UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the Quarterly Period Ended September 30, 2003
Commission File Number 0-18044
PROCYTE CORPORATION
(Exact name of the registrant as specified in its charter)
|
Washington |
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91-1307460 |
|
(State of incorporation) |
|
(I.R.S. Employer Identification No.) |
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|
|
|
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8511 154th Avenue N.E., Redmond, WA |
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98052 |
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(Address of principal executive offices) |
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(Zip code) |
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|
|
|
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Registrant’s telephone number, including area code: |
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(425) 869-1239 |
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.
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Yes ý |
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No o |
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
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Yes o |
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No ý |
As of November 7, 2003, there were issued and outstanding 15,782,602 shares of common stock, par value $.01 per share.
ProCyte Corporation
Index
2
Part I - Financial Information
(in thousands)
|
|
|
September 30, 2003 |
|
December 31, 2002 |
|
||
|
ASSETS |
|
|
|
|
|
||
|
Cash and cash equivalents |
|
$ |
4,456 |
|
$ |
4,556 |
|
|
Accounts receivable, net of allowance for doubtful accounts |
|
1,122 |
|
1,328 |
|
||
|
Inventory |
|
2,600 |
|
1,718 |
|
||
|
Prepaid expenses |
|
196 |
|
326 |
|
||
|
Other current assets |
|
105 |
|
3 |
|
||
|
Total current assets |
|
8,479 |
|
7,931 |
|
||
|
Property and equipment, net |
|
1,106 |
|
1,286 |
|
||
|
Intangible assets, net |
|
2,891 |
|
2,903 |
|
||
|
Note due from sale of contract manufacturing operations, net |
|
1,849 |
|
1,826 |
|
||
|
Other assets |
|
40 |
|
143 |
|
||
|
Total Assets |
|
$ |
14,365 |
|
$ |
14,089 |
|
|
|
|
|
|
|
|
||
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
||
|
Accounts payable, trade |
|
$ |
290 |
|
$ |
277 |
|
|
Accrued salaries and benefits |
|
261 |
|
405 |
|
||
|
Other accrued liabilities |
|
191 |
|
260 |
|
||
|
Deferred revenue |
|
249 |
|
21 |
|
||
|
Total current liabilities |
|
991 |
|
963 |
|
||
|
Other liabilities |
|
93 |
|
91 |
|
||
|
Deferred proceeds on sale of contract manufacturing operations |
|
1,016 |
|
1,217 |
|
||
|
Total Liabilities |
|
2,100 |
|
2,271 |
|
||
|
Common stock and additional paid-in-capital |
|
85,351 |
|
85,312 |
|
||
|
Deferred compensation |
|
— |
|
(11 |
) |
||
|
Accumulated deficit |
|
(73,086 |
) |
(73,483 |
) |
||
|
Stockholders’ Equity |
|
12,265 |
|
11,818 |
|
||
|
Total Liabilities and Stockholders’ Equity |
|
$ |
14,365 |
|
$ |
14,089 |
|
See notes to condensed consolidated financial statements
3
(in thousands, except per share amounts)
|
|
|
Three
months ended |
|
Nine
months ended |
|
||||||||
|
|
|
2003 |
|
2002 |
|
2003 |
|
2002 |
|
||||
|
Revenues |
|
|
|
|
|
|
|
|
|
||||
|
Product sales |
|
$ |
2,286 |
|
$ |
2,735 |
|
$ |
7,481 |
|
$ |
8,404 |
|
|
Licenses and royalties |
|
437 |
|
391 |
|
1,220 |
|
1,028 |
|
||||
|
Total revenues |
|
2,723 |
|
3,126 |
|
8,701 |
|
9,432 |
|
||||
|
Cost of product sales |
|
675 |
|
1,285 |
|
2,477 |
|
3,308 |
|
||||
|
Gross profit |
|
2,048 |
|
1,841 |
|
6,224 |
|
6,124 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Operating Expenses |
|
|
|
|
|
|
|
|
|
||||
|
Marketing and selling |
|
1,024 |
|
728 |
|
3,237 |
|
2,279 |
|
||||
|
Research, general, and administrative |
|
797 |
|
840 |
|
2,731 |
|
2,642 |
|
||||
|
Total operating expenses |
|
1,821 |
|
1,568 |
|
5,968 |
|
4,921 |
|
||||
|
Operating income |
|
227 |
|
273 |
|
256 |
|
1,203 |
|
||||
|
Interest and other income |
|
34 |
|
49 |
|
159 |
|
142 |
|
||||
|
Net income before tax |
|
261 |
|
322 |
|
415 |
|
1,345 |
|
||||
|
Provision for income tax |
|
— |
|
— |
|
(18 |
) |
— |
|
||||
|
Net income |
|
$ |
261 |
|
$ |
322 |
|
$ |
397 |
|
$ |
1,345 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net earnings per share |
|
|
|
|
|
|
|
|
|
||||
|
Basic |
|
$ |
0.02 |
|
$ |
0.02 |
|
$ |
0.03 |
|
$ |
0.09 |
|
|
Diluted |
|
$ |
0.02 |
|
$ |
0.02 |
|
$ |
0.02 |
|
$ |
0.08 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Shares used in per share computation |
|
|
|
|
|
|
|
|
|
||||
|
Basic |
|
15,774 |
|
15,722 |
|
15,761 |
|
15,703 |
|
||||
|
Diluted |
|
15,974 |
|
16,031 |
|
15,973 |
|
16,996 |
|
||||
See notes to condensed consolidated financial statements
4
(in thousands)
|
|
|
Nine months ended September 30, |
|
||||
|
|
|
2003 |
|
2002 |
|
||
|
Operating Activities |
|
|
|
|
|
||
|
Net income |
|
$ |
397 |
|
$ |
1,345 |
|
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
|
||
|
Depreciation and amortization |
|
244 |
|
236 |
|
||
|
Amortization of deferred proceeds |
|
(201 |
) |
(201 |
) |
||
|
Non-cash expense related to stock-based compensation |
|
36 |
|
36 |
|
||
|
Amortization of promissory note discount |
|
(23 |
) |
(23 |
) |
||
|
Amortization of deferred compensation |
|
4 |
|
4 |
|
||
|
Change in operating assets and liabilities: |
|
|
|
|
|
||
|
Accounts receivable |
|
206 |
|
(502 |
) |
||
|
Inventory |
|
(882 |
) |
349 |
|
||
|
Prepaid expenses |
|
130 |
|
(103 |
) |
||
|
Other current assets |
|
2 |
|
12 |
|
||
|
Accounts payable, trade |
|
13 |
|
(427 |
) |
||
|
Accrued salaries and benefits |
|
(144 |
) |
(218 |
) |
||
|
Other accrued liabilities |
|
(69 |
) |
334 |
|
||
|
Deferred revenue |
|
228 |
|
(41 |
) |
||
|
Other liabilities |
|
2 |
|
(13 |
) |
||
|
Net cash provided by (used in) operating activities |
|
(57 |
) |
788 |
|
||
|
Financing Activities |
|
|
|
|
|
||
|
Proceeds from issuance of common stock |
|
10 |
|
26 |
|
||
|
Investing Activities |
|
|
|
|
|
||
|
Purchase of property and equipment |
|
(53 |
) |
(16 |
) |
||
|
Decrease in other assets |
|
— |
|
45 |
|
||
|
Net cash provided by (used in) investing activities |
|
(53 |
) |
29 |
|
||
|
Net increase (decrease) in cash and cash equivalents |
|
(100 |
) |
843 |
|
||
|
Cash and Cash Equivalents |
|
|
|
|
|
||
|
At beginning of period |
|
4,556 |
|
3,003 |
|
||
|
At end of period |
|
$ |
4,456 |
|
$ |
3,846 |
|
See notes to condensed consolidated financial statements
5
(in thousands)
|
|
|
Common Stock |
|
Additional |
|
Deferred |
|
Accumulated |
|
Total |
|
|||||||
|
Shares |
|
Par Value |
||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Balance – December 31, 2002 |
|
15,734 |
|
$ |
158 |
|
$ |
85,154 |
|
$ |
(11 |
) |
$ |
(73,483 |
) |
$ |
11,818 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Shares issued under non-employee director stock plan |
|
29 |
|
(* |
) |
36 |
|
— |
|
— |
|
36 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Shares issued upon exercise of options |
|
12 |
|
(* |
) |
10 |
|
— |
|
— |
|
10 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Re-measurement of stock options granted to non-employees |
|
— |
|
— |
|
(7 |
) |
7 |
|
— |
|
— |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Amortization of deferred compensation |
|
— |
|
— |
|
— |
|
4 |
|
— |
|
4 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Net income for nine months ended September 30, 2003 |
|
— |
|
— |
|
— |
|
— |
|
397 |
|
397 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Balance – September 30, 2003 |
|
15,775 |
|
$ |
158 |
|
$ |
85,193 |
|
$ |
— |
|
$ |
(73,086 |
) |
$ |
12,265 |
|
(*) rounds to less than $1,000
See notes to condensed consolidated financial statements
6
ProCyte Corporation
1. Basis of Presentation
The accompanying condensed consolidated financial statements (unaudited) include the accounts of ProCyte Corporation and its wholly-owned, subsidiaries NextDerm, Inc. (a Delaware corporation) and NextDerm, Inc. (a Washington corporation incorporated February 28, 2003) (collectively “ProCyte” or the “Company”), for the three and nine month periods ended September 30, 2003 and 2002 have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Pursuant to such rules and regulations, the consolidated condensed financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for audited financial statements. Accordingly, this financial information should be read in conjunction with the complete audited financial statements, including the notes thereto, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion of management, all material adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial statements have been included. Interim results are not necessarily indicative of the results that may be expected for the year.
Stock Based Compensation
The Company follows the intrinsic value-based accounting method for stock options contained in APB Opinion No. 25, Accounting for Stock Issued to Employees, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation. Under this method, no compensation expense has been recognized as the exercise price of options granted equals the fair value on the date of grant. Had compensation expense for the Company’s stock options under the incentive compensation plan been recognized based upon the fair value for awards granted, the Company’s net earnings would have been changed to the following pro forma amounts for the three and nine months ended September 30, 2003 and 2002:
|
|
|
(in thousands, except per share amounts) |
|
||||||||||
|
|
|
Three
months ended |
|
Nine
months ended |
|
||||||||
|
|
|
2003 |
|
2002 |
|
2003 |
|
2002 |
|
||||
|
Net income, as reported |
|
$ |
261 |
|
$ |
322 |
|
$ |
397 |
|
$ |
1,345 |
|
|
Stock option-based compensation expense determined under fair value-based method |
|
(97 |
) |
(115 |
) |
(224 |
) |
(184 |
) |
||||
|
Pro forma net income |
|
$ |
164 |
|
$ |
207 |
|
$ |
173 |
|
$ |
1,161 |
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
||||
|
As reported basic |
|
$ |
0.02 |
|
$ |
0.02 |
|
$ |
0.03 |
|
$ |
0.09 |
|
|
As reported diluted |
|
$ |
0.02 |
|
$ |
0.02 |
|
$ |
0.02 |
|
$ |
0.08 |
|
|
Pro forma basic |
|
$ |
0.01 |
|
$ |
0.01 |
|
$ |
0.01 |
|
$ |
0.07 |
|
|
Pro forma diluted |
|
$ |
0.01 |
|
$ |
0.01 |
|
$ |
0.01 |
|
$ |
0.07 |
|
7
The Company determined the fair value of stock options granted during the three and nine months ended September 30, 2003 and 2002 using the Black-Scholes option pricing model and the following assumptions:
|
|
|
Three months ended September 30, |
|
Nine months ended September 30, |
|
||||
|
|
|
2003 |
|
2002 |
|
2003 |
|
2002 |
|
|
Options Granted |
|
|
|
|
|
|
|
|
|
|
Risk-free interest rate |
|
2.35 |
% |
3.30 |
% |
2.35%-2.81 |
% |
3.30%-3.92 |
% |
|
Expected option life (years) |
|
6.00 |
|
6.00 |
|
6.00 |
|
6.00 |
|
|
Dividend yield |
|
0.00 |
|
0.00 |
|
0.00 |
|
0.00 |
|
|
Expected volatility |
|
60 |
% |
64 |
% |
59%-62 |
% |
61%-67 |
% |
Recent accounting pronouncements
In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS No. 149). SFAS No. 149 amends and clarifies financial reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The Company believes adoption of SFAS No. 149 will not have a material effect on the financial condition, results of operations, or liquidity of the Company.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity, and is effective for financial instruments entered into after May 31, 2003. The Company believes it does not have any financial instruments with characteristics of both liabilities and equity and that adoption of SFAS No. 150 will not have a material effect on the financial condition, results of operations, or liquidity of the Company.
2. Accounts Receivable
Customers, which represented greater than 10% of the net accounts receivable balance at September 30, 2003 and December 31, 2002, are as follows:
|
|
|
September 30, 2003 |
|
December 31, 2002 |
|
|
Customer A |
|
30 |
% |
44 |
% |
|
|
|
|
|
|
|
|
Customer B |
|
14 |
% |
13 |
% |
|
|
|
|
|
|
|
|
Customer C |
|
10 |
% |
— |
|
The Company provided an allowance for uncollectable receivables in the amount of $104,000 and $68,000 at September 30, 2003 and December 31, 2002, respectively. The bad debt expense, net of recoveries of $1,000 in 2003 and $1,000 in 2002, was $15,000 and $12,000 for the three months ended September 30, 2003 and 2002, respectively. The bad debt expense, net of recoveries of $6,000 in 2003 and $28,000 in 2002, was $44,000 and $5,000 for the nine months ended September 30, 2003 and 2002, respectively. Accounts written off to the allowance account amounted to $1,000 and $6,000 for the three months period ended September 30, 2003 and 2002, respectively. Accounts written off to the allowance
8
account amounted to $14,000 and $186,000 for the nine month periods ended September 30, 2003 and 2002, respectively.
3. Inventory
Inventory consisted of the following:
|
|
|
(in thousands) |
|
||||
|
|
|
September 30, 2003 |
|
December 31, 2002 |
|
||
|
Finished Goods |
|
$ |
2,077 |
|
$ |
1,254 |
|
|
|
|
|
|
|
|
|
|
|
Work in process |
|
375 |
|
228 |
|
||
|
|
|
|
|
|
|
||
|
Raw materials |
|
148 |
|
236 |
|
||
|
|
|
|
|
|
|
||
|
Total |
|
$ |
2,600 |
|
$ |
1,718 |
|
4. Property and Equipment
Property and equipment consisted of the following:
|
|
|
(in thousands) |
|
||||
|
|
|
September 30, 2003 |
|
December 31, 2002 |
|
||
|
Equipment |
|
$ |
385 |
|
$ |
333 |
|
|
|
|
|
|
|
|
|
|
|
Leasehold improvements |
|
4,029 |
|
4,029 |
|
||
|
|
|
|
|
|
|
||
|
Less accumulated depreciation & amortization |
|
(3,308 |
) |
(3,076 |
) |
||
|
|
|
|
|
|
|
||
|
Property and equipment, net |
|
$ |
1,106 |
|
$ |
1,286 |
|
5. Intangible Assets
Intangible assets include patents of $74,000 and $86,000 at September 30, 2003 and December 31, 2002, respectively. Patents are shown net of accumulated amortization of $217,000 and $205,000, at September 30, 2003 and December 31, 2002, respectively. Patents are amortized over the term of the patent and the amortization expense related thereto was $4,000 for each of three-month periods ended September 30, 2003 and 2002, respectively, and $12,000 for each of the nine-month periods ended September 30, 2003 and 2002, respectively. Patent amortization expense is expected to be $16,000 for each of the years ending December 31, 2003 through 2007 and $6,000 for the year ending December 31, 2008.
Intangible assets also include goodwill of $2.8 million at September 30, 2003 and at December 31, 2002. Under the guidance of Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets,” the Company performed an annual impairment test on the value of certain intangibles such as goodwill on March 31, 2003, and concluded that goodwill was not impaired. There were no events since March 31, 2003, which would cause the Company to change its valuation as of September 30, 2003. The Company determined that it has one reportable unit, therefore, all of goodwill is deemed to be associated with ProCyte’s overall business operations.
9
6. Federal and State Income Taxes
No provision was made for federal income taxes for the three and nine months ended September 30, 2003 and 2002. At September 30, 2003 and December 31, 2002, the Company provided a full valuation allowance for its net deferred tax assets. The Company believes sufficient uncertainty exists regarding the realizability of the deferred tax assets. The net changes in the valuation allowance during the nine months ended September 30, 2003 and the year ended December 31, 2002, due primarily to short term timing differences, were a reduction of $206,000 and $627,000, respectively.
A provision for state income tax was made for California state income tax in the quarter ended March 31, 2003. The Company has a net operating loss carry forward for California state income tax of $350,000, however in the fourth quarter of 2002 the State of California temporarily suspended the use of the net operating loss carry forward deduction for 2002 and 2003. As a result, the Company recognized $18,000 related to state income taxes in the first quarter of 2003.
As of September 30, 2003, the Company’s U.S. federal net operating loss and general business credit carry forward for income tax purposes were approximately $68.0 million and $1.6 million, respectively. If not utilized, the federal net operating loss carry forward and tax credits carry forward will expire between 2004 and 2021. Changes in ownership, as defined by Section 382 of the IRC, may limit the amount of net operating loss carry forward used in any one year.
7. Earnings per share
Basic and diluted per share results for all periods presented were computed based on the net earnings for the respective periods. The weighted average number of common shares outstanding during the period was used in the calculation of basic earnings per share. In accordance with FAS 128, “Earnings Per Share,” the weighted average number of common shares used in the calculation of diluted per share amounts is adjusted for the dilutive effects of stock options based on the treasury stock method only if an entity records earnings from operations, as such adjustments would otherwise be anti-dilutive to earnings per share from operations. For the three months ended September 30, 2003 and 2002, 200,823 and 309,740 dilutive stock options, respectively, were included in the calculation of average number of common shares outstanding for diluted computations. For the three months ended September 30, 2003 and 2002, options and warrants to purchase 1,043,007 shares and 487,500 shares, respectively, of common stock with exercise prices greater than the average fair market value of our stock for the period of $1.16 and $1.49, respectively, were not included in the computation of diluted earnings per share because the effect would have been antidilutive. For the nine months ended September 30, 2003 and 2002, 203,565 and 292,666 dilutive stock options, respectively, were included in the calculation of average number of common shares outstanding for diluted computations. For the nine months ended September 30, 2003 and 2002, options to purchase 981,342 shares and 487,500 shares, respectively, of common stock with exercise prices greater than the average fair market value of our stock for the period of $1.19 and $1.62, respectively, were not included in the computation of diluted earnings per share because the effect would have been antidilutive.
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8. Stock Options
Information relating to stock options granted, exercised, canceled and currently exercisable is as follows:
|
|
|
Shares Subject to Option |
|
Weighted
Average |
|
|
|
Outstanding, January 1, 2002 |
|
2,087,002 |
|
$ |
1.57 |
|
|
Granted |
|
294,500 |
|
$ |
1.77 |
|
|
Exercised |
|
(28,837 |
) |
$ |
0.89 |
|
|
Canceled or expired |
|
(323,164 |
) |
$ |
1.84 |
|
|
Outstanding, September 30, 2002 |
|
2,029,501 |
|
$ |
1.57 |
|
|
|
|
Shares |
|
Weighted
Average |
|
|
|
Outstanding, January 1, 2003 |
|
2,185,335 |
|
$ |
1.57 |
|
|
Granted |
|
169,500 |
|
$ |
1.29 |
|
|
Exercised |
|
(12,000 |
) |
$ |
0.86 |
|
|
Canceled or expired |
|
(149,835 |
) |
$ |
2.74 |
|
|
Outstanding, September 30, 2003 |
|
2,193,000 |
|
$ |
1.47 |
|
|
Exercisable, September 30, 2003 |
|
1,633,179 |
|
$ |
1.51 |
|
The weighted average fair value of options granted during the three months ended September 30, 2003 and 2002 were approximately $0.51 and $1.14, respectively. The weighted average fair value of options granted during the nine months ended September 30, 2003 and 2002 were approximately $0.76 and $1.32, respectively.
9. Related Party Disclosure
The Company holds a promissory note in the principal amount of $2.0 million from Emerald Pharmaceutical L.P., which it received as partial consideration for the sale of its contract manufacturing operations in 2001. The note is secured by the manufacturing assets sold and bears interest equal to the effective yield on the 10 Year U.S. Treasury Note, which is adjusted quarterly. The yield for the quarter ended September 30, 2003 was 3.51%. Emerald will begin making annual principal payments of $286,000 in July 2005. The Company also received a minority limited partnership interest in Emerald as part of consideration received in the sale. As part of the agreement, ProCyte leases a portion of its current 34,532 square foot leased facility, including existing leasehold improvements, to Emerald. A portion of the proceeds from the sale in the amount of $1.7 million has been determined to represent consideration for Emerald’s use of the leasehold improvements, and is being recognized over the term of the lease. ProCyte engages Emerald Pharmaceutical L.P. to do certain manufacturing and other quality and analytical services. Emerald billed ProCyte for such services a total of $415,000 and $643,000 for the three months ended September 30, 2003 and 2002, respectively, and $1.6 million and $837,000 for the nine months ended September 30, 2003 and 2002, respectively. ProCyte had trade payables to Emerald of $20,000 and $18,000 on September 30, 2003 and December 31, 2002, respectively.
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One of the Company’s Directors also serves as Chairman and Chief Executive Officer of one of ProCyte’s customers. ProCyte’s net sales to the customer were $248,000 and $298,000 for the three months ended September 30, 2003 and 2002, respectively and $593,000 and $607,000 for the nine months ended September 30, 2003 and 2002, respectively. The customer’s trade receivable balances were $158,000 and $274,000 on September 30, 2003 and December 31, 2002, respectively.
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This Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to future events or future financial performance. In some cases you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “propose” or “continue,” the negative of these terms, or other terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors described below in the section entitled “Important Factors Regarding Forward-Looking Statements.” These factors may cause our actual results to differ materially from any forward-looking statement.
Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, product demand, performance or achievements. You should not place undue reliance on our forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.
Critical Accounting Policies and Estimates
The “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures included elsewhere in this Form 10-Q, are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingencies. On an ongoing basis, we evaluate the estimates used, including those related to impairment and useful lives of intangible assets, allowances for accounts receivable and notes receivable, and for excess and obsolete inventory. We base our estimates on historical experience, current conditions and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources as well as identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of the consolidated financial statements.
Product revenues are recognized when products are shipped, license fees are recognized over the term of the license agreement, and royalties are recognized when earned. On occasion, the Company will receive advance deposits with customer purchase orders. These deposits are reported as a deferred revenue liability, until the product is shipped to the customer.
Approximately 20% of ProCyte’s assets as of September 30, 2003 consisted of goodwill, most of which was acquired in business combinations and recorded based on the fair value of the common stock issued to effect those business combinations. Under the guidance of SFAS 142 “Goodwill and Other Intangible Assets,” we analyze whether the fair value of recorded goodwill is impaired on an annual basis. Our analysis of whether the fair value of recorded goodwill is impaired involves a substantial amount of judgment, as does establishing and monitoring estimated lives of amortizable intangible assets. Future charges related to intangible assets could be material depending on future developments and changes in technology and our business.
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We maintain an allowance for doubtful accounts for estimated losses resulting from the potential inability of our customers or other debtors to make required payments. We believe such allowances are adequate as of September 30, 2003; however, if the financial condition of our customers or other debtors were to deteriorate, resulting in an impairment of their ability to make payments to us, additional allowances may be required.
Inventories are stated at the lower of cost or market value. Cost is principally determined by the first-in, first-out method. The Company records adjustments to the value of inventory based upon its forecasted plans to sell its inventories. The physical condition (e.g., age and quality) of the inventories is also considered in establishing its valuation. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from the amounts that the Company may ultimately realize upon the disposition of inventories, if future economic conditions, customer inventory levels, product discontinuances or competitive conditions differ from our estimates and expectations.
The Company has provided a full valuation reserve for tax benefits of net operating losses and research and development tax credit carry forwards due the uncertainty of realizing the tax benefits of the assets. In evaluating the need for a reserve, each quarter we consider all positive and negative evidence to determine whether it is more likely than not that the deferred tax assets will be utilized. In doing so we use judgment in considering the relative impact of negative and positive evidence and the weight given to this evidence is commensurate with the extent to which it can be objectively verified.
Corporate Overview
ProCyte develops, manufactures, distributes and markets products for skin health, hair care and wound care, many of which incorporate clinically tested technologies such as its patented Copper Peptide compounds. ProCyte receives revenue from the sale of products via its U.S. sales force, distributors and international customers, from royalties and the sale of Copper Peptide compounds under license and supply agreements, and from the manufacture and sale of private label products containing our technologies.
Our growth strategy includes acquisition, licensing, and/or distribution of products that we believe have a demonstrated market and may require more directed marketing and promotional attention. We have acquired, and intend to acquire, rights to manufacture and/or market products that studies have shown to be effective, but which are not actively promoted and where the surrounding competitive environment is conducive to our entry. In addition to acquisitions, our growth strategy includes the introduction of new products developed through our research and development program.
During the fourth quarter of 2002, ProCyte initiated work on an infomercial, a form of direct-to-consumer distribution, with a new brand of anti-aging and skin care products called VitalCopper™. Many of the initial VitalCopper™ products include GHK Copper Peptide compounds. First production and filming were completed in January 2003, and the initial market test began in selected markets during March 2003. Continuation of the market test was placed on hold as public and media attention focused on the Iraq conflict. During this hold period, based upon expert feedback, a number of changes were made to content, style and approach and a new multi-week market test program was initiated at the end of July 2003. The new market test results indicated that additional modification and testing cycles would be required. While this test, modify and retest methodology in not unusual for infomercials, management believes that additional investment would not produce as much return as other opportunities available to the Company. Therefore all activities related to the infomercial have been suspended. ProCyte will continue to market the VitalCopper™ brand products to consumers through the VitalCopper™ web site, selected print advertising catalog sales and specialty retail. As a result of required accounting practices
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for an infomercial, development and production costs totaling $540,000 were expensed and included under marketing and selling in the first quarter of 2003, when the first infomercial test ran. For the nine months ended September 30, 2003, expenses included in marketing and selling related to the infomercial were $770,000, or approximately $0.05 per share.
Revenues
Total revenue for the third quarter of 2003 decreased to $2.7 million as compared to $3.1 million reported in the same quarter of the prior year. Revenues in the first nine months of 2003 decreased to $8.7 million from $9.4 million as compared to the comparable 2002 period. The revenue decrease for the quarter and first nine months is due to lower shipments of ProCyte’s patented Copper Peptide compound to licensed partners during the second and third quarters. The timing and amount of product shipments are dependent on customers’ production schedules and can fluctuate widely from quarter to quarter. However, revenue from Copper Peptide compound is expected to remain at the current period level into the fourth quarter of 2003 and therefore is expected to remain below the prior comparable period level. Product sales to physicians and distributors in the 2003 third quarter and nine-month periods were even with the prior-year periods. Royalty revenue was higher in the third quarter and nine-month periods of 2003 as compared to the 2002 periods.
Product sales, which include the sale of Copper Peptide compounds under license and supply agreements, decreased 16 percent to $2.3 million in the third quarter as compared to $2.7 million reported in the third quarter of 2002. Within this category, physician and distributor sales for the third quarter improved 3 percent from the prior year quarter while this same category was down 1 percent for the first nine-months of 2003; an improvement from the second quarter and first six months of 2003, which were lower than the 2002 comparable periods and reflects the action taken late in the second quarter to focus on the company’s core customer base. Sales of Copper Peptide compounds during the third quarter of 2003 were down 58 percent as compared to the third quarter of 2002 and were down 35 percent for the first nine months. Shipments of the Copper Peptide compounds are driven by the purchasing patterns of our largest licensing partner, Neutrogena. While volatile from quarter to quarter, and lower in the second and third quarters, sales to this partner for the first nine months of 2003 were still 5 percent greater than the same period in 2002. Offsetting this nine month increase were zero purchases of Copper Peptide compound by the other licensing partners, who had purchased $1.0 million during the first nine-months of 2002. These prior period shipments were related to the other licensing partners’ inventory build up for their initial market launches. The Company has been advised that follow on sales to consumers were much slower than these other licensing partners anticipated, thereby eliminating their need for material in the first nine months of 2003, and reducing the related royalty revenue earned by the Company as noted below. It is not known when or whether shipments to these others partners will resume, and the Company is currently evaluating its alternatives with these licensees.
For the quarter ended September 30, 2003, licensing and royalties revenue increased 11 percent as compared to the same period in 2002 and 19 percent in the first nine months as compared to the same period in 2002. Royalty revenues may fluctuate from quarter to quarter, due to the licensees’ timing of new market launches, special promotions and other factors beyond the Company’s control. For the nine months of 2003 as compared to the same period in 2002, the Company’s largest licensing partner represented a 30 percent increase in royalty revenue, which was partially offset by a decline in royalty revenues of 85 percent from the other licensing partners noted above.
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Gross Profit
In the third quarter of 2003, gross profit increased 11 percent to $2.0 million as compared to $1.8 million reported in same quarter in 2002. The related gross margin for the third quarter of 2003 was 75 percent as compared to 59 percent in the third quarter of 2002. The increase was primarily attributable to the revenue mix having greater product sales and royalty income versus Copper Peptide compound sales during the quarter and from realizing an improved gross profit on the sale of the Company’s Copper Peptide compound as compared to the year earlier period. For the first nine months of 2003, gross profit was up 2 percent as compared to the comparable year earlier period for the same reasons. Gross margin is sensitive to the revenue mix of packaged products, licensee purchases of Copper Peptide compounds and royalty revenue and will vary from period to period as a result.
Expenses
Total operating expenses increased 16 percent to $1.8 million in the third quarter of 2003 from $1.6 million reported for the same quarter in 2002. For the nine months ended, expenses were up 21 percent to $6.0 million from $4.9 million reported in the same period in 2002.
Marketing and selling expenses for the third quarter increased by $296,000 to $1.0 million as compared to $728,000 for the prior year quarter of which $83,000 related to the additional market testing and modification of the infomercial in the 2003 third quarter. In addition sales training, sales force compensation, selling aids and advertising expenses increased as more resources were invested in these areas. Year to date, marketing and selling expenses were $3.2 million as compared to $2.3 million in the first nine months of 2002, an increase of $958,000 of which $770,000 were infomercial related expenses. The rest of the increase results from the above increased sales and advertising expenses and the addition of a Director of Business Development in February 2003, which were partially offset by lower sales commissions and sales compensation expense in the first half of 2003.
Research, general and administrative expenses declined 5 percent to $797,000 in the third quarter of 2003 as compared to $840,000 in the corresponding 2002 period. The decline was due to a reduction in legal and consulting services during the 2003 quarter and, as a result of lower revenues and net income performance, not accruing any estimated bonus expense during the 2003 third quarter. This decline in expenses was partially offset by an increase in salary and benefits related to the addition of the Chief Financial Officer in October 2002 and retainer fees paid to the company’s investment bank in the 2003 quarter. Expenses for the nine months of 2003 increased 3 percent to $2.7 million as compared to $2.6 million in the same period in 2002. The increase for the nine months is due to increased salaries and benefits related to the addition of a Chief Financial Officer in the 2003 period, increased legal and audit fees incurred for compliance with new corporate governance and reporting standards, and increased legal fees related to actions initiated by ProCyte to enforce its rights under certain agreements. These increases were partially offset by decreases in consulting and recruiting expenses and the aforementioned lower accrual for the management bonus plan.
Interest and Other Income
Interest and other income earned during the third quarter of 2003 decreased 31 percent to $34,000 as compared to $49,000 earned in the same quarter in 2002. The decline in the quarterly income was primarily due to declining short-term interest rates. For the nine months ended September 30, 2003, the Company reported a 12 percent increase in interest and other income as compared to the same nine-month period in 2002, primarily due to receiving a one-time termination settlement from Merck KGaA for $50,000, which was partially offset by the lower interest rates.
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Income Taxes
As of September 30, 2003 the Company’s U.S. federal net operating loss and general business tax credit carry forwards for income tax purposes were approximately $68.0 million and $1.6 million, respectively. The Company has not yet recognized the benefit of these tax expense savings for future period earnings. The Company has had net operating losses since inception, with the exception of net income reported for the first time in 2002. Thus, sufficient uncertainty still exists regarding the realizability of using the deferred tax assets in future periods. If not utilized, the federal net operating loss carry forward and tax credit carry forwards will expire between 2004 and 2021.
A provision for state income tax was made for California income tax in the first nine months of the year. The Company has a net operating loss carry forward for California state income tax of $350,000, however in the fourth quarter of 2002 the State of California temporarily suspended the use of the net operating loss carry forward deduction for 2002 and 2003. As a result, the Company recognized $18,000 related to state income taxes for the nine months ended September 30, 2003.
Net Income
For the quarter ended September 30, 2003, ProCyte reported net income of $261,000 as compared to net income of $322,000 in the same quarter in 2002. This decrease was primarily due to the increase in operating expenses that were partially offset by the higher gross profit during the third quarter of 2003. For the nine months ended September 30, 2003, the Company reported net income of $397,000 as compared to $1.3 million reported for the same period in 2002. This $948,000 decrease in net income for the nine-month period was primarily due to the aforementioned $770,000 infomercial related expenses, increased investment in the Company’s sales activities and advertising which were partially offset by an improvement in gross profit in the 2003 period.
Liquidity and Capital Resources
The Company has relied primarily on cash flow from operations, interest income and equity financing to fund its operations and capital expenditures. At September 30, 2003, the Company had approximately $4.5 million in cash and cash equivalents, compared to $4.6 million at December 31, 2002. The net change in cash and cash equivalents during the first nine months of 2003 reflects a net use of cash of $100,000. The significant components of this net use of cash are disbursements related to the infomercial, an increase in Copper Peptide compound inventory which is partially offset by a related customer deposit, the payment of 2002 management bonuses in 2003 and capital expenditures primarily related to updating the Company’s computer and network systems. These outflows were mostly offset by positive cash generated by operations during the nine month period. We may see fluctuations in cash flows in future periods as they depend in large part on the timing of deposits received from our strategic partners and their initiation of new product introductions.
Effective October 14, 2003 ProCyte entered into non-binding Letter of Intent with Annette Hanson to acquire the principal assets of her product distribution business for approximately $730,000 in cash. Ms. Hanson’s business, focused on the spa and salon markets, has sold products containing ProCyte’s technology under the Simple Solutions® brand since April 2002. Included in the proposed purchase are receivables, inventory, selected equipment, brand names and trademarks. Annualized revenues of the existing business are approximately $1 million. If completed, the proposed acquisition is expected to allow ProCyte to expand into targeted retail distribution and leverage its Copper Peptide technology and sales and marketing expertise. ProCyte believes that significant product synergies would also occur as a
17
result of the proposed acquisition. Based upon such assumptions and subject to due diligence, ProCyte believes the acquisition will be accretive in 2004 and, due to the short revenue period remaining in 2003 after the closing, may be slightly dilutive in the fourth quarter.
Completion of the transaction is subject to the completion of due diligence, negotiation and execution of the definitive agreements, including a consulting contract with Ms. Hanson, and satisfaction of customary conditions of closing and Board approval. ProCyte currently believes that these requirements will be successfully satisfied and expects that the proposed acquisition will close in the fourth quarter.
The Company believes that its existing cash and cash equivalents and interest thereon, will be sufficient to meet its working capital requirements for at least the next two years. However, there can be no assurance that the underlying assumed levels of revenue and expense will prove accurate. The Company’s actual cash requirements will depend upon numerous factors, including actions by regulatory authorities, the levels of resources that the Company devotes to taking advantage of strategic acquisitions and/or establishing and maintaining marketing, sales and distribution capabilities, the emergence of competitive products and other adverse market developments, the timing and amount of revenues and expense reimbursements resulting from relationships with third parties, our degree of success in commercializing new products and the cost of preparing, filing, prosecuting, maintaining and enforcing patent claims and intellectual property rights. The Company will depend on product revenues, royalties and license fees, interest income, equity financing, and funding from corporate partnerships to meet its future capital needs. See “Important Factors Regarding Forward-Looking Statements – Need for Additional Capital.”
Important Factors Regarding Forward-Looking Statements
Loss of or Reduction in Orders by Significant Customers Could Adversely Affect Our Net Revenues and Results of Operations
Although the Company’s customer base is made up of a large number of customers, our top three customers comprised approximately 41 percent of net revenues during the first nine months of 2003, one of which accounted for approximately 29 percent of the Company’s net revenue. Any decrease in or loss of revenues from these customers could have an adverse effect on our net revenues and results of operations or impair our ability to increase net revenues. We expect that we will continue to depend on revenue from larger customers, generally under multi-year license or supply agreements. Such agreements can be terminated under certain circumstances, including our inability to supply product within required time frames. Any downturn in the business from these customers or the inability to renew or replace agreements with new customers as they expire could significantly decrease sales to such customers, which could adversely affect our net revenues and results of operations.
Furthermore, we do not have a substantial non-cancelable backlog of orders; our customers can generally cancel or reschedule orders upon short notice. Variations in the timing of these orders can cause significant fluctuations in our quarterly operating results, and the cancellation or deferral of product orders or overproduction due to the failure of anticipated orders to materialize could result in the Company holding excess or obsolete inventory, which has resulted and could again in the future result in write-downs of inventory that would have a material adverse effect on our operating results.
Dependence on and Management of Existing and Future Corporate Alliances
The successful commercialization of the Company’s existing and future products in the consumer and wound care markets will depend upon ProCyte’s ability to enter into and effectively manage corporate
18
alliances. There can be no assurance that the Company will be successful in establishing corporate alliances in the future, or that it will be successful in performing and maintaining existing or any future corporate alliances. Moreover, there can be no assurance that the interests and motivations of any corporate partner, distributor or licensee would be or will remain consistent with those of the Company, or that the Company and such partners, distributors or licensees will successfully perform the necessary technology transfer, clinical development, regulatory compliance, manufacturing, marketing, commercialization and other obligations under their agreements. Any of these failures could have a material adverse effect on the Company’s business, financial condition and results of operations.
Recent Profitability; No Assurance of Achieving Consistent Profitable Earnings
The Company has been launching and marketing products based on its proprietary Copper Peptide technology since 1996. In addition to sales of products based on its proprietary Copper Peptide technology, the Company’s revenues have historically included sales of non-proprietary products, license fees and royalties, revenue from contract manufacturing and interest income. During 2002, the Company reported net income and positive cash flow from operations for the first time in its operating history. During the nine months ended September 30, 2003, the Company reported a net income and a slight net use of cash from operations. There can be no assurance that the Company can maintain a consistent, profitable level of operations. Attaining consistent profitability is dependent upon a wide variety of factors, including successfully manufacturing and marketing of the Company’s products, entering into and maintaining agreements with corporate partners for commercialization of the Company’s products, and successfully licensing the Company’s products and technology. Payments under corporate partnerships and licensing arrangements may be subject to fluctuations in both timing and amounts and therefore the level of profitability may vary significantly from quarter to quarter.
We Rely on Third Party Manufacturers for Our Products
We use third party manufacturers to make products. In many cases, third party manufacturers are not obligated under contracts that fix the term of their commitments and they may discontinue production upon little or no advance notice. Manufacturers also may experience problems with product quality or timeliness of product delivery. We rely on these manufacturers to comply with applicable current quality system regulations (“QSR”). The loss of a contract manufacturer may force us to shift production to in-house facilities and possibly cause manufacturing delays, disrupt our ability to fill orders, or require us to suspend production until we find another third party manufacturer. We are not able to control the manufacturing efforts of these third party manufacturers as closely as we control our business. Should any of these manufacturers fail to meet the applicable standards, we, or our third-party manufacturers, could face various enforcement actions, which would have an adverse effect on the Company’s net revenues and results of operations.
Need for Additional Capital
As of September 30, 2003, the Company had cash and cash equivalents of $4.5 million. The Company estimates that, exclusive of possible acquisitions not yet identified and at its planned rate of spending, its existing cash and cash equivalents and the interest income thereon will be sufficient to meet its operating and capital requirements for at least the next two years. There can be no assurance, however, that our underlying assumed levels of revenue and expense will prove accurate. Whether or not these assumptions prove to be accurate, the Company may need to raise additional capital. Furthermore, the Company may require additional funds to expand or enhance its sales and marketing activities, to accelerate product development, or to acquire a product line or company. The Company may be required to seek this additional funding through public or private financing, including equity financing, or through
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collaborative arrangements. Adequate funds for these purposes, whether obtained through financial markets or from collaborative or other arrangements with corporate partners or other sources, may not be available when needed or may not be available on terms favorable to the Company. If we issue equity securities to raise additional funds, dilution to existing shareholders will result. In addition, in the event that additional funds are obtained through arrangements with collaborative partners, such arrangements may require the Company to relinquish its rights to certain technologies or potential products that it would otherwise seek to develop or commercialize on its own. If funding is insufficient at any time in the future, the Company may be required to: delay, scale back or eliminate some or all of its marketing and research and development programs; or license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to develop on its own. Furthermore, the terms of any such license agreements or asset sales might be less favorable than if the Company were negotiating from a stronger position.
Uncertainty of Patent Position and Proprietary Rights
The patent positions of biotechnology, medical device and healthcare products companies are often uncertain and involve complex legal and factual questions, and the breadth of claims allowed in such patents cannot be predicted. The Company’s success will depend on its ability to obtain patents and licenses to patent rights, to maintain trade secrets, and to operate without infringing on the proprietary rights of others, both in the United States and in other countries. The failure of the Company or its licensors to obtain, maintain and enforce patent protection for the Company’s technology could have a material adverse effect on the Company.
ProCyte’s success depends, in part, upon its ability to protect its products and technology under intellectual property laws in the United States and abroad. As of September 30, 2003, the Company had 21 issued U.S. patents expiring between 2005 and 2017 and numerous issued foreign patents and patent registrations. The patents relate to use of the Company’s copper-based technology for a variety of healthcare applications, and to the composition of certain biologically active, synthesized compounds. The Company’s strategy has been to apply for patent protection for certain compounds and their discovered uses that are believed to have potential commercial value in countries that offer significant market potential. There can be no assurance that patent applications relating to the technology used by the Company will result in patents being issued. Nor can there be any assurance that any patent issued to the Company will not be subjected to further proceedings limiting the scope of the rights under the patent or that such patent will provide a competitive advantage, will afford protection against competitors with similar technology, or will not be successfully challenged, invalidated or circumvented by competitors.
The Company’s processes and potential products may conflict with patents that have been or may be granted to competitors and others. As the biotechnology, medical device and healthcare industries expand and more patents are issued, the risk increases that the Company’s processes and potential products may give rise to claims that they infringe the patents of others. Such other persons could bring legal actions against the Company claiming damages and seeking to enjoin clinical testing, manufacturing and marketing of the affected product or use of the affected process. Litigation may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company or to determine the enforceability, scope and validity of proprietary rights of others. If the Company becomes involved in such litigation, it could result in substantial expense to the Company and significant diversion of effort by the Company’s technical and management personnel. In addition to any potential liability for significant damages, the Company could be required to obtain a license to continue to manufacture or market the affected product or use the affected process. Costs associated with any licensing arrangement may be substantial and could include ongoing royalties. There can be no assurance that any license required under any such patent would be made available to the Company on
20
acceptable terms, if at all. If such licenses could not be obtained on acceptable terms, the Company could be prevented from manufacturing and marketing existing or potential products. Accordingly, an adverse determination in such litigation could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company is not aware of any conflicts at this time.
The Company also relies upon non-patented proprietary technology. There can be no assurance that the Company can meaningfully protect its rights to such non-patented technology, that any obligation to maintain the confidentiality of such proprietary technology will not be breached by employees, consultants, collaborators or others or that others will not independently develop or acquire substantially equivalent technology. To the extent that corporate partners or consultants apply Company technological information independently developed by them or by others to Company projects or apply Company technology or know-how to other projects, disputes may arise as to the ownership of proprietary rights to such information. Any failure to protect non-patented proprietary technology or any breach of obligations designed to protect such technology or development of equivalent technology may have a material adverse effect on the Company’s business, financial condition and results of operations.
Uncertainty of Government Regulatory Requirements
The Federal Food, Drug and Cosmetic Act, and the regulations promulgated thereunder, and other federal and state statutes govern, among other things, the testing, manufacture, safety, labeling, storage, record-keeping, advertising and promotion of cosmetic products and medical devices. The Company’s products and product candidates may be regulated by any of a number of divisions of the FDA and in other countries by similar health and regulatory authorities. The process of obtaining and maintaining regulatory approvals for the manufacturing or marketing of the Company’s existing and potential products is costly and time-consuming and is subject to unanticipated delays. Regulatory requirements ultimately imposed could also adversely affect the ability of the Company to clinically test, manufacture or market products.
In the United States, products that do not seek to make effectiveness claims based on human clinical evaluation may be subject to review and regulation under the FDA’s cosmetic, drug or 510(k) medical device guidelines. Similar guidelines exist for such products in other countries. Such 510(k) products, which include wound care dressings and certain ointments and gels, must show safety and substantial equivalency with predicate products already cleared by the FDA to be marketed. There can be no assurance that product applications submitted to the FDA or similar agencies in other countries will receive clearance to be marketed, or that the labeling claims sought will be approved, or that, if cleared, such products will be commercially successful or free from third party claims relating to the effectiveness or safety of such products.
The Company also is or may become subject to various other federal, state, local and foreign laws, regulations and policies relating to, among other things, safe working conditions, good laboratory practices, and the use and disposal of hazardous or potentially hazardous substances used in connection with research and development.
Failure to obtain regulatory approvals where appropriate for its product candidates or to attain or maintain compliance with QSR or other manufacturing requirements would have a material adverse effect on the Company’s business, financial condition and results of operations.
21
Intense Competition
Competition in the wound care, skin health and hair care markets is intense. The Company’s competitors include well-established pharmaceutical, cosmetic and healthcare companies such as Johnson and Johnson, Galderma, Obagi, La Roche Posay, and Allergan. These competitors have substantially more financial and other resources, larger research and development staffs, and more experience and capabilities in researching, developing and testing products in clinical trials, in obtaining FDA and other regulatory approvals and in manufacturing, marketing and distribution than the Company. In addition, a number of smaller companies are developing or marketing competitive products. The Company’s competitors may succeed in developing and commercializing products or obtaining patent protection or other regulatory approvals for products more rapidly than the Company. In addition, competitive products may be manufactured and marketed more successfully than the Company’s potential products. Such developments could render the Company’s existing or potential products less competitive or obsolete and could have a material adverse effect on the Company’s business, financial condition and results of operations.
Product Liability Claims
The testing, manufacturing, marketing and sale of our products may subject the Company to product liability claims. ProCyte maintains coverage against product liability risks. However, continuing insurance coverage may not be available at an acceptable cost, if at all. The Company may not be able to obtain insurance coverage that will be adequate to satisfy any liability that may arise. Regardless of merit or eventual outcome, product liability claims may result in decreased demand for a product, injury to its reputation and loss of revenues. As a result, regardless of whether the Company is insured, a product liability claim or product recall may result in losses that could be material to ProCyte.
Potential Volatility of Stock Price; Bulletin Board Listing
The market prices for securities of healthcare, pharmaceutical and biotechnology companies are subject to volatility, and the market has from time to time experienced significant fluctuations that are unrelated to the operations of the Company. ProCyte’s market price has fluctuated over a wide range since the Company’s initial public offering in 1989, and since March 25, 1999, the Company’s common stock has traded on the NASD OTC bulletin board. Because real-time price information may not be easily available for bulletin board securities, an investor is likely to find it more difficult to dispose of, or to obtain accurate quotations on the market value of, the Company’s securities than if they were listed on a the Nasdaq or a national exchange. In addition, purchases and sales of the Company’s securities may become subject to Rule 15g-9 of the Exchange Act, which imposes various sales practice requirements on broker-dealers, or to the “penny stock” rules, either of which would likely reduce the level of trading activity in the secondary market for the Company’s securities and make selling the securities more difficult for an investor.
Announcements concerning the Company or its competitors, including fluctuations in operating results, research and development program direction, results of clinical trials, addition or termination of corporate alliances, technology licenses, clearance or approval to market products, announcements of technological innovations or new products by the Company or its competitors, changes in government regulations, healthcare reform, developments in patent or other proprietary rights of the Company or its competitors, litigation concerning business operations or intellectual property, or public concern as to safety of products, as well as changes in general market conditions and mergers and acquisitions, may have a significant effect on the market price of ProCyte’s common stock.
22
ProCyte did not own any derivative financial instruments as of September 30, 2003. The Company is debt-free and is exposed to interest rate risk to the extent that it has invested idle cash balances and the promissory note receivable described below. At September 30, 2003, the idle cash balances were invested in a United States Treasury money market fund. ProCyte employs established policies and procedures to manage its exposure to changes in the market risk of its investments. The Company believes that the market risk arising from holdings of its financial instruments is not material. The Company holds a $2.0 million promissory note as a result of the sale of its contract manufacturing operation to Emerald Pharmaceutical L.P. The note has a variable interest rate, adjusted quarterly, and is guaranteed by a security agreement giving ProCyte a first lien position on the assets sold to Emerald.
Under the supervision of and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness and design and operation of its disclosure controls and procedures as of the end of the quarter covered by this report, and, based on their evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that these disclosure controls and procedures are effective in ensuring that all material information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 have been made know to them in a timely fashion. There were no changes in the Company’s internal controls over financial reporting that occurred during the quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
23
Not applicable.
Not applicable.
Not applicable.
Not applicable.
Not applicable.
(a) Exhibits
See Exhibit Index below.
(b) Reports on Form 8-K
Current Report on Form 8-K filed on July 24, 2003, reporting the Company’s earnings for the second quarter of 2003.
24
Pursuant to the requirements of Section 13 or 15(d) 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.
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ProCyte Corporation (Registrant) |
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Date: November 13, 2003 |
By: |
/s/ John F. Clifford |
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John F. Clifford, Chairman and CEO |
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Date: November 13, 2003 |
By: |
/s/ Robert W. Benson |
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Robert W. Benson, Chief Financial Officer |
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25
Exhibit Index
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Exhibit |
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Description |
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Note |
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3.1 |
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Restated Articles of Incorporation of the Registrant |
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A |
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3.2 |
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Restated Bylaws of the Registrant |
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A |
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4.1 |
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Rights Agreement between the Registrant and American Securities Transfer and Trust as of December 7, 1994 |
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G |
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10.1* |
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1987 Stock Benefit Plan of ProCyte Corporation |
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A |
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10.2* |
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ProCyte Corporation 1989 Restated Stock Option Plan |
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B |
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10.3* |
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ProCyte Corporation 1991 Restated Stock Option Plan for Non-employee Directors and amendments thereto |
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D |
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10.4† |
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Teachers Insurance & Annuity Association Lease dated as of October 1, 1993 and second amendment thereto dated February 28, 1997 |
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D |
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10.5* |
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1996 Stock Option Plan |
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D |
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10.6* |
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ProCyte Corporation 1998 Non-employee Director Stock Plan |
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F |
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10.7* |
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Change of Control Agreement for Ms. Robin Carmichael |
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F |
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10.8* |
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Change of Control Agreement for Mr. John Clifford |
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D |
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10.13* |
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Form of Indemnity Agreement dated February 23, 1995 between the Registrant and each of Dr. Blake, Mr. Patterson and Mr. Clifford. |
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C |
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10.14* |
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Form of Indemnity Agreement between ProCyte Corporation and each of various of its Officers and Directors |
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F |
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10.15* |
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Form of Severance Agreement for Mr. John Clifford |
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D |
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10.16* |
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Form of Promissory Note between ProCyte Corporation and Mr. John Clifford |
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H |
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10.17† |
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License Agreement dated April 19, 2000 between ProCyte Corporation and Neutrogena Corporation |
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I |
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31.1 |
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Certification of President and Chief Executive Officer pursuant to Rule 13a-14a |
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J |
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31.2 |
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Certification of Chief Financial Officer pursuant to Rule 13a-14a |
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J |
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32.1 |
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Certification of President and Chief Executive Officer pursuant to 18 USC Section 1350 |
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J |
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32.2 |
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Certification of Chief Financial Officer pursuant to 18 USC Section 1350 |
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J |
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* |
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Management contract or compensatory plan or arrangement. |
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† |
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Confidential treatment has been granted or requested with respect to portions of this exhibit. |
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A |
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Incorporated by reference to the Registrant’s Registration Statement of Form S-1 (No. 33-31353). |
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B |
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Incorporated by reference to the Registrant’s Registration Statement of Form S-1 (No. 33-46364). |
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C |
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Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1994. |
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D |
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Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1996. |
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F |
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Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the Quarter ended June 30, 1998. |
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G |
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Incorporated by reference to the Registrant’s Amended Annual Report on Form 10-K/A dated December 31, 1997. |
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H |
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Incorporated by reference to the Registrant’s Amended Annual Report on Form 10-K/A dated December 31, 1998. |
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I |
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Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the Quarter ended March 31, 2000. |
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J |
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Filed herewith. |
26