UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number 000-31615
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DURECT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-3297098
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10240 Bubb Road
Cupertino, California 95014
(Address of principal executive offices, including zip code)
(408) 777-1417
(Registrant's telephone number, including area code)
------------
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 the past 90 days. Yes [x] No [_]
As of August 3, 2001, there were 48,003,522 shares of the registrant's Common
Stock outstanding.
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1
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements....................................................................... 3
Condensed Consolidated Statements of Operations............................................ 3
For the three and six months ended June 30, 2001 and 2000 (unaudited)
Condensed Consolidated Balance Sheets...................................................... 4
As of June 30, 2001(unaudited) and December 31, 2000
Condensed Consolidated Statements of Cash Flows............................................ 5
For the six months ended June 30, 2001 and 2000 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited)........................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................. 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 31
Item 2. Changes in Securities and Use of Proceeds.................................................. 31
Item 3. Defaults Upon Senior Securities............................................................ 32
Item 4. Submission of Matters to a Vote of Security Holders........................................ 32
Item 5. Other Information.......................................................................... 32
Item 6. Exhibits and Reports on Form 8-K........................................................... 32
(a) Exhibits............................................................................... 32
(b) Reports on Form 8-K.................................................................... 32
Signatures................................................................................................. 33
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
DURECT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended Six months ended
------------------ ----------------
June 30, June 30,
-------- --------
2001 2000 2001 2000
---- ---- ---- ----
Revenue, net.................................................... $ 1,687 $ 998 $ 3,086 $ 1,081
Cost of goods sold(1)........................................... 974 575 1,585 611
-------- ------- -------- -------
Gross profit.................................................... 713 423 1,501 470
-------- ------- -------- -------
Operating expenses:
Research and development...................................... 5,315 2,983 9,409 5,242
Research and development to related party..................... 18 171 65 433
Selling, general and administrative........................... 2,157 1,003 4,035 1,973
Amortization of intangible assets............................. 461 233 735 302
Stock-based compensation(1)................................... 919 1,367 1,854 2,499
Acquired in-process research and development.................. 14,030 -- 14,030 --
-------- ------- -------- -------
Total operating expenses................................... 22,900 5,757 30,128 10,449
-------- ------- -------- -------
Loss from operations............................................ (22,187) (5,334) (28,627) (9,979)
Other income (expense):
Interest income............................................... 1,281 540 2,864 828
Interest expense.............................................. (84) (33) (145) (55)
-------- ------- -------- -------
Net other income................................................ 1,197 507 2,719 773
-------- ------- -------- -------
Net loss................................................... (20,990) (4,827) (25,908) (9,206)
Accretion of cumulative dividends on Series B
convertible preferred stock.................................... -- 326 -- 653
-------- ------- -------- -------
Net loss attributable to common stockholders.................... $(20,990) $(5,153) $(25,908) $(9,859)
======== ======= ======== =======
Net loss per common share, basic and diluted.................... $ (0.45) $ (0.65) $ (0.57) $ (1.35)
======== ======= ======== =======
Shares used in computing basic and diluted net loss
per share...................................................... 46,325 7,958 45,726 7,279
======== ======= ======== =======
Pro forma net loss per share, basic and diluted(2).............. $ (0.14) $ (0.28)
======= =======
Shares used in computing pro forma net loss
per share(2)................................................... 35,461 33,055
======= =======
___________
(1) Stock-based compensation related to the following:
Cost of goods sold.............................................. $ 65 $ 21 $ 87 $ 21
Research and development........................................ 613 960 1,294 1,665
Selling, general and administrative............................. 306 407 560 834
-------- ------- -------- -------
$ 984 $ 1,388 $ 1,941 $ 2,520
======== ======= ======== =======
(2) See note 1 for a description of the calculation of pro forma amounts.
See accompanying notes.
3
DURECT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
2001 2000
---- ----
(unaudited)
-----------
Assets
Current assets:
Cash and cash equivalents................................................. $ 35,623 $ 46,702
Short-term investments.................................................... 33,092 57,730
Accounts receivable, net.................................................. 1,262 1,261
Inventories............................................................... 2,389 2,682
Prepaid expenses and other current assets................................. 2,143 938
-------- --------
Total current assets................................................... 74,509 109,313
Property and equipment, net................................................. 10,527 4,472
Intangible assets, net...................................................... 11,186 5,175
Long-term investments....................................................... 25,476 1,652
-------- --------
Total assets................................................................ $121,698 $120,612
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable.......................................................... $ 1,242 $ 658
Accrued liabilities....................................................... 1,865 923
Accrued construction in progress.......................................... 1,152 1,673
Accrued contract manufacturing............................................ -- 248
Accrued liabilities to related party...................................... 25 54
Contract research liability............................................... 663 290
Current portion of long-term debt......................................... 150 --
Equipment financing obligations, current portion.......................... 517 407
-------- --------
Total current liabilities................................................... 5,614 4,253
Long-term debt, less current portion........................................ 1,575 --
Equipment financing obligations, noncurrent portion......................... 823 1,105
Other noncurrent liabilities................................................ 100 --
Commitments and contingencies
Stockholders' equity:
Common stock.............................................................. 4 4
Additional paid-in capital................................................ 188,809 165,638
Notes receivable from stockholders........................................ (632) (652)
Accumulated other comprehensive income.................................... 294 29
Deferred compensation..................................................... (4,046) (4,830)
Deferred royalties and commercial rights.................................. (13,480) (13,480)
Accumulated deficit....................................................... (57,363) (31,455)
-------- --------
Stockholders' equity........................................................ 113,586 115,254
-------- --------
Total liabilities and stockholders' equity.................................. $121,698 $120,612
======== ========
4
DURECT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six months ended
June 30,
--------
2001 2000
-------- -------
Cash flows from operating activities
Net loss..................................................................................... $(25,908) $(9,206)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.............................................................. 540 278
Noncash charges related to stock-based compensation........................................ 1,941 2,520
Amortization of certain intangible assets.................................................. 735 302
Acquired in-process research and development............................................... 14,030
Changes in assets and liabilities:
Accounts receivable....................................................................... 673 (644)
Inventories............................................................................... 592 (3,346)
Prepaid expenses and other assets......................................................... (888) (640)
Accounts payable ........................................................................ 308 (182)
Accrued liabilities ..................................................................... (151) 607
Accrued liabilities to related party .................................................... (29) 2,269
Contract research liability ............................................................. 373 30
-------- -------
Total adjustments ..................................................................... 18,124 1,194
-------- -------
Net cash and cash equivalents used in operating activities ............................ (7,784) (8,012)
-------- -------
Cash flows from investing activities
Purchases of equipment ..................................................................... (3,860) (999)
Purchases of investments ................................................................... (49,122) (2,634)
Payment of transaction costs in the acquisition of SBS....................................... (450) --
Proceeds from maturities of investments .................................................... 50,202 11,690
Acquisition of intangible assets ........................................................... -- (4,635)
-------- -------
Net cash and cash equivalents provided by (used in) investing activities .............. (3,230) 3,422
-------- -------
Cash flows from financing activities
Net proceeds from equipment financing obligations .......................................... -- 976
Payments on equipment financing obligations ................................................ (203) (133)
Payments on short-term debt.................................................................. (100) --
Net proceeds from notes receivable from stockholders ....................................... 20 (360)
Net proceeds from issuances of common and preferred stock .................................. 218 25,423
-------- -------
Net cash and cash equivalents provided by (used in) financing activities ............... (65) 25,906
-------- -------
Net increase (decrease) in cash and cash equivalents ....................................... (11,079) 21,316
Cash and cash equivalents, beginning of the period ......................................... 46,702 3,863
-------- -------
Cash and cash equivalents, end of the period ............................................... $ 35,623 $25,179
======== =======
Supplemental disclosure of cash flow information
Cash paid during the period for interest ................................................... $ 112 $ 32
======== =======
Issuance of stock, stock options and warrants for acquisition of SBS ....................... $ 22,716 $ --
======== =======
Notes receivable from stockholders issued in connection with exercise of stock options ..... $ -- $ 591
======== =======
Issuance of warrants to equipment lessor ................................................... $ -- $ 190
======== =======
Issuance of warrants to ALZA Corporation ................................................... $ -- $ 4,576
======== =======
See accompanying notes.
5
DURECT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001
Note 1. Summary of Significant Accounting Policies
Nature of Operations and Basis of Presentation
DURECT Corporation (the "Company") was incorporated in the state of Delaware
on February 6, 1998. The Company is a pharmaceutical systems company developing
therapies for chronic disorders that require continuous dosing. The Company's
lead product is for the treatment of chronic pain. Additionally, the Company
manufactures and sells osmotic pumps used in laboratory research and sells
micro-catheters used in the treatment of ear disorders. The Company's wholly
owned subsidiary, Southern BioSystems, Inc. ("SBS") manufacturers biodegradable
polymers used in pharmaceutical products and conducts research and development
of pharmaceutical products with third party pharmaceutical company partners.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the rules and regulations of the Securities and
Exchange Commission and, therefore, do not include all the information and
footnotes necessary for a complete presentation of the Company's results of
operations, financial position, and cash flows in conformity with generally
accepted accounting principles. The unaudited financial statements reflect all
adjustments (consisting only of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of the financial
position at June 30, 2001, the operating results for the three and six months
ended June 30, 2001 and 2000, and cash flows for the six months ended June 30,
2001 and 2000. The condensed consolidated balance sheet as of December 31, 2000
has been derived from the 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. These financial
statements and notes should be read in conjunction with the Company's audited
financial statements and notes thereto, included in the Company's annual report
on Form 10-K filed with the Securities and Exchange Commission.
The results of operations for the interim periods presented are not
necessarily indicative of results that may be expected for any other interim
period or for the full fiscal year.
Inventories
Inventories are stated at the lower of cost or market, with cost determined on
a first-in, first-out basis.
Inventories consisted of the following (in thousands):
June 30, December 31,
------------ --------------
2001 2000
------ ------
(unaudited)
Raw materials ................................................................... $ 291 $ 191
Work in process ................................................................. 118 1,278
Finished goods .................................................................. 1,980 1,213
------ ------
Total inventories ............................................................ $2,389 $2,682
====== ======
Revenue Recognition
Revenue from the sale of products is recognized at the time product is shipped
to customers, provided no continuing obligation exists. The Company maintains
consigned inventory at customer locations for certain products. For these
products, revenue is recognized at the time the Company is notified that the
device has been used. The Company provides credit, in the normal course of
business, to its customers. The Company also maintains an allowance for doubtful
customer accounts and charges actual losses when incurred to this allowance.
6
Comprehensive Loss
Statement of Financial Accounting Standards No.130, "Reporting Comprehensive
Income" ("SFAS 130"), establishes standards for reporting comprehensive loss and
its components in the financial statements. SFAS 130 requires unrealized gains
and losses on the Company's available-for-sale securities to be included in
other comprehensive income or loss. The Company's comprehensive losses for the
three months ended June 30, 2001 and 2000, were $20,943,000 and $4,829,000,
respectively, compared to its net losses of $20,990,000 and $4,827,000,
respectively. The Company's comprehensive losses for the six months ended June
30, 2001 and 2000, were $25,643,000 and $9,228,000, respectively, compared to
its net losses of $25,908,000 and $9,206,000, respectively.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current
period presentation. Such reclassifications did not change the previously
reported net loss amounts.
Net Loss Per Share
Basic net loss per share and diluted net loss per share are computed in
conformity with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" ("SFAS 128") and Securities and Exchange Commission Staff Accounting
Bulletin No. 98. Basic net loss per share is calculated by dividing net loss
attributable to common stockholders by the weighted-average number of common
shares outstanding, less the weighted average number of common shares subject to
the Company's right of repurchase, which lapses ratably. Diluted net loss per
share includes the impact of options and warrants to purchase common stock
(using the treasury stock method), if dilutive. There is no difference between
basic and diluted net loss per share as the Company incurred a net loss in each
period presented.
Pro forma basic and diluted net loss per share has been computed as described
above and also gives effect, under SEC guidance, to the conversion of
convertible preferred stock (using the if-converted method) from the original
date of issuance. Upon conversion of the Series B preferred stock at the time of
the Company's initial public offering, all accumulated dividends were forgiven
and did not continue to accumulate. The net loss used in the pro forma basic and
diluted net loss per share excludes the accumulated dividends. The following
table presents the calculations of basic and diluted and pro forma basic and
diluted net loss per share (in thousands, except per share amounts):
Three months ended Six months ended
------------------ ----------------
June 30, June 30,
-------- --------
2001 2000 2001 2000
---- ---- ---- ----
Net loss ....................................................... $(20,990) $(4,827) $(25,908) $(9,206)
Less: accumulated dividend on Series B preferred stock ....... -- (326) -- (653)
-------- ------- -------- -------
Net loss available to common stockholders ...................... $(20,990) $(5,153) $(25,908) $(9,859)
======== ======= ======== =======
Basic and diluted weighted average shares:
Weighted-average shares of common stock outstanding .......... 47,525 10,957 47,045 10,129
Less: weighted-average shares subject to repurchase .......... (1,200) (2,999) (1,319) (2,850)
-------- ------- -------- -------
Weighted-average shares used in computing basic and diluted
net loss per share ......................................... 46,325 7,958 45,726 7,279
======== ======= ======== =======
Basic and diluted net loss per share ........................... $ (0.45) $ (0.65) $ (0.57) $ (1.35)
======== ======= ======== =======
Pro forma:
Net loss ..................................................... $(4,827) $(9,206)
======= =======
Shares used above ............................................ 7,958 7,279
Pro forma adjustment to reflect weighted effect of assumed
conversion of convertible preferred stock .................. 27,503 25,776
------- -------
Shares used in computing pro forma basic and diluted net loss
per share .................................................. 35,461 33,055
======= =======
Pro forma net loss per share, basic and diluted ................. $ (0.14) $ (0.28)
======= =======
7
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"),
which we adopted on January 1, 2001. This statement establishes accounting and
reporting standards requiring that every derivative instrument, including
certain derivative instruments embedded in other contracts, be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement also requires that changes in the derivative's fair value be
recognized in earnings unless specific hedge accounting criteria are met. The
adoption of SFAS 133 did not have a material effect on our operating results or
financial position since we currently do not invest in derivative instruments or
engage in hedging activities.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
141, Business Combinations ("SFAS 141"). SFAS 141 establishes new standards for
accounting and reporting for business combinations and will require that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Use of the pooling-of-interests method will be prohibited.
We expect to adopt this statement during the first quarter of fiscal 2002 and we
do not believe that SFAS 141 will have a material effect on our operating
results or financial position.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142, Goodwill and Other Intangible Assets ("SFAS 142"), which supersedes APB
Opinion No. 17, Intangible Assets. SFAS 142 establishes new standards for
goodwill, including the elimination of goodwill amortization to be replaced with
methods of periodically evaluating goodwill for impairment. We expect to adopt
this statement during the first quarter of fiscal 2002, and we do not believe
that SFAS 142 will have a material effect on our operating results or financial
position.
Note 2. Acquisition of Southern BioSystems, Inc.
On April 30, 2001, the Company acquired SBS, a privately held Alabama
corporation, that designs, develops, licenses and manufactures controlled-
release products, and through its wholly-owned subsidiary, Birmingham Polymers,
Inc., SBS also designs, develops and manufactures biodegradable polymers. Under
the terms of the acquisition, the Company issued 1,355,235 shares of common
stock, and agreed to issue up to 720,161 additional shares of common stock upon
the exercise of outstanding SBS options and warrants, in exchange for all of
SBS's outstanding equity interests, and assumed SBS's liabilities, including
$1.7 million in debt. The total purchase price was $23.2 million. The
transaction was accounted for as a purchase and is intended to qualify as a tax-
free reorganization.
At the time of the registration of these shares with the Securities and
Exchange Commission, which is expected to be in the fourth quarter of 2001, the
Company may be required to issue additional shares of common stock to former SBS
shareholders, as well as reserve additional shares for issuance upon the
exercise of outstanding SBS options and warrants, depending on the Company's
stock price at that time. Up to 4,150,854 additional shares may be issued and
reserved for issuance upon the exercise of outstanding SBS options and warrants.
The maximum total number of shares issued and shares reserved for issuance upon
the exercise of outstanding SBS options and warrants in connection with our
acquisition of SBS will be determined by dividing $24.9 million by the greater
of $4.00 or the average closing sale price of the Company's stock during a
specified time period proceeding the registration of shares, subject to certain
conditions. Further information regarding the SBS acquisition is included in the
company's current Report on Form 8-K filed with the SEC on May 15, 2001.
The Company recorded $918,000 of unearned compensation related to the
intrinsic value of approximately 152,000 unvested employee options assumed in
connection with the acquisition. This amount will be expensed to stock
compensation ratably over the vesting period. Direct transaction costs related
to the acquisition were approximately $450,000.
8
The acquisition has been accounted for as a purchase and accordingly, the
accompanying financial statements include the results of operations of SBS
subsequent to the acquisition date. The purchase price has been allocated to the
tangible net assets acquired, the intangible assets acquired, and in-process
research and development based on their estimated fair values as determined by
an independent appraisal. The purchase price allocation is as follows (in
thousands):
Net tangible assets acquired $ 1,472
Intangible assets acquired:
Core technology 1,560
Developed technology 1,810
Assembled workforce 740
Acquired in-process research and development 14,030
Goodwill 2,636
Unearned compensation 918
-------
Total purchase price allocation $23,166
=======
Tangible net assets acquired include cash, accounts receivable, inventories
and fixed assets. Liabilities assumed principally include accounts payable,
accrued expenses, a line of credit, and an issued bond. For the remainder of
2001, the intangible assets acquired and goodwill are each being amortized on a
straight-line basis over their estimated useful lives, which are 4 and 10 years,
respectively. Beginning in 2002, goodwill and assembled workforce will not be
amortized but reviewed for impairment (See Note 1: Recent Accounting
Pronouncements). Acquired in-process research and development, which has not
reached technological feasibility and therefore has no alternative future use,
has been expensed during the three months ended June 30, 2001.
SBS's research and development programs are in various stages of preclinical
development. Currently, none of the products utilizing SBS's proprietary
technology is in any stage of human clinical testing nor is approved for
marketing in humans.
A valuation of the purchased assets was undertaken to assist us in
determining the fair value of each identifiable intangible asset and in
allocating the purchase price among the acquired assets, including the portion
of the purchase price attributed to in-process research and development
projects. Standard valuation procedures and techniques were utilized in
determining the fair value of the acquired in-process research and development.
To determine the value of the technology in the development stage, we
considered, among other factors, the stage of development of each project, the
time and resources needed to complete each project, expected income and
associated risks. Associated risks included the inherent difficulties and
uncertainties in completing pharmaceutical research and development and
obtaining regulatory approval to sell the resulting products. The analysis
resulted in $14.3 million of the purchase price being charged to in-process
research and development. The intangible assets, consisting of core technology,
developed technology, assembled workforce and goodwill, were assigned a value of
$6.7 million and will be amortized over their estimated useful lives of four to
ten years. Management believes that the amounts are reasonable and reflect the
fair value of the assets acquired.
Goodwill and intangible assets are generally evaluated on an individual
acquisition, market, or product basis whenever events or changes in
circumstances indicate that such assets are impaired or the estimated useful
lives are no longer appropriate. Periodically, the Company reviews its goodwill
and other intangible assets for impairment based on estimated future
undiscounted cash flows attributable to the assets. In the event such cash flows
are not expected to be sufficient to recover the recorded value of the assets,
the assets are written down to their estimated fair values. No such charges have
been recorded in 2001 related to the SBS or any other of the Company's
acquisitions.
In conjunction with our acquisition of SBS in April 2001, we assumed Alabama
State Industrial Development Bonds with remaining principal payments of $1.7
million and a current interest rate of 6.35% increasing each year up to 7.2% at
maturity on November 1, 2009. As part of the acquisition agreement, we are
required to guarantee and collateralize these bonds with a letter of credit of
approximately $2.5 million that the Company deposited with a local bank in July
2001. Interest payments are due semi-annually and principal payments increase
from $150,000 to $240,000 over the term of the bond until the principal is fully
amortized in 2009. We have an option to call these bonds beginning in November
2001, which we may exercise. The call premium decreases annually from 1 1/2%
if we call the bonds in November 2001 to 0% in November 2004.
9
Unaudited Pro Forma Information
The following unaudited pro forma information presents the consolidated
results of operations of the Company, excluding the charge for acquired in-
process research and development, as if the acquisition of SBS had occurred at
the beginning of fiscal 2000. The pro forma 2001 and 2000 results of operations
combine the consolidated results of operations of the Company, excluding the
charge for acquired in-process research and development attributable to SBS, for
the six months ending June 30, 2001 and 2000 with the historical results of
operations of SBS for the six months ended June 30, 2001 and 2000, respectively.
The unaudited pro forma information does not purport to be indicative of what
would have occurred had the acquisition been made as of the beginning of fiscal
2000 or of results which may occur in the future.
Six months ended
(in thousands, except per share amounts) ---------------------
June 30,
---------------------
2001 2000
-------- --------
Revenue.......................................................... $ 4,108 $ 2,807
Net loss......................................................... (13,080) (10,801)
Net loss per common share, basic and diluted..................... $ (0.29) $ (1.48)
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results
of Operations as of June 30, 2001 and 2000 should be read in conjunction with
our annual report on Form 10-K filed with the Securities and Exchange Commission
and "Factors that May Affect Future Results" section included elsewhere in this
Form 10-Q. This Form 10-Q contains forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934, as amended, and Section
27A of the Securities Act of 1933, as amended. When used in this report or
elsewhere by management from time to time, the words "believes," "anticipates,"
"intends," "plans," "estimates," "expects," and similar expressions are forward-
looking statements. Such forward-looking statements contained herein are based
on current expectations. Any such forward-looking statements are not guarantees
of future performance and involve risks and uncertainties. Actual events or
results may differ materially from those discussed in the forward-looking
statements as a result of various factors. For a more detailed discussion of
such forward-looking statements and the potential risks and uncertainties that
may impact upon their accuracy, see the "Factors that May Affect Future Results"
and "Overview" sections of this Management's Discussion and Analysis of
Financial Condition and Results of Operations. These forward-looking statements
reflect our view only as of the date of this report. Except as required by law,
we undertake no obligations to update any forward looking statements. You should
also carefully consider the factors set forth in other reports or documents that
we file from time to time with the Securities and Exchange Commission.
Overview
DURECT Corporation is pioneering the treatment of chronic diseases and
conditions by developing and commercializing pharmaceutical systems to deliver
the right drug to the right place in the right amount at the right time. These
capabilities can enable new drug therapies or optimize existing ones based on a
broad range of compounds, including small molecule pharmaceuticals as well as
biotechnology molecules such as proteins, peptides and genes.
We were founded in February 1998. During that year, we were engaged in
negotiating a licensing agreement with ALZA Corporation to gain specified rights
to its DUROS system, raising capital, recruiting scientific and management
personnel and commencing research and development activities. In late 1998, we
filed an investigational new drug application relating to our first product,
Chronogesic(TM) (which we formerly referred to as "DUROS sufentanil"), a DUROS-
based pharmaceutical system for the treatment of chronic pain. In 1999, we began
a Phase I clinical trial for Chronogesic(TM) using an external pump to test the
safety of continuous chronic infusion of this drug, initiated the development of
a spinal hydromorphone product, and initiated the research and development of
other products based on the DUROS system. In 2000, we prepared for and initiated
our Phase II clinical trial for Chronogesic(TM) , which included the development
of our manufacturing process, developed a prototype of our spinal hydromorphone
product, and continued to research and develop other products based on the DUROS
system.
In the first six months of 2001, we completed the clinical portion of our
Phase II clinical trial for Chronogesic(TM), secured a long-term supply
agreement for our bulk drug requirements for Chronogesic(TM), and completed
construction of our manufacturing facility. In addition, we completed our
acquisition of Southern BioSystems, Inc. ("SBS") in the second quarter of 2001.
SBS, a privately held Alabama corporation, designs, develops, licenses and
manufactures controlled-release products, and through its wholly-owned
subsidiary, Birmingham Polymers, Inc., also designs, develops and manufactures
biodegradable polymers. With this acquisition, we have added three additional
drug delivery platforms, the SABER(TM) delivery system, microspheres and drug
loaded implants, from which to develop new products.
Prior to our initial public offering in September 2000, we financed operations
primarily through the sale of convertible preferred stock, resulting in net
proceeds of $53.2 million. Our initial public offering together with the
exercise in part of our underwriters' over-allotment option in November 2000,
resulted in net proceeds of $84.0 million.
11
We have sustained losses since inception. As of June 30, 2001, we had an
accumulated deficit of $57.4 million. Our net losses attributable to common
stockholders were $20.8, $9.3, and $1.3 million for the fiscal years ended
December 31, 2000, 1999, and 1998 respectively.
These losses have resulted primarily from costs incurred in the research and
development of our products, and to a lesser extent, selling, general and
administrative costs associated with our operations and product sales. Our
research and development expenses consist of salaries and related expenses for
research and development personnel, contract research and development services,
supplies and a portion of overhead operating expenses. We expense all of our
research and development costs as they are incurred. We expect our research and
development expenses to increase in the future as we expand clinical trials and
research and development activities. Selling, general and administrative
expenses consist primarily of salaries and related expenses for administrative,
finance, marketing and executive personnel, legal, accounting and other
professional fees and a portion of overhead operating expenses. To support our
research and development activities and the additional obligations of a public
reporting entity, we expect to increase our selling, general and administrative
expenses. We also expect to incur substantial non-cash expenses relating to
stock-based compensation and the amortization of acquired intangible assets. As
a result of these factors, we expect to incur significant losses and negative
cash flows from operations for the foreseeable future.
Under the terms of the acquisition of SBS, we issued 1,355,235 shares of
common stock, and agreed to issue up to 720,161 additional shares of common
stock upon the exercise of outstanding SBS options and warrants, in exchange for
all of SBS's outstanding equity interests, and assumed SBS's liabilities,
including $1.7 million in debt. The total purchase price was $23.2 million. The
transaction was accounted for as a purchase and is intended to qualify as a tax-
free reorganization. At the time of the registration of these shares with the
Securities and Exchange Commission, which is expected to be in the fourth
quarter of 2001, we may be required to issue additional shares of common stock
to former SBS shareholders, as well as reserve additional shares for issuance
upon the exercise of outstanding SBS options and warrants, depending on our
stock price at that time. Up to 4,150,854 additional shares may be issued and
reserved for issuance upon the exercise of outstanding SBS options and warrants.
The maximum total number of shares issued and shares reserved for issuance upon
the exercise of outstanding SBS options and warrants in connection with our
acquisition of SBS will be determined by dividing $24.9 million by the greater
of $4.00 or the average closing sale price of the Company's stock during a
specified time period proceeding the registration of shares, subject to certain
conditions. Further information regarding the SBS acquisition is included in our
current Report on Form 8-K filed with the SEC on May 15, 2001. We recorded
$918,000 of unearned compensation related to the intrinsic value of
approximately 152,000 unvested employee options assumed in connection with the
acquisition. This amount will be expensed to stock compensation ratably over the
vesting period. Direct transaction costs related to the acquisition were
approximately $450,000. SBS, and its wholly owned subsidiary Birmingham
Polymers, Inc., operates as a wholly owned subsidiary of DURECT, and our
financial statements for the three months ended June 30, 2001 include the
results of operations of SBS subsequent to the acquisition date.
We do not anticipate revenues from our pharmaceutical systems, should they be
approved, for at least several years. To date, our revenues have resulted from
sales of the ALZET product line, which we acquired from ALZA in April 2000,
polymer sales and contract research and development revenue from SBS, which we
acquired in April 2001, and, to a lesser extent, from sales of ear catheter
products, which we acquired as part of our acquisition of substantially all of
the assets of IntraEAR, Inc. in October 1999.
We have a limited history of operations and anticipate that our quarterly and
annual results of operations will fluctuate for the foreseeable future. We
believe that period-to-period comparisons of our operating results should not be
relied upon as predictive of future performance. Our prospects must be
considered in light of the risks, expenses and difficulties encountered by
relatively new companies, particularly companies in new and rapidly evolving
markets such as pharmaceuticals, drug delivery, and biotechnology. To address
these risks, we must, among other things, obtain regulatory approval for and
commercialize our products, which may not occur. We may not be successful in
addressing these risks and difficulties. We may require additional funds to
complete the development of our products and to fund operating losses to be
incurred in the next several years.
Results of Operations
Three and six months ended June 30, 2001 and 2000
Revenue. Net revenues increased to $1.7 million and $3.1 million for the
three and six months ended June 30, 2001, respectively, from $1.0 million and
$1.1 for the corresponding periods in 2000. The increase in revenue in the three
months ended June 30, 2001 compared to the corresponding period
12
in 2000 is attributable primarily to the acquisition of SBS in April 2001 and
its related revenues from polymer sales and contract research and development.
The increase in revenue in the six months ended June 30, 2001 compared to the
corresponding period in 2000 is attributable to our selling the ALZET product
line over the entire six month period in 2001, compared to the partial period
following the acquisition of the ALZET product line in April of 2000, and to our
acquisition of SBS and its related revenues.
We consider our core business to be developing and commercializing
pharmaceutical systems; we do not expect to generate revenues from our
pharmaceutical systems, should they be approved, for at least several years. As
such, and in the near future, we do not intend to significantly increase our
investments in or efforts to sell or market any of our existing product lines or
revenue generating businesses. As a result, we do not anticipate that our
revenues will increase significantly, if it all, for several years.
Cost of goods sold. Cost of goods sold was $974,000 and $1.6 million for the
three and six months ended June 30, 2001, respectively, and $575,000 and
$611,000 for the three and six months ended June 30, 2000, respectively. Cost of
goods sold as a percent of net revenues was 58% and 51% for the three and six
months ended June 30, 2001, respectively, and 58% and 57% for the corresponding
periods in 2000. The decrease in cost of goods sold as a percentage of net
revenues for the six months ended June 30, 2001 compared to the corresponding
period in 2000 is attributable to manufacturing efficiencies related to our
ALZET product, partially offset by the introduction of relatively higher costs
from sales of polymers and contract research and development which commenced
following our acquisition of SBS.
Cost of good sold includes variances from expected costs that occur during
the manufacturing processes for the Alzet and SBS product lines, which may be
large relative to our sales. As a result, we expect cost of goods sold as a
percentage of revenue related to these products to fluctuate.
Research and Development. Research and development expenses increased to
$5.3 million and $9.5 million for the three and six months ended June 30, 2001
respectively, from $3.2 million and $5.7 million for the corresponding periods
in 2000. The increase was attributable to increased research and development
activity, including expenses related to the company's Phase II clinical trial
for our lead product, Chronogesic(TM). A significant portion of our research and
development expenses in the first six months of 2001 related to the
organization, enrollment, and treatment of approximately 50 patients at 10
clinical sites in this trial. The increase was also due to an increase in
research and development personnel and related expenses. As of June 30, 2001, we
had 62 research and development employees compared with 34 as of the
corresponding date in 2000. We expect research and development expenses to
increase as we begin Phase III clinical trials for Chronogesic(TM), continue to
hire research and development personnel, continue to develop our spinal
hydromorphone product, and research and develop other products, including
products utilizing the SBS delivery technology.
In addition, we expect research and development expenses to continue to
increase in order to meet minimum product funding requirements under our license
agreement with ALZA. To maintain our rights under this agreement, we must spend
minimum amounts each year on product development, with the amount and duration
of funding in each field varying over time. For our two products currently in
development, we are required to fund each in the amount of at least $3.0 million
per year until the time of commercialization. Funding requirements to maintain
rights to additional products began in 2001. The future minimum annual product
funding requirements for all fields of use are as follows:
(in
thousands)
-------------
Year ended December 31,
2001................................................................. $ 8,000
2002................................................................. 13,000
2003................................................................. 14,000
2004*................................................................ 17,000
-------
Total minimum funding required.......................................... $52,000
=======
________________
* Funding requirements after 2004 are to be mutually agreed upon by us and ALZA.
Selling, General and Administrative. Selling, general and administrative
expenses increased to $2.2 million and $4.0 million for the three and six months
ended June 30, 2001 respectively, from $1.0 million and $2.0 million for the
corresponding periods in 2000. The increase was primarily due to an increase in
general and administrative personnel and related expenses necessary to support
our growth. Selling expenses increased following the acquisition of the ALZET
product line in April 2000. As of June 30, 2001, we had 48 sales and
administrative personnel compared with 20 as of the corresponding date in 2000.
We expect selling, general and administrative
13
expenses to continue to increase as we increase the number of personnel and
related resources required to meet the obligations of a public company and
support our growth.
Amortization of intangible assets. In connection with our acquisitions of
IntraEAR, Inc., the ALZET product line and SBS, we acquired goodwill of $4.5
million and other intangible assets of $8.3 million. Goodwill is amortized over
the estimated useful life of 6 to 10 years; other intangible assets are
amortized over their estimated useful lives, which are between 4 and 7 years.
Amortization of intangible assets increased to $461,000 and $735,000 for the
three and six months ended June 30, 2001, respectively, from $233,000 and
$302,000 for the corresponding periods in 2000. Amortization of intangibles
assets in the three months and six months ended June 30, 2000 resulted from the
acquisition of the ALZET product line in April 2000 and IntraEAR, Inc. in
October 1999. The increase in amortization of goodwill and other intangibles in
the three months and six months ended June 30, 2001 resulted from the
acquisition of SBS in April 2001, and the amortization of goodwill and other
intangibles associated with the ALZET product line and the IntraEAR acquisition.
The remaining goodwill and assembled workforce for these three acquisitions at
June 30, 2001 was $4.0 million and $1.0 million, respectively, of which we will
amortize $291,000 and $149,000, respectively, in the six months ending December
31, 2001. In subsequent periods, goodwill and assembled workforce will not be
amortized, but will be periodically evaluated for impairment or obsolescence. An
impairment would be deemed to have occurred when estimated undiscounted future
cash flows expected to result from the use of the asset and its eventual
disposition is less than the carrying amount. Impairment, if any, is assessed
using discounted cash flows. Should the intangible assets become impaired, we
may amortize them on an accelerated schedule or write them down to their
estimated fair market value. Through June 30, 2001, there have been no such
impairments.
The remaining other intangible assets for these three acquisitions at June 30,
2001 was $6.1 million, which will be amortized as follows: $670,000 for the six
months ending December 31, 2001, $1.3 million for each of the years ending
December 31, 2002 and 2003, $1.2 million for each of the years ending December
31, 2004 and 2005, and $393,000 for the year ending December 31, 2006. We
periodically evaluate acquired intangible assets for impairment or obsolescence.
Should the intangible assets become impaired, we may amortize them on an
accelerated schedule or write them down to their estimated fair market value.
Stock-Based Compensation. We have recorded aggregate deferred compensation
charges of $11.2 million in connection with stock options granted to employees
and directors, including $918,000 that we recorded at the time of our
acquisition of SBS in April 2001 for the assumption of outstanding stock options
granted to employees and directors of that company. We have amortized $7.1
million through June 30, 2001. For the three months and six months ended June
30, 2001, we recorded $837,000 and $1.7 million of stock-based compensation,
respectively, compared with $1.2 million and $2.1 million for the corresponding
periods of 2000. Of these amounts, employee stock compensation related to the
following: cost of goods sold of $65,000 and $87,000 for the three and six
months ended June 30, 2001, respectively, and $21,000 and $21,000 for the
corresponding periods in 2000; research and development expenses of $493,000 and
$1.1 million for the three and six months ended June 30, 2001, respectively, and
$845,000 and $1.5 million in the corresponding periods in 2000; and selling,
general and administrative expenses of $280,000 and $522,000 in the three and
six months ended June 30, 2001, respectively, and $363,000 and $644,000 in the
corresponding periods of 2000.
Non-employee stock compensation related to research and development expenses
was $120,000 and $210,000 for the three and six months ended June 30, 2001,
respectively, and $114,000 and $215,000 for the corresponding periods of 2000.
Non-employee stock compensation related to selling, general and administrative
expenses was $26,000 and $38,000 for the three months and six months ended June
30, 2001, respectively, and $44,000 and $190,000 for the corresponding periods
in 2000. Expenses for non-employee stock options are recorded over the vesting
period of the options, with the amount determined by the Black-Scholes option
valuation method and remeasured over the vesting term.
The remaining employee deferred stock compensation at June 30, 2001 was $4.1
million, which will be amortized as follows: $1.5 million for the six months
ending December 31, 2001, $1.7 million for the year ending December 31, 2002,
$739,000 for the year ending December 31, 2003, $111,000 for the year ending
December 31, 2004, $18,000 for the year ending December 31, 2005, and $2,000 for
the year ending December 31, 2006 . Termination of employment of option holders
could cause stock-based compensation in future years to be less than indicated.
Acquired in-process research and development. Acquired in-process research and
development was $14.3 million for the three and six months ended June 30, 2001
compared to $0 for the corresponding periods in 2000. This write off resulted
from the acquisition of SBS in April 2001. Actions and comments from the
Securities and Exchange Commission have indicated that they are reviewing the
current valuation methodology of purchased in-process technology relating to
acquisitions. The Commission is concerned that some companies are writing off
more of the value of an acquisition than is appropriate. We believe that we are
in compliance with all of the rules and related guidance as they currently
exist. However, the Commission may seek to reduce the amount of purchased in-
process technology previously expensed by us. This would result in the
restatement of previously filed financial statements of DURECT and could have a
material adverse impact on the financial results for the period subsequent to
the acquisition.
Other Income (Expense). Interest income increased to $1.3 million and $2.9
million for the three and six months ended June 30, 2001, respectively, from
$540,000 and $828,000 for the corresponding periods in 2000. The increase
14
in interest income was primarily attributable to higher average outstanding
balances of cash and investments resulting from our initial public offering in
September 2000. We expect our interest income to decline as our average
outstanding balances of cash and investments decline; should yields on our
investments decline with interest rates in general, our interest income will
also decrease. Interest expense was $84,000 and $145,000 for the three and six
months ended June 30, 2001, respectively, and $33,000 and $55,000 for the
corresponding periods in 2000. The increase in interest expense was primarily
due to an increase in debt obligations from equipment financings and the
assumption of $1.7 million of debt as part of our acquisition of SBS. We expect
interest expense to increase due to the structure of the payment schedule on our
equipment loan and as we record interest on the debt assumed from SBS over an
entire period.
Liquidity and Capital Resources
From inception through the time of our initial public offering in September
2000, we raised $53.2 million, net of issuance costs, through convertible
preferred stock financings. On September 28, 2000 we raised $76.2 million, net
of issuance costs, through an initial public offering of our common stock, and
in November 2000, we raised $7.8 million from the exercise in part of our
underwriters' over-allotment option. At June 30, 2001, we had cash, cash
equivalents and investments totaling $94.2 million compared to $106.1 million at
December 31, 2000.
Working capital at June 30, 2001 was $68.9 million compared to $105.1 million
at December 31, 2000. The decrease was primarily attributable to purchases of
long-term investments, operating losses of $14.6 million, excluding acquired
in-process research and development and an increase in accrued and other current
liabilities of $1.3 million.
We used $7.8 million of cash for operations for the six months ended June 30,
2001 and $8.0 million in the corresponding period in 2000. The increases in net
loss and accounts receivable in the first six months in 2001 compared to the
first six months of 2000 was offset by an increase in noncash charges for the
amortization of certain intangible assets and by a decrease in accrued
liabilities. As part of our purchase of the ALZET product line in April 2000, we
acquired $3.5 million of inventory, $2.5 million of which was recorded as an
accrued liability to a related party.
We used $3.2 million of cash from investing activities for the six months
ended June 30, 2001 compared to a receipt of $3.4 million for the corresponding
period in 2000. The decrease was primarily due to an increase in purchases of
investments and equipment, offset by an increase in proceeds from maturities of
investments.
We used $65,000 of cash in financing activities for the six months ended June
30, 2001 compared to a receipt of $25.9 million for the corresponding period in
2000. The decrease was primarily due to the receipt of proceeds from the
issuance of preferred stock and an equipment financing received in 2000.
We anticipate that cash used in operating and investing activities will
increase significantly in the future as we research, develop, and manufacture
our products, and, as discussed above, meet our product funding requirements
under our agreement with ALZA. We anticipate incurring capital expenditures of
at least $2.0 million over the next 9 months to construct, equip and validate
our DUROS manufacturing facility. The amount and timing of these capital
expenditures will depend on the success of clinical trials for our products.
Assets relating to our manufacturing facilities will be depreciated over their
estimated useful lives.
In March 2001, we signed a noncancelable operating lease for an office
facility. This lease commenced in June 2001, expires in May 2006, and has two
options to extend the lease term for up to an additional eight years. The
monthly payments under this noncancelable operating lease increase over the term
of the lease from $102,000 to $119,000.
In conjunction with our acquisition of SBS in April 2001, we assumed Alabama
state Industrial Development Bonds with remaining principal payments of $1.7
million and current interest rate of 6.35%, increasing each year up to 7.2% at
maturity on November 1, 2009. These bonds are guaranteed and collateralized by a
letter of credit of approximately $2.5 million that the Company maintains with a
local bank. Interest payments are due semi-annually and principal payments
increase from $150,000 to $240,000 over the term of the bond until the principal
is fully amortized in 2009. We have an option to call these bonds beginning in
November 2001, which we may exercise. The call premium decreases annually from
1 1/2% if we call the bonds in November 2001 to 0% in November 2004.
We believe that our existing cash, cash equivalents and investments will be
sufficient to finance our planned operations and capital expenditures through at
least the next 18 months. We may consume available resources more rapidly than
currently anticipated, resulting in the need for additional funding.
Accordingly, we may be required to raise additional capital through a variety of
sources, including:
15
. the public equity market;
. private equity financing;
. collaborative arrangements; and
. public or private debt.
There can be no assurance that additional capital will be available on
favorable terms, if at all. If adequate funds are not available, we may be
required to significantly reduce or refocus our operations or to obtain funds
through arrangements that may require us to relinquish rights to certain of our
products, technologies or potential markets, either of which could have a
material adverse effect on our business, financial condition and results of
operations. To the extent that additional capital is raised through the sale of
equity or convertible debt securities, the issuance of such securities would
result in ownership dilution to our existing stockholders.
Our cash and investments policy emphasizes liquidity and preservation of
principal over other portfolio considerations. We select investments that
maximize interest income to the extent possible given these two constraints. We
satisfy liquidity requirements by investing excess cash in securities with
different maturities to match projected cash needs and limit concentration of
credit risk by diversifying our investments among a variety of high credit-
quality issuers.
Factors that May Affect Future Results
In addition to the other information in this Form on 10-Q, the following
factors should be considered carefully in evaluating our business and prospects:
We have not completed development of any of our pharmaceutical systems, and we
cannot be certain that our pharmaceutical systems will be able to be
commercialized
To be profitable, we must successfully research, develop, obtain regulatory
approval for, manufacture, introduce, market and distribute our pharmaceutical
systems under development. For each pharmaceutical system that we intend to
commercialize, we must successfully meet a number of critical developmental
milestones for each disease or medical condition that we target, including:
. selecting and developing drug delivery platform technology to deliver the
proper dose of drug over the desired period of time;
. selecting and developing catheter technology, if appropriate, to deliver
the drug to a specific location within the body;
. determining the appropriate drug dosage for use in the pharmaceutical
system;
. developing drug compound formulations that will be tolerated, safe and
effective and that will be compatible with the system; and
. demonstrating the drug formulation will be stable for commercially
reasonable time periods.
The time frame necessary to achieve these developmental milestones for any
individual product is long and uncertain, and we may not successfully complete
these milestones for any of our products in development. We have not yet
completed development of any pharmaceutical systems, and DURECT has limited
experience in developing such products. For our lead product, Chronogesic(TM)
and our second product, DUROS hydromorphone, we have not yet determined the drug
dosages we intend to use for commercialization nor finalized the commercial
design. We are continuing testing of these products and exploring possible
design changes to address issues of safety, manufacturing efficiency and
performance. We may not be able to complete the design of these products. In
addition, we may not be able to develop dosages that will be safe and effective
or compatible with the pharmaceutical system for a commercially reasonable
treatment and storage period. If we are unable to complete development of these
or other products, we will not be able to earn revenue from them, which would
materially harm our business.
We must conduct and satisfactorily complete clinical trials for our
pharmaceutical systems
16
Before we can obtain government approval to sell any of our pharmaceutical
systems, we must demonstrate through preclinical (animal) studies and clinical
(human) trials that each system is safe and effective for human use for each
targeted disease. We have completed an initial Phase I clinical trial for our
lead product, Chronogesic(TM), using an external pump to test the safety of
continuous chronic infusion of the drug, and we have completed the clinical
portion of the Phase II clinical trial for this product in May 2001. We are
conducting pre-clinical studies on our second product, DUROS hydromorphone. We
plan to continue extensive and costly clinical trials to assess the safety and
effectiveness of Chronogesic(TM), DUROS hydromorphone and our other potential
products. We may not be permitted to begin or continue our planned clinical
trials for our potential products or, if our trials are permitted, our potential
products may not prove to be safe or produce their intended effects.
The length of our clinical trials will depend upon, among other factors, the
rate of trial site and patient enrollment. We may fail to obtain adequate levels
of patient enrollment in our clinical trials. Delays in planned patient
enrollment may result in increased costs, delays or termination of clinical
trials, which could have a material adverse effect on us. In addition, even if
we enroll the number of patients we expect in the time frame we expect, our
clinical trials may not provide the data necessary for their successful
completion. Additionally, we may fail to effectively oversee and monitor these
clinical trials, which would result in increased costs or delays of our clinical
trials. Even if these clinical trials are completed, we may fail to complete and
submit a new drug application as scheduled. Even if we are able to submit a new
drug application as scheduled, the Food and Drug Administration may not clear
our application in a timely manner or may deny the application entirely.
Data already obtained from preclinical studies and clinical trials of our
pharmaceutical systems do not necessarily predict the results that will be
obtained from later preclinical studies and clinical trials. Moreover,
preclinical and clinical data such as ours is susceptible to varying
interpretations, which could delay, limit or prevent regulatory approval. A
number of companies in the pharmaceutical industry have suffered significant
setbacks in advanced clinical trials, even after promising results in earlier
trials. The failure to adequately demonstrate the safety and effectiveness of a
product under development could delay or prevent regulatory clearance of the
potential product, resulting in delays to the commercialization of our products,
and could materially harm our business. Our clinical trials may not demonstrate
the sufficient levels of safety and efficacy necessary to obtain the requisite
regulatory approvals for our products, and thus our products may not be approved
for marketing.
Failure to obtain product approvals or comply with ongoing governmental
regulations could delay or limit introduction of our new products and result in
failure to achieve anticipated revenues
The manufacture and marketing of our products and our research and development
activities are subject to extensive regulation for safety, efficacy and quality
by numerous government authorities in the United States and abroad. Before
receiving FDA clearance to market a product, we will have to demonstrate that
the product is safe and effective on the patient population and for the diseases
that will be treated. Clinical trials, manufacturing and marketing of products
are subject to the rigorous testing and approval process of the FDA and
equivalent foreign regulatory authorities. The Federal Food, Drug and Cosmetic
Act and other federal, state and foreign statutes and regulations govern and
influence the testing, manufacture, labeling, advertising, distribution and
promotion of drugs and medical devices. As a result, clinical trials and
regulatory approval can take a number of years to accomplish and require the
expenditure of substantial resources.
Data obtained from clinical trials are susceptible to varying interpretations,
which could delay, limit or prevent regulatory clearances. As of June 30, 2001,
we have completed an initial Phase I clinical trial for our Chronogesic(TM)
product using an external pump to test the safety of continuous chronic infusion
of the drug, and have completed the clinical portion of a Phase II clinical
trial, but have not begun our Phase III trial of this product, or initiated
clinical trials for any other products. We are currently conducting prelinical
studies on our second product, DUROS hydromorphone. If we fail to obtain timely
clearance or approval for our products, we will not be able to market and sell
our products, which will limit our ability to generate revenue.
In addition, we may encounter delays or rejections based upon additional
government regulation from future legislation or administrative action or
changes in FDA policy during the period of product development, clinical trials
and FDA regulatory review. We may encounter similar delays in foreign countries.
Sales of our products outside the U.S. are subject to foreign regulatory
approvals that vary from country to country. The time required to obtain
approvals from foreign countries may be shorter or longer than that required for
FDA approval, and requirements for foreign licensing may differ from FDA
requirements. We may be unable to obtain requisite approvals from the FDA and
foreign regulatory authorities, and even if obtained, such approvals may not be
on a timely basis, or they may not cover the clinical uses that we specify.
Marketing or promoting a drug for an unapproved use is subject to very strict
controls. Furthermore, clearance may entail ongoing requirements for post-
marketing studies. The manufacture and marketing of drugs are subject to
continuing FDA and foreign regulatory review and requirements that we update our
regulatory filings. Later discovery of previously unknown problems with a
product, manufacturer or facility, or our failure to update regulatory files,
may result in restrictions, including withdrawal of the product from the market.
Any of the following events, if they were to occur, could delay or preclude us
from further developing, marketing or realizing full commercial use of our
products, which in turn would materially harm our business, financial condition
and results of operations:
. failure to obtain or maintain requisite governmental approvals;
. failure to obtain approvals for clinically intended uses of our products
under development; or
. identification of serious and unanticipated adverse side effects in our
products under development.
Manufacturers of drugs also must comply with the applicable FDA good
manufacturing practice regulations, which include production design controls,
testing, quality control and quality assurance requirements as well as the
corresponding maintenance of records and documentation. Compliance with current
good manufacturing practices regulations is difficult and costly. 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 for the commercial manufacture of our products.
We or our present or future suppliers may be unable to comply with the
applicable good manufacturing practice regulations and other FDA regulatory
requirements. We have not been subject to a good manufacturing regulation
inspection by the FDA relating to our pharmaceutical systems. If we do not
achieve compliance for the products we manufacture, the FDA may withdraw
marketing clearance or require product recall, which may cause interruptions or
delays in the manufacture and sale of our products.
We may not be able to manufacture sufficient quantities of our products to
support our clinical and commercial requirements at an acceptable cost, and we
have limited manufacturing experience
We must manufacture our products in clinical and commercial quantities,
either directly or through third parties, in compliance with regulatory
requirements and at an acceptable cost. We have not yet completed development
of the manufacturing process for any of our pharmaceutical systems, and DURECT
has limited experience in developing such manufacturing processes. We are still
optimizing our manufacturing process and exploring possible changes to increase
efficiencies and lower costs. If we fail to develop manufacturing processes to
permit us to manufacture our pharmaceutical systems at an acceptable cost, then
we may not be able to commercialize our pharmaceutical systems.
To date, we do not own manufacturing facilities capable of supplying
clinical and commercial quantities of our products. Our current manufacturing
facilities are only capable of manufacturing sub-assemblies of our DUROS-based
pharmaceutical systems and cannot perform the final fill steps of our
manufacturing process. We completed construction of a manufacturing facility
for your DUROS-based pharmaceutical systems in May 2001 in accordance with our
initial plans, and we anticipate that this facility, once it is ready for
production, will be capable of manufacturing supplies for our Phase III
clinical trial and commercial launch of our Chronogesic(TM) product and for
clinical trials of our DUROS hydromorphone product as well as other products
on a pilot scale. However, in order for the facility to be ready to produce
clinical and anticipated commercial supplies of our products, we must still do
work to ensure that the facility is compatible with the manufacturing process
for our DUROS systems and meets all applicable regulatory standards, and we
must complete validation and qualification of our facility. The manufacture of
our DUROS-based pharmaceutical systems is a complex process, and federal,
state and foreign regulatory standards relating to manufacture of
pharmaceutical products are rigorous, complex and subject to varying
interpretations. We may need to alter our facility design, install additional
equipment or do additional construction or testing in order to adapt our
facility to our current DUROS manufacturing process, meet regulatory
requirements, optimize the production process, increase efficiencies or
production capacity or for other reasons, which may result in additional cost
to us or delay production of product needed for our clinical trials and
commercial launch. We have commenced validating and qualifying the
manufacturing facility but have not completed these processes. DURECT has no
experience validating and qualifying manufacturing facilities. Furthermore,
our new facility will be subject to government audits to determine compliance
with good manufacturing practices regulations, and we may be unable to attain
and maintain compliance with these regulations. If we are unable to ready our
manufacturing facility for production in a timely manner or at an acceptable
cost and attain and maintain compliance with applicable regulations, we could
experience a delay in our clinical trials and the commercial sale of our DUROS-
based pharmaceutical systems. We may also be required or choose to subcontract
with third party contractors to perform the final manufacturing steps of our
DUROS-based pharmaceutical systems in which case we will be subject to the
schedule, expertise and performance of third parties as well as incur
significant additional costs. See "We rely heavily on third parties to support
development, clinical testing and manufacturing of our products." Under our
development and commercialization agreement with ALZA, we cannot subcontract
the manufacture of subassemblies of the DUROS system without approval from
ALZA. If we cannot manufacture product in time to meet our clinical or
commercial requirements or at an acceptable cost, our operating results will
be harmed.
In April 2000, we acquired the ALZET product and related assets from
ALZA. We manufacture subassemblies of the ALZET product at our Vacaville
facility. We currently rely on ALZA to perform the coating process for the
manufacture of the ALZET product, but we will be required to perform this
process ourselves starting April 2003. We have limited experience
manufacturing this product, and we may not be able to successfully or
consistently manufacture this product at an acceptable cost, if at all.
Our agreement with ALZA limits our fields of operation for our DUROS-based
pharmaceutical systems, requires us to spend significant funds on product
development and gives ALZA a first right to distribute selected products for us,
including Chronogesic(TM)
In April 1998, we entered into a development and commercialization agreement
with ALZA Corporation, which was amended and restated in April 1999 and April
2000. ALZA was acquired by Johnson & Johnson, Inc. in June 2001 and has since
operated as a wholly owned subsidiary. This agreement gives us exclusive rights
to develop, commercialize and manufacture products using ALZA's DUROS technology
to deliver by catheter:
. drugs to the central nervous system to treat select nervous system
disorders;
. drugs to the middle and inner ear;
. drugs to the pericardial sac of the heart; and
. select drugs into vascular grafts.
We also have the right to use the DUROS technology to deliver systemically and
by catheter:
. sufentanil to treat chronic pain; and
. select cancer antigens.
We may not develop, manufacture or commercialize DUROS-based pharmaceutical
systems outside of these specific fields without ALZA's prior approval. In
addition, if we develop or commercialize any drug delivery technology for use in
a manner similar to the DUROS technology in a field covered in our license
agreement with ALZA, then we may lose our exclusive rights to use the DUROS
technology in such field as well as the right to develop new products using
DUROS technology in such field. Furthermore, to maintain our rights under this
license agreement, we must meet annual minimum development spending requirements
totaling $52.0 million to develop
17
products in some or all of these fields through 2004 and fund development of a
minimum number of products per year up to a total of eight products through
2004. In order to maintain commercialization rights for our products in the U.S.
and any foreign countries, we must diligently develop our products, procure
required regulatory approvals and commercialize the products in these countries.
If we fail to meet the various diligence requirements, we may:
. close our rights to develop, commercialize and manufacture some of our
DUROS-based pharmaceutical systems;
. lose rights for products in some or all countries, including the U.S.; or
. lose rights in some fields of use.
These rights would revert to ALZA, which could then develop DUROS-based
pharmaceutical products in such countries or fields of use itself or license
others to do so. In addition, in the event that our rights terminate with
respect to any product or country, or this agreement terminates or expires in
its entirety (except for termination by us due to a breach by ALZA), ALZA will
have the exclusive right to use all of our data, rights and information relating
to the products developed under the agreement as necessary for ALZA to
commercialize these products, subject to the payment of a royalty to us based on
the net sales of the products by ALZA.
Our agreement with ALZA gives us the right to develop and manufacture the
DUROS pump component of our pharmaceutical systems in the fields described
above. In the event of a change in our corporate control, including an
acquisition of us, our right to manufacture and develop the DUROS pump would
terminate and ALZA would have the right to manufacture and develop DUROS systems
for us so long as ALZA can meet our specification and supply requirements
following such change in control.
Under the ALZA agreement, we must pay ALZA royalties on sales of DUROS- based
pharmaceutical systems we commercialize and a percentage of any up-front license
fees, milestone or special fees, payments or other consideration we receive,
excluding research and development funding. In addition, commencing upon the
commercial sale of a product developed under the agreement, we are obligated to
make minimum product payments to ALZA on a quarterly basis based on our good
faith projections of our net product sales of the product. These minimum
payments will be fully credited against the product royalty payments we must pay
to ALZA.
ALZA also has an exclusive option to distribute our Chronogesic(TM) product in
the U.S. and Canada and any DUROS-based pharmaceutical system we develop to
deliver non-proprietary cancer antigens worldwide. The terms of any distribution
arrangement have not been set and are to be negotiated in good faith between
ALZA and ourselves. If ALZA chooses not to exercise its option to distribute our
Chronogesic(TM) product, this may be interpreted as a negative factor, resulting
in a decline in our stock price. ALZA's option to acquire distribution rights
limits our ability to negotiate with other distributors for these products and
may result in lower payments to us than if these rights were subject to
competitive negotiations. We must allow ALZA an opportunity to negotiate in good
faith for commercialization rights to our products developed under the agreement
prior to granting these rights to a third party. These rights do not apply to
products that are subject to ALZA's option or products for which we have
obtained funding or access to a proprietary drug from a third party to whom we
have granted commercialization rights prior to the commencement of human
clinical trials.
ALZA has the right to terminate the agreement in the event that we breach a
material obligation under the agreement and do not cure the breach in a timely
manner. In addition, ALZA has the right to terminate the agreement if, at any
time prior to July 2002, we solicit for employment or hire, without ALZA's
consent, a person who is or within the previous 180 days has been an employee of
ALZA, or if at any time prior to July 2006, we solicit for employment or hire,
without ALZA's consent, a person who is or within the previous 180 days has been
an employee of ALZA in the DUROS technology group.
Technologies and businesses which we have acquired may be difficult to
integrate, disrupt our business, dilute stockholder value or divert management
attention. We may also acquire additional businesses or technologies in the
future, which could have these same effects
We may acquire technologies, products or businesses to broaden the scope of
our existing and planned product lines and technologies. For example, in October
1999, we acquired substantially all of the assets of IntraEAR, Inc., in April
2000 we acquired the ALZET product and related assets from ALZA and in April
2001, we completed the acquisition of SBS. These and our future acquisitions
expose us to:
. increased costs associated with the acquisition and operation of the new
businesses or technologies and the management of geographically dispersed
operations;
18
. the risks associated with the assimilation of new technologies, operations,
sites and personnel;
. the diversion of resources from our existing business and technologies;
. the inability to generate revenues to offset associated acquisition costs;
. the requirement to maintain uniform standards, controls, and procedures;
and
. the impairment of relationships with employees and customers as a result of
any integration of new management personnel.
Acquisitions may also result in the issuance of dilutive equity securities, the
incurrence or assumption of debt or additional expenses associated with the
amortization of acquired intangible assets or potential businesses. Past
acquisitions, such as our acquisitions of IntraEAR, ALZET and SBS, as well
future acquisitions, may not generate any additional revenue or provide any
benefit to our business.
19
Our products contain controlled substances, the making, use, sale, importation
and distribution of which are subject to regulation by state, federal and
foreign law enforcement and other regulatory agencies
20
Our products currently under development contain, and our products in the
future may contain, controlled substances which are subject to state, federal
and foreign laws and regulations regarding their manufacture, use, sale,
importation and distribution. Our first two products under development contain
opioids which are classified as Schedule II controlled substances under the
regulations of the U.S. Drug Enforcement Agency. For our products containing
controlled substances, we and our suppliers, manufacturers, contractors,
customers and distributors are required to obtain and maintain applicable
registrations from state, federal and foreign law enforcement and regulatory
agencies and comply with state, federal and foreign laws and regulations
regarding the manufacture, use, sale, importation and distribution of controlled
substances. These regulations are extensive and include regulations governing
manufacturing, labeling, packaging, testing, dispensing, production and
procurement quotas, record keeping, reporting, handling, shipment and disposal.
Failure to obtain and maintain required registrations or comply with any
applicable regulations could delay or preclude us from developing and
commercializing our products containing controlled substances and subject us to
enforcement action. In addition, because of their restrictive nature, these
regulations could limit our commercialization of our products containing
controlled substances.
Our limited operating history makes evaluating our stock difficult
You can only evaluate our business based on a limited operating history. We
were incorporated in February 1998 and have engaged primarily in research and
development, licensing technology, raising capital and recruiting scientific and
management personnel. This short history may not be adequate to enable you to
fully assess our ability to successfully develop our products, achieve market
acceptance of our products and respond to competition.
Acceptance of our products in the marketplace is uncertain, and failure to
achieve market acceptance will delay our ability to generate or grow revenues
Our future financial performance will depend upon the successful introduction
and customer acceptance of our future products, including Chronogesic(TM). Even
if approved for marketing, our products may not achieve market acceptance. The
degree of market acceptance will depend upon a number of factors, including:
. the receipt of regulatory clearance of marketing claims for the uses that
we are developing;
. the establishment and demonstration in the medical community of the safety
and clinical efficacy of our products and their potential advantages over
existing therapeutic products, including oral medication, transdermal drug
delivery products such as drug patches, or external or implantable drug
delivery products; and
. pricing and reimbursement policies of government and third-party payors
such as insurance companies, health maintenance organizations and other
health plan administrators.
Physicians, patients, payors or the medical community in general may be
unwilling to accept, utilize or recommend any of our products. If we are unable
to obtain regulatory approval, commercialize and market our future products when
planned and achieve market acceptance, we will not achieve anticipated revenues.
If users of our products are unable to obtain adequate reimbursement from third-
party payors, or if new restrictive legislation is adopted, market acceptance of
our products may be limited and we may not achieve anticipated revenues
The continuing efforts of government and insurance companies, health
maintenance organizations and other payors of healthcare costs to contain or
reduce costs of health care may affect our future revenues and profitability,
and the future revenues and profitability of our potential customers, suppliers
and collaborative partners and the availability of capital. For example, in
certain foreign markets, pricing or profitability of prescription
pharmaceuticals is subject to government control. In the United States,
recent federal and state government initiatives have been directed at lowering
the total cost of health care, and the U.S. Congress and state legislatures will
likely continue to focus on health care reform, the cost of prescription
pharmaceuticals and on the reform of the Medicare and Medicaid systems. While we
cannot predict whether any such legislative or regulatory proposals will be
adopted, the announcement or adoption of such proposals could materially harm
our business, financial condition and results of operations.
Our ability to commercialize our products successfully will depend in part on
the extent to which appropriate reimbursement levels for the cost of our
products and related treatment are obtained by governmental authorities, private
health insurers and other organizations, such as HMOs. Third-party payors are
increasingly limiting payments or reimbursement for medical products and
services. Also, the trend toward managed health care in the United States and
the concurrent growth of organizations such as HMOs, which could control or
significantly influence the purchase of health care services and products, as
well as legislative proposals to reform health care or reduce government
insurance programs, may limit reimbursement or payment for our products. The
cost containment measures that health care payors and providers are instituting
and the effect of any health care reform could materially harm our ability to
operate profitably.
We have a history of operating losses, expect to continue to have losses in the
future and may never achieve or maintain profitability
We have incurred significant operating losses since our inception in 1998 and,
as of June 30, 2001, had an accumulated deficit of approximately $57.4 million.
We expect to continue to incur significant operating losses over the next
several years as we continue to incur increasing costs for research and
development, clinical trials and manufacturing. Our ability to achieve
profitability depends upon our ability, alone or with others, to successfully
complete the development of our proposed products, obtain the required
regulatory clearances and manufacture and market our proposed products.
Development of pharmaceutical systems is costly and requires significant
investment. In addition, we may choose to license either additional drug
delivery platform technology or rights to particular drugs for use in our
pharmaceutical systems. The license fees for these technologies or rights would
increase the costs of our pharmaceutical systems.
21
To date, we have not generated significant revenue from the commercial sale of
our products and do not expect to receive significant revenue in the near
future. All revenues to date are from the sale of products we acquired in
October 1999 in connection with the acquisition of substantially all of the
assets of IntraEAR, Inc., the ALZET product we acquired in April 2000 from ALZA
and the sale of biodegradable polymers and contract research and development
revenues from our SBS subsidiary. We do not expect these revenues to increase
significantly in future periods. We do not anticipate commercialization and
marketing of our products in development in the near future, and therefore do
not expect to generate sufficient revenues to cover expenses or achieve
profitability in the near future.
We do not control ALZA's ability to develop and commercialize DUROS technology
outside of fields licensed to us, and problems encountered by ALZA could result
in negative publicity, loss of sales and delays in market acceptance of our
DUROS-based pharmaceutical systems
ALZA retains complete rights to the DUROS technology for fields outside the
specific fields licensed to us. Accordingly, ALZA may develop and commercialize
DUROS-based products or license others to do so, so long as there is no conflict
with the rights granted to us. ALZA recently received FDA approval to market its
first DUROS-based product, Viadur (leuprolide acetate implants) for the
palliative treatment of advanced prostate cancer. If ALZA fails to commercialize
this product successfully, or encounters problems associated with this product,
negative publicity could be created about all DUROS-based products, which could
result in harm to our reputation and cause reduced sales of our products. In
addition, if any third-party that may be licensed by ALZA fails to develop and
commercialize DUROS-based products successfully, the success of all DUROS-based
systems could be impeded, including ours, resulting in delay or loss of revenue
or damage to our reputation, any one of which could harm our business.
We do not own the trademark "DUROS" and any competitive advantage we derive from
the name may be impaired by third-party use
ALZA owns the trademark "DUROS." Because ALZA is also developing and marketing
DUROS-based systems, and may license third parties to do so, there may be
confusion in the market between ALZA, its potential licensees and us, and this
confusion could impair the competitive advantage, if any, we derive from use of
the DUROS name. In addition, any actions taken by ALZA or its potential
licensees that negatively impact the trademark "DUROS" could negatively impact
our reputation and result in reduced sales of our DUROS-based pharmaceutical
systems.
We may be sued by third parties which claim that our products infringe on their
intellectual property rights, particularly because there is substantial
uncertainty about the validity and breadth of medical patents
We may be exposed to future litigation by third parties based on claims that
our products or activities infringe the intellectual property rights of others
or that we have misappropriated the trade secrets of others. This risk is
exacerbated by the fact that the validity and breadth of claims covered in
medical technology patents and the breadth and scope of trade secret protection
involve complex legal and factual questions for which important legal principles
are unresolved. Any litigation or claims against us, whether or not valid, could
result in substantial costs, could place a significant strain on our financial
resources and could harm our reputation. In addition, intellectual property
litigation or claims could force us to do one or more of the following:
. cease selling, incorporating or using any of our products that incorporate
the challenged intellectual property, which would adversely affect our
revenue;
. obtain a license from the holder of the infringed intellectual property
right, which license may be costly or may not be available on reasonable
terms, if at all; or
. redesign our products, which would be costly and time-consuming.
If we are unable to adequately protect or enforce our intellectual property
rights or secure rights to third-party patents, we may lose valuable assets,
experience reduced market share or incur costly litigation to protect our rights
22
Our success will depend in part on our ability to obtain patents, maintain
trade secret protection and operate without infringing the proprietary rights of
others. As of June 30, 2001, we held four issued U.S. patents and one issued
foreign patent. In addition, we have 17 pending U.S. patent applications and
have filed 12 patent applications under the Patent Cooperation Treaty, from
which 11 national phase applications are currently pending in Europe, Australia
and Canada. As of June 30, 2001, our subsidiary SBS held 3 issued U.S. patents,
1 issued foreign patent and 6 pending U.S. patent applications and has filed 6
patent applications under the Patent Cooperation Treaty. To maintain the license
rights to ALZA intellectual property granted to us under our development and
commercialization agreement with ALZA, we must meet annual minimum development
spending requirements and fund development of a minimum number of products. If
we do not meet these diligence requirements, we may lose rights to one or more
of our licensed fields. Also, under our agreement with ALZA, we must assign to
ALZA any intellectual property rights relating to the DUROS system and its
manufacture and any combination of the DUROS system with other components,
active agents, features or processes. In addition, ALZA retains the right to
enforce and defend against infringement actions relating to the DUROS system,
and if ALZA exercises these rights, it will be entitled to the proceeds of these
infringement actions.
The patent positions of pharmaceutical companies, including ours, are
uncertain and involve complex legal and factual questions. In addition, the
coverage claimed in a patent application can be significantly reduced before the
patent is issued. Consequently, our patent applications or those of ALZA that
are licensed to us may not issue into patents, and any issued patents may not
provide protection against competitive technologies or may be held invalid if
challenged or circumvented. Our competitors may also independently develop
products similar to ours or design around or otherwise circumvent patents issued
to us or licensed by us. In addition, the laws of some foreign countries may not
protect our proprietary rights to the same extent as U.S. law.
We also rely upon trade secrets, technical know-how and continuing
technological innovation to develop and maintain our competitive position. We
require our employees, consultants, advisors and collaborators to execute
appropriate confidentiality and assignment-of-inventions agreements with us.
These agreements typically provide that all materials and confidential
information developed or made known to the individual during the course of the
individual's relationship with us is to be kept confidential and not disclosed
to third parties except in specific circumstances, and that all inventions
arising out of the individual's relationship with us shall be our exclusive
property. These agreements may be breached, and in some instances, we may not
have an appropriate remedy available for breach of the agreements. Furthermore,
our competitors may independently develop substantially equivalent proprietary
information and techniques, reverse engineer our information and techniques, or
otherwise gain access to our proprietary technology.
We may be unable to meaningfully protect our rights in trade secrets,
technical know-how and other non-patented technology. We may have to resort to
litigation to protect our intellectual property rights, or to determine their
scope, validity or enforceability. Enforcing or defending our proprietary rights
is expensive, could cause diversion of our resources and may not prove
successful. Any failure to enforce or protect our rights could cause us to lose
the ability to exclude others from using our technology to develop or sell
competing products.
23
We rely heavily on third parties to support development, clinical testing and
manufacturing of our products
We rely on third party contract research organizations, service providers and
suppliers to provide critical services to support development, clinical testing,
and manufacturing of our pharmaceutical systems. For example, we currently
depend on MDS Pharma, Inc. to perform blood plasma assays in connection with our
clinical trials for Chronogesic(TM) and Nelson Laboratories, Inc. to perform
quality control services related to components of our DUROS-based pharmaceutical
systems. In the past, we relied on Chesapeake Biological Labs, Inc. to perform
the final manufacturing steps of our Chronogesic(TM) product, and we may need to
rely on a third party manufacturer again if we encounter delays in readying our
manufacturing facility for production. See "We may not be able to manufacture
sufficient quantities of our products to support our clinical and commercial
requirements at an acceptable cost, and we have limited manufacturing
experience." We anticipate that we will continue to rely on these and other
third party contractors to support development, clinical testing, and
manufacturing of our pharmaceutical systems. Failure of these contractors to
provide the required services in a timely manner or on reasonable commercial
terms could materially delay the development and approval of our products,
increase our expenses and materially harm our business, financial condition and
results of operations.
Key components of our DUROS-based pharmaceutical systems are provided by
limited numbers of suppliers, and supply shortages or loss of these suppliers
could result in interruptions in supply or increased costs
Certain components and drug substances used in our DUROS-based pharmaceutical
systems are currently purchased from a single or a limited number of outside
sources. The reliance on a sole or limited number of suppliers could result in:
. delays associated with redesigning a product due to a failure to obtain a
single source component;
. an inability to obtain an adequate supply of required components; and
. reduced control over pricing, quality and time delivery.
We have a supply agreement with Mallinckrodt, Inc. for our sufentanil
requirements for our Chronogesic(TM) product, which expires in September 2004.
Additionally, we have a supply agreement with RMS Company under which RMS has
agreed to supply us with titanium components of our DUROS-based pharmaceutical
systems until April 2004. Other that these agreements, we do not have long-term
agreements with any of our suppliers, and therefore the supply of a particular
component could be terminated at any time without penalty to the supplier. Any
interruption in the supply of single source components could cause us to seek
alternative sources of supply or manufacture these components internally. If the
supply of any components for our pharmaceutical systems is interrupted,
components from alternative suppliers may not be available in sufficient volumes
within required timeframes, if at all, to meet our needs. This could delay our
ability to complete clinical trials and obtain approval for commercialization
and marketing of our products, causing us to lose sales, incur additional costs
and delay new product introductions and could harm our reputation.
We lack marketing, sales and distribution experience for pharmaceutical systems
and we may not be able to sell our products if we do not enter into
relationships with third parties or develop a direct sales organization
We have yet to establish marketing, sales or distribution capabilities for our
pharmaceutical systems. We intend to enter into agreements with third parties to
sell our products or to develop our own sales and marketing force. We may be
unable to establish or maintain third-party relationships on a commercially
reasonable basis, if at all. In addition, these third parties may have similar
or more established relationships with our competitors.
If we do not enter into relationships with third parties for the sales and
marketing of our products, we will need to develop our own sales and marketing
capabilities. DURECT has only limited experience in developing, training or
managing a sales force. If we choose to establish a direct sales force, we will
incur substantial additional expenses in developing, training and managing such
an organization. We may be unable to build a sales force, the cost of
establishing such a sales force may exceed our product revenues, or our direct
marketing and sales efforts may be unsuccessful. In addition, we compete with
many other companies that currently have extensive and well- funded marketing
and sales operations. Our marketing and sales efforts may be unable to compete
successfully against these other companies. We may be unable to establish a
sufficient sales and marketing organization on a timely basis, if at all. We may
be unable to engage qualified distributors. Even if engaged, these distributors
may:
. fail to satisfy financial or contractual obligations to us;
. fail to adequately market our products;
. cease operations with little or no notice to us; or
. offer, design, manufacture or promote competing product lines.
If we fail to develop sales, marketing and distribution channels, we would
experience delays in product sales and incur increased costs, which would harm
our financial results.
If we are unable to train physicians to use our pharmaceutical systems to treat
patients' diseases or medical conditions, we may incur delays in market
acceptance of our products
Broad use of our pharmaceutical systems will require extensive training of
numerous physicians. The time required to begin and complete training of
physicians could delay introduction of our products and adversely affect market
acceptance of our products. We may be unable to rapidly train physicians in
numbers sufficient to generate adequate demand for our pharmaceutical systems.
Any delay in training would materially delay the demand for our systems. In
addition, we may expend significant funds towards such training before any
orders are placed for our products.
We may have difficulty raising needed capital in the future
24
Our business currently does not generate sufficient revenues to meet our
capital requirements and we do not expect that it will do so in the near future.
We have expended and will continue to expend substantial funds to complete the
research, development and clinical testing of our products. We will require
additional funds for these purposes, to establish additional clinical- and
commercial-scale manufacturing arrangements and facilities and to provide for
the marketing and distribution of our products. Additional funds may not be
available on acceptable terms, if at all. If adequate funds are unavailable from
operations or additional sources of financing, we may have to delay, reduce the
scope of or eliminate one or more of our research or development programs which
would materially harm our business, financial condition and results of
operations.
We believe that our cash, cash equivalents and investments, will be adequate
to satisfy our capital needs for at least the next 18 months. However, our
actual capital requirements will depend on many factors, including:
. continued progress and cost of our research and development programs;
. progress with preclinical studies and clinical trials;
. the time and costs involved in obtaining regulatory clearance;
. costs involved in preparing, filing, prosecuting, maintaining and enforcing
patent claims;
. costs of developing sales, marketing and distribution channels and our
ability to sell our products;
. costs involved in establishing manufacturing capabilities for commercial
quantities of our products;
. competing technological and market developments;
. market acceptance of our products; and
. costs for recruiting and retaining employees and consultants.
We may consume available resources more rapidly than currently anticipated,
resulting in the need for additional funding. We may seek to raise any necessary
additional funds through equity or debt financings, collaborative arrangements
with corporate partners or other sources, which may be dilutive to existing
stockholders. In addition, in the event that additional funds are obtained
through arrangements with collaborative partners or other sources, we may have
to relinquish rights to some of our technologies, product candidates or products
under development that we would otherwise seek to develop or commercialize
ourselves. If adequate funds are not available, we may be required to
significantly reduce or refocus our product development efforts, or relinquish
to ALZA rights to develop DUROS products in certain fields, resulting in loss of
sales, increased costs, and reduced revenues.
Future deferred compensation expenses and non-cash charges may adversely impact
or delay our profitability
To date, we have recorded deferred compensation expenses related to stock
options grants, including stock options assumed in our acquisition of SBS, which
will be amortized as follows: $1.5 million for the six months ending December
31, 2001, $1.7 million for the year ending December 31, 2002, $739,000 for the
year ending December 31, 2003, $111,000 for the year ending December 31, 2004,
$18,000 for the year ending December 31, 2005, and $2,000 for the year ending
December 31, 2006. In addition, deferred compensation expense related to option
awards to non-employees will be calculated during the vesting period of the
option based on the then-current price of our common stock, which could result
in significant charges that adversely impact or delay our profitability.
Furthermore, we have issued a warrant to ALZA with a deemed value of
approximately $6.5 million, which will be amortized over time based on sales of
our products and which will also adversely impact or delay our profitability.
We depend upon key personnel who may terminate their employment with us at any
time, and we need to hire additional qualified personnel
Our success will depend to a significant degree upon the continued services of
key management, technical, and scientific personnel, including Felix Theeuwes,
our Chairman and Chief Scientific Officer, James E. Brown, our
25
President and Chief Executive Officer and Thomas A. Schreck, our Chief Financial
Officer. Although we have obtained key man life insurance policies for each of
Messrs. Theeuwes, Brown and Schreck in the amount of $1 million, this insurance
may not adequately compensate us for the loss of their services. In addition,
our success will depend on our ability to attract and retain other highly
skilled personnel. Competition for qualified personnel is intense, and the
process of hiring and integrating such qualified personnel is often lengthy. We
may be unable to recruit such personnel on a timely basis, if at all. Our
management and other employees may voluntarily terminate their employment with
us at any time. The loss of the services of key personnel, or the inability to
attract and retain additional qualified personnel, could result in delays to
product development or approval, loss of sales and diversion of management
resources.
We may not successfully manage our growth
Our success will depend on the expansion of our operations and the effective
management of growth, which will place a significant strain on our management
and on our administrative, operational and financial resources. To manage such
growth, we must expand our facilities, augment our operational, financial and
management systems and hire and train additional qualified personnel. If we are
unable to manage growth effectively our business would be harmed.
The market for our products is new, rapidly changing and competitive, and new
products or technologies developed by others could impair our ability to grow
our business and remain competitive
The pharmaceutical industry is subject to rapid and substantial technological
change. Developments by others may render our products under development or
technologies noncompetitive or obsolete, or we may be unable to keep pace with
technological developments or other market factors. Technological competition in
the industry from pharmaceutical and biotechnology companies, universities,
governmental entities and others diversifying into the field is intense and is
expected to increase. Many of these entities have significantly greater research
and development capabilities than we do, as well as substantially more
marketing, manufacturing, financial and managerial resources. These entities
represent significant competition for us. Acquisitions of, or investments in,
competing pharmaceutical or biotechnology companies by large corporations could
increase such competitors' financial, marketing, manufacturing and other
resources.
We are a new enterprise and are engaged in the development of novel
therapeutic technologies. As a result, our resources are limited and we may
experience technical challenges inherent in such novel technologies. Competitors
have developed or are in the process of developing technologies that are, or in
the future may be, the basis for competitive products. Some of these products
may have an entirely different approach or means of accomplishing similar
therapeutic effects than our products. Our competitors may develop products that
are safer, more effective or less costly than our products and, therefore,
present a serious competitive threat to our product offerings.
The widespread acceptance of therapies that are alternatives to ours may limit
market acceptance of our products even if commercialized. Chronic pain can also
be treated by oral medication, transdermal drug delivery systems, such as drug
patches, or with other implantable drug delivery devices. These treatments are
widely accepted in the medical community and have a long history of use. The
established use of these competitive products may limit the potential for our
products to receive widespread acceptance if commercialized.
26
We could be exposed to significant product liability claims which could be time
consuming and costly to defend, divert management attention and adversely impact
our ability to obtain and maintain insurance coverage
The testing, manufacture, marketing and sale of our products involve an
inherent risk that product liability claims will be asserted against us.
Although we are insured against such risks up to a $5 million annual aggregate
limit in connection with clinical trials and commercial sales of our products,
our present product liability insurance may be inadequate and may not fully
cover the costs of any claim or any ultimate damages we might be required to
pay. Product liability claims or other claims related to our products,
regardless of their outcome, could require us to spend significant time and
money in litigation or to pay significant damages. Any successful product
liability claim may prevent us from obtaining adequate product liability
insurance in the future on commercially desirable or reasonable terms. In
addition, product liability coverage may cease to be available in sufficient
amounts or at an acceptable cost. An inability to obtain sufficient insurance
coverage at an acceptable cost or otherwise to protect against potential product
liability claims could prevent or inhibit the commercialization of our
pharmaceutical systems. A product liability claim could also significantly harm
our reputation and delay market acceptance of our products.
Our business involves environmental risks and risks related to handling
regulated substances
In connection with our research and development activities and our manufacture
of materials and products, we are subject to federal, state and local laws,
rules, regulations and policies governing the use, generation, manufacture,
storage, air emission, effluent discharge, handling and disposal of certain
materials, biological specimens and wastes. Although we believe that we have
complied with the applicable laws, regulations and policies in all material
respects and have not been required to correct any material noncompliance, we
may be required to incur significant costs to comply with environmental and
health and safety regulations in the future. Our research and development
involves the use, generation and disposal of hazardous materials, including but
not limited to certain hazardous chemicals, solvents, agents and biohazardous
materials. The extent of our use, generation and disposal of such substances
has increased substantially since our acquisition of SBS, which, through its
subsidiary Birmingham Polymers, Inc., is engaged in the business of
manufacturing and selling biodegradable polymers. Although we believe that our
safety procedures for storing, handling and disposing of such materials comply
with the standards prescribed by state and federal regulations, we cannot
completely eliminate the risk of accidental contamination or injury from these
materials. We currently contract with third parties to dispose of these
substances generated by us, and we rely on these third parties to properly
dispose of these substances in compliance with applicable laws and regulations.
If these third parties do not properly dispose of these substance in compliance
with applicable laws and regulations, we may be subject to legal action by
governmental agencies or private parties for improper disposal of these
substances. The costs of defending such actions and the potential liability
resulting from such actions are often very large. In the event we are subject to
such legal action or we otherwise fail to comply with applicable laws and
regulations governing the use, generation and disposal of hazardous materials
and chemicals, we could be held liable for any damages that result, and any such
liability could exceed our resources.
Our stock price may fluctuate, and your investment in our stock could decline in
value
The average daily trading only volume of our common stock for the six months
ending June 30, 2001, was 125,256 shares. The limited trading volume of our
stock may contribute to its volatility, and an active trading market in our
stock might not develop or continue. The market price of our common stock may
fluctuate significantly in response to factors which are beyond our control. The
stock market in general has recently experienced extreme price and volume
fluctuations. In addition, the market prices of securities of technology and
pharmaceutical companies have also been extremely volatile, and have experienced
fluctuations that often have been unrelated or disproportionate to the operating
performance of these companies. These broad market
27
fluctuations could result in extreme fluctuations in the price of our common
stock, which could cause a decline in the value of your shares.
Future sales of our common stock may depress our stock price
Commencing on March 27, 2001, which was 180 days after the date of our initial
public offering, as many as 34,173,026 shares of our common stock became
available for sale in the public market, subject to applicable securities laws.
Additionally, in connection with our acquisition of SBS, we are obligated to use
our reasonable best efforts to prepare and file with the SEC a registration
statement on Form S-3 (or such successor or other appropriate form) under the
Securities Act with respect to the common stock issued to the former SBS
shareholders on or before November 30, 2001. The common stock issued in
connection with this acquisition shall become freely tradable in the public
market after the registration statement has been declared effective by the
Securities and Exchange Commission. Further information regarding the SBS
acquisition is included in the company's current report on Form 8-K filed with
the SEC on May 15, 2001. If substantial amounts of our common stock were to be
sold in the public market, the market price of our common stock could fall. In
addition, these sales could create the perception to the public of difficulties
or problems in our business. As a result, these sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate.
We have broad discretion over the use of our cash and investments, and their
investment may not yield a favorable return
Our management has broad discretion over how our cash and investments are used
and may invest in ways with which our stockholders may not agree and that do not
yield favorable returns.
Executive officers, directors and entities affiliated with them have
substantial control over us, which could delay or prevent a change in our
corporate control favored by our other stockholders
Our directors, executive officers and principal stockholders, together with
their affiliates have substantial control over us. The interests of these
stockholders may differ from the interests of other stockholders. As a result,
these stockholders, if acting together, would have the ability to exercise
control over all corporate actions requiring stockholder approval irrespective
of how our other stockholders may vote, including:
. the election of directors;
. the amendment of charter documents;
. the approval of certain mergers and other significant corporate
transactions, including a sale of substantially all of our assets; or
. the defeat of any non-negotiated takeover attempt that might otherwise
benefit the public stockholders.
Our certificate of incorporation, our bylaws, Delaware law and our stockholder
rights plan contain provisions that could discourage another company from
acquiring us
Provisions of Delaware law, our certificate of incorporation, bylaws and
stockholder rights plan may discourage, delay or prevent a merger or acquisition
that stockholders may consider favorable, including transactions in which you
might otherwise receive a premium for your shares. These provisions include:
. authorizing the issuance of "blank check" preferred stock without any need
for action by stockholders;
. providing for a dividend on our common stock, commonly referred to as a
"poison pill", which can be triggered after a person or group acquires
17.5% or more of common stock;
. providing for a classified board of directors with staggered terms;
. requiring supermajority stockholder voting to effect certain amendments to
our certificate of incorporation and by-laws;
28
. eliminating the ability of stockholders to call special meetings of
stockholders;
. prohibiting stockholder action by written consent; and
. establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
Investors may experience substantial dilution of their investment
In the past, we have issued options to acquire common stock at prices below
the initial public offering price. To the extent these outstanding options are
ultimately exercised, there will be dilution to investors.
In connection with our acquisition of SBS we issued 1,355,235 shares of common
stock, and agreed to issue up to 720,161 additional shares of common stock upon
the exercise of outstanding SBS options and warrants, in exchange for all of
SBS's outstanding equity interests, and assumed SBS's liabilities, including
$1.7 million in debt. At the time of the registration of these shares with the
Securities and Exchange Commission, which is expected to be in the fourth
quarter of 2001, we may be required to issue additional shares of common stock
to former SBS shareholders, as well as reserve additional shares for issuance
upon the exercise of outstanding SBS options and warrants, depending on our
stock price at that time. Up to 4,150,854 additional shares may be issued and
reserved for issuance upon the exercise of outstanding SBS options and warrants.
The maximum total number of shares issued and shares reserved for issuance upon
the exercise of outstanding SBS options and warrants in connection with our
acquisition of SBS will be determined by dividing $24.9 million by the greater
of $4.00 or the average closing sale price of the Company's stock during a
specified time period proceeding the registration of shares, subject to certain
conditions. If we are obligated to issue additional shares to the former SBS
shareholders and reserve additional shares for issuance upon the exercise of
outstanding SBS options and warrants, there will be additional dilution to our
investors. Further information regarding the SBS acquisition is included in the
company's current Report on Form 8-K filed with the SEC on May 15, 2001.
29
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Sensitivity
Our exposure to market risk for changes in interest rates relates primarily to
our investment portfolio and long-term debt obligations. Our primary investment
objective is to preserve principal while at the same time maximizing yields
without significantly increasing risk. Our portfolio includes money markets
funds, commercial paper, medium-term notes, corporate notes, government
securities, auction rate securities, corporate bonds and market auction
preferreds. The diversity of our portfolio helps us to achieve our investment
objective. As of June 30, 2001, approximately 73% of our investment portfolio is
composed of investments with original maturities of one year or less and
approximately 38% of our investment portfolio matures less than 90 days from the
date of purchase.
In October 1998, the Company financed the purchase of certain equipment
through a bank loan with a variable interest rate. The average interest rates
were 8.26% and 10.40% during 3 months ended June 30, 2001 and June 30, 2000,
respectively. At June 30, 2001 and June 30, 2000, the Company had loans
outstanding in the amounts of $122,000 and $256,000, respectively.
The following table presents the amounts of our cash equivalents and
investments that may be subject to interest rate risk and the average interest
rates as of June 30, 2001 by year of maturity (dollars in thousands):
2001 2002 2003 Total
-------- -------- -------- ---------
Cash equivalents:
Fixed rate............................ $21,873 -- -- $21,873
Average fixed rate.................... 3.86% -- -- 3.86%
Variable rate......................... $14,546 -- -- $14,546
Average variable rate................. 4.82% -- -- 4.82%
Short-term investments:
Fixed rate............................ $14,063 $15,229 -- $29,292
Average fixed rate.................... 5.77% 5.76% -- 5.77%
Variable rate......................... $ 3,800 -- -- $ 3,800
Average variable rate................. 3.90% -- -- 3.90%
Long-term investments:
Fixed rate............................ $ -- $13,322 $12,154 $25,476
Average fixed rate.................... -- 5.74% 4.80% 5.20%
------- ------- ------- -------
Total investment securities.............. $54,282 $28,551 $12,154 $94,987
------- ------- ------- -------
Average rate............................. 4.87% 5.76% 4.80% 5.14%
------- ------- ------- -------
30
The following table presents the amounts of our cash equivalents and
investments that may be subject to interest rate risk and the average interest
rates as of December 31, 2000 by year of maturity (dollars in thousands):
2001 2002 Total
-------- -------- ---------
Cash equivalents:
Fixed rate................................... $ 21,610 -- $ 21,610
Average fixed rate........................... 6.58% -- 6.58%
Variable rate................................ $ 25,280 -- $ 25,280
Average variable rate........................ 6.82% -- 6.82%
Short-term investments:
Fixed rate................................... $ 52,830 -- $ 52,830
Average fixed rate........................... 6.58% -- 6.58%
Variable rate................................ $ 4,900 -- $ 4,900
Average variable rate........................ 6.75% -- 6.75%
Long-term investments:
Fixed rate................................... $ -- $1,652 $ 1,652
Average fixed rate........................... -- 7.26% 7.26%
-------- ------ --------
Total investment securities..................... $104,620 $1,652 $106,272
-------- ------ --------
Average rate.................................... 6.63% 7.26% 6.65%
-------- ------ --------
PART II--OTHER INFORMATION
ITEM 1. Legal Proceedings
None
ITEM 2. Changes in Securities and Use of Proceeds
On September 27, 2000, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-35316) was declared effective by the
Securities and Exchange Commission, pursuant to which 7,000,000 shares of our
common stock were offered and sold for our account at a price of $12.00 per
share, generating gross offering proceeds of $84 million. The managing
underwriters were Morgan Stanley Dean Witter, Chase H&Q, and CIBC World Markets.
Our initial public offering closed on October 3, 2000. After deducting
underwriters' discounts and commissions and other offering expenses, the net
proceeds were approximately $76.2 million. On November 1, 2000, the underwriters
exercised in part their over-allotment option in part and purchased an
additional 700,000 shares at the initial public offering price of $12.00 per
share. The net proceeds of the over-allotment option, after deducting
underwriters' discounts and other offering expenses, were approximately $7.8
million. After giving effect to the sale of the over-allotment shares, a total
of 7,700,000 shares of common stock were offered and sold in the initial public
offering with total net proceeds of $84.0 million. None of the payments for
underwriting discounts and commissions and other transaction expenses
represented direct or indirect payments to directors, officers or other
affiliates of the Company. As of June 30, 2001, we used $18.7 million for
development expenses related to our products, including the allocation of
certain general and administrative costs, $5.3 million for the construction and
validation our new manufacturing facility, and, under the terms of our agreement
to purchase the ALZET product line from ALZA Corporation, we were required to
make our final payment for inventory following the completion of our initial
public offering, in the amount of $805,000. We invested the remainder of the net
proceeds in investment grade securities.
We intend to use the net proceeds of the initial public offering as follows:
. approximately $40-$60 million to fund development expenses related to our
products, including clinical trial expenses;
. approximately an additional $2.0-$4.0 million to fund the development,
construction and validation of our manufacturing facility;
31
. to fund the commercialization of our products, once approved; and
. for working capital and general corporate purposes.
We may use a portion of the net proceeds to fund, acquire or invest in
complementary businesses or technologies. The amount of cash that we actually
expend for any of the described purposes will vary significantly based on a
number of factors, including the progress of our research and development and
clinical trials, the establishment of collaborative relationships, the cost and
pace of establishing and expanding our manufacturing capabilities, the
development of sales and marketing activities if undertaken by us and competing
technological and market developments. Our management will have significant
discretion in applying the net proceeds of this offering.
On May 11, 2001, in connection with an Exclusive Trademark License and
Assignment Agreement with Daniel Carr dated May 11, 2001, we issued to Daniel
Carr a warrant to purchase 770 shares of our common stock at an exercise price
of $8.50 per share, which represented the closing sale price of our common stock
on May 11, 2001. This issuance was deemed exempt from registration under the
Securities Act in reliance on Section 4(2) of the Securities Act as transactions
by an issuer not involving a public offering.
ITEM 3. Defaults Upon Senior Securities
None
ITEM 4. Submission of Matters to a Vote of Security Holders
On June 27, 2001, the Annual Meeting of Stockholders of DURECT Corporation.
was held in Cupertino, California.
An election of Class I directors was held with the following individuals being
elected to our Board of Directors to serve until our annual meeting of
stockholders for the year ending December 31, 2004:
Felix Theeuwes (28,784,504 votes for, 1,193,941 votes withheld)
Albert L. Zesiger (29,806,839 votes for, 171,606 votes withheld)
Other matters voted upon and approved at the meeting and the number of
affirmations, negative votes cast and abstentions with respect to each such
matter were as follows:
. To ratify the appointment of Ernst & Young LLP as our independent auditors
for the fiscal year ending December 31, 2001 (29,954,210 votes in favor, 8,375
votes opposed, 15,860 votes abstaining).
ITEM 5. Other Information
None
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on From 8-K:
Durect filed a Report on Form 8-K and Form 8-K/A on May 15, 2001 and June
29, 2001, respectively, regarding the completion of its acquisition of
Southern BioSystems, Inc.
32
SIGNATURES
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.
DURECT CORPORATION
By: /s/ Thomas A. Schreck
---------------------------------------
Thomas A. Schreck
Chief Financial Officer
(Principal Financial Officer)
Date: August 14, 2001
By: /s/ Jon W. Kawaja
--------------------------------------
Jon W. Kawaja
Sr. Director of Finance
Date: August 14, 2001
33