory
registration of its products in foreign countries. There can be no assurance
that such registration can be obtained in foreign countries.
GOVERNMENT REGULATION; NEED FOR FDA AND OTHER REGULATORY APPROVALS.
Government regulation in the United States and abroad will be a significant
factor in the production, testing and marketing of the Company's current and
future products. Prior to marketing, each of the Company's products must undergo
an extensive regulatory approval process conducted by the United States Food and
Drug Administration (the "FDA") and by comparable agencies in other countries.
The approval process can take many years and require the expenditure of
substantial resources, and there can be no assurance that any product that the
Company may develop will be approved by the FDA or any foreign regulatory
authority in a timely manner, or at all. Generally, only a very small percentage
of newly discovered pharmaceutical compounds that enter pre-clinical development
are approved for sale. The Company will not be permitted to market any medicine
it may develop as a prescription product in any jurisdiction, including foreign
countries, in which the product does not receive regulatory approval. Once
approved, the Division of Drug Marketing, Advertising and Communication
("DDMAC"), the FDA's marketing surveillance department within the Center for
Drugs, must approve marketing claims, which are the basis for a product's
labeling, advertising and promotion. There can be no assurance that the claims
the Company is seeking will be approved by DDMAC. The failure to obtain
acceptable marketing claims on a product from DDMAC could have a material
adverse effect on the Company and its prospects.
The Company depends on external laboratories and medical institutions to conduct
its pre-clinical and clinical testing in compliance with clinical and laboratory
practices established by the FDA. The data obtained from pre-clinical and
clinical testing are subject to varying interpretations that could delay, limit
or prevent regulatory approval. In addition, delays or rejection may be
encountered based upon changes in FDA policy for drug approval during the period
of development and by the requirements for regulatory review of each submitted
New Drug Application ("NDA"). Moreover, even if the FDA approves a product, such
approval may entail commercially unacceptable limitations on the uses, or
"indications," for which a product may be marketed, and further studies may be
required to provide additional data on safety or effectiveness. The FDA also
requires post-marketing adverse event surveillance programs to monitor the
product's side effects.
An approved FDA product and the product's manufacturer are subject to continual
regulatory review and the subsequent discovery of previously unknown problems
with a product or manufacturer may result in restrictions or sanctions by the
FDA on such products or manufacturer, including the withdrawal of such product
from the market. Most changes in the manufacturing procedures for any of the
Company's approved products and any change in manufacturers will require the
approval of the FDA prior to their implementation. Obtaining the FDA's approval
for
<PAGE>
Page 3 of 9
a change in manufacturing procedures or change in manufacturers could cause
production delays and loss of sales, which would have a material adverse effect
on the Company's business and its prospects.
In certain countries, the sales price of a product must also be approved after
marketing approval is granted. No assurance can be given that satisfactory
prices can be obtained in foreign markets even if marketing approval is granted
by foreign regulatory authorities.
ORPHAN DRUG STATUS.
Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs
intended to treat a "rare disease or condition," which generally is a disease or
condition that affects populations of fewer than 200,000 people in the United
States. Orphan drug designation must be requested before submitting an NDA, and
after the FDA grants orphan drug designation, the generic identity of the
therapeutic agent and its potential orphan use are publicized by the FDA. Under
current law, orphan drug status is conferred upon the first company to receive
FDA approval to market the designated drug for the designated indication, which
also grants United States marketing exclusivity for a period of seven years
following approval by the NDA, subject to certain limitations. Orphan drug
designation does not convey any advantage in, or shorten the duration of, the
regulatory approval process. Moreover, although obtaining FDA approval to market
a product with orphan drug status can be advantageous, there can be no assurance
that the scope of protection or the level of marketing exclusivity that is
currently afforded by orphan drug status and marketing approval will remain in
effect in the future. In addition, NDA approval of a drug with an orphan drug
designation does not provide any marketing exclusivity in foreign markets.
Certain foreign countries provide development and marketing benefits to orphan
drugs, however, there can be no assurance that such benefits can be obtained or,
if obtained, will be of material value to the Company.
Of the Company's products, Xyrem has orphan drug designation, while Antizol,
Elliotts B Solution, Cystadane, Sucraid, and Busulfex have orphan drug status.
Sodium oxybate is the generic identity of the therapeutic agent for the
Company's proposed product, Xyrem. Orphan drug designation does not prevent
another pharmaceutical company from attempting to develop sodium oxybate for the
same designated indication as Xyrem or from obtaining the approval of an NDA for
their drug prior to the approval of an NDA for Xyrem. The Company is aware that
Teva (formerly Biocraft) has been granted orphan drug designation for the use of
sodium oxybate to treat the symptoms of narcolepsy. If another sponsor's NDA for
the same drug and the same indication is approved first, that sponsor is
entitled to exclusive marketing rights if that sponsor has received orphan drug
designation for its drug. In that case, the FDA would refrain from approving an
application by the Company to market Xyrem for seven years, subject to certain
limitations. There can be no assurance that Xyrem will be the first to be
approved by the FDA for the designated indication and, thereby, obtaining orphan
drug status, nor can there be no assurance that other competing products will
not receive orphan drug designations and FDA marketing approval prior to
Company's NDA for Xyrem.
NDA approval of a drug with an orphan drug designation does not prevent the FDA
from approving the same drug for a different indication, or a molecular
variation of the same drug for the same indication. The Company is aware that
Sparta Pharmaceutical, which recently agreed to be acquired by SuperGen Inc.,
was granted orphan drug designation for its intravenous busulfan and could seek
orphan drug status, if an NDA for another indication is approved by the FDA, for
a closely related indication. Because doctors are not restricted by the FDA from
prescribing an approved drug for uses not approved by the FDA, it is also
possible that another company's drug could be prescribed for indications for
which the Company's product has received orphan drug status and NDA approval.
Such prescribing of approved drugs for unapproved uses (commonly referred to as
"off label" use) could adversely affect the marketing potential of products that
have received orphan drug status and NDA approval.
The possible amendment of the Orphan Drug Act by the United States Congress has
been the subject of frequent discussion. Although no significant changes to the
Orphan Drug Act have been made for a number of years, members of Congress have
from time to time proposed legislation that would limit the application of the
Orphan Drug Act. There can be no assurance as to the precise scope of protection
that may be afforded by orphan drug designation and marketing approval in the
future or that the current level of exclusivity will remain in effect.
<PAGE>
Page 4 of 9
RELIANCE ON PATENTS AND OTHER PROPRIETARY RIGHTS.
The pharmaceutical industry places considerable importance on obtaining patent
and trade secret protection for new technologies, products and processes. The
Company's success will depend, in part, on its ability to enjoy, obtain and
enforce protection for its products under United States and foreign patent laws
and other intellectual property laws, preserve the confidentiality of its trade
secrets and operate without infringing the proprietary rights of third parties.
The patent position of pharmaceutical firms is often highly uncertain and
generally involves complex legal and factual questions. The Company evaluates
the desirability of seeking patent or other forms of protection for its products
in foreign markets based on the expected costs and relative benefits of
attaining such protection. There can be no assurance that any patents will be
issued from any applications or that any issued patents will afford adequate
protection to the Company. Further, there can be no assurance that any issued
patents will not be challenged, invalidated, infringed or circumvented or that
any rights granted thereunder will provide competitive advantages to the
Company. Parties not affiliated with the Company have obtained or may obtain
United States or foreign patents or possess or may possess proprietary rights
relating to the Company's products. There can be no assurance that patents now
in existence or hereafter issued to others will not adversely affect the
development or commercialization of the Company's products or that the Company's
planned activities will not infringe patents owned by others.
The active ingredients or compounds in the Company's FDA approved and proposed
products: Cystadane, Elliotts B Solution, Antizol, Antizol-Vet, Xyrem and
Sucraid are believed to be in the public domain and not presently subject to
patent protection in the United States. However, the Company has filed a patent
application with respect to its formulation of Xyrem oral solution. Busulfex,
which is licensed by the Company, is the Company's only FDA approved product for
which its formulation and use are covered by United States patents issued to the
licensor.
The Company could incur substantial costs in defending itself in infringement
suits brought against it or any of its licensors or in asserting any
infringement claims that the Company may have against others. The Company could
also incur substantial costs in connection with any suits relating to matters
for which the Company has agreed to indemnify its licensors or distributors. An
adverse outcome in any such litigation could have a material adverse effect on
the Company's business and prospects. In addition, the Company could be required
to obtain licenses under patents or other proprietary rights of third parties.
No assurance can be given that any such licenses would be made available on
terms acceptable to the Company, or at all. If the Company is required to, and
does not obtain any such required licenses, it could be prevented from, or
encounter delays in, developing, manufacturing or marketing one or more of its
products.
The Company also seeks to protect its proprietary information and technology in
part by confidentiality agreements and inventors' rights agreements with its
employees. There can be no assurance that these agreements will not be breached,
that the Company will have adequate remedies for any breach or that the
Company's trade secrets will not otherwise be disclosed to or discovered by its
competitors.
COMPETITION; RAPID TECHNOLOGICAL CHANGE.
Competition in the pharmaceutical industry is intense. Potential competitors in
the United States are numerous and include pharmaceutical, chemical and
biotechnology companies, most of which have substantially greater capital
resources, marketing experience, research and development staffs and facilities
than the Company. Although the Company seeks to limit potential sources of
competition by developing products that are eligible for orphan drug designation
and NDA approval or other forms of protection, there can be no assurance that
the Company's competitors will not succeed in developing similar technologies
and products more rapidly than the Company or that these competing technologies
and products will not be more effective than any of those that are being or will
be developed by the Company.
The pharmaceutical industry has experienced rapid and significant technological
change. The Company expects that pharmaceutical technology will continue to
develop rapidly, and the Company's future success will depend, in large part, on
its ability to develop and maintain a competitive position. Technological
development by others may result in the Company's products becoming obsolete
before they are marketed or before the Company recovers a significant portion of
the development and commercialization expenses incurred with respect to such
products. In addition, alternative therapies or new medical treatments could
alter existing treatment regimes, and thereby reduce the need for one or more of
the Company's products, which would adversely affect the Company's business and
its prospects.
<PAGE>
Page 5 of 9
RISKS OF PRODUCT DEVELOPMENT; MARKET UNCERTAINTY.
Six of the Company's products have been approved for marketing by regulatory
authorities in the United States or elsewhere. Even if the Company obtains FDA
approval for marketing Xyrem, there can be no assurance that the Company's
products will be commercially successful or that the products will obtain the
financial results expected. The Company may encounter unanticipated problems
relating to the development, manufacturing, distribution and marketing of its
products, some of which may be beyond the Company's financial and technical
capacity to solve. The failure to adequately address any such problems could
have a material adverse effect on the Company's business and its prospects.
No drug development portfolio can be completely insulated from potential
failures, and it is likely that some products selected for development by the
Company will not produce the results expected during clinical studies, not
receive FDA approval or fail to generate product sales of an acceptable level.
The Company has discontinued the development of eleven products from its
portfolio since inception: L-Cycloserine in 1994, Glucaric Acid in 1996, and
nine products in 1997. With respect to the nine products discontinued in 1997,
the Company took this action in order to focus its development efforts on those
products that fit within three selected STMS: Antidote, Oncology Support, and
Sleep Disorders. In December 1998, the Company sold its rights to colloidal
bismuth subcitrate for $750,000, and is evaluating the potential value of its
rights to one or more of the other proposed products that were discontinued in
1997. Depending on the availability of financing in subsequent periods, the
Company may continue development of one or more of the proposed products that
were discontinued in 1997. There can be no assurance that the Company won't
discontinue development on any other proposed products or that it won't
discontinue marketing any FDA approved products.
Most orphan drugs have a potential United States market of less than $25 million
annually and many address annual markets of less than $1 million. There can be
no assurance that the Company's sales of its products will be profitable even if
accepted and used by patients and medical specialists.
DEPENDENCE UPON OTHERS FOR MANUFACTURING AND ON LIMITED SOURCES OF SUPPLY.
The Company does not have and does not intend to establish any internal product
testing, drug or chemical synthesis of bulk drug substance, and manufacturing
capability for drug product. Accordingly, the Company will be required to enter
into arrangements with third parties for the supply and manufacture of the
components incorporated into the Company's finished drug products. Inability by
the Company to retain third parties for these purposes on acceptable terms could
adversely affect the Company's ability to develop and market its products. Any
failures by third parties to adequately perform their responsibilities may delay
the submission of products for regulatory approval, impair the Company's ability
to deliver its products on a timely basis or otherwise impair the Company's
competitive position. In addition, the Company's dependence on third-parties for
the manufacture of its products may adversely affect its potential profit
margins and its ability to develop and deliver its products on a timely basis.
The manufacture of drugs can be an expensive, time consuming and complex process
and may require the use of materials with limited availability or a dependence
on sole suppliers. Manufacturers of the Company's products will be subject to
applicable good manufacturing practices ("GMP") prescribed by the FDA or other
rules and regulations prescribed by foreign regulatory authorities. The Company
has entered into bulk drug supply and drug product manufacturing agreements with
third parties for all of its FDA approved products and is dependent on such
third parties for continued compliance with GMP and applicable foreign
standards. Failure by a third party manufacturer or supplier to comply with GMP
or applicable foreign requirements could result in significant time delays or
the inability of the Company to commercialize or continue to market a product
and could have a material adverse effect on the Company and its prospects. In
the United States, failure to comply with GMP or other applicable legal
requirements can lead to federal seizure of violative products, injunctive
actions brought by the federal government, and potential criminal and civil
liability on the part of a company and its officers and employees. There can be
no assurance that the Company will be able to maintain relationships either
domestically or abroad with its third party manufacturers and suppliers whose
facilities and procedures comply or will continue to comply with GMP or
applicable foreign requirements.
<PAGE>
Page 6 of 9
Bulk drug substance is the active chemical compound used in the manufacture of
the Company's drug products. The Company is substantially dependent on Ash
Stevens, Inc. ("Ash Stevens") for the supply of bulk drug substance used in
Busulfex, Antizol, and Antizol-Vet, and on Lonza, Inc. ("Lonza") for the supply
of bulk drug substance used in Xyrem. If the Company were to lose Ash Stevens as
a supplier, it would be required to identify a new supplier for the bulk drug
substance used in products that provided approximately 90% of 1998 total
revenues and are expected to generate over 90% of 1999 total revenues. If the
Company were to lose Lonza as a supplier, it would be required to identify a new
supplier before an NDA is submitted for Xyrem. Moreover, the loss of Ash Stevens
or Lonza as suppliers, or an interruption of drug product manufacturing
services, could have a material adverse effect on the Company and its prospects.
There can be no assurance that the Company's bulk drug supply arrangements with
Ash Stevens and Lonza might not change in the future, and if a change occurred,
no assurance can be given that the change would not adversely affect production
of Busulfex, Antizol, Antizol-Vet, and Xyrem.
Drug product manufacturers are responsible for formulating bulk drug substance
into a finished drug product and packaging the product for sale or for use in
clinical trials. The Company is substantially dependent on an affiliate of
Boehringer Ingelheim ("BI") for drug product manufacturing of Busulfex, Antizol,
and Antizol-Vet, and on GlobalPharm, Inc. ("GlobalPharm") for drug product
manufacturing of Xyrem. Although the Company has identified GlobalPharm as the
drug product manufacturer for Xyrem and expects to contract with this company,
it does not currently have a contract with GlobalPharm for the continuation of
this arrangement. If the Company were to lose BI as a manufacturer, it would be
required to identify a new manufacturer for drug products that provided
approximately 90% of 1998 total revenues and are expected to generate over 90%
of 1999 total revenues. If the Company were to lose GlobalPharm as a
manufacturer, it would be required to identify a new drug product manufacturer
before an NDA is submitted for Xyrem. Moreover, the loss of BI or GobalPharm as
manufacturers, or an interruption of bulk drug supply to BI or GlobalPharm,
could have a material adverse effect on the Company and its prospects. There can
be no assurance that the Company's drug product manufacturing arrangements with
BI and GlobalPharm might not change in the future, and if a change occurred, no
assurance can be given that the change would not adversely affect production of
Busulfex, Antizol, Antizol-Vet, and Xyrem.
The loss of either a bulk drug supplier or drug product manufacturer would
require the Company to obtain regulatory clearance in the form of a "pre
approval submission" and incur validation and other costs associated with the
transfer of the bulk drug or drug product manufacturing process. The Company
believes that it could take as long as one year for the FDA to approve such a
submission. Because the Company's products are targeted to relatively small
markets and its manufacturing production runs are small by industry standards,
the Company has not incurred the added costs to certify and maintain a secondary
source of supply for bulk drug substance or a backup drug product manufacturer.
Should the Company lose either a bulk drug supplier or a drug product
manufacturer, the Company could run out of salable product to meet marketing
demands or investigational product for use in clinical trials, while it waits
for the FDA to approve a new bulk drug supplier or drug product manufacturer.
There can be no assurance that the change of a bulk drug supplier or drug
product manufacturer and the transfer of the processes to another third party
will be approved by the FDA, and if approved, in a timely manner. The loss of or
the change of a bulk drug supplier or a drug product manufacturer could have a
material adverse effect on the Company and its prospects.
DEPENDENCE UPON OTHERS FOR DISTRIBUTION.
The Company has an exclusive agreement with Cardinal Health, Inc. ("Cardinal"),
whereby Cardinal, through its affiliates, will provide a variety of services to
support the effective distribution of Orphan Medical's products. Cardinal will
provide integrated distribution and operations services to process and support
transactions between Orphan Medical and wholesalers, specialty distributors, and
direct customers; reimbursement management; patient assistance and information
hotline services; and specialty distribution and marketing services to physician
practices. Busulfex, Cystadane, Elliotts B Solution, Antizol, Antizol-Vet, and
Sucraid are currently distributed by Cardinal, which also will distribute the
Company's proposed products should those products receive marketing clearance
from the FDA in the future. The Company will be substantially dependent upon
Cardinal's ability to successfully distribute Busulfex, Elliotts B Solution,
Antizol, Antizol-Vet, and Sucraid and all of the Company's proposed products
that receive marketing clearance from the FDA.
<PAGE>
Page 7 of 9
Cystadane is principally distributed, on a non-exclusive basis in the U.S., by
Chronimed Inc. ("Chronimed"), which distributes this product directly to
patients through its mail order pharmacy. The Company is substantially dependent
upon Chronimed's ability to successfully distribute Cystadane directly to
patients in the U.S.
There can be no assurance that other distribution companies would be available
or continue to be available on commercially acceptable terms, if at all. The
loss of a distributor or failure to renew agreements with an existing
distributor would have a material adverse effect on the Company and its
prospects.
UNCERTAIN EXTENT OF PRICE FLEXIBILITY AND THIRD-PARTY REIMBURSEMENT.
The Company's ability to commercialize its products successfully will depend in
part on the price it may be able to charge for its products and 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
insurers and other third-party payors. Government officials and private health
insurers are increasingly challenging the price of medical products and
services. Significant uncertainty exists as to the pricing flexibility suppliers
will have with respect to, and the reimbursement status of, newly approved
health care products.
In the United States, the Company expects that there will continue to be a
number of federal and state proposals to implement government control of pricing
and profitability of prescription pharmaceuticals. Cost controls, if mandated by
a government agency, could decrease the price the Company receives for its
products or products it may develop in the future and, by preventing the
recovery of development costs, which could be substantial, and an appropriate
profit margin, could have a material adverse effect on the Company. Furthermore,
federal and state regulations govern or influence the reimbursement to health
care providers in connection with medical treatment of certain patients. If any
actions are taken by federal and/or state governments, such actions could
adversely affect the prospects for sales of the Company's products. There can be
no assurance that actions taken by federal and/or state governments, if any,
with regard to health care reform will not have a material adverse effect on the
Company and its prospects.
Certain third-party payors may attempt to further control costs by selecting
exclusive providers of their pharmaceutical products. If such arrangements were
made with competitors of the Company, such payors would not reimburse patients
for purchases of the Company's competing products. This lack of reimbursement
would diminish the market for the Company's products and could have a material
adverse effect on the Company and its prospects.
RISK OF PRODUCT RECALL
Product recalls may be issued at the discretion of the Company, the FDA, the
U.S. Federal Trade Commission, or other government agencies having regulatory
authority for product sales, and may occur due to disputed labeling claims,
manufacturing issues, quality defects, or other reasons. No assurance can be
given that product recalls will not occur. The Company does not carry any
insurance to cover the risk of a potential product recall. Any product recall
could have a material adverse effect on the Company and its prospects.
PRODUCT LIABILITY AND INSURANCE RISKS.
The testing and sale of human health care products by the Company entails an
inherent risk that product liability claims may be asserted against the Company.
The pharmaceutical industry has experienced increasing difficulty in maintaining
product liability insurance coverage at reasonable levels, and substantial
increases in insurance premium costs in many cases have rendered coverage
economically impractical. The Company currently carries product liability
coverage in the aggregate amount of $10 million for all claims made in any
policy year. Although to date the Company has not been the subject of any
product liability or other claims, there can be no assurance that the Company
will be able to maintain product liability insurance on acceptable terms or that
its insurance will provide adequate coverage against potential claims. The
successful assertion of any uninsured product liability or other claim against
the Company could have a material adverse effect on the Company's business and
prospects.
IMPACT OF YEAR 2000 READINESS ISSUE
The Company has assessed and continues to assess the impact of the so called
"Year 2000 Readiness Issue" on its reporting systems and operations. The Year
2000 Readiness Issue relates to the ability of computer hardware, software, and
firmware products to accurately process date/time data (including calculating,
comparing, and
<PAGE>
Page 8 of 9
sequencing) from, into, and between the twentieth and twenty-first centuries,
and the years 1999 and 2000 and leap year calculations. The Year 2000 Readiness
Issue also relates to the ability to properly exchange time/date data between
such products. When the year 2000 occurs, systems that are not year 2000
compliant might recognize the year 2000 as the year 1900, or not at all. This
inability to recognize or properly treat the year 2000 may cause the Company's
systems, or the systems used by its suppliers, distributors, customers or
regulatory agencies (i.e., FDA) to process critical financial and operational
information incorrectly, or not at all.
The Company's information technology ("IT") systems consist of computer hardware
systems and software applications supplied by third parties. The Company's
strategy has been to replace its IT systems with current technology, which is
both year 2000 compliant and more efficient. The Company has also purchased and
implemented financial and operational software upgrades that are year 2000
compliant. For the three months ended March 31, 1999, the Company's IT system
purchases have not been material. The Company's IT systems are year 2000
compliant.
The Company's assessment of internal systems includes a review of
non-information technology ("non IT") systems. This assessment includes a review
of the Company's internal equipment and facilities. Based upon this review, the
Company believes that its processes and equipment are year 2000 compliant.
The Company has identified third parties with which it has material
relationships, including suppliers, distributors and other key vendors of
materials and services. The Company has confirmed with these parties or
organizations that they have implemented Year 2000 Readiness Programs. The
Company has not developed a contingency plan to provide for continuity of
business operations in the event material third parties experience a disruption
of service due to the Year 2000 Readiness Issue, which could include, but not be
limited to, loss of electricity, loss of communications (data and voice), and
loss of transportation services. However, even if all material third parties
confirm that they are or expect to be year 2000 compliant by December 31, 1999,
it is not possible to state with certainty that such parties will be compliant.
If third party systems on which the Company relies should fail, there could be a
significant disruption of the Company's ability to transact business with its
customers and suppliers. It is impossible to fully assess the potential
consequences in the event service interruptions from suppliers occur or in the
event that there are disruptions in such infrastructure areas as utilities,
communications, transportation, banking and government.
LIMITATIONS TO SOURCES OF ADDITIONAL CAPITAL - RESTRICTIONS, COVENANTS AND
RIGHTS RELATED TO SENIOR CONVERTIBLE PREFERRED STOCK
On July 23, 1998 (the "First Issuance Date"), the Company completed the sale to
UBS Capital II LLC ("UBS Capital") of a private placement of $7.5 million of
Senior Convertible Preferred Stock (the "Preferred Shares"). In conjunction with
the issuance of the Preferred Shares, the Company agreed to several restrictions
and covenants, and granted certain voting and other rights to the holders of the
Preferred Shares. The most important of these restrictions are: (1) the Company
cannot incur additional indebtedness, except for indebtedness secured solely by
the Company's trade receivables, until it has profitable operations, subject to
certain limitations and (2) the Company cannot, without the approval of a
majority of the preferred stockholders, issue additional equity securities
unless the selling price per share exceeds the then conversion price, presently
$8.50 per share, of the outstanding convertible preferred stock or the sale of
equity is accomplished in a public offering. These restrictions could make it
more difficult and more costly for the Company to obtain additional capital.
However, there can be no assurance that additional sources of capital will be
available to the Company and, if available, on terms acceptable to the Company.
POSSIBLE VOLATILITY OF STOCK PRICE AND REDUCED LIQUIDITY OF THE MARKET FOR THE
STOCK - LOSS OF NASDAQ NATIONAL MARKET LISTING AND FAILURE TO QUALIFY FOR NASDAQ
SMALL CAP MARKET LISTING.
There is risk that the market value and the liquidity of the public float for
the Company's Common Stock could be adversely affected in the event the Company
no longer meets the Nasdaq's requirements for continued listing on the National
Market. For continued listing on the Nasdaq National Market, a company must
satisfy a number of requirements, which in the Company's case include either:
(1) net tangible assets in excess of $4,000,000 million as reported on Form 10-Q
or Form 10-K or (2) a market capitalization of at least $50,000,000 million. At
March 31, 1999, the Company's net tangible assets equaled $4,082,520 and its
market capitalization was approximately $47.6 million (based on the last sale
price of $7.25 and 6,562,707 registered shares outstanding as of March 31,
1999).
<PAGE>
Page 9 of 9
Net tangible assets are defined as total assets less the sum of total
liabilities and intangible assets. Market capitalization is defined as total
outstanding shares multiplied by the last sales price quoted by Nasdaq. Should
the Company fail to satisfy at least one of the aforementioned Nasdaq listing
requirements, the Company's Common Stock would no longer qualify for listing on
the Nasdaq National Market, but would qualify for quotation on the Nasdaq Small
Cap Market as long as its net tangible assets exceed $2.0 million. The Company's
ability to raise additional capital and the market value of the Company's Common
Stock could be adversely affected by failing to meet Nasdaq's requirements for
listing on either the National Market or the Small Cap Market. The realization
of any one or combination of these risks could have a material adverse effect on
the Company's business, its prospects and its shareholders.
POSSIBLE VOLATILITY OF STOCK PRICE - GENERAL.
There is generally significant volatility in the market prices of securities of
early stage pharmaceutical companies. Contributing to this volatility are
various factors and events, such as the announcements by the Company or its
competitors of new product developments, clinical testing results, governmental
approvals, regulations or actions, developments or disputes relating to patents
or proprietary rights, public concern over the safety of therapies and
fluctuations in financial performance from period to period. These and other
factors and events may have a significant impact on the Company's business and
on the market price of the Common Stock.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING BALANCE SHEETS OF ORPHAN MEDICAL, INC. AS OF MARCH 31, 1999 AND THE
RELATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 2,154,069
<SECURITIES> 4,031,557
<RECEIVABLES> 648,860
<ALLOWANCES> 22,622
<INVENTORY> 128,270
<CURRENT-ASSETS> 7,032,056
<PP&E> 576,013
<DEPRECIATION> 293,912
<TOTAL-ASSETS> 7,325,968
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0
78
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</TABLE>
