Research and development expense decreased by $1,180,000, or 23%, in the three months ended March 31, 2006 to $3,987,000 from $5,167,000 in the three months ended March 31, 2005. This decrease was attributable to certain 2005 expenses, including costs associated with the improved manufacturing efficiencies of Oxandrin, toxicology studies of Prosaptide and Puricase (PEG-uricase) patent and trademark costs, partially offset by an increase in Puricase (PEG-uricase) study and material costs in the first three months of 2006. In December 2005, the Company made the decision to terminate all development efforts related to Prosaptide.
Marketing and sales expense decreased by $358,000, or 7%, in the three months ended March 31, 2006 to $4,656,000 from $5,014,000 in the three months ended March 31, 2005. The decrease was primarily attributable to the reduction of sales outsourcing in 2006.
General and administrative expense increased by $3,339,000 or 62%, in the three months ended March 31, 2006 to $8,710,000 from $5,371,000 in the three months ended March 31, 2005. The increase in general and administrative expense primarily resulted from significant increases in audit and consulting fees related to the completion of our restatement and year-end audit. Additionally, we incurred a significant increase in consulting fees related to accounting and finance outsourcing and compliance with the requirements of the Sarbanes-Oxley Act, as well as an increase in legal expense and compensation expenses. Our audit and consulting fees related to our restatement were approximately $1.0 million in the first quarter of 2006 and our consulting fees related to accounting and finance outsourcing and Sarbanes-Oxley compliance increased approximately $1.0 million during the first quarter of 2006.
Amortization of intangibles. In connection with our acquisition of our oral liquid pharmaceutical business, we recorded intangibles of $80,800,000, consisting of developed products, trademarks and patents. We are amortizing these intangibles using the straight-line method over the estimated useful life of approximately 20 years. We recorded $1,013,000 of amortization of these intangibles in the first three months of each of 2006 and 2005.
Commissions and royalties expense was $1,000 in the three months ended March 31, 2006, compared to $1,319,000 in the three months ended March 31, 2005. The decrease was primarily attributable to the termination of our agreement with Ross Products Division of Abbott Laboratories on sales of Oxandrin for the long-term care market and an elimination of the royalties that we previously paid related to arrangements involving our former Delatestryl and Mircette products.
Other income, net was $8,855,000 for the three months ended March 31, 2006, compared to $2,186,000 for the three months ended March 31, 2005. The change is primarily attributable to the gain on sale of Delatestryl of approximately $6.0 million, an increase of approximately $1.2 million in net investment income primarily due to the increase in our cash position and a $1.3 million settlement due from Ross Pharmaceutical Limited related to commission payment overcharges.
Income taxes. Provision for income taxes for the three months ended March 31, 2006 was $1,561,000, compared to provision for income taxes $126,000 for the three months ended March 31, 2005. The increase in the provision for income taxes was primarily attributable to our oral liquid pharmaceutical products segment.
Our working capital at March 31, 2006 was $89,343,000, compared to an adjusted working capital figure of $84,997,000 at December 31, 2005.
Our cash flows have fluctuated significantly as a result of changes in our revenues, operating expenses, capital spending, working capital requirements, the issuance of common stock and other financing activities. We expect that cash flows in the near future will be primarily determined by the levels of our net income,
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working capital requirements, milestone payment obligations and financings, if any. Net cash increased by $13,832,000 and $2,346,000 in the three months ended March 31, 2006 and 2005, respectively.
Net cash provided by operating activities was $2,033,000 in the three months ended March 31, 2006, compared to $2,919,000 in the three months ended March 31, 2005. Net income was $3,978,000 in the three months ended March 31, 2006, compared to a net loss of $477,000 in the three months ended March 31, 2005.
In the three months ended March 31, 2006, net cash provided by operating activities was less than our net income primarily due to the gain on sale of Delatestryl of $5,997,000, an increase in inventory of $951,000, an increase in prepaid expenses and other current assets of $1,320,000, and a decrease in other current liabilities of $2,337,000, partially offset by amortization of intangible assets of $1,013,000, a decrease in accounts receivable, net, of $2,717,000 and an increase in accounts payable of $4,242,000. In the three months ended March 31, 2005, net cash provided by operating activities was greater than our loss because of amortization of intangible assets of $1,013,000, a decrease in accounts receivables of $2,545,000, a decrease in inventory of $890,000 and a decrease in assets held for sale of $4,958,000, partially offset by a $788,000 decrease in liabilities held for sale and a $5,993,000 decrease in other current liabilities, of which $3,000,000 was related to the retirement of reserves for two specified litigations.
Net cash provided by investing activities was $11,545,000 in the three months ended March 31, 2006, compared to net cash provided by investing activities was $1,003,000 in the three months ended March 31, 2005. Net cash provided by investing activities in the three months ended March 31, 2006 primarily was attributable to proceeds from the sale of Delatestryl of $5,644,000 and proceeds from the collection of a note receivable issued in connection with the sale of our former global biologics manufacturing business of $6,700,000, partially offset by capital expenditures of $805,000. In the three months ended March 31, 2005, net cash provided by investing activities primarily related to proceeds from the sale of our investment in Omrix Corporation of $1,625,000, partially offset by capital expenditures of $578,000.
Net cash provided by financing activities was $161,000 in the three months ended March 31, 2006, compared to net cash used in financing activities was $1,466,000 in the three months ended March 31, 2005. The net cash provided by financing activities in the three months ended March 31, 2006 was related to proceeds from issuance of common stock. The net cash used in financing activities in the three months ended March 31, 2005 primarily reflected repayment of $1,759,000 of debt, partially offset by net proceeds from issuance of common stock.
We believe that our cash resources as of March 31, 2006, together with anticipated product sales, will be sufficient to fund our ongoing operations for at least the next twelve months. However, we may fail to achieve our anticipated liquidity levels as a result of unexpected events or failure to achieve our goals. Our future capital requirements will depend on many factors, including the following:
| | • | the timing and amount of product sales, particularly our continued ability to sell Oxandrin prior to the introduction of generic versions of the product; |
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| | • | continued progress in our research and development programs, particularly with respect to Puricase (PEG-uricase); |
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| | • | the timing of, and the costs involved in, obtaining regulatory approvals, including regulatory approvals for Puricase (PEG-uricase), and any other product candidates that we may seek to develop in the future and regulatory approval to enable Rosemont to manufacture oral liquid pharmaceutical products for supply into the U.S. market; |
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| | • | the timing and magnitude of any future milestone payment obligations; |
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| | • | fluctuations in foreign exchange rates for sales denominated in currencies other than the U.S. dollar; |
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| | • | the quality and timeliness of the performance of our third party suppliers and distributors; |
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| | • | the cost of commercialization activities, including product marketing, sales and distribution; |
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| | • | the costs involved in preparing, filing, prosecuting, maintaining, and enforcing patent claims and other patent related costs, including litigation costs and the results of such litigation; |
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| | • | the outcome of pending purported class action and other related, or potentially related, actions and the litigation costs with respect to such actions; and |
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| | • | our ability to establish and maintain collaborative arrangements. |
If we are required to seek additional funding for our operations, we might not be able to obtain such additional funds or, if such funds are available, such funding might be on unacceptable terms. We continue to seek additional collaborative research and development and licensing arrangements in order to provide revenue from sales of certain products and funding for a portion of the research and development expenses relating to the products covered. However, we may not be able to enter into any such agreements.
Critical Accounting Policies and the Use of Estimates |
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States. Applying these principles requires our judgment in determining the appropriateness of acceptable accounting principles and methods of application in diverse and complex economic activities. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of revenues, expenses, assets and liabilities, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
While our significant accounting policies are more fully described in Note 1 to our consolidated financial statements included in this report, we believe the following accounting policies are most critical to aid in fully understanding and evaluating our reported financial results:
Product revenue recognition. Product sales are recognized when title to the product has transferred to our customers in accordance with the terms of the sale. We recognize revenue in accordance with the SEC’s Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by Staff Accounting Bulletin No. 104 (together, “SAB 104”), and SFAS No. 48 “Revenue Recognition When Right of Return Exists” (“SFAS No. 48”). SAB 104 states that revenue should not be recognized until it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed and determinable; and (4) collectibility is reasonably assured. SFAS No. 48 states that revenue from sales transactions where the buyer has the right to return the product shall be recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated.
Our net product revenues represent total product revenues less allowances for returns, Medicaid rebates, other government rebates, discounts, and distribution fees.
Allowances for returns. In general, we provide credit for product returns that are returned six months prior to and twelve months after the product expiration date. Our product sales in the United States primarily relate to the following three products:
Product | | Expiration (in years) | |
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| Oxandrin 2.5 mg | | | 5 | |
| Oxandrin 10 mg (1) | | | 3 | |
| Delatestryl (2) | | | 5 | |
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| (1) | In 2006, the Company determined, based on its review of stability data, that the Oxandrin 10mg dosage form demonstrated stability over a 3 year shelf life and thus the Company modified the product’s label to indicate a 3 year expiration date. For periods prior to the Company’s March 31, 2006 balance sheet date, this product dosage was sold with 2 year expiration dating. |
| (2) | On January 9, 2006, the Company completed its sale of Delatestryl to Indevus Pharmaceuticals, Inc. |
Upon sale, we estimate an allowance for future returns. We will provide additional return reserves for contemporaneous events that were not known and knowable at the time of shipment. In order to reasonably estimate future returns, we analyze both quantitative and qualitative information including, but not limited to, actual return rates by lot productions, the level of product manufactured by us, the level of product in the distribution channel, expected shelf life of the product, current and projected product demand, the introduction of new or generic products that may erode current demand, and general economic and industry wide indicators. Certain specifics regarding these analyses are as follows:
| | • | Actual return rates — We track actual returns by product and analyzes historical return trends. We use these historical trends as part of our overall process of estimating future returns. |
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| | • | The level of product manufactured — The level of product produced has an impact on the valuation of that product. For productions that exceed anticipated future demand, a valuation adjustment will be required. Generally, this valuation adjustment occurs as an offset to gross inventory. During 2003, the valuation adjustment also impacted return reserves since product entered the channel with expiration dating that was below our then-standard of ten months before expiration. Currently, we have mandated that product with less than twelve months of expiry dating will not be sold into the channel. |
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| | • | Level of product in the distribution channel — From the third quarter of 2002 through the first quarter of 2004, we followed the practice of offering customers quarter-end promotions and pricing incentives with specified maximum purchases to ensure that supplies in the distribution channel would be sufficient to avoid stock outs. Analyses have shown that, although these quarter-end promotions caused wholesaler buying spikes, the channel was not inflated. Based upon our review of the wholesaler inventory and third-party prescription data that were and are available to us, the level of product in the channel is at a reasonable level at an average of approximately three months or less. Given the twelve-month shipping policy, the level of product in the distribution channel appears reasonable for both five- year and two-year expiration product. |
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| | • | Estimated shelf life — Product returns generally occur due to product expiration. Therefore, it is important for us to ensure that product sold into the channel has excess dating that will allow the product to be sold through the channel without nearing its expiration date. Currently we have mandated that product with less than twelve months of expiry dating will not be sold into the channel. We have taken the appropriate measures to enforce this policy, including setting up certain controls with our third party distributor. In addition, we entered into a distributor service agreement with one of our large wholesalers which limits the level of product at the wholesaler. The terms of this agreement are consistent with the industry’s movement toward a fee-for-service approach which we believe has resulted in better channel inventory management, higher levels of channel transparency, and more consistent buying and selling patterns. Since a majority of our sales flow through three large wholesalers, we expect that these industry changes will have a direct impact on our future sales to wholesalers, inventory management, product returns and estimation capabilities. |
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| | • | Current and projected demand — We analyze prescription demand data provided by industry standard third-party sources. This data is used to estimate the level of product in the channel and to determine future sales trends. |
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| | • | Product launches and new product introductions — For future product launches, we will analyze projected product demand and production levels in order to estimate return and inventory reserve allowances. New product introductions, including generics, will be monitored for market erosion and adjustments to return estimates will be made accordingly. |
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We also utilize the guidance provided in SFAS No. 48 and SAB 104 in establishing our return estimates. SFAS No. 48 discusses potential factors that may impair the ability to make a reasonable estimate including: (1) the susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand, (2) relatively long periods in which a particular product may be returned, (3) absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprise’s marketing policies or relationships with its customers, and (4) absence of a large volume of relatively homogeneous transactions. SAB 104 provides additional factors that may impair the ability to make a reasonable estimate including: (1) significant increases in or excess levels of inventory in a distribution channel (sometimes referred to as “channel stuffing”), (2) lack of “visibility” into or the inability to determine or observe the levels of inventory in a distribution channel and the current level of sales to end users, (3) expected introductions of new products that may result in the technological obsolescence of and larger than expected returns of current products, (4) the significance of a particular distributor to the registrant’s (or a reporting segment’s) business, sales and marketing, (5) the newness of a product, (6) the introduction of competitors’ products with superior technology or greater expected market acceptance, and (7) other factors that affect market demand and changing trends in that demand for the registrant’s products.
The aggregate net return allowance reserves as of March 31, 2006 and December 31, 2005 was $2,399,000 and $2,888,000, respectively.
Allowances for Medicaid and other government rebates. Our contracts with Medicaid and other government agencies such as the Federal Supply System commit us to providing those agencies with our most favorable pricing. This ensures that our products remain eligible for purchase or reimbursement under these government-funded programs. Based upon our contracts and the most recent experience with respect to sales through each of these channels, we provide an allowance for rebates. We monitor the sales trends and adjusts the rebate percentages on a regular basis to reflect the most recent rebate experience. The aggregate net rebate accrual balances as of March 31, 2006 and December 31, 2005 was $3,003,000 and $2,491,000, respectively.
Inventory valuation. We state inventories at the lower of cost or market. We determine cost using the weighted-average method. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, we record reserves for the difference between the cost and the market value. We determine these reserves based on estimates.
The aggregate net inventory valuation reserves as of March 31, 2006 and December 31, 2005 were $6,865,000 and $7,740,000, respectively.
Our inventories include Oxandrin inventories that we believe would potentially be in excess of expected product demand if the FDA approves a generic form of the product in the near term. The amount of such potential excess will vary depending upon the timing of the approval of a generic product, the number of generic products that are approved and the rate by which generic sales reduce demand for branded Oxandrin.
Stock Based Compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS No. 123(R)”) using the modified-prospective-transition method. Under this transition method, compensation cost in 2006 includes cost for options granted prior to, but not amortized, as of December 31, 2005. The modified-prospective-transition method does not result in the restatement of prior periods which were accounted for under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. Options are granted to certain employees and directors at prices equal to the market value of the stock on the dates the options were granted. The options granted have a term of 10 years from the grant date and granted options for employees generally vest ratably over a four year period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. We have estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are highly subjective, judgmental and sensitive in the determination of compensation expense, including the option’s expected term and the price volatility of the underlying stock.
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The cumulative effect on net income from continuing operations and net income in the three months ended March 31, 2006 related to the adoption of SFAS No. 123(R) is approximately $325,000 which includes both stock option and employee stock purchase plan expenses. As of March 31, 2006, there was $1.4 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to unamortized stock option compensation which is expected to be recognized over a weighted average period of approximately 1.4 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. To date our exposure to market risk has been limited. We do not currently hedge any market risk, although we may do so in the future. We do not hold or issue any derivative financial instruments for trading or other speculative purposes.
Our material interest-bearing assets consist of cash and cash equivalents and short-term investments, including investments in commercial paper, time deposits and other debt instruments. Our interest income is sensitive to changes in the general level of interest rates, primarily U.S. interest rates, and other market conditions.
As a result of our operations in the United Kingdom, we are subject to currency exchange rate fluctuations that can affect our results of operations.
ITEM 4. CONTROLS AND PROCEDURES |
a) Evaluation of disclosure controls and procedures.
The Company is required to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) as appropriate, to allow timely decisions regarding required disclosure.
In connection with the preparation of the Form 10-Q for the period ended March 31, 2006, management, under the supervision of the CEO and CFO, conducted an evaluation of disclosure controls and procedures. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were not effective as of March 31, 2006 due to the material weaknesses described in the Company’s management report on internal control over financial reporting included in Item 9A to its 2005 Form 10-K (the “2005 Form 10-K”) and outlined below. To date, the material weaknesses identified in the 2005 Form 10-K have not been fully remediated. Additionally, since the material weaknesses described below have not been fully remediated, the CEO and CFO continue to conclude that the Company’s disclosure controls and procedures are not effective as of the filing date of this Form 10-Q.
As disclosed in the 2005 Form 10-K, management identified the following material weaknesses in connection with its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005:
| | • | insufficient personnel resources that are in dedicated permanent positions within the finance function with sufficient skills and industry knowledge of GAAP and tax, which resulted in insufficient documentation and monitoring over the financial statement close and restatement of quarterly financial reporting attributed to (a) deficiencies in the analysis of estimates relating to product returns, inventory obsolescence and rebates and (b) errors in the income tax provision; |
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| | • | deficiencies in the income tax analysis consisting of (a) insufficient review of the U.K. tax provision by Rosemont management in the United Kingdom and by the corporate tax function, (b) insufficient monitoring of U.K. tax regulation changes and (c) inaccurate calculation of quarterly tax provision; |
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| | • | insufficient communication at the intercompany and intradepartmental level and between the Company and its third-party service and data providers. At the intradepartmental level, inconsistent exchange of important financial information between the Company’s finance and operating functions led to errors in |
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| | | reporting. The insufficient coordination of data exchanged between the Company and certain third party service providers resulted in errors in quarterly product return estimates, as previously restated, and also resulted in certain shortfalls related to the Company’s administration of its stock incentive award programs; |
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| | • | insufficient controls over the Cash and Treasury process including (a) authorization, monitoring and segregation of duties over wire transfers, (b) non-timely revision of signature authority over Company bank accounts and (c) monitoring and segregation of duties with respect to access to check stock at Rosemont; and |
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| | • | insufficient control over the authorization of the Employee Stock Purchase Plan purchases and accounting for pro forma stock based compensation expense in accordance with SFAS No. 123, Accounting for Stock Based Compensation, the latter of which resulted in errors to and restatement of the historically reported pro forma stock based compensation expense disclosures. |
b) Remediation Steps to Address Material Weakness.
As described below, through March 31, 2006, we have implemented, or plan to implement, the following measures to remediate the material weaknesses described above and in our 2005 Form 10-K.
Accounting and Tax Personnel |
The Company has hired the following accounting personnel:
| | • | Chief Financial Officer, on an interim basis, effective October 5, 2005, to coordinate the restatement effort (completed during January 2006) and to improve financial controls and procedures. This interim Chief Financial Officer replaced the Company’s former Chief Financial Officer, who resigned effective October 5, 2005. The Company is diligently searching for a permanent replacement Chief Financial Officer and expects to fill this position during the second quarter of 2006. |
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| | • | Vice President — Finance and Controller, effective February 6, 2006 to assist with the implementation of internal controls over financial reporting. |
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| | • | Financial Analyst, effective January 23, 2006 to provide an additional accounting resource. |
Additional remediation steps related to accounting and tax personnel are as follows:
| | • | a self sufficient tax department has been developed that will coordinate all tax financial reporting matters and tax compliance processes; |
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| | • | recruitment of additional personnel with SEC reporting and financial planning experience; |
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| | • | assessment of finance staff capabilities and provide training to new and existing personnel on corporate policies and procedures; and |
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| | • | changes are being made in assigned roles and responsibilities within the accounting department to complement the hiring of additional accounting personnel and enhance our segregation of duties within the Company. |
Our remediation steps related to the Company’s review of the U.K. tax provision, the monitoring of U.K. tax regulation changes, and enhancement of its quarterly tax provision process include:
| | • | retained a U.K. tax specialist during the first quarter of 2006 to review Rosemont’s tax provision and to provide technical tax expertise as needed; |
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| | • | engaged external tax consultants during the first quarter of 2006 to provide additional tax expertise related to the 2005 year end closing process and to provide on going tax support; |
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| | • | continuing to enhance its review procedures related to both domestic and foreign tax calculations; and |
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| | • | establishment of periodic finance meetings to discuss tax issues and tax implications of significant business matters. |
Our remediation steps related to improving internal departmental communications include:
| | • | instituting communication protocols that will foster improved shared intelligence between the finance function and other departments including, but not limited to, legal, operations, and executive management; |
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| | • | conducting reviews of significant contracts by the accounting department for completeness, accuracy and proper accounting treatment, including accounting input into contract terms prior to execution of significant contracts; and |
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| | • | commenced an overall increase in the communication level between parent and subsidiary personnel, including the establishment of standardized periodic meetings to discuss business results and objectives. |
Our remediation steps related to improving communications with third parties include:
| | • | establishment of periodic meetings with third party process providers in order to educate these entities regarding our enhanced policies and procedures; |
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| | • | having third party process providers educate us on the level of data that they provide, the controls over their processes, and how we can better utilize the information that is currently available; and |
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| | • | institute monthly reporting standards from third party process providers and third party vendors/ customers that will enhance our estimation capabilities. We have historically received many of these reports; however, standards related to these reports will assist us with financial reporting timing and accuracy. |
Our remediation steps related to controls over the cash and treasury process include:
| | • | the segregation of duties has been evaluated and changes are being implemented such that personnel generating wire transfers are independent from the authorization and reconciliation processes; |
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| | • | implementing improved check stock access control and monitoring at Rosemont; and |
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| | • | bank signature cards have been updated. |
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Stock Award Administration |
Our remediation steps related to stock award administration include:
| | • | each quarterly 1998 ESPP purchase is approved by senior management; |
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| | • | engagement of consultants to provide guidance regarding SFAS No. 123(R) implementation; and |
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| | • | increased communication frequency and managed the relationship more effectively with the Company’s third party stock award administrator to coordinate all stock award activity and to assist with software applications related to stock based expense calculations and related stock based accounting requirements. |
No other 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 March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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OTHER INFORMATION
Our disclosure and analysis in this Quarterly Report on Form 10-Q contain some forward-looking statements that set forth anticipated results based on management’s plans and assumptions. From time to time, we also provide forward-looking statements in other materials we release to the public as well as oral forward-looking statements. Such statements discuss our strategy, expected future financial position, results of operations, cash flows, financing plans, development of products, strategic alliances, intellectual property, competitive position, plans and objectives of management. We often use words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will” and similar expressions to identify forward-looking statements. In particular, the statements regarding our new strategic direction and its potential effects on our business, the development of our lead drug candidate Puricase (PEG-uricase) and the statements regarding our exploration of the strategic alternatives with respect to our subsidiary Rosemont Pharmaceuticals Limit are forward-looking statements. Additionally, forward-looking statements include those relating to future actions, prospective products or product approvals, future performance, financing needs, liquidity or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates and the outcome of contingencies, such as legal proceedings, and financial results.
We cannot guarantee that any forward-looking statement will be realized. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements.
We undertake no obligation to publicly update forward-looking statements. You are advised, however, to consult any further disclosures we make on related subjects in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, we think could cause our actual results to differ materially from expected and historical results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties.
Risks Related to our Restatement |
The restatement of our consolidated financial statements had, and could continue to have, a material adverse impact on us, including increased costs, the possibility of legal or administrative proceedings and delisting warnings from The NASDAQ National Market.
In 2005, we determined that our consolidated financial statements for the years ended December 31, 2002, 2003, and 2004 and for the quarter ended March 31, 2005 should be restated. We incurred substantial unanticipated costs for accounting and legal fees in 2005 and 2006 in connection with the restatement, and although the restatement is complete, we may incur additional related costs.
For example, the Division of Corporation Finance of the SEC has provided comments to us relating to certain of our accounting practices. We believe that we have responded to all of these questions in full; however, it is possible that the Division of Corporation Finance will have further comments. Any further comment letters from the Division of Corporation Finance would likely divert more of our management’s time and attention and cause us to incur additional costs. Similarly, in the event litigation is pursued or other relief is sought by persons asserting claims for damages allegedly resulting from or based on this restatement, or events related thereto, we may incur additional defense costs beyond our insurance coverage regardless of their outcome. Likewise, such events might cause a diversion of our management’s time and attention. If we do not prevail in any such actions, we could be required to pay substantial damages or settlement costs.
We have identified material weaknesses in our internal controls over financial reporting, some of which have not been fully remediated. In addition, we may experience additional material weaknesses in
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the future. Any material weaknesses in our internal control over financial reporting or our failure to remediate such material weaknesses could result in a material misstatement in our financial statements not being prevented or detected and could adversely affect investor confidence in the accuracy and completeness of our financial statements, as well as our stock price.
We have identified material weaknesses in our internal control over financial reporting relating to insufficient personnel resources, deficiencies in income tax analysis, insufficient communications, insufficient treasury controls, and insufficient controls related to stock based compensation. Some of these material weaknesses have not been fully remediated. These material weaknesses and our remediation plans are described further in Item 4 in this Quarterly Report on Form 10-Q. Material weaknesses in our internal control over financial reporting could result in material misstatements in our financial statements not being prevented or detected. We may experience difficulties or delays in completing remediation or may not be able to successfully remediate material weaknesses at all. Any material weakness or unsuccessful remediation could harm investor confidence in the accuracy and completeness of our financial statements, which in turn could harm our business and have an adverse effect on our stock price and our ability to raise additional funds.
Risks Relating to Our New Strategic Direction |
We are repositioning our company to focus on product development, including an enhanced focus on the clinical development of Puricase (PEG-uricase), our lead product candidate currently entering Phase 3 clinical trials. If we are unable to commercialize this product candidate or any other product candidate that we may pursue in the future, or if we experience significant delays or unanticipated costs in doing so, our business will be materially harmed.
As part of our strategic business plan, we are repositioning our company to focus on the full development of our pipeline. This will include an enhanced focus on the clinical development of Puricase (PEG-uricase), our lead product candidate currently entering Phase 3 clinical trials and for which we recently reached an agreement with the FDA on the Phase 3 program. We also plan to engage in an active in-licensing program to access and develop novel compounds in later clinical development as well as marketed products complementary to this strategy.
Our ability to commercialize Puricase (PEG-uricase) or any other product candidate that we may develop in the future will depend on several factors, including:
| | • | successfully completing clinical trials; |
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| | • | successfully manufacturing fully comparable clinical and commercial drug supply; |
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| | • | receiving marking approvals from the FDA and similar foreign regulatory authorities; |
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| | • | establishing commercial manufacturing arrangements with third party manufacturers, to the extent we do not manufacture the product candidates ourselves; |
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| | • | launching commercial sales of the product, whether alone or in collaboration with others; and |
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| | • | acceptance of the product in the medical community and with third party payors. |
If we are unable to successfully commercialize Puricase (PEG-uricase), or if we experience significant delays or unanticipated costs in doing so, our business will be materially harmed. We will face similar drug development risks for any other product candidates that we may develop in the future.
Puricase (PEG-uricase), and any other product candidate that we may develop in the future, must satisfy rigorous standards of safety and efficacy before they can be approved for sale. To satisfy these standards, we must engage in expensive and lengthy clinical trials and extensive manufacturing quality assessments to obtain regulatory approval.
We must successfully complete clinical trials for Puricase (PEG-uricase) before we can apply for its marketing approval.
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In December 2004, we administered the last patient dose in a Phase 2 clinical trial of Puricase (PEG-uricase) and we completed the full analysis of the results of this study in April 2005. In May 2005, we reported positive top-line Phase 2 clinical trial results for Puricase (PEG-uricase). The results from the Phase 2 clinical trial showed that Puricase (PEG-uricase) showed effectiveness in reducing uric acid levels. Based on the results of our end of Phase 2 meeting with the FDA and post-meeting interactions, in December 2005, we submitted a Special Protocol Assessment (SPA) of the Company’s Phase 3 protocols. In March 2006 the Company received a written response from the FDA reflecting the agency’s agreement with the Phase 3 protocols. On May 3, 2006, the Company announced that it had received written notification from the FDA that the SPA was approved. The Company plans to implement the protocols in support of a marketing application for the orphan drug indication of the control of hyperuricemia in patients with treatment-failure gout in whom conventional therapy is contraindicated or has been ineffective. We expect patient dosing to begin in May 2006, subject to no objections from Institutional Review Boards in the United States and/or Ethics Committees outside the United States. Our Phase 3 trial may be unsuccessful which would materially harm our business. Even if this trial is successful, we may be required to conduct additional clinical trials or additional manufacturing quality assessments before a BLA can be filed with the FDA for marketing approval or as a condition of approval.
Clinical testing is expensive, is difficult to design and implement, can take many years to complete and is uncertain as to outcome. Success in early phases of clinical trials does not ensure that later clinical trials will be successful and interim results of a clinical trial do not necessarily predict final results. A failure of one or more of our clinical trials can occur at any stage of testing. We may experience numerous unforeseen events during, or as a result of, the clinical trial process that could delay or prevent our ability to receive regulatory approval or commercialize Puricase (PEG-uricase), including:
| | • | regulators or institutional review boards may not authorize us to commence a clinical trial or conduct a clinical trial at a prospective trial site; |
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| | • | our clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional preclinical testing or clinical trials or we may abandon projects that we expect to be promising; |
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| | • | enrollment in our clinical trials may be slower than we currently anticipate, or participants may drop out of our clinical trials; |
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| | • | we might have to suspend or terminate our clinical trials if the participating patients are being exposed to unacceptable health risks; |
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| | • | regulators or institutional review boards may require that we hold, suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements; |
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| | • | the cost of our clinical trials may be greater than we currently anticipate; |
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| | • | any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the product not commercially viable; and |
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| | • | the effects of our product candidates may not be the desired effects or may include undesirable side effects or the product candidates may have other unexpected characteristics. |
If we are required to conduct additional clinical trials or other testing of our product candidates beyond those that we currently contemplate, if we are unable to successfully complete our clinical trials or other testing or if the results of these trials or tests are not positive or are only modestly positive, we may:
| | • | be delayed in obtaining marketing approval for our product candidates; |
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| | • | not be able to obtain marketing approval; |
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| | • | obtain approval for indications that are not as broad as intended; or |
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| | • | not obtain marketing approval before other companies are able to bring competitive products to market. |
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Our product development costs will also increase if we experience delays in testing or approvals. We do not know whether our ongoing clinical trials will be completed on schedule. Similarly, we do not know whether our clinical trials will begin as planned, will need to be restructured or will be completed on schedule, if at all. Significant delays in clinical trials could also allow our competitors to bring products to market before we do and impair our ability to commercialize our products or product candidates.
Our new strategic focus includes a licensing program to partner our Puricase (PEG-uricase) product outside the United States and to in-license other novel compounds to build our development portfolio. We may not be successful in our licensing efforts and in expanding our portfolio of products in this manner.
As part of the change in our strategic business plan, we announced that we intend to seek a development and commercialization partner for Puricase (PEG-uricase) outside the United States and to also concentrate on an active in-licensing program to access and develop novel compounds in later clinical development. To date, we have had limited success in identifying a suitable partner outside the United States and in identifying and in-licensing the appropriate compounds, and we may continue to have difficulty in this area for a number of reasons. In particular, the licensing, partnering and acquisition of pharmaceutical products is a competitive area. Numerous companies are also pursuing strategies to license, partner or acquire products similar to those that we may pursue. These companies may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities. Other factors that may prevent us from partnering, licensing or otherwise acquiring suitable product candidates include the following:
| | • | we may be unable to identify a partner outside the United States that possesses the expertise or size necessary to successfully complete the development and commercialization of Puricase (PEG-uricase); |
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| | • | we may be unable to identify suitable products or product candidates within our areas of expertise; |
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| | • | we may be unable to license or acquire the relevant technology on terms that would allow us to make an appropriate return on our investment in the product; or |
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| | • | companies that perceive us to be their competitors may be unwilling to assign or license their product rights to us. |
If we are unable to develop suitable potential product candidates by obtaining rights to novel compounds from third parties, our business could suffer.
Risks Related to Our Business |
We incurred a substantial operating loss in the first quarter of 2006 and anticipate that we may incur net losses for the foreseeable future. If we are unable to commercialize Puricase (PEG-uricase) or any other product candidates, we may never return to profitability.
We incurred an operating loss of $3,316,000 in the first quarter of 2006 primarily related to a decrease in revenues, as well as the increase in general and administrative expenses; partially offset by lower cost of sales, commissions and royalties expense, and research and development expenses. We expect to continue to incur losses for the foreseeable future. Our financial results have been substantially dependent on Oxandrin sales. Sales of Oxandrin accounted for 50% of our net product sales in the three months ended March 31, 2006 and 52% in the three months ended March 31, 2005. However, although we cannot predict when generic competition for Oxandrin will begin, the FDA may approve one or more generic versions of Oxandrin at any time. If the FDA approves a generic version of Oxandrin, our revenues will decline significantly, and our results of operations will be materially adversely affected.
Our return to profitability is dependent on the successful commercialization of Puricase (PEG-uricase) and any other product candidates that we may develop, license or acquire. If we are unable to successfully commercialize Puricase (PEG-uricase) or any other product candidates, or if we experience significant delays or unanticipated costs in doing so, or if sales revenue from any product candidate that receives marketing approval is insufficient, we may never return to profitability. Even if we do become profitable again, we may not be able to sustain or increase our profitability on a quarterly or annual basis.
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We will need substantial capital to fully develop and commercialize our development drug product and execute on our refocused strategic business plan, and we may be unable to obtain additional capital. If we are unable to obtain additional financing, our business, results of operations and financial condition may be adversely affected.
The development and commercialization of pharmaceutical products requires substantial funds. In addition, we may require cash to acquire new product candidates and to fully execute on our refocused strategic business plan. In recent periods, we have satisfied our cash requirements primarily through product sales, the divestiture of assets that are not core to our refocused strategic business plan and the monetization of underperforming investments. Historically, we have also obtained capital through collaborations with third parties, contract fees, government funding and equity and debt financings. These financing alternatives might not be available in the future to satisfy our cash requirements.
We might not be able to obtain additional funds or, if such funds are available, such funding might be on unacceptable terms. If we raise additional funds by issuing equity securities, dilution to our then existing stockholders will result. If we raise additional funds through the issuance of debt securities or borrowings, we may incur substantial interest expense and could become subject to financial and other covenants that could restrict our ability to take specified actions, such as incurring additional debt or making capital expenditures. If adequate funds are not available, we may be required to significantly curtail one or more of our commercialization efforts or development programs or obtain funds through sales of assets or arrangements with collaborative partners or others on less favorable terms than might otherwise be available.
A significant portion of our revenues is attributable to sales of Oxandrin. Sales of Oxandrin declined during the first three months of 2006 as compared to the first three months of 2005. Oxandrin may begin facing generic competition at any time, which would likely cause a significant further decrease in Oxandrin sales and render our existing Oxandrin inventory obsolete.
Net sales of Oxandrin amounted to $9,372,000 in the first three months of 2006 and $10,821,000 in the first three months of 2005, representing approximately 50% and 52% of our net product sales, respectively.
Oxandrin was one of numerous products deleted from the Florida Medicaid formulary effective January 1, 2006. This loss of sales is significant and we estimate a negative revenue impact as a result. There can be no assurances that this cannot happen with other state formularies. In addition, the implementation of the Medicare Part D program has created disruption in the market as patients switch to a variety of new prescription coverage programs.
We believe several companies have filed Abbreviated New Drug Applications, or ANDAs, with the FDA relating to a generic drug with the same active pharmaceutical ingredient as Oxandrin. Although we cannot predict when generic competition for Oxandrin will begin, the FDA may approve one or more generic versions of Oxandrin at any time. The introduction of these generic products would likely cause a significant decrease in our Oxandrin revenues, which would adversely affect our results of operations. As a result, we anticipate that Oxandrin will be a less significant product for our future operating results.
Our inventories include Oxandrin inventories that we believe would potentially be in excess of expected product demand if the FDA approves a generic form of the product in the near term. The amount of such potential excess will vary depending upon the timing of the approval of a generic product, the number of generic products that are approved and the rate by which generic sales reduce demand for branded Oxandrin.
Our efforts to ensure that any generic product containing oxandrolone undergo stringent safety testing before approval by the FDA may not prevail.
In February 2004 we filed a Citizens Petition with the FDA requesting that, in the interest of public health and safety, the Commissioner of Food and Drugs not approve any ANDAs for generic oral products containing oxandrolone prior to their adopting standard bioequivalence standards as well as the requirement for any generic product to have completed a warfarin interaction trial. Our request is based on evidence of significant interaction between Oxandrin and warfarin which requires a warfarin dose reduction of up to 90% in patients when initiating therapy of Oxandrin. This petition cited a serious safety concern in patients using Oxandrin together with anticoagulant drugs containing warfarin if the warfarin dose adjustment was not made
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appropriately. In addition, our petition cited concerns related to the physical-chemical properties of the oxandrolone drug substance which are important for manufacturing quality assurance. The petition argues that, as a result of these physical-chemical properties, oxandrolone is categorized by the FDA as a “problem drug” in terms of manufacturing.
We have since filed with the FDA affidavits supporting our February 2004 petition. In August and September 2004, two opposition comment letters to our petition were filed with the FDA. In August 2004 the FDA issued a letter to us stating that extensive review of the questions raised in our petition will be required before the FDA can respond. In February 2005 we submitted another supplemental position paper to the FDA in support of our Citizens Petition advocating the adoption of rigorous impurity standards for oxandrolone consistent with those recently published by the United States Pharmacopeia, which will become the standard in 2006. Since the August 2004 letter from the FDA, we have received no further communication from the FDA regarding our first petition.
In September 2005 we filed a second Citizens’ Petition with the FDA requesting that the Commissioner of Food and Drugs not approve any ANDAs for generic oral products containing oxandrolone prior to the expiration of the Company’s exclusive labeling for geriatric dosing on June 20, 2008. We were granted the three years of market exclusivity on June 20, 2005 under section 505(j) of the Federal Food, Drug and Cosmetic Act (FFDCA) for changes to the labeling of Oxandrin for its use in geriatric patients based on clinical data which was derived from a clinical study on elderly patients examining the safety and pharmakinetics of a range of Oxandrin doses and was submitted to the FDA. On the basis of this data, the labeling of Oxandrin was changed to include the specification of a lower starting dose in patients older than 65 years of age. The FDA’s guidance on geriatric labeling also requires that ANDA’s contain the same geriatric labeling as the Reference Listed Drug (“RLD”).
A significant number of patients who are treated with Oxandrin are geriatric patients. Savient’s clinical data confirmed that geriatric patients have different pharmacological reactions to Oxandrin; therefore, geriatric labeling for Oxandrin is necessary for its safe use. In this second Citizens’ Petition we set forth our position that, if fully substitutable generic versions of oxandrolone were to be approved without Oxandrin’s protected geriatric labeling, such drugs would have labeling that is less restrictive and potentially less safe than that of Oxandrin for use by the elderly. In October 2005 and February 2006, three opposition comment letters to our September 2005 petition were filed with the FDA. In March 2006 the FDA issued a letter to us stating that our September 2005 petition raises complex issues which requires extensive review and analysis by FDA officials before they can respond.
There was no indication from the FDA as to when we might expect a decision on either of our Citizens’ Petitions. However, if we are unsuccessful on our Citizens’ Petition efforts, our sales of Oxandrin would be negatively affected.
Oxandrin sales in particular reporting periods may be affected by wholesalers’ buying patterns and product returns.
A significant portion of our sales of Oxandrin in the United States are to major drug wholesalers. These sales are affected by fluctuations in the buying patterns of these wholesalers and the corresponding changes in inventory levels that they maintain. These changes may not reflect underlying prescriber demand and can be influenced by price concessions or announcements of price increases in future periods. Our Oxandrin sales in future periods may be further reduced if wholesalers continue to reduce inventories. This may be more likely if and when a generic version of Oxandrin is introduced.
The Ross Products Division of Abbott Laboratories, or Ross, marketed Oxandrin under a co-promotion agreement with us for the treatment of weight loss by residents of long-term care facilities. We terminated the co-promotion agreement effective as of December 31, 2005. To date, the average prescription written for the elderly in the long-term care market involves a lower dose of Oxandrin than the average prescription written for the HIV market. As a result, the rate of growth in Oxandrin sales may be less than the rate of growth in prescriptions. With our termination of the Ross co-promotion agreement we plan to direct a portion of our sales and marketing efforts to the long-term care market. However, if we are unsuccessful in these efforts, our sales of Oxandrin would be negatively affected.
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Future returns of Oxandrin or other products could also affect our results of operations.
As of March 31, 2006 and December 31, 2005, $2,399,000 and $2,888,000, respectively, represents our allowance for future product returns. Future product returns in excess of our reserves would reduce our revenues and adversely affect our results of operations.
We operate in a highly competitive market. Our competitors may develop alternative technologies or safer or more effective products before we are able to do so.
The pharmaceutical and biotechnology industries are intensely competitive. The technological areas in which we work continue to evolve at a rapid pace. Our future success will depend upon our ability to compete in the research, development and commercialization of products and technologies in our areas of focus. Competition from pharmaceutical, chemical and biotechnology companies, universities and research institutions is intense and we expect it to increase. Many of these competitors are substantially larger than we are and have substantially greater capital resources, research and development capabilities and experience and manufacturing, marketing, financial and managerial resources than we do. Acquisitions of competing companies by large pharmaceutical companies or other companies could enhance the financial, marketing and other resources available to these competitors.
Rapid technological development may result in our product candidates in development becoming obsolete before we can begin marketing these product candidates or before we are able to recover a significant portion of the research, development and commercialization expenses incurred in the development of those products. For example, since our launch of Oxandrin, a significant portion of Oxandrin sales has been for treatment of patients suffering from HIV-related weight loss. These patients’ needs for Oxandrin may decrease as a result of the development of safer or more effective treatments, such as protease inhibitors. In fact, since January 2001, growth in the AIDS-related weight loss market has slowed substantially and actually began to decline over the past six months.
Our products must compete with others to gain market acceptance and market share. An important factor will be the timing of market introduction of competitive products. For example, the most recent competitor to enter this market was Par’s introduction of megace ES in June 2005. Par is primarily displacing generic megace which represents 75% of our market, but also has an impact on Oxandrin. Accordingly, the relative speed with which we and competing companies can develop products, complete the clinical testing and approval processes, and supply commercial quantities of the products to the market will be an important element of market success.
Our competitors may develop safer, more effective or more affordable products or achieve earlier product development completion, patent protection, regulatory approval or product commercialization than we do. Our competitors’ achievement of any of these goals could have a material adverse effect on our business. These companies also compete with us to attract qualified personnel and to attract third parties for acquisitions, joint ventures or other collaborations.
Manufacturing our products and those of Rosemont’s requires us and Rosemont to meet stringent quality control standards. In addition, we depend on third parties to manufacture our products and plan to rely on third parties to manufacture any future products. If we or these third parties fail to meet applicable quality requirements, our revenues and product development efforts may be materially adversely affected.
The manufacture of our products involves a number of technical steps and requires us, Rosemont, or our third party suppliers and manufacturers to meet stringent quality control specifications imposed by us or by governmental regulatory bodies. In the event of a natural disaster, equipment failure, strike, war or other difficulty, we or our suppliers may be unable to manufacture our products in a manner necessary to fulfill demand. The inability of us or Rosemont to fulfill market demand, the inability of Rosemont to fulfill the demand requirements of its U.S. distribution partner, Cytogen, for Soltamox, or the inability of our third party manufacturers to meet our demands will have a direct and adverse impact on our sales and may also permit our licensees and distributors to terminate their agreements.
Further, we depend on third parties for the supply of our products. Failure of any third party to meet applicable regulatory requirements may adversely affect our profit margins or result in unforeseen delays or
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other problems beyond our control. Should Rosemont fail to continue to meet applicable regulatory requirements for its products within its market or for supply to the United States such failure may adversely affect Rosemont’s sales and profit margins or result in product back-orders or withdrawal or suspension of the marketing authorization for its products in the relevant jurisdiction.
Risks involved with engaging third party suppliers include:
| | • | reliance on the third party for regulatory compliance and quality assurance; |
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| | • | the possible breach of the manufacturing agreement by the third party or the inability of the third party to meet our production schedules because of factors beyond our control, such as shortages in qualified personnel; and |
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| | • | the possibility of termination or non-renewal of the agreement by the third party, based on its own business priorities, at a time that is costly or inconvenient for us. |
Additionally, we rely on a single source supplier for the manufacture of our product candidate Puricase (PEG-uricase) and have a single source supplier of an active ingredient contained in such product with which we currently have no long term supply agreement. We have entered into an arrangement with our former global biologics manufacturing business, BTG-Israel, to serve as the initial primary manufacturer of our product candidate, Puricase (PEG-uricase). To date, BTG-Israel has manufactured all of our requirements of clinical supplies of Puricase (PEG-uricase). The ability of BTG-Israel to consistently perform these activities may be affected by economic, military and political conditions in Israel and in the Middle East in general. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors. These hostilities have, at times, caused security and economic problems in Israel.
Any major hostilities involving Israel could adversely affect BTG-Israel’s ability to supply adequate quantities of the product under our Agreement and in turn affect our ability to complete the clinical development of Puricase (PEG-uricase). While we are in the process of identifying additional alternate sources of supply of Puricase (PEG-uricase) and concluding a long term supply agreement with the supplier of the key active ingredients for the product, the completion of the process to successfully identify and reach agreement with such additional alternate source and the time to conduct a technology transfer to enable the alternate source to scale up and validate it manufacturing processes for Puricase (PEG-uricase) will be lengthy. While this is one of the high priority matters for us, if we experience an interruption in the supply of Puricase (PEG-uricase) from BTG-Israel or the active ingredients from other third party suppliers before we have succeeded in concluding long term supply arrangements and entering into and validating an alternate supply arrangement for Puricase (PEG-uricase) it may affect our financial results, possibly materially.
The manufacture and packaging of pharmaceutical products are subject to the requirements of the FDA and similar foreign regulatory bodies. If we or our third party suppliers fail to satisfy these requirements, our business operations may be materially harmed.
The manufacturing process for pharmaceutical products is highly regulated. Manufacturing activities must be conducted in accordance with the FDA’s Current Good Manufacturing Practices, and comparable requirements of foreign regulatory bodies. For example, Rosemont recently completed upgrading its manufacturing facility to obtain FDA approval to sell Soltamox, the first oral liquid formulation of tamoxifen, in the United States.
Failure by us or our third party suppliers to comply with applicable regulations, requirements, or guidelines could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our products, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of product, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our business. Other than by contract, we do not have control over the compliance by our third party suppliers with these regulations and standards.
Changes in manufacturing processes or procedures, including changes in the location where a product is manufactured or changes in a third party supplier may require prior FDA or other governmental review or approval or revalidation of the manufacturing process. This is particularly an issue with biologic products,
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such as our product candidate Puricase (PEG-uricase). This review or revalidation may be costly and time-consuming.
Because there are a limited number of manufacturers that operate under applicable regulatory requirements, it may be difficult for us to change a third party supplier if we are otherwise required to do so. Similarly, because of the applicable requirements, we may not be able to quickly and efficiently replace our manufacturing capacity if we are unable to manufacture our products at our facilities.
We may not be successful in establishing additional strategic alliances, which could adversely affect our ability to develop and commercialize products and services.
Part of our strategic plan to focus on product development involves entering into new strategic alliances for the development and commercialization of products and services when we believe that doing so will maximize product value. For example, we plan to seek development and commercial partners to commercialize Puricase (PEG-uricase) outside the United States.
If we are unsuccessful in reaching an agreement with a suitable collaborator for our current or future product candidates, we may fail to meet our business objectives for the applicable product or program. We face significant competition in seeking appropriate collaborators. Moreover, these alliance arrangements are complex to negotiate and time-consuming to document. We may not be successful in our efforts to establish additional strategic alliances or other alternative arrangements. The terms of any additional strategic alliances or other arrangements that we establish may not be favorable to us. Moreover, such strategic alliances or other arrangements may not be successful.
The risks that we are likely to face in connection with any future strategic alliances include the following:
| | • | strategic alliance agreements are typically for fixed terms and are subject to termination under various circumstances, including, in many cases without cause; |
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| | • | our collaborators may change the focus of their development and commercialization efforts; |
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| | • | we may rely on our collaborators to manufacture the products covered by our alliances; |
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| | • | the areas of research, development and commercialization that we may pursue, either alone or in collaboration with third parties, may be limited as a result of non-competition provisions of our strategic alliance agreements; |
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| | • | our collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with the products and services that are the subject of the alliance with us; and |
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| | • | failure to establish steady supply of essential raw materials from vendors. |
Our sales depend on payment and reimbursement from third party payors and a reduction in the payment or reimbursement rate could result in decreased use or sales of our products.
Most patients rely on Medicare and Medicaid, private health insurers and other third party payors to pay for their medical needs, including any drugs we or our collaborators may market. If third party payors do not provide adequate coverage or reimbursement for any products that we may develop, our revenues and prospects for profitability will suffer. The U.S. Congress enacted a limited prescription drug benefit for Medicare recipients in the Medicare Prescription Drug and Modernization Act of 2003 which was expanded by the Medicare Part D prescription plan that went into effect January 1, 2006. While the program established by this statute may increase demand for our products, our prices will be negotiated with drug procurement organizations for Medicare beneficiaries and are likely to be lower than we might otherwise obtain if we participate in this program. Non-Medicare third party drug procurement organizations may also base the price they are willing to pay on the rate paid by drug procurement organizations for Medicare beneficiaries.
A primary trend in the U.S. healthcare industry is toward cost containment. In addition, in some foreign countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can
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take six to twelve months or longer after the receipt of regulatory marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost effectiveness of our product candidates or products to other available therapies. The conduct of such a clinical trial could be expensive and result in delays in commercialization of our products.
Third party payors are challenging the prices charged for medical products and services, and many third party payors limit reimbursement for newly approved healthcare products. In particular, third party payors may limit the indications for which they will reimburse patients who use any products we may develop. Cost control initiatives could decrease the price we might establish for products that we may develop, which would result in lower product revenues to us.
Some states, including New York, California and Florida, have eliminated or limited reimbursement of prescription drugs for HIV and AIDS, including Oxandrin, under their AIDS Drug Assistance Programs (ADAP) or via their state Medicaid program. For example, the state of Florida removed Oxandrin from its formulary on January 1, 2006. This has affected sales of Oxandrin in those states. Efforts and discussions are ongoing with these state agencies to reverse these changes, but to date we have not been successful and we cannot predict whether we will be successful in the future. If we are not successful, our Oxandrin sales in this HIV/AIDS related involuntary weight loss market will continue to be adversely impacted. States may also shift patient coverage from ADAP and other state prescription programs to the new Medicare Part D prescription programs creating additional market disruption.
We have recently made significant changes in our senior management team. If we fail to attract and keep senior management and key scientific personnel, we may be unable to successfully develop or commercialize our product candidates.
We have recently made significant changes in our senior management team. In July 2004, Christopher Clement, who had been our President and Chief Operating Officer, became our President and Chief Executive Officer. In May 2004, Philip K. Yachmetz, currently our Executive Vice President and Chief Business Officer, joined us as Senior Vice President-Corporate Strategy and General Counsel, and in March 2005, David Fink joined us as Senior Vice President of Commercial Operations. In October 2005, Gina Gutzeit joined us as interim Chief Financial Officer. We are currently searching for a permanent Chief Financial Officer. Our success will depend in part on our ability to attract, retain and motivate highly qualified personnel and to establish and maintain continuity and stability within our management team.
There is a great deal of competition from other companies and research and academic institutions for the limited number of pharmaceutical development professionals with expertise in the areas of our activities. If we cannot continue to attract and retain, on acceptable terms, the qualified personnel necessary for the continued development of our business and products, we may not be able to sustain our operations and execute our business plan. We generally do not enter into employment agreements with any of our product development personnel. In addition, we do not maintain, and have no current intention of obtaining, “key man” life insurance on any of our employees.
Economic and political risks and pricing regulation in foreign jurisdictions, and other risks associated with foreign operations, could adversely affect our international sales.
We significantly expanded our international operations with our 2002 acquisition of Rosemont. Our product sales outside the United States accounted for approximately 50% of our total product sales in the first quarter of 2006 and 53% in the first quarter of 2005. The U.K. government in 2004 reviewed the overall pricing structure for branded prescription medicines and reduced the prices for branded prescription medicines by 7% effective as of January 1, 2005. While this was the first reduction in such pricing since 1999, there can be no assurances as to the frequency with which such pricing reviews may be conducted. Because we and Rosemont sell our products worldwide, our businesses are subject to risks associated with doing business internationally, including:
| | • | difficulties in staffing and managing foreign operations; |
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| | • | mandated price reductions for some or all of the products sold within a foreign jurisdiction; |
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| | • | changes in a country’s or region’s political or economic conditions affecting terms of payment; |
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| | • | longer payment cycles of foreign customers and difficulty of collecting receivables in foreign jurisdictions; |
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| | • | trade protection measures and import or export licensing requirements; |
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| | • | less familiarity with business customs and practices; |
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| | • | the imposition of tariffs and import and export controls; |
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| | • | the impact of possible recessionary environments in economies outside the United States; |
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| | • | unexpected changes in regulatory requirements; |
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| | • | currency exchange rate fluctuations; |
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| | • | differing labor laws and changes in those laws; |
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| | • | differing protection of intellectual property and changes in that protection; |
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| | • | differing tax laws and changes in those laws; and |
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| | • | differing regulatory requirements and changes in those requirements. |
We do not currently engage in currency hedging transactions. However, depending on our sales from international operations and our perception as to currency volatility, we may choose to limit our exposure by the purchase of forward foreign exchange contracts or similar hedging strategies. The currency exchange strategy that we adopt may not be successful in avoiding exchange-related losses. In addition, the above-listed factors may cause a decline in our future international revenue and, consequently, may harm our business. We may not be able to sustain or increase revenue that we derive from international sources.
We may incur substantial costs related to product liability.
The testing and marketing of our products entail an inherent risk of product liability and associated adverse publicity. Pharmaceutical product liability exposure could be extremely large and poses a material risk.
To the extent we elect to test or market products independently, we bear the risk of product liability directly. We currently have $20 million of product liability insurance coverage in place. We might not be able to maintain existing insurance or obtain additional insurance on acceptable terms, or at all. It is possible that a single product liability claim could exceed our insurance coverage limits, and multiple claims are possible. Any successful product liability claim made against us could substantially reduce or eliminate any stockholders’ equity we may have and could materially harm our financial results. Product liability claims, regardless of their merits, could be costly and divert management’s attention, and adversely affect our reputation and the demand for our products.
The ultimate outcome of pending securities litigation is uncertain.
After the restatement of our financial statements for the years ended December 31, 1999, 2000 and 2001 and the first two quarters of 2002, we and some of our former officers were named in a series of similar purported securities class action lawsuits. The complaints in these actions, which have been consolidated into one action, allege violations of U.S. securities law through alleged material misrepresentations and omissions and seek an unspecified award of damages.
In addition, members of our board of directors prior to June 2003, Fulbright & Jaworski LLP, our former corporate counsel, and Arthur Andersen LLP, our prior auditor, were named in derivative actions that claimed, among other things, that our directors breached their fiduciary duties by failing to implement and maintain an adequate internal accounting control system. Although these derivative suits were dismissed, we received a letter on behalf of a purported stockholder demanding that we commence an action against most of our directors, certain former directors, Arthur Andersen LLP and others who were responsible for the actions that resulted in the restatement of our financial statements. A special committee of our board of directors, consisting of directors who were not directors prior to our 2003 annual meeting, investigated this demand and determined that litigation relating to this matter should not proceed.
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In August 2005, citing the failure of the plaintiff’s amended complaint to set forth particularized facts that give rise to a strong inference that the defendants acted with the required state of mind, the district court granted our motion to dismiss the action, without prejudice, and granted plaintiffs leave to file an amended complaint. In October 2005 the plaintiffs filed a second amended complaint, again seeking unspecified compensatory damages, purporting to set forth particularized facts to support their allegations of violations of Sections 10(b) and 20(a) of the Exchange Act by us and our former officers. In December 2005 we filed a motion to dismiss the second amended complaint which has now been fully briefed by both the Company and the Plaintiffs and is pending a decision by the Court. The Company has received no indication from the Court as to when a decision may be expected. The Company intends to continue its vigorous defense against plaintiffs’ allegations in this matter.
We intend to contest the pending securities action against us vigorously. However, an adverse decision in this case could adversely affect us financially. We have referred these claims to our directors and officers insurance carrier, which has reserved its rights as to coverage with respect to this action.
Risks Relating to Intellectual Property |
If we are unable to obtain and maintain protection for the intellectual property relating to our technology and products, the value of our technology and products will be adversely affected.
Our success will depend in large part on our ability to obtain and maintain protection in the United States and other countries for the intellectual property covering or incorporated into our technology and products. The patent situation in the field of biotechnology and pharmaceuticals is highly uncertain and involves complex legal and scientific questions. We may not be able to obtain additional issued patents relating to our technology or products. Even if issued, patents may be challenged, narrowed, invalidated or circumvented, which could limit our ability to stop competitors from marketing similar products or limit the length of term of patent protection we may have for our products. Changes in either patent laws or in interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection.
Our patents also may not afford us protection against competitors with similar technology. 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 the scientific literature often lag behind actual discoveries, neither we nor our licensors can be certain that we or they were the first to make the inventions claimed in issued patents or pending patent applications, or that we or they were the first to file for protection of the inventions set forth in these patent applications.
If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and products could be adversely affected.
In addition to patented technology, we rely upon unpatented proprietary technology, processes and know-how. We seek to protect this information in part by confidentiality agreements with our employees, consultants and third parties. These agreements may be breached and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. If our confidential information or trade secrets become publicly known, they may lose their value to us.
If we infringe or are alleged to infringe intellectual property rights of third parties, it will adversely affect our business.
Our 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.
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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 biopharmaceutical 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 U.S. Patent and Trademark Office and opposition proceedings in the European Patent Office or in another 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. 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 adversely affect our ability to compete in the marketplace. Patent litigation and other proceedings may also absorb significant management time.
In the future we may be involved in costly legal proceedings to enforce or protect our intellectual property rights or to defend against claims that we infringe the intellectual property rights of others.
Litigation is inherently uncertain and an adverse outcome could subject us to significant liability for damages or invalidate our proprietary rights. Legal proceedings that we initiate to protect our intellectual property rights could also result in counterclaims or countersuits against us. Any litigation, regardless of its outcome, could be time-consuming and expensive to resolve and could divert our management’s time and attention. Any intellectual property litigation also could force us to take specific actions, including:
| | • | cease selling products or undertaking processes that are claimed to be infringing a third party’s intellectual property; |
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| | • | obtain licenses to make, use, sell, offer for sale or import the relevant technologies from the intellectual property’s owner, which licenses may not be available on reasonable terms, or at all; |
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| | • | redesign those products or processes that are claimed to be infringing a third party’s intellectual property; or |
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| | • | pursue legal remedies with third parties to enforce our indemnification rights, which may not adequately protect our interests. |
We have been involved in several lawsuits and disputes regarding intellectual property in the past. We could be involved in similar disputes or litigation with other third parties in the future. An adverse decision in any intellectual property litigation could have a material adverse effect on our business, results of operations and financial condition.
We are subject to stringent governmental regulation, and our failure to comply with applicable regulations could adversely affect our ability to conduct our business.
Virtually all aspects of our business are subject to extensive regulation by numerous federal and state governmental authorities in the United States, such as the FDA, as well as by foreign countries where we manufacture or distribute our products. Of particular significance are the requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of pharmaceutical products for human use. All of our products, manufacturing processes and facilities require governmental licensing or approval prior to commercial use and maintenance of those approvals during commercialization. A pharmaceutical product cannot be marketed in the United States until it has been approved by the FDA, and
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then can only be marketed for the indications and claims approved by the FDA. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical information required for approval of an NDA or a BLA are substantial. The approval process applicable to products of the type being developed by us usually takes five to seven years from the commencement of human clinical trials and typically requires substantial expenditures. We and our collaborators may encounter significant delays or excessive costs in our or their respective efforts to secure necessary approvals or licenses. Before obtaining regulatory approval for the commercial sale of our products, we are required to conduct pre-clinical and clinical trials to demonstrate that the product is safe and efficacious for the treatment of the target indication. The timing of completion of clinical trials depends on a number of factors, many of which are outside our control. In addition, we and our collaborators may encounter delays or rejections based upon changes in the policies of regulatory authorities. The FDA and foreign regulatory authorities have substantial discretion to terminate clinical trials, require additional testing, delay or withhold registration and marketing approval, and mandate product withdrawals.
Regulation by governmental authorities in the United States and other countries is a significant factor affecting the timing of the commercialization of our products and our ongoing research and development activities. The timing of regulatory approvals is not within our control. Failure to obtain and maintain requisite governmental approvals, or failure to obtain approvals of the scope requested, could delay or preclude us or our collaborators from marketing our products, could limit the commercial use of the products and could also allow competitors time to introduce competing products ahead of product introductions by us. Even after regulatory approval is obtained, use of the products could reveal side effects that, if serious, could result in suspension of existing approvals and delays in obtaining approvals in other jurisdictions.
Failure to comply with applicable regulatory requirements can, among other things, result in significant fines or other sanctions, termination of clinical trials, suspension of regulatory approvals, product recalls, seizure of products, imposition of operating restrictions and criminal prosecutions. While we have developed and instituted a corporate compliance program based on current best practices, we or our employees might not be, or might fail to be, in compliance with all potentially applicable federal and state regulations.
Further, FDA policy or similar policies of regulatory agencies in other countries may change and additional governmental requirements may be established that could prevent or delay regulatory approval of our products. We cannot predict what effect changes in regulations, enforcement positions, statutes or legal interpretation, when and if promulgated, adopted or enacted, may have on our business in the future. Changes could, among other things, require changes to manufacturing methods or facilities, expanded or different labeling, new approvals, the recall, replacement or discontinuance of certain products, additional record keeping and expanded scientific substantiation. These changes, or new legislation, could adversely affect our business.
Risks Relating to an Investment in Our Common Stock |
Our stock price is volatile, which could adversely affect your investment.
Our stock price is volatile. Since June 1, 2001, our common stock traded as high as $13.57 per share and as low as $1.77 per share. The market price of our common stock may be influenced by many factors, including:
| | • | our ability to successfully implement our new strategic direction; |
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| | • | announcements of technological innovations or new commercial products by us or our competitors; |
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| | • | announcements by us or our competitors of results in pre-clinical testing and clinical trials; |
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| | • | regulatory developments; |
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| | • | patent or proprietary rights developments; |
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| | • | public concern as to the safety or other implications of biotechnology products; |
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| | • | changes in our earnings estimates and recommendations by securities analysts; |
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| | • | period-to-period fluctuations in our financial results; and |
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| | • | general economic, industry and market conditions. |
The volatility of our common stock imposes a greater risk of capital losses on our stockholders than a less volatile stock would. In addition, volatility makes it difficult to ascribe a stable valuation to a stockholder’s holdings of our common stock. The stock market in general and the market for biotechnology companies in particular have also experienced significant price and volume fluctuations that are often unrelated to the operating performance of particular companies. In the past, following periods of volatility in the market price of the securities of biopharmaceutical companies, securities class action litigation has often been instituted against these companies. Such litigation would result in substantial costs and a diversion of management’s attention and resources, which could adversely affect our business.
We expect our quarterly results to fluctuate, which may cause volatility in our stock price.
Our revenues and expenses have in the past and may in the future continue to display significant variations. These variations may result from a variety of factors, including:
| | • | the amount and timing of product sales; |
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| | • | changing demand for our products; |
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| | • | our inability to provide adequate supply for our products; |
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| | • | changes in wholesaler buying patterns; |
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| | • | returns of expired product; |
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| | • | changes in government or private payor reimbursement policies for our products; |
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| | • | increased competition from new or existing products, including generic products; |
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| | • | the timing of the introduction of new products; |
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| | • | the timing and realization of milestone and other payments from licensees; |
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| | • | the timing and amount of expenses relating to research and development, product development and manufacturing activities; |
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| | • | the extent and timing of costs of obtaining, enforcing and defending intellectual property rights; and |
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| | • | any charges related to acquisitions. |
Because many of our expenses are fixed, particularly in the short-term, any decrease in revenues will adversely affect our earnings until revenues can be increased or expenses reduced. We also expect our revenues and earnings to be adversely affected if a generic version of Oxandrin is introduced. Because of fluctuations in revenues and expenses, it is possible that our operating results for a particular quarter or quarters will not meet the expectations of public market analysts and investors, which could cause the market price of our common stock to decline. We believe that period-to-period comparisons of our operating results are not a good indication of our future performance and stockholders should not rely on those comparisons to predict our future operating or share price performance.
Effecting a change of control of our company could be difficult, which may discourage offers for shares of our common stock.
Our certificate of incorporation and the Delaware General Corporation Law contain provisions that may delay or prevent an attempt by a third party to acquire control of us. These provisions include the requirements of Section 203 of the Delaware General Corporation Law. In general, Section 203 prohibits designated types of business combinations, including mergers, for a period of three years between us and any third party that owns 15% or more of our common stock. This provision does not apply if:
| | • | our board of directors approves of the transaction before the third party acquires 15% of our stock; |
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| | • | the third party acquires at least 85% of our stock at the time its ownership goes past the 15% level; or |
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| | • | our board of directors and two-thirds of the shares of our common stock not held by the third party vote in favor of the transaction. |
We have also adopted a stockholder rights plan intended to deter hostile or coercive attempts to acquire us. Under the plan, if any person or group acquires more than 20% of our common stock without approval of our board of directors under specified circumstances, our other stockholders have the right to purchase shares of our common stock, or shares of the acquiring company, at a substantial discount to the public market price. As a result, the plan makes an acquisition much more costly to a potential acquirer.
Our certificate of incorporation also authorizes us to issue up to 4 million shares of preferred stock in one or more different series with terms fixed by our board of directors. Stockholder approval is not necessary to issue preferred stock in this manner. Issuance of these shares of preferred stock could have the effect of making it more difficult for a person or group to acquire control of us. No shares of our preferred stock are currently outstanding. While our board of directors has no current intention or plan to issue any preferred stock, issuance of these shares could also be used as an anti-takeover device.
(a) Exhibits
The exhibits listed in the Exhibit Index are included in this report.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | SAVIENT PHARMACEUTICALS, INC. |
| | | (Registrant) |
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| | By: | /s/ Christopher Clement |
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| | | Christopher Clement |
| | | President and Chief Executive Officer |
| | | (Principal Executive Officer) |
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| | By: | /s/ Gina Gutzeit |
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| | | Gina Gutzeit |
| | | Interim Chief Financial Officer |
| | | (Principal Financial Officer) |
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EXHIBIT INDEX
Exhibit No. | | | Description | |
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| |
| | | | | |
| 31.1 | | | Certification of principal executive officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended | |
| 31.2 | | | Certification of the principal financial officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended | |
| 32.1 | | | Statement pursuant to 18 U.S.C. §1350 | |
| 32.2 | | | Statement pursuant to 18 U.S.C. §1350 | |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934