================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
|_| TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________________ TO_____________________
COMMISSION FILE NUMBER 1-10113
----------
ACURA PHARMACEUTICALS, INC.
(FORMERLY HALSEY DRUG CO., INC.)
(Exact name of registrant as specified in its charter)
NEW YORK 11-0853640
(State or other Jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
616 N. NORTH COURT, SUITE 120
PALATINE, ILLINOIS 60067
(Address of Principal Executive Offices) (Zip Code)
(847) 705-7709
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
As of November 12, 2004 the registrant had 22,189,252 shares of Common
Stock, $.01 par value, outstanding.
================================================================================
ACURA PHARMACEUTICALS, INC. & SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets-
September 30, 2004 (Unaudited) and December 31, 2003 ................................... 2
Condensed Consolidated Statements of
Operations (Unaudited) - Three months and nine months ended September 30, 2004
and September 30, 2003 ................................................................. 4
Condensed Consolidated Statements of Cash
Flows (Unaudited) - Nine months ended September 30, 2004
and September 30, 2003 ................................................................. 5
Consolidated Statement of Stockholders'
Equity (Deficit) (Unaudited) - Nine months ended September 30, 2004 .................... 7
Notes to Condensed Consolidated Financial Statements ................................... 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................................... 16
Risk Factors Relating to the Company.................................................... 32
Item 4. Controls and Procedures................................................................. 44
PART II. OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities........ 44
Item 4. Submission of Matters to a Vote of Security Holders..................................... 45
Item 6. Exhibits ............................................................................... 46
SIGNATURES ........................................................................................ 47
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ACURA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED AUDITED
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(IN THOUSANDS)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................................. $4,616 $942
Accounts receivable - net of allowance for
doubtful accounts of $0 and $428
at September 30, 2004 and December 31, 2003, respectively -- 467
Inventories ............................................... -- 312
Prepaid expenses and other current assets ................. 225 401
------ ------
Total current assets .................................... 4,841 2,122
PROPERTY, PLANT & EQUIPMENT, NET ................................ 1,413 3,394
DEFERRED PRIVATE DEBT OFFERING COSTS,
net of accumulated amortization of $0 and $318
at September 30, 2004 and December 31, 2003, respectively -- 714
OTHER ASSETS AND DEPOSITS ....................................... 28 392
------ ------
TOTAL ASSETS .................................................... $6,282 $6,622
====== ======
See accompanying notes to the condensed consolidated financial statements.
2
ACURA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED AUDITED
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Current maturities of capital lease obligations ........ 28 45
Accounts payable ........................................ -- 1,895
Accrued interest ........................................ 113 1,544
Accrued expenses ........................................ 867 2,108
Department of Justice settlement ........................ -- 300
--------- ---------
Total current liabilities ............................ 1,008 5,892
SENIOR SECURED TERM NOTE PAYABLE ........................... 5,000 21,401
BRIDGE LOANS ............................................... -- 2,000
Less: debt discount ..................................... -- (568)
--------- ---------
-- 1,432
CONVERTIBLE SUBORDINATED DEBENTURES ........................ -- 86,632
Less: debt discount ...................................... -- (56,893)
--------- ---------
-- 29,739
CAPITAL LEASE OBLIGATIONS, less current maturities ......... 71 92
DEPARTMENT OF JUSTICE SETTLEMENT, less current portion ..... -- 133
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.01 par value; authorized
560,000,000 shares; issued and outstanding,
21,927,943 and 21,601,704 shares at September 30, 2004
and December 31, 2003, respectively .................. 219 216
Convertible Preferred Stock - $.01 par value; authorized
290,000,000 shares; issued and outstanding,
217,972,986 and 0 shares, at September 30, 2004
and December 31, 2003, respectively (see Note 8) .... 2,180 --
Additional paid-in capital .............................. 275,261 157,262
Accumulated deficit ..................................... (277,457) (209,545)
--------- ---------
STOCKHOLDERS' EQUITY (DEFICIT) ............................ 203 (52,067)
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) ...... $ 6,282 $ 6,622
========= =========
See accompanying notes to the condensed consolidated financial statements.
3
ACURA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30,
------------------------------------------------------------
FOR THE NINE MONTHS ENDED FOR THE THREE MONTHS ENDED
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net product revenues $ 838 $ 4,210 $ -- $ 1,478
Cost of manufacturing 1,437 7,405 -- 2,267
Research and development 3,179 955 1,937 339
Selling, marketing, general and administrative 4,236 6,114 1,873 2,197
------------ ------------ ------------ ------------
Loss from operations (8,014) (10,264) (3,810) (3,325)
Other income (expense)
Interest expense (2,839) (4,436) (687) (1,532)
Interest income 40 22 18 1
Amortization and writeoff of deferred debt
discount and private debt offering costs (72,491) (18,050) (47,836) (6,367)
Gain on asset disposals 2,388 -- 633 --
Gain on debt restructure 12,401 -- -- --
Other 603 (464) 202 (367)
------------ ------------ ------------ ------------
NET LOSS $(67,912 ) $ (33,192) $ (51,480) $ (11,590)
============ ============ ============ ============
Basic and diluted loss per share $ (3.12) $ (1.57) $ (2.35) $ (0.55)
============ ============ ============ ============
Weighted average number of outstanding shares 21,749,212 21,196,131 21,927,943 21,222,993
============ ============ ============ ============
See accompanying notes to the condensed consolidated financial statements.
4
ACURA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
2004 2003
-------- --------
(IN THOUSANDS)
Cash flows from operating activities
Net loss ....................................................................... $(67,912) $(33,192)
-------- --------
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization ............................................... 328 640
Amortization of deferred debt discount and private debt offering costs ...... 30,684 18,050
Write off unamortized deferred debt discount and private debt offering costs 41,807 --
Non-cash compensation charge on options ..................................... 1,442 --
(Gain) loss on asset disposals .............................................. (2,388) 10
Increase in fair value of warrants .......................................... -- 457
Gain on debt restructuring .................................................. (12,401) --
Gain on Department of Justice settlement .................................... (403) --
Bad debt reserve ............................................................ (428) --
Changes in assets and liabilities
Accounts receivable ...................................................... 729 (1,521)
Inventories .............................................................. 312 (353)
Prepaid expenses and other current assets ................................ 176 (364)
Other assets and deposits ................................................ 159 66
Accounts payable ......................................................... (1,895) (18)
Accrued expenses ......................................................... 1,650 4,387
-------- --------
Total adjustments ..................................................... 59,772 21,354
-------- --------
Net cash used in operating activities ....................................... (8,140) (11,838)
-------- --------
Cash flows from investing activities
Capital expenditures ........................................................ (273) (1,306)
Proceeds from asset disposals ............................................... 4,520 --
-------- --------
Net cash provided by (used in) investing activities ...................... 4,247 (1,306)
-------- --------
Cash flows from financing activities
Payments on senior secured term note payable ................................ (4,000) --
Payments on capital lease obligations ....................................... (38) (33)
Proceeds from issuance of subordinated convertible debentures ............... 11,951 5,100
Payments on private offering costs .......................................... (315) --
Payments to Department of Justice ........................................... (31) (245)
-------- --------
Net cash provided by financing activities ................................... 7,567 4,822
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................... 3,674 (8,322)
Cash and cash equivalents at beginning of period ............................... 942 9,211
-------- --------
Cash and cash equivalents at end of period ..................................... $ 4,616 $ 889
======== ========
Cash paid for interest ......................................................... $ 47 $ 405
======== ========
See accompanying notes to the condensed consolidated financial statements.
5
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004:
1. The Company's Convertible Subordinated Debentures contained beneficial
conversation features, which were valued at $14,000,000.
2. The Company has repaid $166,000 of indebtedness in the form of product
deliveries.
3. Bridge Loans of $2,000,000 and accrued interest of $49,000 were converted
into like amounts of Convertible Subordinated Debentures.
4. The Company has issued 326,239 shares of common stock as payment of
$169,000 of Senior Secured Term Note Payable accrued interest.
5. Convertible Subordinated Debentures of $100,632,000 and accrued interest
of $3,939,000 were converted into 217,973,000 shares of Convertible
Preferred Stock (See Note 8).
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003:
1. The Company issued 645,000 warrants with an estimated relative fair value
of $581,000 for the lending commitment in the form of Debentures.
2. The Company has repaid $1,578,000 of indebtedness in the form of product
deliveries.
3. The Company issued 189,075 shares of common stock upon the conversion of
$110,000 of Debentures.
4. The Company issued 150,000 warrants with an estimated relative fair value
of $112,000 in connection with the termination of an employment agreement.
5. Equipment financed through capital leases aggregated approximately
$111,000.
See accompanying notes to the condensed consolidated financial statements.
6
ACURA PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
NINE MONTHS ENDED SEPTEMBER 30, 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
COMMON STOCK CONVERTIBLE PREFERRED
$.01 PAR VALUE STOCK
$.01 PAR VALUE (NOTE 8)
ADDITIONAL
PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE AT JANUARY 1, 2004 21,601,704 $ 216 -- $ -- $ 157,262 $ (209,545) $ (52,067)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss for the nine
months ended September 30, 2004 (67,912) (67,912)
Issuance of Common Shares
for payment of interest 326,239 3 166 169
Fair value of options
issued to employees 1,442 1,442
Issuance of Series A
Convertible Preferred
Shares for convertible
debentures 21,963,757 220 13,892 14,112
Issuance of Series B Junior
Convertible Preferred
Shares for convertible
debentures 20,246,506 203 6,722 6,925
Issuance of Series C-1
Junior Convertible
Preferred Shares for
convertible debentures 56,422,558 564 32,025 32,589
Issuance of Series C-2
Junior Convertible
Preferred Shares for
convertible debentures 37,433,096 374 22,059 22,433
Issuance of Series C-3
Junior Convertible
Preferred Shares for
convertible debentures 81,907,069 819 27,693 28,512
Beneficial conversion
features in conjunction
with issuance of
convertible debentures 14,000 14,000
BALANCE AT SEPTEMBER 30, 2004 21,927,943 $ 219 217,972,986 $ 2,180 $ 275,261 $ (277,457) $ 203
=========== =========== =========== =========== =========== =========== ===========
See accompanying notes to the condensed consolidated financial statements.
7
ACURA PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial
statements of Acura Pharmaceuticals, Inc. and subsidiaries (the "Company") have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles in the United
States for complete financial statements. In the opinion of management, all
adjustments, consisting of normal recurring accrual adjustments, considered
necessary to present fairly the financial position, results of operations and
changes in cash flows for the nine months ended September 30, 2004, assuming
that the Company will continue as a going concern, have been made. The results
of operations for the nine month period ended September 30, 2004 are not
necessarily indicative of the results that may be expected for the full year
ended December 31, 2004. The unaudited condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and footnotes thereto for the year ended December 31, 2003 included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
In the fourth quarter of 2003 and first quarter of 2004, the Company
restructured its operations, as more fully described in "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations", and
ceased the manufacture, sale and distribution of the Company's generic finished
dosage pharmaceutical products by the Company's subsidiary, Axiom Pharmaceutical
Corporation ("Axiom"). Axiom's manufacturing operations ceased on January 30,
2004, packaging and labeling operations ceased approximately February 12, 2004
and quality assurance and related support activities ceased approximately
February 27, 2004.
As restructured, the Company is a development state enterprise engaged in
the development of proprietary opioid abuse deterrent formulation technology
(the "ADF Technology"), the manufacture, packaging and stability testing of
clinical trial supplies of finished product candidates utilizing the ADF
Technology, the evaluation of such product candidates in appropriate clinical
trials, the development and scale up of novel active pharmaceutical ingredient
("API") opioid synthesis technologies (the "Opioid Synthesis Technologies"), and
the prosecution of the Company's application to the Drug Enforcement
Administration ("DEA") for a registration to import narcotic raw materials
("NRMs"). The Company proposes to enter into license agreements with strategic
partners providing that such licensees will further develop abuse deterrent
formulation finished dosage product candidates, file for regulatory approval
with the U.S. Food and Drug Administration ("FDA") and other regulatory
authorities and commercialize such products. The Company intends to manufacture
commercial supplies of such products for sale by the Company's licensees.
The Company's development activities involve inherent risks. These risks
include, among others, the feasibility and commercial acceptance of the
Company's proprietary technologies, dependence on key personnel and
determination of patentability and protection of the Company's products and
technologies. Additionally, the Company's product candidates have not yet
obtained the approval of the Food and Drug Administration. Successful future
operations depend on the Company's ability to obtain approval for and
commercialize these products.
NOTE 2 - LIQUIDITY MATTERS
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. At September 30, 2004 the Company had
cash and cash equivalents of $4.6 million, working capital of $3.8 million, and
accumulated deficit of $277.5 million. At December 31, 2003, the Company had
cash and cash equivalents of $.9 million, working capital deficit of $3.8
million and a stockholders' deficit of $52.1 million. The Company incurred a
loss from operations of $8.0 million and a net loss of $67.9 million during the
nine months ended September 30, 2004. The Company incurred a loss from
operations of $17.2 million and a net loss of $48.5 million during the year
ended December 31, 2003. Historically, the Company has incurred significant
losses from operations and until such time as its research and development
efforts are commercialized, of which no assurance can be given, the Company will
continue to incur operating losses. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern.
Reference is made to "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
8
NOTE 3 - CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid debt instruments purchased with a maturity date of
three months or less to be cash equivalents. At September 30, 2004 and December
31, 2003, cash equivalents consisted of bank commercial paper totaling
approximately $4.0 million and $0, respectively.
NOTE 4 - RESEARCH AND DEVELOPMENT
Research and development expenses consist of direct costs and indirect
costs. Direct research and development costs include salaries and related
research costs of research and development personnel, and the costs of
consultants, facilities, materials and supplies associated with research and
development projects as well as various laboratory studies. Indirect research
and development costs include depreciation and other indirect overhead expenses.
The Company considers that regulatory and other uncertainties inherent in the
research and development of new products preclude it from capitalizing such
costs. This includes up-front and milestone payments made to third parties in
connection with research and development collaborations. The Company had no
research and development commitments with third parties at September 30, 2004 or
December 31, 2003.
NOTE 5 - INCOME TAXES
The Company has net operating loss carryforwards aggregating in excess of
$100 million expiring during the years 2011 through 2024. The tax loss
carryforwards of the Company and its subsidiaries may be subject to limitation
by Section 382 of the Internal Revenue Code with respect to the amount
utilizable each year. This limitation reduces the Company's ability to utilize
net operating loss carryforwards each year. The amount of the limitation has not
been quantified by the Company.
The Financial Accounting Standards Board Statement "Accounting for Income
Taxes" ("SFAS 109") requires a valuation allowance against deferred tax assets
if, based on the weight of available evidence, it is more likely than not that
some or all of the deferred tax assets may not be realized. At September 30,
2004, a valuation allowance equal to 100% of the deferred tax assets was used
and primarily pertains to uncertainties with respect to future utilization of
net operating loss carryforwards.
NOTE 6 - STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations ("APB
No. 25") and has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure, an amendment of FASB Statement No. 123." Under APB
No. 25, when the exercise price of the Company's employee stock options equals
or exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
The following table illustrates the effect on net loss and loss per share
had the Company applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation (in thousands, except per
share data):
9
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net loss, as reported .......................... $ (67,912) $ (33,192) $ (51,480) $ (11,590)
Deduct: Total stock-based employee compensation
expense determined under fair value-based method
for all awards ................................. (342) (554) (250) (265)
---------- ---------- ---------- ----------
Net loss, pro forma ............................ $ (68,254) $ (33,746) $ (51,730) $ (11,855)
========== ========== ========== ==========
Basic EPS -- as reported ...................... $ (3.12) $ (1.57) $ (2.35) $ (0.55)
---------- ---------- ---------- ----------
Basic EPS -- pro forma ........................ $ (3.14) $ (1.59) $ (2.36) $ (0.56)
========== ========== ========== ==========
Diluted EPS -- as reported ..................... $ (3.12) $ (1.57) $ (2.35) $ (0.55)
---------- ---------- ---------- ----------
Diluted EPS -- pro forma ....................... $ (3.14) $ (1.59) $ (2.36) $ (0.56)
========== ========== ========== ==========
Pro forma compensation expense may not be indicative of future disclosures
because they do not take into effect pro forma compensation expense related to
grants before 1995. For purposes of estimating the fair value of each option on
the date of grant, the Company utilized the Black-Scholes option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
NOTE 7 - LOSS PER SHARE
Basic loss per share is computed by dividing net loss by the weighted
average common shares outstanding during the reporting period. Diluted loss per
share is computed by dividing net loss by the weighted average common shares
plus potential dilutive common share equivalents outstanding during the
reporting periods presented. Potential dilutive common share equivalents consist
of outstanding stock options, assuming the exercise of all in-the-money stock
options, warrants, convertible debentures and convertible preferred shares. The
treasury stock method is used to calculate potential dilutive outstanding stock
options and warrants.
In all periods presented we have reported a loss and therefore all
potential shares of common stock related to potentially dilutive securities have
been excluded from the calculation of diluted loss per share because they are
anti-dilutive.
Excluded from the computation of diluted loss per share are approximately
355,943,000 and 239,305,000 common share equivalents for both the nine months
and three months ended September 30, 2004 and September 30, 2003, respectively.
NOTE 8 - CONVERTIBLE PREFERRED STOCK
As further discussed in Note 11, at August 13, 2004 the holders of the
Company's 5% convertible debentures converted their debentures into various
series of convertible preferred stock. At September 30, 2004, convertible
preferred stock consists of the following:
10
SEPTEMBER 30, 2004
$.01 PAR VALUE, ISSUED AND
CONVERTIBLE AUTHORIZED OUTSTANDING PAR COMMON STOCK
PREFERRED STOCK SHARES SHARES VALUE EQUIVALENTS
Series A 45,000,000 21,963,757 $ 220 109,818,785
Series B Junior 25,000,000 20,246,506 203 20,246,506
Series C-1 Junior 70,000,000 56,422,558 564 56,422,558
Series C-2 Junior 50,000,000 37,433,096 374 37,433,096
Series C-3 Junior 100,000,000 81,907,069 819 81,907,069
Total 290,000,000 217,972,986 $ 2,180 349,755,528
Series A Preferred Stock Liquidation Preference, Conversion Right and
Participation Right
In general, the Series A Preferred shares have a liquidation preference
equal to five (5) times the initial $0.6425 Series A conversion price (the
"Series A Liquidation Preference"). In addition, the Series A Preferred shares
are convertible into the Company's Common Stock, with each Series A Preferred
share convertible into the number of shares of Common Stock obtained by dividing
(i) the Series A Liquidation Preference, by (ii) the $0.6425 Series A conversion
price, as such conversion price may be adjusted, from time to time, pursuant to
the dilution protections of such shares. Without limiting the Series A
Liquidation Preference, the holders of Series A Preferred shares also have the
right to participate with the holders of the Company's Common Stock upon the
occurrence of a liquidation event, including the Company's merger, sale of all
or substantially all of its assets or a change of control transaction, on an
as-converted basis (but for these purposes only, assuming the Series A Preferred
shares to be convertible into only thirty percent (30%) of the shares of Common
Stock into which they are otherwise then convertible). The holders of Series A
Preferred shares also have the right to vote as part of a single class with all
holders of the Company's voting securities on all matters to be voted on by such
security holders. Each holder of Series A Preferred shares will have such number
of votes as shall equal the number of votes he would have had if such holder
converted all Series A Preferred shares held by such holder into shares of
Common Stock immediately prior to the record date relating to such vote.
Liquidation Preference of Junior Preferred Shares
In general, the Series B and Series C Preferred Shares (collectively, the
"Junior Preferred Shares") have a liquidation preference equal to one (1) time
the principal amount plus accrued and unpaid interest of the Debentures that
were converted into Junior Preferred Shares. The liquidation preference of the
Series B Preferred has priority over, and will be satisfied prior to, the
liquidation preference of the Series C Preferred. The liquidation preference for
each class of the Junior Preferred Shares is equal to the conversion prices of
such shares. The Junior Preferred Shares are convertible into the Company's
Common Stock, with each Junior Preferred Share convertible into one share of
Common Stock. The holders of the Junior Preferred Shares have the right to vote
as part of the single class with all holders of the Company's Common Stock and
the holders of the Series A Preferred on all matters to be voted on by such
stockholders, with each holder of Junior Preferred Shares having such number of
votes as shall equal the number of votes he would have had if such holder had
converted all Junior Preferred Shares held by such holder into Common Stock
immediately prior to the record date relating to such vote.
11
NOTE 9 - INVENTORIES
Inventories consist of the following:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
(IN THOUSANDS)
Finished Goods ...................................... $ -- $ 357
Work in Process ..................................... -- 953
Raw Materials ....................................... -- 356
--------- ---------
-- 1,666
Less impairment reserve ............................. -- (1,354)
--------- ---------
$ -- $ 312
========= =========
NOTE 10 - ACCRUED EXPENSES
Accrued expenses are summarized as follows:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
(IN THOUSANDS)
Payroll, Payroll Taxes and Benefits ................. $ 448 $ 468
Legal and Audit Fees ................................ 170 519
Property and Sales Taxes ............................ 114 142
Medicaid Rebates and Other Customer Allowances ...... 81 50
Benefit Plan Taxes .................................. -- 200
Restructuring Costs ................................. 54 100
Investment Fees ..................................... -- 201
Director Fees ....................................... -- 45
Other ............................................... -- 383
--------- ---------
$ 867 $ 2,108
========= =========
NOTE 11 - CONVERTIBLE SUBORDINATED DEBENTURES
Convertible Subordinated Debentures consist of the following:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
(IN THOUSANDS)
1998 Debentures ..................................... $ 31,212 $ 31,212
1999 Debentures ..................................... 21,485 21,485
2002 Debentures ..................................... 27,303 27,303
2003 Debentures ..................................... 6,632 6,632
2004 Debentures ..................................... 14,000 --
--------- ---------
100,632 86,632
Debentures converted into Convertible Preferred Stock (100,632) --
--------- ---------
-- 86,632
Less: Unamortized Debt Discount ...................... (--) (56,893)
--------- ---------
Convertible Subordinated Debentures, net ......... $ -- $ 29,739
========= =========
The 2004 Debentures plus interest accrued automatically converted into the
Company's Series A convertible preferred stock (the "Series A Preferred") on
August 13, 2004, the business day following the Company's receipt of shareholder
approval to restate the Company's Certificate of Incorporation (the "Charter
Amendment") to authorize the Series A Preferred and the Junior Preferred Shares
(See "Liquidity and Capital Resources") and the filing of the Charter Amendment
with the Office of the New York Department of State, as provided in the 2004
Debenture Purchase Agreement. The 2004 Debentures and interest converted into an
aggregate of 21,963,757 Series A Preferred shares based on a $0.6425 per share
conversion price.
In accordance with the terms of the Conversion Agreement among the Company
and the holders of the Company's Convertible Debentures, effective August 13,
2004, each holder of 1998-2002 Debentures converted the 1998-2002 Debentures
held by such holder into the Company's Series B convertible preferred stock (the
"Series B Preferred") and/or Series C-1, C-2 and/or C-3 convertible preferred
stock (collectively, the "Series C Preferred").
12
Under the Conversion Agreement, the holders of approximately $6.6 million
in principal amount of 2002 Debentures issued during 2003 converted such 2002
Debentures (plus accrued and unpaid interest) into Series B Preferred Shares. Of
the remaining approximate $80 million in principal amount of the 1998-2002
Debentures, approximately $31.2 million was comprised of 1998 Debentures,
approximately $21.5 million was comprised of 1999 Debentures and approximately
$27.3 million was comprised of 2002 Debentures. Effective August 13, 2004, the
1998 Debentures were converted into Series C-1 Preferred shares, the 1999
Debentures were converted into Series C-2 Preferred shares and the remaining
balance of the 2002 Debentures were converted into Series C-3 Preferred shares.
The number of Junior Preferred Shares issued by the Company to by each
holder of 1998-2002 Debentures was based on the respective prices at which the
1998-2002 Debentures were convertible into Common Stock. The 2002 Debentures
issued in 2003 had a conversion price of $0.3420 per share. The 1998 Debentures,
1999 Debentures and the remaining balance of the 2002 Debentures had conversion
prices of $0.5776, $0.5993 and $0.3481 per share, respectively. Upon the
automatic conversion of the 1998-2002 Debentures on August 13, 2004, the Company
issued an aggregate of 20,246,506 Series B Preferred shares, 56,422,558 Series
C-1 Preferred shares, 37,433,096 Series C-2 Preferred shares and 81,907,069
Series C-3 Preferred shares.
During the nine months ended September 30, 2004, the Company incurred
$30.4 million and $0.3 million for the amortization of deferred debt discount
and private debt offering costs, respectively. As a result of the August 13,
2004 conversion of the Company's 2004 and 1998-2002 Debentures, unamortized debt
discount of $41.1 million and unamortized private debt offering costs of $0.7
million were charged off to expense.
Related-Party Transactions
A Company Officer and a former Director of the Company held certain of the
1998 Debentures and 1999 Debentures. The aggregate principal amount of such
debentures was approximately $175,000 at December 31, 2003. Interest expense on
these debentures was approximately $5,500 and $6,500 for the nine months ended
September 30, 2004 and 2003, respectively, of which approximately $0 and $3,100
was paid through the issuance of like debentures for the nine months ended
September 30, 2004 and 2003, respectively. Interest expense on these debentures
was approximately $1,100 and $2,200, for the three months ended September 30,
2004 and 2003, respectively, of which no like debentures were issued for the
payment of interest for the three month period ended September 30, 2004 and
2003, respectively. On August 13, 2004, the 1998 Debentures and 1999 Debentures,
including accrued interest, held by this individual were converted into shares
of preferred stock.
Indemnifications
Each of the purchase agreements for the Company's 1998 Debentures, 1999
Debentures, 2002 Debentures, 2003 Debentures and 2004 Debentures, and the Bridge
Loan Agreements to which the Company was a party, contain provisions by which
the Company is obligated to indemnify the purchasers of the debentures for any
losses, claims, damages, liabilities, obligations, penalties, awards, judgments,
expenses or disbursements arising out of or resulting from the breach of any
representation, warranty or agreement of the Company related to the purchase of
the debentures and bridge loans. These indemnification obligations do not
include a limit on maximum potential future payments, nor are there any recourse
provisions or collateral that may offset the cost. As of September 30, 2004, the
Company does not believe that any liability has been incurred as a result of
these indemnification obligations.
NOTE 12 - SENIOR SECURED TERM NOTE PAYABLE
Terms of Watson Term Loan
In connection with various transactions between the Company and Watson
completed in 2001, Watson advanced $17.5 million to the Company under the terms
of a certain loan agreement by and between the Company and Watson ("Watson Term
Loan"), dated as of March 29, 2000, as subsequently amended on each of March 31,
2000, December 20, 2002 and February 6, 2004. The Watson Term Loan was evidenced
by a note in the principal amount of $17.5 million (the "Original Watson Note").
The Watson Term Loan was secured by a first lien on all of the Company's assets,
senior to the lien securing all other Company indebtedness, and carried a
floating rate of interest equal to prime plus two percent and had an original
maturity date of June 30, 2004.
13
2002 Amendment to Watson Term Loan and Issuance of the Watson Warrant
As part of the Company's 2002 Debenture Offering, the Watson Term Loan was
amended to (1) extend the maturity date to March 31, 2006, (2) increase the
interest rate to prime plus four and one half percent and (3) increase the
principal amount to approximately $21.4 million to reflect the inclusion of the
Company's payment obligations under the Core Products Supply Agreement between
Watson and the Company. As amended, the Watson Term Loan was evidenced by the
Original Watson Note and an additional note in the principal amount of
approximately $ 3.9 million (collectively, the "Watson Notes"). In consideration
of the amendment to the Watson Term Loan, the Company issued to Watson a common
stock purchase warrant ("Watson Warrant") exercisable for 10,700,665 shares of
the Company's common stock at an exercise price of $0.34 per share. The warrant
has a term expiring December 31, 2009. The fair value of the Watson Warrant on
the date of grant, as calculated using the Black-Scholes option-pricing model,
of $11,985,745 was charged to earnings on the date of grant as a loss on the
extinguishment of debt. As of December 31, 2003, Watson had advanced
approximately $21.4 million to the Company under the Watson Term Loan and the
interest rate was 8.50%.
2004 Amendment to Watson Term Loan
In satisfaction of a condition to the completion of the 2004 Debenture
Offering, simultaneous with the closing of the 2004 Purchase Agreement, the
Watson Term Loan was further amended, as a result of which (1) the Company paid
Watson the sum of approximately $4.3 million (which amount was funded from the
proceeds of the 2004 Debenture Offering), (2) the Company conveyed to Watson
certain Company assets in consideration for Watson's forgiveness of
approximately $16.4 million of indebtedness under the Watson Notes, (3) all
then-current supply agreements between the Company and Watson were terminated ,
(4) Watson waived the dilution protections contained in the Watson Warrant, to
the extent such dilution protections were triggered by the transactions provided
in the 2004 Debenture Offering and (5) the Watson Notes were consolidated into a
single note in the principal amount of $5.0 million (the "New Watson Note"),
which (i) bears interest at the rate equal to the prime rate plus four and one
half percent (4.5%) per annum, (ii) has a maturity date of June 30, 2007
(extended from March 31, 2006), (iii) provides for satisfaction of future
quarterly interest payments thereunder in the form of the Company's Common
Stock, (iv) provides for the forbearance from the exercise of rights and
remedies upon the occurrence of certain events of default thereunder and (v) is
secured by a first lien on all assets of the Company. Further, the Company's
obligations under the New Watson Note are guaranteed by Acura Pharmaceutical
Technologies, Inc. and Axiom Pharmaceutical Corporation, each a wholly-owned
subsidiary of the Company, which guarantees are secured by all assets of such
subsidiaries, and, in the case of Acura Pharmaceutical Technologies, Inc., by a
mortgage lien on its real property located in Culver, Indiana.
Purchase of the New Watson Note
Simultaneous with the issuance of the New Watson Note, each of the
investors in the 2004 Debentures at the initial closing of the 2004 Purchase
Agreement on February 10, 2004 (collectively, the "Watson Note Purchasers")
purchased the New Watson Note from Watson in consideration for a payment to
Watson of $1.0 million. The new Note is secured by a first lien on all of the
Company's and its subsidiaries' assets, carries a floating rate of interest
equal to the prime rate plus 4.5%, provides for the satisfaction of interest
payments in the form of the Company's Common Stock and matures on June 30, 2007.
The rate of interest at September 30, 2004 was 9.25%.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
U.S. Department of Justice Settlement
On June 21, 1993, the Company entered into a Plea Agreement with the U.S.
Department of Justice (the "DOJ") to resolve the DOJ's investigation into the
manufacturing and record keeping practices at the Company's former Brooklyn, New
York plant. The Plea Agreement required the Company to pay a fine of $2,500,000
over five years in quarterly installments of $125,000, commencing on or about
September 15, 1993.
14
As of February 28, 1998, the Company was in default of the payment terms
of the Plea Agreement and had made payments aggregating $350,000. On May 8,
1998, the Company and the DOJ signed the Letter Agreement serving to amend the
Plea Agreement relating to the terms of the Company's satisfaction of the fine
assessed under the Plea Agreement (the "Letter Agreement"). Specifically, the
Letter Agreement provided that the Company will satisfy the remaining $2,150,000
of the fine through the monthly payments of $25,000 commencing June 1, 1998,
plus interest on such outstanding balance (at the rate calculated pursuant to 28
U.S.C. Section 1961 (5.319%)). Such payment schedule provided for the full
satisfaction of the DOJ fine in July 2005. The Letter Agreement also provides
certain restrictions on the payment of salary or compensation to any individual
in excess of certain amounts without the written consent of the DOJ. In
addition, the Letter Agreement requires the repayment of the outstanding fine to
the extent of 25% of the Company's after-tax profit or 25% of the net proceeds
received by the Company on any sale of a capital asset for a sum in excess of
$10,000, if not invested in another capital asset. At December 31, 2003, the
Company was current in its payment obligations, with a remaining obligation of
$433,000. In February 2004, the Company fully satisfied its obligation to the
DOJ under the Letter Agreement.
Employment Contracts
During April 2004, the Company entered into an employment agreement with a
new officer/employee of the Company. The agreement provides for, among other
things: (i) an annual base salary of $260,000, and (ii) the commitment to issue
an aggregate of 3,000,000 stock options to purchase the Company's stock at an
exercise price of $0.13 per common share that vest 1,000,000 option shares on
October 1, 2004 and the balance thereafter at a rate of 333,333 per calendar
quarter, beginning January 1, 2005 with an exercise term expiring in ten years.
The commitment to issue the stock option was subject to the receipt of
shareholder approval to modify the Company's 1998 Stock Option Plan to (i)
increase the number of shares reserved for issuance and (ii) authorize issuance
of stock options having an exercise price less than fair market value of the
common stock of the Company on the date of issuance. On August 13, 2004, the
Company's shareholders approved the modifications to the 1998 Stock Option Plan
and 3,000,000 stock options were issued. The employment agreement term is for a
two year period, which automatically renews for successive one-year periods
unless either the Company or the employee provides 90 days' notice of
non-renewal.
During August 2003, the Company entered into an employment agreement with
a new officer/employee of the Company. The agreement provides for, among other
things: (i) an annual base salary of $300,000, and (ii) the commitment to issue
an aggregate of 5,500,000 options to purchase the Company's stock at an exercise
price of $0.34 per common share that vest 1,000,000 option shares on March 31,
2004 and the balance thereafter at a rate of 500,000 per calendar quarter,
beginning June 30, 2004 which an exercise term expiring in ten years. The
commitment to issue the stock option was subject to the receipt of shareholder
approval to modify the Company's 1998 Stock Option Plan to (i) increase the
number of shares reserved for issuance and (ii) authorize issuance of stock
options having an exercise price less than fair market value of the common stock
of the Company on the date of issuance. In May 2004, such employment agreement
was amended, among other things, to adjust the Company's commitment to issue
stock options from 5,500,000 shares to 8,750,000 shares and to provide for an
exercise price of $0.13 per share. On August 13, 2004, the Company's
shareholders approved the modifications to the 1998 Stock Option Plan and
8,750,000 stock options were issued. The options have a ten-year term and
provide for vesting in the amount of 2,750,000 shares on June 30, 2004 and the
balance thereafter at a rate of 250,000 shares per calendar month, beginning
July 31, 2004. The employment agreement term is for a two year period, which
automatically renews for successive one-year periods unless either the Company
or the employee provides 90 days' notice of non-renewal.
During April 2004, the Company committed to issue to current employees
stock options that upon grant, will be exercisable for an aggregate of 1,425,000
shares of the Company's common stock at an exercise price of $0.13 per common
share and will vest 25% annually over four years and provide for immediate
vesting upon change of control. The grant of these stock options was subject to
the receipt of shareholder approval to modify the Company's 1998 Stock Option
Plan to (i) increase the number of shares reserved for issuance and (ii)
authorize issuance of stock options having an exercise price less than fair
market value of the common stock of the Company on the date of issuance. On
August 13, 2004, the Company's shareholders approved the modifications to the
1998 Stock Option Plan and 1,425,000 stock options were issued.
15
During November 2002, the Company entered into an employment contract with
a new officer/employee of the Company. The contract calls for, among other
things: (1) annual base salary of $180,000, and (2) an aggregate of 400,000
options to purchase the Company's stock at an exercise price of $1.15 per common
share that vest evenly over a four-year period. The two year employment
agreement automatically renews for successive one-year periods unless the
Company provides 90 days' notice of nonrenewal. In August 2004, the Company gave
notice of non renewal as required under the provisions of such employment
agreement . Under the terms of a negotiated separation and general release
agreement with this employee/officer, the Company will grant an option having a
two-year term to this individual for the purchase of up to 200,000 shares of the
Company's common stock at an exercise price of $0.13 per share, which will be
fully vested upon the employee's separation date. The fair value of the option
will be calculated using closing price of the Company's common stock on the date
of grant.
Stock Option Grants to Board Members
On June 26, 2004, the Company committed to issue to the members of its
board of directors, including the Independent Committee of the Board, stock
options that upon grant or complete vesting, will be exercisable for an
aggregate of 1,100,000 shares of the Company's common stock at an exercise price
equal to the fair market value of the Company's Common Stock on the date of
grant. With the exception of stock options to purchase an aggregate of 200,000
shares of the Company's Common Stock, all options are fully vested at the time
of grant. Options to purchase an aggregate of 200,000 shares of the Company's
Common Stock will vest 25% quarterly over one year. The commitment to issue all
such stock options was subject to the receipt of shareholder approval to modify
the Company's 1998 Stock Option Plan. On August 13, 2004, the Company's
shareholders approved the modifications to the 1998 Stock Option Plan and
1,100,000 stock options were issued at an exercise price of $0.36 per common
share.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis should be read in conjunction with the
Company's financial statements and accompanying notes included elsewhere in this
Report. Operating results are not necessarily indicative of results that may
occur in future periods.
This Report contains "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
Acura Pharmaceuticals, Inc. ("Acura" or the "Company"), or industry results, to
be materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following: changes in general economic and business
conditions; future operating losses and anticipated operating and capital
expenditures; the anticipated results of our pre-clinical and clinical
development of our product candidates, including the timing of development and
any regulatory approvals; the protection of our intellectual property; expected
future sources of revenue and capital; potential competitors or products; future
market acceptance of our product candidates; future expectations regarding trade
secretes, technological innovations, licensing agreements and outsourcing of
certain business functions; the sufficiency of our current resources to fund
near term operations; the development of our internal systems and
infrastructure; regulatory changes in the pharmaceutical industry; difficulties
encountered in the development of novel products and manufacturing techniques;
regulatory obstacles to the introduction of new technologies or products that
are important to the Company's growth; availability of qualified personnel; and
other factors both referenced and not referenced in this Report. When used in
this Report, the words "estimate," "project," "anticipate," "expect," "intend,"
"believe" and similar expressions are intended to identify forward-looking
statements.
16
Such forward-looking statements involve risks and uncertainties including,
without limitation, those risks and uncertainties relating to the development,
testing, regulatory approval and commercialization of the Company's product
candidates; the uncertainty of patent protection of the Company's intellectual
property; potential infringement of intellectual property rights or trade
secrets of third parties; and the Company's ability to obtain additional
financing. Additionally, such forward-looking statements are subject to the
risks and uncertainties discussed below under the section entitled "Risk Factors
Relating to the Company".
Overview
The Company is a development stage specialty pharmaceutical company
engaged in research, development and manufacture of innovative abuse deterrent
formulations ("ADF Technology") intended for use in orally administered
opioid-containing pharmaceutical products. In addition, the Company is engaged
in research, development and manufacture of proprietary, high-yield, short cycle
time, environmentally sensitive opioid synthesis processes (the "Opioid
Synthesis Technologies" and, collectively with the ADF Technology, the
"Technologies") intended for use in the commercial production of certain bulk
opioid active pharmaceutical ingredients ("APIs"). To date, the Company has one
(1) issued US patent (issued September 2004), one issued US Notice of Allowance,
one (1) foreign patent application and six (6) patent applications pending with
the United States Patent and Trademark Office ("PTO") relating to the Opioid
Synthesis Technologies . Additionally, the Company has one (1) pending US patent
application relating to the ADF Technology . One of the Company's product
candidates incorporating the ADF Technology is in Phase I Clinical Trials. The
Company currently retains all commercial rights to its product candidates, ADF
Technology and Opioid Synthesis Technologies.
In November 2003, the Company commenced the restructuring of its
operations to focus its efforts on research and development relating to the ADF
Technology and Opioid Synthesis Technologies and to provide for the cessation of
operations, and the sale of assets, relating to the manufacture and distribution
of finished dosage generic products conducted at the Company's Congers, New York
facilities (the "Congers Facilities").
To fund continuing operations and the research and development of the
Company's proprietary technologies, on February 10, 2004, the Company completed
a private offering of debentures in the aggregate principal amount of
approximately $12.3 million (the "2004 Debenture Offering"). As part of the
completion of the 2004 Debenture Offering, the Company retired approximately
$16.4 million in indebtedness under the Company's $21.4 million term loan with
Watson Pharmaceuticals. On April 14, 2004 and May 26, 2004 the Company completed
additional funding under the 2004 Debenture Offering in the aggregate principal
amount of approximately $1.7 million resulting in an aggregate principal amount
of convertible secured debentures issued as part of the 2004 Debenture Offering
of $14.0 million.
On February 18, 2004, the Company sold certain of its inactive,
non-revenue generating Abbreviated New Drug Applications ("ANDAs") to Mutual
Pharmaceutical Company, Inc. in consideration of $2.0 million. On March 19,
2004, the Company and its wholly-owned subsidiary, Axiom Pharmaceutical
Corporation, entered into an Asset Purchase Agreement with IVAX Pharmaceuticals
New York LLC ("IVAX") pursuant to which the Company and Axiom agreed to sell to
IVAX substantially all of the Company's assets used in the operation of the
Congers Facilities in consideration of $2.5 million. On August 13, 2004, the
Company completed the sale of the assets used in the operation of the Congers
Facilities to IVAX.
Company's Present Financial Condition and Commercial Focus
At September 30, 2004 the Company had cash and cash equivalents of
approximately $4.6 million compared to $942,000 at December 31, 2003. The
Company had working capital of $3.8 million at September 30, 2004 and a working
capital deficit of approximately $3.8 million at December 31, 2003. The Company
had an accumulated deficit of approximately $277.5 million and approximately
$209.5 million as September 30, 2004 and December 31, 2003, respectively. The
Company had an operating loss of approximately $8.0 million for the nine months
ended September 30, 2004. The Company incurred a loss from operations of
approximately $17.2 million and a net loss of approximately $48.5 million during
the year ended December 31, 2003.
17
In implementing the restructuring adopted by the Board, the Company has
transitioned to a single vertically integrated operations facility located in
Culver, Indiana. The Company's strategy and key activities to be conducted at
the Culver Facility are as follows:
o Development of the Company's ADF Technology for use in orally
administered opioid finished dosage product candidates.
o Manufacture and quality assurance release of clinical trial
supplies of certain finished dosage form product candidates utilizing the
ADF Technology.
o Evaluation of certain finished dosage product candidates utilizing
the ADF Technology in clinical trials.
o Scale-up and manufacture of commercial quantities of certain
product candidates utilizing the ADF Technology for sale by the Company's
licensees.
o Research, development and scale up of the Company's Opioid
Synthesis Technologies.
o Prosecution of the Company's application to the U.S. Drug
Enforcement Administration ("DEA") to for registration to import narcotic
raw materials ("NRMs") for use in the production of opioid API's utilizing
the Company's Opioid Synthesis Technologies.
o Negotiating and executing license and development agreements with
strategic pharmaceutical company partners providing that such licensees
will further develop certain finished dosage product candidates utilizing
the ADF Technology, file for regulatory approval with the FDA and other
regulatory authorities and commercialize such products.
The Company has incurred net losses since 1992 and the Company's
consolidated financial statements for the year ended December 31, 2003 and the
nine months ended September 30, 2004 have been prepared on a going-concern
basis, expressing substantial doubt about the Company's ability to continue as a
going-concern as a result of recurring losses and negative cash flows. The
Company expects net losses to continue at least through 2005. The Company's
future profitability will depend on several factors, including:
o The successful completion of the development, scale-up, clinical
testing and acceptable regulatory review of the ADF Technology;
o The receipt of a notice of allowance from the PTO for the material
claims in the Company's patent application relating to the ADF Technology;
o The commercialization of products incorporating the ADF Technology
without infringing the patents and other intellectual property rights of
third parties;
o The completion of the development, commercial scale-up and
acceptable regulatory review of the Opioid Synthesis Technologies;
o The receipt of approval from the DEA to import NRMs to be used in
the Company's development and manufacturing efforts; and
o The interest of third parties in the Technologies and the
Company's ability to negotiate and execute commercially viable
collaboration agreements with interested third parties relating to the
Technologies.
Many of these factors will depend upon circumstances beyond the Company's
control.
18
In order to complete the development and regulatory approval of the
Company's product candidates and commercialize such products, if any are
approved by the FDA, the Company must enter into development and
commercialization agreements with third party pharmaceutical company partners
providing that such partners license the Company's Technologies and further
develop, register and commercialize the Company's orally administered
opioid-containing finished dosage products utilizing such Technology. Product
revenue will be derived from a share of profits and/or royalty payments relating
to such collaborative partners' sale of products incorporating the Company's
Technologies. Currently, the Company does not have any such collaborative
agreements, nor can there be any assurance that the Company will actually enter
into collaborative agreements in the future.
Estimating the dates of completion of clinical development, and the costs
to complete development, of the Company's product candidates would be highly
speculative, subjective and potentially misleading. Pharmaceutical products take
a significant amount of time to research, develop and commercialize, with the
clinical trial portion of development generally taking several years to
complete. The Company expects to reassess its future research and development
plans based on the review of data received on current research and development
activities. The cost and pace of future research and development activities are
linked and subject to change.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
In comparing results of operations for the nine months ended September 30, 2004
with those for 2003 it is important to consider that in 2004 the Company, as
restructured, has focused the majority of its efforts and resources on research
and development activities and subsequent to March, 2004, no longer maintained
any generic manufacturing facilities or conducted any finished dosage
manufacturing activities. Net product revenues and manufacturing expenses
realized in 2004 were incurred as part of an orderly phase out of all generic
manufacturing activities.
NET PRODUCT REVENUES
The Company's net product revenues for the nine months ended September 30,
2004 and September 30, 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
NET PRODUCT REVENUES NET PRODUCT NET PRODUCT NET PRODUCT
REVENUES REVENUE CHANGE REVENUE CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 838 $ 4,210 ($ 3,372) (80%)
- -------------------------------------------------------------------------------------------------------------------
The decrease in net product revenues was a result of the Company's
decision to restructure operations and cease the manufacture of finished dosage
generic pharmaceutical products. The net product revenues for the nine months
ended September 30, 2004 reflect the sale of all remaining inventories of
saleable finished dosage generic pharmaceutical products during the first two
quarters of 2004. No revenues were recorded for the third quarter 2004.
COST OF MANUFACTURING
The Company's cost of manufacturing for the nine months ended September
30, 2004 and September 30, 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 COST OF 9/30/04-9/30/03 COST OF
COST OF MANUFACTURING COST OF MANUFACTURING MANUFACTURING MANUFACTURING
CHANGE CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 1,437 $ 7,405 ($ 5,968) (81%)
- -------------------------------------------------------------------------------------------------------------------
19
For the nine months ending September 30, 2004 cost of manufacturing
includes the fixed costs of the Company's generic finished dosage manufacturing
operations in the first quarter of 2004 and residual expenses through the second
quarter 2004. The Company's generic finished dosage manufacturing operations
ceased in March 2004.
RESEARCH AND DEVELOPMENT EXPENSES
The Company's research and development expenses for the nine months ended
September 30, 2004 and September 30, 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
R&D EXPENSES R&D EXPENSES R&D EXPENSES CHANGE R&D EXPENSES CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 3,179 $ 955 $ 2,224 233%
- -------------------------------------------------------------------------------------------------------------------
The increase in R&D expenses is primarily related to the Company's
strategic decision to devote a major portion of its resources in 2004 to
research and development activities relating to its ADF Technology and to a
lesser extent to its Opioid Synthesis Technologies. The expenses include a non
cash compensation charge of $356 recorded for the issuance of stock options and
the effect of the reallocation of $997 in costs otherwise classified and charged
as general and administrative expenses during the period ending 2003.
SELLING, MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, marketing, general and administrative expenses for the nine
months ended September 30, 2004 and 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
SELLING, MARKETING, SELLING, SELLING, MARKETING, G&A EXPENSES SELLING, MARKETING, G&A EXPENSES
G&A EXPENSES MARKETING, G&A CHANGE CHANGE
EXPENSES ($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 4,236 $ 6,114 ($ 1,878) (31%)
- -------------------------------------------------------------------------------------------------------------------
The decrease in selling, marketing, general and administrative expenses
resulted from the Company's decision to restructure operations by discontinuing
the marketing and sale of generic finished dosage products and reducing its
administrative and manufacturing support staff. The decrease includes the effect
from the reallocation and reclassification of $997 in costs charged to research
and development which were otherwise classified as general and administrative
expenses during the period ended 2003, a nonrecurring benefit for settlement of
trade payables at a discount of $194 and a non cash compensation charge of
$1,085 recorded for the issuance of stock options. ENVIRONMENTAL COMPLIANCE
EXPENSES
During the nine months ended September 30, 2004 and September 30, 2003,
the Company incurred the following expenses in connection with environmental
compliance (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
ENVIRONMENTAL COMPLIANCE ENVIRONMENTAL ENVIRONMENTAL COMPLIANCE ENVIRONMENTAL COMPLIANCE
EXPENSES COMPLIANCE EXPENSES EXPENSES CHANGE EXPENSES CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 180 $ 268 ($ 88) (33%)
- -------------------------------------------------------------------------------------------------------------------
20
The environmental compliance expenses related primarily to disposal of
hazardous and controlled substances waste and related personnel costs for
environmental compliance during the period the Company maintained its
manufacturing operations.
INTEREST EXPENSE, NET OF INTEREST INCOME
The Company's interest expense, net of interest income for the nine months
ended September 30, 2004 and September 30, 2003 was as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
INTEREST EXPENSE, NET OF INTEREST EXPENSE, NET OF INTEREST EXPENSE, NET OF INTEREST EXPENSE, NET OF
INTEREST INCOME INTEREST INCOME INTEREST INCOME CHANGE INTEREST INCOME CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 2,799 $ 4,414 ($ 1,615) (37%)
- -------------------------------------------------------------------------------------------------------------------
The change in the interest expense, net of interest income reflects the
interest savings from the restructuring of the Company's term note indebtedness
to Watson Pharmaceuticals as well as the conversion of the Company's 5%
convertible debentures into convertible preferred stock on August 13, 2004.
AMORTIZATION OF DEFERRED DEBT DISCOUNT AND PRIVATE DEBT OFFERING COSTS
The Company's deferred debt discount and private debt offering costs for
the nine months ended September 30, 2004 and September 30, 2003 were as follows
(in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
DEFERRED DEBT DISCOUNT AND DEFERRED DEBT DISCOUNT AND DEFERRED DEBT DISCOUNT DEFERRED DEBT DISCOUNT AND
PRIVATE DEBT OFFERING COSTS PRIVATE DEBT OFFERING COSTS AND PRIVATE DEBT OFFERING PRIVATE DEBT OFFERING
COSTS CHANGE COSTS CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 72,491, consisting of $ 18,050, consisting of $ 54,441 302%
o $ 1,030 private o $ 698 private
debt offering costs debt offering
costs
o $ 71,461 deferred o $ 17,352 deferred
debt discount debt discount
- -------------------------------------------------------------------------------------------------------------------
The change in the deferred debt discount and private debt offering costs
reflects the amortization of the remaining deferred debt discount and private
debt offering costs incurred from all of the Company's debenture and bridge loan
financings. As a result of the conversion of all convertible debentures into
preferred stock at August 13, 2004, all remaining unamortized deferred debt
discount and private debt offering cost balances were written off to expense.
21
NET LOSS
The Company's net loss for the nine months ended September 30, 2004 and
September 30, 2003 was as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
NET LOSS NET LOSS NET LOSS NET LOSS
CHANGE CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
($ 67,912) ($ 33,192) $ 34,720 105%
- -------------------------------------------------------------------------------------------------------------------
Included in the net loss for the nine months ending September 30, 2004 is
the full amortization of the remaining deferred debt discount and private
offering costs of $72,491, gains on debt restructuring of $12,401 and asset
sales of $2,388, net interest expense of $2,799 and other income of $603
relating to settlements of a liabilities at discount.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
In comparing results of operations for the three months ended September 30, 2004
with those for 2003 it is important to consider that in 2004 the Company, as
restructured, has focused the entirety of its efforts and resources on research
and development activities and, unlike for the same three month period in 2003,
no longer maintained any generic manufacturing facilities or conducted any
finished dosage manufacturing activities.
NET PRODUCT REVENUES
The Company's net product revenues for the three months ended September
30, 2004 and September 30, 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 3 MONTHS ENDED 3 MONTHS ENDED 3 MONTHS ENDED
9/30/04 9/30/03 9/30/04- 9/30/03 9/30/04-9/30/03
NET PRODUCT REVENUES NET PRODUCT NET PRODUCT NET PRODUCT
REVENUES REVENUE CHANGE REVENUE CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ -- $ 1,478 ($ 1,478) (100%)
- -------------------------------------------------------------------------------------------------------------------
The Company had no revenue or cost of goods sold during the three months
ended September 30, 2004 as a result of the Company's restructuring of
operations and cessation of the manufacturing finished dosage generic
pharmaceutical products. All remaining inventories of saleable finished dosage
products had been sold during the first two quarters of 2004.
COST OF MANUFACTURING
The Company's cost of manufacturing for the three months ended September
30, 2004 and September 30, 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 9/30/04 3 MONTHS ENDED 9/30/03 3 MONTHS ENDED 3 MONTHS ENDED
COST OF MANUFACTURING COST OF MANUFACTURING 9/30/04-9/30/03 COST OF 9/30/04-9/30/03 COST OF
MANUFACTURING MANUFACTURING
CHANGE CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ -- $ 2,267 ($ 2,267) (100%)
- -------------------------------------------------------------------------------------------------------------------
22
The Company had no revenue or cost of goods sold during the three months
ended September 30, 2004. The generic finished dosage manufacturing operations
were discontinued in March 2004.
RESEARCH AND DEVELOPMENT EXPENSES
The Company's research and development expenses for the three months ended
September 30, 2004 and September 30, 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 3 MONTHS ENDED 3 MONTHS ENDED 3 MONTHS ENDED
9/30/04 9/30/03 9/30/04-9/30/03 9/30/04-9/30/03
R&D EXPENSES R&D EXPENSES R&D EXPENSES CHANGE R&D EXPENSES CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 1,937 $ 339 $ 1,598 471%
- -------------------------------------------------------------------------------------------------------------------
The increase in R&D expenses is primarily related to the Company'
strategic decision to devote a large portion of its resources in 2004 to
research and development activities relating to its ADF Technology and to a
lesser extent to its Opioid Synthesis Technologies. The expenses of the period
ended 2004 also include a non cash compensation charge of $356 recorded for the
issuance of stock options and the effect of the reallocation of $570 in costs
otherwise classified and charged as general and administrative expenses during
the period ending 2003.
SELLING, MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, marketing, general and administrative expenses for the three
months ended September 30, 2004 and 2003 were as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 9/30/04 3 MONTHS ENDED 9/30/03 3 MONTHS ENDED 3 MONTHS ENDED
SELLING, MARKETING, G&A SELLING, MARKETING, 9/30/04-9/30/03 9/30/04-9/30/03
EXPENSES G&A EXPENSES SELLING, MARKETING, G&A SELLING, MARKETING, G&A
EXPENSES CHANGE EXPENSES CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 1,873 $ 2,197 ($ 324) (15%)
- -------------------------------------------------------------------------------------------------------------------
The decrease in selling, marketing, general and administrative expenses
results from the Company's decision to restructure operations by discontinuing
the marketing and sale of generic finished dosage products and reducing its
administrative and manufacturing support staff. The decrease includes the effect
from the reallocation and reclassification of $570 in costs charged to research
and development which were otherwise classified as general and administrative
expenses during the period ended 2003, offset by a non cash compensation charge
of $1,085 recorded for the issuance of stock options.
ENVIRONMENTAL COMPLIANCE EXPENSES
During the three months ended September 30, 2004 and September 30, 2003,
the Company incurred the following expenses in connection with environmental
compliance (in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 9/30/04 3 MONTHS ENDED 9/30/03 3 MONTHS ENDED 3 MONTHS ENDED
ENVIRONMENTAL COMPLIANCE ENVIRONMENTAL 9/30/04-9/30/03 9/30/04-9/30/03
EXPENSES COMPLIANCE EXPENSES ENVIRONMENTAL COMPLIANCE ENVIRONMENTAL COMPLIANCE
EXPENSES CHANGE EXPENSES CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ -- $ 148 ($ 148) (100%)
- -------------------------------------------------------------------------------------------------------------------
23
The environmental compliance expenses related to disposal of hazardous and
controlled substances waste and related personnel costs for environmental
compliance during the period the Company maintained its manufacturing
operations.
INTEREST EXPENSE, NET OF INTEREST INCOME
The Company's interest expense, net of interest income for the three
months ended September 30, 2004 and September 30, 2003 was as follows (in
thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 9/30/04 3 MONTHS ENDED 9/30/03 3 MONTHS ENDED 3 MONTHS ENDED
INTEREST EXPENSE, NET OF INTEREST EXPENSE, NET OF 9/30/04-9/30/03 9/30/04-9/30/03
INTEREST INCOME INTEREST INCOME INTEREST EXPENSE, NET OF INTEREST EXPENSE, NET OF
INTEREST INCOME CHANGE INTEREST INCOME CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 669 $ 1,531 ($ 863) (56%)
- -------------------------------------------------------------------------------------------------------------------
The change in the interest expense, net of interest income reflects the
interest savings from the restructuring of the Company's term note indebtedness
to Watson Pharmaceutical as well as the conversion of the Company's 5%
convertible debentures into convertible preferred stock on August 13, 2004.
AMORTIZATION OF DEFERRED DEBT DISCOUNT AND PRIVATE DEBT OFFERING COSTS
The Company's deferred debt discount and private debt offering costs or
the three months ended September 30, 2004 and September 30, 2003 were as follows
(in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 9/30/04 3 MONTHS ENDED 9/30/03 3 MONTHS ENDED 3 MONTHS ENDED
DEFERRED DEBT DISCOUNT AND DEFERRED DEBT DISCOUNT AND 9/30/04-9/30/03 9/30/04-9/30/03
PRIVATE DEBT OFFERING COSTS PRIVATE DEBT OFFERING COSTS DEFERRED DEBT DISCOUNT DEFERRED DEBT DISCOUNT AND
AND PRIVATE DEBT OFFERING PRIVATE DEBT OFFERING
COSTS CHANGE COSTS CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
$ 47,836, consisting of $ 6,367, consisting of $ 41,469 651%
o $ 796 private debt o $ 392 private
offering costs debt offering
costs
o $ 47,040 deferred o $ 5,975 deferred
debt discount debt discount
- -------------------------------------------------------------------------------------------------------------------
24
The change in the deferred debt discount and private debt offering costs
reflects the amortization of the remaining deferred debt discount and private
debt offering costs incurred from all of the Company's debenture and bridge loan
financings. As a result of the conversion of all convertible debentures into
preferred stock at August 13, 2004, all remaining unamortized deferred debt
discount and private debt offering cost balances were written off to expense.
NET LOSS
The Company's net loss for the three months ended September 30, 2004 and
September 30, 2003 was as follows (in thousands):
- -------------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED 9/30/04 3 MONTHS ENDED 9/30/03 3 MONTHS ENDED 3 MONTHS ENDED
NET LOSS NET LOSS 9/30/04-9/30/03 9/30/04-9/30/03
NET LOSS CHANGE NET LOSS CHANGE
($) (%)
- -------------------------------------------------------------------------------------------------------------------
($ 51,480) ($ 11,590) $ 39,890 344%
- -------------------------------------------------------------------------------------------------------------------
Included in the net loss for the three months ending September 30, 2004 is
the full amortization of the remaining deferred debt discount and private
offering costs of $47,836, gains on asset sales of $633, net interest expense of
$669 and other income of $202 relating to settlement of a liability at a
discount.
LIQUIDITY AND CAPITAL RESOURCES
2004 Debenture Offering
On February 10, 2004, the Company consummated a private offering of
convertible senior secured debentures (the "2004 Debentures") in the aggregate
principal amount of approximately $12.3 million (the "2004 Debenture Offering").
The 2004 Debentures were issued by the Company pursuant to a certain Debenture
and Share Purchase Agreement dated as of February 6, 2004 (the "2004 Purchase
Agreement") by and among the Company, Care Capital Investments, Essex Woodlands
Health Ventures, Galen Partners and each of the purchasers listed on the
signature page thereto. On April 14, 2004 and May 26, 2004, the Company
completed additional closings under the 2004 Purchase Agreement raising the
aggregate gross proceeds received by the Company from the offering of the 2004
Debentures to $14 million. As the conversion price of the 2004 Debentures was
less than the fair market value of the Company's common stock on the date of
issue, beneficial conversion features were determined to exist. The Company
recorded approximately $14.0 million of debt discount limited to the face amount
of the new debt. The debt discount was amortized over the life of the debt,
which matured on August 13, 2004, the date the 2004 Debentures were
automatically converted into the Company's Series A Convertible Preferred Stock
(see "Conversion of 2004 Debentures into Series A Preferred Stock" below).
Source and Amount of Funding under 2004 Purchase Agreement
Of the $14.0 million in 2004 Debentures issued in the 2004 Debenture
Offering, approximately $2.0 million of 2004 Debentures were issued in exchange
for the surrender of like amount of principal plus accrued interest outstanding
under Company's 5% convertible senior secured debentures issued pursuant to
working capital bridge loan transactions with Care Capital, Essex and Galen
during November and December, 2003.
25
Conversion of 2004 Debentures into Series A Preferred Stock
The 2004 Debentures (including the principal amount plus interest accrued)
converted automatically into the Company's Series A convertible preferred stock
(the "Series A Preferred") on August 13, 2004, the business day following the
Company's receipt of shareholder approval to restate the Company's Certificate
of Incorporation (the "Charter Amendment") to authorize the Series A Preferred
and the Junior Preferred Shares (as described below) and the filing of the
Charter Amendment with the Office of the New York Department of State, as
provided in the 2004 Purchase Agreement. The 2004 Debentures converted into an
aggregate of 21,963,757 Series A Preferred shares based on a $0.6425 per share
conversion price.
Series A Preferred Stock Liquidation Preference, Conversion Right and
Participation Right
In general, the Series A Preferred shares have a liquidation preference
equal to five (5) times the initial $0.6425 Series A conversion price (the
"Series A Liquidation Preference"). In addition, the Series A Preferred shares
are convertible into the Company's Common Stock, with each Series A Preferred
share convertible into the number of shares of Common Stock obtained by dividing
(i) the Series A Liquidation Preference, by (ii) the $0.6425 Series A conversion
price, as such conversion price may be adjusted, from time to time, pursuant to
the dilution protections of such shares. Without limiting the Series A
Liquidation Preference, the holders of Series A Preferred shares also have the
right to participate with the holders of the Company's Common Stock upon the
occurrence of a liquidation event, including the Company's merger, sale of all
or substantially all of its assets or a change of control transaction, on an
as-converted basis (but for these purposes only, assuming the Series A Preferred
shares to be convertible into only thirty percent (30%) of the shares of Common
Stock into which they are otherwise then convertible). The holders of Series A
Preferred shares also have the right to vote as part of a single class with all
holders of the Company's voting securities on all matters to be voted on by such
security holders. Each holder of Series A Preferred shares will have such number
of votes as shall equal the number of votes he would have had if such holder
converted all Series A Preferred shares held by such holder into shares of
Common Stock immediately prior to the record date relating to such vote.
Impact of Conversion of the Company's Outstanding Debentures
As of February 10, 2004, the date of the initial closing of the 2004
Purchase Agreement, the Company had issued and outstanding and aggregate of
approximately $86.6 million in principal amount of 5% convertible senior secured
debentures maturing March 31, 2006 issued pursuant to three separate Debenture
Purchase Agreements dated March 10, 1998, as amended (the "1998 Debentures"),
May 26, 1999, as amended (the "1999 Debentures") and December 20, 2002 (the
"2002 Debentures"), respectively. The 1998 Debentures, 1999 Debentures and 2002
Debentures are referred to collectively as the "1998-2002 Debentures". After
giving effect to the Company's issuance of additional 5% convertible senior
secured debentures in satisfaction of interest payments on the 1998-2002
Debentures, as of February 10, 2004, the 1998-2002 Debentures were convertible
into an aggregate of approximately 190.4 million shares of the Company's Common
Stock.
Conversion Agreement of Holders of 1998-2002 Debentures
Simultaneous with the execution of the 2004 Purchase Agreement, and as a
condition to the initial closing of the 2004 Purchase Agreement, the Company,
the 2004 Debenture Investor Group and each of the holders of the 1998-2002
Debentures executed a certain Debenture Conversion Agreement, dated as of
February 6, 2004 (the "Conversion Agreement"). In accordance with the terms of
the Conversion Agreement, effective August 13, 2004, each holder of 1998-2002
Debentures converted the 1998-2002 Debentures held by such holder into the
Company's Series B convertible preferred stock (the "Series B Preferred") and/or
Series C-1, C-2 and/or C-3 convertible preferred stock (collectively, the
"Series C Preferred"). The Series C Preferred shares together with the Series B
Preferred shares are herein referred to as, the "Junior Preferred Shares".
Under the Conversion Agreement, the holders of approximately $6.6 million
in principal amount of 2002 Debentures issued during 2003 converted such 2002
Debentures (plus accrued and unpaid interest) into Series B Preferred Shares. Of
the remaining approximate $80 million in principal amount of the 1998-2002
Debentures, approximately $31.2 million was comprised of 1998 Debentures,
approximately $21.5 million was comprised of 1999 Debentures and approximately
$27.3 million was comprised of 2002 Debentures. Effective August 13, 2004, the
1998 Debentures were converted into Series C-1 Preferred shares, the 1999
Debentures were converted into Series C-2 Preferred shares and the remaining
balance of the 2002 Debentures were converted into Series C-3 Preferred shares.
26
The number of Junior Preferred Shares issued by the Company to by each
holder of 1998-2002 Debentures was based on the respective prices at which the
1998-2002 Debentures were convertible into Common Stock. The 2002 Debentures
issued in 2003 had a conversion price of $0.3420 per share. The 1998 Debentures,
1999 Debentures and the remaining balance of the 2002 Debentures had conversion
prices of $0.5776, $0.5993 and $0.3481 per share, respectively. Upon the
automatic conversion of the 1998-2002 Debentures on August 13, 2004, the Company
issued an aggregate of 20,246,506 million Series B Preferred shares, 56,422,558
million Series C-1 Preferred shares, 37,433,096 million Series C-2 Preferred
shares and 81,907,069 million Series C-3 Preferred shares.
Liquidation Preference of Junior Preferred Shares
In general, the Junior Preferred Shares have a liquidation preference
equal to one (1) time the principal amount plus accrued and unpaid interest of
the 1998-2002 Debentures converted into Junior Preferred Shares. The liquidation
preference of the Series B Preferred has priority over, and will be satisfied
prior to, the liquidation preference of the Series C Preferred. The liquidation
preference for each class of the Junior Preferred Shares is equal to the
conversion prices of such shares. The Junior Preferred Shares are convertible
into the Company's Common Stock, with each Junior Preferred Share convertible
into one share of Common Stock. The holders of the Junior Preferred Shares have
the right to vote as part of the single class with all holders of the Company's
Common Stock and the holders of the Series A Preferred on all matters to be
voted on by such stockholders, with each holder of Junior Preferred Shares
having such number of votes as shall equal the number of votes he would have had
if such holder had converted all Junior Preferred Shares held by such holder
into Common Stock immediately prior to the record date relating to such vote.
Amendment to Watson Term Loan Agreement
The Company was a party to a certain loan agreement with Watson
Pharmaceuticals ("Watson") pursuant to which Watson made term loans to the
Company (the "Watson Term Loan Agreement") in the aggregate principal amount of
$21.4 million as evidenced by two promissory notes (the "Watson Notes"). It was
a condition to the completion of the 2004 Debenture Offering that simultaneous
with the closing of the 2004 Purchase Agreement, the Company shall have paid
Watson the sum of approximately $4.3 million (which amount was funded from the
proceeds of the 2004 Debenture Offering) and conveyed to Watson certain Company
assets in consideration for Watson's forgiveness of approximately $16.4 million
of indebtedness under the Watson Notes. A part of such transaction, the Watson
Notes were amended to extend the maturity date of such notes from March 31, 2006
to June 30, 2007, to provide for satisfaction of future interest payments under
the Watson Notes in the form of the Company's Common Stock, to reduce the
principal amount of the Watson Notes from $21.4 million to $5.0 million, and to
provide for the forbearance from the exercise of rights and remedies upon the
occurrence of certain events of default under the Watson Notes (the Watson Notes
as so amended, the "New Watson Note"). Simultaneous with the issuance of the New
Watson Note, each of Care Capital, Essex Woodlands, Galen Partners and the other
investors in the 2004 Debentures as of February 10, 2004 (collectively, the
"Watson Note Purchasers") purchased the New Watson Note from Watson in
consideration for a payment to Watson of $1.0 million.
In addition to Watson's forgiveness of approximately $16.4 million under
the Watson Notes, as additional consideration for the Company's payment to
Watson of approximately $4.3 million and the Company's conveyance of certain
Company assets, all supply agreements between the Company and Watson were
terminated and Watson waived the dilution protections contained in the Common
Stock purchase warrant dated December 20, 2002 exercisable for approximately
10.7 million shares of the Company's Common Stock previously issued by the
Company to Watson, to the extent such dilution protections were triggered by the
transactions provided in the 2004 Debenture Offering.
27
Terms of the New Watson Note
The New Watson Note in the principal amount of $5.0 million as purchased
by the Watson Note Purchasers is secured by a first lien on all of the Company's
and its subsidiaries' assets, senior to the lien securing the Outstanding
Debentures and all other Company indebtedness, carries a floating rate of
interest equal to the prime rate plus 4.5% and matures on September 30, 2007.
Sale of Certain Company Assets to IVAX
On March 19, 2004, the Company and its wholly-owned subsidiary, Axiom
Pharmaceutical Corporation, entered into an Asset Purchase Agreement with IVAX
Pharmaceuticals New York LLC ("IVAX"). Pursuant to the Purchase Agreement, the
Company and Axiom agreed to sell to IVAX substantially all of the Company's
assets used in the operation of the Company's former generic manufacturing and
packaging operations located in Congers, New York in consideration of an
immediate payment of $2.0 million and an additional payment $0.5 million upon
receipt of shareholder approval of the transaction. Shareholder approval of the
asset sale transaction with IVAX was obtained on August 12, 2004 and the closing
was completed on August 13, 2004, at which time the Company received the
remaining payment of $500,000 from IVAX.
ADF Technology Research and Development
The Company's primary business focus is the research and development of
proprietary abuse deterrent formulation technologies (the "ADF Technology")
intended to deter the abuse of opioid-containing orally administered
prescription products. A patent application relating to the ADF Technology was
filed with the PTO in the fourth quarter of 2003 (see discussion below under the
caption "Patent Applications"). The Company's first product candidate ("Product
Candidate #1") incorporating the ADF Technology is a tablet formulation intended
for oral administration. The Company received regulatory clearance to initiate
its clinical trial program for Product Candidate #1 following the acceptance by
the FDA of an Investigational New Drug application in October 2004. The clinical
development program for Product Candidate #1 will focus on optimizing the
product's formulation to most effectively deter opioid abuse while minimizing
the potential for any new adverse events compared to non-ADF formulated
products.
To date, the Company has performed pre-clinical research and development
on Product Candidate #1 through a combination of internal and external
collaborative research programs. The Company has and will continue to rely on
contract research organizations ("CROs") to perform key components of its
product development activities. Such development efforts include the completion
of studies demonstrating the effectiveness of the ADF Technology compared to
selected currently marketed opioid products in deterring potential intravenous
injection. Through the use of CROs, the Company has submitted an investigational
new drug application ("IND") relating to Product Candidate #1. Such IND was
reviewed by the FDA and in October 2004, after amending such IND, the Company
was cleared by the FDA to begin phase I clinical trials for Product Candidate
#1. Also through the use of CROs, the Company has evaluated Product Candidate #1
in a single dose clinical study to assess the bioavailability and bioequivalence
("BA/BE") of such product candidate in comparison to a frequently prescribed,
commercially marketed drug product with the same opioid active ingredient but
without abuse deterrent properties. The results of the BA/BE study indicate that
Product Candidate #1 is sufficiently bio-available but not bio-equivalent to the
reference commercially marketed opioid product. The Company has subsequently
developed a revised formulation of Product Candidate #1 and plans to test such
revised formulation in a pilot BA/BE study to confirm that the revised
formulation is both bioavailable and bioequilavent to the commercially marketed
product without the abuse deterrent properties. There can be no assurance,
however, that Product Candidate #1 will be bioavailable and bioequivalent to the
extent required to justify continued clinical testing or that, even if it
demonstrates acceptable bioequivalence, that it will result in a commercially
acceptable drug product. To receive marketing authorization for commercial
distribution in the United States, all drug products formulated with the ADF
Technology will require the development, submission and filing of a new drug
application ("NDA") and approval of such application by the FDA. In the event
that Product Candidate #1 is stable and demonstrates acceptable bioequivalence,
then substantial additional clinical and non-clinical testing will be required
prior to the submission of an NDA. There can be no assurances that Product
Candidate #1 will lead to an NDA submission or that if an NDA is filed, that the
FDA will approve such regulatory application for commercial distribution.
28
Opioid Synthesis Technologies Research and Development
The Company is also engaged in the research, development and scale-up of a
variety of proprietary manufacturing processes for opioid active pharmaceutical
ingredients (the "Opioid Synthesis Technologies") as generally described in the
table below.
- ------------------------------------------------------------------------------------------------------------------------
OPIOID SYNTHESIS STARTING ESTIMATED APPLICABLE DEA STATUS OF PATENT
TECHNOLOGY MATERIAL YIELD REGISTRATIONS APPLICATION
---------- -------- ----- REQUIRED -----------
--------
- ------------------------------------------------------------------------------------------------------------------------
Oxycodone HCl Codeine 40 - 50% a) Research One (1) patent issued,
Process #1 Phosphate b) Manufacturing US 6,790,959
One (1) Notice of Allowance issued
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Hydrocodone Codeine 85% a) Manufacturing Patent Application filed in the
Bitartrate Phosphate second quarter of 2004
Process #1
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Oxycodone HCl NRMs 68 - 72% a) Research Patent Application filed in July, 2004
Process #2 b) Manufacturing
c) Import
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Codeine Phosphate NRMs 90 - 100% a) Research Patent Application filed in the
b) Manufacturing second quarter of 2004
Process #1 c) Import
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Codeine Phosphate NRMs 80-90% a) Research Patent Application filed in the
Process #2 b) Manufacturing second quarter of 2004
c) Import
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Codeine Phosphate NRMs 65-85% a) Research Patent Application filed in the
Process #3 b) Manufacturing fourth quarter of 2003
c) Import
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Hydrocodone Codeine Base 85 - 95% a) Research Patent Application filed
Bitartrate b) Manufacturing in the second quarter of 2004
Process #2
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Morphine Sulfate NRMs 96% a) Research Patent Application expected to be
b) Manufacturing filed in the second quarter of 2005
c) Import
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Dihydrocodeine Codeine Phosphate >90% a) Research Patent Application filed in the
Bitartrate b) Manufacturing second quarter of 2004
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Hydrocodone Derivatives Dihydrocodeine 90% a) Research Patent Application drafted
b) Manufacturing
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
29
The Company believes at this stage of development that, except for
oxycodone hydrochloride process #1, the Opioid Synthesis Technologies are
efficient and cost-effective methods of manufacturing opioid APIs. The Company
believes that the primary advantages of these processes include a substantial
reduction in the time and number of processing steps required to produce the
desired opioid APIs and reduction of the quantity and/or toxicity of the waste
products relating to such production. The Company believes that at the current
manufacturing scale Hydrocodone Bitartrate Process #1 meets all USP release
testing specifications, provides high yields and high levels of purity compared
to competitive manufacturing processes used for this active ingredient. The
development and documentation of Hydrocodone Bitartrate Process #1 has been
completed and the Company believes such process is ready to be tested at full
commercial scale.
The Company estimates that to scale up its Hydrocodone Bitartrate Process
#1 Opioid Synthesis Technology to desirable commercial scale at its Culver
Facility, additional funding of approximately $7.0 million will be required for
facility improvements, the purchase, installation and validation of new API
manufacturing equipment, environmental waste management compliance, the
preparation of the drug master files for the API to be produced at the facility,
and related direct labor expenses (collectively, the "API Scale Up Expenses").
No portion of the net proceeds received by the Company from the 2004 Debenture
Offering or from the sale of the assets used in the operation of the Congers
Facilities to IVAX is budgeted for the API Scale Up Expenses. Until such time,
if any, as the Company secures third-party financing dedicated to the API Scale
Up Expenses, the Company will be unable to complete the commercial scale up of
the Hydrocodone Bitartrate Process #1 or the other Opioid Synthesis Technologies
described in the above table. No assurance can be given that the Company will
obtain the third-party financing necessary to scale-up the Opioid Synthesis
Technologies or that if such financing is obtained, that any one or more of the
Opioid Synthesis Technologies will be capable of commercial scale up. As an
alternative to scaling-up the Opioid Synthesis Technologies in its own facility,
the Company may license-out such Technology to third parties, on an exclusive or
non-exclusive basis. There can be no assurance, however, that the Company will
actually enter into any license agreements relating to the Opioid Synthesis
Technologies or derive any licensing fees, milestone payments or royalties from
such arrangements.
Patent Applications
To date, the Company has one (1) issued US patent, one (1) issued US
Notice of Allowance, one (1) foreign patent application and six (6) patent
applications pending with the United States Patent and Trademark Office ("PTO")
relating to the Opioid Synthesis Technologies. Additionally, the Company has one
(1) pending US patent application relating to the ADF Technology. The typical
review time of a U.S. patent application varies. The initial review generally
occurs approximately 12 to 18 months from date of patent filing. At the
completion of the initial review, the patent examiner will issue an Office
Action letter, which will detail any necessary amendments, supplements or
reasons for the rejection. Subsequent processing of the patent application will
depend on the number of Office Action letters issued and the speed of review of
the Company's responses thereto. If an application is granted, a Notice of
Allowance will be issued, requiring a payment of the issue fee within three (3)
months from the date of the notice. Upon the payment of the fee, the patent
would be issued.
In September 2004, the Company received from the PTO an issued patent
relating to one of the oxycodone HCI Opioid Synthesis Technologies. In October
2004, the Company received from the PTO a Notice of Allowance for a second
patent application relating to one of the oxycodone HCI Opioid Synthesis
Technologies. The Company has paid the issuing fee relating to the Notice of
Allowance and expects that the corresponding US patent will be issued for the
second oxycodone HCI patent. No assurance can be given, however, that any other
currently pending patent applications or future patent applications relating to
the Opioid Synthesis Technologies will be granted. In addition, the Company is
currently unable to provide any assurance that the U.S. patent application
associated with the ADF Technology will issue, or if such patent issues, that
the claims granted will be sufficiently broad to provide economic value.
Moreover, even if such patents issue, there can be no assurance that the
commercialization of products incorporating the ADF Technology will not infringe
the patents or other intellectual property rights of third parties. The
Company's success depends in significant part on the Company's ability to obtain
protection for the ADF Technology, both in the United States and in other
countries, to enforce these patents and to avoid infringing third-party patent
and intellectual property rights.
30
Import License Registration
To provide for an economical source of raw materials for the commercial
manufacture of opioids utilizing certain of the Opioid Synthesis Technologies,
the Company filed with the U.S. Drug Enforcement Agency (the "DEA") an
application for registration to import certain narcotic raw materials ("NRMs").
The Company filed its application for registration to import NRMs on January 31,
2001 (the "Import Registration"). Notice of the Company's application was
published in the Federal Register on September 6, 2001. Within the 30 day period
provided under DEA guidelines, three parties, including two companies that the
Company believes are the largest U.S. importers of NRMs requested a hearing to
formally object to the Company's request for an Import Registration. Pursuant to
established procedures, an evidentiary hearing relating to the Company's Import
Registration application was held before a DEA Administrative Law Judge ("ALJ")
in August 2003. The ALJ later re-opened the administrative record, at the
request of opposing parties, to consider the Company's November and December
2003 announcements concerning the Company restructuring and financing
activities. After submission of additional testimony by the Company and certain
of the opposing parties, the ALJ closed the evidentiary record on May 25, 2004.
As of August 31, 2004, the Company and the opposing parties have prepared and
submitted to the ALJ briefing documents based on the evidentiary record and
replies to the opposing parties' briefing documents. With the evidentiary record
closed and the briefing documents and reply briefing documents submitted, the
Company estimates that within 18 months from September 1, 2004, the ALJ will
make findings of fact, draw legal conclusions and recommend a specific
recommendation on the Company's Import Registration application to the DEA
Deputy Administrator. Historically, within 14 months after receiving the ALJ's
recommendation, the DEA deputy administrator will issue an order relating to the
Company's application. Assuming DEA grants the Company's application, of which
no assurance can be given, the Company would be permitted to import NRMs upon
appropriate notice in the Federal Register. However, the opposing parties may
challenge the DEA decision to grant the Company's application in an appropriate
Court of Appeals. In such a case, assuming the Company opposes an appellate
challenge, the Company would likely incur additional time delays and legal
expenses prior to the issuance of a final decision by the U.S. Court of Appeals.
Provided the Company continues to seek the Import Registration, it is expected
that the proceedings will continue through 2005 and beyond. No assurance can be
given that the Company's Import Registration application will be granted by the
DEA or that if granted by DEA, the Import Registration would be upheld following
an appellate challenge. Furthermore, the Company's cash flow and limited sources
of available financing make it uncertain that the Company will have sufficient
capital to continue to fund the development of the Opioid Synthesis
Technologies, to obtain required DEA approvals and to fund the capital
improvements necessary for the manufacture of APIs and finished dosage products
incorporating the Opioid Synthesis Technologies.
Commercial Focus, Cash Reserves and Funding Requirements of the Restructured
Company
As of November 11, 2004, the Company had cash and cash equivalents of
approximately $3.8 million. All of such cash reserves will be dedicated to the
development of the Company's ADF Technology, the Opioid Synthesis Technologies,
the prosecution of the Company's patent applications and Import Registration and
for administrative and related operating expenses.
Subsequent to the completed restructuring of its operations, the Company
is no longer engaged in the manufacture and sale of finished dosage generic
pharmaceutical products. As a result, the Company has no ability presently to
generate revenue from product sales. Accordingly, the Company must rely on its
current cash reserves to fund the development of its ADF Technology, the Opioid
Synthesis Technologies and related ongoing administrative and operating
expenses. The Company's future sources of revenue, if any, will be derived from
the sale of API manufactured using its Opioid Synthesis Technologies and from
contract signing fees, milestone payments and royalties and/or profit sharing
payments from licensees for the Company's ADF Technology or Opioid Synthesis
Technologies. The Company estimates that its current cash reserves will be
sufficient to fund the development of the ADF Technology, the Opioid Synthesis
Technologies and related operating expenses through April, 2005. To fund
operations through December 2005, the Company estimates that it must raise
additional financing, or enter into alliances or collaboration agreements with
third parties providing for net proceeds to the Company of at least $5 million.
No assurance can be given that the Company will be successful in obtaining any
such financing or in securing collaborative agreements with third parties on
acceptable terms, if at all, or if secured, that such financing or collaborative
agreements will provide for payments to the Company sufficient to continue to
fund operations. In the absence of such financing or third-party collaborative
agreements, the Company will be required to scale back or terminate operations
and/or seek protection under applicable bankruptcy laws.
31
Even assuming the Company is successful in securing additional sources of
financing to fund the continued development of the ADF Technology or the Opioid
Synthesis Technologies, or otherwise enters into alliances or collaborative
agreements relating to such technologies, there can be no assurance that the
Company's development efforts will result in commercially viable products. The
Company's failure to successfully develop the ADF Technology in a timely manner,
to obtain an issued U.S. patent relating to such technology and to avoid
infringing third-party patents and other intellectual property rights will have
a material adverse impact on its financial condition and results of operations.
In view of the matters described above, recoverability of a major portion
of the recorded asset amounts shown in the Company's accompanying consolidated
balance sheets is dependent upon continued operations of the Company, which in
turn are dependent upon the Company's ability to meet its financing requirements
on a continuing basis, to maintain present financing, and to succeed in its
future operations. The Company's financial statements do not include any
adjustment relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue in existence.
RISK FACTORS RELATING TO THE COMPANY
THE COMPANY RECEIVED A "GOING CONCERN" OPINION FROM ITS INDEPENDENT AUDITORS,
HAS A HISTORY OF OPERATING LOSSES AND MAY NOT ACHIEVE PROFITABILITY SUFFICIENT
TO GENERATE A POSITIVE RETURN ON SHAREHOLDERS' INVESTMENT
We have incurred net losses since 1992, including net losses of
approximately $67.9 million in the nine months ended September 30, 2004 and
$48.5, $59.6 and $12.5 million during fiscal 2003, 2002 and 2001, respectively.
As of September 30, 2004 our accumulated deficit was approximately $277.5
million. The Company's consolidated financial statements for the year ended
December 31, 2003 and the nine months ended September 30, 2004 have been
prepared on a going-concern basis, expressing substantial doubt about the
Company's ability to continue as a going concern as a result of recurring losses
and negative cash flows. Our future profitability will depend on several
factors, including:
o the successful completion of the formulation development, clinical
testing and acceptable regulatory review of our opioid abuse
deterrent formulation technology (the "ADF Technology");
o the receipt of a notice of allowance and issued patent from the US
Patent and Trademark Office ("PTO") for the material claims in our
patent application relating to the ADF Technology;
o the ADF Technology not infringing third-party patents or other
intellectual property rights;
o the completion of the development, commercial scale up and
acceptable regulatory review of our opioid active pharmaceutical
ingredient manufacturing process technology (the "Opioid Synthesis
Technologies");
o the receipt of approval from the U.S. Drug Enforcement
Administration ("DEA") to import narcotic raw materials to be used
in our development and manufacturing efforts; and
o the interest of qualified third parties in our ADF Technology and
our Opioid Synthesis Technologies (collectively the "Technologies")
and our ability to negotiate and execute commercially viable
collaboration agreements with qualified third parties relating to
the Technologies.
32
Many of these factors will depend on circumstances beyond our control. We
cannot assure you that we will ever have a product approved by the FDA, that we
will bring any product to market or, if we are successful in doing so, that we
will ever become profitable.
WE REQUIRE ADDITIONAL FUNDING
Our requirements for additional capital are substantial and will depend on
many factors, including:
o the expenses incurred in the development and commercialization of
products incorporating our Technologies;
o the structure of any future collaborative or development agreements
relating to the Technologies, including the timing and amount of
payments, if any, that may be received under possible future
collaborative agreements;
o our ability to develop additional products utilizing the
Technologies;
o our ability to negotiate agreements with third parties for
development, marketing, sale and distribution of products utilizing
our Technologies;
o the prosecution, defense and enforcement of patent claims and other
intellectual property rights relating to the Technologies; and
o the commercialization of products incorporating our Technologies
without infringing third-party patents or other intellectual
property rights.
We currently have no committed sources of capital. We anticipate that our
existing capital resources will be sufficient to fund operations only through
April, 2005. To fund operations through December, 2005, the Company estimates
that it must raise additional financing, or enter into alliances or
collaborative agreements with third parties providing for net proceeds to the
Company of at least $5 million. No assurance can be given that the Company will
be successful in obtaining any such financing or in securing collaborative
agreements with third parties on acceptable terms, if at all, or if secured,
that such financing or collaborative agreements will provide for payments to the
Company sufficient to continue to fund operations. In the absence of such
financing or third-party collaborative agreements, the Company will be required
to scale back or terminate operations and/or seek protection under applicable
bankruptcy laws.
Even assuming the Company is successful in securing additional sources of
financing to fund the continued development of the Technologies, or otherwise
enters into alliances or collaborative agreements relating to the Technologies,
there can be no assurance that the Company's development efforts will result in
commercially viable products.
WE HAVE NO NEAR TERM SOURCES OF REVENUE AND MUST RELY ON CURRENT CAPITAL
RESOURCES, THIRD PARTY FINANCING, AND TECHNOLOGY LICENSING FEES TO FUND
OPERATIONS
Pending the completion of the development and commercial scale up of our
Technologies, and the receipt of regulatory approval of products incorporating
our Technologies, of which no assurance can be given, the Company must rely on
its current capital resources, third-party financing and technology licensing
fees to fund the Company's operations. As a consequence of the restructuring of
our operations, including the cessation of our finished dosage manufacturing and
packaging operations at our former Congers, NY facilities and the sale of such
assets and related generic products to third parties , we have no ability to
generate revenues from the sale of generic products. As of September 30 , 2004,
we had cash and cash equivalents of approximately $4.6 million. No assurance can
be given that such cash resources will be sufficient to fund the continued
development of our Technologies until such time as we generate revenue from the
license of products incorporating the Technologies to third parties. Moreover,
in the event of a cash shortfall, no assurance can be given that we will be
successful in raising additional financing to fund operations or, if funding is
obtained, that such funding will be sufficient to fund operations until the
Company's Technologies, or products incorporating such Technologies, may be
commercialized.
33
OUR PRODUCT CANDIDATES ARE BASED ON TECHNOLOGIES THAT COULD ULTIMATELY PROVE
INEFFECTIVE
In accordance with the restructuring of the Company's operations, the
Company has transitioned to a single operations facility located in Culver,
Indiana. At such site, the Company will seek to develop its proprietary ADF
Technology and Opioid Synthesis Technologies. With respect to the ADF
Technology, the first product candidate ("ADF Product Candidate #1") resulting
from the ADF Technology is a tablet formulation intended for oral
administration. Such product candidate is currently undergoing stability
testing. Six month real time stability data for Product Candidate #1 appear to
be satisfactory. However, the Company can provide no assurance that the
stability of ADF Product Candidate #1 will result in a commercially acceptable
drug product with at least 24 months of acceptable stability data. In addition,
ADF Product Candidate #1 has been evaluated in a single dose clinical study to
assess the bio-availability and bio-equivalence ("BA/BE") of such product
candidate in comparison to a frequently prescribed commercially marketed drug
product with the same opioid active ingredient but without abuse deterrent
properties. The results of the BA/BE study indicate that ADF Product Candidate
#1 is sufficiently bio-available but not bioequivalent to the reference
commercially marketed opioid product. The Company has subsequently developed a
more discriminating dissolution test methodology and a revised formulation of
Product Candidate #1 (Product Candidate #1R) and plan to test such revised
formulation in a second BA/BE study to confirm that the revised formulation is
both bio-available and bio-equivalent to the commercially marketed product
without the abuse deterrent properties. Even if ADF Product Candidate #1R is
stable and demonstrates acceptable bio-availability, substantial additional
clinical and non-clinical testing will required to continue development and for
the preparation and submission of an NDA filing with the FDA. There can be no
assurance that ADF Product Candidate #1R or any other product developed using
the ADF Technology will lead to an NDA submission to the FDA and that if an NDA
is filed, that the FDA will approve such regulatory application to allow for
commercial distribution of the product.
With respect to the Opioid Synthesis Technologies, while the Company
believes that such technologies are effective and cost-effective methods of
manufacturing opioid APIs, such technologies will need to be scaled up to
commercial scale to have economic value, of which no assurance can be given.
Additionally, unless the Company secures third-party financing dedicated to the
scale up expenses relating to the Opioid Synthesis Technologies (estimated by
the Company to be approximately $7.0 million), the Company will be unable to
complete the commercial scale up of the Opioid Synthesis Technologies. No
assurance can be given that the Company will obtain the third-party financing
necessary to scale up the Opioid Synthesis Technologies or, if such financing is
obtained, that any one or more of the Opioid Synthesis Technologies will be
capable of commercial scale up.
The Company is committing substantially all of its resources and available
capital to the development of the ADF Technology, the Opioid Synthesis
Technologies and the prosecution of its patent applications for such
Technologies. The failure of the Company to successfully develop the ADF
Technology, to successfully obtain an issued patent from the PTO relating to the
ADF Technologies and ADF Product Candidates, and to avoid infringing third-party
patents and other intellectual property rights in the commercialization of such
ADF Products will have a material adverse effect on the Company's operations and
financial condition.
IF PRE-CLINICAL TESTING OR CLINICAL TRIALS FOR OUR PRODUCT CANDIDATES ARE
UNSUCCESSFUL OR DELAYED, WE WILL BE UNABLE TO MEET OUR ANTICIPATED DEVELOPMENT
AND COMMERCIALIZATION TIMELINES.
To obtain FDA approval for any of our product candidates, we must submit
to the FDA a new drug application ("NDA") demonstrating, among other things,
that the product candidate is safe and effective in humans for its intended use.
This demonstration requires significant research and animal tests, which are
referred to pre-clinical studies, as well as human tests, which are referred to
as clinical trials. As we do not possess the resources or employ all the
personnel necessary to conduct clinical trial studies, it is our intention to
rely on collaborative partners to conduct Phase II and Phase III clinical trials
on our product candidates. As a result, we will have less control over the
timing and other aspects of these clinical trials than if we performed the
monitoring and supervision of clinical trials entirely on our own. Third parties
may not perform their responsibilities for our pre-clinical testing or clinical
trials on our anticipated schedule or, for clinical trials, consistent with a
clinical trial protocol. Delays in pre-clinical and clinical testing could
significantly increase our product development costs and delay product
commercialization. In addition, many of the factors that may cause, or lead to,
a delay in the clinical trials may also ultimately lead to denial of regulatory
approval of a product candidate.
34
The commencement of clinical trials can be delayed for a variety of reasons,
including delays in:
o demonstrating sufficient pre-clinical safety required to obtain
regulatory approval to commence a clinical trial;
o reaching agreement on acceptable terms with prospective
collaborative partners;
o manufacturing and quality assurance releasing a sufficient supply of
a product candidate for use in our clinical trials; and
o obtaining institutional review board approval to conduct a clinical
trial at a prospective site.
Once a clinical trial has begun, it may be delayed, suspended or terminated by
us or the FDA or other regulatory authorities due to a number of factors,
including:
o ongoing discussions with the FDA or other regulatory authorities
regarding the scope or design of our clinical trials;
o failure to conduct clinical trials in accordance with regulatory
requirements;
o lower than anticipated recruitment or retention rate of patients in
clinical trials;
o inspection of the clinical trial operations or trial sites by the
FDA or other regulatory authorities resulting in the imposition of a
clinical hold;
o lack of adequate funding to continue clinical trials; or
o negative results of clinical trials.
Phase III clinical trials may not demonstrate the safety or efficacy of
our product candidates. Success in pre-clinical testing and early clinical
trials does not ensure that later clinical trials will be successful. Results of
later clinical trials may not replicate the results of prior clinical trials and
pre-clinical testing. Even if the results of our pivotal Phase III clinical
trials are positive, we and our collaborative partners may have to commit
substantial time and additional resources to conduct further pre-clinical and
clinical studies before we can submit NDAs or obtain final FDA approval for our
product candidates.
Clinical trials are often very expensive and difficult to design and
implement, in part because they are subject to rigorous requirements. Further,
if participating patients in clinical studies suffer drug-related adverse
reactions during the course of such trials, or if we, our collaborative partner
or the FDA believes that participating patients are being exposed to
unacceptable health risks, our collaborative partner may have to suspend the
clinical trials. Failure can occur at any stage of the trials, and our
collaborative partner could encounter problems that cause the abandonment of
clinical trials or the need to conduct additional clinical studies, relating to
a product candidate.
Even if our clinical trials are completed as planned, their results may
not support our product claims. The clinical trial process may fail to
demonstrate that our product candidates are safe and effective for their
intended use. Such failure would cause us or our collaborative partner to
abandon a product candidate and could delay the development of other product
candidates.
IF WE RETAIN COLLABORATIVE PARTNERS AND OUR PARTNERS DO NOT SATISFY THEIR
OBLIGATIONS, WE WILL BE UNABLE TO DEVELOP OUR PARTNERED PRODUCT CANDIDATES
35
To complete the development and regulatory approval of our products and
commercialize our products, if any are approved by the FDA, we plan to enter
into development and commercialization agreements with strategically focused
pharmaceutical company partners providing that such partners license our
Technologies and further develop, register and commercialize multiple
formulations and strengths of orally administered opioid-containing finished
dosage products utilizing such Technologies. We expect to receive a share of
profits and/or royalty payments derived from such collaborative partners' sale
of products incorporating the Technologies. Currently, we do not have any such
collaborative agreements, nor can there be any assurance that we will actually
enter into collaborative agreements in the future. Our inability to enter into
collaborative agreements, or our failure to maintain such agreements, would
limit the number product candidates that we can develop and ultimately, decrease
our sources of any future revenues. In the event we enter into any collaborative
agreements, we may not have day-to-day control over the activities of our
collaborative partners with respect to any product candidate. Any collaborative
partner may not fulfill its obligations under such agreements. If a
collaborative partner fails to fulfill its obligations under an agreement with
us, we may be unable to assume the development of the product covered by that
agreement or to enter into alternative arrangements with a third party. In
addition, we may encounter delays in the commercialization of the product
candidate that is the subject of a collaboration agreement. Accordingly, our
ability to receive any revenue from the product candidates covered by
collaboration agreements will be dependent on the efforts of our collaborative
partner. We could be involved in disputes with a collaborative partner, which
could lead to delays in or termination of, our development and commercialization
programs and time consuming and expensive litigation or arbitration. In
addition, any such dispute could diminish our collaborative partners' commitment
to us and reduce the resources they devote to developing and commercializing our
products. If any collaborative partner terminates or breaches its agreement, or
otherwise fails to complete its obligations in a timely manner, our chances of
successfully developing or commercializing our product candidates would be
materially and adversely effected.
Additionally, due to the nature of the market for pain management
products, it may be necessary for us to license all or significant portion of
our product candidates to a single collaborator, thereby eliminating our
opportunity to commercialize other pain management products with other
collaborative partners.
THE MARKET MAY NOT BE RECEPTIVE TO PRODUCTS INCORPORATING OUR TECHNOLOGIES
The commercial success of products incorporating our Technologies that are
approved for marketing by the FDA and other regulatory authorities will depend
upon their acceptance by the medical community and third party payors as
clinically useful, cost-effective and safe. There can be no assurance given,
even if we succeed in the development of products incorporating our Technologies
and receive FDA approval for such products, that our products incorporating the
Technologies would be accepted by the medical community and others. Factors that
we believe could materially affect market acceptance of these products include:
o the relative advantages and disadvantages of our Technologies and
timing to commercial launch of products utilizing our Technologies
compared to products incorporating competitive technologies;
o the timing of the receipt of marketing approvals and the countries
in which such approvals are obtained;
o the safety and efficacy of products incorporating our Technologies
as compared to competitive products; and
o the cost-effectiveness of products incorporating our Technologies
and the ability to receive third party reimbursement.
Our product candidates, if successfully developed, will compete with a
number of products manufactured and marketed by other brand focused
pharmaceutical companies, biotechnology companies and manufacturers of generic
products. Our products may also compete with new products currently under
development by others. Physicians, patients, third-party payors and the medical
community may not accept or utilize any of our product candidates. Physicians
may not be inclined to prescribe the products utilizing the ADF Technology
unless our products bring substantial and demonstrable advantages over other
products currently marketed for the same indications. If our products do not
achieve market acceptance, we will not be able to generate significant revenues
or become profitable.
36
IN THE EVENT THAT WE ARE SUCCESSFUL IN BRINGING ANY PRODUCTS TO MARKET, OUR
REVENUES MAY BE ADVERSELY AFFECTED IF WE FAIL TO OBTAIN ACCEPTABLE PRICES OR
ADEQUATE REIMBURSEMENT FOR OUR PRODUCTS FROM THIRD-PARTY PAYORS
Our ability to commercialize pharmaceutical products successfully may
depend in part on the availability of reimbursement for our products from:
o government and health administration authorities;
o private health insurers; and
o other third-party payors, including Medicare.
We cannot predict the availability of reimbursement for newly-approved
health care products. Third-party payors, including Medicare, are challenging
the prices charged for medical products and services. Government and other
third-party payors increasingly are limiting both coverage and the level of
reimbursement for new drugs. Third-party insurance coverage may not be available
to patients for any of our products.
The continuing efforts of government and third-party payors to contain or
reduce the costs of health care may limit our commercial opportunity. If
government and other third-party payors do not provide adequate coverage and
reimbursement for any product we bring to market, doctors may not prescribe them
or patients may ask to have their physicians prescribe competing products with
more favorable reimbursement. In some foreign markets, pricing and profitability
of pharmaceutical products are subject to government control. In the United
States, we expect that there will continue to be federal and state proposals for
similar controls. In addition, we expect that increasing emphasis on managed
care in the United States will continue to put pressure on the pricing of
pharmaceutical products. Cost control initiatives could decrease the price that
we receive for any products in the future. Further, cost control initiatives
could impair our ability to commercialize our products and our ability to earn
revenues from this commercialization.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY
Our success depends in significant part on our ability to obtain patent
protection for our ADF Technology, both in the United States and in other
countries, and to enforce these patents. The patent positions of pharmaceutical
firms, including us, are generally uncertain and involve complex legal and
factual questions. Although we have filed a patent application with the PTO on
our ADF Technology, there is no assurance that a patent will issue or, if
issued, that such patent will be valid and enforceable against third party
infringement or that such patent will not infringe any third party patent or
intellectual property. Moreover, even if patents do issue on our ADF Technology,
the claims allowed may not be sufficiently broad to protect the products
incorporating the ADF Technology. In addition, issued patents may be challenged,
invalidated or circumvented. Even if issued, our patents may not afford us
protection against competitors with similar technology or permit the
commercialization of our products without infringing third-party patents or
other intellectual property rights.
Our success also depends on our not infringing patents issued to
competitors or others. We may become aware of patents and patent applications
belonging to competitors and others that could require us to alter our
Technologies. Such alterations could be time consuming and costly.
We may not be able to obtain a license to any technology owned by or
licensed to a third party that we require to manufacture or market one or more
products incorporating our Technologies. Even if we can obtain a license, the
financial and other terms may be disadvantageous.
37
Our success also depends on our maintaining the confidentiality of our
trade secrets and know-how. We seek to protect such information by entering into
confidentiality agreements with employees, potential collaborative partners,
potential investors and consultants. These agreements may be breached by such
parties. We may not be able to obtain an adequate, or perhaps, any remedy to
such a breach. In addition, our trade secrets may otherwise become known or be
independently developed by our competitors. Our inability to protect our
intellectual property or to commercialize our products without infringing
third-party patents or other intellectual property rights would have a material
adverse effect on our operations and financial condition.
WE MAY BECOME INVOLVED IN PATENT LITIGATION OR OTHER INTELLECTUAL PROPERTY
PROCEEDINGS RELATING TO OUR PRODUCTS OR TECHNOLOGIES WHICH COULD RESULT IN
LIABILITY FOR DAMAGES OR DELAY OR STOP OUR DEVELOPMENT AND COMMERCIALIZATION
EFFORTS
The pharmaceutical industry has been characterized by significant
litigation and other proceedings regarding patents, patent applications and
other intellectual property rights. The types of situations in which we may
become parties to such litigation or proceedings include:
o we may initiate litigation or other proceedings against third parties to
enforce our patent rights or other intellectual property rights;
o we may initiate litigation or other proceedings against third parties to
seek to invalidate the patents held by such third parties or to obtain a
judgment that our products or processes do not infringe such third
parties' patents;
o if our competitors file patent applications that claim technology also
claimed by us, we may participate in interference or opposition
proceedings to determine the priority of invention; and
o if third parties initiate litigation claiming that our processes or
products infringe their patent or other intellectual property rights, we
will need to defend against such proceedings.
The costs of resolving any patent litigation or other intellectual
property proceeding, even if resolved in our favor, could be substantial. Some
of our competitors may be able to sustain the cost of such litigation and
proceedings more effectively than we can because of their substantially greater
resources. Uncertainties resulting from the initiation and continuation of
patent litigation or other intellectual property proceedings could have a
material adverse effect on our ability to compete in the marketplace. Patent
litigation and other intellectual property proceedings may also consume
significant management time.
Our Technologies may be found to infringe upon claims of patents of owned
by others. If we determine or if we are found to be infringing on a patent held
by another, we might have to seek a license to make, use, and sell the patented
technologies. In that case, we might not be able to obtain such license on terms
acceptable to us, or at all. If a legal action is brought against us, we could
incur substantial defense costs, and any such action might not be resolved in
our favor. If such a dispute is resolved against us, we may have to pay the
other party large sums of money and our use of our Technologies and the testing,
manufacturing, marketing or sale of one or more of our products could be
restricted or prohibited. Even prior to resolution of such a dispute, use of our
Technologies and the testing, manufacturing, marketing or sale of one or more of
our products could be restricted or prohibited.
Moreover, other parties could have blocking patent rights to products made
using the Company's ADF Technology. For example, the Company has recently become
aware of certain United States and European patent applications owned by third
parties that claim multiple-form abuse deterrent technologies. If such patent
applications result in issued patents, with claims encompassing our ADF
Technology or products, the Company may need to obtain a license in order to
commercialize products incorporating the ADF Technology, should one be available
or, alternatively, alter the ADF Technology so as to avoid infringing such
third-party patents. If the Company is unable to obtain a license on
commercially reasonable terms, the Company could be restricted or prevented from
commercializing products incorporating the ADF Technology. Additionally, any
alterations to the Company's ADF Technology in view of such pending third-party
patent applications could be time consuming and costly and may not result in
technologies or products that are non-infringing or commercially viable.
38
The Company expects to seek and obtain licenses to such patents or patent
applications when, in the Company's judgment, such licenses are needed. If any
such licenses are required, there can be no assurances that the Company would be
able to obtain any such license on commercially favorable terms, or at all, and
if these licenses are not obtained, the Company might be prevented from making,
using and selling the Company's ADF Technology and products. The Company's
failure to obtain a license to any technology that it may require would
materially harm the Company's business, financial condition and results of
operations. We cannot assure that the Company's products and/or actions in
developing products incorporating the Company's ADF Technology will not infringe
such patents.
WE MAY NOT OBTAIN REQUIRED FDA APPROVAL; THE FDA APPROVAL PROCESS IS
TIME-CONSUMING AND EXPENSIVE
The development, testing, manufacturing, marketing and sale of
pharmaceutical products are subject to extensive federal, state and local
regulation in the United States and other countries. Satisfaction of all
regulatory requirements typically takes many years, is dependent upon the type,
complexity and novelty of the product candidate, and requires the expenditure of
substantial resources for research, development and testing. Substantially all
of the Company's operations are subject to compliance with FDA regulations.
Failure to adhere to applicable FDA regulations would have a material adverse
effect on the Company's operations and financial condition. In addition, in the
event the Company is successful in developing product candidates for sale in
other countries, the Company would become subject to regulation in such
countries. Such foreign regulations and product approval requirements are
expected to be time consuming and expensive.
We may encounter delays or rejections during any stage of the regulatory
approval process based upon the failure of clinical or laboratory data to
demonstrate compliance with, or upon the failure of the products to meet, the
FDA's requirements for safety, efficacy and quality; and those requirements may
become more stringent due to changes in regulatory agency policy or the adoption
of new regulations. After submission of a marketing application, in the form of
a New Drug Application ("NDA"), a 502(b)(2) application, or an Abbreviated New
Drug Application ("ANDA"), the FDA may deny the application, may require
additional testing or data and/or may require post-marketing testing and
surveillance to monitor the safety or efficacy of a product. The FDA commonly
takes one to two years to grant final approval to a marketing application (NDA,
505(b)(2) or ANDA). Further, the terms of approval of any marketing application,
including the labeling content, may be more restrictive than we desire and could
affect the marketability of the products incorporating the Company's
Technologies.
Even if we comply with all FDA regulatory requirements, we may never
obtain regulatory approval for any of our product candidates. If we fail to
obtain regulatory approval for any of our product candidates, we will have fewer
saleable products and corresponding lower revenues. Even if we receive
regulatory approval of our products, such approval may involve limitations on
the indicated uses or marketing claims we may make for our products.
The FDA also has the authority to revoke or suspend approvals of
previously approved products for cause, to debar companies and individuals from
participating in the drug-approval process, to request recalls of allegedly
violative products, to seize allegedly violative products, to obtain injunctions
to close manufacturing plants allegedly not operating in conformity with current
Good Manufacturing Practices (GMP) and to stop shipments of allegedly violative
products. As any future source of Company revenue will be derived from the sale
of FDA approved products, the taking of any such action by the FDA would have a
material adverse effect on the Company.
THE U.S. DRUG ENFORCEMENT ADMINISTRATION ("DEA") LIMITS THE AVAILABILITY OF THE
ACTIVE INGREDIENTS USED IN OUR PRODUCT CANDIDATES AND, AS A RESULT, OUR QUOTA
MAY NOT BE SUFFICIENT TO COMPLETE CLINICAL TRIALS, OR TO MEET COMMERCIAL DEMAND
OR MAY RESULT IN DEVELOPMENT DELAYS
The DEA regulates chemical compounds as Schedule I, II, III, IV or V
substances, with Schedule I substances considered to present the highest risk of
substance abuse and Schedule V substances the lowest risk. Certain opioid active
ingredients in our current product candidates are classified by the DEA as
Schedule II or III substances under the Controlled Substances Act of 1970.
Consequently, their manufacture, research, shipment, storage, sale and use are
subject to a high degree of regulation. These regulations require, for example,
that all Schedule II product prescriptions must be signed by a physician,
physically presented to a pharmacist and may not be refilled without a new
prescription. Furthermore, the amount of Schedule II substances we can obtain
for clinical trials and commercial distribution is limited by the DEA and our
quota may not be sufficient to complete clinical trials or meet commercial
demand. There is a risk that DEA regulations may interfere with the supply of
the products used in our clinical trials, and, in the future, our ability to
produce and distribute our products in the volume needed to meet commercial
demand.
39
WE MAY NOT OBTAIN REQUIRED DEA APPROVAL FOR OUR NARCOTIC RAW MATERIALS IMPORT
REGISTRATION
Our business strategy focuses on the development of opioid containing
products incorporating the Technologies. The development, marketing and sale of
products incorporating the Technologies is subject to extensive regulation by
the DEA and FDA. At present, the Company's facility located in Culver, Indiana
is approved by the DEA to manufacture Schedule II to V controlled substance
active pharmaceutical ingredients ("APIs") and finished dosage products
incorporating such API's. To continue the development and commercialization of
the Opioid Synthesis Technologies, we are seeking to obtain a registration from
the DEA to import narcotic raw materials ("NRMs") and have been engaged in the
application process seeking approval to import NMRs directly from foreign
countries for use in our opioid API manufacturing efforts since early 2001.
No assurance can be given that the Import Registration application will be
approved by the DEA or that if granted by DEA, the Import Registration would be
upheld following an appellate challenge. Furthermore, our cash flow and limited
sources of available financing make it uncertain that the Company will have
sufficient capital to continue to fund the development of the Opioid Synthesis
Technologies, to obtain required DEA approvals and to fund the capital
improvements necessary for the commercial manufacture of APIs and finished
dosage products incorporating the Opioid Synthesis Technologies.
WE MUST OBTAIN FDA APPROVAL TO MANUFACTURE OUR PRODUCTS AT OUR FACILITIES;
FAILURE TO OBTAIN FDA APPROVAL AND MAINTAIN COMPLIANCE WITH FDA REQUIREMENTS MAY
PREVENT OR DELAY THE MANUFACTURE OF OUR PRODUCTS AND COSTS OF MANUFACTURE MAY BE
HIGHER THAN EXPECTED
We have constructed and installed the equipment necessary to manufacture
clinical trial supplies of our ADF product candidates in tablet formulations at
our Culver, Indiana facility. To be used in clinical trials, all of our product
candidates must be manufactured in conformity with current Good Manufacturing
Practice (cGMPs) regulations as interrupted and enforced by the FDA. All such
product candidates must be manufactured, packaged, and labeled and stored in
accordance with cGMPs. Modifications, enhancements or changes in manufacturing
sites of marketed products are, in many circumstances, subject to FDA approval,
which may be subject to a lengthy application process or which we may be unable
obtain. Our Culver, Indiana facility, as well as those of any third-party
manufacturers that we may use, are periodically subject to inspection by the FDA
and other governmental agencies, and operations at these facilities could be
interrupted or halted if such inspections are unsatisfactory.
Failure to comply with FDA or other governmental regulations can result in
fines, unanticipated compliance expenditures, recall or seizure of products,
total or partial suspension of production or distribution, suspension of FDA
review of our products, termination of ongoing research, disqualification of
data for submission to regulatory authorities, enforcement actions, injunctions
and criminal prosecution.
WE FACE SIGNIFICANT COMPETITION, WHICH MAY RESULT IN OTHERS DISCOVERING,
DEVELOPING OR COMMERCIALIZING PRODUCTS BEFORE OR MORE SUCCESSFULLY THAN WE DO
The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability of
financing, litigation and other factors. If our product candidates receive FDA
approval, they will compete with a number of existing and future drugs and
therapies developed, manufactured and marketed by others. Existing or future
competing products may provide greater therapeutic convenience or clinical or
other benefits for a specific indication than our products, or may offer
comparable performance at lower costs. If our products are unable to capture and
maintain market share, we will not achieve significant product revenues and our
financial condition will be materially adversely affected.
40
We will compete for market share against fully integrated pharmaceutical
companies or other companies that collaborate with larger pharmaceutical
companies, academic institutions, government agencies and other public and
private research organizations. Many of these competitors have opioid analgesics
already approved or in development. In addition, many of these competitors
either alone or together with their collaborative partners, operate larger
research and development programs and have substantially greater financial
resources then we do as well as significantly greater experience in developing
products, conducting pre-clinical testing and human clinical trials, obtaining
FDA and other regulatory approvals, formulating and manufacturing drugs, and
commercializing drugs.
We will be concentrating all of our efforts on the development of the
Technologies. The commercial success of products using our Technologies will
depend, in large part, on the intensity of competition from branded opioid
containing products, generic versions of branded opioid containing products and
other drugs and technologies that compete with the products incorporating our
Technologies, as well as the timing of product approval.
Alternative technologies and products are being developed to improve or
replace the use of opioids for pain management, several of which are in clinical
trials or are awaiting approval from the FDA. In addition, the opioid active
ingredients in all of our product candidates are readily available for use in
generic products. Companies selling generic opioid containing products may
represent substantial competition. Most of these organizations competing with us
have substantially greater capital resources, larger research and development
staff and facilities, greater experience in drug development and in obtaining
regulatory approvals and greater manufacturing and marketing capabilities than
we do.
The pharmaceutical industry is characterized by frequent litigation. Those
companies with significant financial resources will be better able to bring and
defend any such litigation. No assurance can be given that we would not become
involved in such litigation. Such litigation may have material adverse
consequences to the Company's financial conditions and operations.
WE MAY BE EXPOSED TO PRODUCT LIABILITY CLAIMS AND MAY NOT BE ABLE TO OBTAIN
ADEQUATE PRODUCT LIABILITY INSURANCE
Our business exposes us to potential product liability risks, which are
inherent in the testing, manufacturing, marketing and sale of pharmaceutical
products. Product liability claims might be made by consumers, health care
providers or pharmaceutical companies or others that sell our products. These
claims may be made even with respect to those products that are manufactured in
licensed and regulated facilities or that otherwise possess regulatory approval
for commercial sale.
We are currently covered by clinical trial product liability insurance in
the amount of $1.0 million per occurrence and $3.0 million annually in the
aggregate on a claims-made basis. This coverage may not be adequate to cover any
product liability claims. Product liability coverage is expensive. In the
future, we may not be able to maintain or obtain such product liability
insurance at a reasonable cost or in sufficient amounts to protect us against
losses due to liability claims. Any claims that are not covered by product
liability insurance could have a material adverse effect on our business,
financial condition and results of operations.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE
The market price of our common stock, like the market price for securities
of pharmaceutical, biopharmaceutical and biotechnology companies, has
historically been highly volatile. The market from time to time experiences
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. Factors, such as fluctuations in our
operating results, future sales of our common stock, announcements of
technological innovations or new therapeutic products by us or our competitors,
announcements regarding collaborative agreements, clinical trial results,
government regulation, developments in patent or other proprietary rights,
public concern as to the safety of drugs developed by us or others, changes in
reimbursement policies, comments made by securities analysts and general market
conditions may have a significant effect on the market price of our common
stock. In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted. A securities class action suit against us could result in
substantial costs, potential liabilities and the diversion of management's
attention and resources.
41
In addition, since the Company's delisting from the American Stock
Exchange in September 2000, the Company's common stock has been traded on the
OTC Bulletin Board, a NASD-sponsored inter-dealer quotation system. As the
Company's common stock is not quoted on a stock exchange and is not qualified
for inclusion on the NASD Small-Cap Market, our common stock could be subject to
a rule by the Securities and Exchange Commission that imposes additional sales
practice requirements on broker-dealers who sell such securities to persons
other than established customers and accredited investors. For transactions
covered by this rule, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent for a transaction prior to sale. Consequently, the rule may affect the
ability of broker-dealers to sell the Company's common stock and the ability of
purchasers in the offering to sell the common stock received upon conversion of
the Preferred Shares in the secondary market. There is no guaranty that an
active trading market for our common stock will be maintained on the OTC
Bulletin Board. Investors may be not able to sell their shares of common stock
quickly or at the latest market price if trading in our common stock is not
active.
NO DIVIDENDS
The Company has not declared and paid cash dividends on its common stock
in the past, and the Company does not anticipate paying any cash dividends in
the foreseeable future. The Company's senior term loan indebtedness prohibits
the payment of cash dividends.
CONTROL OF THE COMPANY
Galen Partners beneficially owns in excess of an aggregate of
approximately 46.3% of the Company's common stock (after giving effect to the
conversion of outstanding common stock purchase warrants held by Galen
Partners). In addition, pursuant to the terms of the Amended and Restated Voting
Agreement dated February 6, 2004, between the Company and the holders of the
Company's outstanding convertible preferred stock, all holders of the Company's
convertible preferred stock have agreed that the Board of Directors shall be
comprised of not more than 7 members, 4 of whom shall be the designees of each
of Care Capital Investments II, LP, Essex Woodlands Health Venture V, L.P. and
Galen Partners. Each of Care Capital, Essex Woodlands and Galen Partners has the
right to designate one member of the Company's Board of Directors and each of
such investors collectively may designate one additional member to the Board. As
a result, Galen Partners, in view of its ownership percentage of the Company,
and each of Care Capital, Essex Woodlands and Galen Partners, by virtue of their
controlling positions on the Company's Board of Directors, will be able to
control or significantly influence all matters requiring approval by our
shareholders, including the approval of mergers or other business combination
transactions. The interests of Care Capital, Essex Woodlands and Galen Partners
may not always coincide with the interests of other shareholders and such
entities may take action in advance of their interests to the detriment of our
other shareholders.
KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND OUR FUTURE SUCCESS DEPENDS ON
OUR ABILITY TO RETAIN THEM
We are highly dependent on the principal members our of management and
scientific team, particularly Andrew Reddick, our President and Chief Executive
Officer, and Ron Spivey, Ph.D. our Chief Scientific Officer. We may not be able
to attract and retain personnel on acceptable terms given the intense
competition for such personnel among biotechnology, pharmaceutical and
healthcare companies, universities and non-profit research institutions. We are
not aware of any present intention of any our key personnel to leave our Company
or to retire. However, while we have employment agreements with certain of our
employees, all of our employees are at-will employees who may terminate their
employment at any time. We do not currently have key personnel insurance on any
of our officers or employees. The loss of any of our key personnel, or the
inability to attract and retain such personnel, may significantly delay or
prevent the achievement of our research, development and business objectives and
could materially aversely affect our business, financial condition and results
of such operations.
42
WE EXPECT THAT OUR QUARTERLY RESULTS OF OPERATIONS WILL FLUCTUATE, AND THESE
FLUCTUATIONS COULD CAUSE OUR STOCK PRICE TO DECLINE
Our quarterly operating results are likely to fluctuate in the future.
These fluctuations could cause our stock price to decline. The nature of our
business involves variable factors, such as the timing of the research,
development and regulatory pathways of our product candidates that could cause
our operating results to fluctuate.
THE COMPANY IS SUBJECT TO RESTRICTIONS ON THE INCURRENCE OF ADDITIONAL
INDEBTEDNESS, WHICH MAY ADVERSELY IMPACT THE COMPANY'S ABILITY TO FUND
OPERATIONS
Pursuant to the terms of each of the Company's outstanding $5.0 million
senior term loan and the Investor Rights Agreement with the holders of the
Company's convertible preferred stock, the Company is limited as to the type and
amount of future indebtedness it may incur. The restriction on the Company's
ability to incur additional indebtedness in the future may adversely impact the
Company's ability to fund the development and commercialization of its products.
ACCOUNTING POLICIES
Note A of the Notes to Consolidated Financial Statements, as contained in
the Company's Annual Report on Form 10-K, includes a summary of the Company's
significant accounting policies and methods used in the preparation of the
financial statements. The application of these accounting policies involves the
exercise of judgment and use of assumptions as to future uncertainties and, as a
result, actual results could differ from these estimates. The Company does not
believe there is a great likelihood that materially different amounts would be
reported under different conditions or using different assumptions. The
Company's critical accounting policies are as follows:
Stock Compensation. The Company accounts for stock-based employee
compensation arrangements in accordance with provisions of APB Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25") and complies with the
disclosure provision of SFAS No. 148, "Accounting for Stock-based Compensation -
Transition and Disclosure, an amendment of FASB Statement No. 123" ("SFAS No.
148"). If the Company were to include the cost of stock-based employee
compensation in the financial statements, the Company's operating results would
decline based on the fair value of the stock-based employee compensation.
Deferred Debt Discount. Deferred debt discount results from the issuance
of stock warrants and beneficial conversion features in connection with the
issuance of subordinated debt and other notes payable. The amount of the
discount is recorded as a reduction of the related obligation and is amortized
over the remaining life of the related obligations. Management determines the
amount of the discount, based, in part, by the relative fair values ascribed to
the warrants determined by an independent valuation or through the use of the
Black-Scholes valuation model. Inherent in the Black-Scholes valuation model are
assumptions made by management regarding the estimated life of the warrant, the
estimated volatility of the Company's common stock and the expected dividend
yield.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. 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 and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14 as of
the end of the period covered by this Report. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic Securities and
Exchange Commission filings. No significant changes were made in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
43
Changes in Internal Control Over Financial Reporting. There was no change
in the Company's internal control over financial reporting that occurred during
the period covered by this quarterly report on Form 10-Q that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEED AND ISSUER PURCHASES OF EQUITY
SECURITIES
Issuance of Common Shares
During the quarter ended September 30, 2004 the Company issued 211,918
shares of the Company's common stock as payment of $106,000 accrued interest due
June 30, 2004 on the Company's senior secured term note . In October 2004, the
Company issued an additional 261,309 shares of the Company's common stock as
payment of $112,000 accrued interest due September 30, 2004 on the Company's
senior secured term note .
Conversion of the Company's Debentures
On August 13, 2004, the business day following the Company's receipt of
shareholder approval to restate the Company's Certificate of Incorporation (the
"Charter Amendment") to authorize Series A Convertible Preferred Stock ("Series
A Preferred"), Series B Convertible Preferred Stock ("Series B Preferred"),
Series C-1 Convertible Preferred Stock, Series C-2 Convertible Preferred Stock
and Series C-3 Convertible Preferred Stock (collectively, "Series C Preferred"
and collectively with Series A Preferred and Series B Preferred, the "Preferred
Stock"), all of the Company's outstanding convertible senior secured debentures
(the "Debentures") automatically converted into the Preferred Stock. As a result
of such automatic conversion of the Debentures, the Company issued an aggregate
of 21,963,757 million Series A Preferred shares, 20,246,506 million Series B
Preferred shares, 56,422,558 million Series C-1 Preferred shares, 37,433,096
million Series C-2 Preferred shares and 81,907,069 million Series C-3 Preferred
shares. The Company received no additional consideration as a result of the
automatic conversion of the Debentures into the Preferred Stock
Preferred Stock
Series A Preferred shares are convertible into the Company's Common Stock,
with each Series A Preferred share convertible into the number of shares of
Common Stock obtained by dividing (i) 3.125 (five (5) times the initial $0.6425
Series A conversion price) by (ii) Series A conversion price of $0.6425, as such
conversion price may be adjusted, from time to time, pursuant to the dilution
protections of such shares.
Each of the Series B Preferred shares and Series C Preferred shares are
convertible into the Company's Common Stock, with each Series B Preferred share
and Series C Preferred share convertible into one share of Common Stock.
Exemption from Registration
The Company issued the Preferred Stock in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended
and/or Regulation D promulgated under the Securities Act of 1933. Each of the
holders of the Debentures, senior secured term note and shares of common stock
issued during the Quarter ended September 30, 2004, represented to the Company
that such holder was an accredited investor as defined in Rule 501(a) of the
Securities Act of 1933 and that the Debentures and any securities issued
pursuant thereto were being acquired for investment purposes.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
44
The Company's 2004 Annual Meeting of Shareholders was held on August 12,
2004 (the "Annual Meeting"). In connection with the Annual Meeting proxies were
solicited by management pursuant to Regulation 14A under the Securities Exchange
Act of 1934. On the record date for the Annual Meeting, the Company's
outstanding voting securities consisted of 66,453,861 shares of common stock, of
which 60,841,517 shares were represented in person or by proxy at the Annual
Meeting.
At the Annual Meeting, the following matters were submitted to a vote of
the company's voting security holders, with the results indicated below:
1. Election of Directors.
The following five (5) incumbent directors and one (1) new director were
elected to serve until the next Annual Meeting of Shareholders. The tabulation
of votes was as follows:
Nominee For Withheld
- ---------------------- ---------- -------------
Jerry Karabelas 60,617,128 224,389
Immanuel Thangaraj 60,616,204 225,313
Bruce F. Wesson 60,617,028 224,489
Andrew D. Reddick 60,616,304 225,213
William A.Sumner 60,658,074 183,443
William Skelly 60,658,204 183,313
2. Proposal to Restate the Company's Certificate of Incorporation to Increase
its Authorized Capital Stock.
- ----------------------------------------------------
The tabulation of votes was as follows:
For Against Abstained Not Voted
---------- ------- --------- ---------
51,199,369 347,528 9,664 9,284,956
3. Proposal to Approve the Amendment to the Company's Certificate of
Incorporation to Change the Name of the Company.
- -------------------------------------------------------------------------
The tabulation of votes was as follows:
For Against Abstained
---------- ------------ ---------
60,794,914 37,548 9,055
4. Proposal to Approve the Sale of Substantially All of the Assets used in
Manufacture and Sale of Finished Dosage Pharmaceutical Products at the
Company's Former Congers, New York Locations.
- -------------------------------------------------------------------------
45
The tabulation of votes was as follows:
For Against Abstained Not Voted
---------- ------- ---------- ---------
51,347,419 199,562 9,580 9,284,956
5. Proposal to Approve the Amendment to the Company's 1998 Stock Option Plan.
-------------------------------------------------------------------------
The tabulation of votes was as follows:
For Against Abstained Not Voted
---------- ------- ---------- ---------
50,979,253 543,769 33,539 9,284,956
6. Proposal to Ratify the Company's Independent Accountants for the Current
Fiscal Year.
-------------------------------------------------------------------------
The tabulation of votes was as follows:
For Against Abstained
---------- ------- ---------
60,777,144 55,874 8,499
ITEM 6. EXHIBITS
(a) The exhibits required to be filed as part of this Report on form
10-Q are listed in the attached Exhibit Index.
46
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.
Date: November 12, 2004 ACURA PHARMACEUTICALS, INC.
By: /s/ Andrew D. Reddick
------------------------------------------
Andrew D. Reddick
President & Chief Executive Officer
By: /s/ Peter A. Clemens
------------------------------------------
Peter A. Clemens
Senior Vice President & Chief Financial
Officer
47
EXHIBIT INDEX
Exhibit Document
- ------- --------
31.1 Certification of Periodic Report by Chief Executive Officer
pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange
Act of 1934.
31.2 Certification of Periodic Report by Chief Financial Officer
pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange
Act of 1934.
32.1 Certification of Periodic Report by Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Periodic Report by Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
48