Exhibit 99.5
CONSOLIDATED FINANCIAL STATEMENTS
ESP Pharma Holdings and Subsidiary
September 30, 2004
ESP Pharma Holdings and Subsidiary
Index to Consolidated Financial Statements
Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
ESP Pharma Holdings and Subsidiary
We have audited the accompanying consolidated balance sheets of ESP Pharma Holdings and Subsidiary as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders’ equity and cash flows for the year ended December 31, 2003 and for the period from April 15, 2002 (inception) to December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing our opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ESP Pharma Holdings and Subsidiary at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for the year ended December 31, 2003 and for the period from April 15, 2002 (inception) to December 31, 2002, in conformity with U.S. generally accepted accounting principles.
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March 12, 2004
1
ESP Pharma Holdings and Subsidiary
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| December 31 |
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| 2003 |
| 2002 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
| $ | 29,507,156 |
| $ | 5,938,706 |
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Accounts receivable, net |
| 6,140,579 |
| 3,426,265 |
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Inventories |
| 3,465,543 |
| 702,745 |
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Prepaid expenses and other current assets |
| 2,922,494 |
| 129,159 |
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Deferred tax asset |
| 1,034,078 |
| — |
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Total current assets |
| 43,069,850 |
| 10,196,875 |
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Property and equipment, net |
| 1,056,438 |
| 515,548 |
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Non-marketable investments |
| 1,600,000 |
| 400,000 |
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Product rights, net |
| 70,245,851 |
| 27,285,844 |
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Deferred tax assets |
| 2,558,964 |
| 310,000 |
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Restricted cash |
| — |
| 418,739 |
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Deferred financing costs |
| 1,289,838 |
| — |
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Total assets |
| $ | 119,820,941 |
| $ | 39,127,006 |
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Liabilities and stockholders’ equity |
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Current liabilities: |
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Accounts payable |
| $ | 2,472,001 |
| $ | 1,463,820 |
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Accrued expenses |
| 4,493,485 |
| 1,239,789 |
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Other current liabilities |
| 4,860,069 |
| 1,410,223 |
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Income taxes payable |
| 883,737 |
| 38,000 |
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Current portion of long-term debt |
| 10,761,301 |
| — |
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Total current liabilities |
| 23,470,593 |
| 4,151,832 |
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Long-term debt |
| 42,738,699 |
| 9,500,000 |
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Stockholders’ equity: |
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Series A convertible preferred stock; $0.0001 par value; 28,200,000 shares authorized, issued and outstanding as of December 31, 2003 and 2002, respectively (minimum liquidation preference of $28,200,000) |
| 27,404,602 |
| 27,404,602 |
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Series B convertible preferred stock; $0.0001 par value; 12,500,000 shares authorized, issued and outstanding as of December 31, 2003 (minimum liquidation preference of $20,000,000) |
| 19,943,210 |
| — |
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Common stock; $0.0001 par value; 36,300,000 shares authorized, 6,588,708 and 6,775,000 issued and outstanding at December 31, 2003 and 2002, respectively |
| 659 |
| 678 |
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Additional paid-in capital |
| 98,055 |
| 9,339 |
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Notes receivable – related parties |
| (152,904 | ) | (146,564 | ) | ||
Retained earnings (accumulated deficit) |
| 6,408,418 |
| (1,792,881 | ) | ||
Other comprehensive income |
| (90,391 | ) | — |
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Total stockholders’ equity |
| 53,611,649 |
| 25,475,174 |
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Total liabilities and stockholders’ equity |
| $ | 119,820,941 |
| $ | 39,127,006 |
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See accompanying notes.
2
ESP Pharma Holdings and Subsidiary
Consolidated Statements of Operations
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| Year ended |
| Period from |
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Revenue |
| $ | 62,544,565 |
| $ | 14,746,464 |
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Cost of goods sold |
| 20,610,249 |
| 6,757,594 |
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Gross profit |
| 41,934,316 |
| 7,988,870 |
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Selling and marketing |
| 13,778,859 |
| 3,223,071 |
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General and administrative |
| 11,587,033 |
| 4,126,881 |
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Research and development |
| 586,993 |
| — |
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Other operating expenses |
| 2,279,505 |
| 2,043,459 |
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Income (loss) from operations |
| 13,701,926 |
| (1,404,541 | ) | ||
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Interest expense |
| (1,211,695 | ) | (441,399 | ) | ||
Interest income |
| 107,613 |
| 53,059 |
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Income (loss) before provision for income taxes |
| 12,597,844 |
| (1,792,881 | ) | ||
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Provision for income taxes |
| 4,396,545 |
| — |
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Net income (loss) |
| $ | 8,201,299 |
| $ | (1,792,881 | ) |
See accompanying notes.
3
ESP Pharma Holdings and Subsidiary
Consolidated Statements of Stockholders’ Equity
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| Series A Convertible |
| Series B Convertible Preferred Stock |
| Common Stock |
| Additional Paid-in |
| Notes |
| Retained Earnings (Accumulated |
| Other Comprehensive |
| Total Stockholders’ |
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| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Receivable |
| Deficit) |
| Income |
| Equity |
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Balance at April 15, 2002 (inception) |
| — |
| $ | — |
| — |
| $ | — |
| — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
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Issuance of Series A Preferred Stock, net of issuance costs |
| 28,200,000 |
| 27,404,602 |
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| 27,404,602 |
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Issuance of common stock |
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| 6,775,000 |
| 678 |
| 163,172 |
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| 163,850 |
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Shares subject to repurchase rights |
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| (153,833 | ) |
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| (153,833 | ) | ||||||||
Issuance of notes receivable |
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| (146,564 | ) |
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| (146,564 | ) | ||||||||
Net loss |
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| (1,792,881 | ) |
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| (1,792,881 | ) | ||||||||
Balance at December 31, 2002 |
| 28,200,000 |
| 27,404,602 |
| — |
| — |
| 6,775,000 |
| 678 |
| 9,339 |
| (146,564 | ) | (1,792,881 | ) | — |
| 25,475,174 |
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Issuance of Series B Preferred Stock, net of issuance costs |
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| 12,500,000 |
| 19,943,210 |
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| 19,943,210 |
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Issuance of common stock |
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| 50,375 |
| 5 |
| 26,075 |
| (8,669 | ) |
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| 17,411 |
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Shares no longer subject to repurchase rights |
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| 51,119 |
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| 51,119 |
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Options issued to non-employees |
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| 13,865 |
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| 13,865 |
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Return of unvested shares to reserve |
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| (236,667 | ) | (24 | ) | (2,343 | ) | 2,329 |
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| (38 | ) | ||||||||
Comprehensive income: |
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Net income |
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| 8,201,299 |
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| 8,201,299 |
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Other comprehensive income, net of tax |
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| (90,391 | ) | (90,391 | ) | ||||||||
Total comprehensive income |
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| 8,110,908 |
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Balance at December 31, 2003 |
| 28,200,000 |
| $ | 27,404,602 |
| 12,500,000 |
| $ | 19,943,210 |
| 6,588,708 |
| $ | 659 |
| $ | 98,055 |
| $ | (152,904 | ) | $ | 6,408,418 |
| $ | (90,391 | ) | $ | 53,611,649 |
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See accompanying notes.
4
ESP Pharma Holdings and Subsidiary
Consolidated Statements of Cash Flows
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| Year ended |
| Period from |
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Operating activities |
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Net income (loss) |
| $ | 8,201,299 |
| $ | (1,792,881 | ) |
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
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Depreciation |
| 167,406 |
| 44,829 |
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Amortization of product rights |
| 8,925,294 |
| 4,214,156 |
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Interest rate swap |
| (90,391 | ) | — |
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Non-cash expense associated with non-employee options |
| 13,865 |
| — |
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Deferred tax assets |
| (3,283,042 | ) | (310,000 | ) | ||
Changes in operating assets and liabilities: |
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Accounts receivable |
| (2,328,185 | ) | (3,426,265 | ) | ||
Inventories |
| (2,762,798 | ) | (702,745 | ) | ||
Prepaid expenses and other current assets |
| (2,793,335 | ) | (129,159 | ) | ||
Accounts payable |
| 1,008,181 |
| 1,463,820 |
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Accrued expenses |
| 3,304,777 |
| 1,239,789 |
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Other current liabilities and income tax payable |
| 5,357,677 |
| 1,294,930 |
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Deferred financing costs |
| (1,289,838 | ) | — |
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Net cash provided by operating activities |
| 14,430,910 |
| 1,896,474 |
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Investing activities |
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Additions to fixed assets |
| (708,296 | ) | (560,377 | ) | ||
Restricted cash |
| 418,739 |
| (418,739 | ) | ||
Purchase of non-marketable investments |
| (1,200,000 | ) | (400,000 | ) | ||
Purchase of product rights |
| (51,885,301 | ) | (22,000,000 | ) | ||
Net cash used in investing activities |
| (53,374,858 | ) | (23,379,116 | ) | ||
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Financing activities |
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Proceeds from the issuance of long-term debt, net |
| 52,051,777 |
| — |
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Payment of note payable |
| (9,500,000 | ) | — |
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Proceeds from issuance of common stock |
| 17,411 |
| 16,746 |
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Proceeds from issuance of preferred stock, net of issuance costs |
| 19,943,210 |
| 27,404,602 |
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Net cash provided by financing activities |
| 62,512,398 |
| 27,421,348 |
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Net increase in cash and cash equivalents |
| 23,568,450 |
| 5,938,706 |
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Cash and cash equivalents at beginning of period |
| 5,938,706 |
| — |
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Cash and cash equivalents at end of period |
| $ | 29,507,156 |
| $ | 5,938,706 |
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Supplemental disclosures of cash flow information |
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Cash paid during the year for interest |
| $ | 1,205,453 |
| $ | 412,124 |
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Cash paid during the year for taxes |
| $ | 4,503,141 |
| $ | 190,000 |
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Other non-cash activities |
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Deferred tax assets |
| $ | 2,424,233 |
| $ | 310,000 |
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Note issued for product rights |
| $ | — |
| $ | 9,500,000 |
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Shares issued for notes |
| $ | 3,997 |
| $ | 146,564 |
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See accompanying notes.
5
ESP Pharma Holdings and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2003
1. Organization and Description of Business
ESP Pharma Holdings and Subsidiary (the “Company”) was incorporated on April 15, 2002 (inception) in the State of Delaware for the purpose of selling and marketing specialty pharmaceutical products. Immediately following its inception, the Company secured financing in the amount of $27.4 million and acquired the sales and marketing rights to four cardiovascular products from Wyeth Pharmaceuticals Inc. Since its inception, the Company has focused its efforts primarily on building the infrastructure required to support the sales and marketing of its products, and expanding its product portfolio.
2. Significant Accounting Policies
Consolidation
The financial statements include the accounts of ESP Pharma Holdings and Subsidiary and its wholly-owned subsidiary, ESP Pharma, Inc. Intercompany transactions and balances are eliminated in consolidation.
Reclassification
Certain prior year balances have been reclassified to conform to the current year presentation.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. Assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities are affected by such estimates and assumptions. The most significant assumptions are employed in estimates used in determining allowances for doubtful accounts, values of inventories and intangible assets, accruals for rebates, returns and chargebacks, as well as estimates used in applying the revenue recognition policy. The Company is subject to risks and uncertainties that may cause actual results to differ from those estimates.
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Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash, accounts payable, accrued compensation and related benefits, an interest rate swap, long-term debt, non-marketable investments and other accrued liabilities. The Company believes the carrying value of all of its financial instruments approximates fair value. The fair value of the Company’s debt approximates fair value because of its variable interest rate.
Concentration of Credit Risk and Major Sources of Revenue
Financial instruments that potentially subject the Company to concentration of credit risk include cash and cash equivalents, accounts receivable, and revenue. The Company places its cash and cash equivalents with high-credit quality financial institutions. Concentrations of credit risk, with respect to these financial instruments, exist to the extent of the amounts presented in the financial statements.
The following table outlines customers with revenues and/or accounts receivable that individually exceed 10% of the Company’s total revenues and/or accounts receivable during the year ended December 31, 2003 and for the period ended December 31, 2002 (in thousands):
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| 2003 |
| 2002 |
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| Cardinal |
| AmeriSource |
| McKesson |
| Cardinal |
| AmeriSource |
| McKesson |
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Accounts receivable |
| $ | 675 |
| $ | 4,336 |
| $ | 1,441 |
| $ | 2,021 |
| $ | 965 |
| $ | 494 |
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Revenue |
| 18,734 |
| 20,766 |
| 19,547 |
| 4,084 |
| 4,073 |
| 3,408 |
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Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using a weighted-average approach, which approximates the first-in, first-out method. If the cost of the inventories exceeds their expected market value, provisions are recorded currently for the difference between the cost and the market value. Inventories consist of finished goods, raw materials (active pharmaceutical ingredients), and work-in-process.
7
Property and Equipment
Furniture and equipment, including computer equipment and software, are stated at cost, less accumulated depreciation. Depreciation is provided over the estimated useful lives of the respective assets, generally three to five years, using the straight-line method. Leasehold improvements are capitalized as incurred and are amortized over the estimated life of the assets or related lease term, whichever is shorter.
Non-Marketable Investments
The Company has an investment in a strategic partner whose securities are not publicly traded. Because these securities are not publicly traded, the Company reviews these investments periodically for impairment by using information acquired from industry trends, the management of the investee, financial statements, and other external sources. The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is considered to be other than temporary. No impairment charges were recorded or deemed necessary through December 31, 2003.
Derivative Instrument
The Company uses a derivative to hedge its exposure to changes in interest rates. At December 31, 2003, the Company designated $26,750,000 in notional value of its derivative as a cash flow hedge. The derivative is in a loss position at December 31, 2003 with the liability classified in other current liabilities and the net unrealized loss recorded as a component of other comprehensive income. There was no impact on earnings during the period resulting from hedge ineffectiveness since the hedges qualify for the “short-cut method” assumption of no ineffectiveness under the provisions of SFAS 133.
Intangible Assets
Intangible assets represent the value of product rights purchased from Wyeth Pharmaceuticals and Orphan Medical, Inc. In accordance with FAS 142, these intangible assets are being amortized on a straight-line basis over their estimated useful lives and are reviewed for impairment in accordance with FAS 144. The Company uses the remaining patent life as its estimated useful life or three years, for generic pharmaceuticals. No impairment charges were recorded or deemed necessary for the year ended December 31, 2003 or for the period ended December 31, 2002.
8
Deferred Financing Costs
Deferred financing costs related to the term loan are being amortized over five years, the term of the facility. Total accumulated amortization of deferred financing costs was $311,715 at December 31, 2003.
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than their carrying amount. Impairment, if any, is assessed using discounted cash flows. No impairment charges were recorded or deemed necessary for the year ended December 31, 2003 and for the period ended December 31, 2002.
Accruals for Rebates, Returns, and Chargebacks
The Company establishes accruals for rebates, returns, and chargebacks in the same period the Company recognizes the related sales and reduces revenues for these accruals. Accrued rebates include amounts due under Medicaid, and other commercial contractual rebates. The Company estimates accrued rebates based on a percentage of selling price determined from historical experience. With respect to accruals for estimated Medicaid rebates, the Company evaluates historical rebate payments by product as a percentage of historical sales, product pricing and current contracts. At the time of rebate payment, which generally occurs with a delay after the related sale, the Company records a reduction to accrued expenses and, at the end of each period, adjust accrued expenses for any differences between estimated and actual payments. Due to estimates and assumptions inherent in determining the amount of the rebate, rebate payments remain subject to retroactive adjustment. Returns are accrued based on historical and industry experience and is currently estimated at two percent of net sales. Chargebacks are based on the estimated days of unprocessed claims using historical experience. In all cases, judgment is required in estimating these reserves, and actual claims for rebates, returns and chargebacks could be different from the estimates.
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Revenue Recognition
Revenue is recognized when title and risk of loss are transferred to customers, collection of sales is reasonably assured, and the Company has no further performance obligations. This is generally at the time products are received by the customer. Accruals for estimated discounts, returns, rebates and chargebacks, determined based on historical experience, reduce revenues at the time of sale.
Cost of Goods Sold
Cost of goods sold includes manufacturing costs and allocated costs including packaging materials, labor and overhead, royalty costs, and amortization of intangible assets associated with the products rights acquisition. The Company is required to pay royalties on its marketed products Cardene I.V., Ismo, IVBusulfex, and Declomycin. Royalty expenses directly related to product sales are classified as cost of sales and range from 12-21% of net product sales. Royalties are paid on a quarterly basis and are included as a component of cost of goods sold when the expense is incurred.
Advertising and Promotion
The Company engages in promotional activities, which typically take the form of detail aids, industry publications, journal ads, hospital grants, exhibits, speaker programs, and other forms of media. In accordance with procedures defined under Statement of Position (“SOP”) 93-7, Reporting on Advertising Costs, advertising and promotion expenditures are expensed as incurred. Total advertising costs incurred during the year ended December 31, 2003 and for the period ended December 31, 2002 were $6,429,822 and $1,420,892, respectively.
Stock-Based Compensation
The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations as permitted under Financial Accounting Standards Board Statement (“FASB”) No. 123, Accounting for Stock-Based Compensation (SFAS 123) which requires the use of option valuation models that were not developed for use in valuing employee stock options.
10
The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:
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| Year ended |
| Period from |
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Net income (loss), as reported |
| $ | 8,201,299 |
| $ | (1,792,881 | ) |
Add total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
| (174,621 | ) | (15,142 | ) | ||
Pro forma net income (loss) |
| $ | 8,026,678 |
| $ | (1,808,023 | ) |
The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force in Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services, which require that such equity instruments are recorded at their fair value on the measurement date, which is typically the date the services are performed and such equity instruments may be subject to periodic revaluation over the vesting term.
Other Operating Expenses
Other operating expenses consists principally of technology transfer costs and other start-up costs that are expensed as incurred. These expenses are separately classified as the Company does not consider these costs to be a recurring component of operating expenses.
Income Taxes
The Company accounts for income taxes under the asset and liability method whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
11
Research and Development Costs
Research and development costs are expensed as incurred. Upfront payments made to third parties in connection with research and development collaborations are expensed as incurred up to the point of regulatory approval.
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, requires components of other comprehensive income, including unrealized gains and losses on available-for-sale securities and other components of comprehensive income, to be included as part of total comprehensive income. The components of comprehensive income are typically included in the statements of stockholders’ equity. Through December 31, 2003, the Company recorded $90,391, net of tax in comprehensive income reflecting the non-cash impact of the interest rate swap.
Recently Issued Accounting Standards
In December 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities (“FIN 46-R”) to address certain FIN 46 implementation issues. The effective dates and impact of FIN 46 and FIN 46-R are as follows:
(i) Special purpose entities (“SPEs”) created prior to February 1, 2003. The Company must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the first interim or annual reporting period ending after December 15, 2003.
(ii) Non-SPEs created prior to February 1, 2003. The Company is required to adopt FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004.
(iii) All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003. The provisions of FIN 46 were applicable for variable interest in entities obtained after January 31, 2003. The Company is required to adopt FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004.
The adoption of FIN 46 is not expected to have a material impact.
12
On November 21, 2002, the EITF reached a consensus on Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, regarding whether an arrangement involving multiple deliverables contains more than one unit of accounting and how arrangement consideration should be measured and allocated to the separate units of accounting in an arrangement. For contracts including multiple deliverables meeting the separation criteria of EITF 00-21, the Company will allocate the total arrangement consideration to each separate unit of accounting based on the relative fair values of the deliverables in each unit of accounting and recognizes revenue based on the Company’s revenue recognition policy applicable to each separate unit of accounting. In general, EITF 00-21 limits the amount of revenue allocated to an individual deliverable under an agreement to the lesser of its relative fair value or the amount not contingent on the Company’s delivery of other elements under the agreement, regardless of the probability of the Company’s performance. The adoption of EITF 00-21 did not impact the financial statements of the Company.
3. Product Rights Acquisitions
Immediately following its inception in April 2002, the Company purchased the sales and marketing rights to four commercialized cardiovascular pharmaceutical products from Wyeth Pharmaceuticals for an aggregate purchase price of $31.5 million, including $22.0 million in cash and a $9.5 million note (see Note 6).
On June 10, 2003, the Company acquired from Orphan Medical, Inc. the worldwide sales and marketing rights (excluding Australia) and existing inventory of IVBusulfex for an aggregate purchase price of $29.3 million in cash. On October 3, 2003, the Company acquired from Wyeth Pharmaceuticals the U.S. rights to Declomycin for a net purchase price of $22.6 million in cash.
13
These acquisitions were accounted for as asset acquisitions. The products and medical indications are summarized below:
Product Name |
| Product Indication |
|
|
|
|
|
Cardene I.V. |
| For short-term treatment of hypertension when oral therapy is not feasible or desirable |
|
IVBusulfex |
| For use as a conditioning regimen prior to bone marrow transplantation for chronic myelogenous leukemia |
|
Declomycin |
| For use as an antibiotic in treating numerous bacterial infections |
|
Sectral |
| For chronic treatment of hypertension and ventricular arrhythmias |
|
Tenex |
| For chronic treatment of hypertension |
|
Ismo |
| For the prevention of angina pectoris due to coronary artery disease |
|
The fair value of the product rights acquisition was allocated based on discounted cash flow projections. The following tables summarize the gross carrying amount of the assets acquired and estimated useful lives at the date of acquisition with accumulated amortization through December 31, 2003 and 2002 (in thousands):
Product |
| Gross |
| Accumulated |
| Estimated |
| ||
|
|
|
|
|
|
|
| ||
December 31, 2003 |
|
|
|
|
|
|
| ||
Cardene I.V. |
| $ | 25,626 |
| $ | (6,441 | ) | 7 |
|
IVBusulfex |
| 29,300 |
| (1,424 | ) | 12 |
| ||
Declomycin |
| 22,585 |
| (1,848 | ) | 3 |
| ||
Sectral |
| 2,685 |
| (1,567 | ) | 3 |
| ||
Tenex |
| 2,421 |
| (1,412 | ) | 3 |
| ||
Ismo |
| 768 |
| (448 | ) | 3 |
| ||
Total |
| $ | 83,385 |
| $ | (13,140 | ) |
|
|
|
|
|
|
|
|
|
| ||
December 31, 2002 |
|
|
|
|
|
|
| ||
Cardene I.V. |
| $ | 25,626 |
| $ | (2,746 | ) | 7 |
|
Sectral |
| 2,685 |
| (671 | ) | 3 |
| ||
Tenex |
| 2,421 |
| (605 | ) | 3 |
| ||
Ismo |
| 768 |
| (192 | ) | 3 |
| ||
Total |
| $ | 31,500 |
| $ | (4,214 | ) |
|
|
14
The estimated amortization expense for the next five years is as follows (in thousands):
For the year ending December 31: |
|
|
| |
2004 |
| $ | 15,571 |
|
2005 |
| 14,103 |
| |
2006 |
| 11,735 |
| |
2007 |
| 6,103 |
| |
2008 |
| 6,103 |
| |
Thereafter |
| 16,630 |
| |
4. Property and Equipment
Property and equipment consisted of the following:
|
| December 31 |
| ||||
|
| 2003 |
| 2002 |
| ||
|
|
|
|
|
| ||
Office equipment |
| $ | 578,915 |
| $ | 242,862 |
|
Furniture and fixtures |
| 472,933 |
| 229,457 |
| ||
Computer equipment and software |
| 216,825 |
| 88,058 |
| ||
|
| 1,268,673 |
| 560,377 |
| ||
Less accumulated depreciation and amortization |
| 212,235 |
| 44,829 |
| ||
Property, plant and equipment, net |
| $ | 1,056,438 |
| $ | 515,548 |
|
Depreciation expense was $167,406 and $44,829 for the year ended December 31, 2003 and for the period ended December 31, 2002, respectively.
5. Non-Marketable Investments
On September 25, 2002, the Company entered into two agreements (the “Hydralazine Agreements”) with Barbeau Pharma, Inc. (Evanston, IL). Under the terms of the Hydralazine Agreements, Barbeau Pharma, Inc. provided to the Company the exclusive rights to market a new formulation of hydralazine hydrochloride (“Hydralazine”), and a derivative compound in late-stage development both for treating severe hypertension in pregnancy, a potentially life-threatening condition. Additionally, Barbeau Pharma, Inc. is responsible for preparing an NDA for submission to the FDA for the approval to market Hydralazine. The fair value of these rights was not deemed significant at the date of acquisition. In accordance with these arrangements, the Company purchased 900 shares of Series A cumulative preferred stock for $900,000 in a series of transactions between
15
September 2002 and November 2003. Upon approval of Hydralazine by the FDA, the Company will owe Barbeau Pharma, Inc. an additional payment ranging from $750,000 to $2,000,000 based on the extent of marketing exclusivity inherent in such approval.
In June 2003, the Company entered into two additional agreements (the “BP104 Agreements”) with Barbeau Pharma, Inc. whereby Barbeau Pharma, Inc. provided the Company with exclusive rights to develop and market an injectable form of an anti-emetic (“BP104”) for the treatment of chemotherapy induced nausea and vomiting and post operative nausea and vomiting. Barbeau Pharma, Inc. is responsible for preparing an NDA for submission to the FDA for the approval to market BP104. The Company purchased 700 shares of Series A cumulative preferred stock for $700,000 in a series of transactions. The fair value of these rights was not deemed significant at the date of acquisition. Under the BP104 Agreements the Company is obligated to make additional investments in Barbeau Pharma, Inc. preferred stock of $600,000. Further, the Company may be required to pay an additional $1,200,000 upon the clinical data review by the FDA, and an additional $1,000,000 upon approval by the FDA. As of December 31, 2003, the Company had less than 10% ownership of Barbeau Pharma, Inc. and, as such, the investment is accounted for under the cost method.
6. Debt
In connection with the 2002 products rights acquisition discussed in Note 3, the Company issued a $9.5 million Senior Secured Promissory Note. Principal payments were due annually, commencing April 25, 2004. Interest accrued on the unpaid principal amount at a variable rate and was payable semiannually. This note was paid in full in October, 2003 with a portion of the proceeds of a Credit Facility (as further described below).
On October 3, 2003, in connection with the acquisition of Declomycin, the Company entered into a long-term financing arrangement (the “Credit Facility”) with a group of financial institutions. The Credit Facility is comprised of: (i) a $6.5 million Revolving Credit Facility (the “Revolver”), and (ii) a $53.5 million Term Loan (“Term Loan”). The Credit Facility is secured by substantially all of the tangible and intangible assets of the Company.
Under the terms of the Revolver, through October 3, 2008, the Company may borrow on a revolving basis up to $6.5 million where amounts repaid may be re-borrowed. The Revolver includes a $1.0 million letter of credit sub-facility and a $1.0 million Swingline sub-facility. Through December 31, 2003, there were no draws on the Revolver.
16
The Company borrowed $53.5 million under the Term Loan which fully matures on October 3, 2008. Scheduled principal payments of $2.7 million are required on a quarterly basis commencing on September 30, 2004 with the balance due at the maturity date. Additionally, the Term Loan also includes annual mandatory principal payments commencing in April, 2004 in amounts based on a percentage of the Company’s excess cash flow as defined in the Credit Facility. These mandatory principal payments are classified as a current liability.
Borrowings under the Credit Facility bear interest, which is payable monthly, at a floating rate equal to the Base Rate (as defined in the Credit Facility) plus a margin of 1.25%, or at a rate equal to LIBOR plus a margin of 3.75% based on the type of borrowing. Additionally, a fee of 0.50% is charged on the average daily unused amount of the Revolver, and a fee of 3.75% is charged on the amount of any issued letters of credit. Under the terms of the Credit Facility, the Company was required to execute an interest rate swap for half of the principal balance converting the variable rate note to a fixed rate (see Note 2).
The Credit Facility contains limitations and restrictions concerning, among other things, additional indebtedness, acquisitions and dispositions of assets, dividend payments and transactions with affiliates. In addition, the Credit Facility requires the Company to maintain certain ratios (as defined therein). The Company believes it is in compliance with all financial covenants at December 31, 2003.
The following is a summary of the scheduled principal payments of the Term Loan for the next five years and does not include the annual mandatory principal payments as such amounts are contingent on future operations:
2004 |
| $ | 10,761,301 |
|
2005 |
| 10,700,000 |
| |
2006 |
| 10,700,000 |
| |
2007 |
| 10,700,000 |
| |
2008 |
| 10,638,699 |
| |
Total principal payments |
| $ | 53,500,000 |
|
7. Stockholders’ Equity
Convertible Preferred Stock
In April and May of 2002, the Company issued 28.2 million shares of Series A convertible preferred stock for proceeds of $27.4 million.
17
In April 2003, the Company completed its Series B convertible stock financing, which raised $19.9 million through the sale of 12.5 million shares. The Series B preferred stock preferences are the same as the Series A convertible preferred stock.
Conversion
Each share of preferred stock is, at the option of the holder, convertible into shares of common stock on a one-for-one basis, subject to certain adjustments for dilution, if any, resulting from future stock issuances. The initial conversion price for the preferred stock is $1.00 per share. The convertible preferred stock shall be automatically converted into common stock upon (a) the consummation of an IPO at an offering price which is not less than $3 per share in an offering with aggregate proceeds to the Company of not less than $40,000,000 or (b) the vote of a two-thirds interest of the convertible preferred stock voting together as a single class.
Dividend Rights
Convertible preferred shareholders are entitled to cumulative dividends at an annual rate of 8% per share if and when declared by the Board of Directors. Dividends will be paid only out of legally available funds. No dividends have been declared or paid as of or for any period ended December 31, 2003. The amount of cumulative dividends in arrears related to the preferred stock is $4,855,459 as of December 31, 2003.
Liquidation Preferences
In the event of any liquidation, sale or merger, or winding up of the Company, the preferred shareholders are entitled to receive, in preference to the holders of common stock, an initial preference equal to one times the original purchase price per share plus all accrued and unpaid dividends declared, then for any remaining assets, shall participate with the holders of common stock on an as-converted basis, until the preferred shareholders receive a total of three times their purchase price per share, plus all accrued and unpaid dividends declared.
Voting Rights
The preferred shareholders will vote together with the common shareholders and not as a separate class except as specifically provided in the investment agreement or required by law. Specifically, the preferred and common stock will vote separately on mergers, acquisitions,
18
sale of all, or substantially all assets, and transactions that would result in a change of control. Each share of preferred shall have a number of votes equal to the number of shares of common stock then issuable upon conversion of such share of preferred.
Common Stock and Common Stock Options
Restricted Common Stock Purchases
Prior to closing of the Company’s Series A Preferred Stock financing, the Company issued 6,065,000 shares of $0.0001 par value restricted common stock to founders and other advisors at a price of $0.01 per share. The Company issued additional shares totaling 710,000 to management and other employees at $0.16 per share. All common shares issued to Company employees were purchased with cash or with full recourse loans with an average interest rate of 4.75%, and have certain restrictions in connection with the ownership of such shares.
The restricted founders shares vest (i.e. have a lapsing forfeiture provision) as follows: a) 33.33% of the common stock vests on the date each founder commences employment with the Company, b) 16.67% vests on the first anniversary of the date of employment, c) the remaining 50% vests in equal monthly installments over a three year period beginning the month following the first anniversary. The vesting accelerates upon an approved sale or a liquidating event.
The Company will, at all times, reserve and keep available from its authorized but unissued shares of common stock, sufficient shares to be issued upon the conversion of the shares of the convertible preferred stock and upon the exercise of the stock options. As of December 31, 2003, the Company reserved 29,525,000 shares of common stock for future issuance pursuant to its equity compensation plan.
Stock Options
In June 2002, the Company’s Board of Directors and shareholders approved the Company’s 2002 Stock Option Plan (the “2002 Plan”). The 2002 Plan provides for the granting of options to purchase common stock in the Company to employees, advisors and consultants at a price to be determined by the Company’s Board of Directors. The Options may be incentive stock options or non-statutory stock options. Under the provisions of the 2002 Plan, no option will have a term in excess of 10 years. At December 31, 2003, the Company reserved up to 3,025,000 shares for issuance upon exercise of options.
19
The 2002 Plan is intended to encourage ownership of stock by employees and consultants of the Company and to provide additional incentives for them to promote the success of the Company’s business and is administered by the Board of Directors or a committee consisting of members of the Board. The Board or committee is responsible for determining the individuals to be granted options, the number of options each individual will receive, the option price per share and the exercise period of each option. Options granted pursuant to the 2002 Plan generally vest 25% after the first year, and the remaining 75% vest equally over the next three years.
The following table summarizes information about stock options outstanding at December 31, 2003 and 2002.
|
|
|
|
|
| Options Outstanding |
| ||||||
|
| Shares |
| Restricted |
| Number |
| Option |
| Weighted- |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Balance at April 15, 2002 (inception) |
| — |
| — |
| — |
| $ | — |
| $ | — |
|
Shares authorized |
| 1,325,000 |
| — |
| — |
| — |
| — |
| ||
Options granted |
| (223,500 | ) | — |
| 223,500 |
| 0.16 |
| 0.16 |
| ||
Options exercised |
| — |
| — |
| — |
| — |
| — |
| ||
Options forfeited |
| — |
| — |
| — |
| — |
| — |
| ||
Balance at December 31, 2002 |
| 1,101,500 |
| — |
| 223,500 |
| 0.16 |
| 0.16 |
| ||
Shares authorized |
| 1,700,000 |
| — |
| — |
| — |
| — |
| ||
Shares issued |
| (20,000 | ) | 20,000 |
| — |
| — |
| — |
| ||
Options granted |
| (2,652,200 | ) | — |
| 2,652,200 |
| 0.16-0.46 |
| 0.28 |
| ||
Options exercised |
| — |
| — |
| (30,375 | ) | 0.16 |
| 0.16 |
| ||
Options forfeited |
| 103,625 |
| — |
| (103,625 | ) | 0.16 |
| 0.16 |
| ||
Balance at December 31, 2003 |
| 232,925 |
| 20,000 |
| 2,741,700 |
| $ | 0.16-0.46 |
| $ | 0.21 |
|
The following table summarizes information about stock options outstanding at December 31, 2003:
Exercise Price |
| Options |
| Options |
| Weighted- |
| |
|
|
|
|
|
|
|
| |
$ | 0.16 |
| 1,154,250 |
| 136,438 |
| 4.00 |
|
0.22 |
| 462,500 |
| 7,500 |
| 4.25 |
| |
0.25 |
| 1,083,500 |
| 10,000 |
| 4.50 |
| |
0.46 |
| 41,450 |
| 5,000 |
| 4.75 |
| |
|
| 2,741,700 |
| 158,938 |
|
|
| |
20
At December 31, 2003, the average remaining contractual life of outstanding options was approximately 4 years. The weighted-average fair value of options granted since inception was approximately $0.32.
If compensation cost had been determined based on the fair value of the options at the grant dates for those options for which no compensation cost has been recognized, consistent with the method of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), the Company’s net income per share would have decreased. Such pro forma disclosures (see Note 2) may not be representative of future compensation expense because options vest over several years and additional grants may be made each year. The fair value of these options was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions for 2003:
Employee Share Options |
|
|
|
|
|
|
|
Expected life |
| 5 years |
|
Risk-free interest rate |
| 3.5 | % |
Volatility |
| 100 | % |
Dividend yield |
| 0 | % |
8. Income Taxes
Significant components of the state and federal income tax provision (benefit) for income taxes are as follows:
|
| Year ended December 31 |
| ||||
|
| 2003 |
| 2002 |
| ||
Current provision: |
|
|
|
|
| ||
Federal |
| $ | 5,941,000 |
| $ | 235,000 |
|
State |
| 1,690,000 |
| 75,000 |
| ||
Total current provision |
| 7,631,000 |
| 310,000 |
| ||
|
|
|
|
|
| ||
Deferred benefit: |
|
|
|
|
| ||
Federal |
| (2,856,000 | ) | (946,000 | ) | ||
State |
| (378,000 | ) | (174,000 | ) | ||
Total deferred benefit |
| (3,234,000 | ) | (1,120,000 | ) | ||
Valuation allowance |
| — |
| 810,000 |
| ||
Net deferred benefit |
| (3,234,000 | ) | (310,000 | ) | ||
Total income tax provision |
| $ | 4,397,000 |
| $ | — |
|
21
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets for financial reporting and the amount used for income tax purposes. At December 31, 2002, a valuation allowance was recorded to partially offset the net deferred tax assets. At December 31, 2003, the Company believed it was more likely than not that it would realize its deferred tax assets and reduced the valuation allowance to zero. The change in the valuation allowance for the year ended December 31, 2003 and the period ended December 31, 2002 was approximately ($810,000) and $810,000, respectively. Significant components of the Company’s deferred tax assets as of December 31, 2003 and 2002 are as follows:
|
| December 31 |
| ||||
|
| 2003 |
| 2002 |
| ||
Deferred tax assets: |
|
|
|
|
| ||
Accounts receivable allowances |
| $ | 1,642,000 |
| $ | 394,000 |
|
Amortization of intangible assets |
| 1,767,000 |
| 452,000 |
| ||
Amortization of start-up costs |
| 231,000 |
| 270,000 |
| ||
Other |
| (47,000 | ) | 4,000 |
| ||
Total deferred tax assets |
| 3,593,000 |
| 1,120,000 |
| ||
Less valuation allowance |
| — |
| (810,000 | ) | ||
Net deferred tax asset |
| $ | 3,593,000 |
| $ | 310,000 |
|
The net deferred tax asset included a current portion of $1,034,078 at December 31, 2003 and a long-term portion of $2,558,964 at December 31, 2003.
9. Operating Leases and Commitments
Minimum annual rental commitments under non-cancelable operating leases, primarily office facilities in effect at December 31, 2003 are as follows:
2004 |
| $ | 403,440 |
|
2005 |
| 432,066 |
| |
2006 |
| 433,328 |
| |
2007 |
| 433,328 |
| |
2008 |
| 36,111 |
|
Operating lease rental expense aggregated $305,578 and $199,030 for the year ended December 31, 2003 and for the period ended December 31, 2002, respectively.
Letter of Credit
In accordance with the terms of the Company’s leasing arrangement, the Company is required to maintain an irrevocable letter of credit in the amount of $309,000. Through December 31, 2003, there were no draws on the letter of credit.
22
10. Employee Benefit Plan
The Company has established a defined contribution pension plan (the “Plan”) covering all eligible employees. Employees are eligible to participate in the Plan on the first quarterly entry date following date of hire, as defined in the Plan document. Employees can contribute from 1% to 60% of eligible pay, subject to the annual Federal Tax Law limits. The Company matches 100% of the first 3% of employee contributions and may also elect to make a discretionary non-matching contribution to the Plan on behalf of all eligible employees. Total expenses incurred for the year ended December 31, 2003 and the period ended December 31, 2002 was approximately $87,700 and $68,000, respectively.
12. Related Party Transactions
As permitted under the Stock Plan, certain purchasers of restricted stock and option grants signed full recourse promissory notes for the value of their shares and options at the date of grant. Under the terms of these notes, the principal balance and all unpaid interest is at various dates through 2007. Both interest and principal can be prepaid without penalty. At December 31, 2003 and 2002, notes and accrued interest receivable of $152,904 and $146,564, respectively, remain outstanding and are classified in stockholders’ equity.
Two of the officers of ESP Pharma are members of the Board of Directors for a company that ESP Pharma has non-marketable investments.
13. Subsequent Events
On March 3, 2004 the Company entered into a License and Supply Agreement with Orphan Therapeutics, LLC which gives the Company the exclusive license and other intellectual property related to marketing an injectible pharmaceutical product for treatment of complications related to liver disease (“ESP303”) once approved by the FDA. In consideration of the rights to ESP303, the Company paid Orphan Therapeutics $2 million upon signing the License and Supply Agreement which was charged as a Research and Development expense. The Company is obligated to make additional payments totaling $4.2 million contingent on the achievement of certain milestones, including the approval of a New Drug Application by the U.S. Food and Drug Administration.
23
ESP Pharma Holdings and Subsidiary
|
| September 30, |
| December 31, |
| ||
|
| (unaudited) |
|
|
| ||
Assets |
|
|
|
|
| ||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 34,001,667 |
| $ | 29,507,156 |
|
Accounts receivable, net of reserves of $3,045,000 and $2,071,000 as of September 30, 2004 and December 31, 2003, respectively |
| 11,345,627 |
| 6,140,579 |
| ||
Inventories |
| 5,429,181 |
| 3,465,543 |
| ||
Prepaid expenses and other current assets |
| 2,346,358 |
| 2,922,494 |
| ||
Deferred tax asset |
| 3,374,574 |
| 1,034,078 |
| ||
Total current assets |
| 56,497,407 |
| 43,069,850 |
| ||
|
|
|
|
|
| ||
Property and equipment, net |
| 1,065,207 |
| 1,056,438 |
| ||
Non-marketable investments |
| — |
| 1,600,000 |
| ||
Product rights, net |
| 58,554,117 |
| 70,245,851 |
| ||
Deferred tax assets |
| 3,711,298 |
| 2,558,964 |
| ||
Deferred financing costs |
| 1,159,589 |
| 1,289,838 |
| ||
Total assets |
| $ | 120,987,618 |
| $ | 119,820,941 |
|
|
|
|
|
|
| ||
Liabilities and stockholders’ equity |
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Accounts payable |
| $ | 1,235,977 |
| $ | 2,472,001 |
|
Accrued expenses |
| 7,851,965 |
| 4,493,485 |
| ||
Other current liabilities |
| 8,805,818 |
| 4,860,069 |
| ||
Income taxes payable |
| 269,635 |
| 883,737 |
| ||
Current portion of long-term debt |
| 10,700,000 |
| 10,761,301 |
| ||
Total current liabilities |
| 28,863,395 |
| 23,470,593 |
| ||
|
|
|
|
|
| ||
Long-term debt |
| 37,300,000 |
| 42,738,699 |
| ||
|
|
|
|
|
| ||
Series A convertible preferred stock; $0.0001 par value; 28,200,000 shares authorized, issued and outstanding as of September 30, 2004 and December 31, 2003, respectively (minimum liquidation preference of $28,200,000) |
| 27,404,602 |
| 27,404,602 |
| ||
Series B convertible preferred stock; $0.0001 par value; 12,500,000 shares authorized, issued and outstanding as of September 30, 2004 and December 31, 2003 (minimum liquidation preference of $20,000,000) |
| 19,943,210 |
| 19,943,210 |
| ||
|
|
|
|
|
| ||
Stockholders’ equity |
|
|
|
|
| ||
Common stock; $0.0001 par value; 36,300,000 shares authorized, 6,578,024 and 6,588,708 issued and outstanding at September 30, 2004 and 2003, respectively |
| 658 |
| 659 |
| ||
Additional paid-in capital |
| 307,034 |
| 98,055 |
| ||
Notes receivable - related parties |
| (140,912 | ) | (152,904 | ) | ||
Deferred compensation |
| (156,876 | ) | — |
| ||
Retained earnings |
| 7,457,376 |
| 6,408,418 |
| ||
Other comprehensive income (loss) |
| 9,131 |
| (90,391 | ) | ||
Total stockholders’ equity |
| 7,476,411 |
| 6,263,837 |
| ||
Total liabilities and stockholders’ equity |
| $ | 120,987,618 |
| $ | 119,820,941 |
|
See accompanying notes.
24
ESP Pharma Holdings and Subsidiary
Consolidated Statements of Income
|
| Nine months ended |
| ||||
|
| 2004 |
| 2003 |
| ||
|
| (unaudited) |
| ||||
|
|
|
|
|
| ||
Revenue |
| $ | 67,615,685 |
| $ | 39,235,747 |
|
Cost of goods sold |
| 26,397,941 |
| 11,898,631 |
| ||
Gross profit |
| 41,217,744 |
| 27,337,116 |
| ||
|
|
|
|
|
| ||
Selling and marketing |
| 16,802,028 |
| 10,165,112 |
| ||
General and administrative |
| 12,062,013 |
| 8,255,858 |
| ||
Research and development |
| 4,819,136 |
| 400,107 |
| ||
Other operating expenses |
| 3,369,905 |
| 1,118,963 |
| ||
Income from operations |
| 4,164,662 |
| 7,397,076 |
| ||
|
|
|
|
|
| ||
Interest expense |
| (2,441,684 | ) | (480,486 | ) | ||
Interest income |
| 117,299 |
| 74,959 |
| ||
Income before provision for income taxes |
| 1,840,277 |
| 6,991,549 |
| ||
|
|
|
|
|
| ||
Provision for income taxes |
| 791,319 |
| 2,351,652 |
| ||
Net income |
| $ | 1,048,958 |
| $ | 4,639,897 |
|
See accompanying notes.
25
ESP Pharma Holdings and Subsidiary
Consolidated Statements of Stockholders’ Equity
|
| Common Stock |
|
|
| Additional |
| Notes |
| Deferred |
| Retained |
| Other |
| Total |
| ||||||||||
|
| Shares |
| Amount |
|
|
| Capital |
| Receivable |
| Amount |
| Deficit) |
| Income |
| Equity |
| ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||
Balance at December 31, 2002 |
| 6,775,000 |
| $ | 678 |
| $ | 9,339 |
| $ | 9,339 |
| $ | (146,564 | ) | $ | — |
| $ | (1,792,881 | ) | $ | — |
| $ | (1,929,428 | ) |
Issuance of common stock |
| 50,375 |
| 5 |
| 26,075 |
| 26,075 |
| (8,669 | ) |
|
|
|
|
|
| 17,411 |
| ||||||||
Shares no longer subject to repurchase rights |
|
|
|
|
| 51,119 |
| 51,119 |
|
|
|
|
|
|
|
|
| 51,119 |
| ||||||||
Options issued to non-employees |
|
|
|
|
| 13,865 |
| 13,865 |
|
|
|
|
|
|
|
|
| 13,865 |
| ||||||||
Return of unvested shares to reserve |
| (236,667 | ) | (24 | ) | (2,343 | ) | (2,343 | ) | 2,329 |
|
|
|
|
|
|
| (38 | ) | ||||||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
| 8,201,299 |
|
|
| 8,201,299 |
| ||||||||
Other comprehensive income, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (90,391 | ) | (90,391 | ) | ||||||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 8,110,908 |
| ||||||||
Balance at December 31, 2003 |
| 6,588,708 |
| 659 |
| 98,055 |
| 98,055 |
| (152,904 | ) | — |
| 6,408,418 |
| (90,391 | ) | 6,263,837 |
| ||||||||
Issuance of common stock |
| 34,625 |
| 3 |
| 7,375 |
| 7,375 |
|
|
|
|
|
|
|
|
| 7,378 |
| ||||||||
Shares no longer subject to repurchase rights |
|
|
|
|
| 175,800 |
| 33,046 |
|
|
|
|
|
|
|
|
| 33,046 |
| ||||||||
Deferred compensation related to stock options, net of forfeitures |
|
|
|
|
|
|
| 175,800 |
|
|
| (175,800 | ) |
|
|
|
| — |
| ||||||||
Amortization of deferred compensation |
|
|
|
|
|
|
|
|
|
|
| 18,924 |
|
|
|
|
| 18,924 |
| ||||||||
Return of unvested shares to reserve |
| (45,309 | ) | (4 | ) | (7,242 | ) | (7,242 | ) | 11,992 |
|
|
|
|
|
|
| 4,746 |
| ||||||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
| 1,048,958 |
|
|
| 1,048,958 |
| ||||||||
Other comprehensive income, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 99,522 |
| 99,522 |
| ||||||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 1,148,480 |
| ||||||||
Balance at September 30, 2004 (unaudited) |
| 6,578,024 |
| $ | 658 |
| $ | 307,034 |
| $ | 307,034 |
| $ | (140,912 | ) | $ | (156,876 | ) | $ | 7,457,376 |
| $ | 9,131 |
| $ | 7,476,411 |
|
See accompanying notes.
26
ESP Pharma Holdings and Subsidiary
Consolidated Statements of Cash Flows
|
| Nine months ended September 30 |
| ||||
|
| 2004 |
| 2003 |
| ||
|
| (unaudited) |
| ||||
Operating activities |
|
|
|
|
| ||
Net income |
| $ | 1,048,958 |
| $ | 4,639,897 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
| ||
Depreciation |
| 219,891 |
| 112,394 |
| ||
Amortization of product rights |
| 11,691,734 |
| 5,028,049 |
| ||
Change in interest rate swap |
| 99,522 |
| — |
| ||
Non-cash expense associated with non-employee options |
| — |
| 13,865 |
| ||
Deferred tax assets |
| (3,492,830 | ) | (162,285 | ) | ||
Amortization of deferred compensation |
| 18,924 |
| — |
| ||
Changes in operating assets and liabilities: |
|
|
|
|
| ||
Accounts receivable |
| (5,205,048 | ) | (3,887,125 | ) | ||
Inventories |
| (1,963,638 | ) | (2,949,538 | ) | ||
Prepaid expenses and other current assets |
| 576,136 |
| (3,762,586 | ) | ||
Accounts payable |
| (1,236,024 | ) | 369,743 |
| ||
Accrued expenses |
| 3,396,272 |
| 6,075,288 |
| ||
Other current liabilities and income tax payable |
| 3,331,647 |
| 1,556,571 |
| ||
Deferred financing costs |
| 130,249 |
| — |
| ||
Net cash provided by operating activities |
| 8,615,793 |
| 7,034,273 |
| ||
|
|
|
|
|
| ||
Investing activities |
|
|
|
|
| ||
Additions to fixed assets |
| (228,660 | ) | (749,914 | ) | ||
Non-cash write-off of investment |
| 2,200,000 |
| — |
| ||
Purchase of non-marketable investments |
| (600,000 | ) | (600,000 | ) | ||
Purchase of product rights |
| — |
| (29,300,000 | ) | ||
Net cash provided by (used in) investing activities |
| 1,371,340 |
| (30,649,914 | ) | ||
|
|
|
|
|
| ||
Financing activities |
|
|
|
|
| ||
Payment of note payable |
| (5,500,000 | ) | — |
| ||
Proceeds from issuance of common stock |
| 7,378 |
| 17,411 |
| ||
Proceeds from issuance of preferred stock, net of issuance costs |
| — |
| 19,943,210 |
| ||
Net cash (used in) provided by financing activities |
| (5,492,622 | ) | 19,960,621 |
| ||
|
|
|
|
|
| ||
Net increase (decrease) in cash and cash equivalents |
| 4,494,511 |
| (3,655,020 | ) | ||
Cash and cash equivalents at beginning of period |
| 29,507,156 |
| 5,938,706 |
| ||
Cash and cash equivalents at end of period |
| $ | 34,001,667 |
| $ | 2,283,686 |
|
|
|
|
|
|
| ||
Supplemental disclosures of cash flow information |
|
|
|
|
| ||
Cash paid during the period for interest |
| $ | 330,729 |
| $ | 2,143,095 |
|
Cash paid during the period for taxes |
| $ | 1,780,179 |
| $ | 4,839,723 |
|
See accompanying notes.
27
ESP Pharma Holdings and Subsidiary
Notes to Consolidated Financial Statements
1. Organization and Description of Business
ESP Pharma Holdings and Subsidiary (the “Company”) was incorporated on April 15, 2002 (inception) in the State of Delaware for the purpose of selling and marketing specialty pharmaceutical products. Immediately following its inception, the Company secured financing in the amount of $27.4 million and acquired the sales and marketing rights to four cardiovascular products from Wyeth Pharmaceuticals Inc. Since its inception, the Company has focused its efforts primarily on building the infrastructure required to support the sales and marketing of its products, and expanding its product portfolio.
2. Significant Accounting Policies
Consolidation
The financial statements include the accounts of ESP Pharma Holdings and Subsidiary and its wholly-owned subsidiary, ESP Pharma, Inc. Intercompany transactions and balances are eliminated in consolidation.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. In the opinion of management, the accompanying financial statements include all adjustments considered necessary for a fair presentation of the Company’s financial position, results of operations, and cash flows for the periods presented.
The results of operations for the nine month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the entire fiscal year ending December 31, 2004. These consolidated financial statements should be read in conj unction with the audited financial statements included in the Company’s consolidated financial statements for the year ended December 31, 2003.
Reclassification
Certain prior year balances have been reclassified to conform to the current year presentation.
28
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. Assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities are affected by such estimates and assumptions. The most significant assumptions are employed in estimates used in determining allowances for doubtful accounts, values of inventories and intangible assets, accruals for rebates, returns and chargebacks, as well as estimates used in applying the revenue recognition policy. The Company is subject to risks and uncertainties that may cause actual results to differ from those estimates.
Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash, accounts payable, accrued compensation and related benefits, an interest rate swap, long-term debt, non-marketable investments and other accrued liabilities. The Company believes the carrying value of all of its financial instruments approximates fair value. The fair value of the Company’s debt approximates fair value because of its variable interest rate.
Concentration of Credit Risk and Major Sources of Revenue
Financial instruments that potentially subject the Company to concentration of credit risk include cash and cash equivalents, accounts receivable, and revenue. The Company places its cash and cash equivalents with high-credit quality financial institutions. Concentrations of credit risk, with respect to these financial instruments, exist to the extent of the amounts presented in the financial statements.
The following table outlines customers with revenues and/or accounts receivable that individually exceed 10% of the Company’s total revenues and/or accounts receivable during the nine month period ended September 30, 2004 and the year ended December 31, 2003 (in thousands):
29
|
| 2004 |
| 2003 |
| ||||||||||||||
|
| Cardinal |
| AmeriSource |
| McKesson |
| Cardinal |
| AmeriSource |
| McKesson |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Accounts receivable |
| $ | 2,875 |
| $ | 1,499 |
| $ | 6,457 |
| $ | 675 |
| $ | 4,336 |
| $ | 1,441 |
|
Revenue |
| 22,354 |
| 12,223 |
| 21,463 |
| 18,734 |
| 20,766 |
| 19,547 |
| ||||||
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using a weighted-average approach, which approximates the first-in, first-out method. If the cost of the inventories exceeds their expected market value, provisions are recorded currently for the difference between the cost and the market value. Inventories consist of finished goods, raw materials (active pharmaceutical ingredients), and work-in-process.
|
| September |
| December |
| ||
|
| (unaudited) |
|
|
| ||
|
|
|
|
|
| ||
Raw material |
| $ | 1,836,689 |
| $ | 363,658 |
|
Work in process |
| — |
| 148,000 |
| ||
Finished goods |
| 3,887,678 |
| 3,009,997 |
| ||
Less: Inventory reserves |
| 295,186 |
| 56,112 |
| ||
Total inventories |
| $ | 5,429,181 |
| $ | 3,465,543 |
|
Property and Equipment
Furniture and equipment, including computer equipment and software, are stated at cost, less accumulated depreciation. Depreciation is provided over the estimated useful lives of the respective assets, generally three to five years, using the straight-line method. Leasehold improvements are capitalized as incurred and are amortized over the estimated life of the assets or related lease term, whichever is shorter.
30
Non-Marketable Investments
The Company has an investment in a strategic partner whose securities are not publicly traded. Because these securities are not publicly traded, the Company reviews this investment periodically for impairment by using information acquired from industry trends, the management of the investee, financial statements, and other external sources. The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is considered to be other than temporary. The investment was evaluated as of September 30, 2004 for net realizable value and a reserve was established as of that time for the total amount of the investment.
Derivative Instrument
The Company uses a derivative to hedge its exposure to changes in interest rates. At September 30, 2003, the Company designated $26,750,000 in notional value of its derivative as a cash flow hedge. The derivative is in a net gain position at September 30, 2004 with the asset classified as an offset to other current liabilities and the net unrealized gain recorded as a component of other comprehensive income. There was no impact on earnings during the period resulting from hedge ineffectiveness since the hedges qualify for the “short-cut method” assumption of no ineffectiveness under the provisions of SFAS 133.
Intangible Assets
Intangible assets represent the value of product rights purchased from Wyeth Pharmaceuticals and Orphan Medical, Inc. In accordance with FAS 142, these intangible assets are being amortized on a straight-line basis over their estimated useful lives and are reviewed for impairment in accordance with FAS 144. The Company uses the remaining patent life as its estimated useful life or three years, for generic pharmaceuticals. No impairment charges were recorded or deemed necessary for the period ended September 30, 2004 and the year ended December 31, 2003.
Deferred Financing Costs
Deferred financing costs related to the term loan are being amortized into interest expense over five years, the term of the facility. Total accumulated amortization of deferred financing costs was $334,264 at September 30, 2004.
31
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than their carrying amount. Impairment, if any, is assessed using discounted cash flows. Consequently, the investment in a strategic partner was evaluated as of September 30, 2004 for net realizable value and a reserve was established as of that time for the total amount of the investment.
Accruals for Rebates, Returns, and Chargebacks
The Company establishes accruals for rebates, returns, and chargebacks in the same period the Company recognizes the related sales and reduces revenues for these accruals. Accrued rebates include amounts due under Medicaid, and other commercial contractual rebates. The Company estimates accrued rebates based on a percentage of selling price determined from historical experience. With respect to accruals for estimated Medicaid rebates, the Company evaluates historical rebate payments by product as a percentage of historical sales, product pricing and current contracts. At the time of rebate payment, which generally occurs with a delay after the related sale, the Company records a reduction to accrued expenses and, at the end of each period, adjust accrued expenses for any differences between estimated and actual payments. Due to estimates and assumptions inherent in determining the amount of the rebate, rebate payments remain subject to retroactive adjustment. Returns are accrued based on historical and industry experience and is currently estimated at two percent of net sales. Chargebacks are based on the estimated days of unprocessed claims using historical experience. In all cases, judgment is required in estimating these reserves, and actual claims for rebates, returns and chargebacks could be different from the estimates.
Revenue Recognition
Revenue is recognized when title and risk of loss are transferred to customers, collection of sales is reasonably assured, and the Company has no further performance obligations. This is generally at the time products are received by the customer. Accruals for estimated discounts, returns, rebates and chargebacks, determined based on historical experience, reduce revenues at the time of sale.
32
Cost of Goods Sold
Cost of goods sold includes manufacturing costs, including packaging materials, labor and overhead, royalty costs, and amortization of intangible assets associated with the products rights acquisition. The Company is required to pay royalties on its marketed products Cardene I.V., Ismo, IV Busulfex, and Declomycin. Royalty expenses directly related to product sales are classified as cost of sales and range from 12-30% of net product sales. Royalties are paid on a quarterly basis and are included as a component of cost of goods sold when the expense is incurred.
Advertising and Promotion
The Company engages in promotional activities, which typically take the form of detail aids, industry publications, journal ads, hospital grants, exhibits, speaker programs, and other forms of media. In accordance with procedures defined under Statement of Position (“SOP”) 93-7, Reporting on Advertising Costs, advertising and promotion expenditures are expensed as incurred. Total advertising costs incurred during the nine month periods ended September 30, 2004 and 2003 were $8,868,979 and $4,247,328, respectively.
Stock-Based Compensation
The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations as permitted under Financial Accounting Standards Board Statement (“FASB”) No. 123, Accounting for Stock-Based Compensation (SFAS 123), which requires the use of option valuation models that were not developed for use in valuing employee stock options.
The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:
33
|
| Nine months ended |
| ||||
|
| 2004 |
| 2003 |
| ||
|
| (unaudited) |
| ||||
|
|
|
|
|
| ||
Net income, as reported |
| $ | 1,048,958 |
| $ | 4,639,897 |
|
Add non-cash employee compensation as reported |
| 18,924 |
| — |
| ||
Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
| (82,008 | ) | (130,966 | ) | ||
Pro forma net income |
| $ | 985,874 |
| $ | 4,508,931 |
|
The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force in Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services, which require that such equity instruments are recorded at their fair value on the measurement date, which is typically the date the services are performed and such equity instruments may be subject to periodic revaluation over the vesting term.
Other Operating Expenses
Other operating expenses consist principally of technology transfer costs and other start-up costs that are expensed as incurred. These expenses are separately classified as the Company does not consider these costs to be a recurring component of operating expenses. In addition, the investment in a strategic partner was evaluated as of September 30, 2004 for net realizable value and a reserve of $2,200,000 was established as of that time for the total amount of the investment. This amount is included with other operating expenses in the statement of income for the nine months ended September 30, 2004.
Income Taxes
The Company accounts for income taxes under the asset and liability method whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect
34
for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Research and Development Costs
Research and development costs are expensed as incurred. Upfront payments made to third parties in connection with research and development collaborations are expensed as incurred up to the point of regulatory approval.
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, requires components of other comprehensive income, including unrealized gains and losses on available-for-sale securities and derivatives used to hedge exposure to interest rates, and other components of comprehensive income, to be included as part of total comprehensive income. The components of comprehensive income are typically included in the statements of stockholders’ equity. For the nine months ended September 30, 2004, the Company recorded $99,522, net of tax in comprehensive income reflecting the non-cash impact of the interest rate swap.
Recently Issued Accounting Standards
Exposure Draft on Stock Compensation
The FASB recently issued FASB Statement No. 123 (revised 2004), Share-Based Payment, an Amendment of FASB Statements No. 123 and 95. The change in accounting would replace existing requirements under FAS 123, Accounting for Stock-Based Compensation, and APB Opinion No. 25, Accounting for Stock Issued to Employees.
The statement covers a wide range of equity-based compensation arrangements. Under the Board’s statement, all forms of share-based payments to employees, including employee stock options, would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award would generally be measured at fair value at the grant date.
35
On October 13, 2004, the FASB concluded that Statement 123R would be effective for public companies (except small business issuer as defined in SEC Regulation S-B) for interim or annual periods beginning after June 15, 2005. Retroactive application of the requirements of Statement 123 (not Statement 123R) to the beginning of the fiscal year that includes the effective date would be permitted but not required. Early adoption of Statement 123R is encouraged.
A calendar-year company therefore would be required to apply Statement 123R beginning July 1, 2005 (that is adopt Statement 123R in its financial statements for the quarter ended September 30, 2005), and could choose to apply Statement 123 retroactively from January 1, 2005 to June 30, 2005 (that is, restate the year-to-date period in its third quarter 2005 Form 10-Q to account for all share-based payments under the fair value method from January 1, 2005; under Statement 123 for the first six months and under Statement 123R thereafter). The cumulative effect of adoption, if any, would be measured and recognized on July 1, 2005. Further, the Company could choose to early adopt the proposed Statement at the beginning of its first quarter ended March 31, 2005 (or even in the fourth quarter of 2004 if the FASB issues the final Statement prior to the issuance of those financial statements).
Inventory Costs
The FASB issued FASB No. 151, Inventory Costs, amendment of ARB No. 43. This statement classifies the following items as current period charges, regardless of whether they met the criterion of “so abnormal” as required under ARB 43: idle facility expense, excessive spoilage, double freight, and re-handling costs. A final standard when issued will achieve more comparability in cross-border financial reporting through convergence to a single set of high-quality accounting standards. Inventory costs was an area identified in which the FASB and IASB could improve accounting by converging their standards. The statement is applicable to inventory costs incurred during periods beginning after the adoption date (i.e. no cumulative effect upon adoption) and effective for fiscal years beginning on or after December 15, 2004.
36
3. Product Rights Acquisitions
Immediately following its inception in April 2002, the Company purchased the sales and marketing rights to four commercialized cardiovascular pharmaceutical products from Wyeth Pharmaceuticals for an aggregate purchase price of $31.5 million, including $22.0 million in cash and a $9.5 million note.
On June 10, 2003, the Company acquired from Orphan Medical, Inc. the worldwide sales and marketing rights (excluding Australia) and existing inventory of IVBusulfex for an aggregate purchase price of $29.3 million in cash. On October 3, 2003, the Company acquired from Wyeth Pharmaceuticals the U.S. rights to Declomycin for a net purchase price of $22.6 million in cash.
These acquisitions were accounted for as asset acquisitions. The products and medical indications are summarized below:
Product Name |
| Product Indication |
|
|
|
|
|
Cardene I.V. |
| For short-term treatment of hypertension when oral therapy is not feasible or desirable |
|
IVBusulfex |
| For use as a conditioning regimen prior to bone marrow transplantation for chronic myelogenous leukemia |
|
Declomycin |
| For use as an antibiotic in treating numerous bacterial infections |
|
Sectral |
| For chronic treatment of hypertension and ventricular arrhythmias |
|
Tenex |
| For chronic treatment of hypertension |
|
Ismo |
| For the prevention of angina pectoris due to coronary artery disease |
|
The fair value of the product rights acquisition was allocated based on discounted cash flow projections. The following tables summarize the gross carrying amount of the assets acquired and estimated useful lives at the date of acquisition with accumulated amortization through September 30, 2004 and December 31, 2003 (in thousands):
37
Product |
| Gross |
| Accumulated |
| Estimated |
| ||
|
|
|
|
|
|
|
| ||
September 30, 2004 |
|
|
|
|
|
|
| ||
Cardene I.V. |
| $ | 25,626 |
| $ | (9,152 | ) | 7 |
|
IVBusulfex |
| 29,300 |
| (3,256 | ) | 12 |
| ||
Declomycin |
| 22,585 |
| (7,528 | ) | 3 |
| ||
Sectral |
| 2,685 |
| (2,238 | ) | 3 |
| ||
Tenex |
| 2,421 |
| (2,038 | ) | 3 |
| ||
Ismo |
| 768 |
| (619 | ) | 3 |
| ||
Total |
| $ | 83,385 |
| $ | (24,831 | ) |
|
|
|
|
|
|
|
|
|
| ||
December 31, 2003 |
|
|
|
|
|
|
| ||
Cardene I.V. |
| $ | 25,626 |
| $ | (6,441 | ) | 7 |
|
IVBusulfex |
| 29,300 |
| (1,424 | ) | 12 |
| ||
Declomycin |
| 22,585 |
| (1,848 | ) | 3 |
| ||
Sectral |
| 2,685 |
| (1,567 | ) | 3 |
| ||
Tenex |
| 2,421 |
| (1,412 | ) | 3 |
| ||
Ismo |
| 768 |
| (448 | ) | 3 |
| ||
Total |
| $ | 83,385 |
| $ | (13,140 | ) |
|
|
The estimated amortization expense for the next five years is as follows (in thousands):
For the year ending December 31: |
|
|
| |
2005 |
| $ | 14,103 |
|
2006 |
| 11,735 |
| |
2007 |
| 6,103 |
| |
2008 |
| 6,103 |
| |
2009 |
| 3,357 |
| |
Thereafter |
| 13,273 |
| |
In April, 2004, the Company learned that Impax Laboratories, Inc.’s (“Impax”) Abbreviated New Drug Application to manufacture and distribute Demeclocycline Hydrochloride, a generic form of Declomycin, was approved by the FDA. Impax announced that it planned to immediately commence marketing Demeclocycline Hydrochloride through its Global Pharmaceutical division. ESP is currently implementing several strategic responses to this announcement and is determining the short-term and long-term impact on the operations of the Company.
38
As part of the Company’s strategic response, an agreement was finalized in June 2004 with Stiefel Laboratories, Inc. to sell a generic version of Declomycin through its Glades Pharmaceutical division (“Glades”). As part of the arrangement, the Company will realize profit in the sale of brand product to Glades, plus share in the gross profit of Demeclocycline sold through Glades’ distribution channel. On September 9, 2004, Glades began receiving products from the Company.
4. Property and Equipment
Property and equipment consisted of the following:
|
| September |
| December |
| ||
|
|
|
|
|
| ||
Office equipment |
| $ | 728,148 |
| $ | 578,915 |
|
Furniture and fixtures |
| 268,629 |
| 472,933 |
| ||
Computer equipment and software |
| 500,556 |
| 216,825 |
| ||
|
| 1,497,333 |
| 1,268,673 |
| ||
Less accumulated depreciation and amortization |
| 432,126 |
| 212,235 |
| ||
Property, plant and equipment, net |
| $ | 1,065,207 |
| $ | 1,056,438 |
|
Depreciation expense was $219,891 and $112,394 for the nine month period ended September 30, 2004 and 2003, respectively.
5. Non-Marketable Investments
On September 25, 2002, the Company entered into two agreements (the “Hydralazine Agreements”) with Barbeau Pharma, Inc. (Evanston, IL). Under the terms of the Hydralazine Agreements, Barbeau Pharma, Inc. provided to the Company the exclusive rights to market a new formulation of hydralazine hydrochloride (“Hydralazine”), and a derivative compound in late-stage development both for treating severe hypertension in pregnancy, a potentially life-threatening condition. Additionally, Barbeau Pharma, Inc. is responsible for preparing an NDA for submission to the FDA for the approval to market Hydralazine. The fair value of these rights was not deemed significant at the date of
39
acquisition. In accordance with these arrangements, the Company purchased 900 shares of Series A cumulative preferred stock for $900,000 in a series of transactions between September 2002 and November 2003.
In June 2003, the Company entered into two additional agreements (the “BP104 Agreements”) with Barbeau Pharma, Inc. whereby Barbeau Pharma, Inc. provided the Company with exclusive rights to develop and market an injectable form of an anti-emetic (“BP104”) for the treatment of chemotherapy induced nausea and vomiting and post operative nausea and vomiting. Barbeau Pharma, Inc. is responsible for preparing an NDA for submission to the FDA for the approval to market BP104. The Company purchased 1,300 shares of Series A cumulative preferred stock for $1,300,000 in a series of transactions. The fair value of these rights was not deemed significant at the date of acquisition.
Under the Hydralazine and BP104 Agreements, the Company may be required to pay an additional $800,000 to $3.8 million, depending upon the achievement of certain developmental and regulatory milestones. As of September 30, 2004, the Company’s ownership (fully diluted) was approximately 10% of Barbeau Pharma, Inc. The investment in Barbeau Pharma was evaluated as of September 30, 2004 for net realizable value and a reserve was established as of that time for the total amount of the investment, effectively writing down the investment to zero.
6. Debt
On October 3, 2003, in connection with the acquisition of Declomycin, the Company entered into a long-term financing arrangement (the “Credit Facility”) with a group of financial institutions. The Credit Facility is comprised of: (i) a $6.5 million Revolving Credit Facility (the “Revolver”), and (ii) a $53.5 million Term Loan (“Term Loan”). The Credit Facility is secured by substantially all of the tangible and intangible assets of the Company.
Under the terms of the Revolver, through October 3, 2008, the Company may borrow on a revolving basis up to $6.5 million where amounts repaid may be re-borrowed. The Revolver includes a $1.0 million letter of credit sub-facility and a $1.0 million Swingline sub-facility. Through September 30, 2004 there were no draws on the Revolver.
40
The Company borrowed $53.5 million under the Term Loan which fully matures on October 3, 2008. Scheduled principal payments of $2.7 million are required on a quarterly basis commencing on September 30, 2004 with the balance due at the maturity date. Additionally the Term Loan also includes annual mandatory principal payments commencing in April 2004 in amounts based on a percentage of the Company’s excess cash flow as defined in the Credit Facility. On April 10, 2004, the Company made a $5,411,301 payment pursuant to this excess cash flow requirement, plus a voluntary payment of $88,699 ($5,500,000 in total).
Borrowings under the Credit Facility bear interest, which is payable monthly, at a floating rate equal to the Base Rate (as defined in the Credit Facility) plus a margin of 1.25%, or at a rate equal to LIBOR plus a margin of 3.75% based on the type of borrowing. Additionally, a fee of 0.50% is charged on the average daily unused amount of the Revolver, and a fee of 3.75% is charged on the amount of any issued letters of credit. Under the terms of the Credit Facility, the Company was required to execute an interest rate swap for half of the principal balance converting the variable rate note to a fixed rate (see Note 2).
The Credit Facility contains limitations and restrictions concerning, among other things, additional indebtedness, acquisitions and dispositions of assets, dividend payments and transactions with affiliates. In addition, the Credit Facility requires the Company to maintain certain ratios (as defined therein). The Company believes it is in compliance with all financial covenants at September 30, 2004.
The following is a summary of the scheduled principal payments of the Term Loan for the next five years and does not include the annual mandatory principal payments as such amounts are contingent on future operations:
October 1 through December 31, 2004 |
| $ | 5,350,000 |
|
2005 |
| 10,700,000 |
| |
2006 |
| 10,700,000 |
| |
2007 |
| 10,700,000 |
| |
2008 |
| 10,550,000 |
| |
Total principal payments |
| $ | 48,000,000 |
|
41
7. Stockholders’ Equity
Convertible Preferred Stock
In April and May of 2002, the Company issued 28.2 million shares of Series A convertible preferred stock for proceeds of $27.4 million.
In April 2003, the Company completed its Series B convertible stock financing, which raised $19.9 million through the sale of 12.5 million shares. The Series B preferred stock preferences are the same as the Series A convertible preferred stock.
Conversion
Each share of preferred stock is, at the option of the holder, convertible into shares of common stock on a one-for-one basis, subject to certain adjustments for dilution, if any, resulting from future stock issuances. The initial conversion price for the Series A preferred stock is $1.00 per share. The initial conversion price for the Series B preferred stock is $1.60 per share. The convertible preferred stock shall be automatically converted into common stock upon (a) the consummation of an IPO at an offering price which is not less than $3 per share in an offering with aggregate proceeds to the Company of not less than $40,000,000 or (b) the vote of a two-thirds interest of the convertible preferred stock voting together as a single class.
Dividend Rights
Convertible preferred shareholders are entitled to cumulative dividends at an annual rate of 8% per share if and when declared by the Board of Directors. Dividends will be paid only out of legally available funds, subject to restrictions set forth in the Credit Facility. No dividends have been declared or paid as of or for any period ended September 30, 2004. Dividends may be paid either in cash or by the issuance of additional shares of common stock (determined by the then fair market value) at the option of the preferred shareholders. The amount of cumulative dividends in arrears related to the preferred stock is $7,879,333 as of September 30, 2004.
Liquidation Preferences
In the event of any liquidation, sale or merger, or winding up of the Company, the preferred shareholders are entitled to receive, in preference to the holders of common stock, an initial preference equal to on times the original purchase price per share
42
plus all accrued and unpaid dividends declared, then for any remaining assets, shall participate with the holders of common stock on an as-converted basis, until the preferred shareholders receive a total of three times their purchase price per share, plus all accrued and unpaid dividends declared.
Voting Rights
The preferred shareholders will vote together with the common shareholders and not as a separate class except as specifically provided in the investment agreement or required by law.
Specifically, the preferred and common stock will vote separately on mergers, acquisitions, sale of all, or substantially all assets, and transactions that would result in a change of control. Each share of preferred shall have a number of votes equal to the number of shares of common stock then issuable upon conversion of such share of preferred.
Common Stock and Common Stock Options
Restricted Common Stock
Prior to closing of the Company’s Series A Preferred Stock financing, the Company issued 6,065,000 shares of $0.0001 par value restricted common stock to founders and other advisors at a price of $0.01 per share. In 2002, the Company issued additional shares totaling 710,000 to management and other employees at $0.16 per share. Subsequently, there have been a number of grants, forfeitures upon termination from the Company and exercises of options impacting the number of outstanding shares. All common shares issued to Company employees were purchased with cash or with full recourse loans with an average interest rate of 4.75%, and have certain restrictions in connection with the ownership of such shares.
43
The outstanding shares are as follows:
|
|
|
| Shares |
| Shares |
| Options |
| Total |
| Average |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Inception through December 31, 2002 |
| Founders |
| 6,065,000 |
| — |
| — |
| — |
| $ | .01 |
|
|
| Management and other employees |
| 710,000 |
|
|
|
|
|
|
| .16 |
| |
Balance, December 31, 2002 |
|
|
| 6,775,000 |
| — |
| — |
| 6,775,000 |
| .03 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Twelve months ended December 31, 2003 |
| Directors |
| 20,000 |
|
|
|
|
| 20,000 |
| .46 |
| |
|
| Founders |
|
|
| (236,667 | ) |
|
| (236,667 | ) | .01 |
| |
|
| Employees |
|
|
|
|
| 30,375 |
| 30,375 |
| .21 |
| |
Balance, December 31, 2003 |
|
|
| 6,795,000 |
| (236,667 | ) | 30,375 |
| 6,588,708 |
| .03 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Nine months ended September 30, 2004 |
| Employees |
|
|
| (45,309 | ) | 34,625 |
| (45,309 | ) | .16 |
| |
|
| Employees |
|
|
|
|
|
|
| 34,625 |
| .18 |
| |
Balance, September 30, 2004 |
|
|
| 6,795,000 |
| (281,976 | ) | 65,000 |
| 6,578,024 |
| $ | .03 |
|
The restricted founders shares vest (i.e. have a lapsing forfeiture provision) as follows: a) 33.33% of the common stock vests on the date each founder commences employment with the Company, b) 16.67% vests on the first anniversary of the date of employment, c) the remaining 50% vests in equal monthly installments over a three year period beginning the month following the first anniversary. The vesting accelerates upon an approved sale or a liquidating event.
The Company will, at all times, reserve and keep available from its authorized but unissued shares of common stock, sufficient shares to be issued upon the conversion of the shares of the convertible preferred stock and upon the exercise of the stock options. As of September 30, 2004, the Company reserved 40,700,000 shares of common stock for future issuance for the potential conversion of preferred shares.
44
Stock Options
In June 2002, the Company’s Board of Directors and shareholders approved the Company’s 2002 Stock Option Plan (the “2002 Plan”). The 2002 Plan provides for the granting of options to purchase common stock in the Company to employees, advisors and consultants at a price to be determined by the Company’s Board of Directors. The Options may be incentive stock options or non-statutory stock options. Under the provisions of the 2002 Plan, no option will have a term in excess of 10 years. At September 30, 2004, the Company reserved up to 143,151 shares for issuance upon exercise of options.
The 2002 Plan is intended to encourage ownership of stock by employees and consultants of the Company and to provide additional incentives for them to promote the success of the Company’s business and is administered by the Board of Directors or a committee consisting of members of the Board. The Board or committee is responsible for determining the individuals to be granted options, the number of options each individual will receive, the option price per share and the exercise period of each option. Options granted pursuant to the 2002 Plan generally vest 25% after the first year, and the remaining 75% vest equally over the next three years.
The following table summarizes information about stock options outstanding at September 30, 2004 and December 31, 2003.
|
|
|
|
|
| Options Outstanding |
| ||||||
|
| Shares |
| Restricted |
| Number |
| Option |
| Weighted- |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Balance at December 31, 2002 |
| 1,101,500 |
|
|
| 223,500 |
| $ | 0.16 |
| $ | 0.16 |
|
Shares authorized |
| 1,700,000 |
|
|
| — |
| — |
| — |
| ||
Shares issued |
| (20,000 | ) | 20,000 |
| — |
| — |
| — |
| ||
Common stock forfeited |
| 236,667 |
|
|
| — |
| — |
| — |
| ||
Options granted |
| (2,652,200 | ) |
|
| 2,652,200 |
| 0.16-0.46 |
| 0.28 |
| ||
Options exercised |
| — |
|
|
| (30,375 | ) | 0.16 |
| 0.16 |
| ||
Options forfeited |
| 103,625 |
|
|
| (103,625 | ) | 0.16 |
| 0.16 |
| ||
Balance at December 31, 2003 |
| 469,592 |
| 20,000 |
| 2,741,700 |
| 0.16-0.46 |
| 0.21 |
| ||
Shares authorized |
| — |
|
|
| — |
| — |
| — |
| ||
Common stock forfeited |
| 45,309 |
|
|
| — |
| 0.16 |
| 0.16 |
| ||
Options granted |
| (455,200 | ) |
|
| 455,200 |
| 0.46-2.63 |
| 0.91 |
| ||
Options exercised |
|
|
|
|
| (34,625 | ) | 0.16-0.25 |
| 0.18 |
| ||
Options forfeited |
| 83,450 |
|
|
| (83,450 | ) | 0.16-1.75 |
| 0.26 |
| ||
Balance at September 30, 2004 |
| 143,151 |
| 20,000 |
| 3,078,825 |
| $ | 0.16 - 2.63 |
| $ | .31 |
|
45
The following table summarizes information about stock options outstanding at September 30, 2004:
Exercise Price |
| Options |
| Options |
| Weighted- |
| |
|
|
|
|
|
|
|
| |
$ | 0.16 |
| 1,097,750 |
| 378,500 |
| 3.25 |
|
0.22 |
| 456,250 |
| 118,750 |
| 3.50 |
| |
0.25 |
| 1,044,875 |
| 261,125 |
| 3.75 |
| |
0.46 |
| 329,300 |
| 7,113 |
| 4.00 |
| |
0.77 |
| 15,750 |
| — |
| 4.50 |
| |
1.75 |
| 105,400 |
| — |
| 4.75 |
| |
2.63 |
| 29,500 |
| — |
| 5.00 |
| |
|
| 3,078,825 |
| 765,488 |
|
|
| |
At September 30, 2004, the average remaining contractual life of outstanding options was approximately 4 years. The weighted-average fair value of options granted since inception was approximately $0.31.
If compensation cost had been determined based on the fair value of the options at the grant dates for those options for which no compensation cost has been recognized, consistent with the method of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), the Company’s net income per share would have decreased. Such pro forma disclosures (see Note 2) may not be representative of future compensation expense because options vest over several years and additional grants may be made each year. The fair value of these options was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions for 2004:
Employee Share Options |
|
|
|
|
|
|
|
Expected life |
| 5 years |
|
Risk-free interest rate |
| 3.5 | % |
Volatility |
| 100 | % |
Dividend yield |
| 0 | % |
46
8. Income Taxes
Significant components of the state and federal income tax provision (benefit) for income taxes are as follows:
|
| Nine months ended |
| ||||
|
| 2004 |
| 2003 |
| ||
|
| (unaudited) |
| ||||
Current provision: |
|
|
|
|
| ||
Federal |
| $ | 3,721,321 |
| $ | 1,760,604 |
|
State |
| 562,828 |
| 753,333 |
| ||
Total current provision |
| 4,284,149 |
| 2,513,937 |
| ||
|
|
|
|
|
| ||
Deferred benefit: |
|
|
|
|
| ||
Federal |
| (3,040,418 | ) | (142,811 | ) | ||
State |
| (452,412 | ) | (19,474 | ) | ||
Total deferred benefit |
| (3,492,830 | ) | (162,285 | ) | ||
Net deferred benefit |
| (3,492,830 | ) | (162,285 | ) | ||
Total income tax provision |
| $ | 791,319 |
| $ | 2,351,652 |
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets for financial reporting and the amount used for income tax purposes. At December 31, 2003, the Company believed it was more likely than not that it would realize its deferred tax assets and reduced the valuation allowance to zero. The change in the valuation allowance for the year ended December, 2003 was ($810,000). Significant components of the Company’s deferred tax assets as of September 30, 2004 and December 31, 2003 are as follows:
47
|
| September |
| December |
| ||
|
| (unaudited) |
| ||||
Deferred tax assets: |
|
|
|
|
| ||
Accounts receivable allowances |
| $ | 3,464,000 |
| $ | 1,642,000 |
|
Amortization of intangible assets |
| 3,779,000 |
| 1,767,000 |
| ||
Amortization of start-up costs |
| 156,000 |
| 231,000 |
| ||
Other |
| (313,000 | ) | (47,000 | ) | ||
Total deferred tax assets |
| 7,086,000 |
| 3,593,000 |
| ||
Less valuation allowance |
| — |
| — |
| ||
Net deferred tax asset |
| $ | 7,086,000 |
| $ | 3,593,000 |
|
The net deferred tax asset included a current portion of $3,374,574 and $1,034,078 at September 30, 2004 and December 31, 2003 respectively and a long-term portion of $3,711,298 and $2,558,964 at September 30, 2004 and December 31, 2003 respectively.
9. Operating Leases and Commitments
Minimum annual rental commitments under non-cancelable operating leases, primarily office facilities in effect at September 30, 2004 are as follows:
2005 |
| $ | 434,785 |
|
2006 |
| 433,328 |
| |
2007 |
| 433,328 |
| |
2008 |
| 433,328 |
| |
Thereafter |
| 36,111 |
|
48
Operating lease rental expense aggregated $317,495 and $272,871 for the nine months ended September 30, 2004 and 2003, respectively.
Letter of Credit
In accordance with the terms of the Company’s leasing arrangement, the Company is required to maintain an irrevocable letter of credit in the amount of $230,000. Through September 30, 2004, there were no draws on the letter of credit.
10. Employee Benefit Plan
The Company has established a defined contribution pension plan (the “Plan”) covering all eligible employees. Employees are eligible to participate in the Plan on the first quarterly entry date following date of hire, as defined in the Plan document. Employees can contribute from 1% to 60% of eligible pay, subject to the annual Federal Tax Law limits. The Company matches 100% of the first 3% of employee contributions and may also elect to make a discretionary non-matching contribution to the Plan on behalf of all eligible employees. Total expenses incurred for the nine months ended September 30, 2004 and 2003 was approximately $ 251,785 and $133,214 respectively.
11. Related Party Transactions
As permitted under the Stock Plan, certain purchasers of restricted stock and option grants signed full recourse promissory notes for the value of their shares and options at the date of grant. Under the terms of these notes, the principal balance and all unpaid interest is at various dates through 2007. Both interest and principal can be prepaid without penalty. At September 30, 2004 and December 31, 2003, notes and accrued interest receivable of $140,912 and $152,904, respectively, remain outstanding and are classified in stockholders’ equity.
Two of the officers of ESP Pharma are members of the Board of Directors for a company that ESP Pharma has non-marketable investments.
49