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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NO. 0-23556
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INHALE THERAPEUTIC SYSTEMS
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3134940
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
150 INDUSTRIAL ROAD, SAN CARLOS, CA 94070
(Address of principal executive offices and zip code)
(650) 631-3100
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR
VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The approximate aggregate market value of voting stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock on March 9, 1998 as reported by Nasdaq National Market was approximately
$394,332,870. Determination of affiliate status for this purpose is not a
determination of affiliate status for any other purpose.
15,580,145
(Number of shares of common stock outstanding as of March 9, 1998)
------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive Proxy Statement to be filed for its 1998
Annual Meeting of Shareholders are incorporated by reference into Part III
hereof.
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INHALE THERAPEUTIC SYSTEMS
1997 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business................................................................................... 1
Item 2. Properties................................................................................. 28
Item 3. Legal Proceedings.......................................................................... 28
Item 4. Submission of Matters to a Vote of Security Holders........................................ 28
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters...................... 29
Item 6. Selected Financial Data.................................................................... 30
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 31
Item 8. Financial Statements and Supplementary Data................................................ 34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....... 34
PART III
Item 10. Directors and Executive Officers of the Registrant......................................... 34
Item 11. Executive Compensation..................................................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 34
Item 13. Certain Relationships and Related Transactions............................................. 34
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 35
SIGNATURES.................................................................................................. 37
PART I
ITEM 1. BUSINESS
OVERVIEW
Inhale Therapeutic Systems ("Inhale" or the "Company") is creating an
inhalation drug delivery system to deliver a wide range of drugs, including
peptides, proteins and other macromolecule drugs to the deep lung. Inhale is
using this system principally to enable non-invasive delivery of macromolecule
drugs currently administered by injection. The Company's insulin program,
sponsored by Pfizer Inc. ("Pfizer"), is in a multi-site Phase IIb in-home trial
with up to 240 diabetics. Baxter Healthcare Corporation (a subsidiary of Baxter
International, Inc.) ("Baxter") is sponsoring four non-peptide or protein drugs
for inhalation delivery, one of which is in a Phase II clinical trial and one of
which is in a Phase I clinical trial. Eli Lilly & Company ("Lilly") is
sponsoring two projects: an osteoporosis drug in a Phase I clinical trial and an
undisclosed protein. In total, Inhale has 14 programs in development, ten of
which are sponsored by collaborative partners. Six programs are in human
clinical trials.
Currently there are approximately 30 macromolecule drugs marketed in the
United States and about 120 others in human clinical trials. Sales of
genetically engineered protein drugs were estimated at $7.6 billion worldwide in
1995. Most of these drugs are currently delivered by injection. Injections are
undesirable for numerous reasons including patient discomfort, inconvenience and
risk of infection. Poor patient acceptance of, and compliance with, injectable
therapies can lead to increased incidence of medical complications and higher
disease management costs. Alternatives to injection such as oral, transdermal
and nasal delivery have to date been shown generally to be commercially
unattractive due to low natural bioavailability (the amount of drug absorbed
from the delivery site into the bloodstream). As an alternative to the
invasiveness of injection, Inhale believes a pulmonary delivery system could
expand the market for macromolecule drug therapies and may enable new
therapeutic uses of certain macromolecule drugs.
Inhale is creating a proprietary platform integrating customized
formulation, fine-powder processing and packaging with a novel inhalation device
to enable efficient, reproducible delivery of macromolecule drugs for systemic
and local lung indications. For specific drug products, Inhale formulates and
processes bulk drugs supplied by collaborative partners into fine powders which
are packaged into individual dosing units referred to as blisters. The blisters
are designed to be loaded into Inhale's device, which patients then activate to
inhale the aerosolized drugs. Inhale has developed a prototype inhalation device
that is being used several times per day for several months in outpatient trials
for insulin. In addition, the Company has demonstrated room temperature
stability of a year or more for a number of macromolecule drugs, and has
scaled-up its powder processing and packaging for late stage clinical trials and
small-scale production for certain drugs.
Inhale's development strategy is to focus efforts on applying its pulmonary
delivery system primarily to drugs that either have proven efficacy and are
approved for delivery by injection or are in late stage human clinical trials.
Inhale's business strategy is to work with collaborative partners to develop and
commercialize macromolecule drugs for pulmonary delivery. Generally, these
partners have rights to the drugs, seek regulatory approvals and supply the
drugs to Inhale for formulation. In addition to Pfizer, Baxter and Lilly, the
Company is engaged in early stage feasibility and preclinical research and
development collaborations with Centeon L.L.C. (a joint venture of Hoechst AG
and Rhone-Poulenc Rorer, Inc.) on alpha-1 proteinase inhibitor for genetic
emphysema and Genzyme Corporation on gene vectors for lung diseases. In addition
to collaborations, Inhale has initiated projects with several macromolecule
drugs including calcitonin, heparin, interferon beta, interferon alpha and
follicle stimulating hormone. One of these drugs is currently partnered with
Lilly. The Company anticipates that any product that may be developed would be
commercialized with a collaborative partner and believes its partnering strategy
will enable it to reduce the amount of cash required to develop a large and
diversified potential product portfolio.
1
Inhale is developing a pulmonary drug delivery system applicable to a wide
range of peptides, proteins and other macromolecules currently delivered by
injection or by other routes. As an alternative to invasive delivery techniques,
a pulmonary delivery system could potentially expand the market for
macromolecule drug therapies by increasing patient acceptance and improving
compliance, which in turn could decrease medical complications and the
associated costs of disease management. Additionally, pulmonary delivery may
enable new therapeutic uses of certain macromolecule drugs. Inhale is focusing
development efforts on applying its pulmonary delivery system primarily to drugs
for systemic and local lung diseases that either have proven efficacy and are
approved for delivery by injection or are in late stage human clinical trials.
During 1997 and early 1998, Inhale continued to make progress toward its
goals of broadening its partner base and moving products toward
commercialization. The Company completed three new partnering agreements to
develop products using its pulmonary delivery system, moved the pulmonary
insulin product development program through a Phase IIb clinical trial, entered
two new drugs into clinical trials, completed Phase I testing for two product
development programs, strengthened its balance sheet by completing a $30.5
million private placement as well as a $40.0 million public offering of its
common stock, and expanded its technology and manufacturing development
activities.
While the Company believes its pulmonary delivery system will provide a
unique delivery alternative for a wide range of drugs, development and testing
are still ongoing and there can be no assurance that the Company's pulmonary
delivery technology will prove to be technically feasible or commercially
applicable to a range of drugs. Although many of the underlying drug compounds
with which the Company is working have been tested in humans by others using
alternative delivery routes, Inhale's potential products will require extensive
research, development, pre-clinical and clinical testing, and may involve
lengthy regulatory review. There can be no assurance that any of the Company's
potential products will prove safe and effective in clinical trials, meet
applicable regulatory standards, be capable of being produced in commercial
quantities at acceptable cost or be successfully marketed to health care
providers, payors or patients. In addition, there can be no assurance that the
Company's strategic relations with any and all of its partners will continue in
the future. Any failure by the Company to maintain or continue its partner
relations, achieve technical feasibility, demonstrate safety, achieve clinical
efficacy, obtain regulatory approval or, together with partners, successfully
market products, would have a material adverse effect on the Company.
OPPORTUNITY FOR PULMONARY DRUG DELIVERY
MACROMOLECULES
Innovations in biotechnology and recombinant techniques have led to a large
increase in the number of macromolecule drugs over the last several years. These
drugs, which are identical or similar to the body's natural molecules, are
enabling new therapies for many previously untreated or poorly treated diseases.
Approximately 30 macromolecule drugs are approved for marketing in the United
States and approximately 120 additional macromolecule drugs are in human
clinical trials, many for chronic and subchronic diseases. Sales of genetically
engineered protein drugs were estimated at $7.6 billion worldwide in 1995.
Worldwide sales of insulin, for example, were estimated at $2.5 billion in 1995.
Due principally to their large size, most macromolecules typically have been
delivered by injection. Drug injections performed in hospitals or doctors'
offices can be expensive and inconvenient to patients. Many patients find
self-injectable therapies unpleasant. As a result, such therapies for many
chronic and subchronic diseases meet with varying degrees of patient acceptance
and compliance with the prescribed regimens. Poor acceptance and compliance can
lead to increased incidence of medical complications and potentially higher
disease management costs. In addition, some elderly, infirm or pediatric
patients cannot administer their own injections and require assistance, thereby
increasing both inconvenience to these patients and the cost of therapy.
2
Medical science, health care providers and consumers have been searching for
alternatives to injection as a means of delivery of macromolecules used in the
systemic treatment of chronic and subchronic diseases. Several non-invasive
routes of delivery are being explored for macromolecule drugs, including oral,
transdermal, nasal and pulmonary, such as metered-dose inhalers (MDIs).
Oral delivery is a common method of delivery for many small molecule drugs.
However, drug delivery scientists generally believe that oral delivery provides
extremely low delivery system efficiency for most macromolecules. In addition,
the Company believes that dosage reproducibility for oral delivery of
macromolecules may be very poor because of their low oral bioavailability. While
several companies are working on oral delivery for macromolecule drugs, no
commercially viable system is currently being marketed.
Passive transdermal delivery using "patch" technology has not been
successful to date since the skin is even less naturally permeable to
macromolecules than the gastrointestinal tract. No macromolecule drugs have been
approved for marketing in the United States utilizing patch technology. Certain
peptides and proteins can be transported across the skin barrier into the
bloodstream using high pressure "needle-less" injection devices. The devices,
which inject proteins like insulin through the skin into the body, have been
available for many years. However, the Company believes these devices have not
been well accepted due to patient discomfort and relatively high cost.
The nasal route has been shown to have low and variable bioavailability for
proteins and peptides, which is a major limitation for the nasal administration
of such drugs. As a result of these limitations, penetration enhancers are often
used with nasal delivery to achieve higher bioavailability; these enhancers may
cause local irritation to the nasal tissue and result in safety concerns with
long-term use. Only four peptides have been approved for marketing in the United
States utilizing nasal delivery.
Pulmonary drug delivery systems, such as MDIs, existing dry powder inhalers
and nebulizers, are used primarily to deliver drugs to the airways of the lung
for local lung applications. Approximately 30 drugs are approved for marketing
by the FDA for delivery into the lung, but none of these delivery devices was
designed to optimize drug delivery to the deep lung for absorption into the
bloodstream. Current MDIs, dry powder inhalers and nebulizers typically deliver
only a fraction of the drug to the deep lung, with most of the drug being lost
in the delivery device or in the mouth and throat. Consequently, the Company
believes that the total efficiency of such systems is generally not high enough
to be commercially feasible for systemic delivery of most macromolecule drugs.
In addition, current pulmonary drug delivery devices do not provide the
dosage reproducibility and formulation stability generally needed for
commercially viable systemic macromolecule drug delivery. The Company believes
that many MDI and dry powder systems do not provide the deep lung dosage
reproducibility necessary for many systemic applications because the patient
must coordinate the breathing maneuver with the generation of the aerosol.
Further, the Company believes that many macromolecules currently cannot be
formulated for use in MDI systems, since macromolecule drugs could be denatured
by the MDI formulating ingredients. In addition, Inhale believes that some
macromolecules may be inactivated by nebulization and that many dry powder
systems do not provide the protection needed for long-term stability that may be
needed for macromolecule formulations.
Inhale believes that an efficient, reproducible pulmonary delivery system
for systemic macromolecule drugs used in the treatment of chronic and subchronic
diseases represents a significant commercial opportunity. Such a system could
improve patient acceptance of systemic macromolecule drug therapy and compliance
with prescribed regimens, thereby improving therapeutic outcomes and reducing
the costs of administration and overall disease treatment. Additionally,
pulmonary delivery may enable new therapeutic uses of certain macromolecule
drugs.
Inhale also believes that opportunities for an integrated pulmonary delivery
system exist in the delivery of macromolecules for local lung diseases due to
the limitations of current pulmonary devices.
3
Biotechnology and pharmaceutical companies are developing new macromolecule
drugs for pulmonary diseases such as asthma, cystic fibrosis, emphysema, lung
cancer, pneumonia and bronchitis. Pulmonary delivery is the preferred route for
treating most lung diseases since much smaller amounts of certain drugs
generally are needed than for systemic administration and the drug can be
applied directly to the site of action, thereby potentially reducing systemic
side effects.
OTHER MOLECULES
In addition to developing a pulmonary delivery system for macromolecules,
Inhale is investigating opportunities of leveraging its technology for small
molecules where there is a clear, demonstrable need for an alternative drug
delivery system and where the Company's existing technology can be applied
without significant modification. Examples include molecules that require rapid
systemic absorption for efficacy, i.e., analgesics and antiemetics, molecules
that undergo massive first pass metabolism by the oral route or molecules used
for local lung delivery for diseases such as asthma that are currently delivered
by sub-optimal aerosol systems.
MDIs, existing dry powder inhalers and nebulizers have been used primarily
to deliver drugs to the airways of the lung for local lung applications. Some of
the problems associated with traditional small molecule aerosol delivery systems
include poor reproducibility, low efficiency, low drug payload per puff, poor
moisture barrier and, in the case of wet systems, long dosing time and microbial
growth.
Inhale is applying its technology to the delivery of small molecules where
there is a clear, demonstrable need for an alternative drug delivery system and
where the Company's existing technology can be applied without significant
modification. Examples include molecules that require rapid systemic absorption
for efficacy such as analgesics and antiemetics, molecules that undergo massive
first pass metabolism by the oral route or molecules used for local lung
delivery for diseases such as asthma that are currently delivered by sub-optimal
aerosol systems.
Inhale believes that its technology could be used to address these problems
through the following: efficient dispersion of the drug into the lungs,
reproducible delivery of a consistent and predictable amount of drug into the
bloodstream, and a strong moisture barrier in the blister packs. The Company
further believes its technology could potentially be applied economically in
market segments where it is essential that significant drug doses reach the
lung, such as severe asthma cases where nebulizers are used today. Large amounts
of drugs taken orally or through inefficient inhalers can result in side effects
which could be avoided or reduced through more efficient pulmonary delivery.
STRATEGY
Inhale's goal is to become the leading drug delivery company in the field of
pulmonary delivery of macromolecules. In addition, the Company is leveraging its
technology base for other applications where its system can provide significant
market advantages. The Company's strategy incorporates the following principal
elements:
- DEVELOP A BROADLY APPLICABLE PULMONARY DELIVERY SYSTEM. Inhale is
developing its non-invasive pulmonary drug delivery system to be
applicable to a wide range of peptides, proteins and other molecules
currently delivered by injection or poorly delivered by inhalation or
other routes. Inhale intends to develop an effective non-invasive delivery
alternative that can: (i) expand market penetration for existing
therapeutics currently delivered by injection, infusion or other routes;
(ii) commercialize new indications by using pulmonary delivery as a new
route of administration; and (iii) extend existing patents or seek new
patents to gain important competitive advantages for Inhale and its
partners.
- BUILD COMPETITIVE ADVANTAGE THROUGH AN INTEGRATED SYSTEMS APPROACH. The
Company is developing a commercially viable pulmonary delivery system
through an integrated systems solution. Inhale
4
combines its expertise in aerosol engineering, chemical engineering,
mechanical engineering, aerosol science, protein formulations, fine powder
processing and powder filling, and pulmonary physiology and biology to
build a proprietary, fully-integrated system for pulmonary delivery of
therapeutic drugs. The Company believes that building expertise in
technology across several disciplines provides it with a significant
competitive advantage.
- PARTNER WITH PHARMACEUTICAL AND BIOTECHNOLOGY COMPANIES. Inhale's strategy
is to market its proposed products through collaborative partners. The
Company is seeking to work with partners that have significant clinical
development and marketing resources, and currently has collaborations with
several large pharmaceutical and biotechnology companies. For patented
drug products, Inhale intends to partner with owners or licensees from the
outset of the project. For drugs that are off-patent or licensed-in,
Inhale may perform initial feasibility screening work, formulations
development and early stage human clinical trials before entering into a
partner relationship for further development. The Company believes this
partnering strategy enables it to reduce its cash requirements while
developing a large and diversified potential product portfolio.
- FOCUS ON APPROVED DRUGS. To date, Inhale has focused primarily on drugs
that either have proven efficacy and are approved for marketing or are in
late stage clinical trials. The Company believes that working primarily
with drugs with demonstrated efficacy reduces the technical risk of its
projects. In the future, Inhale anticipates working on drugs at earlier
stages of development.
- EXPAND MANUFACTURING CAPABILITY. Inhale intends to formulate, manufacture
and package dry powders for most of its drugs and to subcontract the
manufacture of its device. The Company believes that this strategy will
provide manufacturing economies of scale across a range of therapeutic
products and expand capacity for additional partnerships and commercial
scale production.
INHALE'S PULMONARY DELIVERY SYSTEM
Inhale believes that the following criteria are necessary for a commercially
viable non-invasive drug delivery system:
- SYSTEM EFFICIENCY/COST: The system must attain a certain minimum
efficiency in delivering a drug to the bloodstream as compared to
injection. Bioavailability (the percentage of drug absorbed into the
bloodstream from the lungs relative to that absorbed from injection) is
the most important element of system efficiency since it cannot be
increased without enhancing the natural permeability of the delivery site.
Total system efficiency is critical due to the high cost of macromolecule
drugs. Total system efficiency is determined by the amount of drug loss
during manufacture, in the delivery device, in reaching the site of
absorption, and during absorption from that site into the bloodstream.
Inhale believes that for most systemic macromolecule drugs, a non-invasive
delivery system must show total delivery system efficiency of at least 5%
to 25% compared to injection for the system to be commercially viable.
- REPRODUCIBILITY: The system must deliver a consistent and predictable
amount of drug to the lung and into the bloodstream.
- FORMULATION STABILITY: Formulations used in the system must remain
physically and chemically stable over time and under a range of storage
conditions.
- SAFETY: The system should not introduce local toxicity problems during
chronic or subchronic use by a wide patient population.
- CONVENIENCE: The system must be convenient to the patient in terms of
comfort, ease of operation, transportability and required dosage time.
5
Inhale approaches pulmonary drug delivery with the objective of maximizing
overall delivery system efficiency while addressing commercial requirements for
reproducibility, formulation stability, safety and convenience. To achieve this
goal, Inhale's delivery system integrates customized drug formulations with its
proprietary inhalation device. Inhale combines an understanding of lung biology,
aerosol science, chemical engineering, mechanical engineering and protein
formulations in its system development efforts. The Company believes that this
interdisciplinary capability provides an important competitive advantage.
Inhale has chosen to base its pulmonary delivery system on dry powders for
several reasons. Many proteins are more stable in dry powders than in liquids.
In addition, dry powder aerosols can carry approximately five times more drug in
a single breath than MDI systems and, for many drugs, at least 25 times more
than currently marketed liquid or nebulizer systems. The Company believes that a
dry powder system for drugs requiring higher doses, such as insulin, alpha-1
antitrypsin and heparin, could decrease dosing time as compared with nebulizers.
Inhale takes bulk drugs supplied by partners and formulates and processes
them into fine powders that are then packaged into individual blisters. The
blisters are designed to be loaded into Inhale's device, which patients activate
to inhale the aerosolized drugs. Once inhaled, the aerosol particles are
deposited in the deep lung, dissolved in the alveolar fluid and absorbed into
the bloodstream. Although Inhale is in the advanced stages of developing its
system technologies, there can be no assurance that the Company's products will
ever be successfully commercialized.
FORMULATIONS. Each macromolecule drug poses different formulation
challenges due to varying chemical and physical characteristics and dosing
requirements, which therefore requires significant optimization work for each
specific drug. Inhale has assembled a team with expertise in protein
formulations, powder science and aerosol science and is applying this expertise
to develop proprietary techniques and methods that it believes will produce
stable, fillable and dispersible dry powder drug formulations. Inhale has
several protein powders with on-going room temperature stability (both chemical
and physical) of more than one year. Through its work with numerous
macromolecules, Inhale is developing an extensive body of knowledge on aerosol
dry powder formulations, including knowledge relating to powder flow
characteristics and solubility within the lung, as well as physical and chemical
properties of various excipients, and has filed and expects to continue to file
patent applications on several of its formulations. In June 1997, the Company
acquired the intellectual property portfolio of the BioPreservation Division of
Pafra Limited ("Pafra") of Basildon, England. This portfolio includes issued
U.S. and foreign Letters Patent and pending applications relating to the
stabilization of macromolecule drugs in dry formulations. See "Risk Factors --
Dependence upon Proprietary Technology; Uncertainty of Obtaining Licenses or
Developing Technology."
POWDER PROCESSING. Inhale is modifying standard powder processing equipment
and developing custom techniques to enable it to produce fine dry powders
consistently with particle diameters of between one and five microns without
drug degradation or significant loss of expensive bulk drug. The Company has
scaled up powder processing to sufficient levels for producing test powders for
late stage clinical trials and small volume marketed products, if any. Inhale is
in the process of scaling up its powder processing systems in order to produce
quantities sufficient for commercial production of products the Company believes
it will need to supply in high volumes, such as insulin. However, there can be
no assurance that the Company will be successful in further scaling up its
powder processing on a timely basis or at a reasonable cost, or that the powder
processing system will be applicable for every drug.
POWDER PACKAGING. Fine particle powders have special handling requirements
that are different from those for larger particles. Current commercial filling
and packaging systems are designed for filling larger particle powders and
therefore must be modified to dispense finer particles more accurately and in
the small quantities required. Initially, powder filling was performed manually.
Inhale has since developed and qualified a proprietary automated filling system
suitable for use in clinical trials and initial production
6
quantities for certain products. Inhale is also developing with Pfizer a
proprietary, high capacity system for production use.
INHALATION DEVICE. Inhale's proprietary pulmonary delivery device is
designed to provide deep lung delivery of therapeutic powders in a reproducible,
safe and efficient manner. The first of a series of patents applied for covering
the device was granted in the United States in October 1995. See "Business --
Patents and Proprietary Rights." To achieve this goal, Inhale has designed a
prototype of its pulmonary delivery device to perform the following:
- EFFECTIVELY DISPERSE FINE PARTICLES INTO AN AEROSOL CLOUD. Fine powders
have different dispersion requirements than large powders. Most current
dry powder inhalers use larger powders and are not efficient in dispersing
powders with diameters of one to five microns. Inhale has developed and is
refining its dispersion system for its prototype device specifically for
fine powders. Inhale's device has been designed to efficiently remove
powders from the packaging, effectively break up the powder particles and
create an aerosol cloud while maintaining the integrity of the
macromolecule drug.
- EFFICIENTLY AND REPRODUCIBLY DELIVER THE AEROSOL CLOUD TO THE DEEP
LUNG. Inhale has developed a proprietary aerosol cloud handling system in
its device that facilitates deep lung powder deposition and reproducible
patient dosing. The handling system design is intended to enable the
aerosolized particles to be transported from the device to the deep lung
during a patient's breath, reducing losses in the throat and upper
airways. In addition, the aerosol cloud handling system, in conjunction
with the dispersion mechanism and materials used in the device, is
designed to reduce powder loss in the device itself.
- ELIMINATE THE USE OF PROPELLANTS TO AVOID ASSOCIATED ENVIRONMENTAL
CONCERNS AND FORMULATION DIFFICULTIES. Unlike MDIs, the Inhale device does
not use propellants. The oily surfactants required to stabilize propellant
formulations can cause aggregation of macromolecules. Current
chlorofluorocarbon propellants, which are used in most commercial MDI
systems, are being phased out in many countries due to environmental
concerns.
Inhale believes that its device will be capable of achieving deep lung
delivery with commercially feasible efficiencies for many macromolecule drugs.
An early prototype of the device was used in Inhale's insulin Phase I clinical
trial and in Immunex's IL-1 human clinical trial. Another prototype is currently
being used in several Phase I and II trials, including the outpatient Phase II
insulin trial with Pfizer, in which diabetics have been using the Inhale system
for several months.
The success of Inhale's pulmonary drug delivery system for any drug will
depend upon the Company achieving sufficient formulation stability, safety
dosage reproducibility and system efficiency (measured by the percentage of bulk
drug entering the manufacturing process that eventually is absorbed into the
bloodstream relative to injection for systemic indications, or the amount of
drug delivered to the lung tissue for local lung indications). The initial
screening determinant for the feasibility of pulmonary delivery of any systemic
macromolecule drug is pulmonary bioavailability, which measures the percentage
of the drug absorbed into the bloodstream when delivered directly to the lungs.
In addition, a certain percentage of each drug dose may be lost at various
stages of the manufacturing and pulmonary delivery process in drug formulation,
dry powder processing, packaging, and in moving the drug from a delivery device
into the lungs. Excessive drug loss at any one stage or cumulatively in the
manufacturing and delivery process would render a drug commercially unfeasible
for pulmonary delivery. Formulation stability (the physical and chemical
stability of the formulated drug over time and under various storage conditions)
and safety will vary with each macromolecule and the type and amount of
excipients that are used in the formulation. Reproducible dosing (the ability to
deliver a consistent and predictable amount of drug into the bloodstream over
time both for a single patient and across patient groups) requires the
development of an inhalation device that consistently delivers predictable
amounts of dry powder formulations to the deep lung, accurate unit dose
packaging of dry powder formulations and moisture resistant packaging. There
7
can be no assurance that the Company will be able to successfully develop such
an inhalation device or overcome such other obstacles to reproducible dosing.
See "Risk Factors -- Uncertainties Related to Technology and Product
Development."
THERAPEUTIC PRODUCTS UNDER DEVELOPMENT
The following table sets forth the type of product currently in development,
the application(s) for the particular product, its present stage of development
and the identity of the Company's corporate partner, if any, for such product
application.
DRUG POTENTIAL INDICATIONS STATUS PARTNER
--------------------------- --------------------------- --------- ----------
1) Human Insulin Type I and II Diabetes Phase IIb Pfizer
2) * * Phase II Baxter
3) * * Phase I Baxter
4) * Osteoporosis Phase I Lilly
5) Calcitonin Osteoporosis, Bone Pain, Phase I **
Paget's Disease
6) Interleukin-1 Receptor Asthma Phase Immunex+
I/II
7) * * Preclinical Baxter
8) * * Feasibility Baxter
9) Alpha-1 Antitrypsin Genetic Emphysema Preclinical Centeon
10) Follicle Stimulating Infertility and Feasibility **#
Hormone Reproductive Diseases
11) Gene Vectors Lung Diseases Feasibility Genzyme
12) Heparin Blood Clotting Feasibility **#
13) Interferon Alpha Hepatitis B and C Feasibility **#
14) Interferon Beta Multiple Sclerosis Feasibility **#
STATUS:
PHASE IIb -- OUT-PATIENT CLINICAL TRIALS TO ESTABLISH SAFETY AND EFFICACY.
PHASE II -- HUMAN CLINICAL TRIALS TO ESTABLISH DOSING AND EFFICACY IN PATIENTS.
PHASE I -- HUMAN CLINICAL TRIALS TO TEST SAFETY, AND FOR DRUGS WITH SYSTEMIC
APPLICATIONS, ALSO TESTS BIOAVAILABILITY COMPARED WITH INJECTION IN HEALTHY
SUBJECTS.
PRECLINICAL -- FORMULATION DEVELOPMENT AND ANIMAL TESTING IN PREPARATION FOR
HUMAN CLINICAL TRIALS.
FEASIBILITY -- STUDIES TO ESTABLISH VIABILITY OF PULMONARY DELIVERY WITH
INHALE'S SYSTEM INCLUDING ANIMAL BIOAVAILABILITY STUDIES OR INITIAL FORMULATION
DEVELOPMENT.
* DRUG OR POTENTIAL INDICATIONS WITHHELD AT PARTNER'S REQUEST.
** NOT CURRENTLY PARTNERED.
+ THIS PROGRAM IS AWAITING FURTHER WORK AND/OR LICENSING FROM IMMUNEX.
# ONE OF THESE FOUR IS PARTNERED WITH LILLY.
8
INHALE'S PULMONARY DRUG DELIVERY PROGRAMS IN PROGRESS
Inhale has 14 programs in development, six of which are in human clinical
trials and ten of which are sponsored by collaborative partners. In general, the
Company's partnership arrangements provide funding for development, payments
upon the achievement of certain milestones and royalty and manufacturing
revenues upon the commencement of commercial sales. The arrangements are
cancelable by the partner at any time without significant penalty.
PFIZER PROGRAM. Insulin is a protein hormone naturally secreted by the
pancreas to induce the removal of glucose from the blood. Diabetes, the
inability of the body to regulate properly blood glucose levels, is caused by
insufficient production of insulin by the pancreas or insufficient use of the
insulin that is secreted. Over time, high blood glucose levels can lead to
failure of the microvascular system, which may lead to blindness, loss of
circulation, kidney failure, heart disease or stroke. Insulin currently is
marketed only in injectable form. Worldwide sales of insulin were estimated at
$2.5 billion in 1995. Insulin is supplied by various manufacturers, including
Eli Lilly and Novo-Nordisk A/S.
The American Diabetes Association estimates that in 1995 there were
approximately eight million diagnosed Type I (juvenile onset) and Type II (adult
onset) diabetics in the United States. They estimate an additional eight million
who have not been diagnosed. All Type I diabetics, estimated at between 5% and
15% of all diabetics, require insulin therapy. Type I diabetics generally
require both a baseline treatment of long-acting insulin and multiple treatments
of regular insulin throughout the day. Type II diabetics, depending on the
severity of their case, may or may not require insulin therapy. Type II
diabetics who use insulin are best treated with regular insulin and sometimes
require long-acting insulin as well. Many Type II patients who do not require
insulin to survive but would benefit from it are reluctant to start treatment
because of the inconvenience and unpleasantness of injections.
Regular insulin is generally administered 30 minutes before mealtimes and
generally is given only twice a day. A ten-year study by the National Institutes
of Health ("NIH"), however, demonstrated that the side effects of diabetes could
be significantly reduced by dosing more frequently. The NIH study recommended
dosing regular insulin three to four times per day, a regimen which would more
closely mirror the action of naturally produced insulin in non-diabetics.
However, many patients are reluctant to increase their number of doses because
they find injections unpleasant and inconvenient.
Although non-invasive routes of insulin delivery have been sought, the only
commercially viable way to deliver insulin to date has been by subcutaneous
injection. Subcutaneous injections are generally given with a syringe and
needle, although high pressure needle-less injection devices are also available.
Needle-less injection devices, which inject proteins like insulin through the
skin into the body, have been available for many years. However, the Company
believes these devices have not been well accepted due to patient discomfort and
relatively high cost.
Inhale is developing a regular insulin that can be administered in one to
three blisters using its pulmonary delivery system. The Company believes that
its pulmonary delivery system could provide increased user convenience and
result in greater patient compliance by eliminating some injections for Type I
and Type II patients and all injections for some Type II patients. In addition,
the Company believes that pulmonary delivery could yield medical advantages by
providing a more rapid acting insulin than certain current injectable products.
Through its collaboration with Inhale, Pfizer conducted Phase I and Phase
IIa clinical trials which indicated that pulmonary insulin was absorbed
systemically and reduced glucose levels. In late October 1996, Pfizer initiated
a multi-site Phase IIb outpatient trial to include up to 240 patients with
diabetes mellitus. In late October 1997, Pfizer announced the results of current
Phase II testing. In 70 Type I diabetics treated with either inhaled or
conventional injected insulin therapy for three months, the levels of hemoglobin
A1c, the best index of blood glucose control, were statistically equivalent.
Virtually identical results were obtained in a group of Type II diabetics.
Pfizer also announced that it intends to continue the
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insulin project with a Phase III study. In connection with the collaboration
with Inhale, Pfizer has made two $5 million equity investments in Inhale at a
25% premium to the market price of Inhale stock at the time of each investment.
BAXTER PROGRAM. In March 1996, Inhale entered into a collaboration
agreement with Baxter to use Inhale's dry powder pulmonary delivery system as a
technology platform for developing and launching therapeutic products. In
connection with the collaboration, Baxter made a $20 million equity investment
in Inhale at a 25% premium to the market price of Inhale stock at the time of
the investment. Baxter will receive worldwide commercialization rights in
exchange for up to an estimated $60 million in research and development funding
and milestone payments for four molecules, assuming successful development and
continuation of the program by Baxter. Baxter also has an option to add other
molecules to the collaboration that could result in additional funding and
milestone payments to Inhale. Inhale will receive royalties and manufacturing
payments on sales of products developed through the collaboration. Inhale has
primary responsibility for development of the selected therapeutics. Inhale will
develop dry powder formulations for use with its portable inhalation device and
will process and package powders for clinical supplies and marketed products.
Clinical trials will also be managed by Inhale. Baxter will be responsible for
the worldwide commercialization of the products resulting from the
collaboration.
In September 1997 Inhale announced that the first compound from its
collaboration with Baxter has entered Phase II clinical testing using Inhale's
pulmonary delivery system. On November 11, 1997 the Company announced that the
second compound from this collaboration has entered clinical testing in a Phase
I study. Inhale is currently renegotiating with Baxter certain terms of their
collaboration agreement to address concerns raised by both parties about the
overall scope and cost of the collaborative arrangement. As of February 1998 no
formal renegotiation has been agreed to, and there can be no assurance that the
parties will be able to reach an agreement or that the collaborative arrangement
between Inhale and Baxter will be continued. See "Risk Factors -- Dependence on
Collaborative Partners."
ELI LILLY & CO. PROGRAMS. In January 1997 Inhale entered into a
collaborative agreement with Lilly to develop pulmonary delivery for a selected
osteoporosis product. Osteoporosis is estimated to affect approximately 25
million Americans, mostly women. If not prevented or left untreated,
osteoporosis can progress painlessly until a bone breaks. As many as 35,000
people die each year as a result of hip fractures, primarily due to
complications that result from surgery or from being confined to bed. Associated
medical costs of the estimated 1.5 million bone fractures caused annually by
osteoporosis are estimated to be about $10 billion per year in the United
States.
Under the terms of its agreement with Lilly, Inhale will receive up to an
estimated $20 million in initial fees, funding for research and milestone
payments. Lilly will receive global commercialization rights for the pulmonary
delivery of the products with Inhale receiving royalties on any marketed
products. Inhale will manufacture packaged powders and supply inhalation devices
for Lilly.
Phase I clinical trials of this osteoporosis drug, completed in
collaboration with Alza Corporation ("Alza") indicated that the drug was
systemically absorbed when delivered with Inhale's pulmonary system. Under an
agreement between Alza and Inhale, Alza has agreed not to participate in the
future development and commercialization of the osteoporosis product.
Subsequently, the Company entered into an agreement with Lilly, pursuant to
which Lilly has agreed to conduct future clinical trials and will receive
worldwide commercialization rights.
In January 1998 Lilly and Inhale entered into a second collaborative
agreement to develop pulmonary delivery for an unspecified protein product based
on Inhale's deep-lung delivery system for macromolecules. Under the terms of the
agreement, Inhale will receive funding of up to $20 million in research,
development and milestone payments. Lilly will receive global commercialization
rights for the pulmonary delivery of the products with Inhale receiving
royalties on any marketed products. Inhale will manufacture packaged powders for
and supply inhalation devices to Lilly.
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CALCITONIN PROGRAM. Inhale is funding a proprietary program to develop
pulmonary delivery of calcitonin for the treatment of osteoporosis, bone pain
and Paget's disease. Calcitonin is a peptide hormone secreted by the thyroid
gland that inhibits bone resorption and lowers serum calcium. Calcitonin is
available in two forms, fish and human. Calcitonin is administered daily or
every other day by injection in the United States. In the United States, salmon
calcitonin is approved for the treatment of postmenopausal osteoporosis, Paget's
disease, hypercalcemia of cancer and bone pain. Human calcitonin is approved for
Paget's disease and bone pain. Paget's disease is a chronic disorder of the
adult skeleton, in which localized areas of bone become hyperactive and are
replaced by a softened and enlarged bone structure. About 3% of Caucasians in
the United States over age 60 have Paget's disease. Hypercalcemia occurs as a
result of excessive serum calcium levels caused by hyperparathyroidism and
malignancy. It occurs in approximately 10-20% of cancer patients.
Osteoporosis is by far the most important potential clinical indication for
calcitonin. It has been demonstrated in clinical trials to reduce the incidence
of bone fractures in osteoporosis patients. While there is some evidence that
calcitonin can restore bone, its primary benefit appears to be the retardation
of bone loss. In addition, clinical evidence suggests that calcitonin may
provide superior efficacy to estrogens in cases of rapid turnover osteoporosis.
While considerable work has been done on non-invasive delivery of calcitonin, to
date only salmon calcitonin for nasal delivery has been marketed.
Nasally-delivered calcitonin, however, is sometimes characterized, depending
upon the formulation used, by low bioavailability, irritation caused by
enhancers and poor reproducibility. Inhale believes that pulmonary calcitonin
could be more efficient, more reproducible and less irritating than nasal
calcitonin.
In April 1997 the Company announced the successful completion of Phase I
clinical trials to determine the safety and bioavailability of pulmonary
delivery of a dry powder, aerosolized form of salmon calcitonin as a potential
treatment for osteoporosis, Paget's disease, hypercalcemia and other bone
diseases. The single-dose study conducted in the United Kingdom with a total of
36 fasted normal volunteers indicated that the drug was systemically absorbed
through the pulmonary route when delivered with Inhale's system. The Company is
seeking a partner for further clinical development.
IMMUNEX PROGRAM. Interleukin-1 is a cytokine that helps initiate the
inflammatory response to foreign pathogens. Inhale collaborated with Immunex to
develop pulmonary delivery of a therapeutic product for asthma. Initial
formulation development and animal toxicology have been completed, and the two
companies successfully completed Phase I/II trials demonstrating pulmonary
delivery. This program is awaiting further work and/or licensing by Immunex.
CENTEON PROGRAM. Alpha-1 antitrypsin deficiency results from a patient's
liver producing insufficient alpha-1 antitrypsin, a protein that circulates in
the blood and inhibits the activity of elastase enzyme. It is estimated that as
many as 100,000 people in the United States were born with alpha-1 antitrypsin
deficiency and potentially 28,000 in Northern Europe. Of this group, emphysema
resulting from the deficiency afflicts up to 40,000 people in the United States
alone.
If not treated, alpha-1 antitrypsin deficiency leads to the breakdown of the
intricate protein fiber network in the adult lung which provides support for the
millions of tiny airsacs which make up the lung (the alveoli). The degradation
of these fibers leads to a gradual loss of surface area for gas exchange, which
can cause the inability to breathe properly and ultimately premature death.
Alpha-1 antitrypsin is approved in the United States and several European
countries for augmentation treatment of alpha-1 antitrypsin deficiency. Current
treatment is given by systemic intravenous infusion on a weekly basis. This
"replacement therapy" consists of a concentrated form of alpha-1 antitrypsin
derived from human plasma.
In January 1997 Inhale and Centeon entered into a collaboration to develop a
pulmonary formulation of alpha-1 antitrypsin to treat patients with alpha-1
antitrypsin deficiency. Under the terms of the collaboration, Centeon will
receive commercialization rights worldwide excluding Japan and Inhale will
11
receive royalties on product sales, an up-front signing fee and up to an
estimated $15 million in research and development funding and milestone
payments. Centeon will manufacture the active ingredient for use in Inhale's
delivery device. Inhale will manufacture and package the dry powder and supply
inhalation devices to Centeon for commercialization and marketing.
The two companies completed pre-clinical work that indicates Inhale's dry
powder formulation of Centeon's alpha-1 antitrypsin has the potential to
significantly improve the efficiency of delivery compared with current infusion
therapy. The Company believes its pulmonary delivery system could significantly
reduce the amount of drug needed for genetic emphysema therapy since alpha-1
antitrypsin could be delivered directly to the lung.
Centeon is currently negotiating with multiple partners to secure rights
under patents that have been granted in the United States and Europe directed to
aerosol formulations for the treatment of the lung containing alpha-1
antitrypsin (U.S.) and serine protease inhibitors including alpha-1 antitrypsin
(Europe). The failure by Centeon to secure rights under these patents could
result in the termination of the program. See "Risk Factors -- Dependence on
Proprietary Technology; Uncertainty of Obtaining Licenses or Developing
Technology."
GENZYME PROGRAM. In July 1996 the Company signed an agreement with Genzyme
Corporation to examine the feasibility of developing dry powder formulations of
gene vectors for pulmonary applications. Gene vectors are currently being
investigated by several companies and academic institutions for use in treating
lung diseases such as cystic fibrosis. Inhale believes that its delivery system
is well suited for the delivery of gene therapies to treat lung disease because
its system could provide efficiency, reproducibility, stability and containment
advantages relative to alternative pulmonary delivery methods. Early stage
research has shown that Inhale's dry powder formulations and powder processing
technology can be used to make powders containing active gene vectors.
FOLLICLE STIMULATING HORMONE (FSH) PROGRAM. FSH, a glycoprotein hormone
secreted by the pituitary gland, has been utilized since the 1960s for treatment
of infertility. In female reproduction, FSH is responsible for ovarian
follicular growth and development. Therapeutic use of FSH has expanded since the
1970s. It is currently administered in a series of daily injections over one to
three weeks to enhance follicle growth and ovum production. According to
industry sources, the female infertility market was approximately $600 million
in 1996. Inhale has demonstrated the feasibility of pulmonary FSH in an animal
model.
HEPARIN AND LOW MOLECULAR WEIGHT HEPARIN (LMWHS) PROGRAM. Heparin is a low
cost mucopolysaccharide anticoagulant isolated from the lungs and intestines of
pigs and cows. Heparin, which is delivered by subcutaneous or intravenous
injection, is approved for many applications pertaining to blood clotting,
including prophylaxis and treatment of deep vein thrombosis, pulmonary embolism
and prevention of other thromboembolitic indications. Worldwide sales in 1996
were estimated to be approximately one billion dollars. Research studies have
indicated that heparin may have additional, non-antithrombotic properties,
including anti inflammatory properties which are useful in treating local lung
diseases such as asthma. Others have also suggested that it possesses
antiprotease activity, similar to alpha-1 antitrypsin, and could be used to
treat lung diseases.
Warfarin, a small molecule oral anticoagulant, is the most widely used
non-invasively delivered alternative to heparin. Warfarin, however, has some
serious associated risks which include hemorrhaging and, less frequently,
necrosis or gangrene of the skin or other tissues.
Inhale believes that a non-invasive heparin or LMWH could expand the drug's
use for preoperative, postoperative and prophylactic use at home. A number of
human studies on pulmonary-delivered heparin suggest that it is safe and
efficacious as an inhaled systemic anticoagulant. Inhale has developed an
initial dry powder formulation for heparin and conducted animal absorption
screening studies.
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INTERFERON ALPHA PROGRAM. Interferon alpha is produced by a number of cell
types in the body and serves to turn on an array of genes in cells for fighting
viral infections. It has been approved for Hepatitis B and C (inflammatory viral
diseases of the liver), hairy cell leukemia (a blood cancer), and AIDS-related
Kaposi's sarcoma (a skin cancer prevalent in AIDS patients). The global market
for all interferon alpha agents was estimated to be approximately $700 million
in 1995. There are at least five companies competing in the interferon alpha
market, including Schering-Plough Corporation, Hoffmann-La Roche, Inc., Sumitomo
Corp. and Otsuka Pharmaceutical Co., Ltd. Interferon alpha is currently given in
all indications three times per week by subcutaneous injection. Inhale believes
that a pulmonary delivery system could provide a competitive advantage in what
is now an exclusively injectable market and could reduce the cost of treatment
by enabling more home therapy. Inhale has completed feasibility testing,
including animal studies, showing that interferon alpha is well absorbed
systemically following pulmonary administration.
INTERFERON BETA PROGRAM. Interferon beta has been approved for treatment of
multiple sclerosis, an immunological disorder in which the immune system attacks
the myelin sheath that coats the nerves. Analysts estimate this market at
approximately $300 million. There are an estimated 700,000 cases in North
America and Europe.
Two interferon beta products are FDA approved for chronic treatment of
multiple sclerosis (Betaseron by Berlex and Avonex by Biogen). Betaseron is
administered as daily injections and Avonex is administered as a weekly
injection. Inhale believes that a pulmonary drug delivery system could provide a
competitive advantage in this exclusively injectable market. The Company has
successfully completed formulation feasibility testing of Interferon-beta.
There can be no assurance that the Company will be able to enter into
additional collaborations or that its feasibility agreements will lead to
collaborations. There also can be no assurance that the Company will be able to
maintain any such collaborative arrangements or feasibility agreements or that
any such collaborative arrangements or feasibility agreements will be
successful. The failure of the Company to enter into or maintain such
collaborative arrangements and feasibility agreements would have a material
adverse effect on the Company. See "Risk Factors -- Dependence on Collaborative
Partners."
MANUFACTURING
Inhale generally plans to formulate, manufacture and package the powders for
its pulmonary delivery products and to subcontract the manufacture of its
proprietary pulmonary delivery devices. Under its collaborative agreement with
Pfizer to develop insulin powders, Inhale will be the primary manufacturer of
powders and Pfizer will be primarily responsible for filling blisters. Prior to
the commercialization of its first products, the Company must build and have
validated a powder processing and packaging facility. The Company must also
select and have validated a device manufacturer. Inhale believes its
manufacturing strategy will enable it to achieve the following: (i) provide
economies of scale by utilizing manufacturing capacity for multiple products;
(ii) improve its ability to retain any manufacturing know-how; and (iii) allow
its customers to bring pulmonary delivery products to market faster than if they
established their own powder processing and packaging facilities.
The Company has built a powder manufacturing and packaging facility capable
of producing powders in quantities sufficient for Phase I, Phase II, and the
initiation of Phase III human clinical trials. This facility has been inspected
and licensed by the State of California and was used to manufacture and package
powders under Good Manufacturing Practices ("GMP") for Inhale's Phase I and
Phase II human insulin trials, Phase I and II trials with Baxter, Immunex's IL-1
receptor Phase I/II clinical trial, Phase I calcitonin, and a Phase I clinical
trial for another project. Inhale intends to build a facility capable of
manufacturing and packaging powders in quantities sufficient for registration
batches and initial commercial production.
13
Inhale is working to further scale up its powder processing to a larger
production scale system and to further develop the necessary powder packaging
technologies. Fine particle powders and small quantity packaging (such as those
to be used in the Company's delivery system) require special handling. Current
commercial packaging systems are designed for filling larger quantities of
larger particle powders and therefore must be modified to dispense finer
particles in the small quantities required by the Company. Inhale has developed
and validated a proprietary small scale prototype automated filling system which
the Company believes is capable of supporting its requirements through Phase III
trials and into commercial production for some products. Inhale is developing a
higher capacity automated filling unit capable of filling blisters on a
production scale for moderate and large volume products. The Company faces
significant technical challenges in developing an automated, commercial-scale
filling system that can accurately and economically handle the small dose and
particle sizes of its powders. There can be no assurance that the Company will
be able to develop or acquire the technology necessary to develop successfully
any such system in a timely manner or at commercially reasonable cost. Any
failure or delay in developing such technology would delay product development
or bar commercialization of the Company's products and would have a material
adverse effect on the Company. See "Risk Factors -- Limited Manufacturing
Experience; Risk of Scale-Up."
Inhale used a prototype of its inhalation device in its Phase I human
insulin trial and in Immunex's Phase I/II clinical trial. Inhale has completed
development of a prototype take-home device which is being used in several Phase
I and II trials, including a Phase IIb insulin trial. Additionally, Inhale is
refining the device design for use in later-stage clinical trials and commercial
products.
Inhale plans to subcontract the manufacture of its pulmonary delivery
devices before commercial production of its first product. The Company has
identified contract manufacturers that it believes have the technical
capabilities and production capacity to manufacture its devices and which can
meet the requirements of GMP. There can be no assurance that Inhale will be able
to obtain and maintain satisfactory contract manufacturing on commercially
acceptable terms, if at all. The Company's dependence upon third parties for the
manufacture of its potential inhalation device may adversely affect the
Company's cost of goods and its ability to develop and commercialize products on
a timely and competitive basis.
GOVERNMENT REGULATION
The research and development, manufacture and marketing of pulmonary drug
delivery systems are subject to regulation by the FDA in the United States and
by comparable regulatory agencies in other countries. These national agencies
and other federal, state and local entities regulate, among other things,
research and development activities and the testing, manufacture, safety,
effectiveness, labeling, storage, record keeping, approval, advertising and
promotion of the Company's products.
The process required by the FDA before a pulmonary drug delivery system may
be marketed in the United States depends on whether the compound has existing
approval for use in other dosage forms. If the drug is a new chemical entity
that has not been approved, the process includes the following: (i) pre-clinical
laboratory and animal tests; (ii) the filing of an Investigational New Drug
application ("IND"); (iii) adequate and well-controlled human clinical trials to
establish the safety and efficacy of the drug in its intended indication; and
(iv) submission to the FDA for approval of a New Drug Application ("NDA") with
respect to drugs or a Biological License Application ("BLA") with respect to
biologics. If the drug has been previously approved, the approval process is
similar, except that certain toxicity tests normally required for the IND and
NDA/BLA application may not be necessary.
Pre-clinical tests include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. Pulmonary systems must be formulated according to GMP, and
pre-clinical safety tests must be conducted by laboratories that comply with FDA
Good Laboratory Practices regulations. The results of the pre-clinical tests are
submitted to the FDA as
14
part of an IND application and are reviewed by the FDA before human clinical
trials begin. The IND application becomes effective 30 days after receipt by the
FDA, unless the FDA raises objections.
Clinical trials involve the administration of the drug to healthy volunteers
or to patients under the supervision of a qualified principal investigator.
Clinical trials are conducted in accordance with protocols that detail the
objectives of the study, the parameters to be used to monitor safety and the
efficacy criteria to be evaluated. Each protocol is submitted to the FDA as part
of the IND. Each clinical study is conducted under the auspices of an
independent Institutional Review Board ("IRB"). The IRB will consider, among
other things, ethical factors, the safety of human subjects and the possible
liability of the institution.
Clinical trials are typically conducted in three sequential phases, but the
phases may overlap. In Phase I, the initial introduction of the drug into
healthy human subjects, the product generally is tested for safety, dosage
tolerance, pharmacokinetics, absorption, metabolism and excretion. Phase II
involves studies in a limited patient population to (i) determine the efficacy
of the product for specific, targeted indications, (ii) determine dosage
tolerance and optimal dosage, and (iii) identify possible adverse effects and
safety risks. When Phase II evaluations demonstrate that dosing the drug by the
pulmonary system is effective and has an acceptable safety profile, Phase III
trials are undertaken to evaluate further clinical efficacy and safety within an
expanded patient population at geographically dispersed clinical study sites.
The FDA, the clinical trial sponsor, the investigator or the IRB may suspend
clinical trials at any time if it believes that clinical subjects are being
exposed to an unacceptable health risk.
The results of product development, pre-clinical studies and clinical
studies are submitted to the FDA as an NDA/BLA for approval of the marketing and
commercial shipment of the pulmonary system. The FDA may deny an NDA/BLA if
applicable regulatory criteria are not satisfied or may require additional
clinical testing. Even if such data are submitted, the FDA may ultimately decide
that the NDA/BLA does not satisfy the criteria for approval. Product approvals
may be withdrawn if compliance with regulatory standards are not maintained or
if problems occur after the product reaches the market. The FDA may require
testing and surveillance programs to monitor the effect of pulmonary systems
that have been commercialized, and has the power to prevent or limit future
marketing of the product based on the results of these post-marketing programs.
Each domestic drug product manufacturing establishment must be registered
with, and approved by, the FDA. Drug product manufacturing establishments
located in California also must be licensed by the State of California.
Establishments handling controlled substances must be licensed by the United
States Drug Enforcement Administration ("DEA"). Domestic manufacturing
establishments are subject to biennial inspections by the FDA for GMP
compliance. Inhale is also subject to United States federal, state and local
regulations regarding workplace safety, environmental protection and hazardous
and controlled substance controls, among others.
Many of the drugs with which the Company is working are already approved for
marketing by the FDA. The Company believes that when working with approved
drugs, the approval process for delivery by pulmonary delivery may require less
time and fewer tests than for new chemical entities. However, the Company
expects that its formulations often will use excipients not currently approved
for pulmonary use. Use of these excipients will require additional toxicological
testing that may increase the costs of, or lengthen the time in, gaining
regulatory approval. In addition, regulatory procedures applicable to the
Company's products may change as regulators gain experience in the area of
macromolecules, and any such changes may delay or increase the cost of
regulatory approval.
The Company's device will not be developed as an independent product but
will be an inseparable part of the pulmonary drug delivery system for each
specific molecule. Prior to or at the time of submission of the IND, the FDA
Center and division within the Center will be identified to be responsible for
the review of the IND and NDA/BLA. In the case of Inhale's products, either the
Center for Drug Evaluation and Research or the Center for Biologics Evaluation
and Research, in consultation with the Center for
15
Devices and Radiological Health, will be involved in the review. However, one
Center is designated as the Center which has the lead responsibility for
regulating the product. The jurisdiction within the FDA is based on the primary
mode of action of the drug and is identified in the FDA's intercenter agreement.
Inhale expects that its partners generally will be responsible for clinical
and regulatory approval procedures, but Inhale may participate in this process
by submitting to the FDA or to each partner portions of the Drug Master File
being developed and to be maintained by Inhale which contains data concerning
the manufacturing processes for the product. The regulatory review process
generally takes a number of years and requires the expenditure of substantial
resources. Inhale's ability to manufacture and sell products developed under
contract depends upon the partner's completion of satisfactory clinical trials
and obtaining marketing approvals. Inhale may prepare and submit an IND
application and perform initial clinical studies before licensing the product to
a partner. The Company's business strategy contemplates performing more of these
studies in the future.
Sales of the Company's products outside the United States are subject to
regulatory requirements governing human clinical trials and marketing approval
for drugs and pulmonary delivery systems. Such requirements vary widely from
country to country.
Prior to marketing a new dosage form of any drug, including one developed
for use with the Company's pulmonary drug delivery system, whether or not such
drug was already approved for marketing in another dosage form, the product must
undergo rigorous pre-clinical and clinical testing and an extensive review
process mandated by the FDA and equivalent foreign authorities. These processes
generally take a number of years and require the expenditure of substantial
resources. None of the Company's proposed products has been submitted to the FDA
for marketing approval. The Company has no experience obtaining such regulatory
approval, does not have the expertise or other resources to do so and intends to
rely on its partners to fund clinical testing and to obtain product approvals.
PATENTS AND PROPRIETARY RIGHTS
Inhale's policy is to apply for patent protection for the technology,
inventions and improvements deemed important to the development of its business.
The Company also relies upon trade secrets, know-how, continuing technological
innovations and licensing opportunities to maintain and further develop its
competitive position. The Company plans to defend aggressively its proprietary
technology and any issued patents.
Inhale expects that its integrated system for the development of pulmonary
delivery technology for macromolecule drugs will yield innovations in dry powder
formulations, powder processing, powder packaging and device design. It is the
Company's strategy to build proprietary positions in each of its technological
areas. The Company's success will depend in part upon its ability to protect its
proprietary technology from infringement, misappropriation, duplication and
discovery. Inhale has filed patent applications covering certain aspects of its
device and powder processing technology and powder formulations and pulmonary
route of delivery for certain molecules, and plans to file additional patent
applications. On October 17, 1995, the Company received United States Patent
Number 5,458,135 from the United States Patent and Trademark Office (the "PTO")
for certain claims covering the use of its device in a method for delivering
powder formulations of drugs to the lung. On March 4, 1997, the Company received
United States Patent Number 5,607,915 from the United States Patent Trademark
Office for pulmonary delivery of active fragments of parathyroid hormone (PTH)
1-34. On October 17, 1997, Inhale was granted United States patent No. 5,654,007
covering a system and methods for processing fine dispersible powders for easier
processing. There can be no assurance that any of the patents applied for by the
Company will issue, or that any patents that issue will be valid and
enforceable. Even if such patents are enforceable, the Company anticipates that
any attempt to enforce its patents could be time consuming and costly.
It is the Company's policy to require its employees and consultants, outside
scientific collaborators, sponsored researchers and other advisors who receive
confidential information from the Company to
16
execute confidentiality agreements upon the commencement of employment or
consulting relationships with the Company. These agreements provide that all
confidential information developed or made known to the individual during the
course of the individual's relationship with the Company is to be kept
confidential and not disclosed to third parties except in specific
circumstances. The agreements provide that all inventions conceived by an
employee shall be the property of the Company. There can be no assurance,
however, that these agreements will provide meaningful protection or adequate
remedies for the Company's trade secrets in the event of unauthorized use or
disclosure of such information.
In June 1997 the Company acquired the intellectual property portfolio of the
BioPreservation Division of Pafra. This portfolio includes issued U.S. and
foreign Letters Patent and pending applications relating to the stabilization of
macromolecule drugs in dry formulations. A granted European patent included in
this portfolio is currently the subject of an opposition proceeding before the
European Patent Office and the Company is continuing the defense of this patent,
the opposition to which was initiated prior to the acquisition. There can be no
assurance that the Company will be successful in the defense of this opposition
proceeding. In addition, there can be no assurance that any of the Pafra patent
applications will issue, or that any Pafra patents will be valid and
enforceable. The loss of the opposition proceeding or the inability to obtain or
defend the Pafra patents could have a material adverse effect on the Company.
See "Risk Factors -- Dependence Upon Proprietary Technology; Uncertainty of
Obtaining Licenses or Developing Technology."
The Company has obtained license rights to certain know-how and patent
applications owned by Genentech, Inc. covering formulations and powder
processing and pulmonary delivery of certain molecules, which it believes could
be important to the development of its business. These license rights are
worldwide, nonexclusive, sublicensable and royalty free. Recently, Genentech
successfully defended an opposition proceeding involving a pending European
patent licensed to Inhale. This decision is currently on appeal. The pending
patent covers the pulmonary delivery of cytokines and growth factors.
SCIENTIFIC ADVISORS
The Company has assembled scientific and development advisors that provide
Inhale expertise in critical scientific, development, engineering, manufacturing
and business issues facing the Company. The scientific advisory group assists
Inhale on issues related to pulmonary delivery, pulmonary toxicology, aerosol
science, government regulation, product selection and clinical trial design. Its
members are called upon individually as needed and include:
NAME AFFILIATION AREA OF EXPERTISE
- ---------------------- ------------------------------------------ ---------------------
Joseph Brain, Ph.D. Professor, Harvard School of Public Health Pulmonary safety
Chairman, Department of Environmental
Health Director, Physiology Program
Peter Byron, Ph.D. Professor of Pharmacy, Virginia Pharmaceutical
Commonwealth University, Medical College aerosols
of Virginia
Carl Grunfeld, M.D. Professor of Medicine, University of Endocrinology
California, San Francisco
Michael Matthay, M.D. Professor of Medicine and Anesthesiology, Pulmonology
University of California, San Francisco
Gerald Smaldone, M.D. Professor of Medicine, State University of Aerosol medicine
New York at Stony Brook
17
EMPLOYEES AND CONSULTANTS
As of December 31, 1997, Inhale had 147 employees, of which 119 were engaged
in research and development (including manufacturing) activities and 28 in
general administration and business development. Seventy-six of the employees
hold advanced degrees, of which 35 are Ph.D.s. The Company employs scientists
and engineers with expertise in the areas of pulmonary biology, aerosol science,
mechanical engineering, protein chemistry and chemical engineering. None of the
Company's employees are covered by a collective bargaining agreement and the
Company has experienced no work stoppages. Inhale believes that it maintains
good relations with its employees.
To complement its own expertise, Inhale utilizes specialists in regulatory
affairs, pulmonary toxicology, process engineering, manufacturing, quality
assurance, device design, clinical trial design and business development. These
individuals include certain of the Company's scientific advisors as well as
independent consultants.
RESEARCH AND DEVELOPMENT
Research and development expenditures totaled $23.6 million, $14.4 million,
and $9.0 million for the years ended December 31, 1997, 1996, and 1995
respectively. Research and development expenditures funded by partners were
approximately $16.2 million, $6.9 million, and $3.4 million for the years ended
December 31, 1997, 1996, and 1995 respectively.
THIRD-PARTY REIMBURSEMENT
In both domestic and foreign markets, sales of the Company's potential
products, if any, will depend in part on the availability of reimbursement from
third-party payors such as government health administration authorities, private
health insurers and other organizations. Third-party payors are increasingly
challenging the price and cost-effectiveness of medical products and services.
Significant uncertainty exists as to the reimbursement status of newly approved
health care products. There can be no assurance that the Company's proposed
products will be considered cost effective or that adequate third-party
reimbursement will be available to enable Inhale to maintain price levels
sufficient to realize an appropriate return on investment in product
development. Legislation and regulations affecting the pricing of
pharmaceuticals may change before the Company's proposed products are approved
for marketing and any such changes could further limit reimbursement for medical
products and services. (See "Risk Factors -- Uncertainty Related to Health Care
Reform and Third-Party Reimbursement")
RISK FACTORS
In addition to the other information in this Report, the following risk
factors should be considered carefully in evaluating the Company and its
business.
EARLY STAGE COMPANY. Inhale is in an early stage of development. There can
be no assurance that the Company's pulmonary delivery technology will prove to
be technically feasible or commercially applicable to a range of macromolecules
and small molecule drugs. Only six of the Company's fourteen pulmonary delivery
formulations, insulin, interleukin-1 receptor, salmon calcitonin, the Lilly
osteoporosis drug and two small molecules have been subject to any human
clinical testing. Although many of the underlying drug compounds with which the
Company is working have been tested in humans by others using alternative
delivery routes, Inhale's potential products will require extensive research,
development, pre-clinical and clinical testing, and may involve lengthy
regulatory review. There can be no assurance that any of the Company's potential
products will prove to be safe and effective in clinical trials, meet applicable
regulatory standards, be capable of being produced in commercial quantities at
acceptable cost or be marketed successfully. Any failure of the Company to
achieve technical feasibility, demonstrate safety, achieve clinical efficacy,
obtain regulatory approval or, together with partners, successfully market
products, would have a material adverse effect on the Company. See "Risk Factors
- -- No Assurance of
18
Successful Development or Commercialization of Drugs for Pulmonary Delivery,"
"-- Government Regulation; Uncertainty of Obtaining Regulatory Approval" and
"-Uncertainty Related to the Health Care Industry and Third-Party
Reimbursement."
UNCERTAINTIES RELATED TO TECHNOLOGY AND PRODUCT DEVELOPMENT. The success of
Inhale's pulmonary drug delivery system for any drugs will depend upon the
Company achieving sufficient system efficiency (measured by the percentage of
bulk drug entering the manufacturing process that eventually is absorbed into
the bloodstream relative to injection for systemic indications, or the amount of
drug delivered to the lung tissue for local lung indications), formulation
stability, safety and dosage reproducibility.
The initial screening determinant for the feasibility of pulmonary delivery
of any systemic drug is pulmonary bioavailability, which measures the percentage
of the drug absorbed into the bloodstream when delivered directly to the lungs.
In addition, a certain percentage of each drug dose is lost at various stages of
the manufacturing and pulmonary delivery process in drug formulation, dry powder
processing, packaging, and in moving the drug from a delivery device into the
lungs. Excessive drug loss at any one stage or cumulatively in the manufacturing
and delivery process could render a drug commercially unfeasible for pulmonary
delivery.
Formulation stability (the physical and chemical stability of the formulated
drug over time and under various storage conditions) and safety will vary with
each drug and the type and amount of excipients that are used in the
formulation. Reproducible dosing (the ability to deliver a consistent and
predictable amount of drug into the bloodstream over time both for a single
patient and across patient groups) requires the development of an inhalation
device that consistently delivers predictable amounts of dry powder formulations
to the deep lung, accurate unit dose packaging of dry powder formulations and
moisture resistant packaging. There can be no assurance that the Company will be
able to develop successfully such an inhalation device or overcome such other
obstacles to reproducible dosing.
The Company's integrated approach to systems development relies upon several
different but related technologies. Development of powder formulations,
processing and packaging technology and the delivery device, establishing
collaborations with partners, laboratory and clinical testing, and manufacturing
scale-up must proceed contemporaneously so as not to delay any aspect of systems
development. Any delay in one component of product or business development could
cause consequential delays in the Company's ability to develop, obtain approval
of or market therapeutic products using its system. Further refinement of the
Company's device prototype, further scale-up of the powder processing system and
automated packaging system will need to be accomplished before initiation of
late stage clinical trials.
There can be no assurance that Inhale will be able to demonstrate pulmonary
bioavailability for the drug candidates it has identified or may identify, will
be able to achieve commercial viability of its pulmonary delivery system or will
achieve the total system efficiency needed to be competitive with alternative
routes of delivery. Further, there can be no assurance that the Company's
pulmonary delivery system will prove to be safe or provide reproducible dosages
of stable formulations sufficient to achieve clinical efficacy, regulatory
approval or market acceptance. In addition, there can be no assurance that
Inhale will advance the numerous aspects of product and business development
such that delays in overall product development do not occur. The failure to
demonstrate pulmonary bioavailability, achieve total system efficiency, provide
safe, reproducible dosages of stable formulations or advance on a timely basis
the numerous aspects of product and business development would have a material
adverse effect on the Company. See "Risk Factors -- Dependence Upon
Collaborative Partners" and "-- Government Regulation; Uncertainty of Obtaining
Regulatory Approval;" "Business -- Inhale's Pulmonary Device System" and "--
Government Regulation."
UNCERTAINTIES RELATED TO CLINICAL TRIALS. The Company has limited
experience in conducting clinical trials and intends to rely primarily on the
pharmaceutical companies with which it collaborates, including Pfizer and Lilly.
The Company is responsible for managing the clinical trials in its collaboration
with Baxter. Before seeking regulatory approvals for the commercial sale of
products under development, the
19
Company must demonstrate through pre-clinical studies and clinical trials that
such products are safe and effective for use in the target indications. The
results from pre-clinical studies and early clinical trials may not be
indicative of results that will be obtained in large-scale testing, and there
can be no assurance that the Company's clinical trials will demonstrate
sufficient safety and efficacy to obtain the requisite regulatory approvals or
will result in marketable products. Clinical trials are also often conducted
with patients having advanced stages of disease. During the course of treatment,
these patients can die or suffer other adverse medical effects for reasons that
may not be related to the pharmaceutical agent being tested but which can
nevertheless affect clinical trial results. A number of companies in the
pharmaceutical industry have suffered significant setbacks in advanced clinical
trials, even after promising results in earlier trials. Clinical trials for
products being developed by the Company and its partners may be delayed by many
factors, including enrolling a sufficient number of patients fitting the
appropriate trial profile. If any of the Company's products under development
are not shown to be safe and effective in clinical trials, the resulting delays
in developing other compounds and conducting related pre-clinical testing and
clinical trials, as well as the need for additional financing, would have a
material adverse effect on the Company.
HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY. The
Company has not been profitable since inception and, through December 31, 1997,
has incurred a cumulative deficit of approximately $37.6 million. The Company
expects to continue to incur substantial and increasing losses over at least the
next several years as the Company's research and development efforts,
preclinical and clinical testing activities and manufacturing scale-up efforts
expand and as the Company plans and builds its late stage clinical and early
commercial production facility. All of the Company's potential products are in
research or in the early stages of development, and no revenues have been
generated from approved product sales. The Company's revenues to date have
consisted primarily of payments under short-term research and feasibility
agreements and development contracts. To achieve and sustain profitable
operations, the Company, alone or with others, must successfully develop, obtain
regulatory approval for, manufacture, introduce, market and sell products
utilizing its pulmonary drug delivery system. There can be no assurance that the
Company can generate sufficient product or contract research revenue to become
profitable or to sustain profitability. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
DEPENDENCE UPON COLLABORATIVE PARTNERS. The Company currently does not
possess the resources necessary to develop, obtain regulatory approvals, or
commercialize any of its potential therapeutic products. The Company's ability
to apply its pulmonary delivery system to a broad range of drugs will depend
upon its ability to establish and maintain collaborative arrangements since many
of the drugs currently approved for sale or in clinical testing are covered by
third-party patents. The Company has entered into collaborative arrangements
with certain of its partners to fund clinical trials, assist in obtaining
regulatory approvals, supply drugs for formulation and market and distribute
products. While Inhale has also entered into agreements with partners to test
the feasibility of its pulmonary delivery system with certain of their
proprietary molecules, there can be no assurance that the Company will be able
to enter into additional collaborations or that its feasibility agreements will
lead to collaborations. There also can be no assurance that the Company will be
able to maintain any such collaborative arrangements or feasibility agreements
or that any such collaborative arrangements or feasibility agreements will be
successful. The failure of the Company to enter into or maintain such
collaborative arrangements and feasibility agreements would have a material
adverse effect on the Company. Moreover, the inability of the Company to enter
into a collaborative arrangement with the owner of any patented drug may
preclude the Company from working with such drug. Beginning in October 1997,
Inhale announced that it plans to renegotiate with Baxter certain terms of their
collaboration agreement to address concerns raised by both parties about the
overall scope and cost of the collaborative arrangement. There can be no
assurance that the parties will be able to reach agreement or that the
collaborative arrangement between Inhale and Baxter will be continued. See
"Business -- Inhale's Pulmonary Drug Delivery Programs in Progress."
20
The Company's existing partners have rights to pursue parallel development
of other drug delivery systems which may compete with the Company's pulmonary
drug delivery system and to terminate their agreements with the Company at any
time without significant penalty. The Company anticipates that any future
partners would have similar rights. Although the Company intends generally to
formulate and manufacture powders for partners and to supply inhalation devices
for such powders, certain partners may choose to formulate or manufacture their
own powders, or to develop or supply their own device, thereby limiting one or
more potential sources of revenue for Inhale. In addition, the Company
anticipates that it may be precluded from entering into new arrangements with
companies whose products compete with those of its existing partners. The
Company also has limited or no control over the resources that any partner may
devote to the Company's products, over partners' development efforts, including
the design and conduct of clinical trials, and over the pricing of any such
products. The pharmaceutical and biotechnology industries are consolidating, and
acquisitions by, or of, the Company's existing or potential collaborative
partners may affect the initiation or continuation of any such collaborations.
There can be no assurances that any of the Company's present or future
collaborative partners will perform their obligations as expected, will devote
sufficient resources to the development, clinical testing or marketing of the
Company's potential products or will not terminate their agreements with the
Company prematurely or renegotiate such agreements. Any parallel development by
a partner of alternate drug delivery systems, development by a partner rather
than by Inhale of components of the delivery system, preclusion from entering
into competitive arrangements, failure to obtain timely regulatory approvals,
premature termination of an agreement, renegotiation of an agreement, or failure
by a partner to devote sufficient resources to the development and
commercialization of the Company's products would have a material adverse effect
on the Company. See "Risk Factors -- Dependence Upon Proprietary Technology;
Uncertainty of Obtaining Licenses or Developing Technology;" and "Business --
Inhale's Pulmonary Drug Delivery Programs in Progress."
LIMITED MANUFACTURING EXPERIENCE; RISK OF SCALE-UP. To achieve the levels
of production of Inhale's dry powder drug formulations necessary to support late
stage human clinical trials and for early commercialization of any of such
products, the Company will need to scale-up its current powder processing
facilities and automated filling, build a late stage clinical and early
commercial production facility, and comply with the good manufacturing practice
("GMP") standards prescribed by the United States Food and Drug Administration
("FDA") and other standards prescribed by various federal, state and local
regulatory agencies in the United States and any other country of use.
The Company has no experience manufacturing products for large scale
clinical testing or commercial purposes. To date, the Company has performed
powder processing on the small scale needed for early stage trials and for
testing formulations of certain other potential therapeutic products and
scaled-up powder processing for larger clinical trials. There can be no
assurance that manufacturing and control problems will not arise as the Company
attempts to further scale-up its powder processing facilities or that such
scale-up can be achieved in a timely manner or at a commercially reasonable
cost. Any failure to surmount such problems could delay or prevent late stage
clinical testing and commercialization of the Company's products and would have
a material adverse effect on the Company. To date, the Company has relied on a
particular method of powder processing. There can be no assurance that this
technology will be applicable to all drugs or that the drug losses in powder
processing will not be too high for commercial viability for certain drugs. In
the event that the Company decides to pursue alternative powder processing
methods for some or all of its drugs, there can be no assurance that these
methods will prove commercially practical for aerosol drugs or that the Company
will have or be able to acquire rights to use such alternative methods. See
"Risk Factors -- Dependence Upon Proprietary Technology; Uncertainty of
Obtaining Licenses or Developing Technology."
Fine particle powders and small quantity packaging (such as those to be used
in the Company's delivery system) require special handling. The Company has
designed and qualified small scale automated filling equipment for small
quantity packaging of fine powders. The Company faces significant technical
21
challenges scaling-up an automated filling system that can accurately and
economically handle the small dose and particle sizes of its powders in
commercial quantities. There can be no assurances that the Company will be able
to scale-up its automated filling equipment in a timely manner or at
commercially reasonable costs. Any failure or delay in such scale-up would delay
product development or bar commercialization of the Company's products and would
have a material adverse effect on the Company.
The Company also faces technical challenges in further developing its
inhalation device to achieve the efficiency necessary to deliver a broad range
of drugs, to produce such a device in quantities sufficient for later stage
clinical trials and early commercialization, and to adapt the device as may be
required for different powder formulations. There can be no assurance that
Inhale will successfully achieve such efficiencies, will be able to produce such
quantities or will be able to adapt the device as required. The failure of the
Company to overcome any such challenges would have a material adverse effect on
the Company. For late stage clinical trials and initial commercial production,
the Company intends to use one or more contract manufacturers to produce its
device. There can be no assurance that Inhale will be able to enter into or
maintain such arrangements. The failure of the Company to enter into and
maintain such arrangements would have a material adverse effect on the Company.
See "Risk Factors -- No Assurance of Successful Development or Commercialization
of Drugs for Pulmonary Delivery;" and "Business -- Manufacturing."
UNCERTAINTY OF MARKET ACCEPTANCE. The commercial success of the Company's
pulmonary drug delivery system will depend upon market acceptance by health care
providers, payors and patients. The Company's products under development use a
new method of drug delivery, and there can be no assurance that any of the
Company's products under development will ever achieve market acceptance. Market
acceptance will depend on many factors, including the safety and efficacy
results of the Company's clinical trials, favorable regulatory approval and
product labeling, the frequency of administration, the availability of
third-party reimbursement, the availability of alternative technologies and the
price of the Company's products relative to alternative technologies. There can
be no assurance that health care providers, patients or third-party payors will
accept the Company's pulmonary drug delivery system and the failure to do so
would have a material adverse effect on the Company.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company's
operations to date have consumed substantial and increasing amounts of cash. The
negative cash flow from operations is expected to continue and to accelerate in
the foreseeable future. The development of the Company's technology and proposed
products will require a commitment of substantial funds to conduct costly and
time-consuming research, preclinical and clinical testing, establish an early
commercial production facility and bring any such products to market. The
Company's future capital requirements will depend on many factors, including
continued progress in the research and development of the Company's technology
and drug delivery system, the ability of the Company to establish and maintain
collaborative arrangements with others and the terms thereof, payments received
from partners under research and development agreements, progress with
preclinical and clinical trials, the time and costs involved in obtaining
regulatory approvals, the cost of development and the rate of scale-up of the
Company's powder processing and packaging technologies, the timing and costs of
its late stage clinical and early commercial production facility, the cost
involved in preparing, filing, prosecuting, maintaining and enforcing patent
claims, the need to acquire licenses to new technology and the status of
competitive products. See "Risk Factors -- Dependence Upon Collaborative
Partners."
The Company expects that its existing capital resources, contract research
revenues from collaborations and the net proceeds from the November 1997 public
offering and the interest thereon, will enable the Company to maintain its
current and planned operations at least through 1999. Thereafter, the Company
may need to raise substantial additional capital to fund its operations. The
Company intends to seek such additional funding through collaborative or
partnering arrangements, the extension of existing arrangements, or through
public or private equity or debt financings. There can be no assurance that
additional financing will be available on acceptable terms or at all. If
additional funds are raised by issuing
22
equity securities, further dilution to shareholders may result. If adequate
funds are not available, the Company may be required to delay, reduce the scope
of, or eliminate one or more of its research or development programs or obtain
funds through arrangements with collaborative partners or others that may
require the Company to relinquish rights to certain of its technologies, product
candidates or products that the Company would otherwise seek to develop or
commercialize. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and "Use of Proceeds."
DEPENDENCE UPON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF OBTAINING LICENSES OR
DEVELOPING TECHNOLOGY. The Company's success will depend in part upon protecting
its proprietary technology from infringement, misappropriation, duplication and
discovery. The Company intends to rely principally on a combination of patent
law, trade secrets and contract law to protect its proprietary technology in the
United States and abroad. Inhale has filed patent applications covering certain
aspects of its device, powder processing technology, and powder formulations and
pulmonary route of delivery for certain molecules, and plans to file additional
patent applications. On October 17, 1995 the PTO issued U.S. Patent No.
5,458,135 to Inhale covering the use of its device as a method for delivering
powder formulations of drugs to the lung. There can be no assurance that any of
the patents applied for by the Company will issue, or that any patents that
issue will be valid and enforceable. Even if such patents are enforceable, the
Company anticipates that any attempt to enforce its patents could be time
consuming and costly.
The patent positions of pharmaceutical, biotechnology and drug delivery
companies, including Inhale, are uncertain and involve complex legal and factual
issues. Additionally, the coverage claimed in a patent application can be
significantly reduced before the patent is issued. As a consequence, the Company
does not know whether any of its patent applications will result in the issuance
of patents or, if any patents issue, whether they will provide significant
proprietary protection or will be circumvented or invalidated. Since patent
applications in the United States are maintained in secrecy until patents issue,
and since publication of discoveries in the scientific or patent literature
often lag behind actual discoveries, the Company cannot be certain that it was
the first inventor of inventions covered by its pending patent applications or
that it was the first to file patent applications for such inventions. Moreover,
the Company may have to participate in interference proceedings declared by the
PTO to determine priority of invention, which could result in substantial cost
to the Company, even if the eventual outcome is favorable to the Company. An
adverse outcome could subject the Company to significant liabilities to third
parties, require disputed rights to be licensed from or to third parties or
require the Company to cease using the technology in dispute.
The Company is aware of numerous pending and issued U.S. and foreign patent
rights and other proprietary rights owned by third parties that relate to
aerosol devices and delivery, pharmaceutical formulations, dry powder processing
technology and the pulmonary route of delivery for certain macromolecules. The
Company cannot predict with any certainty which, if any, patents and patent
applications will be considered relevant to the Company's technology by
authorities in the various jurisdictions where such rights exist, nor can the
Company predict with certainty which, if any, of these rights will or may be
asserted against it by such third parties. The Company is aware of an alternate
dry powder processing technology which Inhale is not using for its current
products under development but may desire to use for certain products in the
future. The ownership of this powder processing technology is unclear and the
Company is aware that multiple parties, including Inhale, claim patent, trade
secret and other rights in the technology. If the Company determines that this
alternate powder processing technology is relevant to the development of future
products and further determines that a license to this alternate powder
processing technology is needed, there can be no assurance that the Company can
obtain a license from the relevant party or parties on commercially reasonable
terms, if at all. The Company is also aware of an issued U.S. patent which
covers a broad range of macromolecule drugs in dry formulations. The Company is
evaluating the validity of this patent, its relevance to the Company's products
and whether the license proposed by the patent owner is of interest to the
Company. There can be no assurance that the Company can obtain any license to
any technology that the Company determines it needs, on reasonable
23
terms, if at all, or that Inhale could develop or otherwise obtain alternate
technology. The failure of the Company to obtain licenses if needed would have a
material adverse effect on the Company.
In June 1997, the Company acquired the intellectual property portfolio of
the BioPreservation Division of Pafra Limited of Basildon, England ("Pafra").
This portfolio includes issued U.S. and foreign Letters Patent and pending
applications relating to the stabilization of macromolecule drugs in dry
formulations. A granted European patent included in this portfolio is currently
the subject of an opposition proceeding before the European Patent Office and
the Company is continuing the defense of this patent, the opposition to which
was initiated prior to the acquisition. There can be no assurance that the
Company will be successful in the defense of this opposition proceeding. In
addition, there can be no assurance that any of the Pafra patent applications
will issue, or that any Pafra patents will be valid and enforceable. The loss of
the opposition proceeding or the inability to obtain or defend the Pafra patents
could have a material adverse effect on the Company.
Third parties from time to time have asserted and may assert that the
Company is employing technology that they believe is based on issued patents,
trade secrets or know-how of others. In addition, future patents may issue to
third parties which the Company's technology may infringe. The Company could
incur substantial costs in defending itself and its partners against any such
claims. Furthermore, parties making such claims may be able to obtain injunctive
or other equitable relief which could effectively block the Company's ability to
further develop or commercialize some or all of its products in the United
States and abroad, and could result in the award of substantial damages. In the
event of a claim of infringement, the Company and its partners may be required
to obtain one or more licenses from third parties. There can be no assurances
that the Company or its partners will be able to obtain such licenses at a
reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such
license could have a material adverse effect on the Company.
The Company's ability to develop and commercialize its technology will be
affected by the Company's or its partners' access to the drugs which are to be
formulated. Many drugs, including powder formulations of certain drugs which are
presently under development by the Company, are subject to issued and pending
United States and foreign patent rights which may be owned by competing
entities. There are issued patents and pending patent applications relating to
the pulmonary delivery of macromolecule drugs, including several for which the
Company is developing pulmonary delivery formulations. Specifically, patents
have been granted in the United States and Europe directed to aerosol
formulations for the treatment of the lung containing alpha-1 antitrypsin (U.S.)
and serine protease inhibitors, including alpha-1 antitrypsin (Europe). The
Company's development partner for alpha-1 antitrypsin, Centeon, is negotiating
with multiple partners to secure rights under these patents. The failure by
Centeon to secure rights under these patents could result in the termination of
this program by Centeon. The resulting patent situation is highly complex, and
the ability of any one company to commercialize a particular biopharmaceutical
drug is highly unpredictable. The Company intends generally to rely on the
ability of its partners to provide access to the drugs which are to be
formulated for pulmonary delivery. There can be no assurance that the Company's
partners will be able to provide access to drug candidates for formulation for
pulmonary delivery or that, if such access is provided, the Company or its
partners will not be accused of, or determined to be, infringing a third party's
rights and will not be prohibited from working with the drug or be found liable
for damages that may not be subject to indemnification. Any such restriction on
access or liability for damages would have a material adverse effect on the
Company.
The Company also will rely on trade secrets and contract law to protect
certain of its proprietary technology. There can be no assurance that any such
contract will not be breached, or that if breached, the Company will have
adequate remedies. Furthermore, there can be no assurance that any of the
Company's trade secrets will not become known or independently discovered by
third parties.
In 1995 the PTO adopted changes to the United States patent law that changed
the term of issued patents, subject to certain transition periods, to 20 years
from the date of filing rather than 17 years from
24
date of issuance. Beginning in June 1995, the patent term became 20 years from
the earliest effective filing date of the underlying patent application. Such
change may reduce the effective term of protection for patents that are pending
for more than three years in the PTO. In addition, as of January 1996, all
inventors who work outside of the United States are able to establish a date of
invention on the same basis as those working in the United States. Such change
could adversely affect the ability of the Company to prevail in a priority of
invention dispute with a third party located or doing work outside of the United
States. While the Company cannot predict the effect that such changes will have
on its business, such changes could have a material adverse effect on the
Company's ability to protect its proprietary information and sustain the
commercial viability of its products. Furthermore, the possibility of extensive
delays in such process, could effectively further reduce the term during which a
marketed product could be protected by patents. See "Risk Factors -- Dependence
Upon Collaborative Partners," "-- Government Regulation; Uncertainty of
Obtaining Regulatory Approval;" and "Business -- Patents and Proprietary
Rights."
DEPENDENCE UPON AND NEED TO ATTRACT KEY PERSONNEL. The Company is highly
dependent upon the principal members of its scientific and management staff. The
Company does not have employment contracts with its key employees, nor does the
Company have key man insurance policies on them. The Company also relies on
consultants and advisors to assist the Company in formulating research and
development strategy. To pursue its product development and commercialization
plans, the Company will be required to hire additional qualified scientific
personnel to perform research and development, as well as personnel with
expertise in clinical testing, government regulation and manufacturing.
Expansion in product development and manufacturing also is expected to require
the addition of management personnel and the development of additional expertise
by existing management personnel. Retaining and attracting qualified personnel,
consultants and advisors will be critical to the Company's success. The Company
faces competition for qualified individuals from numerous pharmaceutical,
biotechnology and drug delivery companies, universities and other research
institutions. There can be no assurance that the Company will be able to retain
its current key employees or attract and retain qualified additional personnel
and management when needed and its failure to do so would have a material
adverse effect on the Company's ability to develop and commercialize products.
GOVERNMENT REGULATION; UNCERTAINTY OF OBTAINING REGULATORY APPROVAL. The
production and marketing of the Company's products and its ongoing research and
development activities are subject to regulation by numerous governmental
authorities in the United States and other countries. Prior to marketing a new
dosage form of any drug, including one developed for use with the Company's
pulmonary drug delivery system, whether or not such drug was already approved
for marketing in another dosage form, the product must undergo rigorous
preclinical and clinical testing and an extensive review process mandated by the
FDA and equivalent foreign authorities. These processes generally take a number
of years and require the expenditure of substantial resources. None of the
Company's proposed products has been submitted to the FDA for marketing
approval. The Company has no experience obtaining such regulatory approval, does
not have the expertise or other resources to do so and intends to rely on its
partners to fund clinical testing and to obtain product approvals. See "Risk
Factors -- Dependence Upon Collaborative Partners."
The time required for completing such testing and obtaining such approvals
is uncertain. Further refinement of the device prototype, further scale-up of
the powder processing system and automated powder filling and packaging system
will need to be accomplished before initiation of later stage clinical trials.
Any delay in any of these components of product development may delay testing.
In addition, delays or rejections may be encountered based upon changes in FDA
policy, including FDA policy relating to GMP compliance, during the period of
product development. Similar delays may also be encountered in other countries.
If regulatory approval of a product is granted, such approval may entail
limitations on the indicated uses for which the product may be marketed, and the
marketed product, its manufacturer, and its manufacturing facilities remain
subject to continual review and periodic inspections. Later discovery of
previously unknown problems with a product, manufacturer or facility may result
in restrictions on such
25
product or manufacturer, including withdrawal of the product from the market.
There can be no assurance that regulatory approval will be obtained for any
products developed by the Company on a timely basis, or at all. The failure to
obtain timely regulatory approval of its products, any product marketing
limitations or a product withdrawal would have a material adverse effect on the
Company. See "Business -- Government Regulation."
UNCERTAINTY RELATED TO THE HEALTH CARE INDUSTRY AND THIRD-PARTY
REIMBURSEMENT. Political, economic and regulatory influences are subjecting the
health care industry in the United States to fundamental change. Recent
initiatives to reduce the federal deficit and to reform health care delivery are
increasing cost-containment efforts. The Company anticipates that Congress,
state legislatures and the private sector will continue to review and assess
alternative benefits, controls on health care spending through limitations on
the growth of private health insurance premiums and Medicare and Medicaid
spending, the creation of large insurance purchasing groups, price controls on
pharmaceuticals and other fundamental changes to the health care delivery
system. Any such proposed or actual changes could cause the Company or its
collaborative partners to limit or eliminate spending on development projects.
Legislative debate is expected to continue in the future, and market forces are
expected to demand reduced costs. Inhale cannot predict what effect the adoption
of any federal or state health care reform measures or future private sector
reforms may have on its business.
In both domestic and foreign markets, sales of the Company's products under
development will depend in part upon the availability of reimbursement from
third-party payors, such as government health administration authorities,
managed care providers, private health insurers and other organizations. In
addition, other third-party payors are increasingly challenging the price and
cost effectiveness of medical products and services. Significant uncertainty
exists as to the reimbursement status of newly approved health care products.
There can be no assurance that the Company's proposed products will be
considered cost effective or that adequate third-party reimbursement will be
available to enable Inhale to maintain price levels sufficient to realize an
appropriate return on its investment in product development. Legislation and
regulations affecting the pricing of pharmaceuticals may change before the
Company's proposed products are approved for marketing. Adoption of such
legislation could further limit reimbursement for medical products. If adequate
coverage and reimbursement levels are not provided by the government and
third-party payors for the Company's potential products, the market acceptance
of these products would be adversely affected, which would have a material
adverse effect on the Company.
HIGHLY COMPETITIVE INDUSTRY; RISK OF TECHNOLOGICAL OBSOLESCENCE. The
biotechnology and pharmaceutical industries are highly competitive and rapidly
evolving and significant developments are expected to continue at a rapid pace.
The Company's success depends upon maintaining a competitive position in the
development of products and technologies for pulmonary delivery of
pharmaceutical drugs. If a competing company were to develop or acquire rights
to a better dry powder pulmonary delivery device or fine powder processing
technology, a better system for efficiently and reproducibly delivering drugs to
the deep lung, a non-invasive drug delivery system which is more attractive for
the delivery of drugs than pulmonary delivery, or an invasive delivery system
which overcomes some of the drawbacks of current invasive systems for chronic or
subchronic indications (such as a sustained release system), the Company's
business could be materially adversely affected.
The Company is in competition with pharmaceutical, biotechnology and drug
delivery companies, hospitals, research organizations, individual scientists and
nonprofit organizations engaged in the development of alternative drug delivery
systems or new drug research and testing, as well as with entities producing and
developing injectable drugs. The Company is aware of a number of companies
currently seeking to develop new products and non-invasive alternatives to
injectable drug delivery, including oral delivery systems, intranasal delivery
systems, transdermal systems and colonic absorption systems. Several of these
companies may have developed or be developing dry powder devices that could be
used for pulmonary delivery. The Company is also aware of other companies
currently engaged in the development and commercialization of pulmonary drug
delivery systems and enhanced injectable drug delivery systems.
26
Many of these companies and entities have greater research and development
capabilities, experience, manufacturing, marketing, financial and managerial
resources than the Company and represent significant competition for the
Company. Acquisitions of competing drug delivery companies by large
pharmaceutical companies could enhance competitors' financial, marketing and
other resources. Accordingly, the Company's competitors may succeed in
developing competing technologies, obtaining FDA approval for products or gain
market acceptance more rapidly than the Company. There can be no assurance that
developments by others will not render the Company's products or technologies
uncompetitive or obsolete.
PRODUCT LIABILITY; AVAILABILITY OF INSURANCE. The design, development and
manufacture of the Company's products involve an inherent risk of product
liability claims and associated adverse publicity. Although the Company
currently maintains general liability insurance, there can be no assurance that
the coverage limits of the Company's insurance policies will be adequate. The
Company obtained clinical trial product liability insurance of $3.0 million per
event for certain clinical trials and intends to obtain insurance for future
clinical trials of insulin and other products under development. There can be no
assurance, however, that the Company will be able to obtain or maintain
insurance for any future clinical trials. Such insurance is expensive, difficult
to obtain and may not be available in the future on acceptable terms, or at all.
A successful claim brought against the Company in excess of the Company's
insurance coverage would have a material adverse effect upon the Company and its
financial condition.
HAZARDOUS MATERIALS. The Company's research and development involves the
controlled use of hazardous materials, chemicals and various radioactive
compounds. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state
and federal regulations, the risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of such an
accident, the Company could be held liable for any damages that result and any
such liability could exceed the resources of the Company. The Company may incur
substantial costs to comply with environmental regulations.
ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's Restated
Articles of Incorporation and the California General Corporation Law could
discourage a third party from attempting to acquire, or make it more difficult
for a third party to acquire, control of the Company without approval of the
Company's Board of Directors. Such provisions could also limit the price that
certain investors might be willing to pay in the future for shares of Common
Stock. Certain of the provisions allow the Board of Directors to authorize the
issuance of Preferred Stock with rights superior to those of the Common Stock.
The Company also will be subject to the provisions of Section 1203 of the
California General Corporation Law which requires a fairness opinion to be
provided to the Company's shareholders in connection with their consideration of
any proposed "interested party" reorganization transaction.
POTENTIAL VOLATILITY OF STOCK PRICE. The market prices for securities of
early stage biotechnology companies have historically been highly volatile and
the market from time to time experienced significant price and volume
fluctuations that are unrelated to the operating performance of particular
companies. Factors such as fluctuations in the Company's operating results,
announcements of technological innovations or new therapeutic products or the
announcement or termination of collaborative relationships by the Company or its
competitors, governmental regulation, clinical trial results, developments in
patent or other proprietary rights, public concern as to the safety of drug
formulations developed by the Company or others and general market conditions
may have a significant effect on the market price of the Common Stock. The
Company's securities are subject to a high degree of risk and volatility. In the
past, following periods of volatility in the market price of a company's
securities, class action securities litigation has often been instituted against
such a company. Any such litigation instigated against the Company could result
in substantial costs and a diversion of management's attention and resources,
which could have a material adverse effect on the Company's business, financial
condition and operating results. See "Price Range of Common Stock."
27
ITEM 2. PROPERTIES
Inhale currently leases approximately 121,000 square feet in San Carlos,
California and 35,000 square feet in Palo Alto, California. The space in Palo
Alto is used for research, development, administration and manufacturing of
drugs for early stage clinical trials. This manufacturing facility operates
under Good Manufacturing Practices and has been validated and licensed by the
State of California to manufacture clinical supplies for use in human clinical
trials. The lease is for a five year term, ending May 31, 1998, and provides
Inhale with an option to renew at the then fair market value for one building at
its Palo Alto facility and an option at a fixed rate for the other building at
such facility, both of which expire on May 31, 2003. In October 1997, the
Company exercised its option to extend the term of the lease for one building
for an additional five years at the Consumer Price Index to the current rate.
The Company declined to exercise its option to extend the lease term for the
second building at the then fair market value.
The San Carlos facility is leased pursuant to a 15-year lease agreement. The
Company intends to consolidate its operations into this facility over the next
twelve months and intends to use the facility as its initial commercial
manufacturing site. The lease provides Inhale with an option to lease
approximately 100,000 additional square feet in the same facility.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders in the
quarter ended December 31, 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and positions of the
executive officers of the Company:
NAME AGE POSITION
- ------------------------ --- -------------------------------------------------------------
Robert B. Chess 41 President, Chief Executive Officer and Director
Ajit S. Gill 49 Chief Operating Officer
Stephen L. Hurst 42 Vice President, Intellectual Property and Licensing
John S. Patton, Ph.D. 51 Vice President, Research and Director
Robert M. Platz 46 Vice President, Technology
ROBERT B. CHESS has served as President of the Company since December 1991
and as Chief Executive Officer since May 1992. Mr. Chess was also elected a
Director of the Company in May 1992. From September 1990 until October 1991, he
was an Associate Deputy Director in the White House Office of Policy
Development. In March 1987, Mr. Chess co-founded Penederm Incorporated
("Penederm"), a topical dermatological drug delivery company, and served as its
President until February 1989. He left Penederm in October 1989. Prior to
co-founding Penederm, Mr. Chess held management positions at Intel Corp., a
semiconductor manufacturer, and Metaphor, a computer software company (acquired
by International Business Machines). Mr. Chess holds a BS in Engineering from
the California Institute of Technology and an MBA from the Harvard Business
School.
AJIT S. GILL, Chief Operating Officer, has also served as the Company's
Chief Financial Officer from January 1993 until October 1996. Mr. Gill has
experience in building new businesses. Before joining Inhale, Mr. Gill was Vice
President and General Manager of Kodak's Interactive Systems division. Mr. Gill
has served as Chief Financial Officer for TRW-Fujitsu, Director of Business
Development for Visicorp, and as start-up President for three high technology
companies. He completed a BTech at the Indian Institute of Technology, an MS in
Electrical Engineering from the University of Nebraska, and holds an MBA from
the University of Western Ontario.
28
STEPHEN L. HURST has been Vice President, Intellectual Property and
Licensing of the Company since March 1994. From July 1990 to February 1994, Mr.
Hurst was in private law practice and consulted with COR Therapeutics, Inc., a
biotechnology company, on intellectual property and business development issues.
From November 1987 to June 1990, he was the Campus Patent Coordinator for the
University of California, San Francisco. He also worked as an Associate Counsel
at Townsend & Townsend, the San Francisco area's largest intellectual property
law firm. He received a BS degree in Environmental Science from the University
of California at Berkeley and his JD from Golden Gate University in San
Francisco.
JOHN S. PATTON, PH.D., a co-founder of Inhale, has been Vice President,
Research since December 1991 and a Director of the Company since July 1990. He
served as President of the Company from its incorporation in July 1990 to
December 1991. From 1985 to 1990, Dr. Patton was a Project Team Leader with
Genentech, Inc., a biotechnology company, where he headed their non-invasive
drug delivery activities. Dr. Patton was on the faculty of the Marine Science
and Microbiology Departments at the University of Georgia from 1979 through
1985, where he was granted tenure in 1984. Dr. Patton received a BS in Zoology
and Biochemistry from Pennsylvania State University, an MS from the University
of Rhode Island, a Ph.D. in Biology from the University of California, San Diego
and received post doctorate fellowships from Harvard Medical School and the
University of Lund, Sweden both in biomedicine.
ROBERT M. PLATZ, a co-founder of Inhale, has served as Vice President,
Technology of the Company since August 1990. He also served as a Director of the
Company from July 1990 to August 1991. From January 1983 to August 1991, Mr.
Platz was employed by SRI International, a contract research company, most
recently as Senior Chemical Engineer, where he headed the pharmaceutical aerosol
group. Mr. Platz received a BS in biology and an MS in Chemical Engineering from
the University of California, Los Angeles.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock trades on the Nasdaq National Market under the
symbol INHL. The table below sets forth the high and low sales prices for the
Company's Common Stock (as reported on the Nasdaq National Market) during the
periods indicated.
PRICE RANGE
OF COMMON STOCK
--------------------
YEAR ENDED DECEMBER 31, 1996: HIGH LOW
- ---------------------------------------------------------------------------------- --------- ---------
1st Quarter....................................................................... $ 16.750 $ 9.750
2nd Quarter....................................................................... 21.500 15.000
3rd Quarter....................................................................... 18.625 12.625
4th Quarter....................................................................... 17.625 12.875
YEAR ENDED DECEMBER 31, 1997:
- ----------------------------------------------------------------------------------
1st Quarter....................................................................... $ 22.625 $ 15.125
2nd Quarter....................................................................... 25.000 18.375
3rd Quarter....................................................................... 33.625 18.750
4th Quarter....................................................................... 36.500 25.000
As of December 31, 1997, there were approximately 118 holders of record of
the Company's Common Stock. The Company has not paid any cash dividends since
its inception and does not intend to pay any cash dividends in the foreseeable
future.
29
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Contract revenue.................................................... $ 16,249 $ 6,890 $ 3,445 $ 1,651 $ 708
Operating costs and expenses:
Research and development.......................................... 23,645 14,376 9,041 4,934 2,765
General and administrative........................................ 6,328 4,004 3,232 2,465 856
---------- ---------- --------- --------- ---------
Total operating costs and expenses.................................. 29,973 18,380 12,273 7,399 3,621
---------- ---------- --------- --------- ---------
Loss from operations................................................ (13,724) (11,490) (8,828) (5,748) (2,913)
---------- ---------- --------- --------- ---------
Net loss.......................................................... $ (9,983) $ (9,909) $ (7,662) $ (5,279) $ (2,861)
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
Net loss per share (pro forma in 1993 and 1994) (1)............... $ (0.72) $ (0.88) $ (0.78) $ (0.86) $ (0.48)
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
Shares used in computation of net loss per share (pro forma in 1993
and 1994) (1)..................................................... 13,792 11,207 9,837 6,103 5,969
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital..................................... $ 83,811 $ 31,304 $ 17,701 $ 13,451 $ 4,954
Total assets........................................ 119,762 41,492 23,248 17,249 7,190
Equipment financing obligations, less current
portion........................................... 5,102 187 353 460 652
Accumulated deficit................................. (37,642) (27,691) (17,770) (10,108) (4,829)
Shareholders' equity................................ 97,093 35,061 20,182 15,427 5,891
- ------------------------
No cash dividends have been paid for any of the periods presented.
(1) Basic and diluted net loss per share is based upon the weighted average
number of common and certain common equivalent shares outstanding. All share
amounts have been adjusted to reflect the implementation of FASB Statement
No. 128 and Staff Accounting Bulletin No. 98. See Note 1 of Notes to
Financial Statements.
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE DISCUSSED HERE. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THIS SECTION AS
WELL AS IN PART I OF THIS ANNUAL REPORT UNDER THE HEADING "RISK FACTORS".
OVERVIEW
Since its inception in July 1990, Inhale has been engaged in the development
of a pulmonary system for the delivery of macromolecules and other drugs for
systemic and local lung applications. The Company has been unprofitable since
inception and expects to incur significant and increasing additional operating
losses over the next several years primarily due to increasing research and
development expenditures and expansion of manufacturing facilities. To date,
Inhale has not sold any products and does not anticipate receiving revenue from
product sales or royalties in the near future. For the period from inception
through December 31, 1997, the Company incurred a cumulative net loss of
approximately $37.6 million. Inhale's sources of working capital have been
equity financings, financings of equipment acquisitions, interest earned on
investments of cash, and revenues from short term research and feasibility
agreements and development contracts.
Inhale typically has been compensated for research and development expenses
incurred during initial feasibility work as well as for work performed under
collaborative arrangements. Inhale's strategy is to enter into development
contracts with pharmaceutical and biotechnology corporate partners after
feasibility is demonstrated. Partners that enter into collaborative agreements
will pay for research and development expenses and will make payments to Inhale
as it achieves certain key milestones. Inhale expects to receive royalties from
its partners based on revenues received from product sales, and to receive
revenue from the manufacturing of powders and the supply of devices. In certain
cases, the Company may enter into collaborative agreements under which the
Company's partners would manufacture powders or supply inhalation devices,
thereby potentially limiting one or more sources of revenue for the Company. To
achieve and sustain profitable operations, the Company, alone or with others,
must successfully develop, obtain regulatory approval for, manufacture,
introduce, market and sell products utilizing its pulmonary drug delivery
system. There can be no assurance that the Company will be able to generate
sufficient product or contract research revenue to become profitable or to
sustain profitability.
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (year 2000) approaches. The "year
2000" problem is pervasive and complex as virtually every computer operation
will be affected in some way by the rollover of the two digit year value to 00.
The issue is whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
The Company is utilizing internal resources to conduct a comprehensive
review of its computer systems to identify the systems that could be affected by
the "year 2000" issue and is developing an implementation plan to resolve the
issue. The Company presently believes that, with modifications to existing
software and converting to new software, the "year 2000" problem will not pose
significant operational problems for the Company's computer systems as so
modified and converted. However, if such modifications and conversions are not
completed timely, the "year 2000" problem may have a material impact on the
operations of the Company.
31
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Contract research revenue was $16.2 million for the year ended December 31,
1997 compared to $6.9 million and $3.4 million for the years ended December 31,
1996 and 1995, respectively. Revenue increased 136% in 1997 from 1996 levels and
100% in 1996 from 1995 levels. Costs of contract research revenue approximate
such revenue and are included in research and development expense.
The 136% increase in revenue for the year ended December 31, 1997 as
compared to December 31, 1996 was primarily due to expansion of the Company's
existing collaborative agreements as well as the signing of additional corporate
partners in 1997. Contract revenues are expected to fluctuate from year to year,
and future contract revenues cannot be predicted accurately. The level of
contract revenues depends in part upon future success in obtaining new
collaborative agreements, timely completion of feasibility studies, the
continuation of existing collaborations and achievement of milestones under
current and future agreements.
Research and development expenses were $23.6 million for the year ended
December 31, 1997, as compared to $14.4 million and $9.0 million for the years
ended December 31, 1996 and 1995, respectively. These expenses represent
proprietary research expenses as well as the costs related to contract research
revenue and include salaries and benefits of scientific and development
personnel, laboratory supplies, consulting services, facilities, costs of
obtaining intellectual property protection for Inhale's technologies and
expenses associated with the development of manufacturing processes. The $9.3
million increase in research and development expenses in 1997 from 1996 and the
$5.3 million increase in research and development expenses in 1996 from 1995 are
primarily attributed to continued expansion of research activities resulting
from an increase in the number of projects, hiring of additional scientific
personnel, costs associated with the development of the Company's commercial
manufacturing facility and increased costs of laboratory supplies and consulting
services. The Company expects research and development and process development
spending to increase significantly over the next few years as the Company
expands its development efforts under collaborative agreements and plans, builds
and scales up a late stage clinical and early commercial manufacturing facility.
General and administrative expenses were $6.3 million for the year ended
December 31, 1997 as compared to $4.0 million and $3.2 million for the years
ended December 31, 1996 and 1995, respectively. The $2.3 million increase in
general and administrative expenses in 1997 from 1996 and the $772,000 increase
in 1996 from 1995 were due primarily to costs associated with supporting the
Company's increased research efforts including administrative staffing, business
development activities and marketing activities. General and administrative
expenses are expected to continue to increase over the next few years as the
Company expands its research, development and manufacturing activities.
Interest income was $3.8 million for the year ended December 31, 1997 as
compared to $1.6 million and $1.3 million for the years ended December 31, 1996
and 1995, respectively. The 132% increase in interest income in 1997 from 1996
was due to the Company maintaining larger cash and investment balances. The
higher cash and investment balances are a result of the Company receiving
research funding and milestone payments from collaborative partners, the
completion of a private placement of the Company's Common Stock in February 1997
which raised net proceeds of $30.5 million as well as the completion of a public
offering of the Company's Common Stock in November 1997 which raised net
proceeds of $40.0 million. The 31% increase in interest income in 1996 from 1995
was due primarily to interest earned on higher average cash balances as a result
of Baxter making a $20.0 million equity investment in Inhale at a 25%
premium-to-market price in conjunction with the March 1996 development agreement
between the Company and Baxter. In addition, in October 1996 Pfizer made an
additional $5.0 million investment in Inhale pursuant to the January 1995
agreement between the Company and Pfizer to develop insulin products using
Inhale's non-invasive pulmonary drug delivery system.
32
At December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $27.4 million. These carryforwards will expire
beginning in the year 2006. Utilization of net operating loss carryforwards may
be subject to substantial annual limitation due to the ownership change
limitation provided for by the Internal Revenue Code of 1986. The annual
limitation may result in the expiration of net operating loss carryforwards
before utilization.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through public and private
placements of its equity securities, contract research revenues, interest income
earned on its investments of cash and financing of equipment acquisitions. In
its initial public offering completed May 1994, the Company raised net proceeds
of approximately $14.4 million and raised additional net proceeds of $7.2
million in its public offering completed in March 1995. On February 7, 1997 the
Company completed a private placement of its Common Stock, selling 1.8 million
newly issued shares for net proceeds of $30.5 million. In November 1997 the
Company completed a public offering of its Common Stock, selling 1.725 million
newly issued shares for net proceeds of $40.0 million. In May 1997, the Company
obtained a $10 million line of credit which may be drawn upon to finance the
purchases of equipment and facility improvements. As of December 31, 1997, the
Company had not drawn on this line of credit. The Company secured a $5 million
loan in November 1997 to also finance the purchases of equipment and facility
improvements. At December 31, 1997, the Company had cash, cash equivalents and
short-term investments of approximately $100.2 million.
The Company's operations provided cash of $5.0 million and used cash of $5.8
million and $5.3 million in the years ended December 31, 1997, 1996 and 1995,
respectively. These amounts differed from the Company's net operating losses in
these periods principally due to increases in accounts payable and accrued
liabilities, depreciation expenses and deferred revenue. Additionally, in 1997
the Company recorded a non-cash transaction of $600,000 in connection with the
completion of a licensing agreement.
The Company purchased property and equipment of approximately $17.3 million,
$2.2 million and $1.3 million during the years ended December 31, 1997, 1996 and
1995, respectively. The increase for the year ended December 31, 1997 is
primarily due to the build out of the Company's new facility in San Carlos,
California as well as the acquisition of laboratory equipment to support its
research activities.
The Company expects its cash requirements to increase due to expected
increases in expenses related to the further research and development of its
technologies resulting from a larger number of projects, development of drug
formulations, process development for the manufacture and filling of powders and
devices, marketing and general and administrative costs. These expenses include,
but are not limited to, increases in personnel and personnel related costs,
purchases of capital equipment, inhalation device prototype construction and
facilities expansion, including the planning and building of a late stage
clinical and early stage commercial manufacturing facility.
The Company believes that its cash, cash equivalents and short-term
investments as of December 31, 1997 together with interest income and possible
additional equipment financing, will be sufficient to meet its operating expense
and capital expenditure requirements at least through 1999. However, the
Company's capital needs will depend on many factors, including continued
scientific progress in its research and development arrangements, progress with
pre-clinical and clinical trials, the time and costs involved in obtaining
regulatory approvals, the costs of developing and the rate of scale-up of the
Company's powder processing and packaging technologies, the timing and cost of
its late-stage clinical and early commercial production facility, the costs
involved in preparing, filing, prosecuting, maintaining and enforcing patent
claims, the need to acquire licenses to new technologies and the status of
competitive products. To satisfy its long-term needs, the Company intends to
seek additional funding, as necessary, from corporate partners and from the sale
of securities. There can be no assurance that additional funds, if and when
required, will be available to the Company on favorable terms, if at all.
33
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128")
which requires disclosure of basic earnings per share and diluted earnings per
share and is effective for periods ending subsequent to December 15, 1997. As
such, the Company adopted this standard for the year ended December 31, 1997.
In June 1997, the Financial Accounting Standards Board issued the Statement
of Financial Accounting Standard No. 130 "SFAS 130", "Reporting Comprehensive
Income," which the Company is required to adopt for its fiscal year ending
December 31, 1998. This Statement requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements.
In June 1997, the Financial Accounting Standards Board also issued the
Statement of Financial Accounting Standard No. 131 "SFAS 131", "Disclosures
about Segments of an Enterprise and Related Information," which the Company is
required to adopt for its fiscal year ending December 31, 1998. This Statement
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
disclosures about products and services, geographic areas, and major customers.
Both standards issued in June 1997 will require additional disclosures, but will
not have an effect on the Company's financial position or results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements for the years ended December 31, 1997, 1996 and
1995 are submitted as a separate section of this report. See Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Inhale incorporates by reference the information concerning its directors
set forth under the heading "Election of Directors" in Inhale's definitive Proxy
Statement to be filed for its 1998 Annual Meeting of Shareholders.
Information concerning Inhale's executive officers appears at the end of
Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
Inhale incorporates by reference the information set forth under the heading
"Executive Compensation" in the Company's definitive Proxy Statement to be filed
for its 1998 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Inhale incorporates by reference the information set forth under the heading
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's definitive Proxy Statement to be filed for its 1998 Annual Meeting of
Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Inhale incorporates by reference the information set forth under the heading
"Certain Transactions" in the Company's definitive Proxy Statement to be filed
for its 1998 Annual Meeting for Shareholders.
34
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The Financial Statements required by this item, with the report of
independent auditors, are submitted in a separate section beginning on page
F-1 of this report.
PAGE
---------
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Balance Sheets as of December 31, 1997 and 1996............................. F-3
Statements of Operations for each of the three years in the period ended
December 31, 1997........................................................... F-4
Statement of Shareholder's Equity for each of the three years in the period
ended December 31, 1997..................................................... F-5
Statements of Cash Flows for each of the three years in the period ended
December 31, 1997........................................................... F-6
Notes to Financial Statements............................................... F-7
(2) Financial Statement Schedules
Schedules have been omitted because the information required to be set forth
therein is not applicable or is shown in the Financial Statements or notes
thereto.
(3) Exhibits
The following exhibits are filed herewith or incorporated by reference:
EXHIBIT EXHIBIT TITLE
- ----------- -----------------------------------------------------------------------------------------------------
3.1 (3) Restated Articles of Incorporation of the Registrant.
3.2 (1) Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.1 through 3.2.
4.2 (1) Restated Investor Rights Agreement among the Registrant and certain other persons named therein,
dated April 29, 1993, as amended October 29, 1993.
4.5 (1) Warrant to purchase 18,182 Shares of Series C Preferred Stock between the Registrant and Phoenix
Leasing Incorporated, dated October 29, 1993.
4.6 (1) Specimen stock certificate.
4.9 (2) Stock Purchase Agreement between the Registrant and Pfizer Inc., dated January 18, 1995.
4.10 (8) Warrant to purchase 10,000 shares of Common Stock between the Registrant and Thomas J. Peirona, dated
November 1, 1996.
4.11 (8) Warrant to purchase 10,000 shares of Common Stock between the Registrant and Kiet Nguyen, dated
November 1, 1996.
4.12 (9) Form of Stock Purchase Agreement between the Registrant and the Selling Shareholders dated January
28, 1997.
10.1 (4) Registrant's 1994 Equity Incentive Plan (the "Equity Incentive Plan").
10.2 (1) Form of Incentive Stock Option under the Equity Incentive Plan.
10.3 (1) Form of Nonstatutory Stock Option under the Equity Incentive Plan.
10.4 (7) Registrant's 1994 Non-Employee Directors' Stock Option Plan, as amended.
10.5 (1) Registrant's 1994 Employee Stock Purchase Plan.
10.6 (1) Standard Industrial Lease between the Registrant and W.F. Batton & Co., Inc., dated September 17,
1992, as amended September 18, 1992.
35
EXHIBIT EXHIBIT TITLE
- ----------- -----------------------------------------------------------------------------------------------------
10.7 (1) Master Equipment Lease between the Registrant and Phoenix Leasing Incorporated, dated August 15, 1992
and Schedules i to 4 thereto.
10.8 (1) Senior Loan and Security Agreement between the Registrant and Phoenix Leasing Incorporated, dated
September 15, 1993.
10.9 (1) Sublicense Agreement between the Registrant and John S. Patton, dated September 13, 1991.
10.11 (2) Addendum to Lease dated September 17, 1992, between the Registrant and W.F. Batton and Marie A.
Batton.
10.12 (6) Lease dated May 31, 1995, between the Registrant and W.F. Batton and Marie A. Batton.
10.13 (6) Addendum Number One to Lease dated September 17, 1992, between the Registrant and W.F. Batton and
Marie A. Batton.
10.14 (6) Addendum to Lease dated May 31, 1995 between the Registrant and W.F. Batton and Marie A. Batton.
10.15 (6) Addendum Number Two to Lease dated September 17, 1992, between the Registrant and W.F. Batton and
Marie A. Batton.
10.16 (5) Stock Purchase Agreement between the Registrant and Baxter World Trade Corporation, dated March 1,
1996.
10.17 (8) Sublease and Lease Agreement, dated October 2, 1996 between the Registrant and T.M.T. Associates
L.L.C.
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney. Reference is made to page 36.
27.1 Financial Data Schedule
- ------------------------
(1) Incorporated by reference to the indicated exhibit in the Company's
Registration Statement (No. 33-75942), as amended.
(2) Incorporated by reference to the indicated exhibit in the Company's
Registration Statement (No. 33-89502), as amended.
(3) Incorporated by reference to the indicated exhibit in the Company's Annual
Report on Form 10-K for the year ended December 31, 1994.
(4) Incorporated by reference to the Company's Registration Statement on Form
S-8 (No. 333-07969).
(5) Incorporated by reference to the indicated exhibit in the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1996.
(6) Incorporated by reference to the indicated exhibit in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(7) Incorporated by reference to the indicated exhibit in the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.
(8) Incorporated by reference to the indicated exhibit in the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
(9) Incorporated by reference to the Company's Registration Statement on Form
S-3 (No. 333-20787)
(b) Reports on Form 8-K.
No Reports on Form 8-K were filed during the quarter ended December 31,
1997.
(c) See Exhibits listed under Item 14(a)(3).
(d) Not applicable. See Item 14(a)(2).
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 23rd day of March
1998.
INHALE THERAPEUTIC SYSTEMS
By: /s/ ROBERT B. CHESS
-----------------------------------------
Robert B. Chess
PRESIDENT, CHIEF EXECUTIVE OFFICER AND
DIRECTOR
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints, Robert B. Chess as his attorney-in-fact for him
in any and all capacities, to sign any and all amendments to this report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that the said attorney-in-fact, or his substitutes,
may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
President, Chief Executive
/s/ ROBERT B. CHESS Officer and Director
- ------------------------------ (PRINCIPAL EXECUTIVE March 23, 1998
Robert B. Chess OFFICER)
/s/ CHRISTIAN O. HENRY Corporate Controller
- ------------------------------ (CHIEF ACCOUNTING March 23, 1998
Christian O. Henry OFFICER)
/s/ JOHN S. PATTON
- ------------------------------ Vice President and March 23, 1998
John S. Patton Director
/s/ MARK J. GABRIELSON
- ------------------------------ Director March 23, 1998
Mark J. Gabrielson
/s/ JAMES B. GLAVIN
- ------------------------------ Director March 23, 1998
James B. Glavin
/s/ MELVIN PERELMAN
- ------------------------------ Director March 23, 1998
Melvin Perelman
/s/ TERRY L. OPDENDYK
- ------------------------------ Chairman of the Board March 23, 1998
Terry L. Opdendyk
37
INHALE THERAPEUTIC SYSTEMS
INDEX TO FINANCIAL STATEMENTS
PAGE
-----
Report of Ernst & Young LLP, Independent Auditors.......................................................... F-2
Balance Sheets at December 31, 1997 and 1996............................................................... F-3
Statements of Operations for each of the three years in the period ended December 31, 1997................. F-4
Statement of Shareholders' Equity for each of the three years in the period ended December 31, 1997........ F-5
Statements of Cash Flows for each of the three years in the period ended December 31, 1997................. F-6
Notes to Financial Statements.............................................................................. F-7
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders of
Inhale Therapeutic Systems
We have audited the accompanying balance sheets of Inhale Therapeutic
Systems as of December 31, 1997 and 1996, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Inhale Therapeutic Systems
at December 31, 1997 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Palo Alto, California
January 22, 1998
F-2
INHALE THERAPEUTIC SYSTEMS
BALANCE SHEETS
(IN THOUSANDS)
ASSETS
DECEMBER 31,
----------------------
1997 1996
---------- ----------
Current assets:
Cash and cash equivalents............................................................... $ 14,948 $ 18,568
Short-term investments.................................................................. 85,225 17,741
Other current assets.................................................................... 752 1,239
---------- ----------
Total current assets.................................................................. 100,925 37,548
Property and equipment, net............................................................... 18,694 3,770
Deposits and other assets................................................................. 143 174
---------- ----------
$ 119,762 $ 41,492
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................................ $ 5,975 $ 1,130
Accrued liabilities..................................................................... 3,812 1,746
Accrued compensation.................................................................... 558 479
Deferred revenue........................................................................ 6,686 2,723
Equipment financing obligations -- current portion...................................... 83 166
---------- ----------
Total current liabilities............................................................. 17,114 6,244
Equipment financing obligations........................................................... 5,102 187
Accrued rent.............................................................................. 453 --
Commitments (See Note 2)
Shareholders' equity:
Preferred stock, 10,000 shares authorized, no shares issued or outstanding.............. -- --
Common stock, no par value; 30,000 shares authorized; 15,542 shares and 11,835 shares
issued and outstanding at December 31, 1997 and 1996, respectively.................... 135,273 62,840
Deferred compensation................................................................... (538) (88)
Accumulated deficit..................................................................... (37,642) (27,691)
---------- ----------
Total shareholders' equity............................................................ 97,093 35,061
---------- ----------
$ 119,762 $ 41,492
---------- ----------
---------- ----------
See accompanying notes
F-3
INHALE THERAPEUTIC SYSTEMS
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ---------
Contract research revenue...................................................... $ 16,249 $ 6,890 $ 3,445
Operating costs and expenses:
Research and development..................................................... 23,645 14,376 9,041
General and administrative................................................... 6,328 4,004 3,232
---------- ---------- ---------
Total operating costs and expenses......................................... 29,973 18,380 12,273
---------- ---------- ---------
Loss from operations........................................................... (13,724) (11,490) (8,828)
Interest income................................................................ 3,807 1,638 1,252
Interest expense............................................................... (66) (57) (86)
---------- ---------- ---------
Net loss....................................................................... $ (9,983) $ (9,909) $ (7,662)
---------- ---------- ---------
---------- ---------- ---------
Basic and diluted net loss per share........................................... $ (0.72) $ (0.88) $ (0.78)
---------- ---------- ---------
---------- ---------- ---------
Shares used in basic and diluted net loss per share calculation................ 13,792 11,207 9,837
---------- ---------- ---------
---------- ---------- ---------
See accompanying notes
F-4
INHALE THERAPEUTIC SYSTEMS
STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
TOTAL
DEFERRED ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT COMPENSATION DEFICIT EQUITY
--------- ---------- --------------- ------------ -------------
Balance at December 31, 1994................... 8,656 $ 25,947 $ (412) $ (10,108) $ 15,427
Issuance of common stock in connection with a
collaborative agreement...................... 453 5,000 -- -- 5,000
Issuance of common stock in public offering,
net of issuance costs of $757................ 1,000 7,243 -- -- 7,243
Amortization of deferred compensation.......... -- -- 162 -- 162
Common stock issued upon exercise of stock
options...................................... 33 12 -- -- 12
Net loss....................................... -- -- -- (7,662) (7,662)
--------- ---------- ----- ------------ -------------
Balance at December 31, 1995................... 10,142 38,202 (250) (17,770) 20,182
Issuance of common stock in connection with
collaborative agreements, net of issuance
costs of $806................................ 1,608 24,196 -- -- 24,196
Amortization of deferred compensation.......... -- -- 162 -- 162
Common stock issued upon exercise of stock
options...................................... 85 442 -- -- 442
Unrealized loss on securities held as
available-for-sale........................... -- -- -- (12) (12)
Net loss....................................... -- -- -- (9,909) (9,909)
--------- ---------- ----- ------------ -------------
Balance at December 31, 1996................... 11,835 62,840 (88) (27,691) 35,061
Issuance of common stock in private placement,
net of issuance costs of $1,940.............. 1,800 30,460 -- -- 30,460
Issuance of common stock in connection with
licensing agreement.......................... 28 600 -- -- 600
Issuance of common stock in public offering,
net of issuance costs of $2,885.............. 1,725 40,024 -- -- 40,024
Common stock issued upon exercise of stock
options...................................... 125 798 -- -- 798
Issuance of common stock in connection with
exercise of warrant.......................... 29 -- -- -- --
Deferred compensation.......................... -- 551 (551) -- --
Amortization of deferred compensation.......... -- -- 101 -- 101
Unrealized gain on securities held as
available-for-sale........................... -- -- -- 32 32
Net loss....................................... -- -- -- (9,983) (9,983)
--------- ---------- ----- ------------ -------------
Balance at December 31, 1997................... 15,542 $ 135,273 $ (538) $ (37,642) $ 97,093
--------- ---------- ----- ------------ -------------
--------- ---------- ----- ------------ -------------
See accompanying notes
F-5
INHALE THERAPEUTIC SYSTEMS
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
1997 1996 1995
--------- --------- ---------
YEARS ENDED DECEMBER 31,
-------------------------------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net loss....................................................... $ (9,983) $ (9,909) $ (7,662)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................ 2,337 1,071 955
Amortization of deferred compensation........................ 101 162 162
Issuance of common stock in connection with licensing
agreement.................................................. 600 -- --
Increase (decrease) in other current assets, deposits and
other assets............................................... 518 (752) (110)
Increase in accounts payable and accrued liabilities......... 7,443 1,465 847
Increase in deferred revenue................................. 3,963 2,145 483
--------- --------- ---------
Net cash provided by (used in) operating activities............ 4,979 (5,818) (5,325)
--------- --------- ---------
CASH FLOWS USED IN INVESTING ACTIVITIES
Purchases of short-term investments............................ (483,247) (58,993) (49,318)
Sales of short-term investments................................ 80,662 2,020 7,812
Maturities of short-term investments........................... 335,133 55,313 29,326
Purchases of property and equipment, net....................... (17,261) (2,181) (1,340)
--------- --------- ---------
Net cash used in investing activities.......................... (84,713) (3,841) (13,520)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of equipment loan obligations......................... (85) (52) (32)
Payments of capital lease obligations.......................... (83) (193) (205)
Proceeds from tenant improvement loan.......................... 5,000 -- --
Issuance of equipment loan obligations......................... -- -- 151
Issuance of common stock, net of issuance costs................ 71,282 24,638 12,255
--------- --------- ---------
Net cash provided by financing activities...................... 76,114 24,393 12,169
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents........... (3,620) 14,734 (6,676)
Cash and cash equivalents at beginning of period............... 18,568 3,834 10,510
--------- --------- ---------
Cash and cash equivalents at end of period..................... $ 14,948 $ 18,568 $ 3,834
--------- --------- ---------
--------- --------- ---------
See accompanying notes
F-6
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Inhale Therapeutic Systems (the "Company") was incorporated in the State of
California in July 1990. Since inception, the Company has been engaged in the
development of systems for the pulmonary delivery of macromolecule drug
therapies for systemic and local lung applications.
The Company expects increasing losses over the next several years as
research and development efforts continue, and as the Company expands its
facilities for late stage clinical trials and early stage commercial
manufacturing. Management plans to continue to finance the Company primarily
through issuances of equity securities, research and development contract
revenue, and in the longer term, revenue from product sales and royalties. If
the financing arrangements contemplated by management are not consummated, the
Company may have to seek other sources of capital or reevaluate its operating
plans.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. Cash and cash
equivalents include demand deposits held in banks and interest bearing money
market funds. All other liquid investments are classified as short-term
investments. Short-term investments consist of federal and municipal government
securities, repurchase agreements or corporate commercial paper with A1 or P1
short-term ratings and A or better long-term ratings with remaining maturities
at date of purchase of greater than 90 days and less than one year. The Company
limits its concentration of risk by diversifying its investments among a variety
of industries and issuers. The Company has experienced no losses on its
investments.
At December 31, 1997, all short-term investments are designated as
available-for-sale and are carried at fair value, with material unrealized gains
and losses, if any, reported in shareholders' equity. The amortized cost of
securities is adjusted for amortization of material premiums and accretion of
discounts to maturity. Such amortization, if any, is included in interest
income. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities, if any, are included in
interest income. The cost of securities sold is based on the specific
identification method. Interest and dividends on
F-7
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
securities classified as available-for-sale are included in interest income. The
following is a summary of available-for-sale securities as of December 31, 1997:
AVAILABLE-FOR-SALE SECURITIES
----------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ------------- ------------- -----------
(IN THOUSANDS)
Obligations of U.S. government agencies.................. $ 19,943 $ -- $ -- $ 19,943
U.S. corporate commercial paper.......................... 70,584 20 -- 70,604
Repurchase agreements, secured by U.S. Government
securities............................................. 7,001 -- -- 7,001
Other.................................................... 57 -- -- 57
--------- ----- ----- -----------
$ 97,585 $ 20 $ -- $ 97,605
--------- ----- ----- -----------
--------- ----- ----- -----------
Amounts included in cash and cash equivalents............ $ 11,536 $ -- $ -- $ 11,536
Amounts included in short-term investments............... 86,049 20 -- 86,069
--------- ----- ----- -----------
$ 97,585 $ 20 $ -- $ 97,605
--------- ----- ----- -----------
--------- ----- ----- -----------
The following is a summary of available-for-sale securities as of December
31, 1996:
AVAILABLE-FOR-SALE SECURITIES
----------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ------------- ------------- -----------
(IN THOUSANDS)
Obligations of U.S. government agencies.................. $ 15,812 $ -- $ -- $ 15,812
U.S. corporate commercial paper.......................... 8,874 -- 12 8,862
Repurchase agreements, secured by U.S. Government
securities............................................. 11,811 -- -- 11,811
Other.................................................... 153 -- -- 153
--------- ----- ----- -----------
$ 36,650 $ -- $ 12 $ 36,638
--------- ----- ----- -----------
--------- ----- ----- -----------
Amounts included in cash and cash equivalents............ $ 18,897 $ -- $ -- $ 18,897
Amounts included in short-term investments............... 17,753 -- 12 17,741
--------- ----- ----- -----------
$ 36,650 $ -- $ 12 $ 36,638
--------- ----- ----- -----------
--------- ----- ----- -----------
The gross realized losses and gains on the sale of securities
available-for-sale during the years ended December 31, 1997 and 1996, were not
material. At December 31, 1997, the average portfolio duration was approximately
three months (three months at December 31, 1996) and the contractual maturity of
any single investment did not exceed nine months (nine months at December 31,
1996).
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
market data must be interpreted to
F-8
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts that the Company could realize in
a current market exchange.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and consists of the following at
December 31:
1997 1996
--------- ---------
(IN THOUSANDS)
Laboratory and other equipment.................................................... $ 8,469 $ 3,679
Leasehold improvements............................................................ 14,729 2,258
Leased equipment.................................................................. 676 677
--------- ---------
23,874 6,614
Less accumulated depreciation and amortization.................................... (5,180) (2,844)
--------- ---------
$ 18,694 $ 3,770
--------- ---------
--------- ---------
Equipment is depreciated using the straight-line method over estimated
useful lives of four to seven years. Leasehold improvements and assets acquired
under capital leases are amortized using the straight-line method over the
shorter of the estimated useful life of the assets or the term of the lease.
REVENUE RECOGNITION
Contract revenue from collaborative research agreements is recorded when
earned and as the related costs are incurred. Payments received which are
related to future performance are deferred and recognized as revenue when earned
over future performance periods. In accordance with contract terms, upfront and
milestone payments from collaborative research agreements are considered
reimbursements for costs incurred under the agreements, and accordingly, are
generally recognized based on actual efforts expended over the remaining terms
of the agreements. The Company's research revenue is derived primarily from
clients in the pharmaceutical industry. Contract research revenue from three
partners represented 47%, 25% and 21% of the Company's revenue in 1997. Contract
revenue from two partners accounted for 77% and 14% of the Company's revenue in
1996, and two partners accounted for 78% and 13% of the Company's revenue in
1995. Costs of contract research revenue approximate such revenue and are
included in research and development expenses.
STOCK-BASED COMPENSATION
As permitted by the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), the
Company continues to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock option plans. Under APB 25,
if the exercise price of the Company's employee stock options equals or exceeds
the fair value of the underlying stock on the date of grant as determined by the
Company's Board of Directors, no compensation expense is recognized. See Note 3
for pro forma disclosures required by FAS 123.
F-9
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
RESEARCH AND DEVELOPMENT AGREEMENTS
The Company performs research and development for others pursuant to
feasibility agreements and development and license agreements. Under the
feasibility agreements, the Company generally is reimbursed for the cost of work
performed. Feasibility agreements are designed to evaluate the applicability of
the Company's technologies to a particular macromolecule and therefore are
generally completed in less than one year. Under the Company's development and
license agreements, the partner companies receive an exclusive license to
develop, use and sell a dry powder formulation and a suitable delivery device to
be developed by the Company for one of the partner's macromolecule drugs. Under
these development agreements, the Company will be reimbursed for development
costs and may also be entitled to milestone and advance royalty payments when
and if certain development milestones are achieved. All of the Company's
research and development agreements are generally cancelable by the partner
without significant financial penalty to the partner.
ACCOUNTING FOR INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). Under
FAS 109, the liability method is used in accounting for income taxes.
NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share" (FAS 128) which replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the FAS 128
requirements.
Basic and diluted net loss per common share is computed based upon the
weighted average number of common shares outstanding in accordance with FAS 128.
Common equivalent shares for stock options and warrants are not included in the
per share calculations where the effect of their inclusion would be
antidilutive.
NOTE 2 -- COMMITMENTS AND EQUIPMENT FINANCING OBLIGATIONS
The Company leases its office and laboratory facilities under several
arrangements expiring through the year 2012. Rent expense was approximately
$1,106,000, $416,000 and $217,000 for the years ended December 31, 1997, 1996
and 1995, respectively.
Included in property and equipment at December 31, 1997 and 1996, are assets
with costs of $677,000 acquired pursuant to capital lease obligations and
equipment loans secured by the equipment with interest rates ranging from 14% to
18% per annum. Accumulated amortization of assets acquired pursuant to these
equipment financing obligations was approximately $673,000 and $658,000 at
December 31, 1997 and 1996, respectively.
F-10
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 2 -- COMMITMENTS AND EQUIPMENT FINANCING OBLIGATIONS (CONTINUED)
In November 1997, the Company received from the landlord of its facility in
San Carlos, California a loan of $5.0 million to fund a portion of the cost of
improvements made to the facility. The loan bears interest at 9.46% per annum,
and principal and interest payments are payable monthly over the ten year loan
term. The loan is recorded on the balance sheet at December 31, 1997 as an
equipment financing obligation.
Future noncancelable commitments under equipment financing obligations and
operating leases at December 31, 1997 are as follows:
EQUIPMENT
OPERATING FINANCING
LEASES OBLIGATIONS
----------- -----------
(IN THOUSANDS)
Years ending December 31,
1998.......................................................................... $ 956 $ 565
1999.......................................................................... 947 563
2000.......................................................................... 989 612
2001.......................................................................... 1,062 503
2002 and thereafter........................................................... 13,565 7,481
----------- -----------
Total minimum payments required................................................. $ 17,519 $ 9,724
----------- -----------
Less amount representing interest............................................... (4,539)
-----------
Present value of future lease payments.......................................... 5,185
Less current portion............................................................ (83)
-----------
Non-current portion............................................................. $ 5,102
-----------
-----------
NOTE 3 -- SHAREHOLDERS' EQUITY
COMMON STOCK
EMPLOYEE STOCK PURCHASE PLAN
In February 1994, the Company's Board of Directors adopted the Employee
Stock Purchase Plan (the "Purchase Plan"). Under the Purchase Plan, 150,000
shares of common stock have been reserved for purchase by the Company's
employees pursuant to section 423(b) of the Internal Revenue Code of 1986. As of
December 31, 1997, no shares of common stock have been issued under the Purchase
Plan.
STOCK OPTION PLANS
EQUITY INCENTIVE PLAN
The Company's 1994 Equity Incentive Plan (the "Equity Incentive Plan") was
adopted by the Board of Directors in February 1994. The Equity Incentive Plan is
an amendment and restatement of the Company's 1992 Stock Option Plan. The
purpose of the Equity Incentive Plan is to attract and retain qualified
personnel, to provide additional incentives to employees, officers, consultants
and employee directors of the Company and to promote the success of the
Company's business. Pursuant to the Equity Incentive Plan, the Company may grant
or issue incentive stock options to employees and officers and non-
F-11
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 3 -- SHAREHOLDERS' EQUITY (CONTINUED)
qualified stock options, restricted stock purchase awards, stock bonuses and
stock appreciation rights to consultants, employees, officers and employee
directors.
The maximum term of a stock option under the Equity Incentive Plan is ten
years, but if the optionee at the time of grant has voting power of more than
10% of the Company's outstanding capital stock, the maximum term of an incentive
stock option is five years. The exercise price of incentive stock options
granted under the Equity Incentive Plan must be at least equal to 100% (or 110%)
with respect to holders of more than 10% of the voting power of the Company's
outstanding capital stock) of the fair market value of the stock subject to the
option on the date of the grant. The exercise price of non-qualified stock
options, and the purchase price of restricted stock purchase awards, granted
under the Equity Incentive Plan are determined by the Board of Directors. Stock
appreciation rights authorized for issuance under the Equity Incentive Plan may
be tandem stock appreciation rights, concurrent stock appreciation rights or
independent stock appreciation rights.
The Equity Incentive Plan may be amended at any time by the Board, although
certain amendments would require shareholder approval. The Equity Incentive Plan
will terminate in February 2004 unless earlier terminated by the Board.
NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
In February 1994, the Company's Board of Directors adopted the Non-employee
Directors' Stock Option Plan under which options to purchase up to 200,000
shares of the Company's common stock at the then fair market value may be
granted to the Company's non-employee directors. No options were granted to
non-employee directors during 1997. As of December 31, 1997, options on 6,000
shares had been exercised and options to purchase 110,000 shares were
exercisable.
F-12
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 3 -- SHAREHOLDERS' EQUITY (CONTINUED)
A summary of activity under the Equity Incentive Plan and the Non-Employee
Directors' Stock Option plan is as follows:
OPTIONS OUTSTANDING
----------------------------------
EXERCISE WEIGHTED-AVERAGE
OPTIONS AVAILABLE PRICE PER EXERCISE PRICE
FOR GRANT NUMBER OF SHARES SHARE PER SHARE
----------------- ------------------- ------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
Balance at December 31, 1994....... 1,202 848 $0.06-15.25 $ 4.50
Shares authorized................ -- -- -- --
Options granted.................. (428) 428 7.63-12.00 9.34
Options exercised................ -- (33) 0.06-2.78 0.36
Options canceled................. 10 (10) 0.22-10.00 1.84
----- ----- ------------- ------
Balance at December 31, 1995....... 784 1,233 0.06-15.25 6.32
Shares authorized................ 1,500 -- -- --
Options granted.................. (620) 620 10.13-19.25 14.05
Options exercised................ -- (85) 0.06-12.00 5.22
Options canceled................. 109 (109) 0.31-15.25 8.33
----- ----- ------------- ------
Balance at December 31, 1996....... 1,773 1,659 0.06-19.25 9.13
Options granted.................. (847) 847 0.01-35.25 20.99
Options exercised................ -- (124) 0.06-16.13 6.41
Options canceled................. 34 (34) 0.56-22.75 15.27
----- ----- ------------- ------
Balance at December 31, 1997....... 960 2,348 $0.01-35.25 $ 13.46
----- ----- ------------- ------
----- ----- ------------- ------
At December 31, 1997, 1996 and 1995, options were exercisable to purchase
approximately 784,000, 514,000 and 335,000 at weighted-average exercise prices
of $8.17, $5.83 and $4.31 per share, respectively.
Exercise prices for options outstanding as of December 31, 1997 ranged from
$0.01 to $35.25 per share. The weighted-average contractual life of those
options is 8.0 years. The following table provides information regarding the
Company's equity incentive plan.
OPTIONS OUTSTANDING
---------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED-AVERAGE ---------------------------------
WEIGHTED- AVERAGE REMAINING WEIGHTED- AVERAGE
RANGE OF EXERCISE PRICE CONTRACTUAL LIFE EXERCISE PRICE
EXERCISE PRICES NUMBER PER SHARE (IN YEARS) NUMBER PER SHARE
- --------------- -------------- ---------------- ---------------- -------------- ----------------
(IN THOUSANDS) (IN THOUSANDS)
$ 0.01-5.75 483 $ 3.42 6.14 354 $ 3.09
6.25-10.13 570 8.95 7.40 201 8.59
10.25-17.50 502 14.75 8.47 193 14.87
18.63-19.63 487 18.90 8.98 31 19.20
22.25-35.25 306 27.00 9.68 5 23.27
- --------------- ----- ------ --- --- ------
$ 0.01-35.25 2,348 $13.46 7.99 784 $ 8.17
- --------------- ----- ------ --- --- ------
- --------------- ----- ------ --- --- ------
F-13
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 3 -- SHAREHOLDERS' EQUITY (CONTINUED)
Pro forma information regarding net income and earnings per share is
required by Statement 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1997: risk-free interest rate of 5.7%; a dividend yield of 0.0%;
volatility factors of the expected market price of the Company's common stock of
0.578; and a weighted-average expected life of 6 years.
The Black-Scholes options valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options. However, the
Company has presented the pro forma net loss and pro forma basic and diluted net
loss per common share using the assumptions noted above.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period, generally five
years. The Company's pro forma information follows (in thousands except for
earnings per share):
1997 1996
---------- ----------
Pro forma net loss.............................................................. $ (13,168) $ (11,252)
---------- ----------
---------- ----------
Pro forma basic and fully diluted net loss per common share..................... $ (0.95) $ (1.00)
---------- ----------
---------- ----------
Because FAS 123 is applicable only to options granted subsequent to December
31, 1994, the pro forma effect of the statement will not be fully reflected
until approximately the year 2000.
WARRANTS
In October 1996 the Company issued two warrants ("the warrants") to purchase
a total of 20,000 shares of Common Stock (10,000 shares each) at a price of
$13.125 per share in connection with a facility lease. The warrants expire in
October 2006 and were both outstanding and exercisable at December 31, 1997.
STOCK COMPENSATION
The Company recorded deferred compensation of approximately $551,000 during
the year ended December 31, 1997. There was no deferred compensation recorded in
the year ended December 31, 1996. These amounts represent the difference between
the exercise price and the deemed fair value of certain of the Company's stock
options granted in these periods. The Company recorded amortization expense of
approximately $101,000 and $162,000 for the years ended December 31, 1997 and
1996, respectively.
F-14
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 3 -- SHAREHOLDERS' EQUITY (CONTINUED)
RESERVED SHARES
A total of 4,132,727 shares of common stock have been reserved for issuance
at December 31, 1997 for the various equity incentive plans and the warrants.
NOTE 4 -- INCOME TAXES
As of December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $27,400,000. The net operating loss and credit
carryforwards will expire at various dates beginning in 2006 through 2012 if not
utilized.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets as of December 31 are as follows:
1997 1996
---------- ----------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards.............................................. $ 9,400 $ 7,900
Research credits (expiring 2006-2012)......................................... 800 900
Capitalized research expenses................................................. 1,300 600
Deferred revenue.............................................................. 2,700 1,000
Other......................................................................... 1,500 700
---------- ----------
Total deferred tax assets....................................................... 15,700 11,100
Valuation allowance for deferred tax assets..................................... (15,700) (11,100)
Net deferred tax assets......................................................... $ -- $ --
---------- ----------
---------- ----------
Because of the Company's lack of earnings history, the deferred tax assets
have been fully offset by a valuation allowance. The valuation allowance
increased by $4,600,000 and $4,200,000 during the years ended December 31, 1997
and 1996, respectively.
Utilization of net operating losses and credits may be subject to
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses and credits before utilization.
NOTE 5 -- STATEMENT OF CASH FLOWS DATA (IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Supplemental disclosure of cash flows information:
Interest paid........................................................................... $ 66 $ 57 $ 86
--------- --------- ---------
--------- --------- ---------
Supplemental schedule of non-cash investing and financing activities:
Deferred compensation related to the issuance of certain stock options.................. $ 551 $ -- $ --
--------- --------- ---------
--------- --------- ---------
Issuance of common stock in connection with licensing agreement......................... $ 600 $ -- $ --
--------- --------- ---------
--------- --------- ---------
F-15
INHALE THERAPEUTIC SYSTEMS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 (CONTINUED)
NOTE 6 -- SUBSEQUENT EVENTS (UNAUDITED)
In January 1998, the Company entered into a development and license
agreement with Eli Lilly & Co. to develop pulmonary delivery for an unspecified
protein product based on the Company's deep-lung delivery system for
macromolecules. This is the second collaborative agreement between the two
companies. Under the terms of this agreement, the Company will receive funding
of up to $20 million in research, development and milestone payments. Lilly will
receive global commercialization rights for the pulmonary delivery of the
products with the Company receiving royalties on any marketed products. The
Company will manufacture packaged powders for and supply inhalation devices to
Lilly.
F-16