-----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, OLABQTwKsfZXw+sRymmbLNmYdDCTmqs91CP1Irwc5DLSwk6yOGL8Dj1rA/IjozBY bVEWoGbhG31qY3svi10dQQ== 0000950117-97-000518.txt : 19970401 0000950117-97-000518.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950117-97-000518 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALGOS PHARMACEUTICAL CORP CENTRAL INDEX KEY: 0000924862 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 223142274 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-28844 FILM NUMBER: 97570640 BUSINESS ADDRESS: STREET 1: 4900 ROUTE 33 CITY: NEPTUNE STATE: NJ ZIP: 07753 BUSINESS PHONE: 9089385959 10-K 1 ALGOS PHARMACEUTICAL CORPORATION 10K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________ COMMISSION FILE NO. 011 - 12221 ALGOS PHARMACEUTICAL CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 22-3142274 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) COLLINGWOOD PLAZA, 4900 ROUTE 33, NEPTUNE NJ 07753-6804 (Address of principal executive offices) (ZIP Code) Registrant's telephone number, including area code:(908) 938-5959 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 [ 'ch' ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $165 million, based on the last sales price of the Common Stock as of February 28, 1977. As of February 28, 1997 15,789,451 shares of Common Stock, $0.01 par value, of the registrant were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE See Part III hereof with respect to incorporation by reference from the registrant's definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. PART I Item 1. BUSINESS COMPANY OVERVIEW Algos Pharmaceutical Corporation ("Algos" or the "Company") is developing a new generation of proprietary pain management products which combine existing analgesic or anesthetic drugs with N-methyl-D-Aspartate ("NMDA") antagonist drugs that have been approved for human use in other applications. Independent research and the Company's pre-clinical studies and clinical trials conducted to date have shown that the Company's products may significantly improve pain relief over currently available analgesics, including narcotic drugs such as morphine, hydrocodone and oxycodone and non-narcotic analgesics such as acetaminophen (e.g., Tylenol'r'), ibuprofen (e.g., Advil'r') and etodolac (Lodine'r') . In addition, the Company is using its NMDA antagonist technology to develop: (i) extended duration local anesthetics for surgery; (ii) an intranasal treatment of migraine; (iii) treatments for opiate and cocaine addiction; and (iv) an urge incontinence treatment. The Company believes that its analgesic and anesthetic products have the potential for more rapid market introduction than many other new drugs because (i) the Company's products combine existing drugs whose separate safety profiles are known and established and (ii) clinical trials for new analgesics and anesthetics historically have achieved statistically significant results with fewer patients than may be required for many other drugs. The Company currently anticipates that it will file its first New Drug Application ("NDA") with the United States Food and Drug Administration ("FDA") in the latter part of 1997. The Company's products that have reached Phase II or Phase III clinical trials or are scheduled for Phase II or Phase III clinical trials in 1997 are: (i) Narcotic analgesic/NMDA antagonist combination products: MorphiDex'tm', expected to be used primarily to treat cancer and AIDS pain, HydrocoDex Plus'tm', expected to be used primarily to treat moderate to moderately severe post-operative pain, trauma pain, and chronic pain conditions and OxycoDex'tm', expected to be used primarily to treat moderate to moderately severe pain including arthritis flare-up pain; (ii) Over-The-Counter ("OTC") analgesic/NMDA antagonist combination products licensed to McNeil Consumer Products Company including a combination product of an NMDA antagonist with acetaminophen, the largest selling OTC analgesic, and a combination product of an NMDA antagonist with an OTC non-steroidal anti-inflammatory drug ("NSAID"); (iii) An Etodolac/NMDA antagonist combination product intended to treat arthritis pain; (iv) An Injectable local anesthetic/NMDA combination product intended to provide greater anesthetic effect with longer and more controlled duration for use in dental procedures and in-patient and out-patient surgeries; (v) LidoDex NS'tm', an intranasal combination of lidocaine and an NMDA antagonist for the treatment of migraine headache developed in collaboration with Interneuron Pharmaceuticals, Inc.; (vi) Products intended as treatments for opiate addiction which the Company expects to develop in collaboration with the National Institute on Drug Abuse ("NIDA"), National Institutes of Health ("NIH"); and (vii) An NMDA antagonist intended as a treatment for urge urinary incontinence. NARCOTIC ANALGESICS: Narcotic analgesic drugs remain the most common and useful treatment for moderate to severe pain in both acute and chronic conditions. These drugs consist of naturally occurring opiates (e.g., morphine), opiate derivatives (e.g., codeine, hydrocodone, oxycodone) and synthetic opiates (e.g., methadone). Drawbacks to these drugs include unwanted side effects such as mental clouding, respiratory depression, nausea and constipation and the development of rapid tolerance and physical dependence. Tolerance refers to the condition under which a drug dose that was initially effective in producing analgesia becomes less effective with repeated administrations. Therefore, to alleviate the same level of pain, the drug dose has to be increased over time. Increasing the drug dose may, however, produce an increase in unwanted side effects and may also increase the potential for drug dependence. 1 Pre-clinical studies of the Company's narcotic analgesic/NMDA antagonist combination products and pivotal Phase II double-blinded, placebo-controlled clinical trials of MorphiDex'tm' indicate superior first-dose analgesic effects as compared to equivalent dosage levels of the narcotic analgesic alone. Pre-clinical studies also indicate greater efficacy with the Company's narcotic/NMDA antagonist combinations with repeated administrations over time, when the narcotic analgesic administered alone became less effective. MorphiDex'tm' MorphiDex'tm', the Company's most developmentally-advanced product, is a patented morphine and dextromethorphan combination designed to treat moderate to severe pain, primarily cancer and AIDS pain. The Company's research and development activities to date with respect to MorphiDex'tm' include: (i) pre-clinical pharmacology studies which indicate that morphine tolerance may be significantly reduced by co-administration with an NMDA antagonist; (ii) two completed 28-day toxicity studies in rats and dogs which indicate that MorphiDex'tm' is safe at multiples of the projected clinical doses. (iii) one completed, double-blind Phase I/II clinical trial to assess safety and abuse liability which indicates no significant decrease in product safety and possible lower abuse potential over morphine; (iv) one completed, double-blind Phase I/II clinical trial in chronic pain patients which confirmed a combination of morphine or morphine equivalents together with an NMDA antagonist, at projected therapeutic dose levels, was as safe as morphine and that such a combination may provide superior pain relief over morphine; (v) two completed pivotal Phase II clinical efficacy trials in oral surgery patients which indicate statistically significant superior pain relief of MorphiDex'tm' over morphine alone (second pivotal Phase II clinical trial completed in February, 1997). Additional Phase III clinical trials are underway which, together with completed Phase I/II and Pivotal Phase II clinical trials, are anticipated by the Company to lead to an NDA filing in 1997. HydrocoDex Plus'tm' Hydrocodone is a narcotic primarily used to treat moderate to moderately severe post-operative, musculoskeletal and trauma-related pain. The analgesic products containing hydrocodone that are sold commercially in the U.S. are combination products containing acetaminophen. Current products include Lorcet'r' and Vicodin'r'. HydrocoDex Plus'tm' is a hydrocodone, acetaminophen and dextromethorphan combination product. The Company's initial research indicates that HydrocoDex Plus'tm' may be able to offer the same analgesic pain relief with lower dosages of the narcotic component compared to the hydrocodone/acetaminophen combinations. The combination of a narcotic analgesic with an NMDA antagonist appears to extend analgesic duration negating the need for sustained release. Thus, HydrocoDex Plus'tm' offers the potential to provide the first sustained-duration analgesic in the hydrocodone/acetaminophen market. Multiple Phase II and Phase III studies are scheduled in 1997. 2 OxycoDex'tm' Oxycodone is an opiate narcotic that, in combination with acetaminophen or aspirin, forms the basis for a group of products which are used for the treatment of moderate to moderately severe pain. Current products include Percocet'r' and Tylox'r'. OxycoDex'tm' is a combination of oxycodone, aspirin and dextromethorphan. A Phase II trial of OxycoDex'tm' is underway with the National Institute of Dental Research ("NIDR"). The Company plans to initiate its own Phase II trials in 1997. It is anticipated that OxycoDex'tm' will be used with various inflamatory pain conditions (e.g., arthritis flare-up pain) where an NSAID analgesic provides insufficient pain relief. NON-NARCOTIC ANALGESICS: OTC Analgesics In June 1996, the Company entered into a license agreement (the "McNeil License Agreement") with McNeil Consumer Products Company, an affiliate of Johnson & Johnson, pursuant to which the Company granted McNeil the exclusive rights to develop certain acetaminophen/NMDA antagonist combination products and certain NSAID/NMDA antagonist combination products (ibuprofen and certain other NSAIDs approved for OTC use) for the treatment of pain. The Company sponsored pre-clinical studies to evaluate acetaminophen in combination with NMDA antagonists. The results indicate that combining an NMDA antagonist with acetaminophen may increase the efficacy of acetaminophen. In a placebo-controlled Phase II clinical trial conducted by NIDR, patients taking a scheduled regimen of an NMDA antagonist (dextromethorphan) before and after oral surgery required substantially less acetaminophen after the surgery to relieve pain. McNeil Consumer Products Company has completed one double-blind, placebo-controlled clinical trial of an acetaminophen and dextromethorphan combination product in dental surgery patients. An acetaminophen and dextromethorphan combination product Phase III clinical trial is in progress. A Phase II clinical trial of an ibuprofen and dextromethorphan combination product is scheduled in 1997. PRESCRIPTION NSAID: Pre-clinical studies have indicated that the analgesic efficacy of NSAIDs, such as etodolac, may be increased when combined with an NMDA antagonist. The Company believes that a product based on a combination of existing dosage levels of an NSAID with an NMDA antagonist would offer analgesic efficacy that is superior to existing NSAID analgesics and could have the potential to achieve rapid market acceptance. In addition, at dosage levels where the NSAID indicated no analgesic effect by itself, a significant analgesic effect was indicated by the addition of an NMDA antagonist. As a result, an NSAID/NMDA antagonist combination product may also be formulated to give an equivalent analgesic effect while lowering the NSAID dosage and thus potentially reducing certain dosage-related side effects of NSAIDs, such as gastrointestinal bleeding and ulcers. The Company plans to initiate a Phase II clinical study of an etodolac/NMDA antagonist combination product in 1997. LIDOCAINE/NMDA ANTAGONIST COMBINATIONS: Injectable Anesthetic The Company, in collaboration with Brigham and Women's Hospital, Harvard Medical School, is conducting research into the potentiation of local anesthetics by NMDA antagonists. Pre-clinical studies have indicated that the NMDA antagonist, dextromethorphan, may increase the depth and duration of anesthesia of lidocaine. With the current emphasis on preemptive analgesia, same day surgery and shorter hospital stays, the Company believes that a longer duration anesthetic may provide greater patient comfort when post-surgical pain is most severe. A Phase II clinical study, in cooperation with NIDR, is planned in 1997. LidoDex NS'tm' 3 An agreement has been entered into with Interneuron Pharmaceuticals, Inc. for LidoDex NS'tm', a combination of lidocaine and an NMDA antagonist for the treatment of migraine. This agreement has three stages: (i) initial development which encompasses IND preparation, a Phase I safety study and a Phase II efficacy study; (ii) Phase III clincals; and (iii) marketing activities. Initial development will be largely funded by Interneuron, while costs of Phase III clinicals will be shared equally. ADDICTION TREATMENT DRUGS: NIDA estimates that there are two million opiate addicts in the United States and 1.5 to 2 million cocaine abusers. The Company is developing NMDA antagonist-based products as opiate and cocaine addiction treatment drugs. Pre-clinical studies have indicated that NMDA antagonists may have potential for the treatment of dependence on opiate narcotics and cocaine abuse. NIDA has initiated a Phase II clinical study of methadone in combination with an NMDA antagonist in collaboration with the Company to test the opiate addiction treatment drug. OTHER PRODUCTS: An estimated five million people in the U.S. suffer from urge urinary incontinence. Existing urge urinary incontinence drugs generally have unpleasant side effects and low levels of efficacy. Company-sponsored pre-clinical studies have indicated that NMDA antagonists may block the bladder micturition reflex. A Phase II clinical trial is currently being conducted at the Stanford University School of Medicine to evaluate an NMDA antagonist in urge incontinent patients. The Company is considering a number of other possible products. The Company's drug development program is based upon a continuous review of clinical results, newly published scientific papers, the possibility of joint development or research arrangements with research institutions or commercial organizations, the availability of resources, including acceptable third party clinical facilities and available funds. Accordingly, the Company's development program is subject to revision and change at any time without notice. The preceding discussion with respect to the Company's plans is a description of the Company's present intentions as of the date of this report, and the Company does not expect to update this schedule prior to its next annual report, although it may choose to do so. The Company's product development schedule and plans for drug development constitute forward-looking statements and are subject to the numerous contingencies and risks set forth under "Risk Factors." SCIENTIFIC OVERVIEW A key element of the Company's technology is the use of NMDA antagonists which block the NMDA receptor. NMDA receptors are believed to be present in nerve cells in the brain and spinal cord. There is increasing evidence that there may also be peripheral NMDA receptors. The important role of the NMDA receptor in pain response has become recognized among scientists and clinicians. Research indicates that the NMDA receptor plays a role in neuropathic pain, development of tolerance to and dependence on narcotic analgesics and development of hyperalgesia due to chronic administration of opiate narcotics. According to current scientific theory, activation of this receptor results in a cascade of intracellular events beginning with the influx of extracellular calcium. This influx of calcium results in activation of the enzyme protein kinase C and its subsequent translocation from cytosol to the membrane. Through protein phosphorylation, enduring changes then occur in the membrane constituents including receptors. This cascade of events beginning with the activation of the NMDA receptor has been implicated in numerous neuroplastic phenomena such as post-tetanic potentiation resulting in sensitized and overly active nerve cells and consequently may cause spontaneous pain and/or increased sensitivity to pain. It is believed that narcotic analgesics reduce pain by binding to opiate receptors located on nerve cells in the brain and spinal cord. Although the initial effect of this binding is to inhibit the nerve cell and thereby reduce pain, opiate receptor activation is also believed to stimulate the NMDA receptor leading to the cascade of events described in the previous paragraph. Many researchers believe that increased NMDA receptor activation represents the underlying cellular mechanism of opiate tolerance and dependence. Pre-clinical studies indicate that by blocking the NMDA receptor, tolerance to and dependence on opiates may be reduced and the development of hyperalgesia prevented. The involvement of the NMDA receptor in dependence is also the basis for development of NMDA antagonists to treat drug addiction. 4 CORPORATE AND GOVERNMENT COLLABORATIONS The McNeil License Agreement provided for an initial payment of $2.0 million by McNeil to the Company and provides for additional payments of up to $8.0 million by McNeil upon the achievement of certain milestones, generally relating to product development and patent issuances. In addition, the Company will be entitled to receive royalty payments from McNeil based upon net product sales subject to minimum royalties, provided that certain conditions have been met, even if McNeil has not commenced marketing of an acetaminophen product or an NSAID product. McNeil will bear substantially all future costs of developing products it selects. The McNeil License Agreement extends until the later of the expiration of the Company's patent rights or ten years, provided that the McNeil License Agreement is terminable: (i) by either party in the event of a material breach by the other party upon 90 days notice or upon certain events of bankruptcy; (ii) by McNeil, at any time after one year from the effective date of the agreement; and (iii) by the Company under certain circumstances. Under certain circumstances, the McNeil License Agreement could terminate with respect to either acetaminophen or NSAID products without terminating with respect to the other category. In the event of a termination by McNeil, McNeil must pay all royalty payments and milestone payments due through the date of termination and the technology licensed by McNeil reverts to the Company. In such event, the Company retains the rights to the results of two clinical studies funded by the Company, and McNeil retains the rights to the results of the clinical studies funded by McNeil during the term of the McNeil License Agreement. See "Business -- Patents, Trade Secrets and Licenses -- Licenses." In December 1996, the Company entered into a development and marketing collaboration and license agreement with Interneuron Pharmaceuticals, Inc. for the development and commercialization of a product to treat acute migraine headache. The agreement grants to Interneuron rights, co-exclusive with Algos, to use Algos patents and know-how to manufacture and market the product. In the initial stage of development, Algos will supply formulation development in support of the IND and Interneuron will perform toxicology, Phase I safety and Phase I/II safety and efficacy studies. Thereafter, the companies will generally share equally the remaining development costs, including clinical trials, regulatory activities, and manufacturing scale-up, and similarly share in marketing and profits of the resulting product, if any. After the initial stage of development, the agreement may be terminated by either Company with the terminating party retaining an interest in a resulting product, either in the form of a royalty on sales or the repayment of certain of its development costs. In June 1996, the Company entered into a letter of intent with NIDA, NIH, pending formal approval of a CRADA to conduct joint research on a methadone/NMDA antagonist combination drug as a potential treatment for opiate addiction. ACADEMIC AND RESEARCH COLLABORATIONS Virginia Commonwealth University, The Medical College of Virginia In 1994, the Company entered into a collaborative research agreement with The Medical College of Virginia with the option for subsequent annual renewals. Under the terms of this agreement, The Medical College of Virginia provides pre-clinical research exclusively to the Company in the field of: (i) prevention of tolerance to and dependence on opiates, opiate derivatives and opioids; (ii) treatment of chronic pain; and (iii) treatment of neuropathic pain, under the direction of David J. Mayer, Ph.D and Donald D. Price, Ph.D., Professors, Department of Anesthesiology, The Medical College of Virginia. Brigham and Women's Hospital In 1995, the Company entered into a research agreement with Brigham and Women's Hospital, Inc., a teaching affiliate of the Harvard Medical School. Under the terms of this agreement, Brigham and Women's Hospital performs pre-clinical research exclusively for the Company in the field of long lasting anesthetics under the direction of Gary R. Strichartz, Ph.D., Professor of Anesthesia (Pharmacology). The research is designed to measure certain characteristics and effects of various anesthetic/NMDA antagonist combinations covered by the Company's existing or pending patents. 5 Stanford University The Company has entered into a series of research agreements with Stanford University. Under the direction of Christos E. Constantinou, Ph.D. of the Stanford University School of Medicine, certain NMDA antagonists were tested in pre-clinical studies to assess their potential for use in the treatment of urge urinary incontinence. The studies were conducted with products that are the subject of one of the Company's pending patent applications. In addition, Christopher Payne, M.D. is currently conducting a clinical trial to further test the potential of such NMDA antagonists for the treatment of urge urinary incontinence. In addition, the Company conducts clinical trials with major research institutions and medical centers and Contract Research Organizations ("CROs") that provide additional manpower as required to manage several study programs simultaneously. TECHNICAL DEVELOPMENT AND PRODUCTION The Company generally seeks to contract third parties for formulation development, manufacture of clinical trial materials and scale-up work. The Company generally selects third party contractors that it believes have the capability to commercially manufacture the products. The key advantage to this approach is that the third party contractor which performed the developmental work will have the equipment, operational parameters and validated testing procedures already in place for the commercial manufacture of the Company's products. The Algos management team is experienced in selecting and managing activities at third party contract companies. By selecting qualified third party contractors or by choosing development partners that provide full-scale contract manufacturing services, the Company believes it will be able to shorten development and production scale-up time. MARKETING Algos plans to market its products either directly or through co-marketing or licensing agreements with pharmaceutical companies. The Company's marketing strategy is to develop a direct sales force in the U.S. in market segments with relatively concentrated distribution channels to target hospitals, health maintenance organizations and pharmaceutical buyer groups. Algos does not expect to establish a direct sales capability until such time as one or more of its products in development receives marketing approval from the FDA. In market segments that require large or specialized sales capabilities, such as OTC analgesic products and certain foreign countries, the Company will seek strategic alliances with leading pharmaceutical companies such as under the McNeil License Agreement or the agreement with Interneuron. Implementation of this strategy will depend on the market potential of the Company's products, its financial resources and timely regulatory approvals. COMPETITION The Company's products under development are expected to address several different markets. The Company's proposed products will be competing with currently existing or future products of other companies. Competition among these products will be based on, among other things, product efficacy, safety, reliability, availability, price and patent position. Many of the Company's existing or potential competitors have substantially greater financial, technical and human resources than the Company, may be better equipped to develop, manufacture and market products and have more extensive experience in pre-clinical testing and human clinical trials. These companies may develop and introduce products and processes competitive to those of the Company. The Company competes with pharmaceutical companies that develop, produce and market products in the United States, Europe and elsewhere. In addition, academic institutions, government agencies and other public and private organizations conducting research may seek patent protection, discover new drugs or establish collaborative arrangements for drug research. The Company's narcotic analgesic and anesthetic products, when developed and marketed, will compete with products generally marketed by medium-sized pharmaceutical companies. In other analgesic segments, such as antiarthritic and OTC analgesic products, the Company's products, when developed and marketed, will compete with products marketed by some of the largest pharmaceutical companies in the U.S. In these segments, the Company may enter into license agreements with pharmaceutical companies having greater resources than the Company. 6 PATENTS, TRADE SECRETS AND LICENSES Patent Rights The Company seeks to protect its proprietary position by, among other methods, filing United States and foreign patent applications with respect to the development of its products and their uses. The Company plans to prosecute and defend its patent applications, issued patents and proprietary information. The Company's ability to compete effectively will depend in part on its ability to develop and maintain proprietary aspects of its planned products. The Company, as of March 1, 1997, has an exclusive license for four U.S. patents, one pending U.S. patent application for which it has received a notice of allowance and five other pending U.S. patent applications under its agreement with The Medical College of Virginia, and several corresponding pending foreign patent applications. The Company also owns seven pending U.S. patent applications and plans to file additional patent applications. Of the patents issued to The Medical College of Virginia, U.S. Patent No. 5,321,012 entitled "Inhibiting the Development of Tolerance to and/or Dependence on a Narcotic Addictive Substance" (issued June 14, 1994) claims compositions and methods for inhibiting the development of tolerance to and/or dependence on a variety of narcotic analgesics including codeine, fentanyl, heroin, hydrocodone, morphine and oxycodone employing any one of several specific nontoxic NMDA antagonists including dextromethorphan and dextrorphan; U.S. Patent No. 5,352,683 entitled "Method for the Treatment of Chronic Pain" (issued October 4, 1994) claims a method for treating chronic pain employing any one of several specific nontoxic NMDA antagonists such as those previously mentioned;, U.S. Patent No. 5,502,058 entitled "Method for the Treatment of Pain" (issued March 26, 1996) covers a method of alleviating preexisting or prospectively occurring pain employing dextromethorphan or dextrorphan in combination with lidocaine,and U.S. Patent No. 5,556,838 (issued September 17, 1996) claims a composition containing any nontoxic NMDA antagonist, or any nontoxic substance that blocks a major intracellular consequence of NMDA receptor activation, and any one of several addictive substances, including morphine. A related patent application covering a companion method for inhibiting the development of tolerance to and/or dependence on any addictive substances has been allowed. Reflecting the Company's major research and development direction, its patent program is primarily focused on securing intellectual property rights to technology for the following categories of its business: (i) the use of pharmacologically acceptable NMDA antagonists for the management of acute, chronic, pre-operative and post-operative pain states, (ii) the use of NMDA antagonists for the potentiation of local anesthesia and (iii) the use of NMDA antagonists for the treatment of other conditions such as urge urinary incontinence. The Company is employing a dual-level strategy of claiming its drug discoveries mechanistically and in terms of specific therapeutics. This strategy is intended to maximize the Company's opportunities for obtaining the broadest possible patent protection and, at the same time, result in issued patents with complementary and mutually reinforcing claims. The patent positions of pharmaceutical firms, including the Company, are generally uncertain and involve complex legal and factual questions. Consequently, even though the Company is currently prosecuting its patent applications with the U.S. Patent and Trademark Office ("PTO") and certain foreign patent authorities, the Company does not know whether any of its applications will result in the issuance of any patents, or if any patents issue, whether they will provide significant proprietary protection or will be circumvented or invalidated. Since patent applications in the U.S. are maintained in secrecy until patents issue, and since publication of discoveries in the scientific or patent literature tend to lag behind actual discoveries by several months, the Company cannot be certain that it was the first creator of inventions claimed by pending patent applications or that the Company was the first to file patent applications for such inventions. See "Risk Factors -- Uncertain Ability to Protect Proprietary Technology". The Company also relies upon trade secrets, know-how, continuing innovation and licensing opportunities to develop and maintain its competitive position. It is the Company's current practice to require its employees, consultants, members of its Medical and Research Advisory Board, sponsored researchers and other advisors to execute confidentiality agreements upon the commencement of employment or consulting relationships with the Company. These agreements provide that all confidential information developed or made known to the individual during the course of the individual's relationship with the Company is to be kept confidential and not disclosed to third parties, subject to certain exceptions. In the case of employees, the agreements provide that all inventions conceived by the individual shall be the exclusive property of the Company. There can be no assurance, however, that these agreements will provide meaningful protection for the Company's trade secrets or adequate remedies in the event of unauthorized use or disclosure of such information. The Company engages in collaborations and sponsored research agreements and enters into pre-clinical and clinical testing agreements with academic and research institutions and U.S. government agencies, such as NIH. 7 Consistent with pharmaceutical industry and academic standards, and the rules and regulations under the Federal Technology Transfer Act of 1986, these agreements may provide that developments and results will be freely published, that information or materials supplied by the Company will not be treated as confidential and that the Company may be required to negotiate a license to any such developments and results in order to commercialize products incorporating them. There can be no assurance that the Company will be able to successfully obtain any such license at a reasonable cost or that such developments and results will not be made available to competitors of the Company on an exclusive or a non-exclusive basis. The Company's success depends in part on its ability to obtain patent protection for its products and to preserve its trade secrets and operate without infringing on the proprietary rights of third parties. No assurance can be given that the Company's pending patent applications will be approved or that any patents will provide competitive advantages for its products or will not be successfully challenged or circumvented by its competitors. No assurance can be given that patents do not exist or could not be filed which would have an adverse effect on the Company's ability to market its products or maintain its competitive position with respect to its products. The Company's patents may not prevent others from developing competitive products using related technology. Other entities may obtain patents which cover aspects of the Company's products or processes which are necessary for or useful to the development, manufacture or use of the Company's products. As a result, the Company may be required to obtain licenses from others to develop, manufacture or market such products. There can be no assurance that the Company will be able to obtain any such licenses on commercially reasonable terms, if at all. No assurance can be given that any patent issued to, or licensed by, the Company will provide protection that has commercial significance. In this regard the patent position of pharmaceutical compounds and compositions is particularly uncertain. Even issued patents may be later modified or revoked by the PTO in proceedings instituted by the Company or others. In addition, no assurance can be given that the Company's patents will afford protection against competitors with similar compounds or technologies, that others will not obtain patents claiming aspects similar to those covered by the Company's patents or applications, or that the patents of others will not have an adverse effect on the ability of the Company to do business. The Company's patents may not prevent others from developing competitive positions using related technology. Licenses The Company has entered into a license agreement, which was last amended in June 1996 (the "Amendment"), with The Medical College of Virginia for certain patents or pending patent applications owned by The Medical College of Virginia in the field of pain management in the country in which any such product or part thereof is made, used, sold or manufactured. In consideration for the terms of the Amendment, the Company issued 100,000 shares of Series B Preferred Stock to The Medical College of Virginia which are convertible at the option of the holder into 100,000 shares of the Company's Common Stock at any time after February 1, 1997. The Company pays no license signing fees or milestone payments. Royalties for the life of the patent equal 4% of net sales. If a product is combined with a drug or other substance for which the Company is paying an additional royalty, the royalty rate paid to The Medical College of Virginia is generally reduced by the amount of such additional royalty. If the Company enters into sublicensing agreements for a covered product, the Company will pay The Medical College of Virginia 50% of royalty payments received from such sublicensees' net sales for each year until the payments total $500,000 for such year, 33% until the payments total an additional $500,000 for such year and 25% thereafter. The McNeil License Agreement is a sublicense agreement of the Company's license agreement with The Medical College of Virginia. GOVERNMENT REGULATION In the U.S., pharmaceutical products intended for therapeutic or diagnostic use in humans are subject to rigorous FDA regulation. The process of completing clinical trials and obtaining FDA approvals for a new drug is likely to take a number of years and require the expenditure of substantial resources. There can be no assurance that any product will receive such approval on a timely basis, if at all. See "Risk Factors - Government Regulation; No Assurance of United States or Foreign Regulatory Approval." Applicable FDA regulations treat the Company's combination of dextromethorphan with analgesics such as morphine, acetaminophen and ibuprofen and local anesthetics such as lidocaine as new drugs and require the filing of an NDA and approval by the FDA. However, since each of these drugs has been separately approved by the FDA, management believes that the risks associated with the development of these new proprietary drugs are less than the risks inherent in new molecular drug discovery. The steps required before a new pharmaceutical product for use in humans may be marketed in the U.S. include (i) pre-clinical studies, (ii) submission to the FDA of an Investigational New Drug application ("IND"), which must 8 become effective before human clinical trials commence, (iii) adequate and well-controlled human clinical trials to establish the safety and effectiveness of the product, (iv) submission of an NDA to the FDA, and (v) FDA approval of the NDA prior to any commercial sale or shipment of the product. Pre-clinical studies include laboratory evaluation of product chemistry and formulation, and animal studies to assess the potential safety and effectiveness of the product. The results of the pre-clinical studies are submitted to the FDA as a part of an IND and are reviewed by the FDA prior to the commencement of human clinical trials. Unless the FDA objects to, or otherwise responds to, an IND, the IND will become effective 30 days following its receipt by the FDA. Clinical trials are typically conducted in three sequential phases, although phases may overlap. In Phase I, the investigational new drug usually is administered to healthy human subjects and is tested for safety (adverse effects), dosage, tolerance, metabolism, distribution, excretion and pharmacodynamics (clinical pharmacology). Phase II involves studies in a limited patient population to (i) determine the effectiveness of the investigational new drug for specific indications, (ii) determine dosage tolerance and optimal dosage and (iii) identify possible adverse effects and safety risks. When an investigational new drug is found to be effective and to have an acceptable safety profile in Phase II evaluation, Phase III trials are undertaken to further evaluate clinical effectiveness and to further test for safety within an expanded patient population at geographically dispersed clinical study sites. For analgesic drugs, Phase II analgesic efficacy studies have historically served as the pivotal studies for an NDA. Phase III studies for these products normally focus greater attention on safety in larger patient populations rather than efficacy. There can be no assurance that Phase I, Phase II or Phase III testing will be completed successfully within any specified time period, if at all, with respect to any of the Company's products subject to such testing. Furthermore, the FDA may suspend clinical trials at any time there is concern that the participants are being exposed to an unacceptable health risk. The results of pharmaceutical development, pre-clinical studies and clinical trials are submitted to the FDA in the form of an NDA for approval of the marketing and commercial shipment of the product. The FDA may require additional testing or information before approving the NDA. The FDA may deny an NDA approval if safety, efficacy or other regulatory requirements are not satisfied. Moreover, if regulatory approval of the product is granted, such approval may require post-marketing testing and surveillance to monitor the safety of the product or may entail limitations on the indicated uses for which the product may be marketed. Finally, product approval may be withdrawn if compliance with regulatory standards is not maintained or if problems occur following initial marketing. At present, pharmaceutical products generally may not be exported from the U.S. for other than research purposes until the FDA has approved the product for marketing in the U.S. However, a company may apply to the FDA for permission to export finished products or partially processed products to a limited number of countries prior to obtaining FDA approval for marketing in the U.S. The Company is also subject to regulation under federal and state laws, including the Occupational Safety and Health Act, the Environmental Protection Act, the Clean Air Act, national restrictions on technology transfer, and import, export and customs regulations. In addition, all of the Company's products that contain narcotics are subject to Drug Enforcement Agency ("DEA") regulations relating to storage, distribution and physician prescribing procedures. There can be no assurance that any portion of the regulatory framework under which the Company currently operates will not change and that such change will not have a material effect on the current and anticipated operations of the Company. Whether or not FDA approval has been obtained, approval of a pharmaceutical product by comparable governmental regulatory authorities in foreign countries must be obtained prior to the commencement of clinical trials and subsequent marketing of such product in such countries. The approval procedure varies from country to country, and the time required may be longer or shorter than that required for FDA approval. EMPLOYEES At February 28, 1997, the Company had twelve employees and two executive consultants, including five Ph.Ds and/or MDs. In addition, the Company engages consultants from time to time to perform services on a per diem or hourly basis. 9 Item 2. PROPERTIES The Company's executive office is located at Collingwood Plaza, 4900 Route 33, Neptune, New Jersey 07753. The Company's current lease agreement expires in November 1997. The leased property consists of approximately 2,000 square feet of office and storage space which will increase to 6,000 square feet effective April 1, 1997. Item 3. LEGAL PROCEEDINGS There are no legal proceedings pending against the Company. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 10 PART II Item 5. MARKET PRICE At March 3, 1997, Algos had approximately 150 shareholders of record and the Company believes that the number of beneficial holders exceeds 500. Common shares of the Company are traded in the over-the-counter market and their price quoted on the NASDAQ Stock Market under the symbol "ALGO." The following table sets forth the range of the highest and lowest sales prices for the Company's common stock since public trading commenced:
Year Ended December 31, 1996: High Low ---- --- Third Quarter, beginning September 26 14 1/2 14 Fourth Quarter 15 9 7/8
The Company has never declared or paid any cash dividends on its capital stock. Item 6. SELECTED FINANCIAL DATA The selected financial information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Company's financial statements and related notes contained elsewhere in this report.
Years Ended December 31, (in thousands, except per share data) ---------------------------------------------------------------- Statement of Operations Data: 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- Revenues . . . . . . . . . . . . . $ 96(1) $ 215(1) $ --- $ --- $ 2,000 Operating expenses: Research and development . . . . 125 40 654 1,615 3,344 General and administrative . . . 369 436 623 760 2,467 --- --- ----- ----- ----- Total operating expenses. . . 494 476 1,277 2,375 5,810 --- --- ----- ----- ----- Interest income. . . . . . . . . . 13 4 153 253 723 --- --- ----- ----- ----- Net loss. . . . . . . . . . . . . $ (385) $(257) $(1,124) $(2,122) $(3,087) ======= ====== ======== ======== ======== Pro forma net loss per common share (2) $ (0.17) $(0.23) ======== ======= Pro forma weighted average common shares outstanding (2) 12,199 13,161 ====== ====== December 31, (in thousands) ---------------------------------------------------------------- Balance Sheet Data: 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- Cash and cash equivalents . . . . $ 288 $ 124 $ 5,634 $ 3,707 $48,576 Working capital . . . . . . . . . 180 81 5,503 3,419 47,932 Total assets. . . . . . . . . . . 330 153 5,765 3,820 49,202 Deficit accumulated during the development stage . . . . . . . . (385) (642) (1,766) (3,888) (6,976) Total stockholders equity. . . . . 214 108 5,618 3,521 48,228
(1) Represents revenues from consulting activities in which the Company has ceased to engage. (2) Adjusted to give effect as of January 1, 1995 to the automatic conversion of all outstanding shares of Series A Preferred Stock upon consummation of the Company's initial public offering of Common Stock. See Note 2 to the Financial Statements. 11 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Algos, a development stage company, is engaged primarily in the development and commercialization of proprietary pharmaceutical products. Since its formation in January 1992, the Company has devoted a substantial amount of its efforts to licensing technology, recruiting key management and staff, developing products, filing patents and other regulatory applications and raising capital. To date, the Company has earned no revenue from its planned principal line of business. The Company has incurred losses since its inception and expects to incur significant operating losses in the future. The Company expects that its product development expenses will increase significantly during 1997 and in future years as the drugs that the Company currently has under development move into advanced clinical trials and as additional drugs are considered for development. In addition, the Company expects that its personnel costs will increase significantly in the future, primarily as a result of the planned development of a direct sales force. Results of Operations Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995 Revenue In the 1996 period, the Company recognized $2,000,000 of license revenue representing the initial payment under the McNeil License Agreement. Research and Development In 1996, research and development expenses increased $1,728,673, to $3,343,616 in 1996 from $1,614,943 in 1995. The 1996 period reflects expansion of the Company's clinical trials, particularly trials of its most developmentally-advanced product MorphiDex'tm' and the Company's non-narcotic drugs licensed to McNeil. Fees to clinical investigators and CROs, which increased approximately $1.3 million, and related increases in clinical drug supplies, consultants, etc. were partially offset by reduced spending on pre-clinical studies and formulation development. General and Administrative Expenses In 1996, general and administrative expenses increased $1,706,537 to $2,466,577 in 1996 from $760,040 in 1995. The increase was due primarily to a charge of $915,000 in the 1996 period relating to the issuance of Series B Preferred Stock in connection with an amendment to the license agreement with The Medical College of Virginia and amortization of unearned compensation expense of approximately $361,000 in connection with the grant of stock options. Added professional fees and compensation expense also contributed to the increase. Interest Income In 1996, interest income increased $470,167 to $722,715 in 1996 from $252,548 in 1995 as a result of the investment of proceeds from the Company's initial public offering of Common Stock in October 1996. Year Ended December 31, 1995 Compared to the Year Ended December 31, 1994 Research and Development In 1995, research and development expenses increased $961,229, to $1,614,943 from $653,714 in 1994. This increase was primarily attributable to the Company's pre-clinical studies in the field of NMDA antagonists. In 1995, direct costs associated with pre-clinical studies and clinical trials were approximately $542,000 and formulation development, drug supplies and related analytical services totaled approximately $265,000. Compensation expense increased as a result of the addition of employees and consultants. Spending on other programs also contributed to the increase in 1995 expenditures. Expenses in 1994 consisted primarily of employee and consultant compensation as the Company established its research management team and initiated sponsored research programs at three universities. General and Administrative Expenses 12 In 1995, general and administrative expenses increased $136,821, to $760,040 from $623,219 in 1994. This increase was primarily attributable to additional employee compensation and related taxes and benefits. In addition, general office expenses such as rent, utilities, and supplies increased as a result of increased business activities and employment. Interest Income In 1995, interest income increased $99,301, to $252,548 from $153,247 in 1994 as a result of the investment of proceeds from the Company's private placement of Series A Preferred Stock, which was completed in August 1994. Liquidity and Capital Resources General In 1996, 1995, and 1994, spending for the Company's product development efforts and related activities resulted in net cash outflows from operations of $1,556,604, $1,929,321, and $991,928 respectively. Accumulated cash balances at December 31, 1993, which resulted from the Company's initial capitalization together with additional investments by the Company's founders, were sufficient to provide operating funds into 1994. In 1994, in order to initiate its planned product development programs, the Company sold 700,000 shares of Series A Preferred Stock in a private placement, resulting in net proceeds of $6,609,015. A portion of these funds were used to fund the Company's development efforts in 1995 and part of 1996. In July 1996, the Company received $2.0 million from McNeil upon execution of the McNeil License Agreement and in October 1996 completed its initial public offering of 3,625,000 shares of Common Stock which provided net proceeds to the Company of $46.3 million. The Company had cash and cash equivalents of $48.6 million at December 31, 1996. The Company expects to invest substantial funds in the development of its products and to generate significant losses in the future. The Company has entered into a number of agreements for research and development spending, primarily related to its development of MorphiDex'tm'. Its future spending and funding requirements will depend on a number of factors, including the results of the Company's development efforts, the timing and cost of obtaining required regulatory approvals, the development of competing technologies, the amount of resources required for the establishment of marketing and distribution capabilities, the execution of licensing or other collaborative research agreements on terms acceptable to the Company, and the cost of prosecuting and defending patents. The Company currently expects that its cash and equivalents at December 31, 1996 will be sufficient to fund its operations for the development of products currently in clinical trials, based upon the Company's presently anticipated schedule of clinical trials, and other working capital requirements for more than two years. If, however, additional trials are deemed to be necessary or advisable, the Company may require additional funds to complete such trials and, in the event that revenue and income from successful product introductions or other internally generated funds are insufficient for such efforts, the Company will need to raise additional funds by incurring debt, issuing additional equity or through collaborative or license arrangements. In addition, the Company may determine to develop additional products. Development of additional products would require additional funds. See -"Risk Factors -- Need for Additional Funds." Certain information set forth in the prior paragraphs contains forward-looking statements as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. All statements concerning the expected use of funds, its development schedule and the ability to fund operations for approximately three years are forward looking statements. Certain factors discussed herein could cause actual results to differ materially from those in the forward-looking statements. See "Risk Factors." Net Operating Loss Carryforwards At December 31, 1996, the Company had accumulated net operating loss carryforwards of approximately $4.0 million, which expire in 2009 through 2011 and are available to reduce future taxable income recognized in the carryforward period, if any. Due to the uncertainty of future taxable income, the Company has established a valuation allowance for these carryforwards and has not recognized their potential benefit on a current basis. The future utilization of these carryforwards may be limited by Section 382 of the Internal Revenue Code related to changes in Company ownership. 13 Other Generally, the Company's results of operations are not significantly affected by seasonal factors and the Company does not believe that inflation has had a significant impact on its business. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 123 - "Accounting for Stock Based Compensation,'" which generally requires disclosure of the impact on earnings of stock based employee compensation arrangements. The Company has adopted the disclosure requirements of SFAS No. 123. In February 1997, the Financial Accounting Standards Board Issued SFAS No. 128 - "Earnings Per Share" which specifies computation and disclosure requirements for earnings per share and is effective for financial statements issued after December 15, 1997. Management has not yet determined the impact that SFAS No. 128 will have on the Company's financial statements, when adopted. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA 14 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Stockholders ALGOS PHARMACEUTICAL CORPORATION: We have audited the accompanying balance sheets of Algos Pharmaceutical Corporation (a development stage enterprise) as of December 31, 1996 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Algos Pharmaceutical Corporation as of December 31, 1996 and 1995 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Princeton, New Jersey March 4, 1997 15 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) BALANCE SHEETS
December 31, December 31, 1995 1996 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 3,707,100 $48,575,719 Prepaid expenses 11,057 330,083 ------------ ------------- Total current assets 3,718,157 48,905,802 Property and equipment, net 100,704 86,682 Other assets 1,591 209,257 ------------ ------------- Total assets $3,820,452 $49,201,741 ============ ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 158,297 $ 456,684 Other current liabilities 141,335 516,786 ------------ ------------- Total current liabilities 299,632 973,470 ------------ ------------- Commitments Stockholders' equity: Preferred stock, $10,537,500 and $100,000 aggregate liquidation preference 7,025 1,000 Common stock, $.01 par value, 50,000,000 shares authorized, 6,010,030 and 15,669,101 shares outstanding 60,100 156,691 Additional paid-in-capital 7,341,890 55,902,403 Unearned compensation expense (856,150) Deficit accumulated during the development stage (3,888,195) (6,975,673) ------------ ------------- Total stockholders' equity 3,520,820 48,228,271 ------------ ------------- Total liabilities and stockholders' equity $ 3,820,452 $49,201,741 ============ =============
The accompanying notes are an integral part of these statements 16 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF OPERATIONS
Cumulative from For the year ended December 31, inception to ------------------------------------------ December 31, 1994 1995 1996 1996 ---- ---- ---- ---- (UNAUDITED) Revenues $ - $ - $2,000,000 $2,311,000 -------------- ------------- ------------- ---------------- Operating expenses: Research and development 653,714 1,614,943 3,343,616 5,777,273 General and administrative 623,219 760,040 2,466,577 4,654,839 -------------- ------------- ------------- ---------------- Total operating expenses 1,276,933 2,374,983 5,810,193 10,432,112 -------------- ------------- ------------- ---------------- Loss from operations (1,276,933) (2,374,983) (3,810,193) (8,121,112) Interest income 153,247 252,548 722,715 1,145,439 -------------- ------------- ------------- ---------------- Net loss $(1,123,686) $(2,122,435) $(3,087,478) $(6,975,673) ============== ============= ============= ================ Pro forma: Net loss per common share $ (0.17) $ (0.23) ============= ============= Weighted average common shares outstanding 12,199,217 13,161,287 ============= =============
The accompanying notes are an integral part of these statements 17 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF CASH FLOWS
Cumulative from For the year ended December 31, inception to ------------------------------------------- December 31, 1994 1995 1996 1996 ---- ---- ---- ---- (UNAUDITED) Net loss $(1,123,686) $(2,122,435) $(3,087,478) $(6,975,673) Net loss Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 18,115 35,782 44,038 111,297 Amortization of unearned compensation 424,690 424,690 Common stock issued for technology 125,000 Preferred stock issued for services 25,000 25,000 Preferred stock issued under license agreement 915,000 915,000 Changes in assets and liabilities: Prepaid expenses (14,096) 5,476 (319,026) (330,083) Other assets 600 (675) (207,666) (209,257) Accounts payable 25,549 102,371 298,387 456,684 Other current liabilities 76,590 50,160 375,451 516,786 ------------- --------------- ------------- ------------- Net cash used in operating activities (991,928) (1,929,321) (1,556,604) (4,940,556) ------------- --------------- ------------- ------------- Cash flows from investing activities: Purchases of property and equipment (106,757) (22,500) (30,016) (197,979) ------------- --------------- ------------- ------------- Net cash used in investing activities (106,757) (22,500) (30,016) (197,979) ------------- --------------- ------------- ------------- Cash flows from financing activities: Proceeds from issuance of preferred stock, net 6,609,015 50,000 6,659,015 Proceeds from issuance of common stock, net 50 24,950 46,405,239 47,055,239 ------------- --------------- ------------- ------------- Net cash provided by financing activities 6,609,065 24,950 46,455,239 53,714,254 ------------- --------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents 5,510,380 (1,926,871) 44,868,619 48,575,719 Cash and cash equivalents, beginning of period 123,591 5,633,971 3,707,100 - ------------- --------------- ------------- ------------- Cash and cash equivalents, end of period $5,633,971 $3,707,100 $48,575,719 $48,575,719 ============= =============== ============= =============
The accompanying notes are an integral part of these statements 18 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Convertible preferred stock Common stock ------------------------------ ----------------------------- Shares Amount Shares Amount ------------ ------------ ------------- ------------ Issuance of Common Stock, January 1992, $.10 per share 4,841,664 $ 48,417 Issuance of Common Stock for technology, January 1992, $.10 per share 968,336 9,683 Net loss ------------ ------------ ------------ ------------ Balance, December 31, 1992 5,810,000 58,100 Capital contributions, including $25,000 of technology Net loss ------------ ------------ ------------ ------------ Balance, December 31, 1993 5,810,000 58,100 Issuance of Series A Preferred Stock, May through August 1994, $10.00 per share, net of offering costs 700,000 $ 7,000 Issuance of Series A Preferred Stock for services, May 1994, $10.00 per share 2,500 25 Exercise of stock options 415 4 Net loss ------------ ------------ ------------ ------------ Balance, December 31, 1994 702,500 7,025 5,810,415 58,104 Exercise of stock options 199,615 1,996 Net loss ------------ ------------ ------------ ------------ Balance, December 31, 1995 702,500 7,025 6,010,030 60,100 Exercise of Series A Preferred Stock warrants 5,000 50 Issuance of Series B Preferred Stock under license agreement, June 1996, $9.15 per share 100,000 1,000 Exercise of stock options 161,821 1,618 Issuance of Common Stock, October 1996, $14.00 per share, net of offering costs 3,625,000 36,250 Conversion of Series A Preferred Stock (707,500) (7,075) 5,872,250 58,723 Unearned compensation expense Amortization of unearned compensation expense Net loss ------------ ------------ ------------ ------------ Balance, December 31, 1996 100,000 $ 1,000 15,669,101 $ 156,691 ============ ============ ============ ============
Deficit accumulated Unearned during the Total Additional paid compensation development stockholders' in capital expense stage equity ------------ ----------- ------------ ------------- Issuance of Common Stock, January 1992, $.10 per share $ 451,583 $ 500,000 Issuance of Common Stock for technology, January 1992, $.10 per share 90,317 100,000 Net loss $ (385,434) (385,434) ------------ ------------ ------------ ------------ Balance, December 31, 1992 541,900 (385,434) 214,566 Capital contributions, including $25,000 of technology 150,000 150,000 Net loss (256,640) (256,640) ------------ ------------ ------------ ------------ Balance, December 31, 1993 691,900 (642,074) 107,926 Issuance of Series A Preferred Stock, May through August 1994, $10.00 per share, net of offering costs 6,602,015 6,609,015 Issuance of Series A Preferred Stock for services, May 1994, $10.00 per share 24,975 25,000 Exercise of stock options 46 50 Net loss (1,123,686) (1,123,686) ------------ ------------ ------------ ------------ Balance, December 31, 1994 7,318,936 (1,765,760) 5,618,305 Exercise of stock options 22,954 24,950 Net loss (2,122,435) (2,122,435) ------------ ------------ ------------ ------------ Balance, December 31, 1995 7,341,890 (3,888,195) 3,520,820 Exercise of Series A Preferred Stock warrants 49,950 50,000 Issuance of Series B Preferred Stock under license agreement, June 1996, $9.15 per share 914,000 915,000 Exercise of stock options 17,851 19,469 Issuance of Common Stock, October 1996, $14.00 per share, net of offering costs 46,349,520 46,385,770 Conversion of Series A Preferred Stock (51,648) Unearned compensation expense 1,280,840 $ (1,280,840) Amortization of unearned compensation expense 424,690 424,690 Net loss (3,087,478) (3,087,478) ------------ ------------ ------------ ------------ Balance, December 31, 1996 $ 55,902,403 $ (856,150) $ (6,975,673) $ 48,228,271 ============ ============ ============ ============
The accompanying notes are an integral part of these financial statements. 19 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION Algos Pharmaceutical Corporation (the "Company"), is engaged primarily in the development of proprietary pain management pharmaceuticals. Since its formation in January 1992, the Company has devoted a substantial portion of its efforts to developing products, licensing technology, filing regulatory applications and raising capital. The Company is subject to a number of risks common to companies in similar stages of development including, but not limited to, the lack of assurance of successful product development, the absence of manufacturing facilities, and the risk of technological obsolescence. In May 1996, the Company effected an 8.3-for-1 stock split in the form of a stock dividend. All historical share and per share data have been restated to reflect the stock split. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Development Stage Enterprise The accompanying statements have been prepared in accordance with the provisions of Statement of Financial Accounting Standard (SFAS) No. 7, "Accounting and Reporting by Development Stage Enterprises." Cash and Cash Equivalents The Company considers money market securities with maturities of three months or less, when purchased, to be cash equivalents. Property and Equipment, Net Property and equipment are recorded at cost less accumulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives of the assets which range from three to seven years. Gains and losses on depreciable assets retired or sold are recognized in the statement of operations in the year of disposal. Repairs and maintenance expenditures are expensed as incurred. Revenue License fees are recognized as revenue when earned in accordance with the terms of the underlying agreements. Income Taxes The Company accounts for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse. Stock Based Compensation In October 1996, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock Based Compensation" which requires expanded disclosures of stock-based compensation arrangements with employees and encourages, but does not require, the recognition of employee compensation expense related to stock compensation based on the fair value of the equity instrument granted. The Company has elected to adopt the disclosure requirements of this pronouncement. 20 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS Earnings Per Share Pro forma net loss per common share is based on the net loss and the weighted average number of common shares after giving effect to the conversion of all Series A Preferred Stock into 5,872,250 shares of common stock as of January 1, 1995. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, all common stock options and other common stock equivalents granted by the Company during the twelve months prior to the filing date of the registration statement for the Company's initial public offering of common stock have been included in the calculation of pro forma weighted average common shares outstanding as if they were outstanding for all periods prior to the offering. Stock options and warrants granted prior to this twelve-month period have not been included in the calculation of net loss per common share because inclusion of such shares would be antidilutive. Historical net loss per common share is based on the weighted average number of common shares outstanding during the periods presented. Historical net loss per common share is as follows:
For the years ended December 31, -------------------------------- 1994 1995 1996 ---- ---- ---- Net loss per common share $(0.19) $(0.35) $(0.36) Weighted average number of common shares outstanding 5,810,050 6,002,635 8,535,080
3. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of investments in money market funds and obligations of the U.S. Treasury and federal agencies which mature within three months. 1. PROPERTY AND EQUIPMENT, NET Property and equipment consist of the following:
December 31, ------------ 1995 1996 ---- ---- Office furniture and equipment $ 94,510 $111,042 Computer equipment 73,453 86,937 -------- -------- 167,963 197,979 Less accumulated depreciation 67,259 111,297 -------- -------- $100,704 $ 86,682 ======== ========
5. PREPAID EXPENSES AND OTHER ASSETS Prepaid expenses and other assets consist primarily of insurance premiums which are amortized on the straight-line basis over the coverage periods of the underlying policies. 6. OTHER CURRENT LIABILITIES Other current liabilities consist of the following:
December 31, ------------ 1995 1996 ---- ---- Accrued compensation $118,100 $ 214,750 Accrued research expenses 23,235 302,036 -------- --------- $141,335 $ 516,786 ======== =========
21 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS 7. INCOME TAXES Prior to March 1, 1994, the Company had elected to be treated as an S Corporation for federal income tax reporting purposes. Under this election, the Company's stockholders were responsible for reporting the Company's federal taxable loss on their personal tax returns. In connection with the issuance of Series A Preferred Stock, the Company's S status terminated and the corporation converted to C Corporation status. The C Corporation assumed the tax bases of the assets and liabilities of the S Corporation as of the termination date. Accordingly, the Company records deferred taxes for the effect of cumulative temporary differences in accordance with the provisions of SFAS No. 109, 'Accounting for Income Taxes' for federal tax purposes as of the termination date. For state tax purposes, the Company has been treated as a C Corporation since inception. At December 31, 1996, the Company had available net operating loss carryforwards and research and development credits for federal income tax purposes of approximately $4,000,000 and $149,000, respectively, which expire in the years 2009 through 2011. The use of these net operating loss and credit carryforwards may be subject to limitations under section 382 of the Internal Revenue Code pertaining to changes in stock ownership. Due to the uncertainty of their realization, no income tax benefits have been recorded by the Company for these net operating loss or credit carryforwards as valuation allowances have been established for any such benefits. The increase in the valuation allowance amounted to $406,100, $906,300 and $1,122,200 in 1994, 1995, and 1996 respectively. Deferred tax assets and (liabilities) for federal and state income taxes consist of the following:
December 31 ----------- 1995 1996 ---- ---- Net operating loss carryforwards $ 1,236,800 $ 1,776,900 ----------- ----------- Research and development tax credits 70,000 149,100 License Costs 355,300 Accrued liabilities and other 3,200 147,400 Depreciation and amortization 2,400 5,900 ----------- ----------- Total deferred tax assets 1,312,400 2,434,600 Valuation allowance (1,312,400) (2,434,600) Net deferred tax assets $ 0 $ 0 =========== ===========
8. COMMITMENTS AND CONTINGENT LIABILITIES Licensing Agreements The Company has a license agreement with a university for certain pain management technology which requires the Company to pay royalties based on sales of licensed products and a share of royalties received from sublicensees. Leases Rent expense for the Company's office facilities amounted to $12,608, $21,841, $22,475 for the years ended December 31, 1994, 1995, and 1996 respectively and $67,924 cumulatively from the date of inception. Minimum lease payments amount to $56,607 in 1997 when the Company's current lease agreement expires. 9. SIGNIFICANT AGREEMENTS In June 1996, the Company entered into a license agreement with McNeil Consumer Products Company, an affiliate of Johnson & Johnson, which provides McNeil with exclusive worldwide marketing rights to certain of the Company's products under development. The Company received an initial payment of $2,000,000 in 1996 and may receive additional payments based on the achievement of certain milestones. McNeil will be responsible for substantially all of the remaining development costs subsequent to an initial clinical study funded by the Company in 1996. In addition, the Company will receive royalties based on sales of licensed products, if any. The agreement may be terminated by McNeil after one year. In December 1996, the Company entered into a development and marketing collaboration and license agreement with Interneuron Pharmaceuticals, Inc. for the development and commercialization of a product to treat acute migraine headache. The agreement grants to Interneuron rights, co-exclusive with Algos, to use Algos patents and know-how 22 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS to manufacture and market the product. After an initial stage of development, which will be largely funded by Interneuron, the agreement provides that the companies will generally share equally the remaining development costs, including pre-clinical studies, clinical trials, and regulatory activities, and similarly share in marketing and profits of the resulting product, if any. After the initial stage of development, the agreement may be terminated by either Company with the terminating party retaining an interest in a resulting product, either in the form of a royalty on sales or the repayment of certain of its development costs. In 1996, the Company contributed certain intangible assets having no book value to a newly formed company, and received preferred stock with an aggregate stated value and liquidation preference of $2,800,000 and all of the transferee's common stock. The common stock was subsequently distributed to the Company's stockholders, warrant holders and certain of its employees. The preferred stock provides for an annual cumulative dividend of 30%, which may be paid in the form of cash or common stock, and a share of other earnings. The preferred stock may be redeemed for the stated value plus accrued dividends at any time at the transferee's option or at the Company's option at the end of two years. The Company recorded no gain in connection with the transactions as management believes that at the present time realization of the redemption value is not assured. 10. STOCKHOLDERS' EQUITY The Company is authorized to issue 10,000,000 shares of $.01 par value per share preferred stock with rights, preferences and limitations determined by the Board of Directors of the Company, 100,000 of which have been designated Series B. In 1996, the Company issued 100,000 shares of convertible Series B Preferred Stock in connection with an amendment to a license agreement with a university and recorded an administrative expense of $915,000. Shares of Series B Preferred Stock carry dividend rights equal to shares of Common Stock and are convertible into an equal number of shares of Common Stock at any time on or after February 1, 1997. In connection with the Company's initial public offering of Common Stock, all shares of previously issued Series A Preferred Stock were converted to Common Stock and Preferred Stock warrants were converted to Common Stock warrants at a rate of 8.30 common shares for each preferred share or warrant. Preferred Stock consists of the following:
December 31, ------------ 1995 1996 ---- ---- Convertible Series A; 872,000 and 0 shares authorized, 702,500 and 0 shares issued and outstanding $ 7,025 Convertible Series B; 0 and 100,000 shares authorized, 0 and 100,000 shares issued and outstanding $ 1,000
As of December 31, 1996, warrants to purchase 296,725 shares of common stock at an exercise price of $1.20 per share were outstanding and exercisable. The warrants expire in 2001. The Company maintains stock option plans for its employees, directors and consultants. See Footnote 12. 11. OTHER RELATED PARTY TRANSACTIONS Certain directors and shareholders of the Company have been associated with law firms that rendered various legal services to the Company. The Company recorded charges of approximately $163,000, $16,000 and $443,000 in 1994, 1995, and 1996 respectively, and $625,000 from the date of inception, for these services, including services rendered in connection with issuances of stock. As of December 31, 1995 and 1996, $2,500 and $4,500 of these charges were unpaid, respectively. 12. STOCK OPTION PLANS The 1996 Stock Option Plan authorizes the grant of non-qualified stock options and incentive stock options to purchase shares of Common Stock covering 415,000 authorized but unissued or reacquired shares of Common Stock. Unless sooner terminated by the Board of Directors, the 1996 Option Plan will expire on January 31, 2006. The Compensation Committee of the Board of Directors has the authority to select the persons to whom grants are to be made, to designate the number of shares of Common Stock to be covered by such grants, to determine the exercise price of options, to establish the period of exercisability of options, and to take all other actions for the administration of the 1996 Option Plan. The 1996 Option Plan permits the payment of the option exercise price to be made in cash or 23 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS by delivery of shares of Common Stock valued at their fair market value on the date of exercise or delivery of other property, or by a recourse promissory note payable to the Company, or by a combination of the foregoing. The 1996 Non-Employee Director Stock Option Plan covers 83,000 authorized but unissued or reacquired shares of Common Stock and is intended to assist the Company in attracting and retaining qualified non-employee directors. The Director Plan is administered by the Board of Directors and provides for automatic grants of non-qualified stock options to purchase 10,000 shares of Common Stock to each non-employee director at the time of appointment or election to the Board of Directors. The exercise price of the options shall be the fair market value of a share of Common Stock on the date of grant. Each option shall generally become exercisable in cumulative annual installments of one-third on each of the first three annual meetings of the Company's stockholders following the date of grant so long as the non-employee director continues to serve as a director of the Company. In addition, each non-employee director shall be granted an option to purchase 5,000 shares of Common Stock on an annual basis. Unless sooner terminated by the Board of Directors, the Director Plan will expire in 2006. A summary of the status of the Company's stock option plans as of December 31, 1994, 1995, and 1996 and changes in the years then ended is as follows:
1994 1995 1996 -------------------- -------------------- --------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Outstanding at beginning of year -- -- 772,315 $ 0.13 597,600 $ 0.13 Granted 772,730 $ 0.13 24,900 $ 0.12 316,690 $ 3.13 Exercised (415) $ 0.12 (199,615) $ 0.13 (161,850) $ 0.12 -------- ------ --------- ------ --------- ------ Outstanding at end of year 772,315 $ 0.13 597,600 $ 0.13 752,440 $ 1.39 ======== ======== ======== Options exercisable at end of year 199,200 215,800 343,530 Weighted average fair value of options granted during the year: Exercise price equal to market value of stock $ 0.01 $ 4.30 Exercise price greater than market value of stock Exercise price less than market value of stock $ 4.60
The fair value of each option grant is estimated using the Black-Scholes option pricing model for grants after the Company's October 1996 initial public offering of Common Stock and a minimum value method for prior grants. The following weighted-average assumptions were used for grants in 1994, 1995 and 1996, respectively: no dividend yield for all years, risk-free interest rates of 6.7%, 6.0%, and 6.2%, expected lives of 3.9, 1.0, and 3.9, and expected volatility of 55% after October 1996. A summary of stock options outstanding as of December 31, 1996 is as follows:
Outstanding Exercisable -------------------------------- -------------------- Weighted average Weighted Weighted remaining average average contractual exercise exercise Range of exercise prices Number life price Number price ------------------------ ------ ---- ----- ------ ----- $ 0.12 - $ 0.13 678,970 4.0 $ 0.13 324,530 $ 0.13 $11.25 - $14.00 73,500 8.5 $13.06 19,000 $12.47 --------- --------- 752,440 4.4 $ 1.39 343,530 $ 0.81 ======= =======
24 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS The Company records compensation expense for stock option grants in accordance with APB No. 25, "Accounting for Stock Issued to Employees." Had the Company elected to record compensation for stock option grants in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's pro forma net income and earnings per share amounts would be as follows:
1995 1996 ----------------- ----------------- Net income As reported: ($2,122,435) ($3,087,478) Pro forma: ($2,122,610) ($3,118,334) Pro forma earnings per As reported: ($0.17) ($0.23) share Pro forma: ($0.17) ($0.24) Historical earnings per As reported: ($0.35) ($0.36) share Pro forma: ($0.35) ($0.37)
Pro forma amounts reflect options granted after 1994 and are not likely to be representative of amounts in future years, as additional options are awarded and vested. Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTANTING AND FINANCIAL DISCLOSURE Not Applicable. 25 PART III The information required by Item 10, Directors and Executive Officers of the Registrant; Item 11, Executive Compensation; Item 12, Security Ownership of certain Beneficial Owners and Management; and Item 13, Certain Relationships and Related Transactions will be included in and is incorporated by reference from the Registrant's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the close of its fiscal year. 26 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Exhibits:
Exhibit No. Title - -------- --------------------------------------------------------------------------------- 3.1 Form of Amended and Restated Certificate of Incorporation of Algos Pharmaceutical Corporation(1) 3.2 Form of Amended and Restated By-laws of Algos Pharmaceutical Corporation(1) 4.1 Form of Stock Certificate of Common Stock(1) 10.1.1 Employment Agreement with Respect to John W. Lyle(1) 10.1.2 Employment Agreement with Respect to Gastone Bello(1) 10.1.3 Employment Agreement with Respect to Frank S. Caruso(1) 10.2.1 1994 Stock Option Plan(1) 10.2.2 Form of 1996 Stock Option Plan(1) 10.2.3 Form of 1996 Non-Employee Director Stock Option Plan 10.3.1 Algos Pharmaceutical Corporation Stockholders' Agreement(1) 10.4.1 License Agreement with The Medical College of Virginia(1) 'D''D' 10.4.2 License Agreement with McNeil(1) 'D''D' 10.4.3 Registration Rights Agreement with The Medical College of Virginia(1) 11 Statement Regarding Computation of Per Share Earnings 21 Subsidiaries of the Registrant(1) 27 Financial Data Schedule 'D' 99 Risk Factors
(1) Incorporated by reference to the Registrant's registration statement on Form S-1 declared effective on September 25, 1996. 'D' Included in EDGAR filing only. 'D''D' Portions of this Exhibit have received confidential treatment pursuant to Rule 406(b) under the Securities Act. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Algos Pharmaceutical Corporation /s/ JOHN W. LYLE DATE: MARCH 31, 1997 BY: __________________________________ JOHN W. LYLE PRESIDENT AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
NAME TITLE DATE ---- ----- ---- /s/ JOHN W. LYLE - ------------------------- President, Chief Executive March 31, 1997 JOHN W. LYLE Officer and Director /s/ DONALD G. DRAPKIN - ------------------------- Director March 31, 1997 DONALD G. DRAPKIN - ------------------------- Director March , 1997 MICHAEL HYATT /s/ ROGER H. KIMMEL - ------------------------- Director March 31, 1997 ROGER H. KIMMEL /s/ JAMES R. LEDLEY - ------------------------- Assistant Secretary and Director March 31, 1997 JAMES R. LEDLEY - ------------------------- Director March , 1997 DIETER A. SULSER /s/ GARY ANTHONY - ------------------------- Chief Financial Officer March 31, 1997 GARY ANTHONY (Principal Accounting Officer)
28 STATEMENT OF DIFFERENCES ------------------------ The checkmark shall be expressed as ....................... 'ch' The trademark symbol shall be expressed as ................ 'tm' the registered trademark symbol shall be expressed as ..... 'r' The dagger symbol shall be expressed as ................... 'D' EX-10 2 EXHIBIT 10.2.3 THE ALGOS PHARMACEUTICAL CORPORATION 1996 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN Algos Pharmaceutical Corporation, a Delaware corporation, has adopted the Algos Pharmaceutical Corporation 1996 Non-Employee Director Stock Option Plan (the "Plan"), effective ___________ ___, 1996, for the benefit of its eligible non-employee directors. The purposes of this Plan are as follows: (1) To provide an additional incentive for non-employee directors to further the growth, development and financial success of the Company by personally benefiting through the ownership of options with respect to Company stock which recognize such growth, development and financial success. (2) To enable the Company to obtain and retain the services of non-employee directors considered essential to the long range success of the Company by offering them an opportunity to own options with respect to stock in the Company which will reflect the growth, development and financial success of the Company. ARTICLE I DEFINITIONS 1.1 General. Wherever the following terms are used in this Plan they shall have the meaning specified below, unless the context clearly indicates otherwise. 1.2 Board. "Board" shall mean the Board of Directors of the Company. 1.3 Code. "Code" shall mean the Internal Revenue Code of 1986, as amended. 1.4 Common Stock. "Common Stock" shall mean the common stock of the Company, par value $0.01 per share. 1.5 Company. "Company" shall mean Algos Pharmaceutical Corporation, Delaware corporation. 1.6 Corporate Transaction. "Corporate Transaction" shall mean any of the following stockholder-approved transactions to which the Company is a party: (a) a merger or consolidation in which the Company is not the surviving entity, except for a transaction the principal purpose of which is to change the state in which the Company is incorporated, form a holding company or effect a similar reorganization as to form whereupon this Plan and all Options are assumed by the successor entity; (b) the sale, transfer, exchange or other disposition of all or substantially all of the assets of the Company, in complete liquidation or dissolution of the Company in a transaction not covered by the exceptions to clause (a), above; or (c) any reverse merger in which the Company is the surviving entity but in which securities possessing more than fifty percent (50%) of the total combined voting power of the Company's outstanding securities are transferred to a person or persons different from those who held such securities immediately prior to such merger. 1.7 Director. "Director" shall mean a member of the Board. 1.8 Employee. "Employee" shall mean any officer or other employee (as defined in accordance with Section 3401(c) of the Code) of the Company or of any corporation which is a Subsidiary. 1.9 Exchange Act. "Exchange Act" shall mean the Securities Exchange Act of 1934, ------------ as amended. 1.10 Fair Market Value. "Fair Market Value" of a share of Common Stock as of a given date shall be (a) the average on that date of the high and low prices of a share of Common Stock on the principal national securities exchange on which shares of Common Stock are then trading, or, if shares were not traded on such date, then on the next preceding date on which a trade occurred, or (b) if Common Stock is not traded on a national securities exchange but is quoted on NASDAQ or a successor quotation system, the last reported sale price on such date as reported by NASDAQ or such successor quotation system; or (c) if Common Stock is not traded on a national securities exchange and is not reported on NASDAQ or a successor quotation system, the closing bid price (or average of bid prices) last quoted on such date by an established quotation service for over-the-counter securities; or (d) if Common Stock is not traded on a national securities exchange, is not reported on NASDAQ or a successor quotation system and is not otherwise publicly traded on such date, the fair market value of a share of Common Stock as established by the Board acting in good faith and taking into consideration all factors which it deems appropriate, including, without limitation, recent sale offer prices for the Common Stock in private arm's-length transactions. 1.11 Independent Director. "Independent Director" shall mean a member of the Board who is not an Employee of the Company. 1.12 Option. "Option" shall mean a stock option granted under Article III of this Plan, which is not intended to qualify as an "incentive stock option" under Section 422 of the Code. 1.13 Option Agreement. "Option Agreement" shall mean an agreement between the Company and an Optionee that sets forth the terms, conditions and limitations applicable to an Option. 1.14 Optionee. "Optionee" shall mean an Independent Director granted an Option under this Plan. 1.15 Plan. "Plan" shall mean this Algos Pharmaceutical Corporation 1996 Non- Employee Director Stock Option Plan. 1.16 QDRO. "QDRO" shall mean a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended, or the rules thereunder. 1.17 Rule 16b-3. "Rule 16b-3" shall mean that certain Rule 16b-3 under the Exchange Act, as such Rule may be amended from time to time. 2 1.18 Securities Act. "Securities Act" shall mean the Securities Act of 1933, as amended. 1.19 Subsidiary. "Subsidiary" shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. 1.20 Termination of Directorship. "Termination of Directorship" shall mean the time when an Optionee ceases to be a Director for any reason, including, but not by way of limitation, a termination by resignation, failure to be elected, removal or death. The Board, in its sole discretion, shall determine the effect of all matters and questions relating to Termination of Directorship. ARTICLE II SHARES SUBJECT TO PLAN 2.1 Shares Subject to Plan. The shares of stock subject to Options shall be Common Stock. The aggregate number of such shares which may be issued upon exercise of such Options under the Plan shall not exceed 10,000 thousand (10,000). The shares of Common Stock issuable upon exercise of such options may be either previously authorized but unissued shares or treasury shares. 2.2 Add-back of Options. If any Option under this Plan expires or is cancelled without having been fully exercised, or is exercised in whole or in part for cash as permitted by this Plan, the number of shares subject to such Option but as to which such Option was not exercised prior to its expiration, cancellation or exercise may again be optioned hereunder, subject to the limitations of Section 2.1. Furthermore, any shares subject to Options which are adjusted pursuant to Section 7.3 and become exercisable with respect to shares of stock of another corporation shall be considered cancelled and may again be optioned hereunder, subject to the limitations of Section 2.1. Shares of Common Stock which are delivered by the Optionee or withheld by the Company upon the exercise of any Option under this Plan, in payment of the exercise price thereof or withholding taxes thereon, may again be optioned hereunder, subject to the limitations of Section 2.1. ARTICLE III GRANTING OF OPTIONS 3.1 Eligibility. Each Independent Director of the Company shall be eligible to be granted Options at the times and in the manner set forth in Section 3.2. 3.2 Granting of Options (a) During the term of the Plan, each person who is initially elected or appointed to the Board, and who is an Independent Director at the time of such initial election or appointment automatically shall be granted an Option to purchase one hundred twenty (120) shares of Common Stock (subject to adjustment as provided in Section 7.3) on the date of such initial election or appointment. Members of the Board who are employees of the Company who subsequently incur a Termination of Employment and remain on the Board will not receive an initial Option grant pursuant to this subsection (a), but to the extent that they are otherwise eligible, will receive, after such Termination of Employment, Options as described in subsection (b) below. 3 (b) During the term of the Plan, each Independent Director automatically shall be granted an Option to purchase sixty (60) shares of Common Stock (subject to adjustment as provided in Section 7.3) on the date of each annual meeting of stockholders at which Directors are elected and at the close of which the Independent Director is then serving as a Director, provided that the Independent Director has served as a Director during the entire six month period preceding the date of such annual meeting. (c) All the foregoing Option grants authorized by this Section 3.2 are subject to stockholder approval of the Plan. ARTICLE IV TERMS OF OPTIONS 4.1 Option Agreement. Each Option shall be evidenced by a written Option Agreement, which shall be executed by the Optionee and an authorized officer of the Company and which shall contain such terms and conditions as the Board shall determine, consistent with this Plan. 4.2 Exercise Price. The price per share of the shares subject to each Option shall be 100% of the Fair Market Value of a share of Common Stock on the date the Option is granted. 4.3 Option Term. The term of an Option shall be ten (10) years from the date the Option is granted, except as provided in Section 7.3(b). 4.4 Option Vesting (a) Options granted pursuant to Section 3.2(a) shall become exercisable in cumulative annual installments of one-third each on each of the first, second and third annual meetings of stockholders of the Company at which Directors are elected following the date of grant, without variation or acceleration hereunder except as provided in Section 7.3(b). (b) Options granted pursuant to Section 3.2(b) shall become exercisable in full on the date of the first annual meeting of stockholders of the Company at which Directors are elected following the date of grant, without variation or acceleration hereunder except as provided in Section 7.3(b). (c) No portion of an Option which is unexercisable at Termination of Directorship shall thereafter become exercisable. 4.5 Consideration. In consideration of the granting of an Option, the Optionee shall agree, in the written Option Agreement, to render faithful and efficient services as Director of the Company. Nothing in this Plan or in any Option Agreement shall confer upon any Optionee any right to continue as a Director of the Company, or shall interfere with or restrict in any way the rights of the Company and any Subsidiary, which are hereby expressly reserved, to discharge any Optionee at any time for any reason whatsoever, with or without good cause. 4 ARTICLE V EXERCISE OF OPTIONS 5.1 Partial Exercise. An exercisable Option may be exercised in whole or in part. However, an Option shall not be exercisable with respect to fractional shares and the Board may require that, by the terms of the Option Agreement, a partial exercise be with respect to a minimum number of shares. 5.2 Manner of Exercise. All or a portion of an exercisable Option shall be deemed exercised upon delivery of all of the following to the Secretary of the Company or his or her office: (a) A written notice complying with the applicable rules established by the Board stating that the Option, or a portion thereof, is exercised. The notice shall be signed by the Optionee or other person then entitled to exercise the Option or such portion; (b) Such representations and documents as the Board, in its sole discretion, deems necessary or advisable to effect compliance with all applicable provisions of the Securities Act, as amended, and any other federal or state securities laws or regulations. The Board may, in its sole discretion, also take whatever additional actions it deems appropriate to effect such compliance including, without limitation, placing legends on share certificates and issuing stop-transfer notices to agents and registrars; (c) In the event that the Option shall be exercised pursuant to Section 7.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the Option; and (d) Full cash payment to the Secretary of the Company for the shares with respect to which the Option, or portion thereof, is exercised. However, the Board, may in its sole discretion (i) allow a delay in payment up to thirty (30) days from the date the Option, or portion thereof, is exercised; (ii) allow payment, in whole or in part, through the delivery of shares of Common Stock owned by the Optionee, duly endorsed for transfer to the Company with a Fair Market Value on the date of delivery equal to the aggregate exercise price of the Option or exercised portion thereof; (iii) allow payment, in whole or in part, through the surrender of shares of Common Stock then issuable upon exercise of the Option having a Fair Market Value on the date of Option exercise equal to the aggregate exercise price of the Option or exercised portion thereof; (iv) allow payment, in whole or in part, through the delivery of property of any kind which constitutes good and valuable consideration; (v) allow payment, in whole or in part, through the delivery of a full recourse promissory note bearing interest (at no less than such rate as shall then preclude the imputation of interest under the Code) and payable upon such terms as may be prescribed by the Board or (vi) allow payment, in whole or in part, through the delivery of a notice that the Optionee has placed a market sell order with a broker with respect to shares of Common Stock then issuable upon exercise of the Option, and that the broker has been directed to pay a sufficient portion of the net proceeds of the sale to the Company in satisfaction of the Option exercise price; or (vii) allow payment through any combination of the consideration provided in the foregoing subparagraphs (ii), (iii), (iv), (v) and (vi). In the case of a promissory note, the Board may also prescribe the form of such note and the security to be given for such note. The Option may not be exercised, however, by delivery of a promissory note or by a loan from the Company when or where such loan or other extension of credit is prohibited by law. 5 5.3 Conditions to Issuance of Stock Certificates. The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of any Option or portion thereof prior to fulfillment of all of the following conditions: (a) The admission of such shares to listing on all stock exchanges on which such class of stock is then listed; (b) The completion of any registration or other qualification of such shares under any state or federal law, or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body which the Board shall, in its sole discretion, deem necessary or advisable; (c) The obtaining of any approval or other clearance from any state or federal governmental agency which the Board shall, in its sole discretion, determine to be necessary or advisable; (d) The lapse of such reasonable period of time following the exercise of the Option as the Board may establish from time to time for reasons of administrative convenience; and (e) The receipt by the Company of full payment for such shares, including payment of any applicable withholding tax. 5.4 Rights as Stockholders. The holders of Options shall not be, nor have any of the rights or privileges of, stockholders of the Company in respect of any shares purchasable upon the exercise of any part of an Option unless and until certificates representing such shares have been issued by the Company to such holders. 5.5 Ownership and Transfer Restrictions. The Board, in its sole discretion, may impose such restrictions on the ownership and transferability of the shares purchasable upon the exercise of an Option as it deems appropriate. Any such restriction shall be set forth in the respective Option Agreement or other agreement between the Company and the holders of such shares and may be referred to on the certificates evidencing such shares. 5.6 Limitations on Exercise of Options. No Option may be exercised to any extent by anyone after the first to occur of the following events: (a) The expiration of twelve (12) months from the date of the Optionee's death; (b) the expiration of twelve (12) months from the date of the Optionee's Termination of Directorship by reason of his permanent and total disability (within the meaning of Section 22(e)(3) of the Code); (c) the expiration of seven (7) days from the date of the Optionee's Termination of Directorship by reason of removal for cause (as determined by the Board in its sole discretion); (d) the expiration of thirty (30) days from the date of the Optionee's Termination of Directorship for any reason other than such Optionee's death, removal for cause or his permanent and total disability, unless the Optionee dies within said three-month period; or (e) The expiration of ten years from the date the Option was granted. 6 ARTICLE VI ADMINISTRATION 6.1 Duties and Powers of Board. It shall be the duty of the Board to conduct the general administration of this Plan in accordance with its provisions. The Board shall have the power to interpret this Plan and the agreements pursuant to which Options are granted, and to adopt such rules for the administration, interpretation, and application of this Plan as are consistent therewith and to interpret, amend or revoke any such rules. 6.2 Majority Rule; Unanimous Written Consent. The Board shall act by a majority of its members in attendance at a meeting at which a quorum is present or by a memorandum or other written instrument signed by all members of the Board. 6.3 Professional Assistance; Good Faith Actions. All expenses and liabilities which members of the Board incur in connection with the administration of this Plan shall be borne by the Company. The Board may employ attorneys, consultants, accountants, appraisers, brokers, or other persons. The Company and the Company's officers and Directors shall be entitled to rely upon the advice, opinions or valuations of any such persons. All actions taken and all interpretations and determinations made by the Board in good faith shall be final and binding upon all Optionees, the Company and all other interested persons. No members of the Board shall be personally liable for any action, determination or interpretation made in good faith with respect to this Plan or the Options and all members of the Board shall be fully protected by the Company in respect of any such action, determination or interpretation. ARTICLE VII MISCELLANEOUS PROVISIONS 7.1 Not Transferable. Options under this Plan may not be sold, pledged, assigned, or transferred in any manner other than by will or the laws of descent and distribution or pursuant to a QDRO, unless and until such Options have been exercised, or the shares underlying such Options have been issued, and all restrictions applicable to such shares have lapsed. No Option or interest therein shall be liable for the debts, contracts or engagements of the Optionee or his or her successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted disposition thereof shall be null and void and of no effect, except to the extent that such disposition is permitted by the preceding sentence. During the lifetime of the Optionee only he or she may exercise an Option (or any portion thereof) granted to him or her under the Plan, unless it has been disposed of pursuant to a QDRO. After the death of the Optionee, any exercisable portion of an Option may, prior to the time when such portion becomes unexercisable under the Plan or the applicable Option Agreement or other agreement, be exercised by his or her personal representative or by any person empowered to do so under the deceased Optionee's will or under the then applicable laws of descent and distribution. 7.2 Amendment, Suspension or Termination of this Plan. Except as otherwise provided in this Section 7.2, this Plan may be wholly or partially amended or otherwise modified, suspended or terminated at any time or from time to time by the Board. However, without approval of 7 the Company's stockholders given within twelve months before or after the action by the Board, no action of the Board may, except as provided in Section 7.3, increase the limits imposed in Section 2.1 on the maximum number of shares which may be issued under this Plan, and no action of the Board may be taken that would otherwise require stockholder approval as a matter of applicable law, regulation or rule. No amendment, suspension or termination of this Plan shall, without the consent of the holder of Options alter or impair any rights or obligations under any Options theretofore granted, unless the Option Agreement itself otherwise expressly so provides. No Options may be granted during any period of suspension or after termination of this Plan. 7.3 Changes in Common Stock or Assets of the Company, Acquisition or Liquidation of the Company and Other Corporate Events. (a) Subject to Section 7.3(d), in the event that the Board determines that any dividend or other distribution (whether in the form of cash, Common Stock, other securities, or other property), recapitalization, reclassification, stock split, reverse stock split, reorganization, merger, consolidation, split-up, spin-off, combination, repurchase, liquidation, dissolution, or sale, transfer, exchange or other disposition of all or substantially all of the assets of the Company, or exchange of Common Stock or other securities of the Company, issuance of warrants or other rights to purchase Common Stock or other securities of the Company, or other similar corporate transaction or event, in the Board's sole discretion, affects the Common Stock such that an adjustment is determined by the Board to be appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan or with respect to an Option, then the Board shall, in such manner as it may deem equitable, adjust any or all of (i) the number and kind of shares of Common Stock (or other securities or property) with respect to which Options may be granted under the Plan (including, but not limited to, adjustments of the limitations in Section 2.1 on the maximum number and kind of shares), (ii) the number and kind of shares of Common Stock (or other securities or property) subject to outstanding Options, and (iii) the exercise price with respect to any Option. (b) Subject to Sections 7.3(b)(vi) and 7.3(d), in the event of any Corporate Transaction or other transaction or event described in Section 7.3(a) or any unusual or nonrecurring transactions or events affecting the Company, any affiliate of the Company, or the financial statements of the Company or any affiliate, or of changes in applicable laws, regulations, or accounting principles, the Board in its sole discretion is hereby authorized to take any one or more of the following actions whenever the Board determines that such action is appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan or with respect to any Option under this Plan, to facilitate such transactions or events or to give effect to such changes in laws, regulations or principles: (i) In its sole discretion, and on such terms and conditions as it deems appropriate, the Board may provide, either by the terms of the Option Agreement or by action taken prior to the occurrence of such transaction or event and either automatically or upon the Optionee's request, for either the purchase of any such Option for an amount of cash equal to the amount that could have been attained upon the exercise of such Option or realization of the Optionee's rights had such Option been currently exercisable or the replacement of such Option with other rights or property selected by the Board; 8 (ii) In its sole discretion, the Board may provide, either by the terms of the Option Agreement or by action taken prior to the occurrence of such transaction or event that it cannot be exercised after such event; (iii) Subject to subsection (d), in its sole discretion, and on such terms and conditions as it deems appropriate, the Board may provide, either by the terms of such Option or by action taken prior to the occurrence of such transaction or event, that for a specified period of time prior to such transaction or event, such Option shall be exercisable as to all shares covered thereby, notwithstanding anything to the contrary in (A) Section 4.4 or (B) the provisions of the applicable Option Agreement; (iv) In its sole discretion, and on such terms and conditions as it deems appropriate, the Board may provide, either by the terms of such Option or by action taken prior to the occurrence of such transaction or event, that upon such event, such option be assumed by the successor or survivor corporation, or a parent or subsidiary thereof, or shall be substituted for by similar options covering the stock of the successor or survivor corporation, or a parent or subsidiary thereof, with appropriate adjustments as to the number and kind of shares and prices; and (v) In its sole discretion, and on such terms and conditions as it deems appropriate, the Board may make adjustments in the number and type of shares of Common Stock (or other securities or property) subject to outstanding Options and/or in the terms and conditions of (including the exercise price), and the criteria included in, outstanding Options and Options which may be granted in the future. (vi) None of the foregoing discretionary terms of this Section 7.3(b) shall be permitted to the extent that such discretion would be inconsistent with the applicable exemptive conditions of Rule 16b-3. In the event of Corporate Transaction, to the extent that the Board does not have the ability under Rule 16b-3 to take or to refrain from taking the discretionary actions set forth in Section 7.3(b)(iii) above, each Option shall be exercisable as to all shares covered thereby during the five days immediately preceding the consummation of such Corporate Transaction and subject to such consummation, notwithstanding anything to the contrary in Section 4.4 or the vesting schedule of such Options. In the event of a Corporate Transaction, to the extent that the Board does not have the ability under Rule 16b-3 to take or to refrain from taking the discretionary actions set forth in Section 7.3(b)(ii) above, no Option may be exercised following such Corporate Transaction unless such Option is, in connection with such Corporate Transaction, either assumed by the successor or survivor corporation (or parent or subsidiary thereof) or replaced with a comparable right with respect to shares of the capital stock of the successor or survivor corporation (or parent or subsidiary thereof). (c) Subject to Section 7.3(d) and 7.8, the Board may, in its sole discretion, include such further provisions and limitations in any Option Agreement as it may deem equitable and in the best interests of the Company. (d) No adjustment or action described in this Section 7.3 or in any other provision of the Plan shall be authorized to the extent that such adjustment or action would result in short-swing profits liability under Section 16 of the Exchange Act or violate the exemptive conditions of Rule 16b-3 unless the Board determines that the Option is not to comply with such exemptive conditions. The number of shares of Common Stock subject to any Option shall always be rounded to the next whole number. 9 7.4 Approval of Plan by Stockholders. This Plan will be submitted for the approval of the Company's stockholders within twelve months after the date of the Board's initial adoption of this Plan. Options may be granted prior to such stockholder approval, provided that such Options shall not be exercisable prior to the time when this Plan is approved by the stockholders, and provided further that if such approval has not been obtained at the end of said twelve-month period, all Options previously granted under this Plan shall thereupon be cancelled and become null and void. 7.5 Tax Withholding. The Company shall be entitled to require payment in cash or deduction from other compensation payable to each Optionee of any sums required by federal, state or local tax law to be withheld with respect to the issuance or exercise of any Option. The Board may in its sole discretion allow such Optionee to elect to have the Company withhold shares of Common Stock otherwise issuable under such Option (or allow the return of shares of Common Stock) having a Fair Market Value equal to the sums required to be withheld. 7.6 Loans. The Board may, in its sole discretion, extend one or more loans to Independent Directors in connection with the exercise of an Option granted under this Plan. The terms and conditions of any such loan shall be set by the Board. 7.7 Forfeiture Provisions. Pursuant to its general authority to determine the terms and conditions applicable to Options under the Plan consistent with the provisions of the Plan, the Board shall have the right (to the extent consistent with the applicable exemptive conditions of Rule 16b-3) to provide, in the terms of Options granted under the Plan, or to require the recipient to agree by separate written instrument, that (a) any proceeds, gains or other economic benefit actually or constructively received by the recipient upon any receipt or exercise of the Option or upon the receipt or resale of any Common Stock underlying such Option must be paid to the Company, and (b) the Option shall terminate and any unexercised portion of such Option shall be forfeited, if (i) the Optionee incurs a Termination of Directorship prior to a specified date, or within a specified time period following receipt or exercise of the Option, or (ii) the Optionee at any time, or during a specified time period, engages in any activity in competition with the Company, or which is inimical, contrary or harmful to the interests of the Company, as further defined by the Board. 7.8 Limitations Applicable to Section 16 Persons. Notwithstanding any other provision of this Plan, this Plan and any Option granted to any individual who is then subject to Section 16 of the Exchange Act shall be subject to any additional limitations set forth in any applicable exemptive rule under Section 16 of the Exchange Act (including any amendment to Rule 16b-3 of the Exchange Act) that are requirements for the application of such exemptive rule. To the extent permitted by applicable law, the Plan and Options granted hereunder shall be deemed amended to the extent necessary to conform to such applicable exemptive rule. 7.9 Effect of Plan Upon Options and Compensation Plans. The adoption of this Plan shall not affect any other compensation or incentive plans in effect for the Company or any Subsidiary. Nothing in this Plan shall be construed to limit the right of the Company (a) to establish any other forms of incentives or compensation for Employees, Directors or consultants of the Company or any Subsidiary or (b) to grant or assume options or other rights otherwise than under this Plan in connection with any proper corporate purpose including but not by way of limitation, the grant or assumption of options in connection with the acquisition by purchase, lease, merger, consolidation or otherwise, of the business, stock or assets of any corporation, partnership, firm or association. 7.10 Compliance with Laws. This Plan, the granting and vesting of Options under this Plan and the issuance and delivery of shares of Common Stock under Options granted hereunder are 10 subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law and federal margin requirements) and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Company, be necessary or advisable in connection therewith. Any securities delivered under this Plan shall be subject to such restrictions, and the person acquiring such securities shall, if requested by the Company, provide such assurances and representations to the Company as the Company may deem necessary or desirable to assure compliance with all applicable legal requirements. To the extent permitted by applicable law, the Plan and the Options granted hereunder shall be deemed amended to the extent necessary to conform to such laws, rules and regulations. 7.11 Titles. Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of this Plan. 7.12 Governing Law. This Plan and any agreements hereunder shall be administered, interpreted and enforced under the internal laws of the state of New York without regard to conflicts of laws thereof. * * * I hereby certify that the foregoing Plan was duly adopted by the Board of Directors of Algos Pharmaceutical Corporation on __________________ 1996. Executed on this ____ day of _______________, 199___. ----------------------------------- Secretary 11 FIRST AMENDMENT TO THE ALGOS PHARMACEUTICAL CORPORATION 1996 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN 1. Effective January 16, 1997, Section 3.2 of the Plan is hereby amended in its entirety to read as follows: "3.2 Granting of Options (a) During the term of the Plan, each person who is initially elected or appointed to the Board, and who is an Independent Director at the time of such initial election or appointment automatically shall be granted an Option to purchase ten thousand (10,000) shares of Common Stock (subject to adjustment as provided in Section 7.3) on the date of such initial election or appointment. Members of the Board who are employees of the Company who subsequently incur a Termination of Employment and remain on the Board will not receive an initial Option grant pursuant to this subsection (a), but to the extent that they are otherwise eligible, will receive, after such Termination of Employment, Options as described in subsection (b) below. (b) During the term of the Plan, on the date of the first meeting of the Board that occurs in each calendar year each Independent Director then serving as such automatically shall be granted an Option to purchase five thousand (5,000) shares of Common Stock (subject to adjustment as provided in Section 7.3). (c) All the foregoing Option grants authorized by this Section 3.2 are subject to stockholder approval of the Plan in accordance with Section 7.4." 2. Effective January 16, 1997, Section 4.4 of the Plan is hereby amended in its entirety to read as follows: "4.4 Option Vesting (a) Options granted pursuant to Section 3.2(a) shall become exercisable in cumulative annual installments of one-third each on each of the first, second and third annual meetings of stockholders of the Company at which Directors are elected following the date of grant, without variation or acceleration hereunder except as provided in Section 7.3(b). (b) Options granted pursuant to Section 3.2(b) shall become exercisable in full on the first anniversary of the date of the grant, without variation or acceleration hereunder except as provided in Section 7.3(b). (c) No portion of an Option which is unexercisable at the Optionee's Termination of Directorship shall thereafter become exercisable." EX-11 3 EXHIBIT 11 EXHIBIT 11 STATEMENT RE COMPUTATION OF PRO FORMA PER SHARE EARNINGS
1996 ----------- Net loss........................................................................................... $(3,087,478) Weighted average number of common shares outstanding: Weighted average number of common shares outstanding.......................................... 8,535,080 Common shares issuable upon conversion of Series A Preferred Stock............................ 4,377,178 Incremental common shares outstanding from the exercise of stock options granted within one year of the initial public offering and the conversion of Series B Preferred Stock........... 249,029 ----------- 13,161,287 ----------- ----------- Net loss per common share.......................................................................... $(.23) ------ ------
EX-27 4 EXHIBIT 27
5 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 48,575,719 0 0 0 0 48,905,802 197,979 111,297 49,201,741 973,470 0 156,691 0 1,000 49,044,050 49,201,741 0 2,000,000 0 5,810,193 0 0 0 0 0 0 0 0 0 (3,087,478) (0.23) 0 EX-99 5 EXHIBIT 99 RISK FACTORS The Company operates in a rapidly changing environment that involves a number of risks that may significantly affect the Company's results, some of which are beyond the Company's control. The following discussion highlights some of these risks, and others are discussed elsewhere herein and in other documents filed by the Company with the Securities and Exchange Commission. Early Stage of the Company; Continuing Losses; Uncertainty of Future Profitability Since its formation in January 1992, the Company has been engaged primarily in organizational and start-up activities, conducting research and development programs, recruiting officers and key scientists, and negotiating and consummating technology licensing and research agreements. The Company has no revenues from product sales and no history of manufacturing or marketing. To date, substantially all of its funding has been provided by contributions of capital made by its founders, sales of its stock and an initial payment from McNeil pursuant to the McNeil License Agreement. There can be no assurance that the Company will have any source of product revenue or that its operations will eventually generate sufficient revenues to achieve profitability. The Company has experienced losses since its inception. The Company had accumulated losses of approximately $7.0 million through December 31, 1996, and losses are continuing and are expected to continue for the foreseeable future. Therefore, the Company has a limited history upon which investors may base an evaluation of its likely performance. The Company's prospects must be considered in light of the problems, expenses, complications and delays frequently encountered in connection with the formation of a new business, the development of new pharmaceutical products, including obtaining the necessary regulatory approvals, the utilization of unproven technology and the competitive environment in which the Company plans to operate. Uncertainty Associated with Pre-Clinical Studies and Clinical Trials In order to receive regulatory approval to sell its products commercially, the Company must demonstrate in pre-clinical studies and clinical trials that its potential products are safe and effective in humans. Although the results of the Company's initial pre-clinical studies and clinical trials to date have been encouraging, the results of initial pre-clinical studies and clinical trials are not by themselves predictive of results that will be obtained from subsequent or more extensive trials. Furthermore, there can be no assurance that clinical trials of products under development will demonstrate the safety and efficacy of such products to the extent necessary to obtain regulatory approvals. Many pharmaceutical companies have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. The failure to adequately demonstrate the safety and efficacy of a product could delay or prevent regulatory approval of such product and could have a material adverse effect on the Company. The rate of completion of clinical trials is dependent upon, among other factors, the enrollment of patients. Patient accrual is a function of many factors, including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the study and the existence of competitive clinical trials. Delays in planned patient enrollment in the Company's current trials or future clinical trials may result in increased costs, program delays or both, which could have a material adverse effect on the Company. There can be no assurance that if clinical trials are completed the Company will be able to submit an NDA as scheduled or that any such application will be reviewed and approved by the FDA in a timely manner, or at all. See "Business -- Government Regulation." Uncertainty of Market Acceptance Even if regulatory approvals are obtained, uncertainty exists as to whether the Company's products will be accepted by the market. A number of factors may limit the market acceptance of the Company's products, including the timing of regulatory approvals and market entry relative to competitive products, the availability of alternative products, the price of the Company's products relative to alternative products, the availability of third-party reimbursement and the extent of marketing efforts by third-party distributors or agents retained by the Company. There can be no assurance of the Company's ability, or the length of time required, to achieve market acceptance of the Company's products. In addition, certain of the Company's products contain narcotic ingredients that may require stringent record-keeping obligations, strict storage requirements and other limitations on such products' availability that may limit the commercial usage of such products. Certain Risks Associated With the McNeil License Agreement The McNeil License Agreement extends until the later of the expiration of the Company's patent rights or ten years from the date of execution, provided that the McNeil License Agreement is terminable: (i) by either party in the event of a breach by the other party upon 90 days notice or upon certain events of bankruptcy; (ii) by McNeil, at any time after one year from the effective date of the agreement; and (iii) by the Company upon certain other circumstances. Under certain circumstances, the McNeil License Agreement could terminate with respect to either acetaminophen or NSAID products without terminating with respect to the other category. In the event of a termination by McNeil, McNeil must pay all royalty payments and milestone payments due, if any, through the date of termination and the technology licensed by McNeil reverts to the Company. In such event, the Company retains the rights to the results of the two clinical studies funded by the Company, and McNeil retains the rights to the results of the clinical studies funded by McNeil during the term of the McNeil License Agreement. Competition and Technological Changes, Uncertainty and Obsolescence The Company's success will depend, in part, upon its ability to successfully achieve market share at the expense of existing and established products in the Company's target markets. The Company's products will be competing directly with the products of companies that are well-established and which may have a significantly higher degree of brand and name recognition and substantially more financial resources than those of the Company. The Company is also in competition with other pharmaceutical companies, hospitals, research organizations, individual scientists and non-profit organizations engaged in the development of new pain management pharmaceuticals. Many of these companies and entities have greater research and development capacities, experience, recognition and marketing, financial and managerial resources than the Company and represent significant competition for the Company. Also, the Company's competitors may succeed in developing competing technologies and obtaining FDA approval for products more rapidly than the Company. There can be no assurance that developments by others will not render the Company's products or technologies non-competitive or obsolete. Government Regulation; No Assurance of United States or Foreign Regulatory Approval The FDA and comparable agencies in foreign countries impose substantial requirements on the introduction of therapeutic pharmaceutical products through lengthy and detailed laboratory and clinical testing and other costly and time-consuming procedures. Satisfaction of these requirements typically takes a number of years, varies substantially based upon the type, complexity and novelty of the pharmaceutical products and is subject to uncertainty. Government regulation also affects the manufacture and marketing of pharmaceutical products. Regulatory approvals, if granted, may include significant limitations on the indicated uses for which a product may be marketed. The FDA actively enforces regulations prohibiting marketing of products for non-indicated use. Failure to comply with applicable regulatory requirements can result in, among other things, government imposed fines, suspensions of approvals, seizures or recalls of products, operating restrictions and criminal prosecutions. Furthermore, changes in existing regulations or adoption of new regulations could prevent the Company from obtaining, or affect the timing of, future regulatory approvals. The effect of government regulation may be to delay marketing of the Company's new products for a considerable period of time, to impose costly procedures upon the Company's activities and to furnish a competitive advantage to larger companies that compete with the Company. There can be no assurance that FDA or other regulatory approval for any products developed by the Company will be granted on a timely basis, if at all. Any such delay in obtaining, or failure to obtain, such approvals would adversely affect the marketing of the Company's products and the ability to generate product revenue. The Company is also subject to certain DEA regulations, including restrictions on storage, transportation and administration, for its narcotic products. Government regulation may increase at any time, creating additional hurdles for the Company. The extent of potentially adverse government regulation which might arise from future legislation or administrative action cannot be predicted. See 'Business -- Government Regulation.' Need for Additional Funds The amount and timing of the Company's expenditures will depend on the progress of its research and development, the cost and timing of regulatory approvals, general market conditions, relationships with potential strategic partners, changes in the focus and direction of the Company's research and development programs, competitive and technological advances and other factors. The Company's cash requirements may vary materially from those now planned and no assurance can be given that development costs will not exceed the amounts budgeted for such purposes. The Company may require additional funding for its research and product development programs, operating expenses, regulatory clearances and sales and marketing expenses. Adequate funds for these purposes, whether obtained through financial markets or through collaborative or other arrangements with partners or from other sources, may not be available when needed or on terms acceptable to the Company. Insufficient funds may require the Company to delay, scale back or eliminate certain of its research and development programs or to make arrangements with third parties to commercialize products or technologies that the Company would otherwise seek to develop itself. As a result, the Company may not be able to independently develop any or all of the products described in this Report. Limited Sales and Marketing Experience The Company intends to market and sell certain of its products, if successfully developed and approved, through a direct sales force in the United States. The Company currently has no marketing and sales staff, and has yet to establish any product distribution channels. In order to market its products directly, the Company must develop a sales force with technical expertise. There can be no assurance that the Company will be able to successfully establish a direct sales organization or distribution channels. Failure to establish a sales force capability in the U.S. may have a material adverse effect on the Company. Reliance on Third-Party Manufacturers The Company currently uses, and expects to continue to use, outside contractors to manufacture drug supplies for its clinical trials. In addition, the Company currently intends to use outside contractors to manufacture products approved for sale, if any. There is no assurance that supplies from any such contractor will not be reduced or interrupted due to FDA and DEA regulatory requirements or other reasons. Such a reduction or interruption could have a material adverse effect on the Company's development and commercialization activities. The Company currently uses a single contract manufacturer for supplies of its most developmentally advanced product, MorphiDex'tm'. The regulatory qualification of additional suppliers may require significant time and expense. In addition, the acquisition of narcotics as components of certain of the Company's products is subject to quota restrictions imposed and administered by DEA. There is no assurance that the Company will be able to obtain its requested quantities of such narcotics. Dependence on Qualified Personnel Because of the specialized scientific nature of the Company's business, the Company is highly dependent upon its ability to attract and retain qualified scientific and technical personnel. The loss of significant scientific and technical personnel or the failure to recruit additional key scientific and technical personnel could have a material adverse effect on the Company. While the Company has consulting agreements with certain key individuals and institutions and has employment agreements with its key executives, there can be no assurance that the Company will be successful in retaining such personnel or their services under existing agreements. The loss of John Lyle, the Company's Chief Executive Officer, could have a material adverse effect on the Company. The Company currently maintains a $6.0 million life insurance policy on Mr. Lyle. There is intense competition for qualified personnel in the areas of the Company's activities, and there can be no assurance that the Company will be able to continue to attract and retain the qualified personnel necessary for the development of its business. Uncertain Ability to Protect Proprietary Technology The Company's success, competitive position and amount of potential future income will depend in part on its ability to obtain patent protection relating to the technologies, processes and products it is developing and may develop in the future. The Company's policy is to seek patent protection and enforce intellectual property rights. With respect to its products, the Company holds seven U.S. patent applications pending and has exclusive licenses for four issued U.S. patents, one pending U.S. patent application for which it has received a notice of allowance and five other U.S. patent applications pending. No assurance can be given that any patent issued or licensed to the Company will provide protection against competitive products or otherwise be commercially viable. In this regard, the patent position of pharmaceutical compounds and compositions is particularly uncertain. Even issued patents may later be modified or revoked by the PTO or in legal proceedings. Moreover, the Company believes that obtaining foreign patents may be more difficult than obtaining domestic patents because of differences in patent laws, and accordingly, its patent position may be stronger in the U.S. than abroad. In addition, foreign patents may be more difficult to protect and/or the remedies available may be less extensive than in the U.S. Patent applications in the U.S. are maintained in secrecy until patents issue and, since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries, the Company cannot be certain that it was the first creator of the inventions covered by pending patent applications or the first to file patent applications on such inventions. No assurance can be given that any of the Company's pending patent applications will be allowed, or if allowed, whether the scope of the claims allowed will be sufficient to protect the Company's products. The Company also expects to rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain its competitive position. There can be no assurance that others will not independently develop substantially equivalent proprietary information or be issued patents that may prevent the sale of the Company's products or know-how or require licensing and the payment of significant fees or royalties by the Company in order to produce its products. Moreover, there can be no assurance that the Company's technology does not infringe upon any valid claims of patents owned by others. If the Company were found to be infringing on a patent held by another, the Company might have to seek a license to use the patented technology. There can be no assurance that, if required, the Company would be able to obtain such a license on terms acceptable to the Company, if at all. If a legal action were to be brought against the Company or its licensors, the Company could incur substantial costs in defending itself, and there can be no assurance that such an action would be resolved in the Company's favor. If such a dispute were to be resolved against the Company, the Company could be subject to significant damages and the testing, manufacture or sale of one or more of the Company's technologies or proposed products, if developed, could be enjoined. No assurance can be given as to the degree of protection any patents will afford, whether patents will be issued or whether the Company will be able to avoid violating or infringing upon patents issued to others. Despite the use of confidentiality agreements and non-compete agreements, which themselves may be of limited effectiveness, it may be difficult for the Company to protect its trade secrets. See "Business -- Patents, Trade Secrets and Licenses" and "Risk Factors -- Dependence on Qualified Personnel." Uncertain Availability of Health Care Reimbursement The Company's ability to commercialize its pain management products may depend in part on the extent to which reimbursement for the costs of such products will be available from government health administration authorities, private health insurers and others. There can be no assurance that third-party insurance coverage will be adequate for the Company to establish and maintain price levels sufficient for realization of an appropriate return on its investment. Government, private insurers and other third-party payers are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement for new products approved for marketing by the FDA and by refusing, in some cases, to provide any coverage for uses of approved products for indications for which the FDA has not granted marketing approval. If adequate coverage and reimbursement levels are not provided by government and third-party payers for uses of the Company's products, the market acceptance of these products could be adversely affected. No Product Liability Insurance The Company will be exposed to potential product liability risks, which are inherent in the testing, manufacturing and marketing of human therapeutic products. The Company is contractually obligated under certain of its license agreements to indemnify the individuals and/or institutions from whom it has licensed the technology against claims relating to the manufacture and sale of the products to be sold by the Company. McNeil, however, has agreed to indemnify the Company for third party claims or suits resulting from the manufacture, use or sale of the products pursuant to the McNeil License Agreement. The Company's indemnification liability, as well as direct liability to consumers for any defects in the products sold, could expose the Company to substantial risk and losses. The Company currently does not have any product liability insurance. The Company plans to purchase such product liability insurance as it deems appropriate prior to marketing its products. McNeil is required by the McNeil License Agreement to maintain product liability insurance and may self-insure to cover its indemnification obligations to the Company. However, there can be no assurance that the Company will be able to obtain or maintain such insurance on acceptable terms or that any insurance obtained will provide adequate coverage against potential liabilities. Concentration of Ownership The Company's directors and officers beneficially own approximately 32% of the Company's Common Stock. In addition, the Company's largest stockholder, Unifina AG, and related investors control approximately 11% of the Common Stock. As a result, these stockholders, if they acted together, would have the ability to influence significantly the election of the Company's directors as well as the management and policies of the Company. This concentration of ownership may have the effect of delaying or preventing a change of control of the Company. Possible Volatility of Stock Price The stock market has from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. In addition, the market price of the Common Stock may prove to be highly volatile. Announcements of technological innovations, regulatory matters or new commercial products by the Company or its competitors, developments or disputes concerning patent or proprietary rights, publicity regarding actual or potential clinical results relating to products under development by the Company or its competitors, regulatory developments in both the U.S. and foreign countries, public concern as to the safety of pharmaceutical products, and economic and other external factors, as well as period-to-period fluctuations in financial results, may have a significant impact on the market price of the Common Stock. Forward Looking Statements This report contains certain 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, as amended concerning the Company's operations, economic performance and financial conditions, including, in particular, the likelihood of the Company's success in developing and bringing to market the products which it currently has under development and its schedule for development. These statements are based upon a number of assumptions and estimates which are inherently subject to significant uncertainties and contingencies, many of which are beyond the control of the Company and reflect future business decisions which are subject to change many of these contingencies are described in "Risk Factors". Some of these assumptions inevitably will not materialize, and unanticipated events will occur which will affect the Company's results. Consequently, actual results will vary from the statements contained herein and such variance may be, and is likely to be, material. Prospective investors should not place undue reliance on this information. Shares Eligible for Future Sale No shares of Common Stock, other than the 3,625,000 shares of Common Stock sold in the Company's initial public offering, are eligible for resale in the public market without restriction prior to March 31, 1997, after taking into consideration the effect of lock-up agreements entered into by all officers, directors and other stockholders of the Company. On March 31, 1997, approximately 11,840,358 additional shares of Common Stock will become eligible for resale in the public market, subject as to certain of such shares to compliance with applicable provisions of Rules 144 and 701. The Series B Preferred Stock is convertible into an aggregate of 100,000 shares of Common Stock, subject to customary anti-dilution adjustments, at any time after February 1, 1997. The initial holder of the Series B Preferred Stock has the right to require the Company to register the resale of the Common Stock that such holders receive upon conversion of the Series B Preferred Stock into Common Stock. If any such stockholders cause a large number of shares to be sold in the public market, such sales may have an adverse effect on the market price of the Common Stock and the Company's ability to raise capital. Dilution; Absence of Dividends The Company has never declared or paid any cash dividends on its capital stock. The Company currently intends to retain earnings, if any, to support its growth strategy and does not anticipate paying cash dividends in the foreseeable future. Payment of future dividends, if any, will be at the discretion of the Company's Board of Directors after taking into account various factors, including the Company's financial condition, operating results, current and anticipated cash needs and plans for expansion. Effect of Anti-Takeover Provisions The Company's Amended and Restated Certificate of Incorporation provides for a classified Board of Directors and that members of the Board of Directors may be removed only for cause upon the affirmative vote of holders of at least a majority of the shares of capital stock of the Company entitled to vote. The Company's Amended and Restated Certificate of Incorporation requires that any action required or permitted to be taken by stockholders of the Company must be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing, and will require reasonable advance notice by a stockholder of a proposal or director nomination which such stockholder desires to present at any annual or special meeting of stockholders. Special meetings of stockholders may be called only by the Chief Executive Officer or, if none, the President of the Company or by the Board of Directors. In addition, the Board of Directors has the authority, without further action by the stockholders, to fix the rights and preferences of, and issue shares of, Preferred Stock. The Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibits the Company from engaging in a 'business combination' with an 'interested stockholder' for a period of three years after the date of the transaction in which the person first becomes an 'interested stockholder,' unless the business combination is approved in a prescribed manner. The application of these provisions could have the effect of delaying or preventing a change of control of the Company. Certain other provisions of the Company's Amended and Restated Certificate of Incorporation could also have the effect of delaying or preventing changes of control or management of the Company, which could adversely affect the market price of the Common Stock. -----END PRIVACY-ENHANCED MESSAGE-----