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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
COMMISSION FILE NUMBER: 0-27406
CONNETICS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-3173928
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3400 WEST BAYSHORE ROAD, PALO ALTO, CALIFORNIA 94303
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (650) 843-2800
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE PER SHARE
PREFERRED SHARE PURCHASE RIGHTS
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $149,283,077 as of March 23, 2001, based upon
the closing sale price on the Nasdaq National Market reported for that date. The
calculation excludes shares of common stock held by each officer and director
and by each person who owns 5% or more of the outstanding common stock in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
There were 29,761,379 shares of Registrant's Common Stock issued and
outstanding as of March 23, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report, to the extent that it
is not set forth in this Report, is incorporated by reference to the
registrant's definitive proxy statement for the Annual Meeting of Stockholders
to be held on May 17, 2001.
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PART I
ITEM 1. BUSINESS
Special Note: Our disclosure and analysis in this Report, in other reports
that we file with the Securities and Exchange Commission, in our press releases
and in public statements of our officers contain forward-looking statements
within the meaning of Section 27A of the Securities Act, and Section 21E of the
Securities Exchange Act. Forward-looking statements give our current
expectations or forecasts of future events. You can identify these statements by
the fact that they do not relate strictly to historical or current events. They
use words such as "anticipate," "estimate," "expect," "will," "may," "intend,"
"plan," "believe" and similar expressions in connection with discussion of
future operating or financial performance. These include statements relating to
future actions, prospective products or product approvals, future performance or
results of current and anticipated products, sales efforts, expenses, the
outcome of contingencies such as legal proceedings and financial results.
Forward-looking statements may turn out to be wrong. They can be affected
by inaccurate assumptions or by known or unknown risks and uncertainties. Many
factors mentioned in this Report -- for example, governmental regulation and
competition in our industry -- will be important in determining future results.
No forward-looking statement can be guaranteed, and actual results may vary
materially from those anticipated in any forward-looking statement.
Although we believe that our plans, intentions and expectations reflected
in these forward-looking statements are reasonable, we can give no assurance
that these plans, intentions or expectations will be achieved. Forward-looking
statements in this Report include, but are not limited to, those relating to the
commercialization of our currently marketed products, the progress of our
product development programs, developments with respect to clinical trials and
the regulatory approval process, developments related to acquisitions and
clinical development of drug candidates, and developments relating to the growth
of our sales and marketing capabilities. Actual results, performance or
achievements could differ materially from those contemplated, expressed or
implied by the forward-looking statements contained in this Report. Important
factors that could cause actual results to differ materially from our
forward-looking statements are set forth in this Report. These factors are not
intended to represent a complete list of the general or specific factors that
may affect us. It should be recognized that other factors, including general
economic factors and business strategies, and other factors not currently known
to us, may be significant, presently or in the future, and the factors set forth
in this Report may affect us to a greater extent than indicated. All
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by the cautionary statements set forth
in this Report. Except as required by law, we do not undertake any obligation to
update any forward-looking statement, whether as a result of new information,
future events or otherwise.
THE COMPANY
References in this prospectus to "Connetics," "the Company," "we," "our"
and "us" refer to Connetics Corporation, a Delaware corporation. Our principal
executive offices are located at 3400 West Bayshore Road, Palo Alto, CA 94303.
Our telephone number is (650) 843-2800. Connetics(R), Luxiq(R), Ridaura(R), and
the interlocking globe design are registered trademarks of Connetics. We also
own the trademark OLUX(TM). All other trademarks or service marks appearing in
this Report are the property of their respective companies. We disclaim any
proprietary interest in the marks and names of others.
OVERVIEW
We currently market three pharmaceutical products. In May 2000, the United
States Food and Drug Administration, or FDA, granted us clearance to market
OLUX(TM) Foam (clobetasol propionate) 0.05% for the treatment of moderate to
severe scalp dermatoses. We launched OLUX on November 6, 2000. Our commercial
business is focused on the dermatology marketplace, which is characterized by a
large patient population that is served by relatively small, and therefore more
accessible, groups of treating physicians.
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We are offering two dermatology products with clinically proven therapeutic
advantages and are providing quality customer service to physicians through our
experienced sales and marketing staff. We also sell Ridaura, a product to treat
rheumatoid arthritis.
As of the date of this report, we are selling three products targeted at
specialty medical markets, and developing other products.
PRODUCT DISEASE STATUS MARKETING RIGHTS(1)
LUXIQ(R) mild to moderate Marketed North America
scalp dermatoses
OLUX(TM) moderate to severe Marketed Worldwide
scalp dermatoses
KETOCONAZOLE FOAM fungal infections Clinical trials Worldwide
scheduled to begin in
second half of 2001
ANTI-ACNE FOAM acne Clinical trials North America
scheduled to begin in
2001
MINOXIDIL FOAM hair loss Clinical trials North America
scheduled to begin in
2002
LIQUIPATCH various diseases of formulation North America
the skin development
OTHER FOAM various diseases of formulation
FORMULATIONS the skin development North America
RIDAURA rheumatoid arthritis Marketed United States
(1) On March 21, 2001, we entered into an agreement to acquire Soltec Research
Pty Ltd., the licensor of our foam and liquipatch formulations. In the
original license agreements, Soltec reserved rights to certain specific
Liquipatch formulations for North America. Following completion of the
acquisition, we will own worldwide rights to all of the formulations
listed, subject to licenses already granted to certain third parties for
various territories.
In addition, during 2000, we received revenues from the sale of
Actimmune(R) pursuant to our relationship with InterMune Pharmaceuticals, Inc.
In December 1995, we entered into a license agreement with Genentech to acquire
exclusive U.S. development and marketing rights to interferon gamma for
dermatological indications. Subsequent amendments to the original license
agreement expanded the fields of use for which the license applies, and added
Japan and Canada to the licensed territory. We established a subsidiary,
InterMune, in 1998 to develop Actimmune for serious pulmonary and infectious
diseases and congenital disorders. In April 1999, InterMune became an
independent company, and in March 2000, InterMune became a public company. As of
December 31, 2000, we held 149,000 shares of common stock of InterMune.
Effective April 1, 2000 we assigned our remaining revenue rights and obligations
under the license with Genentech and the corresponding supply agreement to
InterMune. We retained the option to purchase the product rights for potential
dermatological applications of Actimmune. We will receive an additional cash
payment in March 2001, and royalties on Actimmune sales after December 31, 2001.
Our dermatology strategy is to maximize product sales by leveraging novel
delivery technologies, accelerating the processes of getting products to market,
and targeting specific market opportunities. Our commercial strategy permits us
to effectively reach the majority of the treating physicians. Our primary
commercial focus is on dermatology. Approximately 6,000 of the 8,500 U.S.
dermatologists account for 92% of the prescriptions written by dermatologists.
Our two marketed foam products, Luxiq(R) (betamethasone valerate) Foam,
0.12%, and OLUX(TM) (clobetasol propionate) Foam, 0.05%, compete in the topical
steroids market. According to IMS Health, in 2000, the low potency steroid
market represented $121 million in retail sales, the mid-potency market in
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which Luxiq competes represented $317 million in retail sales, and the high- and
super-high potency steroid market in which OLUX is positioned represented $457
million in retail sales.
Dermatological diseases often persist for an extended period of time and
are treated with clinically proven drugs that are currently delivered in a
variety of formulations, including solutions, creams, gels and ointments. We
believe that these existing delivery systems often inadequately address a
patient's needs for efficacy and cosmetic elegance, and that the failure to
address those needs may decrease patient compliance. We believe that the
proprietary foam delivery system unique to Luxiq and OLUX has significant
advantages over conventional therapies for scalp dermatoses. The advantages of
foam include higher absorption and more localized delivery of the active agent.
The foam formulation liquefies when applied to the skin, and enables rapid
penetration of the active dermatologic agent. When the foam is applied, it dries
quickly, is not greasy, and does not stain or have any odor. We believe that the
combination of the increased efficacy and the cosmetic elegance of the foam may
actually improve patient compliance and satisfaction.
LUXIQ FOAM
Luxiq is a foam formulation of betamethasone valerate, a mid-potency
topical steroid which is prescribed for the treatment of mild to moderate
steroid responsive scalp dermatoses such as psoriasis, eczema and seborrheic
dermatitis. We licensed the North American rights from Soltec Research Pty Ltd.,
a subsidiary of F.H. Faulding & Co., Ltd., to develop and commercialize Luxiq.
In our pivotal trial, patients treated with Luxiq experienced a statistically
significant improvement over patients treated with placebo or a currently
approved betamethasone valerate lotion. In March 1999, we received FDA clearance
for Luxiq and in April 1999 we initiated commercial sales in the United States.
OLUX FOAM
OLUX is a foam formulation of clobetasol propionate, one of the most widely
prescribed super high-potency topical steroids. In May 2000, we received FDA
clearance to market OLUX. We began selling OLUX in November 2000 for the
treatment of moderate to severe steroid-responsive dermatoses of the scalp. We
have licensed worldwide rights from Soltec to develop and commercialize OLUX. In
our pivotal clinical trial of approximately 190 scalp psoriasis patients,
comparing OLUX to a currently approved clobetasol solution and placebo during a
two week treatment regimen, OLUX showed a 74% improvement in the global response
to treatment as judged by the investigators as opposed to 63% for clobetasol
solution and 8% for placebo.
DERMATOLOGY PRODUCT PIPELINE
We have the rights to a variety of pharmaceutical agents in various stages
of development in multiple novel delivery technologies. Our dermatology strategy
involves the rapid evaluation and formulation of new therapeutics by using
previously approved active ingredients reformulated in our proprietary delivery
system. This product development strategy allows us to conduct limited
preclinical safety trials, and to move rapidly into safety and efficacy testing
in humans with products that offer significant improvements over existing
products.
We are party to four agreements with Soltec, which give us exclusive rights
to specified applications of a broad range of unique topical delivery
technologies, including several distinctive aerosol foams. Our relationship with
Soltec led to our development of Luxiq, which we launched in April 1999, and to
the development of OLUX. Each of those formulations is licensed to us by a
separate agreement with Soltec. In May 2000, the FDA approved our new drug
application, or NDA, for OLUX for the treatment of moderate to severe scalp
dermatoses. We anticipate conducting simultaneous development on several
products over the next several years.
In December 1999, we entered into a comprehensive licensing agreement with
Soltec for exclusive rights to certain applications of a broad range of unique
topical delivery technologies, including aerosol foam formulations and Soltec's
patented Liquipatch technology. Under the agreement, we paid Soltec
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$1 million in cash and stock, and agreed to make future milestone, development
and royalty payments. We have obligations to develop new products incorporating
the licensed technology on timelines agreed to by the parties, and we will pay
royalties on our net sales on those products if and when they are approved for
sale in the licensed territory. We also agreed to pay Soltec an annual fee in
exchange for continuing research and the rights to future product formulations
that Soltec may develop.
Similar to our foam delivery system for Luxiq and OLUX, the new aerosol
foams, including water-, ethanol- and petrolatum-based foams, may offer improved
efficacy over traditional formulations due to greater absorption of the active
ingredient to the skin. In addition to the potential for improved efficacy, the
foam formulations represent a cosmetically elegant alternative to existing
dermatologic treatments. Liquipatch is a gel-matrix delivery system that applies
to the skin like a normal gel and dries to form a very thin, invisible,
water-resistant film. This film enables a controlled release of the active agent
to provide longer relief, with the potential of being less irritating to the
skin than other delivery systems. We anticipate developing one or more new
products in the aerosol foam or Liquipatch formulations, by incorporating
leading dermatologic agents, in such a way as to deliver formulations that are
tailored to treat specific diseases or different areas of the body. We currently
expect to seek partners for over-the-counter market opportunities worldwide and
for development and commercialization of prescription products outside the
United States.
On March 21, 2001, we entered into an agreement with F.H. Faulding & Co.
Limited to acquire Soltec Research Pty Ltd, a division of Faulding Healthcare.
Under the agreement, which is subject to customary closing conditions and is
expected to close in April 2001, Connetics will acquire all of Soltec's issued
capital for Australian $32 million or approximately U.S. $16.9 million. Faulding
will retain current development projects relating to Faulding's injectable
technologies and injectables product pipeline.
All products and technologies under development require significant
commitments of personnel and financial resources. Several products require
extensive clinical evaluation and clearance by the FDA and comparable agencies
in other countries before we can sell them commercially. If we fail to meet our
obligations under our agreements with Soltec, our rights under such agreements
might be terminated. In addition, we regularly reevaluate our product
development efforts. On the basis of these reevaluations, we have in the past,
and may in the future, abandon development efforts for particular products. We
cannot assure you that any product or technology under development will result
in the successful introduction of any new product.
RIDAURA
Ridaura is an oral formulation of a gold salt for the treatment of
rheumatoid arthritis, a chronic autoimmune disease that results in painful
inflammation and erosion of the joints and loss of mobility. Over two million
individuals in the United States suffer from this disease. Ridaura is currently
indicated for adults with active rheumatoid arthritis who are not responsive to,
or are intolerant of, treatment with non-steroidal anti-inflammatory drugs.
Ridaura competes on the basis of clinical evidence that shows the drug slows the
progression of damage to joint tissue. Our 2000 sales of Ridaura were
approximately $6.0 million, compared to $5.7 million in 1999. We do not actively
promote Ridaura.
ACTIMMUNE
In 1998, we licensed from Genentech exclusive rights to Actimmune,
interferon gamma, for the United States and Japan. Interferon gamma is one of a
family of proteins involved in the regulation of the immune system and has been
shown to reduce the frequency and severity of certain infections. We formed a
subsidiary, InterMune Pharmaceuticals, Inc., to develop Actimmune for various
infections and fungal diseases. In April 1999, InterMune became an independent
company, and in March 2000, InterMune became a public company. Effective April
1, 2000, we assigned to InterMune our remaining rights and obligations under the
license with Genentech and the corresponding supply agreement. In exchange,
InterMune paid us approximately $5.2 million; an additional $0.9 million is
payable to us at the end of March 2001. InterMune will pay us a royalty on
Actimmune sales beginning January 1, 2002. In addition,
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we have retained the product rights for potential dermatological applications.
We recorded sales of Actimmune of approximately $1.8 million during the first
quarter of 2000; commencing in the second quarter, InterMune acquired our
remaining rights to sell Actimmune.
OUR RELAXIN DEVELOPMENT PROGRAM
OVERVIEW
In addition to our commercial business, we are developing a biotechnology
product that has the potential to treat multiple diseases. Our product is a
recombinant form of a natural human hormone called relaxin. Relaxin reduces the
hardening, or fibrosis, of skin and organ tissue, dilates existing blood vessels
and stimulates new blood vessel growth. We manufacture a cloned version of
relaxin. Relaxin circulates in the blood and has a broad spectrum of biological
activities. It plays a role during pregnancy in pelvic remodeling and increasing
blood supply to the fetus. Relaxin may also enhance the kidneys' ability to
remove wastes from the woman's body. In a non-pregnant state, administering
relaxin stimulates blood flow to oxygen-deprived tissue, and has been shown in
pre-clinical tests to increase blood volume and cardiac output.
On October 8, 2000, we announced that in our pivotal trial for scleroderma
there was no statistically significant difference between the response to
relaxin and the response to placebo with respect to the measurement of skin
score. Skin score was defined as the "primary endpoint" of our scleroderma
trial. Based on the result of the pivotal trial, we have discontinued the
relaxin program for scleroderma. There were, however, statistically significant
responses with respect to secondary parameters measured in that trial.
Our strategy has been to retain U.S. rights for all potential indications
for the drug. We maintain North American rights for relaxin and have entered
into collaborative relationships for this program for markets outside of the
United States. We have licensed rights to relaxin development and
commercialization to Paladin Labs, Inc. for Canada, and to F.H. Faulding & Co.
in Australia. In October 2000, our collaborative partners in Japan (Suntory
Ltd.) and Europe (Celltech Medeva PLC) both exercised their rights to terminate
the relationships according to the contracts. The rights to Japan have reverted
to us, and the European rights will revert to us on April 13, 2001, and as of
December 31, 2000 we had no further obligations under either contract.
SCLERODERMA
The first indication for which we developed relaxin was scleroderma, a
serious disease for which there is no known cure involving the excessive
formation of connective tissue. Scleroderma is characterized by thickening and
hardening of the skin and, in severe cases, the internal organs, including the
heart, lungs, kidneys and the organs of the gastrointestinal tract.
We completed enrollment of a 239-patient Phase II/III pivotal clinical
trial of relaxin for the treatment of diffuse scleroderma on December 12, 1999.
As discussed above, because the clinical trial did not meet its primary
endpoint, we withdrew plans to submit a biologics license application to the FDA
requesting approval to market relaxin for the treatment of scleroderma.
OTHER POTENTIAL INDICATIONS
Infertility, peripheral vascular disease, cardiovascular disease, and
kidney disease represent opportunities for relaxin's biologic properties of
enhancing blood flow. There are two ways to increase blood flow to a specific
region. The first is by increasing the diameter of the blood vessel
(vasodilation), and the second is by generating the growth of new blood vessels
(angiogenesis).
Peripheral Arterial Disease. Clinical trials using porcine relaxin for the
treatment of blocked or restricted blood vessels in the extremities, known in
the medical field as peripheral arterial disease, were published prior to the
era of recombinant DNA technology. Those studies reported improved blood flow
and healing of oxygen-deprived ulcers. We have initiated a clinical trial to
determine efficacy of
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recombinant human relaxin for the treatment of peripheral arterial disease.
Peripheral arterial disease, which is characterized by inadequate blood flow to
the extremities, often leads to severe leg pain and debilitating ulcers due to
chronic oxygen deprivation of the lower extremities. In its more serious
manifestations, patients with peripheral arterial disease can develop gangrene,
which may result in amputation of the affected limb. Although there are drugs
currently available for pain due to constricted blood vessels, surgery is the
only option available for more severe incidences.
The promise of relaxin to treat peripheral arterial disease is based on its
ability to increase blood flow to oxygen-deprived tissue through its
vasodilatory and angiogenic activities. Relaxin's angiogenic property relates to
its ability to stimulate the growth of new blood vessels at the site of
oxygen-deprived tissue through a several step process, enhancing the blood flow
to the site of oxygen-deprived tissue. At this site, macrophages, which are
cells that help fight infection and injury, become activated. Relaxin is known
to bind to activated macrophages, which in turn stimulates the production of
vascular endothelial growth factor, or VEGF, and basic fibroblast growth factor,
or bFGF. These two growth factors play a significant role in the growth of new
blood vessels. Because relaxin stimulates the production of VEGF and bFGF only
at the site where the tissue is oxygen-deprived, and not throughout the whole
body, we believe that relaxin may have more potential to treat vascular diseases
than administering VEGF or bFGF directly. Relaxin's vasodilatory property
relates to its ability to stimulate the secretion of nitric oxide into the blood
stream at selective targets without side effects. Nitric oxide is an agent known
to relax and expand blood vessels, which enables the vessels to carry more
blood. There is evidence that the synthesis of nitric oxide is impaired in
patients with peripheral arterial disease, and restoration of nitric oxide
levels in the blood vessels by administering a known nitric oxide stimulator
reduced the severe pain experienced by peripheral arterial disease patients due
to constricted blood vessels.
Infertility. Industry sources estimate that one out of six American
couples is infertile, with 60% of the cases being due to disorders in the woman.
One half of these problems in women are caused by pelvic factors, including how
receptive the endometrium is to implantation of an embryo. Major causes of
infertility include the failure of the embryo to implant in the uterus, and
failure of the embryo and fetus to receive adequate blood flow to develop and
grow.
The promise of relaxin to treat infertility is based on its ability to
stimulate new blood vessel growth in the endometrium. We believe this mechanism
of action is due to relaxin's ability to induce VEGF and bFGF, which are potent
angiogenic agents, locally in the cells of the endometrium. Endometrial blood
flow is believed to be important in determining how receptive the endometrial
lining is to implantation of an embryo. We believe that, by enhancing
endometrial blood flow, relaxin treatment may increase the likelihood that an
embryo will successfully implant in the endometrium, and therefore would
increase pregnancy success rates.
In December 1999, we initiated a clinical trial with relaxin to determine
the safety and efficacy for the treatment of infertility in women who do not
intend to become pregnant. The trial is designed to test relaxin's ability to
cause both increased blood flow to and thickening in the endometrium, which may
enhance implantation of the embryo. We are conducting reproductive toxicology
tests in animals in parallel with the trial in anticipation of evaluating
whether to begin U.S. clinical trials to study relaxin in women trying to get
pregnant.
Kidney and Heart Function. We are also exploring the possibility of using
relaxin to improve kidney function or to treat cardiac diseases, specifically
the scarring of the heart that occurs in heart attacks, atherosclerosis and
hypertension, as well as vessel blockage following angioplasty. During the first
quarter of 2001, we are convening a number of expert panels comprised of medical
doctors who specialize in renal and cardiac function and infertility. We
anticipate using the information developed in these panel discussions to
determine the future direction of clinical research with relaxin.
SALES AND MARKETING
We have an experienced, highly productive sales and marketing organization.
Our sales representatives focus on cultivating relationships of trust and
confidence with the physicians they call upon. We use a
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variety of advertising, promotional material, specialty publications,
participation in educational conferences and product internet sites to achieve
our marketing objectives. In 2000, we supplemented our sales staff with contract
sales representatives to increase the frequency and reach of our sales calls or
to assist with the launch of products. As of March 1, 2001, we had 68 people in
our sales and marketing organization, including 41 sales representatives and
others working outside of our principal offices, and 20 "full time equivalents"
working for us through our contract sales force. In March 2001, we announced our
plans to hire an additional 27 sales representatives, and the field sales team
will cover more dermatologists with increased frequency. We will discontinue our
use of the contract sales force in May 2001.
Our marketing efforts are focused on assessing and meeting the needs of
dermatologists. In 2000, our sales efforts were focused on routinely calling on
the approximately 4,500 dermatologists who are responsible for 85% of all
prescriptions written by dermatologists in the United States. We have created an
incentive program that rewards our sales force for the number of topical steroid
prescriptions actually written by the dermatologists they call on. We focus on
cultivating relationships of trust and confidence with the dermatologists
themselves. We also use a variety of marketing techniques to promote our
products, including journal advertising, promotional materials, rebate coupons,
and product guarantees.
In addition to traditional marketing and field sales approaches, we use
internet marketing to convey basic information about our products and our
company. Our corporate website at http://www.connetics.com includes fundamental
information about the company as well as descriptions of ongoing research,
development and clinical work. Our product websites, at http://www.luxiq.com and
http://www.olux.com, provide information about the products and their approved
indications, as well as copies of the full prescribing information, the patient
information booklet, and rebate coupons.
WAREHOUSING AND DISTRIBUTION
Currently, all of our product distribution activities are handled by CORD
Logistics, Inc., an independent national warehousing corporation. CORD stores
and distributes our products from a regional warehouse in Tennessee. Upon the
receipt of a purchase order through electronic data input, phone, mail or
facsimile, the order is processed into our inventory systems. Upon shipment to
the customer placing the order, usually within 24 hours, the warehouse sends
back to us the necessary information to automatically process the invoice in a
timely manner. Any delay or interruption in the process could have a material
effect on our business.
CUSTOMERS
Our customers include the nation's leading wholesale pharmaceutical
distributors, such as McKesson HBOC, Inc., Cardinal Health, Inc., Bergen
Brunswig Corporation, Bindley Western Industries, Inc., and other major drug
chains. During 2000, McKesson, Cardinal, Bergen Brunswig and Bindley accounted
for 27%, 32%, 15% and 11%, respectively, of our gross product revenues. The
distribution network for pharmaceutical products is subject to increasing
consolidation. As a result, a few large wholesale distributors control a
significant share of the market. In addition, the number of independent drug
stores and small chains has decreased as retail consolidation has occurred.
Further consolidation among, or any financial difficulties of, distributors or
retailers could cause a reduction in the inventory levels of distributors and
retailers, or otherwise result in reductions in purchases of our products, any
of which could have a material adverse impact on our business. If we lose any of
these customer accounts, or our relationship with them were to deteriorate, our
business could also be materially and adversely affected.
RELAXIN ALLIANCES
We have entered into numerous strategic development and commercialization
relationships with a primary goal of gaining access to additional product and
market opportunities and to share the risk and financial cost of developing
relaxin.
Medeva PLC. In January 1999, we entered into a collaboration and exclusive
license agreement with Medeva PLC (now Celltech Group Plc) for the development
and commercialization of relaxin in Europe.
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In October 2000, Medeva notified us that they wished to terminate the agreement.
To date, under the terms of the agreement, Medeva has paid us $20.0 million in
development, milestone and equity payments for the development of relaxin. We
are in the process of winding down the relationship.
Suntory Pharmaceuticals. In April 1998, we entered into a collaboration
and exclusive license agreement with Suntory for the development,
commercialization and supply of relaxin for scleroderma in Japan. In October
2000, Suntory notified us that they were terminating the agreement. To date,
Suntory has paid us $2.5 million in license and development payments.
Paladin Labs, Inc. In July 1999, we entered into a collaboration and
exclusive license agreement with Paladin for the development and
commercialization of relaxin in Canada. Under the terms of the agreement, we may
receive additional milestone payments for the approval of additional indications
for relaxin in Canada. Paladin is responsible for all development and
commercialization activities in Canada, and will pay royalties on all sales of
relaxin in Canada.
F.H. Faulding & Co., Ltd. In April 2000, we entered into a collaboration
and exclusive license agreement with Faulding for the development and
commercialization of relaxin in Australia. Under the terms of the agreement,
Faulding paid $510,000 for the initial license of relaxin for the treatment of
scleroderma. Although we have discontinued our development efforts for relaxin
for scleroderma, Faulding has indicated that it will continue the collaboration
for other indications. We may receive additional milestone payments for the
approval of additional indications for relaxin in Australia. Faulding is
responsible for all development and commercialization activities in Australia,
and will pay royalties on all sales of relaxin in Australia.
Genentech. In September 1993, we entered into an agreement with Genentech,
which was subsequently amended in July 1994 and April 1996. The agreement, as
amended, grants to us exclusive rights, for indications other than reproductive
indications, to make, have made, use, import and sell certain products derived
from recombinant human relaxin. Many of our relaxin patent rights are owned by
The Florey Institute, and we license them through the agreements with Genentech.
Genentech retains co-exclusive rights for reproductive indications. The
agreement also includes technology transfer, supply, and intellectual property
provisions, including a provision requiring us to meet milestones. If we fail to
achieve designated milestones, Genentech may terminate the license. Upon
termination, we could be required to license our relaxin technology to
Genentech, on a non-exclusive basis.
PATENTS AND PROPRIETARY RIGHTS
Our success will depend in part on our ability and our licensors' ability
to obtain and retain patent protection for our products and processes, to
preserve our trade secrets, and to operate without infringing the proprietary
rights of third parties.
We own or are exclusively licensed under pending applications and/or issued
patents worldwide relating to recombinant human relaxin, Luxiq and OLUX, as well
as other technology in the earlier stages of research.
In 2000, a U.S. patent was issued that covers the delivery technology that
is the basis for OLUX and Luxiq. U.S. Patent 6,126,920 is licensed exclusively
to us pursuant to our license agreement with Soltec and covers methods of
treating various skin diseases, and in particular, scalp psoriasis, using a foam
pharmaceutical composition comprising a corticosteroid active substance, a
propellant and a buffering agent. If we finalize our proposed acquisition of
Soltec, we will own a number of other patents and patent applications relating
to the dermatology field, as well as other technology developed by Soltec.
We license many of our relaxin patent rights from The Florey Institute
through a sublicense from Genentech. We provide annual research funding to the
Florey Institute for up to five years or until the date of the first sale of a
relaxin product. We have also agreed to pay the Florey Institute a portion of
revenues we receive from corporate collaborators, and relaxin royalties based on
commercial sales in addition to those royalties payable to Genentech.
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Our relaxin patent portfolio includes pending applications and issued
patents in the United States and various international equivalents. Our relaxin
patent portfolio includes certain claims within the following categories:
- compositions of matter,
- pharmaceutical compositions,
- methods of manufacture, and
- methods of treatment.
The issued patents in our relaxin patent portfolio will expire at various
times between 2002 and 2015. Recently, new biological activities of relaxin have
been elucidated, and we are pursuing methods of treatment patents with our
academic collaborators. The U.S. Patent and Trademark Office does not have a
consistent policy regarding the breadth of claims allowed in biotechnology
patents and the degree of future protection for our proprietary rights is
uncertain. In addition, the patent laws of foreign countries differ from those
of the U.S. and the claims allowed may differ from country to country.
Accordingly, the degree of protection, if any, afforded by foreign patents may
be different from that in the U.S.
One of the European patents licensed to us, which claims gene sequence
encoding human relaxin, was opposed by a third party challenging the ethics of
patents on a human gene sequence. Our licensor successfully defended the
original opposition, resulting in a decision in our favor, but the decision has
been appealed. We may not be successful on appeal. An adverse decision could
result in a requirement that our licensor amend the language of the patent in
ways that we cannot currently predict, and would require us to reassess the
strength of that patent after it was amended.
With respect to patent applications that we or our licensors have filed,
and patents issued to us or our licensors, we cannot assure you that:
- any of our or our licensors' patent applications will issue as patents,
- any such issued patents will provide competitive advantage to us, or
- our competitors will not successfully challenge or circumvent any such
issued patents.
We encourage ongoing scientific research on relaxin by making samples of
recombinant human relaxin available for medical or scientific research studies.
To preserve our rights to the recombinant protein and to the technology in
general, we require each recipient of relaxin samples to sign a materials
transfer agreement. If these agreements are breached, however, remedies may not
be available or adequate and our trade secrets may otherwise become known to
competitors. To the extent that our consultants, employees or other third
parties apply technological information independently developed by them or by
others to our proposed projects, third parties may own all or part of the
proprietary rights to such information, and disputes may arise as to the
ownership of these proprietary rights that may not be resolved in our favor.
Such third parties may attempt to patent their work and, if patents are issued,
they may not be available to license to us.
We rely on and expect to continue to rely on unpatented proprietary
know-how and continuing technological innovation in the development and
manufacture of many of our principal products. Our policy is to require all our
employees, consultants and advisors to enter into confidentiality agreements
with us. We cannot assure you, however, that these agreements will provide
meaningful protection for our trade secrets or proprietary know-how in the event
of any unauthorized use or disclosure of such information. In addition, there
can be no assurance that others will not obtain access to or independently
develop similar or equivalent trade secrets or know-how.
TRADEMARKS
We believe that trademark protection is an important part of establishing
product recognition. We own seven registered trademarks and trademark
applications, and several common law trademarks. United
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States federal registrations for trademarks remain in force for 10 years and may
be renewed every 10 years after issuance, provided the mark is still being used
in commerce. We cannot assure you that any such trademark or service mark
registrations will afford us adequate protection, or that we will have the
financial resources to enforce our rights under any such trademark or service
mark registrations. If we are unable to protect our trademarks or service marks
from infringement, any goodwill developed in such trademarks or service marks
could be impaired.
MANUFACTURING
We contract with independent sources to manufacture our products, which
enables us to focus on product and clinical development strengths, minimize
fixed costs and capital expenditures, and gain access to advanced manufacturing
process capabilities. The FDA requires that we contract only with manufacturers
that comply with current Good Manufacturing Practice (cGMP) regulations and
other applicable laws and regulations. Whether or not we have manufacturing
contracts with third-party manufacturers, we cannot assure you that we will be
able to obtain adequate supplies of our products in a timely fashion, on
acceptable terms, or at all.
CCL Pharmaceuticals manufactures Luxiq and OLUX for us. At the end of 2000,
CCL Pharmaceuticals was in the process of being sold to Miza Pharmaceuticals,
and as of the date of this report the transition has been smooth. Ridaura is
manufactured by GlaxoSmithKline. Our agreement with GlaxoSmithKline expires at
the end of 2001, and we are in discussions with other parties about continuing
manufacturing of Ridaura under new contracts beginning in 2002.
Boehringer Ingelheim manufactures relaxin for us for clinical uses under a
long-term contract. In July 2000, in anticipation of successful results in our
relaxin clinical trial for scleroderma, we submitted a purchase order to
Boehringer Ingelheim for product to be used for commercial supply. The purchase
order was for a price to be negotiated. In view of the failure of the clinical
trial, we have no immediate need for commercial grade relaxin, and we have
agreed with Boehringer Ingelheim that it is premature to set the price for
commercial supply. We are in discussions with Boehringer Ingelheim concerning
the practical effect of the cancellation of the purchase order.
COMPETITION
The pharmaceutical and biotechnology industries are characterized by
intense competition, rapid product development and substantial technological
change. Competition is intense among manufacturers of prescription
pharmaceuticals, such as for our dermatology products as well as other products
that we may develop and market in the future. Most of our competitors are large,
well-established pharmaceutical, chemical, cosmetic or health care companies
with considerably greater financial, marketing, sales and technical resources
than those available to us. Additionally, many of our present and potential
competitors have research and development capabilities that may allow such
competitors to develop new or improved products that may compete with our
product lines. Our products could be rendered obsolete or made uneconomical by
the development of new products to treat the conditions addressed by our
products, technological advances affecting the cost of production, or marketing
or pricing actions by one or more of our competitors. Each of our products
competes for a share of the existing market with numerous products that have
become standard treatments recommended or prescribed by dermatologists.
Luxiq and OLUX compete with a number of corticosteroid brands in the
super-, high- and mid-potency categories for the treatment of inflammatory skin
conditions. Competing brands include Halog(R) and Ultravate(R), marketed by
Bristol-Myers Squibb Company; Elocon(R) and Diprolene(R), marketed by
Schering-Plough Corporation; Cyclocort and Aristocort, marketed by Fujisawa
Healthcare, Inc.; Temovate(R) and Cutivate(R), marketed by GlaxoSmithKline; and
Psorcon(R), marketed by Dermik Laboratories, Inc. In addition, both Luxiq and
OLUX compete with generic (non-branded) pharmaceuticals, which claim to offer
equivalent therapeutic benefits at a lower cost. In some cases, insurers and
other third-party payors seek to encourage the use of generic products making
branded products less attractive, from a cost perspective, to buyers.
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We believe that relaxin provides opportunities for treatment of life
threatening diseases for which there are few or no current alternatives.
Nevertheless, the pharmaceutical and biotechnology industries are highly
competitive, and numerous pharmaceutical and biotechnology companies and
academic research groups throughout the world are engaged in research and
development efforts with respect to therapeutic products targeted at diseases or
conditions that we are also addressing.
Many of our existing or potential competitors, particularly large
pharmaceutical companies, have substantially greater financial, technical and
human resources than we do. In addition, many of these competitors have more
collective experience than we do in undertaking preclinical testing and human
clinical trials of new pharmaceutical products and obtaining regulatory
approvals for therapeutic products. Accordingly, our competitors may succeed in
obtaining FDA approval for products more rapidly than we do.
We intend to compete on the basis of the quality and efficacy of our
products, combined with the effectiveness of our marketing and sales efforts.
Competing successfully will depend on our continued ability to attract and
retain skilled and experienced personnel, to identify, secure the rights to, and
develop pharmaceutical products and compounds, and to exploit these products and
compounds commercially before others are able to develop competitive products.
With regard to Ridaura, there are numerous products on the market, and
under development, for the treatment of rheumatoid arthritis. We believe that
Ridaura competes with other rheumatoid arthritis therapies sold by Aventis,
Immunex Corporation and Monsanto Company.
GOVERNMENT REGULATION
The pharmaceutical and biotechnology industries are subject to regulation
by the FDA under the Food Drug and Cosmetic Act, by the states under state food
and drug laws, and by similar agencies outside of the United States. We expect
that all of our pharmaceutical products will require regulatory approval by
governmental agencies before we can commercialize them. In particular, human
pharmaceutical therapeutic products are subject to rigorous preclinical and
clinical testing and other approval procedures by the FDA in the United States
and similar health authorities in foreign countries. Labeling and promotional
activities are subject to scrutiny by the FDA. Various federal and, in some
cases, state statutes and regulations also govern or influence the
manufacturing, safety, labeling, storage, record keeping and marketing of such
pharmaceutical products. Failure to comply with applicable requirements can
result in, among other things, warning letters, fines, injunctions, penalties,
recall or seizure of products, total or partial suspension of production, denial
or withdrawal of approval, and criminal prosecution. Accordingly, ongoing
regulation by governmental entities in the United States and other countries
will be a significant factor in the production and marketing of any
pharmaceutical products that we have or may develop. The process of obtaining
these approvals and the subsequent compliance with appropriate federal and
foreign statutes and regulations are time-consuming and require the expenditure
of substantial resources.
Generally, in order to obtain FDA approval for a new therapeutic agent, a
company first must conduct pre-clinical studies. The basic purpose of
pre-clinical investigation is to gather enough evidence on the potential new
agent through laboratory experimentation and animal testing, to determine if it
is reasonably safe to begin preliminary trials in humans. The results of these
studies are submitted as a part of an investigational new drug application,
which the FDA must review before human clinical trials of an investigational
drug can start. We have filed and will continue to be required to sponsor and
file investigational new drug applications, and will be responsible for
initiating and overseeing the clinical studies to demonstrate the safety and
efficacy that are necessary to obtain FDA approval of our products.
Clinical trials are normally done in phases and generally take two to five
years, but may take longer, to complete. The rate of completion of our clinical
trials depends upon, among other factors, the rate at which patients enroll in
the study. Patient enrollment is a function of many factors, including the size
of the patient population, the nature of the protocol, the proximity of patients
to clinical sites and the eligibility criteria for the study. Delays in planned
patient enrollment may result in increased costs and
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delays, which could have a material adverse effect on our business. Phase I
trials generally involve administration of a product to a small number of
persons to determine safety, tolerance and the metabolic and pharmacologic
actions of the agent in humans and the side effects associated with increasing
doses. Phase II trials generally involve administration of a product to a larger
group of patients with a particular disease to obtain evidence of the agent's
effectiveness against the targeted disease, to further explore risk and side
effect issues, and to confirm preliminary data regarding optimal dosage ranges.
Phase I and Phase II trials can sometimes be combined, with the FDA's
concurrence, into a Phase I/II trial. Phase III trials involve more patients,
and often more locations and clinical investigators than the earlier trials. At
least one such trial is required for FDA approval to market a drug. Phase II and
Phase III trials can sometimes be combined, with the FDA's concurrence, into a
Phase II/III trial, which is an accelerated clinical trial intended to provide
sufficient data for approval.
Section 505(b)(2) of the Food, Drug and Cosmetic Act makes it possible for
a company to possibly accelerate the FDA approval process. A so-called 505(b)(2)
application permits a sponsor of a drug that may differ substantially from any
drug listed in the FDA's list of approved drugs to rely on published studies or
the FDA's findings of safety and effectiveness based on studies in a
previously-approved NDA sponsored by another person, together with the studies
generated on its own drug products, as a way to satisfy the requirements for a
full NDA. The FDA evaluates 505(b)(2) applications using the same standards of
approval for an NDA, but the number of clinical trials required to support a
505(b)(2) application, and the amount of information in the application itself,
may be substantially less than that required to support an NDA application.
Connetics used the 505(b)(2) application process for both Luxiq and OLUX. We
cannot assure you that the 505(b)(2) process will be available for our other
product candidates, and as a result the FDA process may be longer for those
product candidates than it was for Luxiq and OLUX.
After we complete the clinical trials of a product, we must file with the
FDA a new drug application, if the product is classified as a new drug, or a
biologics license application if the product is classified as a biologic. We
must receive FDA clearance before we can commercialize the product. The testing
and approval processes require substantial time and effort, and the FDA may not
grant approval on a timely basis or at all. The FDA can take between one and two
years to review new drug applications and biologics license applications, and
can take longer if significant questions arise during the review process. While
various legislative and regulatory initiatives have focused on the need to
reduce FDA review and approval times, the ultimate impact of such initiatives on
our products cannot be certain. In addition, if there are changes in FDA policy
while we are in product development, we may encounter delays or rejections that
we did not anticipate when we submitted the new drug application or biologics
license application for that product. We could encounter similar delays in other
countries. We may not obtain regulatory approval for any products that we
develop, even after committing such time and expenditures to the process. If
regulatory approval of a product is granted, such approval may entail
limitations on the indicated uses for which the product may be marketed.
The FDA continues to review marketed products even after granting
regulatory clearances, and later discovery of previously unknown problems or
failure to comply with the applicable regulatory requirements may result in
restrictions on the marketing of a product or withdrawal of the product from the
market, recalls, seizures, injunctions or criminal sanctions.
We are required in most states to be licensed with the state pharmacy board
as either a manufacturer, wholesaler, or wholesale distributor. Many of the
states allow exemptions from licensure if our products are distributed through a
licensed wholesale distributor. The regulations of each state are different, and
the fact that we are licensed in one state does not authorize us to sell our
products in other states. Accordingly, we undertake an annual review of our
license status and that of our distributor to ensure continued compliance with
the state pharmacy board requirements.
Our products will also be subject to foreign regulatory requirements
governing human clinical trials, manufacturing and marketing approval for
pharmaceutical products. The requirements governing the
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conduct of clinical trials, product licensing, pricing and reimbursement are
similar, but not identical, to FDA requirements, and they vary widely from
country to country.
MARKETING EXCLUSIVITY
Pharmaceutical companies can petition the FDA to grant new drug product
exclusivity for a drug, independent of any orphan drug or patent term
exclusivity accorded to that drug. The exclusivity granted by the FDA
essentially prevents competition from other manufacturers who wish to put
generic versions of the product into U.S. commerce. The FDA has granted
marketing exclusivity to Connetics for foam-based products incorporating
clobetasol propionate for three years. The exclusivity prevents other parties
from submitting or getting approval for any application before the exclusive
period expires. The FDA determines whether a drug is eligible for exclusivity on
a case-by-case basis. The FDA may grant three-year exclusivity provided that the
application included at least one new clinical investigation other than
bioavailability studies, the investigation was conducted or sponsored by the
drug company, and the reports of the clinical investigation were essential to
the approval of the application.
THIRD PARTY REIMBURSEMENT
Our operating results will depend in part on whether adequate reimbursement
is available for our products from third-party payors, such as government
entities, private health insurers and managed care organizations. Third-party
payors increasingly are seeking to negotiate the pricing of medical services and
products and to promote the use of generic, non-branded pharmaceuticals through
payor-based reimbursement policies designed to encourage their use. In some
cases, third-party payors will pay or reimburse users or suppliers of a
prescription drug product only a portion of the product purchase price. If
government entities or other third-party payors do not provide adequate
reimbursement levels for our products, or if those reimbursement policies
increasingly favor the use of generic products, our business and financial
condition would be materially adversely affected. In addition, managed care
initiatives to control costs have influenced primary-care physicians to refer
fewer patients to dermatologists, resulting in a declining target market for us.
Further reductions in referrals to dermatologists could have a material adverse
effect upon our business.
The commercial success of our products will be substantially dependent upon
the availability of government or private third-party reimbursement for the use
of such products. Medicare, Medicaid, health maintenance organizations and other
third-party payers may not authorize or otherwise budget such reimbursement.
Such governmental and third party payers are increasingly challenging the prices
charged for medical products and services. Consumers and third-party payers may
not view our marketed products as cost-effective, and consumers may not be able
to get reimbursement or reimbursement may be so low that we cannot market our
products on a competitive basis. Furthermore, federal and state regulations
govern or influence the reimbursement to health care providers of fees and
capital equipment costs in connection with medical treatment of certain
patients. We cannot predict the likelihood that federal and state legislatures
will pass laws related to health care reform or lowering pharmaceutical costs.
In certain foreign markets pricing of prescription pharmaceuticals is already
subject to government control. Continued significant changes in the U.S. or
foreign health care systems could have a material adverse effect on our
business.
ENVIRONMENTAL REGULATION
Our research and development activities involve the controlled use of
hazardous materials, chemicals and various radioactive materials. We are subject
to federal, state and local laws and regulations governing the use, storage,
handling and disposal of such materials and certain waste products. Although we
believe that our safety procedures for handling and disposing of such materials
comply with the standards prescribed by state, federal, and local laws and
regulations, we cannot completely eliminate the risk of accidental contamination
or injury from these materials.
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DEVELOPMENT
Our products require clinical and manufacturing development. Our
development activities involve work related to product formulation, preclinical
and clinical study coordination, regulatory administration, manufacturing, and
quality control and assurance. While many other pharmaceutical and biotechnology
companies conduct earlier stage research and drug discovery, our focus is on
later-stage development to minimize the risk and time requirements for us to get
a product on the market.
In addition to our in-house staff and resources, we contract a substantial
portion of development work to outside parties. For example, we typically engage
contract research organizations to manage our clinical trials. We have contracts
with vendors to conduct product analysis and stability studies, and we outsource
all of our manufacturing scale-up and production activities.
We also use collaborative relationships with pharmaceutical partners and
academic researchers to augment our product development activities, and from
time to time we enter agreements with academic or university-based researchers
to conduct various studies for us.
EMPLOYEES
As of March 1, 2001, we had 136 full-time employees. Of the full-time
employees, 51 were engaged in sales and marketing, 61 were in research and
development and 24 were in general and administrative positions. We believe our
relations with our employees are good.
FACTORS AFFECTING OUR BUSINESS AND PROSPECTS
Our results of operation have varied widely in the past, and they could
continue to vary significantly from quarter to quarter due to a number of
factors, including those listed below. Any shortfall in revenues would have an
immediate impact on our earnings per share, which could adversely affect the
market price of our common stock. Our operating expenses, which include sales
and marketing, research and development and general and administrative expenses,
are based on our expectations of future revenues and are relatively fixed in the
short term. Accordingly, if revenues fall below our expectations, we will not be
able to reduce our spending rapidly in response to such a shortfall. Due to the
foregoing factors, we believe that quarter-to-quarter comparisons of our results
of operations are not a good indication of our future performance.
RISKS RELATED TO OUR BUSINESS
IF WE DO NOT SUSTAIN PROFITABILITY, STOCKHOLDERS MAY LOSE THEIR INVESTMENT.
Until the first quarter of fiscal year 2000, we lost money every year since
our inception. We had net losses of $27.3 million in 1999 and net income of
$27.0 million in 2000. If we exclude a gain of $43.0 million on sales of stock
we held in InterMune, and the associated income tax, our net loss for 2000 would
have been $15.0 million. Our accumulated deficit was $92.8 million at December
31, 2000. We may incur additional losses during the next few years. If we do not
sustain the profitability we achieved in 2000, our stock price may decline.
IF WE DO NOT OBTAIN THE CAPITAL NECESSARY TO FUND OUR OPERATIONS, WE WILL BE
UNABLE TO DEVELOP OR MARKET OUR PRODUCTS.
We currently believe that our available cash resources will be sufficient
to fund our operating and working capital requirements for the next 18 months.
Accordingly, we may need to raise additional funds through public or private
financings, strategic relationships or other arrangements. If we are unable to
raise additional funds when needed, we may not be able to market our products as
planned or continue development of our other products. If we are unable to
successfully complete development and commercialization of relaxin, we may never
achieve profitability.
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IF WE FAIL TO PROTECT OUR PROPRIETARY RIGHTS, COMPETITORS MAY BE ABLE TO USE OUR
TECHNOLOGIES, WHICH WOULD WEAKEN OUR COMPETITIVE POSITION, REDUCE OUR REVENUES
AND INCREASE OUR COSTS.
Our commercial success depends in part on our ability and the ability of
our licensors to protect our technology and processes. The foam technology used
in our Luxiq(R) and OLUX(TM) products is covered by one issued patent. In
addition, the patents in our relaxin patent portfolio begin to expire in 2002 in
foreign countries and 2005 in the United States. Patent expiration dates range
from 2002 to 2017.
We are pursuing several U. S. patent applications, although we cannot be
sure that any of these patents will ever be issued. We also have acquired rights
under certain patents and patent applications in connection with our licenses to
distribute products and from the assignment of rights to patents and patent
applications from certain of our consultants and officers. These patents and
patent applications may be subject to claims of rights by third parties. If
there are conflicting claims to the same patent or patent application, we may
not prevail and, even if we do have some rights in a patent or application,
those rights may not be sufficient for the marketing and distribution of
products covered by the patent or application.
The patents and applications in which we have an interest may be challenged
as to their validity or enforceability. Challenges may result in potentially
significant harm to our business. The cost of responding to these challenges and
the inherent costs to defend the validity of our patents, including the
prosecution of infringements and the related litigation, could be substantial
whether or not we are successful. Such litigation also could require a
substantial commitment of management's time. A judgment adverse to us in any
patent interference, litigation or other proceeding arising in connection with
these patent applications could materially harm our business.
The ownership of a patent or an interest in a patent does not always
provide significant protection. Others may independently develop similar
technologies or design around the patented aspects of our technology. We only
conduct patent searches to determine whether our products infringe upon any
existing patents, when we think such searches are appropriate. As a result, the
products and technologies we currently market, and those we may market in the
future, may infringe on patents and other rights owned by others. If we are
unsuccessful in any challenge to the marketing and sale of our products or
technologies, we may be required to license the disputed rights, if the holder
of those rights is willing, or to cease marketing the challenged products, or to
modify our products to avoid infringing upon those rights. Under these
circumstances, we may not be able to obtain a license to such intellectual
property on favorable terms, if at all. We may not succeed in any attempt to
redesign our products or processes to avoid infringement.
OUR CURRENT PRODUCT REVENUE WILL NOT COVER THE COST OF FULLY DEVELOPING AND
COMMERCIALIZING RELAXIN.
Product revenue from sales of our marketed products does not cover the full
cost of developing relaxin and other products in our pipeline. Historically, we
have depended on licensing agreements with our corporate partners to
successfully develop and commercialize our products. We also generate revenue by
licensing our products to third parties for specific territories and
indications. Our reliance on licensing arrangements with third parties carries
several risks, including the possibilities that:
- a product development contract may expire or a relationship may be
terminated, and we will not be able to attract a satisfactory
alternative corporate partner within a reasonable time;
- a corporate partner involved in the development of our products does not
commit sufficient capital to successfully develop our products; and
- we may be contractually bound to terms that, in the future, are not
commercially favorable to us.
If any of these risks occurs, we may not be able to successfully develop our
products.
WE DEPEND ON THIRD PARTIES TO PROTECT AND MAINTAIN OUR PATENT PORTFOLIO.
Nearly our entire patent portfolio is licensed from third parties, who are
responsible to varying degrees for the prosecution and maintenance of those
patents. Our success will depend on our ability, or the ability
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of our licensors, to obtain and maintain patent protection on technologies, to
preserve trade secrets, and to operate without infringing the proprietary rights
of others. It is possible that before any of our products in development can be
commercialized, the related patents may have expired or be close to expiration,
thus reducing any advantage of the patent. Moreover, composition of matter
patent protection, which gives patent protection for a compound or a
composition, may not be available for some of our product candidates.
IF WE DO NOT SUCCESSFULLY COMMERCIALIZE RELAXIN, WE MAY LOSE FUNDAMENTAL
INTELLECTUAL PROPERTY RIGHTS TO THE PRODUCT.
Licenses with Genentech, Inc. and The Howard Florey Institute of
Experimental Physiology and Medicine require us to use our best efforts to
commercialize relaxin. Our failure to successfully commercialize relaxin may
result in the reversion of our rights under these licenses to Genentech and the
Florey Institute. The termination of these agreements and subsequent reversion
of rights could cause us to lose fundamental intellectual property rights to
relaxin. This would prohibit us from continuing our relaxin development
programs.
WE ARE SUBJECT TO FOREIGN EXCHANGE RISKS WHICH MAY INCREASE OUR OPERATIONAL
EXPENSES.
We make payments to Boehringer Ingelheim for the production of relaxin in
Austrian schillings, and to CCL Pharmaceuticals for the production of Luxiq and
OLUX in pounds sterling. If the U.S. dollar depreciates against the schilling or
the pound, the payments that we must make will increase, which will increase our
expenses. We do not currently hedge our foreign currency exposure related to
these Agreements.
WE RELY ON OUR EMPLOYEES AND CONSULTANTS TO KEEP OUR TRADE SECRETS CONFIDENTIAL.
We rely on trade secrets and unpatented proprietary know-how and continuing
technological innovation in developing and manufacturing our products. We
require each of our employees, consultants and advisors to enter into
confidentiality agreements prohibiting them from taking our proprietary
information and technology or from using or disclosing proprietary information
to third parties except in specified circumstances. The agreements also provide
that all inventions conceived by an employee, consultant or advisor, to the
extent appropriate for the services provided during the course of the
relationship, shall be our exclusive property, other than inventions unrelated
to us and developed entirely on the individual's own time. Nevertheless, these
agreements may not provide meaningful protection of our trade secrets and
proprietary know-how if they are used or disclosed. Despite all of the
precautions we may take, people who are not parties to confidentiality
agreements may obtain access to our trade secrets or know-how. In addition,
others may independently develop similar or equivalent trade secrets or
know-how.
OUR USE OF HAZARDOUS MATERIALS EXPOSES US TO THE RISK OF ENVIRONMENTAL
LIABILITIES, AND WE MAY INCUR SUBSTANTIAL ADDITIONAL COSTS TO COMPLY WITH
ENVIRONMENTAL LAWS.
Our research and development activities involve the controlled use of
hazardous materials, chemicals and various radioactive materials. We are subject
to laws and regulations governing the use, storage, handling and disposal of
these materials and certain waste products. In the event of accidental
contamination or injury from these materials, we could be liable for any damages
that result and any liability could exceed our resources. We may also be
required to incur significant costs to comply with environmental laws and
regulations as our research activities increase.
RISKS RELATED TO OUR PRODUCTS
MANUFACTURING DIFFICULTIES COULD DELAY COMMERCIALIZATION OF OUR PRODUCTS OR
FUTURE REVENUES FROM PRODUCT SALES.
We depend on third parties to manufacture our products, and each product is
manufactured by a sole source manufacturer. Boehringer Ingelheim Austria GmbH,
GlaxoSmithKline, and CCL Pharmaceuticals
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are our sole source manufacturers for our products. All of our contractors must
comply with the applicable FDA good manufacturing practice regulations, which
include quality control and quality assurance requirements as well as the
corresponding maintenance of records and documentation. Manufacturing facilities
are subject to ongoing periodic inspection by the FDA and corresponding state
agencies, including unannounced inspections, and must be licensed before they
can be used in commercial manufacturing of our products. If our sole source
manufacturers cannot provide us with our product requirements in a timely and
cost-effective manner, if the product they are able to supply cannot meet
commercial requirements for shelf life, or if they are not able to comply with
the applicable good manufacturing practice regulations and other FDA regulatory
requirements, our sales of marketed products could be reduced and we could
suffer delays in the progress of clinical trials for products under development.
We do not have control over our third-party manufacturers' compliance with these
regulations and standards. In addition, any commercial dispute with any of our
sole source suppliers could result in delays in the manufacture of product, and
affect our ability to commercialize our products.
IF WE ARE UNABLE TO CONTRACT WITH THIRD PARTIES TO MANUFACTURE AND DISTRIBUTE
OUR PRODUCTS IN SUFFICIENT QUANTITIES, ON A TIMELY BASIS, OR AT AN ACCEPTABLE
COST, WE MAY BE UNABLE TO MEET DEMAND FOR OUR PRODUCTS AND MAY LOSE POTENTIAL
REVENUES.
We have no manufacturing or distribution facilities for any of our
products. Instead, we contract with third parties to manufacture our products
for us. We have manufacturing agreements with the following companies:
- CCL Pharmaceuticals, a Division of CCL Industries Limited, a U.K.
corporation, for Luxiq and OLUX;
- Boehringer Ingelheim Austria GmbH for relaxin; and
- GlaxoSmithKline for Ridaura.
Typically, these manufacturing contracts are short-term. We are dependent
upon renewing agreements with our existing manufacturers or finding replacement
manufacturers to satisfy our requirements. As a result, we cannot be certain
that manufacturing sources will continue to be available or that we can continue
to out-source the manufacturing of our products on reasonable or acceptable
terms.
Any loss of a manufacturer or any difficulties which could arise in the
manufacturing process could significantly affect our inventories and supply of
products available for sale. In each case, our products are made by a sole
source of supply. If these third parties are unable or unwilling to produce our
products in sufficient quantities, with appropriate quality, and under
commercially reasonably terms, it could have a negative effect on our sales
margins and market share, as well as our overall business and financial results.
If we are unable to supply sufficient amounts of our products on a timely basis,
our market share could decrease and, correspondingly, our profitability could
decrease.
IF OUR CONTRACT MANUFACTURERS FAIL TO COMPLY WITH CGMP REGULATIONS, WE MAY BE
UNABLE TO MEET DEMAND FOR OUR PRODUCTS AND MAY LOSE POTENTIAL REVENUE.
The FDA requires that all manufacturers used by pharmaceutical companies
comply with the FDA's regulations, including those cGMP regulations applicable
to manufacturing processes. The cGMP validation of a new facility and the
approval of that manufacturer for a new drug product may take a year or more
before manufacture can begin at the facility. Delays in obtaining FDA validation
of a replacement manufacturing facility could cause an interruption in the
supply of our products. Although we have business interruption insurance
covering the loss of income for up to $6.0 million, which may mitigate the harm
to our business from the interruption of the manufacturing of products caused by
certain events, the loss of a manufacturer could still have a negative effect on
our sales, margins and market share, as well as our overall business and
financial results.
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IF OUR SUPPLY OF FINISHED PRODUCTS IS INTERRUPTED, OUR ABILITY TO MAINTAIN OUR
INVENTORY LEVELS COULD SUFFER.
We try to maintain inventory levels that are no greater than necessary to
meet our current projections. Any interruption in the supply of finished
products could hinder our ability to timely distribute finished products. If we
are unable to obtain adequate product supplies to satisfy our customers' orders,
we may lose those orders and our customers may cancel other orders and stock and
sell competing products. This in turn could cause a loss of our market share and
negatively affect our revenues.
We cannot be certain that supply interruptions will not occur or that our
inventory will always be adequate. Numerous factors could cause interruptions in
the supply of our finished products including shortages in raw material required
by our manufacturers, changes in our sources for manufacturing, our failure to
timely locate and obtain replacement manufacturers as needed and conditions
effecting the cost and availability of raw materials.
IF WE DO NOT OBTAIN AND MAINTAIN GOVERNMENTAL APPROVALS FOR OUR PRODUCTS, WE
CANNOT SELL THESE PRODUCTS FOR THEIR INTENDED DISEASES.
Pharmaceutical companies are subject to heavy regulation by a number of
national, state and local agencies. Of particular importance is the FDA in the
United States. It has jurisdiction over all of our business and administers
requirements covering testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of our products.
Failure to comply with applicable regulatory requirements could, among other
things, result in fines; suspensions of regulatory approvals of products;
product recalls; delays in product distribution, marketing and sale; and civil
or criminal sanctions.
The process of obtaining and maintaining regulatory approvals for
pharmaceutical and biological drug products, and obtaining and maintaining
regulatory approvals to market these products for new indications, is lengthy,
expensive and uncertain. The manufacturing and marketing of drugs are subject to
continuing FDA and foreign regulatory review, and later discovery of previously
unknown problems with a product, manufacturing process or facility may result in
restrictions, including withdrawal of the product from the market. Our products
receive FDA review regarding their safety and effectiveness. However, the FDA is
permitted to revisit and change its prior determinations and we cannot be sure
that the FDA will not change its position with regard to the safety or
effectiveness of our products. If the FDA's position changes, we may be required
to change our labeling or formulations, or cease to manufacture and market the
challenged products. Even before any formal regulatory action, we could
voluntarily decide to cease distribution and sale or recall any of our products
if concerns about the safety or effectiveness develop.
To market our products in countries outside of the United States, we and
our partners must obtain similar approvals from foreign regulatory bodies. The
foreign regulatory approval process includes all of the risks associated with
obtaining FDA approval, and approval by the FDA does not ensure approval by the
regulatory authorities of any other country. The process of obtaining these
approvals is time consuming and requires the expenditure of substantial
resources.
In recent years, various legislative proposals have been offered in
Congress and in some state legislatures that include major changes in the health
care system. These proposals have included price or patient reimbursement
constraints on medicines and restrictions on access to certain products. We
cannot predict the outcome of such initiatives, and it is difficult to predict
the future impact of the broad and expanding legislative and regulatory
requirements affecting us.
WE MAY SPEND A SIGNIFICANT AMOUNT OF MONEY TO OBTAIN FDA AND OTHER REGULATORY
APPROVALS, WHICH MAY NEVER BE GRANTED.
The process of obtaining FDA and other regulatory approvals is lengthy and
expensive. To obtain approval, we must show in preclinical and clinical trials
that our products are safe and effective, and the marketing and manufacturing of
pharmaceutical products are subject to rigorous testing procedures. The FDA
approval processes require substantial time and effort, the FDA continues to
modify product development guidelines, and the FDA may not grant approval on a
timely basis or at all. Clinical trial data
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can be the subject of differing interpretation, and the FDA has substantial
discretion in the approval process. The FDA may not interpret our clinical data
the way we do. The FDA may also require additional clinical data to support
approval. The FDA can take between one and two years to review new drug
applications and biologics license applications, or longer if significant
questions arise during the review process. We may not be able to obtain FDA
approval to conduct clinical trials or to manufacture and market any of the
products we develop, acquire or license. Moreover, the costs to obtain approvals
could be considerable and the failure to obtain or delays in obtaining an
approval could have a significant negative effect on our business performance
and financial results. Even if we obtain approval from the FDA, the FDA is
authorized to impose post-marketing requirements such as:
- testing and surveillance to monitor the product and its continued
compliance with regulatory requirements;
- submitting products for inspection and, if any inspection reveals that
the product is not in compliance, the prohibition of the sale of all
products from the same lot;
- suspending manufacturing;
- recalling products; and
- withdrawing marketing clearance.
In its regulation of advertising, the FDA from time to time issues
correspondence to pharmaceutical companies alleging that some advertising or
promotional practices are false, misleading or deceptive. The FDA has the power
to impose a wide array of sanctions on companies for such advertising practices,
and the receipt of correspondence from the FDA alleging these practices can
result in the following:
- incurring substantial expenses, including fines, penalties, legal fees
and costs to comply with the FDA's requirements;
- changes in the methods of marketing and selling products;
- taking FDA-mandated corrective action, which may include placing
advertisements or sending letters to physicians rescinding previous
advertisements or promotion; and
- disruption in the distribution of products and loss of sales until
compliance with the FDA's position is obtained.
IF LUXIQ AND OLUX DO NOT ACHIEVE OR SUSTAIN MARKET ACCEPTANCE, OUR REVENUES WILL
NOT INCREASE AND MAY NOT COVER OUR OPERATING EXPENSES.
Our future revenues will depend upon dermatologist and patient acceptance
of Luxiq and OLUX. Factors that could affect acceptance of Luxiq and OLUX
include:
- satisfaction with existing alternative therapies;
- the effectiveness of our sales and marketing efforts;
- undesirable and unforeseeable side effects; and
- the cost of the product as compared with alternative therapies.
Since we have only had approval to sell Luxiq for two years, and we only
began selling OLUX in November 2000, we cannot predict the potential long-term
patient acceptance of either product.
IF WE ARE UNABLE TO DEVELOP ALTERNATIVE DELIVERY SYSTEMS FOR RELAXIN, PATIENTS
THAT DO NOT SUFFER FROM SEVERE DISEASES MAY NOT BE WILLING TO USE THE CURRENT
DRUG DELIVERY SYSTEM.
In addition to demonstrating that relaxin is safe and effective in our
current clinical trials, we must meet several additional major development
objectives for relaxin. In particular, we may need to develop an alternative
means of delivering the drug. In our current clinical trials, relaxin is being
delivered through the
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use of an infusion pump. For a serious and life threatening condition, this
method of delivery may be acceptable. However, for the indications we are
studying, such as treatment of infertility and peripheral arterial disease, we
may need to develop an alternative delivery system. The known biological
properties of the relaxin molecule may decrease the availability of certain
delivery systems. If we are not able to develop a suitable alternative delivery
system for relaxin, we may be unable to market relaxin effectively for
indications that are not life threatening, such as infertility, and the
commercial potential of relaxin would be seriously harmed. Our inability to
develop relaxin to its full commercial potential would harm our future prospects
and revenue growth and our stock price would likely decline.
WE RELY ON THIRD PARTIES TO CONDUCT CLINICAL TRIALS FOR OUR PRODUCTS, AND THOSE
THIRD PARTIES MAY NOT PERFORM SATISFACTORILY.
We do not have the ability to independently conduct clinical studies, and
we rely on third parties to perform this function. If these third parties do not
perform satisfactorily, we may not be able to locate acceptable replacements or
enter into favorable agreements with them, if at all. If we are unable to rely
on clinical data collected by others, we could be required to repeat clinical
trials, which could significantly delay commercialization and require
significantly greater capital.
IF WE ARE UNABLE TO DEVELOP NEW PRODUCTS, OUR EXPENSES MAY INCREASE WITHOUT ANY
IMMEDIATE RETURN ON THE INVESTMENT.
We currently have a variety of new products in various stages of research
and development and are working on possible improvements, extensions and
reformulations of some existing products. These research and development
activities, as well as the clinical testing and regulatory approval process,
which must be completed before commercial quantities of these developments can
be sold, will require significant commitments of personnel and financial
resources. Delays in the research, development, testing or approval processes
will cause a corresponding delay in revenue generation from those products.
Regardless of whether they are ever released to the market, the expense of such
processes will have already been incurred.
We reevaluate our research and development efforts regularly to assess
whether our efforts to develop a particular product or technology are
progressing at a rate that justifies our continued expenditures. On the basis of
these reevaluations, we have abandoned in the past, and may abandon in the
future, our efforts on a particular product or technology. There can be no
certainty that any product we are researching or developing will ever be
successfully released to the market. If we fail to take a product or technology
from the development stage to market on a timely basis, we may incur significant
expenses without a near-term financial return.
IF WE DO NOT SUCCESSFULLY INTEGRATE NEW PRODUCTS, WE MAY NOT BE ABLE TO SUSTAIN
REVENUE GROWTH AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
When we acquire or develop new products and product lines, we must be able
to integrate those products and product lines into our systems for marketing,
sales and distribution. If these products or product lines are not integrated
successfully, the potential for growth is limited. The new products we acquire
or develop could have channels of distribution, competition, price limitations
or marketing acceptance different from our current products. As a result, we do
not know whether we will be able to compete effectively and obtain market
acceptance in any new product categories. After acquiring or developing a new
product, we may need to significantly increase our sales force and incur
additional marketing, distribution and other operational expenses. These
additional expenses could negatively affect our gross margins and operating
results. In addition, many of these expenses could be incurred prior to the
actual distribution of new products. Because of this timing, if the new products
are not accepted by the market or if they are not competitive with similar
products distributed by others, the ultimate success of the acquisition or
development could be substantially diminished.
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RISKS RELATED TO OUR INDUSTRY
WE FACE INTENSE COMPETITION, WHICH MAY LIMIT OUR COMMERCIAL OPPORTUNITIES AND
OUR ABILITY TO BECOME PROFITABLE.
The pharmaceutical and biotechnology industries are highly competitive.
Competition in our industry occurs on a variety of fronts, including developing
and bringing new products to market before others, developing new technologies
to improve existing products, developing new products to provide the same
benefits as existing products at less cost and developing new products to
provide benefits superior to those of existing products.
Most of our competitors are large, well-established companies in the fields
of pharmaceuticals and health care. Many of these companies have substantially
greater financial, technical and human resources than we have to devote to
marketing, sales, research and development and acquisitions. Some of these
competitors have more collective experience than we do in undertaking
preclinical testing and human clinical trials of new pharmaceutical products and
obtaining regulatory approvals for therapeutic products. As a result, they have
a greater ability to undertake more extensive research and development,
marketing and pricing policy programs. It is possible that our competitors may
develop new or improved products to treat the same conditions as our products
treat or make technological advances reducing their cost of production so that
they may engage in price competition through aggressive pricing policies to
secure a greater market share to our detriment. Our commercial opportunities
will be reduced or eliminated if our competitors develop and market products
that are more effective, have fewer or less severe adverse side effects or are
less expensive than our products. These competitors also may develop products
that make our current or future products obsolete. Any of these events could
have a significant negative impact on our business and financial results,
including reductions in our market share and gross margins.
Physicians may not adopt our products over competing products, and our
products may not offer an economically feasible alternative to existing modes of
therapy.
Our products compete with generic pharmaceuticals, which claim to offer
equivalent benefit at a lower cost. In some cases, insurers and other health
care payment organizations try to encourage the use of these less expensive
generic brands through their prescription benefits coverages and reimbursement
policies. These organizations may make the generic alternative more attractive
to the patient by providing different amounts of reimbursement so that the net
cost of the generic product to the patient is less than the net cost of our
prescription brand product. Aggressive pricing policies by our generic product
competitors and the prescription benefits policies of insurers could cause us to
lose market share or force us to reduce our margins in response.
IF THIRD PARTY PAYORS WILL NOT PROVIDE COVERAGE OR REIMBURSE PATIENTS FOR THE
USE OF OUR PRODUCTS, OUR REVENUES AND PROFITABILITY WILL SUFFER.
Our products' commercial success is substantially dependent on whether
third-party reimbursement is available for the use of our products by hospitals,
clinics and doctors. Medicare, Medicaid, health maintenance organizations and
other third-party payers may not authorize or otherwise budget for the
reimbursement of our products. In addition, they may not view our products as
cost-effective and reimbursement may not be available to consumers or may not be
sufficient to allow our products to be marketed on a competitive basis.
Likewise, legislative proposals to reform health care or reduce government
programs could result in lower prices for or rejection of our products. Changes
in reimbursement policies or health care cost containment initiatives that limit
or restrict reimbursement for our products may cause our revenues to decline.
IF MANAGED CARE ORGANIZATIONS AND OTHER THIRD-PARTY REIMBURSEMENT POLICIES DO
NOT COVER OUR PRODUCTS, WE MAY NOT INCREASE OUR MARKET SHARE AND OUR REVENUES
AND PROFITABILITY WILL SUFFER.
Our operating results and business success depends in large part on the
availability of adequate third-party payor reimbursement to patients for our
prescription-brand products. These third-party payors
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include governmental entities (such as Medicaid), private health insurers and
managed care organizations. Over 70% of the U.S. population now participates in
some version of managed care. Because of the size of the patient population
covered by managed care organizations, marketing of prescription drugs to them
and the pharmacy benefit managers that serve many of these organizations has
become important to our business. Managed care organizations and other
third-party payors try to negotiate the pricing of medical services and products
to control their costs. Managed care organizations and pharmacy benefit managers
typically develop formularies to reduce their cost for medications. Formularies
can be based on the prices and therapeutic benefits of the available products.
Due to their lower costs, generics are often favored. The breadth of the
products covered by formularies varies considerably from one managed care
organization to another, and many formularies include alternative and
competitive products for treatment of particular medical conditions. Exclusion
of a product from a formulary can lead to its sharply reduced usage in the
managed care organization patient population. Payment or reimbursement of only a
portion of the cost of our prescription products could make our products less
attractive, from a net-cost perspective, to patients, suppliers and prescribing
physicians. We cannot be certain that the reimbursement policies of these
entities will be adequate for our products to compete on a price basis. If our
products are not included within an adequate number of formularies or adequate
reimbursement levels are not provided, or if those policies increasingly favor
generic products, our market share and gross margins could be negatively
affected, as could our overall business and financial condition.
IF PRODUCT LIABILITY LAWSUITS ARE BROUGHT AGAINST US, WE MAY INCUR SUBSTANTIAL
COSTS.
Our industry faces and inherent risk of product liability claims from
allegations that our products resulted in adverse effects to the patient or
others. These risks exist even with respect to those products that are approved
for commercial sale by the FDA and manufactured in facilities licensed and
regulated by the FDA. Our insurance may not provide adequate coverage against
potential product liability claims or losses. We also cannot be certain that our
current coverage will continue to be available in the future on reasonable
terms, if at all. Even if we are ultimately successful in product liability
litigation, the litigation would consume substantial amounts of our financial
and managerial resources, and might create adverse publicity, all of which would
impair our ability to generate sales. If we were found liable for any product
liability claims in excess of our coverage or outside of our coverage, the cost
and expense of such liability could severely damage our business, financial
condition and profitability.
RISKS RELATED TO OUR STOCK
OUR STOCK PRICE IS VOLATILE AND THE VALUE OF YOUR INVESTMENT IN OUR STOCK COULD
DECLINE IN VALUE.
The market prices for securities of biotechnology companies like our
company have been and are likely to continue to be highly volatile. As a result,
investors in these companies often buy at very high prices only to see the price
drop substantially a short time later, resulting in an extreme drop in value in
the stock holdings of these investors. In addition, the volatility could result
in securities class action litigation. Any litigation would likely result in
substantial costs, and divert our management's attention and resources.
IF OUR OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS ACT TOGETHER, THEY MAY BE
ABLE TO CONTROL OUR MANAGEMENT AND OPERATIONS AND THEY MAY MAKE DECISIONS THAT
ARE NOT IN THE BEST INTERESTS OF OTHER STOCKHOLDERS.
Our directors, executive officers and principal stockholders and their
affiliates currently beneficially own in the aggregate approximately 43% of our
outstanding common stock. Accordingly, they collectively have the ability to
substantially influence the outcome of all matters requiring stockholder
approval, including the election of directors, and any merger, consolidation, or
sale of all or substantially all of our assets. They may exercise this ability
in a manner that advances their best interests and not necessarily those of
other stockholders. This concentration of ownership may also have the effect of
delaying, deferring or preventing a change in control of our company, even if
the change in control would be beneficial to other stockholders.
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OUR CHARTER DOCUMENTS AND DELAWARE LAW CONTAIN PROVISIONS THAT COULD DELAY OR
PREVENT AN ACQUISITION OF US, EVEN IF THE ACQUISITION WOULD BE BENEFICIAL TO OUR
STOCKHOLDERS.
Our certificate of incorporation authorizes our board of directors to issue
undesignated preferred stock and to determine the rights, preferences,
privileges and restrictions of the preferred stock without further vote or
action by our stockholders. The issuance of preferred stock could make it more
difficult for third parties to acquire a majority of our outstanding voting
stock. We also have a stockholder rights plan, which entitles existing
stockholders to rights, including the right to purchase shares of preferred
stock, in the event of an acquisition of 15% or more of our outstanding common
stock, or an unsolicited tender offer for such shares. The existence of the
rights plan could delay, prevent, or make more difficult a merger or tender
offer or proxy contest involving us. Other provisions of Delaware law and of our
charter documents, including a provision eliminating the ability of stockholders
to take actions by written consent, could also delay or make difficult a merger,
tender offer or proxy contest involving us. Further, our stock option and
purchase plans generally provide for the assumption of such plans or
substitution of an equivalent option of a successor corporation or,
alternatively, at the discretion of the board of directors, exercise of some or
all of the option stock, including non-vested shares, or acceleration of vesting
of shares issued pursuant to stock grants, upon a change of control or similar
event.
ITEM 2. PROPERTIES
We currently lease 36,964 square feet of laboratory and office space at
3400 and 3294 West Bayshore Road in Palo Alto, California. We lease this space
under two lease agreements that will expire in January 2002 and January 2003. We
believe that our existing facilities are adequate to meet our requirements for
the near term and that additional space will be available on commercially
reasonable terms if needed.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2000.
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PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
"CNCT." The following table sets forth for the periods indicated the low and
high closing prices for our common stock.
- -----------------------------------------------------
HIGH LOW
- -----------------------------------------------------
1999
First Quarter $ 9.13 $ 4.75
Second Quarter 7.56 6.00
Third Quarter 7.50 5.00
Fourth Quarter 10.50 4.13
2000
First Quarter $15.13 $ 7.69
Second Quarter 14.69 6.13
Third Quarter 24.31 14.75
Fourth Quarter 26.88 4.13
- -----------------------------------------------------
On March 23, 2001, the last reported sale price of the common stock on the
Nasdaq National Market was $5.02 per share. As of that date, we had
approximately 195 stockholders of record of our common stock.
We have never declared or paid cash dividends on our common stock. We
currently intend to retain all available funds for use in our business, and do
not anticipate paying any cash dividends in the foreseeable future.
SALES OF UNREGISTERED SECURITIES.
On June 20, 2000, we sold 2,010,000 shares of our common stock to new and
existing investors for a total purchase price of approximately $20.1 million.
This transaction was exempt from registration under Section 4(2) of the
Securities Act of 1933. The transaction was privately negotiated and each
purchaser was an accredited investor. We made no public solicitation in the
placement of these securities. In July 2000, we registered the shares of common
stock issued in this transaction under the Securities Act of 1933 on a Form S-3
registration statement (File No. 333-41048).
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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been derived from
our audited consolidated financial statements. This historical data should be
read in conjunction with our consolidated Financial Statements and the related
Notes to Consolidated Financial Statements, and with the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing in Item 7 of this Report.
- ---------------------------------------------------------------------------------------------------------------------
December 31,
--------------------------------------------------------
2000 1999 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Revenues:
Product $ 20,095 $ 16,595 $ 7,473 $ 6,803 $ 428
License 20,679 10,311 1,648 -- --
- ---------------------------------------------------------------------------------------------------------------------
Total revenues 40,774 26,906 9,121 6,803 428
Operating costs and expenses:
Cost of product revenues 3,868 5,229 1,374 1,149 --
License amortization -- 6,160 6,720 7,124 594
Research and development 21,875 21,309 11,446 17,162 13,161
Selling, general and administrative 26,673 20,834 11,680 8,966 5,434
Charge for in process research and development -- 1,000 4,000 -- --
- ---------------------------------------------------------------------------------------------------------------------
Total operating costs and expenses 52,416 54,532 35,220 34,401 19,189
Loss from operations (11,642) (27,626) (26,099) (27,598) (18,761)
Gain on sale of investment 42,967 -- -- -- --
Gain on sale of license rights -- -- -- 525 --
Interest income (expense), net 1,873 343 (496) (862) 247
- ---------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and cumulative effect
of a change in accounting 33,198 (27,283) (26,595) (27,935) (18,154)
Income tax (1,010) -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of change in
accounting principal 32,188 (27,283) (26,595) (27,935) (18,514)
Cumulative effect of change in accounting principal(1) (5,192) -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 26,996 $(27,283) $(26,595) $(27,935) $(18,514)
- ---------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE --
Income (loss) per share before cumulative effect of
change in accounting principle $ 1.13 $ (1.21) $ (1.61) $ (2.69) $ (2.71)
Cumulative effect of change in accounting principle $ (0.18) -- -- -- --
Net income (loss) per share $ 0.95 $ (1.21) $ (1.61) $ (2.69) $ (2.71)
DILUTED EARNINGS PER SHARE --
Income (loss) per share before cumulative effect of
change in accounting principle $ 1.07 $ (1.21) $ (1.61) $ (2.69) $ (2.71)
Cumulative effect of change in accounting principle $ (0.17) -- -- -- --
Net income (loss) per share $ 0.90 $ (1.21) $ (1.61) $ (2.69) $ (2.71)
Shares used to calculate basic net earnings (loss) per
share(2) 28,447 22,619 16,533 10,412 6,825
Shares used to calculate diluted net earnings per
share(2) 30,086 22,619 16,533 10,412 6,825
Pro forma amounts assuming the accounting change was
applied retroactively
Net income (loss) $ 32,188 $(30,968) $(28,102) $(27,935) $(18,514)
Earnings per share
Basic $ 1.13 $ (1.37) $ (1.70) $ (2.69) $ (2.71)
Diluted $ 1.07 $ (1.37) $ (1.70) $ (2.69) $ (2.71)
- ---------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments $ 80,184 $ 26,299 $ 23,020 $ 14,346 $ 24,554
Working capital 71,030 13,401 12,464 6,687 14,904
Total assets 85,713 30,410 31,394 31,068 47,922
Current portion of capital lease obligations, capital
loans and long-term debt 37 47 582 2,746 2,408
Current portion of notes payable, deferred revenue and
other liabilities 1,399 3,594 6,822 2,884 --
Non-current portion of capital lease obligations and
long-term debt -- 799 4,002 649 3,062
Other long-term liabilities, deferred revenue and notes
payable 659 -- 3,781 9,666 10,858
Redeemable convertible preferred stock -- -- -- 600 2,000
Total stockholders' equity 72,606 14,288 12,452 10,809 21,800
- ---------------------------------------------------------------------------------------------------------------------
(1) Effective January 1, 2000, we changed our method of accounting for
non-refundable license fees in accordance with Staff Accounting Bulletin
101, "Revenue Recognition in Financial Statements."
(2) Earnings per share amounts prior to 1997 have been restated as required to
comply with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" and Staff Accounting Bulletin No. 98, "Earnings Per Share."
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes filed with this Report.
OVERVIEW
We currently market three pharmaceutical products. In May 2000, the FDA
granted us clearance to market OLUX(TM) Foam (clobetasol propionate), 0.05% for
the treatment of moderate to severe scalp dermatoses. We launched OLUX on
November 6, 2000. Our commercial business is focused on the dermatology
marketplace, which is characterized by a large patient population that is served
by relatively small, and therefore more accessible, groups of treating
physicians. We are offering two dermatology products with clinically proven
therapeutic advantages and are providing quality customer service to physicians
through our experienced sales and marketing staff. We also sell Ridaura, a
product to treat rheumatoid arthritis.
In addition to our commercial business, we are developing a biotechnology
product that has the potential to treat multiple diseases. Our product is a
recombinant form of a natural hormone called relaxin. Relaxin reduces the
hardening, or fibrosis, of skin and organ tissue, dilates existing blood vessels
and stimulates new blood vessel growth. We currently have clinical trials
underway with relaxin for infertility. We intend to develop relaxin for other
indications.
On October 8, 2000, we announced that our pivotal trial for relaxin for the
treatment of scleroderma failed to reach its primary endpoint. We have
discontinued our development program related to relaxin for scleroderma. We are
in earlier stage clinical trials of relaxin for the treatment of infertility and
peripheral arterial disease. We maintain North American rights for relaxin and
have entered into collaborative relationships for this program for markets
outside of the United States. In October 2000, our partners in Japan and Europe
notified us that they would terminate our relaxin development agreements with
them in accordance with the termination provisions of the respective agreements
and as of December 31, 2000, we have no further development obligations under
either agreement. Consequently, the rights for relaxin in Japan have reverted to
us, and the European rights will revert to us in April 2001.
RESULTS OF OPERATIONS
REVENUES
- -------------------------------------------------------------------------------------
Years Ended December 31,
----------------------------
(IN THOUSANDS) 2000 1999 1998
- -------------------------------------------------------------------------------------
Product:
Luxiq $10,973 $ 6,025 $ --
Ridaura 6,013 5,737 7,473
Actimmune 1,898 4,833 --
OLUX 1,211 -- --
- -------------------------------------------------------------------------------------
Total product revenues 20,095 16,595 7,473
License:
Medeva/Celltech 11,500 8,000 --
InterMune 6,768 500 --
Suntory 1,319 879 1,648
Paladin Labs 703 400 --
Immune Response 350 532 --
Faulding 39 -- --
- -------------------------------------------------------------------------------------
Total license revenues 20,679 10,311 1,648
- -------------------------------------------------------------------------------------
Total revenues $40,774 $26,906 $9,121
- -------------------------------------------------------------------------------------
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Our product revenues in 2000 were $20.1 million compared to $16.6 million
in 1999 and $7.5 million in 1998. The increase in total product sales in 2000
was due to continued sales growth of Luxiq(R) Foam (betamethasone valerate),
0.12%, which we began marketing in April 1999, and the launch of OLUX in
November 2000. Although Ridaura sales increased year to year, we believe that
Ridaura will experience decreased sales due to competition from new and existing
products. Beginning with the second quarter of 2000, in connection with our
agreement with InterMune, we sold our remaining Actimmune product rights,
effective April 1, 2000. The increase in total product sales in 1999 over 1998
was due to sales of Actimmune, which we began shipping in February 1999, and
Luxiq, which we launched in April 1999. This increase was partially offset by
lower sales of Ridaura.
License revenues were $20.7 million in 2000 compared to $10.3 million in
1999 and $1.6 million in 1998. The increase in license revenues for 2000 over
1999 includes $1.5 million paid by InterMune in connection with our sublicense
agreement, $5.2 million in connection with the sale of Actimmune product rights
to InterMune, $4.4 million related to revenue recognized in 2000 which had been
deferred January 1, 2000 in connection with the change in accounting principle
in accordance with SAB 101, and a one-time $5.0 million milestone payment from
Celltech in connection with our collaboration agreement for the development of
relaxin before Medeva gave notice of termination of the contract in October
2000. In 1999, we recorded $8.0 million in license revenue ($4.0 million of a
license fee and $4.0 million for quarterly reimbursements of product development
costs) in connection with our agreement with Medeva in relation to the
development of relaxin. In addition, we recorded $0.9 million for a milestone
payment made by Suntory, and $0.4 million for a license fee paid by Paladin
Labs. Payments made by Suntory and Paladin Labs are associated with
collaboration agreements for relaxin. The $1.6 million license revenue recorded
in 1998 was for a license fee paid by Suntory under the collaboration agreement
for relaxin. Also in 1999, we recorded $0.5 million for a license fee associated
with InterMune and $0.5 million license fee for the assignment of patent rights
to The Immune Response Corporation. We expect license revenue to fluctuate
significantly depending on when and whether we or our partners achieve
milestones under existing agreements, and on new business opportunities that we
may identify.
InterMune purchased the remaining United States commercial rights and
revenue rights to Actimmune effective April 1, 2000. As part of the transaction,
InterMune paid $5.2 million which included the prepayment of a $1.0 million
obligation owed in 2002. Prior to this transaction, Connetics had retained
rights to Actimmune revenue based on a fixed amount of unit sales in the years
1999, 2000 and 2001. Beginning with the quarter ended June 30, 2000, InterMune
has purchased all of our remaining product rights to Actimmune.
COST OF PRODUCT REVENUES
Our cost of product revenues includes the costs of Luxiq, Ridaura,
Actimmune (until April 1, 2000) and OLUX, royalty payments on these products
based on a percentage of our product revenues and product freight and
distribution costs from CORD. We recorded cost of product revenues of $3.9
million compared to $5.2 million in 1999 and $1.4 million in 1998. The decrease
in cost of product revenues from 1999 to 2000 is primarily due to discontinued
sales of Actimmune effective April 1, 2000. Actimmune cost more to manufacture
and produce than our other products do. The increase in cost of product revenues
in 1999 over 1998 was primarily due to costs associated with the sales of Luxiq
and Actimmune, which we began marketing in 1999, and higher product and royalty
costs.
LICENSE AMORTIZATION
The expenses associated with the acquisition of product rights to Ridaura
were fully amortized by December 31, 1999. Accordingly, we did not record any
amortization expense in 2000. We recorded amortization expense of $6.2 million
in 1999 associated with the acquisition of product rights to Ridaura, compared
to $6.7 million in 1998. The decrease of $0.6 million amortization expense in
1999 compared to 1998 was the result of the asset being fully amortized by the
end of November 1999 (eleven months) compared to a full year amortization in
1998.
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RESEARCH AND DEVELOPMENT
Research and development expenses were $21.9 million in 2000, $21.3 million
in 1999, and $11.4 million in 1998. In 2000, our research and development
expenses consisted of:
- manufacturing scale-up of Relaxin;
- conducting a Phase II/III trial of Relaxin for the treatment of
scleroderma;
- increasing personnel in our organization; and
- expenses associated with the initiation of clinical trials of Relaxin.
Research and development expenses for 1999 were consistent in nature with
those recognized in 2000. The increase in research and development expenses in
1999 over 1998 was due to:
- the commencement of manufacturing scale-up of Relaxin, which accounted
for approximately 70% of the increase;
- conducting a Phase II/III trial of Relaxin for the treatment of
scleroderma in 1999;
- increasing personnel in our development organization; and
- initiation of clinical trials of Relaxin for the treatment of
infertility.
We expect research and development expenses to remain at the same level for
the next few quarters, due to Relaxin clinical trial activities for new disease
indications, preclinical activities associated with technologies acquired from
Soltec, pre-manufacturing start-up costs associated with qualifying a new
supplier for OLUX, ongoing expenses related to Relaxin manufacturing, and
possible acquisitions of new technologies and products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $26.7 million in 2000,
$20.8 million in 1999, and $11.7 million in 1998. The increase in 2000 was
primarily due to:
- expenses associated with launching OLUX in the fourth quarter of 2000;
and
- increases in the number of personnel in our sales and marketing and
clinical organizations.
The increase in expenses from 1999 over 1998 was due to the following
factors:
- the increase in our sales and marketing staff compared to the same
period in 1998;
- expenses associated with the market launch of Luxiq;
- co-promotion fees for Luxiq and Ridaura; and
- stock compensation related expenses.
CHARGE FOR IN PROCESS RESEARCH AND DEVELOPMENT
There were no license fee charges in 2000. In 1999 we recorded a $1.0
million license fee charge in connection with our December licensing agreement
with Soltec for exclusive rights to certain applications of a broad range of
unique topical delivery technologies. In 1998, we recorded a $4.0 million
non-cash license fee charge associated with our interferon gamma license
agreement with Genentech. We determined that it was highly uncertain whether the
amount paid for these two licenses would be realized, as they relate to pre-FDA
approved products and are dependent on additional research and development and
do not have alternative future uses. Consequently, we expensed the full purchase
amounts.
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INTEREST AND OTHER INCOME, NET
Interest and other income, net, were $45.1 million for 2000, compared with
$1.2 million in 1999, and $0.8 million in 1998. The increase in interest and
other income in 2000 over 1999 was due to realized gains of $43.0 million from
the sale of marketable securities and higher interest income from higher cash
and short-term investment balances. The increase in interest income in 1999
compared to 1998 was due to a higher investment balance as a result of receiving
a total of $14.1 million from our corporate partnership arrangements and net
proceeds of approximately $21.9 million through a public offering of our common
stock in October 1999. Cash received in 1999 was offset in part by cash used in
operations and payment of debt obligations, including payments of approximately
$6.7 million of principal and interest to GlaxoSmithKline for rights to Ridaura
and $2.6 million principal and interest payments for a bank loan.
Interest expense was $0.2 million in 2000, compared with $0.9 million in
1999, and $1.3 million in 1998. The decrease in interest expense in 2000 from
1999 resulted from lower interest expense associated with lower balances
outstanding for obligations under capital leases, and a note payable. The
decrease in interest expense in 1999 from 1998 was the result of lower balances
for obligations under capital leases and loans, and notes payable.
INCOME TAXES
Income tax expense was $1.0 million in 2000, compared to zero in 1999 and
1998. The reason for the increase in income tax expense in 2000 compared to 1999
is that we recorded pre-tax income in 2000 as compared to net losses in 1999 and
1998. Our results for 2000 reflect a gain of $43 million on the sale of
securities in 2000. For a more complete description of our income tax position,
refer to Note 12 in our consolidated financial statements.
NET INCOME (LOSS)
In 2000, we had net income of $26.9 million, compared to net losses of
$27.3 million in 1999 and $26.6 million in 1998.
The net income in 2000 compared to the net loss in 1999 was primarily
attributable to the following:
- a $43.0 million gain on the sale of common stock of InterMune;
- increased product revenues in 2000 compared to 1999;
- no product amortization charges related to the acquisition of Ridaura in
2000 as compared to a charge of $6.2 million in 1999;
- a one-time $5.0 million milestone payment and $1.0 million of quarterly
development reimbursement from Celltech in connection with our
collaboration agreement for the development of relaxin; and
- the sale effective April 1, 2000 of our remaining Actimmune product
rights for $5.2 million to InterMune and a one-time payment of $1.5
million in connection with our exclusive sublicense agreement with
InterMune.
The increase in net loss in 1999 from 1998 was primarily due to:
- An increase of approximately $9.9 million in development activities
related primarily to Relaxin;
- Increasing personnel in the sales and marketing organization;
- Expenses associated with the launch of Luxiq;
- $1.0 million licensing charge in connection with the license of delivery
technologies from Soltec;
- Stock compensation related expenses; and
- Co-promotion fees for Luxiq and Ridaura.
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These costs were offset in part by a $17.8 million increase in product and
contract revenues, and $0.8 million increase in net interest and other income.
We expect to incur losses for the foreseeable future. These losses are
expected to fluctuate from period to period based on timing of product revenues,
clinical material purchases, clinical trial expenses, and possible acquisitions
of new products and technologies.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations to date primarily through proceeds from
equity financings, sale of investments, collaborative arrangements with
corporate partners and bank loans. At December 31, 2000, cash, cash equivalents
and short-term investments totaled $80.2 million compared to $26.3 million at
December 31, 1999, and accounts receivable totaled $2.7 million at December 31,
2000 compared to $1.6 million at December 31, 1999. Our cash balances are held
in a variety of interest-bearing instruments including high-grade corporate
bonds, commercial paper and money market accounts.
Cash Flows from Operating Activities. Cash used in operations for 2000 was
$15.3 million compared with $14.1 million in 1999 and $12.0 million in 1998. Net
income of $27.0 million for 2000 was affected by the gain on sale of InterMune
stock of $43.0 million and non-cash charges of $0.8 million of depreciation and
amortization expense and $1.0 million non-cash compensation expense. The primary
reason for the decrease in operating cash flows was due to the decrease in
accrued and other current liabilities.
Net loss of $27.3 million for 1999 was affected by non-cash charges of $6.7
million depreciation and amortization expense and $1.3 million deferred
compensation expense. Cash outflow for 1999 was primarily for operating
activities, including growth in inventory due primarily to carrying three
products, and increases in accounts receivable due to higher product sales. Cash
usage was partially offset by an increase in accounts payable and accrued
liabilities related to higher development, sales and marketing expenses. The
1998 net loss was affected by a number of charges that did not use cash,
including a $4.0 million charge for the write-off of technology licensed in
exchange for common stock, $6.7 million of amortization expense and $0.5 million
of imputed interest expense associated with the acquisition of Ridaura. Cash
outflow for 1998 was primarily for operating activities and approximately $3.6
million in principal and interest payments to GlaxoSmithKline.
Cash Flows from Investing Activities. Cash provided by investing
activities for 2000 was $44.2 million compared with cash used in investing
activities of $10.3 million in 1999 and $2.9 million in 1998. The increase in
cash from investing activities in 2000 was primarily related to $43.0 million of
proceeds from the sale of shares of InterMune stock. Cash outlays in 2000 were
due to equipment expenditures required for operations. Cash outlays in 1999 were
due to leasehold improvements and equipment expenditures required for
operations. Cash outlays in 1998 included $0.2 million for equipment
expenditures required for operations and $0.3 million for fulfillment of
obligations under the equity and asset purchase agreements with GlaxoSmithKline.
Cash Flows from Financing Activities. Cash provided by financing
activities was $21.3 million in 2000 compared to $18.2 million in 1999 and $21.1
million in 1998. Cash provided by financing activities in 2000 included $23.8
million of cash proceeds from the issuance of stock, offset by $4.5 million of
note and lease payments. Of the $23.8 million of cash proceeds, $20.0 million
relates to a private placement of 2,010,000 shares of Connetics' unregistered
common stock.
Financing activities in 1999 included the receipt of proceeds of $4.4
million from the sale of common stock to Celltech and Paladin Labs, and $21.9
million in a public offering of our common stock. This was offset in part by a
$6.3 million principal payment to GlaxoSmithKline for obligations under a
promissory note in connection with the Ridaura acquisition, $2.3 million pay
down on a bank loan and $0.5 million in payments under capital leases and loans.
In 1998 we raised $22.7 million through private sales of our common stock and
obtained $4.0 million through a bank loan, offset in part by $2.8 million in
payments on obligations under capital leases and loans and principal payments of
$3.2 million to GlaxoSmithKline.
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Working Capital. Working capital increased to $71.0 million at December
31, 2000, from $13.4 million at December 31, 1999. The increase in working
capital was due to a $20.0 million private placement of our common stock and the
$5.2 million sale of Actimmune rights to InterMune and the $43.0 million of
proceeds from the sale of stock of InterMune, partially offset by cash used for
operations.
The increase in working capital in 1999 compared to 1998 was due to
proceeds from our public offering of common stock and payments received from our
corporate partnering arrangements, offset in part by our use of cash in
operations, higher accounts payable and accrued liabilities as a result of
increased development, sales and marketing expenses, and payment of debt
obligations.
As of December 31, 2000, we had $1.7 million in future obligations for
non-cancelable operating leases, which are to be paid in 2003.
We believe our existing cash, cash equivalents and short-term investments,
cash generated from product sales and collaborative arrangements with corporate
partners, will be sufficient to fund our operating expenses, debt obligations
and capital requirements through at least the next 18 months. Our future capital
uses and requirements depend on numerous factors, including the progress of our
research and development programs, the progress of clinical testing, the time
and costs involved in obtaining regulatory approvals, the cost of filing,
prosecuting, and enforcing patent claims and other intellectual property rights,
competing technological and market developments, our ability to establish other
collaborative arrangements, the level of product revenues, the possible
acquisition of new products and technologies and the development of
commercialization activities. Therefore such capital uses and requirements may
increase in future periods. As a result, we may require additional funds prior
to reaching profitability and may attempt to raise additional funds through
equity or debt financings, collaborative arrangements with corporate partners or
from other sources.
We currently have no commitments for any additional financings. If we need
to raise additional money to fund our operations, funding may not be available
to us on acceptable terms, or at all. If we are unable to raise additional funds
when needed, we may not be able to market our products as planned or continue
development of our other products, or we could be required to delay, scale back
or eliminate some or all of our research and development programs.
RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133), which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that we recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. We are required to adopt SFAS 133 effective January
1, 2001. Because we do not hold any derivative instruments and do not engage in
hedging activities, we do not believe that adopting SFAS 133 will have and
impact on our financial position or results of operations.
FACTORS THAT MAY AFFECT FORWARD-LOOKING STATEMENTS
A wide range of factors could materially affect our future developments and
performance, including the following:
- We have a limited operating history and are subject to the uncertainties
and risks associated with any new business. We have experienced
operating losses every year since our incorporation and expect to incur
additional losses for at least the next few years. Losses are expected
to fluctuate from period to period based on timing of product revenues,
clinical material purchases, possible acquisitions of new products and
technologies, scale-up activities and clinical activities. Therefore,
the time for us to reach profitability is uncertain and there can be no
assurance that we will ever be able to generate revenue from our
products now under development or achieve profitability on a sustained
basis.
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- There are risks related to the management of the marketing and sales of
our products. Our success depends in part on our ability to effectively
manage the distribution of our products and to market and sell our
products successfully. If Luxiq and OLUX do not sustain market
acceptance, our financial condition and results of operations will be
adversely affected. Future revenues from sales are uncertain as we are
subject to patent risks and competition from new products.
- Our products for research, preclinical testing and sale have been
supplied by collaborators and contract manufacturing companies. We
currently have no manufacturing facilities nor do we intend to develop
such capabilities in the near future. The failure of any of our contract
manufacturers to provide products for clinical testing or to manufacture
products on a commercial scale on a timely basis will have a material
adverse effect on our results of operations.
- We are subject to uncertainties associated with product development and
market acceptance. Several of our products are in clinical or
preclinical development. There can be no assurance that products under
development will be safe and effective, approved by the FDA, produced in
commercial quantities at reasonable costs or will gain satisfactory
market acceptance.
- Our future capital uses and requirements depend on numerous factors,
including costs associated with the research, development, clinical
testing and obtaining regulatory approvals of products in our pipeline;
enforcing patent claims and intellectual property rights; acquisition of
new products and technologies; commercialization activities and the
ability to establish collaborative arrangements. Such requirements may
increase in the future and we may attempt to raise additional funds
through equity or debt financings, collaborative arrangements or from
other sources. Future financings could have a dilutive effect on our
stockholders.
- A key element of our strategy is to in-license or acquire additional
marketed or late-stage development products, which involve risks. A
portion of the funds needed to acquire, develop and market any new
products may come from our existing cash, which will result in fewer
resources available to our current products and clinical programs. We
may also have to recruit additional qualified employees to manage the
development, marketing, sale and distribution of newly acquired
products. We cannot assure you that newly acquired products will achieve
the marketing or therapeutic success expected of them by us, industry
analysts or others at the time of acquisition.
- Our success will depend in part on our ability to preserve our trade
secrets, to operate without infringing the proprietary rights of third
parties, and to obtain patent protection for our products and processes.
Products or processes made, used or sold by us may be covered by patents
held by third parties that could prevent us from practicing the subject
matter, require us to obtain licenses or redesign our products or
processes to avoid infringement. The patent positions can be highly
uncertain and involve complex legal and factual questions. Accordingly,
the breadth of such claims cannot be predicted. Patent disputes are
frequent and we could in the future be involved in material patent
litigation.
This list of factors that may affect future performance and the accuracy of
forward-looking statements is illustrative, but by no means exhaustive.
Accordingly, all forward-looking statements should be evaluated with the
understanding of their inherent uncertainty.
OUR BUSINESS STRATEGY MAY CAUSE FLUCTUATING OPERATING RESULTS
Our operating results and financial condition may fluctuate from quarter to
quarter and year to year depending upon the relative timing of events or
uncertainties which may arise. For example, the following events or occurrences
could cause fluctuations in our financial performance from period to period:
- changes in the levels we spend to develop new product lines
- changes in the amount we spend to promote our products
- changes in treatment practices of physicians that currently prescribe
our products
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- changes in reimbursement policies of health plans and other similar
health insurers, including changes that affect newly developed or newly
acquired products
- increases in the cost of raw materials used to manufacture our products
- the development of new competitive products by others
- the mix of products that we sell during any time period
- our responses to price competition
- forward-buying patterns by wholesalers that may result in significant
quarterly swings in revenue reporting.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK. Our holdings of financial instruments comprise a mix
of securities that may include U.S. corporate debt, U.S. government debt, and
commercial paper. All such instruments are classified as securities available
for sale. Generally, we do not invest in portfolio equity securities or
commodities or use financial derivatives for trading purposes. Our market risk
exposure consists principally of exposure to changes in interest rates. The
table below presents the principal amounts and weighted average interest rates
by year of maturity for our investment portfolio as of December 31, 2000 (in
thousands):
- ---------------------------------------------------------------------------------------
2001 2002 Total Fair Value
- ---------------------------------------------------------------------------------------
Available-for-sale securities $21,607 -- $21,607 $ 21,607
Weighted average interest rate 7.55% --
- ---------------------------------------------------------------------------------------
FOREIGN CURRENCY EXCHANGE RISK. We make payments to CCL Pharmaceuticals
for the production of Luxiq and OLUX in pounds sterling, and to Boehringer
Ingelheim for the production of relaxin in Austrian schillings. If the U.S.
dollar depreciates against the schilling or the pound, the payments that we must
make will increase, which will increase our expenses. We have a bank loan that
is sensitive to movement in interest rates. Interest income from our investments
is sensitive to changes in the general level of U.S. interest rates,
particularly since the majority of our investments are in short-term
instruments. Due to the nature of our short-term investments, we have concluded
that we face minimal material market risk exposure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section to this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
We have had no changes in or disagreements with our independent public
accountants on accounting and financial disclosure.
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PART III
ITEM 10. OUR DIRECTORS AND EXECUTIVE OFFICERS
Information regarding our Board of Directors is incorporated by reference
to the sections entitled "Election of Directors" and "Further Information
Concerning the Board of Directors" in our Proxy Statement ("2001 Proxy
Statement") to be filed with the Securities and Exchange Commission relating to
our annual meeting of stockholders to be held May 17, 2001.
The following table shows information about our executive officers as of
March 23, 2001:
NAME AGE POSITION
Thomas G. Wiggans 49 President, Chief Executive Officer and Director
- ---------------------------------------------------------------------------------------------------
C. Gregory Vontz 40 Chief Operating Officer
- ---------------------------------------------------------------------------------------------------
John L. Higgins 31 Chief Financial Officer; Executive Vice President, Finance
and Administration
- ---------------------------------------------------------------------------------------------------
Robert G. Lederer 56 Sr. Vice President, Commercial Operations
- ---------------------------------------------------------------------------------------------------
Katrina J. Church 39 Sr. Vice President, Legal Affairs, General Counsel and
Secretary
- ---------------------------------------------------------------------------------------------------
M. Sue Preston 48 Sr. Vice President, Regulatory and Quality Affairs
- ---------------------------------------------------------------------------------------------------
Rebecca Gardiner 38 Vice President, Human Resources
Thomas G. Wiggans has served as President, Chief Executive Officer and as a
director since July 1994. From February 1992 to April 1994, Mr. Wiggans served
as President and Chief Operating Officer of CytoTherapeutics, a biotechnology
company. From 1980 to February 1992, Mr. Wiggans served in various positions at
Ares-Serono Group, a pharmaceutical company, including President of its U.S.
pharmaceutical operations and Managing Director of its U.K. pharmaceutical
operations. From 1976 to 1980 he held various sales and marketing positions with
Eli Lilly & Co., a pharmaceutical company. He is currently a director of the
Biotechnology Industry Organization (BIO), and a member of its Emerging Company
Section. He is also a director of Paladin Labs, a public Canadian pharmaceutical
company. He is also Chairman of the Biotechnology Institute, a non-profit
educational organization. Mr. Wiggans received a B.S. in Pharmacy from the
University of Kansas and an M.B.A. from Southern Methodist University.
C. Gregory Vontz joined the Company as Executive Vice President, Chief
Commercial Officer in December of 1999. He was promoted to Chief Operating
Officer in January 2001. Before joining the Company, Mr. Vontz spent 12 years
with Genentech, Inc., most recently as Director of New Markets and Healthcare
Policy. Before joining Genentech, Inc. in 1987, Mr. Vontz worked for Merck &
Co., Inc. Mr. Vontz received his B.S. in Chemistry from the University of
Florida and his M.B.A. from the Haas School of Business at University of
California at Berkeley.
John L. Higgins has served as Chief Financial Officer since September 1997,
and as Executive Vice President, Finance and Administration, since January 2000.
He served as Vice President, Finance and Administration from the time he joined
Connetics through December 1999. Prior to joining Connetics, he was a member of
the executive management team at BioCryst Pharmaceuticals, Inc. Before joining
BioCryst in 1994, Mr. Higgins was a member of the healthcare banking team of
Dillon, Read & Co. Inc., an investment banking firm. He is on the Board of
Directors of InterMune Pharmaceuticals, Inc. He received his A.B. from Colgate
University.
Robert G. Lederer joined Connetics as Senior Vice President, Marketing and
Sales in July 1998, and has served as Senior Vice President, Commercial
Operations since January 1999. Before joining the Company, Mr. Lederer spent 15
years with Serono Laboratories, most recently as the Executive Vice President
for Business Operations. Before joining Serono, Mr. Lederer held sales and
management
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positions with Becton Dickinson and Genovese Drugs. Mr. Lederer received his
B.A. from St. John's University in New York.
Katrina J. Church joined Connetics as Vice President, Legal Affairs and
Corporate Counsel in June 1998, and has served as Secretary since September
1998. She has served as Senior Vice President, Legal Affairs and General Counsel
since January 2000. Prior to joining Connetics, Ms. Church served in various
positions at VISX, Incorporated, most recently as Vice President, General
Counsel. Before joining VISX in 1991, Ms. Church practiced law with the firm
Hopkins & Carley in San Jose, California. Ms. Church received her J.D. from the
New York University School of Law, and her A.B. from Duke University.
M. Sue Preston has served as Senior Vice President, Regulatory and Quality
Affairs since October 2000. Prior to joining Connetics, she spent seven years at
Alpha Therapeutic Corporation with executive management responsibility in
quality control, quality assurance, and regulatory affairs, most recently as
Corporate Vice President, Worldwide Regulatory Affairs. Before joining Alpha
Therapeutic in 1993, Ms. Preston held various quality and regulatory positions
with Baxter Healthcare, Neocrin, and Medarex. From 1980 to 1988, Ms. Preston
worked in the Center for Biologics Evaluation and Research at the Food and Drug
Administration. Ms. Preston received her B.A. from Lycoming College and did
graduate work at American University and the University of Maryland.
Rebecca Gardiner joined Connetics in 1996 as Director of Human Resources.
She has served as Vice President of Human Resources since December 1999. She
worked at COR Therapeutics from 1990 to 1996 in the positions of Manager of
Research Administration, Manager of Human Resources, and Senior Manager of Human
Resources. Ms. Gardiner also worked at Genelabs as Manager of Research
Administration from 1988 to 1990, at Genentech in 1987, and in various hospital
administration positions from 1984 to 1987. Ms. Gardiner received her B.A. from
UC Santa Barbara and her M.P.A./H.S.A. from the University of San Francisco.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated by reference
to the information set forth under the caption "Executive Compensation and
Related Information" in our 2001 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding the beneficial ownership of our common stock by
certain beneficial owners and by our directors and management is incorporated
into this item by reference to the information set forth under the caption
"Common Stock Ownership of Certain Beneficial Owners and Management" in our 2001
Proxy Statement
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
incorporated by reference to the information set forth under the caption
"Certain Relationships and Related Transactions" in our 2001 Proxy Statement.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) 1. Financial Statements. See Index to Consolidated Financial Statements at
Item 8 on Page 33 of this Report.
2. Financial Statement Schedules. Financial statement Schedule
II -- Valuation and Qualifying Accounts, is included at page 37 of this
Report. All other schedules have been omitted because the required
information is either not applicable, not sufficiently material to
require submission of the schedule, or is included in the consolidated
financial statements or the notes to the consolidated financial
statements.
3. The Exhibits filed as a part of this Report are listed in the Index to
Exhibits.
(B) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the fourth
quarter of 2000. On April 2, 2001, we filed a report on Form 8-K relating
to the proposed acquisition of Soltec Research Pty Ltd. That acquisition is
scheduled to close on or about April 2, 2001.
(C) EXHIBITS. See Index to Exhibits.
(D) FINANCIAL STATEMENT SCHEDULES. See Item 14(a)(2), above.
36
38
CONNETICS CORPORATION
FINANCIAL STATEMENT SCHEDULES
The following additional consolidated financial statement schedule should
be considered in conjunction with our consolidated financial statements. No
applicable amounts were recorded in 1999 or 1998.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------------------------------------------------------------------------
Balance at start Additions Charged Balance at end
Year Ended December 31, 2000 of period to Expense Deductions of period
- ------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts $ -- $200,000 $ -- $200,000
- ------------------------------------------------------------------------------------------------------
37
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Connetics Corporation
a Delaware corporation
By: /s/ JOHN L. HIGGINS
------------------------------------
John L. Higgins
Executive Vice President, Finance
and
Administration and Chief Financial
Officer
Date: March 28, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
PRINCIPAL EXECUTIVE OFFICER:
/s/ THOMAS G. WIGGANS President, Chief Executive March 28, 2001
- --------------------------------------------------- Officer and Director
Thomas G. Wiggans
PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:
/s/ JOHN L. HIGGINS Executive Vice President, March 28, 2001
- --------------------------------------------------- Finance and Administration
John L. Higgins and Chief Financial Officer
DIRECTORS:
/s/ ALEXANDER E. BARKAS Director March 28, 2001
- ---------------------------------------------------
Alexander E. Barkas
/s/ EUGENE A. BAUER Director March 28, 2001
- ---------------------------------------------------
Eugene A. Bauer
/s/ BRIAN H. DOVEY Director March 28, 2001
- ---------------------------------------------------
Brian H. Dovey
/s/ JOHN C. KANE Director March 28, 2001
- ---------------------------------------------------
John C. Kane
38
40
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ THOMAS D. KILEY Director March 28, 2001
- ---------------------------------------------------
Thomas D. Kiley
/s/ GLENN OCLASSEN Director March 28, 2001
- ---------------------------------------------------
Glenn Oclassen
/s/ LEON E. PANETTA Director March 28, 2001
- ---------------------------------------------------
Leon E. Panetta
/s/ G. KIRK RAAB Chairman of the Board, Director March 28, 2001
- ---------------------------------------------------
G. Kirk Raab
39
41
CONNETICS CORPORATION
INDEX TO EXHIBITS
[Item 14(c)]
EXHIBIT NUMBER DESCRIPTION
3.1* Form of Amended and Restated Certificate of Incorporation
(previously filed as an exhibit to Form S-1 Registration
Statement No. 33-80261)
3.2* Form of Bylaws (previously filed as an exhibit to Form S-1
Registration Statement No. 33-80261)
3.3* Amendment to the Company's Amended and Restated Certificate
of Incorporation, as filed with the Delaware Secretary of
State on May 15, 1997 (previously filed as an exhibit to the
Company's Report on Form 8-K dated May 23, 1997, Commission
file number 0-27406)
3.4* Certificate of Designation of Rights, Preferences and
Privileges of Series B Participating Preferred Stock, as
filed with the Delaware Secretary of State on May 15, 1997.
Reference is made to Exhibit 4.2.
4.1* Form of Common Stock Certificate (previously filed as
Exhibit 4.1 to the Company's Report on Form 10-K for the
year ended December 31, 1998, Commission file number
0-27406)
4.2* Preferred Shares Rights Agreement, dated as of May 20, 1997,
between the Company and U.S. Stock Transfer Corporation,
including the Certificate of Designation of Rights,
Preferences and Privileges of Series B Participating
Preferred Stock, the form of Rights Certificate and the
Summary of Rights attached thereto as Exhibits A, B and C,
respectively (previously filed as an exhibit to Registration
Statement on Form 8-A filed on May 23, 1997, Commission file
number 0-27406)
10.1* Form of Indemnification Agreement with the Company's
directors and officers (previously filed as an exhibit to
the Company's Form S-1 Registration Statement No. 33-80261)
10.2(M)* 1994 Stock Plan, (as amended through May 1999) and form of
Option Agreement (previously filed as Exhibit 4.1 to the
Company's Form S-8 Registration Statement No. 333-85155)
10.3(M)* 1995 Employee Stock Purchase Plan, (as amended through May
2000), and form of Subscription Agreement (previously filed
as Exhibit 4.1 to the Company's Form S-8 Registration
Statement No. 333-46562)
10.4(M)* 1995 Directors' Stock Option Plan, (as amended through May
1999), and form of Option Agreement (previously filed as
Exhibit 4.2 to the Company's Form S-8 Registration Statement
No. 333-85155)
10.5+* License Agreement dated September 27, 1993, between
Genentech, Inc. and Connetics, Amendment dated July 14,
1994, and side letter agreement dated November 17, 1994
(previously filed as an exhibit to Form S-1 Registration
Statement No. 33-80261)
10.9* Business Loan Agreement, dated July 18, 1995, among
Connetics, Silicon Valley Bank and MMC/GATX Partnership No.
1 (previously filed as an exhibit to Form S-1 Registration
Statement No. 33-80261)
10.10* Consulting Agreement dated November 17, 1993 between
Connetics and Brian Seed (previously filed as an exhibit to
Form S-1 Registration Statement No. 33-80261)
10.11* Consulting Agreement dated November 17, 1993 between
Connetics and Eugene Bauer (previously filed as an exhibit
to Form S-1 Registration Statement No. 33-80261)
10.12(M)* Employment Agreement dated June 9, 1994 between Connetics
and Thomas Wiggans (previously filed as an exhibit to the
Company's Form S-1 Registration Statement No. 33-80261)
10.13(M)* Loan Agreements between the Company and Thomas Wiggans dated
July 15, 1994 and August 1, 1994 (previously filed as an
exhibit to Form S-1 Registration Statement No. 33-80261)
10.14(M)* Letter Agreement with G. Kirk Raab dated October 1, 1995
(previously filed as an exhibit to Form S-1 Registration
Statement No. 33-80261)
40
42
EXHIBIT NUMBER DESCRIPTION
10.15* Facility Master Lease between the Company and Renault &
Handley dated February 9, 1994 (previously filed as an
exhibit to Form S-1 Registration Statement No. 33-80261)
10.16* Loan and Security Agreement dated December 21, 1995 by and
among the Company, Silicon Valley Bank and MMC/GATX
Partnership No. 1 (previously filed as an exhibit to Form
S-1 Registration Statement No. 33-80261)
10.17+* Agreement on Relaxin Rights in Asia dated April 1, 1996
between the Company and Mitsubishi Chemical Corporation
(previously filed as an exhibit to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended June 30,
1996)
10.18+* Soltec License Agreement dated June 14, 1996 (previously
filed as an exhibit to the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended June 30, 1996)
10.19(M)* Form of Directors and Officers Change in Control Agreement
(previously filed as an exhibit to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended September
30, 1996)
10.20* Warrant, dated December 4, 1996 between Connetics and a
certain purchaser (previously filed as an exhibit to the
Company's Report on Form 8-K dated December 4, 1996)
10.21+* Asset Purchase Agreement dated December 2, 1996 between
Connetics, SmithKline Beecham Corporation, SmithKline
Beecham Pharma Inc., SmithKline Beecham Properties, Inc. and
SmithKline Beecham Inter-American Corporation (previously
filed as an exhibit to the Company's Report on Form 8-K
dated January 15, 1997)
10.22* Stock Issuance Agreement dated December 31, 1996 between
Connetics and SmithKline Beecham Properties, Inc (previously
filed as an exhibit to the Company's Report on Form 8-K
dated January 15, 1997)
10.23* Secured Promissory Note dated December 31, 1996 issued to
SmithKline Beecham Corporation (previously filed as an
exhibit to the Company's Report on Form 8-K dated January
15, 1997)
10.24* Security Agreement dated December 31, 1996 between Connetics
and SmithKline Beecham Corporation (previously filed as an
exhibit to the Company's Report on Form 8-K dated January
15, 1997)
10.25+* Supply Agreement dated December 31, 1996 between Connetics
and SmithKline Beecham Corporation (previously filed as an
exhibit to the Company's Report on Form 8-K dated January
15, 1997)
10.26* Structured Equity Line Flexible Financing Agreement dated
January 2, 1997 between Connetics and Kepler Capital LLC
(previously filed as an exhibit to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1996, and as Exhibit 10.1 to the Company's Form S-3
Registration Statement No. 333-45002)
10.27* Registration Rights Agreement dated January 2, 1997 between
Connetics and Kepler Capital LLC (previously filed as an
exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1996)
10.28(M)* Form of Notice of Stock Option Grant to G. Kirk Raab for
stock option issued in January 1997 (previously filed as an
exhibit to Form S-8 Registration Statement No. 333-04985)
10.29* Common Stock and Warrant Purchase Agreement dated May 15,
1997 by and among Connetics, Genentech, Inc. and certain
investors (previously filed as an exhibit to the Company's
Current Report on Form 8-K dated May 23, 1997)
10.30* Registration Rights agreement dated May 15, 1997 by and
among Connetics and certain investors (previously filed as
an exhibit to the Company's Current Report on Form 8-K dated
May 23, 1997)
10.31* Form of Common Stock Purchase Warrant issued to certain
investors on May 16, 1997 (previously filed as an exhibit to
the Company's Current Report on Form 8-K dated May 23, 1997)
41
43
EXHIBIT NUMBER DESCRIPTION
10.32* Amendment dated November 13, 1997 to Secured Promissory Note
dated December 31, 1996 issued to SmithKline Beecham
Corporation (previously filed as an exhibit to Form S-1
Registration Statement No. 333-41195)
10.33* Omnibus Agreement with SmithKline Beecham Corporation and
related entities dated December 18, 1997 (previously filed
as an exhibit to Form S-1 Registration Statement No.
333-41195)
10.34* Canadian Asset Purchase Agreement with Pharmascience, Inc.
dated December 19, 1997 (previously filed as an exhibit to
Form S-1 Registration Statement No. 333-41195)
10.35* Supply Agreement with Pharmascience, Inc. dated December 19,
1997 (previously filed as an exhibit to Form S-1
Registration Statement No. 333-41195)
10.36*+ License Agreement dated January 1, 1998 between Connetics
and Soltec Research Pty Limited (previously filed as an
exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997)
10.37*+ Agreement on Relaxin dated January 19, 1998 by and between
Connetics and Howard Florey Institute of Experimental
Physiology and Medicine (previously filed as an exhibit to
the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997)
10.38* Common Stock Purchase Agreement dated April 10, 1998 by and
among Connetics and certain investors (previously filed as
Exhibit 10.1 to the Company's Report on Form 8-K dated May
6, 1998)
10.39*+ Agreement dated as of April 23, 1998 between Connetics and
Suntory Limited (previously filed as Exhibit 10.1 to the
Company's Report on Form 10-Q for the quarter ended June 30,
1998)
10.40*+ Second Omnibus Agreement with SmithKline Beecham Corporation
and related entities dated April 28, 1998 (previously filed
as an exhibit to the Company's Current Report on Form 8-K
filed May 6, 1998)
10.41*+ License Agreement dated as of May 5, 1998 between Connetics
and Genentech, Inc. (previously filed as Exhibit 10.2 to the
Company's Report on Form 10-Q for the quarter ended June 30,
1998)
10.42*+ Supply Agreement dated as of May 5, 1998 between Connetics
and Genentech, Inc. (previously filed as Exhibit 10.3 to the
Company's Report on Form 10-Q for the quarter ended June 30,
1998)
10.43* Stock Purchase Agreement dated May 5, 1998 between Connetics
and Genentech, Inc. (previously filed as Exhibit 10.4 to
Form S-3 Registration Statement No. 333-69055)
10.44* Common Stock Purchase Agreement dated November 20, 1998 by
and among Connetics and certain investors (previously filed
as Exhibit 10.1 to Form S-3 Registration Statement No.
333-69055)
10.45* Registration Rights Agreement dated November 20, 1998 by and
among Connetics and certain investors (previously filed as
Exhibit 10.2 to Form S-3 Registration Statement No.
333-69055)
10.46*(M) Secured Loan Agreement and associated documents dated
January 9, 1998, between Connetics and John L. Higgins
(previously filed as Exhibit 10.55 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.47*(M) Letter of Employment dated July 1, 1998 from Connetics to
Robert G. Lederer (previously filed as Exhibit 10.56 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.48*(M) Loan Agreement and associated documents dated August 21,
1998, between the Company and Robert G. Lederer (previously
filed as Exhibit 10.57 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998)
10.49* Loan and Security Agreement between Silicon Valley Bank and
the Company dated September 24, 1998, as modified December
22, 1998 pursuant to a Loan Modification Agreement
(previously filed as Exhibit 10.58 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998)
42
44
EXHIBIT NUMBER DESCRIPTION
10.50*(M) Restricted Common Stock Purchase Agreement dated November 5,
1998 between the Company and Kirk Raab (previously filed as
Exhibit 10.59 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.51*(M) 1998 Supplemental Stock Plan (previously filed as Exhibit
10.60 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1998)
10.52* Industrial Building Lease dated November 20, 1998, by and
between the Company and West Bayshore Associates, a general
partnership, et al. (previously filed as Exhibit 10.61 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.53*+ Relaxin Scale-up and Bulk Supply Agreement effective as of
December 1, 1998, by and between the Company and Bender +
Co. Ges.m.b.H. (previously filed as Exhibit 10.62 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.54* Amendment No. One to License Agreement, effective December
28, 1998, between Connetics and Genentech (previously filed
as Exhibit 10.63 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.55* Amendment No. One to Stock Purchase Agreement, effective
December 28, 1998, between Connetics and Genentech
(previously filed as Exhibit 10.64 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998)
10.56*+ Relaxin Development, Commercialization and License Agreement
dated January 11, 1999 by and between Connetics and Medeva
Pharmaceuticals, Inc. (previously filed as Exhibit 10.65 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998)
10.57* Common Stock Purchase Agreement, dated January 11, 1999, by
and between Connetics and Medeva PLC (previously filed as
Exhibit 10.66 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.58* Registration Rights Agreement, dated January 11, 1999 by and
between Connetics and Medeva PLC (previously filed as
Exhibit 10.67 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.59* Promotion Agreement effective as of April 1, 1999 between
the Company and MGI Pharma, Inc. (previously filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 30, 1999)
10.60* Co-promotion Agreement effective as of April 1, 1999 between
the Company and MGI Pharma, Inc. (previously filed as
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 30, 1999)
10.61* Amendment No. Two to License Agreement, effective as of
January 15, 1999, between the Company and Genentech, Inc.
(previously filed as Exhibit 10.3 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 30,
1999)
10.62*+ Amendment No. Three to License Agreement, effective as of
April 27, 1999, between the Company and Genentech, Inc.
(previously filed as Exhibit 10.4 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 30,
1999)
10.63*(M) Restricted Common Stock Purchase Agreement dated March 9,
1999 between the Company and Kirk Raab (previously filed as
Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 30, 1999)
10.64*(M) Restricted Common Stock Purchase Agreement dated March 9,
1999 between the Company and Thomas G. Wiggans (previously
filed as Exhibit 10.6 to the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended March 30, 1999)
10.65* Collaboration Agreement dated April 27, 1999 between the
Company and InterMune Pharmaceuticals, Inc. (previously
filed as Exhibit 10.7 to the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended March 30, 1999)
10.66* Series A-1 and A-2 Preferred Stock Purchase Agreement dated
April 27, 1999 among the Company, InterMune Pharmaceuticals,
Inc., and various other investors (previously filed as
Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 30, 1999)
43
45
EXHIBIT NUMBER DESCRIPTION
10.67*+ Transition Agreement dated April 27, 1999 between the
Company and InterMune Pharmaceuticals, Inc. (previously
filed as Exhibit 10.9 to the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended March 30, 1999)
10.68*+ Relaxin Development, Commercialization and License Agreement
dated July 7, 1999 between the Company and Paladin Labs Inc.
(previously filed as Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended June 30,
1999)
10.69* Common Stock Purchase Agreement dated July 7, 1999 between
the Company and Paladin Labs Inc. (previously filed as
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended June 30, 1999)
10.70* Registration Rights Agreement dated July 7, 1999 between the
Company and Paladin Labs Inc. (previously filed as Exhibit
10.3 to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended June 30, 1999)
10.71*+ License Agreement (Ketoconazole) dated July 14, 1999 between
the Company and Soltec Research Pty Ltd. (previously filed
as Exhibit 10.4 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended June 30, 1999)
10.72* Stock Plan (2000) and form of Option Agreement (previously
filed as Exhibit 4.4 to the Company's Form S-8 Registration
Statement No. 333-85155)
10.73*+ Agreement dated December 9, 1999 between the Company and
Soltec Research Pty Ltd. (previously filed as Exhibit 10.75
to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1999)
10.74* Common Stock Purchase Agreement dated June 20, 2000 between
the Company and the investors named therein (previously
filed as Exhibit 10.1 to the Company's Current Report on
Form 8-K dated June 20, 2000 and filed with the Commission
on July 18, 2000, Commission File No. 0-27406)
10.75* Registration Rights Agreement dated June 20, 2000 between
the Company and the investors named therein (previously
filed as Exhibit 10.2 to the Company's Current Report on
Form 8-K dated June 20, 2000 and filed with the Commission
on July 18, 2000, Commission File No. 0-27406)
10.76 2000 Non-Officer Employee Stock Plan (previously filed as
Exhibit 4.3 to the Company's Form S-8 Registration Statement
No. 333-46562)
10.77(M) Consulting Agreement effective April 1, 2000 between the
Company and Leon Panetta
10.78(M) Consulting Agreement dated January 10, 2001 between the
Company and Glenn Oclassen
10.79*(C) Share Sale Agreement dated March 21, 2001 among the Company,
F. H. Faulding & Co. Ltd., Faulding Healthcare, and
Connetics Australia Pty Ltd. (previously filed as Exhibit
2.1 to the Company's Current Report on Form 8-K dated March
20, 2001 and filed with the Commission on April 2, 2001,
Commission File No. 0-27406)
23.1 Consent of Ernst & Young LLP, Independent Auditors
Key to Footnotes:
* Incorporated by this reference to the previous filing, as
indicated.
(M) This item is a management compensatory plan or arrangement
required to be listed as an exhibit to this Report pursuant
to Item 601(b)(10)(iii) of Regulation S-K.
(C) We have omitted certain portions of this Exhibit and have
requested confidential treatment of such portions from the
SEC.
+ We have requested and the SEC has granted confidential
treatment for certain portions of this Exhibit.
44
46
CONNETICS CORPORATION
FORM 10-K (ITEM 8)
LIST OF CONSOLIDATED FINANCIAL STATEMENTS
The following Financial Statements and Report of Independent Auditors are
filed as part of this Report:
- ------------------------------------------------------------------
PAGE
- ------------------------------------------------------------------
Report of Ernst & Young LLP, Independent Auditors F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statement of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
- ------------------------------------------------------------------
F-1
47
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
BOARD OF DIRECTORS AND STOCKHOLDERS
CONNETICS CORPORATION
We have audited the accompanying consolidated balance sheets of Connetics
Corporation as of December 31, 2000 and 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2000. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Connetics
Corporation at December 31, 2000 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
As discussed in Note 1 to the consolidated financial statements, in 2000
the Company changed its method of accounting for nonrefundable license fee
revenue.
ERNST & YOUNG LLP
Palo Alto, California
February 2, 2001
F-2
48
CONNETICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
December 31,
---------------------
---------------------
2000 1999
- -----------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 58,577 $ 8,460
Short-term investments 21,607 17,839
Accounts receivable, net 2,749 1,608
Other current assets 545 817
- -----------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 83,478 28,724
Property and equipment, net 1,807 1,505
Deposits and other assets 428 181
- -----------------------------------------------------------------------------------
TOTAL ASSETS $ 85,713 $ 30,410
- -----------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,208 $ 4,988
Accrued liabilities 2,271 1,945
Current portion of deferred revenue 132 --
Accrued process development expenses 1,736 3,296
Accrued payroll and related expenses 1,797 1,453
Current portion of notes payable 750 2,541
Other current liabilities 517 1,053
Current portion of capital lease obligations 37 47
- -----------------------------------------------------------------------------------
Total current liabilities 12,448 15,323
Non-current portion of capital lease obligations and
long-term debt -- 799
Deferred revenue 659 --
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value:
5,000,000 shares authorized; none issued or outstanding
in 2000 and 1999 -- --
Common stock, $0.001 par value, and additional paid-in
capital:
50,000,000 shares authorized; shares issued and
outstanding: 29,684,854 in 2000 and 26,903,716 in 1999 159,242 133,963
Deferred compensation (21) (39)
Accumulated deficit (92,756) (119,752)
Accumulated other comprehensive income 6,141 116
- -----------------------------------------------------------------------------------
Total stockholders' equity 72,606 14,288
- -----------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 85,713 $ 30,410
- -----------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
F-3
49
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
Years Ended December 31,
--------------------------------
--------------------------------
2000 1999 1998
- ---------------------------------------------------------------------------------------------
REVENUES:
Product $ 20,095 $ 16,595 $ 7,473
License 20,679 10,311 1,648
- ---------------------------------------------------------------------------------------------
Total revenues 40,774 26,906 9,121
OPERATING COSTS AND EXPENSES:
Cost of product revenues 3,868 5,229 1,374
License amortization -- 6,160 6,720
Research and development 21,875 21,309 11,446
Selling, general and administrative 26,673 20,834 11,680
Charge for in process research and development -- 1,000 4,000
- ---------------------------------------------------------------------------------------------
Total operating costs and expenses 52,416 54,532 35,220
LOSS FROM OPERATIONS (11,642) (27,626) (26,099)
OTHER INCOME (EXPENSE):
Interest and other income 2,108 1,211 808
Gain on sale of investment 42,967 -- --
Interest expense (235) (868) (1,304)
- ---------------------------------------------------------------------------------------------
Income before income taxes and cumulative effect of a
change in accounting principle 33,198 (27,283) (26,595)
- ---------------------------------------------------------------------------------------------
Income tax provision (1,010)
- ---------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle 32,188 (27,283) (26,595)
Cumulative effect of change in accounting principle (5,192) -- --
- ---------------------------------------------------------------------------------------------
Net income (loss) $ 26,996 $(27,283) $(26,595)
- ---------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE --
Income (loss) per share before cumulative effect of
change in accounting principle $ 1.13 $ (1.21) $ (1.61)
Cumulative effect of change in accounting principle $ (0.18) -- --
Net income (loss) per share $ 0.95 $ (1.21) $ (1.61)
DILUTED EARNINGS PER SHARE --
Income (loss) per share before cumulative effect of
change in accounting principle $ 1.07 $ (1.21) $ (1.61)
Cumulative effect of change in accounting principle $ (0.17) -- --
Net income (loss) per share $ 0.90 $ (1.21) $ (1.61)
Shares -- basic net income (loss) per share 28,447 22,619 16,533
Shares -- diluted income per share 30,086 22,619 16,533
Pro forma amounts assuming the accounting change was
applied retroactively:
Net income (loss) 32,188 (30,968) (28,102)
Net income (loss) per share
Basic $ 1.13 $ (1.37) $ (2.69)
Diluted $ 1.07 $ (1.37) $ (2.69)
- ---------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
F-4
50
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------------------------------
COMMON
NUMBER OF STOCK AND ACCUMULATED
COMMON ADDITIONAL OTHER TOTAL
SHARES PAID IN NOTES DEFERRED ACCUMULATED COMPREHENSIVE STOCKHOLDERS'
OUTSTANDING CAPITAL RECEIVABLE COMPENSATION DEFICIT INCOME EQUITY
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 13,244 $ 77,518 $(75) $(763) $ (65,873) $ 2 $ 10,809
Common stock issued under
stock option and purchase
plans 337 513 -- -- -- -- 513
Conversion of Series A
preferred stock and accrued
dividends 251 604 -- -- (1) -- 603
Common stock issued pursuant
to private placements, net 5,330 22,671 -- -- -- -- 22,671
Issuance of common stock and
amendment to guaranteed
market value of common stock
issued to 1,038 (308) -- -- -- -- (308)
Common stock issued pursuant
to license agreements 382 4,010 -- -- -- -- 4,010
Payment of notes receivable
and repurchase of common
stock (5) (14) 10 -- -- -- (4)
Deferred compensation, net -- 291 -- 461 -- -- 752
Comprehensive loss:
Net loss -- -- -- -- (26,595) -- (26,595)
Unrealized gain on
investments -- -- -- -- -- 1 1
--------
Comprehensive loss (26,594)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 20,577 105,285 (65) (302) (92,469) 3 12,452
Common stock issued under
stock option and purchase
plans 542 916 -- -- -- -- 916
Issuance of common stock
pursuant to license
agreements 672 5,120 -- -- -- -- 5,120
Issuance of common stock
pursuant to secondary
offering, net 4,920 21,933 -- -- -- -- 21,933
Issuance of common stock and
amendment to guaranteed
market value of common stock
issued to Genentech 229 -- -- -- -- -- --
Payment of notes receivable (36) (315) 65 -- -- -- (250)
Deferred compensation, net -- 1,024 -- 263 -- -- 1,287
Comprehensive loss:
Net loss -- -- -- -- (27,283) -- (27,283)
Unrealized gain on
investments -- -- -- -- -- 113 113
--------
Comprehensive loss (27,170)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 26,904 $133,963 $ -- $ (39) $(119,752) $ 116 $ 14,288
Common stock issued under
stock option and purchase
plans 561 2,298 -- -- -- -- 2,298
Issuance of common stock
pursuant to license
agreements 90 561 -- -- -- -- 561
Issuance of common stock
pursuant to private
placement 2,010 19,980 -- -- -- -- 19,980
Issuance of common stock
pursuant to equity line 100 814 -- -- -- -- 814
Exercise of warrants 20 247 -- -- -- -- 247
Stock compensation expense 1,092 -- -- -- -- 1,092
Tax benefit realized from
stock option exercises 287 -- -- -- -- 287
Deferred compensation, net -- -- 18 -- -- 18
Comprehensive income:
Net income -- -- -- 26,996 -- 26,996
Unrealized gain on
investments -- -- -- 6,025 6,025
--------
Comprehensive income 33,022
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 29,685 $159,242 $ -- $ (21) $ (92,756) $6,141 $ 72,606
- ---------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
F-5
51
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- ---------------------------------------------------------------------------------------------
Years Ended December 31,
--------------------------------
2000 1999 1998
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 26,996 $(27,283) $(26,595)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 764 6,665 7,488
Gain on sale of investment (42,967) -- --
Technology acquired in exchange for note payable and
other long-term liability -- -- 4,010
Stock compensation expense 1,092
Amortization of deferred compensation 18 1,287 752
Tax benefit realized from stock option exercises 287 -- --
Accrued interest on notes payable -- -- 519
Changes in assets and liabilities:
Accounts receivable, net (1,141) (1,123) 1,042
Current and other assets 25 (255) 18
Accounts payable 220 3,759 (263)
Accrued and other current liabilities (1,426) 2,829 1,038
Deferred revenue 791 -- --
- ---------------------------------------------------------------------------------------------
Net cash used in operating activities (15,341) (14,121) (11,991)
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (23,148) (12,852) (10,969)
Sales and maturities of short-term investments 68,372 3,438 8,552
Purchases of property and equipment (1,066) (882) (176)
Payment for licensed assets and product rights -- -- (308)
- ---------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 44,158 (10,296) (2,901)
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments of) debt (1,000) (2,250) 4,000
Payment of notes payable (1,553) (6,300) (3,200)
Payments on obligations under capital leases (47) (531) (2,836)
Proceeds from issuance of common stock, net 23,900 27,250 23,184
- ---------------------------------------------------------------------------------------------
Net cash provided by financing activities 21,300 18,169 21,148
- ---------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 50,117 (6,248) 6,256
Cash and cash equivalents at beginning of year 8,460 14,708 8,452
- ---------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 58,577 $ 8,460 $ 14,708
- ---------------------------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION:
Interest paid $ 235 $ 864 $ 698
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Conversion of notes payable into common stock $ -- $ 719 $ --
Deferred compensation related to stock options, purchase
rights and purchase plan $ -- $ 747 $ 470
Issuance of common stock for licensed assets and product
rights $ -- $ -- $ 4,010
Preferred dividends on redeemable preferred stock, series
A $ -- $ -- $ 1
Conversion of redeemable preferred stock, series A and
preferred dividends into common stock $ -- $ -- $ 604
- ---------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
F-6
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Connetics Corporation was incorporated in the State of Delaware on February
8, 1993. Since our inception we have principally been involved in the
development of therapeutics for a variety of human diseases and disorders. Since
our inception, we have completed numerous financings, secured operating
facilities, and entered a variety of business development opportunities.
In December 1996, we transitioned from a purely development focused company
to a company focused on both development and commercialization of
pharmaceuticals, when we acquired exclusive U.S. and Canadian rights to
Ridaura(R), a product to treat rheumatoid arthritis, from SmithKline Beecham
Corporation and related entities (now GlaxoSmithKline). Our launch of Ridaura in
1997 signified the beginning of our transition from purely product development
to a revenue-based sales and marketing company. In 1998, we formed a
wholly-owned subsidiary corporation, InterMune Pharmaceuticals, Inc. (InterMune)
to further develop and market certain patent rights and know-how to interferon
gamma in the United States through an exclusive license from Genentech, Inc.
(see Note 5). In March 1999, we received marketing clearance from the FDA to
sell Luxiq and in April 1999, we launched Luxiq. In 1999, we filed an NDA for
OLUX. In May 2000, OLUX was approved and in November 2000 we began selling the
product. We cannot assure you that any of our other potential products will be
successfully developed, receive the necessary regulatory approvals or be
successfully commercialized. Accordingly, our ability to continue our
development and commercialization activities is dependent upon the ability of
our management to obtain substantial additional financing.
Liquidity and Financial Viability
In the course of our development activities, we have sustained continuing
operating losses and expect such losses to continue for the next few years. Our
future capital uses and requirements depend on numerous factors, including the
level of product revenues, the possible acquisition of new products and
technologies, the development of commercialization activities, the progress of
our research and development programs, the progress of clinical testing, the
time and costs involved in obtaining regulatory approvals, the cost of filing,
prosecuting, and enforcing patent claims and other intellectual property rights,
competing technological and market developments, and our ability to establish
collaborative arrangements. Therefore, our uses of capital and our requirements
may increase in future periods. As a result, we may require additional funds
before we are able to sustain profitability and we may attempt to raise
additional funds through equity or debt financings, collaborative arrangements
with corporate partners or from other sources.
We currently have no commitments for any additional financings, and we
cannot assure you that additional funding will be available to finance our
ongoing operations when needed or, if available, that the terms for obtaining
such funds will be favorable or will not result in dilution to the our
stockholders. If we are not able to obtain sufficient funds, we could be
required to delay, scale back or eliminate some or all of our research and
development programs, to limit the marketing of our products or to license to
third parties the rights to commercialize products or technologies that we would
otherwise seek to develop and market ourselves.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, InterMune Pharmaceuticals, Inc. (InterMune),
through April 28, 1999, when InterMune became an independent company through
capital venture funding and a portion of our original investment in InterMune
was returned to us. At that date our investment in InterMune was diluted from
100 percent to nine percent and we began accounting for our investment using the
cost method. Material intercompany
F-7
53
balances and transactions have been eliminated. Certain prior year balances have
been reclassified for comparative purposes.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Cash Equivalents and Short-term Investments
Cash and cash equivalents consist of cash on deposit with banks and money
market instruments with original maturity of 90 days or less at the date of
purchase. Investments with maturities beyond three months at the date of
acquisition and that mature within one year from the balance sheet date are
considered to be short-term investments. Short-term investments are classified
as available-for-sale at the time of purchase and are carried at fair value,
with unrealized gains and losses reported as a separate component of
stockholders' equity. The cost of securities sold is based on the specific
identification method.
We believe we have established guidelines for investment of its excess cash
relative to diversification and maturities that maintain safety and liquidity.
Fair Value of Financial Instruments
The fair value of our cash equivalents and investments is based on quoted
market prices. The fair value of capital lease obligations, capital loans and
long-term debt is based on current interest rates available to us for debt
instruments with similar terms, degrees of risk, and remaining maturities. The
carrying amount of cash, cash equivalents and short-term investments, notes
receivable from related parties, notes payable, loans and debt are considered to
be representative of their respective fair values at December 31, 2000 and 1999.
Property and Equipment
Property and equipment is stated at cost and depreciated using the
straight-line method over the useful lives of the assets, generally three to
five years. Leasehold improvements and assets acquired under capital lease
arrangements are amortized over the shorter of the estimated useful lives of the
assets or the lease term.
Research and Development
We charge research and development costs to expense as they are incurred.
Inventories
Inventories consist primarily of finished good and supplies and are valued
at the lower of cost or market. In general, cost is determined on the basis of
average cost or first-in, first-out methods.
Revenue Recognition
Product Sales and Royalty Revenue. We recognize revenue from product sales
when there is persuasive evidence that an arrangement exists, when title has
passed upon shipment, the price is fixed and determinable, and collectibility is
reasonably assured. We establish allowances for estimated returns, rebates and
chargebacks. We are obligated to accept from customers the return of
pharmaceuticals that have reached their expiration date. To date we have not
experienced significant returns of expired product.
F-8
54
Contract Revenue. We record contract revenue for research and development,
or R&D, as it is earned based on the performance requirements of the contract.
We recognize non-refundable contract fees for which no further performance
obligations exist, and for which Connetics has no continuing involvement, on the
earlier of when the payments are received or when collection is assured.
Commencing January 1, 2000, we recognize revenue from non-refundable
upfront license fees ratably over the development period when, at the execution
of the agreement, the development period involves significant risk due to the
incomplete stage of the product's development.
We recognize revenue associated with performance milestones based upon the
achievement of the milestones, as defined in the respective agreements. We
recognize revenue under R&D cost reimbursement contracts as the related costs
are incurred.
Royalty expense directly related to product sales are classified in cost of
sales. Royalty expense, totaled $2.1 million in 2000, $2.6 million in 1999, and
$0.6 million in 1998.
We previously recognized non-refundable license fees received in connection
with collaborative agreements as revenue when we received the fees, when the
technology had been transferred, and when all significant contractual
obligations of Connetics relating to the fees had been fulfilled. Effective
January 1, 2000, we changed our method of accounting for non-refundable license
fees to recognize such fees over the expected research and development period.
We believe the change in accounting principle is preferable based on guidance in
SEC Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements."
The $5.2 million cumulative effect of the change in accounting principle,
calculated as of January 1, 2000, was reported as a charge in the year ended
December 31, 2000. The cumulative effect was initially recorded as deferred
revenue and is being recognized as revenue over the research and development
period of the agreements. During the year ended December 31, 2000, the impact of
this change in accounting method (excluding the cumulative effect itself)
increased net income by $4.4 million (net of tax of 0.005 per share) or $0.15
per share. This increase consists of $4.9 million revenue deferred in the
cumulative effect that was recognized as income in 2000 under the new accounting
method, offset by the impact of deferring upfront fees received in 2000. During
2000, approximately $4.1 million of revenue deferred as a component of the
cumulative effect charge was fully recognized in the fourth quarter when two of
our collaboration partners terminated their agreements with us as a result of
the failure of relaxin to meet the primary endpoint in the Phase III trial, and
Connetics was released from further obligations. The unamortized balance of
deferred revenue at December 31, 2000 of approximately $791,000 is expected to
be recognized as revenue during the years ending 2001 through 2006. The pro
forma amounts presented in the statement of operations were calculated assuming
the accounting change had been in effect for prior periods, and was made
retroactive to prior periods.
Concentrations of Credit Risk
Financial instruments that potentially subject us to concentration of
credit risk consist principally of investments in debt securities and trade
receivables. Management believes the financial risks associated with these
financial instruments are minimal. We maintain our cash, cash equivalents and
investments with high-quality financial institutions. We do not require
collateral on accounts receivable. We contract with independent sources to
manufacture our products. For each of our products, we rely on one manufacturer
for the production of the product. If any of these manufacturers is unable to
fulfill our supply requirements, our future results could be negatively
impacted. We sell our products to distributors in the United States. For the
year ended December 31, 2000, four customers represented 32%, 27%, 15% and 11%
of total product sales. For the year ended December 31, 1999, three customers
represented 29%, 28%, and 18% of total product sales. For the year ended
December 31, 1998, four customers represented 29%, 23%, 18%, and 11% of total
product sales. For the year ended December 31, 2000, three customers
F-9
55
represented 45%, 26%, and 10% of outstanding trade receivables. For the year
ended December 31, 1999, four customers represented 41%, 18%, 14%, and 11% of
outstanding trade receivables.
Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of net income (loss) and other
comprehensive income (loss). The only component of other comprehensive income
(loss) is unrealized gains and losses on our available-for-sale securities.
Comprehensive income (loss) has been disclosed in the Consolidated Statement of
Stockholders' Equity.
Income Taxes
Income taxes are accounted for under the asset and liability method where
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
Advertising
We expense advertising costs as we incur them. Advertising costs were
$292,000, $293,000 and $204,000 for the years ended December 31, 2000, 1999 and
1998 respectively.
Stock-Based Compensation
Connetics generally grants stock options to its employees for a fixed
number of shares with an exercise price equal to the fair value of the shares on
the date of grant. As allowed under the Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"),
Connetics has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for stock awards to employees. Accordingly, no
compensation expense is recognized in our financial statements in connection
with stock options granted to employees with exercise prices not less than fair
value. Deferred compensation for options granted to employees is determined as
the difference between the deemed fair market value of our common stock on the
date options were granted and the exercise price.
We have determined compensation expense for options granted to
non-employees in accordance with SFAS 123 as the fair value of the consideration
received or the fair value of the equity instruments issued, whichever is more
reliably measured. Compensation expense for options granted to non-employees is
periodically re-measured as the underlying options vest.
Net Income (loss) Per Share
Basic net income (loss) per common share is computed using the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed using the weighted average of common and diluted
equivalent stock options and warrants outstanding during the period. We excluded
all stock option and warrants from the calculation of diluted loss per common
share for the years ended December 31, 1999 and 1998 because these securities
are anti-dilutive during those years.
F-10
56
Disclosure about Segments of an Enterprise and Related Information
We operate in one segment, the development and commercialization of
therapeutics and pharmaceuticals. For the years ended December 31, 2000 and
1999, all our product sales were to customers in the United States. Revenues by
product are as follows for the years ended December 31 (in thousands):
- -------------------------------------------------------------------------------------
December 31,
----------------------------
2000 1999 1998
- -------------------------------------------------------------------------------------
Luxiq $10,973 $ 6,025 $ --
Ridaura 6,013 5,737 7,473
Actimmune 1,898 4,833 --
OLUX 1,211 -- --
- -------------------------------------------------------------------------------------
$20,095 $16,595 $7,473
- -------------------------------------------------------------------------------------
Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities (SFAS 133), which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that we recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. We are required to adopt SFAS 133 effective January
1, 2001. Because we do not hold any derivative instruments and do not engage in
hedging activities, we do not believe that adopting SFAS 133 will have and
impact on our financial position or results of operations.
2. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The following tables summarize our available-for-sale investments as of
December 31, 2000 and 1999 (in thousands):
- ------------------------------------------------------------------------------------------
DECEMBER 31, 2000
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Loss Fair Value
- ------------------------------------------------------------------------------------------
Corporate debt $13,146 $ 2 $ -- $13,148
Commercial paper 1,690 (1) 1,689
Equity securities 630 6,140 -- 6,770
Money market funds 423 -- -- 423
- ------------------------------------------------------------------------------------------
Total 15,889 6,143 (1) 22,030
Less amount classified as cash
equivalents (423) -- -- (423)
- ------------------------------------------------------------------------------------------
Total short-term
investments $15,466 $6,142 $ (1) $21,607
- ------------------------------------------------------------------------------------------
F-11
57
- ------------------------------------------------------------------------------------------
DECEMBER 31, 1999
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Loss Fair Value
- ------------------------------------------------------------------------------------------
Corporate debt $14,307 $ -- $(15) $14,292
Commercial paper 6,313 2 -- 6,315
Equity securities 433 129 -- 562
Money market funds 1,005 -- -- 1,005
- ------------------------------------------------------------------------------------------
Total 22,058 131 (15) 22,174
Less amount classified as cash
equivalents (4,334) (1) -- (4,335)
- ------------------------------------------------------------------------------------------
Total short-term
investments $17,724 $ 130 $(15) $17,839
- ------------------------------------------------------------------------------------------
The gross realized gains on sales of available-for-sale investments for the
years ended December 31, 2000 and 1999 totaled $43,116,000 and $588,000,
respectively, and gross realized losses for the same periods totaled $82,000 and
$31,000, respectively. Realized gains and losses were calculated based on the
specific identification method. The average maturity of our available-for-sale
securities was less than one year.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
- --------------------------------------------------------------------------------
December 31,
------------------
2000 1999
- --------------------------------------------------------------------------------
Laboratory equipment $ 2,915 $ 2,360
Computer equipment 1,034 770
Furniture and fixtures 772 574
Leasehold improvements 760 760
- --------------------------------------------------------------------------------
5,481 4,464
Less accumulated depreciation and amortization (3,674) (2,959)
- --------------------------------------------------------------------------------
Property and equipment, net $ 1,807 $ 1,505
- --------------------------------------------------------------------------------
Property and equipment includes assets under capitalized leases at December
31, 2000 and 1999 of approximately $1.0 million. Accumulated amortization
related to leased assets was approximately $1.0 million at December 31, 1999 and
2000. There were no new capitalized leases for the years ended December 31, 2000
or 1999.
4. RESEARCH AND LICENSE AGREEMENTS
License Agreements: Soltec
In June 1996, we entered into an exclusive License Agreement with Soltec
Research Pty Ltd. (Soltec), to develop and market a foam formulation of the
dermatologic drug, betamethasone valerate, in North America. Under the terms of
the license, we paid and expensed $75,000 ($35,000 was paid in 1996, $22,500 was
paid in January 1998, and $17,500 was paid in April 1999), in licensing fees to
Soltec (based on certain milestones) and will pay royalties on future sales of
products, if any, arising from the licensed technology. We also have an
exclusive option on Soltec's foam formulation for the delivery of other
compounds.
In July 1999, we received exclusive worldwide rights (excluding Australia
and New Zealand) from Soltec to develop, manufacture and market ketoconazole
foam (a quick-break foam formulation of the antifungal dermatologic drug,
ketoconazole). Under the terms of the agreement, we will pay up to a total of
$277,500 in license fees, of which $120,000 was paid upon signing of agreement
and expensed, $67,500
F-12
58
is due upon the filing of a New Drug Application ("NDA") and $90,000 is due upon
FDA approval of product, plus royalties on future product sales, if any, arising
from the licensed technology. In addition, we will pay Soltec ten percent (10%)
of any upfront payments received in connection with sublicense of the rights to
the product.
In December 1999, we entered into a comprehensive licensing agreement with
Soltec for exclusive rights to certain applications of a broad range of unique
topical delivery technologies, including aerosol foam formulations and Soltec's
patented Liquipatch(TM) technology. We paid Soltec a $500,000 license fee upon
signing of agreement and issued 80,154 shares of our common stock in January
2000 valued at $500,000. The $1.0 million was charged to research and
development expense. In addition, we will also be required to pay Soltec certain
development and commercialization milestones and royalties on sales. On March
21, 2001, we entered into an agreement to acquire Soltec. For details, see Note
15.
Ridaura Agreements
In December 1996, we acquired exclusive United States and Canadian rights
to Ridaura, a disease modifying anti-rheumatic drug, from SmithKline (now
GlaxoSmithKline) (as amended in 1997 and 1998, referred to as the SKB
Agreement). Under the SKB Agreement, we paid $3.0 million in cash in January
1997, issued a non-interest bearing $11.0 million promissory note, issued
637,733 shares of common stock with a guaranteed value of $9.0 million at
December 31, 1997, and are obligated to pay up to $6.0 million in royalty
payments based on future product sales, for a potential aggregate consideration
of up to $29.0 million.
We determined the useful life of the acquired asset to be three years and
have fully amortized the acquired asset as of December 31, 1999. We recorded
amortization expense of zero in 2000, $6.2 million in 1999, and $6.7 million in
1998. Accumulated amortization was zero in 2000, $20.6 million at December 31,
1999, and $14.4 million at December 31, 1998.
We are required to pay interest at prime rate plus 3% per year on the
principal amount outstanding of $5.3 million from January 5, 1999 through April
1, 2000. We paid GlaxoSmithKline $3.6 million in principal and interest in 1998;
we paid GlaxoSmithKline $6.7 million in principal and interest in 1999,
including the January 3, 2000 payment, which we paid in October 1999, and we
paid GlaxoSmithKline $1.6 million in principal and interest in 2000. At December
31, 2000, there were no amounts outstanding.
Under the SKB Agreement, the guaranteed value of the common stock was
revised from $9.0 million to $8.0 million based on the fair market value of our
common stock on April 1, 1998, with a maximum of 1,675,512 shares to be issued
in total. As of April 1, 1998, the aggregate fair market value of the shares
previously issued under the agreement was less than $8.0 million and, as a
result, we issued an additional 1,037,779 shares of common stock and paid
additional cash consideration of approximately $308,000 to GlaxoSmithKline in
fulfillment of our obligation to issue equity to GlaxoSmithKline under the SKB
Agreement.
Under a related Supply Agreement, GlaxoSmithKline will manufacture and
supply Ridaura, in final package form, to us for an initial term through
December 2001. Under a Supply Agreement with Pharmascience, we intend, through
our relationship with GlaxoSmithKline or other future vendors, to supply Ridaura
exclusively in Canada to Pharmascience.
License Agreements: Genentech
Relaxin. In September 1993, we entered into an agreement with Genentech,
Inc., which was subsequently amended in July 1994, for an exclusive right to
make, use and sell certain products arising from recombinant human relaxin in a
defined field. In April 1996, we acquired worldwide rights to relaxin from
Genentech. In 1994, we incurred a liability of $684,000 for the purchase of
research materials and payment of technology transfer costs under the agreement.
In April 1999, we issued 95,815 shares to Genentech with a fair market value of
$709,000 to satisfy this obligation. We will also pay to Genentech royalties on
sales of products arising from relaxin, if any.
F-13
59
Interferon Gamma. In December 1995, we entered into a license agreement
with Genentech to acquire exclusive development and marketing rights to
interferon gamma in the United States for dermatologic indications. In May 1998,
we amended and restated this agreement and entered into a new license agreement
that granted us an exclusive license under certain patent rights and know-how to
ACTIMMUNE(R) (interferon gamma). Under the terms of the agreement, we issued
Genentech 380,048 shares of its common stock valued at $2.0 million at the time
of closing with a guaranteed value of $4.0 million at the second closing date,
originally set as December 28, 1998. Based on that provision, in December 1999
we issued an additional 228,882 shares of Common Stock to Genentech to bring the
value of the consideration to $4.0 million. We recorded a $4.0 million non-cash
license fee charge in 1998. We formed a subsidiary, InterMune Pharmaceuticals,
Inc., to develop Actimmune. In April 1999, InterMune became an independent
company, and in March 2000, InterMune became a public company. Effective April
1, 2000 we assigned to InterMune our remaining revenue rights and obligations
under the license with Genentech and the corresponding supply agreement. In
exchange, InterMune paid us approximately $5.2 million; an additional $0.9
million is payable at the end of March 2001. InterMune will pay us a royalty on
Actimmune sales beginning January 1, 2002. In addition, we have retained the
product rights for potential dermatological applications. We recorded sales of
Actimmune of approximately $1.8 million during the first quarter of 2000;
commencing in the second quarter, InterMune acquired all remaining rights to
sell Actimmune.
Agreement with Xoma
In December 1999 we sold all of our rights to T-cell receptor (TCR)
vaccines technology to The Immune Response Corporation. We acquired our rights
in June 1994, pursuant to a Technology Acquisition Agreement with XOMA
Corporation under which we were granted the exclusive right to make, use and
sell certain products under a sublicense agreement. In addition to two
promissory notes (which were repaid in 1996), we accrued additional
consideration of $500,000 (included in the current portion of notes payable and
other liabilities at December 31, 1999). The Immune Response Corporation assumed
all of our obligations under the agreement. Connetics received a cash payment of
$100,000 in 1999 and IRC common stock valued at $433,000, and will receive
additional cash, and royalties on future sales of products.
Relaxin Development, Commercialization and Supply Agreements
In April 1998, we entered into a development, commercialization and supply
agreement with Suntory Pharmaceuticals (Suntory), a division of Suntory Limited
of Osaka, Japan, for relaxin for the treatment of scleroderma. Under the terms
of the agreement, Suntory paid us a total of $2.5 million in non-refundable
license and development fees. In October 2000, following the announcement of the
results of our Phase III clinical trial for scleroderma, Suntory notified us
that they were terminating the agreement in accordance with its terms.
In January 1999, we entered into a development, commercialization and
supply agreement with Medeva PLC (now Celltech Group PLC) of the United Kingdom
for certain therapeutic indications pertaining to relaxin in Europe. Under the
terms of the agreement, Celltech paid a total of $20.0 million representing a
$4.0 million contract fee, a $4.0 million equity investment, and a $5.0 million
milestone payment, plus reimbursement of 50% of our product development costs in
the U.S. during the term of the agreement. In October 2000, following the
announcement of the results of our Phase III clinical trial for scleroderma,
Celltech notified us that they were terminating the agreement in accordance with
its terms. As of December 31, 2000, we have no further development obligations
under the agreement and we are winding down the contract; all rights will revert
to us in April 2001. We have discontinued our development program related to
relaxin for scleroderma. As a result, we recorded an accrual for $372,000
related to costs we were contractually obligated to pay principally to contract
research organizations. These costs only related to the scleroderma trials and
do not provide future benefit for any other trials.
In July 1999, we entered into a development, commercialization and supply
agreement with Paladin Labs Inc., a Canadian corporation, for relaxin. Under the
terms of the agreement, we received an initial
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sum of $800,000, which includes payments for development fees and an equity
investment. In addition, we will receive semi-annual development payments and
potential milestone payments of approximately $2.4 million over the next several
years. Paladin is responsible for all development and commercialization
activities in Canada, and will pay royalties on all sales of relaxin in Canada.
For the year ended December 31, 1999, we recorded $0.4 million in contract
revenue under this agreement. For the year ended December 31, 2000, we recorded
$0.7 million in contract revenue under this agreement.
In April 2000, we entered into a collaboration and exclusive license
agreement with Faulding for the development and commercialization of relaxin in
Australia. Under the terms of the agreement, Faulding paid $510,000 for the
initial license of relaxin for the treatment of scleroderma. Although we have
discontinued our development efforts for relaxin for scleroderma, Faulding has
indicated that it will continue the collaboration for other indications. We may
receive additional milestone payments for the approval of additional indications
for relaxin in Australia. Faulding is responsible for all development and
commercialization activities in Australia, and will pay royalties on all sales
of relaxin in Australia.
Promotion Agreements
In March 1999, we entered into two agreements with MGI Pharma, Inc. (MGI).
Under the terms of the agreements, MGI promoted Ridaura and Luxiq to the
rheumatology market in the United States in exchange for promotional fees. This
arrangement was to take advantage of MGI's specialty sales force that calls on
rheumatologists in the United States, and allowed us to focus our attention on
the dermatology marketplace. For the years ended December 31, 2000 and 1999,
respectively, we recorded $1.0 million and $750,000 in promotional fee expense.
We terminated the agreements in accordance with their terms in September 2000,
and MGI has ceased to promote either product.
In September 1999, we entered into an agreement with Ventiv Health US Sales
(formerly Snyder Healthcare Sales, Inc.), to promote Luxiq to the dermatology
market in the United States in exchange for promotional fees comprised of both
fixed and variable expenses dependant upon the scope of services provided. For
the years ended December 31, 2000 and 1999, we recorded $1.6 million and
$47,000, respectively, in promotional fee expense. In February 2001, we gave
notice under the agreement of our intent to terminate the agreement effective
May 11, 2001.
5. FINANCING ARRANGEMENTS
Long-Term Debt
On September 24, 1998, we entered into a term Loan and Security Agreement
(the Term Loan) with a bank (the Lender), which was modified on December 22,
1998, under which we borrowed $4.0 million. The Term Loan bears interest at
prime rate plus 1.25% (8.98% at December 31, 2000) with interest only payments
for the first twelve months (through September 23, 1999), and is to be repaid
thereafter in forty-eight (48) equal monthly installments of principal plus
accrued interest. On the first anniversary of the loan, we had the right to
elect whether the aggregate Term Loan outstanding will bear interest at (i) a
floating rate equal to prime rate plus 1.25% or (ii) a fixed rate equal to 4.5
percentage points above the yield of the 48-month Treasury Bill (fixed at the
time of election). We elected for the Term Loan to bear interest prime plus
1.25%. In October 1999, we made a $2.25 million payment to reduce the principal
loan balance down to $1.75 million. In conjunction with the Term Loan, we
granted the Lender a first priority security interest in our presently existing
intellectual property collateral, as defined in the loan documents. Covenants
governing the Term Loan require the maintenance of certain financial ratios, and
if we do not meet the covenants during the loan period, a restricted cash pledge
must be made against 100% of the outstanding loan balance. Principal maturities
of the debt under the Term Loan at December 31, 2000 was $0.75 million.
Structured Equity Line Flexible Financing
We entered into a three year Structured Equity Line Flexible Financing
Agreement (the Equity Line) with Kepler Capital LLC (Kepler) on January 2, 1997,
and the equity line under the agreement
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became available to us beginning December 1, 1997. The agreement expired on
December 1, 2000. The equity line agreement allowed us to access up to $25
million through sales of our common stock. Under the terms of the agreement we
could obtain from $500,000 to $2,000,000 at any one time through a sale of
common stock to Kepler, subject to the satisfaction of certain conditions,
including minimum volume requirements and a minimum trading price of $7.00 per
share over a specified period. In addition, under the terms of the agreement we
were required to sell $500,000 of our common stock from time to time if the
price per share exceeded $10.00 and certain volume conditions were met. Over the
term of the equity line agreement we received a total of $792,000 in net
proceeds.
As a commitment fee under the equity line agreement, on January 2, 1997 we
issued Kepler a five-year warrant to purchase 250,000 shares of our common stock
at an exercise price of $8.25 per share. The agreement also required that we
issue Kepler warrants to purchase up to 25,000 shares of our common stock on
December 1, 1998, 1999 and 2000, at an exercise price equal to 110% of the
closing price of our common stock as quoted on the Nasdaq National Market on the
date the warrant was issued.
In January 2000, Kepler exercised its right to require us to draw down
$500,000 against the equity line in exchange for our common stock, and we issued
58,438 shares to Kepler at a purchase price of $8.556 on February 10, 2000. On
June 6, 2000, we issued to Kepler a warrant to purchase 22,063 shares at an
exercise price of $7.859, and on September 27, 2000 we issued to Kepler a
warrant to purchase 33,099 shares at an exercise price of $15.12 per share. Both
the June 2000 and the September 2000 warrants were issued in lieu of shares of
common stock required to be issued to Kepler upon a draw down on the equity
line.
6. CAPITAL LEASE OBLIGATIONS AND CAPITAL LOANS
We have borrowings under our capital leases and capital loan credit lines
totaling $0.2 million at December 31, 2000. No additional borrowings are
available under capital lease and capital loan credit lines at December 31,
2000. Under the terms of a master lease agreement, ownership of the leased
equipment reverts to us at the end of the lease term. As of December 31, 2000,
our capital lease obligation was $37,000.
The obligations under the capital leases and loans are secured by the
leasehold improvements and equipment financed, bear interest at fixed rates of
approximately 12% and are payable in monthly installments through September
2001.
Operating Leases
We lease two facilities under non-cancelable operating leases. The first
lease expires in January 2003; the second lease commenced January 1, 1999 and
expires on January 31, 2002. The future minimum rental payments under the leases
as of December 31, 2000 are as follows (in thousands):
- ----------------------------------------------------
YEARS ENDING DECEMBER 31:
- ----------------------------------------------------
2001 $ 978
2002 704
2003 56
- ----------------------------------------------------
$1,738
- ----------------------------------------------------
We recognize rent expense on a straight-line basis over the term of each
lease. Rent expense under operating leases was approximately $938,000, $882,000
and $687,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
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7. STOCKHOLDERS' EQUITY
Warrants
We have outstanding warrants to purchase up to 1,415,492 shares of our
common stock, at various prices and with varying expiration dates. The following
table summarizes our outstanding warrants; additional details follow the table.
- ------------------------------------------------------------------------------------------------
NUMBER OF EXERCISE TERMINATION
ACTIVITY WARRANTS PRICE IN YEARS EXPIRATION
- ------------------------------------------------------------------------------------------------
Issuance of Series B preferred stock 15,329 $4.89 7 2002
Loan and security agreement 68,574 $5.78 5 2002
Issuance of Series A preferred stock 20,000 $7.43 5 2001
Structured Equity Line Flexible
Financing Agreement 235,000 $8.25 3 2002
Commitment Fee pursuant to Equity
Line Agreement 130,589 $4.84 - $15.12 1-5 2001 - 2005
Issuance of common stock 905,000 $9.08 4 2001
Issuance pursuant to License
Agreement 20,000 $5.31 10 2010
Consulting services 6,000 $6.00 5 2003
Consulting services 15,000 $6.063 5 2004
- ------------------------------------------------------------------------------------------------
Total 1,415,492
- ------------------------------------------------------------------------------------------------
In July 1995, we issued warrants to purchase 18,395 shares of Series B
Preferred Stock pursuant to a capital lease and capital loan agreement. Each
such warrant was converted into a warrant for the purchase of one share of
common stock and such warrants are exercisable any time through July 2002.
Under a Master Bridge Loan Agreement with certain of our stockholders in
December 1995, we issued warrants that expired in December 2000 to purchase a
total of 22,727 shares of common stock. Also in December 1995, in connection
with a loan and security agreement with a bank consortium, we issued warrants,
which expire in December 2002, to purchase 73,071 shares of common stock.
In conjunction with our issuance of 200 shares of Series A Redeemable
Preferred Stock in December 1996, we issued warrants that allow the holders to
purchase up to an aggregate of 20,000 shares of our common stock, with an
expiration date of December 2001.
In conjunction with our issuance of 1,810,000 common shares in May 1997 to
certain private investors, we issued warrants to purchase 905,000 shares of our
common stock. These warrants will expire May 15, 2001.
In January 1998, we issued a warrant to a third party to purchase 6,000
shares of common stock as partial compensation for services rendered to us in
connection with a private placement of our common stock on December 15, 1997. We
did not record the fair value of this warrant as the amount was immaterial.
In July 1999, we issued a warrant to a third party to purchase 15,000
shares of common stock as partial compensation for financial advice pertaining
to investor and media relations. The warrant has an expiration date of July 1,
2004. We recorded the fair value of $66,000 for the issuance of this warrant.
Kepler Warrants. As a commitment fee under the Equity Line (see Note 6),
on January 2, 1997 we issued Kepler a five-year warrant to purchase 250,000
shares of our common stock at an exercise price of $8.25. The Equity Line
Agreement also required that we issue Kepler warrants to purchase up to 25,000
shares of our common stock on December 1, 1998, 1999 and 2000, at an exercise
price equal to 110% of the closing price of our common stock as quoted on the
Nasdaq National Market on the date the warrant is issued. On December 1, 1998,
we issued warrants to purchase 25,0000 shares at an exercise price of $4.40 per
share and expiring on December 1, 2003. On December 1, 1999, we issued warrants
to purchase
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up to 25,000 shares at an exercise price of $6.875 per share and expiring on
December 1, 2004. On December 1, 2000, we issued warrants to purchase up to
25,427 shares at an exercise price of $5.3625 per share and expiring on December
1, 2005. On June 6, 2000, we issued to Kepler a warrant to purchase 22,063
shares of our common stock at an exercise price of $7.859 per share. The warrant
expires on July 31, 2001. On September 27, 2000, we issued to Kepler a warrant
to purchase 33,099 shares of our common stock at an exercise price of $15.12 per
share. The warrant expires on October 27, 2001. Both the June 2000 and the
September 2000 warrants were issued in lieu of shares of common stock required
to be issued to Kepler upon a draw down on the equity line.
Bigazzi. On October 10, 2000, we issued a warrant to Professor Mario
Bigazzi to purchase 20,000 shares of our common stock at an exercise price of
$5.31. The warrant was fully vested and immediately exercisable when issued as
partial consideration for services rendered in connection with intellectual
property matters. The warrant expires on October 10, 2010. We valued the warrant
using the Black-Scholes method and recorded $82,000. This amount is recorded in
selling, general and administrative expense.
Dividend Restrictions
Our loan agreement with a bank lender prohibits us from declaring or paying
a dividend without the bank's prior written consent.
Common Shares Reserved for Future Issuance
We have reserved shares of common stock as follows:
- ------------------------------------------------------------------------------------
December 31,
----------------------
2000 1999
- ------------------------------------------------------------------------------------
1994 Stock Plan 1,964,089 2,417,877
1995 Employee Stock Purchase Plan 386,257 89,305
1995 Directors Stock Option Plan 377,500 400,000
1998 Supplemental Stock Plan 192,683 237,500
2000 Stock Plan 472,179 --
2000 Non-Officer Stock Plan 500,000 --
Non-plan stock options outstanding 33,992 38,488
Common stock warrants 1,415,492 1,360,193
- ------------------------------------------------------------------------------------
Total 5,342,192 4,543,363
- ------------------------------------------------------------------------------------
8. STOCK PLANS
1994 Stock Plan
Our 1994 Stock Plan (the Plan) authorizes our Board of Directors (the
Board) to grant incentive stock options, non-statutory stock options, and stock
purchase rights for up to 2,600,000 shares of common stock. At our annual
meeting in May 1999, the stockholders approved the increase of shares in the
Plan to an aggregate of 3,100,000 shares of common stock. The Plan was
terminated on December 31, 1999, and the Board is no longer authorized to grant
options under the 1994 Plan.
The options under this Plan expire no later than ten years from the date of
grant. The exercise price of the incentive stock options, non-statutory stock
options and options granted to 10% shareholders must be at least 100%, 85%, and
110%, respectively, of the fair value of the stock subject to the option on the
grant date. The price for shares purchased pursuant to stock purchase rights by
10% shareholders must be at least 100% of the fair market value of the stock on
the date of grant.
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The options generally become exercisable as determined by the Board, but in
no event at a rate of less than 20% per year for a period of five (5) years from
date of grant. Shares granted under the Plan pertaining to stock purchase rights
are generally subject to repurchase by us at the original issue price per share.
Our right to repurchase these shares generally expires ratably over a period of
time not greater than five years.
1995 Director Stock Option Plan
The 1995 Director Stock Option Plan (the Directors' Plan) was adopted by
the Board in December 1995. A total of 250,000 shares of common stock have been
reserved for issuance under the Directors' Plan. The Directors' Plan provides
for the grant of non-statutory stock options to non-employee directors of
Connetics. At our annual meeting in May 1999, the stockholders approved an
increase in the Directors' Plan to an aggregate of 400,000 shares of common
stock.
The Directors' Plan provides that each person who first becomes a
non-employee director shall be granted a non-statutory stock option to purchase
30,000 shares of common stock (the First Option) on the date on which he or she
first becomes a non-employee director. Thereafter, on the date of each annual
meeting of our stockholders, each non-employee director is granted an additional
option to purchase 7,500 shares of common stock (a Subsequent Option) if he or
she has served on the Board for at least six months as of the annual meeting
date.
Under the Directors' Plan, the First Option is exercisable in installments
as to 25% of the total number of shares subject to the First Option on each of
the first, second, third and fourth anniversaries of the date of grant of the
First Option; each Subsequent Option becomes exercisable in full on the first
anniversary of the date of grant of that Subsequent Option. The exercise price
of all stock options granted under the Directors' Plan shall be equal to the
fair market value of a share of our common stock on the date of grant of the
option. Options granted under the Directors' Plan have a term of ten years. At
December 31, 1999, 217,500 shares had been granted, of which 180,000 shares were
outstanding at a weighted average price of $6.34, with 220,000 shares available
for future grants. At December 31, 2000, 82,500 shares had been granted, of
which 210,000 shares were outstanding at a weighted average price of $7.3705,
with 167,500 shares available for future grants.
1998 Supplemental Stock Plan
On November 5, 1998, the Board approved the 1998 Supplemental Stock Plan
(the Supplemental Plan) that provided the Board the authority to grant
non-statutory stock options to employees and consultants for up to 500,000
shares of common stock. Effective May 19, 1999, the Board is no longer
authorized to grant options under the Supplemental Plan.
Officers and directors of Connetics were not eligible for grants under the
Supplemental Plan. The options granted under this Plan expire no later than ten
years from the date of grant. The exercise price of the non-statutory stock
options is at least 100% of the fair value of the stock subject to the option on
the grant date. The options generally become exercisable at such times as
determined by the Board, but in no event at a rate of less than 20% per year for
a period of five (5) years from date of grant.
Stock Plan (2000)
In February 1999, the Board approved, and in May 1999 the stockholders
approved, the 2000 Stock Plan (the 2000 Plan). The Plan became available on
January 1, 2000, and was initially funded with 808,512 shares, which equals
three percent (3%) of shares outstanding on December 31, 1999. On the first day
of each new calendar year during the term of the 2000 Plan, the number of shares
available will be increased (with no further action needed by the Board or the
stockholders) by a number of shares equal to the lesser of three percent of the
number of shares of common stock outstanding on the last preceding business day,
or an amount determined by the Board.
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2000 Non-Officer Stock Option Plan
In February 2000, the Board approved a new 2000 Non-Officer Stock Plan,
which became immediately available. The plan was funded with 500,000 shares. No
additional shares will be added to this plan, although shares can be granted if
they become available through cancellation. The plan provides for options to be
granted only to non-officer employees of Connetics, and the options granted
under the plan are nonstatutory stock options.
Non-Plan Stock Options
We may from time to time grant options outside one of our qualified plans
(Non-Plan Stock Options). As of December 31, 1999, a total of 139,612 Non-Plan
Stock Options had been granted with options to purchase 38,488 shares were
outstanding at a weighted average price of $4.79 per share. At December 31,
2000, a total of 139,612 Non-Plan Stock Options had been granted with options to
purchase 33,992 shares were outstanding at a weighted average price of $5.36 per
share.
Activity under the Plan, the Directors' Plan, Supplemental Stock Plan and
Non-Plan Stock Options is summarized as follows:
- -----------------------------------------------------------------------------------------
OUTSTANDING OPTIONS
---------------------
WEIGHTED
SHARES NUMBER AVERAGE
AVAILABLE FOR OF EXERCISE
GRANT SHARES PRICE
- -----------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 163,487 1,731,843 $4.33
Additional shares authorized 1,225,000 -- --
Options granted (1,033,000) 1,033,000 $3.68
Options exercised -- (185,328) $0.80
Options canceled 247,135 (247,135) $5.27
Shares repurchased 4,356 -- $0.44
- -----------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 606,978 2,332,380 $4.22
Additional shares authorized 499,250 -- --
Options granted (1,160,608) 1,160,608 $6.18
Options exercised -- (316,993) $2.38
Options canceled 274,380 (302,130) $5.81
- -----------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 220,000 2,873,865 $5.05
Additional shares authorized 1,308,512 -- --
Options granted (1,389,195) 1,389,195 $7.85
Options exercised (416,387) $4.22
Options canceled 180,406 (300,673) $7.33
- -----------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 319,723 3,546,000 $6.06
- -----------------------------------------------------------------------------------------
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The following table summarizes information concerning outstanding and
exercisable options at December 31, 2000:
- ------------------------------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ---------------------------
WEIGHTED
RANGE NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OF OF REMAINING LIFE AVERAGE OF AVERAGE
EXERCISE PRICES SHARES (IN YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- ------------------------------------------------------------------------------------------------------
$0.44 - $3.87 691,056 6.66 $2.45 478,507 $2.02
$4.00 - $4.56 783,973 8.50 $4.37 274,305 $4.18
$4.62 - $7.00 750,619 8.47 $6.36 362,432 $6.46
$7.12 - $8.50 550,588 7.43 $7.44 349,673 $7.28
$8.62 - $18.06 769,764 8.77 $9.74 133,721 $10.26
- ------------------------------------------------------------------------------------------------------
$0.44 - $18.06 3,546,000 8.03 $6.06 1,598,638 $5.24
- ------------------------------------------------------------------------------------------------------
For the years ended December 31, 2000, 1999 and 1998, we recorded deferred
compensation expense of $0, $747,000, and $470,000, respectively, for the
difference between the exercise price and the deemed fair value of our common
stock, related to shares issued pursuant to stock purchase rights and options
granted in 1996 and 1995. These options were granted to provide additional
incentives to retain management and key employees. This deferred compensation
expense is being amortized over the related vesting period, generally a 48-month
period.
1995 Employee Stock Purchase Plan
The Board adopted the 1995 Employee Stock Purchase Plan (the Purchase Plan)
in December 1995, and amended the Plan in February 2000 and November 2000. We
have reserved 948,591 shares of common stock for issuance under the Purchase
Plan. The Purchase Plan has an evergreen feature pursuant to which, on November
30 of each year, the number of shares available is increased automatically by a
number of shares equal to the lesser of one half of one percent (0.5%) of the
number of shares of common stock outstanding on that date, or an amount
determined by the Board of Directors. The Purchase Plan is administered by the
Compensation Committee of the Board. Employees (including officers and employee
directors) of Connetics are eligible to participate if they are employed by us
or any such subsidiary for at least 20 hours per week and more than 5 months per
year. The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions, which may not exceed 15% of an employee's
compensation, at a price equal to the lower of 85% of the fair market value of
our common stock at the beginning or end of the offering period. We issued
151,639 shares under the plan in 2000 and 200,233 shares in 1999. At December
31, 2000, we had 386,257 shares reserved for future issuance. For the years
ended December 31, 1999 and 1998, we recorded $221,000 and $323,000,
respectively, in stock compensation expense relating to this plan; we did not
record any stock compensation expense for the year ended December 31, 2000.
Pro Forma Information
In accordance with the provisions of SFAS 123, we apply APB Opinion No. 25
and related interpretations in accounting for our stock option plans and,
accordingly, do not recognize compensation cost for options granted with
exercise prices not less than fair value on the date of grant. If we had elected
to recognize compensation cost based on the fair value of the options granted at
grant date and including stock purchases under the Purchase Plan as prescribed
by SFAS 123, our net loss and net loss per share
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numbers would have been increased to the pro forma amounts indicated in the
table below for the years ended December 31(in thousands except per share
amounts):
- -----------------------------------------------------------------------------
2000 1999 1998
- -----------------------------------------------------------------------------
NET INCOME (LOSS):
as reported $26,996 $(27,283) $(26,595)
pro forma $22,596 $(29,473) $(27,964)
NET INCOME (LOSS) PER SHARE:
as reported $ 0.95 $ (1.21) $ (1.61)
pro forma $ 0.79 $ (1.30) $ (1.69)
- -----------------------------------------------------------------------------
We estimate the fair value of each option grant on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions:
- -----------------------------------------------------------------------------------------------
STOCK OPTION PLANS STOCK PURCHASE PLAN
-------------------- --------------------
2000 1999 1998 2000 1999 1998
- -----------------------------------------------------------------------------------------------
Expected stock price volatility 100% 76.0% 90.0% 100% 76.0% 76.6%
Risk-free interest rate 6.00% 5.71% 4.74% 5.80% 5.70% 5.05%
Expected life (in years) 3.89 3.7 3.8 1.71 0.5 0.5
Expected dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
- -----------------------------------------------------------------------------------------------
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. Because our stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, our management
does not believe that the existing models necessarily provide a reliable single
measure of the fair value of its options. The weighted average fair value of
options granted was $5.37 in 2000, $3.84 in 1999 and $2.44 per share in 1998.
The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures of future years.
1997 Stockholder Rights Plan
In May 1997, we adopted a stockholder rights plan (the Rights Plan) that
provides existing stockholders with the right to purchase one one-thousandth of
a share of our Series B Participating Preferred Stock, $0.001 par value, at an
exercise price of $49 per one one-thousandth of a preferred share in the event
of certain changes in our ownership. We will be entitled to redeem the rights at
$0.01 per right at any time on or before the tenth day following acquisition by
a person or group of 15% or more of our common stock. The Rights Plan may serve
as a deterrent to certain abusive takeover tactics that are not in the best
interest of stockholders. At each of December 31, 2000, and 1999, a total of
90,000 shares were designated under the Rights Plan and no shares were issued
and outstanding.
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9. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share for the years ended December 31 (in thousands except per
share amounts):
- ---------------------------------------------------------------------------------------------
2000 1999 1998
- ---------------------------------------------------------------------------------------------
NUMERATOR:
Net income (loss) $26,996 $(27,283) $(26,595)
Preferred stock dividends -- -- (1)
Numerator for basic and diluted earnings per share --
income (loss) to common stockholders $26,996 $(27,283) $(26,596)
- ---------------------------------------------------------------------------------------------
DENOMINATOR FOR BASIC EARNINGS PER SHARE --
WEIGHTED-AVERAGE SHARES 28,447 22,619 16,533
EFFECT OF DILUTIVE SECURITIES:
Stock Options 1,276 -- --
Warrants 363 -- --
- ---------------------------------------------------------------------------------------------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE --
ADJUSTED WEIGHTED-AVERAGE SHARES AND ASSUMED
CONVERSIONS 30,086 22,619 16,533
- ---------------------------------------------------------------------------------------------
BASIC NET INCOME (LOSS) PER SHARE $0.95 $(1.21) $(1.61)
DILUTED NET INCOME (LOSS) PER SHARE $0.90 $(1.21) $(1.61)
- ---------------------------------------------------------------------------------------------
10. INCOME TAXES
As of December 31, 2000, the Company had federal net operating loss
carryforwards of approximately $66.6 million. We also had federal and California
research and other tax credit carryforwards of approximately $7.2 million.
The provision for income taxes consists of the following:
- -------------------------------------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------------------------------------
CURRENT
Federal $ 614 $ -- $ --
State 396 -- --
- -------------------------------------------------------------------------------------------
TOTAL $ 1,010 $ -- $ --
- -------------------------------------------------------------------------------------------
The provision (benefit) for income taxes differs from the federal statutory
rate as follows:
- -------------------------------------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------------------------------------
Provision (benefit) at U.S. federal statutory rate $ 9,500 $(9,300) $(6,700)
Unbenefited losses (utilization of net operating loss) $(9,500) 9,100 6,000
State taxes, net of federal benefit 330 -- --
Alternative minimum tax 614 -- --
Other 66 200 700
- -------------------------------------------------------------------------------------------
TOTAL $ 1,010 $ -- $ --
- -------------------------------------------------------------------------------------------
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69
Significant components of our deferred tax assets for federal and state
income taxes are as follows (in thousands):
- ----------------------------------------------------------------------------------
December 31,
--------------------
2000 1999
- ----------------------------------------------------------------------------------
DEFERRED TAX ASSETS:
Net operating loss carryforward $ 22,600 $ 33,500
Research and other credits 7,200 4,600
Capitalized research expenses 5,000 4,200
Capitalized license and acquired technology 3,700 3,200
- ----------------------------------------------------------------------------------
Total Deferred Tax Assets 38,500 45,500
DEFERRED TAX LIABILITIES:
Unrealized gain on marketable securities $ (2,400) $ --
Net deferred tax liabilities $ -- $ --
Valuation allowance (36,100) (45,500)
- ----------------------------------------------------------------------------------
Net deferred tax assets $ -- $ --
- ----------------------------------------------------------------------------------
Due to our lack of earnings history, the net deferred tax assets have been
fully offset by a valuation allowance. The valuation allowance decreased by $9.4
million during the year ended December 31, 2000, and increased by $10.0 million
during the year ended December 31, 1999, and by $9.6 million during the year
ended December 31, 1998.
As of December 31, 2000, we had federal net operating loss carryforwards of
approximately $66 million. We also have federal and California research and
other tax credit carryforwards of approximately $7.2 million. The federal net
operating loss and credit carryforwards will expire in the years 2008 through
2020, if we do not use them.
Whether we are able to use the federal and state net operating loss and
credit carryforwards may be subject to a substantial annual limitation due to
the "change in ownership" provisions of the Internal Revenue Code of 1986. The
annual limitation may result in the expiration of net operating losses and
credits before we are able to use them. Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets for
financial reporting and the amount used for income tax purposes.
11. INTERMUNE PHARMACEUTICALS, INC.
On April 28, 1999, our wholly-owned subsidiary InterMune became an
independent company through venture capital funding and a portion of our
original investment in InterMune was returned to us. At that date, our
investment in InterMune was diluted from 100 percent to nine percent and we
began accounting for our investment in InterMune using the cost method. We
established InterMune in 1998 to develop Actimmune for serious pulmonary and
infectious diseases and congenital disorders shortly after we in-licensed
Actimmune from Genentech in May 1998. In April 1999, InterMune became an
independent company, and in March 2000, InterMune became a public company. As of
December 31, 2000 we held 149,000 shares of common stock of InterMune. Effective
April 2000, we assigned our remaining revenue rights and obligations under the
license with Genentech and the corresponding supply agreement to InterMune. In
addition, we hold an option to purchase the product rights for potential
dermatological applications of Actimmune. We will receive additional cash
payments from InterMune in March 2001, and royalties on Actimmune sales after
December 31, 2001.
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12. CONTINGENCY
Boehringer Ingelheim manufactures relaxin for us for clinical uses under a
long-term contract. In July 2000, in anticipation of successful results in our
relaxin clinical trial for scleroderma, we submitted a purchase order to
Boehringer Ingelheim for product to be used for commercial supply. The purchase
order was for a price to be negotiated. In view of the failure of the clinical
trial, we have no immediate need for commercial grade relaxin, and we have
agreed with Boehringer Ingelheim that it is premature to set the price for
commercial supply. We are in discussions with Boehringer Ingelheim concerning
the practical effect of the cancellation of the purchase order.
13. SUBSEQUENT EVENT (UNAUDITED)
On March 21, 2001, we entered into an agreement with F. H. Faulding & Co.
Limited to acquire Soltec Research Pty Ltd, a division of Faulding Healthcare.
Under the agreement, which is subject to customary closing conditions and is
expected to close in April 2001, Connetics will acquire all of Soltec's issued
capital for Australian $32 million or approximately U.S. $16.9 million. Faulding
will retain current development projects relating to Faulding's injectable
technologies and injectables product pipeline.
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14. QUARTERLY FINANCIAL DATA (UNAUDITED)
Following is a summary of the quarterly results of operations for the years
ended December 31, 2000 and 1999 (in thousands, except per share amounts):
- -----------------------------------------------------------------------------------------------------------
2000 1999
FIRST SECOND THIRD FOURTH SECOND FOURTH
(1) (2) (3) (4) FIRST (5) THIRD (6)
- -----------------------------------------------------------------------------------------------------------
Total revenues $13,603 $10,522 $ 7,087 $ 9,562 $ 7,161 $ 7,101 $ 6,173 $ 6,471
Gross profit on net
sales 11,804 10,061 6,368 8,673 5,990 5,621 4,545 5,521
Operating income
(loss) 140 31 (6,225) (5,588) (5,965) (4,865) (7,950) (8,846)
Income (loss) before
cumulative effect
of change in
accounting
principle 785 567 (5,600) 36,436 (5,923) (4,791) (7,982) (8,587)
Cumulative effect of
change in
accounting
principle (5,192)
Net income (loss) (4,407) 567 (5,600) 36,436 (5,923) (4,791) (7,982) (8,587)
Earnings per share --
basic
Income (loss)
before cumulative
effect of change
in accounting
principle 0.03 0.02 (0.19) 1.23 (0.28) (0.22) (0.37) (0.33)
Cumulative effect
of change in
accounting
principle (0.19)
Net income (loss) (0.17) 0.02 (0.19) 1.23 (0.28) (0.22) (0.37) (0.33)
Earnings per share --
diluted
Income (loss)
before cumulative
effect of change
in accounting
principle 0.03 0.02 (0.19) 1.16 (0.28) (0.22) (0.37) (0.33)
Cumulative effect
of change in
accounting
principle (0.18)
Net income (loss) (0.16) 0.02 (0.19) 1.16 (0.28) (0.22) (0.37) (0.33)
Shares used to
calculate income
(loss) per share --
basic 26,627 27,481 29,507 29,692 21,088 21,382 21,588 26,420
Shares used to
calculate income
(loss) per share --
diluted 28,412 28,704 29,507 31,331 21,088 21,382 21,588 26,420
- -----------------------------------------------------------------------------------------------------------
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(1) In the first quarter of 2000, Connetics recorded a net charge of $5.2
million ($0.18 per diluted share) for a cumulative effect of a change in
accounting principle relating to the adoption of SAB 101 for the deferral
of certain fees recognized in prior years. Connetics also recognized $0.2
million of deferred revenue in connection with the adoption of SAB 101.
(2) In accordance with the adoption of SAB 101, Connetics restated the results
of operations for the second quarter of 2000. The impact of the restatement
was to increase net income by $0.2 million or $0.01 per diluted share. The
increase was related to the amortization of the amount deferred in the
first quarter.
(3) In accordance with the adoption of SAB 101, Connetics restated the results
of operations for the third quarter of 2000. The impact of the restatement
was to decrease net income by $0.3 million or $0.01 per diluted share,
comprised of the reversal of $0.5 million in fees previously recognized
during the period, net of $0.2 million of deferred revenue.
(4) In the fourth quarter of 2000, Connetics recognized $4.1 in revenue from
amounts deferred in the first quarter as a result of contract
cancellations. Connetics also recorded a $43.0 million gain on the sale of
securities.
(5) In the second quarter of 1999, our wholly-owned subsidiary InterMune
Pharmaceuticals, Inc. was funded by venture capital investors, our
investment dropped from 100% to 9%, and we recorded a gain on our
investment of $1.1 million which was offset by the operating results of
InterMune through April 28, 1999 of approximately $1.0 million and was
included in interest and other income.
(6) In the fourth quarter of 1999, Connetics completed a public offering of 4.8
million primary shares of common stock resulting in net proceeds of
approximately $21.4 million. An additional 120,000 shares was issued to the
underwriting group upon the exercise of an option to purchase, resulting in
additional net proceeds of approximately $0.5.
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