1
FINANCIAL STATEMENTS
SELECTED FINANCIAL DATA 1
MANAGEMENT'S DISCUSSION AND ANALYSIS 2
CONSOLIDATED BALANCE SHEETS 6
CONSOLIDATED STATEMENTS OF OPERATIONS 7
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 8
CONSOLIDATED STATEMENTS OF CASH FLOWS 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 17
2
SELECTED FINANCIAL DATA
IN THOUSANDS, EXCEPT PER SHARE AND EMPLOYEE DATA
Selected Quarterly Financial Data (unaudited)
Quarter Ended
-------------------------------------------------------------
1997 March 31 June 30 September 30 December 31
---------- ---------- ---------- ----------
Net income $ 9,554 $ 9,958 $ 11,259 $ 5,846
Net income per diluted common and equivalent share $ 0.27 $ 0.28 $ 0.31 $ 0.17
Common stock prices
High $ 39.06 $ 25.88 $ 38.13 $ 40.56
Low $ 18.75 $ 15.31 $ 22.81 $ 9.94
1996
Net income (loss) $ (6,235) $ (3,745) $ 2,662 $ (9,209)
Net income (loss) per diluted common and
equivalent share $ (0.23) $ (0.14) $ 0.07 $ (0.28)
Common stock prices
High $ 15.63 $ 16.38 $ 20.38 $ 19.00
Low $ 11.88 $ 13.00 $ 14.44 $ 14.50
The Company's common stock is traded over-the-counter on The Nasdaq Stock Market
under the symbol "VVUS." As of December 31, 1997, there were approximately 608
shareholders of record. The Company has not paid any dividends since its
inception and does not intend to pay any dividends in the foreseeable future.
Selected Financial Data
Year Ended December 31,
-----------------------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
Product revenue $ 129,337 $ -- $ -- $ -- $ --
Milestone revenue 9,000 20,000 -- -- --
Total $ 138,337 $ 20,000 $ -- $ -- $ --
Income (loss) before taxes $ 39,801 $ (16,527) $ (22,811) $ (14,864) $ (7,775)
Net income (loss) $ 36,617 $ (16,527) $ (22,811) $ (14,864) $ (7,775)
Net income (loss) per diluted share $ 1.03 $ (0.55) $ (0.85) $ (0.63) $ (0.40)
Shares used in per share computation 35,559 29,833 26,914 23,488 19,656
Financial position at year end:
Total assets $ 150,669 $ 96,532 $ 44,049 $ 43,021 $ 24,732
Accumulated deficit $ (29,537) $ (66,154) $ (49,627) $ (26,816) $ (11,952)
Stockholders' equity $ 123,930 $ 89,780 $ 41,181 $ 40,307 $ 23,435
Additional information:
Working capital $ 54,888 $ 60,388 $ 19,878 $ 21,656 $ 16,010
Capital expenditures $ 32,268 $ 3,682 $ 3,148 $ 787 $ 1,007
Common shares outstanding 33,168 32,454 26,952 23,448 4,656
Number of employees 215 95 38 28 15
See notes to consolidated financial statements.
1
3
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
VIVUS, Inc. (the Company) was incorporated in 1991 to develop products for the
treatment of erectile dysfunction. In November 1996, the Company obtained
regulatory marketing clearance by the U.S. Food and Drug Administration (FDA) to
manufacture and market its first product, MUSE((R)) (alprostadil), in the United
States. The Company commenced product shipments to wholesalers in December 1996
and commercially introduced MUSE (alprostadil) in the United States through its
direct sales force beginning in January 1997. Furthermore, the Company received
FDA clearance in December 1996 for ACTIS((R)), an adjustable elastomeric venous
flow control device designed for those patients who suffer from venoocclusive
dysfunction (commonly referred to as venous leak syndrome). The Company
commenced commercial sales of ACTIS in the United States in July 1997.
The Company has entered into international marketing agreements with Astra AB
("Astra") and Janssen Pharmaceutica International ("Janssen") under which Astra
and Janssen will purchase MUSE (alprostadil) for resale in various international
markets. In November 1997, the Company obtained regulatory marketing clearance
by the Medicines Control Agency (MCA) to market MUSE (alprostadil) in the United
Kingdom. The Company began selling MUSE (alprostadil) to Astra in the fourth
quarter of 1997. Astra began selling MUSE (alprostadil) in the United Kingdom in
February 1998. In addition, applications for regulatory approval to market MUSE
(alprostadil) have been submitted in several other countries. These applications
will be subject to rigorous approval processes, and there can be no assurance
such approvals will be granted in a timely manner, if at all.
The Company is subject to a number of risks including its ability to scale-up
its manufacturing capabilities and secure an adequate supply of raw materials,
its ability to successfully market, distribute and sell its products, its
reliance on a single therapeutic approach for the treatment of erectile
dysfunction, and intense competition. There can be no assurance that the Company
will be able to achieve profitability on a sustained basis. Accordingly, there
can be no assurance of the Company's future success.
The Company has limited experience in manufacturing and selling MUSE
(alprostadil) in commercial quantities. Since the commercial launch of MUSE
(alprostadil) in January 1997, the Company has experienced product shortages due
to higher than expected demand and difficulties encountered in scaling up
production of MUSE (alprostadil). The Company leased 90,000 square feet of space
in New Jersey in which it has constructed additional manufacturing and testing
facilities. The Company has filed for regulatory approvals of the facility with
both the FDA and MCA. In March 1998, the MCA authorized the Company to begin
commercial production and shipment of MUSE (alprostadil) from its new facility.
In addition, the Company has negotiated a long-term lease for a site in Ireland
for construction of a European manufacturing operation. Until the Company
receives the required approvals for its new New Jersey facility, domestic and
certain international markets will need to be supplied from its current facility
within the Paco Pharmaceutical Services, Inc. ("Paco") facility. There can be no
assurance such approvals will be granted in a timely manner, if at all. If
international sales increase as anticipated, product available for the domestic
market may be reduced and gross margins will be adversely impacted. If the
Company encounters further difficulties with its current manufacturing facility
or delays in regulatory approvals of its new manufacturing facility, capacity
constraints could continue for an extended period of time, which would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Because of the production capacity constraints, the Company did not initiate
significant MUSE advertising programs in 1997 and experienced declining demand
for MUSE (alprostadil) in late 1997. In anticipation of receiving regulatory
approvals of its new manufacturing facility and because of available inventories
at the wholesale level, the Company launched its first domestic
direct-to-consumer advertising campaign in January 1998. This campaign includes
major television, newspaper and magazine placements. In February 1998, the FDA
notified the Company that it objected to, among other things, the prominence and
balance of side effect
2
4
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
information relative to efficacy information in certain written materials and
the Company's television advertisements. The Company has ceased running its
television advertisements and requested a meeting with the FDA to discuss
necessary changes to the Company's television advertisements. There can be no
assurance that the Company's domestic sales and marketing efforts will be
successful at increasing the demand for MUSE (alprostadil). In addition, there
can be no assurance that the Company's capacity constraints will not prevent the
Company from supplying any increased demand.
Results of Operations
YEARS ENDED DECEMBER 31, 1997 AND 1996
Product revenue of $129,337,000 and cost of goods sold of $38,288,000 were
recorded in 1997 compared with none in 1996. Product revenue and related cost of
sales in 1997 were primarily the result of the commercial launch of MUSE
(alprostadil) in the United States. Product gross margin for 1997 was 70% which
includes the effect of reduced cost of sales related to expensed materials of
$4.7 million. International sales commenced in the fourth quarter of 1997.
Because of revenue sharing arrangements with the Company's international
partners, international sales result in lower gross margin as compared to
domestic sales. International revenue in 1998 is expected to compose a greater
proportion of total revenue which will have the effect of lowering gross
margins. This impact may be offset by production efficiencies at the new
manufacturing facility.
Milestone revenue of $9,000,000 was recorded in 1997 compared with
$20,000,000 in 1996, a decrease of 55%. In 1997, milestone revenue was recorded
as a result of signing the international marketing agreement with Janssen ($5
million) in January 1997, expanding the Janssen agreement ($2 million) in
October 1997, and an Astra milestone payment associated with clearance from the
MCA to market MUSE (alprostadil) in the United Kingdom ($2 million) in November
1997. In 1996, milestone revenue was recorded as the result of signing the
international marketing agreement with Astra ($10 million), and upon filing the
application for marketing authorization in the United Kingdom ($10 million).
Research and development expenses in 1997 were $12,123,000 compared with
$28,279,000 in 1996, a decrease of 57%. This decrease resulted primarily from
1996 having higher pre-launch manufacturing costs, higher expenses associated
with the preparation and filing of the Company's new drug application for MUSE
(alprostadil) and a $5.8 million charge related to the issuance of 400,000
shares of common stock to ALZA Corporation to maintain exclusive rights to
certain patents and patent applications beyond 1998.
Selling, general and administrative expenses in 1997 were $47,931,000
compared with $11,733,000 in 1996, an increase of 309%. This increase resulted
primarily from the addition of a direct sales force, higher product marketing
expenses and costs associated with adding personnel to support the growth of the
Company's operations and commercial launch of MUSE (alprostadil). The Company
currently employs approximately 75 sales representatives who call upon
urologists and other specialists. Effective February 1998, the Company entered
into a Sales Force Services Agreement with Innovex Inc. ("Innovex"). Pursuant to
this agreement, Innovex will provide approximately 200 additional contract sales
representatives, the substantial majority of whom will be calling upon primary
care physicians. Due to this sales force expansion, as well as the Company's
direct-to-consumer advertising campaign and addition of personnel to support the
Company's operations, selling, general and administrative expenses are expected
to increase significantly in 1998.
During the fourth quarter of 1997, the Company recorded the settlement of a
lawsuit with a former consultant. Payment of the $5.1 million settlement was
made on January 5, 1998.
Interest income in 1997 was $4,856,000 compared with $3,485,000 in 1996, an
increase of 39%. The increase resulted from higher average invested cash
balances primarily due to higher cash flows from operating activities which were
partially offset by property and equipment purchases.
The provision for income taxes in 1997 was $3,184,000 compared with none for
1996. The increase is the result of having pre-tax income primarily due to
3
5
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
product revenue in 1997 as compared to a net loss in 1996. The effective tax
rate computation for 1997 includes the effect of operating losses carried
forward from prior years which have been fully utilized in 1997. Therefore, the
Company expects that its effective tax rate will increase in future periods.
YEARS ENDED DECEMBER 31, 1996 AND 1995 In May 1996, the Company completed a
marketing agreement with Astra AB (Astra) where Astra will purchase the
Company's products for resale in Europe, South America, Central America,
Australia and New Zealand. In consideration for execution of the marketing
agreement, Astra paid the Company $10 million in June 1996. In September 1996,
the Company received a $10 million milestone payment from Astra upon filing an
application for marketing authorization for MUSE (alprostadil) in the United
Kingdom. The Company recorded these receipts as revenue in the consolidated
statement of operations during 1996. The Company began generating revenues from
product sales in January 1997. No product revenues were recorded in 1996 or
1995.
Research and development expenses in 1996 were $28,279,000 compared with
$21,313,000 in 1995, an increase of 33%. This increase resulted primarily from a
$5.8 million charge related to the issuance of 400,000 shares of common stock in
May 1996 to ALZA Corporation to maintain exclusive rights to certain patents and
patent applications beyond 1998. In addition, higher pre-launch manufacturing
costs were partially offset by lower clinical and regulatory expenses.
General and administrative expenses in 1996 were $11,733,000 compared with
$4,389,000 in 1995, an increase of 167%. This increase resulted primarily from
higher product marketing and market research expenses, hiring and training the
U.S. sales force, and additional personnel and increased facilities costs to
support the growth of the Company's operations.
Interest income in 1996 was $3,485,000 compared with $2,891,000 in 1995, an
increase of 21%. The increase resulted from higher average invested cash
balances associated with the $57,468,000 in net proceeds received from the stock
offering in June 1996.
Liquidity and Capital Resources In 1997, the Company achieved a positive cash
flow from operations for the first year since inception. In prior years, the
Company had financed operations primarily from the sale of common stock. The
Company has raised $152,334,000 to date through the sale of stock. Cash and
available-for-sale securities totaled $91,696,000 at the end of 1997 compared
with $84,325,000 at the end of 1996. The Company maintains its current excess
cash balances in a variety of interest-bearing financial securities such as U.S.
government securities, high-grade corporate debt and certificates of deposit.
Principal preservation, liquidity and safety are the primary investment
objectives.
Cash provided by operations in 1997 was $42,594,000 compared with cash used
of $10,379,000 in 1996. The increase for 1997 is primarily due to net income of
$36,617,000.
Accounts receivable at December 31, 1997 were $11,791,000 compared with none
at the end of 1996. This increase is entirely the result of product sales in
1997.
Inventories were $9,084,000 at December 31,1997 as compared to $4,540,000 at
December 31, 1996. The increase resulted primarily from increased purchases of
raw materials and a lower inventory reserve at the end of 1997.
Current liabilities were $26,739,000 at December 31, 1997 compared with
$6,752,000 at December 31, 1996, an increase of $19,987,000. This increase was
primarily due to increased sales and marketing expenses, the settlement of a
lawsuit and other increases associated with the growth in operations of the
Company.
Capital expenditures in 1997 were $32,268,000 compared with $3,682,000 in
1996, an increase of $28,586,000. Capital expenditures were higher in 1997
primarily due to construction of the Company's new manufacturing facility in
Lakewood, New Jersey, the purchase of additional manufacturing equipment for use
4
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
at the Company's dedicated manufacturing operation within the Paco facility,
also in Lakewood, New Jersey, and the completion of the Company's new corporate
headquarters and research and development laboratory facility located in
Mountain View, California. Capital expenditures over the next two years are
likely to increase as they are expected to include additional expenditures
associated with the manufacturing facilities in New Jersey and a new
manufacturing facility in Europe.
The Company repurchased 336,700 shares of its common stock at a cost of
$7,716,000 in 1997 compared with none in 1996. The Company repurchased an
additional 1,663,300 shares of its common stock in January and February 1998 at
a cost of $23,584,000.
The Company expects to incur substantial additional costs, including expenses
related to its manufacturing facilities in New Jersey and a new manufacturing
facility in Europe, expenses related to marketing and sales of MUSE
(alprostadil), including expenses associated with expanding its sales force by
approximately 200 sales representatives and a direct-to-consumer marketing
campaign, new product preclinical and clinical costs, ongoing research and
development activities and general corporate purposes. The Company anticipates
that its existing capital resources will be sufficient to support the Company's
operations through the commercial introduction of MUSE (alprostadil)
internationally, but may not be sufficient for the introduction of any
additional future products. Accordingly, the Company anticipates that it may be
required to issue additional equity or debt securities and may use other
financing sources including, but not limited to, corporate alliances and lease
financing to fund the future development and possible commercial launch of its
future products. The sale of additional equity securities would result in
additional dilution to the Company's stockholders. The Company's working capital
and additional funding requirements will depend upon numerous factors,
including: (i) the level of resources that the Company devotes to sales and
marketing capabilities; (ii) the level of resources that the Company devotes to
expanding manufacturing capacity; (iii) the activities of competitors; (iv) the
progress of the Company's research and development programs; (v) the timing and
results of preclinical testing and clinical trials; (vi) technological advances;
and (vii) continued profitability.
Management's discussion and analysis of financial condition and results of
operations contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Actual results could differ materially from
those projected in the forward-looking statements as a result of the factors set
forth above. The discussion of those factors is incorporated herein by this
reference as if said discussion was fully set forth at this point.
5
7
CONSOLIDATED BALANCE SHEETS
IN THOUSANDS
December 31,
--------------------------
1997 1996
--------- ---------
Assets
Current assets:
Cash $ 6,161 $ 555
Available-for-sale securities 52,955 60,710
Accounts receivable (net of allowance for doubtful accounts of $137 at
December 31, 1997) 11,791 --
Inventories 9,084 4,540
Prepaid expenses and other assets 1,636 1,335
Total current assets 81,627 67,140
Property and equipment 36,462 6,332
Available-for-sale securities, non-current 32,580 23,060
Total $ 150,669 $ 96,532
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 6,574 $ 3,324
Accrued and other liabilities 20,165 3,428
Total current liabilities 26,739 6,752
--------- ---------
Commitments (Notes 8 and 9)
Stockholders' equity:
Common stock; $.001 par value; shares authorized -- 200,000 at December 31,
1997 and 1996; shares outstanding -- December 31, 1997, 33,168
December 31, 1996, 32,454 33 32
Paid in capital 153,336 156,173
Unrealized gain on securities 98 77
Deferred compensation -- (348)
Accumulated deficit (29,537) (66,154)
Total stockholders' equity 123,930 89,780
Total $ 150,669 $ 96,532
--------- ---------
See notes to consolidated financial statements.
6
8
CONSOLIDATED STATEMENTS OF OPERATIONS
IN THOUSANDS, EXCEPT PER SHARE DATA
Year Ended December 31,
---------------------------------------
1997 1996 1995
-------- -------- --------
Revenue:
Product $129,337 $ -- $ --
Milestone 9,000 20,000 --
Total revenue 138,337 20,000 --
Cost of goods sold 38,288 -- --
Gross margin 100,049 20,000 --
Operating expenses:
Research and development 12,123 28,279 21,313
Selling, general and administrative 47,931 11,733 4,389
Settlement of lawsuit 5,050 -- --
Total operating expenses 65,104 40,012 25,702
Income (loss) from operations 34,945 (20,012) (25,702)
Interest and other income 4,856 3,485 2,891
Income (loss) before taxes 39,801 (16,527) (22,811)
Provision for income taxes 3,184 -- --
Net income (loss) $ 36,617 $(16,527) $(22,811)
-------- -------- --------
Net income (loss) per share:
Basic $ 1.11 $ (0.55) $ (0.85)
Diluted $ 1.03 $ (0.55) $ (0.85)
Shares used in per share computation:
Basic 32,996 29,833 26,914
Diluted 35,559 29,833 26,914
See notes to consolidated financial statements.
7
9
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
IN THOUSANDS, EXCEPT PER SHARE DATA
Common Stock and
Paid In Capital Unrealized
-------------------- Gain (Loss) Deferred Accumulated
Shares Amount on Securities Compensation Deficit
------ ------ ----- ------- --------
BALANCES, December 31, 1994 23,448 $ 68,698 $(339) $(1,236) $(26,816)
Sale of common stock at $7.25 per
share for cash (net of issuance costs
of $1,732) 3,340 22,483
Sale of common stock through employee
stock purchase plan 31 172
Exercise of common stock options for cash 133 132
Unrealized gain on securities 453
Amortization of deferred compensation 445
Net loss (22,811)
------ -------- ----- ------- --------
BALANCES, December 31, 1995 26,952 91,485 114 (791) (49,627)
Issuance of common stock at $14.56
per share for patent rights 400 5,821
Sale of common stock at $13.38 per
share for cash (net of issuance costs
of $4,057) 4,600 57,468
Sale of common stock through employee
stock purchase plan 20 226
Exercise of common stock options for cash 482 1,205
Unrealized loss on securities (37)
Amortization of deferred compensation 443
Net loss (16,527)
------ -------- ----- ------- --------
BALANCES, December 31, 1996 32,454 156,205 77 (348) (66,154)
Warrants exercised, net 166 --
Sale of common stock through employee
stock purchase plan 34 486
Exercise of common stock options for cash 851 4,254
Repurchase of common stock for cash (337) (7,716)
Stock compensation costs 140 348
Unrealized gain on securities 21
Net income 36,617
------ ------ ----- ------- --------
BALANCES, December 31, 1997 33,168 $153,369 $ 98 $ -- $(29,537)
====== ======== ===== ======= ========
See notes to consolidated financial statements.
8
10
CONSOLIDATED STATEMENTS OF CASH FLOWS
IN THOUSANDS
Year Ended December 31,
-------------------------------------------
1997 1996 1995
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $ 36,617 $ (16,527) $ (22,811)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization 2,138 1,238 708
Stock compensation costs 488 443 445
Issuance of common stock for patent rights -- 5,821 --
Changes in assets and liabilities:
Accounts receivable (11,791) -- --
Inventories (4,544) (4,540) --
Prepaid expenses and other assets (301) (698) (63)
Accounts payable 3,250 2,971 (298)
Accrued and other liabilities 16,737 913 452
--------- --------- ---------
Net cash provided by (used for) operating activities 42,594 (10,379) (21,567)
--------- --------- ---------
Cash flows from investing activities:
Property and equipment purchases (32,268) (3,682) (3,148)
Investment purchases (323,609) (177,074) (146,338)
Proceeds from sale and maturity of securities 321,865 131,818 147,202
--------- --------- ---------
Net cash used for investing activities (34,012) (48,938) (2,284)
--------- --------- ---------
Cash flows from financing activities:
Sale of common stock -- 57,468 22,483
Exercise of common stock options 4,254 1,205 132
Sale of common stock through employee stock purchase plan 486 226 172
Repurchase of common stock (7,716) -- --
--------- --------- ---------
Net cash provided by (used for) financing activities (2,976) 58,899 22,787
--------- --------- ---------
Net increase (decrease) in cash 5,606 (418) (1,064)
Cash:
Beginning of year 555 973 2,037
--------- --------- ---------
End of year $ 6,161 $ 555 $ 973
========= ========= =========
Non-cash investing and financing activities:
Unrealized gain (loss) on securities $ 21 $ (37) $ 453
Supplemental cash flow disclosure:
Income taxes paid $ 1,653 $ -- $ --
See notes to consolidated financial statements.
9
11
Note 1. Business and Significant Accounting Policies
Business -- VIVUS, Inc. was incorporated in California in 1991 to develop
products for the treatment of erectile dysfunction. The Company was
reincorporated in Delaware in 1996.
The Company obtained clearance from the U.S. Food and Drug Administration
("FDA") to manufacture and market MUSE (alprostadil) in the United States in
November 1996 and clearance to market MUSE (alprostadil) in the United Kingdom
from the Medicines Control Agency ("MCA") in November 1997. The Company is
currently seeking marketing clearance in other countries. The Company commenced
product shipments to wholesalers in December 1996 and commercially introduced
MUSE (alprostadil) in the United States through its direct sales force beginning
in January 1997.
The Company is subject to a number of risks including its ability to scale-up
its manufacturing capabilities and secure an adequate supply of raw materials,
its ability to successfully market, distribute and sell its products, its
reliance on a single therapeutic approach for the treatment of erectile
dysfunction, and intense competition. Accordingly, there can be no assurance of
the Company's future success.
Revenue Recognition -- Product revenue is generally recognized upon shipment.
While there were product shipments in December 1996, the Company did not
recognize product revenue nor the associated cost of sales on these shipments
until 1997 because of extended rights-of-return privileges which were granted to
customers during this initial selling period.
The Company primarily sells its products through the wholesale channel in the
United States. Product shipments are generally to distribution centers
throughout the U.S. for the larger wholesalers. During 1997, five of these
wholesalers accounted for 24%, 18%, 14%, 13%, and 11% of total product revenue.
The Company recognized revenue of $9 million and $20 million in the years
ended December 31, 1997 and 1996 respectively as a result of achieving certain
milestones related to its international marketing agreements. The amounts
recognized are not refundable and do not involve any significant future
performance obligations.
Principles of Consolidation -- The consolidated financial statements include
VIVUS, Inc., VIVUS International Limited, a wholly-owned subsidiary, and VIVUS
Ireland Limited, VIVUS UK Limited and VIVUS BV Limited, wholly-owned
subsidiaries of VIVUS International Limited. All significant intercompany
transactions and balances have been eliminated.
Cash and Cash Equivalents -- The Company considers all highly liquid debt
instruments purchased with an original maturity of 90 days or less to be cash
equivalents.
Inventories -- Inventories are stated at the lower of cost (first-in, first-out
basis) or market. Cost includes material and conversion costs. Pending FDA
marketing clearance, which was obtained in November 1996, the Company expensed
to research and development all raw material purchases prior to October 1, 1996.
Certain of these expensed raw material costs benefited 1997 by reducing cost of
sales by $4.7 million. The remaining balance of $5.4 million at December 31,
1997 will benefit future periods by reducing cost of sales.
Available-for-Sale Securities -- The Company accounts for available-for-sale
securities in accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Available-for-sale securities represent debt securities that are stated at fair
value. The difference between amortized cost (cost adjusted for amortization of
premiums and accretion of discounts which are recognized as adjustments to
interest income) and fair value, representing unrealized holding gains or
losses, are recorded as a separate component of stockholders' equity until
realized. The Company's policy is to record debt securities as
available-for-sale because the sale of such securities may be required prior to
maturity. Any gains and losses on the sale of debt securities are determined on
a specific identification basis.
10
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
Property -- Property and equipment are stated at cost. For financial reporting,
depreciation and amortization are computed using the straight-line method over
estimated useful lives of three to seven years.
Income Taxes -- The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," which requires an asset and liability approach for financial reporting
of income taxes.
License Agreements -- The Company has obtained rights to patented technologies
related to its initial product MUSE (alprostadil) under several licensing
agreements. These agreements generally required milestone payments during the
development period and royalties on product sales. Royalties on product sales
are included in cost of goods sold in 1997. Milestone payments are included in
research and development expense in 1997 and prior years.
Research and Development -- Research and development costs are expensed as
incurred.
Net Income (Loss) Per Share -- The Company has adopted Statement of Financial
Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share" which replaced
Accounting Principles Board Opinion No. 15 ("APB 15"). SFAS 128 requires a dual
presentation of basic and diluted earnings per share. Basic earnings per share
is based on the weighted average number of common shares outstanding during the
periods. Diluted earnings per share is based on the weighted average number of
common and common equivalent shares, which represent shares that may be issued
in the future upon the exercise of outstanding stock options and warrants.
Diluted earnings per share is computed similarly to earnings per share
previously reported pursuant to APB 15 and, for the Company, diluted earnings
per share amounts are the same as amounts previously reported under APB 15. The
computation of basic and diluted earnings per share for the years ended December
31, 1997, 1996 and 1995 is as follows:
(In thousands,
except per share data) 1997 1996 1995
-------- ---------- ----------
Net income (loss) $ 36,617 $ (16,527) $ (22,811)
======== ========== ==========
Net income (loss) per
share-- Basic $ 1.11 $ (0.55) $ (0.85)
Common equivalent shares:
Options (0.07) -- --
Warrants (0.01) -- --
-------- ---------- ----------
Net income (loss) per
share-- Diluted $ 1.03 $ (0.55) $ (0.85)
======== ========== ==========
Shares used in the
computation of net income
(loss) per share-- Basic 32,996 29,833 26,914
Common equivalent shares:
Options 2,215 -- --
Warrants 348 -- --
-------- ---------- ----------
Diluted shares 35,559 29,833 26,914
======== ========== ==========
Options to purchase 286,500 shares at prices ranging from $24.81 to $37.38 which
were outstanding at December 31, 1997 are not included in the computation of
diluted EPS for 1997 because the option prices were greater than the average
market price of common shares.
Use of Estimates -- The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures 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.
Recently Issued Accounting Pronouncements -- In June 1997, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes
standards for the reporting and
11
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
display of comprehensive income and its components in general purpose financial
statements. In June 1997, the FASB issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," which establishes annual and
interim reporting standards for business segments of a company and related
disclosures. Both SFAS No. 130 and SFAS No. 131 are effective for fiscal years
beginning after December 15, 1997. The Company believes that the adoption of
these new pronouncements will not have a material effect on the financial
statements.
Reclassifications -- Reclassifications have been made to the prior years'
Consolidated Financial Statements to conform to the fiscal 1997 presentation.
Note 2. Available-for-Sale Securities The fair value and the amortized cost of
available-for-sale securities at December 31, 1997 and 1996 are presented in the
table that follows. Fair values are based on quoted market prices obtained from
an independent broker. For each category of investment securities, the table
presents gross unrealized holding gains and losses.
As of December 31, 1997:
Fair Unrealized Unrealized
Amortized Market Holding Holding
(In thousands) Cost Value Gains Losses
------- ------- ------- -------
U.S. government
securities $36,255 $36,276 $ 148 $ (127)
Corporate debt 49,182 49,259 79 (2)
------- ------- ------- -------
Total $85,437 $85,535 $ 227 $ (129)
======= ======= ======= =======
As of December 31, 1996:
Fair Unrealized Unrealized
Amortized Market Holding Holding
(In thousands) Cost Value Gains Losses
------- ------- ------- -------
U.S. government
securities $55,441 $55,488 $ 84 $ (37)
Corporate debt 28,252 28,282 32 (2)
------- ------- ------- -------
Total $83,693 $83,770 $ 116 $ (39)
======= ======= ======= =======
The contractual maturities of these securities as of December 31, 1997 are as
follows:
Fair
Amortized Market
(In thousands) Cost Value
------- -------
Less than 1 year $52,961 $52,955
From 1 to 2 years 32,476 32,580
------- -------
Total $85,437 $85,535
======= =======
Note 3. Inventories
Inventories are recorded net of reserves of $5.4 million and $10.1 million as of
December 31, 1997 and 1996, respectively, and consist of:
(In thousands) 1997 1996
------ ------
Raw materials $8,603 $1,893
Work in process 190 344
Finished goods 291 2,303
------ ------
Total $9,084 $4,540
====== ======
Note 4. Property
Property and equipment as of December 31 consists of:
(In thousands) 1997 1996
-------- --------
Machinery and equipment $ 10,247 $ 4,763
Computers and software 2,884 1,859
Furniture and fixtures 781 535
Construction in progress 27,067 1,554
-------- --------
40,979 8,711
Accumulated depreciation and
amortization (4,517) (2,379)
-------- --------
Property and equipment, net $ 36,462 $ 6,332
======== ========
Note 5. Accrued and Other Liabilities
Accrued and other liabilities as of December 31 consist of:
(In thousands) 1997 1996
------- -------
Settlement of lawsuit $ 5,050 $ --
Sales and marketing expenses 4,913 711
Manufacturing expenses 2,619 1,086
Employee compensation and benefits 2,308 392
Research and clinical expenses 1,579 347
Income taxes 1,531 --
Other 2,164 892
------- -------
$20,165 $ 3,428
======= =======
12
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
Note 6. Stockholders' Equity
Common Stock -- The Company's Board of Directors approved a stock repurchase
program in May 1997 whereby the Company could purchase up to two million shares
of its common stock. As of December 31, 1997, the Company had repurchased
336,700 shares at a cost of $7,716,000. During January and February 1998, the
Company repurchased 1,663,300 additional shares of its common stock at a cost of
$23,583,990.
In June 1997, the Company effected a two-for-one common stock split. All
common stock data in the accompanying consolidated financial statements for all
years presented have been adjusted to reflect this stock split.
Preferred Stock-- The Company is authorized to issue 5,000,000 shares of
undesignated preferred stock. Such shares of preferred stock may be issued by
the Company in the future, without stockholder approval, upon such terms as the
Company's Board of Directors may determine.
Stock Warrants -- In connection with the issuance of convertible preferred stock
in 1993, the Company issued warrants exercisable for up to 528,600 shares of
common stock at an exercise price of $4.31 per share. In June 1997, 203,590
warrants were exercised and the Company issued 165,928 net shares based on the
market price on June 23, 1997. The remaining 325,010 warrants outstanding as of
December 31, 1997 expire in 1999.
Note 7. Stock Option and Purchase Plans
Stock Option Plans -- Under the 1991 Incentive Stock Plan (the Plan), the
Company may grant incentive or non-statutory stock options or stock purchase
rights (SPRs). Up to 7,800,000 shares of common stock have been authorized for
issuance under the Plan. The Plan allows the Company to grant incentive stock
options (ISOs) and nonstatutory stock options (NSOs) to employees, directors and
consultants at not less than the fair market value (for an ISO) of the stock at
the date of grant (110% of fair market value for individuals who control more
than 10% of the Company stock; otherwise, not less than 85% of fair market value
for an NSO), as determined by the Board of Directors. Under the Plan, 25% of the
options generally become exercisable after one year and 2.0833% per month
thereafter. The term of the option is determined by the Board of Directors on
the date of grant but shall not be longer than ten years. The Plan allows the
Company to grant SPRs to key employees and consultants at not less than 85% of
the fair market value of the stock at the date of grant, as determined by the
Board of Directors. Sales of stock under SPRs are made pursuant to restricted
stock purchase agreements containing provisions established by the Board of
Directors. The Company has a right to repurchase the shares at the original sale
price, which expires at a rate to be determined by the Board of Directors. As of
December 31, 1997, no SPRs have been granted under the Plan.
Under the 1994 Director Stock Option Plan (the Director Option Plan), the
Company reserved 400,000 shares of common stock for issuance to nonemployee
directors of the Company pursuant to NSOs issued at the fair market value of the
Company's common stock at the date of grant. Under the Director Option Plan,
non-employee directors will receive an option to purchase 32,000 shares of
common stock when they join the Board of Directors. These options vest 25% after
one year and 25% annually thereafter. Thereafter, each director shall receive an
option to purchase 8,000 shares of the Company's common stock annually upon
their reelection. These options are fully exercisable ratably over eight months.
Details of option activity under these plans are as follows:
Weighted
Average
Number Exercise
of Shares Price
--------- ------
Outstanding, December 31, 1994 2,184,768 $ 2.90
Granted 1,254,050 8.12
Exercised (132,770) 1.00
Canceled (41,416) 6.72
---------
Outstanding, December 31, 1995 3,264,632 4.93
Granted 1,444,746 16.40
Exercised (485,796) 2.48
Canceled (25,732) 10.24
---------
Outstanding, December 31, 1996 4,197,850 9.13
Granted 1,289,722 22.32
Exercised (850,550) 5.00
Canceled (115,827) 12.90
---------
Outstanding, December 31, 1997 4,521,195 $13.57
=========
13
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------------- ---------------------------
Number Number
Outstanding Weighted-Average Weighted- Exercisable Weighted-
Range of December 31, Remaining Average December 31, Average
Exercise Prices 1997 Contractual Life Exercise Price 1997 Exercise Price
- --------------- --------- ---------------- -------------- ----------- --------------
$ 0.09-$ 6.56 938,900 6.21 years $ 3.33 817,005 $ 2.96
$ 6.63-$11.88 996,850 7.23 years 8.28 596,271 7.91
$ 13.50-$16.75 1,118,058 7.04 years 15.98 380,638 15.77
$ 16.88-$21.63 1,126,887 9.06 years 20.56 66,196 18.61
$ 21.94-$37.38 340,500 8.65 years 26.29 10,000 28.81
--------- ---------
$ 0.09-$37.38 4,521,195 7.53 years $13.57 1,870,110 $ 7.83
========= =========
At December 31, 1997, 2,100,323 options remain authorized and unissued under
these plans.
The Company accounts for these plans as prescribed by the Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Accordingly, compensation expense is recognized only if options are granted to
someone who is not an employee or director of the Company or if options are
granted at a discounted exercise price. Except for compensation discussed in the
following paragraph, no compensation cost has been recognized because the
exercise price equals the market value of stock on the date of grant.
During 1997, options to purchase 100,000 shares of common stock were granted
to research consultants at the fair market value on the date of grant.
Compensation costs using the Black-Scholes option pricing model are estimated to
be approximately $1.1 million over the option's vesting period of which $140,000
was recorded as expense for the year ended December 31, 1997.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used for
grants: risk-free rates ranging from 5-7% and corresponding to government
securities with original maturities similar to the vesting periods; expected
dividend yield of 0%; expected lives of .64 years beyond vest dates; and
expected volatility of 55% in all years. The weighted average of fair values of
options granted during 1997, 1996 and 1995 respectively, were $9.32, $6.76 and
$3.42.
Under FASB Statement No. 123 (FASB 123), "Accounting for Stock-based
Compensation," the estimated fair value of options is amortized to expense over
the options' vesting period. In accordance with the disclosure requirements of
FASB 123, if the Company had elected to recognize this expense, income (loss)
and income (loss) per share would have been reduced to the following pro forma
amounts:
(In thousands,
except per share data) 1997 1996 1995
---------- ---------- ----------
Pro forma net income (loss) $ 31,958 $ (20,039) $ (23,941)
Pro forma net income
(loss) per share:
Basic $ 0.97 $ (0.67) $ (0.89)
Diluted $ 0.90 $ (0.67) $ (0.89)
Because the FASB 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma amounts may not be
representative of that to be expected in future years.
Stock Purchase Plan -- In June 1994, the Company implemented an employee stock
purchase plan under which eligible employees may authorize payroll deductions of
up to 10% of their base compensation (as defined) to purchase common stock at a
price equal to 85% of the lower of the fair market value as of the beginning or
the end of the offering period. A total of 400,000 shares were reserved for
issuance under the employee stock purchase plan. As of December 31,
14
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
1997, 94,896 shares have been issued to employees. During 1997, the weighted
average fair market value of shares issued under the employee stock purchase
plan was $23.45 per share.
Note 8. License Agreements
The Company has entered into several agreements to license patented technologies
that are essential to the development and production of the Company's product.
In connection with these agreements, upon meeting certain milestones (as
defined) and contingent on the issuance of patents in certain countries, the
Company is obligated to (1) pay license fees of $2,575,000 (of which $2,175,000
was paid prior to December 31, 1997 and $400,000 was paid in January 1998); (2)
issue 896,492 shares of the Company's common stock (all of which has been
issued); and (3) pay royalties on product sales covered by the license
agreements (4% of U.S. and Canadian product sales and 3% of sales elsewhere in
the world). In 1996, the Company issued an additional 400,000 shares of common
stock to maintain exclusive rights to certain patents and patent applications
beyond 1998. In connection with this issuance, the Company recorded a charge of
$5,821,000 to the consolidated statements of operations. In 1997, the Company
recorded royalty expense as cost of goods sold based on product sales.
Note 9. Lease Commitments
The Company leases its principal administrative and research and development
laboratory facility under a fifteen year non-cancelable operating lease expiring
in 2012. Under the terms of this lease, the Company has posted a $1.75 million
letter of credit to secure ongoing performance under the lease. The Company also
leases its manufacturing facilities under a five year non-cancelable operating
lease expiring in 2002. The Company has the option to extend this lease for two
renewal terms of five years each.
Future minimum lease payments under operating leases are as follows:
(In thousands)
1998 $ 1,749
1999 1,778
2000 1,811
2001 1,846
2002 1,282
Thereafter 14,467
-------
$22,933
=======
Rent expense under operating leases totaled $1,302,000, $560,000, and $342,000
for the years ended December 31, 1997, 1996, and 1995, respectively.
Note 10. Income Taxes
The provision for income taxes consisted of the following components as of
December 31, 1997:
(In thousands) 1997
------
Current
Federal $2,170
State 1,332
------
Total current 3,502
Deferred (prepaid)
Federal (318)
State --
Total deferred (prepaid), net (318)
------
Total provision for income taxes $3,184
======
15
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
The provision for income taxes differs from the amount computed by applying the
statutory federal income tax rates as follows:
1997
----
Provision computed at federal statutory rates 35%
State income taxes, net of federal tax effect 6
Net operating losses utilized (20)
Tax credits utilized (10)
Income not subject to federal and state taxation (4)
Other 1
----
Provision for income taxes 8%
====
Deferred income taxes result from differences in the recognition of expenses for
tax and financial reporting purposes, as well as operating loss and tax credit
carry-forwards. Significant components of the Company's deferred tax assets as
of December 31, are as follows:
(In thousands) 1997 1996
-------- --------
Deferred tax assets:
Net operating loss carryforwards $ -- $ 7,870
Research and development credit
carryforwards -- 2,715
Capitalized research and
development expenses 1,947 3,695
Inventory reserve 3,022 4,237
Accruals and other 648 709
Deferred gain (859) (1,760)
Depreciation 1,260 487
-------- --------
6,018 17,953
Valuation allowance (6,018) (17,953)
-------- --------
Total $ -- $ --
======== ========
Note 11. Legal Matters
In December 1997, the Company reached a settlement agreement with a former
consultant of the Company whereby the former consultant dismissed his claims
against the Company and certain of its officers and directors. The Company
agreed to pay the former consultant $5.1 million. The Company recorded the
settlement in 1997 and paid the $5.1 million on January 5, 1998 in accordance
with the agreement.
In February 1998, the Company and certain of its officers and directors were
named in class action lawsuits filed in California state court alleging
violations of state securities laws. On March 20, 1998, the Company learned that
a federal class action had been filed against the Company and certain current
and former officers and directors. The lawsuits involve events which allegedly
took place between May 15, 1997 and December 9, 1997. The Company believes that
the allegations are without merit and intends to vigorously defend these cases.
The Company does not believe that resolution of these claims will have an
adverse material impact on the operations or financial position of the Company.
In the normal course of business, the Company receives and makes inquiries
regarding patent infringement and other legal matters. The Company believes that
it has meritorious claims and defenses and intends to pursue any such matters
vigorously. The Company is not aware of any asserted or unasserted claims
against it, excluding the settlement above, where the resolution would have an
adverse material impact on the operations or financial position of the Company.
16
18
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of VIVUS, INC.:
We have audited the accompanying consolidated balance sheets of VIVUS, Inc. (a
Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VIVUS, Inc. and subsidiaries at
December 31, 1997 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
San Jose, California
March 20, 1998
17