SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 2003
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[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _______ to _______
Commission File Number 0-24760
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Orphan Medical, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 41-1784594
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(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
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(Address of principal executive office (Registrant's telephone number,
and zip code) including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes _X_ No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ___ No _X_
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 par value 10,519,509
---------------------------- ----------
(Class) (Outstanding at May 1, 2003)
INDEX
ORPHAN MEDICAL, INC.(R)
Page No.
PART I. FINANCIAL INFORMATION --------
------------------------------
Item 1. Financial Statements (Unaudited)
Balance Sheets - March 31, 2003 and December 31, 2002. 3
Statements of Operations - Three months ended March 31, 2003 and March 31, 2002. 4
Statements of Cash Flows - Three months ended March 31, 2003 and March 31, 2002. 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
---------------------------
Items 1 through 5 have been omitted since all items are inapplicable or answers
negative.
Item 6. Exhibits and Reports on Form 8-K 26
Antizol(R), Antizol-Vet(R), Busulfex(R), Cystadane(R), Elliotts B(R) Solution,
Xyrem(R), MedExpand(TM), "The" Orphan Drug Company(TM), Orphan Medical(R), Inc.
and Dedicated to Patients with Uncommon Diseases(R) are trademarks of the
Company.
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ORPHAN MEDICAL, INC.
BALANCE SHEETS
MARCH 31 DECEMBER 31,
------------ ------------
2003 2002
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(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 2,250,434 $ 6,920,685
Restricted cash 251,744 251,144
Accounts receivable, less allowance for doubtful accounts
of $40,300 and $25,000, respectively 2,961,103 2,215,462
Inventories 2,028,739 2,019,758
Prepaid expenses and other 574,882 576,156
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Total current assets 8,066,902 11,983,205
Property and equipment:
Property and equipment 2,121,126 2,096,618
Accumulated depreciation (1,052,520) (940,901)
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1,068,606 1,155,717
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Total assets $ 9,135,508 $ 13,138,922
============ ============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 1,400,479 $ 1,379,790
Accrued royalties 197,311 234,688
Accrued compensation 1,314,782 1,795,410
Accrued expenses 2,077,438 1,901,227
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Total current liabilities 4,990,010 5,311,115
Capital lease obligation-less current maturities 74,084 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; 3,816 and 3,677 shares issued
and outstanding 38 37
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;
10,519,509 and 10,460,283 issued and outstanding 105,195 104,602
Additional paid-in capital 74,676,311 74,033,403
Accumulated deficit (70,710,217) (66,388,335)
------------ ------------
Total shareholders' equity 4,071,414 7,749,794
------------ ------------
Total liabilities and shareholders' equity $ 9,135,508 $ 13,138,922
============ ============
NOTE: THE BALANCE SHEET AT DECEMBER 31, 2002 HAS BEEN DERIVED FROM THE AUDITED
FINANCIAL STATEMENTS AT THAT DATE BUT DOES NOT INCLUDE ALL OF THE INFORMATION
AND FOOTNOTES REQUIRED BY GENERALLY ACCEPTED ACCOUNTING PRINCIPLES FOR COMPLETE
FINANCIAL STATEMENTS.
SEE ACCOMPANYING NOTES.
3
STATEMENTS OF OPERATIONS
ORPHAN MEDICAL, INC.
(Unaudited)
For the Three Months Ended
-----------------------------
March 31, March 31,
2003 2002
------------ ------------
Revenues $ 4,568,267 $ 3,681,638
Cost of sales 746,720 533,276
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Gross Profit 3,821,547 3,148,362
Operating expenses:
Research and development 1,696,883 1,077,031
Sales and marketing 4,160,430 2,019,916
General and administrative 1,825,777 1,068,454
------------ ------------
Total operating expenses 7,683,090 4,165,401
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Loss from operations (3,861,543) (1,017,039)
Other income:
Interest, net 7,841 84,332
------------ ------------
Net loss (3,853,702) (932,707)
Less: Preferred stock dividends 234,090 225,730
------------ ------------
Net loss attributable to common shareholders $ (4,087,792) $ (1,158,437)
============ ============
Basic and diluted loss per
common share $ (0.39) $ (0.11)
============ ============
Weighted average number of
shares outstanding 10,472,263 10,282,223
============ ============
SEE ACCOMPANYING NOTES.
4
STATEMENTS OF CASH FLOWS
ORPHAN MEDICAL, INC.
(Unaudited)
For the Three Months Ended
-----------------------------
March 31, March 31,
2003 2002
------------ ------------
OPERATING ACTIVITIES
Net loss $ (3,853,702) $ (932,707)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 111,619 41,269
Changes in operating assets and liabilities:
Accounts receivable and other current assets (744,367) (271,682)
Inventories (8,981) (22,233)
Accounts payable and accrued expenses (321,105) (1,278,489)
------------ ------------
Net cash used in operating activities (4,816,536) (2,463,842)
INVESTING ACTIVITIES
Purchase of property and equipment (24,508) (52,101)
------------ ------------
Net cash provided by (used in) investing activities (24,508) (52,101)
FINANCING ACTIVITIES:
Employee stock purchase plan 9,090 10,650
Stock option exercise proceeds 166,261 23,162
Private common stock placement -- (8,101)
Cash dividends (30) (197)
Principal payments on capital lease (4,528) --
------------ ------------
Net cash provided by financing activities 170,793 25,514
------------ ------------
Increase (decrease) in cash and cash equivalents (4,670,521) (2,490,429)
Cash and cash equivalents at beginning of
period 6,920,685 19,011,245
------------ ------------
Cash and cash equivalents at end of
period $ 2,250,434 $ 16,520,816
============ ============
SEE ACCOMPANYING NOTES
5
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
Orphan Medical, Inc. (the "Company") acquires, develops, and markets products of
high medical value intended to address inadequately treated or uncommon diseases
within selected strategic therapeutic areas. A drug has high medical value if it
offers a major improvement in the safety or efficacy of patient treatment and
has no substantially equivalent substitute. The Company has six products that
have been approved for marketing by the Food and Drug Administration (the "FDA")
and is currently developing one potential product. The Company expects to seek
additional products for development.
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, these financial statements do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal, recurring accruals) considered necessary for fair presentation have
been included. Operating results for the three-month period ended March 31, 2003
are not necessarily indicative of the results that may be expected for the year
ended December 31, 2003. For further information, refer to the audited financial
statements and accompanying notes contained in the Company's Annual Report filed
on Form 10-K for the year ended December 31, 2002.
2. 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.
3. 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 the periods ended March 31, 2003 or 2002, 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.
4. REVENUE RECOGNITION
Sales for all products, except Xyrem, 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, which range from 18 months to four years depending on the
product. 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.
6
Deferred revenue represents prepayment from customers for products not yet
shipped.
5. 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.
MARCH 31, DECEMBER 31,
2003 2002
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Raw materials and packaging $ 500,528 $ 1,023,256
Finished goods 1,528,210 996,502
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$ 2,028,738 $ 2,019,758
=========== ===========
6. COMMITMENTS
The Company has various commitments under agreements with outside consultants
and contractors to provide services relating to drug development, drug
acqusition, manufacturing and marketing. At March 31, 2003, the Company
estimates that it could incur approximately $7.1 million of additional
expenditures in subsequent periods under existing commitments. Commitments for
research and development expenditures will likely fluctuate from quarter to
quarter and from year to year depending on, among other factors, the timing of
product development and the progress of clinical development programs.
7. BORROWINGS
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.
The Company has not borrowed under this facility at March 31, 2003.
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.
7
QUARTER ENDED MARCH 31,
2003 2002
---- ----
Net loss as reported $(4,087,792) $(1,158,437)
Add stock-based employee
compensation included in net loss --
Deduct total stock-based employee
compensation expense determined
under fair value-based method for all
awards (574,335) (329,055)
Pro forma net loss (4,662,127) (1,487,492)
===========================
Loss per share
Basic and diluted - as reported $ (0.39) $ (0.11)
===========================
Basic and diluted - as pro forma $ (0.45) $ (0.14)
===========================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CAUTIONARY STATEMENT
This Quarterly Report on Form 10-Q contains statements that are not descriptions
of historical facts. The words or phrases "will likely result", "look for", "may
result", "will continue", "is anticipated", "expect", "project", or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
8
statements may be forward-looking statements that are subject to risks and
uncertainties. Actual results could differ materially from those currently
anticipated due to a number of factors, including those identified in the
section of this Quarterly Report filed on Form 10-Q for the quarterly period
ended March 31, 2003 titled Risk Factors.
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 six 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 March 31, 2003 of $70.7 million. In addition, the Company expects to
incur additional losses from operations in fiscal years at least for the next 6
fiscal quarters.
RECENT DEVELOPMENTS
The Company completed the sale of the product Sucraid to a specialty
pharmaceutical company on May 6, 2003 with the receipt of $1.5 million of
proceeds. The Company will also receive royalties based on future revenues. The
Company has also indicated that it has committed to sell the product Elliotts B
Solution later in the second quarter. Proceeds from that transaction will not be
significant. The sale of these products will provide operating capital to the
Company and allow the Company to begin to focus its commitment to build an
expanded presence in the sleep and central nervous system (CNS) therapeutic
areas.
On April 30, 2003 the Company announced a revised forecast for total revenue for
the current fiscal year in the range of $20.0 to $23.0 million, including $4.5
to $6.0 million of revenue from sales of Xyrem. The Company's market research
indicates that most physicians are prescribing Xyrem first for patients
suffering from severe cataplexy and intend to treat patients with mild and
moderate cataplexy once they have greater experience with Xyrem. Prescribers
also indicate that they evaluate patients for Xyrem treatment when they come in
for regularly scheduled appointments rather than asking patients to come in for
a separate visit. These factors have slowed the anticipated uptake of Xyrem. The
Company remains confident that Xyrem will become the first line treatment for
cataplexy. The Company anticipates a higher level of marketing and sales
activities in the second quarter to drive increased prescribing breadth and
depth in the second half of 2003 and into 2004. Three major medical meetings,
supported by expanded local medical education programs, will occur in the second
quarter. The Associated Professional Sleep Societies (APSS) meeting, attended by
most sleep specialists in the United States, occurs in June.
The Company continues to estimate that the total cataplexy market is in excess
of $125 million annually. Cataplexy is a debilitating symptom of narcolepsy,
affecting sixty to ninety percent of the 140,000 Americans with narcolepsy. It
involves the sudden partial or total loss of muscle tone, usually triggered by
strong emotions such as laughter, anger, or surprise.
9
THREE MONTHS ENDED MARCH 31, 2003 VS. THREE MONTHS ENDED MARCH 31, 2002
Net loss applicable to common shareholders was $4.1 million for the three months
ended March 31, 2003 compared to $1.2 million for the three months ended March
31, 2002. The increase in net loss can be attributed, in part, to an increase in
sales and marketing expenses associated with the product Xyrem, which was
commercially launched early in the fourth quarter of 2002. Research and
development expenses also increased during the quarter as a result of increased
expense associated with ongoing clinical trials, post-approval trials and the
initiation of the EXCEEDS trial. General and administrative expenses also
increased in the quarter compared to prior year as a result of increased
staffing and infrastructure to support Xyrem. These increases in expenses were
partially offset by an increase in revenue for the quarter ended March 31, 2003
compared to the same period in the prior year. The preferred stock dividend
increased in the first quarter of 2003 compared to the first quarter of 2002 due
to issuance of additional preferred shares in August 2002 and February 2003 to
pay dividends on outstanding Preferred Stock. This preferred stock dividend
increased the net loss applicable to common shareholders in the current quarter.
Net sales increased 24% to $4.6 million for the three months ended March 31,
2003 compared to $3.7 million for the same period in the prior year. Sales for
Xyrem were approximately $600,000 for the quarter ended March 31, 2003. More
than 500 physicians had written 1,250 prescriptions for Xyrem. The Company's
market research indicates that overall satisfaction by both patients and
physicians continues to be strong and third party reimbursement has been high.
As of March 31, 2003, over one-third of all hospitals with emergency departments
in the United States had purchased Antizol, an antidote for suspected or
confirmed ethylene glycol or methanol poisoning. Revenue for Antizol increased
22% above the comparable period last year. Use of Busulfex in preparative
regimens for bone marrow transplantation continued to grow resulting in an
increase in first quarter revenue of 32% compared to prior year in the United
States and Canada. The increase was largely due to the conversion of additional
protocols in key institutions to regimens that include Busulfex. The market
share for Busulfex increased to 55% in transplants where busulfan-based regimens
are used. International revenue declined approximately 32% from the prior year.
The prior year amount included sales to the distribution partner for the
completion of clinical trails in Asia. Sales from these sources will vary from
quarter to quarter based on the needs of the distribution partners.
Gross profit margins decreased to 84% for the quarter ended March 31, 2003
compared to 85% for the same period the prior year due to product mix. Cost of
sales was $0.7 million for the three months ended March 31, 2003 compared to
$0.5 million for the same period the prior year. Cost of sales as a percentage
of net sales will fluctuate from quarter to quarter and from year to year
depending on, among other factors, demand for the Company's products, new
product introductions and the mix of approved products shipped.
Research and development expense increased 57% to 1.7 million in the three
months ended March 31, 2003 compared to $1.1 million for three months ended
March 31, 2002. The increase results from increased spending for the ongoing
Phase III(b) trial for Xyrem and the initiation of
10
the EXCEEDS trial during the first quarter of 2003. Both of theses trials for
Xyrem now underway will increase research and development spending in subsequent
quarters. Clinical spending for trials is dependent on a number of factors,
including among others, the number of human subjects screened and enrolled in
the trial, and the number of active clinical sites.
Sales and marketing expense increased 106% to $4.2 million for the three months
ended March 31, 2003 from $2.0 million for the three months ended March 31,
2002. This increase is attributable to spending supporting the commercial launch
of Xyrem, approved in July 2002 and launched in October 2002. These expenses
included the addition of staff, including a dedicated sales force and other
staff supporting the selling and marketing efforts for Xyrem, along with
extensive marketing and medical education efforts. Sales and marketing expenses
will likely continue at For the Three Months Ended this level or increase
slightly as the Company continues to broaden the awareness of Xyrem.
General and administrative expense increased 70% to $1.8 million for the period
ended March 31, 2003 compared to $1.1 million for the three months ended March
31, 2002. The increase results from increased staffing and other infrastructure
supporting the growth of the Company. General and administrative expenses will
increase during the next few quarters as the Company expands its infrastructure
to support Xyrem.
Other income is the sum of interest income from investment activities less
interest expense from financing activities. Other income decreased as a result
of lower invested balances and lower interest rates on any excess cash invested.
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
$0.2 million for both the 2003 and 2002 first quarters. Preferred stock
dividends, which commenced on February 1, 1999, are payable in arrears on August
1 and February 1 of each year. The Company has chosen to satisfy its dividend
payment obligation by issuing additional common or preferred stock, as permitted
by the terms of the Senior Convertible Preferred Stock and the Series B
Convertible Preferred Stock respectively. For the February 1, 2003 Senior
Preferred Stock dividend, the Company elected to issue 33,167 shares of common
stock to satisfy its obligation. The Company also intends to continue to satisfy
this obligation in the future by issuing common stock. The Company is obligated
to pay the dividend for the Series B Convertible Preferred Stock in cash or
through the issuance of additional preferred shares, which will cause preferred
stock dividends to increase in subsequent quarters. The Company also intends to
satisfy the Series B Convertible Preferred Stock obligation by issuing
additional preferred shares.
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 of $60.5
million from several public and private financings, interest income and product
sales.
11
Net working capital (current assets less current liabilities) decreased from
$6.8 million at December 31, 2002 to $3.1 million at March 31, 2003. Cash and
cash equivalents decreased from $6.9 million at December 31, 2002 to $2.3
million at March 31, 2003. The decrease is a result of cash used to fund
operations.
The Company entered into a new line of credit facility with a commercial bank on
March 27, 2003, and terminated its previous line of credit on that date. 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. The Company has not
borrowed under this facility at March 31, 2003.
The Company's commitments for outside development spending were $7.1 million at
March 31, 2003 and $5.6 million at December 31, 2002. This increase is the
result of the initiation of the EXCEEDS clinical trial. If additional products
are licensed for development, these expenditures and commitments could increase
significantly.
Management believes the Company's current cash availability, anticipated
operating cash flows from product revenues, proceeds from the sale of the
Company's rights to Sucraid and Elliotts B, and license fees earned at the
execution of an agreement with a European partner for the registration and
marketing of Xyrem will be sufficient to fund its operations at least through
March 31, 2004.
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 assets 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
March 31, 2003. The Company's market capitalization was approximately $88.4
million (based on the last sale price of $8.40 and 10,519,509 shares outstanding
as of March 31, 2003). Although the Company does not expect to be profitable in
2003, the Company nevertheless expects to continue to meet the listing
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
net tangible asset requirement 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. Even without these
restrictions, the Company can make no assurances that additional financing
opportunities will be available or, if available, on acceptable terms.
GEOGRAPHIC SALES INFORMATION
The Company tracks sales 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 quarters ended March 31, 2002
and 2001, respectively.
12
For the Three Months Ended
------------------------------
March 31, March 31,
2003 2002
----------- -----------
Domestic $ 3,572,714 $ 2,543,925
International 995,553 1,137,713
------------------------------
Total $ 4,568,267 $ 3,681,638
==============================
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 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.
13
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 March 31, 2003, 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
14
net tangible asset requirement.
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 , 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
15
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 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.
16
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.
Six 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
17
production delays and loss of sales, which would have a material adverse effect
on our business and our prospects.
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 area, 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
18
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 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 70% 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 20% 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 70% of our revenues in
2003. We depend substantially on
19
a different supplier for the supply of Xyrem, which is expected to account for
approximately 20% 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, and Antizol-Vet. 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,
20
Antizol, and Antizol-Vet, and other potential products.
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, and Cystadane 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 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, and Cystadane 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 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
21
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 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.
22
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, and Xyrem, 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. 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 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.
23
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 3. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable
Item 4. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer have
concluded, based on
24
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.
25
PART II - OTHER INFORMATION
Items 1-5 are not applicable and have been omitted.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit
Number Description
------ -----------
99.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
None.
26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Orphan Medical, Inc.
Registrant
Date May 15, 2003 By /s/ Timothy G. McGrath
--------------- ----------------------
Timothy G McGrath
Chief Financial Officer
(duly authorized officer and principal
financial officer)
CERTIFICATIONS
I, John H. Bullion, President and Chief Executive Officer of Orphan Medical,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q 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;
27
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: May 15, 2003
/S/ John H. Bullion
-----------------------------------------
President and Chief Executive Officer
28
I, Timothy G. McGrath, Vice President and Chief Financial Officer of Orphan
Medical, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q 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
29
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: May 15, 2003
/S/ Timothy G. McGrath
---------------------------------------------
Vice President and Chief Financial Officer
30
INDEX TO EXHIBITS
EXHIBIT PAGE
--------------------------------------------------------------------------------
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002....................................... 32
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002....................................... 33
31