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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission File Number 0-26866
SONUS PHARMACEUTICALS, INC.
(Exact name of the registrant as specified in its charter)
DELAWARE 95-4343413
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
22026 20TH AVENUE S.E., BOTHELL, WASHINGTON 98021
(Address of principal executive offices)
(425) 487-9500
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Not Applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $0.001 per share
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 13, 1998, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the Registrant was $104,254,957 based on the
closing sales price of $19.75 per share of the Common Stock as of such date, as
reported by The Nasdaq National Market. As of March 13, 1998, 8,614,043 shares
of the registrant's Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be filed in
connection with the solicitation of proxies for its 1998 Annual Meeting of
Stockholders to be held April 30, 1998 are incorporated by reference in Items
10, 11, 12, and 13 of Part III hereof.
PAGE 1 OF 48 PAGES
EXHIBIT INDEX APPEARS ON PAGE 45
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PART I
ITEM 1. BUSINESS
SONUS Pharmaceuticals, Inc. ("SONUS" or the "Company") is primarily engaged
in the research, development and commercialization of proprietary contrast
agents for use in ultrasound imaging. Ultrasound imaging is a widely used,
non-invasive, cost-effective technique to examine soft tissues, internal body
organs and blood flow in the body. In contrast to other imaging modalities,
ultrasound imaging is currently largely performed without the use of a contrast
agent. The Company's principal product under development, EchoGen(R) Emulsion,
is a contrast agent designed to be administered to a patient prior to performing
ultrasound studies to improve image quality. Based upon the Company's clinical
trials to date involving over 1,800 people, the Company believes that EchoGen
will significantly improve the effectiveness of ultrasound imaging by increasing
the reflectivity differential between the bloodstream which carries the contrast
agent and the surrounding soft tissue being imaged.
EchoGen is a stable, liquid emulsion, based on the Company's proprietary
PhaseShift(TM) technology, which changes from microscopic liquid droplets of
dodecafluoropentane ("DDFP") to gas microbubbles during administration. The
Company believes EchoGen offers significant benefits as a contrast agent
including (i) small bubble size which allows EchoGen to pass through capillaries
in the lungs and other organs, (ii) a long half-life which will allow physicians
sufficient time to complete an EchoGen-enhanced ultrasound study, (iii)
intensity of the sound wave reflectivity or echogenicity providing for better
quality images and (iv) works in fundamental and other imaging modes.
A New Drug Application ("NDA") was submitted to the U.S. Food and Drug
Administration ("FDA") in August 1996 for the approval to market EchoGen in the
U.S. In February 1998, the Company received an action letter from the FDA which
indicated that the EchoGen NDA is inadequate for approval, citing certain
deficiencies in the application. The Comany is preparing an amendment to the
NDA to address the issues raised in the FDA's letter. A Marketing
Authorization Application ("MAA") was submitted to the European Medicines
Evaluation Agency ("EMEA") in November 1996 for the approval to market EchoGen
in the European Union ("E.U."). In March 1998, the Committee for Proprietary
Medicinal Products ("CPMP"), the scientific review committee of the EMEA,
issued a positive opinion on EchoGen for use in patients with suspected or
established cardiovascular disease, which generally precedes the final approval
by the European Commmision. See "Certain Factors That May Affect the Company's
Business and Future Results."
OVERVIEW
Medical imaging to diagnose and treat disease states and conditions has
been an important element of medical treatment since the introduction of x-ray
technology. As imaging technology has advanced in recent decades, applications
of medical imaging have expanded to address increasingly complex disease states
and conditions involving soft tissues and internal body organs. For example,
medical imaging currently plays an important role in the diagnosis and treatment
of disease states and conditions affecting the vascular and nervous systems and
major organs such as the heart, kidney and liver. Sources indicate over 100
million soft tissue and organ imaging studies are performed annually in the U.S.
The most widely used imaging modalities for soft tissues and organs include
computed tomography ("CT"), magnetic resonance imaging ("MRI"), nuclear
medicine, x-ray angiography and ultrasound. Each medical imaging modality
requires specialized equipment and has different patterns
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of use and applications. The imaging modality to be used is selected based on a
variety of factors, including the particular disease state or condition to be
studied, image quality, the cost of the study and the status of the patient in
the patient management cycle. The use of image-enhancing contrast agents is
crucial to some imaging modalities, and has greatly clarified images in others,
and in general has broadened the number of imaging applications. A contrast
agent is a substance that is administered to the patient, either orally,
intravenously or by other routes of injection, to enhance the image by
increasing the visibility of the blood vessels or body cavities, as well as
other tissues and organs containing the contrast agent. It is estimated that 36
million imaging studies utilizing contrast agents are performed annually in the
U.S. with an estimated cost of $1.6 billion attributable to the contrast agents.
ULTRASOUND IMAGING
Ultrasound was introduced for medical imaging purposes in the late 1950s as
a safe, non-invasive and relatively inexpensive method to provide images of most
major soft tissues and organs. Initially, ultrasound was used to image the
general shape, size and structure of internal soft tissues and organs. With
advances in technology, ultrasound imaging has been used to image blood flow in
soft tissues, organs and the vascular system as a means of determining the
presence of a disease state or condition. Based on published reports, the
Company believes that over 50 million ultrasound imaging procedures are
performed annually in the U.S., of which a majority are for cardiology and
radiology indications. Approximately 14 million ultrasound studies
are performed annually in the U.S. for cardiac function indications at a typical
cost to payors of approximately $200. In an ultrasound study for cardiac
function indications, otherwise known as echocardiography, the physician
attempts to obtain an enhanced image of the internal heart structure, including
the valves and chambers, to diagnose coronary artery disease, valvular disease
and congenital heart defects. In addition, approximately 18 million radiology
ultrasound studies are performed annually in the U.S. at a typical cost to
payors of approximately $100 per study to image various tissues and organs. In
an ultrasound study for radiology indications, the physician attempts to image
soft tissues and organs and to identify abnormalities and obstructions of the
major veins and arteries of the body. There are over 50,000 ultrasound systems
installed in the U.S. and 147,000 worldwide in substantially all hospitals and
clinics and in many physicians' offices.
Ultrasound systems use low-power, high-frequency sound waves to produce
real-time images. The sound waves emitted by the ultrasound transducer, which is
placed on the skin or in a body cavity near the targeted area, are reflected by
tissues and fluids, thus allowing the physician to view, characterize and define
tissues and organs. The reflected sound waves, or echoes, are received and
processed by the ultrasound system and displayed in real-time on the system's
monitor. The intensity of the echoes received by the ultrasound system is
proportional to the acoustical reflectivity of the tissue or fluid. In standard
ultrasound imaging, known as grayscale for radiology applications or
two-dimensional ("2D") for cardiology applications, the physician can diagnose,
treat and monitor disease states and conditions by analyzing the relative
shading of tissues or organs.
In 1984, color Doppler ultrasound system enhancements were introduced that
utilize the principle that the frequency of sound waves reflected by moving
objects is altered in proportion to their velocity (a Doppler frequency shift).
These enhancements allow physicians to make a hemodynamic assessment (the study
of blood circulation through the body) of the patient based on the direction and
speed of blood flow through the body as well as in the chambers and valves of
the heart. However, since the velocity of blood flow measured by the Doppler
ultrasound transducer is dependent upon
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the angle of the blood vessel in relation to skin surface, the use of Doppler
enhancements for certain applications, such as the imaging of the renal artery,
which is parallel to the skin, has been limited. More recently, the use of newly
introduced "power" Doppler systems, which are capable of measuring the variation
of the intensity of signals that have undergone a Doppler frequency shift, has
improved the diagnostic utility of ultrasound imaging systems by reducing much
of the angle dependence of earlier generation Doppler systems and by allowing
the imaging of certain vessels and tissues that could not be imaged effectively
with earlier systems.
Despite such advancements in ultrasound equipment, ultrasound imaging
produces images that are less defined and more difficult to interpret than
images produced by other imaging modalities such as CT and MRI. For example, the
depth and angle of certain organs or arterial vessels within the body limit the
use of ultrasound imaging because of the inability to receive echoes from deep
within the body and the inability to see the entire length of certain arterial
vessels such as the renal artery. In addition, the low acoustic density and
reflectivity of blood also limits the use of ultrasound imaging for vascular or
perfusion imaging. Accordingly, while anatomical structures may be viewed
effectively using ultrasound imaging, physiologic functions of the body, such as
blood flow, are not monitored easily. As a further limitation, the lower
velocity of blood flow in certain vessels of the body makes it difficult for
ultrasound systems to detect Doppler frequency shift signals. For example,
infections (abscesses) and tumors, which are characterized by lower velocity
blood flow, may not be detected by today's ultrasound systems. As a result, many
ultrasound procedures are non-diagnostic for technical reasons because the
physician is not able to make a definitive diagnosis with the information that
is provided by the ultrasound image.
ULTRASOUND CONTRAST AGENTS
While the use of contrast agents in diagnostic imaging is well established
and broadly utilized in other imaging modalities, historically there has been a
lack of commercially available ultrasound contrast agents. For many years,
scientists have attempted to develop such agents focusing primarily on methods
to encapsulate air microbubbles that reflect the sound waves generated by the
ultrasound system. Historically, the development of an effective contrast agent
has been hampered by the lack of persistence of the microbubbles, or by the
challenge that microbubbles were too fragile to pass through the lungs or too
large to pass through small blood vessels. Persistence, size and stability of
microbubbles are important characteristics given that, once injected in the
bloodstream, the contrast agent must pass through the lungs, where gas exchange
can eliminate the microbubbles, before reaching the left chambers of the heart
and before circulating throughout the vascular system.
Cardiology Indications. The Company believes that an effective ultrasound
contrast agent could enable physicians to assess the function of the
cardiovascular system as well as myocardial perfusion. An effective ultrasound
contrast agent could improve echocardiography by allowing physicians to use
left ventricular chamber opacification to assist cardiac function analysis
regionally, through wall motion analysis and globally, through ejection
fraction measurements. Further, an ultrasound contrast agent, which is
persistent and able to pass through small blood vessels, could allow physicians
to assess myocardial perfusion to differentiate functioning cardiac tissue from
ischemic (blood deficient) and infarcted (dead) tissue. The use of exercise
stress to increase the work load of the heart before contrast-enhanced
echocardiography could also assist the differentiation of ischemia from
infarction. In 1994, the FDA approved the first ultrasound contrast agent for
use as an aid for the enhancement of images of ventricular chambers and improved
endocardial (inner heart chamber) border definition in patients with suboptimal
echoes undergoing certain cardiac function studies and a second agent was
approved in December 1997. In addition, the Company believes that several others
are in clinical trials.
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Radiology Indications. The Company believes that the development of an
effective ultrasound contrast agent could improve the capabilities of ultrasound
imaging for radiology indications, including diagnostic imaging of kidney, liver
and peripheral vascular diseases, by increasing the visibility of blood flow and
blood flow patterns, and by improving the detection of small lesions or
structures deep within the body, where acoustic energy is lost as the
transmitted acoustical beam passes through the body. The Company is developing
EchoGen for both macrovascular and microvascular indications. In macrovascular
indications (the diagnosis of disease states and conditions of the major
arteries and veins of the body), an effective ultrasound contrast agent may aid
in the detection of strokes and pre-stroke conditions through visualization of
intracranial (within the skull) blood vessels, atherosclerosis, vascular graft
patency and peripheral vascular thrombosis, a major cause of pulmonary emboli
(blood clots in the pulmonary artery and the lungs). For microvascular
indications (the diagnosis of disease states and conditions through the analysis
of patterns of small vessel blood flow), ultrasound contrast agents may allow
the physician to identify lesions, tumors or other diseases in the liver (e.g.,
adenomas and hemangiomas), kidneys and other tissues and organs. There are no
FDA approved ultrasound contrast agents for radiology indications although the
Company believes that several are in clinical trials.
TECHNOLOGY AND PRODUCTS
ECHOGEN
The Company has primarily focused its research and development efforts on
the development of EchoGen, which produces small microbubbles in the bloodstream
that persist long enough to permit completion of diagnostic studies and which
can be manufactured and packaged with an acceptable shelf life. To develop
EchoGen, the Company initially focused its efforts on identifying a chemical
agent that exhibited the desired properties of high persistence and the ability
to form small microbubbles when injected. The Company measures the persistence
of microbubbles by a standard the Company has defined as a "Q factor." By
definition, a Q factor of one equals the length of time an air bubble three
microns in diameter remains undissolved in the blood. After studying over 400
chemicals, primarily fluorocarbons, the Company selected DDFP to develop as a
potential contrast agent. DDFP has a Q factor of approximately 200,000, which
permits it to persist in the blood for over 10 minutes. In addition, DDFP has a
boiling point of 28.5(degree)C (approximately 83(degree)F), which allows it to
exist as a liquid at room temperature or below but change into a gas when
administered to a patient. This process, which the Company calls the
PhaseShift(TM) process, leads to microbubbles in the patient's bloodstream.
Through its research and development efforts, and utilizing its proprietary
technology, the Company developed EchoGen. EchoGen is a stable, 2% emulsion of
DDFP, that through the PhaseShift process creates microbubbles that are small
enough to pass through the lungs and circulate in the vascular system. EchoGen
is packaged in vials and easily administered by the physician with a single
peripheral venous injection prior to or during the ultrasound study. Based on
studies conducted to date, EchoGen has a useful shelf life of 18 months at room
temperature.
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The Company believes that EchoGen has the following characteristics, which
the Company believes will provide it with an advantage over competing ultrasound
contrast agents:
- Long Persistence. Based on results from clinical trials, the Company
believes that EchoGen is sufficiently persistent to complete typical
radiology and cardiology studies. The period of persistence of EchoGen
varies widely depending upon numerous factors. In Phase 3 studies of
cardiac function, where 2D is the preferred imaging modality, EchoGen
persisted on average for approximately four minutes. In radiology
indications where Doppler is the primary imaging modality, based on
Phase 3 clinical trials, EchoGen persisted on average for approximately
fifteen minutes.
- Small Microbubble Size. Following administration, EchoGen microbubbles
are small enough to pass through the lungs and circulate in the
vascular system, enabling imaging of small blood vessels and tissues.
In addition, the small microbubble size may enable EchoGen to penetrate
the microvasculature of the heart facilitating myocardial perfusion
imaging.
- Sound Wave Reflectivity. EchoGen exhibits significant sound wave
reflectivity, thereby improving image quality and allowing imaging of
vessels or organs that are deep within the body.
- Safety. Results from preclinical and clinical trials conducted to date
indicate that DDFP, the active ingredient of EchoGen, is substantially
excreted from the body through the lungs within 25 minutes of
administration without metabolic changes. Some patients experience
transient side effects such as feeling of warmth, taste perversion,
headache and nausea.
SONOGEN
The Company is developing a second generation fluorocarbon-based ultrasound
agent, SonoGen(TM), a charge-stabilized emulsion of DDFP. SonoGen was selected
for development because it may have tissue or disease selective properties.
Preclinical and Phase 1 clinical studies in Europe have suggested that SonoGen
may also have improved tissue grayscale persistence compared to EchoGen or other
first generation fluorocarbon contrast agents. The Company intends to commence
advanced clinical studies of SonoGen during 1998.
STATUS OF CLINICAL TRIALS
The Company commenced clinical trials of EchoGen in January 1994. The
Company uses academic institutions and clinical research organizations to
conduct and monitor its clinical trials for radiology and cardiology
indications. Under the Company's agreements with Abbott Laboratories ("Abbott"),
SONUS is responsible for conducting clinical trials and obtaining regulatory
clearances in the U.S. and E.U. Abbott is responsible for conducting clinical
trials and obtaining all regulatory clearances in all other countries of the
world, excluding Japan and nine other countries in the Pacific Rim. As part of
the Company's agreement with Daiichi Pharmaceutical Co., Ltd. ("Daiichi"),
Daiichi is responsible for conducting clinical trials and obtaining all
regulatory clearances in Japan and nine other countries in the Pacific Rim.
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CARDIOLOGY INDICATIONS
From late 1995 to early 1996, the Company performed a pivotal 252 patient
Phase 3 clinical study at 19 sites in the U.S. to evaluate the efficacy of
EchoGen in improving the use of echocardiography to assess cardiac disease in
patients who previously had a suboptimal (non-diagnostic) echo exam. EchoGen
provided blood pool enhancement or left ventricular opacification in 90% of
patients, improved endocardial border delineation in 88% of patients, and
improved wall motion assessment in 88% of patients. These results lead to an
increased diagnostic confidence in 76% of the patients, disclosed findings not
present at baseline in 63% and prevented the need for further studies in 19% of
patients. EchoGen salvaged suboptimal echoes in 50% of the patients.
RADIOLOGY INDICATIONS
In 1995, the Company performed a pivotal 253 patient Phase 3 clinical study
in the U.S. at 18 sites to evaluate radiology indications for EchoGen,
specifically contrast enhancement and facilitated visualization of anatomic
structures, lesions and blood flow during studies of the liver, kidney and
peripheral vasculature. The study design included a placebo-control, randomized
single administration and a dosage of 0.05 mL/kg with the results of the study
also read by blinded investigators. In the study, based on 151 patients who were
studied using the final formulation, EchoGen enhanced or facilitated
visualization of abnormal structures, lesions or blood flow patterns in 94% of
the patients. In addition, EchoGen increased diagnostic confidence in 54% of
the studies; reduced non-diagnostic studies by 46%; provided the primary
information needed for the diagnosis in 31% of patients; and changed the
diagnosis in 12% of patients. Over 42% of the examinations were completed more
quickly with EchoGen. EchoGen prevented further ;75;1&w;75;1&wstudies in 13% of
patients and assisted in the therapeutic management of patients 18% of the time.
SAFETY RESULTS
In analyzed clinical trials with 1,128 patients utilizing the current
formulation of EchoGen, there were no findings that the Company believes would
suggest a toxicologic or pharmacologic response to the administration of
EchoGen. There were no effects on organ function, blood chemistry, hematologic
or urinalysis results. Adverse events that were considered possibly, probably or
definitely related to EchoGen administration were experienced by 9.5% of
patients. Those events occurring in greater than 1.0% of patients include
feeling of warmth (3.5%), taste perversion (1.7%), headache (1.0%), and nausea
(1.0%). The events were usually mild, occurred within 30 minutes of injection,
generally required no treatment and left no sequelae.
ADDITIONAL STUDIES
In August 1997, the Company completed two multi-center Phase 2 trials to
determine the safety of EchoGen as a contrast agent during echocardiography in
135 patients with severe chronic obstructive pulmonary disease and in 146
patients with NYHA Class III or IV congestive heart failure. The results suggest
that there are no clinically or statistically significant differences in the
safety profiles exhibited by EchoGen and the inactive placebo (saline) in these
patient populations.
In September 1997, the Company completed enrollment in a multi-center,
randomized, blinded Phase 3 trial of 304 patients which compared the
discriminatory power of contrast echocardiography
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with EchoGen and nuclear medicine scans in the detection of perfusion deficits
in the myocardium. Data analysis is currently underway.
In July 1997, the Company initiated a Phase 3 multi-center trial to assess
the use of EchoGen in improving the detection of prostate cancer by contrast
ultrasound. Patients with elevated PSA (prostate specific antigen) levels and/or
abnormal rectal examinations who have been referred for biopsy received a
contrast enhanced transrectal ultrasound examination using EchoGen. Enrollment
of 213 patients in this trial was completed in early 1998.
In March 1997, a Phase 1 trial in 20 healthy volunteers undergoing stress
echocardiography with EchoGen was completed in the U.K. The results of the trial
suggest that the administration of EchoGen in multiple doses at rest and peak
stress are safe and effective when used in conjunction with either pharmacologic
or exercise stress echocardiography. In August 1997, the Company initiated a
Phase 3 multi-center single blinded study comparing the discriminatory power of
non-enhanced stress echocardiography and contrast enhanced stress
echocardiography in the visualization of cardiac wall motion. This trial is
investigating the use of EchoGen during either Dobutamine (pharmacologic
stress) or exercise stress echocardiography. Non-enhanced and enhanced stress
echo results will be compared to the results of the patients cardiac
catheterization procedure.
In 1996, the Company performed a Phase 2 trial in Europe that enrolled 20
patients who underwent contrast enhanced ultrasound studies of the breast. The
results suggest that EchoGen-enhanced ultrasound appears to be useful in
distinguishing malignant from benign breast lesions after suspicious lumps are
discovered by mammography examination. In 1998, the Company plans to initiate a
Phase 3 Breast Cancer multi-center blinded study. This study will investigate
the ability of EchoGen to improve on the diagnosis of breast disease by
enhancing the increase in vascularity exhibited by lesions.
In late 1997, SONUS completed a Phase 1 trial of SonoGen at the Leicester
Clinical Research Unit in the U.K. There were no serious adverse events among
the 20 normal human subjects at a range of doses. Investigators concluded that
SonoGen was safe and well tolerated.
The commercialization of SonoGen, or of EchoGen for new indications, beyond
those contained in the NDA, will require approval of separate regulatory
submissions based on extensive additional clinical testing. There can be no
assurance the clinical trial results from the above or future trials will
demonstrate any efficacy or will be adequate for regulatory approval. See
"Certain Factors That May Affect the Company's Business and Future Results."
MARKETING AND DISTRIBUTION
The Company's strategy is to market EchoGen and SonoGen through
arrangements with third parties in the U.S. and the rest of the world.
The Company and Abbott have formed a strategic alliance for the marketing,
manufacturing and distribution of ultrasound contrast agents, including EchoGen,
in the U.S., Europe, Latin America, Canada, Africa, Middle East and certain
countries in the Pacific Rim. Under the Abbott alliance the Company has the
responsibility to provide technical marketing support during the launch and
commercialization of EchoGen in the U.S. The Company and Daiichi have formed a
strategic
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alliance for the marketing, manufacturing and distribution of EchoGen in Japan
and nine other countries in the Pacific Rim. See "Strategic Alliances." There
can be no assurance that the Company's strategic relationships will be
successful.
MANUFACTURING
The Company has utilized three outside FDA-certified organizations to
manufacture EchoGen under current Good Manufacturing Practices ("GMP")
requirements for the Company's use in preclinical and clinical studies and
produces non-GMP batches of EchoGen at its facilities in Bothell, Washington as
part of the Company's ongoing development of the product.
The Company has entered into an agreement with Abbott pursuant to which
Abbott has agreed to scale-up, manufacture and sell EchoGen to the Company at a
fixed price, subject to increases in the producer's price index, packaged in
final dosage form for a period of five years from the date of FDA approval,
subject to automatic renewal unless otherwise terminated by either party with 12
months prior notice. Abbott has produced EchoGen in commercial-scale lots for
use by the Company in its clinical trials in the U.S. The product is
manufactured from raw materials supplied to Abbott by the Company. Under the
agreement, the Company must purchase minimum annual quantities of EchoGen if FDA
approval is received, and the Company has retained the right to manufacture or
to have a third party manufacture a portion of its requirements. The inability
of Abbott or any alternative contract manufacturer to manufacture and supply the
Company with EchoGen would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Strategic
Alliances" and "Certain Factors That May Affect the Company's Business and
Future Results."
The active chemical ingredients in EchoGen, DDFP and PEG Telomer B, a
surfactant, are manufactured by a limited number of vendors worldwide. The
inability of these vendors to supply medical-grade materials to the Company
could delay the Company's manufacture of, or cause the Company to cease the
manufacturing of, EchoGen. Any such delay or cessation could have a material
adverse effect on the Company's business, financial condition and results of
operations. The Company believes the other raw materials of EchoGen are readily
available from various suppliers.
RESEARCH AND DEVELOPMENT
The Company currently conducts research and development activities at its
facilities in Bothell, Washington. The Company also funds certain research,
preclinical studies and clinical development efforts at universities and other
institutions. The Company's primary research and development efforts are
directed at the development and application of EchoGen and SonoGen, including
clinical trials. In addition, the Company is conducting research in other
applications of its proprietary technology including pulmonary and intravascular
drug delivery.
The Company incurred expenses of approximately $11.6 million, $11.2
million and $7.2 million on research and development in fiscal 1997, 1996 and
1995, respectively.
STRATEGIC ALLIANCES
The Company's strategy is to enter into strategic alliances to facilitate
the development, manufacture and distribution of EchoGen. To date, the Company
has entered into a collaborative
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agreement with Daiichi with respect to the marketing and distribution of EchoGen
in certain Pacific Rim countries and agreements with Abbott for the
manufacturing, marketing and distribution of EchoGen in the rest of the world.
ABBOTT LABORATORIES
In May 1993, the Company and Abbott, a worldwide manufacturer of health
care products, entered into a supply agreement relating to EchoGen. Under this
agreement, Abbott has agreed to develop the manufacturing process, assist the
Company in FDA submissions and manufacture and sell the product to the Company
for an initial five-year period after FDA approval, subject to automatic renewal
unless otherwise terminated by either party with 12 months prior notice. Abbott
is supplying the Company with most of its requirements for EchoGen clinical
trials. The Company has agreed to purchase a portion of the U.S. commercial
requirements of EchoGen upon receipt of FDA approval, subject to certain annual
minimum purchase requirements at a fixed price, subject to increases in the
producer's price index.
In May 1996, the Company entered into additional agreements with Abbott for
the marketing and sale of EchoGen in the U.S. The Company has primary
responsibility for clinical development, regulatory affairs, and medical and
technical marketing support of EchoGen, and Abbott has primary responsibility
for manufacturing and U.S. marketing and sales. The Company has retained certain
co-promotion rights to EchoGen in the U.S. Under the agreements, Abbott has
agreed to pay the Company $31.0 million in license, clinical support and
milestone payments, of which the Company had received $23.0 million as of
December 31, 1997. After the FDA has approved the marketing of EchoGen, for
which there can be no assurance, the Company will receive 47% of net EchoGen
revenues in the U.S. - a portion of which the Company must use to fund its
responsibilities under the agreement. Subject to early termination, the
agreement spans the later of the life of the patents relating to EchoGen or the
introduction of a generic equivalent by a third party. Abbott can acquire the
rights to certain additional indications for EchoGen by making additional
clinical support payments. During 1997, Abbott paid $0.7 million to the Company
to support clinical trials for the indications of stress echocardiography and
prostate cancer. In addition, in 1996, Abbott paid $4.0 million for five year
warrants to acquire 500,000 shares of the Company's common stock at an exercise
price of $16.00 per share.
In October 1996, the Company expanded its strategic alliance with Abbott by
signing an agreement for EchoGen that extends Abbott's licensed territory to
include Europe, Latin America, Canada, Middle East, Africa and certain
Asia/Pacific Rim countries. Under the agreement, Abbott has agreed to pay the
Company $34.6 million in payments conditioned upon the achievement of certain
regulatory and commercialization milestones, of which $12.6 million may be
offset against future royalty payments. As of December 31, 1997, the Company had
received $8.5 million under the agreement. After applicable regulatory agencies
have approved the marketing of EchoGen, for which there can be no assurance, the
Company will receive a royalty that ranges from 36% to 42% of EchoGen net sales
based on aggregate annual sales in the territory. Subject to early termination,
the agreement spans the later of the life of the patents relating to EchoGen in
the countries of the territory, 10 years from the date of the agreement, or the
introduction of a generic equivalent by a third party. If the Company's
relationship with Abbott is terminated early, it could have a material adverse
effect on the Company's business, financial condition and results of operation.
See "Certain Factors That May Affect the Company's Business and Future Results."
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DAIICHI PHARMACEUTICAL CO., LTD.
In April 1993, the Company and Daiichi entered into an option agreement
pursuant to which Daiichi was granted an option to exclusive marketing and
distribution rights to EchoGen in the Pacific Rim countries of Japan, Taiwan,
The Peoples Republic of China, South Korea, Hong Kong, Thailand, Indonesia,
Singapore, Malaysia and the Philippines. Daiichi is a market leader in Japan in
the sale of contrast agents for medical imaging. Under the option agreement, the
exercise of the option was contingent upon, among other factors, the receipt by
Daiichi of certain clinical trial data related to EchoGen. In March 1995,
Daiichi exercised its option and entered into a license agreement with the
Company. Under these agreements, as of December 31, 1997, Daiichi has paid the
Company option and license fees totaling $12.8 million and has agreed to pay an
additional $19.6 million mainly in the form of milestone payments conditioned on
the achievement of certain clinical development, regulatory and
commercialization milestones in Japan. Daiichi is responsible for conducting
clinical trials and obtaining all regulatory clearances in the licensed
territory and has agreed to pay royalties to the Company on sales of the
product. The Company may be required to share with Daiichi any technical
advances relating to EchoGen. During 1997, Daiichi completed Phase 1 clinical
studies for EchoGen. Daiichi has the option to manufacture EchoGen, with raw
materials supplied by the Company, for sales in Japan and Taiwan. The term of
the license shall expire upon the later of the expiration of the last to expire
patents or 10 years after the first commercial sale of EchoGen in the licensed
territory. Daiichi has the right to terminate the license agreement at any time,
in which case all rights to EchoGen revert to the Company and the Company
retains all payments made through the date of termination. In addition, in
November 1993, the Company issued a convertible subordinated debenture to
Daiichi in the principal amount of $3.0 million, which was converted into
462,857 shares of common stock concurrently with the closing of the Company's
initial public offering. There can be no assurance that the Company will receive
any further funding of milestone payments from Daiichi. If this collaboration is
terminated or unsuccessful, it would have a material adverse effect on the
Company's business, financial condition and results of operations. Nycomed
Imaging A.S. ("Nycomed") recently announced that it has entered into a licensing
arrangement with Daiichi to market an ultrasound contrast agent in Japan. The
arrangement between Daiichi and Nycomed could have an adverse effect on the
relationship of the Company with Daiichi. See "Certain Factors That May Affect
the Company's Business and Future Results."
GOVERNMENT REGULATION
Regulation by governmental authorities in the U.S. and other countries is a
significant factor in the production and marketing of the Company's products and
in its ongoing research and development activities. In order to undertake
clinical tests, to produce and to market products for human diagnostic or
therapeutic use, mandatory procedures and safety standards established by the
FDA and comparable agencies in foreign countries must be followed.
The standard process required by the FDA before a pharmaceutical agent may
be marketed in the U.S. includes (i) preclinical studies, (ii) submission to the
FDA of an application for an Investigational New Drug Application ("IND"), which
must become effective before human clinical trials may commence, (iii) adequate
and well-controlled human clinical trials to establish the safety and efficacy
of the drug in its intended application, (iv) submission to the FDA of an NDA
with respect to the drug, which application is not automatically accepted by the
FDA for consideration and (v) FDA approval of the NDA prior to any commercial
sale or shipment of the drug. In addition
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to obtaining FDA approval for each product, each domestic drug manufacturing
establishment must be registered or licensed by the FDA. Domestic manufacturing
establishments are subject to inspections by the FDA and by other Federal, state
and local agencies and must comply with GMP requirements applicable to the
production of pharmaceutical agents.
Preclinical studies include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. The results of the preclinical studies are submitted to the FDA
as part of an IND, and unless the FDA objects, the IND will become effective 30
days following its receipt by the FDA. Clinical trials involve the
administration of the drug to healthy volunteers or to patients under the
supervision of a qualified principal investigator. Clinical trials are conducted
in accordance with protocols that detail the objectives of the study, the
parameters to be used to monitor safety and the efficacy criteria to be
evaluated. Each protocol is submitted to the FDA as part of the IND. Each
clinical study is approved and monitored by an independent Institutional Review
Board ("IRB") at the institution at which the study will be conducted. The IRB
will consider, among other things, ethical factors, informed consents, the
safety of human subjects and the possible liability of the institution.
Clinical trials typically are conducted in three sequential phases, but the
phases may overlap. In Phase 1, the initial introduction of the drug to humans
or the first studies involving new routes of administration or unusual
conditions, such as stress echocardiography, the drug is tested for safety,
dosage tolerance, metabolism, distribution, excretion and clinical pharmacology
in healthy adult subjects. Phase 2 involves detailed evaluation of safety and
efficacy of the drug in a range of doses in patients with the disease or
condition being studied. Phase 3 trials consist of larger scale evaluation of
safety and efficacy and may require greater patient numbers, depending on the
clinical indications for which marketing approval is sought.
The process of completing clinical testing and obtaining FDA approval for a
new product is likely to take a number of years and require the expenditure of
substantial resources. The FDA may grant an unconditional approval of a drug for
a particular indication or may grant approval conditioned on further
post-marketing testing. The FDA also may conclude that the submission is not
adequate to support an approval and may require further clinical and preclinical
testing, resubmission of the NDA, and further time consuming review. Even after
initial FDA approval has been obtained, further studies may be required to
provide additional data on safety or to gain approval for the use of a product
as a treatment for clinical indications other than those for which the product
was approved initially. Also, the FDA may require post-marketing testing and
surveillance programs to monitor the drug's efficacy and side effects. Results
of these post-marketing programs may prevent or limit the further marketing of
the drug.
In August 1996, the Company submitted an NDA for EchoGen with the FDA based
on the data from the Phase 3 clinical trials for cardiology and radiology
indications. The FDA accepted the NDA as filed in September 1996. In October
1997, the Company was informed by the FDA that a Medical Imaging Drug Committee
Advisory meeting is not necessary to complete the review of the NDA for EchoGen.
In February 1998, the Company received an action letter from the FDA which
indicated that the review of the EchoGen NDA was completed and the application
is inadequate for approval, citing certain deficiencies in the application. The
Company is in the process of preparing an amendment to the NDA and has scheduled
a meeting for April 27, 1998 with the FDA to discuss the letter and the contents
of the proposed amendment. The Company expects to be able to provide all of the
information necessary to address the deficiencies noted in the letter, however,
the Company
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]
is unable to predict the timing of the submission until the meeting with the FDA
has taken place. No assurance can be given that the Company will successfully
address the deficiencies raised by the FDA or that the FDA will ultimately
approve the NDA.
Sales of pharmaceutical products outside of the U.S. are subject to
regulatory requirements that vary widely from country to country. In the E.U.,
the general trend has been towards coordination of common standards for clinical
testing of new drugs, leading to changes in various requirements imposed by each
E.U. country.
In November 1996, the Company submitted a Marketing Authorization
Application ("MAA") to the European Medicines Evaluation Agency ("EMEA")for
EchoGen under the new centralized "fast track" application procedures whereby
a generally binding approval, valid for all 15 nations of the E.U., is obtained
by a single application. With the single EMEA review, EchoGen may gain approval
in the U.K., Ireland, France, Germany, Italy, Spain, Portugal, Sweden, Finland,
Denmark, Belgium, Luxembourg, the Netherlands, Greece and Austria.
At the March 1998 meeting of the Committee for Proprietary Medicinal
Products ("CPMP"), the committee issued a positive opinion on EchoGen for use
in patients with suspected or established cardiovascular disease. The CPMP is
the scientific review committee of the EMEA and makes recommendations to the
EMEA which typically accepts and ratifies the CPMP opinions generally within
three to four months. The committee recommended labeling which includes the
following indications: EchoGen is a transpulmonary echocardiographic contrast
agent for use in patients with suspected or eatablished cardiovascular disease
to provide opacification of cardiac chambers, enhance left ventricular border
delineation with resulting improvement in wall motion visualization. Additional
labeling states that the use of EchoGen in spectral and color Doppler studies
was shown to enhance the visualization of blood flow across mitral, aortic and
tricuspid valves in a subset of patients and that in studies of blood flow
patterns in renal, hepatic and peripheral vasculature, the duration of color
Doppler signal enhancement varied between 13 and 20 minutes. The Company also
had filed data to support a broad radiology indication in the MAA. The CPMP
will require additional data before it will consider issuing a positive
opinion for such radiology indications. The Company intends to prepare the data
to address the CPMP's issues. There can be no assurance that final approval of
the CPMP recommended labeling will be granted by the EMEA within such time, or
at all or that the Company will be able to satisfactorily address the CPMP
requirements for broad radiology indications.
The level of regulation in other foreign jurisdictions varies widely. The
time required to obtain regulatory approval from comparable regulatory agencies
in each foreign country may be longer or shorter than that required for FDA or
EMEA approval. In addition, in certain foreign markets, the Company may be
subject to governmentally mandated prices for EchoGen.
The Company is and may be subject to regulation under state and Federal law
regarding occupational safety, laboratory practices, handling of chemicals,
environmental protection and hazardous substance control. The Company also will
be subject to other present and possible future local, state, federal and
foreign regulation.
COMPETITION
The health care industry is characterized by extensive research efforts and
rapid technological change. Competition in the development of ultrasound imaging
contrast agents is intense and expected to increase. Although there are
currently only two FDA approved ultrasound imaging contrast agents in
the U.S. for certain cardiology applications and, to the knowledge of the
Company, no other ultrasound imaging agent has been submitted to the FDA for
approval, the Company believes that other medical and pharmaceutical companies
are in clinical trials with ultrasound contrast agents. In addition, there are
two ultrasound contrast agents approved for marketing in certain countries in
Europe for certain cardiology and radiology indications and the Company believes
that other agents are in clinical trials. The Company also believes that other
medical and pharmaceutical companies will compete with the Company in areas of
research and development, acquisition of products and technology licenses, and
the manufacturing and marketing of ultrasound contrast agents. The Company
expects that competition in the ultrasound contrast imaging agent field will be
based primarily on efficacy, safety, ease of administration, breadth of
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approved indications and physician, healthcare payor and patient acceptance.
Although the Company believes that if and when EchoGen is approved for
commercial sale, EchoGen will be well positioned to compete successfully, there
can be no assurance that the Company will be able to do so. Many of the
Company's competitors and potential competitors have substantially greater
financial, technical and human resources than the Company and have substantially
greater experience in developing products, obtaining regulatory approvals and
marketing and manufacturing medical products. Accordingly, these competitors may
succeed in obtaining FDA or foreign jurisdictional approval for their products
more rapidly than the Company. Historically, products that reach the market
first generally have a market advantage. In addition, other technologies or
products may be developed that have an entirely different approach or means of
accomplishing the enhancement of ultrasound imaging or other imaging modalities
that would render the Company's technology and products uncompetitive or
obsolete.
PATENTS AND PROPRIETARY RIGHTS
The Company considers the protection of its technology to be material to
its business. In addition to seeking U.S. patent protection for many of its
inventions, the Company is seeking patent protection in certain foreign
countries in order to protect its proprietary rights to inventions. The Company
also relies upon trade secrets, know-how, continuing technological innovations
and licensing opportunities to develop and maintain its competitive position.
The Company's success will depend, in part, on its ability to obtain
patents, defend patents and protect trade secrets. The Company has filed patent
applications in the U.S. and 40 foreign countries relating to its principal
technologies. In the U.S., 10 patents have been issued to the Company, the
claims of which are directed to ultrasound contrast media which include
fluorine-containing chemicals (such as EchoGen) as well as methods of making and
using these media. The patent position of medical and pharmaceutical companies
is highly uncertain and involves complex legal and factual questions. There can
be no assurance that any claims which are included in pending or future patent
applications will be issued, that any issued patents will provide the Company
with competitive advantages or will not be challenged by third parties, or that
the existing or future patents of third parties will not have an adverse effect
on the ability of the Company to commercialize its products. Furthermore, there
can be no assurance that other companies will not independently develop similar
products, duplicate any of the Company's products or design around patents that
may be issued to the Company. Litigation may be necessary to enforce any patents
issued to the Company or to determine the scope and validity of others'
proprietary rights in court or administrative proceedings. Any litigation or
administrative proceeding could result in substantial costs to the Company and
distraction of the Company's management. An adverse ruling in any litigation or
administrative proceeding could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company currently
has pending a patent infringement suit initiated by the Company. See "Legal
Proceedings."
The commercial success of the Company also will depend in part on not
infringing patents issued to competitors. There can be no assurance that patents
belonging to competitors will not require the Company to alter its products or
processes, pay licensing fees or cease development of its current or future
products. Any litigation regarding infringement could result in substantial
costs to the Company and distraction of the Company's management, and any
adverse ruling in any litigation could have a material adverse effect on the
Company's business, financial condition and results of operations. Further,
there can be no assurance that the Company will be able to license other
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technology that it may require at a reasonable cost or at all. Failure by the
Company to obtain a license to any technology that it may require to
commercialize its products would have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, to
determine the priority of inventions and the ultimate ownership of patents, the
Company may participate in interference, reissue or re-examination proceedings
conducted by the U.S. Patent and Trademark Office ("PTO") or in proceedings
before foreign agencies with respect to any of its existing patents or patent
applications or any future patents or applications, any of which could result in
loss of ownership of existing, issued patents, substantial costs to the Company
and distraction of the Company's management. Two of the Company's 10 U.S.
patents, U.S. 5,573,751 and U.S. 5,558,094 are being re-examined by the PTO. In
each of these re-examinations the PTO has initially rejected claims in these
patents as unpatentable. SONUS has responded to those rejections and is awaiting
further action by the PTO. Although the Company believes its responses will
result in the reissuance to the Company of these two patents by the PTO, there
can be no assurance that the PTO will reissue the patents. See "Legal
Proceedings."
The Company has obtained registered trademarks for its corporate name and
for EchoGen in the U.S. and certain foreign countries. There can be no assurance
that the registered or unregistered trademarks or trade names of the Company may
not infringe upon third party rights. The requirement to change the trademarks
or trade name of the Company could entail significant expenses and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company also relies on unpatented trade secrets, proprietary know-how
and continuing technological innovation which it seeks to protect, in part, by
confidentiality agreements with its corporate partners, collaborators, employees
and consultants. There can be no assurance that these agreements will not be
breached, that the Company would have adequate remedies for any breach, or that
the Company's trade secrets or know-how will not otherwise become known or be
independently discovered by competitors. Further, there can be no assurance that
the Company will be able to protect its trade secrets or that others will not
independently develop substantially equivalent proprietary information and
techniques.
PRODUCT LIABILITY INSURANCE
The clinical testing, manufacturing and marketing of the Company's products
may expose the Company to product liability claims. The Company maintains
liability insurance for claims arising from the use of its products in clinical
trials with limits of $5.0 million per claim and in the aggregate. Although the
Company has never been subject to a product liability claim, there can be no
assurance that the coverage limits of the Company's insurance policies will be
adequate or that one or more successful claims brought against the Company would
not have a material adverse effect upon the Company's business, financial
condition and results of operations. Further, if EchoGen is approved by the FDA
for marketing, there can be no assurance that adequate product liability
insurance will be available, or if available, that it will be available at a
reasonable cost. Any adverse outcome resulting from a product liability claim
could have a material adverse effect on the Company's business, financial
condition and results of operations.
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HUMAN RESOURCES
At March 1, 1998, the Company had 62 employees, 43 engaged in research,
development, clinical development and manufacturing activities, and 19 in
marketing and administration. The Company considers its relations with its
employees to be good, and none of its employees is a party to a collective
bargaining agreement.
CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS AND FUTURE RESULTS
FORWARD-LOOKING STATEMENTS. THIS ANNUAL REPORT ON FORM 10-K CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED, AND THE COMPANY INTENDS THAT SUCH FORWARD-LOOKING
STATEMENTS BE SUBJECT TO THE SAFE HARBORS CREATED THEREBY. EXAMPLES OF THESE
FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, (i) THE PROGRESS AND
RESULTS OF CLINICAL TRIALS (ii) FUTURE MARKETING APPROVALS, (iii) THE
ANTICIPATED OUTCOME OR FINANCIAL IMPACT OF LITIGATION, (iv) FUTURE PRODUCT
REVENUES, AND (v) THE FUTURE USES OF CAPITAL AND FINANCIAL NEEDS OF THE COMPANY.
WHILE THESE STATEMENTS MADE BY THE COMPANY ARE BASED ON MANAGEMENT'S CURRENT
BELIEFS AND JUDGMENT, THEY ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD
CAUSE ACTUAL RESULTS TO VARY. IN EVALUATING SUCH STATEMENTS, STOCKHOLDERS AND
INVESTORS SHOULD SPECIFICALLY CONSIDER A NUMBER OF FACTORS AND ASSUMPTIONS,
INCLUDING THOSE DISCUSSED IN THE TEXT AND THE FINANCIAL STATEMENTS AND THEIR
ACCOMPANYING FOOTNOTES IN THIS REPORT AND THE RISK FACTORS DETAILED FROM TIME TO
TIME IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE
FORWARD-LOOKING STATEMENTS AS A RESULT OF THE FOLLOWING FACTORS, AMONG OTHERS.
Uncertainty of Governmental Regulatory Requirements; Lengthy Approval
Process. The Company is subject to uncertain governmental regulatory
requirements and a lengthy approval process for its products prior to any
commercial sales of its products. The development and commercial use of the
Company's products is regulated by the FDA, EMEA and comparable foreign
regulatory agencies. The regulatory approval process for new ultrasound contrast
agents, including required preclinical studies and clinical trials, is lengthy
and expensive. The Company has filed for approval of only one product, EchoGen,
with the FDA and the EMEA and the FDA in February 1998 issued an action letter
indicating that the NDA is inadequate for approval, citing certain deficiencies
in the application. The Company is in the process of preparing an amendment to
the NDA and has scheduled a meeting for April 27, 1998 with the FDA to discuss
the letter and the contents of the proposed amendment. The Company expects to be
able to provide all of the information necessary to address the deficiencies
noted in the letter, however, the Company is unable to predict the timing of the
submission until the meeting with the FDA has taken place. No assurance can be
given that the Company will successfully address the deficiencies raised by the
FDA or that the FDA will ultimately approve the NDA. In addition, in March 1998
the CPMP recommended the approval of EchoGen for marketing in the E.U.,
however there can be no assurance that the Company will receive final approval
to market EchoGen.
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The Company's collaborative partners are responsible for regulatory
filings in all other jurisdictions, none of which have been approved. The
Company and its collaborative partners may encounter significant delays or
excessive costs in its efforts to secure necessary approvals. There can be no
assurance that the necessary FDA and EMEA clearances and other foreign
regulatory approvals will be obtained in a timely manner, if at all. The
Company cannot predict if or when any of its products under development will be
commercialized. See "Government Regulations."
Unproven Safety and Efficacy; Uncertainty of Clinical Trials. The Company
currently has only two products, EchoGen and SonoGen, in human clinical trials.
Although the Company has completed the necessary pivotal clinical trials it
believes will satisfy the requirements for approval of EchoGen by the FDA and
the EMEA, the FDA has issued an action letter indicating that the NDA is
inadequate for approval, citing certain deficiencies including the clinical and
statistical sections of the NDA. There can be no assurance that the FDA or the
EMEA will not require additional clinical trials or that such trials if begun,
will demonstrate any efficacy or will be completed successfully in a timely
manner, if at all. See "Status of Clinical Trials" and "Government Regulations.
" In addition, the initial filings for approval of EchoGen covers only certain
cardiology and radiology applications. The Company believes EchoGen may be used
in other applications, such as myocardial perfusion, stress echocardiography,
breast and prostate cancer and has begun clinical studies in those applications.
Failure to complete successfully any of its clinical trials on a timely basis or
at all would have a material adverse effect on the Company's business, financial
condition and results of operations. In clinical trials in humans to date
adverse events related to the final formulation of EchoGen have been infrequent,
generally mild and transient, including feelings of warmth, taste perversion,
headache and nausea. There can be no assurance that more serious side effects
will not be encountered in future trials.
Future U.S. or foreign legislative or administrative actions also could
prevent or delay regulatory approval of the Company's products. Even if
regulatory approvals are obtained, they may include significant limitations on
the indicated uses for which a product may be marketed. A marketed product also
is subject to continual FDA, EMEA and other regulatory agency review and
regulation. Later discovery of previously unknown problems or failure to comply
with the applicable regulatory requirements may result in restrictions on the
marketing of a product or withdrawal of the product from the market, as well as
possible civil or criminal sanctions. In addition, if marketing approval is
obtained, the FDA, EMEA or other regulatory agency may require post-marketing
testing and surveillance programs to monitor the drug's efficacy and side
effects. Results of these post-marketing programs may prevent or limit the
further marketing of the monitored drug.
History of Operating Losses; Uncertainty of Future Financial Results. The
Company's future financial results are uncertain. Although the Company reported
net income for the year ended December 31, 1997, the Company has experienced
significant losses since its inception in 1991, and may incur net losses in the
foreseeable future. These losses have resulted primarily from expenses
associated with the Company's research and development activities, including
preclinical and clinical trials, and general and administrative expenses. The
Company anticipates that its operating expenses will increase significantly in
the future as the Company prepares for the anticipated commercialization of
EchoGen and increases its research and development expenditures on new products.
However, there can be no assurance that the Company will obtain regulatory
approvals in order to generate product revenues. If the Company is unable to
generate significant product revenues, it may incur substantial losses.
Moreover, even if the Company generates significant product revenues, there can
be no assurance that the Company will be able to sustain profitability.
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The Company's results of operations have varied and will continue to vary
significantly from quarter to quarter and depend on, among other factors, the
timing of fees and milestone payments made by collaborative partners, the
entering into of new product license agreements by the Company and the timing
and costs of clinical trials conducted by the Company.
Uncertainty of Market Acceptance. To date, only two contrast agents for use
in ultrasound imaging have received FDA approval, and the general market
acceptance of contrast agents for ultrasound imaging is uncertain. If the
existing approved contrast agents fail to gain market acceptance it could make
the market acceptance of EchoGen more difficult. Market acceptance of EchoGen
may depend upon a number of factors, including efficacy, safety, price and ease
of administration. In addition, market acceptance may depend upon the Company's
ability to educate the medical community on the diagnostic and clinical efficacy
of ultrasound contrast agents in general and EchoGen in particular and the
ability to obtain reimbursement from third party payors. Market acceptance may
also depend upon the clinical utility and cost effectiveness of EchoGen. There
can be no assurance that EchoGen, if successfully developed and commercialized,
will gain market acceptance. Failure of EchoGen to gain market acceptance would
have a material adverse effect on the Company's business, financial condition
and results of operations.
Future Capital Requirements and Uncertainty of Additional Funding. The
Company's development efforts to date have consumed substantial amounts of cash
and the Company has generated only limited revenues from payments received from
its collaborative partners. There can be no assurance that the Company will
continue to receive such payments in the future. The Company expects that its
cash requirements will increase significantly in the future, and there can be no
assurance that such cash requirements will be met on satisfactory terms, if at
all. The Company's capital requirements will depend on numerous factors,
including: the progress of the Company's research and development programs;
progress with preclinical testing and clinical trials; the time and costs
required to gain regulatory approvals; the resources the Company devotes to
product development; the costs of filing, prosecuting and enforcing patents,
patent applications, patent claims and trademarks; and the costs of developing
the technical marketing support capabilities required under the Company's
agreements with Abbott. The Company may be required to seek additional funds
through debt or equity financing. Issuance of additional equity securities by
the Company could result in substantial dilution to stockholders. If adequate
funds are not available on acceptable terms, the Company will be required to
delay or scale back its product development programs or obtain funds through
arrangements with collaborative partners or others that may require the Company
to relinquish rights to certain of its technologies or products. The Company's
inability to fund its capital requirements would have a material adverse effect
on the Company's business, financial condition and results of operations.
Dependence on Third Parties for Funding, Clinical Development and
Distribution. The Company is dependent on collaborative partners for a variety
of activities, including conducting foreign clinical trials, obtaining required
foreign regulatory approvals and manufacturing, marketing and distributing its
products. The Company has entered into a number of agreements with Abbott for
the manufacturing, marketing and distribution of EchoGen in all territories of
the world except for Japan and nine other Pacific Rim countries. The Company is
dependent on Abbott to fund a substantial portion of the Company's operating
expenses, to manufacture EchoGen for clinical trials and for commercial sale, if
approved, to conduct clinical trials and obtain regulatory approval in its
territories outside of the U.S. and the E.U., and to market and distribute
EchoGen in its territories. There can be no assurance that the collaboration
will continue or be successful. Abbott has the right,
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in its sole discretion, to terminate the marketing collaboration at any time
with 12 months notice to the Company. The Company has entered into a license
agreement with Daiichi to market and distribute EchoGen throughout the Pacific
Rim. The Company is dependent on Daiichi to fund a portion of the Company's
operating expenses and to conduct clinical trials, make required regulatory
filings, obtain regulatory approval for EchoGen and distribute EchoGen in the
Pacific Rim. Nycomed recently announced that it has entered into a licensing
arrangement with Daiichi to market an ultrasound contrast agent in Japan. The
arrangement between Daiichi and Nycomed could have an adverse effect on the
relationship of the Company with Daiichi. There can be no assurance that the
collaboration will continue or be successful. Daiichi has the right, in its sole
discretion, to terminate the collaboration at any time upon notice to the
Company. If the agreements with Abbott or Daiichi are terminated or the
collaborations are not successful, the Company will not receive scheduled
milestone and funding payments and will be required to identify an alternative
collaborative partner(s), which would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Strategic Alliances."
Dependence on Patents and Proprietary Rights. The Company's success will
depend, in part, on its ability to obtain patents, defend patents and protect
trade secrets. The Company has filed patent applications in the U.S. and 40
foreign countries relating to its principal technologies. In the U.S., 10
patents have been issued to the Company, the claims of which are directed to
ultrasound contrast media which include fluorine-containing chemicals (such as
EchoGen) as well as methods of making and using these media. The patent position
of medical and pharmaceutical companies is highly uncertain and involves complex
legal and factual questions. There can be no assurance that any claims which are
included in pending or future patent applications will be issued, that any
issued patents will provide the Company with competitive advantages or will not
be challenged by third parties, or that the existing or future patents of third
parties will not have an adverse effect on the ability of the Company to
commercialize its products. Furthermore, there can be no assurance that other
companies will not independently develop similar products, duplicate any of the
Company's products or design around patents that may be issued to the Company.
Litigation may be necessary to enforce any patents issued to the Company or to
determine the scope and validity of others' proprietary rights in court or
administrative proceedings. Any litigation or administrative proceeding could
result in substantial costs to the Company and distraction of the Company's
management. An adverse ruling in any litigation or administrative proceeding
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Legal Proceedings."
The commercial success of the Company also will depend in part on not
infringing patents issued to competitors. There can be no assurance that patents
belonging to competitors will not require the Company to alter its products or
processes, pay licensing fees or cease development of its current or future
products. Any litigation regarding infringement could result in substantial
costs to the Company and distraction of the Company's management, and any
adverse ruling in any litigation could have a material adverse effect on the
Company's business, financial condition and results of operations. Further,
there can be no assurance that the Company will be able to license other
technology that it may require at a reasonable cost or at all. Failure by the
Company to obtain a license to any technology that it may require to
commercialize its products would have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, to
determine the priority of inventions and the ultimate ownership of patents, the
Company may participate in interference, reissue or re-examination proceedings
conducted by the PTO or in proceedings before foreign agencies with respect to
any of its existing patents or patent applications or any future patents or
applications, any of which could result in loss of ownership of existing,
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issued patents, substantial costs to the Company and distraction of the
Company's management. Two of the Company's 10 U.S. patents, U.S. 5,573,751 and
U.S. 5,558,094 are being re-examined by the PTO. In each of these
re-examinations the PTO has initially rejected claims in these patents as
unpatentable. SONUS has responded to those rejections and is awaiting further
action by the PTO. Although the Company believes its responses will result in
the re-issuance to the Company of these two patents by the PTO, there can be
no assurance that the PTO will reissue the patents. See "Legal Proceedings."
Competition and Risk of Technological Obsolescence. The health care
industry is characterized by extensive research efforts and rapid technological
change. Competition in the development of ultrasound imaging contrast agents is
intense and expected to increase. Although there is currently only two
FDA approved ultrasound imaging contrast agents in the U.S. for certain
cardiology applications and, to the knowledge of the Company, no other
ultrasound imaging agent has been submitted to the FDA for approval, the Company
believes that other medical and pharmaceutical companies are in clinical trials
with ultrasound contrast agents. The Company also believes that other medical
and pharmaceutical companies will compete with the Company in the areas of
research and development, acquisition of products and technology licenses, and
the manufacturing and marketing of ultrasound contrast agents. The Company
expects that competition in the ultrasound contrast imaging agent field will be
based primarily on efficacy, safety, ease of administration, breadth of approved
indications and physician, healthcare payor and patient acceptance. Although the
Company believes that if and when EchoGen is approved for commercial sale,
EchoGen will be well positioned to compete successfully, there can be no
assurance that the Company will be able to do so. Many of the Company's
competitors and potential competitors have substantially greater financial,
technical and human resources than the Company and have substantially greater
experience in developing products, obtaining regulatory approvals and marketing
and manufacturing medical products. Accordingly, these competitors may succeed
in obtaining FDA approval for their products more rapidly than the Company. In
addition, other technologies or products may be developed that have an entirely
different approach or means of accomplishing the enhancement of ultrasound
imaging or other imaging modalities that would render the Company's technology
and products uncompetitive or obsolete.
Limited Manufacturing Experience; Dependence on Limited Contract
Manufacturers and Suppliers. The Company currently relies primarily on Abbott to
produce EchoGen for research and development and clinical trials. Abbott's
manufacturing site is subject to routine FDA and other regulatory inspections of
its manufacturing practices. In addition there are a limited number of contract
manufacturers that operate under GMP regulations, as required by the FDA. Unless
the Company develops an in-house manufacturing capability or is able to identify
and qualify alternative contract manufacturers, it will be entirely dependent on
Abbott for the manufacture of EchoGen. There can be no assurance that the
Company's reliance on Abbott for the manufacture of its products will not result
in interruptions, delays or stoppages in the supply of EchoGen. The active
chemical ingredients in EchoGen, DDFP and PEG Telomer B, a surfactant, are
manufactured by a limited number of vendors worldwide. The inability of these
vendors to supply medical-grade materials to the Company could delay the
Company's manufacture of, or cause the Company to cease the manufacturing of,
EchoGen. Any such delay or cessation could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
believes the other raw materials of EchoGen are readily available from various
suppliers. See "Manufacturing" and "Strategic Alliances."
20
21
Lack of Marketing and Sales Experience. The Company has no experience in
marketing, sales and distribution. The Company's strategy is to market EchoGen
through its established strategic alliances and distribution arrangements with
Abbott and Daiichi. There can be no assurance that the Company will be
successful in maintaining these arrangements or that its collaborative partners
in these arrangements will be successful in marketing and selling the Company's
products. The Company's agreement with Abbott requires the Company to provide
technical marketing support to Abbott's sales, marketing and distribution
activities in the U.S. The Company is in the early stages in recruiting the
staff which will provide such technical support. There can be no assurance that
the Company will be successful in establishing technical support capability. If
the Company does not provide adequate technical support, Abbott can choose to
take over the technical support responsibilities and SONUS would be required to
negotiate a lower royalty rate with Abbott to reflect the reduced
responsibilities.
Limitations on Third-Party Reimbursement. The Company's ability to
successfully commercialize EchoGen will depend in part upon the extent to which
reimbursement of the cost of EchoGen and related treatments will be available
from domestic and foreign health administration authorities, private health
insurers and other payor organizations. Third party payors are increasingly
challenging the price of medical products and services or restricting the use of
certain procedures in an attempt to limit costs. Further, significant
uncertainty exists as to the reimbursement status of newly approved health care
products, and there can be no assurance that adequate third party coverage will
be available. In certain foreign markets, the Company may be subject to
governmentally mandated prices for EchoGen. If adequate reimbursement is not
provided by governments and third party payors for the Company's potential
products or if adverse pricing is mandated by foreign governments, the Company's
business, financial condition and results of operations would be materially
adversely affected.
ITEM 2. PROPERTIES
The Company currently leases approximately 27,000 square feet of laboratory
and office space in a single facility in Bothell, Washington. The lease expires
in April 1999 and includes an option to extend the term of the lease for three
years. The Company believes that this facility will be adequate to meet its
projected needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
On August 1, 1997, a lawsuit was filed in the U.S. District Court for the
District of Columbia by Molecular Biosystems, Inc. ("MBI") and Mallinckrodt,
Inc. against the Company, Nycomed Imaging A.S. ("Nycomed"), ImaRx Pharmaceutical
Corporation, DuPont Merck and Bracco International BV. The suit alleged that
certain of the Company's ultrasound contrast agent patents were invalid and that
the Company had made certain false public representations about MBI and a
proposed MBI product. On September 3, 1997, Nycomed filed a counter-claim
against the Company in the above action, alleging that a Nycomed patent was
entitled to priority over one of the SONUS patents and that the SONUS patent was
invalid. The Company along with several other co-defendants moved to dismiss the
lawsuit, and on January 5, 1998, the District Court of the District of Columbia
dismissed the lawsuit filed by MBI and the cross-claim filed by Nycomed.
21
22
On January 7, 1998, the Company announced that it had filed a patent
infringement action in the U.S. District Court in Seattle, Washington, against
MBI and Mallinckrodt. Inc. The suit alleges that one of MBI's ultrasound
contrast agents infringes one or more of the Company's patents. MBI has filed
counterclaims alleging that the patents asserted by SONUS are invalid and not
infringed, and that SONUS has made false public statements and engaged in other
actions intended to damage MBI and one of its ultrasound contrast agents. No
trial date has been set for this lawsuit.
In addition, the patents in this lawsuit are the subject of re-examination
by the U.S. Patent and Trademark Office. The outcome of the re-examination may
have an impact on the above patent infringement action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 1997.
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23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
The Company's common stock first began trading on the Nasdaq National
Market under the symbol SNUS on October 12, 1995. No cash dividends have been
paid on the common stock and the Company does not anticipate paying any cash
dividends in the foreseeable future. As of February 28, 1998, there were 110
stockholders of record of the Company's common stock. The high and low sales
prices of the Company's common stock as reported by Nasdaq are as follows:
1995 HIGH LOW
- ---- ------ ------
Fourth Quarter 13 6 3/4
1996
- ----
First Quarter 19 1/2 10 1/2
Second Quarter 23 5/8 15
Third Quarter 21 3/4 15 1/4
Fourth Quarter 31 1/4 18 1/2
1997
- ----
First Quarter 34 3/4 25 1/8
Second Quarter 31 21 3/4
Third Quarter 46 3/4 25 1/2
Fourth Quarter 46 7/8 31 5/8
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues . . . . . . . . . . . . . . . . . . . $ 18,900 $ 16,600 $ 4,500 $ 1,053 $ 3,300
Total operating expenses . . . . . . . . . . . 18,763 14,988 9,416 9,259 5,491
Net income (loss) . . . . . . . . . . . . . . 1,011 1,722 (5,939) (8,897) (2,589)
Net income (loss) per share:
Basic . . . . . . . . . . . . . . . . . . . $ 0.12 $ 0.20 $ (1.81) $ (4.19) $ (1.23)
Diluted . . . . . . . . . . . . . . . . . . $ 0.11 $ 0.19 $ (1.81) $ (4.19) $ (1.23)
Shares used in calculation of net income
(loss) per share:
Basic . . . . . . . . . . . . . . . . . . . 8,565 8,481 3,281 2,122 2,111
Diluted . . . . . . . . . . . . . . . . . . 9,580 9,064 3,281 2,122 2,111
DECEMBER 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities . . . . . . . . . . . . . . . . $ 26,571 $ 25,131 $ 18,221 $ 1,644 $ 2,307
Total assets . . . . . . . . . . . . . . . . . 28,946 26,762 19,646 3,195 3,411
Total stockholders' equity (deficit) . . . . . 18,505 16,877 10,947 (13,041) (4,222)
23
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion and analysis set forth below contains trend analysis,
discussions of regulatory approval and other forward-looking statements. Actual
results could differ materially from those projected in the forward-looking
statement as a result of the following factors, among others: uncertainty of
governmental regulatory requirements; unproven safety and efficacy; uncertainty
of clinical trials; history of operating losses; uncertainty of future
financial results; uncertainty of market acceptance; future capital
requirements and uncertainty of additional funding; dependence on third parties
for funding, clinical development and distribution; dependence on patents and
proprietary rights; competition and risk of technological obsolescence; limited
manufacturing experience; dependence on limited contract manufacturers and
suppliers; lack of marketing and sales experience; and limitations on
third-party reimbursement. See "Business -- Certain Factors That May Affect
the Company's Business and Future Results."
OVERVIEW
SONUS Pharmaceuticals, Inc. ("the Company") is primarily engaged in the
research, development and commercialization of proprietary contrast agents for
use in ultrasound imaging. The Company has financed its research and
development, and clinical trials through payments received under agreements with
its collaborative partners, private equity and debt financings, and an initial
public offering ("IPO") completed in October 1995. The Company currently has on
file for EchoGen, a New Drug Application ("NDA") with the United States Food and
Drug Administration ("FDA") and a Marketing Authorization Application ("MAA")
with the European Medicines Evaluation Agency ("EMEA").
The Company will not be able to commence sales of EchoGen in the U.S. or
various international markets unless and until it receives the appropriate
regulatory approvals. Through December 31, 1997, all of the Company's revenues
have been derived from agreements with third parties for the collaborative
development of EchoGen worldwide.
In May 1996, the Company formed a strategic alliance with Abbott
Laboratories ("Abbott") for marketing and selling EchoGen in the U.S. Under the
agreement, Abbott has agreed to pay the Company an aggregate of $31.0 million in
up-front, clinical support and milestone payments, of which $23.0 million has
been paid as of December 31, 1997. In addition, Abbott purchased in May 1996,
for $4.0 million, warrants to acquire 500,000 shares of common stock of the
Company, equal to approximately six percent (6%) of the Company's outstanding
common stock. The warrants are exercisable over five years at $16.00 per share.
In October 1996, the Company and Abbott entered into an agreement expanding
Abbott's territory to include Europe, Latin America, Canada, Middle East, Africa
and certain Asia/Pacific countries. Under the October 1996 agreement, Abbott has
agreed to pay the Company $34.6 million in license and milestone payments, a
portion of which will be credited against future royalties once EchoGen is
approved for commercial sale. As of December 31, 1997, $8.5 million has been
paid to the Company by Abbott under the October 1996 agreement of which $3.5
million are creditable against future royalties.
The Company has granted Daiichi Pharmaceutical Co., Ltd. ("Daiichi")
exclusive marketing and distribution rights to EchoGen in Japan and certain
other countries in the Pacific Rim. As of December 31, 1997, Daiichi has paid
the Company option, license and milestone fees totaling $12.8 million and has
agreed to pay an additional $19.2 million in the form of milestone payments
conditioned on the achievement of certain clinical development, regulatory and
commercialization milestones in Japan.
24
25
The Company's results of operations have varied and will continue to vary
from quarter to quarter and are affected by, among other factors, the timing of
fees and milestone payments made by collaborative partners, the entering into
product license agreements by the Company and the timing and costs of the
clinical trials conducted by the Company. The Company's current collaborative
partners can terminate their agreements on short notice, and there can be no
assurance that the Company will receive any additional funding or milestone
payments.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND DECEMBER 31, 1996
Revenue from collaborative agreements increased to $18.9 million for the
year ended December 31, 1997 as compared to $16.6 million for the year ended
December 31, 1996. Revenue in 1997 consisted of $18.5 million and $0.4 million
of payments received from Abbott and Daiichi, respectively. The increase
reflects the continued achievement of certain clinical and regulatory milestones
which trigger payments from collaborative partners. In 1996, revenue consisted
of $12.0 million and $4.6 million of payments received from Abbott and Daiichi,
respectively.
Research and development expenses increased slightly to $11.6 million in
1997 compared to $11.2 million in 1996 primarily due to ongoing and new clinical
trials investigating additional indications for EchoGen, and continued
investment in the research and development of new products offset by $0.7
million of clinical development cost reimbursement by Abbott.
General and administrative expenses were $7.2 million in 1997 compared to
$3.8 million in 1996. The higher level of general and administrative expenses
reflects the implementation of marketing programs in anticipation of FDA
approval and planned product launch of EchoGen, costs of filing, prosecuting and
protecting patents and patent applications, and growth in marketing and
administration personnel.
The Company anticipates total operating expenses will increase in future
quarters due to ongoing and planned clinical trials to study additional
indications for EchoGen and due to higher marketing and administrative expenses
as the Company continues to prepare for commercialization of EchoGen. The
Company may also incur significant expenses relating to legal matters. See
"Legal Proceedings" and Note 10 to the Notes to Financial Statements. In
addition, revenues in future quarters are primarily dependent upon the timing of
certain regulatory and commercialization milestones.
Interest income increased to $1.1 million in 1997 from $0.8 million in
1996. The increase was primarily due to the larger cash and marketable
securities balances in 1997 arising from the higher level of payments under
collaborative agreements. Interest expense decreased to $0.1 million in 1997
compared to $0.2 million in 1996.
The Company recorded $90,000 of income tax expense in 1997 and $510,000 in
1996. Income tax expense is lower than statutory rates primarily due to the use
of net operating loss carryforwards.
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26
YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
Revenue from collaborative agreements increased to $16.6 million for the
year ended December 31, 1996 as compared to $4.5 million for the year ended
December 31, 1995. Revenue in 1996 consisted of $12.0 million and $4.6 million
of payments received from Abbott and Daiichi, respectively. The increase
reflects the achievement of certain clinical trial and regulatory milestones
which trigger payments from collaborative partners. Milestone payments in 1996
related primarily to the EchoGen NDA filing in the U.S. and the MAA filing with
the EMEA in Europe.
Research and development expenses increased to $11.2 million in 1996
compared to $7.2 million in 1995 primarily due to increased clinical trial costs
associated with EchoGen, preparation of the NDA and MAA filings with the FDA and
EMEA, respectively, and additional investment in the development of new
products.
General and administrative expenses were $3.8 million in 1996 compared to
$2.2 million in 1995. The higher level of expenses was primarily the result of
the increase in business development activities and associated revenue related
to corporate alliances, the implementation of marketing programs in anticipation
of FDA approval and planned product launch, costs of filing new patent and
trademark applications and, to a lesser extent, the additional activities of
being a publicly-held company including investor and shareholder relations and
SEC reporting and compliance.
Interest income increased to $0.8 million in 1996 from $0.3 million in
1995. The increase was primarily due to the larger cash and marketable
securities balances in 1996 resulting from the Company's IPO in October 1995 and
proceeds from a warrant purchased by Abbott in May 1996. Interest expense
decreased to $0.2 million in 1996 compared to $0.8 million in 1995 primarily due
to the repayment of notes to stockholders and the conversion of certain debts
into common stock at the time of the IPO.
Income taxes of $0.5 million for the year ended December 31, 1996 were
primarily attributable to withholding taxes related to collaborative payments
received from Daiichi.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations with payments from collaborative
agreements, proceeds from equity financings and a bank line of credit. At
December 31, 1997, the Company had cash, cash equivalents and marketable
securities of $26.6 million, compared to $25.1 million at December 31, 1996.
Cash provided by operations for the year ended December 31, 1997 was $1.4
million compared to $3.5 million for the comparable period in fiscal 1996.
In August 1997, the Company renewed a loan agreement with Silicon Valley
Bank which provides for a $5.0 million revolving line of credit facility, which
bears interest at the prime rate plus 1.0% per annum. At December 31, 1997,
there was $5.0 million outstanding under the line of credit. The line of credit
expires in August 1998 and is secured by the tangible assets of the Company. The
Company is required to maintain certain minimum balances of cash and marketable
securities in order to borrow under the line of credit.
At December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $14.8 million. These carryforwards will expire
beginning in the year 2006. The IPO
26
27
of common stock by the Company in 1995 caused an ownership change pursuant to
applicable regulations in effect under the Internal Revenue Code of 1986. This
change resulted in the annual limitation of net operating losses during the
carryforward period which may result in the inability to use a portion of the
Company's net operating loss carryforwards due to their expiration.
The Company expects that its cash needs will increase significantly in
future periods due to pending and planned clinical trials and higher
administrative and marketing expenses as the Company prepares for
commercialization of EchoGen. The Company estimates that existing cash, cash
equivalents and marketable securities will be sufficient to meet the Company's
capital requirements for at least the next 12 months. The Company's future
capital requirements will, however, depend on many factors, including the time
and costs required to gain regulatory approvals, the progress of the Company's
research and development programs, clinical trials and the ability of the
Company to obtain and retain continued funding from third parties under
collaborative agreements, the costs of filing, prosecuting and enforcing
patents, patent applications, patent claims and trademarks, the costs of
marketing and distribution, the status of competing products and the market
acceptance of the Company's products, if and when approved. The Company may have
to raise substantial additional funds to complete development of any product or
to commercialize any products if and when approved by the FDA. There can be no
assurance that additional financing will be available on acceptable terms, if at
all.
YEAR 2000 COMPLIANCE
During 1997 the Company completed a comprehensive review of software
applications used in critical business processes. The Company has determined
that all of it's critical business systems are year 2000 compliant. There is no
guarantee that the systems of the Company's collaborative partners or
significant vendors will be year 2000 compliant. If the Company's collaborative
partners and significant vendors are not year 2000 compliant, this could have an
adverse effect on the ability of collaborative partners or vendors to satisfy
their obligations to the Company.
27
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS: PAGE
- ------------------------------ ----
Report of Independent Public Accountants............................................................... 29
Balance Sheets as of December 31, 1997 and 1996........................................................ 30
Statements of Operations for the years ended December 31, 1997, 1996 and 1995.......................... 31
Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995................ 32
Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995.......................... 33
Notes to the Financial Statements...................................................................... 34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
28
29
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
SONUS Pharmaceuticals, Inc.
We have audited the accompanying balance sheets of SONUS Pharmaceuticals,
Inc. as of December 31, 1997 and 1996, and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of SONUS Pharmaceuticals, Inc.
at December 31, 1997 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Seattle, Washington
January 23, 1998
29
30
SONUS PHARMACEUTICALS, INC.
BALANCE SHEETS
DECEMBER 31,
1997 1996
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ............................................... $ 5,253,227 $ 7,236,615
Marketable securities ................................................... 21,317,835 17,894,450
Other current assets .................................................... 599,303 397,733
------------ ------------
Total current assets .............................................. 27,170,365 25,528,798
Equipment, furniture and leasehold improvements, net ...................... 1,734,737 1,168,503
Other assets .............................................................. 40,667 64,878
------------ ------------
Total assets .............................................................. $ 28,945,769 $ 26,762,179
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank line of credit ..................................................... $ 5,000,000 $ 5,000,000
Accounts payable and accrued expenses ................................... 2,612,065 2,203,806
Accrued clinical trial expenses ......................................... 1,743,208 1,213,563
Deferred revenue ........................................................ -- 1,000,000
Current portion of capital lease obligations ............................ 146,762 228,049
------------ ------------
Total current liabilities ......................................... 9,502,035 9,645,418
Long-term debt ............................................................ 845,939 --
Capital lease obligations, less current portion ........................... 93,178 239,511
Commitments
Stockholders' equity:
Preferred stock, $.001 par value:
5,000,000 shares authorized; no shares outstanding ................ -- --
Common stock, $.001 par value:
20,000,000 shares authorized; 8,611,376 and 8,530,911 shares issued
and outstanding in 1997 and 1996, respectively .................... 34,860,237 34,275,015
Accumulated deficit .................................................... (16,338,949) (17,355,374)
Deferred compensation .................................................. (16,671) (42,391)
------------ ------------
Total stockholders' equity ........................................ 18,504,617 16,877,250
------------ ------------
Total liabilities and stockholders' equity ................................ $ 28,945,769 $ 26,762,179
============ ============
See accompanying notes.
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31
SONUS PHARMACEUTICALS, INC.
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
1997 1996 1995
------------ ------------ ------------
Revenues:
Collaborative agreements ............................... $ 18,900,000 $ 16,600,000 $ 4,500,000
Operating expenses:
Research and development ............................... 11,561,849 11,181,468 7,189,478
General and administrative ............................. 7,201,553 3,806,858 2,226,345
------------ ------------ ------------
Total operating expenses ............................ 18,763,402 14,988,326 9,415,823
------------ ------------ ------------
Operating income (loss) .................................. 136,598 1,611,674 (4,915,823)
Other income (expense):
Interest income ........................................ 1,093,149 832,936 260,860
Interest expense ....................................... (128,468) (212,465) (752,334)
------------ ------------ ------------
Income (loss) before income taxes ........................ 1,101,279 2,232,145 (5,407,297)
Income taxes ............................................. 90,000 510,000 531,644
------------ ------------ ------------
Net income (loss) ........................................ $ 1,011,279 $ 1,722,145 $ (5,938,941)
============ ============ ============
Net income (loss) per share:
Basic ................................................. $ 0.12 $ 0.20 $ (1.81)
Diluted ............................................... $ 0.11 $ 0.19 $ (1.81)
Shares used in calculation of net income (loss) per share:
Basic ................................................. 8,565,279 8,481,084 3,280,928
Diluted ............................................... 9,580,240 9,063,749 3,280,928
See accompanying notes.
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32
SONUS PHARMACEUTICALS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ACCUMULATED DEFERRED
SHARES AMOUNT DEFICIT COMPENSATION TOTAL
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1994 .................. 2,028,920 $ 140,396 $(13,133,307) $ (47,990) $(13,040,901)
Initial public offering of
common stock net of
offering costs of $2,476,938 .............. 3,063,750 18,969,313 -- -- 18,969,313
Conversion of redeemable preferred
stock into common stock ................... 2,325,219 3,995,000 -- -- 3,995,000
Conversion of refundable option fees into
common stock .............................. 549,410 3,845,875 -- -- 3,845,875
Conversion of convertible subordinated
debenture into common stock ............... 462,857 3,000,000 -- -- 3,000,000
Issuance of common stock .................... 97,840 49,651 -- -- 49,651
Repurchase of common stock .................. (79,914) (26,172) -- -- (26,172)
Net loss .................................... -- -- (5,938,941) -- (5,938,941)
Deferred compensation ....................... -- 132,575 -- (132,575) --
Amortization of deferred compensation ....... -- -- -- 87,636 87,636
Unrealized gains on marketable securities ... -- -- 5,834 -- 5,834
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1995 .................. 8,448,082 30,106,638 (19,066,414) (92,929) 10,947,295
Issuance of common stock .................... 82,829 168,377 -- -- 168,377
Proceeds from issuance of warrants .......... -- 4,000,000 -- -- 4,000,000
Net income .................................. -- -- 1,722,145 -- 1,722,145
Amortization of deferred compensation ....... -- -- -- 50,538 50,538
Unrealized losses on marketable securities... -- -- (11,105) -- (11,105)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1996 .................. 8,530,911 34,275,015 (17,355,374) (42,391) 16,877,250
Issuance of common stock .................... 80,465 585,222 -- -- 585,222
Net income .................................. -- -- 1,011,279 -- 1,011,279
Amortization of deferred compensation ....... -- -- -- 25,720 25,720
Unrealized gains on marketable securities.... -- -- 5,146 -- 5,146
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1997 .................. 8,611,376 $ 34,860,237 $(16,338,949) $ (16,671) $ 18,504,617
============ ============ ============ ============ ============
See accompanying notes.
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33
SONUS PHARMACEUTICALS, INC.
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
1997 1996 1995
------------ ------------ ------------
OPERATING ACTIVITIES:
Net income (loss) .......................................... $ 1,011,279 $ 1,722,145 $ (5,938,941)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ........................... 593,548 421,098 352,311
Amortization of discount on marketable securities ....... (24,815) (11,105) (12,662)
Realized losses on marketable securities ................ 21,383 -- --
Loss on asset retirements ............................... -- 53,958 --
Deferred taxes .......................................... -- -- 200,000
Amortization of deferred compensation ................... 25,720 50,538 87,636
Changes in operating assets and liabilities:
Other assets ............................................ (177,359) (160,703) (142,871)
Accounts payable and accrued expenses ................... 408,259 749,199 265,669
Accrued clinical trial expenses ......................... 529,645 (355,429) 1,404,729
Deferred revenue ........................................ (1,000,000) 1,000,000 (4,000,000)
------------ ------------ ------------
Net cash provided by (used in) operating activities ........ 1,387,660 3,469,701 (7,784,129)
INVESTING ACTIVITIES:
Purchases of equipment, furniture and
leasehold improvements .................................... (1,159,782) (520,470) (283,674)
Purchases of marketable securities ......................... (36,802,059) (74,256,557) (49,907,612)
Proceeds from sales of marketable securities ............... 22,144,047 62,529,763 38,429,216
Proceeds from maturities of marketable securities .......... 11,243,205 6,396,857 541,720
------------ ------------ ------------
Net cash used in investing activities ...................... (4,574,589) (5,850,407) (11,220,350)
FINANCING ACTIVITIES:
Proceeds from line of credit borrowings .................... 20,000,000 21,400,000 10,000,000
Repayment of line of credit borrowings ..................... (20,000,000) (21,400,000) (5,000,000)
Proceeds from long-term debt ............................... 845,939 -- --
Proceeds from capital lease obligations .................... -- -- 274,560
Repayment of capital lease obligations ..................... (227,620) (207,676) (313,967)
Proceeds from issuance of common stock and warrants ........ 585,222 4,168,377 18,992,792
Repayment of notes payable to stockholders ................. -- -- (2,927,005)
Refundable option fees converted into common stock ......... -- -- 3,600,000
------------ ------------ ------------
Net cash provided by financing activities .................. 1,203,541 3,960,701 24,626,380
------------ ------------ ------------
Change in cash and equivalents for the period .............. (1,983,388) 1,579,995 5,621,901
Cash and equivalents at beginning of period ................ 7,236,615 5,656,620 34,719
------------ ------------ ------------
Cash and equivalents at end of period ...................... 5,253,227 7,236,615 5,656,620
Marketable securities at end of period ..................... 21,317,835 17,894,450 12,564,513
------------ ------------ ------------
TOTAL CASH AND MARKETABLE SECURITIES .................... $ 26,571,062 $ 25,131,065 $ 18,221,133
============ ============ ============
Supplemental cash flow information:
Interest paid ........................................... $ 127,770 $ 198,934 $ 694,677
Income taxes paid ....................................... $ 55,272 $ 460,000 $ 331,644
See accompanying notes.
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SONUS PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SUMMARY OF ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
SONUS Pharmaceuticals, Inc. (the "Company") is engaged in the research and
development of ultrasound contrast agents and drug delivery systems based on its
proprietary PhaseShift(TM) and fluorocarbon technology.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of highly liquid investments with a
maturity of three months or less at the date of purchase.
MARKETABLE SECURITIES
The Company classifies the marketable securities investment portfolio as
available-for-sale, and such securities are stated at fair value based on quoted
market prices, with the unrealized gains and losses included as a component of
accumulated deficit. Interest earned on securities available-for-sale is
included in interest income. The cost of debt securities in this category is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization and accretion are included in interest income. Realized gains
and losses and declines in value judged to be other than temporary on securities
available-for-sale also are included in interest income. The cost of securities
sold is based on the specific identification method.
CONCENTRATIONS OF CREDIT RISK
The Company invests its excess cash in accordance with guidelines which
limit the credit exposure to any one financial institution and to any one type
of investment, other than securities issued by the U.S. government. The
guidelines also specify that the financial instruments are issued by
institutions with strong credit ratings. These securities are generally not
collateralized and mature within one year.
REVENUES FROM COLLABORATIVE AGREEMENTS
Payments under collaborative agreements are recorded as earned based upon
the provisions of each agreement. Payments received which have not met the
appropriate criteria are recorded as deferred revenue.
EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS
Equipment, furniture and leasehold improvements are stated at cost.
Depreciation of equipment is provided using the straight-line basis over three
to five years, the estimated useful life of the assets. Leasehold improvements
are amortized over the lesser of the economic useful lives of the improvements
or the term of the related lease.
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35
STOCK COMPENSATION
In 1996, the Company adopted Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). In accordance
with SFAS 123, the Company has elected to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the market price of the Company's common
stock at the date of grant over the stock option exercise price. Under the
Company's plans, stock options are generally granted at fair market value.
PER SHARE DATA
In 1997, the Company adopted Statement of Financial Accounting Standards No
128, "Earnings Per Share ("EPS")" (SFAS 128). In accordance with this statement,
the Company has presented both basic and diluted EPS. Basic EPS is based on the
weighted average number of common shares outstanding. Diluted EPS is based on
the weighted average number of common shares and dilutive potential common
shares. Dilutive potential common shares are calculated under the treasury stock
method and consist of unexercised stock options and warrants. Amounts previously
reported have been restated to conform to the provisions of SFAS 128.
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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
2. MARKETABLE SECURITIES
Marketable securities consist of the following at December 31, 1997 and
1996:
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------------ ------------ ------------ ------------
1997:
U.S. Government Obligations .......... $ 3,137,012 $ 287 $ (249) $ 3,137,050
Corporate Debt Securities
(principally commercial paper) ....... 18,175,677 5,308 (200) 18,180,785
------------ ------------ ------------ ------------
$ 21,312,689 $ 5,595 $ (449) $ 21,317,835
============ ============ ============ ============
1996:
U.S. Government Obligations .......... $ 11,996,089 $ 7,406 $ (8,470) $ 11,995,025
Corporate Debt Securities
(principally commercial paper) ....... 5,904,645 1,363 (6,583) 5,899,425
------------ ------------ ------------ ------------
$ 17,900,734 $ 8,769 $ (15,053) $ 17,894,450
============ ============ ============ ============
The realized gains and losses on sales of available-for-sale securities
were $29,000 and $50,000, respectively, in 1997. There were no realized gains or
losses during 1996 or 1995. All marketable securities at December 31, 1997 and
1996 mature within one year.
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3. EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS
Equipment, furniture and leasehold improvements consist of the following:
1997 1996
---------- ----------
Laboratory equipment .................................. $1,755,770 $1,388,738
Office furniture and equipment ........................ 970,465 491,561
Leasehold improvements ................................ 746,771 432,925
---------- ----------
3,473,006 2,313,224
Less accumulated depreciation and amortization ........ 1,738,269 1,144,721
---------- ----------
$1,734,737 $1,168,503
========== ==========
4. DEBT
The Company has a Loan Agreement with Silicon Valley Bank which provides
for a $5.0 million revolving line of credit facility. Borrowings bear interest
at the prime rate plus 1.0% per annum (9.5% at December 31, 1997). At December
31, 1997 and December 31, 1996, there was $5.0 million outstanding under the
line of credit. The line of credit expires in August 1998 and is secured by the
tangible assets of the Company. The Company is required to maintain a minimum
balance of cash and marketable securities in order to borrow under the line of
credit.
Prior to 1996, substantially all of the Company's equipment and furniture
was financed through a capital lease agreement. In the aggregate, the Company
has borrowed approximately $1.4 million under the lease agreement. The
obligations bear interest at rates ranging from 15.8% to 17.1%, with principal
and interest payable monthly at approximately $14,473 per month.
Future minimum payments under these leases are as follows:
1998..................................................... $ 172,577
1999..................................................... 101,420
---------
Total minimum lease payments............................. 273,997
Less amounts representing interest....................... 34,057
---------
Present value of minimum lease payments.................. 239,940
Less current portion..................................... 146,762
---------
Capital lease obligations, less current portion.......... $ 93,178
=========
In 1997, Abbott Laboratories ("Abbott") agreed to fund certain clinical
trials of the Company in accordance with the Company's collaborative agreements
with Abbott (see Note 5). Of the total funding, 50% is to be paid back to Abbott
within five years of the receipt of funds, plus accrued interest. The obligation
to Abbott, reported as long-term debt, bears interest at the prime rate plus 1%
per annum (9.5% at December 31, 1997). At December 31, 1997, the balance
including interest was $845,939.
5. COLLABORATIVE AGREEMENTS
In May 1996, the Company formed a strategic alliance with Abbott for the
marketing and sale of EchoGen in the U.S. The Company has primary responsibility
for clinical development, regulatory affairs, and medical and technical
marketing support of EchoGen, and Abbott has primary
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37
responsibility for manufacturing and U.S. marketing and sales. The Company has
retained certain co-promotion rights to EchoGen in the U.S. Under the agreement,
Abbott has agreed to pay the Company $31.0 million in license, clinical support
and milestone payments, of which the Company had received $23.0 million as of
December 31, 1997. After the U.S. Food and Drug Administration ("FDA") has
approved the marketing of EchoGen, for which there can be no assurance, the
Company will receive 47% of EchoGen sales in the U.S. -- a portion of which the
Company must use to fund its responsibilities under the agreement. Subject to
early termination, the agreement spans the later of the life of the patents
relating to EchoGen or the introduction of a generic equivalent by a third
party. Abbott can acquire the rights to certain additional indications for
EchoGen by making additional clinical support payments. In addition, Abbott paid
$4.0 million for five year warrants to acquire 500,000 shares of the Company's
common stock at an exercise price of $16.00 per share.
In October 1996, the Company expanded its strategic alliance with Abbott by
signing a second agreement for EchoGen that extends Abbott's licensed territory
to include: Europe, Latin America, Canada, Middle East, Africa and certain
Asia/Pacific Rim countries. Under the agreement, Abbott has agreed to pay the
Company $34.6 million in payments conditioned upon the achievement of certain
regulatory and commercialization milestones (of which $12.6 million may be
offset against future royalty payments). As of December 31, 1997, the Company
had received $8.5 million under the agreement. After applicable regulatory
agencies have approved the marketing of EchoGen, for which there can be no
assurance, the Company will receive payments that range from 36% to 42% of
EchoGen sales in these territories. Subject to early termination, the agreement
spans the later of the life of the patents relating to EchoGen in the countries
of the territory, 10 years from the date of the agreement, or the introduction
of a generic equivalent by a third party.
In March 1995, the Company entered into a license agreement with Daiichi
Pharmaceutical Co., Ltd. ("Daiichi"). The agreement provides Daiichi an
exclusive license to distribute the Company's first product to several Pacific
Rim countries including Japan, Taiwan, China, and Korea (the "Territory"). In
March 1995, the Company recognized a $2.0 million advance as revenue and
received an additional $1.3 million of non-refundable license fees. Daiichi is
required to pay specified amounts to the Company to maintain its product license
rights, including regular quarterly payments of $400,000, which were completed
during the first quarter of 1997, and additional payments upon achievement of
certain clinical development and regulatory milestones. Total payments from
Daiichi if the Company achieves the agreed-upon milestones will be $32.0
million. As of December 31, 1997, the Company had received $12.8 million under
the agreement. Subject to early termination, the term of the license shall
expire upon the later of the expiration of the last to expire patents or 10
years after the first commercial sale of the Company's first product in the
Territory. The license agreement also includes product supply and royalty
provisions. For all areas in the Territory outside Japan and Taiwan, Daiichi is
obligated to purchase the finished product from the Company at a fixed unit
price. For Japan and Taiwan, Daiichi has the option of obtaining finished goods
directly from the Company or obtaining raw materials from the Company and
manufacturing the product.
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6. INCOME TAXES
Income tax expense consists of the following:
1997 1996 1995
-------- -------- --------
Current:
Federal ................... $ 50,000 $ 50,000 $ --
State ..................... -- -- 1,644
Foreign ................... 40,000 460,000 330,000
-------- -------- --------
90,000 510,000 331,644
Deferred:
Foreign ................... -- -- 200,000
-------- -------- --------
Total ....................... $ 90,000 $510,000 $531,644
======== ======== ========
The Company's foreign income tax expense is for withholding taxes paid in
Japan relating to the collaborative payments made by Daiichi (see Note 5).
Significant components of the Company's net deferred tax assets and
liabilities as of December 31, 1997 and 1996 are as follows:
1997 1996
------------ ------------
Deferred tax assets:
Federal net operating loss carryforwards ............. $ 5,049,000 $ 5,355,000
Accrued expenses ..................................... 197,000 165,000
Research and development credits ..................... 983,000 691,000
Foreign tax credits .................................. 1,183,000 1,143,000
Deferred compensation ................................ 6,000 112,000
------------ ------------
Total deferred tax assets .............................. 7,418,000 7,466,000
Deferred tax liabilities:
Tax in excess of book depreciation expense ........... (14,000) (107,000)
------------ ------------
Gross deferred tax assets .............................. 7,404,000 7,359,000
Valuation allowance for net deferred tax assets ...... (7,404,000) (7,359,000)
------------ ------------
Net deferred tax assets ................................ $ -- $ --
============ ============
A reconciliation of the Federal Statutory tax rate of 34% to the Company's
effective income tax rate follows:
1997 1996
-------- --------
Statutory tax rate .................................... 34.00% 34.00%
Permanent differences ................................. 1.91 0.19
Utilization of net operating loss carryforwards ....... (35.91) (34.19)
Federal tax expense (AMT) ............................. 4.54 2.24
Foreign tax expense ................................... 3.63 20.61
-------- --------
Effective tax rate .................................... 8.17% 22.85%
======== ========
Due to the uncertainty of the Company's ability to continue to generate
taxable income to realize its net deferred tax assets at December 31, 1997 and
1996, a valuation allowance has been recognized for financial reporting
purposes. The Company's valuation allowance for deferred tax
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assets increased $45,000 and decreased $22,000 for the years ended December 31,
1997 and 1996, respectively.
The Company has federal net operating loss carryforwards of approximately
$14,791,000 at December 31, 1997, for income tax reporting purposes and research
and development tax credit carryforwards of approximately $983,000 at December
31, 1997. The federal operating loss carryforwards begin to expire in 2006. The
research and development credits begin to expire in 1998.
The initial public offering ("IPO") of common stock by the Company caused
an ownership change pursuant to applicable regulations in effect under the
Internal Revenue Code of 1986. Therefore, the Company's use of losses incurred
through the date of ownership change will be limited during the carryforward
period and may result in the expiration of net operating loss carryforwards
before utilization.
7. STOCKHOLDERS' EQUITY
COMMON STOCK
In October 1995, the Company sold 3,063,750 shares of common stock in an
IPO resulting in net proceeds of approximately $19.0 million. Upon completion of
the IPO, all of the convertible redeemable preferred stock outstanding converted
into 2,325,219 shares of common stock, and the convertible subordinated
debenture converted into 462,857 shares of common stock. In August 1995, $3.6
million refundable option fees, plus accrued interest ($245,875 at the time of
conversion), were converted into 549,410 shares of common stock under a prior
agreement.
At December 31, 1997, the Company had reserved shares of common stock for
the following purposes:
Stock Option Plans ......................... 1,375,226
Warrants ................................... 784,547
Other Stock Options ........................ 76,335
Employee Stock Purchase Plan ............... 21,244
---------
2,257,352
=========
STOCK OPTION PLANS
The Company has adopted two plans which provide for the granting of
incentive and nonqualified stock options. 1,500,000 shares were reserved for
issuance under the employee plan and 122,137 shares were reserved under the
director plan. As of December 31, 1997, there were 266,762 shares available for
future grant under the plans. Employee stock options vest over a period of time
determined by the Board of Directors, generally four years, and director options
are fully vested at the date of grant. All options expire 10 years from the date
of grant.
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A summary of activity related to the Company's stock option plans follow:
WEIGHTED
AVERAGE
EXERCISE EXERCISE
SHARES PRICE PRICE
---------- --------------- --------
Balance, December 31, 1994..................... 175,542 $ .07 -- .66 $ 0.15
Granted...................................... 149,656 .66 -- 8.19 4.06
Exercised.................................... (91,578) .07 -- .33 0.14
Canceled..................................... (33,604) .07 -- 8.19 7.52
----------
Balance, December 31, 1995..................... 200,016 .07 -- 8.19 1.94
Granted...................................... 649,955 13.00 -- 23.00 14.49
Exercised.................................... (68,766) .07 -- 7.86 0.45
Canceled..................................... (34,276) .07 -- 20.00 11.77
----------
Balance, December 31, 1996..................... 746,929 .07 -- 23.00 12.66
Granted...................................... 287,802 24.13 -- 44.00 29.86
Exercised.................................... (51,484) .20 -- 23.00 9.13
Canceled..................................... (14,663) .20 -- 40.13 13.77
----------
Balance, December 31, 1997..................... 948,584 .07 -- 44.00 17.43
==========
Options exercisable at December 31, 1997....... 475,315 $ .07 -- 44.00 $15.04
==========
The following table summarizes information about stock options outstanding
at December 31, 1997:
WEIGHTED WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER REMAINING EXERCISE OPTIONS EXERCISE
PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- ------------- ----------- ---------------- ---------- ----------- --------
$0.066-$ 8.19 79,456 5.23 years $ 2.86 53,918 $ 2.98
$13.25-$23.00 602,826 8.20 years $14.30 386,377 $14.55
$24.13-$44.00 286,302 9.39 years $29.80 35,020 $39.04
ACCOUNTING FOR STOCK-BASED COMPENSATION
In 1996, the Company adopted Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). In accordance
with SFAS 123, the Company has elected to continue following the intrinsic value
method allowed under the statement for its stock option plans and present pro
forma disclosures using the fair value method.
Had the Company elected to recognize compensation cost based on the fair
value of the options as prescribed by SFAS 123, the pro forma amounts for net
income (loss) and associated basic EPS amounts would have been $(1.0) million or
$(.11) per share for the year ended December 31, 1997 and $0.3 million or $.03
per share and $(6.0) million or $(1.81) per share for the years ended December
31, 1996 and 1995, respectively. The fair value of each option is estimated
using the Black-Scholes option pricing model. The assumptions used in this model
include an estimated option life of four years, expected stock price volatility
ranging from .576 to .645, a dividend yield of 0.0%, and a risk-free interest
rate at the grant date ranging from 5.25% to 7.70%. The weighted average fair
value of options granted during 1997, 1996 and 1995 was $14.91, $6.72 and $4.43,
respectively, per share.
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For certain options granted between December 1994 and September 1995, the
Company is recognizing as compensation expense the excess of the deemed fair
value for financial reporting purposes of the common stock issuable over the
exercise price. Deferred compensation is amortized over the vesting period of
the option.
STOCK PURCHASE PLAN
In 1995, the Company established an employee stock purchase plan. Under the
plan, employees may contribute up to 15% of their compensation to purchase
shares of the Company's common stock at 85% of the stock's fair market value at
the lower of the beginning or end of each three-month offering period. Shares
purchased under the plan were 10,273, and 6,111 in 1997 and 1996, respectively.
At December 31, 1997, 21,244 shares were reserved for future purchase by
employees under the plan.
OTHER OPTIONS AND WARRANTS
In connection with the Abbott Agreement signed in May 1996, Abbott
purchased, for $4.0 million, warrants to acquire 500,000 shares of common stock.
The warrants are exercisable for five years at $16.00 per share.
In connection with bridge financing prior to the IPO, the Company issued
warrants to purchase an aggregate of 303,590 shares of common stock at exercise
prices ranging from $5.24 to $7.05 per share. The warrants expire at various
times from October 1998 through July 2000. 26,114 warrants were exercised in
1997 and 5,361 warrants were exercised in 1996.
In September 1994, the Board of Directors granted an option, expiring in
2004, to purchase 76,335 shares of common stock to the Company's President and
Chief Executive Officer. The option is exercisable at $0.66 per share. In
connection with the grant, the Company recorded deferred compensation of
$50,000, representing the excess of the deemed fair value for financial
reporting purposes of the common stock issuable over the exercise price, which
amount is being amortized over the vesting period of the option.
In connection with the deferral of the payment of reimbursements related to
the relocation of the Company's executive offices, in November 1994 the Company
issued warrants to certain employees to purchase an aggregate of 17,949 shares
of common stock at an exercise price of $6.55 per share. 2,929 and 2,588
warrants were exercised in 1997 and 1996, respectively.
SHAREHOLDER RIGHTS PLAN
In 1996, the Board of Directors of the Company adopted a Shareholder Rights
Plan ("Plan"). Under the Plan, the Board declared a dividend of one Preferred
Stock Purchase Right ("Right") for each outstanding common share of the Company.
The Rights have an exercise price of $140 per Right and provide the holders with
the right to purchase, in the event a person or group acquires 15% or more of
the Company's common stock, additional shares of the Company's common stock
having a market value equal to two times the exercise price of the Right. The
Rights expire in 2006.
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8. EARNINGS PER SHARE
A reconciliation between basic and diluted EPS follows:
1997 1996
---------- ----------
BASIC EARNINGS PER SHARE:
Net income ..................................... $1,011,279 $1,722,145
Weighted average common shares ................. 8,565,658 8,481,084
Basic EPS ................................... $ 0.12 $ 0.20
DILUTED EARNINGS PER SHARE:
Net income ..................................... $1,011,279 $1,722,145
Weighted average common shares - basic ......... 8,565,658 8,481,089
Dilutive potential common shares ............... 1,014,582 582,660
---------- ----------
Total ....................................... 9,580,240 9,063,749
========== ==========
Diluted EPS ................................. $ 0.11 $ 0.19
9. COMMITMENTS
The Company has leased office and laboratory space under two operating
lease agreements which expire in April 1998 and April 1999. Under the main
office lease which expires in April 1999, the Company has the option to extend
the lease for an additional three years at 95% of the then fair market value of
the premises. The Company anticipates extension of the second office lease
through April 1999. Future minimum lease payments are as follows:
1998.............................................. $379,599
1999.............................................. 91,926
--------
$471,525
========
Rental expense for the years ended December 31, 1997, 1996 and 1995 was
approximately $458,000, $340,000 and $328,000, respectively.
In May 1993, the Company entered into a manufacturing and supply agreement
with Abbott. In the event that EchoGen is approved by the FDA, the Company is
obligated to purchase certain minimum quantities of materials from Abbott or
make cash payments for the shortages from the predetermined purchase level over
a five-year period.
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10. LEGAL PROCEEDINGS
On August 1, 1997, a lawsuit was filed in the U.S. District Court for the
District of Columbia by Molecular Biosystems, Inc. ("MBI") and Mallinckrodt,
Inc. against the Company, Nycomed Imaging A.S. ("Nycomed"), ImaRx Pharmaceutical
Corporation, DuPont Merck and Bracco International BV. The suit alleged that
certain of the Company's ultrasound contrast agent patents were invalid and that
the Company had made certain false public representations about MBI and a
proposed MBI product. On September 3, 1997, Nycomed filed a counter-claim
against the Company in the above action, alleging that a Nycomed patent was
entitled to priority over one of the SONUS patents and that the SONUS patent was
invalid. The Company along with several other co-defendants moved to dismiss the
lawsuit, and on January 5, 1998, the District Court of the District of Columbia
dismissed the lawsuit filed by MBI and the cross-claim filed by Nycomed.
On January 7, 1998, the Company announced that it had filed a patent
infringement action in the U.S. District Court in Seattle, Washington, against
MBI and Mallinckrodt. Inc. The suit alleges that one of MBI's ultrasound
contrast agents infringes one or more of the Company's patents. MBI has filed
counterclaims alleging that the patents asserted by SONUS are invalid and not
infringed, and that SONUS has made false public statements and engaged in other
actions intended to damage MBI and one of its ultrasound contrast agents. No
trial date has been set for this lawsuit.
In addition, the patents in this lawsuit are the subject of re-examination
by the U.S. Patent and Trademark Office. The outcome of the re-examination may
have an impact on the above patent infringement action.
11. RECENT ACCOUNTING PRONOUNCEMENTS
During 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and SFAS No 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 130 and 131 are effective for
financial statements for fiscal years beginning after December 15, 1997. The
adoption of SFAS No 130 or 131 are not expected to have a material impact on the
Company's results of operations, financial position or cash flows.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required hereunder is incorporated by reference from the
section of the Company's Proxy Statement to be filed in connection with its 1998
Annual Meeting of Stockholders entitled "Election of Directors."
ITEM 11. EXECUTIVE COMPENSATION
The information required hereunder is incorporated by reference from the
section of the Company's Proxy Statement to be filed in connection with its 1998
Annual Meeting of Stockholders entitled "Compensation of Executive Officers."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required hereunder is incorporated by reference from the
section of the Company's Proxy Statement to be filed in connection with its 1998
Annual Meeting of Stockholders entitled "Security Ownership of Management and
Certain Beneficial Owners."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required hereunder is incorporated by reference from the
sections of the Company's Proxy Statement to be filed in connection with its
1998 Annual Meeting of Stockholders entitled "Compensation of Executive
Officers" and "Compensation Committee Interlocks and Insider Participation."
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The financial statements filed as a part of this Report are listed
on the "Index to Financial Statements" on Page 28.
(2) All schedules are omitted because they are not required or the
required information is included in the financial statements or
notes thereto.
(3) Exhibits
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION LOCATION
----------- ------------------------------------------------------------------ --------
3.2 Amended and Restated Certificate of Incorporation of the Company. *
3.4 Amended and Restated Bylaws of the Company. *
4.1 Specimen Certificate of Common Stock. *
4.2 Rights Agreement, dated as of August 23, 1996, between the ***
Company and U.S. Stock Transfer Corporation.
10.1 SONUS Pharmaceuticals, Inc. Incentive Stock Option, Nonqualified *
Stock Option and Restricted Stock Purchase Plan -- 1991 (the
"1991 Plan"), as amended.
10.2 Form of Incentive Stock Option Agreement pertaining to the 1991 Plan. *
10.3 Form of Nonqualified Stock Option Agreement pertaining to *
the 1991 Plan.
10.4 Form of Restricted Stock Purchase Agreement pertaining to the *
1991 Plan.
10.5 SONUS Pharmaceuticals, Inc. 1995 Stock Option Plan for Directors *
(the "Director Plan").
10.6 Form of Stock Option Agreement pertaining to the Director Plan. *
10.12 License Agreement dated as of March 31, 1995 by and between *
the Company and Daiichi Company (portions omitted pursuant
to Rule 406 of the Securities Act of 1933, as amended (the
"1933 Act")).
10.14 Contrast Agent Development and Supply Agreement dated May 6, *
1993 by and between the Company and Abbott Laboratories,
Inc. (portions omitted pursuant to Rule 406 of the 1933
Act).
10.14A Amendment to Contrast Agent Development and Supply Agreement *
dated August 22, 1995 by and between the Company and
Abbott Laboratories, Inc. (portions omitted pursuant to Rule
406 of the 1933 Act).
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EXHIBIT NO. DESCRIPTION LOCATION
----------- ------------------------------------------------------------------ --------
10.15 Lease Agreement dated February 26, 1992 by and between the *
Company and Cambridge Park Partners, L.P.
10.16 First Amendment to Lease dated December 15, 1994 by and between *
the Company and Cambridge Park Partners, L.P.
10.17 Sublease dated December 15, 1994 by and between the Company and *
McGaw, Inc.
10.18 Lease Agreement dated January 17, 1994 between the Company and WRC *
Properties, Inc.
10.19 Form of Indemnification Agreement for Officers and Directors of *
the Company.
10.20 Manufacturing Agreement dated August 2, 1995 by and between *
the Company and Pharmaceutical Education and Development
Foundation of the Medical University of South Carolina
(portions omitted pursuant to Rule 406 of the 1933 Act).
10.21 Loan and Security Agreement dated August 11, 1995 by and between *
the Company and Silicon Valley Bank.
10.21A Loan Modification Agreement dated September 10, 1997 to Loan *
and Security Agreement by and between the Company and
Silicon Valley Bank.
10.22 SONUS Pharmaceuticals, Inc. Employee Stock Purchase Plan. **
10.24 Employment Agreement, effective as of January 16, 1996, #
by and between the Company and Steven C. Quay, M.D., Ph.D.
10.25 Agreement between Abbott Laboratories, Inc. and the Company, ##
dated May 14, 1996 (portions omitted pursuant to Rule 24b-2).
10.26 Third Amended and Restated Registration Rights Agreement ###
dated as of May 15, 1996.
10.28 International License Agreement, dated October 1, 1996, by ####
and between Abbott Laboratories, Inc. and the Company
(portions omitted pursuant to Rule 24b-2).
23.1 Consent of Ernst & Young LLP, Independent Auditors +
24.1 Power of Attorney (included on the Signature Page of this
Annual Report on Form 10-K).
27.1 Financial Data Schedule. +
27.1A Restated Financial Data Schedule - First Quarter 1997 +
27.1B Restated Financial Data Schedule - Second Quarter 1997 +
27.2A Restated Financial Data Schedule - 1996 Annual Report +
on Form 10-K
46
47
EXHIBIT NO. DESCRIPTION LOCATION
----------- ------------------------------------------------------------------ --------
Executive Compensation Plans and Arrangements
10.1 1991 Plan. *
10.2 Form of Incentive Stock Option Agreement pertaining to *
the 1991 Plan.
10.3 Form of Nonqualified Stock Option Agreement pertaining *
to the 1991 Plan.
10.4 Form of Restricted Stock Purchase Agreement pertaining to *
the 1991 Plan.
10.5 Director Plan. *
10.6 Form of Stock Option Agreement pertaining to the Director *
Plan.
10.22 SONUS Pharmaceuticals, Inc. Employee Stock Purchase Plan. **
10.24 Employment Agreement, effective as of January 16, 1996, #
by and between the Company and Steven C. Quay, M.D.,
Ph.D.
- ----------
* Incorporated by reference to the referenced exhibit number to the
Company's Registration Statement on Form S-1, Reg. No. 33-96112.
** Incorporated by reference to Exhibit 4.7 to the Company's Registration
Statement on Form S-8, Registration No. 33-80623.
*** Incorporated by reference to the Company's Registration Statement on Form
8-A, dated August 23, 1996.
# Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1996.
## Incorporated by reference to the referenced exhibit number to the
Company's Current Report on Form 8-K dated May 14, 1996.
### Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996.
#### Incorporated by reference to the referenced exhibit number to the
Company's Current Report on Form 8-K dated October 1, 1996.
+ Filed herewith
(b) The Company filed no reports on Form 8-K during the quarter ended
December 31 1997.
EchoGen(R) is a registered trademark and SonoGen(TM), High-Q Factor(TM) and
PhaseShift(TM) are trademarks of SONUS Pharmaceuticals, Inc.
47
48
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, in the City of Bothell,
State of Washington, on March 31, 1998.
SONUS PHARMACEUTICALS, INC.
Dated: March 31, 1998 By: /s/ Steven C. Quay, M.D., Ph.D.
-------------------------------
Steven C. Quay, M.D., Ph.D.
President, Chief Executive
Officer and Director
We, the undersigned directors and officers of SONUS Pharmaceuticals, Inc.,
do hereby constitute and appoint Steven C. Quay, M.D., Ph.D. and Gregory Sessler
our true and lawful attorneys and agents, with full powers of substitution to do
any and all acts and things in our name and behalf in our capacities as
directors and officers and to execute any and all instruments for us and in our
names in the capacities indicated below, which said attorneys and agents may
deem necessary or advisable to enable said corporation to comply with the
Securities Exchange Act of 1934, as amended, and any rules, regulations and
requirements of the Securities and Exchange Commission, in connection with this
Annual Report on Form 10-K, including specifically but without limitation, power
and authority to sign for us or any of us in our names in the capacities
indicated below, any and all amendments hereto; and we do hereby ratify and
confirm all that said attorneys and agents, shall 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.
/s/ Steven C. Quay, M.D., Ph.D. President, Chief Executive March 31, 1998
- ----------------------------------------- Officer and Director
Steven C. Quay, M.D., Ph.D. (Principal Executive Officer)
/s/ Gregory Sessler Chief Financial Officer March 31, 1998
- ----------------------------------------- (Principal Financial and
Gregory Sessler Accounting Officer)
/s/ Donald B. Milder Director March 31, 1998
- -----------------------------------------
Donald B. Milder
/s/ Harry A. Shoff Director March 31, 1998
- -----------------------------------------
Harry A. Shoff
/s/ Dwight Winstead Director March 31, 1998
- -----------------------------------------
Dwight Winstead
/s/ George W. Dunbar, Jr. Director March 31, 1998
- -----------------------------------------
George W. Dunbar, Jr.
48
DEAD TABLE GARK