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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
-- ACT OF 1934
For the fiscal year ended December 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 0-11749
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SCIOS INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 95-3701481
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2450 Bayshore Parkway, Mountain View, California 94043-1173
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 966-1550
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
Contingent Payment Rights
Common Share Purchase Rights
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. [X]
The approximate aggregate market value of voting stock held by nonaffiliates of
the registrant as of March 16, 1999 was $354,094,819.
As of March 16, 1999, 37,770,114 shares of the registrant's Common Stock were
outstanding (net of Treasury Shares).
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Part
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Definitive Proxy Statement with respect to III
the 1999 Annual Meeting of Stockholders
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PART I
Item 1. BUSINESS
Overview
Scios Inc. ("Scios" or the "Company") is a biopharmaceutical company engaged
in the discovery, development, manufacture and commercialization of novel human
therapeutics based upon its capabilities in both protein-based and
small-molecule drug discovery and development. An NDA for the use of Natrecor(R)
(nesiritide) for the short-term management of congestive heart failure is
pending with the U.S. Food and Drug Administration ("FDA"). On January 29, 1999,
the Cardiovascular and Renal Drugs Advisory Committee to the FDA recommended
that the FDA approve Natrecor(R) for sale in the United States. Fiblast(R)
(trafermin) is in Phase II/III clinical trials in Europe for stroke and the
Company plans to do additional Phase II clinical trials for other vascular
indications.
Scios is seeking to reach profitability in the next several years through
the launch of Natrecor(R), cost reductions, funding from collaborations with
corporate partners on other products and the acquisition of late stage products
that it can market. In March 1999, the Company announced a reduction in its
workforce, termination of its manufacturing operations and consolidation of its
headquarters, development and research staff in leased facilities in Sunnyvale.
These steps are expected to save approximately $14 million annually. In the
quarter ending March 31, 1999, the Company is expected to record a one-time
restructuring charge of approximately $7 million for the disposition of certain
assets and severance costs. The elimination of the manufacturing operation in
Mountain View was due mainly to the facility's low capacity and high operating
expense and the Company's belief that recombinant protein manufacturing is
available from third parties. Scios will maintain process science personnel and
pilot scale manufacturing capability in order to develop protein products in its
pipeline. As part of the restructuring, the Company also announced plans to sell
its Mountain View campus following the relocation of its operations to leased
space in Sunnyvale. Subsequently, the Company signed a letter of intent with a
prospective purchaser of the Mountain View facility.
The Company currently focuses its proprietary research and development
efforts primarily in the areas of cardiorenal disorders, inflammatory disease
and Alzheimer's disease. The Company has research and development collaborations
with Bayer AG, Wyeth-Ayerst Laboratories, the pharmaceutical division of
American Home Products Corporation, Eli Lilly and Company, DuPont
Pharmaceuticals Company, Kaken Pharmaceutical Co., Ltd., and Novo Nordisk A/S.
More detail regarding these relationships is provided below in "Business --
Products in Development."
Scios' collaborator on Natrecor(R) is Bayer AG ("Bayer"). In May 1998, Bayer
and Scios entered into an exclusive worldwide strategic alliance under which
Bayer will market Natrecor(R) (nesiritide) for the short-term treatment of
congestive heart failure ("CHF"). Under the agreement, Scios will continue to
manage the production of Natrecor(R) and most of the Phase IIIb clinical trials,
with Bayer managing further worldwide development and commercialization of
Natrecor(R). Scios received an up-front cash payment of $20 million and
additional cash milestone payments of up to $40 million upon regulatory
approvals in the United States, Europe and Japan. Scios will receive additional
payments based on annual sales for supplying Natrecor(R), which reflect its
advanced stage of development and regulatory status. The agreement also provides
Scios the option to participate in co-promotion of Natrecor(R) in the U.S. after
three years upon achievement of specified sales levels, and it provides for
Scios to actively participate in the further development of Natrecor(R).
Scios' collaborators on Fiblast(R) are Kaken Pharmaceutical Co., Ltd.
("Kaken") of Japan and the Wyeth-Ayerst Laboratories division of American Home
Products Corporation ("Wyeth-Ayerst"). In June 1996, Kaken filed an NDA seeking
approval to market Fiblast(R) in Japan as a treatment for recalcitrant wounds.
In October 1996, Wyeth-Ayerst began working with Scios on the use of Fiblast(R)
in the treatment of stroke and vascular disorders. During 1997, Wyeth-Ayerst
initiated separate Phase II/III clinical trials in Europe and North America to
evaluate Fiblast(R) for the treatment of stroke. In July 1998, the Company
announced the termination of the North American clinical trial for safety
reasons. An interim analysis is being conducted of data from approximately 350
patients in the European stroke trial and results of this analysis are expected
to be announced in midyear. Termination of the North American stroke trial,
despite indications of success in earlier animal and human studies, demonstrates
the challenges and risks inherent in the Company's business of pharmaceutical
development.
The Company also has a Commercial Operations Division which sells
third-party psychiatric products in the United States utilizing a flex-time
sales force. The product line includes five products that are sold under a
license from SmithKline Beecham Corporation: Eskalith(R), Eskalith CR(R)
(lithium), Thorazine(R) (chlorpromazine), Stelazine(R) (trifluoperazine) and
Parnate(R) (tranylcypromine). For part of 1998, the Scios sales force marketed
Haldol(R) Decanoate (haloperidol) for Ortho-McNeil Pharmaceutical, until the
parties terminated their agreement in April, 1998 when a generic form of the
product entered into the market, and Effexor(R) (venlafaxine HCI), which was
co-promoted with Wyeth-Ayerst until April, 1998 when the parties terminated the
Effexor(R) agreement. Subsequently in 1998, the Company entered into two new
co-promotion agreements - an agreement to co-promote Risperdal(R) (resperidone)
with Janssen Pharmaceutica Inc. ("Janssen") and an agreement to co-promote
Paxil(R) (paroxetine HCL) with SmithKline Beecham Corporation. See "Business --
Marketing and Sales."
Certain of the Company's product candidates have been licensed to corporate
partners for development or are being developed by Scios with funding from
corporate partners. Under its arrangements with corporate partners, Scios
typically receives research and development funding, payments for clinical
supplies and/or milestone payments for achieving scientific and clinical
benchmarks. Generally, the Company is also entitled to royalties on commercial
sales of products by its partner or will share in profits in countries where
Scios is co-marketing the product with its partner. In some cases, Scios may
receive all or part of its compensation in the form of payments for the supply
of the product.
The Company is also seeking to supplement its product pipeline by the
acquisitions or in-licensing of products that represent commercial opportunities
over the short-term. While market conditions at the present time appear
favorable for meeting this objective, there can be no assurance that the Company
will be able to acquire or in-license products on acceptable terms or that once
acquired such products can be successfully developed or that they will achieve
the Company's revenue expectations for them. Many companies, including larger
pharmaceutical companies possessing greater resources, also routinely seek to
in-license or acquire products and compete with the Company for these
opportunities.
Until the suspension of the development of Auriculin(R) (anaritide) in 1997,
the Company had expected to achieve profitability in 1998 based on development
milestone and royalty payments related to that product which the Company
expected to receive from its partner, Genentech, Inc. As these events
demonstrate, the Company's goal for achieving profitability, as well as other
statements in this Annual Report on Form 10-K concerning matters like the
results and timing of product development, future revenues, operations and
expenditures, regulatory approval and market introduction of the Company's
products are "forward-looking statements" which are subject to change. Each
statement is based on current expectations of the Company at the time the
statement is made. These forward-looking statements are subject to the risks and
uncertainties inherent in the Company's business. In accordance with the Private
Securities Litigation Reform Act of 1995 ("PSLRA-95"), the Company reminds
investors that all such "forward-looking statements" are necessarily only
estimates of future results and that the actual results achieved by the Company
may differ materially from these projections due to a number of factors,
including: (1) the demonstration of the safety and efficacy of its products at
each stage of clinical development; (2) timely regulatory approval and patent
and other proprietary rights protection for the Company's products; (3) the
actions of third parties, including collaborators, licensees, manufacturing
partners, and competitors; (4) market acceptance of the Company's products; (5)
the ability to secure and retain third party manufacturers to produce the
Company's products in commercial quantities at reasonable cost and in a manner
acceptable to various regulatory authorities; (6) the Company's ability to
identify and then acquire products that will contribute to the profitable growth
of the Company; and (7) the accuracy of the Company's information concerning the
products and resources of competitors and potential competitors. Factors
creating uncertainty are discussed in more detail in individual sections of this
Annual Report on Form 10-K. In particular see "Business-Product Development
Activities and Risks" below and the "Outlook and Risks" and "Financial Risk
Management" sections of "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
The Company was incorporated in California in 1981 under the name California
Biotechnology Inc. and reincorporated in Delaware in 1988. The Company changed
its name to Scios Inc. in February 1992, to Scios Nova Inc. in September 1992
following acquisition of Nova Pharmaceuticals, Inc., and returned to using the
name Scios Inc. in March 1996. Through approximately August 1999, the principal
executive offices of the Company will be located at 2450 Bayshore Parkway,
Mountain View, California 94043. The telephone number at that location is (650)
966-1550. Thereafter, the principal executive offices of the Company will be
located at 820 West Maude Avenue, Sunnyvale, California 94086. The telephone
number at the Sunnyvale location is (408) 481-9177.
Product Development Activity Table
The following table summarizes certain information concerning Scios'
principal products under development. The information in the table is qualified
in its entirety by reference to the more detailed information concerning the
Company's products that is set forth elsewhere in this report:
Potential Applications Developer/Corporate
Product Status Indications Partner (Territory)
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Natrecor(R) (nesiritide) Phase III complete Acute congestive heart failure Bayer AG
NDA filed
Fiblast(R)(trafermin) NDA filed (Japan) Recalcitrant dermal wounds Kaken Pharmaceutical Co., Ltd.
Fiblast(R)(trafermin) Phase II/III (Europe) Stroke Wyeth-Ayerst Laboratories
Fiblast(R)(trafermin) Phase II (on hold) Peripheral vascular disease Wyeth-Ayerst Laboratories
Fiblast(R)(trafermin) Phase II (on hold) Coronary artery disease Wyeth-Ayerst Laboratories
VEGF121 Phase I Cardiovascular disease: gene GenVec, Inc.
therapy
VEGF121 Preclinical Cardiovascular disease: protein --
therapy
p38 inhibitors Preclinical Inflammatory disease --
Insulinotropin Preclinical Type 2 diabetes Novo Nordisk A/S
Secreted protein therapies Research Cardiorenal disorders --
Beta-amyloid modulators Research Alzheimer's disease Eli Lilly and Company
Beta-amyloid modulators Research Alzheimer's disease DuPont Pharmaceuticals Company
BNP diagnostic assay Marketed (Japan & Europe) Diagnosis/monitoring of heart Shionogi & Co., Ltd.
failure
BNP diagnostic assay Development Diagnosis/monitoring of heart Abbott Laboratories
failure
BNP diagnostic assay Development Diagnosis/monitoring of heart Biosite Diagnostics Inc.
failure
<FN>
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* "Research" denotes discovery research and initial bench scale production.
"Preclinical" denotes studies in animal models necessary to support an
application to the FDA and foreign health registration authorities to commence
clinical testing in humans. Clinical trials for pharmaceutical products are
conducted in three phases. In Phase I, studies are conducted to determine
safety. In Phase II, studies are conducted to gain additional safety
information, as well as preliminary evidence as to the efficacy and appropriate
doses of the product. In Phase III, studies are conducted to provide sufficient
data for the statistical proof of safety and efficacy, including dosing regimen.
Phase III is the final stage of such clinical studies prior to the submission of
an application for approval of a new drug or licensure of a biological product.
"NDA filed" means an application for commercial sale of a new drug has been
filed in the indicated country seeking approval to market the product in that
country for the covered indication.
</FN>
Product Development Activities and Risks
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Scios currently focuses its product research and development efforts on
proprietary novel therapeutics, principally in the areas of cardiorenal
disorders, inflammatory disease and Alzheimer's disease. The Company's success
will depend on its ability to achieve scientific and technological advances and
to translate such advances into commercially competitive products on a timely
basis. As described in "Business -- Products In Development," Scios' products
are at various stages of research and development, and in most cases further
development and testing will be required to determine their technical
feasibility and commercial viability. The Company cautions investors that its
business is subject to significant risks and uncertainties. In particular, the
proposed development schedules for the Company's products may be affected by a
wide variety of factors, such as technological difficulties, proprietary
technology and rights developed by others, reliance on third parties to perform
certain activities or provide certain resources, and changes in governmental
regulation. Many of the factors affecting development of the Company's products
will not be within the control of Scios. As a result, there can be no assurance
that any of the products described in this Item 1 or resulting from Scios'
research programs will be successfully developed, proved to be safe and
effective, meet applicable regulatory standards, be capable of being produced in
commercial quantities at reasonable costs, or be successfully marketed.
In developing pharmaceutical products, the Company faces critical challenges
in at least three broad areas: the discovery and manufacture of novel compounds
that are worth developing; the successful clinical testing in humans of
candidate compounds that the Company and its collaborators deem worthy of
development; and competition in many forms and areas. The discovery process in
pharmaceutical development often involves doing or understanding what has not
previously been done or understood, while working in biological systems that are
not always predictable or predictive. Pharmaceutical drug discovery is an
inherently challenging and risky undertaking in which numerous factors come into
play in determining success or failure. Some of the key factors include the
ability to identify appropriate targets and models to use in understanding
complex disease processes, to comprehensively screen many compounds under
consistent conditions in order to identify those which show promise, to build on
insights gained from numerous and frequently imperfect data points in selecting
the compounds most likely to treat the target disease, even though the target
disease itself is not completely understood (both as to what causes that disease
and how the disease manifests itself), and to avoid being misled by false
indicators. These efforts all take place in increasingly competitive
environments in which many companies are often simultaneously trying to apply
their resources and insights to the same targets and challenges. How well a
particular company marshals its resources to attack an issue will often
determine its success. Because it is impractical, if not impossible, for any
company to do everything imaginable to acquire sufficient knowledge to assure
success in meeting these challenges, intuition, untested assumptions and luck
can sometimes play a significant role in determining a particular company's
success in pharmaceutical discovery and development.
The Company particularly cautions investors that any decision to commence or
continue clinical trials in humans based on the results of preclinical work in
cell-based assays and animal models or an earlier clinical study does not
necessarily mean that the results achieved in subsequent human clinical studies
will be similar to those achieved in the earlier studies. A central issue in all
pharmaceutical development is how well a particular cell-based assay or
preclinical animal model selected by the investigator predicts the effectiveness
of a drug candidate in treating the target disorder in humans. While
well-developed and well-tested models exist for some disorders, often it is not
possible to know with certainty the predictive quality of a model until results
in humans are obtained. In some cases, it turns out that the selected model does
not accurately predict the effect of a drug candidate in humans or whether the
product is safe to use in humans at all.
In clinical testing of compounds selected for development, the Company faces
challenges in several areas. In the clinical trial initiation phase, these
factors include creating a sound study design that will, as effectively and
efficiently as possible, reveal the safety and efficacy of a particular compound
and then finding appropriate clinical investigators who can identify and recruit
patients and follow the clinical protocol. Each clinical trial itself contains
the risk that a compound will not produce positive clinical results in the
specific subjects included in that study population or that it will produce
ambiguous or mixed results in which the benefits of the compound do not clearly
enough outweigh any adverse side effects, or that judgments will have been
incorrect about how large the study population needed to be to demonstrate the
effects of the compound. Uncertainty as to the outcome is inherent in every
clinical trial, even when a previous clinical study has produced a favorable
result. This was demonstrated in the Company's experience with Auriculin(R) for
the treatment of acute renal failure and with the North American clinical trial
of Fiblast(R) for the treatment of stroke. See "Business - Additional Products"
below.
When clinical trials for a compound are completed, a vast quantity of data
on a wide range of topics must be assembled in a manner that will give
regulatory authorities the basis, following intense review by the FDA and
comparable regulators in other countries, to decide whether or not to approve
the product for marketing. Inherent in the regulatory review process is the risk
that the particular regulatory agency or its advisors will not find sufficiently
reliable the methods that the company selected or that such agency will place
different weight on various factors and results than the developing company did.
In addition, when another company's product is already on the market to treat
the target indication, the company developing a new drug for the same indication
faces additional challenges, which may include demonstrating that the new
product has superior properties or economic benefit. Because the regulators in
various countries operate under different regulatory systems and approaches, the
decisions and requirements with respect to the clinical testing of a compound
may vary from one country to another. These issues and a company's inability to
address them adequately may lead the regulatory authority to put limits on how
or for what indication a compound may be marketed, thereby directly affecting a
product's commercial success. Failure to deal with these factors to the
satisfaction of the regulatory authority can also lead to the denial or delay of
approval to market a product.
The intellectual property rights of third parties can also affect the
Company's development of its products. For instance, patent rights of other
companies may need to be licensed in order for the Company to commercialize a
product. These third party patent rights may not be available for license by the
Company or may be available only at a high cost to the Company. See "Business -
Patents and Proprietary Rights" for a discussion of the patent positions that
the Company is endeavoring to establish for its products and information on some
of the competing patent positions of third parties.
The Company plans to continue the development of selected products primarily
under the sponsorship of corporate partners. The Company's alliances with Eli
Lilly and Company and DuPont Pharmaceuticals Company in the Alzheimer's field
and with Kaken and Wyeth-Ayerst on Fiblast(R) are examples. Continued funding
and participation by the Company's corporate partners under joint development or
licensing agreements will depend not only on the timely achievement of research
and development objectives by the Company, which cannot be assured, but also on
each corporate partner's own financial, competitive, marketing and strategic
considerations and overall attitude towards engaging in outside collaborations.
Under several of its joint development or license agreements, Scios relies on
its corporate partners to conduct all or a portion of preclinical and clinical
trials, to obtain regulatory approvals, and to manufacture and market products.
Although the Company believes that its corporate partners will have an economic
incentive to meet their contractual responsibilities, the amount and timing of
resources devoted to these activities generally will be controlled by the
corporate partner. The wave of mergers among the established pharmaceutical
companies over the last few years and the downsizing and shift in research
strategy that often follows these mergers have underscored the fact that
corporate partners can change their strategy, and may sometimes drop entirely
the collaborations they or their predecessor have had with other companies.
All of these factors combine to make drug development extremely risky,
challenging and competitive. At the same time, these factors contribute to the
significant rewards and satisfaction that can accrue to the stockholders and
personnel of a company that successfully overcomes the challenges of drug
discovery and development and succeeds in creating and marketing a new
pharmaceutical agent.
Products in Development
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Natrecor(R) (nesiritide). In January 1999, the Cardiovascular and Renal
Advisory Committee to the FDA recommended by a 5 to 3 vote that Natrecor(R) be
approved by the FDA for sale in the United States for the short-term management
of congestive heart failure ("CHF"). Acute episodes of CHF require
hospitalization of approximately one million people annually in the United
States. In the Company's clinical studies, Natrecor(R) produced improvements in
important measures of heart function: pulmonary capillary wedge pressure
("PCWP") and cardiac index. The Company filed the new drug application ("NDA)"
for Natrecor(R) with the FDA in April 1998, and the FDA is expected to announce
its decision on the NDA sometime in the second quarter of 1999. If approved by
the FDA, Natrecor(R) will be the first new short-term treatment for CHF in 10
years.
Over 500 patients have participated in Scios' clinical program to study
Natrecor(R). The pivotal efficacy study was a randomized, double-blind,
placebo-controlled Phase III study that studied one hundred and twenty-seven
patients with acutely decompensated CHF requiring hospitalization. Patients
received an infusion of either Natrecor(R) (0.015 or 0.03(mu)g/kg/min) or
placebo. The primary endpoint of the study was a reduction in PCWP. Secondary
endpoints included cardiac index and symptom improvement. With respect to the
primary endpoint, the analysis indicates that Natrecor(R) reduced PCWP by 20%
(p=0.003) and 31% (p<0.001) in the 0.015 and 0.03(mu)g/kg/min dose groups,
respectively, compared to placebo. Symptom scores and cardiac index also
improved compared to placebo at a statistically significant level.
In May 1998, the Company entered into an agreement with Bayer establishing a
collaboration for the worldwide development and commercialization of
Natrecor(R). Under the agreement, the Company will continue to manage the
manufacture of Natrecor(R) and Phase IIIb clinical trials in the United States,
with Bayer managing further worldwide development and commercialization. On
signing the contract, the Company received a payment of $20.0 million and will
receive up to $40.0 million in milestone payments upon regulatory approvals in
the United States, Europe and Japan. The agreement provides the Company the
option to participate in co-promotion of Natrecor(R) in the U.S. after three
years upon achievement of specified sales levels, and it provides for Scios to
actively participate in the further development of Natrecor(R) with funding from
Bayer at specified minimum levels. For a discussion of certain rights in
Natrecor(R) related to its use in another indication, see "Business --
Additional Projects -- Auriculin(R) anaritide." A number of low cost
pharmaceutical products are already being used by physicians to treat acute
episodes of CHF. Hence, the Company and Bayer will need to demonstrate positive
clinical benefits and an ability to continue to produce Natrecor(R)
cost-effectively in order to successfully introduce Natrecor(R) into this
competitive market.
This discussion of Natrecor(R) includes forward-looking statements within
the meaning of the PSLRA-95, which are based on current information. Many
factors could influence the commercial success of Natrecor(R), principally
including the reaction of various regulatory agencies, including the FDA, to the
data Scios has developed concerning the degree of efficacy and safety of
Natrecor(R), the scope of any approval such agencies may grant for the product,
and Bayer's ability to successfully exploit the opportunity. See "Business --
Product Development Activities and Risks" for a further discussion of factors
that can impact the Company's commercialization of its products, including
Natrecor(R).
The Company believes that it was the first to discover human b-type
natriuretic peptide ("BNP"), whose gene it cloned in 1988 as a part of its
cardiorenal research program in natural human peptides. BNP is made in the heart
and is part of the body's natural response to a failing heart. Preclinical
studies at the Company and elsewhere suggest that BNP has the biological effects
of increasing the elimination of salt and water from the body, dilating blood
vessels, and decreasing the secretion of other hormones which lead to blood
vessel constriction and elevated blood pressure. The Company holds issued United
States and European patents covering human BNP, which currently expire in
mid-May 2009. These patents issued to Scios are subject to possible extension
due to time taken up in the regulatory approval process. The Company also has
the exclusive right to develop therapeutic products using BNP under certain
patents and applications on BNP originally filed by Daiichi Pharmaceutical Co.,
Ltd. which were subsequently acquired by Shionogi & Co., Ltd. All issued patents
are subject to the risk that they may be challenged by another entity which may
result in a court invalidating or limiting the patent. See "Business -- Patents
and Proprietary Rights."
Fiblast(R) (trafermin). Fiblast(R) trafermin) is Scios' form of human basic
fibroblast growth factor, an agent that has been shown to promote angiogenesis
(the growth of new blood vessels), to directly stimulate the growth of
connective tissue, and to possess certain neuroprotective properties, the
mechanisms of which are not yet fully understood. As described below, Scios is
working with two key partners on the development of Fiblast(R) for a variety of
indications.
Since 1988, Scios has worked with Kaken, the Company's corporate partner for
Fiblast(R) in Japan. Pursuant to a 1988 agreement, Kaken has exclusive rights to
develop and market Fiblast(R) for all indications in Japan, Korea, Taiwan, Hong
Kong and the People's Republic of China. Scios has received research and
development support payments, is entitled to receive additional payments as
regulatory milestones are met, and will receive royalties on any sales of
Fiblast(R) products by Kaken. In 1994, the Company and Kaken signed a series of
agreements expanding the 1988 agreement. Under these agreements, Scios will
manufacture a specified quantity of Fiblast(R) for Kaken, following which Kaken
will arrange its own supply. The agreements also establish a collaboration on
manufacturing process development between the companies and provide Kaken with a
license to Scios' manufacturing technology for Fiblast(R). It is intended that
at some point Kaken will manufacture Fiblast(R) for its own use. However, the
timing for Kaken to assume this responsibility has not been determined. Under
the 1994 agreements, Kaken made a series of payments to Scios from 1994 through
1998 for the supply of material, the process development collaboration, and the
license to Fiblast(R) know-how, patents and manufacturing technology. Scios is
endeavoring to produce the amount of material due to Kaken before closing its
Mountain View manufacturing facility in May 1999. If Scios does not succeed in
producing the full quantity, Scios has the option of refunding the amount Kaken
paid for material not delivered or having the material produced by a third
party.
Kaken conducted two Phase III trials in Japan for evaluation of Fiblast(R)
in recalcitrant wounds. Based on the results of these studies, in June 1996
Kaken filed an NDA in Japan for this indication. Before it may begin to market
Fiblast(R) in Japan, Kaken must obtain approvals from the Japanese authorities
with respect to the NDA for Fiblast(R) in the target indication and also for
importation of Fiblast(R) in bulk form from Scios into Japan and for product
pricing in Japan. Obtaining these approvals is a complex process involving a
thorough review of the comprehensive set of data that Kaken is required to
submit. Approval for Kaken to market the product in Japan will require that the
Japanese authorities reach the conclusion that such data demonstrate to the
regulators' satisfaction that Fiblast(R) is safe and effective in the treatment
of recalcitrant wounds, and that the processes and facilities used by Scios for
manufacturing the bulk drug substance used in Fiblast(R) are satisfactory.
Although Japanese regulators will apply Japanese standards and practices in
reviewing Kaken's NDA seeking approval to market Fiblast(R), Kaken faces many of
the same challenges and factors that are discussed in "Business -- Product
Development Activities and Risks."
In 1996, Scios signed a Collaboration Agreement with the Wyeth-Ayerst
Laboratories division of American Home Products Corporation ("Wyeth-Ayerst")
creating a joint development and commercialization program to examine the use of
Fiblast(R) in the treatment of stroke and cardiovascular disorders. Under the
terms of the agreement, Wyeth-Ayerst and Scios are collaborating in the
development and commercialization of Fiblast(R) in North America, where the
companies will share development costs and profits. Scios has granted
Wyeth-Ayerst exclusive marketing rights outside of North America and excluding
the Pacific Rim countries licensed to Kaken. Scios will receive royalties on
sales outside of North America and payments for bulk drug supply worldwide. In
1996, Wyeth-Ayerst made a $12 million upfront payment to Scios in cash and will
also pay Scios up to $32 million in milestone payments upon achievement of key
future development events.
In extensive preclinical studies, Fiblast(R) has been shown to protect
neurons from damaging effects associated with stroke, including oxygen and
glucose deprivation, and glutamate release. Fiblast(R) has demonstrated a
reduction of neuronal death in both permanent occlusion and reperfusion animal
models of stroke. Early in 1996, Scios began a Phase I/II study of Fiblast(R)
for the treatment of stroke. This study was concluded in 1997, ultimately
enrolling 66 patients and further demonstrating the safety of Fiblast(R) after
systemic administration. In 1997, Wyeth-Ayerst assumed the responsibility of
lead development party for Fiblast(R) in stroke. In October 1997, the Company
and Wyeth-Ayerst announced the initiation of two 900-patient Phase II/III
clinical trials of Fiblast(R) in stroke. In July 1998, Wyeth-Ayerst and Scios
announced termination of the stroke clinical trial in the United States for
safety reasons. The stroke clinical trial in Europe, which uses a different
dosing regimen, was continued. Results of an interim analysis of the European
stroke trial are expected by mid-1999 and, if negative, the European trial could
also be terminated.
Scios has also demonstrated in preclinical studies the potential of
Fiblast(R) to increase blood flow to peripheral blood vessels and reduce the
complications of peripheral vascular disease ("PVD") through angiogenesis, or
the growth of new blood vessels. Scios is the lead development party for
Fiblast(R) in PVD. Scios and Wyeth-Ayerst also hope to explore the potential of
Fiblast(R) to increase blood flow to the heart in patients with advanced
coronary artery disease ("CAD"). This could reduce the need for bypass surgery
through the patient's growth of new blood vessels to supply the heart.
Scios has also granted licenses under its Fiblast(R) patents and technology
to companies working to develop products in other areas. These include a
non-exclusive license to Orquest, Inc., a company developing products for the
treatment of bone fractures, and a license to Selective Genetics Incorporated
(formerly Prizm Pharmaceuticals, Inc.), a company using bFGF for the targeted
delivery of other pharmaceutical agents. Scios is supplying Orquest with
Fiblast(R) for incorporation into Orquest's product.
Scios is obligated to make payments to Organon International ("Organon")
based on amounts received by Scios upon commercialization of Fiblast(R).
Approximately $693,301 remains to be paid under the obligation, which stems from
the Company's 1989 reacquisition of certain Fiblast(R) rights previously
licensed to Organon. The basic research on Fiblast(R) was funded by
Biotechnology Research Partners, Ltd. See Note 11 of Notes to Consolidated
Financial Statements. See also "Business -- Patents and Proprietary Rights" for
a discussion of Fiblast(R) patent issues.
Vascular Endothelial Growth Factor (VEGF121). Scios is conducting
pre-clinical studies of its proprietary 121 amino acid form of VEGF ("VEGF121"),
another potent angiogenic substance. The company has shown that VEGF121 is
effective in an animal model of peripheral vascular disease following several
different modes of administration, including intravenous and subcutaneous
administration. Scios also intends to explore the possible use of VEGF121 in
coronary artery disease. The Company has granted a license to GenVec, Inc. for
the use of the gene encoding VEGF121 in gene therapy paradigms. GenVec is
conducting clinical testing of VEGF121 gene therapy in the U.S. in collaboration
with its partner, Parke-Davis. Scios has been awarded U.S. and European patents
covering VEGF121. Other companies hold patents on competing forms of VEGF121.
See "Business -- Patents and Proprietary Rights" for a discussion of patent
issues.
p38-kinase Inhibitors. The Company is working to develop compounds that
inhibit specific cytokines and kinases. These agents could be useful to treat
certain inflammatory and cardiovascular conditions. The Company recently moved
into preclinical development its lead candidates from a family of small
molecules which act as p38-kinase inhibitors. The Company's research has
demonstrated that this family of small molecules inhibits a key intracellular
signaling pathway that regulates inflammation, tissue remodeling, fibrosis, and
joint destruction. If successfully commercialized, the product's oral
administration could be a competitive advantage in the market that currently
contains TNF-inhibitor products that are taken by injection for inflammatory
conditions such as rheumatoid arthritis and inflammatory bowel disease. Current
development plans anticipate the initiation of clinical development around
mid-2000.
Discovery Research. The Company also has conducted discovery research, both
on its own and in collaboration with other companies, to identify other agents
for development or new applications for agents under development by the Company
for other indications. The current focus of Scios' research effort is on the
discovery of agents for cardiorenal and anti-inflammatory applications and on
agents to prevent or delay the onset of Alzheimer's disease. The Company's
research efforts include the following programs:
Cardiorenal Disease Genomics. The Company is conducting research to discover
novel genes that are functionally relevant to cardiac and kidney diseases. The
Company has assembled a series of technologies to assist in the identification
of new therapeutic factors and targets for drug discovery. The Company has
worked with Synteni, a subsidiary of Incyte Pharmaceuticals, Inc., to analyze
the expression of cardiac genes on DNA chips. Scios is also a member of the
DiscoverEase(TM) program, which has been developed by Genetics Institute, Inc.
to define the function of novel secreted proteins.
Alzheimer's Disease. For over 10 years, the Company has conducted research
to develop new therapies for Alzheimer's disease primarily based on the
investigation of the beta-amyloid precursor protein. During this time, the
Company has collaborated with a variety of pharmaceutical company partners. In
1997, Scios formed separate research collaborations with Eli Lilly and Company
("Lilly") and with DuPont Pharmaceuticals Corporation. Each of these
collaborations provides funding to Scios for the research it conducts, potential
milestone payments to Scios by the partner if certain events are achieved and
the right of the partner to commercialize resulting products subject to royalty
payments to Scios. In 1998, Lilly expanded the scope and funding of the
collaboration and extended it through April 2001.
Previously, Scios had a research alliance on Alzheimer's disease with Marion
Merrell Dow, Inc. which merged with Hoechst Roussel in 1995 to form Hoechst
Marion Roussel, Inc. ("HMR"). HMR terminated the collaboration in 1996, and in
early 1997, the parties clarified certain issues concerning the rights of each
party to use the technology developed in the program. Among other terms, the
resolution included certain payments by HMR to Scios. HMR's decision to
terminate its collaboration with the Company represents an example of how a
change in the priorities of a corporate sponsor, such as HMR, can impact Scios.
This risk is discussed in the section "Business --Product Development Activity
and Risks."
Additional Projects
The Company has from time to time pursued product development activities
outside of the focus areas described above. In the past, Scios divested or
otherwise leveraged certain technologies that were not central to its long-term
business strategy and may continue to do so in the future. Some of these
programs are discussed below.
Insulinotropin. The Company initially developed insulinotropin under a
collaboration begun with Pfizer Inc. ("Pfizer") in 1988. After several years,
Pfizer assumed responsibility for clinical development. As part of that effort,
Pfizer initiated a collaboration with Novo Nordisk A/S of Denmark ("Novo
Nordisk"), a world leader in insulin and diabetes care products. In 1996, Pfizer
elected to terminate its license from Scios on insulinotropin. Following a three
month review of the product, Novo Nordisk acquired an exclusive license from
Scios under a new agreement providing for Scios to receive from Novo Nordisk an
upfront payment, potential milestone payments based on time and events, and
royalties on product sales. In 1998, Scios received $5 million in time based
payments from Novo Nordisk. Novo Nordisk is now responsible for development
activities for insulinotropin. Insulinotropin appears to be a potent peptide
that stimulates insulin release when blood sugar levels are above normal. Type 2
diabetics do not release enough insulin from the pancreas when blood glucose
levels rise in response to eating a meal and they become progressively more
resistant to insulin action in stimulating glucose uptake by muscle and fat
tissue. Insulinotropin controls blood glucose levels in Type 2 diabetics by
stimulating insulin release and perhaps by overcoming insulin resistance.
Present therapies for Type 2 diabetics include insulin injections and oral
hypoglycemic agents, which can induce dangerously low blood sugar levels. Since
insulinotropin appears to stimulate insulin release only when blood sugar levels
are above normal, it may have a lower risk of this serious side effect. The
Company holds an exclusive license to patent applications covering
insulinotropin and certain analogs held by Massachusetts General Hospital, which
rights were licensed to Novo Nordisk.
BNP Diagnostics. Third-party researchers have determined that the level of
circulating b-type natriuretic peptide (BNP) may be a good basis for a
diagnostic to identify and track patients suffering from congestive heart
failure. Scios has granted Abbott Laboratories and Biosite Diagnostics
Incorporated nonexclusive rights under the Company's BNP patents to develop BNP
diagnostics. In 1998, Scios and Shionogi & Company, Ltd. ("Shionogi") entered
into a cross-license of their respective BNP patent rights for the diagnostic
field. The diagnostic cross-license is royalty free. Shionogi also granted Scios
a royalty-bearing, exclusive license under its BNP patents to develop
therapeutic products. Shionogi has begun marketing a radioimmunoassay (RIA)-BNP
diagnostic in Japan and Europe.
CNS Disorders; Guilford Pharmaceuticals. In 1993, Scios founded Guilford
Pharmaceuticals Inc. ("Guilford") to develop pharmaceutical products for the
treatment of diseases of the central nervous system ("CNS"). In its initial
years, Guilford operated as a majority-owned subsidiary of Scios. Following
various equity offerings by Guilford, including its initial public offering and
Scios' subsequent sale of a portion of its holdings, Scios' ownership interest
in Guilford was reduced to approximately 7% as of December 31, 1998. In March
1999, Scios sold substantially all of its position in Guilford, reducing Scios'
holding to less than 1% of Guilford's outstanding stock. Scios had previously
transferred to Guilford certain neuroscience technology, and had licensed to
Guilford the GLIADEL(R) implant project and related drug delivery technology
described below for application in the treatment of tumors of the central
nervous system and cerebral edema. The most advanced Guilford product is
GLIADEL(R), which was approved for marketing in the United States in 1996.
Drug Delivery Systems. Prior to Scios' acquisition of Nova in 1992, Nova had
been developing certain drug delivery systems. Its two most advanced projects
were the GLIADEL(R) implant to treat primary brain cancer and the SEPTACIN(R)
implant for the treatment of osteomyelitis, a serious bone infection. These
projects were developed pursuant to a license agreement with the Massachusetts
Institute of Technology ("MIT") relating to MIT's BIODEL(R) drug delivery
technology. As noted above, the Company licensed a portion of the drug delivery
technology, including Gliadel(R), to Guilford. In 1994, the Company licensed to
another third party the drug delivery technology, including Septacin(R), for all
uses outside the area licensed to Guilford. Scios thereafter assigned its
Biodel(R) license rights back to MIT, which will administer these licenses. The
Company and MIT are receiving royalty and milestone payments under the license
agreements with Guilford and the other licensee as products are developed. The
licensees are also obligated to meet certain diligence standards in pursuing
development of their respective product candidates. The Gliadel(R) and
Septacin(R) projects were undertaken by the Company on behalf of Nova Technology
Limited Partnership, the limited partnership that funded Nova's research and
development on these projects. See Note 11 of Notes to Consolidated Financial
Statements for a description of the Company's payment obligations to former
limited partners.
Auriculin(R) (anaritide). Auriculin(R) is a synthetic version of a human
hormone, atrial natriuretic peptide ("ANP"), which is produced in the heart and
has a range of biological activities known to be important in kidney and heart
function, including increasing the elimination of water and salt from the body.
Initial studies in animal and humans also suggested that ANP improved kidney
function by increasing blood flow into the filtration units of the kidney and
restricting blood outflow. On December 30, 1994, the Company entered into a
Collaboration Agreement (the "Collaboration Agreement") with Genentech, Inc.
("Genentech") relating to the joint development and commercialization of
Auriculin(R) for use in the treatment of acute rental failure ("ARF"). In 1997,
Scios and Genentech suspended development of Auriculin(R) in ARF. Under the
Collaboration Agreement, the Company bore the development costs of Auriculin(R)
and Genentech will have certain options described below because the Company did
not file an NDA for Auriculin(R) by December 31, 1998. These options include (i)
electing to bring a Genentech product for ARF into the Collaboration Agreement,
(ii) electing to bring Natrecor(R) or another natriuretic peptide product under
development by Scios into the Collaboration Agreement for use in the treatment
of ARF or (iii) terminating the Collaboration Agreement. In February, 1999,
Genentech notified Scios that it was considering electing to bring certain
Genentech products into the Collaboration Agreement, subject to Scios'
agreement. The companies are engaged in ongoing discussions, and Genentech is
expected to make its election by the end of April 1999.
Concurrent with the signing of the Collaboration Agreement, Genentech made
(i) a $20 million equity investment in Scios by purchasing a new class of
nonvoting preferred stock, all of which has now converted to outstanding common
stock, and (ii) a $30 million loan commitment, which the Company drew down in
1997. See Note 3 of Notes to Consolidated Financial Statements.
Marketing and Sales
- -------------------
Once they have been approved for marketing, the Company ultimately intends
to promote certain of its proprietary products in the United States through its
own sales force for some or all approved indications. This could be done by the
Company alone or jointly with its commercial partner for any such product. In
1998, Scios generated approximately $35 million in revenues by marketing
products that were developed by others.
Third-Party Products. The Company has a sales force of approximately 98
representatives who are employed on a part-time basis marketing psychiatric
products. The Company currently markets in the United States five psychiatric
products discussed below under license from SmithKline Beecham Corporation
("SB") and in mid-1998 began co-promoting two additional products: Risperdal(R)
(risperidone), the most frequently prescribed antipsychotic under a co-promotion
agreement with Janssen Pharmaceutica and Paxil(R) (paroxetine HCL), which
participates in both the selective serotonin reuptake ("SSRI") antidepressant
and antianxiety markets, under a co-promotion agreement with SB. Prior to
entering into the co-promotion agreements on Risperdal(R) and Paxil(R), the
Company had agreements to co-promote Haldol(R) Decanoate (haloperidol), a depot
injection product to treat schizophrenia that was distributed by Ortho-McNeil
Pharmaceutical, and Effexor(R) (venlafaxine HCl), an antidepressant that is
marketed by Wyeth-Ayerst. The Haldol(R) agreement was terminated by mutual
agreement in April 1998 when generic competition entered the market. The
Effexor(R) agreement was also terminated by mutual agreement in April 1998.
Generally, the various companies with whom Scios enters into co-promotion
agreements for psychiatric products remain responsible for the manufacture and
distribution of the product and these companies generally indemnify Scios
against product liability claims. In its current co-promotion arrangements,
Scios is compensated at a fixed level for performing detailing activity for the
product to selected groups of psychiatrists and other prescribers, with Scios
having the opportunity to earn additional incentive compensation based on
increasing sales of the product over targets established for the prescribers to
whom Scios details the product.
The Company has exclusive rights to market the following SB products in the
United States: Eskalith(R) and Eskalith CR(R) (lithium) for the treatment of
manic depressive illness, Thorazine(R) (chlorpromazine) and Stelazine(R)
(trifluoperazine) for the treatment of schizophrenia, and Parnate(R)
(tranylcypromine) for the treatment of depression (collectively, the "SB
Products"). SB currently manufactures and distributes the SB Products. SB may
discontinue manufacturing one or more of the products if it gives the Company at
least 12 months notice, in which case Scios has the right to manufacture such
product(s). SB is responsible for all ancillary matters relating to sales of the
SB Products (including various administrative tasks) and for the maintenance in
good standing of all new drug applications with respect to the SB Products. The
agreement also grants Scios certain rights to indemnification from SB for
product liability claims. The Company is obligated to spend certain amounts for
marketing support based on the prior year's net sales and to reimburse SB for
certain third-party royalty payments. Scios pays SB 40% of the Company's net
profits (as defined in the Company's agreement with SB) from United States sales
of the SB Products. See Note 3 of Notes to Consolidated Financial Statements.
Risperdal(R), Paxil(R) and the SB Products all face competition which is
likely to become greater over time. For the SB Products, unit volume for certain
products has been eroding and can be expected to continue to erode due to
competition from generic products sold at substantially lower prices. These
statements are forward-looking within the meaning of the PSLRA-95. Numerous
factors will influence the impact that competitive products will have on the
Company's revenues from the SB Products and the Company's co-promotion
activities. These factors include the success of the Company's and its partners'
marketing strategies and efforts, the actual and perceived features of competing
products, the amount of the difference in price of competing products, and the
marketing effort by third parties on competing products. Although past decreases
in unit sales of the SB Products have been partially offset by price increases,
there can be no assurance that the market will accept any additional price
increases. Among the SB Products, the Company has placed particular marketing
emphasis on those product formulations, such as Eskalith CR(R) (a controlled
release formulation), where generic equivalents are less available.
From time to time, the Company may seek to acquire the right to market
additional or replacement products. Numerous factors will determine whether and
when the Company is able to do so and then the degree to which the Company
realizes net revenue contribution from marketing such additional products.
Factors influencing the availability of such additional products on terms
favorable to the Company include the ability of the Company to demonstrate
success under its current agreements, the willingness of other companies to
enter into such agreements with the Company, which will be based in part on
where such companies elect to deploy their own marketing resources, and
competition from other companies offering sales and marketing assistance similar
to that offered by the Company.
Proprietary Products. The Company ultimately plans to participate in
marketing certain of its proprietary products in the United States when and if
approved by the FDA. In the case of the Company's agreement with Bayer on
Natrecor(R), Bayer will promote Natrecor(R) in the United States on its own for
at least the first three years after which time, and assuming certain sales
levels have been achieved, the Company has the option to begin its co-promotion
alongside Bayer. This section on Proprietary Products describes some of the
challenges the Company will face in developing the capability to market
successfully its own products. This discussion necessarily contains
forward-looking statements within the meaning of the PSLRA-95. These
forward-looking statements are based on current expectations, and the Company
assumes no obligation to update this information. Numerous factors, including
those discussed below, could cause actual results to differ from those described
in these forward-looking statements. Under certain circumstances, the Company
could abandon its plans eventually to market any or all of its own products in
the United States in favor of granting outright licenses of its products and
technology. The Company has pursued (and expects to pursue for the foreseeable
future) a strategy of entering into licensing arrangements with other companies
as the means to make its products available outside of the United States.
Scios believes that its experience in marketing third-party products under
arrangements such as those described above will prove useful as it prepares to
market its own products. However, to date, Scios' marketing experience has been
limited to psychiatric products, and the Company does not currently have in
place all of the resources to market the products it is seeking to develop or
that it may acquire. The commercialization of the Company's major products will
require significant financial resources, as well as sales, marketing and
distribution capabilities. In order to provide funds and expertise to meet these
requirements, particularly outside of North America, the Company will consider
entering into additional corporate partnerships with established pharmaceutical
companies, as it has with Bayer for the promotion of Natrecor(R) and with
Wyeth-Ayerst for the promotion of Fiblast(R) for stroke and cardiovascular
disorders. There can be no assurance that the Company will be able to enter into
such partnerships on favorable terms or to develop such a marketing capability
on its own. Scios believes that such collaborations may enable it to speed the
timing of product launch and increase market penetration of selected new
therapies. However, such a partnering arrangement could also result in a lower
level of income to Scios than if it marketed the products entirely on its own.
When entering into agreements with partners for the purpose of obtaining sales
and marketing expertise and services, the Company incurs the additional risk
that the partner's level of effort or marketing approach may differ from that
which the Company might choose if operating solely on its own behalf. The
Company has tried to structure its agreements, particularly with Bayer and
Wyeth-Ayerst, to provide for Scios' participation in the planning of sales and
marketing strategies and to align the interests of both parties to product
success. However, changes in priorities or other circumstances at the partner
company could have an adverse effect on achieving potential levels of product
sales. See "Business -- Product Development Activities and Risks."
The Company's ability to commercialize its products successfully may depend
in part on the extent to which reimbursement for the cost of such products and
related treatment will be available from government health administration
authorities, private health coverage insurers and other organizations.
Government and other third-party payors are increasingly attempting to contain
healthcare costs by limiting both coverage and the level of reimbursement for
new therapeutic products. Market acceptance of Scios' products would be
adversely affected if adequate coverage and reimbursement levels are not
provided for approved uses of Company products. In addition, in view of
expressed governmental concerns over drug prices and other healthcare costs,
there can be no assurance that future government and private cost control
initiatives will not adversely affect the Company's ability to maintain price
levels on its products sufficient to realize an appropriate return on
development efforts.
Manufacturing
- -------------
Scios has concentrated its resources on product discovery and development
before investing substantially in manufacturing capability. Prior to March 1999,
the Company produced only the bulk active ingredient in Fiblast(R) in its own
facility and relied on third parties for the manufacture of other products,
including Natrecor(R) and the final product form of Fiblast(R). In March 1999,
the Company announced a restructuring plan that included closure in 1999 of the
manufacturing facility where it had manufactured Fiblast(R). The decision was
based on a combination of factors including the low capacity and high operating
cost of the facility compared to third party manufacturing facilities and the
availability of third party recombinant protein manufacturing capacity.
Therefore, the Company does not itself possess the staff or facilities that may
be necessary to manufacture any product in the commercial quantities that may be
required in the long-term. The strategy of utilizing third-party facilities
carries with it certain risks, as there can be no assurance that such facilities
can be arranged on commercially acceptable terms or that Scios will be able to
meet manufacturing quantity and quality requirements through the use of such
arrangements. Scios has in place an agreement providing for manufacture of
Natrecor(R) by Biochemie Gesellschaft M.B.H. of Austria through 2006. Having a
low-cost manufacturing capability for Natrecor(R) and smoothly managing
third-party manufacturers are expected to be keys to commercializing this and
other products successfully and on a timely basis. Failure to do so could
adversely impact the commercial success of the product. See "Business --
Competition."
Janssen manufactures Risperdal(R) and SB manufactures Paxil(R) and the SB
Products. If SB were to discontinue manufacturing the SB Products and the
Company wished to continue selling the products, the Company would have to
develop additional facilities to manufacture independently on a large scale or
enter into an arrangement with a third party to manufacture such products. See
"Business -- Marketing and Sales."
Patents and Proprietary Rights
- ------------------------------
Scios is seeking patent protection for proprietary technology and products
in the United States and abroad to prevent others from unfairly capitalizing on
its investment in research. Other companies engaged in research and development
of new health care products based on biotechnology also are actively pursuing
patents for their technologies, which they consider to be novel and patentable.
Scios also relies and will continue to rely upon trade secrets and know-how to
develop and maintain its competitive position. There can be no assurance,
however, that others will not develop similar technology or that confidentiality
agreements on which the Company relies to protect trade secrets will be honored.
The Company currently owns or holds exclusive rights to approximately 58
issued United States patents and 34 United States pending patent applications
covering its proprietary technology and products. The Company also files foreign
applications corresponding to most of its United States applications. Scios'
issued patents include patents on Natrecor(R), Fiblast(R), VEGF121 and
insulinotropin. The Company's patent position with respect to certain principal
products under development is described above in the section discussing each
product. See "Business -- Product Development Activities and Risks." If a patent
issues prior to marketing approval, as has been the case with all of the
Company's issued patents to date, Scios can apply for extension of the patent
term for a limited period of time to make up for a portion of the patent term
lost to the regulatory approval period. The actual period of the extension
varies but generally cannot exceed five years. In certain of its third-party
agreements, the absence of a patent covering a product licensed by Scios could
reduce the royalties due to the Company under the agreements.
This section entitled "Patents and Proprietary Rights" contains
forward-looking statements under the PSLRA-95. Actual results will vary
depending on numerous factors, many of which are discussed. Investors should
appreciate that the patent position of biotechnology and pharmaceutical firms is
generally highly uncertain and involves complex legal and factual questions.
Although Scios believes it has strong patent positions on certain of its
products, there can be no assurance that any patent will issue on pending
applications of the Company, or that any patent issued will afford the Company
significant commercial protection against competitors for the technology or
product covered by it, or that patents will not be infringed upon or designed
around. Third parties have filed applications for, or have been issued patents
relating to, products or processes which are similar to or competitive with
certain of the Company's products or processes. Scios is incurring and expects
to continue to incur substantial costs in interference proceedings and in
defending the validity or scope of its patents or in challenging the validity or
scope of competing patents. The Company is unable to predict how the courts will
resolve issues relating to the validity and scope of such patents. If any such
patent were to be interpreted to cover any of the Company's products and could
not be licensed, circumvented or shown to be invalid, the results of Scios'
future operations could be materially and adversely affected. Described below
are patent positions of other companies of which Scios is aware that potentially
overlap the Company's principal product development areas discussed above.
Natrecor(R). Scios has been issued United States, Canadian, European and
Japanese patents covering the endogenous form of Natrecor(R), human b-type BNP.
An opposition proceeding has been filed against Scios' Japanese patent. Scios
has also obtained from Shionogi & Co., Ltd., Tokyo a worldwide license for
therapeutic uses to certain issued BNP patents that are based on work by Daiichi
Pharmaceutical Co., Ltd., Tokyo, including a patent issued to Daiichi by the
European Patent Office.
Fiblast(R). In February 1991, a United States patent with one claim covering
a form of fibroblast growth factor (FGF) protein was issued to Synergen, Inc.
("Synergen"), which was later acquired by Amgen Inc. In June 1991, a United
States patent with one claim covering the DNA for the same form of FGF was
issued to Synergen. Based on a review of the publicly-available documents
relating to these patents, Scios believes that the Synergen form of FGF or DNA
differs from the form of FGF produced by the Company. On August 8, 1995,
following a decision favorable to Scios in a patent interference proceeding with
the Salk Institute for Biological Studies ("Salk"), Scios received a United
States patent covering DNA sequences, expression vectors and microorganisms used
in the recombinant production of human basic FGF. On May 7, 1996, Scios received
a United States patent covering the recombinant production of human basic FGF.
On February 18, 1997, Scios received a United States patent covering
recombinantly produced human basic FGF. On January 12, 1999, Scios received a
United States patent covering a cysteine mutant of human basic FGF.
In October 1992, a United States patent was issued to Salk which contains
claims directed to substantially pure mammalian basic FGF containing the 146
amino acid sequence of bovine basic FGF or a naturally occurring homologous
sequence of another mammalian species. If any claim of this patent were
determined to be valid and construed to cover Scios' human basic FGF, the
Company's ability to develop basic FGF might be hindered or prevented if it were
unable to obtain a license. Scios' outside counsel has reviewed the
publicly-available documents relating to the Salk patent. Based upon this
review, such counsel has opined that, to the extent any claims of the patent may
be interpreted to cover human basic FGF, such claims are overly broad and would
likely be held invalid by an informed court.
In May 1994, the European Patent Office issued European Patent No. 0 248 819
to Scios covering Scios' form of recombinant basic FGF known by the product name
Fiblast(R). An opposition proceeding has been instituted against this patent by
Chiron Corp. and Pharmacia S.p.A. In June 1996, the Opposition Division of the
European Patent Office upheld the validity of the Scios patent; however, the
opponents have filed an appeal against this ruling. In August 1994, the European
Patent Office issued European Patent No. 0 228 449 to Salk covering the 146
amino acid sequence of bovine basic FGF or an equivalent or analog thereof. The
Company filed an opposition to this patent and in September, the Opposition
Division revoked the patent; however, Salk has filed an appeal against this
ruling. The results of these opposition proceedings cannot be predicted with
certainty.
In March 1994, the Company obtained a non-exclusive license to make, use and
sell Fiblast(R) under a United States patent issued to Harvard University
containing claims to purified cationic (basic) FGF. The Harvard patent is based
on a patent application having a filing date earlier than the application which
formed the basis for the Salk patent.
VEGF121. Vascular endothelial growth factor ("VEGF") is a highly specific
mitogen for vascular endothelial cells. Five isoforms of human VEGF ("hVEGF")
are known, having 121, 145, 165, 189 and 206 amino acids, respectively. Scios
believes it was the first to identify, clone and produce by recombinant DNA
technology the 121 amino acid form of hVEGF (hVEGF121). This form is unique in
that, unlike the other four isoforms, it does not bind heparin. Scios owns two
U.S. patents issued in 1993 covering hVEGF121, and in 1996 received a European
patent covering this VEGF isoform. Patent applications are pending in Canada and
Japan. Other companies and institutions, including Genentech, Monsanto, and the
Regents of the University of California, hold patents and pending patent
applications claiming various isoforms of hVEGF and certain VEGF variants.
p38-kinase Inhibitors. Scios has filed a series of patent applications in
the United States covering the classes of p38-kinase inhibitors that the Company
has identified. While the classes of small molecule compounds identified by
Scios researchers appear to be unique, the Company is aware that other companies
are also working to develop p38-kinase inhibitor compounds, have filed patent
applications on and received patents covering the classes of compounds that
these competing companies have developed. Among the companies competing to
develop p38-kinase inhibitors are SmithKline Beecham Corporation, G.D. Searle
Pharmaceuticals, a division of Monsanto Company, Johnson & Johnson Company and
Merck, Inc., each of whom has substantial resources.
Trademarks. Natrecor(R), Fiblast(R) and Auriculin(R), are registered
trademarks of Scios. Paxil(R), Eskalith(R), Eskalith CR(R), Thorazine(R),
Stelazine(R) and Parnate(R) are registered trademarks of SB. Risperdal(R) is the
registered trademark of Janssen. Haldol(R) is a registered trademark of
Ortho-McNeil Pharmaceutical, Inc. Effexor(R) is a registered trademark of
American Home Products Inc. Gliadel(R) is the registered trademark of Guilford.
Approval of the generic compound name used with Natrecor(R) -- (nesiritide) --
is pending before USAN.
Competition
- -----------
Competition is intense in the development of pharmaceutical products. There
are numerous companies and academic research groups throughout the world engaged
in similar research and development. Some of the Company's competitors,
including some of its licensees, are working on products similar to those being
developed by Scios. Many of these companies have substantially greater
financial, marketing and human resources than Scios. In the case of Natrecor(R),
a number of products are already clinically accepted for the short-term
management of CHF. Hence, the Company will need to demonstrate positive low cost
clinical benefits compared to the existing products and an ability to continue
to produce Natrecor(R) cost-effectively in order to successfully introduce
Natrecor(R) into this competitive market. Fiblast(R) and VEGF121 face potential
competition from other growth factors and alternative treatments.
There can be no assurance that technological developments or superior
marketing capabilities possessed by competitors will not materially adversely
affect the commercial potential of the Company's products. In addition, if the
Company commences significant commercial sales of products, manufacturing
efficiency and marketing capability are likely to be significant competitive
factors. With respect to products no longer covered by patents, such as the SB
Products, Scios faces, or expects to face, competition from companies offering
generic products.
The Company believes that the competitive success of the Company will be
based primarily on scientific and technological superiority, managerial
competence in identifying and pursuing opportunities, operational competence in
developing, protecting, producing and marketing products, and obtaining timely
regulatory agency approvals and adequate funds. Achieving success in these areas
will depend on the Company's ability to attract and retain skilled and
experienced personnel, to develop and secure the rights to advanced proprietary
technology and to exploit commercially its technology prior to the development
of competitive products by others. Scios expects that there will be continued
competition for highly qualified scientific, technical and managerial personnel.
This section entitled Competition contains forward-looking statements within the
meaning of the PSLRA-95. Numerous factors, including the factors identified
above, could cause actual results to differ from those described in these
forward-looking statements.
Government Regulation
- ---------------------
The industry in which the Company participates -- the development and
marketing of pharmaceutical products -- is heavily regulated. As is true for all
companies developing pharmaceuticals, the Company's research and development
activities and the production and marketing of its products are subject to
extensive regulation for safety and efficacy by numerous governmental
authorities in the United States and other countries. This regulation is a
significant factor in the production and marketing of the products resulting
from Scios' research and development activities. Testing, production and
marketing of pharmaceutical products for human use require approval of the FDA
and comparable authorities in other countries. Over the next several years,
Scios expects to expend substantial resources to meet these requirements for the
products it is developing. See "Business -- Product Development Activities and
Risks."
The procedure for seeking and obtaining the required governmental approvals
for a new product involves many steps, beginning with animal testing to
determine safety and potential toxicity. In addition, extensive human clinical
testing is required to demonstrate the efficacy, optimal dose and safety of each
product. The time and expense required to perform clinical testing can far
exceed the time and expense of developing the product prior to clinical testing.
Whether undertaken by the Company or its commercial partners, the process of
seeking and obtaining these approvals for a new product is likely to take a
number of years and involves the expenditure of substantial resources. In
addition, there can be no assurance that any of the Company's products will
obtain the necessary approvals on a timely basis, if at all. The regulatory
environment is constantly evolving and one of the demands on companies in the
pharmaceutical industry is to take account of and anticipate these changes in
order to minimize negative impact on the Company or its product development
timelines. As a developer of pharmaceutical products, the Company and its
commercial partners must also deal with differences in the regulatory
requirements of different countries. Although there is an effort at greater
harmonization of regulatory standards, differences still impact whether and in
what time frame a product may be approved in a particular country, if at all.
Because of these differences between countries, approval in one country does not
assure approval in another.
Even if initial FDA approval is obtained for a product, further studies may
be required to provide additional data or to gain approval for the use of a
product as a treatment for clinical indications other than those initially
targeted. Moreover, the FDA may reconsider its approval of any product at any
time and may withdraw such approval. In addition, before the Company's products
can be marketed in foreign countries, they are subject to regulatory approval in
such countries similar to that required in the United States. Accordingly,
numerous factors will impact the timing, extent and value of any regulatory
approvals that may be obtained for the Company's products, including changes in
regulatory requirements, which may either decrease or increase the burden on the
Company, the level of side effects exhibited by the Company's products as
compared to their beneficial effects, the availability of adequate resources to
regulatory agencies which will impact the speed of regulatory review, and the
price the Company is able to charge for its products.
FDA regulations require that any drug to be tested in humans must be
manufactured according to cGMP regulations. The cGMPs set certain minimum
requirements for procedures, record-keeping and the physical characteristics of
the laboratories used in the production of these drugs. In addition, various
foreign and United States federal, state and local laws and regulations relating
to safe working conditions, laboratory practices, the experimental use of
animals, and the storage, use and disposal of hazardous or potentially hazardous
substances, including radioactive compounds and infectious disease agents, used
in connection with the Company's research and manufacturing work are or may be
applicable to such activities. They include, among others, the United States
Atomic Energy Act, the Clean Air Act, the Clean Water Act, the Occupational
Safety and Health Act, the National Environmental Policy Act, the Toxic
Substances Control Act, the Resource Conservation and Recovery Act, national
restrictions on technology transfer, import, export and customs regulations, and
other present and possible future foreign, federal, state and local regulations.
Although the Company believes that its safety procedures for handling and
disposing of hazardous materials comply with prescribed regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. The Company may also incur substantial costs to comply with
environmental regulations if the Company develops additional manufacturing
capacity or otherwise changes its operations. For example, in connection with
the closure of its Baltimore research and development facility in 1994 to
consolidate such activities at its California headquarters, the Company incurred
costs of approximately $370,000 for chemical disposal, storage and related
costs. Furthermore, the Company employs third-party contractors that it believes
to be reliable to perform certain work in connection with the disposal of
hazardous materials generated in the Company's research in compliance with
applicable laws, but it cannot ensure their compliance. Notwithstanding such
reliance, the Company may remain responsible for the materials and
the actions of its contractors related to such materials. From time to
time, the Company has been notified that certain of its contractors may
not have disposed of such materials in full compliance with applicable laws
and that the Company may be required to contribute to the cost of environmental
clean-up efforts. See Item 3 below and Note 10 of Notes to Consolidated
Financial Statements.
Employees
- ---------
The Company had 274 full-time employees as of December 31, 1998 (of which
221 were engaged in research, product and clinical development) and 103
part-time employees (primarily its sales force). As part of restructuring
certain of its operations, in March 1999, the Company announced staff reductions
aggregating 80 positions that will occur over 4 months ending June 1999.
Item 2. PROPERTIES
The Company's current headquarters facility in Mountain View, California,
consists of three buildings owned by the Company and land occupied under a
long-term ground lease. In March 1999, the Company announced its plan to sell
its Mountain View facility and consolidate its operations in smaller leased
facilities in Sunnyvale, California. The Company has entered into a letter of
intent with a purchaser for the Mountain View property. The move from the
Mountain View facility is expected to be completed in August 1999. The three
buildings in the Mountain View facility represent 98,000 square feet of office
and laboratory space. During 1998, the Company occupied approximately 88,000
square feet and leased the remaining space to a tenant. The Mountain View
facility includes a 13,000 square foot combination process and product
development and biological testing facility in which Scios previously produced
bulk supplies of Fiblast(R).
In 1995, the Company began leasing a 52,000 square foot building in
Sunnyvale, California, and constructed research laboratories in a portion of the
space. The Company relocated its discovery research group to the Sunnyvale
facility in September 1996. The Company's annual lease payments for the
Sunnyvale research and development facility are approximately $762,000. In 1999,
the Company will build out the remaining space in the Sunnyvale facility to
consolidate all of its research and development laboratories in one building.
The Company is also in the process of leasing a neighboring 33,400 square foot
office building to house certain of its employees. The Company expended
approximately $2.5 million in capital expenditures in 1998 and anticipates
spending approximately $5.0 million in capital expenditures in 1999.
The Company also owns a 57,428 square foot administrative and laboratory
building in Baltimore, Maryland (the "Holabird Facility") originally used by
Nova Pharmaceuticals Corporation, which the Company acquired in 1992.
Approximately two-thirds of the Holabird Facility is currently leased to third
parties under short-term leases extending through July 1999 (32,700 square feet)
and July 2000 (approximately 10,000 square feet). The Company is endeavoring to
sell the Holabird Facility.
Item 3. LEGAL PROCEEDINGS
In November 1995, the Company was notified by the United States
Environmental Protection Agency ("EPA") that it may have a liability in
connection with the clean-up of a toxic waste site arising out of the alleged
disposal of hazardous substances by a subcontractor of Nova Pharmaceutical
Corporation, which was acquired by the Company in 1992. An agreement has been
reached between the EPA and parties whose waste was disposed of at the site. The
Company believes that its exposure for clean-up costs is approximately $90,000,
and it has created a reserve for such exposure.
The Company is also involved in certain legal proceedings related to patents
and patent application covering its products. See "Business -- Patents and
Proprietary Rights."
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
MANAGEMENT
Executive Officers
- ------------------
The executive officers of the Company and their ages at March 16, 1999 are
as follows:
Name Age Position
- ---- --- --------
Richard B. Brewer 47 President and
Chief Executive Officer
Jack Cohen, Ph.D. 62 Vice President, Quality
& Regulatory
Thomas L. Feldman 48 Vice President of Commercial
Operations
Elliott B. Grossbard, M.D. 51 Senior Vice President of
Development
David W. Gryska 42 Vice President of Finance
and Chief Financial Officer
John A. Lewicki, Ph.D. 47 Vice President of Research
John H. Newman 48 Senior Vice President, General
Counsel and Secretary
Mr. Brewer is President and Chief Executive Officer of Scios Inc. He joined
Scios in September 1998 and has served as a Director since that time. From early
1996 to 1998, he was with Heartport Inc., first as Executive Vice President of
Operations and then, Chief Operating Officer. Prior to that, Mr. Brewer served
in various capacities with Genentech, Inc. from 1984 to 1995, most recently as
Senior Vice President, U.S. Sales and Marketing, Genentech Europe Ltd., and
Genentech Canada, Inc. Mr. Brewer earned a B.S. from Virginia Polytechnic
Institute and a M.B.A. from Northwestern University.
Dr. Cohen joined Scios in 1992 as Vice President of Quality and became Vice
President of Quality & Compliance in 1994, and the Vice President of Quality &
Regulatory in September, 1997. Prior to joining the Company, Dr. Cohen was the
Director, Technical Resource Planning for Syntex Corporation. From 1981 to
1991, he was Vice President, Quality Assurance at Syntex Laboratories, Inc. and
prior to that from 1978 to 1981, the Director, Quality Control.
Mr. Feldman joined Scios in January 1995 as Vice President of Commercial
Operations. Prior to joining the Company, Mr. Feldman was responsible for sales
and marketing activities in two pharmaceutical companies affiliated with Johnson
& Johnson. From 1993 through 1994, Mr. Feldman was National Sales Manager at
Ortho Pharmaceutical Corporation. From 1973 to 1993, Mr. Feldman held various
sales and marketing positions at McNeil Pharmaceutical, where he most recently
served as National Sales Manager from 1990 to 1993.
Dr. Grossbard joined Scios in 1991 as Vice President of Medical and
Regulatory Affairs and became Senior Vice President in 1996. Immediately prior
to joining Scios, he was Vice President of Medical Affairs for HemaGen/PFC, a
privately-held company developing perfluorocarbon products for oxygen transport
and as blood substitutes. From 1982 to 1990, he was Associate Director and later
Director of Clinical Research for Genentech, in charge of the clinical
development of Alteplase (TPA). From 1978 to 1980, as an Assistant Attending
Physician at Memorial Hospital and Assistant Professor of Medicine at Cornell
Medical School, he helped to establish the Bone Marrow Transplant Service at
Memorial Hospital. He received his M.D. from the Columbia College of Physicians
and Surgeons in 1973, trained in internal medicine at Massachusetts General
Hospital in Boston and received subspecialty training in hematology at the
Columbia-Presbyterian Medical Center and the Memorial Sloan-Kettering Cancer
Center in New York.
Mr. Gryska joined Scios in December 1998 as Vice President of Finance and
Chief Financial Officer. Prior to joining Scios, Mr. Gryska was Vice President,
Finance and Chief Financial Officer of Cardiac Pathways Corporation since 1993.
Mr. Gryska was with Ernst & Young LLP from 1982 to September 1993, and as a
partner since 1989.
Dr. Lewicki joined Scios in 1983 as a Scientist, and became Senior Scientist
in 1984, Vice President, Research in August 1986, Vice President and Deputy
Director, Research in March 1987, and Vice President and Director of Research in
February 1988. Dr. Lewicki received his Ph.D. in Physiology/Pharmacology from
the University of California, San Diego in 1979. From 1979 to 1981, Dr. Lewicki
conducted postdoctoral research at the University of Virginia, Department of
Internal Medicine, and, from 1981 to 1983, he was a research pharmacologist at
Stanford University, Division of Clinical Pharmacology.
Mr. Newman joined Scios in 1983 as Vice President, General Counsel and
Secretary, and became Vice President of Commercial Development, General Counsel
and Secretary in December 1989, Vice President of Legal Affairs, General Counsel
and Secretary in March 1992 and Senior Vice President, General Counsel and
Secretary in February 1998. Prior to joining Scios, Mr. Newman was an attorney
in private practice.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market System
under the symbol SCIO. The table below sets forth the high and low sales prices
as reported by Nasdaq for the Common Stock during the last two fiscal years.
Prices represent quotations among dealers without adjustment for retail markups,
markdowns or commissions, and may not represent actual transactions. No cash
dividends have been paid on Common Stock, and the Company does not anticipate
paying cash dividends in the foreseeable future. As of December 31, 1998, there
were approximately 4,871 stockholders of record of the Company's Common Stock.
Common Stock
FY 1998 FY 1997
------- -------
High Low High Low
---- --- ---- ---
Q1 13-5/8 8-1/8 8-3/4 5-3/8
Q2 13-1/4 8 7 3-5/8
Q3 9-1/8 4-1/8 9-7/8 5-7/8
Q4 10-13/16 3-1/2 10-5/8 6-7/8
Year 13-5/8 3-1/2 10-5/8 3-5/8
Item 6. SELECTED FINANCIAL DATA
(Dollars in thousands, except per share amounts)
Year Ended December 31, 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Revenues $ 73,715 $ 47,429 $ 64,223 $ 49,187 $ 53,667
Loss from operations (11,991) (39,737) (22,020) (28,175) (31,719)
Other income 11,122 2,254 4,497 5,049 4,045
Net loss (2,363) (38,667) (18,403) (26,382) (27,961)
Net loss per common share and
per common share assuming
dilution (0.06) (1.07) (0.51) (0.74) (0.79)
Cash and securities 97,311 64,700 62,170 87,069 104,439
Working capital 8,103 4,524 (5,838) 11,642 38,942
Total assets 138,829 116,871 113,961 131,550 146,096
Long-term obligations 34,593 31,919 426 1,082 1,739
Stockholders' equity 74,926 60,142 93,628 109,394 126,438
Employees at year end 279 258 256 216 202
Field sales representatives 98 92 79 85 81
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion contains forward-looking statements about plans,
objectives and future results of Scios Inc. (the "Company"). These
forward-looking statements are based on the current expectations of the Company,
and the Company assumes no obligation to update this information. Realization of
these plans and results involves risks and uncertainties, and 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 below, as well as in other sections of this Annual Report, and
those discussed in the Company's Form 10-K for the year ended December 31, 1998.
Operating Results (1998, 1997 and 1996)
- -----------------
Total revenues for the Company were $73.7 million in 1998, $47.4 million in
1997 and $64.2 million in 1996. The revenue decline from 1996 to 1997 and
increase from 1997 to 1998 was principally due to changes in the level of
research and development contract revenues.
Revenue from product sales of certain psychiatric products ("SB Products")
under license from SmithKline Beecham Corporation ("SB") was $29.1 million,
$35.2 million and $38.2 million in 1998, 1997 and 1996, respectively. Product
sales declined 17% from 1997 to 1998 and 8% from 1996 to 1997 due to competition
from generic drugs and new competing products.
Co-promotion commissions were $6.5 million, $5.8 million and $6.5 million in
1998, 1997 and 1996, respectively. In 1998, 1997 and 1996 the Company received
co-promotion commissions under agreements with Ortho-McNeil Pharmaceutical
("Ortho-McNeil"), an affiliate of Johnson & Johnson, for the co-promotion of the
psychiatric product Haldol(R) Decanoate (haloperidol) ("Haldol") and with
Wyeth-Ayerst Laboratories ("Wyeth-Ayerst"), a division of American Home Products
Corp., for the co-promotion of its psychiatric product Effexor(R) (venlafaxine
hydrochloride) ("Effexor"). In April 1998, the respective agreements with
Ortho-McNeil and Wyeth-Ayerst to co-promote Haldol and Effexor were terminated
by mutual agreement. In 1998, the Company also received co-promotion commissions
under new agreements with SB for the co-promotion of its drug Paxil(R)
(paroxetine HCl) ("Paxil") for the treatment of depression, panic disorder and
obsessive-compulsive disorder and with Janssen Pharmaceutica Inc. ("Janssen")
for the co-promotion of its anti-psychotic drug Risperdal(R) (risperdone)
("Risperdal"). Co-promotion commissions increased from 1997 to 1998 due to the
change in product mix and decreased from 1996 to 1997 as a result of lower sales
of Haldol.
Revenue from research and development contracts was $38.1 million in 1998,
$6.4 million in 1997 and $19.5 million in 1996. The increase in revenue from
1997 to 1998 was primarily due to: receipt of a $20.0 million payment from Bayer
AG ("Bayer") on entering a worldwide strategic alliance for the
commercialization of Natrecor(R) (nesiritide) ("Natrecor") and $4.5 million in
additional development funding; milestone payments of $5.0 million from Novo
Nordisk A/S for development of insulinotropin; and additional contract funding
from Eli Lilly and Company ("Eli Lilly") and DuPont Pharmaceuticals Company
("DuPont") for the Company's Alzheimer's research program. The decrease in
revenue from 1996 to 1997 was principally due to receipt of $12.0 million in
1996 from Wyeth-Ayerst upon entering into a collaboration agreement for the
development and commercialization of Fiblast(R) (trafermin) ("Fiblast") for the
treatment of neurological and cardiovascular disorders and $2.0 million received
under other agreements. Revenues from Bayer and Novo Nordisk A/S accounted for
64% and 13% of contract revenues in 1998. Revenues under collaboration with Eli
Lilly to study Alzheimer's disease comprised 8% of 1998 and 28% of 1997 contract
revenues. In 1996, the payment from Wyeth-Ayerst accounted for 62% of total
research and development contract revenue. Revenues from the collaboration with
Hoechst Marion Roussel to study Alzheimer's disease comprised approximately 3%,
16% and 8% of contract revenues in 1998, 1997 and 1996, respectively. The
collaboration was terminated by mutual agreement in 1997. Revenues under the
collaboration with Kaken Pharmaceutical Co., Ltd. ("Kaken") to develop Fiblast
in Japan for the treatment of dermal ulcers, were 2%, 3% and 9% of contract
revenues in 1998, 1997 and 1996, respectively.
Cost of goods sold for the SB Products were $16.6 million, $20.2 million and
$22.3 million in 1998, 1997 and 1996, respectively. The declines from year to
year were principally the result of lower unit sales. Gross margins were 43% in
1998 and 1997 compared to 42% in 1996. Future changes in gross margins will be
principally dependent on the effects of price increases, competition in the
marketplace and changes in the product mix.
Research and development expenses were $46.6 million in 1998, $41.9 million
in 1997 and $39.4 million in 1996. The increases year to year were the result of
higher staffing levels, greater expenses for the purchase of drug supply to
support further development of the Company's lead products, and increased
clinical trials expenses.
Marketing, general and administrative expenses were $19.4 million in 1998,
$20.7 million in 1997 and $19.7 million in 1996. The decreased spending from
1997 to 1998 was primarily due to lower depreciation expenses. The spending
increase from 1996 to 1997 was principally due to higher staffing levels.
The profit distributions to third parties of $3.1 million, $4.4 million and
$4.8 million in 1998, 1997 and 1996, respectively, represent SB's share of the
net profits from sales of the SB Products. The decreases year to year were
principally due to declining product sales.
Other income was $11.1 million in 1998, $2.3 million in 1997 and $4.5
million in 1996. The increase from 1997 to 1998 was due to the gain on the sale
of the Company's entire interest in its subsidiary Karo Bio AB, 70,000 shares of
the common stock of Guilford Pharmaceuticals Inc. ("Guilford"), and other
marketable securities in the Company's portfolio. The decrease from 1996 to 1997
was due to lower investment income from the Company's invested portfolio and the
addition of interest expense on the $30.0 million loan from Genentech that was
drawn down in March 1997.
The $1.3 million net loss in equity of affiliate in both 1997 and 1998 was
the result of Guilford's losses in those respective years. The $0.3 million gain
in equity in affiliate in 1996 was the result of profitable operations of
Guilford in 1996. The Company's percent ownership in Guilford has declined from
62% in May 1994 to 7% at December 31, 1998 as a result of Guilford's public
stock offerings and the sales of Guilford stock by the Company. In the fourth
quarter of 1998, the Company reclassified the Company's investment in Guilford's
stock to marketable securities. From June of 1994, the date of Guilford's
initial public stock offering, until the fourth quarter of 1998, the Company
used the equity method of accounting for its investment in Guilford. Prior to
the public stock offering, the financial results of Guilford were consolidated
with those of the Company. The minority interest of ($0.02) million in 1998,
$0.1 million in 1997 and ($1.1) million in 1996 is the net income or expense
associated with the minority partners of the Biotechnology Research Partnership.
Outlook and Risks
- -----------------
The Company is striving to achieve profitability in the next several years.
The ability of the Company to achieve sustainable profitability depends
principally upon the success of the Company and its collaboration partner,
Bayer, in achieving regulatory approvals and generating sales from Natrecor.
Under the Natrecor strategic alliance, Bayer is solely responsible for the
marketing and sales effort in the United States for at least the first three
years after product launch. While the Company expects Bayer will be diligent in
its sales and marketing efforts, and has secured an option to terminate the
agreement if certain minimum sales activity levels are not achieved, the Company
cannot require Bayer to take actions the Company might take itself if it were
promoting the product solely on its own.
Profitability will also depend on the Company's ability to generate
additional revenues through the development and commercialization of products
such as Fiblast and vascular endothelial growth factor 121 ("VEGF121"), either
through its own efforts or in collaboration with partners. The Company expects
to continue to generate revenue from the sale and co-promotion of the
psychiatric drugs it currently sells or of other third party product rights
which it may acquire as additions to or replacements for existing products. In
addition, the Company expects to continue to rely on outside partners to fund
certain research activities such as its ongoing Alzheimer's research program.
Such funding will depend, in part, on priorities set by the sponsors in relation
to the sponsors' other product opportunities and their assessment of the
continued benefit of sponsoring a particular program at the Company.
As a result of closing down its manufacturing facility, the Company is
wholly dependent on third party suppliers for the manufacture of drug for sale
and is evaluating additional supply sources for its other products in
development. Before closing its manufacturing facility, the Company will produce
all of the Fiblast drug supply necessary to fulfill its contractual agreement
with Kaken. Although the Company does not currently foresee a supply problem,
future product supply and the Company's profitability could be affected by
events at these suppliers over which the Company has limited control.
Profitability may also be affected by any gains realized on the sale of all or a
portion of the Company's equity holding in Guilford and by any merger or
acquisition activity undertaken by the Company to expand its portfolio of drugs
in development.
Further development of the Company's products will require substantial
additional investment to cover, among other things, the costs of marketing and
sales expenses associated with product introductions, the securing of
commercial-scale manufacturing capability and the completion of clinical trials
for new and expanded indications. While market introduction of new products may
require considerable expenditures by the Company, revenues generated from such
products, assuming they are successfully developed, may not be realized for
several years. Principal factors that could affect the level of new product
revenues will include the rate of market penetration, the availability of
alternative therapies, the price charged by the Company per course of therapy,
the breadth of the approved indication allowed by the Food and Drug
Administration and what, if any, income can be obtained from potential
third-party licensees. In the case of Fiblast for use in neurological and
cardiovascular disorders, development and commercialization expenses and any
subsequent revenues will be shared with Wyeth-Ayerst at varying percentages.
Sales of the SB Products, in total, are likely to continue to decline during
the next few years because of continuing or new competition from generic
products or new market entrants. The Company hopes to offset any such decrease
with payments received for the co-promotion of other third party products such
as Risperdal and Paxil that are currently being co-promoted. Factors influencing
the availability of additional products on terms favorable to the Company
include the ability of the Company to demonstrate success under its current
agreements and the willingness of other companies to enter into such agreements.
For the reasons stated above, the operating results of the Company are
expected to fluctuate from period to period. Inflation is not expected to have a
significant effect upon the business of the Company. In addition, because the
Company participates in a highly dynamic industry, the Company's common stock
price is subject to significant volatility as a result of developments at both
the Company and in the biopharmaceutical industry in general.
Restructuring
- -------------
On March 1, 1999, the Company announced a restructuring and right-sizing
plan that includes reduction of the Company's full-time workforce by
approximately 30% and the consolidation of its headquarters, development and
research staff into currently leased facilities in Sunnyvale, California. In the
first half of 1999, the Company will close its manufacturing facility due to its
low capacity and high operating expenses and the ready availability of third
party recombinant protein manufacturing capacity. The Company's Mountain View,
California, campus will be sold. The consolidation is expected to create
improved management and operational synergies and save approximately $14.0
million annually. In the quarter ending March 31, 1999, the Company will record
a one-time restructuring charge of approximately $7.0 million for the
disposition of certain excess assets and severance costs.
Year 2000 Computer Systems Compliance
- -------------------------------------
Many older computer software programs refer to years only in terms of their
final two digits. Such programs may interpret the year 2000 to mean the year
1900. If not corrected, those programs could cause date-related transaction
failures. The Company has developed plans to address the potential exposures
related to the impact on its computer systems for the year 2000 and beyond. A
project team, consisting of Company personnel, is continuing its assessment of
key internal computer systems and is developing and implementing plans to
correct the problems. The Company expects the assessment, implementation and
testing to be successfully completed during 1999 and believes that with these
plans, the Year 2000 issue will not pose significant problems for its computer
systems or ongoing operations. However, if such modifications and conversions
are not made, or are not completed in a timely fashion, the Company does not
expect the Year 2000 issue to have a material impact on its operations.
In addition to risks associated with the Company's own computer systems, the
Company has relationships with, and is dependent upon, a large number of third
parties that provide information, goods and services to the Company. These
include financial institutions, suppliers, vendors, research partners and
governmental entities. If significant third parties experience failures in their
computer systems due to Year 2000 noncompliance, it could affect the Company's
ability to process transactions or engage in similar normal business activities.
While some of these risks are outside the control of the Company, the Company
has instituted a program to identify key third parties, update contracts and
address any noncompliance issues.
As the Company's plan is to address its Year 2000 issues prior to being
affected by them, it has not developed a comprehensive contingency plan.
However, if the Company identifies significant risks related to its Year 2000
compliance or its progress deviates from the anticipated timeline, the Company
will develop contingency plans as deemed necessary at that time.
The total cost of the Year 2000 systems assessments and conversions is
funded through operating cash flows, and the Company is expensing these costs.
The financial impact of making the required system changes cannot be known
precisely at this time but is not expected to be material to the Company's
financial position, results of operations or cash flows.
Liquidity and Capital Resources
- -------------------------------
Combined cash, cash equivalents and marketable securities (both current and
non-current) totaled $97.3 million at December 31, 1998, an increase of $32.6
million from December 31, 1997. The increase was mainly attributable to
favorable operating cashflows, stock option exercises, and the reclassification
of the investment in Guilford to marketable securities. The increases were
partially offset by $2.5 million used for property and equipment purchases and
$1.5 million used in repurchases of the Company's stock in the public market.
In October 1998 the Company announced that its Board of Directors had
authorized an additional expenditure of $5.0 million for the repurchase of
shares of the Company's common stock. In November 1995, the Company had
authorized the expenditure of up to $6.0 million for the repurchase of shares of
the Company's common stock. The Company purchased 327,000 treasury stock shares
for $1.5 million in 1998 and 352,500 shares for $1.8 million in 1997. As of
December 31, 1998, the Company had purchased 1,356,500 shares at an aggregate
price of $6.3 million under the repurchase program since its inception in 1995.
To date, the Company's operations and capital requirements have been
financed primarily from the proceeds of public and private sales of common
stock, research and development partnerships, collaborative agreements with
pharmaceutical firms, product sales and investment income. The Company's net
operating losses and credit carryforwards will provide an additional source of
liquidity only to the extent that profitable operations are achieved prior to
the expiration of carryforward periods. The utilization of losses generated
through the date of the 1992 merger with Nova Pharmaceutical Corporation will be
subject to annual limitations.
Outlook and Risks
- -----------------
The Company's cash, cash equivalents and marketable securities of
approximately $97.3 million at December 31, 1998, together with revenues from
product sales, royalties, collaborative agreements and interest income, will be
used to fund new and continuing research and development programs, expand
clinical trials for its products under development and for other general
purposes. The Company believes its cash resources will be sufficient to meet its
capital requirements for the next several years. Key factors that will affect
future cash use and the timing of the Company's need to seek additional
financing include the Company's decision concerning the degree to which it will
incur expenses to launch its products following the necessary regulatory
approvals, the results of the Company's partnering efforts and the timing and
amounts realized from licensing and partnering activities, the rate of spending
required to develop the Company's products and respond to changing business
conditions and the net contribution produced by the Commercial Operations
Division from co-promoting and marketing products for third parties.
Over the long term, the Company may need to arrange additional financing for
the future operation of its business, including the commercialization of its
products currently under development, and will consider collaborative
arrangements and additional public or private financings, including additional
equity financings. Factors influencing the availability of additional funding
include the Company's progress in product development, investor perception of
the Company's prospects and the general conditions of the financial markets.
Financial Risk Management
- -------------------------
The Company is exposed to a variety of risks, including changes in interest
rates affecting the return on its investments and foreign currency fluctuations.
In the normal course of business, the Company employs established policies and
procedures to manage its exposures to fluctuations in interest rates and foreign
currency values.
The Company's exposure to market-rate risk for changes in interest rates
relates primarily to the Company's investment portfolio. The Company places its
investment with high quality issuers and, by policy, limits the amount of credit
exposure to any one issuer and does not use derivative financial instruments in
its investment portfolio. The Company maintains an investment portfolio of
various issuers, types and maturities, which consist of both fixed and variable
rate financial instruments. These securities are classified as
available-for-sale and, consequently, are recorded on the balance sheet at fair
value with unrealized gains or losses reported as a separate component in
stockholders' equity, net of applicable taxes. At any time sharp changes in
interest rates can affect the fair value of the investment portfolio and its
interest earnings. Currently the Company does not hedge these interest rate
exposures.
The Company's exposure to foreign currency fluctuations is currently limited
to its supply contract for Natrecor, which is denominated in German marks.
Changes in the exchange rate between German marks and the U.S. dollar could
adversely affect the Company's manufacturing costs. All of the Company's other
contracts are denominated in U.S. dollars. Exposure to foreign currency exchange
rate risk may change over time as the business evolves and the Company's
products are introduced into international markets. Currently, the Company does
not hedge against any foreign currencies and, as a result, could incur
unanticipated gains or losses.
Recent Pronouncements
- ---------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes new standards of
accounting and reporting for derivative instruments and hedging activities. SFAS
133 will be effective for fiscal years beginning after June 15, 1999. The
Company does not currently hold derivative instruments or engage in hedging
activities.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Financial Statements appearing on page F-1 of this Form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Identification of Directors. The information required by Item 10 of Form
10-K with respect to identification of directors is incorporated by reference to
the information contained in the section captioned "Election of Directors" of
the Company's definitive Proxy Statement for the 1999 Annual Meeting of
Stockholders.
Identification of Executive Officers. See page17 of this Form 10-K.
Item 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by
reference to the information contained in the sections captioned "Executive
Compensation" and "Stock Option Grants and Exercises" of the Company's
definitive Proxy Statement for the 1999 Annual Meeting of Stockholders.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Security
Ownership of Management and Principal Stockholders" of the Company's definitive
Proxy Statement for the 1999 Annual Meeting of Stockholders.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Certain
Relationships and Transactions" of the Company's definitive Proxy Statement for
the 1999 Annual Meeting of the Stockholders.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements. See Index to Financial Statements at page F-1
of this Form 10-K.
(2) Financial Statement Schedules. Omitted because they are not required,
are not applicable, or the information is included in the consolidated
financial statements or notes thereto.
(3) Exhibits. See Exhibit Index at page 25 of this Form 10-K.
(b) Reports on Form 8-K. Form 8-K filed October 27, 1998 respecting the
appointment of Richard B. Brewer as President and Chief Executive Officer
of the Company.
EXHIBIT INDEX
Exhibit
Number Page
------- ----
3.1 Certificate of Incorporation...........................................................................Q
3.2 Bylaws.................................................................................................J
10.1 Biotechnology Research Partners, Ltd. Agreement of Limited
Partnership dated October 29, 1982; Development Contract,
Technology License Agreement and Joint Venture Agreement
between Biotechnology Research Partners, Ltd. and the
Registrant dated December 29, 1982; Promissory Note dated
December 29, 1982; and Memorandum of Understanding between
Battery Park Credit Company and
Biotechnology Research Partners, Ltd. dated December 28, 1982..........................................A
10.2* 1983 Incentive Stock Option Plan, as amended, and form of Stock Option
Agreement, Promissory Note and Pledge Agreement........................................................E
10.3 Common Stock Purchase Agreement dated April 15, 1985 between the Registrant
and American Home Products Corporation.................................................................B
10.4 Agreement of Purchase and Sale (Real Estate) and Joint Escrow
Instructions by and between Charleston Properties and
Bio-Shore Holdings, Ltd.
dated December 30, 1986................................................................................C
10.5* 1986 Supplemental Stock Option Plan, as amended, and form of Stock Option
Agreement, Promissory Note and Pledge Agreement........................................................E
10.6 Rights Exercise Agreement between the Registrant and American Home Products
Corporation dated February 28, 1986 and Letter of March 26 and May 16, 1986............................B
10.9 Rights Agreement dated as of June 18, 1990 between the Registrant and
The First National Bank of Boston......................................................................F
10.11* 1992 Equity Incentive Plan.............................................................................H
10.18 Form of Purchase Option Agreement between each of the limited partners of
Nova Technology Limited Partnership and Nova...........................................................I
10.19* Nonemployee Director Stock Option Plan.................................................................G
10.27 Purchase Agreement dated as of July 29, 1988 between Nova and SKB Properties, Ltd......................M
10.29 CNS Psychiatric Products Agreement dated June 30, 1990 between SmithKline
Beecham Corporation and Nova...........................................................................N
10.30 Master Security Agreement, Promissory Note and Negative Covenant Agreement,
each dated April 28, 1993, between the Registrant and General Electric
Capital Corporation....................................................................................O
10.32 Collaboration Agreement dated December 30, 1994 between the Registrant and
Genentech, Inc.........................................................................................Q
10.33 Preferred Stock Purchase Agreement dated December 30, 1994 between the
Registrant and Genentech, Inc..........................................................................Q
10.34 Note Agreement dated December 30, 1994 between the Registrant and Genentech, Inc.......................Q
10.35 Assignment of Lease dated March 22, 1995 for premises located at 820 West Maude
Avenue, Sunnyvale, California..........................................................................R
10.36 Special Warranty Deed of Improvements dated February 24, 1995 from Rouse-Teachers
Properties, Inc. ("RTP") to the Registrant and Assignment of Ground Lease dated
February 22, 1995 from RTP to the Registrant...........................................................R
10.38* Employment Letter dated September 8, 1998 between the Registrant and
Richard B. Brewer
21.1 Subsidiaries of Registrant.............................................................................S
23.1 Consent of PricewaterhouseCoopers LLP.
24.1 Powers of Attorney. Reference is made to page 28.
- -------------------
<FN>
* Management contract or compensatory plan or arrangement.
A Filed as an exhibit to Form S-1 Registration Statement (File No. 2-86086), as
amended, and incorporated herein by reference.
B Filed as an exhibit to Form S-1 Registration Statement (File No. 33-3186), as
amended, and incorporated herein by reference.
C Filed as an exhibit to Annual Report on Form 10-K for fiscal year 1986 and incorporated herein by reference.
E Filed as an exhibit to Annual Report on Form 10-K for fiscal year 1988 and incorporated herein by reference.
F Filed as an exhibit to Form 8-K filed on June 19, 1990 and Form 8-A Registration Statement filed on June 20, 1990 and
incorporated herein by reference.
G Filed as an exhibit to Form S-8 Registration Statement (File No. 33-39878) filed on April 8, 1991 and incorporated herein by
reference.
H Filed as an exhibit to Annual Report on Form 10-K for fiscal year 1991 and incorporated herein by reference.
I Filed as an exhibit to Form S-1 Registration Statement (File No. 33-14937) filed on behalf of Nova Technology Limited
Partnership and incorporated herein by reference.
J Filed as an exhibit to Form S-4 Registration Statement (File No. 33-49846) filed on July 22, 1992 and incorporated herein by
reference.
M Filed as an exhibit to Nova's Report on Form 8-K dated July 29, 1988 and incorporated herein by reference.
N Filed as an exhibit to Nova's Annual Report on Form 10-K for fiscal year 1990 and incorporated herein by reference.
O Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 and incorporated herein by
reference.
Q Filed as an exhibit to Annual Report on Form 10-K for fiscal year 1994 and incorporated herein by reference.
R Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by
reference.
S Filed as an exhibit to Annual Report on Form 10-K for fiscal year 1996 and incorporated herein by reference.
</FN>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
SCIOS INC.
Date: March 26, 1999 By: /s/ Richard B. Brewer
---------------------------------------
Richard B. Brewer
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Richard B. Brewer his attorney-in-fact,
with the power of substitution, for him in any and all capacities, to sign any
amendments to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that the said
attorney-in-fact, or his substitute or substitutes, may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Richard B. Brewer President and Chief Executive Officer March 26, 1999
----------------------------- (Principal Executive Officer)
Richard B. Brewer
/s/ David W. Gryska Chief Financial Officer March 26, 1999
----------------------------- (Principal Accounting Officer)
David W. Gryska
/s/ Donald B. Rice, Ph.D. Chairman of the Board March 26, 1999
-----------------------------
Donald B. Rice, Ph.D.
/s/ Samuel H. Armacost Director March 26, 1999
-----------------------------
Samuel H. Armacost
/s/ Myron Du Bain Director March 26, 1999
-----------------------------
Myron Du Bain
/s/ Charles A. Sanders Director March 26, 1999
-----------------------------
Charles A. Sanders
/s/ Robert W. Schrier, MD Director March 26, 1999
-----------------------------
Robert W. Schrier, MD
/s/ Burton E. Sobel, MD Director March 26, 1999
-----------------------------
Burton E. Sobel, MD
/s/ Solomon H. Snyder, MD Director March 26, 1999
-----------------------------
Solomon H. Snyder, MD
/s/ Eugene L. Step Director March 26, 1999
-----------------------------
Eugene L. Step
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants........................................F-2
Consolidated Balance Sheets at December 31, 1998 and
December 31, 1997......................................................F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996.......................................F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................................F-5
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996...........................F-6
Notes to the Consolidated Financial Statements...........................F-7
Financial Statement Schedules
(Omitted because they are not required, are not applicable, or the information
is included in the consolidated financial statements or notes thereto.)
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Scios Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and statements of changes
in stockholders' equity and of cash flows present fairly, in all material
respects, the financial position of Scios Inc. and it subsidiaries at
December 31, 1998 and 1997, and the results of their operations and their
cash flows for each of the three years in the period ended December 31,
1998 in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on theses financial
statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audits 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,
assessing the accounting principles used and significant estimates made
by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
January 30, 1999
(Except for note 17, as to which the
date is March 1, 1999.)
F-2
CONSOLIDATED BALANCE SHEETS
December 31, 1998 1997
(In thousands, except share data) ---- ----
Assets
Current assets:
Cash and cash equivalents $6,683 $10,197
Marketable securities 23,394 13,322
Accounts receivable 6,768 5,215
Prepaid expenses 568 600
-------- --------
Total current assets 37,413 29,334
Marketable securities, non-current 67,234 41,181
Investment in affiliate -- 10,537
Property and equipment, net 32,214 33,583
Other assets 1,968 2,236
-------- --------
Total Assets $138,829 $116,871
======== ========
Liabilities And Stockholders' Equity
Current liabilities:
Accounts payable $2,327 $1,685
Other accrued liabilities 10,087 11,134
Deferred contract revenue 16,896 11,652
Current portion of long-term debt -- 339
-------- -------
Total current liabilities 29,310 24,810
Long-term debt 34,573 31,919
Minority interests 20 --
-------- -------
Total liabilities 63,903 56,729
Commitments and contingencies (Notes 9, 10 and 11)
Stockholders' equity:
Preferred stock; $.001 par value; 20,000,000
shares authorized; none issued and outstanding -- --
Common stock; $.001 par value; 150,000,000
shares authorized; issued and outstanding
38,468,652 and 38,032,120, respectively 38 38
Additional paid-in capital 416,428 411,045
Treasury stock; 754,199 and 1,029,500
shares, respectively (3,481) (4,758)
Notes receivable from stockholders (145) (13)
Deferred compensation, net (505) --
Accumulated other comprehensive income 11,412 288
Accumulated deficit (348,821) (346,458)
-------- --------
Total stockholders' equity 74,926 60,142
-------- --------
Total Liabilities And Stockholders' Equity $138,829 $116,871
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except share data)
Year Ended December 31,
1998 1997 1996
---- ---- ----
Revenues:
Product sales $29,101 $35,193 $38,189
Co-promotion commissions 6,513 5,822 6,503
Research & development contracts 38,101 6,414 19,531
--------- --------- ---------
73,715 47,429 64,223
--------- --------- ---------
Costs and expenses:
Cost of goods sold 16,606 20,179 22,313
Research and development 46,637 41,907 39,424
Marketing, general and administration 19,407 20,720 19,746
Profit distribution to third parties 3,056 4,360 4,760
--------- --------- ---------
85,706 87,166 86,243
--------- --------- ---------
Loss from operations (11,991) (39,737) (22,020)
Other income (expense):
Investment income 4,154 3,966 6,361
Interest expense (2,685) (2,229) (419)
Realized gains on securities 9,003 -- --
Other income (expense) 650 517 (1,445)
--------- --------- ---------
11,122 2,254 4,497
--------- --------- ---------
Equity in net income (loss) of affiliate (1,343) (1,261) 274
Minority interests (20) 77 (1,121)
--------- --------- ---------
Loss before provision for income taxes (2,232) (38,667) (18,370)
Provision for income taxes (131) -- (33)
Net Loss (2,363) (38,667) (18,403)
========= ========= =========
Other comprehensive income (loss):
Unrealized gains (losses) on securities 11,124 358 (648)
Comprehensive income (loss) $8,761 ($38,309) ($19,051)
Loss per common share:
Basic and diluted ($0.06) ($1.07) ($0.51)
Weighted average number of
common shares outstanding
used in calculation of:
Basic and diluted 37,694,358 36,105,797 35,885,922
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
(In thousands)
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net loss ($2,363) ($38,667) ($18,403)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 3,845 5,740 5,330
Accrued long-term interest payable 2,577 1,919 --
Loss on sale of assets -- -- (2,620)
Equity in net (income) loss of affiliate 1,343 1,261 (274)
Minority interests 97 (77) 1,121
Recognition of deferred compensation 92 -- --
Change in assets and liabilities:
Accounts receivable (1,553) (407) (1,794)
Accounts payable 642 (822) (2,315)
Other accrued liabilities (1,047) 1,123 2,148
Other 168 370 (206)
Deferred contract revenue 5,244 7,986 (2,109)
------- ------- -------
Net cash provided by (used in) operating activities 9,045 (21,574) (19,122)
======= ======= =======
Cash flows from investing activities:
Purchases of property and equipment (2,476) (2,490) (6,682)
Proceeds from sale of investment in affiliate 459 90 3,600
Proceeds from sale of assets -- 6 44
Sales/maturities of marketable securities 260,388 264,745 219,027
Purchases of marketable securities (276,654) (258,307) (196,036)
------- ------- -------
Net cash provided by (used in) investing activities (18,283) 4,044 19,953
======= ======= =======
Cash flows from financing activities:
Issuance of common stock and collection of notes
receivable from stockholders, net 7,572 1,641 601
Purchase of treasury stock (1,509) (1,767) (2,024)
Payment of notes payable (339) (3,734) (668)
Proceeds from notes payable --- 30,000 --
------- ------- -------
Net cash provided by (used in) financing activities 5,724 26,140 (2,091)
======= ======= =======
Net increase (decrease) in cash and cash equivalents (3,514) 8,610 (1,260)
Cash and cash equivalents at beginning of year 10,197 1,587 2,847
------- ------- -------
Cash and cash equivalents at end of year $ 6,683 $10,197 $ 1,587
======= ======= =======
Supplemental cash flow data:
Cash paid during the year for interest $21 $309 $419
Supplemental disclosure of non-cash investing
and financing:
Change in net unrealized gains(losses) on securities $ 11,124 $358 ($648)
Investment in affiliate $ 1,343 $4,949 $4,708
Write-off of fully depreciated assets $ 143 $ 39 $ 158
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumu-
lated
Pre- Notes Other
Common ferred Receivable Def- Compre-
Common Stock Additional Stock Treas- From erred hensive Accu-
(in thousands, except Preferred Stock Par Paid-In Par ury Stock Compen- Income mulated
share data) Shares Shares Value Capital Value Stock holders sation (Loss) Deficit Total
- --------------------- --------- ---------- ------ ---------- ------ ----- ---------- ------ ------- ------- -----
Balances at
December 31, 1995 16,053 36,009,055 $36 $399,155 $-- ($967) ($20) $-- $578 ($289,388) $109,394
Conversion of preferred (3,421) 342,100 1 (1) --
Purchase of treasury (2,024) (2,024)
stock
Options exercised 155,142 594 594
Notes receivable from 7 7
stockholders
Changes in unrealized (648) (648)
losses on
available-for-sale
securities
Investment in Guilford 4,708 4,708
Net loss (18,403) (18,403)
--------- ---------- ------ --------- ------ ----- ---------- ------ ------- -------- -------
Balances at
December 31, 1996 12,632 36,506,297 37 404,456 -- (2,991) (13) -- (70) (307,791) 93,628
Conversion of preferred (12,632) 1,263,200 1 (1) --
Purchase of treasury (1,767) (1,767)
stock
Options exercised 262,621 1,641 1,641
Stock issued for services 2 --
Notes receivable from --
stockholders
Changes in unrealized 358 358
gains on
available-for-sale
securities
Investment in Guilford 4,949 4,949
Net loss (38,667) (38,667)
--------- ---------- ------ --------- ------ ----- ---------- ------ ------- ------- -------
Balances at
December 31, 1997 -- 38,032,120 38 411,045 -- (4,758) (13) -- 288 (346,458) 60,142
Common stock issued 262,283 3,048 3,048
Purchase of treasury (1,509) (1,509)
stock
Options exercised 677,249 4,524 4,524
Treasury stock reissued (603,000) (2,786) 2,786 --
Notes receivable from (132) (132)
stockholders
Deferred compensation 100,000 597 (597) --
Amortization of deferred 92 92
compensation
Changes in unrealized 11,124 11,124
gains on
available-for-sale
securities
Investment in Guilford --
Net loss (2,363) (2,363)
--------- ---------- ------ --------- ------ ----- ---------- ----- ------- --------- -------
Balances at
December 31, 1998 -- 38,468,652 $38 $416,428 $-- ($3,481) ($145) ($505) $11,412 ($348,821) $74,926
1998
- ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business of the Company
-----------------------
Scios Inc. (the "Company") is a biopharmaceutical company engaged in
the discovery, development, manufacture and commercialization of novel
human therapeutics. The Company's research and development efforts are
primarily focused on cardiorenal disorders, inflammatory conditions
and Alzheimer's disease. The Company has research and development
collaborations with a number of other biopharmaceutical companies
under which it may share costs and revenues. The Company's commercial
operations division also markets seven psychiatric products in the
United States in co-operation with the Company's partners. In the
course of its development activities, the Company has sustained
operating losses and expects such losses to continue through fiscal
1999.
2. Summary of Significant Accounting Policies
------------------------------------------
Principles of consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned and majority-owned subsidiaries. Other
affiliates, more than 20% but less than 50% owned, are accounted for
on the equity basis. Intercompany transactions and balances are
eliminated on consolidation. The Company accounted for its 7%
ownership in Guilford Pharmaceuticals Inc. ("Guilford") under the
equity method through September 1998 because it had representation on
Guilford's Board of Directors. In October 1998, the Company
reclassified its Guilford investment to marketable securities because
of a change in the Company's representation on Guilford's Board of
Directors.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principals 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 equivalents
The Company considers all highly liquid investments with maturities of
less than 90 days, at the time acquired, to be cash equivalents. Cash
equivalents are stated at cost, which approximates market value.
Marketable securities
All marketable securities at December 31, 1998 and 1997 were deemed by
management to be available-for-sale and are stated at fair value with
net unrealized gains or losses reported in stockholders' equity.
Realized gains and losses on sales of all such securities are reported
in earnings and computed using the specific identification cost
method.
Business risk and credit concentration
Approximately one-third of the Company's revenues in 1998 were derived
from product sales, which consist entirely of sales in the U.S. under
a license agreement with SmithKline Beecham Corp. ("SB") (see Note 3).
Any factor adversely affecting demand for, or supply of, the
psychiatric products covered by the license agreement could materially
adversely affect the Company's business and financial performance.
Approximately two-thirds of 1998 research and development contract
revenues were from the strategic alliance for the marketing of
Natrecor(R) (nesiritide) ("Natrecor") with Bayer AG ("Bayer"). Future
Bayer revenues will be dependent on continued Natrecor development
efforts, success in achieving regulatory approvals, and successful
commercialization.
F-7
In 1998, Bayer contributed 33% of the Company's total revenues. In
1997, no individual customer or partner contributed more than 10% of
total revenues. In 1996, Wyeth-Ayerst Laboratories ("Wyeth-Ayerst")
contributed 21% of total revenues.
At December 31, 1998, the $6.8 million in accounts receivable included
$3.3 million from Bayer, $1.0 million from Janssen Pharmaceutica Inc.
("Janssen") and $2.1 million from SB. At December 31, 1997, the $5.2
million in accounts receivable included the following receivables
associated with Commercial Operations: $0.6 million from Ortho-McNeil
Pharmaceutical ("Ortho-McNeil"), $0.9 million from Wyeth-Ayerst and
$3.2 million from SB.
The Company's excess cash is invested in a diversified portfolio of
securities consisting of U.S. Treasury Notes, deposits with major
banks and financial institutions, and investment-grade
interest-bearing corporate securities issued by companies in a variety
of industries. In addition, the Company owned 1,367,500 shares of
Guilford stock that was recorded on December 31, 1998 at fair value as
an available-for-sale marketable security.
Depreciation and amortization
Buildings and equipment are stated at cost and are depreciated using
the straight-line method over the estimated useful lives of the assets
(3 to 7 years for equipment and 40 years for buildings). Leasehold
improvements are amortized on a straight-line basis over the shorter
of the asset life or fixed-lease term. Upon sale or retirement of
assets, the cost and related accumulated depreciation or amortization
are removed from the balance sheet, and the resulting gain or loss is
reflected in operations.
Product sales
Revenue from product sales is recognized in the period in which the
products are shipped. Provision is made for estimated returns and
allowances, cash discounts and rebates attributable to Medicaid
programs related to sales of the SB Products.
Co-promotion commissions
Revenue from co-promotion commissions (see Note 3) is recognized based
on estimated sales levels of Janssen's psychiatric product
Risperdal(R) (risperdone) ("Risperdal") and SB's psychiatric product
Paxil(R) (paroxetine HCl) ("Paxil") for their respective contract
years.
Contract Revenues
Research and development contract revenues from cost-reimbursement
agreements are recorded as the related expenses are incurred, up to
contractual limits. Payments received that are related to future
performance are deferred and recorded as revenues as they are earned
over specified future performance periods. Research and development
payments for which no services are required to be performed in the
future, license payments irrevocably received and royalty payments
based on sales to third parties are recognized as revenues upon
receipt. Research and development expenses in 1998, 1997 and 1996
include approximately $4.9 million, $2.1 million and $1.9 million,
respectively, incurred in connection with programs subject to cost
reimbursement, collaborative or other performance agreements.
Treasury stock
Treasury stock is stated at cost and is considered issued and
outstanding.
Fair value of financial instruments
Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, accounts receivable, accounts
payable and other accrued liabilities approximate fair value due to
their short maturities. Based on borrowing rates currently available
to the Company for loans with similar terms, the carrying value of
notes payable approximates fair value. Estimated fair values for
marketable securities, which are separately disclosed elsewhere, are
based on quoted market prices for the same or similar instruments.
F-8
Computation of net loss per share
Effective December 31, 1997, the Company adopted Financial Accounting
Standards No. 128, "Earnings Per Share" and, accordingly, all prior
periods presented have been restated. Basic net loss per share is
calculated using the weighted average number of common shares
outstanding for the period. Diluted net loss is calculated using the
weighted average number of common and dilutive common equivalent
shares outstanding during the period. The outstanding options to
purchase common stock were excluded from diluted earnings calculations
for 1998, 1997, and 1996 because inclusion of the options would have
been anti-dilutive.
Comprehensive income (loss)
The Company adopted Statement of Financial Accounting Standards No.
130, "Accounting for Comprehensive Income," during the fiscal year
ended 1998. This statement establishes standards for reporting and
display of comprehensive income (loss) and its components (including
revenues, expenses, gains and losses) in a full set of general-purpose
financial statements. The Company's unrealized gains on investments
represent the only component of comprehensive income, that is excluded
from net loss for 1998 and prior years. The Company's comprehensive
income (loss) has been presented in the consolidated financial
statements. As the Company is in a loss position tax effects have not
been allocated to the components of other comprehensive income (loss).
Accumulated other comprehensive income (loss) balances are as follows
for the years ended (in thousands):
Accumulated
Unrealized Other
Gains (losses) Comprehensive
on Securities Income (loss)
-------------- -------------
Balance, December 31, 1996 $ (70) $ (70)
Current period change 358 358
-------- -------
Balance, December 31, 1997 288 288
Current period change 11,124 11,124
------- ------
Balance, December 31, 1998 $11,412 $11,412
======= =======
Income taxes
The Company accounts for income taxes under Statement of Financial
Accounting Standard No. 109, "Accounting for Income Taxes," which
prescribes the use of the liability method whereby deferred tax asset
or liability account balances are calculated at the balance sheet date
using current tax laws and rates in effect for the year in which the
differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized.
Recent pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133
establishes new standards of accounting and reporting for derivative
instruments and hedging activities. SFAS 133 will be effective for
fiscal years beginning after June 15, 1999. The Company does not
currently hold derivative instruments or engage in hedging activities.
F-9
3. Joint Business Arrangements
---------------------------
a. Agreement with Bayer AG
In May 1998, the Company entered into an agreement with Bayer for the
worldwide development and commercialization of Natrecor, a new drug
for the short-term management of congestive heart failure (CHF). Under
the agreement, the Company will continue to manage the manufacture of
Natrecor and Phase IIIb clinical trials, with Bayer managing further
worldwide development and commercialization. Upon signing the
contract, the Company received a payment of $20.0 million and will
receive up to $40.0 million in milestone payments upon regulatory
approvals in the United States, Europe and Japan. The agreement
provides the Company the option to participate in co-promotion of
Natrecor in the U.S. after three years upon achievement of specified
sales levels, and it provides for the Company to actively participate
in the further development of Natrecor with funding from Bayer at
specified minimum levels
b. Agreement with Janssen Pharmaceutica Inc.
The Company entered into a three-year agreement, effective in April
1998, with Janssen to jointly promote the antipsychotic Risperdal in
the United States. Under the agreement, the Company receives base
payments plus incentive compensation on achieving specified sales
levels over a contract year beginning in April and ending in March.
Janssen manufactures and distributes the product. The agreement may be
extended by mutual agreement for additional periods of at least 12
months each.
c. Agreement with SmithKline Beecham Corporation
Under the terms of an agreement with SB, the Company has the exclusive
rights to market certain SB Products in the U.S. SB is fully
responsible for ancillary matters relating to sales of the SB Products
(including various administrative tasks), for the maintenance in good
standing of all New Drug Applications with respect to the SB Products
and for the maintenance of certain product liability insurance. The
Company pays SB 40% of net profits, as defined in the agreement, from
sales of the SB Products.
In September 1998, the Company entered into an agreement with SB to
co-promote Paxil in the U.S. Paxil, which regulates the brain chemical
serotonin, is currently approved to treat depression, panic disorder
and obsessive-compulsive disorder. Under the agreement, the Company
receives base payments plus incentive compensation on achieving
specified sales levels during a specified term. The companies are
currently in discussions on revising the incentive compensation
structure.
d. Agreement with DuPont Pharmaceuticals Company
In December 1997, the Company entered into an agreement with DuPont
Pharmaceuticals Company ("DuPont") establishing a research
collaboration in the area of Alzheimer's disease with the goal of
developing pharmaceuticals that prevent or retard the disease. Under
the terms of the agreement, DuPont will fund research at the Company
and will have responsibility to develop and commercialize products
from this collaboration. DuPont also purchased $3.0 million of the
Company's common stock in 1998 and will make milestone and royalty
payments to the Company as products advance through development.
e. Agreement with Eli Lilly and Company
In May 1997, the Company entered into a research collaboration with
Eli Lilly and Company ("Eli Lilly") for the development of drugs to
prevent or retard the progression of Alzheimer's disease. Under the
terms of the agreement, Eli Lilly will fund research and will have the
first opportunity to develop products from the collaboration. The
Company may elect to develop other products from the collaboration.
The commercialization partner will make milestone and royalty payments
to the other partner. In 1998, the agreement was amended to increase
the funding for additional research staff to facilitate future product
completions.
F-10
f. Agreements with Wyeth-Ayerst Laboratories
In October 1996, the Company entered into a collaboration agreement
with Wyeth-Ayerst, an affiliate of American Home Products Corp., for
the joint development and commercialization of Fiblast(R) (trafermin)
("Fiblast") for the treatment of neurological and cardiovascular
disorders. The two companies will co-promote Fiblast for these
indications in North America and share development costs and profits.
Wyeth-Ayerst received exclusive marketing rights outside North America
and within certain Pacific Rim countries in return for a royalty on
sales and payments for bulk drug supply worldwide. Wyeth-Ayerst has
provided a $12.0 million line of credit that the Company may use to
fund expansion of its manufacturing facility for Fiblast (see Note 9).
In April 1996, the Company entered into an agreement with Wyeth-Ayerst
to promote the antidepressant Effexor(R) (venlafaxine hydrochloride)
to selected psychiatrists in the U.S. Under the agreement, the Company
received payments based on achieving specified increases in sales to
the selected psychiatrists over an adjusted base level during each
contract year beginning in June 1996. Wyeth-Ayerst manufactured and
distributed the product. The agreement was terminated by mutual
agreement in April 1998.
g. Agreement with Genentech, Inc.
In December 1994, the Company entered into a collaboration agreement
with Genentech, Inc. ("Genentech") for the development and
commercialization of Auriculin(R) (anaritide) ("Auriculin") for the
treatment of acute renal failure. Concurrent with the collaboration
agreement, Genentech purchased $20.0 million of the Company's
preferred stock, convertible into approximately 2.1 million shares of
common stock and provided a $30.0 million loan to the Company in the
form of a letter of credit (see Note 9), which the Company drew down
in March of 1997. The loan plus accrued interest is payable in cash or
stock or a combination thereof. As of December 31, 1997, Genentech had
converted all shares of preferred stock into common stock. In 1997,
the Company and Genentech discontinued development of Auriculin based
upon the negative results of an interim study.
h. Agreement with Ortho-McNeil Pharmaceutical
In July 1993, the Company entered into a five-year agreement with
Ortho-McNeil, an affiliate of Johnson & Johnson, to jointly promote
the injectable antipsychotic Haldol(R) Decanoate (haloperidol) in the
U.S. Under the agreement, the Company received payments based on
achieving specified sales levels over a contract year beginning in
August and ending in July. Ortho-McNeil manufactured and distributed
the product. The agreement was terminated by mutual agreement in April
1998.
i. Agreements with Kaken Pharmaceutical Co., Ltd.
In September 1994, the Company entered into a series of agreements
with Kaken Pharmaceutical Co., Ltd. ("Kaken") to expand a previous
agreement signed in 1988 for Fiblast. Under the 1994 agreements, the
Company will collaborate with Kaken to further develop the Fiblast
manufacturing process, provide Kaken a license to the Company's
Fiblast manufacturing technology and supply a specified amount of
Fiblast product. In return, the Company has received milestone
payments, which are contingent on Kaken's continuing development of
the product. On December 31, 1998, $15.9 million of the Company's
deferred revenue consisted of payments received to date under these
agreements. The Company expects to complete production of the Fiblast
product in accordance with its agreement prior to closing down its
manufacturing operations.
4. Affiliate
---------
In June 1994, Guilford, then a fully consolidated subsidiary of the
Company, completed an initial public offering, which decreased the
Company's percentage ownership from 62% to 29%. As a result, the
equity method of accounting was adopted by the Company. Prior to the
date of the public offering, the financial results of Guilford were
fully consolidated with those of the Company. Due to subsequent public
stock offerings, and the sale by the Company of 200,000 shares of
Guilford stock in 1996, 12,500 shares in 1997, and 70,000 shares in
1998, the Company's ownership in Guilford has been reduced to 7%.
F-11
The Company continued to use the equity method of accounting for its
investment in Guilford through September 1998 because it had
representation on Guilford's Board of Directors. In October 1998, the
Company reclassified its Guilford investment to marketable securities
because of a change in the Company's representation on Guilford's
Board of Directors.
5. Marketable Securities
---------------------
Unrealized gains and losses on marketable securities at December 31,
1998 by classification were as follows:
Accrued Unrealized Unrealized
(in thousands) Cost Basis Interest Gains Losses Fair Value
---------- -------- ---------- ---------- ----------
Debt securities:
U.S. Government &
Government Agency
Securities $32,722 $286 $ 346 ($7) $33,347
Corporate Bonds 37,117 355 260 (21) 37,711
Equity Investments 8,736 -- 10,834 -- 19,570
------- ---- ------- ----- -------
Total $78,575 $641 $11,440 ($28) $90,628
======= ==== ======= ===== =======
Unrealized gains and losses on marketable securities at December 31,
1997 by classification were as follows:
Accrued Unrealized Unrealized
(in thousands) Cost Basis Interest Gains Losses Fair Value
---------- -------- ---------- ---------- ----------
Debt securities:
U.S. Government &
Government Agency
Securities $24,784 $131 $100 ($5) $25,010
Corporate Bonds 28,957 343 112 (14) 29,398
Equity Investments -- -- 95 -- 95
------- ---- ---- ----- -------
Total $53,741 $474 $307 ($19) $54,503
======= ==== ==== ===== =======
The scheduled maturities for marketable securities at December 31,
1998 by classification were as follows:
Maturity Maturity
(in thousands) 1 year or less Greater than 1 year
-------------- -------------------
Debt securities:
U.S. Government &
Government Agency
Securities $ 283 $33,064
Corporate Bonds 3,624 34,087
Equity Investments 19,487 83
------- -------
Total $23,394 $67,234
======= =======
The Company realized gains of $9,099,000 and losses of $96,000 on the
disposal of marketable securities during 1998 and gains of $176,000
and losses of $298,000 on the disposal and write-down of marketable
securities during 1997.
F-12
6. Property and Equipment
----------------------
December 31, 1998 1997
---- ----
(in thousands)
Laboratory equipment $12,802 $11,880
Computer and related equipment 4,780 4,103
Furniture and other 2,519 2,421
Buildings and building improvements 49,878 48,951
------- -------
69,979 67,355
Accumulated depreciation and amortization (38,827) (35,125)
------- -------
31,152 32,230
Construction in progress 1,062 1,353
------- -------
Total $32,214 $33,583
======= =======
7. Other Assets
------------
December 31, 1998 1997
---- ----
(in thousands)
Deposits $ 229 $ 387
Other assets 304 188
Equity investments 1,067 1,067
Employee notes receivable 368 594
------ ------
Total $1,968 $2,236
====== ======
8. Other Accrued Liabilities
-------------------------
December 31, 1998 1997
---- ----
(in thousands)
Accrued contract payable $ 1,220 $ 19
Accrued Medicaid rebates 781 1,191
Accrued payroll 3,566 2,881
Profit distribution to third parties 1,212 1,911
Accrued clinical trial expenses 1,231 200
Deferred equity purchase -- 3,000
Other 2,077 1,932
------- ------
Total $10,087 $11,134
======= =======
9. Lease and Debt Commitments
--------------------------
a. Operating leases
The Company leases facilities in California and the land where the
Company's Mountain View, California facilities are located under
operating leases. The facilities lease expires in 2002 with an option
to extend for six years and seven months. The long-term ground lease
expires in 2053. Beginning in July 2010, a portion of the annual
ground rent is subject to renegotiation. In addition, the Company has
entered into operating leases covering certain laboratory and computer
equipment.
F-13
Future minimum payments under these leases are as follows:
Land and
Facilities Equipment
Operating Operating
(in thousands) Leases Leases
---------- ---------
1999 $ 944 $327
2000 980 --
2001 1,016 --
2002 268 --
2003 203 --
Thereafter 1,652 --
------ ----
Total $5,063 $327
====== ====
Rent expenses for all facilities operating leases was approximately
$963,000, $1,112,000, and $1,177,000 in 1998, 1997 and 1996,
respectively.
b. Borrowing arrangements
In 1998, the Company's paid off two five-year notes that were secured
by equipment.
In December 1997, the Company repaid a $3.0 million bank loan entered
into in 1995 and renewed in 1996.
As part of the Auriculin agreement, Genentech committed to loan the
Company up to $30.0 million. The $30.0 million was drawn down in March
of 1997, and bears interest at the prime rate (7.75% at December 31,
1998). The loan is repayable in cash or the Company common stock, at
the prevailing market price, at the Company's option at any time
through December 31, 2002.
c. Wyeth-Ayerst loan commitment
As part of the Fiblast agreement, Wyeth-Ayerst has committed to loan
the Company up to $12.0 million to fund expansion of the Company's
manufacturing facility for Fiblast. The Company does not expect to use
this source of funding as it will use third party manufacturing.
d. Natrecor supply contract
The Company has entered into a long-term supply agreement with a
manufacturer for the supply of bulk Natrecor. The contract provides
for the purchase of at least 25 kg of bulk solution over an eight-year
period at a maximum price of 48.0 million German marks (U.S.
equivalent at December 31, 1998, $29.0 million).
10. Litigation
----------
On November 29, 1995, the Company was notified by the United States
Environmental Protection Agency ("EPA") that it may have a liability
in connection with the clean-up of a toxic waste site arising out of
the alleged disposal of hazardous substances by a subcontractor of
Nova Pharmaceutical Corporation, which the Company acquired in 1992.
The Company is one of many potentially responsible parties that have
been identified as associated with this specific site. The Company is
in discussions with the EPA to finalize the amount of potential
liability. The Company has accrued $90,000 as provision for the
liability or loss that may result from the settlement thereof.
11. Research and Development Commitments
------------------------------------
a. Research commitments
The Company's commitments for payments to research consultants and
institutions are $75,000 in 1999, $75,000 in 2000, and $58,000 in
2001.
F-14
b. Commitments to research partnerships
Under the Company's collaboration agreement with Wyeth-Ayerst for the
development and commercialization of Fiblast, the Company is obligated
to pay 30% of the joint development expenses, with Wyeth-Ayerst
responsible for the remaining 70%.
In 1988, the Company purchased the interests of Biotechnology Research
Partners, a limited partnership in a joint venture, and made a down
payment of $575,000. The balance of the purchase price is to be paid
in quarterly installments in accordance with the following formula:
(i) until the minority partners have received payments of
approximately $22.8 million, the Company will pay approximately 37% of
the royalty income from third-party licenses and approximately 3.7% of
the Company's gross sales of Partnership products; (ii) thereafter,
until the minority partners have received aggregate payments of
approximately $34.1 million, the Company will pay approximately 31% of
the royalty income and approximately 3.1% of the Company's gross sales
of Partnership products; and (iii) thereafter, until the earlier of 20
years from the date of exercise of the option or the time all patents
relating to the Partnership's technology expire and all information
relating to that technology becomes part of the public domain, the
Company will pay to the minority partners approximately 20.5% of the
royalty income and approximately 2% of the Company's gross sales of
Partnership products. Partnership products for which minority partners
will receive payments include Fiblast.
In December 1992, the Company exercised its option to acquire all
interests in Nova Technology Limited Partnership for $20.4 million.
The Company also issued contingent payment rights to all limited
partners of the partnership, pursuant to which the Company is
obligated until January 15, 2008 to pay royalties on the sale or
license of certain products that were under development by the
partnership. As of December 31, 1998, $84,048 was accrued for payment
in 1999 primarily as a result of royalties associated with the
commercialization of Guilford's Gliadel(R) wafer.
12. Stockholders' Equity
--------------------
Warrants to purchase approximately 789,000 shares of the Company's
common stock at $26.74 per share expired unexercised in June 1998. At
December 31, 1998, there were no warrants outstanding.
a. Convertible preferred stock
The Company's convertible preferred stock may be issued in series that
have such rights as may be designated by the Board of Directors from
time to time. There were no shares of preferred stock issued and
outstanding at December 31, 1998.
b. Common stock
The Company has a Common Share Purchase Rights Plan under which
stockholders have a right to purchase for each share held, one share
of the Company's common stock at a 50% discount and, in certain
circumstances, a share of common stock of an acquirer at a similar
discount. The rights become exercisable, at $55.00 per right, in the
event of an acquisition or tender offer, which results in the
acquisition of 20% or more of the Company's common stock. The rights
may be redeemed, in certain circumstances, at $0.01 per right and
expire on July 31, 2000.
c. Deferred compensation
In September 1998, the Company granted shares of restricted stock to
an officer and director. The shares vest over a two-year period
provided that the recipient is still employed by the Company. The
market value of the shares awarded was $597,000 and has been recorded
as a separate component of stockholders' equity. Deferred compensation
is being amortized over the two-year period.
F-15
13. Employee 401(k) Benefit Plan
----------------------------
The Company has a qualified profit sharing plan and trust under
Internal Revenue Service Code sections 401(a) and 401(k). Employees
are eligible to participate in the plan the first day of the month
after hire and can elect to contribute to the plan up to 15% of their
salary subject to current statutory limits. In 1998, the Company
matched employee contributions at a rate of 100% to a maximum of
$3,000 per employee, except as restricted by statutory limits. The
Company contribution is 100% vested at the end of an employee's third
year of employment. Company contributions to the plan totaled
approximately $838,000 in 1998, $664,000 in 1997 and $649,000 in 1996.
14. Stock Option Plans
------------------
Under the Company's stock option plans, the Board of Directors has the
authority to determine to whom options will be granted, the number of
shares, the vesting period and the exercise price (which cannot be
less than fair market value ("FMV") at date of grant for incentive
stock options or 85% of FMV for nonstatutory options). The options are
exercisable at times and in increments as specified by the Board of
Directors, generally expire ten years from date of grant and fully
vest over periods from three to five years. The following shares are
authorized and available for grant as of December 31, 1998:
Shares
Plan Shares Options Available
Title Authorized Outstanding for Grant Option Price
----- ---------- ----------- --------- ------------
1983/86 2,200,000 480,867 -- Not less than 85% of FMV*
1989 170,000 25,000 -- FMV
1992 5,000,000 2,914,229 1,102,058 Not less than 85% of FMV
1996 1,500,000 1,085,739 389,777 Not less than 85% of FMV
NQ 443,161 0 -- Not less than 85% of FMV
<FN>
*FMV = fair market value
</FN>
Additional information with respect to the activity of outstanding
options is summarized in the following table:
Aggregate
Number of Price
Common Stock Shares Option Price (in thousands)
--------- ------------ --------------
Balances at December 31, 1995 3,831,543 $2.56-$21.13 $29,022
Granted 627,000 $4.56-$ 6.88 3,579
Exercised (155,142) $2.56-$ 7.13 (594)
Canceled (527,078) $3.50-$21.13 (3,797)
--------- ------------- -------
Balances at December 31, 1996 3,776,323 $3.50-$21.13 $28,210
Granted 819,740 $6.06-$ 8.13 5,266
Exercised (262,621) $4.13-$ 9.13 (1,641)
Canceled (347,300) $5.44-$15.06 (2,491)
--------- ------------ -------
Balances at December 31, 1997 3,986,142 $3.50-$21.13 $29,344
Granted 1,515,475 $5.19-$12.75 13,245
F-16
Exercised (677,249) $3.50-$ 9.13 (4,524)
Canceled (318,533) $3.50-$20.54 (2,502)
--------- ------------ -------
Balances at December 31, 1998 4,505,835 $3.69-$21.13 $35,563
========= ============ =======
The options outstanding by range of exercise price at December 31,
1998 are as follows:
Weighted
Number of Average Weighted
Options Remaining Average
Exercise Price Outstanding Contractual Life Exercise Price
-------------- ----------- ---------------- --------------
$ 3.69-$ 6.13 1,280,826 7.38 $ 5.77
$ 6.25-$ 7.13 909,096 3.85 $ 7.00
$ 7.21-$ 9.13 1,044,485 5.49 $ 8.00
$ 9.19-$10.88 910,615 7.99 $ 9.69
$11.75-$21.13 360,813 4.68 $12.84
------------- --------- ---- ------
$ 3.69-$21.13 4,505,835 6.14 $ 7.89
============= ========= ==== ======
The options currently exercisable by range of exercise price at
December 31, 1998 are as follows:
Number of Weighted
Options Average
Exercise Price Exercisable Exercise Price
-------------- ----------- --------------
$ 3.69-$ 6.13 534,389 $ 5.82
$ 6.25-$ 7.13 823,283 $ 7.05
$ 7.21-$ 9.13 631,627 $ 8.27
$ 9.19-$10.88 258,217 $ 9.82
$11.75-$21.13 304,637 $12.85
------------- --------- ------
$ 3.69-$21.13 2,552,153 $ 8.07
============= ========= ======
Stock based compensation
The Company accounts for stock based compensation using the intrinsic
value method prescribed by APB Opinion No. 25, "Accounting for Stock
Issued to Employees." Accordingly, compensation cost for stock options
is measured as the excess, if any, of the quoted market price of the
Company's stock at the date of the grant over the amount an employee
must pay to acquire the stock. The Company has adopted the
disclosure-only provision of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123").
The following pro forma information has been prepared following the
provisions of SFAS No. 123:
December 31, 1998 1997 1996
------------ ---- ---- ----
(in thousands, except per share amounts)
Net loss - as reported $(2,363) $(38,667) $(18,403)
Net loss - pro forma (6,331) (40,163) (19,029)
Net loss per common share
and per common share -
assuming dilution -
as reported $ (0.06) (1.07) $ (0.51)
F-17
Net loss per common share - pro forma
and per common share -
assuming dilution -
pro forma $ (0.17) $ (1.10) $ (0.53)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes single option pricing method assuming the
following parameters:
1998 1997 1996
---- ---- ----
Risk free interest rate 5.29% 5.87% 6.41%
Expected life (years) 4.8 5.0 5.0
Volatility 0.7916 0.7920 0.8134
Dividend yield -- -- --
The weighted average fair value of options granted in 1998, 1997 and
1996 was $5.71, $4.33 and $3.92, respectively.
The impact on pro forma loss per share and net loss in the table above
may not be indicative of the effect in future years as options vest
over several years and the Company continues to grant stock options to
employees. This policy may or may not continue.
15. Income Taxes
------------
The Company's deferred tax assets and liabilities are determined based
on the difference between the financial statement and tax bases of
assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred
tax assets to the amounts expected to be realized.
The Company has federal and state income tax net operating loss
("NOL") and research credit carryforwards at December 31, 1998 for tax
purposes available as follows:
Federal NOL $278,000,000
State NOL 20,000,000
Federal Research Credit 15,200,000
State Research Credit 7,200,000
These federal and state NOL carryforwards expire in the years 1999
through 2013 and 1999 through 2003, respectively. The federal and
state research credit carryforwards expire in the years 1999 through
2013, and 2003 through 2013, respectively.
Due to a change in the ownership of the Company, as defined, a portion
of the federal and state NOL carryover is subject to an annual
utilization limitation. Should another change in ownership occur,
future utilization of the Company's NOL carryforwards may be subject
to additional limitations.
F-18
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are presented below:
December 31,
(in thousands) 1998 1997
---- ----
Depreciable and amortizable
assets, primarily technology $ 9,100 $ 7,900
Other accrued liabilities 1,300 4,800
State (net of federal benefit) 13,800 8,800
Net operating loss carryforward 94,000 93,600
Research credit 15,200 10,200
Valuation allowance (133,400) (125,300)
--------- ---------
Net deferred tax asset $ -- $ --
========= =========
Due to the uncertainty surrounding the realization of the favorable
tax attributes in future tax returns, the Company has placed a
valuation allowance against its otherwise recognizable net deferred
tax assets.
16. Industry and Geographic Segment Information
-------------------------------------------
The Company has adopted the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information", ("SFAS
131"). SFAS 131 supercedes Statement of Financial Accounting
Standards, "Financial Reporting for Segments of a Business Enterprise"
("SFAS 14"). SFAS 131 changes current practice under SFAS 14 by
establishing a new framework on which to base segment reporting and
also requires interim reporting of segment information.
Management uses one measurement of profitability for its business. The
Company receives revenue from product sales and from licensing and
development of products. The Company markets its products in the
United States and Japan and received licensing revenue from partners
in the United States, Europe and Asia Pacific and operates in one
business segment.
Revenue and long-lived assets by geographic area as of and for the
year ended:
Long lived
(in thousands) Revenues Assets
-------- ----------
December 31, 1998:
U.S. $42,243 $32,214
International 31,472 --
------- -------
Total $73,715 $32,214
December 31, 1997:
U.S. $46,609 $33,583
International 820 --
------- -------
Total $47,429 $33,583
December 31, 1996:
U.S. $63,834 $36,839
International 389 --
------- -------
Total $64,223 $36,839
F-19
17. Subsequent Event
----------------
On March 1, 1999, the Company announced a restructuring and
right-sizing plan that includes reduction of the Company's full-time
workforce by approximately 30% and the consolidation of its
headquarters, development and research staff into currently leased
facilities in Sunnyvale, California. In the first half of 1999, the
Company will close its manufacturing facility due to its low capacity
and high operating expenses and the ready availability of third party
recombinant protein manufacturing capacity. The Company's Mountain
View, California, campus will be sold. The consolidation is expected
to create improved management and operational synergies and save
approximately $14.0 million annually. In the quarter ending March 31,
1999, the Company will record a one-time restructuring charge of
approximately $7.0 million for the disposition of certain excess
assets and severance costs.
F-20