1
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 JUNE 30, 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 July 31, 2000, 29,530,672 shares of the Registrant's common stock
were outstanding, at $0.001 par value.
2
CONNETICS CORPORATION
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2000 and December 31,
1999.......................................................................... 3
Condensed Consolidated Statements of Operations for the three and six months
ended June 30, 2000 and 1999.................................................. 4
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 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................... 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................. 24
Item 4. Submission of Matters to a Vote of Security Holders........................... 25
Item 6. Exhibits and Reports on Form 8-K.............................................. 25
(a) Exhibits.................................................................. 25
(b) Reports on Form 8-K....................................................... 25
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONNETICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
June 30, December
2000 31, 1999
----------- ---------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 31,580 $ 8,460
Short-term investments 10,657 17,839
Accounts receivable 1,351 1,608
Other current assets 1,060 817
--------- ---------
Total current assets 44,648 28,724
Property and equipment, net 1,531 1,505
Non-current marketable securities 43,355 --
Notes receivable from related parties 335 60
Deposits and other assets 121 121
--------- ---------
Total assets $ 89,990 $ 30,410
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,689 $ 4,988
Accrued liabilities 2,671 1,596
Accrued process development expenses 1,125 3,296
Accrued payroll and related expenses 1,033 1,453
Current portion of notes payable and other liabilities 1,590 2,594
Current portion of capital lease obligations, capital
loans and long-term debt -- 1,396
--------- ---------
Total current liabilities 8,108 15,323
Non-current portion of capital lease obligations, capital
loans and long-term debt 262 799
Stockholders' equity:
Common stock, treasury stock and additional paid-in capital 157,266 133,963
Deferred compensation (29) (39)
Accumulated deficit (118,771) (119,752)
Accumulated other comprehensive income 43,154 116
--------- ---------
Total stockholders' equity 81,620 14,288
--------- ---------
Total Liabilities and Stockholders' Equity $ 89,990 $ 30,410
========= =========
See accompanying notes to condensed consolidated financial statements.
-3-
4
CONNETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ---------------------------
2000 1999 2000 1999
-------- -------- -------- --------
Revenues:
Product $ 3,793 $ 4,722 $ 9,460 $ 6,883
Contract 1,325 2,379 9,075 7,379
Sale of Actimmune revenue rights 5,218 -- 5,218 --
-------- -------- -------- --------
Total revenues 10,336 7,101 23,753 14,262
-------- -------- -------- --------
Operating costs and expenses:
Cost of product revenues 461 1,480 2,260 2,651
License amortization -- 1,680 -- 3,360
Research and development 3,983 3,899 10,128 8,580
Selling, general and administrative 6,046 4,907 11,565 10,501
-------- -------- -------- --------
Total operating costs and expenses 10,490 11,966 23,953 25,092
Interest and other income 604 306 1,350 640
Interest expense (69) (232) (169) (524)
-------- -------- -------- --------
Net income (loss) $ 381 $ (4,791) $ 981 $(10,714)
======== ======== ======== ========
Net income (loss) per share:
Basic $ 0.01 $ (0.22) $ 0.04 $ (0.50)
======== ======== ======== ========
Diluted $ 0.01 $ (0.22) $ 0.03 $ (0.50)
======== ======== ======== ========
Shares used to calculate net income (loss) per share
Basic 27,481 21,382 27,295 21,235
======== ======== ======== ========
Diluted 28,704 21,382 28,558 21,235
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
-4-
5
CONNETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended June 30,
---------------------------
2000 1999
-------- --------
Cash flows from operating activities:
Net income (loss) $ 981 $(10,714)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization 361 3,781
Amortization of deferred compensation & non-cash stock compensation 1,017 1,002
Changes in assets and liabilities:
Accounts receivable 257 (2,888)
Current and other assets (518) (469)
Current and other liabilities (3,926) 2,335
Other long-term liabilities -- (226)
-------- --------
Net cash used by operating activities (1,828) (7,179)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments (1,989) (1,901)
Sales and maturities of short-term investments 8,854 4,248
Capital expenditures (387) (931)
-------- --------
Net cash provided by investing activities 6,478 1,416
-------- --------
Cash flows from financing activities:
Payment of notes payable (2,378) (3,300)
Payments on obligations under capital leases and capital loans (558) (232)
Proceeds from issuance of common stock, net 21,406 4,617
-------- --------
Net cash provided by financing activities 18,470 1,085
-------- --------
Net change in cash and cash equivalents 23,120 (4,678)
Cash and cash equivalents at beginning of period 8,460 14,708
-------- --------
Cash and cash equivalents at end of period $ 31,580 $ 10,030
======== ========
Supplementary information:
Interest paid $ 197 $ 423
Financing activity:
Conversion of notes payable into common stock $ -- $ 719
Issuance of common stock as payment on accrued liabilities $ 888 $ --
See accompanying notes to condensed consolidated financial statements.
-5-
6
CONNETICS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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 and six month periods ended June
30, 2000 are not necessarily indicative of the results that may be expected for
the year ended 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 June 30, Six months ended June 30,
--------------------------- -------------------------
(In thousand, except per share amounts) 2000 1999 2000 1999
------- -------- ------- --------
Numerator for basic and diluted earnings-
per share-
Net income (loss) $ 381 $ (4,791) $ 981 $(10,714)
======= ======== ======= ========
Denominator for basic earnings per share- 27,481 21,382 27,295 21,235
Weighted average shares
Effect of dilutive securities- 1,223 -- 1,263 --
Stock options and warrants
------- -------- ------- --------
Denominator for diluted earnings per share 28,704 21,382 28,558 21,235
Earnings (loss) per share:
Basic $ 0.01 $ (0.22) $ 0.04 $ (0.50)
======= ======== ======= ========
Diluted $ 0.01 $ (0.22) $ 0.03 $ (0.50)
======= ======== ======= ========
-6-
7
3. COMPREHENSIVE INCOME (LOSS)
During the three and six month periods ended June 30, 2000, total
comprehensive income amounted to $22.5 million and $44.0 million, respectively,
compared to a comprehensive loss of $4.8 million and $10.7 million for the
comparable periods in 1999. The components of comprehensive income (loss) for
the three and six month periods ended June 30, 2000 and June 30, 1999 are as
follows:
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
(In thousands) 2000 1999 2000 1999
------- ------- ------- --------
Net income (loss) $ 381 $(4,791) $ 981 $(10,714)
Unrealized gain (loss) on securities 22,118 (15) 43,038 (24)
------- ------- ------- --------
Comprehensive income (loss) $22,499 $(4,806) $44,019 $(10,738)
======= ======= ======= ========
Accumulated other comprehensive income at June 30, 2000 and December 31, 1999
consisted of unrealized gains on securities of $43.2 million and $0.1 million,
respectively.
4. RESEARCH AND LICENSE AGREEMENTS
In January 1999, we 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. Celltech will purchase relaxin from us and pay royalties
on European sales of relaxin. 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. Until the earlier of five
years after we launch relaxin in the United States or the end of the first
calendar year when Celltech's European net sales of relaxin exceed $25.0
million, Celltech will receive 50% of our operating profits from U.S. relaxin
sales. We recorded $1.0 million and $7.0 million, respectively, for the three
and six month periods ended June 30, 2000, and $1.0 million and $6.0 million,
respectively, for the three and six month periods ended June 30, 1999, in
contract revenue under this agreement.
In July 1999, we entered into an exclusive license agreement with
Paladin Labs Inc. for the development and commercialization of relaxin in
Canada. 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
and six month periods ended June 30, 2000, we recorded $0.2 million and $0.5
million, respectively, in contract revenue under this agreement.
-7-
8
5. INTERMUNE
In December 1995, we entered into a license agreement with Genentech,
Inc. to acquire exclusive U.S. development and marketing rights to interferon
gamma for dermatological indications. The cumulative effect of a number of
subsequent amendments to the original license agreement is to expand the fields
of use for which the license applies, and add Japan and Canada to the licensed
territory. Genentech manufactures and supplies Actimmune pursuant to a separate
supply agreement. We established a subsidiary, InterMune Pharmaceuticals, Inc.,
in 1998 to develop Actimmune for serious pulmonary and infectious diseases and
congenital disorders. In April 1999, InterMune became an independent company,
and in March 2000, InterMune went public. We currently hold 1,049,445 shares of
common stock of InterMune, which represents approximately a 4.8% equity position
in InterMune. On June 27, 2000, we assigned all of our rights and obligations
under the license with Genentech and the corresponding supply agreement to
InterMune for a cash payment of $5.2 million. In addition, we hold an option to
purchase the product rights for potential dermatological applications of
Actimmune and will receive royalties on Actimmune sales recorded by InterMune
after December 31, 2001.
6. LIQUIDITY AND FINANCIAL VIABILITY
Until the first quarter of fiscal year 2000, we lost money every year
since our inception. We may incur additional losses during the next few years.
Accordingly, we may need to raise additional funding in the future. In
particular, we would need to raise additional funds if our relaxin clinical
trial is successful because our working capital needs will increase as we incur
additional regulatory and commercialization expenses for relaxin. 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. If we are
unable to successfully complete development and commercialization of relaxin, 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.
-8-
9
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 SAB 101 requires a change in our accounting, 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 ended December 31, 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.
-9-
10
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
that, in our view, could cause actual results to differ are discussed under the
caption "Factors That May Affect Future-Results, Financial Condition and the
Market Price of Securities" and in our Annual Report on Form 10-K. Our
historical operating results are not necessarily indicative of the results to be
expected in any future period.
OVERVIEW
We currently have clinical trials under way with recombinant human
relaxin for the treatment of scleroderma and infertility, and have submitted an
application to the FDA to begin testing the efficacy of relaxin to treat blocked
or restricted blood vessels in the extremities, which is known in the medical
field as peripheral arterial disease. In May 2000, the FDA granted us clearance
to market OLUX Foam (clobetasol propionate) 0.05%, for the treatment of moderate
to severe scalp dermatoses.
On June 27, 2000, we sold our remaining rights to Actimmune revenue in
the United States for the years 2000 and 2001 to InterMune Pharmaceuticals, Inc
("InterMune"). Beginning with the quarter ended June 30, 2000, InterMune will
record all Actimmune revenue and related expenses in the United States.
-10-
11
RESULTS OF OPERATIONS
REVENUES
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
Revenues (In thousands) 2000 1999 2000 1999
------- ------ ------- -------
Product:
Luxiq $ 2,588 $2,651 $ 4,847 $ 2,651
Ridaura 1,065 981 2,715 2,250
Actimmune 140 1,090 1,898 1,982
------- ------ ------- -------
Total product revenues 3,793 4,722 9,460 6,883
Contract:
Celltech 1,000 1,000 7,000 6,000
Suntory Ltd. -- 879 -- 879
F.H. Faulding & Co., Ltd. 25 -- 25 --
Paladin Labs, Inc. 250 -- 450 --
InterMune -- -- 1,500 500
Immune Response Corp. 50 500 100 --
------- ------ ------- -------
Total contract revenues 1,325 2,379 9,075 7,379
------- ------ ------- -------
Sale of InterMune Revenue Rights 5,218 -- 5,218 --
------- ------ ------- -------
Total revenues $10,336 $7,101 $23,753 $14,262
======= ====== ======= =======
Our product revenues for the three and six month periods ended June 30,
2000, were $3.8 million and $9.5 million, respectively, compared to $4.7 million
and $6.9 million for the three and six month periods ended June 30, 1999. The
increase in total product revenues was due to continued sales growth of Luxiq,
which we began marketing in April 1999. 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. As part of
the June 27, 2000 agreement with InterMune, we did not record Actimmune sales in
the second quarter of 2000. However, previously recorded sales reserves of $0.1
million were reversed during the second quarter.
Contract revenues for the three and six month periods ended June 30,
2000 were $1.3 million and $9.1 million, respectively, compared to $2.4 million
and $7.4 million for the three and six month periods ended June 30, 1999. Each
quarter includes $1.0 million representing reimbursement by Celltech for
research and developments costs. The decrease in contract revenue from the three
month period ended June 30, 1999, reflects a one-time licensing agreement
payment by Suntory in 1999. The increase in contract revenues for the six months
ended June 30, 2000 over the same period in 1999 reflects $1.5 million paid by
InterMune in connection with our sublicense agreement, and a one-time $5.0
million payment from Celltech in connection with our agreement for the
development of relaxin. We expect contract revenues to fluctuate significantly
depending on when and whether our partners or we achieve milestones under
existing agreements, and on new business opportunities that we may identify.
InterMune purchased the remaining United States commercial rights and
revenue to Actimmune on June 27, 2000. As part of the transaction, InterMune
paid $5.2 million which included the prepayment of a $1.0 million obligation
owed in 2002. Prior to this transaction, Connetics had the right to book revenue
based on a fixed amount of unit sales in the years 1999, 2000 and 2001.
Beginning with the quarter ended June 30, 2000, InterMune will record all
Actimmune revenue and related expenses.
-11-
12
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 our
distributor. We recorded cost of product revenues of $0.5 million and $2.3
million, respectively for the three and six month periods ended June 30, 2000,
compared to $1.5 million and $2.7 million for the three and six month periods
ended June 30, 1999. The decrease in cost of product revenues for the first six
months of 2000 over the first six months of 1999 is primarily due to the
reversal of costs associated with Actimmune revenue sold to InterMune effective
as of March 31, 2000. In addition, we recorded $1.7 million of amortization
expense associated with the acquisition of product rights to Ridaura in the
first quarter of 1999, thus resulting in a decrease in cost for the same period
ended June 30, 2000.
RESEARCH AND DEVELOPMENT
Research and development expenses were $4.0 million for the three month
period ended June 30, 2000 and $10.1 million for the six month period ended June
30, 2000, compared to $3.9 million and $8.6 million for the comparable periods
in 1999. The increase in expenses from the six months ended June 30, 2000 over
the six months ended June 30, 1999 was due to:
- continued manufacturing scale-up of relaxin;
- initiation of long-term study in connection with conducting the Phase
III trial of relaxin for the treatment of scleroderma;
- increasing personnel in our development organization; and
- initiating clinical development of relaxin for the treatment of
infertility
We expect research and development expenses to increase over the next
few quarters, due to expenses related to relaxin manufacturing and relaxin
clinical trial activities for new disease indications.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased to $6.0 million
for the three month period ended June 30, 2000 and $11.6 million for the six
month period ended June 30, 2000, compared to $4.9 million and $10.5 million for
the comparable periods in 1999. We expect selling, general and administrative
expenses to increase slightly during the remainder of fiscal 2000 due to:
- expenses associated with launching OLUX in the fourth quarter of 2000;
and
- increasing personnel in our sales and marketing, clinical and
regulatory organizations.
-12-
13
INTEREST INCOME (EXPENSE)
Interest and other income were $0.6 million for the three month period
ended June 30, 2000, and $1.4 million for the six month period ended June 30,
2000, compared with $0.3 million and $0.6 million for the comparable periods in
1999. The increase in interest income was due to realized gains from the sale of
marketable securities and higher interest income from higher cash and short-term
investment balances. Interest expense was $0.1 million for the three month
period ended June 30, 2000 and $0.2 million for the six month period ended June
30, 2000, compared with $0.2 million and $0.5 million for the comparable periods
in 1999. The decrease in interest expense resulted from lower interest expense
associated with lower balances outstanding for obligations under capital leases,
loans, and notes payable.
NET INCOME (LOSS)
Net income was $0.4 million for the three month period ended June 30,
2000 and $1.0 million for the six month period ended June 30, 2000 compared to a
net loss of $4.8 million and $10.7 million for the comparable periods in 1999.
Net income for the second quarter of 2000 was primarily attributable to an
increase in Luxiq product revenue and the following non-recurring revenue items:
- a one-time $5.0 million contract payment and $1.0 million quarterly
development payment from Celltech in connection with our agreement for
the development of relaxin; and
- the sale on June 27, 2000 of Actimmune revenue rights for $5.2 million
to InterMune and a one-time payment of $1.5 million in connection with
our exclusive sublicense agreement with InterMune.
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 June 30, 2000, cash, cash equivalents and short-term investments and
non-current marketable securities totaled $85.6 million compared to $26.3
million at December 31, 1999. Our cash reserves are held in a variety of
interest-bearing instruments including high-grade corporate bonds, commercial
paper and money market accounts.
-13-
14
Cash flows from operating activities. Cash used in operations for the
six month periods ended June 30, 2000, and 1999, was $1.9 million and $7.2
million, respectively. Net income of $1.0 million for the first six months of
2000 was affected by non-cash charges of $0.4 million of depreciation and
amortization expense and $0.7 million non-cash compensation expense. Cash
outflow for the first six months of 2000 was primarily for operating activities
which included a $3.3 million and $2.2 million reduction in accounts payable and
accrued process development expense, respectively, partially offset by a higher
accrued liabilities balance.
Cash flows from investing activities. Investing activities provided $6.5
million in cash during the six month period ended June 30, 2000, due to the sale
of $8.9 million of short-term investments partially offset by $2.0 million of
short term investment purchases.
Cash flows from financing activities. Cash provided by financing
activities for the six months ended June 30, 2000 included $21.4 million of cash
proceeds from the issuance of stock, offset by $2.9 million of note and lease
payments. Of the $21.4 million of cash proceeds, $20.0 million relates to
private placement of 2,000,000 shares of the Company's unregistered common
stock.
Working Capital. Working capital increased by $23.1 million to $36.5
million at June 30, 2000 from $13.4 million at December 31, 1999. The increase
in working capital was due to the $20.0 million private placement of our common
stock and the $5.2 million sale of Actimmune rights to InterMune, partially
offset by cash used for operations.
At June 30, 2000, we had an aggregate of $1.9 million in future
obligations of principal payments under capital leases, loans, long-term debt
and other obligations, of which $1.6 million is to be paid within one year.
We have an equity line agreement with Kepler Capital LLC. In connection
with that agreement, which expires December 1, 2000, we are required to sell
$0.5 million of our common stock to Kepler approximately every 90 days if our
stock meets certain volume restrictions and trades above $10.00 per share. In
addition, we may elect to draw down approximately $2.0 million every 90 days if
our stock trades above $7.00 per share. Our stock met the restrictions in both
the first and second quarters of 2000, and in that connection we issued 58,438
shares to Kepler at a purchase price of $8.556 on February 10, 2000. Also on
June 28, 2000, we issued 41,562 shares to Kepler with a purchase price of
$7.8585 and committed to issue a warrant for 22,063 with an exercise price of
$7.8585.
-14-
15
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.
Except for the equity line agreement discussed above, we have no
commitments for any additional financing. If we need to raise additional money
to fund our operations, funding may not be available to us on acceptable terms,
or at all. If we 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.
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 on Form 10-K
where we have described our business and the challenges and risks we may face in
the future.
Our results of operation 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. 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.
-15-
16
RISKS RELATED TO OUR BUSINESS
We may never make a profit, and stockholders may lose their investment.
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 $118.8
million at June 30, 2000. 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. If we do not achieve
profitability, our stock price may decline.
If we do not obtain the capital necessary to fund our operations, we will be
unable to develop or market our products.
We currently believe that our available cash resources will be
sufficient to fund our operating and working capital requirements at least for
the next 12 months. Accordingly, we may need to raise additional funding in the
future. In particular, if our relaxin clinical trial is successful, our working
capital needs will increase as we will incur additional regulatory and
commercialization expenses for relaxin. 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
clinical trial for scleroderma is successful, we would incur significant
additional expenditures associated with pursuing regulatory approval and
eventual commercialization of relaxin, which would extend the date as of which
we could first achieve profitability. If we are unable to successfully complete
development and commercialization of relaxin, 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.
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.
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.
-16-
17
With regard to patent applications that our licensors or we have filed,
or patents issued to our licensors or us:
- 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.
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 our corporate partners are no longer willing or able to fund the development
of relaxin, our current product revenue will not cover the cost of fully
developing and commercializing relaxin.
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 licensing arrangements with third parties carries
several risks, including the possibilities that:
- 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;
- a corporate partner involved in the development of our products does
not commit sufficient capital to successfully develop our products;
and
- 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.
-17-
18
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 is 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.
If we do not successfully commercialize relaxin, we may lose fundamental
intellectual property rights to the product.
Licenses with Genentech, Inc. and The Howard Florey Institute of
Experimental Physiology and Medicine 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 relaxin development
programs.
We are subject to foreign exchange risks, which may increase our operational
expenses.
We make payments to Boehringer Ingelheim for the production of relaxin
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 will
increase our expenses.
We rely on our employees and consultants to keep our trade secrets confidential.
We rely on trade secrets and proprietary know-how. We require each of
our employees, consultants and advisors to execute a confidentiality agreement
providing that all proprietary information developed or made known to the
individual during the course of the relationship will be kept confidential and
not used or disclosed to third parties except in specified circumstances. The
agreements also provide that all inventions conceived by an employee, consultant
or advisor, to the extent appropriate for the services provided during the
course of the relationship, shall be our exclusive property, other than
inventions unrelated to us and developed entirely on the individual's own time.
These agreements may not provide meaningful protection or adequate remedies for
misappropriation of our trade secrets in the event of unauthorized use or
disclosure of such information.
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. In the
event of accidental contamination or injury from these materials, we could be
liable for any damages that result and any liability could exceed our resources.
We may also be required to incur significant costs to comply with environmental
laws and regulations as our research activities increase.
-18-
19
RISKS RELATED TO OUR PRODUCTS
If we do not obtain and maintain governmental approvals for our products, we
cannot sell these 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. To obtain
approval, we must show in preclinical and clinical trials that our products are
safe and effective.
After we complete the clinical trials for a product, we must 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 FDA approval processes require substantial time
and effort, the FDA continues to modify product development guidelines, and the
FDA may not grant approval on a timely basis or at all. 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. 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. Even after such time and
expenditures, we may not obtain regulatory approval or the approval we get may
have strict limitations.
In particular, relaxin is critical to our future success. Relaxin is a
hormone that occurs naturally in humans, and which we manufacture using
recombinant process. We are initially studying relaxin for the treatment of
diffuse scleroderma, a serious disease involving the excessive formation of
connective tissue, and we are in earlier stages of clinical development of
relaxin for other indications, including infertility and the treatment of
blocked or restricted blood vessels in the arms and legs. For relaxin to
succeed, we will need, at a minimum, to demonstrate the safety and efficacy of
relaxin in these clinical studies.
To market our products in countries outside of the United States, our
partners and we must 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.
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. Factors that could affect acceptance of Luxiq and
OLUX include:
- satisfaction with existing alternative therapies;
- the effectiveness of our sales and marketing efforts;
-19-
20
- undesirable and unforeseeable side effects; and
- the cost of the product as compared with alternative therapies.
Since we have only had approval to sell Luxiq for one year, and OLUX was
only approved on May 26, 2000, we cannot predict the potential long-term patient
acceptance of either product.
If we are unable to develop alternative delivery systems for relaxin, 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 relaxin in our
current clinical trials, we must meet several additional major development
objectives for relaxin. In particular, we may need to develop an alternative
means of delivering the drug. In our current clinical trials, relaxin 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 relaxin, such as
treatment of infertility and peripheral arterial 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 delivery systems. If we are not able to develop a suitable alternative
delivery system for relaxin, we may be unable to market relaxin effectively for
indications that are not life threatening, such as infertility, and the
commercial potential of relaxin would be seriously harmed. Our inability to
develop relaxin 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.
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. Boehringer Ingelheim. All of our
contractors 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, 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.
-20-
21
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. We have manufacturing agreements with the following companies:
- Boehringer Ingelheim Austria GmbH for relaxin;
- CCL Pharmaceuticals, a Division of CCL Industries Limited, a U.K.
corporation, for Luxiq and OLUX; and
- SmithKline for Ridaura.
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 and Ridaura. If CORD is unable to continue to distribute our
products in an effective manner or if we are unable to maintain sufficient
personnel with the appropriate levels of experience to manage this function, we
may be unable to meet the demand for our products and we may lose potential
revenues.
-21-
22
RISKS RELATED TO OUR INDUSTRY
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 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 products. 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. We believe that competitive factors
in our industry include:
- scientific and technological expertise;
- sales and marketing resources;
- operational competence in developing, protecting, manufacturing and
marketing products and obtaining timely regulatory agency approvals;
- managerial competence in identifying and pursuing product in-licensing
and acquisition opportunities; and
- financial resources.
Physicians may not adopt our products over competing products, and our
products may not offer an economically feasible alternative to existing modes of
therapy.
If third party payers 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.
-22-
23
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 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.
-23-
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We make payments to Boehringer Ingelheim for the production of relaxin
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 will
increase our expenses. We have a bank loan that is sensitive to movement in
interest rates. Interest income from out 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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 10, 2000, we received notice of a complaint filed with the
California Employment Development Department in connection with charges made by
a scientist formerly employed with the company. We filed a written response with
the EDD. Based on our review of the issues we believe that the case is without
merit and that its resolution will not have a material adverse effect on our
business or financial position.
-24-
25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 11, 2000, we held our annual meeting of stockholders. At the
meeting, the stockholders approved the following matters by the following votes:
1) Election of the following directors:
FOR WITHHELD
Alexander E. Barkas, Ph.D. 24,460,933 115,254
Eugene A. Bauer, M.D. 23,458,317 1,117,870
Brain H. Dovey 24,539,642 36,545
John C. Kane 24,501,442 74,745
Thomas D. Kiley, Esq. 24,501,442 74,745
Leon E. Panetta 24,539,242 36,945
G. Kirk Raab 24,452,384 123,803
Joseph J. Ruvane, Jr. 24,539,842 36,345
Thomas G. Wiggans 24,460,934 115,253
2) Approval of amendments to the 1995 Employee Stock Purchase Plan
to increase the number of shares issuable thereunder by 300,000
shares and make certain changes to the ability of the Board to
modify the plan in the future.
FOR AGAINST ABSTAIN
23,769,059 778,903 28,225
2) Ratification of the appointment of Ernst & Young LLP to serve as
the Company's independent auditors for the fiscal year ended
December 31, 2000.
FOR AGAINST ABSTAIN
24,554,382 8,750 13,055
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Assignment and Option Agreement, dated June 23, 2000, between
Connetics and InterMune
10.2 Consent to Assignment Agreement, dated June 23, 2000, among Connetics,
InterMune and Genentech, Inc.
10.3 Revenue Adjustment Agreement, dated June 27, 2000, between Connetics
and InterMune
27.1 Financial Data Schedule (EDGAR -- filed version only)
(b) Reports on Form 8-K.
We filed a current report on Form 8-K on July 18, 2000, with respect to the
private placement of 2,010,000 shares of our common stock on June 20, 2000.
-25-
26
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: August 14, 2000
-26-
27
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
10.1 Assignment and Option Agreement, dated June 23, 2000, between
Connetics and InterMune
10.2 Consent to Assignment Agreement, dated June 23, 2000, among Connetics,
InterMune and Genentech, Inc.
10.3 Revenue Adjustment Agreement, dated June 27, 2000, between Connetics
and InterMune
27.1 Financial Data Schedule (EDGAR -- filed version only)