Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
------------------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
-----------------
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------- ------------
Commission File Number 0-28308
COLLAGENEX PHARMACEUTICALS, INC.
--------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1758016
- ----------------------------------- --------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
41 University Drive, Newtown, Pennsylvania 18940
- -------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (215) 579-7388
--------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Each Exchange on Which Registered
- --------------------------------- ------------------------------------------
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
- -------------------------------------------------------------------------------
(Title of Class)
Preferred Stock Purchase Rights, $0.01 par value
- -------------------------------------------------------------------------------
(Title of Class)
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 twelve (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 ninety (90) days.
Yes: X No:
------- -------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes: X No:
------- -------
The aggregate market value of the registrant's voting shares of common
stock held by non-affiliates of the registrant on June 30, 2003, based on $13.26
per share, the last reported sale price on the NASDAQ National Market on that
date, was $130.6 million.
The number of shares outstanding of each of the registrant's classes of
common stock, as of March 11, 2004:
Class Number of Shares
----- ----------------
Common Stock, $0.01 par value 14,121,677
The following documents are incorporated by reference into the Annual
Report on Form 10-K: Portions of the registrant's definitive Proxy Statement for
its 2004 Annual Meeting of Stockholders are incorporated by reference into Part
III of this Report.
TABLE OF CONTENTS
------------------
Item Page
---- ----
PART I 1. Business....................................................... 1
2. Properties..................................................... 32
3. Legal Proceedings.............................................. 32
4. Submission of Matters to a Vote of Security Holders............ 34
PART II 5. Market for the Company's Common Equity and Related
Stockholder Matters........................................ 35
6. Selected Consolidated Financial Data........................... 36
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 39
7A. Quantitative and Qualitative Disclosures about Market Risk..... 56
8. Financial Statements and Supplementary Data.................... 57
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 57
9A. Controls and Procedures........................................ 57
PART III 10. Directors and Executive Officers of the Registrant............. 58
11. Executive Compensation......................................... 58
12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................. 58
13. Certain Relationships and Related Transactions................. 58
14. Principal Accountant Fees and Services......................... 58
PART IV 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K................................................... 59
SIGNATURES.................................................................. 60
EXHIBIT INDEX............................................................... 62
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULE......................................................... F-1
-i-
PART I
Item 1. Business.
General
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 dental pharmaceutical to treat adult
periodontitis by inhibiting the enzymes that destroy periodontal support
tissues. Periostat is indicated as an adjunct to scaling and root planing, or
SRP, the most prevalent therapy for adult periodontitis, to promote attachment
level gain and to reduce pocket depth in patients with adult periodontitis.
Adult periodontitis, a chronic disease characterized by the progressive loss of
attachment between the tooth root and the surrounding periodontal structures,
may result in tooth loss if untreated.
We currently market 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 Atrisorb-D(R), to the United States
dental market. In May 2002, we executed a sublicense agreement with Altana Inc.
to market and distribute Pandel(R), a prescription mid-potency topical
corticosteroid product developed by Altana Inc. to dermatologists in the United
States and Puerto Rico. We distribute Periostat and Pandel exclusively through
drug wholesalers 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 dental products are
distributed through a specialty distributor who sells these products directly to
dental practitioners in the United States and Puerto Rico.
Research has shown that certain unique properties of the tetracyclines
discovered during the development of Periostat may be applicable to other
diseases involving inflammation and/or destruction of the body's connective
tissues, including acne, rosacea, meibomianitis and cancer metastasis, among
others. CollaGenex is further evaluating Periostat and a series of novel,
proprietary compounds known as IMPACS(R) (Inhibitors of Multiple Proteases and
Cytokines), to assess whether they are safe and effective in these applications.
Phase I clinical trials for Metastat(R), our lead compound for the treatment of
metastatic cancer, were initiated under the sponsorship of the National Cancer
Institute, or NCI. In Phase I clinical trials, Metastat demonstrated an overall
tumor response rate of 44% in patients with Kaposi's sarcoma, and the NCI is
sponsoring a Phase II clinical trial to continue to evaluate the safety and
efficacy of Metastat in HIV-related Kaposi's sarcoma. We anticipate that the
results of this trial will be available during the second quarter of 2004.
In 2003, we continued to implement our plans to expand into the dermatology
market. A growing number of studies have shown the safety and efficacy of
Periostat to treat
dermatological conditions and diseases, and two of these studies have been
published in peer-reviewed medical journals. There is no FDA or other regulatory
approval for the use of Periostat to treat any dermatological condition or
disease. In September 2001, we announced the results of a 59-patient,
double-blinded, placebo-controlled clinical trial designed to evaluate the
efficacy of Periostat to treat adult patients with acne. The results from this
trial revealed that the patients who were administered Periostat experienced a
greater than 50% reduction in the number of comedones, inflammatory lesions and
total lesions relative to baseline lesion counts, a statistically significant
improvement compared to the patients in the placebo group.
During 2002 and 2003, we conducted a double-blinded, placebo-controlled,
134-patient Phase III clinical trial to evaluate the safety and efficacy of
Periostat in the treatment of rosacea, a dermatological condition that affects
approximately 15 to 20 million patients in the United States. In February 2004,
we announced the positive outcome of that study. Preliminary data analysis
indicated that patients treated with Periostat showed a continuous improvement
during the 16-week course of the study compared to patients on placebo. In the
study, patients on Periostat had a significantly greater reduction in the number
of inflammatory lesions (papules and pustules) compared to patients on placebo.
This improvement was both clinically and statistically highly significant.
Overall clinical disease severity based on the Clinician's Global Severity
Assessment Scale declined significantly in the group of patients treated with
Periostat compared to placebo, with a greater number of patients on Periostat
showing a complete clearing of the disease at 16 weeks compared to those
patients on placebo. In addition, the erythema, or persistent redness of the
skin, in patients in the Periostat group showed a trend towards greater
improvement compared to patients in the placebo group.
In February 2002, we announced that we had licensed a new dermal and
transdermal drug delivery technology called Restoraderm(TM), which we intend to
develop for dermatological applications. Several products based on the
Restoraderm technology have completed preliminary stability studies, and we are
developing plans to launch two products based on this technology by 2007.
Manufacturing arrangements are currently being pursued for the first of these
products, which we expect to launch in 2005. We are actively seeking additional
product licensing opportunities to augment our near-term offerings to the
dermatology market.
In May 2002, we executed a sublicense Agreement with Altana Inc. with
respect to the marketing and distribution of Pandel. Our sales force has been
promoting Pandel to the dermatological community since July 2002.
Our core IMPACS technology is licensed on a perpetual basis from the
Research Foundation of the State University of New York at Stony Brook, or SUNY.
SUNY also conducts research and development on other potential applications of
the core technology on a project basis.
We are a Delaware corporation. We were incorporated and began operations in
1992 under the name CollaGenex, Inc. and changed our name to CollaGenex
Pharmaceuticals, Inc. in April 1996. Our principal executive offices are located
at 41 University Drive, Suite 200, Newtown, Pennsylvania 18940, and our
telephone number is (215) 579-7388.
-2-
In this Annual Report on Form 10-K, the terms "CollaGenex," "we," "us" and
"our" includes CollaGenex Pharmaceuticals, Inc. and its subsidiaries.
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), Dentaplex(R), Lytra(TM),
Periostat-MR(TM) and Xerostat(TM) 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), Periocycline(R), Periostatus(R) and Periostat-SR(R) are United
Kingdom trademarks of our wholly-owned subsidiary, CollaGenex International Ltd.
CollaGenex(R), PS20(R), Dermastat(R), Periostan(R), "C" Logo(R) and "The Whole
Mouth Treatment" Logo(R) are European Community and United Kingdom trademarks of
CollaGenex International Ltd. Periocycline(TM), Restoraderm(TM) and
Periostat-SR(TM) are European Community Trademarks of CollaGenex International
Ltd. All other trade names, trademarks or service marks appearing in this Annual
Report are the property of their respective owners and are not property of
CollaGenex Pharmaceuticals, Inc. or any of our subsidiaries.
Products and Product Agreements
Our Current Marketed Products
Our current proprietary and licensed products are summarized below:
- -----------------------------------------------------------------------------------------------
Products Territory Where Marketed Marketing Partner
- -----------------------------------------------------------------------------------------------
Periostat United States and Puerto Rico Not applicable
- -----------------------------------------------------------------------------------------------
Periostat United Kingdom CollaGenex International Ltd.
- -----------------------------------------------------------------------------------------------
Periostat Israel Taro Pharmaceuticals, Inc.
- -----------------------------------------------------------------------------------------------
Periostat Portugal ISDIN S.A.
- -----------------------------------------------------------------------------------------------
Periostat Austria Willovonseder & Marchesani Ges.m.b.H & Co.
KG
- -----------------------------------------------------------------------------------------------
Periostat Switzerland Karr Dental, Inc.
- -----------------------------------------------------------------------------------------------
Periostat Canada Pharmascience, Inc.
- -----------------------------------------------------------------------------------------------
Atridox United States and Puerto Rico Atrix Laboratories, Inc.
- -----------------------------------------------------------------------------------------------
Atrisorb FreeFlow United States and Puerto Rico Atrix Laboratories, Inc.
- -----------------------------------------------------------------------------------------------
Atrisorb-D United States and Puerto Rico Atrix Laboratories, Inc.
- -----------------------------------------------------------------------------------------------
Pandel United States and Puerto Rico Altana, Inc.
- -----------------------------------------------------------------------------------------------
-3-
Periostat
Adult periodontitis is a chronic disease characterized by the progressive
loss of attachment between the periodontal ligament and the surrounding alveolar
bone, ultimately resulting in tooth loss. According to industry data, in the
United States alone, an estimated one-third of all adults, or approximately 67
million people, suffer from some form of periodontal disease. Approximately 13
million people seek professional treatment annually for periodontal disease,
resulting in over 15 million periodontal procedures and annual expenditures of
approximately $6.0 billion, primarily for procedures and surgeries performed by
a periodontist or a dental professional.
The most prevalent therapy for adult periodontitis is SRP, a mechanical
procedure that removes bacteria deposits called plaque from tooth and root
surfaces above and below the gum line. Periostat is the first orally
administered, systemically delivered pharmaceutical indicated as an adjunct to
SRP to promote attachment level gain and to reduce pocket depth in patients with
adult periodontitis. The Proceedings of the American Academy of Periodontology
2003 Workshop on Contemporary Sciences in Clinical Periodontics, published
January 22, 2004, set forth a detailed report and summary by leading United
States academic and clinical periodontology experts who concluded that the
peer-reviewed scientific evidence strongly supports the use of Periostat as an
adjunct to conventional therapy, such as SRP, in the management of chronic
periodontitis.
Periostat, a 20 mg dose of doxycycline hyclate, is a unique
sub-anti-microbial dosage strength that suppresses the chronic and progressive
tissue degradation characteristic of periodontitis without exerting any
anti-microbial effect. Doxycycline is an active ingredient of several FDA
approved drugs and has been in use, at higher dosages, for approximately 35
years, for the treatment of microbial infections and, along with other
tetracyclines, has a well established safety record. Periostat is intended to be
taken orally by the patient between dental visits. Periostat's mechanism of
action is believed in part to be through the down-regulation of the activity of
collagenases, enzymes that belong to a broad class of enzymes known as matrix
metalloproteinases. Collagenase is excessively produced as a result of
inflammation resulting from bacterial infection in the gums. In September 1998,
the FDA granted United States marketing approval for Periostat as an adjunct to
SRP to promote attachment level gain and reduce pocket depth in patients with
adult periodontitis. Periostat was made available for prescription use in
November 1998 and was fully launched commercially in January 1999. Since January
1999, more than 3.0 million Periostat prescriptions have been filled and over
40,000 dentists have written a Periostat prescription. Periostat tablets are
manufactured for us by Pharmaceutical Manufacturing Research Services, Inc., a
contract manufacturing company. We intend to supply Periostat tablets to our
foreign marketing partners upon receipt of requisite regulatory approvals, if at
all, for distribution in countries other than the United States and the United
Kingdom.
We currently actively sell Periostat in the United States and the United
Kingdom and our partners have begun initial sales of Periostat in Israel,
Portugal, Austria, Switzerland and Canada. We also have other marketing and
distribution partnerships for the sale of Periostat in various foreign
countries, subject to regulatory approval.
-4-
Atridox, Atrisorb FreeFlow and Atrisorb-D
Pursuant to the terms of an exclusive License and Marketing Agreement that
we executed with Atrix Laboratories, Inc. in August 2001, we obtained the right
to market, sell and distribute Atrix's proprietary dental products, Atridox,
Atrisorb FreeFlow and Atrisorb-D to the United States dental community. We
believe that these products generally complement Periostat in the treatment of
adult periodontitis.
Atridox is a locally-applied, anti-microbial therapy for the treatment of
chronic adult periodontitis. Atridox uses Atrix's patented drug delivery
technology, Atrigel(R), for the targeted delivery of doxycycline, which has been
shown to reduce the levels of bacteria in the periodontal pocket. Atridox is a
gel that is placed into affected periodontal pockets by a dental professional
and resorbs over a two week period. In pivotal double-blinded,
placebo-controlled clinical trials conducted by Atrix, the administration of
Atridox was shown to increase attachment level between the gums and the teeth
and decrease periodontal pocket depth in patients with adult periodontitis.
Atrisorb FreeFlow is a guided tissue regeneration, or GTR, barrier product
used in the surgical treatment of periodontal defects to help regenerate tissue.
In periodontal surgery, a section of the gums called a flap is cut away from the
underlying bone structure to allow the periodontist to repair the periodontal
support structure. When the flap is subsequently repositioned, a membrane
barrier product such as Atrisorb FreeFlow is placed between the flap and the
bone to prevent the downgrowth of epithelial tissues, which interferes with the
re-attachment of the gums to the teeth.
Atrisorb-D is the first GTR barrier product to incorporate an antibiotic,
which has been shown to reduce the incidence of infections during GTR
procedures.
Under the terms of our License and Marketing Agreement with Atrix, we
committed to: (i) expend no less than $2.0 million in advertising and selling
expenses related to the Atrix products during the fiscal year beginning January
1, 2002, during which year we met this requirement; (ii) maintain, for a period
of 24 months, a force of no less than 90 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 (iii) making
the Atrix products 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. These annual
requirements were met by us in 2003. In 2003, we and Atrix agreed to share
funding for training and maintaining a corps of dental hygienists who would
serve as part-time, professional sales associates in the dental market, with a
specific focus on the Atrix products. This 2003 addendum will terminate on
December 31, 2004, unless extended by Atrix and us.
-5-
The License and Marketing Agreement terminates incrementally with respect
to each Atrix product, upon each successive expiration date of the patent
protection afforded to such product. We may terminate the License and Marketing
Agreement at any time, with or without cause, upon twelve (12) months prior
written notice to Atrix. Furthermore, either party may terminate the agreement
upon the occurrence of certain conditions, as more fully set forth in the
License and Marketing Agreement.
Pandel
On May 24, 2002, we executed a Sublicense Agreement with Altana Inc., the
United States subsidiary of Altana Pharma AG, pursuant to which we were granted
the exclusive right to market, advertise, promote, distribute, offer for sale
and sell, in the United States and Puerto Rico, Pandel Cream, a mid-potency
topical corticosteroid that is indicated for the relief of mild-to-moderate
inflammatory disorders of the skin in adults, such as atopic dermatitis and
psoriasis. We had detailed Pandel on a co-promotional basis with Altana since
October 2001. Altana currently licenses such rights from Taisho Pharmaceutical
Co., Ltd., a company organized and existing under the laws of Japan. Pursuant to
the terms of such agreement, we agreed to pay Altana an aggregate sublicense fee
of $1.7 million, $800,000 of which was paid in June 2002 and $900,000 of which
was paid in May 2003. We purchase from Altana all Pandel products to be sold and
are required to pay Altana a royalty fee equal to a percentage of the net sales
of Pandel.
Vioxx
Pursuant to a Co-Promotion Agreement we executed with Merck in September
1999, we received the exclusive right to co-promote Vioxx, a prescription
strength non-steroidal anti-inflammatory drug that was approved by the FDA on
May 20, 1999 to relieve osteoarthritis and manage acute pain in adults,
including dental pain. The agreement provided for certain payments by Merck to
us upon sales of Vioxx to the dental community. On September 23, 2002, we
executed an amendment, extension and restatement of our Co-Promotion Agreement
with Merck with respect to Vioxx. In accordance with that amendment, extension
and restatement, our agreement with Merck automatically expired on December 31,
2003. We will continue to earn residual contract revenues under the co-promotion
agreement with Merck through December 2005.
AVAR
In March 2003, we executed co-promotion agreements with Sirius
Laboratories, Inc. pursuant to which we jointly marketed Sirius' AVAR(TM)
product line and Pandel to dermatologists in the United States. These agreements
were mutually terminated on December 31, 2003. We do not expect contract
revenues from AVAR beyond this date.
Denavir
Denavir is an FDA-approved topical antiviral cream used for the treatment
of recurrent cold sores in adults. We marketed Denavir to the dental community
under a Co-Promotion Agreement that we executed with SmithKline Beecham Consumer
Healthcare in October 1998, that provided for certain payments by SmithKline
Beecham to us. Following the acquisition of
-6-
SmithKline Beecham by Novartis Consumer Health, Inc., Novartis terminated this
Co-Promotion Agreement effective April 13, 2001.
On October 1, 2002, we entered into a Product Detailing Agreement with
Novartis Consumer Health, Inc. pursuant to which we co-promoted Denavir to our
target dentists in the United States and received detailing fees and performance
incentives from Novartis Consumer Health, Inc. Our agreement with Novartis to
co-promote Denavir expired on September 30, 2003, and we and Novartis decided
not to renew our arrangement with respect to Denavir. We do not expect to earn
contract revenues for Denavir beyond 2003.
Sales and Marketing
We market and sell our dental and dermatological products in the United
States through a dedicated sales force comprised of approximately 115 sales
representatives and managers. We currently market Periostat in certain foreign
markets, either through our wholly-owned subsidiary, CollaGenex International
Ltd., or through marketing and distribution partnerships with companies in these
markets, and we intend to market Periostat in additional foreign markets upon
receipt of all requisite regulatory approvals. We currently actively sell
Periostat in the United States and the United Kingdom and our partners have
begun initial sales of Periostat in Israel, Portugal, Austria, Switzerland and
Canada. We currently have such agreements with foreign companies, subject to
requisite regulatory approvals, covering Japan, Spain and Greece.
Typically, our foreign marketing and distribution agreements provide for
milestone payments upon the achievement of various regulatory and commercial
events as well as supply agreements for manufactured product.
United States
Our field sales organization is currently comprised of one regional
manager, eleven district managers and approximately 103 full-time equivalent
sales representatives. Each full-time equivalent sales representative is
responsible for covering a territory that includes approximately 100 dentists
and periodontists that are believed to be potential high volume prescribers of
Periostat based on the estimated number of scaling and root planings performed
in their respective practices. Additionally, each representative calls on
approximately 50 dermatology offices that have high potential for prescribing
Pandel. In accordance with legal and regulatory requirements, our
representatives also provide peer-reviewed scientific literature about the
safety and use of Periostat to treat dermatological conditions and diseases.
Our field sales organization currently details Periostat, Atridox, Atrisorb
FreeFlow and Atrisorb-D, to dental professionals, and Pandel to dermatological
professionals.
We believe that our dental sales effort is distinguished from typical
dental promotion by our focus on education and the clinical benefits of
pharmaceutical dentistry, a new approach to treating dental diseases.
Accordingly, we produce educational marketing materials, detail aids and product
samples that are used extensively by our representatives in their presentations
to dentists. Clinical reprints and video presentations are also provided. We
believe that peer-to-peer communications are vital to increasing the acceptance
of Periostat and, therefore, we
-7-
arrange speaking engagements and teleconferences where Periostat advocates share
their experiences with other dental professionals.
Sales training is an important component of our sales and marketing
efforts. New representatives receive four weeks of field training and two weeks
of intensive office training in periodontal disease, host response, dermatology,
territory management and selling skills. Training continues at district-level
meetings throughout the year. In order to provide an integrated dental and
dermatology product line and leverage our sales and marketing organization, we
are actively seeking to in-license or acquire other high-quality therapeutic
dental and dermatology products.
International
We are establishing relationships with key partners to market and sell
Periostat internationally, upon receipt of the requisite foreign regulatory
approvals. In 1996, we executed a manufacturing and distribution agreement with
Roche S.P.A. (formerly Boehringer Mannheim Italia) pursuant to which Roche
S.P.A. had the exclusive right to market Periostat in Italy, San Marino and The
Vatican City pending requisite regulatory approval. In 1997, we announced that a
Marketing Authorization for Approval was filed for Periostat by Roche S.P.A.
with the Italian Ministry of Health. Due to delays incurred in the review of
national filings, Roche S.P.A. withdrew the Marketing Authorization for Approval
in Italy, and Italy was included under the pan-European Mutual Recognition
Procedure, which we filed in June 2001. In February 2002, we received
provisional approval to market Periostat in Italy. In June 2002, we received
final approval to market Periostat in Italy. Subsequent to this approval, we
were notified by Roche that due to changes in Roche's local market strategy,
Roche was not going to launch Periostat in the Italian market. In January 2003,
we attempted to reach agreement with Roche regarding compensation for
outstanding milestone payments. In March 2003, we terminated our agreement with
Roche and notified them of our intent to take the matter to arbitration as is
provided for in our agreement with Roche. In June 2003 we received $425,000 in
outstanding milestone payments which settled all outstanding obligations due
from Roche. We currently do not have a licensing partner for Periostat in Italy.
In October 1998, we announced that a Marketing Authorization Application
had been filed with the United Kingdom Medicines Control Agency with respect to
Periostat. A capsule formulation of Periostat was approved by the United Kingdom
Medicines Control Agency in February 2000, and we launched a modest direct
marketing effort in the United Kingdom to dentists through our United Kingdom
subsidiary, CollaGenex International Limited. Sales of Periostat capsules
commenced in the United Kingdom in September 2000. In December 2000, the United
Kingdom Medicines Control Agency approved a tablet formulation of Periostat, and
in June 2001, we applied for the registration of Periostat tablets with the
European Union Member States and Norway under the Mutual Recognition Procedure,
with the United Kingdom Medicines Control Agency acting as our Reference Member
State.
Under the Mutual Recognition Procedure, once marketing approval for a
pharmaceutical is granted by one European Member State, such state then acts as
a Reference Member State, and assists in expediting the review and approval of
the pharmaceutical in other European Member States.
-8-
In February 2002, we received provisional approval for the marketing of
Periostat from seven European Member States including Austria, Finland, Ireland,
Italy, Luxembourg, the Netherlands and Portugal. In April 2002, we announced
that we received the final Marketing Authorizations from the Ministries of
Health in Austria and Finland. In June 2002, we announced that we had received
final Marketing Authorizations from the Ministries of Health in the Netherlands
and Portugal. In June 2002 we received final approval to market Periostat in
Ireland and Italy.
We cannot be certain that we will achieve other foreign regulatory
approvals or will be successful in marketing Periostat in the United Kingdom or
other European countries.
We executed a licensing agreement with Pharmascience Inc. in June 1999
pursuant to which Pharmascience will market and distribute Periostat in Canada.
In the fourth quarter of 1999, Pharmascience submitted an application to the
Canadian Therapeutic Products Program of Health Canada for Canadian marketing
approval of a capsule formulation of Periostat which was approved in March 2003.
In August 2003, Pharmascience launched Periostat in Canada and accordingly, we
began recognizing royalty income on Pharmascience net product sales. Future
milestones fees will be due from Pharmascience upon individual provincial
formulary approval expected in 2004.
On May 2, 2000, we announced that we had executed an exclusive marketing
and distribution agreement with ISDIN S.A., a joint venture between the Spanish
companies Laboratorios del Dr. Esteve S.A. and Antonio Puig S.A., for the
marketing and distribution of Periostat tablets in Spain, pending requisite
regulatory approval, and Portugal, where we have received such regulatory
approval and began recording sales in June 2003. Such agreement was subsequently
extended, granting ISDIN S.A. the right to market and distribute Periostat in
Greece, pending requisite regulatory approval.
On June 9, 2000, we announced that we had executed marketing and
distribution agreements with Willvonseder & Marchesani Ges.m.b.H & Co. KG, a
Vienna-based company and Karr Dental Ltd., a Zurich-based company, with respect
to the marketing and distribution of Periostat tablets in Austria and
Switzerland, respectively. In April 2002, Periostat received regulatory approval
under the Mutual Recognition Procedure for marketing in Austria. In December
2002, we made our first sales of Periostat to Willvonseder & Marchesani
Ges.m.b.H and the product was launched in Austria by them in April 2003. The
regulatory authorities in Switzerland granted final approval for Periostat in
October 2003 and we have made our first shipment of product to Karr Dental in
January 2004.
On August 9, 2000, we announced that we had executed an exclusive marketing
and supply agreement with Showa Yakuhin Kako Co. Ltd., a Japanese company, with
respect to the marketing and supply of Periostat tablets in Japan, pending
requisite regulatory approval. Showa continues to work with the regulatory
authorities in Japan to establish the appropriate clinical development program
in order to gain regulatory approval for Periostat in Japan.
On August 24, 2000, we announced that we had executed an agreement for the
marketing and distribution of Periostat in Israel with Taro International Ltd.,
a wholly-owned subsidiary of Taro Pharmaceutical Industries Limited, an Israeli
company. This agreement provides for the
-9-
payment of milestone fees to us associated with the regulatory approvals of
Periostat. In February 2002, the Israeli authorities notified Taro with respect
to the provisional approval of Periostat in Israel. In May 2002, we announced
that the Israeli Ministry of Health had granted a Marketing Authorization to
Taro. In October 2002, we made initial sales of Periostat and Taro formerly
launched the product in Israel in January 2003. We have made additional sales to
Taro in 2003.
On January 30, 2001, we announced that we had signed an exclusive Middle
East Export Marketing Agreement with Pharma Med Inc. to distribute and manage
the introduction of Periostat in certain Middle Eastern countries, pending
requisite regulatory approval. In January 2004, we informed Pharma Med that we
elected not to renew such arrangement.
In November 2001, we terminated our distribution and marketing agreement
for Germany with Hain Diognostika GmbH due to Hain's failure to fulfill its
obligations under the agreement. We signed a settlement agreement with Hain in
November 2002 with respect to Hain's non-payment of milestone fees due to
CollaGenex. We currently do not have a licensing partner for Periostat in
Germany.
In February 2002, we announced that we had contracted with Dexcel-Dental, a
division of Dexcel-Pharma Limited, to promote Periostat to the dental profession
in the United Kingdom and, upon receipt of final regulatory approval, the
Republic of Ireland. In October 2002, we provided Dexcel-Dental with a formal
termination notice of our agreement. During 2003, we and Dexcel-Pharma commenced
non-binding mediation to resolve their dispute regarding the termination of the
agreement. In March, 2004, we and Dexcel-Pharma agreed to settle the dispute and
resolve outstanding invoices from Dexcel-Pharma. We continue to market Periostat
in the United Kingdom through our wholly-owned subsidiary, CollaGenex
International Ltd.
Manufacturing, Distribution and Suppliers
In 1995, we entered into a supply agreement with Hovione International
Limited pursuant to which the active ingredient in Periostat, doxycycline
hyclate, is supplied to us by Hovione from its offshore facilities. Hovione
supplies a substantial portion of the doxycycline used in the United States from
two independent facilities, providing for a back-up supply in the event that one
facility is unable to manufacture. The initial term of the supply agreement
expired on January 25, 2000 and, pursuant to an addendum to that agreement, the
term was extended to 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 that remains 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.
On September 26, 2000, we entered into a Service and Supply Agreement with
a contract manufacturer, Pharmaceutical Manufacturing Research Services, Inc.,
for the tablet formulation of Periostat. Our current arrangement with
Pharmaceutical Manufacturing Research Services 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, Pharmaceutical Manufacturing Research
Services is
-10-
the sole third-party contract manufacturer to supply a tablet formulation of
Periostat to us. We intend to contract with additional manufacturers for the
commercial manufacture of Periostat tablets. Pharmaceutical Manufacturing
Research Services is required to comply with current good manufacturing
practices, or cGMP, requirements.
In November 1998, we executed a Distribution Services Agreement with
Cardinal Health Specialty Pharmaceutical Services, or SPS, pursuant to which SPS
acts as our exclusive logistics provider for Periostat in the United States and
Puerto Rico. Under this agreement, SPS warehouses and ships Periostat and Pandel
from its central distribution facility near Nashville, Tennessee to wholesalers
that distribute our products to pharmacies throughout the United States for
prescription sale to patients. SPS also provides various customer and financial
support services to us, including billing and collections, contract pricing
maintenance, cash application, chargeback processing and related reporting
services. The Distribution Services Agreement had an initial term of three years
with automatic renewal for successive one-year periods unless notice of
termination was provided by either party 90 days prior to expiration. We
negotiated a three-year extension of such agreement having similar terms to the
original agreement with an effective date of March 1, 2002.
In February 2002, we executed a Wholesale Service Agreement effective
November 2001 with National Specialty Services, Inc., now known as Cardinal
Health Specialty Pharmaceutical Distribution, or SPD, pursuant to which SPD acts
as our non-exclusive authorized distributor of Atridox, Atrisorb FreeFlow and
Atrisorb-D. Under this agreement, SPD will also provide certain additional
services, including marketing, sales detail report production, contract
administration and chargeback processing. The Wholesale Service Agreement has an
initial term of three years and shall renew automatically for successive
one-year periods unless notice of termination is provided by either party 90
days prior to expiration.
We do not have the resources, facilities or capabilities to manufacture any
of our products or product candidates. We have no current plans to establish a
manufacturing facility. We expect that we will be dependent, to a significant
extent, on contract manufacturers for commercial scale manufacturing of our
products or product candidates in accordance with regulatory standards.
We cannot be certain that we will be able to enter into additional, or
maintain existing manufacturing, distribution or supply agreements on acceptable
terms, if at all. In the event that we are unable to obtain sufficient
quantities of doxycycline hyclate or Periostat on commercially reasonable terms,
or in a timely manner, or if our suppliers fail to comply with cGMP or if our
distributors are unable to ship or support our products, our business, financial
condition and results of operations may be materially adversely affected.
Customers/Backlog
During 2003, net product sales to each of Cardinal Health, Inc., McKesson
Corporation and Amerisource-Bergen Corporation accounted for 43%, 31% and 20%,
respectively, of our aggregate net product sales. As is common practice in the
pharmaceutical industry, wholesalers may become very speculative in their
purchasing practices in anticipation of product price increases. Accordingly, we
may limit, fulfill or delay shipment of customer purchase orders
-11-
depending on the availability of product and other factors necessary to operate
our business efficiently. At December 31, 2003, there were open customer
purchase orders with an aggregate value of approximately $800,000. These orders
were shipped complete during January 2004.
Research and Development
Overview
Our research and development activities are conducted primarily by third
parties including contract research organizations and academic and government
institutions. The main focus of these activities is the identification and
development of novel tetracycline-based compounds for application in a variety
of inflammatory and tissue-destructive disorders. Other than Periostat, the most
advanced program involves Metastat, our lead compound for treating metastatic
cancer.
Major research programs currently being conducted by us include: (i) the
clinical development of the sub-antimicrobial dose of doxycycline for the
treatment of rosacea, perioral dermatitis (a skin condition characterized by
inflammatory lesions and redness around the mouth frequently associated with the
use of topical steriods) and meibomianitis (a disorder characterized by "dry
eye"); (ii) the development of a "once-a-day" formulation of Periostat
(Periostat MR); and (iii) limited support for the conduct of exploratory studies
in the utility of Metastat (COL-3) as a treatment for soft tissue sarcoma,
periodontitis and rosacea.
As of December 31, 2003, we had five products or product candidates in
various stages of clinical trials. Completion of clinical trials may take
several years or more, but the length of time can vary substantially according
to the type, complexity, novelty and intended use of a product candidate.
Because of this, it is very difficult to estimate the cost of completing these
trials. We continue to study Periostat in a series of clinical studies in order
to determine its usefulness in certain patient types or in conjunction with
procedures other than SRP. For example, data on the use of Periostat in diabetic
patients was published in 2003 and suggested that the drug may provide benefits
not only in improved periodontal outcomes but also in improved diabetic control.
Extensive additional studies are required before this finding can be confirmed,
if at all. We intend to continue the Phase IV development of Periostat in 2004.
If a particular indication proves promising during early stage clinical
development, and the commercial opportunity justifies the investment, the next
stage of development typically involves more extensive Phase II trials to
determine the appropriate dose and dosing regimen. Based on our assessment of
the data obtained, we may then decide to conduct Phase III clinical trials
involving the indication and use positive results from the Phase III trials, if
any, to support a New Drug Application, or NDA, to the FDA. However, we cannot
be certain that any of our products will prove to be safe or effective, will
receive regulatory approvals, or will be successfully commercialized.
The duration and the cost relating to preclinical testing and clinical
trials may vary significantly over the life of a project. Our joint development
arrangement for Metastat with the NCI may also result in variability in our
development costs. We closely monitor our research
-12-
and development costs in order to ensure that our investment is consistent with
the return we predict from each project.
Technology
Our core technology involves the use of pharmaceutical products to inhibit
the destruction of the connective tissues of the body and to down-regulate the
pathological host response to a variety of external and internal mediators of
inflammation and tissue destruction.
The technology works in part by modulating the activity of matrix
metalloproteinases. Matrix metalloproteinases are responsible for the normal
turnover of collagen and other proteins that are integral components of a
variety of connective tissues such as skin, bone, cartilage and ligaments.
Under normal physiological conditions, the natural breakdown of collagen is
in part regulated by the interaction between the degradative properties of
matrix metalloproteinases and a group of naturally occurring biomolecules called
tissue inhibitors of metalloproteinases, which modulate the level of matrix
metalloproteinase activity. In many pathological conditions, however, the
balance between collagen production and degradation is disrupted resulting in
excessive loss of tissue collagen, a process called collagenolysis. One such
example is the progressive destruction of the periodontal ligament and alveolar
bone in adult periodontitis. Similar degradative activity is associated with
other disorders and conditions such as cancer metastasis, wounds,
osteoarthritis, osteoporosis, rheumatoid arthritis and diabetic nephropathy.
Elements of our core technology are licensed on an exclusive basis from
SUNY and results from the research of Drs. Lorne M. Golub and Thomas F. McNamara
and their colleagues at SUNY. These researchers demonstrated that tetracyclines
can significantly reduce the pathologically excessive collagen degradation
associated with periodontitis. They also were able to demonstrate that this
result was unrelated to the antibiotic properties of tetracyclines. Furthermore,
they demonstrated that the administration of doses of antibiotic tetracyclines
well below the dosage levels necessary to destroy microbes (sub-antimicrobial
doses) was effective in preventing the loss of connective tissue in models of
periodontitis. Studies published in scientific journals support the hypothesis
that the mechanism of action for this activity is the result, in part, of the
direct binding of tetracyclines to certain metal binding sites associated with
the matrix metalloproteinase structure.
Additional research suggests that tetracyclines also have the ability to
stimulate new bone protein synthesis by a variety of mechanisms. These
properties, which are independent from the anticollagenoyltic properties of the
compounds, are particularly important during the development of certain types of
bone deficiency disorders, including periodontitis. Particularly in patients
with concomitant disorders, such as diabetic osteopenia and peri- or
post-menopausal osteoporosis, periodontitis can occur in the absence of
inflammatory-mediated elevated collagenolytic activity and is primarily a
function of alterations in the balance of osteoblast and osteoclast mediated
resorption and bone formation (in particular a reduction of bone formation). In
these and other circumstances during development of the bony lesion
characterizing adult periodontitis, the property of tetracyclines to stimulate
new bone formation is the means by which the compounds are able to effectively
treat periodontitis.
-13-
Other commercially available antibiotic tetracyclines show effective
anti-collagenolytic and independent bone protein synthesis stimulating
potential. Long-term administration of these compounds at normal antibiotic
doses, however, can result in well-known complications of antibiotic therapy,
such as gastrointestinal disturbance, overgrowth of yeast and fungi, and the
emergence of antibiotic-resistant bacteria. Our Phase III clinical trials with
Periostat demonstrated that the administration of sub-antimicrobial doses of
doxycycline over a twelve-month period exerted no anti-microbial effects. Thus,
the use of this dosage strength provides the anti-collagenolytic and bone
protein synthesis effects without the complications of long-term antibiotic
therapies. In pharmacokinetic studies, Periostat MR, our once-daily, modified
release formulation of Periostat, showed similar blood concentration levels (bio
availability) as Periostat, and we believe Periostat MR will show similar safety
and efficacy as Periostat.
Our license from SUNY also covers the uses of a broad class of compounds
(IMPACS) that have been chemically modified to retain and enhance their
anti-collagenolytic and other properties but which may have the structural
elements responsible for their antibiotic activity removed. These compounds have
shown potential in a number of pre-clinical models of excessive connective
tissue breakdown. Our current research and development programs focus on the
potential use of Periostat as well as the use of IMPACS for a variety of
disorders characterized by inflammation and connective tissue destruction.
Additional research has been conducted to identify, synthesize and
characterize a new generation of IMPACS compounds, and we have filed patent
applications on these compounds. The first of these compounds, called COL-1002,
recently issued in the United States. We have also filed patent applications on
other IMPACS compounds, which are pending.
Periostat
We have completed various clinical trials that evaluate the use of
Periostat for other therapeutic indications. Studies that evaluated Periostat's
ability to promote attachment level, decrease pocket depth and promote healing
in patients undergoing periodontal flap surgery are complete and data are
awaiting final analysis, which is expected to be completed during the first half
of 2004. Preliminary data from this study were presented at the American Academy
of Periodontology meeting in 2002 and suggested that Periostat significantly
improved certain clinical and biochemical parameters that are key to the
successful outcome of periodontal surgery. Other Phase IV clinical trials are
being conducted or are planned to evaluate Periostat as an adjunct to SRP in
institutionalized geriatric patients, in patients with Type I and Type II
diabetes and in a population of smokers. Two of the studies in diabetic patients
reported encouraging preliminary data at the American Association for Dental
Research meeting in March 2003, suggesting that Periostat had the potential to
improve periodontal clinical outcomes and possibly contribute to improvements in
diabetic control in these patients. In January 2003, we announced that the first
patients had entered a multi-center, double-blinded, placebo-controlled Phase IV
clinical study to evaluate the combined efficacy of Periostat and Atridox
(doxycycline hyclate) 10%, a locally-applied antimicrobial gel, in the treatment
of adult periodontitis. This study is fully enrolled and results are expected to
be reported during 2004. We have incurred approximately $300,000 in expenses to
date for this project and expect to incur approximately $100,000 in 2004 to
complete the study.
-14-
To extend the possible therapeutic use of Periostat beyond the oral cavity,
we and our collaborators are planning, conducting or have completed clinical
trials in other indications. Of these studies, only the study in meibomianitis
(dry eye) is being fully funded by us, although we support additional studies
through the provision of active drug and placebo without charge.
A study carried out in 2002 focused on the use of Periostat to treat
moderate acne. The Periostat acne clinical trial was a multi-center,
placebo-controlled, double-blind study chaired by Dr. Robert Skidmore, Chief of
Dermatology at the University of Florida Medical Center. The results revealed
statistically and clinically significant benefits to patients receiving
Periostat for all three of the pre-established primary endpoints: change in
total comedones, total inflammatory lesions and total lesion counts.
Rosacea
In May 2003, we announced the results of a double-blinded,
placebo-controlled clinical study designed to evaluate the efficacy of Periostat
when combined with MetroLotion(R) (metronidazole) Topical Lotion, 0.75%, for the
treatment of rosacea. The study was conducted by Jorge Sanchez, M.D., Professor
of Dermatology at the University of Puerto Rico. Forty patients were randomized
to receive either MetroLotion and Periostat tablets or MetroLotion and placebo
tablets for 12 weeks. After week 12, patients discontinued the use of
MetroLotion and were maintained on either Periostat or placebo for an additional
4 weeks. Lesion counts, along with an assessment of erythema, or persistent
redness, and overall clinical disease severity were recorded. The project was
completed in 2003 at a total cost of approximately $50,000.
At all points during the course of the study, patients receiving Periostat
had significantly fewer inflammatory lesions than those on placebo. At week 12
there was a 59% reduction in lesion count in the group receiving MetroLotion and
Periostat, compared with a 34% reduction in the group receiving MetroLotion and
placebo, a clinically significant difference. The Clinician's Global Severity
Assessment Scale, which is a numerical scoring system that evaluates a patient's
overall disease severity, was also significantly improved in the Periostat
group, and there was a trend towards improvement in the erythema scores.
Patients who were maintained on Periostat for an additional four weeks
maintained the improvements observed at week 12, which was not true for those
patients on placebo.
In July 2003, we announced that the July/August issue of the peer-reviewed
dermatology journal, Skin Med, featured an article describing the positive
outcome of a physician-sponsored clinical study of Periostat in the treatment of
rosacea. This open-label, 50-patient study was designed to determine whether
monotherapy with Periostat improved the symptoms associated with various stages
of rosacea. Joseph B. Bikowski, M.D., Department of Dermatology, University of
Pittsburgh School of Medicine, and author of the article, concluded that
treatment with Periostat resulted in a significant clearing of inflammatory
lesions as well as a reduction in erythema and telangiectatic vessels. Patients
were treated for up to eight weeks with Periostat. After an average of four
weeks treatment, patients experienced an 80% to 100% clearing of inflammatory
lesions and a 50% reduction in erythema. Periostat was well tolerated by the
patients in the study, with no reports of nausea, vomiting, headache, diarrhea,
vaginitis or photosensitivity, effects often observed with the chronic use of
higher doses of tetracycline antibiotics.
-15-
In February 2004, we announced the positive outcome of a Phase 3
double-blinded, placebo-controlled clinical study designed to evaluate the
safety and efficacy of Periostat for the treatment of rosacea. The study
enrolled 134 patients and is the largest clinical trial ever conducted to
evaluate a systemic therapy for rosacea. The detailed study data will be
presented at the Skin Disease Education Foundation's Dermatology Open Seminar on
March 21, 2004.
Preliminary data analysis indicated that patients treated with Periostat
showed a continuous improvement during the 16-week course of the study compared
to patients on placebo. In the study, patients that were administered Periostat
had a significantly greater reduction in the number of inflammatory lesions
(papules and pustules) compared to patients on placebo. This improvement was
both clinically and statistically significant.
Overall clinical disease severity based on the Clinician's Global Severity
Assessment Scale declined significantly in the group of patients treated with
Periostat compared to placebo, with a greater number of patients on Periostat
showing a complete clearing of the disease at 16 weeks compared to those
patients on placebo. The erythema in patients in the Periostat group showed a
trend toward greater improvement compared to patients in the placebo group. The
total expenses incurred to date on this project were $880,000. We expect to
incur an additional $500,000 in 2004 to complete this trial.
Periostat MR Once-A-Day Formulation
The development of a once-a-day formulation, Periostat MR, is being
conducted through a development agreement with Shire Laboratories. Formulations
arising from this research were administered to human volunteers during 2002 and
exhibited promising results, leading to the selection of a formulation for more
complete clinical testing in 2003. In October 2003, we announced that these
tests had shown that we had a suitable formulation and planned to enter Phase
III clinical trials with this new once-a-day formulation in the second quarter
of 2004. We also expect to launch a Phase III clinical trial in periodontitis
patients and two Phase III clinical trials in roseacea patients by mid-2004. We
have incurred approximately $3.3 million in expenses through December 31, 2003.
The total anticipated expenses, through commercialization, including various
milestones to Shire, is estimated to be between $16.0 million and $18.0 million.
Metastat
Cancer metastasis is the spread of cancer cells from a diseased organ to
the lymphatic or circulatory system, where such cells then migrate throughout
the body causing tumor growth in other organs. Tumor cell invasion is a complex
process that involves the destruction of the basement membrane, or structural
support tissue, of the lymphatic or circulatory system, and the migration of
tumor cells to secondary sites, followed by proliferation of these cells. Data
from pre-clinical studies sponsored by us at two major universities suggest that
several of our IMPACS drug candidates have potent activity in models of cancer
invasion, including prostate, breast, lung, colon and melanoma.
These studies also demonstrated that the down-regulation of the invasive
phenotype by conventional tetracyclines and IMPACS results in a decreased
ability of tumor cells to invade the
-16-
lung in models of metastasis. For example, IMPACS have been shown to modulate
the specific type of matrix metalloproteinases isolated from human lung cancer
cells, the activity of which has been correlated with the metastatic potential
of tumors. In animal models involving a variety of human cancer cell types,
including prostate, breast, lung, colon and melanoma, IMPACS developed by us
exhibited an ability to inhibit metastasis.
In 2001, at their cost, the NCI initiated an open-label, two-dose study to
establish clinical efficacy of Metastat in patients with HIV-related Kaposi's
sarcoma. This multi-center Phase 2 study enrolled 77 patients with HIV-related
Kaposi's sarcoma by March 2003. Patients received one of two different doses of
Metastat for six months. The primary objectives of the study were to evaluate
the tumor response rate and duration as well as to evaluate the biologic
activity of Metastat by measuring serum levels of pro-angiogenic mediators.
Due to the unexpected finding that patients on Metastat continued to
improve over the course of their therapy, the AIDS Malignancy Consortium and the
NCI did not undertake an interim analysis of this database until January 2004.
We believe the analysis will be finalized in the second quarter of 2004. Early
reports of this open-label study suggest that certain patients obtained
significant relief (both partial responses and complete responses) of their
clinical symptoms during the course of the study, but we cannot be certain until
the data is formally analyzed.
COL-3
A Phase I, ascending dose trial with COL-3 in normal human volunteers
succeeded in establishing the maximum tolerated dose that could be supported in
investigational new drug, or IND-based, exploratory studies. During 2003, we set
up clinical studies with COL-3, the active ingredient in Metastat, in the
treatment of adult periodontitis and rosacea. The rosacea study began recruiting
patients in 2003 and the periodontitis study will begin recruiting patients
during 2004. However, we do not know whether the drug will exhibit sufficient
efficacy in the treatment of rosacea or periodontitis to justify further
clinical investigation.
We have not developed forecasts for the sale of products arising from the
commercialization of COL-3, nor do we anticipate spending significant resources
on the development of COL-3 until it is clear from the currently conducted
studies with the NCI or other sources of external funding that the drug has a
tolerable safety profile and a high likelihood of clinical and commercial
success.
Preclinical and Other Research and Development Activities
A preclinical program has identified and characterized IMPACS that exhibit
the potential for enhanced biological activities compared to Periostat and
Metastat. In collaboration with the University of Rochester, we have synthesized
a number of new IMPACS. These novel compounds underwent preliminary evaluation
in a variety of in vitro and in vivo assay systems. In March 2003, we announced
the issuance of the first United States patent claiming a compound that was
discovered as a result of these efforts. Further patents for other compounds in
the series have issued in 2003, and we anticipate that others will issue in 2004
and beyond.
-17-
We receive certain proprietary rights to inventions or discoveries that
arise as a result of this research. Our current research and development
objective is to develop additional products utilizing our IMPACS technology,
preferably in conjunction with development partners.
In October 2002, we announced with Discovery Laboratories, Inc. the
formation of a research collaboration to evaluate the combination of Discovery's
platform technologies for the development of novel respiratory disease
therapeutics. Due to changed priorities at Discovery, this agreement was
terminated in September 2003.
In October 2002, we also announced the execution of a license agreement
with Medtronic, Inc. involving our IMPACS compounds, pursuant to which Medtronic
obtained an exclusive, worldwide license to technology relating to the use of
the compounds to treat aortic aneurysms and other forms of vascular disease with
medical devices. This program is still underway.
In February 2002 we announced that we had licensed a dermal and transdermal
drug delivery technology named Restoraderm from its inventor. Restoraderm is
designed to enhance the dermal delivery of a variety of active ingredients and
we intend to develop it into a portfolio of topical dermatological
pharmaceuticals.
The Restoraderm technology is based on the ability of certain lipid
compositions to enhance the natural skin barrier and facilitate the dermal and
transdermal delivery of therapeutic active ingredients. The Restoraderm
technology is currently still under development, and we anticipate that the
first products to be developed using the technology will be available in early
2005. We have acquired exclusive rights to the technology and will pay the
inventor milestone fees upon the achievement of certain objectives as well as
royalties on future sales of products based on the technology. To date, we have
spent $1.2 million in development costs for the Restoraderm technology. This
amount includes $930,000 in milestone payments to the inventor. We anticipate
spending approximately $8.2 million in development expenses through
commercialization.
Our research and development expenditures were approximately $5.5 million,
$4.4 million and $3.8 million in 2003, 2002 and 2001, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations." We expect to significantly increase our
investment in research and development in 2004.
Patents, Trade Secrets and Licenses
Our success will depend in part on patent and trade secret protection for
our technologies, products and processes, and on our ability to operate without
infringement of proprietary rights of other parties both in the United States
and in foreign countries. Because of the substantial length of time and expense
associated with bringing new products through development to the marketplace,
the pharmaceutical industry places considerable importance on obtaining and
maintaining patent and trade secret protection for new technologies, products
and processes.
We depend on our license from SUNY for all of our core technology. The SUNY
License grants us an exclusive worldwide license to make and sell products
employing
-18-
tetracyclines that are designed or utilized to alter a biological process.
Thirty one United States patents and five United States patent applications held
by SUNY are licensed to us under the SUNY License. Three of the 31 patents have
been co-assigned to the University of Miami, Florida, and another patent has
been co-assigned to Washington University. Other institutions are co-owners with
SUNY as follows: one patent is co-owned with the Hospital for Joint Diseases in
New York City; three patents are co-owned with the University of Helsinki; and
one patent is co-owned with the University of Rochester.
The primary United States patent claims methods of use of conventional
tetracyclines to inhibit pathologically excessive collagenolytic activity (the
"Primary Patent"), while a related United States patent claims methods of use of
tetracyclines which have no antibiotic activity (the "Secondary Patent"). The 29
other United States patents relate to chemically modified tetracyclines, or
CMTs, and compositions of certain CMTs with anti-proteinase properties,
including anti-gelatinase, anti-membrane-type metalloproteinase,
anti-collagenase, and anti-elastase properties and methods of use of
tetracyclines to reduce bone loss and skeletal muscle wasting; and methods of
use of tetracyclines to enhance bone growth and promote synthesis in skeletal
muscle, inhibit protein glycosylation, inhibit excess phospholipase A2
activity/production, inhibit endogenous production of nitric oxide, or NO,
enhance endogenous production of interleukin 10, reduce dental plaque adhesion,
and inhibit or reduce pulmonary neutrophil infiltration (or accumulation). SUNY
did not apply in foreign countries for patents corresponding to the Primary
Patent, but has obtained patents that correspond to the Secondary Patent in
Australia, Canada and certain European countries. One of the Secondary Patents
has also been issued in Japan. SUNY also has obtained patents in certain
European countries, Canada and Japan, and has pending patent applications in
certain other foreign countries which correspond to its United States patents
relating to methods of use of tetracyclines to reduce bone loss. Eighty seven
patents have been issued in foreign countries. All of SUNY's United States and
foreign patents expire between 2004 and 2019. Our rights under the SUNY License
are subject to certain statutory rights of the United States government
resulting from federal support of research activities at SUNY. The failure to
obtain and maintain patent protection may mean that we will face increased
competition in the United States and in foreign countries. The SUNY License is
terminable by SUNY on 90 days prior notice only upon our failure to make timely
payments, reimbursements or reports, if the failure is not cured by us within 90
days. The termination of the SUNY License, or the failure to obtain and maintain
patent protection for our technologies, would have a material adverse effect on
our business, financial condition and results of operations.
One of the United States patents and a corresponding Japanese patent
application licensed to us under the SUNY License are owned jointly by SUNY and
a Japanese company. These patent rights, which expire in 2012, cover particular
CMTs (the "Jointly Owned CMTs") that were involved in research activities
between SUNY and the Japanese company. The Japanese company may have exclusive
rights to these Jointly Owned CMTs in Asia, Australia and New Zealand and may
have a non-exclusive right to exploit these Jointly Owned CMTs in other
territories. These Jointly Owned CMTs are not involved in our Periostat product
but could, in the future, prove to be important for one or more of our other
potential applications of its technology. If we incorporate the Jointly Owned
CMTs in any future product, we may be precluded from marketing these products in
Asia, Australia and New Zealand and could experience increased competition in
other markets from the joint owner.
-19-
In consideration of the license granted to us, we: (i) issued to SUNY
78,948 shares of common stock in 1992; and (ii) have agreed to pay SUNY
royalties on the net sales of products employing tetracyclines, with minimum
annual royalty payments of $50,000 per year. The term of the license is: (i)
until the expiration of the last to expire of the licensed patents in each
country; or (ii) until November 18, 2018, at which time we have a fully paid,
non-exclusive license.
In addition to the patents and patent applications licensed from SUNY which
represent the core technology, we own additional technology for which
applications for United States patents have been filed and have been issued. In
this regard, we report the existence of an issued patent for a
toothpaste/mouthwash formulation for the amelioration of dentin
hypersensitivity. A second patent was issued which covers one of the novel
compounds discovered by us and its use to treat abdominal aortic aneurysm,
ulceration of the cornea, periodontal disease, diabetes, diabetes mellitus,
scleroderma, progeria, lung disease (such as ARDS, cystic fibrosis, emphysema or
acute lung injury resulting from inhalation of toxicants), cancer, graft versus
host disease, disease of depressed bone marrow function, thrombocytopenia,
prosthetic joint loosening, spondyloarthropathies, osteoporosis, Paget's
disease, autoimmune disease, systemic lupus erythematosus, acute or chronic
inflammatory condition (such as inflammatory bowel disease, arthritis,
osteoarthritis, rheumatoid arthritis, pancreatitis, nephritis,
glomerulongephritis, sepsis, septic shock, lipopolysaccharide endotoxin shock,
multisystem organ failure or psoriasis), renal disease (such as chronic renal
failure, acute renal failure, nephritis or glomerulonephritis), connective
tissue disease, and neurological or neurodegenerative condition (such as
Alzheimer's disease, Guillain-Barre Syndrome, Krabbe's disease,
adrenoleukodystrophy, Parkinson's disease, Huntington's disease, multiple
sclerosis, amyotrophic lateral sclerosis or an encephalopathy, e.g., spongiform
encephalopathy). Furthermore, we report pending applications covering other new
tetracycline derivatives, and, among other things, methods of treating acne,
rosacea, meibomianitis and Kaposi's sarcoma.
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. 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.
Pursuant to the terms of such agreement, we shall also pay a percentage of
certain net sales of products, if any, utilizing any part of the technology. We
may terminate the agreement upon sixty days notice.
We intend to enforce our patent rights against third-party infringers. Due
to the general availability of generic tetracyclines for use as antibiotics, we
could become involved in infringement actions, which could entail substantial
costs to us. Regardless of the outcome, defense or prosecution of patent claims
is expensive and time consuming, and results in the diversion of substantial
financial, management and other resources from our other activities.
-20-
During 2003, we announced that we had settled all pending litigations
between CollaGenex and West-ward Pharmaceutical Corporation, or West-ward, a
generic pharmaceutical company that had filed an ANDA for a generic version of
Periostat. We sued West-ward and other defendants in the United States District
Court for the Eastern District of New York, alleging that West-ward infringes
our patents for Periostat for the treatment of adult periodontitis. Our
complaint also alleged that West-ward infringed our patent rights under the
Hatch-Waxman act by submitting an ANDA with the FDA, 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. We agreed to pay a portion of West-ward's actual
legal expenses in the amount of $700,000.
In a related case, we have separately sued United Research
Laboratories/Mutual Pharmaceutical Company, or Mutual, in the United States
District Court for the Eastern District of New York, claiming that Mutual
infringes the claims of our Periostat patents. Mutual has sued us in the United
States District Court for the Eastern District of Pennsylvania, alleging that we
engaged in tortious and anticompetitive behavior to prevent Mutual from
commercializing a generic version of Periostat. Mutual has also intervened in
the FDA action in the United States District Court for the District of Columbia.
In addition, on July 14, 2003 we submitted a Citizen Petition to the FDA
requesting that it refuse to approve any generic version of Periostat, submitted
by Mutual on the ground that the bioequivalence studies Mutual submitted are
insufficient to show that the Mutual product is bioequivalent to Periostat. The
FDA has not reached a decision on our Citizen Petition. The resolution of the
West-ward cases does not resolve any of the pending Mutual litigations or
administrative proceedings. We cannot predict the outcome of these matters.
Our patent positions, like those of other pharmaceutical firms, are
generally uncertain and involve complex legal and factual questions.
Consequently, as to the patent applications licensed to us, even though we
currently prosecute such patent applications with United States and foreign
patent offices, we do not know whether any of such applications will result in
the issuance of any additional patents or, if any additional patents are issued,
whether they will provide significant proprietary protection or will be
circumvented or invalidated. Since patent applications in the United States are
maintained in secrecy until published or until patents issue, and since
publication of discoveries in the scientific and patent literature tends to lag
behind
-21-
actual discoveries by several months, we cannot be certain that we were the
first creator of inventions covered by pending patent applications or that we
were the first to file patent applications for such inventions.
There can be no assurance that patent applications to which we hold rights
will result in the issuance of patents, that any patents issued or licensed to
us will not be challenged and held to be invalid, or that any such patents will
provide commercially significant protection to our technology, products and
processes. In addition, there can be no assurance that others will not
independently develop substantially equivalent proprietary information not
covered by patents to which we own rights or obtain access to our know-how, or
that others will not be issued patents which may prevent the sale of one or more
of our products, or require licensing and the payment of significant fees or
royalties by us to third parties in order to enable us to conduct our business.
In the event that any relevant claims of third-party patents are upheld as valid
and enforceable, we could be prevented from selling our products or could be
required to obtain licenses from the owners of such patents. There can be no
assurance that such licenses would be available or, if available, would be on
terms acceptable to us. Our failure to obtain these licenses would have a
material adverse effect on our business, financial condition and results of
operations.
Our success is also dependent upon know-how, trade secrets, and the skills,
knowledge and experience of our scientific and technical personnel. We require
all employees to enter into confidentiality agreements that prohibit the
disclosure of confidential information to anyone outside CollaGenex. In
addition, we seek to obtain such agreements from our consultants, advisors and
research collaborators. There can be no assurance that adequate protection will
be provided for our trade secrets, know-how or other proprietary information in
the event of any unauthorized use or disclosure. We occasionally provide
information and chemical compounds to research collaborators in academic
institutions, and request that the collaborators conduct tests in order to
investigate certain properties of the compounds. There can be no assurance that
the academic institutions will not assert intellectual property rights in the
results of the tests conducted by the research collaborators, or that the
academic institutions will grant licenses under such intellectual property
rights to us on acceptable terms. If the assertion of intellectual property
rights by an academic institution can be substantiated, failure of the academic
institution to grant intellectual property rights to us could have a material
adverse effect on our business, financial condition and results of operations.
Government Regulation
Government authorities in the United States and other countries extensively
regulate, among other things, the research, development, testing, manufacture,
labeling, promotion, advertising, distribution, and marketing of the products we
develop and market. In the United States, the FDA regulates Atridox, Pandel,
Periostat and our products in development as drugs under the Federal Food, Drug,
and Cosmetic Act and implementing regulations. The FDA regulates Atrisorb
FreeFlow and Atrisorb-D as medical devices under the Food, Drug and Cosmetic Act
and implementing regulations. Failure to comply with FDA requirements may
subject us to administrative or judicial sanctions, such as the FDA's refusal to
approve pending applications or warning letters, product recalls, product
seizures, total or partial suspension of production or distribution, withdrawal
of approvals, import detentions, injunctions, and/or criminal prosecution.
-22-
Our products in development are drugs. The steps required before a drug may
be marketed in the United States include:
- pre-clinical laboratory tests, animal studies, and formulation
studies;
- submission to the FDA of an investigational new drug exemption
for human clinical testing, which must become effective before
human clinical trials may begin;
- adequate and well-controlled clinical trials to establish the
safety and efficacy of the drug for each indication;
- submission to the FDA of an NDA for approval;
- satisfactory completion of an FDA inspection of the manufacturing
facility or facilities at which the drug is produced to assess
compliance with cGMP; and
- FDA review and approval of the NDA.
Pre-clinical tests include laboratory evaluations of product chemistry,
toxicity, and formulation, as well as animal studies. The results of the
pre-clinical tests, together with manufacturing information, analytical data,
and a plan for studying the product in humans, are submitted to the FDA as part
of an investigational new drug exemption, which must become effective before
human clinical trials may begin. An investigational new drug exemption
automatically becomes effective 30 days after receipt by the FDA, unless before
that time the FDA raises concerns or questions about issues such as the conduct
of the trials outlined in the investigational new drug exemption. In that case,
the investigational new drug exemption is placed on clinical hold and the
sponsor and the FDA must resolve any outstanding FDA concerns or questions
before clinical trials can proceed. Submission of an investigational new drug
exemption does not always result in the FDA allowing clinical trials to
commence.
Clinical trials involve administration of the investigational drug to human
subjects under the supervision of qualified investigators and are conducted
under protocols detailing the objectives of the study, the parameters to be used
in monitoring safety, and the effectiveness criteria to be evaluated. Each
protocol must be submitted to the FDA as part of the investigational new drug
exemption process, and must be reviewed and approved by an independent
Institutional Review Board before it can begin. Clinical trials typically are
conducted in three sequential phases, but the phases may overlap or be combined.
Phase I usually involves the initial introduction of the investigational drug
into people to evaluate its safety, dosage tolerance, phamacodynamics, and, if
possible, to gain an early indication of its effectiveness. Phase II usually
involves trials in a limited patient population to evaluate dosage tolerance and
appropriate dosage, identify possible adverse effects and safety risks and
evaluate preliminarily the efficacy of the drug for specific indications. Phase
III trials usually further evaluate clinical efficacy and test further for
safety by using the drug in its final form in an expanded patient population. We
cannot guarantee that Phase I, Phase II, or Phase III testing for our products
in development will be completed successfully within any specified period of
time, if at all. Many products that initially appear promising are found, after
clinical evaluation, not to
-23-
be safe and effective. Also, we, or the FDA, may suspend clinical trials at any
time on various grounds, including a finding that the subjects or patients are
being exposed to an unacceptable health risk.
Assuming successful completion of the required clinical testing, the
results of the preclinical studies and of the clinical studies, together with
other detailed information, including information on the manufacture and
composition of the drug, are submitted to the FDA in the form of a new drug
application requesting approval to market the product for one or more
indications. Before approving an application, the FDA usually will inspect the
facility or the facilities at which the drug is manufactured, and will not
approve the product unless compliance with cGMP is satisfactory. If the FDA
determines the application and the manufacturing facilities are acceptable, the
FDA will issue an approval letter. If the FDA determines the application or
manufacturing facilities are not acceptable, the FDA will outline the
deficiencies in the submission and often will request additional testing or
information. Notwithstanding the submission of any requested additional
information, the FDA ultimately may decide that the application does not satisfy
the regulatory criteria for approval. The FDA approved our NDA for Periostat in
1998, however, we cannot be sure that any additional approvals will be granted
on a timely basis, if at all. After approval, certain changes to the approved
product, such as adding new indications, manufacturing changes, or additional
labeling claims are subject to further FDA review and approval. For example,
before we can market Periostat for additional indications now being evaluated,
we will be required to obtain an additional FDA approval.
As a condition of approval of an application, the FDA may require
postmarketing testing and surveillance to monitor the drug's safety or efficacy.
As part of the NDA for Periostat, the FDA has requested a postmarket animal
study related to long-term dosing and carcogenicity, which was completed in
2000.
In some circumstances, approved drugs are provided protection from
competitive versions of the approved drug for specified time periods. For
example, the law provides for patent extension or market exclusivity in certain
circumstances. The FDA has not provided such protection to Periostat.
Approved and cleared drugs and medical devices 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. For example, marketers of approved and cleared drugs and medical
devices are required to report certain adverse reactions and production
problems, if any, to the FDA, and to comply with requirements concerning
advertising and promotional labeling for their products. Also, the FDA does not
permit a manufacturer to market or promote an approved or cleared drug product
or medical device for an unapproved or uncleared use. Also, quality control and
manufacturing procedures must continue to conform to the FDA's requirements for
current Good Manufacturing Practices (for drugs) or Quality Systems Regulation
(for medical devices) after approval. Accordingly, manufacturers must continue
to expend time, money, and effort in the area of production and quality control
to maintain compliance with these and other aspects of regulatory compliance.
The FDA periodically inspects manufacturers to assess compliance with
manufacturing and other requirements. We buy bulk active ingredient for
Periostat and our products in development from third party suppliers and finish
the products in third party manufacturing facilities. The other
-24-
products we market, Atridox, Atrisorb FreeFlow, Atrisorb-D and Pandel are
provided by suppliers. Our failure, or the failure of our suppliers, to comply
with FDA requirements could disrupt production and subject us to administrative
or judicial sanctions.
In addition to the applicable FDA requirements, we are subject to foreign
regulatory authorities governing clinical trials and drug sales. Whether or not
FDA approval has been obtained, approval of a pharmaceutical product by the
comparable regulatory authorities of foreign countries must be obtained prior to
the commencement of marketing of the product in those countries. The approval
process varies from country to country and the time required may be longer or
shorter than that required for FDA approval.
Competition
The pharmaceutical industry is subject to intense competition as well as
rapid and significant technological change.
We expect that competition in the periodontal area will be based on a
variety of factors, including product efficacy, safety, cost-effectiveness, ease
of use, patient discomfort, availability, price, patent position and effective
product promotion. We believe that Periostat is distinguished from other
existing and known periodontitis treatments in that it is the only treatment
that is directed to suppression of the enzymes that degrade periodontal support
tissues. We believe that all other therapies of which we are aware focus on
temporarily removing the bacteria associated with periodontitis. Periostat is a
prescription pharmaceutical tablet indicated as an adjunct to SRP to promote
attachment level gain and to reduce pocket depth in patients with adult
periodontitis that is taken by the patient between dental visits. We believe
that the following chart summarizes the pharmacotherapies available in the
United States and indicated for the treatment of adult periodontitis:
Product Patient
Product Manufacturer/ Dental Delivery Adminis- Treatment
Name Marketer Procedure Route tered Focus Indication
- ----------- ---------------- --------- ---------- --------- ------------ -------------
Periostat CollaGenex No Systemic Yes Tissue As an adjunct to SRP
Pharmaceuticals, degradation to promote
Inc. attachment level gain
and to reduce pocket
depth in patients with
adult periodontitis
*Atridox Atrix Laboratories/ Yes Local No Bacteria For treatment of
CollaGenex chronic adult
Pharmaceuticals, Inc. periodontitis for a
gain in clinical
attachment, reduction
in probing depth and
reduction in bleeding
on probing
-25-
Periochip Vendent on behalf of Yes Local No Bacteria As an adjunct to SRP
Dexcel procedures for
reduction of pocket
depth in patients with
adult periodontitis
Arestin Orapharma, a Yes Local No Bacteria As an adjunct to SRP
Division of Johnson procedures for
reduction of pocket
depth in patients with
adult periodontitis
* In August 2001, we entered into a License and Marketing Agreement with
Atrix Laboratories, Inc. pursuant to which we market Atridox, Atrisorb FreeFlow
and Atrisorb-D to the United States dental community. See - "Item 1. Business"
Many of the companies participating in the periodontal area have
substantially greater financial, technical and human resources than we do, and
may be better equipped to develop, manufacture and market products. These
companies may develop and introduce products and processes competitive with or
superior to ours.
In addition, we may face competition from generic competitors. If one or
more generic versions of Periostat are approved and marketed, our revenues from
Periostat would significantly decrease. We cannot be certain that parties will
not receive FDA approval to introduce a competitive generic version of
Periostat.
Employees
We have historically outsourced our manufacturing, clinical trials, new
drug application preparation, warehousing, distribution and other activities. We
intend to continue to outsource many of the activities which we have
historically outsourced. As of December 31, 2003, we employed 156 persons. Each
of our management personnel has had extensive prior experience with
pharmaceutical, biotechnology or medical products companies. We cannot be
certain that we will be able to recruit and retain qualified inside sales and
marketing personnel, additional foreign sub-licensees or distributors or
marketing partners or that our marketing and sales efforts will be successful.
Currently, none of our employees are covered by collective bargaining
agreements. In general, our employees are covered by confidentiality agreements.
We consider relations with our employees to be excellent.
Additional Factors That May Affect Future Results
We Rely on Periostat for Most of Our Revenue.
During the years ended December 31, 2003, 2002 and 2001, Periostat
accounted for approximately 82%, 82% and 87% of our total net revenues,
respectively. Although we currently derive additional revenue from marketing
and/or selling other products (Atridox, Atrisorb FreeFlow, Atrisorb-D and
Pandel) and from licensing fees from foreign marketing
-26-
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, 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 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 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. If the
Court decides in favor of the FDA, the FDA could begin to approve generic drugs
immediately thereafter.
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 predict the outcome of these
matters. In addition, we cannot be sure 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 a 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. As of December
31, 2003, we have an accumulated deficit of $69.9 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 and our
other products. Although we achieved net income of $6.4 million and $902,000 for
the years ended December 31, 2003 and 2002, respectively, we expect to incur
significant future expenses, particularly with respect to the sales and
marketing of our existing products, 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.
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.
-27-
Our core technology is licensed from SUNY, and other academic and research
institutions collaborating with SUNY. Under the license agreement with SUNY, or
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 six 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 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.
-28-
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, or 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., or 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, Pandel and
Atridox have been approved by the FDA as drugs. 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 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,
-29-
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, Luxembourg, 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 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, 2003, sales to Cardinal Health,
Inc., McKesson Corporation and Amerisource-Bergen Corporation, represented
approximately 43%, 31% and 20%, 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 our products trade
inventory level, this plan may not be effective. If trade inventory levels
become too high, or if prescription growth of our products are lower than
expected by the trade, wholesalers and large retail chains could reduce their
orders for our products, which could result in reduced sales of our products and
adversely affect our operating results.
We Cannot Assure You that Our Pursuit of Business in the Dermatology Market
will be Successful.
During 2003, we began to implement our plans to expand into the dermatology
market. We have completed and announced the preliminary results of a
double-blind, placebo-controlled 134-patient Phase III clinical trial to
evaluate the safety and efficacy of Periostat to treat rosacea, we have licensed
a new dermal and transdermal drug delivery technology called Restoraderm and we
executed a sublicense Agreement with Altana Inc. with respect to the marketing
and distribution of Pandel. 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
-30-
sales and marketing of dental products, we have limited experience in this
market. 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 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.
-31-
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 December 31, 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
December 31, 2003.................. $11.82 $8.90
Item 2. Properties.
We own no real property. Our principal executive offices, located at 41
University Drive, Suite 200, Newtown, Pennsylvania, consist of approximately
14,204 square feet. Our lease for such premises continues through April 2009.
Item 3. Legal Proceedings.
In November 2002, we commenced an action in the United States District
Court for the Eastern District of New York seeking to prevent West-ward
Pharmaceutical Corporation, or West-ward, from selling 20 mg. capsules of
doxycycline hyclate to treat periodontal disease, which we believe would
infringe patents covering our Periostat product. As discussed below, we have
settled all pending litigation with West-ward.
In July 2003, we commenced an action against 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. Our suit alleges infringement of patents to which we are the
exclusive licensee.
In July 2003, Mutual commenced an action against us in the United States
District Court for the Eastern District of Pennsylvania. Mutual alleges that we
have engaged in an overall scheme to monopolize the market for low-dose
doxycycline products. In addition, the suit alleges that we have engaged in
exclusionary, unfair, and anticompetitive practices. Mutual seeks an
-32-
award of treble damages, injunctive relief, compensatory, punitive and exemplary
damages and reasonable attorneys' fees. In January 2004, the Court stayed all
proceedings in this case.
In June 2003, we commenced an action and filed a motion for a preliminary
injunction in the United States District Court for the District of Columbia
challenging FDA's decision to treat Periostat as an antibiotic drug, thus
denying Periostat certain protections afforded non-antibiotic drugs under the
Food, Drug, and Cosmetic Act and against FDA approval of generic copies of
Periostat. 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 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 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. Cross motions for summary judgment are pending.
As a result of the ruling in the United States District Court for the
District of Columbia, we withdrew our then pending motion for a temporary
restraining order and preliminary injunction in our patent infringement suit
against Mutual, which was filed in the United States District Court for the
Eastern District of New York, although our complaint remains outstanding. In
November, 2003 the proceedings in the patent infringement case were stayed
pending a determination by the United States Patent and Trademark Office of its
re-examination of the patents-in-suit, subject to the parties' right to conduct
limited discovery related to the potential re-instatement of our motion for a
temporary restraining order and preliminary injunction. We cannot predict the
outcome of these matters.
On November 7, 2003, we settled all pending litigation between us and
West-ward. 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 this settlement, we agreed to
pay a portion of West-ward's actual legal expenses in the amount of $700,000.
We anticipate that our future legal costs in these matters relating to
patent infringement and defense will be reimbursed by SUNY pursuant to our
Technology License Agreement with SUNY to the extent that these legal expenses
do not exceed royalties earned by SUNY during that period. During 2002 and 2003,
we incurred $129,000 and $3.8 million respectively, in legal defense, litigation
and settlement costs for the aforementioned law suits with West-ward and Mutual,
$129,000 and $1.7 million respectively, of which were deducted from royalties
payable to SUNY during those periods. In the event such cumulative legal costs
exceed in the amount of the royalties payable to SUNY, we will not be able to
recover such legal costs from SUNY. As of December 31, 2003, we have $1.7
million in previously recorded legal expenses available to offset future
royalties which may become payable to SUNY.
-33-
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
-34-
PART II
Item 5. Market for the Company's Common Equity and Related Stockholder Matters.
Prior to June 1996, there was no established market for our common stock.
Since June 20, 1996, our common stock has traded on the Nasdaq National Market
under the symbol "CGPI."
The following table sets forth the high and low per share sales prices for
our common stock for each of the quarters in the period beginning January 1,
2002 through December 31, 2003 as reported on the Nasdaq National Market.
Quarter Ended High Low
----------------------------------- ------------ -----------
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
December 31, 2003.................. $11.82 $8.90
As of March 11, 2004, the approximate number of holders of record of our
common stock was 114 and the approximate number of beneficial holders of our
common stock was 4,406.
We have never declared or paid any cash dividends on our common stock.
Except as set forth below, we intend to retain earnings, if any, to fund future
growth and the operation of our business. On May 12, 1999, we consummated a
$20.0 million financing through the issuance of our Series D cumulative
convertible preferred stock. As a result of such financing, we had certain
common stock dividend obligations and continue to have certain cumulative cash
dividend obligations to the holders of the Series D preferred stock. Such
financing arrangement also limits our ability to generally declare dividends to
our common stockholders. In addition, our ability to generally declare dividends
to our common stockholders is further limited by the terms of our credit
facility with Silicon Valley Bank for which we are currently negotiating a
two-year renewal upon expiration. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
The following information relates to all securities of the Company sold by
us during the year ended December 31, 2003 which were not registered under the
securities laws at the time of grant, issuance and/or sale (and which were not
previously reported on a Quarterly Report on Form 10-Q):
-35-
Option Grants
During the fourth quarter of 2003, we granted stock options pursuant to our
1996 Stock Plan and outside of 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:
Number of Options Weighted Average
Granted Exercise Price
-------------------------- ---------------------
309,650 $10.15
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 us. On February 6, 2004, we filed a registration statement on
Form S-8 with the Securities and Exchange Commission with respect to the
foregoing securities.
Item 6. Selected Consolidated Financial Data.
The selected consolidated financial data set forth below with respect to
our consolidated statement of operations data for each of the years in the
three-year period ended December 31, 2003, and with respect to the consolidated
balance sheet data as of December 31, 2003 and 2002 are derived from and are
qualified by reference to our audited consolidated financial statements and the
related notes thereto found at "Item 15. Exhibits, Financial Statement
Schedules, and Reports on Form 8-K" herein. The consolidated statement of
operations data for the years ended December 31, 2000 and 1999 and with respect
to the consolidated balance sheet data as of December 31, 2001, 2000 and 1999
are derived from our audited consolidated financial statements not included in
this Annual Report on Form 10-K. The selected consolidated financial data set
forth below should be read in conjunction with and is qualified in its entirety
by our audited consolidated financial statements and related notes thereto found
at "Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K"
and "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" which are included elsewhere in this Annual Report on
Form 10-K.
-36-
Years Ended December 31,
------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands except for per share data)
----------------------------------------
Consolidated Statement of Operations
Data:
Revenues:
Net product sales................ $ 49,038 $ 42,111 $ 31,358 $ 20,501 $ 15,211
Contract revenues................ 3,122 2,332 3,386 3,240 770
License revenues................. 699 176 488 530 100
---------- ---------- ---------- ---------- ----------
Total revenues...................... 52,859 44,619 35,232 24,271 16,081
Operating expenses:
Cost of product sales............ 7,362 6,713 5,825 4,070 3,139
Research and development......... 5,462 4,394 3,764 3,128 5,005
Selling, general and administrative 33,668 32,699 34,010 25,746 23,180
---------- ---------- ---------- ---------- ----------
Operating income (loss)...... 6,367 813 (8,367) (8,673) (15,243)
Interest income..................... 148 77 232 613 851
Interest expense.................... -- (5) (17) (15) (197)
Other (expense) income.............. (3) 17 8 9 (2)
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes and
cumulative effect of change in
accounting principle............. 6,512 902 (8,144) (8,066) (14,591)
Income taxes........................ 85 -- -- -- --
Cumulative effect of change in
accounting principle(1).......... -- -- -- (764) --
---------- ---------- ---------- ---------- ----------
Net income (loss)................... $ 6,427 $ 902 $ (8,144) $ (8,830) $ (14,591)
========== ========== ========== ========== ==========
Net income (loss) allocable to common
stockholders..................... $ 4,827 $ (727) $ (9,824) $ (10,519) $ (15,683)
========== ========== ========== ========== ==========
Basic net income (loss) per share
allocable to common stockholders
before cumulative effect of change
in accounting principle(1)(2).... $ 0.40 $ (0.06) $ (0.94) $ (1.12) $ (1.82)
========== ========== ========== ========== ==========
Diluted net income (loss) per share
allocable to common stockholders
before cumulative effect of change
in accounting principle(1)(2).... $ 0.38 $ (0.06) $ (0.94) $ (1.12) $ (1.82)
========== ========== ========== ========== ==========
Basic net income (loss) per share
allocable to common stockholders(2) $ 0.40 $ (0.06) $ (0.94) $ (1.21) $ (1.82)
========== ========== ========== ========== ==========
Diluted net income (loss) per share
allocable to common stockholders(2) $ 0.38 $ (0.06) $ (0.94) $ (1.21) $ (1.82)
========== ========== ========== ========== ==========
Shares used in computing basic per
share amounts(2)................. 12,094,638 11,234,652 10,413,663 8,711,668 8,597,676
Shares used in computing diluted per
share amounts(2)................. 12,836,364 11,234,652 10,413,663 8,711,668 8,597,676
-37-
As of December 31,
------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(in thousands)
--------------
Consolidated Balance Sheet Data:
Cash, cash equivalents and
short-term investments............... $ 32,670 $ 10,112 $ 6,171 $ 5,448 $ 14,367
Working capital......................... 32,010 5,992 6,194 5,308 12,987
Total assets............................ 43,305 17,634 14,698 10,431 18,563
Note payable, less current portion...... -- -- -- 47 116
Accumulated deficit..................... (69,854) (74,681) (73,954) (64,130) (53,611)
Total stockholders' equity.............. 33,956 8,352 7,127 5,264 13,607
(1) Refers to the Company's adoption of Staff Accounting Bulletin No. 101
during 2000 and the corresponding cumulative effect of the change in
accounting principle.
(2) See Note 2 of Notes to Consolidated Financial Statements for information
concerning computation of net income (loss) per share.
-38-
Item 7. 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 dental 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 Atrisorb-D(R), to the United States
dental market. 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. We distribute Periostat and Pandel exclusively through drug
wholesalers 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 dental products are distributed through
specialty distributors who sell these products directly to dental practitioners
in the United States and Puerto Rico.
For the years ended December 31, 2003 and 2002, we achieved net income of
approximately $6.4 million and $902,000, respectively. We have, however,
incurred losses in each year from inception through 2002 and have an accumulated
deficit of $69.9 million at December 31, 2003.
During the years ended December 31, 2003, 2002 and 2001, Periostat
accounted for approximately 82%, 82% and 87% of our total net revenues,
respectively. Although we currently derive additional revenue from marketing
and/or selling other products (Atridox, Atrisorb FreeFlow, Atrisorb-D and
Pandel) 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.
Mutual has submitted an application to the FDA for approval of a generic
version 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. We cannot predict the outcome
of these matters. In addition, we cannot be sure 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 a result, our business, financial
condition, cash flows and results of operations would be materially adversely
affected.
-39-
This Annual Report on Form 10-K and the documents incorporated herein
contain forward-looking statements within the meaning of Section 21E of the
Securities and Exchange Act of 1934, as amended. For this purpose, any
statements contained herein or incorporated herein that are not statements of
historical fact may be forward-looking statements. For example, the words "may,"
"will," "continue," "believes," "expects," "anticipates," "intends,"
"estimates," "should" and similar expressions are intended to identify
forward-looking statements. There are a number of important factors that could
cause our results to differ materially from those indicated by such
forward-looking statements. These factors include those set forth in the section
entitled "Additional Factors That May Affect Future Results" included in Item 1
of this Annual Report. In particular, our business of selling, marketing and
developing pharmaceutical products is subject to a number of significant risks,
including risks relating to the implementation of our sales and marketing plans
for Periostat and other products that we market, risks 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, 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. Our 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 our 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, Luxembourg, 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 us. In
addition, there can be no assurance that we will successfully promote Pandel,
Atridox, Atrisorb-FreeFlow or Atrisorb-D. 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 our filings with the Securities and
Exchange Commission, our 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.
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, stock compensation and deferred taxes.
-40-
Revenue Recognition
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 filled. Accordingly, since we never
take title to the product being promoted, no significant obligations exist
beyond the point that revenue is recognized.
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.
Stock-Based Compensation
It is our policy to apply Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations to
account for our stock option grants rather than Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation." As
such, compensation expense is recorded on fixed stock option grants only if the
current market value of the underlying stock exceeds the exercise price of the
option at the date of grant and is recognized on a straight-line basis over the
vesting period. Had we applied SFAS No. 123, which requires recording stock
option grants at their fair value, our net income (loss) for each of the years
ended December 31, 2003, 2002 and 2001 would have varied from the reported net
income (loss) as we would have recorded additional expenses in each period.
Deferred Taxes
In assessing the realizability of deferred tax assets, we consider whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. This assessment requires significant judgment and
estimates. The ultimate realization of the deferred tax assets is dependent upon
the generation of future taxable income during the period in which those
-41-
temporary differences become deductible. We consider our history of losses,
scheduled reversal of deferred tax assets and liabilities and projected future
taxable income over the periods in which the deferred tax asset items are
deductible. Should we continue to be profitable, we will assess and may reduce
the valuation allowance. The Tax Reform Act of 1986 contains provisions that may
limit the net operating loss (NOL) and research and experimentation credit
carryforwards available to be used in any given year upon the occurrence of
certain events, including significant changes in ownership interest. The rules
providing for the definition of an ownership change are complex.
Recently Issued Accounting Standards
FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
Statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For us, the Statement was effective for
instruments entered into or modified after May 31, 2003. For certain mandatorily
redeemable financial instruments, the Statement will be effective at a later
date. The effective date has been deferred indefinitely for certain other types
of mandatorily redeemable financial instruments. We currently do not have any
financial instruments that are within the scope of this Statement.
Results of Operations
We generated net income allocable to common stockholders of $4.8 million,
or $0.38 per diluted share, for the year ended December 31, 2003 as compared to
a net loss of $727,000, or $0.06 per diluted share for the year ended December
31, 2002. The increase in profitability from 2002 to 2003 was primarily a result
of increases in net product sales, contract revenues, and licensing revenues.
Product sales increased as a result of the increased volume in Periostat product
sales as well as increases in Pandel product sales, which we began to sell
direct in July 2002. The increase in contract revenues was primarily
attributable to our co-promotion efforts related to the AVAR and Denavir product
lines, partially offset by the termination of other co-promotion agreements.
License revenues increased primarily as the result of milestones achieved by our
foreign partners in 2003 and the accelerated recognition of previously deferred
up-front payments that were recognized as the result of terminated license
agreements. These increases were partially offset by increased research and
development expenditures as well as increases in cost of products sold and
selling, general and administrative expenses.
Our revenues are affected by a number of factors, including our ability to
influence physician prescribing habits, managing the purchasing practices of the
United States drug wholesalers, managing our sales professionals and delivering
our marketing message effectively. We believe future revenues will be affected
by our ability to maintain the current business and expand the use of Periostat
for new indications.
In order to effectively manage the wholesale channel, we executed Inventory
Management Agreements with our major wholesalers in 2003. These agreements help
us manage the level of inventory of our products in the wholesale channel,
obtain weekly retail demand information for our products and to make sales that
are consistent with end-user
-42-
prescription demand for our products. In exchange for retail demand data, we
allow our wholesalers to purchase a specific amount of inventory from us at the
sales price in effect immediately prior to announced price increases.
Periostat sales have historically been subject to seasonality in the United
States market based on holiday schedules and vacation patterns. Our sales may
fluctuate on a quarterly basis based on such seasonal fluctuations.
Years Ended December 31, 2003 and December 31, 2002
Revenues
Revenues
(dollars in thousands) 2003 Change 2002
---- ------ ----
- -------------------------------------------------------------------------------
Net Product Sales $ 49,038 16.4% $ 42,111
- -------------------------------------------------------------------------------
Contract Revenues 3,122 33.9 2,332
- -------------------------------------------------------------------------------
License Revenues 699 297.2 176
----------- -----------
- -------------------------------------------------------------------------------
Total $ 52,859 18.5% $ 44,619
- -------------------------------------------------------------------------------
Total revenues during the year ended December 31, 2003 were $52.9 million,
an 18.5% increase over total revenues of $44.6 million during the year ended
December 31, 2002. Such 2003 revenues included approximately $49.0 million in
net product sales of Periostat, Atridox, Atrisorb FreeFlow, Atrisorb-D and
Pandel, $3.1 million in contract revenues, which were derived from our
co-promotion of Vioxx, Denavir and AVAR, and $699,000 in international licensing
revenues. Our agreement with Novartis Consumer Health Inc. to co-promote Devavir
expired on September 30, 2003, and we and Novartis mutually decided not to renew
our arrangement with respect to Denavir. Our agreement with Merck to co-promote
Vioxx expired on December 31, 2003 and the parties mutually decided not to renew
such arrangement. In addition, our co-promotion agreement with Sirius
Laboratories, Inc. with respect to our joint marketing activities of the AVAR
product line and Pandel was mutually terminated on December 31, 2003. Net
product sales increased $6.9 million, or 16.4%, during the year ended December
31, 2003 to $49.0 million compared to $42.1 million during the year ended
December 31, 2002, mainly due to increased volume of prescriptions and price
increases relating to Periostat and the addition of the Pandel product line
which we began selling direct in July 2002. Total international sales increased
to $558,000 in 2003 from $350,000 in 2002.
Contract revenues for the year ended December 31, 2003 increased 33.9% to
$3.1 million from $2.3 million during the year ended December 31, 2002,
primarily due to increased contract revenues relating to our co-promotion
activities with respect to Denavir and the AVAR product line, which were
partially offset by lower Pandel contract revenues earned during 2003 following
our acquisition of a license to Pandel when we began selling Pandel directly and
recording related product sales. We do not expect to earn contract revenues for
Denavir and AVAR in 2004. During 2003, our co-promotional agreements with Merck,
Novartis and Sirius generated approximately $3.1 million in revenue. We will
continue to earn nominal residual contract revenues through 2005 from our
expired agreement with Merck for Vioxx.
-43-
We recorded $52,000 and $59,000 in licensing revenues for the years ended
December 31, 2003 and December 31, 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 years ended December 31,
2003 and 2002, respectively, from 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 years ended December 31, 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 $ 7,362 9.7% $ 6,713
- -------------------------------------------------------------------------------
Percent of Net Product Sales 15.0% 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 $7.4 million, or 15.0% of net product sales for
the year ended December 31, 2003, compared to $6.7 million, or 15.9% of net
product sales during the year ended December 31, 2002. During the year ended
December 31, 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 year ended December 31, 2003, compared to the
year ended December 31, 2002, primarily due to product sales price increases for
Periostat in 2003, 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.
Research and Development
- -------------------------------------------------------------------------------
Research and Development 2003 Change 2002
(dollars in thousands) ---- ------ ----
- -------------------------------------------------------------------------------
Research and Development $ 5,462 24.3% $ 4,394
- -------------------------------------------------------------------------------
Percentage of Total Revenue 10.3% 9.8%
- -------------------------------------------------------------------------------
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 $1.1 million, or 24.3%, to $5.5
million during the year ended December 31, 2003 from $4.4 million during the
year ended December 31, 2002.
-44-
Development projects conducted during the year ended December 31, 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 $2.0 million and $820,000, respectively. If all of the potential
products are successful, additional formulation development expenses and
milestone fees could be as much as $11.1 million.
Clinical projects totaling $832,000 were conducted during the year ended
December 31, 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 134 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 year ended
December 31, 2003 included $108,000 in regulatory consulting and legal and
filing fees under the Mutual Recognition Procedure in Europe and $484,000 for
various regulatory costs, including annual FDA filing fees, patent fees and
regulatory expenses in the United States, and $335,000 in development costs for
Metastat and the IMPACS compounds. Direct salaries and other personnel expenses
incurred during the year ended December 31, 2003 were $657,000. Additionally,
during such period we incurred $243,000 in consulting, travel and other office
expenses. We expect to significantly increase our investment in research and
development in 2004.
Development projects conducted during the year ended December 31, 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
$1.3 million and $349,000, respectively.
Clinical projects totaling $1.1 million were conducted during the year
ended December 31, 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 meibomianitis, clinical development
work relating to Periostat in dermatological indications, limited clinical
testing of Restoraderm formulations and initiation of a Phase III trial in 134
patients to evaluate Periostat for the treatment of rosacea. Additionally,
during 2002 we granted $253,000 for research to various academic institutions
for conducting research related to our core technology.
Other research and development expenses incurred during the year ended
December 31, 2002 included $247,000 in regulatory consulting and filing fees
under the Mutual Recognition Procedure in Europe and $373,000 for various
regulatory costs, including annual FDA filing fees, legal, and regulatory
expenses in the United States. Direct salaries and other personnel expenses
incurred during the year ended December 31, 2002 were $480,000. Additionally,
during such period we incurred $266,000 in consulting, travel and other office
expenses.
-45-
Selling, General and Administrative
- -------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands) 2003 Change 2002
---- ------ -----
- -------------------------------------------------------------------------------
Selling, General and Administrative $ 33,668 3.0% $ 32,699
- --------------------------------------------------------------------------------
Percentage of Total Revenues 63.7% 73.3%
- -------------------------------------------------------------------------------
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 3.0% to $33.7
million during the year ended December 31, 2003 from $32.7 million during the
year ended December 31, 2002. This increase of $969,000 was primarily the result
of approximately $2.5 million in increased legal fees and settlement costs
relating to our ongoing litigation, net of reimbursable legal expenses from
SUNY, additional personnel costs of $1.2 million, approximately $1.9 million in
additional promotional expenses for AVAR and Pandel, offset in part by a $4.7
million reduction in selling and marketing expenditures for Periostat, Vioxx and
the Atrix products.
Significant components of selling, general and administrative expenses
incurred during the year ended December 31, 2003 included $15.7 million in
direct selling and sales training expenses, $8.8 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
$8.9 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 year ended
December 31, 2002 included $15.7 million in direct selling and sales training
expenses, $11.3 million in marketing expenses (including direct to consumer
advertising and promotion expenditures for Periostat, the Atrix products and
co-promotion expenses relating to Vioxx and Pandel) and $5.7 million in general
and administrative expenses, which include business development, finance and
corporate activities.
Selling, general and administrative expenses also included $251,000 during
the year ended December 31, 2003 which resulted from certain modifications made
to stock option agreements held by Brian M. Gallagher, Ph.D., our former
chairman, chief executive officer and president, in connection with a Transition
Agreement we executed with Dr. Gallagher on March 18, 2003.
Other Income/Expense
- -------------------------------------------------------------------------------
Other Income/Expense
(dollars in thousands) 2003 Change 2002
---- ------ ----
- -------------------------------------------------------------------------------
Interest Income $ 148 92.2% $ 77
- -------------------------------------------------------------------------------
Interest Expense $ -- (100%) $ 5
- -------------------------------------------------------------------------------
Other Income (Expense) $ (3) (117.6%) $ 17
- -------------------------------------------------------------------------------
Interest income increased to $148,000 for the year ended December 31, 2003
compared
-46-
to $77,000 for the year ended December 31, 2002. This increase was due to higher
average investment balances in 2003, partially offset by lower average yields.
There was no interest expense for the year ended December 31, 2003, compared to
$5,000 for the year ended December 31, 2002. Other expense was $3,000 for the
year ended December 31, 2003 compared to other income of $17,000 for the year
ended December 31, 2002. Such other income (expense) was attributable to foreign
currency transaction gains (losses).
Income Taxes
Income tax expense for the year ended December 31, 2003 consisted primarily
of a provision for current Federal alternative minimum tax.
Preferred Stock Dividend
Preferred stock dividends included in net income (loss) allocable to common
stockholders were $1.6 million during each of the years ended December 31, 2003
and 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.
Years Ended December 31, 2002 and December 31, 2001
We incurred net losses allocable to common stockholders of $727,000, or
$0.06 per basic and diluted share, and $9.8 million, or $0.94 per basic and
diluted share, for the years ended December 31, 2002 and December 31, 2001,
respectively. The decrease in the net loss allocable to common stockholders from
2001 to 2002 was primarily a result of increased product sales, including the
addition of Atrix dental product sales in 2002, and decreased selling, general
and administrative expenditures. Selling, general and administrative
expenditures decreased primarily as a result of a decline in expenditures
related to a direct to consumer campaign for Periostat. These contributors to
the decrease in the net loss allocable to common stockholders from 2001 to 2002
were partially offset by a decrease in contract revenues as well as moderate
increases in the cost of products sold and research and development
expenditures. Contract revenues decreased primarily due to the termination of
the Novartis arrangement to co-promote Denavir and a decline in co-promotion
revenues related to Vioxx.
-47-
Revenues
- -------------------------------------------------------------------------------
Revenues
(dollars in thousands) 2002 Change 2001
---- ------ -----
- -------------------------------------------------------------------------------
Net Product Sales $ 42,111 34.3% $ 31,358
- -------------------------------------------------------------------------------
Contract Revenues 2,332 (31.1) 3,386
- -------------------------------------------------------------------------------
License Revenues 176 (63.9) 488
- -------------------------------------------------------------------------------
Total $ 44,619 26.6% $ 35,232
- -------------------------------------------------------------------------------
Total revenues during the year ended December 31, 2002 were $44.6 million,
representing a 26.6% increase over total revenues of $35.2 million during the
year ended December 31, 2001. Such 2002 revenues included approximately $42.1
million in net product sales of Periostat, Atridox, Atrisorb FreeFlow,
Atrisorb-D and Pandel (since July 1, 2002), $2.3 million in contract revenues,
which were derived from our co-promotion of Vioxx and Pandel (prior to June 30,
2002) and Denavir (effective October 1, 2002), and $176,000 in deferred foreign
license and milestone revenues for Periostat. Net product sales increased $10.8
million, or 34.3%, during the year ended December 31, 2002 to $42.1 million
compared to $31.4 million during the year ended December 31, 2001, mainly due to
increased volume of prescriptions and price increases relating to Periostat, the
addition of the Atrix dental products, which we began marketing in October 2001,
and Pandel, which we began selling on July 1, 2002. Total international sales
increased to $350,000 in 2002 from $35,000 in 2001.
Contract revenues for the year ended December 31, 2002 declined 31.1% to
$2.3 million from $3.4 million during the year ended December 31, 2001 as a
result of the termination in April 2001 of our prior agreement with Novartis to
co-promote Denavir and a decline in contract revenues from Merck relating to our
co-promotion of Vioxx. Contract revenues for the year ended December 31, 2001
included $297,000 in co-promotion revenues for Denavir. Contract revenues for
the year ended December 31, 2002 included $100,000 in co-promotion revenues for
Denavir, pursuant to our Product Detailing agreement with Novartis executed in
October 2002. We were compensated at a higher rate for sales growth for the
previous year's sales of Vioxx. In 2001, a significant portion of our
Vioxx-related compensation was attributed to sales growth. Vioxx sales, however,
were lower in 2002 compared to 2001, and therefore we were paid at lower rates,
resulting in a decline in contract revenues.
License revenues for the year ended December 31, 2002 declined 63.9% to
$176,000 from $488,000 for the year ended December 31, 2001. In accordance with
SAB 101, which we adopted in 2000, $59,000 and $60,000 in licensing revenues,
respectively, for the years ended December 31, 2002 and 2001 was attributable to
our recognition of up-front license fees received for various agreements that
were deferred in accordance with SAB 101 and is recognized as income over the
expected performance period of these agreements. We also recorded milestone
revenues from our foreign licensing partners of $70,000 and $425,000 during the
years ended December 31, 2002 and 2001, respectively, related to obtaining
regulatory approval in certain countries.
-48-
Cost of Product Sales
- -------------------------------------------------------------------------------
Cost of Product Sales
(dollars in thousands) 2002 Change 2001
---- ------ ----
- -------------------------------------------------------------------------------
Cost of Product Sales $ 6,713 15.2% $ 5,825
- -------------------------------------------------------------------------------
Percent of Net Product Sales 15.9% 18.6%
- -------------------------------------------------------------------------------
Cost of product sales includes product packaging, third-party royalties,
obsolete inventory provisions, 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 $6.7 million, or 15.9% of net product sales
during the year ended December 31, 2002, compared to $5.8 million, or 18.6% of
net product sales during the year ended December 31, 2001. Cost of product sales
increased in absolute dollars but decreased as a percentage of net product sales
during 2002 compared to 2001, primarily due to manufacturing cost savings for
Periostat tablets, which we launched in July 2001, compared to Periostat
capsules and product price increases. Cost of product sales in 2001 also
included a $602,000 provision for obsolete inventory; there was no such
provision in 2002. This decrease in percent of Periostat net product sales in
2002 was slightly offset by a higher percent of product sales for the Atrix
products and Pandel, launched in November 2001 and July 2002, respectively,
which have lower margins than Periostat.
Research and Development
- -------------------------------------------------------------------------------
Research and Development
(dollars in thousands) 2002 Change 2001
---- ------ -----
- -------------------------------------------------------------------------------
Research and Development $ 4,394 16.7% $ 3,764
- -------------------------------------------------------------------------------
Percentage of Total Revenue 9.8% 10.7%
- -------------------------------------------------------------------------------
Research and development expenses consist primarily of funds paid to third
parties for the provision of services and materials for drug development,
manufacturing and formulation enhancements, clinical trials, statistical
analysis, report writing, regulatory compliance and internal payroll and related
costs.
Research and development expenses increased $630,000, or 16.7% to $4.4
million during the year ended December 31, 2002 from $3.8 million during the
year ended December 31, 2001.
Development projects conducted during the year ended December 31, 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
$1.3 million and $349,000, respectively.
Clinical projects totaling $1.1 million were conducted during the year
ended December 31, 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 meibomianitis, clinical development
work relating to Periostat in dermatological indications, limited clinical
testing of Restoraderm formulations and initiation of a Phase III trial in 134
patients to evaluate
-49-
Periostat for the treatment of rosacea. Additionally, during 2002 we granted
$253,000 for research to various academic institutions for conducting research
related to our core technology.
Other research and development expenses incurred during the year ended
December 31, 2002 included $247,000 in regulatory consulting and filing fees
under the Mutual Recognition Procedure in Europe and $373,000 for various
regulatory costs, including annual FDA filing fees, legal, and regulatory
expenses in the United States. Direct salaries and other personnel expenses
incurred during the year ended December 31, 2002 were $480,000. Additionally,
during such period we incurred $266,000 in consulting, travel and other office
expenses.
Research and development expenses incurred in 2001 included $210,000 in
research grants to various academic institutions for conducting research related
to our core technology and $765,000 in contracted clinical and development
expenses related to a completed safety and pharmacokinetic study for Metastat
and other IMPACs compounds. During 2001, our three-year evaluation testing
agreement for such compounds with SUNY expired and was not renewed. The amount
paid to SUNY in 2001 under this agreement was $168,000. The total cumulative
costs incurred through 2001 under this agreement were approximately $1.4
million.
Development projects contracted in 2001 included an initial feasibility
study and formulation development work for a once-a-day formulation of
Periostat, which totaled $455,000 in 2001.
Clinical projects conducted during 2001 included the completion of several
Phase 3b studies for Periostat in various dental indications and the initiation
of clinical trials for Periostat in dermatological indications. Clinical project
costs incurred in 2001 were $230,000.
Other expenses incurred in 2001 included $400,000 in regulatory consulting
and filing fees under the Mutual Recognition Procedure in Europe and $535,000
for various regulatory costs, including annual FDA filing fees, legal, and
regulatory expenses in the United States related to obtaining FDA approval for
Periostat tablets. During 2001 we incurred $535,000 in direct salaries and other
personnel and $164,000 in noncash compensation expense relating to the extension
of the exercisability of certain stock options for one of our ex-board members.
Additionally, we incurred $110,000 in ongoing manufacturing support relating to
our existing products and $194,000 in travel and other office expenses.
Selling, General and Administrative
- -------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands) 2002 Change 2001
---- ------ -----
- -------------------------------------------------------------------------------
Selling, General and Administrative $ 32,699 (3.9%) $ 34,010
- -------------------------------------------------------------------------------
Percentage of Total Revenues 73.3% 96.5%
- -------------------------------------------------------------------------------
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.
-50-
Selling, general and administrative expenses decreased 3.9% to $32.7
million during the year ended December 31, 2002 from $34.0 million during the
year ended December 31, 2001. The decrease of $1.3 million in selling, general
and administrative expenses, or 3.9%, from the year ended December 31, 2001 to
the year ended December 31, 2002, was the result of spending $3.8 million less
on our DTC campaign in 2002 compared to 2001. This was partially offset by
incremental promotional expenses for the newly licensed Atrix dental products,
other direct professional Periostat promotion expenses and the launch and
promotional expenses for Pandel, effective July 1, 2002.
Significant components of selling, general and administrative expenses
incurred during the year ended December 31, 2002 included $15.7 million in
direct selling and sales training expenses, $11.3 million in marketing expenses
(including Periostat DTC advertising and promotion expenditures for Periostat,
the Atrix products and co-promotion expenses relating to Vioxx and Pandel) and
$5.7 million in general and administrative expenses, which include business
development, finance and corporate activities. Significant components of
selling, general and administrative expenses during the year ended December 31,
2001 included $13.9 million in direct selling and training expenses, $14.9
million in marketing expenses (including Periostat DTC advertising expenditures,
launch expenses for the Atrix products and Dentaplex and co-promotion expenses
related to Vioxx) and $5.2 million in general and administrative expenses.
Other Income/Expense
- -------------------------------------------------------------------------------
Other Income/Expense
(dollars in thousands) 2002 Change 2001
---- ------ -----
- -------------------------------------------------------------------------------
Interest Income $ 77 (66.8%) $ 232
- -------------------------------------------------------------------------------
Interest Expense $ 5 (70.6%) $ 17
- -------------------------------------------------------------------------------
Other Income $ 17 (112.5%) $ 8
- -------------------------------------------------------------------------------
Interest income decreased to $77,000 for the year ended December 31, 2002
compared to $232,000 for the year ended December 31, 2001. This decrease was due
to lower average balances in cash and short-term investments and lower
investment yields during the year ended December 31, 2002. Interest expense for
the year ended December 31, 2002 was $5,000, compared to $17,000 for the year
ended December 31, 2001 due to lower average principle amounts outstanding on
our notes payable. Other income for the year ended December 31, 2002 was $17,000
compared to $8,000 for the year ended December 31, 2001. These amounts represent
foreign currency transaction gains and vary based on transaction volume.
Preferred Stock Dividend
Preferred stock dividends were $1.6 million for the year ended December 31,
2002 and $1.7 million for the year ended December 31, 2001. Such preferred stock
dividends, paid in shares of our common stock through May 11, 2002, and
thereafter in cash, were 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
-51-
dividends on the Series D preferred stock in shares of our common stock, and we
became obligated to pay such dividends in cash, at a rate equal to 8% per annum.
Cash dividends incurred for the period May 12, 2002 to December 31, 2002 were
approximately $1.0 million.
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 $18.7 million, after the payment
of placement agent fees and related expenses.
Our 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 December 31, 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 are currently negotiating to renew the credit facility for
a two-year term upon expiration. 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
-52-
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 December 31, 2003, the letter of credit had been reduced to
$124,000. 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 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 bank with respect to
all of our assets, including our intellectual property. As of December 31, 2003,
we had no borrowings outstanding against the credit facility.
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. These annual
requirements were met by us during 2003.
During 2003, our co-promotional agreements with Merck, Novartis and Sirius
generated approximately $3.1 million in revenue and approximately $1.6 million
in positive cash-flows. As of December 31, 2003, all of these agreements either
expired or were mutually terminated. We do not expect any future revenues or
cash in-flows from Merck, Novartis and Sirius other than nominal residual
contract revenues through 2005 from our expired agreement with Merck for Vioxx.
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
-53-
payments in the aggregate amount of up to approximately $3.2 million, of which
no more than $2.2 million could 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 $600,000 under this agreement in the year ended December 31, 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 December 31, 2003, we had cash and cash equivalents of approximately
$32.7 million, an increase of $22.6 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 money market funds. Our working capital at December 31,
2003 was $32.0 million, an increase of $26.0 million from $6.0 million at
December 31, 2002. This increase was primarily attributable to the operating
profitability experienced during 2003, the addition of $1.8 million in cash
proceeds from the exercise of stock options and warrants and the sale of
2,000,000 shares of our common stock, at a per share purchase price of $10.00,
which generated net proceeds to us of approximately $18.7 million. During the
year ended December 31, 2003, we generated $4.8 million in cash from our
operating activities principally from net income of $6.4 million less changes in
certain assets and liabilities. During the year ended December 31, 2003, we
invested $305,000 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 our working capital at December 31, 2003 will
allow us to fund our operations, capital expenditures and preferred stock
dividend requirements for at least the forseeable future and we do not anticpate
requiring additional capital to fund our operations. Our line of credit is due
to expire on March 15, 2004. While it is our intention to renew the credit
facility for an additional two-year term, we believe our current cash balance
along with our cash flows from operations is adequate to fund our operations in
the event that the line of credit is not renewed. 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. We
expect to significantly increase our investment in research and development in
2004. 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:
- Revenues and profits from sales of Periostat and other products and
contracted services;
- The success of our dermatology franchise;
- The success of our pre-clinical, clinical and development programs;
-54-
- The receptivity of the capital markets to future financings;
- Our ability to enter into additional strategic collaborations and to
maintain existing and new collaborations and the success of such
collaborations; and
- 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,
operating leases for our sales force, computer equipment, and contractual
commitments with our marketing partners for certain selling and promotional
expenses associated with the products we are currently detailing. Additionally,
we also expect to make certain inventory purchases from our contract
manufacturer of Periostat.
Below is a table which presents our contractual obligations and commercial
commitments as of December 31, 2003:
-------------------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD
- ----------------------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL 2004 2005 AND 2006 2007 AND 2008 2009 AND AFTER
- ----------------------------------------------------------------------------------------------------------------------
Operating Leases(1)...... $2,528,000 $530,000 $1,108,000 $694,000 $196,000
- ----------------------------------------------------------------------------------------------------------------------
Unconditional Purchase
Obligations........... $1,139,000(2) $1,139,000(2) -- -- --
- ----------------------------------------------------------------------------------------------------------------------
Co-Promotional
Commitments........... (3) (3) (3) (3) (3)
- ----------------------------------------------------------------------------------------------------------------------
Cash Dividends on
Series D Preferred
Stock................. $8,000,000(4) $1,600,000(4) $3,200,000(4) $3,200,000(4) (4)
- ----------------------------------------------------------------------------------------------------------------------
Consulting Payments...... $628,000(5) $324,000(5) 304,000(5) -- --
- ----------------------------------------------------------------------------------------------------------------------
Total Contractual
Obligations........... $12,295,000 $3,593,000 $4,612,000 $3,894,000 $196,000
- ----------------------------------------------------------------------------------------------------------------------
(1) Such amounts primarily include minimum rental payments for our office
lease in Newtown, Pennsylvania, as well as payments for sales force
computer equipment leases.
(2) Such amount represents purchase order commitments for inventory
purchases and clinical supplies with various vendors.
(3) 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
-55-
Atrix License and Marketing Agreement under the heading "Liquidity and
Capital Resources."
(4) 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 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."
(5) Such amount represents consulting payments to be made to Brian M.
Gallagher, our former 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 could
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 $600,000 under this
agreement in the year ended December 31, 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.
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.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
We had cash equivalents at December 31, 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 December 31, 2003.
-56-
Item 8. Financial Statements and Supplementary Data.
The financial statements and supplementary data required to be filed
pursuant to this Item 8 are appended to this Annual Report on Form 10-K. A list
of the financial statements filed herewith is found at "Item 15. Exhibits,
Financial Statement Schedules, and Reports on Form 8-K."
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
Item 9A. 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 December 31, 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 December 31, 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 as of December 31, 2003 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
-57-
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information relating to our directors, nominees for election as
directors and executive officers under the headings "Election of Directors",
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in our definitive proxy statement for the 2004 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.
We have adopted a written code of business conduct and ethics that applies
to our directors, officers and employees, including our principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. We will make available our
code of business conduct and ethics free of charge through our website which is
located at www.collagenex.com. We intend to disclose any amendments to, or
waivers from, our code of business conduct and ethics that are required to be
publicly disclosed pursuant to rules of the Securities and Exchange Commission
and the Nasdaq National Market by filing such amendment or waiver with the
Securities and Exchange Commission and by posting it on our website.
Item 11. Executive Compensation.
The discussion under the heading "Executive Compensation" in our definitive
proxy statement for the 2004 Annual Meeting of Stockholders is incorporated
herein by reference to such proxy statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The discussion under the heading "Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters" in our definitive proxy
statement for the 2004 Annual Meeting of Stockholders is incorporated herein by
reference to such proxy statement.
Item 13. Certain Relationships and Related Transactions.
The discussion under the heading "Certain Relationships and Related
Transactions" in our definitive proxy statement for the 2004 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.
Item 14. Principal Accountant Fees and Services.
The discussion under the heading "Independent Auditors Fees and Other
Matters" in our definitive proxy statement for the 2004 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.
-58-
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) Financial Statements.
Reference is made to the Index to Consolidated Financial Statements
and Schedule on Page F-1.
(2) Financial Statement Schedule.
Reference is made to the Index to Consolidated Financial Statements
and Schedule on Page F-1.
(3) Exhibits.
Reference is made to the Index to Exhibits on Page 62.
(b) Reports on Form 8-K.
On October 8, 2003, we filed a Current Report on Form 8-K under Item
5, announcing 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.
On October 28, 2003, we furnished a Current Report on Form 8-K under
Item 9, containing a copy of our earnings release for the period ended
September 30, 2003 (including financial information) pursuant to Item
12 (Results of Operations and Financial Condition).
On November 10, 2003, we filed a Current Report on Form 8-K under Item
5, relating to our settlement of all pending litigation between
West-ward Pharmaceutical Corporation and us.
On December 8, 2003, we filed a Current Report on Form 8-K under Item
5, relating to the appointment of Colin W. Stewart as our president
and chief executive officer.
On December 8, 2003, we filed a Current Report on Form 8-K under Item
5, relating to our grant of inducement stock options to Colin W.
Stewart in accordance with NASDAQ Marketplace Rule 4350.
On February 24, 2004, we furnished a Current Report on Form 8-K under
Item 9, containing a copy of our earnings release for the quarter and
year ended December 31, 2003 (including financial information)
pursuant to Item 12 (Results of Operations and Financial Condition).
-59-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized this 15th day of March,
2004.
COLLAGENEX PHARMACEUTICALS, INC.
By: /s/ Colin W. Stewart
----------------------------------------------
Colin W. Stewart, Chief Executive Officer and
President
-60-
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- ------------------------------ ---------------------------------------- --------------
/s/ Colin W. Stewart President, Chief Executive Officer March 15, 2004
- ----------------------------- and Director (Principal Executive
Colin W. Stewart Officer)
/s/ Nancy C. Broadbent Chief Financial Officer, Treasurer and March 15, 2004
- ----------------------------- Secretary (Principal Financial and
Nancy C. Broadbent Accounting Officer)
/s/ Brian M. Gallagher Director March 8, 2004
- -----------------------------
Brian M. Gallagher, Ph.D.
/s/ Peter R. Barnett, D.M.D. Director March 15, 2004
- -----------------------------
Peter R. Barnett, D.M.D.
/s/ Robert C. Black Director March 15, 2004
- -----------------------------
Robert C. Black
/s/ James E. Daverman Chairman of the Board and Director March 15, 2004
- -----------------------------
James E. Daverman
/s/ Robert J. Easton Director March 15, 2004
- -----------------------------
Robert J. Easton
/s/ Stephen A. Kaplan Director March 15, 2004
- -----------------------------
Stephen A. Kaplan
/s/ W. James O'Shea Director March 8, 2004
- -----------------------------
W. James O'Shea
-61-
EXHIBIT INDEX
Exhibit No. Description of Exhibit
- ---------- ----------------------------------------------------
3.1(a) Amended and Restated Certificate of Incorporation.
3.2(v) Amended and Restated Bylaws.
3.3(m) Amended Certificate of Designation, Preferences and Rights of the
Series D Cumulative Convertible Preferred Stock of CollaGenex
Pharmaceuticals, Inc. dated as of October 15, 2001.
3.4(t) Amended Certificate of Designation of Series A Participating
Preferred Stock, as filed with the Secretary of State of the
State of Delaware on June 5, 2002.
4.1(a) Registration Rights Agreement dated September 29, 1995 by and
among the Company and certain investors, as supplemented.
4.2(a) Fourth Investment Agreement as of September 29, 1995 by and among
the Company and certain Investors.
4.3(t) Amended and Restated Shareholder Protection Rights Agreement,
dated as of May 29, 2002, by and between CollaGenex
Pharmaceuticals, Inc. and American Stock Transfer & Trust
Company.
+10.1(a) Assignment of, Amendment to and Restatement of Agreement, with
all exhibits, as amended, and schedules, dated January 13, 1992
by and among the Company, Johnson & Johnson Consumer Products,
Inc. and Research Foundation of State University of New York.
+10.2(a) Supply Agreement dated January 23, 1995 between the Company and
Hovione International Limited.
10.3(a) Form of Non-Disclosure Agreement executed by all Employees as
employed from time to time.
10.4(a)(b) Form of Non-Competition Agreement executed by each of Nancy C.
Broadbent and Robert A. Ashley.
10.5(a) Form of Mutual Non-Disclosure Agreement executed by certain
consultants and research collaborators as retained from time to
time.
10.6(a)(b) Form of Indemnification Agreement executed by each of the
Company's directors and officers.
10.7(a) Forms of Consulting Agreement executed by each of Lorne M. Golub
and Thomas F. McNamara.
62
Exhibit No. Description of Exhibit
- ---------- ----------------------------------------------------
10.8(a) Form of Material Transfer Agreement between the Company and
Researchers.
10.9(a)(b) 1992 Stock Option Plan of the Company, as amended to date.
10.10(a)(b) 1996 Stock Plan of the Company.
10.11(a)(b) 1996 Non-Employee Director Stock Option Plan of the Company.
+10.12(e) Distribution Services Agreement dated August 15, 1998 between
Cord Logistics, Inc. and the Company.
10.13(f) Stock Purchase Agreement dated March 19, 1999, between the
Company, OCM Principal Opportunities Fund, L.P. and other
Purchasers set forth therein.
10.14(g) Lease Agreement dated March 15, 1999 between the Company and
Newton Venture IV Associates, effective May 15, 1999.
10.15(h) Stockholders and Registration Rights Agreement, dated March 19,
1999, by and among CollaGenex Pharmaceuticals, Inc., OCM
Principal Opportunities Fund, L.P. and the Purchasers set forth
therein.
10.16(i) Form of Common Stock Purchase Agreement, dated March 12, 2001,
between the Company and the Investors set for therein, together
with form of Registration Rights Agreement as an exhibit thereto
and form of Warrant as an exhibit thereto.
10.17(j) Loan and Security Agreement dated March 19, 2001, between the
Company and Silicon Valley Bank.
+10.18(k) Services and Supply Agreement dated as of September 26, 2000 as
amended by letter agreement dated as of December 1, 2000, by and
between the Company and Pharmaceutical Manufacturing Research
Services, Inc.
10.19(l) Letter Agreement dated as of June 26, 2001 by and between the
Company and Pharmaceutical Manufacturing Research Services, Inc.
10.20(m) Amendment No. 1 to Stockholders and Registration Rights
Agreement, dated March 19, 1999, by and among CollaGenex
Pharmaceuticals, Inc., OCM Principal Opportunities Fund, L.P, and
the Purchasers set forth therein.
63
Exhibit No. Description of Exhibit
- ---------- ----------------------------------------------------
10.21(m) Amendment No. 2 to Stockholders and Registration Rights
Agreement, dated March 19, 1999, by and among CollaGenex
Pharmaceuticals, Inc.,
OCM Principal Opportunities Fund, L.P, and the Purchasers set
forth therein.
+10.22(n) License Agreement dated August 24, 2001 by and between CollaGenex
Pharmaceuticals, Inc. and Atrix Laboratories, Inc.
+10.23(n) Stock Purchase Agreement dated August 24, 2001 by and between
CollaGenex Pharmaceuticals, Inc. and Atrix Laboratories, Inc.
+10.24(o) First Addendum December 10, 2001 to the Supply Agreement dated
January 23, 1995 by and between CollaGenex, Inc. and Hovione
International Limited.
10.25(p) Common Stock Purchase Agreement dated February 14, 2002 by and
between CollaGenex Pharmaceuticals, Inc. and Kingsbridge Capital
Limited.
10.26(p) Warrant dated February 14, 2002 issued to Kingsbridge Capital
Limited.
+10.27(r) Wholesale Service Agreement effective as of November 1, 2001, by
and between CollaGenex Pharmaceuticals, Inc. and National
Specialty Services, Inc.
+10.28(r) First Amendment to Wholesale Service Agreement effective as of
November 12, 2001, by and between CollaGenex Pharmaceuticals,
Inc. and National Specialty Services, Inc.
+10.29(r) Exclusive Distribution Agreement dated as of March 1, 2002, by
and between CollaGenex Pharmaceuticals, Inc. and CORD Logistics,
Inc.
10.30(r) First Loan Modification Agreement dated as of March 22, 2002 by
and between CollaGenex Pharmaceuticals, Inc. and Silicon Valley
Bank.
10.31(r) Second Loan Modification Agreement dated as of March 27, 2002 by
and between CollaGenex Pharmaceuticals, Inc. and Silicon Valley
Bank.
+10.32(u) Agreement by and between Altana Inc. and CollaGenex
Pharmaceuticals, Inc., dated May 24, 2002.
10.33(v) Form of Change of Control Agreement executed with each of Nancy
C. Broadbent, Robert Ashley, David Pfeiffer and Douglas Gehrig.
64
Exhibit No. Description of Exhibit
- ---------- ----------------------------------------------------
+10.34 Letter Agreement dated as of September 12, 2002 by and between
the Company and Pharmaceutical Manufacturing Research Services,
Inc.
10.35(w) Transition Agreement and Release dated March 18, 2003 by and
between Brian Gallagher and CollaGenex Pharmaceuticals, Inc.
10.36(w) Consulting Agreement dated March 18, 2003 by and between Brian
Gallagher and CollaGenex Pharmaceuticals, Inc.
10.37(x) Form of Incentive Bonus Agreement executed with each of David F.
Pfeiffer and Robert A. Ashley.
10.38(y) Severance Agreement by and between CollaGenex Pharmaceuticals,
Inc. and Paul Lubetkin.
21* List of subsidiaries of the Registrant.
23.1* Consent of KPMG LLP.
31.1* Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the
Exchange Act, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Chief Executive Officer).
31.2* Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the
Exchange Act, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Chief Financial Officer).
32.1* Certification Pursuant to 18 U.S.C. Section 1350.
* Filed herewith
+ Confidential treatment has been requested and granted for a portion of
this Exhibit.
(a) Incorporated by reference to the Company's Registration Statement on
Form S-1 (File Number 333-3582) which became effective on June 20,
1996.
(b) A management contract or compensatory plan or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
(c) Incorporated by reference to the Company's Current Report on Form 8-K,
dated September 16, 1997, which was filed with the Securities and
Exchange Commission on September 17, 1997.
(d) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998, which was filed with
the Securities and Exchange Commission on November 16, 1998.
65
(e) Incorporated by reference to the Company's Current Report on Form 8-K,
dated March 19, 1999 which was filed with the Securities and Exchange
Commission on March 25, 1999.
(f) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1999, which was filed with the
Securities and Exchange Commission on May 7, 1999.
(g) Incorporated by reference to the Company's Current Report on Form 8-K,
dated May 12, 1999, which was filed with the Securities and Exchange
Commission on May 26, 1999.
(h) Incorporated by reference to the Company's Current Report on Form 8-K,
dated March 16, 2001, which was filed with the Securities and Exchange
Commission on March 16, 2001.
(i) Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 2000, which was filed with the
Securities and Exchange Commission on March 26, 2001. The Company
amended such Form 10-K by filing a Form 10-K/A on January 2, 2002.
(j) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2001, which was filed with the
Securities and Exchange Commission on May 15, 2001.
(k) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 2001, which was filed with the
Securities and Exchange Commission on August 14, 2001.
(m) Incorporated by reference to the Company's Current Report on Form 8-K,
dated October 15, 2001, which was filed with the Securities and
Exchange Commission on October 18, 2001.
(n) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2001, which was filed with
the Securities and Exchange Commission on November 14, 2001. The
Company amended such Form 10-Q by filing a Form 10-Q/A on February 14,
2002.
(o) Incorporated by reference to the Company's Current Report on Form 8-K,
dated December 10, 2001, which was filed with the Securities and
Exchange Commission on December 10, 2001.
(p) Incorporated by reference to the Company's Current Report on Form 8-K,
dated February 14, 2002, which was filed with the Securities and
Exchange Commission on February 15, 2002.
(q) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2001, which was filed with
the Securities and Exchange Commission on November 14, 2001. The
Company amended such Form 10-Q by filing a Form 10-Q/A on February 14,
2002.
(r) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2002, which was filed with the
Securities and Exchange Commission on May 15, 2002.
66
(s) Incorporated by reference to the Company's Current Report on Form 8-K,
dated May 15, 2002, which was filed with the Securities and Exchange
Commission on May 20, 2002.
(t) Incorporated by reference to the Company's Current Report on Form 8-K,
dated May 29, 2002, which was filed with the Securities and Exchange
Commission on June 5, 2002.
(u) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002, which was filed with the
Securities and Exchange Commission on August 14, 2002.
(v) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, which was filed with
the Securities and Exchange Commission on November 14, 2002.
(w) Incorporated by reference to the Company's Current Report on Form 8-K,
dated March 18, 2003, which was filed with the Securities and Exchange
Commission on March 19, 2003.
(x) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003, which was filed with
the Securities and Exchange Commission on November 14, 2003.
(y) Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003, which was filed with
the Securities and Exchange Commission on November 14, 2003.
67
COLLAGENEX PHARMACEUTICALS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Page
-----
Independent Auditors' Report............................................. F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002............. F-3
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002, and 2001........................................ F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001......................................... F-5
Consolidated Statements of Cash Flows for the years
ended December 31, 2003, 2002 and 2001................................... F-6
Notes to Consolidated Financial Statements............................... F-7
Financial Statement Schedule - Valuation and Qualifying Accounts
for the years ended December 31, 2003, 2002 and 2001..................... F-31
F-1
Independent Auditors' Report
The Board of Directors and Stockholders
CollaGenex Pharmaceuticals, Inc.:
We have audited the consolidated financial statements of CollaGenex
Pharmaceuticals, Inc. and subsidiaries as listed in the accompanying index. In
connection with our audits, we also have audited the financial statement
schedule as listed in the accompanying index. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of CollaGenex
Pharmaceuticals, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion the related financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly in
all material respects, the information set forth therein.
/s/ KPMG LLP
Princeton, New Jersey
February 20, 2004
F-2
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2003 and 2002
(Dollars in thousands, except per share data)
Assets 2003 2002
---------- ---------
Current assets:
Cash and cash equivalents............................................ $ 32,670 $ 10,112
Accounts receivable, net of allowances of $1,308 and $1,412
in 2003 and 2002, respectively................................... 4,959 2,142
Inventories.......................................................... 1,672 1,415
Prepaid expenses and other current assets............................ 1,732 1,044
---------- ----------
Total current assets............................................. 41,033 14,713
Equipment and leasehold improvements, net................................. 496 559
Acquired product rights, net.............................................. 1,749 2,335
Other assets.............................................................. 27 27
---------- ----------
Total assets..................................................... $ 43,305 $ 17,634
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable..................................................... 3,273 3,616
Accrued expenses..................................................... 4,950 4,305
Preferred dividends payable.......................................... 800 800
---------- ----------
Total current liabilities............................... 9,023 8,721
---------- ----------
Deferred revenue.......................................................... 326 561
---------- ----------
Commitments and contingencies (Note 11)
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 in 2003 and 2002, (liquidation
value $20,800); 150,000 shares of Series A participating
preferred stock, $0.01 par value, designated and no shares
issued and outstanding in 2003 and 2002.......................... 2 2
Common stock, $0.01 par value; 25,000,000 shares authorized,
13,842,200 and 11,377,631 shares issued and outstanding in
2003 and 2002, respectively...................................... 138 114
Additional paid in capital........................................... 103,670 82,917
Accumulated deficit.................................................. (69,854) (74,681)
---------- ----------
Stockholders' equity............................................. 33,956 8,352
---------- ----------
Total liabilities and stockholders' equity....................... 43,305 17,634
========== ==========
See accompanying notes to consolidated financial statements.
F-3
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
2003 2002 2001
----------- ---------- ----------
Revenues:
Net product sales................................ $ 49,038 $ 42,111 $ 31,358
Contract revenues................................ 3,122 2,332 3,386
License revenues................................. 699 176 488
---------- ---------- ----------
Total revenues............................... 52,859 44,619 35,232
---------- ---------- ----------
Operating expenses:
Cost of product sales............................ 7,362 6,713 5,825
Research and development......................... 5,462 4,394 3,764
Selling, general and administrative.............. 33,668 32,699 34,010
---------- ---------- ----------
Total operating expenses..................... 46,492 43,806 43,599
---------- ---------- ----------
Operating income (loss)...................... 6,367 813 (8,367)
Other income (expense):
Interest income.................................. 148 77 232
Interest expense................................. -- (5) (17)
Other............................................ (3) 17 8
---------- ---------- ----------
Income (loss) before income taxes............ 6,512 902 (8,144)
Income taxes..................................... 85 -- --
---------- ---------- ----------
Net income (loss)............................ 6,427 902 (8,144)
Preferred stock dividends............................. 1,600 1,629 1,680
---------- ---------- ----------
Net income (loss) allocable to common stockholders.... $ 4,827 $ (727) $ (9,824)
========== ========== ==========
Basic net income (loss) per share allocable to common
stockholders..................................... $ 0.40 $ (0.06) $ (0.94)
========== ========== ==========
Diluted net income (loss) per share allocable to common
stockholders..................................... $ 0.38 $ (0.06) $ (0.94)
========== ========== ==========
Weighted average shares used in computing per share
amounts:
Basic............................................ 12,094,638 11,234,652 10,413,663
========== ========== ==========
Diluted.......................................... 12,836,364 11,234,652 10,413,663
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-4
COLLAGENEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2003, 2002 and 2001
(Dollars in thousands)
Series D
cumulative convertible
preferred stock Common stock
---------------------- -----------------------
Common
Number of Number of stock to be
shares Par value shares Par value issued
---------- --------- ---------- --------- -----------
Balance, December 31, 2000...................... 200,000 $ 2 8,775,176 $ 88 $ 872
Issuance of common stock for common
stock options previously exercised......... -- -- 16,000 -- (32)
Issuance of common stock, net of issuance
costs...................................... -- -- 1,830,556 18 --
Common stock dividends issued on Series D
cumulative convertible preferred stock..... -- -- 377,841 4 (840)
Common stock dividends declared on Series D
cumulative convertible preferred stock..... -- -- -- -- 840
Compensation expense resulting from
modifications of options................... -- -- -- -- --
Amortization of deferred compensation ........ -- -- -- -- --
Net loss...................................... -- -- -- -- --
---------- --------- ---------- --------- ----------
Balance, December 31, 2001 ..................... 200,000 2 10,999,573 110 840
Exercise of common stock options and
warrants...................................... -- -- 35,704 -- --
Issuance of common stock, net of issuance
cost.......................................... -- -- 151,522 2 --
Common stock dividends declared on Series D
cumulative convertible preferred stock........ -- -- -- -- 611
Common stock dividends issued on Series D
cumulative convertible preferred
stock .................................... -- -- 190,832 2 (1,451)
Cash dividends declared on Series D cumulative
convertible preferred stock .................. -- -- -- -- --
Net income...................................... -- -- -- -- --
---------- --------- ---------- --------- ----------
Balance, December 31, 2002...................... 200,000 2 11,377,631 114 --
Exercise of common stock options and
warrants ..................................... -- -- 464,569 4 --
Issuance of common stock, net of issuance
cost.......................................... -- -- 2,000,000 20 --
Cash dividends declared on Series D cumulative
convertible preferred stock .................. -- -- -- -- --
Compensation expense resulting from the
modification of options .................. -- -- -- -- --
Net income...................................... -- -- -- -- --
---------- --------- ---------- --------- ----------
Balance, December 31, 2003...................... 200,000 $ 2 13,842,200 $ 138 $ --
========== ========= ========== ========= ==========
Additional Total
paid-in Deferred Accumulated stockholders'
capital compensation deficit equity
---------- ------------ ----------- -------------
Balance, December 31, 2000...................... $ 68,461 $ (29) $ (64,130) $ 5,264
Issuance of common stock for common
stock options previously exercised......... 32 -- -- --
Issuance of common stock, net of issuance
costs...................................... 9,796 -- -- 9,814
Common stock dividends issued on Series D
cumulative convertible preferred stock..... 1,676 -- (840) --
Common stock dividends declared on Series D
cumulative convertible preferred stock .... -- -- (840) --
Compensation expense resulting from
modifications of options .................. 164 -- -- 164
Amortization of deferred compensation ........ -- 29 -- 29
Net loss ..................................... -- -- (8,144) (8,144)
---------- ------------ ----------- ---------
Balance, December 31, 2001 ..................... 80,129 -- (73,954) 7,127
Exercise of common stock options and
warrants ..................................... 165 -- -- 165
Issuance of common stock, net of issuance
cost ......................................... 1,174 -- -- 1,176
Common stock dividends declared on Series D
cumulative convertible preferred stock ....... -- -- (611) --
Common stock dividends issued on Series D
cumulative convertible preferred
stock .................................... 1,449 -- -- --
Cash dividends paid on Series D cumulative
convertible preferred stock .................. -- -- (218) (218)
Cash dividends declared on Series D cumulative
convertible preferred stock .................. -- -- (800) (800)
Net income ..................................... -- -- 902 902
---------- ------------ ----------- ---------
Balance, December 31, 2002 ..................... 82,917 -- (74,681) 8,352
Exercise of common stock options and
warrants ..................................... 1,819 -- -- 1,823
Issuance of common stock, net of issuance
cost ......................................... 18,683 -- -- 18,703
Cash dividends declared on Series D cumulative
convertible preferred stock .................. -- -- (1,600) (1,600)
Compensation expense resulting from the
modification of options .................. 251 -- -- 251
Net income ..................................... -- -- 6,427 6,427
---------- ------------ ----------- ---------
Balance, December 31, 2003 ..................... $ 103,670 $ -- $ (69,854) $ 33,956
========== ========= ========== =========
See accompanying notes to consolidated financial statements.
F-5
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2003, 2002 and 2001
(Dollars in thousands)
2003 2002 2001
Cash flows from operating activities:
Net income (loss)................................................... $ 6,427 $ 902 $ (8,144)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Noncash compensation expense.................................. 251 -- 193
Depreciation and amortization expense......................... 954 524 263
Accounts receivable provisions................................ (104) 462 569
Change in assets and liabilities:
Accounts receivable....................................... (2,713) 1,874 (2,009)
Inventories............................................... (257) (13) (1,125)
Prepaid expenses and other assets......................... (688) 156 (111)
Accounts payable.......................................... (343) (153) 1,904
Accrued expenses.......................................... 1,545 252 639
Deferred revenue.......................................... (235) (53) (62)
--------- --------- ---------
Net cash provided by (used in) operating activities.... 4,837 3,951 (7,883)
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures................................................ (305) (298) (131)
Acquisition of product rights....................................... (900) (800) (1,000)
Proceeds from the sale of short-term investments.................... -- -- 2,035
Purchase of short-term investments.................................. -- -- (296)
--------- --------- ---------
Net cash provided by (used in) investing activities.... (1,205) (1,098) 608
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock.......................... 20,526 1,341 9,814
Payment of preferred dividends...................................... (1,600) (218) --
Repayment of long-term debt......................................... -- (35) (77)
--------- --------- ---------
Net cash provided by financing activities............... 18,926 1,088 9,737
--------- --------- ---------
Net increase in cash and cash equivalents............... 22,558 3,941 2,462
Cash and cash equivalents at beginning of year........................... 10,112 6,171 3,709
--------- --------- ---------
Cash and cash equivalents at end of year................................. 32,670 $ 10,112 $ 6,171
========= ========= =========
Supplemental schedule of noncash investing and financing activities:
Common stock dividends issued or issuable on preferred stock........ $ -- $ 1,451 $ 1,680
========= ========= =========
Accrued liability for Altana license................................ $ -- $ 900 $ --
========= ========= =========
Cash dividends declared on preferred stock.......................... $ 800 $ 800 $ --
========= ========= =========
Issuance of warrants to purchase common stock in connection
with equity line............................................... $ -- $ 248 $ --
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest.............................. $ -- $ 5 $ 17
========= ========= =========
Cash paid during the year for income taxes.......................... $ 197 $ -- $ --
========= ========= =========
See accompanying notes to consolidated financial statements.
F-6
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
(1) Business
CollaGenex Pharmaceuticals, Inc. and subsidiaries ("CollaGenex
Pharmaceutical" or the "Company") was incorporated in Delaware on January
10, 1992. The Company is a specialty pharmaceutical company focused on
providing innovative medical therapies to the dental and dermatology
markets. The Company, through its own sales and marketing group, is
currently marketing Periostat(R), the Company's lead drug for the treatment
of adult periodontal disease, Atridox, Atrisorb FreeFlow and Atrisorb-D
(the "Atrix Products") under an exclusive licensing and marketing agreement
with Atrix Laboratories, Inc. ("Atrix") and Pandel under a sublicensing
agreement with Altana, Inc. ("Altana"). During 2001, 2002 and 2003, the
Company also co-promoted VIOXX(R) with Merck and Co. ("Merck") and
Denavir(R) with Novartis Consumer Health, Inc. ("Novartis") to dental
professionals on a contract basis. Beginning in April of 2003, the Company
was engaged in a co-promotion agreement with Sirius Laboratories, Inc.
("Sirius") in which the parties jointly marketed Sirius' AVAR(TM) product
line to dermatologists in the United States, while Sirius co-promoted the
Pandel product line. Co-promotion agreements with Merck, Novartis and
Sirius expired or were mutually terminated as of December 31, 2003. The
Company has other internally developed proprietary compounds for cancer
metastasis and a broad range of inflammatory diseases that are currently in
the research and development stage.
The accompanying consolidated financial statements include the results of
operations of the Company and its wholly-owned subsidiaries. All
intercompany accounts and transactions have been eliminated in
consolidation.
(2) Summary of Significant Accounting Policies
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents. All
cash equivalents are invested in money market funds.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
Acquired Product Rights
Product rights are stated at cost and are amortized over the estimated
useful life of the products using the straight-line method and have a
weighted average useful life of 6 years. Amortization of product rights is
charged to cost of product sales.
F-7
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
Equipment and Leasehold Improvements
Equipment and leasehold improvements, consisting of computer and office
equipment, exhibit equipment and leasehold improvements are recorded at
cost. Depreciation and amortization is provided using the straight-line
method over the estimated useful lives of the assets or the related lease
term, whichever is shorter, generally three to ten years. Expenditures for
repairs and maintenance are expensed as incurred.
Segment Information
The Company is managed and operated as one business. The entire business is
managed by a single management team that reports to the chief executive
officer. The Company does not operate separate lines of business or
separate business entities with respect to any of its products or product
candidates. Accordingly, the Company does not prepare discrete financial
information with respect to separate product areas or by location and does
not have separately reportable segments.
Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable, accrued expenses and preferred dividends payable
approximate fair value because of the short term nature of these
instruments.
Net Product Sales
In September 1998 the Company received approval from the Food and Drug
Administration ("FDA") to market Periostat. In 2001, the Company entered
into an exclusive licensing and marketing agreement with Atrix for the
Atrix Products. In 2002, the Company entered into a sublicense agreement
with Altana to market and distribute Pandel. The Company recognizes sales
revenue for Periostat, Pandel and the Atrix Products upon shipment. Sales
are reported net of allowances for discounts, rebates, wholesaler and
distributor chargebacks and product returns which are provided for at the
time of the sale.
Contract Revenues
Contract revenues for Vioxx and Denavir are fee-based arrangements where
revenue is earned as prescriptions are filled and recognized according to
the provisions of each collaborative agreement. Contract revenues for AVAR
are calculated as a percentage of the sales gross margin recognized by
Sirius, in accordance with the provisions of the agreement with Sirius and
are recognized when product is shipped by Sirius. The Company does not take
title to the products being promoted under these arrangements.
F-8
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
License Revenue
Milestone revenue from license 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.
Payments, if any, received in advance of performance under a contract are
deferred and recognized when earned. Upfront license fees where the Company
has continuing involvement are deferred and recognized over the estimated
performance period of each individual licensing agreement in accordance
with the SEC's Staff Accounting Bulletin No. 104 (SAB 104). In 2003, SAB
104 replaced Staff Accounting Bulletin No. 101 (SAB 101) which the Company
adopted in 2000. The provisions related to up-front license fees were
unchanged in SAB 104 versus SAB 101. During 2003, 2002, and 2001,
respectively, the Company recorded $52, $59 and $60 in license revenues
which were deferred upon the implementation of SAB 101 and which were
previously recognized as license revenues under the historical revenue
recognition policy prior to the adoption of SAB 101.
Advertising Costs
The Company incurs advertising costs from print advertisements in various
periodicals and television advertisements. The Company records advertising
expense when incurred. Such amounts charged to the consolidated statements
of operations for 2003, 2002 and 2001 were $139, $3,091 and $6,190,
respectively.
Research and Development
Research and development expenses consist primarily of funds paid to third
parties for the provision of services and materials for drug development,
manufacturing and formulation enhancements, clinical trials, statistical
analysis and report writing and regulatory compliance costs. Research and
product development costs are expensed as incurred.
Accounting for Income Taxes
Deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities and
are measured using the enacted tax rates and laws that will be in effect
when such differences are expected to reverse. The measurement of deferred
tax assets is reduced, if necessary, by a valuation allowance for any tax
benefits which are not expected to be realized. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in the period
that such tax rate changes are enacted.
Management Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to
F-9
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
Stock-Based Compensation
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 and director
compensation plans at fair value. Accordingly, compensation cost for stock
options issued to employees and directors 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.
The Company has elected to account for stock-based compensation under APB
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. As set forth below, the pro forma disclosures of net
income (loss) allocable to common stockholders and income (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 using the assumptions described in note 8:
2003 2002 2001
--------------------------------------------
Net income (loss) allocable to
common stockholders:
As reported.............................. $ 4,827 $ (727) $ (9,824)
Add: Stock-based employee
compensation expenses included in
net income (loss) allocable to common
stockholders reported.................... 251 -- 29
Less: Stock-based employee
compensation under fair value
based method............................. (5,015) (3,735) (3,898)
-------- --------- ---------
Pro forma................................ $ 63 $ (4,462) $ (13,693)
======== ========= =========
Basic net income (loss) per share
allocable to common
stockholders:
F-10
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
As reported.............................. $ 0.40 $ (0.06) $ (0.94)
======== ========= =========
Pro forma................................ $ 0.01 $ (0.40) $ (1.31)
======== ========= =========
2003 2002 2001
--------------------------------------------
Diluted net income (loss) per share
allocable to common stockholders
As reported.............................. $ 0.38 $ (0.06) $ (0.94)
======== ========= =========
Pro forma................................ $ 0.01 $ (0.40) $ (1.31)
======== ========= =========
Concentration of Credit and Other Risks
The Company invests its excess cash in money market funds with major U.S.
financial institutions. The Company has established guidelines relative to
diversification and maturities that maintain safety and liquidity.
The Company currently contracts with a single source for the domestic
manufacturing of Periostat tablets which are sold throughout the United
States exclusively to wholesale and retail distributors. In addition, the
Company has a supply agreement with a single company to supply the active
ingredient in Periostat(R). A single company also provides all warehousing
and distribution services to the Company. During 2003, three customers
accounted for 43%, 31% and 20% of net product sales, respectively. During
2002, three customers accounted for 32%, 24% and 19% of net product sales,
respectively. During 2001, four customers accounted for 28%, 15%, 13% and
10%, of net product sales, respectively.
During the years ended December 31, 2003, 2002 and 2001, Periostat(R)
accounted for approximately 82%, 82% and 87% of our total net revenues,
respectively.
The Company's business of selling, marketing and developing pharmaceutical
products is subject to a number of significant risks, including risks
relating to the implementation of the Company's sales and marketing plans,
risks inherent in research and development activities, risks associated
with conducting business in a highly regulated environment and
uncertainties related to clinical trials of products under development.
F-11
Impairment of Long-Lived Assets
Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," we evaluate long-lived assets and intangible assets for
impairment when factors indicate that the carrying amount of an asset may
not be recoverable. When factors indicate that such assets should be
evaluated for possible impairment, we review the realizability of our
long-lived assets by analyzing the projected undiscounted cash flows in
measuring whether the asset is recoverable. Impairment, if any, is
recognized as the difference between the asset carrying value and its fair
value. No such adjustments were recorded in 2003, 2002 or 2001.
Net Income (Loss) Per Share
Basic income per share (EPS) is calculated by dividing income (loss)
allocable to common stockholders by the weighted average shares of common
stock outstanding. Net income (loss) allocable to common stockholders
includes dividends on the preferred stock. Diluted EPS reflects the
potential dilution that could occur if outstanding options and warrants
were exercised. As of December 31, 2002 and December 31, 2001, the Company
had outstanding stock options and stock warrants which were not included in
the calculation of diluted net loss per share allocable to common
stockholders because to do so would be anti-dilutive. Diluted EPS would
also include the effect of dilution to income of convertible securities. As
of December 31, 2003, 2002 and 2001, the Company had certain convertible
preferred stock which had not been included in the calculation of diluted
net income (loss) per share allocable to common stockholders because to do
so would be anti-dilutive. As such, the numerator and denominator used in
computing both basic and diluted net loss per share allocable to common
stockholders were equal in 2002 and 2001. For the year ended December 31,
2003, the denominator used to calculate diluted income per share was
741,726 higher than the denominator used to calculate basic income per
share. This difference in share amounts related to in the money employee
stock options and warrants.
Recently Issued Accounting Standards
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003.
This Statement establishes standards for the classification and measurement
of certain financial instruments with characteristics of both liabilities
and equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective
for instruments entered into or modified after May 31, 2003. For certain
mandatorily redeemable financial instruments, the Statement will be
effective for the Company on a later date. The Company currently does not
have any financial instruments that are within the scope of this Statement.
F-12
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
Reclassification
Certain amounts in the 2002 consolidated financial statements have been
reclassified to the 2003 presentation.
(3) Composition of Certain Financial Statement Captions
Inventories
Inventories at December 31, 2003 and 2002 consist of the following:
2003 2002
-------------- --------------
Raw materials................... $ 396 $ 233
Work-in-process................. 52 56
Finished goods.................. 1,224 1,126
-------------- --------------
$ 1,672 $ 1,415
============== ==============
Equipment and Leasehold Improvements
Equipment and leasehold improvements at December 31, 2003 and 2002 consist
of the following:
2003 2002 Useful Life
------------- -------------- -------------------------
Computer and office equipment............ $ 1,133 $ 1,203 3-5 years
Exhibit equipment........................ 451 327 5 years
Shorter of 10 years or
Leasehold improvements................... 45 45 lease term
-------------- --------------
1,629 1,575
Less: accumulated depreciation
and amortization.................... (1,133) (1,016)
-------------- ---------------
$ 496 $ 559
============== ==============
Acquired Product Rights
Acquired product rights at December 31, 2003 and 2002 consist of the
following:
2003 2002
-------------- -------------
Acquired product rights.............. $ 2,700 $ 2,700
Less: accumulated
amortization.................... (951) (365)
--------- ---------
$ 1,749 $ 2,335
========= =========
F-13
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
Amortization expense which is included in cost of product sales was $586,
$366 and $17 in 2003, 2002 and 2001, respectively. Expected amortization of
acquired product rights is as follows:
2004................. $ 586
2005................. 586
2006................. 100
2007................. 100
2008................. 100
Thereafter........... 277
-----------
$ 1,749
===========
Accrued Expenses
Accrued expenses at December 31, 2003 and 2002 consist of the following:
2003 2002
--------------- ---------------
Product licensing fees............... $ -- $ 900
Contracted development and
manufacturing costs............ 835 456
Sales and marketing costs............. 202 255
Payroll and related costs............. 1,925 1,479
Professional and consulting fees...... 922 339
Royalties............................. 645 553
Deferred revenue...................... 52 59
Income taxes.......................... 85 --
Miscellaneous taxes................... 139 103
Other................................. 145 161
----------- -----------
$ 4,950 $ 4,305
=========== ===========
(4) Note Payable
In April 1999, the Company received $219 in proceeds from the issuance of a
note payable. The proceeds of such note were used to fund the purchase of
equipment, fixtures and furniture for the Company's leased corporate office
in Newtown, Pennsylvania. The term of the note was three years with
interest at 9.54% per annum, with monthly minimum payments of principal and
interest. The Company repaid the note in 2002.
(5) Stockholders' Equity
The Company's Board of Directors may, without further action by the
Company's stockholders, from time to time, direct the issuance of shares of
preferred stock in series
F-14
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
and may, at the time of issuance, determine the rights, preferences and
limitations of each series. The holders of preferred stock would normally
be entitled to receive a preference payment in the event of any
liquidation, dissolution or winding-up of the Company before any payment is
made to the holders of the common stock.
On May 12, 1999, the Company consummated a $20,000 financing (the
Financing) through the issuance of 200,000 shares of its Series D
Cumulative Convertible preferred stock (the preferred stock), which
generated net proceeds to the Company of approximately $18,500. OCM
Principal Opportunities Fund, L.P. (OCM) led the investor group, which also
included certain current stockholders of the Company.
During the first three years following issuance, the preferred stock paid
dividends in common stock at a rate of 8.4% per annum. Beginning May 12,
2002, the preferred stock pays dividends in cash at a rate of 8.0% per
annum. The preferred stock was convertible into common shares of the
Company at an initial conversion price of $11.00 per share, subject to
adjustment (see below and note 6), at any time by the holder and under
certain conditions by the Company. The conversion price is subject to
adjustment in the event the Company fails to declare or pay dividends when
due or should the Company issue new equity securities or convertible
securities at a price per share or having a conversion price per share
lower than the applicable conversion price of the preferred stock (see
below and note 6). Dividends totaling $1,600, $1,629 and $1,680 were
declared in 2003, 2002 and 2001, respectively.
The holders of the preferred stock are entitled to vote with the holders of
the Company's common stock on all matters to be voted on by the Company's
stockholders on an as converted to common stock basis, subject to
adjustment. The holders of the preferred stock are entitled to liquidation
preferences equal to the original purchase price plus dividends accrued and
unpaid plus other dividends in certain circumstances. In connection with
the issuance of the preferred stock, the rights of the holders of the
Company's common stock may be limited in certain instances with respect to
dividend rights, rights on liquidation, winding up and dissolution of the
Company, and the right to vote in connection with certain matters submitted
to the Company's stockholders.
Without written approval of a majority of the holders of record of the
preferred stock, the Company, among other things, shall not: (i) declare or
pay any dividend or distribution on any shares of capital stock of the
Company other than dividends on the 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 debt securities of the
Company, except that the Company may incur such indebtedness in any amount
not to exceed $10,000 in the aggregate outstanding at any time for working
capital requirements in the ordinary course of business; or (iii) make
F-15
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
research and development expenditures in excess of $7,000 in any continuous
twelve month period, unless the Company has reported positive net income
for four consecutive quarters immediately prior to such twelve month
period.
On March 12, 2001, the Company consummated a private equity offering of
1,500,000 shares of common stock for an aggregate purchase price of $7,500,
which generated net proceeds to the Company of approximately $6,800. In
addition, the investors in this financing were also issued an aggregate of
400,000 warrants which are exercisable for up to three years into 400,000
shares of the Company's common stock at an exercise price per share of
$6.00. The consideration received for such warrants is included in the
aggregate proceeds received in the financing. No warrants have been
exercised and all 400,000 warrants remain outstanding at December 31, 2003.
The Company also issued to its financial advisor in this financing,
warrants to purchase an aggregate of 150,000 shares of the Company's common
stock, exercisable for up to three years, at an exercise price of $5.70 per
share. During 2002, 7,140 warrants were exercised into 4,654 shares of the
Company's common stock. During 2003, the remaining 142,860 warrants were
exercised into 92,195 shares of the Company's common stock. The majority of
these warrant exercises were in cashless transactions. Accordingly, none of
the 150,000 warrants remain outstanding at December 31, 2003. As a result
of this financing, the conversion price of the preferred stock was reduced
to $9.94 per share. Such conversion price was further reduced to $9.91 per
share in connection with the sale of shares of the Company's common stock
to Atrix (see note 6).
On February 14, 2002, the Company entered into an equity line arrangement
under the terms of a Common Stock Purchase Agreement with Kingsbridge
Capital Limited. Pursuant to this agreement, the Company was able, at its
sole discretion and from time to time through February 13, 2003, to sell
shares of its common stock to Kingsbridge at a discount to market price, as
determined prior to each such sale. The equity line provided for the sale
of up to $8,500 in registered shares of the Company's common stock to
Kingsbridge. The equity line terminated pursuant to its terms on February
13, 2003 and, prior to such termination, the Company issued an aggregate of
151,522 shares of common stock for gross proceeds of $1,266.
In connection with the consummation of such equity line and pursuant to the
terms of a warrant agreement executed by the Company, the Company issued
Kingsbridge a warrant to purchase 40,000 shares of its common stock at an
exercise price of $9.38 per share. The conversion price of the Company's
preferred stock was reduced to $9.89 as a result of the issuance of shares
under the equity line and the issuance of such warrant. Such warrant is
exercisable as of August 14, 2002, and will expire on August 13, 2007. The
fair value of the warrants issued in connection with the Equity Line of
approximately $248 has no net impact as the increase to additional paid in
capital representing the value of the warrants
F-16
issued is offset by the decrease in additional paid in capital representing
a cost of the offering. No warrants have been exercised and all 40,000
warrants are outstanding at December 31, 2003.
On May 29, 2002, the Company's Board of Directors approved an Amended and
Restated Shareholder Protection Rights Agreement (the "Rights Agreement").
The Rights Agreement amended and restated, in its entirety, the Company's
then existing Shareholder Protection Rights Agreement (the "Prior Rights
Agreement") dated September 15, 1997, as amended, by and between the
Company and American Stock Transfer & Trust Company, as rights agent
thereunder. American Stock Transfer & Trust Company remains as rights agent
under the Rights Agreement. Each right previously authorized and
distributed under the Prior Rights Agreement was deemed to constitute a
Right under the Rights Agreement effective May 29, 2002. The Board of
Directors further authorized the issuance of one Right for each share of
the Company's common stock issued between the date of the Rights Agreement
and the earlier of the Distribution Date or the Expiration Date, as defined
in the Rights Agreement.
Each Right, once exercisable, entitles the holder to purchase from the
Company one one-hundredth of a share of the Company's Series A
Participating preferred stock at an exercise price of $65. All Rights
expire on September 26, 2007 unless earlier redeemed. At December 31, 2003,
the Rights were neither exercisable nor traded separately from the
Company's common stock, and become exercisable only if a person or a group
of affiliated or associated persons has acquired, or obtained the right to
acquire, beneficial ownership of 20% or more of the voting power of all
outstanding shares of the Company's common stock and in certain other
limited circumstances. Upon separation from the common stock, each Right
will entitle the holder, other than the acquiring person that has triggered
such separation, to effectively purchase certain shares of the Company's
common stock equal in market value to two times the then applicable
exercise price of the Right. If the Company is acquired in a merger or
other business combination transaction, or 50% or more of the Company's
assets or earning power are sold in one or more related transactions, the
Rights will entitle holders, upon exercise of the Rights, to receive shares
of common stock of the acquiring or surviving company with a market value
equal to twice the exercise price of each Right.
In February 2003, the Company filed a registration statement on Form S-3
with the Securities and Exchange Commission related to the public offering
of up to an aggregate of 2,000,000 shares of common stock. In October 2003,
the Company sold 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
$18,703, after the payment of placement agent fees and related expenses.
F-17
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
(6) Licensing and Marketing Agreements
On August 24, 2001, the Company signed an exclusive License Agreement (the
"Atrix License Agreement") with Atrix to market Atrix's proprietary dental
products, Atridox(R), Atrisorb(R) FreeFlow and Atrisorb(R)-D, to the United
States dental markets. Pursuant to the terms of the Atrix License
Agreement, among other things, Atrix will manufacture the dental products
for the Company at an agreed upon transfer price and will receive royalties
on future net sales of the products each calendar year. The Company paid a
$1,000 licensing fee to Atrix in 2001 to market such products in the United
States. The Company has also committed to no less than $2,000 in
advertising and selling expenses related to the licensed products during
2002, which was met for 2002, and on an annual basis commencing with fiscal
year 2003, the lesser of $4,000 or 30% of the Company's contribution
margin, as 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. These annual requirements were met
by the Company in 2003. Additionally, the Company must maintain a minimum
amount of full time sales professionals and make a specific amount of sales
presentations over the first twenty-four months of the agreement, which
were met. The $1,000 license fee payment has been capitalized and is being
amortized to cost of product sales over the ten year estimated term of the
license on a straight-line basis.
In addition, pursuant to the terms of a Stock Purchase Agreement dated
August 24, 2001 by and between the Company and Atrix, Atrix purchased
330,556 of unregistered shares of the Company's common stock for an
aggregate purchase price of approximately $3,000. As a result of the sale
of such shares to Atrix, the conversion price of the Company's preferred
stock was reduced to $9.91 per share.
On May 24, 2002, the Company executed a Sublicense Agreement with Altana
Inc. ("Altana"), the United States subsidiary of Altana Pharma AG, pursuant
to which the Company was granted the exclusive right to create improvements
to, market, advertise, promote, distribute, offer for sale and sell, in the
United States and Puerto Rico, Pandel(R) Cream, a mid-potency topical
corticosteroid that is indicated for the relief of mild-to-moderate
inflammatory disorders of the skin, such as atopic dermatitis and
psoriasis. Altana currently licenses such rights from Taisho Pharmaceutical
Co., Ltd., a company organized and existing under the laws of Japan. The
Company will purchase from Altana all Pandel products to be sold. Pursuant
to the terms of such agreement, the Company agreed to pay Altana an
aggregate sublicense fee of $1,700, of which $800 was paid in September
2002 and $900 of which was paid in May 2003. The sublicense fee has been
capitalized and is being amortized to cost of product sales over the
estimated term of agreement. In addition, the Company is required to pay a
royalty fee equal to a percentage
F-18
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
of the net sales of the product, if any. The agreement may be terminated by
the Company: (i) at any time, without cause, upon twelve months prior
written notice; (ii) if Altana shall commit any uncured, willful or
material breach of the provisions of the agreement; or (iii) if Altana
shall cease to manufacture or supply the product to the Company. Altana may
terminate the agreement: (i) at any time, without cause, upon twelve months
written notice; (ii) if the Company shall commit any uncured, willful or
material breach of the provisions of the agreement; (iii) if the Company
shall cease to offer the product for distribution to its customers; or (iv)
if the Company fails to make certain payments or fulfill certain invoicing
obligations.
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 2003, the
Company accelerated the recognition of the remaining $222 of unamortized
deferred revenue related to the $400 up-front payment received in 1996. In
June 2003, the Company recognized $425 related to the collection of
outstanding milestone payments from Roche.
Pursuant to a Co-Promotion Agreement the Company executed with Merck in
September 1999, the Company received the exclusive right to co-promote
Vioxx, a prescription strength non-steroidal anti-inflammatory drug that
was approved by the FDA on May 20, 1999 to relieve osteoarthritis and
manage acute pain in adults, including dental pain. The agreement provided
for certain payments by Merck to the Company upon sales of Vioxx to the
dental community. On September 23, 2002, the Company executed an amendment,
extension and reinstatement of the Co-Promotion Agreement with Merck with
respect to Vioxx. In accordance with that amendment, extension and
restatement, the Company's agreement with Merck automatically expired on
December 31, 2003.
In March 2003, the Company executed co-promotion agreements with Sirius
pursuant to which we jointly marketed both the Sirius' AVAR product line
and Pandel to dermatologists in the United States. These agreements were
mutually terminated in December 2003.
On October 1, 2002, the Company entered into a Product Detailing Agreement
with Novartis pursuant to which the Company co-promoted Denavir to target
dentists in the United States and received detailing fees and performance
incentives from Novartis. The agreement with Novartis to co-promote Denavir
expired on September 30, 2003, and the Company and Novartis decided not to
renew the arrangement with respect to Denavir.
(7) Line of Credit
On March 19, 2001, the Company consummated a revolving credit facility with
Silicon Valley Bank, which was subsequently amended in March 2002. The
credit facility, as amended, extends through March 15, 2004. The Company
may borrow up to the lesser of
F-19
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
$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. As of December 31, 2003, the Company had
an outstanding letter of credit approximating $124 that served as
collateral for certain inventory purchase committments of the Company (see
note 11). As the Company pays 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 the 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 defined in
the amendment, 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, which expires March 15, 2004.
The Company is currently negotiating to renew the credit facility for a
two-year term upon termination. 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 December 31, 2003 and 2002, the Company had no
borrowings outstanding against the credit facility.
(8) Stock Option Plans
The Company has three stock-based compensation plans (the Plans) and has
adopted the disclosure-only provisions of SFAS 123 and SFAS 148,
"Accounting For Stock Based Compensation-Transition and Dislcosures and
Amendment of SFAS 123". The Company continues to apply APB Opinion No. 25
in accounting for its stock option plans and, accordingly, no compensation
expense has been recognized at the date of grant in the consolidated
financial statements for stock options issued to employees and directors as
exercise prices equal the market value on the grant date.
The 1992 Stock Option Plan, as amended, (the 1992 Plan) provided for the
granting of incentive and nonqualified options to directors, employees and
consultants to purchase up to 291,000 shares of the Company's common stock
at a price, for the incentive options, not less than the fair market value
on the measurement date. Such options are exercisable for a period of ten
years from the grant date and generally vest over a four year period. All
such 291,000 options available under the 1992 Plan were granted by 1996.
The 1996 Stock Option Plan, as amended, (the 1996 Plan) provides for the
granting of incentive and nonqualified options to employees and consultants
to purchase up to 3,000,000 shares of the Company's common stock at a
price, for the incentive options, not
F-20
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
less than the fair market value on the measurement date. Incentive and
nonqualified options granted to individuals owning more than 10% of the
voting power of all classes of stock at the time of grant must have an
exercise price no less than 110% of the fair market value on the date of
grant. Such options are exercisable for a period of ten years from the
grant date and generally vest over a two to five year period, and may be
accelerated for certain grants in certain circumstances.
The Nonemployee Director Stock Option Plan (the Nonemployee Director Plan)
provides for the issuance of stock options to new nonemployee directors to
purchase up to 300,000 shares of common stock at an exercise price equal to
the fair market value on the date of grant. Such options vest 20% per annum
commencing one year from the grant date.
During 2003 and 2002, certain existing members of the Board of Directors
were granted 74,500 and 62,136 options, respectively, at a fair market
value of $10.80 and $6.60 per share, respectively. These grants were issued
under the 1996 Stock Option Plan. Such options vest 25% per annum,
commencing one year from the grant date.
During 2001 and 2000, 360,000 and 237,750 options were granted to employees
at fair market value with weighted average exercise prices of $5.19 and
$5.00 per share, respectively. These grants were not issued under the terms
of any of the above Plans. Such options are exercisable for a period of ten
years from the date of grant and generally vest over a two to five year
period.
At December 31, 2003, there were 575,672 shares available for grant under
the 1996 Plan and 100,000 under the Nonemployee Director Plan.
Deferred compensation had been recorded in years prior to 1998 for options
granted where the fair value of the Company's stock on the measurement date
exceeded the exercise price of such options. Deferred compensation has been
amortized to compensation expense in the accompanying consolidated
statements of operations over the respective vesting periods of such grants
$0, $0 and $29 in 2003, 2002 and 2001, respectively.
In 2001, the Company extended through the remaining contractual life the
exercisability of certain vested options for an ex-board member of the
Company. Accordingly, $164 was recognized as compensation expense in 2001,
based on the fair value of the options on the date the extension was
granted as determined using a Black-Scholes option pricing model.
As a result of a transition agreement with Brian M. Gallagher, Ph.D., the
Company's former chairman, chief executive officer and president, the
Company recognized a non-cash compensation charge of $251 for the year
ended December 31, 2003 relating to certain modifications to Dr.
Gallagher's stock option agreements (see note 11).
F-21
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
On December 8, 2003, the Company granted stock options to Colin W. Stewart,
its newly appointed president and chief executive officer, effective the
date of commencement of his employment. These options were granted without
stockholder approval under the following terms: 300,000 non-qualified stock
options, exercise price equal to the fair market value on the grant date,
ten-year term and vesting at the rate of 20% for each year of service with
the Company. In certain circumstances, if the closing price of the
Company's common stock exceeds a pre-determined per share price for a
certain number of consecutive days, a portion of such options will vest
immediately.
The following table summarizes stock option activity for 2001 through 2003:
Weighted average
Options exercise price per share
------------ -------------------------
Balance, December 31, 2000............ 2,023,009 $ 10.20
Granted.......................... 570,100 5.85
Cancelled........................ (140,500) 10.87
---------- ----------
Balance, December 31, 2001............ 2,452,609 $ 9.15
Granted.......................... 616,086 7.91
Exercised........................ (31,050) 4.70
Cancelled........................ (82,475) 9.90
---------- ----------
Balance, December 31, 2002............ 2,955,170 $ 8.91
Granted.......................... 899,350 10.23
Exercised........................ (374,374) 4.52
Cancelled........................ (47,142) 10.38
---------- ----------
Balance, December 31, 2003............ 3,433,004 $ 9.72
========== ==========
F-22
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
As of December 31, 2003, the following options were outstanding and
exercisable by price range as follows:
Outstanding Exercisable
----------------------------------------------- -----------------------------
Weighted Weighted
average Weighted average
remaining average exercise
Range of exercise Number of contractual exercise price Number of price per
prices options life (in years) per share options share
------------------ -------- -------------- -------------- ---------- ------------
$0.33-$2.00 69,000 1.6 $1.02 69,000 $1.02
$4.62-$6.75 643,871 6.1 5.55 436,143 5.56
$7.01-$8.88 603,640 7.9 8.04 241,726 8.04
$9.00-$11.88 1,534,413 6.8 10.07 620,313 9.88
$12.00-$22.63 582,080 5.7 16.17 487,579 15.92
--------- ------ -------- --------- --------
3,433,004 6.6 $9.72 1,854,761 $9.88
========= ====== ======== ========= ========
The weighted average fair values of stock options granted to employees
during 2003, 2002 and 2001 were $6.39, $6.07 and $4.57 per share,
respectively, on the date of grant. Such fair values were determined using
the Black-Scholes option pricing model and are based on the following
assumptions:
2003 2002 2001
-----------------------------------
Expected life in years -
Employees and directors............... 7 7 7
Risk-free interest rate................... 3.52% 4.30% 4.88%
Volatility................................ 81% 83% 85%
Expected dividend yield................... --% --% --%
On September 18, 2002, the Company executed agreements with each of five
officers of the Company that provided, among other things, for the
accelerated vesting of unvested options upon a change of control of the
Company. As of December 31, 2003, there were 300,000 options whose vesting
would have accelerated as a result of these agreements if a change of
control had occurred, and in this circumstance the Company would have
recorded compensation expense of $116, as measured by the difference in the
exercise price of the options with potentially accelerated vesting and the
fair value of the Company's common stock on the date the agreements were
executed. A non-cash charge will be recorded in the future upon a change in
control for only those options which would have otherwise expired unvested
except for the resulting acceleration of vesting as a result of these
agreements.
F-23
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
(9) Income Taxes
The Company utilizes the asset and liability method of accounting for
income taxes in accordance with SFAS No. 109, "Accounting for Income
Taxes". Under the asset and liability method, deferred taxes are determined
based on the differences between the financial statement and tax bases of
assets and liabilities using currently enacted tax rates.
For 2003, income tax expense consists of current Federal alternative
minimum tax of $80 and state income tax of $5. The tax effects of temporary
differences that give rise to significant portions of the deferred tax
assets and deferred tax liability at December 31, 2003 and 2002 are
presented below:
2003 2002
---------- ----------
Deferred tax assets:
Depreciation $ 14 $ 16
Amortization 230 --
Net operating loss carryforwards 23,198 23,952
Tax credit carryforwards 973 874
Accrued expenses 1,190 1,053
Deferred revenue 134 242
--------- ---------
Total gross deferred assets 25,739 26,137
Less valuation allowance (25,739) (26,137)
--------- ----------
Net deferred taxes $ -- $ --
========== ==========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. In
assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which temporary differences are deductible and carryforwards are
available. Due to the uncertainty of the Company's ability to realize the
benefit of the deferred tax assets, the net deferred tax assets are fully
offset by a valuation allowance at December 31, 2003 and 2002. As of
December 31, 2003 and 2002, $1,463 and $45, respectively, of the Company's
gross deferred tax assets are attributable to stock option compensation. To
the extent such asset is realized in the future, the benefit would be
credited directly to stockholders' equity.
The net change in the valuation allowance for the years ended December 31,
2003 and 2002 was a decrease of approximately $1,816 and $544,
respectively, related primarily to utilization of net operating losses in
2003 and 2002.
F-24
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
At December 31, 2003, the Company had approximately $57,000 of Federal and
$32,000 of state net operating loss carryforwards available to offset
future taxable income. The Federal and state net operating loss
carryforwards will begin expiring in 2010 and 2006, respectively, if not
utilized. The Company also has research and development tax credit
carryforwards of approximately $893 available to reduce Federal income
taxes which begin expiring in 2007. In addition, the Company had
approximately $3,400 of foreign net operating loss carryforwards with an
indefinite expiration date.
Section 382 of the Internal Revenue Code of 1986 subjects the future
utilization of net operating losses and certain other tax attributes, such
as research and development credits, to an annual limitation in the event
of an ownership change, as defined. Due to the Company's equity
transactions, a portion of the net operating losses and tax credits of the
Company are subject to an annual limitation of approximately $3,800. To the
extent that any single-year limitation is not utilized to the full amount
of the limitation, such unused amounts are carried over to subsequent years
until the earlier of its utilization or the expiration of the relevant
carryforward period. As of December 31, 2003, approximately $35,000 is
immediately available to offset future taxable income. In addition to the
section 382 limitation, the state net operating loss carryforwards are
subject to a $2,000 annual limitation.
Reconciliations of the income tax expense (benefit) from the Federal
statutory rates for 2003, 2002 and 2001 are as follows:
Year Ended December 31,
----------------------------------------------------------------
2003 2002 2001
----------------- ------------------- --------------------
Statutory Federal income tax $ 2,214 34.0% $ 307 34.0% $ (2,769) (34.0%)
Adjustments resulting from:
State taxes, net of Federal 3 -- 16 1.8 (588) 7.2
benefit
Permanent items and others (316) (4.8) 221 24.5 1,506 18.5
Increase (decrease) in valuation
allowance (1,816) (27.9) (544) (60.3) 1,851 22.7
--------- ----- -------- ------ --------- -----
Total income tax expense (benefit) $ 85 1.3% $ -- --% $ -- --%
========= ===== ======== ====== ======== ======
(10) Technology License
At the time of its formation in 1992, the Company entered into an agreement
with the Research Foundation of the State University of New York at Stony
Brook ("SUNY") whereby the Company received an option to acquire a certain
technology license. The Company's option to acquire the license was
exercised in 1995 and remains in effect for a period not to exceed twenty
years from the date of the first sale of product incorporating the
technology under license or the last to expire of the licensed patents in
each country. The Company is liable to SUNY for annual royalty fees based
on net Periostat sales, if any, as defined in the agreement. Legal costs
incurred by the Company in defending the patent
F-25
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
underlying the technology license, if any, are deducted from royalties paid
to SUNY (See Note 12). A minimum annual royalty of $50 per year is required
for the duration of the technology license. The Company incurred royalty
expense for this technology of $1,832, $1,563 and $1,348 in 2003, 2002 and
2001, respectively.
In addition, the Company is required to reimburse SUNY for certain patent
related costs, as well as to support certain additional research efforts.
(11) Commitments and Contingencies
The Company maintains various operating leases, primarily for office space
and equipment. As of December 31, 2003, future minimum rent payments under
noncancellable operating leases are as follows:
2004................... $ 530
2005................... 554
2006................... 554
2007................... 360
2008................... 334
Thereafter............. 196
-------
Total........... $ 2,528
========
Rent expense for the years ended December 31, 2003, 2002 and 2001 totaled
$327, $356 and $337, respectively.
During 2003, the Company entered into a three-year operating lease
agreement for certain sales automation equipment. Under this agreement the
Company is required to make monthly payments based on the monthly number of
users.
Pursuant to the terms of the Atrix License Agreement (see note 6), 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
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.
The Company met the required spending requirements in 2002 and 2003 related
to this Agreement.
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
F-26
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
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 $3,188, and no more
than $2,150 and $1,038 of which shall be payable prior to January 1, 2004
and January 1, 2005, respectively. The Company paid $600 and $330,
respectively, under this Agreement in 2003 and 2002. 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 the Company does not acquire any patentable products, 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.
As of December 31, 2003, the Company has obligations to purchase $1,139 of
inventory from various suppliers over the next twelve months.
In December 2003, Brian M. Gallagher, Ph.D., the Company's former chairman,
chief executive officer and president, left the Company to pursue other
interests. Dr. Gallagher will continue to serve as a member of the
Company's Board of Directors. In March 2003, the Company executed an
agreement with Dr. Gallagher, pursuant to which Dr. Gallagher will also
remain a consultant to the Company through December 2005. Expected future
payments to Dr. Gallagher, are $324 and $304 for 2004 and 2005,
respectively. The Company paid $20 in consulting fees to Dr. Gallagher for
the year ended December 31, 2003. In 2003, the Company also recognized a
stock compensation charge of approximately $251 relating to certain
modifications of Dr. Gallagher's stock option agreements.
(12) Litigation
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
F-27
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
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 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 January 2004, the Court stayed all proceedings in the case.
In June 2003, we commenced an action and filed a motion for a preliminary
injunction in the United States District Court for the District of Columbia
challenging FDA's decision to treat Periostat as an antibiotic drug, thus
denying Periostat certain protections afforded non-antibiotic drugs under
the Food, Drug, and Cosmetic Act against FDA approval of generic copies of
Periostat. 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 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 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. Cross motions for summary judgment are pending.
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. In November, 2003 the proceedings in the patent
infringement case were stayed pending a determination by the United States
Patent and Trademark Office of its re-examination of the patents-in-suit,
subject to the parties' right to conduct limited discovery related to the
potential re-instatement of the Company's motion for a temporary
F-28
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
restraining order and preliminary injunction. The Company cannot predict
the outcome of these matters.
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.
The Company anticipates that its future legal costs in these matters
relating to patent infringement and defense will be reimbursed by 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. During the years ended December 31 2003 and 2002, the Company
incurred $3,757 and $129, respectively, in legal, defense, litigation and
settlement costs for the aforementioned law suits with West-ward and
Mutual, $1,750 and $129 of which was deducted from royalties payable to
SUNY during these 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 December 31, 2003, the Company
has $1,749 in previously recorded legal expenses available to offset future
royalties which may become payable to SUNY, if any.
(13) 401(k) Salary Reduction Plan
In January 1995, the Company adopted a 401(k) Salary Reduction Plan (the
401(k) Plan) available to all employees meeting certain eligibility
requirements. The 401(k) Plan permits participants to contribute up to 15%
of their annual salary, as defined, not to exceed the limits established by
the Internal Revenue Code. All contributions made by participants vest
immediately in the participant's account. During each of the years ended
December 31, 2003 and 2002, the Company made a discretionary contribution
of $100 to the Plan. The Company did not make any contributions in 2001.
(14) Related Party Transactions
During 2003, the Company engaged an outside firm to perform certain
consulting services for approximately $55. One of the primary stakeholders
in the outside firm is a current member of the Company's Board of
Directors.
F-29
COLLAGENEX PHARMACEUTICALS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
(15) Quarterly Financial Data (Unaudited)
The tables below summarize the Company's unaudited quarterly operating
results for 2003 and 2002.
Three months ended
-----------------------------------------------------------------
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
-------------- ----------- ------------ ------------
Total revenues........................ $ 12,157 $ 12,686 $ 13,916 $ 14,099
Gross margin on product sales......... 9,456 10,012 10.890 11,319
Net income........................... 1,228 1,597 1,230 2,371
Net income allocable to common
stockholders....................... 828 1,197 830 1,971
Basic net income per share allocable
to common stockholders............. 0.07 0.10 0.07 0.14
Diluted net income per share
allocable to common stockholders... $ 0.07 $ 0.10 $ 0.06 $ 0.14
-----------------------------------------------------------------
Three months ended
-----------------------------------------------------------------
March 31, June 30, September 30, December 31,
2002 2002 2002 2002
-------------- ----------- ------------ ------------
Total revenues............................ $ 10,760 $ 10,967 $ 11,229 $ 11,662
Gross margin on product sales............. 8,301 8,779 9,054 9,263
Net income (loss)......................... (557) (385) 756 1,088
Net income (loss) allocable to common
stockholders............................ (977) (794) 356 688
Basic and diluted net income (loss) per
share allocable to common stockholders..
$ (0.09) $ (0.07) $ 0.03 $ 0.06
F-30
COLLAGENEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
FINANCIAL STATEMENT SCHEDULE
Valuation and Qualifying Accounts
Years Ended December 31, 2003, 2002 and 2001
(in thousands)
- ----------------------------------------------------------------------------------------------------------------------
Col A Col B Col C Col D Col E
- ----------------------------------------------------------------------------------------------------------------------
Description Balance at the Additions Deductions Balance at the End
Beginning of Period of Period
- ----------------------------------------------------------------------------------------------------------------------
Accounts Receivable Charged to Statement Other
Allowance: of Operations
- ----------------------------------------------------------------------------------------------------------------------
2003 $ 1,412 $ 3,009 $ -- $ 3,113 $ 1,308
2002 $ 950 $ 3,462 $ -- $ 3,000 $ 1,412
2001 $ 381 $ 1,906 $ -- $ 1,337 $ 950
- ----------------------------------------------------------------------------------------------------------------------
F-31