Back to GetFilings.com
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
Form 10-K
(Mark One)
[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
For the transition period from to
Commission file number: 000-31615
----------------
DURECT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-3297098
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10240 Bubb Road
Cupertino, CA 95014
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 777-1417
----------------
Securities registered pursuant to Section 12(b) of the Act:
Common Stock Nasdaq National Market
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $74,175,581 as of March 16, 2001 based upon
the closing sale price on the Nasdaq National Market reported for such date.
Shares of Common Stock held by each officer and director and by each person
who owns 5% or more of the outstanding Common Stock have been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
There were 46,565,486 shares of the registrant's Common Stock issued and
outstanding as of March 16, 2001.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
PART I
Item 1. Business.
Overview
We are pioneering the treatment of chronic diseases and conditions by
developing and commercializing pharmaceutical systems to deliver the right
drug to the right place in the right amount at the right time. Our
pharmaceutical systems combine engineering innovations and delivery technology
from the medical device and drug delivery industries with our proprietary
pharmaceutical and biotechnology drug formulations. By integrating these
technologies, we are able to control the rate and duration of drug
administration as well as target the delivery of the drug to its intended site
of action, allowing our pharmaceutical systems to meet the special challenges
associated with treating chronic diseases or conditions. Our pharmaceutical
systems can enable new drug therapies or optimize existing therapies based on
a broad range of compounds, including small molecule pharmaceuticals as well
as biotechnology molecules such as proteins, peptides and genes. Our initial
portfolio of products combine the DUROS technology, a proven and patented drug
delivery platform licensed for specified fields of use from ALZA Corporation,
with drugs for which data on medical efficacy and safety are available.
Our pharmaceutical systems are suitable for providing long-term drug
therapy because they store highly concentrated, stabilized drugs in a small
volume and can protect the drug from degradation by the body. This, in
combination with our ability to continuously deliver precise and accurate
doses of a drug, allows us to extend the therapeutic value of a wide variety
of drugs, including those which would otherwise be ineffective, too unstable,
too potent or cause adverse side effects. Delivering the drug directly to the
intended site of action can also improve efficacy while minimizing unwanted
side effects elsewhere in the body, which often limit the long-term use of
many drugs. Our pharmaceutical systems can thus provide better therapy for
chronic diseases or conditions by replacing multiple injection therapy or oral
dosing, improving drug efficacy, reducing side effects and ensuring dosing
compliance. Our pharmaceutical systems can improve patients' quality of life
by eliminating more repetitive treatments, reducing dependence on caregivers
and allowing them to lead more independent lives.
We are currently developing pharmaceutical systems based on the DUROS
technology in a variety of therapeutic areas, including chronic pain, central
nervous system disorders, cardiovascular diseases and inner ear disorders. The
DUROS technology is a miniature drug-dispensing pump that releases minute
quantities of concentrated drug formulations in a continuous, consistent flow
over months or years using an osmotic engine. The miniature pump, made out of
titanium, can be as small as a wooden matchstick and can be implanted under
the skin. Beyond the DUROS technology, we intend to develop other technologies
consistent with our objective of delivering the right drug to the right place
in the right amount at the right time.
Our lead product is for the treatment of chronic pain and combines the
DUROS technology with a proprietary formulation of sufentanil, a potent opioid
currently used in hospitals as an anesthetic. We completed an initial Phase I
trial in November 1999 using an external pump to test the safety of continuous
chronic infusion of the drug. We commenced a Phase II clinical trial in
December 2000. Following this trial, we intend to complete the final
commercial design of this product. This product is aimed at the approximately
$1 billion market for the treatment of chronic pain and will compete with oral
opioids, analgesic patches and external and implantable infusion pumps. We are
also researching and developing pharmaceutical systems based on the DUROS
technology in a variety of other therapeutic areas, including central nervous
system disorders, cardiovascular disease and inner ear disorders.
Our second product in development is designed to target the delivery of
hydromorphone via a catheter directly to its intended site of action in the
central nervous system for the treatment of end-stage cancer pain.
Hydromorphone is an opioid approved for use as an analgesic. We are currently
conducting pre-clinical studies on this product.
1
Industry Background
Chronic Diseases and Conditions
Although the pharmaceutical, biotechnology and medical device industries
have played key roles in increasing life expectancy and improving health, many
chronic, debilitating diseases continue to be inadequately addressed with
current drugs or medical devices. Cardiovascular disease, cancer,
neurodegenerative diseases, diabetes, arthritis, epilepsy and other chronic
diseases claim the lives of millions of Americans each year. These illnesses
are prolonged, are rarely cured completely, and pose a significant societal
burden in mortality, morbidity and cost. The Centers for Disease Control
estimates that the major chronic diseases are responsible for approximately
70% of all deaths in the U.S., and medical care costs for these conditions
totaled more than $400 billion annually. Currently, more than 60% of total
health care spending in the U.S. is devoted to the treatment of chronic
diseases. Demographic trends suggest that, as the U.S. population ages, the
cost of treating chronic disease as a proportion of total health care spending
will increase.
Current Approaches to Treatment
Drugs are available to treat many chronic diseases, but harmful side
effects can limit prolonged treatment. In addition, patients with chronic
diseases commonly take multiple medications, often several times a day, for
the remainder of their lives. If patients fail to take drugs as prescribed,
they often do not receive the intended benefits or may experience side effects
which are harmful or decrease quality of life. These problems become more
common as the number of drugs being taken increases, the regimen of dosing
becomes more complicated, or the patient ages or becomes cognitively impaired.
It is estimated that only half of prescribed medicines are taken correctly.
The Pharmaceutical Industry. The pharmaceutical industry has traditionally
focused on the chemical structure of small molecules to create drugs that can
treat diseases and medical conditions. The ability to use these molecules as
drugs is based on their potency, safety and efficacy. Therapeutic outcome and
ultimately the suitability of a molecule as a drug depends to a large extent
on how it gets into the body, distributes throughout the body, reacts with its
intended site of action and is eliminated from the body. However, small
molecules act at locations throughout the body and are often accompanied by
unwanted side effects.
Most drugs require a minimum level in blood and tissues to have significant
therapeutic effects. Above a maximum level, however, the drug becomes toxic or
has some unwanted side effects. These two levels define the therapeutic range
of the drug. With oral dosing and injections, typically a large quantity of
drug is administered to the patient at one time, which results in high blood
levels of drug immediately after dosing. Because of these high levels, the
patient can be over-medicated during the period immediately following dosing,
resulting in wasted drug and possible side effects. Due to distribution
processes and drug clearance, the blood level of drug falls as time elapses
from the last dose. For some duration, the patient is within the desired
therapeutic range of blood levels. Eventually, the blood level of drug falls
sufficiently such that the patient becomes under-medicated and experiences
little or no drug effect until the next dose is administered.
When drugs are administered orally, transdermally or by injection, they are
absorbed into the systemic circulation and distributed throughout the body.
Because the drug is dispersed throughout the body, relatively large quantities
are necessary to create the desired effect at the intended site of action. In
addition, systemic administration of drugs in this fashion may result in
unwanted side effects, because the drug has access to many tissues and organs
in the body other than the intended site of action.
The Biotechnology Industry. Over the past twenty years, the biotechnology
revolution and the expanding field of genomics have led to the discovery of
huge numbers of proteins and genes. Tremendous resources have been committed
in the hope of developing drug therapies that would better mimic the body's
own processes and allow for greater therapeutic specificity than is possible
with small molecule drugs. Unfortunately, this huge effort has led to only a
limited number of therapeutic products. The proteins and genes identified by
the biotechnology industry are large, complex, intricate molecules, and many
are unsuitable as drugs. If these
2
molecules are given orally, they are often digested before they can have an
effect; if given by injection, they may be destroyed by the body's natural
processes before they can reach their intended sites of action. The body's
natural elimination processes require frequent, high dose injections that may
result in unwanted side effects. As a result, the development of biotechnology
molecules for the treatment of human diseases has been limited.
The Drug Delivery Industry. In the last thirty years, a multibillion dollar
drug delivery industry has developed on the basis that medicine can be
improved by delivering drugs to patients in a precise, controlled fashion.
Several commercially successful oral controlled release products, transdermal
controlled release patches, and injectable depot formulations have been
developed. These products demonstrate that the delivery system can be as
important to the ultimate therapeutic value of a pharmaceutical product as the
drug itself. However, to date, most drug delivery products deliver drug
systemically and do not target delivery to the intended site of action. In
addition, drug delivery products are generally limited in duration and
therefore may be less desirable for treating chronic diseases.
The Medical Device Industry. Advances in the field of medical device
technology have dramatically improved device miniaturization and
sophistication and allowed minimally invasive surgical access to remote
locations within the body. For example, a coronary bypass patient can be
treated with a stent in a procedure with a relatively short recovery, rather
than with major surgery. Most devices, however, apply only mechanical
solutions, rather than addressing chemical or biological mechanisms of
disease.
The DURECT Solution: Pharmaceutical Systems
We are pioneering the treatment of chronic diseases and conditions by
developing and commercializing pharmaceutical systems that will deliver the
right drug to the right place in the right amount at the right time. By
integrating chemistry and engineering advancements, we can achieve what drugs
or devices alone cannot. Our pharmaceutical systems enable optimized therapy
for a given disease or patient population by controlling the rate and duration
of drug administration as well as targeting the delivery of the drug to its
intended site of action.
. The Right Drug: By precisely controlling the dosage and targeting
delivery to a specific site, we can expand the therapeutic use of
compounds that otherwise would be too potent to be administered
systemically, do not remain in the body long enough to be effective, or
have significant side effects when administered systemically. This
flexibility allows us to work with a variety of drug candidates
including small molecules, proteins, peptides or genes.
. The Right Place: We draw on innovations in the medical device industry
to enhance our products. With precise placement of proprietary
microcatheters, we can design our pharmaceutical systems to deliver
drugs directly to the intended site of action. This can ensure that the
drug reaches the target tissue in effective concentrations, eliminates
many side effects caused by delivery of drug to unintended sites in the
body, and may reduce the total amount of drug administered to the body.
. The Right Amount: Our pharmaceutical systems can automatically deliver
drug dosages continuously within the desired therapeutic range for the
duration of the treatment period, for up to one year, without the
fluctuations in drug levels associated with pills or injections. This
can reduce side effects, eliminate gaps in drug therapy, conveniently
ensure accurate dosing and patient compliance, and may reduce the total
amount of drug administered to the body.
. The Right Time: Our pharmaceutical systems technology allows drugs to be
delivered automatically without intervention of the patient or care-
giver. In addition to reducing the cost of care, continuous drug therapy
frees the patient from repeated treatment or hospitalization, improving
convenience and quality of life. Our systems are well-suited for
treating chronic, debilitating diseases such as chronic pain, cancer,
heart disease, and neurodegenerative diseases that last for months or
years. We believe that it is more effective to treat chronic diseases
with continuous, long-term therapy than with alternatives such as
multiple injections that create short-term effects. Because our
pharmaceutical systems are designed to operate automatically, patient
compliance is assured.
3
DURECT Pharmaceutical Systems Technology
The technological foundation of our initial products is the DUROS implant
technology, coupled with proprietary catheter and drug formulation technology.
The DUROS system is a miniature drug-dispensing pump made out of titanium
which can be as small as a wooden matchstick. We have licensed the DUROS
technology for specified fields of use from ALZA. The potential of the DUROS
technology as a platform for providing drug therapy was demonstrated by the
Food and Drug Administration's approval in March 2000 of ALZA's Viadur
(leuprolide acetate implant), a once-yearly implant for the palliative
treatment of prostate cancer, the first approved product to incorporate the
DUROS implant technology. By leveraging this proven technology, we believe we
can reduce our development risk and more rapidly introduce new products to the
market.
Most of the volume of the DUROS system will contain our proprietary drug
formulation. The DUROS pump operates like a miniature syringe. Through
osmosis, water from the body is slowly drawn through a semi-permeable membrane
into the pump by salt residing in the engine compartment. This water fills the
engine compartment and slowly and continuously pushes a piston to dispense
minute amounts of drug formulation from the drug reservoir. The osmotic engine
does not require batteries, switches or other electromechanical parts in order
to operate. The amount of drug delivered by the system is regulated by the
semi-permeable membrane's control of the rate of body water entering the
engine compartment and the concentration of the drug formulation.
The DUROS system has performance characteristics that cannot be matched by
drug delivery pumps on the market today. First, the engine can generate
sufficient pressure to deliver highly concentrated and viscous formulations.
Second, the system can be engineered to deliver a drug formulation at the
desired dosing rate with a high degree of precision, to less than 1/100th of a
drop per day on a continuous basis. The titanium shell of the DUROS system
protects the drug formulation from degradation by enzymes and clearance
processes within the body. As a result, the DUROS system can store drugs for
up to one year as they are being released into the body.
The DUROS system can be used for therapies requiring systemic or site-
specific administration of drug. To deliver drugs systemically, the DUROS
system is placed just under the skin, for example in the upper arm, in an
outpatient procedure that is completed in just a few minutes using local
anesthetic. Removal or replacement of the product is also a simple, quick
procedure completed in the doctor's office.
To deliver drug to a specific site, we are developing proprietary
miniaturized catheter technology that can be attached to the DUROS system to
direct the flow of drug directly to the target organ, tissue or synthetic
medical structure, such as a graft. Site specific delivery enables a
therapeutic concentration of a drug to be present at the desired target
without exposing the entire body of the patient to a similar dose. The
precision, size and performance characteristics of the DUROS system will allow
for continuous site-specific delivery to a variety of precise locations within
the body.
By concentrating drug in proprietary formulations, we can store enough drug
in our pharmaceutical systems to dose a patient for extended periods of time,
for up to one year. Our proprietary formulations of traditional small molecule
drugs are much more concentrated than those currently available on the market.
Concentrated formulations allow our pharmaceutical systems to be significantly
smaller than alternative drug delivery systems available today. We also
believe that we can keep these formulations chemically and physically stable
for extended periods of time at body temperature. Our formulation expertise,
combined with the protection provided by the reservoir of the DUROS system,
may allow for the stable storage and delivery of proteins, peptides, and other
large molecule agents in a long-term continuous fashion, thus enabling the
full therapeutic potential of a wide range of biotechnology compounds.
4
DURECT Strategy
Our objective is to develop and commercialize pharmaceutical systems that
address significant medical needs and improve patients' quality of life. To
achieve this objective, our strategy includes the following key elements:
Focus on Chronic Debilitating Medical Conditions. Many of the diseases that
present the greatest challenges to medicine are chronic, debilitating diseases
such as chronic pain, central nervous system disorders, cardiovascular
disorders, cancer, degenerative neurological diseases and ear disorders. Our
initial efforts will focus on using the versatile DUROS platform technology to
develop products that address these diseases.
Minimize Product Development Risk and Speed Time-to-Market. Initially, we
intend to minimize product development risk and speed time-to-market by using
the proven DUROS platform to administer drugs for which medical data on
efficacy and safety are available. This strategy reduces much of the
development risk that is inherent in traditional pharmaceutical product
discovery. We anticipate that we can expand the medical usefulness of existing
well-characterized drugs in several ways:
. expand uses or create new uses for existing drugs with clear safety
profiles;
. create new uses for drugs which were previously thought to be too potent
to be used safely; and
. enhance drug performance by minimizing side effects.
We anticipate that our products can be more rapidly developed at lower cost
than comparable products that are developed purely based on chemical solutions
to the problems of efficacy, side effects, stability and delivery of the
active agent. This allows us to use potent agents that would otherwise not be
available as therapies to treat chronic diseases. It also allows us to
innovate more rapidly in the development of products and to respond to market
feedback by optimizing our existing products or developing line extensions
that address new market needs.
Enable the Development of Pharmaceutical Systems Based on Biotechnology and
Other New Compounds. We believe there is a significant opportunity for
pharmaceutical systems to add value to therapeutic medicine by administering
biotechnology products, such as proteins, peptides and genes. We believe our
technology will improve the specificity, potency, convenience and cost-
effectiveness of proteins, genes and other newly discovered drugs. Our systems
can enable these compounds to be effectively administered, thus allowing them
to become viable medicines. We can address the stability and storage needs of
these compounds through our advanced formulation technology and package them
in a suitable pharmaceutical system for optimum delivery. Through continuous
administration, the DUROS system may eliminate the need for multiple
injections of these drugs. In addition, through the use of our proprietary
miniature catheter technology, proteins and genes can be delivered to specific
tissues for extended periods of time, thus ensuring that large molecule agents
are present at the desired site of action and minimizing the potential for
adverse side effects elsewhere in the body.
Expand Our Technology Platforms. In addition to the DUROS technology, we
will continue to develop, license and acquire other technologies consistent
with our objective of delivering the right drug to the right place in the
right amount at the right time. For example, in our October 1999 acquisition
of IntraEAR, we acquired proprietary products and intellectual property that
allow for continuous delivery of fluids to treat inner and middle ear
disorders. We have and expect to continue to license or acquire technology
from others that will complement our core capabilities.
5
Product Development Programs
Our pharmaceutical systems are designed to provide improved treatment
efficacy with a high level of precision and quality. Our development efforts
are focused on the application of our pharmaceutical systems technologies to
potential products in the broad areas of focus set forth in the following
table:
Delivery
Area of Focus Drug Method Indications Status
------------- ---- -------- ----------- ------
Chronic Pain . Sufentanil . Systemic . Opioid-Responsive . Initial Phase I trial
Chronic Malignant completed; Phase II
and Non-Malignant trial commenced
Pain December 2000
Central . Hydromorphone . Targeted . Cancer Pain . Preclinical Stage
Nervous
System . Others . Others in . Research Stage
Disorders Development
Ear Disorders . Gentamycin . Targeted . Meniere's Disease . Preclinical Stage
. Others . Others in
Development
Cardiovascular . Various . Targeted . Various . Research Stage
Diseases
Vascular Graft . Various . Targeted . Various . Research Stage
Cancer . Various . Targeted . Various . Research Stage
Immunotherapy or
Systemic
Chronic Pain
Market Opportunity. Chronic pain, defined as pain lasting 6 months or
longer, is a significant problem associated with chronic diseases, including
cancer and various neurological and skeletal disorders. Chronic nonmalignant
pain affects as many as 34 million Americans annually. In addition, the
National Cancer Institute estimates that 8.4 million Americans alive today
have a history of cancer. About 1.2 million new cancer cases were expected to
be diagnosed in 2000, and about 50%-70% of cancer patients experience chronic
pain during the course of the disease. Sales of opioids for the treatment of
chronic malignant and nonmalignant pain are approximately $1 billion. With our
lead product, DUROS sufentanil, we intend to target patients with chronic pain
that is stable and opioid responsive and results from a variety of causes.
Sufentanil is an off-patent, highly potent opioid that is currently used in
hospitals as an anesthetic. This product will provide an alternative to
current therapies for the treatment of chronic pain, as well as ensuring
improved patient compliance and convenience.
Development Strategy. We are developing a subcutaneous, implantable DUROS-
based system that delivers sufentanil systemically at a constant rate for 3
months. We will develop a family of dosage strengths, tailored to meet market
needs. An initial Phase I trial using an external pump to test the safety of
continuous chronic infusion of the drug was completed in 1999. A Phase II
clinical trial commenced in December 2000. Following this trial, we intend to
complete the commercial design of this product. These trials are designed to
develop data in support of dose selection for later trials and commercial use
as well as data to guide physicians in converting patients from previous
therapies to the DUROS sufentanil implant.
Central Nervous System Disorders
Market Opportunity. Millions of people suffer from chronic diseases and
disorders of the central nervous system, including brain and spinal cord
tumors, epilepsy, spasticity, spinal meningitis, Parkinson's disease,
6
multiple sclerosis and back disorders. Opportunities exist to apply our
pharmaceutical systems for treatment of these disorders. The first central
nervous system disorder we will address is end-stage cancer pain. Roughly
550,000 people in the U.S. will die from cancer and cancer-related
complications this year. It is estimated that over half of terminal cancer
patients experience severe, chronic pain. Infusion of opiates into the spinal
fluid has become accepted medical therapy in patients who find high dose oral
or transdermal opioids ineffective or who experience side effects that make
systemic therapy unacceptable. This method of delivery increases analgesic
potency and reduces side effects. However, patients with cancer pain are often
not treated with this therapeutic regimen because currently available
implantable spinal infusion pumps are only approved for patients with life
expectancies of three months or more. Furthermore, external infusion pumps are
inconvenient and expose a patient to a risk of infection. A need exists for a
minimally invasive, spinal infusion device that has improved cost benefit for
end-stage cancer patients with chronic pain.
Development Strategy. Our strategy is to develop an infusion system that
can deliver hydromorphone into the spinal fluid via a catheter. This product
will be considerably smaller and less invasive than currently available spinal
infusion pumps. Hydromorphone is an opioid that has been approved for
treatment of pain. We are currently conducting preclinical studies on this
product.
Middle and Inner Ear Disorders
Market Opportunity. Inner ear disorders, including tinnitus, hearing loss
and Meniere's disease impact the lives of millions of people worldwide.
Opportunities may exist to treat these inner ear disorders through continuous
low dose application of drug. For example, Meniere's disease is a debilitating
inner ear disorder characterized by vertigo, tinnitus, fluctuating hearing
loss and aural pressure. In the U.S., it is estimated that Meniere's disease
afflicts at least 3 million people with 100,000 new cases being diagnosed each
year. Current first line treatments include vestibular suppressants, diet
modifications and diuretics. We estimate that about 30 percent of patients
receive second line treatments such as large doses of gentamycin or surgery
that can destroy inner ear function. These destructive treatments can result
in permanent loss of hearing and impair balance. We are researching treatments
which therapeutically rather than destructively treat Meniere's disease while
minimizing risk of hearing loss and preserving balance function.
Development Strategy. In October 1999, we acquired substantially all of the
assets of IntraEAR, Inc. This acquisition provided us with an extensive
intellectual property portfolio related to devices and methods for the
delivery of fluids to the round window niche of the middle ear. We are
researching pharmaceutical systems that include this proprietary catheter
technology to treat intractable inner ear disorders such as Meniere's disease,
hearing loss and tinnitus.
Ongoing Research
We plan to devote substantial resources to developing multiple products
based on our pharmaceutical systems technology in one or more of the areas of
focus in the above table or others. For example, we are currently engaged in
research on treating chronic cardiovascular diseases and other central nervous
system disorders.
Ear Catheter Business
Our acquisition in October 1999 of substantially all of the assets of
IntraEAR, Inc. provided us with catheter technology and products that had
previously received 510K marketing clearance from the FDA and European CE Mark
approval. We currently market these catheters through a direct sales force in
the U.S. and through a network of 13 distributors outside the U.S.
The Round Window (mu)-Cath and Round Window e-Cath products are dual- and
triple-lumen micro-catheters of proprietary design which allow controlled
fluid delivery to the round window membrane for
7
treatment of ear disorders. These catheters feature a proprietary tip which is
designed to allow the surgeon to secure it in the round window niche of the
middle ear. When attached to a commercially available, external infusion pump,
such as those manufactured by Disetronic Medical Systems, a variety of
therapeutic fluids can be continuously delivered to the round window membrane
to potentially treat ear disorders including Meniere's disease, hearing loss
and tinnitus. These catheters can be left in place for up to 29 days and can
be connected to a syringe or pump for continuous delivery. The dual-lumen
design allows the treating physician to add and remove fluid or flush the
device without a build-up of air or fluid pressure. The e-Cath design
incorporates an additional electrode to allow physicians to record electrical
signals related to activities in the ear.
ALZET Business
In April 2000, we acquired from ALZA the ALZET product and assets used
primarily in the manufacture, sale and distribution of this product. This
acquisition provides us with an ongoing business making and selling this
product worldwide. We currently market the ALZET product through a direct
sales force in the U.S. and through a network of 10 distributors outside the
U.S.
The ALZET product is a miniature, implantable osmotic pump used for
experimental research in mice, rats and other laboratory animals. These pumps
are not approved for use in humans, nor are they intended for such use. ALZET
pumps continuously deliver drugs, hormones and other test agents at controlled
rates from one day to four weeks without the need for external connections,
frequent handling or repeated dosing. In laboratory research, these infusion
pumps can be used for systemic administration when implanted under the skin or
in the body. They can be attached to a catheter for intravenous,
intracerebral, or intra-arterial infusion or for targeted delivery, where the
effects of a drug or test agent are localized in a particular tissue or organ.
We believe that the ALZET business provides us with innovative design and
application opportunities for potential new products.
Marketing and Sales
In general, we intend to establish strategic distribution and marketing
alliances for our products. We recognize that pharmaceutical companies have
established sales organizations in markets we are targeting. We plan to
leverage these sales organizations to achieve greater market penetration for
our products than we could on our own. Because our first products combine
drugs for which medical data on efficacy and safety are available with a
proven technology platform, we believe we have the flexibility to enter into
these alliances at a later stage of clinical development, when the product
development risk is diminished, in order to retain greater economic
participation. We may also establish our own sales force when strategically or
economically advantageous.
We have established a small sales force in the U.S. to market our approved
catheters for delivering fluids to the inner ear. In addition, we sell our
catheters through 13 distributors outside the U.S. We market and sell our
ALZET product in the U.S. through a direct sales force, and we have a network
of ten distributors for this product outside of the U.S.
ALZA has an option to exclusively market and distribute DUROS sufentanil in
the U.S. and Canada on terms to be negotiated by the parties at arms-length.
Should ALZA decide not to exercise its option, we will market and distribute
DUROS sufentanil in the U.S. and Canada ourselves or through a third party.
Customers
Since our acquisition of the ALZET product line in April 2000, we have been
dependent on a small number of customers for a substantial portion of our
revenues. In fiscal 2000, one customer accounted for more than 10% of our
revenues: Muromachi Kikai Co., Ltd. represented 14% of our revenues. Until
such time that we are able to bring our pharmaceutical systems to market, if
at all, we expect this trend to continue.
8
Manufacturing
The process for manufacturing our pharmaceutical systems is technically
complex, requires special skill in aseptic processing, and must be performed
in a qualified facility. For our lead product, we subcontract to third-parties
the manufacture of components of the DUROS system, which we then assemble. We
are in the process of constructing a flexible manufacturing facility to
produce product for our Phase III clinical trial and market launch of DUROS
sufentanil and to serve as a pilot facility for additional products under
development. In addition, we are evaluating alternative strategies to meet our
long-term commercial manufacturing needs.
For the manufacture of our ear catheter products, we have a supply
agreement with a third party manufacturer of disposable medical products.
Under this agreement, renewable annually, the third party has responsibility
for all manufacturing and packaging of finished goods and some regulatory
responsibilities. We manufacture our ALZET product in a leased facility
located in Vacaville, California.
Development and Commercialization Agreement with ALZA Corporation
On April 21, 1998, we entered into a Development and Commercialization
Agreement with ALZA Corporation, which was amended and restated on April 28,
1999 and April 14, 2000. Pursuant to this agreement, ALZA granted to us
exclusive, world-wide rights under ALZA intellectual property, including
patents, trade secrets and know-how, to develop and commercialize products
using the DUROS drug delivery technology in the fields of the delivery of
drugs by catheter (except for the sufentanil product) to the central nervous
system to treat selected central nervous system disorders, the delivery of
drugs by catheter to the middle and inner ear, the delivery of drugs by
catheter into the pericardial sac of the heart, the delivery of selected drugs
by catheter into vascular grafts and the delivery of selected cancer antigens.
We have the exclusive right to commercialize each product developed under the
agreement for a period of 20 years from the first commercial sale of the
product in the U.S., Canada, Japan, France, Germany, Italy or the United
Kingdom. We can extend this commercialization period at our option on a year-
by-year basis.
To maintain the rights granted to us in our licensed fields, we must meet
annual minimum development spending requirements totaling $52 million through
2004 and fund development of a minimum number of products per year up to a
total of eight products through 2004. We must also diligently procure required
regulatory approvals and commercialize the products in each country in order
to maintain commercialization rights for such product in that country. If we
fail to meet the various diligence requirements, we may lose our rights to
develop, commercialize and manufacture some of our DUROS-based pharmaceutical
systems, lose rights to commercialize products in some or all countries,
including the U.S., or lose rights in some fields of use, and these rights
would revert to ALZA. If we develop or commercialize any drug delivery
technology for use in a manner similar to the DUROS technology in a field
covered in our license agreement with ALZA, then we may lose our exclusive
rights to use the DUROS technology in such field as well as the right to
develop new products using DUROS technology in such field.
Under this agreement, we initiate product development by sending ALZA a
written notice containing a description of the proposed product and proposed
target dates for key milestones. These target dates are subject to ALZA's
reasonable approval and may be adjusted from time to time by mutual agreement.
We have the right to subcontract to third parties product development
activities including development of components of the DUROS system, provided
that design of the DUROS system and other development activities relating to
the DUROS system must be performed by ourselves or ALZA unless ALZA permits us
to subcontract out such development. We also have the right to partner with
third parties to commercialize our products on a product-by-product basis,
provided that ALZA has options to distribute our DUROS sufentanil product in
the U.S. and Canada and our cancer antigen products which do not incorporate
proprietary molecules owned by a third party throughout the world. We must
allow ALZA an opportunity to negotiate in good faith for commercialization
rights to our products developed under the agreement prior to granting these
rights to a third party, other than products that are subject to ALZA's option
or products for which we have obtained funding or access to a proprietary drug
from a third party to whom we have granted commercialization rights prior to
commencement
9
of human clinical trials. We have the right to subcontract manufacturing
activities relating to our products other than the assemblage of the
components of the DUROS system itself. In the event of a change in our
corporate control, including an acquisition of us, our right to develop and
manufacture the DUROS system would terminate, and ALZA would have the right to
develop and manufacture DUROS systems for us for so long as ALZA can meet our
specification and supply requirements following such change in control. If
ALZA elects to provide development services related to the DUROS system for
us, we will pay ALZA its development costs, including research expenses (both
direct and indirect, which are billed at a rate of 160% of direct research
salaries), general and administrative expenses (at a rate of 80% of direct
research salaries) and capital asset expenditures. In the periods from
inception (February 6, 1998) to December 31, 1998, and the years ended
December 31, 1999 and 2000, we incurred development expenses of $243,000,
$1,182,000 and $666,000, respectively, for work performed by ALZA under the
Development and Commercialization Agreement relating to our DUROS sufentanil
product. ALZA invoices us quarterly for development services performed, with
payments due within 30 days of our receipt of the invoice. If ALZA elects to
manufacture the DUROS system for us, we will pay ALZA its manufacturing costs
plus 25% of such costs. See "Risk Factors--Our agreement with ALZA limits our
fields of operation for our DUROS-based pharmaceutical systems, requires us to
spend significant funds on product development and gives ALZA a first right to
distribute selected products for us."
Any inventions and related intellectual property rights developed by us or
ALZA under the agreement which relate to the DUROS system or its manufacture
or to any combination of the DUROS system with other components, active
agents, features or processes, shall be owned exclusively by ALZA. All other
inventions and related intellectual property rights developed under the
agreement, whether by us or ALZA, shall be owned exclusively by us. In
addition, ALZA was granted a non-exclusive license to any proprietary
technology we may develop relating to a means of connecting a catheter to the
DUROS system. This license was granted in consideration for ALZA abiding by
the terms of a market stand-off agreement under which, for a period of two
years following the termination of any market stand-off or other similar
agreement between ALZA and the underwriters of this offering, ALZA may not
dispose of 25% or more of the maximum number of all securities it has owned
prior to this offering in any six month period.
In consideration for the rights granted to us under this agreement, ALZA
received 5,600,000 shares of our Series A-1 Preferred Stock pursuant to a
Series A-1 and Series A-2 Preferred Stock Purchase Agreement dated as of June
19, 1998. As additional consideration, ALZA is entitled to receive a royalty
on the net sales of products in an amount not less than 2.5% nor more than 5%
of such net sales for so long as we sell the product. Alza is also entitled to
a percentage of any up-front license fees, milestone or any special fees,
payments or other consideration we receive, excluding research and development
funding, in an amount of 5% of such payment. In addition, commencing upon
commercial sale of a product developed under the agreement, we are obligated
to make minimum quarterly product payments at an annual rate of 1.5% of
projected annual net product sales to ALZA based on our good faith projections
for such net product sales, which minimum payments will be fully credited
against the product royalty payments we must make to ALZA under the agreement.
In connection with an amendment to the agreement made in April 2000, ALZA
received 1,000,000 shares of our common stock and a warrant to purchase
1,000,000 shares of our common stock at an exercise price equal to the price
per share of our common stock sold in our initial public offering, or $12 per
share. The amendments to our development and commercialization agreement with
ALZA included a reduction in product royalties and up front payments payable
to ALZA by us under the agreement. In addition, ALZA's option to distribute
the DUROS sufentanil product was amended in geographic scope to cover only the
U.S. and Canada, instead of worldwide.
The term of this agreement is for so long as we are obligated to make
product payments to ALZA. Either party has the right to terminate the
agreement in the event that the other party breaches a material obligation
under the agreement and does not cure the breach in a timely manner. In
addition, ALZA has the right to terminate the agreement if, at any time prior
to July 2002, we solicit for employment or hire, without ALZA's consent, a
person who is or within the previous 180 days has been an employee of ALZA, or
if at any time prior to July 2006, we solicit for employment or hire, without
ALZA's consent, a person who is or within the previous 180 days has been an
employee of ALZA in the DUROS technology group. In the event that our rights
terminate
10
with respect to any product or country, or the agreement terminates or expires
in its entirety (except for termination by us due to a breach by ALZA), ALZA
will have the exclusive right to use all our data, rights and information
relating to the products developed under the agreement as necessary for ALZA
to commercialize products which rights have reverted to ALZA, subject to
payment of a royalty to us based on the net sales of the products by ALZA. The
agreement is assignable by either party to an acquiror of all or substantially
all of such party's business.
Patents, Licenses and Proprietary Rights
Our success depends in part on our ability to obtain patents, to protect
trade secrets, to operate without infringing upon the proprietary rights of
others and to prevent others from infringing on our proprietary rights. Our
policy is to seek to protect our proprietary position by, among other methods,
filing U.S. and foreign patent applications related to our proprietary
technology, inventions and improvements that are important to the development
of our business. As of December 31, 2000, we held four issued U.S. patents and
one issued foreign patent. Our patents expire at various dates starting in the
year 2012. In addition, as of December 31, 2000, we had 15 pending U.S. patent
applications and have filed 11 patent applications under the Patent
Cooperation Treaty, from which 8 national phase applications are currently
pending in Europe, Australia and Canada. In addition, pursuant to our
agreement with ALZA, we have a license under a portfolio of pending, issued
and future patents of ALZA which may cover our products depending on the
attributes of our products.
Proprietary rights relating to our planned and potential products will be
protected from unauthorized use by third parties only to the extent that they
are covered by valid and enforceable patents or are effectively maintained as
trade secrets. Patents owned by or licensed to us may not afford protection
against competitors, and our pending patent applications now or hereafter
filed by or licensed to us may not result in patents being issued. In
addition, the laws of certain foreign countries may not protect our
intellectual property rights to the same extent as do the laws of the U.S.
The patent positions of biopharmaceutical companies involve complex legal
and factual questions and, therefore, their enforceability cannot be predicted
with certainty. Our patents or patent applications, or those licensed to us,
if issued, may be challenged, invalidated or circumvented, and the rights
granted thereunder may not provide proprietary protection or competitive
advantages to us against competitors with similar technology. Furthermore, our
competitors may independently develop similar technologies or duplicate any
technology developed by us. Because of the extensive time required for
development, testing and regulatory review of a potential product, it is
possible that, before any of our products can be commercialized, any related
patent may expire or remain in existence for only a short period following
commercialization, thus reducing any advantage of the patent, which could
adversely affect our ability to protect future product development and,
consequently, our operating results and financial position.
Because patent applications in the U.S. are maintained in secrecy until
patents issue and since publication of discoveries in the scientific or patent
literature often lag behind actual discoveries, we cannot be certain that we
were the first to make the inventions covered by each of our issued or pending
patent applications or that we were the first to file for protection of
inventions set forth in such patent applications. Our planned or potential
products may be covered by third-party patents or other intellectual property
rights, in which case we would need to obtain a license to continue developing
or marketing these products.
Any required licenses may not be available to us on acceptable terms, if at
all. If we do not obtain any required licenses, we could encounter delays in
product introductions while we attempt to design around these patents, or
could find that the development, manufacture or sale of products requiring
such licenses is foreclosed. Litigation may be necessary to defend against or
assert such claims of infringement, to enforce patents issued to us, to
protect trade secrets or know-how owned by us, or to determine the scope and
validity of the proprietary rights of others. In addition, interference
proceedings declared by the U.S. Patent and Trademark Office may be necessary
to determine the priority of inventions with respect to our patent
applications. Litigation or interference proceedings could result in
substantial costs to and diversion of effort by us, and could have a material
adverse effect on our business, financial condition and results of operations.
These efforts by us may not be successful.
11
We may rely, in certain circumstances, on trade secrets to protect our
technology. However, trade secrets are difficult to protect. We seek to
protect our proprietary technology and processes, in part, by confidentiality
agreements with our employees and certain contractors. There can be no
assurance that these agreements will not be breached, that we will have
adequate remedies for any breach, or that our trade secrets will not otherwise
become known or be independently discovered by competitors. To the extent that
our employees, consultants or contractors use intellectual property owned by
others in their work for us, disputes may also arise as to the rights in
related or resulting know-how and inventions.
Government Regulation
The FDA and comparable regulatory agencies in state and local jurisdictions
and in foreign countries impose substantial requirements upon the clinical
development, manufacture and marketing of pharmaceutical products. These
agencies and other federal, state and local entities regulate research and
development activities and the testing, manufacture, quality control, safety,
effectiveness, labeling, storage, record keeping, approval, advertising and
promotion of our products. We believe that our initial products will be
regulated as drugs by the FDA rather than as biologics or devices, whereas
later products may be regulated as combination products with a device
designation for all or some of the final product components.
The process required by the FDA under the new drug provisions of the
Federal Food, Drug and Cosmetics Act before our initial products may be
marketed in the U.S. generally involves the following:
. preclinical laboratory and animal tests;
. submission of an IND application which must become effective before
clinical trials may begin;
. adequate and well-controlled human clinical trials to establish the
safety and efficacy of the proposed pharmaceutical in our intended use;
and
. FDA approval of a new drug application.
The testing and approval process requires substantial time, effort, and
financial resources and we cannot be certain that any approval will be granted
on a timely basis, if at all.
Preclinical tests include laboratory evaluation of the product, its
chemistry, formulation and stability, as well as animal studies to assess the
potential safety and efficacy of the product. We then submit the results of
the preclinical tests, together with manufacturing information and analytical
data, to the FDA as part of an IND, which must become effective before we may
begin human clinical trials. The IND automatically becomes effective 30 days
after receipt by the FDA, unless the FDA, within the 30-day time period,
raises concerns or questions about the conduct of the trials as outlined in
the IND and imposes a clinical hold. In such a case, the IND sponsor and the
FDA must resolve any outstanding concerns before clinical trials can begin.
Our submission of an IND may not result in FDA authorization to commence
clinical trials. Further, an independent Institutional Review Board at each
medical center proposing to conduct the clinical trials must review and
approve any clinical study.
Human clinical trials are typically conducted in three sequential phases
which may overlap:
. PHASE I: The drug is initially introduced into healthy human subjects or
patients and tested for safety, dosage tolerance, absorption,
metabolism, distribution and excretion.
. PHASE II: Involves studies in a limited patient population to identify
possible adverse effects and safety risks, to determine the efficacy of
the product for specific targeted diseases and to determine dosage
tolerance and optimal dosage.
. PHASE III: When Phase II evaluations demonstrate that a dosage range of
the product is effective and has an acceptable safety profile, Phase III
trials are undertaken to further evaluate dosage, clinical efficacy and
to further test for safety in an expanded patient population, often at
geographically dispersed clinical study sites.
12
In the case of products for severe diseases, such as chronic pain, or life-
threatening diseases such as cancer, the initial human testing is often
conducted in patients with disease rather than in healthy volunteers. Since
these patients already have the target disease or condition, these studies may
provide initial evidence of efficacy traditionally obtained in Phase II trials
and thus these trials are frequently referred to as Phase I/II trials. We
cannot be certain that we will successfully complete Phase I, Phase II or
Phase III testing of our product candidates within any specific time period,
if at all. Furthermore, the FDA or the Institutional Review Board or the
sponsor may suspend clinical trials at any time on various grounds, including
a finding that the subjects or patients are being exposed to an unacceptable
health risk.
The results of product development, preclinical studies and clinical
studies are submitted to the FDA as part of a new drug application for
approval of the marketing and commercial shipment of the product. The FDA may
deny a new drug application if the applicable regulatory criteria are not
satisfied or may require additional clinical data. Even if such data is
submitted, the FDA may ultimately decide that the new drug application does
not satisfy the criteria for approval. Once issued, the FDA may withdraw
product approval if compliance with regulatory standards is not maintained or
if safety problems occur after the product reaches the market. In addition,
the FDA requires surveillance programs to monitor approved products which have
been commercialized, and the agency has the power to require changes in
labeling or to prevent further marketing of a product based on the results of
these post-marketing programs.
In addition to the drug approval requirements applicable to our initial
product for the treatment of chronic pain through the Center for Drug
Evaluation and Research (CDER), the FDA may require an intercenter
consultation review by the Center for Devices and Radiological Health (CDRH).
This request for consultation may be based on the device-like nature of a
number of aspects of the DUROS technology.
Satisfaction of the above FDA requirements or similar requirements of
state, local and foreign regulatory agencies typically takes several years and
the actual time required may vary substantially, based upon the type,
complexity and novelty of the pharmaceutical product. Government regulation
may delay or prevent marketing of potential products for a considerable period
of time and impose costly procedures upon our activities. We cannot be certain
that the FDA or any other regulatory agency will grant approval for any of our
products under development on a timely basis, if at all. Success in
preclinical or early stage clinical trials does not assure success in later
stage clinical trials. Data obtained from preclinical and clinical activities
is not always conclusive and may be susceptible to varying interpretations
which could delay, limit or prevent regulatory approval. Even if a product
receives regulatory approval, the approval may be significantly limited to
specific indications. Further, even after regulatory approval is obtained,
later discovery of previously unknown problems with a product may result in
restrictions on the product or even complete withdrawal of the product from
the market. Delays in obtaining, or failures to obtain regulatory approvals
would have a material adverse effect on our business. Marketing our products
abroad will require similar regulatory approvals and is subject to similar
risks. In addition, we cannot predict what adverse governmental regulations
may arise from future U.S. or foreign governmental action.
Any products manufactured or distributed by us pursuant to FDA clearances
or approvals are subject to pervasive and continuing regulation by the FDA,
including record-keeping requirements and reporting of adverse experiences
with the drug. Drug manufacturers and their subcontractors are required to
register their establishments with the FDA and state agencies, and are subject
to periodic unannounced inspections by the FDA and state agencies for
compliance with good manufacturing practices, which impose procedural and
documentation requirements upon us and our third party manufacturers. We
cannot be certain that we or our present or future suppliers will be able to
comply with the GMP regulations and other FDA regulatory requirements.
The FDA regulates drug labeling and promotion activities. The FDA has
actively enforced regulations prohibiting the marketing of products for
unapproved uses. Under the FDA Modernization Act of 1997, the FDA will permit
the promotion of a drug for an unapproved use in certain circumstances, but
subject to very stringent requirements. We and our products are also subject
to a variety of state laws and regulations in those states or
13
localities where our products are or will be marketed. Any applicable state or
local regulations may hinder our ability to market our products in those
states or localities. We are also subject to numerous federal, state and local
laws relating to such matters as safe working conditions, manufacturing
practices, environmental protection, fire hazard control, and disposal of
hazardous or potentially hazardous substances. We may incur significant costs
to comply with such laws and regulations now or in the future.
The FDA's policies may change and additional government regulations may be
enacted which could prevent or delay regulatory approval of our potential
products. Moreover, increased attention to the containment of health care
costs in the U.S. and in foreign markets could result in new government
regulations that could have a material adverse effect on our business. We
cannot predict the likelihood, nature or extent of adverse governmental
regulation that might arise from future legislative or administrative action,
either in the U.S. or abroad.
Competition
We may face competition from other companies in numerous industries
including pharmaceuticals, medical devices and drug delivery. Our DUROS
sufentanil product will compete with oral opioids, transdermal opioid patches,
and implantable and external infusion pumps which can be used for infusion of
opioids. Products of these types are marketed by Purdue Pharma, Knoll,
Janssen, Medtronic, AstraZeneca, Arrow International, Tricumed and others. Our
spinal hydromorphone product will compete with implantable and external
infusion pumps marketed by Medtronic, Arrow International, Tricumed, Abbott,
Deltec and others. Numerous companies are applying significant resources and
expertise to the problems of drug delivery and several of these are focusing
or may focus on delivery of drugs to the intended site of action, including
Alkermes, Genetronics, The Liposome Company, Focal, Matrix Pharmaceuticals and
others. Although we have exclusivity with respect to our license of the DUROS
technology in specific fields of therapy, ALZA is also a potential competitor
with technologies other than DUROS.
Some of these competitors may be addressing the same therapeutic areas or
indications as us. Our current and potential competitors may succeed in
obtaining patent protection or commercializing products before us. Any
products we develop using our pharmaceutical systems technologies will compete
in highly competitive markets. Many of our potential competitors in these
markets have greater development, financial, manufacturing, marketing, and
sales resources than we do and we cannot be certain that they will not succeed
in developing products or technologies which will render our technologies and
products obsolete or noncompetitive. In addition, many of those potential
competitors have significantly greater experience than we do in their
respective fields.
Item 2. Properties.
We are headquartered in Cupertino, California, where we lease approximately
30,000 square feet of space under a lease expiring in January 2004 with
options to extend for up to an additional ten years. This facility contains
both office and laboratory space and is the site of the manufacturing facility
we are constructing. We also lease approximately 7,800 square feet of space in
Vacaville, California, which contains manufacturing space for the ALZET
product. Our lease of this facility expires in August 2003 with an option to
extend for two years. We believe that our existing and planned facilities are
adequate to meet our current and foreseeable requirements or that suitable
additional or substitute space will be available as needed.
Item 3. Legal Proceedings.
We are not a party to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Price Range of Common Stock
Our common stock has been listed for quotation on the Nasdaq National
Market under the symbol "DRRX" since our initial public offering on September
28, 2000. The following table shows the high and low sales prices of our
common stock as reported by the Nasdaq National Market for the period
indicated.
Fiscal 2000 High Low
----------- ------ ------
Quarter ended September 30, 2000 (from September 28, 2000)... $18.50 $12.00
Quarter ended December 31, 2000.............................. $16.37 $ 9.06
The closing sale price of the common stock as reported on the Nasdaq
National Market on March 16th, 2001 was $5.25 per share. As of that date there
were approximately 196 holders of record of the common stock. This does not
include the number of persons whose stock is in nominee or "street name"
accounts through brokers. The market price of our common stock has been and
may continue to be subject to wide fluctuations in response to a number of
events and factors, such as quarterly variations in our operating results,
announcements of technological innovations or new products by us or its
competitors, changes in financial estimates and recommendations by securities
analysts, the operating and stock performance of other companies that
investors may deem comparable to us, and news reports relating to trends in
our markets. These fluctuations, as well as general economic and market
conditions, may adversely affect the market price for our common stock.
Dividend Policy
We have never paid cash dividends on our common stock. We currently intend
to retain any future earnings to fund the development and growth of our
business. Therefore, we do not currently anticipate paying any cash dividends
in the foreseeable future.
Recent Sales of Unregistered Securities
In March 2000, we sold an aggregate of 3,571,429 shares of our unregistered
Series C preferred stock for $7.00 per share for an aggregate price of
approximately $25,000,000 to selected institutional and other accredited
investors, including, Biotech Growth S.A. (funds controlled by BB Biotech),
Brookside Capital Partners Fund, L.P., and the Zesiger Capital Group LLC. In
issuing these securities, we relied on Section 4(2) of the Securities Act, on
the basis that the transaction did not involve a public offering.
In April 2000, we sold 1,000,000 shares of our unregistered common stock
and issued a warrant to purchase 1,000,000 shares of our unregistered common
stock to ALZA Corporation in exchange for ALZA's agreement to amend the
Amended and Restated Development and Commercialization Agreement dated April
28, 1999. In issuing these securities, we relied on Section 4(2) of the
Securities Act, on the basis that the transaction did not involve a public
offering.
In the year ending December 31, 2000, we issued 1,833,200 shares of
unregistered common stock to our employees and nonemployees pursuant to the
exercise of stock options under our 1998 stock option plan and our 2000 stock
plan. These options were exercised at a weighted average exercise price of
$0.88 per share. These issuances were made in reliance upon Rule 701
promulgated under the Securities Act.
Use of Proceeds from Sales of Registered Securities
On September 27, 2000, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-35316) was declared effective by
the Securities and Exchange Commission, pursuant to which 7,000,000 shares of
our common stock were offered and sold for our account at a price of $12.00
per share,
15
generating gross offering proceeds of $84 million. The managing underwriters
were Morgan Stanley Dean Witter, Chase H&Q, and CIBC World Markets. Our
initial public offering closed on October 3, 2000. After deducting
underwriters' discounts and commissions and other offering expenses, the net
proceeds were approximately $76.2 million. On November 1, 2000, the
underwriters exercised their over-allotment option in part and purchased an
additional 700,000 shares at the initial public offering price of $12.00 per
share. The net proceeds of the over-allotment option, after deducting
underwriters' discount and other offering expenses, were approximately $7.8
million. After giving effect to the sale of the over-allotment shares, a total
of 7,700,000 shares of common stock were offered and sold in the initial
public offering with total net proceeds of $84.0 million. None of the payments
for underwriting discounts and commissions and other transaction expenses
represented direct or indirect payments to directors, officers or other
affiliates of the Company. As of December 31, 2000, we used $5.3 million for
development expenses related to our products including the allocation of
certain general and administrative costs, $416,000 for the construction of our
new manufacturing facility, and, under the terms of our agreement to purchase
the ALZET product line from ALZA Corporation, we were required to make our
final payment for inventory following the completion of our initial public
offering, in the amount of $805,000. We invested the remainder of the net
proceeds in investment grade securities.
We intend to use the net proceeds of the initial public offering as
follows:
. approximately $40-$60 million to fund development expenses related to
our products, including clinical trial expenses;
. approximately an additional $5-$8 million to fund the development and
construction of our manufacturing facility;
. to fund the commercialization of our products, once approved; and
. for working capital and general corporate purposes.
We may use a portion of the net proceeds to fund, acquire or invest in
complementary businesses or technologies. The amount of cash that we actually
expend for any of the described purposes will vary significantly based on a
number of factors, including the progress of our research and development and
clinical trials, the establishment of collaborative relationships, the cost
and pace of establishing and expanding our manufacturing capabilities, the
development of sales and marketing activities if undertaken by us and
competing technological and market developments. Our management will have
significant discretion in applying the net proceeds of this offering.
16
Item 6. Selected Financial Data.
The following selected financial and operating data should be read in
conjunction with and are qualified by reference to "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and our
financial statements and related notes, which are included in this Form 10-K.
The statement of operations data for the period from inception (February 6,
1998) to December 31, 1998, the years ending December 31, 1999 and 2000, and
the balance sheet data at December 31, 1999 and 2000 are derived from, and are
qualified by reference to, the audited financial statements included elsewhere
in this Form 10-K. The December 31, 1998 balance sheet data is derived from
our audited statements not included in this Form 10-K but included in our S-1
filings. Historical operating results are not necessarily indicative of
results in the future, and the results for interim periods are not necessarily
indicative of the results that may be expected for the entire year. See Note--
1 of notes to financial statements for an explanation of the determination of
the shares used in computing net loss per share.
Period from
inception
Year ended (February 6,
December 31, 1998) to
----------------- December 31,
2000 1999 1998
-------- ------- ------------
Statement of Operations Data:
Revenue, net.................................. $ 3,155 $ 86 $ --
Cost of goods sold............................ 1,941 39 --
-------- ------- -------
Gross profit.................................. 1,214 47 --
-------- ------- -------
Operating expenses:
Research and development.................... 12,669 5,181 466
Research and development to related party... 666 1,182 243
Selling, general and administrative......... 4,874 2,109 585
Amortization of intangible assets........... 850 69 --
Noncash charges related to stock-based
compensation............................... 4,978 865 149
-------- ------- -------
Total operating expenses...................... 24,037 9,406 1,443
-------- ------- -------
Loss from operations.......................... (22,823) (9,359) (1,443)
Other income (expense):
Interest income............................. 3,103 678 121
Interest expense............................ (131) (27) --
-------- ------- -------
Net other income.............................. 2,972 651 121
-------- ------- -------
Net loss...................................... (19,851) (8,708) (1,322)
Accretion of cumulative dividends on Series B
convertible preferred stock.................. 972 602 --
-------- ------- -------
Net loss attributable to common stockholders.. $(20,823) $(9,310) $(1,322)
======== ======= =======
Basic and diluted net loss per common share... $ (1.22) $ (1.76) $ (0.36)
Shares used in computing basic and diluted net
loss per share............................... 17,120 5,291 3,655
As of December 31,
-----------------------
2000 1999 1998
-------- ------- ------
(in thousands)
Balance Sheet Data:
Cash, cash equivalents and investments................ $106,084 $18,933 $7,975
Working capital....................................... 105,060 15,921 7,664
Total assets.......................................... 120,612 22,463 8,283
Equipment financing obligations, net of current
portion.............................................. 1,105 189 83
Stockholders' equity.................................. 115,254 20,728 7,749
17
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations as of December 31, 2000, 1999, and 1998 should be read
in conjunction with our Registration Statement on Form S-1 filed with the
Securities and Exchange Commission and declared effective on September 27,
2000, as amended, and our Condensed Financial Statements, including the Notes
thereto and "Factors that May Affect Future Results" section included
elsewhere in this Form 10-K. This Form 10-K contains forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, and Section 27A of the Securities Act of 1933, as amended.
When used in this report or elsewhere by management from time to time, the
words "believe," "anticipates," "intends," "plans," "estimates," and similar
expressions are forward looking statements. Such forward looking statements
contained herein are based on current expectations. Any such forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties. Actual events or results may differ materially from those
discussed in the forward-looking statements as a result of various factors.
For a more detailed discussion of such forward looking statements and the
potential risks and uncertainties that may impact upon their accuracy, see the
"Factors that May Affect Future Results" and "Overview" sections of this
Management's Discussion and Analysis of Financial Condition and Results of
Operations. These forward-looking statements reflect our view only as of the
date of this report. Except as required by law, we undertake no obligations to
update any forward looking statements. You should also carefully consider the
factors set forth in other reports or documents that we file from time to time
with the Securities and Exchange Commission.
Overview
DURECT Corporation is pioneering the treatment of chronic diseases and
conditions by developing and commercializing pharmaceutical systems to deliver
the right drug to the right place in the right amount at the right time. These
capabilities can enable new drug therapies or optimize existing ones based on
a broad range of compounds, including small molecule pharmaceuticals as well
as biotechnology molecules such as proteins, peptides and genes.
We were founded in February 1998. During that year, we were engaged in
negotiating a licensing agreement with ALZA Corporation to gain specified
rights to its DUROS system, raising capital, recruiting scientific and
management personnel and commencing research and development activities. In
late 1998, we filed an investigational new drug application relating to our
first product, DUROS sufentanil, a DUROS-based pharmaceutical system for the
treatment of chronic pain. In 1999, we began a Phase I clinical trial for
DUROS sufentanil using an external pump to test the safety of continuous
chronic infusion of this drug, initiated the development of a spinal
hydromorphone product, and initiated the research and development of other
products based on the DUROS system. In 2000, we prepared for and initiated our
Phase II clinical trial for DUROS sufentanil, which included the development
of our manufacturing process, developed a prototype of our spinal
hydromorphone product, and continued to research and develop other products
based on the DUROS system.
Prior to our initial public offering, we financed operations primarily
through the sale of convertible preferred stock, resulting in net proceeds of
$53.2 million. Our initial public offering in September 2000, together with
the exercise in part of our underwriters' over-allotment option in November
2000, resulted in net proceeds of $84.0 million.
We have sustained losses since inception. As of December 31, 2000, we had
an accumulated deficit of $31.5 million. Our net losses attributable to common
stockholders were $20.8, $9.3, and $1.3 million for the fiscal years ended
December 31, 2000, 1999, and 1998 respectively.
These losses have resulted primarily from costs incurred in the research
and development of our products, and to a lesser extent, selling, general and
administrative costs associated with our operations and product sales. Our
research and development expenses consist of salaries and related expenses for
research and development personnel, contract research and development
services, supplies and a portion of overhead operating expenses.
18
We expense all of our research and development costs as they are incurred. We
expect our research and development expenses to increase in the future as we
expand clinical trials and research and development activities. Selling,
general and administrative expenses consist primarily of salaries and related
expenses for administrative, finance, marketing and executive personnel,
legal, accounting and other professional fees and a portion of overhead
operating expenses. To support our research and development activities and the
additional obligations of a public reporting entity, we expect to increase our
selling, general and administrative expenses. We also expect to incur
substantial non-cash expenses relating to stock-based compensation. As a
result of these factors, we expect to incur significant losses and negative
cash flows for the foreseeable future.
We do not anticipate revenues from our pharmaceutical systems, should they
be approved, for at least several years. To date, our revenues have been
derived from two product lines we acquired.
In October 1999, we acquired substantially all of the assets of IntraEAR,
Inc, a developer and marketer of catheters that permit controlled fluid
delivery to the round window membrane of the ear. The total purchase price
consisted of 325,023 shares of Series B-1 preferred stock and $320,000 in
cash. The acquisition was accounted for using the purchase method of
accounting. From the time of the acquisition through December 31, 1999, our
sales of catheters resulted in revenues of $86,000. We do not anticipate that
revenues derived from catheter sales will increase significantly in the near
future. In the future, we may research and develop products that incorporate
technology acquired from IntraEAR.
In April 2000, we acquired from ALZA the ALZET product and assets used
primarily in the manufacture, sale and distribution of this product. The ALZET
product is a miniature, implantable osmotic pump used for experimental
research in mice, rats and other laboratory animals. This acquisition provides
us with an ongoing business making and selling this product worldwide. The
total purchase price consisted of $8.3 million in cash. The acquisition was
accounted for using the purchase method.
In April 2000, we amended our development and commercialization agreement
with ALZA. The amendments included a reduction in product royalties and
upfront payments to ALZA by us under the agreement. In addition, ALZA's option
to distribute the DUROS sufentanil product was amended to cover only the U.S.
and Canada instead of worldwide. As consideration, ALZA received 1,000,000
shares of our common stock and a warrant to purchase 1,000,000 shares of our
common stock at an exercise price equal to the price at which our common stock
was to be sold in our initial public offering. At the time of our initial
public offering in September 2000, the exercise price was set at $12 per
share. The fair value of the stock and warrant of $13.5 million was recorded
as additional paid-in capital and deferred royalties and commercial rights,
included as a contra-equity account in the statement of stockholders' equity,
and will be amortized as royalty expense and sales and marketing expense,
respectively, as associated product sales commence.
Since our acquisition of the ALZET product line in April 2000, we have been
dependent on a small number of customers for a substantial portion of our
revenues. In fiscal 2000, one customer accounted for more than 10% of our
revenues: Muromachi Kikai Co., Ltd. represented 14% of our revenues. Until
such time that we are able to bring our pharmaceutical systems to market, if
at all, we expect this trend to continue.
Revenue by geographic region for the fiscal year 2000 and 1999 are as
follows:
December 31,
--------------
2000 1999
------- ------
(in
thousands)
Sales to unaffiliated customers:
United States.................................................. $ 2,161 $ 67
Japan.......................................................... 443 5
Europe......................................................... 371 7
Other.......................................................... 180 7
------- ----
Total.......................................................... $ 3,155 $ 86
------- ----
19
We have a limited history of operations and anticipate that our quarterly
and annual results of operations will fluctuate for the foreseeable future. We
believe that period-to-period comparisons of our operating results should not
be relied upon as predictive of future performance. Our prospects must be
considered in light of the risks, expenses and difficulties encountered by
companies at an early stage of development, particularly companies in new and
rapidly evolving markets such as pharmaceuticals, drug delivery, and
biotechnology. To address these risks, we must, among other things, obtain
regulatory approval for and commercialize our products, which may not occur.
We may not be successful in addressing these risks and difficulties. We may
require additional funds to complete the development of our products and to
fund operating losses to be incurred in the next several years.
Results of Operations
Comparison of years ended December 31, 2000 and 1999
Revenue. Net revenues were $3.2 million in 2000 compared to $86,000 in
1999. We initiated sales in October 1999 following the acquisition of
IntraEAR, Inc. and its ear catheter products. Since the acquisition of the
ALZET product line in April 2000, our revenues have primarily resulted from
sales of ALZET minipumps, with the remainder from our ear catheter products.
In the near future, we do not intend to significantly increase our efforts to
sell and market either of these product lines and as such do not anticipate
that revenues from them will increase significantly.
Gross profit. Gross profit was $1.2 million or 38% of revenues in 2000
compared to $47,000 or 55% of revenues in 1999. The decrease in gross profit
as a percentage of revenues is attributable to higher proportions of sales of
the relatively higher cost ALZET minipumps. Cost of goods sold includes
manufacturing cost variances that result from the completion of batches of the
ALZET product, which may be large relative to our sales. As a result, we
expect gross profit as a percentage of revenue related to this product to
fluctuate.
Research and Development. Research and development expenses increased to
$13.3 million in 2000 from $6.4 million in 1999. The increase was attributable
to increases in research and development personnel and related expenses,
contract research and development services, and activity related to the
preparation for our Phase II clinical trial relating to DUROS sufentanil,
including the manufacturing of product to be used in the trial. As of December
31, 2000, we had 40 research and development employees compared with 23 as of
the corresponding date in 1999. We expect research and development expenses to
increase as we expand our Phase II and begin our Phase III clinical trials for
DUROS sufentanil, continue to hire research and development personnel,
continue to develop our spinal hydromorphone product, and research and develop
other products.
In addition, we expect research and development expenses to continue to
increase in order to meet minimum product funding requirements under our
license agreement with ALZA. To maintain our rights under this agreement, we
must spend minimum amounts each year on product development, with the amount
and duration of funding in each field varying over time. For our two products
currently in development, we are required to fund each in the amount of at
least $3.0 million per year until the time of commercialization. Funding
requirements to maintain rights to additional products begin in 2001. The
future minimum annual product funding requirements for all fields of use are
as follows:
Year ended December 31,
----------------------- (in thousands)
2001....................................................... $ 8,000
2002....................................................... 13,000
2003....................................................... 14,000
2004*...................................................... 17,000
-------
Total minimum funding required........................... $52,000
=======
- --------
* Funding requirements after 2004 are to be mutually agreed upon by us and
ALZA.
20
Selling, General and Administrative. Selling, general and administrative
expenses increased to $4.9 million in 2000 from $2.1 million in 1999. The
increase was primarily due to an increase in general and administrative
personnel and related expenses necessary to support our growth. Selling
expenses increased following the acquisition of the ALZET product line in
April 2000. As of December 31, 2000, we had 22 selling, general and
administrative personnel compared with 13 as of the corresponding date in
1999. We expect selling, general and administrative expenses to continue to
increase as we increase the number of personnel and related resources required
to meet the obligations of a public company and support our growth. Selling
expenses for subsequent years will be greater as we sell the ALZET products
over the entire year.
Amortization of intangible assets. In connection with our acquisitions of
IntraEAR, Inc. and the ALZET product line, we acquired goodwill of $1.9
million and other intangible assets of $4.2 million. Goodwill is amortized
over the estimated useful life of 6 years; other intangible assets are
amortized over their estimated useful lives, which are between 4 and 7 years.
Amortization of intangible assets increased to $850,000 in 2000 from $69,000
in 1999. Amortization of intangibles assets in 1999 resulted from the
acquisition of IntraEAR, Inc. in October 1999. The increase in amortization of
goodwill and other intangibles in 2000 resulted from the acquisition of the
ALZET product line in April 2000 and the amortization of goodwill and other
intangibles associated with the IntraEAR acquisition over the entire year.
The remaining goodwill for both acquisitions at December 31, 2000 was $1.6
million, which will be amortized as follows: $317,000 for each of the years
ending December 31, 2001, 2002, 2003 and 2004, $289,000 for the year ending
December 31, 2005, and $59,000 for the year ending December 31, 2006. The
remaining other intangible assets for both acquisitions at December 31, 2000
was $3.6 million, which will be amortized as follows: $779,000 for each of the
years ending December 31, 2001 and 2002, $762,000 for the year ending December
31, 2003, $567,000 for the year ending December 31, 2004, $505,000 for the
year ending December 31, 2005, and $167,000 for the year ending December 31,
2006. We periodically evaluate acquired intangible assets for impairment or
obsolescence. Should the intangible assets become impaired or obsolete, we may
reduce the amortization period or write them off at one time.
Stock-Based Compensation. We have recorded aggregate deferred compensation
charges of $10.3 million in connection with stock options granted to employees
and directors through December 31, 2000. Of this amount, we have amortized
$5.4 million through December 31, 2000. For 2000, we recorded $5.0 million of
stock-based compensation, compared with $865,000 for the year ending December
31, 1999. Of these amounts, employee stock compensation related to the
following: cost of goods sold of $65,000 in 2000, and $0 in 1999; research and
development expenses of $3.1 million in 2000, and $485,000 in 1999; and
selling, general and administrative expenses of $1.3 million in 2000 and
$380,000 in 1999.
Non-employee stock compensation related to research and development
expenses was $369,000 in 2000 and $0 in 1999. Non-employee stock compensation
related to selling, general and administrative expenses was $250,000 in 2000
and $0 in 1999. Expenses for non-employee stock options are recorded over the
vesting period of the options, with the amount determined by the Black-Scholes
option valuation method and remeasured over the vesting term.
The remaining employee deferred stock compensation at December 31, 2000 was
$4.8 million, which will be amortized as follows: $2.7 million for the year
ending December 31, 2001, $1.4 million for the year ending December 31, 2002,
$600,000 for the year ending December 31, 2003, and $51,000 for the year
ending December 31, 2004. Termination of employment of option holders could
cause stock-based compensation in future years to be less than indicated.
Other Income (Expense). Interest income increased to $3.1 million in 2000,
from $678,000 in 1999. The increase in interest income was primarily
attributable to higher average outstanding balances of cash and investments
resulting from the sale of convertible preferred stock in March 2000 and our
initial public offering in September 2000. Interest expense was $131,000 in
2000, and $27,000 in 1999. The increase in interest expense was primarily due
to increased debt obligations from equipment financings. We expect interest
expense to increase as we finance additional equipment.
21
Comparison of years ended December 31, 1999 and the period from inception
(February 6, 1998) to December 31, 1998
Revenue. We initiated sales in October 1999 following the acquisition of
IntraEAR, Inc. and its ear catheter products. We derived revenues of $86,000
from these products through December 31, 1999. We had no revenues in 1998.
Gross profit. Gross profit, which was derived from ear catheter products,
was $47,000 or 55% of revenues in 1999. We had no gross profit in 1998.
Research and Development. Research and development expenses increased to
$6.4 million in 1999 from $709,000 in 1998. The increase was attributable to
increases in contract research and development services, research and
development personnel and related expenses, and activity related to our Phase
I clinical trials relating to DUROS sufentanil. In 1999, research and
development activities were also initiated in other product areas.
Selling, General and Administrative. Selling, general and administrative
expenses increased to $2.1 million in 1999, from $585,000 million in 1998. The
increase was primarily due to an increase in general and administrative
personnel and related expenses necessary to support our growth.
Amortization of intangible assets. In connection with our acquisition of
IntraEAR, Inc. in October of 1999, we acquired goodwill of $690,000 and other
intangible assets of $770,000. Amortization of intangible assets commenced at
the time of the acquisition and was $69,000 for 1999.
Stock-Based Compensation. We recorded $865,000 of stock-based compensation
in 1999 compared with $149,000 in 1998. Of these amounts, employee stock
compensation related to the following; research and development expenses of
$485,000 in 1999 and $46,000 in 1998, and selling, general and administrative
expenses of $380,000 in 1999 and $103,000 in 1998.
Other Income (Expense). Interest income increased to $678,000 in 1999 from
$121,000 in 1998. The increase in interest income was primarily attributable
to higher average outstanding balances of cash and investments resulting from
the sale of convertible preferred stock in July 1999. Interest expense was
$27,000 in 1999 and resulted from the initiation of payments on an equipment
financing obligation.
Income Taxes
Deferred tax assets and liabilities reflect the net tax effects of net
operating loss and credit carryforwards and the temporary differences between
the carrying amounts of assets and liabilities for financial reporting and the
amounts used for income tax purposes. Significant components of our deferred
tax assets are as follows (in thousands):
December 31,
-----------------
2000 1999
-------- -------
Deferred tax assets:
Net operating loss carryforwards........................ $ 9,100 $ 3,600
Capitalized research and development.................... 600 --
Research credit carryforwards........................... 600 --
Other individually immaterial items..................... 200 (100)
-------- -------
Total deferred tax assets............................. 10,500 3,500
Valuation allowance for deferred tax assets............... (10,500) (3,500)
-------- -------
Net deferred tax assets................................... $ -- $ --
======== =======
Realization of deferred tax assets is dependent upon future earnings, if
any, the timing and amount of which are uncertain. Accordingly, the net
deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by $7,000,000 and $2,950,000 during 2000 and
1999, respectively.
22
As of December 31, 2000, we had federal and state net operating loss
carryforwards of approximately $24,000,000 which expire at various dates
beginning in 2006 through 2020, if not utilized. We also had federal and state
research and development tax credits of approximately $600,000 which expire at
various dates beginning in 2018 through 2020, if not utilized.
Utilization of the net operating losses may be subject to a substantial
annual limitation due to federal and state ownership change limitations. The
annual limitation may result in the expiration of net operating losses before
utilization.
Liquidity and Capital Resources
For the year ended December 31, 2000, excluding $3.2 million of inventory
acquired related to the purchase of the ALZET product line, cash expenditures
for operating activities and additions to capital equipment were $15.5
million. We anticipate that these expenditures will increase in future
periods.
From inception through the time of our initial public offering in September
2000, we raised $53.2 million, net of issuance costs, through convertible
preferred stock financings. On September 28, 2000 we raised $76.2 million, net
of issuance costs, through an initial public offering of our common stock, and
in November 2000, we raised $7.8 million from the exercise of our
underwriter's over-allotment. We had cash, cash equivalents, and investments
totaling $106.1 million, $18.9 million, and $8.0 million at December 31, 2000,
1999 and 1998, respectively.
Working capital was $105.1 million, $15.9 million, and $7.7 million at
December 31, 2000, 1999, and 1998, respectively. The increase in 2000 compared
to 1999 was primarily attributable to the sale of common stock in our initial
public offering and the sale of Series C convertible preferred stock,
partially offset by operating losses of $22.8 million and an increase in
accrued and other current liabilities of $2.7 million. The increase in 1999
compared to 1998 was primarily attributable to the sale of Series B
convertible preferred stock, partially offset by operating losses of $9.4
million and an increase in accounts payable and other current liabilities of
$1.0 million.
We used $14.9 million, $7.3 million, and $885,000 of cash for operations in
the years ended December 31, 2000 and 1999, and the period from inception to
December 31, 1998, respectively. The increase in 2000 compared to 1999 was
primarily attributable to increased operating losses and the acquisition of
ALZET inventory, offset by increased noncash charges related to stock awards,
depreciation and amortization. The increase in 1999 compared to 1998 was
primarily attributable to increased operating losses, offset by increased
noncash charges related to stock compensation, depreciation and amortization.
We used $52.7 million, $16.2 million, and $62,000 of cash in investing
activities in the years ended December 31, 2000 and 1999, and the period from
inception to December 31, 1998, respectively. The increase in uses of
investing cash in 2000 compared to 1999 was primarily due to purchases of
short-term investments, intangible assets related to the ALZET product, and
equipment. The increase in use of investing cash in 1999 compared to 1998 was
due to increases in purchases of short-term investments, equipment and
leasehold improvements.
We received $110.4 million, $19.3 million, and $8.9 million of cash from
financing activities in the years ended December 31, 2000 and 1999, and the
period from inception to December 31, 1998, respectively. Cash received from
financing activities in 2000 was primarily the result of our initial public
offering, and in 1999, from the sale of convertible preferred stock. In the
year ending December 31, 2000 we received $1.6 million of net equipment
financing. Cash received from financing activities in 1998 was primarily the
result of the sale of convertible preferred stock.
We anticipate that cash used in operating and investing activities will
increase significantly in the future as we research, develop, and manufacture
our products, and, as discussed above, meet our product funding
23
requirements under our agreement with ALZA. We anticipate incurring capital
expenditures of at least $4.0 million over the next 12 months to construct and
equip our DUROS manufacturing facility, and to purchase research and
development equipment. The amount and timing of these capital expenditures
will depend on the success of clinical trials for our products. Assets
relating to our manufacturing facilities will be depreciated over their useful
lives, which is generally between three and ten years.
We believe that our existing cash, cash equivalents and investments,
together with available equipment financing and the net proceeds from our
initial public offering will be sufficient to finance our planned operations
and capital expenditures through at least 18 months. We may consume available
resources more rapidly than currently anticipated, resulting in the need for
additional funding. Accordingly, we may be required to raise additional
capital through a variety of sources, including:
. the public equity market;
. private equity financing;
. collaborative arrangements; and
. public or private debt.
There can be no assurance that additional capital will be available on
favorable terms, if at all. If adequate funds are not available, we may be
required to significantly reduce or refocus our operations or to obtain funds
through arrangements that may require us to relinquish rights to certain of
our products, technologies or potential markets, either of which could have a
material adverse effect on our business, financial condition and results of
operations. To the extent that additional capital is raised through the sale
of equity or convertible debt securities, the issuance of such securities
would result in ownership dilution to our existing stockholders.
Our cash and investments policy emphasizes liquidity and preservation of
principal over other portfolio considerations. We select investments that
maximize interest income to the extent possible given these two constraints.
We satisfy liquidity requirements by investing excess cash in securities with
different maturities to match projected cash needs and limit concentration of
credit risk by diversifying our investments among a variety of high credit-
quality issuers.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standard
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"), which will be effective for the year ending December 31, 2001. This
statement establishes accounting and reporting standards requiring that every
derivative instrument, including certain derivative instruments embedded in
other contracts, be recorded in the balance sheet as either an asset of
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. We believe the adoption of SFAS 133 will not have
a material effect on the financial statements, since we currently do not
invest in derivative instruments or engage in hedging activities.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas of
the Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. We believe our current revenue
recognition policies comply with SAB 101.
In March 2000, the FASB issued FASB Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation" ("FIN 44"), which contains
rules designed to clarify the application of APB 25. FIN 44 was effective on
July 1, 2000, and we adopted it at that time. The impact of the adoption of
FIN 44 was not material to our operating results or financial position.
24
Factors that May Affect Future Results
In addition to the other information in this Form on 10-K, the following
factors should be considered carefully in evaluating our business and
prospects:
We have not completed development of any of our pharmaceutical systems, and
we cannot be certain that our pharmaceutical systems will be able to be
commercialized
To be profitable, we must successfully research, develop, obtain regulatory
approval for, manufacture, introduce, market and distribute our pharmaceutical
systems under development. For each pharmaceutical system that we intend to
commercialize, we must successfully meet a number of critical developmental
milestones for each disease or medical condition that we target, including:
. selecting and developing drug delivery platform technology to deliver
the proper dose of drug over the desired period of time;
. selecting and developing catheter technology, if appropriate, to deliver
the drug to a specific location within the body;
. determining the appropriate drug dosage for use in the pharmaceutical
system;
. developing drug compound formulations that will be tolerated, safe and
effective and that will be compatible with the system; and
. demonstrating the drug formulation will be stable for commercially
reasonable time periods.
The time frame necessary to achieve these developmental milestones for any
individual product is long and uncertain, and we may not successfully complete
these milestones for any of our products in development. We have not yet
completed development of any pharmaceutical systems, and DURECT has limited
experience in developing such products. For our lead product, DUROS sufentanil
and our second product, DUROS hydromorphone, we have not yet determined the
drug dosages we intend to use for commercialization nor finalized the
commercial design. We are continuing testing of these products and exploring
possible design changes to address issues of safety, manufacturing efficiency
and performance. We may not be able to complete the design of these products.
In addition, we may not be able to develop dosages that will be safe and
effective or compatible with the pharmaceutical system for a commercially
reasonable treatment and storage period. If we are unable to complete
development of these or other products, we will not be able to earn revenue,
which would materially harm our business.
We must conduct and satisfactorily complete clinical trials for our
pharmaceutical systems
Before we can obtain government approval to sell any of our pharmaceutical
systems, we must demonstrate through preclinical (animal) studies and clinical
(human) trials that each system is safe and effective for human use for each
targeted disease. We have completed an initial Phase I clinical trial for our
lead product, DUROS sufentanil, using an external pump to test the safety of
continuous chronic infusion of the drug, and we initiated a Phase II clinical
trial for this product in December 2000. We are conducting pre-clinical
studies on our second product, DUROS hydromorphone. We plan to continue
extensive and costly clinical trials to assess the safety and effectiveness of
DUROS sufentanil, DUROS hydromorphone and our other potential products. We may
not be permitted to begin or continue our planned clinical trials for our
potential products or, if our trials are permitted, our potential products may
not prove to be safe or produce their intended effects.
The length of our clinical trials depends upon, among other factors, the
rate of trial site and patient enrollment. We may fail to obtain adequate
levels of patient enrollment in our clinical trials. Delays in planned patient
enrollment may result in increased costs, delays or termination of clinical
trials, which could have a material adverse effect on us. In addition, even if
we enroll the number of patients we expect in the time frame we expect, our
clinical trials may not provide the data necessary for their successful
completion. Additionally, we may fail to effectively oversee and monitor these
clinical trials, which would result in increased costs or delays of our
clinical trials. Even if these clinical trials are completed, we may fail to
complete and submit a
25
new drug application as scheduled. Even if we are able to submit a new drug
application as scheduled, the Food and Drug Administration may not clear our
application in a timely manner or may deny the application entirely.
Data already obtained from preclinical studies and clinical trials of our
pharmaceutical systems do not necessarily predict the results that will be
obtained from later preclinical studies and clinical trials. Moreover,
preclinical and clinical data such as ours is susceptible to varying
interpretations, which could delay, limit or prevent regulatory approval. A
number of companies in the pharmaceutical industry have suffered significant
setbacks in advanced clinical trials, even after promising results in earlier
trials. The failure to adequately demonstrate the safety and effectiveness of
a product under development could delay or prevent regulatory clearance of the
potential product, resulting in delays to the commercialization of our
products, and could materially harm our business. Our clinical trials may not
demonstrate the sufficient levels of safety and efficacy necessary to obtain
the requisite regulatory approvals for our products, and thus our products may
not be approved for marketing.
Our agreement with ALZA limits our fields of operation for our DUROS-based
pharmaceutical systems, requires us to spend significant funds on product
development and gives ALZA a first right to distribute selected products for
us
In April 1998, we entered into a development and commercialization
agreement with ALZA Corporation, which was amended and restated in April 1999
and April 2000. This agreement gives us exclusive rights to develop,
commercialize and manufacture products using ALZA's DUROS technology to
deliver by catheter:
. drugs to the central nervous system to treat select nervous system
disorders;
. drugs to the middle and inner ear;
. drugs to the pericardial sac of the heart; and
. select drugs into vascular grafts.
We also have the right to use the DUROS technology to deliver systemically
and by catheter:
. sufentanil to treat chronic pain; and
. select cancer antigens.
We may not develop, manufacture or commercialize DUROS-based pharmaceutical
systems outside of these specific fields without ALZA's prior approval. In
addition, if we develop or commercialize any drug delivery technology for use
in a manner similar to the DUROS technology in a field covered in our license
agreement with ALZA, then we may lose our exclusive rights to use the DUROS
technology in such field as well as the right to develop new products using
DUROS technology in such field. Furthermore, to maintain our rights under this
license agreement, we must meet annual minimum development spending
requirements totaling $52.0 million to develop products in some or all of
these fields through 2004 and fund development of a minimum number of products
per year up to a total of eight products through 2004. In order to maintain
commercialization rights for our products in the U.S. and any foreign
countries, we must diligently develop our products, procure required
regulatory approvals and commercialize the products in these countries. If we
fail to meet the various diligence requirements, we may:
. lose our rights to develop, commercialize and manufacture some of our
DUROS-based pharmaceutical systems;
. lose rights for products in some or all countries, including the U.S.;
or
. lose rights in some fields of use.
These rights would revert to ALZA, which could then develop DUROS-based
pharmaceutical products in such countries or fields of use itself or license
others to do so. In addition, in the event that our rights terminate with
respect to any product or country, or this agreement terminates or expires in
its entirety (except for
26
termination by us due to a breach by ALZA), ALZA will have the exclusive right
to use all of our data, rights and information relating to the products
developed under the agreement as necessary for ALZA to commercialize these
products, subject to the payment of a royalty to us based on the net sales of
the products by ALZA.
Our agreement with ALZA gives us the right to develop and manufacture the
DUROS pump component of our pharmaceutical systems in the fields described
above. In the event of a change in our corporate control, including an
acquisition of us, our right to manufacture and develop the DUROS pump would
terminate and ALZA would have the right to manufacture and develop DUROS
systems for us so long as ALZA can meet our specification and supply
requirements following such change in control.
Under the ALZA agreement, we must pay ALZA royalties on sales of DUROS-
based pharmaceutical systems we commercialize and a percentage of any up-front
license fees, milestone or special fees, payments or other consideration we
receive, excluding research and development funding. In addition, commencing
upon the commercial sale of a product developed under the agreement, we are
obligated to make minimum product payments to ALZA on a quarterly basis based
on our good faith projections of our net product sales of the product. These
minimum payments will be fully credited against the product royalty payments
we must pay to ALZA. ALZA also has an exclusive option to distribute our DUROS
sufentanil product in the U.S. and Canada and any DUROS-based pharmaceutical
system we develop to deliver non-proprietary cancer antigens worldwide. The
terms of any distribution arrangement have not been set and are to be
negotiated in good faith between ALZA and ourselves. ALZA's option to acquire
distribution rights limits our ability to negotiate with other distributors
for these products and may result in lower payments to us than if these rights
were subject to competitive negotiations. We must allow ALZA an opportunity to
negotiate in good faith for commercialization rights to our products developed
under the agreement prior to granting these rights to a third party. These
rights do not apply to products that are subject to ALZA's option or products
for which we have obtained funding or access to a proprietary drug from a
third party to whom we have granted commercialization rights prior to the
commencement of human clinical trials.
ALZA has the right to terminate the agreement in the event that we breach a
material obligation under the agreement and do not cure the breach in a timely
manner. In addition, ALZA has the right to terminate the agreement if, at any
time prior to July 2002, we solicit for employment or hire, without ALZA's
consent, a person who is or within the previous 180 days has been an employee
of ALZA, or if at any time prior to July 2006, we solicit for employment or
hire, without ALZA's consent, a person who is or within the previous 180 days
has been an employee of ALZA in the DUROS technology group.
We have limited manufacturing experience and may not be able to manufacture
sufficient quantities of our products at an acceptable cost
We must manufacture our products in clinical and commercial quantities,
either directly or through third parties, in compliance with regulatory
requirements and at an acceptable cost. We have not yet completed development
of the manufacturing process for any of our pharmaceutical systems, and DURECT
has limited experience in developing such manufacturing processes. If we fail
to develop manufacturing processes to permit us to manufacture our
pharmaceutical systems at an acceptable cost, then we may not be able to
commercialize our pharmaceutical systems. To date, we do not own manufacturing
facilities necessary to provide clinical and commercial quantities of our
products. We currently manufacture sub-assemblies of our DUROS-based
pharmaceutical systems. We intend to complete the final steps of the
manufacturing of our DUROS-based pharmaceutical systems at our manufacturing
facility once it is completed. If we are unable to build or qualify our
manufacturing facility, or are unable to do so in a timely manner, we may be
required to rely on third party contractors to perform the final manufacturing
steps of our DUROS-based pharmaceutical systems. See "We rely heavily on third
parties to support development, clinical testing and manufacturing of our
products." Under our development and commercialization agreement with ALZA, we
cannot subcontract the manufacture of subassemblies of the DUROS system.
We are currently building a manufacturing facility, and we expect that this
facility, once built, will allow us to manufacture product for our Phase III
clinical trial and commercial launch of our DUROS sufentanil product
27
and for clinical trials of our DUROS hydromorphone product as well as other
products on a pilot scale. The manufacture of our DUROS-based pharmaceutical
systems is a complex process, and any facility that we build must comply with
federal and state good manufacturing practices regulations. DURECT has no
experience building facilities, and we may not be able to build a facility
that would support our requirements of product, or complete construction in a
timely manner or at currently anticipated costs. If the costs of building a
new manufacturing facility significantly exceed our expectations, our
operating results will be harmed.
Our new facility will be subject to government audits to determine
compliance with good manufacturing practices regulations, and we may be unable
to obtain and maintain certifications for complying with these regulations. If
we fail to build and qualify a manufacturing facility in time to meet our
product requirements or at currently anticipated costs, or fail to obtain and
maintain certification for compliance with good manufacturing practices
regulation, we could experience a delay in our clinical trials and the
commercial sale of our DUROS- based pharmaceutical systems.
In April 2000, we acquired the ALZET product and related assets from ALZA.
We manufacture the ALZET product at a leased facility. We have limited
experience manufacturing this product, and we may not be able to successfully
or consistently manufacture this product at an acceptable cost, if at all.
Failure to obtain product approvals or comply with ongoing governmental
regulations could delay or limit introduction of our new products and result
in failure to achieve anticipated revenues
The manufacture and marketing of our products and our research and
development activities are subject to extensive regulation for safety,
efficacy and quality by numerous government authorities in the United States
and abroad. Before receiving FDA clearance to market a product, we will have
to demonstrate that the product is safe and effective on the patient
population and for the diseases that will be treated. Clinical trials,
manufacturing and marketing of products are subject to the rigorous testing
and approval process of the FDA and equivalent foreign regulatory authorities.
The Federal Food, Drug and Cosmetic Act and other federal, state and foreign
statutes and regulations govern and influence the testing, manufacture,
labeling, advertising, distribution and promotion of drugs and medical
devices. As a result, clinical trials and regulatory approval can take a
number of years to accomplish and require the expenditure of substantial
resources.
Data obtained from clinical trials are susceptible to varying
interpretations, which could delay, limit or prevent regulatory clearances. As
of December 31, 2000, we have completed an initial Phase I clinical trial for
our DUROS sufentanil product using an external pump to test the safety of
continuous chronic infusion of the drug, and have initiated a Phase II
clinical trial, but have not begun our Phase III trial of this product, or
initiated clinical trials for any other products. We are currently conducting
prelinical studies on our second product, DUROS hydromorphone. If we fail to
obtain timely clearance or approval for our products, we will not be able to
market and sell our products, which will limit our ability to generate
revenue.
In addition, we may encounter delays or rejections based upon additional
government regulation from future legislation or administrative action or
changes in FDA policy during the period of product development, clinical
trials and FDA regulatory review. We may encounter similar delays in foreign
countries. Sales of our products outside the U.S. are subject to foreign
regulatory approvals that vary from country to country. The time required to
obtain approvals from foreign countries may be shorter or longer than that
required for FDA approval, and requirements for foreign licensing may differ
from FDA requirements. We may be unable to obtain requisite approvals from the
FDA and foreign regulatory authorities, and even if obtained, such approvals
may not be on a timely basis, or they may not cover the clinical uses that we
specify.
Marketing or promoting a drug for an unapproved use is subject to very
strict controls. Furthermore, clearance may entail ongoing requirements for
post-marketing studies. The manufacture and marketing of drugs are subject to
continuing FDA and foreign regulatory review and requirements that we update
our regulatory filings. Later discovery of previously unknown problems with a
product, manufacturer or facility, or our failure to update regulatory files,
may result in restrictions, including withdrawal of the product from the
market. Any
28
of the following events, if they were to occur, could delay or preclude us
from further developing, marketing or realizing full commercial use of our
products, which in turn would materially harm our business, financial
condition and results of operations:
. failure to obtain or maintain requisite governmental approvals;
. failure to obtain approvals for clinically intended uses of our products
under development; or
. identification of serious and unanticipated adverse side effects in our
products under development.
Manufacturers of drugs also must comply with the applicable FDA good
manufacturing practice regulations, which include production design controls,
testing, quality control and quality assurance requirements as well as the
corresponding maintenance of records and documentation. Compliance with
current good manufacturing practices regulations is difficult and costly.
Manufacturing facilities are subject to ongoing periodic inspection by the FDA
and corresponding state agencies, including unannounced inspections, and must
be licensed before they can be used for the commercial manufacture of our
products. We or our present or future suppliers may be unable to comply with
the applicable good manufacturing practice regulations and other FDA
regulatory requirements. We have not been subject to a good manufacturing
regulation inspection by the FDA or any state agency relating to our
pharmaceutical systems. If we do not achieve compliance for the products we
manufacture, the FDA may withdraw marketing clearance or require product
recall, which may cause interruptions or delays in the manufacture and sale of
our products.
Our products contain controlled substances, the making, use, sale,
importation and distribution of which are subject to regulation by state,
federal and foreign law enforcement and other regulatory agencies
Our products currently under development contain, and our products in the
future may contain, controlled substances which are subject to state, federal
and foreign laws and regulations regarding their manufacture, use, sale,
importation and distribution. Our first two products under development contain
opioids which are classified as Schedule II controlled substances under the
regulations of the U.S. Drug Enforcement Agency. For our products containing
controlled substances, we and our suppliers, manufacturers, contractors,
customers and distributors are required to obtain and maintain applicable
registrations from state, federal and foreign law enforcement and regulatory
agencies and comply with state, federal and foreign laws and regulations
regarding the manufacture, use, sale, importation and distribution of
controlled substances. These regulations are extensive and include regulations
governing manufacturing, labeling, packaging, testing, dispensing, production
and procurement quotas, record keeping, reporting, handling, shipment and
disposal. Failure to obtain and maintain required registrations or comply with
any applicable regulations could delay or preclude us from developing and
commercializing our products containing controlled substances and subject us
to enforcement action. In addition, because of their restrictive nature, these
regulations could limit our commercialization of our products containing
controlled substances.
Our limited operating history makes evaluating our stock difficult
You can only evaluate our business based on a limited operating history. We
were incorporated in February 1998 and have engaged primarily in research and
development, licensing technology, raising capital and recruiting scientific
and management personnel. This short history may not be adequate to enable you
to fully assess our ability to successfully develop our products, achieve
market acceptance of our products and respond to competition.
Acceptance of our products in the marketplace is uncertain, and failure to
achieve market acceptance will delay our ability to generate or grow revenues
Our future financial performance will depend upon the successful
introduction and customer acceptance of our future products, including DUROS
sufentanil. Even if approved for marketing, our products may not achieve
market acceptance. The degree of market acceptance will depend upon a number
of factors, including:
. the receipt of regulatory clearance of marketing claims for the uses
that we are developing;
29
. the establishment and demonstration in the medical community of the
safety and clinical efficacy of our products and their potential
advantages over existing therapeutic products, including oral
medication, transdermal drug delivery products such as drug patches, or
external or implantable drug delivery products; and
. pricing and reimbursement policies of government and third-party payors
such as insurance companies, health maintenance organizations and other
health plan administrators.
Physicians, patients, payors or the medical community in general may be
unwilling to accept, utilize or recommend any of our products. If we are
unable to obtain regulatory approval, commercialize and market our future
products when planned and achieve market acceptance, we will not achieve
anticipated revenues.
We have a history of operating losses, expect to continue to have losses in
the future and may never achieve or maintain profitability
We have incurred significant operating losses since our inception in 1998
and, as of December 31, 2000, had an accumulated deficit of approximately
$31.5 million. We expect to continue to incur significant operating losses
over the next several years as we continue to incur increasing costs for
research and development, clinical trials and manufacturing. Our ability to
achieve profitability depends upon our ability, alone or with others, to
successfully complete the development of our proposed products, obtain the
required regulatory clearances and manufacture and market our proposed
products. Development of pharmaceutical systems is costly and requires
significant investment. In addition, we may choose to license either
additional drug delivery platform technology or rights to particular drugs for
use in our pharmaceutical systems. The license fees for these technologies or
rights would increase the costs of our pharmaceutical systems.
To date, we have not generated significant revenue from the commercial sale
of our products and do not expect to receive significant revenue in the near
future. All revenues to date are from the sale of products we acquired in
October 1999 in connection with the acquisition of substantially all of the
assets of IntraEAR, Inc. and the ALZET product we acquired in April 2000 from
ALZA. We do not expect these revenues to increase significantly in future
periods. We do not anticipate commercialization and marketing of our products
in development in the near future, and therefore do not expect to generate
sufficient revenues to cover expenses or achieve profitability in the near
future.
We do not control ALZA's ability to develop and commercialize DUROS
technology outside of fields licensed to us, and problems encountered by ALZA
could result in negative publicity, loss of sales and delays in market
acceptance of our DUROS-based pharmaceutical systems
ALZA retains complete rights to the DUROS technology for fields outside the
specific fields licensed to us. Accordingly, ALZA may develop and
commercialize DUROS-based products or license others to do so, so long as
there is no conflict with the rights granted to us. ALZA recently received FDA
approval to market its first DUROS-based product, Viadur (leuprolide acetate
implants) for the palliative treatment of advanced prostate cancer. If ALZA
fails to commercialize this product successfully, or encounters problems
associated with this product, negative publicity could be created about all
DUROS-based products, which could result in harm to our reputation and cause
reduced sales of our products. In addition, if any third-party that may be
licensed by ALZA fails to develop and commercialize DUROS-based products
successfully, the success of all DUROS-based systems could be impeded,
including ours, resulting in delay or loss of revenue or damage to our
reputation, any one of which could harm our business.
We do not own the trademark "DUROS" and any competitive advantage we derive
from the name may be impaired by third-party use
ALZA owns the trademark "DUROS." Because ALZA is also developing and
marketing DUROS-based systems, and may license third parties to do so, there
may be confusion in the market between ALZA, its potential licensees and us,
and this confusion could impair the competitive advantage, if any, we derive
from use
30
of the DUROS name. In addition, any actions taken by ALZA or its potential
licensees that negatively impact the trademark "DUROS" could negatively impact
our reputation and result in reduced sales of our DUROS- based pharmaceutical
systems.
We may be sued by third parties which claim that our products infringe on
their intellectual property rights, particularly because there is substantial
uncertainty about the validity and breadth of medical patents
We may be exposed to future litigation by third parties based on claims
that our products or activities infringe the intellectual property rights of
others or that we have misappropriated the trade secrets of others. This risk
is exacerbated by the fact that the validity and breadth of claims covered in
medical technology patents and the breadth and scope of trade secret
protection involve complex legal and factual questions for which important
legal principles are unresolved. Any litigation or claims against us, whether
or not valid, could result in substantial costs, could place a significant
strain on our financial resources and could harm our reputation. In addition,
intellectual property litigation or claims could force us to do one or more of
the following:
. cease selling, incorporating or using any of our products that
incorporate the challenged intellectual property, which would adversely
affect our revenue;
. obtain a license from the holder of the infringed intellectual property
right, which license may be costly or may not be available on reasonable
terms, if at all; or
. redesign our products, which would be costly and time-consuming.
If we are unable to adequately protect or enforce our intellectual property
rights or secure rights to third-party patents, we may lose valuable assets,
experience reduced market share or incur costly litigation to protect our
rights
Our success will depend in part on our ability to obtain patents, maintain
trade secret protection and operate without infringing the proprietary rights
of others. As of December 31, 2000, we held four issued U.S. patents and one
issued foreign patent. In addition, we have 15 pending U.S. patent
applications and have filed 11 patent applications under the Patent
Cooperation Treaty, from which 8 national phase applications are currently
pending in Europe, Australia and Canada. To maintain the license rights to
ALZA intellectual property granted to us under our development and
commercialization agreement with ALZA, we must meet annual minimum development
spending requirements and fund development of a minimum number of products. If
we do not meet these diligence requirements, we may lose rights to one or more
of our licensed fields. Also, under our agreement with ALZA, we must assign to
ALZA any intellectual property rights relating to the DUROS system and its
manufacture and any combination of the DUROS system with other components,
active agents, features or processes. In addition, ALZA retains the right to
enforce and defend against infringement actions relating to the DUROS system,
and if ALZA exercises these rights, it will be entitled to the proceeds of
these infringement actions.
The patent positions of pharmaceutical companies, including ours, are
uncertain and involve complex legal and factual questions. In addition, the
coverage claimed in a patent application can be significantly reduced before
the patent is issued. Consequently, our patent applications or those of ALZA
that are licensed to us may not issue into patents, and any issued patents may
not provide protection against competitive technologies or may be held invalid
if challenged or circumvented. Our competitors may also independently develop
products similar to ours or design around or otherwise circumvent patents
issued to us or licensed by us. In addition, the laws of some foreign
countries may not protect our proprietary rights to the same extent as U.S.
law.
We also rely upon trade secrets, technical know-how and continuing
technological innovation to develop and maintain our competitive position. We
require our employees, consultants, advisors and collaborators to execute
appropriate confidentiality and assignment-of-inventions agreements with us.
These agreements typically provide that all materials and confidential
information developed or made known to the individual during the course of the
individual's relationship with us is to be kept confidential and not disclosed
to third parties except in specific circumstances, and that all inventions
arising out of the individual's relationship with us shall be our
31
exclusive property. These agreements may be breached, and in some instances,
we may not have an appropriate remedy available for breach of the agreements.
Furthermore, our competitors may independently develop substantially
equivalent proprietary information and techniques, reverse engineer our
information and techniques, or otherwise gain access to our proprietary
technology.
We may be unable to meaningfully protect our rights in trade secrets,
technical know-how and other non-patented technology. We may have to resort to
litigation to protect our intellectual property rights, or to determine their
scope, validity or enforceability. Enforcing or defending our proprietary
rights is expensive, could cause diversion of our resources and may not prove
successful. Any failure to enforce or protect our rights could cause us to
lose the ability to exclude others from using our technology to develop or
sell competing products.
We rely heavily on third parties to support development, clinical testing and
manufacturing of our products
We rely on third party contract research organizations, service providers
and suppliers to support development, clinical testing, and manufacturing of
our pharmaceutical systems. Failure of these contractors to provide the
required services in a timely manner or on reasonable commercial terms could
materially delay the development and approval of our products, increase our
expenses and materially harm our business, financial condition and results of
operations.
Key components of our DUROS-based pharmaceutical systems are provided by sole
or limited numbers of suppliers, and supply shortages or loss of these
suppliers could result in interruptions in supply or increased costs
Certain components and drug substances used in our DUROS-based
pharmaceutical systems are currently purchased from a single or a limited
number of outside sources. The reliance on a sole or limited number of
suppliers could result in:
. delays associated with redesigning a product due to a failure to obtain
a single source component;
. an inability to obtain an adequate supply of required components; and
. reduced control over pricing, quality and timely delivery.
We have a supply agreement with Mallinckrodt, Inc. for our sufentanil
requirements, which expires in September 2004. Other than this agreement, we
do not have long-term agreements with any of our suppliers, and therefore the
supply of a particular component could be terminated at any time without
penalty to the supplier. Any interruption in the supply of single source
components could cause us to seek alternative sources of supply or manufacture
these components internally. If the supply of any components for our
pharmaceutical systems is interrupted, components from alternative suppliers
may not be available in sufficient volumes within required timeframes, if at
all, to meet our needs. This could delay our ability to complete clinical
trials and obtain approval for commercialization and marketing of our
products, causing us to lose sales, incur additional costs and delay new
product introductions and could harm our reputation.
We lack marketing, sales and distribution experience for pharmaceutical
systems and we may not be able to sell our products if we do not enter into
relationships with third parties or develop a direct sales organization
We have yet to establish marketing, sales or distribution capabilities for
our pharmaceutical systems. We intend to enter into agreements with third
parties to sell our products or to develop our own sales and marketing force.
We may be unable to establish or maintain third-party relationships on a
commercially reasonable basis, if at all. In addition, these third parties may
have similar or more established relationships with our competitors.
If we do not enter into relationships with third parties for the sales and
marketing of our products, we will need to develop our own sales and marketing
capabilities. DURECT has only limited experience in developing, training or
managing a sales force. If we choose to establish a direct sales force, we
will incur substantial
32
additional expenses in developing, training and managing such an organization.
We may be unable to build a sales force, the cost of establishing such a sales
force may exceed our product revenues, or our direct marketing and sales
efforts may be unsuccessful. In addition, we compete with many other companies
that currently have extensive and well- funded marketing and sales operations.
Our marketing and sales efforts may be unable to compete successfully against
these other companies. We may be unable to establish a sufficient sales and
marketing organization on a timely basis, if at all. We may be unable to
engage qualified distributors. Even if engaged, these distributors may:
. fail to satisfy financial or contractual obligations to us;
. fail to adequately market our products;
. cease operations with little or no notice to us; or
. offer, design, manufacture or promote competing product lines.
If we fail to develop sales, marketing and distribution channels, we would
experience delays in product sales and incur increased costs, which would harm
our financial results.
If we are unable to train physicians to use our pharmaceutical systems to
treat patients' diseases or medical conditions, we may incur delays in market
acceptance of our products
Broad use of our pharmaceutical systems will require extensive training of
numerous physicians. The time required to begin and complete training of
physicians could delay introduction of our products and adversely affect
market acceptance of our products. We may be unable to rapidly train
physicians in numbers sufficient to generate adequate demand for our
pharmaceutical systems. Any delay in training would materially delay the
demand for our systems. In addition, we may expend significant funds towards
such training before any orders are placed for our products.
We may have difficulty raising needed capital in the future
Our business currently does not generate sufficient revenues to meet our
capital requirements and we do not expect that it will do so in the near
future. We have expended and will continue to expend substantial funds to
complete the research, development and clinical testing of our products. We
will require additional funds for these purposes, to establish additional
clinical- and commercial-scale manufacturing arrangements and to provide for
the marketing and distribution of our products. Additional funds may not be
available on acceptable terms, if at all. If adequate funds are unavailable
from operations or additional sources of financing, we may have to delay,
reduce the scope of or eliminate one or more of our research or development
programs which would materially harm our business, financial condition and
results of operations.
We believe that our cash, cash equivalents and investments, will be
adequate to satisfy our capital needs for at least the next 18 months.
However, our actual capital requirements will depend on many factors,
including:
. continued progress and cost of our research and development programs;
. progress with preclinical studies and clinical trials;
. the time and costs involved in obtaining regulatory clearance;
. costs involved in preparing, filing, prosecuting, maintaining and
enforcing patent claims;
. costs of developing sales, marketing and distribution channels and our
ability to sell our products;
. costs involved in establishing manufacturing capabilities for commercial
quantities of our products;
. competing technological and market developments;
. market acceptance of our products; and
. costs for recruiting and retaining employees and consultants.
33
We may consume available resources more rapidly than currently anticipated,
resulting in the need for additional funding. We may seek to raise any
necessary additional funds through equity or debt financings, collaborative
arrangements with corporate partners or other sources, which may be dilutive
to existing stockholders. In addition, in the event that additional funds are
obtained through arrangements with collaborative partners or other sources, we
may have to relinquish rights to some of our technologies, product candidates
or products under development that we would otherwise seek to develop or
commercialize ourselves. If adequate funds are not available, we may be
required to significantly reduce or refocus our product development efforts,
or relinquish to ALZA rights to develop DUROS products in certain fields,
resulting in loss of sales, increased costs, and reduced revenues.
Future deferred compensation expenses and non-cash charges may adversely
impact or delay our profitability
We recorded deferred compensation expenses related to stock option grants
made through December 31, 2000, which will be amortized as follows: $2.7
million for the year ending December 31, 2001; $1.4 million for the year
ending December 31, 2002; $600,000 for the year ending December 31, 2003; and
$51,000 for the year ending December 31, 2004. In addition, deferred
compensation expense related to option awards to non-employees will be
calculated during the vesting period of the option based on the then-current
price of our common stock, which could result in significant charges that
adversely impact or delay our profitability. Furthermore, we have issued a
warrant to ALZA with a deemed value of approximately $6.5 million, which will
be amortized over time based on sales of our products and which will also
adversely impact or delay our profitability.
We may acquire technologies and businesses which may be difficult to
integrate, disrupt our business, dilute stockholder value or divert
management attention
We may acquire technologies, products or businesses to broaden the scope of
our existing and planned product lines and technologies. For example, in
October 1999, we acquired substantially all of the assets of IntraEAR, Inc.
and in April 2000 we acquired the ALZET product and related assets from ALZA.
These and other acquisitions expose us to:
. increased costs associated with the acquisition and operation of the new
businesses or technologies;
. the risks associated with the assimilation of new technologies,
operations, sites and personnel;
. the diversion of resources from our existing business and technologies;
. the inability to generate revenues to offset associated acquisition
costs;
. the requirement to maintain uniform standards, controls, and procedures;
and
. the impairment of relationships with employees and customers as a result
of any integration of new management personnel.
Acquisitions may also result in the issuance of dilutive equity securities,
the incurrence or assumption of debt or additional expenses associated with
the amortization of acquired intangible assets or potential businesses. Past
acquisitions, such as our acquisitions of IntraEAR and ALZET, as well future
acquisitions, may not generate any additional revenue or provide any benefit
to our business.
We depend upon key personnel who may terminate their employment with us at
any time, and we need to hire additional qualified personnel
Our success will depend to a significant degree upon the continued services
of key management, technical, and scientific personnel, including Felix
Theeuwes, our Chairman and Chief Scientific Officer and James E. Brown, our
President and Chief Executive Officer. Although we have obtained key man life
insurance policies for each of Drs. Theeuwes and Brown in the amount of $1
million, this insurance may not adequately compensate us for the loss of their
services. In addition, our success will depend on our ability to attract and
34
retain other highly skilled personnel. Competition for qualified personnel is
intense, and the process of hiring and integrating such qualified personnel is
often lengthy. We may be unable to recruit such personnel on a timely basis,
if at all. Our management and other employees may voluntarily terminate their
employment with us at any time. The loss of the services of key personnel, or
the inability to attract and retain additional qualified personnel, could
result in delays to product development or approval, loss of sales and
diversion of management resources.
We may not successfully manage our growth
Our success will depend on the expansion of our operations and the
effective management of growth, which will place a significant strain on our
management and on our administrative, operational and financial resources. To
manage such growth, we must expand our facilities, augment our operational,
financial and management systems and hire and train additional qualified
personnel. If we are unable to manage growth effectively our business would be
harmed.
The market for our products is new, rapidly changing and competitive, and new
products or technologies developed by others could impair our ability to grow
our business and remain competitive
The pharmaceutical industry is subject to rapid and substantial
technological change. Developments by others may render our products under
development or technologies noncompetitive or obsolete, or we may be unable to
keep pace with technological developments or other market factors.
Technological competition in the industry from pharmaceutical and
biotechnology companies, universities, governmental entities and others
diversifying into the field is intense and is expected to increase. Many of
these entities have significantly greater research and development
capabilities than we do, as well as substantially more marketing,
manufacturing, financial and managerial resources. These entities represent
significant competition for us. Acquisitions of, or investments in, competing
pharmaceutical or biotechnology companies by large corporations could increase
such competitors' financial, marketing, manufacturing and other resources.
We are a new enterprise and are engaged in the development of novel
therapeutic technologies. As a result, our resources are limited and we may
experience technical challenges inherent in such novel technologies.
Competitors have developed or are in the process of developing technologies
that are, or in the future may be, the basis for competitive products. Some of
these products may have an entirely different approach or means of
accomplishing similar therapeutic effects than our products. Our competitors
may develop products that are safer, more effective or less costly than our
products and, therefore, present a serious competitive threat to our product
offerings.
The widespread acceptance of therapies that are alternatives to ours may
limit market acceptance of our products even if commercialized. Chronic pain
can also be treated by oral medication, transdermal drug delivery systems,
such as drug patches, or with other implantable drug delivery devices. These
treatments are widely accepted in the medical community and have a long
history of use. The established use of these competitive products may limit
the potential for our products to receive widespread acceptance if
commercialized.
If users of our products are unable to obtain adequate reimbursement from
third-party payors, or if new restrictive legislation is adopted, market
acceptance of our products may be limited and we may not achieve anticipated
revenues
The continuing efforts of government and insurance companies, health
maintenance organizations and other payors of healthcare costs to contain or
reduce costs of health care may affect our future revenues and profitability,
and the future revenues and profitability of our potential customers,
suppliers and collaborative partners and the availability of capital. For
example, in certain foreign markets, pricing or profitability of prescription
pharmaceuticals is subject to government control. In the United States, given
recent federal and state government initiatives directed at lowering the total
cost of health care, the U.S. Congress and state legislatures will likely
continue to focus on health care reform, the cost of prescription
pharmaceuticals and on the reform of
35
the Medicare and Medicaid systems. While we cannot predict whether any such
legislative or regulatory proposals will be adopted, the announcement or
adoption of such proposals could materially harm our business, financial
condition and results of operations.
Our ability to commercialize our products successfully will depend in part
on the extent to which appropriate reimbursement levels for the cost of our
products and related treatment are obtained by governmental authorities,
private health insurers and other organizations, such as HMOs. Third-party
payors are increasingly challenging the prices charged for medical products
and services. Also, the trend toward managed health care in the United States
and the concurrent growth of organizations such as HMOs, which could control
or significantly influence the purchase of health care services and products,
as well as legislative proposals to reform health care or reduce government
insurance programs, may all result in lower prices for or rejection of our
products. The cost containment measures that health care payors and providers
are instituting and the effect of any health care reform could materially harm
our ability to operate profitably.
We could be exposed to significant product liability claims which could be
time consuming and costly to defend, divert management attention and
adversely impact our ability to obtain and maintain insurance coverage
The testing, manufacture, marketing and sale of our products involve an
inherent risk that product liability claims will be asserted against us.
Although we are insured against such risks up to a $5 million annual aggregate
limit in connection with clinical trials and commercial sales of our products,
our present product liability insurance may be inadequate and may not fully
cover the costs of any claim or any ultimate damages we might be required to
pay. Product liability claims or other claims related to our products,
regardless of their outcome, could require us to spend significant time and
money in litigation or to pay significant damages. Any successful product
liability claim may prevent us from obtaining adequate product liability
insurance in the future on commercially desirable or reasonable terms. In
addition, product liability coverage may cease to be available in sufficient
amounts or at an acceptable cost. An inability to obtain sufficient insurance
coverage at an acceptable cost or otherwise to protect against potential
product liability claims could prevent or inhibit the commercialization of our
pharmaceutical systems. A product liability claim could also significantly
harm our reputation and delay market acceptance of our products.
Our business involves environmental risks and risks related to handling
regulated substances
In connection with our research and development activities and our
manufacture of materials and products, we are subject to federal, state and
local laws, rules, regulations and policies governing the use, generation,
manufacture, storage, air emission, effluent discharge, handling and disposal
of certain materials, biological specimens and wastes. Although we believe
that we have complied with the applicable laws, regulations and policies in
all material respects and have not been required to correct any material
noncompliance, we may be required to incur significant costs to comply with
environmental and health and safety regulations in the future. Our research
and development involves the controlled use of hazardous materials, including
but not limited to certain hazardous chemicals and narcotics. Although we
believe that our safety procedures for storing, handling and disposing of such
materials comply with the standards prescribed by state and federal
regulations, we cannot completely eliminate the risk of accidental
contamination or injury from these materials. In the event of such an
occurrence, we could be held liable for any damages that result and any such
liability could exceed our resources.
Our stock price may fluctuate, and your investment in our stock could decline
in value
An active trading market in our stock might not develop or continue. The
market price of our common stock may fluctuate significantly in response to
factors which are beyond our control. In addition, the stock market in general
has recently experienced extreme price and volume fluctuations. In addition,
the market prices of securities of technology and pharmaceutical companies
have been extremely volatile, and have experienced fluctuations that often
have been unrelated or disproportionate to the operating performance of these
companies.
36
These broad market fluctuations could result in extreme fluctuations in the
price of our common stock, which could cause a decline in the value of your
shares.
Future sales of our common stock may depress our stock price
Commencing on March 27, 2001, which was 180 days after the date of our
initial public offering, as many as 34,173,026 shares of our common stock
became available for sale in the public market, subject to applicable
securities laws. If substantial amounts of our common stock were to be sold in
the public market, the market price of our common stock could fall. In
addition, these sales could create the perception to the public of
difficulties or problems in our business. As a result, these sales also might
make it more difficult for us to sell equity or equity-related securities in
the future at a time and price that we deem appropriate.
We have broad discretion over the use of our cash and investments, and their
investment may not yield a favorable return
Our management has broad discretion over how our cash and investments are
used and may invest in ways with which our stockholders may not agree and that
do not yield favorable returns.
Executive officers, directors and entities affiliated with them have
substantial control over us, which could delay or prevent a change in our
corporate control favored by our other stockholders.
Our directors, executive officers and principal stockholders, together with
their affiliates have substantial control over us. The interests of these
stockholders may differ from the interests of other stockholders. As a result,
these stockholders, if acting together, would have the ability to exercise
control over all corporate actions requiring stockholder approval irrespective
of how our other stockholders may vote, including:
. the election of directors;
. the amendment of charter documents;
. the approval of certain mergers and other significant corporate
transactions, including a sale of substantially all of our assets; or
. the defeat of any non-negotiated takeover attempt that might otherwise
benefit the public stockholders.
Our certificate of incorporation, our bylaws and Delaware law contain
provisions that could discourage another company from acquiring us
Provisions of Delaware law, our certificate of incorporation and by-laws
may discourage, delay or prevent a merger or acquisition that stockholders may
consider favorable, including transactions in which you might otherwise
receive a premium for your shares. These provisions include:
. authorizing the issuance of "blank check" preferred stock without any
need for action by stockholders;
. providing for a classified board of directors with staggered terms;
. requiring supermajority stockholder voting to effect certain amendments
to our certificate of incorporation and by-laws;
. eliminating the ability of stockholders to call special meetings of
stockholders;
. prohibiting stockholder action by written consent; and
. establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
Investors may experience substantial dilution of their investment
In the past, we have issued options to acquire common stock at prices below
the initial public offering price. To the extent these outstanding options are
ultimately exercised, there will be dilution to investors.
37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Sensitivity
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio and long-term debt obligations. Our primary
investment objective is to preserve principal while at the same time
maximizing yields without significantly increasing risk. Our portfolio
includes money markets funds, commercial paper, medium-term notes, corporate
notes, government securities, auction rate securities, corporate bonds and
market auction preferreds. The diversity of our portfolio helps us to achieve
our investment objective. As of December 31, 2000, approximately 57% of our
investment portfolio is composed of investments with original maturities of
one year or less and approximately 41% of our investment portfolio matures
less than 90 days from the date of purchase.
In October 1998, the Company financed the purchase of certain equipment
through a bank loan with a variable interest rate. The average interest rates
were 10.63% and 8.80% in 2000 and 1999, respectively. At December 31, 2000 and
1999, the Company had loans outstanding in the amounts of $189,000 and
$322,000, respectively.
The following table presents the amounts of our cash equivalents and
investments that may be subject to interest rate risk and the average interest
rates as of December 31, 2000 by year of maturity (dollars in thousands):
2001 2002 Total
-------- ------ --------
Cash equivalents:
Fixed rate..................................... $ 21,610 -- $ 21,610
Average fixed rate............................. 6.58% -- 6.58%
Variable rate.................................. $ 25,280 -- $ 25,280
Average variable rate.......................... 6.82% -- 6.82%
Short-term investments:
Fixed rate..................................... $ 52,830 -- $ 52,830
Average fixed rate............................. 6.58% -- 6.58%
Variable rate.................................. $ 4,900 -- $ 4,900
Average variable rate.......................... 6.75% -- 6.75%
Long-term investments:
Fixed rate..................................... $ -- $1,652 $ 1,652
Average fixed rate............................. -- 7.26% 7.26%
-------- ------ --------
Total investment securities...................... $104,620 $1,652 $106,272
-------- ------ --------
Average rate..................................... 6.63% 7.26% 6.65%
-------- ------ --------
The following table presents the amounts of our cash equivalents and
investments that may be subject to interest rate risk and the average interest
rates as of December 31, 1999 by year of maturity (dollars in thousands):
2000 2001 Total
-------- ------ --------
Cash equivalents:
Fixed rate..................................... $ 3,713 -- $ 3,713
Average fixed rate............................. 6.24% -- 6.24%
Variable rate.................................. $ 82 -- $ 82
Average variable rate.......................... 5.70% -- 5.70%
Short-term investments:
Fixed rate..................................... $ 12,735 -- $ 12,735
Average fixed rate............................. 5.98% -- 5.98%
Variable rate.................................. -- -- --
Average variable rate.......................... -- -- --
Long-term investments:
Fixed rate..................................... $ -- $2,335 $ 2,335
Average fixed rate............................. -- 6.37% 6.37%
-------- ------ --------
Total investment securities...................... $ 16,530 $2,335 $ 18,865
-------- ------ --------
Average rate..................................... 6.02% 6.37% 6.06%
-------- ------ --------
38
Item 8. Financial Statements and Supplementary Data.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
DURECT Corporation
We have audited the accompanying balance sheets of DURECT Corporation as of
December 31, 2000 and 1999, and the related statements of operations,
stockholders' equity, and cash flows for the years then ended and for the
period from inception (February 6, 1998) to December 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule 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 DURECT Corporation at
December 31, 2000 and 1999, and the results of its operations and its cash
flows for the years then ended and for the period from inception (February 6,
1998) to December 31, 1998, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
Palo Alto, California
February 9, 2001
39
DURECT CORPORATION
BALANCE SHEETS
(in thousands, except per share amounts)
December 31,
------------------
2000 1999
-------- --------
ASSETS
------
Current assets:
Cash and cash equivalents................................ $ 46,702 $ 3,863
Short-term investments................................... 57,730 12,735
Accounts receivable, net of allowance of $226 and $5,
respectively............................................ 1,261 97
Inventories.............................................. 2,682 188
Prepaid expenses and other current assets................ 938 584
-------- --------
Total current assets....................................... 109,313 17,467
Property and equipment, net................................ 4,472 1,271
Intangible assets, net..................................... 5,175 1,390
Long-term investments...................................... 1,652 2,335
-------- --------
Total assets........................................... $120,612 $ 22,463
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable......................................... $ 658 $ 483
Accrued liabilities...................................... 923 429
Accrued construction in progress......................... 1,673 --
Accrued contract manufacturing........................... 248 --
Accrued liabilities to related party..................... 54 321
Contract research liability.............................. 290 180
Equipment financing obligations, current portion......... 407 133
-------- --------
Total current liabilities.............................. 4,253 1,546
Equipment financing obligations, noncurrent portion........ 1,105 189
Stockholders' equity:
Convertible Preferred stock, issuable in series--$0.0001
par value, 10,000 and 24,242 shares authorized at
December 31, 2000 and 1999, respectively; no shares and
23,931 issued and outstanding at December 31, 2000 and
1999 respectively....................................... -- 2
Common stock, $0.0001 par value: 110,000 and 41,542
shares authorized at December 31, 2000 and 1999
respectively; 46,565 and 8,502 shares issued and
outstanding at December 31, 2000 and 1999,
respectively............................................ 4 1
Additional paid-in capital............................... 165,638 34,642
Notes receivable from stockholders....................... (652) (33)
Deferred compensation.................................... (4,830) (3,252)
Deferred royalties and commercial rights................. (13,480) --
Accumulated other comprehensive income................... 29 --
Accumulated deficit...................................... (31,455) (10,632)
-------- --------
Stockholders' equity....................................... 115,254 20,728
-------- --------
Total liabilities and stockholders' equity............. $120,612 $ 22,463
======== ========
The accompanying notes are an integral part of these statements.
40
DURECT CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Period from
inception
Year ended (February 6,
December 31, 1998) to
----------------- December 31,
2000 1999 1998
-------- ------- ------------
Revenue, net.................................. $ 3,155 $ 86 $ --
Cost of goods sold(1)......................... 1,941 39 --
-------- ------- -------
Gross profit.................................. 1,214 47 --
-------- ------- -------
Operating expenses:
Research and development.................... 12,669 5,181 466
Research and development to related party... 666 1,182 243
Selling, general and administrative......... 4,874 2,109 585
Amortization of intangible assets........... 850 69 --
Noncash charges related to stock-based
compensation(1)............................ 4,978 865 149
-------- ------- -------
Total operating expenses...................... 24,037 9,406 1,443
-------- ------- -------
Loss from operations.......................... (22,823) (9,359) (1,443)
Other income (expense):
Interest income............................. 3,103 678 121
Interest expense............................ (131) (27) --
-------- ------- -------
Net other income.............................. 2,972 651 121
-------- ------- -------
Net loss...................................... (19,851) (8,708) (1,322)
Accretion of cumulative dividends on Series B
convertible preferred stock.................. 972 602 --
-------- ------- -------
Net loss attributable to common stockholders.. $(20,823) $(9,310) $(1,322)
======== ======= =======
Net loss per common share, basic and diluted.. $ (1.22) $ (1.76) $ (0.36)
======== ======= =======
Shares used in computing basic and diluted net
loss per share............................... 17,120 5,291 3,655
======== ======= =======
- --------
(1) Stock-based compensation related to the following:
Cost of goods sold.......................... $ 65 $ -- $ --
Research and development.................... 3,426 485 46
Selling, general and administrative......... 1,552 380 103
-------- ------- -------
$ 5,043 $ 865 $ 149
======== ======= =======
The accompanying notes are an integral part of these statements.
41
DURECT CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
Convertible Deferred
Preferred Notes Royalties Accumulated
Stock Common Stock Additional Receivable and Other
------------- ------------- Paid-In From Deferred Commercial Comprehensive Accumulated
Shares Amount Shares Amount Capital Stockholders Compensation Rights Income Deficit
------ ------ ------ ------ ---------- ------------ ------------ ---------- ------------- -----------
Issuance of
common stock to
founders for
cash........... -- $ -- 8,400 $ 1 $ 29 $ -- $ -- $ -- $ -- $ --
Issuance of
Series A-1
convertible
preferred stock
for license
rights......... 5,600 -- -- -- -- -- -- -- -- --
Issuance of
Series A-2
convertible
preferred stock
for cash, net
of issuance
costs of $277.. 5,636 1 -- -- 5,359 -- -- -- -- --
Issuance of
Series A-2
convertible
preferred stock
for cash, net
of issuance
costs of $66... 2,907 -- -- -- 3,568 (36) -- -- -- --
Deferred
compensation
related to
stock options.. -- -- -- -- 670 -- (521) -- -- --
Net loss........ -- -- -- -- -- -- -- -- -- (1,322)
------ ---- ----- --- ------- ---- ------- ---- ---- --------
Balance at
December 31,
1998........... 14,143 1 8,400 1 9,626 (36) (521) -- -- (1,322)
Issuance of
common stock
upon exercise
of stock
options for
notes
receivable and
cash........... -- -- 102 -- 34 (33) -- --- -- --
Repayment of
notes
receivable..... -- -- -- -- -- 36 -- -- -- --
Issuance of
Series A-2
convertible
preferred stock
for cash, net
of issuance
costs of $21... 99 -- -- -- 103 7 -- -- -- --
Issuance of
Series B
convertible
preferred stock
for cash, net
of issuance
costs of $880.. 9,364 1 -- -- 19,251 -- -- -- -- --
Issuance of
Series B-1
convertible
preferred stock
in connection
with the
acquisition of
IntraEar....... 325 -- -- -- 1,430 -- -- -- -- --
Deferred
compensation
related to
stock options.. -- -- -- -- 3,596 -- (2,731) -- -- --
Accretion of
cumulative
dividends on
Series B
convertible
preferred
stock.......... -- -- -- -- 602 -- -- -- -- (602)
Net loss........ -- -- -- -- -- -- -- -- -- (8,708)
------ ---- ----- --- ------- ---- ------- ---- ---- --------
Balance at
December 31,
1999........... 23,931 $ 2 8,502 $ 1 $34,642 $(33) $(3,252) $ -- $ -- $(10,632)
====== ==== ===== === ======= ==== ======= ==== ==== ========
Total
Stockholders'
Equity
-------------
Issuance of
common stock to
founders for
cash........... $ 30
Issuance of
Series A-1
convertible
preferred stock
for license
rights......... --
Issuance of
Series A-2
convertible
preferred stock
for cash, net
of issuance
costs of $277.. 5,360
Issuance of
Series A-2
convertible
preferred stock
for cash, net
of issuance
costs of $66... 3,532
Deferred
compensation
related to
stock options.. 149
Net loss........ (1,322)
-------------
Balance at
December 31,
1998........... 7,749
Issuance of
common stock
upon exercise
of stock
options for
notes
receivable and
cash........... 1
Repayment of
notes
receivable..... 36
Issuance of
Series A-2
convertible
preferred stock
for cash, net
of issuance
costs of $21... 103
Issuance of
Series B
convertible
preferred stock
for cash, net
of issuance
costs of $880.. 19,252
Issuance of
Series B-1
convertible
preferred stock
in connection
with the
acquisition of
IntraEar....... 1,430
Deferred
compensation
related to
stock options.. 865
Accretion of
cumulative
dividends on
Series B
convertible
preferred
stock.......... --
Net loss........ (8,708)
-------------
Balance at
December 31,
1999........... $20,728
=============
42
DURECT CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY--(Continued)
(in thousands)
Convertible Deferred
Preferred Notes Royalties Accumulated
Stock Common Stock Additional Receivable and Other
--------------- ------------- Paid-In From Deferred Commercial Comprehensive Accumulated
Shares Amount Shares Amount Capital Stockholders Compensation Rights Income Deficit
------- ------ ------ ------ ---------- ------------ ------------ ---------- ------------- -----------
Balance at
December 31,
1999 (carried
forward)........ 23,931 $ 2 8,502 $ 1 $ 34,642 $ (33) $(3,252) $ -- $ -- $(10,632)
Issuance of a
warrant to
purchase 31
shares of
convertible
preferred stock
to equipment
lessor.......... -- -- -- -- 190 -- -- -- -- --
Exercise of a
warrant for
common stock by
an equipment
lessor.......... -- -- 27 -- -- -- -- -- -- --
Issuance of
common stock
upon exercise of
stock options
for notes
receivable and
cash............ -- -- 1,833 -- 747 (619) -- -- -- --
Issuance of
Series C
convertible
preferred stock
for cash net of
issuance costs
of $45.......... 3,572 -- -- -- 24,955 -- -- -- -- --
Issuance of
common stock net
of issuance cost
of $7 and a
warrant to
purchase 1,000
shares of common
stock to ALZA
corporation for
commercial
rights and
reduced
royalties....... -- -- 1,000 -- 13,473 -- -- -- -- --
Deferred
royalties and
commercial
rights.......... -- -- -- -- -- -- -- (13,480) -- --
Accretion of
cumulative
dividends on
Series B
convertible
preferred
stock........... -- -- -- -- 972 -- -- -- -- (972)
Issuance common
stock in initial
public offering
at $12.00 per
share net of
issuance costs
of $8,361....... -- -- 7,700 1 84,038 -- -- -- -- --
Conversion of
convertible
preferred stock
to common stock
upon initial
public
offering........ (27,503) (2) 27,503 2 -- -- -- -- -- --
Deferred
compensation
related to stock
options......... -- -- -- -- 6,002 -- (1,578) -- -- --
Noncash charges
related to stock
options issued
to
nonemployees.... -- -- -- -- 619 -- -- -- -- --
Net unrealized
gain in
available-for-
sale
securities...... -- -- -- -- -- -- -- -- 29 --
Net loss........ -- -- -- -- -- -- -- -- -- (19,851)
Total
comprehensive
net loss........ -- -- -- -- -- -- -- -- -- --
------- --- ------ --- -------- ----- ------- -------- ---- --------
Balance at
December 31,
2000............ -- $-- 46,565 $ 4 $165,638 $(652) $(4,830) $(13,480) $ 29 $(31,455)
======= === ====== === ======== ===== ======= ======== ==== ========
Total
Stockholders'
Equity
-------------
Balance at
December 31,
1999 (carried
forward)........ $ 20,728
Issuance of a
warrant to
purchase 31
shares of
convertible
preferred stock
to equipment
lessor.......... 190
Exercise of a
warrant for
common stock by
an equipment
lessor.......... --
Issuance of
common stock
upon exercise of
stock options
for notes
receivable and
cash............ 128
Issuance of
Series C
convertible
preferred stock
for cash net of
issuance costs
of $45.......... 24,955
Issuance of
common stock net
of issuance cost
of $7 and a
warrant to
purchase 1,000
shares of common
stock to ALZA
corporation for
commercial
rights and
reduced
royalties....... 13,473
Deferred
royalties and
commercial
rights.......... (13,480)
Accretion of
cumulative
dividends on
Series B
convertible
preferred
stock........... --
Issuance common
stock in initial
public offering
at $12.00 per
share net of
issuance costs
of $8,361....... 84,039
Conversion of
convertible
preferred stock
to common stock
upon initial
public
offering........ --
Deferred
compensation
related to stock
options......... 4,424
Noncash charges
related to stock
options issued
to
nonemployees.... 619
Net unrealized
gain in
available-for-
sale
securities...... 29
Net loss........ (19,851)
-------------
Total
comprehensive
net loss........ (19,822)
-------------
Balance at
December 31,
2000............ $115,254
=============
The accompanying notes are an integral part of these statements.
43
DURECT CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands)
Period from
inception
Year ended (February 6,
December 31, 1998) to
------------------ December 31,
2000 1999 1998
-------- -------- ------------
Cash flows from operating activities
Net loss..................................... $(19,851) $ (8,708) $(1,322)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.............. 1,500 311 5
Noncash charges related to stock-based
compensation.............................. 5,043 865 149
Changes in assets and liabilities:
Accounts receivable...................... (1,164) (97) --
Inventory................................ (2,494) (188) --
Prepaid expenses and other assets........ (354) (444) (140)
Accounts payable......................... 175 430 53
Accrued liabilities...................... 2,415 274 155
Accrued liabilities to related party..... (267) 118 203
Contract research liability.............. 110 168 12
-------- -------- -------
Total adjustments...................... 4,964 1,437 437
-------- -------- -------
Net cash and cash equivalents used in
operating activities.................. (14,887) (7,271) (885)
Cash flows from investing activities
Purchase of equipment........................ (3,801) (1,016) (62)
Purchase of investments...................... (58,277) (15,070) --
Proceeds from maturities of short-term
investments................................. 13,994 -- --
Payment for acquisition of IntraEar, net..... -- (69) --
Acquisition of intangible assets............. (4,636) -- --
-------- -------- -------
Net cash and cash equivalents used in
investing activities.................. (52,720) (16,155) (62)
-------- -------- -------
Cash flows from financing activities
Net proceeds from equipment financing
obligations................................. 1,611 -- --
Payments on equipment financing obligations.. (280) (78) --
Net proceeds from issuances of common stock.. 84,160 37 30
Net proceeds from issuances of convertible
preferred stock............................. 24,955 19,355 8,892
-------- -------- -------
Net cash and cash equivalents provided
by financing activities............... 110,446 19,314 8,922
-------- -------- -------
Net increase (decrease) in cash and cash
equivalents................................. 42,839 (4,112) 7,975
Cash and cash equivalents at beginning of
period/year................................. 3,863 7,975 --
-------- -------- -------
Cash and cash equivalents at end of
period/year................................. $ 46,702 $ 3,863 $ 7,975
======== ======== =======
Supplemental disclosure of cash flow
information
Equipment financed through an equipment
loan........................................ $ -- $ 289 $ 111
======== ======== =======
Cash paid during the year for interest....... $ 81 $ 27 $ --
======== ======== =======
Notes receivable issued in connection with
exercise of stock options................... $ 619 $ 33 $ 36
======== ======== =======
Issuance of Series B-1 convertible preferred
stock for assets acquired in acquisition of
IntraEar.................................... $ -- $ 1,430 $ --
======== ======== =======
Issuance of warrants to equipment lessor..... $ 190 $ -- $ --
======== ======== =======
Issuance of stock and warrants to Alza
Corporation................................. $ 13,480 $ -- $ --
======== ======== =======
The accompanying notes are an integral part of these statements.
44
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Operations and Basis of Presentation
DURECT Corporation (the "Company") was incorporated in the state of
Delaware on February 6, 1998. The Company is a pharmaceutical company
developing therapies for chronic disorders that require continuous dosing. The
Company's lead product is for the treatment of chronic pain. Additionally, the
Company manufactures and sells osmotic pumps used in laboratory research and
sells micro-catheters used in the treatment of ear disorders.
The Company was in the development stage through 1999. In 2000, the Company
entered its lead product into Phase II clinical trials, commenced
manufacturing of its osmotic pump products, and expanded its research and
development and product sales efforts. Accordingly, the Company is no longer
in the development stage.
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 disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period.
Actual results could differ materially from those estimates.
Cash Equivalents and Marketable Securities
The Company considers all highly liquid investments with maturities of 90
days or less from the date of purchase to be cash equivalents. Investments
with maturities of greater than 90 days but less than one year are classified
as short-term investments. Management determines the appropriate
classification of its cash equivalents and investment securities at the time
of purchase and reevaluates such determination as of each balance sheet date.
Management has classified the Company's cash equivalents and marketable
securities as available-for-sale securities in the accompanying financial
statements. Available-for-sale securities are carried at fair value, with
unrealized gains and losses reported as a component of accumulated other
comprehensive income. Realized gains and losses are included in interest
income. There were no realized gains or losses in the periods presented. The
cost of securities sold is based on the specific identification method.
The Company invests its excess cash in debt instruments of financial
institutions and corporations, and money market funds with high credit
ratings. The Company has established guidelines regarding diversification of
its investments and their maturities with the objectives of maintaining safety
and liquidity, while maximizing yield.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to credit risk
consist principally of interest-bearing investments and trade receivables. The
Company maintains cash, cash equivalents and investments with various major
financial institutions. The Company performs periodic evaluations of the
relative credit standing of these financial institutions and limits the amount
of credit exposure with any one institution.
Universities, pharmaceutical companies and hospitals account for a
substantial portion of the trade receivables; collateral for these receivables
is generally not required by the Company. The risk associated with this
concentration is limited due to the large number of accounts and their
geographic dispersion. The Company monitors the creditworthiness of its
customers to which it grants credit terms in the normal course of business.
The Company maintains reserves for estimated credit losses and, to date,
such losses have been within management's expectations.
45
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company maintains cash, cash equivalents and investments with various
financial institutions. The Company performs periodic evaluations of the
relative credit quality of its investments.
Customer Concentrations
A limited number of customers have accounted for a substantial portion of
the Company's revenues. In fiscal 2000, one customer accounted for more than
10% of our revenues: Muromachi Kikai Co., Ltd. represented 14% of the
Company's revenues.
Revenue by geographic region for the fiscal years 2000 and 1999 are as
follows:
December 31, December 31,
2000 1999
------------ ------------
(in thousands)
Sales to unaffiliated customers:
United States...................................... $2,161 $67
Japan.............................................. 443 5
Europe............................................. 371 7
Other.............................................. 180 7
------ ---
Total............................................ $3,155 $86
====== ===
Inventories
Inventories are stated at the lower of cost or market, with cost determined
on a first-in, first-out basis.
Inventories consisted of the following (in thousands):
December 31, December 31,
2000 1999
------------ ------------
Raw materials...................................... $ 190 $ --
Work in process.................................... 1,279 --
Finished goods..................................... 1,213 188
------ -----
Total inventories................................ $2,682 $ 188
====== =====
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation,
which is computed using the straight-line method over the estimated useful
lives of the assets, which range from three to five years. Leasehold
improvements are amortized using the straight-line method over the estimated
useful lives of the assets or terms of the related leases, whichever are
shorter.
Acquired intangible assets and goodwill
Acquired intangible assets consist of patents, developed technology,
trademarks, assembled workforce and customer lists related to the Company's
acquisitions accounted for using the purchase method. Amortization of these
purchased intangibles and goodwill is calculated on the straight-line basis
over the respective estimated useful lives of the assets ranging from four to
seven years. Amortization of these purchased intangibles and goodwill is
included in operating expenses. Acquired in-process research and development
without alternative future use is charged to operations when acquired.
46
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Impairment of Long-Lived Assets
In accordance with the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" (" SFAS 121"), the Company reviews long-
lived assets, including property and equipment, intangible assets and other
long term assets, for impairment whenever events or changes in business
circumstances indicate that the carrying amount of the assets may not be fully
recoverable. Under SFAS 121, an impairment loss would be recognized when
estimated undiscounted future cash flows expected to result from the use of
the asset and its eventual disposition is less than the carrying amount.
Impairment, if any, is assessed using discounted cash flows. Through
December 31, 2000, there have been no such losses.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions and related interpretations of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
and has elected to follow the "disclosure only" alternative prescribed by
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
Under APB No. 25, stock-based compensation is based on the difference, if any,
on the date of grant, between the fair value of the Company's stock and the
exercise price. Unearned compensation is amortized using the graded vesting
method and expensed over the vesting period of the respective options. The
Company accounts for stock options issued to nonemployees in accordance with
the provisions of SFAS 123 and Emerging Issues Task Force 96-18, "Accounting
for Equity Instruments that are Issued to other than Employees for Acquiring,
or in Conjunction with Selling, Goods or Services." The fair value of options
granted to non-employees is periodically remeasured as the underlying options
vest.
Revenue Recognition
Revenue from the sale of products is recognized at the time product is
shipped to customers, provided no continuing obligation exists and the
collectability of the amounts owed is reasonably assured. The Company
maintains consigned inventory at customer locations for certain products. For
these products, revenue is recognized at the time the Company is notified that
the device has been used. The Company provides credit, in the normal course of
business, to its customers. The Company also maintains an allowance for
doubtful customer accounts and charges actual losses when incurred to this
allowance. The Company does not provide price protection or allow a right of
return for products sold to distributors.
Research and Development Expenses
Research and development costs are expensed as incurred. Research and
development costs paid to third parties under sponsored research agreements
are recognized as the related services are performed, generally ratably over
the period of service. Purchased research and development is recognized in
purchase business combinations for the portion of the purchase price allocated
to the appraised value of in-process technologies. The portion assigned to in-
process technologies excludes the value of core and developed technologies,
which are recorded as intangible assets.
Comprehensive Loss
The Company has adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes
standards for reporting comprehensive loss and its components in the financial
statements. SFAS 130 requires unrealized gains and losses on the Company's
available-for-sale securities to be included in other comprehensive income or
loss. The Company's
47
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
comprehensive loss through December 31, 1999 was the same as its net loss. For
the year ended December 31, 2000, the Company's total comprehensive loss was
$19,822,000 compared to its net loss of $19,851,000.
Segment Reporting
Effective January 1, 1999, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes
standards for the way companies report information about operating segments in
annual financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company has determined that it did not have any separately reportable
business segments during any of the periods from inception to December 31,
2000.
Reclassifications
Certain prior year amounts have been reclassified to conform with current
year presentation.
Net Loss Per Share
Basic net loss per share and diluted net loss per share are computed in
conformity with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" ("SFAS 128"). In accordance with SFAS 128, basic net loss per share
is calculated as net loss divided by the weighted-average number of common
shares outstanding, less the weighted average number of common shares subject
to repurchase during the period. Diluted net loss per share is computed using
the weighted-average number of common shares outstanding and common stock
equivalents (i.e. options and warrants to purchase common stock) outstanding
during the period, if dilutive, using the treasury stock method. Pursuant to
the Securities and Exchange Commission Staff Accounting Bulletin No. 98,
common stock and convertible preferred stock issued or granted for nominal
consideration prior to the anticipated effective date of an initial public
offering must be included in the calculation of basic and diluted net loss per
share as if they had been outstanding for all periods presented. Through
December 31, 2000, the Company had not had any issuances or grants for nominal
consideration other than the shares issued to the founders.
48
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Pro forma basic and diluted net loss per share amounts are computed as
described above and also gives effect, under SEC guidance, to the conversion
of convertible preferred stock (using the if-converted method) as though it
had happened on the original date of issuance. The following table presents
the calculations of basic and diluted and pro forma basic and diluted net loss
per share (in thousands, except per share amounts):
Period from
inception
Year ended (February 6,
December 31, 1998) to
----------------- December 31,
2000 1999 1998
-------- ------- ------------
Net loss....................................... $(19,851) $(8,708) $(1,322)
Less: accumulated dividend on Series B
preferred stock............................. 972 602 --
-------- ------- -------
Net loss available to common stockholders...... $(20,823) $(9,310) $(1,322)
======== ======= =======
Basic and diluted weighted average shares:
Weighted-average shares of common stock
outstanding................................. 19,752 8,407 8,400
Less: weighted-average shares subject to
repurchase.................................. (2,632) (3,116) (4,745)
-------- ------- -------
Weighted-average shares used in computing
basic and diluted net loss per share........ 17,120 5,291 3,655
======== ======= =======
Basic and diluted net loss per share........... $ (1.22) $ (1.76) $ (0.36)
======== ======= =======
Pro forma:
Net loss..................................... $(19,851) $(8,708) $(1,322)
======== ======= =======
Shares used above............................ 17,120 5,291 3,655
Pro forma adjustment to reflect weighted
effect of assumed conversion of convertible
preferred stock............................. 19,539 18,480 8,080
-------- ------- -------
Shares used in computing pro forma basic and
diluted net loss per share.................. 36,659 23,771 11,735
======== ======= =======
Pro forma basic and diluted net loss per
share......................................... $ (0.54) $ (0.37) $ (0.11)
======== ======= =======
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 requires the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through net income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of the derivative are either offset against the change in fair
value of assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized
in earnings. The ineffective portion of the derivative's change in fair value
will be immediately recognized in earnings. SFAS 133 is effective for the
Company's year ending December 31, 2001. The Company does not currently hold
any derivatives and does not expect the adoption of SFAS 133 to materially
impact the results of its operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas of
the Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. The Company believes its current
revenue recognition policies comply with SAB 101.
49
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
In March 2000, the FASB issued FASB Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation" ("FIN 44"), which contains
rules designed to clarify the application of APB 25. FIN 44 was effective on
July 1, 2000, and the Company adopted it at that time. The impact of adoption
of FIN 44 was not material to the operating results and financial position of
the Company.
2. Agreements with ALZA
In April 1998, the Company entered into a development and commercialization
agreement with ALZA Corporation ("ALZA") for certain product development
rights, patent rights, and other know-how relating to the DUROS system. The
Company issued 5,600,000 shares of Series A-1 preferred stock to ALZA in
connection with this agreement and is required to pay ALZA a royalty on the
net sales of products and a percentage of up front license fees, milestone
payments, or any other payments or consideration received by the Company,
excluding research and development funding. Under the terms of this agreement,
the Company is required to meet annual minimum development spending
requirements and develop a minimum number of products.
As provided for in the license agreement, the Company may pursue a number
of products in specified fields of use using the DUROS technology. However, to
maintain its rights under the agreement, the Company must commit to a minimum
annual level of product development funding with the amount and duration of
such funding in each field varying over time.
The future minimum annual product development funding required under the
ALZA agreement for all fields of use is as follows (in thousands):
Year ended December 31,
2001.............................................................. $ 8,000
2002.............................................................. 13,000
2003.............................................................. 14,000
2004.............................................................. 17,000
-------
Total minimum funding required...................................... $52,000
=======
The agreement may be terminated by the Company, by providing ninety days
written notice to ALZA, or when the Company ceases to have royalty payment
obligations to ALZA (at least 20 years).
In the years ended December 31, 2000 and 1999, and the period from
inception (February 6, 1998) to December 31, 1998, the Company incurred
development expenses of $666,000, $1,182,000, and $243,000, respectively, for
work performed by ALZA, of which $941,000, $1,064,000 and $40,000 was paid
during the years ended December 31, 2000 and 1999, and the period from
inception (February 6, 1998) to December 31, 1998, respectively. At December
31, 2000 and 1999, $45,000 and $321,000 respectively, were included in accrued
liabilities.
In April 2000, ALZA and the Company amended and restated their development
and commercialization agreement. This amendment includes a reduction in
product royalties and up-front payments to ALZA by the Company under the
agreement. In addition, ALZA's option to distribute the DUROS sufentanil
product was amended in geographic scope to cover only the U.S. and Canada
instead of worldwide. As consideration for these amendments, ALZA received
1,000,000 shares of the Company's common stock and, subject to conditions on
exercise, a warrant to purchase 1,000,000 shares of common stock at an
exercise price equal to the price at which the Company sold its common stock
in its initial public offering (See Note 8). The deemed fair value of the
stock and the warrant was $13.5 million (See Note 8). This value was recorded
as additional paid-in capital and
50
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
deferred royalties and commercial rights, included as a contra-equity account
in the statement of stockholders' equity, and will be amortized as royalty
expense and sales and marketing expense, respectively, as associated product
sales commence. The Company will periodically evaluate the recoverability of
these amounts and assess whether an indicator of impairment has occurred.
Indicators of impairment for products under the agreement may include: failure
to complete product development, unfavorable outcomes from the clinical
trials, suspension of clinical trial activities, failure to receive approval
from the FDA, and/or lack of market acceptance.
3. Acquisitions
IntraEAR
On October 1, 1999, the Company acquired substantially all of the assets of
IntraEAR, Inc. ("IntraEAR") for a total cost of approximately $1,797,000
(consisting of $320,000 in cash, 325,023 shares of Series B-1 convertible
preferred stock, and transaction costs of approximately $46,000). IntraEAR
developed and commercialized products that permit controlled fluid delivery to
the round window membrane of the ear. The purchase price was allocated to the
tangible and identifiable intangible assets acquired on the basis of their
fair values, as follows:
Tangible assets................................................... $ 297,000
Patents........................................................... 410,000
Developed technology.............................................. 90,000
Other intangibles................................................. 310,000
Goodwill.......................................................... 690,000
----------
Total purchase price............................................ $1,797,000
==========
The acquisition of IntraEAR has been accounted for as a purchase, with the
results of IntraEAR's operations included in the Company's results of
operations from the date of acquisition. The unaudited pro forma information,
had the acquisition of IntraEAR occurred at the beginning of 1999, is as
follows (in thousands, except per share amounts):
Year ended
December 31,
1999
------------
Revenue......................................................... $ 364
Net loss........................................................ $(9,292)
Net loss per common share, basic and diluted.................... $ (1.76)
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the operating results that would
have occurred had the transaction been completed at the beginning of the
earliest period presented, nor is it necessarily indicative of future
operating results.
Intangible assets represent the excess of total acquisition cost of
IntraEAR over the fair value of identifiable net assets of businesses
acquired. Intangible assets are amortized using the straight-line method over
their estimated useful lives over periods ranging from four to seven years.
Management periodically reviews the carrying amount of goodwill and other
intangible assets to assess their continued recoverability. Accumulated
amortization of patents, developed technology, goodwill and other intangibles
totaled $256,000 and $69,000 at December 31, 2000 and 1999, respectively.
Alzet
On April 14, 2000, the Company acquired from ALZA the ALZET product line
and certain assets used primarily in the manufacture, sale and distribution of
this product. This acquisition provides the Company with
51
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
an ongoing business of making and selling this product worldwide. The total
purchase price consisted of approximately $8.3 million in cash. The purchase
price was allocated to the tangible and identifiable intangible assets
acquired on the basis of their fair values, as follows:
Tangible assets................................................... $3,634,000
Completed technology.............................................. 1,540,000
Other intangibles................................................. 1,880,000
Goodwill.......................................................... 1,216,000
----------
Total purchase price............................................ $8,270,000
==========
The acquisition of the ALZET product has been accounted for as a purchase,
with the results of ALZET's operations included in the Company's results of
operations from the date of acquisition. The unaudited pro forma information,
had the acquisition of the ALZET product occurred at the beginning of 1999, is
as follows (in thousands, except per share amounts):
Year ended
December 31,
-----------------
2000 1999
-------- -------
Revenue.................................................. $ 4,229 $ 3,933
Net loss................................................. (19,873) (8,893)
Net loss per common share, basic and diluted............. $ (1.22) $ (1.68)
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the operating results that would
have occurred had the transaction been completed at the beginning of the
earliest period presented, nor is it necessarily indicative of future
operating results.
Intangible assets represent the excess of the total acquisition cost of the
ALZET product over the fair value of identifiable net assets of businesses
acquired. Intangible assets are amortized using the straight-line method over
their estimated useful lives over periods ranging from four to six years.
Management periodically reviews the carrying amount of goodwill and other
intangible assets to assess their continued recoverability. Accumulated
amortization of completed technology, goodwill and other intangibles totaled
$599,000 at December 31, 2000.
4. Financial Instruments
The following methods and assumptions were used by the company in
estimating its fair value disclosures for financial instruments:
The carrying amount of cash and cash equivalents reported on the balance
sheet approximates its fair value. Short-term investments consist of
marketable debt securities and are classified as available-for-sale. These
investments are carried at fair value and any unrealized gains and losses are
reported in a separate component of stockholders' equity. The fair values are
based upon quoted market prices.
The carrying amounts of the Company's borrowings under its secured debt
agreements approximate their fair values. The fair values are estimated using
a discounted cash flow analysis based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
52
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following is a summary of available-for-sale securities as of December
31, 2000 and 1999 (in thousands):
December 31, 2000
----------------------------------------- December 31, 1999
Estimated Amortized Cost
Amortized Unrealized Unrealized Fair and Estimated
Cost Gain Loss Value Fair Value
--------- ---------- ---------- --------- -----------------
Money market fund....... $ 5,280 $ -- $ -- $ 5,280 $ 82
Commercial paper........ 61,751 -- (17) 61,734 18,783
Auction Rate
Securities............. 20,000 -- -- 20,000 --
Market Auction
Preferreds............. 4,900 -- -- 4,900 --
Corporate Bonds and
Notes.................. 7,935 29 -- 7,964 --
Others.................. 6,377 17 -- 6,394 --
-------- ---- ---- -------- -------
$106,243 $ 46 $(17) $106,272 $18,865
======== ==== ==== ======== =======
Reported as:
Cash equivalents...... $ 46,898 $ -- $ (8) $ 46,890 $ 3,795
Short-term marketable
securities........... 57,705 31 (6) 57,730 12,735
Long-term marketable
securities........... 1,640 12 -- 1,652 2,335
-------- ---- ---- -------- -------
$106,243 $ 43 $(14) $106,272 $18,865
======== ==== ==== ======== =======
As of December 31, 1999, the difference between the fair value and the
amortized cost of available-for-sale securities was immaterial.
The following is a summary of the cost and estimated fair value of
available-for-sale securities at December 31, 2000 and 1999, by contractual
maturity (in thousands):
December 31, 2000
----------------------------------------- December 31, 1999
Estimated Cost and
Amortized Unrealized Unrealized Fair Estimated
Cost Gain Loss Value Fair Value
--------- ---------- ---------- --------- -----------------
Mature in one year or
less................... $104,603 $31 $(14) $104,620 $16,530
Mature after one year
through two years...... 1,640 12 -- 1,652 2,335
-------- --- ---- -------- -------
Total................. $106,243 $43 $(14) $106,272 $18,865
======== === ==== ======== =======
5. Property and Equipment
Property and equipment consist of the following (in thousands):
December 31,
--------------
2000 1999
------ ------
Equipment.................................................... $2,237 $1,161
Leasehold improvement........................................ 385 155
Construction-in-progress..................................... 2,657 162
------ ------
5,279 1,478
Less accumulated depreciation................................ (807) (207)
------ ------
Equipment, net............................................... $4,472 $1,271
====== ======
53
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
At December 31, 2000 and 1999, financed equipment totaled approximately
$2,011,000 and $400,000, respectively. Accumulated depreciation for this
equipment was $593,000 and $102,000 as of December 31, 2000 and 1999,
respectively.
6. Equipment Financing Obligations
In October 1998, the Company financed the purchase of certain equipment
through a bank loan. The loan was renewed in April 1999 and the amount of the
loan was increased to $400,000 from $250,000 in June 1999, with an interest
rate increase to 1.25% plus the bank's base rate from 0.5% plus the bank's
base rate, respectively (effective rates of 10.75% and 9.75% as of December
31, 2000 and 1999). This loan is repayable in equal monthly installments over
three years (payments commenced in April 1999). This equipment loan is secured
by substantially all of the Company's assets.
In January 2000, the Company amended and restated the loan agreement to
include a one-time advance of $750,000. This advance is repayable in monthly
installments of principal and interest over 42 months with a balloon payment
of $75,000 due at the end of the term. The interest rate was 3.49% through
January 2001 and will increase to 15.02% thereafter. Simultaneously, the
Company entered into a lease agreement with the same bank that allows the
Company to finance up to $1,500,000 of future equipment purchases and
leasehold improvements. The payment terms of the lease are substantially the
same as the loan, with a 10 percent balloon payment due at the end of the
lease. Lease payments include interest rates ranging from 13.01% to 13.55% as
of December 31, 2000. Both the loan and the lease are secured by the equipment
financed.
In connection with these agreements, the Company issued warrants to the
bank to purchase 31,395 shares of Series B-1 preferred stock at $2.15 per
share. The warrants expire on December 16, 2006, and, unless exercised sooner,
will be automatically exercised, on a net exercise basis, in the event of an
initial public offering on the first date the bank is permitted to sell the
shares without restriction. The fair value of the warrants was determined to
be $190,000, calculated using the Black-Scholes option pricing model, using
the following assumptions: dividend rate of zero; contractual term of seven
years; risk-free interest rate of 6%; and expected volatility of 70%. The fair
value of the warrants has been recorded as additional paid-in capital and debt
discount and is being amortized as interest expense over the term of the loan.
In November 2000, the bank exercised the warrant, resulting in the issuance of
27,126 shares of common stock.
Aggregate future minimum lease payments on equipment financing obligations
are due as follows (in thousands):
December 31,
2000
------------
2001............................................................ 636
2002............................................................ 698
2003............................................................ 601
2004............................................................ 139
------
Total minimum lease and principal payments...................... 2,074
Less: Amount representing interest.............................. (562)
------
Present value of future lease payments.......................... 1,512
Less: Current portion of equipment financing obligations........ (407)
------
Long-term portion of equipment financing obligations............ $1,105
======
The carrying value of the Company's equipment financing obligations
approximates their fair value. The fair value of the Company's equipment loan
is estimated using a discounted cash flow analysis based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements.
54
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. Commitments
The Company leases its office and research facility under a noncancelable
operating lease which expires in January 2004, with two options to extend the
lease for 5 years each. The company also leases its manufacturing facility
under a noncancelable operating lease which expires in August 2003, with one
option to extend the lease for a period of 2 years. The Company is required to
pay certain maintenance expenses in addition to monthly rent. Rent expense is
recognized on a straight-line basis over the lease term which has scheduled
rental payment increases. Rent expense under this operating lease was $627,000
$313,000 and $80,000, for the years ended December 31, 2000 and 1999, and the
period from inception (February 6, 1998) to December 31, 1998, respectively.
Future minimum lease payments under this noncancelable lease are as follows
(in thousands):
Year ended December 31,
2001................................................................ 868
2002................................................................ 894
2003................................................................ 871
2004................................................................ 134
------
$2,767
======
Through April 2000, the Company subleased office space to a third party.
Sublease income under this lease, which offsets rent expense recognized, was
$137,000, $360,000, and $0 for, the years ended December 31, 2000 and 1999,
and the period from inception (February 6, 1998) to December 31, respectively.
In April 2000, the Company cancelled this sublease.
8. Stockholders' Equity
Preferred Stock
Holders of Series A-1, A-2, and B-1 convertible preferred stock were
entitled to noncumulative dividends of $0.05, $0.05, and $0.13975,
respectively, if and when declared by the board of directors. No such
dividends were declared prior to the conversion of these shares into common
stock (see below).
Holders of Series B convertible preferred stock were entitled to receive
cumulative dividends at the rate of $0.13975 per share per annum on each
outstanding share of Series B convertible preferred stock, payable quarterly
when, as, and if declared by the board of directors. Such dividends accrued on
each share from July 16, 1999, and continued to accrue on a day-to-day basis
whether or not declared. Accumulation of dividends on the Series B convertible
preferred stock did not bear interest. Cumulative dividends with respect to
Series B convertible preferred stock which were accrued and/or in arrears were
forgiven upon conversion of such shares to common stock.
In March 2000, the Company completed a private placement of 3,571,429
shares of Series C convertible preferred stock at $7.00 per share, resulting
in net cash proceeds of approximately $25.0 million. Holders of Series C
preferred stock were entitled to annual noncumulative dividends of $0.35 per
share when and if declared by the board of directors. No dividends had been
declared at the time of conversion of such shares into common stock.
Upon the completion of the Company's initial public offering (see below),
all outstanding convertible preferred stock converted on a one-to-one basis
into an aggregate of 27,502,660 shares of common stock.
55
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Common Stock
In September 2000, the company completed its initial public offering, in
which it sold 7,000,000 shares of common stock at a price of $12 per share.
The net proceeds of the offering, after deducting underwriters' discounts and
other offering expenses, were approximately $76.2 million.
In November 2000, the underwriters of the company's initial public offering
of common stock exercised their over-allotment option in part and purchased an
additional 700,000 shares at the initial public offering price of $12.00 per
share. The net proceeds of the over-allotment option, after deducting
underwriters' discount and other offering expenses, were approximately $7.8
million. After giving effect to the sale of the over-allotment shares, a total
of 7,700,000 shares of common stock were offered and sold in the initial
public offering with total net proceeds of $84.0 million.
Concurrent with the initial public offering, the Board of Directors amended
the articles of incorporation to increase the authorized stock of the Company
to 120,000,000, consisting of 110,000,000 shares of common stock, $0.0001 par
value, and 10,000,000 shares of preferred stock, $0.0001 par value. There were
46,565,486 shares of common stock outstanding as of December 31, 2000.
As of December 31, 2000, the Company's founders owned 8,400,000 shares of
common stock. The founders' common stock is subject to the Company's right of
repurchase upon termination of their employment at the original issue price,
and to the extent the Company elects not to exercise its right of repurchase,
the remaining founders and certain stockholders may exercise the repurchase
right. Initially 66 2/3% of the founders' shares were subject to repurchase,
but such repurchase rights lapse over time at the rate of 1.85% for each
completed month of employment (until all shares are released from the
repurchase option). As of December 31, 2000, an aggregate of 316,000 shares of
the founders' stock remained subject to repurchase.
As described in Note 2, in April 2000 the Company amended and restated its
development and commercialization agreement with ALZA. As consideration for
these amendments, ALZA received 1,000,000 shares of the Company's common stock
and, subject to conditions on exercise, a warrant to purchase 1,000,000 shares
of common stock at an exercise price equal to the price at which the Company
sold its common stock in its initial public offering. The common stock issued
to ALZA was valued at $7.00 per share. The deemed fair value of the stock and
the warrant was $13.5 million. The fair value of the warrant was determined to
be $6,480,000, calculated using the Black-Scholes option pricing model, using
the following assumptions: stock price of $12.00 per share; no dividends;
contractual term of four years; risk-free interest rate of 6%; and expected
volatility of 64%.
As of December 31, 2000, shares of common stock reserved for future
issuance consisted of the following:
December 31,
2000
------------
Warrants to purchase common stock............................... 1,000,000
Stock options outstanding....................................... 1,299,682
Stock options available for grant............................... 198,368
---------
2,498,050
=========
Incentive Stock Plans
In March 1998, the Company adopted the DURECT Corporation 1998 Stock Option
Plan under which incentive stock options and nonstatutory stock options may be
granted to employees, directors of, or consultants to, the Company and its
affiliates. In January 2000, the Company reduced the number of shares
available for issuance under this plan by 296,500, and ceased granting options
from this plan.
56
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
In January 2000, the Company's Board of Directors and stockholders adopted
the DURECT Corporation 2000 Stock Option Plan, under which incentive stock
options and nonstatutory stock options and stock purchase rights may be
granted to employees, consultants and nonemployee directors. The 2000 Stock
Option Plan was amended by written consent of the Board of Directors in March
2000 and written consent of the stockholders in August 2000. A total of
1,796,500 shares of common stock have been reserved for issuance under this
plan.
Options granted under the 1998 and 2000 Stock Option Plans ("Plans") expire
no later than ten years from the date of grant. Options may be granted with
different vesting terms from time to time but not to exceed five years from
the date of grant.
The option price of an incentive stock option granted to an employee or of
a nonstatutory stock option granted to any person who owns stock representing
more than 10% of the total combined voting power of all classes of stock of
the Company (or any parent or subsidiary) shall be no less than 110% of the
fair market value per share on the date of grant. The option price of an
incentive stock option granted to any other employee shall be no less than
100% of the fair market value per share on the date of grant. The option price
of a nonstatutory stock option that is granted to any other person shall be no
less than 85% of the fair market value per share on the date of grant.
Activity under the Stock Plans through December 31, 2000 is as follows:
Weighted-
Shares Average
Available Number of Exercise
for Grant Shares Price
---------- ---------- ---------
Shares authorized....................... 1,000,000 -- --
Options granted......................... (804,000) 804,000 $0.10
---------- ----------
Balance at December 31, 1998............ 196,000 804,000 $0.10
Shares authorized....................... 1,000,000 -- --
Options granted......................... (934,500) 934,500 $0.35
Options exercised....................... -- (102,500) $0.35
Options canceled........................ 35,000 (35,000) $0.35
---------- ----------
Balance at December 31, 1999............ 296,500 1,601,000 $0.23
Shares authorized, net.................. 1,500,000 -- --
Options granted......................... (1,598,132) 1,598,132 $5.55
Options exercised....................... -- (1,833,200) $0.88
Options canceled........................ -- (66,250)(1) $0.14
---------- ----------
Balance at December 31, 2000............ 198,368 1,299,682 $6.52
========== ==========
- --------
(1) Options to purchase 66,250 shares of common stock granted under the 1998
Stock Option Plan were cancelled and not available for future grant.
The Company recorded deferred compensation in connection with certain stock
option grants, net of forfeitures, of $6.0 million in 2000, $3,596,000 in 1999
and $670,000 in 1998. The Company amortized deferred compensation of $4.4
million in 2000, $865,000 in 1999, and $149,000 in 1998. The remaining
deferred compensation at December 31, 2000 was $4.8 million, which will be
amortized as follows: $2.7 million for the year ending December 31, 2001, $1.4
million for the year ending December 31, 2002, $600,000 for the year ending
December 31, 2003, and $51,000 for the year ending December 31, 2004.
The weighted-average grant-date fair value of options granted was $2.73 in
2000, $0.12 in 1999 and $0.02 in 1998.
57
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
In 1999 and 2000, Durect issued options to purchase 102,975 shares of
common stock to several third party consultants in exchange for services. In
connection with these options to purchase common stock, Durect recorded a non-
cash charge of $619,000 in its statement of operations for the year ended
December 31, 2000. Expenses for non-employee stock options are recorded over
the vesting period of the options, with the amount determined by the Black-
Scholes option valuation method and remeasured over the vesting term.
The following table summarizes the information about stock options
outstanding at December 31, 2000:
Weighted-
Average Weighted- Weighted-
Range of Number of Remaining Average Number of Average
Exercise Options Contractual Exercise Options Exercise
Price Outstanding Life Price Exercisable Price
-------- ----------- ----------- --------- ----------- ---------
(In years)
$0.10 187,500 7.68 $ 0.10 187,500 $ 0.10
$0.35 224,350 8.70 $ 0.35 224,350 $ 0.35
$1.00 139,150 9.26 $ 1.00 139,150 $ 1.00
$6.00 111,927 9.56 $ 6.00 24,975 $ 6.00
$9.00 6,500 9.72 $ 9.00 -- $ 9.00
$11.63-14.25 630,255 9.92 $11.91 -- $11.91
--------- -------
1,299,682 9.29 $ 6.52 575,975 $ 0.67
========= =======
As of December 31, 1999, outstanding options to purchase an aggregate of
211,000 shares of common stock were vested and exercisable at a weighted-
average exercise price per share of $0.10. As of December 31, 2000,
outstanding options to purchase an aggregate of 116,825 shares of common stock
were vested and exerciseable at a weighted-average exercise price per share of
$0.64.
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock-based compensation plans. Because the
exercise price of the employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is generally
recognized. Pro forma information regarding net loss has been determined as if
the Company accounted for its employee stock options under the fair value
method prescribed by SFAS 123. The resulting effect on pro forma net loss
disclosed is not likely to be representative of the effects on net loss on a
pro forma basis in future years, due to additional grants and years of vesting
in subsequent years. The fair value of each option granted through the period
from inception (February 6, 1998) to December 31, 1998, the year ended
December 31, 1999, and the period from the beginning of 2000 to the time of
the initial public offering, were estimated on the date of grant using the
minimum value method, with the following weighted-average assumptions:
Period from
inception
Year ended (February 6,
December 31, 1998)
----------------- to December 31,
2000 1999 1998
--------- ------- ---------------
Risk-free interest rate.................... 5.3-6.5% 6.0% 4.5%
Expected dividend yield.................... -- -- --
Expected life of option.................... 3.5 years 5 years 5 years
For the period following the Company's initial public offering, the Black
Scholes methods was used to calculate the fair value of the options granted.
This method included the above assumptions as well as an estimated volatility
of the Company's common stock of 64%.
58
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Had the
Company accounted for its employee stock options under the fair value method
prescribed by SFAS 123, the Company's net loss and net loss per share would
have been as follows (in thousands, except per share amounts):
Period from
inception
Year ended (February 6,
December 31, 1998)
----------------- to December 31,
2000 1999 1998
-------- ------- ---------------
Net loss--as reported................... $(20,823) $(9,310) $(1,322)
Net loss--pro forma..................... $(21,176) $(9,330) $(1,325)
Basic and diluted net loss per share.... $ (1.22) $ (1.76) $ (0.36)
Basic and diluted net loss per share--
pro forma.............................. $ (1.24) $ (1.76) $ (0.36)
2000 Employee Stock Purchase Plan
In August 2000, the Company adopted the 2000 Employee Stock Purchase Plan.
A total of 150,000 shares of common stock have been reserved for issuance
under the purchase plan. This purchase plan will be implemented by a series of
overlapping offering periods of approximately 24 months' duration, with new
offering periods, other than the first offering period, beginning on May 1 and
November 1 of each year and ending April 30 and October 31, respectively, two
years later. The purchase plan allows eligible employees to purchase common
stock through payroll deductions at a price equal to the lower of 85% of the
fair market value of the Company's common stock at the beginning of each
offering period or at the end of each purchase period. The initial offering
period commenced on the effectiveness of the initial public offering.
2000 Directors' Stock Option Plan
In March 2000, the Board of Directors adopted the 2000 Directors' Stock
Option Plan. A total of 300,000 shares of common stock have been reserved for
issuance under this plan. The directors' plan provides that each person who
becomes a nonemployee director of the Company after the effective date of this
offering will be granted a nonstatutory stock option to purchase 20,000 shares
of common stock on the date on which the optionee first becomes a nonemployee
director of the Company. This plan also provides that each option granted to a
new director shall vest at the rate of 33 1/3% per year and each annual option
shall vest in full at the end of one year. No shares have been issued under
the directors' plan.
59
DURECT CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
9. Income Taxes
Deferred tax assets and liabilities reflect the net tax effects of net
operating loss and credit carryforwards and the temporary differences between
the carrying amounts of assets and liabilities for financial reporting and the
amounts used for income tax purposes. Significant components of the Company's
deferred tax assets are as follows (in thousands):
December 31,
-----------------
2000 1999
-------- -------
Deferred tax assets:
Net operating loss carryforwards........................ $ 9,100 $ 3,600
Capitalized research and development.................... 600 --
Research credit carryforwards........................... 600 --
Other individually immaterial items..................... 200 (100)
-------- -------
Total deferred tax assets................................. 10,500 3,500
Valuation allowance for deferred tax assets............... (10,500) (3,500)
-------- -------
Net deferred tax assets................................... $ -- $ --
======== =======
Realization of deferred tax assets is dependent upon future earnings, if
any, the timing and amount of which are uncertain. Accordingly, the net
deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by $7,000,000 and $2,950,000 during 2000 and
1999, respectively.
As of December 31, 2000, the Company had federal and state net operating
loss carryforwards of approximately $24,000,000 which expire at various dates
beginning in 2006 through 2020, if not utilized. The Company also had federal
and state research and development tax credits of approximately $600,000 which
expire at various dates beginning in 2018 through 2020, if not utilized.
Utilization of the net operating losses may be subject to a substantial
annual limitation due to federal and state ownership change limitations. The
annual limitation may result in the expiration of net operating losses before
utilization.
10. Selected Quarterly Financial Data (Unaudited) (In thousands, except per
share amounts)
Second Fourth
First Quarter Quarter Third Quarter Quarter
-------------- -------------- -------------- --------------
2000 1999 2000 1999 2000 1999 2000 1999
------ ------ ------ ------ ------ ------ ------ ------
Revenue, net............ $ 83 $ -- $ 998 $ -- $1,101 $ -- $ 973 $ 86
Gross profit............ 47 -- 423 -- 456 -- 288 47
Net loss attributable to
common stockholders.... $4,705 $1,284 $5,153 $2,068 $6,031 $2,353 $4,933 $3,607
Basic and diluted net
loss per share......... $(0.71) $(0.28) $(0.65) $(0.41) $(0.62) $(0.43) $(0.11) $(0.60)
11. Subsequent Event (unaudited)
On March 22, 2001, the Company signed a noncancelable operating lease for
an office facility. This lease commences in June 2001, expires in May 2006,
and has two options to extend the lease term for up to an additional eight
years. The monthly payments under this noncancelable operating lease increase
over the term of the lease and are between $102,000 and $119,000. Future
minimum lease payments under this noncancelable lease are not included in Note
7.
60
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The directors and executive officers of DURECT Corporation and their ages
as of March 16, 2000 are as follows:
Name Age Position
---- --- --------
Chairman, Chief Scientific Officer and
Felix Theeuwes, D.Sc. ........ 63 Director
President, Chief Executive Officer and
James E. Brown, D.V.M. ....... 44 Director
Thomas A. Schreck............. 43 Chief Financial Officer and Director
Edward M. Gillis.............. 39 Vice President, Engineering
Randolph M. Johnson, Ph.D. ... 50 Vice President, Preclinical Research
Jean I Liu.................... 32 Vice President, Legal and General Counsel
Vice President, Regulatory and
Judy A. Magruder.............. 42 Development
Vice President, Business and Commercial
Timothy S. Nelson............. 37 Development
Scott M. Wheelwright, Ph.D. .. 46 Vice President, Manufacturing
James R. Butler(2)............ 60 Director
John L. Doyle(2).............. 69 Director
Douglas A. Lee(1)............. 36 Director
Matthew V. McPherron(1)(2).... 36 Director
Armand P. Neukermans.......... 60 Director
Albert L. Zesiger(1).......... 71 Director
- --------
(1) Member of Audit Committee
(2) Member of Compensation Committee
Felix Theeuwes, D.Sc. co-founded DURECT in February 1998 and has served as
our Chairman, Chief Scientific Officer and a Director since July 1998. He is
also currently a consultant to ALZA Corporation, a pharmaceutical and drug
delivery company which is an affiliate of us. Prior to that, Dr. Theeuwes held
various positions at ALZA Corporation, including President of New Ventures
from August 1997 to August 1998, President of ALZA Research and Development
from 1995 to August 1997, President of ALZA Technology Institute from 1994 to
April 1995 and Chief Scientist from 1982 to June 1997. Dr. Theeuwes is also a
director of Genetronics, a medical device company, and several private
companies. Dr. Theeuwes holds a D.Sc. degree in Physics from the University of
Leuven (Louvain), Belgium. He also served as a post-doctoral fellow and
visiting research assistant professor in the Department of Chemistry at the
University of Kansas and has completed the Stanford Executive Program.
James E. Brown, D.V.M. co-founded DURECT in February 1998 and has served as
our President, Chief Executive Officer and a Director since June 1998. He
previously worked at ALZA Corporation as Vice President of Biopharmaceutical
and Implant Research and Development from June 1995 to June 1998. Prior to
that, Dr. Brown held various positions at Syntex Corporation, a pharmaceutical
company, including Director of Business Development from May 1994 to May 1995,
Director of Joint Ventures for Discovery Research from April 1992 to May 1995,
and held a number of positions including Program Director for Syntex Research
and Development from October 1985 to March 1992. Dr. Brown holds a B.A. from
San Jose State University and a D.V.M. (Doctor of Veterinary Medicine) from
the University of California, Davis where he also conducted post-graduate work
in pharmacology and toxicology.
Thomas A. Schreck co-founded DURECT in February 1998 and served as Chief
Executive Officer, Chief Financial Officer and President from February 1998 to
June 1998. Since June 1998, he has served as our Chief
61
Financial Officer and a Director. Prior to founding DURECT, he founded and was
President of Schreck Merchant Group, Inc., an investment bank specializing in
private placements and mergers and acquisitions, from June 1994 to February
1998. Mr. Schreck also founded and served as Risk Manager to Genesis Merchant
Group/Portola Capital Partners, L.P., a convertible arbitrage fund, from 1993
to 1994. He also served as a Manager of the Convertible Securities Department
at Montgomery Securities, from 1988 to 1991. Mr. Schreck holds a B.A. from
Williams College.
Edward M. Gillis has served as our Vice President of Engineering since
March 2000. Prior to that, Mr. Gillis served as our Executive Director of
Engineering from April 1999 to March 2000. Prior to that, he served as our
Director of Engineering from October 1998 to April 1999. From March 1997 to
October 1998, Mr. Gillis served as the Director of Pilot Manufacturing and
Process Engineering at EndoTex Interventional Systems, a private medical
device company. From July 1993 to March 1997, Mr. Gillis served as Director of
Catheter Ablation Product Development and Manufacturing Engineering Manager at
Cardiac Pathways Corporation, a medical device company. Mr. Gillis holds a
B.S. in Biological Sciences and an M.S. in Plastics Engineering from the
University of Lowell.
Randolph M. Johnson, Ph.D. has served as our Vice President of Preclinical
Research and Director of CNS (Central Nervous System) Programs since September
1998. From July 1995 to September 1998, Dr. Johnson held various positions at
Roche Bioscience, a pharmaceutical company. From July 1995 to October 1997,
Dr. Johnson served as the Department Head of Neurobiology, Center for
Biological Research and from October 1997 to September 1998, as the Department
Head of Molecular & Cellular Biochemistry, Center for Biological Research.
From January to June 1995, Dr. Johnson served as the Director of Preclinical
Development at Syntex Development Research, a pharmaceutical company. Dr.
Johnson holds a B.S. in Zoology from California State University, Long Beach,
an M.A. in Biology-Physiology from California State University, Long Beach and
a Ph.D. in Biomedical Science-Pharmacology from the University of South
Carolina School of Medicine. In addition, he was a Postdoctoral Research
Associate in the Department of Pharmacology at the University of Virginia
School of Medicine.
Jean I Liu has served as our Vice President of Legal and General Counsel
since February 1999. Previously, from October 1998, Ms. Liu served as our Vice
President of Legal. Prior to that, Ms. Liu worked as an attorney at Venture
Law Group, a law firm, from May 1997 to October 1998. Ms. Liu worked as an
attorney at Pillsbury Madison & Sutro LLP, a law firm, from September 1993 to
May 1997. Ms. Liu holds a B.S. in Cellular & Molecular Biology from University
of Michigan, an M.S. in Biology from Stanford University and a J.D. from
Columbia University School of Law.
Judy A. Magruder has served as our Vice President of Regulatory and
Development since February 2000. From March 1999 to February 2000, Ms.
Magruder served as our Executive Director of Regulatory and Product
Development. Prior to that, Ms. Magruder served as Director of Product
Development at Vascular Therapeutics, Inc., a private pharmaceuticals company,
from January 1998 to March 1999. Ms. Magruder held various positions at ALZA
Corporation, including Head of Program Management, Implant Development and a
Research Scientist from February 1996 to January 1998, Product Development
Manager/Program Manager as well as Research Scientist from January 1991 to
February 1996, and Chemist from May 1984 to April 1989. Ms. Magruder holds a
B.S. in Animal Science from the University of California, Davis and an M.B.A.
from Santa Clara University.
Timothy S. Nelson has served as our Vice President of Business and
Commercial Development since September 1998. Previously, Mr. Nelson held
various positions at Medtronic, Inc., a medical device company, including
Business Director of Neurological Division, Europe, Middle East and Africa
from June 1996 to September 1998, and Manager of Drug Delivery Ventures and
Business Development from August 1992 to June 1996. Mr. Nelson holds a
Bachelor of Chemical Engineering degree from the University of Minnesota and a
Master of Management degree with Distinction from the J.L. Kellogg Graduate
School of Management, Northwestern University.
Scott M. Wheelwright, Ph.D. has served as our Vice President of
Manufacturing since February 2000. Previously, Dr. Wheelwright was the Vice
President of Development and Manufacturing at Calydon, Inc., a
62
privately held biotechnology company developing cancer therapeutics, from
March 1998 to February 2000. From October 1992 to March 1998, he served as
Senior Director of Process Development, Manufacturing and Engineering at Scios
Inc., a biotechnology company. Dr. Wheelwright holds a B.S. in Chemical
Engineering from the University of Utah, a Ph.D. in Chemical Engineering from
the University of California, Berkeley, and conducted post-doctoral research
at the Max Planck Institute for Biophysics in Frankfurt, Germany.
James R. Butler has served as a Director since July 1999. Mr. Butler is
currently an employee of ALZA where he holds two positions. Mr. Butler joined
ALZA in July 1993 as Vice President of Sales and Marketing and in January
2000, Mr. Butler became the Group Vice President of ALZA International. Mr.
Butler is also a director of Aronex Pharmaceuticals, a pharmaceutical company
and OMP, Inc., a medical products company. Mr. Butler holds a B.A. in Business
Administration from the University of Florida.
John L. Doyle has served as a Director since February 2000. Mr. Doyle is
currently an independent consultant. In 1957, he joined Hewlett-Packard, a
computer company, where from 1957 to 1991 he served in several manufacturing
and general management positions, including the Vice President of Personnel
from 1976 to 1980, Vice President of Research and Development from 1980 to
1984, Executive Vice President of the Computer Sector from 1984 to 1988, and
of Business Development until his retirement in 1991. Mr. Doyle is also a
director of Analog Devices Inc., a semiconductor company, Dupont Photomasks
Inc., a manufacturer of semiconductor manufacturing equipment, and Xilinx
Inc., a semiconductor company. Mr. Doyle studied naval architecture at Glasgow
University and holds a B.S. in Mechanical Engineering as well as an M.S. in
Electrical Engineering and Business from Stanford University.
Douglas A. Lee has served as a Director since June 1998. Mr. Lee joined The
Dr. Spock Company, Inc., a parenting media company, in February 2000, and
became its President and Chief Executive Officer in April 2000. From September
1997, until joining The Dr. Spock Company, Mr. Lee served as Managing Director
of Premier Medical Partner Fund L.P., a health care venture capital fund. From
October 1995 to February 1997, Mr. Lee worked at Guidant Corporation, a
medical device company, where he was Vice President and Chief Financial
Officer of its new ventures and corporate business development group. Mr. Lee
is also a Director of Atrionix, Inc., a private medical device company and The
Dr. Spock Company, Inc. Mr. Lee holds a B.S. from the University of
California, Berkeley and an M.B.A. from the University of Chicago.
Matthew V. McPherron has served as a Director since July 1999. Since June
1998, Mr. McPherron has been a Director of Brookside Capital Partners Fund,
L.P. Previously, Mr. McPherron served as the President and Chief Operating
Officer of US Carelink, a health care internet company from September 1997 to
March 1998. From August 1993 to September 1997, Mr. McPherron served in a
number of roles at Medtronic, Inc., most recently as the Global Marketing
Manager for Pain Therapy. Mr. McPherron holds a B.S. from the University of
Kansas and an M.B.A. from the Harvard Graduate School of Business
Administration.
Armand P. Neukermans has served as a Director since March 2001. Dr.
Neukermans founded Xros, Inc. in December 1996. Xros was acquired by and
became a division of Nortel Networks in March 2000. Throughout, Dr. Neukermans
has held the position of Chairman and Chief Technical Officer at Xros. In
October 1993, Dr. Neukermans founded Adagio Associates, a consulting firm in
the area of instrumentation, metrology and microfabrication and currently
serves as its President. From 1992 to 1993, Dr. Neukermans was Vice President,
Systems Development at Teknekron TSDC. Between 1985 and 1992, Dr. Neukermans
held various positions at Tencor Instruments including Vice President and
Chief Technical Officer. From 1973 to 1985, Dr. Neukermans held various
positions at Hewlett Packard Company, HP Labs, including Department Manager.
Dr. Neukermans holds an Engineer's Degree in Mechanical and Electrical
Engineering from Louvain University, an M.S. in Electrical Engineering from
Arizona State University and a Ph.D. in Applied Physics from Stanford
University.
Albert L. Zesiger has served as a Director since 1998. Mr. Zesiger is a
Managing Director of Zesiger Capital Group, LLC, an investment advisory firm,
which Mr. Zesiger co-founded in October 1995. In 1968, Mr. Zesiger founded BEA
Associates, Inc., an investment advisory firm, which in 1995 became wholly-
owned by CS Holdings, the holding company for Credit Suisse Bank and CS First
Boston. Mr. Zesiger also serves on the
63
Board of Directors of Eos Biotechnology, Inc., Hayes Medical Inc., and Praecis
Pharmaceuticals Inc. Mr. Zesiger holds a B.S. in Engineering from the
Massachusetts Institute of Technology and an M.B.A. from the Harvard Graduate
School of Business Administration.
Compliance with Section 16(a) of the Securities Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires our directors
and executive officers, and persons who own more than ten percent of a
registered class of our equity securities to file with the Securities and
Exchange Commission initial reports of ownership and reports of changes in
ownership of common stock and other of our equity securities. Officers,
directors and holders of more than ten percent of our common stock are
required by the SEC regulations to furnish us with copies of all Section 16(a)
forms they file.
To our best knowledge, based solely upon review of the copies of such
reports furnished to us and written representations that no other report were
required, during the year ended December 31, 2000 all Section 16(a) filing
requirements applicable to our officers, directors and holders of more than
ten percent of our common stock were complied with.
Item 11. Executive Compensation.
The following table provides certain summary information concerning the
compensation earned for services rendered to us during the fiscal year ended
December 31, 2000 by our Chief Executive Officer and our four other most
highly compensated executive officers who earned more than $100,000 in 2000
and were serving as executive officers at the end of 2000, whom we refer to
collectively as the named executive officers.
Summary Compensation Table
Annual Compensation Long-Term Compensation
-------------------- ----------------------------
Securities
Name and Principal Other Annual Underlying All Other
Position Year Salary Bonus ($) Compensation ($) Options (#) Compensation ($)
------------------ ---- ------- ------------ ---------------- ----------- ----------------
James E. Brown, D.V.M... 2000 225,000 -- -- 80,000 --
President, Chief
Executive 1999 225,000 -- -- -- --
Officer and Director
Felix Theeuwes, D.Sc.... 2000 250,000 -- -- 80,000 --
Chairman, Chief 1999 177,564 -- -- -- --
Scientific Officer
Thomas A. Schreck(1).... 2000 200,000 -- -- 80,000 --
Chief Financial Officer 1999 200,000 -- -- -- --
and
Director
Timothy S. Nelson....... 2000 175,794 -- -- 185,607 26,136(2)
Vice President, 1999 165,000 -- -- 88,500 24,543(2)
Business &
Commercial Development
Randolph M. Johnson,
Ph.D................... 2000 167,030 -- -- 30,000 --
Vice President, 1999 160,000 -- -- 20,000 --
Preclinical
Research, Director of
CNS
Programs
- --------
(1) Pursuant to a Financial Advisory Services Agreement, dated May 29, 1998,
we paid an investment banking fee to Schreck Merchant Group, Inc., a
financial services company controlled by Mr. Schreck, in the amount of
$279,000. The Advisory Agreement was terminated effective December 18,
1998.
(2) Mr. Nelson receives $24,543 per year for three years, beginning in 1999,
for a housing allowance.
64
Option Grants During The Year Ended December 31, 2000
The following table sets forth certain information for the year ended
December 31, 2000 with respect to grants of stock options to each of the named
executive officers. All options granted by us in 2000 were granted under our
1998 stock option plan and our 2000 stock plan. These options have a term of
10 years. We granted options to purchase common stock and issued shares of
common stock pursuant to restricted stock purchase agreements equal to a total
of 758,107 shares during 2000. Options were granted at an exercise price equal
to the fair market value of our common stock, as determined in good faith by
our board of directors. Potential realizable values are net of exercise price
before taxes, and are based on the assumption that our common stock
appreciates at the annual rate shown, compounded annually, from the date of
grant until the expiration of the ten-year term.
These numbers are calculated based on Securities and Exchange Commission
requirements and do not reflect our projection or estimate of future stock
price growth. Unless the market price of the common stock appreciates over the
option term, no value will be realized from the option grants made to
executive officers. Actual gains, if any, on stock option exercises will be
dependent on the future performance of our common stock. The assigned 5% and
10% rates of stock appreciation are based on the fair market value of our
common stock ($12.00) at December 29, 2000.
Individual Grants
--------------------------
Potential Realizable Value
Number of Percent of At Assumed Annual Rates of
Securities Total Options Stock Price Appreciation
Underlying Granted Exercise for Option Term
Options to Employees Price Expiration ---------------------------
Name Granted (#) In Fiscal Year ($/Share) Date 5% 10%
- ---- ----------- -------------- --------- ---------- ------------- -------------
James E. Brown.......... 80,000 5.2% $11.63 12/14/2010 $ 633,739 $ 1,559,993
Felix Theeuwes.......... 80,000 5.2% $11.63 12/14/2010 $ 633,739 $ 1,559,993
Thomas A. Schreck....... 80,000 5.2% $11.63 12/14/2010 $ 633,739 $ 1,559,993
Timothy S. Nelson....... 30,000 2.0% $11.63 12/14/2010 $ 237,652 $ 584,997
53,255 3.5% $12.00 9/27/2010 $ 401,901 $ 1,018,497
40,852 2.7% $ 6.00 7/19/2010 $ 553,411 $ 1,026,403
61,500 4.0% $ 1.00 3/24/2010 $ 1,140,624 $ 1,852,682
Randolph M. Johnson..... 30,000 2.0% $11.63 12/14/2010 $ 237,652 $ 584,997
Aggregated Option Exercises in Last Fiscal Year and 2000 Year-End Option
Values
The following table sets forth information with respect to the named
executive officers concerning exercisable and unexercisable options held as of
December 31, 2000. The value of in-the-money options is based on the fair
market value of our common stock on December 29, 2000 and net of the option
exercise price.
Number of Securities
Underlying Unexercised Value of Unexercised
Shares Options at In-the-Money Options at
Acquired on Value December 31, 2000 December 31, 2000
Name Exercise (#) Realized ($) Exercisable/Unexercisable Exercisable/Unexercisable
- ---- ------------ ------------ ------------------------- -------------------------
James E. Brown.......... -- -- 0/80,000 0/30,000
Felix Theeuwes.......... -- -- 0/80,000 0/30,000
Thomas A. Schreck....... -- -- 0/80,000 0/30,000
Timothy S. Nelson....... -- -- 0/124,107 0/256,362
Randolph M. Johnson..... -- -- 150,000/30,000 1,785,500/11,250
Options shown above were granted under the 1998 stock option plan and the
2000 stock plan and vest at a rate of 25% of the shares on each twelve month
anniversary of the vesting commencement date. Notwithstanding the foregoing,
all options issued prior to June 17, 2000 were immediately exercisable;
however, the underlying shares are subject to our right of repurchase at the
original purchase price. Such repurchase right will lapse with respect to 25%
of the shares on each twelve month anniversary of the vesting commencement
date.
65
Compensation of Directors
Our board members are reimbursed for reasonable travel expenses relating to
attendance at board meetings and receive $1,000 for each board meeting
attended in compensation for their services as member of the board of
directors. Employee directors are eligible to participate in our 1998
incentive stock option plan, our 2000 stock plan and our 2000 employee stock
purchase plan. Nonemployee directors are eligible to participate in our 2000
directors' stock option plan.
Mr. Doyle was granted an option to purchase 15,000 shares of common stock
under the 2000 stock plan at an exercise price of $.35 per share in February
2000 and 1/3 of the shares vest on each anniversary of the date of grant. Mr.
Doyle was granted an option to purchase 5,000 shares of common stock under the
2000 stock plan at an exercise price of $6.88 per share in March 2001 and 1/3
of the shares vest on each anniversary of the date of grant. Dr. Neukermans
was granted an option under the 2000 directors' stock option plan to purchase
20,000 shares of common stock at an exercise price of $7.00 per share upon his
becoming a nonemployee director in March 2001 and 1/3 of the shares vest on
each anniversary of the date of grant.
Limitation of Liability and Indemnification Matters
As permitted by the Delaware General Corporation Law, we have included in
our restated certificate of incorporation a provision eliminating the personal
liability of our officers and directors for monetary damages for breach or
alleged breach of their fiduciary duties as officers or directors,
respectively, subject to certain exceptions. In addition, our bylaws provide
that we are required to indemnify our officers and directors under certain
circumstances and we are required to advance expenses to our officers and
directors as incurred in connection with proceedings against them for which
they may be indemnified. We have entered into indemnification agreements with
our officers and directors containing provisions that are in some respects
broader than the specific indemnification provisions contained in the Delaware
Law. The indemnification agreements require us, among other things, to
indemnify our officers and directors against certain liabilities that may
arise by reason of their status or service as officers and directors (other
than liabilities arising from willful misconduct of a culpable nature), to
advance their expenses incurred as a result of any proceeding against them as
to which they could be indemnified, and to obtain directors' and officers'
insurance if available on reasonable terms. We have also obtained directors'
and officers' liability insurance.
At present, we are not aware of any pending or threatened litigation or
proceeding involving any of our directors, officers, employees or agents in
which indemnification would be required or permitted. We are not aware of any
threatened litigation or proceeding that might result in a claim for such
indemnification. We believe that our charter provisions and indemnification
agreements are necessary to attract and retain qualified persons as directors
and officers.
Employment Agreements
We have entered into an employment agreement with James E. Brown, our Chief
Executive Officer and President, for a term of three years starting on June
19, 1998. The agreement acknowledges that for the first twelve months of
employment Dr. Brown would perform services for ALZA Corporation, but after
that period, he became a full time employee of DURECT. The agreement also
provides that Dr. Brown will be paid an annual salary of $225,000 and makes
him eligible for any salary, stock option, bonus and other benefits we offer.
In the event of involuntary termination, Dr. Brown is entitled to his regular
monthly salary for the remainder of the original term of the employment
agreement, any bonus payable, and continued health insurance benefits. In the
event of termination for cause, Dr. Brown is entitled to his accrued unpaid
salary and vacation. In the event of termination by reason of death or
disability, Dr. Brown or his estate is entitled to all salary and unpaid
vacation accrued and any other benefits payable under our then existing
benefit plans. In the event of a constructive termination, Dr. Brown is
entitled to a lump sum payment of the salary we would have paid him during the
twelve-month period following his termination, as well as continuing health
insurance benefits for the twelve-month period following his termination.
66
We have entered into an employment agreement with Felix Theeuwes, our
Chairman and Chief Scientific Officer, for a term of three years starting on
June 19, 1998. His duties also include arranging funding and participating in
overall management of the company. The agreement acknowledges that for the
first twelve months of employment Dr. Theeuwes would perform services for ALZA
Corporation, but after that period, he became a full time employee of DURECT.
The agreement also provides that Dr. Theeuwes will be paid an annual salary of
$250,000 to be reduced by an amount to reflect his time and work for ALZA
Corporation and makes him eligible for any salary, stock option, bonus and
other benefits we may offer. In the event of involuntary termination, Dr.
Theeuwes is entitled to his regular monthly salary for the remainder of the
original term of the employment agreement, any bonus payable, and continued
health insurance benefits. In the event of termination for cause, Dr. Theeuwes
is entitled to his accrued unpaid salary and vacation. In the event of
termination by reason of death or disability, Dr. Theeuwes or his estate is
entitled to all salary and unpaid vacation accrued and any other benefits
payable under our then existing benefit plans. In the event of a constructive
termination, Dr. Theeuwes is entitled to a lump sum payment of the salary we
would have paid him during the twelve-month period following his termination,
as well as continuing health insurance benefits for the twelve-month period
following his termination.
We have entered into an employment agreement with Thomas A. Schreck, our
Chief Financial Officer, for a term of three years starting June 19, 1998. The
agreement acknowledges the financial relationship with Schreck Merchant Group
Inc., of which Mr. Schreck is a principal, for financial services. The
agreement also provides for an annual salary of $100,000 for Mr. Schreck for
the first two years of the term and an increase in his annual salary to
$200,000 effective on June 19, 2000. The agreement also makes him eligible for
any salary, stock option, bonus and other benefits we may offer. In the event
of involuntary termination, Mr. Schreck is entitled to his regular monthly
salary for the remainder of the original term of the employment agreement, any
bonus payable, and continued health insurance benefits. In the event of
termination for cause, Mr. Schreck is entitled to accrued unpaid salary and
vacation. In the event of termination by reason of death or disability, Mr.
Schreck or his estate is entitled to all salary and unpaid vacation accrued
and any other benefits payable under our then existing benefit plans. In the
event of a constructive termination, Mr. Schreck is entitled to a lump sum
payment of the salary we would have paid him during the twelve-month period
following his termination, as well as continuing health insurance benefits for
the twelve-month period following his termination.
We have entered into change of control agreements with Randolph M. Johnson
and Timothy S. Nelson. These agreements provide that, in the event of a change
in our control, one half of the unvested portion of any stock option or
restricted stock held by Dr. Johnson and Mr. Nelson on the effective date of
the change of control is automatically accelerated so as to become completely
vested as of the effective date and, if such individual remains employed by
the Company as of the first anniversary of the effective date of the change of
control, then the remaining unvested portion of any stock option or restricted
stock held by such individual as of the effective date of the change of
control shall automatically be accelerated so as to become completely vested
as of the anniversary, unless either such acceleration would make us
ineligible for "pooling of interests" accounting treatment in the transaction.
In addition, in the event of a termination without cause within the twelve
months following the change in our control, the unvested portion of any stock
option or restricted stock held by such individual is automatically
accelerated so as to become completely vested as of the effective date of the
termination unless the acceleration would make us ineligible for "pooling of
interests" accounting treatment in the change in control transaction.
In May 1998, we purchased key-man life insurance policies in the basic
amounts of $1 million each for James Brown and Felix Theeuwes for terms of 20
years each. We are the beneficiaries for both policies.
Compensation Committee Interlocks and Insider Participation
The members of the compensation committee of our board of directors during
2000 were James R. Butler, John L. Doyle, and Matthew V. McPherron. Neither
Mr. Butler, Mr. Doyle, nor Mr. McPherron has at any time been an officer or
employee of DURECT or any of our subsidiaries. The Chief Executive Officer,
President and Chief Scientific Officer are entitled to be non-voting
participants in each meeting of the compensation committee and are excused
from any discussion that relates to their own compensation.
67
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table presents information concerning the beneficial
ownership of the shares of our common stock as of March 16, 2001 and as
adjusted to reflect the sale of the shares of common stock in this offering
by:
. each person who is known by us to beneficially own more than 5% of our
common stock;
. each of our directors;
. each of the named executive officers; and
. all of our directors and executive officers of as a group.
The number and percentage of shares beneficially owned are based on
46,565,486 shares of common stock outstanding as of March 16, 2001. Beneficial
ownership is determined under the rules and regulations of the Securities and
Exchange Commission. Shares of common stock subject to options or warrants
that are currently exercisable or exercisable within 60 days of March 16, 2001
are deemed to be outstanding and beneficially owned by the person holding the
options or warrants for the purpose of computing the number of shares
beneficially owned and the percentage ownership of that person, but are not
deemed to be outstanding for the purpose of computing the percentage ownership
of any other person. Except as indicated in the footnotes to this table, and
subject to applicable community property laws, these persons have sole voting
and investment power with respect to all shares of our common stock shown as
beneficially owned by them. Percentage ownership figures after the offering do
not include shares that may be purchased by each person in the offering.
Number of Percentage
Shares of Shares
Beneficially Beneficially
Owned Owned
------------ ------------
ALZA Corporation................................. 7,600,000 16.0%
1900 Charleston Road
Mountain View, CA 94043
Brookside Capital Partners(1).................... 3,990,514 8.6
Two Copley Place
Boston, MA 02116
Morgan Trust(2).................................. 2,325,583 5.0
522 Fifth Avenue
New York, NY 10036
Biotech Growth S.A.(3)........................... 2,857,143 6.1
Swiss Bank Tower
Obarie Street
Panama 1
Republic of Panama
Albert L. Zesiger(4)............................. 6,522,629 14.0
Matthew V. McPherron(1).......................... 3,990,514 8.6
Felix Theeuwes, D.Sc.(5)......................... 1,691,001 3.6
Thomas A. Schreck(6)............................. 2,846,568 6.1
James E. Brown, D.V.M.(7)........................ 2,800,000 6.0
Randolph M. Johnson, Ph.D.(8).................... 98,800 *
Timothy S. Nelson(9)............................. 408,500 *
Douglas A. Lee(10)............................... 1,931,316 4.1
James R. Butler.................................. 17,000 *
John L. Doyle.................................... 15,000 *
Armand P. Neukermans............................. -- *
All executive officers and directors as a group
(15 persons)(11)................................ 20,736,578 44.5
- --------
* Less than 1% of the outstanding shares of common stock. Except as
otherwise noted, the address of each person listed in the table is c/o
DURECT Corporation, 10240 Bubb Road, Cupertino, California 95104.
68
(1) Represents 145,000 shares held by Matthew V. McPherron and 3,845,514
shares held by Brookside Capital Partners Fund, L.P. Matthew V.
McPherron, one of our directors, is a director of this partnership.
Mr. McPherron disclaims beneficial ownership of these shares except to
the extent of his pecuniary interest in these shares.
(2) Includes 1,627,907 shares held by Morgan (Co-Mingled) Guaranty Trust
Company of New York, 348,838 shares held by Morgan (Multi-Market)
Guaranty Trust Company of New York, and 348,838 shares held by BOST & Co.
(3) Includes 714,286 shares held by Medgrowth S.A. Biotech Growth S.A. is a
fully-owned subsidiary of BB Biotech A.G. Mr. Anders Hove shares voting
and investment power over the shares held by Biotech Growth and disclaims
beneficial ownership of such shares.
(3) Includes 15,000 shares held by Douglas A. Lee (of which 5,000 shares are
subject to repurchase by us at the original purchase price in the event
Mr. Lee ceases to be a director, which repurchase right lapses over time)
and 1,916,316 shares held by Premier Medical Partner Fund L.P. Mr. Lee,
one of our directors, is a former managing director of this partnership
and is the only natural person who is both a stockholder of DURECT and
who shares beneficial ownership of the shares attributed to Premier
Medical Partner Fund L.P. Mr. Lee disclaims beneficial ownership of these
shares except to the extent of his pecuniary interest in these shares.
(4) Includes 230,000 shares held by Albert L. Zesiger and 92,000 shares held
by Barrie Ramsay Zesiger. Also includes an aggregate of 6,200,629 shares
of common stock held in accounts managed for various parties by Zesiger
Capital Group LLC, an investment advisor, for which Albert L. Zesiger is
a principal. Mr. Zesiger, in his capacity as a principal, has voting and
investment power with respect to these shares but disclaims beneficial
ownership with respect hereto.
(5) Includes 1,691,001 shares held by Felix and Marie-Therese Theeuwes Family
Trust.
(6) Includes 1,860,000 shares held by Thomas A. Schreck, 840,000 shares held
by Thomas A. Schreck, Trustee for Mason and Thomas Schreck, 100,000
shares held by Portola Capital Partners, L.P. for the benefit of Albert
R. Schreck, Joel Schreck and the Thomas A. Schreck 1959 Trust, 23,312
shares held by Joel W. Schreck and 23,256 shares held by Albert R.
Schreck.
(7) Includes 2,240,000 shares held by James E. Brown, and 560,000 shares held
by James & Karen Brown 1998 Trust U/A.
(8) Includes 20,000 shares held by Randolph M. Johnson, Ph.D. (of which
15,000 shares are subject to repurchase by us at the original purchase
price in the event of termination of Dr. Johnson's employment with us,
which repurchase right lapses over time) and 3,000 shares held by Dean
Witter Reynolds Inc. c/f Randolph M. Johnson IRA Rollover dtd. 11/10/98.
Also includes 75,000 shares issuable upon exercise of options exercisable
within 60 days of March 16, 2001.
(9) Includes 383,500 shares held by Timothy S. Nelson (of which 234,875
shares are subject to repurchase by us at the original purchase price in
the event of termination of Mr. Nelson's employment with us, which
repurchase right lapses over time) and 25,000 shares held by PaineWebber
Incorporated, not in its individual capacity but solely as Custodian of
the IRA of Timothy S. Nelson.
(10) Includes 15,000 shares held by Douglas A. Lee (of which 5,000 shares are
subject to repurchase by us at the original purchase price in the event
Mr. Lee ceases to be a director, which repurchase right lapses over time)
and 1,916,316 shares held by Premier Medical Partners Fund L.P. Mr. Lee,
one of our directors, is a former managing director of this partnership
and is the only natural person who is both a stockholder of DURECT and
who shares beneficial ownership of the shares attributed to Premier
Medical Partners Fund L.P. Mr. Lee disclaims beneficial ownership of
these shares except to the extent of his pecuniary interest in these
shares.
(11) Includes an aggregate of 82,500 shares issuable pursuant to the exercise
of outstanding stock options. Also includes an aggregate of 10,000 shares
which are subject to repurchase by us at the original purchase price in
the event of termination of consulting relationship with us, which
repurchase right terminates with
69
respect to each consultant at the rate of 1/3 of the consultant's shares
on each annual anniversary of the consultant's consulting relationship
with us. Also includes an aggregate of 507,875 shares which are subject to
repurchase by us at the original purchase price in the event of the
termination of individual employees' employment with us, which repurchase
right terminates with respect to each employee at the rate of 1/4 of the
employee's shares on each annual anniversary of such employee's original
option grant date.
Item 13. Certain Relationships and Related Transactions.
We believe that we have executed all of the transactions set forth below on
terms no less favorable to us than we could have obtained from unaffiliated
third parties. It is our intention to ensure that all future transactions,
including loans, between us and our officers, directors and principal
stockholders and their affiliates, are approved by a majority of the board of
directors, including a majority of the independent and disinterested members
of the board of directors, and are on terms no less favorable to us than those
that we could obtain from unaffiliated third parties.
Private Placements of Securities
In March 2000, we sold an aggregate of 3,571,429 shares of our Series C
preferred stock for $7.00 per share. The purchasers of the Series C preferred
stock included, among others, Biotech Growth S.A. (funds controlled by BB
Biotech), Brookside Capital Partners Fund, L.P., and the Zesiger Capital Group
LLC, whose principal, Albert L. Zesiger is also a director of DURECT.
In April 2000, we amended our development and commercialization agreement
with ALZA. The amendments included a reduction in product royalties and
upfront payment to ALZA by us under the agreement. In addition, ALZA's option
to distribute the DUROS sufentanil product was amended to cover only the U.S.
and Canada instead of worldwide. As consideration, ALZA received 1,000,000
shares of our common stock and a warrant to purchase 1,000,000 shares of our
common stock at an exercise price equal to the price at which our common stock
is sold in this offering.
The following members of our board of directors are affiliated with certain
private investors that participated in the foregoing transactions:
. Albert L. Zesiger, principal of the Zesiger Capital Group LLC
. Matthew V. McPherron, a director of Brookside Capital Partners, L.P.
. Douglas A. Lee, a former managing director of Premier Medical Partner
Fund, L.P.
. James R. Butler, an employee of ALZA Corporation
Other Transactions
In April 2000, we acquired from ALZA the ALZET product and assets used
primarily in the manufacture, sale and distribution of this product. This
acquisition provides us with an ongoing business making and selling this
product worldwide. The total purchase price consisted of approximately $8.3
million in cash. In addition, we are obligated to provide employment benefits
to employees hired in connection with the acquisition. Pursuant to a General
Support Services Agreement, a Coating Services Agreement and a New Models
Development Agreement entered into between us and ALZA effective April 14,
2000, at our request and on an as-needed basis, ALZA has agreed to provide
general support services until December 31, 2000, product coating services
until April 14, 2003, and services in connection with the development of new
models of the ALZET product until such models are completed, and we will pay
ALZA for any such services provided by ALZA. For a full description of the
terms and conditions of these agreements, see "Business--ALZET Business."
We entered into an Amended and Restated Market Stand-off Agreement with
ALZA, effective as of June 1998 and amended and restated in April 2000. This
agreement was executed in consideration for the grant of a
70
non-exclusive license to ALZA to any proprietary technology we may develop
relating to a means of connecting a catheter to the DUROS system under the
Development and Commercialization Agreement, dated April 21, 1998. Under this
agreement, for a period of two years following the termination of any market
stand-off or other similar agreement between ALZA and the underwriters of this
offering, ALZA may not dispose of 25% or more of the maximum number of all
securities it has owned prior to this offering, within any six month period.
In 2000, we issued promissory notes in the aggregate amount of $92,460 to
Timothy S. Nelson, our Vice President of Business and Commercial Development,
for the purchase of common stock upon the exercise of stock options. These
promissory notes were issued in the amounts of $6,998, $23,968 and $61,494 on
January 24, January 24, and April 19, respectively. They bear interest rates
of 6.12%, 6.12% and 6.60% respectively and shall be due and payable on May 10,
2003, December 9, 2003 and March 24, 2004 respectively.
During the last fiscal year, we have issued and sold shares of our common
stock and granted options to purchase common stock to our employees, directors
and consultants.
71
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements
The financial statements required by this item are submitted in a
separate section beginning on page F-1 of this report.
(2) Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts
All other schedules have been omitted because of the absence of
conditions under which they are required or because the required
information is included in the financial statements or notes thereto.
(3) Exhibits are incorporated herein by reference or are filed in
accordance with Item 601 of Regulation S-K.
Number Description
------ -----------
+3.3 Amended and Restated Certificate of Incorporation of the Company.
+3.5 Amended and Restated Bylaws of the Company.
+3.6 Certificate of Designation of Rights, Preferences and Privileges of
Series B-1 Preferred Stock.
+3.7 Certificate of Designation of Rights, Preferences and Privileges of
Series C Preferred Stock.
+4.2 Second Amended and Restated Investors' Rights Agreement.
+10.1 Form of Indemnification Agreement between the Company and each of
its Officers and Directors.
+10.2 1998 Stock Option Plan.
+10.3 2000 Stock Plan.
++10.4 2000 Employee Stock Purchase Plan.
+10.5 2000 Directors' Stock Option Plan.
+10.6** Second Amended and Restated Development and Commercialization
Agreement between the Company and ALZA Corporation effective April
28, 1999.
+10.7** Product Acquisition Agreement between the Company and ALZA
Corporation dated as of April 14, 2000.
+10.8 Amended and Restated Loan and Security Agreement between the Company
and Silicon Valley Bank dated as of October 28, 1998.
+10.9** Manufacturing and Supply Agreement between Neuro-Biometrix, Inc. and
Novel Biomedical, Inc. dated as of November 24, 1997.
+10.10** Master Services Agreement between the Company and Quintiles, Inc.
dated as of November 1, 1999.
+10.11 Modified Net Single Tenant Lease Agreement between the Company and
DeAnza Enterprises, Ltd. dated as of February 18, 1999.
+10.12 Sublease Amendment between the Company and Ciena Corporation dated
as of November 29, 1999 and Sublease Agreement between Company and
Lightera Networks, Inc. dated as of March 10, 1999.
72
Number Description
------ -----------
+10.13** Project Proposal between the Company and Chesapeake Biological
Laboratories, Inc. dated as of October 11, 1999.
+10.14 Employment Agreement with James E. Brown.
+10.15 Employment Agreement with Felix Theeuwes.
+10.16 Employment Agreement with Thomas A. Schreck.
+10.17 Common Stock Purchase Agreement between the Company and ALZA
Corporation dated April 14, 2000.
+10.18 Warrant issued to ALZA Corporation dated April 14, 2000.
+10.19 Amended and Restated Market Stand-off Agreement between the Company
and ALZA Corporation dated as of April 14, 2000.
+10.20** Asset Purchase Agreement between the Company and IntraEAR, Inc. dated
as of September 24, 1999.
+10.21 Warrant issued to Silicon Valley Bank dated December 16, 1999.
+10.22 Amendment to Second Amended and Restated Investors' Rights Agreement
dated as of April 14, 2000.
+10.23** Master Agreement between the Company and Pacific Data Designs, Inc.
dated as of July 6, 2000.
+10.24** Master Services Agreement between the Company and Clinimetrics
Research Associates, Inc. dated as of July 11, 2000.
10.25* Supply Agreement between the Company and Mallinckrodt, Inc. dated as
of October 1, 2000.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (see signature page 75).
- --------
+ Incorporated by reference to our registration statement on Form S-1 (File
No. 333-35316) initially filed with the SEC on April 20, 2000.
* Material has been omitted pursuant to a request for confidential treatment
and such material has been filed separately with the SEC.
** Confidential treatment granted with respect to certain portions of this
Exhibit.
(b) No reports on Form 8-K were filed during the year ended December 31,
2000.
73
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Year Ended December 31, 2000, 1999 and 1998
(in thousands)
Balance at Balance at
beginning end of the
of year Additions Deductions year
---------- --------- ---------- ----------
December 31, 2000
Allowance for doubtful accounts.. $ 5 $221 $ -- $226
December 31, 1999
Allowance for doubtful accounts.. -- 5 -- 5
December 31, 1998
Allowance for doubtful accounts.. -- -- -- --
74
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 its behalf by the undersigned, thereunto duly authorized.
DURECT CORPORATION
/s/ James E. Brown
By: _________________________________
James E. Brown
President and Chief Executive
Officer
Date: March 30, 2001
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James E. Brown and Felix Theeuwes,
jointly and severally, his or her attorneys-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys-
in-fact, or his or her substitute or substitutes may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ James E. Brown President, Chief Executive March 30, 2001
____________________________________ Officer and Director
James E. Brown (Principal Executive
Officer)
/s/ Felix Theeuwes Chairman and Chief March 30, 2001
____________________________________ Scientific Officer
Felix Theeuwes
/s/ Thomas A. Schreck Chief Financial Officer and March 30, 2001
____________________________________ Director (Principal
Thomas A. Schreck Financial and Accounting
Officer)
/s/ James R. Butler Director March 30, 2001
____________________________________
James R. Butler
/s/ John L. Doyle Director March 30, 2001
____________________________________
John L. Doyle
/s/ Douglas A. Lee Director March 30, 2001
____________________________________
Douglas A. Lee
75
Signature Title Date
--------- ----- ----
/s/ Matthew V. McPherron Director March 30, 2001
____________________________________
Matthew V. McPherron
/s/ Armand P. Neukermans Director March 30, 2001
____________________________________
Armand P. Neukermans
/s/ Albert L. Zesiger Director March 30, 2001
____________________________________
Albert L. Zesiger
76