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SECURITIES AND EXCHANGE COMMISSION
Washington, DC
Form 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
- ------
Exchange Act of 1934
For the quarterly period ended June 30, 2002
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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: 0-28748
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CLOSURE MEDICAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 56-1959623
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(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
5250 Greens Dairy Road, Raleigh, North Carolina 27616
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(Address of principal executive offices) (Zip Code)
(919) 876-7800
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at August 12, 2002
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Common Stock, par value $0.01 per share 13,546,553
CLOSURE MEDICAL CORPORATION
INDEX
Page Number
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PART I: FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 ............ 3
Statements of Operations (unaudited) for the three months ended June 30,
2002 and 2001 and for the six months ended June 30, 2002 and 2001 ............ 4
Statements of Cash Flows (unaudited) for the six months ended June 30,
2002 and 2001 ................................................................ 5
Notes to Condensed Financial Statements (unaudited) ............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ...................................................... 8
Item 3. Quantitative and Qualitative Disclosure about Market Risk .................. 16
PART II: OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders ........................ 16
Item 6. Exhibits and Reports on Form 8-K ........................................... 17
2
PART I- FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
CLOSURE MEDICAL CORPORATION
BALANCE SHEETS
(In thousands, except per share data)
JUNE 30, DECEMBER 31,
2002 2001
(unaudited)
------------ ------------
Assets
Cash and cash equivalents $ 201 $ 2,914
Short-term investments 12,196 8,925
Accounts receivable 3,140 1,985
Inventories 829 1,246
Prepaid expenses 293 263
-------- --------
Total current assets 16,659 15,333
Furniture, fixtures and equipment, net 6,195 6,181
Intangible assets, net 2,893 2,707
Long-term investments 1,005 1,119
-------- --------
Total assets $ 26,752 $ 25,340
======== ========
Liabilities and Stockholders' Equity
Accounts payable $ 1,251 $ 1,206
Accrued expenses 1,703 2,355
Deferred revenue 1,402 1,182
Capital lease obligations 142 333
Short-term debt obligations - 936
-------- --------
Total current liabilities 4,498 6,012
Other accrued liabilities 50 100
Deferred revenue 2,147 1,981
Long-term debt obligations 636 -
-------- --------
Total liabilities 7,331 8,093
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Commitments and Contingencies - -
Preferred Stock, $.01 par value. Authorized 2,000 shares; none
issued or outstanding - -
Common Stock, $.01 par value. Authorized 35,000 shares;
13,530 and 13,508 shares issued and outstanding, respectively 135 135
Additional paid-in capital 48,890 48,521
Accumulated deficit (29,604) (31,409)
-------- --------
Total stockholders' equity 19,421 17,247
-------- --------
Total liabilities and stockholders' equity $ 26,752 $ 25,340
======== ========
The accompanying notes are an integral part of these
condensed financial statements.
3
CLOSURE MEDICAL CORPORATION
STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2002 2001 2002 2001
-------- -------- -------- --------
Product sales $ 5,399 $ 4,227 $ 10,554 $ 7,965
License and product development revenues 258 181 503 360
-------- -------- -------- --------
Total revenues 5,657 4,408 11,057 8,325
Cost of products sold 1,614 1,166 3,277 2,334
-------- -------- -------- --------
Gross profit 4,043 3,242 7,780 5,991
-------- -------- -------- --------
Research, development and regulatory affairs expenses 1,743 1,455 3,343 2,735
General and administrative expenses 1,459 1,435 2,797 2,764
-------- -------- -------- --------
Total operating expenses 3,202 2,890 6,140 5,499
-------- -------- -------- --------
Income from operations 841 352 1,640 492
Interest income, net 81 99 144 228
-------- -------- -------- --------
Income before income taxes 922 451 1,784 720
Provision (benefit) for income taxes (36) 10 (21) 10
-------- -------- -------- --------
Net income $ 958 $ 441 $ 1,805 $ 710
======== ======== ======== ========
Shares used in computation of net income per common share:
Basic 13,530 13,450 13,525 13,445
======== ======== ======== ========
Diluted 13,774 13,722 13,852 13,722
======== ======== ======== ========
Net income per common share- basic
and diluted $ 0.07 $ 0.03 $ 0.13 $ 0.05
======== ======== ======== ========
The accompanying notes are an integral part of these
condensed financial statements.
4
CLOSURE MEDICAL CORPORATION
STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
SIX MONTHS ENDED
JUNE 30,
2002 2001
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Cash flows from operating activities:
Net income $ 1,805 $ 710
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization expense 570 504
Loss on abandonment of patents 140 -
Change in accounts receivable (1,155) (84)
Change in inventories 417 (161)
Change in prepaid expenses (30) 98
Change in accounts payable and accrued expenses (657) (257)
Change in deferred revenue 386 (344)
------- -------
Net cash provided by operating activities 1,476 466
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Cash flows from investing activities:
Purchases of furniture, fixtures and equipment (545) (288)
Investment in intangible assets (365) (271)
Purchases of investments (4,908) (4,125)
Proceeds from the sale of investments 1,751 4,636
------- -------
Net cash used by investing activities (4,067) (48)
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Cash flows from financing activities:
Repayment of debt (300) (251)
Net proceeds from sale of common stock 369 378
Payments under capital lease obligations (191) (155)
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Net cash used by financing activities (122) (28)
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Increase (decrease) in cash and cash equivalents (2,713) 390
Cash and cash equivalents at beginning of period 2,914 1,382
------- -------
Cash and cash equivalents at end of period $ 201 $ 1,772
======= =======
The accompanying notes are in an integral part of these
condensed financial statements.
5
Closure Medical Corporation
Notes to Condensed Financial Statements
(Unaudited)
1. Organization
Closure Medical Corporation (the "Company" or "Closure") develops, manufactures
and commercializes medical tissue adhesive products based on its proprietary
medical-grade cyanoacrylate technology to be used for human and veterinary wound
care and wound closure. From May 10, 1990 to February 29, 1996, the business of
the Company was conducted by its predecessor, Tri-Point Medical L.P. The Company
was incorporated in Delaware on February 20, 1996.
2. Significant Accounting Policies
The significant accounting policies followed by the Company for interim
financial reporting are consistent with the accounting policies followed for
annual financial reporting. These unaudited financial statements have been
prepared in accordance with Rule 10-01 of Regulation S-X, and in management's
opinion, all adjustments of a normal recurring nature necessary for a fair
presentation have been included. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements and should be read in conjunction with the
financial statements and notes thereto for the year ended December 31, 2001
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2001.
The results of operations for the three and six month periods ended June 30,
2002 are not necessarily indicative of the results to be expected for the entire
fiscal year ending December 31, 2002.
Certain prior year balances have been reclassified to conform to the current
year presentation.
In June 2001, the Financial Accounting Standards Board issued Statement No. 143,
"Accounting for Asset Retirement Obligations" ("SFAS 143"). The objectives of
SFAS 143 are to establish accounting standards for the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. SFAS 143 is effective for fiscal years beginning after June 15,
2002. At the present time, the adoption of this standard is not expected to have
a material impact on the Company's financial position or results of operations.
3. Income Taxes
During the three and six months ended June 30, 2002, the Company recorded a tax
benefit of $36,000 and 21,000, respectively, to reflect tax law changes under
the Job Creation and Worker Assistance Act of 2002. The tax law changes increase
the use of net operating losses to reduce alternative minimum taxes and,
accordingly, the Company will receive a refund of all alternative minimum taxes
previously paid in 2001 and 2002. The Company utilized a portion of its net
operating loss carryforwards to offset current year taxes. At June 30, 2002, the
Company has provided a full valuation allowance on all deferred tax assets,
consisting primarily of net operating loss and research and development credit
carryforwards, because of uncertainty regarding their realization.
6
Closure Medical Corporation
Notes to Condensed Financial Statements
(Unaudited)
4. Inventories
Inventories included the following (in thousands):
June 30, December 31,
2002 2001
---------------- ----------------
Packaging $ 445 $ 451
Raw materials 89 61
Work-in-process 180 309
Finished goods 115 425
---------------- ----------------
$ 829 $ 1,246
================ ================
5. Net Income Per Common Share
Basic net income per common share is computed using the weighted average number
of shares of common stock outstanding during the period.
Diluted net income per common share is computed using the weighted average
number of shares of common and common equivalent shares outstanding during the
period. Common equivalent shares consist of stock options using the treasury
stock method and are excluded from the computation if their effect is
antidilutive.
7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION ACT OF 1995
The following discussion should be read in conjunction with the unaudited,
condensed financial statements and notes thereto included in Part I--Item 1 of
this Form 10-Q and the audited financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in our Annual Report on Form 10-K for the year ended
December 31, 2001.
This report and the documents incorporated by reference herein contain
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. When used in this report and the documents incorporated herein by
reference, the words "anticipate," "believe," "estimate," and similar
expressions are generally intended to identify forward-looking statements. These
forward-looking statements include, among others, the statements in Management's
Discussion and Analysis about the following:
.. The risk that the tragedies of September 11, 2001 and their aftermath will
have an adverse effect on markets and businesses and exacerbate the
following risks and uncertainties;
.. our expectations with respect to increases in operating expenses;
.. expectations with respect to increases in research and development and
general and administrative expenses in order to develop new products,
manufacture commercial quantities of products and fund additional clinical
studies;
.. expectations with respect to the development, manufacturing and approval of
new products;
.. expectations with respect to incurring additional capital expenditures to
expand our manufacturing capabilities;
.. expectations with respect to generating revenue or maintaining
profitability;
.. our ability to enter into additional marketing agreements and the ability
of our existing marketing partners to successfully commercialize products
incorporating our technologies;
.. the sufficiency of our existing cash, cash equivalents and investments to
finance our capital requirements for at least 12 months; and
.. expectations with respect to future capital requirements.
There are important factors that could cause actual results to differ materially
from those expressed or implied by such forward-looking statements including,
but not limited to, the following:
.. a decline in the level of demand for our products;
.. developments by competitors;
.. our inability to obtain regulatory clearances;
.. general economic conditions and specifically, conditions in the health care
industry;
.. our ability to protect our proprietary products, know-how and manufacturing
processes;
8
.. our inability to obtain adequate supply of raw materials;
.. the failure to enter into definitive marketing agreements;
.. unanticipated cash requirements to support current operations or research
and development; and
.. our ability to attract and retain key personnel.
These and other risks and uncertainties affecting Closure are discussed in
greater detail in this report and in other filings by Closure with the
Securities and Exchange Commission.
OVERVIEW
We develop, manufacture and commercialize medical tissue adhesive products for
wound care and wound closure for the professional healthcare, over-the-counter,
or OTC, and veterinary markets based on our proprietary medical grade
cyanoacrylate technology. To date, we have commercialized nonabsorbable products
for topical use and our research efforts include the development of absorbable
and nonabsorbable formulations for internal use.
Our flagship product, DERMABOND adhesive, is sold to healthcare professionals
and can be used professionally to rapidly close, seal and protect wounds and
incisions from infection, and to stop leakage of blood and other body fluids
from injured tissue. This product allows natural healing to proceed by closing
and sealing injured tissue without the trauma caused by suturing or stapling. We
believe that using DERMABOND adhesive results in enhanced patient and physician
benefits such as lower overall procedure costs and is easier and quicker to use
than sutures or staples.
We have other products that are marketed in the OTC adhesive bandage and the OTC
oral pain relief markets. BAND-AID(R) Brand Liquid Bandage quickly seals,
protects and stops bleeding from minor cuts and scrapes. SOOTHE-N-SEAL(R)
adhesive provides a protective barrier that shields oral ulcers and sores from
irritation caused by eating and drinking while providing immediate and long-term
pain relief.
In addition, we have two veterinary products in our NEXABAND(R) product line
that are used in cat declaw procedures as well as spay and neuter procedures.
We have entered into marketing partnerships with third parties that distribute
and market our current products to professionals and consumers. Our partners
include Ethicon, Inc., a Johnson & Johnson company; Johnson & Johnson Consumer
Products Company; Colgate Oral Pharmaceuticals, Inc.; Johnson & Johnson Wound
Management; and Abbott Laboratories, Inc.
PRODUCTS
DERMABOND Topical Skin Adhesive
Our flagship product, DERMABOND adhesive, is a nonabsorbable, topical tissue
adhesive that can be used to close wounds from skin lacerations, incisions,
minimally invasive surgery and plastic surgery. DERMABOND adhesive is used as an
alternative to topical sutures or staples, including as an adjunct to
subcuticular sutures or staples which are used for internal tissue closure.
Suturing and stapling involve puncturing healthy tissue in order to align and
close the wound. These procedures may allow leakage or cause additional scarring
at the puncture sites, require anesthetics, are time consuming in their
application, and generally require return patient visits and physician time to
remove the sutures or staples. DERMABOND adhesive may be applied quickly, may
not require anesthetics, does not induce trauma to surrounding tissues and may
not require return visits to the physician for removal. DERMABOND adhesive is
not intended for use on high skin tension areas such as the hands, feet or
across joints.
9
Although the unit cost is greater than sutures or staples, we believe that the
use of DERMABOND adhesive results in lower overall procedure costs because it
may reduce treatment time and the need for anesthetics, simplify post-closure
wound care and eliminate suture or staple removal. The DERMABOND adhesive
clinical trial demonstrated the product to be at least equivalent to topical
nonabsorbable U.S.P. size 5.0 or smaller diameter sutures, staples or adhesive
strips/tapes in wound closure, wound healing, cosmetic outcome and infection
rate, and also demonstrated that the use of DERMABOND adhesive substantially
reduced procedure time and inflammation. Moreover, we recently received approval
from the U.S. Food and Drug Administration, or FDA, to include in DERMABOND
adhesive's device labeling that it acts as a barrier to microbial penetration
and protects against the two most common bacteria that cause infection,
staphylococcus and pseudomonas. Sutures and staples have not been shown to
protect against microbial penetration.
In March 1996, we entered into an exclusive worldwide agreement with Ethicon to
market and distribute DERMABOND adhesive. On August 28, 1998, we received
premarket approval to market DERMABOND adhesive in the United States and Ethicon
launched the product in September 1998. Additionally, Ethicon has been
distributing DERMABOND adhesive outside the United States since late 1997 and is
currently marketing DERMABOND adhesive in approximately 36 foreign countries and
regions, including Japan.
BAND-AID(R) Brand Liquid Bandage
In January 2001, we received FDA clearance to market our liquid bandage, which
is the first and only cyanoacrylate medical device approved by the FDA for the
OTC adhesive bandage market. Clinical trials demonstrated the effectiveness of
our proprietary nonabsorbable formulation as compared to traditional adhesive
bandages when applied to minor cuts and abrasions. In the clinical trials, it
was found that our liquid bandage speeds wound healing, provides a superior
barrier to bacteria that cause infections versus traditional adhesive bandages,
stops bleeding and can help to reduce the pain associated with minor cuts and
abrasions. Our liquid bandage utilizes the same proprietary technology as our
professional product, DERMABOND adhesive.
In May 2001, we entered into an agreement providing Johnson & Johnson Consumer
Products Company, or CPC, with worldwide supply, distribution and development
rights to our liquid bandage technology. The agreement includes rights to the
liquid bandage and future OTC products, excluding our SOOTHE-N-SEAL(R) adhesive
technology. During February 2002, CPC began the marketing and distribution of
our liquid bandage as BAND-AID(R) Brand Liquid Bandage to retail outlets such as
Wal-Mart and CVS. CPC is conducting a consumer oriented marketing campaign that
includes television advertising, consumer promotions, and trade promotions.
SOOTHE-N-SEAL(R) canker sore relief
In 1999, we received FDA clearance to market SOOTHE-N-SEAL(R) adhesive, which
was the first cyanoacrylate adhesive approved by the FDA for the OTC consumer
market. In clinical trials, SOOTHE-N-SEAL(R) adhesive was found to provide
immediate and long-term pain relief associated with oral ulcers, as well as
providing a protective barrier that shields oral ulcers and mouth sores from
irritation due to eating and drinking. SOOTHE-N-SEAL(R) adhesive utilizes the
same proprietary technology as our professional product, DERMABOND adhesive.
In December 2000, we entered into an agreement providing Colgate Oral
Pharmaceuticals, Inc. with exclusive worldwide supply, distribution and
development rights to SOOTHE-N-SEAL(R) adhesive technology. Beginning in the
second quarter of 2001, Colgate began distributing SOOTHE-N-SEAL(R) adhesive to
national retail outlets. Colgate's 2001 marketing approach to create product
awareness included distributing sample units through direct mail campaigns and
its sales force to professionals such as dentists and pharmacists. Colgate has
adopted a similar approach for 2002.
NEXABAND(R) veterinary adhesives
We have developed two topical tissue adhesive products under the NEXABAND(R)
trade name for use in veterinary wound closure and wound care. NEXABAND(R)
Liquid Topical Tissue Adhesive, designed for use in cat declaw surgeries,
reduces procedure time, seals exposed nerve endings and reduces leakage and
irritation. NEXABAND(R) S/C Topical Tissue Adhesive is indicated for the topical
closure and sealing of various surgical incisions, including those made during
spay and neuter procedures and provides an effective, flexible barrier against
fluids, dirt and contaminants.
10
In July 2001, we entered into an agreement providing Abbott Laboratories, Inc.
with worldwide supply, distribution and development rights to the NEXABAND(R)
product line which Abbott is currently distributing in the United States and the
United Kingdom.
PRODUCTS IN DEVELOPMENT
We are currently developing additional nonabsorbable and absorbable tissue
adhesive products. These future products require further development and are
subject to clinical trials and regulatory clearance or approval before
commercialization.
Nonabsorbable
We have completed the enrollment and follow-up of an 84-patient definitive
clinical trial for a high-viscosity version of DERMABOND adhesive. This version
is the second product line extension for DERMABOND adhesive and will allow for
more precise application without the "rundown" experienced with the less viscous
versions. The data from the trial has been assembled and we are seeking
marketing clearance for the product through submission of an amendment to our
current premarket approval, or PMA, supplement. Depending on the FDA review
time, it is possible that the product could be introduced to the market in the
first half of 2003.
We are currently developing a liquid occlusive dressing, or LOD, to treat
partial thickness wounds such as pressure ulcers and skin tears. The LOD
formulation is transparent thereby permitting enhanced wound assessment. It is
being developed to adhere directly to the wound tissue, allowing the product to
conform to various wound sizes and shapes, flex with the skin and provide a
barrier to infection. To date, we have completed animal research as well as a
10-patient human pilot clinical study for pressure ulcers. A second pilot
clinical study is underway to further define the LOD wear time and wound healing
rates versus leading dressings in the category. Based on the outcomes from the
completed pilot studies, we anticipate the initiation of a definitive,
multi-center, human clinical study allowing for FDA approval through the 510(k)
premarket clearance. In November 2001, distribution and development rights for
our professional wound management products, including LOD, were granted to
Johnson & Johnson Wound Management, a division of Ethicon, through an amendment
to the terms of our existing licensing and development agreement with Ethicon.
In February 2001, we entered into a Cooperative Research and Development
Agreement with Walter Reed Army Medical Center and the Uniformed Services
University of the Health Sciences to conduct animal research related to the
development of a novel, minimally invasive treatment for emphysema called
Endobronchial Lung Volume Reduction, or ELVR. Currently, surgeons perform a Lung
Volume Reduction procedure through open chest surgery. This procedure involves
removing the diseased lung and allowing healthier lung tissue to expand more
easily. In performing ELVR, our proprietary medical adhesive will be delivered
using a bronchoscope and small catheter to achieve bronchial occlusion without
the need for open chest surgery. Once occluded, dysfunctional lung tissue would
collapse and allow for healthier lung tissue to expand. We have completed two
animal studies aimed at optimizing the formulation and anticipate the next step
will be to conduct a longer-term animal study and file an investigational device
exemption with the FDA to enter human pilot studies.
Absorbable
In 1998, we established our Internal Products Development team, or IPD, to
develop our absorbable/degradable adhesive products. The IPD is comprised of
dedicated scientists with extensive surgical device development experience who
are developing biocompatible cyanoacrylate formulations that may potentially be
used for internal tissue bonding or sealing applications. The IPD also is
performing synthesis, formulation design, development of analytical methods and
in vitro testing to establish the characteristics of the unique biocompatible
cyanoacrylate formulations. Through collaborations with leading research
institutions, the formulations are being evaluated using various in vivo models
to assess potential surgical use in soft tissue applications such as
cardiovascular and neurology procedures. These formulations and future
absorbable products require further development and will be subject to clinical
trials and regulatory clearance or approval prior to commercialization.
11
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Revenue recognition. The sales price of DERMABOND adhesive and NEXABAND
adhesives is ultimately determined by the sales price of the product to the
ultimate customer. For DERMABOND adhesive and NEXABAND adhesives, we recognize
revenue at an agreed-upon amount per unit at the time these products are
shipped. For these products, our marketing partners subsequently provide a
summary of their sales on a quarterly basis, and at that time, we recognize
additional revenue in an amount equal to the difference between the previously
recognized amount at shipment and the average sales price received by the
marketing partners. In addition, we recognize royalty revenue for DERMABOND
adhesive. Advance payments received by us that relate to future sales of product
or future royalties due on these sales are deferred and recorded as revenue as
they are earned over future periods. Revenues from our other products are
recognized upon shipment which is when title is transferred.
Non-refundable fees received upon the execution of marketing and distribution
agreements for which Closure has an ongoing commitment to provide product are
deferred and recognized ratably over the period of the related agreement
pursuant to SEC Staff Accounting Bulletin No. 101. Under these marketing and
distribution agreements, we may receive additional milestone payments after the
execution of the contract. Because these payments are based on events or
achievements that may be outside of our control, we are unable to reasonably
estimate the amount of revenue, if any, that we might receive in the future
under our agreements. However, potential payments under existing contracts could
total $2.9 million over the next two years assuming that all criteria are
achieved. The revenue related to these payments would be deferred and recognized
ratably over the remaining period of the related agreement, which could extend
as far out as 2011 for certain agreements.
Intangible assets. Intangible assets consist primarily of patents and licenses.
Costs incurred to secure patents and obtain licenses are capitalized until
either the related patent or license is issued or obtained, in which case they
are amortized over the shorter of their remaining economic or useful lives,
generally fifteen years for patents, or they are rejected or abandoned, in which
case they are written off. On an ongoing basis, we evaluate the adequacy of our
patents and licenses carrying values.
Inventories. Inventories are stated at the lower of cost (first-in, first-out)
or market. We evaluate our inventory for obsolete or unmarketable inventory on
an ongoing basis.
Income taxes. Income taxes are computed using the asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in our
financial statements or tax returns. In estimating future tax consequences, we
generally consider all expected future events other than enactment of changes in
tax law or rates. A valuation allowance is recorded if realization of some
portion or all of a deferred asset cannot be reasonably assured. On a quarterly
basis, we consider all positive and negative evidence, including our earnings
history and existing contracts and partnerships, to determine whether it is more
likely than not that certain deferred tax assets will be recovered in the
future. Despite achieving profitability in fiscal 2001 and the first half of
2002, we believe a full valuation allowance is necessary at June 30, 2002 due to
the limited earnings history coupled with uncertainties surrounding future
market conditions.
Related parties. On January 1, 1998, we entered into an agreement with Innocoll
GmbH, of Saal-Donau, Germany, pursuant to which we pay Innocoll $180,000 per
year for five years. Innocoll acts as Closure's authorized representative in
Europe under the Medical Device Directive and will provide alternative
manufacturing space as needed. Two members of the Company's Board of Directors
own 99% of the equity of Innocoll.
RESULTS OF OPERATIONS
Revenues. Total revenues for the three months ended June 30, 2002 were $5.7
million compared to $4.4 million for the corresponding period of 2001. For the
six months ended June 30, 2002 and 2001, total revenues were $11.1 million and
$8.3 million, respectively, which included license and product development
revenue of $503,000 and $360,000, respectively. These increases primarily relate
to increased shipments of DERMABOND adhesive as well
12
as the continued product launch sales of BAND-AID(R) Brand Liquid Bandage offset
by lower sales of SOOTHE-N-SEAL(R) adhesive.
Cost of products sold. Cost of products sold was $1.6 million for the three
months ended June 30, 2002 compared to $1.2 million for the same period of 2001.
For the six months ended June 30, 2002 and 2001 cost of products sold was $3.3
million and $2.3 million, respectively. Cost of products sold as a percentage of
product sales increased to 30% for the three months ended June 30, 2002 from 28%
for the three months ended June 30, 2001. In addition, costs of products sold as
a percentage of product sales increased to 31% for the six months ended June 30,
2002 compared to 29% for the six months ended June 30, 2001. The cost of
products sold as a percentage of product sales increase was due to the revenue
mix including a significant amount of lower margin BAND-AID(R) Brand Liquid
Bandage product as compared to the 2001 period. We expect that future gross
margins on product sales will continue to fluctuate based on production volumes
and the relative proportion of our various products.
Operating Expenses. Operating expenses were $3.2 million for the three months
ended June 30, 2002 and $2.9 million for the same period of 2001. For the six
months ended June 30, 2002 and 2001 operating expenses were $6.1 million and
$5.5 million, respectively. The increase in operating expenses for the three and
six month periods is primarily due to an increase in regulatory affairs
expenses, which included clinical trial expenses for the high-viscosity
DERMABOND adhesive line extension designed to increase the viscosity of the
original product. Also contributing to the increase were expenses related to
pilot clinical studies for our liquid occlusive dressing product for the
treatment of bedsores and skin tears.
Net interest income. Net interest income was $81,000 for the three months ended
June 30, 2002, compared to $99,000 for the three months ended June 30, 2001. For
the six months ended June 30, 2002, net interest income decreased to $144,000
from $228,000 for the six months ended June 30, 2001. Total interest income
decreased due to the continued lower investment yields as a result of market
interest rate changes during the past year. Interest expense also declined due
to the continued reduction of our total debt obligations through monthly
principal payments coupled with a decline in interest rates associated with
those obligations.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations to date primarily through the sale of equity
securities, borrowings from lenders, license and product development revenues
and product sales. Our principal sources of liquidity include cash, cash
equivalents and marketable investments, which totaled $13.4 million at June 30,
2002.
In May 2002, our equipment term loan and line of credit matured and the
outstanding balance of approximately $690,000 was refinanced as a borrowing
within our $3.0 million line of credit, which was renewed for a two-year period.
The renewed agreement contains certain restrictive covenants including, but not
limited to maintenance of certain financial ratios and a minimum tangible net
worth requirement and is secured by certain of our assets. The outstanding
balance on the line of credit is classified as long-term debt as the agreement
does not require principal payments within the next 12 months.
Our capital lease obligation at June 30, 2002 was $142,000 and is classified as
a current liability. Upon expiration of the leases between April and December
2002, we are required to purchase primarily all of the equipment for the fair
market value of approximately $130,000.
Capital Expenditures
There are no individually material capital expenditure commitments outstanding
as of June 30, 2002. We estimate that capital investments for 2002 will be less
than $1.0 million. We believe that our balances of cash, cash equivalents, and
investments together with funds generated from operations and existing borrowing
facilities will be sufficient to meet our operating cash requirements and fund
required capital expenditures for the foreseeable future.
13
Research and Development
During 2001, we spent approximately $5.6 million in research, development and
regulatory affairs expenses. We anticipate that research and development
expenses will continue to increase for the next several years as we develop new
products and line extensions for existing products. We also expect that clinical
trials related to new products and line extensions will be costly and represent
a significant part of future expenses. Research, development and regulatory
affairs expenses consist of items related to personnel, costs of supplies,
clinical trials, professional fees, facility costs and fees paid to consultants
and outside contractors and are expensed as incurred. We are reimbursed for a
fixed percentage of research and development expenses related to projects
approved under cost sharing arrangements with marketing partners. These
reimbursements are recorded as a reduction in research, development and
regulatory affairs expenses on a quarterly basis. We cannot estimate the costs
to complete our internal research and development projects due to uncertainties
regarding successful completion of projects, clinical trial outcomes, regulatory
approvals and cost sharing arrangements with partners. We believe that funds for
future research and development needs can be obtained from existing cash and
investment balances and from cash generated from operations. However, no
assurance can be given that we may not require additional funds to support the
completion of new product development, conduct clinical trials and obtain
regulatory approvals.
CEO Compensation and Severance
On May 17, 2002, we entered into an Amendment to Executive Agreements with
Robert V. Toni, our current President and Chief Executive Officer (the
"Amendment"). Among other things, the Amendment provides that following the
naming of a successor Chief Executive Officer, Mr. Toni will provide certain
transitional services to us (e.g., making introductions of such successor Chief
Executive Officer to clients and other parties) as well as enter into a
noncompetition agreement with us restricting Mr. Toni's ability to compete with
us for a period of three years. If Mr. Toni satisfies all of his obligations
under the Amendment (including entering into the noncompetition agreement), Mr.
Toni will be entitled to thirty-six monthly payments commencing in the month in
which such duties are satisfied, for an aggregate amount of $600,000 plus
benefits of approximately $40,000. If Mr. Toni fails to satisfy any of his
obligations under the Amendment, he will not be entitled to such monthly
payments and we will simply be obligated to pay Mr. Toni his salary and benefits
through the last date in which he is employed with us. We anticipate recording
the cost of these payments as a one-time expense in the period that the
successor Chief Executive Officer is hired. During the transition period, we
will also be compensating and providing benefits for the successor Chief
Executive Officer. Further, we may incur one-time charges relating to the
successor Chief Executive Officer's compensation arrangements in the period of
hire.
Cash Flows
Net cash provided by operating activities was $1.5 million for the six months
ended June 30, 2002 compared to $466,000 for the same period in 2001. The
increase in cash provided by operations was primarily due to the increase in
product sales during the 2002 period.
Net cash used by investing activities was $4.1 million for the six months ended
June 30, 2002 compared to $48,000 during the 2001 period. The increase in net
cash used during 2002 primarily related to net purchases of investments using
available cash coupled with increased purchases of fixed assets and investment
in intangible assets.
Net cash used by financing activities was $122,000 for the six months ended June
30, 2002 compared to $28,000 for same period in 2001. The increase in net cash
used by financing activities was primarily due to the repayment of debt and
capital lease obligations.
Based on our current plans, we believe that existing cash, cash equivalents and
investments, which totaled $13.4 million as of June 30, 2002, will be sufficient
to finance our operating and capital requirements for at least 12 months. We
anticipate that our recurring operating expenses will increase for the next
several years, as we expect research, development and regulatory and general and
administrative expenses to increase in order to develop new products,
manufacture in commercial quantities and fund additional clinical trials. We
also may invest in long-term assets such as intangible assets and capital
expenditures to expand our manufacturing capabilities.
14
Our future capital requirements, however, will depend on numerous factors,
including but not limited to the following:
. our ability to manufacture and commercialize successfully our lead product,
DERMABOND adhesive;
. the progress of our research and product development programs for future
nonabsorbable and absorbable products, including clinical studies;
. the effectiveness of product commercialization activities and marketing
agreements for our future products, including the scale-up of manufacturing
capabilities for increased capacity in anticipation of product
commercialization and development and progress of sales and marketing
efforts;
. our ability to maintain existing marketing agreements, including our
agreement with Ethicon for DERMABOND adhesive, and establish and maintain
new marketing agreements;
. our ability to achieve product development milestones;
. the costs involved in preparing, filing, prosecuting, defending and
enforcing intellectual property rights and complying with regulatory
requirements;
. the effect of competing technological and market developments;
. timely receipt of regulatory clearances and approvals;
. general acceptance of our products by the medical community and consumers;
and
. general economic conditions.
We may be required to seek additional capital to finance our operations in the
future. If our currently available funds and internally generated cash flow are
not sufficient to satisfy our financing and operating needs, we will be required
to seek additional funding through bank borrowings, additional public or private
sales of our securities, including equity securities, or through other
arrangements with marketing partners. Other than our capital lease obligations
and working capital line of credit, we have no credit facility or other
committed sources of capital. There can be no assurance that additional funds,
if required, will be available to us on favorable terms, if at all.
15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
We are subject to interest rate risk on our investment portfolio which consists
primarily of high quality short-term money market funds, commercial paper and
corporate bonds with an average maturity of less than one year. We mitigate
default risk by investing in what we believe are safe and high credit quality
securities and by monitoring the credit rating of investment issuers. The
portfolio includes only marketable securities with active secondary or resale
markets to ensure portfolio liquidity and there are limitations regarding
average and individual duration of investments. These available-for-sale
securities are subject to interest rate risk and will decrease in value if
market interest rates increase. At June 30, 2002, our total portfolio consisted
of approximately $13.4 million of cash, cash equivalents and investments, the
majority of which had average maturities within one year. Additionally, we
generally have the ability to hold fixed income investments to maturity.
Therefore, we do not expect our results of operations or cash flows to be
materially affected due to a sudden change in interest rates.
FOREIGN CURRENCY EXCHANGE RISK
Our international sales and related royalties of DERMABOND adhesive and
international sales of NEXABAND(R) adhesives are based on sales in foreign
currencies. However, all of our sales to customers are payable in U.S. dollars
and we may be adversely affected by fluctuations in currency exchange rates.
Additionally, fluctuations in currency exchange rates may adversely affect
demand for our products by increasing the price of our products in the currency
of the countries in which the products are sold.
PART II- OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders of the Company (the "Meeting") was held on
June 18, 2002. At the Meeting, the following nominees were re-elected as
directors for the Company to serve until the Annual Meeting of Stockholders of
the Company in 2005 and until their successors shall have been elected and
qualified and received the votes set forth after their names below:
Name of Nominee For Withheld
- --------------- --- ---------
Randy H. Thurman 12,551,185 429,157
Robert V. Toni 12,482,435 497,907
The terms of office of the following directors continued after the Meeting in
accordance with the Company's Certificate of Incorporation: Ronald A. Ahrens,
Dennis C. Carey, Richard W. Miller, James E. Niedel, F. William Schmidt and Rolf
D. Schmidt.
Also at the Meeting, the stockholders of the Company approved and adopted an
amendment to the Company's Amended and Restated 1996 Equity Compensation Plan
(the "Plan") to increase the number of shares authorized for issuance under the
Plan from 4,500,000 to 6,000,000 and to increase the number of shares issuable
annually to any individual under the Plan from 300,000 to 500,000. The results
of the voting on such matter were as follows:
For Against Abstentions or Broker Non-Votes
--- ------- -------------------------------
8,439,776 2,388,430 2,152,136
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In addition, the stockholders of the Company approved and ratified the selection
by the Board of Directors of PricewaterhouseCoopers LLP as the Company's
independent accountants for the fiscal year ending December 31, 2002. The
results of the voting on such matters were as follows:
For Against Abstentions or Broker Non-Votes
--- ------- -------------------------------
12,952,018 23,332 4,992
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit 3.3 - Amended and Restated By-Laws, effective June 17,
2002
Exhibit 99.1 - Certification of Chief Executive Officer
Exhibit 99.2 - Certification of Chief Financial Officer
(b) Reports on Form 8-K.
A Form 8-K was filed on May 24, 2002 disclosing the Amendment to
Executive Agreements between the Company and Robert V. Toni.
17
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.
CLOSURE MEDICAL CORPORATION
Date: August 14, 2002 By: /s/ Robert V. Toni
------------------
Robert V. Toni
President and Chief Executive Officer
Date: August 14, 2002 By: /s/ Benny Ward
--------------
Benny Ward
Vice President of Finance and
Chief Financial Officer