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EXHIBIT 13
[SEPRACOR LOGO]
Sepracor Inc., 111 Locke Drive, Marlborough, Massachusetts 01752
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Feeling Better
[FEELING BETTER PHOTO]
Is Our Business
[IS OUR BUSINESS PHOTO]
1997 Annual Report
[SEPRACOR LOGO]
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SEPRACOR is a specialty pharmaceutical company that develops
and commercializes potentially improved versions of widely-prescribed drugs.
Referred to as Improved Chemical Entities ("ICEs"), Sepracor's ICE(TM)
Pharmaceuticals are being developed as proprietary, single-isomer or
active-metabolite versions of these leading drugs. ICE Pharmaceuticals are
designed to offer meaningful improvements in patient outcome through reduced
side effects, increased therapeutic efficacy, or improved dosage forms. In some
cases, our ICE Pharmaceuticals may provide an opportunity for additional
indications. - Sepracor plans to market its ICE Pharmaceuticals directly where
its specialty sales force can significantly penetrate target markets. For drugs
and markets requiring substantial field sales support and extensive marketing
resources, Sepracor seeks co-promotion, co-development, and licensing
arrangements with
[SEPRACOR PRODUCT CHART]
SEPRACOR PRODUCT Parent Drug NDA TARGET
CHEMISTRY PRECLINICAL PHASE I/II PHASE III REVIEW LAUNCH
FEXOFENADINE ALLEGRA(R) - Seldane(R) `96
LEVALBUTEROL - Ventolin(R) /Proventil(R) `98
NORASTEMIZOLE - Hismanal(R) `00
(R,R)-FORMOTEROL - Foradil(R)/Atock(R) `01
(S)-OXYBUTYNIN - Ditropan(R) `00
(S)-FLUOXETINE - Prozac(R)
(R)-KETOPROFEN - Orudis(R)/Actron(R)
DESCARBOETHOXYLORATADINE - Claritin(R)
(S)-DOXAZOSIN - Cardura(R)
(2R, 4S)-ITRACONAZOLE - Sporanox(R)
(R)-KETOROLAC - Toradol(R)
(R)-BUPROPION - Zyban(TM)
(-)-CERTIRIZINE - Zyrtec(R)
(R)-FLUOXETINE - Prozac(R)
(S)-LANSOPRAZOLE - Prevacid(R)
NORCISAPRIDE - Propulsid(R)
(R)-ONDANSETRON - Zofran(R)
(-)-PANTOPRAZOLE - Pantozol(TM)
(S)-SIBUTRAMINE - Meridia(R)
(S)-ZOPICLONE - Imovane(R)
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leading pharmaceutical companies. These partners provide the development and
marketing resources to expand market penetration. - In 1993, Sepracor licensed
its U.S. patents covering fexofenadine to Hoechst Marion Roussel, Inc. ("HMRI"),
which developed and launched the drug. Marketed as Allegra(R) by HMRI, the drug
is indicated for allergic conditions, but avoids the cardiovascular side effects
associated with its parent drug, terfenadine (Seldane(R)). - Currently,
Sepracor's New Drug Application (NDA) for levalbuterol HCl inhalation solution,
the single-isomer version of the widely-sold bronchodilator, racemic albuterol,
is being reviewed by the FDA. Racemic albuterol is marketed as Ventolin(R) by
Glaxo-Wellcome and as Proventil(R) by Schering-Plough. -Sepracor recently
completed a large-scale clinical trial for norastemizole, an active-metabolite
of astemizole, marketed as Hismanal(R) by Johnson & Johnson. This study included
750 patients, and was conducted in 30 U.S. sites. Phase I and Phase II clinical
trials indicate that norastemizole is a potentially safe and efficacious
non-sedating antihistamine. - Sepracor has six ICE Pharmaceuticals in human
clinical trials and thirteen additional active-metabolite or single-isomer drugs
are undergoing preclinical investigation.
[BACKGROUND PHOTO]
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TO OUR SHAREHOLDERS: Nineteen ninety-seven was a year of considerable
accomplishments for Sepracor. Our Annual Report describes the Company's progress
in building a leading specialty pharmaceutical company based on our strategy of
developing and commercializing ICETM Pharmaceuticals. ICEs are potentially
improved single-isomer or active-metabolite versions of existing drugs. The
estimated worldwide sales of the parent compounds of Sepracor's product pipeline
exceeded $12 billion in 1997. - SEPRACOR ACHIEVED SIGNIFICANT CLINICAL AND
COMMERCIAL MILESTONES IN 1997. A New Drug Application for levalbuterol was
submitted to the U.S. Food and Drug Administration. We also completed a
750-patient, Phase II/III study for norastemizole, a potential third generation
nonsedating antihistamine. In addition, we initiated clinical trials of both our
long-acting beta agonist (R,R)-formoterol, for the treatment of asthma, and our
urinary incontinence compound, (S)-oxybutynin. - WE HAVE SUBSTANTIALLY INCREASED
THE VALUE OF OUR ANTIHISTAMINE PORTFOLIO THROUGH TWO MAJOR CORPORATE
COLLABORATIONS IN 1997 AND EARLY 1998. Sepracor signed a licensing agreement in
the fourth quarter of 1997 with Schering-Plough Corporation for the development
of DCL, an active metabolite of the leading antihistamine Claritin(R). Pursuant
to that agreement, Sepracor will be entitled to receive royalties beginning upon
product launch. Under this agreement, Schering-Plough is developing DCL and
intends to market the product worldwide. This potentially more potent
antihistamine may serve as a new platform for extending the lifecycle of the
Claritin(R) franchise. In addition, in the first quarter of 1998, we announced a
collaboration with Janssen Pharmaceutica, N.V., a wholly-owned subsidiary of
Johnson & Johnson, for the development and marketing of norastemizole. - THIS
YEAR, WE HAVE SEEN A CONTINUED VALIDATION OF SEPRACOR'S ICE PHARMACEUTICAL
STRATEGY. While Sepracor is leading the emerging industry trend to develop
single-isomer or active-metabolite versions of existing compounds, major
pharmaceutical companies have also validated this strategy. For example, Johnson
& Johnson successfully launched Levaquin(R), the single-isomer of the quinolone
antibiotic ofloxacin, which has a broader spectrum of activity than its parent
drug.
SEPRACOR SALES FORCE GROWTH
[SEPRACOR SALES FORCE GROWTH CHART]
PLANNED ICE PHARMACEUTICAL INTRODUCTION SCHEDULE AND SEPRACOR RESPIRATORY SALES
FORCE BUILD
SEPRACOR
SALES
FORCE (R,R)-formoterol
Dry Powder Inhaler
200 Levalbuterol (R,R)-formoterol
Dry Powder Inhaler
Norastemizole Norastemizole
with Decongestant
150 Levalbuterol
Metered Dose Inhaler
Levalbuterol
Sustained Release
100 Levalbuterol
Oral
Levalbuterol
0 Nebule
YEAR 1998 1999 2000 2001 2002 2003
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Marketed by Daiichi, this new anti-infective is already one of the largest
pharmaceutical products in Japan. Astra announced its intention to develop the
single-isomer version of Prilosec(R), the world's largest selling drug in 1997,
which may offer improved efficacy. In addition, Hoechst Marion Roussel
successfully completed its market conversion of the Seldane(R) franchise to
Allegra(R), which does not exhibit the cardiovascular side effects associated
with the parent drug. - OUR ICE PHARMACEUTICALS ARE NOW PROGRESSING FROM THE
CLINICAL TRIAL PHASE TO FDA REVIEW, AND FINALLY, TO THE MARKETPLACE. The
Company's strategy for commercializing its ICE Pharmaceuticals includes
licensing agreements, co-promotion collaborations with major pharmaceutical
companies, and direct marketing through one or more specialty sales forces. -
Levalbuterol, under review by the FDA, would be the first drug to be sold by our
respiratory sales force. Sepracor plans to launch levalbuterol in the second
half of 1998. In the future, Sepracor plans to introduce other drugs to be sold
by the Company's respiratory sales force, such as norastemizole and
(R,R)-formoterol. - Sepracor's agreement with Janssen illustrates our
co-promotion strategy. In February 1998, the companies announced an agreement
for the joint development and marketing of norastemizole. Sepracor has retained
the right to co-promote the product in the United States. - OUR DRUG DISCOVERY
EFFORTS ALSO HAVE BEGUN TO SHOW RESULTS. We are combining Sepracor's
combinatorial chemistry and high-throughput screening expertise with known
biological and new genomic-identified drug targets. Sepracor has discovered lead
compounds that when further developed, could complement our ICE Pharmaceutical
pipeline in the years to come. - Sepracor's consolidated cash position has never
been stronger. For the year ended December 31, 1997, the Company had $92.6
million in consolidated cash and marketable securities. In February 1998,
Sepracor completed a $189 million offering of convertible subordinated
debentures. With approximately $275 million in cash and marketable securities
following our recent financing, Sepracor is well positioned to continue
developing and marketing its respiratory product line. In addition to these
products, we are initiating development of several candidates in the fields of
psychiatry/neurology and urology/gastroenterology. - We congratulate Sepracor's
shareholders, partners, and employees on an excellent year. We look forward to
sharing Sepracor's clinical and commercial successes with you throughout the
coming year.
[PHOTO of Timothy J. Barberich]
Sincerely,
/s/ Timothy J. Barberich
Timothy J. Barberich
President and Chief Executive Officer
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Sepracor's
ICE(TM) Strategy
CHIRAL CHEMISTRY FORMS THE BASIS OF OUR ICE(TM)STRATEGY. Chiral molecules exist
in mirror-image forms called optical isomers. Often only one optical isomer of
the pair in a chiral drug is responsible for the drug's efficacy. The other may
be inert or may cause undesirable side effects. Many established drugs on the
market today are racemic mixtures with equal amounts of two isomers, an
(R)-isomer and an (S)-isomer. The United States Food and Drug Administration's
1992 published stereoisomer policy guidelines have encouraged the development of
optically pure drugs by suggesting that drug makers submit analyses on the
pharmacological activities of each isomer of a new racemic drug candidate.
[MOLECULE GRAPHIC]
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SEPRACOR'S ICE(TM) PHARMACEUTICALS HAVE THE POTENTIAL TO BE PURER, SAFER, OR
MORE POTENT VERSIONS OF THEIR PARENT DRUG COMPOUNDS. Since the parent drugs have
well-known efficacy and safety profiles, ICE Pharmaceuticals generally can be
developed significantly faster, at lower cost, and with decreased regulatory
risk than new chemical entities. In addition, established franchises of the
parent compounds, combined with long-term patent protection, provide a strong
indicator of the market potential for ICE Pharmaceuticals. - SINGLE-ISOMER ICE
PHARMACEUTICALS. Racemic drugs exist in mirror-image forms called isomers,
designated as (R) and (S). Often only one isomer of a racemic drug is
therapeutically active. The other isomer may be inert or may cause undesirable
side effects. Racemic albuterol, a widely-prescribed asthma bronchodilator,
consists of equal amounts of two isomers, (R)-albuterol and (S)-albuterol. -
Sepracor's development of the single-isomer version of racemic albuterol
illustrates the potential benefits of purification. Based on preclinical and
clinical research, Sepracor has demonstrated that racemic albuterol's
therapeutic effect resides exclusively in the (R)-isomer. Scientific data have
suggested the (S)-isomer may cause detrimental airway hyperreactivity. Sepracor
is developing levalbuterol ((R)-albuterol) as a pure and potentially more
efficacious single-isomer version of the racemic bronchodilator. -
ACTIVE-METABOLITE ICE PHARMACEUTICALS. An active metabolite is a therapeutically
active compound produced when a drug is metabolized in the body. Most drugs
administered to treat diseases are transformed (metabolized) within the body
into a variety of related forms (metabolites), some of which have therapeutic
activity. - For example, fexofenadine is an active metabolite of the former
best-selling nonsedating antihistamine Seldane(R) (terfenadine). Toxic levels of
terfenadine can accumulate in the body when certain other medications interfere
with its metabolism. Fexofenadine is marketed as Allegra(R) by HMRI under a
patent licensing agreement with Sepracor. Allegra does not exhibit the rare but
serious cardiac toxicity associated with its parent drug. - The following pages
in this report discuss the clinical and commercial progress of Sepracor's ICE
Pharmaceuticals.
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Respiratory Therapy [DOG WALK PHOTO]
Allergy
ICE PHARMACEUTICALS FOR ALLERGY
ICE PHARMACEUTICALS PARENT DRUG EXPECTED DEVELOPMENT
Potential Benefit of Sepracor Candidate Current Marketer INDICATION STAGE
FEXOFENADINE (ALLEGRA(R)) Seldane(R) Allergy Launched
nonsedating antihistamine with HMRI
reduced cardiovascular side effects
NORASTEMIZOLE HISMANAL(R) Allergy Phase II/III
nonsedating antihistamine with J & J
improved potency, rapid onset,
longer duration, reduced cardiovascular
side effects
DESCARBOETHOXYLORATADINE (DCL) CLARITIN(R) Allergy Preclinical
nonsedating antihistamine with Schering-Plough
improved potency
(-)-CERTIRIZINE ZYRTEC(R) Allergy Preclinical
antihistamine without sedation Pfizer/UCB
1997 WORLDWIDE SALES TO TREAT ALLERGIES WERE APPROXIMATELY $3 BILLION*
[PIE CHART]
ALLEGRA(R)
(SELDANE(R))
$400 MILLION
HISMANAL(R)
$150 MILLION
CLARITIN(R)
$1.7 BILLION
ZYRTEC(R)
$550 MILLION
* INCLUDES RELATED BRANDS
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OVER 40 MILLION AMERICANS SUFFER FROM SEASONAL ALLERGIC RHINITIS (HAY FEVER), AN
ALLERGY TO AIRBORNE POLLENS. Symptoms include runny nose, watery eyes, and
scratchy throat. Nonsedating antihistamines, such as Claritin(R) and Allegra(R),
provide relief to allergy sufferers without causing drowsiness. Worldwide sales
of nonsedating antihistamines were approximately $3 billion in 1997. Sales are
forecasted to double to $6 billion in the next five years. - ALLEGRA...IMPROVED
SELDANE(R) WITHOUT CARDIOTOXICITY. In 1993, Sepracor licensed its U.S. patents
covering fexofenadine to HMRI, which developed the drug and launched it in late
1996 as Allegra, a nonsedating antihistamine. While Sepracor is entitled to
receive royalty payments upon the expected expiration in 2001 of HMRI's
composition-of-matter patent covering fexofenadine, the right to receive
royalties is subject to successful resolution of a pending patent interference
action. (See Sepracor Inc. Notes to Consolidated Financial Statements,
N-Litigation). - NORASTEMIZOLE...A POTENTIALLY SAFER AND MORE POTENT THIRD
GENERATION NONSEDATING ANTIHISTAMINE. Janssen Pharmaceutica N.V.'s product,
Hismanal(R) (astemizole), has a "black box" warning in its product labeling
alerting physicians to serious cardiac side effects and the drug-drug
interactions. In February 1998, Sepracor and Janssen, a wholly-owned subsidiary
of Johnson & Johnson, announced an agreement under which the companies will
jointly fund the development of Sepracor's ICE Pharmaceutical, norastemizole,
one of the major metabolites of Hismanal. This development and commercialization
agreement gives Janssen an option to acquire certain rights in the U.S. and
abroad. Sepracor retains the right to co-promote norastemizole in the U.S.
Sepracor's first 750-patient, 30-center, Phase III seasonal allergic rhinitis
clinical trial has been completed. - DCL... METABOLITE OF CLARITIN WITH THE
POTENTIAL FOR GREATER POTENCY. Loratadine, marketed by Schering Corporation as
Claritin, is the world's largest-selling nonsedating antihistamine. Claritan
sales rose 50% in 1997 to total $1.7 billion worlwide. Loratadine's active
metabolite, DCL (descarboethoxyloratadine), has been shown in preclinical
studies to offer the potential for greater potency than other commercial
antihistamines. - In December 1997, Sepracor and Schering-Plough entered into an
agreement which gives Schering-Plough exclusive worldwide rights to Sepracor's
patents covering DCL. Under this agreement, Schering-Plough is developing DCL
and intends to market the product worldwide. Based on its potential as a more
potent antihistamine, DCL could serve as a platform for the evolution of the
Claritin franchise. Sepracor is entitled to royalty payments upon the initial
sale of the product.
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Respiratory Therapy [KID IN POOL PHOTO]
Asthma
ICE PHARMACEUTICALS FOR ASTHMA
ICE PHARMACEUTICALS PARENT DRUG EXPECTED DEVELOPMENT
Potential Benefit of Sepracor Candidate Current Marketer INDICATION STAGE
LEVALBUTEROL VENTOLIN(R)/ Asthma NDA filed
bronchodilator with improved PROVENTIL(R)
safety and efficacy Glaxo-Wellcome,
Schering-Plough
and generics
(R,R) - FORMOTEROL FORADIL(R)/ Asthma Phase I/II
bronchodilator with rapid onset ATOCK(R)
and longer duration Novartis/
Yamanouchi
1997 WORLDWIDE SALES OF SHORT-ACTING AND LONG-ACTING BRONCHODILATORS FOR ASTHMA
THERAPY WERE $2.5 BILLION
[PIE CHART]
LONG-ACTING
BRONCHODILATORS
(SEREVENT(R)/
FORADIL(R)/Atock(R))
$.7 BILLION
SHORT-ACTING
BRONCHODILATORS
(VENTOLIN(R)/Proventil(R))
AND OTHERS
$1.8 BILLION
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ASTHMA AFFECTS ABOUT 15 MILLION AMERICANS, INCLUDING 5 MILLION CHILDREN. THE
INCIDENCE OF ASTHMA IS INCREASING IN AMERICA. People are twice as likely to
suffer from asthma as compared to 1980. Approximately 5,000 deaths occur as a
result of asthma in the U.S. each year. - Bronchodilators are the primary
treatment for acute and chronic asthma attacks and are necessary complements to
other asthma therapies, such as steroids or leukotriene antagonists.
Short-acting and long-acting bronchodilators prescribed for the treatment of
asthma had worldwide sales of over $2.5 billion in 1997. Sepracor's levalbuterol
is a single-isomer form of the current market-leading bronchodilator, racemic
albuterol. In 1997, racemic albuterol sales exceeded $1.4 billion. - In addition
to levalbuterol, Sepracor is developing (R,R)-formoterol as a long-acting
bronchodilator. This ICE Pharmaceutical is being investigated to determine onset
and duration of action as a prophylactic asthma therapy. -
LEVALBUTEROL...ADVANCING ASTHMA THERAPY THROUGH PURER MEDICINE. On July 1, 1997,
Sepracor announced that it had submitted a New Drug Application (NDA) to the
U.S. Food and Drug Administration (FDA) for levalbuterol HCl nebulizer solution.
The NDA submission came approximately two years after the drug entered U.S.
clinical trials, confirming Sepracor's ability to rapidly develop its ICE
Pharmaceuticals. If the FDA approves the NDA, Sepracor plans to launch
levalbuterol using its own specialty respiratory sales force during the second
half of 1998. - In addition to the nebulized dosage form, Sepracor will be
initiating clinical trials with several other formulations and pulmonary drug
delivery systems for levalbuterol, including syrup, controlled release tablet,
metered-dose inhaler, and dry-powder inhaler versions. - (R,R)-FORMOTEROL
...POTENTIAL FOR RAPID ONSET OF ACTION COUPLED WITH LONG DURATION OF THERAPY.
Sepracor is studying (R,R)-formoterol, a single-isomer ICE Pharmaceutical, for
the dual benefits of rapid onset of action and long duration of therapy.
Worldwide sales of long-acting bronchodilators exceeded $700 million in 1997
(Norvartis' Foradil(R), Yamanouchi's Atock(R), Astra's Oxis(TM) Turbuhaler(R),
and Glaxo-Wellcome's Serevent(R)). - As Sepracor continues to strengthen and
expand its commercial capabilities, the Company is building a specialty
respiratory sales force to market the portfolio of respiratory drugs under
development. The sales force will sell directly to high-prescribing respiratory
specialists, pediatricians, and primary care physicians in leading hospitals and
clinics in the U.S.
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Urology/
Gastroenterology [BACKPACKING PHOTO]
ICE PHARMACEUTICALS FOR UROLOGICAL DISORDERS AND GASTROENTEROLOGY
ICE PHARMACEUTICALS PARENT DRUG EXPECTED DEVELOPMENT
Potential Benefit of Sepracor Candidate Current Marketer INDICATION STAGE
(S) - OXYBUTYNIN DITROPAN(R) Urinary Phase I/II
reduced anticholinergic side effects HMRI Incontinence
including dry mouth, restlessness,
nausea and palpitations
(S) - DOXAZOSIN CARDURA(R) Benign Prostatic Preclinical
reduced orthostatic hypotension Pfizer Hyperplasia (BPH)
and improved potency
NORCISAPRIDE PROPULSID(R) Emesis Preclinical
improved potency without the J & J (nausea,
adverse side effect of cardiac toxicity vomiting)
(S) - LANSOPRAZOLE PREVACID(R) Gastroesophageal Preclinical
improved dosing consistency TAP Reflux Disease
and efficacy Pharmaceuticals (GERD)
(-) - PANTOPRAZOLE PANTOZOL(TM) Gastroesophageal Preclinical
GERD treatment with more consistent Byk/AHP Reflux Disease
plasma levels that may lead to better (GERD)
efficacy and safety
1997 WORLDWIDE SALES FOR URINARY INCONTINENCE PRODUCTS,
ADULT DIAPERS AND DEVICES WERE $2.1 BILLION
[PIE CHART]
DITROPAN(R)*
$134 MILLION
DIAPERS
AND DEVICES
$2 BILLION
* INCLUDES RELATED BRANDS
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URINARY INCONTINENCE (UI) AFFECTS A BROAD RANGE OF ADULTS. THE CONDITION AFFECTS
APPROXIMATELY 10 MILLION WOMEN AND 3 MILLION MEN IN THE UNITED STATES, with
estimated annual treatment costs of $16 billion. The incidence of urinary
incontinence increases progressively with age; approximately 15-30% of older
adults have experienced problems with bladder control. Additionally, more than
50% of nursing home residents have been diagnosed with UI. - Drug therapy is
rarely used to treat urinary incontinence due to the severe side effects of the
existing compounds. A majority of patients use adult diapers or incontinence
devices. U.S. sales of these alternatives exceed $2 billion annually.
Ditropan(R) (racemic oxybutynin), the most widely used drug to treat urinary
incontinence, is associated with unpleasant side effects including dry mouth,
nausea, restlessness, and heart palpitations. As a result, pharmaceutical
products capture only about 5% of the domestic UI market. - (S)-OXYBUTYNIN...A
POTENTIAL TREATMENT FOR URINARY INCONTINENCE WITHOUT THE UNPLEASANT SIDE EFFECTS
OF DITROPAN. Sepracor is developing (S)-oxybutynin as a treatment primarily for
urge urinary incontinence, a disorder characterized by sudden and involuntary
bladder contractions. Racemic oxybutynin is marketed as Ditropan by HMRI. While
Ditropan is effective in blocking contractions, it is linked to undesirable
anticholinergic side effects that limit the drug's usefulness. - Phase II
clinical trials of (S)-oxybutynin are underway. The clinical trials are designed
to investigate the drug's efficacy as well as its tolerability. -
(S)-DOXAZOSIN...A POTENTIAL BPH TREATMENT WITH DECREASED ORTHOSTATIC HYPOTENSION
COMPARED TO CARDURA(R). Sepracor is developing its proprietary (S)-doxazosin as
a potentially improved single-isomer version of Cardura, Pfizer's treatment for
benign prostatic hyperplasia (BPH). A primary side effect of treatment with
alpha-blockers is orthostatic hypotension, which is a lowering of blood pressure
that can cause severe dizziness and fainting. This side effect often requires
prescribing physicians to titrate to effective dose levels, which necessitates
multiple visits to the physician's office. - Sepracor's preclinical studies
indicate that (S)-doxazosin may combine a significantly lower incidence of
orthostatic hypotension with greater potency than the racemic parent drug. -
Other Sepracor ICE Pharmaceuticals under development for the treatment of
gastrointestinal and urological disorders include: norcisapride as anantiemetic
to treat nausea and vomiting; (S)-lansoprazole and pantoprazole as treatments
for gastroesophageal reflux disease (GERD).
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Psychiatry/Neurology
ICE PHARMACEUTICALS FOR PSYCHIATRY AND NEUROLOGY [HAPPY LADY PHOTO]
ICE PHARMACEUTICALS PARENT DRUG EXPECTED DEVELOPMENT
Potential Benefit of Sepracor Candidate Current Marketer INDICATION STAGE
(R) - FLUOXETINE PROZAC(R) Depression Preclinical
increase in flexibility in treating Eli Lilly
depression
(S) - FLUOXETINE PROZAC(R) Migraine Phase I/II
prevention of migraine headaches Eli Lilly
(S) - ZOPICLONE IMOVANE(R) Sleep Preclinical
reduced anticholinergic side effects Rhone-Poulenc Disorder
including dry mouth Rorer
(S) - SIBUTRAMINE MERIDIA(R) Obesity Preclinical
reduced anticholinergic side effects Knoll
including dry mouth and constipation Pharmaceutical
(R) - BUPROPION ZYBAN(TM) Smoking Preclinical
reduced incidence of seizures, Glaxo-Wellcome Cessation
dry mouth and insomnia
1997 WORLDWIDE SALES FOR THE SSRI MARKET WERE $6.5 BILLION, WHICH DOMINATED THE
ANTIDEPRESSANT MARKET*
[PIE CHART]
PROZAC(R)
$2.6 BILLION
PAXIL(TM)
$1.4 BILLION
WELLBUTRIN(R)
$.3 BILLION
OTHER
$.8 BILLION
ZOLOFT(R)
$1.4 BILLION
* INCLUDES RELATED BRANDS
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DEPRESSION IS A PSYCHIATRIC DISORDER THAT AFFECTS APPROXIMATELY 17 MILLION
PEOPLE IN THE UNITED STATES ANNUALLY. Selective Serotonin Reuptake Inhibitors
(SSRIs), such as racemic fluoxetine, are prescribed as first-line therapy for
the treatment of depression. In 1997, worldwide sales of SSRIs reached $6.5
billion. In addition to SSRIs, other central nervous system (CNS) drugs are
available to treat conditions such as sleep disorders, obesity, and smoking
cessation. - (R)-FLUOXETINE...POTENTIALLY INCREASED FLEXIBILITY IN THE TREATMENT
OF DEPRESSION. Racemic fluoxetine is marketed as the antidepressant Prozac(R) by
Eli Lilly & Co. Sepracor is conducting preclinical studies of the (R)-isomer of
fluoxetine to treat depression. The Company is planning to initiate full-scale
clinical trials during 1998. The use of (R)-fluoxetine may provide greater
treatment flexibility by reducing the half-life, which would lead to an
expedited washout period and the ability to switch drug therapies more rapidly.
The single-isomer version of the drug may also increase the suitability of
fluoxetine to treat the elderly, as well as other patient groups that have
difficulty metabolizing certain drugs. - (S)-ZOPICLONE...A POTENTIAL TREATMENT
FOR SLEEP DISORDERS WITH REDUCED ANTICHOLINERGIC SIDE EFFECTS. Sleep disorders
affect 56 million people in the U.S. Zopiclone is marketed as Imovane(R) in
Europe by Rhone-Poulenc Rorer Inc. Imovane is a non-benzodiazepine, short-acting
hypnotic sedative for the treatment of sleep disorders. In 1997, worldwide sales
of Imovane were approximately $144 million. Imovane was not developed for the
U.S. market, which is served primarily by zolpidem tartrate, marketed as
Ambien(R) by Searle. Ambien is a rapid onset, non-benzodiazepine hypnotic. U.S.
sales of Ambien in 1997 were approximately $500 million. Preclinical studies
show that the use of (S)-zopliclone has the potential to reduce anticholinergic
side effects, particularly dry mouth. -(S)-SIBUTRAMINE...SINGLE-ISOMER FORM OF
MERIDIA(R). Knoll Pharmaceutical Co., a division of BASF AG, markets racemic
sibutramine as Meridia for the treatment of obesity. Sepracor has initiated an
exploratory program to determine whether (S)-sibutramine may reduce
anticholinergic side effects associated with Meridia. - Other ICE
Pharmaceuticals in preclinical development for treatment of central nervous
system disorders or for pain management include: (S)-fluoxetine for migraine
prophylaxis; norcisapride as an anti-anxiety drug; (R)-ketoprofen and
(R)-ketorolac for pain management; and (R)-bupropion for smoking cessation.
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Drug Discovery [LAB PHOTO]
SEPRACOR'S NEW CHEMICAL ENTITIES
SEPRACOR LEAD COMPOUND DISEASE RECEPTOR/ENZYME
Adenosine
SEP - 89,068 Pain, Anxiety A2A
SEP - 42,960 Asthma A3
Phosphatase
SEP - 121,788 Diabetes, Cancer P1B
Opiate
SEP - 130,551 Pain, Respiratory mm
SEP - 130,169 kappa
SEP - 119,249 Inflammation Glucocorticoid
SEP - 119,244 Osteoporosis, Cancer Estrogen
SEP - 132,613 Bacterial Infection Infectious Disease
SEP - 119,255 narrow spectrum, resistant
gram-positive infection
THE DRUG DISCOVERY PROCESS
[FLOW CHART]
COMBINATORIAL
CHEMISTRY
MANY COMPOUNDS
FUNCTIONAL
GENOMICS
DISEASE TARGETS
BIOINFORMATICS
COMPUTER CONTROL
HIGH-THROUGHPUT
SCREENING
"HITS"
LEAD COMPOUNDS
PRECLINICAL AND
CLINICAL TRIALS
14
18
SEPRACOR'S DISCOVERY STRATEGY IS CLOSELY ALIGNED WITH THE ICE PHARMACEUTICAL
STRATEGY. BOTH PROGRAMS FOCUS ON RELATED THERAPEUTIC AREAS, such as
inflammation, pain, and urological diseases. While the ICE Pharmaceutical
strategy potentially improves existing drugs, the Discovery approach creates new
chemical entities, which may lead to breakthrough compounds. By focusing drug
discovery efforts on synthetic, medicinal, and combinatorial chemistries,
Sepracor has developed a proprietary and highly diverse corporate file of small,
drug-like molecules with potential therapeutic advantages over compounds
currently used for treatment. - COMBINATORIAL CHEMISTRY TECHNIQUES ARE
USED TO PRODUCE LIBRARIES OF NOVEL COMPOUNDS FOR SCREENING. For both known
biological and new genomic-identified drug targets, relevant assays are designed
and implemented in high-throughput screening formats. Sepracor's unique method
of leveraging combinatorial chemistry combined with high-throughput screening
provides for competitive advantages in the drug discovery arena. The Company's
propriety chemistry allows Sepracor to create specifically shaped molecules that
will target receptors in a highly precise manner. This process is generating
more selective and potent lead compounds, which complement Sepracor's current
therapeutic focus. - Sepracor's collaborative relationships with select
biotechnology partners give the Company access to proprietary molecular targets
that are within Sepracor's therapeutic areas of interest and are suitable for
high-throughput screening formats. The relationship between high-throughput
screening and combinatorial chemistry dramatically shortens the time to discover
lead compounds and develop drug candidates. - THE POTENCY, SELECTIVITY,
AND STRUCTURE OF A LEAD COMPOUND, COMBINED WITH ITS PHYSICAL PROPERTIES AND
BIOAVAILABILITY, INCREASE THE PROBABILITY THAT THE SUBSTANCE WILL BECOME A DRUG.
When a lead is discovered, focused libraries are designed and synthesized
utilizing directed combinatorial chemistry techniques. Using this technology,
Sepracor has generated a number of lead compounds in less than one year. For
example, Sepracor has identified SEP-132,613 as a promising lead anti-infective
compound with "in vitro" potency against a wide range of resistant organisms.
Sepracor has also identified SEP-42,960 and SEP-89,068 as unique, drug-like
molecules with "in vitro" activity against the adenosine receptor subtypes.
Other lead compounds that have shown high potency and selectivity against the
opiate receptor subtypes "in vitro" are SEP-130,551 and SEP-130,169. - IN
THE FUTURE, SEPRACOR EXPECTS THESE DRUG DISCOVERY ACTIVITIES TO COMPLEMENT THE
COMPANY'S ICE PHARMACEUTICAL PIPELINE.
15
19
SEPRACOR INC. SELECTED FINANCIAL DATA
Year Ended December 31, (in thousands, except per share data) 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales $ 9,636 $ 13,784 $ 14,271 $ 12,382 $ 9,862
Collaborative research and development 58 25 1,036 303 2,209
License fees and royalties 5,643 1,232 900 5,425 1,359
----------------------------------------------------------------
Total revenues 15,337 15,041 16,207 18,110 13,430
----------------------------------------------------------------
Costs and expenses:
Cost of products sold 5,992 6,784 10,410 6,919 6,786
Research and development 43,055 35,828 21,707 17,723 13,301
Purchase of in-process research and development (1) -- -- -- 3,500 --
Selling, general, administrative and patent costs 17,254 16,312 20,411 16,212 12,494
Restructuring and impairment charges (2) 4,179 -- 4,144 -- 2,015
----------------------------------------------------------------
Total costs and expenses 70,480 58,924 56,672 44,354 34,596
----------------------------------------------------------------
Loss from operations (55,143) (43,883) (40,465) (26,244) (21,166)
----------------------------------------------------------------
Other income (expense):
Equity in investee losses (3) (2,755) (17,539) (808) -- --
Interest income 5,766 6,713 3,228 1,390 1,096
Interest expense (5,976) (6,140) (2,077) (832) (751)
Gain on Sale of ChiRex, Inc. 30,069 -- -- -- --
Other (4) 547 (107) (1,171) (213) (86)
----------------------------------------------------------------
Net loss before minority interests (27,492) (60,956) (41,293) (25,899) (20,907)
Minority interests in subsidiaries 1,369 846 7,881 5,556 --
----------------------------------------------------------------
Net loss $(26,123) $(60,110) $(33,412) $(20,343) $(20,907)
----------------------------------------------------------------
Net loss applicable to common shares (5) $(26,723) $(60,710) $(33,412) $(20,343) $(20,907)
----------------------------------------------------------------
Basic and diluted net loss per common share $ (0.97) $ (2.25) $ (1.54) $ (1.09) $ (1.16)
Basic and diluted weighted average number of common
shares outstanding 27,599 27,032 21,637 18,644 18,038
BALANCE SHEET DATA (IN THOUSANDS):
Cash and marketable securities $ 92,560 $103,650 $143,250 $ 27,590 $ 20,677
Total assets 128,507 146,689 202,713 73,419 46,681
Long-term debt 84,268 85,267 85,818 5,929 5,676
Stockholders' equity 12,032 30,392 89,227 30,485 33,152
(1) Represents a charge in connection with an acquisition by BioSepra Inc.
(2) Represents restructuring and impairment charges taken by BioSepra in
December 1997 and June 1995. See Footnote H - Notes to Consolidated
Financial Statements.
(3) 1996 figures reflect a net loss for ChiRex and HemaSure that includes
one-time charges taken in connection with ChiRex's initial public
offering and related transactions and HemaSure's loss from discontinued
operations, respectively. See Footnote D - Notes to Consolidated
Financial Statements.
(4) Includes a write-off of approximately $800,000 relating to certain
deferred finance charges taken in September 1995.
(5) Includes $600,000 in preferred stock dividends. See Footnote B - Notes
to Consolidated Financial Statements.
16
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
The consolidated financial statements include the accounts of Sepracor Inc. and
its majority and wholly-owned subsidiaries, including BioSepra Inc.
("BioSepra"), Sepracor Canada Limited, HemaSure Inc. ("HemaSure") (from January
1994 to September 1995), SepraChem Inc. (from January 1996 to March 1996), New
England Pharmaceuticals, Inc. (from June 1995 to June 1996 when it was merged
into Sepracor), and Versicor (from May 1995 to December 1997).
In September 1995, HemaSure completed the sale of 2,500,000 shares of its common
stock, $.01 par value per share, pursuant to an underwritten public offering. As
a result of the sale, the Company's ownership of the outstanding shares of
common stock of HemaSure was reduced from approximately 55% to approximately
37%. Effective September 27, 1995, the Company no longer consolidates HemaSure's
financial statements and accounts for the Company's investment in HemaSure using
the equity method. The sale resulted in a gain of approximately $15,235,000,
which was recorded as an increase to Sepracor's additional paid-in capital. At
December 31, 1997, the Company's investment in HemaSure was recorded to zero.
In March 1996, ChiRex Inc. ("ChiRex"), a newly formed corporation that is a
combination of Sterling Organics Limited, a United Kingdom fine chemical
manufacturer, and the chiral chemistry business of Sepracor, which was conducted
through its subsidiary SepraChem, completed an initial public offering of common
stock. ChiRex sold 6,675,000 shares of its common stock at $13 per share. In
exchange for the contribution of SepraChem, Sepracor received 3,489,301 shares
of ChiRex common stock and as a result Sepracor owned approximately 32% of
ChiRex. Sepracor accounted for this transaction as a non monetary exchange of
assets and, therefore, no gain or loss was recorded as a result of this
transaction. From March 11, 1996 until March 31, 1997, Sepracor carried its
investment in ChiRex using the equity method of accounting and, accordingly,
recorded $2,518,000 as its share of ChiRex's losses for the year ended December
31, 1996 and $383,000 as its share of ChiRex's income for the quarter ended
March 31, 1997. On March 31, 1997, Sepracor received net proceeds of
approximately $31,125,000 from the public sale of all of its shares of ChiRex
common stock. As a result of this transaction, Sepracor recognized a gain of
$30,069,000, which was recorded as other income.
In March 1996, Sepracor loaned BioSepra $3,500,000. In addition, Sepracor agreed
to loan BioSepra up to an additional $2,000,000 until March 1997 (the "loans").
Interest on the loans was prime plus 3/4%. The loans, including any interest
thereon, were convertible into shares of BioSepra stock, at the option of
Sepracor at any time prior to payment. On June 10, 1996, BioSepra borrowed the
additional $2,000,000 and Sepracor converted the outstanding principal amount of
$5,500,000 plus accrued interest of $47,639 into 1,369,788 shares of BioSepra
common stock. As a result of the conversion, Sepracor owns approximately 64% of
BioSepra.
Versicor was formed in May 1995 to develop novel drug candidates principally for
the treatment of infectious diseases.
In 1995, Versicor entered into a Convertible Subordinated Note Agreement ("the
Note Agreement") with Sepracor. Under this Note Agreement, Sepracor agreed to
loan to Versicor until October 2, 1998, up to an aggregate of $4,700,000.
Amounts outstanding accrued interest at the prime rate plus 1/2% not to exceed
9.5%. Amounts outstanding were convertible, at the option of Sepracor, into
Versicor Series B Convertible Preferred Stock by dividing the amount
outstanding, including principal and interest, by $0.7833.
In 1996, Versicor entered into a loan agreement with Sepracor. Under this
agreement, Sepracor agreed to loan to Versicor until October 2, 1998 up to an
aggregate of $7,500,000. As of June 23, 1997, this agreement was amended to
provide that principal and interest payments due to Sepracor, would be
convertible, at the option of Sepracor, into Versicor Series B Convertible
Preferred Stock, by dividing the amount outstanding, including principal and
interest, by $0.7833. The loan accrued interest equal to the prime rate minus
1/4%, adjusted under certain circumstances.
On December 10, 1997, Versicor completed a private equity financing for
approximately $22,000,000 and issued Series C Preferred Stock. As part of the
transaction, Sepracor exercised its conversion option on the Versicor
Convertible Subordinated Notes (the "Notes") in the amount of $9,530,000. The
remaining $6,034,000, which was outstanding under the Notes at the time, was
repaid to Sepracor before the end of 1997. Sepracor recognized a gain of
approximately $5,688,000 on the transaction, which was recorded as an increase
to additional paid-in capital. At December 31, 1997, Sepracor had an investment
in Versicor of $3,971,000 and there were no amounts outstanding under the Notes.
Sepracor's ownership as of December 31, 1997 was approximately 22%, thereby
making Versicor an affiliate and reportable under the equity method. Sepracor
recorded $75,000 as its share of Versicor losses for the period December 10
though December 31, 1997.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
REVENUE Product sales were $9,636,000 in 1997, $13,784,000 in 1996 and
$14,271,000 in 1995. Product sales are primarily attributable to BioSepra's
sales of bioprocessing media, supplies and equipment. The decrease in revenue
from 1995 to 1996 was primarily due to only consolidating the results of
SepraChem through March 11, 1996. The decrease in revenue from 1996 to 1997 is
attributable to fluctuations in the timing of large production scale media
orders and to the absence of one-time stocking orders from a major distributor
of research instruments, which occurred in 1996. In addition, the Company
believes that the sales of HyperD media have historically been adversely
affected by the now settled patent litigation with PerSeptive Biosystems Inc.
BioSepra's future success is dependent, in part, on its ability to generate
increased sales of its HyperD media products and research devices.
Collaborative research and development revenues were $58,000, $25,000 and
$1,036,000, in 1997, 1996 and 1995, respectively. The decrease from 1995 to 1996
was primarily related to a milestone
17
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
payment recorded in 1995 from Bayer Corporation. This contract was subsequently
terminated by Bayer.
License fees and royalties were $5,643,000 in 1997, $1,232,000 in 1996 and
$900,000 in 1995. The increase from 1995 to 1996 was due to revenue recognized
by BioSepra under an agreement with Beckman Instruments Inc. ("Beckman") in
1996. The increase from 1996 to 1997 was due to a $1,875,000 milestone payment
from Hoechst Marion Roussel Inc. ("HMRI") under the patent license agreement on
terfenadine carboxylate, marketed by HMRI as AllegraTM, and $3,600,000
recognized by BioSepra under the agreement with Beckman, that was revised in
December 1997. The increases in 1996 and 1997 were offset by decreases in
royalties received by Tanabe Seiyake Co. Ltd. ("Tanabe") relating to Tanabe's
licensing and use of Sepracor's technology in the manufacture of the chiral
intermediate of diltiazem: $168,000 in 1997, $333,000 in 1996 and $675,000 in
1995. Beginning in March 1996, Sepracor splits the royalty revenue from Tanabe
with ChiRex on a 50/50 basis.
In December 1997, Sepracor signed a licensing agreement with Schering-Plough
Corporation ("Schering") giving Schering exclusive worldwide rights to
Sepracor's patents covering descarboethoxyloratadine ("DCL"), an active
metabolite of loratadine. Under the terms of the agreement, Sepracor has
exclusively licensed its DCL rights to Schering, which expects to develop and
market the DCL product worldwide. Schering will pay Sepracor an upfront license
fee of $5,000,000 and royalties on DCL sales, if any, beginning at first product
launch. Any such royalties paid to Sepracor will escalate over time and upon the
achievement of sales volume and other milestones. As of December 31, 1997, the
agreement was still pending clearance under the Hart Scott Rodino Act. In
January 1998, Sepracor and Schering were notified that no objection would be
raised under the Hart Scott Rodino Act with respect to the license agreement.
Shortly thereafter, Sepracor received the $5,000,000 upfront license payment
from Schering and recorded the payment as license revenue in the first quarter
of 1998. The upfront license fee will be offset against future royalty payments.
On February 4, 1998, Sepracor signed a collaboration and license agreement with
Janssen Pharmaceutica, N.V. ("Janssen"), a wholly-owned subsidiary of Johnson &
Johnson, relating to the development and marketing of norastemizole, a third
generation nonsedating antihistamine. Under the terms of the agreement, the
companies will jointly fund the development of norastemizole, and Janssen has an
option to acquire certain rights regarding the product in the U.S. and abroad.
When exercised, Janssen and Sepracor will equally share the costs and profits
associated with the further development, marketing and sales of norastemizole in
the U.S. Sepracor will also retain the right to co-promote the product in the
U.S. Alternatively, Sepracor can elect to receive royalties, if any, on Janssen
sales of norastemizole in the U.S., in the event it decides not to co-promote
the product. Outside of the U.S., Janssen has the right to develop and market
norastemizole, and Sepracor will earn royalties on product sales, if any. In
addition, Janssen has worldwide OTC rights to norastemizole.
Cost of products sold, as a percentage of product sales, was 57% in 1997, 49% in
1996 and 73% in 1995. Cost of products sold decreased in 1996 as compared with
1995 primarily as a result of the elimination of sales of Biopass S.A.
("Biopass") products, a wholly owned subsidiary of BioSepra, which was sold in
July 1995. To a lesser extent, cost of products sold decreased in 1996 compared
to 1995 as a result of overall reductions in manufacturing costs at BioSepra.
The increase in 1997 from 1996 was primarily due to product mix changes and
fluctuations in timing of production-scale customer orders of BioSepra. In
addition, the increase is also attributable to the transition of BioSepra
resources from product development to production support, in association with
the commercialization of new media and instrument products. A payment of
$469,000 was made to a third party in connection with the HMRI milestone payment
and is included in cost of products sold in 1997.
Research and development expenses were $43,055,000 in 1997, $35,828,000 in 1996
and $21,707,000 in 1995. Research and development spending was primarily focused
on preclinical and clinical trials in Sepracor's pharmaceutical program and on
discovery initiatives at Versicor. The increase in 1996 compared to 1995 was due
to the costs associated with the progression of Sepracor's drug candidates into
later and more costly stages of development. In 1996, levalbuterol and
(S)-ketoprofen progressed into Phase III clinical trials, and norastemizole
progressed into Phase II clinical trials, and the Company initiated Phase I
clinical trials on (S)-oxybutynin and preclinical trials on (R,R)-formoterol. In
addition, costs increased in 1996 compared to 1995 due to the full-scale
operation of discovery capabilities at Versicor. Costs increased in 1997 as
compared to 1996 as levalbuterol Phase III clinical trials were completed, a new
drug application ("NDA") was submitted for levalbuterol to the Food and Drug
Administration ("FDA"), Phase III clinical trials began for norastemizole, and
Phase I clinical trials were initiated for (R,R)-formoterol.
Selling, general and administrative expenses were $15,594,000, $15,245,000 and
$19,037,000, in 1997, 1996 and 1995, respectively. The decrease in expenses in
1996 as compared to 1995 was primarily due to the hiring of certain management
personnel at Sepracor and BioSepra in 1995, increased legal expenses in 1995,
related to the recently settled lawsuits filed by and against PerSeptive, and
increased marketing expenses for HemaSure's LeukoNet Pre-Storage Leukoreduction
Filtration System ("Leukonet"). In addition, in 1996, HemaSure ceased being
consolidated in the results of Sepracor and BioSepra began to realize the
benefits of a cost-reduction program implemented in June 1995. The increase in
1997 as compared with 1996 resulted primarily from market research costs
incurred by Sepracor in determining the positioning of Sepracor's levalbuterol
product in the market and costs related to infrastructure development for a
direct sales force, offset by savings from personnel reductions at BioSepra. The
Company expects selling, general and administrative expenses to increase in 1998
as the Company accelerates the establishment of its direct sales force. Subject
to FDA approval of the Company's NDA, Sepracor is currently planning to commence
sales of the nebulized form of levalbuterol in late 1998.
In December 1997, BioSepra implemented a cost-reduction program that included
the discontinuance of a product line and a reduction in the number of employees.
The purpose of the program was to enable BioSepra to focus on the process
segments of the biopharmaceutical and genomics market. In conjunction
18
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
with the cost-reduction program BioSepra also wrote down intangible assets to
their net realizable value. In total, BioSepra recorded restructuring and
impairment charges totaling $4,179,000 in the fourth quarter of 1997. Of this
amount, $3,328,000 represents the write down of goodwill to its net realizable
value, $690,000 represents the write down of inventory and fixed assets
associated with the discontinued product line and $161,000 represents severance
and benefits related to the reduction in workforce in the U.S. BioSepra
terminated seven employees consisting of marketing/sales, finance and
administrative personnel. BioSepra expects to pay all of the severance and
related benefits in 1998.
In June 1995, BioSepra announced a major cost-reduction program that involved
the consolidation of its facilities and a significant reduction in the number of
employees. The purpose of the program was to enable BioSepra to focus on the
process development and process segments of the biopharm aceutical market. In
connection with this program in July 1995, BioSepra completed the sale of
Biopass. As part of the cost-reduction program, BioSepra recorded restructuring
and impairment charges totaling $4,144,000 in the second quarter of 1995. Of
this amount, $1,180,000 represents severance and benefits related to the
reduction in workforce in the U.S. and France and $2,964,000 related to
impairment of intangibles and loss on assets to net realizable value. BioSepra
has completed its reduction in workforce related to this cost-reduction program
resulting in the termination of 55 employees consisting of research and
development, administrative, production and marketing/sales personnel. BioSepra
paid $140,000 and $1,025,000 of the costs relating to the employee reduction as
of December 31, 1996 and 1995, respectively, and the remaining severance and
medical payments were paid in 1997.
In July 1995, BioSepra sold Biopass while retaining the chromatography column
technology that it obtained when it acquired Biopass. The results of Biopass
operations through July 19, 1995 have been included in the consolidated results
of operations for the year ended December 31, 1995. The loss of $2,964,000 on
the sale of Biopass was recorded in restructuring and impairment costs in the
results of operations in 1995. In 1996, BioSepra wrote-off the remaining
unamortized portion of certain purchased technology of approximately $741,000.
Legal expenses related to patents were $1,660,000, $1,067,000 and $1,374,000 for
1997, 1996 and 1995, respectively. The decrease in 1996 compared to 1995 was due
to chiral patent costs being transferred to ChiRex, beginning in March 1996. The
increase in 1997 compared with 1996 was due to maintenance fees associated with
the increased volume of patent filings and costs incurred in defending patent
interference claims made against the Company in 1997.
Equity in loss of investees was $2,755,000, $17,539,000 and $808,000 for 1997,
1996 and 1995, respectively. The equity in loss of investees consists of the
Company's portion of the net loss of HemaSure, ChiRex (through March 31, 1997)
and Versicor (beginning December 10, 1997). The increase in 1996 as compared to
1995 was due to one-time write-offs of $11,076,000 from ChiRex's initial public
offering and resulting transactions (Sepracor's portion of this one-time
write-off was $3,544,000). Included in HemaSure's results was $24,748,000
relating to the operations and discontinuation of HemaSure's blood plasma
business (Sepracor's portion of this was $9,157,000). The decrease in 1997
compared to 1996 was primarily related to the absence of any one-time
write-offs, ChiRex having net income for the period in 1997 during which
Sepracor maintained an interest and recording of HemaSure losses for only 11
months of 1997 as the investment was written down to zero.
Interest income was $5,766,000, $6,713,000 and $3,228,000 for 1997, 1996, and
1995, respectively. The increase in 1996 was primarily due to a larger average
cash balance available for investment, while the decrease in 1997 is principally
the result of a lower average cash balance available for investment.
Interest expense was $5,976,000, $6,140,000 and $2,077,000 in 1997, 1996 and
1995, respectively. The increase in interest expense in 1996 compared to 1995
were due to the $80,880,000 subordinated convertible debenture offering
completed in November and December of 1995. The decrease in 1997 was a result of
reduced borrowings by BioSepra and more favorable interest rates on the
remaining borrowings.
Net other income (expense) was $547,000, $(107,000), $(1,171,000) for 1997, 1996
and 1995, respectively. The decrease in expense in 1996 was primarily due to the
one-time write-off of approximately $800,000 of certain deferred financing costs
by Sepracor related to SepraChem in 1995. Income in 1997 related to the receipt
of a Canadian tax refund and favorable foreign exchange transactions associated
with BioSepra.
Minority interests in subsidiaries resulted in a reduction of consolidated net
loss of $1,369,000, $846,000, and $7,881,000 for 1997, 1996 and 1995,
respectively. The decrease in 1996 compared to 1995 resulted from smaller losses
at BioSepra and from HemaSure no longer being consolidated into the results of
operations of Sepracor. The increase in 1997 compared to 1996 related to larger
losses at BioSepra, offset by a reduction in the percentage of minority
interest, as Sepracor's ownership increased to 64% in June 1996.
OTHER The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standard No. 130 "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 requires that changes in comprehensive income be shown in a
financial statement that is displayed with the same prominence as other
financial statements. SFAS 130 will become effective for fiscal years beginning
in the first quarter of the fiscal year ending December 31, 1998. The Company
does not believe that the adoption will have a material effect on results from
operations.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 specifies new
guidelines for determining a company's operating segments and related
requirements for disclosure. Sepracor is in the process of evaluating the impact
of the new
19
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
standard on the presentation of the financial statements and the disclosure
therein. SFAS 131 will become effective for fiscal years beginning after
December 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents plus marketable
securities of Sepracor and its subsidiaries, including BioSepra, totaled
$92,560,000 at December 31, 1997, compared to $103,650,000 at December 31, 1996.
Cash and cash equivalents plus marketable securities of Sepracor, excluding
BioSepra, at December 31, 1997 were $90,044,000.
The net cash used in operating activities for the twelve months ended December
31, 1997 was $43,763,000. The net cash used in operating activities includes a
net loss of $26,123,000 adjusted by non-cash charges of $11,561,000. Non-cash
charges include a restructuring and impairment charge of $4,018,000 relating to
BioSepra. This was offset by the gain on sale of ChiRex of $30,069,000 and the
minority interest in subsidiary portion of the net loss of $1,369,000. The
accounts payable and accrued expense balances increased a total of $5,470,000
from the December 31, 1996 balances, primarily due to increased research and
development accruals at Sepracor. The deferred revenue decreased a total of
$3,620,000 due to BioSepra's recognition of license revenue relating to the
Beckman contract.
In 1994, Sepracor, BioSepra and HemaSure entered into an equipment leasing
arrangement that provides for a total of up to $2,000,000 of financing to
Sepracor and its subsidiaries for the purpose of financing capital equipment in
the United States. All outstanding amounts are collateralized by the assets so
financed and are guaranteed by Sepracor. At December 31, 1997, there was
$355,000 outstanding under this credit facility relating to Sepracor and
BioSepra, of which $205,000 represented Sepracor's portion.
At December 31, 1997, Sepracor had guaranteed $624,000 of outstanding bank
borrowings of BioSepra S.A., BioSepra's wholly owned French subsidiary.
In 1994, Sepracor's wholly owned subsidiary, Sepracor Canada Limited, entered
into two credit agreements with two Canadian provincial and federal business
development agencies for approximately $2,960,000 in term debt, of which
$2,590,000 is at an annual interest rate of 9.25% and $370,000 is interest free.
As of December 31, 1997, Sepracor Canada Limited had received approximately
$2,960,000 of such term debt, of which $2,295,000 was outstanding.
In 1995 and in 1997, Versicor entered into Convertible Subordinated Note
Agreements ("the Note Agreements") with Sepracor. Under these Note Agreements,
Sepracor agreed to loan to Versicor amounts as required for operating purposes.
The amounts outstanding under the 1995 note accrued interest at the prime rate
plus 1/2% not to exceed 9.5%. The amounts outstanding under the 1997 note
accrued interest at the prime rate minus 1/4%, adjusted under certain
circumstances. The Note Agreements were convertible, at the option of Sepracor,
into Versicor Series B Convertible Preferred Stock by dividing the amount
outstanding, including principal and interest, by $0.7833.
On December 9, 1997, Sepracor converted an aggregate of $9,530,000 of the
foregoing Note Agreements into 12,166,667 shares of Versicor Series B Preferred
Stock (1,095,000 shares on a common equivalent basis after giving effect to a
9-for-1 reverse common stock split declared by Versicor in December 1997). On
December 31, 1997, Versicor repaid Sepracor the remaining $6,034,000 due under
the Note Agreements.
In 1996, Sepracor, BioSepra and Versicor entered into a revolving credit
agreement with a commercial bank that provides for borrowing of up to an
aggregate of $10,000,000 (the "Revolving Credit Agreement"), pursuant to which
BioSepra and Versicor could borrow up to $3,000,000 each. All borrowings are
collateralized by certain assets of the companies. On December 30, 1997, the
Revolving Credit Agreement was amended to remove Versicor as a party thereto.
The Revolving Credit Agreement contains covenants relating to minimum tangible
capital base, minimum cash or cash equivalents, minimum liquidity ratio and
maximum leverage for Sepracor and BioSepra. Sepracor is a guarantor of all
outstanding borrowings. At December 31, 1997, there were no amounts outstanding
under this agreement. The annual interest rate on such borrowings is at the
lower of the prime rate or LIBOR plus 175 basis points.
On December 30, 1997, Sepracor entered into a put agreement with a commercial
bank pursuant to which Sepracor agreed to purchase $2,000,000 of indebtedness of
Versicor, a former wholly owned subsidiary, in the event of a default by
Versicor under its loan agreement with the bank. In the event that the put right
is exercised by the bank, the bank will assign its security interest in the
fixed assets of Versicor to Sepracor.
On February 10, 1998, Sepracor issued $189,475,000 of 6 1/4% Convertible
Subordinated Debentures due 2005 (the "6 1/4% Debentures"). The 6 1/4%
Debentures are convertible into Sepracor common stock, at the option of the
holder, at a price of $47.369 per share. The 6 1/4% Debentures bear interest at
6 1/4% payable semi-annually, commencing on August 15, 1998. The 6 1/4%
Debentures are not redeemable by the Company prior to February 18, 2001. The
Company may be required to repurchase the 6 1/4% Debentures at the option of the
holders in certain circumstances. As part of the sale of the 6 1/4% Debentures,
Sepracor incurred approximately $5,915,000 of offering costs, which will be
recorded as other assets and amortized over seven years, the term of the 6 1/4%
Debentures. The net proceeds to the Company after offering costs was
$183,560,000. The Company intends to use the proceeds from the sale of the 6
1/4% Debentures for the establishment of the Company's respiratory sales force,
marketing of certain ICEs, ongoing preclinical and clinical trials, funding of
other research and development programs, and working capital and other general
corporate purposes.
On March 26, 1998, Sepracor and Beckman terminated their Stock Purchase
Agreement under which Beckman acquired 312,500 shares of Sepracor Series B
Redeemable Preferred Stock. Sepracor paid Beckman the original purchase price of
the stock plus accrued dividends totalling $6,850,000. As a result of this
termination, subsequent to year-end, Sepracor has reclassed its convertible
redeemable preferred stock as a current liability at December 31, 1997. In
addition, BioSepra and Beckman amended their distribution agreement whereby
BioSepra granted a non-exclusive right to manufacture instruments to Beckman,
20
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
removed its obligation to manufacture instruments for Beckman, and sold the
discontinued instrument product inventory to Beckman for $250,000.
LEGAL PROCEEDINGS In July 1997, the United States Patent and Trademark Office
(the "PTO") informed Sepracor that it had declared an interference between
Sepracor's previously issued method-of-use patent on fexofenadine to treat
allergic rhinitis and another similar patent application of Sepracor, and HMRI's
method-of-use patent application on the anti-histaminic effects of fexofenadine
on hepatically impaired patents. The primary objective of a patent interference,
which can only be declared by the PTO, is to determine the first to invent any
overlapping subject matter claimed by more than one party. In the course of an
interference, the parties typically present evidence relating to their inventive
activities as to the overlapping subject matter. The PTO then reviews the
evidence to determine which party has the earliest legally sufficient inventive
date, and, therefore, is entitled to a patent claiming the overlapping subject
matter.
If Sepracor prevails in the interference, Sepracor will retain all of its claims
in its issued patent. If, however, Sepracor loses the interference, HMRI will be
issued a U.S. patent containing its claims involved in the interference and may
not be obligated to pay Sepracor milestone or royalty payments pursuant to the
terms of the license agreement whereby Sepracor licensed its U.S. patent rights
covering fexofenadine to HMRI in 1993.
In December 1997, The Company and its subsidiary, BioSepra, settled their long
standing patent lawsuit with PerSeptive Biosystems, Inc. ("PerSeptive"), a
competitor of BioSepra. Under the terms of the settlement, PerSeptive received
an unspecified amount and BioSepra obtained a limited, non-exclusive license
under PerSeptive's Perfusion Chromatography R patents to make, use and sell its
HyperD R product line free of claims of infringements by PerSeptive.
HemaSure is a defendant in two lawsuits brought by Pall Corporation ("Pall"). In
complaints filed in February 1996 and November 1996, Pall alleged that
HemaSure's manufacture, use and/or sale of the LeukoNet product infringes upon
three patents held by Pall. On October 14, 1996, in connection with the first
action concerning U.S. Patent No. 5,451,321 (the "'321 patent"), HemaSure filed
for summary judgment of noninfringement. Pall filed a cross motion for summary
judgment of infringement at the same time. In October 1997, the U.S. District
Court of the Eastern District of New York granted in part Pall's summary
judgment motion relating to the '321 patent. The court has not yet ruled on the
validity of Pall's '321 patent claims, which HemaSure has asserted are invalid
and unenforceable. The court now will need to review and determine the validity
of this patent prior to any further action. No date has been set for these
proceedings.
With respect to the second action concerning U.S. Patent Nos. 4,340,479 (the
"'479 patent") and 4,952,572 (the "'572 patent"), HemaSure has answered the
complaint stating that it does not infringe any claim of the asserted patents.
Further, HemaSure has counterclaimed for declaratory judgment of invalidity,
noninfringement and unenforceability of the '572 patent, and a declaratory
judgment of noninfringement of the '479 patent, as a result of a license.
HemaSure believes, based on advice of its patent counsel, that a properly
informed court should conclude that the manufacture, use and/or sale by HemaSure
or its customers of the present LeukoNet product does not infringe any valid
enforceable claim of the three asserted Pall patents. However, there can be no
assurance that HemaSure will prevail in the pending litigations, and an adverse
outcome in a patent infringement action would have a material adverse effect on
HemaSures's future business and operations.
FACTORS AFFECTING FUTURE OPERATING RESULTS Certain of the information contained
in this Annual Report, including information with respect to the safety,
efficacy and potential benefits of the Company's Improved Chemical Entities
("ICE(TM)s") under development and the scope of patent protection with respect
to these products and information with respect to the other plans and strategy
for the Company's business and the business of the subsidiaries and certain
affiliates of the Company, consists of forward-looking statements. Important
factors that could cause actual results to differ materially from the
forward-looking statements include the following:
Since substantially all of Sepracor's ICEs are at the early stages of
development, there can be no assurance that these drugs will have improved
characteristics that provide greater benefits or fewer side effects than the
corresponding parent drugs or that research efforts undertaken by Sepracor will
lead to the discovery of future drugs with such improved characteristics. All of
the drugs under development will require significant additional research,
development, preclinical and/or clinical testing, regulatory approval and an
additional commitment of resources prior to their successful development and
commercialization. Sepracor has limited experience in conducting human clinical
trials and in manufacturing pharmaceutical products and has no experience in
marketing such products.
Proprietary rights relating to the products of Sepracor will be protected from
unauthorized use by third parties only to the extent that they are covered by
valid and enforceable patents or are maintained in confidence as trade secrets.
Sepracor has filed patent applications covering compositions containing, and
methods of using, single isomer or active-metabolite forms of various compounds
for specific applications. The ability to commercialize successfully any ICE
will depend to a significant degree upon the ability to obtain and maintain use
patents of sufficient scope to prevent third parties from developing similar or
competitive products. Most of the ICEs for which Sepracor has obtained use
patents or filed applications therefor are claimed by composition of matter or
other patents or patent applications held by third parties. In each such case,
unless subject to an existing license agreement, the ICE may not be
commercialized until the expiration of corresponding third party
composition-of-matter or other patents. There can be no assurance that any
pending patent applications relating to the products of Sepracor will result in
patents being issued or that any such patents will afford protection against
competitors with similar technology. There may be pending or issued third-party
patents relating to the product of Sepracor and Sepracor may need to acquire
licenses to, or to contest the validity of, any such patents. It is likely that
significant funds would be required to defend any claim that Sepracor
21
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
infringes a third-party patent, and any such claim could adversely affect sales
of the challenged product of Sepracor until the claim is resolved. There can be
no assurance that any license required under any such patent would be made
available. Certain of the technology that may be used in the products of
Sepracor is not covered by any patent or patent application. In the absence of
patent protection, the business of Sepracor may be adversely affected by
competitors who independently develop substantially equivalent technology.
In July 1997, the PTO informed Sepracor that it had declared an interference
between Sepracor's previously issued use patent on fexofenadine to treat
allergic rhinitis and another similar patent application of Sepracor, and the
use patent application of HMRI on the anti-histaminic effects of fexofenadine on
hepatically impaired patients. The primary objective of a patent interference,
which can only be declared by the PTO, is to determine which party was the first
to invent any overlapping subject matter claimed by more than one party. In the
course of an interference, the parties typically present evidence relating to
their invention of the overlapping subject matter. The PTO then reviews the
evidence to determine which party has the earliest legally sufficient date of
invention, and, therefore, is entitled to a patent claiming the overlapping
subject matter. If Sepracor prevails in the interference, Sepracor will retain
all of its claims in its issued patent. If, however, Sepracor loses the
interference, HMRI will be issued a U.S. patent containing its claims involved
in the interference and may not be obligated to pay Sepracor milestone or
royalty payments pursuant to the terms of the license agreement whereby Sepracor
licensed its U.S. patent rights covering fexofenadine to HMRI in 1993. Sepracor
and HMRI have agreed to resolve the interference by arbitration. Selection of
the arbitrator and initiation of the arbitration proceeding is expected to occur
in the first half of 1998. While it is possible that the arbitrator's decision
may be rendered during 1998, there can be no assurance that the arbitrator's
decision will be rendered at that time. Once rendered, the arbitrator's decision
must be submitted to the PTO for final approval. The interference is in its
early stages and the Company is unable to predict its outcome.
The marketing and sale of pharmaceutical products developed by Sepracor or its
development partners will require FDA approvals as well as similar approvals in
foreign countries. To obtain such approvals, the safety and efficacy of such
products must be demonstrated through clinical trials. There can be no assurance
that the results of such clinical trials will be consistent with the results
obtained in preclinical studies or that the results obtained in later phases of
clinical trials will be consistent with those obtained in earlier phases. There
also can be no assurance that any such products will be shown to be safe and
efficacious or that regulatory approval for any such products will be obtained
on a timely basis, if at all. The clinical trial and regulatory approval process
can take a number of years and require the expenditure of substantial resources.
With respect to certain of the Company's ICEs, the Company has been able to
shorten the regulatory approval process of its ICEs by relying on preclinical
and clinical toxicology data already on file with the FDA with respect to the
parent drug. Although Sepracor has to date been successful in employing this
strategy in connection with the approval process of certain of its proposed
products, there can be no assurance that the FDA will permit the Company to
utilize this strategy in the future. Accordingly, the Company may be required to
expend significant resources to complete such preclinical and clinical studies
for its other ICEs, thereby significantly delaying the regulatory approval
process. The failure of the Company to obtain regulatory approval on a timely
basis and unanticipated significant expenditures on preclinical and clinical
studies could adversely affect the financial condition of the Company. While the
Company expects FDA approval of its NDA for the nebulized form of levalbuterol
in late 1998, there can be no assurance that the FDA will approve such NDA by
such date, if at all.
The Company currently has very limited sales and marketing experience. If the
Company is successful in developing and obtaining regulatory approval for its
products under development, it expects to license certain products to large
pharmaceutical companies and market and sell certain other products through its
direct specialty sales forces or through other arrangements, including
co-promotion arrangements. In anticipation of expected FDA approval of the
nebulized form of levalbuterol later this year, the Company is beginning to
establish a direct sales force to market the inhalation solution of
levalbuterol. Further, as the Company begins to enter into co-promotion
arrangements or market and sell additional products directly, the Company will
need to significantly expand its sales force. It is expected that the Company
will incur significant expense in establishing its direct sales force. The
ability of the Company to realize significant revenues from its direct marketing
and sales activities is dependent on its ability to attract and retain qualified
sales personnel in the pharmaceutical industry. There can be no assurance,
however, that the Company will be able to attract and retain such qualified
sales personnel, that it will successfully expand its marketing and direct sales
force in the future on a timely basis, that the cost of establishing such
marketing or sales force will not exceed any product revenues, that its sales
and marketing efforts will be successful, or that the need to comply with FDA
limits on drug product marketing, including limits on claims of comparative
safety or efficacy, will not inhibit the effectiveness of such marketing. In
addition, the Company will need to enter into co-promotion arrangements with
third parties where its own direct sales force is neither well situated nor
large enough to achieve maximum penetration in the market. There can be no
assurance that the Company will be successful in entering into any such
arrangements or that the terms of any such arrangements will be favorable to the
Company.
Sepracor's ability to commercialize certain drugs that it develops is likely to
depend in significant part on its ability to enter into collaborative agreements
with pharmaceutical companies to fund all or part of the costs to complete the
development of such drugs and to manufacture and/or market such drugs. To date,
the Company has entered into three such collaborative agreements. The Company
has licensed its U.S. patent rights to Allegra (fexofenadine) to HMRI and is
entitled to receive royalties on all U.S. sales of Allegra when the patent on
the parent drug expires. The Company, however, is currently party to an
interference involving Allegra which, if decided adversely to the Company, could
result in the loss of all or substantially all of the royalties to which the
Company is entitled under the license agreement on future sales of Allegra. The
Company has also licensed its worldwide patent
22
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
rights in DCL to Schering-Plough, pursuant to which the Company is entitled to
receive royalties from Schering-Plough upon the initial sale of the product. The
Company has entered into an agreement with Janssen with respect to the joint
development and co-promotion of norastemizole. In each of these collaborative
arrangements and, to the extent the Company enters into additional collaborative
arrangements, the Company is dependent upon the efforts of the collaboration
partners and there can be no assurance that such efforts will be successful. If
any collaborators were to breach or terminate their agreements with the Company
or fail to perform their obligations thereunder in a timely manner, the
development and commercialization of the products could be delayed or
terminated. Any such delay or termination could have a material, adverse effect
on the Company's financial condition and results of operation. Sepracor's
failure or inability to perform certain of its obligations under a collaborative
agreement could result in a reduction or loss of the benefits to which Sepracor
is otherwise entitled under such agreement. There can be no assurance that
Sepracor will be able to enter into any such agreements for ICEs in the future
or that such collaborative agreements, if any, will be entered into on terms
favorable to the Company.
The Company currently operates a current Good Manufacturing Practices ("cGMP")
compliant manufacturing plant which the Company believes has sufficient capacity
to support the production of its drugs in quantities required for its clinical
trials. While the Company believes it has the capability to scale up its
manufacturing processes and manufacture sufficient quantities of certain of the
products which may be approved for sale, without additional expansion, the
Company will not have the capability to manufacture in sufficient quantities all
of the products which may be approved for sale. Accordingly, the Company may be
required to expend additional resources to expand its current facility,
construct an additional facility or contract the production of these drugs to
third party manufacturers. There can be no assurance that the Company will have
the resources to expand its existing or develop additional facilities or
contract with manufacturers to produce its products in commercial quantities or
that any contract with third party manufacturers will be on favorable terms to
the Company. There can be no assurance that the Company will succeed in scaling
up its manufacturing processes or maintaining cGMP compliance. Failure in either
respect can lead to refusal by the FDA to approve marketing applications.
Failure to maintain cGMP compliance may also be the basis for action by the FDA
to withdraw approvals that have been granted and for other regulatory action.
The testing, marketing and sale of human health care products entails an
inherent risk of product liability and there can be no assurance that product
liability claims will not be asserted against Sepracor. Sepracor and its
subsidiaries maintain limited product liability insurance coverage for both the
clinical trials and commercialization of its products. There can be no assurance
that Sepracor will be able to obtain further product liability insurance on
acceptable terms, if at all, or that any current insurance subsequently obtained
will provide adequate coverage against all potential claims.
The Company will require substantial additional funds for its research and
product development programs, operating expenses, the pursuit of regulatory
approvals and expansion of its production, sales and marketing capabilities.
Adequate funds for these purposes, whether through equity or debt financing,
collaborative or other arrangements with corporate partners or from other
sources, may not be available when needed or terms acceptable to the Company.
Insufficient funds could require the Company to delay, scale back or eliminate
certain of its research and product development programs or to license to third
parties to commercialize products or technologies that the Company would
otherwise develop or commercialize itself. While the Company believes that its
available cash balances will be sufficient to meet its capital requirements into
2000, the Company may need to raise additional funds to support its long term
product development and commercialization programs. There can be no assurance
that such capital will be available on favorable terms, if at all. The Company's
cash requirements may vary materially from those now planned because of results
of research and development, results of product testing, relationships with
customers, changes in focus and direction of the Company's research and
development programs, competitive and technological advances, patent
developments, the FDA regulatory process, the capital requirements of BioSepra
and Sepracor Canada Limited, and other factors.
The Company is currently evaluating the potential impact of the year 2000 on the
processing of date-sensitive information by the Company's computerized
information systems. The year 2000 problem is the result of computer programs
being written using two digits (rather than four) to define the applicable year.
Any of the Company's programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000, which could result
in miscalculation or system failures. Based on preliminary information, costs of
addressing potential problems are not currently expected to have a material
adverse impact on the Company's financial position, results of operations or
cash flows in the future periods. However, if the Company, its customers or
vendors are unable to resolve such processing issues in a timely manner, it
could result in a material financial risk. Accordingly, the Company plans to
devote the necessary resources to resolve all significant year 2000 issues in a
timely manner.
Other factors that may affect the Company's future operating results include the
Company's fluctuations in quarterly operating results, its ability to meet its
debt service requirements and to compete successfully in the market.
Factors that may affect the future operating results of Sepracor include the
ability of BioSepra to obtain additional financing, the dependence on BioSepra
sales of HyperD media, which was introduced in 1993, and BioSepra's ability to
sell its products to customers at the early stage of their product development
cycles.
Factors that may affect the future operating results of Sepracor include the
ability of HemaSure to develop commercially viable products and HemaSure's
limited number of customers.
Because of the foregoing factors, past financial results should not be relied
upon as an indication of future performance. The Company believes that
period-to-period comparisons of its financial results are not necessarily
meaningful and it expects that its results of operations may fluctuate from
period to period in the future.
23
27
SUPPLEMENTAL STOCKHOLDER INFORMATION
PRICE RANGE OF COMMON STOCK
The Common Stock of Sepracor Inc. is traded on the Nasdaq National Market under
the symbol SEPR. Prior to September 20, 1991, the Company's Common Stock was not
publicly traded. On March 13, 1998, the closing price of the Company's Common
Stock, as reported on the Nasdaq National Market, was $39 13/16 per share. The
following table sets forth for the periods indicated the high and low sales
prices per share of the Common Stock as reported by the Nasdaq National Market.
1997 HIGH LOW
- ---------------------------------------------------------------------------------
FIRST QUARTER 27 1/8 16
SECOND QUARTER 27 1/8 18
THIRD QUARTER 42 3/4 19
FOURTH QUARTER 42 3/4 28 3/8
1996 High Low
- ---------------------------------------------------------------------------------
First Quarter 20 1/8 14
Second Quarter 16 1/4 11 1/8
Third Quarter 16 1/8 10 1/4
Fourth Quarter 17 1/8 13 3/4
On March 13, 1998, Sepracor had approximately 479 stockholders of record.
DIVIDEND POLICY
Sepracor has never paid cash dividends on its Common Stock. The Company
currently intends to reinvest its earnings, if any, for use in the business and
does not expect to pay cash dividends in the foreseeable future.
TRANSFER AGENT AND REGISTRAR
Questions regarding accounts, address changes, stock transfer and lost
certificates should be directed to:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
P.O. Box 8040
Boston, MA 02266-8040
Phone: (781) 575-3120
FORM 10-K
A copy of the Company's Annual Report on Form 10-K for the year ended December
31, 1997 is available without charge upon written request to:
Investor Relations
Sepracor Inc.
111 Locke Drive
Marlborough, MA 01752
24
28
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF SEPRACOR INC.:
We have audited the accompanying consolidated balance sheets of Sepracor Inc. as
of December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of Sepracor's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
1997 and 1996 financial statements of BioSepra Inc., a majority-owned
subsidiary, whose statements constitute 12% and 16% of total assets and 87% and
95% of total revenues of the related 1997 and 1996 consolidated totals,
respectively.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sepracor Inc. as of
December 31, 1997 and 1996 and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31, 1997
in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Boston, Massachusetts
February 19, 1998, except as to the information in Note W for which the date is
March 26, 1998.
25
29
SEPRACOR INC. CONSOLIDATED BALANCE SHEETS
December 31 (in thousands, except par value amounts) 1997 1996
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents (Note B) $ 82,579 $ 83,344
Marketable securities (Note B) 9,981 20,306
Accounts receivable (Note E) 2,415 3,129
Inventories (Note F) 2,722 3,481
Other assets 1,543 1,588
-------------------------
Total current assets 99,240 111,848
-------------------------
Property and equipment, net (Note G) 15,126 17,045
Investment in affiliates (Note D) 3,971 3,100
Excess of investment over net assets acquired, net (Notes B, H and T) 5,288 9,254
Other assets (Note L) 4,882 5,442
-------------------------
Total assets 128,507 146,689
-------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,018 $ 4,300
Accrued expenses (Note I) 17,670 12,174
Deferred revenue (Note B and J) 21 3,646
Notes payable and current portion of capital lease obligation and
long-term debt (Notes K and M) 861 804
Convertible redeemable preferred stock (Notes O and W) 6,700 --
-------------------------
Total current liabilities 29,270 20,924
-------------------------
Long-term debt and capital lease obligation (Notes K and M) 3,388 4,387
Convertible subordinated debentures (Note L) 80,880 80,880
-------------------------
Total liabilities 113,538 106,191
-------------------------
Convertible redeemable preferred stock (Notes O and W) -- 6,100
Minority interest (Note C) 2,937 4,006
Commitments and contingencies (Notes M and N)
Stockholders' equity (Notes C, D, L, O and P)
Common stock, $.10 par value, authorized 40,000 in 1997 and 1996, issued and
outstanding 27,853 in 1997 and 27,271 in 1996 2,785 2,727
Additional paid-in capital 222,504 214,399
Unearned compensation, net (Note O) (94) (234)
Accumulated deficit (213,028) (186,905)
Equity adjustments (135) 405
-------------------------
Total stockholders' equity 12,032 30,392
-------------------------
Total liabilities and stockholders' equity $ 128,507 $ 146,689
-------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
26
30
SEPRACOR INC. CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, (in thousands, except per share amounts) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Revenues:
Product sales $ 9,636 $ 13,784 $ 14,271
Collaborative research and development 58 25 1,036
License fees and royalties (Note R) 5,643 1,232 900
--------------------------------------
Total revenues 15,337 15,041 16,207
--------------------------------------
Costs and expenses:
Cost of products sold 5,992 6,784 10,410
Research and development 43,055 35,828 21,707
Selling, general and administrative 15,594 15,245 19,037
Legal expense related to patents 1,660 1,067 1,374
Restructuring and impairment charges (Note H) 4,179 -- 4,144
--------------------------------------
Total costs and expenses 70,480 58,924 56,672
--------------------------------------
Loss from operations (55,143) (43,883) (40,465)
--------------------------------------
Other income (expense):
Equity in investee losses (Note D) (2,755) (17,539) (808)
Interest income 5,766 6,713 3,228
Interest expense (5,976) (6,140) (2,077)
Gain on sale of ChiRex Inc. 30,069 -- --
Other income (expense) 547 (107) (1,171)
--------------------------------------
Net loss before minority interests (27,492) (60,956) (41,293)
Minority interests in subsidiaries (Note C) 1,369 846 7,881
--------------------------------------
Net loss $(26,123) $(60,110) $(33,412)
--------------------------------------
Net loss applicable to common shares (Note B) $(26,723) $(60,710) $(33,412)
--------------------------------------
Basic and diluted net loss per common share (Note B) $ (0.97) $ (2.25) $ (1.54)
--------------------------------------
Basic and diluted weighted average number of common shares
outstanding (Note B) 27,599 27,032 21,637
The accompanying notes are an integral part of the consolidated financial
statements.
27
31
SEPRACOR INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Additional
Preferred Stock Common Stock Paid-In
Year ended December 31, 1997, 1996 and 1995 (in thousands) Shares Amount Shares Amount Capital
- -------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 79 $ 79 18,681 $1,868 $122,048
-------------------------------------------------------------
Issuance of common stock to employees
under stock plans 430 43 1,141
Gain on issuance of subsidiary's stock 15,235
Issuance of common stock in public
follow-on offering and warrant exercises 5,620 562 68,110
Issuance of common stock for acquisition 102 11 1,399
Issuance of common stock from conversion
of subordinated convertible notes 1,189 119 5,381
Issuance of common stock from conversion
of preferred stock (79) (79) 794 79
Accrued dividends from preferred stock (500)
Net loss
Equity adjustments
-------------------------------------------------------------
Balance at December 31, 1995 -- -- 26,816 $2,682 212,814
-------------------------------------------------------------
Issuance of common stock to employees
under stock plans 455 45 2,185
Accrued dividends from preferred stock (600)
Unearned compensation, net
Net loss
Equity adjustments
-------------------------------------------------------------
Balance at December 31, 1996 -- -- 27,271 $2,727 214,399
-------------------------------------------------------------
Issuance of common stock to employees
under stock plans 582 58 3,017
Unearned compensation, net
Accrued dividends from preferred stock (600)
Gain on issuance of subsidiary's stock 5,688
Net loss
Equity adjustments
-------------------------------------------------------------
Balance at December 31, 1997 -- $-- $27,853 $2,785 $222,504
-------------------------------------------------------------
Total
Unearned Accumulated Equity Stockholders'
Year ended December 31, 1997, 1996 and 1995 (in thousands) Compensation Deficit Adjustments Equity
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 $ -- $ (93,383) $(127) $ 30,485
-------------------------------------------------------------
Issuance of common stock to employees
under stock plans 1,184
Gain on issuance of subsidiary's stock 15,235
Issuance of common stock in public
follow-on offering and warrant exercises 68,672
Issuance of common stock for acquisition 1,410
Issuance of common stock from conversion
of subordinated convertible notes 5,500
Issuance of common stock from conversion
of preferred stock
Accrued dividends from preferred stock (500)
Net loss (33,412) (33,412)
Equity adjustments 653 653
-------------------------------------------------------------
Balance at December 31, 1995 -- (126,795) 526 89,227
-------------------------------------------------------------
Issuance of common stock to employees
under stock plans 2,230
Accrued dividends from preferred stock (600)
Unearned compensation, net $(234) (234)
Net loss (60,110) (60,110)
Equity adjustments (121) (121)
-------------------------------------------------------------
Balance at December 31, 1996 (234) (186,905) 405 30,392
-------------------------------------------------------------
Issuance of common stock to employees
under stock plans 3,075
Unearned compensation, net 140 140
Accrued dividends from preferred stock (600)
Gain on issuance of subsidiary's stock 5,688
Net loss (26,123) (26,123)
Equity adjustments (540) (540)
-------------------------------------------------------------
Balance at December 31, 1997 $ (94) $(213,028) $(135) $(12,032)
-------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
28
32
SEPRACOR INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, (in thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $ (26,123) $ (60,110) $ (33,412)
Adjustments to reconcile net loss to net cash used in operating activities:
Minority interests in subsidiaries (1,369) (846) (7,881)
Depreciation and amortization 4,614 4,400 2,785
Provision for doubtful accounts 150 142 286
Equity in investee losses 2,755 17,539 808
Loss on disposal of property and equipment 24 125 10
Restructuring and impairment charges 4,018 -- 2,629
Gain on sale of equity investee (30,069) -- --
Changes in operating assets and liabilities, net of effects of acquired
business:
Accounts receivable 383 2,069 4,272
Inventories (46) (72) 1,727
Other current assets 50 (796) (313)
Accounts payable (136) 1,115 (3,315)
Accrued expenses 5,606 6,176 1,424
Deferred revenue (3,620) 147 2,757
-----------------------------------------
Net cash used in operating activities (43,763) (30,111) (28,223)
-----------------------------------------
Cash flows from investing activities:
Purchases of marketable securities (60,961) (93,328) (24,584)
Sales and maturities of marketable securities 71,285 80,454 19,350
Additions to property and equipment (2,653) (10,121) (3,184)
Proceeds from sale of equipment 7 147 34
Investment in subsidiary -- -- (6,639)
Investment in affiliate (4,046) -- --
Net proceeds from sale of equity investee 30,625 -- --
Proceeds from affiliate's repayment of long-term note 6,034 -- --
(Increase) decrease in other assets 449 1,560 (1,203)
-----------------------------------------
Net cash provided by (used in) investing activities 40,740 (21,288) (16,226)
-----------------------------------------
Cash flows from financing activities:
Net proceeds from issuance of stock 3,203 2,047 74,904
Proceeds from sale of convertible subordinated debentures -- -- 78,268
Borrowings under long-term debt 174 -- 3,778
Repayments of long-term debt (962) (826) (439)
Repayments under line of credit agreements (11) (2,299) (1,701)
-----------------------------------------
Net cash provided by (used in) financing activities 2,404 (1,078) 154,810
-----------------------------------------
Effect of exchange rate changes on cash and cash equivalents (146) 3 60
-----------------------------------------
Net increase (decrease) in cash and cash equivalents (765) (52,474) 110,421
Cash and cash equivalents at beginning of year 83,344 135,818 25,397
-----------------------------------------
Cash and cash equivalents at end of year 82,579 $ 83,344 $ 135,818
-----------------------------------------
Supplemental schedule of cash flow information:
Cash paid during the year for interest $ 5,980 $ 6,337 $ 1,666
Capital lease obligations incurred $ -- $ 61 $ 915
-----------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
29
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A - NATURE OF THE BUSINESS
Sepracor Inc. was incorporated in 1984 to research, develop and commercialize
products for the synthesis, separation and purification of pharmaceutical and
biopharmaceutical compounds. Specifically, Sepracor is developing improved
versions of top-selling drugs called ICE(TM) Pharmaceuticals (Improved Chemical
Entities). Sepracor is focusing on advancing its pharmaceutical programs and
strengthening its patent positions for these ICE pharmaceuticals. Sepracor's
100% owned subsidiary, Sepracor Canada Ltd., supplies clinical material to
Sepracor through its manufacturing facility in Windsor, Nova Scotia which
commenced operations in February 1995. Sepracor's 64% owned subsidiary, BioSepra
Inc., with operations in France and the U.S., is committed to supplying
high-quality, reliable bioprocessing media and equipment to the biotechnology
industry (See Note H). Sepracor's 37% owned subsidiary, HemaSure Inc., is
dedicated to making blood safer through blood filtration devices. Sepracor's 22%
owned subsidiary, Versicor Inc., has initiated a program in combinatorial
chemistry. This emerging field involves the creation of diverse chemical
libraries, consisting of three-dimensional, space filling chiral molecules.
Sepracor and its subsidiaries are subject to risks common to companies in the
industry including, but not limited to, development by Sepracor or its
competitors of new technological innovations, dependence on key personnel,
protection of proprietary technology and compliance with government regulations.
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: Consolidated financial statements include the
accounts of Sepracor and all of its wholly and majority owned subsidiaries. All
material intercompany transactions have been eliminated. Investments in
affiliated companies which are 50% owned or less are accounted for using the
equity method. Versicor had been a consolidated entity until December 10, 1997
and was included in Sepracor's consolidated financial statements for the years
ended December 31, 1996 and December 31, 1995. Versicor's financial results were
consolidated for the period January 1, 1997 through December 10, 1997. See Notes
C and D for further discussion.
The Company accounts for the sale of subsidiary stock in different manners,
depending on the life-cycle of the entity. The Company will offset any gains or
losses against additional paid-in capital for early development stage
subsidiaries. For later stage subsidiaries, the Company records gains or losses
as other income or expense.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the following:
(1) the reported amounts of assets and liabilities, (2) the disclosure of
contingent assets and liabilities at the dates of the financial statements and
(3) the reported amounts of the revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
TRANSLATION OF FOREIGN CURRENCIES: The assets and liabilities of Sepracor's
international subsidiaries are translated into U.S. dollars using current
exchange rates. Statement of operations amounts are translated at average
exchange rates prevailing during the period. The resulting translation
adjustment is recorded in the equity adjustments account in stockholders'
equity. Foreign exchange transaction gains and losses are included in other
income (expense).
CASH AND CASH EQUIVALENTS: Sepracor considers all highly liquid debt instruments
purchased with an initial maturity of three months or less to be cash
equivalents. As of December 31, 1997 and 1996, cash equivalents primarily
consist of $1,165,000 and $4,511,000 in repurchase agreements, $61,011,000 and
$70,215,000 in high quality corporate and government commercial paper and
$19,530,000 and $8,403,000 of money market instruments which invest primarily in
U.S. Treasury securities, respectively.
CONCENTRATION OF CREDIT RISK: The Company has no significant off-balance-sheet
concentration of credit risk such as foreign exchange contracts, option
contracts or other foreign hedging arrangements. The Company maintains the
majority of its cash balances with financial institutions. Financial instruments
that potentially subject the Company to concentrations of credit risk primarily
consist of the cash and cash equivalents. The Company places its cash, temporary
cash investments and marketable securities with high credit quality financial
institutions. Financial instruments that subject the Company to credit risk
consist primarily of trade accounts receivable. Customers with amounts due to
the Company that represent greater than 10% of the accounts receivable balance
are as follows:
Year Ended December 31: 1997 1996
- --------------------------------------------------
Customer A 16% 25%
Customer B -- 15%
Customer C 11% --
Customer D -- --
Customer E 24% --
Revenues from significant customers are as follows:
Year Ended December 31: 1997 1996 1995
- ---------------------------------------------------------------
Customer A 33% 24% --
Customer B -- 12% --
Customer C 10% -- --
Customer D 12% -- --
Customer E -- -- --
For financial information by geographic area see Note V.
MARKETABLE SECURITIES: Sepracor has classified its marketable securities as
"available for sale". Marketable securities include government securities and
corporate commercial paper, maturing in less than a year, which can be readily
purchased or sold using established markets. Marketable securities are stated at
fair value. Net realized gains and losses on security transactions are
determined on the
30
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
specific identification cost basis. The market value of Sepracor's marketable
securities at December 31, 1997 and 1996, was not materially different from
cost.
Marketable securities consist of the following at December 31:
(in thousands) 1997 1996
- -------------------------------------------------------------------------------
Government Security $ -- $ 5,000
Corporate commercial paper 9,981 15,306
--------------------------------
$9,981 $20,306
================================
There were no gross realized gains or losses on the sale of marketable
securities for the years ended December 31, 1997, 1996 and 1995, respectively.
INVENTORIES: Inventories are stated at the lower of cost (first-in, first-out)
or market.
PROPERTY AND EQUIPMENT: Property and equipment are stated at cost. Costs of
major additions and betterments are capitalized; maintenance and repairs which
do not improve or extend the life of the respective assets are charged to
operations. On disposal, the related cost and accumulated depreciation or
amortization are removed from the accounts and any resulting gain or loss is
included in the results of operations. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. All
laboratory, manufacturing and office equipment have estimated useful lives of
three to ten years. The building has an estimated useful life of thirty years.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the improvements or the remaining term of the lease.
SOFTWARE DEVELOPMENT COSTS: In accordance with the provision of Statement of
Financial Accounting Standards No. 86 "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed," the Company capitalized
$199,000 of software costs in 1995. These costs are being amortized over the
expected number of units to be shipped. Amortization of $157,000, $311,000 and
$165,000 was charged to cost of sales in 1997, 1996 and 1995, respectively.
There were no capitalizable software costs in 1997 and 1996.
INTANGIBLE ASSETS: The excess of investment over net assets acquired is
amortized using the straight-line method over 20 years. Accumulated amortization
was $7,476,000 and $3,510,000 at December 31, 1997 and 1996, respectively. The
Company evaluates the possible impairment of goodwill at each reporting period
based on the undiscounted projected cash flows of the related unit. Sepracor
capitalizes all significant costs associated with the successful filing of a
patent application. Patent costs are amortized over their estimated useful
lives, not to exceed 17 years. Deferred finance costs relating to expenses
incurred to complete the convertible subordinated debenture offering, completed
in 1995, are amortized over seven years.
Long-lived assets are reviewed for impairment by comparing the fair value of the
assets with their carrying amount. Any write-downs are treated as permanent
reductions in the carrying amount of the assets. Accordingly, the Company
evaluates the possible impairment of goodwill and other assets at each reporting
period based on the undiscounted projected cash flows of the related asset.
REVENUE RECOGNITION: Revenues from product sales are recognized when goods are
shipped or installation is complete. Revenues for contracted services and
research and development contracts are recorded based on effort incurred or
milestones achieved in accordance with the terms of the contract. Deferred
revenues represent progress payments received from customers pursuant to
contract revenues not yet recorded. For construction contracts for bioprocessing
equipment, a downpayment of up to one-third of the approximate value of the
equipment contracts is required prior to beginning work on the contract.
INCOME TAXES: The Company recognizes deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse.
BASIC AND DILUTED NET LOSS PER COMMON SHARE: The Company adopted Statement of
Financial Accounting Standard No. 128, "Earnings Per Share", which modifies the
way in which earnings per share ("EPS") is calculated and disclosed in the
quarter ended December 31, 1997. Basic EPS excludes dilution and is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS is based upon the
weighted-average number of common shares outstanding during the period plus the
additional weighted-average common equivalent shares during the period. Common
equivalent shares are not included in the per share calculations where the
effect of their inclusion would be antidilutive. Common equivalent shares result
from the assumed conversion of preferred stock and the assumed exercises of
outstanding stock options, the proceeds of which are then assumed to have been
used to repurchase outstanding stock options using the treasury stock method. At
December 31, 1997, had the result not been antidilutive, the Company would have
shown 34,137,001 shares as the diluted weighted average number of shares
outstanding. Included in the 1997 and 1996 basic and diluted net loss applicable
to common shares is $600,000 of dividends relating to Series B Redeemable
Exchangeable Preferred Stock (See Note O).
OTHER: The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standard No. 130 "Reporting Comprehensive Income"("SFAS
130") which requires that changes in comprehensive income be shown in a
financial statement that is displayed with the same prominence as other
financial statements. SFAS 130 will become effective for fiscal years beginning
in the first quarter of the fiscal year ending December 31, 1998. The Company
does not expect this standard to have a material effect on the results from
operations.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 specifies new
guidelines for determining a company's operating segments and related
requirements for disclosure. Sepracor is in the process of evaluating the impact
of the new standard on
31
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the presentation of the financial statements and the disclosure therein. SFAS
131 will become effective for fiscal years beginning after December 31, 1998.
C - SEPRACOR SUBSIDIARIES
In 1993, Sepracor formed two wholly-owned subsidiaries, BioSepra and HemaSure.
Sepracor transferred to BioSepra its chromatography business, including all of
the outstanding shares of Sepracor S.A., a French company. Sepracor transferred
to HemaSure its technology relating to the manufacture, use and sale of its
membrane filter products and medical devices for the separation and purification
of blood, blood products and blood components. In March 1994, BioSepra and
HemaSure each completed its initial public offering.
In November 1994, SepraChem, Inc. ("SepraChem") was established as a
wholly-owned subsidiary of Sepracor. In January 1995, in exchange for 7,999,999
common shares, Sepracor transferred to SepraChem the pharmaceutical fine
chemical manufacturing business.
In May 1995, Versicor was formed as a subsidiary of Sepracor. In October 1995,
Versicor sold 485,000 shares of common stock to certain stockholders, 1,600,000
shares of common stock to Sepracor and 400,000 shares of Series A Convertible
Preferred Stock (the "Preferred Stock") to Sepracor. The Preferred Stock was
convertible, at the option of Sepracor, into common on a one-for-one basis.
In June 1995, Sepracor purchased New England Pharmaceuticals ("NEP"). NEP was a
manufacturer of a breath activated inhaler for asthma patients and has patents
relating to this technology. The acquisition was accounted for under the
purchase method of accounting. In June 1996, NEP was merged into Sepracor.
In October 1995, Versicor entered into a Convertible Subordinated Note Agreement
("Note") with Sepracor. Under this Note, Sepracor agreed to loan to Versicor
until October 2, 1998, up to an aggregate of $4,700,000. The Note accrued
interest at prime plus 1/2% not to exceed 9.5%. The Note was convertible, at the
option of Sepracor, into Versicor Series B Convertible Preferred Stock by
dividing the amount outstanding, including principal and interest, by $0.7833.
The amount outstanding was $0 and $5,066,000 at December 31, 1997 and December
31, 1996, respectively. Total interest expense charged to Versicor under this
agreement was $60,000, $349,000 and $17,000 in 1997, 1996 and 1995,
respectively.
In 1996, Versicor also entered into a loan agreement with Sepracor. Under this
agreement Sepracor agreed to loan to Versicor up to an aggregate of $7,500,000.
The loan accrued interest equal to the prime rate minus 1/4, adjusted under
certain circumstances. The total amount outstanding under this loan agreement
was $0 and $2,705,000 at December 31, 1997 and December 31, 1996, respectively.
Total interest expense charged to Versicor under this agreement was $120,000 and
$68,000 in 1997 and 1996, respectively. As of June 23, 1997, this agreement was
amended to provide that the accumulated principal and interest payments due to
Sepracor, was convertible, at the option of Sepracor, into Versicor Series B
Convertible Preferred Stock, by dividing the amount outstanding, including
principal and interest, by $0.7833.
In December 1997, Versicor received private equity financing of approximately
$22,000,000. In exchange for the funding, Versicor issued Series C Preferred
Stock. As part of the transaction, Sepracor exercised its conversion option on
the Versicor Convertible Subordinated Notes in the amount of $9,530,000. The
remaining $6,034,000 outstanding under the Notes was repaid to Sepracor by the
end of 1997. Sepracor recognized a gain of approximately $5,688,000 on the
transaction which was recorded as an increase to additional paid-in capital. At
December 31, 1997, Sepracor had an investment in Versicor of $3,971,000 and
there were no amounts outstanding under either Note. Sepracor's ownership as of
December 31, 1997 was approximately 22%, thereby making Versicor an affiliate
and reportable under the equity method. (See Note D)
In January 1996, BioSepra signed a Promissory Note for $350,000, or so much of
such sum as shall have been advanced by Sepracor (the "Promissory Note"). This
amount is payable over sixty installments and does not bear interest. BioSepra
used the funds for leasehold improvements in its new office space. As of
December 31, 1997, BioSepra had received $350,000 under the Promissory Note and
$245,000 remained outstanding.
In March 1996, Sepracor loaned BioSepra $3,500,000. In addition, Sepracor agreed
to loan BioSepra up to an additional $2,000,000 until March 1997 (the "loans").
Interest on the loans was at prime plus 3/4%. The loans including any interest
thereon, were convertible into the shares of BioSepra common stock, at the
option of Sepracor at any time prior to payment. On June 10, 1996, Sepracor
converted the outstanding principal amount of $5,500,000 plus accrued interest
of $47,639 into 1,369,788 shares of BioSepra common stock. As a result of the
conversion Sepracor owns approximately 64% of BioSepra.
D - SEPRACOR AFFILIATES
In September 1995, HemaSure completed the sale of 2,500,000 shares of its common
stock, pursuant to an underwritten public offering. As a result of the sale,
Sepracor's ownership of the outstanding shares of common stock of HemaSure was
reduced from approximately 55% to approximately 37%. Effective September 27,
1995, Sepracor no longer consolidates HemaSure's financial statements and
accounts for the investment in HemaSure using the equity method. The sale
resulted in a gain of approximately $15,235,000, which was recorded as an
increase to additional paid-in capital. Since the sale, Sepracor recorded
$2,927,000, $15,021,000 and $808,000 of equity investee losses in 1997, 1996 and
1995, respectively. HemaSure's loss in 1996 included $24,748,000 relating to its
one-time operating loss and loss on disposal of its discontinued blood plasma
business. (Sepracor's portion of this was $9,157,000). At December 31, 1997,
Sepracor's investment in HemaSure was zero.
In March 1996, ChiRex Inc. ("ChiRex"), a newly formed corporation that is a
combination of Sterling Organics Limited, and the chiral chemistry business of
Sepracor, completed an initial public offering of common stock. ChiRex sold
6,675,000 shares at $13 per share. In exchange for the contribution of
SepraChem, Sepracor received 3,489,301 shares of ChiRex common stock and as a
result Sepracor owned approximately 32% of ChiRex. Sepracor accounted for this
transaction as a non-monetary exchange of assets and, therefore, no gain or loss
was recorded as a result of this transaction. Since
32
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
March 11, 1996, Sepracor
carried its investment in ChiRex using the equity method of accounting and,
accordingly, recorded $383,000 and $2,518,000 as its share of ChiRex's losses
for the years ended December 31, 1997 (through March 31) and December 31, 1996,
respectively. Included in ChiRex's 1996 results were one-time write-offs of
$11,076,000 (Sepracor's portion of this was $3,544,000) from ChiRex's initial
public offering and resulting transactions.
In March 1997, the Securities and Exchange Commission declared effective a
registration statement for the offering to the public of the 3,489,301 shares of
ChiRex common stock held by Sepracor. On March 31, 1997, Sepracor received net
proceeds of approximately $31,125,000. As a result of this transaction, Sepracor
recognized a gain of $30,069,000, which was recorded as other income.
In December 1997, upon the completion of the private equity financing, Versicor,
a former subsidiary, became an affiliate of Sepracor and accordingly, Sepracor
recorded $75,000 as its share of Versicor's losses for the year ended December
31,1997.
E - ACCOUNTS RECEIVABLE
Sepracor's trade receivables primarily represent amounts due to BioSepra from
companies and research institutions in the United States, Europe and Japan
engaged in the research, development, or production of pharmaceutical and
biopharmaceutical products. BioSepra performs ongoing credit evaluations of its
customers and generally does not require collateral. The allowance for doubtful
accounts was $369,000 and $233,000 at December 31, 1997 and 1996, respectively.
F - INVENTORIES
Inventories consist of the following at December 31:
(in thousands) 1997 1996
- -------------------------------------------------------------------------------
Raw materials $ 600 $1,155
Work in progress 129 310
Finished goods 1,993 2,016
---------------------
$2,722 $3,481
---------------------
G - PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
(in thousands) 1997 1996
- ------------------------------------------------------------------------------
Land $ 74 $ 74
Building 1,993 1,932
Laboratory and manufacturing equipment 10,407 11,233
Office equipment 4,450 4,844
Leasehold improvements 5,411 5,493
---------------------------
22,335 23,576
Accumulated depreciation and amortization (7,761) (6,724)
---------------------------
14,574 16,852
Construction in progress 552 193
---------------------------
$ 15,126 $ 17,045
---------------------------
Depreciation expense was $3,129,000, $2,189,000 and $1,477,000 for the years
ended December 31, 1997, 1996 and 1995, respectively.
H - RESTRUCTURING AND IMPAIRMENT CHARGES
In December 1997, BioSepra recorded restructuring and impairment charges
totaling $4,179,000. Of this amount, $851,000 relates to a cost-reduction
program and $3,328,000 relates to the writedown of intangible assets to their
net realizable value.
The purpose of the cost-reduction program was to enable BioSepra to focus on the
process segments of the biopharmaceutical and genomics market. The program
involved the discontinuance of the instrument product line and a reduction in
the number of employees. As part of the cost-reduction program, $690,000
represents the write down of inventory and fixed assets associated with the
discontinued product line and $161,000 represents severance and benefits related
to the reduction in workforce in the U.S. BioSepra terminated seven employees
consisting of marketing/sales, finance and administrative personnel. BioSepra
expects to pay all of the severance and benefits associated with this workforce
reduction in the first half of 1998. There can be no assurances that this
program will not result in the loss of customers or temporary sales or
production disruptions that could have a materially adverse effect on BioSepra's
business, financial condition or results of operations.
In June 1995, BioSepra announced a major cost-reduction program that involved
the consolidation of its facilities and a significant reduction in the number of
employees. The purpose of the program was to enable BioSepra to focus on the
process development and process segments of the biopharmaceutical market. In
connection with this program in July 1995, BioSepra completed the sale of
Biopass S.A. ("Biopass"), one of BioSepra's French subsidiaries (see Note Q). As
part of the cost-reduction program, BioSepra recorded restructuring and
impairment charges totaling $4,144,000 in the second quarter of 1995. Of this
amount, $1,180,000 represents severance and medical benefits related to the
reduction in workforce in the U.S. and France and $2,964,000 relates to
impairment of intangibles and loss on
33
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
assets to net realizable value. BioSepra has completed its reduction in
workforce related to this cost-reduction program resulting in the termination of
55 employees consisting of research and development, administrative, production
and marketing/sales personnel. BioSepra had paid all of the costs, relating to
the employee reductions made as part of the 1995 restructuring, as of December
31, 1997.
I - ACCRUED EXPENSES
Included in accrued expenses is $9,754,000 and $5,828,000 of accrued research
and development expenses and $1,427,000 and $1,000,000 of accrued compensation
as of December 1997 and 1996, respectively.
J - DEFERRED REVENUE
In March 1995, Sepracor and BioSepra, entered into separate agreements with
Beckman Instruments, Inc. ("Beckman"). Beckman entered into a joint distribution
and development agreement with BioSepra, and Beckman entered into an agreement
with Sepracor to purchase certain preferred stock of Sepracor. The distribution
agreement was extended in July 1996, allowing Beckman to market on a worldwide
exclusive basis for a period of three years certain HyperD chromatographic
columns, and provides for the development (in accordance with certain
milestones) and manufacture by BioSepra of chromatographic systems for Beckman.
In 1997, the agreement was amended, due to the settlement of the PerSeptive
lawsuit (see Note N), eliminating BioSepra's obligation to repay to Beckman part
of such payments made by Beckman under the agreement if BioSepra failed to meet
such milestones or if BioSepra terminates Beckman's right to use and sell
licensed products, including HyperD media, because a court finds that any such
licensed products infringe any third-party patents. As a result of the
amendment, BioSepra recognized $2,700,000 of license fee revenue in December
1997, rather than over the next three years. Under the agreement, Beckman made
payments of $1,400,000 and $3,500,000 in 1996 and 1995, respectively. BioSepra
recognized $3,600,000, $900,000 and $400,000, of revenue under the agreement in
1997, 1996 and 1995, respectively and $3,600,000 was recorded as deferred
revenue as of December 31, 1996. There was no deferred revenue under this
agreement as of December 31, 1997. See Note W for subsequent event.
K - NOTES PAYABLE TO BANK AND LONG-TERM DEBT
Notes payable and long-term debt consist of the following at December 31:
(in thousands) 1997 1996
- -------------------------------------------------------------------------------------------
PIBOR plus .08% French Franc Loan Payable in
quarterly installments through 2000 $ 624 $ 1,012
PIBOR plus 1.8%, French Franc Loan
Payable in quarterly installments through 2001 138 --
Variable rate, 6.45% - 6.57%,
French Franc Line of Credit 1 --
Variable rate, 4.89% - 5.08%,
French Franc Line of Credit -- 13
8.05% French Franc Term Loan, payable in monthly
installments through 1997 -- 7
Loan from Nova Scotia Business Development
Corporation ("NSBDC") bearing interest at 9.25%
until May 31, 2000 and thereafter at 9.5%, repayable
in 120 consecutive monthly payments of $21 principal
plus interest with a final payment of $20 in June 2005 1,925 2,183
Loan from Atlantic Canada Opportunities Agency, non-
interest bearing, repayable in 60 equal installments
commencing March 15, 1998 370 370
Government grant from Nova Scotia Department
of Economic Development 816 992
Obligations under Capital Lease Obligations
(See Note M) 375 614
-------------------------
4,249 5,191
Less current portion (861) (804)
-------------------------
Total $ 3,388 $ 4,387
-------------------------
At December 31, 1997, BioSepra's wholly-owned French subsidiary ("BioSepra
S.A.") had two available credit facilities aggregating 3,000,000 French Francs
from two French commercial banks, of which $1,000 and $13,000 was outstanding at
December 31, 1997 and 1996, respectively. The amount available under the 4.89% -
5.08% credit facility, which is payable on demand, is guaranteed by Sepracor.
Sepracor also guarantees a certain French Franc loan held by BioSepra S.A. The
amount outstanding under this loan was $624,000 and $1,012,000 as of December
31, 1997 and 1996, respectively. The interest rate on this loan at December 31,
1997 and 1996 was 4.50% and 4.23%, respectively.
In December 1996, Sepracor, BioSepra and Versicor entered into a revolving
credit agreement with a commercial bank that provides for borrowing of up to
$10,000,000. This agreement was amended in
34
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 1997 to remove Versicor as a party thereto. BioSepra can borrow up to
$3,000,000. All borrowings are collateralized by certain assets of the
companies. The credit agreement contains covenants relating to minimum tangible
capital base, minimum cash or cash equivalents, minimum liquidity ratio and
maximum leverage for Sepracor and BioSepra. Sepracor is a guarantor of all
outstanding borrowings. At December 31, 1997, there was no amount outstanding
under this agreement. The annual interest rate on such borrowings is the lower
of the prime rate or LIBOR plus 1.75%.
In December 1996, Versicor entered into a term loan agreement with a commercial
bank that provided for borrowing of up to $3,000,000 for the purpose of
financing capital equipment purchases. No term loan could be less than $500,000
and should be payable in sixteen equal quarterly installments commencing on
January 1, 1998 with the final payment of the balance on December 31, 2001 or
such earlier date that the balance shall have been reduced to zero. The annual
interest rate on such borrowings was at the lower of the prime rate or the
bank's Fixed Quoted Rate plus 1/2%. This agreement was terminated in December
1997 and replaced with two term loans, one for $4,034,000 and another for
$2,000,000. Sepracor entered into a put agreement with the commercial bank
pursuant to which Sepracor agreed to purchase $2,000,000 of indebtedness of
Versicor, in the event of a default by Versicor under its loan agreement with
the commercial bank. In the event that the put right is exercised by the bank,
the bank will assign its security interest in the fixed assets of Versicor to
Sepracor.
Sepracor guarantees the loan from NSBDC. The government grant received by
Sepracor Canada Limited may be repayable if Sepracor Canada Limited fails to
meet certain conditions of the agreement. The government assistance is recorded
as debt and is amortized on the same basis as the depreciation of the related
capital assets.
Minimum annual principal repayment of long-term debt, excluding capital leases,
in each of the next five years are as follows: 1998-$603,000, 1999-$623,000,
2000-$501,000, 2001-$343,000, 2002-$332,000.
L - CONVERTIBLE SUBORDINATED DEBENTURES
In November and December, 1995, Sepracor issued $80,880,000 of Convertible
Subordinated Debentures (the "Debentures"). The Debentures bear interest at 7%
payable semi-annually, commencing on June 1, 1996, and are due on December 1,
2002. The Debentures are convertible into shares of Common Stock of the Company
at $19.68 per share. The Debentures are not redeemable by the Company until
December 1, 1998. As part of the sale of the Debentures, Sepracor incurred
approximately $2,788,000 of offering costs. These costs are classified in other
assets and are being amortized over the life of the Debentures, which is seven
years.
On February 10, 1998, Sepracor issued $189,475,000 of 6 1/4% Convertible
Subordinated Debentures due 2005 (the "6 1/4% Debentures"). The 6 1/4%
Debentures are convertible into Sepracor Common Stock, at the option of the
holder, at a price of $47.369 per share. The 6 1/4% Debentures bear interest at
6 1/4% payable semi-annually, commencing on August 15, 1998. The 6 1/4%
Debentures are not redeemable by the Company prior to February 18, 2001. The
Company may be required to repurchase the 6 1/4% Debentures at the option of the
holders in certain circumstances. As part of the sale of the 6 1/4% Debentures,
Sepracor incurred approximately $5,915,000 of offering costs, which will be
recorded as other assets and amortized over seven years, the term of the 6 1/4%
Debentures. The net proceeds to the Company after offering costs was
$183,560,000. The Company intends to use the proceeds from the sale of the
6 1/4% Debentures for the establishment of the Company's respiratory sales
force, marketing of certain ICEs, ongoing preclinical and clinical trials,
funding of other research and development programs, and working capital and
other general corporate purposes.
M - COMMITMENTS
In 1994, Sepracor, HemaSure and BioSepra entered into an equipment leasing
arrangement that provides for a total of $2,000,000 for the purpose of financing
the purchase of capital equipment in the United States. All outstanding amounts
are collateralized by the assets so financed and BioSepra's portion is
guaranteed by Sepracor. There was a total of $355,000 and $565,000, relating to
Sepracor and BioSepra, outstanding under this agreement at December 31, 1997 and
1996, respectively.
Future minimum lease payments under all noncancelable leases in effect at
December 31, 1997, are as follows: (in thousands)
Year Operating Leases Capital Leases
- --------------------------------------------------------------------------------------
1998 $1,017 $294
1999 865 118
2000 736 --
2001 735 --
2002 766 --
Thereafter 3,634 --
------------------------------
Total minimum lease payments $7,753 $412
Less amount representing interest (37)
------------------------------
Present value of minimum lease payments $375
------------------------------
Future minimum lease payments under operating leases relate to Sepracor's and
BioSepra's principal office, laboratory and production facilities. The lease
terms provide options to extend the leases. The leases require Sepracor to pay
its allocated share of taxes and operating costs in addition to the annual base
rent payments. Rental expense under these and other leases amounted to
$1,687,000, $1,240,000 and $1,003,000 for the years ended December 31, 1997,
1996 and 1995, respectively.
N - LITIGATION
In July 1997, the United States Patent and Trademark Office (the "PTO") informed
Sepracor that it had declared an interference between Sepracor's previously
issued method-of-use patent on fexofenadine to treat allergic rhinitis and
another similar patent application of Sepracor, and the method-of-use patent
application held by Hoechst Marion Roussel Inc. ("HMRI") on the anti-histaminic
effects of fexofenadine on hepatically impaired patents. The primary objective
of a patent interference, which can only be declared by the PTO, is to determine
the first to invent any overlapping subject matter claimed by more
35
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
than one party. In the course of an interference, the parties typically present
evidence relating to their inventive activities as to the overlapping subject
matter. The PTO then reviews the evidence to determine which party has the
earliest legally sufficient inventive date, and, therefore, is entitled to a
patent claiming the overlapping subject matter. (See Note R for further
discussion.)
If Sepracor prevails in the interference, Sepracor will retain all of its claims
in its issued patent. If, however, Sepracor loses the interference, HMRI will be
issued a U.S. patent containing its claims involved in the interference and may
not be obligated to pay Sepracor milestone or royalty payments pursuant to the
terms of the license agreement whereby Sepracor licensed its U.S. patent rights
covering fexofenadine to HMRI in 1993.
In December 1997, the Company and its subsidiary, BioSepra, settled their
longstanding patent lawsuit with PerSeptive Biosystems, Inc. ("PerSeptive"), a
competitor of BioSepra. Under the terms of the settlement, PerSeptive received
an unspecified amount and BioSepra obtained a limited, non-exclusive license
under PerSeptive's Perfusion Chromatography R patents to make, use and sell its
HyperD R product line free of claims of infringements by PerSeptive.
HemaSure is a defendant in two lawsuits brought by Pall Corporation ("Pall"). In
complaints filed in February 1996 and November 1996, Pall alleged that
HemaSure's manufacture, use and/or sale of the LeukoNet Pre-Storage
Leukoreduction Filtration System product infringes upon three patents held by
Pall. On October 14, 1996, in connection with the first action concerning
U.S.Patent No. 5,451,321 (the "'321 patent"), HemaSure filed for summary
judgment of noninfringement. Pall filed a cross motion for summary judgment of
infringement at the same time. In October 1997, the U.S. District Court for the
Eastern District of New York granted in part Pall's summary judgment motion
relating to the '321 patent. The court has not yet ruled on the validity of
Pall's '321 patent claims, which HemaSure has asserted are invalid and
unenforceable. The court now will need to review and determine the validity of
this patent prior to any further action. No date has been set for these
proceedings.
With respect to the second action concerning U.S. Patent Nos. 4,340,479 (the
"'479 patent") and 4,952,572 (the "'572 patent"), HemaSure has answered the
complaint stating that it does not infringe any claim of the asserted patents.
Further, HemaSure has counterclaimed for declaratory judgment of invalidity,
noninfringement and unenforceability of the '572 patent, and a declaratory
judgment of noninfringement of the '479 patent, as a result of a license.
HemaSure believes, based on advice of its patent counsel, that a properly
informed court should conclude that the manufacture, use and/or sale by HemaSure
or its customers of the present LeukoNet product does not infringe any valid
enforceable claim of the three asserted Pall patents. However, there can be no
assurance that HemaSure will prevail in the pending actions, and an adverse
outcome in a patent infringement action would have a material adverse effect on
HemaSure's future business and operations.
O - STOCKHOLDERS' EQUITY
In October 1995, all 79,365 outstanding shares of Series A Convertible Preferred
Stock were converted into 793,650 shares of Sepracor's Common Stock.
In March 1995, Beckman acquired 312,500 shares of Sepracor's Series B Redeemable
Exchangeable Preferred Stock for $5,000,000. This issue is exchangeable into a
portion of Sepracor's holdings of BioSepra common stock, representing
approximately 4% of BioSepra's shares outstanding, in return for certain rights
granted to Beckman under a change of control of BioSepra and is redeemable after
the year 2000 based upon certain other events. The holders of Series B
Redeemable Exchangeable Preferred Stock are entitled to receive, when, and if
declared by the Board of Directors, an annual cash dividend of $1.92 per share.
Such dividends shall accrue daily and are cumulative from the date of issuance.
The dividends are payable at the mandatory redemption date of February 2000. As
of December 31, 1997, Sepracor had accrued $1,700,000 of dividends payable. See
Note W for subsequent event.
In August 1995, Sepracor received approximately $62,336,000 of net proceeds from
the sale of 4,600,000 shares of its Common Stock in a follow-on public offering.
In May 1996, the stockholders of Sepracor approved an amendment to Sepracor's
Restated Certificate of Incorporation increasing from 35,000,000 to 40,000,000
the number of authorized shares of Common Stock.
In 1996, Sepracor issued stock options to certain consultants. As a result,
$248,000 was initially recorded as unearned compensation. In 1997, an adjustment
of $107,000 was made for cancelled options and $28,000 and $14,000 were recorded
in related amortization in 1997 and 1996, respectively.
P - STOCK PLANS AND WARRANTS
STOCK PLANS: The Company has two stock-based compensation plans, which are
described below. In October 1995, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standard No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation." SFAS 123 is effective for periods
beginning after December 15, 1995. SFAS 123 requires that companies either
recognize compensation expense for grants of stock, stock options, and other
equity instruments to employees based or fair value, or provide pro forma
disclosure of net income and earnings per share in the notes to the financial
statements. The Company adopted disclosure provisions of SFAS 123 in 1996 and
has applied APB Opinion 25 and related interpretations in accounting for its
plans. Had compensation expense for the Company's stock-based compensation plans
been determined based on the fair value at the grant dates, as calculated in
accordance with SFAS 123, the Company's net loss and basic and
36
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
diluted loss per share for the years ended December 31, 1997 and 1996 would have
been increased to the pro forma amounts indicated below:
1997 1996
NET BASIC AND DILUTED Net Basic and Diluted
(in thousands) LOSS LOSS PER SHARE Loss Loss Per Share
- -----------------------------------------------------------------------------------------
As Reported $(26,723) $(0.97) $(60,710) $(2.25)
Pro forma $(30,745) $(1.11) $(63,398) $(2.35)
The effects of applying SFAS 123 in this pro forma disclosure are not indicative
of future amounts, since SFAS 123 does not apply to awards prior to 1995 and
additional awards in future years are not anticipated.
The fair value of each stock option is estimated on the date of grant using
Black-Scholes option-pricing model with the following weighted average
assumptions: an expected life of 7 years, expected volatility of 60%, a
risk-free interest rate of 5.0% to 7.8% and no dividends.
The 1985 Stock Option Plan (the "Plan") permits Sepracor to grant shares of
common stock under incentive stock options ("ISOs") and nonstatutory stock
options ("NSOs"). The Plan provides for the granting of ISOs to officers and key
employees of Sepracor and NSOs to officers, key employees, consultants and
directors of Sepracor. ISOs and NSOs granted under the Plan have a maximum term
of ten years from the date of grant and have an exercise price not less than the
fair value of the stock on the date of grant and vest over five years.
In 1991, the Board adopted the 1991 Restated Stock Option Plan which amended and
restated the 1985 Stock Option Plan. In May 1996, the stockholders approved an
amendment to the Plan increasing the number of shares of common stock, which may
be granted to 5,000,000. Stock option activity related to this plan is
summarized below.
In January 1995, Sepracor adopted a Stock Option Exchange Program. Upon employee
consent, the program provides for the grant to each employee a new stock option
in exchange for the cancellation of the old stock option. The new stock option,
granted at fair market value at date of issuance, will become exercisable for a
number of shares of common stock equal to the number of shares covered by the
old stock option.
The 1991 Directors' Plan provides for the granting of NSOs to directors of
Sepracor who are not officers or employees of Sepracor. The options granted
under the Directors' Plan have a maximum term of ten years from date of grant
and have an exercise price of not less than the fair market value of the stock
on the date of grant and vest over five years. In May 1996, the shareholders
approved an amendment to the Directors' Plan increasing the number of shares of
common stock, which may be granted to 275,000.
On October 1997, the Board of Directors approved the Company's 1997 Stock Option
Plan. The 1997 Stock Option Plan permits Sepracor to grant ISOs and NSOs to
purchase up to 500,000 shares of common stock to employees and consultants of
the Company. Executive officers are not entitled to receive stock options under
the 1997 Stock Option Plan. ISOs and NSOs granted under the Plan have a maximum
term of ten years from the date of grant and ISOs may not be granted at an
exercise price less than fair market value.
The following tables summarize information about stock options outstanding at
December 31, 1997 (in thousands, except per share amounts):
Options Outstanding Options Exercisable
Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Per Share Outstanding Life Price Exercisable Price
- ---------------------------------------------------------------------------------------------------------
$ 1.50 - 3.50 27 2.52 $ 2.75 27 $ 2.75
5.00 - 5.00 365 6.57 5.00 200 5.00
5.25 - 5.75 351 6.96 5.71 190 5.70
6.00 - 6.56 379 6.59 6.12 202 6.07
6.63 - 12.63 506 7.15 10.08 206 9.03
14.13 - 14.13 99 8.09 14.13 22 14.13
14.62 - 14.62 736 7.79 14.62 292 14.62
14.75 - 22.50 371 8.84 17.65 101 15.40
24.13 - 24.13 56 9.37 24.13 -- --
24.25 - 41.00 595 9.51 24.37 -- --
- ---------------------------------------------------------------------------------------------------------
$ 1.50 - 41.00 3,485 7.75 $13.16 1,240 $ 9.18
- ---------------------------------------------------------------------------------------------------------
1997 1996 1995
AVERAGE Average Average
PRICE PER Price Per Price Per
NUMBER SHARE Number Share Number Share
- ------------------------------------------------------------------------------------------------------------------
Balance at January 1 3,277 $ 9.55 3,225 $ 7.77 2,468 $ 5.47
Granted 757 24.10 651 13.77 1,760 10.22
Exercised (433) 6.00 (429) 3.88 (340) 3.00
Cancelled (116) 9.84 (170) 6.37 (663) 8.14
- ------------------------------------------------------------------------------------------------------------------
Balance at December 31 3,485 $13.16 3,277 $ 9.55 3,225 $ 7.77
- ------------------------------------------------------------------------------------------------------------------
Options exercisable at
December 31 1,240 1,088 948
Weighted average fair
value of options granted
during the year $15.88 $ 9.46 $ 6.99
There were 537,000 options available for future grant as of December 31, 1997.
37
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In 1996, the shareholders approved the 1996 Employee Stock Purchase Plan ("1996
Plan"), which succeeded the 1994 Employee Stock Purchase Plan. Under the 1996
plan, an aggregate of 120,000 shares of common stock maybe purchased by
employees at 85% of market value on the first or last day of each six month
offering period, whichever is lower, through accumulation of payroll deductions
ranging from 1% to 10% of compensation as defined, subject to certain
limitations. Options were exercised to purchase 31,423, 23,977, and 39,820
shares for a total of $556,111, $296,016, and $229,506, during the years ended
December 31, 1997, 1996 and 1995, respectively. At December 31, 1997, there were
86,844 shares of authorized but unissued common stock reserved for future
issuance under the 1996 plan.
STOCK WARRANTS: In 1991, Sepracor issued warrants to purchase 200,000 shares of
common stock at $10.00 per share, all of which were exercised in 1995. The
warrants were exercised in a cashless transaction in August 1995 with the
issuance of 48,340 shares of common stock. In connection with a subordinated
debt agreement, Sepracor issued warrants to purchase 30,140 shares of common
stock at a price of $1 per share. Warrants to purchase 10,520 shares are
outstanding at December 31, 1997. The warrants may be exercised at any time
until 2001 and are callable by Sepracor and redeemable at certain times or
events.
In 1994, in connection with the issuance of the Series A Convertible Preferred
Stock, Sepracor issued warrants to purchase 1,021,650 shares of common stock at
prices of between $6.30 and $12.00 per share. The warrants expire on September
30, 2004, subject to accelerated expiration in certain events. In July 1995,
Sepracor received approximately $6,335,000 from the exercise of these warrants
to purchase 971,650 shares of common stock with exercise prices of $6.30 and
$7.50 per share. At December 31, 1997, warrants to purchase 23,000 shares remain
outstanding, all of which are exercisable at $6.30 per share.
Q - INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to tax benefit carryforwards and to differences
between the financial statement amounts of assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates.
A valuation reserve is established if it is more likely than not that all or a
portion of the deferred tax asset will not be realized. Accordingly, a valuation
reserve has been established for the full amount of the deferred tax asset.
Sepracor's statutory and effective tax rates were 34% and 0%, respectively, for
the years 1997, 1996 and 1995. The effective tax rate was 0% due net operating
losses and nonrecognition of any deferred tax asset. At December 31, 1997,
Sepracor had federal and state tax net operating loss carryforwards ("NOL") of
approximately $115,000,000 and $75,000,000, which will expire through 2012 and
2002, respectively. Based upon the Internal Revenue Code and changes in company
ownership, utilization of the NOL will be subject to an annual limitation.
Sepracor also had a NOL from its operation in France of approximately
$13,000,000. Approximately $12,000,000 of this NOL will expire in 2000; the
remainder may be carried forward indefinitely. Sepracor also had a NOL from its
operation in Canada of approximately $3,600,000 which may be carried forward
indefinitely. At December 31, 1997, Sepracor had federal and state research and
experimentation credit carryforwards of approximately $3,900,000 and $2,900,000,
respectively, which will expire through the year 2012. Sepracor also had
Canadian research and experimentation credits of $1,100,000 which will expire
through 2007.
The components of Sepracor's net deferred taxes were as follows at December 31:
(in thousands) 1997 1996
- ------------------------------------------------------------------------------
Assets
NOL Carryforwards $ 50,213 $ 50,596
Reserves 226 306
Tax Credit Carryforward 7,989 5,287
Patent 489 389
Accrued Expenses 5,434 3,735
Research and development
capitalization 9,827 9,217
Equity in loss of investees 7,638 7,981
Other 1,605 2,657
- ------------------------------------------------------------------------------
Liabilities
Basis difference of subsidiaries (13,628) (12,005)
Property and Equipment -- (237)
Valuation allowance $(69,793) $(67,926)
- ------------------------------------------------------------------------------
Net deferred taxes $ -- $ --
- ------------------------------------------------------------------------------
R - AGREEMENTS
In December 1997, Sepracor signed a licensing agreement with Schering-Plough
Corporation ("Schering") giving Schering exclusive worldwide rights to
Sepracor's patents covering descarboethoxyloratadine ("DCL"), an active
metabolite of loratadine. Under the terms of the agreement, Sepracor has
exclusively licensed its DCL rights to Schering, which expects to develop and
market the DCL product worldwide. Schering will pay Sepracor an upfront license
fee of $5,000,000 and royalties on DCL sales, if any, beginning at first product
launch. Any such royalties paid to Sepracor would escalate over time and upon
the achievement of sales volume and other milestones. As of December 31, 1997,
the agreement was still pending clearance under the Hart Scott Rodino Act.
In January 1998, Sepracor and Schering were notified that no objection would be
raised under the Hart Scott Rodino Act with respect to their license agreement.
Shortly thereafter, Sepracor received the $5,000,000 upfront license payment
from Schering and recorded the payment as license revenue in the first quarter
of 1998. The upfront license fee will be offset against future royalty payments.
On February 4, 1998, Sepracor signed a collaboration and license agreement with
Janssen Pharmaceutica, N.V. ("Janssen"), a wholly-owned subsidiary of Johnson &
Johnson, relating to the development and mar-
38
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
keting of norastemizole, a third generation nonsedating antihistamine. Under the
terms of the agreement, the companies will jointly fund the development of
norastemizole, and Janssen has an option to acquire certain rights regarding the
product in the U.S. and abroad. When exercised, Janssen and Sepracor will
equally share the costs and profits associated with the further development,
marketing and sales of norastemizole in the United States. Sepracor will also
retain the right to co-promote the product in the U.S. Alternatively, Sepracor
can elect to receive royalties, if any, on Janssen sales of norastemizole in the
U.S. in the event it decides not to co-promote the product. Outside of the U.S.,
Janssen has the right to develop and market norastemizole, and Sepracor will
earn royalties on product sales, if any. In addition, Janssen has worldwide OTC
rights to norastemizole.
In June 1993, Sepracor licensed to MMD (now Hoescht Marion Roussel Inc.) its
U.S. patent application covering the use of terfenadine carboxylate, a
metabolite of terfenadine ("Seldane"), to be developed by MMD. Under this
agreement, Sepracor recorded $3,750,000 as license fee revenue in 1994, for the
issuance of a patent covering the use of terfenadine carboxylate. The agreement
calls for future license fees of up to $3,750,000 subject to certain other
milestones and royalties on sales if and when they occur. As of December 31,
1997, Sepracor had received the first milestone payment of $1,875,000 and
recorded $469,000 in sub-license expense payable to a third party for the year
ended December 31, 1997. See Note N for discussion of patent interference.
In 1992, Sepracor licensed to Sterling Healthcare, Inc. Sepracor's use-patent
application and related technology for the single isomer of a non-steroidal
anti-inflammatory drug. Under the terms of the agreement, Sepracor received
research and development funding and license fees. In 1995, Sepracor recognized
$650,000 related to achievement of a specific benchmark in the agreement. In
December 1995, this agreement was terminated with no remaining obligations
outstanding.
S - EMPLOYEES' SAVINGS PLAN
Sepracor has a 401(K) savings plan (the "401K Plan") for all domestic employees.
Under the provisions of the 401K Plan, employees may voluntarily contribute up
to 15% of their compensation up to the statutory limit. In addition, Sepracor
can make a matching contribution at its discretion. Sepracor matched 50% of the
first $2,000 contributed by employees up to $1,000 maximum per employee during
1996. In June 1997, this match was raised to 50% of the first $3,000. This match
amounted to $119,000 and $49,000 in 1997 and 1996, respectively. There were no
Company matches in 1995.
T - DISPOSAL OF BIOPASS
In July 1995, BioSepra sold Biopass for $1,300,000, payable in quarterly
installments of $100,000 from September 30, 1995 through June 30, 1996 and
$150,000 beginning on September 30, 1996 through December 31, 1997. The full
value of the sale price was reserved pending the buyer's payment and was
recognized as payments were received. In 1995, one payment of $100,000 was
received. No payments were received in 1996 or 1997. As part of the sale
agreement BioSepra retained the chromatography column technology that it assumed
when it acquired Biopass. In 1996, BioSepra wrote-off the remaining unamortized
portion of this purchased technology of approximately $741,000. The sales
contract also provided for a renewable royalty free technology license in which
the buyer may develop, manufacture and sell products incorporating the
technology retained by BioSepra. During the period the buyer is required to make
installment payments, BioSepra is the exclusive seller of chromatography columns
and accessories and had committed to at least $1,000,000 in orders per year,
provided minimum gross margins are met. In January 1996, the commitment to
purchase chromatography columns and accessories was terminated by the Company
due to the inability of the purchaser to meet certain commitments.
The results of Biopass' operations through July 1995 have been included in the
consolidated results. The revenues, loss from operations and net loss for
Biopass for 1995 are $1,878,000, $(1,208,000) and $(44,000), respectively. The
loss of $2,964,000, on the disposal, was recorded as restructuring and
impairment charges in the statement of operations (see Note H). This loss equals
the net liabilities transferred in the sale; the net liabilities are excluded
from the Company's consolidated balance sheet for 1995.
U - SUMMARIZED FINANCIAL INFORMATION
The following is the summarized financial information for Versicor, HemaSure and
ChiRex:
1997 1996
(in thousands) VERSICOR HEMASURE ChiRex HemaSure
- --------------------------------------------------------------------------------
Current assets $19,610 $ 9,097 $40,853 $ 18,263
Non-current assets 7,300 1,510 89,953 2,297
Current liabilities 1,308 3,026 25,405 3,419
Non-current liabilities 6,034 9,048 15,333 9,212
Net sales -- 2,357 74,615 779
Gross profit (loss) -- (1,326) 18,107 (3,006)
Net income (loss) $(6,203) $(9,884) $(8,309) $(40,598)
Summarized financial information for ChiRex is not presented in 1997, as
Sepracor sold its investment on March 31, 1997 (see Footnote D).
V - SEGMENT INFORMATION
Sepracor, through BioSepra, develops, manufactures and markets processes and
products for the synthesis, separation and purification of pharmaceutical and
biopharmaceutical compounds. BioSepra operates exclusively in the separations
business, which Sepracor considers to be one business segment. Financial
information by geographic area is as follows for the periods indicated:
39
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
Revenues
United States:
Unaffiliated customers $ 9,810 $ 11,651 $ 8,883
Transfer to other geographic areas (16) 3,050 1,195
------------------------------------
Total 9,794 14,701 10,078
------------------------------------
Europe:
Unaffiliated customers 5,527 6,187 7,324
Transfer to other geographic areas 1,571 2,999 1,703
------------------------------------
Total 7,098 9,186 9,027
------------------------------------
Eliminations and adjustments (1,555) (8,846) (2,898)
------------------------------------
Total Revenues $ 15,337 $15,041 $ 16,207
------------------------------------
Operating Loss
United States $(55,666) $(45,638) $(33,865)
Europe 942 1,752 (6,049)
Eliminations and adjustments (419) 3 (551)
------------------------------------
Total Operating Loss $(55,143) $(43,883) $(40,465)
------------------------------------
Total Assets
United States $203,806 $165,871 $292,236
Europe 5,802 6,343 6,713
Canada 7,427 7,088 7,744
Eliminations and adjustments (88,528) (32,613) (103,980)
------------------------------------
Total Assets $128,507 $146,689 $202,713
------------------------------------
Of the $9,810,000, $11,651,000 and $8,883,000 U.S. sales to unaffiliated
customers for the years ended December 31, 1997, 1996 and 1995, respectively,
$168,000, $630,000, and $1,822,000, respectively, were export sales to the Far
East.
W - SUBSEQUENT EVENT
On March 26, 1998, Sepracor and Beckman terminated their Stock Purchase
Agreement under which Beckman acquired 312,500 shares of Sepracor Series B
Redeemable Exchangeable Preferred Stock. Sepracor paid Beckman the original
purchase price of the stock plus accrued dividends totalling $6,850,000. As a
result of this termination subsequent to year-end, Sepracor has reclassed its
convertible redeemable preferred stock as a current liability at December 31,
1997. In addition, BioSepra and Beckman amended their distribution agreement
whereby BioSepra granted a non-exclusive right to manufacture instruments to
Beckman, removed its obligation to manufacture instruments for Beckman, and sold
the discontinued instrument product inventory to Beckman for $250,000.
ANNUAL MEETING INFORMATION
The Annual Meeting of Shareholders will be held at 9:00 a.m. on May 27, 1998 at
the offices of Hale and Dorr, Sixty State Street, Boston, MA.
COMMON STOCK
The Common Stock of Sepracor Inc. is traded on the Nasdaq Stock Market under the
symbol SEPR.
GENERAL COUNSEL
Hale and Dorr, Boston, MA
PATENT COUNSEL
Pennie & Edmonds, New York, NY
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand LLP, Boston, MA
CORPORATE HEADQUARTERS
Sepracor Inc.
111 Locke Drive
Marlborough, MA 01752
Telephone: (508) 481-6700
Facsimile: (508) 357-7499
Sepracor and ICE are trademarks of Sepracor Inc. HemaSure, LeukoNet, and
SteriPath are trademarks of HemaSure Inc. BioSepra is a trademark,
and Hyper D and ProSys are registered trademarks of BioSepra Inc. Ventolin,
Zofran and Serevent are registered trademarks of Glaxo Group Limited. Proventil
and Claritin are registered trademarks of Schering Corporation. Foradil is a
registered trademark of Ciba-Geigy Corporation. Atock is a trademark of
Yamanouchi, Inc. Hismanal is a registered trademark of Janssen Pharmaceutica
N.V. Seldane is a registered trademark of Merrell Dow Pharmaceuticals, Inc.
Ditropan is a registered trademark of Marion Merrell Dow. Allegra is a
registered trademark of Merrell Pharmaceuticals. Cardura is a registered
trademark of Pfizer Inc. Orudis is a registered trademark of Rhone-Poulenc
Rorer, S.A. Actron is a trademark of Bayer Corporation. Prozac is a registered
trademark of Eli Lilly and Company. Propulsid and Sporanox are registered
trademarks of Johnson & Johnson. Toradol is a registered trademark of Syntex
USA. Levaquin is a trademark of Daiichi Pharmaceutical Company LTD. POROS is a
registered trademark of PerSeptive BioSystems, Inc. Prilosec is a registered
trademark of Astra Aktiebolag. Prevacid is a registered trademark of TAP
Holdings Inc. Imovane is a registered trademark of Rhone-Poulenc Sante. Meridia
is a registered trademark of Knoll Pharmaceutical Company. Zyban is a trademark
of Glaxo Group Limited. Ambien is a registered trademark of Synthelabo. Paxil is
a trademark of Smithkline Beecham Corp. Zoloft is a registered trademark of
Pfizer Inc. Wellbutrin is a registered trademark of Glaxo Wellcome Inc. Oxis is
a trademark and Turbuhaler is a registered trademark of Akiebolaget Astra.
Pantozol is a trademark of Byk Gulden Lomberg Chemische Fabrik GMBH.
40
44
DIRECTORS OFFICERS
James G. Andress Timothy J. Barberich
Former Chairman, Beecham Pharmaceuticals, President and Chief Executive Officer
Former President and COO, Sterling Drug Inc.
David S. Barlow
Timothy J. Barberich Executive Vice President and President, Pharmaceuticals
President and Chief Executive Officer, Sepracor Inc.
David P. Southwell
Digby W. Barrios Executive Vice President; Chief Financial Officer and
Secretary
Former President and CEO, Boehringer Ingelheim
Corporation James R. Hauske, Ph.D.
Senior Vice President, Discovery
Robert J. Cresci
Managing Director, Pecks Management Partners Ltd. Douglas E. Reedich, Ph.D., J.D.
Chief Patent Counsel
Robert F. Johnston
Managing Director, Johnston Associates Paul D. Rubin, M.D.
Senior Vice President, Drug Development
Keith Mansford, Ph.D.
Former Chairman, R&D, SmithKline Beecham plc Robert F. Scumaci
Senior Vice President, Finance & Administration,
James F. Mrazek and Treasurer
Former Vice President and General Manager,
Healthcare Division of Johnson & Stephen A. Wald
Johnson Products Inc. Vice President, Chemical R&D
Alan A. Steigrod
Former Executive Vice President, Glaxo Holdings plc
[PICTURE OF DIRECTORS/OFFICERS]
Pictured left to right, front row: Paul D. Rubin, M.D., Timothy J. Barberich
and David S. Barlow. Middle row: James R. Hauske, Ph.D. and David P. Southwell.
Back row: Robert F. Scumaci, Stephen A. Wald and Douglas E. Reedich, Ph.D.
Design: MediaConcepts Corporation