SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] Annual Report pursuant Section 13 or 15(d) of the Securities Exchange Act
of 1934 [No Fee Required]
For the fiscal year ended December 31, 1998
or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
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
(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)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Aggregate market value of common stock held by non-affiliates of Registrant,
based upon the last sale price of the Common Stock reported on the Nasdaq
National Market tier of The Nasdaq Stock Market on March 26, 1999 was
$38,884,615. Common stock outstanding at March 26, 1999: 6,562,707 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Registrant's Annual Meeting of Shareholders to be held on May
26, 1999 are incorporated by reference in Part III, Items 10, 11, 12 and 13 of
this Form 10-K.
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PART I.
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1933, as amended. All forward-looking
statements are inherently uncertain as they are based on current expectations
and assumptions concerning future events or future performance of the Company.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which are only predictions and speak only as of the date hereof.
Forward-looking statements 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, 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 the "Cautionary Statements" filed as an Exhibit to this Annual
Report on Form 10-K, 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.
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, Inc.(R) and Dedicated to Patients with
Uncommon Diseases(R) are trademarks of the Company.
Provigil(R) is a registered trademark of Cephalon, Inc.
ITEM 1. BUSINESS
OVERVIEW
Orphan Medical, Inc. (the "Company") is a development stage company that
acquires, develops and markets products of high medical value for patients
within selected strategic therapeutic market segments ("STMS"). A drug has high
medical value if it offers a major improvement in the safety or efficacy of
patient treatment and has no substantially equivalent substitute. The Company
concentrates its efforts on drugs with high medical value that may be marketed
within its three well-defined, selected STMS: Antidote, Oncology Support, and
Sleep Disorders. Antizol and Busulfex are commercially available and are the
Company's lead products in its Antidote and Oncology Support STMS, respectively.
Xyrem is an investigational drug and is expected to be the Company's lead
product in its Sleep Disorders STMS. In addition, the Company manufactures and
distributes Cystadane, Antizol-Vet, and Sucraid even though these products do
not fall into any of the three selected STMS. However, the Company expects to
continue offering Cystadane, Antizol-Vet, and Sucraid because these products
have high medical value and require limited resources to market and distribute.
The Company operates within a single segment: pharmaceutical product
development. To date, the Company has obtained marketing clearance from the U.
S. Food and Drug Administration (the "FDA") on all six of its New Drug
Applications ("NDA"). These six products are commercially available in the
United States and several foreign countries. Revenues of $4,707,038 were
generated for the twelve months ended December 31, 1998 by five approved
products. Revenues from the Company's approved products outside the United
States were less than 10% of total 1998 revenues.
A Treatment Investigational New Drug ("IND") application for Xyrem was approved
by the FDA in December 1998 and the Company began shipping Xyrem in February
1999 for use in its Treatment IND clinical trials. The Treatment IND allows the
Company to seek payments for Xyrem used by patients enrolled in the Treatment
IND clinical trials and to obtain additional clinical safety data in support of
an NDA for Xyrem, which the Company expects to file as early as the second half
of 2000. In addition, in February 1999 the FDA approved the Company's NDA for
Busulfex and the Company began shipping Busulfex during the same month. As a
result of these developments, the Company will discontinue reporting as a
development stage company for its first quarter ending March 31, 1999, although
the Company does not expect to achieve profitable operations in 1999.
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In July 1998, the Company completed the sale of $7.5 million of Senior
Convertible Preferred Stock in a private placement. The Company realized net
cash proceeds of $7,075,008 from the sale of this private placement, after the
payment of related offering expenses. However, due to the operating losses it
incurred during the second half of 1998 and the amount of expected operating
losses in 1999, the Company will require additional financing during 1999 to
fund its plan to advance the development of Xyrem as expeditiously as possible.
The Company believes its approach to pharmaceutical product development reduces
the time, costs and risks traditionally involved in bringing pharmaceutical
products to market. The Company does not conduct basic research and does not
attempt to discover new drugs. Instead, the Company acquires licenses for
proposed products that already have some clinical data that indicate therapeutic
value and safety. In addition, the Company may consider acquiring products that
have already received marketing clearance from the FDA. The Company uses
contract development, manufacturing, and consulting companies to assist it in
its product development activities. This approach avoids the costs and financial
risks associated with developing these capabilities internally.
Each STMS defined by the Company is characterized by a well-defined patient
population and treated by a well-defined group of medical specialists. The
Company believes this approach makes a large specialized sales force unnecessary
to market the Company's products because its marketing efforts can be focused on
a limited number of medical specialists or patients. The high medical value of
the Company's products is expected to facilitate marketing efforts directed
toward users and prescribers. Through its sales force, the Company intends to
promote awareness of the key advantages of Orphan Medical brand products within
the Antidote, Oncology Support, and Sleep Disorders STMS. The sales force will
differentiate the Company's products on the basis of quality, potentially
improved medical outcomes, and cost effectiveness. The Company believes the
physical distribution of its products can be efficiently handled by other
companies, such as Cardinal Health, a distributor of pharmaceutical products.
STRATEGIC BACKGROUND
In the 1950s and early 1960s, drug development was relatively inexpensive and
regulatory approval was straightforward. Pharmaceutical companies marketed their
products directly to physicians who made prescription and purchase decisions. In
the 1970s, however, regulatory standards and competition increased and the price
of research and development and manufacturing rose dramatically. In the 1980s
and 1990s, drug companies revised their targeted rates-of-return or financial
"hurdle rates", as well as other selection criteria, to avoid developing drugs
whose incremental profit contributions were considered insufficient to provide
acceptable returns on investment. Many of the drugs that did not meet these
criteria were drugs for smaller patient populations. As a consequence, new drugs
for smaller patient populations were less likely to be developed by larger
companies. Some research institutions, universities and small companies,
however, have continued to develop and initiate clinical studies on such drugs.
The Company's strategy is based on several factors relating to these and other
changes in the health care and pharmaceutical industries:
* Larger pharmaceutical companies generally have increased their financial
hurdle rates, seek new products with annual revenues greater than $200
million and avoid developing new products that address diseases outside
their therapeutic area of focus. As a result, many developmental products
of high medical value are available for licensing on favorable terms. If
these products are intended to address smaller markets, they may be
eligible for orphan drug designation. Many of these products have already
been developed to the point where the time and cost required to bring the
product to market can be reasonably estimated.
* Because of corporate "downsizings," many pharmaceutical companies have
released skilled employees experienced in the research, development,
manufacturing or commercialization of new medicines. These individuals
have often formed or joined contract clinical research organizations
("CROs"), contract manufacturing companies or drug development and
marketing consulting firms. Thus, the knowledge and
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skills required to address many aspects of drug development are available
on a contract basis from outside companies or individuals.
* To address rapidly changing market forces, alternative means of marketing
and distributing pharmaceuticals have been created. Many products,
particularly those targeted to smaller, well-defined markets, do not
require a large, specialized sales force and can be marketed through
direct means such as continuing medical education programs, exhibits at
professional meetings, direct mailings and telemarketing. In addition,
these products can be effectively distributed through companies proficient
in distribution of pharmaceutical products to smaller patient populations.
In response to these changes, the Company has adopted a business strategy that
is centered on products of high medical value within well-defined strategic
therapeutic market segments, uses the knowledge and skills available on a
contract basis from outside sources, and uses alternative marketing and
distribution channels.
BUSINESS STRATEGY
The Company focuses on products of high medical value intended to address
inadequately treated or uncommon diseases within a selected STMS. A drug has
high medical value if it offers a major improvement in the safety or efficacy of
patient treatment and has no substantially equivalent substitute. In addition to
those with high medical value, the Company seeks products that will likely be
eligible for insurance reimbursement, have readily measured clinical endpoints,
existing positive clinical data, proprietary attributes, and offer attractive
financial returns. The Company does not conduct basic research and does not
attempt to discover new drugs, but instead seeks to acquire and further develop
products that already have some clinical data that indicate the presence of
therapeutic value and safety. The Company's strategy of developing and marketing
high medical value drugs with these additional characteristics is intended to
achieve the following benefits.
* REGULATORY REQUIREMENTS AND REVIEW - Drugs of high medical value have
greater likelihood of receiving expedited review by the FDA. If such drugs
also have smaller patient populations, the number of patients required for
clinical trials is generally reduced.
* REDUCTION OF PRODUCT DEVELOPMENT TIME AND COST - While the safety and
efficacy of every drug must be established to the satisfaction of the FDA,
the amount of data required to bring a new drug of high medical value to
market is generally less than for a drug that is available in similar
dosage forms or formulations and that is intended for very large markets.
Furthermore, the Company generally attempts to concentrate resources and
project management attention on a single medical indication in order to
limit the amount of clinical information required by the FDA to clear a
product for marketing. The time and cost of development is directly
related to the amount of clinical information required for regulatory
approval.
* LIMITED INFRASTRUCTURE - The Company believes that high quality
pharmaceutical products can be efficiently and economically developed
using well established independent contractors to assist its experienced
staff. Accordingly, the Company uses the available pool of contract
development, manufacturing, distribution and consulting companies to
assist in product development and marketing activities. This approach
allows the Company to avoid the costs, time and financial risks associated
with developing an extensive infrastructure in support of these
capabilities internally.
* MARKETING STRATEGY - The Company focuses on products of high medical value
intended to address inadequately treated or uncommon diseases within
selected STMS. An STMS is a subset of a therapeutic area where one or more
products can be grouped to satisfy unmet needs. To assess the viability of
an STMS, the Company considers the following questions:
* Are there unmet therapeutic needs as defined by the customer (the
patient or the health care practitioner)?
* Do product development or product acquisition opportunities exist in
order to build a profitable business in a particular STMS?
* Can the Company build brand recognition and command significant
market share in a particular STMS?
* DIRECT SALES - The Company has built a small, specialized sales force to
promote Antizol and Busulfex. The sales force has extensive knowledge of
the Antidote and Oncology Support STMS, as well as extensive
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marketing and business experience. The Company's sales force utilizes a
consultative, customer oriented approach to selling, which is aided by
high quality information systems. The Company expects to utilize a similar
sales force approach with the Sleep Disorders STMS.
* ALLIANCES - The high medical value of the Company's products has
interested other companies seeking to market the Company's products
outside the U.S. To date, the Company has agreements with six distributors
relating to five of the Company's products. The Company also believes that
its relationships with these distribution partners, among others, may
provide strategic benefits; possibly in the area of product acquisition
opportunities or in market share penetration programs.
* ATTRACTION OF POTENTIAL NEW PRODUCTS - As the Company's strategy and focus
on products of high medical value within a selected STMS become better
known and understood by others in the research and development community
and as the Company proves its ability to market and sell into an STMS, the
Company expects more product development or acquisition opportunities will
be presented in the future.
RISK MANAGEMENT
The Company's strategy is designed, in part, to manage its overall business
risk. The Company is pursuing three distinct STMS rather than concentrating
financial, development and marketing resources on a single STMS or a single
platform technology. To reduce its product development risk, the Company
generally seeks to develop products that (1) are known to the medical community
and to the FDA, (2) have a straightforward formulation that can be synthesized
in one or two steps as opposed to requiring many steps, and (3) do not require
biotechnology processes for development or manufacture. In addition, the Company
generally seeks to acquire products that are already in Phase II or Phase III
clinical trials, or in an earlier stage of development if the Company believes
there is a relatively high likelihood of obtaining FDA approval. When a product
is licensed without the equivalent of Phase II or III data, the Company may
conduct one or more "pilot clinical trials" to better assess this likelihood.
Each such pilot trial is narrowly defined and has a separate budget that to date
has not exceeded $500,000. Upon the completion of such a pilot clinical trial,
management seeks the approval of the Board of Directors for authority to proceed
to full development of the product. The Company does not conduct basic research
and does not attempt to discover new drugs. The Company may also purchase rights
to existing products in order to reduce development risk. To reduce its
marketing risk, the Company generally attempts to obtain some form of
proprietary protection, such as orphan drug designation, patent protection,
exclusive licensing agreements, predominant market penetration or sole supplier
agreements.
PROPRIETARY RIGHTS
To encourage the continued development of drugs for smaller patient populations,
the federal government enacted the Orphan Drug Act of 1983. This Act provides
incentives to companies to develop and market drugs for rare diseases or
conditions that are known to affect fewer than 200,000 people in the United
States. A company must request orphan drug designation before an NDA is
approved, and after the FDA grants orphan drug designation, the generic identity
of the therapeutic agent (drug) and its potential orphan use (market) are
publicized by the FDA. Orphan drug designation does not convey any advantage in,
or shorten the duration of, the regulatory approval process. The FDA may grant
orphan drug designation to more than one company of an identical drug for the
same designated indication. Under current law, orphan drug status is granted to
the first company receiving FDA marketing approval of a drug with orphan drug
designation. A company receiving orphan drug status for a designated indication
is entitled to a seven-year exclusive marketing period in the United States for
the drug with the approved indication, subject to certain limitations. However,
orphan drug status does not prevent subsequent approval of a different drug for
the same designated indication, nor subsequent approval of the same drug for a
different designated indication, nor provide any marketing exclusivity in
foreign markets.
Since 1983, the FDA has assigned orphan drug designation to more than 650
potential products. Although the Company believes the size of the aggregated
markets for orphan and small market drugs may be large, the total annual market
for any particular orphan drug rarely exceeds $100 million and most have
potential markets of less than $25 million annually.
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The Company believes it is important that its proposed products receive patent
protection or orphan drug designation or have other factors that limit potential
competition. All of the Company's products, except Antizol-Vet, have been
designated orphan drugs by the FDA and applications for such designation will be
made for any additional products to the extent available. A drug that has orphan
drug designation and which is the first product to receive marketing approval
for its product claim, indication or application, receives orphan drug status
and is entitled to a seven-year exclusive marketing period in the United States
for that product claim, indication or application, subject to certain
limitations. The Company has five products with orphan drug status. Veterinary
products are not eligible for orphan drug status, but the Company's Antizol-Vet
product has another form of U.S marketing exclusivity for a period of five years
from its November 1996 marketing approval date.
The license agreement pursuant to which the Company has acquired its rights to
develop and market Busulfex provide for an assignment of the licensor's
proprietary rights, including patent and technology rights. With respect to
additional products it may license in the future, if any, the Company expects
that such licenses will include, if such rights are available, an assignment of
the licensor's proprietary rights with respect to the licensed product. Foreign
patent applications have been filed for Busulfex and Xyrem. The Company
evaluates the desirability of registering approved patents or other forms of
protection for its products in individual foreign markets based on the expected
costs and relative benefits of attaining such protection.
THE REGULATORY PROCESS
Pharmaceutical products intended for therapeutic use in humans are governed by
extensive FDA regulations in the United States and by comparable regulations in
foreign countries. The process of seeking and obtaining FDA approval for a
previously unapproved new human pharmaceutical product generally requires a
number of years and involves the expenditure of substantial resources.
Following drug discovery, the process required before a drug product may be
marketed in the United States includes (i) pre-clinical laboratory and animal
safety tests, (ii) the submission to the FDA of an IND application, (iii)
clinical and other studies to assess safety and parameters of use, (iv) adequate
and well-controlled clinical trials to establish the safety and effectiveness of
the drug product, (v) the submission to the FDA of an NDA, (vi) FDA approval of
the NDA prior to any commercial sale or shipment of the product and (vii)
finally, marketing of the drug.
Typically, pre-clinical studies are conducted in the laboratory and in animal
model systems to gain preliminary information on the product's pharmacology and
toxicology and to identify any potential safety problems that would preclude
testing in humans. The results of these studies, together with the general
investigative plan, protocols for specific human studies and other information,
are submitted to the FDA as part of the IND application. The FDA regulations do
not, by their terms, require FDA approval of an IND. Rather, if the FDA does not
notify the sponsor to the contrary within 30 days of receipt of the IND, a
clinical investigation is allowed to commence. As a practical matter, however,
FDA approval is often sought before a company commences clinical investigations.
That approval may come within 30 days of IND receipt, but may involve
substantial delays if the FDA requests additional information.
The initial phase of clinical testing (Phase I) is conducted to evaluate the
metabolism and pharmacological actions of the experimental product in humans, as
well as the side effects associated with increasing doses, and, if possible, to
gain early evidence of possible effectiveness. Phase I studies can also evaluate
various dosages, methods and schedules of product administration. These studies
generally involve a small number of healthy volunteer subjects, but may be
conducted in people with the disease that the product is intended to treat. The
total number of subjects is generally in the range of 20 to 80. A demonstration
of therapeutic benefit is not required in order to complete Phase I trials
successfully. If acceptable product safety is demonstrated, Phase II trials may
be initiated.
Phase II trials are designed to evaluate the effectiveness of the product in the
treatment of a given disease and involve patients with the disease under study.
These trials often are well-controlled, closely monitored studies involving a
relatively small number of subjects, usually no more than several hundred. The
optimal dosages, methods and schedules of administration are determined in these
studies. If Phase II trials are successfully
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completed, Phase III trials are often commenced, although Phase III trials are
not always required, particularly for drugs of high medical value intended for
smaller patient populations.
Phase III trials are expanded, controlled trials that are performed after
preliminary evidence of the effectiveness of the experimental product has been
obtained. These trials are intended to gather the additional information about
safety and effectiveness needed to evaluate the overall risk/benefit
relationship of the experimental product. In addition, these trials provide the
confirmatory evidence of both effectiveness and safety necessary for product
approval. Phase III trials usually involve several hundred to several thousand
subjects.
A clinical trial may combine the elements of more than one phase (i.e., a Phase
I/II or II/III trial) and typically two or more Phase III studies are required
for FDA approval. A company's designation of a clinical trial as being of a
particular Phase is not necessarily indicative that such a trial will be
sufficient to satisfy the FDA requirements of that Phase because this
determination cannot be made until the protocol and data have been submitted to
and reviewed by the FDA. In addition, a clinical trial may contain elements of
more than one Phase notwithstanding the designation of the trial as being of a
particular Phase. The FDA closely monitors the progress of the Phases of
clinical testing and may, at its discretion, re-evaluate, alter, suspend or
terminate the testing based on the data accumulated and its assessment of the
risk/benefit ratio to patients. It is not possible to predict with certainty the
time required to complete Phase I, II and III studies with respect to a given
product. Likewise, it is difficult to predict with any certainty the
requirements of the FDA.
Upon the successful completion of clinical testing, a marketing application
(e.g., NDA) is submitted to the FDA for approval. This application requires
detailed data on the results of pre-clinical testing, clinical testing and the
composition of the product; specimen labeling to be used with the drug;
information on manufacturing methods; and samples of the product. Following the
passage of the Prescription Drug User Fee Act ("PDUFA"), the FDA typically takes
from six to eighteen months to review an NDA after it has been accepted for
filing. Following its review of a marketing application, the FDA invariably
raises questions or requests additional information. The NDA approval process
can, accordingly, be very lengthy. Further, there is no assurance that the FDA
will ultimately approve an NDA. If the FDA approves the NDA, the new product may
be marketed for the applications or treatments that have been approved by the
FDA. The claims with which a product can be marketed are also subject to review
and approval by the Division of Drug Marketing, Advertising and Communications
("DDMAC"), the FDA's marketing surveillance department within the Center for
Drugs. The FDA often clears a product for marketing with a modification to the
proposed label claims or requires that post-marketing surveillance, or Phase IV
testing, be conducted.
OPERATING FUNCTIONS
The Company has structured each of its operating functions to support its
strategy. Following is a general explanation of the typical steps in the
Company's processes of product acquisition, development and marketing.
PRODUCT ACQUISITION
The Company is actively searching for product licensing opportunities within its
selected strategic therapeutic market segments. The continual acquisition of
products for development and/or commercialization is a key element of the
Company's growth strategy. The Company attracts product acquisition proposals
through a network of customer and industry contacts, licensing brokers and a
growing awareness of its activities by governmental, academic and industry
sources. Since its inception, the Company has carefully evaluated many product
opportunities. To date, sixteen products have been acquired and, of these, seven
products are currently under development or being marketed.
The Company seeks to acquire pharmaceutical products within selected STMS that,
in the Company's opinion, generally:
* Are of high medical value as defined by the customer (physician or
patient) within a STMS;
* Are targeted at distinct patient populations;
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* Are prescribed by physician specialists;
* Can be marketed with a small, specialized sales effort to health care
specialists, health care institutions, and patients;
* Are likely to be eligible for reimbursement by third-party payors;
* Have or are candidates for patent protection or orphan drug designation or
have other characteristics that enhance the Company's competitive
position;
* Treat diseases that have clinical endpoints (i.e., signs or symptoms) that
are readily measured;
* Are conventional pharmaceutical products that are relatively
straightforward in formulation and development, and do not involve the
application of new technologies;
* Are in Phase II or Phase III clinical trials and have a relatively high
likelihood of obtaining the approval of the FDA within three years of
their acquisition;
* Offer attractive potential financial returns with relatively inexpensive
development costs;
* "Fit" with other companion products in an existing STMS or can be grouped
with other products to build a new STMS.
In selecting additional products for potential inclusion in its portfolio, the
Company generally focuses on acquiring rights to medicines that serve distinct
patient populations. Many major drug companies and generic manufacturers are
less likely to address these orphan drug and niche markets because they do not
believe that these markets are capable of producing acceptable revenues and
returns on their product development investments. This reluctance limits the
number of potential sources of competition. In addition, a product designed for
smaller patient populations is often eligible for orphan drug designation. By
obtaining orphan drug designation, the Company is granted exclusive marketing
rights or status in the United States for seven years, subject to certain
limitations, after an NDA for a product is approved, if the Company is the first
to receive approval for the designated drug and indication.
The Company seeks to acquire potential products that already have, or will not
require, a substantial quantity of clinical data to demonstrate their relative
efficacy and safety. The Company also searches for product candidates that
represent new dosage forms of previously approved or known compounds because the
Company believes these types of products are more likely to be quickly approved
by the FDA and accepted by the medical community. In addition, the Company
attempts to develop medicines where there are clear clinical endpoints that
demonstrate their effectiveness. Generally, the Company seeks to acquire
products that can be developed to the point of FDA approval within three years
of their acquisition with expected development costs in the range of $1.0 to
$10.0 million. Contrast this approach to the development of therapies for
complex diseases (e.g., Alzheimer's disease, AIDS, psychoses or complex cancers)
that can require a decade or more of development and involve the expenditure of
tens of millions of dollars or more. Typically, the Company also focuses its
development efforts on one indication and, when possible, one dosage form to
minimize development costs. Additional indications or dosage forms will only be
evaluated after the primary NDA is submitted.
An additional element of the Company's product development strategy is to
acquire products that have or can have a degree of proprietary protection.
Generally, this goal is accomplished by selecting products that are eligible for
orphan drug designation, are covered by patents or are the subject of an
exclusive license from a sole supplier or a manufacturer with specialized or
proprietary processes. The likely availability of adequate levels of
reimbursement from third-party payors is also an important factor in product
acquisition decisions.
The Company has established a Product Selection and Review Committee. This
Committee reviews all new product opportunities and makes recommendations to the
Board of Directors of the Company regarding the approval of any proposed
additional products. The product review process generally involves discussions
with customers (physicians and patients) within a given STMS to identify unmet
needs, and with the initial product developer and experts in the disease treated
by the drug; a review of research publications and other databases to gauge
competitive activities; market research aimed at identifying potential
acceptance by the end user; technical evaluations to determine manufacturability
and cost; expected FDA regulatory requirements to obtain acceptable marketing or
promotional claims; and a legal review of any relevant proprietary rights. If
this review indicates that the proposed product meets the Company's selection
criteria, efforts to negotiate a license are initiated. Generally,
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the Company seeks to obtain licenses that require a minimal signing fee, are
subject to commercially acceptable royalty levels and, where appropriate,
provide for the continued involvement of the original developer in the
development process through a consulting or similar arrangement.
The Company is continually evaluating additional proposed products within the
selected STMS. Although the Company is actively discussing licensing
possibilities for several products, it does not have any binding agreements or
arrangements for the acquisition of any additional products. Should the Company
be unsuccessful in acquiring additional proposed products for development and
commercialization within a selected STMS, the Company may reassess the viability
of the selected STMS and redefine the selected STMS to expand the number of
potential products that might satisfy the Company's acquisition criteria for a
viable STMS.
PRODUCT DEVELOPMENT
Pharmaceutical product development is the Company's principal activity. The
Company has incurred $24,816,427 in research and development expense from
January 1, 1993 (inception) through December 31, 1998. In addition, the Company
estimates that it will need to incur at least an additional $9.0 million in
research and development expense relating to the products it currently markets
and to advance the development of Xyrem as expeditiously as possible.
A major element of the Company's product development strategy is to use
third-parties to conduct safety and efficacy testing and clinical studies, to
assist the Company in guiding products through the FDA review and approval
process, and to manufacture and distribute any FDA approved products. The
Company believes that maintaining a minimal infrastructure will enable it to
develop products efficiently and cost effectively. To facilitate this strategy,
the Company utilizes a team approach to develop its proposed products. A
development team is organized and managed by senior staff within the Company's
Development Department. The development team is cross-functional and includes
in-house experts, as well as appropriate outside consultants, to manage all
development activities with respect to a proposed product. A development team
designs a development plan and a financial budget for the proposed product,
which will support the proposed indication and marketing claims, and contracts
with outside development agents and consultants to arrange for the necessary
clinical and toxicology studies, manufacturing arrangements and FDA filings.
Upon submission of the NDA to the FDA, the management of the proposed product is
transitioned to the Company's Marketing and Sales Department.
The Company believes the use of third parties to develop and manufacture its
products has several advantages. This approach generally allows a greater pool
of resources to be concentrated on a product than if these functions were
performed by internal personnel who were required to support all of the
Company's products. Although this approach will allow the Company to avoid the
expense associated with developing a large internal infrastructure to support
its product development efforts, it will result in the Company being dependent
on the ability of outside parties to perform critical functions for the Company.
This contract approach to product development requires project management by
professionals with substantial industry experience. The Company has in-house
experts in areas of critical importance to all of its proposed products who can
be consulted by the development teams. These areas include regulatory affairs,
marketing and sales, quality assurance, manufacturing, clinical trials
management, finance, information systems and general management.
The product development process is designed to identify any problems associated
with a proposed product's clinical aspects. The Company attempts to reduce the
risk that a proposed product will not be accepted in the marketplace by
conducting the market research and planning process concurrently with a
product's development. No drug development portfolio can be completely insulated
from potential failures and it is likely that some proposed products selected
for development by the Company will not produce the clinical or revenue results
expected. To date, the Company has discontinued development activities with
respect to eleven proposed products because the estimated future financial
potential for these proposed products was unacceptable to management.
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MANUFACTURING
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. Manufacturers of the Company's products are subject
to applicable GMP as 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. The Company
believes that qualified manufacturers will continue to be available in the
future, at a reasonable cost to the Company, although there can be no assurance
that this will be the case.
Due to FDA mandated dating requirements and the limited market size for each of
the Company's approved products, the Company is subject to complex manufacturing
logistics, minimum order quantities that have resulted in excess inventory as
determined under the Company's accounting policy, unsalable inventory as a
result of product dating expiring prior to use, and competition with others for
manufacturing services when needed or expected. The Company has a production
planning program to assess and manage the manufacturing logistics amongst the
vendors supplying the required finished product components of bulk drug
substance, drug product and packaging.
The Company is substantially dependent on its contract drug product
manufacturers. These manufacturers have been approved by the FDA for the
production of the Company's approved products. Following is a listing of the
Company's contract drug product manufacturers:
<TABLE>
<CAPTION>
Contract Drug Product Manufacturer Marketed and Proposed Products
- ------------------------------------------------- -------------------------------------------------------
<S> <C>
An affiliate of Boehringer Ingelheim Antizol, Antizol-Vet, Elliotts B Solution, and Busulfex
NutraMax, Inc. Sucraid
Proclinical, Inc. Cystadane
GlobalPharm, Inc. (final contract not negotiated) Xyrem (clinical supplies)
</TABLE>
In addition to the contract drug product manufacturers, the Company is
substantially dependent on Ash Stevens, Inc. ("Ash Stevens") and Lonza, Inc.
("Lonza"). Ash Stevens is the Company's sole supplier of bulk drug substance for
the manufacture of Antizol, Antizol-Vet, and Busulfex; while Lonza is the
Company's sole supplier of bulk drug substance for the manufacture of Xyrem for
use in clinical trials.
MARKETING - UNITED STATES
The Company has designed its product selection strategy to maximize the success
of its marketing efforts. By having products that current and potential
customers have identified as having "high medical value", the Company believes
it should be able to more easily attract the attention of targeted segments of
the medical community. The Company also believes that its focus on well-defined
patient populations will allow the use of a small, focused sales force instead
of a large, specialized sales force. Because of the distinct nature of most of
its potential markets, the Company expects to be able to concentrate its
marketing efforts on a limited number of medical specialists, or on patients
themselves.
As part of its marketing efforts, the Company identifies and defines appropriate
STMS, identifies customer needs within each STMS, identifies specific product
acquisition candidates within each STMS, works with the development team to
insure clinical data are collected that supports the desired indication and
marketing claims, and if FDA approval is obtained, designs and implements
marketing plans for each of its approved products. Market research is conducted
to analyze the potential of products prior to their acquisition. Once a product
is acquired and is being developed, further market research is completed and,
based on this analysis, the product's marketing plan is developed. Upon
submission to the FDA of a proposed product's NDA, the product management
responsibilities transition from the development team to the Company's Marketing
and Sales Department. The
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Company's Marketing and Sales Department are responsible for all aspects of a
product's marketing introduction and commercialization, including product
forecasting, defining product positioning, price, promotion and physical
distribution to successfully commercialize the product. Senior sales and
marketing employees lead a cross functional team of internal personnel and
external consultants to implement a product's marketing and commercialization
plan.
MARKETING - FOREIGN
In general, the Company expects to license foreign marketing, sales and
distribution rights after an NDA is submitted in the United States. The Company
contracts with foreign companies (usually pharmaceutical companies) to market
and distribute its products. The Company considers Europe, Japan and Canada to
be its most attractive foreign markets. The Company has entered into marketing,
sales and distribution agreements for Antizol, Cystadane and Sucraid in Europe,
Cystadane and Sucraid in Australia and New Zealand, Busulfex, Cystadane, Elliots
B Solution and Sucraid in Israel, and Elliotts B Solution in Central America.
Currently, the Company is seeking a marketing and distribution partner for
Busulfex in Europe and Japan.
The Company's practice is to negotiate contracts with foreign distributors that
generally provide for minimum order and sales performance, including minimum fee
payments. The Company's accounting policy is to recognize minimum fees, if any,
when earned. Minimum fees negotiated with foreign parties to date are not
material and are not refundable, nor subject to future performance criteria. The
foreign contracting party is responsible for obtaining marketing approval for
the Company's product to which the agreement relates and the Company is
responsible for providing selected U.S regulatory information to the foreign
party on request. The Company cannot unilaterally terminate these agreements
without establishment of default, but these agreements do expire over a defined
period of time and the Company may seek other foreign parties to provide
comparable services upon expiration. The principal benefit a foreign party
receives from entering into these agreements with the Company and paying the
minimum fees, if any, is a contracted price for acquisition of product from the
Company because the Company is the sole supplier of its approved products on a
worldwide basis.
DISTRIBUTION
The Company does not intend to develop internal physical distribution
capabilities because the Company believes its relatively low-volume products can
be more economically and efficiently distributed through third party
distribution organizations. The physical distribution of the Company's products
through third parties allows the Company to avoid some of the costs associated
with developing internal information systems that comply with regulatory
requirements and satisfy customer service demands. Cystadane and Sucraid are
principally distributed directly to patients through third party mail order
pharmacies. Chronimed and an affiliate of Cardinal Health are the principal
third party distributors of Cystadane and Sucraid, respectively. Elliotts B
Solution, Antizol and Busulfex are primarily used in a hospital setting and are
distributed by an affiliate of Cardinal Health. The distribution of Antizol and
Busulfex through an affiliate of Cardinal Health facilitates the sale of these
products directly into hospitals or, if customers prefer, through their primary
wholesaler. Antizol-Vet is a product used in veterinary clinics and is
distributed by an affiliate of Cardinal Health to individual veterinary clinics
and veterinary wholesalers.
COMPETITION
Potential competitors in the United States are numerous and include
pharmaceutical, chemical and biotechnology companies. The Company will
experience competition in several specific areas, including those described
below.
* PRODUCT ACQUISITION - The Company intends to acquire the rights to
products with important therapeutic advantages that generally are not of
interest to larger pharmaceutical companies. Nevertheless, the Company
will compete with other entities in acquiring product rights from
universities and other research institutions, as well as other potential
licensors.
* PRODUCT DEVELOPMENT RESOURCES - The Company will compete for certain
resources, such as the services of clinical investigators, contract
manufacturers, advisors and other consultants. The Company will generally
have little or no control over the allocation of such resources.
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<PAGE>
* ORPHAN DRUG DESIGNATION - The Company is aware of two other companies that
have filed for and received orphan drug designation on products similar to
two of its products. Sparta Pharmaceutical and Teva (formerly Biocraft)
have been granted orphan drug designations for their intravenous busulfan
and sodium oxybate, respectively. Intravenous busulfan and sodium oxybate
are the equivalent of the Company's Busulfex and Xyrem products,
respectively. While the Company is not aware of others holding or seeking
orphan drug designations for products that would compete with the
Company's products for NDA approval, there can be no assurance that the
Company's products will not have such competition for the protection
conferred by orphan drug status.
* MARKETING AND SALES - Each of the Company's current products will face
competition from other products or from other therapeutic alternatives. In
general, the Company's products will compete against products whose
marketers have substantially greater resources, including large
specialized sales forces, than the Company.
GRANTS
The FDA Office of Orphan Drug Products (Orphan Drug grants) and the Small
Business Administration (SBIR grants) offer grants to companies whose efforts
meet certain requirements. Orphan Drug grants were made available for Busulfex,
Antizol and Colomed and a SBIR grant was made available for Intrachol. From July
1, 1995 through December 31, 1998, the Company collected approximately
$1,567,000 in grant proceeds with respect to approximately $1,567,000 in grant
related disbursements. The grant proceeds collected by the Company are
non-refundable. There can be no assurance that Orphan Drug or SBIR grants will
be made available to the Company in subsequent periods.
GOVERNMENT REGULATION
GENERAL.
Political, economic and regulatory influences are subjecting the health care
industry in the United States to fundamental change. Several potential
approaches are under consideration, including mandated basic health care
benefits, controls on health care spending through limitations on the growth of
private health insurance premiums and Medicare and Medicaid spending, price
discounts from drug manufacturers, the creation of large purchasing groups and
other significant changes to the health care delivery system. In addition, some
states have adopted or are considering various health care reform proposals. The
Company anticipates that Congress and state legislatures will continue to review
and assess alternative health care delivery systems and payment methods and that
public debate of these issues will likely continue in the future. Because of
uncertainties regarding the ultimate features of reform initiatives and their
enactment and implementation, the Company cannot predict which, if any, of such
reform proposals will be adopted, when they may be adopted or what impact they
may have on the Company or its prospects.
REIMBURSEMENT.
Employers, through payments to their employee benefit plans, bear a significant
share of the health care costs of their employees. These plans are typically
administered by insurance companies, health maintenance organizations, preferred
provider organizations and other third-party payors. Health care services and
products, including pharmaceutical products, are also paid for by government
agencies, such as Medicaid. Employers and the payors involved in providing or
administering health care benefits are increasingly turning to "managed care"
systems to control health care costs. Under these systems, the administrative
requirements and standards of care are established by the health care purchasers
and providers and the benefit level depends on the negotiated price. Managed
care systems usually limit treatment options to approved therapeutic regimens
and "formularies," or lists of approved drugs and medical products.
Being included on the formularies of managed care groups is important to the
commercial success of a prescription medicine. A pharmaceutical must be included
on a third-party payor's formulary or must be deemed "medically necessary" to be
eligible for reimbursement by that payor. In deciding whether a drug is to be
included on a formulary, payors will generally consider its therapeutic value
and cost in comparison to other available treatments. The Company believes that
the proprietary nature and medical usefulness of its products should assist it
in its
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<PAGE>
efforts to have its products approved for reimbursement. No assurance can be
given, however, that the Company's products will be approved for reimbursement
by third-party payors at acceptable levels, or at all.
PRODUCT APPROVALS.
The Company's products require FDA approvals in the United States and comparable
approvals in foreign markets before they can be marketed. The development of
investigational products and the marketing of approved products requires
continuing compliance with FDA regulations. Products that are designated
"controlled" substances also require compliance with regulations administered by
the U.S. Drug Enforcement Agency ("DEA"), and similar regulations administered
by state regulatory agencies.
MANUFACTURING REGULATION.
All facilities and manufacturing techniques used to manufacture products for
clinical use or sale in the United States must be operated in conformity with
GMP, the FDA requirements governing the production of pharmaceutical products.
FDA approval is required before a contract manufacturer can implement most
changes in manufacturing procedures for any of the Company's approved products.
The Company has established a quality assurance program to monitor third-party
manufacturers of its products to promote compliance by such manufacturers with
domestic and foreign regulations (based on country of use). In addition, FDA
approval is required for changing contract manufacturers of approved products.
Obtaining the FDA's approval for a change in manufacturing procedures or change
in manufacturers could cause production delays and loss of revenue.
FOREIGN REGULATION.
Products marketed outside of the United States are subject to regulatory
approval requirements similar to those required in the United States, although
the requirements governing the conduct of clinical trials, product licensing,
pricing and reimbursement vary widely from country to country. No action can be
taken to market any product in a country until an appropriate application has
been approved by the regulatory authorities in that country. The current
approval process varies from country to country, and the time spent in gaining
approval varies from that required for FDA approval. In certain European
countries, the sales price of a product must also be approved. The pricing
review period often begins after market approval is granted. The Company intends
to utilize foreign partners to apply for foreign marketing approvals.
INSURANCE
Providing health care products entails an inherent risk of liability. In recent
years, participants in the health care industry have been subject to a large
number of lawsuits alleging malpractice, product liability or related legal
theories, many of which involve large claims and significant defense costs. The
Company may from time to time be subject to such suits as a result of the nature
of its business. The Company carries product liability insurance coverage in the
aggregate amount of $10 million. The Company also carries a $2 million general
business insurance policy. The Company does not carry any insurance to cover the
financial risks associated with a potential FDA mandated recall of an approved
product. There can be no assurance, however, that such insurance policies will
be sufficient to fully indemnify the Company against any asserted claims or that
such insurance will continue to be available.
HUMAN RESOURCES
The Company has thirty seven full-time and seven part-time employees. The
Company believes that its relationship with its employees is good. None of the
Company's employees is represented by a labor union.
TRADE SECRETS
The Company also relies on trade secrets and proprietary know-how to protect
certain of its technologies and potential products. The Company requires
employees, consultants and advisors to enter into confidentiality
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<PAGE>
agreements that prohibit disclosure to any third party or use of such secrets
and know-how for commercial purposes. Company employees also agree to disclose
and assign to the Company all methods, improvements, modifications,
developments, discoveries and inventions conceived during their employment that
relate to the Company's business. There can no assurance, however, that these
agreements will be observed and prevent disclosure or provide adequate
protection for the Company's confidential information and inventions.
DISCONTINUED DEVELOPMENT PRODUCTS
Since inception and through December 31, 1998, the Company discontinued
development activities on a total of eleven proposed products. During 1997, the
Company discontinued development activities on the following proposed products:
Colomed, Caprogel, Clonidine, alpha-galactosidase A, colloidal bismuth
subcitrate, Intrachol, Repliderm, 5FU (5-fluorouracil), and other indications of
Cystadane. 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 based on the criteria described under the Product
Acquisition section. In addition, prior to 1997, the Company discontinued
development activities on two proposed products, which proved to have little
potential future value. There can be no assurance that the Company's license
rights and/or any clinical data related to a discontinued product have any value
to a third party and, if such rights or clinical data have value, there can be
no assurance that the Company can come to terms with a third party for the sale
of such rights or clinical data.
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<PAGE>
PRODUCTS
The following tables summarize certain information relating to the Company's
products:
<TABLE>
<CAPTION>
MARKETED PRODUCTS
- ----------------------------------------------------------------------------------------------------------------------------
U.S. Patent
NDA Issued or Orphan
Approval Applied Drug Status
Approved Product and STMS Application Date For **
- ----------------------------------- ---------------------------------- -------- ----------- -----------
<S> <C> <C> <C> <C>
I. ANTIDOTE STMS Antidote for ethylene glycol December No Granted
Antizol(R)(fomepizole) Injection (antifreeze) or suspected ethylene 1997
glycol ingestion in humans
II. ONCOLOGY SUPPORT STMS Diluent for intrathecally September No Granted
Elliotts B(R) Solution (buffered administered methotrexate 1996
intrathecal electrolyte/dextrose sodium and cyarabine
solution)
Busulfex(TM)(busulfan) Injection For use in combination with February Yes Granted
cyclophosphamide as a 1999
conditioning regimen prior
to allogenic hematopoietic
cell transplantation for
chronic myelogenous
leukemia ("CML")
III. OTHER
Cystadane(R) (betaine anhydrous for Homocystinuria, a genetic October No Granted
oral solution) disease 1996
Antidote for ethylene glycol November No Five year
Antizol-Vet(R)(fomepizole) (antifreeze) or suspected ethylene 1996 period of
for Injection glycol ingestion in dogs exclusivity
Sucraid(R)(sacrosidase) oral April No Granted
solution Sucrase deficiency, a genetic disease 1998
<CAPTION>
PRODUCTS UNDER DEVELOPMENT
- ----------------------------------------------------------------------------------------------------------------------------
U.S. Patent Orphan
Phase of Issued or Drug
Development Applied Designation
Proposed Product and STMS Proposed Application * For **
- ----------------------------------- ---------------------------------- ----------- ----------- -----------
I. SLEEP DISORDERS STMS
Xyrem(TM)(sodium oxybate) oral Under investigation for the II Yes Yes
solution treatment of narcolepsy
</TABLE>
* Development Phases are discussed under "Business - The Regulatory Process".
** Orphan Drug Designation and Status are discussed under "Business -
Proprietary Rights"
15
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ANTIDOTE STMS - APPROVED PRODUCT
ANTIZOL (FOMEPIZOLE) INJECTION
Antizol, the first of the Company's products in the Antidote STMS, received
marketing clearance from the FDA on December 4, 1997. The Company commenced
shipping Antizol in December 1997. Antizol is primarily used in a hospital
setting and is distributed for the Company by an affiliate of Cardinal Health.
Antizol is the first drug indicated as an antidote for ethylene glycol
poisoning, or to treat suspected ethylene glycol ingestions. When ingested by
humans, ethylene glycol (found in antifreeze) and methanol (found in windshield
wiper fluid) can lead to death or permanent and serious physical damage. In a
survey conducted in 1996 by the American Association of Poison Control Centers,
over 6,000 cases of ethylene glycol poisoning were reported to United States
poison control centers. In the same year, there were about 600 treatments for
such poisonings. The Company believes that hospital pharmacies stock or will
stock Antizol because it is important to treat poisoned patients very quickly in
order to improve the chances of successful recovery. For 1998, Antizol
contributed approximately 85% of the Company's total 1998 revenue. The Company
expects, after its initial stocking by hospitals in 1998, Antizol revenues will
decline to reflect the level of drug usage in poisonings, both accidental and
intentional.
The Company has obtained orphan drug status for Antizol as an antidote to treat
ethylene glycol poisonings, which provides marketing exclusivity to the Company
through December 2004. Fomepizole, the active ingredient in Antizol, is a known
compound and is not patentable. The Company has contracted with a third party
for the production of Antizol under GMP conditions. The Company, through a
sublicense agreement with Mericon Investment Group, Inc. ("MIG"), has an
exclusive, worldwide license to develop and market Antizol, which expires in
July 2013, subject to a five year renewal through July 2018 exercisable by MIG
at the request of the Company.
Studies on treatment with Antizol for methanol poisoning and to determine dosing
in pediatric cases are ongoing. A supplemental NDA covering the methanol
indication is expected to be submitted to the FDA in the second half of 1999.
ONCOLOLOGY SUPPORT STMS - APPROVED PRODUCTS
ELLIOTTS B SOLUTION (BUFFERED INTRATHECAL ELECTROLYTE/DEXTROSE
SOLUTION)
Elliotts B Solution, the first of the Company's products in the Oncology Support
STMS, received marketing clearance from the FDA in September 1996. The first
commercial sales of Elliotts B Solution occurred in December 1996. Elliotts B
Solution is primarily used in a hospital setting and is distributed for the
Company by an affiliate of Cardinal Health. Elliotts B Solution is a buffered
diluent for the intrathecal administration (injection into the fluid space
surrounding the spinal cord) of chemotherapeutic agents. Intrathecal injections
are most commonly made in treating acute lymphoblastic leukemia ("ALL"). ALL is
the most prevalent form of leukemia in children. Due to advances in
chemotherapy, the cure rate for ALL has improved dramatically in the past 30
years, going from almost zero to nearly 75% today. As a part of modern
chemotherapy, doctors often administer a series of up to 20 injections of
methotrexate sodium into the cerebrospinal fluid of patients. Elliotts B
Solution is comparable in pH, electrolyte composition, glucose content and
osmolarity to cerebrospinal fluid. It is estimated that cerebrospinal injections
of methotrexate sodium are administered to about 6,000 people in the United
States on an annual basis. Elliotts B Solution revenues through December 1998
have not been material nor does the Company expect that revenues to be material
in subsequent periods.
The Company has obtained orphan drug status for the use of Elliotts B Solution
as a diluent for methotrexate sodium or cytarabine, which provides marketing
exclusivity through September 2003. Elliotts B Solution is a known compound that
has been used previously for the intrathecal administration of chemotherapeutic
agents and is, therefore, not patentable. The Company has contracted with a
third party for the production of Elliotts B Solution under GMP conditions. No
license was required for the Company to develop and market Elliotts B Solution.
BUSULFEX (BUSULFAN) INJECTION
Following an accelerated six-month priority review, the Company received
regulatory approval from the FDA in February 1999 to market Busulfex. Busulfex
will be the Company's lead product in its Oncology Support STMS.
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Busulfex is primarily used in a hospital setting and is distributed for the
Company by an affiliate of Cardinal Health. The FDA approved Busulfex for use in
combination with cyclophosphamide as a conditioning regimen prior to allogeneic
hematopoietic progenitor cell transplantation for chronic myelogenous leukemia
("CML"). Bone marrow and peripheral stem cell transplants are collectively known
as hematopoietic progenitor cell transplants, but are more commonly referred to
as bone marrow transplants ("BMTs"). BMTs are considered to be one of the more
effective treatments currently available for patients with CML. By the year
2000, more than 20,000 BMTs are expected to be performed each year in the United
States, with another 20,000 expected to be performed annually outside the United
States. Of the 20,000 procedures expected to be performed in the United States,
more than 4,000 of these may receive some form of busulfan, as part of the
pre-transplantation conditioning regimen. The Company is marketing Busulfex to
hematologists and oncologists who perform BMTs at cancer treatment centers in
the United States. The first commercial sales of Busulfex occurred in February
1999, within two weeks of FDA approval.
One of the many complex steps in performing a BMT includes killing the patient's
abnormal blood cells, known as the "conditioning regimen," either by using a
combination of chemotherapeutic agents or total body irradiation. Busulfan is
one of the chemotherapeutic agents used in a BMT conditioning regimen. The oral
form of busulfan has been used in the transplant setting for a number of years.
However, there are difficulties associated with its use. A patient undergoing a
BMT may take up to 35 pills every six hours, or up to 140 pills each day, over
four days, often while in a state of nausea. If the patient vomits any of the
pills, they are often given additional pills to ensure they receive the
administered dose. Unfortunately, because the absorption of the pills through
the gastrointestinal system is erratic, it is difficult to determine how much of
the administered dose has been absorbed. This variation in drug exposure can
cause underdosing, possibly leading to an ineffective conditioning regimen or
failure of the patient to "engraft." Conversely, the variation can lead to
overdosing, causing an excessive amount of toxicity to the patient. Because of
these variations, many authors have cited the need for an intravenous form of
busulfan. The Company is the first to bring an intravenous form of busulfan to
the market.
Busulfex has been featured in presentations at national meetings attended by
oncologists and hematologists. As clinicians review the clinical study results,
they have responded positively to the results seen in the Busulfex trials. The
pharmacokinetics seen with Busulfex, meaning the level of drug exposure,
demonstrate the consistency that would be expected with an intravenous drug.
This consistency has led to the outcomes seen with Busulfex, which show a low
rate of liver toxicity as well as an acceptable rate of early mortality within
the first 100 days, the most critical period for the patient. In addition, all
evaluable patients receiving Busulfex engrafted, and there were no reports of a
late graft failure with Busulfex. These factors may lead to improved safety and
an improved likelihood that a BMT will be successful. An increased success rate
is important to patient well-being and for economic reasons because the average
cost of a BMT in the United States is estimated at over $100,000.
Many other drugs are currently being developed for use in the BMT area. Although
most of these new drugs treat bone marrow cells removed from the body as a part
of a BMT and are not chemotherapeutic drugs, some of them may compete with
Busulfex. In addition, 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.
The Company has obtained orphan drug status for Busulfex for the approved
indication, which provides marketing exclusivity to the Company through February
2006. The Company has contracted with a third party for the production of
Busulfex under GMP conditions. In addition, the Company has an exclusive,
worldwide license from M.D. Anderson Cancer Center, The University of Texas, and
The University of Houston (collectively, the "busulfan licensors") to develop
and market an intravenous form of busulfan, which is effective for the term of
busulfan licensors' patent rights. The busulfan licensors have been granted two
U.S. patents covering the licensed product's formulation and its use in bone
marrow transplants and other conditions, which expire in September 2016 and July
2015, respectively.
17
<PAGE>
SLEEP DISORDERS STMS - INVESTIGATIONAL PRODUCT
XYREM (SODIUM OXYBATE) ORAL SOLUTION
Narcolepsy is a chronic neurologic sleep disorder characterized by excessive
daytime sleepiness, unavoidable daytime sleep attacks, cataplexy or sudden loss
of muscle control provoked by emotions, sleep paralysis or brief periods of
muscle paralysis and hynagogic hallucinations or vivid and sometimes frightening
dreaming when falling asleep. Other related symptoms include fragmentation of
night-time sleep, disturbances of auditory and visual perception, lapses of
consciousness and memory problems. These symptoms can lead to a variety of
complications, such as limitations on education and employment opportunities,
driving or machine accidents, difficulties at work resulting in disability,
forced retirement or job dismissal, and depression. Narcolepsy is thought to
affect between 125,000 and 180,000 patients in the United States and
approximately 80,000 to 100,000 of these patients are thought be diagnosed.
Although the peak age of reported symptoms is between 15 to 25 with a smaller
peak occurring between 35 and 45, symptoms have been noted in persons as young
as five years old.
The usual treatment for narcolepsy includes symptomatic treatment of daytime
drowsiness and sleep attacks with stimulants. The symptoms of cataplexy, sleep
paralysis and hynagogic hallucinations are typically treated with tricyclic
antidepressants ("TCAs") or selective serotonin reuptake inhibitors ("SSRIs"),
none of which have been approved by the FDA for this indication or for use in
the treatment of cataplexy. These treatment regimens, in addition to limited
efficacy, are often unsatisfactory for a number of other reasons. Amphetamines
and other stimulants often cause undesirable side effects of insomnia,
hypertension, palpitations, irritability and, at higher doses, may mimic the
symptoms of schizophrenia. The TCAs and SSRIs can cause the side effects of dry
mouth, impotence, loss of libido, rapid heart beats and drug tolerance. Xyrem is
a naturally occurring substance found in many human tissues. Clinical studies
with Xyrem suggest that it is both safe and effective in the treatment of
narcolepsy. When administered at night, it has been shown to improve night-time
sleep and to control cataplexy, and to lower the incidence of daytime
sleepiness. More than 180 narcolepsy patients have been exposed to clinical
doses with no consistent ill effects, some of these patients for up to 15 years
of treatment. Xyrem does not appear to have the side effects associated with
TCAs and SSRIs. Narcoleptic patients could be treated with Xyrem at night and,
if needed, with stimulants during waking hours.
Provigil(R) (modafinil), a product marketed by Cephalon, Inc., was approved by
the FDA in late 1998 for the treatment of excessive daytime sleepiness
associated with narcoplepsy. The Company believes that Provigil and the proposed
use for Xyrem are for different symptoms of narcolepsy, which could mean that
some patients may benefit from both modafinil and Xyrem. In addition, 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.
During 1998, the Company completed clinical trials with over 120 patients at 18
sleep centers, which assessed Xyrem at different dose levels against placebo.
When compared against placebo, Xyrem demonstrated a reduction in the number of
cataplexy attacks per week, the primary measure of efficacy in this clinical
trial. During the first quarter of 1999, the Company commenced a Treatment IND
program, which is a clinical trial, to collect additional clinical safety data
necessary for the submission of an NDA. The FDA permits an investigational drug,
like Xyrem, to be used under a Treatment IND if there is sufficient evidence of
safety and effectiveness and the drug is intended to treat a serious disease. By
approving the Company's Treatment IND application, the FDA authorizes the
Company to seek reimbursement from patients and their insurance providers for
the use of Xyrem in this trial. The Company plans to meet with the FDA in the
second quarter of 1999 regarding its plans for the submission of an NDA.
Depending on the outcome of the Company's meeting with the FDA, and on any
additional work required by the FDA in support of an NDA, the Company expects
that an NDA could be submitted as early as the first half of 2000. If an NDA is
submitted and approved by the FDA, Xyrem will be the Company's first product in
the Company's Sleep Disorder STMS.
Sodium oxybate has been reported to be a drug of abuse. For this reason the
Company has requested that Xyrem be classified a "schedule III/IV drug" under
the federal Controlled Substances Act. Many states have an equivalent
classification system and compliance requirements for drugs classified as a
scheduled drug. The Company is working with federal and state authorities to
provide for the appropriate classification of Xyrem. A scheduled drug must be
manufactured, sold, distributed and used according to strict regulations
administered by the DEA.
18
<PAGE>
Sodium oxybate, the active ingredient in Xyrem, is a known compound and is not
patentable. The Company has received an orphan drug designation for its proposed
use of Xyrem. The Company has also filed a patent application with respect to
its formulation of Xyrem oral solution. No license was required for the Company
to develop Xyrem nor will a license be required for marketing Xyrem, if approved
by the FDA. The Company has contracted with third party bulk drug and drug
product manufacturers for the production of Xyrem.
OTHER APPROVED PRODUCTS
CYSTADANE (BETAINE ANHYDROUS FOR ORAL SOLUTION)
Cystadane received marketing clearance from the FDA in October 1996. The first
commercial sales of Cystadane occurred in December 1996. Cystadane is
principally distributed on a non exclusive basis by Chronimed directly to
patients in the United States through its mail order pharmacy. Although
Cystadane does not fit into one of the Company's three STMS, the Company
believes that the small size of the market and the high medical value of
Cystadane justify the limited resources required by the Company to continue
making this product available to patients. It is the first agent approved by the
FDA for the treatment of homocystinuria, an inherited metabolic disease. The
clinical consequences are wide-ranging and include dislocation of the ocular
lens, early (under age 30) thromboembolism, developmental and mental retardation
and reduced life span related to elevated plasma homocysteine levels. It has
been estimated that homocystinuria occurs about once in every 200,000 live
births worldwide. There are estimated to be 1,000 patients with homocystinuria
in the United States. The annual market potential for Cystadane is expected to
be under $500,000. Cystadane revenues through December 1998 met the Company's
expectations and are expected to grow slightly in subsequent periods.
The Company has obtained orphan drug status for Cystadane for the treatment of
homocystinuria, which provides marketing exclusivity to the Company through
October 2003. Betaine anhydrous, the active ingredient in Cystadane, is a known
compound and is not patentable. The Company has contracted with a third party
for the production of Cystadane under GMP conditions. No license was required
for the Company to develop and market Cystadane.
ANTIZOL-VET (FOMEPIZOLE) FOR INJECTION
In November 1996, the Center for Veterinary Medicine of the FDA approved
Antizol-Vet for dogs that have ingested or are suspected of having ingested
ethylene glycol. The first commercial sales of Antizol-Vet occurred in January
1997. Antizol-Vet is primarily used by veterinarians and is distributed to
veterinary clinics and veterinary wholesalers for the Company by an affiliate of
Cardinal Health. It is estimated that at least 10,000 cases of ethylene glycol
poisoning occur in dogs each year. The earlier an ethylene glycol poisoned dog
is treated with Antizol-Vet, the more likely that there will be a positive
outcome. The annual market potential for Antizol-Vet is expected to be under
$250,000. Although Antizol-Vet is not included in one of the Company's three
STMS, the Company will continue making Antizol-Vet available to veterinarians
justify the limited resources required by the Company to market and distribute
the product. The Company has found that most veterinarians are not stocking this
product for emergency use due to its high cost, but they are ordering it when a
poisoning occurs. In 1997, Antizol-Vet was the Company's largest revenue
generating product, contributing approximately 57% of the Company's total 1997
revenue. However, Antizol-Vet revenues declined in 1998 following its
introduction in 1997, and are expected to decline in subsequent periods.
Federal law provides the Company with a marketing exclusivity period through
November 2001 for the use of Antizol-Vet in dogs for the approved indication.
Fomepizole, the active ingredient in Antizol, is a known compound and is not
patentable. The Company has contracted with a third party for the production of
Antizol-Vet under GMP conditions. The Company, through a sublicense agreement
with Mericon Investment Group, Inc. ("MIG"), has an exclusive, worldwide license
to develop and market Antizol-Vet, which expires in July 2013, subject to a five
year renewal through July 2018 exercisable by MIG at the request of the Company.
SUCRAID (SACROSIDASE) ORAL SOLUTION
Sucraid received marketing clearance from the FDA in April 1998. The first
commercial sales of Sucraid occurred in July 1998. Sucraid is principally
distributed by an affiliate of Cardinal Health directly to patients in the
United States through its mail order pharmacy. The FDA approved Sucraid to be
used for oral replacement therapy of
19
<PAGE>
genetically determined sucrase deficiency, which is part of congenital sucrase
isomaltase deficiency (CSID). Sucraid is used as a replacement for an enzyme in
the small intestine that is necessary for the digestion of sucrose, which is
common table sugar. Although Sucraid does not fit into one of the Company's
three STMS, the Company believes that the small size of the market and the high
medical value of Sucraid justify the limited resources required by the Company
for making this product available to patients. The annual market potential for
Sucraid is expected to be under $500,000. Sucraid revenues since July 1998 met
the Company's expectations and are expected to grow slightly in subsequent
periods.
The primary symptoms of CSID include severe watery diarrhea, chronic
malabsorption and failure to thrive (in infants and toddlers). Other common
symptoms include nausea, vomiting, abdominal cramps and abdominal pain following
the consumption of foods containing sucrose. Prior to the approval of Sucraid,
the only specific treatment of CSID available to patients was the life-long
adherence to a sucrose-free diet. Compliance with a sucrose-free diet is very
difficult because sucrose is found in many foods in the typical American diet.
Nonspecific symptomatic treatments include antidiarrheal, antispasmodic and
antiflatulence drugs, all of which are limited in their efficacy. Sucraid is a
specific replacement of the missing enzyme responsible for CSID.
Sacrosidase, the active ingredient in Sucraid, is a known compound and is not
patentable. The Company has obtained orphan drug status for Sucraid for the
approved indication, which provides marketing exclusivity to the Company through
April 2005. The Company has contracted with a third party for the production of
Sucraid under GMP conditions. In addition, the Company has an exclusive,
worldwide license from Hartford Hospital to develop and market Sucraid, which
expires in April 2005. The license provides for two five year extension options,
the first through April 2010 and the second through April 2015, unless either
party decides to terminate the license within 90 days prior to April 2005 or
April 2010.
ITEM 2. PROPERTIES
The Company currently occupies approximately 9,544 square feet of leased office
space at a monthly rent of approximately $12,070, including operating expenses.
This lease expires on June 30, 1999. The Company is currently negotiating a four
year lease for 9,426 square feet of office space that will satisfy its expected
requirements, which would result in the Company moving to a different facility
in Minnetonka, Minnesota by July 1, 1999.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of March 1, 1999.
Name Age Title
- ------------------------ --- -------------------------------------------
John Howell Bullion 47 Chief Executive Officer and Chairman of the
Board
William Houghton, M.D. 56 Chief Operating Officer
Dayton T. Reardan, Ph.D. 43 Vice President of Regulatory Affairs
Patti A. Engel 38 Vice President of Marketing & Sales
Executive officers of the Company serve at the discretion of the Board of
Directors with no fixed term. There are no family relationships between or among
any of the executive officers or directors of the Company.
20
<PAGE>
Mr. Bullion has been Chief Executive Officer of the Company since June 24, 1994
and Chairman of the Board of Directors since December 30, 1998. Mr. Bullion is a
co-founder of Chronimed Inc., the company from which Orphan Medical, Inc. was
spun in 1994. He has been a director of Chronimed since 1985. Prior to joining
Orphan Medical, Mr. Bullion served as President of Bluestem Partners, an
investment and consulting company; Dahl & Associates, a soil and ground water
remediation company; and Concurrent Knowledge Systems, Inc., a software
development company. Mr. Bullion also served as partner and Vice President with
First Bank System Venture Capital Company for seven years.
Dr. Houghton has been the Company's Chief Operating Officer since August 1998.
Dr. Houghton's most recent position was Chief Scientific Officer and Vice
President of Clinical and Regulatory Affairs at Iotek, Inc. from April 1995 to
August 1998. At Iotek, Dr. Houghton was responsible for all research activities,
regulatory and clinical research, and served as the medical liaison with Iotek's
Medical advisory Board. From February 1984 to March 1995, Dr. Houghton also held
a variety of management positions with Abbott Australasia and Abbott
Laboratories in the United States.
Dr. Reardan has been the Company's Vice President of Regulatory Affairs since
May 1995 and had been the Director of Regulatory Affairs since joining the
Company in 1994. From 1993 to 1994, he was Director of Development at CV
Therapeutics. From 1984 to 1993, he held a variety of management positions at
Xoma Corporation, most recently Director of Project Management.
Ms. Engel has been the Company's Vice President of Marketing & Sales since May
1995 and had been Director of Marketing for the Company since joining the
Company in 1994. From 1984 to 1994, Ms. Engel held a variety of sales and
marketing management positions with 3M Pharmaceuticals, a division of the 3M
Company. Prior to joining 3M, Ms. Engel was a practicing nurse in the field of
pediatric oncology.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the National Market tier of The Nasdaq
Stock Market under the Symbol: ORPH. The following table sets forth the
quarterly high and low sales prices for the Company's Common Stock for the years
ended December 31, 1997 and December 31, 1998.
- ------------------------------------------------------------------------
High Low
----------- -------------
YEAR ENDED DECEMBER 31, 1997
January 1, 1997 through March 31, 1997 $9.625 $4.172
April 1, 1997 through June 30, 1997 $6.500 $3.500
July 1, 1997 through September 30, 1997 $8.875 $5.000
October 1, 1997 through December 31, 1997 $8.000 $4.500
YEAR ENDED DECEMBER 31, 1998
January 1, 1998 through March 31, 1998 $12.625 $4.750
April 1, 1998 through June 30, 1998 $13.875 $8.625
July 1, 1998 through September 30, 1998 $11.813 $5.938
October 1, 1998 through December 31, 1998 $9.250 $5.875
- ------------------------------------------------------------------------
As of March 19, 1999, the Company's Common Stock was held by 275 shareholders of
record and the Company estimates that there were approximately 4,348 beneficial
owners of its Common Stock on such date.
The Company has never declared or paid any dividends and does not anticipate
paying dividends on its Common Stock in the foreseeable future. The Company
currently intends to retain future earnings, if any, for use in the Company's
business. The payment of any future dividends on its Common Stock will be
determined by the Board
21
<PAGE>
of Directors in light of conditions then existing, including the Company's
earnings, financial condition and requirements, restrictions in financing
agreements, business conditions and other factors.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company as of December 31, 1998 and
1997 and for the three years ended December 31, 1998, 1997 and 1996, and for the
period from January 1, 1993 (inception) to December 31, 1998 are derived from,
and are qualified by reference to, the financial statements of the Company
audited by Ernst & Young LLP, independent auditors, included elsewhere in this
Form 10-K. The following selected financial data as of and for the six months
ended December 31, 1995, and as of and for the twelve months ended June 30, 1995
are derived from audited financial statements not included herein. In 1995, the
Company changed its fiscal year ending June 30 to a calendar year ending
December 31. This change resulted in a shortened fiscal year of six months, July
1, 1995 to December 31, 1995. The information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations", the Financial Statements and Notes thereto and other
financial information included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
FINANCIAL POSITION
- ----------------------------------------------------------------------------------------------------------------------------
December 31, December 31, December 31, December 31, June 30,
1998 1997 1996 1995 1995
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and
available-for-sale securities $ 7,521,483 $ 7,169,230 $ 16,707,906 $ 8,749,237 $ 10,871,937
Working capital 5,274,550 4,479,714 14,538,893 7,317,554 10,329,804
Total assets 9,046,730 8,238,950 17,150,599 8,987,362 11,090,806
Deficit accumulated during
the development stage (34,433,640) (26,196,538) (14,808,669) (7,191,485) (4,193,335)
Total shareholders' equity 5,575,577 3,645,902 14,795,331 7,493,990 10,492,140
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FINANCIAL RESULTS
- ----------------------------------------------------------------------------------------------------------------------------
Period from
January 1,
For the Year For the Year For the Year For Six For the Year 1993
Ended Ended Ended Months Ended Ended (Inception) to
December 31, December 31, December 31, December 31, June 30, December 31,
1998 1997 1996 1995 1995 1998
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 4,707,038 $ 634,838 $ 36,681 $ -- $ -- $ 5,378,557
Operating expenses 13,122,025 12,572,063 8,512,544 3,287,761 3,546,814 41,933,537
Other income, net 177,885 549,356 858,679 289,611 245,809 2,121,340
------------ ------------ ------------ ------------ ------------ ------------
Net loss $ (8,237,102) $(11,387,869) $ (7,617,184) $ (2,998,150) $ (3,301,005) $(34,433,640)
Less: Preferred stock
dividend 249,658 -- -- -- -- 249,658
------------ ------------ ------------ ------------ ------------ ------------
Net loss applicable to
common shareholders $ (8,486,760) $(11,387,869) $ (7,617,184) $ (2,998,150) $ (3,301,005) $(34,683,298)
============ ============ ============ ============ ============ ============
Basic and diluted loss
per common share $ (1.36) $ (1.87) $ (1.43) $ (.80) $ (2.28) $ (9.15)
Weighted average
shares outstanding 6,236,897 6,074,342 5,331,356 3,739,588 1,447,452 3,792,572
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company is a development stage company incorporated in June 1994 to carry on
the business previously conducted by the Orphan Medical Division of Chronimed.
Since its inception in January 1993, the activities of the
22
<PAGE>
Orphan Medical Division and the Company have consisted primarily of obtaining
the rights for developing and marketing proposed pharmaceutical products,
managing the development of these products and preparing for the commercial
introduction of six products. The Company operates in a single business segment:
pharmaceutical product development. The Company has experienced recurring losses
from operations and has generated an accumulated deficit from inception through
December 31, 1998 of $34,433,640. In addition, the Company expects to incur
additional losses from operations in 1999. Nevertheless, the Company believes
that, if necessary, it would be able to continue to meet its ongoing financial
obligations and operate through December 31, 1999 solely by reducing its current
expense level through reductions in personnel and by delaying Xyrem development
activities. However, the Company has estimated that it would need to raise 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.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 1998 VS. TWELVE MONTHS ENDED DECEMBER 31, 1997
Revenues increased from $634,838 for the twelve months ended December 31, 1997
to $4,707,038 for the twelve months ended December 31, 1998. Compared to 1997,
revenues increased by $4,072,200 or 641%. The 1998 increase is principally
attributable to Antizol, which the Company commenced shipping for the first time
in December 1997. Antizol revenue growth to date reflects the initial stocking
of this product by hospitals during 1998. The Company expects Antizol revenues
after 1998 to decline because most hospitals that were expected to stock Antizol
have done so, and future orders will most likely be based on use. In 1998,
Antizol-Vet revenues declined from 1997 levels and are expected to decline in
1999. The Company expects 1999 Antizol-Vet revenues will be based on use because
most distributors and wholesalers that were expected to stock Antizol-Vet have
done so, and because veterinarians are reluctant to stock this product due to
its relatively high price. Cystadane and Sucraid revenues increased from 1997
levels principally because of international shipments of Cystadane and the 1998
commercial introduction of Sucraid, which the Company commenced shipping in July
1998. Revenues 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 Company's ability to optimize distribution of its
approved products.
Cost of sales increased from $297,727 or 47% of revenues for the twelve months
ended December 31, 1997 to $825,994 or 18% of revenues for the twelve months
ended December 31, 1998. Compared to 1997, cost of sales increased by $528,267
or 177%. The 1998 increase is attributable to significantly higher unit sales
volume of new products, Antizol and Sucraid, and provisions to write off excess
Antizol and Antizol-Vet inventories. Based on the Company's expectation of lower
demand for Antizol and Antizol-Vet after 1998, inventories in excess of expected
1999 demand were written off to zero, which increased cost of sales by
approximately $93,000. Cost of sales as a percentage of revenues 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 increased from $6,482,004 for the twelve months
ended December 31, 1997 to $6,611,011 for the twelve months ended December 31,
1998. Compared to 1997, research and development expense increased by $129,007
or 2%. For the twelve months ended December 31, 1997, approximately $1,706,000,
including a $780,000 charge in the Company's third quarter of 1997, of research
and development expense related to the nine development products the Company
discontinued during 1997. Excluding the research and development expense of
$1,706,000 attributable to the nine discontinued development products, research
and development expense related to 1998 increased by approximately $1,835,000
over the corresponding 1997 period. This increase is largely attributable to
significantly higher regulatory and clinical spending for Busulfex and Xyrem in
1998 as compared to 1997. In February 1999, the FDA approved the Company's NDA
for Busulfex and, as a result, the Company expects Busulfex development spending
to decrease from 1998 levels. However, the Company expects research and
development expense, principally clinical and toxicology spending for Xyrem, to
increase significantly over 1998 levels due to the commencement in 1999 of
additional Xyrem clinical trials and management's objective to complete the
Xyrem development plan as expeditiously as possible. The Company expects to meet
with the FDA during the second quarter of 1999 to determine FDA requirements for
a Xyrem NDA
23
<PAGE>
submission, which could significantly influence the timing and amount of the
Company's spending plan for Xyrem in subsequent quarters. In addition, the
Company's product development schedule for Xyrem will be influenced by
availability of funding.
Sales and marketing expense increased from $1,158,988 for the twelve months
ended December 31, 1997 to $2,739,299 for the twelve months ended December 31,
1998. Compared to 1997, sales and marketing expense increased by $1,580,311 or
136%. This increase is largely attributable to significantly higher spending
related to the addition of an Antizol and Busulfex sales force, sales and
marketing program costs for Antizol and Busulfex, and an incentive program for
employees. The Company expects sales and marketing expenses to increase because
of the commercial introduction of Busulfex in February 1999.
General and administrative expense increased from $2,461,344 for the twelve
months ended December 31, 1997 to $2,945,721 for the twelve months ended
December 31, 1998. Compared to 1997, general and administrative expense
increased by $484,377 or 20%. This increase is principally related to a
management consulting arrangement for regulatory and product development
assistance necessitated by the 1997 departure of the Company's former President
and Chief Operating Officer, and a charge to compensation expense related to
stock options. General and administrative expenses are not expected to increase
significantly in subsequent quarters.
Contract termination fee of $2,172,000 for the twelve months ended December 31,
1997 was a one-time expense related to the June 1997 termination of an agreement
under which Chronimed had exclusive rights to distribute certain Orphan Medical
products, including Antizol and Busulfex. The amount expensed at the time of the
contract termination in the Company's second quarter of 1997 was $2,172,000,
which represented the present value of future payments that aggregated
$2,500,000, discounted at 12%. Interest expense attributable to the contract
termination fee obligation is included in other income. As of December 31, 1998,
the Company had fully satisfied its obligation to Chronimed with respect to the
contract termination fee and no additional expense is expected in subsequent
quarters.
Other income is the sum of interest income from investment activities less
interest expense from financing activities. Other income decreased from $549,346
for the twelve months ended December 31, 1997 to $177,885 for the twelve months
ended December 31, 1998. This decrease is due to less interest income resulting
from lower levels of invested funds during the year, and to approximately
$192,000 of interest expense attributable to the Company's obligation to
Chronimed resulting from the 1997 contract termination fee. Other 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 accumulated were $249,658 for the twelve months ended December 31,
1998. Preferred stock dividends are payable in arrears on August 1 and February
1 of each year, commencing on February 1, 1999. The Company satisfied its
February 1, 1999 dividend payment obligation by issuing additional preferred
stock, as permitted by the terms of the Senior Convertible Stock. The Company
intends to continue 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.
Net loss applicable to common shareholders of $(8,486,760) for the twelve months
ended December 31, 1998 compares with a net loss of $(11,387,869) for the twelve
months ended December 31, 1997. Basic and diluted loss per common share for
these respective periods were $(1.36) and $(1.87), based on weighted average
number of common shares outstanding of 6,236,897 and 6,074,342, respectively.
TWELVE MONTHS ENDED DECEMBER 31, 1997 VS. TWELVE MONTHS ENDED DECEMBER 31, 1996
The Company had approximately twelve months of sales from three products in
1997, whereas it had approximately one month of sales from two products in 1996.
In addition, the Company commenced shipping Antizol for the first time in
December 1997. Revenues increased from $36,681 for the twelve months ended
December 31, 1996 to $634,838 for the twelve months ended December 31, 1997.
24
<PAGE>
Cost of sales increased from $10,446 for the twelve months ended December 31,
1996 to $297,727 for the twelve months ended December 31, 1997. Based on the
Company's expectation of lower demand for Antizol-Vet after 1997, inventories in
excess of expected 1998 demand were written off to zero, which resulted in a
provision to increase cost of sales by approximately $104,000.
Research and development expenses increased from $6,248,381 (74% of the total
loss from operations) for the twelve months ended December 31, 1996 to
$6,482,004 (54% of the total loss from operations) for the twelve months ended
December 31, 1997. The $233,623 increase, net of grant proceeds, is largely
attributable to significantly higher clinical trial program spending for
Busulfex and Xyrem, which was offset in part by reduced development spending on
the nine products the Company determined to discontinue. The Company recorded a
charge of $780,000 to earnings during its third quarter of 1997 relating to
discontinued development activities on these nine products. The Company filed
one NDA during 1997 for Sucraid compared to one NDA during 1996 for Antizol. As
of December 31, 1997, the Company had three products under development, whereas
thirteen products were under development as of December 31, 1996.
Sales and marketing expenses increased from $399,444 (5% of the total loss from
operations) for the twelve months ended December 31, 1996 to $1,158,988 (10% of
the total loss from operations) for the twelve months ended December 31, 1997.
The $759,544 increase is principally due to costs related to initiating the new
distribution agreement with Cardinal Health and marketing costs for the
Company's four FDA approved products.
General and administrative expenses increased from $1,854,273 (22% of the total
loss from operations) for the twelve months ended December 31, 1996 to
$2,461,344 (21% of the total loss from operations) for the twelve months ended
December 31, 1997. The $607,071 increase is principally due to the full year
effect of 1996 staff additions, lease costs for added office and storage space,
and information systems expenditures.
Contract termination fee increased from zero for the twelve months ended
December 31, 1996 to $2,172,000 for the twelve months ended December 31, 1997.
The contract termination fee is a one time expense related to the June 1997
termination of an agreement under which Chronimed had exclusive rights to
distribute certain Orphan Medical products, including Antizol and Busulfex. The
amount expensed at the time of the contract termination in the Company's second
quarter of 1997 was $2,172,000, which represented the present value of future
payments that aggregated $2,500,000, discounted at 12%. Interest expense
attributable to the contract termination fee obligation is included in other
income.
Other income is the sum of interest income from investment activities less
interest expense from financing activities. Other income decreased from $858,679
for the twelve months ended December 31, 1996 to $549,356 for the twelve months
ended December 31, 1997. This decrease is due to less interest income resulting
from lower levels of invested funds during the year, and to approximately
$136,000 of interest expense attributable to the Company's obligation to
Chronimed resulting from the 1997 contract termination fee.
Net loss for the twelve months ended December 31, 1997 and for the twelve months
ended December 31, 1996 was $(11,387,869) and $(7,617,184), respectively. Basic
and diluted loss per common share for these respective periods were $(1.87) and
$(1.43), based on weighted average number of common shares outstanding of
6,074,342 and 5,331,356, respectively.
LIQUIDITY AND CAPITAL RESOURCES
From inception through December 31, 1998, the Company has used $29,468,797 to
fund operating activities. 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, net proceeds from public offerings in 1995 and
1996, net proceeds from a 1998 private placement of convertible preferred stock,
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 $30,703,053.
25
<PAGE>
Net working capital (current assets less current liabilities) increased from
$4,479,714 at December 31, 1997 to $5,274,550 at December 31, 1998. Cash, cash
equivalents, and available-for-sale securities increased from $7,169,230 at
December 31, 1997 to $7,521,483 at December 31, 1998. The Company invests excess
cash in short-term, interest-bearing, investment grade securities.
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 based on the Company's
trade accounts receivable. To date, the Company has not borrowed under this
arrangement. The Company expects that the bank will offer to extend this
arrangement for another twelve months, but there can be no assurance that the
bank will do so, or that it would do so on terms acceptable to the Company.
The Company's commitments for outside development spending increased from
$2,700,000 at December 31, 1997 to $3,350,000 at December 31, 1998. The $650,000
increase is principally attributable to Xyrem development activities. The
Company expects future commitments for Xyrem to increase significantly over
current levels.
The Company expects spending during 1999 for research and development, and sales
and marketing to increase significantly over 1998 levels. Management believes
the Company's current working capital and anticipated operating cash flows from
product sales will be sufficient to fund its operations through December 31,
1999. However, included in the Company's estimate of 1999 anticipated cash flows
from product sales are significant revenues from the sale of a new product,
Busulfex. Any material reduction in projected Busulfex revenues, or other
developments that negatively affects the Company's cash position, would require
the Company to seek additional equity or debt financing or substantially reduce
spending. There can be no assurance that equity or debt financing will be
available or, if available, on acceptable terms. The Company believes that, if
necessary, it would be able to continue to meet its ongoing financial
obligations and operate through December 31, 1999 solely by reducing its current
expense level through reductions in personnel and by delaying Xyrem development
activities.
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 include either: (1) net
tangible assets in excess of $4.0 million or (2) a market capitalization of at
least $50.0 million. The Company's net tangible assets at December 31, 1998
equaled approximately $5,575,000. Net tangible assets are defined as total
assets less the sum of total liabilities and intangible assets. The Company must
continue to either satisfy the $4.0 million net tangible asset requirement or
maintain a market capitalization of at least $50.0 million. If the Company fails
to satisfy at least one of these 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. Without additional equity financing, the Company estimates
that its net tangible assets will fall below $4.0 million during the first half
of 1999 and below $2.0 million as early as June 30, 1999. The Company estimates
that it would need to raise 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. The Company has no assurance
that such capital will be available or, if available, on acceptable terms.
In connection with the 1998 private placement of convertible preferred stock,
the Company agreed to certain restrictions and covenants, which could limit its
ability to obtain additional financing. 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. Even
without these restrictions, the Company can make no assurances that additional
financing opportunities will be available or, if available, on acceptable terms.
On March 25, 1999, UBS Capital LLC ("UBS") informed the Company it would invest,
on terms to be mutually agreed, up to the amount obtained by subtracting the
amount of revenues booked, according to GAAP, for sales of
26
<PAGE>
Busulfex through the filing of the Company's Annual report on Form 10-K, from
$2.0 million. This commitment would expire on December 31, 1999. However, the
Company and UBS have not agreed to terms for such an additional investment.
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 twelve months ended December 31, 1998, 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's investments consist of debt securities with contractual maturities
of less than one year. Therefore, the Company does not believe its operations
are exposed to significant market risk relating to interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The financial statements of the Company as of and for the year ended December
31, 1998 begin on page F-1 of this Annual Report.
27
<PAGE>
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) DIRECTORS OF THE REGISTRANT.
The information required by this item is incorporated by reference from the
information under the caption "Election of Directors" contained in the Company's
Proxy Statement to be filed with the Securities and Exchange Commission in
connection with the solicitation of proxies for the Company's Annual Meeting of
Shareholders to be held on May 26, 1999 (the "Proxy Statement").
(b) EXECUTIVE OFFICERS OF THE REGISTRANT.
Information concerning Executive Officers of the Company is included in this
Annual Report in Item 4A under the caption "Executive Officers of the
Registrant".
(c) COMPLIANCE WITH 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934.
The information required by this item is incorporated by reference from the
information under the caption "Section 16(a) Reporting" contained in the Proxy
Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
information under the caption "Executive Compensation" contained in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this item is incorporated by reference from the
information under the caption "Stock Ownership" contained in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
information contained under the caption "Certain Transactions" contained in the
Proxy Statement.
28
<PAGE>
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1). FINANCIAL STATEMENTS
PAGE NUMBER
IN THIS
DESCRIPTION ANNUAL REPORT
- ----------------------------------------------------------------- -------------
Audited Financial Statements:
Report of Independent Auditors F-1
Balance Sheets F-2
Statements of Operations F-3
Statements of Cash Flows F-4
Statement of Changes in Shareholders' Equity F-5
Notes to Financial Statements F-6 to F-13
(a)(2). The following financial statement schedule should be read in conjunction
with the Audited Financial Statements referred to under Item 14 (a)(1) above.
Financial statement schedules not included in this Report have been omitted
because they are not applicable or the required information is shown in the
Audited Financial Statement or Notes thereto.
PAGE NUMBER
IN THIS
DESCRIPTION ANNUAL REPORT
- ----------------------------------------------------------------- -------------
Schedule II - Valuation and Qualifying Accounts: Years Ended F-14
December 31, 1998, 1997 and 1996
(a)(3). LISTING OF EXHIBITS
Exhibit Method of
Number Description Filing
- ------- --------------------------------------------------------- --------
3.1 Articles of Incorporation of Orphan Medical, Inc. ("OMI") (1)
3.1.1 Certificate of Designation for Senior Convertible
Preferred Stock (11)
3.2 Bylaws of OMI, as amended (1)
4.1 OMI 1994 Stock Option Plan (1)
4.2 OMI Employee Incentive Stock Option Agreement (1)
4.3 OMI Non-Incentive Stock Option Agreement (1)
4.4 OMI Non-Incentive Stock Option Agreement for Non-Employee
Directors (1)
10.1 Marketing and Distribution Agreement between OMI and
Chronimed effective July 2, 1994 (1)
10.2 Transfer Agreement between OMI and Chronimed effective
July 1, 1994 (1)
10.3 Distribution and Spin-off Agreement between OMI and
Chronimed effective July 2, 1994 (1)
10.4 Administrative Services Agreement between OMI and
Chronimed effective July 2, 1994 (1)
10.5 Security Agreement between OMI and Chronimed effective
July 2, 1994 (1)
10.6 Aminocaproic Acid License Agreement between Chronimed and
Virginia's Center for Innovative Technology dated
September 17, 1993 (1)
10.7 Patent and Technology License Agreement for Busulfan
between Chronimed and The University of Texas M.D.,
Anderson Cancer Center, the Board of Regents of the
University of Texas System and the University of Houston
effective February 14, 1994 (1)
10.8 Letter Agreement regarding L-Cycloserine between Chronimed
and Dr. Meier Lev dated December 29, 1993 (1)
10.9 Sublicense Agreement regarding 4-Methylpyrazole between
Chronimed and Mericon Investment Group, Inc. dated
December 17, 1993 (1)
10.10 License Agreement regarding Short Chain Fatty Acids
between Chronimed and Richard Breuer dated March 2, 1994 (1)
10.11 Employment Agreement between OMI and John Howell Bullion
dated August 31, 1994 (1)
29
<PAGE>
Exhibit Method of
Number Description Filing
- ------- --------------------------------------------------------- --------
10.12 Employment Agreement between OMI and Bertram A. Spilker,
Ph.D., M.D. dated August 31, 1994 (1)
10.13 Assumption Agreement and Consent to Assignments regarding
Short Chain Fatty Acids between OMI and Richard Breuer
dated September 30, 1994 (2)
10.14 Assumption Agreement and Consent to Assignment regarding
Aminocaproic Acid between OMI and Virginia's Center for
Innovative Technology dated September 30, 1994 (2)
10.15 Assumption Agreement and Consent to Assignment regarding
4-Methylpyrazole between OMI and Mericon Investment Group,
Inc. dated October 5, 1994 (2)
10.16 License Agreement regarding 4-Methylpyrazole between
Kenneth McMartin and Mericon Investment Group, Inc. dated
July 6, 1993 (2)
10.17 License Agreement regarding Glucaric Acid between OMI and
Ohio State University Research Foundation dated December
28, 1994 (2)
10.18 Manufacturing Development and Supply Agreement regarding
Aminocaproic Acid between OMI and Lifecore Biomedical,
Inc. dated December 21, 1994 (2)
10.19 Marketing Agreement regarding Cystagon between OMI and
Chronimed dated October 19, 1994 (2)
10.20 Assumption Agreement and Consent to Assignment regarding
Busulfan between OMI and the University of Texas, M.D.,
Anderson Cancer Center, the Board of Regents of the
University of Texas System and the University of Houston
dated October 18, 1994 (2)
10.21 License Agreement regarding Catrix between OMI and
Lescarden, Inc. dated October 28, 1994 (2)
10.22 License Agreement regarding Sucrase between OMI and
Hartford Hospital dated December 30, 1994 (2)
10.23 Option to Acquire License regarding Tretinoin between OMI
and James Hannan dated February 6, 1995 (2)
10.24 Consulting Agreement between OMI and William B. Adams
dated November 15, 1994 (3)
10.25 Lease Agreement between OMI and Wahldick Rice Property
Management, Inc. ("Wahldick") dated January 5, 1995 (2)
10.26 Lease Agreement between OMI and Wahldick dated October 3,
1994 (2)
10.27 Agreement regarding Cystagon between Chronimed and Mylan
Pharmaceutical dated October 17, 1994 (2)
10.28 Lease Agreement between OMI and Wahldick dated May 26,
1995 (4)
10.29 Agreement between OMI and David A. Feste effective July 1,
1995 (4)
10.30 Development and License Agreement regarding Choline
Chloride between OMI and Alan Buchman, Donald J. Jenden,
Marvin E. Ament and Mark D. Dubin dated May 11, 1995 (4)
10.31 Addendum to License Agreement regarding Short Chain Fatty
Acids between OMI and Richard Breuer dated May 12, 1995 (4)
10.32 Addendum to Administrative Services Agreement between OMI
and Chronimed dated August 2, 1995 (4)
10.33 Amendment to Aminocaproic Acid License Agreement between
OMI and Virginia's Center for Innovative Technology dated
September 17, 1993 (5)
10.34 Amendment No. 1 to Marketing and Distribution Agreement
between OMI and Chronimed dated July 2, 1994 (5)
10.35 Amendment to Marketing Agreement regarding Cystagon
between OMI and Chronimed dated October 19, 1994 (5)
10.36 IRS tax qualification letter dated January 10, 1996
regarding the favorable determination of the tax status of
the OMI 401(k) Savings Plan (5)
10.37 Lease Agreement between OMI and Wahldick Rice Property
Management, Inc. dated February 5, 1996 (5)
30
<PAGE>
Exhibit Method of
Number Description Filing
- ------- --------------------------------------------------------- --------
10.38 Form of License Agreement regarding Colloidal Bismuth
Subcitrate between OMI and Josman Laboratories, Inc. dated
March 4, 1996 (5)
10.39 Agreement between OMI and Chronimed dated June 3, 1996 to
amend Marketing and Distribution Agreement dated July 2,
1996 (6)
10.40 Cystadane Agreement between the OMI and Chronimed dated
October 11, 1996 (7)
10.41 License Agreement regarding alpha galactosidase A between
OMI and Research Corporation Technologies, Inc. Dated
March 15, 1996 (8)
10.42 License Agreement regarding 5-fluorouracil between OMI and
the University of Miami and its Department of Opthalmology
dated December 6, 1996 (8)
10.43 Collaborative Development Agreement regarding Clonidine
between OMI and Medtronic, Inc. dated November 27, 1996 (8)
10.44 Distribution Agreement between OMI and W. A. Butler
Company dated November 26, 1996 (8)
10.45 Distribution Services Agreement between OMI and Cardinal
Health dated June 1, 1997 (9)
10.46 Termination Agreement between OMI and Chronimed dated as
of June 27, 1997. (10)
10.47 Loan Agreement and Security Agreement between OMI and
Riverside Bank dated May 15, 1998. (11)
10.48 Stock Purchase Agreement between OMI and UBS Capital II
LLC dated July 23, 1998. (11)
10.49 Supplement to Termination Agreement between OMI and
Chronimed dated December 7, 1998. (12)
10.50 Supplement II to Termination Agreement between OMI and
Chronimed dated February 9, 1999. (13)
10.51 Purchase Agreement between OMI and UTECH, LLC dated Filed
December 30, 1998 regarding the sale and assignment to herewith
UTECH LLC of license rights to Colloidal Bismuth
Subcitrate.
10.52 Common Stock Purchase Warrant between OMI and R.J. Filed
Steichen dated January 1, 1999. herewith
23.1 Consent of Ernst & Young LLP Filed
herewith
24 Power of Attorney Filed
herewith
99 Cautionary Statements Filed
herewith
27 Financial Data Schedule - EDGAR SCHEDULE Filed
herewith
(1) Incorporated by reference to the corresponding exhibit numbers
in OMI's Registration Statement on Form 10 filed on August 31, 1994,
Commission File No. 0-24760.
(2) Incorporated by reference to the corresponding exhibit numbers
in OMI's Registration Statement on Form S-1 filed on March 3, 1995,
Commission File No. 0-24760.
(3) Incorporated by reference to the corresponding exhibit number in
OMI's Quarterly Report on Form 10-Q for the quarter ended December
30, 1994, Commission File No. 0-24760.
(4) Incorporated by reference to the corresponding exhibit numbers
in OMI's Annual Report on Form 10-K filed for the year ended June
30, 1995, Commission File No. 0-24760.
(5) Incorporated by reference to the corresponding exhibit numbers
in OMI's Registration Statement on Form S-1 filed on March 11, 1996,
Commission File No. 0-24760.
(6) Incorporated by reference to the corresponding exhibit number in
OMI's Quarterly Report on Form 10-Q for the quarter ended June 30,
1996, Commission File No. 0-24760.
(7) Incorporated by reference to the corresponding exhibit number in
OMI's Quarterly Report on Form 10-Q for the quarter ended September
30, 1996, Commission File No. 0-24760.
31
<PAGE>
(8) Incorporated by reference to the corresponding exhibit numbers
in OMI's Annual Report on Form 10-K filed for the year ended
December 31, 1996, Commission File No. 0-24760.
(9) Incorporated by reference to the corresponding exhibit number in
OMI's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997, Commission File No. 0-24760.
(10) Incorporated by reference to the corresponding exhibit numbers
in OMI's Annual Report on Form 10-K filed for the year ended
December 31, 1997, Commission File No. 0-24760.
(11) Incorporated by reference to the corresponding exhibit numbers
in OMI's Quarterly Report on Form 10-Q for the quarter ended June
30, 1998, Commission File No. 0-24760.
(12) Incorporated by reference to the similarly described exhibit
included with OMI's Current Report on Form 8-K dated December 7,
1998, Commission File No. 0-24760.
(13) Incorporated by reference to the similarly described exhibit
included with OMI's Current Report on Form 8-K dated February 9,
1999, Commission File No. 0-24760.
(b). REPORTS ON FORM 8-K
The Company filed a Current Report dated December 7, 1998 on Form 8-K to report
under Item 5 the Company and Chronimed agreed to amend the Termination Agreement
dated June 27, 1997 between the Company and Chronimed. The Termination Agreement
provided for the termination of certain agreements that had been in existence
between the Company and Chronimed since July 1994. The December 7, 1998
amendment to the Termination Agreement required the Company to issue and deliver
to Chronimed 127,723 shares, subject to adjustment in subsequent quarters, of
Common Stock on or before December 31, 1998.
(c). EXHIBITS
See Item 14(a)(3) above.
(d). FINANCIAL STATEMENT SCHEDULES
See Item 14(a)(2) above.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the registrant has duly caused this report on Form 10-K to be signed on
its behalf by the undersigned thereunto duly authorized, in the City of
Minnetonka, Minnesota, on the 26th day of March, 1999.
ORPHAN MEDICAL, INC.
By:
/s/ John Howell Bullion
-----------------------
John Howell Bullion
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934 this report has been
signed by the following persons on behalf of the Registrant and in the
capacities indicated as of March 26, 1999.
SIGNATURE TITLE
- ------------------------------------------- ----------------------------------
/s/ John Howell Bullion Chief Executive Officer (Principal
- ------------------------------------------- Executive Officer) and a Director
John Howell Bullion
* Director
- -------------------------------------------
Michael Greene
* Director
- -------------------------------------------
Julius A. Vida
* Director
- -------------------------------------------
W. Leigh Thompson, Ph.D., M.D.
* Director
- -------------------------------------------
William M. Wardell, Ph.D., M.D.
* Director
- -------------------------------------------
Lawrence C. Weaver, Ph.D., D.Sc. (Hon.)
By: /s/ John Howell Bullion
-----------------------
John Howell Bullion, Attorney-In-Fact
* John Howell Bullion, pursuant to the Powers of Attorney executed by each
of the officers and directors above whose name is marked by a "*", by
signing his name hereto, does hereby sign and execute this Annual Report
on behalf of each of the officers and directors in the capacities in which
the name of each appears above.
33
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Orphan Medical, Inc.
We have audited the accompanying balance sheets of Orphan Medical, Inc. (a
development stage company) as of December 31, 1998 and 1997, the related
statements of operations, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1998, and the period
from January 1, 1993 (inception) to December 31, 1998. Our audits also included
the financial statement schedule listed in Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion. Also, in
our opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Orphan Medical, Inc. at
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998, and the
period from January 1, 1993 (inception) to December 31, 1998, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
February 5, 1999
F-1
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 2,980,342 $ 2,150,877
Available-for-sale securities 4,541,141 5,018,353
Accounts receivable, less allowance for doubtful
accounts of $48,620 and $22,617 for 1998 and 1997,
respectively 989,339 238,356
Other receivables 6,925 143,581
Inventories 112,725 308,548
Prepaid expenses 115,231 41,599
------------ ------------
Total current assets 8,745,703 7,901,314
Property and equipment:
Property and equipment 556,358 494,680
Accumulated depreciation (255,331) (157,044)
------------ ------------
301,027 337,636
------------ ------------
Total assets $ 9,046,730 $ 8,238,950
============ ============
Liabilities and shareholders' equity
Current liabilities:
Chronimed, Inc. obligation - current portion $ -- $ 876,655
Accounts payable 586,816 358,845
Accrued outdated product return allowance 304,582 --
Accrued expenses 2,579,755 2,186,100
------------ ------------
Total current liabilities 3,471,153 3,421,600
Non-current liabilities
Chronimed, Inc. obligation -- 1,171,448
Commitments
Shareholders' equity:
Senior Convertible Preferred Stock, $.01 par value;
14,400 shares authorized; 7,500 shares issued and
outstanding 75 --
Common stock, $.01 par value; 25,000,000 shares
authorized; 6,560,096 and 6,099,562 issued and
outstanding 65,601 60,996
Additional paid-in capital 39,946,113 29,783,404
Deficit accumulated during the development stage (34,433,640) (26,196,538)
------------ ------------
5,578,149 3,647,862
Unrealized gain (loss) on available-for-sale securities (2,572) (1,960)
------------ ------------
Total shareholders' equity 5,575,577 3,645,902
------------ ------------
Total liabilities and shareholders' equity $ 9,046,730 $ 8,238,950
============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
F-2
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
FOR THE YEAR FOR THE YEAR FOR THE YEAR JANUARY 1, 1993
ENDED ENDED ENDED (INCEPTION) TO
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues $ 4,707,038 $ 634,838 $ 36,681 $ 5,378,557
Operating expenses:
Cost of sales 825,994 297,727 10,446 1,134,167
Research and development 6,611,011 6,482,004 6,248,381 24,816,427
Sales and marketing 2,739,299 1,158,988 399,444 4,297,731
General and administrative 2,945,721 2,461,344 1,854,273 9,513,212
Contract termination fee (Note 12) -- 2,172,000 -- 2,172,000
------------- ------------- ------------- -------------
Loss from operations (8,414,987) (11,937,225) (8,475,863) (36,554,980)
Other income:
Interest, net 177,885 549,356 858,679 2,121,340
------------- ------------- ------------- -------------
Net loss and deficit accumulated during the
development stage (8,237,102) (11,387,869) (7,617,184) (34,433,640)
Less: Preferred stock dividends 249,658 -- -- 249,658
------------- ------------- ------------- -------------
Net loss and deficit accumulated during the
development stage applicable to common
shareholders $ (8,486,760) $ (11,387,869) $ (7,617,184) $ (34,683,298)
============= ============= ============= =============
Basic and diluted loss per common share
applicable to common shareholders $ (1.36) $ (1.87) $ (1.43) $ (9.15)
============= ============= ============= =============
Weighted average number of
Shares outstanding 6,236,897 6,074,342 5,331,356 3,792,572
============= ============= ============= =============
</TABLE>
SEE ACCOMPANYING NOTES.
F-3
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
FOR THE YEAR FOR THE YEAR FOR THE YEAR JANUARY 1, 1993
ENDED ENDED ENDED (INCEPTION) TO
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (8,237,102) $ (11,387,869) $ (7,617,184) $ (34,433,640)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 98,287 76,491 48,898 255,331
Compensatory options 323,608 26,703 -- 350,311
Loss on disposition of fixed assets -- -- 4,091 4,091
Contract termination fee -- 2,048,103 -- 2,048,103
Changes in operating assets and liabilities:
Accounts payable 227,971 110,989 105,992 586,816
Accrued expenses 758,312 78,688 755,904 2,944,412
Inventories 195,823 (308,548) -- (112,725)
Accounts receivable and other (687,959) (237,281) (124,566) (1,111,496)
------------- ------------- ------------- -------------
Net cash used in operating activities (7,321,060) (9,592,724) (6,826,865) (29,468,797)
INVESTING ACTIVITIES
Purchase of property and equipment (61,678) (157,689) (132,991) (598,641)
Proceeds from fixed asset sales -- -- -- 38,192
Purchase of short-term investments (12,749,402) (12,253,885) (19,523,044) (49,922,034)
Maturities of short term investments 13,226,002 20,013,533 10,462,638 45,378,322
------------- ------------- ------------- -------------
Net cash provided by (used in) investing
activities 414,922 7,601,959 (9,193,397) (5,104,161)
FINANCING ACTIVITIES
Capital contribution -- -- -- 5,000,000
Stock option exercise proceeds 660,595 213,697 83,625 957,917
Net proceeds from Common and Preferred
Stock offerings 7,075,008 -- 14,834,900 30,703,053
Expenses paid by Chronimed -- -- -- 892,330
------------- ------------- ------------- -------------
Net cash provided by financing activities 7,735,603 213,697 14,918,525 37,553,300
------------- ------------- ------------- -------------
Increase (decrease) in cash and cash
equivalents 829,465 (1,777,068) (1,101,737) 2,980,342
Cash and cash equivalents at the beginning
of period 2,150,877 3,927,945 5,029,682 --
------------- ------------- ------------- -------------
Cash and cash equivalents at the
end of period $ 2,980,342 $ 2,150,877 $ 3,927,945 $ 2,980,342
============= ============= ============= =============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest received $ 438,923 $ 730,618 $ 719,542 $ 2,387,580
============= ============= ============= =============
</TABLE>
SEE ACCOMPANYING NOTES.
F-4
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED
COMMON STOCK PREFERRED STOCK ADDITIONAL DURING
---------------------- --------------------- PAID-IN DEVELOPMENT
SHARES AMOUNT SHARES AMOUNT CAPITAL STAGE TOTAL
---------------------- --------------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net loss for the period of January 1,
1993 (inception) to July 2, 1993 -- $ -- -- $ -- $ -- $ (43,668) $ (43,668)
Contribution by Chronimed -- -- -- -- 43,668 -- 43,668
---------------------- --------------------- ------------ ------------ ------------
Balance at July 2, 1993 -- -- -- -- 43,668 (43,668) --
Net loss -- -- -- -- -- (848,662) (848,662)
Issuance of Common Stock in
connection with spin-off 1,187,750 11,878 -- -- 5,828,163 -- 5,840,041
---------------------- --------------------- ------------ ------------ ------------
Balance at July 1, 1994 1,187,750 11,878 -- -- 5,871,831 (892,330) 4,991,379
Net loss -- -- -- -- -- (3,301,005) (3,301,005)
Adjustment to number of shares
issued in connection with spin-off (6,912) (70) -- -- 70 -- --
Net proceeds from public offering in
May and June of 2,558,750 shares 2,558,750 25,588 -- -- 8,776,128 -- 8,801,716
Proceeds from issuance of warrant -- -- -- -- 50 -- 50
---------------------- --------------------- ------------ ------------ ------------
Balance at June 30, 1995 3,739,588 37,396 -- -- 14,648,079 (4,193,335) 10,492,140
Net loss -- -- -- -- -- (2,998,150) (2,998,150)
---------------------- --------------------- ------------ ------------ ------------
Balance at December 31, 1995 3,739,588 37,396 -- -- 14,648,079 (7,191,485) 7,493,990
Net loss -- -- -- -- -- (7,617,184) (7,617,184)
Net proceeds from public offering in
April of 2,300,000 shares 2,300,000 23,000 -- -- 14,811,900 -- 14,834,900
Options exercised 16,500 165 -- -- 83,460 -- 83,625
---------------------- --------------------- ------------ ------------ ------------
Balance at December 31, 1996 6,056,088 60,561 -- -- 29,543,439 (14,808,669) 14,795,331
Net loss -- -- -- -- -- (11,387,869) (11,387,869)
Options exercised 41,287 413 -- -- 213,284 -- 213,697
Compensatory options -- -- -- -- 26,703 -- 26,703
Warrants exercised 2,187 22 -- -- (22) -- --
---------------------- --------------------- ------------ ------------ ------------
Balance at December 31, 1997 6,099,562 60,996 -- -- 29,783,404 (26,196,538) 3,647,862
Net loss -- -- -- -- -- (8,237,102) (8,237,102)
Net proceeds from private offering in
July of 7,500 of Senior Convertible
Preferred Stock -- -- 7,500 75 7,074,933 -- 7,075,008
Stock issued to Chronimed for
contract termination fee 313,694 3,137 -- -- 2,105,041 -- 2,108,178
Options exercised 160,100 1,601 -- -- 808,994 -- 810,595
Shares tendered in connection with
stock option exercises (16,551) (166) -- -- (149,834) -- (150,000)
Compensatory options -- -- -- -- 323,608 -- 323,608
Warrants exercised 3,291 33 -- -- (33) -- --
---------------------- --------------------- ------------ ------------ ------------
Balance at December 31, 1998 6,560,096 $ 65,601 7,500 $ 75 $ 39,946,113 $(34,433,640) $ 5,578,149
====================== ===================== ============ ============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
F-5
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. BUSINESS ACTIVITY
Orphan Medical, Inc. (the "Company"), is a development stage company that
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
substantially equivalent substitute. The Company is the successor to the
business previously conducted by the Orphan Medical Division of Chronimed Inc.
("Chronimed") from January 1, 1993 (inception) to July 1, 1994. Since inception
and through December 31, 1998, the Company operated within a single segment,
pharmaceutical product development, and had five approved products commercially
available in the United States and several foreign countries. These five
approved products accounted for $4,707,038 in revenue for the year ended
December 31, 1998, with less than 10% of total revenues from customers outside
the United States.
As of December 31, 1998, the Company had not completed product development,
obtained required regulatory approvals or verified the market acceptance and
demand for Busulfex and Xyrem, two of its three principal products. Antizol,
Busulfex and Xyrem are the Company's principal products. The Company estimates
that the future revenues from Antizol, which has been commercially available
since December 1997, and Busulfex will be required to fund its operations in
subsequent periods, but additional financing may be required to fund an
accelerated development plan for Xyrem. In February 1999, the U.S. Food and Drug
Administration (the "FDA") approved the Company's New Drug Application ("NDA")
for Busulfex and the Company began commercial shipments of Busulfex to
distributors and wholesalers during the same month. In addition, a Treatment
Investigational New Drug ("IND") application for Xyrem was approved by the FDA
in December 1998 and the Company began shipping Xyrem in February 1999, for use
in its Treatment IND clinical trials. The Treatment IND allows the Company to
seek payments for Xyrem used by patients enrolled in the Treatment IND clinical
trials, as well as gain additional clinical safety data that are expected to
support the Company's planned NDA filing for Xyrem after 1999.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
The Company's activities have been accounted for as those of a "development
stage enterprise" as set forth in Statement of Financial Accounting Standards
("SFAS") No. 7. Among the disclosures required by SFAS No. 7 are that the
Company's financial statements be identified as those of a development stage
enterprise and that the statements of operations, shareholders' equity (deficit)
and cash flows disclose activities since the date of the Company's inception.
However, in the first quarter of 1999, the Company expects to discontinue
reporting as a development stage enterprise upon commencing commercial sales of
Busulfex.
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.
REVENUE RECOGNITION
Sales are recognized at the time a product is shipped to the Company's
customers. Provisions are established for estimated returns of outdated product
and for discounts for prompt payment.
CASH EQUIVALENTS AND AVAILABLE-FOR-SALE SECURITIES
The Company considers all highly liquid investments with remaining maturities of
90 days or less when purchased to be cash equivalents. The Company considers all
highly liquid investments with remaining maturities of more than 90 days when
purchased to be available-for-sale securities. Cash equivalents are carried at
cost plus accrued interest, which approximates market value. The Company records
unrealized gain or loss, if any, on available-for-sale securities to a separate
component of shareholders' equity.
F-6
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONCENTRATION OF CREDIT RISK
The Company invests its excess cash in U.S. government agency securities,
investment grade commercial paper, and other money market instruments and has
established guidelines relative to diversification and maturities in an effort
to maintain safety and liquidity. These guidelines are periodically reviewed to
take advantage of trends in yields and interest rates. The Company has not
experienced any significant losses on its cash equivalents or available-for-sale
securities.
ACCOUNTS RECEIVABLE ALLOWANCE
The Company determines an allowance amount based upon an analysis of the
collectibility of specific accounts and the aging of the accounts receivable.
There is a concentration of sales to larger medical wholesalers and
distributors. The Company performs periodic credit evaluations of its customers'
financial condition. Receivables are generally due within 30 days of the invoice
date. Credit losses relating to customers have not been material since the
Company's inception.
INVENTORIES
Inventories consist principally of raw materials, packaging and finished goods
for products that have been approved by the FDA for commercial sale and are
valued at the lower of cost or market determined under the standard cost method,
which approximates the first-in, first-out (FIFO) method. The Company's policy
is to establish an excess and obsolete reserve for its products in excess of the
expected demand for such products during the twelve months following the balance
sheet date.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Maintenance and repairs are expensed
as incurred. Depreciation is computed using the straight-line method over the
assets' estimated useful lives of five to seven years.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to operations as incurred.
Research and development costs consist principally of preclinical and clinical
testing costs, certain salary and related expenses, bulk drug and drug product
costs incurred in support of clinical testing and for validation lots required
by the FDA, toxicology studies and various technical consulting costs.
GRANT AWARDS
The FDA Office of Orphan Drug Products and the Small Business Administration
provide, upon application and approval, non-refundable grant awards in support
of certain research and development activities. Cash proceeds collected pursuant
to the terms of such grant awards are accounted for on a reimbursement basis.
INCOME TAXES
The Company accounts for income taxes using the liability method. Deferred
income taxes are provided for temporary differences between the financial
reporting and tax bases of assets and liabilities.
STOCK BASED COMPENSATION
The Company accounts for its stock option plans under the intrinsic-value-based
method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees". The Company has adopted the disclosure only
provision of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock Based Compensation".
LOSS PER SHARE
Basic and diluted loss per common share applicable to common shareholders are
based upon the weighted average number of Common Stock shares outstanding during
the respective period. Basic loss per share excludes any dilutive effects of
options, convertible senior preferred stock and warrants. Basic and diluted loss
per share are the
F-7
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOSS PER SHARE (CONTINUED)
same for the reported periods because the effect of stock options, warrants, and
convertible securities is anti-dilutive.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income" was issued in 1997 and is effective for the Company's year
ended December 31, 1998. SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in the financial statements.
In the Company's case, SFAS 130 would apply solely to its unrealized holding
losses on available-for-sale securities for the years ended December 31, 1998
and 1997, which were $2,572 and $1,960, respectively. Comprehensive loss for
1998, 1997, and 1996 was $8,237,714, $11,389,829, and $7,617,184, respectively,
including comprehensive losses of $(612), $(1,960), and $0, respectively.
RECLASSIFICATIONS
Certain prior year balances have been reclassified in order to conform with the
current year presentation. These reclassifications have no impact on net loss or
shareholders' equity as previously reported.
3. AVAILABLE-FOR-SALE SECURITIES
The amortized cost and estimated market value of available-for-sale securities,
all of which have contractual maturities of one year or less, are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
As of December 31, 1998
Commercial paper $ 500,289 $ -- $ 2,161 $ 498,128
U.S. Government securities 4,043,424 -- 411 4,043,013
----------------------------------------------------------
$4,543,713 $ -- $ 2,572 $4,541,141
==========================================================
As of December 31, 1997:
Commercial paper $ 998,931 $ -- $ 858 $ 998,073
U.S. Government securities 4,021,382 -- 1,102 4,020,280
----------------------------------------------------------
$5,020,313 $ -- $ 1,960 $5,018,353
==========================================================
</TABLE>
4. OPERATING LEASES
The Company has a non-cancelable operating lease for office space that expires
on June 30, 1999. Future minimum lease payments, including current real estate
taxes and operating expenses under this operating lease are $72,420. Total rent
expense was approximately $125,000, $107,000, and $66,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
5. 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 December 31, 1998, the Company has not borrowed under this arrangement.
F-8
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
The Company has incurred net operating losses applicable to common shareholders
since inception. Net losses through July 1, 1994, were utilized by Chronimed in
its consolidated income tax return. As of December 31, 1998, the Company had net
operating loss (NOL) carryforwards of approximately $27,590,000, credit for
increasing research activities (the "R&D credit") carryforwards of approximately
$359,000 and orphan drug credit carryforwards of approximately $4,266,000,
available to reduce its future tax liabilities. These carryforwards will begin
expiring after 2009. For the years ended December 31, 1998 and 1997, a valuation
allowance of $14,658,000 and $10,323,000, respectively, has been recognized to
offset the deferred tax assets related to these carryforwards.
No current income taxes have been provided for the years ended December 31,
1998, 1997 and 1996 as the Company had a loss for both financial reporting and
tax purposes.
Significant components of the Company's net deferred tax assets are as follows:
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 9,381,000 $ 7,661,000
R&D and orphan drug credit carryforwards 4,625,000 1,834,000
Contract termination fee 230,000 696,000
Inventory reserves 169,000 65,000
All other reserves 284,000 112,000
Deferred tax liabilities:
Depreciation (31,000) (45,000)
Valuation allowance for deferred tax assets (14,658,000) (10,323,000)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
As a result of the 1995 public stock offering, the Company exceeded the limits
allowable under Section 382 of the Internal Revenue Code related to changes in
ownership percentage which governs future utilization of NOL, R&D credit, and
orphan drug credit carryforwards (collectively, "tax benefit carryforwards").
The effect of this occurrence is to limit the annual utilization of a portion of
the Company's tax benefit carryforwards attributable to the period prior to the
change in ownership. Should another change in ownership occur, future
utilization of the Company's tax benefit carryforwards may be subject to
additional limitations under Section 382.
7. EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) Savings Plan, which is funded by elective salary
deferrals by employees. The Plan covers substantially all employees meeting
minimum eligibility requirements. The Plan does not require mandatory
contributions by the Company, but discretionary contributions may be made at the
election of the Company. The Company has not made any provision for
discretionary contributions to the Plan.
8. STOCK OPTIONS
The Company has one stock option plan for employees and non-employees, the 1994
Stock Option Plan (the "Plan"). The Plan provides the Company may grant employee
incentive stock options and non-qualified stock options at a price of not less
than 100% of fair market value. Options are exercisable as prescribed by the
Plan and expire up to fifteen years from the grant date for non-qualified stock
options and up to ten years from the grant date for employee incentive stock
options. At December 31, 1998, the Plan has 1,550,000 shares of Common Stock
reserved for issuance. At the May 1999 Annual Meeting, shareholders of the
Company are expected to vote on an amendment to the Plan to increase by 375,000
the number of shares reserved for issuance under the Plan.
F-9
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED) Options outstanding were granted as follows:
<TABLE>
<CAPTION>
PLAN WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- --------------
<S> <C> <C>
Balance at December 31, 1995 1,234,000 $ 5.12
Options granted 36,500 8.06
Options canceled (46,000) 5.23
Options exercised (16,500) 5.07
-------------
Balance at December 31, 1996 1,208,000 5.18
Options granted 308,000 5.81
Options canceled (78,566) 5.41
Options exercised (41,287) 5.18
-------------
Balance at December 31, 1997 1,396,147 5.32
Options granted 199,500 7.77
Options canceled (6,900) 10.13
Options exercised (160,100) 5.06
-------------
Balance at December 31, 1998 1,428,647 $ 5.66
=============
</TABLE>
The following table summarizes information about the stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$4.19 - $5.00 863,147 5.37 years $5.00 859,260 $4.99
$5.38 - $6.63 329,000 5.97 years 5.44 159,700 5.75
$6.83 - $10.13 236,500 7.05 years 7.79 83,000 7.79
----------- -----------
$4.19 - $10.13 1,428,647 $5.66 1,101,960 $5.31
=========== ===========
</TABLE>
Fully vested and exercisable options were 1,101,960, 903,947, and 590,933 as of
December 31, 1998, 1997, and 1996, respectively. The weighted average exercise
prices for the fully vested and exercisable options as of December 31, 1998,
1997, and 1996 were $5.31, $5.16, and $5.12, respectively.
PRO FORMA INFORMATION:
The Company applies the intrinsic-value method in accounting for stock issued to
employees and directors. Accordingly, compensation expense is recognized only
when options are granted with a discounted exercise price. Any such compensation
expense is recognized ratably over the associated service period, which is
generally the option vesting period.
Pro forma net loss and loss per share information, as required by Statement of
Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" (SFAS 123), has been determined as if the Company had accounted
for employee stock options under the fair value method. The fair value of these
options was estimated at grant date using a Black-Scholes option pricing model
with the following assumptions for 1998, 1997, and 1996, respectively :
risk-free interest rate of 5.5 percent; no dividend; expected option life of 5
years; and volatility of 61 percent. The weighted average fair value of the
options granted in 1998, 1997, and 1996 was $4.79, $2.99, $4.50, respectively,
as computed as described above.
F-10
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTIONS (CONTINUED)
PRO FORMA INFORMATION:
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over a four year average vesting period. The Company's
pro forma net loss for 1998, 1997 and 1996 was $(9,015,936), $(11,690,085) and
$(7,853,667), and pro forma net loss per share was $(1.45), $(1.92) and $(1.47),
respectively. These pro forma amounts include amortized fair values attributable
to options granted after June 30, 1995 only, and therefore are not
representative of future pro forma amounts.
9. STOCK WARRANTS
The Company issued warrants to the underwriter related to the Company's 1995
initial public stock offering to purchase 222,500 shares of Common Stock at a
price of $5.20 per share. These warrants are exercisable at any time between May
11, 1997 and May 12, 2000. At December 31, 1998 and 1997, the Company had
warrants outstanding to purchase 206,725 and 213,255 shares, respectively, of
Common Stock, all of which are currently exercisable.
10. SHAREHOLDERS' EQUITY
On October 12, 1994, Chronimed Inc. distributed 1,180,838 shares of the
Company's Common Stock to its shareholders of record as of September 6, 1994.
The distribution of the Company's Common Stock by Chronimed Inc. represented a
complete distribution in connection with a spin-off of the Company, effective
July 1, 1994. The Company completed a public offering of Common Stock on May 19,
1995, and June 29, 1995, pursuant to which it sold 2,558,750 shares of Common
Stock at $4.00 per share, before commissions and expenses. The Company also
completed a public offering of Common Stock on April 23, 1996 pursuant to which
it sold 2,300,000 shares of Common Stock at $7.125 per share, before commissions
and expenses.
On July 23, 1998 the Company issued $7.5 million of Senior Convertible Preferred
Stock (the "Preferred Shares") in a private placement. The Company realized net
cash proceeds of $7,075,008 from the sale of the Preferred Shares after the
payment of related offering expenses. The Preferred Shares are convertible, at
the option of the holders, into shares of the Company's Common Stock at a price
equal to $8.50 per share. The Preferred Shares have anti-dilution and change of
control protection, and bear a dividend of 7.5% per annum, payable semi
annually, which during the first two years may by paid either in cash or by
issuing additional Preferred Shares. In the third year and thereafter, the
dividend may be paid either in cash or by issuing Common Stock valued at the
then current market price. At the Company's option upon their maturity in July
2008, the Preferred Shares must be (a) converted into Common Stock, subject to a
$3.0 million conversion fee payable in cash or by issuing additional Common
Shares, or (b) redeemed for cash at $1,000 per share plus accrued dividends. The
holders of the Preferred Shares are entitled to and have exercised their right
to designate an individual to serve on the Company's Board of Directors.
11. RESEARCH AND DEVELOPMENT COMMITMENTS
The Company has various commitments under agreements with outside consultants,
contract drug development and manufacturers, technical service companies,
license and research agreements, and agreements with drug distributors. The
Company does not have any joint venture agreements nor does it have any
arrangements to perform research and development for other parties. The Company
recognizes the costs associated with these commitments as incurred based on the
accrual method of accounting. Expenditures associated with these commitments
totaled approximately $5,200,000, $5,232,000, and $5,242,000 for the years ended
December 31, 1998, 1997, and 1996, respectively. The Company's commitment to
incur additional expenditures in subsequent periods for development activities
totaled approximately $3,350,000, $2,700,000, and $4,287,000 at December 31,
1998, 1997, and 1996, respectively. Commitments for research and development
expenditures will likely fluctuate from year to year depending on, among other
factors, the timing of new product development, if any, and clinical trial
activity.
F-11
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. RESEARCH AND DEVELOPMENT COMMITMENTS (CONTINUED)
The Company collected cash proceeds of approximately $511,000, $788,000, and
$210,000 for the years ended December 31, 1998, 1997, and 1996, respectively,
relating to certain research and development expenditures that qualified for
reimbursement under the terms of several grant awards provided by the FDA Office
of Orphan Drug Products. At December 31, 1998, the Company had collected all
cash proceeds relating to research and development expenditures qualifying for
reimbursement and no additional reimbursements are available under these grant
awards.
12. CONTRACT TERMINATION FEE
The Company and Chronimed entered into an Agreement dated June 27, 1997, in
which Chronimed agreed to terminate certain agreements that had been in
existence since the spin-off of the Company from Chronimed. Among the terminated
agreements was the Marketing and Distribution Agreement dated July 2, 1994, as
amended, under which Chronimed had the exclusive right to market and distribute
certain of Orphan Medical's products, including Busulfex and Antizol. In
consideration for terminating these agreements, the Company agreed to pay
Chronimed compensation equal to $2,500,000, consisting of cash and shares of the
Company's Common Stock. Chronimed was paid $250,000 in cash on June 27, 1997,
with the remaining balance of $2,250,000 payable in quarterly installments based
on a temporary royalty arrangement equal to 3 percent of the Company's sales and
the issuance of Common Stock equal to 1 percent of the Company's issued and
outstanding Common Stock at each quarter end. As provided by the Agreement, the
Company paid Chronimed approximately $131,000 and $9,400 in royalties for the
years ended December 31, 1998 and 1997, respectively. In addition, the Company
has issued to Chronimed 313,694 of Common Stock through December 31, 1998, of
which 185,971 have been sold by Chronimed in market transactions for net cash
proceeds of $1,433,061. Based on the value of 127,723 shares of the Company's
Common Stock, which was not sold by Chronimed by December 31, 1998, the Company
believes it has fully satisfied its obligation to Chronimed as of December 31,
1998 (see Note 15 - Subsequent Event).
13. RELATED PARTY TRANSACTIONS
During 1998, three directors of the Company were also directors of Chronimed.
One of the three directors resigned from the Board during 1998 and was replaced
by an individual without any relationship to Chronimed. The Company paid
approximately $16,200, $27,900, and $22,000 in director fees and reimbursed
expenses to the Company's three directors who are also directors of Chronimed
for the years ended December 31, 1998, 1997 and 1996, respectively. Employees of
the Company serving as directors are not compensated.
14. GOING CONCERN
The Company has incurred net losses of $34,433,640 and used $29,468,797 of cash
for operating activities since inception. The Company's operations have been
funded primarily from initial working capital balances, the net proceeds from
the 1995 and 1996 public stock offerings, the net proceeds from the 1998 private
placement, interest income and Antizol revenues.
Management expects that its current working capital balance of $5,274,550, plus
projected Antizol and Busulfex sales will be sufficient to fund its operations
through 1999. The Company began shipping Antizol in December 1997 and it has
developed more than one year of sales history for this product. In addition, the
Company expects Antizol revenue to decline following its initial stocking period
during 1998. However, a significant component of the Company's plan to fund its
operations during 1999 is based on anticipated sales of Busulfex; a new product
that the Company commenced shipping to customers in February 1999. Because
Busulfex is a new product in 1999 and the Company has no sales history nor
significant orders for the product, there is uncertainty concerning the
Company's annual sales estimate and the timing during the year of such sales. If
the Company's expected Busulfex sales are significantly below planned levels for
the year or occur significantly later in the year than planned, the Company
would be forced to cut expenses by reducing payroll, deferring planned
development activities for Xyrem, and obtain additional financing. Additionally,
the Company intends to meet with the FDA during the first half of 1999 regarding
its plans for the submission of an NDA for Xyrem. Even if there is a positive
outcome to this meeting with the FDA, it is doubtful that the Company could
reduce expenses enough and in time to meet its obligations if Busulfex sales are
significantly less than projected for 1999. The Company has,
F-12
<PAGE>
ORPHAN MEDICAL, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
14. GOING CONCERN (CONTINUED)
however, obtained a commitment from an investor to provide additional financing
should a minimum level of Busulfex sales not be achieved during 1999.
To fully implement its current business plan, the Company will have to raise
additional capital. Although the Company was successful in obtaining additional
equity and debt financing in the past, there can be no assurance that such
additional financing will be available, if at all, or available on terms
acceptable to the Company. Access by the Company to additional financing will
depend substantially upon prevailing market conditions and the financial
condition and prospects for the Company at that time. The Company's continuation
as a going concern is dependent upon its ability to generate sufficient cash
flow to meet its obligations on a timely basis, obtaining additional financing,
and ultimately attaining profitable operations.
15. SUBSEQUENT EVENT
On February 9, 1999, the Company completed the acquisition from Chronimed Inc.
of 127,723 unregistered shares of the Company's Common Stock. The Company had
issued the unregistered shares to Chronimed in December 1998 as a payment of its
obligation under a June 1997 Termination Agreement (see Note 12 Contract
Termination Fee). The Company paid Chronimed $338,281 on February 9, 1999 and
will make a final payment to Chronimed of $338,282 on March 31, 1999 to satisfy
all of its obligations under the June 1997 Termination Agreement.
F-13
<PAGE>
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ORPHAN MEDICAL, INC.
<TABLE>
<CAPTION>
Additions
-----------------------------------
Balance at Charged to Other Balance at
Beginning of Charged to Costs Accounts- Deductions - End
Description Period and Expenses Describe Describe (1) of Period
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Reserves and allowances
deducted from asset accounts:
Allowance for doubtful
accounts $ 22,617 $ 26,003 $ -- $ -- $ 48,620
Allowance for excess
inventory 192,453 304,747 -- -- 497,200
YEAR ENDED DECEMBER 31, 1997
Reserves and allowances
deducted from asset accounts:
Allowance for doubtful
accounts -- 22,617 -- -- 22,617
Allowance for excess
inventory 301,830 91,050 -- 200,427 192,453
YEAR ENDED DECEMBER 31, 1996
Reserves and allowances
deducted from asset accounts:
Allowance for doubtful
accounts -- -- -- -- --
Allowance for excess
inventory -- 301,830 -- -- 301,830
</TABLE>
(1) Recovery of amounts previously reserved for.
F-14
EXHIBIT 10.51
Page 1 of 6
PURCHASE AGREEMENT
This Purchase Agreement ("Purchase Agreement") is entered into and
made effective this 30th day of December, 1998, by and between ORPHAN MEDICAL,
INC., a Minnesota corporation, whose principal place of business is 13911
Ridgedale Drive, Suite 475, Minnetonka, MN 55305 (hereinafter referred to as
"ORPHAN"), and UTECH, L.L.C. a Utah limited liability company, whose principal
place of business is 1414 East 3850 South, St. George, UT 84790 (hereinafter
referred to as "UTECH").
WITNESSETH:
WHEREAS, ORPHAN is party to a License Agreement, dated March 4, 1996
(the "License Agreement"), with Josman Laboratories, Inc., a California
corporation, with offices at that time located at 318 W. Katella Avenue, Suite
6B, Orange, CA 92667 (hereinafter referred to as "JOSMAN").
WHEREAS, UTECH wishes to purchase and acquire from ORPHAN all of
ORPHAN's rights to an interest in the License Agreement; and
WHEREAS, ORPHAN wishes to sell and assign to UTECH all of ORPHAN's
right to and interest in the License Agreement.
NOW THEREFORE, in consideration of the premises, the respective
commitments of the parties set forth below, and other good and valuable
consideration, the receipt and adequacy of which are hereby acknowledged, the
parties agree as follows:
ARTICLE 1
DEFINITIONS
As used herein, the following terms shall have the meanings set
forth below:
1.1 "License Agreement" shall mean the License Agreement between
ORPHAN and JOSMAN, dated the 4th day of March 1996, a copy of which is attached
hereto as Exhibit "A."
1.2 "Purchase Agreement" shall mean this agreement, all exhibits
hereto, and any addenda subsequently added hereto.
1.3 All other capitalized terms used in this Purchase Agreement and
not otherwise defined herein shall have the meanings ascribed to them in License
Agreement.
<PAGE>
EXHIBIT 10.51
Page 2 of 6
ARTICLE 2
ASSIGNMENT
2.1 ORPHAN hereby transfers and assigns to UTECH (a) all of ORPHAN's
rights to and interest in the License Agreement, including, without limitation,
all of ORPHAN's rights and privileges of the License Agreement relating to the
"Technology", as that term is defined in the License Agreement, and (b) all
improvements or enhancements to the Technology that ORPHAN has developed during
the term of the License Agreement and all intellectual property rights and
documentation related thereto. UTECH hereby accepts such assignment and agrees
to perform; in accordance with the provisions of the License Agreement, all of
the undertakings and commitments of ORPHAN under the License Agreement.
2.2 ORPHAN agrees that subsequent to the date of this Agreement it
will not use any Technology or any of the improvements, enhancements,
intellectual property rights or documentation assigned to UTEC pursuant to this
Agreement in connection with the development, manufacture, marketing or sale of
any products that are competitive with the Licensed Products, as that term is
defined in the License Agreement.
2.3 UTECH acknowledges that Kaigai Selyaku Co. Ltd. ("Kaigai"),
Tokyo, Japan, was granted a right of first refusal by JOSMAN to license the
Licensed Products in the Pacific Rim countries and that Kaigai has not waived or
terminated such right of first refusal rights.
ARTICLE 3
CONSIDERATION
3.1 The consideration to be paid by UTECH to ORPHAN for the
assignment of the License Agreement shall be the sum of Seven Hundred and Fifty
Thousand Dollars ($750,000.00).
3.2 All payments to ORPHAN shall be made in U.S. Dollars UTECH and
shall be paid by wire payment to ORPHAN's account immediately upon receipt by
UTECH of evidence (by facsimile transmission) of the execution of this Agreement
by both ORPHAN and UTECH.
3.3 Prior to the execution of this Agreement by ORPHAN, ORPHAN has
delivered to UTECH the following:
(a) Patent file in ORPHAN'S possession.
(b) All Technical Regulatory and Clinical data files.
(c) Other files and information that deal with the Licensed
Product.
<PAGE>
EXHIBIT 10.51
Page 3 of 6
Immediately upon execution of this Agreement by both ORPHAN and
UTECH, ORPHAN shall deliver to Brinks, Hofer, et al, a letter directing that
firm to release to UTECH all patent files relating to the Technology.
ARTICLE 4
WARRANTIES
4.1 ORPHAN represents and warrants to UTECH that (a) it is the sole
owner of all rights bestowed on it by the License Agreement, (b) it has not
sublicensed any of the rights obtained by it under the License Agreement, (c) it
has the power and authority to assign to UTECH all rights granted to it under
the License Agreement, and (d) the execution and performance of this Purchase
Agreement by ORPHAN have been authorized by all required corporate action.
ORPHAN also represents and warrants to UTECH that it is in full compliance with
all of its obligations under the License Agreement relative to the prosecution
and/or maintenance of patents.
4.2 UTECH represents and warrants to ORPHAN that (a) it has the
power and authority to enter into this Purchase Agreement and to assume
responsibility for the performance of the obligations of ORPHAN under the
License Agreement, and (b) the execution and performance of this Purchase
Agreement by UTECH have been authorized by all required corporate action.
4.3 The provisions of this Article 4 shall continue beyond the
termination of this Purchase Agreement.
ARTICLE 5
INDEMNIFICATION
5.1 ORPHAN agrees to indemnify and hold harmless UTECH and it
Affiliates, successors and assigns, from and against any and all losses,
expenses, claims, actions, lawsuits and judgments thereon (including attorneys'
fees through appellate levels), which may arise out of any negligent action or
omission of ORPHAN, its agents or employees or the use, production, development,
patent prosecution, sale, lease or advertisement by ORPHAN, or its Affiliates,
or sublicensees, of any patent rights, product or process license under the
License Agreement prior to the closing date.
5.2 UTECH agrees to indemnify and hold harmless ORPHAN and its Affiliates,
successors and assigns, from and against any and all losses, expenses, claims,
actions, lawsuits and judgments thereon (including attorneys fees through
appellate levels), which may arise out of any acts or omissions of UTECH, its
agents or employees or the use, productions, development, patent prosection,
sale, lease or advertisement by UTECH, or its Affiliates or sublicensees, of any
patent rights, or licenses under the License Agreement from and after the
closing date.
<PAGE>
EXHIBIT 10.51
Page 4 of 6
ARTICLE 6
OBLIGATIONS
UTECH shall not assume any obligations of ORPHAN that are incurred
during the term of the License Agreement up until the time of closing,
including, without limitation, all obligations relating to patent prosecution
fees or other costs which were incurred by ORPHAN prior to the date of this
Agreement. UTECH shall be solely responsible for the payment or satisfaction of
all obligations that arise or become due pursuant to the License Agreement from
and after the closing date.
ARTICLE 7
CLOSING
The closing of the transactions contemplated by this Purchase
Agreement shall take place immediately upon execution of this Agreement by UTECH
and ORPHAN.
ARTICLE 8
NOTICES, ETC.
Any notice, payment, report or other correspondence (hereinafter
collectively referred to as "Correspondence") required or permitted to be given
hereunder shall be mailed by Certified Mail, delivered by hand to the party to
whom such Correspondence is required or permitted to be given hereunder. If
mailed, any such notices shall be deemed to have been given when mailed as
evidenced by the postmark at a point of mailing. If delivered by hand, any such
Correspondence shall be deemed to have been given when received by the party
whom such Correspondence is given, as evidenced by writing and date receipt of
the receiving party.
All Correspondence to ORPHAN shall be addressed as follows:
President
ORPHAN MEDICAL, INC.
13911 Ridgedale Drive, Suite 475
Minnetonka, MN 55305
<PAGE>
EXHIBIT 10.51
Page 5 of 6
All Correspondence to UTECH shall be addressed as follows:
President
UTECH, L.L.C.
1414 East 3850 South
St. George, UT 84790
Either party may change the address to which Correspondence is to be
addressed by notification as provided hereunder.
ARTICLE 9
GOVERNING LAW
This Purchase Agreement shall be governed by and interpreted in
accordance with the laws of the State of Delaware.
ARTICLE 10
CAPTIONS AND PARAGRAPHS
Caption and paragraph headings in this Purchase Agreement are solely
for convenience or reference and do not affect its interpretation.
ARTICLE 11
SEVERABILITY
Should any part or provision of this Purchase Agreement be held
unenforceable or in conflict with the applicable laws or the regulation of any
jurisdiction, the invalid, unenforceable part of the provisions shall be
replaced with the provisions which accomplishes, to the extent possible, the
original business purposes said part or provision invalid and enforceable
manner, and the remainder of this Purchase Agreement shall remain binding upon
the parties.
ARTICLE 12
AMENDMENTS
No amendment or modification under the terms of this Purchase
Agreement shall be binding on either party unless reduced in writing and signed
by an authorized officer of the party to be bound.
<PAGE>
EXHIBIT 10.51
Page 6 of 6
ARTICLE 13
WAIVERS
No delay on any part of any party in exercising any right hereunder
will operate as a waiver of, or impair, any such right. No single or partial
exercise of any such right will preclude any other or further exercises thereof,
or the exercise of any right. No waiver of any such right will be deemed a
waiver of any other right hereunder.
ARTICLE 14
CONFIDENTIALITY
ORPHAN agrees to hold all information obtained under the License
Agreement prior and subsequent to its closing to be strictly confidential, and
ORPHAN will not disclose any of such confidential information to a third party
without the written permission of UTECH.
ARTICLE 15
COMPLETE AGREEMENT
This Purchase Agreement constitutes the entire agreement between
ORPHAN and UTECH respecting the subject matter therefore, and supersedes and
terminates all prior agreement respecting the subject matter hereof, whether
written or oral.
IN WITNESS WHEREOF, the parties hereto have caused this Purchase
Agreement to be executed by the respective duly authorized officers as of the
date set forth in the first paragraph.
ORPHAN MEDICAL, INC.
By: /s/ John Howell Bullion
----------------------------------
John Howell Bullion
Title: Chief Executive Officer
UTECH, L.L.C.
By: /s/ Scott Gubler
----------------------------------
Scott Gubler
Title: General Manager
EXHIBIT 10.52
Page 1 of 8
ORPHAN MEDICAL, INC.
COMMON STOCK PURCHASE WARRANT
Orphan Medical, Inc., a Minnesota corporation (the "Company"),
hereby agrees that, for value received, R.J. Steichen, Minneapolis, Minnesota,
or its assigns, is entitled, subject to the terms set forth below, to purchase
from the Company at any time or from time to time after January 1, 1999, and
before 4:30 p.m., Minneapolis, Minnesota time, on December 31, 2004, Ten
Thousand (10,000) Shares of the Company at an exercise price of $8.50 per Share
(the "Shares")
1. Exercise of Warrant. The purchase rights granted by this Warrant
shall be exercised (in minimum quantities of 100 Shares) by the holder
surrendering this Warrant with the form of exercise attached hereto duly
executed by such holder, to the Company at its principal office, accompanied by
payment, in cash or by cashier's check payable to the order of the Company, of
the purchase price payable in respect of the Shares being purchased. If less
than all of the Shares purchasable hereunder are purchased, the Company will,
upon such exercise, execute and deliver to the holder hereof a new Warrant
(dated the date hereof) evidencing the number of Shares not so purchased. As
soon as practicable after the exercise of this Warrant and payment of the
purchase price, the Company will cause to be issued in the name of and delivered
to the holder hereof, or as such holder may direct, a certificate or
certificates representing the Shares purchased upon such exercise. The Company
may require that such certificate or certificates contain on the face thereof a
legend substantially as follows:
"The transfer of the Shares represented by this certificate is
restricted pursuant to the terms of a Common Stock Purchase Warrant
dated January 1, 1999, issued by Orphan Medical, Inc., a copy of
which is available for inspection at the offices of Orphan Medical,
Inc. Transfer may not be made except in accordance with the terms of
the Common Stock Purchase Warrant. In addition, no sale, offer to
sell or transfer of the Shares represented by this certificate shall
be made without (i) the opinion of counsel satisfactory to Orphan
Medical, Inc. that such sale, offer or transfer may be made without
registration or qualification under the Federal Securities Act of
1933, as amended (the "Act"), and applicable state securities laws;
or (ii) such registration or qualification."
2. Negotiability and Transfer. This Warrant is issued upon the
following terms, to which each holder hereof consents and agrees:
(a) Until this Warrant is duly transferred on the books of the
Company, the Company may treat the registered holder of this Warrant
as absolute owner hereof for all purposes without being affected by
any notice to the contrary.
(b) Each successive holder of this Warrant, or of any portion
of the rights represented thereby, shall be bound by the terms and
conditions set forth herein.
<PAGE>
EXHIBIT 10.52
Page 2 of 8
3. Antidilution Adjustments. If the Company shall at any time
hereafter subdivide or combine its outstanding shares of Common Stock, or
declare a dividend payable in Common Stock, the exercise price in effect
immediately prior to the subdivision, combination or record date for such
dividend payable in Common Stock shall forthwith be proportionately increased,
in the case of combination, or proportionately decreased, in the case of
subdivision or declaration of a dividend payable in Common Stock, and the number
of Shares purchasable upon exercise of this Warrant, immediately preceding such
event, shall be changed to the number determined by dividing the then current
exercise price by the exercise price as adjusted after such subdivision,
combination or dividend payable in Common Stock and multiplying the result of
such division against the number of Shares purchasable upon the exercise of this
Warrant immediately preceding such event, so as to achieve an exercise price and
number of Shares purchasable after such event proportional to such exercise
price and number of Shares purchasable immediately preceding such event. All
calculations hereunder shall be made to the nearest cent or to the nearest
one-hundredth of a share, as the case may be.
No fractional Shares are to be issued upon the exercise of this
Warrant, but the Company shall pay a cash adjustment in respect of any fraction
of a Share which would otherwise be issuable in an amount equal to the same
fraction of the market price per share of Shares on the day of exercise as
determined in good faith by the Company.
In case of any capital reorganization or any reclassification of the
shares of Common Stock of the Company, or in the case of any consolidation with
or merger of the Company into or with another corporation, or the sale of all or
substantially all of its assets to another corporation, which is effected in
such a manner that the holders of Common Stock shall be entitled to receive
stock, securities or assets with respect to or in exchange for Common Stock,
then, as a part of such reorganization, reclassification, consolidation, merger
or sale, as the case may be, lawful provision shall be made so that the holder
of the Warrant shall have the right thereafter to receive, upon the exercise
hereof, the kind and amount of shares of stock or other securities or property
which the holder would have been entitled to receive if, immediately prior to
such reorganization, reclassification, consolidation, merger or sale, the holder
had held the number of Shares which were then purchasable upon the exercise of
the Warrant. In any such case, appropriate adjustment (as determined in good
faith by the Board of Directors of the Company) shall be made in the application
of the provisions set forth herein with respect to the rights and interest
thereafter of the holder of the Warrant, to the end that the provisions set
forth herein (including provisions with respect to adjustments of the exercise
price) shall thereafter be applicable, as nearly as reasonably may be, in
relation to any shares of stock or other property thereafter deliverable upon
the exercise of the Warrant.
When any adjustment is required to be made in the exercise price,
initial or adjusted, the Company shall forthwith determine the new exercise
price, and
<PAGE>
EXHIBIT 10.52
Page 3 of 8
(a) prepare and retain on file a statement describing in
reasonable detail the method used in arriving at the new exercise
price; and
(b) cause a copy of such statement to be mailed to the holder
of the Warrant as of a date within ten (10) days after the date when
the circumstances giving rise to the adjustment occurred.
4. Registration Rights. Prior to making any disposition of the
Warrant or of any Shares purchased upon exercise of the Warrant, the holder will
give written notice to the Company describing briefly the manner of any such
proposed disposition. The holder will not make any such disposition until (i)
the Company has notified him that, in the opinion of its counsel, registration
under the Act is not required with respect to such disposition, or (ii) a
Registration Statement covering the proposed distribution has been filed by the
Company and has become effective. The Company agrees that, upon receipt of
written notice from the holder hereof with respect to such proposed
distribution, it will use its best efforts, in consultation with the holder's
counsel, to ascertain as promptly as possible whether or not registration is
required, and will advise the holder promptly with respect thereto, and the
holder will cooperate in providing the Company with information necessary to
make such determination.
If, at any time prior to the expiration of seven (7) years from
January 1, 1999, the Company shall propose to file any Registration Statement
(other than any registration on Forms S-4, S-8 or any other similarly
inappropriate form) under the Securities Act of 1933, as amended, covering a
public offering of the Company's Shares or other shares of Common Stock, it will
notify the holder hereof at least thirty (30) days prior to each such filing and
will include in the Registration Statement (to the extent permitted by
applicable regulation), the Shares purchased by the holder or purchasable by the
holder upon the exercise of the Warrant to the extent requested by the holder
hereof. Notwithstanding the foregoing, the number of Shares of the holders of
the Warrants proposed to be registered thereby shall be reduced pro rata with
any other selling shareholder (other than the Company) upon the reasonable
request of the managing underwriter of such offering.
At any time prior to the expiration of five (5) years from January
1, 1999, and provided that a registration statement on Form S-3 (or its
equivalent) is then available to the Company, and on a one-time basis only, if
the holders of 50% or more of the Warrants and/or the Shares acquired upon
exercise of the Warrants request the registration of at least 51% of the Shares
on Form S-3 (or its equivalent), the Company shall promptly thereafter use its
best efforts to effect the registration under the Securities Act of 1933, as
amended, of all such shares which such holders request in writing to be so
registered, and in a manner corresponding to the methods of distribution
described in such holders' request (and with respect to the "demand"
registration rights referred to immediately above, on a one-time basis only);
provided, however, that the Company may postpone taking action with respect to a
requested registration or may require that holders of Shares cease making sales
under an effective registration for a reasonable period of time, not to exceed
180 days, if, in the good faith opinion of the Board of Directors of the
<PAGE>
EXHIBIT 10.52
Page 4 of 8
Company, effecting the registration or allowing such sales would adversely
affect or require the premature disclosure of information the disclosure of
which would have an adverse effect on the Company.
All expenses of any such registrations referred to in this Section
4, except the fees of counsel to such holders and underwriting commissions or
discounts, filing fees, and any transfer or other taxes applicable to such
shares, shall be borne by the Company.
The Company will mail to each record holder, at the last known post
office address, written notice of any exercise of the rights granted under this
paragraph 4, by certified or registered mail, return receipt requested, and each
holder shall have twenty (20) days from the date of deposit of such notice in
the U.S. Mail to notify the Company in writing whether such holder wishes to
join in such exercise. The Company will furnish the holder hereof with a
reasonable number of copies of any prospectus included in such filings and will
amend or supplement the same as required during the period of required use
thereof. The Company will maintain, at its expense, the effectiveness of any
Registration Statement or the Offering Statement filed by the Company, whether
or not at the request of the holder hereof, for a time sufficient to allow for
the disposition of the Shares, but not to exceed ninety (90) days, following the
effective date thereof.
In the case of the filing of any Registration Statement, and to the
extent permissible under the Securities Act of 1933, as amended, and controlling
precedent thereunder, the Company and the holder hereof shall provide cross
indemnification agreements to each other in customary scope covering the
accuracy and completeness of the information furnished by each.
The holder of the Warrant agrees to cooperate with the Company in
the preparation and filing of any such Registration Statement or Offering
Statement, and in the furnishing of information concerning the holder for
inclusion therein, or in any efforts by the Company to establish that the
proposed sale is exempt under the Act as to any proposed distribution.
Shares shall cease to be entitled to the registration rights set
forth in this Section 4 when they (i) shall have been disposed of pursuant to an
effective registration statement under the Securities Act, or (ii) they shall
have been distributed to the public pursuant to Rule 144 promulgated under the
Securities Act.
5. Right to Convert.
(a) The holder of this Warrant shall have the right to require
the Company to convert this Warrant (the "Conversion Right") into
shares of Common Stock as provided for in this Section 5. Upon
exercise of the Conversion Right, the Company shall deliver to the
holder (without payment by the holder of any exercise price) that
number of shares of Common Stock equal to the number of shares of
Common Stock resulting from multiplying the number of shares
requested to be converted hereunder times the quotient
<PAGE>
EXHIBIT 10.52
Page 5 of 8
obtained by dividing (x) the value of the Warrant at the time the
Conversion Right is exercised (determined by subtracting the
aggregate exercise price for the Warrant Shares in effect
immediately prior to the exercise of the Conversion Right from the
aggregate Fair Market Value (as determined below) for the Warrant
Shares immediately prior to the exercise of the Conversion Right) by
(y) the Fair Market Value of one share of Common Stock immediately
prior to the exercise of the Conversion Right.
(b) The Conversion Right may be exercised by the holder, at
any time or from time to time, prior to its expiration, on any
business day, by delivering a written notice (the "Conversion
Notice") to the Company at the offices of the Company exercising the
Conversion Right and specifying (i) the total number of shares of
Stock the Warrant holder will purchase pursuant to such conversion,
and (ii) a place, and a date not less than five (5) nor more than
twenty (20) business days from the date of the Conversion Notice for
the closing of such purchase.
(c) At any closing under Section 5(b) hereof, (i) the holder
will surrender the Warrant, (ii) the Company will deliver to the
holder a certificate or certificates for the number of shares of
Common Stock issuable upon such conversion, together with cash, in
lieu of any fraction of a share, and (iii)the Company will deliver
to the holder a new Warrant representing the number of shares, if
any, with respect to which the Warrant shall not have been
converted.
(d) "Fair Market Value" of a share of Common Stock as of a
particular date (the "Determination Date") shall mean:
(i) If the Company's Common Stock is traded on an
exchange or is quoted on the National Association of
Securities Dealers, Inc. Automated Quotation ("NASDAQ")
National or Small-Cap Market, then the average closing or last
sale prices, respectively, reported for the ten (10) business
days immediately preceding the Determination Date.
(ii) If the Company's Common Stock is not traded on an
exchange or on the NASDAQ National or Small-Cap Market, but is
traded in the over-the-counter market, then the average of the
closing bid and asked prices reported for the ten (10)
business days immediately preceding the Determination Date.
6. Notices. The Company shall mail to the registered holder of the
Warrant, at his or her last known post office address appearing on the books of
the Company, not less than fifteen (15) days prior to the date on which (a) a
record will be taken for the purpose of determining the holders of Shares
entitled to dividends (other than cash dividends) or subscription rights, or (b)
a record will be taken (or in lieu thereof, the transfer books will be closed)
for the purpose of determining the holders of common stock entitled to notice of
and to vote at a meeting of
<PAGE>
EXHIBIT 10.52
Page 6 of 8
shareholders at which any capital reorganization, reclassification of common
stock, consolidation, merger, dissolution, liquidation, winding up or sale of
substantially all of the Company's assets shall be considered and acted upon.
7. Reservation of Common Stock. A number of shares of Common Stock
sufficient to provide for the exercise of the Warrant and the Shares included
therein upon the basis herein set forth shall at all times be reserved for the
exercise thereof.
8. Miscellaneous. Whenever reference is made herein to the issue or
sale of shares of Common Stock, the term "Common Stock" shall include any stock
of any class of the Company other than preferred stock that has a fixed limit on
dividends or a payment preference in the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Company.
The Company will not, by amendment of its articles of incorporation
or through reorganization, consolidation, merger, dissolution or sale of assets,
or by any other voluntary act or deed, avoid or seek to avoid the observance or
performance of any of the covenants, stipulations or conditions to be observed
or performed hereunder by the Company, but will, at all times in good faith,
assist, insofar as it is able, in the carrying out of all provisions hereof and
in the taking of all other action which may be necessary in order to protect the
rights of the holder hereof against dilution.
Upon written request of the holder of this Warrant, the Company will
promptly provide such holder with a then current written list of the names and
addresses of all holders of warrants originally issued under the terms of, and
concurrent with, this Warrant.
The representations, warranties and agreements herein contained
shall survive the exercise of this Warrant. References to the "holder of"
include the immediate holder of shares purchased on the exercise of this
Warrant, and the word "holder" shall include the plural thereof. This Common
Stock Purchase Warrant shall be interpreted under the laws of the State of
Minnesota.
All Shares or other securities issued upon the exercise of the
Warrant shall be validly issued, fully paid and non-assessable, and the Company
will pay all taxes in respect of the issuer thereof.
Notwithstanding anything contained herein to the contrary, the
holder of this Warrant shall not be deemed a stockholder of the Company for any
purpose whatsoever until and unless this Warrant is duly exercised.
<PAGE>
EXHIBIT 10.52
Page 7 of 8
IN WITNESS WHEREOF, this Warrant has been duly executed by Orphan
Medical, Inc., this 1st day of January, 1999.
ORPHAN MEDICAL, INC.
By: /s/ John Howell Bullion
-----------------------
Title: CEO
---
<PAGE>
EXHIBIT 10.52
Page 8 of 8
WARRANT EXERCISE FORM
To be signed only upon exercise of Warrant.
The undersigned, the holder of the within Warrant, hereby irrevocably
elects to exercise the purchase right represented by such Warrant for, and to
purchase thereunder, ___________ of the Shares of Orphan Medical, Inc. to which
such Warrant relates and herewith makes payment of $ _____________, therefor in
cash or by certified check, and requests that such shares be issued and be
delivered to, ______________________________, the address for which is set forth
below the signature of the undersigned.
Dated: _____________________
---------------------------------------
(Taxpayer's I.D. Number) (Signature)
---------------------------------------
---------------------------------------
(Address)
==============================
ASSIGNMENT FORM
To be signed only upon authorized transfer of Warrant.
FOR VALUE RECEIVED, the undersigned hereby sells, assigns, and transfers
unto _____________________ the right to purchase Shares of Orphan Medical, Inc.
to which the within Warrant relates and appoints ____________________________,
attorney, to transfer said right on the books of Orphan Medical, Inc. with full
power of substitution in the premises.
Dated: _______________________
---------------------------------------
(Signature)
---------------------------------------
---------------------------------------
(Address)
EXHIBIT 23.1
ORPHAN MEDICAL, INC.
CONSENT OF ERNST & YOUNG LLP
We consent to the incorporation by reference in the Registration Statements on
Form S-8 (Nos. 333-29487 and 333-3674) pertaining to the Orphan Medical, Inc.
1994 Stock Option Plan of our report dated February 5, 1999, with respect to the
financial statements and schedule of Orphan Medical, Inc. included in its Annual
Report on Form 10-K for the year ended December 31, 1998.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 23, 1999
EXHIBIT 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature
appears below hereby constitutes and appoints John Howell Bullion , his true and
lawful attorneys-in-fact and agents, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities, to sign the Annual Report on Form 10-K of Orphan Medical, Inc. for
the twelve months ended December 31, 1998, and all amendments to such Annual
Report on Form 10-K and to file same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in and about the premises, as fully to all intents and
purposes he might or could do in person, hereby ratifying and confirming all
said attorneys-in-fact and agents or any of them, or their or his substitutes,
may lawfully do or cause to be done by virtue hereof.
Signature Date
--------- ----
/s/ John Howell Bullion March 1, 1999
- -----------------------
John Howell Bullion
Chairman of the Board, Chief Executive Officer
& Secretary (Principal Executive Officer)
and Director
/s/ Michael Greene March 1, 1999
- ------------------
Michael Greene
Director
/s/ Julius A. Vida February 22, 1999
- ------------------
Julius A. Vida
Director
/s/ W. Leigh Thompson January 23, 1999
- ---------------------
W. Leigh Thompson
Director
/s/ William M. Wardell February 12, 1999
- ----------------------
William M. Wardell
Director
/s/ Lawrence C. Weaver January 29, 1999
- ----------------------
Lawrence C. Weaver
Director
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. From
inception through December 31, 1998, the Company had a net loss and deficit
accumulated during the development stage applicable to common shareholders of
$34,683,298 on product revenues of $5,378,557. The Company expects operating
losses in 1999 because anticipated gross profits from products revenues,
including anticipated Busulfex 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.
DEVELOPMENT STAGE COMPANY.
The Company is in the development stage. As of December 31, 1998, the Company
had not completed product development, obtained required regulatory approvals,
or verified the market acceptance and demand for two of its three principal
products. Antizol, Busulfex, and Xyrem are considered the Company's principal
products. The Company's operations, of which pharmaceutical product development
is the principal activity, are subject to all of the risks inherent in the
establishment of a new business enterprise. Accordingly, the Company is
substantially dependent on key personnel, uncertain market acceptance and demand
for its principal products, insufficient capital, a competitive environment
characterized by numerous well-established and well-capitalized competitors,
expected operating losses in 1999, a market subject to extensive regulatory
oversight, and reliance on outside contractors for the manufacture and
distribution of its products. The likelihood of the success of the Company must
be considered in light of the problems, expenses and delays frequently
encountered in connection with the development of new pharmaceutical products
and the competitive and regulatory environment in which the Company operates.
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 $9.0 million in research and development expense relating to
the products it currently markets and to advance the development of Xyrem. In
addition, sales and marketing spending will increase significantly with the FDA
approval of Busulfex in February 1999. 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.
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EXHIBIT 99
Page 2 of 9
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 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. From inception through December 31, 1998, 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.
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 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.
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EXHIBIT 99
Page 3 of 9
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 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.
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
<PAGE>
EXHIBIT 99
Page 4 of 9
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.
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
<PAGE>
EXHIBIT 99
Page 5 of 9
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.
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.
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EXHIBIT 99
Page 6 of 9
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.
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
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EXHIBIT 99
Page 7 of 9
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.
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.
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EXHIBIT 99
Page 8 of 9
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 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 twelve months ended December 31, 1998, 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
<PAGE>
EXHIBIT 99
Page 9 of 9
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 $4.0 million as reported on Form 10-Q or
Form 10-K or (2) a market capitalization of at least $50.0 million. At December
31, 1998, the Company's net tangible assets equaled $5,575,577 and its market
capitalization was approximately $49.8 million (based on the last sale price of
$7.75 and 6,432,373 registered shares outstanding as of December 31, 1998). 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 both 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 DECEMBER 31, 1998, AND
THE RELATED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,980,342
<SECURITIES> 4,541,141
<RECEIVABLES> 1,044,884
<ALLOWANCES> 48,620
<INVENTORY> 112,725
<CURRENT-ASSETS> 8,745,703
<PP&E> 556,358
<DEPRECIATION> 255,331
<TOTAL-ASSETS> 9,046,730
<CURRENT-LIABILITIES> 3,471,153
<BONDS> 0
0
75
<COMMON> 65,601
<OTHER-SE> 5,509,901
<TOTAL-LIABILITY-AND-EQUITY> 9,046,730
<SALES> 4,707,038
<TOTAL-REVENUES> 4,707,038
<CGS> 825,994
<TOTAL-COSTS> 825,994
<OTHER-EXPENSES> 12,296,031
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (177,885)
<INCOME-PRETAX> (8,237,102)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,237,102)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,486,760)
<EPS-PRIMARY> (1.36)
<EPS-DILUTED> (1.36)
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