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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT
OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NO. 0-23556
-----------------------
INHALE THERAPEUTIC SYSTEMS
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3134940
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1060 EAST MEADOW CIRCLE, PALO ALTO, CA 94303
(Address of principal executive offices and zip code)
(415) 354-0700
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO
PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The approximate aggregate market value of voting stock held by
non-affiliates of the Registrant, based upon the last sale price of the
Common Stock on March 10, 1997 as reported by Nasdaq National Market was
approximately $211,702,383. Determination of affiliate status for this
purpose is not a determination of affiliate status for any other purpose.
13,642,004
(Number of shares of common stock outstanding as of March 28, 1997)
-----------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive Proxy Statement to be filed for its
1997 Annual Meeting of Shareholders are incorporated by reference into
Part III hereof.
INHALE THERAPEUTIC SYSTEMS
1996 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . 1
Item 2. Properties . . . . . . . . . . . . . . . . . . . 31
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . 31
Item 4. Submission of Matters to a Vote of
Security Holders . . . . . . . . . . . . . . . . 31
PART II
Item 5. Market for Registrant's Common Equity
and Related Shareholder Matters. . . . . . . . . 33
Item 6. Selected Financial Data. . . . . . . . . . . . . 34
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . 34
Item 8. Financial Statements and Supplementary
Data . . . . . . . . . . . . . . . . . . . . . . 37
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure . . . . . . . . . . . . . . . . . . . 37
PART III
Item 10. Directors and Executive Officers of
the Registrant . . . . . . . . . . . . . . . . . 37
Item 11. Executive Compensation . . . . . . . . . . . . . 37
Item 12. Security Ownership of Certain
Beneficial Owners and Management . . . . . . . . 37
Item 13. Certain Relationships and Related
Transactions . . . . . . . . . . . . . . . . . . 37
PART IV
Item 14. Exhibits, Financial Statement
Schedules, and Reports on Form 8-K . . . . . . . 38
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . 40
PART I
ITEM 1. BUSINESS
OVERVIEW
Inhale Therapeutic Systems ("Inhale" or the "Company") is developing a
pulmonary drug delivery system applicable to a wide range of peptides, proteins
and other macromolecules currently delivered by injection or by other routes
including existing inhalation systems. As an alternative to invasive delivery
techniques, a pulmonary delivery system potentially could expand the market for
macromolecule drug therapies by increasing patient acceptance and improving
compliance, which in turn could decrease medical complications and the
associated costs of disease management. Additionally, pulmonary delivery may
enable new therapeutic uses of certain macromolecule drugs. Inhale is focusing
development efforts on applying its pulmonary delivery system primarily to
drugs for systemic and local lung diseases that either have proven efficacy and
are approved for delivery by injection or are in late stage human clinical
trials.
Inhale has created a system that integrates customized formulation and
proprietary fine-powder processing and packaging technologies with a
proprietary inhalation device for efficient, reproducible, deep-lung drug
delivery. The Company has developed and completed the initial scale-up needed
for production of pulmonary products for major clinical trials. As of February
28, 1997 Inhale had 15 programs in various stages of feasibility, pre-clinical
and clinical development. Ten of the 15 programs are sponsored by partners
and four of the 15 programs are in human clinical trials. The insulin program
with Pfizer Inc. ("Pfizer") is in a multi-site Phase IIb trial with up to 240
people.
Inhale approaches pulmonary drug delivery with the objective of maximizing
overall system efficiency while addressing commercial requirements for
reproducibility, formulations stability, safety and convenience. Inhale is
designing its delivery system to integrate customized formulations and
proprietary fine dry powder processing and packaging technology with a
proprietary inhalation device for efficient, reproducible lung delivery of
macromolecule powders. To achieve this goal, Inhale is combining an
understanding of lung biology, aerosol science, chemical engineering,
mechanical engineering, and protein formulations in its system development
efforts. Inhale intends to take bulk drugs supplied by collaborative
pharmaceutical and biotechnology partners, formulate and process these drugs
into fine powders and fill and package the powders into individual dosing units
(blisters). The blisters are designed to be loaded into Inhale's device, which
patients then activate to inhale the aerosolized drugs.
Inhale's strategy is to work with collaborative partners to develop and
commercialize macromolecule drugs for systemic and local lung indications using
its pulmonary delivery system. As part of this strategy, Inhale is engaged in
early stage feasibility, research or development collaborations with Pfizer,
Baxter Healthcare Corporation (a subsidiary of Baxter International, "Baxter"),
Immunex Corporation ("Immunex"), Centeon L.L.C. (a joint venture of Hoechst AG
and Rhone-Poulenc Rorer, Inc.) ("Centeon"), Asahi Chemical Industry Co., Ltd.
("Asahi"), Genzyme Corporation ("Genzyme"), and Eli Lilly & Company ("Eli
Lilly" or "Lilly"). In addition to its collaborations, Inhale has initiated
projects with several macromolecule drugs including calcitonin, heparin,
interferon-beta, interferon alpha and follicle stimulating hormone ("FSH").
The Company anticipates that any product that may be developed would be
commercialized through a collaborative partner and believes its partnering
strategy will enable it to reduce its cash requirements while developing a
large and diversified potential product portfolio.
During 1996 and early 1997, Inhale made progress toward its goals of
broadening its partner base and moving products toward commercialization. The
Company entered into strategic relationships with four new collaborative
partners, moved the pulmonary insulin product development program into a Phase
IIb clinical trial and two additional product development programs into Phase I
testing, strengthened its balance sheet by adding $25 million of equity
financing from corporate partners, completed a $32.4 million private placement
of its common stock, and expanded its technology and manufacturing development
activities as well as its management team.
1
While the Company believes its pulmonary delivery system will provide a
unique delivery alternative for a wide range of drugs, development and testing
are still ongoing and there can be no assurance that the Company's pulmonary
delivery technology will prove to be technically feasible or commercially
applicable to a range of drugs. Although many of the underlying drug compounds
with which the Company is working have been tested in humans by others using
alternative delivery routes, Inhale's potential products will require extensive
research, development, pre-clinical and clinical testing, and may involve
lengthy regulatory review. There can be no assurance that any of the Company's
potential products will prove safe and effective in clinical trials, meet
applicable regulatory standards, be capable of being produced in commercial
quantities at acceptable cost or be successfully marketed to health care
providers, payors or patients. Any failure of the Company to achieve technical
feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory
approval or, together with partners, successfully market products, would have a
material adverse effect on the Company.
OPPORTUNITY FOR PULMONARY DRUG DELIVERY
MACROMOLECULES
Innovations in biotechnology and recombinant techniques have led to a
large increase in the number of macromolecule drugs over the last several
years. These therapeutics, which are identical or similar to the body's
natural molecules, are enabling new therapies for many previously untreated or
poorly treated diseases and serve as the bases for most biotechnology
therapeutic products. Some 30 macromolecule drugs are approved for marketing
in the United States and more than 130 additional macromolecule drugs are in
human clinical trials, many for chronic and sub-chronic diseases. Sales of
genetically engineered protein drugs were estimated at $10.7 billion worldwide
in 1995 with projections of sales of macromolecule drugs predicted to reach or
exceed $20 billion by 2000. Worldwide sales of insulin, for example, were
estimated at $2.1 billion in 1996.
Due principally to their large size, most macromolecules typically have
been delivered by injection. Drug injections performed in hospitals or
doctors' offices can be expensive and inconvenient to patients. Many patients
find self-injectable therapies unpleasant. As a result, such therapies for
many chronic and sub-chronic diseases meet with varying degrees of patient
acceptance and compliance with the prescribed regimens. Poor acceptance and
compliance can lead to increased incidents of medical complications and
potentially higher disease management costs. In addition, some elderly, infirm
or pediatric patients cannot administer their own injections and require
assistance, thereby increasing inconvenience to these patients and the cost of
therapy.
Medical science, health care providers and consumers have been searching
for alternatives to injection as a means of delivery of macromolecules used in
the systemic treatment of chronic and sub-chronic diseases. Several non-
invasive routes of delivery are being explored for macromolecule drugs,
including oral, transdermal, nasal and pulmonary, such as metered-dose inhalers
(MDIs).
Oral delivery is a common method of delivery for many small molecule
drugs. However, drug delivery scientists generally believe that oral delivery
provides extremely low delivery system efficiency for most macromolecules. In
addition, the Company believes that dosage reproducibility for oral delivery of
macromolecules may be very poor because of their low oral bioavailability.
While several companies are working on oral delivery for macromolecule drugs,
no commercially viable system is currently being marketed.
Since the skin is even less naturally permeable to macromolecules than the
gastrointestinal tract, passive transdermal delivery using "patch" technology
has not been successful to date and no macromolecule drugs have been approved
for marketing in the United States utilizing patch technology.
2
Certain peptides and proteins can be transported across the skin barrier
into the bloodstream using high pressure "needle-less" injection devices. The
devices, which inject proteins like insulin through the skin into the body,
have been available for many years. However, in general, these devices have
not been well accepted.
The nasal route has been shown to have low natural bioavailability for
many peptides and proteins. The natural bioavailability of peptides and
proteins, such as insulin and growth hormones, delivered nasally is generally
less than 2%. As a result, to achieve higher bioavailability and thus higher
system efficiency, penetration enhancers may be required, which may cause
local irritation or may result in long-term safety concerns. Only four small
peptide drugs have been approved for marketing in the United States utilizing
nasal delivery. There are no nasal-delivered products being marketed for
larger peptides and proteins in the United States.
Pulmonary drug delivery systems, such as MDIs, existing dry powder
inhalers and nebulizers, are used primarily to deliver drugs to the airways of
the lung for local lung applications. Approximately 20 drugs are approved for
marketing by the FDA for delivery into the lung, but none of these delivery
devices was designed to optimize drug delivery to the deep lung for absorption
into the bloodstream. Current MDIs, dry powder inhalers and nebulizers
typically deliver only a fraction of the drug to the deep lung, with most of
the drug being lost in the delivery device or in the mouth and throat.
Consequently, the Company believes that the total efficiency of such systems
generally is not high enough to be commercially feasible for systemic delivery
of most macromolecule drugs.
In addition, current pulmonary drug delivery devices do not provide the
dosage reproducibility and formulation stability generally needed for
commercially viable systemic macromolecule drug delivery. The Company believes
that many MDI and dry powder systems do not provide to the deep lung the inter-
patient dosage reproducibility necessary for many systemic applications because
the patient must coordinate the breathing maneuver with the generation of the
aerosol. Further, the Company believes that many macromolecules currently
cannot be formulated for use in MDI systems, since macromolecule drugs could be
denatured by the MDI formulating ingredients. In addition, Inhale believes
that some macromolecules may be inactivated by nebulization and that many dry
powder systems do not provide the protection needed for long term stability
that may be needed for macromolecule formulations.
Inhale believes that an efficient, reproducible pulmonary delivery system
for systemic macromolecule drugs used in the treatment of chronic and sub-
chronic diseases may provide significant potential commercial opportunities.
Such a system could improve patient acceptance of systemic macromolecule drug
therapy and compliance with prescribed regimens, thereby improving therapeutic
outcome and reducing the costs of administration and overall disease treatment.
Additionally, pulmonary delivery may enable new therapeutic uses of certain
macromolecule drugs.
Inhale believes that opportunities for an integrated pulmonary delivery
system exist in the delivery of macromolecules for local lung diseases due to
the limitations of current pulmonary devices. Biotechnology and pharmaceutical
companies are developing new macromolecule drugs for pulmonary diseases such as
asthma, cystic fibrosis, emphysema, lung cancer, pneumonia and bronchitis.
Pulmonary delivery is the preferred route for treating most lung diseases,
since much smaller amounts of certain drugs generally are needed than for
systemic administration and the drug can be applied directly to the site of
action, thereby potentially reducing systemic side effects.
3
OTHER MOLECULES
In addition to developing a pulmonary delivery system for macromolecules,
Inhale is investigating opportunities of leveraging its technology for small
molecules where there is a clear, demonstrable need for an alternative drug
delivery system and where the Company's existing technology can be applied
without significant modification. Examples include molecules that require
rapid systemic absorption for efficacy, i.e., analgesics and antiemetics,
molecules that undergo massive first pass metabolism by the oral route or
molecules used for local lung delivery for diseases such as asthma that are
currently delivered by sub-optimal aerosol systems.
MDIs, existing dry powder inhalers and nebulizers have been used primarily
to deliver drugs to the airways of the lung for local lung applications. Some
of the problems associated with traditional small molecule aerosol delivery
systems include: poor reproducibility, very low efficiency, low drug payload
per puff, poor moisture barrier and, in the case of wet systems, long dosing
time and microbial growth.
Inhale believes that its technology could be used to address these
problems through: efficient dispersion of the drug into the lungs;
reproducible delivery of a consistent and predictable amount of drug into the
bloodstream; and a strong moisture barrier in the blister packs. The Company
further believes its technology could potentially be applied economically in
market segments where it is essential that significant drug doses reach the
lung, e.g., severe asthma cases where nebulizers are used today. Large amounts
of drugs taken orally or through inefficient inhalers can result in side
effects which could be avoided or reduced through more efficient pulmonary
delivery.
STRATEGY
Inhale's goal is to become the leading drug delivery company in the field
of pulmonary delivery of macromolecules. In addition, the Company is
leveraging its technology base for other applications where its system can
provide major market advantages. The Company's strategy incorporates the
following principal elements:
- - CREATE A BROADLY APPLICABLE PULMONARY DELIVERY SYSTEM. Inhale is
developing its non-invasive pulmonary drug delivery system to be applicable
to a wide range of peptides, proteins and other molecules currently delivered
by injection or poorly delivered by inhalation or other routes. Inhale
intends to develop an effective non-invasive delivery alternative that can:
(i) expand market penetration for existing therapeutics currently delivered
by injection or infusion; (ii) commercialize new indications by using
pulmonary delivery as a new route of administration; and (iii) extend
existing patents or seek new patents to gain important competitive
advantages for Inhale and its partners.
- - USE AN INTEGRATED SYSTEM APPROACH. The Company intends to develop a
commercially viable pulmonary delivery system through an integrated systems
solution. Inhale is combining its expertise in aerosol engineering, chemical
engineering, mechanical engineering, aerosol science, protein formulations,
fine powder processing and powder filling, and pulmonary physiology and
biology to build a proprietary, fully-integrated system for pulmonary
delivery of therapeutic drugs. The Company believes that building
expertise in technology across several disciplines provides it with a
significant competitive advantage.
- - FOCUS INITIAL EFFORTS ON APPROVED DRUGS. To date, Inhale has focused
primarily on drugs that either have proven efficacy and are approved for
marketing or are in late stage clinical trials. The Company believes that
working primarily with drugs with demonstrated efficacy reduces the technical
risk of its projects. In the future, Inhale anticipates working on drugs at
earlier stages of development.
- - PURSUE COLLABORATIONS WITH PHARMACEUTICAL AND BIOTECHNOLOGY COMPANIES.
Inhale is building a drug delivery company and currently does not intend to
market its own pharmaceutical products. The Company is seeking to work with
partners that have significant clinical development and marketing resources,
and
4
currently has early stage collaborations with several large
pharmaceutical and biotechnology companies. For drug products that are
covered by third-party patents, Inhale intends to work with partners from
the outset of the project. For drugs that are off-patent or licensed-in,
Inhale may perform initial feasibility screening work, formulations
development and early stage human clinical trials before entering into a
partner relationship for further development. The Company believes this
partnering strategy will enable it to reduce its cash requirements while
developing a large and diversified potential product portfolio.
- - EXPAND MANUFACTURING CAPABILITY. Inhale intends to formulate, manufacture
and package dry powders for most of its drugs and to subcontract the
manufacture of its device. The Company believes that this strategy will help
it to achieve a proprietary position in the manufacture of dry powder drug
formulations for pulmonary delivery and provide manufacturing economies of
scale across a range of therapeutic products.
- - LEVERAGE TECHNOLOGY BASE FOR OTHER APPLICATIONS. Inhale intends to
leverage its core technologies over a targeted group of molecules where the
Company views the use of pulmonary delivery systems a significant advantage.
INHALE'S PULMONARY DELIVERY SYSTEM
Inhale believes that the following criteria are necessary for a
commercially viable non-invasive drug delivery system:
SYSTEM EFFICIENCY/COST: The system must attain a certain minimum
efficiency in delivering a drug to the bloodstream as compared with
injection. Bioavailability (the percentage of drug absorbed into the
bloodstream from the lungs relative to that absorbed from injection)
is the most important element of system efficiency, since it cannot
be increased without enhancing the natural permeability of the
delivery site. Total system efficiency is critical because of the
high cost of macromolecule drugs. Total system efficiency is
determined by the amount of drug loss during manufacture, in the
delivery device, in reaching the site of absorption, and in being
absorbed from that site into the bloodstream. Inhale believes that
for most systemic macromolecule drugs, a non-invasive delivery system
must show total delivery system efficiency of a least 5% to 25%
compared to injection for the system to be commercially viable.
REPRODUCIBILITY: The system must deliver a consistent and
predictable amount of drug to the lung and into the bloodstream.
FORMULATION STABILITY: Formulations used in the system must remain
physically and chemically stable over time and under a range of
storage conditions.
SAFETY: The system should not introduce local toxicity problems with
chronic or sub-chronic use by a wide patient population.
CONVENIENCE: The system must be convenient to the patient in terms
of ease of operation, transportability and required dosage time.
Inhale approaches pulmonary drug delivery with the objective of maximizing
overall delivery system efficiency while addressing commercial requirements for
reproducibility, formulation stability, safety and convenience. To achieve
this goal, Inhale is designing its delivery system to integrate customized
formulations with its proprietary inhalation device specifically designed for
efficient, reproducible lung delivery of macromolecule powders. Inhale is
combining an understanding of lung biology, aerosol science, chemical
engineering, mechanical engineering and protein formulations
5
in its system development efforts. Finally, the Company believes that this
interdisciplinary capability provides it with an important competitive
advantage.
Inhale has chosen to base its pulmonary delivery system on dry powders for
several reasons. First, many proteins are more stable in dry powders than in
liquids. In addition, dry powder aerosols can carry approximately five times
more drug in a single breath than MDI systems and at least 25 times more than
liquid or nebulizer systems. The Company believes that a dry powder system for
drugs requiring higher doses, such as insulin, alpha-1 antitrypsin and heparin,
could decrease dosing time as compared with nebulizers.
Inhale takes bulk drugs supplied by partners and formulates and processes
them into fine powders that are then packaged into individual blisters. The
blisters are designed to be loaded into Inhale's device, which patients
activate to inhale the aerosolized drugs. Once inhaled, the aerosol particles
are deposited in the deep lung, dissolved in the alveolar fluid and absorbed
into the bloodstream. Although Inhale is in the advanced stages of developing
its system technologies, there can be no assurance that the Company will be
able to successfully commercialize and market its delivery system.
FORMULATIONS. Each macromolecule drug poses different formulation challenges
due to varying chemical and physical characteristics and dosing requirements,
which therefore requires significant optimization work for each specific drug.
Inhale has assembled a team with substantial expertise in protein formulations,
powder science and aerosol science and is applying this expertise to develop
proprietary techniques and methods that it believes will produce stable,
fillable and dispersible dry powder drug formulations. Inhale has several
protein powders with on-going room temperature stability (both chemical and
physical) of more than one year. Through its work with numerous
macromolecules, Inhale is developing an extensive body of knowledge on aerosol
dry powder formulations, including knowledge relating to powder flow
characteristics and solubility within the lung, as well as physical and
chemical properties of various excipients, and has filed and expects to
continue to file patent applications on several of its formulations. In
addition, in July 1994 Inhale entered into an agreement with Pafra Limited
under which the Company obtained an exclusive license to certain proprietary
technologies for use in the respiratory delivery of macromolecules covering
protein powder compositions with enhanced room temperature stability and
methods for their production.
POWDER PROCESSING. Inhale is modifying standard powder processing equipment
and developing custom techniques to enable it to produce fine dry powders
consistently with particle diameters of between one and five microns without
drug degradation or significant loss of expensive bulk drug. The Company has
scaled up powder processing to sufficient levels for producing test powders at
the scale-level necessary for late stage clinical trials and small volume
marketed products. Inhale is in the process of scaling up its powder
processing systems in order to produce quantities sufficient for Phase III
clinical trials and initial commercial production. However, there can be no
assurance that the Company will be successful in scaling up its powder
processing at all, on a timely basis or at a reasonable cost or that the system
will be applicable for every drug.
POWDER PACKAGING. Fine particle powders have special handling requirements
that are different from those for larger particles. Current commercial filling
and packaging systems are designed for filling larger particle powders and
therefore must be modified to dispense accurately finer particles in the small
quantities required. Initially, powder filling was performed manually. Inhale
has since developed and qualified a proprietary automated filling system
suitable for use for clinical trials and initial production quantities for
certain products. Inhale is also developing with Pfizer a proprietary, high
capacity system for production use.
INHALATION DEVICE. Inhale's proprietary pulmonary delivery device is designed
to provide deep lung delivery of therapeutic powders in a reproducible, safe
and efficient manner. The first of a series of patents applied for covering
the device was granted in the U.S. in October 1995 (see "Patents and
Proprietary Rights"). To achieve this goal, Inhale has designed a prototype of
its pulmonary delivery device to:
6
- - EFFECTIVELY DISPERSE FINE PARTICLES INTO AN AEROSOL CLOUD. Fine powders
have different dispersion requirements than large powders. Most current dry
powder inhalers use larger powders and are not efficient in dispersing powders
with diameters of one to five microns. Inhale has developed and is refining
its dispersion system for its prototype device specifically for fine powders.
Inhale's device has been designed to efficiently remove powders from the
packaging, effectively break-up the powder particles and create an aerosol
cloud while maintaining the integrity of the macromolecule drug.
- - EFFICIENTLY AND REPRODUCIBLY DELIVER THE AEROSOL CLOUD TO THE DEEP LUNG.
Inhale has developed a proprietary aerosol cloud handling system in its
device that facilitates deep lung powder deposition and reproducible patient
dosing. Its design is intended to enable the aerosolized particles to be
transported from the device to the deep lung during a patient's breath,
reducing losses in the throat and upper airways. In addition, the aerosol
cloud handling system, in combination with the dispersion mechanism and
materials used in the device, is designed to decrease powder loss in the
device itself.
- - ELIMINATE THE USE OF PROPELLANTS TO AVOID ASSOCIATED ENVIRONMENTAL
CONCERNS AND FORMULATION DIFFICULTIES. Unlike MDIs, the Inhale device does
not use propellants. The oily surfactants required to stabilize propellant
formulations can cause aggregation of macromolecules. Current
chlorofluorocarbon propellants, which are used in most commercial MDI
systems, are being phased out in many countries due to environmental
concerns.
Inhale believes that its device will be capable of achieving deep lung
delivery with commercially feasible efficiencies for many macromolecule drugs.
An early prototype of the device was used in Inhale's insulin Phase I clinical
trial and in Immunex's IL-1 human clinical trial. A prototype is currently
being used in Phase II insulin trials and Phase I trials for calcitonin and
several other drugs. Inhale's insulin project with Pfizer has now moved into
take-home trials where diabetics will be using the Inhale system for several
months.
The commercial viability of Inhale's pulmonary drug delivery system for
any drug will depend upon the Company achieving sufficient formulation
stability, safety dosage reproducibility and system efficiency (measured by the
percentage of bulk drug entering the manufacturing process that eventually is
absorbed into the bloodstream relative to injection for systemic indications,
or the amount of drug delivered to the lung tissue for local lung indications).
The initial screening determinant for the feasibility of pulmonary delivery of
any systemic macromolecule drug is pulmonary bioavailability, which measures
the percentage of the drug absorbed into the bloodstream when delivered
directly to the lungs. In addition, a certain percentage of each drug dose may
be lost at various stages of the manufacturing and pulmonary delivery process
in drug formulation, dry powder processing, packaging, and in moving the drug
from a delivery device into the lungs. Excessive drug loss at any one stage or
cumulatively in the manufacturing and delivery process would render a drug
commercially unfeasible for pulmonary delivery. Formulation stability (the
physical and chemical stability of the formulated drug over time and under
various storage conditions) and safety will vary with each macromolecule and
the type and amount of excipients that are used in the formulation.
Reproducibility (the ability to deliver a consistent and predictable amount of
drug into the bloodstream over time both for a single patient and across
patient groups) will require, among other things, the inhalation device to
consistently deliver predictable amounts of dry powder formulations to the deep
lung.
The Company's integrated approach to systems development relies upon
several different but related technologies, and its business strategy depends
upon collaborations with corporate partners. Development of powder
formulations, processing and packaging technology and the delivery device,
establishing collaborations with partners, laboratory and clinical testing, and
manufacturing scale-up must proceed contemporaneously so as not to delay any
aspect of systems development. Any delay in one component of product or
business development could cause consequential delays in the Company's ability
to develop, obtain approval of or market therapeutic products using its system.
Further refinement of the Company's device prototype, further scale-up of the
powder processing system and development of a prototype automated packaging
system will need to be accomplished before commercialization of a product using
the Company's system and subsequent commercialization of its delivery system.
7
There can be no assurance that Inhale will be able to demonstrate
pulmonary bioavailability for the drug candidates it has identified or may
identify, will be able to achieve commercial viability of its pulmonary
delivery system or will achieve the total system efficiency needed to be
competitive with alternative routes of delivery. Further, there can be no
assurance that the Company's pulmonary delivery system will prove to be safe,
provide reproducible dosages of stable formulations sufficient to achieve
clinical efficacy, regulatory approval or market acceptance. In addition,
there can be no assurance that Inhale will not experience delays in the various
aspects of product and business development. Any such delays would cause
delays in overall product development. The failure to demonstrate pulmonary
bioavailability, achieve total system efficiency, provide safe, reproducible
dosages of stable formulations or advance timely the various aspects of product
and business development would have a material adverse effect on the Company.
8
THERAPEUTIC PRODUCTS UNDER DEVELOPMENT
DRUG POTENTIAL INDICATIONS STATUS PARTNER
- ----------------- ------------------------ ------------------------------ -------------------------
Human insulin Type I and II diabetes Completed Phase I(1) , IIa(2) Pfizer
Clinical Trials; Started Phase
IIb(3) Clinical Trial
* Osteoporosis IND Filed; One Phase I trial Alza completed Phase I;
completed(4) Eli Lilly will take
trials to next step
Calcitonin Osteoporosis, Bone pain, In Phase I clinical trial(1)
Paget's Disease
Interleukin-1 Asthma Phase I/II Clinical Trial(1)(2) Immunex
Receptor
Alpha-1 proteinase Alpha-1 antitrypsin Pre-clinical Centeon
inhibitor deficiency (leads to
emphysema)
* Osteoporosis Formulation Development(5) Asahi
Gene Vectors Lung diseases Research(6) Genzyme
Heparin Blood clotting Formulation Development(5)
Interferon Alpha Hepatitis B and C Feasibility(7)
Interferon Beta Multiple Sclerosis Formulation Development(5)
Follicle Stimulating Infertility and Feasibility(7)
Hormone (FSH) Reproductive Diseases
Four molecules * Feasibility/Formulation(5)(6) Baxter
DEFINITION OF DEVELOPMENT STATUS:
(1) PHASE I CLINICAL TRIAL - TESTS SAFETY AND COMPARES BIOAVAILABILITY AND
BIOACTIVITY IN PULMONARY DELIVERY VERSUS SUBCUTANEOUS INJECTION IN HEALTHY
SUBJECTS.
(2) PHASE II CLINICAL TRIAL - TESTS BIOAVAILABILITY AND BIOACTIVITY IN
PULMONARY DELIVERY VERSUS SUBCUTANEOUS INJECTION.
(3) PHASE IIB CLINICAL TRIAL - OUT-PATIENT CLINICAL TRIALS OF PULMONARY
INSULIN USING INHALE'S PULMONARY DELIVERY SYSTEM WITH UP TO 240 PATIENTS.
(4) COMPLETED SINGLE-DOSE BIOAVAILABILITY STUDY THAT COMPARED SUBCUTANEOUS
INJECTION OF THE DRUG WITH PULMONARY DELIVERY USING THE INHALE AEROSOLIZED
DELIVERY. SHOWED THAT DRUG WAS SYSTEMICALLY ABSORBED.
(5) FORMULATION DEVELOPMENT - DEVELOPING DRY POWDER AEROSOL FORMULATION FOR
DRUG.
(6) RESEARCH - EARLY STAGE WORK TO DETERMINE APPLICABILITY OF INHALE SYSTEM;
PRODUCT NOT YET ON PATH TO CLINICAL DEVELOPMENT.
(7) FEASIBILITY - WORK TO DETERMINE PULMONARY BIOAVAILABILITY.
* DRUG, PARTNER NAME OR INDICATION WITHHELD AT PARTNER'S REQUEST.
9
INHALE PULMONARY DRUG DELIVERY PROGRAMS IN PROGRESS
Inhale is in various stages of development or research on potential
products for several indications. The Company has 15 programs in various
stages of feasibility, formulation, pre-clinical and clinical development.
Ten of the 15 programs are sponsored by partners. Four are in human clinical
trials; and insulin is in a Phase IIb trial with Pfizer with up to 240
patients.
PFIZER PROGRAM (INSULIN). Insulin is a protein hormone naturally secreted
by the pancreas to induce the removal of glucose from the blood. Diabetes, the
inability of the body to regulate properly blood glucose levels, is caused by
insufficient production of insulin by the pancreas or insufficient use of the
insulin that is secreted. Over time, high blood glucose levels can lead to
failure of the microvascular system which may lead to blindness, loss of
circulation, kidney failure, heart disease or stroke. Insulin currently is
marketed only in injectable form. Worldwide sales of insulin were estimated at
$2.1 billion in 1996. Insulin is supplied by various manufacturers, including
Eli Lilly and Novo-Nordisk A/S.
The American Diabetes Association estimates that in 1995 there were
approximately seven million diagnosed Type I (juvenile onset) and Type II
(adult onset) diabetics in the United States. They estimate an additional
seven million who have not been diagnosed. All Type I diabetics, estimated at
about 10% of all diabetics, require insulin therapy. Type I diabetics
generally require both a baseline treatment of long-acting insulin and multiple
treatments of regular insulin throughout the day. Type II diabetics, depending
on the severity of their case, may or may not require insulin therapy. Type II
diabetics who use insulin are best treated with regular insulin and sometimes
require long-acting insulin as well. Many Type II patients who do not require
insulin to survive but would benefit from it are reluctant to start treatment
because of the inconvenience and unpleasantness of injections.
Regular insulin generally is supposed to be administered 30 minutes before
mealtimes and generally is given only twice a day. A ten-year study by the
National Institute of Health ("NIH"), however, demonstrated that the side
effects of diabetes could be significantly reduced by dosing more frequently.
The NIH study recommended dosing regular insulin three to four times per day, a
regimen which would more closely mirror the action of naturally produced
insulin in non-diabetics. However, many patients are reluctant to increase
their number of doses because they find injections unpleasant and inconvenient.
Although non-invasive routes of insulin delivery have been sought, the
only commercially viable way to deliver insulin to date has been by
subcutaneous injection. Subcutaneous injections are generally given with a
syringe and needle, although high pressure needle-less injection devices are
also available. Needle-less injectors have been available for many years,
however, they have not gained wide acceptance in the United States.
Inhale is developing a regular insulin that can be administered in one to
three doses using its pulmonary delivery system. The Company believes that its
pulmonary delivery system could provide increased user convenience and result
in greater patient compliance by eliminating some injections for Type I and
Type II patients, and all injections for some Type II patients, and could yield
medical advantages by providing a more rapid acting insulin than current
injectable products.
Through its collaboration with Inhale, Pfizer conducted additional Phase I
and Phase IIa clinical trials. The Phase I and IIa trial data indicated that
pulmonary insulin was absorbed systemically and lowered glucose levels. In
late October 1996 Pfizer initiated a multi-site Phase IIb outpatient trial to
include up to 240 patients. The trial is designed to test the effectiveness of
pulmonary-delivered insulin using Inhale's system in controlling blood glucose
levels following chronic administration in diabetics over several months of
use. In connection with the collaboration, Pfizer made two $5 million equity
investments in Inhale at a 25% premium to the market price of Inhale stock at
the time of each investment.
BAXTER PROGRAM (FOUR MOLECULES). In March 1996, Inhale entered into a
collaboration agreement with Baxter to use Inhale's dry powder pulmonary
delivery system as a technology platform for developing and launching
therapeutic
10
products. In connection with the collaboration, Baxter made a $20 million
equity investment in Inhale at a 25% premium to the market price of Inhale
stock at the time of the investment. Baxter will receive worldwide
commercialization rights in exchange for up to an estimated $60 million in
research and development funding and milestone payments for the first four
molecules, assuming successful development and continuation of the program by
Baxter. Baxter also has an option to add other molecules to the
collaboration that could result in additional funding and milestone payments
to Inhale. Inhale will receive royalties and manufacturing payments on sales
of products developed through the collaboration. Inhale has primary
responsibility for development of the selected therapeutics. Inhale will
develop dry powder formulations for use with its portable inhalation device
and will process and package powders for clinical supplies and marketed
products. Clinical trials also will be managed by Inhale. Baxter will be
responsible for the worldwide commercialization of the products resulting
from the collaboration.
OSTEOPOROSIS PROGRAMS. Osteoporosis, the thinning of bones, is estimated
to affect approximately 150 million people worldwide, including 25 million
Americans, mostly women. If not prevented or left untreated, osteoporosis can
progress painlessly until a bone breaks. As many as 50,000 people die each
year as a result of hip fractures - usually because of complications that
result from surgery or from being confined to bed. Associated medical costs of
the estimated 1.3 million bone fractures caused annually by osteoporosis are
estimated to be about $10 billion per year in the United States. Inhale has
three programs underway to develop a pulmonary delivered product for drugs used
to treat osteoporosis: one with Eli Lilly, one being performed by the Company,
and one with Asahi.
ELI LILLY PROGRAM. In January 1997, Inhale entered into a collaborative
agreement with Eli Lilly to develop pulmonary delivery for a selected
osteoporosis product. Under the terms of the agreement, Inhale will receive up
to an estimated $20 million in initial fees and funding for research and
milestone payments. Lilly will receive global commercialization rights for the
pulmonary delivery of the products with Inhale receiving royalties on any
marketed products. Inhale will manufacture packaged powders and supply
inhalation devices for Lilly.
Phase I clinical trials of this osteoporosis drug completed with Alza
Corporation ("Alza") indicated that the drug was systemically absorbed when
delivered with Inhale's pulmonary system. The single-dose bioavailability
study compared subcutaneous injection of the drug with pulmonary delivery using
the Inhale aerosolized delivery system in 18 fasted, normal volunteers. The
results indicated that the drug was systemically absorbed when delivered with
Inhale's system.
Alza collaborated with Inhale on development and funding for the Phase I
trial of the pulmonary product. As previously reported, the two companies
agreed that they would seek a new corporate partner to fund further development
and commercialization of the osteoporosis product following successful
completion of the Phase I trial. Lilly will be taking the clinical trials to
the next step and will receive worldwide commercialization rights.
CALCITONIN PROGRAM. Calcitonin is a peptide hormone secreted by the
thyroid gland that inhibits bone resorption and lowers serum calcium.
Calcitonin is available in two forms, fish and human. Calcitonin is
administered daily or every other day by injection in the United States. In
the United States, salmon calcitonin is approved for the treatment of
postmenopausal osteoporosis, Paget's disease, hypercalcemia of cancer and bone
pain. Human calcitonin is approved for Paget's disease and bone pain. Paget's
disease is a chronic disorder of the adult skeleton, in which localized areas
of bone become hyperactive and are replaced by a softened and enlarged bone
structure. About 3% of Caucasians in the United States over age 40 have
Paget's disease. Hypercalcemia occurs as a result of excessive serum calcium
levels caused by hyperparathyroidism and malignancy. It occurs in
approximately 5-10% of cancer patients.
The worldwide calcitonin market is dominated by fish calcitonins,
including salmon and eel, which are thought to be about ten times more potent
than human calcitonin. The calcitonin markets are supplied by various
manufacturers, including Rhone-Poulenc Rorer, Sandoz and Asahi. In addition to
its injectable formulation, salmon calcitonin is available in several
countries, including the United States, as a non-invasive nasal spray.
11
Osteoporosis is by far the most important potential clinical indication
for calcitonin. It has been shown in clinical trials to reduce the incidence
of bone fractures in osteoporosis patients. While there is some evidence that
calcitonin can restore bone, its primary benefit appears to be the retardation
of bone loss. Oral and transdermal estrogens (and progestins) are also
prescribed for osteoporosis and currently are the dominant therapies in the
United States. While long term estrogen therapy may cause vaginal bleeding in
some women, calcitonins have exhibited no such side effect. In addition,
clinical evidence suggests that calcitonin may provide superior efficacy to
estrogens in cases of rapid turnover osteoporosis.
Considerable work has been done on non-invasive delivery of calcitonin.
While oral bioavailabilities of several percent have been reported, to date
only salmon calcitonin for nasal delivery has been marketed. Nasally-delivered
calcitonin, however, is sometimes characterized, depending upon the formulation
used, by low bioavailability, irritation caused by enhancers and poor
reproducibility. Inhale believes that pulmonary calcitonin could be more
efficient, more reproducible and less irritating than nasal calcitonin.
Inhale has shown in animal tests that calcitonin is well absorbed from the
lung. The Company announced the start of a Phase I clinical trial of an
aerosolized form of salmon calcitonin in late July 1996. The study is being
performed in the United Kingdom using Inhale's pulmonary delivery system for
macromolecules. Pulmonary calcitonin was Inhale's fourth product to enter
human clinical trials.
ASAHI PROGRAM. Inhale is developing a dry powder formulation of a
proprietary drug for osteoporosis for use in the Inhale delivery system with
Asahi Chemical Industry Co., Ltd., Tokyo, Japan. With Asahi, Inhale will test
that formulation in initial human clinical studies.
CENTEON PROGRAM (ALPHA-1 ANTITRYPSIN DEFICIENCY). Alpha-1 antitrypsin
deficiency results from a patient's liver producing insufficient alpha-1
antitrypsin, a protein that circulates in the blood and inhibits the activity
of elastase enzyme. The deficiency was first identified in 1963 and is usually
found in individuals of Northern European descent. In infants, it causes
neonatal cirrhosis which is often fatal. In adults, it can lead to pulmonary
emphysema. It is estimated that as many as 100,000 people in the U.S. were
born with alpha-1 antitrypsin deficiency and potentially 28,000 in Northern
Europe. Of these, emphysema resulting from the deficiency afflicts up to
40,000 people in the U.S. alone.
Alpha-1 antitrypsin normally provides one type of protection against
enzymes which are part of white blood cells that clean up wounds and perform
other valuable, healthy functions. If, due to the lack of alpha-1 antitrypsin,
the activities of these substances are not controlled, they can attack normal
tissues in the body. In the lung, they can damage the tiny air sacs. If not
treated, alpha-1 antitrypsin deficiency leads to the breakdown of the intricate
protein fiber network in the adult lung which provides support for the millions
of tiny airsacs which make up the lung (the alveoli). The degradation of these
fibers leads to a gradual loss of surface area for gas exchange, which can
cause the inability to breathe properly and ultimately premature death. In
addition, alpha-1 antitrypsin deficiency can cause a mild strain on the liver,
leading to occasional liver problems. Every person inherits two alpha-1
antitrypsin genes, one from each parent. A person has alpha-1 antitrypsin
deficiency only if he or she inherits a combination of abnormal genes or none
at all.
Early symptoms of related alpha-1 antitrypsin deficiency emphysema often
appear between ages of 30 and 40 and consist of shortness of breath following
activity, as well as decreased exercise capacity and wheezing. Both the early
age at which the disease is present and the fact that the disease most
frequently appears in the lower rather than the upper lung regions help
distinguish genetic emphysema from other types of emphysema.
Alpha-1 proteinase inhibitor is approved in the United States and several
European countries for augmentation treatment of alpha-1 antitrypsin
deficiency. Current treatment is given by systemic intravenous infusion on a
weekly basis. Infusion therapy can take about 45 minutes. This "replacement
therapy" consists of a concentrated form of alpha-
12
1 proteinase inhibitor derived from human plasma. It increases the alpha-1
antitrypsin in the blood to levels that should help to protect the lungs.
In January 1997, Inhale and Centeon entered into a collaboration to
develop a pulmonary formulation of alpha-1 proteinase inhibitor to treat
patients with alpha-1 antitrypsin deficiency. Under the terms of the
collaboration, Centeon will receive commercialization rights worldwide
excluding Japan and Inhale will receive royalties on product sales, an up-front
signing fee and up to an estimated $15 million in research and development
funding and milestone payments. Centeon will manufacture the active ingredient
for use in Inhale's deep-lung delivery device for macromolecules. Inhale will
manufacture and package the dry powder and supply inhalation devices to Centeon
for commercialization and marketing.
The two companies completed pre-clinical work that indicates Inhale's dry
powder formulation of Centeon's alpha-1 proteinase inhibitor has the potential
to significantly improve the efficiency of delivery compared to current
infusion therapy. A pulmonary-delivered therapy could be a significant
improvement in therapeutic efficiency and delivery convenience over weekly
infusion therapy. A pulmonary delivery system could significantly reduce the
amount of drug needed for genetic emphysema therapy since alpha-1 proteinase
inhibitor could be delivered directly to the lung. In addition, the companies
believe that pulmonary delivery would be more convenient and less invasive than
intravenous infusion, thereby providing increased patient convenience and
potentially improving the patient's quality of life.
GENZYME PROGRAM (GENE VECTORS). Gene vectors are currently being
investigated by several companies and academic institutions for use in treating
lung diseases such as cystic fibrosis. Inhale believes that its delivery
system is well suited for the delivery of gene therapies to treat lung disease
because its system could provide efficiency, reproducibility, stability and
containment advantages relative to alternative pulmonary delivery products.
Early stage research has shown that Inhale's dry powder formulations and powder
processing technology can be used to make powders containing gene vectors that
retain their activity.
In July 1996, the Company signed an agreement with Genzyme Corporation to
examine the feasibility of developing dry powder formulations of gene vectors
for pulmonary applications.
IMMUNEX PROGRAM (INTERLEUKIN-1 RECEPTOR). Interleukin-1 is a cytokine
that helps initiate the inflammatory response to foreign pathogens. Inhale
collaborated with Immunex for the development of a pulmonary delivery system
potentially for the treatment of asthma. Initial formulation development and
animal toxicology have been completed, and the two companies successfully
completed Phase I/II trials demonstrating pulmonary delivery. This program is
awaiting further work and/or licensing by Immunex.
HEPARIN AND LOW MOLECULAR WEIGHT HEPARIN (LMWHS) (ANTICOAGULANT).
Heparin is a low cost mucopolysaccharide anticoagulant isolated from the lungs
and intestines of pigs and cows. Heparin, which is delivered by subcutaneous
or intravenous injection, is approved for many applications pertaining to blood
clotting, including prophylaxis and treatment of deep vein thrombosis,
pulmonary embolism and prevention of other thromboembolitic indications.
Worldwide sales in 1994 were estimated to be approximately $400 million. Major
suppliers in the United States include The Upjohn Company, Wyeth-Ayerst
Laboratories Division of American Home Products, Inc. and Eli Lilly. There are
also indications that heparin may have local lung applications. Heparin has
been shown in a study reported in the NEW ENGLAND JOURNAL OF MEDICINE to have
efficacy in treating asthma. Others have also suggested that it possesses anti-
protease activity, similar to alpha-1 antitrypsin, and could be used to treat
lung diseases.
Thromboembolitic diseases such as deep vein thrombosis, pulmonary
embolism, heart attacks and restenosis are caused by blood clots. Warfarin, a
small molecule oral anticoagulant, is the most widely used non-invasively
delivered alternative to heparin. The most serious risks associated with
warfarin are hemorrhaging and, less frequently, necrosis or gangrene of the
skin or other tissues.
13
Inhale believes that a non-invasive heparin or LMWH could expand the
drug's use for preoperative, postoperative and prophylactic use at home. A
number of human studies on pulmonary-delivered heparin suggest that it is safe
and efficacious as an inhaled systemic anticoagulant. Inhale has developed an
initial dry powder formulation for heparin and conducted animal absorption
screening studies. The Company anticipates that any product that might be
developed would be commercialized through a marketing partner.
INTERFERON ALPHA (HEPATITIS). Interferon alpha is produced by a number of
cell types in the body and serves to turn on an array of genes in cells for
fighting viral infections. It has been approved for Hepatitis B and C
(inflammatory viral diseases of the liver), hairy cell leukemia (a blood
cancer), and AIDS-related Kaposi's sarcoma (a skin cancer prevalent in AIDS
patients). The global market for all interferon alpha agents was estimated to
be approximately $1.3 billion. One of the largest markets for interferon alpha
is in Japan where an estimated three million people suffer from Hepatitis B and
C, as compared to an estimated 300,000 people in the United States. There are
at least five companies competing in the interferon alpha market, including
Schering-Plough Corporation, Hoffmann-La Roche, Inc., Sumitomo Corp. and Otsuka
Pharmaceutical Co., Ltd. Interferon alpha is currently given in all
indications three times per week by subcutaneous injection.
Early attempts to use high doses of nasally-delivered interferon alpha for
the common cold demonstrated limited success, but were accompanied by nasal
irritation. Some companies are exploring sustained release interferon alpha
injections.
Inhale believes that a pulmonary delivery system could provide a
competitive advantage in what is now an exclusively injectable market. A
pulmonary interferon alpha could reduce the cost of treatment by enabling more
home therapy. Inhale has shown in animal studies that interferon alpha is well
absorbed systemically following pulmonary administration. Inhale has completed
feasibility testing and may seek a partner for further development.
INTERFERON-BETA (MULTIPLE SCLEROSIS). Interferon is a protein with anti-
viral activity formed by mammalian cells in response to infection by viruses.
The structure of interferons was not known until recombinant DNA techniques
were used to clone the mammalian genes in bacteria. Interferons are
synthesized as a more rapid response to viral infection than the formation of
serum antibodies and are associated with the body's protective mechanism
against and recovery from viral infection. This has led to an interest in
interferons as potential therapeutic agents against viral diseases, some forms
of cancer, and other diseases of suspected viral or unknown etiology.
Interferon-beta has been approved for treatment of multiple sclerosis, an
immunological disorder in which the immune system attacks the myelin sheath
that coats the nerves. In 1996, analysts estimated this market to be
approximately $300 million. There are an estimated 700,000 cases in North
America and Europe in total with 75% being female. The disorder affects mostly
upper and middle class female Caucasians.
Two companies have gained FDA approval for interferon beta for relapsing
and remitting multiple sclerosis. The first drug is Betaseron, which is
interferon-beta 1b, and is sold by Berlex Laboratories Inc., of Wayne, N.J. and
manufactured by Chiron Corp., of Emeryville, Calif. Worldwide sales of
Betaseron were $277 million in 1995. Berlex is a subsidiary of Schering AG, of
Berlin. Betaseron has been shown to reduce relapses, but not to slow the
disorder's deteriorating march. Biogen markets Avonex, or Interferon-beta-1a.
Biogen has demonstrated in clinical trials that Avonex can slow progression of
the disease and reduce flare-ups. Avonex is taken weekly compared with daily
injections of Betaseron.
Inhale believes that a pulmonary drug delivery system could provide a
competitive advantage in this exclusively injectable market. The Company has
successfully completed formulation feasibility testing of Interferon-beta and
may seek a partner for further development.
FOLLICLE STIMULATING HORMONE (FSH) (INFERTILITY). FSH, a glycoprotein
hormone secreted by the pituitary gland, has been utilized since the 1960s for
treatment of infertility. In female reproduction, FSH is responsible for
ovarian
14
follicular growth and development. Therapeutic use of FSH has expanded
since the 1970s. It is currently given in a series of daily injections over
two weeks to enhance follicle growth and ovum production. Analysts estimate
the female infertility market to be approximately $400 million. Inhale has
demonstrated the feasibility of pulmonary FSH in an animal model and now seeks
a pharmaceutical partner for development.
There can be no assurance that Inhale will be able to demonstrate
pulmonary bioavailability for any drug or that its pulmonary delivery system
will provide safe, reproducible dosages of stable formulations. There also can
be no assurance that Inhale will be able to scale-up its manufacturing, obtain
marketing approval for, or successfully market, any drug for pulmonary
delivery. Further, there can be no assurance that any of the Company's
collaborative partners will complete product development and commercialization.
The Company's ability to apply its pulmonary delivery system to a broad range
of drugs will depend upon its ability to establish and maintain collaborative
arrangements since many of the drugs currently approved for sale or in clinical
testing are covered by third party patents. The Company has entered into
collaborative arrangements with certain of its partners to fund clinical
trials, assist in obtaining regulatory approval and commercialize certain
products. There can be no assurance that the company will be able to enter
into additional collaborations or that its feasibility agreements will lead to
collaborations. There also can be no assurance that the Company will be able
to maintain any such collaborative arrangements or feasibility agreements or
that any such collaborative arrangements or feasibility agreements will be
successful. The failure of the Company to enter into or maintain such
collaborative arrangements and feasibility agreements would have a material
adverse effect on the Company. (See "Risk Factors.")
The Company's existing partners have the right to pursue parallel
development of other drug delivery systems which may compete with the Company's
pulmonary drug delivery system and to terminate their agreements with the
Company at any time without significant penalty. The Company also will have
limited or no control over the resources that any partner may devote to the
Company's products, over partners' development efforts, including the design
and conduct of clinical trials, or over the pricing of any such products.
There can be no assurance that any of the Company's present or future
collaborative partners will perform their obligations as expected, will devote
sufficient resources to the development, clinical testing or marketing of the
Company's potential products or will not terminate their agreements with the
Company prematurely.
The design, development and manufacture of the Company's products involve
an inherent risk of product liability claims and associated adverse publicity.
Although the Company currently maintains general liability insurance, there can
be no assurance that the coverage limits of the company's insurance policies
will be adequate. The Company obtained clinical trial product liability
insurance of $3 million for all current human clinical trials, and intends to
obtain insurance for future clinical trials of insulin and other products under
development. However, there can be no assurance that the Company will be able
to obtain or maintain insurance for any future clinical trials. Such insurance
is expensive, difficult to obtain and may not be available in the future on
acceptable terms or at all. A successful claim brought against the Company in
excess of the Company's insurance coverage would have a material adverse effect
upon the Company and its financial condition.
MANUFACTURING
Inhale generally plans to formulate, manufacture and package the powders
for its pulmonary delivery products and to subcontract the manufacture of its
proprietary pulmonary delivery devices. Under its collaborative agreement with
Pfizer to develop insulin powders, Inhale will be the primary manufacturer of
powders and Pfizer will be primarily responsible for filling blisters. Prior
to the commercialization of its first products, the Company must build and have
validated a powder processing and packaging manufacturing facility. The
Company also must select and have validated a device manufacturer. Inhale
believes its manufacturing strategy will: (i) provide economies of scale by
utilizing manufacturing capacity for multiple products; (ii) improve its
ability to retain any manufacturing know-how; and (iii) allow its customers to
bring pulmonary delivery products to market faster than if they established
their own powder processing and packaging facilities.
15
The Company has built a powder and packaging manufacturing facility
capable of producing powders in quantities sufficient for Phase I, Phase II,
and early Phase III human clinical trials. This facility has been inspected
and licensed by the State of California and was used to manufacture and package
powders under Good Manufacturing Practices ("GMP") for Inhale's Phase I and
Phase II human insulin trial, Immunex's IL-IR Receptor Phase I/II clinical
trial, Phase I calcitonin, and a Phase I clinical trial for another project.
Inhale intends to build a facility capable of manufacturing and packaging
powders in quantities sufficient for registration batches and initial
commercial production.
Inhale is working on scaling-up its powder processing to a production
scale system and is developing the necessary powder packaging technologies.
Fine particle powders and small quantity packaging (such as those to be used
in the Company's delivery system) require special handling. Current commercial
packaging systems are designed for filling larger quantities of larger particle
powders and therefore must be modified to dispense finer particles in the small
quantities required by the Company. Inhale has developed and validated a
proprietary small scale prototype automated filling system, which the Company
believes is capable of supporting its requirements through Phase III trails and
into commercial production for some products. Inhale plans to develop a higher
capacity automated filling unit, which would be capable of filling its powders
on a production scale for moderate and large volume products. The Company
faces significant technical challenges in developing an automated, commercial-
scale filling system that can accurately and economically handle the small dose
and particle sizes of its powders. There can be no assurance that the Company
will be able to develop or acquire the technology necessary to develop
successfully any such system in a timely manner or at commercially reasonable
cost. Any failure or delay in developing such technology would delay product
development or bar commercialization of the Company's products and would have a
material adverse effect on the Company. (See "Risk Factors")
Inhale used a prototype of its inhalation device in its Phase I human
insulin trial and in Immunex's Phase I/II clinical trial. Inhale has completed
development of a prototype take-home device which is being used in a Phase II
insulin trial and a Phase I clinical trial for another project. Additionally,
Inhale is refining the device design for use in later-stage clinical trials and
commercial products.
Inhale plans to subcontract the manufacture of its pulmonary delivery
devices before commercial production of its first product. The Company has
identified contract manufacturers that it believes have the technical
capabilities and production capacity to manufacture its devices, and which can
meet the requirements of GMP. There can be no assurance that Inhale will be
able to obtain and maintain satisfactory contract manufacturing on commercially
acceptable terms, if at all. The Company's dependence upon third parties for
the manufacture of its potential inhalation device may adversely affect the
Company's cost of goods and its ability to develop and commercialize products
on a timely and competitive basis.
The Company has no experience manufacturing products for large scale
clinical testing or commercial purposes. To date, the Company has performed
powder processing only on the small scale needed for clinical trials and for
testing formulations of certain other potential therapeutic products. There
can be no assurance that manufacturing and control problems will not arise as
the Company attempts to scale-up its powder processing facilities or that such
scale-up can be achieved in a timely manner or at a commercially reasonable
cost. Any failure to surmount such problems could delay or prevent late stage
clinical testing and commercialization of the Company's products and would have
a material adverse effect on the Company. To date, the Company has relied on a
particular method of powder processing. There can be no assurance that this
technology will be applicable to all drugs or that the drug yields in powder
processing will be sufficient for commercial viability for certain drugs. In
the event that the Company decides to pursue alternative powder processing
methods for some or all of its drugs, there can be no assurance that these
methods will prove commercially practical for aerosol drugs or that the Company
will have or be able to acquire rights to use such alternative methods.
The Company also faces technical challenges in further developing its
inhalation device to achieve the efficiency necessary to deliver a broad range
of drugs, to produce such a device in quantities sufficient for later stage
clinical trials and early commercialization, and to adapt the device as may be
required for different powder formulations. There can be no assurance that
Inhale will successfully achieve such efficiencies, will be able to produce
such quantities or will be able
16
to adapt the device as required. The failure of the Company to overcome any
such challenges would have a material adverse effect on the Company. To
date, the Company has used small machine shops for production of its
prototype inhalation devices. For late stage clinical trials and initial
commercial production, the Company intends to use one or more contract
manufacturers to produce its device. There can be no assurance that Inhale
will be able to enter into or maintain satisfactory contract manufacturing
arrangements. The failure of the Company to enter into and maintain such
arrangements would have a material adverse effect on the Company. (See "Risk
Factors")
GOVERNMENT REGULATION
The research and development, manufacture and marketing of pulmonary drug
delivery systems are subject to regulation by the FDA in the United States and
by comparable regulatory agencies in other countries. These national agencies
and other federal, state and local entities regulate, among other things,
research and development activities and the testing, manufacture, safety,
effectiveness, labeling, storage, record keeping, approval, advertising and
promotion of the Company's products.
The process required by the FDA before a pulmonary drug delivery system
may be marketed in the United States depends on whether the compound has
existing approval for use in other dosage forms. If the drug is a new chemical
entity that has not been approved, the process includes: (i) pre-clinical
laboratory and animal tests; (ii) the filing of an Investigational New Drug
application ("IND") (iii) adequate and controlled human clinical trials to
establish the safety and efficacy of the drug in its intended indication; and
(iv) submission to the FDA for approval of a New Drug Application ("NDA") with
respect to drugs or a Product License Application ("PLA") and an Establishment
License Application with respect to biologics. If the drug has been previously
approved, the approval process is similar, except that certain toxicity tests
normally required for the IND and NDA/PLA application may not be necessary.
Pre-clinical tests include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. Pulmonary systems must be formulated according to GMP, and
pre-clinical safety tests must be conducted by laboratories that comply with
FDA Good Laboratory Practices regulations. The results of the pre-clinical
tests are submitted to the FDA as part of an IND application and are reviewed
by the FDA before human clinical trials begin. The IND application becomes
effective 30 days after receipt by the FDA, unless the FDA raises objections.
Clinical trials involve the administration of the drug to healthy
volunteers or to patients under the supervision of a qualified principal
investigator. Clinical trials are conducted in accordance with protocols that
detail the objectives of the study, the parameters to be used to monitor safety
and the efficacy criteria to be evaluated. Each protocol is submitted to the
FDA as part of the IND. Each clinical study is conducted under the auspices of
an independent Institutional Review Board ("IRB"). The IRB will consider,
among other things, ethical factors, the safety of human subjects and the
possible liability of the institution.
Clinical trials are typically conducted in three sequential phases, but
the phases may overlap. In Phase I, the initial introduction of the drug into
healthy human subjects, the product generally is tested for safety, dosage
tolerance, pharmacokinetics, absorption, metabolism and excretion. Phase II
involves studies in a limited patient population to (i) determine the efficacy
of the product for specific, targeted indications, (ii) determine dosage
tolerance and optimal dosage, and (iii) identify possible adverse effects and
safety risks. When Phase II evaluations demonstrate that dosing the drug by
the pulmonary system is effective and has an acceptable safety profile, Phase
III trials are undertaken to evaluate further clinical efficacy and safety
within an expanded patient population at geographically dispersed clinical
study sites. The FDA, the clinical trial sponsor or the investigator may
suspend clinical trials at any time if it believes that clinical subjects are
being exposed to an unacceptable health risk.
The results of product development, pre-clinical studies and clinical
studies are submitted to the FDA as an NDA/PLA for approval of the marketing
and commercial shipment of the pulmonary system. The FDA may deny an
17
NDA/PLA if applicable regulatory criteria are not satisfied or may require
additional clinical testing. Even if such data are submitted, the FDA may
ultimately decide that the NDA/PLA does not satisfy the criteria for
approval. Product approvals may be withdrawn if compliance with regulatory
standards are not maintained or if problems occur after the product reaches
the market. The FDA may require testing and surveillance programs to monitor
the effect of pulmonary systems that have been commercialized, and has the
power to prevent or limit future marketing of the product based on the
results of these post-marketing programs.
Each domestic drug product manufacturing establishment must be registered
with, and approved by, the FDA. Drug product manufacturing establishments
located in California also must be licensed by the State of California.
Establishments handling controlled substances must be licensed by the United
States Drug Enforcement Administration ("DEA"). Domestic manufacturing
establishments are subject to biennial inspections by the FDA for GMP
compliance. Inhale is also subject to United States federal, state and local
regulations regarding workplace safety, environmental protection and hazardous
and controlled substance controls, among others.
The Company's research and development involve the controlled use of
hazardous materials, chemicals and various radioactive compounds. Although the
Company believes that its safety procedures for handling and disposing of such
materials comply with the standards prescribed by state and federal
regulations, the risk of accidental contamination or injury from these
materials cannot be completely eliminated. In the event of such an accident,
the Company could be held liable for any damages that result and any such
liability could exceed the resources of the Company. The Company may incur
substantial costs to comply with environmental regulations.
Many of the drugs with which the Company is working are already approved
for marketing by the FDA. The Company believes that when working with approved
drugs, the approval process for delivery by pulmonary delivery may require less
time and fewer tests than for new chemical entities. However, the Company
expects that its formulations often will use excipients not currently approved
for pulmonary use. Use of these excipients will require additional
toxicological testing that may increase the costs of, or lengthen the time in,
gaining regulatory approval. In addition, regulatory procedures applicable to
the Company's products may change as regulators gain experience in the area of
macromolecules, and any such changes may delay or increase the cost of
regulatory approval.
The Company's device will not be developed as an independent product but
will be an inseparable part of the pulmonary drug delivery system for each
specific molecule. Prior to or at the time of submission of the IND, the FDA
Center and division within the Center will be identified to be responsible for
the review of the IND and NDA/PLA. In the case of Inhale's products, either
the Center for Drug Evaluation and Research or the Center for Biologics
Evaluation and Research, in consultation with the Center for Devices and
Radiological Health, will be involved in the review. However, one Center is
designated as the Center which has the lead responsibility for regulating the
product. The jurisdiction within the FDA is based on the primary mode of
action of the drug and is identified in the FDA's intercenter agreement.
Inhale expects that its partners generally will be responsible for the
clinical and regulatory approval procedures, but Inhale may participate in this
process by submitting to the FDA or to each partner portions of the Drug Master
File being developed and to be maintained by Inhale which contains data
concerning the manufacturing processes for the product. The regulatory review
process generally takes a number of years and requires the expenditure of
substantial resources. Inhale's ability to manufacture and sell products
developed under contract depends upon the partner's completing satisfactory
clinical trials and obtaining marketing approvals. Inhale may prepare and
submit an IND application and perform initial clinical studies before licensing
the product to a partner. The Company's business strategy contemplates
performing more of these studies in the future.
Sales of the Company's products outside the United States are subject to
regulatory requirements governing human clinical trials and marketing approval
for drugs and pulmonary delivery systems. Such requirements vary widely from
country to country.
18
Prior to marketing a new dosage form of any drug, including one developed
for use with the Company's pulmonary drug delivery system, whether or not such
drug was already approved for marketing in another dosage form, the product
must undergo rigorous pre-clinical and clinical testing and an extensive review
process mandated by the FDA and equivalent foreign authorities. These
processes generally take a number of years and require the expenditure of
substantial resources. None of the Company's proposed products has been
submitted to the FDA for marketing approval. The Company has no experience
obtaining such regulatory approval, does not have the expertise or other
resources to do so and intends to rely on its partners to fund clinical testing
and to obtain product approvals.
The time required for completing such testing and obtaining such approvals
is uncertain. Further refinement of the device prototype, further scale up of
the powder processing system and development of a prototype automated powder
filling and packaging system will need to be accomplished before initiation of
later stage clinical trials. Any delay in any of these components of product
development may delay testing. In addition, delays or rejections may be
encountered based upon changes in FDA policy during the period of product
development. Similar delays may also be encountered in other countries. If
regulatory approval of a product is granted, such approval may entail
limitations on the indicated uses for which the product may be marketed, and
the marketed product, its manufacturer, and its manufacturing facilities remain
subject to continual review and periodic inspections. Later discovery of
previously unknown problems with a product, manufacturer, or facility may
result in restrictions on such product or manufacturer, including withdrawal of
the product from the market. There can be no assurance that regulatory
approval will be obtained for any products developed by the Company on a timely
basis, or at all. The failure to obtain timely regulatory approval of its
products, any product marketing limitations or a product withdrawal would have
a material adverse effect on the Company.
Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. Although Congress
has failed to pass comprehensive health care reform legislation to date, the
Company anticipates that Congress, state legislatures and the private sector
will continue to review and assess alternative health care delivery and payment
systems. Potential approaches that have been considered include mandated basic
health care benefits, controls on health care spending through limitations on
the growth of private health insurance premiums and Medicare and Medicaid
spending, the creation of large insurance purchasing groups, price controls on
pharmaceuticals and other fundamental changes to the health care delivery
system. Any such proposed or actual changes may cause Inhale's collaborative
partners or potential partners to limit or eliminate spending on collaborative
drug development projects. Legislative debate is expected to continue in the
future, market forces are expected to demand reduced costs, and Inhale cannot
predict what impact the adoption of any federal or state health care reform
measures or future private sector reform may have on its business.
In both domestic and foreign markets, sales of the Company's potential
products, if any, will depend in part on the availability of reimbursement from
third-party payors such as government health administration authorities,
private health insurers and other organizations. Third-party payors are
increasingly challenging the price and cost-effectiveness of medical products
and services. Significant uncertainty exists as to the reimbursement status of
newly approved health care products. There can be no assurance that the
Company's proposed products will be considered cost effective or that adequate
third-party reimbursement will be available to enable Inhale to maintain price
levels sufficient to realize an appropriate return on investment in product
development. Legislation and regulations affecting the pricing of
pharmaceuticals may change before the Company's proposed products are approved
for marketing and any such changes could further limit reimbursement for
medical products and services.
PATENTS AND PROPRIETARY RIGHTS
Inhale's policy is to apply for patent protection for the technology,
inventions and improvements deemed important to the development of its
business. The Company also relies upon trade secrets, know-how, continuing
technological innovations and licensing opportunities to maintain and further
develop its competitive position. The Company plans to defend aggressively its
proprietary technology and any issued patents.
19
Inhale expects that its integrated system for the development of pulmonary
delivery technology for macromolecule drugs will yield innovations in dry
powder formulations, powder processing, powder packaging and device design. It
is the Company's strategy to build proprietary positions in each of its
technological areas. The Company's success will depend in part upon its
ability to protect its proprietary technology from infringement,
misappropriation, duplication and discovery. Inhale has filed patent
applications covering certain aspects of its device and powder processing
technology and powder formulations and pulmonary route of delivery for certain
molecules, and plans to file additional patent applications. On October 17,
1995, the Company received United States Patent Number 5,458,135 from the
United States Patent and Trademark Office (the "PTO") for certain claims
covering the use of its device in a method for delivering powder formulations
of drugs to the lung. On March 4, 1997 the Company received United States
Patent Number 5,607,915 from the United States Patent Trademark Office for
pulmonary delivery of active fragments of parathyroid hormone (PTH) 1-34.
There can be no assurance that any of the other patents applied for by the
Company will issue, or that any patents that issue will be valid and
enforceable. Even if such patents are enforceable, the Company anticipates
that any attempt to enforce its patents could be time consuming and costly.
The patent positions of pharmaceutical, biotechnology and drug delivery
companies, including Inhale, are uncertain and involve complex legal and
factual issues. Additionally, the coverage claimed in a patent application can
be significantly reduced before the patent is issued. As a consequence, the
Company does not know whether any of its patent applications will be
circumvented or invalidated. Since patent applications in the United States
are maintained in secrecy until patents issue, and since publication of
discoveries in the scientific or patent literature often lag behind actual
discoveries, the Company cannot be certain that it was the first inventor of
inventions covered by its pending patent applications or that it was the first
to file patent applications for such inventions. Moreover, the Company may
have to participate in interference proceedings declared by the PTO to
determine priority of invention, which could result in substantial cost to the
Company, even if the eventual outcome is favorable to the Company. There can
be no assurance that the Company's patents, if issued, would be held valid by a
court of competent jurisdiction. An adverse outcome could subject the Company
to significant liabilities to third parties, require disputed rights to be
licensed from or to third parties or require the Company to cease using the
technology in dispute.
The Company is aware of numerous pending and issued United States and
foreign patent rights and other proprietary rights owned by third parties that
relate to aerosol devices and delivery, pharmaceutical formulations, dry powder
processing technology and the pulmonary route of delivery for certain powder
formulations of macromolecules. The Company cannot predict with any certainty
which, if any, patent references will be considered relevant to the Company's
technology by authorities in the various jurisdictions where such rights exist,
nor can the Company predict with certainty which, if any, of these rights will
or may be asserted against it by such third parties. The Company is aware of
an alternate dry powder processing technology which Inhale is not using for its
current products under development but may desire to use for certain products
in the future. The ownership of the powder processing technology is unclear
and the Company is aware that multiple parties, including Inhale, claim patent,
trade secret and other rights in the technology. If the Company determines
that this alternate powder processing technology is relevant to the development
of future products and further determines that a license to this alternate
powder processing technology is needed, there can be no assurance that the
Company can obtain a license from the relevant party or parties on commercially
reasonable terms, if at all. There can be no assurance that the Company can
obtain any license to any technology that the Company determines it needs, on
reasonable terms, if at all, or that Inhale could develop or otherwise obtain
alternate technology. The failure of the Company to obtain licenses if needed
would have a material adverse effect on the Company.
The Company also relies upon trade secret protection for its confidential
and proprietary information. No assurance can be given that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets or disclose
such technology, or that the Company can meaningfully protect its trade
secrets.
Third parties from time to time have asserted or may assert that the
Company is infringing their proprietary rights based upon issued patents, trade
secrets or know-how that they believe cover the Company's technology. In
20
addition, future patents may issue to third parties which the Company's
technology may infringe. The Company could incur substantial costs in
defending itself and its partners against any such claims. Furthermore,
parties making such claims may be able to obtain injunctive or other equitable
relief which could effectively block the Company's ability to further develop
or commercialize some or all of its products in the United States and abroad,
and could result in the award of substantial damages. In the event of a claim
of infringement, the Company and its partners may be required to obtain one or
more licenses from third parties. There can be no assurance that the Company
or its partners will be able to obtain such licenses at a reasonable cost, if
at all. Defense of any lawsuit or failure to obtain any such required license
could have a material adverse effect on the Company.
The Company's ability to develop and commercialize its technology will be
affected by the Company's or its partners' access to the drugs which are to be
formulated. Many biopharmaceutical drugs, including some of those which are
presently under development by the Company, are subject to issued and pending
United States and foreign patent rights which may be owned by competing
entities. There are issued patents and pending patent applications relating to
the pulmonary delivery of macromolecule drugs, including several for which the
Company is developing pulmonary delivery formulations. Specifically, a patent
has been granted in Europe which is directed to aerosol formulations of serine
protease inhibitors, including alpha-1 antitrypsin, for the treatment of the
lung. The resulting patent situation is highly complex, and the ability of any
one company to commercialize a particular biopharmaceutical drug is highly
unpredictable. The Company intends generally to rely on the ability of its
partners to provide access to the drugs which are to be formulated for
pulmonary delivery. There can be no assurance, however, that the Company's
partners will be able to provide access to drug candidates for formulation for
pulmonary delivery or that, if such access is provided, the Company or its
partners will not be accused of, or determined to be, infringing a third
party's rights and will not be prohibited from working with the drug or be
found liable for damages that may not be subject to indemnification. Any such
restriction on access or liability for damages would have a material adverse
effect on the Company.
It is the Company's policy to require its employees and consultants,
outside scientific collaborators, sponsored researchers and other advisors who
receive confidential information from the Company to execute confidentiality
agreements upon the commencement of employment or consulting relationships with
the Company. These agreements provide that all confidential information
developed or made known to the individual during the course of the individual's
relationship with the Company is to be kept confidential and not disclosed to
third parties except in specific circumstances. The agreements provide that
all inventions conceived by an employee shall be the property of the Company.
There can be no assurance, however, that these agreements will provide
meaningful protection or adequate remedies for the Company's trade secrets in
the event of unauthorized use or disclosure of such information.
The Company has obtained license rights to certain know-how and patent
applications owned by Genentech, Inc. covering formulations and powder
processing and pulmonary delivery of certain molecules, which it believes could
be important to the development of its business. These license rights are
worldwide, nonexclusive, sublicensable and royalty free. Recently, Genentech
successfully defended an opposition proceeding involving a pending European
patent licensed to Inhale. This decision is currently on appeal. The pending
patent covers the pulmonary delivery of cytokines and growth factors. Under
the terms of the license, Genentech has exclusive rights to work with Inhale
on certain molecules until August 1, 1997.
COMPETITION
The Company believes that products developed using Inhale's technology
will compete on the basis of system efficiency, dosage reproducibility, safety,
patient convenience and cost. There is intense competition to develop a
solution to the non-invasive delivery of drugs from several drug delivery and
pharmaceutical companies, many of which are much larger and have far greater
resources than Inhale. These include companies working on developing systems
for other non-invasive routes of delivery, such as oral, transdermal, bucal,
nasal, and needle-less injections, as well as companies working on pulmonary
delivery systems. In addition, several companies are working on sustained
release injectable systems. While these latter systems involve injections, the
lower number of injections could be competitive
21
with Inhale's pulmonary delivery technology in certain applications. The
Company believes its technology and integrated pulmonary delivery systems
approach provides it with important competitive advantages in the delivery of
drugs compared with currently known alternatives. However, new drugs or
further developments in alternative drug delivery methods may provide greater
therapeutic benefits for a specific drug or indication, or may offer
comparable performance at lower cost than the Company's proprietary pulmonary
delivery system.
With respect to pulmonary delivery, several companies are marketing and
developing dry powder, MDI, liquid and nebulizer devices that could have
applications for drug delivery. Several of these companies may be developing
dry powder devices that could be used for pulmonary delivery of macromolecules.
There can be no assurance that competitors will not introduce products or
processes competitive with or superior to those of the Company. The Company
intends to monitor competitive device activities and continue to focus its
activities on those products for which the Company believes it has and can
maintain a competitive advantage. If a device is developed that is superior to
Inhale's for certain applications, the Company may seek to obtain a license to
allow Inhale's partners to use such a device with Inhale-developed powders,
although there can be no assurance that the Company would be able to do so.
The Company's success depends upon maintaining a competitive advantage in
the development of products and technologies for pulmonary delivery of
macromolecules. If a competing company were to develop or acquire rights to a
better dry powder pulmonary delivery device or fine powder processing
technology, a better system for efficiently and reproducibly delivering
macromolecule drugs to the deep lung, a non-invasive drug delivery system which
is more attractive for the delivery of macromolecule drugs than pulmonary
delivery, or an invasive delivery system which overcomes some of the drawbacks
of current invasive systems for chronic or sub-chronic indications (such as
sustained release system), the Company's business would be materially adversely
affected.
The Company is in competition with pharmaceutical, biotechnology and drug
delivery companies, hospitals, research organizations, individual scientists
and nonprofit organizations engaged in the development of alternative drug
delivery systems or new drug research and testing, as well as with entities
producing and developing injectable drugs. The Company is aware of a number of
companies currently seeking to develop new products and non-invasive
alternatives to injectable drug delivery, including oral delivery systems,
intranasal delivery systems, transdermal systems, bucal and colonic absorption
systems. Several of these companies may have or be developing dry powder
devices that could be used for pulmonary delivery of macromolecules. The
Company also is aware of other companies currently engaged in the development
and commercialization of pulmonary drug delivery systems and enhanced
injectable drug delivery systems. Many of these companies and entities have
greater research and development capabilities, experience, manufacturing,
marketing, financial and managerial resources than the Company and represent
significant competition for the Company. Acquisitions of competing drug
delivery companies by large pharmaceutical companies could enhance competitors'
financial, marketing and other resources. Accordingly, the Company's
competitors may succeed in developing competing technologies, obtaining FDA
approval for products more rapidly than the Company and gaining market
acceptance. There can be no assurance that developments by others will not
render the Company's products or technologies noncompetitive or obsolete.
SCIENTIFIC ADVISORS
The Company has assembled scientific advisors that provide Inhale
expertise in critical scientific, development, engineering, manufacturing and
business issues facing the Company. The scientific advisory group assists
Inhale on issues related to pulmonary delivery, pulmonary toxicology, aerosol
science, government regulation, product selection and clinical trial design.
Its members are called upon individually as needed and include:
22
SCIENTIFIC ADVISORS
Name AFFILIATION AREA OF EXPERTISE
Joseph Brain, Ph.D. Professor, Harvard School of Public Health Pulmonary safety
Chairman, Department of Environmental Health
Director, Physiology Program
Peter Byron, Ph.D. Professor of Pharmacy Pharmaceutical aerosols
Virginia Commonwealth University, Medical
College of Virginia
Carl Grunfeld, M.D. Professor of Medicine Endocrinology
University of California, San Francisco
Michael Matthay, M.D. Professor of Medicine and Anesthesiology Pulmonology
University of California, San Francisco
Gerald Smaldone, M.D. Professor of Medicine, State University of Aerosol medicine
New York at Stony Brook
EMPLOYEES AND CONSULTANTS
As of February 28, 1997, Inhale had 92 employees, 76 engaged in research
and development activities and 16 in general administration and business
development. Sixty-two of the employees hold advanced degrees, of which 18 are
Ph.D.s. The Company employs scientists and engineers with expertise in the
areas of pulmonary biology, aerosol science, mechanical engineering, protein
chemistry and chemical engineering. None of the Company's employees are
covered by a collective bargaining agreement and the Company has experienced no
work stoppages. Inhale believes that it maintains good relations with its
employees.
To complement its own expertise, Inhale uses specialists in regulatory
affairs, pulmonary toxicology, process engineering, manufacturing, quality
assurance, device design, clinical trial design and business development.
These individuals include certain of the Company's scientific advisors as well
as independent consultants.
RESEARCH AND DEVELOPMENT
Research and development expenditures totaled $14.4 million, $9.0
million, and $4.9 million for the years ended December 31, 1996, 1995, and 1994
respectively. Research and development expenditures funded by partners were
approximately $6.9 million, $3.4 million, and $1.7 million for the years ended
December 31, 1996, 1995, and 1994 respectively.
THIRD-PARTY REIMBURSEMENT
Successful commercialization of certain of the Company's products will
depend in part on the availability of reimbursement from third-party health
care payors, such as private insurance plans and the government. There can be
no assurance that such reimbursement will be available. Third-party payers are
increasingly attempting to contain health care costs by limiting both coverage
and the level of reimbursement for new therapeutic and diagnostic products.
(See "Government Regulation.")
RISK FACTORS
In addition to the other information in this Report, the following risk
factors should be considered carefully in evaluating the Company and its
business.
23
EARLY STAGE COMPANY. Inhale is in an early stage of development. There
can be no assurance that the Company's pulmonary delivery technology will prove
to be technically feasible or commercially applicable to a range of
macromolecule and other drugs. Only four of the Company's pulmonary delivery
formulations, insulin, Interleukin-1 Receptor, salmon calcitonin and a peptide
for the treatment of osteoporosis have been subject to any human clinical
testing. Although many of the underlying drug compounds with which the Company
is working have been tested in humans by others using alternative delivery
routes, Inhale's potential products will require extensive research,
development, preclinical and clinical testing, and may involve lengthy
regulatory review. There can be no assurance that any of the Company's
potential products will prove safe and effective in clinical trials, meet
applicable regulatory standards, be capable of being produced in commercial
quantities at acceptable cost or be successfully marketed. Moreover, even if
the Company's products prove to be safe and effective and are approved for
marketing by the United States Food and Drug Administration ("FDA") and other
regulatory authorities, there can be no assurance that health care providers,
payors or patients will accept the Company's products. Any failure of the
Company to achieve technical feasibility, demonstrate safety, achieve clinical
efficacy, obtain regulatory approval or, together with partners, successfully
market products, would have a material adverse effect on the Company. See
"Risk Factors No Assurance of Successful Development or Commercialization of
Drugs for Pulmonary Delivery," " Government Regulation; Uncertainty of
Obtaining Regulatory Approval" and " Uncertainty Related to Health Care Reform
and Third-Party Reimbursement."
NO ASSURANCE OF SUCCESSFUL DEVELOPMENT OR COMMERCIALIZATION OF DRUGS FOR
PULMONARY DELIVERY. The commercial viability of Inhale's pulmonary drug
delivery system for any drugs will depend upon the Company achieving sufficient
system efficiency (measured by the percentage of bulk drug entering the
manufacturing process that eventually is absorbed into the bloodstream relative
to injection for systemic indications, or the amount of drug delivered to the
lung tissue for local lung indications), formulation stability, safety and
dosage reproducibility.
The initial screening determinant for the feasibility of pulmonary
delivery of any systemic drug is pulmonary bioavailability, which measures the
percentage of the drug absorbed into the bloodstream when delivered directly to
the lungs. In addition, a certain percentage of each drug dose may be lost at
various stages of the manufacturing and pulmonary delivery process in drug
formulation, dry powder processing, packaging, and in moving the drug from a
delivery device into the lungs. Too much drug loss at any one stage or
cumulatively in the manufacturing and delivery process could render a drug
commercially unfeasible for pulmonary delivery.
Formulation stability (the physical and chemical stability of the
formulated drug over time and under various storage conditions) and safety will
vary with each drug and the type and amount of excipients that are used in the
formulation. Reproducibility (the ability to deliver a consistent and
predictable amount of drug into the bloodstream over time both for a single
patient and across patient groups) will require, among other things, the
development of an inhalation device that consistently delivers predictable
amounts of dry powder formulations to the deep lung.
The Company's integrated approach to systems development relies upon
several different but related technologies, and its business strategy depends
upon collaborations with corporate partners. Development of powder
formulations, processing and packaging technology and the delivery device,
establishing collaborations with partners, laboratory and clinical testing, and
manufacturing scale-up must proceed contemporaneously so as not to delay any
aspect of systems development. Any delay in one component of product or
business development could cause consequential delays in the Company's ability
to develop, obtain approval of or market therapeutic products using its system.
Further refinement of the Company's device prototype, further scale-up of the
powder processing system and automated packaging system will need to be
accomplished before initiation of later stage clinical trials.
There can be no assurance that Inhale will be able to demonstrate
pulmonary bioavailability for the drug candidates it has identified or may
identify, will be able to achieve commercial viability of its pulmonary
delivery system or will achieve the total system efficiency needed to be
competitive with alternative routes of delivery. Further, there can be no
assurance that the Company's pulmonary delivery system will prove to be safe,
provide reproducible dosages of stable formulations sufficient to achieve
clinical efficacy, regulatory approval or market acceptance. In addition,
there can be no assurance that Inhale will advance the various aspects of
product and business development on a timely basis
24
that does not cause delays in overall product development. The failure to
demonstrate pulmonary bioavailability, achieve total system efficiency,
provide safe, reproducible dosages of stable formulations or advance timely
the various aspects of product and business development would have a material
adverse effect on the Company. See "Risk Factors Dependence Upon Partners"
and " Government Regulation; Uncertainty of Obtaining Regulatory Approval."
HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY. The
Company has not been profitable since inception and, through December 31, 1996,
had incurred a cumulative deficit of approximately $27.7 million. The Company
expects to continue to incur substantial and increasing losses over at least
the next several years as the Company's research and development efforts,
preclinical and clinical testing activities and manufacturing scale-up efforts
expand and as the Company plans and builds its late stage clinical and early
commercial production facility. All of the Company's potential products are in
research or in the early stages of development, and no revenues have been
generated from approved product sales. The Company's revenues to date have
consisted primarily of payments under short-term research and feasibility
agreements, development contracts and interest income. To achieve and sustain
profitable operations, the Company, alone or with others, must successfully
develop, obtain regulatory approval for, manufacture, introduce, market and
sell products utilizing its pulmonary drug delivery system. There can be no
assurance that the Company can generate sufficient product or contract research
revenue to become profitable or to sustain profitability.
DEPENDENCE UPON PARTNERS. The Company currently does not possess the
resources necessary to develop, complete the FDA approval process for, or
commercialize any of its potential therapeutic products. The Company's ability
to apply its pulmonary delivery system to a broad range of drugs will depend
upon its ability to establish and maintain collaborative arrangements since
many of the drugs currently approved for sale or in clinical testing are
covered by third party patents. The Company has entered into collaborative
arrangements with certain of its partners to fund clinical trials, assist in
obtaining regulatory approval and commercialize certain products. Inhale has
also entered into agreements with partners to test the feasibility of its
pulmonary delivery system with certain of their proprietary molecules. There
can be no assurance that the Company will be able to enter into additional
collaborations or that its feasibility agreements will lead to collaborations.
There also can be no assurance that the Company will be able to maintain any
such collaborative arrangements or feasibility agreements or that any such
collaborative arrangements or feasibility agreements will be successful. The
failure of the Company to enter into or maintain such collaborative
arrangements and feasibility agreements would have a material adverse effect on
the Company. Moreover, the inability of the Company to enter into a
collaborative arrangement with the owner of any patented drug may preclude the
Company from working with such drug.
The Company's existing partners have the rights to pursue parallel
development of other drug delivery systems which may compete with the Company's
pulmonary drug delivery system and to terminate their agreements with the
Company at any time without significant penalty. The Company anticipates that
any future partners would have similar rights. Although the Company intends
generally to formulate and manufacture powders for partners and to supply
inhalation devices for such powders, certain partners may choose to formulate
or manufacture their own powders, or to develop or supply their own device,
thereby limiting one or more potential sources of revenue for Inhale. In
addition, the Company anticipates that it may be precluded from entering into
arrangements with companies whose products compete with products sold by its
partners. The Company also will have limited or no control over the resources
that any partner may devote to the Company's products, over partners'
development efforts, including the design and conduct of clinical trials, and
over the pricing of any such products. The pharmaceutical and biotechnology
industries are consolidating, and acquisitions by, or of, the Company's
existing or potential collaborative partners may affect the initiation or
continuation of any such collaborations. There can be no assurances that any
of the Company's present or future collaborative partners will perform their
obligations as expected, will devote sufficient resources to the development,
clinical testing or marketing of the Company's potential products or will not
terminate their agreements with the Company prematurely. Any parallel
development by a partner of alternate drug delivery systems, development by a
partner rather than by Inhale of components of the delivery system, preclusion
from entering into competitive arrangements, failure to obtain timely
regulatory approvals, premature termination of an agreement, or failure by a
partner to devote sufficient resources to the development and commercialization
of the Company's products would have a material adverse effect on the Company.
25
See "Risk Factors Dependence Upon Proprietary Technology; Uncertainty of
Obtaining Licenses or Developing Technology."
LIMITED MANUFACTURING EXPERIENCE; RISK OF SCALE-UP. To achieve the levels
of production of Inhale's dry powder drug formulations necessary to support
late stage human clinical trials and for early commercialization of any of such
products, the Company will need to scale-up its current powder processing
facilities and automated filling, plan and build a late stage clinical and
early commercial production facility, and comply with the good manufacturing
practices ("GMP") prescribed by the FDA and other standards prescribed by
various federal, state and local regulatory agencies in the United States and
any other country of use.
The Company has no experience manufacturing products for large scale
clinical testing or commercial purposes. To date, the Company has performed
powder processing only on the small scale needed for early stage trials and for
testing formulations of certain other potential therapeutic products and scaled-
up for larger clinical trials. There can be no assurance that manufacturing
and control problems will not arise as the Company attempts to further scale-up
its powder processing facilities or that such scale-up can be achieved in a
timely manner or at a commercially reasonable cost. Any failure to surmount
such problems could delay or prevent late stage clinical testing and
commercialization of the Company's products and would have a material adverse
effect on the Company. To date, the Company has relied on a particular method
of powder processing. There can be no assurance that this technology will be
applicable to all drugs or that the drug losses in powder processing will not
be too high for commercial viability for certain drugs. In the event that the
Company decides to pursue alternative powder processing methods for some or all
of its drugs, there can be no assurance that these methods will prove
commercially practical for aerosol drugs or that the Company will have or be
able to acquire rights to use such alternative methods. See "Risk Factors
Dependence Upon Proprietary Technology; Uncertainty of Obtaining Licenses or
Developing Technology."
Fine particle powders and small quantity packaging (such as those to be
used in the Company's delivery system) require special handling. The Company
has designed and qualified small scale automated filling equipment for small
quantity packaging of fine powders. The Company faces significant technical
challenges scaling-up an automated filling system that can accurately and
economically handle the small dose and particle sizes of its powders in
commercial quantities. There can be no assurances that the Company will be
able to scale-up its automated filling equipment in a timely manner or at
commercially reasonable costs. Any failure or delay in such scale-up would
delay product development or bar commercialization of the Company's products
and would have a material adverse effect on the Company.
The Company also faces technical challenges in further developing its
inhalation device to achieve the efficiency necessary to deliver a broad range
of drugs, to produce such a device in quantities sufficient for later stage
clinical trials and early commercialization, and to adapt the device as may be
required for different powder formulations. There can be no assurance that
Inhale will successfully achieve such efficiencies, will be able to produce
such quantities or will be able to adapt the device as required. The failure
of the Company to overcome any such challenges would have a material adverse
effect on the Company. For late stage clinical trials and initial commercial
production, the Company intends to use one or more contract manufacturers to
produce its device. There can be no assurance that Inhale will be able to
enter into or maintain such arrangements. The failure of the Company to enter
into and maintain such arrangements would have a material adverse effect on the
Company. See "Risk Factors No Assurance of Successful Development or
Commercialization of Drugs for Pulmonary Delivery."
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company's
operations to date have consumed substantial and increasing amounts of cash.
The negative cash flow from operations is expected to continue and to
accelerate in the foreseeable future. The development of the Company's
technology and proposed products will require a commitment of substantial funds
to conduct the costly and time-consuming research and preclinical and clinical
testing activities necessary to develop early commercial production facility
and to bring any such products to market. The Company's future capital
requirements will depend on many factors, including continued progress in the
research and development of the Company's technology and drug delivery system,
the ability of the Company to establish and maintain collaborative arrangements
with others and the terms thereof, payments received from partners under
research
26
and development agreements, progress with preclinical and clinical trials,
the time and costs involved in obtaining regulatory approvals, the cost of
development and the rate of scale-up of the Company's powder processing and
packaging technologies, the timing and costs of its late stage clinical and
early commercial production facility, the cost involved in preparing, filing,
prosecuting, maintaining and enforcing patent claims, the need to acquire
licenses to new technology and the status of competitive products.
The Company expects that its existing capital resources, contract research
revenues from collaborations and the net proceeds of this offering and interest
thereon, will enable the Company to maintain its current and planned operations
at least through 1998. Thereafter, the Company may need to raise substantial
additional capital to fund its operations. The Company intends to seek such
additional funding through collaborative or partnering arrangements, the
extension of existing arrangements, or through public or private equity or debt
financings. There can be no assurance that additional financing will be
available on acceptable terms or at all. If additional funds are raised by
issuing equity securities, further dilution to shareholders may result. If
adequate funds are not available, the Company may be required to delay, reduce
the scope of, or eliminate one or more of its research or development programs
or obtain funds through arrangements with collaborative partners or others that
may require the Company to relinquish rights to certain of its technologies,
product candidates or products that the Company would otherwise seek to develop
or commercialize.
DEPENDENCE UPON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF OBTAINING LICENSES
OR DEVELOPING TECHNOLOGY. The Company's success will depend in part upon
protecting its proprietary technology from infringement, misappropriation,
duplication and discovery. The Company intends to rely principally on a
combination of patent law, trade secrets and contract law to protect its
proprietary technology in the United States and abroad. Inhale has filed
patent applications covering certain aspects of its device, powder processing
technology, and powder formulations and pulmonary route of delivery for certain
molecules, and plans to file additional patent applications. On October 17,
1995 the United States Patent and Trademark Office ("PTO") issued U.S. Patent
No. 5,458,135 to Inhale covering the use of its device as a method for
delivering powder formulations of drugs to the lung. There can be no assurance
that any of the patents applied for by the Company will issue, or that any
patents that issue will be valid and enforceable. Even if such patents are
enforceable, the Company anticipates that any attempt to enforce its patents
could be time consuming and costly.
The patent positions of pharmaceutical, biotechnology and drug delivery
companies, including Inhale, are uncertain and involve complex legal and
factual issues. Additionally, the coverage claimed in a patent application can
be significantly reduced before the patent is issued. As a consequence, the
Company does not know whether any of its patent applications will result in the
issuance of patents or, if any patents issue, whether they will provide
significant proprietary protection or will be circumvented or invalidated.
Since patent applications in the United States are maintained in secrecy until
patents issue, and since publication of discoveries in the scientific or patent
literature often lag behind actual discoveries, the Company cannot be certain
that it was the first inventor of inventions covered by its pending patent
applications or that it was the first to file patent applications for such
inventions. Moreover, the Company may have to participate in interference
proceedings declared by the PTO to determine priority of invention, which could
result in substantial cost to the Company, even if the eventual outcome is
favorable to the Company. There can be no assurance that the Company's
patents, if issued, would be held valid by a court of competent jurisdiction.
An adverse outcome could subject the Company to significant liabilities to
third parties, require disputed rights to be licensed from or to third parties
or require the Company to cease using the technology in dispute.
The Company is aware of numerous pending and issued United States and
foreign patent rights and other proprietary rights owned by third parties that
relate to aerosol devices and delivery, pharmaceutical formulations, dry powder
processing technology and the pulmonary route of delivery for certain
macromolecules. The Company cannot predict with any certainty which, if any,
patents and patent applications will be considered relevant to the Company's
technology by authorities in the various jurisdictions where such rights exist,
nor can the Company predict with certainty which, if any, of these rights will
or may be asserted against it by such third parties. The Company is aware of
an alternate dry powder processing technology which Inhale is not using for its
current products under development but may desire to use for certain products
in the future. The ownership of this powder processing technology is unclear
and the Company is aware that multiple parties, including Inhale, claim patent,
trade secret and other rights in the technology. If the Company determines
that this alternate powder processing technology is relevant to the development
of future
27
products and further determines that a license to this alternate powder
processing technology is needed, there can be no assurance that the Company
can obtain a license from the relevant party or parties on commercially
reasonable terms, if at all. There can be no assurance that the Company can
obtain any license to any technology that the Company determines it needs, on
reasonable terms, if at all, or that Inhale could develop or otherwise obtain
alternate technology. The failure of the Company to obtain licenses if
needed would have a material adverse effect on the Company.
Third parties from time to time have asserted and may assert that the
Company is employing technology that they believe is based on issued patents,
trade secrets or know-how of others. In addition, future patents may issue to
third parties which the Company's technology may infringe. The Company could
incur substantial costs in defending itself and its partners against any such
claims. Furthermore, parties making such claims may be able to obtain
injunctive or other equitable relief which could effectively block the
Company's ability to further develop or commercialize some or all of its
products in the United States and abroad, and could result in the award of
substantial damages. In the event of a claim of infringement, the Company and
its partners may be required to obtain one or more licenses from third parties.
There can be no assurances that the Company or its partners will be able to
obtain such licenses at a reasonable cost, if at all. Defense of any lawsuit
or failure to obtain any such license could have a material adverse effect on
the Company.
The Company's ability to develop and commercialize its technology will be
affected by the Company's or its partners' access to the drugs which are to be
formulated. Many drugs, including powder formulations of certain drugs which
are presently under development by the Company, are subject to issued and
pending United States and foreign patent rights which may be owned by competing
entities. There are issued patents and pending patent applications relating to
the pulmonary delivery of macromolecule drugs, including several for which the
Company is developing pulmonary delivery formulations. Specifically, a patent
has been granted in Europe which is directed to aerosol formulations of serine
protease inhibitors, including alpha-1 antitrypsin, for the treatment of the
lung. The resulting patent situation is highly complex, and the ability of any
one company to commercialize a particular biopharmaceutical drug is highly
unpredictable. The Company intends generally to rely on the ability of its
partners to provide access to the drugs which are to be formulated for
pulmonary delivery. There can be no assurance that the Company's partners will
be able to provide access to drug candidates for formulation for pulmonary
delivery or that, if such access is provided, the Company or its partners will
not be accused of, or determined to be, infringing a third party's rights and
will not be prohibited from working with the drug or be found liable for
damages that may not be subject to indemnification. Any such restriction on
access or liability for damages would have a material adverse effect on the
Company.
The Company also will rely on trade secrets and contract law to protect
certain of its proprietary technology. There can be no assurance that any such
contract will not be breached, or that if breached, the Company will have
adequate remedies. Furthermore, there can be no assurance that any of the
Company's trade secrets will not become known or independently discovered by
third parties.
The PTO has recently adopted changes to the United States patent law which
change the term of issued patents, subject to certain transition periods, to 20
years from the date of filing rather than 17 years from date of issuance.
Beginning in June 1995, the patent term became 20 years from the earliest
effective filing date of the underlying patent application. Such change may
reduce the effective term of protection for patents that are pending for more
than three years in the PTO. In addition, as of January 1996, all inventors
who work outside of the United States are able to establish a date of invention
on the same basis as those working in the United States. Such change could
adversely affect the ability of the Company to prevail in a priority of
invention dispute with a third party located or doing work outside of the
United States. While the Company cannot predict the effect that such changes
will have on its business, such changes could have a material adverse effect on
the Company's ability to protect its proprietary information and sustain the
commercial viability of its products. Furthermore, the possibility of
extensive delays in such process, could effectively further reduce the term
during which a marketed product could be protected by patents. See "Risk
Factors Dependence Upon Partners," " Government Regulation; Uncertainty of
Obtaining Regulatory Approval."
DEPENDENCE UPON AND NEED TO ATTRACT KEY PERSONNEL. The Company is highly
dependent upon the principal members of its scientific and management staff.
The Company does not have employment contracts with its key employees, nor does
the Company have key man insurance policies on them. The Company also relies
on consultants
28
and advisors to assist the Company in formulating research and development
strategy. To pursue its product development and commercialization plans, the
Company will be required to hire additional qualified scientific personnel to
perform research and development, as well as personnel with expertise in
clinical testing, government regulation and manufacturing. Expansion in
product development and manufacturing also is expected to require the
addition of management personnel and the development of additional expertise
by existing management personnel. Retaining and attracting qualified
personnel, consultants and advisors will be critical to the Company's
success. The Company faces competition for qualified individuals from
numerous pharmaceutical, biotechnology and drug delivery companies,
universities and other research institutions. There can be no assurance that
the Company will be able to retain its current key employees or attract and
retain qualified additional personnel and management when needed. This would
have a material adverse effect on the Company's ability to develop and
commercialize products.
GOVERNMENT REGULATION; UNCERTAINTY OF OBTAINING REGULATORY APPROVAL. The
production and marketing of the Company's products and its ongoing research and
development activities are subject to regulation by numerous governmental
authorities in the United States and other countries. Prior to marketing a new
dosage form of any drug, including one developed for use with the Company's
pulmonary drug delivery system, whether or not such drug was already approved
for marketing in another dosage form, the product must undergo rigorous
preclinical and clinical testing and an extensive review process mandated by
the FDA and equivalent foreign authorities. These processes generally take a
number of years and require the expenditure of substantial resources. None of
the Company's proposed products has been submitted to the FDA for marketing
approval. The Company has no experiences obtaining such regulatory approval,
does not have the expertise or other resources to do so and intends to rely on
its partners to fund clinical testing and to obtain product approvals. See
"Risk Factors Dependence Upon Partners."
The time required for completing such testing and obtaining such approvals
is uncertain. Further refinement of the device prototype, further scale-up of
the powder processing system and automated powder filling and packaging system
will need to be accomplished before initiation of later stage clinical trials.
Any delay in any of these components of product development may delay testing.
In addition, delays or rejections may be encountered based upon changes in FDA
policy during the period of product development. Similar delays may also be
encountered in other countries. If regulatory approval of a product is
granted, such approval may entail limitations on the indicated uses for which
the product may be marketed, and the marketed product, its manufacturer, and
its manufacturing facilities remain subject to continual review and periodic
inspections. Later discovery of previously unknown problems with a product,
manufacturer, or facility may result in restrictions on such product or
manufacturer, including withdrawal of the product from the market. There can
be no assurance that regulatory approval will be obtained for any products
developed by the Company on a timely basis, or at all. The failure to obtain
timely regulatory approval of its products, any product marketing limitations
or a product withdrawal would have a material adverse effect on the Company.
UNCERTAINTY RELATED TO HEALTH CARE REFORM AND THIRD-PARTY REIMBURSEMENT.
Political, economic and regulatory influences are subjecting the health care
industry in the United States to fundamental change. Although Congress has
failed to pass comprehensive health care reform legislation to date, the
Company anticipates that Congress, state legislatures and the private sector
will continue to review and assess alternative health care delivery and payment
systems. Potential approaches that have been considered include mandated basic
health care benefits, controls on health care spending, the creation of large
insurance purchasing groups, price controls on pharmaceuticals and other
fundamental changes to the health care delivery system. Any such proposed or
actual changes could cause Inhale's collaborative partners or potential
partners to limit or eliminate spending on collaborative drug development
projects. Legislative debate is expected to continue in the future, market
forces are expected to demand reduced costs and Inhale cannot predict what
impact the adoption of any federal or state health care reform measures or
future private sector reform may have on its business.
In both domestic and foreign markets, sales of the Company's potential
products, if any, will depend in part on the availability of reimbursement from
third-party payors such as government health administration authorities,
private health insurers and other organizations. Third-party payors are
increasingly challenging the price and cost-effectiveness of medical products
and services. Significant uncertainty exists as to the reimbursement status of
newly approved health care products. There can be no assurance that the
Company's proposed products will be considered cost effective or that
29
adequate third-party reimbursement will be available to enable Inhale to
maintain price levels sufficient to realize an appropriate return on its
investment in product development. Legislation and regulations affecting the
pricing of pharmaceuticals may change before the Company's proposed products
are approved for marketing and any such changes could further limit
reimbursement for medical products and services.
HIGHLY COMPETITIVE INDUSTRY: RISK OF TECHNOLOGICAL OBSOLESCENCE. The
biotechnology and pharmaceutical industries are highly competitive and rapidly
evolving and significant developments are expected to continue at a rapid pace.
The Company's success depends upon maintaining a competitive position in the
development of products and technologies for pulmonary delivery of
pharmaceutical drugs. If a competing company were to develop or acquire rights
to a better dry powder pulmonary delivery device or fine powder processing
technology, a better system for efficiently and reproducibly delivering drugs
to the deep lung, a non-invasive drug delivery system which is more attractive
for the delivery of drugs than pulmonary delivery, or an invasive delivery
system which overcomes some of the drawbacks of current invasive systems for
chronic or subchronic indications (such as a sustained release system), the
Company's business would be materially adversely affected.
The Company is in competition with pharmaceutical, biotechnology and drug
delivery companies, hospitals, research organizations, individual scientists
and nonprofit organizations engaged in the development of alternative drug
delivery systems or new drug research and testing, as well as with entities
producing and developing injectable drugs. The Company is aware of a number of
companies currently seeking to develop new products and non-invasive
alternatives to injectable drug delivery, including oral delivery systems,
intranasal delivery systems, transdermal systems and colonic absorption
systems. Several of these companies may have or be developing dry powder
devices that could be used for pulmonary delivery. The Company is also aware
of other companies currently engaged in the development and commercialization
of pulmonary drug delivery systems and enhanced injectable drug delivery
systems. Many of these companies and entities have greater research and
development capabilities, experience, manufacturing, marketing, financial and
managerial resources than the Company and represent significant competition for
the Company. Acquisitions of competing drug delivery companies by large
pharmaceutical companies could enhance competitors' financial, marketing and
other resources. Accordingly, the Company's competitors may succeed in
developing competing technologies, obtaining FDA approval for products more
rapidly than the Company and gaining market acceptance. There can be no
assurance that developments by others will not render the Company's products or
technologies uncompetitive or obsolete.
PRODUCT LIABILITY; AVAILABILITY OF INSURANCE. The design, development and
manufacture of the Company's products involve an inherent risk of product
liability claims and associated adverse publicity. Although the Company
currently maintains general liability insurance, there can be no assurance that
the coverage limits of the Company's insurance policies will be adequate. The
Company obtained clinical trial product liability insurance of $3.0 million for
certain clinical trials and intends to obtain insurance for future clinical
trials of insulin and other products under development. However, there can be
no assurance that the Company will be able to obtain or maintain insurance for
any future clinical trials. Such insurance is expensive, difficult to obtain
and may not be available in the future on acceptable terms, or at all. A
successful claim brought against the Company in excess of the Company's
insurance coverage would have a material adverse effect upon the Company and
its financial condition.
HAZARDOUS MATERIALS. The Company's research and development involves the
controlled use of hazardous materials, chemicals and various radioactive
compounds. Although the Company believes that its safety procedures for
handling and disposing of such materials comply with the standards prescribed
by state and federal regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could held liable for any damages that result and
any such liability could exceed the resources of the Company. The Company may
incur substantial costs to comply with environmental regulations.
ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's Restated
Articles of Incorporation and the California General Corporation Law could
discourage a third party from attempting to acquire, or make it more difficult
for a third party to acquire control of the Company without approval of the
Company's Board of Directors. Such provisions could also limit the price that
certain investors might be willing to pay in the future for shares of Common
30
Stock. Certain of such provisions allow the Board of Directors to authorize
the issuance of Preferred Stock with rights superior to those of the Common
Stock. The Company also will be subject to the provisions of Section 1203 of
the California General Corporation Law which requires a fairness opinion to be
provided to the Company's shareholders in connection with their consideration
of any proposed "interested party" reorganization transaction.
POTENTIAL VOLATILITY OF STOCK PRICE. The market prices for securities of
early stage technology companies have historically been highly volatile and the
market from time to time experienced significant price and volume fluctuations
that are unrelated to the operating performance of particular companies.
Factors such as fluctuations in the Company's operating results, announcements
of technological innovations or new therapeutic products or the announcement or
termination of collaborative relationships by the Company or its competitors,
governmental regulation, clinical trial results, developments in patent or
other proprietary rights, public concern as to the safety of drug formulations
developed by the Company or others and general market conditions may have a
significant effect on the market price of the Common Stock. The Company
securities are subject to a high degree of risk and volatility.
ITEM 2. PROPERTIES
Inhale currently leases approximately 35,000 square feet in two buildings
in Palo Alto, California. This space is used for research, development,
administration and manufacturing of drugs for early stage clinical trials.
This facility operates under Good Manufacturing Practices and has been
validated and licensed by the State of California to manufacture clinical
supplies for use in human clinical trials. The lease is for a five year term,
ending May 31, 1998, and provides Inhale with an option to renew at the then
fair market value through May 31, 2003.
In October 1996, the Company entered into a 15-year lease agreement on a
third facility totaling approximately 110,000 square feet. The Company plans
to consolidate its operations into this facility over the next eighteen months
and intends to use the facility as its initial commercial manufacturing site.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders in the
quarter ended December 31, 1996.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and positions of the
executive officers of the Company:
NAME AGE POSITION
Robert B. Chess 40 President, Chief Executive Officer and Director
Ajit S. Gill 48 Senior Vice President, Chief Operating Officer
Stephen L. Hurst 41 Vice President, Intellectual Property and
Licensing
Judi R. Lum 36 Vice President, Finance and Administration and
Chief Financial Officer
John S. Patton, Ph.D. 50 Vice President, Research and Director
Robert M. Platz 45 Vice President, Technology
ROBERT B. CHESS has served as President of the Company since December
1991 and as Chief Executive Officer since may 1992. Mr. Chess was also
elected a Director of the Company in May 1992. From September 1990 until
October 1991, he was an Associate Deputy Director in the White House Office
of Policy Development. In March 1987,
31
Mr. Chess co-founded Penederm Incorporated ("Penederm"), a topical
dermatological drug delivery company, and served as its President until
February 1989. He left Penederm in October 1989. Prior to co-founding
Penederm, Mr. Chess held management positions at Intel Corp., a semiconductor
manufacturer, and Metaphor, a computer software company (acquired by
International Business Machines). Mr. Chess holds a BS in Engineering from
the California Institute of Technology and an MBA from the Harvard Business
School.
AJIT S. GILL, Senior Vice President and Chief Operating Officer, has also
served as the Company's Chief Financial Officer from January 1993 until
October 1996. Mr. Gill has experience in building new businesses. Before
joining Inhale, Mr. Gill was Vice President and General Manager of Kodak's
Interactive Systems division. Mr. Gill has served as Chief Financial Officer
for TRW-Fujitsu, Director of Business Development for Visicorp, and as start-up
President for three high technology companies. He completed a BTech at the
Indian Institute of Technology, an MS in Electrical Engineering from the
University of Nebraska, and holds an MBA from the University of Western
Ontario.
STEPHEN L. HURST has been Vice President, Intellectual Property and
Licensing of the Company since March 1994. From July 1990 to February 1994,
Mr. Hurst was in private law practice and consulted with COR Therapeutics,
Inc., a biotechnology company, on intellectual property and business
development issues. From November 1987 to June 1990, he was the Campus Patent
Coordinator for the University of California, San Francisco. He also worked as
an Associate Counsel at Townsend & Townsend, the San Francisco area's largest
intellectual property law firm. He received a BS degree in Environmental
Science from the University of California at Berkeley and his JD from Golden
Gate University in San Francisco.
JUDI R. LUM has served as Vice President, Finance and Administration and
Chief Financial Officer since October 1996. She brings a diversity of
experience in finance, business development, and operations. She most recently
served as Vice President of Finance and Administration for an ophthalmics start-
up company and previously was Director of Corporate Development for GenPharm
International, Inc.. She also served as Director of Finance for the Industrial
Sector of Raychem Corporation, Pilot Operations Manager for Advanced
Cardiovascular Systems, and Assistant Vice President of Crocker National Bank.
She received her BA and MBA degrees from Stanford University.
JOHN S. PATTON, PH.D., a co-founder of Inhale, has been Vice President,
Research since December 1991 and a Director of the Company since July 1990. He
served as President of the Company from its incorporation in July 1990 to
December 1991. From 1985 to 1990, Dr. Patton was a Project Team Leader with
Genentech, Inc., a biotechnology company, where he headed their non-invasive
drug delivery activities. Dr. Patton was on the faculty of the Marine Science
and Microbiology Departments at the University of Georgia from 1979 through
1985, where he was granted tenure in 1984. Dr. Patton received a BS in Zoology
and Biochemistry from Pennsylvania State University, an MS from the University
of Rhode Island, a Ph.D. in Biology from the University of California, San
Diego and received post doctorate fellowships from Harvard Medical School and
the University of Lund, Sweden both in biomedicine.
ROBERT M. PLATZ, a co-founder of Inhale, has served as Vice President,
Technology of the Company since August 1990. He also served as a Director of
the Company from July 1990 to August 1991. From January 1983 to August 1991,
Mr. Platz was employed by SRI International, a contract research company, most
recently as Senior Chemical Engineer, where he headed the pharmaceutical
aerosol group. Mr. Platz received a BS in biology and an MS in Chemical
Engineering from the University of California, Los Angeles.
32
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock trades on the Nasdaq National Market under the
symbol INHL. The table below sets forth the high and low sales prices for the
Company's Common Stock (as reported on the Nasdaq National Market) during the
periods indicated.
PRICE RANGE
OF COMMON STOCK
----------------------
YEAR ENDED DECEMBER 31, 1995: HIGH LOW
------- ------
1st Quarter $11.375 $7.250
2nd Quarter 8.000 7.000
3rd Quarter 14.750 7.625
4th Quarter 11.500 7.250
YEAR ENDED DECEMBER 31, 1996:
1st Quarter $16.750 $9.750
2nd Quarter 21.500 15.000
3rd Quarter 18.625 12.625
4th Quarter 17.625 12.875
As of December 31, 1996, there were approximately 114 holders of record of
the Company's Common Stock. The Company has not paid any cash dividends since
its inception and does not intend to pay any cash dividends in the foreseeable
future.
On October 23, 1996 the Company sold 272,456 shares of Common Stock to
Pfizer, Inc. for aggregate consideration of $5,000,000 in cash pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
33
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
YEARS ENDED DECEMBER 31
------------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
STATEMENT OF OPERATIONS DATA:
Contract revenue $6,890 $3,445 $1,651 $708 $98
Operating costs and expenses:
Research and development 14,376 9,041 4,934 2,765 1,259
General and administrative 4,004 3,232 2,465 856 580
------- ------- ------- ------- -------
Total operating costs and expenses 18,380 12,273 7,399 3,621 1,839
------- ------- ------- ------- -------
Loss from operations (11,490) (8,828) (5,748) (2,913) (1,741)
------- ------- ------- ------- -------
Net lo $(9,909) $(7,662) $(5,279) $(2,861) $(1,681)
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Net loss per share (1) $(0.88) $(0.78) $(0.86) $(1.03) $(0.61)
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Shares used in computation of loss per share (1) 11,207 9,837 6,103 2,787 2,777
------- ------- ------- ------- -------
------- ------- ------- ------- -------
DECEMBER 31,
------------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital $31,304 $17,701 $13,451 $4,954 $3,345
Total assets 41,492 23,248 17,249 7,190 4,376
Equipment financing obligations, less current portion 187 353 460 652 229
Accumulated deficit (27,691) (17,770) (10,108) (4,829) (1,968)
Shareholders' equity 35,061 20,182 15,427 5,891 3,742
___________
No cash dividends have been paid for any of the periods presented.
(1) Net loss per share is based upon the weighted average number of common and
certain common equivalent shares outstanding. See Note 1 of Notes to Financial
Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE DISCUSSED HERE. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THIS SECTION AS
WELL AS IN PART I OF THIS ANNUAL REPORT UNDER THE HEADING "RISK FACTORS".
OVERVIEW
Since its inception in July 1990, Inhale has been engaged in the
development of a pulmonary system for the delivery of macromolecule drugs for
systemic and local lung applications. The Company has been unprofitable since
inception and expects to incur significant and increasing additional operating
losses over the next several years primarily due to increasing research and
development expenditures and expansion of manufacturing facilities. To date,
Inhale has not sold any products
34
and does not anticipate receiving revenue from product sales or royalties in
the near future. For the period from inception through December 31, 1996, the
Company incurred a cumulative net loss of approximately $27.7 million.
Inhale's sources of working capital have been equity financings, financings
of equipment acquisitions, interest earned on investments of cash, and
revenues from short term research and feasibility agreements and development
contracts.
Inhale typically has been compensated for research and development
expenses during initial feasibility work performed under collaborative
arrangements. Inhale's strategy is to enter into development contracts with
pharmaceutical and biotechnology corporate partners after feasibility is
demonstrated. Inhale expects that such partners will pay for research and
development expenses and will make payments to Inhale as it achieves certain
key milestones. Inhale intends to receive a royalty from its partners based on
revenues received from product sales, and to receive revenue from the
manufacturing of powders and the supply of devices. In certain cases, the
Company may enter into collaborative agreements under which the Company's
partners would manufacture powders or supply inhalation devices, thereby
potentially limiting one or more sources of revenue for the Company. To achieve
and sustain profitable operations, the Company, alone or with others, must
successfully develop, obtain regulatory approval for, manufacture, introduce,
market and sell products utilizing its pulmonary drug delivery system. There
can be no assurance that the Company will be able to generate sufficient
product or contract research revenue to become profitable or to sustain
profitability.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Contract research revenue was $6.9 million for the year ended December 31,
1996 compared to $3.4 million and $1.7 million for the years ended December 31,
1995 and 1994, respectively. Revenue increased 100% in 1996 from 1995 levels
and 109% in 1995 from 1994 levels. The year to year increases resulted from an
increase in the number of research feasibility agreements with partners and
development contracts as well as revenue earned in 1996 and 1995 by the Company
under its existing development agreements. Costs of contract research revenue
approximate such revenue and are included in research and development expense.
Contract revenues are expected to fluctuate from year to year, and future
contract revenues cannot be predicted accurately. The level of contract
revenues depends in part upon future success in obtaining new collaborative
agreements, timely completion of feasibility studies, the continuation of
existing collaborations and achievement of milestones under current and future
agreements. Nevertheless, the Company expects higher contract revenues in 1997
as it performs its development activities under its collaborative development
agreements.
Research and development expenses were $14.4 million for the year ended
December 31, 1996, as compared to $9.0 million and $4.9 million for the years
ended December 31, 1995 and 1994, respectively. These expenses represent
proprietary research expenses as well as the costs related to contract research
revenue and include salaries and benefits of scientific and development
personnel, laboratory supplies, consulting services, facilities, costs of
obtaining intellectual property protection for Inhale's technologies and
expenses associated with the development of manufacturing processes. The $5.3
million increase in research and development expenses in 1996 from 1995 and the
$4.1 million increase in research and development expenses in 1995 from 1994
were primarily due to the hiring of additional research personnel and increased
expenses associated with expanding laboratory and clinical manufacturing
facilities. The Company expects research and development and process
development spending to increase significantly over the next few years as the
Company expands its proprietary development efforts under collaborative
agreements and plans, builds and scales up a late stage clinical and early
commercial manufacturing facility.
General and administrative expenses were $4.0 million for the year ended
December 31, 1996 as compared to $3.2 million and $2.5 million for the years
ended December 31, 1995 and 1994, respectively. The $772,000 increase in
general and administrative expenses in 1996 from 1995 and the $767,000 increase
in 1995 from 1994 was due primarily to costs associated with supporting the
Company's increased research and development programs and accelerated business
35
development efforts. The Company expects general and administrative spending to
increase over the next few years as the Company expands its operations.
Interest income was $1.6 million for the year ended December 31, 1996 as
compared to $1.3 million and $592,000 for the years ended December 31, 1995 and
1994, respectively. The $386,000 increase in interest income in 1996 from 1995
was due primarily to interest earned on higher average cash balances as a
result of Baxter World Trade Corporation ("Baxter") making a $20.0 million
equity investment in Inhale at a 25% premium-to-market price in conjunction
with the March 1996 development agreement between the Company and Baxter. In
addition, in October 1996 Pfizer Inc. ("Pfizer") made an additional $5.0
million investment in Inhale pursuant to the January 1995 agreement between the
Company and Pfizer to develop insulin products using Inhale's non-invasive
pulmonary drug delivery system. The increase of $660,000 in interest income in
1995 from 1994 was due primarily to higher cash balances as a result of the
$7.2 million net proceeds received from the Company's follow-on public offering
of Common Stock in March 1995. In addition, in February 1995 Pfizer made a $5.0
million equity investment in Inhale at a 25% premium-to-market price in
conjunction with the January 1995 agreement between the Company and Pfizer.
At December 31, 1996, the Company had federal net operating loss
carryforwards of approximately $23.0 million. These carryforwards will expire
beginning in the year 2006. Utilization of net operating loss carryforwards may
be subject to substantial annual limitation due to the ownership change
limitation provided for by the Internal Revenue Code of 1986. The annual
limitation may result in the expiration of net operating loss carryforwards
before utilization.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through public and
private placements of its equity securities, contract research revenues,
interest income earned on its investments of cash and financing of equipment
acquisitions. In its initial public offering completed May 1994, the Company
raised net proceeds of approximately $14.4 million and raised additional net
proceeds of $7.2 million in its public offering completed in March 1995. At
December 31, 1996, the Company had cash, cash equivalents and short-term
investments of approximately $36.3 million.
The Company's operations used cash of $5.8 million, $5.3 million and $4.0
million in the years ended December 31, 1996, 1995 and 1994, respectively.
These amounts differed from the Company's net operating losses in these periods
due principally to depreciation expenses and increases in accounts payable,
accrued liabilities and deferred revenue. Additionally, in 1994, non-cash
amortization of deferred compensation expense of approximately $350,000
contributed to the difference between the net operating losses and cash used by
operations.
The Company added property and equipment of approximately $2.1 million,
$1.3 million and $1.4 million during the years ended December 31, 1996, 1995
and 1994, respectively. The Company financed approximately $151,000 of these
additions through lease agreements during the year ended December 31, 1995. The
Company did not finance additions through equipment financing agreements in
1996 or 1994.
In February 1997 the Company raised an additional $30.4 million in net
proceeds by completing a private placement of its common stock to a number of
institutional investors. Under the agreements, the investors purchased 1.8
million newly-issued shares of Inhale common stock, no par value, at a price of
$18 per share.
The Company expects its cash requirements to increase due to expected
increases in expenses related to the further research and development of its
technologies resulting from a larger number of projects, development of drug
formulations, process development for the manufacture and filling of powders
and devices, marketing and general and administrative costs. These expenses
include, but are not limited to, increases in personnel and personnel related
costs, acquisition of capital equipment, inhalation device prototype
construction and facilities expansion, including the planning and building of a
late stage clinical and early stage commercial manufacturing facility.
36
The Company believes that its existing cash, cash equivalents and short-
term investments of approximately $66.7 million (including net proceeds from
the private placement completed in February 1997) , when coupled with future
contract revenues from collaborative development arrangements, future equity
investments, interest income and possible additional equipment financings, will
be sufficient to meet its operating expense and capital expenditure
requirements at least through 1998.
The Company's capital needs will depend on many factors, including
continued scientific progress in the research and development of the Company's
technology, the ability of the Company to establish and maintain collaborative
arrangements with others and the terms thereof, the resources that the Company
devotes to the development of self-funded projects, payments received from
partners under research and development arrangements, progress with preclinical
and clinical trials, the time and costs involved in obtaining regulatory
approvals, the cost of developing and the rate of scale-up of the Company's
powder processing and packaging technologies, the timing and cost of its late
stage clinical and early commercial production facility, the costs involved in
preparing, filing, prosecuting, maintaining and enforcing patent claims, the
need to acquire licenses to new technologies and the status of competitive
products. To satisfy its longer-term liquidity needs, the Company intends to
seek additional funding, when needed, from corporate partners and from the sale
of securities. There can be no assurance that additional funds, if and when
required, will be available to the Company on favorable terms, if at all.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements for the years ended December 31, 1996, 1995 and
1994 are submitted as a separate section of this report. See Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Inhale incorporates by reference the information concerning its directors
set forth under the heading "Election of Directors" in Inhale's definitive
Proxy Statement to be filed for its 1997 Annual Meeting of Shareholders.
Information concerning Inhale's executive officers appears at the end of
Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
Inhale incorporates by reference the information set forth under the
heading "Executive Compensation" in the Company's definitive Proxy Statement to
be filed for its 1997 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Inhale incorporates by reference the information set forth under the
heading "Security Ownership of Certain Beneficial Owners and Management" in the
Company's definitive Proxy Statement to be filed for its 1997 Annual Meeting of
Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Inhale incorporates by reference the information set forth under the
heading "Certain Transactions" in the Company's definitive Proxy Statement to
be filed for its 1997 Annual Meeting for Shareholders.
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The Financial Statements required by this item, with the report of
independent auditors, are submitted in a separate section beginning
on page F-1 of this report.
Page
Report of Ernst & Young LLP, Independent Auditors F-2
Balance Sheets as of December 31, 1996 and 1995 F-3
Statements of Operations for each of the three years
in the period ended December 1996 F-4
Statements of Shareholder's Equity for each of the three
years in the period ended December 31, 1996 F-5
Statements of Cash Flows for each of the three years
in the period ended December 1996 F-6
Notes to Financial Statements F-7
(2) Financial Statement Schedules
Schedules have been omitted because the information
required to be set forth therein is not applicable or is
shown in the Financial Statements or notes thereto.
(3) Exhibits
The following exhibits are filed herewith or
incorporated by reference:
EXHIBIT EXHIBIT TITLE
- -------- ----------------------------------------------------------------------
3.1(3) Restated Articles of Incorporation of the Registrant.
3.2(1) Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.1 through 3.2.
4.2(1) Restated Investor Rights Agreement among the Registrant and certain
other persons named therein, dated April 29, 1993, as amended
October 29, 1993.
4.5(1) Warrant to purchase 18,182 Shares of Series C Preferred Stock between
the Registrant and Phoenix Leasing Incorporated, dated October 29,
1993.
4.6(1) Specimen stock certificate.
4.9(2) Stock Purchase Agreement between the Registrant and Pfizer Inc., dated
January 18, 1995.
4.10(8) Warrant to purchase 10,000 shares of Common Stock between the
Registrant and Thomas J. Peirona, dated November 1, 1996.
4.11(8) Warrant to purchase 10,000 shares of Common Stock between the
Registrant and Kiet Nguyen, dated November 1, 1996.
4.12(9) Form of Stock Purchase Agreement between the Registrant and the
Selling Shareholders dated January 28, 1997.
10.1(4) Registrant's 1994 Equity Incentive Plan (the "Equity Incentive Plan").
10.2(1) Form of Incentive Stock Option under the Equity Incentive Plan.
10.3(1) Form of Nonstatutory Stock Option under the Equity Incentive Plan.
10.4(7) Registrant's 1994 Non-Employee Directors' Stock Option Plan, as
amended.
10.5(1) Registrant's 1994 Employee Stock Purchase Plan.
10.6(1) Standard Industrial Lease between the Registrant and W.F. Batton &
Co., Inc., dated September 17, 1992, as amended September 18, 1992.
10.7(1) Master Equipment Lease between the Registrant and Phoenix Leasing
Incorporated, dated August 15, 1992 and Schedules i to 4 thereto.
10.8(1) Senior Loan and Security Agreement between the Registrant and Phoenix
Leasing Incorporated, dated September 15, 1993.
38
EXHIBIT EXHIBIT TITLE
- -------- ----------------------------------------------------------------------
10.9(1) Sublicense Agreement between the Registrant and John S. Patton, dated
September 13, 1991.
10.10(2) Offer Letter, dated September 16, 1994, from the Registrant to Jack M.
Anthony.
10.11(2) Addendum to Lease dated September 17, 1992, between the Registrant and
W.F. Batton & Marie A. Batton.
10.12(6) Lease dated May 31, 1995, between the Registrant and W.F. Batton &
Marie A. Batton.
10.13(6) Addendum Number One to Lease dated September 17, 1992, between the
Registrant and W.F. Batton & Marie A. Batton.
10.14(6) Addendum to Lease dated May 31, 1995 between the Registrant and W.F.
Batton & Marie A. Batton.
10.15(6) Addendum Number Two to Lease dated September 17, 1992, between the
Registrant and W.F. Batton & Marie A. Batton.
10.16(5) Stock Purchase Agreement between the Registrant and Baxter World Trade
Corporation, dated March 1, 1996.
10.17(8) Sublease and Lease Agreement, dated October 2, 1996 between the
Registrant and T.M.T. Associates L.L.C.
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney. Reference is made to page 43.
27.1 Financial Data Schedule
___________
(1)Incorporated by reference to the indicated exhibit in the Company's
Registration Statement (No. 33-75942),
as amended.
(2)Incorporated by reference to the indicated exhibit in the Company's
Registration Statement (No. 33-89502),
as amended.
(3)Incorporated by reference to the indicated exhibit in the Company's Annual
Report on Form 10-K for the year ended December 31, 1994.
(4)Incorporated by reference to the Company's Registration Statement on Form
S-8 (No. 333-07969)
(5)Incorporated by reference to the indicated exhibit in the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1996.
(6)Incorporated by reference to the indicated exhibit in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(7)Incorporated by reference to the indicated exhibit in the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.
(8)Incorporated by reference to the indicated exhibit in the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
(9)Incorporated by reference to the Company's Registration Statement on Form
S-3 (No. 333-20787)
(b) Reports on Form 8-K.
No Reports on Form 8-K were filed during the quarter ended December 31,
1996.
(c) See Exhibits listed under Item 14(a)(3).
(d) Not applicable. See Item 14(a)(2).
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 28th day of
March 1997.
INHALE THERAPEUTIC SYSTEMS
By: /s/ Robert B. Chess
------------------------
Robert B. Chess
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND DIRECTOR
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints, Robert B. Chess and Judi R. Lum as his/her
attorney-in-fact for him/her in any and all capacities, to sign any and all
amendments to this report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that the said
attorney-in-fact, or his substitutes, may do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Robert B. Chess President, Chief Executive March 28, 1997
- ----------------------------- Officer and Director
Robert B. Chess (PRINCIPAL EXECUTIVE OFFICER)
/s/ Judi R. Lum Chief Financial Officer March 28, 1997
- ----------------------------- (PRINCIPAL FINANCIAL AND
Judi R. Lum ACCOUNTING OFFICER)
/s/ JOHN S. Patton Vice President and Director March 28, 1997
- -----------------------------
John S. Patton
/s/ Mark J. Gabrielson Director March 28, 1997
- -----------------------------
Mark J. Gabrielson
/s/ James B. Glavin Director March 28, 1997
- -----------------------------
James B. Glavin
/s/ Melvin Perelman Director March 28, 1997
- -----------------------------
Melvin Perelman
/s/ Terry L. Opdendyk Chairman of the Board March 28, 1997
- -----------------------------
Terry L. Opdendyk
40
INHALE THERAPEUTIC SYSTEMS
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Ernst & Young LLP, Independent Auditors F-2
Balance Sheets at December 31, 1996 and 1995 F-3
Statements of Operations for each of the three years in
the period ended December 31, 1996 F-4
Statement of Shareholders' Equity for the three years
ended December 31, 1996 F-5
Statements of Cash Flows for each of the three years in
the period ended December 31, 1996 F-6
Notes to Financial Statements F-7
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders of
Inhale Therapeutic Systems
We have audited the accompanying balance sheets of Inhale Therapeutic
Systems as of December 31, 1996 and 1995, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Inhale Therapeutic Systems
at December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Palo Alto, California
February 10, 1997
F-2
INHALE THERAPEUTIC SYSTEMS
BALANCE SHEETS
(IN THOUSANDS)
ASSETS
DECEMBER 31,
-----------------------
1996 1995
Current assets:
Cash and cash equivalents $ 18,568 $ 3,834
Short-term investments 17,741 16,093
Other current assets 1,239 487
-------- --------
Total current assets 37,548 20,414
Property and equipment, net 3,770 2,660
Deposits and other assets 174 174
-------- --------
$41,492 $23,248
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,130 $ 717
Accrued liabilities 1,746 899
Accrued compensation 479 274
Deferred revenue 2,723 578
Equipment financing obligations current portion 166 245
-------- --------
Total current liabilities 6,244 2,713
Equipment financing obligations 187 353
Commitments
Shareholders' equity:
Preferred stock, 10,000 shares authorized, no
shares issued or outstanding
Common stock, no par value; 30,000 shares
authorized; 11,835 shares and 10,142 shares issued
and outstanding at December 31, 1996 and 1995,
respectively 62,840 38,202
Deferred compensation (88) (250)
Accumulated deficit (27,691) (17,770)
------- -------
Total shareholders' equity 35,061 20,182
------- -------
$41,492 $23,248
------- -------
------- -------
See accompanying notes
F-3
INHALE THERAPEUTIC SYSTEMS
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- -------
Contract research revenue $ 6,890 $ 3,445 $ 1,651
Operating costs and expenses:
Research and development 14,376 9,041 4,934
General and administrative 4,004 3,232 2,465
-------- -------- -------
Total operating costs and expenses 18,380 12,273 7,399
-------- -------- -------
Loss from operations (11,490) (8,828) (5,748)
Interest income 1,638 1,252 592
Interest expense (57) (86) (123)
-------- -------- -------
Net loss $(9,909) $(7,662) $(5,279)
-------- -------- -------
-------- -------- -------
Net loss per share $(0.88) $ (0.78) $ (0.86)
-------- -------- -------
-------- -------- -------
Shares used in net loss per share calculation 11,207 9,837 6,103
-------- -------- -------
-------- -------- -------
See accompanying notes
F-4
INHALE THERAPEUTIC SYSTEMS
STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
PREFERRED STOCK COMMON STOCK TOTAL
---------------- -------------- DEFERRED ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT COMPENSATION DEFICIT EQUITY
------ ------- ------ ------ ------------ ----------- -------------
Balance at December 31, 1993 2,909 $10,697 934 $ 23 $ -- $ (4,829) $ 5,891
Conversion of Series A, B, and C convertible
preferred stock to common stock (2,909) (10,697) 5,236 10,697 -- -- --
Issuance of common stock in initial public offering,
net of issuance costs of $1,698 -- -- 2,150 14,427 -- -- 14,427
Deferred compensation related to the issuance of
certain stock options granted to employees -- -- -- 760 (760) -- --
Amortization of deferred compensation -- -- -- -- 348 -- 348
Exercise of stock options for cash by employees and
consultants -- -- 336 40 -- -- 40
Net loss -- -- -- -- -- (5,279) (5,279)
------- ------ ------ ------ ------ ------- --------
Balance at December 31, 1994 -- -- 8,656 25,947 (412) (10,108) 15,427
Issuance of common stock in connection with a
collaborative agreement -- -- 453 5,000 -- -- 5,000
Issuance of common stock in follow-on offering, net
of issuance costs of $757 -- -- 1,000 7,243 -- -- 7,243
Amortization of deferred compensation -- -- -- -- 162 -- 162
Exercise of stock options for cash by employees and
consultants -- -- 33 12 -- -- 12
Net loss -- -- -- -- -- (7,662) (7,662)
------- ------ ------ ------ ------ ------- --------
Balance at December 31, 1995 -- -- 10,142 38,202 (250) (17,770) 20,182
Issuance of common stock in connection with
collaborative agreements, net of issuance costs
of $806 -- -- 1,608 24,196 -- -- 24,196
Amortization of deferred compensation -- -- -- -- 162 -- 162
Exercise of stock options for cash by employees and
consultants -- -- 85 442 -- -- 442
Unrealized loss on securities held as
available-for-sale -- -- -- -- -- (12) (12)
Net loss -- -- -- -- -- (9,909) (9,909)
------- ------ ------ ------ ------ -------- --------
Balance at December 31, 1996 -- $-- 11,835 $62,840 $(88) $(27,691) $35,061
------- ------ ------ ------ ------ -------- --------
------- ------ ------ ------ ------ -------- --------
See accompanying notes
F-5
INHALE THERAPEUTIC SYSTEMS
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
CASH FLOWS USED IN OPERATING ACTIVITIES
Net loss $(9,909) $(7,662) $(5,279)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,071 955 539
Amortization of deferred compensation 162 162 348
Increase in other current assets, deposits and other
assets (752) (110) (317)
Increase (decrease) in accounts payable and accrued
liabilities 1,465 847 696
Increase in deferred revenue 2,145 483 8
------- ------- -------
Net cash used in operating activities (5,818) (5,325) (4,005)
------- ------- -------
CASH FLOWS USED IN INVESTING ACTIVITIES
Purchases of available-for-sale securities (58,993) (49,318) (22,786)
Sales of available-for-sale securities 2,020 7,812 4,102
Maturities of available-for-sale securities 55,313 29,326 18,601
Purchases of property and equipment, net (2,181) (1,340) (1,371)
------- ------- -------
Net cash used in investing activities (3,841) (13,520) (1,454)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of equipment loan obligations (52) (32) (27)
Payments of capital lease obligations (193) (205) (154)
Issuance of equipment loan obligations 151
Issuance of common stock, net of issuance costs 24,638 12,255 14,467
------- ------- -------
Net cash provided by financing activities 24,393 12,169 14,286
------- ------- -------
Net increase (decrease) in cash and cash equivalents 14,734 (6,676) 8,827
Cash and cash equivalents at beginning of period 3,834 10,510 1,683
------- ------- -------
Cash and cash equivalents at end of period $18,568 $3,834 $10,510
------- ------- -------
------- ------- -------
See accompanying notes
F-6
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Inhale Therapeutic Systems (the "Company") was incorporated in the State
of California in July 1990. Since inception, the Company has been engaged in
the development of systems for the pulmonary delivery of macromolecule drug
therapies for systemic and local lung applications.
The Company expects increasing losses over the next several years as
research and development efforts continue, and as the Company expands its
facilities for late stage clinical trials and early stage commercial
manufacturing. Management plans to continue to finance the Company primarily
through issuances of equity securities, research and development contract
revenue, and in the longer term, revenue from product sales and royalties. If
the financing arrangements contemplated by management are not consummated, the
Company may have to seek other sources of capital or reevaluate its operating
plans.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. Cash and cash
equivalents include demand deposits held in banks and interest bearing money
market funds. All other liquid investments are classified as short-term
investments. Short-term investments consist of federal and municipal government
securities, repurchase agreements or corporate commercial paper with A1 or P1
short-term ratings and A or better long-term ratings with remaining maturities
at date of purchase of greater than 90 days and less than one year. The Company
limits its concentration of risk by diversifying its investments among a
variety of industries and issuers. The Company has experienced no losses on its
investments.
At December 31, 1996, all short-term investments are designated as
available-for-sale and are carried at fair value, with material unrealized
gains and losses, if any, reported in shareholders' equity. The amortized cost
of securities is adjusted for amortization of material premiums and accretion
of discounts to maturity. Such amortization, if any, is included in interest
income. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities, if any, are included in
interest income. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.
F-7
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
The following is a summary of available-for-sale securities as of
December 31, 1996:
AVAILABLE-FOR-SALE SECURITIES
-------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------- ---------- ---------- ----------
(IN THOUSANDS)
Obligations of U.S. government
agencies $15,812 $ -- $ -- $15,812
U.S. corporate commercial paper 8,874 -- 12 8,862
Repurchase agreements, secured by
U.S. Government securities 11,811 -- -- 11,811
Other 152 -- -- 152
------- ---------- ---------- ----------
$36,649 $ -- $ 12 $36,637
------- ---------- ---------- ----------
Amounts included in cash and
cash equivalents $18,897 $ -- $ -- $18,897
Amounts included in short-term
investments 17,753 -- 12 17,741
------- ---------- ---------- ----------
$36,650 $ -- $ 12 $36,638
The following is a summary of available-for-sale securities as of
December 31, 1995:
AVAILABLE-FOR-SALE SECURITIES
-------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------- ---------- ---------- ----------
(IN THOUSANDS)
Obligations of U.S. government
agencies $11,209 $ -- $ -- $11,209
U.S. corporate commercial paper 5,871 -- -- 5,871
Repurchase agreements, secured
by U.S. Government securities 2,487 -- -- 2,487
Other 360 -- -- 360
------- ---------- ---------- ----------
$19,927 $ -- $ -- $19,927
------- ---------- ---------- ----------
------- ---------- ---------- ----------
Amounts included in cash and cash
equivalents $3,834 $ -- $ -- $3,834
Amounts included in short-term
investments 16,093 -- -- 16,093
------- ---------- ---------- ----------
$19,927 $ -- $ -- $19,927
------- ---------- ---------- ----------
------- ---------- ---------- ----------
The gross realized losses and gains on the sale of securities
available-for-sale during the years ended December 31, 1996 and 1995, were not
material. As of December 31, 1996, the average portfolio duration was
approximately three months and the contractual maturity of any single
investment did not exceed nine months (six months at December 31, 1995).
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
market data must be interpreted to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the Company could realize in a current market exchange.
F-8
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and consists of the following at
December 31:
1996 1995
------- -------
(IN THOUSANDS)
Laboratory and other equipment $3,679 $1,997
Leasehold improvements 2,258 1,759
Leased equipment 677 677
------- -------
6,614 4,433
Less accumulated depreciation and amortization (2,844) (1,773)
------- -------
$3,770 $2,660
------- -------
------- -------
Equipment is depreciated using the straight-line method over
estimated useful lives of four to seven years. Leasehold improvements and
assets acquired under capital leases are amortized using the straight-line
method over the shorter of the estimated useful life of the assets or the term
of the lease.
REVENUE RECOGNITION
Contract revenue from collaborative research agreements is recorded when
earned and as the related costs are incurred. Payments received which are
related to future performance are deferred and recognized as revenue when
earned over future performance periods. In accordance with contract terms, up
front and milestone payments from collaborative research agreements are
considered reimbursements for costs incurred under the agreements, and
accordingly, are generally recognized based on actual efforts expended over the
remaining terms of the agreements. The Company's research revenue is derived
primarily from clients in the pharmaceutical and biotechnology industries.
Contract research revenue from two partners represented 77% and 14% of the
Company's revenue in 1996. Contract revenue from two partners accounted for
78% and 13% of the Company's revenue in 1995, and two partners accounted for
56% and 18% of the Company's revenue in 1994. Costs of contract research
revenue approximate such revenue and are included in research and development
expenses.
STOCK-BASED COMPENSATION
In accordance with the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), the
Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options plans. Under APB
25, if the exercise price of the Company's employee stock options equals or
exceeds the fair value of the underlying stock on the date of grant as
determined by the Company's Board of Directors, no compensation expense is
recognized.
F-9
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
RESEARCH AND DEVELOPMENT AGREEMENTS
The Company performs research and development for others pursuant to
feasibility agreements and development and license agreements. Under the
feasibility agreements, the Company generally is reimbursed for the cost of
work performed. Feasibility agreements are designed to evaluate the
applicability of the Company's technologies to a particular
macromolecule and therefore are generally completed in less than one year.
Under the Company's development and license agreements, the partner companies
receive an exclusive license to develop, use and sell a dry powder formulation
and a suitable delivery device to be developed by the Company for one of the
partner's macromolecule drugs. Under these development agreements, the Company
will be reimbursed for development costs and may also be entitled to milestone
and advanced royalty payments when and if certain development milestones are
achieved. All of the Company's research and development agreements are
generally cancelable by the partner without significant financial penalty to
the partner.
ACCOUNTING FOR INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (Statement 109).
Under Statement 109, the liability method is used in accounting for income
taxes.
NET LOSS PER SHARE
The net loss per common share is computed based upon the weighted average
number of common shares outstanding. Common equivalent shares are not included
in the per share calculations where the effect of their inclusion would be
antidilutive.
NOTE 2 -- COMMITMENTS AND EQUIPMENT FINANCING OBLIGATIONS
The Company leases its office and laboratory facilities under several
arrangements expiring through the year 2012. Rent expense was approximately
$416,000, $217,000 and $185,000 for the years ended December 31, 1996, 1995 and
1994, respectively.
Included in property and equipment at December 31, 1996 and 1995, are assets
with costs of $677,000 acquired pursuant to capital lease obligations and
equipment loans secured by the equipment with interest rates ranging from 14%
to 18% per annum. Accumulated amortization of assets acquired pursuant to these
equipment financing obligations was approximately $658,000 and $541,000 at
December 31, 1996 and 1995, respectively. Future noncancellable commitments
under equipment financing obligations and operating leases at December 31, 1996
are as follows:
F-10
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 2 -- COMMITMENTS AND EQUIPMENT FINANCING OBLIGATIONS (CONTINUED)
EQUIPMENT
OPERATING FINANCING
LEASES OBLIGATIONS
--------- -----------
(IN THOUSANDS)
Years ending December 31,
1997 $ 728 $193
1998 956 62
1999 947 60
2000 989 109
2001 and thereafter 14,627 --
------- -------
Total minimum payments required $18,247 424
------- -------
Less amount representing interest (71)
-------
Present value of future lease payments 353
Less current portion 166
-------
Noncurrent portion $187
-------
-------
NOTE 3 - SHAREHOLDERS' EQUITY
COMMON STOCK
EMPLOYEE STOCK PURCHASE PLAN
In February 1994, the Company's Board of Directors adopted the
Employee Stock Purchase Plan (the "Purchase Plan"). Under the Purchase Plan,
150,000 shares of common stock have been reserved for purchase by the Company's
employees pursuant to section 423(b) of the Internal Revenue Code of 1986. As
of December 31, 1996, no shares of common stock have been issued under the
Purchase Plan.
STOCK OPTION PLANS
EQUITY INCENTIVE PLAN
The Company's 1994 Equity Incentive Plan (the "Equity Incentive Plan") was
adopted by the Board of Directors in February 1994. The Equity Incentive Plan
is an amendment and restatement of the Company's 1992 Stock Option Plan. The
purpose of the Equity Incentive Plan is to attract and retain qualified
personnel, to provide additional incentives to employees, officers, consultants
and employee directors of the Company and to promote the success of the
Company's business. Pursuant to the Equity Incentive Plan, the Company may
grant or issue incentive stock options to employees and officers and
non-qualified stock options, restricted stock purchase awards, stock bonuses
and stock appreciation rights to consultants, employees, officers and employee
directors.
The maximum term of a stock option under the Equity Incentive Plan is ten
years, but if the optionee at the time of grant has voting power of more than
10% of the Company's outstanding capital stock, the maximum term of an
incentive
F-11
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 3 SHAREHOLDERS' EQUITY (CONTINUED)
stock option is five years. The exercise price of incentive stock options
granted under the Equity Incentive Plan must be at least equal to 100% (or
110% with respect to holders of more than 10% of the voting power of the
Company's outstanding capital stock) of the fair market value of the stock
subject to the option on the date of the grant. The exercise price of
non-qualified stock options, and the purchase price of restricted stock
purchase awards, granted under the Equity Incentive Plan are determined by the
Board of Directors. Stock appreciation rights authorized for issuance under the
Equity Incentive Plan may be tandem stock appreciation rights, concurrent stock
appreciation rights or independent stock appreciation rights.
The Equity Incentive Plan may be amended at any time by the Board,
although certain amendments would require shareholder approval. The Equity
Incentive Plan will terminate in February 2004 unless earlier terminated by the
Board.
NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
In February 1994, the Company's Board of Directors adopted the Non-
employee Directors' Stock Option Plan under which options to purchase up to
200,000 shares of the Company's common stock at the then fair market value may
be granted to the Company's non-employee directors. During the year ended
December 31, 1996, options to purchase a total of 60,000 shares were granted to
non-employee directors of the Company at an exercise price ranging from $10.13
to $17.50 per share. As of December 31, 1996, options on 6,000 shares had been
exercised and options to purchase 81,000 shares were exercisable.
A summary of activity under the Equity Incentive Plan and the Non-Employee
Directors' Stock Option plan is as follows:
OPTIONS OUTSTANDING
------------------------------ WEIGHTED-AVERAGE
OPTIONS AVAILABLE EXERCISE PRICE EXERCISE PRICE PER
FOR GRANT NUMBER OF SHARES PER SHARE SHARE
-------------- -------------- -------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
Balance at December 31, 1993........ 1,212 484 $0.06-15.25 $ 0.12
Shares authorized................. 690 -- -- --
Options granted................... (708) 708 0.22-10.25 5.43
Options exercised................. -- (336) 0.06-0.56 0.12
Options canceled.................. 8 (8) 0.22-10.25 5.39
-------------- -------------- -------------- --------------
Balance at December 31, 1994........ 1,202 848 0.06-15.25 4.50
Shares authorized................. -- -- -- --
Options granted................... (428) 428 7.63-12.00 9.34
Options exercised................. -- (33) 0.06-2.78 0.36
Options canceled.................. 10 (10) 0.22-10.00 1.84
-------------- -------------- -------------- --------------
Balance at December 31, 1995........ 784 1,233 0.06-15.25 6.32
Shares authorized................. 1,500 -- -- --
Options granted................... (620) 620 10.13-19.25 14.05
Options exercised................. -- (85) 0.06-12.00 5.22
Options canceled.................. 109 (109) 0.31-15.25 8.33
-------------- -------------- -------------- --------------
Balance at December 31, 1996........ 1,773 1,659 $0.06-19.25 $ 9.13
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
F-12
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 3 - SHAREHOLDERS' EQUITY (CONTINUED)
At December 31, 1996, 1995 and 1994, options were exercisable to purchase
approximately 514,000, 335,000 and 157,000 at weighted-average exercise prices
of $5.83, $4.31 and $1.62 per share, respectively.
Exercise prices for options outstanding as of December 31, 1996 ranged
from $0.06 to $19.25 per share. The weighted-average contractual life of those
options is 8.2 years.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- --------------------------------
WEIGHTED-
AVERAGE
WEIGHTED- REMAINING WEIGHTED-
RANGE OF AVERAGE EXERCISE CONTRACTUAL LIFE AVERAGE EXERCISE
EXERCISE PRICES NUMBER PRICE PER SHARE (IN YEARS) NUMBER PRICE PER SHARE
- -------------- -------------- --------------- --------------- -------------- --------------
(IN THOUSANDS EXCEPT PER SHARE AND YEAR INFORMATION)
$ 0.06-5.56 483 $ 3.21 6.88 244 $ 1.83
5.75-9.13 435 8.04 7.95 166 7.76
9.88-14.50 484 11.66 9.03 86 10.96
15.25-19.25 257 17.32 9.55 18 17.80
- ------------ ----- ------- ---- --- -------
$ 0.06-19.25 1,659 $ 9.13 8.20 514 $ 5.83
- ------------ ----- ------- ---- --- -------
- ------------ ----- ------- ---- --- -------
Pro forma information regarding net income and earnings per share is
required by Statement 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Sholes option pricing model with the following weighted-average
assumptions for 1995 and 1996: risk-free interest rate of 6.4%; a dividend
yield of 0.0%; volatility factors of the expected market price of the Company's
common stock of 0.62; and a weighted-average expected life of 6 years.
The Black-Sholes options valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period, generally
five years. The Company's pro forma information follows (in thousands except
for earnings per share):
1996 1995
--------- --------
Pro forma net loss $(11,252) $(8,106)
-------- -------
-------- -------
Pro forma net loss per share $(1.00) $(0.82)
-------- -------
-------- -------
F-13
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 3 - SHAREHOLDERS' EQUITY (CONTINUED)
Because FAS 123 is applicable only to options granted subsequent to December
31, 1994 the pro forma effect of the statement will not be fully reflected
until approximately the year 2000.
WARRANT
In October 1996 the Company issued two warrants ("the warrants") to
purchase a total of 20,000 shares of Common Stock (10,000 shares each) at a
price of $13.125 per share in connection with a facility lease. The warrants
expire in October 2006 and were both outstanding at December 31, 1996.
As of December 31, 1996, a warrant to purchase 32,727 shares of Common
stock at $3.06 per share issued in connection with equipment financing
arrangements was outstanding and is exercisable through September 2003.
RESERVED SHARES
A total of 4,132,727 shares of common stock have been reserved for
issuance at December 31, 1996 for the various equity incentive plans and the
warrants.
NOTE 4 INCOME TAXES
As of December 31, 1996, the Company had federal net operating loss
carryforwards of approximately $23,000,000. The net operating loss and credit
carryforwards will expire at various dates beginning in 2006 through 2011 if
not utilized.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets as of December 31 are as follows:
1996 1995
------- ------
(THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards $7,900 $5,200
Research credits (expiring 2006-2011) 900 500
Capitalized research expenses 600 400
Deferred revenue 1,000 200
Other 700 600
------- ------
Total deferred tax assets 11,100 6,900
Valuation allowance for deferred tax assets (11,100) (6,900)
------- ------
Net deferred tax assets $ -- $ --
------- ------
------- ------
Because of the Company's lack of earnings history, the deferred tax
assets have been fully offset by a valuation allowance. The valuation
allowance increased by $3,000,000 during the year ended December 31, 1995.
F-14
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1996
NOTE 4 - INCOME TAXES (CONTINUED)
Utilization of net operating losses and credits may be subject to
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses and credits before utilization.
NOTE 5 - STATEMENT OF CASH FLOWS DATA (IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------
1996 1995 1994
---- ---- ----
Supplemental disclosure of cash flows information:
Interest paid $57 $86 $123
---- ---- ----
---- ---- ----
Deferred compensation related to the issuance of
certain stock options $ $ $760
---- ---- ----
---- ---- ----
NOTE 6 - SUBSEQUENT EVENTS (UNAUDITED)
In February 1997 the Company received $30.4 million in net proceeds from
a private placement of 1,800,000 shares its Common Stock to a group of
institutional investors at a price of $18 per share.
F-15