________________________________________________________________________________
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 000 - 28844
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ALGOS PHARMACEUTICAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 22-3142274
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
1333 CAMPUS PARKWAY
NEPTUNE, NJ 07753-6815
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (732) 938-5959
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $411 million, based on the last sales price of
the Common Stock as of March 1, 1999.
As of March 1, 1999, 17,353,045 shares of Common Stock, $0.01 par value, of
the registrant were issued and outstanding.
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PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
Algos Pharmaceutical Corporation is developing a new class of superior
analgesic and anesthetic drugs for managing moderate to severe pain. The
Company's technology is based on combinations of drugs that create analgesic
synergy by effectively managing the intracellular mechanisms of pain perception.
The first applications of the Company's technology are N-methyl-D-aspartate
(NMDA)-enhanced opioid analgesics and anesthetics. These drugs combine existing
analgesics and anesthetics with an NMDA-receptor antagonist drug that has
already been approved for human use in other applications. Independent research
and Algos' pre-clinical studies and clinical trials conducted to date have shown
that these products may provide significantly superior pain relief compared to
currently available analgesics and anesthetics, including opioid drugs such as
morphine, hydrocodone, and oxycodone and anesthetic drugs such as lidocaine.
Algos is using its NMDA-receptor antagonist technology to develop other products
including an intranasal treatment for migraine and addiction treatment products.
Algos filed a New Drug Application (NDA) with the United States Food and
Drug Administration (FDA) for its lead product, MorphiDex'TM', on August 19,
1998. Under the Prescription Drug User Fee Act, the FDA agrees to review and act
on the NDA within 12 months of filing. MorphiDex'TM' is a patented combination
of morphine and the NMDA-receptor antagonist dextromethorphan. The MorphiDex'TM'
NDA consists of data from 2,200 patients in 14 double-blind, single-dose and
multiple-dose studies.
The United States market for moderate to severe pain products reached $1.8
billion in 1998. MorphiDex'TM' will compete in the strong opioid segment of this
market, which has grown at the rate of 35% annually in dollars over the past
three years and is expected to approach $1 billion in sales in the U.S. in 1999.
In addition to MorphiDex'TM', Algos or its development partners have a
number of other products in the pipeline. Products that have reached Human
clinical trials or are scheduled to commence Human clinical trials in 1999
include:
opioid analgesic/NMDA-receptor antagonist combination products: (1)
HydrocoDex'TM', expected to be used primarily to treat moderate to
moderately severe post-operative pain, trauma pain, and chronic pain
conditions and (2) OxycoDex'TM', expected to be used primarily to treat
moderate to moderately severe pain;
an oral neuropathic pain product consisting of an NMDA-receptor antagonist
in combination with a potentially synergistic drug;
anesthetic/NMDA-receptor antagonist combination products: (1) LidoDex
NS'TM', an intranasal formulation of lidocaine and an NMDA-receptor
antagonist for the treatment of migraine headaches, to be developed in
collaboration with Interneuron Pharmaceuticals, Inc. and (2) LidoDex
IED'TM', an injectible local anesthetic/NMDA-receptor antagonist
combination product intended to provide fast onset and extended duration
of effect for use in in-patient and out-patient surgeries;
non-opioid analgesic/NMDA-receptor antagonist combination products
licensed to McNeil Consumer Products Company and expected to be
used primarily to treat mild pain: (1) a combination product
consisting of an NMDA-receptor antagonist and acetaminophen and (2)
a combination product consisting of an NMDA-receptor antagonist and
an over-the-counter non-steroidal anti-inflammatory drug, i.e., an
NSAID; and
addiction treatment products including treatments for: (1) opiate
addiction, which Algos is developing in collaboration with the National
Institute on Drug Abuse (NIDA) of the National Institutes of Health (NIH)
and (2) nicotine addiction.
Algos is evaluating other applications of its proprietary NMDA-receptor
antagonist technology and may choose to advance such additional products to
clinical development. In addition, Algos may
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develop other platform technologies for the management of pain. Algos' drug
development program is based upon a continuous review of clinical results, newly
published scientific papers, the possibility of joint development or research
arrangements with research institutes or commercial organizations, the
availability of resources, including acceptable third party clinical facilities,
and available funds. Furthermore, based on clinical results, marketing studies
or other factors, Algos may elect to delay, modify, or suspend the development
of any of its products in development.
Algos' goal is to become the leading company in the management of moderate
to severe pain. Algos intends to achieve this goal by:
introducing superior proprietary products;
minimizing development time, cost and risk;
leveraging its proprietary technology across multiple product
opportunities;
outsourcing manufacturing and certain research and development functions
to efficiently deploy resources; and
maximizing market penetration and margin potential through a combination
of Algos direct sales and strategic alliances.
Algos believes that the markets in which it intends to compete offer
attractive opportunities. Favorable factors in the target analgesic and
anesthetic markets include:
high growth rates partially attributable to an increase in pain due to the
aging of the population;
heightened physician awareness of the benefits of effective pain treatment
including reductions in healing and recovery time;
the potential for rapid acceptance of new pain management pharmaceuticals
by members of the medical profession;
generally concentrated distribution channels that permit more
cost-effective selling and marketing; and
the potential for higher profit margins from branded proprietary products.
Algos believes that its analgesic and anesthetic products can be developed
cost effectively because:
the products combine existing drugs with extensive clinical safety
profiles; and
clinical trials for new analgesics and anesthetics are less costly and
quicker to conduct than clinical trials for many other pharmaceutical
product categories.
In the United States, Algos has nine issued patents, two patent
applications which have received a notice of allowance and eight pending patent
applications. This patent estate covers method and composition for NMDA-enhanced
analgesics and anesthetics. In addition, forty foreign patent applications are
pending.
Algos was incorporated in Delaware in 1992. Its executive offices are
located at 1333 Campus Parkway, Neptune, New Jersey 07753-6815, and its
telephone number is (732) 938-5959.
This Annual Report on Form 10-K contains 'forward-looking' statements,
within the meaning of Section 27A of Securities Act of 1993, as amended and
Section 21E of the Securities Exchange Act of 1934, that are based on
management's beliefs and assumptions, current expectations, estimates and
projections. Statements that are not historical facts, including statements that
are preceded by, followed by, or that include the words 'believes;'
'anticipates;' 'plans;' 'expects;' or similar expressions and statements about
the Company's commercialization schedule and future use of funds are forward-
looking statements. Many of the factors that will determine the Company's future
results are beyond the ability of the Company to control or predict. These
statements are subject to risks and uncertainties and, therefore, actual results
may differ materially. The reader should not rely on any forward-looking
statement. The Company undertakes no obligations to update any forward-looking
statements whether as a result of new information, future events or otherwise.
Important factors that may affect future results include, but are not limited
to: uncertainty associated with pre-clinical studies and clinical trials and
regulatory approval; uncertainty of market acceptance of new products; impact of
competitive products and pricing; product development; changes in laws and
regulations; customer demand; possible
2
future litigation; the availability of future financing and reimbursement
policies of government and private health insurers and others. Readers should
evaluate any statement in light of these important factors. See 'Risk Factors'.
CLINICAL DEVELOPMENT PROGRAMS
OPIOID ANALGESIC/NMDA-RECEPTOR ANTAGONIST PRODUCTS
Opioid analgesic drugs remain the most common treatment for moderate to
severe pain in both acute and chronic conditions. These drugs consist of
naturally occurring opiates (e.g., morphine), opiate derivatives (e.g., codeine,
hydrocodone, oxycodone) and synthetic opiates (e.g., methadone).
Drawbacks to these drugs include unwanted side effects such as mental
clouding, respiratory depression, nausea and constipation and the development of
tolerance and physical dependence. Tolerance refers to the condition under which
a drug dose that was initially effective in producing analgesia becomes less
effective with repeated administrations. Therefore, to alleviate the same level
of pain, the drug dose has to be increased over time, potentially increasing
unwanted side effects and the likelihood of drug dependence.
Clinical studies of the Company's opioid analgesic/NMDA-receptor antagonist
combination products indicate that these products may provide superior pain
relief as compared to equivalent dosage levels of the opioid analgesic alone, a
faster onset of meaningful pain relief and a longer duration of effect.
Preclinical studies also indicated efficacy of the Company's opioid
analgesic/NMDA-receptor antagonist combinations with repeated administrations
over time, when the opioid analgesic administered alone became less effective.
MorphiDex'TM'
Morphine is an opiate used to treat moderate to severe pain, primarily
cancer pain. MorphiDex'TM', the Company's lead product, is a combination of
morphine and dextromethorphan.
In August 1998, the Company filed an NDA with the FDA with a proposed
indication for the relief of moderate to severe cancer pain. The NDA consists of
data covering 2,200 patients in 14 double-blind, single-dose and multiple-dose
clinical studies and includes:
Safety, abuse liability, and pharmacokinetic/bioavailability studies;
Single-dose Phase II placebo-controlled efficacy studies;
Three multi-center Phase III studies to assess the efficacy and long-term
safety of MorphiDex'TM' in cancer and other chronic pain patients.
Algos filed its NDA under the Prescription Drug User Fee Act. Under the
act, the FDA agrees to review and act on the NDA within 12 months of filing.
There is no guarantee that the NDA filing will be approved without the need to
file additional information. The FDA will independently review data submitted
and the review process is an uncertain one whose outcome cannot be predicted.
In 1999, the Company expects to continue to gather long-term-use safety
data from chronic pain patients in ongoing clinical trials. Algos also expects
to perform required manufacturing validation procedures for MorphiDex'TM'.
HydrocoDex'TM'
Hydrocodone is an opiate derivative primarily used to treat moderate to
moderately severe post-operative, musculoskeletal, trauma-related and chronic
pain. The analgesic products containing hydrocodone that are sold commercially
in the U.S. are combination products containing non-narcotic analgesics. Current
hydrocodone products include Lorcet'r' and Vicodin'r'. Hydrocodone/acetaminophen
(APAP) was the most prescribed drug in the U.S. in 1998. HydrocoDex'TM' is a
hydrocodone, APAP and dextromethorphan combination product.
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The Company initiated four single-dose Phase II clinical studies of
HydrocoDex'TM' in 1998 that are expected to be completed in 1999 and conducted
bioavailability and safety studies. The Company expects to initiate
multiple-dose Phase III studies in 1999.
OxycoDex'TM'
Oxycodone is an opiate derivative that, forms the basis for a group of
products that are used for the treatment of moderate to moderately severe pain.
Current oxycodone products include Oxycontin'r', Percocet'r' and Tylox'r'.
OxycoDex'TM' is a combination of oxycodone and dextromethorphan. The
Company plans to initiate Phase II clinical trials of OxycoDex'TM' in 1999.
NON-OPIOID ANALGESIC/NMDA-RECEPTOR ANTAGONIST PRODUCTS
Treatment for Neuropathic Pain
Independent studies suggest that both NMDA-receptor antagonists and certain
anticonvulsants may be useful in the treatment of neuropathic pain, persistent
pain resulting from certain abnormalities of the nervous system.
The Company has initiated a Phase II clinical study to evaluate the effect
of a combination of an NMDA-receptor antagonist and an existing anticonvulsant
in patients with chronic neurophathic pain following spinal cord injury.
Treatments for Mild Pain
In June 1996, the Company entered into a license agreement (the 'McNeil
License Agreement') with McNeil Consumer Products Company, an affiliate of
Johnson & Johnson, pursuant to which the Company granted McNeil the exclusive
rights to develop certain acetaminophen/NMDA antagonist combination products and
certain NSAID/NMDA-receptor antagonist combination products (ibuprofen and
certain other NSAIDs approved for OTC use) for the treatment of pain. Under the
terms of the McNeil License Agreement, McNeil is required to perform certain
clinical development activities to retain the license and to make payments to
Algos based on the achievement of certain milestones. An
acetaminophen/NMDA-receptor antagonist combination product and an
NSAID/NMDA-receptor antagonist combination product are currently under
development by McNeil. McNeil may terminate the license at its option upon 60
days notice.
ANESTHETIC/NMDA-RECEPTOR ANTAGONIST PRODUCTS
LidoDex NS'TM'
A project has been initiated with Interneuron Pharmaceuticals, Inc. to
develop LidoDex NS'TM', a combination of lidocaine and an NMDA-receptor
antagonist for the treatment of migraine headaches. This agreement has three
stages: (i) initial development which encompasses Investigational New Drug
Application (IND) preparation, a Phase I safety study and a Phase II efficacy
study; (ii) Phase III clinicals; and (iii) marketing activities. Initial
development will be largely funded by Interneuron, while costs of Phase III
clinicals will be shared equally between Algos and Interneuron. An article in
the Journal of the American Medical Association concluded that intranasal
lidocaine provided rapid headache relief in more than half of the patients in
the cited study, but relapse was common. The Company is investigating whether
LidoDex NS'TM' may have a prolonged effect.
Interneuron performed preclinical toxicological studies in support of an
Investigational New Drug Application (IND) which the Company expects to file
subject to successful completion of additional preclinical studies.
4
Injectable Anesthetic
The Company, in collaboration with Brigham and Women's Hospital, Harvard
Medical School, conducted research into the potentiation of local injectable
anesthetics by NMDA-receptor antagonists. Pre-clinical studies indicated that
the NMDA-receptor antagonist dextromethorphan may increase the depth and
duration of anesthesia of lidocaine. With the current emphasis on preemptive
analgesia, same day surgery and shorter hospital stays, the Company believes
that a longer duration anesthetic may provide greater patient comfort when
post-surgical pain is most severe and could reduce the need for administering
certain analgesics for post-operative pain.
ADDICTION TREATMENT DRUGS
Opiate Addiction Treatment
NIDA estimates that there are two million opiate addicts in the United
States. The Company is developing NMDA-receptor antagonist-based products as
opiate addiction treatment drugs. Pre-clinical studies have indicated that the
use of NMDA-receptor antagonists may provide more effective control of opiate
cravings and dependence.
In 1997, the Company entered into a Cooperative Research and Development
Agreement with the NIDA, NIH to evaluate the Company's technology for the
treatment of heroin addiction. Under the terms of the agreement, NIDA will fund
up to five clinical studies to assess a product's ability to reduce addict
relapse following detoxification on methadone, the current maintenance therapy
for heroin addiction. The studies, the first of which was completed in 1998,
will measure safety, withdrawal intensity, cross-tolerance and relapse.
Nicotine Addiction
Laboratory research and preclinical studies suggest that NMDA-receptor
antagonists may be useful in the treatment of addiction to other substances. The
Company has initiated a Phase II clinical study to evaluate the effect of an
NMDA-receptor antagonist on nicotine addiction.
OTHER PRODUCTS
Urge Urinary Incontinence
An estimated five million people in the U.S. suffer from urge urinary
incontinence. Existing urge urinary incontinence drugs generally have unpleasant
side effects and low levels of efficacy. Company-sponsored pre-clinical studies
have indicated that NMDA-receptor antagonists may block the bladder micturition
reflex. A Phase II clinical trial at the Stanford University School of Medicine
evaluating an NMDA-receptor antagonist in urge incontinent patients has been
completed and additional studies may be initiated, subject to the availability
of Algos' clinical development resources.
New Product Development, Generally
The Company is considering a number of other possible products. The
Company's drug development program is based upon a continuous review of clinical
results, newly published scientific papers, the possibility of joint development
or research arrangements with research institutions or commercial organizations,
the availability of resources, including acceptable third party clinical
facilities and available funds. Accordingly, the Company's development program
is subject to revision and change at any time without notice. The preceding
discussion with respect to the Company's plans is a description of the Company's
present intentions as of the date of this report, and the Company does not
expect to update this schedule prior to its next annual report, although it may
choose to do so. Its product development schedule and plans for drug development
constitute forward-looking statements and are subject to the numerous
contingencies and risks set forth under 'Risk Factors.'
5
SCIENTIFIC OVERVIEW
Opioids activate mu receptors triggering an intracellular defense mechanism
from N-methyl-D-aspartate (NMDA) receptors in the brain and spinal cord.
Sensitized NMDA receptors overactivate protein kinase C (PKC) which desensitizes
the mu receptors resulting in reduced analgesia. The introduction of
dextromethorphan, a noncompetitive NMDA-receptor antagonist, inhibits the
activation of PKC. Combining an opioid analgesic with dextromethorphan in an
optimal ratio prevents the desensitization of the mu receptor, thereby
increasing the analgesic effect.
CORPORATE AND GOVERNMENT COLLABORATIONS
In June 1996, the Company entered into a license agreement (the McNeil
License Agreement) with McNeil Consumer Products Company, an affiliate of
Johnson & Johnson, pursuant to which the Company granted McNeil the exclusive
rights to develop certain acetaminophen/NMDA-receptor antagonist combination
products and certain NSAID/NMDA-receptor antagonist combination products
(ibuprofen and certain other NSAIDs approved for OTC use) for the treatment of
pain. The McNeil License Agreement resulted in an initial payment of $2.0
million by McNeil to the Company in 1996, a milestone payment of $1.0 million in
1997 based upon the entry into a large-scale clinical trial of a licensed
product containing acetaminophen, and provides for additional payments of up to
$7.0 million by McNeil upon the achievement of certain milestones, generally
relating to product development and patent issuances. In addition, the Company
will be entitled to receive royalty payments from McNeil based upon net product
sales subject to minimum royalties commencing a certain time after execution of
the agreement, provided that certain conditions have been met, even if McNeil
has not commenced marketing of an acetaminophen product or an NSAID product.
McNeil will bear substantially all costs of developing products it selects. The
McNeil License Agreement extends until the later of the expiration of the
Company's patent rights or ten years, provided that the McNeil License Agreement
is terminable: (i) by either party in the event of a material breach by the
other party upon 90 days notice or upon certain events of bankruptcy; (ii) by
McNeil, at any time upon 60 days notice; and (iii) by the Company under certain
circumstances. Under certain circumstances, the McNeil License Agreement could
terminate with respect to either acetaminophen or NSAID products without
terminating with respect to the other category. In the event of a termination by
McNeil, McNeil must pay all royalty payments and milestone payments due through
the date of termination and the technology licensed by McNeil reverts to the
Company. In such event, the Company retains the rights to the results of two
clinical studies funded by the Company, and McNeil retains the rights to the
results of the clinical studies funded by McNeil during the term of the McNeil
License Agreement. See 'Business -- Patents, Trade Secrets and
Licenses -- Licenses.'
In 1996, the Company entered into a development and marketing collaboration
and license agreement with Interneuron Pharmaceuticals, Inc. (Interneuron) for
the development and commercialization of a product to treat acute migraine
headache. The agreement grants to Interneuron rights, co-exclusive with Algos,
to use Algos patents and know-how to manufacture and market the product. In the
initial stage of development, Algos will supply formulation development in
support of the IND and Interneuron will perform toxicology, Phase I safety and
Phase I/II safety and efficacy studies. Thereafter, the companies will generally
share equally the remaining development costs, including clinical trials,
regulatory activities, and manufacturing scale-up, and similarly share in
marketing and profits of the resulting product, if any. After the initial stage
of development, the agreement may be terminated by either Company with the
terminating party retaining an interest in a resulting product, either in the
form of a royalty on sales or the repayment of certain of its development costs.
In 1997, the Company entered into a Cooperative Research and Development
Agreement with NIDA, NIH, to conduct joint research on a methadone/NMDA-receptor
antagonist combination drug as a potential treatment for opiate addiction. Under
the agreement, NIDA and the Company will jointly develop research protocols for
up to five clinical studies designed primarily to test dextromethorphan for
safety, tolerability and efficacy when co-administered with methadone. NIDA will
conduct the clinical studies and provide certain statistical and analytic
services. Algos will provide NIDA with drug supplies and scientific and
administrative support. The agreement provides for joint ownership of inventions
made jointly by NIDA and the Company and provides the Company with an option to
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license any patent rights developed by NIDA. The agreement may be terminated by
either party at any time upon 30 days notice.
ACADEMIC AND RESEARCH COLLABORATIONS
THE MEDICAL COLLEGE OF VIRGINIA
In 1994, the Company entered into a collaborative research agreement with
The Medical College of Virginia with the option for subsequent annual renewals.
Under the terms of this agreement, The Medical College of Virginia provides
pre-clinical research exclusively to the Company in the field of: (i) prevention
of tolerance to and dependence on opiates, opiate derivatives and opioids; (ii)
treatment of chronic pain; and (iii) treatment of neuropathic pain.
BETH ISRAEL HEALTH CARE SYSTEM
In 1997, the Company entered into a research agreement with Beth Israel
Health Care System. Under the terms of the agreement, the Company will provide a
total of $500,000 over a five-year period to fund certain costs of clinical
trials in pain medicine and palliative care. The Company may contract with Beth
Israel Health Care System for the conduct of trials under the direction of Dr.
Russell Portenoy which would be separately funded. Beth Israel has agreed to
give priority to the scheduling of clinical studies requested by Algos. The
Company can terminate the agreement at any time upon providing continued funding
for a period of six months.
TECHNICAL DEVELOPMENT AND PRODUCTION
The Company generally seeks to contract third parties for formulation
development, manufacture of clinical trial materials and scale-up work. The
Company generally selects third party contractors that it believes have the
capability to commercially manufacture the products. The key advantage to this
approach is that the third party contractor which performed the developmental
work will have the equipment, operational parameters and validated testing
procedures already in place for the commercial manufacture of the Company's
products. The Algos management team is experienced in selecting and managing
activities at third party contract companies. By selecting qualified third party
contractors or by choosing development partners that provide full-scale contract
manufacturing services, the Company believes it will be able to shorten
development and production scale-up time.
MARKETING
Algos plans to market its products either directly or through co-promotion
or licensing agreements with pharmaceutical companies. The Company's marketing
strategy is to develop a direct sales force in the U.S. in market segments with
relatively concentrated distribution channels to target key prescribing
physicians, pain management centers, hospitals, hospices, health maintenance
organizations and pharmaceutical buying groups. Algos does not expect to
establish a direct sales capability until such time as one or more of its
products in development approaches marketing approval from the FDA. Although
Algos believes that it will be able to recruit an effective marketing and sales
force at that time, no assurance can be given that it will be able to do so. In
market segments that require large or specialized sales capabilities, such as
OTC analgesic products and certain foreign countries, the Company will seek
strategic alliances with leading pharmaceutical companies such as under the
McNeil License Agreement. Implementation of this strategy will depend on the
market potential of the Company's products, its financial resources and timely
regulatory approvals. No assurance can be given that any of the Company's
products will gain significant market acceptance.
COMPETITION
The Company's products under development are expected to address several
different markets. The Company's proposed products will be competing with
currently existing or future products of other companies. Competition among
these products will be based on, among other things, product efficacy, safety,
reliability, availability, price and patent position. Many of the Company's
existing or potential
7
competitors have substantially greater financial, technical and human resources
than the Company, may be better equipped to develop, manufacture and market
products and have more extensive experience in pre-clinical testing and human
clinical trials. These companies may develop and introduce products and
processes competitive to those of the Company.
The Company competes with pharmaceutical companies that develop, produce
and market products in the United States, Europe and elsewhere. In addition,
academic institutions, government agencies and other public and private
organizations conducting research may seek patent protection, discover new drugs
or establish collaborative arrangements for drug research.
The markets in which the Company's products are expected to compete have
grown rapidly in the last five years. In addition, there have been numerous
potentially competitive products introduced and development programs initiated.
As a result, competition within these markets may become more costly and
complex. The Company's opioid analgesic and anesthetic products, when developed
and marketed, will primarily compete with products currently marketed by a small
number of medium-sized pharmaceutical companies. In other analgesic segments,
such as antiarthritic and OTC analgesic products, the Company's products, when
developed and marketed, will compete with products marketed by some of the
largest pharmaceutical companies in the world. In these segments, the Company
may enter into license agreements with pharmaceutical companies having greater
resources than the Company.
PATENTS, TRADE SECRETS AND LICENSES
PATENT RIGHTS
The Company seeks to protect its proprietary position by, among other
methods, filing United States and foreign patent applications with respect to
the development of its products and their uses. The Company plans to prosecute
and defend its patent applications, issued patents and proprietary information.
The Company's ability to compete effectively will depend in part on its ability
to develop and maintain proprietary aspects of its planned products. As of March
1, 1999 the Company owns or is exclusively licensed under nine U.S. patents, two
pending U.S. patent applications for which it has received a notice of allowance
and eight other pending U.S. patent applications and several corresponding
pending foreign patent applications.
The nine issued U.S. patents are licensed from The Medical College of
Virginia. The patents, issued between 1994 and 1999, cover methods and
compositions for the Company's NMDA technology to treat pain and to inhibit
tolerance to and dependence on addictive analgesic substances.
Reflecting the Company's major research and development direction, its
patent program is primarily focused on securing intellectual property rights to
technology for the following categories of its business: (i) the use of
pharmacologically acceptable NMDA-receptor antagonists for the management of
acute, chronic, pre-operative and post-operative pain states, (ii) the use of
NMDA-receptor antagonists for the potentiation of local anesthesia and (iii) the
use of NMDA-receptor antagonists for reducing the frequency of nicotine
consumption, for treating migraine and for treating other conditions such as
urge urinary incontinence.
The Company also relies upon trade secrets, know-how, continuing innovation
and licensing opportunities to develop and maintain its competitive position. It
is the Company's current practice to require its employees, consultants, members
of its Medical and Research Advisory Board, sponsored researchers and other
advisors to execute confidentiality agreements upon the commencement of
employment or consulting relationships with the Company. These agreements
provide that all confidential information developed or made known to the
individual during the course of the individual's relationship with the Company
is to be kept confidential and not disclosed to third parties, subject to
certain exceptions. In the case of employees, the agreements provide that all
inventions conceived by the individual shall be the exclusive property of the
Company. There can be no assurance, however, that these agreements will provide
meaningful protection for the Company's trade secrets or adequate remedies in
the event of unauthorized use or disclosure of such information.
8
The Company engages in collaborations and sponsored research agreements and
enters into pre-clinical and clinical testing agreements with academic and
research institutions and U.S. government agencies, such as NIH. Consistent with
pharmaceutical industry and academic standards, and the rules and regulations
under the Federal Technology Transfer Act of 1986, these agreements may provide
that developments and results will be freely published, that information or
materials supplied by the Company will not be treated as confidential and that
the Company may be required to negotiate a license to any such developments and
results in order to commercialize products incorporating them. There can be no
assurance that the Company will be able to successfully obtain any such license
at a reasonable cost or that such developments and results will not be made
available to competitors of the Company on an exclusive or a non-exclusive
basis.
The Company's success depends in part on its ability to obtain patent
protection for its products and to preserve its trade secrets and operate
without infringing on the proprietary rights of third parties. The patent
positions of pharmaceutical firms, including the Company, are generally
uncertain and involve complex legal and factual questions. Consequently, even
though the Company is currently prosecuting its patent applications with the
U.S. Patent and Trademark Office (PTO) and certain foreign patent authorities,
the Company does not know whether any of its applications will result in the
issuance of any patents, or if any patents issue, whether they will provide
significant proprietary protection or will be circumvented or invalidated. Since
patent applications in the U.S. are maintained in secrecy until patents issue,
and since publication of discoveries in the scientific or patent literature tend
to lag behind actual discoveries by several months, the Company cannot be
certain that it was the first creator of inventions claimed by pending patent
applications or that the Company was the first to file patent applications for
such inventions. Issued patents may be later modified or revoked by the PTO in
proceedings instituted by the Company or others. In addition, no assurance can
be given that the Company's patents will afford protection against competitors
with similar compounds or technologies, that others will not obtain patents
claiming aspects similar to those covered by the Company's patents or
applications, or that the patents of others will not have an adverse effect on
the ability of the Company to do business. The Company's patents may not prevent
others from developing competitive positions using related technology. Other
entities may obtain patents which cover aspects of the Company's products or
processes which are necessary for or useful to the development, manufacture or
use of the Company's products. As a result, the Company may be required to
obtain licenses from others to develop, manufacture or market such products.
There can be no assurance that the Company will be able to obtain any such
licenses on commercially reasonable terms, if at all. No assurance can be given
that any patent issued to, or licensed by, the Company will provide protection
that has commercial significance. See 'Risk Factors -- Uncertain Ability to
Protect Proprietary Technology.'
LICENSES
The Company has licensed from The Medical College of Virginia certain
patents or pending patent applications owned by The Medical College of Virginia
in the field of pain management (in the country in which any such product or
part thereof is made, used, sold or manufactured). The Company is obligated to
pay royalties for the life of the patent equal to 4% of net sales of licensed
products. If a product is combined with a drug or other substance for which the
Company is to pay an additional royalty, the royalty rate paid to The Medical
College of Virginia is generally reduced by the amount of such additional
royalty. If the Company enters into sublicensing agreements for a covered
product, the Company will pay The Medical College of Virginia 50% of royalty
payments received from such sublicensees' net sales for each year until the
payments total $500,000 for such year, 33% until the payments total an
additional $500,000 for such year and 25% thereafter. The Company pays no
license signing fees or milestone payments. The McNeil License Agreement is a
sublicense agreement of the Company's license agreement with The Medical College
of Virginia.
GOVERNMENT REGULATION
In the U.S., pharmaceutical products intended for therapeutic or diagnostic
use in humans are subject to rigorous FDA regulation. The process of completing
clinical trials and obtaining FDA approvals for a new drug is likely to take a
number of years and require the expenditure of substantial
9
resources. There can be no assurance that any product will receive such approval
on a timely basis, if at all. See 'Risk Factors -- Government Regulation; No
Assurance of United States or Foreign Regulatory Approval.'
Applicable FDA regulations treat the Company's combination of
dextromethorphan with analgesics such as morphine, and local anesthetics such as
lidocaine as new drugs and require the filing of an NDA and approval by the FDA.
However, since the components have been separately approved by the FDA,
management believes that the risks associated with the development of these new
proprietary combinations are less than the risks inherent in new molecular drug
discovery.
The steps required before a new pharmaceutical product for use in humans
may be marketed in the U.S. include (i) pre-clinical studies, (ii) submission to
the FDA of an IND, which must become effective before human clinical trials
commence, (iii) adequate and well-controlled human clinical trials to establish
the safety and effectiveness of the product, (iv) submission of an NDA to the
FDA, and (v) FDA approval of the NDA prior to any commercial sale or shipment of
the product.
Pre-clinical studies include laboratory evaluation of product chemistry and
formulation, and animal studies to assess the potential safety and effectiveness
of the product. The results of the pre-clinical studies are submitted to the FDA
as a part of an IND and are reviewed by the FDA prior to the commencement of
human clinical trials. Unless the FDA objects to, or otherwise responds to, an
IND, the IND becomes effective 30 days following its receipt by the FDA.
Clinical trials are typically conducted in three sequential phases,
although phases may overlap. In Phase I, the investigational new drug usually is
administered to healthy human subjects and is tested for safety (adverse
effects), dosage, tolerance, absorption, metabolism, distribution, excretion and
pharmacodynamics (clinical pharmacology). Phase II involves studies in a limited
patient population to (i) determine the effectiveness of the investigational new
drug for specific indications, (ii) determine dosage tolerance and optimal
dosage and (iii) identify possible adverse effects and safety risks. When an
investigational new drug is found to be effective and to have an acceptable
safety profile in Phase II evaluation, Phase III trials are undertaken to
further evaluate clinical effectiveness and to further test for safety within an
expanded patient population at geographically dispersed clinical study sites.
For analgesic drugs, Phase II analgesic efficacy studies have historically
served as the pivotal studies for an NDA. Phase III studies for these products
normally focus greater attention on safety in larger patient populations rather
than efficacy. There can be no assurance that Phase I, Phase II or Phase III
testing will be completed successfully within any specified time period, if at
all, with respect to any of the Company's products subject to such testing.
Furthermore, the FDA may suspend clinical trials at any time there is concern
that the participants are being exposed to an unacceptable health risk.
The results of pharmaceutical development, pre-clinical studies and
clinical trials are submitted to the FDA in the form of an NDA for approval of
the marketing and commercial shipment of the product. The FDA may require
additional testing or information before approving the NDA. The FDA may deny an
NDA approval if safety, efficacy or other regulatory requirements are not
satisfied. Moreover, if regulatory approval of the product is granted, such
approval may require post-marketing testing and surveillance to monitor the
safety of the product or may entail limitations on the indicated uses for which
the product may be marketed. Finally, product approval may be withdrawn if
compliance with regulatory standards is not maintained or if problems occur
following initial marketing.
At present, pharmaceutical products generally may not be exported from the
U.S. for other than research purposes until the FDA has approved the product for
marketing in the U.S. However, a company may apply to the FDA for permission to
export finished products or partially processed products to a limited number of
countries prior to obtaining FDA approval for marketing in the U.S.
The Company is also subject to regulation under federal and state laws,
including the Occupational Safety and Health Act, the Environmental Protection
Act, the Clean Air Act, national restrictions on technology transfer, and
import, export and customs regulations. In addition, all of the Company's
products that contain narcotics are subject to Drug Enforcement Agency (DEA)
regulations relating to storage, distribution and physician prescribing
procedures. There can be no assurance that any portion of the regulatory
framework under which the Company currently operates will not change and that
such change will not have a material effect on the current and anticipated
operations of the Company.
10
Whether or not FDA approval has been obtained, approval of a pharmaceutical
product by comparable governmental regulatory authorities in foreign countries
must be obtained prior to the commencement of clinical trials and subsequent
marketing of such product in such countries. The approval procedure varies from
country to country, and the time required may be longer or shorter than that
required for FDA approval.
EMPLOYEES
At March 1, 1999, the Company had forty employees. In addition, the
Company engages consultants from time to time to perform services on a per
diem or hourly basis.
ITEM 2. PROPERTIES
The Company's executive offices are currently located at 1333 Campus
Parkway, Neptune, New Jersey 07753. The leased property consists of
approximately 21,000 square feet of office space.
ITEM 3. LEGAL PROCEEDINGS
There are no legal proceedings pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
11
PART II
ITEM 5. MARKET PRICE
As of March 1, 1999, Algos had approximately 105 shareholders of record and
the Company believes that the number of beneficial holders exceeds 2,000. Common
stock of the Company is traded on the NASDAQ Stock Market under the symbol
'ALGO.' The following table sets forth the range of the highest and lowest
reported sales prices for the Company's common stock in 1997 and 1998:
HIGH LOW
---- ---
Year Ended December 31, 1997:
First Quarter........................................................... 20 3/4 10 7/8
Second Quarter.......................................................... 19 1/4 14
Third Quarter........................................................... 31 5/8 14 3/4
Fourth Quarter.......................................................... 33 21 1/2
Year Ended December 31, 1998:
First Quarter........................................................... 34 26 1/2
Second Quarter.......................................................... 39 1/2 23 3/4
Third Quarter........................................................... 36 19 9/16
Fourth Quarter.......................................................... 29 3/4 18 1/2
The Company has never declared or paid any cash dividends on its capital
stock.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial information set forth below should be read in
conjunction with 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' and with the Company's financial statements and
related notes contained elsewhere in this report.
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Statement of Operations Data:
Revenues............................................. $ -- $ -- $ 2,000 $ 1,000 $ --
Operating expenses:
Research and development........................ 654 1,615 3,344 9,799 13,085
Selling, general and administrative............. 623 760 2,466 2,458 4,813
------- ------- ------- -------- --------
Total operating expenses................... 1,277 2,375 5,810 12,257 17,898
------- ------- ------- -------- --------
Interest income...................................... 153 253 723 2,435 2,028
Net loss............................................. $(1,124) $(2,122) $(3,087) $ (8,822) $(15,870)
------- ------- ------- -------- --------
------- ------- ------- -------- --------
Net loss per common share, basic and diluted......... $(0.35) $(0.36) $(0.56) $(0.98)
------ ------ ------ ------
------ ------ ------ ------
Weighted average common shares outstanding, basic and
diluted............................................ 6,003 8,535 15,863 16,144
------ ------ ------ ------
------ ------ ------ ------
DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- -------- --------
(IN THOUSANDS)
Balance Sheet Data:
Cash, cash equivalents, marketable securities and
interest receivable................................ $ 5,634 $ 3,707 $48,576 $ 41,658 $ 50,497
Working capital...................................... 5,503 3,419 47,932 36,368 44,216
Total assets......................................... 5,765 3,820 49,202 42,360 52,430
Deficit accumulated during the development stage..... (1,766) (3,888) (6,976) (15,798) (31,668)
Total stockholders' equity........................... 5,618 3,521 48,228 39,759 49,518
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Algos, a development stage company, is engaged primarily in the development
and commercialization of proprietary pharmaceutical products for pain
management. Since its formation in January 1992, the Company has devoted a
substantial amount of its efforts to licensing technology, recruiting key
management and staff, developing products, filing patents and other regulatory
applications and raising capital.
The Company has incurred losses since its inception and expects to incur
losses in the future. The Company's product development expenses may increase as
additional drugs are developed. In August 1998, the Company filed an NDA for
MorphiDex'TM'. Algos may incur significant costs associated with the possible
commercialization of MorphiDex'TM' prior to the first commercial sale of the
product, including the purchase of inventory, the establishment of a sales
force, preparation of promotional plans and materials, additions to and changes
in financial and operating systems and other related administrative expenses.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
Revenue:
Algos, which is in the development stage, earned no revenue in 1998. In
1997, Algos earned a $1.0 million contractual milestone payment under the McNeil
License Agreement upon McNeil's initiation of a large-scale clinical trial of a
licensed product.
Research and development:
In 1998, research and development expenses were $13.1 million, an increase
of approximately $3.3 million or 34%, from 1997. The significant increase in
1998 expenses was primarily attributable to large-scale, advanced clinical
trials for MorphiDex'TM' and the expansion of the Company's development staff.
The impact of these increases was partially offset by reduced expenses related
to bioavailability studies and the costs of manufacturing small-scale regulatory
test batches of MorphiDex'TM', which occurred in 1997.
Selling, general and administrative:
In 1998, selling, general and administrative expenses were $4.8 million, an
increase of $2.4 million or 96%, from 1997. The 1998 results include expenses
related to preparations for the possible future commercialization of
MorphiDex'TM', including the addition of sales and marketing personnel. Algos
incurred increased general and administrative costs to support its business
activities, including the addition of administrative personnel and the
relocation and expansion of the Company's headquarters facilities in April 1998.
Interest income:
Interest income decreased 17% in 1998 to $2.0 million as a result of lower
average cash and securities balances prior to the November 1998 private
placement of common stock and a warrant and lower interest rates.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Revenue:
The Company earned $1,000,000 of revenue from the McNeil License Agreement
in 1997 compared to $2,000,000 earned under the agreement in 1996. The 1997
revenue represents a contractual milestone payment due the Company upon
initiation of a large-scale clinical trial of a licensed product.
13
In 1996, the Company received $2,000,000, which was due upon execution of the
agreement. Under the terms of the agreement, the Company may receive future
payments upon the attainment of specified development milestones. However, the
agreement is cancelable by McNeil at any time upon 60 days notice.
Research and development:
In 1997, research and development expenses were $9.8 million, an increase
of $6.5 million, or 193%, from 1996. The increase was primarily attributable to
the development of MorphiDex'TM', which progressed to a more advanced stage of
clinical development, involving clinical studies of greater size and number. The
1997 results also included the costs of manufacturing small-scale test batches
of MorphiDex'TM' and the expansion of development activities for other products.
In addition, personnel costs increased as a result of additions to the Company's
development staff.
General and administrative:
In 1997, general and administrative expenses were $2.5 million, a decrease
of less than 1%, from 1996. The decrease reflects a one-time charge of $915,000
in 1996 related to the issuance of Series B Preferred Stock in connection with
an amendment to a license agreement. This decrease was mostly offset by
increases in professional fees, insurance, and other general and administrative
costs resulting from the Company's increased business activities following the
completion of its initial public offering (IPO) in October 1996.
Interest income:
In 1997, interest income increased substantially due to the investment of
the IPO proceeds over the full calendar year.
LIQUIDITY AND CAPITAL RESOURCES
In 1998, 1997, and 1996, spending for Algos' product development efforts
and related activities resulted in net cash outflows from operations of $15.3
million, $7.3 million, and $1.6 million, respectively. Accumulated cash balances
at December 31, 1995, which resulted from the Company's 1994 private placement
of Series A Preferred Stock were sufficient to fund the Company's operations
into 1996. In 1996, in order to expand its development programs, the Company
completed its initial public offering of 3,625,000 shares of Common Stock, which
provided net proceeds to the Company of $46.4 million. A portion of these funds
and $3.0 million received to date from the McNeil License Agreement were used to
fund the Company's operations in 1997 and 1998. In November 1998, to provide
greater financial flexibility, Algos raised $25 million in a private sale of
common stock and a warrant.
The Company intends to continue certain ongoing large-scale clinical trials
for MorphiDex'TM' in 1999 and has entered into several research and development
commitments for HydrocoDex'TM'. The Company expects to incur continued product
development expenses as clinical trials of MorphiDex'TM' continue and other
drugs that the Company currently has under development, including
HydrocoDex'TM', move into advanced clinical trials and as additional drugs are
developed and its research and development staff increases. In August 1998, the
Company filed an NDA for MorphiDex'TM'. Algos may incur significant costs
associated with the possible commercialization of MorphiDex'TM' prior to the
first commercial sale of the product, including the purchase of inventory, the
establishment of a sales force, preparation of promotional plans and materials,
additions to and changes in financial and operating systems and other related
administrative expenses. The Company currently expects that its cash and
marketable securities at December 31, 1998 will be sufficient to fund its
development activities for approximately two years and provide for certain
pre-launch activities based upon the Company's current schedule of clinical
trials and level of business activities. However, if a significant portion of
existing funds is required in the preparation for the possible commercialization
of MorphiDex'TM', or if additional trials are necessary or advisable, or if
additional products are developed, the Company may require additional funds. In
the event that revenue and income from successful product introductions or
14
other internally generated funds are insufficient for such efforts, the Company
will need to raise additional funds either by incurring debt, issuing additional
equity or through collaborative or license arrangements to continue its
development programs and commercialize its potential products. There is no
assurance that the Company would be able to obtain such additional financing on
terms acceptable to the Company.
The Company's future funding requirements will depend on a number of
factors, including: the amount of resources required for the establishment of
sales and distribution capabilities; preparation of promotional plans and
materials and other activities in preparation for the possible commercialization
of MorphiDex'TM'; the results of its development efforts; the timing and costs
of obtaining required regulatory approvals; the commercialization of competing
products; the execution of licensing or other collaborative research agreements
on terms acceptable to the Company; and the cost of prosecuting and defending
patents.
Net Operating Loss Carryforwards
At December 31, 1998, the Company had accumulated net operating loss
carryforwards of approximately $28 million for federal and state tax purposes.
Federal carryforwards expire in 2009 through 2018 and are available to reduce
future taxable income recognized in the carryforward period, if any. Due to the
uncertainty of future taxable income, the Company has established a valuation
allowance for these carryforwards and has not recognized their potential benefit
on a current basis. The future utilization of these carryforwards may be limited
by Section 382 of the Internal Revenue Code related to changes in Company
ownership.
Other
Generally, the Company's results of operations are not significantly
affected by seasonal factors and the Company does not believe that inflation has
had a significant impact on its business.
The following statements issued by the Financial Accounting Standards Board
became effective in 1998: Statement of Financial Accounting Standards (SFAS)
No. 130 'Reporting Comprehensive Income,' SFAS No. 131, 'Disclosure About
Segments of an Enterprise and Related Information,' and SFAS No. 132,
'Employers' Disclosures About Pensions and Other Postretirement Benefits.' The
adoption of these standards did not have an impact on Algos' financial
statements. SFAS No. 133, 'Accounting for Derivative Instruments and Hedging
Activities' is effective in the year 2000. Based on Algos' current business
activities, the statement is not expected to have a material impact on Algos'
financial statements.
YEAR 2000
A potential problem exists for all companies that rely on computers as the
year 2000 approaches. Any of Algos' computer software applications and systems
that use only the last two digits of a year to refer to a year may not properly
recognize the year 2000. This phenomenon (the Year 2000 Issue) could cause a
disruption of operations, including, among other things, a temporary inability
to engage in normal business activities.
Algos is in the process of evaluating the impact of the Year 2000 Issue and
currently believes that the financial and operational systems of Algos, as
currently used, will function adequately with respect to the Year 2000 Issue
given that Algos is not significantly reliant on its computer software
applications and systems during its developmental stage. In addition, Algos has
very limited information concerning the compliance status of its third party
contractors. Algos' current third party contractors generally test Algos
products and provide Algos with the results of those tests. Algos believes that
any Year 2000 Issue for such third-party contractors would not be material,
since many activities could be performed without the aid of a computer. As part
of the commercialization of MorphiDex'TM', Algos intends to have third parties
manufacture and distribute its products. Algos will evaluate each potential
third party manufacturer's and distributor's readiness for the Year 2000 Issue
and will reevaluate the Year 2000 Issue as it relates to Algos as part of its
preparation for the commercialization of MorphiDex'TM'. Algos has filed an NDA
for MorphiDex'TM' and may make significant additions to and changes in its
existing
15
computer software applications and systems and/or the use of such systems in
anticipation of the possible commercialization of MorphiDex'TM'. If Algos makes
any such additions or changes, it would affect Algos' exposure to the Year 2000
Issue since Algos would become more reliant on its computer software
applications and systems. Therefore, Algos' assessment of its Year 2000 Issue is
not complete and Algos cannot complete its assessment or develop any contingency
plans until mid-1999.
At this time, Algos does not expect that the cost of its Year 2000 Issue
compliance program will be material to its business, financial condition or
results of operations and does not currently anticipate any material disruption
in its operations. Algos has not incurred more than $5,000 of costs to date
related to the Year 2000 Issue.
ITEM 8. FINANCIAL STATEMENTS
16
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of
ALGOS PHARMACEUTICAL CORPORATION:
In our opinion, the accompanying balance sheets and the related statements
of operations and of cash flows present fairly, in all material respects, the
financial position of Algos Pharmaceutical Corporation (a development stage
enterprise) (the Company) 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 and for the period January 1, 1992 (date of inception) to
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 these 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
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,
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
Florham Park, New Jersey
March 4, 1999
17
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
DECEMBER 31,
--------------------------
1997 1998
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents..................................................... $20,246,152 $37,025,445
Marketable securities, current................................................ 17,922,359 9,001,528
Interest receivable........................................................... 484,789 417,042
Prepaid expenses and other current assets..................................... 315,679 683,866
----------- -----------
Total current assets..................................................... 38,968,979 47,127,881
Marketable securities, noncurrent.................................................. 3,004,580 4,052,824
Restricted cash.................................................................... 150,000 150,000
Property and equipment, net........................................................ 146,328 1,098,819
Other assets....................................................................... 90,591 --
----------- -----------
Total assets............................................................. $42,360,478 $52,429,524
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................................. $ 1,861,976 $ 2,117,795
Other current liabilities..................................................... 739,415 794,044
----------- -----------
Total current liabilities................................................ 2,601,391 2,911,839
----------- -----------
Commitments
Stockholders' equity:
Common stock, $.01 par value, 50,000,000 shares authorized, 15,951,701 and
17,028,649 shares outstanding as of December 31, 1997 and 1998,
respectively................................................................. 159,517 170,287
Additional paid-in-capital.................................................... 56,151,504 81,626,800
Unearned compensation expense................................................. (753,707) (611,108)
Deficit accumulated during the development stage.............................. (15,798,227) (31,668,294)
----------- -----------
Total stockholders' equity............................................... 39,759,087 49,517,685
----------- -----------
Total liabilities and stockholders' equity............................... $42,360,478 $52,429,524
----------- -----------
----------- -----------
The accompanying notes are an integral part of these financial statements.
18
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTEPRISE)
STATEMENT OF OPERATIONS
CUMULATIVE FROM
FOR THE YEAR ENDED DECEMBER 31, INCEPTION TO
------------------------------------------- DECEMBER 31,
1996 1997 1998 1998
----------- ------------ ------------ ---------------
Revenues........................................ $ 2,000,000 $ 1,000,000 $ -- $ 3,311,000
----------- ------------ ------------ ---------------
Operating expenses:
Research and development................... 3,343,616 9,799,358 13,085,499 28,662,130
Selling, general and administrative........ 2,466,577 2,458,411 4,813,277 11,926,527
----------- ------------ ------------ ---------------
Total operating expenses.............. 5,810,193 12,257,769 17,898,776 40,588,657
----------- ------------ ------------ ---------------
Loss from operations............................ (3,810,193) (11,257,769) (17,898,776) (37,277,657)
Interest income................................. 722,715 2,435,215 2,028,709 5,609,363
----------- ------------ ------------ ---------------
Net loss........................................ $(3,087,478) $ (8,822,554) $(15,870,067) $ (31,668,294)
----------- ------------ ------------ ---------------
----------- ------------ ------------ ---------------
Net loss per common share, basic and diluted.... $(0.36) $(0.56) $(0.98)
------ ------ ------
------ ------ ------
Weighted average common shares outstanding,
basic and diluted............................. 8,535,080 15,862,562 16,144,484
--------- ---------- ----------
--------- ---------- ----------
The accompanying notes are an integral part of these financial statements.
19
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
CUMULATIVE FROM
FOR THE YEAR ENDED DECEMBER 31, INCEPTION TO
------------------------------------------- DECEMBER 31,
1996 1997 1998 1998
----------- ------------ ------------ ---------------
Cash flows from operating activities:
Net loss................................... $(3,087,478) $ (8,822,554) $(15,870,067) $ (31,668,294)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization......... 44,038 51,386 142,093 304,776
Amortization of unearned
compensation........................ 424,690 278,269 369,917 1,072,876
Amortization of discount on marketable
securities.......................... (79,564) (67,203) (146,767)
Common stock issued for technology.... 125,000
Preferred stock issued for services... 25,000
Preferred stock issued under license
agreement........................... 915,000 915,000
Changes in assets and liabilities:
Interest receivable.............. (484,789) 67,747 (417,042)
Prepaid expenses and other
current assets................. (319,026) 14,404 (368,187) (683,866)
Other assets..................... (207,666) 118,666 90,591 --
Accounts payable................. 298,387 1,405,292 255,819 2,117,795
Other current liabilities........ 375,451 222,629 54,629 794,044
----------- ------------ ------------ ---------------
Net cash used in operating activities...... (1,556,604) (7,296,261) (15,324,661) (27,561,478)
----------- ------------ ------------ ---------------
Cash flows from investing activities:
Investment in marketable securities........ (37,813,447) (29,097,210) (66,910,657)
Redemption of marketable securities........ 16,816,072 37,037,000 53,853,072
Purchases of property and equipment........ (30,016) (111,032) (1,094,584) (1,403,595)
----------- ------------ ------------ ---------------
Net cash used in investing activities...... (30,016) (21,108,407) 6,845,206 (14,461,180)
----------- ------------ ------------ ---------------
Cash flows from financing activities:
Proceeds from issuance of preferred stock,
net...................................... 50,000 6,659,015
Proceeds from issuance of common stock,
net...................................... 46,405,239 75,101 25,258,748 72,389,088
----------- ------------ ------------ ---------------
Net cash provided by financing
activities............................... 46,455,239 75,101 25,258,748 79,048,103
----------- ------------ ------------ ---------------
Net increase (decrease) in cash and cash
equivalents................................... 44,868,619 (28,329,567) 16,779,293 37,025,445
Cash and cash equivalents, beginning of
period........................................ 3,707,100 48,575,719 20,246,152
----------- ------------ ------------ ---------------
Cash and cash equivalents, end of period........ $48,575,719 $ 20,246,152 $ 37,025,445 $ 37,025,445
----------- ------------ ------------ ---------------
----------- ------------ ------------ ---------------
The accompanying notes are an integral part of these financial statements.
20
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FROM INCEPTION TO DECEMBER 31, 1998
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL UNEARNED DURING THE
------------------ ---------------------- PAID IN COMPENSATION DEVELOPMENT
SHARES AMOUNT SHARES AMOUNT CAPITAL EXPENSE STAGE
-------- ------ ---------- -------- ----------- ------------ ------------
Issuance of Common Stock, January
1992, $.10 per share.............. 4,841,664 $ 48,417 $ 451,583
Issuance of Common Stock for
technology, January 1992, $.10 per
share............................. 968,336 9,683 90,317
Net loss............................ $ (385,434)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1992.......... 5,810,000 58,100 541,900 (385,434)
Capital contributions, including
$25,000 of technology............. 150,000
Net loss............................ (256,640)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1993.......... 5,810,000 58,100 691,900 (642,074)
Issuance of Series A Preferred
Stock, May through August 1994,
$10.00 per share, net of offering
costs............................. 700,000 $7,000 6,602,015
Issuance of Series A Preferred Stock
for services, May 1994, $10.00 per
share............................. 2,500 25 24,975
Exercise of stock options........... 415 4 46
Net loss............................ (1,123.686)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1994.......... 702,500 7,025 5,810,415 58,104 7,318,936 (1,765,760)
Exercise of stock options........... 199,615 1,996 22,954
Net loss............................ (2,122,435)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1995.......... 702,500 7,025 6,010,030 60,100 7,341,890 (3,888,195)
Exercise of warrants................ 5000 50 49,950
Issuance of Series B Preferred Stock
under license agreement, June
1996, $9.15 per share............. 100,000 1,000 914,000
Exercise of stock options........... 161,821 1,618 17,851
Issuance of Common Stock, October
1996, $14.00 per share, net of
offering costs.................... 3,625,000 36,250 46,349,520
Conversion of Series A Preferred
Stock............................. (707,500) (7,075) 5,872,250 58,723 (51,648)
Unearned compensation expense....... 1,280,840 $(1,280,840)
Amortization of unearned
compensation expense.............. 424,690
Net loss............................ (3,087,478)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1996.......... 100,000 1,000 15,669,101 156,691 55,902,403 (856,150) (6,975,673)
Exercise of stock options........... 133,630 1,336 14,764
Exercise of warrants................ 48,970 490 58,511
Conversion of Series B Preferred
Stock............................. (100,000) (1,000) 100,000 1,000
Unearned compensation expense....... 175,826 (175,826)
Amortization of unearned
compensation expense.............. 278,269
Net loss............................ (8,822,554)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31,1997........... 15,951,701 159,517 56,151,504 (753,707) (15,798,227)
Exercise of stock options........... 59,850 599 290,526
Exercise of warrants................ 17,098 171 20,429
Issuance of Common Stock and
warrants, November 1998, net of
offering costs.................... 1,000,000 10,000 24,937,023
Unearned compensation expense....... 227,318 (227,318)
Amortization of unearned
compensation expense.............. 369,917
Net loss............................ (15,870,067)
-------- ------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1998.......... -- $-- 17,028,649 $170,287 $81,626,800 $ (611,108) $(31,668,294)
-------- ------ ---------- -------- ----------- ------------ ------------
-------- ------ ---------- -------- ----------- ------------ ------------
TOTAL
STOCKHOLDERS'
EQUITY
------------
Issuance of Common Stock, January
1992, $.10 per share.............. $ 500,000
Issuance of Common Stock for
technology, January 1992, $.10 per
share............................. 100,000
Net loss............................ (385,434)
------------
Balance, December 31, 1992.......... 214,566
Capital contributions, including
$25,000 of technology............. 150,000
Net loss............................ (256,640)
------------
Balance, December 31, 1993.......... 107,926
Issuance of Series A Preferred
Stock, May through August 1994,
$10.00 per share, net of offering
costs............................. 6,609,015
Issuance of Series A Preferred Stock
for services, May 1994, $10.00 per
share............................. 25,000
Exercise of stock options........... 50
Net loss............................ (1,123.686)
------------
Balance, December 31, 1994.......... 5,618,305
Exercise of stock options........... 24,950
Net loss............................ (2,122,435)
------------
Balance, December 31, 1995.......... 3,520,820
Exercise of warrants................ 50,000
Issuance of Series B Preferred Stock
under license agreement, June
1996, $9.15 per share............. 915,000
Exercise of stock options........... 19,469
Issuance of Common Stock, October
1996, $14.00 per share, net of
offering costs.................... 46,385,770
Conversion of Series A Preferred
Stock.............................
Unearned compensation expense.......
Amortization of unearned
compensation expense.............. 424,690
Net loss............................ (3,087,478)
------------
Balance, December 31, 1996.......... 48,228,271
Exercise of stock options........... 16,100
Exercise of warrants................ 59,001
Conversion of Series B Preferred
Stock.............................
Unearned compensation expense.......
Amortization of unearned
compensation expense.............. 278,269
Net loss............................ (8,822,554)
------------
Balance, December 31,1997........... 39,759,087
Exercise of stock options........... 291,125
Exercise of warrants................ 20,600
Issuance of Common Stock and
warrants, November 1998, net of
offering costs.................... 24,947,023
Unearned compensation expense....... --
Amortization of unearned
compensation expense.............. 369,917
Net loss............................ (15,870,067)
------------
Balance, December 31, 1998.......... $ 49,517,685
------------
------------
The accompanying notes are an integral part of these financial statements.
21
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Algos Pharmaceutical Corporation (the Company), is engaged primarily in the
development of proprietary analgesic and anesthetic products. Since its
formation in January 1992, the Company has devoted a substantial portion of its
efforts to developing products, licensing technology, filing regulatory
applications and raising capital. The Company is subject to a number of risks
common to companies in similar stages of development including, but not limited
to, the lack of assurance of successful product development and regulatory
approval, the absence of manufacturing, marketing and distribution capabilities,
the risk of technological obsolescence, changes in pricing and customer demand
and the ability to obtain future financing.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
DEVELOPMENT STAGE ENTERPRISE
The accompanying statements have been prepared in accordance with the
provisions of Statement of Financial Accounting Standard (SFAS) No. 7,
'Accounting and Reporting by Developing Stage Enterprises.'
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
The Company considers money market securities that mature within three
months of purchase to be cash equivalents. A bank certificate of deposit that
serves as collateral for an irrevocable letter of credit required by the terms
of the Company's lease agreement is included in restricted cash.
PROPERTY AND EQUIPMENT, NET
Property and equipment are recorded at cost less accumulated depreciation.
Depreciation is provided on the straight-line method over the estimated useful
lives of the assets which range from three to ten years. Leasehold improvements
are depreciated over the term of the lease. Gains and losses on depreciable
assets retired or sold are recognized in the statement of operations in the year
of disposal. Repairs and maintenance expenditures are expensed as incurred.
REVENUE
License fees are recognized as revenue when contract milestones are
attained or when otherwise earned in accordance with the terms of the underlying
agreements.
INCOME TAXES
The Company accounts for income taxes under the provisions of SFAS No. 109,
'Accounting for Income Taxes.' SFAS No. 109 requires recognition of deferred tax
assets and liabilities for the expected future tax consequences of temporary
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the years in which the
differences are expected to reverse.
22
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
LOSS PER SHARE
Basic per share amounts are calculated by dividing the net loss applicable
to common stock by the weighted average number of common shares outstanding
during the period. Diluted per share amounts are calculated by dividing the net
loss applicable to common stock by the sum of the weighted average number of
common shares outstanding and dilutive common share equivalents. Since the
Company incurred losses in all periods presented, options and warrants to
purchase 1,049,165, 1,028,405 and 1,563,537 shares of common stock that were
outstanding at December 31, 1996, 1997, and 1998, and 100,000 shares of
Convertible Series B Preferred Stock that were outstanding at December 31, 1996
were not included in diluted per share calculations, as their effect would be
antidilutive.
RECENTLY ISSUED ACCOUNTING STANDARDS
The following statements issued by the Financial Accounting Standards Board
became effective in 1998: Statement of Financial Accounting Standards (SFAS)
No. 130 'Reporting Comprehensive Income,' SFAS No. 131, 'Disclosure About
Segments of an Enterprise and Related Information,' and SFAS No. 132,
'Employers' Disclosure About Pensions and Other Postretirement Benefits.' The
adoption of these standards did not have an impact on the Company's financial
statements. SFAS No. 133, 'Accounting for Derivative Instruments and Hedging
Activities' is effective in the year 2000. Based on the Company's current
business activities, the statement is not expected to have a material impact
on the Company's financial statements.
3. MARKETABLE SECURITIES
Marketable securities at December 31, 1997 and 1998 include the following
debt securities:
ESTIMATED
AMORTIZED FAIR UNREALIZED
COST MARKET VALUE GAINS (LOSSES)
----------- ------------ --------------
U.S. Treasury and federal agency debt securities at December 31,
1997............................................................. $20,926,939 $ 20,958,130 $ 31,191
U.S. Treasury and federal agency debt securities at December 31,
1998............................................................. $13,054,352 $ 13,034,030 $(20,322)
The securities are classified as held-to-maturity securities and are stated
at their amortized cost. Noncurrent marketable securities have maturities in
excess of one year and less than two years.
4. PROPERTY AND EQUIPMENT NET
Property and equipment consist of the following:
DECEMBER 31,
----------------------
1997 1998
-------- ----------
Leasehold improvements.............................................. $ 515,491
Office furniture and equipment...................................... $152,727 631,140
Computer equipment.................................................. 156,284 256,964
-------- ----------
309,011 1,403,595
Less accumulated depreciation....................................... 162,683 304,776
-------- ----------
$146,328 $1,098,819
-------- ----------
-------- ----------
23
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
DECEMBER 31,
--------------------
1997 1998
-------- --------
Accrued compensation.................................................. $346,797 $318,800
Accrued research expenses............................................. 392,618 475,244
-------- --------
$739,415 $794,044
-------- --------
-------- --------
6. INCOME TAXES
At December 31, 1998, the Company had available net operating loss
carryforwards and research and development credits for federal income tax
purposes of approximately $28,400,000 and $1,100,000, respectively, which expire
in the years 2009 through 2018. At December 31, 1998, the Company had available
net operating loss carryforwards and research and development credits for state
income tax purposes of approximately $29,000,000 and $800,000 respectively,
which expire in the years 1999 through 2005. The use of federal net operating
loss and credit carryforwards may be subject to limitations under section 382 of
the Internal Revenue Code pertaining to changes in stock ownership. Due to the
uncertainty of their realization, a full valuation allowance has been
established for the potential income tax benefit of net operating loss and
credit carryforwards and temporary differences. The increase in the valuation
allowance amounted to $1,122,200, $4,745,000 and $7,563,500 in 1996, 1997, and
1998, respectively. Deferred tax assets (liabilities) for federal and state
income taxes consist of the following:
DECEMBER 31,
---------------------------
1997 1998
----------- ------------
Net operating loss carryforwards............................... $ 5,612,200 $ 12,283,200
Research and development tax credits........................... 987,600 1,900,000
License costs.................................................. 360,700 338,800
Accrued liabilities and other.................................. 211,700 225,200
Depreciation and amortization.................................. 7,400 (4,100)
----------- ------------
Total deferred tax assets...................................... 7,179,600 14,743,100
Valuation allowance............................................ (7,179,600) (14,743,100)
----------- ------------
Net deferred tax assets........................................ $ 0 $ 0
----------- ------------
----------- ------------
7. COMMITMENTS
LICENSE AGREEMENTS
The Company has licensed from a university certain patents and pending
patent applications in the field of pain management. The Company is required to
pay royalties equal to 4% of sales of licensed products. If the Company enters
into sublicensing agreements for a covered product, the Company will pay the
university 50% of royalty payments received from such sublicensees' net sales
for each year until the payments total $500,000 for such year, 33% until the
payments total an additional $500,000 for such year and 25% thereafter.
24
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
LEASES
Minimum payments under the Company's ten-year operating lease for its
administrative offices are as follows:
1999.................................................................. $ 268,620
2000.................................................................. 268,620
2001.................................................................. 268,620
2002.................................................................. 268,620
2003.................................................................. 296,708
Balance of term....................................................... 1,346,592
The agreement provides the Company with an option to extend the lease term
for an additional five-year period and an option to purchase the building during
the fourth or fifth year of the initial lease term.
Rent expense amounted to $22,475, $58,275 and $239,053 for the years ended
December 31, 1996, 1997, and 1998 respectively and $365,252 cumulatively from
the date of inception.
RESEARCH CONTRACTS
The Company routinely contracts with universities, medical centers,
contract research organizations and other institutions for the conduct of
research and clinical studies on the Company's behalf. These agreements are
generally for the duration of the contracted study and contain provisions that
allow the Company to terminate the study prior to its completion.
EMPLOYMENT AGREEMENTS
At December 31, 1998, the Company's minimum obligation for base salaries
under employment agreements with officers amounted to approximately $567,000.
8. SIGNIFICANT AGREEMENTS
In June 1996, the Company entered into a license agreement with McNeil
Consumer Products Company, an affiliate of Johnson & Johnson, which provides
McNeil with exclusive worldwide marketing rights to certain of the Company's
products under development. McNeil is required to pay license fees contingent on
the achievement of certain milestones, generally related to product development
and patent issuances, and royalties based on sales of licensed products, if any.
McNeil is responsible for development of the licensed products. The agreement
may be terminated by McNeil upon 60 days notice. The Company received license
payments of $2,000,000, $1,000,000, and $0 in 1996, 1997 and 1998, respectively,
under the agreement.
In December 1996, the Company entered into a development and marketing
collaboration and license agreement with Interneuron Pharmaceuticals, Inc. for
the development and commercialization of a product to treat acute migraine
headache. The agreement grants to Interneuron rights, co-exclusive with Algos,
to use Algos patents and know-how to manufacture and market the product. The
development program is currently in an initial stage in which it is expected
that Interneuron's development costs will exceed those of Algos, the agreement
provides that the companies will generally share equally the remaining
developments costs, including pre-clinical studies, clinical trials, and
regulatory activities, and similarly share in marketing and profits of the
resulting product, if any. After the initial stage of development, the agreement
may be terminated by either Company with the terminating party retaining an
interest in a resulting product, either in the form of a royalty on sales or the
repayment of certain of its development costs.
25
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In 1996, the Company contributed certain intangible assets having no book
value to a newly formed company, U.S. Dermatologics, Inc., and received
preferred stock with an aggregate stated value and liquidation preference of
$2,800,000 and all of the transferee's common stock. The common stock was
subsequently distributed to the Company's stockholders, warrant holders and
certain of its employees. The preferred stock provides for an annual cumulative
dividend of 30%, which may be paid in the form of cash or common stock, and a
share of other earnings. The preferred stock may be redeemed for the stated
value plus accrued dividends at any time at the transferee's option or at the
Company's option beginning in August 1999. The Company recorded no gain in
connection with the transaction as management believes that realization is not
assured. In 1998, the Company received $198,000 for certain consulting and
administrative services provided to U.S. Dermatologics, Inc. for a transitional
period which ended in June 1998.
9. STOCKHOLDERS' EQUITY
In May 1996, the Company effected an 8.3-for-1 stock split of its Common
Stock in the form of a stock dividend. All historical Common Stock and per share
data have been restated to reflect the stock split.
CONVERTIBLE PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of $.01 par value per
share preferred stock with rights, preferences and limitations determined by the
Board of Directors of the Company.
In 1994, the Company issued a total of 702,500 shares of convertible
Series A Preferred Stock and received net proceeds of $6,609,015 and services
valued at $25,000. In 1996, an additional 5,000 shares were issued upon
conversion of an outstanding warrant. In connection with the Company's 1996
initial public offering of Common Stock, each outstanding share of convertible
Series A Preferred Stock was converted to 8.3 shares of Common Stock.
In 1996, the Company issued 100,000 shares of convertible Series B
Preferred Stock in connection with an amendment to a license agreement with a
university and recorded an administrative expense of $915,000 for the estimated
fair value of the stock. In 1997, each share of convertible Series B Preferred
Stock was converted by the holder to one share of Common Stock.
WARRANTS
In 1994, in connection with the sale of convertible Series A Preferred
Stock, certain selling agents received warrants to purchase an aggregate of
40,750 shares of convertible Series A Preferred Stock. In connection with the
Company's 1996 initial public offering of Common Stock, outstanding warrants to
purchase an aggregate of 35,750 shares of convertible Series A Preferred Stock
were converted to warrants to purchase an aggregate of 296,725 shares of Common
Stock. The warrants entitle the holders to purchase shares of Common Stock at an
exercise price of $1.20 per share and expire in 2001. Of these warrants,
warrants to purchase 247,755 and 230,657 shares of Common Stock remain
outstanding, as of December 31, 1997 and 1998, respectively, and are
exercisable.
In 1998, the Company sold 1,000,000 shares of its Common Stock together
with a warrant to purchase 250,000 shares of common stock for an aggregate
purchase price of $25,000,000. For financial statement purposes, the Company has
assigned $2,000,000 of the aggregate purchase price to the estimated fair value
of the warrant. The warrant, which is outstanding at December 31, 1998 and
exercisable November 9, 1999, entitles the holder to purchase shares of Common
Stock at an exercise price of $25.00 per share and expires in 2003.
26
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
STOCK OPTION PLANS
The Company's 1996 Stock Option Plan permits the grant of non-qualified
stock options and incentive stock options to purchase an aggregate of 1,215,000
shares of authorized but unissued or reacquired shares of Common Stock. The
Compensation Committee of the Board of Directors has the authority to select the
persons to whom grants are to be made, to designate the number of shares of
Common Stock to be covered by such grants, to determine the exercise price of
options, to establish the vesting period of options, to establish the
contractual life of options, and to take all other actions for the
administration of the 1996 Stock Option Plan. The 1996 Stock Option Plan permits
the Compensation Committee to allow payment of the option exercise price to be
made in cash or by delivery of shares of Common Stock valued at their fair
market value on the date of exercise or delivery of other property, or by a
recourse promissory note payable to the Company, or by a combination of the
foregoing. Unless sooner terminated by the Board of Directors, the 1996 Stock
Option Plan will expire in 2006.
The Company's 1996 Non-Employee Director Stock Option Plan (the Director
Plan) covers 83,000 authorized but unissued or reacquired shares of Common Stock
and is intended to assist the Company in attracting and retaining qualified
non-employee directors. The Director Plan is administered by the Board of
Directors and provides for automatic grants of non-qualified stock options to
purchase 10,000 shares of Common Stock to each non-employee director at the time
of initial appointment or Election to the Board of Directors. The exercise price
of the options shall be the fair market value of a share of Common Stock on the
date of grant. Each option shall generally become exercisable in cumulative
annual installments of one-third on each of the first three annual meetings of
the Company's stockholders following the date of grant so long as the
non-employee director continues to serve as a director of the Company. In
addition, each non-employee director shall be granted an option to purchase
5,000 shares of Common Stock on an annual basis. Unless sooner terminated by the
Board of Directors, the Director Plan will expire in 2006. The Company's Board
of Directors has authorized, subject to shareholder approval, an increase of
200,000 in the number of shares available under the Director Plan and a change
to 10,000 in the number of shares subject to options granted each non-employee
director on an annual basis.
In 1994, 1995 and 1996, the Company also granted stock options under prior
plans.
The following table summarizes stock option activity for the years ended
December 31, 1996, 1997, and 1998:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
--------- --------
Outstanding December 31, 1995......................................... 597,600 $ 0.13
Granted............................................................... 316,690 $ 3.13
Exercised............................................................. (161,850) $ 0.12
Cancelled.............................................................
---------
Outstanding December 31, 1996......................................... 752,440 $ 1.39
Granted............................................................... 166,500 $16.62
Exercised............................................................. (133,630) $ 0.12
Cancelled............................................................. (4,660) $ 4.21
---------
Outstanding December 31, 1997......................................... 780,650 $ 4.81
Granted............................................................... 382,520 $31.34
Exercised............................................................. (59,850) $ 4.86
Cancelled............................................................. (20,440) $15.98
---------
Outstanding December 31, 1998......................................... 1,082,880 $13.97
---------
---------
27
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Options exercisable at December 31, 1996, 1997 and 1998 were 343,530,
503,216 and 656,230, respectively.
A summary of stock options outstanding as of December 31, 1998 is as
follows:
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES NUMBER LIFE PRICE
- ------------------------------------------------------------------- --------- ----------- --------
$ 0.12 - $ 0.13.................................................... 506,300 2.0 $ 0.13
$10.00 - $15.00.................................................... 118,000 6.7 $14.39
$15.01 - $20.00.................................................... 67,100 7.1 $17.12
$20.01 - $25.00.................................................... 840 7.1 $23.58
$25.01 - $30.00.................................................... 89,340 7.1 $27.67
$30.01 - $40.00.................................................... 301,300 7.1 $32.27
---------
1,082,880 4.7 $13.97
---------
---------
A summary of stock options exercisable as of December 31, 1998 is as
follows:
WEIGHTED
AVERAGE
EXERCISE
RANGE OF EXERCISE PRICES NUMBER PRICE
- ------------------------------------------------------------------------ ------- --------
$ 0.12 - $ 0.13......................................................... 452,350 $ 0.13
$10.00 - $15.00......................................................... 78,632 $14.36
$15.01 - $20.00......................................................... 33,500 $17.10
$20.01 - $25.00......................................................... 30 $24.25
$25.01 - $30.00......................................................... 22,400 $27.69
$30.01 - $40.00......................................................... 69,318 $32.45
-------
656,230 $ 7.06
-------
-------
1996 1997 1998
------ ------ ------
Weighted average fair value at grant date of options granted during the
year:
Exercise price equal to market value of stock......................... $ 4.30 $11.13 $20.53
Exercise price less than market value of stock........................ $ 4.60 $23.03
Weighted average exercise price of options granted during the year
Exercise price equal to market value of stock......................... $13.06 $16.62 $31.35
Exercise price less than market value of stock........................ $ 0.13 $31.31
The fair value of each option grant is estimated using the Black-Scholes
option pricing model for grants after the Company's October 1996 initial public
offering of Common Stock and a minimum value method for prior grants. The
following weighted-average assumptions were used for grants in 1996, 1997, and
1998 respectively: no dividend yield for all years, risk-free interest rates of
6.2%, 6.3%, and 5.4%, expected lives of 3.9, 5.0, and 5.0 and expected
volatility of 55%, 60%, and 60%.
In 1998, Algos granted certain options subject to shareholder approval of
an increase of 800,000 in the number of shares of Common Stock issuable under
the 1996 Stock Option Plan. Unearned compensation expense of $227,318 was
recorded for the increase in the market value of Common Stock between the grant
date and the June 1998 approval date which is being amortized over the four-year
vesting period of the options.
The Company records compensation expense for stock option grants in
accordance with APB No. 25, 'Accounting for Stock Issued to Employees.' Had the
Company elected to record
28
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
compensation for stock option grants in accordance with SFAS No. 123,
'Accounting for Stock-Based Compensation,' the Company's pro forma net loss and
loss per share amounts would be as follows:
1996 1997 1998
----------- ----------- ------------
Net loss........................................ $(3,118,334) $(9,480,118) $(18,217,788)
Net loss per common share, basic and diluted.... $(0.37) $(0.60) $(1.13)
Pro forma amounts reflect options granted after 1994 and are not likely to
be representative of amounts in future years, as additional options are awarded
and vested.
10. OTHER RELATED PARTY TRANSACTIONS
Certain directors and shareholders of the Company have been associated with
law firms that rendered various legal services to the Company. The Company
recorded charges of approximately $443,000, $165,000, and $47,000 in 1996, 1997,
and 1998 respectively, and $837,000 from the date of inception, for those
services, including services rendered in connection with issuances of stock. As
of December 31, 1997 and 1998, $0 and $13,900 of these charges were unpaid,
respectively.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not Applicable.
29
PART III
The information required by Item 10, Directors and Executive Officers of
the Registrant: Item 11, Executive Compensation; Item 12, Security Ownership of
certain Beneficial Owners and Management; and Item 13, Certain Relationships and
Related Transactions, will be included in and is incorporated by reference from
the Registrant's definitive proxy statement to be filed pursuant to Regulation
14A within 120 days after the close of its fiscal year.
30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
PAGE
NO. DESCRIPTION
- ---- -----------
17 -- Report of Independent Accountants
18 -- Balance Sheets as of December 31, 1997 and 1998
19 -- Statements of Operations for the years ended December 31, 1996, 1997 and 1998 and cumulative from inception
to December 31, 1998
20 -- Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998 and cumulative from inception
to December 31, 1998
21 -- Statements of Changes in Stockholders' Equity from inception to December 31, 1998
22 -- Notes to Financial Statements
(a)(3) Exhibits:
EXHIBIT
NO. TITLE
- -------- -----
1.1 -- Purchase and Registration Rights Agreement, dated as of November 9.(6)
3.1 -- Amended and Restated Certificate of Incorporation of Algos Pharmaceutical Corporation(1)
3.2 -- Amended and Restated By-laws of Algos Pharmaceutical Corporation(1)
4.1 -- Form of Stock Certificate of Common Stock(1)
4.2 -- Warrant to Purchase 250,000 Shares of Common Stock of Algos Pharmaceutical Corporation and Biotech Target
S.A., a Panamanian corporation, dated November 9, 1998(6)
5.1 -- Opinion of Latham & Watkins as to the validity of the Common Stock(1)
10.1.1 -- Employment Agreement with Respect to John W. Lyle(4)
10.1.3 -- Employment Agreement with Respect to Frank S. Caruso(1)
10.1.4 -- Employment Agreement with Respect to Joseph Sardella(5)
10.2.1 -- 1994 Stock Option Plan(1)
10.2.2 -- 1996 Stock Option Plan(1)
10.2.3 -- 1996 Non-Employee Director Stock Option Plan(2)
10.3.1 -- Algos Pharmaceutical Corporation Stockholders' Agreement(1)
10.4.1 -- License Agreement with The Medical College of Virginia(1)(A)
10.4.2 -- License Agreement with McNeil Consumer Products Company(1)(A)
10.4.3 -- Registration Rights Agreement with The Medical College of Virginia(1)
10.5 -- Lease Agreement with Commercial Realty & Resources Corp.(3)
21 -- Subsidiaries of the Registrant(1)
23.1 -- Consent of PricewaterhouseCoopers LLP
27 -- Financial Data Schedule, December 31, 1998
99 -- Risk Factors
- ------------
(1) Incorporated by reference to the Registrant's registration statement on
Form S-1 declared effective on September 25, 1996.
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1997.
(4) Incorporated by Reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997
(5) Incorporated by Reference to the Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1998.
(6) Incorporated by Reference to the Registrant's registration statement on
Form S-3 dated March 10, 1999.
(A) Portions of this Exhibit have received confidential treatment pursuant to
Rule 406(b) under the Securities Act.
(b) Reports on Form 8-K:
None
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
ALGOS PHARMACEUTICAL CORPORATION
By: /s/ JOHN W. LYLE
.................................
JOHN W. LYLE
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
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.
NAME TITLE DATE
---- ----- ----
/s/ JOHN W. LYLE President, Chief Executive Officer March 30, 1999
......................................... and Director
JOHN W. LYLE
/s/ DONALD G. DRAPKIN Director March 30, 1999
.........................................
DONALD G. DRAPKIN
/s/ MICHAEL HYATT Director March 30, 1999
.........................................
MICHAEL HYATT
/s/ ROGER H. KIMMEL Director March 30, 1999
.........................................
ROGER H. KIMMEL
/s/ JAMES R. LEDLEY Assistant Secretary and Director March 30, 1999
.........................................
JAMES R. LEDLEY
/s/ DIETER A. SULSER Director March 30, 1999
.........................................
DIETER A. SULSER
/s/ GARY ANTHONY Chief Financial Officer March 30, 1999
.........................................
GARY ANTHONY
32
STATEMENT OF DIFFERENCES
The trademark symbol shall be expressed as................................'TM'
The registered trademark symbol shall be expressed as......................'r'