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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 September 30, 1999
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 October 29, 1999, 26,437,703 shares of the Registrant's common stock were
outstanding, at $0.001 par value.
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CONNETICS CORPORATION
Quarterly Report on FORM 10-Q
For the period Ended SEPTEMBER 30, 1999
TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at September 30, 1999 and December 31,
1998..................................................................................... 3
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 1999 and 1998 ............................................................. 4
Condensed Consolidated Statements of Cash Flows for the nine months ended September
30, 1999 and 1998 ....................................................................... 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of
Operations............................................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risks.............................. 14
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................... 15
Exhibits.............................................................................. 15
Reports on Form 8-K............................................................ 15
SIGNATURE ................................................................................... 16
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONNETICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, December 31,
1999 1998
----------------- -----------------
(Unaudited) (Note 1)
Assets
Current assets:
Cash and cash equivalents $ 8,187 $ 14,708
Short-term investments 5,425 8,312
Accounts and other receivables 580 485
Other current assets 887 118
----------------- -----------------
Total current assets 15,079 23,623
Property and equipment, net 1,625 1,128
Notes receivable from related parties 249 379
Deposits and other assets 121 104
License agreements and product rights 1,120 6,160
----------------- -----------------
$ 18,194 $ 31,394
================= =================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,433 $ 1,229
Accrued and other current liabilities 2,761 879
Accrued process development expenses 704 644
Accrued payroll and related expenses 1,545 1,003
Current portion of notes payable and other liabilities 5,233 6,822
Current portion of capital lease obligations, capital loans and long-term debt 1,553 582
----------------- -----------------
Total current liabilities 14,229 11,159
Non-current portion of capital lease obligations, capital loans and long-term debt 3,115 4,002
Other long-term liabilities -- 3,781
Stockholders' equity:
Common stock, treasury stock and additional paid-in capital 112,069 105,285
Notes receivable from stockholders -- (65)
Deferred compensation, net (47) (302)
Accumulated deficit (111,165) (92,469)
Accumulated other comprehensive income(loss) (7) 3
----------------- -----------------
Total stockholders' equity 850 12,452
================= =================
$ 18,194 $ 31,394
================= =================
See notes to condensed consolidated financial statements.
Note 1: The balance sheet at December 31, 1998 has been derived from audited
financial statements at that date, but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
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CONNETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Revenues:
Product $ 4,773 $ 2,209 $ 11,656 $ 5,380
Contract 1,400 -- 8,779 1,648
-------------- -------------- -------------- --------------
Total revenues 6,173 2,209 20,435 7,028
Operating cost and expenses:
Cost of product revenues 1,628 419 4,279 1,026
License amortization 1,680 1,680 5,040 5,040
Research and development 5,783 3,185 14,363 8,468
Selling, general and administrative 5,032 3,162 15,533 8,667
Charge for pre-FDA approved product rights -- -- -- 4,000
-------------- -------------- -------------- --------------
Total operating cost and expenses 14,123 8,446 39,215 27,201
Interest and other income 193 193 833 604
Interest expense (225) (292) (749) (1,031)
-------------- -------------- -------------- --------------
Net loss $ (7,982) $ (6,336) $(18,696) $(20,600)
============== ============== ============== ==============
Basic and diluted net loss per share $ (0.37) $ (0.37) $ (0.88) $ (1.30)
============== ============== ============== ==============
Shares used to calculate net loss per share 21,588 17,207 21,353 15,790
============== ============== ============== ==============
See notes to condensed consolidated financial statements.
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CONNETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
---------------------------------
1999 1998
--------------- ---------------
Cash flows from operating activities
Net loss $ (18,696) $ (20,600)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization 5,659 5,654
Technology acquired in exchange for common stock - 4,010
Amortization of deferred compensation and other stock related
compensation charges 1,199 441
Accrued interest on notes payable - 389
Changes in assets and liabilities:
Accounts receivable (95) 606
Current and other long-term assets (199) (1,980)
Current and other liabilities 3,740 222
Other long-term liabilities (551) 582
--------------- ---------------
Net cash used in operating activities (8,943) (10,676)
--------------- ---------------
Cash flows from investing activities
Purchases of short-term investments (2,390) (5,280)
Sales and maturities of short-term investments, net 5,267 6,553
Capital expenditures (1,116) (186)
Licensed assets and products rights - (308)
--------------- ---------------
Net cash provided by investing activities 1,761 779
--------------- ---------------
Cash flows from financing activities
Proceeds from bank loan - 1,500
Payment of notes payable (4,100) (2,100)
Payments of obligations under capital leases and capital loans (360) (2,069)
Proceeds from issuance of common stock, net of issuance costs 5,121 10,393
--------------- ---------------
Net cash provided by financing activities 661 7,724
--------------- ---------------
Net change in cash and cash equivalents (6,521) (2,173)
Cash and cash equivalents at beginning of period 14,708 8,452
=============== ===============
Cash and cash equivalents at end of period $ 8,187 $ 6,279
=============== ===============
Supplementary information:
Interest paid $ 658 $ 534
Financing activity:
Conversion of notes payable into common stock $ 719 $ -
See notes to condensed consolidated financial statements.
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CONNETICS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Connetics Corporation ("Connetics") have been prepared 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, such 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 nine month periods ended
September 30, 1999 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1999.
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, 1998 included in our Annual Report on Form 10-K.
2. Net Loss per Share
The computation of diluted earnings per share does not include options to
purchase 2,758,016 shares of common stock at exercise prices ranging from
$0.4448 to $11.00 and warrants to purchase 1,310,193 shares of common stock at
exercise prices ranging from $4.89 to $11.00 as their effect would be
antidilutive.
3. Comprehensive Income (Loss)
During the three and nine months ended September 30, 1999, total comprehensive
(loss) amounted to $(8.0) million and $(18.7) million compared to $(6.3) million
and $(20.6) million for the same periods in 1998. The components of
comprehensive (loss) for the three and nine-month periods ended September, 1999
and 1998 are as follows:
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
(In thousands) 1999 1998 1999 1998
-------------- -------------- -------------- --------------
Net loss $(7,982) $(6,336) $(18,696) $(20,600)
Unrealized gains (loss) on securities 14 4 (10) 3
Foreign currency translation adjustment -- -- -- --
-------------- -------------- -------------- --------------
Comprehensive income (loss) $(7,968) $(6,332) $(18,706) $(20,597)
============== ============== ============== ==============
Accumulated other comprehensive income (loss) at September 30, 1999 and December
31, 1998, which consisted of unrealized gains (loss) on securities, were
$(7,000) and $3,000.
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4. Research and License Agreements
In January 1999, Connetics entered into a development, commercialization and
supply agreement with Medeva PLC of the United Kingdom ("Medeva") 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. Medeva is responsible for all
development and commercialization activities in Europe and is required to pay
royalties on sales in Europe. In addition, Medeva 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 share U.S.
co-promotion rights with Medeva for up to five years, and Medeva will purchase
relaxin materials from us. For the three and nine months ended September 30,
1999, we recorded $1.0 million and $7.0 million, respectively in contract
revenue ($4.0 million in contract fee and $3.0 million for the quarterly
reimbursement of product development costs) under this agreement.
In May 1999, we received $791,000 (net of $88,000 international withholding tax)
as a milestone payment from Suntory Pharmaceuticals. The milestone payment
pertained to a collaboration agreement Connetics entered into with Suntory
Pharmaceuticals in April 1998 for the development and commercialization of
ConXn(R) (human recombinant relaxin) for the treatment of scleroderma in Japan,
and was due upon our initiation of a pivotal trial of ConXn. The 1998 agreement
calls for Suntory to pay approximately $14.0 million in license fees and
milestone payments to us, be responsible for all development and
commercialization expenses in Japan, and pay royalties on sales in Japan for the
treatment of scleroderma.
In July 1999, we entered into a development, commercialization and supply
agreement with Paladin Labs Inc., a Canadian corporation, for ConXn, a potential
therapy for the treatment of scleroderma and organ fibrosis. Under the terms of
the agreement, we received an initial sum of $800,000, which includes payments
for development fees and an equity investment. In addition, we will receive
semi-annual development payments and potential milestone payments of
approximately $2.4 million over the next several years. 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 nine months ended
September 30, 1999, we recorded $0.4 million in contract revenue under this
agreement.
Also in July 1999, we entered into an agreement with Soltec Research Pty Ltd.,
an Australian company, for exclusive worldwide rights (excluding Australia and
New Zealand) to develop, manufacture and market ketoconazole foam (a quick-break
foam formulation of the antifungal dermatologic drug, ketoconazole). Under the
terms of the agreement, we will pay a total of $277,500 in license fees, of
which $120,000 was paid upon signing of agreement, $67,500 is due upon the
filing of a New Drug Application ("NDA") and $90,000 is due upon FDA approval of
product, plus royalties on future product sales, if any, arising from the
licensed technology. In addition, we will pay Soltec ten percent (10%) of any
upfront payments received in connection with sublicense of the rights to the
product.
5. Subsidiary Spin Off
On April 28, 1999, we spun-off InterMune Pharmaceuticals, Inc. ("InterMune"),
through the sale of a majority of our equity ownership to outside investors. We
established InterMune to develop Actimmune(R) (interferon gamma) for infectious
and fungal diseases shortly after we in-licensed Actimmune from Genentech, Inc.
in May 1998. At the close of the spin-off, we retained approximately a 10%
equity position in InterMune, received a license fee payment of $500,000, a $4.7
million dividend payment and will receive an additional $2.0 million in license
and milestone payments and $1.5 million in return of equity over the next three
years. We will retain commercial rights to and revenue from
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Actimmune for chronic granulomatous disease for three years and receive a
royalty on Actimmune sales thereafter. In addition, we retain the product rights
for potential dermatological applications of Actimmune. The gain on the spin-off
of approximately $1.1 million has been offset by the operating results of
InterMune through April 28, 1999 of approximately $1.0 million and was included
in interest and other income in the Condensed Consolidated Statement of
Operations.
6. Co-promotion Agreements
In March 1999, we entered into two co-promotion agreements with MGI Pharma, Inc.
("MGI"). Under the terms of the agreements, MGI will promote Ridaura and Luxiq
to the rheumatology market in the United States in exchange for promotional
fees. These arrangements take advantage of MGI's specialty sales force that
calls on rheumatologists and oncologists in the United States, and allows us to
focus our attention on the dermatology marketplace. For the nine months ended
September 30, 1999, we recorded $500,000 in promotion fees.
7. Subsequent Event
On October 1, 1999, we completed a public offering of 4.8 million primary shares
of common stock resulting in net proceeds of approximately $21.4 million. The
underwriting group for the offering exercised an option to purchase 120,000
shares on November 1, 1999 to cover over-allotments resulting in additional net
proceeds of approximately $0.5 million. Net proceeds from this offering will be
used to fund the expansion of commercialization activities, additions to our
dermatology pipeline through in-license or acquisition, the expansion of our
ConXn development program in the area of scleroderma and infertility treatment,
and for general corporate purposes.
8. Liquidity and Financial Viability
In the course of our development activities, we have sustained continuing
operating losses and expect such losses to continue over at least 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 and advanced-stage 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. The inability to
obtain sufficient funds may require us to delay, scale back or eliminate some or
all of our research and product development programs, limit the marketing of our
products, or license to third parties the rights to commercialize products or
technologies that we would otherwise seek to develop and market ourselves.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note: Except for the historical information, the following Management's
Discussion and Analysis of Financial Condition and Results of Operations
("MD&A") contains forward-looking statements that involve risks and
uncertainties. Connetics' actual results of operations could differ materially
from those anticipated in such forward-looking statements as a result of various
factors, including those identified below. Potential risks and uncertainties
include, without limitation, uncertainty of product development and market
acceptance of a product once developed; uncertainty of future Ridaura(R),
Luxiq(TM) and Actimmune(R) revenues and costs; uncertainty of clinical trials
results; uncertainty of future profitability; future capital requirements and
uncertainty of future funding; and risks associated with possible future product
acquisitions. In particular, the factors set forth in the Connetics' Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1998 and Registration
Statement on Form S-3 (Registration No. 333-85833 dated September 30, 1999) may
cause actual results to vary from those contemplated by certain forward-looking
statements set forth in this report and should be considered carefully in
addition to other information presented in this report.
This MD&A should be read in conjunction with the MD&A included in Connetics'
1998 Annual Report on Form 10-K, and with the unaudited condensed consolidated
financial statements and notes to financial statements included in Part I, Item
1 of this Quarterly Report. Results of operations in the current or any prior
fiscal period should not be considered as indicative of results to be expected
for any future fiscal period.
Overview
Connetics is a pharmaceutical company focused on developing and commercializing
products for specialty medical markets, with an emphasis on the dermatology
field. In March 1999, we received marketing clearance from the U.S. Food and
Drug Administration ("FDA") to sell Luxiq(TM) (betamethasone valerate) Foam,
0.12%, for the treatment of steroid responsive scalp dermatoses. In addition, we
market Riduara(R) (auranofin), a treatment for rheumatoid arthritis, and in
January 1999, we began marketing Actimmune(R) (interferon gamma) for the
treatment of chronic granulomatous disease ("CGD"), under a license agreement we
entered into with Genentech Inc. in May 1998. Our products under development
include primarily OLUX(TM) Foam (clobetasol propionate) 0.05%, for the treatment
of moderate to severe scalp dermatoses, and ConXn(R) (human recombinant
relaxin-H2) for the treatment of scleroderma, infertility, peripheral vascular
disease and organ fibrosis. There can be no assurance that any of our potential
products will be successfully developed, receive the necessary regulatory
approvals or be successfully commercialized.
On April 28, 1999, we spun-off our subsidiary, InterMune Pharmaceuticals, Inc.,
by selling a majority interest to outside investors. InterMune was established
in 1998 to develop Actimmune for infectious and fungal diseases. We have
retained approximately a 10% equity position in InterMune, received a license
fee payment of $500,000 and will receive additional cash and equity payments
over the next three years. We have retained the rights to Actimmune for the
treatment of infections resulting from chronic granulomatous disease through
December 31, 2001.
In July 1999, we entered into a development, commercialization and supply
agreement with Paladin Labs Inc., a Canadian corporation, for ConXn, a potential
therapy for the treatment of scleroderma and organ fibrosis. Under the terms of
the agreement, we received an initial sum of $800,000, which includes payments
for development fees and an equity investment. In addition, we will receive
semi-annual development payments and potential milestone payments of
approximately $2.4 million over the next several years. 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 nine months ended
September 30, 1999, we recorded $0.4 million in contract revenue under this
agreement.
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Also in July 1999, we entered into an agreement with Soltec Research Pty Ltd.,
an Australian company, for exclusive worldwide rights (excluding Australia and
New Zealand) to develop, manufacture and market ketoconazole foam (a quick-break
foam formulation of the antifungal dermatologic drug, ketoconazole). Under the
terms of the agreement, we will pay a total of $277,500 in license fees, of
which $120,000 was paid upon signing of agreement, $67,500 is due upon the
filing of a New Drug Application ("NDA") and $90,000 is due upon FDA approval of
product, plus royalties on future product sales, if any, arising from the
licensed technology. In addition, we will pay Soltec ten percent (10%) of any
upfront payments received in connection with sublicense of the rights to the
product.
Results of Operations
Revenues
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
(In thousands) 1999 1998 1999 1998
-------------- -------------- -------------- --------------
Product:
Luxiq $ 1,364 $ -- $ 4,015 $ --
Ridaura 2,035 2,209 4,285 5,380
Actimmune 1,374 -- 3,356 --
--------------- ------------- -------------- --------------
Total product revenues 4,773 2,209 11,656 5,380
Contract:
Medeva PLC 1,000 -- 7,000 --
Suntory Limited -- -- 879 1,648
Paladin Labs 400 -- 400
InterMune Pharmaceuticals -- -- 500 --
--------------- ------------- -------------- --------------
Total contract revenues 1,400 -- 8,779 1,648
Total revenues $ 6,173 $ 2,209 $20,435 $ 7,028
=============== ============= ============== ==============
Our product revenues, derived from the sales of Luxiq, Ridaura and Actimmune,
were $4.8 million and $11.7 million for the three and nine months ending
September 30, 1999, respectively, compared to $2.2 million and $5.4 million for
the same periods in 1998. The increase in total product sales in 1999 was due to
sales of Actimmune, which we began shipping in February, and Luxiq, which was
launched in April. These sales increases were partially offset by lower sales of
Ridaura. In March 1999 we entered into an agreement with MGI Pharmaceuticals,
Inc. ("MGI") to promote Ridaura for us, allowing us to shift our
commercialization focus from rheumatology to dermatology. We expect Ridaura to
continue to experience decreased sales due to competition from new products.
There can be no assurance that Connetics and MGI will be able to market and sell
Ridaura successfully or that Ridaura revenues will equal those achieved in 1998.
The sale of Luxiq during the product launch in the quarter ending June 30, 1999
was to establish inventory at wholesalers. Although we are seeing growth in
prescription demand in the quarter ending September 30, 1999, additional sales
history is needed (as wholesaler inventories of Luxiq normalize over the next
couple of quarters) before a meaningful assessment of the acceptance of Luxiq
into the dermatology market in the U.S. can be completed. If we are unable to
achieve or sustain market acceptance of our products, our financial condition
and results of operations could be materially and adversely affected.
Contract revenues were $1.4 million and $8.8 million for the three and nine
months ending September 30, 1999, respectively, compared to $1.6 million for the
nine-month period in 1998. During the nine
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months in 1999, we recorded $7.0 million in contract revenue ($4.0 million of a
contract fee and $3.0 million for quarterly reimbursements of product
development costs) in connection with our agreement with Medeva (see Note 4 of
Notes to Condensed Financial Statements). In addition, we recorded $0.9 million
for a milestone payment made by Suntory Pharmaceuticals, $0.4 million for an
up-front license fee made by Paladin Labs and $0.5 million for a license fee
associated with the spin-off of InterMune (see above). Payments made by Suntory
Pharmaceuticals and Paladin Labs are associated with collaboration agreements
for ConXn (see Note 4 of Notes to Condensed Financial Statements). The $1.6
million contract revenue recorded for the same period in 1998 was for an
up-front license fee paid by Suntory Pharmaceuticals under the collaboration
agreement for ConXn. Contract revenue is expected to fluctuate significantly
depending on the achievement of milestones under existing agreements and new
business opportunities that may be identified.
Cost of Revenues
We have separate supply agreements with SmithKline Beecham Corporation and
Genentech, Inc. under which SmithKline will manufacture and supply Ridaura in
final package form through December 2001, and Genentech will manufacture and
supply interferon gamma, in bulk or finished form through May 2001. Our Luxiq
product is currently manufactured by CCL Pharmaceuticals in the United Kingdom.
In addition, we have a distribution arrangement with CORD Logistics, Inc.
("CORD") whereby customer orders and distribution of our current marketed
products are managed by CORD.
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 three months and
nine months ended September 30, 1999, we recorded $1.6 million and $4.3 million
in cost of product revenues compared to $0.4 million and $1.0 million for the
same periods in 1998. The increase of $1.2 million and $3.3 million in cost of
product revenues is primarily due to incremental costs associated with the sales
of Luxiq and Actimmune, including higher product and royalty costs. Amortization
expense associated with the acquisition of product rights to Ridaura were $1.7
million and $5.0 million for the three and nine month periods in 1999 and 1998.
Research and Development
Research and development expenses were $5.8 million and $14.4 million for the
three and nine months ended September 30, 1999 compared to $3.2 million and $8.5
for the same periods in 1998. The increase in research and development expenses
of $5.9 million in 1999 was due to:
o the commencement of ConXn manufacturing scale-up activities, which
accounted for approximately 76% of the increase;
o the initiation of a 240 patient Phase II/III pivotal trial of ConXn for the
treatment of scleroderma in February; and
o staffing up of our development organization.
Research and development expenses are expected to increase over the next few
quarters due to relaxin manufacturing activity, ConXn clinical trial activities,
pre-manufacturing start-up costs associated with qualifying a new supplier for
OLUX and possible acquisition of new technologies and products.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $5.0 million and $15.5
million for the three and nine months ended September 30, 1999 compared to $3.2
million and $8.7 million for the same periods in 1998. The increase of $6.9
million in expenses in 1999 was primarily due to:
o the increase in our sales and marketing staff to 54 as of September 30,
1999 compared to 27 for the same period in 1998;
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o market launch expenses associated with Luxiq;
o co-promotion fees for Luxiq and Ridaura;
o increased activities of an established sales and marketing organization;
and
o stock compensation related expenses.
Under our co-promotion agreement with MGI to promote Luxiq and Ridaura to the
Rheumatology market in United States, we incurred $0.5 million in promotion fees
in the nine months ended September 30, 1999. Selling, general and administrative
expenses are expected to increase primarily due to costs associated with selling
and marketing Luxiq, Ridaura and Actimmune, additional hiring of sales
representatives, and commercialization expenses associated with products we may
acquire.
Interest and Other Income (Expense), net
Interest and other income was $0.2 million and $0.8 million for the three and
nine months ended September 30, 1999, compared with $0.2 million and $0.6
million for the same periods in 1998. The increase in interest income during
1999 was due to a higher investment balance as a result of the $9.0 million
received in January from Medeva, $0.8 million received in May from Suntory and
$0.8 million received in July from Paladin Labs (see Note 4 of Notes to
Condensed Financial Statements). Interest earned in the future will depend on
our funding cycles and prevailing interest rates.
Although the effective closing date of our InterMune spin-off transaction to
outside investors through the sale of our equity ownership was April 28, 1999,
the amount of funding was based on the book value of InterMune at December 31,
1998. The terms of our agreement with outside investors call for the
reimbursement of all 1999 expenses associated with InterMune. Accordingly we
recorded an adjustment to reflect $0.9 million reduction for first quarter
expenses in the quarter ended June 30, 1999. The gain of the spin-off of
approximately $1.1 million has been offset by the operating results of InterMune
through April 28, 1999 of approximately $1.0 million and as a result, we
recorded a net amount of $143,000 as other income in 1999.
Interest expense decreased to $0.2 million and $0.7 million for the three and
nine months ended September 30, 1999, compared with $0.3 million and $1.0
million for the same periods in 1998. The decrease in interest expense was the
result of lower balances outstanding for obligations under capital leases and
loans, and notes payable.
Net Loss
Net loss for the three and nine months ended September 30, 1999 was $8.0 million
and $18.7 million compared to $6.3 million and $20.6 million for the same
periods in 1998. The decrease in net loss for the year was due to higher product
and contract revenues offset in part by higher cost of product sold and a
substantial increase in operating expenses in 1999 as a result of development,
marketing and sales activities. We expect to incur additional losses over the
next few years and 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 our
initial public offering in February 1996, six self-managed financings,
collaborative arrangements with corporate partners, and bank loans. At September
30, 1999, cash, cash equivalents and short-term investments totaled $13.6
million compared to $23.0 million at December 31, 1998. On October 1, 1999, we
completed a public offering of 4.8 million primary shares of common stock
resulting in net proceeds of approximately $21 million. Our cash reserves are
held in a variety of interest-bearing instruments including high-grade corporate
bonds, commercial paper and money market accounts.
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Cash used in operations for the nine months ended September 30, 1999 was $8.9
million compared with $10.7 million for the same period in 1998. Net loss of
$18.7 million for the nine months in 1999 was affected by non-cash charges of
$5.7 million depreciation and amortization expense and $1.2 million deferred
compensation expense. Cash outflow for the nine months was primarily for
operating activities, including growth in inventory due primarily to carrying
three products, and changes in long term liabilities. Cash usage was partially
offset by an increase in accounts payable related to higher development, sales
and marketing expenses.
Investing activities, other than the changes in Connetics' short-term
investments, consumed $1.1 million in cash during the nine months in 1999 due to
leasehold improvements and equipment expenditures required for operations.
Cash provided by financing activities was $0.7 million for the nine months ended
September 30, 1999 compared to $7.7 million for the same period in 1998. Our
agreements with Medeva and Paladin Labs provided a total of $4.4 million
investment in our common stock in the 1999 period. This was offset in part by a
$4.1 million principal payment to SmithKline for obligations under a promissory
note in connection with the Ridaura acquisition.
Working capital decreased by $11.6 million to $0.9 million at September 30, 1999
from $12.5 million at December 31, 1998. The decrease in working capital was due
to our use of cash in operations, higher accounts payable and accrued
liabilities as a result of increased development, sales and marketing expenses,
and payment of debt obligations, offset in part by higher inventory and prepaid
expenses.
At September 30, 1999, we have an aggregate of $9.8 million in future
obligations of principal payments under capital leases, loans, long-term debt
and other obligations, of which $6.7 million is to be paid within the next year.
We have an equity line agreement with an investor that may potentially provide
access to capital through sales of our common stock. The three-year equity line
became available on June 26, 1998. During the three-year term, if our stock
meets certain volume restrictions and trades above $10.00, then up to $500,000
would be drawn against the equity line approximately every three months in
exchange for the sale of stock at an approximate minimum price of $10.00.
We believe our existing cash, cash equivalents and short-term investments,
together with the net proceeds from our public offering in October 1999, 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 the first quarter of 2001. 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 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.
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 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 the 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.
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Impact of Year 2000
Many computer systems and software applications were not designed to handle
dates beyond the year 1999, and therefore will need to be modified prior to year
2000 in order to remain functional. Those computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. Beginning in the year 2000, these date code fields will need
to accept four digit entries to the 1900's from the year 2000 or they could
cause a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities. As with many
other companies the year 2000 issue poses a potential risk for us, and computer
systems and/or software used by many companies, including us, may need to be
upgraded to comply with such "Year 2000" requirements.
We have completed an assessment of our core business information systems and
related business processes used in our operations, most of which are provided by
outside suppliers. As of September 30, 1999, we have completed the testing and
upgrading of all our information technology and operating systems. We have
on-line access to our third party distribution service system that includes
customer orders, billing, shipping and inventory management. This vendor has
made its distribution system Year 2000 compliant, and we converted to the
compliant system in November 1998.
Our reliance on key suppliers, and therefore on the proper functioning of their
information systems and software, is increasing, and there can be no assurance
that another company's failure to address year 2000 issues might not have an
adverse effect on Connetics. We have initiated formal communications with each
of our significant suppliers and customers to determine the extent of our
vulnerability to those third parties' failure to remediate their own Year 2000
issues. We have requested that third party vendors represent their products and
services to be Year 2000 compliant and that they have a program to test for Year
2000 compliance. However, the response of those third parties is beyond our
control.
We have initiated the process of developing contingency plans for certain
critical business processes. These contingency plans involve, among other
actions, adjusting production schedules, increasing inventories, developing
manual workarounds, and including a test run with the date "00" for our internal
operating systems by mid-November. The necessity of any contingency plan must be
evaluated on a case-by-case basis and will vary considerably in nature depending
on the Year 2000 issue it may need to address. However, there can be no
assurance that we may be able to solve all potential Year 2000 issues, and if we
fail to correct a material Year 2000 problem, our normal business activities and
operations could be interrupted. Such interruptions could have a material
adverse affect on Connetics' results of operations, liquidity and financial
condition. Our total cost for the Year 2000 project is estimated to be less than
$100,000 and has been funded through available cash resources and has not been
material to our financial condition to date.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have supply contracts with Boehringer Ingelheim Austria GmbH for ConXn and
CCL Pharmaceuticals Ltd. in the U.K. for Luxiq. 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 there is 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.
27.1 Financial Data Schedule (EDGAR - filed version only)
(b) Reports on Form 8-K.
We did not file any Reports on Form 8-K during the quarter ended September
30, 1999.
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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
Vice President, Finance and Administration
and Chief Financial Officer
Date: November 11, 1999
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INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
27.1 Financial Data Schedule (EDGAR - filed version only)