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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 June 30, 2003
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[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _______ to _______
Commission File Number 0-24760
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ORPHAN MEDICAL, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 41-1784594
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
13911 RIDGEDALE DRIVE, SUITE 250,
MINNETONKA, MN 55305 (952) 513-6900
- -------------------------------------- --------------
(Address of principal executive office (Registrant's telephone
and zip code) 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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes _X_ No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes _X_ No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 par value 10,650,980
- ---------------------------- ----------
(Class) (Outstanding at August 1, 2003)
INDEX
ORPHAN MEDICAL, INC.(R)
PAGE NO.
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Balance Sheets - June 30, 2003 and December 31, 2002. 3
Statements of Operations - Three and six months ended
June 30, 2003 and June 30, 2002. 4
Statements of Cash Flows - Six months ended June 30, 2003
and June 30, 2002. 5
Notes to Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 10
ITEM 3. Quantitative and Qualitative Disclosures about
Market Risk 27
ITEM 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Items 1 through 3 and 5 have been omitted since all items are inapplicable or
answers negative.
ITEM 4. Submission of Matters to a Vote of Security Holders 28
ITEM 6. Exhibits and Reports on Form 8-K 29
Antizol(R), Antizol-Vet(R), Cystadane(R), Xyrem(R), MedExpand(TM)"The" Orphan
Drug Company(TM), Orphan Medical(R), Inc. And Dedicated to Patients with
Uncommon Diseases(R)are trademarks of the Company.
2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
ORPHAN MEDICAL, INC.
BALANCE SHEETS
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
June 30, December 31,
2003 2002
---------------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 29,720 $ 6,921
Restricted cash 252 251
Accounts receivable, less allowance for
doubtful accounts of $147 and $25, respectively 1,973 2,215
Inventories 1,321 2,020
Prepaid expenses and other 1,014 576
---------------------
Total current assets 34,280 11,983
Property and equipment, net 965 1,156
---------------------
Total assets $ 35,245 $ 13,139
=====================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 671 $ 1,380
Accrued compensation 1,217 1,795
Accrued income taxes 250 --
Accrued expenses 2,259 2,136
---------------------
Total current liabilities 4,397 5,311
Capital lease obligation-less current maturities 70 78
Commitments
Shareholders' equity:
Senior Convertible Preferred Stock, $.01 par value;
14 shares authorized; 9 shares issued and outstanding -- --
Series B Convertible Preferred Stock, $.01 par value;
5 shares authorized; 3 and 3 shares issued and outstanding -- --
Series C Convertible Preferred Stock, $.01 par value;
4 shares authorized; 0 shares issued and outstanding -- --
Series D Convertible Preferred Stock, $.01 par value;
1,500 shares authorized; 0 shares issued and outstanding -- --
Common stock, $.01 par value; 25,000 shares authorized;
10,586 and 10,460 issued and outstanding 106 105
Additional paid-in capital 75,168 74,033
Accumulated deficit (44,496) (66,388)
---------------------
Total shareholders' equity 30,778 7,750
---------------------
Total liabilities and shareholders' equity $ 35,245 $ 13,139
=====================
NOTE: The Balance Sheet at December 31, 2002 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
SEE ACCOMPANYING NOTES.
3
ORPHAN MEDICAL, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
(Unaudited)
For the Three Months For the Six Months
Ended June 30 Ended June 30
--------------------- ---------------------
2003 2002 2003 2002
-----------------------------------------------
Revenues, net $ 4,349 $ 3,506 $ 8,916 $ 7,160
Cost of sales 718 525 1,465 1,053
--------------------- ---------------------
Gross Profit 3,631 2,981 7,451 6,107
Operating expenses:
Research and development 1,898 1,331 3,595 2,414
Sales and marketing 3,624 1,709 7,786 3,724
General and administrative 1,886 1,465 3,705 2,538
--------------------- ---------------------
Total operating expenses 7,408 4,505 15,086 8,676
--------------------- ---------------------
Loss from operations (3,778) (1,524) (7,635) (2,569)
Interest (expense) income, net (21) 66 (13) 150
Gain on disposition of products 30,267 -- 30,267 --
--------------------- ---------------------
Net income (loss) before taxes 26,469 (1,458) 22,619 (2,419)
Income tax expense 250 -- 257 --
--------------------- ---------------------
Net income 26,219 (1,458) 22,362 (2,419)
Less: Preferred stock dividends 234 227 466 452
--------------------- ---------------------
Net loss attributable to common shareholders $ 25,985 $ (1,685) $ 21,896 $ (2,871)
===================== =====================
Earnings (loss) per share
Basic $ 2.47 ($ 0.16) $ 2.08 ($ 0.28)
Diluted $ 2.06 ($ 0.16) $ 1.75 ($ 0.28)
Weighted average number of shares used to
calculate earnings (loss) per share
Basic 10,538 10,344 10,517 10,313
Diluted 12,709 10,344 12,781 10,313
SEE ACCOMPANYING NOTES
4
ORPHAN MEDICAL, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(Unaudited)
For the Six Months Ended
June 30
---------------------
2003 2002
OPERATING ACTIVITIES
Net loss $ 22,362 $ (2,419)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 247 89
Gain on disposition of products (30,267) --
Changes in operating assets and liabilities:
Accounts receivable and current assets (197) (429)
Inventories 699 (740)
Accounts payable and accrued expenses (914) 104
---------------------
Net cash used in operating activities (8,070) (3,395)
INVESTING ACTIVITIES
Purchase of office equipment (34) (165)
Net proceeds from disposition of products 30,267 --
---------------------
Net cash provided by (used in) investing activities 30,233 (165)
FINANCING ACTIVITIES:
Employee stock purchase plan 23 318
Stock option exercise proceeds 622 20
Private common stock placement -- (8)
Principal payments on capital lease (8) --
Cash dividends (1) --
---------------------
Net cash provided by financing activities 636 330
Increase (decrease) in cash and cash equivalents 22,798 (3,229)
Cash and cash equivalents at beginning of period 6,921 19,011
---------------------
Cash and cash equivalents at end of period $ 29,720 $ 15,782
======================
5
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
BUSINESS
Orphan Medical acquires, develops, and markets products of high medical value
intended to treat sleep disorders, pain and other central nervous disorders that
are addressed by physician specialists. A drug has high medical value if it
offers a major improvement in the safety or efficacy of patient treatment and
has no substantially equivalent substitute. The Company has had six
pharmaceutical products approved for marketing by the United States Food and
Drug Administration (FDA). While three have been divested, the Company is
focusing its resources on Xyrem(R) (sodium oxybate) oral solution, a medication
approved for cataplexy, a significant and debilitating symptom of narcolepsy.
The Company is conducting clinical trials to assess Xyrem in treating excessive
daytime sleepiness and fragmented nighttime sleep, the other prominent symptoms
of narcolepsy. A new compound, Butamben (butyl-p-aminobenzoate) suspension for
injection, is being evaluated for development as a treatment of pain. The
Company seeks other approved or development-stage products in the specialty
areas it serves.
BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, these financial statements do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal, recurring accruals) considered necessary for fair presentation have
been included. Operating results for the three-month and six-month period ended
June 30, 2003 are not necessarily indicative of the results that may be expected
for the year ended December 31, 2003. For further information, refer to the
audited financial statements and accompanying notes contained in the Company's
Annual Report filed on Form 10-K for the year ended December 31, 2002.
2. DISPOSITION OF PRODUCTS
On June 10, 2003, the Company announced the disposition of Busulfex(R)
(busulfan) Injection to ESP Pharma, Inc. for $29.3 million plus the book value
of inventory, approximately $0.2 million. The Company announced the sale of the
product Sucraid(R) (sacrosidase) oral solution to a specialty pharmaceutical
company on May 6, 2003 for $1.5 million. The Company also divested a third
product, Elliotts B Solution(R) to another company for proceeds that were not
material. Proceeds from these dispositions will be used for further development
and marketing of Xyrem(R) (sodium oxybate) oral solution and for the creation of
a stronger presence in the sleep and central nervous system (CNS) markets.
3. USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
6
4. STOCK-BASED COMPENSATION
At December 31, 2002 the Company has a stock-based employee compensation plan.
The Company accounts for its plan under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees", and related interpretations. No stock-based compensation
cost is reflected in the net loss for the three or six month periods ended June
30, 2003 or 2002, as all options granted under this plan had an exercise price
equal to market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net loss and net loss per share if
the Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", to stock-based employee compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
(in thousands except per share data) JUNE 30, JUNE 30,
---------------------------------------------------
2003 2002 2003 2002
Net income (loss) as reported $ 25,985 $ (1,685) $ 21,896 $ (2,871)
Deduct total stock-based employee compensation expense
determined under fair value-based method for all awards (683) (639) (1,257) (968)
---------------------------------------------------
Pro forma net income (loss) $ 25,302 $ (2,324) $ 20,637 (3,839)
===================================================
Earnings (loss) per share
Basic - as reported $ 2.47 $ (0.16) $ 2.08 $ (0.28)
Basic - as pro forma $ 2.40 $ (0.22) $ 1.96 $ (0.37)
Diluted - as reported $ 2.06 $ (0.16) $ 1.75 $ (0.28)
Diluted - as pro forma $ 2.16 $ (0.22) $ 1.75 $ (0.37)
5. REVENUE RECOGNITION
Sales for all products, except Xyrem, are recognized at the time a product is
shipped to the Company's customers and are recorded net of reserves for
discounts for prompt payment. Sales of Xyrem are recognized at the time product
is shipped from the specialty pharmacy to the patient and are recorded net of
discounts for prompt payment. Except for Xyrem, the Company is obligated to
accept, for exchange, from all domestic customers products that have reached
their expiration date, which range from two to four years depending on the
product. The Company is not obligated to accept exchange of outdated product
from its international distribution partners. The Company establishes a reserve
for the estimated cost of the exchanges. The Company monitors the exchange of
product and modifies its reserve as necessary. Management bases these reserves
on historical experience and these estimates are subject to change.
7
6. INVENTORIES
Inventories are valued at the lower of cost or market determined using the
first-in, first-out (FIFO) method. The Company's policy is to establish an
excess and obsolete reserve for its products in excess of the expected demand
for such products.
JUNE 30, 2003 DECEMBER 31, 2002
Raw materials and packaging $ 244 $ 1,023
Finished goods 1,077 997
-----------------------------------
$ 1,321 $ 2,020
===================================
7. EARNINGS PER SHARE
Earnings per share is computed in accordance with SFAS No. 128, "Earnings Per
Share". Basic earnings (loss) per share is computed based on the weighted
average number of common shares outstanding during the period. Diluted earnings
(loss) per share is computed based on the weighted average shares outstanding
and the dilutive impact of common stock equivalents outstanding during the
period. The dilutive effect of employee stock options and warrants is measured
using the treasury stock method. The dilutive effect of both series of
convertible preferred stock is computed using the "if-converted" method. Common
stock equivalents are not included in periods where there is a loss, as they are
antidilutive. The following is a reconciliation of net income (loss) and
weighted average common shares outstanding for purposes of calculating basic and
diluted earnings (loss) per share:
(in thousands, except per share data)
Quarter ended Six months ended
June 30, June 30,
---------------------------------------------
2003 2002 2003 2002
---------------------------------------------
NUMERATOR
Numerator for basic earnings per share -
income available to common shareholders $ 25,985 $ (1,685) $ 21,896 $ (2,871)
Add back to effect assumed conversions:
Preferred stock dividends 234 -- 465 --
---------------------------------------------
Numerator for diluted earnings per share $ 26,219 $ (1,685) $ 22,361 $ (2,871)
=============================================
DENOMINATOR
Denominator for basic earnings per share -
weighted average shares 10,538 10,344 10,517 10,313
Effect of dilutive securities:
Preferred shares 1,657 -- 1,653 --
Stock options 312 -- 380 --
Warrants 202 -- 231 --
-------- -------- -------- --------
Denominator for diluted earnings per share -
weighted average shares and assumed conversions 12,709 10,344 12,781 10,313
======== ======== ======== ========
Basic earnings per share $ 2.47 $ (0.16) $ 2.08 $ (0.28)
======== ======== ======== ========
Diluted earnings per share $ 2.06 $ (0.16) $ 1.75 $ (0.28)
======== ======== ======== ========
8
8. COMMITMENTS
The Company has various commitments under agreements with outside consultants
and contractors to provide services relating to drug development, drug
acquisition, manufacturing and marketing. At June 30, 2003, the Company
estimates that it could incur approximately $8.7 million of additional
expenditures in subsequent periods under existing commitments. Commitments for
research and development expenditures will likely fluctuate from quarter to
quarter and from year to year depending on, among other factors, the timing of
product development and the progress of clinical development programs.
9. BORROWINGS
The Company entered into a new line of credit facility with a commercial bank on
March 27, 2003. The new line of credit facility has a term of one-year and
includes a borrowing base equal to 75% of eligible accounts receivable up to a
maximum amount of $2.5 million. Certain other assets have also been pledged as
collateral for this facility. The interest rate is equal to two points over the
bank's prime rate. The Company is also subject to certain other requirements
during the term of the facility, including (a) minimum quarterly net tangible
equity of $6.0 million plus 50 percent of the proceeds of any equity securities
or subordinated debt offering and (b) maximum monthly operating loss of $2.7
million. The Company had not borrowed under this facility at June 30, 2003.
9
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CAUTIONARY STATEMENT
This Quarterly Report on Form 10-Q contains statements that are not descriptions
of historical facts. The words or phrases "will likely result", "look for", "may
result", "will continue", "is anticipated", "expect", "project", or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
may be forward-looking statements that are subject to risks and uncertainties.
Actual results could differ materially from those currently anticipated due to a
number of factors, including those identified in the section of this Quarterly
Report filed on Form 10-Q for the quarterly period ended June 30, 2003 titled
Risk Factors.
GENERAL
Since its inception, the activities of the Company have consisted primarily of
obtaining the rights to proposed pharmaceutical products for developing and
marketing, managing the development of these products and preparing for and
initiating the commercial introduction of six products. The Company operates in
a single business segment: pharmaceutical products. The Company has experienced
recurring losses from operations and has generated an accumulated deficit
through June 30, 2003 of $44.5 million. In addition, the Company expects to
incur additional losses from operations for at least for the next six fiscal
quarters.
RECENT DEVELOPMENTS
On June 10, 2003, the Company announced the disposition of the rights to
Busulfex(R) (busulfan) Injection to ESP Pharma, Inc. for $29.3 million plus the
book value of inventory, approximately $0.2 million. The Company announced the
disposition of the product Sucraid(R) (sacrosidase) oral solution to a specialty
pharmaceutical company on May 6, 2003 for $1.5 million. The Company also
divested a third product, Elliotts B Solution(R) to another company for proceeds
that were not material. Proceeds from these dispositions will be used for
further development and marketing of Xyrem(R) (sodium oxybate) oral solution and
for the creation of a stronger presence in the sleep and central nervous system
(CNS) markets.
As a result of the disposition of products, the Company announced a revised
total revenue forecast for the current fiscal year in the range of $15.0 to
$18.0 million, including $4.5 to $6.0 million of revenue from sales of Xyrem.
The Company continues to estimate that the total cataplexy market for Xyrem is
in excess of $125 million annually. Cataplexy is a debilitating symptom of
narcolepsy, affecting sixty to ninety percent of the 140,000 Americans with
narcolepsy. It involves the sudden partial or total loss of muscle tone, usually
triggered by strong emotions such as laughter, anger, or surprise.
THREE MONTHS ENDED JUNE 30, 2003 VS. THREE MONTHS ENDED JUNE 30, 2002
Net income applicable to common shareholders was $26.0 million for the three
months ended June 30, 2003 compared to a net loss applicable to common
shareholders of $1.7 million for the three months ended June 30, 2002. This
change is attributable to the product dispositions during the
10
quarter ended June 30, 2003. These product dispositions resulted in gross
proceeds of $30.8 million and approximately $0.5 million of expenses associated
with the transactions. Operating expenses increased over the prior year
primarily due to the commercialization of Xyrem and the ongoing development
activities for Xyrem. These increases in expenses were offset by the disposition
of products during the quarter and an increase in net sales for the quarter
ended June 30, 2003 compared to the same period in the prior year.
Net sales increased 24% to $4.3 million for the three months ended June 30, 2003
compared to $3.5 million for the same period in the prior year. Sales of Xyrem
were approximately $800,000 for the quarter ended June 30, 2003. As of June 30,
2003, more than 700 physicians had written 1,977 prescriptions for Xyrem of
which 1,304 had been filled, with 400 prescriptions in process. Approximately 10
percent of patients do not fill their initial prescription. After initiating
therapy, there has been an 8 percent discontinuation rate following use of Xyrem
of which only 3 percent is due to side effects and 1.5 percent due to lack of
efficacy. During the second half of the quarter the Company experienced a large
increase in the number of new prescriptions written for Xyrem. The Company's
market research indicates that overall satisfaction by both patients and
physicians continues to be strong and third party reimbursement remained high.
Sales of Antizol(R) (fomepizole) Injection increased approximately 30% compared
to the prior year as more hospitals with emergency rooms stocked the product.
Net sales for the quarter include approximately $1.5 million from divested
products prior to the divestiture of these products in the quarter ended June
30, 2003.
Gross profit margins decreased to 84% for the quarter ended June 30, 2003
compared to 85% for the same period the prior year due to product mix. Cost of
sales was $0.7 million for the three months ended June 30, 2003 compared to $0.5
million for the same period the prior year. Cost of sales as a percentage of net
sales will fluctuate from quarter to quarter and from year to year depending on,
among other factors, demand for the Company's products, new product
introductions and the mix of approved products shipped.
Research and development expense increased 43% to $1.9 million in the three
months ended June 30, 2003 compared to $1.3 million for the three months ended
June 30, 2002. The increase results from increased spending for the ongoing
Phase III(b) trial for Xyrem and the initiation of the EXCEEDS trial during the
first quarter of 2003. Both of theses trials for Xyrem now underway will
increase research and development spending in subsequent quarters. Clinical
spending for trials is dependent on a number of factors, including among others,
the number of human subjects screened and enrolled in the trial, and the number
of active clinical sites. Development expenses will increase in the second half
of 2003 to approximately $3.0 million per quarter.
Sales and marketing expense increased 112% to $3.6 million for the three months
ended June 30, 2003 from $1.7 million for the three months ended June 30, 2002.
This increase is attributable to spending for the support of the commercial
launch of Xyrem, approved by the FDA in July 2002 and launched in October 2002.
These expenses included the addition of staff, including a dedicated sales force
and other staff supporting the selling and marketing efforts for Xyrem, along
with
11
extensive marketing and medical education efforts. Sales and marketing expenses
will be in the $4.0 to $4.5 million range in each of the third and fourth
quarters of 2003
General and administrative expense increased 29% to $1.9 million for the period
ended June 30, 2003 compared to $1.5 million for the three months ended June 30,
2002. The increase results from increased staffing and other infrastructure
supporting the growth of the Company. General and administrative expenses will
decrease slightly in each of the third and fourth quarters of 2003.
Interest (expense) income is the sum of interest income from investment
activities less interest expense from financing activities. Other income
decreased as a result of lower invested balances and lower interest rates on any
excess cash invested. In addition, the Company pays minimum interest expense
related to the Company's credit facility.
During the quarter ended June 30, 2003, the Company recorded $0.3 million of
income tax expense related to the product dispositions. Since the Company
expects to be unprofitable for at least the next six quarters, the Company
continues to provide a valuation allowance for the entire amount of deferred tax
assets.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that
was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on
August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were
$0.2 million for both the three-months ended June 30, 2003 and 2002. Preferred
stock dividends, which commenced on February 1, 1999, are payable in arrears on
August 1 and February 1 of each year. The Company has chosen to satisfy its
dividend payment obligation by issuing additional common or preferred stock, as
permitted by the terms of the Senior Convertible Preferred Stock and the Series
B Convertible Preferred Stock respectively. For the February 1, 2003 Senior
Preferred Stock dividend, the Company elected to issue 33,167 shares of common
stock to satisfy its obligation. The Company also intends to continue to satisfy
this obligation in the future by issuing common stock. The Company is obligated
to pay the dividend for the Series B Convertible Preferred Stock in cash or
through the issuance of additional preferred shares. The Company also intends to
satisfy the Series B Convertible Preferred Stock obligation by issuing
additional preferred shares, which will cause preferred stock dividends to
increase in subsequent quarters.
SIX MONTHS ENDED JUNE 30, 2003 VS. SIX MONTHS ENDED JUNE 30, 2002
Net income applicable to common shareholders was $21.9 million for the six
months ended June 30, 2003 compared to a net loss applicable to common
shareholders of $2.9 million for the six months ended June 30, 2002. The
aforementioned product dispositions resulted in gross proceeds of $30.8 million
and approximately $0.5 million of expenses associated with the transactions.
Operating expenses increased over the prior year primarily due to the
commercialization of Xyrem and the ongoing development activities for Xyrem.
These increases in expenses were offset by the disposition of products during
the six-months ended June 30, 2003 and an increase in net sales for the
six-months ended June 30, 2003 compared to the same period in the prior year.
12
Net sales increased 25% to $8.9 million for the six-months ended June 30, 2003
compared to $7.2 million for the same period in the prior year. Sales for Xyrem
were approximately $1.4 million for the six months ended June 30, 2003.
Sales of Antizol increased nearly 24% over the same period the prior year as
more hospitals with emergency rooms are stocking the product.
Net sales for the six-months ended June 30, 2003 included approximately $3.6
million from divested products prior to the divestiture of these products.
Gross profit margins decreased to 84% for the six-months ended June 30, 2003
compared to 85% for the same period the prior year due to product mix. Cost of
sales was $1.5 million for the six-months ended June 30, 2003 compared to $1.1
million for the same period the prior year. Cost of sales as a percentage of net
sales will fluctuate from quarter to quarter and from year to year depending on,
among other factors, demand for the Company's products, new product
introductions and the mix of approved products shipped.
Research and development expense increased 49% to $3.6 million in the six months
ended June 30, 2003 compared to $2.4 million for six months ended June 30, 2002.
The increase results from increased spending for the ongoing Phase III(b) trial
for Xyrem and the initiation of the EXCEEDS trial during the first quarter of
2003. Both of theses trials for Xyrem now underway will increase research and
development spending in subsequent quarters. Clinical spending for trials is
dependent on a number of factors, including among others, the number of human
subjects screened and enrolled in the trial, and the number of active clinical
sites.
Sales and marketing expense increased 109% to $7.8 million for the six months
ended June 30, 2003 from $3.7 million for the six months ended June 30, 2002.
This increase is attributable to spending supporting the commercial launch of
Xyrem, approved in July 2002 and launched in October 2002. These expenses
included the addition of staff, including a dedicated sales force and other
staff supporting the selling and marketing efforts for Xyrem, along with
extensive marketing and medical education efforts.
General and administrative expense increased 46% to $3.7 million for the
six-months ended June 30, 2003 compared to $2.5 million for the six months ended
June 30, 2002. The increase results from increased staffing and other
infrastructure supporting the growth of the Company.
Interest (expense) income is the sum of interest income from investment
activities less interest expense from financing activities. Interest income
decreased as a result of lower invested balances and lower interest rates on any
excess cash invested. In addition, the Company pays minimum interest expense
related to the Company's credit facility.
During the six-months ended June 30, 2003, the Company recorded $0.3 million of
income tax expense related to the product dispositions. Since the Company
expects to be unprofitable for at least the next six quarters, the Company
continues to provide a valuation allowance for the entire amount of deferred tax
assets.
13
Preferred stock dividends relate to the Senior Convertible Preferred Stock that
was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on
August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were
$0.5 million for both the six-months ended June 30, 2003 and 2002. Preferred
stock dividends, which commenced on February 1, 1999, are payable in arrears on
August 1 and February 1 of each year. The Company has chosen to satisfy its
dividend payment obligation by issuing additional common or preferred stock, as
permitted by the terms of the Senior Convertible Preferred Stock and the Series
B Convertible Preferred Stock respectively. For the February 1, 2003 Senior
Preferred Stock dividend, the Company elected to issue 33,167 shares of common
stock to satisfy its obligation. The Company also intends to continue to satisfy
this obligation in the future by issuing common stock. The Company is obligated
to pay the dividend for the Series B Convertible Preferred Stock in cash or
through the issuance of additional preferred shares. The Company also intends to
satisfy the Series B Convertible Preferred Stock obligation by issuing
additional preferred shares, which will cause preferred stock dividends to
increase in subsequent quarters.
LIQUIDITY AND CAPITAL RESOURCES
Since July 2, 1994, the effective date it was spun-off from Chronimed, Inc., the
Company has financed its operations principally from net proceeds of $90.8
million from several public and private financings, interest income and product
sales, including $30.3 million of net proceeds from the divestiture of products
during the quarter ended June 30, 2003.
Net working capital (current assets less current liabilities) increased from
$6.7 million at December 31, 2002 to $29.9 million at June 30, 2003. Cash and
cash equivalents increased from $6.9 million at December 31, 2002 to $29.7
million at June 30, 2003. The increase in these amounts is directly attributable
to the product dispositions discussed previously.
The Company entered into a new line of credit facility with a commercial bank on
March 27, 2003, and terminated its previous line of credit on that date. The
Company's line of credit facility, which has a term of one-year, includes a
borrowing base equal to 75% of eligible accounts receivable up to a maximum
amount. In conjunction with the product dispositions, the Company amended the
maximum amount of the line of credit from $3.5 million to $2.5 million. Certain
other assets have also been pledged as collateral for this facility. The
interest rate is equal to two points over the bank's prime rate. The Company
will be subject to certain other requirements during the term of the facility,
including minimum quarterly net equity amounts. The Company had not borrowed
under this facility as of June 30, 2003.
The Company's commitments for outside development spending were $8.7 million at
June 30, 2003 and $5.6 million at December 31, 2002. This increase is the result
of the initiation of the EXCEEDS clinical trial. If additional products are
licensed for development, these expenditures and commitments could increase
significantly.
Management believes the Company's current cash availability, anticipated
operating cash flows from product revenues and license fees that would be
received upon the execution of an agreement currently under discussion with a
prospective European partner for the registration and marketing of Xyrem will be
sufficient to fund its operations at least through December 31, 2004.
14
For continued listing on the NASDAQ National Market, a company must satisfy a
number of requirements, which in the Company's case include either: (1) net
equity in excess of $10.0 million or (2) a market capitalization of at least
$50.0 million. The Company met both the thresholds at June 30, 2003. The
Company's market capitalization was approximately $96.8 million as of June 30,
2003 (based on the last sale price of $9.14 and 10.6 million shares
outstanding). Although the Company does not expect to be profitable in 2003 or
2004, the Company nevertheless expects to continue to meet the listing
requirements for listing on the NASDAQ National Market. However, there can be no
assurance that the Company will continue meet these requirements there after
through 2003.
In connection with the 1998 and 1999 private placements of convertible preferred
stock, the Company agreed to certain restrictions and covenants, which could
limit its ability to obtain additional financing. Even without these
restrictions, the Company can make no assurances that additional financing
opportunities will be available or, if available, on acceptable terms.
GEOGRAPHIC SALES INFORMATION
The Company tracks sales in two geographic regions, domestic and international.
The Company has no assets outside of the United States. The following is a
summary of net sales by geographic region for the three-month and six-month
periods ended June 30, 2003 and 2002, respectively.
(in thousands)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
Domestic $ 3,865 $ 2,713 $ 7,763 $ 5,230
International 484 793 1,153 1,930
------- ------- ------- -------
Total $ 4,349 $ 3,506 $ 8,916 $ 7,160
======= ======= ======= =======
15
RISK FACTORS
An investment in our common stock involves a number of risks, including among
others, risks associated with companies that operate in the pharmaceutical
industry. These risks are substantial and inherent in our operations and
industry. Any investor or potential investor should carefully consider the
following information about these risks before buying shares of common stock.
WE HAVE A HISTORY OF LOSSES, WHICH WE EXPECT TO CONTINUE.
We have been unprofitable since our inception in January 1993. We expect
operating losses at least through 2004 because anticipated gross profits from
product revenues will not offset our operating expenses, including additional
spending to support drug development activities. The amount of these losses may
vary significantly from year-to-year and quarter-to-quarter. Our actual losses
will depend on, among other factors, the timing of product development,
regulatory approval, and market demand for our Food and Drug Administration
("FDA") approved products. We cannot assure you that we will ever generate
sufficient product revenues to achieve profitability.
LIMITATIONS TO SOURCES OF ADDITIONAL CAPITAL - RESTRICTIONS, COVENANTS AND
RIGHTS RELATED TO SENIOR CONVERTIBLE PREFERRED STOCK AND SERIES B CONVERTIBLE
PREFERRED STOCK.
On July 23, 1998, we completed the private sale to UBS Capital of $7.5 million
of Senior Convertible Preferred Stock. On August 2, 1999, we completed another
private sale to UBS Capital of $2.95 million of Series B Convertible Preferred
Stock. In conjunction with the issuance of the preferred shares, we agreed to
several restrictions and covenants, and granted certain voting and other rights
to the holders of the preferred shares. One of the most important of these
restrictions is that we cannot incur additional indebtedness, except for
indebtedness secured solely by our trade receivables, until we have profitable
operations, subject to certain limitations. Another important restriction is
that, without the approval of a majority of the preferred stockholders, we
cannot issue additional equity securities unless the selling price per share
exceeds the then conversion price of the outstanding convertible preferred stock
or the sale of equity is accomplished in a public offering. The present
conversion price is $8.14 per share for the Senior Convertible Preferred Stock
and $6.50 for the Series B Convertible Preferred Stock.
These restrictions could make it more difficult and more costly for us to obtain
additional capital. We cannot assure you that additional sources of capital will
be available to us or, if available, on terms acceptable to us.
POSSIBLE PRICE VOLATILITY AND LIMITED LIQUIDITY OF STOCK.
There is generally significant volatility in the market prices and limited
liquidity of securities of early stage companies, and particularly of early
stage pharmaceutical companies. Contributing to this volatility are various
factors and events that can affect our stock price in a positive or negative
manner. These factors and events include, but are not limited to:
- - announcements by us or our competitors of new product developments or clinical
testing results;
- - governmental approvals, refusals to approve, regulations or actions;
- - developments or disputes relating to patents or proprietary rights;
16
- - public concern over the safety of therapies;
- - financial performance;
- - fluctuations in financial performance from period to period; and
- - small float or number of shares of our stock available for sale and trade.
These and other factors and events may have a significant impact on our business
and on the market price of the common stock.
WE CANNOT BE SURE THAT FUTURE CAPITAL WILL BE AVAILABLE TO MEET OUR EXPECTED
CAPITAL REQUIREMENTS.
Although we believe that we have sufficient capital to meet out current business
objectives, if we expand our business plans, we may need additional capital.
Adequate funds for our operations, continued development, and expansion of our
business plans, whether from financial markets or from other sources, may not be
available when needed on acceptable terms, or at all. If we issue additional
securities your holding may be diluted.
POSSIBLE VOLATILITY OF STOCK PRICE AND REDUCED LIQUIDITY OF THE MARKET FOR THE
STOCK - POSSIBLE LOSS OF NASDAQ NATIONAL MARKET LISTING AND FAILURE TO QUALIFY
FOR NASDAQ SMALL CAP MARKET LISTING.
There is a risk that the market value and the liquidity of the public float for
our common stock could be adversely affected in the event we no longer meet the
Nasdaq's requirements for continued listing on the National Market. For
continued listing on the Nasdaq National Market, a company must satisfy a number
of requirements, which in our case includes either: (1) minimum net equity in
excess of $10.0 million as reported on Form 10-Q or Form 10-K or (2) a market
capitalization of at least $50.0 million. Market capitalization is defined as
total outstanding shares multiplied by the last sales price quoted by Nasdaq. We
met the market capitalization criteria as of June 30, 2003, however, we cannot
assure you that the market capitalization threshold will continue to be met or
that we will be able to generate adequate capital to meet the net equity
requirement.
THERE IS A LIMITED MARKET FOR OUR PRODUCTS.
Most orphan drugs have a potential United States market of less than $25 million
annually and many address annual markets of less than $1 million. We cannot
assure you that sales of our products will be adequate to make us profitable
even if the products are accepted by medical specialists and used by patients.
WE RELY ON THE LIMITED PROTECTION OF THE ORPHAN DRUG ACT.
United States
- -------------
Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs
intended to treat a "rare disease or condition." The Orphan Drug Act generally
defines "rare disease or condition" as one that affects populations of fewer
than 200,000 people in the United States. The Orphan Drug Act provides us with
certain limited protections for our products.
17
The first step in obtaining the limited protection under the Orphan Drug Act is
acquiring the FDA's approval of "orphan drug designation," which must be
requested before submitting a New Drug Application ("NDA"). After the FDA grants
orphan drug designation, it publishes the generic identity of the therapeutic
agent and the potential orphan use specified in the request. Orphan drug
designation does not constitute FDA approval. In addition, orphan drug
designation does not convey any advantage in, or shorten the duration of, the
regulatory approval process.
The second step in obtaining the limited protection under the Orphan Drug Act is
acquiring the FDA's recognition of "orphan drug status." The Orphan Drug Act
confers orphan drug status upon the first company to receive FDA approval to
market a drug with "orphan drug designation" for a specific designated
indication. Orphan drug status does not protect against another formulation or
drug of materially different composition from being approved, with or without
orphan drug status, for the same indication. FDA approval also results in United
States marketing exclusivity for a period of seven years, subject to certain
limitations. Although obtaining FDA approval to market a product with orphan
drug status can be advantageous, we cannot assure you that the scope of
protection or the level of marketing exclusivity will remain in effect in the
future. In addition, United States orphan drug status does not provide any
marketing exclusivity in foreign markets. Although certain foreign countries
provide development and marketing benefits to orphan drugs, we cannot assure you
that such benefits can be obtained or, if obtained, will be of material value to
us. The FDA has granted us orphan drug status for Xyrem, Antizol, and Cystadane.
Even if the FDA approves an NDA for a drug with an orphan drug designation, the
FDA may still approve the same drug for a different indication, or a molecular
variation of the same drug for the same indication. We are currently not aware
of any orphan drug designation granted to another company for a compound similar
to any of the Company's currently marketed products.
The possible amendment of the Orphan Drug Act by Congress has been the subject
of congressional discussion from time to time over the last ten years. Although
Congress has made no significant changes to the Orphan Drug Act for a number of
years, members of Congress have from time to time proposed legislation that
would limit the application of the Orphan Drug Act. We cannot assure you that
the Orphan Drug Act will remain in effect or that it will remain in effect in
its current form. The precise scope of protection that orphan drug designation
and marketing approval may afford in the future is unknown. We cannot assure you
that the current level of exclusivity will remain in effect.
Europe
- ------
An orphan drug act was enacted in Europe that provides up to ten years of market
exclusivity for a drug that meets the requirements of the act. For a
pharmaceutical product to qualify for the benefits of the act, the prevalence or
incidence (whichever is greater) must not exceed five patients per 10,000 in the
population. Our European partners have obtained orphan drug designation for
Cystadane in Europe. The Company has obtained orphan drug designation for Xyrem
and Antizol, for use in methanol poisonings, in Europe. We cannot provide
assurance that any of our pharmaceutical products will qualify for orphan drug
protection in Europe or that another company will not obtain an approval that
would block us from marketing our product in Europe.
18
THE FDA AND FOREIGN REGULATORY AUTHORITIES MUST APPROVE OUR PRODUCTS FOR SALE.
Government regulation in the United States and abroad is a significant factor in
the testing, production and marketing of our current and future products. Each
product must undergo an extensive regulatory review process conducted by the
United States Food and Drug Administration and by comparable agencies in other
countries. We cannot market any medicine we may develop or license as a
prescription product in any jurisdiction, including foreign countries, in which
the product does not receive regulatory approval. The approval process can take
many years and requires the expenditure of substantial resources.
We depend on external laboratories and medical institutions to conduct our
pre-clinical and clinical analytical testing in compliance with good clinical
and laboratory practices established by the FDA. The data obtained from
pre-clinical and clinical testing is subject to varying interpretations that
could delay, limit or prevent regulatory approval. In addition, changes in FDA
policy for drug approval during the period of development and in the
requirements for regulatory review of each submitted NDA could result in
additional delays or outright rejection.
We cannot assure you that the FDA or any foreign regulatory authority will
approve in a timely manner, if at all, any product we develop. Generally, the
FDA and foreign regulatory authorities approve only a very small percentage of
newly discovered pharmaceutical compounds that enter pre-clinical development.
Moreover, even if the FDA approves a product, it may place commercially
unacceptable limitations on the uses, or "indications," for which a product may
be marketed. This would result in additional cost and delay for further studies
to provide additional data on safety or effectiveness.
FDA APPROVAL DOES NOT GUARANTEE FINANCIAL SUCCESS.
Three of our current products have been approved for marketing by regulatory
authorities in the United States and elsewhere. We cannot assure you that any of
our products will be commercially successful or achieve the expected financial
results. We may encounter unanticipated problems relating to the development,
manufacturing, distribution and marketing of our products. Some of these
problems may be beyond our financial and technical capacity to solve. The
failure to adequately address any such problems could have a material adverse
effect on our business and our prospects. In addition, the efforts of government
entities and third party payors to contain or reduce the costs of health care
may adversely affect our sales and limit the commercial success of our products.
We cannot completely insulate our drug development portfolio from the
possibility of clinical or commercial failures. Some products that we have
selected for development may not produce the results expected during clinical
trials or receive FDA approval. Drugs approved by the FDA may not generate
product sales of an acceptable level. We have discontinued the development of
eleven products from our portfolio since inception.
19
SIGNIFICANT GOVERNMENT REGULATION CONTINUES ONCE A PRODUCT IS APPROVED FOR SALE.
After a reviewing division of the FDA approves a drug, the FDA's Division of
Drug Marketing, Advertising and Communication must accept such drug's marketing
claims, which are the basis for the drug's labeling, advertising and promotion.
We cannot be sure that the Division of Drug Marketing, Advertising and
Communication will accept our proposed marketing claims. The failure of the
Division of Drug Marketing, Advertising and Communication to accept our proposed
marketing claims could have a material adverse effect on our business and
prospects.
The FDA can require that a company conduct "post-marketing adverse event
surveillance programs" to monitor any side effects that occur after the
company's drug is approved for marketing. If the surveillance program indicates
unsafe side effects, the FDA may recall the product, and suspend or terminate a
company's authorization to market the product. The FDA also regulates the
manufacturing process for an approved drug. The FDA may impose restrictions or
sanctions upon the subsequent discovery of previously unknown problems with a
product or manufacturer. One possible sanction is requiring the withdrawal of
such product from the market. The FDA must approve any change in manufacturer as
well as most changes in the manufacturing process prior to implementation.
Obtaining the FDA's approval for a change in manufacturing procedures or change
in manufacturers is a lengthy process and could cause production delays and loss
of sales, which would have a material adverse effect on our business and our
prospects.
Certain foreign countries regulate the sales price of a product after marketing
approval is granted. We cannot be sure that we can sell our products at
satisfactory prices in foreign markets even if foreign regulatory authorities
grant marketing approval.
WE RELY ON OTHERS FOR PRODUCT DEVELOPMENT OPPORTUNITIES.
We engage only in limited research to identify new pharmaceutical compounds. To
build our product portfolio, we have adopted a license and acquisition strategy.
This strategy for growth requires us to identify and acquire pharmaceutical
products targeted at niche markets within selected strategic therapeutic market
segments. These products usually require further development and approval by
regulatory bodies before they can be marketed. We cannot assure you that any
such products can be successfully acquired, developed, approved or marketed. We
must rely upon the willingness of others to sell or license pharmaceutical
product opportunities to us. Other companies, including those with substantially
greater resources, compete with us to acquire such products. We cannot assure
you that we will be able to acquire rights to additional products on acceptable
terms, if at all. Our failure to acquire or license any new pharmaceutical
products, or our failure to promote and market any products successfully or
products within an existing therapeutic area, could have a material adverse
effect on our business and our prospects.
We have contractual development rights to certain compounds through various
license agreements. Generally, the licensor can unilaterally terminate these
agreements for several reasons, including, but not limited to the following
reasons:
- - for cause if we breach the contract;
- - if we become insolvent or bankrupt;
- - if we do not apply specified minimum resources and efforts to develop
the compound under license; or
20
- - if we do not achieve certain minimum royalty payments, or in some
cases, minimum sales levels.
We cannot assure you that we can meet all specified requirements and avoid
termination of any license agreements. We cannot assure you that if any
agreement is terminated, we will be able to enter into similar agreements on
terms as favorable as those contained in our existing license agreements.
WE DEPEND ON OTHERS TO MANUFACTURE AND SUPPLY THE PRODUCTS WE MARKET.
We do not have and do not intend to establish any internal product testing,
synthesis of bulk drug substance, or manufacturing capability for drug product.
Accordingly, we depend on others to supply and manufacture the components
incorporated into all of our finished drug products. The inability to contract
for these purposes on acceptable terms could adversely affect our ability to
develop and market our products. Failure by parties with whom we contract to
adequately perform their responsibilities may delay the submission of products
for regulatory approval, impair our ability to deliver our products on a timely
basis or otherwise adversely affect our business and our prospects. The loss of
a supply or manufacturing contractor could materially adversely affect our
business and our prospects.
The loss of either a bulk drug supplier or drug product manufacturer would
require us to obtain regulatory clearance in the form of a "pre-approval
submission" and incur validation and other costs associated with the transfer of
the bulk drug or drug product manufacturing process. We believe that it could
take as long as two years for the FDA to approve such a submission. Because our
products are targeted to relatively small markets and our manufacturing
production runs are small by industry standards, we have not incurred the added
costs to certify and maintain secondary sources of supply for bulk drug
substance or backup drug product manufacturers for some products. Should we lose
either a bulk drug supplier or a drug product manufacturer, we could run out of
salable product to meet market demands or investigational product for use in
clinical trials, while we wait for the FDA approval of a new bulk drug supplier
or drug product manufacturer. We cannot assure you that the change of a bulk
drug supplier or drug product manufacturer and the transfer of the processes to
another third party will be approved by the FDA, and if approved, in a timely
manner. The loss of or the change of a bulk drug supplier or a drug product
manufacturer could have a material adverse effect on our business and prospects.
Bulk Drug Supply
Bulk drug substance is the active chemical compound used in the manufacture of
our drug products. We depend substantially on single suppliers for the supply of
bulk drug substance used in each of our products. If we were to lose any of
these companies as a supplier, we would be required to identify a new supplier
for the bulk drug substance used in those products. We also cannot assure you
that our bulk drug supply arrangements with our current suppliers, or any other
future such supplier, might not change in the future. We cannot assure you that
any change would not adversely affect production of the Company's currently
marketed products or any other drug the Company might attempt to develop or
market.
21
Drug Product Manufacture
From bulk drug substance, drug product manufacturers formulate a finished drug
product and package the product for sale or for use in clinical trials. We
depend substantially on single suppliers for drug product manufacturing of each
of our products. If we were to lose any of these companies as a supplier, we
would be required to identify a new manufacturer. We cannot assure you that our
drug product manufacturing arrangements with these suppliers will not change or
that the manufacturing services will continue to be available on terms
satisfactory to us. Any change in our manufacturing agreements could adversely
affect production of our currently marketed products or any other drug that we
might attempt to develop or market, which could have a material adverse effect
on our business and prospects.
WE CANNOT CONTROL OUR CONTRACTORS' COMPLIANCE WITH APPLICABLE REGULATIONS.
The FDA defines and regulates good manufacturing practices to which bulk drug
suppliers and drug product manufacturers are subject. The Drug Enforcement
Agency (DEA) defines and regulates the handling and reporting requirements for
certain drugs which have abuse potential, known as "scheduled drugs". Foreign
regulatory authorities prescribe similar rules and regulations. Our supply and
manufacturing contractors must comply with these regulatory requirements.
Failure by our contractors to comply with FDA or DEA requirements or applicable
foreign requirements could result in significant time delays or in our inability
to commercialize or continue to market a product. Either result could have a
material adverse effect on our business and prospects. Failure to comply with
good manufacturing practices or other applicable legal requirements can lead to
federal seizure of violative products, injunctive actions brought by the federal
government, or potential criminal and civil liability for Orphan, our officers,
or our employees. We cannot assure you that we will be able to maintain
relationships either domestically or abroad with contractors whose facilities
and procedures comply or will continue to comply with FDA or DEA requirements or
applicable foreign requirements.
WE DEPEND UPON OTHERS FOR DISTRIBUTION.
We have an agreement with a specialty pharmacy to distribute Xyrem. Xyrem is
classified as a Schedule III controlled substance and approved under Subpart H
of the FDA's review process, and distribution will be strictly controlled. The
specialty pharmacy will be the only source through which Xyrem can be obtained.
Distribution will be governed by the FDA's Subpart H regulations and will fully
comply with the risk-management controls jointly developed by Orphan Medical,
the FDA, the Drug Enforcement Agency and law enforcement agencies. Every
shipment of Xyrem will be subject to stringent safeguards to ensure it reaches
only individuals for whom it has been legitimately prescribed.
We have an agreement with a distribution contractor to provide integrated
distribution and operations services to support transactions between us and our
wholesalers, specialty distributors, and direct customers. This contractor also
provides reimbursement management, patient assistance and information hotline
services along with specialty distribution and marketing services to physician
practices with respect to our products.
22
We have a separate agreement with another distributor that distributes Antizol
and Antizol-Vet. The contractor may also distribute future products should those
products receive marketing clearance from the FDA. We are substantially
dependent on this contractor's ability to successfully distribute Antizol and
Antizol-Vet.
A mail order pharmacy is the principal distributor, on a non-exclusive basis, in
the United States for Cystadane. The pharmacy distributes this product directly
to patients through the mail. We are substantially dependent on this pharmacy's
ability to successfully distribute Cystadane directly to patients in the United
States.
We cannot assure you that our distribution arrangements with these three
entities or other companies would be available, or continue to be available to
us on commercially acceptable terms. The loss of a distributor or failure to
renew agreements with an existing distributor would have a material adverse
effect on our business and prospects.
WE RELY ON FOREIGN MARKETING ALLIANCES AND HAVE NO ASSURANCE OF FOREIGN
LICENSEES.
Our strategy to sell our products in foreign markets is to license foreign
marketing and distribution rights to a foreign company after a new drug
application (referred to in the industry as an "NDA") is submitted or approved
in the United States. We consider Europe, Asia, and Canada our most attractive
foreign markets. Our current foreign arrangements are:
EUROPE. We have licensed the marketing and distribution rights for Antizol and
Cystadane in Europe. If our licensees are unsuccessful in their registration and
distribution efforts, we may find it difficult to contract with other
distributors for these products within Europe. Distribution of all products
except Antizol is limited to "named patient" or "emergency use" basis until full
regulatory approval is obtained. Antizol has been approved for use in the United
Kingdom but is limited to "named patient" basis in other parts of Europe. This
distribution of the Company's products is expected to result in a limited
contribution to the Company's revenues.
AUSTRALIA AND NEW ZEALAND. We have licensed marketing and distribution rights
for Cystadane in Australia and New Zealand, but sales of these products have not
been material. We do not expect sales to increase in the near future to the
point that they become material.
ISRAEL. We have licensed marketing and distribution rights for Antizol and
Cystadane in Israel. Full regulatory approval for Cystadane was obtained in
Israel in February 2000. We do not expect such distribution to result in
material revenues.
CANADA. We have licensed marketing and distribution rights for Antizol in
Canada. For Cystadane we have only licensed the distribution rights in Canada.
We do not expect such distribution to result in material revenues.
We depend on our foreign licensees for the regulatory registration of our
products in foreign countries. We cannot be sure that our licensees can obtain
such registration. In addition, we cannot be sure that we will be able to
negotiate commercially acceptable license agreements for our other
23
products or in additional foreign countries. Furthermore, we cannot assure you
that these companies will be successful in marketing and selling our products in
their respective territories.
OUR PRODUCTS MIGHT BE RECALLED.
A product can be recalled at our discretion or at the discretion of the FDA, the
U.S. Federal Trade Commission, or other government agencies having regulatory
authority for marketed products. A recall may occur due to disputed labeling
claims, manufacturing issues, quality defects, safety issues, or other reasons.
We cannot assure you that a product recall will not occur. We do not carry any
insurance to cover the risk of a potential product recall. Any product recall
could have a material adverse effect on our business and prospects. To date, no
recall of products marketed by the Company has occurred.
WE FACE LIMITS ON PRICE FLEXIBILITY AND THIRD-PARTY REIMBURSEMENT.
The flexibility of prices that we can charge for our products depends on
government regulation, both in the United States and abroad, and on other third
parties. One important factor is the extent to which reimbursement for our
products will be available to patients from government health administration
authorities, private health insurers and other third-party payors. Government
officials and private health insurers are increasingly challenging the price of
medical products and services. We are uncertain as to the pricing flexibility we
will have with respect to, and if we will be reimbursed for, newly approved
health care products.
In the United States, we expect continuing federal and state proposals to
implement greater government control of the pricing and profitability of
prescription pharmaceuticals. Cost controls, if mandated by a government agency,
could decrease, or limit, the price we receive for our products or products we
may develop in the future. We may not be able to recover our development costs,
which could be substantial. We may not be able to realize an appropriate profit
margin. This could have a material adverse effect on our business. Furthermore,
federal and state regulations govern or influence reimbursement of health care
providers for medical treatment of certain patients. We cannot assure you that
actions taken by federal and/or state governments, if any, with regard to health
care reform will not have a material adverse effect on our business and
prospects.
Certain private health insurers and third-party payors may attempt to control
costs further by selecting exclusive providers of pharmaceuticals. If such
arrangements are made with our competitors, these insurers and third-party
payors would not reimburse patients who purchase our competing products. This
would diminish the market for our products and could have a material adverse
effect on our business and prospects.
PATENTS AND OTHER PROPRIETARY RIGHTS ARE SIGNIFICANT FACTORS IN THE
PHARMACEUTICAL INDUSTRY.
The pharmaceutical industry and the investment community places considerable
importance and value on obtaining patent, proprietary, and trade secret
protection for new technologies, products and processes. The patent position of
pharmaceutical firms is often highly uncertain and generally involves complex
legal, technical and factual questions. Our success depends on several issues,
including, but not limited to our ability:
24
- - to obtain, and enforce proprietary protection for our products under United
States and foreign patent laws and other intellectual property laws;
- - to preserve the confidentiality of our trade secrets; and
- - to operate without infringing the proprietary rights of third parties.
We evaluate the desirability of seeking patent or other forms of protection for
our products in foreign markets based on the expected costs and relative
benefits of attaining such protection. We cannot assure you that any patents
will be issued from any applications or that any issued patents will afford us
adequate protection or competitive advantage. Also, we cannot assure you that
any issued patents will not be challenged, invalidated, infringed or
circumvented. Parties not affiliated with us have obtained or may obtain United
States or foreign patents or possess or may possess proprietary rights relating
to our products. We cannot assure you that patents now in existence or later
issued to others will not adversely affect the development or commercialization
of our products.
We believe that the active ingredients or compounds in our FDA-approved
products, Cystadane Antizol, Antizol-Vet, and Xyrem, are in the public domain
and presently are not subject to patent protection in the United States.
However, we have a patent with respect to our formulation of Xyrem. We could,
however, incur substantial costs asserting any infringement claims that we may
have against others.
We seek to protect our proprietary information and technology, in part, through
confidentiality agreements and inventors' rights agreements with our employees.
We cannot assure you that these agreements will not be breached, that we will
have adequate remedies for any breach, or that our trade secrets will not
otherwise be disclosed to or discovered by our competitors. We also cannot
assure you that our planned activities will not infringe patents owned by
others. We could incur substantial costs in defending infringement suits brought
against us. We also could incur substantial costs in connection with any suits
relating to matters for which we have agreed to indemnify our licensors or
distributors. An adverse outcome in any such litigation could have a material
adverse effect on our business and prospects. In addition, we often must obtain
licenses under patents or other proprietary rights of third parties. We cannot
assure you that we can obtain any such licenses on acceptable terms, if at all.
If we cannot obtain required licenses on acceptable terms, we could encounter
substantial difficulties in developing, manufacturing or marketing one or more
of our products.
WE FACE INTENSE COMPETITION IN OUR INDUSTRY.
Competition in the pharmaceutical industry is intense. Potential competitors in
the United States are numerous and include pharmaceutical, chemical and
biotechnology companies. Many of these companies have substantially greater
capital resources, marketing experience, research and development staffs and
facilities than we do. We seek to limit potential sources of competition by
developing products that are eligible for orphan drug status upon NDA approval
or other forms of protection. We cannot assure you, however, that our
competitors will not succeed in developing similar technologies and products
more rapidly than we can. Similarly, we cannot assure you that
25
these competing technologies and products will not be more effective than any of
those that we have developed or are currently developing.
WE EXPECT RAPID TECHNOLOGICAL AND OTHER CHANGE TO BE CONSTANT IN OUR INDUSTRY.
The pharmaceutical industry has experienced rapid and significant technological
change as well as structural changes, such as those brought about by changes in
heath care delivery or in product distribution. We expect that pharmaceutical
technology will continue to develop and change rapidly, and our future success
will depend, in large part, on our ability to develop and maintain a competitive
position. Technological development by others may result in our products
becoming obsolete before they are marketed or before we recover a significant
portion of the development and commercialization expenses incurred with respect
to such products. In addition, alternative therapies, new medical treatments, or
changes in the manner in which health care is delivered or products provided
could alter existing treatment regimes or health care practices, and thereby
reduce the need for one or more of our products, which would adversely affect
our business and our prospects.
WE FACE SUBSTANTIAL PRODUCT LIABILITY AND INSURANCE RISKS.
Testing and selling health care products entails the inherent risk of product
liability claims. The cost of product liability insurance coverage has increased
and is likely to continue to increase in the future. Substantial increases in
insurance premium costs in many cases have rendered coverage economically
impractical. We currently carry product liability coverage in the aggregate
amount of $30 million for all claims made in any policy year. Although to date
we have not been the subject of any product liability or other claims, we cannot
assure you that we will be able to maintain product liability insurance on
acceptable terms or that our insurance will provide adequate coverage against
potential claims. A successful uninsured product liability or other claim
against us could have a material adverse effect on our business and prospects.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable
ITEM 4. Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Under the supervision and with
the participation of our management, including our Chief Executive Officer and
Chief Financial Officer, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of the end of the period covered by this report. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, as of the end of the period covered by this report, our disclosure
controls and procedures are adequately designed to ensure that information
required to be disclosed by us in the reports that we file or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in applicable rules and forms.
26
CHANGES IN INTERNAL CONTROLS. During our second fiscal
quarter, there were no significant changes made in our internal control over
financial reporting (as defined in Rule 13(a)-15(f) under the Exchange Act) that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
27
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
Not Applicable
ITEM 2. Changes in Securities
Not Applicable
ITEM 3. Defaults Upon Senior Securities
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
The annual meeting of shareholders of Orphan Medical, Inc. was held on May 22,
2003. Matters submitted at the meeting for vote by the shareholders were as
follows:
(a) Election of Directors.
The following directors were elected at the Annual Meeting, each with the
following votes:
For Withheld
--------- ---------
John Howell Bullion 8,125,839 570,027
Michael Greene 8,398,228 297,638
Julius A. Vida, Ph.D. 8,394,908 300,598
William M. Wardell, M.D., Ph.D. 8,338,828 357,038
Thomas B. King 8,340,828 355,038
Farah H. Champsi 8,340,708 355,158
(b) Approval of an Amendment Increasing the Number of Authorized Shares
Issuable Under the Company's 1994 Stock Option Plan.
Shareholders approved an amendment increasing the number of shares
authorized for issuance under the Company's 1994 Stock Option Plan from
3,175,000 shares to 3,675,000 shares with a vote of 7,326,829 votes for,
1,363,632 votes against and 5,405 shares abstaining.
(c) Ratification of Appointment of Independent Public Accountants.
Shareholders ratified the appointment of Ernst & Young LLP as the Company's
independent public accountants for the fiscal year ending December 31,
2003, with a vote of 8,625,622 votes for, 57,952 votes against and 12,292
shares abstaining.
ITEM 5. Other Information
Not Applicable
28
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit
Number Description
------ -----------
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
The Company filed the following Current Reports on Form 8-K during the quarter
ended June 30, 2003:
Current Report on Form 8-K filed May 7, 2003 under Item 5. "Other Events"
reporting that the Company completed the sale of Sucraid on May 5, 2003.
Current Report on Form 8-K filed June 12, 2003 under Item 2. "Acquisition
of Disposition of Assets" and Item 9. "Regulation FD Disclosure" reporting that
the Company completed the sale of Busulfex(R) (busulfan) Injection on June 10,
2003.
Current Report on Form 8-K/A filed June 25, 2003 reporting under Item 7.
"Financial Statements and Exhibits" certain pro forma financial information
relating to the sale of Busulfex(R) (busulfan) Injection that was completed on
June 10, 2003.
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Orphan Medical, Inc.
Registrant
Date August 14, 2003 By /s/ Timothy G. McGrath
--------------- ----------------------------------
Timothy G McGrath
Chief Financial Officer
(duly authorized officer and principal
financial officer)
30
INDEX TO EXHIBITS
EXHIBIT PAGE
================================================================================
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.........................................28
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.........................................30
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.........................................32
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.........................................33
31