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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
Commission file number: 0-27406
CONNETICS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-3173928
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
3400 WEST BAYSHORE ROAD
PALO ALTO, CALIFORNIA 94303
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 843-2800
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for at least the past 90 days. Yes [x] No [ ]
As of May 8, 2000, 27, 264, 621 shares of the Registrant's common stock
were outstanding, at $0.001 par value.
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CONNETICS CORPORATION
TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2000 and
December 31, 1999................................................................3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2000 and 1999.............................................4
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2000 and 1999.............................................5
Notes to Condensed Consolidated Financial Statements.............................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...........................................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risks.....................22
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................23
Exhibits........................................................................23
Reports on Form 8-K.............................................................23
SIGNATURE ................................................................................24
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONNETICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31,
2000 December
(unaudited) 31, 1999
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 12,521 $ 8,460
Short-term investments 12,349 17,839
Accounts receivable 1,326 1,608
Other current assets 712 817
--------- ---------
Total current assets 26,908 28,724
Property and equipment, net 1,414 1,505
Non current marketable securities 20,923 --
Notes receivable from related parties 330 60
Deposits and other assets 121 121
--------- ---------
Total assets $ 49,696 $ 30,410
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,962 $ 4,988
Accrued liabilities 3,097 1,596
Accrued process development expenses 1,105 3,296
Accrued payroll and related expenses 1,121 1,453
Current portion of notes payable and other liabilities 1,855 2,594
Current portion of capital lease obligations, capital loans and
long-term debt 1,285 1,396
--------- ---------
Total current liabilities 11,425 15,323
Non-current portion of capital lease obligations, capital loans and
long-term debt 525 799
Stockholders' equity:
Common stock, treasury stock and additional paid-in capital 135,896 133,963
Deferred compensation (34) (39)
Accumulated deficit (119,152) (119,752)
Accumulated other comprehensive income 21,036 116
--------- ---------
Total stockholders' equity 37,746 14,288
--------- ---------
Total Liabilities and Stockholders' Equity $ 49,696 $ 30,410
========= =========
See accompanying notes to condensed consolidated financial statements.
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CONNETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
March 31,
---------------------
2000 1999
-------- --------
Revenues:
Product $ 5,666 $ 2,161
Contract 7,750 5,000
-------- --------
Total revenues 13,416 7,161
-------- --------
Operating costs and expenses:
Cost of product revenues 1,799 1,171
License amortization -- 1,680
Research and development 6,145 4,681
Selling, general and administrative 5,519 5,594
-------- --------
Total operating costs and expenses 13,463 13,126
Interest and other income 746 334
Interest expense (100) (292)
-------- --------
Net income (loss) $ 599 $ (5,923)
======== ========
Net income (loss) per share:
Basic $ 0.02 $ (0.28)
======== ========
Diluted $ 0.02 $ (0.28)
======== ========
Shares used to calculate net income (loss) per
share
Basic 26,627 21,088
======== ========
Diluted 28,412 21,088
======== ========
See accompanying notes to condensed consolidated financial statements.
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CONNETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended March 31,
2000 1999
-------- --------
Cash flows from operating activities:
Net income (loss) $ 599 $ (5,923)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization 170 1,859
Amortization of deferred compensation 5 637
Variable option expense 715 --
Changes in assets and liabilities:
Accounts receivable 282 (716)
Current and other long-term assets (165) (532)
Current and other liabilities (3,047) 2,648
Other long-term liabilities -- 670
-------- --------
Net cash used in operating activities (1,441) (1,357)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments (1,458) (2,784)
Sales and maturities of short-term investments 6,945 4,274
Capital expenditures (79) (664)
-------- --------
Net cash provided by investing activities 5,408 826
-------- --------
Cash flows from financing activities:
Payment of notes payable (739) (2,500)
Payments on obligations under capital leases and capital loans (385) (117)
Proceeds from issuance of common stock, net 1,218 4,086
-------- --------
Net cash provided by financing activities 94 1,469
-------- --------
Net change in cash and cash equivalents 4,061 938
Cash and cash equivalents at beginning of period 8,460 14,708
-------- --------
Cash and cash equivalents at end of period $ 12,521 $ 15,646
======== ========
Supplementary information:
Interest paid $ 53 $ 173
See accompanying notes to condensed consolidated financial statements.
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CONNETICS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
1. BASIS OF PRESENTATION
We have prepared the accompanying unaudited condensed consolidated
financial statements of Connetics Corporation ("Connetics") in accordance with
generally accepted accounting principles for interim financial information and
pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, the financial statements do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In our opinion, all adjustments, consisting of normal
recurring accrual adjustments, considered necessary for a fair presentation have
been included. Operating results for the three month period ended March 31, 2000
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2000.
These financial statements and notes should be read in conjunction with
audited financial statements and notes to those financial statements for the
year ended December 31, 1999 included in our Annual Report on Form 10-K.
2. EARNINGS PER SHARE
We compute basic earnings per share based on the weighted average number
of common shares outstanding during the period. Diluted earnings per share also
includes the incremental shares expected to be issued pursuant to the exercise
of in-the-money stock options and other potentially dilutive securities. The
number of incremental shares from the assumed issuance of stock options and
other potentially dilutive securities is calculated applying the treasury stock
method. Common stock equivalent shares are excluded from the computation when
there is a loss, as their effect is anti-dilutive. The following table sets
forth the computations for basic and diluted earnings per share.
Three months ended March 31,
----------------------------
(In thousand, except per share amounts) 2000 1999
------ ---------
Numerator for basic and diluted earnings
per share-
Net income (loss) $ 599 $ (5,923)
====== =========
Denominator for basic earnings per share- 21,088
Weighted average shares 26,627
Effect of dilutive securities-
Stock options and warrants 1,785 --
------ ---------
Denominator for diluted earnings per share 28,412 21,088
Earnings (loss) per share:
Basic $ 0.02 $ (0.28)
====== =========
Diluted $ 0.02 $ (0.28)
====== =========
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3. COMPREHENSIVE INCOME (LOSS)
During the three months ended March 31, 2000, total comprehensive income
(loss) amounted to $21.5 million compared to $(5.9) million for the same period
in 1999. The components of comprehensive income (loss) for the three-month
periods ended March 31, 2000 and March 31, 1999 are as follows:
Three months ended March 31,
----------------------------
(In thousands) 2000 1999
--------- ----------
Net income (loss) $ 599 $(5,923)
Unrealized gain (loss) on securities 20,920 (9)
Foreign currency translation adjustment -- --
------- -------
Comprehensive Income (loss) $21,519 $(5,932)
======= =======
Accumulated other comprehensive income at March 31, 2000 and December 31, 1999
consisted of unrealized gains on securities of $21.0 million and $ 0.1 million,
respectively.
4. RESEARCH AND LICENSE AGREEMENTS
In January 1999, Connetics entered into a development, commercialization
and supply agreement with Celltech Group, PLC (formerly Medeva PLC) of the
United Kingdom ("Celltech)") for certain therapeutic indications pertaining to
relaxin. Under the terms of the agreement, Medeva paid $8.0 million upon
closing, which included a $4.0 million contract fee and a $4.0 million equity
investment, and will potentially pay $17.0 million of milestone payments based
upon the achievement of development milestones in the U.S. and Europe and $5.0
million for the development and approval of each indication in Europe in
addition to scleroderma. Celltech is responsible for all development and
commercialization activities in Europe and is required to pay royalties on sales
in Europe. In addition, Celltech will reimburse us for 50% of the product
development costs in the U.S. up to a maximum of $1.0 million per quarter, for
an estimated total of $10.0 million. We also agreed to potentially share U.S.
co-promotion rights with Celltech for up to five years, and Celltech will
purchase relaxin materials from us. We recorded $6.0 million for the quarter
ended March 31, 2000, and $5.0 million for the quarter ended March 31, 1999, in
contract revenue under this agreement.
In July 1999, we entered into a development, commercialization and
supply agreement with Paladin Labs Inc., a Canadian corporation, for relaxin.
Under the terms of the agreement, Paladin will pay up to $3.2 million in
development, milestone and equity payments for the successful development of
Relaxin for the treatment of scleroderma. We may receive additional milestone
payments for the approval of additional indications for relaxin in Canada.
Paladin is responsible for all development and commercialization activities in
Canada, and will pay royalties on all sales of relaxin in Canada. For the three
months ended March 31, 2000, we recorded $0.2 million in contract revenue under
this agreement.
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5. INTERMUNE
On April 28, 1999, our wholly-owned subsidiary InterMune became an
independent company through venture capital funding and a portion of our
original investment in InterMune was returned to us. We established InterMune to
develop Actimmune for serious pulmonary and infectious diseases and congenital
disorders shortly after we in-licensed Actimmune from Genentech in May 1998. We
retained approximately a 10% equity position in InterMune, which is now
approximately a 7% equity position, received a license fee payment of $500,000,
a $4.7 million return of invested capital, and will receive an additional return
of invested capital of $3.5 million in the form of cash and equity receivable
through fiscal 2001, of which we received $1.5 million in cash during the first
quarter of 2000. We have retained commercial rights to and revenue from
Actimmune for chronic granulomatous disease up to a predetermined annual
baseline that is preset for three years (January 15, 1999 through December 31,
2001) and will receive a royalty on Actimmune sales thereafter. In addition, we
have retained the product rights for potential dermatological applications of
Actimmune. During the first quarter of 2000, Intermune completed its initial
public offering, and as a result, we recorded a mark-to-market unrealized gain
of $20.4 million on our equity investment. The Intermune investment is included
in non current marketable securities in the Condensed Consolidated Balance Sheet
at March 31, 2000.
6. LIQUIDITY AND FINANCIAL VIABILITY
In the course of our development activities, we have sustained
continuing operating losses and expect such losses to continue for the next few
years. Our future capital uses and requirements depend on numerous factors,
including the progress of our research and development programs, the progress of
clinical testing, the time and costs involved in obtaining regulatory approvals,
the cost of filing, prosecuting, and enforcing patent claims and other
intellectual property rights, competing technological and market developments,
our ability to establish collaborative arrangements, the level of product
revenues, the possible acquisition of new products and technologies, and the
development of commercialization activities. Therefore, such capital uses and
requirements may increase in future periods. As a result, we may require
additional funds prior to reaching profitability and may attempt to raise
additional funds through equity or debt financings, collaborative arrangements
with corporate partners or from other sources. Our inability to obtain
sufficient funds could require us to delay, scale back or eliminate some or all
of our research and development programs, to limit the marketing of our
products, or to license to third parties the rights to commercialize products or
technologies that we would otherwise seek to develop and market ourselves.
7. REVENUE RECOGNITION
When we receive non-refundable fees in connection with collaborative agreements,
we have recognized the fees as revenue when received, when the technology has
been transferred and when all of our contractual obligations relating to the
fees had been fulfilled. In December 1999, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 101 - Revenue Recognition in
Financial Statements (SAB 101). SAB 101 describes the SEC Staff's position on
the recognition of certain non-refundable upfront fees received in connection
with research collaborations. We are currently evaluating the applicability of
SAB 101 to our existing collaborative agreements. Should we conclude that the
approach described in SAB 101 is more
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appropriate, we will change our method of accounting effective January 1, 2000
to recognize such fees over the term of the related agreement. If we make this
change in accounting principle, the cumulative effect would be recognized in the
year to date presentation for the quarter ending June 30, 2000. The cumulative
effect, if any, would be recorded as deferred revenue and would be recognized as
revenue over the remaining term of the respective collaborative research and
development agreements.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This MD&A should be read in conjunction with the MD&A included in our
Annual Report on Form 10-K for the year ended December 31, 1999, and with the
unaudited condensed consolidated financial statements and notes to financial
statements included in this report. Except for historical information, the
discussion in this report contains forward-looking statements that involve risks
and uncertainties. When used in this report, the words "anticipate," "believe,"
"estimate," "will," "intend" and "expect" and similar expressions identify
forward-looking statements. Although we believe that our plans, intentions and
expectations reflected in these forward-looking statements are reasonable, these
plans, intentions, or expectations may not be achieved. Some of the factors
which, in our view, could cause actual results to differ are discussed under the
caption "Factors That May Affect Future-Results, Financial Condition and the
Market Price of Securities" and in our Annual Report on Form 10-K. Our
historical operating results are not necessarily indicative of the results to be
expected in any future period.
OVERVIEW
We are currently developing Relaxin for the treatment of scleroderma,
infertility, peripheral arterial disease and organ fibrosis. We have completed
enrollment in a pivotal clinical trial for scleroderma, and we have two Phase
I/II clinical trials ongoing for infertility. In February, we filed an
investigational new drug application to initiate trials in peripheral arterial
disease. In our dermatology business, we received marketing clearance from the
U.S. Food and Drug Administration (FDA) in March 1999 to sell Luxiq
(betamethasone valerate) Foam, 0.12%, for the treatment of steroid responsive
scalp dermatoses. Our principal dermatology product under development is OLUX
Foam (clobetasol propionate) 0.05%, for the treatment of moderate to severe
scalp dermatoses, for which we submitted an NDA in July 1999. We also market
Ridaura (auranofin), a treatment for rheumatoid arthritis, and Actimmune
(interferon gamma) for the treatment of chronic granulomatous disease (through
licensing arrangements with Genentech and InterMune).
RESULTS OF OPERATIONS
REVENUES
Three Months Ended March 31,
---------------------------
Revenues (In thousands) 2000 1999
--------- --------
Product:
Luxiq $ 2,259 $ --
Ridaura 1,650 1,269
Actimmune 1,757 892
-------- --------
Total product revenues 5,666 2,161
Contract:
Celltech Group 6,000 5,000
Paladin Labs 200 --
InterMune 1,500 --
Immune Response 50 --
-------- --------
Total contract revenues 7,750 5,000
Total revenues $ 13,416 $ 7,161
======== ========
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Our product revenues for the quarter ended March 31, 2000 were $5.7
million, representing a 162% increase over revenues of $2.2 million for the same
period in 1999. The increase in total product sales was due to sales of Luxiq,
which was launched in April 1999, and sales growth for Actimune. Although
Ridaura sales increased quarter over quarter, we believe that Ridaura will
experience decreased sales for the remainder of 2000 due to competition from new
and existing products.
Contract revenues for the quarter ended March 31, 2000 were $7.8 million
which includes a one-time $5 million payment from Celltech in connection with
our agreement for the development of Relaxin. In addition, we recorded $1.5
million in revenue in connection with our sublicense agreement with InterMune.
We expect contract revenue to fluctuate significantly depending on when and
whether we or our partners achieve milestones under existing agreements, and on
new business opportunities that we may identify.
Our cost of product revenues includes the costs of Luxiq, Ridaura and
Actimmune, royalty payments on these products based on a percentage of our
product revenues, and product freight and distribution costs from CORD. For the
quarter ended March 31, 2000, we recorded cost of product revenues of $1.8
million compared to $1.2 million for the same period in 1999. The increase in
cost of product revenues in the first quarter of 2000 over the first quarter of
1999 is primarily due to costs associated with the sales of Luxiq and Actimmune,
which we began shipping in 1999, and higher product and royalty costs. In the
first quarter of 1999, we recorded $1.7 million of amortization expense
associated with the acquisition of product rights to Ridaura.
RESEARCH AND DEVELOPMENT
Research and development expenses were $6.1 million for the three months
ended March 31, 2000 compared to $4.7 million for the same period in 1999. The
increase in research and development expenses quarter over quarter was due to:
o manufacturing scale-up of Relaxin;
o conducting a Phase II/III trial of Relaxin for the treatment of
scleroderma;
o increasing personnel in our development organization; and
o initiating of clinical trials of Relaxin for the treatment of
infertility.
We expect research and development expenses to remain at the same level
for the next few quarters, due to scale-up expenses related to Relaxin
manufacturing, Relaxin clinical trial activities for new disease indications,
and preclinical activities associated with technologies acquired from Soltec.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $5.5 million for the
quarter ended March 31, 2000 compared to $5.6 million for the same period in
1999. We expect selling, general and administrative expenses to remain flat or
increase slightly during the remainder of fiscal 2000.
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INTEREST INCOME (EXPENSE)
Interest income was $0.7 million in the three months ended March 31,
2000, compared with $0.3 million for the same period in 1999. The increase in
interest income quarter over quarter was due to a higher investment balance as a
result of proceeds received through a public offering of our common stock in
October 1999 and funds received from corporate partnership arrangements.
Interest earned in the future will depend on our funding cycles and prevailing
interest rates. Interest expense decreased to $0.1 million for the three months
ended March 31, 2000, compared with $0.3 million for the same period in 1999.
The decrease in interest expense quarter over quarter was due to:
o lower imputed interest expense attributable to the non-interest bearing
promissory note payable to SmithKline in connection with the acquisition
of Ridaura; and
o lower balances outstanding for obligations under capital leases and
loans, and notes payable
NET INCOME (LOSS)
Net income for the three months ended March 31, 2000 was $0.6 million
compared to a net loss $5.9 million for the same period in 1999. The net income
for the first quarter of 2000 was attributable to increased revenues and
included:
o a one-time $5 million contract payment from Celltech in connection with
our agreement for the development of Relaxin; and
o contract payment of $1.5 million in connection with our Amended and
Restated Exclusive Sublicense Agreement with InterMune.
o product revenue increase of 162% or $3.5 million quarter over quarter.
We expect to incur losses for the remainder of 2000 and the foreseeable
future. These losses are expected to fluctuate from period to period based on
timing of product revenues, clinical material purchases, clinical trial
expenses, and possible acquisitions of new products and technologies.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations to date primarily through proceeds from
equity financings, collaborative arrangements with corporate partners, and bank
loans. At March 31, 2000, cash, cash equivalents and short-term investments
totaled $24.9 million compared to $26.3 million at December 31, 1999. During the
first quarter of 2000, we recorded an unrealized gain of $20.4 million on our
equity investment in InterMune. The InterMune investment is included in other
non-current assets. Our cash reserves are held in a variety of interest-bearing
instruments including high-grade corporate bonds, commercial paper and money
market accounts.
Cash flows from operating activity. Cash used in operations for the three month
periods ended March 31, 2000, and March 31, 1999, was $1.4 million and $1.4
million, respectively. Net income of $0.6 million for the first quarter of 2000
was affected by non-cash charges including $0.7 million of variable option
expense. Cash outflow for the first quarter of 2000 was
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primarily for operating activities which included a $2.0 million and $2.2
million reduction in accounts payable and accrued process development expense,
respectively, partially offset by a lower accounts receivable balance.
Cash flows from investing activity. Investing activities provided $5.4
million in cash during the three month period ended March 31, 2000, due to the
sale of $7.0 million of short-term investments partially offset by $1.5 million
of short term investment purchases.
Cash flows from financing activity. Cash provided by financing
activities for the three months ended March 31, 2000 included $1.2 million of
cash proceeds from the issuance of stock, offset by $1.1 million of note and
lease payments.
Working Capital. Working capital increased by $2.1 million to $15.5
million at March 31, 2000 from $13.4 million at December 31, 1999. The increase
in working capital was due to lower accounts payable and accrued liabilities
balances partially offset by cash used for operations.
At March 31, 2000, we had an aggregate of $3.7 million in future
obligations of principal payments under capital leases, loans, long-term debt
and other obligations, of which $3.1 million is to be paid within the next year.
We have an equity line agreement with an investor, Kepler, that may
potentially provide access to capital through sales of our common stock. The
equity line expires in December 2000. Until then, when our stock meets certain
minimum trading volume requirements and trades above $10.00 per share, then the
investor may require us to draw up to $500,000 against the equity line
approximately every three months in exchange for the sale of stock at a discount
to the market price. During the first quarter of 2000, our stock traded over
$10.00 per share for the first time since the Equity Line Agreement became
available in December 1997. Consequently, Kepler exercised its right to draw
down $500,000 against the equity line in exchange for our common stock, and we
issued 58,438 shares to Kepler at a purchase price of $8.556 on February 10,
2000. We also have the right to draw down on the equity line in exchange for the
sale of stock, beyond the $500,000 minimum investment each quarter, provided our
stock trades above $7.00 per share.
We believe our existing cash, cash equivalents and short-term
investments, cash generated from product sales and collaborative arrangements
with corporate partners, will be sufficient to fund our operating expenses, debt
obligations and capital requirements through at least the next 12 months. Our
future capital uses and requirements depend on numerous factors, including the
progress of our research and development programs, the progress of clinical
testing, the time and costs involved in obtaining regulatory approvals, the cost
of filing, prosecuting, and enforcing patent claims and other intellectual
property rights, competing technological and market developments, our ability to
establish other collaborative arrangements, the level of product revenues, the
possible acquisition of new products and technologies and the development of
commercialization activities. Therefore such capital uses and requirements may
increase in future periods. As a result, we may require additional funds before
we become profitable and may attempt to raise additional funds through equity or
debt financings, collaborative arrangements with corporate partners or from
other sources.
Other than the equity line agreement discussed above, we currently have
no commitments for any additional financings, and there can be no assurance that
additional funding will be
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available to finance our ongoing operations when needed or, if available, that
the terms for obtaining such funds will be favorable or will not result in
dilution to our stockholders. Our inability to obtain sufficient funds could
require us to delay, scale back or eliminate some or all of our research and
development programs, to limit the marketing of our products or to license to
third parties the rights to commercialize products or technologies that we would
otherwise seek to develop and market ourselves.
YEAR 2000 COMPLIANCE
As of May 8, 2000, we had not experienced, nor do we expect to
experience, any Year 2000-related disruption in the operation of our systems. To
our knowledge, none of our material suppliers or customers experienced any
material Year 2000 problems or had any difficulty resolving the so-called
"century leap year" algorithm. Although most Year 2000 problems should have
become evident on January 1, 2000 or February 29, 2000, additional Year
2000-related problems may become evident in the future.
FACTORS THAT MAY AFFECT FUTURE RESULTS, FINANCIAL CONDITION AND THE MARKET PRICE
OF SECURITIES
Please also read Items 1 and 3 in our 1999 Annual Report and Form 10-K
where we have described our business and the challenges and risks we may face in
the future.
Our results of operations have varied widely in the past, and they could
continue to vary significantly from quarter to quarter due to a number of
factors, including those listed below. Any shortfall in revenues would have an
immediate impact on our earnings per share, which could adversely affect the
market price of our common stock. Our operating expenses, which include sales
and marketing, research and development and general and administrative expenses,
are based on our expectations of future revenues and are relatively fixed in the
short term. Accordingly, if revenues fall below our expectations, we will not be
able to reduce our spending rapidly in response to such a shortfall. This will
adversely affect our operating results. Due to the foregoing factors, we believe
that quarter-to-quarter comparisons of our results of operations are not a good
indication of our future performance.
RISKS RELATED TO OUR BUSINESS
If we do not obtain the capital necessary to fund our operations, we wil be
unable to develop or market our products.
We believe that our available cash resources will be sufficient to fund our
operating and working capital requirements for the next 12 months. Accordingly,
we may need to raise additional funding in the future. In particular, if our
ConXn clinical trial is successful, our working capital needs will increase as
we will incur additional regulatory and commercialization expenses for ConXn. In
this event, we would need to raise additional funds. If we are unable to raise
additional funds when needed, we may not be able to market our products as
planned, or continue development of our other products.
We may need to raise additional funds through public or private
financings, strategic relationships or other arrangements. In particular, if our
ConXn clinical trial for scleroderma is successful, we would incur significant
additional expenditures associated with pursuing regulatory approval and
eventual commercialization of ConXn which would extend the date as of
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which we could first achieve profitability. If we are unable to successfully
complete development and commercialization of ConXn, we may never achieve
profitability. If we need to raise additional money to fund our operations,
funding may not be available to us on acceptable terms, or at all.
Fluctuations in our operating results may cause our stock price to decline.
Our quarterly and annual operating results are difficult to predict and may
fluctuate significantly from time to time and may not meet the expectations of
securities analysts and investors in some future period. As a result, the price
of our common stock could decline.
We have a history of losses, we expect to incur losses in the future, and we may
not be able to achieve or sustain profitability, which may cause our stock price
to decline.
We have lost money every year since our inception. We had net losses of
$26.6 million in 1998 and $27.3 million 1999. Our accumulated deficit was $119.8
million at December 31, 1999. We expect to incur additional losses for at least
the next few years. We may not achieve profitability and, if we do reach
profitability, we may not be able to sustain it. Our ability to reach and
sustain profitability will depend upon the success of our current products and
our products under development.
If our corporate partners are no longer willing or able to fund the development
of ConXn, our current product revenue will not cover the cost of fully
developing and commercializing ConXn.
We depend on licensing agreements with our corporate partners to
successfully develop and commercialize our products. We also generate revenue by
licensing our products to third parties for specific territories and
indications. Our reliance on third parties for our success carries several
risks, including the possibilities that:
o a product development contract may expire or a relationship may be
terminated, and we will not be able to attract a satisfactory
alternative corporate partner within a reasonable time;
o a corporate partner involved in the development of our products does
not commit sufficient capital to successfully develop our products; and
o we may be contractually bound to terms that, in the future, are not
commercially favorable to us.
If any of these risks occurs, we may not be able to successfully develop our
products at the rate we anticipate, or we may not be able to develop them at
all.
If we fail to protect our proprietary rights, competitors may be able to use our
technologies, which would weaken our competitive position, reduce our revenues
and increase our costs.
Our commercial success depends in part on our ability and the ability of our
licensors to protect our technology and processes.
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The foam technology used in our Luxiq and OLUX products is not covered by
issued patents but is the subject of pending patent applications. If we do not
obtain patent coverage for Luxiq and OLUX, it may be easier and more attractive
for potential new market entrants to develop and introduce competitive products.
With regard to patent applications that we or our licensors have filed, or
patents issued to us or our licensors:
- any pending patent applications may not issue as patents;
- our competitors may successfully challenge or circumvent our
patents; or
- any patents which exist or are issued may not provide us with a
competitive advantage.
In addition, others may obtain patents that contain claims which cover
products or processes that we make, have made, use, or sell. If a third party
claimed an intellectual property right to technology we use, we might be forced
to discontinue an important product or product line; alter our products or
processes to avoid infringement; pay license fees and/or damages; and cease
certain activities.
Under these circumstances, we may not be able to obtain a license to such
intellectual property on favorable terms, if at all. We may not succeed in any
attempt to redesign our products or processes to avoid infringement.
A judgment adverse to us in any patent interference, litigation or other
proceeding arising in connection with these patent applications could materially
harm our business. In addition, the costs of any such proceeding may be
substantial whether or not we are successful.
We depend on third parties to protect and maintain our patent portfolio.
Nearly our entire patent portfolio is licensed from third parties, who are
responsible to varying degrees for the prosecution and maintenance of those
patents. Our success will depend on our ability, or the ability of our
licensors, to obtain and maintain patent protection on technologies, to preserve
trade secrets, and to operate without infringing the proprietary rights of
others. It is possible that before any of our products in development can be
commercialized, the related patents may have expired or be close to expiration,
thus reducing any advantage of the patent. Moreover, composition of matter
patent protection, which gives patent protection for a compound or a
composition, may not be available for some of our product candidates.
The patents licensed to us, if challenged, may not be upheld. In addition,
the patents in our relaxin patent portfolio begin to expire in 2002 in foreign
countries and 2005 in the United States. Additional patents may not issue, and
if they do, they may not be sufficient to protect our relaxin products.
If we do not successfully commercialize relaxin, we may lose fundamental
intellectual property rights to the product.
Licenses with Genentech and the Florey Institute require us to use our best
efforts to commercialize relaxin. Our failure to successfully commercialize
relaxin may result in the reversion of our rights under these licenses to
Genentech and the Florey Institute. The termination of these agreements and
subsequent reversion of rights could cause us to lose fundamental intellectual
property rights to relaxin. This would prohibit us from continuing our
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relaxin development programs, which would seriously harm our business and our
future prospects.
We are subject to foreign exchange risks which may increase our operational
expenses.
We make payments to Boehringer Ingelheim for the production of ConXn in
Austrian schillings, and to CCL Pharmaceuticals for the production of Luxiq and
OLUX in pounds sterling. If the U.S. dollar depreciates against the schilling or
the pound, the payments that we must make will increase, which may harm our
financial condition.
Our use of hazardous materials exposes us to the risk of environmental
liabilities, and we may incur substantial additional costs to comply with
environmental laws.
Our research and development activities involve the controlled use of
hazardous materials, chemicals and various radioactive materials. We are subject
to federal, state and local laws and regulations governing the use, storage,
handling and disposal of these materials and certain waste products. We cannot
completely eliminate the risk of accidental contamination or injury from these
materials. In the event of such an accident, we could be liable for any damages
that result and any liability could exceed our resources. We could be required
to incur significant costs to comply with environmental laws and regulations as
our research activities increase.
RISKS RELATED TO OUR PRODUCTS
If ConXn fails in its clinical trials for the treatment of scleroderma, we will
not be able to market ConXn for that disease.
ConXn, the recombinant human relaxin product that we are developing, is
critical to our future success. We are initially studying ConXn for the
treatment of diffuse scleroderma, a serious disease involving the excessive
formation of connective tissue. We initiated a pivotal Phase II/III trial of
ConXn for the treatment of diffuse scleroderma in February 1999, and completed
patient enrollment in that trial in December 1999. To complete the development
of ConXn for scleroderma, we will need, at a minimum, to demonstrate the safety
and efficacy of ConXn in this clinical study; and submit a biologics license
application to the FDA for the purpose of obtaining approval to market ConXn in
the United States.
The current ConXn clinical trial may not be successful and we may not be
able to submit a biologics license application for ConXn. Even if the clinical
data support the submission of a biologics license application, the FDA may not
approve this application for the indications for which we submit. Furthermore,
we may encounter unforeseen delays in the regulatory approval process.
If our clinical trials fail to demonstrate that our products are safe and
effective for the treatment of the diseases we are targeting, the FDA will not
permit us to market our products for those diseases.
Our current trials or future clinical trials may not demonstrate the safety
and efficacy of any products and may not result in approval to market products.
The results from preclinical studies and early clinical trials may not be
predictive of results that will be obtained in later-stage testing. Many
companies in the pharmaceutical and biotechnology industries have suffered
significant setbacks in advanced clinical trials, even after promising results
from earlier trials.
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In addition to the clinical trial for scleroderma, we are in earlier stages
of development of ConXn for other indications, including infertility and
peripheral arterial disease. Even if ConXn is successful in the treatment of
scleroderma, the long-term potential of ConXn rests with other indications, such
as the ones we are studying. For ConXn to succeed, we will need, at a minimum,
to demonstrate the safety and efficacy of ConXn in these clinical studies, and
apply to the FDA to enter into pivotal trials for these indications in the
United States.
In addition to ConXn, we have a pipeline of potential products that are all
subject to FDA review. Before any company can obtain regulatory approval for the
commercial sale of its products under development, it must demonstrate through
preclinical studies and clinical trials that the product is safe and effective
for use in the target indication for which approval is sought. The results from
preclinical studies and early clinical trials may not be predictive of results
that will be obtained in later-stage testing, and future clinical trials may not
demonstrate the safety and efficacy of any products and may not result in
approval to market products. Furthermore, we may encounter unforeseen delays in
the regulatory approval process. If we are unable to commence clinical trials as
planned, enroll sufficient patients in our clinical trials, complete the
clinical trials, or demonstrate the safety and efficacy of our products, our
business will be harmed. Even if a product from our research and development
programs performs favorably in clinical trials, the FDA may not approve it.
If Luxiq and OLUX do not achieve or sustain market acceptance, our revenues will
not increase and may not cover our operating expenses.
Our future revenues will depend upon dermatologist and patient acceptance of
Luxiq, and OLUX if it receives regulatory clearance. Factors that could affect
acceptance of Luxiq and OLUX include:
o satisfaction with existing alternative therapies; ~
o the effectiveness of our sales and marketing efforts;
o undesirable and unforeseeable side effects; and
o the cost of the product as compared with alternative therapies.
Since we have only had approval to sell Luxiq for one year, the potential
long-term patient acceptance of the product is uncertain. OLUX must receive FDA
clearance before we can sell in the United States, and we will be unable to
begin to assess acceptance of OLUX until we begin commercial sales.
If we are unable to develop alternative delivery systems for ConXn, patients
that do not suffer from severe diseases may not be willing to use the current
drug delivery system.
In addition to demonstrating the safety and efficacy of ConXn in our current
clinical trials, we must meet several additional major development objectives
for ConXn. In particular, we may need to develop an alternative means of
delivering the drug. In our current clinical trials, ConXn is being delivered
through the use of an infusion pump. For a serious and life threatening
condition, such as diffuse scleroderma, this method of delivery may be
acceptable. However, we are pursuing other indications for ConXn, such as
treatment of infertility and peripheral vascular disease. For these indications,
we may need to develop an alternative delivery system; however, the known
biological properties of the relaxin molecule may decrease the availability of
certain
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delivery systems. If we are not able to develop a suitable alternative delivery
system for ConXn, we may not be unable to market ConXn effectively for
indications that are not life threatening, such as infertility, and the
commercial potential of ConXn would be seriously harmed. Our inability to
develop ConXn to its full commercial potential would harm our future prospects
and revenue growth and our stock price would likely decline.
We rely on third parties to conduct clinical trials for our products, and those
third parties may not perform satisfactorily.
We do not have the ability to independently conduct clinical studies, and we
rely on third parties to perform this function. If these third parties do not
perform satisfactorily, we may not be able to locate acceptable replacements or
enter into favorable agreements with them, if at all. If we are unable to rely
on clinical data collected by others, we could be required to repeat clinical
trials, which could significantly delay commercialization and require
significantly greater capital.
If we cannot maintain our regulatory approvals, we will be unable to sell our
products for their intended diseases.
The process of obtaining and maintaining regulatory approvals for
pharmaceutical and biological drug products, and obtaining and maintaining
regulatory approvals to market these products for new indications, is lengthy,
expensive and uncertain. The manufacturing and marketing of drugs are subject to
continuing FDA and foreign regulatory review, and later discovery of previously
unknown problems with a product, manufacturing process or facility may result in
restrictions, including withdrawal of the product from the market.
If we get approval, whether in the United States or internationally, we
will continue to be subject to extensive regulatory requirements. If we fail to
comply or maintain compliance with such laws and regulations, we may be fined
and barred from selling our products. In addition, governmental authorities
could seize our inventory of products or force us to recall our products already
in the market if we fail to comply with FDA regulations.
Manufacturing difficulties could delay commercialization of our products.
We depend on third parties to manufacture our products and each product is
manufactured by a sole source manufacturer. These parties must comply with the
applicable FDA good manufacturing practice regulations, which include quality
control and quality assurance requirements as well as the corresponding
maintenance of records and documentation. Manufacturing facilities are subject
to ongoing periodic inspection by the FDA and corresponding state agencies,
including unannounced inspections, and must be licensed before they can be used
in commercial manufacturing of our products. If our sole source manufacturers
cannot provide us with our product requirements in a timely and cost-effective
manner, or if the product they are able to supply cannot meet commercial
requirements for shelf life, or if they are not able to comply with the
applicable good manufacturing practice regulations and other FDA regulatory
requirements, our sales of marketed products could be reduced and we could
suffer delays in the progress of clinical trials for products under development.
We do not have control over our third-party manufacturers' compliance with these
regulations and standards. CCL will need to pass an FDA inspection before we can
be approved to sell OLUX. The fact that a facility has passed inspection in the
past does not guarantee that it will pass future inspections.
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If we are unable to contract with third parties to manufacture and distribute
our products in sufficient quantities, on a timely basis, or at an acceptable
cost, we may be unable to meet demand for our products and may lose potential
revenues.
We have no manufacturing or distribution facilities for any of our products.
Instead, we contract with third parties to manufacture our products for us. If
these third parties are unable or unwilling to produce our products in
sufficient quantities, with appropriate quality for our clinical trials and
subsequent commercialization, if any, and under commercially reasonably terms,
our business will suffer.
In addition, we have entered into an agreement with CORD Logistics, Inc. to
distribute Luxiq, Ridaura and Actimmune. CORD's inability to continue to
distribute our products in an effective manner or our inability to maintain
sufficient personnel with the appropriate levels of experience to manage this
function would seriously harm our business.
RISKS RELATED TO OUR INDUSTRY
If we do not obtain governmental approvals for our products in development, we
cannot sell these products.
All of our products under development must be approved by the FDA before we
are permitted to sell them in the United States. To obtain approval, we must
show in preclinical and clinical trials that our products are safe and
effective. Clinical trial data can be the subject of differing interpretation,
and the FDA has substantial discretion in the approval process. The FDA may not
interpret our clinical data the way we do. The FDA may also require additional
clinical data to support approval.
After we complete the clinical trials for a product, we will be required to
file a new drug application if the product is classified as a new drug, or a
biologics license application if the product is classified as a biologic, which
is a drug based on natural substances. The requirements for submission of these
applications and the FDA approval processes require substantial time and effort,
and the FDA may not grant approval on a timely basis or at all. The FDA can take
between one and two years to review new drug applications and biologics license
applications, or longer if significant questions arise during the review
process. In addition, delays or rejections may be encountered during FDA review.
Even after such time and expenditures, we may not obtain regulatory approval.
Any regulatory approval of a product that is granted may limit the indicated
uses for which the product may be marketed.
If the FDA modifies existing guidelines for product development, the
time and costs associated with the development of products in our product line
may increase, in which case we may not be able to successfully develop our
products at the rate we anticipate or we may not be able to develop them at all.
To market our products in countries outside of the United States, we and our
partners are required to obtain similar approvals from foreign regulatory
bodies. The foreign regulatory approval process includes all of the risks
associated with obtaining FDA approval, and approval by the FDA does not ensure
approval by the regulatory authorities of any other country. The process of
obtaining these approvals is time consuming and requires the expenditure of
substantial resources.
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We face intense competition, which may limit our commercial opportunities and
our ability to become profitable.
The pharmaceutical and biotechnology industries are highly competitive.
Products and therapies currently on the market or under development could
compete directly with some of our products. Numerous pharmaceutical and
biotechnology companies and academic research groups throughout the world are
engaged in research and development efforts with respect to therapeutic products
targeted at diseases or conditions addressed by us. Our commercial opportunities
will be reduced or eliminated if our competitors develop and market products
that are more effective, have fewer or less severe adverse side effects or are
less expensive than our products. In addition, many of our existing or potential
competitors, particularly large pharmaceutical companies, have substantially
greater financial, technical and human resources than we have. Many of these
competitors have more collective experience than we do in undertaking
preclinical testing and human clinical trials of new pharmaceutical products and
obtaining regulatory approvals for therapeutic product. Accordingly, our
competitors may succeed in developing and marketing products either that are
more effective than those that we may develop, alone or with our collaborators,
or that are marketed before any products we develop are marketed.
If third party payors will not provide coverage or reimburse patients for
the use of our products, our revenues and profitability will suffer.
Our products' commercial success is substantially dependent on whether
third-party reimbursement is available for the use of our products by hospitals,
clinics and doctors. Medicare, Medicaid, health maintenance organizations and
other third-party payers may not authorize or otherwise budget for the
reimbursement of our products. In addition, they may not view our products as
cost-effective and reimbursement may not be available to consumers or may not be
sufficient to allow our products to be marketed on a competitive basis.
Likewise, legislative proposals to reform health care or reduce government
programs could result in lower prices for or rejection of our products. Changes
in reimbursement policies or health care cost containment initiatives that limit
or restrict reimbursement for our products may cause our revenues to decline.
If product liability lawsuits are brought against us, we may incur substantial
costs.
The testing and marketing of pharmaceutical products entails an inherent
risk of product liability. Our insurance may not provide adequate coverage
against potential product liability claims or losses, and insurance coverage may
not continue to be available to us on reasonable terms or at all. Even if we are
ultimately successful in product liability litigation, the litigation would
consume substantial amounts of our financial and managerial resources, and might
create adverse publicity, all of which would impair our ability to generate
sales.
RISKS RELATED TO OUR STOCK
Our stock price is volatile and the value of your investment in our stock could
decline in value.
The market prices for securities of biotechnology companies like our company
have been and are likely to continue to be highly volatile. As a result,
investors in these companies often buy at very high prices only to see the price
drop substantially a short time later, resulting in an extreme
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drop in value in the stock holdings of these investors. In addition, the
volatility could result in securities class action litigation. Any litigation
would likely result in substantial costs, and divert our management's attention
and resources.
If our officers, directors and principal stockholders act together, they may be
able to control our management and operations and they may make decisions that
are not in the best interests of other stockholders.
Our directors, executive officers and principal stockholders and their
affiliates currently beneficially own in the aggregate approximately 65% of our
outstanding common stock. Accordingly, they collectively have the ability to
determine the election of all of our directors and to determine the outcome of
most corporate actions requiring stockholder approval. They may exercise this
ability in a manner that advances their best interests and not necessarily those
of other stockholders. This concentration of ownership may also have the effect
of delaying, deferring or preventing a change in control of our company, even if
the change in control would be beneficial to other stockholders.
Our charter documents and Delaware law contain provisions that could delay or
prevent an acquisition of us, even if the acquisition would be beneficial to our
stockholders.
Our certificate of incorporation authorizes our board of directors to issue
undesignated preferred stock and to determine the rights, preferences,
privileges and restrictions of the preferred stock without further vote or
action by our stockholders. The issuance of preferred stock could make it more
difficult for third parties to acquire a majority of our outstanding voting
stock. We also have a stockholder rights plan, which entitles existing
stockholders to rights, including the right to purchase shares of preferred
stock, in the event of an acquisition of 15% or more of our outstanding common
stock, or an unsolicited tender offer for such shares. The existence of the
rights plan could delay, prevent, or make more difficult a merger or tender
offer or proxy contest involving us. Other provisions of Delaware law and of our
charter documents, including a provision eliminating the ability of stockholders
to take actions by written consent, could also delay or make difficult a merger,
tender offer or proxy contest involving us. Further, our stock option and
purchase plans generally provide for the assumption of such plans or
substitution of an equivalent option of a successor corporation or,
alternatively, at the discretion of the board of directors, exercise of some or
all of the option stock, including non-vested shares, or acceleration of vesting
of shares issued pursuant to stock grants, upon a change of control or similar
event.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have supply contracts with Boehringer Ingelheim for Relaxin and CCL
Pharmaceuticals for Luxiq and OLUX. We also have a collaboration agreement with
Suntory for the development and commercialization of relaxin for the treatment
of scleroderma in Japan. As payments under these contracts are payable in local
currency, our financial results could be affected by changes in foreign currency
exchange rates. We have a bank loan that is sensitive to movement in interest
rates. Interest income from our investments is sensitive to changes in the
general level of U.S. interest rates, particularly since the majority of our
investments are in short-term instruments. Due to the nature of our short-term
investments, we have concluded that we face no material market risk exposure.
Therefore, no quantitative tabular disclosures are required.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1* Relaxin Development, Commercialization and License Agreement between
Connetics and F.H. Faulding & Co., Limited, dated April 7, 2000.
27.1 Financial Data Schedule (EDGAR - filed version only)
* Confidential treatment has been requested for portions of this Agreement.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended March 31, 2000.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CONNETICS CORPORATION
By: /s/ JOHN L. HIGGINS
-------------------------
John L. Higgins
Exec. Vice President, Finance and
Administration and Chief Financial
Officer
Date: May 15, 2000
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Index of Exhibits
Exhibit number Description
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10.1* Relaxin Development, Commercialization and License Agreement
between Connetics and F.H. Faulding & Co., Limited, dated
April 7, 2000.
27.1 Financial Data Schedule
* Confidential treatment has been requested for portions of this Agreement.