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SECURITIES AND EXCHANGE COMMISSION

Washington, DC

Form 10-Q

(Mark One)

For the quarterly period ended March 31, 2005

or

For the transition period from              to             

Commission File Number: 0-28748

CLOSURE MEDICAL CORPORATION

(Exact name of registrant as specified in its charter)

5250 Greens Dairy Road, Raleigh, North Carolina 27616

(Address of principal executive offices) (Zip Code)

(919) 876-7800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

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CLOSURE MEDICAL CORPORATION

INDEX

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PART I- FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

CLOSURE MEDICAL CORPORATION

BALANCE SHEETS

(In thousands, except per share data)

The accompanying notes are an integral part of these condensed financial statements.

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CLOSURE MEDICAL CORPORATION

STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

The accompanying notes are an integral part of these condensed financial statements.

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CLOSURE MEDICAL CORPORATION

STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these condensed financial statements.

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Closure Medical Corporation

Notes to Condensed Financial Statements

(Unaudited)

1. Organization

Closure Medical Corporation (the “Company” or “Closure”) develops and manufactures innovative biomaterial-based medical devices that fulfill the needs of healthcare practitioners, patients and consumers.

On March 3, 2005, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Johnson & Johnson. At the effective time of the Merger, each share of common stock of the Company will be converted into the right to receive $27.00 in cash, without interest. Each outstanding Company stock option at the time of the closing will be cancelled in the Merger and the holder thereof shall be entitled to an amount of cash, without interest, equal to the difference between $27.00 and the exercise price of such stock option. The Merger is subject to the approval of the Company’s stockholders and other customary closing conditions. The Merger is expected to be completed during the second quarter of 2005.

2. Significant Accounting Policies

The significant accounting policies followed by the Company for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. These unaudited financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X, and in management’s opinion, all adjustments of a normal recurring nature necessary for a fair presentation have been included. They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

The results of operations for the three month period ended March 31, 2005 are not necessarily indicative of the results to be expected for the entire fiscal year ending December 31, 2005.

Recently Issued Accounting Standards

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123(R), “Share-Based Payment”. SFAS No. 123(R) revises SFAS 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and its related implementation guidance. SFAS 123(R) will require compensation costs related to share-based payment transactions to be recognized in the financial statements. The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. See “Accounting for Stock-Based Compensation” below for the pro forma net income and net income per share amounts for the three-month periods ended March 31, 2005 and 2004, as if the Company had used a fair-value-based method similar to the methods required under SFAS 123(R) to measure compensation expense for employee stock incentive awards. The Securities and Exchange Commission has ruled that SFAS 123(R) is now effective for public companies for annual, rather than interim, reporting periods that begin after June 15, 2005. The adoption of FAS 123(R)’s fair value method is expected to have a significant impact on our reported results of operations, though it will have no impact on our actual overall financial position.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends ARB 43, Chapter 4 to clarify that “abnormal” amounts of idle freight, handling costs and spoilage should be recognized as current period charges. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not anticipate that the adoption of this standard will have a material impact on the Company’s financial position or results of operations.

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Closure Medical Corporation

Notes to Condensed Financial Statements

(Unaudited)

2. Significant Accounting Policies (continued)

Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123” (“SFAS 148”). This statement amends Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the disclosure requirements of SFAS 123 and SFAS 148.

Had compensation expense, assuming it was recognized on a straight-line basis over the vesting period for awards under the Plan and in the year of purchase for benefits received under the Employee Stock Purchase Plan, been determined based on the fair value at the grant date, consistent with the provisions of SFAS 123, the Company’s results of operations would have been reduced to the pro forma amounts indicated below (in thousands):

The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and experience at the grant date.

3. Income Taxes

The Company’s annualized effective tax rate for 2005 was 34.5 percent at March 31, 2005. The effective tax provision rate differed from the statutory federal income tax rate primarily due to the impact of state taxes, the estimated effect of research and development credits and the estimated effect of the new deduction for domestic production activities enacted in 2004.

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Closure Medical Corporation

Notes to Condensed Financial Statements

(Unaudited)

4. Inventories

Inventories included the following (in thousands):

5. Comprehensive Income

The components of comprehensive income for the three-month periods are as follows (in thousands):

6. Net Income Per Common Share

Basic net income per common share is computed using the weighted average number of shares of common stock outstanding during the period.

Diluted net income per common share is computed using the weighted average number of shares of common and common equivalent shares outstanding during the period. Common equivalent shares consist of stock options using the treasury stock method.

Potential common shares that would have the effect of increasing diluted net income per share are considered to be antidilutive and were not included in calculating diluted net income per share. As of March 31, 2005 and 2004, there were 1,652,987 and 209,205 potential shares, respectively, that were not included in calculating diluted net income per share because their effect was antidilutive.

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

CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION ACT OF 1995

The following discussion should be read in conjunction with the unaudited, condensed financial statements and notes thereto included in Part I—Item 1 of this Form 10-Q and the audited financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2004.

This report and the documents incorporated by reference herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this report and the documents incorporated herein by reference, the words “expect,” “anticipate,” “believe,” “estimate,” and similar expressions are generally intended to identify forward-looking statements. These forward-looking statements are based on a number of factors concerning future events, and are subject to a number of uncertainties and other factors, many of which are outside of our control. In addition to the other information in this Quarterly Report on Form 10-Q, the following risks relating to Closure Medical if the event that the merger with Johnson & Johnson is not completed should be carefully considered. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business, operating results and financial condition. The occurrence of any of the following risks could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock. These statements include, among others, the statements in Management’s Discussion and Analysis about the following:

There are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements including, but not limited to, the following:

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These and other risks and uncertainties affecting Closure are discussed in greater detail in this report and in other filings by Closure with the Securities and Exchange Commission. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.

OVERVIEW

Closure Medical Corporation develops and manufactures innovative biomaterial-based medical devices for topical wound care and closure, as well as surgical sealant applications, that fulfill the needs of healthcare practitioners, patients and consumers. Each of our products utilizes our proprietary medical grade cyanoacrylate technology. Our strategy is to focus our business around three primary platforms: topical wound care, internal surgical sealants and new complementary technologies. Our primary platform is topical wound closure and to date we have commercialized products for wound care and closure for the professional healthcare, over-the-counter, or OTC, and veterinary markets. Within the internal surgical sealants platform, we received CE Mark approval in February 2005 allowing for commercialization of OmNex^™ Surgical Sealant, our first product to be used inside the body, in European countries. The clinical application for OmNex^™ sealant under the CE Mark allows for its use as an adjunct to sutures to achieve hemostasis in peripheral vascular reconstructions, such as when bypassing an occluded blood vessel or to create a shunt for hemodialysis access in diabetic patients. In addition, we have completed the enrollment and patient follow-up phases of the human pivotal study for the OmNex^™ product and plan to submit the U.S. premarket approval application during the third quarter of 2005. Finally, we have ongoing research into other devices and surgical sealants to be used inside the body.

Our leading product, DERMABOND adhesive, is sold to healthcare professionals as an alternative to sutures and staples to rapidly close wounds and incisions while sealing and protecting them from infection. This product allows natural healing to proceed by closing and sealing injured tissue without the trauma caused by suturing or stapling. We believe that using DERMABOND adhesive results in enhanced patient and physician benefits such as lower overall procedure costs and is easier to use than sutures or staples.

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We have other products that are marketed in the OTC market. BAND-AID® Brand Liquid Bandage quickly seals, protects and stops bleeding from minor cuts and scrapes. SOOTHE-N-SEAL® adhesive provides a protective barrier that shields oral ulcers and sores from irritation caused by eating and drinking while providing immediate and long-term pain relief.

In addition, we have two veterinary products in our NEXABAND® product line that are used in cat declaw and spay and neuter procedures.

We have entered into partnerships with third parties for the distribution and marketing of our current products to professionals and consumers. Our partners include Ethicon, Inc., a Johnson & Johnson company; Johnson & Johnson Consumer Products Company; Colgate Oral Pharmaceuticals, Inc.; and Abbott Laboratories, Inc.

On March 3, 2005, Closure, Johnson & Johnson and Holden Merger Sub, Inc., a wholly owned subsidiary of Johnson & Johnson (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). The Merger Agreement provides for a business combination whereby Merger Sub will merge with and into Closure (the “Merger”). As a result of the Merger, the separate corporate existence of Merger Sub will cease and Closure will continue as the surviving corporation in the Merger. At the effective time of the Merger, each share of common stock of Closure (other than shares owned by Closure, Johnson & Johnson and Merger Sub) will be converted into the right to receive $27.00 in cash, without interest. Each outstanding Closure stock option at the time of the closing will be cancelled in the Merger and the holder thereof shall be entitled to an amount of cash, without interest, equal to the difference between $27.00 and the exercise price of such stock option.

The Merger is subject to the approval of Closure’s stockholders and other customary closing conditions. The Merger is expected to be completed during the second quarter of 2005.

On May 6, 2005, a complaint was filed in the Chancery Court of the State of Delaware by a purported stockholder of the Company allegedly on behalf of a class of holders of the Company’s common stock. The action names as defendants the Company, its directors, Johnson & Johnson (“J&J”) and Holden Merger Sub, Inc. (“Merger Sub”). The complaint alleges that the Company’s directors breached fiduciary duties in connection with the Agreement and Plan of Merger, dated as of March 3, 2005, entered into with J&J and Merger Sub, and the disclosure contained in the related definitive proxy statement filed by the Company on May 2, 2005, and further alleges that J&J aided and abetted the alleged breaches. The plaintiff seeks to have the court certify a class and either (i) issue an injunction against the proposed transaction or (ii) in the event the proposed transaction is consummated, issue an order invalidating the transaction or awarding damages to the class. The Company believes the claims are without merit and intends to vigorously oppose the action.

There can be no assurance that the Merger will be consummated. All statements in this report with respect to the nature and needs of our business, its financial prospects and its risks and future development are made based on the assumption that we will be an independently publicly owned company going forward and, therefore, must be considered in light of the pending Merger and the prospects for its consummation.

RESULTS OF OPERATIONS

Revenues. Total revenues increased by five percent to $10.9 million for the three months ended March 31, 2005 compared to $10.5 million for the corresponding period of 2004. DERMABOND adhesive products increased to 79 percent of total revenues during the period versus 67 percent in the prior period. DERMABOND growth, approximately 23 percent, continued to be driven by shipments of the new generation ProPen products. Year-over-year BAND-AID® Brand Liquid Bandage revenues declined approximately 31 percent due to competition in the U.S. market, however sequentially, liquid bandage revenues were up approximately 156 percent primarily for shipments to international markets. We expect that DERMABOND revenues will be the primary growth driver for 2005 and represent over 80 percent of revenues. Sales of our liquid bandage products are projected to provide less than ten percent of total revenues in 2005, the majority of which are expected to be from international sales. In the U.S. market, we expect liquid bandage revenues to decline due to the continuation of the competition and pricing pressures experienced in 2004.

Cost of products sold. Cost of products sold decreased to $2.4 million for the three months ended March 31, 2005 from $2.7 million for the 2004 period. Cost of products sold as a percentage of revenues decreased to 22 percent for the three months ended March 31, 2005 from 25 percent for the corresponding 2004 period. The decrease during the 2005 period was attributable to the higher-margin DERMABOND products representing a greater share of total revenues and cost reductions achieved in the production of ProPen products. The 2004 period included start-up costs and manufacturing inefficiencies related to the production of the ProPen products which were introduced in January of that year. We expect that future costs of products sold will continue to fluctuate based on production volumes and the relative proportions of our products in the revenue mix.

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Operating Expenses. Operating expenses increased 44 percent to $5.7 million for the three months ended March 31, 2005 compared to $4.0 million for the same period of 2004. The majority of the increase was due to merger-related expenses, primarily professional service fees, of $1.3 million. Research and development expenses were $2.6 million, or 24 percent of revenues, for the 2005 period compared to $2.3 million, or 22 percent of revenues, for 2004. The increase is primarily attributable to follow-up, monitoring and data analysis activities related to the pivotal trial for OmNex^™ Surgical Sealant in the United States as well as preparation for a five-site, 100-patient European registry study to support the launch of the product in Europe. We expect these expenses will increase as we expand our product pipeline and related development efforts and clinical trials for potential new products, in particular our internal surgical sealants. General and administrative expenses were $1.8 million in 2005 compared to $1.7 million in 2004. As a percentage of revenues, general and administrative expenses increased to 17 percent in 2005 to support pre-launch initiatives for the OmNex^™ Surgical Sealant from 16 percent for the 2004 period. We expect that general and administrative expenses as a percentage of total revenues will increase during 2005 in support of the launch of the OmNex^™ sealant in Europe.

Interest income. Interest income was $331,000 for the three months ended March 31, 2005, compared to $109,000 for the three months ended March 31, 2004. The increase was due to an overall increase in investments and higher investment yields as a result of market interest rate changes from the 2004 period.

Provision for income taxes.The provision for income taxes was $1.1 million for the three months ended March 31, 2005 compared to $1.4 million during the same 2004 period. The effective tax rate for the three months ended March 31, 2005 declined to 34.5 percent from 35.8 percent in the 2004 period, primarily due to a proportionally greater effect of research and development credits and the effect of the new deduction for domestic production activities enacted in 2004. Although we record a provision for income taxes on our statement of operations, we will not be required to actually pay federal income taxes, other than alternative minimum taxes, until such time as our tax credit carryforwards of approximately $3.0 million as of March 31, 2005 are exhausted.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2005, we had net working capital of $41.9 million. Our principal sources of liquidity include cash, cash equivalents and marketable securities, which totaled $54.6 million at March 31, 2005. Additionally, Closure maintains a $3.0 million available line of credit for working capital purposes which is secured by trade accounts receivable, inventory and equipment. At March 31, 2005, there was no outstanding balance on the line of credit.

Capital Expenditures

There are no individually material capital expenditure commitments outstanding as of March 31, 2005. We estimate that 2005 capital expenditures may be up to approximately $2.0 million. We believe that our balances of cash, cash equivalents, and investments together with funds generated from operations and existing borrowing facilities will be sufficient to meet our operating cash requirements and fund required capital expenditures for the foreseeable future.

Research and Development

During 2004, Closure incurred $10.0 million in research, development and regulatory affairs expenses and through the first three months of 2005 expenses totaled $2.6 million. We anticipate that research and development expenses will continue to increase for the remainder of the year and for the next several years as we develop new products and line extensions for existing products. We also expect that clinical trials related to new products and line extensions will be costly and represent a significant part of future expenses. Research and development costs are expensed as incurred and include items related to personnel, costs of supplies, clinical trials, facility costs and fees paid to consultants and outside contractors and providers. We have arrangements with certain marketing partners in which we share certain research, development and regulatory affairs expenses related to approved projects. During the first three months of 2005, we did not record any reimbursements in accordance with these cost-sharing arrangements. We cannot estimate the costs to complete our research and development projects due to uncertainties regarding successful completion of projects, clinical trial outcomes and regulatory approvals. We believe that funds for future research and development needs can be obtained from existing cash and investment balances and from cash generated from operations. However, no assurance can be given that we may not require additional funds to support the completion of new product development, conduct clinical trials and obtain regulatory approvals.

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Cash Flows

Net cash provided by operating activities was $2.9 million for the three months ended March 31, 2005 compared to $74,000 for the same period in 2004. The increase in cash flow from operations was primarily related to the change in accounts receivable balances resulting from both the timing of shipments and improved average days outstanding during the 2005 period.

Net cash used by investing activities was $4.6 million for the three months ended March 31, 2005 compared to $760,000 during the 2004 period. The increase in net cash used during 2005 was primarily related to purchases of investments.

Net cash provided by financing activities was $1.0 million for the three months ended March 31, 2005 compared to $2.4 million for same period in 2004. The decrease in net cash provided by financing activities was due to the decrease in net proceeds from the exercise of stock options during the 2005 period.

Based on our current plans, we believe that existing cash, cash equivalents and investments, which totaled $54.6 million at March 31, 2005, will be sufficient to finance our operating and capital requirements for at least 12 to 24 months. We anticipate that our recurring operating expenses will increase for the next several years, as we expect research, development and regulatory affairs and general and administrative expenses to increase in order to develop new products, manufacture commercial quantities and fund additional clinical trials. We also may invest in long-term assets such as intangible assets and capital expenditures to expand our manufacturing capabilities.

Our future capital requirements, however, will depend on numerous factors, including but not limited to the following:

We may be required to seek additional capital to finance our operations in the future. If our currently available funds and internally generated cash flows are not sufficient to satisfy our financing and operating needs, we will be required to seek additional funding through bank borrowings, additional public or private sales of our securities, including equity securities, or through other arrangements with marketing partners. Other than our working capital line of credit, we have no credit facility or other committed sources of capital. There can be no assurance that additional funds, if required, will be available to us on favorable terms, if at all.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There have been no material changes to our critical accounting policies and estimates since December 31, 2004. For detailed information on our critical accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2004.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

INTEREST RATE SENSITIVITY

We are subject to interest rate risk on our investment portfolio which consists primarily of high quality short-term money market funds, commercial paper, auction rate securities, corporate bonds and other investments with an average maturity of less than one year, or in the case of auction rate securities having auction reset periods of less than one year. We mitigate default risk by investing in what we believe are safe and high credit quality securities and by monitoring the credit rating of investment issuers. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity and there are limitations regarding average and individual duration of investments. These available-for-sale securities are subject to interest rate risk and will decrease in value if market interest rates increase. At March 31, 2005, our total portfolio consisted of approximately $54.6 million of cash, cash equivalents and investments, the majority of which had average maturities within one year, or in the case of auction rate securities having auction reset periods of less than one year. Additionally, we generally have the ability to hold fixed income investments to maturity. Therefore, we do not expect our results of operations or cash flows to be materially affected due to a sudden change in interest rates.

FOREIGN CURRENCY EXCHANGE RISK

Our international sales and related royalties of DERMABOND adhesive and international sales of NEXABAND^® adhesives are based on sales in foreign currencies. However, all of our sales to customers are payable in U.S. dollars and we may be adversely affected by fluctuations in currency exchange rates. Additionally, fluctuations in currency exchange rates may adversely affect demand for our products by increasing the price of our products in the currency of the countries in which the products are sold.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.

(b) Change in Internal Control over Financial Reporting

No change in the Company’s internal control over financial reporting occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On May 6, 2005, a complaint relating to the Merger was filed in the Chancery Court of the State of Delaware by a purported stockholder of the Company allegedly on behalf of a class of holders of the Company’s common stock. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview” in Part I, Item 2 of this Form 10-Q for a more detailed description of the complaint.

ITEM 6. EXHIBITS

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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.

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