Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Commission File Number 0-25133

PHARMANETICS, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s Telephone Number, Including Area Code 919-582-2600

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 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  ¨  No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Table of Contents

PHARMANETICS, INC.

INDEX TO FORM 10-Q

2

Table of Contents

PHARMANETICS, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share data)

The accompanying notes are an integral part of the unaudited consolidated financial statements.

3

Table of Contents

PHARMANETICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of the unaudited consolidated financial statements.

4

Table of Contents

PHARMANETICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

The accompanying notes are an integral part of the unaudited consolidated financial statements.

5

Table of Contents

PHARMANETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1. Organization and Basis of Presentation

PharmaNetics, Inc. (the “Company”) is a holding company incorporated in July 1998 as the parent company of Cardiovascular Diagnostics, Inc. (“CVDI”). CVDI was incorporated in November 1985 and develops, manufactures and markets rapid turnaround diagnostics to assess blood clot formation and dissolution. CVDI develops tests based on its proprietary dry chemistry diagnostic test system, known as the Thrombolytic Assessment System (“TAS”), to provide rapid and accurate evaluation of hemostasis at the point of patient care. The consolidated financial statements included herein as of any date other than December 31 have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Financial information as of December 31 has been derived from the audited financial statements of the Company, but does not include all disclosures required by generally accepted accounting principles. In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the consolidated financial position, results of operations and cash flows of the Company. For further information regarding the Company’s accounting policies, refer to the Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. Results for the interim period are not necessarily indicative of the results for any other interim period or for the full fiscal year.

Note 2. Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents.

Note 3. Inventory

Inventories consisted of the following (in thousands):

Note 4. Patents and Intellectual Property

Patents and intellectual property costs are capitalized and are amortized using the straight-line method over their estimated useful lives, generally 17 years. Periods of amortization are evaluated periodically to determine whether later events and circumstances warrant revised estimates of useful lives.

Note 5. Loss Per Common Share

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share” (“EPS”), the Company is required to present both basic and diluted EPS on the face of the Statement of Operations. Basic EPS excludes dilution and is computed by dividing income (loss) attributable to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is the same as basic EPS, because, for loss periods, potential common shares (such as options) are not included in computing diluted EPS since the effect would be antidilutive. The number of potential common shares (represented by outstanding options, warrants and convertible preferred stock) as of March 31, 2003 and 2002 totaled 2,587,634 and 2,476,660, respectively.

6

Table of Contents

Note 6. Series A Preferred Stock

During 2000, the Company completed a private placement of 120,000 shares of Series A convertible preferred stock (“Series A”), resulting in net proceeds to the Company of $11,220,000. The Company also issued five-year warrants to acquire 240,000 shares of common stock at $10.00 per share. Approximately $1,275,000 of the net proceeds was allocated to the warrants based on their relative fair value. The Series A has a dividend of 6% payable quarterly in cash or in shares of common stock at the option of the Company. For the quarter ended March 31, 2003, the Series A dividend was paid by issuing 12,913 shares of common stock.

As of March 31, 2003, each share of the Series A is convertible into ten shares of common stock. The number of common shares currently reserved for issuance upon conversion of preferred stock and exercise of warrants, including the related dividends, is approximately 1,281,000. The Series A is convertible at the option of the holder at any time or may be redeemed at the option of the Company upon the occurrence of any of the following events: (a) the common stock closes at or above $20.00 per share for 20 consecutive trading days, (b) completion by the Company of a follow-on public offering of at least $10 million at a per share price of at least $15.00, (c) the acquisition of the Company by another entity by means of a transaction that results in the transfer of 50% or more of the outstanding voting power of the Company, (d) sale of all or substantially all of the Company’s assets, or (e) at any time after February 28, 2004.

The holders of the Series A have a liquidation preference of $100 per preferred share plus any accrued but unpaid dividends then held, such amounts subject to certain adjustments. The liquidation preference is payable upon a change in control of the Company, thus the Series A is carried in the mezzanine section of the balance sheet. The holders also have the right to vote together with the common stock on an as-if-converted basis.

On the date of issuance of the Series A, the effective conversion price of the Series A was at a discount to the price of the common stock into which the Series A is convertible. In accordance with EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, this discount totaled $3,004,000 and was recorded as a preferred stock dividend during 2000.

Note 7. Common Stock

In April 2001, Bayer Diagnostics, the Company’s distributor, purchased 1,450,000 shares of common stock of the Company at $12 per share for $17.4 million. This investment increased Bayer’s ownership percentage in the Company from approximately 7% to 19.9%. At the same time, the Company and Bayer entered into an amended distribution agreement to replace the previous distribution agreement between the parties entered into during 1998. Bayer currently markets and distributes the Company’s routine tests worldwide and the Company’s enoxaparin test in countries other than the United States.

Note 8. Development Income and Deferred Revenue

The Company recognizes development income in accordance with SEC Staff Accounting Bulletin No. 101. Under SAB 101, payments received under collaboration agreements are deferred and recognized as income over the period of the respective agreements. The Company has received payments as part of collaboration agreements with other entities in the past, including payments received during 2002. Revenue recognized related to collaboration agreements for the quarters ended March 31, 2003 and 2002 were $261,000 and $114,000, respectively. At March 31, 2003, total payments received but deferred to future periods was $4,004,000.

Note 9. Significant Customers

During the quarters ended March 31, 2003 and 2002, the Company had sales to one customer totaling $1,146,000 and $926,000, respectively. At March 31, 2003 and December 31, 2002, outstanding receivables from that customer totaled 94% and 96% of total receivables, respectively.

7

Table of Contents

Note 10. Subsequent Event

On May 1, 2003, the Company issued 95,800 shares of Series B convertible preferred stock, no par value per share, for $100 per share in a private offering to accredited investors. The total proceeds from this offering, net of offering costs, were approximately $8.7 million. Dividends on the Series B preferred stock are 8.5% per annum, payable quarterly in additional shares of Series B preferred stock for the first nine quarters and thereafter in-kind as common stock or in cash at the Company’s option so long as the preferred stock is outstanding. Each Series B preferred share is convertible into shares of common stock at an initial conversion price of $6.00 per share at any time at the option of the holder. Holders of the preferred stock will vote with the common on an as converted basis, subject to any limitiations thereon imposed by Nasdaq rules, regulations and interpretations, on all matters except where a separate class vote is required by law. In addition, the holders of the Series B preferred stock received five-year warrants to purchase 510,933 shares of common stock at a price of $7.12 per share. The Series B preferred stock ranks on parity with the Series A preferred stock with respect to liquidation and dividends.

Note 11. Stock Based Compensation

On December 31, 2002, the Financial Accounting Standards Board (FASB or the “Board”) issued FASB Statement No. 148 (FAS 148), “Accounting for Stock-Based Compensation—Transition and Disclosure”, which amends FASB Statement No. 123 (FAS 123), “Accounting for Stock-Based Compensation”. FAS 148 requires new disclosures including an accounting policy footnote that includes: the method of accounting for stock options; total stock compensation cost that is recognized in the income statement and would have been recognized had FAS 123 been adopted for recognition purposes as of its effective date; and pro forma net income and earnings per share (where applicable) that would have been reported had FAS 123 been adopted for recognition purposes as of its effective date.

These disclosures are required to be made in annual financial statements and in quarterly information provided to shareholders without regard to whether the entity has adopted FAS 123 for recognition purposes. The Company implemented the disclosure provisions of SFAS No. 148 beginning with the December 31, 2002 consolidated financial statements.

For purposes of the proforma disclosures required for the quarter ended March 31, 2003, no stock option grants were made in the first quarter of 2003. For the period ended March 31, 2003, the following table summarizes the net loss and stock-based compensation expense, as reported, compared to pro forma amounts had the fair value method been applied:

8

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. Our actual results might differ materially from those projected in the forward-looking statements due to any number of factors, including those set forth below under “—Factors That May Affect Future Results”. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in our other SEC filings, copies of which are available upon request to us.

The following discussion should be read in connection with the unaudited Consolidated Financial Statements and Notes thereto appearing elsewhere in this report. Unless the context indicates otherwise, all references to us include our wholly-owned subsidiary, Cardiovascular Diagnostics, Inc., or CVDI.

INTRODUCTION

PharmaNetics, Inc., through its wholly-owned subsidiary Cardiovascular Diagnostics, Inc. (“CVDI”), develops, manufactures and markets rapid turnaround diagnostics to assess blood clot formation and dissolution. The Company’s products are a proprietary analyzer and dry chemistry tests, known as the Thrombolytic Assessment System or TAS, that provide, at the point of patient care, rapid and accurate evaluation of hemostasis. PharmaNetics is also establishing itself in the emerging field of theranostics, or rapid near-patient testing, in which the diagnostic results may influence treatment decisions. Current tests and tests under development are used in the treatment of angina, heart attack, stroke, deep vein thrombosis and pulmonary and arterial emboli. The TAS technology is used at the point of patient care which provides many potential benefits, including faster results for better treatment of patients, reduced usage of blood products for bleeding complications, quicker patient transfers from costly critical care settings and reduced hospital costs due to less paperwork and personnel time in processing blood samples.

The Company currently derives income from the following sources: TAS product sales, interest income, and development income recognized in connection with collaboration agreements. Currently, product sales mainly consist of the Company’s routine test cards, the PT, aPTT, HMT, HTT, PRT and LHMT tests along with the related controls and analyzers. These products are marketed and distributed under a global distribution agreement with Bayer Diagnostics (“Bayer”). Bayer also markets and distributes the Company’s enoxaparin test in countries other than the United States. Bayer’s strength is in critical care areas of the hospital which the Company believes should facilitate the placement of the TAS technology.

In addition, the Company’s business strategy has evolved towards becoming more focused on theranostics, the development of specialty tests for drugs, some with narrow ranges between over- and under-dosage. Rapid diagnostic capabilities might improve patient care and turnover, and there is a market trend to obtain diagnostic information faster in order to effect therapy sooner. The Company believes that physicians are beginning to see the need for drug management tools and, consequently, the Company is seeking greater involvement of physician thought leaders during development of new test cards. The Company also believes that these trends should allow the Company to obtain higher pricing of these specialty tests. In furtherance of that objective, the Company commercially launched its first theranostic test, the Enox test, in January 2003 to detect the anticoagulant effects of enoxaparin sodium, a leading low molecular weight heparin marketed by Aventis Pharmaceuticals (“Aventis”). The Company has hired contract sales and technical service personnel to promote and market this test and is also leveraging Aventis’ sales force to penetrate the market.

The Company believes the TAS platform is flexible and that its menu of specialty tests can be expanded to monitor the effects of certain new drugs that are in clinical trials or currently being marketed. Increased placement of specialty tests might also further demand for analyzers and routine anticoagulant tests. The Company believes it is well positioned in its development efforts to expand its menu of tests to monitor developmental drugs where rapid therapeutic intervention is needed.

9

Table of Contents

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates, judgments and the policies underlying these estimates on a periodic basis as the situation changes, and regularly discuss financial events, policies, and issues with our independent accountants and members of our audit committee. Actual results could differ from these estimates. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that affect our financial condition and results of operations.

REVENUE RECOGNITION

Revenue from the sale of products is recorded when an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed and determinable and collectibility is reasonably assured. Substantially all of the Company’s product sales in the first quarter of 2003 were made to the Company’s distributor, Bayer. Income under license and development agreements is recognized over the anticipated period of the agreements with the collaborators, in accordance with SEC Staff Accounting Bulletin No. 101 (SAB 101). SAB 101 clarifies conditions to be met to recognize up-front non-refundable payments. Such payments are recognized over the life of the related agreement unless the payment relates to products delivered or services performed that represent the completion of the earnings process. Payments received but not recognized into income in the year of receipt are deferred and recognized over the period of the respective agreements. The Company has recognized revenue related to a development agreement with Aventis. The Company is recognizing revenue related to the Aventis development contract, which was entered into in 2000, over the agreement period.

STOCK-BASED COMPENSATION

The Company has adopted Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”). As permitted by SFAS No. 123, the Company has chosen to continue to apply APB Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations in accounting for its stock plans. Accordingly, in each period, the Company has used the intrinsic-value method to record stock based employee compensation. No compensation expense has been recognized for stock options granted to employees with an exercise price equal to or above the trading price per share of the Company’s common stock on the grant date.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2003 VS MARCH 31, 2002

Net sales for the quarter ended March 31, 2003 increased 23% to $1,162,000 compared to $943,000 in the same period in 2002. Revenues increased due to higher unit sales of routine and specialty test cards and also higher average sales prices of test cards compared to 2002 due to increased sales of specialty tests. Sales of the Company’s HMP system, which includes two specialty test cards and the related Accent analyzer, increased $147,000 compared to the same period in 2002.

Cost of goods sold for the quarter ended March 31, 2003 was $683,000 compared to $906,000 in the comparable period in 2002. As the Company has prepared for the enoxaparin test card launch and also higher card and analyzer sales to Bayer, production of test cards and analyzers has increased in 2003 compared to 2002, leading to decreased total costs per unit. Fixed overhead costs, which are a significant portion of total product costs, were spread among more units thus lowering the cost per unit sold.

Total operating expenses for the quarter ended March 31, 2003 were $3.1 million compared to $2.4 million in the first quarter of 2002. General and administrative expenses were higher due to budgeted compensation increases and increased public relations expenditures compared to the same period in 2002. Sales and marketing expenses

10

Table of Contents

increased significantly due to higher compensation, travel and promotional expenses as the Company initiated a contract sales and technical service force for the launch of the enoxaparin test card in the first quarter of 2003.

Other income (expense) for the quarter ended March 31, 2003, which is composed of interest income, interest expense and development income, was a net income of $230,000 compared to a net income of $156,000 in the first quarter ended March 31, 2002. Interest income decreased due to lower interest rates and lower average cash balances during the first quarter of 2003 compared to the same period in 2002. Development income in both periods was recognized related to the collaboration with Aventis Pharmaceuticals entered into during 2000 that is being recognized over the period of the development agreement. The increase in other income in the first quarter of 2003 relates to the receipt in the second half of 2002 of $3 million in milestone payments from Aventis.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2003, the Company had cash and cash equivalents of $6.2 million and working capital of $7.2 million, as compared to $9.1 million and $9.5 million, respectively, at December 31, 2002. During the quarter ended March 31, 2003, the Company used cash in operating activities of $2.8 million. The use of cash was principally due to funding the net operating loss of the Company, higher inventory balances related to the launch of the enoxaparin test and decreased payables and accrued expenses.

During the first quarter of 2003, the Company invested in new production machinery and equipment, made improvements to its management information systems and purchased sales and marketing equipment to support the launch of a new test card totaling approximately $63,000.

Cash used in financing activities in the quarter ended March 31, 2003 was due to payments on the Company’s debt and capital leases. The Company obtained a $1.5 million equipment loan from General Electric during the fourth quarter of 2002. These debt and lease payments were partially offset by stock option exercises.

In April 2003, the Company raised, net of offering expenses, approximately $8.7 million through the issuance of 95,800 shares of Series B preferred stock at $100 per share. See “Note 10. Subsequent Event” in the Notes to the Consolidated Unaudited Financial Statements.

The Company has sustained continuing operating losses in 2003 and 2002 and had an accumulated deficit of $64.0 million as of March 31, 2003. The Company expects to incur operating losses until product revenues reach a sufficient level to support ongoing operations. The Company expects to incur additional operating losses during the remainder of 2003. The Company’s working capital requirements will depend on many factors, primarily the volume of subsequent orders of TAS products from distributors, primarily Bayer, and from sales of specialty test cards such as the Enoxaparin test launched in the first quarter. If additional liquidity becomes necessary in the future, the Company will consider external sources of financing as needed. These financings may take the form of equity financings such as a private placement of common or preferred stock or additional equity infusions from collaborative partners.

RECENT ACCOUNTING PRONOUNCEMENTS

On December 31, 2002, the Financial Accounting Standards Board (FASB or the “Board”) issued FASB Statement No. 148 (FAS 148), Accounting for Stock-Based Compensation—Transition and Disclosure, which amends FASB Statement No. 123 (FAS 123), Accounting for Stock-Based Compensation. FAS 148 allows for three methods of transition for those companies that adopt FAS 123’s provisions for fair value recognition. The following are two new transition alternatives: Modified Prospective Approach and Limited Retrospective Approach. Under FAS 148, the prospective transition method in FAS 123 resulting in the “ramp-up” effect will not be available for enterprises that elect to initially apply the fair value method of accounting for stock-based employee compensation in fiscal years beginning after December 15, 2003. In addition, the provisions of FAS 148 require that: the accumulated liability or equity balances accrued under APB Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, would be reversed through additional paid-in-capital as of the beginning of the period that FAS 123 is adopted if those liabilities or contra-equity balances would not have been recognized under FAS 123 (e.g., variable stock option

11

Table of Contents

awards under APB 25). Also, companies disclose for each period for which an income statement is presented an accounting policy footnote that includes: the method of accounting for stock options; total stock compensation cost that is recognized in the income statement and would have been recognized had FAS 123 been adopted for recognition purposes as of its effective date; and pro forma net income and earnings per share (where applicable) that would have been reported had FAS 123 been adopted for recognition purposes as of its effective date.

These disclosures would be required to be made in annual financial statements and in quarterly information provided to shareholders without regard to whether the entity has adopted FAS 123 for recognition purposes. The Company implemented the disclosure provisions of SFAS No. 148 beginning with the December 31, 2002 consolidated financial statements.

FACTORS THAT MAY AFFECT FUTURE RESULTS

A number of uncertainties exist that might affect the Company’s future operating results and stock price. There can be no assurance that new tests, particularly specialty tests, can be developed, receive regulatory approval, and be commercialized and accepted in the market. Other risks include: market acceptance of TAS and the Enox test; the Company’s continuing losses and the resulting potential need for additional capital in the future; managed care and continuing market consolidation, which may result in price pressure, particularly on routine tests; competition within the diagnostic testing industry and FDA regulations and other regulatory guidelines affecting the Company and/or its collaborators. The market price of the common stock could be subject to significant fluctuations in response to variations in the Company’s quarterly operating results as well as other factors which may be unrelated to the Company’s performance. The stock market in recent years has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of and announcements concerning public companies. Such broad fluctuations may adversely affect the market price of the Company’s common stock. Securities of issuers having relatively limited capitalization are particularly susceptible to volatility based on short-term trading strategies of certain investors.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable

ITEM 4. CONTROLS AND PROCEDURES

(a) Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer, Chief Financial Officer and Director of Finance, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company’s Chief Executive Officer, Chief Financial Officer and Director of Finance have concluded that the Company’s disclosure controls and procedures are effective.

(b) There have been no significant changes in the Company’s internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation.

12

Table of Contents

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

13

Table of Contents

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.

14

Table of Contents

CERTIFICATION

Securities and Exchange Act of 1934 Rule 13a-14 as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002:

I, John P. Funkhouser, certify that:

15

Table of Contents

CERTIFICATION

Securities and Exchange Act of 1934 Rule 13a-14 as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002:

I, James A. McGowan, certify that:

16