A majority of the Company’s revenue has historically been derived from a small number of wholesale drug distributors and Mutual. For the six months ended June 30, 2005, sales to Cardinal Health, Inc., McKesson Corporation, Amerisource Bergen Corporation and Mutual, represented approximately 32%, 19%, 11% and 29%, respectively, of the Company’s aggregate net product sales. For the six months ended June 30, 2004, sales to Cardinal Health, Inc., McKesson Corporation, Amerisource Bergen Corporation and Mutual represented approximately 34%, 25%, 16% and 17% of the Company’s aggregate net product sales.
During the six months ended June 30, 2005, Periostat and Mutual’s branded version of Periostat accounted for approximately 83% of the Company’s total net revenues. During the six months ended June 30, 2004, Periostat and Mutual’s branded version of Periostat accounted for approximately 90% of the Company’s total net revenues.
Inventories at June 30, 2005 and December 31, 2004 consist of the following:
During the six month period ended June 30, 2005, the Company recorded a charge to cost of product sales of $979 for excess inventory of Periostat and Mutual’s branded version of Periostat. The charge was the result of decreased demand for Periostat and the termination of the Company’s License and Supply Agreement with Mutual both of which resulted from the introduction of a third party generic version of Periostat in May 2005.
Note 4 -- Line of Credit
On June 7, 2004, the Company entered into a Loan Modification Agreement with Silicon Valley Bank to renew and amend its revolving credit facility. The amended credit facility expires on May 31, 2006. Under the amended credit facility, the Company may borrow up to the lesser of $5,000 or 80% of eligible accounts receivable, as defined under the amended credit facility. The amount available to the Company is reduced by any outstanding letters of credit which may be issued under the amended credit facility in amounts totaling up to $2,000. As the Company pays down amounts under any letter of credit, the amount available to it under the credit facility increases. The Company is not obligated to draw down any amounts under the amended credit facility and any borrowings shall bear interest, payable monthly, at the current prime rate. As of June 30, 2005, the Company had no borrowings or letters of credit outstanding.
Note 5 -- Contract and License Revenues
The Company recorded $244 and $151 in contract and licensing revenues for the six months ended June 30, 2005 and June 30, 2004, respectively. During the six months ended June 30, 2005, $160 of license revenue was recorded to reflect the unamortized portion of upfront license revenue from the License and Supply Agreement with Showa Yakuhin Kako Co., Ltd., which was terminated in March 2005.
Note 6 -- Legal Settlements and Proceedings
On April 8, 2004, the Company announced that it had settled all pending litigation between the Company and Mutual. In the settlement, the Company paid to Mutual $2,000, which was recorded during the three month period ended March 31, 2004.
In connection with the settlement, the Company and Mutual entered into a License and Supply Agreement pursuant to which Mutual would purchase a branded version of Periostat from the Company at prices below the Company’s average manufacturer’s price, and received a license to sell a branded version of Periostat. Pursuant to the Agreement the Company agreed to provide price adjustments to Mutual after a generic version of Periostat became available on the market at a price lower than the selling price of Mutual’s branded version of Periostat. These adjustments take the form of rebates or credits to Mutual to reduce the acquisition cost of the branded version of Periostat in Mutual’s inventory or to offset rebates and similar retroactive price adjustments requested by, and actually provided by, Mutual to its customers.
On May 13, 2005, the FDA approved a third party generic version of Periostat and a third party generic product was launched in late May 2005. Upon this generic launch, Mutual was no longer obligated to purchase their branded version of Periostat from the Company.
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As a result, the Company will pay Mutual approximately $1,066 as an adjustment related to price protection on Mutual’s branded version of Periostat. Net product sales for the three months ended June 30, 2005 reflect a $1,000 reduction in revenue for such price protection. As of June 30, 2005, the Company has recorded deferred revenue of $108 related to sales to Mutual for which the final selling price is not fixed and determinable as the final sale and ultimately the price protection rebates have not yet been made by Mutual. (See note 9)
In June 2003, the Company commenced an action and filed a motion for a preliminary injunction in the United States District Court for the District of Columbia challenging the FDA’s decision to treat Periostat as an antibiotic drug, thus denying Periostat certain protections afforded non-antibiotic drugs under the Food, Drug, and Cosmetic Act and against FDA approval of generic copies of Periostat (the “FDA Litigation”). On July 23, 2003, the United States District Court for the District of Columbia issued an injunction in favor of the Company. On January 20, 2005, the United States District Court for the District of Columbia reached its decision on the merits of the FDA Litigation, and dissolved the injunction that had prohibited the FDA from approving any Abbreviated New Drug Applications, or ANDAs, submitted for any generic version of Periostat. The Company lodged, but has now withdrawn, an appeal against this decision in the Court of Appeals for the District of Columbia Circuit.
On October 1, 2004, the Company filed a complaint for patent infringement against IVAX Pharmaceuticals Inc. (“IVAX”) and CorePharma LLC (“CorePharma”) in the United States District Court for the Eastern District of New York. In its complaint, the Company alleged that the submission of ANDAs by each of IVAX and CorePharma for 20 mg tablets of doxycycline hyclate infringed United States Patent RE 34,656, for which the Company is the exclusive licensee. The Company also alleged that any manufacture, importation, marketing and sale of generic 20 mg tablets of doxycycline hyclate by IVAX and CorePharma would infringe the RE 34,656 patent. The Company sought an injunction preventing IVAX and CorePharma from introducing 20 mg tablets of doxycycline hyclate in the United States. The injunction was denied by the Court on June 16, 2005. The litigation on the merits of the Company’s patent infringement claims is ongoing.
Note 7 -- Legal Expenses to Defend Periostat Patents
Under the Company’s license agreement with the Research Foundation of the State University of New York (“SUNY”) covering Periostat, the Company is entitled to deduct costs incurred to defend its patents, including the $2,000 settlement payment to Mutual in April 2004, from current and future royalties due to SUNY on net sales of Periostat and sales to Mutual of its branded version of Periostat. The Company anticipates that its future legal costs in these matters relating to patent infringement and defense will be reimbursed by SUNY pursuant to its Technology License Agreement with SUNY to the extent that these legal expenses do not exceed royalties earned by SUNY during that period. During the six months ended June 30, 2005 and June 30, 2004, the Company incurred $1,062 and $2,867 respectively, in legal defense, litigation and settlement costs, of which $735 and $914, respectively, were deducted from royalties payable to SUNY. In the event such cumulative legal costs exceed the amount of the royalties payable to SUNY, the Company will not be able to recover such legal costs from SUNY. The cumulative legal patent defense, litigation and settlement costs incurred as of June 30, 2005 exceed the amount of the royalties earned and payable to SUNY by $4,266. These amounts, which have been expensed, will be available to offset future royalties earned by SUNY, if any, on net sales of products based on the SUNY technology.
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Note 8 -- Sales Force Restructuring
On May 16, 2005, the Company announced the restructuring of the Company’s sales force following the FDA’s approval of a third party generic version of Periostat. As a result of the restructuring, the Company ceased all sales activities related to Periostat. The Company incurred a $1,184 restructuring charge during the three months ended June 30, 2005. Of this charge, $813 related to employee severance costs while the remaining portion was primarily related to the write-off of assets associated with the Company’s dental sales and marketing activities that could no longer be utilized by the Company. As of June 30, 2005, $273 of the restructuring charge had not yet been paid and is a component of accrued expenses on the Company’s Condensed Consolidated Balance Sheet. (See note 9)
On April 22, 2004, the Company announced the restructuring of the Company’s pharmaceutical sales organization into dedicated dental and dermatology sales forces. The Company incurred a $348 restructuring charge during the year ended December 31, 2004. As of June 30, 2005, all of these costs have been paid by the Company.
Note 9 -- Accrued Expenses
Accrued expenses at June 30, 2005 and December 31, 2004 consist of the following:
| | | 2005 | | 2004 | |
| | |
| |
| |
| Contracted development and manufacturing costs | | $ | 2,410 | | $ | 1,648 | |
| Sales and marketing costs | | | 140 | | | 212 | |
| Payroll and related costs | | | 1,061 | | | 1,731 | |
| Professional and consulting fees | | | 212 | | | 159 | |
| Deferred revenue (notes 1 and 6) | | | 153 | | | 54 | |
| Foreign taxes | | | 945 | | | 945 | |
| Product returns (note 1) | | | 2,740 | | | 592 | |
| Miscellaneous taxes | | | 50 | | | 99 | |
| Restructuring expenses | | | 273 | | | 25 | |
| Other | | | 121 | | | 120 | |
| | |
|
| |
|
| |
| | | $ | 8,105 | | $ | 5,585 | |
| | |
|
| |
|
| |
Note 10 -- Promotion and Cooperation Agreement
In June 2005, the Company entered into a Promotion and Cooperation Agreement with Primus, under which the Company will promote Alcortin, a prescription topical antifungal steroid combination, and Novacort, a prescription topical steroid and anesthetic.
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Under the Promotion Agreement, the Company will receive a percentage of the gross profit arising from prescriptions written by dermatologists that result in sales of the products in the United States. The majority of marketing expenses, excluding sales force compensation and sample product costs, related to the promotion of the Primus products will be funded by Primus. The majority of product sample product costs and all sales force compensation will be funded by the Company.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Our management’s discussion and analysis of our financial condition and results of operations include the identification of certain trends and other statements that may predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated. See “Additional Risks That May Affect Results.”
Overview
CollaGenex Pharmaceuticals, Inc. and subsidiaries is a specialty pharmaceutical company currently focused on developing and marketing innovative proprietary medical therapies to the dermatology market. We currently market three prescription pharmaceutical products to the dermatology market through our professional dermatology sales force. Our marketed dermatology products are Pandel®, a prescription corticosteroid we licensed from Altana, Inc. in May 2002, Novacort™, a prescription topical steroid and anesthetic, and Alcortin™, a prescription topical antifungal steroid combination. We are promoting Novacort and Alcortin to dermatologists pursuant to a Promotion and Cooperation Agreement executed in June 2005 with Primus Pharmaceuticals, Inc. (“Primus”).
Prior to the May 2005 introduction of a third party generic version of Periostat®, our dental sales force detailed four prescription pharmaceutical products to the dental market. On May 20, 2005, we ceased all sales activities for these products. We currently still generate sales from these dental products, which all treat periodontal disease and include our own product Periostat, as well as Atridox®, Atrisorb FreeFlow® and Atrisorb-D® which are licensed from Atrix Laboratories, Inc. (now known as QLT USA, Inc.) (the “Atrix Products”). We had also sold a separately branded version of Periostat to United Research Laboratories, Inc./Mutual Pharmaceutical Company, Inc. (“Mutual”) pursuant to a License and Supply Agreement executed in April 2004 as part of a settlement of our outstanding patent litigation with Mutual. As a result of the launch of a third party generic version of Periostat in May 2005, Mutual is no longer obligated to purchase product from us, and we do not anticipate future purchases from Mutual. Based on data provided by a leading independent prescription tracking service, we estimate that Periostat’s share of the 20 mg doxycycline market was approximately 34% during the month of June 2005. We anticipate Periostat’s share of the market will continue to decrease as a result of the third party introduction of a generic version of Periostat.
In addition to our marketed products, we have a pipeline of products in clinical and pre-clinical development. These products are based on our two proprietary platform technologies, IMPACS™ and Restoraderm®. IMPACS (Inhibitors of Multiple Proteases And CytokineS) are a group of compounds that demonstrate a range of anti-inflammatory activities as well as the ability to inhibit the breakdown of connective tissue. Periostat is our first FDA-approved IMPACS product. Periostat-MR™ is a once-a-day, modified-release formulation of Periostat currently in a Phase III clinical trial for the treatment of adult periodontitis. Oracea™, which has the same active ingredient and modified delivery as Periostat-MR, recently completed two Phase III clinical trials for the treatment of rosacea, a dermatological condition. Our New Drug Application for Oracea was submitted to the FDA on August 1, 2005.
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Col-3, a second generation IMPACS compound, has completed a Phase II proof-of-concept clinical trial for the treatment of rosacea, and we anticipate beginning a Phase II clinical study with Col-3 in acne patients during 2005.
Our Restoraderm technology is a proprietary, foam-based, topical drug delivery technology that originated from a Swedish collaborator. We have acquired all rights, title and interest to the Restoraderm technology and have committed to initiate the development of five products based on this technology before the end of 2005. We are currently developing Restoraderm products for the treatment of acne and psoriasis.
Our strategy is to become a leading developer and marketer of innovative prescription pharmaceutical products to the dermatology and other specialty pharmaceutical markets. We intend to continue to market our current products and develop and launch new products based on our two proprietary platform technologies. Our current focus is on the dermatology market, although we intend to seek additional partnerships with third parties to develop potential uses of our technology outside of our core focus.
We were founded in 1992 and completed an initial public offering of our common stock in 1996. We recorded our first profit in the third quarter of 2002. Although we earned net income of $6.5 million and $6.4 million for the years ended December 31, 2004 and 2003, respectively, we incurred a net loss allocable to common stockholders of $8.3 million during the six months ended June 30, 2005 and we have an accumulated deficit of $72.4 million. We do not expect to generate profits for the year ended December 31, 2005.
Significant Recent Developments
On October 1, 2004, we filed a complaint for patent infringement against IVAX Pharmaceuticals Inc. (“IVAX”) and CorePharma LLC (“CorePharma”) in the United States District Court for the Eastern District of New York. In our complaint, we alleged that the submission of Abbreviated New Drug Applications, or ANDAs, by each of IVAX and CorePharma for 20 mg tablets of doxycycline hyclate infringed United States Patent RE 34,656, for which we are the exclusive licensee. We also alleged that any manufacture, importation, marketing and sale of generic 20 mg tablets of doxycycline hyclate by IVAX and CorePharma would infringe the RE 34,656 patent. We sought an injunction preventing IVAX and CorePharma from introducing 20 mg tablets of doxycycline hyclate in the United States. The injunction was denied by the Court on June 16, 2005. We intend to continue the litigation on the merits of the patent infringement and to seek damages against IVAX and CorePharma.
On May 13, 2005, the FDA approved a third party generic version of Periostat which was launched in late May 2005. On May 16, 2005, we announced the restructuring of our sales force following such approval. As a result of the restructuring, we ceased all sales activities related to Periostat and incurred a $1.2 million restructuring charge during the three months ended June 30, 2005.
In June 2005, we entered into a Promotion and Cooperation Agreement with Primus, under which we will promote Alcortin, a prescription topical antifungal steroid combination and Novacort, a prescription topical steroid and anesthetic. Under the Promotion Agreement, we will
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receive a percentage of the gross profit arising from prescriptions written by dermatologists that result in sales of these products in the United States. The majority of marketing expenses, excluding sales force compensation and sample product costs, related to the promotion of the Primus products will be funded by Primus. The majority of product sample product costs will be funded by us. We are also responsible for the applicable sales force compensation of our employees for such promotion.
In April 2005, we announced the favorable results of a double-blinded, placebo-controlled Phase II clinical study designed to evaluate the safety and efficacy of Col-3 for the treatment of rosacea. Col-3 is a second-generation IMPACS compound that has demonstrated a range of potent anti-inflammatory properties.
In June 2005, we announced the statistically significant positive outcomes of two Phase III, double-blinded, placebo-controlled clinical trials designed to evaluate the safety and efficacy of Oracea for the treatment of rosacea.
In August 2005, we announced the filing of a New Drug Application with the FDA for Oracea, the first orally administered, systemically delivered drug to treat rosacea.
In August 2005, we announced that the United States Patent and Trademark Office had published on its website that U.S. Patent Application, serial no. 10/117,709, had been allowed. This patent covers the use of sub-antimicrobial tetracyclines, including Oracea, for the treatment of acne and acne rosacea. This patent application has a priority date of April 5, 2002 and an expiration date 20 years from that date.
Results of Operations
Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004
Revenues
Revenues
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Net Product Sales | | $ | 6,872 | | (52.2)% | | $ | 14,372 | |
| Contract and License Revenues | | | 45 | | (38.4)% | | | 73 | |
| | |
|
| | | |
|
| |
| Total | | $ | 6,917 | | (52.1)% | | $ | 14,445 | |
The decrease in net product sales during the three months ended June 30, 2005 was primarily due to the launch of a third party generic competitor to Periostat and Mutual’s branded version of Periostat in May 2005. This generic launch had two primary effects in the second quarter of 2005. First, we deferred approximately $2.3 million of Periostat revenues for product shipped during the second quarter of 2005 due to our reduced ability to estimate future returns of product in the distribution channel following the launch of a third party generic competitor. Second, we recorded a lower average selling price on sales to Mutual of its branded version of Periostat in accordance with our agreement, which requires us to compensate Mutual for price erosion experienced by Mutual and its customers on certain of their inventories. This lower average selling price reduced net product sales in the second quarter of 2005 by approximately $1.0 million. During the second quarter of 2005, Periostat and Mutual’s branded version of Periostat accounted for 95% of the total dispensed prescriptions for the 20 mg doxycycline market compared to 100% in the second quarter of 2004.
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Cost of Product Sales
Cost of Product Sales
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Cost of Product Sales | | $ | 1,701 | | (17.1)% | | $ | 2,052 | |
| Percent of Net Product Sales | | | 24.8 | % | N/A | | | 14.3 | % |
Cost of product sales includes product packaging, third party royalties, amortization of product licensing fees, and the costs associated with the manufacturing, storage and stability of Periostat, Mutual’s branded version of Periostat, Pandel and the Atrix Products, as well as charges taken to reflect a decrease in inventory carrying value, if any.
The decrease in cost of products sales was primarily the result of lower net product sales. Cost of product sales also included a charge of approximately $117,000 associated with excess inventories of certain raw materials used to manufacture both Periostat and Mutual’s branded version of Periostat following the launch by a third party generic competitor. Cost of product sales also increased as a percentage of net product sales as a result of lower average selling prices to Mutual during the second quarter of 2005 as compared to the second quarter of 2004.
Research and Development
Research and Development
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Research and development | | $ | 3,200 | | 30.2% | | $ | 2,457 | |
Research and development expenses consist primarily of funds paid to third parties for the provision of services and materials for drug development, including milestone fees, manufacturing and formulation enhancements, clinical trials, statistical analysis and report writing and regulatory compliance costs.
Significant development projects conducted during the three months ended June 30, 2005 included:
| | • | our continuing clinical and manufacturing development work for Oracea, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of rosacea, which accounted for total costs of approximately $937,000; |
| | | |
| | • | our continuing clinical and manufacturing development and formulation work for Periostat-MR, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of adult periodontitis, which accounted for total costs of approximately $502,000; |
| | | |
| | • | our clinical and manufacturing development work for Col-3, a second generation IMPACS compound, totaling $698,000; and |
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| | • | stability testing and formulation costs for two potential products utilizing our Restoraderm technology, which accounted for total costs of approximately $255,000. |
We estimate that if Oracea, Periostat-MR, Col-3 and our Restoraderm acne and psoriasis products are developed to the point of market launch, the additional formulation and clinical development expenses and milestones fees would be in the range of $25.0 million to $30.0 million.
Significant development projects conducted during the three months ended June 30, 2004 included:
| | • | our continuing clinical and manufacturing development work for Oracea, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of rosacea, which accounted for total costs of approximately $1.0 million; and |
| | | |
| | • | our continuing clinical and manufacturing development and formulation work for Periostat-MR, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of adult periodontitis, which accounted for total costs of approximately $335,000. |
Selling, General and Administrative
Selling, General and Administrative
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Selling, General and Administrative – other | | $ | 6,510 | | (13.5)% | | $ | 7,530 | |
| Selling, General and Administrative – restructuring | | | 1,184 | | 146.7% | | | 480 | |
| | |
|
| | | |
|
| |
| Total | | $ | 7,694 | | (3.9)% | | $ | 8,010 | |
Selling, general and administrative – other expenses consist primarily of personnel salaries and benefits, direct marketing costs, professional, legal and consulting fees, insurance and general office expenses.
Significant components of selling, general and administrative – other expenses incurred during the three months ended June 30, 2005 included approximately $2.8 million in direct selling and sales training expenses, approximately $1.9 million in marketing expenses (including advertising and promotion expenditures for Periostat, the Atrix Products, the Primus products and Pandel) and approximately $1.8 million in general and administrative expenses, which include business development, finance, legal and corporate activities. Significant components of selling, general and administrative – other expenses incurred during the three months ended June 30, 2004 included approximately $3.8 million in direct selling and sales training expenses, approximately $2.1 million in marketing expenses (including advertising and promotion expenditures for Periostat, the Atrix Products, and Pandel) and approximately $1.6 million in general and administrative expenses, which include business development, finance, legal and corporate activities. The decrease in selling, general and administrative – other expenses during
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the three months ended June 30, 2005 compared to the three months ended June 30, 2004 is primarily attributable to decreased personnel costs of $853,000 as a result of the April 2004 sales force restructuring and the May 2005 termination of our dental sales and marketing activities and the corresponding reduction of 63 employees, including our dental sales force, which was partially offset by an increase of $170,000 in patent litigation costs.
Selling, general and administrative – restructuring during the three months ended June 30, 2005 consisted of a $1.2 million charge related to a reorganization following the approval of a third party generic version of Periostat. As a result of the restructuring, we ceased all sales activities related to Periostat and our dental franchise. Selling, general and administrative – restructuring during the three months ended June 30, 2004 consisted of a charge of $480,000 that resulted from a the strategic realignment of our sales organization into dedicated dental and dermatology sales forces.
Other Income/Expense
Other Income/Expense
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Interest income | | $ | 264 | | 282.6% | | $ | 69 | |
| Other income (expense) | | $ | (1 | ) | (133.3)% | | $ | 3 | |
The increase in other income was due to higher average investment balances as well as higher average investment yields.
Preferred Stock Dividend
Preferred stock dividends included in net income allocable to common stockholders were $427,000 during the three months ended June 30, 2005 and $400,000 during the three months ended June 30, 2004. Such preferred stock dividends were paid in cash and are the result of our obligations in connection with the issuance of our Series D preferred stock in May 1999.
Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004
Revenues
Revenues
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Net Product Sales | | $ | 18,708 | | (32.5)% | | $ | 27,700 | |
| Contract and License Revenues | | | 244 | | (61.6)% | | | 151 | |
| | |
|
| | | |
|
| |
| Total | | $ | 18,952 | | (32.0)% | | $ | 27,851 | |
Revenues during the six month period ending June 30, 2005 included approximately $18.7 million in net product sales of Periostat, Mutual’s branded version of Periostat, Pandel and the Atrix Products and $244,000 in contract and license revenues, which were derived from residual contract revenues from our expired agreement with Merck & Co., Inc. for Vioxx®, contract revenues from our promotion and cooperation agreement with Primus and international licensing revenues for Periostat. During the six months ended June 30, 2005, $160,000 of contract and license revenue was recorded to reflect the elimination of any continuing involvement related to the
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upfront license revenue, received in 2000, from the License and Supply Agreement with Showa Yakuhin Kako Co., Ltd. which was terminated in March 2005. The decrease in net product sales was primarily due to the launch of a third party generic competitor to Periostat and Mutual’s branded version of Periostat in May 2005. This generic launch had two primary effects during the six month period ended June 30, 2005. First, we deferred approximately $2.3 million of Periostat revenues for product shipped during the second quarter of 2005 due to our reduced ability to estimate future returns of product in the distribution channel following the launch of a third party generic competitor. Second, we recorded a lower average selling price on sales to Mutual of its branded version of Periostat in accordance with our agreement, which requires us to compensate Mutual for price erosion experienced by Mutual and its customers on certain of their inventories. This lower average selling price reduced net product sales in the second quarter of 2005 by approximately $1.0 million. During the six month period ended June 30, 2005, Periostat and Mutual’s branded version of Periostat accounted for approximately 98% of the total dispensed prescriptions for the 20 mg doxycycline market compared to 100% for the six month period ended June 30, 2004.
Cost of Product Sales
Cost of Product Sales
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Cost of Product Sales | | $ | 4,166 | | 2.8% | | $ | 4,053 | |
| Percent of Net Product Sales | | | 22.3 | % | N/A | | | 14.6 | % |
Cost of product sales includes product packaging, third party royalties, amortization of product licensing fees, and the costs associated with the manufacturing, storage and stability of Periostat, Mutual’s branded version of Periostat, Pandel and the Atrix Products, as well as charges taken to reflect a decrease in inventory carrying value, if any.
Cost of product sales for the six months ended June 30, 2005 includes a charge of approximately $979,000 associated with the estimated excess inventories of Periostat and Mutual’s branded version of Periostat as a result of the launch by a third party generic competitor. Cost of product sales also increased as a percentage of net product sales as a result of lower average selling prices to Mutual during the six month period ended June 30, 2005 as compared to the six month period ended June 30, 2004.
Research and Development
Research and Development
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Research and development | | $ | 7,294 | | 89.7% | | $ | 3,845 | |
Research and development expenses consist primarily of funds paid to third parties for the provision of services and materials for drug development, including milestone fees, manufacturing and formulation enhancements, clinical trials, statistical analysis and report writing and regulatory compliance costs.
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Significant development projects conducted during the six months ended June 30, 2005 included:
| | • | our continuing clinical and manufacturing development work for Oracea, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of rosacea, which accounted for total costs of approximately $3.2 million; |
| | | |
| | • | our continuing clinical and manufacturing development and formulation work for Periostat-MR, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of adult periodontitis, which accounted for total costs of approximately $1.0 million; |
| | | |
| | • | our clinical and manufacturing development work for Col-3, a second generation IMPACS compound, totaling $1.2 million; and |
| | | |
| | • | stability testing and formulation costs for two potential products utilizing our Restoraderm technology, which accounted for total costs of approximately $503,000. |
We estimate that if Oracea, Periostat-MR, Col-3 and our Restoraderm acne and psoriasis products are developed to the point of market launch, the additional formulation and clinical development expenses and milestones fees would be in the range of $25.0 million to $30.0 million.
Significant development projects conducted during the six months ended June 30, 2004 included:
| | • | our continuing clinical and manufacturing development work for Oracea, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of rosacea, which accounted for total costs of approximately $1.1 million; |
| | | |
| | • | our continuing clinical and manufacturing development and formulation work for Periostat-MR, our once daily, modified release formulation of doxycycline, 40 mg, for the treatment of adult periodontitis, which accounted for total costs of approximately $583,000; and |
| | | |
| | • | a Phase III clinical trial to evaluate Periostat for the treatment of rosacea, which accounted for total costs of approximately $418,000. |
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Selling, General and Administrative
Selling, General and Administrative
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Selling, General and Administrative – other | | $ | 14,256 | | (8.9)% | | $ | 15,648 | |
| Selling, General and Administrative – legal settlement | | | — | | N/A | | | 2,000 | |
| Selling, General and Administrative – restructuring | | $ | 1,184 | | 146.7% | | | 480 | |
| | |
|
| | | |
|
| |
| Total | | $ | 15,440 | | (14.8)% | | $ | 18,128 | |
Selling, general and administrative – other expenses consist primarily of personnel salaries and benefits, direct marketing costs, professional, legal and consulting fees, insurance and general office expenses.
Significant components of selling, general and administrative – other expenses incurred during the six months ended June 30, 2005 included approximately $6.6 million in direct selling and sales training expenses, approximately $3.8 million in marketing expenses (including advertising and promotion expenditures for Periostat, the Atrix Products, the Primus products and Pandel) and approximately $3.9 million in general and administrative expenses, which include business development, finance, legal and corporate activities. Significant components of selling, general and administrative – other expenses incurred during the six months ended June 30, 2004 included approximately $8.2 million in direct selling and sales training expenses, approximately $4.1 million in marketing expenses (including advertising and promotion expenditures for Periostat, the Atrix Products and Pandel and co-promotion expenses relating to Vioxx and AVARTM), and approximately $3.3 million in general and administrative expenses, which include business development, finance, legal and corporate activities. The decrease in selling, general and administrative -- other expenses during the six months ended June 30, 2005 compared to the six months ended June 30, 2004 was primarily attributable to decreased personnel costs of $1.4 million as a result of the April 2004 sales force restructuring and the May 2005 termination of our dental sales and marketing activities and the corresponding reduction of 63 employees, including our dental sales force, which was partially offset by an increase of $575,000 in patent litigation costs.
Selling, general and administrative – legal settlement consisted of $2.0 million during the three months ended June 30, 2004 that resulted from the accrual for a one-time payment to Mutual in connection with the settlement of all outstanding litigation between us and Mutual.
Selling, general and administrative – restructuring during the six months ended June 30, 2005 consisted of a $1.2 million charge related to a reorganization following the approval of a third party generic version of Periostat. As a result of the restructuring, we ceased all sales activities related to Periostat and our dental franchise. Selling, general and administrative – restructuring during the six months ended June 30, 2004 consisted of $480,000 that resulted from a charge related to the reorganization of our sales organization into dedicated dental and dermatology sales forces.
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Other Income/Expense
Other Income/Expense
(dollars in thousands) | | 2005 | | Change | | 2004 | |
| |
| |
| |
| |
| Interest income | | $ | 476 | | 240.0% | | $ | 140 | |
| Other expense | | $ | (1 | ) | 100% | | $ | — | |
The increase in interest income was due to higher average investment balances in 2005, as well as higher average investment yields.
Preferred Stock Dividend
Preferred stock dividends included in net income allocable to common stockholders were $827,000 during the six months ended June 30, 2005 and $800,000 during the six months ended June 30, 2004. Such preferred stock dividends are the result of our obligations in connection with the issuance of our Series D preferred stock in May 1999.
Liquidity and Capital Resources
Cash Requirements/Sources and Uses of Cash
We require cash to fund our operating expenses, capital expenditures and dividend payments on our outstanding Series D preferred stock. We have historically funded our cash requirements primarily through the following:
| | • | Public offerings and private placements of our preferred and common stock; |
| | | |
| | • | Cash from operations; and |
| | | |
| | • | Exercise of stock options and warrants. |
We believe that other key factors that could affect our ability to maintain and draw on internal and external sources of cash are:
| | • | The success of our dermatology franchise; |
| | | |
| | • | The success of our pre-clinical, clinical and development programs; |
| | | |
| | • | Market penetration by third party generic manufacturers of a generic version of Periostat; |
| | | |
| | • | Revenues and profits from sales of Periostat and our other product candidates, as well as the products we co-promote; |
| | | |
| | • | Our ability to continue to meet the covenant requirements under our revolving credit facility with Silicon Valley Bank; and |
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| | | |
| | • | The state of the capital markets generally and, in particular, the receptivity of the capital markets to our future financings. |
On June 7, 2004, we entered into a Loan Modification Agreement with Silicon Valley Bank to renew and amend our revolving credit facility, which had expired on March 15, 2004. The amended credit facility expires on May 31, 2006. Under the amended credit facility, we may borrow up to the lesser of $5.0 million or 80% of eligible accounts receivable, as defined under the amended credit facility. The amount available to us is reduced by any outstanding letters of credit which may be issued under the amended credit facility in amounts totaling up to $2.0 million. As we pay down amounts under any letter of credit, the amount available to us under the credit facility increases. We are not obligated to draw amounts under the amended credit facility and any borrowings shall bear interest, payable monthly, at the current prime rate. As of June 30, 2005, we had no outstanding borrowings or letters of credit.
At June 30, 2005, we had cash, cash equivalents and short-term investments of approximately $35.7 million, a decrease of $2.9 million compared to the approximately $38.6 million balance at December 31, 2004. This decrease is primarily attributable to our operating loss during the six months ended June 30, 2005 offset in part by cash receipts from revenues which were deferred, collection of our trade receivables and a reduction in our inventory levels. In accordance with investment guidelines approved by our Board of Directors, cash balances in excess of those required to fund operations have been invested in government notes, commercial paper and money market funds. Our working capital at June 30, 2005 was $32.5 million compared to $39.7 million at December 31, 2004. During the six months ended June 30, 2005, we invested approximately $196,000 in capital expenditures, paid $800,000 in cash dividends to the holders of our Series D preferred stock and liquidated approximately $7.0 million (net of purchases) of short-term investments.
As of June 30, 2005 we had approximately $3.9 million in outstanding accounts receivable due from Mutual all of which is due in the third quarter of 2005.
Cash Flows/Cash Management
The principal use of cash in operating activities in the three months ended June 30, 2005 was the payment of operating expenses and related working capital liabilities. Cash flows from operations can vary significantly due to various factors including the timing of payments made to our vendors, vendor payment terms, customer mix and customer payment terms.
Investing activities during the six months ended June 30, 2005 consisted primarily of purchases and sales of short-term investments. Financing activities during the six months ended June 30, 2005 consisted primarily of the payment of preferred dividends to our Series D preferred stockholders.
Contractual Obligations
Our major outstanding contractual obligations relate to cash dividends on our outstanding Series D preferred stock, operating leases for our office space and contractual commitments with our marketing partners for certain selling and promotional expenses associated with the products
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we are currently detailing. The disclosures relating to our contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2004 have not materially changed since we filed that report.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of its financial position and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management believes the critical accounting policies and areas that require the most significant judgments and estimates to be used in the preparation of the consolidated financial statements pertain to revenue recognition, stock compensation and the valuation of deferred taxes, acquired product rights and inventory.
Revenue Recognition
Historically, we have recognized all product sales revenue upon shipment to wholesale customers, net of estimated future returns, estimates for chargebacks, wholesale distribution fees, if applicable, rebates, generic introductions and current inventory levels in the distribution channel provided that collection was probable and no significant obligations remained. Following the launch of generic competition to Periostat in May 2005, and commencing with the second quarter of 2005, we now recognize Periostat sales revenue primarily based on sales to end-users, which we estimate using prescription demand data generated by a leading independent prescription tracking service. Accordingly, since it is possible that the launch of generic competition to Periostat in May 2005 may increase the rate of product returns from the distribution channel we have accrued $2.7 million for potential Periostat returns on sales recognized prior to the launch of generic competition in Accrued Expenses on the Condensed Consolidated Balance Sheet at June 30, 2005.
Upon the launch of a third party generic equivalent to Periostat, our agreement with Mutual provides for rebates to be paid to Mutual to compensate Mutual and its customers for price erosion on the value of certain of its inventories of Mutual’s branded version of Periostat. Accordingly, we have deferred revenues associated with our shipments of these products until such future time as the selling price becomes fixed and determinable. At June 30, 2005, our Condensed Consolidated Balance Sheet included $108,000 in deferred revenue associated with sales of Mutual’s branded version of Periostat.
We recognize all other product sales revenue (excluding Periostat and Mutual’s branded version of Periostat) upon shipment, net of estimated returns, rebates, chargebacks and wholesale distribution fees, if applicable, provided that collection is determined to be probable and no significant obligations remain.
Pursuant to our Promotion and Cooperation Agreement with Primus contract revenues for Novacort and Alcortin are fee-based arrangements where revenue is earned as prescriptions are filled and recognized as a percentage of the gross profit earned by Primus. We do not take title to the inventory sold by Primus under the Promotion Agreement.
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Stock-Based Compensation
It is our policy to apply Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations to account for our stock option grants rather than Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and related interpretations. As such, compensation expense is recorded on fixed stock option grants only if the market value of the underlying stock exceeds the exercise price of the option at the date of grant and is recognized on a straight-line basis over the vesting period. Had we applied SFAS No. 123, which requires recording stock option grants at their fair value, our net income (loss) would have varied from the reported net income (loss) as we would have recorded additional expenses in each period. See Note 1 to our Condensed Consolidated Financial Statements for the pro forma effect of applying SFAS No. 123 to our results of operations and earnings per share allocable to common stockholders.
Deferred Taxes
In assessing the realizability of deferred tax assets, we consider the likelihood that part or all of the deferred tax assets will not be realized. This assessment requires significant judgment and estimates. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. We consider our history of losses, scheduled reversal of deferred tax assets and liabilities and projected future taxable income over the periods in which the deferred tax asset items are deductible. The Tax Reform Act of 1986 contains provisions that may limit the net operating loss and research and experimentation credit carryforwards available to be used in any given year upon the occurrence of certain events, including significant changes in ownership interest. While we have been profitable for the past two years, we have a loss for the six months ended June 30, 2005 and uncertainty regarding our future profitability has prevented us from reaching the “more likely than not” conclusion required under the applicable literature to recognize deferred tax assets on our consolidated balance sheet.
Acquired Product Rights
We are required to test for asset impairment of acquired product rights whenever events or circumstances indicate that the carrying value of an asset may not be recoverable. We apply SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” in order to determine whether or not an asset was impaired. This standard requires an impairment analysis when indicators of impairment are present. If such indicators are present, the standard indicates that if the sum of the future expected cash flows from the asset, undiscounted and without interest charges, is less than the carrying value, an asset impairment must be recognized in the financial statements. The amount of the impairment is the difference between the fair value of the asset and the carrying value of the asset.
In making future cash flow analyses of our acquired product rights, we make assumptions relating to: (i) the intended use of the product rights and the expected future cash flows resulting directly from such use; (ii) generic competitor activities and regulatory initiatives that affect our products; and (iii) customer preferences and expected managed care reimbursement.
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Excess Inventory
During the six month period ended June 30, 2005, we recorded a charge of $979,000 for the estimated excess inventory of Periostat and Mutual’s branded version of Periostat due to decreased demand following the introduction of a third party generic version of Periostat.
Critical accounting estimates and the related assumptions are evaluated periodically as conditions warrant, and changes to such estimates are recorded as new information or changed conditions require revision.
Additional Risks That May Affect Results
Statements contained or incorporated by reference in this Quarterly Report on Form 10-Q that are not based on historical fact are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management including, without limitation, our expectations regarding results of operations, selling, general and administrative expenses, research and development expenses, the sufficiency of our cash for future operations and the success of our pre-clinical, clinical and development programs and our dermatology franchise. Forward-looking statements may be identified by the use of forward-looking terminology such as “believes,” “may,” “will,” “expect,” “estimate,” “anticipate,” “continue,” or similar terms, variations of such terms or the negative of those terms.
We cannot assure investors that our assumptions and expectations will prove to have been correct. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those factors discussed below. We undertake no intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. If any of the following risks actually occur, our business, financial condition, results of operations or liquidity would likely suffer.
We are depending heavily on the success of our most advanced product candidate, Oracea, for the treatment of rosacea, which is still in clinical development. If we are unable to obtain approval for and commercialize Oracea, or experience significant delays in doing so, our business will be materially harmed.
We have invested a significant portion of our recent efforts and financial resources on the development of our most advanced product candidate, Oracea, for the treatment of rosacea. Our ability to generate substantial product revenues from Oracea, which we do not expect will occur for at least the next few years, if ever, will depend heavily on the successful development and commercialization of Oracea. The success of Oracea will depend on several factors, including the following:
| | • | receipt of marketing approvals from the FDA and similar foreign regulatory authorities; and |
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| | | |
| | • | acceptance of the product by patients, the medical community and third party payors. |
If we are unable to obtain FDA approval for and successfully commercialize Oracea, we may never realize revenue from this product candidate and we may have to curtail our other product development programs. As a result, our business would be materially harmed.
If we are not able to obtain and enforce patent protection for Oracea or our other discoveries, our ability to commercialize our product candidates successfully will be harmed and we may not be able to operate our business profitably.
Our success depends, in part, on our ability to protect proprietary methods and technologies that we develop under the patent and other intellectual property laws of the United States and other countries, so that we can prevent others from using our inventions and proprietary information. However, we may not hold proprietary rights to some patents related to our current or future products and technologies. Because patent applications in the United States and many foreign jurisdictions are typically not published until 18 months after filing, or in some cases not at all, and because publications of discoveries in scientific literature lag behind actual discoveries, we cannot be certain that we were the first to make the inventions claimed in issued patents or pending patent applications, or that we were the first to file for protection of the inventions set forth in our patent applications. As a result, we may be required to obtain licenses under third-party patents to market our proposed products. If licenses are not available to us on acceptable terms, or at all, we will not be able to market the affected products.
Our strategy depends on our ability to rapidly identify and seek patent protection for our discoveries. This process is expensive and time consuming, and we may not be able to file and prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. Despite our efforts to protect our proprietary rights, unauthorized parties may be able to obtain and use information that we regard as proprietary. The issuance of a patent does not guarantee that it is valid or enforceable, so even if we obtain patents, they may not be valid or enforceable against third parties. In addition, the issuance of a patent does not guarantee that we have the right to practice the patented invention. Third parties may have blocking patents that could be used to prevent us from marketing our own patented product and practicing our own patented technology.
Our pending patent applications may not result in issued patents. The patent position of pharmaceutical or biotechnology companies, including ours, is generally uncertain and involves complex legal and factual considerations. The standards which the United States Patent and Trademark Office and its foreign counterparts use to grant patents are not always applied predictably or uniformly and can change. There is also no uniform, worldwide policy regarding the subject matter and scope of claims granted or allowable in pharmaceutical or biotechnology patents. The laws of some foreign countries do not protect proprietary information to the same extent as the laws of the United States, and many companies have encountered significant problems and costs in protecting their proprietary information in these foreign countries. Accordingly, we do not know the degree of future protection for our proprietary rights or the breadth of claims allowed in any patents issued to us or to others. The allowance of broader claims may increase the incidence and cost of patent interference proceedings and/or opposition proceedings, and the risk of infringement litigation. On the other hand, the allowance of narrower claims may limit the value of our proprietary rights.
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If issued, our patent for Oracea may not contain claims sufficiently broad to protect us against third parties with similar products, or provide us with any competitive advantage. Moreover, once issued, any of our patents may be challenged, narrowed, invalidated or circumvented. In addition, the patent rights in our products that derive from claims under method of use patents may be hard to assert or enforce if medical professionals prescribe similar (including generic), though non-approved, doxycycline products for indications covered by our patents. If our patents are invalidated or otherwise limited, other companies will be better able to develop products and technologies that compete with ours, which could adversely affect our competitive business position, business prospects and financial condition.
We cannot assure you that our pursuit of business in the dermatology market will be successful.
We continue to implement our plans to expand into the dermatology market. We recently filed a New Drug Application with the FDA for Oracea to treat rosacea, and we continue to seek additional product licensing opportunities to enhance our near-term offerings to the dermatology market. We have also been allowed by the United States Patent and Trademark Office a patent for the use of sub-antimicrobial tetracyclines for the treatment of acne and acne rosacea, including Oracea.
While we have experience in the sales and marketing of dental products, we have limited experience in the dermatology market. This market is very competitive and some of our competitors have substantially greater resources than we have. Our future success will depend on, among other things, our ability to: (i) achieve market acceptance for any current or future dermatological offerings; (ii) hire and retain personnel with experience in the dermatology market; (iii) execute our business plan with respect to this market segment; and (iv) adapt to technical or regulatory changes once operational.
At the same time, new product development is a lengthy, complex and uncertain process that will require significant attention and resources from management. A product candidate can fail at any stage of the development process due to, among other things, efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. We therefore cannot assure you that we will be successful in our pursuit of business in the dermatology market, or that we can sustain any business in which we achieve initial success.
The success of our current technology platforms, and that of any other future technology platforms we may purchase or in-license, will depend on the quality and integrity of the technologies licensed or sold to us. Despite our due diligence and the safeguards we have in place, we cannot guarantee the effectiveness or integrity of such technologies, nor can we be certain that others do not have intervening rights in such technologies. If any of our in-licensed technologies proved ineffective, or if a third party successfully asserted any right to such technologies, our ability to develop new products and implement our strategies would be materially adversely affected.
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If we are not able to obtain required regulatory approvals, we will not be able to commercialize our product candidates, and our ability to generate revenue will be materially impaired.
Our product candidates and the activities associated with their development and commercialization, including their testing, manufacture, safety, efficacy, recordkeeping, labeling, storage, approval, advertising, promotion, sale and distribution, are subject to comprehensive regulation by the FDA and other regulatory agencies in the United States and by comparable authorities in other countries. Failure to obtain regulatory approval for a product candidate will prevent us from commercializing the product candidate. Other than Periostat, we have not received regulatory approval to market any of our product candidates in any jurisdiction. We have only limited experience in filing and prosecuting the applications necessary to gain regulatory approvals. Securing FDA approval requires the submission of extensive preclinical and clinical data, information about product manufacturing processes and inspection of facilities and supporting information to the FDA for each therapeutic indication to establish the product candidate’s safety and efficacy. Our future products may not be effective, may be only moderately effective or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.
The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon, among other things, the type, complexity and novelty of the product candidates involved. Changes in the regulatory approval policy during the development period, changes in or the enactment of additional statutes or regulations, or changes in regulatory review for each submitted product application, may cause delays in the approval or rejection of an application. The FDA has substantial discretion in the approval process and may refuse to accept any application or may decide that our data is insufficient for approval and require additional preclinical, clinical or other studies. In addition, varying interpretations of the data obtained from preclinical and clinical testing could delay, limit or prevent regulatory approval of a product candidate. Any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the product not commercially viable.
Our products could be subject to restrictions or withdrawal from the market and we may be subject to penalties if we fail to comply with regulatory requirements or if we experience unanticipated problems with our products, when and if any of them are approved.
Any product for which we obtain marketing approval, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for such product, will be subject to continual requirements of and review by the FDA and comparable regulatory bodies. These requirements include submissions of safety and other post-marketing information and reports, registration requirements, current Good Manufacturing Practice, or cGMP, requirements relating to quality control, quality assurance and corresponding maintenance of records and documents, requirements regarding the distribution of samples to
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physicians and recordkeeping. Even if regulatory approval of a product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to the conditions of approval, or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product. Later discovery of previously unknown problems with our products, manufacturers or manufacturing processes, or failure to comply with regulatory requirements, may result in:
| | • | restrictions on such products, manufacturers or manufacturing processes; |
| | | |
| | • | warning letters; |
| | | |
| | • | withdrawal of the products from the market; |
| | | |
| | • | refusal to approve pending applications or supplements to approved applications that we submit; |
| | | |
| | • | recall; |
| | | |
| | • | fines; |
| | | |
| | • | suspension or withdrawal of regulatory approvals; |
| | | |
| | • | refusal to permit the import or export of our products; |
| | | |
| | • | product seizure; and |
| | | |
| | • | injunctions or the imposition of civil or criminal penalties. |
We cannot predict with certainty the effect on our business of the decline in revenues generated by the dental business following the commercial launch of generic versions of Periostat and the termination of our dental sales force.
We have historically relied on sales of Periostat and Mutual’s branded version of Periostat, together with revenues generated by the other products that made up our dental business, for most of our revenue. During the six months ended June 30, 2005 and each of the years ended December 31, 2004, 2003 and 2002, Periostat and Mutual’s branded version of Periostat (with respect to the six months ended June 30, 2005 and the year ended December 31, 2004), accounted for approximately 83%, 88%, 82% and 82% of our total net revenues, respectively.
On May 13, 2005, the FDA approved a third party generic version of Periostat and a generic product was launched soon thereafter in late May 2005. Upon this generic launch, Mutual was no longer obligated to purchase and are not expected to purchase their branded product from us. We do not anticipate future shipments to Mutual of Mutual’s branded version of Periostat. In addition, we have had to disband our dental sales force and delay or discontinue certain research and development activities in the dental business. Consequently, while we continue to generate cash flow from the dental business, our revenues and margins from Periostat and the volume of our other dental business, have decreased significantly and are anticipated to
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continue to decrease as a result of the third party introduction of a generic version of Periostat. If this decrease is more significant than we expect, we may experience difficulty in managing our cash, which would have a material adverse effect on our ability execute our strategies and develop our dermatology business.
We cannot assure you that our clinical trials will be completed in a timely manner or will meet agreed upon end-points.
As part of our plans to expand into the dermatology market, we will need to conduct extensive testing of our products, pursuant to protocols that measure end points agreed with the FDA. We cannot guarantee that Phase I, Phase II, or Phase III testing for our products in development will be completed successfully within any specified period of time, if at all. Many products that initially appear promising are found, after clinical evaluation, not to be safe and effective. Also, we, or the FDA, may suspend clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk.
Although we have not to date experienced any significant delays in enrolling Phase III clinical trial patients for our ongoing clinical trials, delays in patient enrollment for future trials may result in increased costs and delays, which could have a harmful effect on our ability to develop products.
It may take several years to complete the testing of a product, and failure can occur at any stage of testing. For example:
| | • | interim results of preclinical or clinical studies do not necessarily predict their final results, and results in early studies might not be seen in later studies; |
| | | |
| | • | potential products that appear promising at early stages of development may ultimately fail for a number of reasons, including the possibility that the products may be ineffective, less effective than products of our competitors or cause harmful side effects; |
| | | |
| | • | any preclinical or clinical test may fail to produce results satisfactory to the FDA or foreign regulatory authorities; |
| | | |
| | • | preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval; |
| | | |
| | • | negative or inconclusive results from a preclinical study or clinical trial or adverse medical events during a clinical trial could cause a preclinical study or clinical trial to be repeated or a program to be terminated, even if other studies or trials relating to the program are successful; |
| | | |
| | • | the FDA can place a hold on a clinical trial if, among other reasons, it finds that patients enrolled in the trial are or would be exposed to an unreasonable and significant risk of illness or injury; |
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| | | |
| | • | we may encounter delays or rejections based on changes in regulatory agency policies during the period in which we develop a drug or the period required for review of any application for regulatory agency approval; and |
| | | |
| | • | our clinical trials may not demonstrate the safety and efficacy needed for our products to receive regulatory approval. |
If we are required to conduct additional clinical trials or other studies beyond those that we currently contemplate, if we are unable to successfully complete our clinical trials or other studies or if the results of these trials or studies are not positive or are only modestly positive, we may be delayed in obtaining marketing approval, we may not be able to obtain marketing approval or we may obtain approval for indications that are not as broad as intended. Our product development costs will also increase if we experience delays in testing or approvals. Significant clinical trial delays could allow our competitors to bring products to market before we do and impair our ability to commercialize our products or potential products. If any of this occurs, our business will be materially harmed.
If we infringe or are alleged to infringe intellectual property rights of third parties, it will adversely affect our business.
Our research, development and commercialization activities, as well as any product candidates or products resulting from these activities, may infringe or be claimed to infringe patents or patent applications under which we do not hold licenses or other rights. Third parties may own or control these patents and patent applications in the United States and abroad. These third parties could bring claims against us or our collaborators that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages. Further, if a patent infringement suit were brought against us or our collaborators, we or they could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit.
As a result of patent infringement claims, or in order to avoid potential claims, we or our collaborators may choose or be required to seek a license from the third party and be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we or our collaborators were able to obtain a license, the rights may be nonexclusive, which could result in our competitors gaining access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations, if, as a result of actual or threatened patent infringement claims, we or our collaborators are unable to enter into licenses on acceptable terms. This could harm our business significantly.
There has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the pharmaceutical and biotechnology industries. In addition to infringement claims against us, we may become a party to other patent litigation and other proceedings, including interference proceedings declared by the United States Patent and Trademark Office and opposition proceedings in the European Patent Office, regarding intellectual property rights with respect to our products and technology. The cost to us of any patent litigation or other proceeding, even if resolved in our favor, could be substantial.
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Some of our competitors may be able to sustain the costs of such litigation or proceedings more effectively than we can because of their substantially greater financial resources. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace. Patent litigation and other proceedings may also absorb significant management time.
We depend upon third party researchers and providers of clinical services to perform as contractually required if we are to be successful in bringing new products to market.
We do not have the ability independently to conduct the clinical trials required to obtain regulatory approval for our products. We rely on independent clinical investigators, contract research organizations and other third party service providers for successful execution of our clinical trials, but do not control many aspects of their activities. We are responsible for ensuring that each of our clinical trials is conducted in accordance with the general investigational plan, protocols for the trial and applicable regulatory requirements. Moreover, the FDA requires us to comply with standards, commonly referred to as Good Clinical Practices, for conducting and recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the rights, integrity and confidentiality of trial participants are protected. Our reliance on third parties that we do not control does not relieve us of these responsibilities and requirements. Third parties may not, however, complete activities on schedule, or may not conduct our clinical trials in accordance with regulatory requirements or our stated protocols. Furthermore the data that they generate may not be accurate or may, in extreme cases, be fraudulent.
Our ability to bring our future products to market depends on the quality and integrity of the data we present to regulatory authorities in order to obtain marketing authorizations. We cannot guarantee the authenticity or accuracy of such data, nor can we be certain that such data has not been fraudulently generated. The failure of these third parties to carry out their obligations would materially adversely affect our ability to develop and market new products and implement our strategies.
We depend upon certain key relationships to generate much of the technology required to maintain our competitive position in the marketplace.
Our IMPACS technology is licensed from SUNY (the “SUNY License”), and other academic and research institutions collaborating with SUNY. Under the SUNY License, we have an exclusive worldwide license to SUNY’s rights in certain patents and patent applications to make and sell products employing tetracyclines to treat certain disease conditions. The SUNY License imposes various payment and reporting obligations on us, and our failure to comply with these requirements permits SUNY to terminate the SUNY License. If the SUNY License is terminated, we would lose our right to exclude competitors from commercializing similar products, and we could be excluded from marketing the same products if SUNY licensed the underlying technology to a competitor after terminating the SUNY License. The SUNY License is terminable by SUNY on 90 days prior notice only upon our failure to make timely payments, reimbursements or reports, if the failure is not cured by us within 90 days. The termination of the SUNY License, or the failure to obtain and maintain patent protection for our technologies, would have a material adverse effect on our business, financial condition, liquidity and results of operations.
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If our products cause injuries, we may incur significant expense and liability.
Our business may be adversely affected by potential product liability claims arising out of the testing, manufacturing and marketing of Periostat and other products developed by or for us or for which we have licensing or promotion and cooperation rights. We have an aggregate of $10.0 million in product liability insurance ($5.0 million for pediatric claims) covering Periostat and Mutual’s branded version of Periostat, our product candidates and products for which we have licensing or promotion and cooperation rights.
Our insurer has also notified us that our general product liability policy will not cover claims arising from our past sales of Vioxx, to the extent such claims are made after December 31, 2004. This does not affect our rights under the Co-Promotion Agreement with Merck, which provides for indemnification of us by Merck against any claims arising from manufacturing or design defects in the Vioxx product or for which we, as the seller of the product, may be strictly liable as a seller of an inherently dangerous product.
Our insurance may not adequately protect us against product liability claims. Insufficient insurance coverage or the failure to obtain indemnification from third parties for their respective liabilities may expose us to product liability claims and/or recalls and could cause our business, financial condition and results of operations to decline.
Changes in stock option accounting rules may have a significant adverse affect on our operating results.
We have a history of using broad based employee stock option programs to hire, incentivize and retain our workforce in a competitive marketplace. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” allows companies the choice of either using a fair value method of accounting for options that would result in expense recognition for all options granted, or using an intrinsic value method, as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB 25, with a pro forma disclosure of the impact on net income (loss) of using the fair value option expense recognition method. We have elected to apply APB 25 and, accordingly, we generally have not recognized any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.
In December 2004, the Financial Accounting Standards Board issued “Share-Based Payment” (Statement 123(R)). Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant-date fair value of the equity instruments issued. In determining the fair value of options and other equity-based awards, companies may use different valuation models that may involve extensive and complex analysis. Statement 123(R) will be effective for us no later than January 1, 2006, which is the first day of our 2006 fiscal year. We are in the process of reviewing Statement 123(R) to determine which model is more appropriate for us.
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While we continue to evaluate the effect that the adoption of Statement 123(R) will have on our financial position and results of operations, we currently expect that our adoption of Statement 123(R) will adversely affect our operating results to some extent in future periods.
Our stock price is highly volatile and, therefore, the value of your investment may fluctuate significantly.
The market price of our common stock has fluctuated and may continue to fluctuate as a result of variations in our quarterly operating results. These fluctuations may be exaggerated if the trading volume of our common stock is low. In addition, the stock market in general has experienced dramatic price and volume fluctuations from time to time. These fluctuations may or may not be based upon any business or operating results. Our common stock may experience similar or even more dramatic price and volume fluctuations that may continue indefinitely.
The following table sets forth the high and low closing market price per share for our common stock for each of the quarters in the period beginning July 1, 2002 through June 30, 2005, as reported on the Nasdaq National Market:
Quarter Ended | | High | | Low | |
| |
| |
| |
| September 30, 2002 | | $ | 7.34 | | $ | 4.70 | |
| December 31, 2002 | | $ | 9.74 | | $ | 4.61 | |
| March 31, 2003 | | $ | 11.03 | | $ | 6.66 | |
| June 30, 2003 | | $ | 13.27 | | $ | 8.62 | |
| September 30, 2003 | | $ | 15.84 | | $ | 10.50 | |
| December 31, 2003 | | $ | 11.82 | | $ | 8.90 | |
| March 31, 2004 | | $ | 14.16 | | $ | 10.07 | |
| June 30, 2004 | | $ | 13.21 | | $ | 8.70 | |
| September 30, 2004 | | $ | 9.49 | | $ | 6.09 | |
| December 31, 2004 | | $ | 7.49 | | $ | 5.37 | |
| March 31, 2005 | | $ | 7.52 | | $ | 4.50 | |
| June 30, 2005 | | $ | 7.61 | | $ | 3.99 | |
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We had cash and cash equivalents and short-term investments at June 30, 2005 which are exposed to the impact of interest rate changes and our interest income fluctuates as interest rates change. Due to the short-term nature of our investments in money market funds, the carrying values of our cash equivalents approximate their fair value at June 30, 2005. Our short-term investments in commercial paper and government notes are carried at fair value.
Item 4. Controls and Procedures.
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of
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June 30, 2005. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2005, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
On October 1, 2004, we filed a complaint for patent infringement against IVAX and CorePharma in the United States District Court for the Eastern District of New York. In our complaint, we alleged that the submission of ANDAs by each of IVAX and CorePharma for 20 mg tablets of doxycycline hyclate infringed United States Patent RE 34,656, for which we are the exclusive licensee. We also alleged that any manufacture, importation, marketing and sale of generic 20 mg tablets of doxycycline hyclate by IVAX and CorePharma would infringe the RE 34,656 patent. We sought an injunction preventing IVAX and CorePharma from introducing 20 mg tablets of doxycycline hyclate in the United States. The injunction was denied by the Court on June 16, 2005. The litigation on the merits of our patent infringement claims is ongoing.
Item 4. Submission of Matters to a Vote of Security Holders.
Our Annual Meeting of Stockholders was held on May 25, 2005.
There were present at the Annual Meeting in person or by proxy stockholders holding an aggregate of 13,184,711 shares of Common Stock and 189,000 shares of Series D preferred stock, which shares of Series D preferred stock account for an additional 1,910,385 shares of Common Stock on an as converted to Common Stock basis. The results of the vote taken at the Annual Meeting with respect to the election of the nominees to be the Common Stock directors were as follows:
Common Stock Nominees | | For | | Withheld |
| |
| |
|
| Colin W. Stewart | | | | |
| Brian M. Gallagher, Ph.D. | | | | |
| Peter R. Barnett, D.M.D. | | | | |
| Robert C. Black | | | | |
| James E. Daverman | | | | |
| Robert J. Easton | | | | |
| W. James O’Shea | | | | |
The results of the vote taken at the Annual Meeting with respect to the election of the nominee to be the Series D Director, Robert A. Beardsley, Ph.D., were as follows: 1,910,385 shares of Series D preferred stock (on an as converted to Common Stock basis) were voted for the Series D preferred stock nominee, with no shares voting against or abstaining.
A vote of the stockholders was taken at the Annual Meeting with respect to the proposal to approve the Company’s 2005 Equity Incentive Plan. For the purposes of such vote, the holders of shares of Common Stock and the holders of Series D preferred stock (on an as converted to Common Stock basis) voted together as a single class. Of such shares, 7,258,121 shares voted in favor of such proposal, 2,926,074 shares were voted against such proposal and 35,246 shares abstained from voting.
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In addition, a vote of the stockholders was taken at the Annual Meeting with respect to the proposal to ratify the selection by the Audit Committee of the appointment of KPMG LLP as the independent registered public accounting firm of the Company for the fiscal year ending December 31, 2005. For the purpose of such vote, the holders of shares of Common Stock and the holders of Series D preferred stock (on an as converted to Common Stock basis) voted together as a single class. Of such shares, 15,065,685 shares voted in favor of such proposal, 20,961 shares were voted against such proposal and 8,450 shares abstained from voting.
Item 6. Exhibits.
| 10.1 | Form of Nonstatutory Stock Option Agreement for 2005 Equity Incentive Plan. |
| | |
| 10.2 | Form of Incentive Stock Option Agreement for 2005 Equity Incentive Plan. |
| | |
| 10.3 | Nonstatutory Stock Option Agreement dated as of June 29, 2005 by and between CollaGenex Pharmaceuticals, Inc. and Peter R. Barnett, D.M.D. |
| | |
| 10.4 | Nonstatutory Stock Option Agreement dated as of June 29, 2005 by and between CollaGenex Pharmaceuticals, Inc. and Robert C. Black. |
| | |
| 10.5 | Nonstatutory Stock Option Agreement dated as of May 26, 2005 by and between CollaGenex Pharmaceuticals, Inc. and Brian M. Gallagher, Ph.D. |
| | |
| 10.6 | Nonstatutory Stock Option Agreement dated as of May 26, 2005 by and between CollaGenex Pharmaceuticals, Inc. and James E. Daverman. |
| | |
| 10.7 | Nonstatutory Stock Option Agreement dated as of June 29, 2005 by and between CollaGenex Pharmaceuticals, Inc. and Robert J. Easton. |
| | |
| 10.8 | Nonstatutory Stock Option Agreement dated as of June 29, 2005 by and between CollaGenex Pharmaceuticals, Inc. and W. James O’Shea. |
| | |
| 10.9 | Nonstatutory Stock Option Agreement dated as of June 29, 2005 by and between CollaGenex Pharmaceuticals, Inc. and Robert A. Beardsley, Ph.D. |
| | |
| 31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
| 31.2 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350. |
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SIGNATURES
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.
| | COLLAGENEX PHARMACEUTICALS, INC. |
| | | |
| Date: August 9, 2005 | By: | /s/ COLIN W. STEWART |
| | |
|
| | | Colin W. Stewart |
| | | President and Chief Executive Officer |
| | | (Principal Executive Officer) |
| | | |
| Date: August 9, 2005 | By: | |
| | |
|
| | | Nancy C. Broadbent |
| | | Chief Financial Officer (Principal |
| | | Financial and Accounting Officer) |
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