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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 000-22171
KOS PHARMACEUTICALS, INC.
(Exact Name of Company as Specified in Its Charter)
FLORIDA 65-0670898
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State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
1001 Brickell Bay Drive, 25th Floor, Miami, Florida 33131
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(Address of Principal Executive Offices, Zip Code)
Company's Telephone Number, Including Area Code: (305) 577-3464
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value
Indicate by check mark whether the Company (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 Company
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 disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of Kos Pharmaceuticals, Inc. Common Stock, $.01
par value, held by non-affiliates, computed by reference to the price at which
the stock was sold as of February 23, 2001: $183,537,163.
Number of shares of Common Stock of Kos Pharmaceuticals, Inc. issued and
outstanding as of February 23, 2001: 19,963,062.
Documents Incorporated by Reference
Definitive Proxy Statement for the Company's 2001 Annual
Meeting of Shareholders (incorporated in Part III to the extent
provided in Items 10, 11, 12 and 13 hereof).
TABLE OF CONTENTS
PART I Page
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Item 1. Business.......................................................... 1
Item 2. Properties........................................................ 13
Item 3. Legal Proceedings................................................. 13
Item 4. Submission of Matters to a Vote of Securities Holders............. 13
PART II
Item 5. Market for the Company's Common Stock and Related Shareholder
Matters........................................................... 14
Item 6. Selected Consolidated Financial Data.............................. 15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 16
Forward-Looking Information: Certain Cautionary Statements........ 22
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........ 32
Item 8. Consolidated Financial Statements and Supplementary Data.......... 32
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures............................................. 55
PART III .................................................................. 56
PART IV
Item 14. Exhibits, Financial Schedules and Reports on Form 8-K............. 57
Signatures................................................................. 60
Niaspan(R) is a trademark of Kos Pharmaceuticals, Inc. Heart AllianceSM is a
service mark of Kos Pharmaceuticals, Inc.
Mavik(R) and Tarka(R) are trademarks of Knoll Pharmaceutical Company.
PART I
ITEM 1. BUSINESS
Kos Pharmaceuticals, Inc. ("Kos" or the "Company") is a fully-integrated
specialty pharmaceutical company engaged in the development of proprietary
prescription products for the treatment of chronic cardiovascular and
respiratory diseases. The Company manufactures its lead product, Niaspan(R), and
markets such product directly through its own specialty sales force.
Additionally, the Company markets two complementary anti-hypertensive products,
Mavik(R) and Tarka(R), through a co-promotion alliance with Knoll Pharmaceutical
Company. The Company's cardiovascular products under development consist of
controlled-release, once-a-day, oral dosage formulations. The Company's
respiratory products under development consist of aerosolized inhalation
formulations to be used primarily with the Company's proprietary inhalation
devices.
The Company believes that substantial market opportunities exist for
developing drugs that are reformulations of existing approved prescription
pharmaceutical products, but which offer certain safety advantages (such as
reduced side effects) or patient compliance advantages (such as once-a-day
rather than multiple daily dosing regimens) over currently existing products.
Kos believes that developing proprietary products based on currently approved
drugs, rather than new chemical entities ("NCEs"), may reduce regulatory and
development risks and, in addition, may facilitate the marketing of such
products because physicians are generally familiar with the safety and efficacy
of such products. All of the Company's products currently under development
require new drug application ("NDA") filings with the U.S. Food and Drug
Administration ("FDA"). Although such NDA filings are more expensive and time
consuming, developing products that require NDA approval offers several
advantages compared with generic products, including the potential for higher
gross margins, limited competition resulting from significant clinical and
formulation development challenges, and a three-year statutory barrier to
generic competition.
The principal elements of the Company's business strategy are as follows:
(i) select products with unrealized commercial potential where safety or patient
compliance may be improved; (ii) focus on the large, rapidly growing
cardiovascular and respiratory markets, which include many chronic diseases
requiring long-term therapy; (iii) develop proprietary formulations of currently
approved pharmaceutical compounds; (iv) manage internally the clinical
development of its products; (v) manufacture its products internally; (vi)
market its products directly through the Company's specialty sales force; and
(vii) leverage its core competencies through corporate and academic alliances.
The Company's predecessor, Kos Holdings, Inc. ("Holdings"), which was
previously named Kos Pharmaceuticals, Inc., was incorporated in Florida on July
1, 1988. On June 25, 1996, Kos (named for the Greek island where Hippocrates
founded the science of medicine) was incorporated in Florida as the successor to
the business of Holdings. On June 30, 1996, all of the assets (except for
certain net operating loss carry-forwards) and all of the liabilities of
Holdings were transferred to the Company in exchange for shares of Common Stock
of the Company (the "Reorganization"). The Reorganization was accomplished in
order to transfer the assets and operations of Holdings to the Company while
preserving Holdings' net operating loss carry-forwards and related tax benefits
for Holdings. As a result, the Company had no tax assets or liabilities as of
June 30, 1996. Kos Investments, Inc. ("Investments") is the sole shareholder of
Holdings. Investments is controlled by, and serves as an investment vehicle for,
Michael Jaharis, one of the Company's founders and its Chairman. All references
in this 10-K to the Company include its wholly owned subsidiaries, Aeropharm
Technology, Inc. ("Aeropharm"), IEP Pharmaceutical Devices, Inc. ("IEP"), and
the business and operations of Holdings until June 30, 1996. The Company's
principal executive offices are located at 1001 Brickell Bay Drive, 25th Floor,
Miami, Florida 33131, and its telephone number is (305) 577-3464.
1
Niaspan
On July 28, 1997, the Company received clearance from the FDA to market
Niaspan for the treatment of mixed lipid disorders. Niaspan is the only
once-a-day formulation of a niacin product ever approved by the FDA for the
treatment of mixed lipid disorders. The Company began shipping Niaspan to
wholesalers in mid-August 1997 and began detailing Niaspan to physicians during
September 1997.
Niacin, the active ingredient in Niaspan, is a water soluble vitamin long
recognized by the National Institutes of Health ("NIH") and the American Heart
Association ("AHA") as an effective pharmacological agent for the treatment of
multiple lipid disorders, including elevated low-density lipoprotein ("LDL") or
"bad" cholesterol, total cholesterol, and triglycerides and depressed
high-density lipoprotein ("HDL") or "good" cholesterol. Based principally on the
results of Kos clinical studies evaluating Niaspan, as well as other long-term
interventional studies evaluating niacin for the reduction of coronary events,
Niaspan is approved by the FDA for the following treatment indications: (i)
reduce elevated total cholesterol, LDL cholesterol, and apolipoprotein B, and
increase low HDL cholesterol; (ii) reduce very high serum triglycerides; (iii)
reduce elevated total and LDL cholesterol when used in combination with a
bile-acid binding resin; (iv) reduce recurrent nonfatal myocardial infarction;
and (v) promote the regression or slow the progression of atherosclerosis when
combined with bile-binding resins. In addition, the FDA-approved prescribing
information for Niaspan references its ability to significantly reduce
lipoprotein (a) ["Lp(a)"], which is an independent risk factor for coronary
heart disease ("CHD").
During the past six years, researchers have established through several
long-term clinical outcome studies that reducing LDL cholesterol results in
about a 30% reduction in cardiac events, such as nonfatal heart attacks and
cardiac death. Such studies, however, also have revealed that despite the
significant reduction in LDL cholesterol levels, about 70% of cardiac events
were not avoided when compared with placebo -- suggesting that there may be
other lipid risk factors that contribute to morbidity and mortality in such
patients. Additionally, a landmark long-term clinical outcome study known as the
HDL Intervention Trial ("HIT"), which was published in the August 5, 1999 issue
of The New England Journal of Medicine, showed that raising HDL cholesterol
reduced significantly the incidence of morbidity and mortality. Specifically,
the HIT results showed that even a 6% increase in HDL resulted in a 26%
reduction in the incidence of CHD-death and nonfatal heart attacks and a 26%
reduction in stroke in patients with CHD who had depressed levels of HDL, but
normal levels of LDL and triglycerides.
The results from HIT are consistent with conclusions from previous
epidemiological studies demonstrating that for each 1% increase in HDL
cholesterol, the risk of developing CHD decreases by 2% to 3%, whereas a 1%
decrease in LDL cholesterol results in only a 1% decrease in CHD risk.
Consequently, agents that further increase HDL cholesterol could potentially
improve the benefits with respect to morbidity and mortality. Niaspan is the
most potent new drug on the market for raising HDL cholesterol.
Niaspan's potency for raising HDL cholesterol was observed in a
double-blinded clinical study that compared the effects of Niaspan with
gemfibrozil, the drug tested in the HIT study, in patients having low HDL as
their only lipid abnormality. The results from this study showed that Niaspan
was twice as effective as gemfibrozil in raising HDL cholesterol and six times
more effective in raising LP-AI, a subfraction of HDL that is thought to be
highly cardio-protective. Additionally, Niaspan significantly reduced
triglycerides and also lowered LDL cholesterol, while gemfibrozil reduced
triglycerides somewhat more than Niaspan but significantly raised LDL
cholesterol by 9%. The Company believes that Niaspan generates the optimal blend
of improving the major lipid components that contribute to coronary heart
disease.
2
During 2000, considerable scientific evidence continued to build showing
that many lipid risk factors contribute to CHD disease and that niacin has
powerful utility in addressing such multiple cholesterol disorders. Academic
research, as well as the industry, began focusing on not only treating LDL
cholesterol but also HDL and triglyceride abnormalities. For example, the HATS
trial, presented at the American Heart Association meeting in November 2000,
showed that combination therapy with niacin and statin showed a 70% reduction in
coronary events and virtually halted CHD progression. Additionally, several
reports, including two using Niaspan, demonstrated that treating diabetic
patients with niacin is safe and highly effective in modulating multiple lipid
risk factors without creating intolerable increases in blood sugar levels, which
previously was considered to be a problem with niacin therapy.
The Company markets Niaspan directly to specialist physicians within the
cardiovascular market who specialize in treating patients with CHD and who are
among the leading prescribers of lipid-altering medications. Such
"lipid-management specialists," consist principally of cardiologists,
endocrinologists, and internists. Of the 14 million Americans who are estimated
by the AHA to have CHD, about 40% have low levels of HDL cholesterol as their
primary lipid abnormality. About 60% of patients with CHD have two or more lipid
disorders. The Company believes that patients with low HDL or multiple lipid
disorders would benefit from Niaspan therapy. Many such patients are candidates
for combination therapy using principally an HMG-CoA reductase inhibitor, or
"statin," to reduce LDL combined with Niaspan to raise HDL, lower triglycerides,
and enhance the statin's LDL efficacy. Since the launch of Niaspan, Kos has
found that many lipid specialists are receptive to using combination therapy to
treat their refractory patients in order to address all of the lipids that may
contribute to a coronary event. Eighty-three percent of the nearly 10,000
cardiologists who have been detailed on Niaspan since 1999 have prescribed
Niaspan, and more than 70,000 physicians have prescribed Niaspan at least once.
During 2000, the Niaspan list of targeted physicians has been further
refined to reflect a more concentrated effort on selected physicians. In total,
the list consists of approximately 25,000 physicians who treat patients who have
had a coronary event such as a myocardial infarction or angina. Such physicians
are receptive to prescribing Niaspan because of Niaspan's effectiveness in
modulating other critical lipid fractions in addition to LDL --- such as HDL,
triglycerides, and Lp(a) -- which typically afflict patients with CHD. Nearly
75% of the targeted physicians specialize in cardiology or internal medicine.
The Company believes that there exists significant opportunity to grow
Niaspan prescriptions within this target universe. For example, only 3% of the
targeted physicians have vigorously adopted Niaspan, prescribing at a rate in
excess of 30 prescriptions per month and accounting for 20% of total
prescriptions. The Company believes that as call frequency continues to increase
to all targeted physicians, more physicians will begin to prescribe at vigorous
levels.
Niaspan will also benefit from a larger field force in 2001 and beyond. In
preparation for the launch of Kos' next internally developed product, a
single-tablet Niaspan/lovastatin combination product, Kos intends to grow its
field force by nearly 50% by year-end 2001. Such an expansion is expected to
offer increased reach and frequency to the Company's target market, which the
Company believes has not yet been saturated.
3
In addition to a larger field force, Kos intends to increase promotional
spending on Niaspan by 50%, including the efforts of a new advertising agency.
Kos, in concert with the advertising agency, will increase investment in medical
education grants, symposia and expert advisory boards to establish the
importance of modulating multiple lipid risk factors in an effort to thwart CHD.
Accordingly, combination therapy using Niaspan and statin is currently the only
effective means to achieve clinically significant changes in the major lipid
risk factors that contribute to CHD. Such an investment in the product is
expected to add awareness and expand usage by not only targeted physicians but
also a broader group of physicians.
Another marketing initiative that will provide added leverage in its effort
to increase awareness for Niaspan is the Heart AllianceSM patient compliance
program. The program is designed to educate patients about the importance of
managing cholesterol levels through Niaspan therapy and ultimately improve
patient compliance. The program has yielded strong results not only for
improving patient persistency, but also for increasing prescribing frequency
among physicians participating in Heart Alliance. At the end of 2000, there were
approximately 15,000 patients enrolled in the Heart Alliance patient compliance
program.
In addition to promoting Niaspan as the drug of choice to treat low HDL
cholesterol and multiple lipid disorders, the Company informs physicians as to
the manner in which Niaspan achieves its safety and efficacy profile. This
marketing program is implemented through direct office visits with selected
physicians, medical journal reprints, medical seminars, and clinical discussion
groups. The Company also educates patients on the benefits and proper use of
Niaspan through brochures and the product sample pack. Information delivered by
the Company to physicians and patients includes a discussion about the flushing
side effects of Niaspan, including the importance of proper dose titration and
adherence to the prescribed dosing regimen to reduce this side effect. Although
most patients taking Niaspan will flush occasionally, the Company believes that
the combination of Niaspan's formulation, its patented dosing regimen, and
proper dose titration should result in an incidence of flushing episodes that
are tolerable for most patients. Niaspan's patented dosing regimen provides for
the drug to be taken once-a-day at night; therefore, any flushing episodes will
normally occur while the patient is sleeping. The Company believes that flushing
during the night will not cause the discomfort or embarrassment that often
accompanies the multiple daytime flushing episodes that occur with
immediate-release niacin.
On June 27, 2000 and October 10, 2000, the Company was issued two patents
covering the use of Niaspan. These two patents reserve for Kos the use of niacin
administered once daily at night for cholesterol therapy, whether alone or in
combination with other compounds. Such intellectual property effectively creates
an exclusive franchise both for the Company's currently marketed Niaspan product
and for its next-generation product, the Niaspan/lovastatin combination product,
until 2017. See "Patents and Proprietary Rights".
Co-Promotion of Mavik(R) and Tarka(R)
In the second half of 1999, Kos entered into an alliance with Knoll
Pharmaceutical Company, the U.S. pharmaceutical unit of BASF Corporation
("BASF"), to co-promote Mavik and Tarka, two anti-hypertensive drugs originally
launched by Knoll in 1996 (the "Knoll Agreement"). The two products complement
Niaspan because of the high degree of physician overlap that exists for
prescribers of cholesterol and anti-hypertensive medications. In this manner,
Kos is able to leverage its sales force to generate incremental revenue from two
additional products without compromising the growth of Niaspan.
Under the terms of the Knoll Agreement, Kos contributes essentially all of
the sales calls and a portion of the promotional spending, while receiving an
increasing percentage of revenue based on sales thresholds. The Company's
co-promotion efforts for 2000 produced $5.0 million in revenue, which was
accretive for the year. In the 16 months that Kos has detailed the products, the
products have grown at
4
nearly twice the rate of the anti-hypertensive market. For the remainder of the
five-year term of the co-promotion agreement, Kos expects increasing
contributions to operating results as sales for the products continue to grow.
Kos and Knoll may elect to continue the arrangement following completion of the
term in mid-2004. The patents for Mavik and Tarka expire in 2007 and 2012,
respectively.
On March 2, 2001, Abbott Laboratories ("Abbott") announced that it had
finalized its acquisition of BASF's pharmaceutical business, which includes the
global operations of Knoll. Under the Knoll Agreement, in the event of an
acquisition of either Kos or Knoll, the acquiring entity has the right to
terminate the Knoll Agreement. The Company has not been informed by either
Abbott or Knoll of their intent to terminate the Knoll Agreement, nor does the
Company have reason to believe that the Knoll Agreement will be terminated. The
Company believes that the termination of the Knoll Agreement would not have a
material adverse effect on the Company's financial position or its results of
operations.
Products Under Development
Although the Company has obtained clearance from the FDA to market Niaspan,
each of its other products under development is at an earlier stage of
development. The drug development and approval process takes many years and
requires the expenditure of substantial resources. There can be no assurance
that the Company will be able to successfully formulate any of its products
under development as planned, or that the Company will be successful in
demonstrating the safety and efficacy of such products under development in
human clinical trials. These trials may be costly and time-consuming. The
Company may not be able to obtain the regulatory approvals necessary to continue
testing or to market any or all of the Company's products under development.
Thus, there can be no assurances that any of the Company's products under
development will be developed and commercialized in a timely manner, or in
accordance with the Company's plans or projections, or at all. The Company may
determine to discontinue the development of any or all of its products under
development at any time.
Niaspan/Lovastatin Combination Product
In addition to Niaspan, Kos is developing a single-tablet
Niaspan/lovastatin combination product (the "Combination Product"). Similar to
Niaspan, the Combination Product will be used to treat mixed lipid disorders. On
September 22, 2000, the Company submitted an NDA for the Combination Product to
the FDA.
The Company believes that its patented once-a-night tablet with the
combined, complementary properties of its Niaspan product and a statin
represents an effective modality for treating patients with mixed lipid
disorders. The Company also believes that this patented once-a-night product
should offer significant improvement in patient compliance compared with taking
each product independently under its recommended dosing regimen. The target
market for the Combination Product consists of patients with mixed lipid
disorders, including high total and LDL cholesterol with high triglycerides or
low HDL cholesterol or both. The Company expects to receive approval to market
the drug during the second-half of 2001. The Company intends to begin detailing
the drug in early 2002 shortly after a regulatory exclusivity period expires for
the statin component of the drug.
5
As of February 2001, over 1,200 patients had been treated with the
Combination Product as part of the clinical program. Results from an open label
safety study, presented at the American College of Cardiology meeting in March
2000 reveal that the Combination Product was well tolerated in patients with
dyslipidemia and no cases of serious liver enzyme elevations or myopathy were
observed in over 800 patients dosed on the drug. Additionally, for patients on
therapy for 52 weeks, the Combination Product reduced, on average, LDL
cholesterol 45%, decreased triglycerides 42% and increased HDL cholesterol 41%.
The Company intends to submit several scientific papers covering these and other
data generated from its Combination Product's clinical development program for
publication before or around the time this product is launched.
On May 5, 2000, Kos and DuPont Pharmaceuticals Company formed a strategic
alliance to co-develop and co-promote the Combination Product. Under the terms
of the $80-million agreement, Kos received from DuPont a $20-million equity
investment at closing and will receive additional equity investments of up to
$10 million and a $17.5-million milestone payment at the time the product is
approved by the FDA. DuPont will also contribute up to $32.5 million in Phase IV
clinical studies to expand usage for the product. The companies also are
exploring additional opportunities for collaboration, including co-promotion of
Kos Pharmaceuticals' currently marketed product, Niaspan, and other
cardiovascular projects.
Solid-Dose Drug Delivery Systems
During 1999, the Company conducted research on novel solid-dose drug
delivery systems. Utilizing the Company's considerable knowledge obtained from
formulating both Niaspan and the Combination Product, Kos made progress in
developing three innovative solid-dose delivery systems that could be used to
formulate a variety of compounds. In 2000, Kos in-licensed technology from
Purdue Research Foundation, an affiliate of Purdue University, granting the
Company exclusive commercialization rights to technology invented at Purdue for
the development of gastric retention drug delivery systems for pharmaceutical
products. The licenses to the patents will enable Kos to formulate both
insoluble and soluble compounds for Kos to develop and market or for Kos to
develop and market with other parties on a collaborative basis. The Company
intends to further refine the solid-dose platforms through formulating several
candidate drugs during 2001.
Budesonide and Triamcinolone
Kos is developing a non-CFC formulation of budesonide to be used with one
of its two proprietary metered-dose inhalation ("MDI") devices. Budesonide is a
long-acting inhaled steroid for the treatment of asthma. The Kos formulation of
budesonide, for which an NDA is required, is currently in development. The
Company intends to pursue the development of budesonide because of its potency
and because of favorable market conditions. Kos intends to initiate non-clinical
toxicology studies in 2001, after which the Company intends to begin human
clinical studies, most likely with a partner.
Kos is also developing a proprietary non-CFC, or environmentally friendly,
formulation of triamcinolone to be used with one of the Company's MDI devices.
Triamcinolone is a corticosteroid that is used to treat the underlying
inflammation of asthma. This product will require the submission of an NDA. In
2001, the Company will continue to generate long-term stability data for
triamcinolone and seek development partners for the product.
Inhalation Delivery of Proteins and Peptides
Leveraging its unique aerosol formulation expertise, Kos has begun to
formulate several unnamed proteins for delivery to the lungs using a Kos
proprietary MDI device. As the Company generates cogent in vitro and in vivo
data demonstrating the performance and efficacy of delivering such proteins via
the lung through Kos MDI devices, Kos expects to attract development partners
skilled in developing
6
biotherapeutic compounds to complete the clinical development of the products
for certain diseases. The Company also intends to offer to formulate other
peptides for other partners on a contract basis. Kos believes it has a
leadership position in formulating proteins to be delivered through MDI devices
using non-CFC propellants.
During 2000, the Company completed an initial formulation of an unrevealed
protein and generated in-vivo pre-clinical data that were positive. In these
studies, Kos' formulation of this well characterized protein demonstrated more
than two-fold greater bioavailability than other leading formulations and showed
reduced drug loss using Kos' device. In 2001, Kos will conduct an initial human
study evaluating the formulation and the device to establish proof-of-principle.
If successful, the Company believes that such compelling results will be
extremely attractive to potential development partners for not only for
developing this product, but also for other proteins/peptides, possibly on a
contract formulation basis.
Metered-Dose Inhalation Devices and Other Device Products
Complementing Kos' strong formulation capabilities, Kos has developed a
line of inhalation devices that are proprietary, state-of-the art and useful for
delivering small and large molecules. The principal features of the devices are
three-fold: 1) improved coordination of inhalation with actuation of medication,
thereby offering possible benefits in patient compliance and uniform dose
administration; 2) improved ergonomics, which leads to increased patient
compliance; and 3) reduced drug retention, due to improved design and mechanics
of the devices. To date, the Company has focused its development efforts on
three MDI devices; a breath-coordinated inhaler, a breath-actuated inhaler and a
spacerless MDI device that generates low plume force. Each of these devices
offers distinct benefits and may be deployed on an a la carte basis depending on
potential partners' interest. The Company also is developing a proprietary
inhalation dose counter designed to indicate when sufficient doses no longer
remain in the aerosol canister, thereby alerting the patient to obtain a refill
prescription. At present, the Company intends to use the inhalation dose-counter
on all of its proprietary inhalation devices.
IEP Pharmaceutical Devices, Inc.
In November 1999, Kos acquired substantially all of the assets and
intellectual property of IEP Group, Inc. (the "IEP Acquisition") for total
consideration of $1.1 million. In connection with this transaction, the Company
established IEP Pharmaceutical Devices, Inc. ("IEP") as a wholly-owned
subsidiary of Aeropharm and contributed to IEP all of the assets obtained
through the IEP Acquisition. IEP is a provider of device engineering and
consultation services, principally for the medical device and pharmaceutical
industries. Prior to this acquisition, IEP Group, Inc. had contributed to the
development of several of Kos MDI devices. Kos completed the IEP acquisition to
solidify its position as a full-scale aerosol device source -- with expertise in
device engineering, development and manufacturing. In 2000, Kos incorporated the
expertise and technology of IEP to develop a spacerless low-plume-force device.
Kos expects to further leverage this full range of capabilities to establish
future licensing, contract development, or joint-venture opportunities.
7
Licensing and Other Activities
The Company is aggressively pursuing collaborative opportunities, including
acquiring or licensing the use of selected products and technologies from third
parties ("in-licensing"); product co-marketing arrangements; joint ventures; and
other strategic alliances. Many existing pharmaceutical products or products
currently under development, may be suitable candidates for specialty
promotional or co-marketing campaigns. Accordingly, Kos intends to attempt to
identify licensing, co-marketing and product acquisition opportunities that can
complement the Company's future product portfolio. In situations where
third-party drug delivery technologies are complementary to the Company's drug
development formulation capabilities, the Company may pursue licensing rights
for such technology.
The Company is also pursuing strategic alliances to license certain of its
products and technologies to third parties ("out-licensing"). Specifically, the
Company is seeking a suitable co-promotion partner for Niaspan in the United
States and one or more licensees to market Niaspan for international markets.
The Company is also seeking to establish one or more corporate alliances to
co-promote the Combination Product for international markets. Lastly, Kos
currently intends to establish strategic alliances with corporate partners with
respect to its respiratory products. There can be no assurance, however, that
any of the collaborative opportunities can be established on terms acceptable to
the Company or at all. Further, the Company's inability to enter into any
strategic alliance or other collaborative opportunity may have a material
adverse effect on the Company's financial position.
Patents and Proprietary Rights
The Company actively seeks, when appropriate and available, protection for
its products and proprietary information by means of United States and foreign
patents, trademarks, trade secrets and contractual arrangements. Patent
protection in the pharmaceutical field, however, can involve complex legal and
factual issues. Moreover, broad patent protection for new formulations or new
methods of use of existing chemical entities is sometimes difficult to obtain
and often of limited usefulness, primarily because the active ingredient and
many of the formulation techniques have been known for some time. Consequently,
some patents claiming new formulations or new methods of use for old drugs may
not provide meaningful protection against competition. Nevertheless, the Company
intends to seek patent protection when appropriate and available and otherwise
to rely on regulatory-related exclusivity and trade secrets to protect certain
of its products, technologies and other scientific information. There can be no
assurance, however, that any steps taken to protect such proprietary information
will be effective.
The U.S. Patent and Trademark Office ("PTO") has issued U.S. Patents
numbers 6,129,930 and 6,080,428 to the Company with claims covering Niaspan's
method of use consistent with its recommended once-a-day dosing regimen.
On February 7, 1997, the Company and a privately owned generic manufacturer
entered into a cross-licensing agreement pursuant to which the parties agreed to
resolve, as between themselves certain potential patent issues by granting
licenses under their respective patents. Accordingly, under the agreement, the
generic manufacturer granted the Company a license to sell products under the
generic manufacturer's above referenced patent, under a formulation patent owned
by such generic manufacturer, and under corresponding foreign patents owned by
such generic manufacturer, and Kos granted the generic manufacturer the right to
sell such generic manufacturer's products that are covered by the claims in its
recently issued patents and corresponding foreign applications owned by the
Company. As consideration for entering into the agreement, the Company agreed to
pay the generic manufacturer certain license fees and royalties on the net sales
of Niaspan subject to a cap on such royalty payments in the United States and a
separate cap on such payments outside the United States. Neither the license
fees nor the royalty payments are material to the financial condition of the
Company. The Company may sublicense its rights under the agreement to third
parties to make, use, or sell products developed by or
8
for the Company. The generic manufacturer may not sublicense or transfer the
license granted to it by the Company, although the generic manufacturer may
sublicense to third parties the right to supply to the generic manufacturer or
market with or on behalf of the generic manufacturer, products that are covered
by the generic manufacturer's patents but which are not covered by the Company's
patents. The Company may terminate the agreement after February 7, 2001.
Various inhalation devices, technologies, and methods of use licensed from,
or assigned to Kos by, researchers and engineers engaged in development projects
or sponsored research on behalf of Kos are the subject of issued or allowed U.S.
patents, as well as various foreign patents or patent applications. In addition,
patent applications on certain of the Company's products under development or
relating to certain sponsored research activities are pending at the PTO.
There can be no assurance that the patents owned and licensed by the
Company, or any future patents, will prevent other companies from developing
similar or therapeutically equivalent products or that others will not be issued
patents that may prevent the sale of Company products or require licensing and
the payment of significant fees or royalties by the Company. Furthermore, there
can be no assurance that any of the Company's future products or methods will be
patentable, that such products or methods will not infringe upon the patents of
third parties, or that the Company's patents or future patents will give the
Company an exclusive position in the subject matter claimed by those patents.
The Company is aware that certain European and U.S. patents have been
issued with claims covering products that contain certain propellant-driven
aerosol formulations. The European patents are currently subject to an
opposition proceeding in Europe, and certain claims in such patents have been
held invalid in the United Kingdom. In the event that the Company develops
aerosol products that use a formulation covered by such European or U.S.
patents, the Company may be prevented from making, using or selling such
products unless the Company obtains a license under such patents, which license
may not be available on commercially reasonable terms, or at all, or unless such
patents are determined to be invalid or unenforceable in Europe or the United
States, respectively. The Company's development of products that are covered by
such patents and its failure to obtain licenses under such patents in the event
such patents are determined to be valid and enforceable could have an adverse
effect on the Company's business.
Niaspan and "Kos" are the Company's principal registered trademarks,
although other applications for registration of trademarks and service marks are
currently pending in the PTO and additional applications are in the process of
being filed.
Marketing
Kos intends to market its branded proprietary products through its own
specialty sales force. A fundamental element of the Company's product selection
strategy is to focus on products where a relatively concentrated group of
specialist physicians account for a significant portion of the prescriptions for
the therapeutic indication addressed by the Company's products. The Company
believes that such specialist physicians will be the most receptive to the
patient compliance, safety, or other therapeutic advantages that the Company's
products will seek to offer. Accordingly, the Company believes that significant
market gains can be achieved with such products through the use of a relatively
small, well-trained sales force concentrating its detailing efforts on informing
such specialist physicians about the scientific basis for the therapeutic
advantages of the Company's products.
9
As of February 28, 2001, the Company had a 215-person sales and marketing
organization. The majority of the sales and marketing personnel have
considerable previous experience with major pharmaceutical companies detailing
products to cardiovascular physicians. Kos began actively detailing Niaspan
during September 1997. During 2000, Kos streamlined its sales force to increase
the focus on high opportunity territories. Additionally, the Company improved
its field force management's span of control. The Company intends to leverage
its sales force by marketing its future cardiovascular products, if and as they
are approved, along with Mavik and Tarka through the co-promotion with Knoll.
Manufacturing
In order to maximize the quality of developed products, assure compliance
with regulatory requirements, and minimize costs, the Company intends to
manufacture its Kos-developed products internally. The Company currently
produces Niaspan at its Hollywood, Florida facility and received approval in
2000 to produce Niaspan at its Edison, New Jersey facility. The Company's Edison
facility will be used to produce the Combination Product and is currently
configured, and largely equipped, to manufacture both solid-dose and aerosol
inhalation products. Although the Company believes that its Edison facility
currently operates using current good manufacturing practices as required by the
FDA for the manufacture of product to be used in clinical trials, the facility
requires inspection and approval by the FDA before the commercial sale of the
Combination Product manufactured at Edison can commence. This approval for the
Edison, New Jersey site is expected in 2001. The Company believes that it has
sufficient capacity, with limited additional capital outlays, to accommodate
sales volume for both solid-dose and aerosol products for the foreseeable
future.
The Company intends to continue to contract the packaging of its
manufactured products to third parties. The Company may begin in-house packaging
operations once product sales volumes justify the capital expenditures required
to establish such capabilities. Certain of the Company's raw materials,
including the active ingredients in Niaspan and in the Combination Product, are
currently obtained from single sources of supply. The Company does not have a
contractual supply arrangement with the sole supplier of the active ingredient
in Niaspan. The Company intends, to the extent possible, to identify multiple
sources for all of its key raw materials, including the active ingredient in
Niaspan, although an alternate source for at least one such material will not be
available because of the supplier's patent rights.
In 2000, Kos steadily improved its efficiency in manufacturing Niaspan.
Specifically, gross margins increased six percentage points, reaching 90% of net
sales during the second-half of 2000. The Company expects improvements in gross
margins for Niaspan as sales volumes increase and more efficient higher yielding
manufacturing equipment becomes operational.
Competition
The Company's product competes with currently existing or future
prescription pharmaceuticals and vitamins in the United States, Europe and
elsewhere. The Company estimates that its existing Niaspan prescriptions account
for approximately 1.6% of the total prescriptions currently being written in the
United States for cholesterol-lowering pharmaceutical compounds. Competition
among these products is based on, among other things, efficacy, safety,
reliability, availability, price and patent position. In addition, academic
institutions, government agencies and other public and private organizations
conducting research may seek patent protection, discover new drugs or establish
collaborative arrangements for drug research. Most of the Company's competitors
have substantially greater financial, technical and human resources than the
Company, including combined field sales forces exceeding 12,000 representatives
compared with the Company's approximately 200-person field sales force and may
be better equipped to develop, manufacture and market products.
10
The Company's cardiovascular and respiratory products, when developed and
marketed, will compete in most cases with well established products containing
the same active ingredient already being marketed by medium-sized and large
pharmaceutical companies in the United States. For example, the Company's
budesonide formulation, if successfully commercialized, will compete with
another budesonide product, which is already being marketed in the United States
by a much larger company.
Moreover, there are numerous manufacturers of niacin preparations indicated
for use as vitamin supplements or, in immediate-release form, for treatment of
hyperlipidemia. The Company believes that a generic manufacturer has performed
at least one early-stage clinical study using niacin as a once-a-day treatment
for lipid-altering, and such manufacturer may be pursuing an NDA for such
product. Further, the Company's Niaspan product will compete with many existing
lipid-altering medications, which currently account for more than 90% of the
lipid-altering market.
Government Regulation
The development, manufacture and potential sales of prescription
pharmaceutical products are subject to extensive regulation by U.S. and foreign
governmental authorities. In particular, pharmaceutical products are subject to
rigorous pre-clinical and clinical testing and to other approval and
post-approval requirements by the FDA in the United States under the Federal
Food, Drug and Cosmetic Act and the Public Health Service Act and by comparable
agencies in most foreign countries. The FDA regulates all aspects of a product's
testing, labeling, promotion, and manufacture, and can impose substantial
restrictions on these activities before or after approval of such product.
Whether or not FDA approval has been obtained, approval of a product by
regulatory authorities in foreign countries must be obtained prior to the
commencement of commercial sales of the product in such countries. The
requirements governing the conduct of clinical trials and product approvals vary
widely from country to country, and the time required for approval may be longer
or shorter than that required for FDA approval. Although there are some
procedures for unified filing for certain European countries, in general, each
country at this time has its own procedures and requirements. Further, the FDA
regulates the export of products produced in the United States and may prohibit
their export even if such products are approved for sale in other countries.
The Company's research and development involves the controlled use of
hazardous materials, chemicals, and various radioactive compounds. Although the
Company believes that its procedures for handling and disposing of those
materials comply with state and federal regulations, the risk of contamination
or injury from these materials cannot be eliminated. In the event of such
contamination or injury, the Company could be held liable for resulting damages,
which could be material to the Company's business, financial condition and
results of operations. The Company is also subject to numerous environmental,
health and workplace safety laws and regulations, including those governing
laboratory procedures, exposure to blood-borne pathogens, and the handling of
biohazardous materials. Additional federal, state and local laws and regulations
affecting the Company may be adopted in the future. Any violation of, and the
cost of compliance with, these laws and regulations could materially and
adversely affect the Company.
Completing the multitude of steps necessary prior to the commencement of
marketing requires the expenditure of considerable resources and a lengthy
period of time. There can be no assurance of approval within any particular
period, if ever; or if approval is granted, of continued approval thereafter.
Delay or failure in obtaining, or the withdrawal of, the required approvals,
clearances, permits or inclusions by the Company or its future corporate
partners or licensees, if any, would have a material adverse effect on the
ability of the Company to generate sales or royalty revenue. Further, the
passage and implementation of new or changed laws or regulations or the
potential impact on the Company of such actions cannot be anticipated.
11
Employees
As of February 28, 2001, the Company had 423 full-time employees. No
employee is represented by a union. The Company believes its employee relations
are good. The Company also regularly employs the services of outside consultants
with respect to regulatory, scientific, and certain administrative and
commercial matters. The Company expects to continue to require the services of
such outside consultants.
12
ITEM 2. PROPERTIES
The Company leased the following properties as of December 31, 2000:
Lease Expiration Minimum
(Including Renewal Annual
Location Use Square Feet Options) Rent
- --------------------- ------------------------------ ----------- ------------------ --------
Miami, FL Corporate offices 13,000 December 2004 $443,000
Miami Lakes, FL Research and admin. offices 13,000 May 2002 237,000
Hollywood, FL Manufacturing, research and
admin. offices 23,500 November 2004 289,000
Edison, NJ Manufacturing, research, and
admin. offices 43,400 October 2006 288,000
Raleigh, NC Engineering offices 6,000 August 2002 49,000
The Company believes that its existing facilities are adequate to meet its
current needs and that there is sufficient additional space at or in close
proximity to its present facilities to accommodate its near-term requirements.
ITEM 3. LEGAL PROCEEDINGS
On August 5, 1998, a purported class action lawsuit was filed in the United
States District Court for the Northern District of Illinois, Eastern Division,
against the Company, the members of the Company's Board of Directors, certain
officers of the Company, and the underwriters of the Company's October 1997
offering of shares of Common Stock. In its complaint, the plaintiff asserts, on
behalf of itself and a putative class of purchasers of the Company's Common
Stock during the period from July 29, 1997, through November 13, 1997, claims
under: (i) sections 11, 12(a)(2) and 15 of the Securities Act of 1933; (ii)
sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder; and (iii) for common law fraud, negligent
misrepresentation and breach of fiduciary duty. The claims in the lawsuit relate
principally to certain statements made by the Company, or certain of its
representatives, concerning the efficacy, safety, sales volume and commercial
viability of the Company's Niaspan product. The complaint sought unspecified
damages and costs, including attorneys' fees and costs and expenses. Upon motion
by the Company, the case was transferred to the United States District Court for
the Southern District of Florida. The Company and the individual Kos defendants
filed a motion to dismiss the complaint on January 7, 1999. On May 24, 1999, the
United States District Court for the Southern District of Florida dismissed the
lawsuit with prejudice. The plaintiffs filed an appeal on June 7, 1999, with the
United States Circuit Court of Appeals for the 11th Circuit. The outcome of the
litigation cannot yet be determined. Accordingly, no provision for any liability
that may result from these matters has been recognized in the accompanying
consolidated financial statements. There can be no assurance, however, that the
outcome of this litigation will not have a material adverse effect on the
Company's business, results of operations, and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 2000.
13
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
The Company's Common Stock, par value $.01 per share, commenced trading on
March 7, 1997, on the Nasdaq National Market under the symbol "KOSP". As of
March 1, 2001, there were 418 registered shareholders of record of the Company's
Common Stock.
The following table sets forth, for the fiscal periods indicated, the range
of high and low prices for trades of the Company's Common Stock on the Nasdaq
National Market System.
Year Ended December 31, 2000 High Low
------- -------
First Quarter.......................................$ 22.13 $ 5.30
Second Quarter...................................... 18.56 10.00
Third Quarter....................................... 17.88 10.75
Fourth Quarter...................................... 25.13 13.63
Year Ended December 31, 1999
First Quarter....................................... $ 7.00 $ 4.00
Second Quarter...................................... 5.75 4.13
Third Quarter....................................... 7.75 4.38
Fourth Quarter...................................... 6.38 4.38
The Company has not declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain future earnings, if
any, to fund the development and growth of its business and does not intend to
pay dividends on its Common Stock in the foreseeable future.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following consolidated selected financial data of the Company for the
five years ended December 31, 2000, should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and related notes thereto.
See "Item 8. Consolidated Financial Statements and Supplementary Data."
Year Ended December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
----------- ----------- ----------- ---------- ----------
(in thousands, except per share data)
Statement of Operations:
Revenues, net............................................ $ 60,174 $ 36,340 $ 13,038 $ 2,892 $ --
Cost of sales............................................ 5,932 5,406 3,276 792 --
----------- ----------- ----------- ---------- ---------
54,242 30,934 9,762 2,100 --
----------- ----------- ----------- ---------- ---------
Operating expenses:
Research and development.............................. 26,459 25,619 29,144 24,130 13,679
Selling, general and administrative................... 56,831 56,843 61,519 20,509 2,881
Expense recognized on modification of stock
option grants(1).................................. -- -- -- -- 5,436
----------- ----------- ----------- ---------- ---------
Total operating expenses.......................... 83,290 82,462 90,663 44,639 21,996
----------- ----------- ----------- ---------- ---------
Loss from operations..................................... (29,048) (51,528) (80,901) (42,539) (21,996)
Other:
Interest income, net.................................. 323 169 1,793 2,787 11
Interest expense-related parties...................... (6,560) (3,207) (68) (868) (136)
Other income (expense)................................ 20 14 15 (10) --
----------- ----------- ----------- ---------- ---------
Loss before minority interest...................... (35,265) (54,552) (79,161) (40,630) (22,121)
Minority interest(2)..................................... -- -- -- -- 15
----------- ----------- ----------- ---------- ---------
Net loss........................................... $ (35,265) $ (54,552) $ (79,161) $ (40,630) $(22,106)
=========== =========== =========== ========== =========
Net loss per share, basic and diluted(3)................. $ (1.84) $ (3.06) $ (4.50) $ (2.79) $ (1.95)
Weighted average common shares used in computing
net loss per share(3)................................ 19,202,877 17,842,879 17,589,767 14,569,474 11,340,000
December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
----------- ----------- ----------- ---------- ----------
(in thousands)
Balance Sheet:
Cash and marketable securities........................... $ 6,125 $ 4,336 $ 4,879 $ 70,396 $ 358
Working capital (deficit)................................. (1,911) (2,354) (3,136) 70,939 (9,355)
Total assets............................................. 29,648 26,258 21,570 84,403 3,197
Total long-term debt...................................... 72,000 62,089 9,239 -- 8,355
Accumulated deficit(4).................................... (274,931) (239,666) (185,114) (105,952) (65,322)
Shareholders' equity (deficit)............................ (65,090) (53,195) (338) 77,870 (6,750)
- -----
(1) Reflects a non-cash charge associated with an extension of the exercise
period for stock options granted during 1988 to 1990 to the Company's Chief
Executive Officer and two independent consultants; no other material
economic terms of these options were changed.
(2) Represents the minority shareholder's interest in Aeropharm Technology,
Inc., which interest was acquired by the Company in June 1996.
(3) See Note 2. of Notes to Consolidated Financial Statements for information
concerning the computation of net loss per share.
(4) In connection with the transfer on June 30, 1996, of assets and liabilities
from Kos Holdings, Inc. to the Company, net operating loss carryforwards
amounting to approximately $51.0 million and related tax benefits, were not
transferred to the Company. The Company can only utilize net operating loss
carryforwards sustained subsequent to June 30, 1996 (amounting to $222.8
million as of December 31, 2000), to offset future taxable income, if any.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations".
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
A predecessor corporation to the Company was formed in July 1988 under the
name of Kos Pharmaceuticals, Inc. principally to conduct research and
development on new formulations of existing prescription pharmaceutical
products. In June 1993, Aeropharm Technology, Inc. ("Aeropharm"), a then
majority-owned subsidiary of the Company, was formed to conduct research and
development activities on aerosolized products for the treatment of respiratory
diseases. During June 1996, this predecessor corporation acquired the
outstanding minority interest in Aeropharm; changed its name to Kos Holdings,
Inc. ("Holdings"); established the Company as a wholly-owned subsidiary under
the name of Kos Pharmaceuticals, Inc.; and, effective as of June 30, 1996,
transferred all of its existing assets, liabilities and intellectual property,
other than certain net operating loss carryforwards, to the Company.
Accordingly, all references in this 10-K filing to the Company's business
include the business and operations of Holdings until June 30, 1996.
On March 12, 1997, the Company completed an initial public offering ("IPO")
of its Common Stock. Through December 31, 2000, the Company had accumulated a
deficit from operations of approximately $274.9 million. In connection with the
transfer of operations from Holdings to the Company on June 30, 1996, net
operating loss carryforwards amounting to approximately $51.0 million and
related tax benefits were retained by Holdings and not transferred to the
Company. Consequently, the Company may utilize net operating losses sustained
subsequent to June 30, 1996, amounting to approximately $222.8 million as of
December 31, 2000, to offset future taxable net income, if any.
From inception through its June 30, 1997, reporting period, the Company was
a development stage company engaged primarily in the development of
cardiovascular and respiratory pharmaceutical products. On July 28, 1997, the
Company was granted clearance by the FDA to market its lead product, Niaspan.
The Company began shipping Niaspan to wholesalers in mid-August 1997 and began
detailing Niaspan to physicians in September 1997. The Company's Board of
Directors changed the end of the Company's fiscal year from June 30 to December
31 effective with its December 31, 1997, reporting period. Fiscal years
presented and referred to in the Company's consolidated financial statements,
along with all other financial data, have been restated to conform with a
December 31 fiscal year basis.
Results of Operations
Years Ended December 31, 2000 and 1999
The Company's revenues increased to $60.2 million for the year ended
December 31, 2000, from $36.3 million for the same period in 1999. This increase
was attributable to a growth of $21.5 million in net sales of the Company's
Niaspan product, and to an increase of $2.4 million in co-promotion revenue
resulting from the Company's co-promotion agreement with Knoll Pharmaceutical
Company (hereinafter "Knoll"), for the promotion of Knoll's Mavik and Tarka
products within the United States (the "Knoll Agreement"). Under the terms of
the Knoll Agreement, the Company receives an increasing percentage of revenue
based on sales thresholds.
During the years ended December 31, 2000 and 1999, certain customers of the
Company purchased abnormally high levels of the Niaspan product. The Company
believes that these higher than expected Niaspan purchases were primarily due to
seasonal fluctuations in customer purchasing patterns rather than
16
underlying market demand for the Niaspan product. As a result, at December 31,
2000 and 1999, the amount of the Company's Niaspan product being warehoused by
these customers increased above normal levels. The Company has deferred the
recognition of $4.8 million and $2.8 million in revenues and related expenses
associated with these sales, as of December 31, 2000 and 1999, respectively,
until the level of the Company's Niaspan product warehoused by these customers
returns to normal levels.
Cost of sales was $5.9 million and $5.4 million for the years ended
December 31, 2000 and 1999, respectively. The higher cost of sales in 2000 was
attributable to higher Niaspan volume during the period, partially offset by
efficiencies attained in the production of Niaspan.
The Company's research and development expenses increased to $26.5 million
for the year ended December 31, 2000, from $25.6 million for the year ended
December 31, 1999. The increased expenses related primarily to increases of $0.9
million in personnel and personnel-related costs, of $0.9 million in formulation
development costs for products under development, of $0.6 million in costs
associated with NDA submission expenses for the Company's single-tablet
Niaspan/lovastatin combination product (the "Combination Product"), and of $0.5
million in costs associated with licensing activities. These costs were
partially offset by a decrease of $2.1 million in the costs of clinical trials
resulting from the completion of most of the clinical trial activities
associated with the submission of a New Drug Application ("NDA") to the U.S.
Food and Drug Administration for the Combination Product during the year ended
December 31, 2000.
Selling, general and administrative expenses remained at the same level
overall for the years ended December 31, 2000 and 1999. Within this category,
however, selling expenses decreased $2.5 million primarily as a result of a
decrease of $3.5 million in sales force operating expenses, and of $2.0 million
in marketing programs in support of Niaspan. These decreases were partially
offset by an increase of $2.5 million in marketing costs associated with Mavik
and Tarka promotional efforts. General and administrative expenses increased to
$13.9 million for the year ended December 31, 2000, from $11.5 million for the
preceding period, primarily as a result of an increase of $1.0 million in
royalty expenses associated with the increase in net sales of the Niaspan
product, and of an increase of $0.8 million in personnel and personnel-related
costs.
The Company is subject to the terms of the July 1, 1998, $30-million credit
facility (the "Credit Facility"), the September 1, 1999, $50-million credit
facility (the "Supplemental Credit Facility"), and the December 21, 1999,
$50-million credit facility (the "Standby Facility"), with Michael Jaharis,
Chairman of the Company's Board of Directors and its principal shareholder.
Borrowings under these credit facilities totaled $72 million as of December 31,
2000 and bear interest at the prime rate (9.5% as of December 31, 2000).
Interest expense under these credit facilities totaled approximately $6.6
million and $3.2 million for the year ended December 31, 2000 and 1999,
respectively.
The Company incurred a net loss of $35.3 million for the year ended
December 31, 2000, compared with a net loss of $54.6 million for the year ended
December 31, 1999.
Years Ended December 31, 1999 and 1998
The Company's revenue increased to $36.3 million for the year ended
December 31, 1999, from $13.0 million for the year ended December 31, 1998. This
increase was attributable to a growth of $20.6 million in net sales of the
Company's Niaspan product and to $2.7 million in co-promotion revenue resulting
from the Knoll Agreement.
17
During the fourth quarter of 1999, certain customers of the Company
purchased abnormally high levels of the Company's Niaspan product. The Company
believes that this higher than expected Niaspan demand was primarily due to
seasonal fluctuations in customer purchasing patterns. Prior to 1999, the
Company had not been materially affected by seasonal fluctuations in customer
purchasing patterns. As a result, at December 31, 1999, the amount of the
Company's Niaspan product being warehoused by these customers increased above
normal levels. The Company deferred the recognition of $2.8 million in revenues
and related expenses associated with these sales until the level of the
Company's Niaspan product warehoused by these customers returned to normal
levels.
Cost of sales was $5.4 million and $3.3 million for the year ended December
31, 1999 and 1998, respectively. The higher cost of sales in 1999 was
attributable to higher sales of the Niaspan product during the period, partially
offset by efficiencies attained in the production of Niaspan.
The Company's research and development expenses decreased to $25.6 million
for the year ended December 31, 1999, from $29.1 million for the year ended
December 31, 1998. The reduced expenses related primarily to decreases of $2.5
million in formulation development costs of the Company's Combination Product
and other products under development, of $2.1 million in medical education
programs in support of the Niaspan product, and of $1.1 million in development
costs paid to other parties. These decreases were partially offset by increases
of $2.3 million in the costs of clinical trials principally associated with the
Company's Combination Product.
Selling, general and administrative expenses decreased to $56.8 million for
the year ended December 31, 1999, from $61.5 million for the year ended December
31, 1998. Selling expenses decreased $5.7 million, primarily as a result of a
$7.8 million reduction in marketing program costs and other costs associated
with the Niaspan product; the reduction principally reflects the absence of
launch expenses incurred in 1998. This reduction was partially offset by $2.0
million in Mavik and Tarka marketing expenses, and by an increase of $0.3
million in personnel and personnel related costs as a result of the full impact
of the presence, during the 1999 period, of the Company's expanded sales and
marketing organization. General and administrative costs increased to $11.5
million for the 1999 period, from $10.5 million during the preceding period,
primarily as a result of an increase of $1.2 million in royalty expenses
associated with the increase in net sales of the Niaspan product.
During 1997, the Company received $65.9 million in net proceeds from its
March IPO and $43.3 million in net proceeds from an October follow-on offering
of its Common Stock. During 1998, the remaining net proceeds from these
offerings, along with other cash balances, were invested primarily in U.S.
Treasury and highly-rated corporate debt securities. The Company recorded $1.8
million of interest income for the year ended December 31, 1998, as a result of
these investments.
Interest expense under the Credit Facility and Supplemental Credit Facility
totaled $3.2 million and $68,000 for the years ended December 31, 1999 and 1998,
respectively.
The Company incurred a net loss of $54.6 million for the year ended
December 31, 1999, compared with a net loss of $79.2 million for the year ended
December 31, 1998.
18
Years Ended December 31, 1998 and 1997
The Company's revenue increased to $13.0 million for the year ended
December 31, 1998, from $2.9 million for the year ended December 31, 1997. The
Company began sales of its Niaspan product to wholesalers during August 1997.
Cost of sales was $3.3 million and $0.8 million for the years ended December 31,
1998 and 1997, respectively. The higher cost of sales in 1998 was attributable
to higher sales of the Niaspan product during the period.
The Company's research and development expenses increased to $29.1 million
for the year ended December 31, 1998, from $24.1 million for the same period in
1997. The change related primarily to increases of $5.4 million during the 1998
period in connection with formulation development of the Company's Combination
Product and other products under development, $4.6 million in medical education
programs in support of Niaspan, and $2.1 million in personnel and personnel
related costs in support of the Company's expanded research and development
activities. These increases in research and development expenses were partially
offset by a $1 million fee received by the Company in 1998 related to the
exchange of certain technology rights with another unaffiliated company. The
1998 increases were also partially offset by the absence of a $3 million charge
attributable to entering into an agreement, in February 1997, with an
unaffiliated generic drug manufacturer to resolve, as between themselves, the
effects of a potential patent interference proceeding, of $1.7 million of
licensing fees associated with obtaining access to certain aerosol safety and
toxicology data, and of $1.2 million of development costs paid to third parties
in 1997.
Selling, general and administrative expenses increased to $61.5 million for
the year ended December 31, 1998, from $20.5 million for the year ended December
31, 1997. Selling expenses increased $36 million as a result of the continued
expansion of the Company's sales and marketing organization and the initiation
of a variety of marketing programs in connection with the Niaspan product.
General and administrative costs also increased during the 1998 period, mostly
as a result of increases of $2.2 million in personnel and personnel-related
costs, $0.6 million in royalty expenses for the Company's Niaspan product, and
other expenses associated with the expanded activities of the Company.
From July 1, 1996, to the completion of its IPO on March 12, 1997, the
Company funded its operations from the proceeds of a loan from Kos Investments,
Inc. (the "Convertible Note"), the sole shareholder of Holdings. The Convertible
Note and its accrued interest were convertible into shares of the Company's
Common Stock at a conversion price per share equal to the IPO price per share
($15.00). Interest expense under the Convertible Note totaled $0.9 million for
the year ended December 31, 1997. On October 25, 1997, the outstanding principal
and interest of the Convertible Note was converted into 960,069 shares of Common
Stock. At the time of conversion, the Convertible Note accrued interest at a
rate of 8.50% per year and had outstanding principal and interest of $13.4
million and $1.0 million, respectively.
The Company recorded $1.8 million and $2.8 million of interest income for
the years ended December 31, 1998 and 1997, respectively, as a result of its
investment in marketable securities from the net proceeds of the IPO and the
follow-on offering. The Company also recorded, mostly as a result of the Credit
Facility during the 1998 period and of the Convertible Note during the 1997
period, $68,000 and $0.9 million of interest expense for the years ended
December 31, 1998 and 1997, respectively.
The Company incurred a net loss of $79.2 million for the year ended
December 31, 1998, compared with a net loss of $40.6 million for the year ended
December 31, 1997.
19
Liquidity and Capital Resources
At December 31, 2000, the Company had cash and cash equivalents totaling
$6.1 million and negative working capital of $1.9 million. The Company's primary
uses of cash to date have been to fund selling, general and administrative
expenses, and research and development expenses, including clinical trials. As
of December 31, 2000, the Company's investment in equipment and leasehold
improvements, net of depreciation and amortization, was $7.9 million. During the
year ended December 31, 2000, the Company spent $0.6 million in capital
expenditures. The Company expects to increase the level of capital expenditures
during 2001 mostly to provide increased production capacity for the Combination
Product. Accordingly, 2001 capital expenditures are expected to be significantly
higher than those incurred during the year ended December 31, 2000.
On July 1, 1998, the Company entered into a $30-million credit facility
(the "Credit Facility") with Michael Jaharis, Chairman of the Company's Board of
Directors and its principal shareholder. On June 9, 2000, in order to reduce
interest costs, the Company utilized the proceeds of a $20-million equity
contribution from DuPont Pharmaceuticals Company ("DuPont") to pay-off
borrowings made under the Credit Facility. In connection with this loan
repayment, Mr. Jaharis agreed to continue to make available to the Company the
full original borrowing capacity of the Credit Facility, provided that future
Company borrowings from Mr. Jaharis be first made from the existing borrowing
capacity of Mr. Jaharis' other credit lines with Kos. All other terms of the
Credit Facility remain in full force and effect. Borrowings under the Credit
Facility totaled $10 million as of December 31, 2000, bear interest at the prime
rate (9.5% as of December 31, 2000), and are due December 31, 2002.
On September 1, 1999, the Company formally agreed to the terms of an
additional $50-million funding arrangement initially entered into with Michael
Jaharis on October 7, 1998 (the "Supplemental Credit Facility"). Borrowings
under the Supplemental Credit Facility totaled $50 million as of December 31,
2000, bear interest at the prime rate, are convertible (at $4.91 per share) into
shares of the Company's Common Stock, and will be due December 31, 2003. As of
December 31, 2000, the conversion of amounts borrowed from Mr. Jaharis under the
Supplemental Credit Facility into shares of the Company's Common Stock would
have resulted in the issuance of 10,183,299 additional shares of the Company's
Common Stock, thus causing material dilution to existing shareholders of the
Company.
On December 21, 1999, Mr. Jaharis agreed to extend another $50-million loan
to the Company (the "Standby Facility"). Borrowings made under the Standby
Facility totaled $12 million as of December 31, 2000, are due June 30, 2005, and
are also subject to most of the terms and conditions of borrowings made under
the Supplemental Credit Facility. Borrowings made under the Standby Facility are
not, however, convertible into shares of the Company's Common Stock. In lieu of
a conversion feature, the Company has granted to Mr. Jaharis non-detachable
warrants to purchase 6,000,000 shares of the Company's Common Stock at $5.00 per
share, which approximates the market value of the Company's Common Stock on the
effective date of the Standby Facility. The warrants are exercisable at any time
until June 30, 2006. The exercise of a significant number of the warrants issued
under the Standby Facility will cause material dilution to existing shareholders
of the Company.
The Company entered into an agreement, effective May 3, 2000, with DuPont
to form a strategic alliance for the purpose of co-promoting the Company's
Combination Product, now in development, in the United States and Canada (the
"DuPont Agreement"). Under the terms of the DuPont Agreement, the Company and
DuPont will share in the future development and commercialization of the
Company's Combination Product. Specifically, DuPont has agreed (i) to make
equity investments in the Company up to $30 million through the date of Food and
Drug Administration ("FDA") approval of the Combination Product; (ii) to pay the
Company $17.5 million in milestone payments upon FDA approval
20
of the Combination Product; (iii) to fund up to $32.5 million for future
clinical development of the Combination Product; and (iv) to share equally in
the costs associated with promoting the Combination Product and share equally in
product profits after deducting a royalty to the Company. On May 31, 2000,
DuPont made a $20-million equity investment in the Company in exchange for
1,250,000 shares of the Company's Common Stock.
Although the Company currently anticipates that, including the capital
available to the Company under the Credit Facility, the Supplemental Credit
Facility and the Standby Facility, it has or has access to an amount of working
capital that will be sufficient to fund the Company's operations until it has
positive cash flows, the Company's cash requirements during this period will be
substantial and may exceed the amount of working capital available to the
Company. The Company's ability to fund its operating requirements and maintain
an adequate level of working capital until it achieves positive cash flows will
depend primarily on its ability to generate substantial growth in sales of its
Niaspan product, to receive approval of the NDA for the Company's Combination
Product on a timely basis, and to successfully market the Combination Product.
Further, during this period, the Company's ability to fund its operating
requirements may, among other things, be affected by its ability to reduce its
operating expenses. The Company's failure to generate substantial growth in the
sales of Niaspan, reduce operating expenses, obtain regulatory approval for its
Combination Product, or meet the conditions necessary for the Company to obtain
funding under the Credit Facility, the Supplemental Credit Facility and the
Standby Facility, and other events -- including the progress of the Company's
research and development programs; the costs and timing of seeking regulatory
approvals of the Company's products under development; the Company's ability to
obtain regulatory approvals; the Company's ability to manufacture products at an
economically feasible cost; costs in filing, prosecuting, defending, and
enforcing patent claims and other intellectual property rights; the extent and
terms of any collaborative research, manufacturing, marketing, joint venture, or
other arrangements; and changes in economic, regulatory, or competitive
conditions or the Company's planned business -- could cause the Company to
require additional capital prior to achieving positive cash flows. In the event
that the Company must raise additional capital to fund its working capital
needs, it may seek to raise such capital through loans or the issuance of debt
securities that would require the consent of the Company's current lender, or
through the issuance of equity securities. To the extent the Company raises
additional capital by issuing equity securities or obtaining borrowings
convertible into equity, ownership dilution to existing shareholders will
result, and future investors may be granted rights superior to those of existing
shareholders. Moreover, there can be no assurance that any additional capital
will be available to the Company on acceptable terms, or at all.
21
FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report that
are not related to historical results are forward-looking statements. Actual
results may differ materially from those projected or implied in the
forward-looking statements. Further, certain forward-looking statements are
based upon assumptions of future events, which may not prove to be accurate.
Subsequent written and oral forward looking-statements attributable to the
Company or to persons acting on its behalf are expressly qualified in their
entirety by the cautionary statements set forth below and elsewhere in this
report and in other reports filed by the Company with the Securities and
Exchange Commission.
Market Acceptance and Sales Growth of Niaspan
The Company's success currently depends primarily upon its ability to
successfully market and sell increasing quantities of its Niaspan product. The
Company's ability to successfully sell increasing quantities of the Niaspan
product will depend significantly on the increasing acceptance of the Niaspan
product by physicians and their patients. The Company believes that intolerable
flushing and potential liver toxicity associated with currently available
formulations of niacin are the principal reasons why physicians generally have
been reluctant to prescribe or recommend such currently available formulations.
Flushing episodes are often characterized by facial redness, tingling or rash.
Although most patients taking the Niaspan product will sometimes flush, the
formulation and dosing regimen for Niaspan have been designed to maximize
patient acceptance and minimize the occurrence of flushing. There can be no
assurance, however, that patients using the Niaspan product will not suffer
episodes of flushing that they consider intolerable. The failure of physicians
to prescribe the Niaspan product or the failure of patients to continue taking
Niaspan due to intolerable flushing or to other side effects would have a
material adverse effect on the Company. Unanticipated side effects or
unfavorable publicity concerning the Niaspan product or any other product
incorporating technology similar to that used in the Niaspan product also could
have an adverse effect on the Company's ability to obtain regulatory approvals,
to achieve acceptance by prescribing physicians, managed care providers, or
patients; any of which would have a material adverse effect on the Company.
Uncertainties Related to FDA Approval of the Combination Product
The Company has submitted an NDA to the FDA for the Combination Product. If
the FDA believes that the results of the pivotal clinical trials for the
Combination Product do not establish the safety and efficacy of the Combination
Product in the treatment of any or all of the referenced indications, the
Company will not receive the approvals necessary to market the Combination
Product. Failure to obtain FDA approval to market the Combination Product on a
timely basis would have a material adverse effect on the Company, including
delaying or terminating the Company's right to receive milestone payments under
the co-promotion agreement for the Combination Product. The Company may be
required to conduct additional clinical trials in order to demonstrate the
safety and efficacy of the Combination Product. Such trials, among other things,
could delay the approval of the NDA for the Combination Product, which could
have a material adverse effect on the Company. There can be no assurance that
the Company will obtain regulatory approval for the commercialization of the
Combination Product on a timely basis, or at all.
22
History of Operating Losses; Uncertainty of Future Profitability
To date, the Company has dedicated most of its financial resources to the
development and commercialization of its Niaspan product, the development of
other products, and general and administrative expenses. The Company expects to
incur significant operating losses for at least the next twelve months, due
primarily to continued manufacturing and marketing, sales and administrative
expenses associated with the Niaspan product, with the anticipated commercial
launch of the Combination Product, and for investments in its research and
development programs. No assurance can be given that additional significant
losses will not continue thereafter. The Company's ability to achieve and
maintain profitability will depend, among other things, on the commercial
success of the Niaspan product; on the Company's ability to obtain regulatory
approval for and achieve market acceptance for the Combination Product; to
successfully exploit its manufacturing and sales and marketing capabilities; to
complete the development of, and obtain regulatory approvals for, and achieve
market acceptance for its other products under development; and on its ability
to maintain sufficient funds to finance its activities. As of December 31, 2000,
the Company's accumulated deficit was $274.9 million. In connection with the
transfer of operations from Holdings to the Company on June 30, 1996, net
operating loss carryforwards amounting to approximately $51.0 million and
related tax benefits remained with Holdings and were not transferred to the
Company. Consequently, the Company may utilize net operating loss carryforwards
sustained subsequent to June 30, 1996, amounting to $222.8 million as of
December 31, 2000, to offset future taxable net income, if any. There can be no
assurance, however, that the Company will be able to achieve profitability to
utilize such carryforwards or that profitability, if any, can be sustained.
Future Capital Needs; Uncertainty of Additional Funding
The Company has experienced negative cash flows from operations since its
inception. The Company has spent and will continue to be required to spend
substantial funds to continue research and development, including clinical
trials of its products under development, and to commercialize the Niaspan
product and its products under development if regulatory approvals are obtained
for such products under development. The Company believes that it has sufficient
resources, including funds available to the Company under certain funding
arrangements, to fund the operations of the Company until the Company achieves
positive cash flows. The Company, however, may need or may elect to raise
additional capital prior to such date. The Company's capital requirements will
depend on many factors, primarily relating to the near-term commercial success
of Niaspan; the Company's ability to obtain regulatory approval for, and
successfully market, the Combination Product; the Company's ability to meet the
conditions necessary to obtain funding under the Credit Facility and the Standby
Facility; the problems, delays, expenses and complications frequently
encountered by companies at this stage of development; the progress of the
Company's research, development, and clinical trial programs; the costs and
timing of seeking regulatory approvals of the Company's products under
development; the Company's ability to obtain such regulatory approvals; costs in
filing, prosecuting, defending, and enforcing patent claims and other
intellectual property rights; the extent and terms of any collaborative
research, manufacturing, marketing, or other arrangements; and changes in
economic, regulatory, or competitive conditions or the Company's planned
business. Estimates about the adequacy of funding for the Company's activities
are based on certain assumptions, including assumptions regarding the marketing
and sales success of the Company's Niaspan product, the regulatory and
commercial success of the Combination Product, and that testing and regulatory
procedures relating to the Company's products under development can be conducted
at projected costs and within projected time frames. There can be no assurances
that any of these assumptions will prove to be accurate.
23
To satisfy its capital requirements, the Company may seek to raise funds in
the public or private capital markets. The Company's ability to raise additional
funds in the public markets may be adversely affected if the Company's sales of
its Niaspan product do not increase rapidly, if the Company is not able to
obtain regulatory approval for, and successfully market, the Combination
Product, if the results of the Company's clinical trials for its products under
development are not favorable, or if regulatory approval for any of the
Company's products under development is not obtained. The Company may seek
additional funding through corporate collaborations and other financing
vehicles. There can be no assurance that any such funding will be available to
the Company, or if available, that it will be available on acceptable terms. If
adequate funds are not available, the Company may be required to curtail
significantly one or more of its research or development programs or it may be
required to obtain funds through arrangements with future collaborative partners
or others that may require the Company to relinquish rights to the Niaspan
product, to the Combination Product, or to some or all of its technologies or
products under development or take significant cost-reducing actions or both. If
the Company is successful in obtaining additional financing, the terms of the
financing may have the effect of diluting or adversely affecting the holdings or
the rights of the holders of Common Stock.
Limited Sales and Marketing Experience and Resources
Although the Company markets its Niaspan product and the Mavik and Tarka
products and intends to market the Combination Product and its other products
under development through its own specialty sales force, its current marketing
resources are limited. Substantial resources will continue to be required for
the Company to promote the sale of the Niaspan, Mavik and Tarka products, the
Combination Product, and its products under development. There can be no
assurance that the Company will be able to devote resources to the Niaspan,
Mavik and Tarka products, to the Combination Product, or to its other products
under development sufficient to achieve increasing market acceptance. The
Company's failure to expend the resources to adequately promote the Niaspan,
Mavik and Tarka products, the Combination Product, or its products under
development would have a material adverse effect on the Company.
Moreover, the Company has fewer sales persons than many of its competitors
and there can be no assurance that the Company's sales force will be able to
detail successfully physicians who prescribe lipid-altering medications. There
can be no assurance that the Company will be able to retain its current sales
representatives, that any additional representatives hired by the Company will
be immediately effective in promoting the sale of the Niaspan, Mavik and Tarka
products, or that the Company's sales representatives will be able to generate
significantly increased sales of the Niaspan, Mavik and Tarka products. The
failure of the Company's sales representatives to generate increased sales of
the Niaspan product would have a material adverse effect on the Company.
Control By Existing Shareholder
Michael Jaharis, the Chairman of the Board of Directors of the Company and
one of its founders, owns, directly or indirectly, approximately 46.6% of the
Common Stock outstanding as of December 31, 2000. Accordingly, this shareholder
can control the outcome of certain shareholder votes, including votes concerning
the election of directors, the adoption or amendment of provisions in the
Company's Articles of Incorporation, and the approval of mergers and other
significant corporate transactions. This level of concentrated ownership by one
person, along with the factors described in a subsequent section, "Anti-Takeover
Provisions," may have the effect of delaying or preventing a change in the
management or voting control of the Company. In addition, the Supplemental
Credit Facility gives Mr. Jaharis the right to convert (at $4.91 per share)
amounts owed to Mr. Jaharis by the Company into shares of the Company's Common
Stock and the Standby Facility gives Mr. Jaharis the right to exercise warrants
to purchase up to 6 million shares of the Company's Common Stock. If this
conversion option or warrant
24
exercise were to occur, Mr. Jaharis would own a significantly greater percentage
of the Company's outstanding Common Stock thus resulting in substantial dilution
to existing shareholders.
Competition and Technological Change
Many products are commercially available for the treatment of elevated LDL
cholesterol, and the manufacturers of such products, individually and
collectively, have significantly greater financial resources and sales and
manufacturing capabilities than the Company, including a combined field sales
force exceeding 12,000 representatives compared with the Company's approximately
200-person field sales force. The Company estimates that its existing Niaspan
prescriptions account for approximately 1.6% of the total prescriptions
currently being written in the United States for cholesterol-lowering
pharmaceutical compounds. There can be no assurance that Niaspan, the
Combination Product, or any other product developed by the Company will be able
to compete successfully with any of those products or that the Company will be
able to overcome such competition and achieve increasing sales of its Niaspan
product. Moreover, the active ingredient in Niaspan, niacin, is available in
several other formulations, most of which do not require a prescription.
Although the Company believes that there are no other currently available niacin
formulations that have been approved by the FDA specifically for once-a-day
dosing, there can be no assurance that physicians will not prescribe or
recommend some of these unapproved niacin formulations, using the Niaspan
product's dosing regimen, to try to achieve the same results as Niaspan.
Substitution of other niacin formulations for the Niaspan product could have a
material adverse effect on the Company. Moreover, manufacturers of other niacin
formulations could promote their products using the Niaspan product's dosing
regimen and could promote the sale of their products to treat the indications
for which the Company has received clearance to market Niaspan. Although such
promotion would be a violation of FDA regulations, the occurrence of such
practices would have a material adverse effect on the Company. Moreover, many
established pharmaceutical and biotechnology companies, universities, and other
research institutions with resources significantly greater than the Company's
may develop products that directly compete with the Company's products. Even if
the Company's products under development prove to be more effective than those
developed by other entities, such other entities may be more successful in
marketing their products than the Company because of greater financial
resources, stronger sales and marketing efforts, and other factors. These
entities may succeed in developing products that are safer, more effective or
less costly than the products developed by the Company. There can be no
assurance that any products developed by the Company will be able to compete
successfully with any of those products.
No Assurance of Adequate Third-Party Reimbursement
The Company's ability to commercialize successfully its products under
development is dependent in part on the extent to which appropriate levels of
reimbursement for the Niaspan product, the Combination Product, or for the
Company's products under development are obtained from government authorities,
private health insurers, and managed care organizations such as health
maintenance organizations ("HMOs"). Managed care organizations and other
third-party payors are increasingly challenging the pricing of pharmaceutical
products. The trend toward managed healthcare in the United States, the growth
of organizations such as HMOs, and legislative proposals to reform healthcare
and government insurance programs could significantly influence the purchase of
pharmaceutical products, resulting in lower prices and reduced demand for
Niaspan, the Combination Product, or the Company's products under development.
Such cost containment measures and potential legislative reform could affect the
Company's ability to sell Niaspan, the Combination Product, or its products
under development and may have a material adverse effect on the Company.
Significant uncertainty exists about the reimbursement status of newly approved
pharmaceutical products. Although the Company has obtained approvals for
reimbursement for the cost of Niaspan from many third-party payers, there can be
no
25
assurance that the Company will be able to maintain such approvals. There can be
no assurance that reimbursement in the United States or foreign countries will
be available for Niaspan, the Combination Product, or any of the Company's
products under development, that any reimbursement granted will be maintained,
or that limits on reimbursement available from third-party payors will not
reduce the demand for, or negatively affect the price of, Niaspan, the
Combination Product, or the Company's products under development. The
unavailability or inadequacy of third-party reimbursement for Niaspan, the
Combination Product, or the Company's products under development would have a
material adverse effect on the Company.
Dependence on Key Personnel
The success of the Company is dependent on its ability to attract and
retain highly qualified scientific, management and sales personnel. The Company
faces intense competition for personnel from other companies, academic
institutions, government entities, and other organizations. There can be no
assurance that the Company will be successful in attracting and retaining key
personnel. The loss of key personnel, or the inability to attract and retain the
additional, highly-skilled employees required for the expansion of the Company's
activities, could adversely affect the Company's results of operations and its
business.
Products Under Development
Although the Company obtained clearance from the FDA to market the Niaspan
product, there can be no assurance that the Company will be able to successfully
formulate any of its other products as planned, or that the Company will be
successful in demonstrating the safety and efficacy of such products in human
clinical trials. These trials may be costly and time-consuming. The
administration of any product the Company develops may produce undesirable side
effects that could result in the interruption, delay or suspension of clinical
trials, or the failure to obtain FDA or other regulatory approval for any or all
targeted indications. Even if regulatory approval is secured, the Company's
products under development may later produce adverse effects that limit or
prevent their widespread use or that necessitate their withdrawal from the
market. The Company may discontinue the development of any of its products under
development at any time.
Patents and Trademarks; Interference
The Company's ability to commercialize any of its products under
development will depend, in part, on its or its licensors' ability to obtain
patents, enforce those patents, preserve trade secrets, and operate without
infringing on the proprietary rights of third parties. In addition, the patents
for which the Company has applied relating to Niaspan and certain other of the
Company's products under development are based on, among other things, the timed
administration of Niaspan. If the indications treated by Niaspan and such other
products under development could be treated using drugs without such timed
administration, the Company's patents, if issued, would not prevent the use of
such drugs for the treatment of such indications, which would have a material
adverse effect on the Company. There can be no assurance that the patent
applications licensed to or owned by the Company will result in issued patents,
that patent protection will be secured for any particular technology, that any
patents that have been or may be issued to the Company or its licensors will be
valid or enforceable or that any patents will provide meaningful protection to
the Company.
In general, the U.S. patents and patent applications owned by or licensed
to the Company are method-of-use patents that cover the timed use of certain
compounds to treat specified conditions. Composition-of-matter protection is not
available for the active ingredient in Niaspan. The active
26
ingredient in Niaspan, niacin, is currently sold in the United States and other
markets for lipid altering and for other uses. Even in jurisdictions where the
use of the active ingredient in Niaspan for lipid altering and other indications
may be covered by the claims of a use patent licensed to the Company, off-label
sales might occur, especially if another company markets the active ingredient
at a price that is less than the price of Niaspan, thereby potentially reducing
the sales of Niaspan.
The U.S. Patent and Trademark Office ("PTO") has issued U.S. Patents
numbers 6,129,930 and 6,080,428 to the Company with claims covering Niaspan's
method-of-use consistent with its recommended once-a-day dosing regimen. On
February 7, 1997, the Company and a privately owned generic manufacturer which
allegedly claims the same dosing regimen invention as that of the Niaspan
product, entered into a cross-licensing agreement (the "License Agreement")
pursuant to which the parties agreed to resolve, as between themselves, the
effects of such potential interference by granting licenses under their
respective patents.
The Company is aware that certain European and U.S. patents have been
issued with claims covering products that contain certain non-CFC
propellant-driven aerosol formulations. The European patents are currently
subject to an opposition proceeding in Europe, and certain claims in such
patents have been held invalid in the United Kingdom. Certain or all of the
Company's aerosol products under development may use a formulation covered by
such European or U.S. patents. In such event, the Company would be prevented
from making, using or selling such products unless the Company obtains a license
under such patents, which license may not be available on commercially
reasonable terms, or at all, or unless such patents are determined to be invalid
or unenforceable in Europe or the United States, respectively. The Company's
development of products that are covered by such patents and its failure to
obtain licenses under such patents in the event such patents are determined to
be valid and enforceable could have an adverse effect on the Company's business.
The patent positions of pharmaceutical and biotechnology companies are
highly uncertain and involve complex legal and factual questions. There can be
no assurance that the patents owned and licensed by the Company, or any future
patents, will prevent other companies from developing similar or therapeutically
equivalent products or that others will not be issued patents that may prevent
the sale of Company products or require licensing and the payment of significant
fees or royalties by the Company. Furthermore, there can be no assurance that
any of the Company's future products or methods will be patentable, that such
products or methods will not infringe upon the patents of third parties, or that
the Company's patents or future patents will give the Company an exclusive
position in the subject matter claimed by those patents. The Company may be
unable to avoid infringement of third party patents and may have to obtain a
license, defend an infringement action, or challenge the validity of the patents
in court. There can be no assurance that a license will be available to the
Company, if at all, on terms and conditions acceptable to the Company, or that
the Company will prevail in any patent litigation. Patent litigation is costly
and time consuming, and there can be no assurance that the Company will have or
will devote sufficient resources to pursue such litigation. If the Company does
not obtain a license under such patents, is found liable for infringement or is
not able to have such patents declared invalid, the Company may be liable for
significant money damages, may encounter significant delays in bringing products
to market, or may be precluded from participating in the manufacture, use, or
sale of products or methods of treatment requiring such licenses.
The Company also relies on trade secrets and other unpatented proprietary
information in its product development activities. To the extent that the
Company relies on trade secrets and unpatented know-how to maintain its
competitive technological position, there can be no assurance that others may
not independently develop the same or similar technologies. The Company seeks to
protect trade secrets and proprietary knowledge in part through confidentiality
agreements with its employees, consultants,
27
advisors and collaborators. Nevertheless, these agreements may not effectively
prevent disclosure of the Company's confidential information and may not provide
the Company with an adequate remedy in the event of unauthorized disclosure of
such information. If the Company's employees, scientific consultants or
collaborators develop inventions or processes independently that may be
applicable to the Company's products under development, disputes may arise about
ownership of proprietary rights to those inventions and processes. Such
inventions and processes will not necessarily become the Company's property, but
may remain the property of those persons or their employers. Protracted and
costly litigation could be necessary to enforce and determine the scope of the
Company's proprietary rights. Failure to obtain or maintain patent and trade
secret protection, for any reason, would have a material adverse effect on the
Company.
The Company engages in collaborations, sponsored research agreements, and
other arrangements with academic researchers and institutions that have received
and may receive funding from U.S. government agencies. As a result of these
arrangements, the U.S. government or certain third parties may have rights in
certain inventions developed during the course of the performance of such
collaborations and agreements as required by law or such agreements. Several
legislative bills affecting patent rights have been introduced in the United
States Congress. These bills address various aspects of patent law, including
publication, patent term, re-examination subject matter and enforceability. It
is not certain whether any of these bills will be enacted into law or what form
such new laws may take. Accordingly, the effect of such potential legislative
changes on the Company's intellectual property estate is uncertain.
Government Regulation; No Assurances of Regulatory Approval
The Company's research and development activities, preclinical studies,
clinical trials, and the manufacturing and marketing of its products are
currently subject to extensive regulation by the FDA and may in the future be
subject to foreign regulations. The drug approval process takes many years and
requires the expenditure of substantial resources. Data obtained from
preclinical and clinical activities are susceptible to varying interpretations
that could delay, limit, or prevent regulatory approval. Although the Company
may consult the FDA for guidance in developing protocols for clinical trials,
that consultation provides no assurance that the FDA will accept the clinical
trials as adequate or well-controlled or accept the results of those trials. In
addition, delays or rejections of applications for regulatory approval may
result from changes in or additions to FDA regulations concerning the drug
approval process. Similar delays may also be encountered in foreign countries.
There can be no assurance that any regulatory review will be conducted in a
timely manner or that regulatory approvals will be obtained for any products
developed by the Company. Even if regulatory approval of a product is obtained,
the approval may be limited as to the indicated uses for which it may be
promoted or marketed. In addition, a marketed drug, its bulk chemical supplier,
its manufacturer and its manufacturing facilities are subject to continual
regulatory review and periodic inspections, and later discovery of previously
unknown problems with a product, supplier, manufacturer or facility may result
in restrictions on such products or manufacturers, which may require a
withdrawal of the product from the market. Failure to comply with the applicable
regulatory requirements can, among other things, result in fines, suspensions of
regulatory approvals, product recalls, operating restrictions and criminal
prosecution, any of which could have a material adverse effect on the Company.
The Company's business is also subject to regulation under state, federal
and local laws, rules, regulations and policies relating to the protection of
the environment and health and safety, including those governing the use,
generation, manufacture, storage, air emission, effluent discharge, handling and
disposal of certain materials. The Company believes that it is in compliance in
all material respects with all such laws, rules, regulations and policies
applicable to the Company. There can be no assurance that
28
the Company will not be required to incur significant costs to comply with such
environmental and health and safety laws and regulations in the future. The
Company's research and development involves the controlled use of hazardous
materials. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by
applicable state, federal and local regulations, the risk of contamination or
injury from these materials cannot be completely eliminated. In the event of
such contamination or injury, the Company could be held liable for any damages
that result and any such liability could exceed the resources of the Company and
materially adversely affect the Company's business, financial condition and
results of operations.
Dependence on Collaborators
The Company relies on various third parties for certain aspects of the
development and promotion of the Company's presently planned or future products,
including the Company's Combination Product. There can be no assurance that the
Company will be able to enter into future collaborative arrangements on
favorable terms, or at all. Even if the Company is successful in entering into
such collaborative agreements, there can be no assurance that any such
arrangement will be successful. The success of any such arrangement is dependent
on, among other things, the skills, experience and efforts of the third party's
employees responsible for the project, the third party's commitment to the
arrangement, and the financial condition of the third party, all of which are
beyond the control of the Company.
Limited Manufacturing Experience; Risk of Scale-Up
The Company manufactures the Niaspan product in one manufacturing plant
that has been inspected and approved by the FDA, and it expects to manufacture
the Combination Product in another manufacturing plant where the clinical
materials for its products under development are currently being manufactured.
The Company believes both plants operate in substantial compliance with current
Good Manufacturing Practices ("cGMP") regulations for the manufacture of
pharmaceutical products. The Company may need to further scale-up certain of its
current manufacturing processes to achieve production levels consistent with the
commercial sale of its products. Further, modifications to the facilities,
systems and procedures may be necessary to maintain capacity at a level
sufficient to meet market demand or to maintain compliance with cGMP regulations
and other regulations prescribed by various regulatory agencies including the
Occupational Safety and Health Administration and the Environmental Protection
Agency. Failure by the Company to successfully further scale-up, expand in
connection with manufacture for commercial sale, or modify its manufacturing
process or to comply with cGMP regulations and other regulations could delay the
approval of the Company's products under development or limit the Company's
ability to meet the demand for its products, either of which would have a
material adverse effect on the Company. Such occurrences may require the Company
to acquire alternative means of manufacturing its products, which may not be
available to the Company on a timely basis, on commercially practicable terms,
or at all.
Dependence on Single Sources of Supply
Some materials used in the Company's products, including niacin, the active
ingredient in Niaspan, are currently sourced from a single qualified supplier.
The Company does not have a contractual arrangement with its sole supplier of
niacin. Although the Company has not experienced difficulty to date in acquiring
niacin, or other materials for product development, no assurance can be given
that supply interruptions will not occur in the future or that the Company will
not have to obtain substitute materials, which would require additional product
validations and regulatory submissions. Any such interruption of supply could
have a material adverse effect on the Company's ability to manufacture its
products or to obtain or maintain regulatory approval of such products.
29
Risk of Product Liability Claims; No Assurance of Adequate Insurance
Manufacturing, marketing, selling, and testing Niaspan, the Combination
Product, and the Company's products under development entails a risk of product
liability. The Company could be subject to product liability claims in the event
the Company's products or products under development fail to perform as
intended. Even unsuccessful claims could result in the expenditure of funds in
litigation and the diversion of management time and resources and could damage
the Company's reputation and impair the marketability of the Company's products.
While the Company maintains liability insurance, there can be no assurance that
a successful claim could not be made against the Company, that the amount of
indemnification payments or insurance would be adequate to cover the costs of
defending against or paying such a claim, or that damages payable by the Company
would not have a material adverse effect on the Company's business, financial
condition, and results of operations and on the price of the Company's Common
Stock.
Shares Eligible for Future Sale; Registration Rights
The Company has granted certain registration rights to the Company's
controlling shareholder and to Kos Investments, Inc. which entitle such entities
to cause the Company to effect three registrations under the Securities Act of
sales of shares of the Company's Common Stock owned by such entities. These
registration rights generally would also permit the holders of such rights to
include shares in any registration statement otherwise filed by the Company. By
exercising these registration rights, these entities could cause a large number
of shares to be registered and become freely tradeable without restrictions
under the Securities Act (except for those purchased in the offering by
affiliates of the Company) immediately upon the effectiveness of such
registration. Such sales may have an adverse effect on the market price of the
Common Stock and could impair the Company's ability to raise additional capital.
Possible Stock Price Volatility
The stock market, including the Nasdaq National Market, on which the
Company's shares are listed, has from time to time experienced significant price
and volume fluctuations that may be unrelated to the operating performance of
particular companies. In addition, the market price of the Company's Common
Stock, like the stock prices of many publicly traded pharmaceutical and
biotechnology companies, has been and may continue to be highly volatile. The
sale by the Company's controlling shareholder or members of the Company's
management of shares of Common Stock, announcements of technological innovations
or new commercial products by the Company or its competitors, developments or
disputes concerning patent or proprietary rights, publicity regarding actual or
potential medical results relating to the Niaspan product, the Combination
Product, or to products under development by the Company or its competitors,
regulatory developments in either the United States or foreign countries, public
concern as to the safety of pharmaceutical and biotechnology products and
economic and other external factors, as well as the trend of prescriptions for
the Niaspan product and the period-to-period fluctuations in sales or other
financial results, among other factors, may have a significant impact on the
market price of the Common Stock.
30
Anti-Takeover Provisions
Certain provisions of the Company's Articles of Incorporation and Bylaws,
as well as the Florida Business Corporation Act, 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 the Common 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. Moreover,
certain provisions of the Company's Articles of Incorporation or Bylaws
generally permit removal of directors only for cause by a 60% vote of the
shareholders of the Company, require a 60% vote of the shareholders to amend the
Company's Articles of Incorporation or Bylaws, require a demand of at least 50%
of the Company's shareholders to call a special meeting of shareholders, and
prohibit shareholder actions by written consent.
31
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's exposure to market risk is limited primarily to fluctuating
interest rates associated with variable rate indebtedness that is subject to
interest rate changes in the United States. The Company does not use, nor has it
historically used, derivative financial instruments to manage or reduce market
risk. At December 31, 2000, the Company had $72 million of variable rate
indebtedness bearing interest at the prime rate (9.5% at December 31, 2000).
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated financial statements and supplementary data required by this
item can be found at the pages listed in the following index.
Page
----
Financial Statements:
Report of Independent Certified Public Accountants................. 33
Consolidated Balance Sheets at December 31, 2000 and 1999.......... 34
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998............................... 35
Consolidated Statements of Shareholders' Equity (Deficit) for
the period December 31, 1997 to December 31, 2000.............. 36
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998............................... 37
Notes to Consolidated Financial Statements......................... 38
Financial Statement Schedule:*
Report of Independent Certified Public Accountants on Schedule II.. 53
Schedule II. Valuation and Qualifying Accounts..................... 54
-----
*All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and
therefore not included herein.
32
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To Kos Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Kos
Pharmaceuticals, Inc. (a Florida corporation) and subsidiary as of December 31,
2000 and 1999, and the related consolidated statements of operations,
shareholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. 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 Kos Pharmaceuticals, Inc.
and subsidiary as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
ARTHUR ANDERSEN LLP
Miami, Florida,
February 2, 2001.
33
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31,
-------------------------------
2000 1999
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents ...................................... $ 6,125,437 $ 4,336,326
Trade accounts receivable, net ................................. 9,602,734 6,976,972
Inventories, net ............................................... 1,826,053 1,085,849
Prepaid expenses and other current assets ...................... 3,272,726 2,610,412
------------- -------------
Total current assets ....................................... 20,826,950 15,009,559
Fixed Assets, net ................................................. 7,914,458 10,430,043
Goodwill .......................................................... 722,864 803,182
Other Assets ...................................................... 184,051 15,323
------------- -------------
Total assets ............................................... $ 29,648,323 $ 26,258,107
============= =============
LIABILITIES AND SHAREHOLDERS'
DEFICIT
Current Liabilities:
Accounts payable ............................................... $ 3,012,861 $ 2,820,840
Accrued expenses ............................................... 15,353,719 12,450,035
Deferred revenue ............................................... 4,322,460 1,980,000
Capital lease obligations ...................................... 49,145 112,641
------------- -------------
Total current liabilities .................................. 22,738,185 17,363,516
------------- -------------
Notes Payable to Shareholder ...................................... 72,000,000 62,000,000
Capital Lease Obligations, net of current portion ................. -- 89,145
Commitments and Contingencies (Notes 1, 11 and 13)
Shareholders' Deficit:
Preferred stock, $.01 par value, 10,000,000 shares authorized,
none issued and outstanding ................................ -- --
Common stock, $.01 par value, 50,000,000 shares authorized,
19,947,061 and 18,026,024 shares issued and outstanding as of
December 31, 2000 and 1999, respectively .................... 199,471 180,260
Additional paid-in capital ..................................... 209,641,721 186,291,218
Accumulated deficit ............................................ (274,931,054) (239,666,032)
------------- -------------
Total shareholders' deficit ................................ (65,089,862) (53,194,554)
------------- -------------
Total liabilities and shareholders' deficit ................ $ 29,648,323 $ 26,258,107
============= =============
The accompanying notes are an integral part of these financial statements.
34
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year Ended December 31,
---------------------------------------------
2000 1999 1998
------------ ------------ ------------
Revenues, net ............................ $ 60,173,940 $ 36,339,514 $ 13,038,241
Cost of sales ............................ 5,931,637 5,405,960 3,276,153
------------ ------------ ------------
54,242,303 30,933,554 9,762,088
------------ ------------ ------------
Operating expenses:
Research and development .............. 26,458,963 25,618,870 29,143,527
Selling, general and administrative ... 56,831,657 56,843,187 61,519,514
------------ ------------ ------------
Total operating expenses ........... 83,290,620 82,462,057 90,663,041
------------ ------------ ------------
Loss from operations ..................... (29,048,317) (51,528,503) (80,900,953)
------------ ------------ ------------
Other:
Interest income, net .................. 323,400 169,326 1,792,796
Interest expense-related parties ...... (6,560,288) (3,206,521) (68,466)
Other income .......................... 20,183 13,471 15,181
------------ ------------ ------------
Total other income (expense) ...... (6,216,705) (3,023,724) 1,739,511
------------ ------------ ------------
Net loss .......................... $(35,265,022) $(54,552,227) $(79,161,442)
============ ============ ============
Net loss per share, basic and diluted .... $ (1.84) $ (3.06) $ (4.50)
Weighted average shares of Common
Stock outstanding, basic and diluted ... 19,202,877 17,842,879 17,589,767
The accompanying notes are an integral part of these financial statements.
35
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
Additional
Common Paid-in Accumulated
Stock Capital Deficit Total
--------- ------------- ------------- -------------
Balance at December 31, 1997 ................... $ 171,657 $ 183,650,564 $(105,952,363) $ 77,869,858
Common Stock issued to employees ............... 29 33,872 -- 33,901
Stock options issued to non-employees .......... -- 380,815 -- 380,815
Exercise of stock options ...................... 5,517 533,594 -- 539,111
Net loss ....................................... -- -- (79,161,442) (79,161,442)
--------- ------------- ------------- -------------
Balance at December 31, 1998 ................... 177,203 184,598,845 (185,113,805) (337,757)
Common Stock granted to employees under
Kos Savings Plan ............................ 1,071 572,484 -- 573,555
Issuance of Common Stock in connection with
acquisition of assets of IEP Group, Inc. .... 750 392,250 -- 393,000
Issuance of Common Stock to employees under
Stock Purchase Plan ......................... 688 301,369 -- 302,057
Stock options issued to non-employees .......... -- 300,000 -- 300,000
Exercise of stock options ...................... 548 126,270 -- 126,818
Net loss ....................................... -- -- (54,552,227) (54,552,227)
--------- ------------- ------------- -------------
Balance at December 31, 1999 ................... 180,260 186,291,218 (239,666,032) (53,194,554)
Common Stock granted to employees under
Kos Savings Plan ............................ 390 535,884 -- 536,274
Issuance of Common Stock to a third party ...... 12,500 19,987,500 -- 20,000,000
Issuance of Common Stock to employees under
Stock Purchase Plan ......................... 1,591 717,447 -- 719,038
Exercise of stock options ...................... 4,730 2,109,672 -- 2,114,402
Net loss ....................................... -- -- (35,265,022) (35,265,022)
--------- ------------- ------------- -------------
Balance at December 31, 2000 ................... $ 199,471 $ 209,641,721 $(274,931,054) $ (65,089,862)
========= ============= ============= =============
The accompanying notes are an integral part of these financial statements.
36
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31,
----------------------------------------------
2000 1999 1998
------------ ------------ ------------
Cash Flows from Operating Activities:
Net loss ...................................................................... $(35,265,022) $(54,552,227) $(79,161,442)
Adjustments to reconcile net loss to net cash used
in operating activities -
Provision for doubtful accounts ............................................. 50,000 160,100 20,000
Depreciation and amortization ............................................... 3,254,338 3,010,462 2,202,251
Provision for inventory obsolescence ........................................ 420,000 640,737 259,500
Gains from disposals of fixed assets ........................................ (20,183) (13,471) (15,181)
Common stock issued to employees ............................................ 536,274 573,555 33,901
Stock options issued to non-employees ....................................... -- 300,000 380,815
Changes in operating assets and liabilities:
Trade accounts receivable ................................................. (2,675,762) (5,119,921) (217,140)
Inventories ............................................................... (1,160,204) (414,030) 1,810,812
Prepaid expenses and other current assets ................................. (662,314) (1,284,723) 547,173
Other assets .............................................................. (168,728) 1,424 14,289
Accounts payable .......................................................... 192,021 (1,512,163) 1,173,318
Accrued expenses .......................................................... 2,903,684 4,254,449 4,821,699
Deferred revenue .......................................................... 2,342,460 1,980,000 --
------------ ------------ ------------
Net cash used in operating activities .................................... (30,253,436) (51,975,808) (68,130,005)
------------ ------------ ------------
Cash Flows from Investing Activities:
Sales of marketable securities ................................................ -- -- 30,894,009
Acquisition of assets of IEP Group, Inc. ...................................... -- (700,000) --
Capital expenditures .......................................................... (638,252) (1,117,637) (6,876,341)
------------ ------------ ------------
Net cash provided by (used in) investing activities ...................... (638,252) (1,817,637) 24,017,668
------------ ------------ ------------
Cash Flows from Financing Activities:
Proceeds from issuance of Common Stock to employees under
Stock Purchase Plan ....................................................... 719,038 302,057 --
Net proceeds from issuance of Common Stock to a third party ................... 20,000,000 -- --
Net proceeds from exercise of stock options ................................... 2,114,402 126,818 539,111
Borrowings under Notes Payable to Shareholder ................................. 30,000,000 53,000,000 9,000,000
Payments of Note Payable to Shareholder ....................................... (20,000,000) -- --
Payments under capital lease obligations ...................................... (152,641) (177,745) (50,617)
------------ ------------ ------------
Net cash provided by financing activities ................................ 32,680,799 53,251,130 9,488,494
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents .................. 1,789,111 (542,315) (34,623,843)
Cash and Cash Equivalents, beginning of period .................................. 4,336,326 4,878,641 39,502,484
------------ ------------ ------------
Cash and Cash Equivalents, end of period ........................................ $ 6,125,437 $ 4,336,326 $ 4,878,641
============ ============ ============
Supplemental Disclosure of Cash Flow Information:
Interest paid.................................................................. $ 6,524,688 $ 3,309,299 $ 14,819
Supplemental Disclosure of Non-cash Information:
Acquisition of equipment under capital lease obligations....................... $ -- $ -- $ 430,148
Common Stock issued in connection with acquisition of assets
of IEP Group, Inc. ........................................................ $ -- $ 393,000 $ --
The accompanying notes are an integral part of these financial statements.
37
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
Kos Pharmaceuticals, Inc. ("Kos" or the "Company") develops prescription
pharmaceutical products principally for the cardiovascular and respiratory
markets.
On July 28, 1997, the Company obtained clearance from the U.S. Food and
Drug Administration to market Niaspan, its first product (Niaspan(R) is a
registered trademark of the Company). The Company began sales of the Niaspan
product during August 1997. Niaspan is a once-a-day, oral, solid dose
extended-release formulation of niacin for the treatment of hyperlipidemia, a
multiple lipid disorder that is a primary risk factor for coronary heart
disease. Niacin is a water soluble vitamin that has long been recognized as an
effective pharmacological agent for the treatment of multiple lipid disorders
including elevated LDL and low HDL cholesterol.
The Company expects to incur additional losses in the near-term due
primarily to its sales and marketing efforts associated with Niaspan and with
its single-tablet Niaspan/lovastatin combination product, and to research and
development activities in connection with its products under development. No
assurance can be given that the Company's products can be successfully marketed,
that products under development can be successfully formulated or manufactured
at acceptable cost and with appropriate quality, or that required regulatory
approvals will be obtained. The Company is subject to a number of other risks
including, but not limited to, uncertainties related to market acceptance,
future capital needs and uncertainty of additional funding, including its
ability to meet all of the conditions necessary to obtain funding under its
credit facilities with Michael Jaharis; uncertainties related to limited sales
and marketing experience; uncertainties related to patents and trademarks,
including interference and risk of infringement; uncertainties related to
competition and technological changes, government regulation, dependence on
product development collaborators, limited manufacturing experience and risk of
scale-up, dependence on single sources of supply, and no assurances of adequate
third party reimbursement. The likelihood of the success of the Company also
must be considered in light of the uncertainty caused by problems, expenses,
complications and delays frequently encountered in connection with the
development of new business ventures.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the results of the Company
and its subsidiary, Aeropharm. All intercompany accounts and transactions have
been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of 90 days or less to be cash equivalents.
38
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Components of inventory cost include
materials, labor, and manufacturing overhead. The Company considers factors such
as the amount of inventory on hand, estimated time required to sell such
inventories, remaining shelf life, and current market conditions to determine
whether inventories are stated at the lower of cost or market. Reserves are
provided as appropriate.
Long-Lived Assets
The Company evaluates the recoverability of long-lived assets not held for
sale by measuring the carrying amount of the assets against the estimated
undiscounted future cash flows associated with them. At the time such
evaluations indicate that the future undiscounted cash flows of certain
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are adjusted to their fair values. Based on these
evaluations, there were no adjustments to the carrying value of long-lived
assets in 2000 or 1999.
The Company evaluates the recoverability of long-lived assets held for sale
by comparing the asset's carrying amount with its fair value less cost to sell.
No assets were held for sale as of December 31, 2000 or 1999.
Goodwill
Goodwill consists of the excess of cost over the fair value of the net
assets acquired. The Company amortizes goodwill on a straight-line basis over
ten years. See Note 6.
Fair Value of Financial Instruments
As of December 31, 2000 and 1999, the carrying amount of cash and cash
equivalents, trade accounts receivable, and accounts payable approximates fair
value due to the short term nature of these accounts. The fair value of notes
payable is determined using interest rates in effect as of the balance sheet
date and, because interest expense is payable utilizing variable rates that
re-price frequently, the carrying value approximates fair value.
Concentration of Credit Risk
The Company maintains its cash and cash equivalents with a major financial
institution. The Company performs periodic evaluations of the relative credit
standing of this institution to limit its credit risk exposure.
The Company conducts a significant amount of its sales with a limited
number of large pharmaceutical wholesalers and warehousing chains. Accordingly,
71% of the trade accounts receivable before allowances at December 31, 2000,
were represented by five of these customers. The Company performs periodic
evaluations of the financial condition of all customers to limit its credit risk
exposure, but does not obtain collateral. The Company has no significant
off-balance-sheet concentrations of credit risk.
39
Revenue Recognition
Sales and the related cost of sales are recognized at the time product is
shipped. The Company's largest customers are distributors who warehouse product
and, in turn, sell that product to retailers and others. Net sales consist of
gross sales to the Company's customers less provisions for expected rebates and
chargebacks, discounts, and returns to customers and to managed care
organizations with whom the Company has contracts. These provisions totaled
$13,148,860 and $6,626,243, for the years ended December 31, 2000 and 1999,
respectively. Included in "Accrued expenses" in the accompanying consolidated
balance sheets are $5,327,651 and $3,235,576, at December 31, 2000 and 1999,
respectively, related to these provisions.
Deferred Revenue
The Company periodically evaluates the inventory position of its customers
to determine whether abnormally high inventory levels of the Niaspan product
exist throughout the product distribution channel. If any such inventory levels
are identified, the Company's policy is to defer recognition of the revenue and
related expenses associated with the excess inventory held by customers until
the amount of such inventories returns to normal levels. During the second half
of 2000 and 1999, certain of the Company's customers purchased abnormally high
levels of the Niaspan product. As a result, as of December 31, 2000 and 1999,
the level of the Niaspan product warehoused by these customers was well above
normal levels. Accordingly, the Company deferred recognition of $4.8 million in
gross revenues and related expenses associated with 2000 product shipments, and
of $2.8 million in gross revenues and related expenses associated with 1999
product shipments, until such time as the level of the Niaspan product
warehoused by these customers returns to normal levels. Included in "Deferred
revenue" in the accompanying consolidated balance sheets are $4,322,000 and
$1,980,000, as of December 31, 2000 and 1999, respectively, representing
payments received on Niaspan product shipments for which revenue recognition had
been deferred.
Co-Promotion and Strategic Alliance Arrangement
During 1999 the Company entered into a co-promotion collaboration agreement
with Knoll Pharmaceutical Company ("Knoll"), for the promotion and marketing of
Knoll's Mavik and Tarka (Mavik(R) and Tarka(R) are registered trademarks of
Knoll Pharmaceutical Company) products within the United States (the "Knoll
Agreement"). Under the terms of the Knoll Agreement, the Company receives an
increasing percentage of revenue based on sales thresholds. The Company recorded
$5.0 million and $2.7 million of co-promotion revenue as a result of the Knoll
Agreement for the years ended December 31, 2000 and 1999, respectively.
The Company entered into an agreement, effective May 3, 2000, with DuPont
Pharmaceuticals Company ("DuPont") to form a strategic alliance for the purpose
of co-promoting the Company's single-tablet Niaspan/lovastatin combination
product (the "Combination Product"), now in development, in the United States
and Canada (the "DuPont Agreement"). Under the terms of the DuPont Agreement,
the Company and DuPont will share in the future development and
commercialization of the Company's Combination Product. Specifically, DuPont
agreed (i) to make equity investments in the Company up to $30 million through
the date of Food and Drug Administration ("FDA") approval of the Combination
Product; (ii) to pay the Company $17.5 million in milestone payments upon FDA
approval of the Combination Product; (iii) to fund up to $32.5 million for
future clinical development of the Combination Product; and (iv) to share
equally in the costs associated with promoting the Combination Product and share
equally in product profits after deducting a royalty to the Company. On May 31,
2000, DuPont made a $20-million equity investment in the Company in exchange for
1,250,000 shares of the Company's Common Stock.
40
Depreciation and Amortization
Fixed assets are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of the assets or lease terms as follows:
Years
-----
Furniture and equipment......................... 3-7
Computer software and hardware.................. 3-5
Laboratory and manufacturing equipment.......... 3-5
Leasehold improvements.......................... Lives of leases
Research and Development Expenses
All research and development expenses are reflected in the Company's
consolidated statements of operations as incurred.
Advertising Expense
The Company records the cost of its advertising efforts when services are
performed or goods are delivered. The Company recorded $1,075,000, $1,508,000
and $4,532,000 in advertising expense for the years ended December 31, 2000,
1999 and 1998, respectively.
Net Loss Per Share
Basic loss per share is determined by dividing the Company's net loss by
the weighted average number of shares of Common Stock outstanding. Diluted loss
per share also includes dilutive Common Stock equivalents outstanding after
applying the "treasury stock" method. The Company's basic and diluted earnings
per share are the same, because the Company's Common Stock equivalents are
antidilutive. The following Common Stock equivalents have been excluded from the
calculation of weighted average shares outstanding:
December 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
Stock options outstanding ................. 4,360,587 3,077,840 2,857,215
Convertible debt ($50 million at $4.91
per share - See Note 8) ................ 10,183,299 6,517,312 --
Non-detachable warrants (at $5.00
per share - See Note 8) ................ 2,400,000 -- --
---------- ---------- ----------
Total ............................... 16,943,886 9,595,152 2,857,215
========== ========== ==========
41
Income Taxes
The Company follows Statement of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes", which requires, among other things,
recognition of future tax benefits measured at enacted rates attributable to
deductible temporary differences between financial statement and income tax
bases of assets and liabilities and to tax net operating loss carryforwards to
the extent that realization of said benefits is more likely than not. The net
operating loss carryforwards attributable to a predecessor of the Company,
amounting to approximately $51 million, were not transferred to the Company. As
of December 31, 2000, the Company had available approximately $222.8 million of
net operating loss carryforwards that expire between 2011 and 2015. Due to the
uncertainty of the Company's ability to generate sufficient taxable income in
the future to utilize such loss carryforwards, the net deferred tax asset has
been fully reserved.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
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. Significant estimates and assumptions made by management in
the preparation of the accompanying financial statements include the allowance
for doubtful accounts; reserves for product returns, chargebacks, rebates and
discounts; estimation of customer inventory levels; and valuation allowance on
deferred income taxes. Actual results could differ from those estimates.
Reporting of Comprehensive Income or Loss
SFAS No. 130 "Reporting Comprehensive Income", establishes standards of
reporting and display of comprehensive income and its components in a full set
of financial statements. Comprehensive income or loss refers to revenues,
expenses, gains and losses that are not included in net income or loss but
rather are recorded directly in stockholders' equity, such as certain unrealized
gain or loss items. The Company's reported loss equals comprehensive loss for
all periods presented.
Recent Accounting Pronouncements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), as amended, is effective for fiscal years ended after
June 15, 2000. The Company adopted SFAS 133 effective June 30, 1998, however,
the Company does not presently have any derivative or hedging-type investment as
defined by SFAS 133.
On December 3, 1999, the staff of the SEC published Staff Accounting
Bulletin 101, "Topic 13: Revenue Recognition" ("SAB 101") to provide guidance on
the recognition, presentation and disclosure of revenue in financial statements.
Specific items discussed in SAB 101 include up-front fees when the seller has
significant continuing involvement and the amount of revenue recognized when the
seller is acting as a sales agent or in a similar capacity. SAB 101 also
provides guidance on disclosures that should be made for revenue recognition
policies and the impact of events and trends on revenue. The Company adopted the
provisions of SAB 101 for the year ended December 31, 2000. The adoption of SAB
101 did not have a material effect on the Company's financial position or
results of operations.
42
In March 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving
Stock Compensation", an interpretation of Accounting Principles Board Opinion
No. 25 ("Opinion 25"). FIN 44 clarifies (a) the definition of "employee" for
purposes of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequence of various
modifications to the terms of previously fixed stock options or awards, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 was effective July 1, 2000. The application of FIN 44 did
not have a material impact on the Company's results of operations, financial
position, or cash flows.
In May 2000, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus on Issue No. 00-14, "Accounting for Certain Sales Incentives" ("EITF
Issue No. 00-14"), which addresses the recognition, measurement, and income
statement classification for sales incentives offered by vendors to customers.
The Company adopted the provisions of EITF Issue No. 00-14 during the year ended
December 31, 2000. The adoption of EITF Issue No. 00-14 did not have a material
impact on Kos' financial condition or results of operations.
In September 2000, the EITF reached a consensus on Issue No. 00-10,
"Accounting for Shipping and Handling Revenues and Costs" ("EITF Issue No.
00-10"), which addresses the income statement classification of shipping and
handling revenues and related costs. The Company adopted the provisions of EITF
Issue No. 00-10 during the year ended December 31, 2000. The adoption of EITF
Issue No. 00-10 did not have a material impact on Kos' financial condition or
results of operations.
3. Trade Accounts Receivable, net
Trade accounts receivable consist of the following:
December 31,
--------------------------
2000 1999
----------- -----------
Trade accounts receivable ............. $ 9,802,802 $ 7,215,072
Less allowance for doubtful accounts .. (200,068) (238,100)
----------- -----------
Trade accounts receivable, net ..... $ 9,602,734 $ 6,976,972
=========== ===========
4. Inventories, net
Inventories consist of the following:
December 31,
--------------------------
2000 1999
------------ -----------
Raw materials ......................... $ 257,326 $ 205,533
Work in process ....................... 446,834 269,379
Finished goods ........................ 1,121,893 610,937
----------- -----------
Total inventories ................... $ 1,826,053 $ 1,085,849
=========== ===========
43
5. Fixed Assets, net
Fixed assets consist of the following:
December 31,
---------------------------
2000 1999
------------ ------------
Furniture and equipment ................. $ 1,569,248 $ 1,628,011
Computer software and hardware .......... 2,910,888 2,665,213
Laboratory and manufacturing equipment .. 8,552,550 8,549,958
Leasehold improvements .................. 5,384,910 5,283,291
------------ ------------
Fixed assets, gross ................... 18,417,596 18,126,473
Less accumulated depreciation and
amortization .......................... (10,503,138) (7,696,430)
------------ ------------
Fixed assets, net ..................... $ 7,914,458 $ 10,430,043
============ ============
6. Goodwill
In late 1999, the Company acquired, for total consideration of $1.1
million, substantially all of the assets and intellectual property of IEP Group,
Inc. (the "IEP Acquisition"). In connection with this transaction, the Company
recorded goodwill of $803,182 representing the excess of the cost of the assets
acquired over their estimated fair value. The pre-acquisition results of IEP
were not material to the Company's results of operations. The Company recognized
goodwill amortization expense of $80,318 for the year ended December 31, 2000.
7. Accrued Expenses
Major components of accrued expenses are as follows:
December 31,
---------------------------
2000 1999
------------ ------------
Employee commissions and bonuses ...... $ 2,316,758 $ 2,169,912
Employee vacations .................... 1,143,592 1,126,105
Clinical studies ...................... 1,740,900 1,226,878
Managed care rebates and chargebacks .. 4,602,574 3,044,246
All other ............................. 5,549,895 4,882,894
------------ ------------
Total accrued expenses .............. $ 15,353,719 $ 12,450,035
============ ============
44
8. Notes Payable to Shareholder
On July 1, 1998, the Company entered into a $30-million credit facility
(the "Credit Facility") with Michael Jaharis, the Company's Chairman and its
principal shareholder. On June 9, 2000, in order to reduce interest costs, the
Company utilized the proceeds of the $20-million equity contribution from DuPont
to pay-off borrowings made under the Credit Facility. In connection with this
loan repayment, Mr. Jaharis agreed to continue to make available to the Company
the full original borrowing capacity of the Credit Facility provided that future
Company borrowings from Mr. Jaharis be first made from the existing borrowing
capacity of Mr. Jaharis' other credit lines with Kos. All other terms of the
Credit Facility remain in full force and effect. Borrowings under the Credit
Facility, which totaled $10 million at December 31, 2000, bear interest at the
prime rate (9.5% as of December 31, 2000), and are due December 31, 2002.
On September 1, 1999, the Company formally agreed to the terms of an
additional $50-million funding arrangement initially committed to by Mr. Jaharis
on October 7, 1998 (the "Supplemental Credit Facility"). Borrowings under the
Supplemental Credit Facility totaled $50 million as of December 31, 2000, bear
interest at the prime rate, are convertible (at $4.91 per share) into shares of
the Company's Common Stock, and will be due December 31, 2003.
On December 21, 1999, Mr. Jaharis agreed to extend another $50-million loan
to the Company (the "Standby Facility"). Borrowings made under the Standby
Facility totaled $12 million as of December 31, 2000, are due June 20, 2005, and
are also subject to most of the terms and conditions of borrowings made under
the Supplemental Credit Facility. Borrowings made under the Standby Facility are
not, however, convertible into shares of the Company's Common Stock. In lieu of
a conversion feature, the Company granted to Mr. Jaharis non-detachable warrants
to purchase up to 6,000,000 shares of the Company's Common Stock at $5.00 per
share, which approximates the market value of the Company's Common Stock on the
effective date of this Standby Facility. The warrants are exercisable at any
time until June 30, 2006.
9. Major Customers
Sales to customers that were at least 10% of the Company's gross sales are
as follows:
December 31,
-------------------------------------------------------
2000 1999 1998
--------------- ---------------- ----------------
Customer A............................................ $17,611,515 $12,376,801 $4,186,863
Customer B............................................ 13,113,597 7,781,733 2,610,655
Customer C............................................ 6,693,483 7,233,560 1,860,512
--------------- ---------------- ----------------
Total.............................................. $37,418,595 $27,392,094 $8,658,030
=============== ================ ================
45
10. Quarterly Financial Information (Unaudited)
The following table summarizes selected quarterly financial data of the
Company for the year ended December 31, 2000 and 1999 (in thousands, except per
share data):
First Second Third Fourth Full
Quarter Quarter Quarter Quarter Year
----------- ------------- ------------ ------------ ------------
2000
----
Revenues, net $13,366 $10,159 $16,559 $20,090 $60,174
Cost of sales 1,561 1,131 1,407 1,833 5,932
Operating expenses 21,679 19,627 21,080 20,905 83,291
Loss from operations (9,874) (10,599) (5,928) (2,647) (29,048)
Net loss (11,206) (12,270) (7,510) (4,279) (35,265)
Basic and diluted loss per share $ (0.62) $ (0.65) $ (0.38) $ (0.19) $ (1.84)
Market prices per common
share:
High $ 22.13 $ 18.56 $ 17.88 $ 25.13 $ 25.13
Low $ 5.30 $ 10.00 $ 10.75 $ 13.63 $ 5.30
1999
----
Revenues, net $ 5,469 $ 7,288 $10,249 $13,334 $36,340
Cost of sales 1,039 1,202 1,386 1,779 5,406
Operating expenses 19,359 21,550 20,807 20,746 82,462
Loss from operations (14,929) (15,464) (11,944) (9,191) (51,528)
Net loss (15,214) (16,097) (12,862) (10,379) (54,552)
Basic and diluted loss per share $ (0.86) $ (0.90) $ (0.72) $ (0.58) $ (3.06)
Market prices per common
share:
High $ 7.00 $ 5.75 $ 7.75 $ 6.38 $ 7.75
Low $ 4.00 $ 4.13 $ 4.38 $ 4.38 $ 4.00
11. Commitments and Contingencies
Letter of Credit Facility
On September 17, 1998, the Company entered into a $3 million letter of
credit facility with a bank (the "Letter of Credit Facility"). Under the terms
of the Letter of Credit Facility, letters of credit outstanding must not exceed
90% of the Company's cash balance kept at such bank. As of December 31, 2000 and
1999, letters of credit outstanding totaled $1,551,000 and $1,492,000,
respectively.
Purchase Commitments
During the normal course of its business, the Company enters into short
term purchase commitments for the acquisition of goods and services needed to
run its operations. As of December 31, 2000, the Company had open purchase
commitments totaling $5,696,000.
46
Employment and Royalty Agreements
As of December 31, 1999, the Company had employment and/or royalty
agreements with three of its officers. Salary and benefits expense recorded
under the employment agreements totaled $749,000, $698,000 and $833,000, during
the years ended December 31, 2000, 1999 and 1998, respectively. The royalty
agreements entitle two of these officers to royalties on sales of the Company's
products, the aggregate amounts of which may not exceed $5,500,000. Royalty
expense from these agreements during the years ended December 31, 2000, 1999 and
1998 was $551,000, $336,000 and $65,000, respectively. Future minimum payments
under the employment agreements are as follows:
Year Ending December 31, Amount
------------------------ -------------
2001........................................... $ 575,000
2002........................................... 200,000
-------------
$ 775,000
=============
The Company, in connection with the IEP Acquisition, is also subject to a
royalty consideration on net sales of future products developed by IEP utilizing
technology acquired through such acquisition. In accordance with the terms of
the IEP Acquisition, the Company is required to make minimum annual royalty
payments of $50,000 commencing in 2002 through 2009.
Lease Commitments
The Company has various operating leases that expire through 2006 for the
rental of office space, laboratory facilities, and vehicles. Future minimum
commitments under these agreements are as follows:
Year Ending December 31, Amount
------------------------ -------------
2001........................................... $2,647,000
2002........................................... 2,226,000
2003........................................... 1,709,000
2004........................................... 1,164,000
2005........................................... 350,000
Thereafter..................................... 306,000
-------------
$8,402,000
=============
As of December 31, 2000 and 1999, standby letters of credit of $1,232,000
and $1,200,000, respectively, were outstanding under the Letter of Credit
Facility in favor of the lessors as collateral for these leases provided to the
Company.
Rent and other expenses incurred under the operating leases were
$3,655,494, $3,493,964 and $3,061,000, during the years ended December 31, 2000,
1999 and 1998, respectively.
Licensing Agreements
The Company has certain license agreements (the "License Agreements") with
third parties (the "Licensees") for the development of future products. Under
the License Agreements, the Company is required to make payments to the
Licensees in order to secure exclusive rights to develop, manufacture, sell
and/or sublicense future products developed through the License Agreements. In
connection with the License Agreements, the Company recorded licensing expense
of approximately $250,000, $135,000 and $490,000, for the years ended December
31, 2000, 1999 and 1998, respectively, and is reflected in "Research and
development" in the accompanying consolidated statements of operations.
47
In order to maintain its rights under the License Agreements, the Company
is required to pay certain future milestone payments and licensing fees. In the
event that no milestone event occurs, the Company generally would not be
required to make any milestone payment. The Company anticipates, based on the
development efforts that have been conducted to date, that it will be required
to make future minimum payments as follows:
Year Ending December 31, Amount
------------------------ -------------
2001........................................... $ 250,000
2002........................................... 30,000
2003........................................... 30,000
2004........................................... 200,000
-------------
$ 510,000
=============
On February 7, 1997, the Company entered into an agreement with an
unaffiliated generic drug manufacturer pursuant to which the parties agreed to
resolve the effects, as between themselves, of a potential interference
proceeding by the United States Patent and Trademark Office by granting cross
licenses under their respective patent applications and patents, regardless of
whether such licenses would be required. In connection with this licensing
agreement, the Company initially recognized $3,000,000 as a licensing expense
for the year ended December 31, 1997. As further consideration for entering into
the agreement, the Company agreed to pay the generic manufacturer certain
royalties on the net sales of Niaspan subject to a cap on such royalty payments
in the United States and a separate cap on such payments for sales outside the
United States. The Company recorded $2,500,000, $1,682,000 and $652,000, of
royalty expense from this agreement for the years ended December 31, 2000, 1999
and 1998, respectively, and are included in "Selling, general and
administrative" in the accompanying consolidated statements of operations.
Sponsored Research
The Company has on-going research agreements with various universities and
a research center. The Company is primarily responsible for funding the
projects, and the university or research center is responsible for providing
personnel, equipment, and facilities to conduct the research activities. Future
minimum payments under the sponsored research agreements are as follows:
Year Ending December 31, Amount
------------------------ -------------
2001........................................... $ 300,000
2002........................................... 135,000
-------------
$ 435,000
=============
The Company also funds, from time to time and at its sole discretion, other
research programs conducted at other universities and research centers. Expenses
recorded under the Company's sponsored research programs totaled approximately
$381,000, $408,000 and $383,000, during the years ended December 31, 2000, 1999
and 1998, respectively, and are reflected in "Research and development" in the
accompanying consolidated statements of operations.
Development Agreements
The Company has development agreements with various third parties (the
"Development Agreements"). As dictated by the Development Agreements, the
Company is responsible for funding all required development activities. In order
to maintain its rights under the Development Agreements, the
48
Company is required to pay certain future milestone payments and development
fees. In the event that no milestone event occurs, the Company generally would
not be required to make any milestone payment.
Expenses recorded under these and other development agreements totaled
approximately $193,000, $380,000 and $1,470,000, during the years ended December
31, 2000, 1999 and 1998, respectively, and are reflected in "Research and
development" in the accompanying consolidated statements of operations.
Employee Benefit Plans
The Company's Internal Revenue Code Section 401(k) Plan, known as the Kos
Savings Plan, became effective on January 1, 1994. Each employee who has
completed at least 90 days of service with the Company and has attained age 21
is eligible to make pre-tax elective deferral contributions each year not
exceeding the lesser of a specified statutory amount or 15% of the employee's
compensation for the year. Beginning in 1999, the Company began matching
employee contributions to the Kos Savings Plan. The Company's matching
contribution to the Kos Savings Plan is made in the form of previously unissued
Common Stock. The Company matches employee contributions up to 50% of an
employee's 401(k) contribution, and not to exceed 3% of such employee's
compensation or $5,000 per employee for any given year. An employee is always
100% vested in the employee's elective deferral contributions to the Kos Savings
Plan and is vested up to 100% in the Company matching contribution portion of
such plan at 25% vesting per year of employment. The Company recorded $536,274
and $573,555, in expenses related to its match of employee contributions to the
Kos Savings Plan for the years ended December 31, 2000 and 1999, respectively,
and are included in "Selling, general and administrative" in the accompanying
consolidated statements of operations.
On February 15, 1999, the Company implemented the Kos Pharmaceuticals, Inc.
1999 Employee Stock Purchase Plan (the "Stock Purchase Plan"). Under the Stock
Purchase Plan, an eligible employee may purchase Common Stock at a 15% discount
by contributing to the Stock Purchase Plan, through payroll deductions, up to
10% of such employee's annual compensation. Each employee's total contributions
are limited to $25,000 per year. Employee payroll deductions are accumulated for
six-month periods at the end of which shares of the Company's Common Stock are
purchased under the Stock Purchase Plan. All full-time employees of the Company
with at least 90 days of continuous service at the beginning of each six-month
offering period are eligible to participate in that offering period. The Company
has reserved 1,000,000 shares of Common Stock for future purchase by employees
under the Stock Purchase Plan. As of December 31, 2000, 772,346 of shares of
Common Stock remain available for issuance under the Stock Purchase Plan.
12. Shareholders' Deficit
Preferred Stock
The Company is authorized to issue 10,000,000 shares of undesignated
preferred stock. Such shares of preferred stock may be issued by the Company in
the future, without shareholder approval, upon such terms as the Company's Board
of Directors may determine.
49
Stock Option Plan
During 1996, the Board of Directors of the Company adopted the Kos
Pharmaceuticals, Inc. 1996 Stock Option Plan (the "Plan"). As of December 31,
2000, a maximum of 7,000,000 shares of Common Stock may be issued pursuant to
stock options granted or to be granted under the Plan. All directors, officers,
employees and certain related parties of the Company designated by the Board are
eligible to receive options under the Plan. The maximum term of any option is
ten years from the date of grant. All options expire within 30 days of
termination of employment. The Plan is administered by a committee appointed by
the Board of Directors of the Company.
On February 19, 1998, the Company's Board of Directors authorized the
re-pricing of options to acquire shares of Common Stock granted to employees at
exercise prices ranging from $15.00 to $43.44 per share (the "February
Re-Pricing"). As a result of the February Re-Pricing, the exercise price for
these options was reduced to $11.16 per share, the average of the high and low
price of the Company's Common Stock on February 19, 1998. No options granted to
members of the Board of Directors were re-priced under the February Re-Pricing.
Effective October 1, 1998, the Board of Directors authorized a second
re-pricing of options to acquire shares of Common Stock granted to employees at
exercise prices ranging from $7.00 to $13.28 (the "October Re-Pricing"). As a
result of the October Re-Pricing, the exercise price of certain options was
reduced to $5.06 per share, the closing price of the Company's Common Stock on
October 1, 1998. No options granted to members of the Board of Directors or to
the Company's officers were re-priced under the October Re-Pricing.
The Company did not record compensation expense related with either the
February Re-Pricing or the October Re-Pricing.
Each outside director of the Company is granted an option to purchase
15,000 shares of Common Stock upon election to the Board, receives options to
purchase 20,000 shares effective on each director's anniversary date and 5,000
shares effective on the date of the Company's Annual Shareholders' Meeting. The
exercise price of such options will be the fair market value of the underlying
Common Stock on the date the option is granted. The Company considered the
provisions of SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") using the Black Scholes method to approximate the related charge to
expense for all options granted to outside directors through June 30, 2000.
Subsequent to June 30, 2000, the Company adopted the provisions of FIN 44, which
allows grantors to account for options to outside directors under Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB
No. 25"). Assumptions for the calculation of charges associated with SFAS 123
include:
Risk-Free Expected
Grant Volatility Interest Expected Term
Date Rate Rate Dividends (Years)
------------- ------------ ----------- ------------- ----------
1998 66.4 4.77 $ - 5
1999 60.0 5.03 - 5
2000 72.5 6.28 - 5
50
As of December 31, 2000, the Company had outstanding options to purchase
4,360,587 shares of Common Stock to employees, consultants, management and
directors, including options granted prior to the implementation of the Plan.
Detail of option activity is as follows:
Exercise Prices
--------------------------------
Number of Weighted
Shares Range Average
----------------- ------------------- -------------
Outstanding, December 31, 1997........... 2,446,790 $0.60 - $43.44 $10.64
Granted(*)............................... 2,955,265 5.06 - 13.28 8.15
Exercised................................ (551,675) 0.60 - 7.00 0.98
Canceled(*).............................. (1,993,165) 5.06 - 43.44 16.67
-----------
Outstanding, December 31, 1998........... 2,857,215 0.60 - 27.25 5.93
Granted.................................. 670,000 4.28 - 7.25 5.39
Exercised................................ (56,375) 0.75 - 5.06 2.21
Canceled................................. (393,000) 5.06 - 11.16 6.78
------------
Outstanding, December 31, 1999........... 3,077,840 0.60 - 27.25 5.76
Granted.................................. 1,959,975 8.47 - 22.22 15.97
Exercised................................ (472,968) 0.75 - 11.16 4.47
Canceled................................. (204,260) 5.06 - 19.88 7.26
------------
Outstanding, December 31, 2000........... 4,360,587 0.60 - 27.25 10.23
===========
- ----------
(*)Includes effect of re-priced options (1,880,565 options, which had original
exercise prices ranging from $7.00 to $43.44, and an original weighted average
exercise price of $16.94, were re-priced in February and October 1998).
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------- ------------------------------
Number Weighted Weighted Number Weighted
Outstanding Average Average Exercisable Average
Range of December 31, Remaining Exercise December 31, Exercise
Exercise Prices 2000 Contractual Life Price 2000 Price
- ------------------------- ----------------- ------------------- ------------- ---------------- -------------
$0.60 300,000 5.5 years $0.60 300,000 $0.60
4.28 to 6.24 1,355,695 7.4 years 5.18 786,615 5.07
6.59 to 8.47 488,392 6.1 years 7.05 467,936 7.04
9.94 to 14.81 1,211,800 8.5 years 12.46 245,825 11.15
15.00 to 22.22 981,700 9.6 years 18.65 19,063 15.00
24.69 to 27.25 23,000 6.2 years 25.02 23,000 25.02
--------- ---------
4,360,587 1,842,439
========= =========
At December 31, 2000, 1,535,485 shares remain reserved for issuance under
the Plan, and options to purchase 1,842,439 shares of Common Stock were
exercisable, including options granted outside the Plan.
51
As permitted by SFAS No. 123, the Company accounts for options issued to
employees and to outside directors (after June 30, 2000) under APB No. 25.
Consequently, no compensation cost has been recognized on options issued to
employees because the exercise price of such options was not less than the
market value of the Common Stock on the date of grant. Compensation costs of
$300,000 and $380,815 were recorded for the years ended December 31, 1999 and
1998, respectively, to reflect the cost associated with stock options granted to
non-employees and to outside directors (through June 30, 2000).
Had compensation cost for options issued to employees been determined
consistent with SFAS No. 123, the Company's net loss and net loss per share
would have been the "Pro Forma" amounts shown in the following table:
For the Year Ended December 31,
---------------------------------------------
2000 1999 1998
------------- ------------- -------------
Net loss:
As reported................................ $(35,265,022) $(54,552,227) $(79,161,442)
Pro Forma.................................. (39,425,660) (57,537,053) (81,638,296)
Net loss per share, basic and diluted:
As reported................................ $ (1.84) $ (3.06) $ (4.50)
Pro Forma.................................. (2.05) (3.22) (4.64)
13. Legal Proceeding
On August 5, 1998, a purported class action lawsuit was filed in the United
States District Court for the Northern District of Illinois, Eastern Division,
against the Company, the members of the Company's Board of Directors, certain
officers of the Company, and the underwriters of the Company's October 1997
offering of shares of Common Stock. In its complaint, the plaintiff asserts, on
behalf of itself and a putative class of purchasers of the Company's Common
Stock during the period from July 29, 1997, through November 13, 1997, claims
under: (i) sections 11, 12(a)(2) and 15 of the Securities Act of 1933; (ii)
sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder; and (iii) for common law fraud, negligent
misrepresentation and breach of fiduciary duty. The claims in the lawsuit relate
principally to certain statements made by the Company, or certain of its
representatives, concerning the efficacy, safety, sales volume and commercial
viability of the Company's Niaspan product. The complaint sought unspecified
damages and costs, including attorneys' fees and costs and expenses. Upon motion
by the Company, the case was transferred to the United States District Court for
the Southern District of Florida. The Company and the individual Kos defendants
filed a motion to dismiss the complaint on January 7, 1999. On May 24, 1999, the
United States District Court for the Southern District of Florida dismissed the
lawsuit with prejudice. The plaintiffs filed an appeal on June 7, 1999, with the
United States Circuit Court of Appeals for the 11th Circuit. The outcome of the
litigation cannot yet be determined. Accordingly, no provision for any liability
that may result from these matters has been recognized in the accompanying
consolidated financial statements. There can be no assurance, however, that the
outcome of this litigation will not have a material adverse effect on the
Company's business, results of operations, and financial condition.
52
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULE II
To Kos Pharmaceuticals, Inc.:
We have audited in accordance with auditing standards generally accepted in
the United States, the financial statements included in this Form 10-K, and have
issued our report thereon dated February 2, 2001. Our audits were made for the
purpose of forming an opinion on the basic financial statements taken as a
whole. The accompanying Schedule II is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the
audits of the basic financial statements and, in our opinion, fairly states, in
all material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Miami, Florida,
February 2, 2001.
53
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(in thousands)
Balance at Charged to Balance at
Beginning of Costs and End
Description Period Expenses Deductions of Period
- ------------------------------------------------------ ------------- ------------ ------------- ------------
Allowance for Doubtful Accounts:
- --------------------------------
Fiscal year ended December 31, 1998............... $ 80 $ 20 $ - $ 100
Fiscal year ended December 31, 1999............... 100 160 22 238
Fiscal year ended December 31, 2000............... 238 50 88 200
54
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES.
None.
55
PART III
The information required in Item 10 (Directors and Executive Officers
of the Registrant), Item 11 (Executive Compensation), Item 12 (Security
Ownership of Certain Beneficial Owners and Management) and Item 13 (Certain
Relationships and Related Transactions) is incorporated by reference to the
Company's definitive proxy statement for the 2001 Annual Meeting of Shareholders
filed with the Securities and Exchange Commission on March 15, 2001.
56
PART IV
ITEM 14. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. The Financial Statements filed as part of this report are
listed separately in the index to Financial Statements
beginning on page 29 of this report.
2. The following Financial Statement Schedules are filed
herewith:
Schedule Description
-------- -----------
II Valuation and Qualifying Accounts for
the Year Ended December 31, 2000.
3. The following exhibits are filed herewith:
Exhibit
Number Exhibit Description
------ -------------------
3.1(1) Amended and Restated Articles of
Incorporation of the Company
3.2(1) Amended and Restated Bylaws of the
Company
4.1 See Exhibits 3.1 and 3.2 for provisions
of the Amended and Restated Articles of
Incorporation and Amended and Restated
Bylaws of the Company defining the
rights of holders of Common Stock of the
Company
4.2(2) Form of Common Stock certificate of the
Company
10.1(1) Employment Agreement dated as of July 1,
1996, between Daniel M. Bell and the
Company
10.2(1) Nonqualified Stock Option Agreement by
and between the Company and Daniel M.
Bell dated as of June 20, 1996.
10.3(1) Employment Agreement dated as of June
15, 1996, between David J. Bova and the
Company
10.4(1) Kos Pharmaceuticals, Inc. 1996 Stock
Option Plan
10.5(3) Kos Pharmaceuticals, Inc. 1999 Employee
Stock Purchase Plan.
10.6(1)+ Development Agreement by and between the
Company and Fuisz Technologies, Ltd.
10.7(1)+ Option/Licensing Agreement by and
between the Company and Fuisz
Technologies, Ltd.
10.8(1)+ Development Agreement by and between the
Company and Fuisz Technologies, Ltd.
57
10.9(1)+ Option/Licensing Agreement by and
between the Company and Fuisz
Technologies, Ltd.
10.10(1)+ License Agreement by and between the
Company and Upsher-Smith Laboratories,
Inc., dated February 7, 1997.
10.11(4) Revolving Credit and Loan Agreement
dated July 1, 1998, between Kos
Pharmaceuticals, Inc. and Michael
Jaharis.
10.12(4) Promissory Note dated July 1, 1998, in
favor of Michael Jaharis.
10.13(5)+ Co-promotion Collaboration Agreement
dated July 22, 1999, between the Company
and Knoll Pharmaceutical Company.
10.14(5) Revolving Credit and Loan Agreement
dated September 1, 1999, between the
Company and Michael Jaharis.
10.15(6) Promissory Note dated September 1, 1999,
in favor of Michael Jaharis.
10.16(6) Revolving Credit and Loan Agreement
dated December 21, 1999, between the
Company and Michael Jaharis.
10.17(6) Second Amended and Restated Registration
Rights Agreement effective as of
December 21, 1999, by and between the
Company, Kos Holdings, Inc., Kos
Investments, Inc., and Michael Jaharis.
10.18(6) Amended and Restated Security Agreement
dated December 21, 1999, by and between
the Company and Michael Jaharis.
10.19(6) Promissory Note dated December 21, 1999,
in favor of Michael Jaharis.
10.20(6) Non-Detachable Common Stock Purchase
Warrant.
10.21(7)+ Copromotion and Future Development
Agreement dated May 3, 2000, between the
Company and DuPont Pharmaceuticals
Company.
10.22(7) Stock Purchase Agreement dated May 3,
2000, between the Company and DuPont
Pharmaceuticals Company.
21(1) Subsidiaries of the Company.
23 Consent of Arthur Andersen LLP.
24 Powers of Attorney (included on
signature page hereto).
--------------
(1) Filed with the Company's Registration Statement on Form S-1
(File No. 333-17991), as amended, filed with the Securities
and Exchange Commission on December 17, 1996, and
incorporated herein by reference.
58
(2) Filed with the Company's Registration Statement on Form 8-A
filed with the Securities and Exchange Commission on
February 25, 1997, and incorporated herein by reference.
(3) Filed with the Company's Registration Statement on Form S-8
(File No. 333-70317), filed with the Securities and Exchange
Commission on January 8, 1999, and incorporated herein by
reference.
(4) Filed with the Company's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission for the
Company's three-month period ended September 30, 1998, and
incorporated herein by reference.
(5) Filed with the Company's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission for the
Company's three-month period ended September 30, 1999, and
incorporated herein by reference.
(6) Filed with the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission for the
Company's year ended December 31, 1999, and incorporated
herein by reference.
(7) Filed with the Company's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission for the
Company's three-month period ended June 30, 2000, and
incorporated herein by reference.
+ Certain confidential material contained in the document has
been omitted and filed separately with the Securities and
Exchange Commission pursuant to Rule 406 of the Securities
Act of 1933, as amended.
(b) The Company did not file any Reports on Form 8-K during its last
fiscal quarter.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
behalf of the undersigned, thereunto duly authorized.
KOS PHARMACEUTICALS, INC.
By: /s/ Daniel M. Bell
--------------------------------
Daniel M. Bell
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Daniel M. Bell and Juan F. Rodriguez and each of
them, his true and lawful attorney-in-fact and agents, with full power of
substitution and resubstitution for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Report on Form 10-K,
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents full power and authority to do and perform
each and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that each of said attorneys-in-fact
or his substitute or substitutes, any lawfully 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/ Michael Jaharis Chairman of the Board March 16, 2001
- ----------------------------- of Directors
Michael Jaharis
/s/ Daniel M. Bell President, Chief Executive March 16, 2001
- ----------------------------- Officer, and Director
Daniel M. Bell (Principal Executive Officer)
/s/ Robert E. Baldini Vice Chairman of the Board and
- ----------------------------- Chief Sales and Marketing Officer March 16, 2001
Robert E. Baldini
/s/ Juan F. Rodriguez Vice President, Controller
- ----------------------------- (Principal Accounting Officer) March 16, 2001
Juan F. Rodriguez
/s/ John Brademas Director March 16, 2001
- -----------------------------
John Brademas
/s/ Steven Jaharis Director March 16, 2001
- -----------------------------
Steven Jaharis
/s/ Louis C. Lasagna Director March 16, 2001
- -----------------------------
Louis C. Lasagna
/s/ Mark Novitch Director March 16, 2001
- -----------------------------
Mark Novitch
/s/ Frederick B. Whittemore Director
- ----------------------------- March 16, 2001
Frederick B. Whittemore
60
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
23 Consent of Arthur Andersen LLP.
61