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Business Description OVERVIEW AeroGen specializes in the development, manufacture and commercialization of products for the controlled delivery of drugs to the lungs, which is called pulmonary drug delivery. Drugs can be delivered via a fine mist, or aerosol, to the lungs to treat breathing-related, or respiratory, conditions such as asthma, and through the lungs to the bloodstream, or systemically, to treat diseases or conditions located outside of the lungs such as diabetes. Our core technology consists of a proprietary aerosol generator. When incorporated in our nebulizer or inhaler platforms, our aerosol generator delivers drugs in an aerosol of a predetermined particle size. We believe our drug delivery platforms will allow us to develop products that deliver drugs formulated as liquids in solutions or suspensions, from single-dose, multi-dose or patient-adjustable dosage forms. Products in development provide drug delivery from our hand-held breath- activated inhalers, nebulizers for home use and nebulizers for patients on ventilators. We believe our technology has the potential to improve therapy by providing a cost-effective, convenient and patient friendly alternative to existing respiratory dosage forms, injections and other forms of drug delivery. Our strategy includes using our core aerosol generator technology to develop respiratory products for marketing by us as well as collaborating with pharmaceutical and biotechnology companies to develop products for improved respiratory therapy and delivery of drugs to the bloodstream. We also out-license our technology for uses outside the field of pulmonary drug delivery. The respiratory products currently under development for marketing by us are targeted to treat pediatric asthma, chronic obstructive pulmonary disease, cystic fibrosis and mechanically ventilated patients. These products will deliver available respiratory drugs and compounds licensed from third parties. We also are developing respiratory products in collaboration with partner companies who will market those products. For example, in March 2000, we signed an agreement with PathoGenesis to develop a small, hand-held AeroDose inhaler to deliver TOBI, an inhaled tobramycin treatment for cystic fibrosis patients. Our first product in development to deliver a drug through the lungs to the bloodstream is an AeroDose inhaler delivering insulin to treat diabetes. We completed our first clinical trial for the product, and are proceeding with additional trials. In May of this year we entered into an agreement with Becton Dickinson under which Becton Dickinson will develop and supply a patient-adjustable container for use in our AeroDose insulin product. INDUSTRY BACKGROUND PULMONARY DRUG DELIVERY Pulmonary drug delivery is widely used to treat respiratory diseases and is believed to be a viable means to deliver drugs to the bloodstream via the lungs. The drugs must be transformed into an aerosol for inhalation by the patient. This aerosol must be delivered at a low-velocity to deposit drugs in the lungs effectively. The size of the aerosol particles generally determines where the drug will be deposited in the lungs. Aerosols containing large particles, greater than three microns in diameter, typically get deposited in the upper airways of the lung, where they may be useful in treating diseases such as asthma, chronic obstructive pulmonary disease and cystic fibrosis. Aerosols containing small particles, less than three microns in diameter, are more likely to pass through the upper airways into the deep lung, where they may be absorbed into the bloodstream to treat diseases such as diabetes. THE RESPIRATORY DISEASE MARKET The worldwide prevalence of respiratory diseases was estimated by Front Line Strategic Management Consulting, Inc. to have exceeded 800 million patients in 1996. The most prevalent respiratory diseases are obstructive airways diseases such as asthma and chronic obstructive pulmonary disease. Respiratory diseases are associated with impaired quality of life, reduced life expectancy and significant treatment costs. Front Line estimated that worldwide pharmaceutical expenditures for the treatment of obstructive airways diseases was approximately $6.8 billion in 1996. According to IMS HEALTH's Market Segment Report, U.S. institutional and pharmacy expenditures for inhaled respiratory medications were over $3.0 billion in 1999. IMS HEALTH is a leading provider of healthcare statistics. Market growth in this area has resulted from increased incidence of disease, diagnosis, medication expenditures and a shift to newer, costlier therapies. We currently are focusing on treating three respiratory diseases--asthma, chronic obstructive pulmonary disease and cystic fibrosis--as well as improving treatments for patients using nebulizers and those receiving therapy via ventilators. Asthma is a chronic inflammatory disorder involving constriction of the muscles lining the bronchial airways due to external stimuli, such as exercise or allergens. The World Health Organization estimates that 100 to 150 million people worldwide suffer from asthma. According to the Centers for Disease Control and Prevention and the National Center for Environmental Health, the number of people in the United States diagnosed with asthma more than doubled from 6.7 million in 1980 to 17.3 million in 1998, and includes an estimated 4.8 million children. Chronic obstructive pulmonary disease is a general term used to characterize the presence of chronic bronchitis and emphysema. Chronic bronchitis is characterized by a persistent, productive cough caused by excessive airway mucous secretion. As the disease progresses, there is a chronic reduction in lung function, with at least partial reversibility following administration of bronchodilators. Emphysema is a chronic disease caused by irreversible destruction of elastin, a protein in the lungs critical to maintaining integrity of the alveolar walls, or air sacs. Emphysema is irreversible and treatment is oriented towards reducing irritation and making the patient more comfortable. The major cause of chronic bronchitis and emphysema is cigarette smoking, followed by environmental pollution, genetic makeup and chronic occupational exposure to high concentrations of irritating gases. Worldwide, chronic obstructive pulmonary disease is the only leading cause of death that still has a rising mortality. We estimate, based on published reports, that by 2020 chronic obstructive pulmonary disease will be fifth worldwide among the medical conditions most costly to society. The Centers for Disease Control and Prevention estimated that in 1996 there were 16 million people in the United States diagnosed with chronic obstructive pulmonary disease. Cystic fibrosis is a genetic disorder associated with dysfunction of the pancreas and liver and is one of the most common life-shortening inherited diseases in the United States. Cystic fibrosis primarily affects digestion and nutrition. Secondary effects seen in the lungs include thick mucous secretions formed and retained in the airways. Most cystic fibrosis patients experience deterioration in lung function, increased incidence of lung infection and respiratory failure over time. According to the Cystic Fibrosis Foundation, cystic fibrosis affects about 30,000 people in the United States. In the 1950s, the typical life expectancy was four years after diagnosis. Today, however, many cystic fibrosis patients live well into their 30s. Earlier diagnosis and more aggressive and effective treatment have been credited with the dramatic increase in longevity. We estimate, based on industry data, that in 1999 the U.S. institutional and pharmacy expenditures for nebulized solutions were over $500 million. Based on industry data and estimates by Frost & Sullivan, we believe that U.S. sales of nebulizer devices will exceed $280 million in 2000, with approximately 25% of the sales for home use. Ventilated patients require a breathing device because they are not able to breathe on their own. We estimate, based on data provided by a consultant, that in the United States in 1998 there were approximately 980,000 patients admitted to hospitals who required ventilation and on average each patient spent five days on a ventilator. We estimate, based on information provided by third parties, that in the United States there are approximately 90,000 ventilators installed in hospitals and approximately 8,000 ventilators purchased annually. We believe that this growth is based on the high prevalence of chronic lung diseases and an aging population. Aerosol therapy is frequently prescribed for patients receiving mechanical ventilation to deliver drugs and to humidify the air reaching the lungs. We estimate, based on third party sources, that the United States hospital and alternate care market for nebulizers and humidifiers in 2000 will exceed $300 million. THE SYSTEMIC DRUG DELIVERY MARKET The physiology of the lungs makes pulmonary delivery an attractive method of delivering drugs to the bloodstream. The absorptive surface area of the lung is as high as 70 square meters, and is only one to two cells thick. This large surface area is available for the free exchange of oxygen, carbon dioxide and other molecules between the air and the bloodstream. This permits drugs deposited in the lungs through aerosols to be transported rapidly into the bloodstream. Pulmonary drug delivery is being evaluated for non-invasive delivery of drugs to the bloodstream to treat non-respiratory diseases. There is increasing interest in pulmonary drug delivery as a result of the inability of currently available dosage forms to deliver molecules such as proteins and peptides to the bloodstream effectively. For these large molecules, oral delivery is not feasible due to rapid breakdown of the molecules following ingestion. Dosage forms such as intravenous or intramuscular injections and implants, while effective for delivering proteins, have many drawbacks, including pain, inconvenience, expense, risk of infection and poor compliance. Alternatives like transdermal and nasal dosage forms do not allow reproducible delivery of large molecules. We believe that systemic drug delivery of biotechnology products via the lungs provides significant market opportunities for us. In addition, pulmonary delivery is being evaluated to deliver drugs such as insulin, which require rapid input to the bloodstream for optimal therapy. Medical Data International reported that the U.S. market for insulin and insulin delivery systems and supplies was over $1.4 billion in 1998 and is forecasted to be over $2.0 billion in 2002. TRADITIONAL METHODS OF PULMONARY DRUG DELIVERY AND THEIR LIMITATIONS Three basic classifications of devices currently are being used for pulmonary drug delivery: metered dose inhalers, dry powder inhalers and nebulizers. These devices were developed originally for local treatment of respiratory diseases, including asthma and chronic obstructive pulmonary disease, and have inherent limitations in delivering drugs directly to the bloodstream. METERED DOSE INHALERS. Metered dose inhalers have been in existence for over 40 years and are the most widely used devices for pulmonary drug delivery. They consist of a portable canister containing the drug as a suspension or solution mixed with a volatile propellant, most often a chlorofluorocarbon. Metered dose inhalers require a patient to inhale the drug in a single breath. In order to administer the drug, the patient must activate the inhaler by pressing down on the canister while simultaneously inhaling slowly and evenly. Even with repeat training, many patients using metered dose inhalers have difficulty coordinating activation of the device with their breathing. Once the inhaler is activated, particles are released at an initial velocity of at least 30 miles per hour. Metered dose inhalers deliver only 10% to 20% of the drug to the lungs. Most of the remainder of the drug is deposited in the mouth and swallowed. To overcome these limitations, patients are sometimes prescribed holding chambers, or spacers, to use with their metered dose inhalers. These spacers increase the complexity of use and reduce the portability of metered dose inhalers. DRY POWDER INHALERS. Traditional dry powder inhalers were introduced to overcome the problems inherent with the use of metered dose inhalers. Dry powder inhalers are inhalers that deliver dry powdered aerosols without using a propellant. Dry powder inhalers are breath activated and thus eliminate the need for the press and breath coordination associated with metered dose inhalers. We believe that traditional dry powder inhalers have meaningful limitations that may prevent their broad use in pulmonary drug delivery. Dry powder inhalers usually require a single strong, deep inhalation to create the aerosol and deliver the drug. Children, the elderly and patients with breathing difficulties often cannot achieve the deep inhalation necessary to receive the required dose. In addition, these devices do not allow the patient to inhale the desired drug in multiple breaths and moisture entering into the dry powder inhaler from the environment or a patient's own breath can result in dose-to-dose variation. NEBULIZERS. Traditional nebulizers create a continuous aerosol that can be inhaled by patients through a mask or mouthpiece. Nebulizers allow patients to breathe regularly, thereby requiring less patient coordination and cooperation than metered dose inhalers and dry powder inhalers. Nebulizers typically require an external power source and therefore are bulky and generally noisy. Nebulizer treatments are time-consuming, with each treatment typically taking up to 15 minutes, and inefficient, with less than 20% of the drug reaching the lungs. The remainder of the drug either is aerosolized during the patient's exhalation and released into the surrounding air or remains in the nebulizer. Because of these limitations, nebulizers are only appropriate for relatively inexpensive, small-molecule drugs that can be formulated and stored as liquids. Aerosol delivery to mechanically ventilated patients currently uses either a metered dose inhaler or a nebulizer. Drugs are administered by opening the tubing connecting the patient to the ventilator, which may result in infection. In addition, it requires significant time and the associated expense of an attendant respiratory therapist, and is inefficient with only a very small amount of the administered drug reaching the lungs. Ventilator performance may be impaired due to the introduction of additional air into the ventilator tubing when drug is administered. This can affect adversely the ability to monitor the patient's pulmonary function. NEW METHODS OF PULMONARY DRUG DELIVERY Several companies are developing technology to improve the efficiency and accuracy of pulmonary drug delivery. Because systemic drug delivery requires the ability to create and deliver small particles to the deep lung, research has centered around developing devices capable of consistently delivering fine particle aerosols. One technique involves the processing of drugs into sophisticated dry powders. Another uses mechanical pressure to aerosolize custom formulations of existing liquid drugs. Both of these technologies will require extensive investment in new formulations, new packaging, new materials, and customized manufacturing, as well as an extensive validation effort for Good Manufacturing Practices. The dry powder technology also will face the challenge of consistently creating a cloud of uniform fine particles in varying environmental conditions that can include high humidity and electrostatic charge. OUR SOLUTION We have developed a proprietary aerosol generator to facilitate the consistent and accurate formation of an aerosol to deliver drugs to the lungs. Our core technology is being incorporated into each of our delivery platforms. We believe that our platforms overcome many of the limitations presented by traditional and new methods of pulmonary drug delivery, and may be used to treat respiratory diseases as well as to deliver drugs to the bloodstream for systemic therapy. Our AeroDose inhaler is designed to safely and effectively deliver drugs of various molecular sizes while eliminating many of the limitations associated with metered dose inhalers, dry powder inhalers and current commercial nebulizers. Our AeroNeb portable nebulizer incorporates our aerosol generator technology to provide end users with a small, portable nebulizer that quietly and efficiently administers currently approved nebulizer solutions. Our AeroNeb InLine nebulizer also incorporates our aerosol generator technology and is designed to improve the delivery of medications to patients on ventilators. We believe our products will provide the following benefits: OPTIMIZATION AND CUSTOMIZATION OF AEROSOL PARTICLE SIZE. Our aerosol generator delivers a low-velocity aerosol of precisely defined particle size. Our aerosol generator enables us to provide either an aerosol with particles averaging three to four microns in diameter for respiratory therapy, or an aerosol with particles averaging one to two microns in diameter for deposition in the deep lung for systemic drug delivery. EASE OF FORMULATION. Drugs can be stored in liquid or dry powder form and can be aerosolized in solution or suspension. Our aerosol generator uses no propellants or pressure, and generates no heat, so it is not likely to degrade drug molecules. In many cases, we can use existing drug formulations, eliminating the need to demonstrate the stability of new formulations. FLEXIBILITY OF DOSING. Our AeroDose inhaler technology can be used to administer drugs as a single dose, or as a unit dose from a multi-dose container. Under collaboration with Becton Dickinson, we are developing an AeroDose inhaler that will use a patient-adjustable container to deliver the required dose of insulin. BREATH-ACTIVATION. We have developed a breath-activation feature which triggers aerosol formation and is designed to enable patients to obtain consistent dosing over one or more breaths. This feature is designed so that drug will be aerosolized only when the patient's inhalation rate has reached a predetermined threshold, which can be adjusted for a particular target patient population. If a patient exhales or coughs, the aerosolization will stop and only resume when the patient begins inhaling again at the predetermined rate. Our electronic controls are designed to allow us to customize inhalers for both relaxed and controlled breathing, facilitating delivery of drug to the desired portion of the lung. DOSAGE GUIDANCE. We can incorporate electronic features to provide information to the patient. Lights can indicate when a dose is ready for inhalation and when the total dose has been inhaled. Additional features may include indicators of patient compliance with the prescribed regimen and lock-out features to prevent abuse or overdose. CONVENIENCE. Our products are designed to be lightweight and easy to use for patients and care-providers. AeroDose inhalers fit in the palm of the hand and can be carried in a shirt pocket or small purse. The AeroNeb nebulizer is portable, quieter and more compact than currently commercialized nebulizers. The AeroNeb InLine nebulizer is lightweight, allowing it to be placed close to the ventilated patient's windpipe, providing efficient generation of aerosol close to the lung. We believe our products will require minimal patient training, will be easy to use for the very young and the elderly and have the potential to increase compliance with prescribed treatment regimens. Our AeroDose inhaler products are expected to be more expensive than metered dose inhalers and currently available dry powder inhalers, as our products are expected to provide significant advantages over currently marketed devices. It is difficult to predict whether, and to what extent, our products will be reimbursed by insurance companies, health maintenance organizations and government healthcare providers. In addition, although we believe that physicians are likely to recommend our products to their patients, it is impossible to predict to what extent or how quickly this may occur. OUR STRATEGY Our goal is to become the leading provider of aerosol-based pulmonary drug delivery products. Key elements of our strategy include: INCORPORATING OUR CORE TECHNOLOGY INTO ADAPTABLE PULMONARY DRUG DELIVERY PLATFORMS. Our core aerosol generator technology is being incorporated into our inhaler and nebulizer platforms. DEVELOPING OUR PLATFORMS FOR MULTIPLE PRODUCT APPLICATIONS. Our platforms are being customized to develop a wide range of products, from the pocket-size AeroDose inhalers to the AeroNeb InLine nebulizers for use in intensive care units. DEVELOPING AND COMMERCIALIZING RESPIRATORY PRODUCTS OURSELVES AND WITH PARTNERS. We are developing a line of AeroDose inhaler and nebulizer products which we will market ourselves. Our initial products will deliver available respiratory drugs. We also are actively working to license proprietary drugs from third parties that will be combined with our platforms to develop respiratory products for our portfolio. We believe that the marketing of products that combine our platforms with generic and in-licensed drugs will make therapy easier and more convenient for patients, as we will be able to provide both the customized container or canister holding the drug as well as the inhaler designed to deliver it. This strategy is designed to enable us to earn revenues from both sales of our inhalers and sales of the drugs to be used with them, as well as from our nebulizers. We intend to retain U.S. marketing rights to our AeroDose inhaler products and to license marketing rights to partners outside the United States. We plan to market our nebulizer products, the AeroNeb and the AeroNeb InLine, ourselves in the United States and to commercialize these products in other countries through marketing partners or distributors. Our products developed with partner companies, such as the AeroDose TOBI product, will be marketed by the partner with whom we collaborate on the development of the product. PARTNERING WITH PHARMACEUTICAL AND BIOTECHNOLOGY COMPANIES FOR SYSTEMIC DELIVERY PRODUCTS. We are pursuing collaborative arrangements with pharmaceutical and biotechnology companies to develop products to deliver drugs systemically via the lungs. We are developing an AeroDose inhaler for an inhaled insulin product to treat diabetes. Under an agreement with Becton Dickinson, this product will incorporate Becton Dickinson's patient-adjustable container. We intend to enter into a collaboration with a marketing partner to further develop and commercialize this product. We currently anticipate commercial introduction of the product by a marketing partner no sooner than 2004. However, the timing of commercial introduction of this product will be largely within the control of the marketing partner. OUT-LICENSING OUR AEROSOL GENERATOR TECHNOLOGY FOR USE OUTSIDE OF THE FIELD OF PULMONARY DRUG DELIVERY. Our aerosol generator technology has proven to be of interest to industries focusing outside the field of pulmonary drug delivery. We have an agreement with a multinational consumer products company covering the use of our technology in the fields of air fresheners and insect repellants. Under the terms of this agreement, we are to receive royalties based on net sales of units and refill cartridges. We will continue to seek out-licensing opportunities outside the pulmonary drug delivery field where our technology can provide significant value. OUR CORE TECHNOLOGY AND PULMONARY DRUG DELIVERY PLATFORMS AEROSOL GENERATOR Our aerosol generator contains a domed, or curved, plate which contains multiple apertures, or holes, of a discrete shape and size. The aperture plate is produced through an electroforming, or plating, process using a metal alloy which is strong, corrosion resistant and durable. The plate is placed within a vibrational element and when energy is applied to this element the plate vibrates. This creates a micro-pumping action that draws solutions in contact with the concave surface of the plate through the apertures to form a fine particle aerosol. The aerosol particle size formed is proportional to the size and shape of the holes in the aperture plate. The same manufacturing process is used to produce aperture plates with holes of various sizes. We are able to optimize the flow rate and produce a low velocity aerosol by controlling the voltage and frequency applied to the vibrational element. Thus, when the aerosol generator is incorporated into a delivery platform, it is capable of producing aerosols of consistent particle size. [Picture of a cross-section of our aerosol generator, annotated with the following: --Vibrational Element --Aperture Plate] SCHEMATIC OF AEROGEN'S AEROSOL GENERATOR We have demonstrated the ability to aerosolize drugs in solutions or suspensions. We believe that our core technology will be applicable to aerosolization of both small- and large-molecule drugs being developed by the biotechnology industry. Results to date indicate that the aerosol generator does not affect the stability of proteins and peptides. AERODOSE INHALERS Each inhaler consists of our proprietary aerosol generator, electronic circuitry, batteries, an inhalation sensor and a drug container. These components are incorporated into a small, compact inhaler that is easy to use and can be carried in a shirt pocket or small purse. We are incorporating several dosing options into our AeroDose inhalers. We believe that this versatility enables us to explore multiple applications of our platforms to deliver a variety of drugs. Our proprietary valves permit accurate dosing in the range of 15 to 3,000 microliters. We believe that this wide dosing range will allow us to deliver the required dose of most drugs of interest for pulmonary delivery, from small quantities of expensive, potent drugs to large quantities of less potent drugs that are sometimes needed for effective therapy. Currently, we are developing four distinct dosing options for our inhalers: SINGLE-DOSE CANISTER. The single-dose canister can contain dosing volumes from 100 to 3,000 microliters. When the patient places the canister in the inhaler, a proprietary adapter punctures the canister and initiates the release of drug to the aerosol generator. Drug flow is automatically coordinated with a patient's breathing until all of the prescribed dose is inhaled. We use standard nebulizer packaging for the single-dose canister. For drugs such as TOBI, which are already packaged using standard packaging technology, we are able to use currently available high capacity manufacturing systems to produce the single-dose canister without having to design and manufacture new drug packaging materials. MULTI-DOSE CANISTER. Our multi-dose canister is designed to deliver multiple small doses of drugs. Our metering valve is designed to maintain sterility over multiple activations of the canister. The valve is designed to provide accurate dispensing of small volumes of solutions as well as the homogeneous suspensions required for the delivery of certain respiratory steroids. The disposable canister holds up to 6,000 microliters of solution and reproducibly dispenses a fixed dose which can be set between 15 and 150 microliters. When activated by the patient, the valve dispenses a precise unit dose of drug-containing solution to the aerosol generator. Each fixed dose remains on the aperture plate until the patient activates the aerosol generator by inhaling at a predetermined rate. DUAL CHAMBER CANISTER. The dual chamber canister is intended to accommodate drugs that are not stable in solution during storage. While most injected drugs exist in liquid formulations, some proteins may require storage as a dry powder to extend shelf life or minimize the need for refrigeration. In a dual chamber canister, drug is stored as a powder in one chamber and a solvent is stored in the second chamber. The patient depresses the barrel to mix the solvent with the drug powder, thereby creating a solution. The dual chamber canister can then function with the ease of our standard single-dose canister or multi-dose canister. PATIENT-ADJUSTABLE CONTAINER. In our collaboration, Becton Dickinson is developing a patient-adjustable container to enable variable dosing of insulin by means of our AeroDose inhaler. This container is designed to allow patients to adjust their insulin dose before each meal based on their anticipated caloric intake. We are incorporating electronic controls into our inhalers to provide flexibility, control and reproducibility of drug delivery that is consistent across our inhalers. A patient can receive a visual signal that a dose of drug has been dispensed to the aperture plate and is ready for inhalation. Once the patient's inhalation rate exceeds a predetermined rate, the aerosol generator is activated and the drug is aerosolized and inhaled. The patient's inhalation rate can be monitored throughout the inhalation cycle, allowing drug aerosolization to occur only while the patient's inhalation rate is above a minimum flow rate for optimal deposition of drug in the lung. A patient can also stop inhalation mid-dose and take multiple breaths to inhale a single dose. Our electronic controls can inform a patient when the complete dose has been aerosolized. Additional electronic features to customize an inhaler for a specific drug application or dosing regimen can include a dose counter, lock-out features and patient identification to prevent misuse. We expect that our inhalers will be purchased by patients for use over a period of six months to a number of years, with periodic replacements of the aerosol generator. Drug canisters or containers designed to fit into our inhalers may contain a daily or weekly supply of drug and will be replaced by the patient when the supply in the canister or container is exhausted. We are designing our inhaler products to be used with a customized container or canister intended to fit only with our inhalers. AERONEB PORTABLE NEBULIZER Our first commercial product, the AeroNeb portable nebulizer, offers many improved features compared to standard nebulizers used by patients and care providers in the home setting. This portable nebulizer weighs less than 12 ounces and can operate on four standard "AA" batteries, a car cigarette lighter or alternating current. The AeroNeb nebulizer operates silently, in any position and with less wasted medication and faster medication delivery rates than standard compressor nebulizers. It incorporates a liquid feed design and generates negligible heat, minimizing drug degradation. The AeroNeb nebulizer was designed and approved for use with commercially available nebulizer solutions of respiratory drugs and is expected to be introduced into the U.S. market in the first half of 2001. AERONEB INLINE NEBULIZER We are developing an application of our aerosol generator technology to deliver drugs to patients during mechanical ventilation. The AeroNeb InLine nebulizer is small and lightweight allowing it to be positioned close to the patient's windpipe, thereby optimizing drug delivery and humidification of the inhaled air. The AeroNeb InLine nebulizer is designed to allow the addition of medication to a nebulizer cup without opening the ventilator tubing, thereby potentially reducing a major source of infections. The drug is aerosolized without the use of a compressor and avoids the introduction of additional air into the ventilator tubing when the drug is administered. The AeroNeb InLine nebulizer can be designed to synchronize with the patient's breathing cycle, thereby optimizing drug delivery. PRODUCTS We intend to incorporate our versatile and flexible core aerosol generator technology into a portfolio of products, some developed for commercialization by us and some developed with partners for marketing by them. We also intend to out-license our technology for applications outside of the field of pulmonary drug delivery. OUR PRODUCTS FOR RESPIRATORY DISEASES We intend to create and market a respiratory disease product portfolio consisting of our nebulizers and our AeroDose inhalers combined with available drugs. We have developed an improved, portable and lightweight quiet nebulizer which we will introduce into the U.S. market in the first half of 2001. We are also developing nebulizers customized for delivery of drugs to patients on mechanical ventilators. We are developing our AeroDose inhalers for delivery of drugs which are currently administered by nebulizers to the lungs of the young and the elderly. Our initial target diseases are pediatric asthma, chronic obstructive pulmonary disease and cystic fibrosis. The types of drugs currently used to treat these diseases include bronchodilators (including beta agonists and anticholinergics), anti-inflammatories (including steroids) and mucolytics. Bronchodilators relieve the airway spasms associated with wheezing, anti-inflammatories reduce airway inflammation and mucolytics cause thinning of the mucous in the lungs. PEDIATRIC ASTHMA. We estimate, based on U.S. National Health Interview Survey data reported from 1980 through 1994, that the U.S. population of asthma patients under age six will be approximately three million by 2001. Two commonly prescribed classes of drugs for treatment are beta agonists and steroids. We estimate based on available data that for pediatric asthma patients under age six, approximately 45% of albuterol prescriptions specify the use of a nebulizer. CHRONIC OBSTRUCTIVE PULMONARY DISEASE. The Centers for Disease Control and Prevention estimated that in 1996 there were 16 million people in the United States diagnosed with chronic obstructive pulmonary disease. Two commonly prescribed drugs to treat chronic obstructive pulmonary disease are beta agonists and anticholinergics. We estimate based on available data that approximately 55% of the prescriptions for these drugs specify the use of a nebulizer. CYSTIC FIBROSIS. According to the Cystic Fibrosis Foundation, cystic fibrosis affects approximately 30,000 patients in the United States. Cystic fibrosis patients spend up to a total of three and one-half hours per day taking inhaled medications, oral medications, enzymes, vitamins and receiving chest physiotherapy. We estimate based on available data that approximately 40% of the albuterol prescriptions for the treatment of cystic fibrosis specify the use of a nebulizer. OUR RESPIRATORY PRODUCTS IN DEVELOPMENT AEROGEN'S PRODUCTS FOR RESPIRATORY THERAPY PRODUCT DOSING OPTION INTENDED MARKET DEVELOPMENT STAGE AeroDose (albuterol) Single- and Pediatric asthma, Preclinical multi-dose canister chronic obstructive development pulmonary disease and cystic fibrosis AeroDose Single- and Pediatric asthma, Preclinical (ipratropium) multi-dose canister chronic obstructive development pulmonary disease and cystic fibrosis AeroDose (budesonide) Single- and Pediatric asthma, Feasibility multi-dose canister chronic obstructive pulmonary disease and cystic fibrosis AeroDose (anti- To be determined Pediatric asthma, Feasibility inflammatory) chronic obstructive pulmonary disease and cystic fibrosis AeroNeb portable Continuous All patients using 510(k) cleared; U.S. nebulizer nebulizers launch targeted first half of 2001 AeroNeb InLine Continuous All patients on 510(k) filing nebulizer mechanical targeted first half ventilation of 2001 Feasibility is the first stage of development of one of our AeroDose products. In the feasibility stage, we determine the solubility of the drug, the type of solution we would likely need in order to use the drug in our inhaler, our ability to aerosolize the drug and the likely stability of the drug when used in our inhaler. In this stage we conduct laboratory studies primarily focused on the drug itself. During the preclinical development stage we focus on the customization of the AeroDose inhaler for use with a particular drug. We work on the appropriate container to hold the drug in the inhaler, the method of delivery of the drug to be aerosolized, the type of breath activation mechanism that is likely to be needed and the configuration of the aperture plate for the product. Preclinical development is conducted primarily in the laboratory and is targeted to developing and building the AeroDose inhaler that will be used in the clinical studies of the particular product in development. After feasibility testing and preclinical development, the AeroDose products listed in the table above will be tested in human subjects. Some of our products, such as the AeroNeb portable nebulizer and the AeroNeb Inline nebulizer, do not require human clinical trials before they can be cleared for marketing. For these products we file a 510(k) application which is reviewed and cleared by the FDA without human clinical studies. The AeroNeb portable nebulizer has been cleared by the FDA, and no further regulatory approvals are required before it can be marketed in the United States. We plan to file a 510(k) application for the AeroNeb Inline nebulizer in the first half of 2001. AERODOSE INHALER. We believe that our AeroDose inhaler is particularly suited to address the most common complaints of physicians and their patients who require aerosolized medication. Our inhaler is designed to combine the convenience and portability of a metered dose inhaler with the ease of administration of a nebulizer, while minimizing drug waste and ensuring reproducible dosing. In a six person imaging study, we compared lung deposition of drug following delivery of the same dose of albuterol from a metered dose inhaler and an AeroDose inhaler. The AeroDose inhaler deposited, on average, 70% of the emitted dose in the lungs, compared to the metered dose inhaler, which deposited, on average, 18%. Based on these findings, we estimate that our AeroDose inhalers have the potential to reduce the typical prescribed dose of drug for a nebulizer or metered dose inhaler by more than half, while still delivering the same therapeutic dose to a patient's lungs. Our AeroDose inhalers are designed to be cost competitive inhalers that span the needs of the youngest and oldest patients in our target markets. We believe our AeroDose inhalers also will address the coordination problems experienced by other patients using metered dose inhalers. Even with repeat training, many of patients using metered dose inhalers have difficulty coordinating the activation of the device to release a high velocity stream of medication with the quick breath intake necessary to capture the high velocity stream in the lungs. Because our AeroDose inhalers will be breath-activated and only deliver a low velocity aerosol when the intake of breath attains a certain threshold, they are expected to avoid these problems. The initial version of our breath-activation mechanism is incorporated into the AeroDose inhalers we are using for clinical studies. We are developing an improved version of the breath-activation mechanism for use in commercial AeroDose inhalers. The initial drugs targeted for development include albuterol, ipratropium and budesonide. Our activities will be focused on U.S. regulatory approval and market introduction. The rights to our products outside the United States will be licensed to partners who will undertake the studies and other activities necessary to obtain regulatory approvals. We also plan to explore the potential for commercializing appropriate drug combinations once individual formulations have been developed including: - AERODOSE (ALBUTEROL). Albuterol solution for inhalation is approved for use by the Food and Drug Administration and is marketed by several different manufacturers. We estimate based on available data that in the United States, nebulized albuterol sales in 1999 were approximately $189 million, while metered dose inhaler albuterol sales were approximately $811 million. We expect that our supplier will purchase albuterol in bulk, formulate it and package it into single-dose and multi-dose canisters. We have completed the feasibility stage of our AeroDose albuterol product and have initiated preclinical development activities. Once the preclinical activities are completed, we intend to file an Investigational New Drug Application with the FDA to allow us to clinically test the product in humans. Human clinical trials must then be completed before a New Drug Application can be filed with the FDA. - AERODOSE (IPRATROPIUM). Ipratropium solution for inhalation is approved for use by the Food and Drug Administration and is marketed by several different manufacturers. We estimate, based on available data, that in the United States nebulized ipratropium sales in 1999 were approximately $165 million, while metered dose inhaler ipratropium sales were over $450 million (including sales in combination with albuterol). We expect that our supplier will purchase ipratropium in bulk, formulate it and package it into single-dose and multi-dose canisters. We have completed the feasibility testing of our AeroDose ipratroprium product and have initiated preclinical development activities. This product is expected to follow substantially the same regulatory pathway as the AeroDose albuterol product. - AERODOSE (BUDESONIDE). We believe, based on current delivery limitations, that there is an unmet need for a budesonide dosage form suitable for use by pediatric asthma and chronic obstructive pulmonary disease patients. Current treatment options for our target patient populations are limited to oral delivery, injections and use of a metered dose inhaler or dry powder inhaler. We have completed feasibility testing of a suspension of budesonide. We expect that our supplier will purchase budesonide in bulk, formulate it and package it into single-dose and multi-dose canisters. We believe that because budesonide is a steroid, it will likely require more clinical trials prior to regulatory approval than products using drug solutions of albuterol or ipratropium. We have completed most of the feasibility testing required for the AeroDose budesonide product. - AERODOSE (ANTI-INFLAMMATORY). We are conducting feasibility studies with a proprietary approved anti-inflammatory drug currently available only in an oral dosage form. If our studies are successful, we intend to pursue licensing of the compound. We anticipate that the compound will require more preclinical studies prior to initiating clinical trials because inhalation is a novel method of delivery for such compound. The regulatory path is therefore likely to be more comprehensive and take longer than for drugs already approved for use in a nebulizer. AERONEB PORTABLE NEBULIZER. Our quiet and portable AeroNeb nebulizer, which uses a mouthpiece like other nebulizers, will be our first commercial product. It has been designed and approved for use with commercially available nebulizer solutions. The product will provide us with commercial experience in the respiratory disease market and our initial target clinical disease area for AeroDose inhalers. We plan to introduce the AeroNeb portable nebulizer in the U.S. market in the first half of 2001. The AeroNeb nebulizer may also be used by partners and potential partners in Phase I clinical studies to evaluate the potential use of our AeroDose inhalers for delivery of their drugs under appropriate feasibility or development agreements. AERONEB INLINE NEBULIZER. The AeroNeb InLine nebulizer incorporates our proprietary aerosol generator. We believe that the AeroNeb InLine nebulizer has the potential to provide drug delivery and humidification to hospitalized patients on ventilators. We have developed a means of integrating the electronic circuits of the ventilator with our nebulizer. We are in discussions with a ventilator company to make the AeroNeb InLine nebulizer an integral part of its line of ventilator products. We expect that our first AeroNeb InLine nebulizer will be sold as a stand-alone product that can be attached to any ventilator. We plan to make a 510(k) submission to the Food and Drug Administration for this version of the AeroNeb InLine nebulizer in the first half of 2001. We intend to market the product ourselves in the United States and through distributors elsewhere. OTHER PRODUCTS FOR RESPIRATORY THERAPY OTHER PRODUCTS FOR RESPIRATORY THERAPY COMPANY PRODUCT DOSING OPTION INTENDED MARKET DEVELOPMENT STAGE PathoGenesis AeroDose TOBI Single-dose Respiratory infection Phase I (tobramycin) canister Biotechnology Company AeroNeb nebulizer Continuous Respiratory Phase I (undisclosed) Biotechnology Company AeroDose Single-dose Respiratory Preclinical (undisclosed) canister development Pharmaceutical Company Undisclosed To be Respiratory Feasibility products determined "Phase I" means testing the product in a small number of patients or normal volunteers, primarily for safety, at one or more dosage strengths. "Preclinical development" means customizing the AeroDose inhaler for a particular application. "Feasibility" means formulation studies to ascertain compatibility of compounds of interest with our aerosol generator. AERODOSE TOBI (TOBRAMYCIN). We are collaborating with PathoGenesis to develop a customized version of the AeroDose inhaler to deliver TOBI, an anti-infective drug used to treat cystic fibrosis. TOBI was approved in late 1997 as a nebulized solution for use by cystic fibrosis patients with PSEUDOMONAS AERUGINOSA lung infections. According to a program sponsored by MCP Hahnemann University School of Medicine, more than 60% of cystic fibrosis patients are chronically infected with PSEUDOMONAS AERUGINOSA by age 17. TOBI has been designated an orphan drug by the Food and Drug Administration which provides seven years of marketing exclusivity in the United States for PathoGenesis. PathoGenesis' sales of TOBI were approximately $39.6 million for the first six months of 2000. Market studies completed by PathoGenesis have shown that the total time required for treatments of the cystic fibrosis patient can have an impact on the patient's compliance with the recommended TOBI treatment regimen and on the physician's assessment of a patient's likelihood of compliance. TOBI currently is given via nebulizer twice a day during alternate months, with each administration taking approximately 15 to 20 minutes per session. PathoGenesis and we believe that due to the efficiencies of the AeroDose inhaler, the administration time per dose of TOBI can potentially be shortened to five to ten minutes or less. In addition, the breath activation feature of the AeroDose inhaler will allow for more efficient drug delivery and less drug waste. By making these improvements, we believe that we can broaden the market acceptance of TOBI by delivering an effective dose more quickly through our hand-held, portable AeroDose inhaler. In March 2000, we entered into a development and supply agreement with PathoGenesis to develop and commercialize the custom AeroDose inhaler and PathoGenesis' formulation of TOBI. PathoGenesis is responsible for the development and manufacture of the portion of the final product that contains the drug. We are responsible for developing and manufacturing the custom AeroDose inhaler. PathoGenesis will conduct the clinical testing needed for regulatory approval of the final product. In July 2000, PathoGenesis announced that it had begun Phase I testing of the AeroDose TOBI product. Under the agreement, PathoGenesis received exclusive worldwide commercialization rights for the AeroDose inhaler when it is sold for use with TOBI. We also granted PathoGenesis exclusive worldwide commercialization rights to the AeroDose inhaler for the delivery of all other aminoglycoside drugs, which are a small subset of antibiotics, provided that we and PathoGenesis agree upon the terms of development of other drug products and the royalties and other payments to be made to AeroGen resulting from the sale of these products. We receive reimbursement of our costs to develop the AeroDose TOBI product. We also will receive reimbursement for our manufacturing costs and a small profit for each inhaler we provide to PathoGenesis, as well as royalties on product sales. Upon entering into this agreement, PathoGenesis made a $2.5 million equity investment in our Series E convertible preferred stock. Unless terminated earlier by either party, the agreement will continue on a country-by-country basis until the last patent covering the product expires, or on January 20, 2015, whichever is later. In September 2000, PathoGenesis was acquired by Chiron Corporation, a leading biopharmaceutical company. Chiron has not informed us of its intentions concerning the agreement, and the development program is continuing. Chiron has the right to terminate the agreement at any time without penalty. OTHER RESPIRATORY PRODUCTS UNDER DEVELOPMENT WITH PARTNERS. We intend to collaborate with pharmaceutical and biotechnology companies to develop novel pulmonary drug delivery products for respiratory therapy. Such collaborations typically take one of two approaches: either a company contacts us with a proprietary drug to be delivered to the lungs, or we proactively identify product opportunities and approach potential partners after obtaining preclinical data, if possible. The flexibility of our technology to facilitate improved respiratory therapy has attracted potential development partners. We currently are working with three companies exploring respiratory therapies, of which one biotechnology product is in Phase I trials, one biotechnology product is in preclinical development and various products with one pharmaceutical company are currently undergoing feasibility studies. We currently are conducting feasibility activities with potential partners with both small and large molecules for respiratory therapy. Feasibility studies can be paid for by the other company or by us, and can include IN VITRO (laboratory) testing and drug deposition studies. These studies may be followed by some early clinical trials. Generally, the agreements and the activities can be cancelled at any time by the other company. In the drug delivery area, it is common for pharmaceutical and biotechnology companies to conduct feasibility studies with multiple partners. Once feasibility of a particular drug has been established, the pharmaceutical and biotechnology companies typically fund additional development work and may make an equity investment. Following collaborative development of a product, the partner will commercialize the product and pay us a royalty on sales. We currently intend to manufacture AeroDose inhalers and supply them to our partners at our cost plus a small profit. PRODUCTS FOR SYSTEMIC THERAPY In addition to our respiratory therapy activities, our strategy includes collaborating with pharmaceutical and biotechnology companies to develop novel pulmonary drug delivery products for systemic therapy. We will pursue these opportunities in the same manner as our partnered respiratory products; either the potential partners will come to us, or we will propose products to them after obtaining preclinical data, if possible. AERODOSE (INSULIN). We are developing a special AeroDose inhaler for delivery of insulin to diabetic patients which will incorporate a patient-adjustable container being developed by Becton Dickinson. The American Diabetes Association estimates that there are 500,000 to one million Type I (insulin dependent) diabetic patients in the United States who require multiple injections of insulin per day. We estimate, based on industry sources, that only 20% of Type II (non-insulin dependent) patients are currently injecting themselves with insulin. Type II patients frequently fail to modify their lifestyle and are reluctant to use injection-based therapy, even though injected insulin can substantially limit complications of diabetes. We believe that once a non-invasive form of insulin is approved, a significant portion of Type II patients may begin treatment. Medical Data International reported that the U.S. market for insulin and insulin delivery systems and supplies was over $1.4 billion in 1998 and is forecasted to be over $2.0 billion in 2002. Our AeroDose insulin product is designed to be the first patient-adjustable inhaler allowing a patient to precisely adjust their insulin dose based on anticipated caloric intake. After extensive focus group testing with patients and physicians, we believe that the AeroDose insulin inhaler will be an attractive method for delivering inhaled insulin due to its small size and ease of use. We have completed a Phase I clinical study using a prototype patient-operated AeroDose inhaler with insulin in the United Kingdom in twelve normal volunteers. The study compared insulin inhalation to subcutaneous injection, focusing on both the absorption of insulin into the bloodstream and its glucose-lowering effects. Subjects used separate AeroDose inhalers, which were configured for slow, deep inhalations and production of a small-particle aerosol appropriate for systemic drug delivery. Results indicated that the absorption and glucose-lowering effects of inhaled insulin, relative to injected insulin, were consistent with the published literature indicating that typically 8% to 15% of inhaled drug reaches the systemic circulation. There were no reported respiratory complaints and no measurable differences in lung function after inhalation versus injection. We recently began an additional Phase I clinical trial in Europe, where we are studying optimal aerosolization parameters. Phase II trials are planned for the first half of 2001. These studies, in the United States and Europe, are designed to provide additional evidence of AeroDose inhaler performance and inter- and intra-subject variability in circulating levels of insulin following inhalation. In May of this year, we entered into an agreement with Becton Dickinson under which Becton Dickinson will develop and supply a patient-adjustable container for use in our AeroDose insulin inhaler. Under the agreement, we will develop the customized AeroDose inhaler at our own cost and Becton Dickinson will develop the container at its own cost. We will have the marketing rights to the product and Becton Dickinson will receive royalties on product sales and a portion of any payments we receive from any future marketing partner. Becton Dickinson will supply the container, without drug. Upon entering into the agreement, Becton Dickinson made a $2.5 million equity investment in our Series E convertible preferred stock. We plan to partner our AeroDose insulin product for further development, clinical testing and commercialization. OTHER PHARMACEUTICAL AND BIOTECHNOLOGY COLLABORATIONS FOR SYSTEMIC THERAPIES. In addition to insulin, we are continuing to evaluate the market opportunities for other drugs that we believe can be delivered to the bloodstream using our AeroDose inhaler. We intend to collaborate with pharmaceutical and biotechnology companies for development, clinical testing and commercialization of these AeroDose products. TECHNOLOGY OUT-LICENSING Our aerosol generator technology has proven to be of value to industries focusing outside the field of pulmonary drug delivery. In October 1999, we entered into an exclusive license agreement with a consumer company permitting them to use our aerosol generator in the fields of air fresheners and insect repellants worldwide. We expect the initial product will first be introduced in Europe in 2002. Under the license agreement, we will receive royalties based on net sales of units and refills, and the license gives us access to any improvements in our technology made by the consumer company during conduct of their development and manufacturing activities. We have the right to terminate the agreement with respect to either the air freshener products or insect repellant products if such products are not introduced within specific time limits. We will continue to explore out-licensing opportunities for our technologies outside the field of pulmonary drug delivery. MANUFACTURING We plan to manufacture our aerosol generators and outsource the manufacture of the other components used in our products. We manufacture the aperture plates and assemble our aerosol generators at our facility in Sunnyvale, California. We design the remaining components of our products, such as molded parts and electronic circuitry, and outsource the manufacture of these parts to qualified vendors. The manufacture of containers and sterile drug filling will be outsourced, minimizing the need for capital investment in specialized drug filling facilities that require Good Manufacturing Practices approval. We currently are planning to have our AeroNeb nebulizer and our AeroNeb InLine nebulizer manufactured for us by a qualified vendor in the European Union, incorporating aerosol generators that we will supply. We plan to assemble our AeroDose inhalers in our California facilities. SALES AND MARKETING We are evaluating options for the sales and marketing of our respiratory products. We anticipate developing a U.S. sales force, through outsourced or internal efforts or both, to support our respiratory products. Our strategy includes maintaining the marketing rights for these products in the United States and commercializing the products in other countries through marketing partners or distributors. Using a targeted sales strategy, we plan to market the AeroNeb portable nebulizer in the United States to certain home medical equipment dealers, retail pharmacies, physicians and patients. We are considering medical device distribution companies or respiratory equipment companies as our partners to commercialize the AeroNeb and AeroNeb InLine nebulizers. We currently expect that the products we develop in collaboration with partner companies will be commercialized by our partners.