-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q5yRb7lMV8pF+lsIuZlee3wvJ5VEss0Ph6QxOL2fMCu77ZCq+YPSDEhyPk/RKz6z +x5EIvp7fGq5aHawDgcZyA== 0000891618-98-004973.txt : 19981118 0000891618-98-004973.hdr.sgml : 19981118 ACCESSION NUMBER: 0000891618-98-004973 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SALIX PHARMACEUTICALS LTD CENTRAL INDEX KEY: 0001009356 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 943267443 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23265 FILM NUMBER: 98751178 BUSINESS ADDRESS: STREET 1: 3600 W BAYSHORE RD STREET 2: STE 205 CITY: PALO ALTO STATE: CA ZIP: 94303 BUSINESS PHONE: 4158561550 MAIL ADDRESS: STREET 1: 3600 W BAYSHORE BLVD STREET 2: SUITE 205 CITY: PALO ALTO STATE: CA ZIP: 94303 FORMER COMPANY: FORMER CONFORMED NAME: SALIX HOLDINGS LTD DATE OF NAME CHANGE: 19970807 10-Q 1 FORM 10-Q 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________. COMMISSION FILE NUMBER: 000-23265 -------------------------- SALIX PHARMACEUTICALS, LTD. (Exact name of Registrant as specified in its charter) BRITISH VIRGIN ISLANDS 94-3267443 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3600 WEST BAYSHORE ROAD, SUITE 205 PALO ALTO, CALIFORNIA 94303 (Address of principal executive offices, including zip code) (650) 856-1550 (Registrant's telephone number, including area code) -------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] The number of shares of the Registrant's Common Stock outstanding as of November 12, 1998 was 10,192,838. ================================================================================ 2 SALIX PHARMACEUTICALS, LTD. TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO. - ------- --------------------- -------- Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997 ............................................. 1 Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 1998 and 1997 ....................... 2 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1997 ............................ 3 Notes to Condensed Consolidated Financial Statements.................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................................ 6 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds .................................. 16 Item 6. Exhibits and Reports on Form 8-K .......................................... 16 Signatures .................................................................................. 17
3 SALIX PHARMACEUTICALS, LTD. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AMOUNTS) (EXPRESSED IN U.S. DOLLARS)
September 30, December 31, 1998 1997 -------- -------- ASSETS Current assets: Cash and cash equivalents .................................... $ 8,146 $ 15,173 Other current assets ......................................... 1,420 460 -------- -------- Total current assets .................................... 9,566 15,633 Property and equipment, net ........................................... 246 194 Other assets .......................................................... 51 51 -------- -------- $ 9,863 $ 15,878 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and other current liabilities ............... $ 2,138 $ 1,749 -------- -------- Total current liabilities ............................... 2,138 1,749 Shareholders' equity: Preferred stock, issuable in series, no par value; 5,000,000 shares authorized; none outstanding ........... -- -- Common stock, no par value; 20,000,000 shares authorized; 10,192,838 shares and 10,120,573 shares issued and outstanding at September 30, 1998 and December 31, 1997, respectively .......................................... 27,609 27,520 Accumulated deficit .......................................... (19,884) (13,391) -------- -------- Shareholders' equity .................................... 7,725 14,129 -------- -------- $ 9,863 $ 15,878 ======== ========
The accompanying notes are an integral part of these financial statements. 1 4 SALIX PHARMACEUTICALS, LTD. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) (EXPRESSED IN U.S. DOLLARS)
Three months ended Nine months ended September 30, September 30, -------- -------- -------- -------- 1998 1997 1998 1997 -------- -------- -------- -------- Revenues: Product revenue ..................................... $ 138 $ 216 $ 284 $ 216 Revenue from collaborative agreements and other ..... -- 1,800 501 1,821 -------- -------- -------- -------- Total revenues ................................. 138 2,016 785 2,037 -------- -------- -------- -------- Expenses: Cost of products sold ............................... 207 389 495 389 License fees ........................................ -- 411 325 461 Research and development ............................ 1,474 1,183 4,841 2,498 General and administrative .......................... 607 708 2,095 1,939 -------- -------- -------- -------- Total expenses ................................. 2,288 2,691 7,756 5,287 -------- -------- -------- -------- Loss from operations ......................................... (2,150) (675) (6,971) (3,250) -------- -------- -------- -------- Interest and other income, net ............................... 138 33 478 133 -------- -------- -------- -------- Net loss ....................................... $ (2,012) $ (642) $ (6,493) $ (3,117) ======== ======== ======== ======== Net loss per share, basic and diluted ........................ $ (0.20) $ (0.09) $ (0.64) $ (0.44) ======== ======== ======== ======== Shares used in computing net loss per share, basic and diluted 10,193 7,118 10,186 7,023 ======== ======== ======== ========
The accompanying notes are an integral part of these financial statements. 2 5 SALIX PHARMACEUTICALS, LTD. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) (EXPRESSED IN U.S. DOLLARS)
Nine months ended September 30, --------------------- 1998 1997 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss ...................................................... $ (6,493) $ (2,475) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................ 66 32 Changes in assets and liabilities: Other current assets ..................................... (960) (352) Accounts payable and other current liabilities ........... 389 (196) -------- -------- Net cash used in operating activities ................ (6,998) (2,991) CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment ........................... 118 (39) -------- -------- Net cash used for property and equipment ................. 118 39 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock ........................ 89 1,063 -------- -------- Net cash provided by financing activities ................ 89 1,063 Net decrease in cash and cash equivalents .............................. (7,027) (1,967) Cash and cash equivalents at beginning of period ....................... 15,173 5,624 -------- -------- Cash and cash equivalents at end of period ............................. $ 8,146 $ 3,657 ======== ========
The accompanying notes are an integral part of these financial statements. 3 6 SALIX PHARMACEUTICALS, LTD. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) 1. Organization and Basis of Presentation Salix Pharmaceuticals, Ltd. (the "Company") was incorporated in the British Virgin Islands in December 1993 for the purpose of acquiring all of the outstanding capital stock of Salix Pharmaceuticals, Inc., a California corporation ("Salix California"), and Glycyx Pharmaceuticals, Ltd., a Bermuda corporation ("Glycyx"). Salix California was incorporated in California in 1989 and Glycyx was incorporated in Bermuda in 1992. The Company is developing new pharmaceuticals, primarily focused in the area of gastrointestinal disease. The Company conducts its business within one industry segment. The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. These statements are stated in United States dollars. The accompanying unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring items) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and cash flows. These financial statements should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Report and with the audited financial statements for the fiscal year ended December 31, 1997 included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 filed with the Securities and Exchange Commission. The results of operations for interim periods are not necessarily indicative of results to be expected for a full year. These statements have been prepared in accordance with accounting principles generally accepted in the United States. The application of these principles conforms in all material respects with financial statements prepared using accounting principles generally accepted in Canada. The Company's Common Shares are traded on The Toronto Stock Exchange. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 2. Net Loss Per Common Share In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement No. 128, "Earnings Per Share" ("FAS 128"). Basic and diluted net losses per common share have been computed using the weighted-average number of common shares outstanding during each period. Common equivalent shares have been excluded from the computation, as their effect is anti-dilutive in all periods. 3. Commitments At September 30, 1998, the Company had a binding purchase order commitment for inventory purchases aggregating approximately $770,000 to be delivered in 1998. 4 7 SALIX PHARMACEUTICALS, LTD. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 1998 (UNAUDITED) 4. Shareholders' Equity In May 1996, the Company closed the initial public offering of its common shares in Canada, at which time the shares listed on The Toronto Stock Exchange. In connection with that offering, the Company issued to the underwriters common share purchase warrants, exercisable into 200,000 common shares at a price of Cdn. $7.00 (U.S. $5.25). All such purchase warrants were exercised in 1997, raising additional proceeds to the Company of approximately Cdn. $1,400,000 (U.S. $1,003,000). In October 1997, the Company completed a public offering, issuing 3,000,000 common shares at a price of Cdn. $7.00 (U.S. $4.98). The Company received approximately U.S. $14 million in cash, net of underwriting discounts, commissions and other offering costs. In addition, options to purchase an aggregate of 72,265 common shares were exercised between January 1, 1998 and September 30, 1998. The exercise price of these shares was U.S. $1.00 per share. 5 8 SALIX PHARMACEUTICALS, LTD. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under "Factors that May Affect Future Results" under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in, or incorporated by reference into, this report. The following discussion should be read in conjunction with the Company's Condensed Consolidated Financial Statements and notes thereto included elsewhere in this report. Unless otherwise indicated, all references to "dollars" or "$" refer to United States dollars. The Company's Common Shares trade on The Toronto Stock Exchange and are quoted in Canadian dollars. OVERVIEW The Company's principal focus is to identify and acquire gastrointestinal products that have near-term commercial potential and to apply its product development expertise to commercialize these products. The Company selects products that it believes serve a gastrointestinal disease in need of new treatments, have the potential for rapid regulatory approval, and are marketable to a small group of specialized physicians. The Company believes this strategy will reduce the expense, time and risk normally associated with pharmaceutical development. The Company believes that its first two products, balsalazide disodium, presently marketed in the United Kingdom under the brand name Colazide, and rifaximin will demonstrate the Company's ability to execute this strategy. The Company has generated limited revenues to date from the sales of products, and it has been unprofitable since inception. The Company expects to continue to incur substantial and increasing losses and expects its operating expenses to increase as the Company continues its balsalazide disodium commercialization efforts in the United Kingdom and, subject to regulatory approval, elsewhere in Europe and continues its product development and clinical programs for other products. The Company does not expect to achieve substantial profitability on an annual basis before 2002 at the earliest. As of September 30, 1998, the Company had accumulated losses of approximately $19.9 million. Since 1992, the Company has financed its operations principally through reimbursement payments, license fees and milestone revenues, totaling approximately $16.3 million under collaborative research and licensing agreements, and sales of equity and convertible debt securities totaling approximately $27.6 million. Over the same period, the Company has recorded expenses totaling $27.3 million, of which $16.6 million were in research and development expenses and $1.5 million in license fees to licensors. The Company's alliances with Astra AB ("Astra") and a division of Menarini Pharmaceutical Industries s.r.l. ("Menarini") have allowed it to fund the development of balsalazide disodium, to in-license other gastrointestinal products, and to help establish itself with a relatively small amount of outside capital. In October 1998 the Company signed an agreement with Astra in which the Company will receive additional research and development funding of $3.0 million from Astra related to an ongoing clinical trial comparing balsalazide disodium to mesalamine, the current leading treatment for ulcerative colitis and Crohn's disease. Under the agreement the Company will receive the funds in three installments: $1.0 million within 15 days of signing the agreement, $1.0 million upon completion of treatment of the last patient in the trial, and $1.0 million upon delivery of the study results report. The Company anticipates that the last two events will occur in 1999. In exchange for the $3.0 million payment, Astra will receive rights to the trial results for use throughout the territories in which it has a license to market balsalazide disodium. In addition, the Company will transfer to Astra the balsalazide disodium New Drug Application ("NDA") for balsalazide disodium, which the Company filed in June 1997 with the United States Food and Drug Administration ("FDA"), although the transfer will occur only after FDA approval is received, if at all. Depending on the outcome of the trial, the results may be useful for obtaining additional approvals in Europe and enhancing US labeling for balsalazide disodium. 6 9 The Company's collaborative research and licensing agreements provide for payments in support of the Company's research activities, as well as additional payments for licensing fees and upon the attainment of specified milestones. Research reimbursements under these agreements are recorded when earned based on contract costs incurred to date compared with total estimated contract costs. License fees and milestone revenues are recognized according to contract terms. Amounts received in advance of the applicable research activities are deferred as unearned revenue. Amounts received that are refundable until the milestones are achieved are deferred as advances from licensees until earned. The Company licensed balsalazide from Biorex Laboratories Limited ("Biorex") in exchange for participation in future milestone revenues and profits. The Company will sell balsalazide disodium, the disodium salt of balsalazide, which is manufactured by third parties under contract with the Company, to its distribution partners, Astra and Menarini, at a formula price. The Company received approval in July 1997 to market balsalazide disodium in the United Kingdom for the treatment of acute ulcerative colitis. Astra began the commercial launch of balsalazide disodium under the brand name Colazide in October 1997 in the United Kingdom. In May 1998, the Company received notification of additional approvals for balsalazide disodium in Austria, Belgium, Denmark, Italy, Luxembourg, and Sweden, through the mutual recognition process of the European Union ("EU"). The Company expects Astra and Menarini to undertake commercial launches of balsalazide disodium in these EU countries beginning in early 1999. Astra and Menarini withdrew marketing applications from other EU countries that had questions that could not be addressed within the time constraints of the review period required by the mutual recognition process. These countries are Finland, France, Germany, Greece, Ireland, Netherlands, Portugal, and Spain. The application process for approval in these countries is the responsibility of Astra and Menarini and there can be no assurance that they will pursue such applications or, if they do, that they will be successful. The Company recognized its initial product revenues from Astra's sales of balsalazide disodium in the United Kingdom in 1997 and expects to recognize product revenues from sales of balsalazide disodium by Menarini and Astra outside the United Kingdom in early 1999. The selling price of balsalazide disodium to Astra outside the United Kingdom has not been determined, and the Company will be obligated to pay to Biorex, the original licensor of the product, a portion of any gross profit on balsalazide disodium sales to Astra and Menarini outside the United States. In addition, the Company anticipates high initial product launch costs due to the cost of scaling up manufacturing processes for commercial distribution. In June 1997, the Company submitted an NDA to the FDA for balsalazide disodium as a therapy for acute ulcerative colitis. In June 1998, the FDA issued an "approvable" letter for the Company's balsalazide disodium NDA. The FDA's letter indicated that the application might be approved upon the satisfaction of specific issues relating to the manufacturing process and other technical issues, as well as product labeling. To the extent necessary, the Company has re-focused part of its management's efforts to concentrate fully on the resolution of the remaining issues, as outlined in the approvable letter, as it seeks to fulfill the FDA requirements and obtain final approval. The Company anticipates that it will not be able to produce and provide the requested information until 1999. While the Company believes that it can successfully fulfill the FDA requirements and obtain marketing approval, there can be no assurance that its efforts in this regard, in whole or in part, will be successful. In addition, certain of the issues raised in the FDA letter require the cooperation of the Company's third-party contract manufacturers to meet the conditions of the approvable letter. There can be no assurance that the Company's third-party contract manufacturers will fully comply with the conditions of the approvable letter. If any issue contained in the approvable letter is not resolved to the satisfaction of the FDA, there can be no assurance that approval will be granted. Failure to obtain marketing approval for balsalazide disodium from the FDA could have a material adverse impact on the Company's financial condition and future results of operations. The Company's second product, rifaximin, is currently under development. The Company obtained the rights to develop, make, use and sell rifaximin in Canada and the United States from Alfa Wassermann S.p.A. ("Alfa Wassermann") in exchange for future royalties and milestone payments. Alfa Wassermann has also agreed to supply Salix with bulk active ingredient rifaximin at a fixed price. If regulatory approvals are obtained, the Company intends to establish its own direct sales force to market rifaximin. This strategy for rifaximin represents the business model that the Company intends to adopt for future product development and commercialization. Although the creation of an independent sales organization will require a substantial investment by the Company, the Company anticipates that the financial results from rifaximin and future products will be more favorable to the Company than those anticipated from the sale of balsalazide disodium by Astra and Menarini since the Company has retained the distribution rights to rifaximin, whereas Astra and Menarini have the distribution rights for balsalazide. In the case of balsalazide disodium, the Company granted exclusive distribution rights in certain territories in exchange for funding needed to complete 7 10 late-stage development of balsalazide disodium, to in-license other gastrointestinal products and to help establish the Company as a viable gastrointestinal pharmaceutical company. The Company is currently unable to provide a meaningful estimate of the investment required to create an independent sales organization because such investment is dependent on a number of contingencies, including receipt of necessary regulatory approvals for specific indications. The Company intends to pursue development of rifaximin for bacterial infections of the lower gastrointestinal tract. The Company intends to conduct and fund clinical trials as may be required to obtain regulatory approvals. The Company plans to develop rifaximin for other possible indications, including antibiotic associated colitis and hepatic encephalopathy as financial resources will allow. In February 1998, the Company received Orphan Drug Designation from the FDA for rifaximin to treat hepatic encephalopathy. Orphan Drug Designation can entail certain possible advantages in the testing and approval process for the drug. See "Factors That May Affect Future Results". RESULTS OF OPERATIONS Three and Nine Month Periods Ended September 30, 1998 and 1997 For the three and nine month periods ended September 30, 1998, the Company recognized product revenue of $138,000 and $284,000, respectively. Due to a short-term manufacturing delay during the first quarter of 1998, shipments of balsalazide disodium were delayed and no revenues recognized during the first quarter of 1998. Product shipments recommenced in April 1998. For the three and nine month periods ended September 30, 1997, the Company recognized product revenue of $216,000 and $284,000, respectively. For the three and nine month periods ended September 30, 1997, the Company recognized revenue from collaborative agreements of $1.8 million and $1.8 million, respectively. The Company recognized no revenue from collaborative agreements for the three months ended September 30, 1998 and $501,000 for the nine months ended September 30, 1998. Operating expenses for the three months ended September 30, 1998 and 1997 were $2.3 million and $2.7 million, respectively. Operating expenses for the nine months ended September 30, 1998 and 1997 were $7.8 million and $5.3 million, respectively. The increase in operating expenses in both the three and nine month periods was the result of increases in all the expense categories noted below. Cost of products sold for the three and nine months ended September 30, 1998 were $207,000 and $495,000, respectively. Although no product was shipped during the three months ended March 31, 1998, the Company incurred ongoing manufacturing related overhead costs of $46,000. Prior to 1997, the Company had no product revenues. Initial costs of products are expected to remain high due to the cost of scaling up manufacturing processes for commercial distribution. License fees payable totaled $250,000 and $411,000 for the three months ended September 30, 1998 and 1997, respectively. Current license fees payable were due in connection with the Company's recognition of revenue from collaborative agreements resulting from the approval of balsalazide disodium for sale in certain European countries. Research and development expense was $1.5 million and $1.2 million for the three months ended September 30, 1998 and 1997, respectively, and $4.8 million and $2.5 million for the nine months ended September 30, 1998 and 1997, respectively. The increase in research and development expenses in 1998 is due primarily to increased spending for an ongoing balsalazide disodium clinical trial initiated in late 1997 and continued spending in regulatory affairs activities related to the balsalazide disodium NDA approval process in the United States. Management expects research and development spending to remain constant or increase due to additional planned clinical trial activities. General and administrative expenses were $607,000 and $708,000 for the three months ended September 30, 1998 and 1997, respectively, and $2.1 million and $1.9 million for the nine months ended September 30, 1998 and 1997. The three month decrease was due mainly to timing of certain development related activities. The nine month increase was due mainly to additions of essential personnel and the increased administrative costs related to becoming a public reporting company in the United States in October 1997. 8 11 Interest income increased to $138,000 in the three months ended September 30, 1998 from $33,000 in the three months ended September 30, 1997. Interest income increased to $478,000 for the nine months ended September 30, 1998 compared to $133,000 in the nine months ended September 30, 1997. Both increases were the result of higher cash balances in 1998. See "Liquidity and Capital Resources". The Company has experienced net losses of $2.0 million and $642,000 for the three months ended September 30, 1998 and 1997, respectively. Net losses for the nine months ended September 30, 1998 and 1997 were $6.5 million and $3.1 million, respectively. The increase in net losses for both the three and nine month periods are attributable to increased expenses and lower revenues from collaborative agreements. At December 31, 1997, the Company had federal net operating loss carryforwards of approximately $8.8 million for United States income tax purposes. These carryforwards will expire in varying amounts through 2012. As the Company adds new investors, utilization of the current loss carryforwards may be substantially limited if, under United States Internal Revenue Code Section 382, a change in ownership is deemed to have occurred within the three most recent fiscal years. Year 2000 Compliance Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. The Company's internal operating systems rely exclusively on software products of third party vendors, who have provided assurance to the Company that such products are year 2000 compliant. Further, the Company believes that it should not experience any material adverse impact as a result of the impairment of software or hardware and other information gathering systems which are not year 2000 compliant, as the Company does not rely on any such systems today for on-going operations. Moreover, the Company has had discussions with its financial institutions regarding the status of their systems' compliance with the year 2000 date capability and all have provided assurances to the Company that all such systems and software have been made or will be remedied and compliant not later than mid-1999. Additionally, the Company intends to conduct a survey of its key vendor's systems in the first quarter 1999 to determine if their systems comply with year 2000 requirements. Following this assessment, the Company will determine what actions it will undertake to mitigate any adverse impact that might result therefrom. Based upon information presently available, the Company does not believe that issues relating to year 2000 compliance will result in a material adverse effect on its financial condition or results of operations. If the information provided by such vendors were to prove incorrect, however, there can be no assurance that the costs and disruption associated with implementing new or corrected software would not have an adverse effect on the Company's business, financial condition or results of operations. LIQUIDITY AND CAPITAL RESOURCES Since 1992 and through September 30, 1998, the Company has financed its operations principally through reimbursement payments, license fees and milestone revenues, totaling approximately $16.3 million under collaborative research and licensing agreements, and sales of equity and convertible debt securities totaling approximately $27.6 million. At September 30, 1998, the Company had approximately $8.1 million in cash and cash equivalents as compared to $15.2 million at December 31, 1997. The decrease of $7.1 million from December 31, 1997 was due to cash used in operating activities (see "Results of Operations"). In October 1997, the Company offered and sold 3,000,000 Common Shares in an underwritten public offering of securities in Canada and the United States at a price of Cdn. $7.00 (U.S. $ 4.98), raising Cdn. $19,635,000 (U.S. $13,973,000) net of underwriting discounts and commissions. The offering in the United States was made pursuant to a Registration Statement on Form S-1 that was declared effective by the Securities and Exchange Commission on October 16, 1997. 9 12 As of September 30, 1998, the Company had no long-term obligations. The Company has non-cancelable purchase order commitments for inventory purchases of approximately $770,000. The Company anticipates capital expenditures will total approximately $150,000 in 1998. The Company's purchases of raw materials and its product sales to its European distribution partners are denominated in British Pound Sterling. Translation into the Company's reporting currency, the United States dollar, has not historically had a material impact on the Company's financial position. Additionally, the Company's net assets denominated in currencies other than the functional currency have not exposed the Company to material risk associated with fluctuations in currency rates. Given these facts, the Company has not considered it necessary to use foreign currency contracts or other derivative instruments to manage changes in currency rates. The Company has sustained continuing operating losses and expects to incur substantial and increasing losses until product approvals are obtained and product revenues reach a sufficient level to support ongoing operations. The Company believes that the net proceeds from its October 1997 offering of Common Shares, together with the Company's cash reserves at September 30, 1998 and the cash flow from operations, should be sufficient to satisfy the cash requirements of the Company's product development programs through at least mid-1999. The Company's actual cash requirements may vary materially from those now planned because of a number of factors, including the results of research and development activities, FDA and foreign regulatory processes, establishment of and changes in relationships with strategic partners, technological advances by the Company and other pharmaceutical companies, the terms of the Company's collaboration arrangements with strategic partners, and the status of competitive products. The Company's ability to execute its business plan, fund future development efforts, and secure future licensing arrangements, as well as fund the commercialization of rifaximin and other new potential products will require the Company to raise additional funds in the form of debt or equity financing in 1999. The Company may also enter into collaborative arrangements with corporate partners that could provide the Company with additional funding in the form of equity, debt, licensing, milestone and/or royalty payments. There can be no assurance that the Company will be able to enter into such arrangements or raise any additional funds on terms favorable to the Company. FACTORS THAT MAY AFFECT FUTURE RESULTS This report, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements and other prospective information relating to future events. These forward-looking statements and other information are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including the following: Dependence on Currently Licensed Products; Uncertainty of Regulatory Approval of Company's Products. The Company's future success will depend, among other factors, on its ability to in-license, develop, and commercialize new pharmaceutical products. The Company currently licenses two pharmaceutical products, balsalazide and rifaximin, and the Company's prospects over the next three to five years are substantially dependent on regulatory approval and successful commercialization of these products. The Company has in-licensed certain rights to balsalazide and rifaximin in certain markets from Biorex and Alfa Wassermann, respectively. In addition, the Company has entered into agreements relating to the development, commercialization, manufacture, and marketing of balsalazide disodium with Astra and Menarini. Development, manufacture, and marketing of both balsalazide and rifaximin are subject to extensive regulation by governmental authorities in the United States and other countries. The FDA has not approved either balsalazide or rifaximin for use in the United States. In June 1997, the Company submitted an NDA to the FDA for balsalazide disodium as a therapy for acute ulcerative colitis. In June 1998, the FDA issued an "approvable" letter to the Company for the balsalazide disodium NDA. The FDA's letter indicated that the application might be approved upon the satisfaction of specific issues relating to manufacturing and other technical issues, as well as product labeling. To the extent necessary, the Company has re-focused part of its management's efforts to concentrate fully on the resolution of the remaining issues, as outlined in the approvable letter, as it seeks to fulfill the FDA requirements and obtain final approval. While the Company believes that it can successfully comply with the issues raised by the approvable letter and obtain FDA approval for balsalazide disodium, there can be no assurance that its efforts in this regard, in whole or in part, will be successful. In addition, certain of the issues raised in the FDA letter require the cooperation of the Company's third-party contract manufacturers to meet the conditions of the approvable letter. There can be no assurance that the Company's third-party contract manufacturers will be able to fully comply with the 10 13 conditions of the approvable letter. If any issue contained in the approvable letter is not resolved to the satisfaction of the FDA, there can be no assurance that approval will be granted. If regulatory approval of balsalazide disodium or any other product is granted, such approval will be limited to those disease states and conditions for which the product has been shown to be safe and effective, as demonstrated to the FDA's satisfaction through well controlled clinical studies. Furthermore, approval may entail ongoing requirements for post-marketing studies. Even if such regulatory approval is obtained, a marketed product, promotional activities for the product, its manufacturer and its manufacturing facilities are subject to continual review and periodic inspections. In addition, identification of certain side effects after a drug is on the market or the occurrence of manufacturing problems could cause subsequent withdrawal of approval, reformulation of the drug, additional preclinical testing or clinical trials and changes in labeling of the product. In July 1997, the Medicines Control Agency in the United Kingdom approved balsalazide disodium under the brand name Colazide as a treatment for acute ulcerative colitis in the United Kingdom. The Company and its partners, Astra and Menarini, received in May 1998 notification of approval of balsalazide disodium as at treatment for acute ulcerative colitis in Austria, Belgium, Denmark, Italy, Luxembourg, and Sweden through the mutual recognition process of the EU. Astra and Menarini withdrew marketing applications from certain other EU countries that had questions that could not be addressed within the time constraints of the review period required by the mutual recognition process. These countries are Finland, France, Germany, Greece, Ireland, Netherlands, Portugal, and Spain. The application procedure for approval in these countries is the responsibility of Astra and Menarini and there can be no assurance that they will pursue such applications, or if they do, that they will be successful. There can be no assurance that balsalazide disodium will receive approval from regulatory agencies in any member country of the European Union where the marketing application was withdrawn. Even if such approvals are ultimately received, there can be no assurance as to the timing of such approvals or market acceptance of balsalazide disodium for the approved indications, or that the Company's marketing partners will launch balsalazide disodium in the countries where the marketing application has been approved. With respect to rifaximin, Alfa Wassermann has recently completed patient enrollment in a clinical trial in Spain relating to the drug as a therapy for hepatic encephalopathy. The Company determined through discussions with the FDA that this study is not sufficient support for the filing of an NDA with the FDA. Therefore, the Company may initiate a Company-sponsored trial in the United States as financial resources may allow. There can be no assurance that this new clinical trial for rifaximin will demonstrate that the drug is safe and effective for the indication tested, that such clinical trial will support the filing of an NDA for rifaximin as a therapy for hepatic encephalopathy, that in the event an NDA is filed with the FDA, the Company will be successful in obtaining regulatory approval in the United States, or that the Company will obtain regulatory approval for rifaximin from authorities in any other foreign jurisdiction. The Company expects that a significant portion of its potential revenues for the next few years will depend on regulatory approval and sales of these products. Failure to obtain regulatory approvals, delays in obtaining regulatory approvals, obtaining regulatory approvals for balsalazide disodium or rifaximin in only limited markets or for limited uses, or lack of market acceptance for either product, to the extent regulatory approvals are obtained, would have a material adverse effect on the Company's business, financial condition, and results of operations. Limited Operating History; History of Operating Losses; Expectation of Future Losses. The Company has only a limited history of operations consisting primarily of development of its products and sponsorship with third parties of research and clinical trials. The Company has had no earnings to date and has not realized any material operating revenues from product sales, either directly by the Company or indirectly through its development and distribution partners. Substantially all of the Company's revenues to date have been derived from milestone payments from the Company's collaborative partners related to the development of balsalazide disodium. As of September 30, 1998, the Company had incurred cumulative losses since inception of approximately $19.9 million. Furthermore, the Company currently expects operating losses to continue at least through 2001 and to increase from current levels as the Company continues to develop balsalazide disodium and rifaximin. The Company's future operating performance will depend on the timing of regulatory approvals of balsalazide disodium and rifaximin, particularly the timing of FDA approval, and, if such approvals can be obtained, will depend on market acceptance. Dependence on Collaborative Partners. The initial commercialization of balsalazide disodium in the United Kingdom and, to the extent regulatory approval is obtained, in other countries in which the Company has commercial 11 14 rights to balsalazide disodium is entirely dependent on Astra and Menarini, in their respective territories. Under its agreements with Astra, the Company has granted Astra exclusive rights to distribute and sell balsalazide disodium on a worldwide basis with the exception of Italy, Spain, Portugal, and Greece, where the Company has granted exclusive distribution rights to Menarini, and with the exception of Japan, Taiwan, and Korea, where the Company does not have rights to balsalazide disodium. Although Astra has agreed to use its best endeavors to promote, market, and sell balsalazide disodium in its exclusive markets, there are no specified financial thresholds that must be achieved for Astra to maintain its exclusivity. The Company's agreements with Astra provide for, with respect to Europe, a term of 15 years and, with respect to the United States, a term ending on the later to occur of the expiration date of the last expiring patent and the date nine years from the first commercial launch date of balsalazide disodium but, in either event, the agreements may be terminated earlier by either party upon the occurrence of specified events, including a material breach. The Company received marketing approval for balsalazide disodium in the United Kingdom from the Medicine Controls Agency in July 1997 and Astra launched balsalazide disodium commercially in the United Kingdom in October 1997, based on a selling price set by Astra. Following regulatory approval of balsalazide disodium in each country in Europe where Astra has exclusive distribution rights, the Company and Astra must agree on the balsalazide disodium sales price for such country, which may be less than the selling price in the United Kingdom. The agreed sales price for balsalazide disodium will directly affect the Company's revenues because the parties' agreement obligates Astra to purchase balsalazide disodium from the Company, and the Company to supply balsalazide disodium to Astra, at a transfer price equal to a percentage of Astra's selling price. The Company does not anticipate significant margins from balsalazide disodium sales to Astra in the United Kingdom or in other European Union countries, where pricing has not yet been determined. In addition, while the Company and its partners, Astra and Menarini, received in May 1998 notification of approval of balsalazide disodium as a treatment for acute ulcerative colitis in Austria, Belgium, Denmark, Italy, Luxembourg and Sweden, Astra and Menarini withdrew marketing applications from countries that had questions that could not be addressed within the time constraints of the review period. Although the Company has been advised by both Astra and Menarini that they intend to seek approval in those countries for which marketing applications were withdrawn, including Finland, France, Germany, Greece, Ireland, Netherlands, Portugal and Spain, the decision as to which additional approvals to seek, the order in which to seek them and the responsibility to complete the approval process lies with Astra and Menarini and not the Company. There can be no assurance that Astra and Menarini will seek such approvals, or if they do that, the approvals will be granted. There can be no assurance that the Company will be able to negotiate acceptable collaborative arrangements in the future, or that its current or future collaborative arrangements, including the agreements with Astra or Menarini, will be successful or will not be terminated by the other party. Although the Company believes that parties to any collaborative arrangements would have an economic motivation to succeed in performing their contractual responsibilities, the amount and timing of resources to be devoted to these activities in most instances will not be within the control of the Company. Failure of the Company and its collaborative partners to develop, commercialize, manufacture or market products, including balsalazide disodium, would have a material adverse effect on the Company's business, financial condition, and results of operations. Dependence on Third Parties for Manufacturing. The Company currently does not manufacture its potential pharmaceutical products, including balsalazide disodium and rifaximin, and, therefore, is dependent on contract manufacturers for the production of such products for development and commercial purposes. In the event that the Company is unsuccessful in obtaining or retaining third-party manufacturing or if the Company's manufacturers experience production difficulties, delays or disruptions or fail to comply with regulatory requirements, the Company may not be able to obtain adequate supplies of products in a timely fashion or at acceptable quality, quantity, timing or prices, or to commercialize its potential products as planned. No assurances can be given that the Company, or its contract manufacturers, will be able to manufacture balsalazide disodium (or other future developed products) in commercial quantities that would enable the Company to meet its business objectives. Under the terms of the Company's distribution agreements with Astra and Menarini, the obligations of such companies to purchase product will terminate under certain circumstances in which the Company is unable or unwilling to adequately supply them with product. In such circumstances, Astra or Menarini, as the case may be, is granted a temporary license to manufacture balsalazide disodium. Under certain situations, such manufacturing licenses may become permanent, in which case the Company's revenues from the arrangements could be, depending on the circumstances, severely reduced or eliminated. Moreover, the contract manufacturers that the Company may use must adhere to current Good 12 15 Manufacturing Practices, which are regulations strictly enforced by the FDA through its facilities inspection program. If these facilities cannot pass a pre-approval plant inspection, the likelihood of the FDA's pre-market approval of balsalazide disodium would be adversely affected. In its "approvable" letter relating to the NDA for balsalazide disodium, the FDA identified certain manufacturing deficiencies that need to be addressed by the Company and its manufacturers if the NDA is to be approved. There can be no assurance that the Company or its manufacturers will be able to the address the FDA's concerns. Certain material manufacturing changes that may occur after approval are also subject to FDA review and approval. There can be no assurance that the FDA or other regulatory agencies will approve the processes or the facilities by which any of the Company's products may be manufactured. In addition, if the facilities cannot pass regular post-approval inspections, manufacturing and distribution may be disrupted, recalls of distributed products may be necessary, and other sanctions could be applied. Any disruption in the supply in manufacturing and marketing of the Company's proposed products would have a material adverse effect on the Company's business, financial condition, and results of operations. Dependence on In-Licensing and Acquisition of New Products for Future Growth. Whether or not balsalazide disodium or rifaximin receives regulatory approvals and is successfully marketed, the Company's ability to grow in the future will depend on its success in in-licensing or acquiring additional pharmaceutical products. The Company seeks to in-license or acquire pharmaceutical products that have been developed beyond the initial discovery phase and for which late-stage human clinical data is already available. There can be no assurance that such pharmaceutical products will be available on attractive terms for in-licensing or acquisition by the Company. Uncertainty of Market Acceptance. The Company's future success will depend in part on its ability to develop and commercialize new products, including balsalazide disodium and rifaximin, or new formulations of, or indications for current products. Assuming the Company can successfully develop such products and obtain regulatory approvals, their future success will depend upon their acceptance by the medical community and third-party payors as useful and cost-effective. Market acceptance will depend upon several factors, including the establishment of the safety, effectiveness, patient tolerance, and cost of the Company's products relative to those of competitors. The Company and its collaborative partners may be required to engage in extensive advertising, educational programs or other means to market its products. Failure of any of the Company's products to achieve market acceptance would have a material adverse effect on the Company's business, financial condition, and results of operations. Lack of Sales and Marketing Experience. The Company has no experience marketing and selling its products either directly or through distributors. The Company's sales and marketing strategy for balsalazide disodium relies on its third-party distributors, Astra and Menarini, to whom the Company has granted exclusive marketing rights. There can be no assurance that either Astra or Menarini will market balsalazide disodium successfully in any country in which they have exclusive rights. The Company intends to establish its own direct sales force for the purpose of achieving direct sales of rifaximin and other future products. There can be no assurance that the Company's marketing and direct sales efforts will be successful. Dependence on Exclusive Licenses. The Company's rights to balsalazide and rifaximin are derived from its license agreements with Biorex and Alfa Wassermann, respectively. The Company's rights under these licenses are subject to early termination by Biorex or Alfa Wassermann, as the case may be, under certain circumstances, including material breach by the Company, the bankruptcy or insolvency of the Company, or the Company's failure to satisfy its manufacturing obligations under its agreements with distribution partners. In the event that Biorex or Alfa Wassermann terminate their respective license agreements, the Company would have no further rights to utilize their respective patents or trade secrets to manufacture and market products based on balsalazide or rifaximin, as the case may be. The Company's licenses for balsalazide and rifaximin provide that the Company's royalty obligations may extend beyond the expiration date of the underlying patents, which could have a material adverse effect on the Company's business, financial condition, and results of operations in the event a generic version of balsalazide or rifaximin, as the case may be, were introduced. In addition, the Company's license agreement with Alfa Wassermann also provides that the Company may not promote, distribute or sell any antibiotic products that compete with rifaximin in its licensed territory (the United States and Canada) for a period of five years after the first commercial sale of rifaximin under the agreement, thereby limiting the Company's ability to in-license, develop, or market such products. Patents and Proprietary Rights; Expiration of Patents. Because of the substantial length of time and expense associated with bringing new products through development and regulatory approval to the marketplace, the pharmaceutical industry places considerable importance on obtaining patent and trade secret protection for new 13 16 technologies, products and processes. Because the Company's strategy is to in-license or acquire pharmaceutical products which typically have been discovered and initially researched by others, such products may have limited or no remaining patent protection due to the time elapsed since their discovery. The patents for the balsalazide disodium composition of matter and method of treating ulcerative colitis with balsalazide expire in July 2001 in the United States, February 2002 in the United Kingdom, May 2002 in France, July 2001 in Italy, and April 2002 in Germany. The patents for the method of treating colon cancer using balsalazide expire in January 2014 in the United States and, assuming patents issue from pending applications, in January 2015 in various countries in Europe, Asia, and North America. The patents for the rifaximin composition of matter (also covering a process of making rifaximin and using rifaximin to treat gastrointestinal infectious diseases) expire in May 2001 in the United States and Canada. The patents for another process of making rifaximin expire in April 2005 in both the United States and Canada. Patents for the use of rifaximin for H. pylori infections expire in June 2013 in the United States and February 2014 in Canada. Although the Company believes it may be granted extensions of up to five years in certain circumstances, based on patent term restoration procedures established in Europe and in the United States under the Waxman-Hatch Act for products that have received regulatory approval, there is no assurance that such extensions will be granted. The Company has filed applications for use patents for additional indications using balsalazide and related chemical substances. There can be no assurance that any patents will be issued. There can be no assurance that competitors will not develop products based on the same active ingredients for marketing as soon as the applicable patents expire or at any time thereafter or that competitors will not design around existing patents. Sales of such generic versions could have an adverse effect on the Company's business, financial condition, and results of operations. The Company's success will depend in part on its ability to obtain United States and foreign patent protection for its products and processes, preserve its trade secrets, and operate without infringing on the proprietary rights of third parties. There can be no assurance that patents will issue with respect to, or that the claims allowed will provide sufficient protection to, the Company's present or future technology. There can be no assurance that any other patents will be issued on any of the Company's patent applications or on patent applications licensed from third parties. Moreover, there can be no assurance that claims allowed in the patents or patent applications are or will be sufficiently broad to protect the Company's technology or that the patents will provide protection against competitive products or otherwise be commercially valuable. Furthermore, as with any pharmaceutical company, the Company's patent and other proprietary rights are subject to uncertainty. The Company's patent or other proprietary rights related to its products might conflict with current or future rights of others. For instance, there is no assurance that the use of the Company's technology will not infringe the patent rights of others. For the same reasons, the products of others could infringe the patent or other proprietary rights of the Company. Litigation or patent interference proceedings, either of which could result in substantial cost to the Company, may be necessary to enforce any patents issued to and other proprietary rights of the Company or to determine the scope and validity of other parties' proprietary rights. The defense and prosecution of patent and intellectual property claims are both costly and time-consuming, even if the outcome is favorable to the Company. Any adverse outcome could subject the Company to significant liabilities to third parties, require disputed rights to be licensed from third parties, or require the Company to cease selling its products. In addition to patent protection, the Company also relies on trade secrets, proprietary know-how and technological advances which it seeks to protect, in part, through confidentiality agreements with its collaborative partners, employees and consultants. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any breach, or that the Company's trade secrets and proprietary know-how will not otherwise become known or be independently developed by others. There can be no assurance that the Company will be able to obtain a license to any third-party technology that it may require to conduct its business or that, if obtainable, such technology can be licensed at a reasonable cost. Failure by the Company to obtain a license to any technology that it may require for commercialization of its technologies or products will have a material adverse effect on the Company. In addition, there can be no assurance that others will not independently develop substantially equivalent proprietary information or obtain access to the Company's know-how, or that others will not be issued patents which prevent the manufacture or sale of Company products or require licensing and the payment of significant fees or royalties by the Company in order for it to be able to carry on its business. Litigation, which could result in substantial cost to the Company, may be necessary to enforce or defend the Company's patents or proprietary rights. 14 17 Intense Competition. Competition in the pharmaceutical industry is intense and characterized by extensive research efforts and rapid technological progress. The Company believes that there are numerous pharmaceutical and biotechnology companies, both public and private and including large well-known pharmaceutical companies, as well as academic research groups throughout the world engaged in research and development efforts with respect to pharmaceutical products targeted at gastrointestinal diseases and conditions addressed by the Company's current and potential products. In particular, the Company is aware of products in research or development by competitors that address the diseases being targeted by the Company's products. There can be no assurance that developments by others will not render the Company's current and potential products obsolete or non-competitive. Competitors may be able to complete the development and regulatory approval process sooner and, therefore, market their products earlier than the Company. Many of the Company's competitors have substantially greater financial, marketing and personnel resources and development capabilities than the Company. For example, many large, well capitalized companies already offer products in the United States and Europe that target the proposed indications for balsalazide disodium, including mesalamine (SmithKline Beecham plc, Dr. Falk Pharma GmbH, Pharmacia & Upjohn, Inc., Solvay S.A., The Procter & Gamble Company, and Hoechst Marion Roussel, Inc.), sulfasalazine (Pharmacia & Upjohn, Inc.), and olsalazine (Pharmacia & Upjohn, Inc.). Technological developments by competitors, earlier regulatory approval for marketing competitive products, or superior marketing capabilities possessed by competitors could adversely affect the commercial potential of the Company's products, including balsalazide disodium, and could have a material adverse effect on the Company's business, financial condition, and results of operations. In addition, manufacturers of generic drugs may seek to compete directly with the Company's products in the absence of effective patent protection or non-patent exclusivity protection. Currency Fluctuations. A significant portion of the company's business is conducted in currencies other than the United States dollar. Foreign currency transaction gains and losses arising from normal business operations are credited to or charged against earnings in the period incurred. As a result, fluctuations in the value of the currencies in which the Company conducts its business relative to the United States dollar have caused and will continue to cause currency transaction gains and losses. Although translation into the Company's reporting currency has not historically had a material impact on the Company's financial position, due to the substantial volatility of currency exchange rates, among other factors, the Company cannot predict the effect of exchange rate fluctuations upon future operating results. There can be no assurance that the Company will not experience currency losses in the future. The Company has not previously undertaken hedging transactions to cover its currency exposure but may hedge a portion of its currency exposure in the future as management deems appropriate. Management of Growth. The Company expects to experience significant growth in the number of its employees and the scope of its operations. This growth is expected to place a significant strain on the Company's management and operations. The Company's ability to manage such growth effectively will depend upon its ability to broaden its management team and its ability to attract, hire, and retain skilled employees. The Company's success will also depend on the ability of its officers and key employees to continue to implement and improve its operational, management information and financial control systems and to expand, train and manage its employee base. The Company's inability to manage growth effectively could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Key Personnel; Ability to Recruit Personnel. The Company is dependent upon a number of key management and technical personnel, none of whom is bound by an employment agreement with the Company, including Randy Hamilton, Chairman, President and Chief Executive Officer, and Lorin Johnson, Ph.D.,Vice President, Research (Salix Pharmaceuticals, Inc.) The loss of the services of one or more key employees could have a material adverse effect on the Company. The Company's success will also depend on its ability to attract and retain additional highly qualified management and technical personnel. The Company faces intense competition for qualified personnel, many of whom are often subject to competing employment offers. In the event the Company obtains regulatory approvals for rifaximin, it intends to sell rifaximin through a small direct sales force. New employees, particularly new sales and marketing employees, will require substantial training and education concerning the Company's products. There can be no assurance that the Company will be successful in attracting and retaining qualified personnel as necessary, and the failure to do so could have a material adverse effect on the Company's business, operating results, and financial condition. Price Volatility; Limited Trading Volume; Foreign Exchange Risk. The securities markets have from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of 15 18 particular companies. In addition, the market prices of the common stock of many publicly traded pharmaceutical and biotechnology companies have in the past and can in the future be expected to be especially volatile. Announcements of technological innovations or new products by the Company or its competitors, developments or disputes concerning proprietary rights, publicity regarding actual or potential medical results relating to products under development by the Company or its competitors, regulatory developments in both the United States and other countries, public concern as to the safety of pharmaceutical products and economic and other external factors, as well as period-to-period fluctuations in the Company's financial results, may have a significant impact on the market price of the Company's Common Shares. The Company's Common Shares have traded on The Toronto Stock Exchange since May 1996 and no public trading market exists for the Common Shares in the United States. Trading volume in the Common Shares on The Toronto Stock Exchange has been low, and there can be no assurances that an active trading market will develop or be sustained on The Toronto Stock Exchange, or any other exchange or dealer quotation system. In addition, the performance of the Company's stock on The Toronto Stock Exchange may increase the difficulty of raising capital and there can be no assurance that the Company will be able to access the public capital markets in the event it needs to raise capital. The Common Shares trade on The Toronto Stock Exchange in Canadian dollars. In addition to the general market risks associated with ownership of equity securities and the more specific risks of ownership of the Common Shares of the Company, U.S. holders of the Common Shares also bear exchange rate risks resulting from fluctuations in the relative values of the Canadian dollar and the U.S. dollar. The value of the Canadian dollar has fluctuated substantially in the past relative to the United States dollar and other currencies and may continue to do so in the future. As a result, for U.S. investors and other non-Canadian investors, the value of the Common Shares in United States dollars or other currencies may vary independently of changes in the trading price of the Common Shares on The Toronto Stock Exchange and for reasons unrelated to the Company or its business, results of operations, or financial condition. PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In October 1997, the Company completed the sale of 3,000,000 Common Shares at a per share price of Cdn. $7.00 (U.S. $4.98) in a firm commitment underwritten public offering. The offering was effected in Canada pursuant to final receipts issued by each of the provincial securities commissions and in the United States pursuant to a Registration Statement on Form S-1 (Registration No. 333-33781), which the United States Securities and Exchange Commission declared effective on October 14, 1997. Levesque Beaubien Geoffrion Inc., Yorkton Securities Inc., Marleau, Lemire Securities Inc., and Midland Walwyn Capital Inc underwrote the offering. In the United States, the offering was made by the United States broker-dealer affiliates of the underwriters, NBC Levesque International Ltd., Yorkton Capital Inc., Marleau Lemire (USA), Inc., and Midland Walwyn Capital Corporation, respectively. On October 16, 1997, the date of the effectiveness of the Registration Statement covering the public offering, the Bank of Canada noon rate of exchange for United States dollars into Canadian dollars was Cdn. $1.3866 per U.S. $1.00. Of the Cdn. $21,000,000 in aggregate proceeds raised in connection with the October 1997 offering, (i) approximately Cdn. $1,365,000 was paid to the underwriters in connection with underwriting discounts, and (ii) approximately Cdn. $1,403,000 was paid by the Company in connection with offering expenses, including legal, printing, and filing fees. There were no direct or indirect payments to directors or officers of the Company or any other person or entity. None of the offering proceeds have been used for the construction of plant, building or facilities or the purchase or installation of machinery or equipment or for purchases of real estate or the acquisition of other businesses. The Company is currently investing the net offering proceeds for future use as additional working capital. Such remaining net proceeds have been invested in short-term, interest-bearing, investment grade securities. A portion of the net proceeds may be used for the acquisition of technologies, businesses or products that are complementary to those of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
16 19 3.1.1 Notice of Amendment of Memorandum of Association dated November 11, 1998 10.9.1 Letter Agreement dated October 16, 1998 to Co-Participation Agreement dated April 30, 1993 by and between Salix Pharmaceuticals, Inc. and Astra AB. 27.1 Financial Data Schedule
17 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. SALIX PHARMACEUTICALS, LTD. Date: November 13, 1998 By: /s/ Randy Hamilton ------------------- Randy Hamilton, President and Chief Executive Officer Date: November 13, 1998 By: /s/ David Boyle ---------------- David Boyle, Executive Vice President and Chief Financial Officer 18 21 INDEX TO EXHIBITS
Exhibit Number Description - ------ ----------- 3.1.1 Notice of Amendment of Memorandum of Association dated November 11, 1998 10.9.1 Letter Agreement dated October 16, 1998 to Co-Participation Agreement dated April 30, 1993 by and between Salix Pharmaceuticals, Inc. and Astra AB. 27.1 Financial Data Schedule
EX-3.1.1 2 CERTIFICATE OF AMDNT. TO MEMORANDUM OF ASSOCIATION 1 EXHIBIT 3.1.1 INTERNATIONAL BUSINESS COMPANIES ACT, CAP 291 SECTION 16(2) NOTICE OF AMENDMENT OF MEMORANDUM AND ARTICLES OF ASSOCIATION TO: REGISTRAR OF COMPANIES RE: SALIX PHARMACEUTICALS, LTD. IBC NO 103705 - -------------------------------------------------------------------------------- We, HWR SERVICES LIMITED of Craigmuir Chambers, Road town, Tortola, British Virgin Islands, Registered Agent of the above Company, hereby certify that the document annexed hereto is a true extract of the minutes of a meeting of directors held on 6th November, 1998 amending the Memorandum of Association. Dated this 11th day of November, 1998 /s/ illegible - ------------------------------------- HWR SERVICES LIMITED Registered Agent 2 SALIX PHARMACEUTICALS, LTD. (The "Company") (An International Business Company) TRUE EXTRACT OF THE MINUTES OF A MEETING OF THE DIRECTORS OF THE COMPANY HELD ON 6TH NOVEMBER, 1998 RESOLVED: That Clause 7 of the Company's Memorandum of Association be deleted in its entirety and replaced with the following: "CLASSES, NUMBER AND PAR VALUE OF SHARES 7. The Company is authorized to issue two classes of shares, designated "Preferred Stock" and "Common Stock", respectively. The total number of shares which the Company shall have authority to issue is Forty-Five Million (45,000,000), none of which has any par value. The number of shares of Preferred Stock authorized to be issued is Five Million (5,000,000), and the number of shares of Common Stock authorized to be issued is Forty Million (40,000,000). The Preferred Stock may be issued from time to time in series. The first series shall be designated Series A Preferred Stock (the "Series A Preferred") and shall consist of One Hundred Fifteen Thousand (115,000) shares with the rights, preferences, privileges and restrictions set forth in Clause 8. The second series shall be designated Series B Preferred Stock (the "Series B Preferred") and shall consist of One Hundred Twenty-Six Thousand Four Hundred Forty-Five (126,445) shares with the rights, preferences, privileges and restrictions set forth in Clause 8. The third series shall be designated Series C Preferred Stock (the "Series C Preferred") and shall consist of Five Hundred Thousand (500,000) shares with the rights, preferences, privileges and restrictions set forth in Clause 8. Any remaining shares of Preferred Stock may be issued from time to time in one or more series. The Board of Directors of the Company is authorized to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of Preferred Stock, and within the limitations and restrictions stated in any resolution or resolutions of the Board originally fixing the number of shares constituting any series, to increase or decrease (but not below the number of shares of any such series then outstanding) the number of shares of any such series subsequent to the issue of shares of that series, to determine the designation of any series and to fix the number of shares of any series." Dated this 11th day of November, 1998 /s/ Authorized signatory - -------------------------------- HWR SERVICES LIMITED Registered Agent 2 EX-10.9.1 3 LETTER AGMT. DATED OCTOBER 16, 1998 1 EXHIBIT 10.9.1 October 16, 1998 Salix Pharmaceuticals, Inc. 2500 West Bayshore Road Suite 205 Palo Alto, CA 94303 Attn: Mr. Randy Hamilton President and CEO RE: Co-Participation Agreement Dear Randy: This letter agreement (the "Letter Agreement") amends the Co-Participation Agreement between Astra AB ("Astra") and Salix Pharmaceuticals, Inc. ("Salix") dated as of April 30, 1993 (the "Co-Participation Agreement") as follows: 1. Defined Terms. All capitalized terms used herein without definition shall have the meanings ascribed to such terms in the Co-Participation Agreement. 2. Definitions. (a) The definition of "Applications" in Section 1.1 of the Co-Participation Agreement is hereby amended and restated in its entirety as follows: "Applications" means any use for gastrointestinal disease in humans excluding the treatment of, inhibition of or prevention against neoplasia, dysplasia, hyperplasia, abherrent crypts, polyps, adenomas, carcinoma and other forms of cancer of the gastrointestinal tract. (b) Section 1.1 of the Co-Participation Agreement is hereby amended to add the following definitions in alphabetical order: "IND" means an Investigational New Drug Application made in accordance with applicable regulations and requirements of the FDA as from time to time in effect. "Transferred NDA" means the New Drug Application (as approved by FDA) with respect to the Developmental Product and any supplemental NDAs with respect to the Product to be transferred to Astra on the terms and conditions set forth in Section 2.6 of the Co-Participation Agreement, including such changes thereto and supplemental NDAs as may thereafter be submitted or filed by Astra. 3. NDA. Section 2.6 of the Co-Participation Agreement is hereby amended and restated in its entirety as follows: "Upon completion of the Dossier, Salix shall file the NDA for the Developmental Product with the FDA and shall apply for and pursue obtaining approval for the 2 Salix Pharmaceuticals, Inc. October 16, 1998 Page - 2 - marketing and sale of the Developmental Product in the U.S., which includes the responsibility to fund, perform and complete any Phase IV studies required by the FDA as a condition for such FDA approval. The Project Team and Astra shall have input into the conduct and performance of any such Phase IV study, subject to Salix's right to final say under terms similar to those set forth in Section 2.3 of the Co-Participation Agreement. Upon FDA approval of the NDA for Developmental Product, Salix shall transfer the Transferred NDA to Astra and thereafter, with respect to the Transferred NDA regarding the Product for the Applications, Astra shall have (i) the overall right and responsibility for the management of the FDA relationship and all communications with the FDA and, (ii) subject to the terms of the Co-Participation Agreement, full legal responsibility to the FDA for all aspects of ownership and maintenance thereof, including, without limitation, all adverse event reporting and other required obligations. Upon the request of Astra, Salix shall provide to Astra and to the FDA all additional data and information in Salix's possession (and not previously provided to Astra) required for maintaining approval of the Transferred NDA. Notwithstanding the foregoing, following FDA approval of the NDA for the Developmental Product and the transfer to Astra of the Transferred NDA, Astra and Salix shall cooperate to establish FDA approved labeling for the Product and to resolve relevant issues regarding the Transferred NDA, subject to Astra's right to final determination with respect to such issues. Astra will not take any action to transfer or change any part or aspect of such Transferred NDA (including, without limitation, any aspect of any Drug Master File, manufacturing method or specification) to the extent such actions would reasonably adversely effect Salix's supply and manufacture of Product under the Co-Participation Agreement without the prior written consent of Salix (such consent not to be unreasonably withheld); provided, however, that changes to the Transferred NDA that are required by the FDA shall not be subject to the foregoing prohibition and such changes shall be completed at Astra's sole cost and expense; provided, further, however, that changes to the Transferred NDA that are required by the FDA with respect to supply or manufacture of Product shall be completed at Salix's sole cost and expense. Upon the written request of Salix, Astra will seek, at Salix's sole cost and expense, approval of such changes, amendments and variations to such Transferred NDA as are reasonably requested by Salix (i) to obtain approval of additional suppliers and bulk manufacturers of Product and (ii) to reflect changes in the manufacturing process for Product to the extent Astra would not be materially and adversely affected by such changes. Notwithstanding the foregoing, the rights granted to Astra hereunder shall be in respect of Product only and Salix reserves all of its rights with respect to any indications or applications for Balsalazide other than the Applications to the extent set forth in the Co-Participation Agreement." 4. IND. Section 2 of the Co-Participation Agreement is hereby amended to add Section 2.8 as follows: "2.8 Salix shall own the IND for Balsalazide and the Developmental Product (including all underlying data); provided, however, that Astra shall have the right to use, obtain full and unrestricted access to, and license on a non-exclusive, royalty-free basis, if 3 Salix Pharmaceuticals, Inc. October 16, 1998 Page - 3 - necessary, Salix's IND for Balsalazide and the Developmental Product (including all underlying data) for the purpose of maintaining the Transferred NDA." 5. Transferred NDA Access. Section 2 of the Co-Participation Agreement is hereby amended to add Section 2.9 as follows: "2.9 Salix shall have the right to reference, use, obtain full and unrestricted access to, and license on a non-exclusive, royalty-free basis, if necessary, the Transferred NDA solely for the purpose of registering and maintaining regulatory filings that do not constitute use for the Applications; provided; however, that all contact with the FDA relating to the Transferred NDA shall be conducted exclusively through and by Astra. Within thirty (30) days after the request of Salix, Astra shall provide notification to FDA and other applicable regulatory authorities to allow Salix to exercise its rights under this Section." 6. Phase III/IV Clinical Study. Section 6 of the Co-Participation Agreement is hereby amended to add Section 6.7 as follows: "Salix is presently conducting a study in the United States, CP079701, comparing Balsalazide with Asacol(R) (the "Study"). Salix agrees to conduct and complete the Study in the manner set forth in the protocol titled "A PHASE III RANDOMIZED, DOUBLE-BLIND, DOSE-RESPONSE COMPARISON OF COLAZIDE(R) (BALSALZIDE DISODIUM) 6.75 G DAILY VS. ASACOL(R) (MELSALAMINE) 2.4 G DAILY IN PATIENTS WITH ACTIVE MILD OR MODERATE ULCERATIVE COLITIS" and dated December 19, 1997 (including, without limitation, completing the Study with 150 "evaluable" (per protocol) patients as specified therein). In consideration therefor, Astra shall pay Salix $3 million as follows: (i) $1 million within 15 days after the date of this Letter Agreement; (ii) $1 million within 15 days after the last patient out of the Study; and (iii) $1 million within 15 days after completion and submission to Astra of a complete study report on the Study. Salix shall keep Astra fully informed as to the status and conduct of the Study (including, without limitation, periodic reports on the Study's progress and forecasted time and date for completion of the Study) and shall provide to Astra full and unrestricted access to such results of the Study. In addition, Salix shall permit Astra to use the results of such Study and to disclose the same to third parties in connection with the use, regulatory approval and sale of the Product in any jurisdiction or territory in which Astra has rights to the Product." 7. Supply of Product. The last sentence of Section 12.7 of the Co-Participation Agreement is hereby amended to delete the word "after" and replace such word with "within". 8. Patent Term Restoration. Section 21 of the Co-Participation Agreement is hereby amended to add Section 21.5 as follows: 4 Salix Pharmaceuticals, Inc. October 16, 1998 Page - 4 - "21.5 Salix and Astra shall cooperate with each other in obtaining patent term restoration or supplemental protection certificates or their equivalents in the U.S. where applicable to the Product." 9. Astra Associate. Salix acknowledges that Astra Pharmaceuticals, L.P. ("APLP") is an "Astra Associate" for purposes of the Co-Participation Agreement and that the rights and obligations of Astra therein and in this Letter Agreement may be exercised or discharged, as the case may be, by APLP. Astra and Salix each acknowledge that any notice or communication received by Salix from APLP shall be deemed as received from Astra for purposes of the Co-Participation Agreement. For purposes of notices under the Co-Participation Agreement, all notices to Astra shall require a copy thereof to APLP at 725 Chesterbrook Blvd., Wayne, PA 19087-5677, facsimile transmission number 610-695-1924 and marked for the attention of General Counsel. 10. Effectiveness. Except as set forth in this Letter Agreement, the Co-Participation Agreement shall remain in full force and effect and unchanged and is hereby confirmed in all respects. 11. Governing Law. This Letter Agreement shall be governed by and construed in accordance with the laws of the State of New York, excluding any choice of law rules which may direct the application of the law of any other jurisdiction. 12. Counterparts. This Letter Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. If the foregoing is acceptable to you, please evidence your agreement by executing a copy of this Letter Agreement and returning same to the undersigned. Very truly yours, ASTRA AB (publ) By: /S/ Carl-Gustaf Johansson --------------------------------- Name: Carl-Gustaf Johansson Title: N/A ACCEPTED and AGREED to this 16th day of October, 1998: SALIX PHARMACEUTICALS, INC. 5 Salix Pharmaceuticals, Inc. October 16, 1998 Page - 5 - By: /S/ Randy W. Hamilton ------------------------------- Name: Randy W. Hamilton Title: President and CEO EX-27.1 4 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1998 SEP-30-1998 8,146 0 584 0 718 9,566 246 232 9,863 2,138 0 0 0 27,609 (19,884) 9,863 138 138 207 207 2,081 0 0 0 0 0 0 0 0 (2,012) (.20) (.20)
-----END PRIVACY-ENHANCED MESSAGE-----