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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly Report pursuant to Section 13 or 15(d) of the Securities
- ------- Exchange Act of 1934 for the quarterly period ended September 30, 2002
Transition report pursuant to Section 13 or 15(d) of the Securities
- ------- Exchange Act of 1934 for the transition period from _______ to _______
Commission File Number 0-24760
Orphan Medical, Inc.
--------------------
(Exact name of registrant as specified in its charter)
Delaware 41-1784594
- ------------------------------------------------ ---------------------------------------
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification Number)
organization)
13911 Ridgedale Drive, Suite 250, Minnetonka, MN 55305 (952) 513-6900
- ------------------------------------------------------ -------------------------------
(Address of principal executive offices (Registrant's telephone number,
and zip code) including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
-------- --------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 par value 10,392,674
---------------------------- -----------
(Class) (Outstanding at November 7, 2002)
INDEX
ORPHAN MEDICAL, INC.(R)
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Balance Sheets - September 30, 2002 and December 31, 2001. 3
Statements of Operations - Three and nine months ended September 30, 2002 and
September 30, 2001. 4
Statements of Cash Flows - Nine months ended September 30, 2002 and
September 30, 2001. 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 9
Item 3. Quantitative and Qualitative Disclosures about Market Risks 27
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Items 1 through 5 have been omitted since all items are inapplicable or answers
negative.
Item 6. Exhibits and Reports on Form 8-K 27
Antizol(R), Antizol-Vet(R), Caprogel(TM), Busulfex(R), Intrachol(TM),
Cystadane(R), Elliotts B(R) Solution, Sucraid(R), Xyrem(R), MedExpand(TM), "The"
Orphan Drug Company(TM), Orphan Medical, Inc.(R) and Dedicated to Patients with
Uncommon Diseases(R) are trademarks of the Company.
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ORPHAN MEDICAL, INC.
BALANCE SHEETS
September 30, December 31,
2002 2001
--------------------- -----------------------
(Unaudited) (See note)
Assets
Current assets:
Cash and cash equivalents $13,100,330 $19,011,245
Accounts receivable, less allowance for doubtful accounts of $27,300
and $25,000 for 2002 and 2001, respectively 2,238,097 1,645,749
Inventories 1,876,031 1,242,120
Other current assets 119,992 63,662
---------------------- -----------------------
Total current assets 17,334,450 21,962,776
Property and equipment 1,724,483 1,056,642
Accumulated depreciation (837,936) (673,142)
---------------------- -----------------------
886,547 383,500
---------------------- -----------------------
Total assets $18,220,997 $22,346,276
====================== =======================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable 1,437,537 1,152,426
Accrued liabilities 4,306,319 2,368,333
Deferred revenues 249,480 431,310
---------------------- -----------------------
Total current liabilities 5,993,336 3,952,069
Commitments
Shareholders' equity:
Senior Convertible Preferred Stock, $.01 par value; 14,400 shares
authorized; 8,706 shares issued and outstanding 87 87
Series B Convertible Preferred Stock, $.01 par value; 5,000 shares
authorized; 3,677 and 3,417 shares issued and outstanding 37 34
Series C Convertible Preferred Stock, $.01 par value; 4,000 shares
authorized; 0 shares issued and outstanding - -
Series D Convertible Preferred Stock, $.01 par value; 1,500,000 shares
authorized; 0 shares issued and outstanding - -
Common stock, $.01 par value; 25,000,000 shares authorized; 10,389,174
and 10,263,961 issued and outstanding 103,892 102,639
Additional paid-in capital 73,634,079 72,364,612
Accumulated deficit (61,510,434) (54,073,165)
--------------------- -----------------------
Total shareholders' equity 12,227,661 18,394,207
--------------------- ---------------------
Total liabilities and shareholders' equity $18,220,997 $22,346,276
====================== =======================
Note: The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes.
3
STATEMENTS OF OPERATIONS
ORPHAN MEDICAL, INC.
(Unaudited)
For the Three Months Ended For the Nine Months Ended
---------------------------------------- -----------------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------------ ------------------ ------------------- -------------------
Revenues, net $4,155,061 $2,940,438 $11,337,338 $7,706,791
Cost of sales 608,626 409,132 1,661,672 1,133,378
------------------ ------------------ ------------------- -------------------
Gross profit 3,546,435 2,531,306 9,675,666 6,573,413
Operating expenses:
Research and development 2,253,710 1,464,063 4,667,520 3,828,950
Sales and marketing 3,538,698 1,508,553 7,262,439 4,142,850
General and administrative 1,922,701 1,455,201 4,484,066 3,838,198
------------------- ------------------- -------------------- --------------------
Total operating expenses 7,715,109 4,427,817 16,414,025 11,809,998
------------------ ------------------ ------------------- --------------------
Loss from operations (4,168,674) (1,896,511) (6,738,359) (5,236,585)
Other income:
Interest, net 64,443 63,230 215,113 303,541
------------------ ------------------ ------------------- -------------------
Net loss (4,104,231) (1,833,281) (6,523,246) (4,933,044)
Less: Preferred stock dividends 235,668 228,366 688,081 673,878
------------------- ------------------- -------------------- --------------------
Net loss attributable to common shareholders ($4,339,899) ($2,061,647) ($7,211,327) ($5,606,922)
=================== =================== ==================== ====================
Basic and diluted loss per common share ($0.42) ($0.24) ($0.70) ($0.66)
=================== =================== ==================== ====================
Weighted average number of shares outstanding 10,373,297 8,497,165 10,330,622 8,486,186
=================== =================== ==================== ====================
See accompanying notes
4
STATEMENTS OF CASH FLOWS
ORPHAN MEDICAL, INC.
(Unaudited)
For the Nine Months Ended
------------------------------------------
September 30, September 30,
2002 2001
------------------ --------------------
OPERATING ACTIVITIES
Net loss ($6,523,246) ($4,933,044)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 164,793 127,769
Stock option expense - 239,887
Changes in operating assets and liabilities:
Accounts payable and accrued expenses 2,041,268 (1,019,528)
Inventories (633,911) (61,535)
Accounts receivable and current assets (648,678) 139,763
-------------------- ---------------------
Net cash used in operating activities (5,599,774) (5,506,688)
INVESTING ACTIVITIES
Purchase of office equipment (667,841) (72,885)
Purchases of short-term investments - (3,498,592)
Maturities of short-term investments - 13,812,869
------------------ ---------------------
Net cash provided by (used in) investing activities (667,841) 10,241,392
FINANCING ACTIVITIES:
Employee stock purchase plan 30,974 78,943
Stock option exercise proceeds 334,906 121,674
Private common stock placement (8,101) -
Cash dividends (1,079) (203)
-------------------- ---------------------
Net cash provided by financing activities 356,700 200,414
-------------------- ---------------------
Increase in cash and cash equivalents (5,910,915) 4,935,118
-------------------- ---------------------
Cash and cash equivalents at beginning of Period 19,011,245 1,115,319
-------------------- ---------------------
Cash and cash equivalents at end of Period $13,100,330 $6,050,437
================== ====================
See accompanying notes
5
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
Orphan Medical, Inc. (the "Company") acquires, develops, and markets products of
high medical value intended to address inadequately treated or uncommon diseases
within selected therapeutic areas. A drug has high medical value if it offers a
major improvement in the safety or efficacy of patient treatment and has no
substantially equivalent substitute. The Company has seven products that have
been approved for marketing by the Food and Drug Administration (the "FDA"). The
Company expects to seek additional products for development.
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, these financial statements do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal, recurring accruals) considered necessary for fair presentation have
been included. Operating results for the nine-month period ended September 30,
2002 are not necessarily indicative of the results that may be expected for the
year ended December 31, 2002. For further information, refer to the audited
financial statements and accompanying notes contained in the Company's Annual
Report filed on Form 10-K for the year ended December 31, 2001.
2. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
3. REVENUE RECOGNITION
Sales for all products except Xyrem(R) (sodium oxybate) oral solution are
recognized at the time a product is shipped to the Company's customers and are
recorded net of reserves for estimated returns of outdated product and for
discounts for prompt payment. Sales of Xyrem are recognized at the time product
is shipped from the specialty pharmacy to the patient and are recorded net of
discounts for prompt payment. Except for Xyrem, the Company is obligated to
accept, for exchange, from all domestic customers products that have reached
their expiration date. The Company is not obligated to accept exchange of
outdated product from its international distribution partners. The Company
monitors the return of product and modifies its accrual for outdated product
returns as necessary. The Company has had two lots of Antizol(R) (fomepizole)
Injection expire this year, one in June and the other in August. A significant
number of the traypacks of Antizol that were sold in the second and third
quarter were sold to customers whose last purchase of the product was from one
of these two expired lots. Many of these customers have not indicated whether
these purchases were replacements for expired products or new purchases of
6
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
product. Since our returns policy for this drug allows for returns after
expiration, we have provided an additional sales reserve for the potential
return of product from these customers. The total reserve at September 30, 2002
for this product was $650,000. This reserve will be reduced as product is
returned from these customers or as the passage of time makes it less likely
that the product will ever be returned. Management bases these reserves on
historical experience and these estimates are subject to change.
Deferred revenue represents prepayment from customers for products not yet
shipped.
4. INVENTORIES
Inventories are valued at the lower of cost or market determined using the
first-in, first-out (FIFO) method. The Company's policy is to establish an
excess and obsolescence reserve for its products in excess of the expected
demand for such products.
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------------- -------------------
Raw materials and packaging $ 822,719 $ 981,583
Finished goods 1,053,312 260,537
-------------------- -------------------
$ 1,876,031 $ 1,242,120
==================== ===================
5. COMPREHENSIVE LOSS
The following summarizes the comprehensive loss for the nine month periods
ended:
SEPTEMBER 30,
2002 2001
-----------------------------------------
Net loss $(7,211,327) $(5,606,922)
Unrealized gain on securities - 12,342
-----------------------------------------
Total net comprehensive loss $(7,211,327) $(5,594,580)
=========================================
7
ORPHAN MEDICAL, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
6. COMMITMENTS
The Company has various commitments under agreements with outside consultants
and contractors to provide services relating to drug development, acquisition,
manufacturing and marketing. At September 30, 2002, the Company estimates that
it could incur approximately $6.2 million of additional expenditures in
subsequent periods under existing commitments. Commitments for research and
development expenditures will likely fluctuate from quarter to quarter and from
year to year depending on, among other factors, the timing of product
development and the progress of clinical development programs.
7. BORROWINGS
The Company has a commercial revolving line of credit with a bank, which expires
in June 2003. The maximum amount available to the Company under this arrangement
is $1.0 million, subject to certain limitations. The Company's indebtedness to
the bank may not exceed the lesser of (1) 75 percent of the Company's trade
accounts receivable that have been outstanding for 90 days or less or (2) $1.0
million in cash. Advances are charged a variable rate of interest equal to the
prime rate. Through September 30, 2002, the Company has not borrowed under this
arrangement.
8. RECLASSIFICATIONS
Certain prior period balances have been reclassified in order to conform with
the presentation for the period ended September 30, 2002. These
reclassifications have no impact on the net loss or shareholders' equity as
previously reported.
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CAUTIONARY STATEMENT
This Quarterly Report on Form 10-Q contains statements that are not descriptions
of historical facts. The words or phrases "will likely result", "look for", "may
result", "will continue", "is anticipated", "expect", "project", or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
may be forward-looking statements that are subject to risks and uncertainties.
Actual results could differ materially from those currently anticipated due to a
number of factors, including those identified in the section of this Quarterly
Report filed on Form 10-Q for the quarterly period ended September 30, 2002
titled "Risk Factors".
GENERAL
Since its inception, the activities of the Company have consisted primarily of
obtaining the rights for developing and marketing proposed pharmaceutical
products, managing the development of these products and preparing for and
initiating the commercial introduction of seven products. The Company operates
in a single business segment: pharmaceutical products. The Company has
experienced recurring losses from operations and has generated an accumulated
deficit through September 30, 2002 of $61.5 million. In addition, the Company
expects to incur additional losses from operations in fiscal years 2002 and
2003.
RECENT DEVELOPMENTS
On July 17, 2002 the Company announced that the U.S. Food and Drug
Administration (FDA) had approved Xyrem(R) (sodium oxybate) oral solution to
treat cataplexy, a sudden loss of muscle tone associated with narcolepsy. Xyrem
is the first approved medication indicated for the treatment of cataplexy.
Narcolepsy is a chronic neurological disorder affecting approximately 140,000
Americans. An estimated 60-90 percent of narcolepsy patients experience
cataplexy. Cataplexy, a sudden partial or total loss of muscle tone, is a
debilitating symptom of narcolepsy usually triggered by strong emotions such as
laughter, anger, or surprise. In its most severe form, cataplexy can cause a
person to collapse during waking hours.
Xyrem (sodium oxybate) is a central nervous system (CNS) depressant and should
not be used in conjunction with alcohol or other CNS depressants. Sodium oxybate
is GHB (gamma hydroxybutyrate), a known drug of abuse. The abuse of GHB has been
associated with a number of important CNS adverse clinical events, including
seizure, respiratory depression, and profound decreases in level of
consciousness, with instances of coma and death. Even at recommended doses, use
has been associated with confusion and other neuropsychiatric events. Reports of
respiratory difficulties occurred in clinical trials.
Distribution of Xyrem, a Schedule III controlled substance, is governed by the
FDA's Subpart H regulations. To comply with these regulations, the Company has
developed a rigorous system
9
that makes Xyrem available to patients from a single, specialty pharmacy. Both
physicians and patients must receive educational materials from the Company
before obtaining Xyrem. Orphan Medical has worked closely with the FDA, DEA and
law enforcement agencies to develop strict distribution and risk-management
controls designed to restrict access to Xyrem to the intended patient
population. The Company has hired and trained 35 additional sales employees who
will call on accredited sleep centers, and other physician specialists treating
those with cataplexy. The Company launched Xyrem on October 8, 2002.
The Company has worked with physicians, patients, and FDA for nearly eight years
to bring Xyrem to patients with cataplexy. The Company is continuing
investigations to fully understand the mechanism of action of Xyrem. The Company
also expects to complete by the end of 2003 the clinical portion of the Phase
III(b) trial designed to assess the efficacy of Xyrem in reducing excessive
daytime sleepiness as a supplement to stimulant therapy.
THREE MONTHS ENDED SEPTEMBER 30, 2002 VS. THREE MONTHS ENDED SEPTEMBER 30, 2001
Net loss applicable to common shareholders was $4.3 million for the three months
ended September 30, 2002 compared to $2.1 million for the three months ended
September 30, 2001. The increase in the loss results principally from an
increase in both sales and marketing expenses and general and administrative
expenses related to the launch planning and sales force recruiting for Xyrem(R)
(sodium oxybate) oral solution. In addition, development expenses were higher
due to increased activity on Phase III(b) trials. These increases were offset by
an increase in revenues of currently marketed products. The preferred stock
dividend increased in the third quarter of 2002 over the third quarter of 2001
due to issuance of additional preferred shares in August 2002 to pay dividends
on outstanding shares of Preferred Stock. This Preferred Stock dividend
increased the net loss applicable to common shareholders in the current quarter.
Net sales increased 41% to $4.2 million for the three months ended September 30,
2002 compared to $2.9 million the prior year. Sales of Antizol and Busulfex(R)
(busulfan) Injection were both significantly higher for the three months ended
September 30, 2002 as compared to the same period in the prior year. The
ordering trend of Antizol by new mid-and large-size hospitals continued to be
strong. The additional growth in the need for stocking is highlighted in two
recent publications concluding that Antizol is the preferred antidote for
methanol poisoning. Busulfex is being used more frequently in place of oral
busulfan in the conditioning regimen for hematopoietic stem cell transplantation
and in more research protocols because of its bioavailability and consistent
pharmacokinetic profile. Several of these research applications have been
highlighted in six recent publications. These publications illustrate the role
of Busulfex in advancing transplant research.
Gross profit margins decreased to 85% for the three months ended September 30,
2002 compared to 86% for the three months ended September 30, 2001. Cost of
sales as a percentage of net sales will fluctuate from quarter to quarter and
from year to year depending on, among other factors, demand for the Company's
products, new product introductions and the mix of approved products shipped.
10
Research and development expense increased 54% to $2.3 million for the three
months ended September 30, 2002 from $1.5 million for three months ended
September 30, 2001. The increase is the result of increased activity in ongoing
trials for Xyrem and other development activities related to Xyrem and other
products. The Phase III(b) trial for Xyrem, now underway, will increase research
and development spending in subsequent quarters as will additional trials and
data updates requested by the FDA. Clinical spending for these activities will
be dependent on a number of factors, including among others, the number of human
subjects screened and enrolled in the trials, and the number of active clinical
sites.
Sales and marketing expense increased 135% to $3.5 million for the three months
ended September 30, 2002 from $1.5 million for the three months ended September
30, 2001. This increase is largely attributable to pre-launch activities for
Xyrem, including the development of marketing materials and the recruitment and
training of a dedicated specialty sales force. With the commercial launch of
Xyrem in October 2002, sales and marketing expenses will increase in subsequent
quarters to support the sales and marketing efforts related to Xyrem.
General and administrative expense increased 32% to $1.9 million for the three
months ended September 30, 2002 from $1.5 million for the three months ended
September 30, 2001. The increase in general and administrative expenses is
related to building infrastructure to prepare for the launch of Xyrem. General
and administrative expenses are expected to increase somewhat above current
levels in the next few quarters as additional personnel are added and other
support projects are initiated.
Other income is the sum of interest income from investment activities less
interest expense from financing activities. Other income increased 2% to $64,443
for the three months ended September 30, 2002 from $63,230 in the same period in
2001. This increase is the result of higher cash balances invested in 2002
offset by lower yields on invested funds. Other income is expected to decline in
subsequent quarters as currently invested funds are used to fund Xyrem
development activities and other working capital requirements.
Preferred stock dividends relate to the Senior Convertible Preferred Stock that
was issued on July 23, 1998 and Series B Convertible Preferred Stock issued on
August 2, 1999. Both have dividend rates of 7.5%. Preferred stock dividends were
$0.2 million for the third quarter of both 2002 and 2001. Preferred stock
dividends, which commenced on February 1, 1999, are payable in arrears on August
1 and February 1 of each year. The Company has chosen to satisfy its dividend
payment obligation by issuing additional common and preferred stock, as
permitted by the terms of the Senior Convertible Preferred Stock and the Series
B Convertible Preferred Stock respectively. For the August 1, 2002 Senior
Preferred Stock dividend, the Company elected to issue 38,120 shares of common
stock to satisfy its obligation. The Company intends to continue to satisfy this
obligation in the future by issuing common stock. The Company is obligated to
pay the dividend for the Series B Convertible Preferred Stock in cash or through
the issuance of additional preferred shares, which will cause preferred stock
dividends to increase in subsequent quarters. The Company intends to continue to
satisfy the Series B Convertible Preferred Stock obligation by issuing
additional preferred shares.
11
NINE MONTHS ENDED SEPTEMBER 30, 2002 VS. NINE MONTHS ENDED SEPTEMBER 30, 2001
Net loss applicable to common shareholders was $7.2 million for the first nine
months of 2002 compared with a net loss of $5.6 million for the first nine
months of 2001. The increase in the loss results principally from an increase in
both sales and marketing expenses and general and administrative expenses
related to the launch planning and sales force recruiting for Xyrem. In
addition, development expenses were higher due to increased activity on Phase
III(b) trials. These increases were offset by an increase in revenues of
currently marketed products. The Preferred Stock dividend increased in the first
nine months of 2002 over the first nine months of 2001 due to the issuance of
additional preferred stock in the prior year to pay dividends. The preferred
stock dividend increased the net loss applicable to common shareholders in the
current period.
Net sales increased 47% to $11.3 million in the first nine months of 2002 from
$7.7 million in the first nine months of 2001. Sales of Antizol and Busulfex
were both significantly higher for the nine months ended September 30, 2002 as
compared to the same period in the prior year. The domestic ordering trend of
Antizol by new mid-and large-size hospitals continued to be strong. Busulfex is
being used more frequently in place of oral busulfan in the conditioning regimen
for hematopoietic stem cell transplantation and in more research protocols
because of its bioavailability and consistent pharmacokinetic profile. Several
of these research applications have been highlighted in six recent publications.
These publications illustrate the role of Busulfex in advancing transplant
research.
Gross profit margins were 85% for nine months ended September 30 2002 and 2001.
Cost of sales as a percentage of net sales will fluctuate from quarter to
quarter and from year to year depending on, among other factors, demand for the
Company's products, new product introductions and the mix of approved products
shipped.
Research and development expense increased 22% to $4.7 million for the nine
months ended September 30, 2002 compared to $3.8 million for the same period the
prior year. The increase is the result of increased activity in the third
quarter for ongoing trials for Xyrem and other development activities related to
Xyrem and other products. The Phase III(b) trial for Xyrem now underway will
increase research and development spending in subsequent quarters as will
additional trials and data updates requested by the FDA and other regulatory
agencies world wide. Clinical spending for these activities will be dependent on
a number of factors, including among others, the number of human subjects
screened and enrolled in the trials, and the number of active clinical sites.
Sales and marketing expense increased 75% to $7.3 million for the nine months
ended September 30, 2002 from $4.1 million for the nine months ended September
30, 2001. This increase is largely attributable to pre-launch activities for
Xyrem, including the development of marketing materials and the recruitment and
training of a dedicated specialty sales force and was incurred in the third
quarter subsequent to the approval letter of July 17, 2002. With the commercial
launch of Xyrem in October 2002, sales and marketing expenses will increase in
subsequent quarters to support the sales and marketing efforts related to Xyrem.
12
General and administrative expense increased 17% to $4.5 million for the nine
months ended September 30, 2002 from $3.8 million for the same period in the
prior year. This increase related to building infrastructure, including the
addition of staff to prepare for the launch of Xyrem. General and administrative
expenses are expected to increase somewhat above current levels in the next few
quarters as additional personnel are added and other support projects are
initiated.
Other income is the sum of interest income from investment activities less
interest expense from financing activities. Other income decreased 29% to $0.2
million in the first nine months of 2002 from $0.3 million in the first nine
months of 2001. This decrease is the result of cash balances being used to fund
development and working capital activities of the Company. In addition, interest
rates on invested funds have been declining, reducing the yields received. Other
income is expected to decline in subsequent quarters as currently invested funds
are used to fund Xyrem development activities, and for working capital
requirements.
Preferred stock dividends relate to shares of Senior Convertible Preferred Stock
that were issued on July 23, 1998 and shares of Series B Convertible Preferred
Stock issued on August 2, 1999. Both have dividend rates of 7.5%. Preferred
stock dividends were $0.7 million for the first nine months of 2002 and 2001.
Preferred stock dividends, which commenced on February 1, 1999, are payable in
arrears on August 1 and February 1 of each year. The Company has chosen to
satisfy its dividend payment obligation by issuing additional shares of common
or preferred stock, as permitted by the Company's Certificate of Incorporation.
For the February 1, 2002 and the August 1, 2002 Senior Preferred Stock
dividends, the Company elected to issue a total of 62,034 shares of common stock
to satisfy its dividend obligations. The Company intends to continue to satisfy
its dividend obligations in the future by issuing common stock. The Company is
obligated to pay the dividend for the Series B Convertible Preferred Stock in
cash or through the issuance of additional Preferred Stock, which will cause
Preferred Stock dividends to increase in subsequent quarters. For the February
1, 2002 and the August 1, 2002 Series B Convertible Preferred Stock dividends,
the Company issued 260 new shares of Series B Convertible Preferred Stock to
satisfy its obligation. The Company also intends to satisfy its future Series B
Convertible Preferred Stock obligation by issuing additional Preferred Shares.
LIQUIDITY AND CAPITAL RESOURCES
Since July 2, 1994, the effective date the Company was spun-off from Chronimed,
it has financed its operations principally from net proceeds from several public
and private financings, interest income and product sales. In December 2001, the
Company completed a private placement of 1.707 million shares of newly issued
common stock, resulting in net proceeds of $13.0 million. The various public and
private placement transactions since inception resulted in aggregate net
proceeds, after commissions and expenses, of $60.5 million.
Net working capital (current assets less current liabilities) decreased from
$18.0 million at December 31, 2001 to $11.3 million at September 30, 2002. Cash
and cash equivalents, and available-for-sale securities decreased from $19.0
million at December 31, 2001 to $13.1 million at September 30, 2002. The Company
continues to invest its excess cash in interest bearing, investment grade
securities. The Company has a $1.0 million commercial revolving line of credit
13
with a bank, expiring in June 2003. To date, the Company has not borrowed under
the credit arrangement.
The Company's commitments for outside development spending were $6.2 million and
$3.0 million at September 30, 2002 and December 31, 2001 respectively. If
additional products are licensed for development, these expenditures and
commitments could increase significantly.
Management believes the Company's current cash availability and anticipated
operating cash flows from product sales will be sufficient to fund its
operations at least through September 30, 2003.
For continued listing on the NASDAQ National Market, a company must satisfy a
number of requirements, which in the Company's case include either: (1) net
tangible assets in excess of $4.0 million or (2) a market capitalization of at
least $50.0 million. Net tangible assets are defined as total assets less the
sum of total liabilities and intangible assets. The Company met both of the
thresholds at September 30, 2002. The Company's net tangible assets at September
30, 2002 equaled approximately $12.2 million and the Company's market
capitalization was approximately $81.0 million (based on the last sale price of
$7.80 and 10,389,174 shares outstanding as of September 30, 2002). Although the
Company does not expect to be profitable in 2002, the Company nevertheless
expects to continue to meet the net tangible asset requirement for listing on
the NASDAQ National Market. However, there can be no assurance that the Company
will continue to have adequate capital to meet the net tangible asset
requirement through the year 2002 and thereafter. The NASDAQ National Market
issued new listing qualifications, which will become effective November 2002,
and which will replace the net asset requirement with a minimum net equity
requirement of $10.0 million. At September 30, 2002, the Company met both of the
new listing requirements. However, there can be no assurance that the Company
will continue to have adequate capital to meet the net tangible asset
requirement through the year 2002 and thereafter.
In connection with the 1998 and 1999 private placements of convertible preferred
stock, the Company agreed to certain restrictions and covenants, which could
limit its ability to obtain additional financing. Even without these
restrictions, the Company can make no assurances that additional financing
opportunities will be available or, if available, on acceptable terms.
14
GEOGRAPHIC SALES INFORMATION
The Company monitors sales in two geographic segments, domestic and
international. The Company has no assets outside of the United States. The
following is a summary of net sales by geographic segment for the quarters and
nine months ended September 30, 2002 and 2001, respectively.
For the Three Months Ended For the Nine Months Ended
------------------------------------- -------------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------------ ------------------ ----------------- ------------------
Domestic $ 3,260,425 $ 2,609,827 $ 8,512,528 $ 6,381,758
International 894,636 330,611 2,824,810 1,325,033
----------------------------------------------------------------------------
Total $ 4,155,061 $ 2,940,438 $ 11,337,338 $ 7,706,791
============================================================================
RISK FACTORS
An investment in our common stock involves a number of risks, including among
others, risks associated with companies that operate in the pharmaceutical
industry. These risks are substantial and inherent in our operations and
industry. Any investor or potential investors should carefully consider the
following information about these risks before buying shares of common stock.
WE HAVE A HISTORY OF LOSSES.
We have been unprofitable since our inception in 1994. We expect operating
losses in 2002 because anticipated gross profits from product revenues will not
offset our operating expenses and additional spending to continue drug
development activities. Our ability to achieve profitability in future years
will depend on, among other factors, market acceptance of, and demand for,
Xyrem, as well as the development, regulatory approval, and market demand for
our other Food and Drug Administration ("FDA") approved products. We cannot
assure you that we will ever generate sufficient product revenues to achieve
profitability.
THE MARKET PRICE OF OUR COMMON STOCK COULD FLUCTUATE IN RESPONSE TO QUARTERLY
OPERATING RESULTS AND OTHER FACTORS.
The market price of our common stock could fluctuate significantly in response
to a number of factors, including but not limited to:
- -our quarterly financial performance;
- -announcements by us or our competitors of new product developments or clinical
testing results;
- -governmental approvals, refusals to approve, regulations or actions;
- -developments or disputes relating to patents or proprietary rights;
- -public concern over the safety of therapies; and
15
- -small float or number of shares of our common stock available for sale and
trade.
The market value and liquidity of the public float for our common stock could be
adversely affected in the event we no longer meet the Nasdaq's requirements for
continued listing on the National Market. For continued listing on the Nasdaq
National Market, a company must satisfy a number of requirements, which in our
case includes either: (1) net tangible assets in excess of $4.0 million as
reported on Form 10-Q or Form 10-K or (2) a market capitalization of at least
$50.0 million. Net tangible assets are defined as total assets less the sum of
total liabilities and intangible assets. Market capitalization is defined as
total outstanding shares multiplied by the last sales price quoted by Nasdaq.
Although we currently meet the requirements for listing on the Nasdaq National
Market, we cannot assure you that we will continue to meet these requirements.
The Nasdaq National Market has issued new listing qualifications which will
become effective November 2002, and which will replace the net tangible asset
requirement with minimum net equity requirements of $10.0 million. At September
30, 2002, we met the new listing qualifications with respect to both of these
requirements. We cannot assure you that we will continue to meet the new listing
qualification requirements.
The market price of our common stock may also fluctuate significantly in
response to other factors over which we have no control and that may not be
directly related to us. Fluctuations or decreases in the trading price of our
common stock may adversely affect your ability to trade your shares and you may
lose all or a part of your investment. In addition, fluctuations and decreases
in our stock price could adversely impact our business and our ability to raise
capital through additional equity financings.
THERE IS A LIMITED MARKET FOR OUR PRODUCTS.
While we will seek to obtain and market products that address diseases with
prevalence larger than orphan diseases (200,000 or fewer patients in the United
States), all our current products and many of our future products will address
orphan diseases. Most orphan drugs have a potential United States market of less
than $25 million annually and many address annual markets of less than $1
million. We cannot assure you that sales of our products will be adequate to
make us profitable even if the products are accepted by medical specialists and
used by patients.
WE RELY ON THE LIMITED PROTECTION OF THE ORPHAN DRUG ACT.
UNITED STATES
Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs
intended to treat a "rare disease or condition." The Orphan Drug Act generally
defines a "rare disease or condition" as one that affects populations of fewer
than 200,000 people in the United States. The Orphan Drug Act provides us with
certain limited protections for our products.
The first step in obtaining the limited protection under the Orphan Drug Act is
obtaining "orphan drug designation" for a product from the FDA. After the FDA
grants orphan drug designation, it publishes the generic identity of the
therapeutic agent and the potential orphan use specified in
16
the request. Orphan drug designation does not constitute FDA approval, nor does
it provide any advantage in, or shorten the duration of, the regulatory approval
process.
The second step in obtaining limited protection under the Orphan Drug Act for a
specific product is acquiring the FDA's recognition of "orphan drug status."
This step involves submission of a New Drug Application ("NDA") to the FDA
containing all clinical study results, safety and manufacturing information and
requesting approval to market a drug for the designated indication. The FDA will
grant orphan drug status to the first company to receive approval of an NDA for
the designated indication. Orphan drug status gives a company the exclusive
right to market the approved product in the United States for that specific
approved indication for a period of seven years, subject to certain limitations.
Obtaining orphan drug status for a particular product may not, however, prevent
another company from developing or marketing a similar drug having a different
formulation or composition for the same or different indication. In addition,
orphan drug status does not provide any marketing exclusivity in foreign
markets. While obtaining FDA approval to market a product with orphan drug
status can be advantageous, we cannot assure you that the scope of protection or
the level of marketing exclusivity will remain in effect in the future or will
have meaningful or material value to us. Although certain foreign countries
provide marketing for orphan drugs, we cannot assure you that such benefits can
be obtained or, if obtained, will be of material value to us.
We have obtained orphan drug status for Antizol, Elliotts B Solution, Cystadane,
Sucraid, Busulfex, and Xyrem. Although we are aware that the FDA has granted
Teva (formerly Biocraft) orphan drug designation for the use of sodium oxybate
to treat the symptoms of narcolepsy, we have obtained the exclusive right to use
Teva's data for one controlled study included in our NDA submission. While we
are not aware of any activities to develop sodium oxybate by any other U.S.
company, we cannot assure you that such activities are not being conducted. We
also cannot assure you that the FDA will not grant orphan drug designation and
orphan drug status to other competing products subsequent to approval of our NDA
for Xyrem.
Even if the FDA approves an NDA for a drug with an orphan drug designation, the
FDA may still approve the same drug for a different indication, or a molecular
variation of the same drug for the same indication. We are aware that the FDA
has granted Sparta Pharmaceutical, which was acquired by SuperGen Inc., orphan
drug designation for an intravenous busulfan with an indication closely related
to the indication for our product Busulfex. If the FDA approves an NDA for
SuperGen's product for a different indication, SuperGen could seek orphan drug
status for that product, which may compete with Busulfex. In addition, the FDA
does not restrict doctors from prescribing an approved drug for uses not
approved by the FDA. Thus, a doctor could prescribe another company's drug for
indications for which our product has received FDA approval and orphan drug
status. Significant "off label" use, that is, prescribing approved drugs for
unapproved uses, could adversely affect the marketing potential of any of our
products that have received orphan drug status and NDA approval by the FDA
should a competitive product for a different indication be approved by the FDA.
The possible amendment of the Orphan Drug Act by Congress has been the subject
of congressional discussion from time to time over the last ten years. Although
Congress has made
17
no significant changes to the Orphan Drug Act for a number of years, members of
Congress have from time to time proposed legislation that would limit the
application of the Orphan Drug Act. We cannot assure you that the Orphan Drug
Act will remain in effect or that it will remain in effect in its current form.
The precise scope of protection that orphan drug designation and marketing
approval may afford in the future is unknown. We cannot assure you that the
current level of exclusivity will remain in effect.
EUROPE
The European orphan drug act provides for up to ten years of market exclusivity
for a pharmaceutical product that meets the requirement of the European orphan
drug act. For a pharmaceutical product to qualify under the act, the prevalence
(or incidence), of the condition being treated must not exceed five patients per
10,000 population. Our European partners submitted and obtained orphan drug
designation under the act for Busulfex and Cystadane, and in May 2001 we were
granted orphan drug designation under the act for Antizol for use in methanol
poisonings. We submitted a request for orphan drug designation for Xyrem in the
European Union in 2002 and expect a decision by the end of the year. While
Antizol, Busulfex and Cystadane are currently designated as orphan drugs, we
cannot assure you that these products will continue to qualify for orphan drug
protection in Europe or that we will be able to obtain orphan drug protection in
Europe for other or future products. We also cannot provide you any assurance
that another company will not obtain an approval, which could block us from
marketing our products in Europe.
THE SALE OF OUR PRODUCTS IS DEPENDENT UPON GOVERNMENTAL APPROVAL.
Government regulation in the United States and abroad is a significant factor in
the testing, production and marketing of our products. Each product must undergo
an extensive regulatory review process conducted by FDA and by comparable
regulatory agencies in other countries. We cannot market any pharmaceutical
product we develop or license as a prescription product in any jurisdiction,
including foreign countries, without regulatory approval. The approval process
can take many years and requires the expenditure of substantial resources.
We depend on external laboratories and medical institutions to conduct our
pre-clinical and clinical analytical testing in compliance with clinical and
laboratory practices established by the FDA. The data obtained from pre-clinical
and clinical testing is subject to varying interpretations that could delay,
limit or prevent regulatory approval. In addition, changes in FDA or any foreign
regulatory authority policy for drug approval during the period of development
and in the requirements for regulatory review of each submitted NDA could result
in additional delays or outright rejection.
We cannot assure you that the FDA or any foreign regulatory authority will
approve in a timely manner, if at all, any product we develop. Generally, the
FDA and foreign regulatory authorities approve only a very small percentage of
newly discovered pharmaceutical compounds that enter pre-clinical development.
Moreover, even if the FDA approves a product, it may place commercially
unacceptable limitations on the uses, or "indications," for which a product may
be
18
marketed. This would result in additional cost and delay for further studies to
provide additional data on safety or effectiveness.
GOVERNMENTAL APPROVAL OF OUR PRODUCTS DOES NOT GUARANTEE FINANCIAL SUCCESS.
Seven of our products have been approved for marketing by regulatory authorities
in the United States or elsewhere. Although we recently obtained FDA approval to
market Xyrem, we cannot assure you that Xyrem or our other products will be
commercially successful or achieve the expected financial results. We may
encounter unanticipated problems relating to the development, manufacturing,
distribution and marketing of our products. Some of these problems may be beyond
our financial and technical capacity to solve. The failure to adequately address
any such problems could have a material adverse effect on our business and our
prospects. In addition, the efforts of government entities and third party
payors to contain or reduce the costs of health care may adversely affect our
sales and limit the commercial success of our products.
We cannot completely insulate our drug development portfolio from the
possibility of clinical or commercial failures. Some products that we have
selected for development may not produce the results expected during clinical
trials or receive FDA approval. Drugs approved by the FDA may not generate an
acceptable level of product sales. We have discontinued the development of
eleven products from our portfolio since inception, primarily to focus our
development efforts and resources on our products that fit within our three
therapeutic areas: Antidotes; Oncology Support; and Sleep Disorders or for which
we believe there is an opportunity for growth or profitability. We evaluate new
opportunities in these and other therapeutic areas that we believe have
opportunities for growth. We cannot assure you that any of these discontinued
products currently, or may in the future, have any value. We cannot assure you
that we will continue development of our current or any proposed products, or
that we will continue marketing all of our FDA approved products.
SIGNIFICANT GOVERNMENT REGULATION CONTINUES ONCE A PRODUCT IS APPROVED FOR SALE.
After the FDA approves a drug, the FDA's Advertising and Communication division
must accept the drug's marketing claims, which are the basis for the drug's
advertising and promotional programs. We cannot assure you that the FDA will
approve our proposed marketing claims. Failure to obtain approval of our
proposed marketing claims could have a material adverse effect on our business
and prospects.
The FDA requires that we conduct "post-marketing adverse event surveillance
programs" to monitor any side effects that occur after any of our drug products
are approved for marketing. If the surveillance program indicates previously
unrecognized unsafe side effects, the FDA may recall the product, and suspend or
terminate our authorization to market the product. The FDA also regulates the
manufacturing process for an approved drug. The FDA may impose restrictions
19
or sanctions upon the subsequent discovery of previously unknown problems with a
product or manufacturer. One possible sanction is requiring the withdrawal of
such product from the market. The FDA must approve any change in manufacturer as
well as most changes in the manufacturing process prior to implementation.
Obtaining the FDA's approval for a change in manufacturing procedures or change
in manufacturers is a lengthy process and could cause production delays and loss
of sales, which would have a material adverse effect on our business and our
prospects. To date, none of our products have been subject to an FDA recall. We
cannot assure you that our products will not be subject to an FDA recall in the
future.
Certain foreign countries regulate the sales price of a product after marketing
approval is granted. We cannot assure you that we will be able to sell our
products at satisfactory prices in foreign markets even if foreign regulatory
authorities grant marketing approval.
If the FDA approves an NDA, the new product may be marketed for the applications
or treatments that have been approved by the FDA. The claims with which a
product can be marketed are also subject to review and approval by the Division
of Drug Marketing, Advertising and Communications ("DDMAC"), the FDA's marketing
surveillance department within the Center for Drugs. The FDA often clears a
product for marketing that requires post-marketing surveillance, or Phase IV
testing, to be conducted. The method and system of a drug's distribution can
also be controlled by the FDA if approved under Subpart H regulations.
WE DEPEND ON OTHERS FOR PRODUCT DEVELOPMENT OPPORTUNITIES.
We engage only in limited research to identify new pharmaceutical compounds. To
build our product portfolio, we utilize a license and acquisition strategy. This
strategy for growth requires us to identify and acquire pharmaceutical products
targeted at niche markets within selected therapeutic areas. These products
usually require further development and approval by regulatory bodies before
they can be marketed. We cannot assure you that any such products can or will be
successfully developed, approved or marketed. We rely upon the willingness of
others to sell or license pharmaceutical product opportunities to us. Other
companies, including those with substantially greater resources, compete with us
to acquire such products. We cannot assure you that we will be able to acquire
rights to additional products on acceptable terms, if at all. Our failure to
license or acquire new pharmaceutical products, or to promote and market
products successfully, would have a material adverse effect on our business and
our prospects.
We have contractual development rights to certain compounds through various
license agreements. Generally, the licensor can unilaterally terminate these
agreements for several reasons, including, but not limited to the following
reasons:
- - if we breach the contract;
- - if we become insolvent or bankrupt;
- - if we do not apply specified minimum resources and efforts to develop the
compound under license; or
- - if we do not achieve certain minimum royalty payments, or in some cases,
minimum sales levels.
We cannot assure you that we will meet, or continue to meet, the requirements
specified in our
20
current or any future license agreements. We cannot assure you that if any
agreement is terminated, we will be able to enter into a similar agreement on
terms as favorable as those contained in our existing license agreement.
WE DEPEND ON OTHERS TO MANUFACTURE AND SUPPLY THE PRODUCTS WE MARKET.
We do not have, and do not intend to establish, any internal product testing,
synthesis of bulk drug substance, or manufacturing capability for drug product.
Accordingly, we depend on others to supply and manufacture the components
incorporated into all of our finished products. The inability to secure
contracts for these components on acceptable terms could adversely affect our
ability to develop and market our products. Failure by parties with whom we
contract to adequately perform their responsibilities may delay our submission
of products for regulatory approval, impair our ability to deliver our products
on a timely basis, or otherwise adversely affect our business and our prospects.
The loss of either a drug supplier or drug product manufacturer would require us
to obtain regulatory clearance in the form of a "pre-approval submission" and
incur validation and other costs associated with the transfer of the drug supply
or manufacturing process to a new supplier or manufacturer. We believe that it
could take as long as one year for the FDA to approve such a submission. Because
our products are targeted to relatively small markets and our manufacturing
production runs are small by industry standards, we have not undertaken to
certify and maintain secondary sources of supply for drug substances or backup
drug manufacturers for some products. If we lose either a supplier or a product
manufacturer, we could run out of salable product to meet market demands or
investigational product for use in clinical trials while we locate and then wait
for FDA approval of a new drug supplier or manufacturer. We cannot assure you
that any change in drug supplier or manufacturer or the transfer of a drug
manufacturing processes to another third party would be approved by the FDA, or
approved in a timely manner. The loss of, or change in, drug supplier or a drug
manufacturer could have a material adverse effect on our business and prospects.
BULK DRUG SUPPLY
Bulk drug substance is the active chemical compound used in the manufacture of
our drug products. We depend substantially on a single supplier for the supply
of bulk drug substance used in Busulfex, Antizol, and Antizol-Vet. If we were to
lose this company as a supplier, we would be required to identify a new supplier
for the bulk drug substance used in products that provided approximately 88% of
our total revenues in 2001 and 2000, and which are expected to account for
approximately 76% of our revenues in 2002. We depend substantially on a
different supplier for the supply of bulk drug substance used in Xyrem. If we
were to lose this company as a supplier, we would be required to identify a new
supplier. We also cannot assure you that our bulk drug supply arrangements with
our current suppliers, or any other future such supplier, might not change in
the future. We cannot assure you that any change would not adversely affect
production of Busulfex, Antizol, Antizol-Vet, Xyrem, or any other drug the
Company might attempt to develop or market.
21
DRUG PRODUCT MANUFACTURE
From bulk drug substance, drug product manufacturers formulate a finished drug
product and package the product for sale or for use in clinical trials. We
depend substantially on a single supplier for drug product manufacturing of
Busulfex, Antizol, and Antizol-Vet and a different supplier has been authorized
to manufacture Xyrem. If we were to lose either of these companies as a
manufacturer, we would be required to identify a new manufacturer for drug
products that provided approximately 88% of our total revenues in 2001 and 2000,
and which are expected to account for approximately 89% of our total revenues in
2002. We cannot assure you that our drug product manufacturing arrangements with
either or both of these suppliers will not change or that the manufacturing
services will continue to be available on terms satisfactory to us. Any change
in our manufacturing agreements could adversely affect production of Busulfex,
Antizol, Antizol-Vet or Xyrem, or any other drug that we might attempt to
develop or market, which could have a material adverse effect on our business
and prospects.
WE CANNOT CONTROL OUR CONTRACTORS' COMPLIANCE WITH APPLICABLE REGULATIONS.
The FDA defines and regulates good manufacturing practices to which bulk drug
suppliers and drug product manufacturers are subject. The Drug Enforcement
Agency (DEA) defines and regulates the handling and reporting requirements for
certain drugs which have abuse potential, known as "scheduled drugs." Foreign
regulatory authorities prescribe similar rules and regulations. Our supply and
manufacturing contractors must comply with these regulatory prescriptions.
Failure by our contractors to comply with FDA or DEA requirements or applicable
foreign requirements could significantly delay our ability to commercialize or
continue to market our products. Either result could have a material adverse
effect on our business and prospects. Our contractors failure to comply with
good manufacturing practices or other legal requirements could also result in
seizure of violative products, injunctive actions brought by the federal
government or criminal and civil liability for Orphan, our officers, or our
employees. We cannot assure you that we will be able to maintain relationships
either domestically or abroad with contractors whose facilities and procedures
comply with, or will continue to comply with, FDA or DEA requirements or
applicable foreign requirements.
WE DEPEND UPON OTHERS FOR DISTRIBUTION OF OUR PRODUCTS.
We have an agreement with a specialty pharmacy to distribute Xyrem. Xyrem is
classified as a Schedule III controlled substance, and distribution will be
strictly controlled. The specialty pharmacy will be the only source through
which Xyrem can be obtained. Distribution will be governed by the FDA's Subpart
H regulations and will fully comply with the risk-management controls jointly
developed by Orphan Medical, the Drug Enforcement Agency and law enforcement
agencies. Every shipment of Xyrem will be subject to stringent safeguards to
ensure it reaches only individuals for whom it has been legitimately prescribed.
We have an agreement with a distribution contractor to provide integrated
distribution and
22
operations services to support transactions between us and our wholesalers,
specialty distributors, and direct customers. This contractor also provides
reimbursement management, patient assistance and information hotline services
and specialty distribution and marketing services to physician practices with
respect to our products. The contractor currently distributes Busulfex, Elliotts
B Solution, Antizol, Antizol-Vet, and Sucraid. The contractor may also
distribute future products should those products receive marketing clearance
from the FDA. We are substantially dependent on this contractor's ability to
successfully distribute Busulfex, Elliotts B Solution, Antizol, Antizol-Vet, and
Sucraid and other potential products.
A mail order pharmacy is the principal distributor, on a non-exclusive basis, in
the United States for Cystadane. The pharmacy distributes this product directly
to patients through the mail. We are substantially dependent on this pharmacy's
ability to successfully distribute Cystadane directly to patients in the United
States.
We cannot assure you that our distribution arrangements with these three
entities or other companies would be available, or continue to be available to
us on commercially acceptable terms. The loss of a distributor or failure to
renew agreements with an existing distributor would have a material adverse
effect on our business and prospects.
WE DEPEND ON FOREIGN COMPANIES TO SELL OUR PRODUCTS OUTSIDE OF THE UNITED STATES
AND OUR INABILITY TO ESTABLISH AND MAINTAIN MARKETING ALLIANCES WITH FOREIGN
COMPANIES COULD ADVERSELY AFFECT OUR BUSINESS.
Our strategy to sell our products outside of the United States is to license
foreign marketing and distribution rights to a foreign company after a NDA is
submitted to, or approved by, the FDA in the United States. We consider Europe,
Asia and Canada our most attractive foreign markets. Our current foreign
developments are:
- - Europe. We have licensed the marketing and distribution rights for Busulfex,
Cystadane and Sucraid in Europe. If our licensees' registration and distribution
efforts are not successful, it may be difficult for us to contract with other
distributors in Europe for these products. Distribution of all products except
Antizol is limited to "named patient" or "emergency use" basis until full
regulatory approval is obtained. Antizol has been approved for use in the United
Kingdom but is limited to "named patient" or "emergency use." Emergency use
distribution of our products is expected to result in limited revenues for us.
- - Asia. We have licensed marketing and distribution rights for Busulfex in
Japan, the Peoples Republic of China, Taiwan and South Korea. Use and
distribution of all products in these countries, except South Korea, is limited
to clinical trials until full regulatory approval is obtained. Revenues prior to
full approval are not expected to be material. Full regulatory approval for
marketing of these products in South Korea was obtained in late 2001. We do not
expect to generate material revenues from our South Korean marketing and
distribution activities.
- - Canada. We have licensed marketing and distribution rights for Antizol and
Cystadane. We do not expect to generate material revenues from these marketing
and distribution activities.
- - Australia and New Zealand. We have licensed marketing and distribution rights
for Cystadane
23
and Sucraid in Australia and New Zealand. We do not expect to generate material
revenues from these marketing and distribution activities.
- - Central America. We have licensed marketing and distribution rights for
Elliotts B Solution in Central America. We do not expect to generate material
revenues from these marketing and distribution activities.
- - Israel. We have licensed marketing and distribution rights for Busulfex,
Cystadane, and Sucraid in Israel. Full regulatory approval for Busulfex and
Cystadane was obtained in February 2000. We do not expect to generate material
revenues from these marketing and distribution activities.
- - Turkey. We have licensed marketing and distribution rights for Busulfex in
Turkey. We do not expect to generate material revenues from these marketing and
distribution activities.
We depend on our foreign licensees for the regulatory registration of our
products in foreign countries. We cannot assure you that our licensees will
obtain such registration. In addition, we cannot assure you that we will be able
to negotiate commercially acceptable license agreements for our other products
or in additional foreign countries. Furthermore, we cannot assure you that our
foreign licensees will be successful in marketing and selling our products in
their respective territories.
OUR PRODUCTS MIGHT BE RECALLED.
A product can be recalled at our discretion or at the discretion of the FDA, the
U.S. Federal Trade Commission, a foreign regulatory authority, or other
government agencies having regulatory authority for marketed products. A recall
may occur due to disputed labeling claims, manufacturing issues, quality
defects, or other reasons. We cannot assure you that a product recall will not
occur. We do not carry any insurance to cover the risk of a potential product
recall. Any product recall could have a material adverse effect on our business
and prospects. To date, none of our products have been subject to a recall. We
cannot assure you that our products will not be subject to a recall in the
future.
THE PRICES WE CHARGE FOR OUR PRODUCTS ARE SUBJECT TO GOVERNMENTAL REGULATION,
WHICH COULD ADVERSELY AFFECT OUR ABILITY TO RECOVER OUR PRODUCT DEVELOPMENT
COSTS AND OUR FINANCIAL PERFORMANCE.
The flexibility of prices that we can charge for our products depends on
government regulation, both in the United States and abroad, and on other third
parties. One important factor is the extent to which reimbursement for our
products will be available to patients from government health administration
authorities, private health insurers and other third-party payors. Government
officials and private health insurers are increasingly challenging the price of
medical products and services. We cannot predict the level of pricing
flexibility we will have with respect to our products or whether we, or users of
our products, will be reimbursed for newly approved health care products.
In the United States, we expect continuing federal and state proposals to
implement government control of the pricing and profitability of prescription
pharmaceuticals. Cost controls could decrease, or limit, the price we receive
for our current and future products. We may not be able to
24
recover our development costs, which could be substantial. We may not be able to
realize an appropriate profit margin. This could have a material adverse effect
on our business and prospects. Furthermore, federal and state regulations govern
or influence reimbursement of health care providers for medical treatment of
certain patients. We cannot assure you that actions taken by federal or state
governments, if any, with regard to health care reform will not have a material
adverse effect on our business and prospects.
Certain private health insurers and third-party payors may attempt to control
costs further by selecting exclusive providers of pharmaceuticals. If such
arrangements are made with our competitors, these insurers and third-party
payors would not reimburse patients who purchase our competing products. This
would diminish the market for our products and could have a material adverse
effect on our business and prospects.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY INFORMATION, WHICH COULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE IN THE PHARMACEUTICAL INDUSTRY.
The pharmaceutical industry and the investment community place considerable
importance and value on obtaining patent and trade secret protection for new
technologies, products and processes. The patent position of pharmaceutical
firms is often highly uncertain and generally involves complex legal, technical
and factual questions. Our success depends on several issues, including, but not
limited to our ability:
- - to obtain, and enforce proprietary protection for our products under United
States and foreign patent laws and other intellectual property laws;
- - to preserve the confidentiality of our trade secrets; and
- - to operate without infringing the proprietary rights of third parties.
We evaluate the desirability of seeking patent or other forms of protection for
our products in foreign markets based on the expected costs and relative
benefits of attaining such protection. We cannot assure you that any patents
will be issued from any applications or that any patents issued to us will
afford us adequate protection or competitive advantage. Also, we cannot assure
you that any issued patents will not be challenged, invalidated, infringed or
circumvented. Parties not affiliated with us have obtained or may obtain United
States or foreign patents, or possess or may possess proprietary rights,
relating to our products. We cannot assure you that patents now in existence or
later issued to others will not adversely affect the development or
commercialization of our products.
We believe that the active ingredients or compounds in our FDA approved and
proposed products, Cystadane, Elliotts B Solution, Antizol, Antizol-Vet, Xyrem
and Sucraid, are in the public domain and are not currently subject to patent
protection in the United States. However, we have filed a patent application
with respect to our formulation of Xyrem oral solution. United States patents
issued to The University of Texas System and The University of
Houston-University Park, the group from whom we license the formulation for
Busulfex, cover our formulation and use of Busulfex. We could, however, incur
substantial costs asserting any infringement claims that we may have against
others.
We seek to protect our proprietary information and technology, in part, through
confidentiality
25
agreements and inventors' rights agreements with our employees. We cannot assure
you that these agreements will not be breached, that we will have adequate
remedies for any breach, or that our trade secrets will not otherwise be
disclosed to or discovered by our competitors. We also cannot assure you that
our planned activities will not infringe patents owned by others. We could incur
substantial costs in defending infringement suits brought against us. We also
could incur substantial costs in connection with any suits relating to matters
for which we have agreed to indemnify our licensors or distributors. An adverse
outcome in any such litigation could have a material adverse effect on our
business and prospects. In addition, we often must obtain licenses under patents
or other proprietary rights of third parties. We cannot assure you that we can
obtain any such licenses on acceptable terms, if at all. If we cannot obtain
required licenses on acceptable terms, we could encounter substantial
difficulties in developing, manufacturing or marketing one or more of our
products.
WE FACE INTENSE COMPETITION IN THE PHARMACEUTICAL INDUSTRY.
Competition in the pharmaceutical industry is intense. Potential competitors in
the United States are numerous and include pharmaceutical, chemical and
biotechnology companies. Many of these companies have substantially greater
capital resources, marketing experience, research and development staffs and
facilities than we do. We seek to limit potential sources of competition by
developing products that are eligible for orphan drug designation and NDA
approval or other forms of protection. We cannot assure you, however, that our
competitors will not succeed in developing similar technologies and products
more rapidly than we can. Similarly, we cannot assure you that these competing
technologies and products will not be more effective than any of those that we
have developed or are currently developing.
IF WE ARE UNABLE TO RESPOND TO RAPIDLY CHANGING TECHNOLOGIES AND OTHER
DEVELOPMENTS, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The pharmaceutical industry has experienced rapid and significant technological
change as well as structural changes, such as those brought about by changes in
heath care delivery or in product distribution. We expect that pharmaceutical
technology will continue to develop and change rapidly, and our future success
will depend, in large part, on our ability to develop and maintain a competitive
position. Technological development by others may result in our products
becoming obsolete before they are marketed or before we recover a significant
portion of the development and commercialization expenses incurred with respect
to such products. In addition, alternative therapies, new medical treatments, or
changes in the manner in which health care is delivered or products provided
could alter existing treatment regimes or health care practices, and thereby
reduce the need for one or more of our products, which would adversely affect
our business and our prospects.
WE FACE SUBSTANTIAL PRODUCT LIABILITY AND INSURANCE RISKS.
Testing and selling health care products entails the inherent risk of product
liability claims. The cost of product liability insurance coverage has increased
and is likely to continue to increase in the future. Substantial increases in
26
insurance premium costs in many cases have rendered coverage economically
impractical. We currently carry product liability coverage in the aggregate
amount of $30 million for all claims made in any policy year. Although to date
we have not been the subject of any product liability or other claims, we cannot
assure you that we will be able to maintain product liability insurance on
acceptable terms or that our insurance will provide adequate coverage against
potential claims. A successful uninsured product liability or other claim
against us could have a material adverse effect on our business and prospects.
Item 3. Quantitative and Qualitative Disclosures about Market Risks
Not Applicable
Item 4. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer have
concluded, based on their evaluation within 90 days of the filing date of this
report, that the Company's disclosure controls and procedures are adequately
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Securities and Exchange Act of
1934, as amended, is recorded, processed, summarized and reported, within the
time periods specified in applicable rules and forms. There have not been any
significant changes in the Company's internal controls or in other factors that
could significantly affect those controls, subsequent to the date of such
evaluation, including any corrective actions taken with regard to significant
deficiencies and material weaknesses.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT INDEX
- ------------------- --------------------------------------------------------------------- ---------------------------
Exhibit Sequentially
Number Description Numbered Page
- ------------------- --------------------------------------------------------------------- ---------------------------
99.1 CERTIFICATION PURSUANT TO 18 U.S.C.ss.1350, AS ADOPTED PURSUANT TO 31
SECTION 906 OF THE SARBANES-OXLEY ACT 0F 2002 - Chief Executive
officer
- ------------------- --------------------------------------------------------------------- ---------------------------
99.2 CERTIFICATION PURSUANT TO 18 U.S.C.ss.1350, AS ADOPTED PURSUANT TO 32
SECTION 906 OF THE SARBANES-OXLEY ACT 0F 2002 - Chief Financial
Officer
- ------------------- --------------------------------------------------------------------- ---------------------------
(b) Reports on Form 8-K
27
Not applicable
Items 1 through 5 are not applicable and have been omitted.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Orphan Medical, Inc.
--------------------
Registrant
Date November 13, 2001 By /s/ Timothy G. McGrath
----------------------
Timothy G. McGrath
Chief Financial Officer
(duly authorized officer and
principal financial officer)
CERTIFICATIONS
I, John H. Bullion, President and Chief Executive Officer of Orphan Medical,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Orphan Medical,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
28
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 13, 2002 /s/ John H. Bullion
--------------------------- -------------------------------------
President and Chief Executive Officer
I, Timothy G. McGrath, Vice President and Chief Financial Officer of Orphan
Medical, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Orphan Medical,
Inc.,
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in
29
light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Timothy G. McGrath
--------------------------- ----------------------------------------
Vice President and Chief Financial Officer
30