UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003
Commission file number: 0-27406
CONNETICS CORPORATION
| Delaware | 94-3173928 | |
| (State or other jurisdiction of | (IRS Employer | |
| incorporation or organization) | Identification Number) |
3290 West Bayshore Road
Palo Alto, California 94303
(Address of principal executive offices)
Registrant’s telephone number, including area code: (650) 843-2800
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
As of May 9, 2003, 31,511,948 shares of the Registrant’s common stock were outstanding, at $0.001 par value.
| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | ||||||||
| SIGNATURE | ||||||||
| INDEX TO EXHIBITS | ||||||||
| EXHIBIT 10.1 | ||||||||
| EXHIBIT 31.1 | ||||||||
| EXHIBIT 31.2 | ||||||||
| EXHIBIT 32.1 | ||||||||
| EXHIBIT 32.2 | ||||||||
We are filing this Amendment No. 1 (“Amendment No. 1”) to our quarterly report on Form 10-Q for the quarter ended March 31, 2003, as filed with the Securities and Exchange Commission on May 14, 2003 (the “Original Form 10-Q”), to reflect certain revisions in Item 2 of Part I and to re-file Exhibit 10.1. This Amendment No. 1 speaks as of the date of the Original Form 10-Q, except for the certifications, which speak as of their respective dates and the filing date of this Amendment No. 1. This Amendment No. 1 does not reflect events occurring after the filing of the Original Form 10-Q, nor does it modify or update the disclosure in the Original Form 10-Q except as specifically set forth herein.
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis should be read in conjunction with the MD&A included in our Annual Report on Form 10-K/A for the year ended December 31, 2002, and with the unaudited condensed consolidated financial statements and notes to financial statements included in this Report. Our disclosure and analysis in this Report, in other reports that we file with the Securities and Exchange Commission, in our press releases and in public statements of our officers contain forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current events. They use words such as “anticipate,” “estimate,” “expect,” “will,” “may,” “intend,” “plan,” “believe” and similar expressions in connection with discussion of future operating or financial performance. These include statements relating to future actions, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, the outcome of contingencies such as legal proceedings, and financial results. Forward-looking statements may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many factors will be important in determining future results. No forward-looking statement can be guaranteed, and actual results may vary materially from those anticipated in any forward-looking statement. Some of the factors that, in our view, could cause actual results to differ are discussed under the caption “Factors That May Affect Future Results, Financial Condition and the Market Price of Securities” and in our Annual Report on Form 10-K/A. Our historical operating results are not necessarily indicative of the results to be expected in any future period.
Overview
Our commercial business is focused on the dermatology marketplace, which is characterized by a large patient population that is served by relatively small, and therefore more accessible, groups of treating physicians. We currently market two pharmaceutical products, OLUX® and Luxíq®. Both products have clinically proven therapeutic advantages and we are providing quality customer service to physicians through our experienced sales and marketing professionals. In December 2002, we received approval from the FDA to sell OLUX for the treatment of non-scalp psoriasis.
In addition to revenue from product sales, we receive royalties on sales of RID®, Actimmune® and Ridaura® in the U.S., and internationally on sales of Banlice®, Milice®, Bettamousse®, and on a super-concentrated aerosol spray licensed worldwide. We have licenses with Novartis and Pharmacia Corporation, which have the potential to bear royalties in the future depending on approval of their products for sale.
During the first quarter of 2003, we had three product candidates in Phase III clinical trials: Extina™, a foam formulation of a 2% concentration of the antifungal drug ketoconazole, for the treatment of seborrheic dermatitis; Actiza™, a formulation of 1% clindamycin in our proprietary foam delivery system for the treatment of acne; and Velac ® Gel (a first-in-class combination of 1% clindamycin and 0.025% tretinoin) for the treatment of acne. In February 2003, we piloted a promotional giveaway to dermatologists of Solux™, a sunscreen formulated in our proprietary foam delivery system. The goal of the program is to introduce the foam delivery vehicle to a broad physician audience during the second quarter of 2003.
Also during the first quarter of 2003, we continued to expand our commitment to the training of new dermatologists. In March 2003, we launched OPIS™, a computer-based and personal digital assistant-based software program designed specifically to help dermatology residents track surgical procedures. We sponsored the development and launch of the pilot program for OPIS, which is the first software program of its kind for dermatology residents.
Critical Accounting Policies
There have been no material changes to our critical accounting policies, which are included in our Form 10K/A for the year ended December 31, 2002.
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Results of Operations
Revenues
| Three Months Ended | |||||||||||
| March 31, | |||||||||||
| (In thousands) | |||||||||||
| 2003 | 2002 | ||||||||||
| Revenues | |||||||||||
| Product: | |||||||||||
| OLUX® | $ | 9,875 | $ | 6,798 | |||||||
| Luxíq® | 4,388 | 3,322 | |||||||||
| Other | 48 | 20 | |||||||||
| Total product revenues | 14,311 | 10,140 | |||||||||
| License, contract and royalty: | |||||||||||
| Royalty | 936 | 649 | |||||||||
| Novartis | — | 580 | |||||||||
| Pharmacia | 31 | 125 | |||||||||
| Other contract | 33 | 37 | |||||||||
| Total license, contract and royalty revenues | 1,000 | 1,391 | |||||||||
| Total revenues | $ | 15,311 | $ | 11,531 | |||||||
Our product revenues were $14.3 million for the three months ended March 31, 2003, compared to $10.1 million for the three months ended March 31, 2002. Total net product sales increased 42% in the first quarter of 2003 as compared to the same period in the prior year. Increased sales volumes accounted for a 25% increase in the net product sales in the first quarter of 2003 compared to the same period in 2002. Higher sales prices for our dermatology products accounted for the remainder of the increase in net product sales in the three months ended March 31, 2003 compared to the same period in 2002.
Contract and royalty revenues were $1.0 million for the three months ended March 31, 2003, compared to $1.4 million for the three months ended March 31, 2002. The decrease in contract and royalty revenue is primarily due to the recognition of $580,000 of license revenue in 2002 related to the global licensing agreement with Novartis for Liquipatch partially offset by an increase in royalty revenues of $220,000 related to sales of Actimmune and Ridaura.
We have an agreement with Prometheus Laboratories, Inc. pursuant to which we receive a royalty on Prometheus’ annual sales of Ridaura in excess of $4.0 million through March 2006. We recognized $133,000 of royalty revenue in the first quarter 2003 and $0 in the first quarter of 2002 in conjunction with this agreement.
We have an agreement with InterMune, Inc. (formerly InterMune Pharmaceuticals, Inc.) pursuant to which we receive a royalty on InterMune’s sales of Actimmune in the United States. We recognized $92,000 of royalty revenue for the three month period ended March 31, 2003 and $0 of royalty revenue for the three month period ended March 31, 2002, in connection with this agreement.
Cost of Product Revenues
Our cost of product revenues includes the third party costs of manufacturing OLUX and Luxiq, royalty payments based on a percentage of our product revenues, and product freight and distribution costs from Cardinal Health Specialty Pharmaceutical Services (formerly CORD Logistics, Inc.), the third party that handles all of our product distribution activities. Currently, DPT, AccraPac Group, Inc., and InyX Pharma, Ltd. (formerly Miza Pharmaceuticals) manufacture commercial supplies of OLUX and Luxiq. We recorded costs of product revenues of $1.1 million for the three months ended March 31, 2003, compared to $675,000 for the three months ended March 31, 2002. The increase in the cost of product revenues in the three month period ended March 31, 2003 compared to the same period in 2002 is directly attributable to the increase in sales volume of our dermatology products.
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Research and Development
Research and development expenses include costs of personnel to support our research and development activities, costs of preclinical studies, costs of conducting our clinical trials, such as clinical investigator fees, monitoring costs, data management and drug supply costs, external research programs, and an allocation of facilities costs, salaries and benefits, and overhead costs such as rent, supplies and utilities. Research and development expenses were $8.6 million for the three month period ended March 31, 2003, compared to $5.0 million for the comparable period in 2002, primarily due to increased clinical trial costs. During the first quarter of 2003, we were conducting concurrent Phase III clinical trials for Velac, Actiza and Extina. The Actiza and Velac trials are still ongoing as of March 31, 2003. The Extina trial was completed during the first quarter of 2003. Subject to successful outcomes, we anticipate submitting New Drug Applications, or NDAs, to the FDA for Extina in mid-2003, Actiza in late 2003, and Velac in 2004.
In April 2003, we announced the outcome of a Phase III clinical trial evaluating Extina, an investigational new drug formulation of 2% ketoconazole in our proprietary foam delivery system, as a potential new treatment for seborrheic dermatitis. The four-week, double-blinded active- and placebo-controlled trial included 619 patients at 25 centers. The trial was designed to demonstrate and the results demonstrated that Extina was not inferior to Nizoral® (ketoconazole) 2% Cream as measured by the primary endpoint of Investigator’s Static Global Assessment (ISGA). The trial was also designed to compare Extina to placebo foam per the ISGA. The result, although in favor of Extina, did not achieve statistical significance. This was due to an unusually high placebo foam response at one of the 25 sites. An analysis excluding the outlying site demonstrates statistical significance.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $11.1 million for the three months ended March 31, 2003, compared to $9.6 million for the comparable quarter in 2002. The increase in expenses for the three month period ended March 31, 2003 compared to the same period in 2002 was due to increased employee-related costs attributable to increased headcount, as well as increased costs associated with our participation in industry trade shows.
Interest and other income (expense), net
Interest income was $126,000 for the first quarter of 2003, compared to $279,000 for the comparable quarter in 2002. The decrease in interest income in the first quarter of 2003 compared to the same period in 2002 was the result of lower cash and investment balances, combined with a decrease in market interest rates on investments.
Other income was $53,000 in the first quarter of 2003, compared to $78,000 for the first quarter of 2002. The decrease in other income during the three month period ended March 31, 2003 compared to the same period in 2002 is directly related to the decrease in income related to a facility sublease which ended January 2003.
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Income Taxes
We recognized income tax expense of $77,000 for the three-month period ended March 31, 2003 related to a foreign tax provision recorded by Connetics Australia. We recognized a net income tax benefit of $224,000 for the three month period ended March 31, 2002, that reflected U.S. tax benefit of $540,000 partially reduced by a foreign tax provision recorded by Connetics Australia of $316,000. The U.S. tax benefit arose principally because of the provisions of the U.S. Job Creation and Worker Assistance Act of 2002 enacted on March 9, 2002, which allows taxpayers to carry back net operating losses generated in 2001 and 2002 to offset alternative minimum tax paid in the last five years.
Net Loss and Financial Outlook for 2003
We have issued 2003 financial guidance that total revenues are expected to be between $65.0 million and $68.0 million. We project that combined sales, general and administrative, and research and development expenses for 2003 will be between $67.0 million and $69.0 million. We anticipate that we will achieve profitability in the second half of 2003, driven by continued positive prescription trends for our core commercial products.
Liquidity and Capital Resources
Sources and Use of Cash.We have financed our operations to date primarily through proceeds from equity financings, sale of investments, collaborative arrangements with corporate partners, bank loans, gross margins and product revenues. At March 31, 2003, cash, cash equivalents and short-term investments totaled $28.5 million compared to $33.1 million at December 31, 2002. Our cash balances are held in a variety of interest-bearing instruments including high-grade corporate bonds, commercial paper, U.S. Government agencies papers, and money market accounts.
Cash used in operating activities.Cash used in operations for the quarter ended March 31, 2003 was $5.7 million compared to $4.7 million for the three month period ended March 31, 2002. The increase in cash used in operating activities during the first quarter of 2003 compared to the same period in 2002 was due primarily to increased clinical trial activities.
Cash flows from investing activities.Investing activities provided $4.6 million and $3.6 million in cash for the three month periods ended March 31, 2003 and 2002, respectively. During the first quarter of 2002 we spent approximately $1.0 million related to the construction of an aerosol filling line at DPT’s plant on their premises in Texas. This expenditure was not repeated in the three month period ended March 31, 2003, which was the primary reason for the increase in cash flows from investing activities compared to the same period in 2002.
Cash flows from financing activities.Financing activities provided $1.5 million and $2.7 million for the three month periods ended March 31, 2003 and 2002, respectively. Cash flows from financing activities for the three month period ended March 31, 2003 compared to the same period in 2002 decreased due to the receipt of $1.5 million in the first quarter of 2002 related to the exercise of warrants that was not repeated in the first quarter of 2003. Additionally, $821,000 of previously restricted certificates of deposit was released in the first quarter of 2002, which was not repeated in the first quarter of 2003. The decrease in cash flows from financing activities related to the events discussed above was partially offset by an increase of approximately $900,000 related to stock sale activity for the three month period ended March 31, 2003 compared to the same period in 2002.
Working Capital.Working capital decreased by $3.7 million to $21.5 million at March 31, 2003 from $25.2 million at December 31, 2002, as we used cash in operations.
Contractual Obligations and Commercial Commitments.There have been no material changes in our contractual obligations and commercial commitments since December 31, 2002. Our commitments, including those disclosed in the Annual Report on Form 10-K/A for the year ended December 31, 2002, consist primarily of operating lease agreements for our facilities as well as minimum purchase commitments under one of our contract manufacturing agreements.
Restricted Cash and Cash Equivalents.In the quarter ended March 31, 2003, $312,000 was released from previously restricted certificates of deposit related to security for our facilities rent. As of March 31, 2003, $410,000 of our total cash and cash equivalents balance was restricted cash, held in various certificates of deposit, for specific purposes.
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We believe our existing cash, cash equivalents and short-term investments, cash generated from product sales and collaborative arrangements with corporate partners, will be sufficient to fund our operating expenses, debt obligations and capital requirements through at least the next 12 months. Our future capital uses and requirements depend on numerous factors, including the progress of our research and development programs, the progress of clinical testing, the time and costs involved in obtaining regulatory approvals, the cost of filing, prosecuting, and enforcing patent claims and other intellectual property rights, competing technological and market developments, the level of product revenues, and the possible acquisition of new products and technologies. A key element of our strategy is to in-license or acquire additional marketed or late-stage development products. A portion of the funds needed to acquire, develop and market any new products may come from our existing cash, which will result in fewer resources available to our current products and clinical programs. We are currently evaluating a number of business development opportunities, including the possibility of acquiring or in-licensing other products. If we successfully reach agreements with third parties, these transactions may require us to use some of our available cash, or to raise additional cash by liquidating some of our investment portfolio and/or raising additional funds through equity or debt financings in connection with the transaction.
We currently have no commitments for any additional financings. If we need to raise additional money to fund our operations, funding may not be available to us on acceptable terms, or at all. If we were unable to raise additional funds when needed, we might not be able to market our products as planned or continue development of our other products, or we could be required to delay, scale back or eliminate some or all of our research and development programs.
Factors that May Affect Future Results, Financial Condition and the Market Price of Securities
Please also read Item 1 in our 2002 Annual Report on Form 10-K/A where we have described our business and the challenges and risks we may face in the future.
There are many factors that affect our business and results of operations, some of which are beyond our control. In our Annual Report on Form 10-K/A for the year ended December 31, 2002 we list some of the important factors that may cause the actual results of our operations in future periods to differ materially from the results currently expected or desired. Due to these factors, we believe that quarter-to-quarter comparisons of our results of operations are not a good indication of our future performance. The factors discussed in our reports filed with the Securities and Exchange Commission, including our Annual Report on form 10-K/A for the year ended December 31, 2002, in particular under the caption “Factors That May Affect Future Results, Financial Condition and the Market Price of Securities,” should be carefully considered when evaluating our business and prospects.
Our Business Strategy May Cause Fluctuating Operating Results
Our operating results and financial condition may fluctuate from quarter to quarter and year to year depending upon the relative timing of events or uncertainties that may arise. For example, the following events or occurrences could cause fluctuations in our financial performance from period to period:
| • | changes in the levels we spend to develop new product lines, | ||
| • | changes in the amount we spend to promote our products, | ||
| • | changes in treatment practices of physicians that currently prescribe our products, | ||
| • | changes in reimbursement policies of health plans and other similar health insurers, including changes that affect newly developed or newly acquired products, | ||
| • | forward-buying patterns by wholesalers that may result in significant quarterly swings in revenue reporting, | ||
| • | increases in the cost of raw materials used to manufacture our products, | ||
| • | the development of new competitive products by others, |
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| • | the mix of products that we sell during any time period, and | ||
| • | our responses to price competition. |
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SIGNATURE
Pursuant to the requirements 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.
| Connetics Corporation |
| By: | /s/ John L. Higgins | ||
| John L. Higgins Exec. Vice President, Finance and Corporate Development and Chief Financial Officer |
Date: December 2, 2003
INDEX TO EXHIBITS
| Exhibit | ||
| Number | Description | |
| 10.1* | Amended and Restated Manufacturing and Supply Agreement dated April 24, 2003 between Connetics and AccraPac Group, Inc. | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. | |
| 32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. |
| * | We have omitted certain portions of this Exhibit and have requested confidential treatment of such portions from the SEC. |
