ITEM 1. BUSINESS
COMPANY OVERVIEW
VIVUS, Inc. ("VIVUS" or the "Company") is the developer and manufacturer of MUSE(R) (alprostadil) and ACTIS(R), two advancements in the treatment of men with erectile dysfunction ("ED"), also known as impotence. The Company's objective is to become a global leader in the development and commercialization of innovative therapies for the treatment of sexual dysfunction and urologic disorders in men and women. VIVUS has on-going research and development ("R&D") programs in male ED, female sexual dysfunction ("FSD"), male premature ejaculation ("PE"), and intends to pursue targeted technology acquisitions to expand its R&D pipeline. The Company intends to market and sell its products through distribution, co-promotion or license agreements with corporate partners. In December 1999, the company filed a New Drug Application ("NDA") with the U.S. Food and Drug Administration ("FDA") for ALIBRA(R), its second-generation male ED treatment.
VIVUS STRATEGY
The Company's objective is to become a global leader in the development and commercialization of innovative therapies for the treatment of sexual dysfunction and other urologic disorders in men and women. The Company is pursuing this objective through the following strategies:
Targeted Research and Development (R&D) Efforts
The Company will exploit its expertise and patent portfolio by focusing its R&D activities on sexual dysfunction, premature ejaculation and other urologic disorders. In order to expand its R&D pipeline, the Company also intends to pursue targeted acquisitions of technologies that are well suited to its core expertise in drug development.
Focus on Development and Regulatory Review
The Company will continue to focus its R&D efforts on developing new patentable uses of known pharmacologic agents for which significant safety data already exists. The Company believes that such agents present a lower development risk profile and may progress more rapidly through the clinical development and regulatory process than agents without pre-existing data.
Maintain Proprietary Technology
The Company will continue to invest in building its patent portfolio. Currently, VIVUS has been awarded 13 patents and has 19 patent applications pending in the United States. The Company also has 44 patents granted and 22 patents pending internationally.
Partnering Strategy
VIVUS is seeking a marketing partner(s) for MUSE and ALIBRA in the United States, Europe, Japan and South America. The Company has entered into an international marketing agreement for its products with Janssen Pharmaceutica ("Janssen") that includes multiple Pacific Rim countries (excluding Japan), Canada, Mexico and South Africa.
1999 HIGHLIGHTS
First Quarter 1999
The Company achieved profitability for the second consecutive quarter after restructuring in the third quarter of 1998, earning $0.12 per share. Cash, cash equivalents and available-for-sale securities increased by $12 million from December 31, 1998, to $36 million.
The Company was granted a new patent for the "Treatment of Female Sexual Dysfunction" by the U.S. Patent Office, providing broad patent protection for the commercialization of topical formulations of vasodilating agents and steroid hormones for the treatment of sexual dysfunction affecting women.
The Company was granted a new patent for the "Method and Composition for Treating Erectile Dysfunction" by the U.S. Patent Office, providing broad patent protection for the commercialization of ALIBRA, its second-generation transurethral treatment for male ED.
The Company appointed Richard Walliser as its Chief Financial Officer, and named Mario Rosati, a partner at Wilson, Sonsini, Goodrich & Rosati, and Mark Logan, Chairman, President and Chief Executive Officer of VISX, Inc. to the Company's Board of Directors.
The Company announced that its abstract "Does Renewed Sexual Activity Increase Cardiac Morbidity? A Meta-Analysis of the Safety Profile with Transurethral Alprostadil (MUSE)" was selected by the XIVth Congress of the European Association of Urology for highlight during a press conference on April 10, 1999 in Stockholm, Sweden. The abstract was presented by co-author Gordon Williams, MD, Consultant Urologist at the Hammersmith Hospital, London.
The Company received $4 million in milestone payments for the approval of MUSE marketing licenses in France and Germany.
Second quarter 1999
The Company achieved profitability for the third consecutive quarter after restructuring in 1998, earning $0.01 per share.
The Company reached a settlement of the shareholder class action lawsuits. The settlement for $6 million was funded by insurance proceeds of $5.4 million and by the Company contributing 120,000 shares of common stock.
Linda M. Dairiki Shortliffe, M.D., Professor at Stanford University School of Medicine and Chair of the Urology Department, was elected to the Company's Board of Directors at the annual meeting of stockholders.
Tulane University School of Medicine reported data at the 94th annual meeting of the American Urologic Association confirming the safety and efficacy of MUSE for patients who were unsuccessful with Viagra(R) (sildenafil citrate) due to lack of efficacy or side effects of treatment.
The Company established a limited U.S. sales organization targeting major accounts.
Third Quarter 1999
The Company achieved profitability for the fourth consecutive quarter after restructuring in 1998, earning $0.03 per share.
The Company received a $2 million milestone payment for the MUSE marketing license approval in Spain.
The Company terminated its license agreement with Albert Einstein College of Medicine of Yeshiva University for the development of gene therapy for the treatment of ED, a strategic decision based on the development risks involved and the amount of funding and time required to potentially bring a product to market.
Fourth Quarter 1999
The Company achieved profitability for the fifth consecutive quarter after restructuring in 1998, earning $0.43 per share. Cash, cash equivalents and available-for-sale securities at December 31, 1999 increased $16.5 million from December 31, 1998, while total liabilities decreased $5.1 million during the same period.
The Company reached agreement with AstraZeneca regarding the financial obligations related to the return of marketing and distribution rights for MUSE in Europe, South America, Central America, Australia, and New Zealand. This resulted in the Company recording $20 million in revenue in the fourth quarter 1999.
The Company filed an NDA for ALIBRA with the FDA.
The Company initiated a proof-of-concept, Phase II clinical study for the evaluation of "on-demand" oral compounds for the treatment of premature ejaculation in men.
The Company entered into a binding Memorandum of Understanding to further solidify its FSD intellectual property position through an exclusive agreement with AndroSolutions, Inc., a privately held biomedical corporation. Definitive agreements were executed in March 2000. The Company and AndroSolutions have jointly formed ASIVI, LLC, a Delaware limited liability corporation, into which VIVUS has contributed its issued U.S. FSD patent and European application and into which AndroSolutions has contributed its U.S. and European FSD patent applications. In turn, ASIVI has granted the Company exclusive global rights to develop and commercialize FSD technologies based on this intellectual property, in return for certain milestone payments and royalties on FSD products developed by VIVUS. The Company and AndroSolutions will each own 50% of ASIVI, LLC. The Company intends to account for their interest in ASIVI, LLC. through the equity method of accounting.
VIVUS' TRANSURETHRAL SYSTEM FOR ERECTION
Administration. Administration of the transurethral system for erection is an easy and painless procedure. The end of the applicator is less than half the diameter of a man's urine stream and is inserted approximately three centimeters into the urethra. To use the transurethral system for erection, a patient urinates, shakes the penis to remove excess urine, inserts the transurethral system for erection into the urethra, releases the medication, and then massages the penis between the hands for 10 seconds to distribute the medication.
The application process takes less than a minute. Once administered, the pharmacologic agent dissolves in the small amount of urine that remains in the urethra, is absorbed across the urethral mucosa, and is transferred via local vasculature to the tissues of the erectile bodies. When successful, an erection is produced within 15 minutes of administration and lasts approximately 30 - 60 minutes. Many patients experience transient penile pain and/or local aching after administration and during intercourse.
Alprostadil is the first pharmacologic agent used in the transurethral system for erection. Alprostadil is the generic name for the synthetic version of prostaglandin E1, a naturally occurring vasodilator present throughout the body and at high levels in seminal fluid. There are four dosage strengths of alprostadil utilized in MUSE: 125 mcg, 250 mcg, 500 mcg, and 1000 mcg. It is recommended that patients initiating therapy with MUSE be titrated to the lowest effective dose under the supervision of a physician.
The Company's second transurethral product for the treatment of ED, ALIBRA utilizes a low 125 mcg dose of alprostadil administered in combination with 500 mcg of prazosin hydrochloride. Because alprostadil and prazosin effect vasodilation by complimentary mechanisms, this low-dose combination product appears to
have efficacy similar to higher doses of single-agent alprostadil and adequate safety for use as an initial starting dose. Since it is not necessary for patients to titrate among multiple doses, ALIBRA may provide patients with the advantage of initiating therapy at home, as opposed to titrating in the physician's office.
ADVANTAGES OF TRANSURETHRAL THERAPY
The Company's transurethral system for erection is designed to overcome the limitations of other available therapies through its unique product attributes that include:
Safety. The Company's transurethral system for erection is a safe local treatment for patients. Because therapeutic levels of drug are delivered locally to the erectile tissues with minimal systemic drug exposure, the opportunity for systemic drug-drug and drug-disease interactions is minimized. Transurethral therapy, therefore, offers an alternative to oral treatments that are delivered to the erectile tissues via the systemic circulation and may be more susceptible to these types of interactions.
Ease of Administration. The Company's transurethral system for erection is easy to use with minimal instruction, unlike needle injection therapy that requires precise injection into the penis.
Minimally-invasive. The Company's transurethral system for erection utilizes urethral delivery, permitting topical application to the urethral lining.
Discreet. The Company's transurethral system for erection utilizes a small, single-use disposable applicator that can be discreetly applied and is easily integrated into the normal sexual life of the patient. Administration takes less than a minute.
Quality of Erection. The Company's transurethral system for erection therapy mimics the normal vasoactive process, producing an erection that is more natural than those resulting from needle injection therapy, vacuum constriction devices or penile implants.
CURRENT THERAPIES
In addition to MUSE, the primary physiological therapies currently utilized for the treatment of ED are:
Oral Medications. In 1998, Pfizer Inc. received clearance from the FDA to market its oral treatment for ED, sildenafil. Commercial introduction of this new competitive product has adversely affected the Company's business, financial condition and results of operations. Yohimbine is another oral medication currently prescribed in the United States for the treatment of ED. Other large pharmaceutical companies are also actively engaged in the development of therapies for the treatment of ED. See "Risk Factors -- Intense Competition" on page 10.
Needle Injection Therapy. This form of treatment involves the needle injection of pharmacologic agents directly into the penis. These agents are generally vasoactive compounds such as alprostadil alone or in combination with phentolamine and papaverine. This form of treatment requires a prescription from a physician and instruction on self-injection. Side effects may include pain associated with injection, local pain and aching, priapism (persistent prolonged erections), fibrosis (build-up of scar tissue) and bleeding.
Vacuum Constriction Devices. This form of treatment involves the use of a mechanical system that creates a vacuum around the penis, causing the erectile bodies to fill with blood. A constriction band is then placed around the base of the penis to impede blood drainage and maintain the erection. Vacuum constriction devices are large, mechanical devices that can be unwieldy and somewhat difficult to use. In addition, the erection may not seem natural since only the part of the penis beyond the constriction band is rigid, and the penis can become cold and discolored due to the constriction of blood flow. Complications encountered by some users of vacuum constriction devices include pain and difficulty ejaculating.
Penile Implants. This therapy involves the surgical implantation of a semi-rigid, rigid or inflatable device into the penile structure to mechanically simulate an erection. In addition to the risks associated with surgical procedures, there is a significant rate of complication with implants such as infection and mechanical failure of the device. This may necessitate a second surgical procedure to remove or reposition the device. In addition,
due to the scarring associated with the implant procedure, the patient may no longer be a viable candidate for less radical therapies.
SALES AND MARKETING
The Company intends to market and sell its products worldwide through distribution, co-promotion or license agreements with corporate partners. The Company has entered into a marketing agreement with Janssen for certain international markets. The Company is currently seeking a pharmaceutical partner(s) to market, distribute and sell its products in Europe, Japan, South America and the United States.
Domestic
The Company supports MUSE sales in the United States with a small focused sales team calling on targeted physicians. VIVUS also participates in national urologic and sexual dysfunction forums and conferences such as the American Urologic Association annual meeting and the International Society for Impotence Research. In addition, the Company supports ongoing research and clinical investigation of MUSE and the publication of data in peer-reviewed journals.
International
The Company signed an international marketing agreement with Janssen in January 1997, a subsidiary of Johnson & Johnson. Janssen purchases the Company's products for resale in multiple Pacific Rim countries (excluding Japan), Canada, Mexico and South Africa. In October 1997, the Company signed an agreement that expanded Janssen's territories to include the Middle East, Russia, the Indian sub-continent, and Africa. To date, Janssen has launched MUSE in several countries, including Canada, South Korea and Mexico.
The Company entered into an international marketing agreement with ASTRA AB (now "Astra-Zeneca") in May 1996 to purchase the Company's products for resale in Europe, South America, Central America, Australia and New Zealand. In October 1999, the marketing and distribution rights in these countries were returned to the Company by AstraZeneca. AstraZeneca will continue to support MUSE in countries where they have launched MUSE during a transition period. The Company is currently evaluating alternative strategic options regarding distribution of its products in these countries.
As of March 2000, approved/licensed countries include:
RESEARCH & DEVELOPMENT
VIVUS' objective is to become a global leader in the development and commercialization of innovative therapies for the treatment of sexual dysfunction and other urologic disorders in men and women. To this end, the Company utilizes its expertise and patent portfolio by focusing its R&D activities on male and female sexual dysfunction, premature ejaculation, and other urologic disorders. The Company also investigates novel patentable uses of pharmacologic agents for which significant safety data already exists. The Company believes that such agents present a lower development risk profile and may progress more rapidly through the clinical development and regulatory process than agents without pre-existing data.
DEVELOPMENT PROJECTS CURRENTLY INCLUDE:
The Company will continue to assess the feasibility and relevance of these and other R&D projects, as determined by the Company's management and Board of Directors.
CLINICAL STUDIES
In 1999, the Company completed a 19-site confirmatory Phase III study of ALIBRA for the treatment of men with ED. This study demonstrated that ALIBRA enabled patients to achieve erections sufficient for successful sexual intercourse significantly more often than did placebo, and it was well tolerated. In this study, ALIBRA demonstrated significant efficacy regardless of patient age, primary etiology of ED, or duration of the complaint. Additionally, the majority of patients treated had ED that was classified as "severe" by baseline scores on the Erectile Function domain of the International Index of Erectile Function Questionnaire. During 1999, the Company also performed an interim analysis on an ongoing long-term (1-year) evaluation of ALIBRA and initiated and completed a pharmacokinetic study evaluating the commercial formulation of ALIBRA. These studies enabled the filing of an NDA for ALIBRA during the fourth quarter of 1999.
During the fourth quarter of 1999, the Company initiated a proof of concept trial in patients with premature ejaculation to evaluate the feasibility of on-demand dosing with several classes of agents for the treatment of this disorder. The Company hopes that this study provides data that will allow the Company to make strategic decisions on various options for the further development of its intellectual property for this indication.
MANUFACTURING AND RAW MATERIALS
The Company has limited experience in manufacturing and selling MUSE in commercial quantities. The Company leases 90,000 square feet of space in New Jersey in which it has constructed manufacturing and testing facilities. The FDA and MCA authorized the Company to begin commercial production and shipment
of MUSE from its new facility in June and March 1998, respectively. In September 1998, the Company closed its contract manufacturing site within PACO Pharmaceutical Services, Inc. and significantly scaled back its manufacturing operations in the New Jersey facility, as a result of lower domestic and international demand for MUSE. Production is currently significantly below capacity for the plant resulting in a higher per unit cost.
The Company has obtained its supply of alprostadil from two sources. The first is Spolana Chemical Works a.s. in Neratovice, Czech Republic ("Spolana") pursuant to a supply agreement that was executed in May 1997. In January 1996, the Company entered into an alprostadil supply agreement with CHINOIN Pharmaceutical and Chemical Works Co., Ltd. ("Chinoin"). Chinoin is the Hungarian subsidiary of the French pharmaceutical company Sanofi Winthrop. Both agreements were amended in December 1998, as a result of excess inventory on hand to reduce future commitments for alprostadil purchases.
The Company relies on a single injection molding company, The Kipp Group ("Kipp"), for its supply of plastic applicator components. In turn, Kipp obtains its supply of resin, a key ingredient of the applicator, from a single source, Huntsman Corporation. The Company also relies on a single source, E-Beam Services, Inc. ("E-Beam"), for sterilization of its product. There can be no assurance that the Company will be able to identify and qualify additional sources of plastic components and an additional sterilization facility. See "Risk Factors -- Dependence on Single Source of Supply" on page 11.
GOVERNMENT REGULATION
The Company's research, pre-clinical development, clinical trials, manufacturing and marketing of its products are subject to extensive regulation by numerous governmental authorities in the United States and other countries. Clinical trials, manufacturing and marketing of the Company's products will be subject to the rigorous testing and approval processes of the FDA and equivalent foreign regulatory agencies. The process of obtaining FDA and other required regulatory approvals is lengthy and expensive. In November 1996, the Company received final marketing clearance from the FDA for MUSE. In November 1997, the Company obtained regulatory marketing clearance by the MCA to market MUSE in the United Kingdom. MUSE has also been approved in 48 countries around the globe. After regulatory approval is obtained, the Company's products are subject to continual review. In December 1999, the Company submitted an NDA for its second- generation product ALIBRA to the FDA. The approval process could take as long as 12 months for the FDA to review. See "Risk Factors -- Government Regulation and Uncertainty of Product Approvals" on pages 14 and 15.
In 1998, the Company leased 90,000 square feet of manufacturing space in Lakewood, New Jersey in which it has constructed manufacturing and testing facilities for the production of MUSE. The FDA and MCA authorized the Company to begin commercial production and shipment of MUSE from its new facility in June and March 1998, respectively.
EMPLOYEES
As of March 3, 2000, the Company employed 140 persons. Of these employees, 101 are located at the manufacturing facility in Lakewood, New Jersey; and 39 are located at the Company's corporate headquarters in Mountain View, CA and other U.S. and international locations. None of the Company's current employees are represented by a labor union or are the subject of a collective bargaining agreement. The Company believes that it maintains good relations with its employees.
This Form 10-K contains "forward-looking" statements about future financial results, future products and other events that have not yet occurred. For example, statements like we "expect," we "anticipate" or we "believe" are forward-looking statements. Investors should be aware that actual results may differ materially from our expressed expectations because of risks and uncertainties about the future. We will not necessarily update the information in this Form 10-K if any forward-looking statement later turns out to be inaccurate. Details about risks affecting various aspects of our business are discussed throughout this Form 10-K. Investors should read all of these risks carefully, and should pay particular attention to risks affecting the following areas: future capital needs and uncertainty of additional financing (page 12); history of losses and limited operating history (pages 12 and 13); limited sales and marketing experience (page 10); dependence on third parties (pages 11 and 12); intense competition (page 11); dependence on key personnel (page 12); and other risk factors as stated (pages 10 through 18).
RISK FACTORS
LIMITED SALES AND MARKETING EXPERIENCE
The Company supports MUSE sales in the U.S. through physician and patient information/help lines, sales support for major accounts, product education newsletters and participation in national urologic and sexual dysfunction forums and conferences, such as the American Urological Association annual and regional meetings and the International Society for Impotence Research. In addition, the Company supports ongoing research and clinical investigation of MUSE and the publication of data in peer-reviewed journals. The Company is currently evaluating alternative strategic options regarding the U.S. market. There can be no assurance that the options are viable, or that the Company will be able to successfully implement those options.
The Company entered into an international marketing agreement with Janssen to purchase the Company's products for resale in multiple Pacific Rim countries (excluding Japan), Canada, Mexico, South Africa, the Middle East, Russia, the Indian sub-continent, and Africa. The marketing agreement does not have minimum purchase commitments and the Company is dependent on Janssen's efforts to distribute and sell the Company's products effectively in the above-mentioned markets. Janssen may take up to twelve months to introduce a product in a given country following regulatory approval in such country. There can be no assurance that such efforts will be successful or that Janssen will continue to support the product.
The Company entered into an international marketing agreement with ASTRA AB (now "AstraZeneca") to purchase the Company's products for resale in Europe, South America, Central America, Australia and New Zealand. In October 1999, the marketing and distribution rights in these countries were returned to the Company by AstraZeneca. The Company is currently evaluating alternative strategic options regarding distribution of its products in these countries. There can be no assurance that the Company's options are viable, or that the Company will be able to successfully implement those options.
INTENSE COMPETITION
Competition in the pharmaceutical and medical products industries is intense and is characterized by extensive research efforts and rapid technological progress. Certain treatments for ED exist, such as oral medications, needle injection therapy, vacuum constriction devices and penile implants, and the manufacturers of these products will continue to improve these therapies. The most significant competitive therapy is sildenafil, an oral medication marketed by Pfizer, which received regulatory approvals in the U.S. in March 1998 and in the European Union in September 1998. The commercial launch of sildenafil in the U.S. in April 1998 dramatically increased the number of men seeking treatment for impotence and significantly decreased demand for MUSE.
Additional competitive products in the erectile dysfunction market include needle injection therapy products from Pharmacia Upjohn and Schwartz Pharma, which were approved by the FDA in July 1995 and June 1997, respectively. Other large pharmaceutical companies are also actively engaged in the development of therapies for the treatment of ED. These companies have substantially greater research and development
capabilities as well as substantially greater marketing, financial and human resources than the Company. In addition, many of these companies have significantly greater experience than the Company in undertaking pre-clinical testing, human clinical trials and other regulatory approval procedures. There are also small companies, academic institutions, governmental agencies and other research organizations that are conducting research in the area of ED. For instance, Zonagen, Inc. has filed for FDA approval of its oral treatment and has received approval in Mexico; TAP Pharmaceuticals, Inc. has submitted an application to the FDA for approval of its sub-lingual treatment; ICOS Corporation has an oral medication in clinical testing; and Senetek has a needle injection therapy product approved recently in Denmark and has filed for approval in other countries. These entities may market commercial products either on their own or through collaborative efforts. For example, Zonagen, Inc. announced a worldwide marketing agreement with Schering-Plough in November 1997; and ICOS Corporation formed a joint venture with Eli Lilly in October 1998 to jointly develop and market its oral treatment. The Company's competitors may develop technologies and products that are more effective than those currently marketed or being developed by the Company. Such developments would render the Company's products less competitive or possibly obsolete. The Company is also competing with respect to marketing capabilities and manufacturing efficiency, areas in which it has limited experience.
DEPENDENCE ON SINGLE SOURCE OF SUPPLY
The Company relies on a single source, E-Beam Services, Inc., for sterilization of its product. There can be no assurance that the Company will be able to identify and qualify additional sterilization sources. The Company is required to receive FDA approval for suppliers. The FDA may require additional clinical studies or other testing prior to accepting a new supplier. Until the Company secures and qualifies additional sources of sterilization facilities, it is entirely dependent on E-Beam. If interruption in this service were to occur for any reason, including a decision by E-Beam to discontinue service, political unrest, labor disputes or a failure of E-Beam to follow regulatory guidelines, the development and commercial marketing of MUSE and other potential products could be delayed or prevented. An interruption in sterilization services would have a material adverse effect on the Company's business, financial condition and results of operations.
NEW PRODUCT DEVELOPMENT
The Company's future operating results may be adversely affected if the Company is unable to continue to develop, manufacture and bring to market pharmacological products rapidly. The process of developing new drugs and/or therapeutic solutions is inherently complex and uncertain. The Company must make long-term investments and commit significant resources before knowing whether its predictions will eventually result in products that will receive FDA approval and achieve market acceptance. After the FDA approves a product, the Company must quickly manufacture sufficient volumes to meet market demand. This is a process that requires accurate forecasting of market demand. Given the alternative treatments and the number of products introduced in the market each year, the drug development process becomes increasingly difficult and risky.
In December 1999, the Company submitted an NDA for ALIBRA to the FDA. The FDA may take up to 12 months to review the Company's submission, and may (1) ask the Company to provide more data; (2) ask the Company to perform additional clinical trials; or (3) not give the Company the approval. Even if ALIBRA is approved, there can be no assurances that there will be a market for this transurethral system to treat ED.
DEPENDENCE ON THIRD PARTIES
In 1996, the Company entered into a distribution agreement with CORD Logistics, Inc. ("CORD"), a wholly owned subsidiary of Cardinal Health, Inc. Under this agreement, CORD warehouses the Company's finished goods for U.S. distribution, takes customer orders; picks, packs and ships its product; invoices customers, and collects related receivables. As a result of this distribution agreement with CORD, the Company is heavily dependent on CORD's efforts to fulfill orders and warehouse its products effectively in the U.S. There can be no assurance that such efforts will be successful.
In 1996, the Company entered into a distribution agreement with Integrated Commercialization Services ("ICS"), a subsidiary of Bergen Brunswig Corporation. ICS provides "direct-to-physician" distribution capabilities in support of U.S. marketing and sales efforts. ICS also stores and ships various promotional materials to sales personnel, including MUSE patient and in-office instructional videos and brochures. As a result of this distribution agreement with ICS, the Company is dependent on ICS's efforts to distribute product samples effectively. There can be no assurance that such efforts will be successful.
In 1996, the Company entered into an agreement with WRB Communications ("WRB") to handle patient and healthcare professional hotlines for the Company. WRB maintains a staff of healthcare professionals to handle questions and inquires about MUSE and ACTIS. These calls may include complaints about the Company's product due to efficacy or quality, as well as reporting of adverse events. As a result of this agreement, the Company is dependent on WRB to effectively handle these hotline calls. There can be no assurance that such effort will be successful.
DEPENDENCE ON KEY PERSONNEL
The Company's success is highly dependent upon the skills of a limited number of key management personnel. To reach its business objectives, the Company will need to retain and hire qualified personnel in the areas of manufacturing, research and development, clinical trial management and pre-clinical testing. There can be no assurance that the Company will be able to retain or hire such personnel, as the Company must compete with other companies, academic institutions, government entities and other agencies. The loss of any of the Company's key personnel or the failure to attract or retain necessary new employees could have an adverse effect on the Company's research, product development and business operations.
FUTURE CAPITAL NEEDS AND UNCERTAINTY OF ADDITIONAL FINANCING
The Company anticipates that its existing capital resources combined with anticipated future revenues may not be sufficient to support the commercial introduction of any additional future products. The Company is currently seeking other sources of financing, which may include joint venture, co-development, or licensing agreement to support the development of its R&D pipeline.
The Company expects that it will be required to issue additional equity or debt securities or use other financing sources including, but not limited to, corporate alliances to fund the development and possible commercial launch of its future products. The sale of additional equity securities would result in additional dilution to the Company's stockholders. The Company's working capital and additional funding requirements will depend upon numerous factors, including: (i) results of operations; (ii) demand for MUSE; (iii) the activities of competitors; (iv) the progress of the Company's research and development programs; (v) the timing and results of pre-clinical testing and clinical trials; (vi) technological advances; and (vii) the level of resources that the Company devotes to sales and marketing capabilities.
HISTORY OF LOSSES AND LIMITED OPERATING HISTORY
The Company has generated a cumulative net loss of $91.0 million for the period from its inception through December 31, 1999. In order to sustain profitable operations, the Company must successfully manufacture and market MUSE and keep its expenditures in line with lower product revenues. The Company is subject to a number of risks including its ability to successfully market, distribute and sell its product, intense competition, and its reliance on a single therapeutic approach to erectile dysfunction and its ability to secure additional operating capital. There can be no assurance that the Company will be able to continue to achieve profitability on a sustained basis. Accordingly, there can be no assurance of the Company's future success.
During 1998, the Company took significant steps to restructure its operations in an attempt to bring the cost structure of the business in line with current demand for MUSE. These steps included significant reductions in personnel, closing the contract-manufacturing site located in PACO Pharmaceutical Services, Inc., the termination of the lease for the Company's leased corporate offices, and recorded significant write-
down of property, equipment and inventory. As a result of these and other factors, the Company experienced an operating loss of $80.3 million, or $2.52 per share, in the year ended December 31, 1998.
In September 1998, the Company significantly scaled back its manufacturing operations as a result of lower demand domestically and internationally for MUSE. Current production is significantly below capacity for the plant, resulting in a higher unit cost, and the Company expects that the gross margin from the sale of MUSE will be less predictable in future periods, which may cause greater volatility in the Company's results of operations and financial condition.
Management believes that these restructuring measures were adequate in bringing the cost structure in line with current and projected revenues; however, there can be no assurance that product demand will not weaken further or that these measures will result in sustained profitability in future periods.
LIMITED MANUFACTURING EXPERIENCE
The Company has limited experience in manufacturing and selling MUSE in commercial quantities. The Company initially experienced product shortages due to higher than expected demand and difficulties encountered in scaling up production of MUSE. The Company leases 90,000 square feet of space in New Jersey in which it has constructed manufacturing and testing facilities. The FDA and European Medicine Controls Agency ("MCA") authorized the Company to begin commercial production and shipment of MUSE from its new facility in June and March 1998, respectively. In September 1998, the Company closed its contract manufacturing site within PACO Pharmaceutical Services, Inc. and significantly scaled back its manufacturing operations in the New Jersey facility, as a result of lower domestic and international demand for MUSE. Production is currently significantly below capacity for the plant.
DEPENDENCE ON THE COMPANY'S TRANSURETHRAL SYSTEM FOR ERECTION
The Company currently relies on a single therapeutic approach to treat ED, its transurethral system for erection. Certain side effects have been found to occur with the use of MUSE. MUSE is applied into the urinary opening and is not for men with sickle cell trait, disease, or other blood disorders. One third of men reported genital pain, causing some to stop use. A few men reported dizziness and, less commonly, fainting. To date, the incidence of post-launch adverse side effects is consistent with that experienced in clinical trials. As a result of the Company's single therapeutic approach, the failure to successfully commercialize the product will have a material adverse effect to the Company's business.
The existence of side effects or dissatisfaction with product results may impact a patient's decision to use or continue to use or a physician's decision to recommend MUSE as a therapy for the treatment of ED, thereby affecting the commercial viability of MUSE.
In addition, technological changes or medical advancements could diminish or eliminate the commercial viability of the Company's product.
RISKS RELATING TO INTERNATIONAL OPERATIONS
The Company's product is currently marketed internationally. Changes in overseas economic and political conditions, currency exchange rates, foreign tax laws or tariffs or other trade regulations could have a material adverse effect on the Company's business, financial condition and results of operations. The international nature of the Company's business is also expected to subject it and its representatives, agents and distributors to laws and regulations of the foreign jurisdictions in which they operate or where the Company's product is sold. The regulation of drug therapies in a number of such jurisdictions, particularly in the European Union, continues to develop, and there can be no assurance that new laws or regulations will not have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the laws of certain foreign countries do not protect the Company's intellectual property rights to the same extent, as do the laws of the United States.
GOVERNMENT REGULATION AND UNCERTAINTY OF PRODUCT APPROVALS
The Company's research, pre-clinical development, clinical studies, manufacturing and marketing of its products are subject to extensive regulation, rigorous testing and approval processes of the Food and Drug Administration ("FDA") and equivalent foreign regulatory agencies. The Company's product MUSE has received marketing clearance in 48 countries to date.
After regulatory approval is obtained, the Company's products are subject to continual review. Manufacturing, labeling and promotional activities are continually regulated by the FDA and equivalent foreign regulatory agencies, and the Company must also report certain adverse events involving its drugs to these agencies. Previously unidentified adverse events or an increased frequency of adverse events that occur post-approval could result in labeling modifications of approved products, which could adversely affect future marketing of a drug. Finally, approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems occur following initial marketing. The restriction, suspension or revocation of regulatory approvals or any other failure to comply with regulatory requirements would have a material adverse effect on the Company's business, financial condition and results of operations.
The Company's clinical studies for future products will generate safety data as well as efficacy data and will require substantial time and significant funding. There is no assurance that clinical studies related to future products would be completed successfully within any specified time period, if at all. Furthermore, the FDA could suspend clinical studies at any time if it is believed that the subjects participating in such studies are being exposed to unacceptable health risks.
Failure to comply with the applicable regulatory requirements can, among other things, result in fines, suspensions of regulatory approvals, product recalls, operating restrictions and criminal prosecution. In addition, the marketing and manufacturing of pharmaceutical products are subject to continuing FDA and other regulatory review, and later discovery of previously unknown problems with a product, manufacturer or facility may result in the FDA and other regulatory agencies requiring further clinical research or restrictions on the product or the manufacturer, including withdrawal of the product from the market. The restriction, suspension or revocation of regulatory approvals or any other failure to comply with regulatory requirements would have a material adverse effect on the Company's business, financial condition and results of operations.
In connection with routine inspection of the Company's New Jersey manufacturing facility at 745 Airport Road, the FDA issued to the Company an FDA Form 483 containing two observations. The observations identified specific areas where the FDA viewed the Company's operations not to be in explicit compliance with Current Good Manufacturing Practices ("cGMP") requirements. A detailed response to the observations was submitted to the FDA on November 24, 1999.
Failure to maintain satisfactory cGMP compliance would have a material adverse effect on the Company's ability to continue to market and distribute its products and, in the most serious cases, could result in the issuance of additional Warning Letters, seizure or recall of products, civil fines or closure of the Company's manufacturing facility until such cGMP compliance is achieved.
The Company obtains the necessary raw materials and components for the manufacture of MUSE as well as certain services, such as testing and sterilization, from third parties. The Company currently contracts with suppliers and service providers, including foreign manufacturers that are required to comply with strict standards established by the Company. Certain suppliers and service providers are required by the Federal Food, Drug, and Cosmetic Act, as amended, and by FDA regulations to follow cGMP requirements and are subject to routine periodic inspections by the FDA and certain state and foreign regulatory agencies for compliance with cGMP and other applicable regulations. Certain of the Company's suppliers were inspected for cGMP compliance as part of the approval process. However, upon routine re-inspection of these facilities, there can be no assurance that the FDA and other regulatory agencies will find the manufacturing process or facilities to be in compliance with cGMP and other regulations. Failure to achieve satisfactory cGMP compliance as confirmed by routine inspections could have a material adverse effect on the Company's ability to continue to manufacture and distribute its products and, in the most serious case, result in the issuance of a
regulatory Warning Letter or seizure or recall of products, injunction and/or civil fines or closure of the Company's manufacturing facility until cGMP compliance is achieved.
PATENTS AND PROPRIETARY RIGHTS
The Company's policy is to aggressively maintain its patent position and to enforce all of its intellectual property rights.
The Company is the exclusive licensee of United States and Canadian patents originally filed in the name of Dr. Gene Voss. These patents claim methods of treating ED with a vasodilator-containing ointment that is administered either topically or transurethrally.
The Company is also the exclusive licensee of patents and patent applications filed in the name of Dr. Nils G. Kock, in numerous countries. Four United States patents have issued directed to methods and compositions for treating ED by transurethrally administering an active agent. Patents have also been granted in Australia, Austria, Belgium, Canada, Finland, France, Germany, Great Britain, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Spain, Sweden and South Africa. Patent applications are pending in Denmark and Romania. The foreign patents and applications, like the U.S. patents and applications, are directed to the treatment of ED by transurethral administration of certain active substances including alpha-receptor blockers, vasoactive polypeptides, prostaglandins or nitroglycerin dispersed in a hydrophilic vehicle.
The Company is the sole assignee of three United States patents, one divisional patent application and two continuation applications all deriving from patent applications originally filed by Alza, covering inventions of Dr. Virgil Place made while he was an employee of Alza. The patents and patent applications are directed to dosage forms for administering a therapeutic agent to the urethra, methods for treating erectile dysfunction and specific drug formulations that can be delivered transurethrally for the treatment of erectile dysfunction. The divisional and continuation applications were filed in the United States on June 7, 1995. All patents issuing on applications filed before June 8, 1995 will automatically have a term that is the greater of twenty years from the patent's effective filing date or seventeen years from the date of patent grant. Foreign patents have been granted in Australia, Europe (including Austria, Belgium, Denmark, Finland, France, Germany, Great Britain, Greece, Ireland, Italy, Luxembourg, Norway, the Netherlands, Portugal, Spain, Sweden and Switzerland), New Zealand, South Africa and South Korea, and foreign applications are pending in Canada, Finland, Ireland, Mexico, and Japan.
The Company's license and assignment agreements for these patents and patent applications are royalty bearing and do not expire until the licensed patents expire. These license and assignment agreements provide that the Company may assume responsibility for the maintenance and prosecution of the patents and bring infringement actions.
In addition to the Voss, Kock, and Place patents and applications identified above, the Company has twelve issued United States patents, nine pending United States patent applications, three Patent Cooperation Treaty ("PCT") applications, two granted foreign patents, and seven pending foreign patent applications. Several of these patents and applications further address the prevention, treatment and diagnosis of ED, while others are directed to prevention and/or treatment of other types of sexual dysfunction, including premature ejaculation in men, and female sexual dysfunction. One of the Company's issued patents covers the Company's ACTIS(R) venous flow control device. Other issued patents and pending patent applications focus on prevention and/or treatment of conditions other than sexual dysfunction, including vascular disorders such as peripheral vascular disease ("PVD"), hormone replacement therapy, and contraception.
The Company has recently entered into an agreement with AndroSolutions, Inc., a privately held biomedical corporation based in Knoxville, Tennessee, that owns patents and applications complementary to the Company's patents and applications directed to the treatment of FSD. Both the Company and AndroSolutions have contributed their FSD patents and applications into a jointly formed limited liability company, ASIVI, LLC, which exclusively licenses to VIVUS worldwide rights to the common patents and applications, and will work to further develop FSD products of interest to the Company.
The Company's success will depend in large part on the strength of its current and future patent position relating to the transurethral delivery of pharmacologic agents for the treatment of erectile dysfunction. The Company's patent position, like that of other pharmaceutical companies, is highly uncertain and involves complex legal and factual questions. The claims of a U.S. or foreign patent application may be denied or significantly narrowed, and patents that ultimately issue may not provide significant commercial protection to the Company. The Company could incur substantial costs in proceedings before the United States Patent and Trademark Office, including interference proceedings. These proceedings could also result in adverse decisions as to the priority of the Company's licensed or assigned inventions. There is no assurance that the Company's patents will not be successfully challenged or designed around by others.
The Company is presently involved in an opposition proceeding that was instigated by the Pharmedic Company against a European patent, inventors Nils G. Kock et al., that is exclusively licensed to VIVUS. As a result of the opposition proceeding, certain pharmaceutical composition claims in the European patent were held unpatentable by the Opposition Division of the EPO. The patentability of all other claims in the patent was confirmed, i.e., those claims directed to the use of active agents in the treatment of ED, and to a pharmaceutical composition claim for prazosin. The Company appealed the EPO's decision with respect to the pharmaceutical composition claims that were held unpatentable. The Pharmedic Company appealed the EPO's decision with respect to the claims that were held patentable, but has since withdrawn the appeal. Despite the withdrawal of the Pharmedic Company from the appeal process, the Company has continued with its own appeal in an attempt to reinstate the composition claims. The EPO Appeals Board must make its own finding whether the claims that were deemed unpatentable by the Opposition Division are indeed patentable before it can reverse the Opposition Division's decision. There can be no assurance that the appeal will be successful or that further challenges to the Company's European patent will not occur should the Company try to enforce the patent in the various European courts.
The Company was also the first to file a Notice of Opposition to Pfizer's European patent application claiming the use of phosphodiesterase inhibitors to treat erectile dysfunction. Numerous other companies have also opposed the patent, and the Company will support these other entities in their oppositions as necessary.
There can be no assurance that the Company's products do not or will not infringe on the patent or proprietary rights of others. The Company may be required to obtain additional licenses to the patents, patent applications or other proprietary rights of others. There can be no assurance that any such licenses would be made available on terms acceptable to the Company, if at all. If the Company does not obtain such licenses, it could encounter delays in product introductions while it attempts to design around such patents, or the development, manufacture or sale of products requiring such licenses could be precluded. The Company believes there will continue to be significant litigation in the pharmaceutical industry regarding patent and other intellectual property rights.
In addition to its patent portfolio, the Company also relies on trade secrets and other unpatented proprietary technology. No assurance can be given that the Company can meaningfully protect its rights in such unpatented proprietary technology or that others will not independently develop substantially equivalent proprietary products and processes or otherwise gain access to the Company's proprietary technology. The Company seeks to protect its trade secrets and proprietary know-how, in part, with confidentiality agreements with employees and consultants. There can be no assurance that the agreements will not be breached or that the Company will have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known or be independently developed by competitors. In addition, protracted and costly litigation may be necessary to enforce and determine the scope and validity of the Company's proprietary rights.
UNCERTAINTY OF PHARMACEUTICAL PRICING AND REIMBURSEMENT
In the U.S. and elsewhere, sales of pharmaceutical products are dependent, in part, on the availability of reimbursement to the consumer from third party payors, such as government and private insurance plans. Third party payors are increasingly challenging the prices charged for medical products and services. With the introduction of sildenafil, third party payors have begun to restrict or eliminate reimbursement for erectile
dysfunction treatments. While a large percent of prescriptions in the U.S. for MUSE have been reimbursed by third party payors since its commercial launch in January 1997, there can be no assurance that the Company's products will be considered cost effective and that reimbursement to the consumer will continue to be available or sufficient to allow the Company to sell its products on a competitive basis.
In addition, certain healthcare providers are moving towards a managed care system in which such providers contract to provide comprehensive healthcare services, including prescription drugs, for a fixed cost per person. The Company hopes to further qualify MUSE for reimbursement in the managed care environment. However, the Company is unable to predict the reimbursement policies employed by third party healthcare payors. Furthermore, reimbursement for MUSE could be adversely affected by changes in reimbursement policies of governmental or private healthcare payors.
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE
The commercial launch of MUSE exposes the Company to a significant risk of product liability claims due to its availability to a large population of patients. In addition, pharmaceutical products are subject to heightened risk for product liability claims due to inherent side effects. The Company details potential side effects in the patient package insert and the physician package insert, both of which are distributed with MUSE, and the Company maintains product liability insurance coverage. However, the Company's product liability coverage is limited and may not be adequate to cover potential product liability exposure. Product liability insurance is expensive, difficult to maintain, and current or increased coverage may not be available on acceptable terms, if at all. Product liability claims brought against the Company in excess of its insurance coverage, if any, could have a material adverse effect upon the Company's business, financial condition and results of operations.
UNCERTAINTY AND POSSIBLE NEGATIVE EFFECTS OF HEALTHCARE REFORM
The healthcare industry is undergoing fundamental changes that are the result of political, economic and regulatory influences. The levels of revenue and profitability of pharmaceutical companies may be affected by the continuing efforts of governmental and third party payors to contain or reduce healthcare costs through various means. Reforms that have been and may be considered include mandated basic healthcare benefits, controls on healthcare spending through limitations on the increase in private health insurance premiums and Medicare and Medicaid spending, the creation of large insurance purchasing groups and fundamental changes to the healthcare delivery system. Due to uncertainties regarding the outcome of healthcare reform initiatives and their enactment and implementation, the Company cannot predict which, if any, of the reform proposals will be adopted or the effect such adoption may have on the Company. There can be no assurance that future healthcare legislation or other changes in the administration or interpretation of government healthcare or third party reimbursement programs will not have a material adverse effect on the Company. Healthcare reform is also under consideration in some other countries.
POTENTIAL VOLATILITY OF STOCK PRICE
The stock market has experienced significant price and volume fluctuations unrelated to the operating performance of particular companies. In addition, the market price of the Company's Common Stock has been highly volatile and is likely to continue to be so. Factors such as the Company's ability to increase demand for its product in the U.S., the Company's ability to successfully sell its product in the U.S. and internationally, variations in the Company's financial results and its ability to obtain needed financing, announcements of technological innovations or new products by the Company or its competition, comments by security analysts, adverse regulatory actions or decisions, any loss of key management, the results of the Company's clinical trials or those of its competition, changing governmental regulations, patents or other proprietary rights, product or patent litigation or public concern as to the safety of products developed by the Company, may have a significant effect on the market price of the Company's Common Stock.
ANTI-TAKEOVER EFFECT OF PREFERRED SHARES RIGHTS PLAN AND CERTAIN CHARTER AND BYLAW PROVISIONS
In February 1996, the Company's Board of Directors authorized its reincorporation in the State of Delaware (the "Reincorporation") and adopted a Preferred Shares Rights Plan. The Company's Reincorporation into the State of Delaware was approved by its stockholders and became effective in May 1996. The Preferred Shares Rights Plan provides for a dividend distribution of one Preferred Shares Purchase Right (a "Right") on each outstanding share of the Company's Common Stock. The Rights will become exercisable following the tenth day after a person or group announces acquisition of 20 percent or more of the Company's Common Stock, or announces commencement of a tender offer, the consummation of which would result in ownership by the person or group of 20 percent or more of the Company's Common Stock. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the tenth day following acquisition by a person or group of 20 percent or more of the Company's Common Stock.
The Preferred Shares Rights Plan and certain provisions of the Company's Certificate of Incorporation and Bylaws may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. The Company's Certificate of Incorporation allows the Company to issue Preferred Stock without any vote or further action by the stockholders, and certain provisions of the Company's Certificate of Incorporation and Bylaws eliminate the right of stockholders to act by written consent without a meeting, specify procedures for director nominations by stockholders and submission of other proposals for consideration at stockholder meetings, and eliminate cumulative voting in the election of directors. Certain provisions of Delaware law could also delay or make more difficult a merger, tender offer or proxy contest involving the Company, including Section 203, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. The Preferred Shares Rights Plan, the possible issuance of Preferred Stock, the procedures required for director nominations and stockholder proposals and Delaware law could have the effect of delaying, deferring or preventing a change in control of the Company, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of the Company's common stock. These provisions could also limit the price that investors might be willing to pay in the future for shares of the Company's Common Stock.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases 90,000 square feet of space in New Jersey in which it has constructed manufacturing and testing facilities. The FDA and MCA authorized the Company to begin commercial production and shipment of MUSE from its new facility in June and March 1998, respectively. In September 1998, the Company closed its contract manufacturing site within PACO Pharmaceutical Services, Inc. and significantly scaled back its manufacturing operations in the New Jersey facility, as a result of lower demand domestically and internationally for MUSE.
In January 2000, the Company leased 14,237 square feet of space in Mountain View, California, which serves as the principal site for administration, clinical trial management, regulatory affairs and monitoring of product production and quality control, as well as its research and development. The Company's lease covering premises consisting of 6,000 square feet of space in a different building in Mountain View, California expired in January 2000.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On October 5, 1998, the Company was named in a civil action filed in the Superior Court of New Jersey. This complaint seeks specific performance and other relief in connection with the Company's leased manufacturing facilities, located in Lakewood, New Jersey. The Company's lease agreement requires that the Company provide a removal security deposit in the form of cash or a letter of credit. The Company and lessor ("plaintiff") have reached a tentative agreement whereby the Company will provide an irrevocable standby letter of credit in the amount of $3.3 million for such security deposit.
On February 18, 1998, a purported shareholder class action entitled Crain et al. v. VIVUS, Inc. et al. was filed in Superior Court of the State of California for the County of San Mateo. Five identical complaints were
subsequently filed in the same court. These complaints were filed on behalf of a purported class of persons who purchased stock between May 15, 1997 and December 9, 1997. The complaints alleged that the Company and certain current and former officers or directors artificially inflated the Company's stock price by issuing false and misleading statements concerning the Company's prospects and issuing false financial statements. On March 16, 1998, a purported shareholder class action entitled Cramblit et al. v. VIVUS Inc. et al. was filed in the United States District Court for the Northern District of California. Five additional complaints were subsequently filed in the same court. The federal complaints were filed on behalf of a purported class of persons who purchased stock between May 2, 1997 and December 9, 1997. The federal complaints asserted the same factual allegations as the state court complaints, but asserted legal claims under the Federal Securities Laws. The federal court cases were consolidated, and a lead plaintiff was appointed and the plaintiff filed a consolidated and amended complaint in 1998.
On May 4, 1999 the Company reached a settlement with plaintiffs of the shareholder class action lawsuits described above. The aggregate settlement amount is $6 million. The settlement is funded by insurance proceeds of $5.4 million and by the Company contributing 120,000 shares of VIVUS Common Stock to the settlement fund.
On November 3, 1999, VIVUS International Limited ("VINTL") filed a demand for arbitration against Janssen Pharmaceutica International ("Janssen") with the American Arbitration Association pursuant to the terms of the Distribution Agreement entered into between VINTL and Janssen on January 22, 1997. VINTL seeks compensation for inventory manufactured by VINTL in 1998 in reliance on contractual forecasts and orders submitted by Janssen. VINTL also seeks compensation for forecasts and order shortfalls attributed to Janssen in 1998, pursuant to the terms of the Distribution Agreement. VINTL seeks an award of $3.9 million plus costs and interest. On December 3, 1999, Janssen submitted its response to VINTL's arbitration demand denying liability. On January 3, 2000, each party designated an independent arbitrator. The designated arbitrators will select a third neutral arbitrator. An arbitration hearing is expected to occur in the second quarter of 2000.
During the first quarter of 2000, the Company reached agreement with Oxford Asymmetry International, plc. ("Oxford") to terminate a long-term supply agreement for prostaglandin E(1)("alprostadil") that was executed on August 29, 1997, following the receipt of a notice of demand for arbitration from Oxford. As a part of this agreement, the Company paid $500 thousand for a non-exclusive license to use analytical and stability data related to alprostadil that was provided by Oxford to the Company. The payment to Oxford will not impact the Company's earnings, as this amount was fully reserved for by the Company as part of its 1998 restructuring.
In the normal course of business, the Company receives and makes inquiries regarding patent infringement and other legal matters. The Company believes that it has meritorious claims and defenses and intends to pursue any such matters vigorously. The Company is not aware of any asserted or unasserted claims against it where the resolution would have an adverse material impact on the operations or financial position of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during the quarter ended December 31, 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades publicly on the Nasdaq Stock Market under the symbol "VVUS." The following table sets forth for the periods indicated the quarterly high and low closing sales prices of the Common Stock on the Nasdaq Stock Market.
As of March 3, 2000, there were no outstanding shares of Preferred Stock and 746 holders of record of 32,219,353 shares of outstanding Common Stock. The Company has not paid any dividends since its inception and does not intend to pay any dividends on its Common Stock in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND EMPLOYEE DATA)
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
SELECTED ANNUAL FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
In the Management Discussion and Analysis section of the 10-K we are providing more detailed information about our operating results and changes in financial position over the past three years. This section should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page 26.
VIVUS, Inc. ("VIVUS" or the "Company") is the developer and manufacturer of MUSE(R) (alprostadil) and ACTIS(R), two advancements in the treatment of men with erectile dysfunction ("ED"), also known as impotence. The Company's objective is to become a global leader in the development and commercialization of innovative therapies for the treatment of sexual dysfunction and urologic disorders in men and women. VIVUS has ongoing research and development ("R&D") programs in male ED, female sexual dysfunction ("FSD"), and male premature ejaculation ("PE"), and intends to pursue targeted technology acquisitions to expand its R&D pipeline. The Company intends to market and sell its products through distribution, co-promotion or license agreements with corporate partners. In December 1999, the company filed a New Drug Application ("NDA") with the U.S. Food and Drug Administration ("FDA") for ALIBRA(R), its second-generation male ED treatment.
In November 1996, the Company obtained marketing clearance by the FDA to manufacture and market its first product, MUSE, and commercially introduced MUSE in the United States beginning in January 1997. The launch of MUSE went on to become one of the top 25 most successful drug launches in the U.S., and the Company recorded a net profit of $36.6 million and product revenue of $129.3 million for the year ended December 31, 1997.
During 1998, the Company experienced a significant decline in market demand for MUSE as the result of the introduction of a competitor's product in April 1998. During the second and third quarters of 1998, the Company took significant steps to restructure its operations in an attempt to bring the cost structure in line with current and projected revenues. As a result, the Company recorded a net loss of $80.3 million for the year ended December 31, 1998.
In 1999, the Company focused its efforts on building a solid foundation for future growth. The Company achieved profitable quarters throughout 1999 and recorded net income of $18.8 million for the year. We successfully completed our ALIBRA Phase III clinical trials and filed an NDA in the fourth quarter with the FDA. We completed enrollment of our premature ejaculation Phase II proof-of-concept study, and we have strengthened our financial position, increasing our cash position from $24 million at December 31, 1998 to $40 million at December 31, 1999, while decreasing total liabilities by $5 million during the same period.
The Company supports MUSE sales in the U.S. through physician and patient information/help lines, sales support for major accounts, product education newsletters and participation in national urologic and sexual dysfunction forums and conferences, such as the American Urological Association annual and regional meetings and the International Society for Impotence Research. In addition, the Company supports ongoing research and clinical investigation of MUSE and the publication of data in peer-reviewed journals. Internationally, the Company has entered into a licensing and distribution agreement with Janssen Pharmaceutical ("Janssen") for certain international markets, including multiple Pacific Rim countries (excluding Japan), Canada, Mexico, South Africa and Australia. The Company is seeking a partner(s) to market and sell its products through distribution, co-promotion or license agreements in the United States, Europe, Japan and South America.
1999 HIGHLIGHTS
The Company was granted a new patent for the "Treatment of Female Sexual Dysfunction" by the U.S. Patent Office, providing broad patent protection for the commercialization of topical formulations of vasodilating agents and steroid hormones for the treatment of sexual dysfunction affecting women. The Company entered into a binding Memorandum of Understanding to further solidify its FSD intellectual property position through an exclusive agreement with AndroSolutions, Inc., a privately held biomedical corporation. Definitive agreements were executed in March 2000. The Company and AndroSolutions have jointly formed ASIVI, LLC, a Delaware limited liability corporation, into which VIVUS contributed its issued U.S. FSD patent and European application and into which AndroSolutions has contributed its U.S. and European FSD patent applications. In turn, ASIVI has granted the Company exclusive global rights to develop and commercialize FSD technologies based on this intellectual property, in return for certain milestone payments and royalties on FSD products developed by VIVUS. The Company and AndroSolutions will each own 50% of ASIVI, LLC. The Company intends to account for their interest in ASIVI, LLC. through the equity method of accounting. The Company began development for its product for the treatment of FSD, ALISTA(TM) and expects to enter clinical testing during year 2000.
The Company was granted a new patent for the "Method and Composition for Treating Erectile Dysfunction" by the U.S. Patent Office, providing broad patent protection for the commercialization of ALIBRA, its second-generation transurethral treatment for male ED. The Company filed an NDA for ALIBRA with the FDA in the fourth quarter of 1999.
The Company initiated a proof-of-concept, Phase II clinical study for the evaluation of "on-demand" oral compounds for the treatment of premature ejaculation in men.
The Company received $8 million in milestone payments for the approval of MUSE marketing licenses in France, Germany, Spain and Italy.
The Company reached a settlement of the shareholder class action lawsuits. The settlement for $6 million was funded by insurance proceeds of $5.4 million and by the Company contributing 120,000 shares of common stock.
The Company terminated its license agreement with Albert Einstein College of Medicine of Yeshiva University for the development of gene therapy for the treatment of ED, a strategic decision based on the development risks involved and the amount of funding and time required to potentially bring a product to market.
The marketing and distribution rights in Europe, Australia, New Zealand, Central and South America were returned to the Company by AstraZeneca. This resulted in the Company recording $20 million in revenue in the fourth quarter of 1999, consisting of $14.9 million in product revenue associated with shipments that occurred throughout 1998 and 1999, $2 million in milestone revenue associated with marketing clearance in Italy, and $3.1 million in other revenue.
RESULTS OF OPERATIONS
Years Ended December 31, 1999 and 1998
Product revenues for year ended December 31, 1999 were $21.2 million in the U.S. and $20.0 million internationally, compared to $39.0 million in the U.S. and $32.7 internationally for the same period in 1998. The significant decline in U.S. product revenue is due to lower demand for the Company's product MUSE, which resulted from the launch of sildenafil, a competitive oral treatment for erectile dysfunction. Internationally, revenues decreased to $20.0 million in 1999, compared to $32.7 million in 1998. The revenue decrease from 1998 is mainly attributable to reduced orders from both AstraZeneca and Janssen.
For the year ended December 31, 1999, the Company recorded $8 million in milestone revenue from AstraZeneca related to regulatory approvals of MUSE in France, Germany, Italy and Spain. For the year ended December 31, 1998, the Company recorded $3 million milestone revenue from Janssen related to regulatory approvals of MUSE in South Korea and Canada.
Total revenue in 1999 also includes $3.1 million in other revenue associated with the return of marketing and distribution rights for MUSE from AstraZeneca. Additionally the Company recorded a $9.1 million charge for the actual and anticipated return of expired product in the U.S. These returns are primarily the result of shipments made during the fourth quarter of 1997 and first quarter of 1998. Demand for MUSE declined following the launch of a competitive product in April 1998, resulting in excess inventories of wholesalers and retailers.
Cost of goods sold for the year ended December 31, 1999 were $12.4 million, compared to $55.6 million for the same period in 1998. The decrease was primarily a result of lower unit shipments in 1999. In addition, an inventory valuation reserve of $16.0 million was recorded in 1998 as part of the Company's restructuring of its operations.
Research and development (R&D) expenses for the year ended December 31, 1999 were $7.9 million, compared to $16.2 million in the year ended December 31, 1998. Lower spending in 1999 was primarily a result of the Company's effort to bring overall cost levels in line with the Company's projected current and projected revenues. Higher spending in 1998 was mainly associated with a significantly larger R&D organization.
Selling, general and administrative expenses for the year ended December 31, 1999 were $6.3 million, compared to $40.5 million in the year ended December 31, 1998. The lower expenses in 1999 were primarily a result of the Company's effort to bring overall cost levels in line with the Company's projected future demand for MUSE. Included in selling, general and administration expenses for 1998 were significant expenses for a direct-to-consumer advertising campaign as well as a direct sales force, which are not included in 1999.
Operating expenses for the year ended December 31, 1999 include a non-cash charge of $600,000 for the issuance of 120,000 share of common stock toward the settlement of shareholders class action lawsuits. In addition, the Company reclassified $1.8 million from other restructuring costs during the fourth quarter to allowance for product returns during earlier quarters. (SEE NOTE 6 on page 38). Operating expenses for the year ended December 31, 1998 include a restructuring charge of $12.5 million, primarily associated with the sales force and other personnel reductions; and a $32.2 million write-down of property and equipment. The write-down was calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 121 and represents the excess of the carrying values of property and equipment over the projected future discounted cash flows for the Company.
The Company recorded a tax provision of five percent of net income before taxes for 1999. The effective tax rate calculation includes the effect of NOLs carried forward from prior periods. The tax rate would have been substantially higher if the NOLs were not available to offset current income. The Company had no tax provision for 1998 as a result of the loss recorded for this year.
Years Ended December 31, 1998 and 1997
During fiscal 1998, the Company took significant steps to restructure its operations in an attempt to bring the cost structure of the business in line with current revenue projections. These steps included significant reductions in headcount in all departments, as well as the closing of VIVUS' contract manufacturing site located within PACO Pharmaceutical Services, Inc., and the consolidation of employees at the Company's corporate headquarters into a smaller space within its current building. As a result, the Company recorded $60.7 million of costs and write-downs during fiscal 1998.
Product revenues for year ended December 31, 1998 were $39.0 million in the U.S. and $32.7 million internationally, compared to $128.3 million in the U.S. and $1.0 million internationally for the same period in 1997. The significant decline in U.S. product revenue is due to lower demand for the Company's product MUSE, which resulted from the U.S. launch of sildenafil, a competitive oral treatment for erectile dysfunction. Underlying demand for MUSE domestically, as measured by retail prescriptions, declined approximately 80% following the commercial launch of sildenafil in April 1998. Internationally, revenues increased to $32.7 million in 1998 as Janssen and AstraZeneca were preparing to launch MUSE in various countries.
For the year ended December 31, 1998, the Company recorded $3 million milestone revenue from Janssen related to regulatory approvals of MUSE in South Korea and Canada. For the year ended December 31, 1997, the Company recorded $7 million milestone revenue; $5 million from Janssen for signing the initial and expanded distribution agreements and $2 million from AstraZeneca for regulatory approval in the United Kingdom.
Cost of goods sold for the year ended December 31, 1998 were $55.6 million, compared to $38.3 million for the same period in 1997. The increase was primarily a result of an inventory valuation reserve of $16.0 million, primarily related to excess raw materials and future inventory purchase commitments for raw materials in excess of anticipated future demand recorded as a part of the Company's restructuring in the third quarter of 1998.
Research and development (R&D) expenses for the year ended December 31, 1998 were $16.2 million, compared to $12.1 million in the year ended December 31, 1997. The increase was mainly due to increased spending associated with new product development.
Selling, general and administrative expenses for the year ended December 31, 1998 were $40.5 million, compared to $47.9 million in the year ended December 31, 1997. The decrease was primarily the result of lower marketing and advertising expenses in addition to personnel reductions in administration, sales and marketing. During 1998, the Company discontinued its direct-to-consumer-advertising, terminated its sales force services agreement with Innovex, and agreed to facilitate the transition of its direct sales force to Alza Corporation. The Company also announced its decision to seek a major pharmaceutical partner to market, distribute and sell MUSE in the U.S. and its comprehensive effort to reduce expenses.
Interest and other income for the year ended December 31, 1998 was $2.0 million, compared with $4.9 million for the same period in 1997. The decrease was primarily the result of lower average invested cash balances.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed operations primarily from the sale of preferred and common stock. Through December 31, 1999, VIVUS has raised $153.8 million from financing activities and has an accumulated deficit of $91.0 million at December 31, 1999.
Cash, cash equivalents and available-for-sale securities totaled $40.4 million at December 31, 1999, compared with $23.9 million at December 31, 1998. The $16.5 million increase during 1999 was primarily the result of net income of $18.8 million and collection of accounts receivable of $3.1 million. These increases were partially offset by payments made related to the restructuring reserve established in 1998 of $5.4 million.
Accounts receivable at December 31, 1999 were $4.4 million, compared with $5.2 million at December 31, 1998, a decrease of $715 thousand due primarily to lower sales and improved collections.
Total liabilities were $27.3 million at December 31, 1999, compared with $32.4 million at December 31, 1998, a decrease of $5.1 million. This decrease relates primarily to the payments made related to the restructuring reserve of $5.4 million and recognition of unearned revenue of $3.1 million. These decreases are partially offset by and increase in the reserve for product returns of $4.3 million.
On October 5, 1998, the Company was named in a civil action filed in the Superior Court of New Jersey. This complaint seeks specific performance and other relief in connection with the Company's leased manufacturing facilities located in Lakewood, New Jersey. The Company's lease agreement requires that the Company provide a removal security deposit in the form of cash or a letter of credit. The Company and lessor ("plaintiff") have reached a tentative agreement whereby the Company will provide an irrevocable standby letter of credit in the amount of $3.3 million for such security deposit.
The Company believes that current cash, investments, and future cash flows will be sufficient to support the Company's operating needs through 12/31/00. The Company expects that it will be required to issue additional equity or debt securities or use other financing source to fund the development and possible commercial launch of its future products.
This Form 10-K contains "forward-looking" statements about future financial results, future products and other events that have not yet occurred. For example, statements like we "expect," we "anticipate" or we "believe" are forward-looking statements. Investors should be aware that actual results may differ materially from our expressed expectations because of risks and uncertainties about the future. We will not necessarily update the information in this Form 10-K if any forward-looking statement later turns out to be inaccurate. Details about risks affecting various aspects of our business are discussed throughout this Form 10-K. Investors should read all of these risks carefully, and should pay particular attention to risks affecting the following areas: future capital needs and uncertainty of additional financing (page 12); history of losses and limited operating history (pages 12 and 13); limited sales and marketing experience (page 10); dependence on third parties (pages 11 and 12); intense competition (page 11); dependence on key personnel (page 12); and other risk factors as stated (pages 10 through 18).
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
VIVUS, INC.
1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following financial statements are filed as part of this Report:
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of VIVUS, Inc.:
We have audited the accompanying consolidated balance sheets of VIVUS, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of VIVUS, Inc. and subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Jose, California January 21, 2000
VIVUS, INC.
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
ASSETS
See notes to consolidated financial statements.
VIVUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See notes to consolidated financial statements.
VIVUS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (IN THOUSANDS)
See notes to consolidated financial statements.
VIVUS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
See notes to consolidated financial statements.
VIVUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See notes to consolidated financial statements.
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
VIVUS, Inc. was incorporated in California in 1991 to develop products for the treatment of erectile dysfunction. The Company was reincorporated in Delaware in 1996. The classification of the capital accounts reflects the effect of the reincorporation for all periods presented.
The Company obtained clearance from the U.S. Food and Drug Administration ("FDA") to manufacture and market MUSE in the U.S. in November 1996. The Company received approval to market MUSE in the United Kingdom from the Medicines Control Agency ("MCA") in November 1997, and is now approved in all European Union Countries. The Company commercially introduced MUSE in the U.S. in January 1997, and MUSE went on to become one of the top 25 most successful drug launches in the U.S., and the Company recorded a net profit of $36.6 million and product revenue of $129.3 million for the year ended December 31, 1997.
During 1998, the Company experienced a significant decline in market demand for MUSE as the result of the introduction of a competitor's product in April 1998. During the second and third quarters of 1998, the Company took significant steps to restructure its operations in an attempt to bring the cost structure in line with current and projected revenues.
In 1999, the Company focused its efforts on building a solid foundation for future growth. We successfully completed our ALIBRA Phase III clinical trials and filed an NDA in the fourth quarter with the FDA. We completed enrollment of our premature ejaculation Phase II proof-of-concept study, and we have strengthened our financial position, increasing our cash position from $24 million at December 31, 1998 to $40 million at December 31, 1999, while decreasing total liabilities by $5 million during the same period.
SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Product revenue is generally recognized upon shipment. The Company primarily sells its products through the wholesale channel in the United States. Product shipments are generally to distribution centers throughout the United States for the larger wholesalers.
The Company recognized revenues of $8 million, $3 million, and $9 million in the years ended December 31, 1999, 1998, and 1997, respectively, as a result of achieving certain milestones related to its international marketing agreements. The amounts are not refundable and do not involve any significant future performance obligations.
The marketing and distribution rights in Europe, Australia, New Zealand, Central and South America were returned to the Company by AstraZenica during the fourth quarter of 1999. This resulted in the Company recording $20 million in revenue in the fourth quarter of 1999, consisting of $14.9 million in product revenue associated with shipments that occurred throughout 1998 and 1999, $2 million in milestone revenue associated with marketing clearance in Italy, and $3.1 million in other revenue.
Principles of Consolidation
The consolidated financial statements include VIVUS, Inc., VIVUS International Limited, a wholly-owned subsidiary, and VIVUS Ireland Limited, VIVUS UK Limited and VIVUS BV Limited, wholly-owned subsidiaries of VIVUS International Limited. All significant intercompany transactions and balances have been eliminated.
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an original maturity of 90 days or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Pending FDA marketing clearance, which was obtained in November 1996, the Company expensed to research and development all raw material purchases prior to October 1, 1996. Certain of these expensed raw material costs benefited 1997 and 1998 by reducing cost of sales by $4.7 million and $2.7 million, respectively. During the quarter ended September 30, 1998, the Company wrote down its inventory to align with new estimates of expected future demand for MUSE. The Company had built up its inventory level prior to and after Pfizer's launch of sildenafil and had not anticipated the impact that this competing product would have on the demand for MUSE. The Company had anticipated sales to ultimately increase as a result of an expanding impotence market. Given the protracted decline in demand for MUSE, the Company recorded a valuation reserve of $16.0 million, primarily related to excess raw materials and future inventory purchase commitments for raw materials. This write-down is included in "Cost of Sales" in 1998 as part of the Company's restructuring.
Available-for-Sale Securities
The Company accounts for available-for-sale securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Available-for-sale securities represent debt securities that are stated at fair value. The difference between amortized cost (cost adjusted for amortization of premiums and accretion of discounts which are recognized as adjustments to interest income) and fair value, representing unrealized holding gains or losses, are recorded in "Accumulated Other Comprehensive Income," a separate component of stockholders' equity until realized. The Company's policy is to record debt securities as available-for-sale because the sale of such securities may be required prior to maturity. Any gains and losses on the sale of debt securities are determined on a specific identification basis.
Prepaid Expenses and Other Assets
Prepaid expense and other assets generally consist of deposits, prepayments for future services and other assets. Prepayments are expensed when the services are received. At December 31, 1999, the prepaid expenses and other assets include a $3.1 million receivable of other revenue due from AstraZeneca in connection with the return of marketing and distribution rights to MUSE.
Property
Property and equipment are stated at cost. For financial reporting, depreciation and amortization are computed using the straight-line method over estimated useful lives of three to seven years. Leasehold improvements are amortized using the straight-line method over the lesser of the estimated useful lives on remaining lease term. During 1998, the Company took multiple steps to restructure the operations of the Company to bring the cost structure in line with current and anticipated future revenues. These steps included the closing of the Company's contract manufacturing facility within PACO Pharmaceutical Services, Inc., and the termination of the Company's leased corporate offices. The Company recorded a $32.2 million write-down of property and equipment. This write-down was calculated in accordance with the provisions of SFAS No. 121 and represents the excess of the carrying values of, property and equipment, primarily the Company's New Jersey manufacturing leaseholds and equipment, over the projected future discounted cash flows for the Company.
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which requires an asset and liability approach for financial reporting of income taxes.
License Agreements
The Company has obtained rights to patented technologies related to its initial product MUSE under several licensing agreements. These agreements generally required milestone payments during the development period and royalties on product sales. Royalties on product sales are included in cost of goods sold. Milestone payments were included in research and development expenses in 1998, 1997 and years prior to 1997.
Net Income (Loss) Per Share
Basic earnings per share is computed using the weighted average number of common shares outstanding during the periods. Diluted earnings per share is based on the weighted average number of common and common equivalent shares, which represent shares that may be issued in the future upon the exercise of outstanding stock options and warrants under the treasury stock method. The computation of basic and diluted earnings per share for the years ended December 31, 1999, 1998 and 1997 are as follows:
Options to purchase 286,500 shares at prices ranging from $24.81 to $37.38 which were outstanding at December 31, 1997 are not included in the computation of diluted EPS for 1997 because the option prices were greater than the average market price of common shares. Options to purchase 964,879 shares at prices ranging from $3.25 to $25.88 which were outstanding at December 31, 1999 are not included in the computation of diluted EPS for 1999 because the option prices were greater than the average market price of common shares. Warrants to purchase 325,000 shares with an exercise price of $4.31 expired on July 12, 1999.
Foreign Currency
Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue, cost and expenses are translated at average rates of exchange in effect during the year. Net gains and losses resulting from foreign exchange transactions were not material in all periods.
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recently Issued Accounting Pronouncements
Accounting for Derivative Instruments and Hedging Activities. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards "SFAS No. 133," "Accounting for Derivative Instruments and Hedging Activities." This statement, as amended in June 1999, will require companies to recognize all derivatives, including those used for hedging foreign currency exposures, on the balance sheet at fair value and is effective for all fiscal years beginning after June 15, 2000. We believe the adoption of this statement will not have a significant effect on the results of operations.
Revenue Recognition in Financial Statements. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "SAB 101," "Revenue Recognition in Financial Statements." SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. We will adopt SAB 101 as required in the first quarter of 2000. We do not expect the adoption of SAB 101 to have a material impact on our consolidated results of operations and financial position.
Reclassifications
Reclassifications have been made to the prior years' Consolidated Financial Statements to conform to the fiscal 1999 presentation.
NOTE 2. AVAILABLE-FOR-SALE SECURITIES
The fair value and the amortized cost of available-for-sale securities at December 31, 1999 and 1998 are presented in the table that follows. Fair values are based on quoted market prices obtained from an independent broker. For each category of investment securities, the table presents gross unrealized holding gains and losses. As of December 31, 1998, available-for-sale securities with maturities between one and two years, which total $12.7 million, are classified as short term assets as it is the Company's intention to sell these securities before maturity as necessary to meet current liability obligations.
As of December 31, 1999 (in thousands):
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 1998 (in thousands):
NOTE 3. INVENTORIES
Inventories are recorded net of reserves of $15.0 million and $14.8 million as of December 31, 1999 and 1998, respectively, and consist of (in thousands):
NOTE 4. FIXED ASSETS
Property and equipment as of December 31 consists of (in thousands):
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. ACCRUED AND OTHER LIABILITIES
In 1999, the Company recorded an allowance for product returns of $9.1 million related to expired products related to excess inventory in the wholesale channel prior to the launch of sildenafil. At December 31, 1999, a balance of $4.3 million remained to offset anticipated future returns.
Accrued and other liabilities as of December 31 consist of (in thousands):
NOTE 6. RESTRUCTURING AND RELATED CHARGES
During the second quarter of 1998, the Company recorded restructuring and related costs of $6.5 million. The charge included costs of $3.2 million resulting from the termination of certain marketing and promotional programs, a provision of $2.3 million for reductions in the Company's workforce that includes severance compensation and benefit costs, and $1.0 million in write-down of fixed assets.
During the third quarter of 1998, the Company took additional steps to restructure its operations and recorded $54.2 million of costs and write-downs. These charges included a $16.0 million write-down of inventory, primarily raw materials and commitments to buy raw materials, a $32.2 million write-down in property, and $6.0 million of other restructuring costs primarily related to personnel costs and operating lease commitments. These write-downs were calculated in accordance with the provisions of SFAS No. 121 and represents the excess of the carrying value of property and equipment, primarily the Company's New Jersey manufacturing leaseholds and equipment, over the projected future discounted cash flows for the Company.
During first quarter, second quarter and third quarter 1999, the Company included expired products returns of $500,000, $1 million, and $293,000, respectively, against the "Other" restructuring. In the fourth quarter 1999, the Company reclassified these charges to returns reserve to offset product revenues, and reversed the "Other" restructuring reserve from operating expenses as such reserves were determined to be excess in 1999.
Restructuring and related charges in fiscal 1999 and 1998 (in thousands):
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company expects that during the fiscal year 2000 it will make cash payments of approximately $2.4 million related to the restructuring, with the remaining $5.7 million in cash payments to occur in later years.
NOTE 7. STOCKHOLDERS' EQUITY
Common Stock
The Company is authorized to issue 200 million shares of common stock. As of December 31, 1999 and 1998, 32,210,500, and 31,890,091 shares, respectively, were issued and outstanding.
The Company's Board of Directors approved a stock repurchase program in May 1997 whereby the Company could purchase up to two million shares of its common stock. As of December 31, 1997, the Company had repurchased 336,700 shares at a cost of $7,716,000. During January and February 1998, the Company repurchased 1,663,300 additional shares of its common stock at a cost of $23,583,990.
During second quarter 1999, the Company reached a settlement of the shareholder class action lawsuits, in which the company incurred a non-cash expense of $600,000 for the issuance of 120,000 shares of VIVUS, Inc. common stock.
Preferred Stock
The Company is authorized to issue 5,000,000 shares of undesignated preferred stock. Shares of preferred stock may be issued by the Company in the future, without stockholder approval, upon such terms as the Company's Board of Directors may determine.
Stock Warrants
In connection with the issuance of convertible preferred stock in 1993, the Company issued warrants exercisable for up to 528,600 shares of common stock at an exercise price of $4.31 per share. In June 1997, 203,590 warrants were exercised and the Company issued 165,928 net shares based on the market price on June 23, 1997. The remaining 325,010 warrants were not exercised and expired on July 12, 1999.
NOTE 8. STOCK OPTION AND PURCHASE PLANS
Stock Option Plans
Under the 1991 Incentive Stock Plan (the Plan), the Company may grant incentive or non-statutory stock options or stock purchase rights (SPRs). Up to 7,800,000 shares of common stock have been authorized for issuance under the Plan. The Plan allows the Company to grant incentive stock options (ISOs) to employees and nonstatutory stock options (NSOs) to employees, directors and consultants at not less than the fair market value (for an ISO) of the stock at the date of grant (110% of fair market value for individuals who control more than 10% of the Company stock; otherwise, not less than 85% of fair market value for an NSO), as determined by the Board of Directors. Under the Plan, 25% of the options generally become exercisable after one year and 2.0833% per month thereafter. The term of the option is determined by the Board of Directors on the date of grant but shall not be longer than ten years. The Plan allows the Company to grant SPRs to employees and consultants at not less than 85% of the fair market value of the stock at the date of grant, as determined by the Board of Directors. Sales of stock under SPRs are made pursuant to restricted stock purchase agreements containing provisions established by the Board of Directors. The Company has a right to repurchase the shares at the original sale price, which expires at a rate to be determined by the Board of Directors. As of December 31, 1999, no SPRs have been granted under the Plan.
Under the 1994 Director Option Plan (the Director Option Plan), the Company reserved 400,000 shares of common stock for issuance to nonemployee directors of the Company pursuant to nonstatutory stock
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
options issued at the fair market value of the Company's common stock at the date of grant. Under the Director Option Plan, nonemployee directors will receive an option to purchase 32,000 shares of common stock when they join the Board of Directors. These options vest 25% after one year and 25% annually thereafter. Each director shall receive an option to purchase 8,000 shares of the Company's common stock annually upon their reelection. These options are fully exercisable ratably over eight months.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants: risk-free rates ranging from 5 - 6% and corresponding to government securities with original maturities similar to the vesting periods; expected dividend yield of 0%; expected lives of .64 years beyond vest dates; and expected volatility of 55% in all years.
Details of option activity under these plans are as follows:
At December 31, 1999, 5,960,960 options remained authorized and unissued and options to purchase 1,929,551 shares were exercisable under these plans. The weighted average fair values of options granted during 1999, 1998, and 1997, were $3.36, $4.96, and $9.32, respectively.
During 1997, options to purchase 100,000 shares of common stock were granted to research consultants at the fair market value on the date of grant. Compensation costs, including the impact of re-pricing, using the Black-Scholes option-pricing model approximately $1.1 million over the option's vesting period of which $182,000, $648,000 and $140,000 were recorded as expenses for the years ended December 31, 1999, 1998 and 1997, respectively. These options were cancelled in July 1999, when the Company decided not to renew the
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
contract with the research consultants. The research consultants exercised a total of 25,000 shares of these options during 1999.
In October 1998, the Company's Board of Directors authorized the re-pricing of all non-executive employees' options, certain consultants' options, and 50% of executives' options to the closing value as of October 19, 1998. The remaining 50% of executive options were re-priced at 150% of the closing value as of the same date. All re-priced stock options have a six-month "black out" period, whereby the re-priced stock options are not exercisable, even if vested. The "black out" period of all re-priced options ended April 18, 1999, and are now exercisable if vested.
The Company accounts for these plans under APB Opinion No. 25. Except for compensation discussed in the preceding paragraph, no compensation cost has been recognized because the exercise price equals the market value of stock on the date of grant. Options under these plans generally vest over four years, and all options expire after ten years.
Under FASB Statement No. 123 (FASB 123), "Accounting for Stock-based Compensation," the estimated fair value of options is amortized to expense over the options' vesting period. In accordance with the disclosure requirements of FASB 123, if the Company had elected to recognize this expense, income (loss) and income (loss) per share would have been reduced to the following pro forma amounts (in thousands, except per share data):
Stock Purchase Plan
In June 1994, the Company implemented an employee stock purchase plan under which eligible employees may authorize payroll deductions of up to 10% of their base compensation (as defined) to purchase common stock at a price equal to 85% of the lower of the fair market value as of the beginning or the end of the offering period. A total of 400,000 shares were reserved for issuance under the employee stock purchase plan. As of December 31, 1999, 269,172 shares have been issued to employees. During 1999, the weighted average fair market value of shares issued under the employee stock purchase plan was $2.16 per share.
NOTE 9. LICENSE AGREEMENTS
The Company has entered into several agreements to license patented technologies that are essential to the development and production of the Company's products. In connection with these agreements, upon meeting certain milestones (as defined) and contingent on the issuance of patents in certain countries, the Company is obligated to (1) pay license fees of $2,575,000 (of which $2,175,000 was paid prior to December 31, 1997 and $400,000 was paid in January 1998); (2) issue 896,492 shares of the Company's common stock (all of which has been issued); and (3) pay royalties on product sales covered by the license agreements (4% of U.S. and Canadian product sales and 3% of sales elsewhere in the world). In 1996, the Company issued an additional 400,000 shares of common stock to maintain exclusive rights to certain patents and patent applications beyond 1998. In connection with this issuance, the Company recorded a charge of $5,821,000 to the consolidated statements of operations. In 1997, 1998 and 1999, the Company recorded royalty expenses as cost of goods sold based on product sales.
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. LEASE COMMITMENTS
The Company leases its manufacturing facilities under a five-year non-cancelable operating lease expiring in 2002. The Company has the option to extend this lease for two renewal terms of five years each. In January 2000, the Company entered into a seven-year lease for a new corporate headquarters in Mountain View, California, which lease expires in January 2007.
Future minimum lease payments under operating leases are as follows (in thousands):
Rent expense under operating leases totaled $994,000, $2,472,000 and $1,320,000 for the years ended December 31, 1999, 1998, 1997, respectively.
NOTE 11. INCOME TAXES
Deferred income taxes result from differences in the recognition of expenses for tax and financial reporting purposes, as well as operating loss and tax credit carryforwards. Significant components of the Company's deferred income tax assets as of December 31, are as follows (in thousands):
For federal and state income tax reporting purposes, net operating loss carryforwards of approximately $17,719,000 and $440,000 are available to reduce future taxable income, if any. These carryforwards begin to expire in 2019. In 1995, the Company implemented an international product distribution strategy for its products. Implementation included the transfer of international product manufacturing and marketing rights to VIVUS International Limited in a taxable transaction. The transfer of rights and related allocation of research and development costs resulted in the current utilization of $29,467,000 of the net operating loss carryforward. Should significant changes in the Company's ownership occur, the annual amount of tax loss and credit carryforwards available for future use would be limited.
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The provision for income taxes consisted of the following components for the years ended December 31, 1999 and 1997, (in thousands):
The provisions for income taxes differs from the amount computed by applying the statutory federal income tax rates as follows, for the years ended December 31, 1999 and 1997:
NOTE 12. LEGAL MATTERS
On November 3, 1999, VIVUS International Limited ("VINTL") filed a demand for arbitration against Janssen Pharmaceutica International ("Janssen") with the American Arbitration Association pursuant to the terms of the Distribution Agreement entered into between VINTL and Janssen on January 22, 1997. VINTL seeks compensation for inventory manufactured by VINTL in 1998 in reliance on contractual forecasts and orders submitted by Janssen. VINTL also seeks compensation for forecasts and order shortfalls attributed to Janssen in 1998, pursuant to the terms of the Distribution Agreement. VINTL seeks an award of $3.9 million plus costs and interest. On December 3, 1999, Janssen submitted its response to VINTL's arbitration demand denying liability. On January 3, 2000, each party designated an independent arbitrator. The designated arbitrators will select a third neutral arbitrator. An arbitration hearing is expected to occur in the second quarter of 2000.
On October 5, 1998, the Company was named in a civil action filed in the Superior Court of New Jersey. This complaint seeks specific performance and other relief in connection with the Company's leased manufacturing facilities, located in Lakewood, New Jersey. The Company's lease agreement requires that the Company provide a removal security deposit in the form of cash or a letter of credit. The Company and lessor ("plaintiff") have reached a tentative agreement whereby the Company will provide an irrevocable standby letter of credit in the amount of $3.3 million for such security deposit in the fourth quarter.
On February 18, 1998, a purported shareholder class action entitled Crain et al. v. VIVUS, Inc. et al., was filed in Superior Court of the State of California for the County of San Mateo. Five identical complaints were subsequently filed in the same court. These complaints were filed on behalf of a purported class of persons who purchased stock between May 15, 1997 and December 9, 1997. The complaints alleged that the Company and
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
certain current and former officers or directors artificially inflated the Company's stock price by issuing false and misleading statements concerning the Company's prospects and issuing false financial statements. On March 16, 1998, a purported shareholder class action entitled Cramblit et al. v. VIVUS, Inc. et al. was filed in the United States District Court for the Northern District of California. Five additional complaints were subsequently filed in the same court. The federal complaints were filed on behalf of a purported class of persons who purchased stock between May 2, 1997 and December 9, 1997. The federal complaints asserted the same factual allegations as the state court complaints, but asserted legal claims under the Federal Securities Laws. The federal court cases were consolidated, and a lead plaintiff was appointed and the plaintiff filed a consolidated and amended complaint in 1998.
On May 4, 1999, the Company reached a settlement with plaintiffs of the shareholder class action lawsuits described above. The aggregate settlement amount was $6 million. The settlement was funded by insurance proceeds of $5.4 million and by the Company contributing 120,000 shares of VIVUS Common Stock to the settlement fund.
In the normal course of business, the Company receives and makes inquiries regarding patent infringement and other legal matters. The Company believes that it has meritorious claims and defenses and intends to pursue any such matters vigorously. The Company is not aware of any asserted or unasserted claims against it where the resolution would have an adverse material impact on the operations or financial position of the Company.
NOTE 13. SEGMENT INFORMATION
During 1998, the Company adopted Statement of Financial Accounting Statement SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." SFAS 131 requires a new basis of determining reportable business segments, i.e. the management approach. This approach requires that businesses disclose segment information used by management to assess performance and manage company resources. On this basis, the Company primarily sells its product through wholesale channels in the United States. International sales are made only to the Company's two international partners. All transactions are denominated in U.S. dollars, therefore, the Company considers the arrangement as operating in a single segment.
- --------------- * Customer's percentage did not fall in the top five
NOTE 14. SUBSEQUENT EVENT (UNAUDITED)
The Company entered into a binding Memorandum of Understanding to further solidify its female sexual dysfunction ("FSD") intellectual property position through an exclusive agreement with AndroSolutions, Inc., a privately held biomedical corporation and definitive agreements were executed in March 2000. The Company and AndroSolutions have jointly formed ASIVI, LLC, a Delaware limited liability company, into which VIVUS has contributed its issued U.S. FSD patent and European application and into which
VIVUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AndroSolutions has contributed its U.S. and European FSD patent applications. In turn, ASIVI has granted the Company exclusive global rights to develop and commercialize FSD technologies based on this intellectual property, in return for certain milestone payments and royalties on FSD products developed by VIVUS. The Company and AndroSolutions will each own 50% of ASIVI, LLC. The Company intends to account for their interest in ASIVI, LLC. through the equity method of accounting.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT
The information required by this item is incorporated by reference from the discussion in the Company's Proxy Statement captioned "Proposal One: Election of Directors."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the discussion in the Company's Proxy Statement captioned "Executive Compensation."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the discussion in the Company's Proxy Statement captioned "Record Date and Share Ownership."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information required by this item is incorporated by reference from the discussion in the Company's Proxy Statement captioned "Certain Transactions and Reports."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. FINANCIAL STATEMENTS
2. FINANCIAL STATEMENT SCHEDULES
Schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or notes thereto incorporated by reference herein.
3. EXHIBITS
- --------------- + Confidential treatment granted.
++ Confidential treatment requested.
(1) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Registration Statement on Form S-1 No. 33-75698, as amended.
(2) Incorporated by reference to the same numbered exhibit filed with the Registrant's Registration Statement on Form S-1 No. 33-90390, as amended.
(3) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995, as amended.
(4) Incorporated by reference to the same numbered exhibit filed with the Registrant's Form 8-B filed with the Commission on June 24, 1996.
(5) Incorporated by reference to the same numbered exhibit filed with the Registrant's Current Report on Form 8-K/A filed with the Commission on June 21, 1996.
(6) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
(7) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, as amended.
(8) Incorporated by reference to exhibit 99.1 filed with Registrant's Amendment Number 2 to the Registration Statement of Form 8-A (File No. 0-23490) filed with the Commission on April 23, 1997.
(9) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
(10) Incorporated by reference to the same numbered exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.
(11) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997.
(12) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(13) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998.
(14) Incorporated by reference to the same-numbered exhibit filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999.
(b) REPORTS ON FORM 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:
VIVUS, INC., a Delaware Corporation
By: /s/ RICHARD WALLISER ------------------------------------ Richard Walliser Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting Officer)
Date: March 30, 2000
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Leland F. Wilson and Richard Walliser as his attorney-in-fact for him, in any and all capacities, to sign each amendment to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact or his substitute or substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
VIVUS, INC.
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998
INDEX TO EXHIBITS*
- --------------- * Only exhibits actually filed are listed. Exhibits incorporated by reference are set forth in the exhibit listing included in Item 14 of the Report on Form 10-K. ++ Confidential treatment requested.