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A sip of success

At a Glen Burnie 7-Eleven, Michael Kropkowski pulled the Diet Pepsi lever of the store's Slurpee-maker and watched as the cola-colored, icy slush climbed the sides of his tall, clear cup and filled the dome-shaped lid. A long straw topped off his creation.

It might not be a cure for cancer, but it represented a sweet moment for a small Beltsville biotechnology firm that has spent years developing Tagatose, the low-calorie sugar substitute it contains. After years of struggles, Spherix Inc. is getting its first big shot at market acceptance.

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Since mid-August, 7-Eleven stores nationwide have been offering Diet Pepsi Slurpees that use Tagatose, the first time Spherix's sugar substitute has been on the market in a widely sold consumer product.

"This could be a really big deal for us," said Gilbert V. Levin, Spherix founder and chairman. "If this really takes off, we'll be thrilled."

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Tagatose, a naturally occurring version of fructose, resembles and tastes a lot like cane sugar, but has less than 40 percent of the calories. A so-called "bulk" sweetener, it's measured the same as regular sugar, a quality most sugar substitutes do not have. That makes Tagatose a candidate for use in baked goods.

"It's not stem-cell research," said Kropkowski, a local field service representative for 7-Eleven. "But it was innovation and biotechnology that enabled us to offer a product like this."

Spherix's debut on the American market could be well-timed: An epidemic of obesity and adult-onset diabetes - a disease linked to obesity - has triggered an onslaught of warnings that Americans are gorging themselves to death. On candy alone, Americans spend more than $84 billion a year.

The market for sugar-replacement sweeteners is worth $1 billion to $2 billion, according to industry trade groups. But the potential could be $25 billion to $30 billion, some estimate.

The momentum is there. While the market for cane sugar was essentially flat in 2002, overall sales of such artificial sweetener mainstays as Equal, Splenda and Sweet 'n Low rose 12.7 percent, according to sales and marketing research firm Information Resources Inc.

Dallas-based 7-Eleven Inc. reported an almost immediate jump in Slurpee sales after the diet version was introduced in August.

There has been other interest in Tagatose, too: Kellogg Co. has been issued a patent allowing the use of Tagatose in breakfast cereal (Kellogg would not discuss any plans for a Tagatose-sweetened product).

And there's more good news: In November, Spherix settled a long-running legal dispute with its licensing partner. The settlement, coupled with the Slurpee deal, has brightened both the short- and long-term outlook of a company that's bled red in recent years, said Lincoln A. Werden, a senior investment analyst at H.G. Wellington & Co. Inc., a New York brokerage firm.

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"All of this is very constructive," said Werden, who expects the big reduction in legal costs to push Spherix, which lost $1.3 million in the first three quarters of last year, to a first-quarter profit this year.

Spherix's stock gained more than 30 percent, rising as high as $9.30, in the days after the announcement of the Diet Pepsi Slurpee in August, but has since retreated. It closed yesterday at $6.71, up 30 cents on the Nasdaq.

The company said it won't know how much it will earn in royalties from Tagatose sales until the end of the month.

The Slurpee is one of 7-Eleven's mainstay products. The chain has sold more than 6 billion since the frozen treat was introduced in 1965 under the name Icee. (It was rechristened Slurpee two years later.)

But over the years, 7-Eleven, which had merchandise sales of $7.3 billion in 2002, realized that some longtime customers were abandoning Slurpees in favor of low-calorie diet drinks.

Customers had been asking for a diet Slurpee, said Pinto Soin, the franchisee of the Glen Burnie 7-Eleven and three other locations. "People [would] specifically come in asking us to develop a diet, sugar-free Slurpee," he said.

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The convenience store chain offered Coca-Cola Co. and PepsiCo Inc. a challenge: The first to market with a proven diet Slurpee would get its business. Pepsi responded with a version that used Tagatose in combination with other artificial sweeteners the company would not identify. It got the nod.

"Pepsi was able to present a good-tasting product with zero calories and zero sugar," said Margaret Chabris, a spokeswoman for 7-Eleven.

The early returns were excellent, both 7-Eleven and Pepsi said. In the three weeks after the Diet Pepsi's unveiling, Slurpee category sales surged about 18 percent, said John Ryckevic, manager of that product for 7-Eleven. "We definitely think it had a positive impact on the category," Ryckevic said.

7-Eleven, which typically doesn't break out sales for specific products, declined to provide more recent figures.

For Levin, who founded Spherix in 1967, the diet Slurpee represented a long-delayed success. A scientist with a Hopkins doctorate in environmental engineering, Levin had dreamed of getting a sugar substitute to market for decades. His first product, Lev-O-Cal, with an estimated price tag of $3,000 a pound, wasn't commercially viable. Tagatose, by contrast, sells for about $2 a pound, according to Levin, who expects the price to fall as production escalates.

The company has survived years of losses by relying on other parts of its business, especially its InfoSpherix Division, which runs reservation centers whose clients include state governments and the U.S. National Park Service.

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Getting Tagatose to market wasn't easy, either. The substance was patented in 1988, but it wasn't until 1996 that the company signed a licensing deal with a company that could make and market the sugar replacement: Denmark's MD Foods AMBA (now Arla Foods AMBA, after a merger in 2000).

In late 2001, when the Food and Drug Administration approved Tagatose for use in foods and beverages in the United States, the domestic market for Spherix's sweet-tooth satisfier finally opened. But the licensing agreement didn't generate the expected sales, prompting Spherix to initiate an arbitration case against Arla in May 2002.

The companies reached a settlement Nov. 13 that extended commission payments from Arla to Spherix. Arla has the exclusive rights to manufacture Tagatose and to market it for food uses, including the diet Slurpee. Spherix, on the other hand, has exclusive rights for nonfood uses such as toothpaste or mouthwash, marketing the same sugar substitute under the brand name "Naturlose."

The turmoil has taken its toll within the company as well. In early March, Spherix President and Chief Operating Officer David Affeldt - the heir apparent to Levin, who was still CEO at the time - resigned without explanation. In late August, the company handed the reins to Thomas W. Gantt, a longtime board member. Levin, 79, retained his chairman's title and assumed the role of executive officer for science.

Gantt said his goal is to boost sales in existing businesses while adding revenue from Tagatose and Naturlose. He played a key role in the settlement talks with Arla, and has embarked upon plans to build an internal sales force.

"We really want to turn this into a profitable company," Gantt said.


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