Item 1. BUSINESS
INTRODUCTION
Certain statements contained in this Annual Report on Form 10-K, including, without limitation, statements containing the words "believes," "anticipates," "estimates," "expects," "projections," and words of similar import, are forward looking as that term is defined by: (i) the Private Securities Litigation Reform Act of 1995 (the "1995 Act") and (ii) releases issued by the SEC. These statements are being made pursuant to the provisions of the 1995 Act and with the intention of obtaining the benefits of the "Safe Harbor" provisions of the 1995 Act. We caution that any forward looking statements made herein are not guarantees of future performance and that actual results may differ materially from those in such forward looking statements as a result of various factors, including, but not limited to, any risks detailed herein, including the "Risk Factors" section contained in this Item 1, or detailed from time to time in our other filings with the Securities and Exchange Commission, or SEC, including our most recent reports on Form 10-Q and Form 8-K, and amendments thereto. We are not undertaking any obligation to update publicly any forward-looking statements. Readers should not place undue reliance on these forward-looking statements.
We design, develop and produce innovative radioisotopic products, including brachytherapy seeds and radiopharmaceuticals, for the treatment and diagnosis of disease. Since 1990, we have applied our expertise in radioisotopes to develop and market products for medical, environmental, research and industrial applications.
In 1996, we began to focus our research and product development activities primarily on high value, high growth medical products which are useful in the diagnosis, management and treatment of diseases such as cancer and heart disease. This initiative resulted in the development of our first two therapeutic products, iodine-based and palladium-based implantable brachytherapy seeds for the treatment of prostate cancer. These products are marketed under the trademarks IoGold® and PdGold®, respectively, by Mentor Corporation ("Mentor"), our distributor for these products. Since the commercial introduction of IoGold™ in January 1998, our brachytherapy business has grown substantially. We believe that we are the third largest manufacturer in the world of brachytherapy seeds for the treatment of prostate cancer.
Our efforts at expanding our products to larger markets also led to the acquisition of Theseus Imaging Corporation ("Theseus") in October 2000. Theseus' primary product candidate is Apomate™, an in vivo nuclear medicine imaging agent that targets cells undergoing apoptosis or necrosis, two forms of cell death. We intend for Apomate™ to provide information that will allow clinicians to make better therapeutic decisions for individual patients by monitoring disease or the patient's response to treatment of disease with increased sensitivity and speed.
Apomate™ is in clinical trials for several indications: determining early response to chemotherapy, assessing the location and extent of heart attack damage, and detecting heart transplant rejection. Apomate™ is primarily being studied for its ability to rapidly assess early response to chemotherapy in cancer patients with lymphoma, non-small cell lung cancer and breast cancer, and its potential to demonstrate the location and extent of irreversibly damaged heart tissue in heart attack patients.
BRACHYTHERAPY SEEDS FOR PROSTATE CANCER
Prostate Cancer. The prostate gland, found only in men, is a small walnut-sized gland surrounding the urethra, located under the bladder and in front of the rectum. According to the American Cancer Society, prostate cancer is considered a slow growing cancer relative to other types of cancer. Symptoms of prostate cancer are often not noticed until the cancer has progressed past early stages of the disease. A digital rectal examination during a routine physical examination is the most commonly
used test for identifying prostate cancer. Additionally, a blood test to detect a prostate specific antigen, or PSA, has rapidly become an accepted means of detecting early-stage prostate cancer. The PSA test, which is recommended for men over the age of 50, determines the amount of prostate specific antigen contained in an examinee's blood. Elevated levels of PSA can result from benign symptoms such as inflammation but can also be indicative of the presence of cancerous cells in the prostate. The emergence of PSA blood testing has greatly improved physicians' ability to diagnose and treat early stage prostate cancer.
Prostate cancer is the second most prevalent form of cancer in men in the United States and is the second most common cause of cancer death in men. The American Cancer Society estimates that in 2001 more than 198,000 new cases of prostate cancer will be diagnosed in the United States and approximately 32,000 deaths will be attributable to the disease. The cost of medical treatment in the United States for patients with prostate cancer has been estimated at approximately $5 billion annually.
There are several therapies available for the treatment of prostate cancer.
Brachytherapy
Overview. Brachytherapy is a minimally invasive medical procedure in which sealed radioactive sources are temporarily or permanently implanted into cancerous tissue, delivering a therapeutically prescribed dose of radiation that is lethal to the cancerous tissue. In the seeding procedure, generally 60 to 120 rice-sized, low-level radioactive seeds, containing either Palladium-103 or Iodine-125, are permanently implanted into the prostate, usually by a radiation oncologist or urologist, to irradiate and destroy cancerous prostatic tissue. Insertion of the seeds is performed under ultrasound guidance that allows the physicians to view the prostate to ensure proper seed implantation. A template, or grid, covers the perineum and is attached to the ultrasound probe to facilitate correct needle placement. Implant needles loaded with seeds are assigned to the appropriate template holes as indicated in the treatment plan. Each needle is guided through the template and then through the perineum to its predetermined position within the prostate under direct ultrasound visualization. The seeds are implanted as the needle is withdrawn from the prostate. Following completion of the procedure, an x-ray or CT image is viewed to verify seed placement.
Brachytherapy patients are typically treated on an outpatient basis, as the entire procedure typically takes less than two hours and patients generally are permitted to go home the same day. Most patients are able to return to their normal activities within two or three days following the procedure.
The use of brachytherapy to treat prostate cancer has grown significantly over the past several years due to its advantages over other therapies, including radical prostatectomy, or RP, and external beam radiation therapy, or EBRT. Brachytherapy is the newest of the three primary techniques for the treatment of prostate cancer. In recent years, ten-year survival data has become available which demonstrates the comparability of brachytherapy treatment with surgery. We believe that the increasing use of this technique reflects the growing acceptance in the medical community and among patients of this comparative data.
Published data has shown that brachytherapy usually results in lower incidences of impotence and incontinence compared to other therapies, and faster recovery times than RP. Moreover, studies show that the disease free survival rates ten years after brachytherapy treatment are comparable to RP. Brachytherapy is most effective for localized tumors treated in the early stages of the disease. Therefore, we believe that the growing use of PSA tests will help detect prostate cancer at an earlier stage and enhance the attractiveness of brachytherapy as a treatment alternative.
Our Brachytherapy Products. We were the first company to manufacture both iodine and palladium based brachytherapy seeds, the two most commonly used seeds for the treatment of prostate cancer. These two products differ in the time each takes to decay, and, consequently in the rate and
intensity at which the radiation dose is delivered. Because physicians may prefer either iodine or palladium seeds, we believe that it is advantageous to offer both in order to address the entire market. Both types of seeds are marketed under the Mentor trademarks of IoGold®and PdGold® through its sales force. Although our products are primarily marketed in the United States, Mentor also has the right to sell our products in foreign countries. In December 2000, we received a CE mark which enables Mentor to market and sell our brachytherapy seeds in Europe.
•IoGold®. In January 1998, we launched our first FDA-approved brachytherapy source, an Iodine-125 based seed, used primarily for the treatment of prostate cancer. Each seed consists of a laser welded biocompatible titanium capsule approximately the size of a grain of rice, containing Iodine-125 absorbed onto four resin beads. The capsule also contains two inactive gold beads that serve as markers for x-ray or CT imaging to identify the source location within the prostate. The iodine in IoGold® has a half life of 59 days; therefore, it utilizes lower activity levels to deliver a therapeutic dose over a longer period of time compared to the Palladium-103 seed.
•PdGold®. In April 1999, we introduced our second FDA-approved brachytherapy source, a Palladium-103 based seed, also used primarily for the treatment of prostate cancer. Each palladium seed consists of a similar laser welded biocompatible titanium capsule containing Palladium-103 absorbed onto four resin beads. The capsule also contains two inactive gold beads that serve as markers for x-ray or CT imaging to identify the source location within the prostate. The palladium in PdGold® has a half life of 17 days; therefore, it utilizes higher activity levels to deliver a therapeutic dose over a shorter period of time compared to the Iodine-125 seed.
Other Treatment Modalities
Radical Prostatectomy. Currently the most common treatment option, radical prostatectomy, or RP, is an invasive surgical procedure in which the entire prostate gland is removed. RP is performed under general anesthesia and typically includes a hospital stay of several days for patient observation and recovery.
This procedure is often associated with high rates of impotence, incontinence and operative morbidity. For instance, a study published in the Journal of the American Medical Association in January 2000 reported that approximately 60% of men who had received RP reported erectile dysfunction as a result of surgery. The same report found that approximately 40% of the patients studied reported at least occasional incontinence. New bilateral nerve-sparing techniques are currently being used more frequently in order to address these side effects, but these techniques require a high degree of surgical skill. RP is typically more expensive than other common treatment modalities.
External Beam Radiation Therapy. External beam radiation therapy, or EBRT, one of the first minimally invasive alternatives to RP, allows patients to receive treatment on an outpatient basis at a significantly lower cost than RP. EBRT involves directing a beam of radiation from outside the body at the prostate gland to destroy cancerous tissue. The course of treatment takes anywhere from seven to eight weeks for the tumor to receive the total dose of radiation prescribed to kill the tumor.
Studies have shown, however, that the ten-year disease free survival rates with treatment through EBRT are not comparable to the disease free survival rates of RP or brachytherapy. In addition, because the radiation beam travels through the body, affecting healthy and cancerous tissue alike, other side effects are associated with EBRT. For instance, rectal wall damage caused by the radiation beam is a noted negative side effect. Data suggests that between 30% and 40% of the patients who undergo EBRT suffer problems with erectile dysfunction after treatment.
While EBRT directs a single beam at the prostate, a new technique, known as Intensity Modulated Radiation Therapy, or IMRT, is designed to spare healthy tissue by directing multiple beams from
various angles to the cancerous tissue, with varying levels of intensity. IMRT has not yet gained widespread use and does not yet have long-term clinical data supporting better efficacy rates or lower incidences of side effects.
Other Treatments. Cryosurgery, a procedure in which tissue is frozen to destroy tumors, is another treatment option for prostate cancer. Currently, this procedure is not widely used, although promising treatment outcomes have been reported. Without precise control of the cryoprobe, tissue freezing may be non-selective. Consequently, diseased and healthy tissue may be destroyed at the same rate. Cryosurgery typically requires a one to two day hospital stay and is associated with higher rates of impotence than brachytherapy.
Other treatments include hormone therapy and chemotherapy, which may be used to reduce the size of cancerous tumors. However, these treatments are not intended to ultimately cure a patient of prostate cancer. Instead, such treatment choices are made by physicians in an attempt to extend patients' lives if the cancer has reached an advanced stage or as ancillary treatment methods used in conjunction with other treatment mechanisms. Common side effects of hormone therapy are impotence, decreased libido and development of breasts, and common side effects of chemotherapy are nausea, hair loss and fatigue.
"Watchful waiting," while not a treatment, is recommended by some physicians in certain circumstances based on the severity and growth rate of the disease, as well as upon the age and life expectancy of the patient. Physicians and patients who choose watchful waiting are frequently seeking to avoid the negative side effects associated with RP or other treatment modalities. Through careful monitoring of PSA levels and close examination for advancing symptoms of prostate cancer, physicians are able to choose more active treatments at a later date.
Mentor Relationship
We have an exclusive worldwide distribution agreement with Mentor which grants them the right to market and sell IoGold® and PdGold® brachytherapy seeds for the treatment of prostate cancer. We originally entered into a five-year agreement with Mentor, effective January 1998, covering Iodine-125 brachytherapy seeds. Subsequently, in February 1999, we amended the agreement to establish provisions providing for Mentor's exclusive worldwide marketing and distribution rights with regard to Palladium-103 seeds. The term of the agreement for both seed product lines expires in 2003, however, Mentor holds a one-time option to extend the exclusive agreement for an additional three years subject to the attainment of certain performance criteria. Under the agreement Mentor is responsible for all sales and marketing activities, including the education and support of urologists, radiation oncologists, medical physicists and other personnel involved in the use of brachytherapy seeds. The agreement also provides us the right to terminate Mentor's exclusivity with respect to any product for which Mentor fails to achieve target market share requirements in certain designated geographic areas, subject to certain curing provisions whereby Mentor can maintain exclusivity.
We believe that Mentor did not meet its 2000 target market share with respect to sales of PdGold® and we believe that it is unlikely that Mentor has met its 2001 target. In addition, we believe that Mentor might not meet its 2001 target with respect to sales of IoGold®. Subject to performance review by both parties, a shortfall can result in our option to terminate Mentor's right of exclusivity subject to certain curing provisions set forth in our agreement with Mentor.
This alliance with Mentor has provided us with the ability to leverage Mentor's sales and marketing capability as an established leader in urology while allowing us to focus on our plans for diversification into other areas. Mentor currently distributes IoGold® and PdGold® through its brachytherapy specialists and its urology sales force which targets urologists, radiation oncologists and medical physicists for the brachytherapy line.
APOMATE™
Apomate™ is a kit consisting of multiple components for the preparation of Technetium Tc-99m labeled Annexin-V, a human protein produced by recombinant techniques. It is administered intravenously and is intended for the in vivo imaging of apoptosis and necrosis, two forms of cell death, using standard nuclear medicine imaging procedures.
Nuclear medicine imaging involves injecting a radioisotope into the patient's body, detecting the signal emitted by the radioisotope with a gamma camera and then creating an image of the target area, usually through the use of a computer. A radioisotope, such as Technetium Tc-99m, is typically coupled with a carrier molecule that binds on a selective basis with targeted tissues. Because of the sensitivity of gamma cameras, only tiny amounts of radioisotopes are required to produce nuclear images. Nuclear medicine imaging is unique in that it documents organ function and structure, in contrast to diagnostic radiology, which images anatomy. Nuclear medicine imaging procedures often identify abnormalities very early in the progression of a disease, long before some medical problems are detected using other diagnostic tests. The Society of Nuclear Medicine estimates that 10 to 12 million nuclear medicine imaging examinations or therapeutic procedures are performed in the United States each year.
Apoptosis was once of interest only in a few specialized fields of biology, but is now recognized as a central feature of cancer treatment, heart attack, and organ transplant rejection. During apoptosis, several physiologic stimuli may trigger a cellular set of processes that result in an orderly self-destruction and disposal of the cell without breaking open the cell membrane. This process can be induced by disease, such as in transplant rejection or heart attack, or can be purposely induced as the result of certain forms of cancer therapy, including chemotherapy and radiotherapy. Unlike apoptosis, necrosis is a disorganized nonphysiologic process characterized by physical disruption of the cell membrane. Necrosis can be caused by mechanical, thermal, electrical or noxious chemical injury and by profound hypoxia (a deficiency in the amount of oxygen reaching body tissues), ischemia (a decrease in the blood supply to a bodily organ, tissue, or part caused by constriction or obstruction of the blood vessels), or respiratory poisons. In a normal healthy cell, membrane integrity is maintained by a series of controlled biochemical processes. The process of apoptosis is characterized by the maintenance of cell membrane integrity, while necrosis is accompanied by the breakdown and fragmentation of the cell membrane.
During apoptosis, the inactivation of a particular enzyme, translocase, allows a molecule known as phosphatidylserine, or PS, which is normally only found on the inside of the cell membrane to migrate to the outer surface of the cell membrane. Annexin-V has a strong binding affinity for PS. As soon as PS is expressed on the surface of the cell it becomes accessible as a binding target site for Apomate™.
Cells dying from necrosis have membrane disruption, typically with cell swelling. Although PS may not migrate to the outer surface of the cell membrane during necrosis, the loss of membrane integrity allows Apomate™ to bind to PS on the inner leaflet of the cell membrane.
Once Apomate™ binds to PS, standard nuclear medicine imaging techniques are used to produce an image of cell death associated with either apoptosis or necrosis. Apomate™ is currently in clinical trials for imaging apoptosis and necrosis to assess early response to cancer treatment, determine the location and extent of damage in heart attack and to image heart transplant rejection. We believe that Apomate™ will allow clinicians to make better therapeutic decisions for individual patients by monitoring the patient's condition or response to treatment with greater sensitivity and speed.
Cancer Treatment
Many cancer treatments, including radiotherapy, chemotherapy or immunotherapy, are intended to kill tumor cells. Apomate™ has been shown in ongoing clinical trials to image in vivo tumors
responding to treatment by binding to apoptosis-specific membrane markers that appear as soon as one to two hours after initial doses of effective treatment.
Normally, it may take many weeks of repeated dosing with cancer drugs until response to treatment is evaluated by observation of tumor size changes. This long evaluation period can be particularly troublesome because, for example, although approximately 25% to 40% of breast cancer patients with recurrent disease respond to the first-line treatment, the side effects of the drug are felt in nearly all of the treated population. Consequently, an imaging agent with the ability to quickly measure patient response to cancer therapy should be in great demand. Such an agent also would allow for rapid identification of ineffective treatments, thereby avoiding negative side effects in circumstances where the patient is unlikely to receive meaningful clinical benefit.
We believe that Apomate™, as a prognostic tool for cancer, has the potential to provide several benefits to patients, physicians and pharmaceutical and biotechnology companies by:
•enabling evaluation of individual patient responses to cancer drugs, as soon as a few hours after initial administration of an effective agent
•reducing unnecessary treatment costs
•saving critical time by avoiding ineffective treatments
•improving clinical outcomes
•more efficiently stratifying cancer patients in clinical trials into responders and nonresponders to therapeutic regimens
•providing pharmaceutical and biotechnology companies with more timely information to enable them to shorten the time to develop new therapeutic agents.
According to the National Cancer Institute, approximately 1.3 million individuals in the United States are diagnosed with cancer each year, of which approximately 400,000 will undergo chemotherapy. Many additional patients with recurrent disease enter chemotherapy programs each year. We believe that Apomate™ imaging will dramatically enhance the choice of particular therapies, since no diagnostic tool in use today gives clinicians such rapid, direct and detailed evidence as to whether a particular treatment is effective.
Another potential market for Apomate™ is in new cancer drugs and cancer treatment regimens under development. The ability to image cell death or lack of cell death in tumors quickly could reduce development time for new therapeutic agents.
Clinical Trials. Phase I clinical trials for this indication have been completed and included 69 Apomate™ imaging studies in 35 cancer patients. Subjects in this trial with positive uptake of Apomate™ post-treatment showed responses to treatment as indicated by decreases in tumor size. In the subjects with lung cancer in this initial trial, those who did not show Apomate™ uptake post-treatment, suggesting no tumor cell death, showed no decrease in tumor size in response to treatment. Thus, Apomate™ appeared to predict clinical response to treatment in non-small cell lung cancer when administered 24 hours after the first course of cancer treatment. Moreover, patients who showed uptake of Apomate™ soon after initial treatment, suggesting early tumor cell death, had a longer time to progression of their disease and a longer survival time compared to patients who failed to show Apomate™ uptake after initial treatment.
Some of the breast cancer patients who did not show increased Apomate™ uptake 24 hours after their first chemotherapy dose did show a partial response to treatment; further studies are planned to optimize use of the agent in that population.
In addition, Phase I studies in some lymphoma patients have shown significant increases in Apomate™ uptake shortly after treatment. We believe that Apomate™ uptake post-treatment in this population may be useful as a prognostic sign of good treatment response. Conversely, lack of post-treatment Apomate™ uptake may indicate a poor prognosis and suggest the need for more aggressive intervention, such as bone marrow transplant in conjunction with high dose chemotherapy.
Additional Phase II studies in lung and breast cancer and in lymphoma have been initiated and are in progress. A Phase II/III study of Apomate™ in patients with non-small cell lung cancer was initiated in November 2001 and is now ongoing. This multi-center, Phase II/III study is designed to enroll patients in the United States and Europe with advanced non-small cell lung cancer, the type of cancer most commonly associated with smoking. The study is intended to assess the ability of Apomate™ to predict tumor response to chemotherapy by imaging patients within seventy-two hours following the first treatment.
Heart Attack and Coronary Artery Disease
Coronary artery disease, or CAD, is one of the most common medical problems, affecting approximately 25% of all Americans. CAD is characterized by the buildup of cholesterol-laden deposits called plaque in the interior of blood vessels supplying blood to the heart. The heart requires a constant supply of oxygen-rich blood to function normally. As plaque in the coronary arteries increases in size, it can reduce blood flow to a region of the heart causing pain, known as angina. If the cholesterol deposits in the coronary arteries totally block the flow of blood, part of the heart muscle can infarct, or die. Infarctions are more commonly known as a heart attack. While electrocardiograms, or ECGs, and clinical laboratory tests for damage to the heart muscle have been enormously helpful, there is still much ambiguity in distinguishing a new infarction from old heart damage in patients with known coronary artery disease. ECG changes may be due to pre-existing damage and enzymes may not be sensitive enough to make a definitive diagnosis. Also, it is sometimes difficult to distinguish cardiac causes of chest pain or shortness of breath from gastrointestinal or musculoskeletal problems.
Apomate™ imaging in patients with known heart attacks has shown positive images with definite areas of increased uptake of the imaging agent in the areas of the heart known to have had a blockage of blood flow. When a blockage occurs in a coronary blood vessel, a region of the heart normally supplied with blood by this vessel is injured and may die. Studies have shown that muscle cells in the heart can begin dying within 15 minutes of oxygen deprivation and are also injured in the first 15-30 minutes after the return of blood flow in patients whose clots are dissolved by drugs or who undergo emergency angioplasty. Apomate™'s ability to localize in areas of apoptosis and necrosis suggests that this imaging procedure may be useful in demonstrating the total volume of irreversibly damaged heart muscle. The Apomate™ studies should allow a definitive diagnosis of the location and extent of the heart damage to be made after a heart attack or after medical or surgical intervention to limit the damage associated with atherosclerosis.
Moreover, we believe that Apomate™ may distinguish previously damaged heart tissue from freshly injured tissue in patients with known cardiovascular disease. Current regional perfusion imaging agents such as Thallium Tl-201™ and Cardiolite™ cannot always distinguish past heart tissue damage from fresh injury.
There are approximately five million hospital or emergency room admissions annually in the United States for the purpose of ruling out a heart attack. ECG and clinical laboratory studies are definitive in diagnosing approximately 1.1 million heart attack cases. We believe that Apomate™ imaging of these patients following intervention will provide valuable information as to the extent of damaged tissue. The remaining 3.5 million patients are not definitively diagnosed with a heart attack but, nevertheless, are often required to stay overnight in the hospital for observation. We believe that Apomate™ imaging could be useful in making a definitive diagnosis of or ruling out heart attack or
ischemic heart damage due to temporary reduction of blood flow to the heart in these patients if nuclear imaging becomes a routine procedure in the emergency room. Consequently, we believe the use of Apomate™ may reduce hospital costs by permitting some patients to be discharged earlier.
Clinical Trials. A preliminary peer-reviewed publication demonstrating the localization of Technetium Tc-99m-labeled Annexin-V in patients with heart attacks was published in the Lancet, a leading British medical journal. In this study, which used an experimental laboratory preparation similar to Apomate™, six of seven patients with heart attacks had images demonstrating areas of heart uptake consistent with known heart tissue damage. Subsequently, these researchers using Apomate™ in seven additional patients with heart attacks have shown localization of Apomate™ in ECG-indicated areas of heart tissue damage in each case.
Phase II clinical trials of Apomate™ in patients with acute myocardial infarction began in November 2000. About 65 patients with known heart attacks were imaged in those Phase II trials which compared Apomate™ imaging to standard enzyme and ECG tests as well as to Thallium Tl-201 imaging. In addition, follow-up studies were conducted in many of those individuals which demonstrated that Apomate™ images appear positive for about two to four weeks after an acute injury; and that the intensity of Apomate™ uptake diminishes over this time. These findings should be useful in establishing the optimal clinical use of Apomate™ in this setting. Phase II studies are continuing in various subpopulations of interest. Initial results have been obtained in 68 patients with acute myocardial infarction documented by chest pain, ECG, and enzyme/troponin elevation. Each patient received Apomate™ within 96 hours of onset of symptoms along with Thallium Tl-201, a perfusion imaging agent, and the distribution of both Apomate and Thallium were imaged simultaneously using a readily available technique known as "single-spin/dual isotope' SPECT imaging. No adverse events likely to be attributable to Apomate™ were observed. Approximately 85% of patients showed abnormal Apomate™ uptake suggesting persisting myocardial tissue injury up to 96 hours after the heart attack, even after interventions, such as angioplasty and thrombolysis, intended to re-open closed blood vessels. The study showed that Apomate™ can be administered safely to patients with heart attacks and that Apomate™ localizes to areas of persisting myocardial damage in most patients, even after measures taken to rapidly re-open closed blood vessels.
Heart Transplant Rejection
A serious concern following a heart transplant is rejection of the donor heart. The body's immune system is designed to protect the body from infection. Without medical intervention, the immune system recognizes the transplanted organ as a foreign body and attempts to destroy it through a process known as rejection. If no medication is given to a transplant recipient, the host white blood cells attack the donor heart, thereby causing apoptotic cell death in the transplanted organ. To prevent rejection of the new heart, patients receive medication that suppresses the body's immune system. Physicians must carefully administer the dose of immunosuppressive drugs, such as cyclosporin, to allow the immune system to fight infection and still protect the new heart from being rejected. Patients must take these immunosuppressant drugs for the rest of their lives.
Transplant patients are monitored for signs of rejection by repeated heart catheterization during which a small piece of heart tissue is biopsied and examined in the laboratory under a microscope for signs of rejection, a procedure known as histopathological examination. This biopsy procedure is invasive and can be painful, involving advancement of a catheter through a vein to the heart and the "snipping off" of a piece of tissue for microscopic examination. Based on the results of the biopsy, a physician may adjust the prescribed level of immunosuppressive drugs.
In initial human trials, Apomate™ has been found to concentrate in areas of cell death, thus providing an early warning of this rejection.
There are approximately 2,300 heart transplants performed annually in the United States. Each heart transplant recipient may undergo up to 15 biopsy procedures in the first year after the transplant in order to assess the adequacy of immunosuppression medication required to prevent rejection of the new heart. After the first year, biopsies are typically performed one to four times annually.
We have also been granted Orphan Drug status for this indication by the Food and Drug Administration, or FDA.
Clinical Trials. In patients experiencing heart transplant rejection, the cells of the new heart are dying as a result of the apoptotic process. Preclinical results have demonstrated the ability of Apomate™ to bind to dying heart cells in rejecting heart transplant recipients. Nuclear medicine images obtained using standard instrumentation available in U.S. hospitals clearly demonstrated localization of Apomate™ in patients with biopsy-confirmed transplant rejection in Phase I clinical trials. Some of this data was recently published as a peer-reviewed article in Nature Medicine, a leading medical journal. This demonstrates the potential for non-invasive nuclear medicine imaging of early signs of rejection.
In June 2000, we presented peer-reviewed data to the Society of Nuclear Medicine from our Phase I trial of Apomate™ in heart transplant rejection which was conducted in 27 patients who were undergoing routine surveillance heart biopsies, the standard diagnostic test for post-transplant patients. Based on these results, we initiated expanded Phase II clinical trials. Patient accrual with documented transplant rejection has proceeded slower than originally anticipated for a number of reasons. The incidence of episodes of cardiac rejection has declined in our study population, possibly due to the availability of more effective anti-rejection drugs. It has taken enrollment of ten or more patients undergoing biopsy to capture each episode of rejection for study. It appears that, given the rate of positive biopsies in this population, the study will take at least one more year to complete; and it appears any submission for marketing approval for this indication would be submitted after the end of calendar 2002. Although additional study sites could be recruited to accelerate this timetable, the Company believes that, in light of the strong results in patients with heart attack and cancer, resources must continue to be directed at those larger populations.
Other Products
By utilizing our expertise in the design, development and manufacturing of radioisotopic products, we have developed or jointly developed the following additional products.
RADIATION CALIBRATION AND REFERENCE SOURCE PRODUCTS
Radioactivity is a natural physical property. Each radioisotope radiates energy characteristic to that specific isotope. Radiation detection instruments monitor the emitted radiation from a given sample (i.e., soil, air, water, etc.) to identify and quantify the radioisotopes present in that sample. In order to determine a particular instrument's efficiency, an accurately measured and contained amount of a radioactive isotope is required to serve as a calibration reference standard. Each type of sample being monitored by an instrument typically requires a radiation source standard of identical form and geometry to the sample.
Our principal products in this category are radiation sources and standards, which are used in a variety of areas for calibration, measurement, analysis and control.
Standards for Nuclear Medicine
Nuclear medicine is practiced at over 5,000 U.S. hospitals. Consistent performance of imaging and calibration instrumentation is crucial to successful diagnostic and patient management and cannot be maintained without extensive calibration programs. We supply many of the required types of calibration standards.
Standards for Calibration and Reference
We manufacture both catalog and customized products for commercial laboratories serving the environmental sector. Calibration standards are critical for accurate environmental analysis of unknown samples collected in the field. Moreover, our products have a variety of industrial uses, ranging from measuring the thickness of materials and gauging fluid levels to electronics stabilization and calibration.
We make standards available to various organizations, including certain government agency contractors and laboratories. These standards are often designed to meet special requirements, customized configurations or special processing services.
Our commercial customers include federal and state governmental agencies, leading medical equipment manufacturers, nuclear utilities and private organizations. Our radiation sources are also sold through a select group of representatives and distributors in North America, Europe and Asia. We support our products through a full product catalog, advertising, telemarketing and trade shows, and engage in direct selling to end users as well as to equipment manufacturers for inclusion in their product lines.
PROSPERA™
Intraocular melanoma, or a tumor occurring inside the eye, is a relatively rare malignancy which accounts for approximately 1,500 new cases each year in the United States. The two most common means of treating this condition are brachytherapy or enucleation (removal of the eye).
In April 2000, we introduced a line of high activity brachytherapy seeds under the trademark Prospera™ for use in the treatment of ocular melanoma and other solid tumor applications. Prospera™ is used with the ultimate goal of destroying the tumor while saving the eye. Prospera™ seeds are available in both Iodine-125 seeds and Palladium-103 seeds. We directly market Prospera™ to ophthalmologists and medical physicists. The number of cases presenting annually will limit Prospera™
sales for this application, but we view it as a natural extension of our brachytherapy business and as a service to the oncology community.
INTELLECTUAL PROPERTY
We believe that patents and other proprietary rights are vital to our business. It is our policy to seek appropriate patent protection both in the United States and abroad for our proprietary technology and to enter into license agreements with various companies to obtain patent rights from them to develop and potentially sell products which use the compounds and technologies protected by those patents.
We currently hold one U.S. patent relating to brachytherapy. In December 1999, we received a patent for a laser welded closure device which will expire in 2018. Additionally, we have applied to extend our patent protection internationally with the European Patent Office. We also filed an application for patent protection in August 1997 on our radioactive brachytherapy source design. This application is still pending. No patent protection is afforded while the application is pending before the United States Patent Office, however, the application is maintained in secrecy so that trade secret status is maintained.
Theseus has exclusively licensed Apomate™ technology for in vivo imaging of cell death from certain entities that have issued and pending patents with respect to this technology. During the last year, the United States Patent Office granted full patent rights to our licensor, Stanford University, for a patent for "Imaging Cell Death In Vivo" which we believe is a key patent providing strong protection for the Apomate™ technology.
The Apomate™ technology is licensed to Theseus under the following arrangements:
•Theseus is a party to a license agreement with Stanford University ("Stanford") dated April 1, 1998, and amended June 1, 1999, relating to the license of a patent for techniques for imaging cell death in vivo. The patent, containing 75 claims for the use of annexin for imaging cell death, was issued by the United States Patent and Trademark Office in March 2001. The agreement does not contain a predetermined termination date, but may be terminated by Theseus at any time upon 30 days written notice to Stanford. Stanford may terminate the Agreement if Theseus is in breach of the terms of the agreement, subject to a 30-day cure period following notice of the breach. Theseus has agreed to pay Stanford a royalty based upon the amount of licensed product sold. Additionally, Theseus has agreed to certain predetermined milestone payments over the life of the agreement which are not material in nature. Theseus' obligation to pay royalties continues for so long as Theseus by its activities would infringe a valid claim of an unexpired licensed patent of Stanford.
•Theseus entered into an agreement with the University of Washington ("Washington") on June 8, 1999, whereby Theseus has licensed technology relating to a patent application covering methods and composition for imaging cell death in vivo. The agreement has no termination date, but may be terminated by Theseus upon 30 days written notice to Washington. Washington may terminate the agreement if Theseus is in breach of the terms of the agreement, subject to a 30-day cure period following notice of breach. Theseus has agreed to pay Washington a royalty based upon the amount of licensed product sold, and to make certain other milestone payments upon designated events over the life of the agreement which are not material in nature. Theseus' obligation to pay royalties continues until the latter of ten years, if no licensed patent issues, or for so long as Theseus by its activities would infringe a valid claim of an unexpired licensed patent of Washington.
•Theseus is a party to a license agreement with NeoRx Corporation dated August 7, 1998, and amended August 7, 1999. Under this agreement, Theseus has an exclusive license of patent
rights and technology relating to the chemical composition of the Annexin imaging agents, and a nonexclusive license of patent rights and technology relating to the attachment of radioactive elements to Annexin. This agreement runs until the last to occur of the expiration of any patents covered by the agreement or ten years after the first commercial sale to a third party of the licensed product following regulatory approval. Theseus has agreed to pay NeoRx certain royalties based upon the amount of licensed product sold, and such obligation continues in effect until the agreement terminates. The termination provisions of this agreement provide that if a default remains uncured for a period of 90 days (or 15 days in the case of a default relating to the payment of money), then the non-defaulting party has the right to terminate the agreement by written notice to the other party. Under the terms of the agreement, Theseus also agreed to pay NeoRx $3 million, $500,000 of which was paid in 1998 and $2.5 million of which was paid in August 2001. Theseus is also obligated to make up to $4.0 million of additional milestone payments upon the occurrence of certain events.
•In July 2001, Theseus entered into a license agreement with AnorMed, Inc., for the rights to use its patented linker technology relating to the modification of proteins with a chemical compound and with other compounds useful in protein labeling to prepare Technetium Tc-99m labeled Annexin-V, among other uses. Studies are underway to evaluate the suitability of this preparation for use in an improved version of our Apomate™kit. The agreement runs until the last of the licensed patents expires. The termination provisions of this agreement provide that if a material default remains uncured for 90 days, then the non-defaulting party has the right to terminate the agreement by written notice to the defaulting party. As consideration for the license, Theseus has agreed to pay AnorMed, Inc. royalties based upon the amount of licensed product sold, and such obligation continues in effect for the duration of the agreement. Furthermore, Theseus is obligated to make a $500,000 milestone payment upon receipt of the first regulatory approval to market a product using AnorMed technology.
In addition, we have in-licensed additional technology governing composition of matter and use of Apomate™.
In July 1997, we were granted a patent on a radioisotope-based device for site localization during biopsy procedures, which expires in 2014.
We also rely upon unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation to develop and maintain our competitive position. Our policy is to enter into confidentiality agreements with our employees, consultants and vendors, and we generally control access to our proprietary information.
COMPETITION
Our brachytherapy business is subject to intense competition. Our primary competitors in the brachytherapy seed business include Nycomed Amersham PLC, which manufactures and sells Iodine-125 brachytherapy seeds, and Theragenics Corporation, which manufacturers and sells Palladium-103 brachytherapy seeds directly and through marketing relationships with third parties, including Prostate Services of America, Inc., Nycomed Amersham PLC, C.R. Bard, Inc. and Imagyn Medical Technologies. Several additional companies have begun to sell seeds and a number of others have announced their intention to market brachytherapy products.
For the indications currently being evaluated in clinical trials for Apomate™, established methods of patient evaluation exist and must be considered "gold standards" of treatment. To our knowledge, no radiopharmaceutical product comparable to Apomate™ currently exists. The competition which Apomate™ could potentially encounter will be physician acceptance and adoption of a new diagnostic and management tool designed to replace well-established procedures. It is also possible that Positron Emission Tomography, or PET, techniques or magnetic resonance imaging, or MRI, techniques could
be used to study patient response to anti-tumor treatment or heart tissue damage. Radiopharmaceuticals, such as Thallium Tl-201 and Bristol-Myers Squibb Medical Imaging, Inc.'s Cardiolite™, are used to show abnormalities of blood flow to heart tissue. However, such agents do not directly image damage to heart tissue.
The radiation reference source business is also subject to intense competition. Our competitors in this industry include AEA Technology PLC and Eckert & Ziegler AG. We believe that these companies have a dominant position in the market for radiation reference source products.
We believe that we compete favorably in our targeted markets with our competitors on the basis of price, diversity of product line, customer service, quality and delivery time.
Many of the companies named above against whom we compete are substantially larger than us and have greater technical, sales, marketing and financial resources. Developments by any of these or other companies or advances by medical researchers at universities, government research facilities or private research laboratories could render our products obsolete. Therefore, additional companies with substantially greater financial resources than we have, as well as more extensive experience in research and development, the regulatory approval process and manufacturing and marketing, may develop seeding treatments and products that are similar to our brachytherapy products.
In addition to the competition from the procedures and companies noted above, many companies, both public and private, are researching new and innovative methods of preventing and treating cancer and heart disease. In addition, many companies, including many large, well-known pharmaceutical, medical device and chemical companies that have significant resources available to them, are engaged in radiological pharmaceutical and device research. These companies are located in the United States, Europe and throughout the world. Significant developments by any of these companies could have a material adverse effect on the demand for our products.
GOVERNMENT REGULATION
Our research and development activities and the manufacturing and marketing of our radioisotope products are subject to the laws, regulations, guidelines and regulatory clearances and approvals of governmental authorities in the United States and other countries in which our products are or will be marketed. Specifically, in the United States, the FDA regulates, among other things, new product clearances and approvals to establish the safety and efficacy of these products. Governments in other countries have similar requirements for testing and marketing. In the United States, in addition to FDA regulations, we are also subject to other federal laws, including the Occupational Safety and Health Act and the Environmental Protection Act, and we are also subject to certain state laws.
U.S. Regulatory Process
Approval of new medical devices and biological products is a lengthy procedure leading from development of a new product through preclinical and clinical testing. This process takes a number of years and the expenditure of significant resources. There is a shorter FDA review and clearance process, the premarket notification process, or the 510(k) process, whereby a company can market certain medical devices that can be shown to be substantially equivalent to other legally marketed devices. We have been able to market some of our products through the 510(k) process.
Regardless of how our product candidates are regulated, the Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations govern or influence the research, testing, manufacture, safety, labeling, storage, record keeping, approval, distribution, use, reporting, advertising and promotion of such products. Noncompliance with applicable requirements can result in civil penalties, recall, injunction or seizure of products, refusal of the government to approve or clear product approval applications, disqualification from sponsoring, or conducting clinical investigations, prevent us
from entering into government supply contracts, withdrawal of previously approved applications and criminal prosecution.
In October 1997, we received 510(k) clearance from the FDA to market Iodine-125 seeds. In July 1998, we received 510(k) clearance from the FDA to market Palladium-103 seeds.
Clinical trials of Apomate™ are ongoing in the United States under investigational new drug, or IND, filings with the Center for Biologics Evaluation and Research of the United States Food and Drug Administration. Studies are also being undertaken in Europe and Canada in accordance with applicable national laws. Apomate™ is in clinical trials as a possible diagnostic adjunctive tool for imaging heart tissue damage, specifically to identify the location and extent of heart attack damage, as well as an adjunct in the diagnosis of a heart attack and in imaging heart transplant rejection. Apomate™ is also in clinical trials for imaging response to chemotherapy, specifically in lymphoma, breast cancer with metastases, and in non-small cell lung cancer. We intend to file a biologic license application, or BLA, for these indications. We have been granted Orphan Drug status for Apomate™ for imaging heart transplant rejection.
In connection with the manufacture and distribution of brachytherapy sources, we are required to be registered as a medical device manufacturer with the FDA. As such, we are subject to inspection by the FDA for compliance with the FDA's current Good Manufacturing Practice regulations, among other things. These regulations require that we and any of our contract manufacturers design, manufacture and service products and maintain documents in a prescribed manner with respect to manufacturing, testing, distribution, storage, design control and service activities. Modifications or enhancements that could significantly affect the safety or effectiveness of a device or that constitute a major change to the intended use of the device require a new 510(k) notice for any product modification. We may be prohibited from marketing the modified product until the 510(k) notice is cleared by the FDA.
The Medical Device Reporting regulation requires that we provide information to the FDA on deaths or serious injuries alleged to be associated with the use of our devices, as well as product malfunctions that are likely to cause or contribute to death or serious injury if the malfunction were to recur. Labeling and promotional activities are regulated by the FDA and, in some circumstances, by the Federal Trade Commission.
For our radiopharmaceutical products under development which may be regulated as biologics, the FDA requires:
•preclinical laboratory and animal testing
•submission to the FDA of an IND application which must be effective prior to the initiation of human clinical studies
•adequate and well-controlled clinical trials to establish the safety and efficacy of the product for its intended use
•preparation and submission to the FDA of a marketing application known as a Biologics License Application.
•review and approval of the BLA as well as inspections of the manufacturing facility by the FDA prior to commercial marketing of the product.
The FDA's IND and post-approval report regulations require that we provide information to the FDA on deaths or serious injuries alleged to be associated with the use of our products, as well as increases in the frequency or severity of the occurrence of adverse effects. Labeling and promotional activities are regulated by the FDA and, in some circumstances, by the Federal Trade Commission.
Foreign Regulatory Process
In order to sell our medical device products within the European Union, we must comply with the European Commission's medical device directive. We received a CE mark on our brachytherapy products for prostate cancer in December 2000. The CE mark is recognized worldwide as an essential European regulatory approval and will enable us to expand our sales and distribution of the products throughout the European Union. In order to perform clinical studies of our radiopharmaceutical candidate agent, we have filed an IND exemption in Canada for Apomate™. Apomate™ is being investigated in that country as an imaging agent for early response to cancer chemotherapy and for determination of heart attack damage. We have also filed a CTX application with the Medicines Control Agency in the United Kingdom for this product. It is being investigated in that jurisdiction as an imaging agent for early response to cancer chemotherapy and determination of heart attack damage. Investigational studies are also under way in other European countries in accordance with applicable national laws.
Other Regulation
In addition to FDA regulation, certain of our activities are regulated by, and require approvals from, other federal and state agencies in the United States. For example, we operate under a license issued by the California Department of Health and renewable every eight years which allows us to manufacture and process radioactive materials. Our licenses for our North Hollywood and Chatsworth facilities expire in 2007 and 2008, respectively. We are also subject to a routine inspection by the California Department of Health Services for compliance with good manufacturing practice, health and safety requirements, and other applicable regulations. Violation or alleged violation of these regulations may result in government action ranging from warning letters to criminal prosecution. Companies that violate these regulations are also subject to large civil penalties. Moreover, our use, management and disposal of certain radioactive substances and wastes are subject to regulation by several federal and state agencies depending on the nature of the substance or waste material. We believe that we are in compliance with all federal and state regulations for this purpose.
MANUFACTURING
We manufacture all of our brachytherapy products at our North Hollywood and Chatsworth, California facilities. We manufacture our calibration and reference source products in our North Hollywood facility. The equipment used to manufacture our products is purchased from a variety of suppliers. Additionally, we have developed an in-house capability to both build and repair certain equipment used in the manufacturing of our products. We consider our manufacturing equipment to be in good condition.
The principal component in our products are radioisotopes. Additionally we use a variety of materials for encapsulation or containment of the radioisotopes. Radioisotopes are available for purchase from a limited number of government or commercial facilities around the world or are manufactured by irradiation of target materials at commercially available sites. We also often process and purify these isotopes in our laboratories. Once purified, we further process, contain and calibrate these materials. Encapsulation and containment materials are available from commercial suppliers in the United States and internationally.
The components of the Apomate™ kit are manufactured by third parties under contract with Theseus. We conduct audits of our third party manufacturers to ensure they comply with the FDA's current Good Manufacturing Practice regulations.
RESEARCH AND DEVELOPMENT
Research and development expenditures totaled $7,602,000 during the year ended October 31, 2001, which relate primarily to the ongoing clinical trial and development costs related to Apomate™. We expect to continue to incur additional significant clinical trial and development costs related to Apomate™ over the next two to three years.
EMPLOYEES
As of October 31, 2001, we had a total of 61 full-time employees. None of our employees are represented by a labor union. We have not experienced a work stoppage in our history, and we believe that our employee relations are good.
Risk Factors
Our acquisition of Theseus and the resulting changes to our core business involve considerable risk and may threaten our future profitability.
On October 13, 2000, we acquired Theseus, a developer of proprietary radiopharmaceutical products to enhance the medical management of various conditions, including cancer, heart attack and heart transplant rejection. Through Theseus, we have acquired product candidates which we plan to develop and expand into a core focus of our future business. Such an expansion and shift in our business involves considerable risk. Our ability to integrate Theseus into our business and succeed in developing and marketing these new product candidates will be affected by the following factors:
•The use of radiopharmaceuticals for imaging cell death is a new and unproven technology and may not receive acceptance among healthcare providers, payors or patients.
•Clinical trials with respect to these products may not be successful and we may not receive government approval in a timely manner or at all. If such approval can be obtained, we do not expect to receive FDA approval for Apomate™ until 2003 at the earliest.
•Any resulting products may not achieve market acceptance or compete successfully against existing or future diagnostic products intended for similar purposes.
•We expect future investment in development and commercialization of the Theseus products to have a significant negative impact on our earnings as a result of expenditures over the next two to three years for ongoing clinical trial and development costs related to Theseus' principal product candidate, Apomate™.
Our ability to commercialize product candidates is subject to uncertainty related to clinical trials.
Before obtaining regulatory approval for the commercial sale of Apomate™ or any other product candidates, we must demonstrate through preclinical studies and clinical trials that such product candidates are safe and efficacious for use in each indication. The results from preclinical testing and early clinical trials may not predict results that will be obtained in large-scale clinical trials, and there can be no assurance that our clinical trials will demonstrate the safety and effectiveness of any of our product candidates or will lead to marketable products. A number of companies have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. We, the FDA or other regulatory authorities may suspend or terminate clinical trials at any time. In addition, there can be no assurance that any of our product candidates will obtain FDA or other regulatory approval for any indication or that an approved product will be capable of being produced in commercial quantities at reasonable cost and successfully marketed.
In particular, if we are delayed or unable to determine the final Apomate™ product candidate we intend to take to market, we may be unable to proceed on schedule with further clinical trials for any indications. In addition, the FDA has indicated that clinical trial data we present from an adequate and well-controlled study suitable for supporting a marketing application, often referred to as a pivotal study, for any indication may not be accepted if Apomate™'s composition changes significantly. As a result, any delay caused by implementing the final design of, or the manufacturing process for, the Apomate™ kit may delay the commercialization of Apomate™.
In addition, the rate at which we complete clinical trials depends upon, among other things, the rate of patient enrollment. Patient enrollment is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the
eligibility criteria for the study. Delays in planned patient enrollment may result in increased costs, program delays, or both.
There can be no assurance that any of our clinical trials will be completed successfully within any specified time period, or at all. There also can be no assurance that the results from any of these clinical trials will warrant commencing further clinical trials or taking a product candidate to market.
If we fail to maintain existing marketing alliances or are unable to enter into new alliances when necessary, commercialization of certain of our products may be delayed or prevented.
We do not have a dedicated sales and marketing force and currently do not have the ability to market and sell any of our products in commercial quantities without entering into marketing relationships with others. We have limited experience marketing and selling our brachytherapy products, which in fiscal 2001 accounted for approximately 79% of our revenue, and do not have experience marketing and selling those products in commercial quantities. On June 16, 1997, we entered into a five-year marketing and exclusive distribution agreement with Mentor, whereby Mentor agreed to market and distribute our Iodine-125 and Palladium-103 brachytherapy seeds for prostate cancer. As a result, sales of those products depend on the marketing efforts of Mentor. Through its sales force, Mentor markets the products to urologists, radiation oncologists and medical physicists and is involved in educating and training physicians in the procedures for using the products.
We believe that Mentor did not meet its 2000 target market share with respect to sales of PdGold® and we believe that it is unlikely that Mentor has met its 2001 target. In addition, we believe that Mentor might not meet its 2001 target with respect to sales of IoGold®. Subject to performance review by both parties, a shortfall can result in our option to terminate Mentor's right of exclusivity subject to certain curing provisions set forth in our agreement with Mentor.
If Mentor's right of exclusivity is terminated, we may be unable to develop other distribution relationships or establish an internal sales and marketing force.
If we terminate our relationship with Mentor because Mentor fails to meet its performance targets, we may be unable to market certain of our products under Mentor's proprietary trademarks.
Additionally, we may rely on marketing alliances to commercialize other products we develop, including Apomate™ and other nuclear medicine products. As a result, we will need to develop third-party distribution relationships and/or create our own direct sales force in order to market our products in the future. We may not be successful in developing other distribution relationships when necessary and we may be unable to develop our own sales force because of the significant costs and dedication of resources involved.
If we fail to maintain our competitive position in key product areas, we may lose significant sources of revenue.
Our brachytherapy business is subject to intense competition. Our primary competitors in the brachytherapy seed business include Nycomed Amersham PLC, which manufactures and sells Iodine-125 brachytherapy seeds, and Theragenics Corporation, which manufacturers and sells Palladium-103 brachytherapy seeds directly and through relationships with third parties, including Prostate Services of America, Inc., Nycomed Amersham PLC, C.R. Bard, Inc. and Imagyn Medical Technologies. Several companies have begun to sell seeds and others have announced their intention to market brachytherapy products, which would result in increased competition. In addition, other products using alternative technologies may be developed which would compete with our brachytherapy products. For example, if treatment methods such as cryosurgery or hormone therapy gain acceptance among healthcare providers, patients and payors, or if new technologies such as gene modification
emerge to become leading treatment standards as alternatives to traditional therapies, we may lose market share for our brachytherapy seeds or may find that our products are rendered non-competitive or obsolete by such market shifts and technological developments.
Our radiation reference source business also is subject to intense competition. Our competitors in this industry include AEA Technology PLC and Eckert & Ziegler AG. We believe that these companies have a dominant position in the market for radiation reference source products.
Currently, the leading imaging technologies include computer tomography, or CT, scanning and magnetic resonance imaging, or MRI, both of which image changes in the anatomy of organs and other tissue. Our Apomate™ product candidate images apoptosis and necrosis at the cellular level; however, there can be no assurance that alternative technologies will not be developed which have equivalent or superior imaging capabilities to Apomate™ and which may become more widely accepted as imaging standards.
In addition, many of our competitors are substantially larger and have greater sales, marketing and financial resources than we do. Developments by any of these or other companies or advances by medical researchers at universities, government facilities or private laboratories could render our products obsolete. Moreover, companies with substantially greater financial resources than us, as well as more extensive experience in research and development, the regulatory approval process, manufacturing and marketing, may be in a better position than we are to seize market opportunities created by technological advances in our industry.
The innovative nature of Apomate™ and other products under development raises questions as to whether the market will accept such products.
The success of our products will depend on our ability to foster and maintain favorable perceptions among patients, doctors, healthcare payors and medical researchers regarding the safety, efficacy and cost effectiveness of these products. This is particularly true with respect to Apomate™. Healthcare providers and payors may not accept gamma imaging of cell death through the use of Apomate™ as a viable alternative to traditional methods for assessing response to cancer, heart attack and heart transplant rejection, or the effects of other diseases involving cellular death. If our products do not receive acceptance among physicians, patients and healthcare payors in the United States or elsewhere, we may be unable to market and sell these products.
If we are unable to acquire sufficient supplies from key suppliers that in some cases may be the only source of raw materials, our ability to deliver our products to the market may be impeded.
We depend upon a limited number of outside unaffiliated suppliers for our radioisotopes. Our principal suppliers are Nordion International, Inc. and certain companies in Russia. We also utilize other commercial isotope manufacturers located in the United States and overseas. To date, we have been able to obtain the required radioisotopes for our products without any significant delays or interruptions. Currently, we rely exclusively upon Nordion International for our supply of the Palladium-103 isotope; if Nordion International ceases to supply isotopes in sufficient quantity to meet our needs, there may not be adequate alternative sources of supply.
If we are unable to adequately protect our technology or enforce our patents we may lose a significant advantage over our competitors.
Our success depends in part on our ability to obtain and enforce patent protections for our products and operate without infringing on the proprietary rights of third parties. We hold rights to issued U.S. patents on a radioisotope-based device for site localization during breast biopsy procedures
and a laser welded closure method for our brachytherapy seeds. The patents expire in 2014 and 2018, respectively. We have also filed for patent protection on our radioactive brachytherapy seed design. Our Theseus subsidiary has also in-licensed patents and technology for which patents are issued and pending related to Apomate™. The scope and extent of patent protection for our products is uncertain and frequently involves complex legal and factual questions. The breadth of the claims allowed in patents relating to biotechnology applications or their enforceability cannot be predicted, and patent litigation can be expensive and time consuming. No assurance can be given that pending patent applications will be approved or that any issued patents will provide competitive advantages for our products. Costly litigation might be necessary to protect our patents or to determine the scope and validity of third-party proprietary rights, and it is possible that we will not have the required resources to pursue such litigation or to protect our patent rights. An adverse outcome in litigation with respect to the validity of any of our patents could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease using a product or technology.
In addition, there can be no assurance that patents have not been issued or will not be issued in the future that conflict with our patent rights or prevent us from marketing our products. Such conflicts could result in a rejection of our licensors' patent applications or the invalidation of patents. Furthermore, if patents that contain dominating or conflicting claims have been or are subsequently issued to others, and such claims are ultimately determined to be valid, we may be required to obtain licenses under patents or other proprietary rights of others. No assurance can be given that any licenses required under any such patents or proprietary rights would be made available on terms acceptable to us, or at all. If we do not obtain such licenses, we could encounter delays or find that we are unable to develop, manufacture or sell products requiring such licenses.
We also rely on trade secrets and proprietary know-how that we seek to protect, in part, through confidentiality agreements with our collaborators, customers, employees and consultants. It is possible that these agreements will be breached or that they will not be enforceable in every instance, and that we will not have adequate remedies for any such breach. Furthermore, enforcing a claim alleging the infringement of trade secrets would be expensive and time consuming, making the outcome uncertain. It is also possible that our trade secrets will become known or independently developed by competitors. If we are unsuccessful in protecting our proprietary technology, we may lose a fundamental component of our competitive advantage.
We depend on several key licenses for our Apomate™ product candidate. If we lose our rights under any of these licenses, our ability to market and sell Apomate™ may be jeopardized.
We license certain technology rights related to Apomate™ from several entities. We are obligated to pay such entities royalties, milestone payments and other payments in exchange for such licenses and we rely on such parties' intellectual property rights to protect our proprietary interests in Apomate™ If we or our licensors breach any of the terms of these license agreements, or if we are unable to pay amounts owed to our licensors when they become due, we may lose the right to use such technology. If such an event occurs, we may be unable to market and sell Apomate™.
In addition, we are aware of other third party rights relating to Apomate™. We believe we have good and sufficient defenses against any possible infringement claims. Nevertheless, should a court rule against us, we may be prohibited from marketing Apomate™ unless we obtain a license from such third party which, if available at all, may require us to make substantial royalty or other payments.
If we are unable to obtain a license from such third party or if we lose rights to use technology related to Apomate™ under any of our current license agreements, we may be unable to market and sell Apomate™.
Extensive government regulation of our industry has had, and will continue to have, a significant impact on our business.
The manufacture and sale of our brachytherapy and other products are subject to stringent government regulation in the United States and other countries. Our products are subject to FDA and other governmental approval and continual review, and future discovery of previously unknown problems may result in restrictions on a product's marketing or withdrawal of the product from the market. The commercial distribution in the United States of any new products we develop will depend upon obtaining the prior approval or clearance of the FDA, which can take many years and entail significant costs, and we have limited experience in filing or pursuing applications necessary to gain regulatory approvals. In countries where our products are not currently approved, the use or sale of our products may require approval by local government agencies with missions comparable to the FDA's. The process of obtaining any such approval may be lengthy, expensive and uncertain. We are also required to adhere to applicable FDA regulations for current Good Manufacturing Practices, including extensive record keeping and reporting and periodic inspections of our manufacturing facilities. Similar requirements are imposed by foreign governmental agencies.
Reimbursement policies by Medicare and other third-party payors have a significant impact on our business.
A substantial percentage of the patients treated for prostate cancer in the United States are covered by Medicare and, consequently, the costs of prostate cancer treatment are subject to Medicare's prescribed rates of reimbursement. Medicare reimbursement amounts for seeding are currently significantly less than for radical prostatectomy, or RP. Although seeding generally requires less physician time than RP, lower reimbursement amounts, when combined with physician familiarity with RP, may create disincentives for urologists to perform seeding. There can be no assurance that:
•current or future limitations on, or requirements for reimbursement by, Medicare or other third-party payors for prostate cancer treatment will not materially adversely affect the market for our products.
•health administration authorities outside the United States will provide reimbursement at acceptable levels or at all.
•any such reimbursement will continue at rates that enable us to maintain prices at levels sufficient to realize an appropriate return.
Also, we, our distributors and healthcare providers performing brachytherapy seeding procedures are subject to state and federal fraud and abuse laws prohibiting kickbacks and, in the case of physicians, patient self-referrals. We may be subjected to civil and criminal penalties if we or our agents violate any of these prohibitions.
In addition, from time to time, significant attention is placed on reforming the healthcare system in the United States. Any future changes in Medicare and other third-party payor reimbursement which may result from healthcare reform or deficit reduction legislation would likely place downward pressure on prices. Future reimbursement policies may also affect the commercial acceptance of products we develop, including Apomate™. A number of legislative proposals have been introduced in Congress and state legislatures in recent years that would effect major reforms of the healthcare system and otherwise reduce healthcare spending. Because of the uncertainties surrounding the nature, timing and extent of any such reimbursement changes, audits and reform initiatives, we are unable to predict the effects of any such matters on our business.
We use radioactive materials which are subject to stringent regulation and which may subject us to liability if accidents occur.
We manufacture and process radioactive materials which are subject to stringent regulation. We operate under licenses issued by the California Department of Health which are renewable every eight years. We received a renewal of our license for our North Hollywood facility in 1998 and we were issued a license for our Chatsworth facility in March 1999. California is one of the "Agreement States," which are so named because the Nuclear Regulatory Commission, or NRC, has granted such states regulatory authority over radioactive materials, provided such states have regulatory standards meeting or exceeding the standards imposed by the NRC. Most users of our products must obtain licenses issued by the state in which they reside (if they are Agreement States) or the NRC. Use licenses are also required by some of the foreign jurisdictions in which we may seek to market our products.
Although we believe that our safety procedures for handling and disposing of these radioactive materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, we could be held liable for any damages that result.
We depend upon key personnel for our continued growth and development. Loss of such key personnel could have material adverse effect on us.
Our success is largely dependent on the personal efforts of key technical and senior management personnel, including L. Michael Cutrer, our Chief Executive Officer and President, and Dr. Allan M. Green, President of Theseus. We do not have an employment agreement with Mr. Cutrer. We believe that our future success will depend in large part upon our ability to attract and retain highly-skilled technical, managerial and marketing personnel and is likely to require the expansion of our management level personnel. Competition for radioisotopic industry personnel can be intense, and the availability of capable personnel may be limited; thus, their services could be difficult to obtain or replace. There can be no assurance that we will be successful in attracting and retaining the personnel we require to develop and market new and enhanced products and to conduct our operations successfully.
In addition, we have limited knowledge and experience with respect to the development of Apomate™ and other related product candidates of our subsidiary, Theseus. To date, we have relied and expect to rely heavily on the skill, knowledge and expertise of Dr. Green in developing and commercializing our Apomate™ product candidate. As the President of Theseus, Dr. Green will continue to have significant responsibility for Apomate™ and potentially other radiopharmaceuticals we develop. We currently have an employment agreement with Dr. Green through October 2002.
As part of our business strategy, we intend to pursue transactions that may cause us to experience significant charges to earnings that may adversely affect our stock price and financial condition.
We regularly review potential transactions related to technologies, product candidates or product rights and businesses complementary to our business. Such transactions could include mergers, acquisitions, strategic alliances, licensing agreements or co-promotion agreements. Our acquisition of Theseus is an example of such a transaction. In the future, we may choose to enter into such transactions at any time. Depending upon the nature of any transaction, we may experience a charge to earnings which could be material.
We may require additional capital in the future and we may be unable to obtain capital on terms favorable to us, or at all.
Our capital requirements have been and are expected to continue to be significant. We expect our existing capital resources and future operating cash flows to be sufficient for the foreseeable future. We anticipate significant expenditures related to ongoing clinical trial and development costs for Apomate™over the next two to three years. However, we may require further capital for the purchase of complementary businesses, technologies or products. Our capital requirements will depend on numerous factors, including the time and cost involved in expanding production capacity, the cost involved in protecting our proprietary rights and the time and expense involved in obtaining required regulatory approvals for new products we may develop or acquire.
Operating results for a particular period may fluctuate and are difficult to predict.
The results of operations for any quarter or fiscal year are not necessarily indicative of results to be expected in future periods. Our operating results have in the past been, and will continue to be, subject to quarterly and annual fluctuations as a result of a number of factors. As a consequence, operating results for a particular future period are difficult to predict. Such factors include the following:
•The costs of research and development in connection with our Apomate™ product candidate are difficult to estimate and vary between periods.
•Our net sales may grow at a slower rate than experienced in previous periods and, in particular periods, may decline.
•Estimates with respect to the useful life and ultimate recoverability of our carrying basis of assets, including goodwill and purchased intangible assets, could change as a result of such assessments and decisions.
•As a result of our growth in past periods, our fixed costs have increased. With increased levels of spending and the impact of long-term commitments, we may not be able to quickly reduce these fixed expenses in response to short-term business changes.
•Acquisitions that result in in-process research and development expenses may be charged fully in an individual quarter.
•Our brachytherapy product lines may experience some variability in revenue due to seasonality. This is primarily due to three major holidays occurring in our first fiscal quarter and the apparent reduction in the number of procedures performed during summer months, which could affect our third fiscal quarter results.
The testing, marketing and sale of our products involve the risk of product liability claims by consumers and other third parties, and insurance against such potential claims is expensive.
Our business is subject to product liability risks inherent in the testing, manufacturing and marketing of products containing radioisotopes. To date, no product liability claims have been asserted against us. However, there can be no assurance that such claims will not arise in the future based on past, present or future services or products we offer. We maintain product liability and general liability insurance with a limit in the aggregate amount of $2 million with additional umbrella insurance coverage of $10 million; however, there can be no assurance that liability claims will not exceed the scope of coverage or limits of such policies or that such insurance will continue to be available on commercially reasonable terms or at all. If we do not or cannot maintain sufficient liability insurance, our ability to market our products may be significantly impaired. In addition, product liability claims, as
well as negative publicity arising out of such claims, could have a material adverse effect on our business, operating results and financial condition.
Item 2.
Item 2. PROPERTIES
We are headquartered in the Los Angeles, California metropolitan area where we occupy two properties totaling approximately 40,000 square feet. These facilities are used for office, manufacturing, engineering, warehouse and research and development. We believe our manufacturing and distribution facilities are adequate, suitable and of sufficient capacity to support our current operations. In 2001, we extended our lease on our North Hollywood facility, which now expires in November 2003. The lease on our Chatsworth facility also expires in November 2003, but we have a five-year renewal option. Theseus is headquartered in Boston, Massachusetts where we lease office space totaling approximately 4,165 square feet, with our lease expiring in September 2003.
Item 3.
Item 3. LEGAL PROCEEDINGS
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since February 12, 1998, our common stock has been traded on the Nasdaq National Market under the symbol "NASI". The following table sets forth, for the periods indicated, the high and low sales prices for our common stock, as reported on the Nasdaq National Market.
As of January 16, 2002, we had approximately 83 holders of record and estimate that we had approximately 5,854 beneficial owners of our Common Stock.
We have never paid cash dividends on our Common Stock and have no plans to do so.
Item 6.
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following data should be read in conjunction with the consolidated financial statements, related notes and other financial information appearing elsewhere herein.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information which our management believes is relevant to an assessment and understanding of our financial condition and results of operations. The discussion should be read in conjunction with the Consolidated Financial Statements contained herein and the notes thereto. Certain statements contained in this Annual Report on Form 10-K, including, without limitation, statements containing the words "believes," "anticipates," "estimates," "expects," "projections," and words of similar import, are forward looking as that term is defined by: (i) the Private Securities Litigation Reform Act of 1995 (the "1995 Act") and (ii) releases issued by the SEC. These statements are being made pursuant to the provisions of the 1995 Act and with the intention of obtaining the benefits of the "Safe Harbor" provisions of the 1995 Act. We caution that any forward looking statements made herein are not guarantees of future performance and that actual results may
differ materially from those in such forward looking statements as a result of various factors, including, but not limited to, any risks detailed herein, including the "Risk Factors" section, or detailed from time to time in our other filings with the Securities and Exchange Commission, or SEC, including our most recent reports on Form 10-Q and Form 8-K, and amendments thereto. We are not undertaking any obligation to update publicly any forward-looking statements. Readers should not place undue reliance on these forward-looking statements.
Overview
We design, develop and produce innovative radioisotopic products, including brachytherapy seeds and radiopharmaceuticals, for the treatment and diagnosis of disease. Since 1990, we have applied our expertise in radioisotopes to develop and market products for medical, environmental, research and industrial applications. Sales of our brachytherapy products represented approximately 79% of our revenue in fiscal 2001.
In October 2000, we acquired Theseus Imaging Corporation, a developer of proprietary radiopharmaceuticals to enhance the medical management of cancer, heart attack and heart transplant rejection. We expect to incur significant ongoing clinical trial and development costs related to Theseus' principal product candidate, Apomate™. In addition, we expect to incur substantial expenses associated with the launch of Apomate™, pending receipt of marketing approval from the FDA.
Results of Operations
Fiscal Year Ended October 31, 2001 Compared to Fiscal Year Ended October 31, 2000
Net sales. Net sales increased $1,853,000, or 11%, to $19,343,000 for the year ended October 31, 2001 from $17,490,000 for the year ended October 31, 2000. The increase in net sales was due to the increase in revenues generated from both our brachytherapy and non-therapeutic product lines.
Gross profit. Gross profit increased $825,000 or 7% to $12,481,000 for the fiscal year ended October 31, 2001 from $11,656,000 for the fiscal year ended October 31, 2000. Gross profit as a percent of sales decreased from 67% to 65% during this period. The decrease in gross profit as a percentage of sales was primarily due to a change in the product mix and increased price competition in our brachytherapy products.
Selling, general and administrative expenses ("SG&A"). SG&A increased $2,372,000 or 64%, to $6,097,000 for the fiscal year ended October 31, 2001, from $3,725,000 for the fiscal year ended October 31, 2000. SG&A expenses increased primarily due to the following: (i) the inclusion of expenses incurred by Theseus which was acquired in October 2000, (ii) amortization of goodwill and other intangible assets resulting from the acquisition of Theseus totaling $582,000 and (iii) other general and administrative expenses were increased as a result of management's plans for the expansion of the Company.
Research and development. Research and development costs totaled $7,602,000 for the fiscal year ended October 31, 2001. Such costs were not significant for the fiscal year ended October 31, 2000. The increase primarily represents our continued investment in Apomate™, which is currently in clinical trials to assess response to cancer treatment, heart attack damage and heart transplant rejection. The increase in research and development spending reflects our belief that to maintain our competitive position in a market characterized by rapid rates of technological advancement, we must continue to invest significant resources in new product development, as well as continue to enhance existing products.
In-process research and development ("IPR&D"). During the fiscal year ended October 31, 2000, we incurred a one-time charge of $11,431,000 for IPR&D relating to our acquisition of Theseus completed in fiscal 2000 (see Note 2 to the Consolidated Financial Statements).
Write-off of construction in progress. Included in the results of operations for the fiscal year ended October 31, 2001, is a charge of $3,743,000 relating to the write-off of construction in progress. Since 1998, the Company has incurred costs in the development of two linear particle accelerators. The Company intended to use these units in the production of Palladium-103 for use in its brachytherapy products. Based on the uncertainty of the estimated costs to complete the units coupled with an increasingly reliable commercial supply of Palladium-103, in June 2001, the Board of Directors authorized the Company's management to attempt to identify buyers for this equipment while continuing to monitor the commercial advantages of purchasing the radioisotopes instead of manufacturing them. In August 2001, the Company concluded that (1) the availability of commercially produced isotopes substantially diminished the economic benefits of completing the accelerators and (2) there were no immediate buyers for the equipment. Accordingly, the Company elected to cease development efforts and to write off the value of the equipment in its entirety.
Interest and other income. Interest and other income increased $776,000 to $1,886,000 for the fiscal year ended October 31, 2001 from $1,110,000 for the fiscal year ended October 31, 2000. This increase resulted from the investment of funds received from our follow-on offering completed in December 2000, which was partially offset by (i) the interest expense incurred on our short-term debt and (ii) the fact that in 2000 we realized a pre-tax gain of $119,000 related to the disposition of 7,680 shares of series A preferred stock in RadioMed, a privately held company. Our effective yield on our investment portfolio has decreased consistent with a declining interest rate environment.
Provision (benefit) for income taxes. The Company's effective income tax rate was 35% (benefit) and 115% for the fiscal years ended October 31, 2001 and 2000, respectively. The decrease in the effective rate is primarily due to the non-deductibility of the IPR&D charge associated with the purchase of Theseus in the year ended October 31, 2000.
Fiscal Year Ended October 31, 2000 Compared to Fiscal Year Ended October 31, 1999
Net sales. Net sales increased $4,723,000, or 37%, to $17,490,000 for the year ended October 31, 2000 from $12,767,000 for the year ended October 31, 1999. The increase in net sales was primarily due to the increase in revenues generated from our brachytherapy product lines. Sales of the non-therapeutic lines also increased by approximately $446,000.
Gross profit. Gross profit increased $3,483,000 or 43% to $11,656,000 for the year ended October 31, 2000 from $8,173,000 for the year ended October 31, 1999. Gross profit as a percent of sales increased from 64% to 67% during this period. The increase in gross profit as a percentage of sales was primarily attributable to the significant proportionate increase in revenues from our brachytherapy product lines in fiscal 2000, which yielded greater gross margins than our non-therapeutic product lines.
Selling, general and administrative expenses. SG&A expenses increased $665,000, or 22%, to $3,725,000 for the year ended October 31, 2000 from $3,060,000 for the year ended October 31, 1999. SG&A as a percent of net sales decreased to 21% for the year ended October 31, 2000 from 24% for the same period in 1999. SG&A expenses increased primarily due to the following: (i) an increase in salaries and related costs as we added a significant number of administrative personnel throughout fiscal 1999 and continued to do so in fiscal 2000 to support our growth and (ii) other general and administrative expenses including insurance and depreciation increased as a result of our expansion.
Research and development. Research and development expenditures totaled $417,000 during the year ended October 31, 2000 compared to $287,000 for the year ended October 31, 1999. The increase was due primarily to development efforts associated with new product lines.
In-process research and development. The amount expensed to IPR&D arose from the purchase acquisition of Theseus completed in fiscal 2000 (see Note 2 to the Consolidated Financial Statements).
The fair value of the technology currently under development was determined using the income approach, which discounts expected future cash flows to present value. Elements of the projected income stream included revenues, cost of goods sold and SG&A expenses. The discount rates used in the present value calculations are generally derived from the cost of equity, taking into account the additional risks inherent in incomplete projects. We do not expect to achieve a material amount of expense reductions or synergies as a result of integrating the acquired IPR&D. Therefore, the valuation assumptions do not include significant anticipated cost savings.
At the date of acquisition, Apomate™ was in Phase I-II clinical trials for heart attack, cancer treatment and heart transplant rejection. Upon successful completion of clinical trials, submission of a new biologics license application, and final approval by the FDA, this technology will be considered complete.
Interest and other income. Interest and other income increased $499,000 to $1,110,000 for the year ended October 31, 2000 from $611,000 for the year ended October 31, 1999 due to the following: (i) we realized a pre-tax gain of $119,000 related to the disposition of 7,680 shares of RadioMed, a privately held company, and (ii) a change in the composition of our investment portfolio.
Provision (benefit) for income taxes. The Company's effective tax rate increased to 115% for the fiscal year ended October 31, 2000 from 38% for the fiscal year ended October 31, 1999. The change in effective tax rate is primarily due to the non-deductible charge for IPR&D incurred during the fiscal year ended October 31, 2000.
Liquidity and Capital Resources
To date, our short-term liquidity needs have generally consisted of operating capital to finance growth in inventories, trade accounts receivable, new product development, capital expenditures and strategic investments in related businesses. We have satisfied these needs primarily through a combination of public offerings and private placements of our common stock and from cash generated by operations. We do not currently have a line of credit or similar arrangements with a bank. In December 2000, we completed a follow-on public offering of 2,695,000 shares of our common stock. The net proceeds we received from the sale were approximately $44.6 million. At October 31, 2001, we had cash and investments in marketable securities aggregating approximately $54.3 million and working capital of $55.7 million. For the year ended October 31, 2001, net cash provided by operating activities was approximately $175,000. Net cash used in investing activities totaled approximately $43.0 million during the year ended October 31, 2001, of which $42.1 million represented the investment of funds from the follow-on offering.
During the year ended October 31, 2001, we received $561,000 from the exercise of stock options. We also received $137,000 from the purchase of shares related to our employee stock purchase plan. Proceeds from the exercise of stock options, employee stock purchase plan, and their related tax benefits will vary from period to period based upon, among other factors, fluctuations in the market value of our stock relative to the exercise price of such options.
We are authorized to repurchase up to $10 million of our common stock on the open market. No such shares have been repurchased as of October 31, 2001.
The primary objectives for our investment portfolio are liquidity and safety of principal. Investments are made to achieve the highest rate of return, consistent with these two objectives. We invest excess cash in securities with varying maturities to meet projected cash needs.
We believe our current cash and marketable securities and anticipated cash flow from operations will be sufficient to support our operations and planned expansion for the foreseeable future. However, the amount of capital that we will need in the future will depend on many factors including:
•costs related to research, development, clinical trials, license fees, royalty obligations, FDA approvals and commercialization of Apomate™ and other product candidates
•market acceptance of our products
•levels of sales and marketing that will be required to launch our new products and achieve and maintain a competitive position in the marketplace
•progress in and scope of our research and development activities
•levels of inventory and accounts receivable that we maintain
•competitors' responses to our products
•level of capital expenditures
•acquisition and/or development of complementary businesses, technologies or products.
We anticipate incurring ongoing substantial expenses with respect to Apomate™ over the next two to three years for ongoing clinical trials and development costs. Milestone payments to third parties of up to $4 million are payable throughout the life of the contracts associated with our licenses of patent rights of technology related to Apomate™. Significant additional milestone payments would be payable to third parties in the event that we file for marketing approval in the European Union or Japan.
We anticipate that available cash will provide sufficient funds to cover the above costs. In addition, the costs related to Apomate™ may be reduced if we enter into any strategic partnerships related to Apomate™.
Future capital requirements will also depend on the extent to which we acquire or invest in businesses, products and technologies. If we should require additional financing due to unanticipated developments, additional financing may not be available when needed or, if available, we may not be able to obtain this financing on terms favorable to our stockholders or us. Insufficient funds may require us to delay, scale back or eliminate some or all of our research and development programs. If additional funds are raised by issuing equity securities, dilution to existing stockholders would result.
Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interest method will be prohibited. The Company has evaluated this standard and believes that adoption will not have an impact on its consolidated financial statements.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." FAS 142, which changes the accounting for goodwill and indefinite-lived intangible assets from an amortization method to an impairment-only approach, will be effective for fiscal years beginning after December 15, 2001. The Company has not determined the impact, if any, that adoption of this Standard will have on its consolidated financial statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Obligations." SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period
in which it is incurred and that the associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Statement is effective for fiscal years beginning after June 15, 2001. The Company has not determined the impact that adoption of this Standard will have on its consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets." SFAS No.144 supercedes SFAS No. 121,"Accounting for the Impairment of Long-Lived Assets to be Disposed Of", and APB Opinion No. 30, "Reporting Extraordinary, Unusual and Infrequently Occurring Events and Transactions" and amends APB No. 51, "Consolidated Financial Statements." This Statement was issued to address the accounting for a segment of a business accounted for as a discontinued operation under APB No. 30 and to establish a single accounting model based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. The Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company has not determined the impact that adoption of this Standard will have on its consolidated financial statements.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments include cash and marketable securities. At January 16, 2002, the carrying values of our financial instruments approximated their fair values based on current market prices and rates.
Our policy is not to enter into derivative financial instruments. We do not have any significant foreign currency exposure since we do not transact business in foreign currencies. Therefore, we do not have significant overall currency exposure. In addition, we do not enter into any futures or forward contracts and therefore do not have significant market risk exposure with respect to commodity prices.
Item 8.
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is presented in the consolidated financial statements listed in Item 14(a) of Part IV of this Form 10-K Annual Report and are incorporated herein by reference.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required under this Item is incorporated by reference to our definitive proxy statement pursuant to Regulation 14A to be filed with the Commission no later than 120 days after the close of our fiscal year ended October 31, 2001.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required under this Item is incorporated by reference to our definitive proxy statement pursuant to Regulation 14A to be filed with the Commission no later than 120 days after the close of our fiscal year ended October 31, 2001.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this Item is incorporated by reference to our definitive proxy statement pursuant to Regulation 14A to be filed with the Commission no later than 120 days after the close of our fiscal year ended October 31, 2001.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this Item is incorporated by reference to our definitive proxy statement pursuant to Regulation 14A to be filed with the Commission no later than 120 days after the close of our fiscal year ended October 31, 2001.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)The following documents are filed as a part of this Annual Report on Form 10-K:
(b)Reports on Form 8-K:
None.
(c)Exhibits
Exhibit No.
Description
3.1
Certificate of Incorporation of the Registrant, incorporated by reference to Exhibit 3(i) of the Registrant's Registration Statement on Form 10-SB, filed August 22, 1995.
3.2
Certificate of Amendment of the Registrant, incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-QSB for the quarterly period ended July 31, 1998.
3.3
Certificate of Domestication of the Registrant, incorporated by reference to Exhibit 3(i)(a) of the Registrant's Registration Statement on Form 10-SB, filed August 22, 1995.
3.4
Bylaws of the Registrant, incorporated by reference to Exhibit 3(ii) of the Registrant's Registration Statement on Form 10-SB, filed August 22, 1995.
10.1
Lease Agreement dated November 30, 1995 between Registrant and Abraham Stricks, incorporated by reference to Exhibit 10.2 of the Registrant's Annual Report on Form 10-KSB, filed January 29, 1998.
10.2+
North American Scientific, Inc. Amended and Restated 1996 Stock Option Plan (as amended through April 6, 2001), incorporated by reference to Exhibit 4.4 of the Registrant's Registration Statement on Form S-8 (Registration No. 333-61688), filed May 25, 2001.
10.3+
The North American Scientific, Inc. 2000 Employee Stock Purchase Plan, incorporated by reference to Exhibit 4.4 of the Registrant's Registration Statement on Form S-8 (Registration No. 333-34200), filed April 6, 2000.
10.4+
The Theseus 1998 Employee, Director and Consultant Stock Plan, incorporated by reference to Exhibit 4.4 to Form S-8 (Registration No. 333-64892), filed July 11, 2001.
10.5
Rights Agreement, incorporated by reference to Exhibit 99.1 of the Registrant's Form 8-K, filed October 16, 1998.
10.6
Restated Agreement and Plan of Merger, dated as of September 22, 2000, among the Registrant, NASI Acquisition Corp., a wholly-owned subsidiary of the Registrant, Theseus Imaging Corporation, Dr. Allan M.Green, Robert Bender, Sally Hansen and Irwin Gruverman, incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed October 19, 2000.
10.7
First Amendment to Exclusive Marketing and Distribution Agreement dated February 24, 1999, by and between Mentor Corporation and the Registrant (Confidential treatment granted for certain portions thereof), incorporated by reference to Exhibit 10.1 to Amendment No. 2 to the Registrant's Registration Statement on Form S-3, filed December 13, 2000.
10.8
License Agreement, effective as of August 7, 1998, by and between NeoRx Corporation and Theseus Imaging Corporation, a wholly-owned subsidiary of the Registrant (Confidential treatment granted for certain portions thereof).
10.9
License Agreement, effective as of April 1, 1998, by and between The Board of Trustees of Leland Stanford Junior University and Theseus Imaging Corporation, a wholly-owned subsidiary of the Registrant (Confidential treatment granted for certain portions thereof).
10.10
License Agreement, effective as of June 8, 1999, by and between The University of Washington and Theseus Imaging Corporation, a wholly-owned subsidiary of the Registrant (Confidential treatment requested).
10.11*
Underwriting Agreement, dated December 13, 2000, among the Company, L. Michael Cutrer, Alan I. Edrick, Dr. Allan M. Green, Irwin J. Gruverman, Michael C. Lee, and CIBC World Markets Corp., as representative of the several underwriters.
10.12*+
Employment Agreement, dated October 13, 2000, by and between Dr. Allan M. Green and the Company.
10.13*+
Employment Agreement, dated April 7, 1998, by and between Alan I. Edrick and the Company, as amended on September 29, 1999.
21.1*
Subsidiaries of the Registrant.
23.1*
Consent of PricewaterhouseCoopers LLP, independent accountants.
+Compensation plan or agreement
*Filed herewith
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
North American Scientific, Inc.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 33 present fairly, in all material respects, the financial position of North American Scientific, Inc. and its subsidiaries at October 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14(a)(2) on page 33 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/PricewaterhouseCoopers LLP
Orange County, California
December 7, 2001
NORTH AMERICAN SCIENTIFIC, INC.
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements.
NORTH AMERICAN SCIENTIFIC, INC.
Consolidated Statements of Income
The accompanying notes are an integral part of the consolidated financial statements.
NORTH AMERICAN SCIENTIFIC, INC.
Consolidated Statements of Changes in Stockholders' Equity
The accompanying notes are an integral part of the consolidated financial statements.
NORTH AMERICAN SCIENTIFIC, INC.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of the consolidated financial statements.
NORTH AMERICAN SCIENTIFIC, INC.
Notes to Consolidated Financial Statements
NOTE 1-ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business
North American Scientific, Inc. (the "Company"), a Delaware corporation, manufactures and markets a line of radioisotopic products for medical, scientific and industrial uses. The Company operates in a single business segment with its primary products being (i) brachytherapy seeds for the treatment of prostate cancer and (ii) radioactive reference sources used to calibrate a variety of medical and commercial equipment. The Company is also engaged in the research and development of a novel, proprietary pharmaceutical imaging agent.
Principles of Consolidation
The consolidated financial statements include the accounts of North American Scientific and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
Inventories
Inventories are valued at the lower of cost or market as determined under the first-in, first-out method. Costs include materials, labor and manufacturing overhead.
The Company's products are subject to shelf-life expiration periods, which are carefully monitored by the Company. Provision is made for inventory items which may not be sold because of expiring dates. The Company routinely reviews other inventories for evidence of impairment of value and makes provision as such impairments are identified.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, receivables, accounts payable, and accrued expenses approximate fair value because of the short maturity of those investments. The Company derives the fair value of its marketable securities based on quoted market prices.
Marketable securities
The Company invests excess cash in short-term marketable securities consisting primarily of commercial paper, corporate notes and bonds, U.S. Government securities and money market funds.
Marketable securities are classified as either held to maturity or available for sale. Held to maturity securities are stated at amortized cost, which approximates fair value. Available for sale
securities are carried at fair value, with unrealized gains and losses included in accumulated other comprehensive income in stockholders' equity. Realized gains and losses and declines in value judged to be other than temporary on available for sale securities are included in other income.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost. Maintenance and repair costs are expensed as incurred, while improvements are capitalized. Gains or losses resulting from the disposition of assets are included in income. Depreciation is computed using the straight-line method over the estimated useful lives as follows:
Furniture, fixtures and equipment
3-15 years
Leasehold improvements
Lesser of the useful life or term of lease
The Company assesses potential impairments to its long-lived assets, including goodwill, on an exception basis, when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. If the sum of the expected future undiscounted cash flows, without interest charges, is less than the carrying value of the asset, an impairment loss is recognized as the excess of the carrying value of the asset over its fair value.
Goodwill
Goodwill represents the excess of cost over the value of net assets of businesses acquired. Goodwill is amortized on a straight-line basis over a period of 10 years. As of October 31, 2001 and 2000, accumulated amortization was $399,000 and $32,000 respectively.
Research and development costs
Research and development costs are expensed as incurred.
License Agreements
License agreements are amortized on a straight-line basis over periods ranging up to twenty years. The amortization periods are based on the lives of the license agreements or the approximate remaining lives of the related patents, whichever is shorter.
Revenue Recognition
During the year ended October 31, 2001, the Company reviewed its revenue recognition policies to ensure conformity with the Securities and Exchange Commission Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements." As a result, the Company changed its revenue recognition policy effective November 1, 2000 to recognize revenue upon delivery, rather than shipment, of products. The effect of this accounting change was not material.
Stock Option Plan
The Company measures compensation expense for employees and directors for its stock option plan using the intrinsic value method and provides pro forma disclosures of net income and earnings per share as if the fair value method had been applied in measuring compensation expense. When options are issued to consultants or other third parties, expense is determined under the fair value method required by SFAS 123, "Accounting for Stock-Based Compensation."
Net Income (Loss) per Share
Basic earnings (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares outstanding for the period.
Diluted earnings (loss) per share is computed by dividing the net income (loss) by the sum of the weighted average number of common shares outstanding for the period plus the assumed exercise of all dilutive securities by applying the treasury stock method unless such assumed exercises are anti-dilutive. The following table sets forth the computation of basic and diluted earnings (loss) per share:
Stock options and warrants to purchase 616,314 and 735,546 common shares for the years ended October 31, 2001 and 2000, respectively, were not included in the computation of diluted earnings (loss) per share for those years because the Company reported a loss, and therefore, the effect of exercise would have been anti-dilutive.
In addition, stock options to purchase 349,212, 96,393, and 90,000 common shares for the years ended October 31, 2001, 2000 and 1999, respectively, were not included in the computation of diluted earnings (loss) per share because the exercise prices of the options were greater than the average market price of the common shares.
Income Taxes
The Company accounts for income taxes under the liability method. Under this method, deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the tax bases and financial reporting amounts of existing assets and liabilities. A valuation allowance is provided when it is more likely than not that all or some portion of deferred tax assets will not be realized.
Diversification of Credit Risk
The Company's financial instruments that are subject to concentrations of credit risk consist primarily of cash equivalents and accounts receivable, which are not collateralized. The Company's policy is to invest its cash with highly rated financial institutions in order to limit the amount of credit exposure. The Company's customers are considered to be financially sound corporations operating in a variety of industries.
The Company closely monitors the credit worthiness of its customers and makes provision whenever there are indications of potential credit losses.
Significant Concentrations
The Company has an exclusive agreement with a distributor for its brachytherapy products. This customer represented 79%, 81% and 77% of total revenues for the years ended October 31, 2001, 2000
and 1999, respectively. As of October 31, 2001, amounts due from this customer accounted for 64% of gross trade receivables.
The Company relies on certain companies as the sole source of various materials in its manufacturing process. Any extended interruption in the supply of these materials could result in the failure to meet customer demand.
Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interest method will be prohibited. The Company has evaluated this standard and believes that adoption will not have an impact on its consolidated financial statements.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." FAS 142, which changes the accounting for goodwill and indefinite-lived intangible assets from an amortization method to an impairment-only approach, will be effective for fiscal years beginning after December 15, 2001. The Company has not determined the impact, if any, that adoption of this Standard will have on its consolidated financial statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Obligations." SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred and that the associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Statement is effective for fiscal years beginning after June 15, 2001. The Company has not determined the impact that adoption of this Standard will have on its consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets." SFAS No.144 supercedes SFAS No. 121,"Accounting for the Impairment of Long-Lived Assets to be Disposed Of", and APB Opinion No. 30, "Reporting Extraordinary, Unusual and Infrequently Occurring Events and Transactions" and amends APB No. 51, "Consolidated Financial Statements." This Statement was issued to address the accounting for a segment of a business accounted for as a discontinued operation under APB No. 30 and to establish a single accounting model based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. The Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company has not determined the impact that adoption of this Standard will have on its consolidated financial statements.
NOTE 2-ACQUISITION OF THESEUS IMAGING CORPORATION
On October 13, 2000, the Company acquired Theseus Imaging Corporation ("Theseus"), a developer of proprietary radiopharmaceuticals to enhance the medical management of cancer, heart attack and organ transplantation. Theseus' stockholders and option holders received a total of 345,665 shares of, or options to purchase for nominal consideration, the Company's common stock in exchange for 100% of Theseus' outstanding common stock and options.
The acquisition was accounted for using the purchase method of accounting. Accordingly, the results of operations of Theseus have been included in the consolidated financial statements since the date of acquisition. The purchase price was determined as follows:
The purchase price was allocated as follows:
The above purchase price allocation reflects certain changes made in 2001 to estimated fair values used in the initial accounting for the acquisition of Theseus. The net effect of these changes resulted in approximately $251,000 of deferred tax assets being reclassified to goodwill based upon the actual tax return filed for Theseus in 2001.
In connection with the purchase transaction, the Company recorded a charge for acquired IPR&D of $11,431,000. The in-process research and development projects were valued through the use of a discounted cash flow analysis, taking into account the projected future cash flows associated with these projects once they achieve technological feasibility, their stage of completion at the acquisition date and the expected return requirements for present valuing the projected cash flow. Since there were no completed products at the date of acquisition, a comparison with historical pricing, margins and expense levels cannot be made.
The cash flow projections for revenues were based on estimates of relevant market sizes and growth factors, expected industry trends, anticipated nature and timing of new product introductions by the Company, individual product life cycles and estimated life of each product's underlying technology. Estimated cost of goods sold, royalties, general and administrative expenses, distribution costs, licensing fees and income taxes were deducted from estimated revenue projections to arrive at estimated after-tax cash flows. The cash flow projection used a risk-adjusted discount rate of 35%.
The unaudited pro forma summaries for the fiscal years ended October 31, 2000 and 1999 reflect combined results of operations of the Company and Theseus as if the acquisition had occurred on November 1, 2000 and November 1, 1999, respectively. Since prior to the current fiscal period, the fiscal year ends of the Company and Theseus differed, for pro forma purposes, the Theseus results of
operations have been adjusted to conform to North American Scientific, Inc.'s reporting periods. The following pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that would have occurred if the acquisition had been consummated as of the beginning of the periods presented, nor is it necessarily indicative of the future operating results of the Company.
The pro forma financial information is as follows (in thousands, except per share data):
(a)Includes the IPR&D charge of $11,431,000 attributable to the acquisition. Excluding this charge results in pro forma basic and diluted earnings per share of $0.25 and $0.22, respectively, for the fiscal year ended October 31, 2000 and pro forma basic and diluted earnings per share of $0.14 and $0.13, respectively, for the fiscal year ended October 31, 1999. NOTE 3-MARKETABLE SECURITIES:
Marketable securities consists of the following:
At October 31, 2001, the company recognized an unrealized gain on equity securities available for sale of $90,000. The amortized cost of all held to maturity securities approximates fair value. At October 31, 2001, investments in debt securities with scheduled maturities within one year were $30,063,000 and for one to three years were $19,603,000.
NOTE 4-INVENTORIES:
Inventories are shown net of applicable reserves and allowances:
NOTE 5-NOTES RECEIVABLE:
During fiscal 1998, the Company advanced $200,000 to a manufacturing company in exchange for a secured convertible note bearing interest at prime rate plus 2% per annum. The note, including accrued interest, was repaid in January 2001.
NOTE 6-EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
Equipment and leasehold improvements consist of the following:
NOTE 7-CONSTRUCTION IN PROGRESS:
Construction in progress included the costs related to two linear particle accelerators, which had been under development since 1998. The Company intended to use these units in the production of Palladium-103 in its brachytherapy products. Based on the uncertainty of the estimated costs to complete the units coupled with an increasingly reliable commercial supply of Palladium-103, the Company ceased the development efforts. Accordingly, the results of operations for the year ended October 31, 2001 include a charge of approximately $3.7 million to reflect the total write-off of the equipment.
NOTE 8-LICENSE AGREEMENTS:
The Company, through its Theseus subsidiary, has licensed certain technology from various commercial entities and universities. In August 1998, the Company licensed certain patent rights and technology from NeoRx Corporation. Under the terms of the license agreement, the Company agreed to pay NeoRx $3 million, $500,000 of which was paid in 1998 and $2.5 million of which was paid in August 2001. The Company has agreed to pay NeoRx certain royalties based upon the amount of licensed products sold. The Company is also obligated to make additional milestone payments upon the occurrence of certain events. The license expires upon the date of the expiration of the last patent covered in the agreement.
The Company has also acquired licenses, patents and technology from certain other entities. The related agreements include certain up-front license payments and additional milestone payments upon
designated events over the life of the agreements, as well as royalties on net sales of products covered by the agreements.
NOTE 9-STOCKHOLDERS' EQUITY:
Preferred Stock
The Company has authorized the issuance of 2,000,000 shares of preferred stock; however, no shares have been issued. The designations, rights and preferences of any preferred stock that may be issued will be established by the Board of Directors at or before the time of such issuance.
Follow-on Offering
In December 2000, the Company completed a follow-on offering of 2,320,000 shares of its common stock. The Company's underwriters also exercised their option to purchase an additional 375,000 shares to cover over-allotments. The net proceeds to the Company from the sale were approximately $44.6 million.
Stock Options
The Company's 1996 Stock Option Plan, as amended through April 6, 2001, provides for the issuance of incentive stock options to employees of the Company and non-qualified options to employees, directors and consultants of the Company with exercise prices equal to the fair market value of the Company's stock on the date of grant. Certain options are immediately exercisable while other options vest over periods ranging from two to four years. The options expire ten years from the date of grant. Certain options are subject to cancellation in the event of termination of employment.
The following table summarizes stock option activity:
There were 740,756 and 565,705 options exercisable with weighted average exercise prices of $7.95 and $6.55 at October 31, 2001, and 2000, respectively.
The following table summarizes significant option groups outstanding at October 31, 2001 and related weighted average exercise price and remaining contractual life information:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants:
Had compensation cost for the Company's option plans been determined based on the fair value at the grant dates, as prescribed by SFAS No. 123, net income (loss) and earnings (loss) per share would have been as follows:
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. The Company uses projected volatility rates, which are based upon historical volatility rates, trended into future years. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of the Company's options. The weighted average estimated fair value of stock options granted during the year ended October 31, 2001, 2000 and 1999 were $4.04, $5.87 and $3.74 per share, respectively.
Stockholders' Rights Plan
In October 1998, the Board of Directors of the Company implemented a rights agreement to protect stockholders' rights in the event of a proposed takeover of the Company. In the case of a triggering event, each right entitles the Company's stockholders to buy, for $80, $160 worth of common stock for each share of common stock held. The rights will become exercisable only if a person or group acquires, or commences a tender offer to acquire, 15% or more of the Company's common stock. The rights, which expire in October 2008, are redeemable at the Company's option for $0.001 per right. The Company also has the ability to amend the rights, subject to certain limitations.
Employee Stock Purchase Plan
In fiscal 2000, the Company adopted a non-compensatory Employee Stock Purchase Plan ("the ESPP"). Eligible employees may authorize payroll deductions of up to 15% of their salary to purchase shares of the Company's common stock at the lower of 85% of the fair market value of common stock on the first or last day of the offering period. A total of 300,000 shares of common stock are authorized for issuance. As of October 31, 2001, 11,314 common shares were purchased under the ESPP.
Common Stock Warrants
In fiscal 1998, the Company granted 96,000 warrants to a third party in connection with a private placement of the Company's common stock at an exercise price of $14.41 per share. The fair value of the warrants was recorded at the grant date as an offset to the proceeds received from the private placement. These warrants have not been exercised.
Common Stock Repurchase Program
In October 2001, the Board of Directors authorized a new stock repurchase program to acquire up to 10 million shares in the open market at any time. The number of shares of common stock actually acquired by the Company will depend on subsequent developments and corporate needs, and the repurchase of shares may be interrupted or discontinued at any time. As of October 31, 2001, no shares had been repurchased by the Company.
NOTE 10-INCOME TAXES:
The provision (benefit) for income taxes is comprised as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's net deferred tax assets are as follows:
At October 31, 2001, the Company had federal net operating loss carryforwards of $10 million beginning to expire in 2018. The use of such net operating loss carryforwards is subject to statutory limitations.
A reconciliation of tax expense computed at the U.S. federal statutory rate is as follows:
The Company's federal and state provisions do not reflect the tax savings from deductions associated with the Company's stock option plan. These savings were $587,000, $37,000, and $948,000 in fiscal 2001, 2000 and 1999, respectively, and were credited to stockholders' equity.
NOTE 11-RETIREMENT PLAN:
The Company has a 401(k) retirement plan that allows eligible employees to contribute up to 15% of their salary, subject to annual limits. Under this plan, the Company makes certain contributions based upon the compensation of eligible employees and makes additional matching contributions for those employees who elect to contribute to the plan. The Company's expense for its plan totaled $135,000, $132,000, and $87,000, for the years ended October 31, 2001, 2000, and 1999, respectively.
NOTE 12-COMMITMENTS AND CONTINGENCIES:
The Company leases office and manufacturing facilities under non-cancelable operating lease agreements. Future minimum lease payments are subject to annual adjustment for increases in the Consumer Price Index. Future minimum lease payments under all operating leases in each of the next five years from fiscal 2002 to 2006 are $386,000, $277,000, $23,000, $0 and $0, respectively. Total rent expense for the years ended October 31, 2001, 2000 and 1999 was $389,000, $302,000, and $265,000, respectively.
The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.
NOTE 13-SELECTED QUARTERLY FINANCIAL DATA:
The following table presents summarized unaudited quarterly financial data (in thousands, except per share data):
SCHEDULE II
NORTH AMERICAN SCIENTIFIC, INC.
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
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.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Signature
Title
Date
/s/ IRWIN J. GRUVERMAN Irwin J. Gruverman
Chairman of the Board of Directors
January 16, 2002
/s/ L. MICHAEL CUTRER L. Michael Cutrer
President, Chief Executive Officer and Director (Principal Executive Officer)
January 16, 2002
/s/ ALAN I. EDRICK Alan I. Edrick
Chief Financial Officer (Principal Financial and Accounting Officer)
January 16, 2002
/s/ ALLAN M. GREEN Dr. Allan M. Green
President, Theseus Imaging and Director
January 16, 2002
/s/ LARRY BERKIN Larry Berkin
Director
January 16, 2002
/s/ MITCHELL H. SARANOW Mitchell H. Saranow
Director
January 16, 2002
FORM 10-K
NORTH AMERICAN SCIENTIFIC, INC. Table of Contents Form 10-K
Risk Factors
Item 2. PROPERTIES
Item 3. LEGAL PROCEEDINGS
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Results of Operations
Liquidity and Capital Resources
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Item 11. EXECUTIVE COMPENSATION
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
NORTH AMERICAN SCIENTIFIC, INC. Consolidated Balance Sheets
NORTH AMERICAN SCIENTIFIC, INC. Consolidated Statements of Income
NORTH AMERICAN SCIENTIFIC, INC. Consolidated Statements of Changes in Stockholders' Equity
NORTH AMERICAN SCIENTIFIC, INC. Consolidated Statements of Cash Flows
NORTH AMERICAN SCIENTIFIC, INC. Notes to Consolidated Financial Statements
SCHEDULE II NORTH AMERICAN SCIENTIFIC, INC. VALUATION AND QUALIFYING ACCOUNTS (In thousands)
SIGNATURES