-----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, LnxkbgTioA819GAZec2wRwJEmHGzb/u8j65m7WBEWv6RGHSxmlXGM/g2FiTk9HBg Rv2PCzVkQ6hLXwt8M7OvNQ== 0000950117-98-002035.txt : 19981118 0000950117-98-002035.hdr.sgml : 19981118 ACCESSION NUMBER: 0000950117-98-002035 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 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-Q SEC ACT: SEC FILE NUMBER: 000-28844 FILM NUMBER: 98753079 BUSINESS ADDRESS: STREET 1: 4900 ROUTE 33 CITY: NEPTUNE STATE: NJ ZIP: 07753 BUSINESS PHONE: 9089385959 10-Q 1 ALGOS PHARMACEUTICAL CORPORATION 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________________ to ____________________ Commission file number 000-28844 ALGOS PHARMACEUTICAL CORPORATION (Exact name of registrant as specified in its charter) Delaware 22-3142274 (State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.) organization)
1333 Campus Parkway, Neptune, New Jersey, 07753-6815 (Address of principal executive offices) 732-938-5959 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ____ --- The aggregate number of shares of the Registrant's common stock outstanding on November 11, 1998 was 17,028,649. 1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) BALANCE SHEETS (Unaudited)
December 31 September 30 1997 1998 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 20,246,152 $ 6,303,792 Marketable securities 17,922,359 19,029,700 Interest receivable 484,789 341,620 Prepaid expenses and other current assets 315,679 798,632 ------------ ------------ Total current assets 38,968,979 26,473,744 Marketable securities, noncurrent 3,004,580 4,000,000 Restricted cash 150,000 150,000 Property and equipment, net 146,328 1,051,341 Other assets 90,591 916 ------------ ------------ Total assets $ 42,360,478 $ 31,676,001 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,861,976 $ 2,805,299 Other current liabilities 739,415 693,823 ------------ ------------ Total current liabilities 2,601,391 3,499,122 ------------ ------------ Commitments Stockholders' equity: Common stock, $.01 par value, 50,000,000 shares authorized, 15,951,701 and 16,028,649 shares issued and outstanding, respectively 159,517 160,287 Additional paid-in-capital 56,151,504 56,833,740 Unearned compensation expense (753,707) (833,108) Deficit accumulated during the development stage (15,798,227) (27,984,040) ------------ ------------ Total stockholders' equity 39,759,087 28,176,879 ------------ ------------ Total liabilities and stockholders' equity $ 42,360,478 $ 31,676,001 ============ ============
The accompanying notes are an integral part of these financial statements. 2 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF OPERATIONS (Unaudited)
Cumulative from For the three months ended For the nine months ended inception to September 30 September 30 September 30 1997 1998 1997 1998 1998 ---- ---- ---- ---- ---- Revenues $ - $ - $ - $ - $ 3,311,000 ------------- ------------- ------------- -------------- -------------- Operating expenses: Research and development 2,370,380 3,396,058 7,504,423 10,399,536 25,976,167 Selling, general and administrative 622,823 1,438,204 1,857,154 3,294,583 10,407,833 ------------- ------------- ------------- -------------- -------------- Total operating expenses 2,993,203 4,834,262 9,361,577 13,694,119 36,384,000 ------------- ------------- ------------- -------------- -------------- Loss from operations (2,993,203) (4,834,262) (9,361,577) (13,694,119) (33,073,000) Interest income 625,167 428,501 1,838,029 1,508,306 5,088,960 ------------- ------------- ------------- -------------- -------------- Net loss $ (2,368,036) $ (4,405,761) $ (7,523,548) $ (12,185,813) $ (27,984,040) ============= ============= ============= ============== ============== Net loss per common share, basic and diluted $ (0.15) $ (0.28) $ (0.48) $ (0.76) Weighted average common shares outstanding, basic and diluted 15,899,597 16,018,284 15,832,849 15,991,067
The accompanying notes are an integral part of these financial statements. 3 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
Cumulative For the nine months ended from inception to September 30, September 30, 1997 1998 1998 ---- ---- ---- Cash flows from operating activities $ (6,326,115) $ (11,150,111) $ (23,386,928) Cash flows from investing activities: Purchases of marketable securities (48,014,558) (25,034,720) (72,848,168) Redemption of marketable securities 13,000,000 22,947,969 49,764,042 Purchases of property and equipment (106,886) (1,017,223) (1,326,234) ------------- -------------- ------------- Net cash used in investing activities (35,121,444) (3,103,974) (24,410,360) ------------- -------------- ------------- Cash flows from financing activities: Proceeds from issuance of preferred stock 6,659,015 Proceeds from issuance of common stock 74,201 311,725 47,442,065 ------------- -------------- ------------- Net cash provided by financing activities 74,201 311,725 54,101,080 ------------- -------------- ------------- Net increase (decrease) in cash and cash equivalents (41,373,358) (13,942,360) 6,303,792 Cash and cash equivalents, beginning of period 48,575,719 20,246,152 - ------------- -------------- ------------- Cash and cash equivalents, end of period $ 7,202,361 $ 6,303,792 $ 6,303,792 ============= ============== ==============
The accompanying notes are an integral part of these financial statements. 4 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The financial statements presented herein have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and are unaudited. In the opinion of management, the financial statements reflect all adjustments (which consist of normal recurring accruals and adjustments) necessary for a fair statement of the financial position and results of the interim periods presented. 2. ACCOUNTING POLICIES In the first quarter of 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which establishes standards for determining and reporting comprehensive income and its components. Comprehensive income represents the change in net assets of a business enterprise as a result of non-owner transactions. The adoption of the standard did not have an impact on the Company's financial statements. 3. LOSS PER SHARE Since the Company incurred net losses in all periods presented, outstanding options and warrants to purchase an aggregate of 1,018,737 and 1,399,755 shares of Common Stock at September 30, 1997 and 1998, respectively were not included in diluted per share calculations as their effect would be antidilutive. 4. PROPERTY AND EQUIPMENT, NET Property and equipment, net consist of the following:
December 31, September 30, 1997 1998 ------------- -------------- Leasehold improvements - $ 515,151 Office furniture and equipment 152,727 582,903 Computer equipment 156,284 228,180 ------------- -------------- 309,011 1,326,234 Less accumulated depreciation 162,683 274,893 ------------- -------------- $146,328 $1,051,341 ============= ==============
5 ALGOS PHARMACEUTICAL CORPORATION (A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 5. OTHER CURRENT LIABILITIES Other current liabilities consist of the following:
December 31, September 30, 1997 1998 ------------- ------------ Accrued research expenses $392,618 $423,823 Accrued compensation 346,797 270,000 ------------- ------------ $739,415 $693,823 ============= ============
6. COMMITMENTS In April 1998, the Company's ten-year operating lease for its executive offices became effective. Minimum annual lease payments are as follows: 1998 $ 179,080 1999 268,620 2000 268,620 2001 268,620 2002 268,620 Balance of Term $1,643,300
7. SUBSEQUENT EVENT In November 1998, the Company received $25,000,000 from a private placement of 1,000,000 shares of Common Stock and a warrant to purchase 250,000 shares of Common Stock at an exercise price of $25 per share. The warrant is exercisable beginning November 9, 1999 and expires November 9, 2003. Algos has agreed to provide certain resale registration rights under the Securities Act of 1933 with respect to the Common Stock sold or issuable under the warrant. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General Algos, a development stage company, is engaged primarily in the development and commercialization of proprietary pharmaceutical products for pain management. 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. The Company has incurred losses since its inception and expects to incur losses in the future. The Company's product development expenses may increase as additional drugs are developed. In August 1998, the Company filed a New Drug Application for its most developmentally advanced drug, MorphiDex'TM'. The Company may incur significant costs associated with the possible commercialization of MorphiDex'TM' prior to the first commercial sale of the product, including the purchase of inventory, the establishment of a sales force, preparation of promotional plans and materials, additions to and changes in financial and operating systems and other related administrative expenses. Results of Operations Three months ended September 30, 1997 and 1998 Research and development: In the three months ended September 30, 1998, research and development expenses were $3.4 million, an increase of approximately $1.0 million or 43%, from the comparable 1997 period. The significant increase in 1998 third quarter expenses was primarily attributable to large-scale, advanced clinical trials of MorphiDex'TM'. The Company also incurred higher expenses due to increased development activity for HydrocoDex'TM' and the expansion of the Company's development staff since the 1997 third quarter. The effect of these increases was partially offset by reduced expenses in other development programs. Selling, general and administrative: In the three months ended September 30, 1998, selling, general and administrative expenses were $1.4 million, an increase of $0.8 million or 131%, from the comparable 1997 period. The 1998 third quarter expense increase was primarily attributable to general expansion of the Company's business, additions to management personnel, market research and expenditures related to the possible future commercialization of products such as the addition of sales and marketing personnel and the move to the Company's new administrative offices. Interest income: Interest income decreased 31% in the three months ended September 30, 1998 to $0.4 million due to lower average cash and securities balances compared to the 1997 third quarter. 7 Nine months ended September 30, 1997 and 1998 Research and development: In the nine months ended September 30, 1998, research and development expenses were $10.4 million, an increase of approximately $2.9 million or 39%, from the 1997 nine-month period. The significant increase in the nine-month 1998 expenses was primarily attributable to large-scale, advanced clinical trials for MorphiDex'TM' and the expansion of the Company's development staff. The impact of these increases was partially offset by reduced expenses related to bioavailability studies and the costs of manufacturing small-scale regulatory test batches of MorphiDex'TM', which occurred in 1997. Selling, general and administrative: In the nine months ended September 30, 1998, selling, general and administrative expenses were $3.3 million, an increase of $1.4 million or 77%, from the 1997 nine-month period. The nine-month results included approximately $0.8 million of expenses for pre-marketing and related activities in preparation for the commercialization of MorphiDex'TM'. The company incurred increased general and administrative costs to support the Company's business activities, including the relocation and expansion of the Company's headquarters facilities in April 1998. Interest income: Interest income decreased 18% in the nine months ended September 30, 1998 to $1.5 million as a result of lower average cash and securities balances. Liquidity and Capital Resources As a result of its drug development efforts, the Company has experienced net cash outflows from operations since its inception in 1992. In the nine months ended September 30, 1998, cash outflows from operations amounted to approximately $11.2 million compared to $6.3 million in the first nine months of 1997, primarily as a result of its increased MorphiDex'TM' development spending. The Company intends to continue certain ongoing large-scale clinical trials for MorphiDex'TM' and has entered into several research and development commitments for HydrocoDex'TM'. The Company expects to incur continued product development expenses as clinical trials of MorphiDex'TM' continue and other drugs that the Company currently has under development including HydrocoDex'TM', move into advanced clinical trials and as additional drugs are developed and its research and development staff increased. In addition, in August 1998, the Company filed a New Drug Application for its most developmentally advanced drug, MorphiDex'TM'. The Company may incur significant costs associated with the possible commercialization of MorphiDex'TM' prior to the first commercial sale of the product, including the purchase of inventory, the establishment of a sales force, preparation of promotional plans and materials, additions to and changes in financial and operating systems, and other administrative expenses. In November 1998, to provide greater financial flexibility the Company raised $25 million in a private sale of common stock and warrants. The Company expects that its cash and 8 marketable securities will be sufficient to fund its development activities for approximately two years and provide for certain pre-launch activities based upon the Company's current schedule of clinical trials and level of business activities. The Company's future funding requirements will depend on a number of factors, including: the amount of resources required for the establishment of sales and distribution capabilities; preparation of promotional plans and materials and other activities in preparation for the possible commercialization of MorphiDex'TM'; the results of its development efforts; the timing and costs of obtaining required regulatory approvals; the commercialization of competing products; the execution of licensing or other collaborative research agreements on terms acceptable to the Company; and the cost of prosecuting and defending patents. If additional funds are required in the preparation for the possible commercialization of MorphiDex'TM', or if additional trials are necessary or advisable, or if additional products are developed, the Company may require additional funds. 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 either by incurring debt, issuing additional equity or through collaborative or license arrangements to ensure continuity of operations. There is no assurance that the Company would be able to obtain such additional financing on terms acceptable to the Company. Year 2000 A potential problem exists for all companies that rely on computers as the year 2000 approaches. Any of the Company's computer software applications and systems that use only the last two digits of a year to refer to a year may not properly recognize the year 2000. This phenomenon (the 'Year 2000 Issue') could cause a disruption of operations, including, among other things, a temporary inability to engage in normal business activities. The Company is in the process of evaluating the impact of the Year 2000 Issue and currently believes that the financial and operational systems of the Company, as currently used, will function adequately with respect to the Year 2000 Issue given that the Company is not significantly reliant on its computer software applications and systems during its developmental stage. In addition, the Company has very limited information concerning the compliance status of its third party contractors. The Company's third party contractors generally test the Company's pharmaceuticals and provide the Company with its results. The Company believes that any Year 2000 Issue for such third-party contractors would not be material, since many activities could be performed without the aid of a computer. As part of the commercialization of Morphidex'TM', the Company intends to have third parties manufacture and distribute its products. The Company will evaluate each potential third party manufacturer's and distributor's readiness for the Year 2000 Issue and will reevaluate the Year 2000 Issue as it relates to the Company as part of its preparation for the commercialization of Morphidex'TM'. The Company has filed an NDA for MorphiDex'TM' and may make significant additions to and changes in its existing computer software applications and systems and/or the use of such systems in anticipation of the possible commercialization of MorphiDex'TM'. If the Company makes any such additions or changes, it would effect the Company's exposure to the Year 2000 Issue since the Company would become more reliant on its computer software applications and systems. Therefore, the Company's assessment of its Year 2000 Issue is not complete and the Company cannot complete its assessment or develop any contingency plans until mid-1999. At this time, the Company does not expect that the cost of its Year 2000 Issue compliance program will be material to its business, financial condition or results of operations and does not currently anticipate any material disruption in its operations. The Company has not incurred significant costs to date related to the Year 2000 Issue. 9 Forward-Looking Statements This Management's Discussion and Analysis of Financial Condition and Results of Operations contains "forward-looking" statements, within the meaning of Section 27A of Securities Act of 1993, as amended and Section 21E of the Securities Exchange Act of 1934, that are based on management's beliefs and assumptions, current expectations, estimates and projections. Statements that are not historical facts, including statements which are preceded by, followed by, or that include the words "believes;" "anticipates" "plans;" "expects;" or similar expressions and statements about the Company's development and commercialization schedule and future use of funds are forward-looking statements. Many of the factors that will determine the Company's future results are beyond the ability of the Company to control or predict. These statements are subject to risks and uncertainties and, therefore, actual results may differ materially. The reader should not rely on any forward-looking statement. The Company undertakes no obligations to update any forward-looking statements whether as a result of new information, future events or otherwise. Important factors that may affect future results include, but are not limited to: uncertainty associated with pre-clinical studies and clinical trials and regulatory approval; uncertainty of market acceptance of new products; impact of competitive products and pricing; product development; changes in laws and regulations; customer demand; possible future litigation; the availability of future financing and reimbursement policies of government and private health insurers. Readers should evaluate any statement in light of these important factors. See "Risk Factors". 10 ITEM 6. EXHIBITS 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) 5.1 Opinion of Latham & Watkins as to the validity of the Common Stock(1) 10.1.1 Employment Agreement with Respect to John W. Lyle(4) 10.1.3 Employment Agreement with Respect to Frank S. Caruso(1) 10.1.4 Employment Agreement with Respect to Joseph Sardella(5) 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(2) 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 Consumer Products Company(1)'D''D' 10.4.3 Registration Rights Agreement with The Medical College of Virginia(1) 10.5 Lease Agreement with Commercial Realty & Resources Corp.(3) 21 Subsidiaries of the Registrant(1) 27 Financial Data Schedule 99 Risk Factors
(1) Incorporated by reference to the Registrant's registration statement on Form S-1 declared effective on September 25, 1996. (2) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997. (4) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998. (5 ) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998. 'D''D' Portions of this Exhibit have received confidential treatment pursuant to Rule 406(b) under the Securities Act. Reports on Form 8K: None 11 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ALGOS PHARMACEUTICAL CORPORATION Date 11/16/98 /s/ John W. Lyle ------------------- ---------------------------------------- John W. Lyle President and Chief Executive Officer Date 11/16/98 /s/ Gary R. Anthony ------------------- ---------------------------------------- Gary R. Anthony Chief Financial Officer and Principal Accounting Officer 12 STATEMENT OF DIFFERENCES The trademark sysmbol shall be expressed as.................................'TM' The dagger symbol shall be expressed as..................................... 'D' EX-27 2 EXHIBIT 27
5 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 6,303,792 19,029,700 341,620 0 0 26,473,744 1,326,234 274,893 31,676,001 3,499,122 0 160,287 0 0 28,016,592 31,676,001 0 0 0 13,694,119 0 0 (12,185,814) 0 0 0 0 0 0 (12,185,814) (.76) (.76) EX-99 3 EXHIBIT 99 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. Development 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 payments from McNeil Consumer Products Company pursuant to a 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 and losses are continuing and are expected to continue. 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 potential problems, expenses, complications, and delays frequently encountered in connection with the formation of a new business and the development of new pharmaceutical products, including obtaining the necessary regulatory approvals, the utilization of unproven technology and the competitive market 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 1 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 a New Drug Application ("NDA") or that any such application will be reviewed and approved by the Food and Drug Administration ("FDA") in a timely manner, or at all. See "Business -- Government Regulation" in the Company's 1997 Annual Report on Form 10-K. 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 Drug Enforcement Agency ("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" in the Company's 1997 Annual Report on Form 10-K. 2 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 could limit the commercial usage of such products. 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, the amount of spending on sales, marketing and distribution activities in preparation for the possible commercialization of MorphiDex'TM', 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 limited 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 3 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' and suppliers of raw materials are limited. The regulatory qualification of additional suppliers and/or manufacturers 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. 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 Patent and 4 Trademark Office ("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 "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 5 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. Limited 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 carries liability insurance for its clinical trial activities but does not have product liability insurance covering commercial use of its products. 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. 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 upon 60 days notice; 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. 6 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. Concentration of Ownership The Company's directors and officers beneficially own approximately 27% of the Company's Common Stock and two additional stockholders and related investors control approximately 16% 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. The market price of the Company's Common Stock may prove to be highly volatile from a variety of variable influences. 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, 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 Company's Common Stock. The timing and amount of the Company's development and commercialization expenditures are subject to significant uncertainties; operating results for any accounting period may not be indicative of expected results for future periods. 7 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. Year 2000 A potential problem exists for all companies that rely on computers as the year 2000 approaches. Any of the Company's computer software applications and systems that use only the two digits of a year to refer to a year may not properly recognize the year 2000. This phenomenon (the 'Year 2000 Issue') could cause a disruption of operations, including, among other things, a temporary inability to engage in normal business activities. The Company is in the process of evaluating the impact of the Year 2000 Issue and currently believes that the financial and operational systems of the Company, as currently used, will function adequately with respect to the Year 2000 Issue given that the Company is not significantly reliant on its computer software applications and systems during its developmental stage. In addition, the Company has very limited information concerning the compliance status of its third party contractors. The Company's third party contractors generally test the Company's pharmaceuticals and provide the Company with its results. The Company believes that any Year 2000 Issue for such third-party contractors would not be material, since many activities could be performed without the aid of a computer. As part of the commercialization of Morphidex'TM', the Company intends to have third parties manufacture and distribute its products. The Company will evaluate each potential third party manufacturer's and distributor's readiness for the Year 2000 Issue and will reevaluate the Year 2000 Issue as it relates to the Company as part of its preparation for the commercialization of Morphidex'TM'. The Company has filed an NDA for MorphiDex'TM' and may make significant additions to and changes in its existing computer software applications and systems and/or the use of such systems in anticipation of the possible commercialization of MorphiDex'TM'. If the Company makes any such additions or changes, it would effect the Company's exposure to the Year 2000 Issue since the Company would become more reliant on its computer software applications and systems. Therefore, the Company's assessment of its Year 2000 Issue is not complete and the Company cannot complete its assessment or develop any contingency plans until mid-1999. At this time, the Company does not expect that the cost of its Year 2000 Issue compliance program will be material to its business, financial condition or results of operations and does not currently anticipate any material disruption in its operations. The Company has not incurred significant costs to date related to the Year 2000 Issue. 8 Forward- Looking Statements This Report contains "forward-looking" statements, within the meaning of Section 27A of the Securities Act of 1993, as amended and Section 21E of the Securities Exchange Act of 1934, that are based on management's beliefs and assumptions, current expectations, estimates and projections. Statements that are not historical facts, including statements which are preceded by, followed by, or that include the words "believes;" "anticipates;" "plans;" "expects;" or similar expressions and statements about the Company's development schedule and future use of funds are forward-looking statements. Many of the factors that will determine the Company's future results are beyond the ability of the Company to control or predict. These statements are subject to risks and uncertainties and, therefore, actual results may differ materially. The reader should not rely on any forward-looking statement. The Company undertakes no obligations to update any forward-looking statements whether as a result of new information, future events or otherwise. Important factors that may affect future results include, but are not limited to: uncertainty associated with pre-clinical studies and clinical trials and regulatory approval; uncertainty of market acceptance of new products; impact of competitive products and pricing; product development; changes in laws and regulations; customer demand; possible future litigation; the availability of future financing and reimbursement policies of government and private health insurers. Readers should evaluate any statement in light of these important factors. 9 -----END PRIVACY-ENHANCED MESSAGE-----