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, 2002
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)
DELAWARE 41-1784594
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
13911 RIDGEDALE DRIVE, SUITE 250,
MINNETONKA, MN 55305 (952) 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 whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
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 June 30, 2002 was $84,190,000
based on approximately 8,909,000 shares held by non-affiliates at that date.
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 22, 2003 are incorporated by reference in Part III, Items 10, 11, 12 and 13
of this Form 10-K.
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), Busulfex(R), Cystadane(R), Elliotts B(R) Solution,
Sucraid(R), Xyrem(R), MedExpan(TM), "The" Orphan Drug Company(TM), Xyrem Success
Program(SM) Orphan Medical, Inc.(R) and Dedicated to Patients with Uncommon
Diseases(R) are trademarks of the Company.
ITEM 1. BUSINESS
OVERVIEW
Orphan Medical, Inc. (the "Company") acquires, develops and markets
pharmaceutical products of high medical value for patients within selected
therapeutic areas. A pharmaceutical product has high medical value if it offers
a major improvement in the safety or efficacy of patient treatment. The Company
currently concentrates its efforts on drugs with high medical value that may be
marketed within three therapeutic areas: Antidotes, Oncology Support, and Sleep
Disorders. Antizol, Busulfex and Xyrem are available commercially and are the
Company's lead products in its Antidotes, Oncology Support and Sleep disorders
areas, respectively. In addition, the Company manufactures and distributes
Cystadane and Sucraid that treat two rare congenital diseases. Antizol-Vet is
marketed through separate channels to the veterinary community. Although these
products do not fall into the selected therapeutic areas, 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.
Our corporate offices are located at 13911 Ridgedale Drive, Suite 250,
Minnetonka, Minnesota 55305. Our telephone number is 952-513-6900 and our
website is www.orphan.com. The information on our website is not incorporated
into and is not intended to be a part of this report. We make available free of
charge on or through our website our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practible after we electronically file such material
with, or furnish it to, the United States Securities and Exchange Commission.
Unless the context otherwise indicates, all references to the "Registrant", the
"Company", or "Orphan Medical" in this Form 10-K relate to Orphan Medical, Inc.
Each therapeutic area defined by the Company is characterized by a well-defined
patient population that is treated by a relatively small number of medical
specialists. The Company believes this approach makes a large sales force
unnecessary to market the Company's products because 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, supported by
marketing and sales methods including the use of computer systems and the
Internet, the Company intends to promote awareness of the key advantages of
Orphan Medical branded products within Antidotes, Oncology Support, and Sleep
Disorders. The Company's marketing and sales efforts will differentiate products
on the basis of quality, potentially improved medical outcomes, and cost
effectiveness. The Company uses established distributors of pharmaceutical
products for its currently marketed products in a manner similar to that of most
other pharmaceutical companies.
The Company believes its approach to pharmaceutical product development reduces
the time, costs and risks traditionally involved in bringing pharmaceutical
products to market. In general, the Company does not conduct basic research and
does not attempt to discover new drugs. The Company's strategy is to acquire
licenses to develop, or develop existing known therapeutic substances for new
indications for market products that preferably have existing clinical data that
indicate therapeutic value and safety. In addition, the Company considers
acquiring
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products that have already received marketing approval from the U.S. Food and
Drug Administration (the "FDA"). The Company uses contract development,
manufacturing, and consulting companies to assist it in its product development
and commercialization activities.
The Company operates within a single industry segment: pharmaceutical product
development, marketing and sales. To date, the Company has obtained marketing
approval from the FDA on seven New Drug Applications ("NDA"). The Company's
products are commercially available in the United States and several foreign
countries. Revenues from the Company's approved products outside the United
States were approximately 22% of total 2002 revenues.
As an emerging and growing specialty pharmaceutical company, the Company did not
achieve profitability in 2002 and does not expect to do so at least through
2003. The Company has significant capital requirements to support product
development and marketing efforts until profitability is achieved.
STRATEGIC BACKGROUND
In the 1950s and early 1960s, drug development was relatively inexpensive and
regulatory approval was straightforward. Pharmaceutical companies marketed their
products through sales forces directly to physicians who generally had
independent responsibility for 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, prescription decisions by physicians were constrained by managed care
entities and 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 that treat diseases affecting smaller patient populations.
As a consequence, new drugs for such diseases were less likely to be developed
by larger companies. Some research institutions, universities and small
companies, however, have continued to develop and conduct clinical trials on
these types of drugs.
The Company's strategy is based on several factors relating to these and other
changes in the health care and pharmaceutical industries:
o Larger pharmaceutical companies generally have increased their financial
return rates, seek new products with annual revenues greater than $300
million and avoid developing new products that address diseases outside
their therapeutic areas of focus. As a result, the Company believes many
developmental products of high medical value are available for licensing.
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.
o The knowledge and skills required to address many aspects of drug
development are available on a contract basis from outside companies or
individuals.
o To address rapidly changing market forces, alternative means of marketing
and distributing pharmaceuticals have been created. The advent of the
Internet has dramatically increased the availability of information,
including information related to health and health care products. 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 exhibits at professional meetings, direct mailings,
telemarketing, continuing medical education programs, and the Internet. In
addition, these products can be effectively distributed through companies
that are 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 where necessary, and uses alternative marketing and distribution
channels, as appropriate.
BUSINESS STRATEGY
The Company focuses on products of high medical value intended to address
inadequately treated or uncommon diseases within selected therapeutic areas. A
drug has high medical value if it offers a major improvement in the safety or
efficacy of current patient treatments. In addition to products with high
medical value, the Company seeks pharmaceuticals that have readily measured
clinical endpoints, existing positive clinical data, proprietary attributes,
eligibility for insurance reimbursement, and that offer attractive financial
returns. The Company generally does not conduct basic research to discover new
drugs, but instead seeks to acquire and further develop products that already
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have some data that indicate the presence of therapeutic value and safety. The
Company's strategy of developing and marketing high medical value drugs with
these clinical characteristics is intended to achieve the following benefits.
o REGULATORY REQUIREMENTS AND REVIEW - Drugs of high medical value have a
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.
o PRODUCT DEVELOPMENT TIME AND COST -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.
o LIMITED INFRASTRUCTURE - The Company believes that high quality
pharmaceutical products can be developed efficiently and economically using
well established independent contractors directed by 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 to perform these functions internally.
o MARKETING STRATEGY -To assess the viability of a potential product, the
Company considers questions such as these:
o Are there unmet therapeutic needs as defined by the customer? (the
patient or the health care practitioner)
o Are there other product development or product acquisition
opportunities that complement the product or does the product fit in
the Company's areas of focus?
o Can the product's brand be established and command significant market
share?
o 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 therapeutic areas, as well as extensive
marketing and business experience. The Company has also created a dedicated
specialty sales force to support Xyrem in the Sleep Disorders market. Each
of the Company's sales forces utilizes a consultative, customer-oriented
approach to selling.
o 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 nine companies relating to five of
the Company's products. The Company also believes that its relationships
with these and other partners may provide strategic benefits, possibly in
the area of product acquisition opportunities.
o ATTRACTION OF POTENTIAL NEW PRODUCTS - As the Company's strategy and focus
on pharmaceutical products of high medical value within a selected
therapeutic area becomes better known and understood by others in the
research and development community and as the Company further proves its
ability to market and sell into a therapeutic area, the Company expects
more product development or acquisition opportunities will be presented to
it in the future.
RISK MANAGEMENT
The Company's strategy has been designed, in part, to manage its overall
business risk. The Company has pursued multiple distinct therapeutic areas
rather than concentrating financial, development and marketing resources on a
single therapeutic area 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 readily manufactured with established technologies, and
(3) do not require excessive specialized 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 with proof of concept established. When a product is licensed
without the equivalent of Phase II or III data, the Company may conduct one or
more "proof of concept" trials to better assess the likelihood of efficacy or
safety. Each such pilot trial is narrowly defined. The Company does not conduct
extensive basic research to discover new chemical entities. The Company may also
purchase rights to approved products. To reduce its marketing risk, the Company
generally attempts to obtain some form of proprietary protection, such as patent
protection, orphan drug status, exclusive licensing agreements, or sole supplier
agreements.
PROPRIETARY RIGHTS
The Company believes it is important that its products receive patent protection
or orphan drug status or have other factors that limit potential competition.
When available and appropriate, the Company will seek orphan drug status to
enhance or provide proprietary protection to a product. A drug that has orphan
drug designation and which is the
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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 and a
10-year exclusive period in Europe for that product claim, indication or
application, subject to certain limitations. The Company has six products with
orphan drug status. Applications for Orphan Drug designation will be made where
appropriate and available for any additional indications or products that may be
licensed in the future.
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 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 published 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, however under current law, orphan drug status is granted
to the first company receiving FDA marketing approval for a specific indication
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. Orphan drug status in the United States, however 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.
Orphan drug protection is available in Japan and the European Union under
requirements similar to those in the United States. An important distinction in
the European Union is the ten-year period of marketing exclusivity for products
designated as orphan drugs, compared to seven year of exclusivity in the United
States. The period of exclusivity in the European Union also begins upon
marketing approval.
The license agreement pursuant to which the Company has acquired rights to
develop and market Busulfex provides 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 and some allowed for Busulfex and Xyrem. The
Company has licensed two patents related to a new potential development
opportunity. The Company is evaluating a development program for this product.
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 and other federal agencies 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 takes many years and involves the expenditure of substantial
resources and considerable risk.
Before a drug product can be investigated or marketed in the United States, the
following general steps are required 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, (vii) marketing
of the drug, and (viii)post-approval safety and risk monitoring.
Upon the successful completion of clinical testing, a marketing application
(i.e. 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; proposed labeling to be used with the drug;
information on manufacturing methods; and sometimes samples of the product.
Since 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. The FDA can also determine that a drug
is "approvable" contingent on satisfactory review of additional information
requested by the FDA. We cannot assure you that such requests by the FDA for
additional information can be fulfilled in a timely manner, if at all. If the
FDA approves the NDA, the new product may be
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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, or
restriction to the proposed label claims or requires that post-marketing
surveillance, or Phase IV testing, to be conducted. The method and system of a
drug's distribution can also be controlled by the FDA if approved under Subpart
H.
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 actively searches for product licensing opportunities. 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 evaluated
many product opportunities. To date, seventeen 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 therapeutic
areas that, in the Company's opinion, generally:
o Are of high medical value as defined by the customer (physician or patient)
within a therapeutic area;
o Treat diseases that affect distinct patient populations;
o Are prescribed by physician specialists;
o Can be marketed with a relatively small, specialized sales team to health
care specialists, health care institutions, and patients;
o Are likely to be eligible for reimbursement by third-party payors;
o Have or are candidates for patent protection, orphan drug designation or have
other characteristics that enhance the Company's competitive position;
o Treat diseases that have clinical endpoints (i.e., signs or symptoms) that
are readily measured;
o Are conventional pharmaceutical products that are relatively straightforward
in formulation and development, and do not involve the application of new
technologies;
o Are in Phase II or Phase III clinical trials and have a relatively high
likelihood of obtaining the approval of the FDA within three to five years of
acquisition;
o Offer attractive potential financial returns with relatively inexpensive
development costs;
o Compliment other products in an existing therapeutic area or can be grouped
with other products to build a new therapeutic area.
In selecting additional products for potential inclusion in its portfolio, the
Company generally focuses on acquiring rights to medicines that serve niche or
defined patient populations. Major drug companies are less likely to address
these niche markets because they do not believe these markets will produce
acceptable revenues and returns. 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 delivery methods or 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 clear clinical
endpoints can demonstrate their effectiveness. Generally, the Company seeks to
acquire products that can be developed to the point of FDA approval within three
to five years of their acquisition. Typically, the Company also focuses its
development efforts on one indication and, when possible, one dosage form to
minimize development costs. Potential additional indications or dosage forms
will only be evaluated after the primary NDA is submitted or approved.
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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 covered by
patents, are eligible for orphan drug designation, 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's management reviews new product opportunities and makes
recommendations to the Board of Directors of the Company regarding the license
or acquisition of any proposed additional products. The product review process
involves discussions with customers (physicians and patients) within a given
therapeutic area to identify unmet needs, and with the initial product developer
and experts in the disease treated by the drug; 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, the Company seeks to obtain licenses that require a
minimal signing fees and commercially acceptable royalty levels.
The Company is continually seeking and evaluating additional proposed products
within selected therapeutic areas. Should the Company be unsuccessful in
acquiring additional proposed products for development and commercialization
within a selected therapeutic area, the Company may reassess the viability of a
therapeutic area or redefine the area to expand the number of potential products
that might satisfy the Company's acquisition criteria for a viable therapeutic
area to ensure adequate future growth of the Company.
PRODUCT DEVELOPMENT
Pharmaceutical product development is one of the Company's principal activities.
The Company has incurred $48.1 million in research and development expense
through December 31, 2002. In addition, the Company estimates that it will need
to incur at least an additional $6.0 million in research and development expense
relating to the seven products it currently markets, including obtaining any
potential additional Xyrem indications.
A major element of the Company's product development strategy is to use
third-parties or contract research organizations (CROs) to assist in the conduct
of 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 uses a team approach to
develop its proposed products. A development team is organized and managed by
senior staff. The development team is cross-functional and includes in-house
experts, as well as appropriate outside consultants, to manage all development
activities as well as market planning with respect to a proposed product. A
development team designs a development plan, which will support the proposed
indication and marketing claims, and creates and manages a financial budget for
the proposed product and contracts with outside development agents and
consultants to arrange for the necessary clinical and toxicology studies,
manufacturing arrangements and FDA filings. Upon approval of the NDA by the FDA,
the Company's marketing and sales staff manages marketing and sales of the
proposed product.
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.
Over time, the Company expects to build internal capabilities to replace certain
functions now contracted to outside parties.
This contract approach to product development requires project management by
professionals with substantial industry experience. The Company believes it 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 problems associated with
a proposed product's safety and effectiveness. The Company attempts to reduce
the risk that a proposed product will not be accepted in the
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marketplace by conducting market research and defining commercial strategy with
a product's development. A drug development portfolio cannot be completely
insulated from potential clinical and marketing failures. 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 either
the products were deemed unapprovable or the estimated financial returns of
these proposed products were unacceptable.
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 Good Manufacturing Processes ("GMP") as required by FDA
regulations, or other rules and regulations prescribed by foreign regulatory
authorities. The Company is negotiating or 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 the
Company's approved products, the Company may be subject to complex manufacturing
logistics, minimum order quantities that could result in excess inventory as
determined under the Company's accounting policy, unsalable inventory as a
result of product 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:
Contract Drug Product Manufacturer Marketed and Proposed Products
------------------------------------ --------------------------------
An affiliate of Boehringer Ingelheim Antizol, Antizol-Vet, Elliotts B
Solution, and Busulfex
NutraMax, Inc. Sucraid
Proclinical, Inc., Ropack, Inc. Cystadane
DSM/Catalytica Pharmaceuticals, Inc. Xyrem
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.
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
physician and patient populations will allow the use of a relatively small,
focused sales force instead of a large, generalized 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
therapeutic areas, identifies customer needs within each therapeutic area,
identifies specific product acquisition candidates within each therapeutic area,
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 of the NDA to the FDA, the product
management responsibilities transition from the development team to the
Company's marketing and sales staff. The development
8
group continues to provide support where needed to enhance marketing and sales
efforts. This group is responsible for all aspects of a product's marketing and
sales, including product forecasting, positioning, price, promotion and physical
distribution to successfully launch and commercialize the product. Senior sales
and marketing employees lead a cross functional team of internal and external
personnel to implement a product's marketing and commercialization plan. In
addition, marketing and sales staff also supports the Company's international
sales efforts through support of and interfacing with international partners.
MARKETING - FOREIGN
In general, the Company expects to out-license foreign marketing, sales and
distribution rights after an NDA is submitted or approved in the United States.
The Company contracts with foreign companies (usually pharmaceutical companies)
to market and distribute its products. The Company considers Europe and Japan 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, Antizol and Cystadane in Canada, and Elliotts
B Solution in Central America.
In October 1999, the Company signed a definitive agreement with Pierre Fabre
Medicament, granting the French company exclusive rights to market and
distribute Busulfex in 21 European countries, as well as Argentina and South
Africa. Upon approval, Pierre Fabre, a private company with 2002 sales in excess
of $1.3 billion and approximately 9,000 employees, will market Busulfex to
transplant centers through its 75 oncology marketing and sales personnel. The
Company has an agreement with IDIS World Medicine to distribute Busulfex on a
"named patient basis" to requesting physicians outside of the United States,
Canada and Israel, and other approved products in territories where the
Company's other products are not approved and where the Company does not have a
distribution partner. The Company began shipments to IDIS in January 2000.
In December 2000, the Company signed a definitive agreement with Kirin Brewing
Co., LTD to market and distribute Busulfex in Asia including Japan, the Peoples
Republic of China, South Korea and Taiwan. Kirin is a diversified company with
more than $14 billion worldwide revenues in the food and beverage industry.
Kirin expanded into the pharmaceutical business in 1982 and has a strong
presence in the fields of nephrology, cancer and cell production, immunology and
allergy.
The Company's historical practice is to negotiate contracts with foreign
distributors that generally provide for minimum order and sales performance.
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
established evidence 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 if not satisfied with the performance of its
partners. 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.
The Company is in the process of obtaining a partner for the distribution of
Xyrem in the European Union, where it received orphan drug designation in
February 2003, and Asia. The commercial agreement with a third party for Xyrem
that provides marketing rights outside of the United States may differ from
previously executed contracts in that the Company hopes to secure an upfront
payment as well as milestone payments for regulatory and/or commercial milestone
achievements.
DISTRIBUTION
In the foreseeable future, 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. Cystadane is principally distributed
directly to patients through a third party mail order pharmacy, Chronimed, Inc.
Elliotts B Solution, Antizol and Busulfex are primarily used in a hospital
setting and are distributed by an affiliate of Cardinal Health. This
distribution system allows 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 a network of veterinary
wholesalers.
9
The Company has a contract with a central pharmacy to distribute Xyrem in the
United States. Xyrem is classified as a Schedule III controlled substance and
approved under Subpart H of the FDA's review and approval process, and
distribution will be strictly controlled. The specialty pharmacy will be the
only source through which Xyrem can be obtained. Distribution will be governed
by the FDA's Subpart H regulations and will fully comply with the
risk-management controls jointly developed by Orphan Medical, the Drug
Enforcement Agency and law enforcement agencies. Every shipment of Xyrem will be
subject to stringent safeguards to ensure it reaches only individuals for whom
it has been legitimately prescribed.
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, but not limited to,
those described below.
o PRODUCT ACQUISITION -The Company will compete with other entities in
acquiring product rights from other companies, universities, other research
institutions, as well as from other potential licensors.
o 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.
o 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 (acquired by SuperGen in 1999) and
Teva (formerly Biocraft) have been granted orphan drug designations for their
intravenous busulfan and sodium oxybate, respectively. Intravenous busulfan
and sodium oxybate are their equivalents of the Company's Busulfex and Xyrem
products, respectively. The Company does not believe SuperGen is developing
an intravenous busulfan. In 1999, the Company entered into an agreement with
Teva that, in effect, transfers Teva's development data to the Company. 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 from another formulation or drug of materially
different composition from being approved, with or without orphan drug
status, for the same indication.
o MARKETING AND SALES - Each of the Company's current products will face
competition from other products or from other therapeutic alternatives. The
Company's products may compete against products whose marketers have
substantially greater resources, including large specialized sales forces,
than the Company.
o MANUFACTURING - The Company may also compete for limited manufacturing
capacity or availability.
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 price controls and 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.
10
Inclusion or listing on the formularies of managed care groups is important to
the commercial success of most prescription medicines. 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 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 approval in the United States and comparable
approvals in foreign markets before they can be marketed. The development of
investigational products and the marketing and supply of approved products
require continuing compliance with FDA regulations on the part of the Company as
well as its manufacturers and distributors.
SCHEDULED PRODUCTS
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. On February 28,
2000 the President signed PL 106-172, a public law that makes gamma
hydroxybutyrate (GHB) a Schedule I substance. Schedule I is the designation by
which illegal and non-approved drugs are controlled. The bill further delineates
GHB products being studied under Food and Drug Administration (FDA) approved
protocols or approved for commercial sale by the FDA as Schedule III substances.
Each state has the ability to schedule products more strictly or equivalent to
the Federally designated schedule. Most states have adopted, either
administratively or legislatively, the bifurcated I/III schedule as described
above. The Company continues its efforts to ensure consistency of scheduling
across all states.
MANUFACTURING REGULATION
All facilities and manufacturing processes used to manufacture products for
clinical use or sale in the United States must be operated in conformity with
Good Manufacturing Practices (GMP). These represent 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 to change 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 price of a product must also be approved. The pricing review
period often begins after market approval is granted. The Company intends to use
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 $20 million. The Company also carries a $10 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.
11
HUMAN RESOURCES
The Company has 108 full-time and five 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 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. We cannot assure, however, that these agreements will be observed to
prevent disclosure or that they will provide adequate protection for the
Company's confidential information and inventions.
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. 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 for certain products.
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. The Company currently has no active grants.
DISCONTINUED DEVELOPMENT PRODUCTS
Through December 31, 2002, the Company discontinued development activities on a
total of eleven proposed products. 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.
PRODUCTS
The following tables summarize certain information relating to the Company's
products:
MARKETED PRODUCTS
------------------------------------------------------------------------------------------------------------
U.S. Patent
NDA Issued or Orphan Drug
Approval Applied Status
Approved Product Application Date For **
------------------------------------- ----------------------- --------- ----------- ----------
Xyrem(R) (sodium oxybate) oral For the treatment of July 2002 Yes Granted
solution cataplexy associated
with narcolepsy
Antizol(R) (fomepizole) Injection Antidote for ethylene December No Granted
glycol (antifreeze) or 1997
suspected ethylene
glycol ingestion in
humans
Antidote for methanol December No Granted
or suspected methanol 2000
ingestion in humans
12
Busulfex(R) (busulfan) Injection For use in combination February Yes Granted
with cyclophosphamide 1999
as a conditioning
regimen prior to
allogenic hematopoietic
cell transplantation
for chronic myelogenous
leukemia ("CML")
Cystadane(R) (betaine anhydrous for Homocystinuria, a October 1996 No Granted
oral solution) genetic disease
Sucraid(R) (sacrosidase) oral Sucrase deficiency, a April No Granted
solution genetic disease 1998
Antizol-Vet(R) (fomepizole) Antidote for ethylene November No Five year
for Injection glycol (antifreeze) or 1996 period of
suspected ethylene exclusivity
glycol ingestion in dogs
Elliotts B(R) Solution (buffered Diluent for September No Granted
intrathecal electrolyte/dextrose intrathecally 1996
solution) administered
methotrexate sodium and
cyarabine
13
PRODUCTS UNDER DEVELOPMENT
----------------------------------------------------------------------------------------------------------
U.S. Patent
Phase of Issued or Orphan Drug
Development Applied Designation
Investigational Product Proposed Application * For **
---------------------------------- -------------------- ----------- --------- ------------
Xyrem(R) (sodium oxybate) oral Sleep disorders III(b)
solution
* Development Phases are discussed under "Business - The Regulatory Process".
** Orphan Drug Designation and Status are discussed under "Business -
Proprietary Rights"
APPROVED PRODUCTS
XYREM (SODIUM OXYBATE) ORAL SOLUTION
Narcolepsy is a chronic neurologic sleep disorder in which sleep is
"fragmented", that is, does not occur in an integrated and cohesive manner. This
fragmentation results in 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 hallucinations, or vivid and
sometimes frightening dreaming when falling asleep or waking up. Other related
symptoms include broken nighttime sleep, disturbances of auditory and visual
perception, and 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 approximately 140,000 persons in the United
States. Approximately 75,000 of these patients are thought to be diagnosed.
Narcolepsy patients usually begin to develop symptoms between the ages of 15-25.
Symptoms have been reported in patients as young as five years of age.
The usual treatment for narcolepsy includes symptomatic treatment of excessive
daytime sleepiness and sleep attacks with stimulants or wakefulness promoting
agents. The symptoms of cataplexy, sleep paralysis and hypnagogic hallucinations
are typically treated with tricyclic antidepressants ("TCAs") or selective
serotonin reuptake inhibitors ("SSRIs"). 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 such as
insomnia, hypertension, palpitations, irritability and, at higher doses, may
mimic the symptoms of schizophrenia. Patients often build tolerance to the TCAs
and SSRIs and doses are increased to obtain clinical effectiveness. These
medications can cause the side effects of dry mouth, impotence, loss of libido,
and increased heart rate. Clinical results with Xyrem suggest that it is
effective in the treatment of narcolepsy symptoms. Administered at night, it is
believed to consolidate sleep and has been shown to reduce cataplexy attacks,
and to reduce the severity of daytime sleepiness when used in combination with
stimulants during the day. More than 500 narcolepsy patients have been exposed
to clinical doses with an acceptable side effect profile. 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.
The Company submitted its NDA for Xyrem on October 2, 2000 and was granted
approval on July 17, 2002. The product is indicated for the treatment of
cataplexy associated with narcolepsy. The Company began shipping product in
September 2002 and the commercial launch commenced on October 7, 2002. Through
December 31, 2002 nearly 1000 new prescriptions have been written for Xyrem by
approximately 280 physicians.
Gamma hydroxybutyrate (GHB) is the active ingredient in Xyrem. Illicitly
produced GHB has been reported to be a drug of abuse. On February 18, 2000, the
President signed PL 106-172, a public law that makes GHB a Schedule I substance.
Schedule I is the designation by which illegal drugs are controlled. The bill
further delineates GHB products being studied under Food and Drug Administration
(FDA) approved protocols or approved for commercial sale as Schedule III
substances.
Each state has the ability to schedule products more strictly or equivalent to
the Federally designated schedule. Most states have adopted, either
administratively or legislatively, the I/III schedule as described above. The
Company continues its efforts to ensure consistency of scheduling across all
states.
Sodium oxybate (GHB), the active ingredient in Xyrem, is a known compound and is
not patentable. The Company has received an orphan drug status for its indicated
use of Xyrem. There are no license fees or royalty payments
14
associated with Xyrem revenues. FDA orphan drug status extends through July 17,
2009. The Company has an issued formulation patent, which expires on December
22, 2019. Other patents are pending. The Company has contracted with third party
bulk drug and drug product manufacturers for the production of Xyrem under GMP
conditions.
BUSULFEX (BUSULFAN) INJECTION
Following an accelerated six-month priority review, the Company received
regulatory approval from the FDA in February 1999 to market Busulfex in the
United States. 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"). The
first commercial sales of Busulfex occurred in February 1999, within two weeks
of FDA approval. Busulfex also received marketing approval in Canada in
September 1999, in Israel in February 2000 and in South Korea in December 2001.
The indications approved in Canada, Israel and South Korea provide for use of
Busulfex as a conditioning regimen prior to bone marrow or hematopoietic
progenitor cell transplantation, when used in combination with other
chemotherapeutic agents and/or radiotherapy. Included in the Canadian indication
are acute lymphocytic leukemia, non-lymphocytic leukemia, acute myeloid
leukemia, non-Hodgkin's lymphoma, Hodgkin's disease, multiple myeloma,
myelodysplastic syndrome, breast cancer, ovarian cancer and several genetic
diseases.
In December 2002, the FDA approved labeling changes for Busulfex with respect to
pediatric dosing, but did not award the Company a pediatric indication.
In December 2000, the Company signed a definitive agreement granting Kirin
Brewery Co., LTD exclusive rights to market and distribute Busulfex in Asia.
Kirin is a diversified company with annual sales of more than $14 billion
worldwide in the food, beverage and pharmaceutical industry. Kirin expanded into
the pharmaceutical industry in 1982 and has established a strong presence in the
fields of nephrology, cancer and cell production, immunology and allergy. The
Company began shipments of clinical trial materials to Kirin in 2001
In October 1999, the Company signed a definitive agreement with Pierre Fabre
Medicament, granting the French company exclusive rights to market and
distribute Busulfex in 21 European countries, Argentina, and South Africa.
Pierre Fabre will market Busulfex to transplant centers through 75 oncology
marketing and sales personnel. The Company signed an agreement with IDIS World
Medicine in December 1999 to distribute Busulfex on a named patient basis to
requesting physicians outside of the United States, Canada and Israel until
marketing approvals are granted by the respective regulatory agencies. The
Company began shipments to IDIS in January 2000. A marketing application was
submitted by Pierre Fabre Medicament in Europe in late 2001. In March 2003 the
European Committee for Proprietary Medicinal Products (CPMP) recommended to the
European Commission that Busulfex(R) (busulfan) Injection be approved for
marketing in Europe as a conditioning treatment prior to haematopoietic
progenitor stem cell or bone marrow transplantation in adult patients.
Bone marrow and peripheral stem cell transplants are collectively known as
hematopoietic progenitor cell transplants, but are more commonly referred to as
stem cell or bone marrow transplants. This year approximately 20,000 stem cell
transplants are expected to be performed in the United States, with another
20,000 expected to be performed outside the United States. One of the many
complex steps in performing a stem cell transplant includes using high doses of
chemotherapeutic drugs, such as Busulfex, and/or radiation as a "conditioning
regimen" to destroy the abnormal cancer cells in the bone marrow and to create
"space" for the engraftment of transplanted stem cells. The stem cell transplant
then replaces the diseased or damaged marrow to grow into healthy marrow. 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 stem cell transplants at cancer treatment centers.
Adoption of Busulfex into standard busulfan-based regimens has been steady, and
several clinicians in leading institutions have initiated new research protocols
using Busulfex to enhance the conditioning regimen, based on clinical data and
experience with Busulfex. Several leading United States research centers have
indicated to the Company that they have initiated or intend to initiate new
study protocols specifying the use of Busulfex.
Many other drugs are currently being developed for use in the BMT area. Although
most of these new drugs are used for a different purpose during the bone marrow
transplant and not in the conditioning regimen, some of them may compete with
Busulfex. The Company is aware that SuperGen Inc., which acquired Sparta
Pharmaceutical in 1999, now owns rights to another form of intravenous busulfan
which was in development by Sparta prior to its acquisition. SuperGen holds
orphan drug designation for its intravenous busulfan and could seek orphan drug
status for a similar or different indication, if SuperGen were to proceed with
development of its intravenous formulation and if the FDA approves an NDA for
such a product.
15
The Company has obtained orphan drug status for Busulfex for the approved
indication, which initially provided marketing exclusivity for that indication
to the Company through February 2006. With the addition of pediatric labeling,
the FDA granted a six-month extension of exclusivity through August 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
except for Australia from M.D. Anderson Cancer Center, The University of Texas,
and The University of Houston (collectively, the "busulfan licensors") to
develop and market this 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. The product is distributed for the Company by an
affiliate of Cardinal Health.
ANTIZOL (FOMEPIZOLE) INJECTION
Antizol received marketing clearance from the FDA in December 1997 for suspected
or confirmed ethylene glycol poisonings and December 2000 for suspected or
confirmed methanol poisonings. 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. When ingested by
humans, ethylene glycol or methanol (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 2001 by the American Association of Poison
Control Centers, approximately 8,500 cases of ethylene glycol poisoning were
reported to United States poison control centers. In the same year, there were
approximately 1,100 treatments for such poisonings. The Company believes that
hospital pharmacies will continue to stock Antizol because it is important to
treat poisoned patients very quickly in order to improve the chances of
successful recovery. For 2002, Antizol contributed approximately 39% of the
Company's total revenues. The Company estimates that over one-third of all
hospitals with emergency rooms currently stock the product. Antizol has become
the standard of care for toxic alcohol poisoning and guidelines issued by the
American Academy of Clinical Toxicologists recommended Antizol as the drug of
choice for such poisonings. The Company expects to see limited incremental
stocking by hospitals in 2003. Future sales will be based more on usage as
stocking levels are expected to plateau. The Company has also received marketing
approval for Antizol in Canada for the treatment of suspected or confirmed
ethylene glycol poisonings.
The Company has obtained orphan drug status for Antizol as an antidote to treat
ethylene glycol and methanol poisonings, which provides marketing exclusivity to
the Company through December 2004 for ethylene glycol and December 2007 for
methanol. 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.
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 Inc. directly to
patients in the United States through its mail order pharmacy. 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 approximately $500,000 in the United States. The
Company does receive sales revenue generated outside of the United States.
Cystadane revenues met the Company's expectations in 2002 and are expected to
grow slightly in subsequent periods. 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.
The Company has obtained orphan drug status for Cystadane for the treatment of
homocystinuria, which provides marketing exclusivity to the Company through
October 2003. 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.
The Company is not currently sponsoring any clinical trials with/for Cystadane.
The Company is aware, however, of clinical trials being conducted by independent
investigators to assess the safety and efficacy of Cystadane as a stand alone or
adjunctive therapy for the following indications: Non-alcoholic steatohepatitis,
Rett syndrome, rheumatoid
16
arthritis and hyperhomocystinemia. The Company does not expect that the results
of any of these clinical trials will significantly enhance or decrease the
current limited market potential for Cystadane in the near future.
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. The FDA approved Sucraid to be used for oral replacement therapy
of 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. 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.
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.
ANTIZOL-VET (FOMEPIZOLE) FOR INJECTION
In November 1996, the Center for Veterinary Medicine of the FDA approved
Antizol-Vet as a treatment for dogs that have ingested or are suspected of
having ingested ethylene glycol. The first commercial sales of Antizol-Vet
occurred in January 1997. 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 $300,000. The Company has found that stocking of this product has been
limited due to its high cost, but it is ordered when a poisoning occurs.
Antizol-Vet revenues met the Company's expectations in 2002 and are expected to
remain constant or decline in subsequent periods.
Federal law provided the Company with a marketing exclusivity period through
November 2001 for the use of Antizol-Vet in dogs for the approved indication.
The Company has contracted with a third party for the production of Antizol-Vet
under GMP conditions.
The Company has partnered with several leading regional and national veterinary
wholesalers to distribute Antizol-Vet to veterinary clinics. It is believed that
the current partners effectively and efficiently encompass the entire country
with limited sales territory overlap, thus helping prevent downward retail
pricing pressures. The Company does not anticipate adding additional
distribution partners.
ELLIOTTS B SOLUTION (BUFFERED INTRATHECAL ELECTROLYTE/DEXTROSE INJECTION)
Elliotts B Solution 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 central nervous system) 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 have not been material
nor does the Company expect that revenues to be material to the Company's
financial results.
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.
17
The primary symptoms of CSID include severe watery diarrhea, chronic
malabsorption and, in infants and toddlers, failure to thrive. 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.
SLEEP DISORDERS - INVESTIGATIONAL PRODUCT
XYREM (SODIUM OXYBATE) ORAL SOLUTION
The Company is conducting a Phase III (b) third clinical trial for Xyrem, which
the FDA has previously indicated is not required for the Company's NDA
submission. This controlled clinical trial assesses the efficacy of Xyrem for
treating excessive daytime sleepiness (EDS) related to narcolepsy as its primary
endpoint. This trial continues to move forward toward completion in the middle
of 2003. A second Phase III(b) trial will begin in early 2003 to assess Xyrem
with and without other stimulant medication for the treatment of EDS associated
with narcolepsy.
18
ITEM 2. PROPERTIES
The Company currently occupies approximately 15,000 square feet of leased office
space at a monthly rent of approximately $25,000, including operating expenses.
This lease expires on October 31, 2003.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
19
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
THIS SECTION NEEDS TO BE UPDSATED TO INCLUDE MARK PERRIN, AND DAVID FULLER The
executive officers of the Company and their ages as of March 1, 2003.
Name Age Title
------------------------------- ----- ------------------------------------
John Howell Bullion 51 Chief Executive Officer and Chairman
of the Board
William Houghton, M.D. 60 Executive Vice President and Chief
Scientific and Medical Officer
Mark Perrin 46 Executive Vice President and Chief
Commercial Officer
Timothy G. McGrath 38 Vice President and Chief Financial
Officer
Dayton T. Reardan, Ph.D. 47 Vice President of Regulatory Affairs
Pamela J. Stahl 37 Vice President of Commercial
Operations
David Fuller, M.D. 39 Vice President of Medical Affairs
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.
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-off in 1994. 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 Executive Vice President, Chief Scientific
and Chief Medical Officer since May 2002. Prior to that Dr. Houghton served as
the Company's Chief Operating Officer since joining the Company in 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.
Mr. Perrin has been the Company's Executive Vice President and Chief Commercial
Officer since May 2002. From 1995 to 2001, Mr. Perrin was Executive Vice
President, Commercial Operations at COR Therapeutics responsible for all aspects
of sales marketing and manufacturing. Prior to that Mr. Perrin held sales,
marketing and commercial operations management positions at Burroughs Wellcome
Company from 1992 to 1995 and Lederle Laboratories from 1979 to 1992.
Mr. McGrath has been the Company's Vice President and Chief Financial Officer
since October 1999. Previously, Mr. McGrath had worked as consultant providing
financial services to growing companies in the Minneapolis and Saint Paul area.
From 1994 to 1998, he was Vice President of Finance at E. W. Blanch Holdings,
Inc., a publicly traded provider of integrated risk management and distribution
services. Prior to joining E.W. Blanch Holdings, Mr. McGrath was with Ernst &
Young LLP in Minneapolis.
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 scientific, development
and management positions at Xoma Corporation.
Ms. Stahl has been the Company's Vice President of Commercial Operations since
October 2001. Most recently, Ms. Stahl was Vice President of Sales at American
TeleCare, Inc. an emerging telemedicine company where she had responsibility for
sales, marketing, and distribution. Previously, she held several management
positions in sales, managed care, and sales training at AstraZeneca L.P. During
her tenure at AstraZeneca L.P., Ms. Stahl was a member of the team that launched
Prilosec(R), the leading treatment of acid related disorders. She also worked at
Merck & Co., Inc. in sales and training positions supporting Zocor(R) and
Pepcid(R). In her position at Orphan Medical, Ms. Stahl manages the Company's
U.S. and International sales, distribution, and Patient Affairs functions.
Dr. Fuller has been the Company's Vice President of Medical Affairs since
February 2002 and had been the Director of Medical Affairs since joining the
Company in July 2001. From February 1999 to July 2001, Dr. Fuller held several
management positions at CeNeS Pharmaceuticals. From 1992 through 1999, Dr.
Fuller was Managing Director at Spectrum Pharmaceuticals, a consulting firm.
Prior to that, Dr. Fuller held various positions at Pfizer Pty Ltd., Bayer
Australia Ltd., and Roche Products. Dr. Fuller was also a Resident Medical
Officer at Royal Prince Alfred Hospital in Camperdown, Australia.
20
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, 2002 and December 31, 2001.
-------------------------------------------------------------------
High Low
----------------------------
YEAR ENDED DECEMBER 31, 2002
January 1 through March 31 $15.000 $10.310
April 1, through June 30 $13.060 $9.000
July 1 through September 30 $12.200 $5.950
October 1 through December 31 $11.350 $6.960
YEAR ENDED DECEMBER 31, 2001
January 1 through March 31 $18.375 $6.375
April 1 through June 30 $15.000 $9.500
July 1 through September 30 $12.200 $6.500
October 1 through December 31 $14.100 $7.240
-------------------------------------------------------------------
EQUITY COMPENSATION PLAN INFORMATION AS OF DECEMBER 31, 2002
The following table summarizes information as of December 31, 2002 relating to
equity compensation plans of the Company pursuant to which grants of options,
restricted stock, or other rights to acquire shares may be granted from time to
time. As of December 31, 2002, the Company had no equity compensation plans that
were not approved by security holders.
-------------------------- ---------------------------- ---------------------------- -------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND (EXCLUDING SECURITIES
WARRANTS AND RIGHTS RIGHTS REFLECTED IN COLUMN (1))
PLAN CATEGORY (1) (2) (3)
-------------------------- ---------------------------- ---------------------------- -------------------------
Equity compensation 1,997,478 $7.90 369,928
plans approved by
security holders
As of March 15, 2003, the Company's Common Stock was held by approximately 250
shareholders of record and the Company estimates that there were approximately
3,000 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 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.
21
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company as of December 31, 2002 and
2001 and for the three years ended December 31, 2002, 2001 and 2000, 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 selected financial data as of December 31, 2000, 1999 and 1998
and for each of the two years ending December 31, 1999 and 1998 are derived from
financial statements, which are not included herein. 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.
FINANCIAL POSITION
-------------------------------------------------------------------------------------------------------
December 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------------------ ---------------------------------------------
Cash, cash equivalents and
available-for-sale
securities $ 6,920,685 $ 19,011,245 $ 11,417,254 $ 4,032,914 $ 7,521,483
Working capital 6,672,090 18,010,707 10,266,029 3,161,324 5,274,550
Total assets 13,138,922 22,346,276 15,296,885 6,241,178 9,046,730
Accumulated deficit (66,388,335) (54,073,165) (47,178,667) (40,243,874) (34,433,640)
Total shareholders' equity 7,749,794 18,412,707 10,742,927 3,561,208 5,575,577
-------------------------------------------------------------------------------------------------------
FINANCIAL RESULTS
-------------------------------------------------------------------------------------------------------
For the Year For the Year For the Year For the Year For the Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- ---------------
Revenues $ 16,130,169 $ 11,274,110 $ 11,185,634 $ 6,457,406 $ 5,048,308
Cost of sales 2,191,598 1,591,826 1,532,446 803,562 1,118,644
------------- ------------- ------------- ------------- ---------------
Gross profit 13,938,571 9,682,284 9,653,188 5,653,844 3,929,664
Operating expenses
Research and development 6,618,091 5,462,336 7,179,605 5,208,099 6,611,011
Sales and marketing 12,518,498 5,729,987 5,259,031 3,198,146 2,739,299
General and administrative 6,458,308 4,807,847 4,094,905 2,756,827 2,994,342
------------- ------------- ------------- ------------- ---------------
Loss from operations (11,656,326) (6,317,886) (6,880,353) (5,509,228) (8,414,987)
Other income, net 255,178 321,315 793,238 287,989 177,885
------------- ------------- ------------- ------------- ---------------
Net loss (11,401,148) (5,996,571) (6,087,115) (5,221,239) (8,237,102)
Less: Preferred stock
dividend 922,170 903,053 872,024 682,872 249,658
------------- ------------- ------------- ------------- ---------------
Net loss applicable to
common shareholders $ (12,323,318) $ (6,899,624) $ (6,959,139) $ (5,904,111) $ (8,486,760)
============= ============= ============= ============= ===============
Basic and diluted loss
per common share $(1.19) $(0.80) $(0.86) $(0.90) $(1.36)
Weighted average
shares outstanding 10,349,679 8,597,331 8,135,224 6,587,790 6,236,897
-------------------------------------------------------------------------------------------------------
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Since its inception, the activities of 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 and
initiating the commercial introduction of seven products. The Company operates
in a single business segment: pharmaceutical products. The Company has
experienced recurring losses from operations and has generated an accumulated
deficit through December 31, 2002 of $66.4 million. In addition, the Company
expects to incur additional losses from operations in 2003.
RECENT DEVELOPMENTS
On July 17, 2002 the Company announced that the U.S. Food and Drug
Administration (FDA) had approved Xyrem(R) (sodium oxybate) oral solution to
treat cataplexy, a sudden loss of muscle tone associated with narcolepsy. Xyrem
is the first approved medication indicated for the treatment of cataplexy.
Narcolepsy is a chronic neurological disorder affecting approximately 140,000
Americans. An estimated 60-90 percent of narcolepsy patients experience
cataplexy. Cataplexy, a sudden partial or total loss of muscle tone, is a
debilitating symptom of narcolepsy usually triggered by strong emotions such as
laughter, anger, or surprise. In its most severe form, cataplexy can cause a
person to collapse during waking hours.
Xyrem (sodium oxybate) is a central nervous system (CNS) depressant and should
not be used in conjunction with alcohol or other CNS depressants. Sodium oxybate
is GHB (gamma hydroxybutyrate), a known drug of abuse. The abuse of GHB has been
associated with a number of important CNS adverse clinical events, including
seizure, respiratory depression, and profound decreases in level of
consciousness, with instances of coma and death. Even at recommended doses, use
has been associated with confusion and other neuropsychiatric events. Reports of
respiratory difficulties occurred in clinical trials.
Distribution of Xyrem, a Schedule III controlled substance, is governed by the
FDA's Subpart H regulations. To comply with these regulations, the Company has
developed a rigorous system that makes Xyrem available to patients from a
single, specialty pharmacy. Both physicians and patients must receive
educational materials from the Company before obtaining Xyrem. Orphan Medical
has worked closely with the FDA, DEA and law enforcement agencies to develop
strict distribution and risk-management controls designed to restrict access to
Xyrem to the intended patient population. The Company has hired and trained 36
additional sales employees who will call on accredited sleep centers, and other
physician specialists treating those with cataplexy. The Company launched Xyrem
on October 7, 2002.
The Company has worked with physicians, patients, and FDA for nearly eight years
to bring Xyrem to patients with cataplexy. The Company is continuing
investigations to fully understand the mechanism of action of Xyrem. The Company
also expects to complete by the end of 2003 the clinical portion of the Phase
III(b) trial designed to assess the efficacy of Xyrem in reducing excessive
daytime sleepiness as a supplement to stimulant therapy. The Company has
initiated a second Phase III(b) trial to assess the efficacy of Xyrem in
reducing excessive daytime sleepiness both with and without concomitant
stimulant therapy.
On March 28, 2003, the Company cancelled its existing line of credit facility
and entered into a new facility with a commercial bank. The new line of credit
facility, which has a term of one-year, includes a borrowing base equal to 75%
of eligible accounts receivable up to a maximum amount of $3.5 million. Certain
other assets have also been pledged as collateral for this facility. The
interest rate is equal to two points over the bank's prime rate. The Company
will be subject to certain other requirements during the term of the facility,
including minimum quarterly net equity amounts.
23
CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION
Sales for all products except Xyrem(R) (sodium oxybate) oral solution are
recognized at the time a product is shipped to the Company's customers and are
recorded net of reserves for estimated returns of outdated product and for
discounts for prompt payment. Sales of Xyrem are recognized at the time product
is shipped from the specialty pharmacy to the patient and are recorded net of
discounts for prompt payment. Except for Xyrem, the Company is obligated to
accept, for exchange, from all domestic customers products that have reached
their expiration date. The Company is not obligated to accept exchange of
outdated product from its international distribution partners. The Company
establishes a reserve for the estimated cost of the exchanges. The Company
monitors the return of product and modifies its accrual for outdated product
returns as necessary. Management bases these reserves on historical experience
and this estimate is subject to change.
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. Domestic receivables are due within 30 days of the invoice
date. International receivables are generally due within 60 to 90 days of
invoice date. Credit losses relating to customers have not been material since
the Company's inception.
INVENTORIES
Inventories are valued at the lower of cost or market determined using 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.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 2002 VS. TWELVE MONTHS ENDED DECEMBER 31, 2001
Revenues increased to $16.1 million for the twelve months ended December 31,
2002 from $11.3 million for the twelve months ended December 31, 2001, an
increase of $4.8 million or 43%. Sales of both Antizol and Busulfex exceeded
revenue expectations in 2002. Antizol(R) (fomepizole) Injection performed very
well throughout 2002. Sales of the antidote experienced 34% growth as compared
to the prior year and Antizol is being stocked in over one-third of all
hospitals with emergency departments. Antizol is established as the standard of
care for confirmed or suspected ethylene glycol and methanol poisonings. Use of
Busulfex(R) (busulfan) Injection in preparative regimens for bone marrow
transplantation also continues to realize significant growth in the United
States, Canada and other countries. Busulfex continues to advance into new
research areas in place of oral busulfan or total body irradiation, and now
holds an approximate 55 percent market share of the transplants that include a
busulfan-based regimen. The sales of Cystadane, Sucraid Antizol-Vet and Elliotts
B met the Company's expectations in 2002 and are not expected to increase
significantly in 2003. 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 to $2.2 million for the twelve months ended December 31,
2002 from $1.6 million for the twelve months ended December 31, 2001, an
increase of $0.6 million or 38%. The increase is primarily attributable to the
increase in sales in 2002. The gross margins for both 2002 and 2001 were 86%.
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 to $6.6 million for the twelve months
ended December 31, 2002 from $5.5 million for the twelve months ended December
31, 2001, an increase of $1.1 million or 21%. The increase is the result of
increased activity in ongoing trials for Xyrem and other development activities
related to Xyrem and other products. The two Phase III(b) trials for Xyrem, now
underway, will increase research and development spending in subsequent
quarters, as will additional trials and data updates requested by the FDA.
Clinical spending
24
for these activities will be dependent on a number of factors, including among
others, the number of human subjects screened and enrolled in the trials, and
the number of active clinical sites.
Sales and marketing expense increased to $12.5 million for the twelve months
ended December 31, 2002 from $5.7 million for the twelve months ended December
31, 2001, an increase of $6.8 million or 118%. This increase is largely
attributable to activities for Xyrem, including the development of marketing
materials, the recruitment and training of a dedicated specialty sales force,
the implementation of the specialty distribution system and the ongoing
activities associated with initial introduction of a new product. Sales and
marketing expenses will increase versus historical levels in subsequent quarters
to support the sales and marketing efforts related to Xyrem.
General and administrative expense increased to $6.5 million for the twelve
months ended December 31, 2002 from $4.8 million for the twelve months ended
December 31, 2001, an increase of $1.7 million or 34%. The increase in general
and administrative expenses is related to building infrastructure for the launch
and subsequent support of Xyrem. General and administrative expenses are
expected to increase somewhat above current levels in the next few quarters as
additional personnel are added and other support projects are initiated.
Other income consists of interest income from investment activities net of
interest expense. Other income was $0.3 million for the twelve months ended
December 31, 2002 and 2001. Even though the equity transaction completed in
December 2001 increased the cash available for investment in 2002, the lower
interest rates and the cash used to fund development and working capital
activities of the Company resulted in no increase in interest income for 2002
over 2001. Other income is expected to decrease in 2003 as a result of cash used
to fund development and working capital activities of the Company.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that
was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on
August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were
$0.9 million for the twelve months ended December 31, 2002 and 2001. Preferred
stock dividends, which commenced on February 1, 1999, are payable in arrears on
August 1 and February 1 of each year. Prior to February 2001, the Company
satisfied its dividend payment obligation by issuing additional preferred stock,
as permitted by the terms of the Senior Convertible Stock. Subsequent to
February 2001, the Company intends to continue to satisfy its future dividend
payment obligations by the issuance of unregistered common shares of stock for
the Senior Convertible Preferred Stock and additional preferred stock for the
Series B Convertible Preferred Stock, which will cause preferred stock dividends
to increase in subsequent quarters.
Net loss applicable to common shareholders was $12.3 million for the twelve
months ended December 31, 2002 compared to a net loss of $6.9 million for the
twelve months ended December 31, 2001. Basic and diluted loss per common share
for these respective periods were $1.19 and $0.80, based on weighted average
number of common shares outstanding of 10,349,679 and 8,597,331, respectively.
TWELVE MONTHS ENDED DECEMBER 31, 2001 VS. TWELVE MONTHS ENDED DECEMBER 31, 2000
Revenues increased from $11.2 million for the twelve months ended December 31,
2000 to $11.3 million for the twelve months ended December 31, 2001, an increase
of $0.1 million or 1%. Sales of both Antizol and Busulfex exceeded revenue
expectations in 2001. International sales of the Company's products decreased in
2001 due primarily to a delay in the shipment of clinical trial supply product
requested by an international partner. The sales of Cystadane, Sucraid
Antizol-Vet and Elliotts B met the Company's expectations in 2001 and are not
expected to increase significantly in 2002.
Cost of sales increased from $1.5 million for the twelve months ended December
31, 2000 to $1.6 million for the twelve months ended December 31, 2001, an
increase of $0.1 million or 4%. The increase is primarily attributable to the
increase in sales in 2001. The gross margins for both 2001 and 2000 were 86%.
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 decreased from $7.2 million for the twelve
months ended December 31, 2000 to $5.5 million for the twelve months ended
December 31, 2001, a decrease of $1.6 million or 23%. The decrease was the
result of reduced research and development spending on Xyrem during 2001. The
Company's efforts in 2001 were primarily focused on supporting the Xyrem NDA
submission. The 2001 spending includes ongoing trials for Xyrem and other
development and regulatory activities. Prior year spending included amounts for
clinical trials included in the NDA submission.
25
Sales and marketing expense increased from $5.3 million for the twelve months
ended December 31, 2000 to $5.7 million for the twelve months ended December 31,
2001, an increase of $0.4 million or 9%. This increase was largely attributable
to significantly higher spending related to the pre-approval market activities
related to Xyrem.
General and administrative expense increased from $4.1 million for the twelve
months ended December 31, 2000 to $4.8 million for the twelve months ended
December 31, 2001, an increase of $0.7 million or 17%. Approximately 34% of the
increase in general and administrative expenses is related to compensation
expense associated with stock options. The balance of the increase is related to
building infrastructure, including the addition of staff to prepare for the
anticipated launch of Xyrem.
Other income consists of interest income from investment activities net of
interest expense. Other income decreased from $0.8 million for the twelve months
ended December 31, 2000 to $0.3 million for the twelve months ended December 31,
2001. This decrease is the result of cash used to fund development and working
capital activities of the Company. In addition, interest rates on invested funds
declined, reducing the yields received.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that
was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on
August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were
$0.9 million for the twelve months ended December 31, 2001 and 2000. Preferred
stock dividends, which commenced on February 1, 1999, are payable in arrears on
August 1 and February 1 of each year. The Company previously satisfied its
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 future dividend payment obligations by the issuance of unregistered
common shares of stock for the Senior Convertible Preferred Stock and additional
preferred stock for the Series B Convertible Preferred Stock, which will cause
preferred stock dividends to increase in subsequent quarters.
Net loss applicable to common shareholders was $6.9 million for the twelve
months ended December 31, 2001 compared to a net loss of $7.0 million for the
twelve months ended December 31, 2000. Basic and diluted loss per common share
for these respective periods were $0.80 and $0.86, based on weighted average
number of common shares outstanding of 8,597,331 and 8,135,224, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Since July 2, 1994, the effective date the Company was spun-off from Chronimed
Inc., it has financed its operations principally from net proceeds from several
public and private financings, interest income and product sales. The various
public and private placement transactions since inception resulted in aggregate
net proceeds, after commissions and expenses, of $60.5 million. These net
proceeds include the private placement of 1.707 million shares of newly issued
common stock, resulting in net proceeds of $13.0 million in December 2001.
Net working capital (current assets less current liabilities) decreased to $6.7
million at December 31, 2002 from $18.0 million at December 31, 2001. Cash and
cash equivalents decreased to $6.9 million at December 31, 2002 from $19.0
million at December 31, 2001. The Company invests excess cash in short-term,
interest-bearing, investment grade securities.
The Company has a commercial revolving line of credit facility with a bank,
which expires on June 15, 2003. The maximum amount available to the Company
under this facility is $1,000,000, subject to certain limitations based on the
Company's cash collateral. The Company intends to renew this line of credit
facility. However the Company cannot assure that the bank will do so, or that it
would do so on terms acceptable to the Company. In connection with the financing
transaction in August 1999, the Company received a $2.05 million commitment in
the form of a line of credit from UBS Capital. This line was eliminated as a
provision of the financing transaction in December 2001. The Company had not
borrowed under the UBS Capital agreement. In addition, the Company had not
borrowed under the bank arrangement.
As discussed previously, the Company entered into a new line of credit facility
with a commercial bank on March 27, 2003. The new line of credit facility, which
has a term of one-year, includes a borrowing base equal to 75% of eligible
accounts receivable up to a maximum amount of $3.5 million. Certain other assets
have also been pledged as collateral for this facility. The interest rate is
equal to two points over the bank's prime rate. The Company will be subject to
certain other requirements during the term of the facility, including minimum
quarterly net equity amounts.
26
The Company's commitments for outside development spending increased to
approximately $5.7 million at December 31, 2002 from $4.0 million at December
31, 2001. These commitments are generally for less than one year. The increase
is principally attributable to the timing of the initiation of clinical trials
for Xyrem development activities. The Company expects development spending to
increase as the two Xyrem Phase III(b) clinical trials progress and post
approval surveillance studies are completed. In addition, the Company continues
to look at new product opportunities and any new initiatives will increase
development spending. Due to the dependence of this estimate on the results of
the studies and other variable components, the actual result of this estimate
may be different.
The Company also has future contractual commitments for the following cash
obligations
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
Total Less than one year 1-3 Years 4-5 Years After 5 Years
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
Capital lease
obligations $ 120,593 $ 24,119 $ 48,238 48,236 --
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
Operating lease
obligations (1) 1,230,300 601,100 629,200 -- --
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
Outside Development
Spending 5,633,000 5,633,000 -- -- --
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
Total contractual
cash obligations $6,983,893 $6,258,219 $ 677,438 $ 48,236 --
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
--------------------- ------------------ --------------------- ------------------- ------------------ ------------------
(1)-These amounts include both space for facilities and automobiles for the
Company's field sales force.
The Company expects spending during 2003 for research and development, sales and
marketing, and administration to increase significantly over 2002 levels.
Management believes the Company's current working capital and anticipated
operating cash flows from product sales will be sufficient to fund its
operations at least through December 31, 2003.
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) minimum
net equity in excess of $10.0 million or (2) a market capitalization of at least
$50.0 million. The Company met the market capitalization threshold at December
31, 2002. The Company's minimum net equity at December 31, 2002 equaled
approximately $7.7 million and the Company's market capitalization was
approximately $92.1 million (based on the last sale price of $8.80 and
10,460,283 shares outstanding as of December 31, 2002). Although the Company
does not expect to be profitable in 2003, the Company nevertheless expects to
continue to meet the requirements for listing on the NASDAQ National Market.
However there can be no assurance that the Company will continue to have
adequate capital to meet the requirements through the year 2003 and thereafter.
In connection with the 1998 and 1999 private placements 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 the
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 of the outstanding convertible preferred stock or the sale of
equity is accomplished in a public offering. The present conversion price is
$8.14 for the Senior Convertible Preferred Stock and $6.50 for the Series B
Convertible Preferred Stock. Even without these restrictions, the Company can
make no assurances that additional financing opportunities will be available or,
if available, on acceptable terms.
RISK FACTORS
An investment in our common stock involves a number of risks, including among
others, risks associated with companies that operate in the pharmaceutical
industry. These risks are substantial and inherent in our operations and
industry. Any investor or potential investor should carefully consider the
following information about these risks before buying shares of common stock.
WE HAVE A HISTORY OF LOSSES, WHICH WE EXPECT TO CONTINUE.
We have been unprofitable since our inception in January 1993. We expect
operating losses at least through 2003 because anticipated gross profits from
product revenues will not offset our operating expenses and additional spending
to continue drug development activities. The amount of these losses may vary
significantly from year-to-year
27
and quarter-to-quarter. Our actual losses will depend on, among other factors,
the timing of product development, regulatory approval, and market demand for
our Food and Drug Administration ("FDA") approved products. We cannot assure you
that we will ever generate sufficient product revenues to achieve profitability.
LIMITATIONS TO SOURCES OF ADDITIONAL CAPITAL - RESTRICTIONS, COVENANTS AND
RIGHTS RELATED TO SENIOR CONVERTIBLE PREFERRED STOCK AND SERIES B CONVERTIBLE
PREFERRED STOCK.
On July 23, 1998, we completed the private sale to UBS Capital of $7.5 million
of Senior Convertible Preferred Stock. On August 2, 1999, we completed another
private sale to UBS Capital of $2.95 million of Series B Convertible Preferred
Stock. In conjunction with the issuance of the preferred shares, we agreed to
several restrictions and covenants, and granted certain voting and other rights
to the holders of the preferred shares. One of the most important of these
restrictions is that we cannot incur additional indebtedness, except for
indebtedness secured solely by our trade receivables, until we have profitable
operations, subject to certain limitations. Another important restriction is
that, without the approval of a majority of the preferred stockholders, we
cannot issue additional equity securities unless the selling price per share
exceeds the then conversion price of the outstanding convertible preferred stock
or the sale of equity is accomplished in a public offering. The present
conversion price is $8.14 per share for the Senior Convertible Preferred Stock
and $6.50 for the Series B Convertible Preferred Stock. These restrictions could
make it more difficult and more costly for us to obtain additional capital. We
cannot assure you that additional sources of capital will be available to us or,
if available, on terms acceptable to us.
POSSIBLE PRICE VOLATILITY AND LIMITED LIQUIDITY OF STOCK.
There is generally significant volatility in the market prices and limited
liquidity of securities of early stage companies, and particularly of early
stage pharmaceutical companies. Contributing to this volatility are various
factors and events that can affect our stock price in a positive or negative
manner. These factors and events include, but are not limited to:
o announcements by us or our competitors of new product developments or
clinical testing results;
o governmental approvals, refusals to approve, regulations or actions;
o developments or disputes relating to patents or proprietary rights;
o public concern over the safety of therapies;
o financial performance;
o fluctuations in financial performance from period to period; and
o small float or number of shares of our stock available for sale and trade.
These and other factors and events may have a significant impact on our business
and on the market price of the common stock.
WE CANNOT BE SURE THAT FUTURE CAPITAL WILL BE AVAILABLE TO MEET OUR EXPECTED
CAPITAL REQUIREMENTS.
Although we believe that we have sufficient capital to meet out current business
objectives, if we expand our business plans, we may need additional capital.
Adequate funds for our operations, continued development, and expansion of our
business plans, whether from financial markets or from other sources, may not be
available when needed on acceptable terms, or at all. If we issue additional
securities your holding may be diluted.
POSSIBLE VOLATILITY OF STOCK PRICE AND REDUCED LIQUIDITY OF THE MARKET FOR THE
STOCK - POSSIBLE LOSS OF NASDAQ NATIONAL MARKET LISTING AND FAILURE TO QUALIFY
FOR NASDAQ SMALL CAP MARKET LISTING.
There is a risk that the market value and the liquidity of the public float for
our common stock could be adversely affected in the event we no longer meet 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 our case includes either: (1) minimum net equity in
excess of $10.0 million as reported on Form 10-Q or Form 10-K or (2) a market
capitalization of at least $50.0 million. Market capitalization is defined as
total outstanding shares multiplied by the last sales price quoted by Nasdaq. We
met the market capitalization criteria as of December 31, 2002, however, we
cannot assure you that the market capitalization threshold will continue to be
met or that we will be able to generate adequate capital to meet the net
tangible asset requirement.
28
THERE IS A LIMITED MARKET FOR OUR 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. We cannot
assure you that sales of our products will be adequate to make us profitable
even if the products are accepted by medical specialists and used by patients.
WE RELY ON THE LIMITED PROTECTION OF THE ORPHAN DRUG ACT.
UNITED STATES
-------------
Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs
intended to treat a "rare disease or condition." The Orphan Drug Act generally
defines "rare disease or condition" as one that affects populations of fewer
than 200,000 people in the United States. The Orphan Drug Act provides us with
certain limited protections for our products.
The first step in obtaining the limited protection under the Orphan Drug Act is
acquiring the FDA's approval of "orphan drug designation," which must be
requested before submitting a New Drug Application ("NDA"). After the FDA grants
orphan drug designation, it publishes the generic identity of the therapeutic
agent and the potential orphan use specified in the request. Orphan drug
designation does not constitute FDA approval. In addition, orphan drug
designation does not convey any advantage in, or shorten the duration of, the
regulatory approval process.
The second step in obtaining the limited protection under the Orphan Drug Act is
acquiring the FDA's recognition of "orphan drug status." The Orphan Drug Act
confers orphan drug status upon the first company to receive FDA approval to
market a drug with "orphan drug designation" for a specific designated
indication. Orphan drug status does not protect against another formulation or
drug of materially different composition from being approved, with or without
orphan drug status, for the same indication. FDA approval also results in United
States marketing exclusivity for a period of seven years, subject to certain
limitations. Although obtaining FDA approval to market a product with orphan
drug status can be advantageous, we cannot assure you that the scope of
protection or the level of marketing exclusivity will remain in effect in the
future. In addition, United States orphan drug status does not provide any
marketing exclusivity in foreign markets. Although certain foreign countries
provide development and marketing benefits to orphan drugs, we cannot assure you
that such benefits can be obtained or, if obtained, will be of material value to
us. The FDA has granted us orphan drug status for Xyrem, Antizol, Elliotts B
Solution, Cystadane, Sucraid, and Busulfex.
Even if the FDA approves an NDA for a drug with an orphan drug designation, the
FDA may still approve the same drug for a different indication, or a molecular
variation of the same drug for the same indication. We are aware that the FDA
granted to Sparta Pharmaceutical, which has been acquired by SuperGen Inc.,
orphan drug designation for an intravenous busulfan for a closely related
indication. If the FDA approves an NDA for SuperGen drug for a different
indication, SuperGen could seek orphan drug status. In addition, the FDA does
not restrict doctors from prescribing an approved drug for uses not approved by
the FDA for that drug. Thus, a doctor could prescribe another company's drug for
indications for which our product has received FDA approval and orphan drug
status. Significant "off label" use, that is, prescribing approved drugs for
unapproved uses, could adversely affect the marketing potential of any of our
products that have received orphan drug status and NDA approval by FDA.
The possible amendment of the Orphan Drug Act by Congress has been the subject
of congressional discussion from time to time over the last ten years. Although
Congress has made no significant changes to the Orphan Drug Act 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. We cannot assure you that
the Orphan Drug Act will remain in effect or that it will remain in effect in
its current form. The precise scope of protection that orphan drug designation
and marketing approval may afford in the future is unknown. We cannot assure you
that the current level of exclusivity will remain in effect.
EUROPE
------
An orphan drug act was enacted in Europe that provides up to ten years of market
exclusivity for a drug that meets the requirements of the act. For a
pharmaceutical product to qualify for the benefits of the act, the prevalence or
incidence (whichever is greater) must not exceed five patients per 10,000 in the
population. Our European partners have obtained orphan drug designation for both
Busulfex and Cystadane Europe. The Company has obtained orphan drug designation
for Xyrem and Antizol, for use in methanol poisonings, in Europe. We cannot
provide assurance
29
that any of our pharmaceutical products will qualify for orphan drug protection
in Europe or that another company will not obtain an approval that would block
us from marketing our product in Europe.
THE FDA AND FOREIGN REGULATORY AUTHORITIES MUST APPROVE OUR PRODUCTS FOR SALE.
Government regulation in the United States and abroad is a significant factor in
the testing, production and marketing of our current and future products. Each
product must undergo an extensive regulatory review process conducted by the
United States Food and Drug Administration and by comparable agencies in other
countries. We cannot market any medicine we may develop or license as a
prescription product in any jurisdiction, including foreign countries, in which
the product does not receive regulatory approval. The approval process can take
many years and requires the expenditure of substantial resources.
We depend on external laboratories and medical institutions to conduct our
pre-clinical and clinical analytical testing in compliance with good clinical
and laboratory practices established by the FDA. The data obtained from
pre-clinical and clinical testing is subject to varying interpretations that
could delay, limit or prevent regulatory approval. In addition, changes in FDA
policy for drug approval during the period of development and in the
requirements for regulatory review of each submitted NDA could result in
additional delays or outright rejection.
We cannot assure you that the FDA or any foreign regulatory authority will
approve in a timely manner, if at all, any product we develop. Generally, the
FDA and foreign regulatory authorities approve only a very small percentage of
newly discovered pharmaceutical compounds that enter pre-clinical development.
Moreover, even if the FDA approves a product, it may place commercially
unacceptable limitations on the uses, or "indications," for which a product may
be marketed. This would result in additional cost and delay for further studies
to provide additional data on safety or effectiveness.
FDA APPROVAL DOES NOT GUARANTEE FINANCIAL SUCCESS.
Seven of our products have been approved for marketing by regulatory authorities
in the United States and elsewhere. We cannot assure you that any of our
products will be commercially successful or achieve the expected financial
results. We may encounter unanticipated problems relating to the development,
manufacturing, distribution and marketing of our products. Some of these
problems may be beyond our financial and technical capacity to solve. The
failure to adequately address any such problems could have a material adverse
effect on our business and our prospects. In addition, the efforts of government
entities and third party payors to contain or reduce the costs of health care
may adversely affect our sales and limit the commercial success of our products.
We cannot completely insulate our drug development portfolio from the
possibility of clinical or commercial failures. Some products that we have
selected for development may not produce the results expected during clinical
trials or receive FDA approval. Drugs approved by the FDA may not generate
product sales of an acceptable level. We have discontinued the development of
eleven products from our portfolio since inception.
SIGNIFICANT GOVERNMENT REGULATION CONTINUES ONCE A PRODUCT IS APPROVED FOR SALE.
After a reviewing division of the FDA approves a drug, the FDA's Division of
Drug Marketing, Advertising and Communication must accept such drug's marketing
claims, which are the basis for the drug's labeling, advertising and promotion.
We cannot be sure that the Division of Drug Marketing, Advertising and
Communication will accept our proposed marketing claims. The failure of the
Division of Drug Marketing, Advertising and Communication to accept our proposed
marketing claims could have a material adverse effect on our business and
prospects.
The FDA can require that a company conduct "post-marketing adverse event
surveillance programs" to monitor any side effects that occur after the
company's drug is approved for marketing. If the surveillance program indicates
unsafe side effects, the FDA may recall the product, and suspend or terminate a
company's authorization to market the product. The FDA also regulates the
manufacturing process for an approved drug. The FDA may impose restrictions or
sanctions upon the subsequent discovery of previously unknown problems with a
product or manufacturer. One possible sanction is requiring the withdrawal of
such product from the market. The FDA must approve any change in manufacturer as
well as most changes in the manufacturing process prior to implementation.
Obtaining the FDA's approval for a change in manufacturing procedures or change
in manufacturers is a lengthy process and could cause production delays and loss
of sales, which would have a material adverse effect on our business and our
prospects.
30
Certain foreign countries regulate the sales price of a product after marketing
approval is granted. We cannot be sure that we can sell our products at
satisfactory prices in foreign markets even if foreign regulatory authorities
grant marketing approval.
WE RELY ON OTHERS FOR PRODUCT DEVELOPMENT OPPORTUNITIES.
We engage only in limited research to identify new pharmaceutical compounds. To
build our product portfolio, we have adopted a license and acquisition strategy.
This strategy for growth requires us to identify and acquire pharmaceutical
products targeted at niche markets within selected strategic therapeutic market
segments. These products usually require further development and approval by
regulatory bodies before they can be marketed. We cannot assure you that any
such products can be successfully acquired, developed, approved or marketed. We
must rely upon the willingness of others to sell or license pharmaceutical
product opportunities to us. Other companies, including those with substantially
greater resources, compete with us to acquire such products. We cannot assure
you that we will be able to acquire rights to additional products on acceptable
terms, if at all. Our failure to acquire or license any new pharmaceutical
products, or our failure to promote and market any products successfully or
products within an existing therapeutic areas, could have a material adverse
effect on our business and our prospects.
We have contractual development rights to certain compounds through various
license agreements. Generally, the licensor can unilaterally terminate these
agreements for several reasons, including, but not limited to the following
reasons:
o for cause if we breach the contract;
o if we become insolvent or bankrupt;
o if we do not apply specified minimum resources and efforts to develop
the compound under license; or
o if we do not achieve certain minimum royalty payments, or in some
cases, minimum sales levels.
We cannot assure you that we can meet all specified requirements and avoid
termination of any license agreements. We cannot assure you that if any
agreement is terminated, we will be able to enter into similar agreements on
terms as favorable as those contained in our existing license agreements.
WE DEPEND ON OTHERS TO MANUFACTURE AND SUPPLY THE PRODUCTS WE MARKET.
We do not have and do not intend to establish any internal product testing,
synthesis of bulk drug substance, or manufacturing capability for drug product.
Accordingly, we depend on others to supply and manufacture the components
incorporated into all of our finished drug products. The inability to contract
for these purposes on acceptable terms could adversely affect our ability to
develop and market our products. Failure by parties with whom we contract to
adequately perform their responsibilities may delay the submission of products
for regulatory approval, impair our ability to deliver our products on a timely
basis or otherwise adversely affect our business and our prospects. The loss of
a supply or manufacturing contractor could materially adversely affect our
business and our prospects.
The loss of either a bulk drug supplier or drug product manufacturer would
require us 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. We believe that it could
take as long as two years for the FDA to approve such a submission. Because our
products are targeted to relatively small markets and our manufacturing
production runs are small by industry standards, we have not incurred the added
costs to certify and maintain secondary sources of supply for bulk drug
substance or backup drug product manufacturers for some products. Should we lose
either a bulk drug supplier or a drug product manufacturer, we could run out of
salable product to meet market demands or investigational product for use in
clinical trials, while we wait for the FDA approval of a new bulk drug supplier
or drug product manufacturer. We cannot assure you that the change of a bulk
drug supplier or drug product manufacturer and the transfer of the processes to
another third party will be approved by the FDA, and if approved, in a timely
manner. The loss of or the change of a bulk drug supplier or a drug product
manufacturer could have a material adverse effect on our business and prospects.
BULK DRUG SUPPLY
Bulk drug substance is the active chemical compound used in the manufacture of
our drug products. We depend
31
substantially on a single supplier for the supply of bulk drug substance used in
Busulfex, Antizol, and Antizol-Vet. If we were to lose this company as a
supplier, we would be required to identify a new supplier for the bulk drug
substance used in products that provided approximately 88% of our total revenues
in 2002, 2001 and 2000, and which are expected to account for approximately 50%
of our revenues in 2003. We depend substantially on a different supplier for the
supply of bulk drug substance used in Xyrem, which is expected to account for
approximately 40% of our revenue in 2003. If we were to lose this company as a
supplier, we would be required to identify a new supplier. We also cannot assure
you that our bulk drug supply arrangements with our current suppliers, or any
other future such supplier, might not change in the future. We cannot assure you
that any change would not adversely affect production of Busulfex, Antizol,
Antizol-Vet, Xyrem, or any other drug the Company might attempt to develop or
market.
DRUG PRODUCT MANUFACTURE
From bulk drug substance, drug product manufacturers formulate a finished drug
product and package the product for sale or for use in clinical trials. We
depend substantially on a single supplier for drug product manufacturing of
Busulfex, Antizol, and Antizol-Vet and a different supplier has been authorized
to manufacture Xyrem. If we were to lose either of these companies as a
manufacturer, we would be required to identify a new manufacturer for drug
products that provided approximately 88% of our total revenues in 2002, 2001 and
2000, and which are expected to account for approximately 50% of our revenues in
2003. We depend substantially on a different supplier for the supply of Xyrem,
which is expected to account for approximately 40% of our revenue in 2003. If we
were to lose this company as a supplier, we would be required to identify a new
manufacturer. We cannot assure you that our drug product manufacturing
arrangements with either or both of these suppliers will not change or that the
manufacturing services will continue to be available on terms satisfactory to
us. Any change in our manufacturing agreements could adversely affect production
of Busulfex, Antizol, Antizol-Vet or Xyrem, or any other drug that we might
attempt to develop or market, which could have a material adverse effect on our
business and prospects.
WE CANNOT CONTROL OUR CONTRACTORS' COMPLIANCE WITH APPLICABLE REGULATIONS.
The FDA defines and regulates good manufacturing practices to which bulk drug
suppliers and drug product manufacturers are subject. The Drug Enforcement
Agency (DEA) defines and regulates the handling and reporting requirements for
certain drugs which have abuse potential, known as "scheduled drugs". Foreign
regulatory authorities prescribe similar rules and regulations. Our supply and
manufacturing contractors must comply with these regulatory requirements.
Failure by our contractors to comply with FDA or DEA requirements or applicable
foreign requirements could result in significant time delays or in our inability
to commercialize or continue to market a product. Either result could have a
material adverse effect on our business and prospects. Failure to comply with
good manufacturing practices or other applicable legal requirements can lead to
federal seizure of violative products, injunctive actions brought by the federal
government, or potential criminal and civil liability for Orphan, our officers,
or our employees. We cannot assure you that we will be able to maintain
relationships either domestically or abroad with contractors whose facilities
and procedures comply or will continue to comply with FDA or DEA requirements or
applicable foreign requirements.
WE DEPEND UPON OTHERS FOR DISTRIBUTION.
We have an agreement with a specialty pharmacy to distribute Xyrem. Xyrem is
classified as a Schedule III controlled substance and approved under Subpart H
of the FDA's review process, and distribution will be strictly controlled. The
specialty pharmacy will be the only source through which Xyrem can be obtained.
Distribution will be governed by the FDA's Subpart H regulations and will fully
comply with the risk-management controls jointly developed by Orphan Medical,
the FDA, the Drug Enforcement Agency and law enforcement agencies. Every
shipment of Xyrem will be subject to stringent safeguards to ensure it reaches
only individuals for whom it has been legitimately prescribed.
We have an agreement with a distribution contractor to provide integrated
distribution and operations services to support transactions between us and our
wholesalers, specialty distributors, and direct customers. This contractor also
provides reimbursement management, patient assistance and information hotline
services and specialty distribution and marketing services to physician
practices with respect to our products. The contractor currently distributes
Busulfex, Elliotts B Solution, Antizol, Antizol-Vet, and Sucraid. The contractor
may also distribute future products should those products receive marketing
clearance from the FDA. We are substantially dependent on this contractor's
ability to successfully distribute Busulfex, Elliotts B Solution, Antizol,
Antizol-Vet, and Sucraid and other potential products.
32
A mail order pharmacy is the principal distributor, on a non-exclusive basis, in
the United States for Cystadane. The pharmacy distributes this product directly
to patients through the mail. We are substantially dependent on this pharmacy's
ability to successfully distribute Cystadane directly to patients in the United
States.
We cannot assure you that our distribution arrangements with these three
entities or other companies would be available, or continue to be available to
us on commercially acceptable terms. The loss of a distributor or failure to
renew agreements with an existing distributor would have a material adverse
effect on our business and prospects.
WE RELY ON FOREIGN MARKETING ALLIANCES AND HAVE NO ASSURANCE OF FOREIGN
LICENSEES.
Our strategy to sell our products in foreign markets is to license foreign
marketing and distribution rights to a foreign company after a new drug
application (referred to in the industry as an "NDA") is submitted or approved
in the United States. We consider Europe, Asia, and Canada our most attractive
foreign markets. Our current foreign arrangements are:
o EUROPE. We have licensed the marketing and distribution rights for
Busulfex, Antizol, Cystadane and Sucraid in Europe. If our licensees
are unsuccessful in their registration and distribution efforts, we may
find it difficult to contract with other distributors for these
products within Europe. Distribution of all products except Antizol is
limited to "named patient" or "emergency use" basis until full
regulatory approval is obtained. Antizol has been approved for use in
the United Kingdom but is limited to "named patient" basis in other
parts of Europe. This distribution of the Company's products is
expected to result in a limited contribution to the Company's revenues.
o AUSTRALIA AND NEW ZEALAND. We have licensed marketing and distribution
rights for Cystadane and Sucraid in Australia and New Zealand, but
sales of these products have not been material. We do not expect sales
to increase in the near future to the point that they become material.
o ISRAEL. We have licensed marketing and distribution rights for Antizol,
Busulfex, Cystadane, Elliotts B Solution and Sucraid in Israel. Full
regulatory approval for all products except Antizol was obtained in
Israel in February 2000. We do not expect such distribution to result
in material revenues.
o CANADA. We have licensed marketing and distribution rights for Antizol
in Canada. For Cystadane we have only licensed the distribution rights
in Canada. We do not expect such distribution to result in material
revenues.
o CENTRAL AMERICA. We have licensed marketing and distribution rights for
Elliotts B Solution in Central America, but sales have not been
material. We do not expect domestic or foreign sales of Elliotts B
Solution to become material.
o ASIA. We have licensed marketing and distribution rights for Busulfex
in Japan, the Peoples Republic of China, Taiwan and South Korea.
Distribution is limited to clinical trial usage until full regulatory
approval is achieved. We have also licensed marketing and distribution
rights for Busulfex in Turkey.
We depend on our foreign licensees for the regulatory registration of our
products in foreign countries. We cannot be sure that our licensees can obtain
such registration. In addition, we cannot be sure that we will be able to
negotiate commercially acceptable license agreements for our other products or
in additional foreign countries. Furthermore, we cannot assure you that these
companies will be successful in marketing and selling our products in their
respective territories.
OUR PRODUCTS MIGHT BE RECALLED.
A product can be recalled at our discretion or at the discretion of the FDA, the
U.S. Federal Trade Commission, or other government agencies having regulatory
authority for marketed products. A recall may occur due to disputed
33
labeling claims, manufacturing issues, quality defects, safety issues, or other
reasons. We cannot assure you that a product recall will not occur. We do not
carry any insurance to cover the risk of a potential product recall. Any product
recall could have a material adverse effect on our business and prospects. To
date, no recall of products marketed by the Company has occurred.
WE FACE LIMITS ON PRICE FLEXIBILITY AND THIRD-PARTY REIMBURSEMENT.
The flexibility of prices that we can charge for our products depends on
government regulation, both in the United States and abroad, and on other third
parties. One important factor is the extent to which reimbursement for our
products will be available to patients 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. We are uncertain as to the pricing flexibility we
will have with respect to, and if we will be reimbursed for, newly approved
health care products.
In the United States, we expect continuing federal and state proposals to
implement greater government control of the pricing and profitability of
prescription pharmaceuticals. Cost controls, if mandated by a government agency,
could decrease, or limit, the price we receive for our products or products we
may develop in the future. We may not be able to recover our development costs,
which could be substantial. We may not be able to realize an appropriate profit
margin. This could have a material adverse effect on our business. Furthermore,
federal and state regulations govern or influence reimbursement of health care
providers for medical treatment of certain patients. We cannot assure you 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 our business and
prospects.
Certain private health insurers and third-party payors may attempt to control
costs further by selecting exclusive providers of pharmaceuticals. If such
arrangements are made with our competitors, these insurers and third-party
payors would not reimburse patients who purchase our competing products. This
would diminish the market for our products and could have a material adverse
effect on our business and prospects.
PATENTS AND OTHER PROPRIETARY RIGHTS ARE SIGNIFICANT FACTORS IN THE
PHARMACEUTICAL INDUSTRY.
The pharmaceutical industry and the investment community places considerable
importance and value on obtaining patent, proprietary, and trade secret
protection for new technologies, products and processes. The patent position of
pharmaceutical firms is often highly uncertain and generally involves complex
legal, technical and factual questions. Our success depends on several issues,
including, but not limited to our ability:
o to obtain, and enforce proprietary protection for our products under
United States and foreign patent laws and other intellectual property
laws;
o to preserve the confidentiality of our trade secrets; and
o to operate without infringing the proprietary rights of third parties.
We evaluate the desirability of seeking patent or other forms of protection for
our products in foreign markets based on the expected costs and relative
benefits of attaining such protection. We cannot assure you that any patents
will be issued from any applications or that any issued patents will afford us
adequate protection or competitive advantage. Also, we cannot assure you that
any issued patents will not be challenged, invalidated, infringed or
circumvented. Parties not affiliated with us have obtained or may obtain United
States or foreign patents or possess or may possess proprietary rights relating
to our products. We cannot assure you that patents now in existence or later
issued to others will not adversely affect the development or commercialization
of our products.
We believe that the active ingredients or compounds in our FDA-approved
products, Cystadane, Elliotts B Solution, Antizol, Antizol-Vet, Xyrem and
Sucraid, are in the public domain and presently are not subject to patent
protection in the United States. However, we have a patent with respect to our
formulation of Xyrem oral solution. United States patents issued to the licensor
covers our formulation and use of Busulfex. We could, however, incur substantial
costs asserting any infringement claims that we may have against others.
We seek to protect our proprietary information and technology, in part, through
confidentiality agreements and inventors' rights agreements with our employees.
We cannot assure you that these agreements will not be breached, that we will
have adequate remedies for any breach, or that our trade secrets will not
otherwise be disclosed to or discovered by our competitors. We also cannot
assure you that our planned activities will not infringe patents owned by
others. We could incur substantial costs in defending infringement suits brought
against us. We also could incur substantial costs in connection with any suits
relating to matters for which we have agreed to indemnify our licensors
34
or distributors. An adverse outcome in any such litigation could have a material
adverse effect on our business and prospects. In addition, we often must obtain
licenses under patents or other proprietary rights of third parties. We cannot
assure you that we can obtain any such licenses on acceptable terms, if at all.
If we cannot obtain required licenses on acceptable terms, we could encounter
substantial difficulties in developing, manufacturing or marketing one or more
of our products.
WE FACE INTENSE COMPETITION IN OUR INDUSTRY.
Competition in the pharmaceutical industry is intense. Potential competitors in
the United States are numerous and include pharmaceutical, chemical and
biotechnology companies. Many of these companies have substantially greater
capital resources, marketing experience, research and development staffs and
facilities than we do. We seek to limit potential sources of competition by
developing products that are eligible for orphan drug status upon NDA approval
or other forms of protection. We cannot assure you, however, that our
competitors will not succeed in developing similar technologies and products
more rapidly than we can. Similarly, we cannot assure you that these competing
technologies and products will not be more effective than any of those that we
have developed or are currently developing.
WE EXPECT RAPID TECHNOLOGICAL AND OTHER CHANGE TO BE CONSTANT IN OUR INDUSTRY.
The pharmaceutical industry has experienced rapid and significant technological
change as well as structural changes, such as those brought about by changes in
heath care delivery or in product distribution. We expect that pharmaceutical
technology will continue to develop and change rapidly, and our future success
will depend, in large part, on our ability to develop and maintain a competitive
position. Technological development by others may result in our products
becoming obsolete before they are marketed or before we recover a significant
portion of the development and commercialization expenses incurred with respect
to such products. In addition, alternative therapies, new medical treatments, or
changes in the manner in which health care is delivered or products provided
could alter existing treatment regimes or health care practices, and thereby
reduce the need for one or more of our products, which would adversely affect
our business and our prospects.
WE FACE SUBSTANTIAL PRODUCT LIABILITY AND INSURANCE RISKS.
Testing and selling health care products entails the inherent risk of product
liability claims. The cost of product liability insurance coverage has increased
and is likely to continue to increase in the future. Substantial increases in
insurance premium costs in many cases have rendered coverage economically
impractical. We currently carry product liability coverage in the aggregate
amount of $30 million for all claims made in any policy year. Although to date
we have not been the subject of any product liability or other claims, we cannot
assure you that we will be able to maintain product liability insurance on
acceptable terms or that our insurance will provide adequate coverage against
potential claims. A successful uninsured product liability or other claim
against us could have a material adverse effect on our business and prospects.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The
Company's market risk is not material.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The financial statements of the Company as of and for the year ended December
31, 2002 begin on page F-1 of this Annual Report.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
35
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 8, 2002 (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 AND RELATED STOCKHOLDER MATTERS
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.
ITEM 14. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have
concluded, based on their evaluation within 90 days of the filing date of this
report, that the Company's disclosure controls and procedures are adequately
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Securities and Exchange Act of
1934, as amended, is recorded, processed, summarized and reported, within the
time periods specified in applicable rules and forms. There have not been any
significant changes in the Company's internal controls or in other factors that
could significantly affect those controls, subsequent to the date of such
evaluation, including any corrective actions taken with regard to significant
deficiencies and material weaknesses.
36
PART IV
ITEM 15. 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-14
(a)(2). FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule should be read in conjunction with
the Audited Financial Statements referred to under Item 15(a)(1) above.
Financial statement schedules not included in the Form 10-K have been omitted
because they are not applicable or the required information is shown in the
Audited Financial Statements or Notes thereto
PAGE NUMBER
IN THIS
DESCRIPTION ANNUAL REPORT
---------------------------------------------------------- -------------
Schedule II - Valuation and Qualifying Accounts:
Years Ended December 31, 2002, 2001 and 2000 F-15
(a)(3). LISTING OF EXHIBITS
Exhibit Description Method of
Number Filing
-------- ------------------------------------------------------------------------------------------ ---------
3.1 Articles of Incorporation of Orphan Medical, Inc. ("OMI") (1)
3.1.1 Certificate of Designation for Senior Convertible Preferred Stock (11)
3.1.2 Certificate of Designation for Series B, C and D Preferred Stock (15)
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)
10.11.1 Employment Agreement between OMI and John Howell Bullion dated October 29, 1999 (16)
37
Exhibit Description Method of
Number 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)
10.27 Agreement regarding Cystagon between Chronimed and Mylan Pharmaceutical dated
October 17, 1994 (2)
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)
10.38 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)
38
Exhibit Description Method of
Number Filing
-------- ------------------------------------------------------------------------------------------ ---------
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 December 30, 1998 regarding the sale (14)
and assignment to UTECH LLC of license rights to Colloidal Bismuth Subcitrate.
10.52 Common Stock Purchase Warrant between OMI and R.J. Steichen dated January 1, 1999. (14)
10.53 Purchase Agreement and Letter of Intent between OMI and Caduceus Capital Trust , Caduceus (16)
Capital II L.P., PaineWebber Eucalyptus Fund LLC, and PaineWebber Eucalyptus Fund Ltd.
10.54 Purchase Agreement and Letter of Intent between DG LUX LACUNA APO BIOTECH FUND (16)
10.55 Stock Purchase Agreement between OMI and UBS Capital II LLC dated August 2, 1999 (15)
10.56 Promissory Note between OMI and UBS Capital II LLC dated August 2, 1999 (15)
10.57 Warrant to purchase shares of Series C Convertible Preferred Stock or Series D Non-Voting (15)
Preferred Stock
10.58 Warrant to purchase shares Series D Non-Voting Preferred Stock (15)
10.59 Form of Change in Control Agreement to be entered into between the OMI and Certain (16)
Executives
23.1 Consent of Ernst & Young LLP Filed
herewith
24 Power of Attorney 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.
(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.
39
(14) Incorporated by reference to the similarly described exhibit
included with OMI's Annual Report on Form 10-K for the year ended
December 31, 1998, Commission File No. 0-24760.
(15) Incorporated by reference to the similarly described exhibit
included with OMI's Current Report on Form 10-Q for the quarter ended
June 30, 1999, Commission File No. 0-24760.
(16) Incorporated by reference to the similarly described exhibit
included with OMI's Annual Report on Form 10-K for the year ended
December 31, 1999, Commission File No. 0-24760.
(b). REPORTS ON FORM 8-K
None.
(c). EXHIBITS
See Item 15(a)(3) above.
(d). FINANCIAL STATEMENT SCHEDULES
See Item 15(a)(2) above.
40
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 31st day of March, 2003.
ORPHAN MEDICAL, INC.
By:
/s/ John Howell Bullion
-----------------------
John Howell Bullion
Chief Executive Officer
/s/ Timothy G. McGrath
-----------------------
Timothy G. McGrath
Chief Financial 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 31, 2003.
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
----------------------------------- |
Farah Champsi |
|
|
* | Director
----------------------------------- |
William M. Wardell, Ph.D., M.D. |
|
|
* | Director
----------------------------------- |
Thomas King |
By: /s/ John Howell Bullion
--------------------------
John Howell Bullion, Attorney-In-Fact
o 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.
41
CERTIFICATIONS
I, John H. Bullion, President and Chief Executive Officer of Orphan Medical,
Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Orphan Medical, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 31, 2003 /S/ John H. Bullion
-------------------------------------
President and Chief Executive Officer
42
I, Timothy G. McGrath, Vice President and Chief Financial Officer of Orphan
Medical, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Orphan Medical, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 31, 2003 /S/ Timothy G. McGrath
-----------------------
Vice President and Chief Financial Officer
43
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Orphan Medical, Inc.
We have audited the accompanying balance sheets of Orphan Medical, Inc. as of
December 31, 2002 and 2001, and the related statements of operations, changes in
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 2002. Our audits also included the financial statement
schedule listed in Item 15(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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Orphan Medical, Inc. at
December 31, 2002 and 2001, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2002, in conformity
with accounting principles generally accepted in the United States. Also in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
Minneapolis, Minnesota Ernst & Young LLP
February 11, 2003, except for Note 13, as to which the date is March 28, 2003
F-1
ORPHAN MEDICAL, INC.
BALANCE SHEETS
DECEMBER 31,
-----------------------------
2002 2001
------------ ------------
Assets
Current assets:
Cash and cash equivalents $ 6,920,685 $ 19,011,245
Restricted cash 251,144 --
Accounts receivable, less allowance for doubtful
accounts of $25,000 for 2002 and 2001 2,215,462 1,645,749
Inventories 2,019,758 1,242,120
Prepaid expenses and other 576,156 63,662
------------ ------------
Total current assets 11,983,205 21,962,776
Property and equipment:
Property and equipment 2,096,618 1,056,642
Accumulated depreciation (940,901) (673,142)
------------ ------------
1,155,717 383,500
------------ ------------
Total assets $ 13,138,922 $ 22,346,276
============ ============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 1,379,790 $ 1,152,426
Accrued royalties 234,688 204,790
Accrued compensation 1,795,410 1,065,662
Deferred revenue -- 431,310
Accrued expenses 1,901,227 1,097,881
------------ ------------
Total current liabilities 5,311,115 3,952,069
Capital lease obligation-less current maturities 78,013 --
Commitments
Shareholders' equity:
Senior Convertible Preferred Stock, $.01 par value;
14,400 shares authorized 8,706 shares issued and
outstanding 87 87
Series B Convertible Preferred Stock, $.01 par value;
5,000 shares authorized; 3,677 and 3,417 shares
issued and outstanding 37 34
Series C Convertible Preferred Stock, $.01 par value;
4,000 shares authorized; 0 shares issued and
outstanding -- --
Series D Convertible Preferred Stock, $.01 par value;
1,500,000 shares authorized; 0 shares issued and
outstanding -- --
Common stock, $.01 par value; 25,000,000 shares
authorized; 10,460,283 and 10,263,961 issued and
outstanding 104,602 102,639
Additional paid-in capital 74,033,403 72,364,612
Accumulated deficit (66,388,335) (54,073,165)
------------ ------------
Total shareholders' equity 7,749,794 18,394,207
------------ ------------
Total liabilities and shareholders' equity $ 13,138,922 $ 22,346,276
============ ============
SEE ACCOMPANYING NOTES.
F-2
ORPHAN MEDICAL, INC.
STATEMENTS OF OPERATIONS
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
Revenues $ 16,130,169 $ 11,274,110 $ 11,185,634
Cost of sales 2,191,598 1,591,826 1,532,446
------------ ------------ ------------
Gross profit 13,938,571 9,682,284 9,653,188
Operating expenses:
Research and development 6,618,091 5,462,336 7,179,605
Sales and marketing 12,518,498 5,729,987 5,259,031
General and administrative 6,458,308 4,807,847 4,094,905
------------ ------------ ------------
Loss from operations (11,656,326) (6,317,886) (6,880,353)
Other income:
Interest, net 255,178 321,315 793,238
------------ ------------ ------------
Net loss (11,401,148) (5,996,571) (6,087,115)
Less: Preferred stock dividends 922,170 903,053 872,024
------------ ------------ ------------
Net loss applicable to common shareholders $(12,323,318) $ (6,899,624) $ (6,959,139)
============ ============ ============
Basic and diluted loss per common share
applicable to common shareholders $ (1.19) $ (0.80) $ (0.86)
============ ============ ============
Weighted average number of
shares outstanding 10,349,679 8,597,331 8,135,224
============ ============ ============
SEE ACCOMPANYING NOTES.
F-3
ORPHAN MEDICAL, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
OPERATING ACTIVITIES
Net loss $(11,401,148) $ (5,996,571) $ (6,087,115)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 267,759 168,955 141,783
Compensatory options -- 239,887 196,390
Changes in operating assets and
liabilities:
Accounts receivable and prepaid
expenses (1,082,207) 103,340 (502,963)
Inventories (777,638) 360,829 (1,057,406)
Accounts payable 227,364 (606,381) 1,194,705
Accrued expenses and deferred
revenue 1,116,895 4,492 679,283
------------ ------------ ------------
Net cash used in operating activities (11,648,975) (5,725,449) (5,435,323)
INVESTING ACTIVITIES
Purchase of property and equipment (947,176) (88,524) (252,781)
Increase in restricted cash (251,144) -- --
Purchase of short-term investments -- -- (27,778,944)
Maturities of short term investments -- 10,314,277 21,296,658
------------ ------------ ------------
Net cash (used in) provided by investing
activities (1,198,320) 10,225,753 (6,735,067)
FINANCING ACTIVITIES
Proceeds from common stock offering (8,102) 12,994,122 10,692,154
Proceeds from the issuance of shares
under the Employee Stock Purchase Plan 61,466 134,288 398,596
Proceeds from stock options and warrants 704,449 267,414 1,992,313
Preferred stock dividend (1,078) (202) (3,032)
------------ ------------ ------------
Net cash provided by financing activities 756,735 13,395,622 13,080,031
------------ ------------ ------------
(Decrease) increase in cash and cash
equivalents (12,090,560) 17,895,926 909,641
Cash and cash equivalents at the beginning
of year 19,011,245 1,115,319 205,678
------------ ------------ ------------
Cash and cash equivalents at the
end of year $ 6,920,685 $ 19,011,245 $ 1,115,319
============ ============ ============
SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Issuance of stock for preferred stock dividends $ 912,944 $ 897,725 $ 841,999
Capital lease for equipment 92,800 -- --
SEE ACCOMPANYING NOTES.
F-4
ORPHAN MEDICAL, INC.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------------ ------------------------------ PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1999 11,038 $ 111 6,606,207 $ 66,062 $ 43,743,664
Net proceeds from private
offering of 1,365,000
shares of Common Stock -- -- 1,365,000 13,650 10,678,504
Options and warrants exercised -- -- 384,746 3,847 1,991,113
Proceeds from Employee
Stock Purchase Plan -- -- 86,806 868 397,728
Options issued for services -- -- -- -- 196,390
Preferred stock dividends 842 8 -- -- 841,991
Comprehensive loss:
Net loss -- -- -- -- --
Unrealized loss on
available-for-sale
securities -- -- -- -- --
Subtotal - comprehensive
loss
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2000 11,880 119 8,442,759 84,427 57,849,390
Net proceeds from private
offering of 1,706,999
shares of Common Stock -- -- 1,706,999 17,070 12,977,052
Options and warrants exercised -- -- 41,700 417 266,997
Proceeds from Employee
Stock Purchase Plan -- -- 19,210 192 134,096
Compensatory options -- -- -- -- 239,887
Preferred stock dividends 243 2 53,293 533 897,190
Comprehensive loss:
Net loss -- -- -- -- --
Unrealized loss on
available-for-sale
securities -- -- -- -- --
Subtotal - comprehensive
loss
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 12,123 121 10,263,961 102,639 72,364,612
Offering costs from
December 2001 private
offering -- -- -- -- (8,102)
Options and warrants exercised -- -- 125,950 1,260 703,189
Proceeds from Employee
Stock Purchase Plan -- -- 8,338 83 61,383
Preferred stock dividends 260 3 62,034 620 912,321
Net loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 12,383 $ 124 10,460,283 $ 104,602 $ 74,033,403
============ ============ ============ ============ ============
[WIDE TABLE CONTINUED FROM ABOVE]
ACCUMULATED
OTHER
ACCUMULATED COMPREHENSIVE
DEFICIT LOSS TOTAL
------------ ------------ ------------
Balance at December 31, 1999 $(40,243,874) $ (4,755) $ 3,561,208
Net proceeds from private
offering of 1,365,000
shares of Common Stock -- -- 10,692,154
Options and warrants exercised (2,647) -- 1,992,313
Proceeds from Employee
Stock Purchase Plan -- -- 398,596
Options issued for services -- -- 196,390
Preferred stock dividends (845,031) -- (3,032)
Comprehensive loss:
Net loss (6,087,115) -- (6,087,115)
Unrealized loss on
available-for-sale
securities -- (7,587) (7,587)
------------
Subtotal - comprehensive
loss (6,094,702)
------------ ------------ ------------
Balance at December 31, 2000 (47,178,667) (12,342) 10,742,927
Net proceeds from private
offering of 1,706,999
shares of Common Stock -- -- 12,994,122
Options and warrants exercised -- -- 267,414
Proceeds from Employee
Stock Purchase Plan -- -- 134,288
Compensatory options -- -- 239,887
Preferred stock dividends (897,927) -- (202)
Comprehensive loss:
Net loss (5,996,571) -- (5,996,571)
Unrealized loss on
available-for-sale
securities -- 12,342 12,342
------------
Subtotal - comprehensive
loss (5,984,229)
------------ ------------ ------------
Balance at December 31, 2001 (54,073,165) -- 18,394,207
Offering costs from
December 2001 private
offering -- -- (8,102)
Options and warrants exercised -- -- 704,449
Proceeds from Employee
Stock Purchase Plan -- -- 61,466
Preferred stock dividends (914,022) -- (1,078)
Net loss (11,401,148) -- (11,401,148)
------------ ------------ ------------
Balance at December 31, 2002 $(66,388,335) $ -- $ 7,749,794
============ ============ ============
SEE ACCOMPANYING NOTES.
F-5
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. BUSINESS ACTIVITY
Orphan Medical, Inc. (the "Company") acquires, develops and markets
pharmaceutical products of high medical value for patients within selected
therapeutic areas. A pharmaceutical product has high medical value if it offers
a major improvement in the safety or efficacy of patient treatment. The Company
currently concentrates its efforts on drugs with high medical value that may be
marketed within three therapeutic areas: Antidotes, Oncology Support, and Sleep
Disorders. Antizol, Busulfex and Xyrem are available commercially and are the
Company's lead products in its Antidotes, Oncology Support and Sleep disorders
areas, respectively. In addition, the Company manufactures and distributes
Cystadane and Sucraid that treat two rare congenital diseases. Antizol-Vet is
marketed through separate channels to the veterinary community. Although these
products do not fall into the selected therapeutic areas, 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's NDA for Xyrem was approved on July 17, 2002.
The Company has experienced losses from operations since inception and has an
accumulated deficit of $66 million at December 31, 2002. The Company
anticipates the revenue from its existing products, including Xyrem, will be
adequate to fund operations in the future. However, in the event that revenue
from any of the products is lower than anticipated, management believes it can
reduce operating expenses to manage its cash flow.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 for all products, except Xyrem(R) (sodium oxybate) oral solution, are
recognized at the time a product is shipped to the Company's customers and are
recorded net of reserves for discounts for prompt payment. Sales of Xyrem are
recognized at the time product is shipped from the specialty pharmacy to the
patient and are recorded net of discounts for prompt payment. Except for Xyrem,
the Company is obligated to accept, for exchange, from all domestic customers
products that have reached their expiration date. The Company is not obligated
to accept exchange of outdated product from its international distribution
partners. The Company establishes a reserve for the estimated cost of the
exchanges. The Company monitors the exchange of product and modifies its reserve
as necessary. Management bases these reserves on historical experience and these
estimates are subject to change.
Deferred revenue represents prepayment from customers for products not yet
shipped.
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. There were no
available-for-sale securities at December 31, 2002 or 2001.
F-6
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
There is a concentration of sales to larger medical wholesalers and
distributors. The Company performs periodic credit evaluations of its customers'
financial condition. Domestic receivables are due within 30 days of the invoice
date. International receivables are generally due within 60 to 90 days of
invoice date. Credit losses relating to customers have not been material since
the Company's inception.
INVENTORIES
Inventories are valued at the lower of cost or market determined using 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.
DECEMBER 31,
----------------------------------
2002 2001
---------------- -----------------
Raw materials and packaging $ 1,023,256 $ 981,583
Finished goods 996,502 260,537
---------------- -----------------
$ 2,019,758 $ 1,242,120
================ =================
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 three to seven years.
LONG-LIVED ASSETS
The Company performs reviews for the impairment of long-lived assets whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. An impairment loss would be recognized when the
estimated undiscounted future cash flows expected to result from the use of the
asset and its eventual disposition are less than its carrying amount.
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.
STOCK-BASED COMPENSATION
At December 31, 2002 the Company has a stock-based employee compensation plan,
which is described more fully in Note 8. The Company accounts for this plan
under the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. No stock-based compensation cost is reflected in the net loss
for 2002 or 2000, as all options granted under this plan had an exercise price
equal to market value of the underlying common stock on the date of grant. In
2001, the Company modified the terms of options granted to an employee. As a
result, the Company recognized compensation expense of $239,887. The following
table illustrates the effect on net loss and net loss per share if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation", to
stock-based employee compensation.
F-7
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Net loss as reported $(12,323,318) $(6,899,624) $(6,959,139)
Add stock-based employee compensation
included in net loss -- 239,887 --
Deduct total stock-based employee
compensation expense determined under
fair value-based method for all awards (1,975,676) (1,273,156) (728,809)
----------------------------------------------
Pro forma net loss (14,298,994) (7,932,893) (7,687,948)
==============================================
Loss per share
Basic and diluted - as reported $ (1.19) $ (0.80) $ (0.86)
==============================================
Basic and diluted - as pro forma $ (1.38) $ (0.92) $ (0.95)
==============================================
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. A valuation
allowance is provided against the deferred tax assets to the extent management
believes that the deferred tax assets may not be realized.
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 and diluted loss per share are the same for the
reported periods because the effect of stock options, warrants, and convertible
securities is anti-dilutive.
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. LEASES
The Company has a non-cancelable operating lease for office space that expires
on October 31, 2003. The Company also has operating leases for certain office
equipment expiring at various times through August 2005. The Company also leases
vehicles for the Company's sales force. The term of this lease runs through
October 2005. The number of vehicles leased may increase as the sales force
expands. The vehicle lease requires the Company to maintain $251,144 in an
account securing a letter of credit. This cash has been disclosed as restricted
in the balance sheet. In December 2002, the Company entered into a capital lease
for phone equipment that expires in December 2007. The lease contains a bargain
purchase option.
Future minimum lease payments, including current real estate taxes and operating
expenses under the facility lease, the auto lease, and the equipment leases are
as follows:
F-8
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. LEASES (CONTINUED)
CAPITAL LEASE OPERATING LEASE
------------- ---------------
2003 $ 24,119 $ 601,100
2004 24,119 352,100
2005 24,119 277,100
2006 24,119 --
2007 24,117 --
------------------------------------
Minimum lease payments 120,593 $ 1,230,300
============
Amounts representing interest 27,793
-------------
Present value of net minimum
lease payments 92,800
Less current maturities 14,787
-------------
$ 78,013
=============
Total rent expense was approximately $476,000, $302,900, and $239,100 for the
years ended December 31, 2002, 2001, and 2000, respectively.
4. BORROWINGS
The Company has a commercial revolving line of credit with a bank, which expires
in June 2003. The maximum amount available to the Company under this arrangement
is $1,000,000, 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) $1,000,000.
Advances are charged a variable rate of interest equal to the prime rate plus
one half of a percent. Through December 31, 2002, the Company has not borrowed
under this arrangement.
5. INCOME TAXES
As of December 31, 2002, the Company had net operating loss (NOL) carryforwards
of approximately $52,255,000, credit for increasing research activities (the
"R&D credit") carryforwards of approximately $359,000 and orphan drug credit
carryforwards of approximately $10,309,000, available to reduce its future tax
liabilities. These carryforwards will begin expiring after 2010. No current
income taxes have been provided for the years ended December 31, 2002, 2001 and
2000 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,
2002 2001
---------------- ---------------
Deferred tax assets:
Net operating loss carryforwards $ 17,767,000 $ 14,361,000
R&D and orphan drug credit carryforwards 10,668,000 9,274,000
Inventory reserves 48,000 168,000
All other reserves 127,000 154,000
Deferred tax liabilities:
Depreciation (77,000) (3,000)
Valuation allowance for deferred tax assets (28,533,000) (23,954,000)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
F-9
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES (CONTINUED)
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.
6. EMPLOYEE BENEFIT PLANS
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. No such discretionary contributions to the Plan have
been made to date.
The Company has a stock purchase plan that is funded by employee contributions,
generally through payroll deductions. All employees are eligible subject to
certain requirements. The purchase price is 85% of the lower of the average of
the high and the low trade on the first and last trading day of each purchase
period, defined as each calendar quarter. The Company reserved 200,000 shares of
its common stock for future issuance at the Plan's inception. From the Plan's
inception through December 31, 2002, there have been 114,354 shares issued under
the Plan.
7. STOCK OPTIONS
The Company has a stock option plan for employees and non-employees, the 1994
Stock Option Plan (the "Plan"). The Plan provides that the Company may grant
employee incentive stock options and non-qualified stock options at an exercise
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, 2002, the Plan has 2,675,000 shares of
Common Stock reserved for issuance.
Options outstanding were granted as follows:
PLAN
-------------- WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
-------------- --------------
Balance at December 31, 1999 1,471,618 5.85
Options granted 40,750 11.08
Options canceled (15,300) 10.85
Options exercised (179,010) 5.10
--------------
Balance at December 31, 2000 1,318,058 6.05
Options granted 259,883 11.49
Options canceled (9,263) 5.82
Options exercised (41,700) 6.52
--------------
Balance at December 31, 2001 1,526,978 6.97
Options granted 652,050 9.78
Options canceled (55,600) 9.31
Options exercised (125,950) 5.59
--------------
Balance at December 31, 2002 1,997,478 $ 7.90
==============
F-10
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. STOCK OPTIONS (CONTINUED)
The following table summarizes information about the stock options outstanding
at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- ---------------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE NUMBER AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE PRICE EXERCISABLE EXERCISE PRICE
PRICES OUTSTANDING LIFE
----------------- ----------- ---------------- ---------------- ----------- ----------------
$ 4.19 - $ 5.00 478,500 1.86 years $5.00 478,500 $ 5.00
$ 5.38 - $ 6.75 451,025 5.86 years 6.12 325,875 5.99
$ 6.83 - $11.30 745,833 7.95 years 8.73 408,783 8.37
$11.31 - $18.31 322,070 8.79 years 12.75 89,210 13.09
----------- -----------
$ 4.19 - $18.31 1,997,478 $7.90 1,302,368 $ 6.86
=========== ===========
Fully vested and exercisable options were 1,302,368, 1,251,772, and 1,098,258,
as of December 31, 2002, 2001, and 2000, respectively. The weighted average
exercise prices for the fully vested and exercisable options as of December 31,
2002, 2001, and 2000 were $6.86, $6.24, and $5.85 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 2002, 2001, and 2000, respectively
2002 2001 2000
----------------------------------
Expected dividend yield 0.00% 0.00% 0.00%
Expected stock price volatility 70% 73% 72%
Risk-free interest rate 4.00% 5.75% 6.00%
Expected life of options 10 years 10 years 10 years
The weighted average fair value of the options granted in 2002, 2001, and 2000
was $7.62, $9.33, and $9.13, respectively, as computed as described above.
The Company granted 15,000 options to purchase unregistered common stock to a
consultant in December 2000. These options were granted at $13.6875, the closing
price of the Company's common stock on the date of grant. The options vest under
certain conditions. The fair value of these options was being charged to expense
over the vesting period of the options.
8. SHAREHOLDERS' EQUITY
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 $7.1 million from the sale of the Preferred Shares after the
payment of related offering expenses. The Preferred Shares were initially
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 August 1999 financing, as
discussed in the following paragraph, triggered antidilution provisions relating
to the $8.1 million of the Senior Convertible Preferred Stock held as of
August 1, 1999 (after giving effect to the semi-annual in-kind dividend
distributions),
F-11
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. SHAREHOLDERS' EQUITY (CONTINUED)
which resulted in a decrease in the conversion price of those shares from $8.50
to $8.14 per share. The Preferred Shares have anti-dilution 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.
On August 2, 1999, the Company completed a $5.0 million financing transaction in
a private placement. The funding consisted of a purchase of 2,950 shares of the
Company's Series B Convertible Preferred Stock for an aggregate purchase price
of $2.95 million and a commitment of $2.05 million of debt in the form of a line
of credit. The Company had not borrowed on this line of credit and it was
eliminated as a part of the December 2001 financing transaction. The Series B
Convertible Preferred Stock ("Series B Preferred Shares") may be converted prior
to August 2, 2009 into shares of the Company's Common Stock at a price of $6.50
per share. The Series B Preferred Shares have anti-dilution 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 Series B 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 August 2009, the Series B Preferred
Shares must be (a) converted into Common Stock, subject to a $1.2 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.
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. One of these restrictions is that the
Company cannot incur additional indebtedness, except for indebtedness secured
solely by our trade receivables, until the Company has profitable operations,
subject to certain limitations. Another important restriction is that, without
the approval of a majority of the preferred stockholders, the Company cannot
issue additional equity securities unless the selling price per share exceeds
the then conversion price of the outstanding convertible preferred stock or the
sale of equity is accomplished in a public offering.
On February 23, 2000, the Company completed the sale of 1,265,000 shares of its
Common Stock at a price of $8.00 per share. The Company received net proceeds of
$9.7 million from the transaction and registered the shares under the Securities
Act of 1933, as amended.
On February 25, 2000, the Company completed the sale of 100,000 shares of its
Common Stock at a price of $10.00 per share. The Company received proceeds of
$1.0 million from the transaction and registered the shares under the Securities
Act of 1933, as amended.
On December 6, 2001, the Company completed the sale of 1,706,999 shares of its
Common Stock at a price of $8.25 per share. The Company received net proceeds of
$13.0 million from the transaction and registered the shares under the
Securities Act of 1933, as amended.
9. STOCK WARRANTS
At December 31, 2002, the Company had warrants outstanding to purchase 5,000
shares of Common Stock at $8.50, all of which are currently exercisable.
In connection with the August 1999 financing, the Company issued two seven-year
warrants. One of the warrants entitles the holder to receive, upon payment of
the $2.05 million exercise price, either 2,050 shares of Series C Convertible
Preferred Stock (which is similar to the Series B Convertible Preferred Stock
and which is convertible to shares of the Company's Series D Non-Voting
Preferred Stock at a conversion price of $6.50 per share) or 315,385 shares of
Series D Non-Voting Preferred Stock (which is equivalent to common stock except
that it has no voting rights) or a combination of Series C Convertible Preferred
Stock and Series D Non-Voting Preferred Stock, so long as the combined purchase
price for the shares does not exceed $2.05 million. The second warrant, issued
in relation to the line of credit, entitled the holder to purchase 282,353
shares of Series D Non-Voting Preferred Stock at an
F-12
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. STOCK WARRANTS (CONTINUED)
exercise price of $4.25 per share. The value of the warrants was $82,000 and was
amortized over the term of the line of credit to interest expense. All of these
warrants are outstanding and exercisable at December 31, 2002.
10. RESEARCH AND DEVELOPMENT COMMITMENTS
The Company has various commitments under agreements with outside consultants,
contract drug developers and manufacturers, technical service companies, and
drug distributors. In addition, the Company has commitments under license and
research agreements. 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 $3,900,000, $3,000,000, and $4,900,000
for the years ended December 31, 2002, 2001, and 2000, respectively. The
Company's commitment to incur additional expenditures in subsequent periods for
development activities totaled approximately $5,676,000 $4,045,000, and
$3,907,000 at December 31, 2002, 2001, and 2000, 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.
11. GEOGRAPHIC INFORMATION
The Company operates in two geographic regions, domestic and international. The
Company has no assets outside of the United States. The following is a summary
of net sales by geographic region for the years ended December 31, 2002, 2001
and 2000, respectively.
2002 2001 2000
------------ ------------ ------------
Domestic $ 12,553,434 $ 9,566,099 $ 9,226,618
International
Japan 799,942 24,570 --
United Kingdom 915,084 620,790 801,698
All other 1,861,709 1,062,651 1,157,368
------------ ------------ ------------
Total $ 16,130,169 $ 11,274,110 $ 11,185,634
============ ============ ============
F-13
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. QUARTERLY FINANCIAL INFORMATION
The following are unaudited quarterly results of operations for the years ended
December 31, 2002 and 2002.
Quarter ended
March 31, June 30, September 30, December 31,
2002 2002 2002 2002
-----------------------------------------------------------------
Revenues $ 3,681,638 $ 3,505,639 $ 4,155,061 $ 4,787,831
Gross profit 3,148,362 2,980,344 3,546,435 4,263,430
Net loss (932,707) (1,458,570) (4,104,231) (4,905,640)
Less: Preferred stock dividends
225,730 226,683 235,668 234,089
Net loss attributable to common
shareholders (1,158,437) (1,685,253) (4,339,899) (5,139,729)
Basic and diluted loss per
common share (0.11) (0.16) (0.42) (0.49)
Quarter ended
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
-----------------------------------------------------------------
Revenues $ 2,341,510 $ 2,424,843 $ 2,940,438 $ 3,567,319
Gross profit 2,051,844 1,990,264 2,531,306 3,108,870
Net loss (1,390,474) (1,709,289) (1,833,281) (1,063,527)
Less: Preferred stock dividends
221,129 224,383 228,366 229,175
Net loss attributable to common
shareholders (1,611,603) (1,933,672) (2,061,647) (1,292,702)
Basic and diluted loss per
common share (0.19) (0.23) (0.24) (0.15)
13. SUBSEQUENT EVENTS
On March 28, 2003, the Company cancelled its existing line of credit facility
and entered into a new facility with a commercial bank. The new line of credit
facility, which has a term of one-year, includes a borrowing base equal to 75%
of eligible accounts receivable up to a maximum line of credit of $3.5 million.
Certain other assets have also been pledged as collateral for this facility. The
interest rate is equal to two points over the bank's prime rate. The Company
will be subject to certain other requirements during the term of the facility,
including minimum quarterly net equity amounts.
F-14
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ORPHAN MEDICAL, INC.
Additions
-----------------------------------------
Balance at Charged to Other
Beginning of Charged to Costs Accounts - Deductions - Balance at End
Description Period and Expenses Describe Describe (1) of Period
-------------------------------------- ----------------- -------------------- -------------------- ----------------- ---------------
YEAR ENDED DECEMBER 31, 2002
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $25,000 $107,400 $107,400 $ 25,000
Allowance for excess
inventory 492,997 11,363 362,693 141,667
YEAR ENDED DECEMBER 31, 2001
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts
$116,200 $56,408 $147,608 $ 25,000
Allowance for excess
inventory 334,602 158,395 492,997
YEAR ENDED DECEMBER 31, 2000
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts
$113,000 $3,200 $ - $116,200
Allowance for excess
inventory 376,593 - 41,991 334,602
(1) Recovery of amounts previously reserved.
F-15