SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
Commission File Number
0-28308
CollaGenex Pharmaceuticals, Inc.
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1758016
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation of Organization) Identification No.)
41 University Drive, Newtown, PA 18940
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(Address of Principal Executive Offices) (Zip Code)
(215) 579-7388
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(Registrant's Telephone Number,
Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: X No:
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes: No: X
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Indicate the number of shares outstanding of each of the Registrant's
classes of Common Stock as of November 10, 2003:
Class Number of Shares
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Common Stock $.01 par value 13,838,167
COLLAGENEX PHARMACEUTICALS, INC.
TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION........................................ 1
Item 1. Financial Statements (unaudited)....................... 1
Condensed Consolidated Balance Sheets as of
September 30, 2003 and December 31, 2002
(unaudited)....................................... 2
Condensed Consolidated Statements of Operations for
the Three Months Ended September 30, 2003 and 2002
(unaudited)....................................... 3
Condensed Consolidated Statements of Operations for
the Nine Months Ended September 30, 2003 and 2002
(unaudited)....................................... 4
Condensed Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 2003 and 2002
(unaudited)....................................... 5
Notes to Condensed Consolidated Financial Statements
(unaudited)....................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 13
Results of Operations................................. 15
Liquidity and Capital Resources....................... 23
Additional Risks That May Affect Results.............. 28
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.................................................. 34
Item 4. Controls and Procedures............................... 35
PART II. OTHER INFORMATION........................................... 36
Item 1. Legal Proceedings..................................... 36
Item 2. Changes in Securities and Use of Proceeds............. 37
Item 5. Other Information..................................... 37
Item 6. Exhibits and Reports on Form 8-K...................... 39
SIGNATURES........................................................... 40
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited).
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, 2003 and December 31, 2002
(dollars in thousands, except per share data)
(unaudited)
September 30, December 31,
Assets 2003 2002
------------ ------------
Current assets:
Cash and cash equivalents..................... $14,519 $ 10,112
Accounts receivable, net of allowances of $1,674
and $1,412 at September 30, 2003 and December
31, 2002, respectively....................... 1,465 2,142
Inventories................................... 1,342 1,415
Prepaid expenses and other current assets..... 2,304 1,630
------- -------
Total current assets...................... 19,630 15,299
Equipment and leasehold improvements, net....... 590 559
Deferred license fees........................... 1,310 1,749
Other assets.................................... 27 27
------ -------
Total assets.............................. $21,557 $ 17,634
======= ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.............................. $ 2,976 $ 3,616
Accrued expenses.............................. 4,613 4,305
Preferred dividends payable................... -- 800
------ -------
Total current liabilities................. 7,589 8,721
------ -------
Deferred revenue................................ 334 561
Commitments and Contingencies
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000
shares authorized; 200,000 shares of Series D
cumulative convertible preferred stock issued
and outstanding at September 30, 2003 and
December 31, 2002 (liquidation value of
$20,000); 150,000 shares of Series A participating
preferred stock, $0.01 par value, designated and
no shares issued and outstanding at September 30,
2003 and December 31, 2002................... 2 2
Common stock, $0.01 par value; 25,000,000 shares
authorized, 11,831,833 and 11,377,631 shares
issued and outstanding at September 30, 2003
and December 31, 2002, respectively.......... 118 114
Additional paid in capital.................... 84,938 82,917
Accumulated deficit........................... (71,424) (74,681)
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Total stockholders' equity................ 13,634 8,352
------- -------
Total liabilities and stockholders' equity $21,557 $ 17,634
======= ========
See accompanying notes to unaudited condensed consolidated financial statements.
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COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
For the Three Months Ended September 30, 2003 and 2002
(dollars in thousands, except per share data)
(unaudited)
Three Months Ended
September 30,
-----------------------------
2003 2002
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Revenues:
Net product sales.......................... $ 12,797 $ 10,767
Contract revenues.......................... 1,111 422
License revenues........................... 8 40
---------- ----------
Total revenues......................... 13,916 11,229
---------- ----------
Operating expenses:
Cost of product sales...................... 1,907 1,713
Research and development................... 1,777 1,344
Selling, general and administrative........ 9,038 7,431
---------- ----------
Total operating expenses............... 12,722 10,488
---------- ----------
Other income (expense):
Interest income............................ 28 18
Interest expense........................... -- (3)
Other income............................... 8 --
---------- ----------
Net income............................. 1,230 756
Preferred stock dividend..................... 400 400
---------- ----------
Net income allocable to common stockholders.. $ 830 $ 356
========== ==========
Net income per basic share allocable to
common stockholders........................ $ 0.07 $ 0.03
========== ==========
Weighted average shares used in computing
net income per basic share allocable to
common stockholders........................ 11,738,583 11,321,679
========== ==========
Net income per diluted share allocable to
common stockholders........................ $ 0.06 $ 0.03
========== ==========
Weighted average shares used in computing
net income per diluted share allocable to
common stockholders........................ 12,813,907 11,589,483
========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
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COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
For the Nine Months Ended September 30, 2003 and 2002
(dollars in thousands, except per share data)
(unaudited)
Nine Months Ended September 30,
-------------------------------
2003 2002
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Revenues:
Net product sales............................. $ 35,917 $ 31,026
Contract revenues............................. 2,164 1,769
License revenues.............................. 679 162
----------- -----------
Total revenues............................ 38,760 32,957
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Operating expenses:
Cost of product sales......................... 5,560 4,891
Research and development...................... 4,397 2,925
Selling, general and administrative - other... 24,578 25,377
Selling, general and administrative -
stock compensation charge.................... 251 --
----------- -----------
Total operating expenses.................. 34,786 33,193
----------- -----------
Other (expense) income:
Interest income............................... 84 55
Interest expense.............................. -- (5)
Other expense................................. (2) --
----------- -----------
Net income (loss)......................... 4,056 (186)
Preferred stock dividend........................ 1,200 1,229
----------- -----------
Net income (loss) allocable to common
stockholders.................................. $ 2,856 $ (1,415)
=========== ===========
Net income (loss) per basic share allocable to
common stockholders........................... $ 0.25 $ (0.13)
=========== ===========
Weighted average shares used in computing net
income (loss) per basic share allocable to
common stockholders........................... 11,521,337 11,189,318
=========== ===========
Net income (loss) per diluted share allocable
to common stockholders........................ $ 0.23 $ (0.13)
=========== ===========
Weighted average shares used in computing net
income (loss) per diluted share allocable to
common stockholders........................... 12,303,922 11,189,318
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
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COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2003 and 2002
(dollars in thousands)
(unaudited)
Nine Months Ended September 30,
------------------------------
2003 2002
------------ -----------
Cash flows from operating activities:
Net income (loss)............................... $ 4,056 $ (186)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Non-cash compensation expense............... 251 --
Depreciation and amortization expense....... 679 194
Accounts receivable provisions.............. 261 466
Changes in operating assets and liabilities:
Accounts receivable......................... 416 (1,368)
Inventories................................. 73 (76)
Prepaid expenses and other assets........... (674) (1,487)
Accounts payable............................ (640) (363)
Accrued expenses............................ 1,208 1,147
Deferred revenue............................ (227) (92)
--------- --------
Net cash provided by (used in) operating
activities................................ 5,403 (1,765)
--------- --------
Cash flows from investing activities:
Capital expenditures............................ (270) (295)
Payment for Altana license...................... (900) --
--------- --------
Net cash used in investing activities.... (1,170) (295)
--------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock...... 1,774 1,279
Payment of preferred dividends.................. (1,600) (218)
Repayment of long-term debt..................... -- (35)
--------- --------
Net cash provided by financing activities 174 1,026
--------- --------
Net increase (decrease) in cash and cash
equivalents.............................. 4,407 (1,034)
Cash and cash equivalents at beginning of period.. 10,112 6,171
--------- --------
Cash and cash equivalents at end of period........ $ 14,519 $ 5,137
========= =========
Supplemental schedule of noncash investing and
financing activities:
Common stock dividends issued or issuable on
preferred stock............................. $ -- $ 611
========= =========
Cash dividends declared........................ $ -- $ 218
========= =========
Issuance of warrants to purchase common stock
in connection with equity line.............. $ -- $ 248
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest....... $ -- $ 5
========= =========
See accompanying notes to unaudited condensed consolidated financial statements.
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COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003 and 2002
(dollars in thousands)
(Unaudited)
Note 1 -- Basis of Presentation
The unaudited condensed consolidated financial statements included herein
have been prepared by the Company, pursuant to the rules and regulations of the
Securities and Exchange Commission and in accordance with accounting principles
generally accepted in the United States of America. Certain information and
footnote disclosures normally included in the annual consolidated financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations. These unaudited condensed consolidated financial
statements should be read in conjunction with the Company's 2002 audited
consolidated financial statements and footnotes included in its Annual Report on
Form 10-K for the year ended December 31, 2002.
The accompanying unaudited condensed consolidated financial statements
include the results of the Company and its wholly-owned subsidiaries. All
intercompany accounts and transactions have been eliminated in consolidation.
Certain amounts in the 2002 consolidated financial statements have been
reclassified to conform to the 2003 presentation.
In the opinion of the Company's management, the accompanying unaudited
condensed consolidated financial statements have been prepared on a basis
substantially consistent with the audited consolidated financial statements and
contain adjustments, all of which are of a normal recurring nature, necessary to
present fairly the Company's consolidated financial position as of September 30,
2003, their results of operations for the three and nine months ended September
30, 2003 and 2002, and their cash flows for the nine months ended September 30,
2003 and 2002. Interim results are not necessarily indicative of results
anticipated for the full fiscal year.
Statement of Financial Accounting Standards (SFAS) No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation," encourages but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. Accordingly, the Company has elected to account for
stock-based compensation under APB Opinion No. 25, "Accounting for Stock Issued
to Employees" and compensation cost for stock options issued to employees is
measured as the excess, if any, of the market price of the Company's stock at
the date both the number of shares and price per share are known (measurement
date) over the exercise price. Such amounts are amortized on a straight-line
basis over the respective vesting periods of the option grants. Transactions
with nonemployees, in which goods or services are the consideration received for
the issuance of equity instruments, are accounted for on a fair value basis in
accordance with SFAS 123 and related interpretations.
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As set forth below, the pro forma disclosures of net loss allocable to
common stockholders and loss per share allocable to common stockholders are as
if the Company had adopted the fair value based method of accounting in
accordance with SFAS No. 123, as amended by SFAS No. 148, which assumes the fair
value based method of accounting had been adopted:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss)
allocable to common
stockholders:
As reported......... $ 830 $ 356 $ 2,856 $(1,415)
Add: Stock-based
employee
compensation
expenses included
in net loss
allocable to common
stockholders........ -- -- -- --
Less: Stock-based
employee
compensation under
fair value based
method.............. (1,288) (934) (3,825) (2,801)
------ ------ ------- -------
Pro forma........... $ (458) $ (578) $ (969) $(4,216)
====== ====== ======= =======
Basic net income (loss)
per share allocable to
common stockholders:
As reported......... $ 0.07 $ 0.03 $ 0.25 $ (0.13)
====== ====== ======= =======
Pro forma........... $ (0.04) $(0.05) $ (0.08) $ (0.38)
====== ====== ======= =======
Diluted net income (loss)
per share allocable to
common stockholders:
As reported......... $ 0.06 $ 0.03 $ 0.23 $ (0.13)
====== ====== ======= =======
Pro forma........... $ (0.04) $(0.05) $ (0.08) $ (0.38)
====== ====== ======= =======
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Note 2 -- Inventories
Inventories at September 30, 2003 and December 31, 2002 consist of the
following:
2003 2002
---------- ---------
Raw materials....... $ 330 $ 233
Work-in-process..... 50 56
Finished goods...... 962 1,126
---------- ---------
$ 1,342 $1,415
Note 3 -- Line of Credit
The Company has a revolving credit facility with Silicon Valley Bank, which
expires on March 15, 2004. The Company may borrow up to the lesser of $4,000 or
80% of eligible accounts receivable, as defined under the credit facility. The
amount available to the Company is also reduced by outstanding letters of credit
which may be issued under the credit facility in amounts totaling up to $1,500.
On April 1, 2003, the Company secured its expected purchase order commitments
for the next twelve months with a letter of credit for approximately $1,061. As
of September 30, 2003, the letter of credit had been reduced to $592. As the
Company continues to pay down amounts under the letter of credit, the amount
available to it under the Facility will increase. The Company is not obligated
to draw amounts and any such borrowings bear interest, payable monthly,
currently at the prime rate plus 1.0% to 1.5% per annum and may be used only for
working capital purposes. Without the consent of Silicon Valley Bank, the
Company, among other things, shall not (i) merge or consolidate with another
entity; (ii) acquire assets outside the ordinary course of business; or (iii)
pay or declare any cash dividends on the Company's Common Stock. The Company
must also maintain a certain tangible net worth of $5,000, subject to certain
upward adjustments, as a result of profitable operations or additional debt or
equity financings and a minimum of $2,000 in cash at Silicon Valley Bank, net of
borrowings under the credit facility. In addition, the Company has secured its
obligations under the credit facility through the granting of a security
interest in favor of the bank with respect to all of its assets, including
intellectual property. As of September 30, 2003, the Company had no borrowings
outstanding against the credit facility.
Note 4 -- Commitments and Contingencies
During 1999, the Company entered into a three-year co-promotion agreement
with Merck & Co., Inc. for Vioxx(R) under which the Company is committed to
spend up to $1,000 annually for promotional expenses, or such lesser amount as
will be determined by mutual agreement of the parties. In September 2002, the
parties amended this agreement and extended the term thereof to December 31,
2003.
On August 24, 2001, the Company signed an exclusive License Agreement (the
"Atrix License Agreement") with Atrix Laboratories, Inc. to market Atrix's
proprietary dental products, Atridox(R), Atrisorb(R) FreeFlow and Atrisorb(R)-D,
to the United States dental market. Pursuant to the terms of the Atrix License
Agreement, the Company will be required to make certain annual minimum
expenditures for the lesser of $4,000 or 30% of the Company's contribution
margin, as
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defined in the agreement, relating to a specific Atrix product that the Company
markets and the lesser of $2,000 or 30% of the Company's contribution margin, as
defined in the agreement, relating to a separate Atrix product that the Company
markets commencing with fiscal year 2003.
On February 11, 2002, the Company executed a Co-operation, Development and
Licensing Agreement pursuant to which the Company was granted an exclusive,
sublicenseable, transferable license with respect to the Restoraderm(TM) topical
drug delivery system which the Company intends to develop for dermatological
applications. Pursuant to the terms of such agreement, upon the occurrence of
certain events, the Company will be required to pay certain future consulting,
royalty and milestone payments in the aggregate amount of up to approximately
$3,225, of which no more than $2,188 shall be payable prior to January 1, 2004
and of which no more than an additional $1,037 shall be payable prior to January
1, 2005. The Company paid $565 under this Agreement in the nine months ended
September 30, 2003. The term of such agreement is for the life of any patent
that may be issued to the Company for the first product the Company develops
utilizing such technology, or, if such a patent fails to issue, seven years.
On June 10, 2002, the Company executed a Development and Licensing
Agreement with Shire Laboratories, Inc. pursuant to which the Company was
granted an exclusive worldwide license (including the right to sublicense) to
develop, make, have made, use, supply, export, import, register and sell
products for the treatment of various inflammatory disorders. In addition, under
the agreement, certain product development functions shall be performed for the
Company. Also under the agreement, the Company has committed to payments, in
cash or at the Company's option, a combination of cash and the Company's Common
Stock, upon the achievement of certain clinical and regulatory milestones in the
event the Company pursues certain applications of the technology which could
total up to $7,900 in the aggregate. Pursuant to the terms of such agreement,
the Company shall also pay a percentage of certain net sales of products, if
any, utilizing any part of the technology. The Company may terminate the
agreement upon sixty days notice.
In November 2002, the Company commenced an action in the United States
District Court for the Eastern District of New York seeking to prevent West-ward
Pharmaceutical Corporation ("West-ward") from selling 20 mg. capsules of
doxycycline hyclate to treat periodontal disease, which the Company believes
would infringe patents covering the Company's Periostat(R) product. As discussed
below, the Company has settled all pending litigation with West-ward.
In July 2003, the Company commenced an action against United Research
Laboratories/Mutual Pharmaceutical Company ("Mutual") in the United States
District Court for the Eastern District of New York seeking to prevent Mutual
from introducing 20 mg. tablets of doxycycline hyclate into the market in the
United States. The Company's suit alleges infringement on patents to which it is
the exclusive licensee.
In July 2003, Mutual commenced an action against the Company in the United
States District Court for the Eastern District of Pennsylvania. Mutual alleges
that the Company has engaged in an overall scheme to monopolize the market for
low-dose doxycycline products. In
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addition, the suit alleges that the Company has engaged in exclusionary, unfair,
and anticompetitive practices. Mutual seeks an award of treble damages,
injunctive relief, compensatory, punitive and exemplary damages and reasonable
attorneys' fees.
In June 2003, the Company commenced an action and filed a motion for a
preliminary injunction, in the United States District Court for the District of
Columbia seeking to prevent the FDA from approving any application from
West-ward, Mutual or any other marketers of generic drugs, to introduce 20 mg.
tablets or capsules of doxycycline hyclate into the market until the expiration
of the period of market exclusivity and up to a 30 month stay of approvals that
attaches while patent infringement litigation is pending, to which the Company
claims entitlement under the Hatch Waxman Act. West-ward and Mutual intervened
in this action. On July 22, 2003, the Court granted a preliminary injunction
temporarily restraining the FDA from approving any Abbreviated New Drug
Applications ("ANDA") submitted for a generic version of Periostat (doxycycline
hyclate) 20 mg.
Until the United States District Court for the District of Columbia has
made a final ruling on the regulatory status of Periostat, the FDA cannot
approve the ANDAs on file for West-ward's 20 mg. doxycycline hyclate capsule,
Mutual's 20 mg. doxycycline hyclate tablet or any other ANDA for a generic
version of Periostat.
As a result of the ruling in the United States District Court for the
District of Columbia, the Company withdrew its then pending motion for a
temporary restraining order and preliminary injunction in its patent
infringement suit against Mutual, which was filed in the United States District
Court for the Eastern District of New York, although its complaint remains
outstanding.
On November 7, 2003, the Company settled all pending litigation between the
Company and West-ward. In the settlement, West-ward agreed and confessed to
judgment that the Company's Periostat patents are valid and infringed by the
filing of West-ward's ANDA. West-ward also agreed and confessed to judgment that
the Company's Periostat patents would be infringed by the manufacture and sale
of a generic version of Periostat. West-ward consented to a judgment enjoining
West-ward and any party acting in concert with West-ward from making and selling
a generic version of Periostat until the Company's patents expire or are
declared invalid or unenforceable by a court of competent jurisdiction. Finally,
West-ward agreed to withdraw from the FDA case in the District of Columbia. In
connection with this settlement, the Company agreed to pay a portion of
West-ward's actual legal expenses in the amount of $700, which has been
reflected in selling, general and administrative expense in the three months
ended September 30, 2003 and selling, general and administrative - other expense
in the nine months ended September 30, 2003.
The Company anticipates that its future legal costs in these matters
relating to patent infringement and defense will be reimbursed by the Research
Foundation of the State University of New York ("SUNY") pursuant to a Technology
License Agreement with SUNY to the extent that these legal expenses do not
exceed royalties earned by SUNY during that period. Legal costs relating to the
litigation with the FDA and certain anti-trust matters, however, are not
eligible for reimbursement by SUNY. During the three and nine months ended
September 30, 2003, the Company incurred $2,004 and $3,160, respectively, in
legal defense, litigation and
-10-
settlement costs for the aforementioned law suits with West-ward and Mutual,
$448 and $1,292, respectively, of which were deducted from royalties payable to
SUNY during those periods. In the event such cumulative legal costs exceed the
amount of the royalties payable to SUNY, the Company will not be able to recover
such legal costs from SUNY. As of September 30, 2003, the Company has $1,451 in
previously recognized legal expenses available to offset future royalties earned
by SUNY, if any.
Note 5 -- Stock Option Plans
At the Company's 2003 Annual Meeting of Stockholders held on May 20, 2003,
the stockholders of the Company approved a proposal to amend the Company's 1996
Stock Option Plan (the "1996 Stock Option Plan") to increase the maximum number
of shares of the Company's Common Stock available for issuance thereunder from
2,500,000 to 3,000,000 shares and to reserve an additional 500,000 shares of the
Company's Common Stock for issuance in connection with such increase for awards
to be granted under the 1996 Stock Option Plan.
Note 6 -- Succession Plan for Chief Executive Officer
On March 19, 2003, the Company announced that Brian M. Gallagher, Ph.D.,
the Company's chairman, chief executive officer and president, will be leaving
the Company to pursue other interests. Dr. Gallagher has agreed to remain in his
current position until a successor is appointed, and will work as a consultant
for a period of time thereafter to ensure a smooth transition.
The Company has executed an agreement with Dr. Gallagher, pursuant to which
Dr. Gallagher will be compensated for, among other things, his services during
the transition period and to recognize his historical contributions to the
Company. As a result of this agreement, the Company recognized a non-cash
compensation charge relating to certain modifications of Dr. Gallagher's stock
option agreements of approximately $251 during the nine months ended September
30, 2003. The Company has also entered into a consulting agreement with Dr.
Gallagher pursuant to which he will provide consulting services to CollaGenex
for a period of 24 months following the earlier of (i) employment of a new chief
executive officer, (ii) such earlier date as may be determined by the Company's
Board of Directors, or (iii) December 31, 2003.
Note 7 -- Termination of License Agreement
On March 14, 2003, the Company terminated its license agreement with Roche
S.P.A. As a result of the termination of the agreement, during the first quarter
of 2003, the Company accelerated the recognition of the remaining $222 of
unamortized deferred revenue related to the $400 up-front payment received in
1996.
Note 8 -- Incentive Bonus Agreements
The Company entered into Incentive Bonus Agreements with effective dates of
August 27, 2003, with each of David F. Pfeiffer, the Company's Senior Vice
President, Sales and Marketing, and Robert A. Ashley, the Company's Senior Vice
President, Commercial
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Development, pursuant to which each of Mr. Pfeiffer and Mr. Ashley shall
receive, in certain circumstances, an incentive bonus equal to their respective
annual base salary. Pursuant to the terms of each agreement, the incentive bonus
shall be payable only if (i) the executive remains actively employed with the
Company through August 27, 2004, or (ii) the Company terminates the executive's
employment without Cause (as defined in each Agreement) prior to August 27,
2004. The incentive bonuses are being accrued quarterly and shall be payable, if
the requirements are met, in a lump sum on or before September 26, 2004.
Note 9 -- Appointment of Senior Vice President and General Counsel
In connection with the appointment of Paul Lubetkin as senior vice
president and general counsel to the Company, on September 29, 2003, the Company
entered into a Change of Control Agreement and a Severance Agreement with Mr.
Lubetkin. In the event Mr. Lubetkin's employment is terminated as a result of an
Involuntary Termination within 24 months of a Change of Control (each as defined
in the Change of Control Agreement), the Change of Control Agreement provides
for, among other things (i) a lump sum payment of 1.5 times base salary and 1.5
times the average bonus paid for the three fiscal years prior to the Termination
Date (as defined in the Change of Control Agreement), (ii) health coverage and
benefits for a period of 24 months, and (iii) certain
outplacement/administrative support for a period of 18 months. The terms of Mr.
Lubetkin's Severance Agreement provide for certain severance benefits upon an
Involuntary Termination (as defined in the Severance Agreement).
Note 10 -- Subsequent Events
On October 3, 2003, the Company announced that it had entered into
agreements for the sale of 2,000,000 shares of its Common Stock previously
registered on its Registration Statement on Form S-3 for an aggregate purchase
price of $20,000, which generated net proceeds to the Company of approximately
$18,800 after the payment of placement agent fees and related expenses.
-12-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
CollaGenex Pharmaceuticals, Inc. and subsidiaries is a specialty
pharmaceutical company currently focused on providing innovative medical
therapies to the dental and dermatology markets. Our first product,
Periostat(R), is an orally administered, prescription pharmaceutical product
that was approved by the United States Food and Drug Administration in September
1998 and is the first and only pharmaceutical to treat adult periodontitis by
inhibiting the enzymes that destroy periodontal support tissues.
We are marketing Periostat and other pharmaceutical products to the dental
and dermatology communities through our own professional pharmaceutical sales
force of approximately 115 sales representatives and managers. Pursuant to an
exclusive License and Marketing Agreement with Atrix Laboratories, Inc., we
began, in October 2001, to actively market Atrix's proprietary dental products,
Atridox(R) and Atrisorb FreeFlow(R), and, in February 2002, Atrisorb-D(R), to
the United States dental market (the "Atrix Products"). In May 2002, we executed
a sublicense agreement with Altana Inc. to, among other things, market and
distribute, in the United States and Puerto Rico, Pandel(R), a mid-potency
topical corticosteroid product developed by Altana Inc. In March 2003, we
executed a co-promotion agreement with Sirius Laboratories, Inc. pursuant to
which we have begun to jointly market Sirius' AVAR(TM) product line and Pandel
to dermatologists in the United States. We distribute Periostat and Pandel
through drug wholesalers and large retail chains in the United States. Periostat
is also sold through wholesalers and direct to dentists in the United Kingdom
through our wholly-owned subsidiary, CollaGenex International Ltd., and by
distributors and licensees in certain other overseas markets. The Atrix Products
are distributed through specialty distributors who sell these products directly
to dental practitioners in the United States and Puerto Rico. Our sales force
also co-promotes Vioxx(R), a prescription non-steroidal, anti-inflammatory drug
developed by Merck & Co., Inc., in the United States, and, from October 1, 2002
to September 30, 2003, Denavir(R), for Novartis Consumer Health, Inc.
For the year ended December 31, 2002, and for each of the three month
periods ended March 31, 2003, June 30, 2003 and September 30, 2003, we achieved
net income of approximately $902,000, $1.2 million, $1.6 million and $1.2
million, respectively. We have, however, incurred losses in each year from
inception through 2002 and have an accumulated deficit of $71.4 million at
September 30, 2003.
Statements contained or incorporated by reference in this Quarterly Report
on Form 10-Q that are not based on historical fact are "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Forward-looking statements may be identified by the use of
forward-looking terminology such as "may," "will," "expect," "estimate,"
"anticipate," "continue," or similar terms, variations of such terms or the
negative of those terms. This Form 10-Q contains forward-looking statements that
involve risks and uncertainties. Our business of selling, marketing and
developing pharmaceutical products is subject to a number of significant risks,
including risks relating to the implementation of CollaGenex's sales and
marketing plans for Periostat and other products that we market, risks
-13-
inherent in research and development activities, risks associated with
enforcement of our intellectual property rights, including risks relating to the
outcome and consequences of our patent litigation against Mutual Pharmaceutical
Company, risks that the FDA will approve products, such as Mutual's product,
that will compete with and limit the market for Periostat, risks relating to our
litigation with the FDA, risks associated with conducting business in a highly
regulated environment and uncertainty relating to clinical trials of products
under development. CollaGenex's success depends to a large degree upon the
market acceptance of Periostat by periodontists, dental practitioners, other
health care providers, patients and insurance companies. There can be no
assurance that CollaGenex's product candidates (other than the FDA's approval of
Periostat for marketing in the United States, the United Kingdom Medicines
Control Agency's approval of Periostat for marketing in the United Kingdom and
Periostat's marketing approval in Austria, Finland, Switzerland, Ireland,
Israel, Italy, Luxemborg, the Netherlands, Portugal and Canada) will be approved
by any regulatory authority for marketing in any jurisdiction or, if approved,
that any such products will be successfully commercialized by CollaGenex. In
addition, there can be no assurance that CollaGenex will successfully promote
Vioxx, Pandel, Atridox, Atrisorb-FreeFlow, Atrisorb-D or the AVAR product line.
As a result of such risks, those risks set forth in the section entitled
"Additional Risks That May Affect Results" and others expressed from time to
time in CollaGenex's filings with the Securities and Exchange Commission,
CollaGenex's actual results may differ materially from the results discussed in
or implied by the forward-looking statements contained herein. We undertake no
obligation to update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.
Periostat(R), Metastat(R), Dermostat(R), Nephrostat(R), Osteostat(R),
Arthrostat(R), Rheumastat(R), Corneostat(R), Gingistat(R), IMPACS(TM), PS20(R),
The Whole Mouth Treatment(R), Restoraderm(TM) and Dentaplex(R) are United States
trademarks of CollaGenex Pharmaceuticals, Inc. Periostat(R), Nephrostat(R),
Optistat(R), Xerostat(R) and IMPACS(TM) are European Community trademarks of
CollaGenex Pharmaceuticals, Inc. Periostat(R), Nephrostat(R), Optistat(R),
Xerostat(R), IMPACS(R), Dentaplex(R), Restoraderm(R), Dermastat(R),
Periocycline(R), Periostatus(R) and Periostan(R) are United Kingdom trademarks
of our wholly-owned subsidiary, CollaGenex International Ltd. CollaGenex(R),
PS20(R), "C" Logo(R) and The Whole Mouth Treatment(R) are European Community and
United Kingdom trademarks of CollaGenex International Ltd. Periocycline(TM) and
Periostan(TM) are European Community Trademarks of CollaGenex International Ltd.
All other trade names, trademarks or service marks appearing in this Quarterly
Report are the property of their respective owners and are not property of
CollaGenex Pharmaceuticals, Inc. or any of our subsidiaries.
Critical Accounting Policies and Estimates
Management's discussion and analysis of its financial position and results
of operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make judgments and estimates that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. Management believes the critical accounting policies and areas
that require the most significant judgments and estimates to be used in the
preparation of the consolidated financial statements pertain to revenue
recognition.
-14-
We recognize product sales revenue upon shipment, net of estimated returns,
provided that collection is determined to be probable and no significant
obligations remain. Sales revenue from our customers is subject to agreements
allowing limited rights of return, rebates and price protection. Accordingly, we
reduce revenue recognized for estimated future returns, rebates and price
protection at the time the related revenue is recorded. The estimates for
returns are adjusted periodically based upon historical rates of returns,
inventory levels in the distribution channel and other related factors. While
management believes it can make reliable estimates for these matters, unsold
products in these distribution channels may be exposed to expiration.
Accordingly, it is possible that these estimates will change in the future or
that the actual amounts could vary materially from our estimates and that the
amounts of such changes could impact our results of operations, financial
condition and our business. Our contract revenues are fee-based arrangements
where revenue is earned as prescriptions are written. Accordingly, since we
never take title to the product being promoted, no significant obligations exist
beyond the point that the fee is earned and is recognized as revenue.
Since our inception, a portion of our revenue has been generated from
license and distribution agreements for our products. We recognize nonrefundable
signing or license fees that are not dependent on future performance under these
agreements as revenue when received and over the term of the arrangement if we
have continuing performance obligations. Any amounts deferred are amortized to
revenue over the expected performance period of each underlying agreement. The
expected performance period is based on management's best estimate and is
subject to change based on current market conditions. Deferred revenue
represents the portion of up front license payments received that has not been
earned. Milestone revenue from licensing arrangements is recognized upon
completion of the milestone event or requirement if it represents the
achievement of a significant step in the research, development or regulatory
process.
Results of Operations
During the three months ended September 30, 2003, we achieved net product
sales of $12.8 million from the sale of Periostat, Atridox, Atrisorb FreeFlow,
Atrisorb-D and Pandel. In addition, during the three months ended September 30,
2003, we generated $1.1 million in contract revenues mainly from our
co-promotion activities with respect to Vioxx, Denavir and AVAR and $8,000 in
international licensing revenues.
Three Months Ended September 30, 2003 Compared to Three Months Ended
September 30, 2002
Revenues
- --------------------------------------------------------------------------------
Revenues
(dollars in thousands) 2003 Change 2002
- --------------------------------------------------------------------------------
Net Product Sales............... $ 12,797 18.9% $ 10,767
- --------------------------------------------------------------------------------
Contract Revenues............... 1,111 163.3% 422
- --------------------------------------------------------------------------------
License Revenues................ 8 (80.0)% 40
--------- ------- ---------
- --------------------------------------------------------------------------------
Total........................ $ 13,916 23.9% $ 11,229
- --------------------------------------------------------------------------------
-15-
Total revenues during the three months ended September 30, 2003 were $13.9
million, representing a 23.9% increase over total revenues of $11.2 million
during the three months ended September 30, 2002. Such 2003 revenues included
approximately $12.8 million in net product sales of Periostat, Pandel and the
Atrix Products, $1.1 million in contract revenues, which were derived from our
co-promotion of Vioxx, Denavir and AVAR, and $8,000 of international licensing
revenues for Periostat. Our agreement with Novartis Consumer Health, Inc. to
co-promote Denavir expired on September 30, 2003, and we and Novartis mutually
decided not to renew our arrangement with respect to Denavir. Net product sales
increased $2.0 million, or 18.9%, to $12.8 million during the three months ended
September 30, 2003 compared to $10.8 million during the three months ended
September 30, 2002 primarily due to higher Periostat sales and the addition of
the Pandel product line which we began selling direct in July 2002.
Contract revenues for the three months ended September 30, 2003 increased
163.3% to $1.1 million from $422,000 during the three months ended September 30,
2002, primarily due to increased contract revenues relating to our co-promotion
activities with respect to Denavir and the AVAR product line partially offset by
lower Pandel contract revenues earned during 2003.
We recorded $8,000 and $15,000 in licensing revenues for the three months
ended September 30, 2003 and September 30, 2002, respectively, that was
attributable to our recognition of previously received up-front license fees
recognized for various agreements that were deferred and are being recognized as
licensing revenue over the expected performance period of the agreements. We
also recorded licensing revenues of $25,000 during the three months ended
September 30, 2002, that represents milestone fees received from foreign
licensing partners upon the achievement of certain milestones.
Cost of Product Sales
- --------------------------------------------------------------------------------
Cost of Product Sales
(dollars in thousands) 2003 Change 2002
- --------------------------------------------------------------------------------
Cost of Product Sales............ $ 1,907 11.3% $ 1,713
- --------------------------------------------------------------------------------
Percent of Net Product Sales..... 14.9% N/A 15.9%
- --------------------------------------------------------------------------------
Cost of product sales includes product packaging, third-party royalties,
amortization of product licensing fees, and the costs associated with the
manufacturing, storage and stability of Periostat, Pandel and the Atrix
products.
Cost of product sales were $1.9 million, or 14.9% of net product sales
during the three months ended September 30, 2003, compared to $1.7 million, or
15.9% of net product sales during the three months ended September 30, 2002.
During the three months ended September 30, 2003, cost of product sales
increased in absolute dollars as a result of increased product sales. As a
percentage of net product sales, cost of product sales decreased during the
three months ended September 30, 2003, compared to the three months ended
September 30, 2002, primarily due to product price increases for Periostat,
offset in part by higher cost of product sales (as a percentage of net product
sales) for the Pandel product line, launched in July 2002.
-16-
Research and Development
- --------------------------------------------------------------------------------
Research and Development
(dollars in thousands) 2003 Change 2002
- --------------------------------------------------------------------------------
Research and development......... $ 1,777 32.2% $ 1,344
- --------------------------------------------------------------------------------
Percentage of Total Revenues..... 12.8% N/A 12.0%
- --------------------------------------------------------------------------------
Research and development expenses consist primarily of funds paid to third
parties for the provision of services and materials for drug development,
including milestone fees, manufacturing and formulation enhancements, clinical
trials, statistical analysis and report writing and regulatory compliance costs.
Research and development expenses increased $433,000, or 32.2%, to $1.8
million during the three months ended September 30, 2003 from $1.3 million
during the three months ended September 30, 2002.
Development projects conducted during the three months ended September 30,
2003 included our continuing formulation development work for a once-a-day
formulation of Periostat and formulation and stability testing for several
potential products utilizing our licensed Restoraderm(TM) technology, which
totaled $1.0 million and $114,000, respectively. Future development of the
once-a-day technology will be contingent on the outcome of the initial phase of
the project, which should be determined by the end of 2003. If all of the
potential products are successful, additional formulation development expenses
and milestone fees could be as much as $8.6 million through 2006.
Clinical projects totaling $140,000 were conducted during the three months
ended September 30, 2003 and included several Phase IV studies for Periostat in
various dental indications and continued clinical development work relating to
Periostat in dermatological indications and including a Phase III trial in 150
patients to evaluate Periostat for the treatment of rosacea. Until the outcome
of these trials is determined, it is premature to estimate the future costs
associated with the clinical development of Periostat for any indication.
Other research and development expenses incurred during the three months
ended September 30, 2003 included $37,000 in regulatory consulting and legal and
filing fees under the Mutual Recognition Procedure in Europe and $85,000 for
various regulatory costs, including annual FDA filing fees, patent fees and
regulatory expenses in the United States, and $161,000 in manufacturing
development costs for Metastat(R) and the Impacs(TM) compounds. Direct salaries
and other personnel expenses incurred during the three months ended September
30, 2003 were $135,000. Additionally, during such period we incurred $84,000 in
consulting, travel and other office expenses.
Development projects conducted during the three months ended September 30,
2002 included our continuing formulation development work for a once-a-day
formulation of Periostat and formulation and stability testing for several
potential products utilizing our licensed Restoraderm technology, which totaled
$706,000 and $83,000, respectively.
-17-
Clinical projects totaling $176,000 were conducted during the three months
ended September 30, 2002 and included several Phase IV studies for Periostat in
various dental indications, initiation of a 70-patient clinical study to
evaluate the efficacy of Periostat to treat meibomiantis (an ocular condition),
clinical development work relating to Periostat in dermatological indications
and initiation of a Phase III trial in 150 patients to evaluate Periostat for
the treatment of rosacea.
Other research and development expenses incurred during the three months
ended September 30, 2002 included $85,000 in regulatory consulting and filing
fees under the Mutual Recognition Procedure in Europe and $29,000 for various
regulatory costs, including annual FDA filing fees, patent fees, and regulatory
expenses in the United States. Direct salaries and other personnel expenses
incurred during the three months ended September 30, 2002 were $124,000.
Additionally, during such period we incurred $141,000 in consulting, travel and
other office expenses.
Selling, General and Administrative
- --------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands) 2003 Change 2002
- --------------------------------------------------------------------------------
Selling, General and Administrative $ 9,038 21.6% $ 7,431
- --------------------------------------------------------------------------------
Percentage of Total Revenues..... 64.9% N/A 66.2%
- --------------------------------------------------------------------------------
Selling, general and administrative expenses consist primarily of personnel
salaries and benefits, direct marketing costs, professional, legal and
consulting fees, insurance and general office expenses.
Selling, general and administrative expenses increased 21.6% to $9.0
million during the three months ended September 30, 2003 from $7.4 million
during the three months ended September 30, 2002. This increase of $1.6 million
was primarily the result of approximately $1.5 million in additional legal fees
and settlement costs relating to our ongoing litigation, net of reimbursable
legal expenses, $636,000 in additional promotional expenses for the AVAR and
Pandel product lines and a $133,000 increase in other administrative costs,
offset in part by a $725,000 reduction in selling and marketing expenditures for
Periostat and the Atrix Products.
Significant components of selling, general and administrative expenses
incurred during the three months ended September 30, 2003 included $3.8 million
in direct selling and sales training expenses, $2.2 million in marketing
expenses (including advertising and promotion expenditures for Periostat, the
Atrix Products and Pandel and co-promotion expenses relating to Vioxx and AVAR)
and $3.0 million in general and administrative expenses, which include business
development, finance, legal and corporate activities. Significant components of
selling, general and administrative expenses incurred during the three months
ended September 30, 2002 included $3.9 million in direct selling and sales
training expenses, $2.2 million in marketing expenses (including advertising and
promotion expenditures for Periostat, the Atrix Products and co-promotion
expenses relating to Vioxx and Pandel) and $1.3 million in general and
administrative expenses, which include business development, finance and
corporate activities.
-18-
Other Income/Expense
- --------------------------------------------------------------------------------
Other Income/Expense 2003 Change 2002
- --------------------------------------------------------------------------------
Interest income.................. $28,000 55.6% $18,000
- --------------------------------------------------------------------------------
Interest expense................. $ -- (100)% $(3,000)
- --------------------------------------------------------------------------------
Other income..................... $ 8,000 N/A $ --
- --------------------------------------------------------------------------------
Interest income increased to $28,000 for the three months ended September
30, 2003 compared to $18,000 for the three months ended September 30, 2002. This
increase was due to higher average investment balances in 2003. There was no
interest expense for the three months ended September 30, 2003, compared to
$3,000 for the three months ended September 30, 2002. Other income was $8,000
for the three months ended September 30, 2003 compared to other income of zero
for the three months ended September 30, 2002. Such income was attributable to
foreign currency transaction gains experienced in 2003.
Preferred Stock Dividend
Preferred stock dividends included in net income allocable to common
stockholders were $400,000 during each of the three months ended September 30,
2003 and September 30, 2002. Such preferred stock dividends, paid in shares of
our Common Stock through May 11, 2002, and thereafter in cash, are the result of
our obligations in connection with the issuance of our Series D preferred stock
in May 1999. As more fully set forth in the Amended Certificate of Designation,
Preferences and Rights of the Series D Cumulative Convertible Preferred Stock,
after May 11, 2002, we no longer pay dividends on the Series D preferred stock
in shares of our Common Stock at a rate of 8.4%, and we became obligated to pay
such dividends in cash, at a rate equal to 8% per annum.
Nine Months Ended September 30, 2003 Compared to Nine Months Ended
September 30, 2002
Revenues
- --------------------------------------------------------------------------------
Revenues 2003 Change 2002
(dollars in thousands)
- --------------------------------------------------------------------------------
Net Product Sales............... $ 35,917 15.8% $ 31,026
- --------------------------------------------------------------------------------
Contract Revenues............... 2,164 22.3% 1,769
- --------------------------------------------------------------------------------
License Revenues................ 679 319.1% 162
--------- ------ ---------
- --------------------------------------------------------------------------------
Total........................ $ 38,760 17.6% $ 32,957
- --------------------------------------------------------------------------------
Total revenues during the nine months ended September 30, 2003 were $38.8
million, representing a 17.6% increase over total revenues of $33.0 million
during the nine months ended September 30, 2002. Such 2003 revenues included
approximately $35.9 million in net product sales of Periostat, Pandel and the
Atrix Products, $2.2 million in contract revenues, which were derived from our
co-promotion of Vioxx, Denavir and AVAR, and $679,000 in international licensing
revenues for Periostat. Our agreement with Novartis Consumer Health, Inc. to
co-promote Denavir expired on September 30, 2003, and we and Novartis mutually
decided not to renew our arrangement with respect to Denavir. Net product sales
increased $4.9 million, or
-19-
15.8%, to $35.9 million during the nine months ended September 30, 2003 compared
to $31.0 million during the nine months ended September 30, 2002 primarily due
to higher Periostat sales and the addition of the Pandel product line which we
began selling direct in July 2002.
Contract revenues for the nine months ended September 30, 2003 increased
22.3% to $2.2 million from $1.8 million during the nine months ended September
30, 2002, primarily due to increased contract revenues relating to our
co-promotion activities with respect to Denavir and the AVAR product line offset
by lower Pandel contract revenues earned during 2003.
We recorded $32,000 and $45,000 in licensing revenues for the nine months
ended September 30, 2003 and September 30, 2002, respectively, that was
attributable to our recognition of previously received up-front license fees
recognized for various agreements that were deferred and are being recognized as
licensing revenue over the expected performance period of the agreements. We
also recorded licensing revenues of $222,000 and $47,000 during the nine months
ended September 30, 2003 and 2002, respectfully, that represent previously
deferred foreign up-front licensing fees where the recognition of revenue was
accelerated in connection with certain licensing agreements that were mutually
terminated during the respective periods. Additionally, during the nine months
ended September 30, 2003 and 2002, respectively, we recognized $425,000 and
$70,000 in license milestone fees received from foreign licensing partners upon
the achievement of certain milestones.
Cost of Product Sales
- --------------------------------------------------------------------------------
Cost of Product Sales 2003 Change 2002
(dollars in thousands)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Cost of Product Sales............ $ 5,560 13.7% $ 4,891
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Percent of Net Product Sales..... 15.5% N/A 15.8%
- --------------------------------------------------------------------------------
Cost of product sales includes product packaging, third-party royalties,
amortization of product licensing fees, and the costs associated with the
manufacturing, storage and stability of Periostat, Pandel and the Atrix
Products.
Cost of product sales were $5.6 million, or 15.5% of net product sales
during the nine months ended September 30, 2003, compared to $4.9 million, or
15.8% of net product sales during the nine months ended September 30, 2002.
During the nine months ended September 30, 2003, cost of product sales increased
in absolute dollars as a result of increased product sales. As a percentage of
net product sales, cost of product sales decreased as a result of Periostat
price increases, which was offset in part by higher costs of product sales (as a
percentage of net product sales) for the Pandel product line launched in July
2002.
Research and Development
- --------------------------------------------------------------------------------
Research and Development 2003 Change 2002
(dollars in thousands)
- --------------------------------------------------------------------------------
Research and development......... $ 4,397 50.4% $ 2,925
- --------------------------------------------------------------------------------
Percentage of Total Revenues..... 11.3% N/A 8.9%
- --------------------------------------------------------------------------------
-20-
Research and development expenses consist primarily of funds paid to third
parties for the provision of services and materials for drug development,
including milestone fees, manufacturing and formulation enhancements, clinical
trials, statistical analysis and report writing and regulatory compliance costs.
Research and development expenses increased $1.5 million, or 50.4%, to $4.4
million during the nine months ended September 30, 2003 from $2.9 million during
the nine months ended September 30, 2002.
Development projects conducted during the nine months ended September 30,
2003 included our continuing formulation development work for a once-a-day
formulation of Periostat and formulation and stability testing for several
potential products utilizing our licensed Restoraderm technology, which totaled
$1.8 million and $702,000, respectively. Future development of the once-a-day
technology will be contingent on the outcome of the initial phase of the
project, which should be determined by the end of 2003. If all of the potential
products are successful, additional formation development expenses and milestone
fees could be as much as $8.6 million through 2006.
Clinical projects totaling $618,000 were conducted during the nine months
ended September 30, 2003 and included several Phase IV studies for Periostat in
various dental indications and continued clinical development work relating to
Periostat in dermatological indications and including a Phase III trial in 150
patients to evaluate Periostat for the treatment of rosacea. Until the outcome
of these trials is determined, it is premature to estimate the future costs
associated with the clinical development of Periostat for any indication.
Other research and development expenses incurred during the nine months
ended September 30, 2003 included $90,000 in regulatory consulting and legal and
filing fees under the Mutual Recognition Procedure in Europe and $329,000 for
various regulatory costs, including annual FDA filing fees, patent fees and
regulatory expenses in the United States, and $169,000 in manufacturing
development costs for Metastat and the Impacs compounds. Direct salaries and
other personnel expenses incurred during the nine months ended September 30,
2003 were $406,000. Additionally, during such period we incurred $280,000 in
consulting, travel and other office expenses.
Development projects conducted during the nine months ended September 30,
2002 included our continuing formulation development work for a once-a-day
formulation of Periostat and formulation and stability testing for several
potential products utilizing our licensed Restoraderm technology, which totaled
$953,000 and $293,000, respectively.
Clinical projects totaling $704,000 were conducted during the nine months
ended September 30, 2002 and included several Phase IV studies for Periostat in
various dental indications, initiation of a 70-patient clinical study to
evaluate the efficacy of Periostat to treat meibomiantis (an ocular condition),
clinical development work relating to Periostat in dermatological indications
and initiation of a Phase III trial in 150 patients to evaluate Periostat for
the treatment of rosacea.
-21-
Other research and development expenses incurred during the nine months
ended September 30, 2002 included $184,000 in regulatory consulting and filing
fees under the Mutual Recognition Procedure in Europe and $93,000 for various
regulatory costs, including annual FDA filing fees, patent fees, and regulatory
expenses in the United States. Direct salaries and other personnel expenses
incurred during the nine months ended September 30, 2002 were $391,000.
Additionally, during such period we incurred $307,000 in consulting, travel and
other office expenses.
Selling, General and Administrative
- --------------------------------------------------------------------------------
Selling, General and Administrative 2003 Change 2002
(dollars in thousands)
- --------------------------------------------------------------------------------
Selling, General and Administrative -
other......................... $24,578 (3.1)% $25,377
- --------------------------------------------------------------------------------
Selling, General and Administrative -
stock compensation charge........ 251 N/A --
- --------------------------------------------------------------------------------
Subtotal.............................. $24,829 (2.2)% $25,377
- --------------------------------------------------------------------------------
Percentage of Total Revenues.......... 64.1% N/A 77.0%
- --------------------------------------------------------------------------------
Selling, general and administrative - other expenses consist primarily of
personnel salaries and benefits, direct marketing costs, professional, legal and
consulting fees, insurance and general office expenses.
Selling, general and administrative - other expenses decreased 3.1% to
$24.6 million during the nine months ended September 30, 2003 from $25.4 million
during the nine months ended September 30, 2002. This decrease of $800,000 was
primarily the result of a $4.0 million reduction in selling and marketing
expenditures for Periostat and the Atrix Products, offset in part by
approximately $1.7 million in increased legal fees and settlement costs relating
to our ongoing litigation, net of reimbursable legal expenses, and approximately
$1.3 million in additional promotional expenses for AVAR and Pandel.
Significant components of selling, general and administrative - other
expenses incurred during the nine months ended September 30, 2003 included $11.6
million in direct selling and sales training expenses, $6.3 million in marketing
expenses (including advertising and promotion expenditures for Periostat, the
Atrix Products and Pandel and co-promotion expenses relating to Vioxx and AVAR)
and $6.7 million in general and administrative expenses, which include business
development, finance, legal and corporate activities. Significant components of
selling, general and administrative expenses incurred during the nine months
ended September 30, 2002 included $12.0 million in direct selling and sales
training expenses, $8.9 million in marketing expenses (including DTC advertising
and promotion expenditures for Periostat, the Atrix Products and co-promotion
expenses relating to Vioxx and Pandel) and $4.5 million in general and
administrative expenses, which include business development, finance and
corporate activities.
Selling, general and administrative - stock compensation charge of $251,000
during the nine months ended September 30, 2003 resulted from certain
modifications made to stock option agreements held by Brian M. Gallagher, Ph.D.,
our chairman, chief executive officer and
-22-
president, in connection with a Transition Agreement we executed with Dr.
Gallagher on March 18, 2003.
Other Income/Expense
- --------------------------------------------------------------------------------
Other Income/Expense 2003 Change 2002
- --------------------------------------------------------------------------------
Interest income.................. $84,000 52.7% $55,000
- --------------------------------------------------------------------------------
Interest expense................. $ -- (100)% $(5,000)
- --------------------------------------------------------------------------------
Other expense.................... $ 2,000 N/A $ --
- --------------------------------------------------------------------------------
Interest income increased to $84,000 for the nine months ended September
30, 2003 compared to $55,000 for the nine months ended September 30, 2002. This
increase was due to higher average investment balances in 2003. There was no
interest expense for the nine months ended September 30, 2003, compared to
$5,000 for the nine months ended September 30, 2002. Other expense was $2,000
for the nine months ended September 30, 2003 compared to other expense of zero
for the nine months ended September 30, 2002. Such increase was attributable to
foreign currency transaction losses experienced in 2003.
Preferred Stock Dividend
Preferred stock dividends included in net income (loss) allocable to common
stockholders were $1.2 million during each of the nine months ended September
30, 2003 and September 30, 2002. Such preferred stock dividends, paid in shares
of our Common Stock through May 11, 2002, and thereafter in cash, are the result
of our obligations in connection with the issuance of our Series D preferred
stock in May 1999. As more fully set forth in the Amended Certificate of
Designation, Preferences and Rights of the Series D Cumulative Convertible
Preferred Stock, after May 11, 2002, we no longer pay dividends on the Series D
preferred stock in shares of our Common Stock at a rate of 8.4%, and we became
obligated to pay such dividends in cash, at a rate equal to 8% per annum.
Liquidity and Capital Resources
On October 3, 2003, we announced that we had entered into agreements for
the sale of 2,000,000 shares of our Common Stock registered under a registration
statement on Form S-3 to certain institutional investors, at a per share
purchase price of $10.00 for aggregate gross proceeds of $20.0 million, which
generated net proceeds to us of approximately $18.8 million, after the payment
of placement agent fees and related expenses.
On May 12, 1999, we consummated a $20.0 million financing through the
issuance of our Series D preferred stock, which generated net proceeds to us of
$18.5 million. The issuance of the Series D preferred stock was approved by a
majority of our stockholders at our Annual Meeting of Stockholders on May 11,
1999. A portion of the proceeds of the Series D preferred stock financing
consummated in May 1999 were used to repay a $10.0 million senior secured
convertible note provided by one of the investors on March 19, 1999 in
connection with such financing. The remaining proceeds have been used for
general working capital purposes.
-23-
The Series D preferred stock is convertible at any time into shares of our
Common Stock at a current conversion price of $9.89 per share, which conversion
price reflects a decrease from the initial conversion price of $11.00 per share
as a result of certain subsequent equity issuances by us. Such conversion price
is not subject to reset except in the event that we should fail to declare and
pay dividends when due or we should issue new equity securities or convertible
securities at a price per share or having a conversion price per share lower
than the then applicable conversion price of the Series D preferred stock.
During the first three years following issuance, holders of the Series D
preferred stock received dividends payable in shares of fully registered Common
Stock at a rate of 8.4% per annum. Thereafter, and beginning on May 12, 2002, we
began paying such dividends in cash at a rate of 8.0% per annum.
All or a portion of the shares of Series D preferred stock shall, at our
option (as determined by our board of directors), automatically be converted
into fully paid, registered and non-assessable shares of Common Stock, if the
following two conditions are met: (i) the last sale price, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices on
the Nasdaq National Market is at least 200% of the conversion price then in
effect (as of September 30, 2003, such conversion price was $9.89 per share) for
forty consecutive trading days; and (ii) a shelf registration statement is in
effect for the shares of Common Stock to be issued upon conversion of the Series
D preferred stock. Without written approval of a majority of the holders of
record of the Series D preferred stock, we, among other things, shall not: (i)
declare or pay any dividend or distribution on any shares of our capital stock
other than dividends on the Series D preferred stock; (ii) make any loans, incur
any indebtedness or guarantee any indebtedness, advance capital contributions
to, or investments in any person, issue or sell any securities or warrants or
other rights to acquire our debt securities, except that we may incur such
indebtedness in any amount not to exceed $10.0 million in the aggregate
outstanding at any time for working capital requirements in the ordinary course
of business; or (iii) make research and development expenditures in excess of
$7.0 million in any continuous twelve month period, unless we have reported
positive net income for four consecutive quarters immediately prior to such
twelve month period.
We have a revolving credit facility with Silicon Valley Bank which expires
on March 15, 2004. We may borrow up to the lesser of $4.0 million or 80% of
eligible accounts receivable, as defined under the credit facility. The amount
available to us is also reduced by outstanding letters of credit which may be
issued under the credit facility in amounts totaling up to $1.5 million. On
April 1, 2003, we secured our expected purchase order commitments for the next
twelve months with a letter of credit for approximately $1.1 million. As of
September 30, 2003, the letter of credit had been reduced to $592,000. As we
continue to pay down amounts under the letter of credit, the amount available to
us under the Facility will increase. We are not obligated to draw amounts and
any such borrowings bear interest, payable monthly, currently at the prime rate
plus 1.0% to 1.5% per annum and may be used only for working capital purposes.
Without the consent of Silicon Valley Bank, we, among other things, shall not:
(i) merge or consolidate with another entity; (ii) acquire assets outside the
ordinary course of business; or (iii) pay or declare any cash dividends on our
common stock. We must also maintain a certain tangible net worth of $5.0
million, subject to certain upward adjustments, as defined in the amendment, as
a result of profitable operations or additional debt or equity financings and a
minimum of $2.0 million in cash at Silicon Valley Bank, net of borrowings under
the credit facility. In addition, we have secured our obligations under the
credit facility through the granting of a security interest in favor of the
-24-
bank with respect to all of our assets, including our intellectual property. As
of September 30, 2003, we had no borrowings outstanding against the credit
facility.
During 1999, we entered into a three-year co-promotion agreement with Merck
& Co., Inc. for Vioxx under which we are committed to spend up to $1.0 million
annually for promotional expenses, or such lesser amount as will be determined
by mutual agreement of the parties. In September 2002, the agreement was amended
and the term was extended to December 31, 2003.
On August 24, 2001, we signed a License and Marketing Agreement with Atrix
Laboratories, Inc. to market Atrix's proprietary dental products, Atridox,
Atrisorb FreeFlow and Atrisorb-D, to the United States dental market. Pursuant
to the terms of this agreement, among other things: (i) Atrix will manufacture
the dental products for us at an agreed upon transfer price and will receive
royalties on future net sales of the products each calendar year; (ii) we paid
to Atrix a $1.0 million licensing fee to market such products; (iii) we
committed to no less than $2.0 million in advertising and selling expenses
related to the Atrix Products during the fiscal year beginning January 1, 2002
(which requirement we met during 2002); (iv) we agreed to maintain, through
August 2003, a force of no less than ninety full time dental consultants and
divisional and regional managers to make sales and product recommendation calls
on dental professionals (which requirement we have fulfilled); and (v) we agreed
that the Atrix Products would be the subject of a specific number of detail
calls in the United States during 2002, which we achieved. We are also required
to make certain annual minimum expenditures for advertising and promotional
activities over the term of the agreement beginning January 1, 2003, including:
(i) the lesser of $4.0 million or 30% of our contribution margin, as defined in
the agreement, relating to a specific Atrix product that we market, and (ii) the
lesser of $2.0 million or 30% of our contribution margin, as defined in the
agreement, relating to a separate Atrix product that we market.
On February 11, 2002, we executed a Co-operation, Development and Licensing
Agreement pursuant to which we were granted an exclusive, sublicenseable,
transferable license with respect to the Restoraderm topical drug delivery
system which we intend to develop for dermatological applications. Pursuant to
the terms of such agreement, upon the occurrence of certain events, we will be
required to pay certain future consulting, royalty and milestone payments in the
aggregate amount of up to approximately $3.2 million, of which no more than $2.2
million shall be payable prior to January 1, 2004 and of which no more than an
additional $1.0 million shall be payable prior to January 1, 2005. We paid
$565,000 under this Agreement in the nine months ended September 30, 2003. The
term of such agreement is for the life of any patent that may be issued to us
for the first product we develop utilizing such technology, or, if such a patent
fails to issue, seven years.
At September 30, 2003, we had cash and cash equivalents of approximately
$14.5 million, an increase of $4.4 million from the $10.1 million balance at
December 31, 2002. In accordance with investment guidelines approved by our
Board of Directors, cash balances in excess of those required to fund operations
have been invested in short-term United States Treasury securities and
commercial paper with a credit rating no lower than A1/P1. Our working capital
at September 30, 2003 was $12.0 million, an increase of $5.4 million from $6.6
million at December 31, 2002. This increase was primarily attributable to the
operating profitability
-25-
experienced during 2003 and the addition of $1.8 million in cash proceeds from
the exercise of stock options and warrants. During the nine months ended
September 30, 2003, we generated $5.4 million in cash from our operating
activities principally from net income of $4.1 million less changes in certain
assets and liabilities. During the nine months ended September 30, 2003, we
invested $270,000 in capital expenditures, made $900,000 in licensing payments
to Altana Inc. and paid $1.6 million in cash dividends to the holders of our
Series D preferred stock.
We currently believe that projected increases in sales of our United States
marketed products in combination with contract and license revenues, working
capital at September 30, 2003, available cash inflows from our revolving credit
facility with Silicon Valley Bank and the proceeds from our offering of
2,000,000 shares of Common Stock in October 2003 will allow us to fund our
operations, capital expenditures and preferred stock dividend requirements for
at least the next twelve months. At this time, however, we cannot accurately
predict the effect of certain developments on future product sales such as the
degree of market acceptance of our products and technology, competition, the
effectiveness of our sales and marketing efforts and the outcome of our research
and development to demonstrate the utility of Periostat in indications beyond
those already included in the FDA approved label. Contract and license revenues
include receipts from co-promotion agreements and performance milestones. The
continuation of any of these agreements is subject to the achievement of certain
milestones and to periodic review by the parties involved.
We believe that other key factors that could affect our internal and
external sources of cash are:
o Revenues and profits from sales of Periostat and other products and
contracted services;
o The success of our dermatology franchise;
o The success of our pre-clinical, clinical and development programs;
o The receptivity of the capital markets to future financings;
o Our ability to enter into additional strategic collaborations and to
maintain existing and new collaborations and the success of such
collaborations;
o Our ability to meet the covenant requirements under our revolving
credit facility; and
o The outcome and consequences of our patent litigation and our
litigation with the FDA.
Contractual Obligations
Our major outstanding contractual obligations relate to cash dividends on
our outstanding Series D preferred stock, operating leases for our office space
and contractual commitments with our marketing partners for certain selling and
promotional expenses associated with the products
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we are currently detailing. Additionally, we also expect to make certain
inventory purchases from our contract manufacturer of Periostat, guaranteed by
our irrevocable Letter of Credit with Silicon Valley Bank.
Below is a table which presents our contractual obligations and commercial
commitments as of September 30, 2003:
Payments Due by Period
- -------------------------------------------------------------------------------
Three
Months
ending
Contractual December 2004 and 2006 and 2008 and
Obligations Total 31, 2003 2005 2007 after
- -------------------------------------------------------------------------------
Operating
Leases(1)...... $1,974,000 $ 82,000 $ 678,000 $ 684,000 $530,000
- -------------------------------------------------------------------------------
Unconditional
Purchase
Obligations.... $ 592,000(2) $ 592,000(2) -- -- --
- -------------------------------------------------------------------------------
Co-Promotional
Commitments.... (3)(4) (3)(4) (4) (4) (4)
- -------------------------------------------------------------------------------
Cash Dividends
on Series D
Preferred Stock $6,400,000(5) --(5) $3,200,000(5) $3,200,000(5) (5)
- -------------------------------------------------------------------------------
Consulting
Payments....... $ 649,000(6) --(6) $ 649,000(6) -- --
- -------------------------------------------------------------------------------
Total
Contractual
Obligations.... $9,615,000 $ 674,000 $4,527,000 $3,884,000 $530,000
- -------------------------------------------------------------------------------
(1) Such amounts primarily include minimum rental payments for our office
lease in Newtown, Pennsylvania.
(2) Such amount represents purchase order commitments for inventory
purchases with various suppliers.
(3) Under the terms of our Co-Promotion Agreement with Merck & Co., Inc.
for Vioxx, which expires December 31, 2003, we are obligated to spend
up to $1.0 million annually for promotional expenses, or such lesser
amount as will be determined by mutual agreement of the parties.
(4) We will be required to make certain annual minimum expenditures for
advertising and promotional activities amounting to: (i) the lesser of
$4.0 million or 30% of our contribution margin (as defined in the
agreement) relating to a specific Atrix product that we market, and
(ii) the lesser of $2.0 million or 30% of our contribution margin (as
defined in the agreement) relating to a separate Atrix product that we
market. See further information regarding the Atrix License and
Marketing Agreement under the heading "Liquidity and Capital
Resources."
(5) Pursuant to the terms of our Series D Cumulative Convertible preferred
stock and unless earlier converted pursuant to its terms, the holders
of the Series D preferred stock are
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entitled to dividends payable in cash at a rate of 8.0% per annum,
which are declared and paid every six months. See further information
regarding our Series D preferred stock under the heading "Liquidity
and Capital Resources."
(6) Such amount represents consulting payments to be made to Brian M.
Gallagher, our chief executive officer and president, upon his
separation from the Company and pursuant to the terms of a consulting
agreement executed March 18, 2003.
In May 1999, we entered into a lease agreement relating to our office space
in Newtown, Pennsylvania. The lease has an initial term of ten years. Rent is
expected to be approximately $318,000 per year and is subject to market
adjustments in 2004.
On February 11, 2002, we executed a Co-operation, Development and Licensing
Agreement pursuant to which we were granted an exclusive, sublicenseable,
transferable license with respect to the Restoraderm topical drug delivery
system which we intend to develop for dermatological applications. Pursuant to
the terms of such agreement, upon the occurrence of certain events, we will be
required to pay certain future consulting, royalty and milestone payments in the
aggregate amount of up to $3.2 million, of which no more than $2.2 million shall
be payable prior to January 1, 2004 and of which no more than an additional $1.0
million shall be payable prior to January 1, 2005. The term of such agreement is
for the life of any patent that may be issued to us for the first product we
develop utilizing such technology, or, if such a patent fails to issue, seven
years.
On June 10, 2002, we executed a Development and Licensing Agreement with
Shire Laboratories, Inc. pursuant to which we were granted an exclusive
worldwide license (including the right to sublicense) to develop, make, have
made, use, supply, export, import, register and sell products for the treatment
of various inflammatory disorders. In addition, under the agreement, certain
product development functions shall be performed for us. Pursuant to the terms
of such agreement, we will pay to Shire a percentage of certain net sales of
products, if any, utilizing any part of Shire's technology. Also under the
agreement, we have committed to payments in cash, or, at our option, a
combination of cash and our Common Stock, upon the achievement of certain
clinical and regulatory milestones in the event we pursue certain applications
of the technology which could total up to $7.9 million in the aggregate.
Additional Risks That May Affect Results
Important factors could cause our actual results to differ materially from
those indicated or implied by forward-looking statements contained or
incorporated by reference in this Quarterly Report on Form 10-Q. Factors that
could cause or contribute to such differences include those factors discussed
below. If any of the following risks actually occur, our business, financial
condition or results of operations would likely suffer.
We Rely on Periostat for Most of Our Revenue.
During the nine months ended September 30, 2003 and the years ended 2002,
2001 and 2000, Periostat accounted for approximately 82%, 82%, 87% and 84% of
our total net revenues, respectively. Although we currently derive additional
revenue from marketing and/or selling other products (Vioxx, Atridox, Atrisorb
FreeFlow, Atrisorb-D, Pandel and Denavir (through
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September 30, 2003)) and from licensing fees from foreign marketing partners,
our revenue and profitability in the near future will depend on our ability to
successfully market and sell Periostat.
Although we recently settled our litigation with West-ward Pharmaceutical
Corporation ("West-ward"), Mutual Pharmaceutical Company, Inc. ("Mutual")
submitted an application to the FDA for approval of a generic version of
Periostat. Other companies may also have submitted applications for approval of
generic versions of Periostat. We have filed suits to enforce our patent rights
and to compel the FDA to award patent and exclusivity protections that would
prevent a generic drug application from being approved now. On July 23, 2003, we
announced that the United States District Court for the District of Columbia had
granted a preliminary injunction temporarily restraining the FDA from approving
any Abbreviated New Drug Applications ("ANDAs") submitted for any generic
version of Periostat. Until the Court has made a final ruling on our complaint,
the FDA cannot approve the ANDAs on file for West-ward's 20 mg doxycycline
hyclate capsule, Mutual's 20 mg doxycycline hyclate tablet or any other ANDA for
a generic version of Periostat. The Court could make a final ruling at any time
after the briefs are due in mid-December 2003. If the Court decides in favor of
the FDA, the FDA could begin to approve generic drugs immediately therafter.
As a result of the ruling in the District Court of the District of
Columbia, we have withdrawn our motion for a temporary restraining order and
preliminary injunction in our patent infringement suit against Mutual, which was
filed in the District Court of the Eastern District of New York. Our suit
against Mutual, however, remains on file and a motion for injunctive relief can
be filed immediately if required. We cannot be sure, however, that one or more
generic versions of Periostat will not be approved and marketed. If one or more
generic versions of Periostat are approved and marketed, our revenues from
Periostat would significantly decrease, and as result, our business, financial
condition, cash flows and results of operations would be materially adversely
affected.
We May Not Be Able to Maintain Profitability.
From our founding in 1992 through the commercial launch of Periostat in
November, 1998, we had no revenue from sales of our own products. During the
year ended December 31, 2000, we experienced a net loss of approximately $8.8
million. During the year ended December 31, 2001, we experienced a net loss of
approximately $8.1 million. As of September 30, 2003, we have an accumulated
deficit of $71.4 million. Our historical losses have resulted primarily from the
expenses associated with our pharmaceutical development program, clinical
trials, the regulatory approval process associated with Periostat and sales and
marketing activities relating to Periostat. Although we achieved net income of
$902,000, $1.2 million, $1.6 million and $1.2 million for the year ended
December 30, 2002, and each of the three months ended March 31, 2003, June 30,
2003 and September 30, 2003, respectively, we expect to incur significant future
expenses, particularly with respect to the sales and marketing of Periostat, new
products and continuing clinical and manufacturing development for other
indications and formulations of Periostat, and therefore, we cannot be certain
that we will be able to maintain our profitability in the future, if at all.
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Our Competitive Position in the Marketplace Depends on Enforcing and
Successfully Defending Our Intellectual Property Rights.
In order to be competitive in the pharmaceutical industry, it is important
to establish, enforce, and successfully defend patent and trade secret
protection for our established and new technologies. We must also avoid
liability from infringing the proprietary rights of others.
Our core technology is licensed from The Research Foundation of the State
University of New York ("SUNY"), and other academic and research institutions
collaborating with SUNY. Under the license agreement with SUNY (the "SUNY
License") we have an exclusive worldwide license to SUNY's rights in certain
patents and patent applications to make and sell products employing
tetracyclines to treat certain disease conditions. The SUNY License imposes
various payment and reporting obligations on us, and our failure to comply with
these requirements permits SUNY to terminate the SUNY License. If the SUNY
License is terminated, we would lose our right to exclude competitors from
commercializing similar products, and we could be excluded from marketing the
same products if SUNY licensed the underlying technology to a competitor after
terminating the SUNY License.
SUNY owns 31 United States patents and 6 United States patent applications
that are licensed to us. The patents licensed from SUNY expire between 2004 and
2019. Two of the patents are related to Periostat and expire in 2004 and 2007.
Technology covered by these patents becomes available to competitors as the
patents expire.
Since many of our patent rights cover new treatments using tetracyclines,
we may be required to bring expensive infringement actions to enforce our
patents and protect our technology. Although federal law prohibits making and
selling pharmaceuticals for infringing use, competitors and/or practitioners may
provide generic forms of tetracycline for treatment(s) which infringe our
patents, rather than prescribe our Periostat product. Enforcement of patents can
be expensive and time consuming.
We are currently enforcing our patent rights against Mutual, a generic drug
company. Mutual has submitted a request for listing a generic tablet replacement
for Periostat on the New Jersey Formulary. In keeping with our patent
enforcement policy, we have initiated a patent infringement action in the
Eastern District of New York to prevent Mutual from introducing a generic
version of Periostat. A motion for preliminary injunction was filed and served
to prevent Mutual from introducing a generic version of Periostat to the
marketplace. As a result of our litigation against the FDA, we have withdrawn
our motion for a temporary restraining order and preliminary injunction in our
patent infringement suit against Mutual, although our complaint against Mutual
remains outstanding. Mutual has filed various claims against us relating to
these matters. We cannot be certain that Mutual or other third parties will not
receive FDA approval and introduce a competitive generic version of Periostat.
Any infringement or related action involving Mutual or any third party will
likely result in significant expenditures, even if such actions are settled,
require substantial management time and may not be resolved in our favor.
Our success also depends upon know-how, trade secrets, and the skills,
knowledge and experience of our scientific and technical personnel. To that end,
we require all of our employees and, to the extent possible, all consultants,
advisors and research collaborators, to
-30-
enter into confidentiality agreements prohibiting unauthorized disclosure. With
respect to information and chemical compounds we provide for testing to
collaborators in academic institutions, we cannot guarantee that the
institutions will not assert property rights in the results of such tests nor
that a license can be reasonably obtained from such institutions which assert
such rights. Failure to obtain the benefit of such testing could adversely
affect our commercial position and, consequently, our financial condition.
If We Lose Our Sole Supplier of Doxycycline Hyclate or Our Current
Manufacturer of Periostat, Our Commercialization of Periostat Will be
Interrupted, Halted or Less Profitable.
We rely on a single supplier, Hovione International Limited ("Hovione"),
for doxycycline, the active ingredient in Periostat. There are relatively few
alternative suppliers of doxycycline and Hovione produces the majority of the
doxycycline used in the United States. Our current supply agreement with Hovione
expires on May 14, 2006 and thereafter automatically renews for successive
two-year periods unless, 90 days prior to the expiration of any such periods,
either party gives the other party written notice of termination. In addition,
in the event of a default, uncured for 90 days, the non-defaulting party can
terminate the supply agreement effective immediately at the end of such
ninety-day period. We rely on Hovione as our sole supplier of doxycycline and
have no back-up supplier at this time. If we are unable to procure a commercial
quantity of doxycycline from Hovione on an ongoing basis at a competitive price,
or if we cannot find a replacement supplier in a timely manner or with favorable
pricing terms, our costs may increase significantly and we may experience delays
in the supply of Periostat.
We have entered into an agreement with a contract manufacturer,
Pharmaceutical Manufacturing Research Services, Inc. ("PMRS"), for our tablet
formulation for Periostat. Our current arrangement with PMRS has been extended
until the earlier of March 30, 2007 or until a generic 20 mg doxycycline hyclate
tablet is available on the market. Currently, PMRS is the sole third-party
contract manufacturer to supply a tablet formulation of Periostat to us. Any
inability of PMRS to produce and supply product on agreed upon terms could
result in delays in the supply of Periostat. The introduction of a generic 20 mg
doxycycline hyclate tablet could leave us without a manufacturer or force us to
negotiate a new arrangement, possibly on less favorable terms. We intend to
contract with additional manufacturers for the commercial manufacture of
Periostat tablets. We believe, however, that it could take up to one year to
successfully transition from PMRS to a new manufacturer.
Our Products are Subject to Extensive Regulation by the FDA.
Drugs and medical devices generally require approval or clearance from the
FDA before they can be marketed in the United States. Periostat, Vioxx, Pandel
and Atridox have been approved by the FDA as drugs. Sirius Laboratories, Inc.,
the manufacturer of the AVAR products, has not sought FDA approval of those
products because the manufacturer believes that no approval is required. We
cannot be sure that the FDA will not object to the lack of approval for these
products. If the FDA were to assert that the AVAR products need approval, we
might be required to stop marketing such products temporarily or permanently and
might be subject to FDA regulatory action. Atrisorb FreeFlow and Atrisorb-D have
been cleared by the FDA as medical devices. Our drug products under development,
however, will have to be approved by
-31-
the FDA before they can be marketed in the United States. Also, we cannot market
our approved products for new indications until FDA approves the product for
that indication. If the FDA does not approve our products under development or
additional indications for marketed products in a timely fashion, or does not
approve them at all, our financial condition may be adversely affected.
In addition, drug and medical device products remain subject to
comprehensive regulation by the FDA while they are being marketed. The drug and
medical device regulatory schemes differ in detail, but they are essentially
similar. The FDA regulates, for example, the safety, manufacturing, labeling,
and promotion of both drug and medical device products. If we or our partners
who manufacture our products fail to comply with regulatory requirements,
various adverse consequences can result, including recalls, civil penalties,
withdrawal of the product from the market and/or the imposition of civil or
criminal sanctions.
We are, and will increasingly be, subject to a variety of foreign
regulatory regimes governing clinical trials and sales of our products. Other
than Periostat, which has been approved by the Medicines Control Agency for
marketing in the United Kingdom and approved for marketing in Austria, Finland,
Switzerland, Ireland, Israel, Italy, Luxemburg, the Netherlands, Portugal and
Canada, our products in development have not been approved in any foreign
country. Whether or not FDA approval has been obtained, approval of drug
products by the comparable regulatory authorities of foreign countries must be
obtained prior to the commencement of marketing of those products in those
countries. The approval process varies from country to country, and other
countries may also impose post-approval requirements.
A Small Number of Wholesale Customers and Large Retail Chains Account for
the Majority of Our Sales, and the Loss of One of Them, or Changes in Their
Purchasing Patterns, Could Result in Reduced Sales, Thereby Adversely Affecting
Our Operating Results.
We sell most of our products to a small number of wholesale drug
distributors. For the year ended December 31, 2002, sales to Cardinal Health,
Inc., McKesson Corporation and Amerisource-Bergen Corporation, represented
approximately 32%, 24% and 19%, respectively, of our aggregate net product
sales. For the nine months ended September 31, 2003, sales to Cardinal Health,
Inc., McKesson Corporation and Amerisource-Bergen Corporation, represented
approximately 43%, 30% and 19%, respectively, of our aggregate net product
sales. The small number of wholesale drug distributors, consolidation in this
industry or financial difficulties of these distributors could result in the
combination or elimination of warehouses, which could temporarily increase
returns of our products or, as a result of distributors reducing inventory
levels, delay the purchase of our products. In addition, wholesalers may
increase purchase levels in anticipation of future price increases or may
capitalize on volume discounts to acquire inventory. This may cause an
unexpected increase in the level of trade inventories normally maintained by
wholesalers. Although we have developed a plan to manage Periostat trade
inventory levels, this plan may not be effective. If Periostat trade inventory
levels become too high, or if prescription growth of Periostat is lower than
expected by the trade, wholesalers and large retail chains could reduce their
orders for Periostat, which could result in reduced sales of Periostat and
adversely affect our operating results.
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We Cannot Assure You that Our Pursuit of Business in the Dermatology Market
will be Successful.
In January 2002, we announced our plans to expand into the dermatology
market. During 2002, we initiated a 150-patient Phase III clinical trial to
evaluate the use of Periostat to treat rosacea, we announced that we had
licensed a new dermal and transdermal drug delivery technology called
Restoraderm, we executed a sublicense Agreement with Altana Inc. with respect to
the marketing and distribution of Pandel, and in March 2003, we executed a
co-promotion agreement with Sirius Laboratories, Inc. pursuant to which we will
jointly market Sirius' AVAR product line. In addition, we continue to actively
seek product licensing opportunities to enhance our near-term offerings to the
dermatology market. Our future success will depend on, among other things, our
ability to: (i) achieve market acceptance for any of these or future
dermatological offerings; (ii) hire and retain personnel with experience in the
dermatology market; (iii) execute our business plan with respect to this market
segment; and (iv) adapt to technical or regulatory changes once operational.
Furthermore, while we have experience in the sales and marketing of dental
products, we have virtually no experience in dermatology. This market is very
competitive and some of our competitors have substantially greater resources
than we have. New product development is a lengthy, complex and uncertain
process that will require significant attention and resources from management. A
product candidate can fail at any stage of the development process due to, among
other things, efficacy or safety concerns, the inability to obtain necessary
regulatory approvals, the difficulty or excessive cost to manufacture and/or the
infringement of patents or intellectual property rights of others. Furthermore,
the sales of new products may prove to be disappointing and fail to reach
anticipated levels. We therefore cannot assure you that we will be successful in
our pursuit of business in the dermatology market, or that we can sustain any
business in which we achieve initial success.
If Our Products Cause Injuries, We May Incur Significant Expense and
Liability.
Our business may be adversely affected by potential product liability risks
inherent in the testing, manufacturing and marketing of Periostat and other
products developed by or for us or for which we have licensing or co-promotion
rights. We have an aggregate of $10.0 million in product liability insurance for
Periostat, our product candidates and products for which we have licensing or
co-promotion rights. This level of insurance may not adequately protect us
against product liability claims. Insufficient insurance coverage or the failure
to obtain indemnification from third parties for their respective liabilities
may expose us to product liability claims and/or recalls and could cause our
business, financial condition and results of operations to decline.
Because Our Executive Officers, Directors and Affiliated Entities Own
Approximately 23.3% of Our Capital Stock, They Could Influence Our Actions in a
Manner That Conflicts With Our Interests and the Interests of Our Other
Stockholders.
Currently, our executive officers, directors and affiliated entities
together beneficially own approximately 23.3% of the outstanding shares of our
Common Stock or equity securities convertible into Common Stock. As a result,
these stockholders, acting together, or in the case of our preferred
stockholders, in certain instances, as a class, will be able to influence
corporate actions requiring stockholder approval, including the election of
directors. This concentration of
-33-
ownership may have the effect of delaying or preventing a change in control,
including transactions in which our stockholders might otherwise receive a
premium for their shares over then current market prices.
Our Stock Price is Highly Volatile and, Therefore, the Value of Your
Investment May Fluctuate Significantly.
The market price of our Common Stock has fluctuated and may continue to
fluctuate as a result of variations in our quarterly operating results. These
fluctuations may be exaggerated if the trading volume of our Common Stock is
low. In addition, the stock market in general has experienced dramatic price and
volume fluctuations from time to time. These fluctuations may or may not be
based upon any business or operating results. Our Common Stock may experience
similar or even more dramatic price and volume fluctuations that may continue
indefinitely.
The following table sets forth the high and low closing market price per
share for our Common Stock for each of the quarters in the period beginning
January 1, 2000 through September 30, 2003, as reported on the Nasdaq National
Market:
Quarter Ended High Low
------------- ---- ---
March 31, 2000.......... $27.13 $12.63
June 30, 2000........... $15.50 $8.25
September 30, 2000...... $9.88 $8.06
December 31, 2000....... $7.88 $3.13
March 31, 2001.......... $6.00 $4.47
June 30, 2001........... $8.80 $5.06
September 30, 2001...... $10.00 $7.25
December 31, 2001....... $9.50 $7.50
March 31, 2002.......... $12.00 $7.72
June 30, 2002........... $11.65 $5.75
September 30, 2002...... $7.34 $4.70
December 31, 2002....... $9.93 $4.05
March 31, 2003.......... $11.03 $6.66
June 30, 2003........... $13.27 $8.62
September 30, 2003...... $15.84 $10.50
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We had cash equivalents at September 30, 2003 which are exposed to the
impact of interest rate changes and our interest income fluctuates as our
interest rates change. Due to the short-term nature of our investments in money
market funds, the carrying values of our cash equivalents approximate their fair
value at September 30, 2003.
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Item 4. Controls and Procedures.
Our management, with the participation of our chief executive officer and
chief financial officer, evaluated the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of September 30, 2003. In designing and evaluating our disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving their objectives and management necessarily applied its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on this evaluation, our chief executive officer and chief financial
officer concluded that, as of September 30, 2003, our disclosure controls and
procedures were (1) designed to ensure that material information relating to us,
including our consolidated subsidiaries, is made known to our chief executive
officer and chief financial officer by others within those entities,
particularly during the period in which this report was being prepared and (2)
effective, in that they provide reasonable assurance that information required
to be disclosed by us in our reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms.
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended September 30, 2003 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
West-ward Pharmaceutical Corporation Litigation
On November 18, 2002, we filed a complaint and on February 13, 2003, we
filed a preliminary injunction in the District Court for the Eastern District of
New York seeking to prevent West-ward Pharmaceutical Corporation ("West-ward")
from introducing a 20 mg. capsule of doxycycline hyclate into the market in the
United States. We alleged that West-ward had infringed our Periostat patents
under the Hatch-Waxman Act by filing an Abbreviated New Drug Application
("ANDA") for a capsule formulation of Periostat. More specifically, our suit
alleged that West-ward infringed two patents to which we are the exclusive
licensee: U.S. Patent No. 4,666,897 and Re-Issue Patent RE 34,656. The remedies
sought by us included an award of treble damages, costs and reasonable
attorneys' fees.
In a separate action in the United States District Court for the District
of Columbia, we sought and, on July 23, 2003, were granted a preliminary
injunction preventing the FDA from approving generic versions of Periostat,
including West-ward's version. West-ward intervened in that case.
On November 7, 2003, we settled all pending litigation between West-ward
and us. In the settlement, West-ward agreed and confessed to judgment that our
Periostat patents are valid and infringed by the filing of West-ward's ANDA.
West-ward also agreed and confessed to judgment that our Periostat patents would
be infringed by the manufacture and sale of a generic version of Periostat.
West-ward consented to a judgment enjoining West-ward and any party acting in
concert with West-ward from making and selling a generic version of Periostat
until our patents expire or are declared invalid or unenforceable by a court of
competent jurisdiction. Finally, West-ward agreed to withdraw from the FDA case
in the District of Columbia. In connection with the settlement, we agreed to pay
a portion of West-ward's actual legal expenses in the amount of $700,000.
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Item 2. Changes in Securities and Use of Proceeds.
Changes in Securities
The following information relates to all securities of the Company sold by
the Company within the past quarter which were not registered under the
securities laws at the time of grant, issuance and/or sale:
Option Grants
During the third quarter of 2003, we granted stock options pursuant to our
1996 Stock Plan which were not registered under the Securities Act of 1933, as
amended (the "Securities Act"). All of such option grants were granted at the
then current fair value of the Common Stock. The following table sets forth
certain information regarding such grants during the quarter:
Weighted Average
Number of Shares Exercise Price
---------------- --------------
64,150 $10.63
We did not employ an underwriter in connection with the issuance of the
securities described above. We believe that the issuance of the foregoing
securities was exempt from registration under either (i) Section 4(2) of the
Securities Act as transactions not involving any public offering and such
securities having been acquired for investment and not with a view to
distribution, or (ii) Rule 701 under the Securities Act as transactions made
pursuant to a written compensatory benefit plan or pursuant to a written
contract relating to compensation. All recipients had adequate access to
information about the Company.
Item 5. Other Information.
Incentive Bonus Agreements
We entered into Incentive Bonus Agreements with effective dates of August
27, 2003, with each of David F. Pfeiffer, the Company's Senior Vice President,
Sales and Marketing, and Robert A. Ashley, the Company's Senior Vice President,
Commercial Development.
Deloitte & Touche Technology Fast 50 Program
On September 29, 2003, we announced that we had been named to Deloitte &
Touche's Technology Fast 50 Program for the Delaware Valley, a ranking of the 50
fastest growing technology companies in the area. Rankings were based on the
percentage of growth in the fiscal year revenues over five years from 1998
through 2002.
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Sale of Common Stock
On October 3, 2003, we announced that we had entered into agreements for
the sale of 2,000,000 shares of our Common Stock registered under a registration
statement on Form S-3 to certain institutional investors, at a per share
purchase price of $10.00 for aggregate gross proceeds of $20.0 million, which
generated net proceeds to us of approximately $18.8 million, after the payment
of placement agent fees and related expenses.
Appointment of Paul Lubetkin as Senior Vice President and General Counsel
On October 6, 2003, we announced the appointment of Paul Lubetkin to the
newly created position of senior vice president and general counsel to oversee
all of our legal affairs. In connection with such appointment, on September 29,
2003, we entered into a Severance Agreement and a Change of Control Agreement
with Mr. Lubetkin.
Sale of Common Stock by Marquette Venture Partners and OCM Principal
Opportunities Fund
On October 7, 2003, we announced that Marquette Venture Partners II, L.P.,
and OCM Principal Opportunities Fund, L.P., had separately entered into
agreements with certain institutional investors to sell 341,302 shares and
320,000 shares, respectively, of our Common Stock held by them.
Settlement of Litigation with West-ward Pharmaceutical Corporation
On November 10, 2003, we announced that we had settled all pending
litigation between West-ward and us. We sued West-ward and other defendants in
the United States District Court for the Eastern District of New York, alleging
that West-ward infringed our patents for Periostat for the treatment of adult
periodontitis. Our complaint also alleged that West-ward infringed the our
patent rights under the Hatch-Waxman Act by submitting an ANDA with the Food and
Drug Administration, seeking FDA approval to market a generic capsule version of
Periostat.
In a separate action in the United States District Court for the District
of Columbia, we sought and, on July 23, 2003, were granted a preliminary
injunction preventing the FDA from approving generic versions of Periostat,
including West-ward's version. West-ward intervened in that case.
In the settlement, West-ward agreed and confessed to judgment that our
Periostat patents are valid and infringed by the filing of West-ward's ANDA.
West-ward also agreed and confessed to judgment that our Periostat patents would
be infringed by the manufacture and sale of a generic version of Periostat.
West-ward consented to a judgment enjoining West-ward and any party acting in
concert with West-ward from making and selling a generic version of Periostat
until our patents expire or are declared invalid or unenforceable by a court of
competent jurisdiction. Finally, West-ward agreed to withdraw from the FDA case
in the District of Columbia. In connection with the settlement, we agreed to pay
a portion of West-ward's actual legal expenses in the amount of $700,000.
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Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
10.1 Form of Incentive Bonus Agreement executed with each of David F.
Pfeiffer and Robert A. Ashley.
10.2 Severance Agreement executed with Paul Lubetkin.
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32 Certification Pursuant to 18 U.S.C. Section 1350.
(b) Reports on Form 8-K.
On July 14, 2003, we filed a Current Report on Form 8-K under Item 5,
relating to our filing and service of a complaint on United Research
Laboratories/Mutual Pharmaceutical Company.
On July 16, 2003, we filed a Current Report on Form 8-K under Item 5,
relating to our filing and service of a preliminary injunction in
connection with our litigation with United Research
Laboratories/Mutual Pharmaceutical Company.
On July 22, 2003, we furnished a Current Report on Form 8-K under Item
9, containing a copy of our earnings release for the period ended June
30, 2003 (including financial information) pursuant to Item 12
(Results of Operations and Financial Condition).
On July 23, 2003, we filed a Current Report on Form 8-K under Item 5,
relating to our award of a preliminary injunction by the United States
District Court of the District of Columbia.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CollaGenex Pharmaceuticals, Inc.
Date: November 14, 2003 By: /s/ Brian M. Gallagher, Ph.D.
---------------------------------
Brian M. Gallagher, Ph.D.
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2003 By: /s/ Nancy C. Broadbent
---------------------------------
Nancy C. Broadbent
Chief Financial Officer (Principal
Financial and Accounting Officer)
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