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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, 2004
Commission File Number 0-27406
CONNETICS CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware
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94-3173928 |
(State or other jurisdiction of
incorporation or organization) |
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(I.R.S. Employer
Identification No.) |
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3160 Porter Drive
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94304 |
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Palo Alto, California
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(zip code) |
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(Address of principal executive offices)
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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 þ No o
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. þ
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the
Act). Yes þ No o
The aggregate market value of the common stock held by
non-affiliates of the registrant was approximately $473,000,000
as of June 30, 2004 based upon the shares outstanding and
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 of the registrant and by each
person known by the registrant to beneficially own more than 5%
of the registrant’s outstanding common stock as of that
date, 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 35,926,559 shares of registrant’s common
stock issued and outstanding as of February 28, 2005.
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
April 22, 2005.
Table of Contents
Forward-Looking Statements
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 of 1933, and
Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements give our current expectations or
forecasts of future events. 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.
You can identify forward-looking 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.
Although we believe that our plans, intentions and
expectations reflected in these forward-looking statements are
reasonable, we may not achieve these plans, intentions or
expectations. 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, and developments
relating to 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. In
particular, this Report sets forth important factors that could
cause actual results to differ materially from our
forward-looking statements. These and other factors, including
general economic factors and business strategies, and other
factors not currently known to us, may be significant, now 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 and in other documents that
we file from time to time with the Securities and Exchange
Commission including the Quarterly Reports on Form 10-Q to
be filed in 2005. 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.
PART I
THE COMPANY
References in this Report to “Connetics,” “the
Company,” “we,” “our” and
“us” refer to Connetics Corporation, a Delaware
corporation, and its consolidated subsidiaries. Unless the
context specifically requires otherwise, these terms include
Connetics Australia Pty Ltd. and Connetics Holdings Pty. Ltd.
Connetics was incorporated in Delaware in February 1993, and our
principal executive offices are located at 3160 Porter Drive,
Palo Alto, California 94304. Our telephone number is
(650) 843-2800. Connetics®, Luxíq®,
OLUX®, Extina®, Soriatane®,
VersaFoam® and the seven interlocking “C’s”
design are registered trademarks, and Evoclin™,
Liquipatch™,
VersaFoam-EFTM,
and Desilux™ are trademarks, of Connetics.
Velac® is a registered trademark of Yamanouchi
Europe B.V. 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.
Connetics is a specialty pharmaceutical company that develops
and commercializes products for the dermatology marketplace.
This marketplace is characterized by a large patient population
that is served by a relatively small, and therefore readily
accessible, number of treating physicians. We currently market
four pharmaceutical products, OLUX® (clobetasol propionate)
Foam, 0.05%, Luxíq® (betamethasone valerate) Foam,
0.12%, Soriatane®-brand acitretin, and
Evoclintm
(clindamycin) Foam, 1%. We promote the clinically proven
therapeutic advantages of our products and provide quality
customer service to physicians and other healthcare providers
through our experienced sales and marketing professionals.
Dermatological diseases often persist for an extended period of
time and are treated with a variety of clinically proven drugs
that are delivered in a variety of formulations. Topical
solutions have traditionally included lotions, creams, gels and
ointments. These topical delivery systems often inadequately
address a patient’s needs for efficacy, ease of use and
cosmetic elegance, and the failure to address those needs may
decrease patient compliance. We believe that VersaFoam®,
the proprietary foam delivery system used in OLUX, Luxíq
and Evoclin, has significant advantages over conventional
therapies for dermatological diseases. The foam formulation
liquefies when applied to the skin, and enables the active
therapeutic agent to penetrate rapidly. When the foam is
applied, it dries quickly and does not leave any residue, stains
or odor. We believe that the combination of the increased
efficacy and the cosmetic elegance of the foam may actually
improve patient compliance and satisfaction. In market research
sponsored by Connetics, more than 80% of patients said that they
preferred the foam to other topical delivery vehicles.
OLUX and Luxíq compete in the topical steroid market.
According to NDC Healthcare, or NDC, for the 12 months
ended December 2004, the value of the retail topical steroid
market for mid-potency and high- and super-high potency steroids
was $869 million. Luxíq competes in the mid-potency
steroid market and OLUX competes in the high- and super-high
potency steroid market. On March 4, 2004, we acquired from
Hoffmann-La Roche, or Roche, the exclusive U.S. rights to
Soriatane®, an approved oral therapy for the treatment of
severe psoriasis in adults. According to NDC, the value of the
entire retail market for psoriasis was $636 million in
2004. In October 2004, we received approval from the Food and
Drug Administration, or FDA, for Evoclin for the treatment of
acne vulgaris, and we launched Evoclin commercially in December
2004. Evoclin competes in the topical antibiotics market for the
treatment of acne. For the 12 months ended December 2004,
NDC reported that this market totaled $547 million.
We have one New Drug Application, or NDA, under review by the
FDA, and one product candidate in Phase III clinical
trials. In August 2004, we submitted an NDA for Velac® (1%
clindamycin and 0.025% tretinoin) with the FDA. In October 2004,
the FDA accepted the NDA for filing effective as of
August 23, 2004 with a user fee goal date of June 25,
2005. In September 2004 we commenced a Phase III clinical
trial for Desilux, a low-potency topical steroid for the
treatment of atopic dermatitis, formulated with 0.05% desonide
in our proprietary emollient foam delivery vehicle,
VersaFoam-EFTM.
In July 2003, we submitted an NDA for Extina® Foam. Extina
is an investigational new drug formulation of 2% ketoconazole
formulated using our proprietary platform foam delivery vehicle
for the treatment of
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seborrheic dermatitis. In November 2004, we received a
non-approvable letter from the FDA for Extina. The FDA’s
position was based on the conclusion that, although Extina
demonstrated non-inferiority to the comparator drug currently on
the market, it did not demonstrate statistically significant
superiority to placebo foam. We have continued discussions with
the FDA about what, if any, steps we can take to secure approval
for Extina, including resubmitting the NDA with additional
information or appealing the FDA’s decision.
We continue to develop and formulate new product candidates by
leveraging the experience and expertise of our wholly owned
subsidiary, Connetics Australia Pty Ltd., and the Connetics
Center for Skin Biology, or CSB. The CSB, which is a segment of
our product development group staffed by Connetics employees,
explores ways to optimize drug penetration, distribution, and
efficiency at the targeted treatment site on the skin, and
assesses novel formulations and new delivery technologies. The
CSB assists in the continued development of innovative topical
dermatology products through rigorous scientific evaluation of
products and product candidates. The CSB presents us with the
opportunity to bring together dermatologists and pharmacologists
from across the country to interact with our researchers to
explore how topical drugs interact with and penetrate the skin.
We believe this novel approach to drug development is a key part
of our innovation and enables us to bring even more effective
and novel treatments to our product platform and the dermatology
market. We did not incur any additional costs to establish the
CSB, which was created in 2001.
We own worldwide rights to a number of unique topical delivery
systems, including several distinctive aerosol foams. We have
leveraged our broad range of drug delivery technologies by
entering into license agreements with several well-known
pharmaceutical companies around the world. Those license
agreements for marketed products bear royalties payable to us.
In 2001, we entered into a global licensing agreement with
Novartis Consumer Health SA for the use of our Liquipatch
drug-delivery system in topical antifungal applications. In 2002
we entered into a license agreement with Pfizer, Inc. (formerly
Pharmacia Corporation) pursuant to which we granted Pfizer
exclusive global rights, excluding Japan, to our proprietary
foam drug delivery technology for use with Pfizer’s
Rogaine® hair loss treatment. In September 2004, we entered
into a license agreement granting Pierre Fabre Dermatologie
exclusive commercial rights to OLUX for Europe, excluding Italy
and the U.K., where the product is licensed to Mipharm S.p.A.
The license agreement with Pierre Fabre also grants marketing
rights for certain countries in South America and Africa. Pierre
Fabre will market the product under different trade names. Under
the terms of the license, we will receive an upfront license
payment, milestone payments and royalties on product sales.
Pierre Fabre will be responsible for costs associated with
product manufacturing, sales, marketing, and distribution in its
licensed territories. As part of the agreement, we also
negotiated a right-of-first-refusal in the United States to an
early-stage, innovative dermatology product currently under
development by Pierre Fabre. Pierre Fabre anticipates an initial
launch of OLUX in select European markets in mid-2005.
OUR STRATEGY
Our principal business objective is to be a leading specialty
pharmaceutical company focused on providing innovative
treatments in the field of dermatologic disease. To achieve this
objective, we intend to continue to pursue our commercial
strategy of maximizing product sales by leveraging novel
delivery technologies, accelerating the processes of getting
products to market, managing the risks of product development
where possible, and identifying and targeting specific market
opportunities where there are unmet needs. We have described our
development paradigm as a “4:2:1 model.” We strive in
any given year to have four product candidates in product
formulation, two product candidates in late-stage clinical
trials, and one product or new indication launched commercially.
We fuel our product pipeline by a combination of internally
developing product candidates and in-licensing novel products
that fit with our broader strategy. Key elements of our business
and commercialization strategy include the following:
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Maximizing Commercial Opportunities for OLUX, Luxíq,
Soriatane and Evoclin. We have a focused sales force
dedicated to establishing our products as the standard of care
for their respective indications. Our commercial strategy is to
call on those medical professionals in dermatology who |
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are most likely to prescribe our products. We are able to
effectively reach approximately 98% of our target audience. In
March 2004, we acquired exclusive U.S. rights to
Soriatane-brand acitretin, and in April 2004 we began promoting
Soriatane to dermatologists for the treatment of severe
psoriasis in adults. In October 2004, we received FDA approval
for Evoclin, a foam formulation of clindamycin for the treatment
of acne vulgaris. We launched Evoclin commercially in December
2004 with availability of the product in 50g and 100g trade unit
sizes. |
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Advancing the Development of Novel Dermatology Drugs. We
plan to continue to leverage our investment in Connetics
Australia and the CSB to enhance our ability to develop novel
products and drug delivery technologies for the dermatology
market. We concluded clinical trials in 2004 and subsequently
submitted an NDA with the FDA for our product candidate Velac, a
combination of 1% clindamycin, and 0.025% tretinoin in a gel
formulation, for the potential treatment of acne vulgaris. The
FDA accepted the Velac NDA for filing in October 2004 with a
filing date of August 23, 2004. In September 2004, we
commenced the Phase III clinical program for Desilux, a
low-potency topical steroid, formulated with 0.05% desonide in
our proprietary emollient foam delivery vehicle. The clinical
program focuses on atopic dermatitis, and subject to a
successful Phase III trial outcome, we plan to file an NDA
for Desilux in the fourth quarter of 2005. |
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Broadening Our Product Portfolio Through Development, License
or Acquisition. We believe that we can leverage our
dermatology-dedicated product development and commercial
activities by acquiring or licensing additional products for the
dermatology market. We regularly evaluate the licensing or
acquisition of additional product candidates. We may also
acquire additional technologies or businesses that we believe
will enhance our research and development or commercial
capabilities. |
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Selective Collaborations that Leverage Our Technology. As
we expand certain aspects of our development pipeline and
delivery technologies, we may partner with pharmaceutical or
biotech companies to gain access to additional marketing
expertise, such as over-the-counter or non-U.S. markets, or
physician groups on whom we do not currently call. Our approach
to partnership will be on a selective basis, seeking to maintain
the highest possible value of our product candidates. |
OUR PRODUCTS
OLUX and Luxíq Foams
OLUX is a foam formulation of clobetasol propionate, one of the
most widely prescribed super high-potency topical steroids. OLUX
has been proven to deliver rapid and effective results for scalp
and non-scalp psoriasis. Topical steroids are used to treat a
range of dermatoses, for which approximately 24 million
steroid prescriptions are written annually. In 2004, OLUX and
Luxíq comprised 9.7% of the branded prescriptions in these
combined topical steroid markets, corresponding to 22.5% of the
retail annual branded sales for 2004. While the topical steroid
market is highly fragmented, we believe that OLUX is the number
one branded super-high potency topical steroid prescribed by
U.S. physicians, and that Luxíq is the number one
branded mid-potency topical steroid by retail sales and the
third most commonly prescribed mid-potency topical steroid by
U.S. dermatologists in 2004.
We began selling OLUX in November 2000 for the short-term,
topical treatment of inflammatory and pruritic manifestations of
moderate to severe corticosteroid-responsive scalp dermatoses.
In December 2002, the FDA approved our supplemental New Drug
Application, or sNDA, to market OLUX for the treatment of mild
to moderate non-scalp psoriasis. Luxíq is a foam
formulation of betamethasone valerate, a mid-potency topical
steroid prescribed for the treatment of mild-to-moderate
steroid-responsive scalp dermatoses such as psoriasis, eczema
and seborrheic dermatitis. We have been selling Luxíq
commercially in the United States since 1999.
A study conducted at Stanford University School of Medicine
compared the safety and effectiveness, patient satisfaction,
quality of life, and cost-effectiveness of two clobetasol
regimens in the treatment of
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psoriasis. In a single-blind design, 29 patients were
randomized to receive either clobetasol foam on the skin and
scalp or a combination of clobetasol cream on the skin and
lotion on the scalp for 14 days. Severity of disease and
quality of life were evaluated using several tools, including
the Psoriasis Area Severity Index, or PASI, and the Dermatology
Life Quality Index. The trial showed that the increased
improvement in clinical severity, decreased application time,
and increased perception of relative efficacy, combined with
similar cost of treatment, suggest that OLUX is a better choice
than cream and lotion for some patients. This study supports our
belief that improved patient compliance with the foam will yield
better treatment results than the same active ingredient in
other formulations.
Currently, OLUX is approved for sale in more than 15 European
countries. Mipharm S.p.A. holds a license to market OLUX in
Italy and the U.K. and we will receive milestone payments and
royalties from Mipharm on future product sales in those
territories. In September 2004, we entered into a license
agreement granting Pierre Fabre Dermatologie exclusive
commercial rights to OLUX for certain European markets. The
license agreement with Pierre Fabre also grants marketing rights
for certain countries in South America and Africa. Pierre Fabre
anticipates an initial launch of OLUX in select European markets
in mid-2005 under different trade names. The European
super-high-potency steroid market is currently estimated at
approximately $50 million.
Soriatane
In March 2004, we entered into a binding purchase agreement with
Roche to acquire exclusive U.S. rights to Soriatane-brand
acitretin, an approved oral medicine for the treatment of severe
psoriasis in adults. Under the terms of the purchase agreement,
we paid Roche a total of $123.0 million in cash. We also
assumed certain liabilities in connection with returns, rebates
and chargebacks, and bought Roche’s then existing inventory
of existing product, active pharmaceutical ingredient, and
product samples.
Soriatane is a once-a-day oral retinoid approved in the
U.S. for the treatment of severe psoriasis in adults.
Approximately 4.5 million people in the U.S. suffer
from psoriasis; of these, approximately one million seek
treatment. Most cases are treated with topical steroids, while
the more severe cases are treated with oral or injectable
treatments. Soriatane is approved for the treatment of severe
psoriasis, and has been studied in plaque, guttate,
erythrodermic, palmar-plantar and pustular psoriasis. Soriatane
is the only treatment approved for both initial and maintenance
psoriasis therapy. It is supplied as 10 mg and 25 mg
capsules. Roche received FDA approval for Soriatane in 1997 and,
although its patent protection ended in 1995, there are
currently no generic competitors in the marketplace. Soriatane
is currently the only oral retinoid indicated for psoriasis in
the U.S. In 2004, our net sales of Soriatane were approximately
$54 million. We began sampling Soriatane in April 2004. At
the FDA’s request, due primarily to concerns that women of
childbearing potential would have access to the drug without
participating in the risk management program, we discontinued
the sampling program in December 2004.
In addition to U.S. sales of Soriatane, by agreement with
Roche we sell product to a U.S.-based distributor that exports
branded pharmaceutical products to certain international
markets. Product sold to this distributor is not permitted to be
resold in the U.S. We pay a royalty to Roche on Soriatane
sales to this distributor.
Clinical efficacy studies showed that 76% of patients taking
Soriatane showed statistically significant improvement in as
little as eight weeks. At six months, 40% of patients
experienced complete or almost complete clearing of their
psoriasis; at 12 months, patients continued to experience
statistically significant improvement in symptoms. In published
literature, patients treated with Soriatane had PASI 50 scores
of 85% (85% percent of the patients improved their PASI score by
at least 50%) and PASI 75 scores of 52%, both at 12 weeks.
Additionally, 59% of patients treated for 12 weeks were
relapse-free from psoriasis at six months post treatment, and at
12 months Soriatane patients had PASI 75 scores of 78%.
Since Soriatane is neither immunosuppressive nor cytotoxic, it
can be used without the risk of reducing a patient’s
resistance to common infections.
In women of childbearing potential, Soriatane should be reserved
for non-pregnant patients who have not responded to other
therapies or whose clinical condition makes other treatments
inappropriate, because
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the drug may cause serious birth defects. Women who are pregnant
or might become pregnant during therapy or within three years
after stopping therapy should not take Soriatane. Less frequent
but potentially serious adverse events that have been reported
include liver toxicity, pancreatitis and increased intracranial
pressure, as well as bone spurs, alteration in lipid levels,
possible cardiovascular effects and eye problems.
Evoclin Foam
Evoclin is a foam formulation of 1% clindamycin for the
treatment of acne vulgaris. Evoclin is Connetics’ first
commercial product that addresses the acne market. According to
the National Institute of Arthritis, Musculoskeletal and Skin
Disorders, in the U.S. an estimated 17 million people
are affected by acne annually, and an estimated 5.6 million
people visited a physician for treatment during the
12 months ended October 2004. Prescriptions for the entire
topical U.S. acne market in 2004 were approximately
$1.2 billion, making it the largest segment of the
dermatology market. In the U.S., acne products containing
clindamycin generated approximately $416 million in revenue
in the 12 month period ended October 2004, making this
active ingredient one of the most widely prescribed for acne.
Evoclin will compete primarily in the topical antibiotic market,
representing approximately $535 million in
U.S. prescriptions in the 12 months ended October
2004. We received FDA approval to market Evoclin in October 2004
and began selling the product in December 2004 in 50g and 100g
trade unit sizes. Net product revenues for Evoclin for the
fourth quarter of 2004 were $2.9 million. Evoclin is
indicated for topical application in the treatment of acne
vulgaris. Evoclin is contraindicated in individuals with a
history of hypersensitivity to preparations containing
clindamycin or lincomycin, a history of regional enteritis or
ulcerative colitis, or a history of antibiotic-associated
colitis.
PRODUCT CANDIDATES AND CLINICAL TRIALS
Our product candidates require extensive clinical evaluation and
clearance by the FDA before we can sell them commercially. Our
4:2:1 development model anticipates that we will conduct
simultaneous studies on several products at a given time.
However, we regularly re-evaluate our product development
efforts. On the basis of these re-evaluations, we have in the
past, and may in the future, abandon development efforts for
particular products. In addition, any product or technology
under development may not result in the successful introduction
of a new product.
Extina® Foam
In April 2003, we announced summary results from our
Phase III clinical trial with Extina, a foam formulation of
a 2% concentration of the antifungal drug ketoconazole for the
treatment of seborrheic dermatitis. Ketoconazole is used to
treat a variety of fungal infections, including seborrheic
dermatitis. Seborrheic dermatitis is a chronic, recurrent skin
condition that affects 3-5% of the U.S. population. It
usually involves the scalp, but also can affect the skin on
other parts of the body, including the face and chest. The
symptoms of seborrheic dermatitis include itching, redness and
scaling. In 2003 an estimated 1.1 million patients sought
physician treatment for seborrheic dermatitis. Extina is
intended to compete primarily in the topical antifungal market,
representing approximately $752 million in
U.S. prescriptions in 2004.
The Extina clinical program consisted of a pivotal trial and two
smaller supplemental clinical studies required by the FDA. In
the pivotal trial, 619 patients were treated for four weeks
in a double-blind, placebo- and active-controlled protocol. As
designed, the trial results demonstrated that Extina was not
inferior to Nizoral® (ketoconazole) 2% cream as
measured by the primary endpoint of Investigator’s Static
Global Assessment, or ISGA. The trial was also designed to
compare Extina to placebo foam per the ISGA. The result,
although in favor of Extina, did not achieve statistical
significance. On all other endpoints, statistical significance
was achieved; therefore, we believe that the totality of the
data demonstrated that Extina was clinically superior to placebo
foam. In July 2003, we submitted an NDA to the FDA for Extina.
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In November 2004, the FDA issued a non-approvable letter for
Extina. The FDA’s position was based on the conclusion
that, although Extina demonstrated non-inferiority to the
comparator drug currently on the market, it did not demonstrate
statistically significant superiority to placebo foam. We have
continued discussions with the FDA about what, if any, steps we
can take to secure approval for Extina, including resubmitting
the NDA with additional information or appealing the FDA’s
decision.
In December 2002, we initiated the Phase III program for
Velac, a first-in-class combination of 1% clindamycin and 0.025%
tretinoin, for the treatment of acne. The Velac clinical program
consists of two pivotal trials designed to demonstrate
superiority to the individual drug products, and two smaller
supplemental clinical studies required by the FDA. We completed
enrollment of both pivotal trials in late 2003, enrolling over
2,200 patients. In March 2004, we announced the positive
outcome of the Phase III clinical trials of Velac. The data
from each trial demonstrated a consistently robust and
statistically superior treatment effect for Velac compared with
clindamycin gel, tretinoin gel and placebo gel on both of the
primary endpoints. An analysis of the combined data from the
clinical trials demonstrated similar results to the individual
trials. The data from these trials also demonstrated that Velac
was safe and well tolerated, with the most commonly observed
adverse effects being application site reactions such as
burning, dryness, redness and peeling. Following this positive
clinical outcome, we submitted an NDA with the FDA for Velac in
August 2004. The NDA was accepted for filing by the FDA in
October 2004 with a filing date of August 23, 2004 and a
user fee goal date of June 25, 2005. If approved by the
FDA, we believe Velac will compete with topical retinoids as
well as topical antibiotics, representing approximately
$988 million in U.S. prescriptions during the
12 months ended December 2004. Prescriptions for the entire
U.S. acne market during that same period were approximately
$1.2 billion not including oral antibiotics.
In September 2004, we commenced the Phase III clinical
program for Desilux, a low-potency topical steroid, formulated
with 0.05% desonide in our proprietary emollient foam delivery
vehicle. The clinical program focuses on atopic dermatitis and
is designed to include infants from three months of age and
children up to 17 years old. Subject to a successful
Phase III trial outcome, we plan to file an NDA for Desilux
in the fourth quarter of 2005.
OLUX-EF
We anticipate initiating Phase III clinical trials for an
emollient foam of OLUX, or OLUX-EF, by the end of the first
quarter of 2005. OLUX-EF is a super-high potency steroid in our
new proprietary ethanol-free emollient VersaFoam vehicle
indicated for the treatment of steroid responsive dermatological
diseases. Our clinical trials will be conducted in atopic
dermatitis and psoriasis.
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Other Pipeline Formulations |
In addition to the product candidates described above, we are
also developing the foam technology for other disease
indications. As part of our 4:2:1 development model, we strive
to have four product candidates in product formulation at any
given time, so that we have some flexibility in determining
which two to move into human clinical trials. Our most promising
preclinical candidates include an emollient foam of Luxíq ,
a low potency steroid, as well as other formulation candidates
in early stages of development. We are exploring various product
formulations for Liquipatch as well, which is described in more
detail below under “Royalty-Bearing Products and
Licensed Technology — Liquipatch.”
ROYALTY-BEARING PRODUCTS AND LICENSED TECHNOLOGY
Foam Technology. In 2002 we entered into a license
agreement with Pfizer, Inc. (formerly Pharmacia Corporation)
pursuant to which we granted Pfizer exclusive global rights,
excluding Japan, to our proprietary foam drug delivery
technology for use with Pfizer’s Rogaine® hair loss
treatment. The
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license with Pfizer will expand the reach of the foam vehicle to
the non-prescription (over-the-counter) pharmaceutical market.
Under the agreement, Pfizer paid us an initial licensing fee,
and agreed to pay us additional fees when it achieves specified
milestones, plus a royalty on product sales. We recognized
$1.0 million under the agreement during 2002 related to
license fees and milestone payments. During 2004 and 2003 we
recognized $11,000 and $86,000, respectively, in license fees
related to development costs. Pfizer will be responsible for
most product development activities and costs. Unless terminated
earlier, the agreement with Pfizer will terminate on the first
date on which all of Pfizer’s obligations to pay royalties
has expired or been terminated. In general, in each country
(excluding Japan) where the manufacture, importation,
distribution, marketing, sale or use of the product would
infringe any of our issued patents covered by the agreement,
Pfizer’s obligation to pay patent royalties with respect to
that country will expire automatically on the expiration or
revocation of the last of our patents to expire (or to be
revoked) in that country. No U.S. patents have yet been
issued covering the minoxidil foam technology, although we have
received a Notice of Allowance of our first patent in this field.
Before April 2001, Connetics Australia (under the name Soltec
Research Pty Ltd., or Soltec) had entered into a number of other
agreements for the foam technology. Connetics Australia licensed
the technology of betamethasone valerate foam to Celltech plc in
Europe, and Celltech has licensed the worldwide rights to their
patent on the steroid foam technology to us through Connetics
Australia. In 2003, we bought the rights to the U.S. patent
from Celltech. In May 2004, Celltech was acquired by UCB Pharma,
or UCB, a subsidiary of UCB Group. We pay UCB royalties on all
sales worldwide of foam formulations containing steroids. UCB
markets their product as Bettamousse®(the product
equivalent of Luxíq), and UCB paid us royalties for their
sales under the betamethasone valerate foam license through
April 2003, at which time their royalty obligation under the
contract ceased. We have license agreements with Bayer (in the
U.S.) and Pfizer and Mipharm (internationally) for the use
of pyrethrin foam for head lice. The head lice product is
marketed as RID® in the U.S., as Banlice® in
Australia, and as Milice® in Italy. We receive royalties on
sales of those products. In February 2004, we entered into an
agreement with Mipharm to license ketoconazole foam to them in
exchange for an initial fee of $90,000, plus future milestone
and royalty payments. In 2004, on a consolidated basis, we
received $244,000 in royalties for foam-based technology.
As discussed under “OLUX and Luxíq Foams,” above,
we have licensed to Mipharm commercial rights to market and sell
OLUX in Italy and the U.K., and we will receive milestone
payments and royalties on future product sales. We have received
$50,000 under the agreement thru December 31, 2004. Based
on the aggregate minimum royalty provisions in the agreement and
assuming the agreement stays in force through 2021, the
aggregate potential minimum royalties under the contract are
$975,000. Unless terminated earlier, the agreement with Mipharm
will terminate on the later of September 2021 and the last
expiration date of the patents covering the aerosol mousse
technology, which is currently 2015. We have also granted
exclusive commercial rights to Pierre Fabre to market and sell
OLUX in Europe, excluding Italy and the U.K. The license
agreement with Pierre Fabre also grants marketing rights for
certain countries in South America and Africa. Under the terms
of the license, we received an upfront license payment of
$250,000 in 2004, and we will receive milestone payments and
royalties on product sales.
Aerosol Spray. We have licensed to S.C.
Johnson & Son, Inc. the rights to a super-concentrated
aerosol spray that is marketed in the U.S. and internationally.
On January 5, 2004, we reached an agreement with S.C.
Johnson to terminate the license agreement and grant them a
fully paid-up, royalty-free license to the technology. We ceased
recognizing royalties in connection with the agreement as of
March 31, 2004. In 2002, 2003 and 2004, we received
$2.4 million, $7.0 million and $1.2 million,
respectively, in royalty payments under the license agreement.
Liquipatch. We have agreements with Novartis to develop
Liquipatch for various indications. Liquipatch is a
multi-polymer 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, which we believe will provide a longer
treatment period. In June 2001, we entered into a global
licensing agreement with Novartis Consumer Health SA for the
Liquipatch drug-delivery system for use in
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topical antifungal applications. The agreement followed
successful pilot development work and gives Novartis the
exclusive, worldwide right to use the Liquipatch technology in
the topical antifungal field. In March 2002, Novartis paid
$580,000 to exercise its then-existing option to expand the
license agreement. We received no payments from Novartis under
the license agreement in 2003, and in July 2004, we received a
milestone payment of $81,000. Novartis has paid an aggregate of
$722,000 under the contract as of December 31, 2004. Unless
terminated earlier, the agreement may be terminated by either
party after the expiration of one or more claims within a patent
covered by the agreement with respect to the relevant country
(which claim has not been declared to be invalid or
unenforceable by a court of competent jurisdiction) or after the
eighth anniversary of the first market introduction of the
product in countries without such a claim. The expiration date
of the last patent to expire is currently 2017. Novartis will be
responsible for all development costs, and will be obligated to
pay royalties on future product sales.
Actimmune®. We have an agreement with InterMune,
Inc. pursuant to which InterMune pays us royalties for sales of
Actimmune (gamma interferon). We recorded $172,000, $358,000,
and $330,000 in royalty revenue related to Actimmune sales in
2002, 2003 and 2004, respectively. In August 2002, we entered
into an agreement with InterMune to terminate our exclusive
option for certain rights in the dermatology field in exchange
for a payment of $350,000. We recognized the full amount of this
revenue in 2002.
SALES AND MARKETING
We have an experienced, highly productive sales and marketing
organization, which is dedicated to dermatology. As of
February 28, 2005, we had 170 employees in our sales and
marketing organization, including 141 field sales directors and
representatives. Since a relatively small number of physicians
write the majority of prescriptions for dermatological
indications, we believe that the size of our sales force is
currently appropriate to reach our target physicians.
Our marketing efforts are focused on assessing and meeting the
needs of dermatologists, residents, dermatology nurses, and
physicians’ assistants. Our sales representatives strive to
cultivate relationships of trust and confidence with the
healthcare professionals they call on. In 2004, our sales force
called on over 11,300 U.S. dermatologists and dermatology
medical professionals who were responsible for approximately 98%
of all topical corticosteroid prescriptions and approximately
99% of all topical acne prescriptions written by dermatologists
in the U.S. To achieve our marketing objectives, we use a
variety of advertising, promotional material (including journal
advertising, promotional literature, and rebate coupons),
specialty publications, participation in educational
conferences, support of continuing medical education activities,
and advisory board meetings, as well as product internet sites
to convey basic information about our products and our company.
Our corporate website at www.connetics.com includes
information about the company as well as descriptions of ongoing
research, development and clinical work. Our product websites,
at www.olux.com, www.luxiq.com,
www.soriatane.com, and www.evoclin.com provide
information about the products and their approved indications,
as well as copies of the full prescribing information, the
patient information booklet, and additional product information.
On the websites for our topical products, we also offer
downloadable rebate coupons.
In March 2004, we entered into an agreement with UCB authorizing
them to promote OLUX and Luxíq to a select group of
U.S. primary care physicians, or PCP’s. In September
2004, in connection with UCB’s acquisition of Celltech plc,
UCB notified us that it intended to discontinue the co-promotion
agreement, effective March 31, 2005. UCB will continue to
promote OLUX and Luxíq until then. Through the end of the
promotion period, UCB’s focus will be on approximately 10%
of PCP’s who are active prescribers of dermatology
products, including OLUX and Luxíq. The purpose of the
co-promotion agreement is to ensure appropriate use of OLUX and
Luxíq with the current PCP users and to build value for the
OLUX and Luxíq brands. We are exploring other possibilities
to assist us in accessing the primary care physician market,
including using a contract sales force or working with other
commercial partners.
In addition to traditional marketing approaches and field sales
relationships with dermatologists, we sponsor several programs
that support the dermatology field. We currently provide funding
to sponsor one
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dermatology resident at Stanford University Medical School and
dermatology fellows at the Harvard Medical School and Johns
Hopkins Medical Center. We also provide corporate sponsorship to
various dermatology groups, including the American Academy of
Dermatology, the National Psoriasis Foundation, the Dermatology
Foundation, the Skin Disease Education Foundation, and the
Foundation for Research & Education in Dermatology. In
2004, we sponsored 34 children to attend Camp Wonder, a summer
camp sponsored by the Childrens’ Skin Disease Foundation
for children suffering from serious skin diseases.
COMPETITION
The specialty pharmaceutical industry is characterized by
intense market competition, extensive product development and
substantial technological change. The principal means of
competition used to market our products include quality,
service, price, intellectual property, and product performance.
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. OLUX and Luxíq
compete with a number of corticosteroid brands in the
super-high-, high- and mid-potency categories for the treatment
of inflammatory skin conditions. In addition, both OLUX and
Luxíq compete with generic (non-branded) pharmaceuticals
which claim to offer similar 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. We
are not currently aware of any generic substitutes for any of
our marketed products. Competing brands for OLUX and Luxíq
include Halog® and Ultravate®, marketed by
Bristol-Myers Squibb Company; Elocon® and Diprolene®,
marketed by Schering-Plough Corporation; Locoid®, marketed
by Ferndale Labs; Temovate® and Cutivate®, which are
marketed by GlaxoSmithKline; DermaSmoothe FS®, marketed by
Hill Dermaceuticals;
Capextm
and
Clobextm,
marketed by Galderma; and Psorcon®, marketed by Dermik
Laboratories, Inc. Soriatane competes with three systemic
biologic drugs for the treatment of severe psoriasis:
Enbrel®, marketed by Amgen and Wyeth Pharmaceuticals;
Amevivetm,
marketed by Biogen; and
Raptivatm,
marketed by Genentech, Inc. Evoclin competes primarily in the
topical antibiotic market. Competition in this market includes
generic and branded clindamycin and erythromycin including
branded products Clindagel marketed by Galderma S.A., Cleocin-T
marketed by Pfizer, Inc., and Clindets marketed by Stiefel
Laboratories, Inc. Additional competition is posed by generic
and branded combinations of clindamycin and benzoyl peroxide,
such as Benzaclin marketed by Dermik and Duac marketed by
Stiefel, and erythromycin and benzoyl peroxide such as
Benzamycin marketed by Dermik.
Many of our existing or potential competitors, particularly
large pharmaceutical companies, have substantially greater
financial, marketing, sales, technical and human resources than
we do. In addition, many of these competitors have more
collective experience than we do in performing preclinical
testing and human clinical trials of new pharmaceutical products
and obtaining regulatory approvals for therapeutic products, and
have research and development capabilities that may allow such
competitors to develop new or improved products that may compete
with our product lines. Furthermore, many of our competitors are
private companies or divisions of much larger companies that do
not have the same disclosure obligations regarding their product
development and marketing strategies and plans that we do as a
public company, which puts us at a distinct competitive
disadvantage relative to these competitors. 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.
Moreover, our competitors may succeed in obtaining FDA approval
for products more rapidly or successfully than we do.
Our philosophy is to compete on the basis of the quality and
efficacy of our products and unique drug delivery vehicles,
combined with the effectiveness of our marketing, sales and
other product support efforts. Whether we are 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.
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CUSTOMERS
We sell our products directly to distributors, who in turn sell
the products into the retail marketplace. Our customers include
the nation’s leading wholesale pharmaceutical distributors,
such as Cardinal Health, Inc., McKesson HBOC, Inc., and
AmerisourceBergen Corporation, and one national retail pharmacy
chain, Walgreens. In December 2004 we entered into a
distribution agreement with each of Cardinal Health, Inc. and
McKesson Corporation under which we agreed to pay a fee to each
of these distributors in exchange for certain product
distribution, inventory information, return goods processing,
and administrative services. While these agreements will provide
us with inventory level reports from these distributors
beginning in 2005, we must also rely on historical prescription
information to estimate future demand for our products. Patients
have their prescriptions filled by pharmacies that buy our
products from the wholesale distributors. Because sources
available to us track prescriptions filled but do not track the
total prescriptions written, and because pharmacies sometimes
substitute other drugs for our products when prescriptions are
presented, the number of prescriptions written for our products
only indirectly affects our product revenues.
RESEARCH AND DEVELOPMENT AND PRODUCT PIPELINE
Innovation by our research and development operations
contributes to the success of our business. Our research and
development expenses were $21.5 million in 2004,
$30.1 million in 2003, and $25.8 million in 2002. Our
goal is to develop and bring to market innovative products that
address unmet healthcare needs. Our substantial investment in
research and development supports this goal. We also have an
active in-licensing strategy. We have a variety of
pharmaceutical agents in various stages of preclinical and
clinical development in several novel delivery technologies.
Our development activities involve work related to product
formulation, preclinical and clinical study coordination,
regulatory administration, manufacturing, and quality control
and assurance. Many pharmaceutical companies conduct early stage
research and drug discovery, but to obtain the most value from
our development portfolio, we are focusing on later-stage
development. This approach helps to minimize the risk and time
requirements for us to get a product on the market. Our strategy
involves targeting product candidates that we believe have
attractive market potential, and then rapidly evaluating and
formulating 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. A secondary strategy is to
evaluate the acquisition of products from other companies.
We have developed a variety of aerosol foams similar to our foam
delivery system for OLUX and Luxíq, including water- and
petrolatum-based foams. We have also developed Liquipatch, a
multi-polymer 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, which we believe provides a longer treatment
period. We anticipate developing one or more new products in the
aerosol foam or gel matrix formulations, by incorporating
leading dermatologic agents in formulations that are tailored to
treat specific diseases or different areas of the body.
All of our products and technologies under development require
us to make significant commitments of personnel and financial
resources. In addition to our in-house staff and resources, we
contract a 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 into
agreements with academic or university-based researchers to
conduct various studies for us.
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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 are pursuing a number of U.S. and
international patent applications, although we cannot be sure
that any of these patents will ever be issued. We also have
acquired rights by assignment 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 to allow us to market and distribute products covered
by the patent or application.
The U.S. and worldwide issued patents and pending applications
we are developing and pursuing in our intellectual property
portfolio relate to novel drug delivery vehicles for the topical
administration of active pharmaceutical ingredients, for use in
both human and veterinary applications. We own or are
exclusively licensed under pending applications and/or issued
patents worldwide relating to OLUX and Luxíq, and other
products in development. Of the 33 U.S. or worldwide issued
patents relating to our technologies, one relates to
corticosteroid foam formulations, three relate to our emollient
foam formulation, one relates to a foam formulation for the
treatment of head lice, three relate to an antibacterial foam
formulation, one relates to ketoconazole foam, 23 relate to
Liquipatch, and one relates to minoxidil. Of the additional 19
issued patents related to the technologies developed by
Connetics Australia, three relate to the aerosol technology
licensed to S. C. Johnson, one relates to an acne treatment and
15 relate to an ectoparasiticidal formulation that has
veterinary applications. We also have an exclusive license under
two patents covering stable retinoid compositions. The patents
discussed above expire between 2005 and 2019.
In May 2004, the U.S. Patent and Trademark Office, or
USPTO, issued to us a patent covering a pharmaceutical aerosol
foam composition having occlusive capability; that patent will
expire in 2019. The delivery technology that is the basis for
OLUX and Luxíq is covered by a U.S. patent on methods
of treating various skin diseases using a foam pharmaceutical
composition comprising a corticosteroid active substance, a
propellant and a buffering agent. That patent will expire in
2016. The Liquipatch technology is covered by one
U.S. patent, which will also expire in 2016. The technology
contained in Evoclin is the subject of a pending
U.S. patent application, as is the technology contained in
Extina.
Even though we or our licensors have filed patent applications
and we hold issued patents, our or our licensors’ patent
applications may not issue as patents, any issued patents may
not provide competitive advantage to us, and our competitors may
successfully challenge or circumvent any issued patents. In
November 2004 we announced that Medicis Pharmaceutical
Corporation, or Medicis, had informed us that it believed a
patent to which it holds certain rights will be infringed by our
product candidate Velac. While we are not aware of any legal
filings related to Medicis’ assertion, we believe, based on
information publicly available on the USPTO website, that the
inventor named on the patent has filed a Reissue Patent
Application with the USPTO. To our knowledge, the USPTO has not
formally announced the filing of the reissue application in the
Official Gazette as of the date of this Report. The cost of
responding to this and other similar challenges that may arise
and the inherent costs to defend the validity of our licensed
technology and issued 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 our management’s time.
Our business could suffer materially if Medicis or any third
party were to be awarded a judgment adverse to us in any patent
litigation or other proceeding arising in connection with Velac
or any of our other products or patent applications.
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. We require all our employees, consultants,
manufacturing partners, and advisors to enter into
confidentiality agreements with us. These agreements, however,
may not provide adequate protection for our trade secrets
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or proprietary know-how in the event of any unauthorized use or
disclosure of such information. In addition, others may 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 and brand recognition. We own ten U.S. and
ten non-U.S. registered trademarks, several trademark
applications and common law trademarks, and servicemarks and
domain names related to our dermatology business. United States
federal registrations for trademarks remain in force for ten
years and may be renewed every ten years after issuance,
provided the mark is still being used in commerce. However, any
such trademark or service mark registrations may not afford us
adequate protection, and we may not 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 do not operate manufacturing or distribution facilities for
any of our products. Instead, we contract with third parties to
manufacture our products for us. Our company policy and the FDA
require that we contract only with manufacturers that comply
with current Good Manufacturing Practice, or cGMP, regulations
and other applicable laws and regulations. Currently, DPT
Laboratories, Ltd., or DPT, and Accra Pac Group, Inc., or Accra
Pac, manufacture commercial supplies of OLUX, Luxíq as well
as physician samples of those products for us. DPT also
manufactures Evoclin and clinical supplies for our various
clinical trial programs. We are currently qualifying Accra Pac
to manufacture Evoclin. We previously entered into agreements
with DPT under which they constructed an aerosol filling line at
their plant in Texas. This line is used to manufacture and fill
our commercial aerosol products. Roche manufactures commercial
supplies of Soriatane. We have agreements with Roche to fill and
finish Soriatane through 2005, and to provide active
pharmaceutical ingredient through 2007. We believe that these
agreements will allow us to maintain supplies of Soriatane
finished product through 2012 due to the five-year shelf life of
the combination of the active pharmaceutical ingredient and
finished product.
WAREHOUSING AND DISTRIBUTION
All of our product distribution activities are handled by
Cardinal Health Specialty Pharmaceutical Services, or SPS. SPS
is a division of Cardinal Health, which was our second largest
customer in 2004. For more information about our customers, see
“Customers” above, and Note 2 of Notes
to Consolidated Financial Statements. SPS stores and
distributes products to our customers from a warehouse in
Tennessee. When SPS receives a purchase order, it processes the
order into a computerized distribution database. Generally, SPS
ships our customers’ orders within 24 hours after
their order is received. Once the order has shipped, SPS
generates and mails invoices on our behalf. Any delay or
interruption in the distribution process or in payment by our
customers could have a material adverse effect on our business.
GOVERNMENT REGULATION
Generally — Product Development. The
pharmaceutical industry is 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. In order to clinically test, manufacture, and
market products for therapeutic use, we must satisfy mandatory
procedures and safety and effectiveness standards established by
various regulatory bodies. We have provided a more detailed
explanation of the standards we are subject to under
“Factors Affecting Our Business and
Prospects — We may spend a significant amount of money
to obtain FDA and other regulatory approvals, which may never be
granted ” and “— We cannot sell our
current products and product candidates if we do not obtain and
maintain governmental approvals ” below.
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We expect that all of our prescription pharmaceutical products
will require regulatory approval by governmental agencies before
we can commercialize them. The nature and extent of the review
process for our potential products will vary depending on the
regulatory categorization of particular products. Federal,
state, and international regulatory bodies govern or influence,
among other things, the testing, manufacture, labeling, storage,
record keeping, approval, advertising, and promotion of our
products on a product-by-product basis. 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, initial and ongoing regulation by governmental
entities in the United States and other countries is a
significant factor in the production and marketing of any
pharmaceutical products that we have or may develop.
Product development and approval within this regulatory
framework, and the subsequent compliance with appropriate
federal and foreign statutes and regulations, takes a number of
years and involves the expenditure of substantial resources.
FDA Approval. The general process for approval by the FDA
is as follows:
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Preclinical Testing. Generally, a company must conduct
preclinical studies before it can obtain FDA approval for a new
therapeutic agent. The basic purpose of preclinical
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 sponsor of these studies submits the results to
the FDA 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
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Clinical Trials. Clinical trials are normally done in
three distinct phases and generally take two to five years, but
may take longer, to complete: |
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Phase I trials generally involve administration of a
product to a small number of patients to determine safety,
tolerance and the metabolic and pharmacologic actions of the
agent in humans and the side effects associated with increasing
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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
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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
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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, the
eligibility criteria for the study, and the sometimes seasonal
nature of certain dermatological conditions. Delays in planned
patient enrollment may result in increased costs and delays,
which could have a material adverse effect on our business. In
addition, side effects or adverse events that are reported
during clinical trials can delay, impede, or prevent marketing
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Regulatory Submissions. The Food, Drug and Cosmetic Act
outlines the process by which a company can request approval to
commercialize a new product. After we complete the clinical
trials of a new drug product, we must file an NDA with the FDA.
We used the so-called 505(b)(2) application process for OLUX,
Luxíq, and Evoclin, which permitted us in each case to
satisfy the requirements for a full NDA by relying on published
studies or the FDA’s findings of safety and effectiveness
based on studies in a previously-approved NDA sponsored by
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together with the studies generated on our products. Generally,
although the FDA evaluation of safety and efficacy is the same,
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
a traditional NDA application. The 505(b)(2) process will not be
available for all of our other product candidates, and as a
result the FDA process may be longer for our future product
candidates than it has been for our products to date. |
We must receive FDA clearance before we can commercialize any
product, 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 an
NDA, and can take longer if significant questions arise during
the review process. 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 NDA for that product. We may not obtain regulatory
approval for any products that we develop, even after committing
such time and expenditures to the process. Even if regulatory
approval of a product is granted, it may entail limitations on
the indicated uses for which the product may be marketed.
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 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.
Manufacturing. The FDA regulates and inspects equipment,
facilities, and processes used in the manufacturing of
pharmaceutical products before providing approval to market a
product. If after receiving clearance from the FDA, we make a
material change in manufacturing equipment, location, or
process, we may have to undergo additional regulatory review. We
must apply to the FDA to change the manufacturer we use to
produce any of our products. We and our contract manufacturers
must adhere to cGMP and product-specific regulations enforced by
the FDA through its facilities inspection program. The FDA also
conducts regular, periodic visits to re-inspect equipment,
facilities, and processes after the initial approval. If, as a
result of these inspections, the FDA determines that our (or our
contract manufacturers’) equipment, facilities, or
processes do not comply with applicable FDA regulations and
conditions of product approval, the FDA may seek sanctions
and/or remedies against us, including suspension of our
manufacturing operations.
Post-Approval Regulation. The FDA continues to review
marketed products even after granting regulatory clearances, and
if previously unknown problems are discovered or if we fail to
comply with the applicable regulatory requirements, the FDA may
restrict the marketing of a product or impose the withdrawal of
the product from the market, recalls, seizures, injunctions or
criminal sanctions. 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.
Pharmacy Boards. 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 SPS to ensure continued compliance
with the state pharmacy board requirements.
Fraud and Abuse Regulations. We are subject to various
federal and state laws pertaining to health care “fraud and
abuse,” including anti-kickback laws and false claims laws.
The Office of Inspector General, or OIG, of the
U.S. Department of Health and Human Services has provided
guidance that outlines several considerations for pharmaceutical
manufacturers to be aware of in the context of marketing and
promotion of products reimbursable by the federal health care
programs. Effective July 1, 2005, pursuant to a new
California law, all pharmaceutical companies doing business in
California will be required to certify that they are in
compliance with the OIG guidance.
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The federal anti-kickback statute places constraints on business
activities in the health care sector that are common business
activities in other industries, including sales, marketing,
discounting, and purchase relations. Practices that may be
common or longstanding in other businesses are not necessarily
acceptable or lawful when soliciting federal health care program
business. Specifically, anti-kickback laws make it illegal for a
prescription drug manufacturer to solicit or to offer or pay
anything of value for patient referrals, or in return for
purchasing, leasing, ordering, or arranging for or recommending
the purchase, lease or ordering of, any item or service that is
reimbursable in whole or part by a federal health care program,
including the purchase or prescription of a particular drug. The
federal government has published regulations that identify
“safe harbors” or exemptions for certain payment
arrangements that do not violate the anti-kickback statutes. We
seek to comply with the safe harbors where possible. Due to the
breadth of the statutory provisions and the absence of guidance
in the form of regulations or court decisions addressing some of
our practices, it is possible that our practices might be
challenged under anti-kickback or similar laws.
False claims laws prohibit anyone from knowingly and willingly
presenting, or causing to be presented for payment to third
party payors (including Medicare and Medicaid) claims for
reimbursed drugs or services that are false or fraudulent,
claims for items or services not provided as claimed, or claims
for medically unnecessary items or services. Our activities
relating to the sale and marketing of our products may be
subject to scrutiny under these laws.
Violations of fraud and abuse laws may be punishable by criminal
and/or civil sanctions, including fines and civil monetary
penalties, as well as the possibility of exclusion from federal
health care programs (including Medicare and Medicaid).
Medicaid and State Rebate Programs. We participate in the
Federal Medicaid rebate program established by the Omnibus
Budget Reconciliation Act of 1990, as well as several state
supplemental rebate programs. Under the Medicaid rebate program,
we pay a rebate to each state Medicaid program for our products
that are reimbursed by those programs. As a manufacturer
currently of single source products only, the amount of the
rebate for each of our products is set by law as the greater of
15.1% of the average manufacturer price of that product, or the
difference between the average manufacturer price and the best
price available from the company to any customer, with the final
rebate amount adjusted upward if increases in average
manufacturer price since product launch have outpaced inflation.
The Medicaid rebate amount is computed each quarter based on our
submission to the U.S. Department of Health and Human
Services Centers for Medicare and Medicaid Services of our
current average manufacturer price and best price for each of
our products. As part of our revenue recognition policy, we
provide reserves on this potential exposure at the time of
product shipment.
Federal law also requires that any company that participates in
the Medicaid program must extend comparable discounts to
qualified purchasers under the Public Health Services, or PHS,
pharmaceutical pricing program. The PHS pricing program extends
discounts comparable to the Medicaid rebate to a variety of
community health clinics and other entities that receive health
services grants from the PHS, as well as hospitals that serve a
disproportionate share of poor Medicare and Medicaid
beneficiaries.
We also make our products available to authorized users of the
Federal Supply Schedule, or FSS, of the General Services
Administration under an FSS contract negotiated by the
Department of Veterans Affairs. The Veterans Health Care Act of
1992, or VHCA, imposes a requirement that the prices a company
such as Connetics charges the Veterans Administration, the
Department of Defense, the Coast Guard, and the PHS be
discounted by a minimum of 24% off the average manufacturer
price charged to non-federal customers. Our computation of the
average price to non-federal customers is used in establishing
the FSS price for these four purchasers. The government
maintains the right to audit the accuracy of our computations.
Among the remedies available to the government for failure to
accurately calculate FSS pricing and the average manufacturer
price charged to non-federal customers is recoupment of any
overpayments made by FSS purchasers as a result of errors in
computations that affect the FSS price.
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The Medicaid rebate statute and the VHCA also provide that, in
addition to penalties that may be applicable under other federal
statutes, civil monetary penalties may be assessed for knowingly
providing false information in connection with the pricing and
reporting requirements under the laws. The amount that may be
assessed is up to $100,000 for each item of false information.
We have provided additional information about the risks
associated with participation in the Medicaid and similar
programs, under “Factors Affecting Our Business and
Prospects — Our sales depend on payment and
reimbursement from third party payors, and if they reduce or
refuse payment or reimbursement, the use and sales of our
products will suffer, we may not increase our market share, and
our revenues and profitability will suffer ” and
“ — The growth of managed care organizations
and other third-party reimbursement policies may have an adverse
effect on our pricing policies and our margins ” below.
MARKETING TO HEALTHCARE PROFESSIONALS
We intend for our relationships with doctors to benefit patients
and to enhance the practice of medicine, and at the same time
represent the interests of our stockholders in maintaining and
growing our company. We have adopted internal policies that
emphasize to our employees that all interactions with healthcare
professionals should be focused on informing them about
FDA-approved uses of our products, providing scientific and
educational information consistent with FDA regulations and
guidance, or supporting medical research and education. We
believe that effective marketing of our products is necessary to
ensure that patients have access to the products they need, and
that the products are correctly used for maximum patient
benefit. Our marketing and sales organizations are critical to
achieving these goals, because they foster relationships that
enable us to inform healthcare professionals about the benefits
and risks of our products, provide scientific and educational
information, support medical research and education, and obtain
feedback and advice about our products through consultation with
medical experts.
MARKETING EXCLUSIVITY
The FDA has the power to grant pharmaceutical companies new drug
product exclusivity for a drug, independent of any orphan drug
or patent term exclusivity accorded to that drug. This marketing
exclusivity essentially prevents competition from other
manufacturers who wish to put generic versions of the product
into U.S. commerce. The FDA has granted us marketing
exclusivity for foam-based products incorporating clobetasol
propionate until December 20, 2005, for the short-term
topical treatment of mild to moderate plaque-type psoriasis of
non-scalp regions. The exclusivity prevents other parties from
submitting or getting approval for any comparable 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. At the time we submitted the sNDA for the expanded
label for OLUX, we requested exclusivity for the new indication.
As an antibiotic, Evoclin is not eligible for marketing
exclusivity.
ENVIRONMENTAL REGULATION
Our research and development activities involve the controlled
use of hazardous materials including biohazardous material,
organic solvents, potent pharmaceutical agents, compressed
flammable gases, and certain radioactive materials, such as
tritium, and carbon-14. 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, to the best of our knowledge, our safety procedures
and equipment for handling and disposing of hazardous materials
comply with all applicable prudent industry standards and all
applicable state, federal, and local laws and regulations, we
cannot completely eliminate the risk of accidental contamination
or injury from these materials.
We are committed to conducting our operations in a manner that
protects the health and safety of our employees, the environment
and the communities in which we operate. Maintaining a clean
environment and a safe and healthy workplace is an integral part
of our daily activities and business decisions. Our
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environmental health and safety programs are developed and
continually improved to ensure the protection of our business,
assets, employees, customers, and the surrounding community.
Compliance with federal, state and local laws regarding the
discharge of materials into the environment or otherwise
relating to the protection of the environment has not had, and
is not expected to have, any adverse effect on our capital
expenditures, earnings or competitive position. We are not
presently a party to any litigation or administrative proceeding
with respect to our compliance with such environmental
standards. In addition, we do not anticipate being required to
expend any funds in the near future for environmental protection
in connection with our operations other than those funds
required for our ordinary course environmental health and safety
compliance programs.
EMPLOYEES
As of February 28, 2005, we had 312 full-time
employees, including 18 in Connetics Australia. Of the full-time
employees, 170 were engaged in sales and marketing, 73 were in
research and development and 51 were in general and
administrative positions. We believe our relations with our
employees are good.
FACTORS AFFECTING OUR BUSINESS AND PROSPECTS
There are many factors that affect our business and results of
operations, some of which are beyond our control. The following
section describes important factors that may cause the actual
results of our operations in future periods to differ materially
from the results currently expected or desired and in turn
materially affect our future developments and performance.
Accordingly, you should evaluate all forward-looking statements
with the understanding of their inherent uncertainty. Due to the
following 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
Our operating results may fluctuate. This fluctuation could
cause financial results to be below expectations and the market
prices of our securities to decline.
Our operating results may fluctuate from period to period for a
number of reasons, some of which are beyond our control. Even a
relatively small revenue shortfall may cause a period’s
results to be below our expectations or projections, which in
turn may cause the market price of our securities to drop
significantly and the value of your investment to decline.
If we do not obtain the capital necessary to fund our
operations, we will be unable to develop or market our
products.
In the future our product revenues could decline or we might be
unable to raise additional funds when we need them. In that
case, we may not have sufficient funds to be able to market our
products as planned or continue development of our other
products. Accordingly, we may need to raise additional funds
through public or private financings, strategic relationships or
other arrangements. Any additional equity financing may be
dilutive to our stockholders, and debt financing, if available,
may involve restrictive covenants, which may limit our operating
flexibility with respect to certain business matters.
If we do not sustain profitability, stockholders may lose
their investment.
Fiscal year 2004 was our first year of operating profitability.
Our accumulated deficit was $111.2 million at
December 31, 2004. We may incur additional losses in the
future. If we are unable to sustain profitability during any
quarterly or annual period, our stock price may decline.
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Our total revenue depends on receiving royalties and contract
payments from third parties, and we cannot control the amount or
timing of those revenues.
We generate contract and royalty revenues 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:
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we may be contractually bound to terms that, in the future, are
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a loss of royalties could have a disproportionately large impact
on our operating income in periods where the operating income is
a small profit. |
Any significant impact on our operating income may prevent us
from successfully developing our products.
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Our reported earnings per share may be more volatile because
of the conversion provisions of our convertible senior notes or
the exercise of outstanding stock options and warrants. |
We issued $90 million principal amount of convertible
senior notes in May 2003 which are due in 2008. Although none of
the noteholders converted their notes in 2004 , they may convert
the notes into shares of our common stock at any time before the
notes mature, at a conversion rate of 46.705 shares per
$1,000 principal amount of notes, subject to adjustment in
certain circumstances. At December 31, 2004 we had
approximately 11.8 million shares reserved for issuance
upon exercise of outstanding stock options, sales through our
Employee Stock Purchase Plan, and conversion of our convertible
senior notes. Should any noteholders convert the notes, or if
our option holders exercise their options, our basic earnings
per share would be expected to decrease as a result of the
inclusion of the underlying shares in the basic earnings per
share calculation.
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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
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We believe that the protection of our intellectual property,
including patents and trademarks, is an important factor in
product recognition, maintaining goodwill, and maintaining or
increasing market share. If we do not adequately protect our
rights in our trademarks from infringement, any goodwill that
has been developed in those trademarks could be lost or
impaired. If the trademarks we use are found to infringe upon
the trademark of another company, we could be forced to stop
using those trademarks, and as a result we could lose all the
goodwill that has been developed in those trademarks and could
be liable for damages caused by an infringement.
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Our commercial success depends in part on our ability and the
ability of our licensors to obtain and maintain patent
protection on technologies, to preserve trade secrets, and to
operate without infringing the proprietary rights of others. |
We are pursuing several U.S. and international patent
applications, although we cannot be sure that any of these
patents will ever be issued. We also have acquired 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. 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. In
November 2004 we announced that Medicis had informed us that it
believes that a patent to which it holds certain rights will be
infringed by our product candidate Velac. While we are not aware
of any legal filings related to
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Medicis’ assertion, we believe, based on information
publicly available on the USPTO website, that the inventor named
on the patent has filed a Reissue Patent Application with the
USPTO. To our knowledge, the USPTO has not formally announced
the filing of the reissue application in the Official Gazette as
of the date of this Report. The cost of responding to this and
other similar challenges that may arise and the inherent costs
to defend the validity of our licensed technology and issued
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. Our business could suffer
materially if Medicis or any third party were to be awarded a
judgment adverse to us in any patent interference litigation or
other proceeding arising in connection with Velac, or any of our
other products or patent applications.
In May 2004, the USPTO issued to us a patent for our
emollient-foam technology. The ownership of this and any other
patent or an interest in a patent, however, 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.
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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, manufacturing partners, 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, are our exclusive property, other
than inventions unrelated to us and developed entirely on the
individual’s own time. These agreements may not provide
meaningful protection 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.
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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, potent compounds, 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. We maintain
general liability insurance in the amount of $10 million
aggregate and workers compensation coverage in the amount of
$1 million per incident, and our insurance may not provide
adequate coverage against potential claims or losses related to
our use of hazardous materials, and we cannot be certain that
our current coverage will continue to be available on reasonable
terms, if at all.
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Evoclin represents a new product entry for us into the acne
market and we may be unable to achieve desired market acceptance
and sales of Evoclin. |
Evoclin was approved by the FDA in October 2004 for the
treatment of acne vulgaris. It is our first product entry into
the acne market, which is generally believed to be more
competitive than the market for other dermatoses. We will not be
able to achieve the desired market acceptance and sales of
Evoclin unless our marketing and sales strategy is effective in
competing with existing and well established products in the
acne market. Additionally, the commercial launch of Evoclin has
required and, we anticipate, will continue to require
significant expenditures of management time and resources from
which we may not realize anticipated returns.
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The growth of our business depends in part on our ability to
identify, acquire on favorable terms, and assimilate
technologies, products or businesses. |
Our strategy for the continuing growth of our business includes
identifying and acquiring strategic pharmaceutical products,
technologies and businesses. These acquisitions may involve the
licensing or purchase of the assets of other pharmaceutical
companies. We may not be able to identify suitable acquisition
or licensing of product or technology candidates or, if we do
identify suitable candidates, they may not be available on
acceptable terms. Even if we are able to identify suitable
product or technology candidates, their acquisition or licensing
may require us to make considerable cash outlays, issue equity
securities, incur debt and contingent liabilities, incur
amortization expenses related to intangible assets, and can
result in the impairment of goodwill, which could harm our
profitability. In addition, acquisitions involve a number of
risks, including:
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difficulties in and costs associated with the assimilation of
the operations, technologies, personnel and products of the
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assumption of known or unknown liabilities or other
unanticipated events or circumstances, and |
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risks of entering markets in which we have limited or no
experience. |
Any of these risks could harm our ability to achieve levels of
profitability of acquired operations or to realize other
anticipated benefits of an acquisition.
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Our future product revenues could be reduced by imports from
countries where our products are available at lower prices. |
Certain of our products are, or will soon be, available for sale
in other countries. In July 2004 we signed a multi-year consent
with Roche to sell Soriatane to a U.S.-based distributor that
exports branded pharmaceutical products to select international
markets. Roche will also continue to market Soriatane outside of
the U.S. Mipharm has exclusive rights to market and sell OLUX in
Italy and the U.K., and in September 2004, we granted to Pierre
Fabre the exclusive commercial rights to OLUX for sale in all
other European markets, with marketing rights for certain
countries in South America and Africa. There have been cases in
which pharmaceutical products were sold at steeply discounted
prices in markets outside the U.S. and then re-imported to the
U.S. where they could be resold at prices higher than the
original discounted price, but lower than the prices
commercially available in the U.S. If this happens with our
products our revenues would be adversely affected.
In addition, in the European Union, we are required to permit
cross border sales. This allows buyers in countries where
government-approved prices for our products are relatively high
to purchase our products legally from countries where they must
be sold at lower prices. Such cross-border sales could adversely
affect our revenues.
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Our current and future indebtedness and debt service
obligations may adversely affect our cash flow. |
In May 2003 we issued $90 million of convertible senior
notes in a private offering. We will pay interest on the notes
at a rate of 2.25% per year. In 2004, we recorded
$2.0 million in interest on the
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notes. Assuming none of the notes are redeemed or converted, we
will record interest on the notes in the amounts of
$2.0 million per year from 2005 through 2007, and $843,750
for 2008. The notes mature on May 30, 2008. Whether we are
able to make payments on the notes will depend on our ability to
generate sufficient cash. Our ability to generate sufficient
cash flow will depend on efficiently developing new products
with significant market potential, increasing sales of our
existing products, collection of receivables and other factors,
including general economic, financial, competitive, legislative
and regulatory conditions, some of which are beyond our control.
To continue the growth of our business we may be required to
incur new indebtedness, increasing the related risks from those
that we now face. Whether we are able to make required payments
on the existing notes and to satisfy any other future debt
obligations will depend on our future operating performance and
our ability to obtain additional debt or equity financing on
favorable terms.
Risks Related to Our Products
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Our reliance on third-party manufacturers and suppliers and
any manufacturing difficulties they encounter could delay future
revenues from our product sales. |
We rely exclusively on third party manufacturers to manufacture
our products. In general, our contract manufacturers purchase
principal raw materials and supplies in the open market.
Manufacturing facilities are also subject to ongoing periodic
inspection by the FDA and corresponding state agencies and must
be licensed before they can be used in commercial manufacturing
of our products. If our contract manufacturers cannot provide us
with our product requirements in a timely and cost-effective
manner, or if the product they supply does not meet commercial
requirements for shelf life, our sales of marketed products
could be reduced. Currently, DPT Laboratories, Ltd. and AccraPac
Group, Inc. manufacture commercial supplies of OLUX, Luxíq,
and Evoclin. Roche is our sole manufacturer for commercial
supplies of Soriatane.
The active ingredient for OLUX is currently supplied by a single
source. We have agreements with Roche to fill and finish
Soriatane through 2005, and to provide active pharmaceutical
ingredient through 2007. We believe that these agreements will
allow us to maintain supplies of Soriatane finished product
through 2012 due to the five-year shelf life of the active
pharmaceutical ingredient. We will continue to buy Soriatane
finished product and active pharmaceutical ingredient from
Roche, and we expect to qualify alternate sources for Soriatane
finished product in 2006. Substantially all other raw materials
are available from a number of sources, and delays in the
availability of some raw materials could cause delays in our
commercial production.
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.
Our inability to maintain agreements on favorable terms with any
of our contract manufacturers and any disruption in the supply
of raw materials required for the manufacture of our products
could impair our ability to deliver our products on a timely
basis or cause delays in our clinical trials and applications
for regulatory approvals which in turn would harm our business
and financial results. In addition, any loss of a manufacturer
or any difficulties that could arise in the manufacturing
process could significantly affect our inventories and supply of
products available for sale. 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.
All of our contract manufacturers must comply with the
applicable FDA cGMP regulations, which include quality control
and quality assurance requirements as well as the corresponding
maintenance of records and documentation. If our contract
manufacturers do not comply with the applicable cGMP regulations
and other FDA regulatory requirements, the availability of
marketed products for sale could be reduced and we could suffer
delays in the progress of clinical trials for products under
development. We do
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not have full control over our third-party manufacturers’
compliance with these regulations and standards. Our business
interruption insurance, which covers the loss of income for up
to $14.1 million at our California and Australia locations,
and lower amounts for each of our contract manufacturers, may
not completely mitigate the harm to our business from the
interruption of the manufacturing of products. 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.
If our supply of finished products is interrupted, our
ability to maintain our inventory levels could suffer and future
revenues may be delayed.
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.
Supply interruptions may occur and our inventory may not 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 affecting the
cost and availability of raw materials.
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We cannot sell our current products and product candidates if
we do not obtain and maintain governmental approvals. |
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. The FDA 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. If we fail to comply
with applicable regulatory requirements, we could be subject to,
among other things, 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 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, including our products,
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 recall or withdrawal of the product from the market.
The FDA is permitted to revisit and change its prior
determinations and it may change its position with regard to the
safety or effectiveness of our products. Even if the FDA
approves our products, the FDA is authorized to impose
post-marketing requirements such as:
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testing and surveillance to monitor the product and its
continued compliance with regulatory requirements, |
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submitting products for inspection and, if any inspection
reveals that the product is not in compliance, prohibiting the
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suspending manufacturing, |
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recalling products, and |
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withdrawing marketing approval. |
Even before any formal regulatory action, we could voluntarily
decide to cease distribution and sale or recall any of our
products if concerns about safety or effectiveness develop.
22
To market our products in countries outside of the United
States, we and our partners must obtain 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.
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 if we
were to receive correspondence from the FDA alleging these
practices we might be required to:
|
|
|
| |
• |
incur substantial expenses, including fines, penalties, legal
fees and costs to comply with the FDA’s requirements, |
| |
| |
• |
change our methods of marketing and selling products, |
| |
| |
• |
take FDA-mandated corrective action, which could include placing
advertisements or sending letters to physicians rescinding
previous advertisements or promotion, and |
| |
| |
• |
disrupt the distribution of products and stop sales until we are
in compliance with the FDA’s position. |
|
|
|
We may spend a significant amount of money to obtain FDA and
other regulatory approvals, which may never be granted. Failure
to obtain such regulatory approvals could adversely affect our
prospects for future revenue growth. |
Successful product development in our industry is highly
uncertain, and the process of obtaining FDA and other regulatory
approvals is lengthy and expensive. Very few research and
development projects produce a commercial product. Product
candidates that appear promising in the early phases of
development may fail to reach the market for a number of
reasons, including that the product candidate did not
demonstrate acceptable clinical trial results even though it
demonstrated positive preclinical trial results, or that the
product candidate was not effective in treating a specified
condition or illness.
The FDA approval processes require substantial time, effort and
expense. The FDA continues to modify product development
guidelines and 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. Clinical trial data can
be the subject of differing interpretation, and the FDA has
substantial discretion in the approval process. The FDA may not
interpret our clinical data the way we do. The FDA may also
require additional clinical data to support approval. The FDA
can take between one and two years to review new drug
applications, or longer if significant questions arise during
the review process. 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.
Any factor adversely affecting the prescription volume
related to our products could harm our business, financial
condition and results of operations.
We derive all of our prescription volume from OLUX, Luxíq,
Soriatane and Evoclin. Accordingly, any factor adversely
affecting our sales related to these products, individually or
collectively, could harm our business, financial condition and
results of operations. OLUX, Luxíq and Evoclin are all
currently subject to generic competition in their respective
markets, and each of them could be rendered obsolete or
uneconomical by regulatory or competitive changes. A generic
competitor for Soriatane could enter the market at any time
which would have a significantly negative impact on its sales.
Sales of all of our products could also be adversely affected by
other factors, including:
|
|
|
| |
• |
manufacturing or supply interruptions; |
| |
| |
• |
the development of new competitive pharmaceuticals and
technological advances to treat the conditions addressed by our
core branded products; |
23
|
|
|
| |
• |
marketing or pricing actions by one or more of our competitors; |
| |
| |
• |
regulatory action by the FDA and other government regulatory
agencies; |
| |
| |
• |
changes in the prescribing or procedural practices of
dermatologists, pediatricians or podiatrists; |
| |
| |
• |
changes in the reimbursement or substitution policies of
third-party payors or retail pharmacies; and |
| |
| |
• |
product liability claims. |
We depend on a limited number of customers, and if we lose
any of them, our business could be harmed.
Our customers include the nation’s leading wholesale
pharmaceutical distributors, such as Cardinal Health, Inc.,
McKesson HBOC, Inc. and AmerisourceBergen Corporation. During
2004, McKesson, Cardinal Health, AmerisourceBergen accounted for
29%, 27%, and 16%, respectively, of our net product revenues. In
December 2004, we entered into distribution agreements with each
of Cardinal Health, Inc. and McKesson Corporation in which we
agreed to pay a fee to each distributor in exchange for the
provision by it of certain product distribution, inventory
information, return goods processing, and administrative
services.
The distribution network for pharmaceutical products is subject
to increasing consolidation, and 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 result in the combination or
elimination of warehouses, which may result in reductions in
purchases of our products, returns of our products, or cause a
reduction in the inventory levels of distributors and retailers,
any of which could have a material adverse impact on our
business. If we lose any of these customer accounts, or if our
relationship with them were to deteriorate, our business could
also be materially and adversely affected.
Orders for our products may increase or decrease depending on
the inventory levels held by our major customers. Significant
increases and decreases in orders from our major customers could
cause our operating results to vary significantly from quarter
to quarter.
Retail availability of our products is greatly affected by
inventory levels held by our customers. We monitor wholesaler
inventory of our products using a combination of methods,
including tracking prescriptions filled at the pharmacy level to
determine inventory amounts sold from the wholesalers to their
customers. Beginning in 2005, pursuant to our agreements with
Cardinal and McKesson, we will receive inventory level reports.
For other wholesalers, however, our estimates of wholesaler
inventories may differ significantly from actual inventory
levels. Significant differences between actual and estimated
inventory levels may result in excessive inventory production,
inadequate supplies of products in distribution channels,
insufficient or excess product available at the retail level,
and unexpected increases or decreases in orders from our major
customers. Forward-buying by wholesalers, for example, may
result in significant and unexpected changes in customer orders
from quarter to quarter. These changes may cause our revenues to
fluctuate significantly from quarter to quarter, and in some
cases may cause our operating results for a particular quarter
to be below our expectations or projections. If our financial
results are below expectations for a particular period, the
market price of our securities may drop significantly.
The expenses associated with our clinical trials are
significant. We rely on third parties to conduct clinical trials
for our product candidates, and those third parties may not
perform satisfactorily. If those third parties do not perform
satisfactorily, it may significantly delay commercialization of
our products, increase expenditures and negatively affect our
prospects for future revenue growth.
The clinical trials we undertake for regulatory approval of our
products are very expensive and we cannot predict the amount and
timing of these expenses from quarter to quarter. We rely on
third parties to independently conduct clinical studies for our
product candidates. 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
24
repeat, extend the duration of, or increase the size of,
clinical trials, which could significantly delay required
regulatory approvals and require significantly greater
expenditures.
Our continued growth depends on our ability to develop new
products, and if we are unable to develop new products, our
expenses may exceed our revenues without any 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, will
require significant commitments of personnel and financial
resources. Delays in the research, development, testing or
approval processes will cause a corresponding delay in the
commencement of revenue generation from those products.
We re-evaluate 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 re-evaluations, we
have abandoned in the past, and may abandon in the future, our
efforts on a particular product or technology. Products we are
researching or developing may never be successfully released to
the market and, regardless of whether they are ever released to
the market, the expense of such processes will have already been
incurred.
If we do not successfully integrate new products into our
business, 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 we do not
integrate these products or product lines 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. A new product may require us 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.
We rely on the services of a single company to distribute our
products to our customers. A delay or interruption in the
distribution of our products could negatively impact our
business.
SPS handles all of our product distribution activities. SPS
stores and distributes our products from a warehouse in
Tennessee. Any delay or interruption in the process or in
payment could result in a delay delivering product to our
customers, which could have a significant negative impact on our
business.
The termination of the agreement for the co- promotion of
OLUX and Luxíq to certain PCP’s could negatively
impact our business.
In October 2004 we were informed by UCB Pharma, Inc. that it
would terminate the co-promotion agreement with us for the
co-promotion of OLUX and Luxíq to a certain segment of
primary care physicians. UCB informed us that the termination
was the result of a decision to shift its commercial focus
following a recent acquisition. The termination of the
co-promotion agreement will become effective on March 31,
2005 and we are exploring other possibilities to assist us in
accessing the PCP market, including using a contract sales force
or working with other commercial partners. If we are unable to
secure an agreement to access those markets, our year over year
revenues for OLUX and Luxíq prescribed by PCP’s could
be negatively affected.
25
Our revenues depend on payment and reimbursement from third
party payors, and if they reduce or refuse payment or
reimbursement, the use and sales of our products will suffer, we
may not increase our market share, and our revenues and
profitability will suffer.
Our operating results and business success depend, in part, on
whether adequate reimbursement is available for the use of our
products by hospitals, clinics, doctors and patients.
Third-party payors include state and federal governments, under
programs such as Medicare and Medicaid, managed care
organizations, private insurance plans and health maintenance
organizations. Because of the size of the patient population
covered by managed care organizations, it is important to our
business that we market our products to them and to the pharmacy
benefit managers that serve many of these organizations. If only
a portion of the cost of our prescription products is paid for
or reimbursed, our products could be less attractive, from a
net-cost perspective, to patients, suppliers and prescribing
physicians.
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 on formularies. 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. 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. Consumers and third-party payors 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. If a product
is excluded from a formulary, its usage may be sharply reduced
in the managed care organization patient population. 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.
To the extent that patients buy our products through a managed
care group with which we have a contract, our average selling
price is lower than it would be for a non-contracted managed
care group. We take reserves for the estimated amounts of
rebates we will pay to managed care organizations each quarter.
Any increase in returns and any increased usage of our products
through Medicaid or managed care programs will affect the amount
of rebates that we owe.
Risks Related to Our Industry
We face intense competition, which may limit our commercial
opportunities and limit our ability to generate revenues.
The specialty pharmaceutical industry is 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, developing new products to
provide benefits superior to those of existing products, and
acquiring or licensing complementary or novel technologies from
other pharmaceutical companies or individuals.
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. Our competitors may develop or
acquire new or improved products to treat the same conditions as
our products treat or make technological advances reducing their
cost of production
26
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 or acquire 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 or acquire 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.
Luxíq, OLUX and Evoclin compete with generic
pharmaceuticals, which claim to offer equivalent benefit at a
lower cost. In some cases, insurers and other health care
payment organizations encourage the use of these less expensive
generic brands through their prescription benefits coverage 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. In particular,
Evoclin faces significant competition in the market for the
treatment of acne, one of the largest segments in
U.S. dermatology market. The active ingredient in Evoclin,
clindamycin, is the most popular topical antibiotic for treating
acne patients. Soriatane competes in the market for the
treatment of severe psoriasis in adults. Generic competition for
Soriatane may arise in the future.
The growth of managed care organizations and other
third-party reimbursement policies and state regulatory agencies
may have an adverse effect on our pricing policies and our
margins.
Managed care initiatives to control costs have influenced
PCP’s to refer fewer patients to specialists such as
dermatologists. Further reductions in these referrals could have
a material adverse effect on the size of our potential market as
well as our business, financial condition and results of
operation.
Federal and state regulations govern or influence the
reimbursement to health care providers of fees in connection
with medical treatment of certain patients. In the U.S., there
have been, and we expect there will continue to be, a number of
state and federal proposals that could limit the amount that
state or federal governments will pay to reimburse the cost of
drugs. Continued significant changes in the health care system
could have a significant negative impact on our business.
Decisions by state regulatory agencies, including state pharmacy
boards, and/or retail pharmacies may require substitution of
generic for branded products, may prefer competitors’
products over our own, and may impair our pricing and thereby
constrain our market share and growth. In addition, we believe
the increasing emphasis on managed care in the U.S. will
continue to put pressure on the price and usage of our products,
which may in turn adversely impact product sales. Further, when
a new therapeutic product is approved, the availability of
governmental and/or private reimbursement for that product is
uncertain, as is the amount for which that product will be
reimbursed. We cannot predict whether reimbursement for our
products or product candidates will be available or in what
amounts, and current reimbursement policies for existing
products may change at any time. Changes in reimbursement
policies or health care cost containment initiatives that limit
or restrict reimbursement for our products may cause our
revenues to decline.
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 to us of the broad and expanding legislative
and regulatory requirements that may apply to us.
Our industry is subject to extensive governmental
regulation.
The FDA must approve a drug before it can be sold in the United
States. In addition, the Federal Food, Drug and Cosmetic Act,
the Federal Trade Commission, Office of the Inspector General
and other federal and state agencies, statutes and regulations
govern the safety, effectiveness, testing, manufacture,
labeling, storage, record keeping, approval, sampling,
advertising and promotion of pharmaceutical
27
products. Complying with the mandates of these agencies,
statutes and regulations is expensive and time consuming, and
adds significantly to the cost of developing, manufacturing and
marketing our products. In addition, failure to comply with
applicable agency, statutory and regulatory requirements could,
among other things, result in:
|
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|
| |
• |
fines or other civil or criminal sanctions; |
| |
| |
• |
delays in product development, distribution, marketing and sale; |
| |
| |
• |
denials or suspensions of regulatory approvals of our
products; and |
| |
| |
• |
recalls of our products. |
If product liability lawsuits are brought against us, we may
incur substantial costs.
Our industry faces an inherent risk of product liability claims
from allegations that our products resulted in adverse effects
to patients 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. In March 2004, we acquired exclusive U.S. rights to
Soriatane, which is a product known to cause serious birth
defects and other serious side effects. We maintain product
liability insurance in the amount of $10 million aggregate,
which may not provide adequate coverage against potential
product liability claims or losses. In particular, we anticipate
that insurers may be less willing to extend product liability
insurance for Soriatane, and that insurance will only be
available at higher premiums and with higher deductibles than
our other products have required. 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 significant negative 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
could decline in value. |
The market prices for securities of specialty pharmaceutical
companies like Connetics 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 holdings of these investors. Such volatility
could result in securities class action litigation. Any
litigation would likely result in substantial costs, and divert
our management’s attention and resources.
The following table sets forth the high and low closing sale
prices of our common stock on the Nasdaq National Market for
2004 and 2003:
| |
|
|
|
|
|
|
|
|
| Period |
|
High | |
|
Low | |
| |
|
| |
|
| |
|
2004
|
|
$ |
29.92 |
|
|
$ |
17.69 |
|
|
2003
|
|
$ |
19.27 |
|
|
$ |
12.30 |
|
The trading price of our common stock could be subject to
significant fluctuations, which may adversely affect the price
at which you can sell our common stock.
The trading price of our common stock has historically been
volatile and may continue to be volatile in the future. Factors
such as announcements of fluctuations in our or our
competitors’ operating results, changes in our prospects
and general market conditions for specialty pharmaceutical or
biotechnology stocks could have a significant impact on the
future trading prices of our common stock. In particular, the
trading price of the common stock of many specialty
pharmaceutical companies, including ours, has experienced
extreme price and volume fluctuations, and those fluctuations
have at times been unrelated to
28
the operating performance of the companies whose stocks were
affected. Some of the factors that may cause volatility in the
price of our securities include:
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| |
• |
clinical trial results and regulatory developments, |
| |
| |
• |
quarterly variations in results, |
| |
| |
• |
business and product market cycles, |
| |
| |
• |
fluctuations in customer requirements, |
| |
| |
• |
the availability and utilization of manufacturing capacity, |
| |
| |
• |
the timing of new product introductions, |
| |
| |
• |
the ability to develop and implement new technologies, |
| |
| |
• |
the timing and amounts of royalties paid to us by third parties,
and issues with the safety or effectiveness of our products |
The price of our securities may also be affected by the
estimates and projections of the investment community, general
economic and market conditions, and the cost of operations in
our product markets. These factors, either individually or in
the aggregate, could result in significant variations in price
of our securities and may have an adverse effect on the trading
prices of our common stock.
AVAILABLE INFORMATION
We file electronically with the Securities and Exchange
Commission our annual reports on Form 10-K, quarterly
reports on Form 10-Q, and current reports on Form 8-K,
pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934. You may obtain a free copy of our annual
reports on Form 10-K, quarterly reports on Form 10-Q
and current reports on Form 8-K and amendments to those
reports on the day of filing with the SEC on our website on the
World Wide Web at http://www.connetics.com, by contacting
our Investor Relations Department by calling 650-843-2800, or by
sending an e-mail message to ir@connetics.com .
EXECUTIVE OFFICERS OF THE COMPANY
The following table shows information about our executive
officers as of February 28, 2005:
| |
|
|
|
|
|
|
| Name |
|
Age | |
|
Position |
| |
|
| |
|
|
|
Thomas G. Wiggans
|
|
|
53 |
|
|
Chief Executive Officer and Director |
|
C. Gregory Vontz
|
|
|
44 |
|
|
President and Chief Operating Officer |
|
John L. Higgins
|
|
|
34 |
|
|
Chief Financial Officer; Executive Vice President, Finance and
Corporate Development |
|
Katrina J. Church
|
|
|
43 |
|
|
Executive Vice President, Legal Affairs; General Counsel and
Secretary |
|
Lincoln Krochmal, M.D.
|
|
|
58 |
|
|
Executive Vice President, Research and Product Development |
|
Matthew W. Foehr
|
|
|
32 |
|
|
Senior Vice President, Technical Operations |
|
Michael Miller
|
|
|
47 |
|
|
Senior Vice President, Sales and Marketing and Chief Commercial
Officer |
|
Rebecca Sunshine
|
|
|
42 |
|
|
Senior Vice President, Human Resources and Organizational
Dynamics |
Thomas Wiggans has served as Chief Executive Officer and
as a director of Connetics since July 1994. He served as
President of Connetics from July 1994 to February 2005. 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
29
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
Executive Committee, and its Emerging Company Section. He is
also Chairman of the Biotechnology Institute, a non-profit
educational organization and a member of the Board of Overseers
of the Hoover Institution at Stanford University.
Mr. Wiggans also serves as a director of Abgenix
Corporation and Onyx Pharmaceuticals, Inc. Mr. Wiggans
received his B.S. in Pharmacy from the University of Kansas and
his M.B.A. from Southern Methodist University.
Gregory Vontz joined Connetics as Executive Vice
President, Chief Commercial Officer in December 1999. He has
served as Chief Operating Officer since January 2001 and
President since February 2005. Before joining Connetics,
Mr. Vontz served 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 Higgins joined Connetics as Chief Financial Officer
in 1997, and has served as Executive Vice President, Finance and
Administration and Corporate Development since January 2002. He
served as Executive Vice President, Finance and Administration,
from January 2000 to December 2001, and as Vice President,
Finance and Administration from September 1997 through December
1999. Before 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 currently serves as a director of
BioCryst and a private company. He received his A.B. from
Colgate University.
Katrina Church joined Connetics in 1998, and has served
as Executive Vice President, Legal Affairs since January 2002
and as Secretary since September 1998. She served as Senior Vice
President, Legal Affairs and General Counsel from January 2000
through December 2001, and as Vice President, Legal Affairs and
Corporate Counsel from June 1998 through December 1999. Before
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.
Lincoln Krochmal, M.D. joined Connetics in October
2003 as Executive Vice President, Research and Product
Development. Dr. Krochmal joined Unilever PLC, where he
worked since 1993, mostly recently as Senior Vice President,
Worldwide Research and Development for the Home and Personal
Care Division. Prior to Unilever, Dr. Krochmal held various
senior management positions in dermatology research and
development at Bristol-Myers Squibb and Westwood
Pharmaceuticals, Inc. Before joining Westwood he spent seven
years in his own private dermatology practice. Dr. Krochmal
received his Bachelor of Medical Sciences degree from the
University of Wisconsin, his Doctor of Medicine from the Medical
College of Wisconsin, as his board certification in dermatology
following successful completion of the residency training
program at the University of Missouri Medical Center. In 2005
Dr. Krochmal was appointed to the Board of Directors of the
International Academy of Cosmetic Dermatology. He is a fellow of
the American Academy of Dermatology, a Diplomat of the American
Board of Dermatology and a member of the International Society
of Dermatology and the Dermatology Foundation.
Matthew Foehr joined Connetics in 1999, and has served as
Senior Vice President, Technical Operations, since January 2003.
He served as Vice President, Manufacturing, from November 2001
through December 2002, and in various director and manager-level
manufacturing positions from July 1999 to November 2001. Before
joining Connetics, Mr. Foehr worked for over five years at
LXR Biotechnology, Inc., most recently serving as Associate
Director, Manufacturing and Process Development. Before joining
LXR, Mr. Foehr worked for Berlex Biosciences in the
Department of Process Development and Biochemistry/ Biophysics.
Mr. Foehr received his B.S. in Biology from
Santa Clara University.
30
Michael Miller joined Connetics in February 2003 as
Senior Vice President of Sales and Marketing and Chief
Commercial Officer. Mr. Miller most recently served as Vice
President of Commercial Operations at Cellegy Pharmaceuticals.
Before Cellegy, Mr. Miller spent four years with ALZA
Corporation, most recently as Vice President of the Urology
Business Unit, three years with VIVUS, Inc. as Marketing
Director, and 14 years with Syntex/ Roche in marketing and
sales management. Mr. Miller received his B.S. in Finance
from University of San Francisco and his M.B.A. in
Information Systems from San Francisco State University.
Rebecca Sunshine joined Connetics in 1996, and has served
as Senior Vice President Human Resources and Organizational
Dynamics since January 2002. Ms. Sunshine served as Vice
President of Human Resources from December 1999 to December
2002, and as Director of Human Resources from 1996 through
November 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. Sunshine 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. Sunshine received her B.A. from UC Santa Barbara
and her M.P.A. in Health Services from the University of
San Francisco.
We currently lease 52,468 square feet of laboratory and
office space at 3290 and 3400 West Bayshore Road in Palo Alto,
California. Two lease agreements govern this space, one of which
expires on March 31, 2005 and the other expires on
April 30, 2005. We do not plan to renew either of these
lease agreements. Effective January 1, 2005, we began
subleasing from Incyte Corporation 96,025 square feet of
laboratory and office space at 3160 Porter Drive also in Palo
Alto. We occupied this space as our new headquarters facility on
February 28, 2005. Pursuant to a letter of intent dated
August 9, 2004, with Incyte Corporation and The Board of
Trustees of the Leland Stanford Junior University, or Stanford,
we signed a sublease for approximately 19,447 square feet
of office space at 1841 Page Mill Road also in Palo Alto. This
sublease will commence on January 1, 2006 and is subject to
the approval of Stanford. Our subsidiary, Connetics Australia
Pty Ltd., owns land and real property consisting of laboratory
and office space at 8 Macro Court, Rowville, Victoria,
Australia. In addition, we make rental payments to DPT
Laboratories, Ltd. for the floor space occupied by our
12,000 square foot aerosol filling line in DPT’s Texas
facility. We believe that our existing facilities are adequate
to meet our requirements for the foreseeable future.
|
|
| 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 2004.
31
PART II
|
|
| Item 5. |
Market for the Company’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities |
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 | |
| |
|
| |
|
| |
|
2003
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
16.75 |
|
|
$ |
12.30 |
|
|
Second Quarter
|
|
|
18.18 |
|
|
|
14.70 |
|
|
Third Quarter
|
|
|
18.74 |
|
|
|
14.24 |
|
|
Fourth Quarter
|
|
|
19.27 |
|
|
|
16.00 |
|
|
2004
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
24.91 |
|
|
$ |
17.69 |
|
|
Second Quarter
|
|
|
22.60 |
|
|
|
18.59 |
|
|
Third Quarter
|
|
|
28.09 |
|
|
|
19.46 |
|
|
Fourth Quarter
|
|
|
29.92 |
|
|
|
20.30 |
|
On March 10, 2005, the closing price of our common stock on
the Nasdaq National Market was $27.03. On February 28,
2005, we had approximately 136 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.
We did not purchase any shares of our common stock during the
quarter ended December 31, 2004 and we do not have a plan
or program to repurchase shares of our common stock.
32
|
|
| Item 6. |
Selected Financial Data |
The selected consolidated financial data that appears below and
on the following page 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 contained elsewhere in this Report, and with the
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” in Item 7 of this
Report. The selected consolidated statement of operations data
for each of the three years in the period ended
December 31, 2004, and the selected consolidated balance
sheet data as of December 31, 2004 and 2003, are derived
from and qualified by reference to the audited consolidated
financial statements included elsewhere in this Report. The
selected consolidated statement of operations data for the years
ended December 31, 2001 and 2000, and the selected
consolidated balance sheet data as of December 31, 2002,
2001 and 2000, are derived from audited financial statements not
included in this Report.
Connetics Corporation
Selected Consolidated Financial Data
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share amounts) | |
|
Consolidated Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Product
|
|
$ |
142,059 |
|
|
$ |
66,606 |
|
|
$ |
47,573 |
|
|
$ |
30,923 |
|
|
$ |
20,095 |
|
| |
|
Royalty and contract(1)
|
|
|
2,296 |
|
|
|
8,725 |
|
|
|
5,190 |
|
|
|
3,141 |
|
|
|
20,679 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Total revenues
|
|
|
144,355 |
|
|
|
75,331 |
|
|
|
52,763 |
|
|
|
34,064 |
|
|
|
40,774 |
|
| |
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Cost of product revenues
|
|
|
12,656 |
|
|
|
5,129 |
|
|
|
4,190 |
|
|
|
3,123 |
|
|
|
3,868 |
|
| |
|
Amortization of intangible assets(2)
|
|
|
11,471 |
|
|
|
819 |
|
|
|
805 |
|
|
|
1,048 |
|
|
|
— |
|
| |
|
Research and development
|
|
|
21,539 |
|
|
|
30,109 |
|
|
|
25,821 |
|
|
|
19,156 |
|
|
|
21,875 |
|
| |
|
Selling, general and administrative
|
|
|
73,206 |
|
|
|
41,781 |
|
|
|
36,819 |
|
|
|
35,014 |
|
|
|
26,673 |
|
| |
|
In-process research and development and milestone payments(3)
|
|
|
3,500 |
|
|
|
— |
|
|
|
4,350 |
|
|
|
1,080 |
|
|
|
— |
|
| |
|
Loss on program termination(4)
|
|
|
— |
|
|
|
— |
|
|
|
312 |
|
|
|
1,142 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Total operating expenses
|
|
|
122,372 |
|
|
|
77,838 |
|
|
|
72,297 |
|
|
|
60,563 |
|
|
|
52,416 |
|
| |
|
|
Income (loss) from operations
|
|
|
21,983 |
|
|
|
(2,507 |
) |
|
|
(19,534 |
) |
|
|
(26,499 |
) |
|
|
(11,642 |
) |
| |
Gain on sale of investment(5)
|
|
|
— |
|
|
|
— |
|
|
|
2,086 |
|
|
|
122 |
|
|
|
42,967 |
|
| |
Gain on sale of Ridaura product line(6)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
8,002 |
|
|
|
— |
|
| |
Interest and other income (expense) net
|
|
|
(1,475 |
) |
|
|
(426 |
) |
|
|
1,039 |
|
|
|
1,978 |
|
|
|
1,873 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income (loss) before income taxes and cumulative effect of a
change in accounting principle
|
|
|
20,508 |
|
|
|
(2,933 |
) |
|
|
(16,409 |
) |
|
|
(16,397 |
) |
|
|
33,198 |
|
| |
Income tax provision
|
|
|
1,493 |
|
|
|
1,167 |
|
|
|
181 |
|
|
|
345 |
|
|
|
1,010 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income (loss) before cumulative effect of
change in
accounting principle
|
|
|
19,015 |
|
|
|
(4,100 |
) |
|
|
(16,590 |
) |
|
|
(16,742 |
) |
|
|
32,188 |
|
| |
Cumulative effect of change in accounting principle, net of
tax(7)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(5,192 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income (loss)
|
|
$ |
19,015 |
|
|
$ |
(4,100 |
) |
|
$ |
(16,590 |
) |
|
$ |
(16,742 |
) |
|
$ |
26,996 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic Earnings Per Share —
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) per share before cumulative effect of change in
accounting principle
|
|
$ |
0.54 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
$ |
(0.56 |
) |
|
$ |
1.13 |
|
|
Cumulative effect of change in accounting principle, net of tax
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(0.18 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share
|
|
$ |
0.54 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
$ |
(0.56 |
) |
|
$ |
0.95 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share amounts) | |
|
Diluted Earnings Per Share —
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) per share before cumulative effect of change in
accounting principle
|
|
$ |
0.51 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
$ |
(0.56 |
) |
|
$ |
1.07 |
|
| |
Cumulative effect of change in accounting principle, net of tax
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(0.17 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share
|
|
$ |
0.51 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
$ |
(0.56 |
) |
|
$ |
0.90 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Shares used to calculate basic net earnings (loss) per share
|
|
|
35,036 |
|
|
|
31,559 |
|
|
|
30,757 |
|
|
|
29,861 |
|
|
|
28,447 |
|
| |
Shares used to calculate diluted net earnings (loss) per share
|
|
|
37,443 |
|
|
|
31,559 |
|
|
|
30,757 |
|
|
|
29,861 |
|
|
|
30,086 |
|
|
Pro forma amounts assuming the accounting change was applied
retroactively:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income (loss)
|
|
$ |
19,015 |
|
|
$ |
(4,100 |
) |
|
$ |
(16,590 |
) |
|
$ |
(16,742 |
) |
|
$ |
32,188 |
|
| |
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Basic
|
|
$ |
0.54 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
$ |
(0.56 |
) |
|
$ |
1.13 |
|
| |
|
Diluted
|
|
$ |
0.51 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
$ |
(0.56 |
) |
|
$ |
1.07 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Cash, cash equivalents, marketable securities and restricted cash
|
|
$ |
76,346 |
|
|
$ |
114,966 |
|
|
$ |
33,788 |
|
|
$ |
48,476 |
|
|
$ |
80,184 |
|
| |
Working capital
|
|
|
71,094 |
|
|
|
112,247 |
|
|
|
25,185 |
|
|
|
44,026 |
|
|
|
71,030 |
|
| |
Total assets
|
|
|
245,728 |
|
|
|
145,897 |
|
|
|
59,553 |
|
|
|
72,327 |
|
|
|
85,713 |
|
| |
Convertible senior notes
|
|
|
90,000 |
|
|
|
90,000 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Total stockholders’ equity
|
|
|
127,920 |
|
|
|
45,754 |
|
|
|
44,743 |
|
|
|
61,354 |
|
|
|
72,606 |
|
|
|
| (1) |
In the second quarter of 2003, we received a one-time royalty
payment from S.C. Johnson in the amount of $2.9 million in
connection with our aerosol spray technology. |
| |
| (2) |
In March 2004, we acquired exclusive U.S. rights to
Soriatane, resulting in an intangible asset that is being
amortized 10 years. Amortization charges for the Soriatane
rights in 2004 were $10.6 million. |
| |
| (3) |
In May 2002, we entered into an agreement with Yamanouchi
Europe, B.V. to license Velac. In connection with this agreement
we paid Yamanouchi an initial $2.0 million licensing fee in
the second quarter of 2002 and recorded another
$2.0 million in the fourth quarter of 2002 when we
initiated the Phase III trial for Velac. In the third
quarter of 2004, we recorded an additional milestone payment of
$3.5 million upon filing an NDA with the FDA. |
| |
| (4) |
In 2001, we recorded a net charge of $1.1 million
representing costs accrued in connection with the reduction in
workforce and the wind down of relaxin development contracts. |
| |
| (5) |
In the fourth quarter of 2000, we recorded a
$43.0 million gain on the sale of securities. |
| |
| (6) |
In April 2001, we sold our rights to Ridaura including
inventory to Prometheus Laboratories, Inc. for $9.0 million
in cash plus a royalty on annual sales in excess of
$4.0 million through March 2006. We recognized a gain of
$8.0 million in connection with the sale of Ridaura. |
| |
| (7) |
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.” |
|
|
| 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 to Consolidated
Financial Statements filed with this Report.
OVERVIEW
We are a specialty pharmaceutical company that develops and
commercializes innovative products for the dermatology market.
Our products aim to improve the management of dermatological
diseases and
34
provide significant product differentiation. We have branded our
proprietary foam drug delivery vehicle, VersaFoam®.
In 2004 our marketed products were: OLUX, a super high-potency
topical steroid prescribed for the treatment of steroid
responsive dermatological diseases; Luxíq, a mid-potency
topical steroid prescribed for scalp dermatoses such as
psoriasis, eczema and seborrheic dermatitis; Soriatane, an oral
medicine for the treatment of severe psoriasis; and
Evoclintm,
a topical treatment for acne vulgaris. We began selling
Soriatane in March 2004 after we acquired the U.S. product
rights from Roche. We launched Evoclin commercially in December
2004 after we received product approval from the FDA. Revenue
from the new products contributed significantly to our revenue
growth in 2004.
In addition to the new products launched in 2004, other projects
in our research and development pipeline in 2004 included Velac
for the treatment of acne, Desilux (desonide) VersaFoam-EF,
0.05%, a low-potency topical steroid formulated to treat atopic
dermatitis, OLUX (clobetasol propionate) VersaFoam-EF, 0.05%, a
high-potency topical steroid formulated to treat atopic
dermatitis and plaque psoriasis, and other products in the
preclinical development stage. In November 2004, the FDA
notified us that it would not approve our NDA for Extina, a
topical anti-fungal treatment for seborrheic dermatitis. The
FDA’s position was based on the conclusion that, although
Extina demonstrated non-inferiority to the comparator drug
currently on the market, it did not demonstrate statistically
significant superiority to placebo foam. We have continued
discussions with the FDA about what, if any, steps we can take
to secure approval for Extina. We have the rights to a variety
of pharmaceutical agents in various stages of preclinical and
clinical development in multiple novel delivery technologies.
We sell product directly to wholesale distributors and to one
national retail pharmacy chain. Consistent with pharmaceutical
industry patterns, approximately 93% of our product revenues in
2004 were derived from seven major customers.
To enable us to focus on our core sales and marketing
activities, we selectively outsource certain non-sales and
non-marketing functions, such as manufacturing, warehousing and
distribution. Currently DPT and AccraPac manufacture commercial
supplies of OLUX, Luxíq and Evoclin. Roche manufactures
commercial supplies of Soriatane. SPS handles all of our product
distribution activities. As we expand our activities in these
areas, we expect to invest additional financial resources in
managing those outsourced functions.
In 2004 we completed our first full year of operating
profitability. Our total revenues increased by 92% to
$144.4 million and we generated net income of
$19.0 million or $0.51 per diluted share.
Product revenues increased by 113% to $142.1 million in
2004 from $66.6 million in 2003. The increase was due to
the introduction of two new products, Soriatane and Evoclin, as
well as growth from our two existing products, OLUX and
Luxíq.
We significantly increased our direct and indirect promotional
capabilities during 2004. This included hiring 66 sales
professionals, which more than doubled our sales force to 124
professionals at the end of the year and positions Connetics as
a strong commercial force in the dermatology market. Selling,
general, and administrative expenses increased from
$41.8 million in 2003 to $73.2 million in 2004.
Research and development expenses in 2004 decreased to
$21.5 million from $30.1 million in 2003 primarily due
to the completion of pivotal trials for Velac, Evoclin and
Extina in 2003.
We generated cash from operations of $29.7 million in 2004,
compared to using $8.5 million of cash in operations in
2003. In addition to the cash provided by operations, our most
significant changes in cash flow during 2004 were the use of
$123.5 million to acquire Soriatane product rights and
$56.9 million of net proceeds from a private placement of
common stock. Our working capital was $71.1 million at the
end of 2004 compared to $112.2 million at the end of 2003.
35
CERTAIN EVENTS IN 2004
During 2004, we filed NDA’s with the FDA for our product
candidates Extina, a foam formulation of a 2% concentration of
the antifungal drug ketoconazole, for the treatment of
seborrheic dermatitis, and Velac, a combination of 1%
clindamycin and 0.025% tretinoin, for the treatment of acne. We
also commenced Phase III clinical trials for our product
candidate, Desilux, a low-potency topical steroid, formulated
with 0.05% desonide in our proprietary emollient foam delivery
vehicle.
In February 2004, we completed the sale of 3.0 million
shares of our common stock in a private offering to certain
accredited investors at a price of $20.25 per share for net
proceeds of $56.9 million. We used the proceeds from this
offering to acquire the exclusive U.S. rights to
Roche’s Soriatane, which we completed in March 2004.
Including the purchase price of $123.0 million, assumed
liabilities of $4.1 million and transaction costs of
$529,000, we recorded an intangible asset of approximately
$127.7 million related to the Soriatane acquisition, which
we are amortizing over an estimated useful life of
10 years. In July 2004, we entered into a multi-year
consent with Roche to sell Soriatane to a U.S.-based distributor
that exports branded pharmaceutical products to select
international markets. Product sold to this distributor is not
permitted to be resold in the U.S. Under the terms of the
agreement, we will pay a royalty to Roche on Soriatane sales
made during the term of the agreement to this distributor.
In March 2004, we entered into an agreement with UCB Pharma, a
subsidiary of UCB Group, pursuant to which we authorized UCB
Pharma to promote OLUX and Luxíq to a segment of
U.S. PCP’s. In September 2004, in connection with UCB
Pharma’s acquisition of Celltech plc, UCB notified us that
it intended to discontinue the co-promotion agreement, effective
March 31, 2005. UCB will continue to promote OLUX and
Luxíq until then. Through the end of the promotion period,
UCB’s focus will be on approximately 10% of PCP’s who
are active prescribers of dermatology products, including OLUX
and Luxíq. The purpose of the co-promotion agreement is to
ensure appropriate use of OLUX and Luxíq with the current
PCP users and to build value for the OLUX and Luxíq brands.
We estimate that before we entered into the agreement with UCB
Pharma, PCP’s wrote approximately 15% of prescriptions for
OLUX and Luxíq, even though we have promoted primarily to
dermatologists. We pay UCB a fee based on prescriptions written
by targeted PCP’s which is recorded as an expense in
selling general and administrative expense. UCB bears the
marketing costs for promoting the products (including product
samples, marketing materials, etc.). We will not have any
financial obligation to UCB on prescriptions generated by
PCP’s after March 31, 2005.
In August 2004, we submitted an NDA for Velac (1% clindamycin
and 0.025% tretinoin) with the FDA and, in October 2004, we
received notification that the FDA accepted the NDA for filing
as of August 23, 2004. For the three months ended
September 30, 2004, we recorded a $3.5 million fee due
to the licensor upon the filing of the NDA. Because the product
has not been approved and has no alternative future use, we
recorded the fee as an in-process research and development and
milestone expense. Under the terms of the license agreement we
entered into in 2002 with Yamanouchi Europe B.V., we hold
exclusive rights to develop and commercialize Velac in the U.S.
and Canada and non-exclusive rights in Mexico.
In September 2004, we licensed to Pierre Fabre Dermatologie
exclusive commercial rights to OLUX for Europe, excluding Italy
and the U.K. where the product is licensed to Mipharm S.p.A. The
license agreement with Pierre Fabre also grants marketing rights
for certain countries in South America and Africa. Pierre Fabre
will market the product under different trade names. Under the
terms of the license, we received an upfront license payment of
$250,000 and we will receive milestone payments and royalties on
product sales. Pierre Fabre will be responsible for costs
associated with product manufacturing, sales, marketing and
distribution in its licensed territories. As part of the
agreement, we also negotiated a right-of-first-refusal in the
U.S. to an early-stage, innovative dermatology product
currently under development by Pierre Fabre. Pierre Fabre
anticipates an initial launch of OLUX in select European markets
in mid-2005.
36
In October 2004, we received approval from the FDA for Evoclin
(clindamycin) Foam, 1% for the treatment of acne vulgaris.
Evoclin is delivered in our proprietary VersaFoam vehicle. In
anticipation of the commercial launch of Evoclin, we hired 66
sales professionals in November 2004 and we announced the
commercial launch of the product in December 2004 with the
availability of 50g and 100g trade unit sizes.
In November 2004, the FDA notified us that it would not approve
Extina. The FDA’s position was based on the conclusion
that, although Extina demonstrated non-inferiority to the
comparator drug currently on the market, it did not demonstrate
statistically significant superiority to placebo foam. We have
continued discussions with the FDA about what, if any, steps we
can take to secure approval for Extina.
In November 2004 we announced that Medicis informed us that it
has in-licensed rights to an issued patent that it asserts will
be infringed by our product candidate Velac. Based on our prior
review of the Medicis licensed patent, we believe that Velac
will not infringe the patent assuming the patent is valid. While
we are not aware of any legal filings related to this assertion
by the patent holder or Medicis, we believe, based on
information publicly available on the USPTO website, that the
inventor named on the patent has filed a Reissue Patent
Application with the USPTO. To our knowledge, the USPTO has not
formally announced the filing of the reissue application in the
Official Gazette as of the date of this Report.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements are prepared in accordance
with generally accepted accounting principles in the United
States, or GAAP. These accounting principles require us to make
certain estimates, judgments and assumptions. We believe that
the estimates, judgments and assumptions upon which we rely are
reasonable based upon information available to us at the time
that they are made. These estimates, judgments and assumptions
can affect the reported amounts of assets and liabilities as of
the date of the financial statements, as well as the reported
amounts of revenues and expenses during the periods presented.
To the extent there are material differences between these
estimates, judgments or assumptions and actual results, our
financial statements will be affected.
Our senior management has reviewed these critical accounting
policies and related disclosures with our Audit Committee. Our
significant accounting policies are described in Note 2 to
the Consolidated Financial Statements included in this Report.
We believe the following critical accounting policies affect our
more significant judgments, assumptions, and estimates used in
the preparation of our condensed consolidated financial
statements, and therefore are important in understanding our
financial condition and results of operations.
|
|
|
Revenue Recognition — Reserves for Discounts,
Returns, Rebates and Chargebacks. |
We recognize product revenue net of allowances for estimated
discounts, returns, rebates and chargebacks. We allow a discount
for prompt payment. We estimate these allowances based primarily
on our past experience. We also consider the volume and price
mix of products in the retail channel, trends in distributor
inventory, economic trends that might impact patient demand for
our products (including competitive environment), and other
factors.
We accept from customers the return of pharmaceuticals that are
within six months before their expiration date. As a practice,
we avoid shipping product that has less than ten months dating.
We authorize returns for damaged products and exchanges for
expired products in accordance with our returned goods policy
and procedures. We monitor inventories in the distributor
channel to help us assess the rate of return.
We establish and monitor reserves for rebates payable by us to
managed care organizations and state Medicaid programs.
Generally, we pay managed care organizations and state Medicaid
programs a rebate on the prescriptions filled that are covered
by the respective programs with us. We determine the reserve
37
amount at the time of the sale based on our best estimate of the
expected prescription fill rate to managed care and state
Medicaid patients, adjusted to reflect historical experience and
known changes in the factors that impact such reserves.
In the past, actual discounts, returns, rebates and chargebacks
have not generally exceeded our reserves. However, the rates and
amount in future periods are inherently uncertain. Our revenue
reserve rate was approximately 17% of our gross product revenues
for 2004 compared to 14% in 2003, reflecting the higher reserve
requirements for Soriatane. If future rates and amounts are
significantly greater than the reserves we have established, the
actual results would decrease our reported revenue; conversely,
if actual returns, rebates and chargebacks are significantly
less than our reserves, this would increase our reported
revenue. If we changed our assumptions and estimates, our
revenue reserves would change, which would impact the net
revenue we report.
|
|
|
Goodwill, Purchased Intangibles and Other Long-Lived
Assets — Impairment Assessments |
We have in the past made acquisitions of products and businesses
that include goodwill, license agreements, product rights, and
other identifiable intangible assets. We assess goodwill for
impairment in accordance with Statement of Financial Accounting
Standards No. 142, “Goodwill and other Intangible
Assets,” or SFAS 142, which requires that goodwill
be tested for impairment at the “reporting unit level”
(“reporting unit”) at least annually and more
frequently upon the occurrence of certain events, as defined by
SFAS 142. Consistent with our determination that we have
only one reporting segment, we have determined that there is
only one reporting unit, specifically the sale of specialty
pharmaceutical products for dermatological diseases. We test
goodwill for impairment in the annual impairment test on
October 1 using the two-step process required by
SFAS 142. First, we review the carrying amount of the
reporting unit compared to the “fair value” of the
reporting unit based on quoted market prices of our common stock
and on discounted cash flows based on analyses prepared by
management. An excess carrying value compared to fair value
would indicate that goodwill may be impaired. Second, if we
determine that goodwill may be impaired, then we compare the
“implied fair value” of the goodwill, as defined by
SFAS 142, to its carrying amount to determine the
impairment loss, if any. Based on these estimates, we determined
that as of October 1, 2004 there was no impairment of
goodwill. Since October 1, 2004, there have been no
indications of impairment and the next annual impairment test
will occur as of October 1, 2005.
In accordance with Statement of Financial Accounting Standards
No. 144, “Accounting for Impairment or Disposal of
Long-Lived Assets,” or SFAS 144, we evaluate
purchased intangibles and other long-lived assets, other than
goodwill, for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may
not be recoverable based on expected undiscounted cash flows
attributable to that asset. The amount of any impairment is
measured as the difference between the carrying value and the
fair value of the impaired asset. We have not recorded any
impairment charges for long-lived intangible assets for the
three years ended December 31, 2004.
Assumptions and estimates about future values and remaining
useful lives are complex and often subjective. They can be
affected by a variety of factors, including external factors
such as industry and economic trends, and internal factors such
as changes in our business strategy and our internal forecasts.
Although we believe the assumptions and estimates we have made
in the past have been reasonable and appropriate, different
assumptions and estimates could materially impact our reported
financial results. Accordingly, future changes in market
capitalization or estimates used in discounted cash flows
analyses could result in significantly different fair values of
the reporting unit, which may result in impairment of goodwill.
We recognize deferred tax assets and liabilities for temporary
differences between the financial reporting basis and the tax
basis of our assets and liabilities. We record valuation
allowances against our
38
deferred tax assets to reduce the net carrying value to an
amount that management believes is more likely than not to be
realized.
Our income tax provision is determined using an annual effective
tax rate, which is generally less than the U.S. Federal
statutory rate, primarily because of tax deductions and
operating loss carryforwards available in the United States. Our
effective tax rate may be subject to fluctuations during the
fiscal year as we obtain new information that may affect the
assumptions we use to estimate our annual effective tax rate,
including factors such as our mix of pre-tax earnings in the
various tax jurisdictions in which we operate, valuation
allowances against deferred tax assets, utilization of tax
credits and changes in tax laws in jurisdictions where we
conduct operations.
In 2004 we experienced a full year of profitability. In prior
years, we recorded an income tax provision primarily based on
the foreign operations of our subsidiary in Australia, while
experiencing losses for our U.S. operations. As a result,
we have some remaining operating losses to carryforward and
partially offset future domestic profits, if and when earned.
The deferred tax asset resulting from the operating loss carry
forwards is offset by a valuation allowance until we meet
certain specific tests regarding continued profitability. Our
effective tax rate and the related income tax provision may
increase significantly in the future after the operating loss
carryforwards have been exhausted.
RESULTS OF OPERATIONS
We recognize product revenues net of allowances for estimated
discounts, returns, rebates and chargebacks.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Product revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
OLUX
|
|
$ |
61,894 |
|
|
|
30 |
% |
|
$ |
47,538 |
|
|
|
47 |
% |
|
$ |
32,339 |
|
| |
Luxíq
|
|
|
23,582 |
|
|
|
25 |
% |
|
|
18,857 |
|
|
|
25 |
% |
|
|
15,042 |
|
| |
Soriatane
|
|
|
53,567 |
|
|
|
100 |
% |
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Evoclin
|
|
|
2,883 |
|
|
|
100 |
% |
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Other
|
|
|
133 |
|
|
|
(37 |
)% |
|
|
211 |
|
|
|
10 |
% |
|
|
192 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Total product revenues
|
|
|
142,059 |
|
|
|
113 |
% |
|
|
66,606 |
|
|
|
40 |
% |
|
|
47,573 |
|
|
Royalty and contract revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Royalty
|
|
|
1,839 |
|
|
|
(76 |
)% |
|
|
7,788 |
|
|
|
166 |
% |
|
|
2,926 |
|
| |
Contract
|
|
|
457 |
|
|
|
(51 |
)% |
|
|
937 |
|
|
|
(59 |
)% |
|
|
2,264 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total royalty and contract revenues
|
|
|
2,296 |
|
|
|
(74 |
)% |
|
|
8,725 |
|
|
|
68 |
% |
|
|
5,190 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Total revenues
|
|
$ |
144,355 |
|
|
|
92 |
% |
|
$ |
75,331 |
|
|
|
43 |
% |
|
$ |
52,763 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our product revenues increased to $142.1 million in 2004
from $66.6 million in 2003. The increase in product
revenues reflects the introduction of two new products in 2004,
Soriatane in March and Evoclin in December, and, to a lesser
extent, increases in sales volume and sales prices for existing
products. Of the 113% increase in revenues, 84% is attributable
to the introduction of the new products, 17% to increases in the
prices of existing products, and 12% to increased sales volumes
on existing products. Net product revenues increased to
$66.6 million in 2003 from $47.6 million in 2002.
Increased sales volumes for OLUX and Luxíq in 2003
accounted for 64% of this increase and increases in pricing
accounted for the remaining 36% of this increase.
39
During the first half of 2004, we made a decision to bring in
house the function of Contract Administration responsibility for
the calculation and related reporting of all allowances and
discounts for which Managed care plans and Medicaid programs are
eligible. Previously we utilized third parties to perform the
allowance calculation and related reporting. In connection with
this change we performed a comprehensive review of our
calculation for Medicaid product pricing allowances, which
resulted in an adjustment to reserves recorded in prior periods.
As a result, we recorded a one-time reduction of product
revenues in the amount of $564,000 in the second quarter of
2004. We have determined that the effect of this change in
estimate would not have had a material impact on our previously
issued financial statements.
Royalty and contract revenues decreased to $2.3 million in
2004 from $8.7 million in 2003. The $6.4 million
decrease was primarily due to the termination of the S.C.
Johnson royalty agreement related to a concentrated aerosol foam
spray in the first quarter of 2004. Royalties received from S.C.
Johnson totaled $1.2 million in 2004 and $7.0 million
in 2003, which included a one-time royalty payment of
$2.9 million. Additionally, in 2003 we recognized $761,000
of relaxin-related revenue associated with the execution of the
agreement with BAS Medical, Inc. in July 2003. Of the
relaxin-related revenue, $661,000 represented previously
deferred revenue associated with license agreements with other
third-parties that was fully recognized upon the execution of
the BAS Medical agreement. We did not receive any
relaxin-related revenue in 2004 and do not expect any in the
future.
Royalty and contract revenues increased to $8.7 million in
2003 from $5.2 million in 2002. The increase was primarily
due to royalties received in connection with the S.C. Johnson
license agreement in the amount of $7.0 million in 2003,
compared to $2.4 million in 2002. The recognition of
$761,000 in relaxin-related revenue in 2003 also contributed to
the increase over 2002. These increases were partially offset by
decreases in contract revenue from other third parties related
to one-time contract payments made in 2002, including an initial
fee of $1.0 million received from Pharmacia Corporation
(now Pfizer) to license certain rights related to our foam drug
delivery technology and $580,000 paid by Novartis to exercise an
option to expand their license.
We expect that product revenues will increase in 2005, although
at a slower rate than in 2004, due to continued sales growth of
all of our products and the effect of having a full year of
revenue for Soriatane, which we acquired in March 2004, and
Evoclin, which we launched in December 2004. In 2005, we
anticipate that royalty and contract revenues will be flat to
slightly down due to the absence of the royalties from S.C.
Johnson. However, in 2005 and beyond, contract revenue may
fluctuate depending on whether we enter into additional
collaborations, when and whether we or our partners achieve
milestones under existing agreements, and the timing of any new
business opportunities that we may identify.
Our cost of product revenues includes the third party costs of
manufacturing OLUX, Luxíq and Evoclin, the cost of
Soriatane inventory acquired from Roche, depreciation costs
associated with Connetics-owned equipment located at the DPT
facility in Texas, allocation of overhead, royalty payments
based on a percentage of our product revenues, product freight
and distribution costs from SPS and certain manufacturing
support and quality assurance costs.
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|
|
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|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
|
|
As a % | |
|
|
|
As a % | |
|
|
|
As a % | |
| |
|
|
|
of Net | |
|
|
|
of Net | |
|
|
|
of Net | |
| |
|
|
|
Product | |
|
|
|
Product | |
|
|
|
Product | |
| |
|
$ | |
|
Revenues | |
|
$ | |
|
Revenues | |
|
$ | |
|
Revenues | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Cost of product revenues
|
|
$ |
12,656 |
|
|
|
9 |
% |
|
$ |
5,129 |
|
|
|
8 |
% |
|
$ |
4,190 |
|
|
|
9 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our cost of product revenues increased to $12.7 million in
2004 from $5.1 million in 2003. The increase included
$2.4 million for increased product revenues,
$4.1 million due to increased royalty payments resulting
primarily from royalties paid on Soriatane sales to a U.S.-based
distributor that exports
40
branded pharmaceutical products to select international markets,
and $1.1 million as a result of the allocation of costs
previously categorized as research and development.
Before January 1, 2004, inventory and cost of goods sold
only captured third party product manufacturing costs,
depreciation on Connetics-owned equipment at our third-party
manufacturers, product freight and distribution costs from the
third party that handles all of our product distribution
activities and royalties. Effective January 1, 2004, we
began including certain manufacturing support and quality
assurance costs in the cost of finished goods inventory and
samples inventory which had previously been classified as
research and development expense. Those activities include
overseeing third party manufacturing, process development,
quality assurance and quality control activities. We have
determined that the effect of this change in accounting would
not have had a material impact on our financial statements in
any prior quarterly or annual period. For the year ended
December 31, 2004, we allocated $4.6 million of costs
which in previous years would have been included in research and
development, or R&D, expense as follows:
(1) $1.1 million to cost of goods sold;
(2) $1.0 million to selling expense;
(3) $2.1 million to the value of commercial inventory;
and, (4) $324,000 to the value of samples inventory.
Cost of product revenues increased to $5.1 million in 2003
from $4.2 million in 2002. The increase is primarily
attributable to the increase in sales volume of our products, as
well as the establishment of a $262,000 reserve recorded during
2003 related to minimum purchase commitments under an agreement
with DPT. If the effects of the $262,000 reserve are excluded,
we experienced a slight improvement in our gross product margin
due to the combined effects of the price increases for OLUX and
Luxíq, effective in the fourth quarter 2002 and the second
quarter 2003, and slightly lower cost of manufacturing our
products.
In 2005, we expect the cost of product revenues as a percentage
of revenue to trend marginally higher due to an increased
proportion of sales coming from products with higher royalty
rates.
Amortization of Intangible Assets
We amortize certain identifiable intangible assets, primarily
product rights, over the estimated life of the asset.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
2002 | |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Amortization of intangible assets
|
|
$ |
11,471 |
|
|
|
NM |
|
|
$ |
819 |
|
|
|
2 |
% |
|
$ |
805 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the first quarter of 2004, we entered into an agreement to
acquire exclusive U.S. rights to Soriatane which resulted
in recording $127.7 million in intangible assets. We are
amortizing the related intangible assets over an estimated
useful life of ten years. Amortization expense in 2004 included
10 months of amortization related to Soriatane totaling
$10.6 million, which is the primary reason for the increase
over 2003.
In 2005 we will record a full year of amortization for the
Soriatane intangible assets totaling approximately
$12.8 million, resulting in an increase in amortization
expense of $2.2 million over 2004.
Research and Development
Research and development expenses include costs of personnel to
support our research and development activities, costs of
preclinical studies, costs of conducting our clinical trials
(such as clinical
41
investigator fees, monitoring costs, data management and drug
supply costs), external research programs and an allocation of
facilities costs.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Research and development expenses
|
|
$ |
21,539 |
|
|
|
(29 |
)% |
|
$ |
30,109 |
|
|
|
17 |
% |
|
$ |
25,821 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As noted above under Cost of Product Revenues, for the year
ended December 31, 2004, we allocated $4.6 million of
costs, which in previous years would have been included in
R&D expense, to cost of goods sold, sales expense, and the
values of commercial and samples of inventory. R&D expense
for 2004 before the allocation was $26.1 million or
$4.0 million less than in 2003.
Year to year changes in research and development expenses are
primarily due to the timing of and sample sizes required for
particular trials. The increase in expenses in 2003 compared to
2002 and the subsequent decrease in 2004 are primarily due to
the timing and completion of pivotal trials for Extina, Evoclin,
and Velac in 2003, as noted in the “Preclinical and
clinical research in the development of new dermatology
products” category in the table below. The reduction in
2004 is also due to the allocation of research and development
expenses as noted above, partially offset by $514,000 related to
the write-off of the Extina finished goods inventory in late
2004.
Our research and development expenses, including the
$4.6 million allocated to other accounts in 2004, primarily
consisted of:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended | |
| |
|
December 31, | |
| |
|
| |
| Category |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In millions) | |
|
Preclinical and clinical research in the development of new
dermatology products
|
|
$ |
6.4 |
|
|
$ |
13.0 |
|
|
$ |
7.4 |
|
|
Quality assurance and quality control in the maintenance and
enhancement of existing dermatology products
|
|
|
4.9 |
|
|
|
5.2 |
|
|
|
5.1 |
|
|
Optimization of manufacturing and process development for
existing dermatology products
|
|
|
2.7 |
|
|
|
2.8 |
|
|
|
3.9 |
|
|
Manufacturing, process development and optimization of
dermatology products under development
|
|
|
3.6 |
|
|
|
2.1 |
|
|
|
2.7 |
|
|
Quality assurance and quality control in the development of new
dermatology products
|
|
|
1.8 |
|
|
|
2.0 |
|
|
|
1.9 |
|
|
Basic research and formulation of new dermatology products
|
|
|
1.6 |
|
|
|
1.3 |
|
|
|
1.3 |
|
|
Regulatory review of new and existing dermatology products
|
|
|
2.7 |
|
|
|
1.6 |
|
|
|
1.1 |
|
42
The following table sets forth the status of, and costs
attributable to, our product candidates currently in clinical
trials as well as other current research and development
programs. The actual timing of completion of phases of research
could differ materially from the estimates provided in the table.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Estimated | |
|
|
| |
|
|
|
Completion | |
|
Accumulated Program- | |
| |
|
|
|
of Phase III | |
|
Related Research and | |
| |
|
Phase of | |
|
Clinical | |
|
Development Expenses | |
| Description/Indication |
|
Development | |
|
Trials | |
|
through 2004 | |
| |
|
| |
|
| |
|
| |
|
Velac, a gel formulation of clindamycin and tretinoin for the
treatment of acne (excluding license and milestone payments to
Yamanouchi)
|
|
|
NDA filed |
|
|
|
Completed |
|
|
$ |
15.6 million |
|
|
Desiluxtm
(desonide), VersaFoam-EF, 0.05%, a low-potency
topical steroid formulated to treat atopic dermatitis
|
|
|
Phase III |
|
|
|
late-2005 |
|
|
$ |
2.8 million |
|
|
OLUX (clobetasol propionate) VersaFoam-EF, 0.05%, a high-potency
topical steroid formulated to treat atopic dermatitis and plaque
psoriasis
|
|
|
Preclinical |
|
|
|
late-2005 |
|
|
$ |
1.3 million |
|
|
Preclinical research and development for multiple dermatological
indications
|
|
|
Preclinical |
|
|
|
N/A |
|
|
$ |
1.6 million |
|
In general, we expect research and development expenses to
increase significantly in 2005 due to additional research and
clinical trials. Consistent with our 4:2:1 development model, we
have a minimum of four product candidates in product
formulation, at least two in late-stage clinical trials and we
expect to launch one new product or indication commercially in
2005. Pharmaceutical products that we develop internally can
take several years to research, develop and bring to market in
the U.S. We cannot reliably estimate the overall completion
dates or total costs to complete our major research and
development programs. The clinical development portion of these
programs can span several years and any estimation of completion
dates or costs to complete would be highly speculative and
subjective due to the numerous risks and uncertainties
associated with developing pharmaceutical products. The FDA
defines the steps required to develop a drug in the
U.S. Clinical development typically involves three phases
of study, and the most significant costs associated with
clinical development are the Phase III trials as they tend
to be the longest and largest studies conducted during the drug
development process. The lengthy process of seeking these
approvals, and the subsequent compliance with applicable
statutes and regulations, require the expenditure of substantial
resources. If we fail to obtain, or experience any delay in
obtaining, regulatory approval, it could materially adversely
affect our business. For additional discussion of the risks and
uncertainties associated with completing development of
potential products, see “Factors Affecting Our Business
and Prospects — We cannot sell our current products
and product candidates if we do not obtain and maintain
governmental approvals,” “— We may spend a
significant amount of money to obtain FDA and other regulatory
approvals, which may never be granted,” — “The
expenses associated with our clinical trials are significant. We
rely on third parties to conduct clinical trials for our product
candidates, and those third parties may not perform
satisfactorily,” and “— Our continued
growth depends on our ability to develop new products, and if we
are unable to develop new products, our expenses may exceed our
revenues without any return on the investment.”
43
|
|
|
Selling, General and Administrative Expenses |
Selling, general and administrative expenses include expenses
and costs associated with finance, legal, insurance, marketing,
sales, and other administrative matters.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Selling, general and administrative expenses
|
|
$ |
73,206 |
|
|
|
75 |
% |
|
$ |
41,781 |
|
|
|
13 |
% |
|
$ |
36,819 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses increased to
$73.2 million in 2004 from $41.8 million in 2003. The
increase was primarily due to:
|
|
|
| |
• |
increased direct and indirect promotional capabilities
($11.0 million), |
| |
| |
• |
increased marketing and sales activities such as advertising,
tradeshows and conventions ($4.1 million), |
| |
| |
• |
increased labor and benefit expenses, primarily due to increased
headcount in the marketing, general and administrative
departments ($2.4 million), |
| |
| |
• |
increased expenses related to product sampling
($1.8 million), |
| |
| |
• |
increased outside legal, audit and tax expenses
($1.9 million), and |
| |
| |
• |
increased business insurance costs ($1.1 million). |
Selling, general and administrative expenses increased to
$41.8 million in 2003 from $36.8 million in 2002. The
increase was primarily due to:
|
|
|
| |
• |
increased labor and benefit expenses due to increased headcount
($2.3 million), |
| |
| |
• |
increased expenses related to product sampling and sales
promotion programs ($1.8 million), |
| |
| |
• |
increased cost of outside service and other fees primarily
related to warehousing, distribution and production of sales and
marketing materials ($600,000), |
| |
| |
• |
increased business development activities ($250,000), and |
| |
| |
• |
increased outside legal expenses incurred ($185,000). |
Those increases were partially offset by a $662,000 decrease in
various marketing activities such as tradeshows, honorariums,
and medical education.
We expect selling, general and administrative expenses to
increase in 2005 primarily because of increased promotional
activities and a full year of expenses related to the increased
headcount in the sales and other departments.
|
|
|
In-Process Research and Development and Milestone
Payments |
In-process research and development and milestone expense
represents payments made in connection with an acquisition of a
product or milestone payments related to product development. We
expense these costs when they are incurred as the product may
not meet either technological feasibility or commercial
44
success because the product remains in clinical development or
alternative future use has not been established.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
In-process research and development and milestone payments
|
|
$ |
3,500 |
|
|
|
NM |
|
|
|
— |
|
|
|
NM |
|
|
$ |
4,350 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In May 2002, we entered into an agreement with Yamanouchi Europe
B.V. to license Velac. Under the terms of the agreement, we paid
Yamanouchi an initial $2.0 million licensing fee, which we
recorded as in-process research and development expense in 2002
as the product remains in clinical development. In 2002, we
initiated a Phase III trial for Velac. Under the terms of
the agreement, we recorded an additional $2.0 million of
in-process research and development expense related to this
milestone.
In August 2004, we submitted a NDA for Velac with the FDA and,
in October 2004, we received notification that the FDA accepted
the NDA for filing as of August 23, 2004. As a result, we
recorded an additional $3.5 million milestone in the third
quarter of 2004 due to the licensor upon the filing of the NDA.
As noted above, because the product has not been approved, we
recorded the fee as in-process research and development and
milestone payment expense.
|
|
|
Interest and other income (expense), net |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Interest and other income (expense), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Interest income
|
|
$ |
1,194 |
|
|
|
23 |
% |
|
$ |
972 |
|
|
|
18 |
% |
|
$ |
823 |
|
| |
Gain on sale of investment
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
NM |
|
|
|
2,086 |
|
| |
Interest expense
|
|
|
(2,778 |
) |
|
|
70 |
% |
|
|
(1,632 |
) |
|
|
NM |
|
|
|
(11 |
) |
| |
Other income (expense), net
|
|
|
109 |
|
|
|
(53 |
)% |
|
|
234 |
|
|
|
3 |
% |
|
|
227 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Income. Interest income increased to
$1.2 million in 2004 from $972,000 in 2003. The increase in
2004 was due to interest earned on larger cash investment
balances in connection with cash we received from
$56.9 million in net proceeds from a private placement of
common stock in February 2004 and issuing $90.0 million in
convertible senior notes in May 2003. Interest income increased
to $972,000 in 2003 from $823,000 in 2002. The increase in 2003
was due to interest earned on larger cash and investment
balances in connection with the cash we received from issuing
$90.0 million of convertible senior notes in May 2003,
partially offset by lower market interest rates on investments.
Interest Expense. Interest expense increased to
$2.8 million in 2004 from $1.6 million in 2003. The
increase reflects the fact that we incurred a full year of
interest expense in 2004 on the convertible senior notes issued
in May 2003. Interest expense increased to $1.6 million in
2003 from $11,000 in 2002. The increase in 2003 is a direct
result of the interest expense associated with the convertible
senior notes issued in May 2003.
Income Taxes
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Income tax provision
|
|
$ |
1,493 |
|
|
|
28 |
% |
|
$ |
1,167 |
|
|
|
545 |
% |
|
$ |
181 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
45
Prior to 2004, we recorded an income tax provision primarily
based on the foreign operations of our subsidiary in Australia,
while experiencing losses for our U.S. operations. As a
result, we will use operating loss carryforwards to partially
offset future domestic profits, if and when earned. The deferred
tax asset resulting from the operating loss carry forwards is
offset by a valuation allowance until we meet certain specific
tests regarding the continued profitability. Our income tax
provision is determined using an annual effective tax rate,
which is generally less than the U.S. Federal statutory
rate, primarily because of tax deductions and operating loss
carryforwards available in the United States.
The income tax provision increased to $1.5 million in 2004
from $1.2 million in 2003 primarily due to an increase for
U.S. Federal tax of $986,000, resulting mostly from the
effect of the alternative minimum tax in 2004, and $281,000 for
various U.S. states, partially offset by a reduction for
foreign taxes of $941,000. The income tax provision increased to
$1.2 million in 2003 from $200,000 in 2002. The increase
was primarily due to an increase for U.S. Federal tax of
$541,000, resulting mostly from tax benefits taken in 2002, and
an increase for foreign tax of $370,000. The U.S. tax
benefit arose principally due to the Job Creation and Worker
Assistance Act of 2002 enacted on March 9, 2002, which
allows taxpayers to carry back net operating losses generated in
2001 and 2002 to offset alternative minimum tax previously paid.
The amounts reported above for U.S Federal tax include
U.S. withholding taxes paid on foreign earnings and the
foreign taxes are net of the foreign tax credit claimed in
Australia for the U.S. withholding tax.
Our effective tax rate and related tax provisions may increase
significantly in the future after our net operating loss and
other carryforwards have been exhausted. For a more complete
description of our income tax position, refer to Note 12
in the Notes to Consolidated Financial Statements
elsewhere in this Report.
LIQUIDITY AND CAPITAL RESOURCES
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
$ | |
|
% Change | |
|
$ | |
| |
|
| |
|
| |
|
| |
| |
|
(Dollars in thousands) | |
|
Cash, cash equivalents and marketable securities
|
|
$ |
72,383 |
|
|
|
(37 |
)% |
|
$ |
114,662 |
|
| |
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and marketable securities totaled
$72.4 million at December 31, 2004, down from
$114.7 million at December 21, 2003. The decrease of
$42.3 million was primarily due to our acquisition of
Soriatane product rights, for which the cash used was
$123.5 million, partially offset by a our private placement
of common stock with net proceeds of $56.9 million and net
cash provided by our operations of $29.7 million. Other
major sources and uses of cash included our net sales of
marketable securities of $42.0 million, primarily to
finance our Soriatane acquisition, partially offset by
$21.2 million used for increases in accounts receivable
resulting from our increased sales.
Working capital at December 21, 2004 was $71.1 million
compared to $112.2 million at December 31, 2003.
Significant changes in working capital during 2004 (in addition
to the changes identified above for cash, marketable securities,
and accounts receivable) included increases in current assets of
$5.3 million for prepayments and other current assets and
$3.5 million for inventory and increases in liabilities of
$12.7 million for allowances for rebates, returns, and
chargebacks and $10.7 million for accounts payable. The
$5.3 million increase for prepayments and other current
assets and the $3.5 million increase in inventory are
primarily a result of growth in our business and related
expenses. We increased our allowance for rebates, returns, and
chargebacks as a result of our increased net product revenues,
primarily due to Soriatane. The $10.7 million increase in
accounts payable was related primarily to the increase in
business activity.
We made capital expenditures of $7.6 million in 2004
compared to $959,000 in 2003 and $3.9 million in 2002. The
expenditures in 2004 were primarily for leasehold improvements
on our new corporate
46
headquarters, which we occupied starting in February 2005, and
for manufacturing and laboratory equipment.
On February 13, 2004, we completed a private placement of
3.0 million shares of our common stock to accredited
institutional investors at a price of $20.25 per share, for
net proceeds of approximately $56.9 million.
On May 28, 2003, we issued $90.0 million of
2.25% convertible senior notes due May 30, 2008 in a
private placement exempt from registration under the Securities
Act of 1933. The notes are senior, unsecured obligations and
rank equal in right of payment with any of our existing and
future unsecured and unsubordinated debt. The notes are
convertible into our shares of common stock at any time at the
option of the note holder at a conversion rate of
46.705 shares of common stock per $1,000 principal amount
of notes, subject to adjustment in certain circumstances, which
is equivalent to a conversion price of approximately
$21.41 per share of common stock. This conversion price is
higher than the price of our common stock on the date the notes
were issued. The notes bear interest at a rate of 2.25% per
annum, which is payable semi-annually in arrears on May 30
and November 30 of each year, beginning November 30,
2003. Offering expenses of $3.7 million related to the
issuance of these notes have been included in other assets and
are amortized to interest expense over the contractual term of
the notes.
Contractual Obligations and Commercial Commitments. As of
December 31, 2004, we had the following contractual
obligations and commitments:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments Due by Period | |
| |
|
| |
| |
|
|
|
Less Than | |
|
|
|
More Than | |
| Contractual Obligations |
|
Total | |
|
1 Year | |
|
1 — 3 Years | |
|
3 — 5 Years | |
|
5 Years | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In millions) | |
|
Long-Term Debt Obligations(1)
|
|
$ |
97.0 |
|
|
$ |
2.0 |
|
|
$ |
4.1 |
|
|
$ |
90.9 |
|
|
$ |
— |
|
|
Operating Lease Obligations(2)
|
|
|
21.2 |
|
|
|
5.0 |
|
|
|
5.3 |
|
|
|
2.8 |
|
|
|
8.1 |
|
|
Purchase Obligations(3)(4)
|
|
|
19.8 |
|
|
|
11.5 |
|
|
|
4.3 |
|
|
|
1.7 |
|
|
|
2.3 |
|
|
Other Long-Term Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Reflected on the Registrant’s
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Balance Sheet under GAAP
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Contractual Cash Obligations
|
|
$ |
138.0 |
|
|
$ |
18.5 |
|
|
$ |
13.7 |
|
|
$ |
95.4 |
|
|
$ |
10.4 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
On May 28, 2003, we issued $90 million of
2.25% convertible senior notes due May 30, 2008 in a
private offering. The notes are unsecured and rank equal to all
of our future unsecured and unsubordinated debts. The notes are
convertible at any time at the option of note holders into
shares of our common stock at a conversion rate of
46.705 shares for each $1,000 principal amount of notes,
subject to adjustment in certain circumstances, which is
equivalent to a conversion price of approximately
$21.41 per share. The amounts reflected above include
annual interest payments of approximately $2.0 million per
year, assuming that the notes are not redeemed or converted
before maturity. |
| |
| (2) |
We lease laboratory and office facilities under non-cancelable
operating leases, which expire in April 2005. In June 2004, we
signed a series of new non-cancelable facility lease agreements
to lease approximately 96,000 square feet of space in Palo
Alto, California that we moved into in February 2005. Under our
agreement with DPT, we are also obligated to pay approximately
$56,000 per year in rent for the pro rata portion of
DPT’s facility allocated to the aerosol line. Under the DPT
agreement, we will pay rent for the term of the agreement or as
long as we own the associated assets, whichever is longer. We
also lease various automobiles and office equipment under
similar leases, expiring through 2008. These obligations are to
be partially offset by $94,000 to be received from subleasing
arrangements with third parties. |
| |
| (3) |
In March 2002 we entered into a manufacturing and supply
agreement with DPT that requires minimum purchase commitments,
beginning six months after the opening of the commercial |
47
|
|
|
production line and continuing for 10 years. Also in 2002
we entered into a license agreement that requires minimum
royalty payments beginning in 2005 and continuing for fifteen
years, unless the agreement is terminated earlier by either
party. In 2003, we entered into a five year service agreement
for prescription information that requires minimum fees. |
| |
| (4) |
Per our manufacturing and supply agreements with our three
suppliers, AccraPac, DPT and Roche, we may incur significant
penalties related to cancellation of purchase orders, including
paying an amount equal to the entire cancelled purchase order.
We had approximately $9.6 million in outstanding open
purchase orders to our suppliers at December 31, 2004 and
the entire amount is included in the table in Year 2005. |
We believe our existing cash, cash equivalents and marketable
securities, cash generated from product sales and collaborative
arrangements with corporate partners, will be sufficient to fund
our operating expenses, debt obligations and capital
requirements through at least the next 12 months. We cannot
be certain of the amount of our future product revenues, as
product sales can be impacted by patent risks and competition
from new products, and products under development may not be
safe and effective or approved by the FDA, or we may not be able
to produce them in commercial quantities at reasonable costs,
and the products may not gain satisfactory market acceptance.
The amount of capital we require for operations in the future
depends on numerous factors, including the level of product
revenues, the extent of commercialization activities, the scope
and progress of our clinical research and development programs,
the time and costs involved in obtaining regulatory approvals,
the cost of filing, prosecuting, and enforcing patent claims and
other intellectual property rights, and competing technological
and market developments. If we need funds in the future to
in-license or acquire additional marketed or late-stage
development products, a portion of the funds may come from our
existing cash, which will result in fewer resources available to
our current products and clinical programs. To take action on
business development opportunities we may identify in the
future, we may need to use some of our available cash, or raise
additional cash by liquidating some of our investment portfolio
and/or raising additional funds through equity or debt
financings.
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 we need
them, 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.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements (as that term
is defined in Item 303 of Regulation S-K) that are
reasonably likely to have a current or future material effect on
our financial condition, revenue or expenses, results of
operations, liquidity, capital expenditures or capital resources.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123
(revised 2004), “Share-Based Payment,” or
SFAS 123R, which requires companies to measure and
recognize compensation expense for all stock-based payments at
fair value. Stock-based payments include grants of employee
stock options. SFAS 123R replaces SFAS No. 123,
“Accounting for Stock-Based Compensation,” or
SFAS 123 and supersedes APB Opinion No. 25,
“Accounting for Stock Issued to Employees.”
SFAS 123R requires companies to recognize all stock-based
payments to employees in the financial statements based on their
fair values. SFAS 123R is effective for all interim or
annual periods beginning after June 15, 2005. The pro forma
disclosures previously permitted under SFAS 123 will no
longer be an alternative to financial statement recognition. We
are required to adopt SFAS 123R in our third quarter of
fiscal 2005, beginning July 1, 2005. Under SFAS 123R,
we must determine the appropriate fair value model to be used
for valuing share-based payments, the amortization method for
compensation cost and the transition method to be used at date
of adoption. The transition methods include prospective and
retroactive adoption options.
48
Under the retroactive options, we may restate prior periods
either as of the beginning of the year of adoption or for all
periods presented. The prospective method requires that we
record compensation expense for all unvested stock options and
restricted stock at the beginning of the first quarter of
adoption of SFAS 123R, while the retroactive methods would
record compensation expense for all unvested stock options and
restricted stock beginning with the first period restated. We
are evaluating the requirements of SFAS 123R and we expect
that the adoption of SFAS 123R will have a material impact
on our consolidated results of operations and earnings per
share. We have not yet determined the method of adoption or the
effect of adopting SFAS 123R, and we have not determined
whether the adoption will result in amounts that are similar to
the current pro forma disclosures under SFAS 123.
|
|
| 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, municipal
debt, and asset and mortgage backed securities. 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
reductions 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. While a reduction in
interest rates would decrease interest income, the negative
effect would be partially offset by an increase in the value of
our marketable securities portfolio. A hypothetical decrease of
100 basis points in market-fixed interest rates would
increase the fair value of our portfolio by approximately
260,000 or one-half of one percent. An increase in interest
rates of 100 basis points would decrease the value of the
portfolio by a similar amount. Due to the nature of our
marketable securities, we have concluded that we face minimal
material market risk exposure.
The table below presents the principal amounts and weighted
average interest rates by year of maturity for our investment
portfolio as of December 31, 2004 (dollars in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2005 | |
|
2006 | |
|
2007 | |
|
2008 | |
|
2009 | |
|
Thereafter | |
|
Total | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
|
$ |
21,075 |
|
|
$ |
12,621 |
|
|
$ |
6,643 |
|
|
$ |
300 |
|
|
$ |
901 |
|
|
$ |
12,016 |
|
|
$ |
53,556 |
|
|
$ |
53,442 |
|
|
Weighted average annual interest rate
|
|
|
4.5 |
% |
|
|
4.5 |
% |
|
|
2.3 |
% |
|
|
1.2 |
% |
|
|
2.4 |
% |
|
|
2.5 |
% |
|
|
— |
|
|
|
— |
|
| |
|
Liabilities: |
|
2.25% Convertible Senior Notes Due 2008
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
$ |
90,000 |
|
|
|
— |
|
|
|
— |
|
|
$ |
90,000 |
|
|
$ |
113,310 |
|
|
Average interest rate
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2.25 |
% |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
The table above includes principal and fair value amounts of
$7.0 million as of December 31, 2004, related to
auction rate securities. Although these securities have long
final maturities (from 19 years to perpetuity), we consider
them to be short-term investments because liquidity is provided
through the short-term (7 to 90 days) interest rate reset
mechanism. These securities are allocated between maturity
groupings based on their final maturities. The table above also
includes principal amounts of $7.3 million and fair value
amounts of $7.2 million related to asset-backed and
mortgage-backed securities that are allocated between maturity
groupings based on their final maturities.
Foreign Currency Exchange Risk. Certain payments that
third parties make to Connetics Australia are made in local
currency or Australian dollars. Any fluctuations in the
currencies of our licensees or licensors against the Australian
or the U.S. dollar will cause our royalty revenues and
expenses to fluctuate as well. We currently do not hedge our
exposure to changes in foreign currency exchange rates.
49
|
|
| Item 8. |
Financial Statements and Supplementary Data |
Our consolidated financial statements and related financial
information are filed as a separate section to this Report.
Please refer to Item 15(a) for an Index to Consolidated
Financial Statements.
|
|
| 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.
|
|
| Item 9A. |
Controls and Procedures |
(a) Evaluation of Disclosure Controls and
Procedures: The Company’s principal executive and
financial officers reviewed and evaluated the Company’s
disclosure controls and procedures (as defined in Exchange Act
Rule 13a-15(e)) as of the end of the period covered by this
Form 10-K. Based on that evaluation, the Company’s
principal executive and financial officers concluded that the
Company’s disclosure controls and procedures are effective
in timely providing them with material information relating to
the Company, as required to be disclosed in the reports the
Company files under the Exchange Act.
(b) Management’s Annual Report on Internal Control
Over Financial Reporting: Our management is responsible for
establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f) and 15d-15(f). Under the supervision and with
the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an
evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2004 based on the
framework in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on that evaluation, our
management concluded that our internal control over financial
reporting was effective as of December 31, 2004.
Management’s assessment of the effectiveness of our
internal control over financial reporting as of
December 31, 2004 has been audited by Ernst & Young
LLP, an independent registered public accounting firm, as stated
in their report which is included elsewhere herein.
(c) Changes in Internal Control Over Financial
Reporting: There were no changes in our internal controls
over financial reporting during the quarter ended
December 31, 2004 that have materially affected, or are
reasonably likely to materially affect our internal controls
over financial reporting.
|
|
| Item 9B. |
Other Information |
None.
PART III
|
|
| Item 10. |
Directors and Executive Officers |
(a) Information regarding our Board of Directors is
incorporated by reference to the sections entitled
“Election of Directors,” “Stock Ownership, ”
“Corporate Governance,” and “Report of the Audit
Committee” in our Proxy Statement (“2005 Proxy
Statement”) to be filed with the Securities and Exchange
Commission relating to our annual meeting of stockholders to be
held April 22, 2005.
(b) Information regarding our executive officers is
included in Part I of this Report in the section entitled
“Business — Executive Officers of the
Company,” and is incorporated by reference to the section
entitled “Stock Ownership” in our 2005 Proxy Statement.
(c) Information regarding the identity of the audit
committee members and the audit committee financial expert is
incorporated by reference to the section entitled “Report
of the Audit Committee” in our 2005 Proxy Statement.
50
(d) Information with respect to our policy regarding
nominations by stockholders for the Board is incorporated by
reference to the section entitled “Corporate
Governance” in our 2005 Proxy Statement.
(e) The information found in our 2005 Proxy Statement under
the heading “Stock Ownership — Section 16
(a) Beneficial Ownership Reporting Compliance” is
incorporated by reference.
(f) The Board has adopted a code of professional conduct
that applies to all employees, and a supplemental code of
professional conduct that applies to our CEO, senior financial
officers, and the Board of Directors. These codes of conduct are
posted on the Corporate Governance section of our website at
http://ir.connetics.com/governance/highlights.cfm. We
intend to disclose any amendments to, or waivers from, our codes
of conduct on our website.
|
|
| 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 2005 Proxy Statement.
|
|
| Item 12. |
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters |
Information regarding the beneficial ownership of our common
stock by certain beneficial owners and by our directors and
management is incorporated by reference to the information set
forth under the caption “Stock Ownership” in our 2005
Proxy Statement.
Information as of December 31, 2004 with respect to all of
our compensation plans under which equity securities are
authorized for issuance is incorporated by reference to the
information set forth under the caption “Equity
Compensation Plan Information” in our 2005 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 2005 Proxy Statement.
|
|
| Item 14. |
Principal Accounting Fees and Services |
The information required by this item is incorporated by
reference to the section entitled “Audit and Other
Fees” in our 2005 Proxy Statement.
51
PART IV
|
|
| Item 15. |
Exhibits and Financial Statement Schedules |
(a) 1. Financial Statements. The following
Consolidated Financial Statements and Reports of Independent
Registered Public Accounting Firm are filed as part of this
Report:
| |
|
|
|
|
| |
|
Page | |
| |
|
| |
|
Report of Independent Registered Public Accounting Firm on
Internal Control over Financial Reporting
|
|
|
F-2 |
|
|
Reports of Independent Registered Public Accounting Firm
|
|
|
F-3 |
|
|
Consolidated Balance Sheets as of December 31, 2004 and 2003
|
|
|
F-4 |
|
|
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2004
|
|
|
F-5 |
|
|
Consolidated Statements of Stockholders’ Equity for each of
the three years in the period ended December 31, 2004
|
|
|
F-6 |
|
|
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2004
|
|
|
F-8 |
|
|
Notes to Consolidated Financial Statements
|
|
|
F-9 |
|
2. Financial Statement Schedules
The following additional consolidated financial statement
schedule should be considered in conjunction with our
consolidated financial statements. 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
Schedule II — Valuation and Qualifying
Accounts
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Allowance for Doubtful |
|
|
|
Additions | |
|
|
|
|
| Accounts, Discounts, |
|
Balance at | |
|
Charged to | |
|
|
|
|
| Returns, Rebates and |
|
Start of | |
|
Expense/Revenue | |
|
|
|
Balance at | |
| Chargebacks |
|
Period | |
|
Net of Reversals | |
|
Utilizations | |
|
End of Period | |
| |
|
| |
|
| |
|
| |
|
| |
|
Year ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
2004
|
|
$ |
5,032,977 |
|
|
$ |
29,793,533 |
|
|
$ |
(16,570,595 |
) |
|
$ |
18,255,915 |
|
| |
2003
|
|
$ |
2,041,507 |
|
|
$ |
10,909,819 |
|
|
$ |
(7,918,349 |
) |
|
$ |
5,032,977 |
|
| |
2002
|
|
$ |
975,318 |
|
|
$ |
5,353,368 |
|
|
$ |
(4,287,179 |
) |
|
$ |
2,041,507 |
|
3. The Exhibits filed as a part of this Report are listed
in the Index to Exhibits.
(b) Exhibits. See Index to Exhibits.
(c) Financial Statements Schedules. See
Item 15(a)(2), above.
52
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 |
|
|
|
| |
|
|
| |
John L. Higgins |
|
| |
Chief Financial Officer |
|
| |
Executive Vice President, Finance |
|
| |
and Corporate Development |
|
Date: March 15, 2005
Each person whose signature appears below constitutes and
appoints Katrina J. Church and John L. Higgins, jointly and
severally, his or her attorneys-in-fact and agents, each with
the power of substitution, for him or her and in his or her
name, place or stead, in any and all capacities, to sign any and
all amendments to this Annual Report on Form 10-K, and to
file the same, with exhibits and other documents in connection
therewith, with the Securities and Exchange Commission, granting
to each attorney-in-fact and agent, full power and authority to
do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully as he
or she might or could do in person, and ratifying and confirming
all that the attorneys-in-fact and agents, or his or her
substitute or substitutes, may do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, this Report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
| |
|
|
|
|
|
|
| Signature |
|
Title |
|
Date |
| |
|
|
|
|
| |
Principal Executive Officer: |
|
|
|
|
| |
/s/ Thomas G. Wiggans
Thomas
G. Wiggans |
|
Chief Executive Officer
and Director |
|
March 15, 2005 |
| |
Principal Financial and Principal Accounting Officer: |
|
|
|
|
| |
/s/ John L. Higgins
John
L. Higgins |
|
Chief Financial Officer;
Executive Vice President,
Finance and Corporate Development |
|
March 15, 2005 |
| |
Directors: |
|
|
|
|
| |
/s/ Alexander E. Barkas
Alexander
E. Barkas |
|
Director |
|
March 15, 2005 |
| |
/s/ Eugene A. Bauer
Eugene
A. Bauer |
|
Director |
|
March 15, 2005 |
53
| |
|
|
|
|
|
|
| Signature |
|
Title |
|
Date |
| |
|
|
|
|
| |
/s/ R. Andrew Eckert
R.
Andrew Eckert |
|
Director |
|
March 15, 2005 |
| |
/s/ Denise M. Gilbert
Denise
M. Gilbert |
|
Director |
|
March 15, 2005 |
| |
/s/ John C. Kane
John
C. Kane |
|
Director |
|
March 15, 2005 |
| |
/s/ Thomas D. Kiley
Thomas
D. Kiley |
|
Director |
|
March 15, 2005 |
| |
/s/ Leon E. Panetta
Leon
E. Panetta |
|
Director |
|
March 15, 2005 |
| |
/s/ G. Kirk Raab
G.
Kirk Raab |
|
Chairman of the Board |
|
March 15, 2005 |
54
CONNETICS CORPORATION
Form 10-K
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements and Reports of
Independent Registered Public Accounting Firm are filed as part
of this Report:
| |
|
|
|
|
| |
|
Page | |
| |
|
| |
|
|
|
|
F-2 |
|
|
|
|
|
F-3 |
|
|
|
|
|
F-4 |
|
|
|
|
|
F-5 |
|
|
|
|
|
F-6 |
|
|
|
|
|
F-8 |
|
|
|
|
|
F-9 |
|
F-1
Report of Independent Registered Public Accounting Firm on
Internal Control over Financial Reporting
The Board of Directors and Stockholders of
Connetics Corporation
We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control Over
Financial Reporting included in 9A, that Connetics Corporation
maintained effective internal control over financial reporting
as of December 31, 2004, based on criteria established in
Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Connetics Corporation’s management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an
opinion on the effectiveness of the Connetics Corporation
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Connetics
Corporation maintained effective internal control over financial
reporting as of December 31, 2004, is fairly stated, in all
material respects, based on the COSO criteria. Also, in our
opinion, Connetics Corporation maintained, in all material
respects, effective internal control over financial reporting as
of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Connetics Corporation as of
December 31, 2004 and 2003, and the related consolidated
statements of operations, stockholders’ equity and cash
flows for each of the three years in the period ended
December 31, 2004 and our report dated March 11, 2005
expressed an unqualified opinion thereon.
Palo Alto, California
March 11, 2005
F-2
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Connetics Corporation
We have audited the accompanying consolidated balance sheets of
Connetics Corporation as of December 31, 2004 and 2003, and
the related consolidated statements of operations,
stockholders’ equity and cash flows for each of the three
years in the period ended December 31, 2004. Our audits
also included the financial statement schedule listed in the
Index at Item 15(a). These financial statements and
schedule are the responsibility of Connetics Corporation’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 the standards of the
Public Company Accounting Oversight Board (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 as of
December 31, 2004 and 2003, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2004, in conformity with
U.S. generally accepted accounting principles. 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.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Connetics Corporation’s internal control
over financial reporting as of December 31, 2004, based on
criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated March 11, 2005
expressed an unqualified opinion thereon.
Palo Alto, California
March 11, 2005
F-3
CONNETICS CORPORATION
CONSOLIDATED BALANCE SHEETS
| |
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(In thousands, except | |
| |
|
share and per share | |
| |
|
amounts) | |
|
ASSETS |
|
Current assets:
|
|
|
|
|
|
|
|
|
| |
Cash and cash equivalents
|
|
$ |
18,261 |
|
|
$ |
17,946 |
|
| |
Marketable securities
|
|
|
54,122 |
|
|
|
96,716 |
|
| |
Restricted cash–current
|
|
|
1,000 |
|
|
|
304 |
|
| |
Accounts receivable, net of allowances of $18,256 and $5,033 in
2004 and 2003, respectively
|
|
|
10,642 |
|
|
|
2,594 |
|
| |
Inventory
|
|
|
4,605 |
|
|
|
1,035 |
|
| |
Prepaid expenses
|
|
|
7,776 |
|
|
|
2,892 |
|
| |
Other current assets
|
|
|
2,076 |
|
|
|
887 |
|
| |
|
|
|
|
|
|
|
Total current assets
|
|
|
98,482 |
|
|
|
122,374 |
|
|
Property and equipment, net
|
|
|
11,830 |
|
|
|
5,628 |
|
|
Restricted cash–long term
|
|
|
2,963 |
|
|
|
— |
|
|
Debt issuance costs, deposits and other assets
|
|
|
3,794 |
|
|
|
5,418 |
|
|
Goodwill
|
|
|
6,271 |
|
|
|
6,271 |
|
|
Other intangible assets, net
|
|
|
122,388 |
|
|
|
6,206 |
|
| |
|
|
|
|
|
|
| |
|
|
Total assets
|
|
$ |
245,728 |
|
|
$ |
145,897 |
|
| |
|
|
|
|
|
|
| |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
Current Liabilities:
|
|
|
|
|
|
|
|
|
| |
Accounts payable
|
|
$ |
14,531 |
|
|
$ |
3,884 |
|
| |
Accrued liabilities related to acquisition of product rights
|
|
|
2,710 |
|
|
|
— |
|
| |
Accrued payroll and related expenses
|
|
|
5,746 |
|
|
|
3,792 |
|
| |
Accrued clinical trial costs
|
|
|
751 |
|
|
|
857 |
|
| |
Other accrued liabilities
|
|
|
3,650 |
|
|
|
1,594 |
|
| |
|
|
|
|
|
|
| |
|
|
Total current liabilities
|
|
|
27,388 |
|
|
|
10,127 |
|
|
Convertible senior notes
|
|
|
90,000 |
|
|
|
90,000 |
|
|
Other non-current liabilities
|
|
|
420 |
|
|
|
16 |
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
| |
Preferred stock, $0.001 par value:
|
|
|
|
|
|
|
|
|
| |
|
5,000,000 shares authorized; none issued or outstanding
|
|
|
— |
|
|
|
— |
|
| |
Common stock, $0.001 par value;
|
|
|
|
|
|
|
|
|
| |
|
50,000,000 shares authorized; 35,792,730 and
31,885,404 shares issued and outstanding at
December 31, 2004 and 2003, respectively
|
|
|
36 |
|
|
|
32 |
|
| |
Additional paid-in capital
|
|
|
237,666 |
|
|
|
174,080 |
|
| |
Deferred stock compensation
|
|
|
(13 |
) |
|
|
(31 |
) |
| |
Accumulated deficit
|
|
|
(111,173 |
) |
|
|
(130,188 |
) |
| |
Accumulated other comprehensive income
|
|
|
1,404 |
|
|
|
1,861 |
|
| |
|
|
|
|
|
|
| |
|
|
Total stockholders’ equity
|
|
|
127,920 |
|
|
|
45,754 |
|
| |
|
|
|
|
|
|
| |
|
|
Total liabilities and stockholders’ equity
|
|
$ |
245,728 |
|
|
$ |
145,897 |
|
| |
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-4
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share | |
| |
|
amounts) | |
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
$ |
142,059 |
|
|
$ |
66,606 |
|
|
$ |
47,573 |
|
| |
Royalty and contract
|
|
|
2,296 |
|
|
|
8,725 |
|
|
|
5,190 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
144,355 |
|
|
|
75,331 |
|
|
|
52,763 |
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Cost of product revenues
|
|
|
12,656 |
|
|
|
5,129 |
|
|
|
4,190 |
|
| |
Amortization of intangible assets
|
|
|
11,471 |
|
|
|
819 |
|
|
|
805 |
|
| |
Research and development
|
|
|
21,539 |
|
|
|
30,109 |
|
|
|
25,821 |
|
| |
Selling, general and administrative
|
|
|
73,206 |
|
|
|
41,781 |
|
|
|
36,819 |
|
| |
In-process research and development and milestone payments
|
|
|
3,500 |
|
|
|
— |
|
|
|
4,350 |
|
| |
Loss on program termination
|
|
|
— |
|
|
|
— |
|
|
|
312 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total operating costs and expenses
|
|
|
122,372 |
|
|
|
77,838 |
|
|
|
72,297 |
|
| |
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
21,983 |
|
|
|
(2,507 |
) |
|
|
(19,534 |
) |
|
Interest and other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Interest income
|
|
|
1,194 |
|
|
|
972 |
|
|
|
823 |
|
| |
Gain on sale of investment
|
|
|
— |
|
|
|
— |
|
|
|
2,086 |
|
| |
Interest expense
|
|
|
(2,778 |
) |
|
|
(1,632 |
) |
|
|
(11 |
) |
| |
Other income (expense), net
|
|
|
109 |
|
|
|
234 |
|
|
|
227 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Income (loss) before income taxes
|
|
|
20,508 |
|
|
|
(2,933 |
) |
|
|
(16,409 |
) |
| |
Income tax provision
|
|
|
1,493 |
|
|
|
1,167 |
|
|
|
181 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net income (loss)
|
|
$ |
19,015 |
|
|
$ |
(4,100 |
) |
|
$ |
(16,590 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic
|
|
$ |
0.54 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
| |
Diluted
|
|
$ |
0.51 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Shares used to compute basic and diluted net loss per share
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic
|
|
|
35,036 |
|
|
|
31,559 |
|
|
|
30,757 |
|
| |
Diluted
|
|
|
37,443 |
|
|
|
31,559 |
|
|
|
30,757 |
|
| |
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-5
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Number of | |
|
|
|
|
|
|
|
|
|
Accumulated | |
|
|
| |
|
Common | |
|
Common | |
|
Additional | |
|
Deferred | |
|
|
|
Other | |
|
Total | |
| |
|
Shares | |
|
Stock | |
|
Paid-in | |
|
Stock | |
|
Accumulated | |
|
Comprehensive | |
|
Stockholders’ | |
| |
|
Outstanding | |
|
Amount | |
|
Capital | |
|
Compensation | |
|
Deficit | |
|
Income | |
|
Equity | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Balance at December 31, 2001
|
|
|
30,257 |
|
|
$ |
30 |
|
|
$ |
164,270 |
|
|
$ |
(69 |
) |
|
$ |
(109,498 |
) |
|
$ |
6,621 |
|
|
$ |
61,354 |
|
|
Common stock issued under stock option and purchase plans
|
|
|
659 |
|
|
|
1 |
|
|
|
3,449 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3,450 |
|
|
Issuance of common stock pursuant to license agreements
|
|
|
1 |
|
|
|
— |
|
|
|
12 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
12 |
|
|
Exercise of warrants
|
|
|
263 |
|
|
|
— |
|
|
|
1,683 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,683 |
|
|
Stock compensation expense
|
|
|
— |
|
|
|
— |
|
|
|
355 |
|
|
|
21 |
|
|
|
— |
|
|
|
— |
|
|
|
376 |
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net loss
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(16,590 |
) |
|
|
— |
|
|
|
(16,590 |
) |
| |
Reclassification adjustment for realized gain on sale of equity
security
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(2,086 |
) |
|
|
(2,086 |
) |
| |
Unrealized gain on investments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(3,532 |
) |
|
|
(3,532 |
) |
| |
Foreign currency translation adjustment
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
76 |
|
|
|
76 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(22,132 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2002
|
|
|
31,180 |
|
|
|
31 |
|
|
|
169,769 |
|
|
|
(48 |
) |
|
|
(126,088 |
) |
|
|
1,079 |
|
|
|
44,743 |
|
|
Common stock issued under stock option and purchase plans
|
|
|
674 |
|
|
|
1 |
|
|
|
4,158 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
4,159 |
|
|
Exercise of warrants
|
|
|
31 |
|
|
|
— |
|
|
|
153 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
153 |
|
|
Stock compensation expense
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
17 |
|
|
|
— |
|
|
|
— |
|
|
|
17 |
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net loss
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,100 |
) |
|
|
— |
|
|
|
(4,100 |
) |
| |
Unrealized loss on investments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(167 |
) |
|
|
(167 |
) |
| |
Foreign currency translation adjustment
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
949 |
|
|
|
949 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,318 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-6
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’
EQUITY — Continued
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Number of | |
|
|
|
|
|
|
|
|
|
Accumulated | |
|
|
| |
|
Common | |
|
Common | |
|
Additional | |
|
Deferred | |
|
|
|
Other | |
|
Total | |
| |
|
Shares | |
|
Stock | |
|
Paid-in | |
|
Stock | |
|
Accumulated | |
|
Comprehensive | |
|
Stockholders’ | |
| |
|
Outstanding | |
|
Amount | |
|
Capital | |
|
Compensation | |
|
Deficit | |
|
Income | |
|
Equity | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Balance at December 31, 2003
|
|
|
31,885 |
|
|
|
32 |
|
|
|
174,080 |
|
|
|
(31 |
) |
|
|
(130,188 |
) |
|
|
1,861 |
|
|
|
45,754 |
|
|
Common stock issued under stock option and purchase plans
|
|
|
858 |
|
|
|
1 |
|
|
|
6,347 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,348 |
|
|
Tax benefit on stock options
|
|
|
— |
|
|
|
— |
|
|
|
213 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
213 |
|
|
Issuance of common stock through private placement
|
|
|
3,000 |
|
|
|
3 |
|
|
|
56,901 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
56,904 |
|
|
Exercise of warrants
|
|
|
50 |
|
|
|
— |
|
|
|
125 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
125 |
|
|
Stock compensation expense
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
18 |
|
|
|
— |
|
|
|
— |
|
|
|
18 |
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
19,015 |
|
|
|
— |
|
|
|
19,015 |
|
| |
Unrealized loss on investments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(583 |
) |
|
|
(583 |
) |
| |
Foreign currency translation adjustment
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
126 |
|
|
|
126 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,558 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
35,793 |
|
|
$ |
36 |
|
|
$ |
237,666 |
|
|
$ |
(13 |
) |
|
$ |
(111,173 |
) |
|
$ |
1,404 |
|
|
$ |
127,920 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-7
CONNETICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income (loss)
|
|
$ |
19,015 |
|
|
$ |
(4,100 |
) |
|
$ |
(16,590 |
) |
| |
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Depreciation
|
|
|
1,433 |
|
|
|
1,422 |
|
|
|
1,285 |
|
| |
|
Amortization of intangible assets
|
|
|
11,471 |
|
|
|
819 |
|
|
|
810 |
|
| |
|
Amortization of debt issuance costs
|
|
|
708 |
|
|
|
430 |
|
|
|
— |
|
| |
|
Allowances for discounts, returns, rebates and chargebacks
|
|
|
12,725 |
|
|
|
2,994 |
|
|
|
1,173 |
|
| |
|
Gain on sale of investment
|
|
|
— |
|
|
|
— |
|
|
|
(2,086 |
) |
| |
Stock compensation expense
|
|
|
18 |
|
|
|
17 |
|
|
|
388 |
|
| |
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Accounts receivable
|
|
|
(21,179 |
) |
|
|
(1,236 |
) |
|
|
(70 |
) |
| |
|
|
Inventory
|
|
|
(3,526 |
) |
|
|
(334 |
) |
|
|
29 |
|
| |
|
|
Other assets
|
|
|
(4,810 |
) |
|
|
(3,439 |
) |
|
|
(960 |
) |
| |
|
|
Accounts payable
|
|
|
10,740 |
|
|
|
(4,199 |
) |
|
|
4,119 |
|
| |
|
|
Accrued and other current liabilities
|
|
|
2,633 |
|
|
|
(146 |
) |
|
|
(3 |
) |
| |
|
|
Deferred revenue
|
|
|
89 |
|
|
|
(739 |
) |
|
|
(600 |
) |
| |
|
|
Other non-current liabilities
|
|
|
404 |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net cash provided by (used in) operating activities
|
|
|
29,721 |
|
|
|
(8,511 |
) |
|
|
(12,505 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Purchases of marketable securities
|
|
|
(62,472 |
) |
|
|
(135,352 |
) |
|
|
(32,573 |
) |
| |
Sales and maturities of marketable securities
|
|
|
104,483 |
|
|
|
62,909 |
|
|
|
47,335 |
|
| |
Purchases of property and equipment
|
|
|
(7,638 |
) |
|
|
(959 |
) |
|
|
(3,907 |
) |
| |
Acquisition of patent and product rights
|
|
|
(123,529 |
) |
|
|
(200 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net cash provided by (used in) investing activities
|
|
|
(89,156 |
) |
|
|
(73,602 |
) |
|
|
10,855 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Transfer from (to) restricted cash
|
|
|
(3,659 |
) |
|
|
420 |
|
|
|
1,415 |
|
| |
Proceeds from issuance of convertible senior notes, net of
issuance costs
|
|
|
— |
|
|
|
86,316 |
|
|
|
— |
|
| |
Proceeds from issuance of common stock in private placement, net
of issuance costs
|
|
|
56,901 |
|
|
|
— |
|
|
|
— |
|
| |
Proceeds from issuance of common stock from the exercise of
stock options and employee stock purchase plan, net of
repurchases of unvested shares
|
|
|
6,476 |
|
|
|
4,312 |
|
|
|
5,133 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net cash provided by financing activities
|
|
|
59,718 |
|
|
|
91,048 |
|
|
|
6,548 |
|
| |
Effect of foreign currency exchange rates on cash and cash
equivalents
|
|
|
32 |
|
|
|
387 |
|
|
|
123 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net change in cash and cash equivalents
|
|
|
315 |
|
|
|
9,322 |
|
|
|
5,021 |
|
| |
Cash and cash equivalents at beginning of year
|
|
|
17,946 |
|
|
|
8,624 |
|
|
|
3,603 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Cash and cash equivalents at end of year
|
|
$ |
18,261 |
|
|
$ |
17,946 |
|
|
$ |
8,624 |
|
| |
|
|
|
|
|
|
|
|
|
|
Supplementary information:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Interest paid
|
|
$ |
2,030 |
|
|
$ |
1,028 |
|
|
$ |
11 |
|
| |
Income taxes paid
|
|
$ |
1,061 |
|
|
$ |
1,541 |
|
|
$ |
654 |
|
| |
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004
|
|
| Note 1. |
Organization and Development of the Company |
Connetics Corporation, or Connetics, was incorporated in the
State of Delaware on February 8, 1993. Connetics is a
specialty pharmaceutical company focusing exclusively on the
treatment of dermatological conditions. We currently market four
pharmaceutical products in the United States, OLUX®
(clobetasol propionate) Foam, 0.05%,
Luxíq®(betamethasone valerate) Foam, 0.12%,
Soriatane® (acitretin) capsules, and
Evoclintm
(clindamycin) Foam, 1%. We acquired exclusive
U.S. rights to Soriatane effective March 4, 2004 (see
Note 4). We also have several product candidates under
development. Our commercial business is focused on the
dermatology marketplace, which is characterized by a large
patient population that is served by a relatively small number
of treating physicians. We cannot assure you that any of our
other potential products will be successfully developed, receive
the necessary regulatory approvals, or be successfully
commercialized.
|
|
| Note 2. |
Summary of Significant Accounting Policies |
|
|
|
Principles of Consolidation |
The accompanying consolidated financial statements include the
accounts of Connetics, as well as its subsidiaries, Connetics
Holdings Pty Ltd. and Connetics Australia Pty Ltd. We have
eliminated all intercompany accounts and transactions in
consolidation. We reclassified certain amounts in our prior year
consolidated balance sheets, consolidated statements of
operations and consolidated statements of cash flows to conform
to the current period presentation. On the consolidated balance
sheets, inventory was reclassified from prepaid and other
current assets and shown separately for the year ended
December 31, 2003. On the consolidated statements of
operations, amortization of intangible assets was reclassified
from selling, general and administrative expense and shown
separately for the years ended December 31, 2003 and 2002.
On the consolidated statements of cash flows, the amortization
of debt issuance costs and amortization of intangible assets,
which had been combined, were shown separately for the year
ended December 31, 2003, and inventory was reclassified
from other assets and shown separately for the years ended
December 31, 2003 and 2002.
To prepare financial statements in conformity with accounting
principles generally accepted in the United States, management
must make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes.
Future events could cause our actual results to differ.
We evaluate our estimates on an on-going basis. In particular,
we regularly evaluate estimates related to recoverability of
accounts receivable and inventory, revenue reserves, assumed
liabilities related to acquired product rights and accrued
liabilities for clinical trial activities and indirect
promotional expenses. We base our estimates on historical
experience and on various other specific assumptions that we
believe to be reasonable under the circumstances. Those
estimates and assumptions form the basis for making judgments
about the carrying value of assets and liabilities that are not
readily apparent from other sources.
Product Revenues. We recognize revenue from product sales
when there is persuasive evidence that an arrangement exists,
when title has passed, the price is fixed or determinable, and
we are reasonably assured of collecting the resulting
receivable. We recognize product revenues net of revenue
reserves which consist of allowances for discounts, returns,
rebates, and chargebacks. We accept from customers the return of
pharmaceuticals that are within six months before their
expiration date. We authorize returns for damaged products and
exchanges for expired products in accordance with our return
goods policy and
F-9
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
procedures, and we establish reserves for such amounts at the
time of sale. To date we have not experienced significant
returns of damaged or expired product. We include product
shipping and handling costs in the cost of product revenues. We
also recognize revenue net of fees paid to wholesalers under
distribution service agreements in exchange for certain product
distribution, inventory, information, return goods processing,
and administrative services. We record accounts receivable net
of allowances for discounts, returns, rebates and chargebacks.
During the first half of 2004, we made a decision to bring in
house the function of Contract Administration responsibility for
the calculation and related reporting of all allowances and
discounts for which Managed care plans and Medicaid programs are
eligible. Previously we utilized third parties to perform the
allowance calculation and related reporting. In connection with
this change we performed a comprehensive review of our
calculation for Medicaid product pricing allowances, which
resulted in an adjustment to reserves recorded in prior periods.
As a result, we recorded a one-time reduction of product
revenues in the amount of $564,000 in the second quarter of
2004. We have determined that the effect of this change in
estimate would not have had a material impact on our previously
issued financial statements.
Royalty Revenues. We collect royalties from our
third-party licensees based on their sales. We recognize
royalties either in the quarter in which we receive the royalty
payment from the licensee or in which we can reasonably estimate
the royalty, which is typically one quarter following the
related sale by the licensee.
Contract Revenues. We record contract revenue for
research and development, or R&D, and milestone payments as
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 date we receive the payments or
the date when collection is assured, whichever is earlier.
If, at the time an agreement is executed, there remains
significant risk due to the incomplete state of the
product’s development, we recognize revenue from
non-refundable upfront license fees ratably over the period in
which we have continuing development obligations. We recognize
revenue associated with substantial “at risk”
performance milestones, as defined in the respective agreements,
based upon the achievement of the milestones. When we receive
advance payments in excess of amounts earned, we classify them
as deferred revenue until they are earned.
|
|
|
Cash Equivalents and Marketable Securities |
Cash and cash equivalents consist of cash on deposit with banks,
money market and other debt instruments with original maturities
of 90 days or less. Investments with maturities beyond
90 days are included in marketable securities. We classify
marketable securities as available for sale at the time of
purchase and we carry them at fair value. We report unrealized
gains and losses on marketable securities as a component of
other comprehensive income (loss) in stockholders’ equity.
We use the specific identification method to determine the cost
of securities sold.
Cash, cash equivalents and marketable securities are financial
instruments that potentially subject us to concentration of risk
to the extent we record them on our balance sheet. We believe we
have established guidelines for investing our excess cash in a
way that will maintain safety and liquidity with respect to
diversification and maturities. We invest our excess cash in
debt instruments of the U.S. Government and its agencies,
and high-quality corporate issuers. By policy, we restrict our
exposure to any single corporate issuer by imposing
concentration limits. To minimize the exposure due to adverse
shifts in interest rates, we maintain investments at an average
maturity of generally less than one year.
F-10
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Restricted cash reflects certificates of deposit used to secure
letter of credit arrangements. Restricted cash–current
includes deposits of $1.0 million as required by our
insurance policy and restricted cash — long term
includes deposits of $3.0 million as required by two office
facility leases and two vehicle fleet services leases.
Connetics Australia’s functional currency is the Australian
dollar. We translate Connetics Australia’s local currency
balance sheet into U.S. dollars using the exchange rates in
effect at the balance sheet date. For revenue and expense
accounts, we use a weighted average exchange rate during the
period. We record foreign currency translation adjustments in
other comprehensive income (loss). Net gains and losses that
result from foreign exchange transactions are included in the
consolidated statements of operations and were immaterial for
all periods presented.
We account for income taxes using the asset and liability
method. Under this method, we recognize deferred tax assets and
liabilities for the future tax consequences attributable to
differences between (1) the financial statement carrying
amounts of existing assets and liabilities and their respective
tax bases, and (2) operating loss and tax credit
carryforwards. We measure deferred tax assets and liabilities
using enacted tax rates that are expected to apply to taxable
income in the years in which we anticipate those temporary
differences will be recovered or settled. When the timing of the
realization is uncertain, we establish a valuation allowance for
the net deferred tax assets. Historically, our income tax
provision related primarily to the operations of our Australian
subsidiary. In 2004, however, the income tax provision is
primarily related to the profitability of our domestic
operations.
We state property and equipment at cost less accumulated
depreciation. We calculate depreciation using the straight-line
method over the estimated useful lives of the assets, generally
three to five years. We are depreciating equipment we have
purchased on behalf of our contract manufacturer using the units
of production method based on contractual minimum quantities to
be produced over the term of the agreement. We amortize
leasehold improvements over the shorter of the estimated useful
lives of the assets or the lease term.
Inventory consists primarily of finished goods. We state
inventory at the lower of cost (determined on a first-in
first-out method) or market.
Before January 1, 2004, inventory and cost of goods sold
only captured third party product manufacturing costs,
depreciation on Connetics-owned equipment at our third-party
manufacturers, product freight and distribution costs from the
third party that handles all of our product distribution
activities and royalties. Effective January 1, 2004, we
began including certain manufacturing support and quality
assurance costs in the cost of finished goods inventory and
samples inventory which had previously been classified as
research and development expense. Those activities include
overseeing third party manufacturing, process development,
quality assurance and quality control activities. We have
determined that the effect of this change in accounting would
not have had a material impact on our financial statements in
any prior quarterly or annual period. For the year ended
December 31, 2004, we allocated $4.6 million of costs
which in previous years would have been included in R&D
expense as follows: (1) $1.1 million to cost of goods
sold; (2) $1.0 million to selling expense;
(3) $2.1 million to the value of
F-11
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
commercial inventory; and, (4) $324,000 to the value of
samples inventory, which is a component of prepaid expenses.
|
|
|
Goodwill and Other Intangible Assets |
We have in the past made acquisitions of products and businesses
that include goodwill, license agreements, product rights, and
other identifiable intangible assets. We assess goodwill for
impairment in accordance with Statement of Financial Accounting
Standards No. 142, “Goodwill and other Intangible
Assets”, or SFAS 142, which requires that goodwill
be tested for impairment at the “reporting unit level”
(“reporting unit”) at least annually and more
frequently upon the occurrence of certain events, as defined by
SFAS 142. We have determined that there is only one
reporting unit, specifically the sale of specialty
pharmaceutical products for dermatological diseases. We test
goodwill for impairment in the annual impairment test on
October 1 using the two-step process required by
SFAS 142. First, we review the carrying amount of the
reporting unit compared to the “fair value” of the
reporting unit based on quoted market prices of our common stock
and, if necessary, the cash flows based on analyses prepared by
management. An excess carrying value compared to fair value
would indicate that goodwill may be impaired. Second, if we
determine that goodwill may be impaired, then we compare the
“implied fair value” of the goodwill, as defined by
SFAS 142, to its carrying amount to determine the
impairment loss, if any. Based on these estimates, we determined
that as of October 1, 2004 there was no impairment of
goodwill. Since October 1, 2004, there have been no
indications of impairment and the next annual impairment test
will occur as of October 1, 2005.
In accordance with Statement of Financial Accounting Standards
No. 144, “Accounting for Impairment or Disposal of
Long-Lived Assets,” or SFAS 144, we evaluate
purchased intangibles and other long-lived assets, other than
goodwill, for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may
not be recoverable based on expected undiscounted cash flows
attributable to that asset. The amount of any impairment is
measured as the difference between the carrying value and the
fair value of the impaired asset. We have not recorded any
impairment charges for long-lived intangible assets for the
three years ended December 31, 2004.
Fair Value of Financial Instruments
The fair value of our cash equivalents and marketable securities
is based on quoted market prices. The carrying amount of cash
equivalents and marketable securities are equal to their
respective fair values at December 31, 2004 and 2003.
Other financial instruments, including accounts receivable,
accounts payable and accrued liabilities, are carried at cost,
which we believe approximates fair value because of the
short-term maturity of these instruments. The fair value of our
convertible subordinated debt was $113.3 million at
December 31, 2004, which we determined using available
market information.
Research and Development
Research and development expenses include related salaries and
benefits, laboratory supplies, external research programs,
clinical studies and allocated overhead costs such as rent,
supplies and utilities. All such costs are charged to research
and development expense as incurred. Beginning in 2004, certain
costs related to internal manufacturing support and quality
assurance are allocated to commercial and samples and inventory.
Certain Concentrations
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
F-12
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
high-quality financial institutions. We perform credit
evaluations of our customers’ financial condition and limit
the amount of credit extended when necessary, but generally we
do not require collateral on accounts receivable.
We contract with independent sources to manufacture our
products. We currently rely on three vendors to manufacture our
products. If these manufacturers are unable to fulfill our
supply requirements, our future results could be negatively
impacted.
We promote our products to dermatologists, but we sell our
products primarily to wholesalers and retail chain drug stores,
and our product revenues and trade accounts receivable are
concentrated with a few customers. In December 2004 we entered
into a distribution agreement with each of Cardinal Health, Inc.
and McKesson Corporation under which we agreed to pay a fee to
each of these distributors in exchange for certain product
distribution, inventory management, return goods processing, and
administrative services. The following tables detail our
customer concentrations in gross product sales and trade
accounts receivable that are greater than 10% of the relative
total, for each of the years ended December 31, 2004, 2003
and 2002.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Percentage of Product | |
| |
|
Revenues Years Ended | |
| |
|
December 31, | |
| |
|
| |
| Customer |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
McKesson
|
|
|
29 |
% |
|
|
30 |
% |
|
|
26 |
% |
|
Cardinal Health
|
|
|
27 |
% |
|
|
36 |
% |
|
|
43 |
% |
|
AmerisourceBergen
|
|
|
16 |
% |
|
|
15 |
% |
|
|
23 |
% |
|
Walgreens
|
|
|
* |
|
|
|
11 |
% |
|
|
* |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Percentage of | |
| |
|
Outstanding Accounts | |
| |
|
Receivable as of | |
| |
|
December 31, | |
| |
|
| |
| Customer |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
McKesson
|
|
|
36 |
% |
|
|
28 |
% |
|
|
6 |
% |
|
Cardinal Health
|
|
|
21 |
% |
|
|
36 |
% |
|
|
54 |
% |
|
AmerisourceBergen
|
|
|
22 |
% |
|
|
17 |
% |
|
|
37 |
% |
|
Walgreens
|
|
|
15 |
% |
|
|
* |
|
|
|
* |
|
Comprehensive Income (Loss)
Comprehensive income (loss) represents net income (loss),
unrealized gains (losses) on our available-for-sale securities,
and foreign currency translation adjustments, all net of taxes.
Accumulated other comprehensive income included $276,000 of net
unrealized gains on investments and $1.1 million of foreign
currency translation adjustments as of December 31, 2004
and $859,000 of net unrealized gains on investments and
$1.0 million of foreign currency translation adjustments as
of December 31, 2003. Comprehensive income (loss) is
disclosed in the Consolidated Statement of Stockholders’
Equity.
Advertising
We expense advertising costs as we incur them. Advertising costs
were $2.1 million, $380,000 and $362,000 in the years ended
December 31, 2004, 2003 and 2002, respectively.
F-13
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Stock-Based Compensation
At December 31, 2004, we had six stock-based compensation
plans, which are more fully described in Note 11. We use
the intrinsic-value method of accounting for stock-based awards
granted to employees, as allowed under Accounting Principles
Board Opinion No. 25, “Accounting for Stock Issued to
Employees”, or APB 25, and related interpretations.
Accordingly, we do not recognize any compensation in our
financial statements in connection with stock options granted to
employees when those options have exercise prices equal to or
greater than fair market value of our common stock on the date
of grant. We also do not record any compensation expense in
connection with our Employee Stock Purchase Plan as long as the
purchase price is not less than 85% of the fair market value at
the beginning or end of each offering period, whichever is lower.
For options granted to non-employees, we have recorded
compensation expense in accordance with SFAS No. 123
“Accounting for Stock-Based Compensation,” or
SFAS 123, as amended, and Emerging Issues Task Force
No. 96-18, “Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling Goods or Services.” By those criteria, we
quantify compensation expense as the fair value of the
consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured.
Although SFAS 123 allows us to continue to follow the
APB 25 guidelines, we are required to disclose pro forma
net income (loss) and basic and diluted income (loss) per
share as if we had applied the fair value based method to all
awards. Because the estimated value is determined as of the date
of grant, the actual value ultimately realized by the employee
may be significantly different.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands except per share | |
| |
|
amounts): | |
|
Net income (loss), as reported
|
|
$ |
19,015 |
|
|
$ |
(4,100 |
) |
|
$ |
(16,590 |
) |
|
Add: stock-based employee compensation expense, net of tax
|
|
|
17 |
|
|
|
17 |
|
|
|
21 |
|
|
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of
tax
|
|
|
(11,355 |
) |
|
|
(9,834 |
) |
|
|
(4,535 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Pro forma net income (loss)
|
|
$ |
7,677 |
|
|
$ |
(13,917 |
) |
|
$ |
(21,104 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Net income (loss per) share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic — as reported
|
|
$ |
0.54 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
Diluted — as reported
|
|
$ |
0.51 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
|
Basic — pro forma
|
|
$ |
0.22 |
|
|
$ |
(0.44 |
) |
|
$ |
(0.69 |
) |
|
Diluted — pro forma
|
|
$ |
0.21 |
|
|
$ |
(0.44 |
) |
|
$ |
(0.69 |
) |
| |
|
|
|
|
|
|
|
|
|
For purposes of this analysis, we estimate the fair value of
each option on the date of grant using the Black-Scholes
option-pricing model. The weighted average assumptions used in
the model were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Stock Option Plans | |
|
Stock Purchase Plan | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Expected stock volatility
|
|
|
57.2 |
% |
|
|
60.6 |
% |
|
|
65.3 |
% |
|
|
54.7 |
% |
|
|
57.5 |
% |
|
|
77.3 |
% |
|
Risk-free interest rate
|
|
|
3.2 |
% |
|
|
4.1 |
% |
|
|
4.6 |
% |
|
|
1.1 |
% |
|
|
4.4 |
% |
|
|
5.6 |
% |
|
Expected life (in years)
|
|
|
3.4 |
|
|
|
3.2 |
|
|
|
3.5 |
|
|
|
1.5 |
|
|
|
1.4 |
|
|
|
1.3 |
|
|
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. This model also
requires us to make
F-14
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
highly subjective assumptions, including the expected volatility
of our stock. 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, we do not believe
that the existing models necessarily provide a reliable single
measure of the fair value of our options. The weighted average
fair value of options granted, determined using the
Black-Scholes model, was $8.64, $5.83 and $5.74 in the years
ended December 31, 2004, 2003 and 2002, respectively.
The effects on pro forma disclosures of applying
SFAS 123 are not likely to be representative of the effects
on reported results of future years.
|
|
|
Net Income (Loss) Per Share |
We compute basic net income (loss) per common share by dividing
net income (loss) by the weighted average number of common
shares outstanding during the period. We compute diluted net
income (loss) per share using the weighted average of all
potential shares of common stock outstanding during the period.
We included all stock options and warrants in the calculation of
diluted loss per common share for the year ended
December 31, 2004, but excluded them for the years ended
December 31, 2003 and 2002 because these securities were
anti-dilutive in those years. We excluded convertible debt for
the years ended December 31, 2003 and 2004 because its
effect is also anti-dilutive.
The calculation of basic and diluted net income (loss) per share
is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands except per share | |
| |
|
amounts): | |
|
Net income (loss)
|
|
$ |
19,015 |
|
|
$ |
(4,100 |
) |
|
$ |
(16,590 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic common shares
|
|
|
35,036 |
|
|
|
31,559 |
|
|
|
30,757 |
|
| |
Effect of dilutive options
|
|
|
2,383 |
|
|
|
— |
|
|
|
— |
|
| |
Effect of dilutive warrants
|
|
|
24 |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
Total weighted average diluted common shares
|
|
|
37,443 |
|
|
|
31,559 |
|
|
|
30,757 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic
|
|
$ |
0.54 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
| |
Diluted
|
|
$ |
0.51 |
|
|
$ |
(0.13 |
) |
|
$ |
(0.54 |
) |
| |
|
|
|
|
|
|
|
|
|
Warrants, options and convertible debt excluded from the
calculation of diluted net income (loss) per share are as
follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Warrants
|
|
|
— |
|
|
|
59,177 |
|
|
|
90,427 |
|
|
Options
|
|
|
262,750 |
|
|
|
5,986,257 |
|
|
|
4,883,966 |
|
|
Convertible Debt
|
|
|
4,203,450 |
|
|
|
4,203,450 |
|
|
|
— |
|
|
|
|
Disclosure about Segments of an Enterprise and Related
Information |
SFAS No. 131, “Disclosures About Segments of an
Enterprise and Related Information,” requires us to
identify the segment or segments we operate in. Based on the
standards set forth in SFAS 131, we operate in one segment:
the development and commercialization of specialty
pharmaceuticals in the field of dermatology. For each of the
years ended December 31, 2004 and 2003, approximately 99%
of our total
F-15
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
revenues were derived from customers in the United States. For
the year ended December 31, 2002, approximately 98% of our
total revenues were derived from customers in the United States.
We do not have a material amount of long-lived assets outside of
the United States.
|
|
|
Recent Accounting Pronouncements |
In December 2004, the FASB issued SFAS No. 123
(revised 2004), “Share-Based Payment,” or
SFAS 123R, which requires companies to measure and
recognize compensation expense for all stock-based payments at
fair value. Stock-based payments include grants of employee
stock options. SFAS 123R replaces SFAS No. 123,
“Accounting for Stock-Based Compensation,” or
SFAS 123, and supersedes APB Opinion No. 25,
“Accounting for Stock Issued to Employees.”
SFAS 123R requires companies to recognize all stock-based
payments to employees in the financial statements based on their
fair values. SFAS 123R is effective for all interim or
annual periods beginning after June 15, 2005. The pro forma
disclosures previously permitted under SFAS 123 will no
longer be an alternative to financial statement recognition. We
are required to adopt SFAS 123R in our third quarter of
fiscal 2005, beginning July 1, 2005. Under SFAS 123R,
we must determine the appropriate fair value model to be used
for valuing share-based payments, the amortization method for
compensation cost and the transition method to be used at date
of adoption. The transition methods include prospective and
retroactive adoption options. Under the retroactive options, we
may restate prior periods either as of the beginning of the year
of adoption or for all periods presented. The prospective method
requires that we record compensation expense for all unvested
stock options and restricted stock at the beginning of the first
quarter of adoption of SFAS 123R, while the retroactive
methods would record compensation expense for all unvested stock
options and restricted stock beginning with the first period
restated. We are evaluating the requirements of SFAS 123R
and we expect that the adoption of SFAS 123R will have a
material impact on our consolidated results of operations and
earnings per share. We have not yet determined the method of
adoption or the effect of adopting SFAS 123R, and we have
not determined whether the adoption will result in amounts that
are similar to the current pro forma disclosures under
SFAS 123.
|
|
| Note 3. |
Cash Equivalents and Marketable Securities |
The following tables summarize our available-for-sale
investments (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, 2004 | |
| |
|
| |
| |
|
|
|
Gross | |
|
Gross | |
|
|
| |
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Estimated | |
| |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Corporate debt
|
|
$ |
32,971 |
|
|
$ |
3 |
|
|
$ |
(72 |
) |
|
$ |
32,902 |
|
|
Government securities
|
|
|
13,318 |
|
|
|
— |
|
|
|
(23 |
) |
|
|
13,295 |
|
|
Asset backed securities
|
|
|
7,268 |
|
|
|
1 |
|
|
|
(24 |
) |
|
|
7,245 |
|
|
Equity securities
|
|
|
289 |
|
|
|
391 |
|
|
|
— |
|
|
|
680 |
|
|
Money market funds
|
|
|
1,114 |
|
|
|
— |
|
|
|
— |
|
|
|
1,114 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
|
54,960 |
|
|
|
395 |
|
|
|
(119 |
) |
|
|
55,236 |
|
|
Less amount classified as cash equivalents
|
|
|
(1,114 |
) |
|
|
|
|
|
|
|
|
|
|
(1,114 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total marketable securities
|
|
$ |
53,846 |
|
|
$ |
395 |
|
|
$ |
(119 |
) |
|
$ |
54,122 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
F-16
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, 2003 | |
| |
|
| |
| |
|
|
|
Gross | |
|
Gross | |
|
|
| |
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Estimated | |
| |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Corporate debt
|
|
$ |
53,165 |
|
|
$ |
17 |
|
|
$ |
(41 |
) |
|
$ |
53,141 |
|
|
Government securities
|
|
|
35,387 |
|
|
|
7 |
|
|
|
(11 |
) |
|
|
35,383 |
|
|
Asset backed securities
|
|
|
7,016 |
|
|
|
7 |
|
|
|
(2 |
) |
|
|
7,021 |
|
|
Equity securities
|
|
|
289 |
|
|
|
882 |
|
|
|
— |
|
|
|
1,171 |
|
|
Money market funds
|
|
|
12,894 |
|
|
|
— |
|
|
|
— |
|
|
|
12,894 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
|
108,751 |
|
|
|
913 |
|
|
|
(54 |
) |
|
|
109,610 |
|
|
Less amount classified as cash equivalents
|
|
|
(12,894 |
) |
|
|
|
|
|
|
|
|
|
|
(12,894 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total marketable securities
|
|
$ |
95,857 |
|
|
$ |
913 |
|
|
$ |
(54 |
) |
|
$ |
96,716 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the amortized cost of the
estimated fair value of available-for-sale debt securities at
December 31, by contract maturity (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
Amortized | |
|
Estimated | |
|
Amortized | |
|
Estimated | |
| |
|
Cost | |
|
Fair Value | |
|
Cost | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Mature in less than one year
|
|
$ |
21,076 |
|
|
$ |
21,013 |
|
|
$ |
50,550 |
|
|
$ |
50,971 |
|
|
Mature in one to three years
|
|
|
19,264 |
|
|
|
19,221 |
|
|
|
20,590 |
|
|
|
20,746 |
|
|
Mature in over three years
|
|
|
13,217 |
|
|
|
13,208 |
|
|
|
23,797 |
|
|
|
23,828 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
$ |
53,557 |
|
|
$ |
53,442 |
|
|
$ |
94,937 |
|
|
$ |
95,545 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
The table above also includes amounts related to asset-backed
and mortgage-backed securities that are allocated between
maturity groupings based on their final maturities. The gross
realized gains and losses on sales of available-for-sale
investments were immaterial for all periods presented except for
2002 in which we recognized a gain of $2.1 million related
to the sale of an equity security we had been holding.
We monitor our investment portfolio for impairment on a periodic
basis in accordance with Emerging Issues Task Force Issue
No. 03-1. In the event that the carrying value of an
investment exceeds its fair value and the decline in value is
determined to be other-than-temporary, an impairment charge is
recorded and a new cost basis for the investment is established.
In order to determine whether a decline in value is
other-than-temporary, we evaluate, among other factors: the
duration and extent to which the fair value has been less than
the carrying value; our financial condition and business
outlook, including key operational and cash flow metrics,
current market conditions and future trends in the our industry;
our relative competitive position within the industry; and our
intent and ability to retain the investment for a period of time
sufficient to allow for any anticipated recovery in fair value.
The decline in value of these investments, shown in the table
above as “Gross Unrealized Losses”, is primarily
related to changes in interest rates and is considered to be
temporary in nature.
|
|
| Note 4. |
Soriatane® Product Line Acquisition and
Distribution Agreement |
On February 6, 2004, we entered into a binding agreement
with Hoffmann-La Roche Inc., or Roche, to acquire exclusive
U.S. rights to Soriatane-brand acitretin, an approved oral
therapy for the treatment of severe psoriasis in adults. The
transaction closed on March 4, 2004, and we have recognized
revenue, net of applicable reserves, for all sales of the
product from that date. Under the terms of the purchase
agreement, we paid Roche a total of $123.0 million in cash
at the closing to acquire Soriatane. We also assumed certain
liabilities in connection with returns, rebates and chargebacks
associated with prior sales of Soriatane by Roche totaling
$4.1 million, and purchased Roche’s existing inventory
of Soriatane at a
F-17
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
cost of approximately $1.5 million. In addition, we
incurred transaction costs of $529,000 during the second quarter
of 2004. Including the cash paid to acquire the rights,
liabilities assumed and transactions costs, the total value of
the acquired product rights for accounting purposes is
$127.7 million. We are amortizing this amount over the
ten-year estimated useful life of the Soriatane asset. As of
December 31, 2004, the balance of the returns, rebates, and
chargebacks reserve assumed at acquisition was $2.1 million.
In July 2004, we entered into a multi-year consent with Roche to
sell Soriatane to a U.S.-based distributor that exports branded
pharmaceutical products to select international markets. Product
sold to this distributor is not permitted to be resold in the
U.S. Under the terms of the agreement, we will pay a
royalty to Roche on Soriatane sales made during the term of the
agreement to this distributor.
|
|
| Note 5. |
Yamanouchi License Agreement |
In 2002, we entered into an agreement with Yamanouchi Europe
B.V. to license Velac (a first in class combination of 1%
clindamycin, and 0.025% tretinoin). We have licensed exclusive
rights to develop and commercialize the product in the U.S. and
Canada, and have licensed non-exclusive rights in Mexico. Under
the terms of the agreement, we paid Yamanouchi an initial
$2.0 million licensing fee and an additional
$2.0 million when we reached a milestone by initiating a
Phase III trial for Velac, both paid and recorded in 2002.
In August 2004, we reached a third milestone when we submitted a
New Drug Application (NDA) for Velac with the Food and Drug
Administration (FDA) and received notification that the FDA
had accepted the NDA for filing. We recorded a $3.5 million
milestone payment due to the licensor upon the filing of the
NDA. All payments were recorded as in-process research and
development and milestone expense as the product has not yet
been approved and has no alternative future use.
|
|
| Note 6. |
Royalty-Bearing Agreements |
Pfizer License Agreement
In December 2001, we entered into an agreement granting
Pharmacia Corporation (now Pfizer) exclusive global rights,
excluding Japan, to our proprietary foam drug-delivery
technology for use with Pfizer’s Rogaine® hair loss
treatment. Under the agreement, Pfizer paid us an initial
licensing fee, and agreed to pay us additional amounts when it
achieves specified milestones, plus a royalty on product sales.
We recognized $1.0 million under the agreement related to
license fees, milestone payments and contract revenue through
December 31, 2002. Our obligation to incur development
expenses in connection with the agreement ended in 2002. We
provided additional development support to Pfizer at their
request in 2004 and 2003 and we recognized $11,000 and $86,000,
respectively, in related fees.
Other
Licenses for Foam Technology
We have entered into a number of agreements for our foam drug
delivery technology. We have licensed the technology to
betamethasone valerate foam to Celltech Group plc in Europe, and
Celltech has licensed the worldwide rights to their patent on
the technology to us. We pay Celltech royalties on all sales
worldwide of foam formulations containing steroids. Celltech
markets their product as Bettamousse (the product equivalent of
Luxíq). We also have license agreements with Bayer (in the
U.S.) and Pfizer and Mipharm (internationally) for the use
of pyrethrin foam for head lice. That product is marketed in the
U.S. as RID®, as Banlice® in Australia, and as
Milice® in Italy. We receive royalties on sales of those
products.
For the years ended December 31, 2004, 2003 and 2002, we
recorded royalty revenues of $244,000, $267,000, and $305,000,
respectively, for our foam-based technology. We have also
entered into development agreements with other companies to
develop the foam for specific indications.
F-18
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Licenses
for Liquipatch Technology
In June 2001, we entered into a global licensing agreement with
Novartis Consumer Health SA for the Liquipatch drug-delivery
system for use in topical antifungal applications. The agreement
gives Novartis the exclusive, worldwide rights to use the
Liquipatch technology in the topical antifungal field. In March
2002, Novartis paid us $580,000 to exercise its then-existing
option to expand the license agreement. Novartis will be
responsible for all development costs, and will be obligated to
pay license fees, milestone payments and royalties on future
product sales. In 2004, we received a milestone payment from
Novartis of $81,000.
S.C.
Johnson License Agreement
We have licensed to S.C. Johnson & Son, Inc. the rights
to a super-concentrated aerosol spray that is marketed in the
U.S. and internationally. In 2002 and 2003, we received
$2.4 million and $7.0 million, respectively, in
royalties in connection with this agreement, which included a
one-time royalty payment of $2.9 million in 2003. On
January 5, 2004, we reached an agreement with S.C. Johnson
to terminate the license agreement. We received an additional
$1.2 million under the agreement in 2004, after which S.C.
Johnson had a fully paid-up, royalty-free license to the
technology.
InterMune
We have an agreement with InterMune, Inc. pursuant to which we
receive royalties for sales of Actimmune. In addition, we have
retained the product rights to Actimmune for certain potential
dermatological applications. For the years ended
December 31, 2004, 2003 and 2002, we received $330,000,
$358,000 and $172,000, respectively, for our foam-based
technology. We recorded gains on the sale of InterMune stock
totaling $2.1 million in 2002. We did not sell any
InterMune stock in 2004 or 2003. As of December 31, 2004,
we owned 50,000 shares of common stock of InterMune.
Relaxin Agreement
On July 15, 2003, we assigned our rights to recombinant
human relaxin to BAS Medical, Inc. (BAS Medical), a private,
development-stage company focused on the development and
marketing of novel medical treatments. As part of the
transaction, we may receive up to $1.0 million in licensing
and milestone fees, plus royalties on future product sales. Upon
the execution of the definitive agreement, we received a
$100,000 upfront assignment fee that we recognized as license
revenue in the third quarter of 2003. We will receive the
remaining $900,000 if BAS Medical achieves various milestones.
BAS Medical assumed the rights to develop and commercialize
relaxin for all indications of use. All of our obligations under
existing contracts related to relaxin, including those with
Paladin Labs, Inc., and F.H. Faulding & Co. Ltd., were
also transferred to BAS Medical as part of this transaction, and
as a result, in the third quarter of 2003, we recognized
$661,000 in deferred revenue relating to previous relaxin
license agreements.
|
|
| Note 7. |
UCB Pharma Agreement |
In March 2004, we entered into an agreement with UCB Pharma, or
UCB, a subsidiary of UCB Group, pursuant to which we authorized
UCB to promote OLUX and Luxíq to a segment of
U.S. primary care physicians, or(PCP’s. In July 2004,
UCB acquired Celltech plc, and in connection with the other
post-acquisition changes, UCB notified us that it intended to
discontinue the co-promotion agreement effective March 31,
2005. UCB will continue to promote OLUX and Luxíq until
then. Through the end of the promotion period, UCB’s focus
will be on the approximately 10% of PCP’s who are active
prescribers of dermatology products, including OLUX and
Luxíq. The purpose of the co-promotion agreement is ensure
appropriate use of OLUX and Luxíq with the current PCP
users and to build value for the OLUX and Luxíq brands.
F-19
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
We record 100% of the revenue from sales generated by
promotional efforts of UCB and pay UCB a portion of revenue as a
promotion expense, which is included in selling, general and
administrative expense. UCB bears the marketing costs for
promoting the products (including product samples, marketing
materials, etc.). We will not have any financial obligation to
UCB on prescriptions generated by PCP’s after
March 31, 2005.
|
|
| Note 8. |
Property and Equipment |
Property and equipment consist of the following (in
thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Laboratory and manufacturing equipment
|
|
$ |
5,952 |
|
|
$ |
5,073 |
|
|
Leasehold improvements
|
|
|
7,705 |
|
|
|
2,982 |
|
|
Computer equipment
|
|
|
2,324 |
|
|
|
2,250 |
|
|
Furniture, fixtures and office equipment
|
|
|
1,333 |
|
|
|
1,284 |
|
|
Land, building and building improvements
|
|
|
785 |
|
|
|
736 |
|
| |
|
|
|
|
|
|
| |
Total
|
|
|
18,099 |
|
|
|
12,325 |
|
|
Less accumulated depreciation and amortization
|
|
|
(6,269 |
) |
|
|
(6,697 |
) |
| |
|
|
|
|
|
|
|
Property and equipment, net
|
|
$ |
11,830 |
|
|
$ |
5,628 |
|
| |
|
|
|
|
|
|
Depreciation expense for the years ended December 31, 2004,
2003 and 2002 was $1.4 million, $1.4 million, and
$1.3 million, respectively.
|
|
| Note 9. |
Goodwill and Other Intangible Assets |
There was no change in the carrying amount of goodwill for the
years ended December 31, 2004 and 2003. The components of
our other intangible assets at December 31 are as follows
(in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
December 31, 2004 | |
|
December 31,2003 | |
| |
|
|
|
| |
|
| |
| |
|
Useful Life | |
|
Gross Carrying | |
|
Accumulated | |
|
|
|
Gross Carrying | |
|
Accumulated | |
|
|
| |
|
in Years | |
|
Amount | |
|
Amortization | |
|
Net | |
|
Amount | |
|
Amortization | |
|
Net | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Acquired product rights
|
|
|
10 |
|
|
$ |
127,652 |
|
|
$ |
(10,638 |
) |
|
$ |
117,014 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
Existing technology
|
|
|
10 |
|
|
|
6,810 |
|
|
|
(2,525 |
) |
|
|
4,285 |
|
|
|
6,810 |
|
|
|
(1,844 |
) |
|
|
4,966 |
|
|
Patents
|
|
|
10-13 |
|
|
|
1,661 |
|
|
|
(572 |
) |
|
|
1,089 |
|
|
|
1,590 |
|
|
|
(350 |
) |
|
|
1,240 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
$ |
136,123 |
|
|
$ |
(13,735 |
) |
|
$ |
122,388 |
|
|
$ |
8,400 |
|
|
$ |
(2,194 |
) |
|
$ |
6,206 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization expense for our other intangible assets was
$11.5 million, $819,000 and $810,000 for the years ended
December 31, 2004, 2003 and 2002, respectively.
The expected future amortization expense of our other intangible
assets is as follows (in thousands):
| |
|
|
|
|
|
For the year ending December 31, 2005
|
|
$ |
13,598 |
|
|
For the year ending December 31, 2006
|
|
|
13,598 |
|
|
For the year ending December 31, 2007
|
|
|
13,598 |
|
|
For the year ending December 31, 2008
|
|
|
13,598 |
|
|
For the year ending December 31, 2009
|
|
|
13,598 |
|
|
Thereafter
|
|
|
54,398 |
|
| |
|
|
|
|
Total
|
|
$ |
122,388 |
|
| |
|
|
|
F-20
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
| Note 10. |
Convertible Senior Notes |
On May 28, 2003, we issued $90 million of
2.25% convertible senior notes due May 30, 2008 in a
private placement exempt from registration under the Securities
Act of 1933. The notes are senior, unsecured obligations and
rank equal in right of payment with any of our existing and
future unsecured and unsubordinated debt. The notes are
convertible into our shares of common stock at any time at the
option of the note holder at a conversion rate of
46.705 shares of common stock per $1,000 principal amount
of notes, subject to adjustment in certain circumstances, which
is equivalent to a conversion price of approximately
$21.41 per share of common stock. This conversion price is
higher than the price of our common stock on the date the notes
were issued. The notes bear interest at a rate of 2.25% per
annum, which is payable semi-annually in arrears on May 30
and November 30 of each year, beginning November 30,
2003. As of December 31, 2004, the fair value of these
notes was approximately $113.3 million.
The notes cannot be redeemed before May 30, 2005. On or
after May 30, 2005 and before May 30, 2007, we may
redeem all or a portion of the notes at our option at a
redemption price equal to 100% of the principal amount of the
notes to be redeemed, plus accrued and unpaid interest if the
closing price of our common stock has exceeded 140% of the
conversion price then in effect for at least 20 trading days
within a period of 30 consecutive trading days ending on the
trading day before the date of mailing of the redemption notice.
We may redeem all or a portion of the notes at any time on or
after May 30, 2007 at a redemption price equal to 100.45%
of the principal amount of the notes to be redeemed, plus
accrued and unpaid interest. Holders of the notes may require us
to repurchase all or a portion of their notes upon a change in
control, as defined in the indenture governing the notes, at
100% of the principal amount of the notes to be repurchased,
plus accrued and unpaid interest.
Offering expenses of $3.7 million related to the issuance
of these notes have been included in other assets and are
amortized on a straight-line basis to interest expense over the
contractual term of the notes. Amortization expense for the
years ended December 31, 2004 and 2003 was $737,000 and
$430,000, respectively.
|
|
| Note 11. |
Stockholders’ Equity |
Equity Issuance
On February 13, 2004, we completed a private placement of
3.0 million shares of our common stock to accredited
institutional investors at a price of $20.25 per share, for
net proceeds of approximately $56.9 million.
Warrants
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 had an exercise price of $6.063 and
was exercised in the year ended December 31, 2004.
In connection with an equity line arrangement, we issued
warrants in December 1999 for 25,000 shares at a purchase
price of $6.875, and in December 2000 for 25,427 shares at
a purchase price of $5.3625, both of which were exercised in the
year ended December 31, 2004.
We have a commitment to a third party to issue a warrant to
purchase 30,000 shares of our common stock when and if
relaxin is approved for a commercial indication. As of
December 31, 2004, the warrant had not been issued.
Although we sold the relaxin program to BAS Medical in 2003, the
warrant obligation was not transferred. We have not reserved any
shares for issuance of common stock pursuant to this commitment.
F-21
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
1995 Director Stock Option Plan
The Board adopted the 1995 Director Stock Option Plan, or
the Directors’ Plan, in December 1995, and amended the Plan
in 1999, 2001 and 2003. We have reserved a total of
850,000 shares of common stock for issuance under the
Directors’ Plan. The Directors’ Plan provides for the
grant of non-statutory stock options to non-employee directors
of Connetics.
The Directors’ Plan provides that each person who first
becomes a non-employee director is 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 15,000 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 is 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.
Employee Stock Plans
We have six plans pursuant to which we have granted stock
options to employees, directors, and consultants. In general,
all of the plans authorize the grant of stock options vesting at
a rate to be set by the Board or the Compensation Committee.
Generally, stock options under all of our employee stock plans
become exercisable at a rate of 25% per year for a period
of four (4) years from date of grant. The plans require
that the options be exercisable at a rate no less than
20% per year. The exercise price of stock options under the
employee stock plans generally meets the following criteria:
exercise price of incentive stock options must be at least 100%
of the fair market value on the grant date, exercise price of
non-statutory stock options must be at least 85% of the fair
market value on the grant date, and exercise price of options
granted to 10% (or greater) stockholders must be at least 110%
of the fair market value on the grant date. The 2000 Non-Officer
Plan, the 2002 Employee Stock Plan and the International Plan do
not permit the grant of incentive stock options. Stock options
under all of our employee stock plans have a term of ten years
from date of grant. Below is a general description of the plans
from which we are still granting stock options.
2000 Stock Plan. Our 2000 Stock Plan (the 2000 Plan) was
approved by the Board and our stockholders in 1999. The 2000
Plan became available on January 1, 2000, and was
initially funded with 808,512 shares. 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 (3%) of the number
of shares of common stock outstanding on the last preceding
business day, or an amount determined by the Board. In 2004, the
increase in authorized shares was 958,501.
Non-Officer Stock Option Plans. The 2000 Non-Officer
Stock Plan was funded with 500,000 shares. No additional
shares will be added to this plan, although shares may be
granted if they become available through cancellation. The 2002
Employee Stock Plan was initially funded with
500,000 shares. In 2003, the 2002 Employee Stock Plan was
amended to increase the shares available for issuance by
750,000 shares, for a total of 1,250,000 shares, and
to permit the issuance of options under the plan to officers of
Connetics who are not executive officers within the meaning of
Section 16 of the Securities Exchange Act of 1934. Our
stockholders approved those amendments in 2003. The options
granted under both plans are nonstatutory stock options.
F-22
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
International Stock Incentive Plan. In 2001, the Board
approved an International Stock Incentive Plan, which provided
for the grant of Connetics’ stock options to employees of
Connetics or its subsidiaries where the employees are based
outside of the United States. The plan was funded with
250,000 shares. The options granted under the plan are
nonstatutory stock options.
Summary of All Option Plans. The following table
summarizes information concerning stock options outstanding
under all of our stock option plans and certain grants of
options outside of our plans. Options canceled under terminated
plans are no longer available for grant.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Outstanding Options | |
| |
|
|
|
| |
| |
|
Shares Available | |
|
Number of | |
|
Weighted Average | |
| |
|
for Grant | |
|
Shares | |
|
Exercise Price | |
| |
|
| |
|
| |
|
| |
|
Balance, December 31, 2001
|
|
|
981,846 |
|
|
|
4,221,556 |
|
|
$ |
6.10 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Additional shares authorized
|
|
|
909,312 |
|
|
|
— |
|
|
|
— |
|
| |
Options granted
|
|
|
(1,400,378 |
) |
|
|
1,400,378 |
|
|
|
11.71 |
|
| |
Options exercised
|
|
|
— |
|
|
|
(469,246 |
) |
|
|
5.20 |
|
| |
Options canceled
|
|
|
248,411 |
|
|
|
(268,722 |
) |
|
|
7.60 |
|
| |
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2002
|
|
|
739,191 |
|
|
|
4,883,966 |
|
|
|
7.72 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Additional shares authorized
|
|
|
1,937,016 |
|
|
|
— |
|
|
|
— |
|
| |
Options granted
|
|
|
(1,759,888 |
) |
|
|
1,759,888 |
|
|
|
14.20 |
|
| |
Options exercised
|
|
|
— |
|
|
|
(554,274 |
) |
|
|
5.69 |
|
| |
Options canceled
|
|
|
102,260 |
|
|
|
(103,323 |
) |
|
|
9.97 |
|
| |
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2003
|
|
|
1,018,579 |
|
|
|
5,986,257 |
|
|
|
9.77 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Additional shares authorized
|
|
|
958,501 |
|
|
|
— |
|
|
|
— |
|
| |
Options granted
|
|
|
(1,777,968 |
) |
|
|
1,777,968 |
|
|
|
19.98 |
|
| |
Options exercised
|
|
|
— |
|
|
|
(753,346 |
) |
|
|
6.83 |
|
| |
Options canceled
|
|
|
172,970 |
|
|
|
(172,970 |
) |
|
|
14.01 |
|
| |
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004
|
|
|
372,082 |
|
|
|
6,837,909 |
|
|
$ |
12.64 |
|
| |
|
|
|
|
|
|
|
|
|
The following table summarizes information concerning
outstanding and exercisable options at December 31, 2004:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Options Outstanding | |
|
Options Exercisable | |
| |
|
| |
|
| |
| |
|
|
|
Weighted Average | |
|
|
|
|
| |
|
Number of | |
|
Remaining Life | |
|
Weighted Average | |
|
Number of | |
|
Weighted Average | |
| Range of Exercise Prices |
|
Shares | |
|
(in years) | |
|
Exercise Price | |
|
Shares | |
|
Exercise Price | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
$ 0.44 - $ 5.84
|
|
|
880,350 |
|
|
|
5.4 |
|
|
$ |
4.40 |
|
|
|
866,412 |
|
|
$ |
4.40 |
|
|
$ 5.85 - $11.67
|
|
|
1,693,297 |
|
|
|
5.0 |
|
|
$ |
8.29 |
|
|
|
1,543,329 |
|
|
$ |
8.21 |
|
|
$11.68 - $17.51
|
|
|
2,312,224 |
|
|
|
7.7 |
|
|
$ |
12.94 |
|
|
|
1,236,021 |
|
|
$ |
12.66 |
|
|
$17.52 - $23.34
|
|
|
1,691,788 |
|
|
|
9.0 |
|
|
$ |
18.71 |
|
|
|
153,636 |
|
|
$ |
18.38 |
|
|
$23.35 - $29.18
|
|
|
260,250 |
|
|
|
9.8 |
|
|
$ |
26.74 |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ 0.44 - $29.18
|
|
|
6,837,909 |
|
|
|
7.1 |
|
|
$ |
12.64 |
|
|
|
3,799,398 |
|
|
$ |
9.20 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1995 Employee Stock Purchase Plan. The Board adopted the
1995 Employee Stock Purchase Plan (the Purchase Plan) in
December 1995, and amended the Purchase Plan in February and
November 2000 and December 2002. We have reserved
1,593,683 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
F-23
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
determined by the Board of Directors. The Compensation Committee
of the Board administers the Purchase Plan. Employees (including
officers and employee directors) of Connetics are eligible to
participate if they are employed for at least 20 hours per
week and more than five 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
131,742 shares under the Purchase Plan in 2004.
Common Shares Reserved for Future Issuance
We have reserved shares of common stock for issuance as follows:
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
1994 Stock Plan
|
|
|
721,042 |
|
|
|
980,617 |
|
|
1995 Employee Stock Purchase Plan
|
|
|
423,251 |
|
|
|
216,320 |
|
|
1995 Directors Stock Option Plan
|
|
|
757,800 |
|
|
|
815,000 |
|
|
1998 Supplemental Stock Plan
|
|
|
39,883 |
|
|
|
52,383 |
|
|
2000 Stock Plan
|
|
|
3,994,623 |
|
|
|
3,285,396 |
|
|
2000 Non-Officer Stock Plan
|
|
|
293,856 |
|
|
|
367,612 |
|
|
International Stock Incentive Plan
|
|
|
229,010 |
|
|
|
246,155 |
|
|
2002 Employee Stock Plan
|
|
|
1,144,281 |
|
|
|
1,228,177 |
|
|
Non-plan stock options
|
|
|
29,496 |
|
|
|
29,496 |
|
|
Common stock warrants
|
|
|
— |
|
|
|
59,177 |
|
|
Convertible senior notes
|
|
|
4,203,450 |
|
|
|
4,203,450 |
|
| |
|
|
|
|
|
|
| |
Total
|
|
|
11,836,692 |
|
|
|
11,483,783 |
|
| |
|
|
|
|
|
|
Stockholder Rights Plan
We adopted a stockholder rights plan (the Rights Plan) in May
1997, as amended and restated in November 2001. The Rights Plan
entitles existing stockholders to purchase from Connetics one
preferred share purchase right, or Right, for each share of
common stock they own. If the Rights become exercisable, each
Right entitles the holder to buy one one-thousandth of a share
of Series B Participating Preferred stock for $80.00. The
Rights attach to and trade only together with our common stock
and do not have voting rights. Rights Certificates will be
issued and the Rights will become exercisable on the
“Distribution Date,” which is defined as the earlier
of the tenth business day (or such later date as may be
determined by our Board of Directors) after a person or group of
affiliated or associated persons (“Acquiring Person”)
(a) has acquired, or obtained the right to acquire,
beneficial ownership of 15% or more of the common shares then
outstanding or (b) announces a tender or exchange offer,
the consummation of which would result in ownership by a person
or group of 15% or more of our then outstanding common shares.
Unless the Rights are earlier redeemed, if an Acquiring Person
obtains 15% or more of our then outstanding common shares, then
any Rights held by the Acquiring Person are void, and each other
holder of a Right which has not been exercised will have the
right to receive, upon exercise, common shares having a value
equal to two times the purchase price. The Rights are redeemable
for $0.001 per Right at the direction of our Board. The
purchase price payable, the number of Rights, and the number of
Series B Participating Preferred Stock or common shares or
other securities or property issuable upon exercise of the
Rights are subject to adjustment from time to time in connection
with the dilutive issuances by Connetics as set forth in the
Rights Plan. At December 31, 2004, a total of
90,000 shares were designated as Series B
Participating Preferred Stock and no shares were issued and
outstanding.
F-24
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The provision for income taxes consists of the following (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Foreign
|
|
$ |
150 |
|
|
$ |
1,017 |
|
|
$ |
467 |
|
| |
Federal
|
|
|
1,171 |
|
|
|
330 |
|
|
|
(211 |
) |
| |
State
|
|
|
426 |
|
|
|
— |
|
|
|
(75 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Total Current
|
|
|
1,747 |
|
|
|
1,347 |
|
|
|
181 |
|
| |
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Foreign
|
|
|
(254 |
) |
|
|
(180 |
) |
|
|
— |
|
| |
Federal
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
State
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
Total Deferred
|
|
|
(254 |
) |
|
|
(180 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,493 |
|
|
$ |
1,167 |
|
|
$ |
181 |
|
| |
|
|
|
|
|
|
|
|
|
The provision for income taxes differs from the federal
statutory rate as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Provision (benefit) at U.S. federal statutory rate
|
|
$ |
7,108 |
|
|
$ |
(960 |
) |
|
$ |
(5,600 |
) |
|
Unbenefited losses (utilization of net operating losses)
|
|
|
(14,066 |
) |
|
|
450 |
|
|
|
4,900 |
|
|
Timing differences not currently benefited
|
|
|
6,814 |
|
|
|
— |
|
|
|
— |
|
|
State taxes, net of federal benefit
|
|
|
281 |
|
|
|
— |
|
|
|
(75 |
) |
|
Non-deductible stock based compensation
|
|
|
6 |
|
|
|
10 |
|
|
|
100 |
|
|
Non-deductible amortization
|
|
|
274 |
|
|
|
270 |
|
|
|
300 |
|
|
Alternative minimum tax
|
|
|
827 |
|
|
|
— |
|
|
|
(542 |
) |
|
Foreign taxes
|
|
|
(104 |
) |
|
|
837 |
|
|
|
467 |
|
|
US withholding tax
|
|
|
334 |
|
|
|
330 |
|
|
|
331 |
|
|
Other
|
|
|
19 |
|
|
|
230 |
|
|
|
300 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,493 |
|
|
$ |
1,167 |
|
|
$ |
181 |
|
| |
|
|
|
|
|
|
|
|
|
Pretax income from foreign operations was approximately
$600,000, $4.0 million, and $2.2 million for the years
ended December 31, 2004, 2003 and 2002, respectively.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets for financial
reporting purposes and the amounts used for income tax purposes.
F-25
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Significant components of our deferred tax assets for federal,
state and foreign income taxes as of December 31 are
approximately as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
| |
Net operating loss carryforwards
|
|
$ |
24,200 |
|
|
$ |
38,200 |
|
| |
Research and other tax credits
|
|
|
6,400 |
|
|
|
5,200 |
|
| |
Capitalized research expenses
|
|
|
4,000 |
|
|
|
5,200 |
|
| |
Capitalized license and acquired technology
|
|
|
4,700 |
|
|
|
2,100 |
|
| |
Accruals and reserves
|
|
|
8,800 |
|
|
|
2,600 |
|
| |
Foreign currency translation
|
|
|
700 |
|
|
|
485 |
|
| |
Other
|
|
|
800 |
|
|
|
1,100 |
|
| |
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
49,600 |
|
|
|
54,885 |
|
|
Valuation allowance
|
|
|
(46,800 |
) |
|
|
(53,600 |
) |
| |
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
2,800 |
|
|
|
1,285 |
|
| |
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
| |
Prepaid expenses
|
|
|
(400 |
) |
|
|
(200 |
) |
| |
Soriatane property acquisition
|
|
|
(1,100 |
) |
|
|
— |
|
| |
Unrealized gain on marketable securities
|
|
|
(100 |
) |
|
|
(300 |
) |
| |
|
|
|
|
|
|
|
Net deferred tax liabilities
|
|
|
(1,600 |
) |
|
|
(500 |
) |
| |
|
|
|
|
|
|
|
Total net deferred tax assets
|
|
$ |
1,200 |
|
|
$ |
785 |
|
| |
|
|
|
|
|
|
The net U.S. deferred tax assets have been fully offset by a
valuation allowance. The valuation allowance decreased by
$6.8 million during the year ended December 31, 2004,
decreased by $0.8 million during the year ended
December 31, 2003 and increased by $13.6 million
during the year ended December 31, 2002. Due to a history
of earnings in Australia, the foreign deferred tax assets of
$1.2 million have not been offset with a valuation
allowance.
As of December 31, 2004, we had federal net operating loss
carryforwards of approximately $71.3 million. We also had
federal and California research and other tax credit
carryforwards of approximately $6.4 million. The federal
net operating loss and credit carryforwards will expire in the
years 2008 through 2024 if not utilized. State tax credit
carryforwards may be carried forward indefinitely.
The annual utilization of the federal and state net operating
loss and tax credit carryforwards is limited for tax purposes
under 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 utilize them.
Tax benefits associated with employee stock options provide a
deferred benefit of approximately $7.4 million, which has
been offset by the valuation allowance. The deferred tax benefit
associated with the employee stock options will be credited to
additional paid-in capital when realized.
We lease two facilities under non-cancelable operating leases,
the last of which expires in April 2005. One of the operating
leases required an irrevocable standby letter of credit that was
secured by a certificate of deposit with our bank. The amount of
the letter of credit included an automatic annual reduction
feature and expired on January 1, 2004.
F-26
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In June 2004, we signed a series of non-cancelable facility
lease agreements with Incyte Corporation and The Board of
Trustees of the Leland Stanford Junior University, or Stanford,
in Palo Alto, California. The leases collectively expire in ten
years and the lease with Stanford includes two three-year
optional renewal periods. We moved into the new facility in
February 2005. In accordance with the new facility lease
agreement, we entered into a $2.0 million letter of credit
arrangement, which is secured by certificates of deposit. The
certificates of deposit are classified as restricted cash,
non-current, at December 31, 2004.
We also lease automobiles under two operating leases in which we
guarantee certain residual values for the vehicles. In
accordance with the automobile lease agreements, in 2004 we
entered into two letters of credit arrangements, which are
secured by certificates of deposit, totaling $300,000. The
certificates of deposit are classified as restricted cash,
non-current, at December 31, 2004. We also lease office
equipment under various operating leases that expire in 2009.
In March 2002 we entered into a manufacturing and supply
agreement with DPT that requires minimum purchase commitments,
beginning in August 2003 and continuing for 10 years.
Additionally in 2002 we entered into a license agreement that
requires minimum royalty payments beginning in 2005 and
continuing for 15 years, unless the agreement is terminated
earlier at the discretion of either party. In 2003, we entered
into a five-year service agreement for prescription information
that requires minimum fees.
The future minimum rental payments under non-cancelable
operating leases and contractual commitments as of
December 31, 2004 are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Operating | |
|
Contractual | |
|
|
| Years Ending December 31: |
|
Leases | |
|
Commitments | |
|
Total | |
| |
|
| |
|
| |
|
| |
| |
2005
|
|
$ |
4,965 |
|
|
$ |
1,875 |
|
|
$ |
6,840 |
|
| |
2006
|
|
|
2,788 |
|
|
|
2,172 |
|
|
|
4,960 |
|
| |
2007
|
|
|
2,476 |
|
|
|
2,172 |
|
|
|
4,648 |
|
| |
2008
|
|
|
1,402 |
|
|
|
850 |
|
|
|
2,252 |
|
| |
2009
|
|
|
1,383 |
|
|
|
850 |
|
|
|
2,233 |
|
|
Thereafter
|
|
|
8,175 |
|
|
|
2,225 |
|
|
|
10,400 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
21,189 |
|
|
$ |
10,144 |
|
|
$ |
31,333 |
|
| |
|
|
|
|
|
|
|
|
|
We recognize facilities rent expense on a straight-line basis
over the term of each lease. Facilities rent expense under
operating leases was approximately $1.7 million (net of
sublease income of $376,000), $1.4 million (net of sublease
income of $490,000) and $1.5 million (net of sublease
income of $742,000) for the years ended December 31, 2004,
2003 and 2002, respectively. The operating lease obligations set
forth above for 2005 are shown net of $94,000 to be received as
a result of a subleasing arrangement with a third party that
expires on March 31, 2005.
Pursuant to our manufacturing and supply agreements with our
three suppliers, AccraPac, DPT and Roche, we may incur
significant penalties related to cancellation of purchase
orders, including paying an amount equal to the entire cancelled
purchase order. We had approximately $9.6 million in
outstanding open purchase orders to our suppliers at
December 31, 2004 that are not included in the table above.
|
|
| Note 14. |
Guarantees and Indemnifications |
In November 2002, the FASB issued Interpretation No. 45,
“Guarantor’s Accounting and Disclosure Requirements
for Guarantees, including Indirect Guarantees of Indebtedness of
Others” (FIN No. 45). FIN No. 45
requires that upon issuance of a guarantee, the guarantor must
recognize a liability for the fair value of the obligations it
assumes under that guarantee.
F-27
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
We enter into indemnification provisions under our agreements
with other companies in the ordinary course of our business,
typically with business partners, contractors, clinical sites,
insurers, and customers. Under these provisions we generally
indemnify and hold harmless the indemnified party for losses
suffered or incurred by the indemnified party as a result of our
activities. These indemnification provisions generally survive
termination of the underlying agreement. In some cases, the
maximum potential amount of future payments Connetics could be
required to make under these indemnification provisions is
unlimited. The estimated fair value of the indemnity obligations
of these agreements is minimal. Accordingly, we have no
liabilities recorded for these agreements as of
December 31, 2004. We have not incurred any costs to defend
lawsuits or settle claims related to these indemnification
arrangements.
|
|
| Note 15. |
Retirement Savings Plan |
We have a retirement savings plan, commonly known as a 401(k)
plan that allows all full-time employees to contribute from 1%
to 60% of their pretax salary, subject to IRS limits. Before
2003, the company match of employee contributions was
discretionary, and the Board authorized the match based on a
“pool” calculated using a formula tied to
Connetics’ annual product sales and the employee’s
actual contribution. Beginning in 2003, we match all
employees’ contributions in an amount equal to 25% of each
participant’s deferral contributions made during the year.
Before 2003 the company contribution vested in relation to each
employee’s tenure with Connetics (40% after the second year
and 100% vested after five years with Connetics). In 2003 we
changed the vesting schedule for company contributions to 100%
vesting at the time the contributions are made. Our
contributions to the 401(k) plan were $387,000, $308,000 and
$238,000 for the years ended December 31, 2004, 2003 and
2002, respectively.
|
|
| Note 16. |
Related Party Transactions |
In February 2000, the Board authorized a loan to our Chief
Executive Officer in the amount of $250,000, at an interest rate
equal to 6.2%. The loan is to be forgiven at a rate of
$50,000 per year plus accrued interest, on each anniversary
of the loan on which our Chief Executive Officer is still
employed by Connetics. As of December 31, 2004 and 2003,
the outstanding balance of this loan, including accrued
interest, was $53,000 and $105,000, respectively.
|
|
| Note 17. |
Quarterly Financial Data (unaudited) |
The following tables summarize the quarterly results of
operations for the years ended December 31, 2004 and 2003
(in thousands, except per share amounts):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 Quarters | |
| |
|
| |
| |
|
First(1) | |
|
Second(2) | |
|
Third(3) | |
|
Fourth | |
| |
|
| |
|
| |
|
| |
|
| |
|
Total revenues
|
|
$ |
24,982 |
|
|
$ |
38,253 |
|
|
$ |
37,344 |
|
|
$ |
43,776 |
|
|
Cost of product revenues
|
|
|
1,568 |
|
|
|
3,578 |
|
|
|
3,067 |
|
|
|
4,443 |
|
|
Operating expenses
|
|
|
21,006 |
|
|
|
25,963 |
|
|
|
30,065 |
|
|
|
32,682 |
|
|
Operating income
|
|
|
2,408 |
|
|
|
8,712 |
|
|
|
4,212 |
|
|
|
6,651 |
|
| |
Net income
|
|
|
1,873 |
|
|
|
7,457 |
|
|
|
3,695 |
|
|
|
5,990 |
|
|
Basic net income per share
|
|
|
0.06 |
|
|
|
0.21 |
|
|
|
0.10 |
|
|
|
0.17 |
|
|
Diluted net income per share
|
|
|
0.05 |
|
|
|
0.19 |
|
|
|
0.10 |
|
|
|
0.16 |
|
|
Shares used to calculate basic net income per share
|
|
|
33,587 |
|
|
|
35,242 |
|
|
|
35,510 |
|
|
|
35,695 |
|
|
Shares used to calculate fully diluted net income per share
|
|
|
35,887 |
|
|
|
41,627 |
|
|
|
38,064 |
|
|
|
38,172 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
F-28
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
| (1) |
In the first quarter of 2004, we received a one-time royalty
payment in the amount of $1.2 million in connection with
the S.C. Johnson license agreement, which we also reached
agreement to terminate in the first quarter. |
| |
| (2) |
In early March of 2004, we acquired exclusive
U.S. rights to Soriatane. Sales of Soriatane accounted for
most of the increase in sales over the first quarter. Operating
expenses increased in the second quarter compared to the first,
primarily related to the Soriatane acquisition and in support of
the increased Soriatane sales, including a $2.1 million
increase in amortization of intangible assets resulting from the
acquisition and $2.4 million for selling, general, and
administrative expenses. |
| |
| (3) |
In the third quarter of 2004, operating expenses included a
$3.5 million milestone payment due under our license
agreement for Velac upon our filing an NDA with the FDA. |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2003 Quarters | |
| |
|
| |
| |
|
First | |
|
Second(1) | |
|
Third(2)(3) | |
|
Fourth | |
| |
|
| |
|
| |
|
| |
|
| |
|
Total revenues
|
|
$ |
15,311 |
|
|
$ |
19,970 |
|
|
$ |
19,712 |
|
|
$ |
20,338 |
|
|
Cost of product revenues
|
|
|
1,072 |
|
|
|
1,185 |
|
|
|
1,388 |
|
|
|
1,484 |
|
|
Operating expenses
|
|
|
19,721 |
|
|
|
19,411 |
|
|
|
16,374 |
|
|
|
17,203 |
|
|
Operating income (loss)
|
|
|
(5,482 |
) |
|
|
(626 |
) |
|
|
1,950 |
|
|
|
1,651 |
|
| |
Net income (loss)
|
|
|
(5,381 |
) |
|
|
(1,856 |
) |
|
|
1,616 |
|
|
|
1,521 |
|
|
Basic net income (loss) per share
|
|
|
(0.17 |
) |
|
|
(0.06 |
) |
|
|
0.05 |
|
|
|
0.05 |
|
|
Diluted net income (loss) per share
|
|
|
(0.17 |
) |
|
|
(0.06 |
) |
|
|
0.05 |
|
|
|
0.05 |
|
|
Shares used to calculate basic net income (loss) per share
|
|
|
31,286 |
|
|
|
31,519 |
|
|
|
31,648 |
|
|
|
31,781 |
|
|
Shares used to calculate fully diluted net income (loss) per
share
|
|
|
31,286 |
|
|
|
31,519 |
|
|
|
33,607 |
|
|
|
33,759 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
In the second quarter of 2003, we received a one-time royalty
payment from S.C. Johnson in the amount of $2.9 million in
connection with the S.C. Johnson license agreement. |
| |
| (2) |
In the third quarter of 2003, we recognized $761,000 of
relaxin related revenue associated with the execution of the
agreement with BAS Medical in July 2003. Of the relaxin related
revenue $661,000 represented previously deferred revenue
associated with relaxin license agreements with other parties
that was fully recognized upon the execution of the BAS Medical
agreement. |
| |
| (3) |
Operating expenses decreased in the third quarter of 2003
when compared to the second quarter of 2003 mainly due to
decreased clinical trial activity of $712,000, decreased
manufacturing expenses of $977,000 primarily related to a
one-time reversal of a previously recorded liability of $576,000
for clinical trial materials, as well as the timing of various
process and product development activities, a $416,000 decrease
in QA/ QC expenses due to the timing of stability and release
testing, and a $605,000 decrease in product samples and sales
promotion expenses related to the timing of the programs. |
F-29
Connetics Corporation
Index to Exhibits
[Item 15(b)]
| |
|
|
|
|
| Exhibit | |
|
|
| Number | |
|
Description |
| | |
|
|
| |
2 |
.1* |
|
Purchase and Sale Agreement dated February 2, 2004
between Connetics and Hoffmann — La Roche Inc.
(previously filed as Exhibit 10.41 of the Company’s Annual
Report on Form 10-K for the year ended December 31,
2003) |
| |
3 |
.1* |
|
Amended and Restated Certificate of Incorporation (previously
filed as an exhibit to the Company’s Form S-1
Registration Statement No. 33-80261) |
| |
| |
3 |
.2* |
|
Certificate of Amendment of the Company’s Amended and
Restated Certificate of Incorporation, as filed with the
Delaware Secretary of State on May 15, 1997 (previously
filed as Exhibit 3.7 to the Company’s Current Report
on Form 8-K dated and filed May 23, 1997) |
| |
| |
3 |
.3* |
|
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
(previously filed as Exhibit A to Exhibit 1 to the
Company’s Form 8-A filed on May 23, 1997). |
| |
| |
3 |
.4* |
|
Amended and Restated Bylaws (previously filed as
Exhibit 3.2 to the Company’s Form 8-A/A filed
November 28, 2001) |
| |
| |
3 |
.5* |
|
Certificate of Elimination of Rights, Preferences and Privileges
of Connetics Corporation, as filed with the Delaware Secretary
of State on December 11, 2001 (previously filed as
Exhibit 3.5 to the Company’s Annual Report on Form
10-K/A for the year ended December 31, 2001) |
| |
| |
4 |
.1* |
|
Form of Common Stock Certificate (previously filed as
Exhibit 4.1 to the Company’s Annual Report on Form
10-K for the year ended December 31, 1998) |
| |
| |
4 |
.2* |
|
Amended and Restated Preferred Stock Rights Agreement, dated as
of November 21, 2001, between the Company and EquiServe
Trust Company, N.A., including the form of Rights Certificate
and the Summary of Rights attached thereto as Exhibits A
and B, respectively (previously filed as Exhibit 4.1 to
the Company’s Form 8-A/A filed November 28, 2001) |
| |
| |
4 |
.3* |
|
Indenture, dated as of May 28, 2003, between Connetics and
J.P. Morgan Trust Company, National Association, including
therein the forms of the notes (previously filed as Exhibit
4.1 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003) |
| |
|
|
|
Management and Consulting Agreements |
| |
| |
10 |
.1*(M) |
|
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) |
|
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 |
.3*(M) |
|
Letter Agreement with G. Kirk Raab dated October 1, 1995
(previously filed as an exhibit to the Company’s
Form S-1 Registration Statement No. 33-80261) |
| |
| |
10 |
.4*(M) |
|
Form of Notice of Stock Option Grant to G. Kirk Raab dated
January 28, 1997 (previously filed as Exhibit 10.4
to the Company’s Annual Report on Form 10-K/A for the year
ended December 31, 2001) |
| |
| |
10 |
.5*(M) |
|
Form of Notice of Stock Option Grant to G. Kirk Raab dated
July 30, 1997 (previously filed as Exhibit 10.5 to
the Company’s Annual Report on Form 10-K/A for the year
ended December 31, 2001) |
| |
| |
10 |
.6*(M) |
|
Restricted Common Stock Purchase Agreement dated
November 5, 1998 between the Company and G. 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 |
.7*(M) |
|
Restricted Common Stock Purchase Agreement dated March 9,
1999 between the Company and G. Kirk Raab (previously
filed as Exhibit 10.5 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended March 31,
1999) |
| |
|
|
|
|
| Exhibit | |
|
|
| Number | |
|
Description |
| | |
|
|
| |
| |
10 |
.8*(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 quarter ended March 31,
1999) |
| |
| |
10 |
.9*(M) |
|
Consulting Agreement effective April 1, 2000 between the
Company and Leon Panetta (previously filed as
Exhibit 10.77 to the Company’s Annual Report on Form
10-K for the year ended December 31, 2000) |
| |
| |
10 |
.10*(M) |
|
Form of Change in Control Agreement between the Company and key
employees of the Company (previously filed as
Exhibit 10.12 to the Company’s Annual Report on Form
10-K/A for the year ended December 31, 2001) |
| |
| |
10 |
.11*(M) |
|
Consulting Agreement dated January 1, 2002, as amended
effective January 1, 2003, between Connetics and Eugene
Bauer, M.D. (previously filed as Exhibit 10.12 to
the Company’s Annual Report on Form 10-K for the year ended
December 31, 2002) |
| |
| |
10 |
.12(M) |
|
Consulting Agreement dated January 1, 2002, as amended
effective December 31, 2003, between Connetics and Eugene
Bauer, M.D. |
| |
| |
10 |
.13(M) |
|
Consulting Agreement dated January 1, 2002, as amended
effective December 31, 2004, between Connetics and Eugene
Bauer, M.D. |
| |
|
|
|
Stock Plans and Equity Agreements |
| |
| |
10 |
.14(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 |
.15(M)* |
|
1995 Employee Stock Purchase Plan (as amended through December
2002), and form of Subscription Agreement (previously filed
as Exhibit 99.1 to the Company’s Form S-8
Registration Statement No. 333-102619) |
| |
| |
10 |
.16*(M) |
|
1995 Directors’ Stock Option Plan (as amended through
May 2003), and form of Option Agreement (previously filed as
Exhibit 99.2 to the Company’s Current Report on Form
8-K dated February 9, 2004 and filed with the Commission on
March 8, 2004) |
| |
| |
10 |
.17* |
|
Structured Equity Line Flexible Financing Agreement dated
January 2, 1997 between Connetics and Kepler Capital LLC
(previously filed as Exhibit 10.1 to the Company’s
Form S-3 Registration Statement No. 333-45002 as filed
on November 7, 2000) |
| |
| |
10 |
.18* |
|
Registration Rights Agreement dated January 2, 1997 between
Connetics and Kepler Capital LLC (previously filed as
Exhibit 10.43 to the Company’s Annual Report on Form
10-K for the year ended December 31, 1996) |
| |
| |
10 |
.19*(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 |
.20*(M) |
|
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 |
.21* |
|
International Stock Incentive Plan (previously filed as
Exhibit 4.1 to the Company’s Form S-8
Registration Statement No. 333-61558) |
| |
| |
10 |
.22* |
|
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 |
.23* |
|
2002 Non-Officer Employee Stock Plan (as amended through May
2003) (previously filed as Exhibit 99.1 to the Company’s
Current Report on Form 8-K dated February 9, 2004 and filed
with the Commission on March 8, 2004) |
| |
| |
10 |
.24* |
|
1995 Employee Stock Purchase Plan (as amended and restated
through May 7, 2004) and form of Subscription Agreement
(previously filed as Exhibit 10.1 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended
June 30, 2004) |
| |
|
|
|
License Agreements |
| |
| |
10 |
.25*† |
|
Soltec License Agreement dated June 14, 1996 (previously
filed as Exhibit 10.28 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996) |
| |
| |
10 |
.26*† |
|
License Agreement dated January 1, 1998 between Connetics
and Soltec Research Pty Limited (previously filed as
Exhibit 10.57 to the Company’s Annual Report on Form
10-K for the year ended December 31, 1997) |
| |
|
|
|
|
| Exhibit | |
|
|
| Number | |
|
Description |
| | |
|
|
| |
| |
10 |
.27*† |
|
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 quarter ended June 30, 1999) |
| |
| |
10 |
.28*(C) |
|
License Agreement with Pierre Fabre Dermatologie and Connetics
Corporation, dated September 29, 2004 (previously filed
as Exhibit 10.1 to our Current Report on Form 8-K dated
September 29, 2004 and filed with the Commission on
October 4, 2004) |
| |
| |
|
|
|
Real Property |
| |
| |
10 |
.29* |
|
Lease between Connetics and Renault & Handley
Employee’s Investment Co., dated June 28, 1999
(previously filed as Exhibit 10.39 to the Company’s
Annual Report on Form 10-K/A for the year ended
December 31, 2001) |
| |
| |
10 |
.30* |
|
Industrial Building Lease dated December 16, 1999, between
Connetics and West Bayshore Associates (previously filed as
Exhibit 10.2 to the Company’s Quarterly Report on Form
10-Q for the quarter ended September 30, 2001) |
| |
| |
10 |
.31* |
|
Assignment and Assumption of Lease between Connetics and
Respond.com, dated August 21, 2001 (previously filed as
Exhibit 10.3 to the Company’s Quarterly Report on Form
10-Q for the quarter ended September 30, 2001) |
| |
| |
10 |
.32* |
|
Agreement dated August 21, 2001, between Connetics and
Respond.com (previously filed as Exhibit 10.4 to the
Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001) |
| |
| |
10 |
.33* |
|
Sublease agreement between Connetics (sublessor) and Tolerian,
Inc., dated June 20, 2002 (previously filed as
Exhibit 10.1 to the Company’s Quarterly Report for the
quarter ended June 30, 2002) |
| |
| |
10 |
.34* |
|
Sublease Agreement between the Board of Trustees of the Leland
Stanford Junior University and Incyte Pharmaceuticals, Inc.,
dated May 6, 2004 (previously filed as Exhibit 10.2
to the Company’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004) |
| |
| |
10 |
.35* |
|
Sublease Consent between The Board of Trustees of the Leland
Stanford Junior University and Incyte Corporation and Connetics
Corporation, dated May 6, 2004 (previously filed as
Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2004) |
| |
| |
10 |
.36* |
|
Agreement Regarding Sublease and Lease between The Board of
Trustees of the Leland Stanford Junior University and Connetics
Corporation, dated May 6, 2004 (previously filed as
Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2004) |
| |
| |
10 |
.37* |
|
First Amendment to Lease between The Board of Trustees of the
Leland Stanford Junior University and Incyte Corporation, dated
May 6, 2004 (previously filed as Exhibit 10.5 to
the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2004) |
| |
|
|
|
Other Agreements |
| |
| |
10 |
.38* |
|
Registration Rights Agreement, dated as of May 28, 2003,
between Connetics and Goldman, Sachs & Co., C.E.
Unterberg, Towbin (a California Limited Partnership), CIBC World
Markets Corp., Thomas Weisel Partners LLC and U.S. Bancorp
Piper Jaffray Inc., as representatives (previously filed as
Exhibit 4.2 to the Company’s Quarterly Report on Form
10-Q for the quarter ended June 30, 2003) |
| |
| |
10 |
.39*† |
|
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 year ended December 31, 1999) |
| |
| |
10 |
.40*† |
|
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) |
| |
| |
10 |
.41*† |
|
Asset Purchase Agreement dated as of April 9, 2001, by and
between Connetics and Prometheus Laboratories, Inc.
(previously filed as Exhibit 2.1 to the Company’s
Current Report on Form 8-K dated April 30, 2001 and filed
with the Commission on May 11, 2001) |
| |
|
|
|
|
| Exhibit | |
|
|
| Number | |
|
Description |
| | |
|
|
| |
| |
10 |
.42*† |
|
Facilities Contribution Agreement between Connetics and DPT
Laboratories, Ltd., with retroactive effect to November 1,
2001 (previously filed as Exhibit 10.55 to the
Company’s Annual Report on Form 10-K/A (Amendment
No. 2) for the year ended December 31, 2001) |
| |
| |
10 |
.43*† |
|
Manufacturing and Supply Agreement between Connetics and DPT
Laboratories, Ltd., dated March 12, 2002 (previously
filed as Exhibit 10.56 to the Company’s Annual Report
on Form 10-K/A (Amendment No. 2) for the year ended
December 31, 2001) |
| |
| |
10 |
.44*† |
|
License and Development Agreement between Connetics and
Pharmacia & Upjohn Company, dated December 21,
2001 (previously filed as Exhibit 99.1 to the
Company’s Current Report on Form 8-K/A-2 dated December 21,
2001, filed with the SEC on July 12, 2002) |
| |
| |
10 |
.45*† |
|
License and Development Agreement between Connetics and
Yamanouchi Europe B.V., dated May 13, 2002 (previously
filed as Exhibit 10.2 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002) |
| |
| |
10 |
.46* |
|
Distribution Agreement between Connetics and CORD Logistics,
Inc., dated January 1, 2001, as amended September 1,
2001, September 3, 2003, and September 24, 2003
(previously filed as Exhibit 10.51 to the Company’s
Annual Report on Form 10-K/A (Amendment No. 2) for the
year ended December 31, 2002) |
| |
| |
10 |
.47*† |
|
Amended and Restated Manufacturing and Supply Agreement dated
April 24, 2003 between Connetics and AccraPac Group, Inc.
(previously filed as Exhibit 10.1 to the Company’s
Quarterly Report on Form 10-Q/A (Amendment No. 1) for
the quarter ended March 31, 2003) |
| |
| |
10 |
.48* |
|
Credit and Guaranty Agreement dated as of February 6, 2004
between Connetics and Goldman Sachs Credit Partners L.P.
(previously filed as Exhibit 99.1 to the Company’s
Current Report on Form 8-K dated February 6, 2004, filed
with the Commission on February 9, 2004) |
| |
| |
10 |
.49 |
|
Purchase and Sale Agreement dated February 2, 2004 between
Connetics and Hoffmann-La Roche Inc. (see Exhibit
2.1) |
| |
| |
10 |
.50* |
|
Stock Purchase Agreement dated as of February 11, 2004 by
and among Connetics and the Purchasers listed on Appendix A to
the Stock Purchase Agreement (previously filed as
Exhibit 99.1 to the Company’s Registration Statement
on Form S-3 (Registration No. 333-113894) filed on
March 24, 2004) |
| |
| |
10 |
.51*(C) |
|
Amendment to Facilities Contribution Agreement between DPT
Laboratories, Ltd. and Connetics Corporation, dated
August 18, 2004 (previously filed at Exhibit 10.1
to the Company’s Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004) |
| |
| |
10 |
.52*(C) |
|
Amended and Restated Manufacturing and Supply Agreement between
DPT Laboratories, Ltd. and Connetics Corporation, dated
August 18, 2004 (previously filed as Exhibit 10.2
to the Company’s Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004) |
| |
| |
10 |
.53(C) |
|
Distribution Services Agreement between Cardinal Health, Inc.
and Connetics Corporation dated December 1, 2004. |
| |
| |
10 |
.54(C) |
|
Core Distribution Agreement between McKesson Corporation and
Connetics Corporation dated December 23, 2004. |
| |
| |
10 |
.55(M) |
|
Summary Compensation Information for Named Executive Officers
and Directors |
| |
| |
99 |
.1* |
|
Industrial Building Lease Between West Bayshore Associates and
Connetics Corporation, dated September 2004 (previously filed
as Exhibit 99.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004) |
| |
| |
21 |
* |
|
Subsidiaries of the Company (previously filed as
Exhibit 21 to the Company’s Annual Report on Form 10-K
for the year ended December 31, 2003) |
| |
| |
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm |
| |
| |
31 |
.1 |
|
Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002 |
| |
|
|
|
|
| Exhibit | |
|
|
| Number | |
|
Description |
| | |
|
|
| |
| |
31 |
.2 |
|
Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002 |
| |
| |
32 |
.1 |
|
Certification by Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350†† |
| |
| |
32 |
.2 |
|
Certification by Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350†† |
Key to Exhibit Index Footnotes:
The Commission file number for our Exchange Act filings
referenced above is 0-27406.
|
|
| * |
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. |
| |
| †† |
The certifications attached as Exhibits 32.1 and 32.2 that
accompany this Annual Report on Form 10-K, are not deemed
filed with the Securities and Exchange Commission and are not to
be incorporated by reference into any filing of Connetics
Corporation under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934, as amended, whether made before
or after the date of this Form 10-K, irrespective of any
general incorporation language contained in such filing. |
Index to Exhibits