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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
------------------
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 0-19777
DUSA Pharmaceuticals, Inc.
(Exact name of registrant as specified in its charter)
New Jersey 22-3103129
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Upton Drive
Wilmington, Massachusetts 01887
(Address of principal executive offices)
(Zip Code)
(978) 657-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 month (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 subsequent to the distribution of securities under a plan confirmed
by a court. Yes No
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
13,887,612 shares as of November 11, 2002
PART 1.
ITEM 1. FINANCIAL STATEMENTS
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
(UNAUDITED)
------------- ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $2,793,848 $7,568,500
United States government securities 53,285,304 57,141,125
Accrued interest receivable 710,919 923,459
Accounts receivable 67,164 121,280
Receivable under co-development program 650,000 864,534
Inventory 598,347 2,333,080
Other current assets 1,418,024 1,254,950
----------- -----------
TOTAL CURRENT ASSETS 59,523,606 70,206,928
Property and equipment, net 4,841,921 3,384,286
Deferred charges 233,330 1,593,708
Deferred royalty -- 679,299
----------- -----------
TOTAL ASSETS $64,598,857 $75,864,221
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $64,013 $314,889
Accrued payroll 521,419 681,190
Other accrued expenses 1,614,986 1,718,293
Current maturities of long-term debt 270,000 --
Deferred revenue 16,830 273,358
Due to licensor 31,447 62,792
----------- -----------
TOTAL CURRENT LIABILITIES 2,518,695 3,050,522
Long-term debt, net of current 1,585,000 --
Deferred revenue -- 22,312,498
Other deferred reimbursement 166,660 666,664
----------- -----------
TOTAL LIABILITIES 4,270,355 26,029,684
----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTE 13)
SHAREHOLDERS' EQUITY
Capital Stock
Authorized: 100,000,000 shares; 40,000,000 shares designated as common
stock, no par, 60,000,000 shares issuable in series or classes; and
40,000 junior Series A preferred shares. Issued and outstanding:
13,887,612 (2001: 13,865,390) shares of common stock, no par. 95,490,561 95,440,561
Additional paid-in capital 2,015,586 2,015,586
Accumulated deficit (40,389,689) (49,845,445)
Accumulated other comprehensive income 3,212,044 2,223,835
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 60,328,502 49,834,537
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $64,598,857 $75,864,221
=========== ===========
See the accompanying Notes to the Condensed Consolidated Financial Statements.
2
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, (UNAUDITED) SEPTEMBER 30, (UNAUDITED)
----------------------------- -----------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
REVENUES
Product sales and rental income $51,185 $58,837 $157,370 $469,516
Research grant and milestone revenue 21,320,830 495,834 22,312,498 1,487,502
Research revenue earned under collaborative
agreements 1,193,739 881,895 2,851,362 2,186,262
----------- ----------- ---------- -----------
TOTAL REVENUES 22,565,754 1,436,566 25,321,230 4,143,280
----------- ----------- ---------- -----------
OPERATING COSTS
Cost of product sales and royalties 3,240,793 441,979 4,696,095 1,818,064
Research and development 2,848,295 2,805,803 9,319,891 7,068,130
General and administrative 1,411,494 984,745 4,104,510 2,902,931
----------- ----------- ---------- -----------
TOTAL OPERATING COSTS 7,500,582 4,232,527 18,120,496 11,789,125
----------- ----------- ---------- -----------
INCOME (LOSS) FROM OPERATIONS 15,065,172 (2,795,961) 7,200,734 (7,645,845)
OTHER INCOME
Interest income 695,701 978,932 2,255,022 3,013,421
----------- ----------- ---------- -----------
NET INCOME (LOSS) $15,760,873 $(1,817,029) $9,455,756 $(4,632,424)
=========== =========== ========== ===========
BASIC AND DILUTED NET INCOME (LOSS) PER
COMMON SHARE $1.13 $(0.13) $0.68 $(0.34)
=========== =========== ========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 13,887,612 13,796,004 13,874,181 13,770,494
=========== =========== ========== ===========
See the accompanying Notes to the Condensed Consolidated Financial Statements.
3
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30, (UNAUDITED)
-------------------------
2002 2001
---------- ----------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income (loss) $9,455,756 $(4,632,424)
Adjustments to reconcile net income (loss) to net cash used in operating
activities
Amortization of premiums and accretion of discounts on U.S. government
securities available for sale, net (8,207) 759,428
Depreciation and amortization expense 2,488,764 721,344
Amortization of deferred revenue (22,312,498) (1,487,502)
Issue of shares of common shares to non-employee 50,000 --
Changes in other assets and liabilities impacting cash flows from
operations:
Accrued interest receivable 212,540 177,992
Accounts receivable 54,116 783,818
Receivable under co-development program 214,534 (71,992)
Inventory 1,734,733 (719,260)
Other current assets (163,074) (1,050,433)
Deferred charges (100,000) (1,400,000)
Accounts payable (250,876) 82,538
Accrued payroll and other accrued expenses (263,078) (376,372)
Due to licensor (31,345) (369,527)
Deferred revenue (256,528) 31,158
----------- ----------
NET CASH USED IN OPERATING ACTIVITIES (9,175,163) (7,551,232)
----------- ----------
INVESTING ACTIVITIES:
Purchases of United States government securities (6,131,356) (21,276,198)
Proceeds from maturing United States government securities 10,983,593 19,502,758
Purchases of property and equipment (2,306,726) (1,401,897)
Deposits on equipment -- (203,518)
----------- ----------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 2,545,511 (3,378,855)
----------- ----------
FINANCING ACTIVITIES:
Proceeds from exercise of options and warrants -- 553,279
Proceeds from long-term debt 1,900,000 --
Payments of long-term debt (45,000)
----------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,855,000 553,279
----------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,774,652) (10,376,808)
----------- ----------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 7,568,500 16,441,114
----------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,793,848 $ 6,064,306
=========== ===========
See the accompanying Notes to the Condensed Consolidated Financial Statements.
4
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
1) BASIS OF PRESENTATION
The Condensed Consolidated Balance Sheet as of September 30, 2002,
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2002 and 2001, and Condensed Consolidated Statements of Cash
Flows for the nine months ended September 30, 2002 and 2001 have been prepared
in accordance with accounting principles generally accepted in the United States
of America. These condensed consolidated financial statements are unaudited but
include all normal recurring adjustments, which management of DUSA
Pharmaceuticals, Inc. ("DUSA" or the "Company") believes to be necessary for
fair presentation of the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. Certain amounts
for 2001 have been reclassified to conform to the current year presentation.
Such reclassifications had no impact on the net income (loss) or shareholders'
equity for any period presented. These condensed consolidated financial
statements should be read in conjunction with the Company's December 31, 2001
audited consolidated financial statements and notes thereto.
The Company believes that it has sufficient capital resources to proceed
with its current research, development, manufacturing and marketing programs for
Levulan(R) PDT, and to fund operations and capital expenditures for the
foreseeable future. The Company has invested its funds in liquid investments, so
that it will have ready access to these cash reserves, as needed, for the
funding of development plans on a short-term and long-term basis. DUSA may seek
to expand or enhance its business by using its resources to acquire by license,
purchase or other arrangements, businesses, new technologies, or products in
PDT-related areas. However, at this time, the Company intends to focus primarily
on increasing the sales of its dermatology products, and on seeking a partner to
help develop and market Levulan(R) PDT for the treatment of dysplasia in
patients with Barrett's esophagus.
2) SCHERING AG COLLABORATION TERMINATION
On September 1, 2002, DUSA and Schering AG, the Company's former marketing
and development partner for Levulan(R) PDT in the field of dermatology,
terminated the parties' Marketing Development and Supply Agreement, dated
November 22, 1999. As a result of this termination, DUSA reacquired all rights
it granted to Schering AG under the agreement. In addition, Schering AG agreed
to continue its financial support for the dermatology R&D program for the
remainder of 2002, including payments totaling $2,050,000, by December 31, 2002,
of which $1,400,000 has been received as of September 30, 2002. Schering AG will
also complete several on-going clinical studies for DUSA's benefit and transfer
all of its interest in the regulatory filings it made in Austria, South Africa
and Brazil. However, as DUSA has determined that it should concentrate solely on
the US market at this time, DUSA has authorized Schering AG to withdraw
5
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
the application for regulatory approval of Levulan(R) PDT in Australia, and
intends to follow the same course for the applications in Austria and South
Africa. The regulatory approvals for Canada (held by Draxis Health, Inc.) and
Brazil will not be affected. (See section entitled "Overview - Schering AG
Collaboration Termination.")
In the quarter ended September 30, 2002, DUSA evaluated certain items on
its Condensed Consolidated Balance Sheet for the timing of revenue recognition
and potential impairment due to the Schering AG agreement termination. These
items included unamortized deferred revenue related to non-refundable milestone
payments previously received under the Schering AG agreement, and assets, which
at June 30, 2002 totaled approximately $6,950,000, including the Company's
nearly completed manufacturing facility, raw material and finished goods
inventories, commercial light units, and deferred charges and royalties. As a
result of this analysis, in addition to normal amortization recorded prior to
the termination of the Schering AG agreement, the Company recorded the following
items in its Condensed Consolidated Statements of Operations during the three
months ended September 30, 2002:
REVENUE
RECOGNITION/
ASSET FOOTNOTE
STATEMENT OF OPERATIONS ITEM BALANCE SHEET ITEM IMPAIRMENT REFERENCE
---------------------------------------------- ----------------------- ------------ ---------
Revenues:
Research grant and milestone revenue Deferred Revenue $20,990,274 Note 8
-----------
Operating Costs:
Cost of product sales Deferred Charges $542,766 Note 7
Inventory 1,705,364 Note 5
Commercial Light Sources
Under Lease or Rental 389,647 Note 6
Research and development costs Deferred Royalty 639,051 Note 7
-----------
Total Operating Cost Impairment $3,276,828
-----------
The Company also concluded that the carrying value of its nearly completed
manufacturing facility as of September 30, 2002 is more likely than not fully
recoverable after considering the effects of the change in business
circumstances caused by the Schering AG agreement termination. Therefore, no
impairment charges were recorded during the current periods; however, the
Company will continue to periodically review the carrying value of the facility.
6
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
3) THIRD-PARTY DISTRIBUTION AGREEMENT
As of September 1, 2002, DUSA engaged Moore Medical Corporation, a national
distributor and marketer of medical and surgical supplies, to be its exclusive
distributor of the Kerastick(R) in the United States. The agreement has a
one-year term, which can be automatically renewed for additional one-year terms,
unless either party notifies the other party prior to a term expiration that it
does not intend to renew the agreement. In addition, either party may terminate
the agreement earlier, on certain terms, or in the event that the other party
shall have materially breached any of its obligations in the agreement. Moore
has a right to return its inventory of Kerastick(R) units for full credit for a
period of time prior to and after the expiration date of the agreement.
Accordingly, DUSA recognizes product sales when Moore sells the Kerastick(R) to
the end-user, as the price is fixed and final to Moore at that point.
4) UNITED STATES GOVERNMENT SECURITIES AVAILABLE FOR SALE
The Company's United States government securities available for sale
consist of obligations of the United States government and its agencies, with
current yields, as of September 30, 2002, ranging from 3.94% to 7.11% and
maturity dates ranging from October 31, 2002 to February 15, 2007. Certain of
the Company's United States government securities are pledged as collateral to
secure a manufacturing construction loan. (See "Note 9 to the Notes to the
Condensed Consolidated Financial Statements - Long-term Debt.")
Accumulated other comprehensive income, which is reported as part of
shareholders' equity in the Condensed Consolidated Balance Sheets, consists of
net unrealized gains or losses on United States government securities available
for sale.
5) INVENTORY
DUSA had built up significant inventory levels to support the September
2000 product launch by its former marketing and development partner, Schering
AG. However, in September 2002, the Company recorded lower of cost or market
adjustments for excess BLU-U(R) inventory of $1,594,000, and $111,000 for bulk
Levulan(R). Such write-downs were based on the termination of the Schering AG
agreement, limited product sales since the product launch, and the Company's
expectation of no significant near-term increases in Kerastick(R) sales levels
and/or BLU-U(R) placements. The inventory charges were recorded in cost of
product sales in the Condensed Consolidated Statements of Operations during the
three months ended September 30, 2002. (See "Note 2 to the Notes to the
Condensed Consolidated Financial Statements - Schering AG Collaboration
Termination.")
7
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
Inventory consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
(UNAUDITED)
----------- ------------
Finished goods $419,112 $2,013,799
Raw materials 179,235 319,281
-------- ----------
$598,347 $2,333,080
======== ==========
6) OTHER CURRENT ASSETS
In September 2002, the Company shortened the useful life of its BLU-U(R)
units that are under lease, rental, or trial arrangements to reflect a
three-year asset life, and recorded an additional $390,000 of depreciation. This
accelerated depreciation policy is attributed to the low level of BLU-U(R)
placements to date, the termination of the Schering AG agreement, including the
decision not to launch the BLU-U(R) in non-US markets, except possibly Canada,
at this time, and expectations that near-term placements will be limited. The
additional depreciation reserve was recorded in cost of product sales in the
Condensed Consolidated Statements of Operations during the three months ended
September 30, 2002. (See "Note 2 to the Notes to the Condensed Consolidated
Financial Statements - Schering AG Collaboration Termination.")
SEPTEMBER 30, DECEMBER 31,
2002 2001
(UNAUDITED)
----------- ------------
Prepaid expenses and deposits $830,855 $447,520
Commercial light units under lease,
rental, or trial arrangements
(net of depreciation of
$411,308 and $21,743) 575,831 764,025
Other current assets 11,338 43,405
---------- ----------
$1,418,024 $1,254,950
========== ==========
7) DEFERRED CHARGES AND ROYALTIES
In September 2002, as a result of the termination of the Schering AG
agreement, the Company charged $509,000 to cost of product sales for deferred
charges associated with its amended Supply Agreement with Sochinaz SA, the
manufacturer of the bulk drug ingredient used in Levulan(R), $33,000 to cost of
product sales for deferred charges associated with underutilization costs paid
to National Biological Corporation ("NBC"), the manufacturer of our BLU-U(R),
and $639,000 to research and development costs for deferred royalties associated
with payments to PARTEQ, the Company's licensor. These charges, in addition to
normal amortization recorded prior to the termination of the Schering AG
agreement, were recorded in the Condensed Consolidated Statements of Operations
during the three months ended September 30, 2002. (See "Note 2 to the
8
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
Notes to the Condensed Consolidated Financial Statements - Schering AG
Collaboration Termination.")
Deferred charges, which include costs paid in advance to third parties
under various agreements were being amortized on a straight-line basis over the
initial expected terms (1 - 4 1/2 years), were as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
(UNAUDITED)
----------- ------------
Facilities underutilization costs $233,330 $933,333
Facilities reimbursement costs -- 660,375
-------- ----------
$233,330 $1,593,708
======== ==========
Outstanding deferred charges as of September 30, 2002, related to
facilities underutilization costs to our Kerastick(R) manufacturing supplier,
will be fully amortized at December 31, 2002 when its obligation to manufacture
Kerastick(R) units is completed.
8) DEFERRED REVENUE
In September 2002, based on the termination of the Schering AG agreement,
the Company recorded $20,990,000 of unamortized research grant and milestone
revenue, in addition to normal amortization recorded prior to the termination of
the Schering AG agreement, in the Condensed Consolidated Statements of
Operations. (See "Note 2 to the Notes to the Condensed Consolidated Financial
Statements - Schering AG Collaboration Termination.")
SEPTEMBER 30, DECEMBER 31,
2002 2001
(UNAUDITED)
----------- ------------
Milestone and unrestricted grant payments $ -- $22,312,498
Sale of BLU-U(R) units -- 273,358
Sale of Levulan(R) Kerastick(R) units 16,830 --
------- -----------
$16,830 $22,585,856
======= ===========
As of September 1, 2002, DUSA engaged a third-party distributor to be its
exclusive distributor of the Levulan(R) Kerastick(R) in the United States. The
Company has recorded $16,830 of deferred revenue for Kerastick(R) units placed
with the distributor as the price was not fixed and final, since the distributor
has a right of return on Kerastick(R) units. (See "Note 3 to the Notes to the
Condensed Consolidated Financial Statements - Third-Party Distribution
Agreement".)
9
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
During the first half of 2002, deferred revenue of $273,000 related to
the sale of BLU-U(R) units was reclassified to other accrued expenses, of which
$130,000 remains outstanding as of September 30, 2002.
9) LONG-TERM DEBT
Long-term debt consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
(UNAUDITED)
----------- ------------
Manufacturing construction loan $1,855,000 $ --
Less: Current maturities (270,000) --
---------- ----------
$1,585,000 $ --
========== ==========
In May 2002, DUSA entered into a secured term loan promissory note ("Note")
with Citizens Bank of Massachusetts to fund the construction of its
manufacturing facility and borrowed $1,900,000 of a $2,700,000 commitment. The
remaining amount of the commitment lapsed on June 30, 2002. DUSA paid interest
only at the prime rate through July 1, 2002, and on August 1, 2002 commenced
monthly loan payments with fixed monthly principal payments of $22,500 plus
interest which are scheduled to continue through June 30, 2009. Based on the
terms of the Note, the Company had an option to select a fixed rate or a rate at
the LIBOR interest rate plus 1.75%, for varying LIBOR periods. The Company
selected a 360-day LIBOR-based rate that resulted in a 4% interest rate for the
initial year of the Note. Prior to expiration of the 360-day LIBOR-based rate
for each year of the loan, DUSA can either continue to choose a LIBOR-based rate
at that time, or can execute a one-time conversion to a fixed rate loan.
Approximately $3,000,000 of the Company's United States government securities
are pledged as collateral to secure the loan.
10) SHAREHOLDERS' RIGHTS PLAN
On September 27, 2002, the Company adopted a shareholder rights plan (the
"Plan") at a special meeting of the Board of Directors on Friday. The Plan
provides for the distribution of one right as a dividend for each outstanding
share of common stock (the "Common Stock") of the Company to holders of record
as of October 10, 2002. Each right entitles the registered holder to purchase
one one-thousandths of a share of preferred stock at an exercise price of $37.00
per right. The rights will be exercisable subsequent to the date that a person
or group either has acquired, obtained the right to acquire, or commences or
discloses an intention to commence a tender offer to acquire, 15% or more of the
Company's outstanding common stock (or 20% of the outstanding common stock in
the case of a shareholder or group who beneficially hold in excess of 15% at the
record date), or if a person or group is declared an Adverse Person, as such
term is defined in the Plan. The rights may be redeemed by the Company at a
redemption price of one one-hundredth of
10
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
a cent per right until ten days following the date the person or group acquires,
or discloses an intention to acquire, 15% or 20% or more, as the case may be, of
the Company, or until such later date as may be determined by the Board.
Under the Plan, if a person or group acquires the threshold amount of the
Common Stock, all holders of rights (other than the acquiring shareholder) may,
upon payment of the purchase price then in effect, purchase shares of Common
Stock having a value of twice the purchase price. In the event that the Company
is involved in a merger or other similar transaction where it is not the
surviving corporation, all holders of rights (other than the acquiring
shareholder) shall be entitled, upon payment of the purchase price then in
effect, to purchase common stock of the surviving corporation having a value of
twice the purchase price. The rights will expire on October 10, 2012, unless
previously redeemed. Also, the Board adopted certain amendments to the Company's
Certificate of Incorporation consistent with the terms of the Plan.
11) BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
Basic net income (loss) per common share is based on the weighted average
number of shares outstanding during each period. Stock options and warrants are
not included in the computation of the weighted average number of shares
outstanding for dilutive net income (loss) per common share during each of the
periods presented in the Condensed Consolidated Statements of Operations, as the
effect would be antidilutive. For the periods ended September 30, 2002 and 2001,
total outstanding stock options and warrants of approximately 2,672,000, and
2,546,000 shares, respectively, have been excluded from consideration in the
computation of diluted net income (loss) per share.
12) COMPREHENSIVE INCOME (LOSS)
For the three and nine months ended September 30, 2002 and 2001,
comprehensive income (loss) consisted of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, (UNAUDITED) SEPTEMBER 30, (UNAUDITED)
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
NET INCOME (LOSS) $15,760,873 $(1,817,029) $9,455,756 $(4,632,424)
Net unrealized gains on United States
securities available for sale 945,511 1,445,831 988,209 1,600,400
----------- ------------ ----------- -----------
COMPREHENSIVE INCOME (LOSS) $16,706,384 $(371,198) $10,443,965 $(3,032,024)
=========== ========= =========== ===========
11
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
13) COMMITMENTS AND CONTINGENCIES
KERASTICK(R) MANUFACTURING LINE - In late 2001, because of the Company's
commitment under the Schering AG agreement, and because the Company's current
Kerastick(R) manufacturing arrangement was scheduled to expire on December 31,
2002, the Company decided to construct a Kerastick(R) manufacturing facility at
its Wilmington, Massachusetts location. Construction started in January 2002,
and is expected to be completed during 2002, and then will be followed by
facility qualification, process validation, drug product stability testing, and
FDA review. As of September 30, 2002, the Company has incurred $2,434,000 for
certain equipment, pre-construction, construction, validation, and testing
activities, which have been classified in property and equipment in the
Condensed Consolidated Balance Sheet.
LEGAL MATTERS - In April 2002, the Company received a copy of a notice
issued by PhotoCure ASA to PARTEQ Research & Development Innovations, the
technology transfer arm of Queen's University at Kingston, Ontario, alleging
that Australian Patent No. 624985, which is one of the patents licensed by
PARTEQ to DUSA, relating to the Company's 5-aminolevulinic acid technology, is
invalid. As a consequence of this action, Queen's University has assigned the
Australian patent to DUSA so that DUSA may participate directly in this
litigation. DUSA has filed an answer setting forth its defenses and a related
countersuit alleging that PhotoCure's activities infringe the patent. The case
is in its earliest stages so the Company is unable to predict the outcome at
this time.
14) RECENT ACCOUNTING PRONOUNCEMENT
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment of Disposal of Long-lived Assets." This statement supercedes SFAS
No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to Be Disposed Of." SFAS No.144 establishes a single accounting model,
based on the framework established in SFAS No. 121, for long-lived assets to be
disposed of by sale, and resolves implementation issues related to SFAS No. 121.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years. When the Company adopted this
statement on January 1, 2002, SFAS No. 144 did not have any effect on its
financial position or results of operations. During the three-month period ended
September 30, 2002, the Company concluded that the termination of the Schering
AG agreement on September 1, 2002 did not have any impairment effects on its
nearly completed manufacturing facility, but did result in impairment
adjustments to certain intangible assets as more fully discussed in Notes 2 and
7 to the Condensed Consolidated Financial Statements.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements and Notes to the Consolidated Financial
Statements for the year ended December 31, 2001 and its Condensed Consolidated
Financial Statements and Notes to the Condensed Consolidated Financial
Statements for the three and nine-month periods ended September 30, 2002 and
2001. DUSA is engaged primarily in the research, development, and
commercialization of a drug named 5-aminolevulinic acid, or ALA, used in
combination with appropriate light devices in order to detect or treat a variety
of medical conditions. The trademark for our brand of ALA is Levulan(R). When
Levulan(R) is used and is followed with exposure to light to produce a
therapeutic effect, the technology is called photodynamic therapy, or PDT. When
Levulan(R) is used and followed with exposure to light to detect medical
conditions, the technology is called photodetection, or PD. Our first products,
which were launched in September 2000 in the United States, are Levulan(R) 20%
topical solution using our Kerastick(R) brand applicator, and our BLU-U(R) brand
light unit. These products are used together to provide photodynamic therapy for
the treatment of non-hyperkeratotic actinic keratoses (AKs) of the face or
scalp.
We have devoted substantial resources to funding research and development
in order to advance our Levulan(R) PDT/PD technology platform, and as a result,
have experienced significant operating losses. As of September 30, 2002, we had
an accumulated deficit of approximately $40,390,000. Achieving our goal of
becoming a profitable operating company is dependent on the market penetration
of our products in the United States, acceptance of our therapy by the medical
and consumer constituencies, and our ability to develop and/or acquire new
products. We expect to continue to incur operating losses as we invest in our
current approved products, research and development opportunities, and until
product sales from current or future products increase significantly. As of
September 30, 2002, our staff included 50 full-time employees as compared to 55
at the end of 2001, in support of all activities including production,
maintenance, customer support, and financial operations for our products, as
well as the research and development programs for dermatology and internal
indications. As a result of the termination of the Schering AG agreement, which
is discussed below, we have reevaluated our expenses and intend to minimize
research and development and related general and administrative expenditures
that are not directly related to our core objectives for 2003. These objectives
include increasing the sales of our dermatology products, and seeking a partner
to help develop and market Levulan(R) PDT for the treatment of dysplasia in
patients with Barrett's esophagus. Subsequent to the end of the current quarter,
DUSA separated employment with an additional 5 employees, which resulted in a
total reduced work force in 2002 through a combination of layoffs and attrition
of approximately 20%.
SCHERING AG COLLABORATION TERMINATION - On September 1, 2002, DUSA and
Schering AG, the Company's former marketing and development partner for
Levulan(R) PDT in the field of dermatology, terminated the parties' Marketing
Development and Supply Agreement, dated November 22, 1999, as amended. As a
result of this termination, DUSA reacquired all rights it granted to Schering AG
under the agreement. In addition, Schering AG agreed to continue its
13
financial support for the dermatology R&D program for the remainder of 2002,
including payments totaling $2,050,000 by December 31, 2002, of which
$1,400,000 has been received as of September 30, 2002. However, the entire
$2,050,000 has been recognized during the nine months ended September 30, 2002.
Schering AG has agreed to also complete several on-going clinical studies for
DUSA's benefit and transfer all of its interest in the regulatory filings it
made in Austria, South Africa and Brazil. However, as DUSA has determined that
it should concentrate solely on the US market at this time. DUSA has authorized
Schering AG to withdraw the application for regulatory approval of Levulan(R)
PDT in Australia, and intends to follow the same course for the applications in
Austria and South Africa. The regulatory approvals for Canada (held by Draxis
Health, Inc.) and Brazil will not be affected.
In the quarter ended September 30, 2002, DUSA evaluated certain items on
its Condensed Consolidated Balance Sheet for the timing of revenue recognition
and potential impairment due to the Schering AG agreement termination. These
items included unamortized deferred revenue related to non-refundable milestone
payments previously received under the Schering AG agreement, and assets, which
as of June 30, 2002 totaled approximately $6,950,000, including the Company's
nearly completed manufacturing facility, raw material and finished goods
inventories, commercial light units, and deferred charges and royalties. As a
result of this analysis, in addition to normal amortization recorded prior to
the termination of the Schering AG agreement, the Company recorded the following
items in its Condensed Consolidated Statements of Operations during the three
months ended September 30, 2002:
REVENUE
RECOGNITION/ FOOTNOTE
STATEMENT OF OPERATIONS ITEM BALANCE SHEET ITEM ASSET IMPAIRMENT REFERENCE
---------------------------------------------- ------------------------ ---------------- ---------
Revenues:
Research grant and milestone revenue Deferred Revenue $20,990,274 Note 8
-----------
Operating Costs:
Cost of product sales Deferred Charges 542,766 Note 7
Inventory 1,705,364 Note 5
Commercial Light
Sources Under Lease
or Rental 389,647 Note 6
Research and development costs Deferred Royalty 639,051 Note 7
-----------
Total Operating Cost Impairment $3,276,828
-----------
The Company also concluded that the carrying value of its nearly completed
manufacturing facility as of September 30, 2002 is more likely than not to be
fully recoverable after considering the effects of the change in business
circumstances caused by the termination of the Schering AG agreement. Therefore,
no impairment charges were recorded during the current periods; however, the
Company will continue to periodically review the carrying value of the facility.
14
As a result of the termination of the Schering AG agreement, DUSA has
commenced implementing its own marketing, education, and development strategy,
and will continue to develop and implement such strategies for the remainder of
2002 and beyond. For now, DUSA has decided not to create a nationwide sales
force, or to seek a new dermatology marketing partner. Instead, the Company
intends to focus on meeting the needs of dermatologists, and educating them
about the benefits of our therapy, in an effort to increase product sales over
time. This will be done through the support of medical education activities,
participation in dermatology conferences, support of company research and
development efforts and independent investigator studies, and support of efforts
to improve third party reimbursement. DUSA is also planning clinical studies,
which if successful, would expand the Company's current FDA approved label for
treatment of AKs. We are also offering a new BLU-U(R) placement program for
physicians and have introduced a Kerastick(R) sampling program to allow new
doctors to become familiar with the therapy.
As a result of the termination of the Schering AG agreement, DUSA has
commenced marketing its products directly and may incur significant expense.
DUSA may also enter into arrangements with other third parties in the future. On
September 1, 2002, DUSA entered into an exclusive distribution agreement with
Moore Medical Corporation to distribute the Kerastick(R) throughout the United
States. (See section entitled "Contractual Obligations and Other Commercial
Commitments - Third-party Distribution Agreement.")
SHAREHOLDERS' RIGHTS PLAN - In order to protect the long term interest of
the Company's shareholders, the Company adopted a Shareholders Rights Plan, on
September 27, 2002. (See "Note 10 to the Notes to the Condensed Consolidated
Financial Statements - Shareholders' Rights Plan.") The Shareholder Rights Plan
is designed to prevent an acquirer from gaining control of the Company without
offering a fair price to all of the Company's shareholders. The Shareholder
Rights Plan was not adopted by the Board in response to any specific offer or
threat, but rather is intended to protect the interests of shareholders in the
event the Company is confronted in the future with takeover tactics. Issuance of
shares of Common Stock under the Shareholder Rights Plan could be used to make a
change in control of the Company more difficult or costly by diluting stock
ownership of persons seeking to obtain control of the Company. The Company's
management is not aware of any takeover activity involving the Company. In
addition, the Board of Directors adopted certain amendments to the Company's
Certificate of Incorporation which are consistent with the terms of the Plan.
CRITICAL ACCOUNTING POLICIES
In May 2002, the United States Securities and Exchange Commission ("SEC")
issued disclosure guidance and proposed rules for "critical accounting policies"
- - "Disclosure in Management's Discussion and Analysis about the Application of
Critical Accounting Policies." The SEC defines "critical accounting policies" as
those that require application of management's most difficult, subjective or
complex judgments, often as a result of the need to make estimates about the
effect of matters that are inherently uncertain and may change in subsequent
periods. DUSA's accounting policies are disclosed in Note 2 of the Company's
Notes to the Consolidated Financial Statements for the year ended December 31,
2001. Since not all of these accounting policies require
15
management to make difficult, subjective or complex judgments or estimates, they
are not all considered critical accounting policies. We consider the following
policies and estimates to be critical to our financial statements.
INVENTORY - Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method. Inventories are continually
reviewed for slow moving, obsolete and excess items. Inventory items identified
as slow-moving are evaluated to determine if an adjustment is required.
Additionally, our industry is characterized by regular technological
developments that could result in obsolete inventory. Although we make every
effort to assure the reasonableness of our estimates, any significant
unanticipated changes in demand, technological developments, or significant
changes to our business model could have a significant impact on the value of
our inventory and our results of operations. DUSA had built up inventory levels
in support of the September 2000 product launch by its former marketing and
development partner, Schering AG. However, in September 2002, based on the
termination of the Schering AG agreement, the Company recorded lower of cost or
market adjustments of $2,095,000 for excess inventory and commercial light units
under lease, rental, or trial arrangements to cost of product sales in its
Condensed Consolidated Statements of Operations during the three months ended
September 30, 2002. (See section entitled "Overview - Schering AG Collaboration
Termination.")
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS - We review long-lived and
intangible assets, comprised of property, plant and equipment, deferred charges,
and deferred royalties for impairment whenever events or changes in business
circumstances indicate that the carrying amount of assets may not be fully
recoverable or that the useful lives of these assets are no longer appropriate.
Factors considered important which could trigger an impairment review include
significant changes relative to: 1) projected future operating results; 2) the
use of the assets or the strategy for the overall business; and 3) industry,
business, or economic trends and developments. Each impairment test is based on
a comparison of the undiscounted cash flow to the recorded value of the asset.
When it is determined that the carrying value of long-lived or intangibles
assets may not be recoverable based upon the existence of one or more of the
above indicators of impairment, the asset is written down to its estimated fair
value on a discounted cash flow basis. During the three-month period ended
September 30, 2002, the Company concluded that the termination of the Schering
AG agreement did not have any impairment on its manufacturing facility under
construction, but did result in impairment adjustments to certain intangible
assets as more fully discussed in Notes 2 and 7 to the Condensed Consolidated
Financial Statements. (Also see section entitled "Overview - Schering AG
Collaboration Termination".)
REVENUE RECOGNITION - Revenues on product sales of the Kerastick(R) are
recognized when persuasive evidence of an arrangement exists, the price is fixed
and final, delivery has occurred, and there is reasonableness of collection.
Research revenue earned under collaborative agreements consists of
non-refundable research and development funding from the Company's former
corporate partner. Research revenue generally compensates the Company for a
portion of agreed-upon research and development expenses and is recognized as
revenue at the time the research and development activities are performed under
the terms of the related agreements and when no future performance obligations
exist. Milestone or other up-front payments have been recorded as deferred
revenue upon receipt and are recognized as income on a straight-line basis over
the term of the
16
Company's agreement with our collaborator. Although we make every effort to
assure the reasonableness of our estimates, significant unanticipated changes in
our estimates due to business, economic, or industry events could have a
material impact on deferred revenue and our results of operations. In September
2002, based on the termination of the Schering AG agreement, the Company
recorded $20,990,000 of research grant and milestone revenue, in addition to
normal amortization recorded prior to the termination of the Schering AG
agreement, in its Condensed Consolidated Statements of Operations during the
three months ended September 30, 2002. (See section entitled "Overview -
Schering AG Collaboration Termination".)
STOCK-BASED COMPENSATION - The Company has elected to continue to use the
intrinsic value-based method to account for employee stock option awards under
the provisions of Accounting Principles Board Opinion No. 25, and to provide
disclosures based on the fair value method in the Notes to the Consolidated
Financial Statements as permitted by SFAS No. 123. Stock or other equity-based
compensation for non-employees is accounted for under the fair value-based
method as required by SFAS No. 123 and Emerging Issues Task Force ("EITF") No.
96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services" and
other related interpretations. Under this method, the equity-based instrument is
valued at either the fair value of the consideration received or the equity
instrument issued on the date of grant. The resulting compensation cost is
recognized and charged to operations over the service period, which, in the case
of stock options, is generally the vesting period. As we utilize stock and stock
options as one means of compensating employees, consultants, and others, the
accounting for stock-based compensation could, under certain circumstances,
result in a material effect on our results of operations, but would not affect
cash flow based on our current stock option plan.
CONCENTRATION OF CREDIT RISK - We invest our cash in accordance with a
policy objective that seeks to preserve both liquidity and safety of principal.
We are subject to credit risk through short-term investments and mitigate this
risk by investing in United States government securities. If there is an adverse
change, other than temporary decline in market value, in the credit risk of the
financial institutions or in the entities that we invest in, we may be required
to record impairment charges in the future. To date, substantially all of our
revenues have been earned from a single collaborator, Schering AG. As a result
of the termination of the Schering AG agreement, we may be subject to credit
risk. (See section entitled "Overview - Schering AG Collaboration Termination".)
RESULTS OF OPERATIONS
REVENUES - Revenues recognized for the current three and nine-month periods
ended September 30, 2002 increased to $22,566,000 and $25,321,000, respectively,
as compared to $1,437,000 and $4,143,000 for the same periods in 2001. Revenues
during the current periods include the one-time recognition of unamortized
up-front milestone and unrestricted grant payments previously received from
Schering AG totaling $20,990,000 due to the finalization of the termination of
the Schering AG agreement. (See section entitled "Overview - Schering AG
Collaboration Termination".) Revenues for the current three and nine-month
periods also included amortization
17
of up-front milestone and unrestricted grant payments recorded prior to the
termination of the Schering AG agreement of $331,000 and $1,322,000, and the
recognition of research and development revenue totaling $1,194,000 and
$2,851,000 as compared to $882,000 and $2,186,000 during the same periods in
2001.
Product sales and rental income for the current three and nine-month
periods totaled $51,000 and $157,000, respectively, primarily due to royalty
revenues of $6,000 and $77,000 earned by DUSA for Kerastick(R) sales by Berlex
to its distributor and $44,000 of revenue recognized during the current quarter
based on direct Kerastick(R) sales to our distributor, Moore Medical
Corporation, a national distributor and marketer of medical and surgical
supplies. (See section entitled "Contractual Obligations and Other Commercial
Commitments - Third-party Distribution Agreement.") During 2002, there were no
direct sales of the Kerastick(R) to Berlex, the subsidiary of the Company's
former marketing partner. Revenues from product sales and rental income for the
three and nine-month periods ended September 30, 2001 were $59,000 and $470,000,
primarily reflecting direct sales of the Kerastick(R) to Berlex, as Berlex
purchased Kerastick(R) units to fill the anticipated forecasts at the time the
units were ordered. During the balance of 2002 and into early 2003, the Company
expects to sell a minimum level of Kerastick(R)' units to our distributor
consistent with the current quarter. Due to the disappointing market acceptance
since the inception of our products, the termination of the Schering AG
agreement, and the historical fluctuations of end-user Kerastick(R) sales and
BLU-U(R) placements up to this point, the Company does not expect any
significant near-term increase in Kerastick(R) sales levels, and/or BLU-U(R)
placements.
In September 2002, the Company initiated a new BLU-U(R) placement strategy
as part of its new marketing initiatives. Under this plan, physicians will
receive the BLU-U(R) unit in exchange for an agreement to purchase a minimum
number of Kerastick(R) units each year. Previous BLU-U(R) marketing programs,
which included leasing or renting the BLU-U(R) to physicians, medical
institutions and academic centers, that were carried out in cooperation with
Schering AG, have now been terminated. As of September 30, 2002, 360 BLU-U(R)
units were in place, down slightly from the 369 units at June 30, 2002. Not
including BLU-U(R) units installed at clinical trial sites or sold to our former
partner, BLU-U(R) units were 338, and 347, respectively as of September 30,
2002, and June 30, 2002, respectively. Kerastick(R) sales to end-users were
1,392 and 5,394 for the current three and nine month periods ended September 30,
2002, as compared to 1,638 and 4,623 for the same periods in 2001. DUSA believes
that as doctors become more familiar with the benefits of Levulan(R) PDT, and
especially if our clinical studies support, and we receive, FDA approval for a
broader label claim and improved reimbursement is achieved, more widespread
adoption of our technology should occur over time.
COST OF PRODUCT SALES AND ROYALTIES - Cost of product sales and royalties
for the three and nine-month periods ended September 30, 2002 increased to
$3,241,000 and $4,696,000, respectively, as compared to $442,000 and $1,818,000
for the comparable periods in 2001. Due to the termination of the Schering AG
agreement, cost of product sales for the current periods amounted to $2,638,000
for lower of cost or market inventory adjustments, increased depreciation taken
on BLU-U(R) units, and deferred charges associated with our amended Supply
Agreement with Sochinaz SA. (See section entitled "Overview - Schering AG
Collaboration Termination".) Direct product costs during the current quarter
were $16,000 representing costs recognized based on direct Kerastick(R) sales
since
18
September 1, 2002 to our distributor, Moore Medical Corporation. (See section
entitled "Contractual Obligations and Other Commercial Commitments - Third-party
Distribution Agreement.") The current three and nine-month periods also included
internal operations costs of $406,000 and $1,030,000 for resources (e.g.
customer service, quality assurance, purchasing, and other product support
operations) assigned to support our products, $47,000 and $611,000 incurred to
ship, install, and maintain the BLU-U(R) in physicians offices, and $16,000 and
$48,000 in royalty and supply fees due to DUSA's licensor. Also included in the
current three-and nine-month periods are $83,000 and $267,000 of net
underutilization costs resulting from payments made to our third-party
manufacturers since our initial orders fell well below certain previously
anticipated levels. The current three and nine-month period also includes
$38,000 and $140,000 in amortization of deferred charges, recorded prior to the
termination of the Schering AG agreement, which were fully amortized as of
September 30, 2002 as a result of the termination of the Schering AG agreement.
Cost of product sales for the prior three and nine-month periods ended
September 30, 2001 included internal operations costs of $178,000 and $564,000
for resources assigned to support our products, $66,000 and $467,000 of
underutilization costs due to orders to our Kerastick(R) manufacturer falling
below certain previously anticipated levels, $56,000 and $169,000 in
amortization of deferred charges, as well as costs incurred for shipping and
installing the BLU-U(R) in physicians offices. The nine month period ended
September 30, 2001 also included $358,000 in direct Kerastick(R) related product
costs.
We incur certain fixed costs resulting in under-absorbed overhead, which
are included in cost of product sales. We expect that the development of our own
facility will enable us to better manage and control the costs of production
when it is operational. However, our unit cost per Kerastick(R) will initially
increase as compared to our unit cost under our agreement with our current
manufacturer, until and unless, production levels increase significantly. DUSA
commenced the construction of its Kerastick(R) manufacturing facility in January
2002. (See section entitled "Contractual Obligations and Other Commercial
Commitments - Manufacturing Facility Construction Loan.") This new facility will
serve to replace our current Kerastick(R) manufacturer, who will cease
production at the end of 2002, while there will be a period of 6-12 months
without an approved source of supply, until our facility receives FDA approval,
assuming that there are no unusual delays in the FDA approval. DUSA expects that
the approximately 45,000 Kerastick(R) units currently being manufactured by our
current manufacturer, together with approximately 8,000 units currently in our
inventory, will be sufficient to supply our customer needs for at least 2003. If
this supply is unable to meet the demand for Kerastick(R) units until our
manufacturing facility received FDA approval, our business would be adversely
affected.
Inventory costs related to the BLU-U(R) units under rental, lease, or trial
arrangements are deferred and recorded in other current assets, and are being
amortized over a thirty-six month period through June 30, 2004. As of September
30, 2002 and December 31, 2001, the net book value of these units amounted to
approximately $576,000 and $764,000, respectively.
RESEARCH AND DEVELOPMENT COSTS - Research and development costs for the
three and nine-month periods ended September 30, 2002 increased to $2,848,000
and $9,320,000, respectively, as compared to $2,806,000 and $7,068,000 for the
comparable periods in 2001. The current three-
19
month period was relatively unchanged as compared to the prior year as lower
spending on dermatological indications in 2002 was offset by a charge of
$639,000 for deferred royalties associated with payments to PARTEQ, the
Company's licensor. (See section entitled "Overview - Schering AG Collaboration
Termination.") The current nine-month increase was mainly attributable to higher
third-party expenditures in support of DUSA's FDA mandated Phase IV clinical
study of the long-term efficacy of our marketed product, clinical feasibility
studies in other dermatological indications, and DUSA's Phase I/II clinical
studies on the safety and efficacy of Levulan PDT treatment of Barrett's
esophagus with and without dysplasia.
DUSA intends to focus its near-term dermatology development program on
expansion of the currently approved Levulan(R) Kerastick(R) product labeling.
The currently approved indication only allows application of Levulan(R) to
individual lesions using the Kerastick(R), so we are seeking to apply Levulan(R)
to the entire face or scalp in a Broad Area Actinic Keratoses (BAAK) treatment.
We are developing a revised protocol for our BLU-U(R) treatment allowing the use
of the Levulan(R) Kerastick(R) for the BAAK indication after a much shorter drug
incubation time. This could be as soon as one hour after the Levulan(R)
application, compared with the 14-18 hours specified in the current labeling. We
believe that should clinical development of this indication be successful and
approved as an expansion of our current FDA approved label, the market
penetration of the therapy could be significantly enhanced. The Company also
intends to complete its FDA-required Phase IV long-term AK tracking study before
the end of 2003.
Analysis of data obtained from DUSA's Phase I/II study on resistant plantar
warts is ongoing. However, DUSA's Phase II study on onychomycosis (nail fungus)
did not appear to show success in treating the disease in the majority of
patients. Further Phase II development for the warts and onychomycosis
indications are not being planned at this time in order to lower DUSA's total
research and development spending for 2003 and beyond, as compared to the 2002
levels, during which DUSA has earned a full-year reimbursement of $2,851,000
from Schering AG based on the parties' termination agreement. This strategy
should keep the Company in a strong financial situation as it works on the BAAK
indication, the long-term tracking study, and increasing revenues from the
current product.
DUSA has also been conducting Phase I/II studies in the treatment of
high-grade and low-grade dysplasia associated with Barrett's esophagus. There is
currently no medical treatment for this condition and it is generally treated by
surgical removal of the dysplastic portion of the esophagus. In the high-grade
study, preliminary analyses have been completed and showed the removal of
regions of high-grade dysplasia in five of six of the treated patients, with
follow-up of these patients continuing. While limited investigator studies in
the high-grade dysplasia indication will still be funded, we do not expect to
fund full Phase II or III clinical trials for this indication on our own. We
have completed the development of a partnering package for the use of Levulan(R)
PDT in the treatment of Barrett's esophagus dysplasia, and began soliciting
potential partners in September 2002. Management's goal is to complete a
partnership for this indication during 2003; however there can be no assurance
that we will be able to consummate any collaboration on terms acceptable to us.
20
GENERAL AND ADMINISTRATIVE COSTS - General and administration costs for the
three and nine-month periods ended September 30, 2002 increased to $1,411,000
and $4,105,000, respectively, as compared to $985,000 and $2,903,000 for the
comparable periods in 2001. These increases were mainly attributable to an
increase in legal expenses incurred during the current three and nine-month
periods of $463,000 and $909,000, due primarily to patent defense, the Schering
AG agreement termination, and strategic initiatives. It is expected that legal
expenses will continue to increase as the patent dispute continues. The Company
also incurred employee separation costs of $190,000 during the current
nine-month period.
INTEREST INCOME - Interest income for the three and nine-month periods
ended September 30, 2002 decreased to $696,000 and $2,255,000, respectively, as
compared to $979,000 and $3,013,000 for the comparable periods in 2001. These
decreases are mainly attributable to lower investable cash balances as we used
cash in support of DUSA's operating activities, and lower yields. Interest
income will continue to decline as our investable cash balances are reduced to
support DUSA's operating activities. During 2002, the Company has incurred
interest expense associated with the development of our new Kerastick(R)
manufacturing facility of approximately $29,000, which has been capitalized in
property and equipment in the Condensed Consolidated Balance Sheet.
NET INCOME (LOSSES) - The Company's net income for the three and nine-month
periods ended September 30, 2002 was $15,761,000, or $1.13 per share and
$9,456,000, or $0.68 per share, respectively, as compared to incurring a net
loss of ($1,817,000), or ($0.13) per share, and ($4,632,000), or ($0.34) per
share, for the comparable periods ended September 30, 2001. As a result of the
termination of the Schering AG agreement, net income for both current periods
included $17,713,000 of income, excluding normal amortization recorded prior to
termination of the Schering AG agreement, from operations that was based on the
one-time recognition of certain items on its Consolidated Condensed Balance
Sheets. (See section entitled "Overview - Schering AG Collaboration
Termination".) This one-time recognition resulted in an increase to earnings per
share of $1.28 for both the current three and nine-month periods. However, going
forward net losses are expected to be incurred until the successful market
penetration of our first products occurs.
LIQUIDITY AND CAPITAL RESOURCES
We are in a strong cash position to continue our research, development,
manufacturing and marketing activities for our Levulan(R) PDT/PD platform. We
invest our cash in United States government securities, which are classified as
available for sale. As of September 30, 2002, we held securities with an
aggregate cost of $50,073,000 and a current aggregate market value of
$53,285,000, resulting in a net unrealized gain on securities available for sale
of $3,212,000, which has been included in shareholders' equity. As of December
31, 2001, DUSA held securities with an aggregate cost of $54,917,000 and a
current aggregate market value of $57,141,000 resulting in a net unrealized gain
on securities available for sale of $2,224,000. Due to fluctuations in interest
rates and depending upon the timing of our need to convert government securities
into cash to meet our working capital requirements, some gains or losses could
be realized. These securities currently have yields ranging from 3.94% to 7.11%
and maturity dates ranging from October 31, 2002 to February 15, 2007.
21
As of September 30, 2002, we had inventory of $598,000, representing
finished goods and raw materials, as compared to $2,333,000 as of December 31,
2001. (See "Note 5 to the Notes to the Condensed Consolidated Financial
Statements - Inventory.") Also, at the end of the current quarter, net fixed
assets increased to $4,842,000, as compared to $3,384,000 as of December 31,
2001, due mainly to the development of our Kerastick(R) manufacturing facility
at our Wilmington, Massachusetts location. As of September 30, 2002, the Company
had incurred $2,434,000 for certain equipment, pre-construction, construction,
validation and testing activities. In May 2002, we secured a seven-year term
loan to finance the construction of the facility. (See section entitled
"Contractual Obligations and Other Commercial Commitments - Manufacturing
Facility Construction Loan" and "Notes 8 and 12 to the Notes to the Condensed
Consolidated Financial Statements.") Other than remaining costs of approximately
$350,000 to validate the facility, we do not expect to incur additional
significant capital expenditures to complete this facility. We have not made
material capital expenditures for environmental control facilities; however, we
know that environmental laws will govern our new manufacturing facility. There
can be no assurance, however, that we will not be required to incur significant
additional costs to comply with environmental laws and regulations in the
future, or that our operations, business or assets will not be materially
adversely affected by current or future environmental laws or regulations.
As of September 30, 2002, we had accounts receivable of $67,000,
representing net sales associated with product sales, compared to $121,000 at
the end of 2001. In addition, based on the termination of the Schering AG
agreement, a receivable of $650,000 has been recorded during the current quarter
for reimbursement of research and development costs, as compared to a
co-development receivable of $864,000 as of December 31, 2001.
As a result of the Schering AG agreement termination and the slow
penetration of our products in the marketplace, we will continue to evaluate
certain items on our Consolidated Balance Sheet for impairment, including
inventory and property and equipment. (See section entitled "Critical Accounting
Policies - Valuation of Long-lived and Intangible Assets".)
We believe that we have sufficient capital resources to proceed with our
current research, development, manufacturing and marketing programs for
Levulan(R) PDT, and to fund operations and capital expenditures for the
foreseeable future. We have invested our funds in liquid investments, so that we
will have ready access to these cash reserves, as needed, for the funding of
development plans on a short-term and long-term basis. DUSA may seek to expand
or enhance its business by using its resources to acquire by license, purchase
or other arrangements, businesses, new technologies, or products in PDT-related
areas. However, at this time, we intend to focus primarily on increasing the
sales of our dermatology products, and on seeking a partner to help develop and
market Levulan(R) PDT for the treatment of dysplasia in patients with Barrett's
esophagus.
While our current cash position enables us to maintain our current research
program and to support the commercialization of Levulan(R) PDT for AKs, we may
need to raise additional funds in the future through corporate alliances,
financings, or other sources, in order to continuing research and development
programs.
22
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
THIRD PARTY DISTRIBUTION AGREEMENT - As of September 1, 2002, DUSA engaged
Moore Medical Corporation, a national distributor and marketer of medical and
surgical supplies, to be its exclusive distributor of the Kerastick(R) in the
United States The agreement has a one-year term, which can be automatically
renewed for additional one-year terms, unless either party notifies the other
party prior to a term expiration that it does not intend to renew the agreement.
In addition, either party may terminate the agreement earlier, on certain terms,
or in the event that the other party shall have materially breached any of its
obligations in the agreement. Moore has a right to return its inventory of
Kerastick(R) units for full credit for a period of time prior to and after the
expiration date of the agreement. Accordingly, DUSA recognizes product sales
when Moore sells the Kerastick(R) to the end-user as the price is fixed and
final to Moore at that point.
THIRD PARTY KERASTICK(R) MANUFACTURER AGREEMENT MODIFICATION - In July
2001, we revised our agreement with our Kerastick(R) manufacturer, North Safety
Products ("North"), covering the period from the execution of this amendment
through December 31, 2002. In accordance with this amendment, we paid North
$1,200,000 in up-front underutilization fees during 2001, and agreed to make
additional payments totaling $200,000 in 2002, of which $100,000 of this amount
has been paid as of September 30, 2002 with the final payment to be made prior
to December 31, 2002. DUSA has reported the total commitment of $1,400,000 in
deferred charges, which is being recognized in cost of product sales on a
straight-line basis over the term of the amendment. In consideration for the
underutilization fees, North has agreed to maintain its Kerastick(R)
manufacturing capabilities in a state of readiness through December 31, 2002,
with the capability of producing at least 25,000 Kerastick(R) units per month in
accordance with established procedures. The term of the agreement will end on
December 31, 2002 since DUSA did not exercise its option to extend the term of
this agreement through June 30, 2003. During the current quarter, DUSA exercised
its option to have North manufacture approximately 45,000 Kerastick(R) units,
which will be available to DUSA during the fourth quarter of 2002. In September
2001, in accordance with an amendment to our former agreement with Schering AG,
Schering AG reimbursed DUSA $1,000,000 of the costs incurred to modify our
manufacturing agreement with North. This amount has been reported in deferred
liabilities and is being recognized as an offset to cost of product sales on a
straight-line basis over the term of the agreement with North.
KERASTICK(R) MANUFACTURING LINE - DUSA commenced the construction of a
Kerastick(R) manufacturing facility at our Wilmington, Massachusetts location in
January 2002. The initial build-out was completed in June 2002, and the Company
has commenced facility qualification, process validation, and drug product
stability testing, which is expected to take approximately six months and be
completed in late 2002 or early 2003. FDA review is also expected to take six
months, with an estimated completion date in mid to late 2003, and should
commence after the completion of all validation and certain stability
activities, as well as the preparation and submission of an NDA supplement. The
Company has estimated that the cost to build and complete testing of this
facility, including equipment, is approximately $2,700,000. This cost includes
estimates to build the facility and all costs of construction, calibration,
validation testing and equipment. As of September 30, 2002, the Company has
incurred $2,434,000 for certain equipment, pre-construction, construction,
23
validation, and testing activities.
MANUFACTURING FACILITY CONSTRUCTION LOAN - In May 2002, DUSA entered into a
secured term loan promissory note ("Note") with Citizens Bank of Massachusetts
to fund the construction of its manufacturing facility and borrowed $1,900,000
of a $2,700,000 commitment. The remaining amount of the commitment lapsed on
June 30, 2002. DUSA paid interest only at the prime rate through July 1, 2002,
and on August 1, 2002 commenced monthly loan payments with fixed monthly
principal payments of $22,500 plus interest, which are scheduled to continue
through June 30, 2009. Based on the terms of the Note, the Company had an option
to select a fixed rate or a rate at the LIBOR interest rate plus 1.75%, for
varying LIBOR periods. The Company selected a 360-day LIBOR-based rate that
resulted in a 4% interest rate for the initial year of the Note. Prior to
expiration of the 360-day LIBOR-based rate for each year of the loan, DUSA can
either continue to choose a LIBOR-based rate at that time, or can execute a
one-time conversion to a fixed rate loan. Approximately $3,000,000 of the
Company's United States government securities are pledged as collateral to
secure the loan.
LEGAL MATTERS - In April 2002, DUSA received a copy of a notice issued by
PhotoCure ASA to PARTEQ Research & Development Innovations, the technology
transfer arm of Queen's University at Kingston, Ontario, alleging that
Australian Patent No. 624985, which is one of the patents licensed by PARTEQ to
DUSA, relating to the Company's 5-aminolevulinic acid technology, is invalid. As
a consequence of this action, Queen's University has assigned the Australian
patent to DUSA so that DUSA may participate directly in this litigation. DUSA
has filed an answer setting forth its defenses and a related countersuit
alleging that PhotoCure's activities infringe the patent. The case is in its
earliest stages so the Company is unable to predict the outcome at this time.
RECENT ACCOUNTING PRONOUNCEMENT
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Disposal of Long-lived Assets." This statement supercedes SFAS No.
121, "Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to Be Disposed Of." SFAS No. 144 establishes a single accounting model,
based on the framework established in SFAS No. 121, for long-lived assets to be
disposed of by sale, and resolves implementation issues related to SFAS No. 121.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years. When DUSA adopted this statement on
January 1, 2002, SFAS No. 144 did not have any effect on its financial position
or results of operations. During the three-month period ended September 30,
2002, the Company concluded that the termination of the Schering AG agreement on
September 1, 2002 did not have any impairment effects on its nearly completed
manufacturing facility, but did result in impairment adjustments to certain
intangible assets as more fully discussed in Notes 2 and 7 to the Condensed
Consolidated Financial Statements.
INFLATION
Although inflation rates have been comparatively low in recent years,
inflation is expected to apply upward pressure on the operating costs of the
Company. We have included an inflation
24
factor in its cost estimates. However, the overall net effect of inflation on
our operations is expected to be minimal.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We hold fixed income U.S. government securities that are subject to
interest rate market risks. We do not believe that the risk is material at this
time as we have apportioned our investments in short-term and longer-term
instruments, up to five years, and we strive to match the maturity dates of
these instruments to our cash flow needs. A ten percent decline in the average
yield of these instruments would not have a material effect on our results of
operations or cash flows. As noted above, if significant, sudden fluctuations in
interest rates occur, losses could be realized. We do not hold derivative
securities. Accordingly, we do not believe that there is a material market risk
exposure with respect to derivative or other financial instruments that would
require disclosure under this item. The term loan used for the construction of
our manufacturing facility bears interest at a fixed rate through June 30, 2003
and thereafter, is subject to change after that date. A ten percent change in
the interest rate would not have a material effect on our results of operations
or cash flows.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management is responsible for the preparation, integrity and
objectivity of the financial statements and other information presented in this
report. Such financial statements have been prepared in accordance with
generally accepted accounting principals and reflect certain estimates and
adjustments by management. The Company's management maintains a system of
internal accounting controls and disclosure controls and procedures which
management believes provide reasonable assurance that the transactions are
properly recorded and the Company's assets are protected from loss or
unauthorized use.
The integrity of the accounting and disclosure systems are based on written
policies and procedures, the careful selection and training of qualified
financial personnel, a program of internal controls and direct management
review. The Company's disclosure control systems and procedures are designed to
ensure timely collection and evaluation of information subject to disclosure, to
ensure the selection of appropriate accounting policies and to ensure compliance
with the Company's accounting policies and procedures. The Audit Committee is
composed solely of independent directors and meets periodically with the
independent auditors and management to discuss accounting, financial reporting,
auditing and internal auditing matters. The independent auditors have direct and
private access to the Audit Committee.
As of September 30, 2002, an evaluation was performed under the supervision
and with the participation of our management, including the Chief Executive
Officer/Chief Financial Officer, regarding the effectiveness of the design and
operation of our disclosure controls and procedures. Based on this evaluation,
our management, including the Chief Executive Officer/Chief Financial Officer,
believes that our disclosure controls and procedures are adequately designed to
ensure that the information that we are required to disclose in this report has
been accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding such required disclosure. There have
25
been no significant changes in our internal controls or in other factors that
could significantly affect internal controls subsequent to September 30, 2002.
FORWARD-LOOKING STATEMENTS
This report, including the Management's Discussion and Analysis, contains
various "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 which represent our expectations or beliefs concerning
future events, including, but not limited to statements regarding expectations
for continuing operating losses; intention to minimize certain expenditures;
intentions to withdraw certain foreign regulatory applications; intention to
review the carrying value of its manufacturing facility; intention to focus on
needs of dermatologists; potential significant marketing expenses and
arrangements with third parties; potential credit risk; expectations for product
sales and revenues; belief regarding adoption of our therapy over time;
expectations for completion and FDA approval of our manufacturing facility, and
costs relating thereto; replacement of our current manufacturer, and control of
costs of production; sufficiency of inventory and potential adverse effect if
supplies cannot meet demand; potential impact of critical accounting policies;
expectation of higher Kerastick(R) costs per unit; recognition over time of
BLU-U(R) inventory costs, intentions to evaluate and pursue licensing and
acquisition opportunities; beliefs regarding environmental compliance;
expectations regarding the clinical trials results for Phase IV long-term AK
tracking study; intentions not to fund further Barrett's esophagus trials and
intention to focus the dermatology development program on BAAK; beliefs
regarding market penetration; requirements of cash resources for our future
liquidity and potential impact on conversion of government securities;
expectations for future strategic opportunities including for Barrett's
esophagus and research and development programs; need for additional funds;
increasing general and administrative expenses, particularly legal expenses, and
anticipated decreasing research and development expenses; decreasing levels of
interest income and expectations for continuing net losses; and sufficiency of
our capital resources and expectations for capital expenditures; intentions to
continue to evaluate assets for impairment; expectations regarding inflation and
market risks; and beliefs regarding the adequacy of accounting controls and
disclosure controls and procedures. These forward-looking statements are further
qualified by important factors that could cause actual results to differ
materially from those in the forward-looking statements. These factors include,
without limitation, the timing of the reacquisition of rights from Schering AG ,
the ability to establish a new marketing capability and to obtain FDA approval
of our manufacturing facility, changing market and regulatory conditions, actual
clinical results of our trials, the impact of competitive products and pricing,
the timely development, FDA approval, and market acceptance of our products,
reliance on third parties for the production, manufacture, sales and marketing
of our products, the securities regulatory process, the maintenance of our
patent portfolio and the ability to affect a change in the levels of
reimbursement by third-party payors, none of which can be assured. Results
actually achieved may differ materially from expected results included in these
statements as a result of these or other factors.
26
PART II- OTHER INFORMATION
Items 1-5.
None.
Item 6. Exhibits and Reports on Form 8-K.
(i) Exhibits
a) Exhibit 10.1 - Wholesale Agreement dated as of September 1, 2002
between DUSA and Moore Medical Corporation, portions of which
have been omitted pursuant to a request for confidential
treatment pursuant to Rule 24b-2 of the Securities Exchange Act
of 1934.
b) Exhibit 99.1 - Certification Pursuant to 18 U.S.C. Section 1350
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
c) Exhibit 99.2 - Press Release dated November 12, 2002 issued by
the Company regarding quarterly results for the period ended
September 30, 2002.
d) Exhibit 99.3 - Amended Certificate of Incorporation, effective
September 30, 2002.
(ii) Form 8-Ks
a) Form 8-K dated August 27, 2002 announcing a finalized termination
agreement with Schering AG, its former marketing and development
partner for Levulan(R) PDT in the field of dermatology.
b) Form 8-K dated September 27, 2002 announcing the adoption of a
shareholder's rights plan.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
DUSA PHARMACEUTICALS, INC.
DATE: NOVEMBER 12, 2002 BY: /S/ D. GEOFFREY SHULMAN
--------------------- -----------------------------------
D. GEOFFREY SHULMAN, MD, FRCPC
DIRECTOR, CHAIRMAN OF THE BOARD,
PRESIDENT, CHIEF EXECUTIVE OFFICER,
AND CHIEF FINANCIAL OFFICER
(PRINCIPAL EXECUTIVE OFFICER AND
PRINCIPAL FINANCIAL OFFICER)
SARBANES-OXLEY SECTION 302(A) CERTIFICATION
I, D. Geoffrey Shulman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DUSA Pharmaceuticals,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
28
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 /s/ D. Geoffrey Shulman
-----------------------------------------
D. Geoffrey Shulman, MD, FRCPC, Director,
Chairman of the Board,
President, Chief Executive Officer
and Chief Financial Officer
(Principal Executive Officer
and Principal Financial Officer)
29