e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-18443
MEDICIS PHARMACEUTICAL CORPORATION
(Exact name of Registrant as specified in its charter)
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Delaware
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52-1574808 |
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(State or other jurisdiction of
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(I.R.S. Employer Identification No.) |
incorporation or organization) |
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8125 North Hayden Road
Scottsdale, Arizona 85258-2463
(Address of principal executive offices)
(602) 808-8800
(Registrants 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 þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule
YES o NO þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
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Class
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Outstanding at May 4, 2007 |
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Class A Common Stock $.014 Par Value
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55,843,845 |
MEDICIS PHARMACEUTICAL CORPORATION
Table of Contents
2
Part I. Financial Information
Item 1. Financial Statements
MEDICIS PHARMACEUTICAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
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March 31, 2007 |
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December 31, 2006 |
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(unaudited) |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
83,899 |
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$ |
203,319 |
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Short-term investments |
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560,565 |
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350,942 |
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Accounts receivable, net |
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17,997 |
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36,370 |
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Inventories, net |
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30,842 |
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27,016 |
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Deferred tax assets, net |
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20,892 |
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23,047 |
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Other current assets |
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22,814 |
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15,990 |
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Total current assets |
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737,009 |
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656,684 |
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Property and equipment, net |
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7,468 |
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6,576 |
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Intangible assets: |
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Intangible assets related to product line
acquisitions and business combinations |
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239,396 |
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239,396 |
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Other intangible assets |
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6,471 |
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6,052 |
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245,867 |
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245,448 |
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Less: accumulated amortization |
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81,086 |
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76,241 |
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Net intangible assets |
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164,781 |
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169,207 |
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Goodwill |
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63,107 |
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63,107 |
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Deferred tax assets, net |
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36,474 |
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41,241 |
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Long-term investments |
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73,558 |
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130,290 |
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Deferred financing costs, net |
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1,645 |
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2,181 |
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$ |
1,084,042 |
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$ |
1,069,286 |
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|
|
|
|
|
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|
See accompanying notes to condensed consolidated financial statements.
3
MEDICIS PHARMACEUTICAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS, Continued
(in thousands, except share amounts)
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March 31, 2007 |
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December 31, 2006 |
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(unaudited) |
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Liabilities |
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Current liabilities: |
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Accounts payable |
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$ |
51,396 |
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$ |
47,513 |
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Income taxes payable |
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36 |
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11,346 |
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Other current liabilities |
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46,420 |
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47,803 |
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Total current liabilities |
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97,852 |
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106,662 |
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Long-term liabilities: |
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Contingent convertible senior notes |
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453,060 |
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453,065 |
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Stockholders Equity |
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Preferred stock, $0.01 par value; shares
authorized: 5,000,000; no shares issued |
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Class A common stock, $0.014 par value;
shares authorized: 150,000,000; issued and
outstanding: 68,477,763 and 68,044,363 at
March 31, 2007 and December 31, 2006,
respectively |
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958 |
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952 |
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Class B common stock, $0.014 par value; shares
authorized: 1,000,000; no shares issued |
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Additional paid-in capital |
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615,165 |
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598,435 |
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Accumulated other comprehensive income |
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693 |
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537 |
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Accumulated earnings |
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259,218 |
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252,431 |
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Less: Treasury stock, 12,653,043 and 12,650,233 shares
at cost at March 31, 2007 and December 31, 2006,
respectively |
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(342,904 |
) |
|
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(342,796 |
) |
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Total stockholders equity |
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533,130 |
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509,559 |
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$ |
1,084,042 |
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$ |
1,069,286 |
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See accompanying notes to condensed consolidated financial statements.
4
MEDICIS PHARMACEUTICAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
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Three Months Ended |
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March 31, 2007 |
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March 31, 2006 |
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Net product revenues |
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$ |
92,371 |
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$ |
71,087 |
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Net contract revenues |
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2,743 |
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|
4,071 |
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Net revenues |
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95,114 |
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75,158 |
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Cost of product revenues (1) |
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10,497 |
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12,179 |
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Gross profit |
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84,617 |
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62,979 |
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Operating expenses: |
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Selling, general and administrative (2) |
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62,260 |
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51,223 |
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Research and development (3) |
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8,006 |
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97,218 |
|
Depreciation and amortization |
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5,455 |
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|
5,856 |
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|
|
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Operating income (loss) |
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8,896 |
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|
(91,318 |
) |
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Interest and investment income |
|
|
9,007 |
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|
7,020 |
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Interest expense |
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|
2,658 |
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|
2,658 |
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Income (loss) before income tax expense |
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|
15,245 |
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|
(86,956 |
) |
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|
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|
|
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Income tax expense |
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|
5,957 |
|
|
|
1,587 |
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|
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Net income (loss) |
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$ |
9,288 |
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|
$ |
(88,543 |
) |
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Basic net income (loss) per share |
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$ |
0.17 |
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$ |
(1.63 |
) |
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Diluted net income (loss) per share |
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$ |
0.15 |
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$ |
(1.63 |
) |
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Cash dividend declared per common share |
|
$ |
0.03 |
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$ |
0.03 |
|
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|
|
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|
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Basic common shares outstanding |
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|
55,626 |
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|
54,356 |
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|
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Diluted common shares outstanding |
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|
71,720 |
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|
54,356 |
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|
|
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|
(1) amounts exclude amortization of intangible
assets related to acquired products |
|
$ |
4,798 |
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|
$ |
5,075 |
|
(2) amounts include share-based
compensation expense |
|
$ |
5,377 |
|
|
$ |
6,647 |
|
(3) amounts include share-based
compensation expense |
|
$ |
138 |
|
|
$ |
534 |
|
See accompanying notes to condensed consolidated financial statements.
5
MEDICIS PHARMACEUTICAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
|
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|
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|
|
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Three Months Ended |
|
|
|
March 31, 2007 |
|
|
March 31, 2006 |
|
Operating Activities: |
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
9,288 |
|
|
$ |
(88,543 |
) |
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
5,455 |
|
|
|
5,856 |
|
Amortization of deferred financing fees |
|
|
536 |
|
|
|
536 |
|
Loss on disposal of property and equipment |
|
|
19 |
|
|
|
|
|
Gain on sale of available-for-sale investments |
|
|
(23 |
) |
|
|
(1 |
) |
Share-based compensation expense |
|
|
5,515 |
|
|
|
7,181 |
|
Deferred income tax expense |
|
|
6,921 |
|
|
|
3,860 |
|
Tax benefit from exercise of stock options and vesting of
restricted stock awards |
|
|
1,602 |
|
|
|
|
|
Excess tax benefits from share-based payment arrangements |
|
|
(849 |
) |
|
|
|
|
(Decrease) increase in provision for doubtful accounts and
returns |
|
|
(6,744 |
) |
|
|
640 |
|
Amortization of (discount)/premium on investments |
|
|
(685 |
) |
|
|
(480 |
) |
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
25,117 |
|
|
|
(4,322 |
) |
Inventories |
|
|
(3,826 |
) |
|
|
3,381 |
|
Other current assets |
|
|
(6,825 |
) |
|
|
(1,228 |
) |
Accounts payable |
|
|
3,883 |
|
|
|
(21,940 |
) |
Income taxes payable |
|
|
(12,118 |
) |
|
|
(22,304 |
) |
Other current liabilities |
|
|
(1,512 |
) |
|
|
5,844 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities |
|
|
25,754 |
|
|
|
(111,520 |
) |
|
|
|
|
|
|
|
|
|
Investing Activities: |
|
|
|
|
|
|
|
|
Purchase of property and equipment |
|
|
(1,520 |
) |
|
|
(343 |
) |
Payment of direct merger costs |
|
|
|
|
|
|
(27,582 |
) |
Payment for purchase of product rights |
|
|
(419 |
) |
|
|
(245 |
) |
Purchase of available-for-sale investments |
|
|
(305,252 |
) |
|
|
(186,744 |
) |
Sale of available-for-sale investments |
|
|
68,036 |
|
|
|
92,032 |
|
Maturity of available-for-sale investments |
|
|
85,223 |
|
|
|
34,270 |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(153,932 |
) |
|
|
(88,612 |
) |
|
|
|
|
|
|
|
|
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Financing Activities: |
|
|
|
|
|
|
|
|
Payment of dividends |
|
|
(1,670 |
) |
|
|
(1,637 |
) |
Excess tax benefits from share-based payment arrangements |
|
|
849 |
|
|
|
|
|
Proceeds from the exercise of stock options |
|
|
9,613 |
|
|
|
567 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
8,792 |
|
|
|
(1,070 |
) |
|
|
|
|
|
|
|
|
|
Effect of exchange rate on cash and cash equivalents |
|
|
(34 |
) |
|
|
(6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents |
|
|
(119,420 |
) |
|
|
(201,208 |
) |
Cash and cash equivalents at beginning of period |
|
|
203,319 |
|
|
|
446,997 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
83,899 |
|
|
$ |
245,789 |
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
6
MEDICIS PHARMACEUTICAL CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2007
(unaudited)
1. NATURE OF BUSINESS
Medicis Pharmaceutical Corporation (Medicis or the Company) is a leading specialty
pharmaceutical company focusing primarily on the development and marketing of products in
the United States (U.S.) for the treatment of dermatological, aesthetic and podiatric
conditions. Medicis also markets products in Canada for the treatment of dermatological and
aesthetic conditions.
The Company offers a broad range of products addressing various conditions or aesthetic
improvements including facial wrinkles, acne, fungal infections, rosacea, hyperpigmentation,
photoaging, psoriasis, skin and skin-structure infections, seborrheic dermatitis and
cosmesis (improvement in the texture and appearance of skin). Medicis currently offers 18
branded products. Its primary brands are OMNICEF®, PERLANE®,
RESTYLANE®, SOLODYN®, TRIAZ®, VANOS and
ZIANA.
On March 17, 2006, Medicis entered into a development and distribution agreement with
Ipsen Ltd., a wholly-owned subsidiary of Ipsen S.A. (Ipsen), whereby Ipsen granted
Aesthetica Ltd., a wholly-owned subsidiary of Medicis, rights to develop, distribute and
commercialize Ipsens botulinum toxin type A product in the U.S., Canada and Japan for
aesthetic use by physicians. The product is commonly referred to as RELOXIN® in
the U.S. aesthetic market and DYSPORT® for medical and aesthetic markets outside
the U.S. The product is not currently approved for use in the U.S., Canada or Japan.
The consolidated financial statements include the accounts of Medicis and its wholly
owned subsidiaries. The Company does not have any subsidiaries in which it does not own
100% of the outstanding stock. All of the Companys subsidiaries are included in the
consolidated financial statements. All significant intercompany accounts and transactions
have been eliminated in consolidation.
The accompanying interim condensed consolidated financial statements of Medicis have
been prepared in conformity with U.S. generally accepted accounting principles, consistent
in all material respects with those applied in the Companys Annual Report on Form 10-K for
the year ended December 31, 2006. The financial information is unaudited, but reflects all
adjustments, consisting only of normal recurring accruals, which are, in the opinion of the
Companys management, necessary to a fair statement of the results for the interim periods
presented. Interim results are not necessarily indicative of results for a full year. The
information included in this Form 10-Q should be read in conjunction with the Companys
Annual Report on Form 10-K for the year ended December 31, 2006.
2. SHARE-BASED COMPENSATION
At March 31, 2007, the Company had seven active share-based employee compensation
plans. Of these seven share-based compensation plans, only the 2006 Incentive Award Plan is
eligible for the granting of future awards. Stock option awards granted from these plans
are granted at the fair market value on the date of grant. The option awards vest over a
period determined at the time the options are granted, ranging from one to five years, and
generally have a maximum term of ten years. Certain options provide for accelerated vesting
if there is a change in control (as defined in the plans). When options are exercised, new
shares of the Companys Class A common stock are issued. Effective July 1, 2005, the
Company adopted SFAS No. 123R using the modified prospective method. Other than restricted
stock, no share-based employee compensation cost has been reflected in net income prior to
the adoption of SFAS No. 123R.
The adoption of SFAS No. 123R decreased net income before income tax expense for the
three months ended March 31, 2007 by approximately $5.5 million and decreased net income for
the three months ended March 31, 2007 by approximately $3.6 million. As a result, basic and
diluted net income per common share were decreased $0.05.
7
The total value of the stock option awards is expensed ratably over the service period
of the employees receiving the awards. As of March 31, 2007, total unrecognized
compensation cost related to stock option awards, to be recognized as expense subsequent to
March 31, 2007, was approximately $31.3 million and the related weighted-average period over
which it is expected to be recognized is approximately 2.1 years.
Prior to the adoption of SFAS No. 123R, the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows in the
condensed consolidated statements of cash flows. SFAS No. 123R requires the cash flows
resulting from the tax benefits resulting from tax deductions in excess of the compensation
cost recognized for those options (excess tax benefits) to be classified as financing cash
flows. Approximately $0.8 million of excess tax benefits were recognized during the three
months ended March 31, 2007.
A summary of stock options activity within the Companys stock-based compensation plans
and changes for the three months ended March 31, 2007 is as follows:
|
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|
|
|
|
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|
|
|
|
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|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
|
|
|
|
|
|
|
Average |
|
Remaining |
|
Aggregate |
|
|
Number |
|
Exercise |
|
Contractual |
|
Intrinsic |
|
|
of Shares |
|
Price |
|
Term |
|
Value |
Balance at December 31, 2006 |
|
|
12,989,011 |
|
|
$ |
27.63 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
14,553 |
|
|
$ |
33.35 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(389,013 |
) |
|
$ |
19.98 |
|
|
|
|
|
|
|
|
|
Terminated/expired |
|
|
(83,507 |
) |
|
$ |
33.03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2007 |
|
|
12,531,044 |
|
|
$ |
27.84 |
|
|
|
5.4 |
|
|
$ |
57,856,726 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The intrinsic value of options exercised during the three months ended March 31, 2007
was $5,815,844. Options exercisable under the Companys share-based compensation plans at
March 31, 2007 were 8,238,112, with a weighted average exercise price of $25.70, a weighted
average remaining contractual term of 4.7 years, and an aggregate intrinsic value of
$48,458,176.
A summary of fully vested stock options and stock options expected to vest, as of March
31, 2007, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
|
|
|
|
|
|
|
Average |
|
Remaining |
|
Aggregate |
|
|
Number |
|
Exercise |
|
Contractual |
|
Intrinsic |
|
|
of Shares |
|
Price |
|
Term |
|
Value |
Outstanding |
|
|
12,105,398 |
|
|
$ |
27.81 |
|
|
|
5.4 |
|
|
$ |
56,121,801 |
|
Exercisable |
|
|
7,999,320 |
|
|
$ |
25.69 |
|
|
|
4.7 |
|
|
$ |
47,164,632 |
|
The fair value of each stock option award is estimated on the date of the grant using
the Black-Scholes option pricing model with the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Three Months Ended |
|
|
March 31, 2007 |
|
March 31, 2006 |
Expected dividend yield |
|
|
0.4 |
% |
|
|
0.4 |
% |
Expected stock price volatility |
|
|
0.35 |
|
|
|
0.36 |
|
Risk-free interest rate |
|
|
4.5 |
% |
|
|
4.5 |
% |
Expected life of options |
|
|
7 |
Years |
|
|
7 |
Years |
The expected dividend yield is based on expected annual dividends to be paid by the
Company as a percentage of the market value of the Companys stock as of the date of grant.
The Company determined that a
8
blend of implied volatility and historical volatility is more
reflective of market conditions and a better indicator of expected volatility than using
purely historical volatility. The risk-free interest rate is based on the U.S. treasury
security rate in effect as of the date of grant. The expected lives of options are based on
historical data of the Company.
The weighted average fair value of stock options granted during the three months ended
March 31, 2007 and 2006 was $14.59 and $13.36, respectively.
The Company also grants restricted stock awards to certain employees. Restricted stock
awards are valued at the closing market value of the Companys Class A common stock on the
date of grant, and the total value of the award is expensed ratably over the service period
of the employees receiving the grants. During the three months ended March 31, 2007,
333,764 shares of restricted stock were granted to certain employees. Share-based
compensation expense related to all restricted stock awards outstanding during the three
months ended March 31, 2007 and 2006, was approximately $0.7 million and $0.5 million,
respectively. As of March 31, 2007, the total amount of unrecognized compensation cost
related to nonvested restricted stock awards, to be recognized as expense subsequent to
March 31, 2007, was approximately $17.5 million, and the related weighted-average period
over which it is expected to be recognized is approximately 4.5 years.
A summary of restricted stock activity within the Companys share-based compensation
plans and changes for the three months ended March 31, 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Grant-Date |
Nonvested Shares |
|
Shares |
|
Fair Value |
Nonvested at December 31, 2006 |
|
|
295,579 |
|
|
$ |
29.98 |
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
333,764 |
|
|
$ |
33.39 |
|
Vested |
|
|
(17,966 |
) |
|
$ |
29.37 |
|
Forfeited |
|
|
(2,895 |
) |
|
$ |
31.83 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested at March 31, 2006 |
|
|
608,482 |
|
|
$ |
31.86 |
|
|
|
|
|
|
|
|
|
|
The total fair value of restricted shares vested during the three months ended March
31, 2007 and 2006 was approximately $0.5 million and $0.1 million, respectively.
3. RESEARCH AND DEVELOPMENT COSTS AND ACCOUNTING FOR STRATEGIC COLLABORATIONS
All research and development costs, including payments related to products under
development and research consulting agreements, are expensed as incurred. The Company may
continue to make non-refundable payments to third parties for new technologies and for
research and development work that has been completed. These payments may be expensed at
the time of payment depending on the nature of the payment made.
The Companys policy on accounting for costs of strategic collaborations determines the
timing of the recognition of certain development costs. In addition, this policy determines
whether the cost is classified as development expense or capitalized as an asset.
Management is required to form judgments with respect to the commercial status of such
products in determining whether development costs meet the criteria for immediate expense or
capitalization. For example, when the Company acquires certain
products for which there is already an Abbreviated New Drug Application (ANDA) or a New
Drug Application (NDA) approval related directly to the product, and there is net
realizable value based on projected sales for these products, the Company capitalizes the
amount paid as an intangible asset. If the Company acquires product rights that are in the
development phase and as to which the Company has no assurance that the third party will
successfully complete its developmental milestones, the Company expenses such payments.
9
4. |
|
DEVELOPMENT AND DISTRIBUTION AGREEMENT WITH IPSEN FOR RIGHTS TO IPSENS
BOTULINUM TOXIN PRODUCT KNOWN AS RELOXIN® |
On March 17, 2006, the Company entered into a development and distribution agreement
with Ipsen, whereby Ipsen granted Aesthetica Ltd., a wholly-owned subsidiary of Medicis,
rights to develop, distribute and commercialize Ipsens botulinum toxin type A product in
the United States, Canada and Japan for aesthetic use by physicians. The product is
commonly referred to as RELOXIN® in the U.S. aesthetic market and
DYSPORT® in medical and aesthetic markets outside the U.S. The product is not
currently approved for use in the U.S., Canada or Japan. Medicis made an initial payment to
Ipsen in the amount of $90.1 million in consideration for the exclusive distribution rights
in the U.S., Canada and Japan.
Additionally, Medicis and Ipsen agreed to negotiate and enter into an agreement
relating to the exclusive distribution and development rights of the product for the
aesthetic market in Europe, and subsequently in certain other markets. Under the terms of
the U.S., Canada and Japan agreement, as amended, Medicis was obligated to make an
additional $35.1 million payment to Ipsen if this agreement was not entered into by April
15, 2006. On April 13, 2006, Medicis and Ipsen agreed to extend this deadline to July 15,
2006. In connection with this extension, Medicis paid Ipsen approximately $12.9 million in
April 2006, which would be applied against the total obligation, in the event an agreement
was not entered into by the extended deadline. On July 17, 2006, Medicis and Ipsen agreed
that the two companies would not pursue an agreement for the commercialization of the
product outside of the U.S., Canada and Japan. On July 17, 2006, Medicis made the
additional $22.2 million payment to Ipsen, representing the remaining portion of the $35.1
million total obligation, resulting from the discontinuance of negotiations for other
territories.
The initial $90.1 million payment was recognized as a charge to research and
development expense during the three months ended March 31, 2006, and the $35.1 million
obligation was recognized as a charge to research and development expense during the three
months ended June 30, 2006.
Medicis will pay an additional $26.5 million upon successful completion of various
clinical and regulatory milestones, $75.0 million upon the products approval by the FDA and
$2.0 million upon regulatory approval of the product in Japan. Ipsen will manufacture and
provide the product to Medicis for the term of the agreement, which extends to September
2019. Ipsen will receive a royalty based on sales and a supply price, the total of which is
equivalent to approximately 30% of net sales as defined under the agreement. Under the
terms of the agreement, Medicis is responsible for all remaining research and development
costs associated with obtaining the products approval in the U.S., Canada and Japan.
10
5. SHORT-TERM AND LONG-TERM INVESTMENTS
The Companys short-term and long-term investments are intended to establish a
high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate
concentrations and delivers an appropriate yield in relationship to the Companys investment
guidelines and market conditions. Short-term and long-term investments consist of corporate
and various government agency and municipal debt securities. Management classifies the
Companys short-term and long-term investments as available-for-sale. Available-for-sale
securities are carried at fair value with unrealized gains and losses reported in
stockholders equity. Realized gains and losses and declines in value judged to be other
than temporary, if any, are included in operations. A decline in the market value of any
available-for-sale security below cost that is deemed to be other than temporary, results in
an impairment in the fair value of the investment. The impairment is charged to earnings
and a new cost basis for the security is established. Premiums and discounts are amortized
or accreted over the life of the related available-for-sale security. Dividends and
interest income are recognized when earned. The cost of security sold is calculated using
the specific identification method. At March 31, 2007, the Company has recorded the
estimated fair value in available-for-sale securities for short-term and long-term
investments of approximately $560.6 million and $73.6 million, respectively. The following
is a summary of available-for-sale securities (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MARCH 31, 2007 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
U.S. corporate securities |
|
$ |
291,230 |
|
|
$ |
177 |
|
|
$ |
115 |
|
|
$ |
291,292 |
|
Other debt securities |
|
|
342,696 |
|
|
|
178 |
|
|
|
43 |
|
|
|
342,831 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
633,926 |
|
|
$ |
355 |
|
|
$ |
158 |
|
|
$ |
634,123 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the three months ended March 31, 2007, the gross realized gains on sales of
available-for-sale securities totaled $22,835, while no gross losses were realized. Such
amounts of gains and losses are determined based on the specific identification method. The
net adjustment to unrealized gains during the three months ended March 31, 2007, on
available-for-sale securities included in stockholders equity totaled $189,380. The
amortized cost and estimated fair value of the available-for-sale securities at March 31,
2007, by maturity, are shown below (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
MARCH 31, 2007 |
|
|
|
|
|
|
|
Estimated |
|
|
|
Cost |
|
|
Fair Value |
|
Available-for-sale |
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
338,325 |
|
|
$ |
338,400 |
|
Due after one year through five years |
|
|
224,551 |
|
|
|
224,673 |
|
Due after five years through 10 years |
|
|
|
|
|
|
|
|
Due after 10 years |
|
|
71,050 |
|
|
|
71,050 |
|
|
|
|
|
|
|
|
|
|
$ |
633,926 |
|
|
$ |
634,123 |
|
|
|
|
|
|
|
|
Expected maturities will differ from contractual maturities because the issuers of the
securities may have the right to prepay obligations without prepayment penalties, and the
Company views its available-for-sale securities as available for current operations. At
March 31, 2007, approximately $73.6 million in estimated fair value expected to mature
greater than one year has been classified as long-term investments since these investments
are in an unrealized loss position and it is managements intent to hold these investments
until recovery of fair value, which may be maturity.
11
The following table shows the gross unrealized losses and fair value of the Companys
investments with unrealized losses that are not deemed to be other-than-temporarily
impaired, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position at March 31, 2007 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than 12 Months |
|
|
Greater Than 12 Months |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
|
Value |
|
|
Loss |
|
|
Value |
|
|
Loss |
|
U.S. corporate securities |
|
$ |
107,551 |
|
|
$ |
97 |
|
|
$ |
3,353 |
|
|
$ |
17 |
|
Other debt securities |
|
|
51,179 |
|
|
|
43 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
158,730 |
|
|
$ |
140 |
|
|
$ |
3,353 |
|
|
$ |
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The unrealized losses on the Companys investments were caused primarily by interest
rate increases. It is expected that the investments will not be settled at a price less
than the amortized cost. Because the Company has the ability, and intent, to hold these
investments until a recovery of fair value, which may be maturity, the Company does not
consider these investments to be other than temporarily impaired at March 31, 2007.
6. SEGMENT AND PRODUCT INFORMATION
The Company operates in one significant business segment: pharmaceuticals. The
Companys current pharmaceutical franchises are divided between the dermatological and
non-dermatological fields. The dermatological field represents products for the treatment
of acne and acne-related dermatological conditions and non-acne dermatological conditions.
The non-dermatological field represents products for the treatment of urea cycle disorder
and contract revenue. The acne and acne-related dermatological product lines include
DYNACIN®, PLEXION®, SOLODYN®, TRIAZ® and
ZIANA. The non-acne dermatological product lines include LOPROX®,
OMNICEF®, RESTYLANE® and VANOS. The
non-dermatological
product lines include AMMONUL® and BUPHENYL®. The non-dermatological
field also includes contract revenues associated with licensing agreements and authorized
generics.
The Companys pharmaceutical products, with the exception of AMMONUL® and
BUPHENYL®, are promoted to dermatologists, podiatrists and plastic surgeons.
Such products are often prescribed by physicians outside these three specialties; including
family practitioners, general practitioners, primary-care physicians and OB/GYNs, as well as
hospitals, government agencies and others. Currently, all products are sold primarily to
wholesalers and retail chain drug stores. Prior to October 2006, BUPHENYL® was
primarily sold directly to hospitals and pharmacies.
The percentage of net revenues for each of the product categories is as follows:
|
|
|
|
|
|
|
|
|
|
|
THREE MONTHS ENDED |
|
|
MARCH 31, |
|
|
2007 |
|
2006 |
Acne and acne-related dermatological products |
|
|
48 |
% |
|
|
19 |
% |
Non-acne dermatological products |
|
|
43 |
|
|
|
67 |
|
Non-dermatological products |
|
|
9 |
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
Total net revenues |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
7. INVENTORIES
The Company utilizes third parties to manufacture and package inventories held for
sale, takes title to certain inventories once manufactured, and warehouses such goods until
packaged for final distribution and sale. Inventories consist of salable products held at
the Companys warehouses, as well as raw materials and components at the manufacturers
facilities, and are valued at the lower of cost or market using the first-in,
first-out method. The Company provides valuation reserves for estimated obsolescence
or unmarketable
12
inventory in an amount equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and market
conditions.
Inventory costs associated with products that have not yet received regulatory approval
are capitalized if, in the view of the Companys management, there is probable future
commercial use and future economic benefit. If future commercial use and future economic
benefit are not considered probable, then costs associated with pre-launch inventory that
has not yet received regulatory approval are expensed as research and development expense
during the period the costs are incurred. As of March 31, 2007 and December 31, 2006, there
are no costs capitalized into inventory for products that have not yet received regulatory
approval.
Inventories are as follows (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, 2007 |
|
|
December 31, 2006 |
|
Raw materials |
|
$ |
8,658 |
|
|
$ |
8,637 |
|
Finished goods |
|
|
23,710 |
|
|
|
19,709 |
|
Valuation reserve |
|
|
(1,526 |
) |
|
|
(1,330 |
) |
|
|
|
|
|
|
|
Total inventories |
|
$ |
30,842 |
|
|
$ |
27,016 |
|
|
|
|
|
|
|
|
8. CONTINGENT CONVERTIBLE SENIOR NOTES
In June 2002, the Company sold $400.0 million aggregate principal amount of its 2.5%
Contingent Convertible Senior Notes Due 2032 (the Old Notes) in private transactions. As
discussed below, approximately $230.8 million in principal amount of the Old Notes was
exchanged for New Notes on August 14, 2003. The Old Notes bear interest at a rate of 2.5%
per annum, which is payable on June 4 and December 4 of each year, beginning on December 4,
2002. The Company also agreed to pay contingent interest at a rate equal to 0.5% per annum
during any six-month period, with the initial six-month period commencing June 4, 2007, if
the average trading price of the Old Notes reaches certain thresholds. The Old Notes will
mature on June 4, 2032.
The Company may redeem some or all of the Old Notes at any time on or after June 11,
2007, at a redemption price, payable in cash, of 100% of the principal amount of the Old
Notes, plus accrued and unpaid interest, including contingent interest, if any. Holders of
the Old Notes may require the Company to repurchase all or a portion of their Old Notes on
June 4, 2007, 2012 and 2017, or upon a change in control (as defined in the indenture
governing the Old Notes) at 100% of the principal amount of the Old Notes, plus accrued and
unpaid interest, and contingent interest, if any, to the date of the repurchase, payable in
cash.
The Old Notes are convertible, at the holders option, prior to the maturity date into
shares of the Companys Class A common stock in the following circumstances:
|
|
|
during any quarter commencing after June 30, 2002, if the closing price of the
Companys Class A common stock over a specified number of trading days during the
previous quarter, including the last trading day of such quarter, is more than 110%
of the conversion price of the Old Notes, or $31.96. The Old Notes are initially
convertible at a conversion price of $29.05 per share, which is equal to a
conversion rate of approximately 34.4234 shares per $1,000 principal amount of Old
Notes, subject to adjustment; |
|
|
|
|
if the Company has called the Old Notes for redemption; |
|
|
|
|
during the five trading day period immediately following any nine consecutive
day trading period in which the trading price of the Old Notes per $1,000 principal
amount for each day of such period was less than 95% of the product of the closing
sale price of the Companys Class A common stock on that day multiplied by the
number of shares of the Companys Class A common stock issuable upon conversion of
$1,000 principal amount of the Old Notes; or |
|
|
|
|
upon the occurrence of specified corporate transactions. |
13
The Old Notes, which are unsecured, do not contain any restrictions on the payment of
dividends, the incurrence of additional indebtedness or the repurchase of the Companys
securities and do not contain any financial covenants.
The Company incurred $12.6 million of fees and other origination costs related to the
issuance of the Old Notes. The Company is amortizing these costs over the first five-year
Put period, which runs through June 4, 2007.
On August 14, 2003, the Company exchanged approximately $230.8 million in principal
amount of its Old Notes for approximately $283.9 million in principal amount of its 1.5%
Contingent Convertible Senior Notes Due 2033 (the New Notes). Holders of Old Notes that
accepted the Companys exchange offer received $1,230 in principal amount of New Notes for
each $1,000 in principal amount of Old Notes. The terms of the New Notes are similar to the
terms of the Old Notes, but have a different interest rate, conversion rate and maturity
date. Holders of Old Notes that chose not to exchange continue to be subject to the terms
of the Old Notes.
The New Notes bear interest at a rate of 1.5% per annum, which is payable on June 4 and
December 4 of each year, beginning December 4, 2003. The Company will also pay contingent
interest at a rate of 0.5% per annum during any six-month period, with the initial six-month
period commencing June 4, 2008, if the average trading price of the New Notes reaches
certain thresholds. The New Notes mature on June 4, 2033.
The Company may redeem some or all of the New Notes at any time on or after June 11,
2008, at a redemption price, payable in cash, of 100% of the principal amount of the New
Notes, plus accrued and unpaid interest, including contingent interest, if any. Holders of
the New Notes may require the Company to repurchase all or a portion of their New Notes on
June 4, 2008, 2013 and 2018, and upon a change in control (as defined in the indenture
governing the New Notes), at 100% of the principal amount of the New Notes, plus accrued and
unpaid interest, including contingent interest, if any, to the date of the repurchase,
payable in cash.
The New Notes are convertible, at the holders option, prior to the maturity date into
shares of the Companys Class A common stock in the following circumstances:
|
|
|
during any quarter commencing after September 30, 2003, if the closing price of
the Companys Class A common stock over a specified number of trading days during
the previous quarter, including the last trading day of such quarter, is more than
120% of the conversion price of the New Notes, or $46.51. The Notes are initially
convertible at a conversion price of $38.76 per share, which is equal to a
conversion rate of approximately 25.7998 shares per $1,000 principal amount of New
Notes, subject to adjustment; |
|
|
|
|
if the Company has called the New Notes for redemption; |
|
|
|
|
during the five trading day period immediately following any nine consecutive
day trading period in which the trading price of the New Notes per $1,000 principal
amount for each day of such period was less than 95% of the product of the closing
sale price of the Companys Class A common stock on that day multiplied by the
number of shares of the Companys Class A common stock issuable upon conversion of
$1,000 principal amount of the New Notes; or |
|
|
|
|
upon the occurrence of specified corporate transactions. |
The New Notes, which are unsecured, do not contain any restrictions on the incurrence
of additional indebtedness or the repurchase of the Companys securities and do not contain
any financial covenants. The New Notes require an adjustment to the conversion price if the
cumulative aggregate of
all current and prior dividend increases above $0.025 per share would result in at least a
one percent (1%) increase in the conversion price. This threshold has not been reached and
no adjustment to the conversion price has been made.
14
As a result of the exchange, the outstanding principal amounts of the Old Notes and the
New Notes were $169.2 million and $283.9 million, respectively. Both the New Notes and Old
Notes are reported in aggregate on the Companys condensed consolidated balance sheets. The
Company incurred approximately $5.1 million of fees and other origination costs related to
the issuance of the New Notes. The Company is amortizing these costs over the first
five-year Put period, which runs through June 4, 2008.
During the quarters ended December 31, 2006, December 31, 2005, September 30, 2005,
December 31, 2004, September 30, 2004, June 30, 2004, March 31, 2004 and December 31, 2003,
the Old Notes met the criteria for the right of conversion into shares of the Companys
Class A common stock. This right of conversion of the holders of Old Notes was triggered by
the Companys Class A common stock closing above $31.96 on 20 of the last 30 trading days
and the last trading day of the quarters ended December 31, 2006, December 31, 2005,
September 30, 2005, December 31, 2004, September 30, 2004, June 30, 2004, March 31, 2004 and
December 31, 2003. The holders of Old Notes had this conversion right only until March 31,
2007. During the quarters ended March 31, 2007, September 31, 2006, June 30, 2006, March
31, 2006, June 30, 2005 and March 31, 2005, the Old Notes did not meet the criteria for the
right of conversion. At the end of each future quarter, the conversion rights will be
reassessed in accordance with the bond indenture agreement to determine if the conversion
trigger rights have been achieved. During the three months ended March 31, 2007, September
30, 2004 and March 31, 2004, outstanding principal amounts of $5,000, $2,000 and $6,000 of
Old Notes, respectively, were converted into shares of the Companys Class A common stock.
As of May 9, 2007, no other Old Notes had been converted.
9. INCOME TAXES
Income taxes are determined using an annual effective tax rate, which generally differs
from the U.S. Federal statutory rate, primarily because of state and local income taxes,
charitable contribution deductions, tax credits available in the U.S., the treatment of
certain share-based payments under SFAS 123R that are not designed to normally result in tax
deductions, and differences in tax rates in certain non-U.S. jurisdictions. The Companys
effective tax rate may be subject to fluctuations during the year as new information is
obtained which may affect the assumptions the Company uses to estimate its annual effective
tax rate, including factors such as the Companys mix of pre-tax earnings in the various tax
jurisdictions in which the Company operates, changes in valuation allowances against
deferred tax assets, reserves for tax audit issues and settlements, utilization of tax
credits and changes in tax laws in jurisdictions where the Company conducts operations. The
Company recognizes deferred tax assets and liabilities for temporary differences between the
financial reporting basis and the tax basis of its assets and liabilities, along with net
operating losses and credit carryforwards. The Company records valuation allowances against
deferred tax assets to reduce the net carrying values to amounts that are more likely than
not to be realized.
At March 31, 2007, the Company had a federal net operating loss carryforward of
approximately $14.2 million that will begin to expire in varying amounts in the years 2008
through 2020 if not previously utilized. The net operating loss carryforward was acquired
in connection with the Companys merger with Ascent Pediatrics, Inc. (Ascent) during
fiscal year 2002. As a result of the merger and related ownership change for Ascent, the
annual utilization of the net operating loss carryforward is limited under Internal Revenue
Code Section 382. The federal net operating loss of $14.2 million is net of the Section 382
limitation, thus representing the Companys estimate of the net operating loss carryforward
that will be realized.
At March 31, 2007, the Company had a charitable contribution carryover of approximately
$4.9 million. The charitable contribution carryover will begin to expire in 2008 if not
previously utilized.
Additionally, the Company has a capital loss carryover of $0.2 million. The capital
loss carryover will begin to expire in 2008 if not previously utilized.
During the three months ended March 31, 2007 and March 31, 2006, the Company made net
tax payments of $12.4 million and $20.7 million, respectively.
15
The Company operates in multiple tax jurisdictions and is periodically subject to audit
in these jurisdictions. These audits can involve complex issues that may require an
extended period of time to resolve and may cover multiple years. The Company and its
domestic subsidiaries file a consolidated U.S. federal income tax return. Such returns have
either been audited or settled through statute expiration through fiscal 2004.
The Company owns two subsidiaries that file corporate tax returns in Sweden. The
Swedish tax authorities examined the tax return of one of the subsidiaries for fiscal 2004.
The examiners issued a no change letter, and the examination is complete. The Companys
other subsidiary in Sweden has not been examined by the Swedish tax authorities. The
Swedish statute of limitation may be open for up to five years from the date the tax return
was filed. Thus, all returns filed since this entitys formation in fiscal 2003 are open
under the statute of limitation.
The Company and its consolidated subsidiaries received a final notice of proposed
assessment in January 2007 from the Arizona Department of Revenue for fiscal years ended
2001 through 2004. The Arizona Department of Revenue has proposed adjustments related to
the subsidiaries to be included in the Companys combined Arizona tax return and to the
Companys apportionment of income to Arizona. In January 2007, the Company filed a protest
of the final assessment from the Arizona Department of Revenue. It is possible that the
Companys protest of the Arizona assessment may be resolved within the next twelve months.
However, at this time, the Company is unable to estimate the outcome of the protest or any
potential settlement with the state. The Company believes that it has made adequate
accruals for the assessment and does not believe that the resolution of the matters under
protest will have a material effect on the financial position of the Company. The final
settlement, when executed, may result in a significant reduction in the Companys
unrecognized tax benefit amount.
Effective January 1, 2007, the Company adopted FIN No. 48, Accounting for Uncertainty
in Income Taxes. In accordance with FIN No. 48, the Company recognized a cumulative-effect
adjustment of approximately $808,000, increasing its liability for unrecognized tax
benefits, interest, and penalties and reducing the January 1, 2007 balance of retained
earnings.
At January 1, 2007, the Company had $3.0 million in unrecognized tax benefits, the
recognition of which would have an effect of $1.8 million on the effective tax rate.
The Company recognizes accrued interest and penalties related to unrecognized tax
benefits in income tax expense. At January 1, 2007, the Company had accrued $200,000 and $0
for the potential payment of interest and penalties on unrecognized tax benefits,
respectively.
There were no significant changes to any of these amounts during the first quarter of
2007.
10. DIVIDENDS DECLARED ON COMMON STOCK
On March 14, 2007, the Company declared a cash dividend of $0.03 per issued and
outstanding share of its Class A common stock payable on April 30, 2007 to stockholders of
record at the close of business on April 2, 2007. The $1.7 million dividend was recorded as
a reduction of accumulated earnings and is included in other current liabilities in the
accompanying condensed consolidated balance sheets as of March 31, 2007.
11. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) includes net income (loss) and other comprehensive
income, which consists of foreign currency translation adjustments and unrealized gains and
losses on available-for-sale investments. Total comprehensive income for the three months
ended March 31, 2007 was $9.4 million. Total comprehensive loss for the three months ended
March 31, 2006 was $87.4 million.
16
12. NET INCOME (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted net income (loss)
per common share (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2007 |
|
|
2006 |
|
BASIC |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
9,288 |
|
|
$ |
(88,543 |
) |
|
|
|
|
|
|
|
|
|
Weighted average number of
common shares outstanding |
|
|
55,626 |
|
|
|
54,356 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per common
share |
|
$ |
0.17 |
|
|
$ |
(1.63 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DILUTED |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
9,288 |
|
|
$ |
(88,543 |
) |
|
|
|
|
|
|
|
|
|
Add: |
|
|
|
|
|
|
|
|
Tax-effected interest expense and
issue costs related to Old Notes |
|
|
836 |
|
|
|
|
|
Tax-effected interest expense and
issue costs related to New Notes |
|
|
839 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) assuming dilution |
|
$ |
10,963 |
|
|
$ |
(88,543 |
) |
|
|
|
|
|
|
|
|
|
Weighted average number of
common shares |
|
|
55,626 |
|
|
|
54,356 |
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
Old Notes |
|
|
5,823 |
|
|
|
|
|
New Notes |
|
|
7,325 |
|
|
|
|
|
Stock options and restricted stock |
|
|
2,946 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common
shares assuming dilution |
|
|
71,720 |
|
|
|
54,356 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income (loss) per common
share |
|
$ |
0.15 |
|
|
$ |
(1.63 |
) |
|
|
|
|
|
|
|
Diluted net income (loss) per common share must be calculated using the if-converted
method in accordance with EITF 04-8, Effect of Contingently Convertible Debt on Earnings
per Share. Diluted net income (loss) per share is calculated by adjusting net income
(loss) for tax-effected net interest and issue costs on the Old Notes and New Notes, divided
by the weighted average number of common shares outstanding assuming conversion.
The diluted net income per common share computation for the three months ended March
31, 2007 excludes 3,096,698 shares of stock that represented outstanding stock options whose
exercise price were greater than the average market price of the common shares during the
period and were anti-dilutive.
Due to the Companys net loss during the three months ended March 31, 2006, a
calculation of diluted earnings per share is not required. For the three months ended March
31, 2006, potentially dilutive securities consisted of restricted stock and stock options
convertible into 2,209,105 shares in the aggregate,
17
and 5,822,894 and 7,324,819 shares of common stock, issuable upon conversion
of the Old Notes and New Notes, respectively.
13. CONTINGENCIES
The government notified the Company on December 14, 2004, that it is investigating
claims that the Company violated the federal False Claims Act in connection with the alleged
off-label marketing and promotion of LOPROX® and LOPROX® TS products
(LOPROX®) to pediatricians during periods prior to the Companys May 2004
disposition of the Companys pediatric sales division. On April 25, 2007, the Company
entered into a Settlement Agreement with the Justice Department, the Office of Inspector
General of the Department of Health and Human Services (OIG) and the TRICARE Management
Activity (collectively, the United States) and private complainants to settle all
outstanding federal and state civil suits against the corporation in connection with claims
related to our alleged off-label marketing and promotion of LOPROX® (the Settlement
Agreement). The settlement is neither an admission of liability by the Company nor a
concession by the United States that its claims are not well founded. Pursuant to the
Settlement Agreement, the Company will pay approximately $10 million to settle the matter
between the parties. The Settlement Agreement provides that, upon full payment of the
settlement fees and execution of a Corporate Integrity Agreement, the United States releases
the Company from the claims asserted by the United States and will refrain from instituting
action seeking exclusion from Medicare, Medicaid, the TRICARE Program and other federal
health care programs for the alleged conduct. These releases relate solely to the
allegations related to the Company and do not cover individuals. The Settlement Agreement
also provides that the private complainants release the Company and its officers, directors
and employees from the asserted claims, and the Company releases the United States and the
private complainants from asserted claims. As of March 31, 2007, the Company has accrued a
loss contingency of $10.2 million for this matter in connection with the possibility of
additional expenses related to the settlement amount. Of this amount, $6.0 million was
recorded during the three months ended March 31, 2006, $2.0 million was recorded during the
three months ended June 30, 2006, and $2.2 million was recorded during the three months
ended September 30, 2006. This $10.2 million loss contingency is included in other current
liabilities as of March 31, 2007 and December 31, 2006 in the accompanying condensed
consolidated balance sheets and $6.0 million is included in selling, general and
administrative expenses for the three months ended March 31, 2006 in the accompanying
condensed consolidated statements of income.
As part of the Settlement Agreement, the Company has entered into a five-year Corporate
Integrity Agreement with the OIG to resolve any potential administrative claims the OIG may
have arising out of the governments investigation (the CIA). The CIA acknowledges the
existence of the Companys comprehensive existing compliance program and provides for
certain other compliance-related activities during the term of the CIA, including the
maintenance of a compliance program that, among other things, is designed to ensure
compliance with the CIA, federal health care programs and FDA requirements. Pursuant to the
CIA, the Company is required to notify the OIG, in writing, of: (i) any ongoing government
investigation or legal proceeding involving an allegation that the Company has committed a
crime or has engaged in fraudulent activities; (ii) any other matter that a reasonable
person would consider a probable violation of applicable criminal, civil, or administrative
laws; (iii) any written report, correspondence, or communication to the FDA that materially
discusses any unlawful or improper promotion of the Companys products; and (iv) any change
in location, sale, closing, purchase, or establishment of a new business unit or location
related to items or services that may be reimbursed by Federal health care programs. The
Company is also subject to periodic reporting and certification requirements attesting that
the provisions of the CIA are being implemented and followed, as well as certain document
and record retention mandates. The Company has hired a Chief Compliance Officer and created
an enterprise-wide compliance function to administer its obligations under the CIA.
On or about October 12, 2006, the Company and the United States Attorneys Office for
the District of Kansas entered into a Nonprosecution Agreement wherein the government agreed
not to prosecute the Company for any alleged criminal violations relating to the alleged
off-label marketing and promotion of LOPROX®. In exchange for the governments
agreement not to pursue any criminal charges against the Company, the Company has agreed to
continue cooperating with the government in its
ongoing investigation into whether past and present employees and officers may have
violated federal criminal law regarding alleged off-label marketing and promotion of
LOPROX® to pediatricians. No individuals have
18
been designated as targets of the
investigation. Any such claims, prosecutions or other proceedings, with respect to the
Companys past and present employees and officers, the cost of their defense and fines and
penalties resulting therefrom could have a material impact on the Companys reputation,
business and financial condition.
In addition to the matters discussed above, in the ordinary course of business, the
Company is involved in a number of legal actions, both as plaintiff and defendant, and could
incur uninsured liability in any one or more of them. Although the outcome of these actions
is not presently determinable, it is the opinion of the Companys management, based upon the
information available at this time, that the expected outcome of these matters, individually
or in the aggregate, will not have a material adverse effect on the results of operations or
financial condition of the Company.
14. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
clarifies the definition of fair value, establishes a framework for measuring fair value,
and expands the disclosures about fair value measurements. SFAS No. 157 is effective for
fiscal years beginning after November 15, 2007. The Company is currently evaluating SFAS
No. 157 and its impact, if any, on the Companys consolidated results of operations and
financial condition.
Effective January 1, 2007, the Company adopted FIN 48, Accounting for Uncertainty in
Income Taxes an interpretation of FASB Statement No. 109. FIN No. 48 provides guidance
for the recognition threshold and measurement attributes for financial statement recognition
and measurement of a tax position taken, or expected to be taken, in a tax return. In
accordance with FIN No. 48, the Company recognized a cumulative-effect adjustment of
approximately $808,000, increasing its liability for unrecognized tax benefits, interest,
and penalties and reducing the January 1, 2007 balance of retained earnings. See Note 9 for
more information on income taxes.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Statements and Financial Liabilities, which provides companies with an option to report
selected financial assets and liabilities at fair value. SFAS No. 159 requires companies to
provide additional information that will help investors and other users of financial
statements to more easily understand the effect of the companys choice to use fair value on
its earnings. It also requires entities to display the fair value of those assets and
liabilities for which the company has chosen to use fair value on the face of the balance
sheet. The new Statement does not eliminate disclosure requirements included in other
accounting standards, including requirements for disclosures about fair value measurements
included in FASB Statements No. 157, Fair Value Measurements, and No. 107, Disclosures about
Fair Value of Financial Instruments. The Company is currently evaluating SFAS No. 159 and
its impact, if any, on the Companys consolidated results of operations and financial
condition.
15. SUBSEQUENT EVENT
On May 2, 2007, the FDA approved the dermal filler PERLANE® for implantation
into the deep dermis to superficial subcutis for the correction of moderate to severe facial
folds and wrinkles, such as nasolabial folds. In accordance with the Companys agreements
with Q-Med AB, the Company paid $29.1 million to Q-Med as a result of this milestone. The
$29.1 million payment will be included in long-lived assets in the Companys condensed
consolidated balance sheets as of June 30, 2007.
19
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
We are a leading independent specialty pharmaceutical company focused primarily on
helping patients attain a healthy and youthful appearance and self-image through the
development and marketing in the U.S. of products for the treatment of dermatological,
aesthetic and podiatric conditions. We also market products in Canada for the treatment of
dermatological and aesthetic conditions. We offer a broad range of products addressing
various conditions or aesthetics improvements, including dermal fillers, acne, fungal
infections, rosacea, hyperpigmentation, photoaging, psoriasis, skin and skin-structure
infections, seborrheic dermatitis and cosmesis (improvement in the texture and appearance of
skin).
Our current product lines are divided between the dermatological and non-dermatological
fields. Our dermatological field represents products for the treatment of acne and
acne-related dermatological conditions and non-acne dermatological conditions. Our
non-dermatological field represents products for the treatment of urea cycle disorder and
contract revenue. Our acne and acne-related dermatological product lines include
DYNACIN®, PLEXION®, SOLODYN®, TRIAZ® and
ZIANA. Our non-acne dermatological product lines include LOPROX®,
OMNICEF®, RESTYLANE®, VANOS and PERLANE®
(approved by the FDA on May 2, 2007). Our non-dermatological product lines include
AMMONUL® and BUPHENYL®. Our non-dermatological field also includes
contract revenues associated with licensing agreements and authorized generic agreements.
Key Aspects of Our Business
We derive a majority of our revenue from our primary products: OMNICEF®,
RESTYLANE®, SOLODYN®, TRIAZ®, VANOS and
ZIANA. We believe that sales of our primary products and PERLANE®,
which was approved for use by the FDA in the U.S. on May 2, 2007, will constitute a
significant portion of our sales for the foreseeable future.
We have built our business by executing a four-part growth strategy: promoting existing
brands, developing new products and important product line extensions, entering into
strategic collaborations and acquiring complementary products, technologies and businesses.
Our core philosophy is to cultivate relationships of trust and confidence with the high
prescribing dermatologists and podiatrists and the leading plastic surgeons in the U.S.
We schedule our inventory purchases to meet anticipated customer demand. As a result,
miscalculation of customer demand or relatively small delays in our receipt of manufactured
products could result in revenues being deferred or lost. Our operating expenses are based
upon anticipated sales levels, and a high percentage of our operating expenses are
relatively fixed in the short term. Depending on the customer, we recognize revenue at the
time of shipment to the customer, or at the time of receipt by the customer, net of
estimated provisions. Consequently, variations in the timing of revenue recognition could
cause significant fluctuations in operating results from period to period and may result in
unanticipated periodic earnings shortfalls or losses.
We estimate customer demand for our prescription products primarily through use of
third party syndicated data sources which track prescriptions written by health care
providers and dispensed by licensed pharmacies. The data represents extrapolations from
information provided only by certain pharmacies and are estimates of historical demand
levels. We estimate customer demand for our non-prescription products primarily through
internal data that we compile. We observe trends from these data, and, coupled with certain
proprietary information, prepare demand forecasts that are the basis for purchase orders for
finished and component inventory from our third party manufacturers and suppliers. Our
forecasts may fail to accurately anticipate ultimate customer demand for our products.
Overestimates of demand may result in excessive inventory production and underestimates may
result in inadequate supply of our products in channels of distribution.
We sell our products primarily to major wholesalers and retail pharmacy chains.
Approximately 75% of our gross revenues are derived from two major drug wholesale concerns.
While we attempt to
20
estimate inventory levels of our products at our major wholesale
customers by using historical prescription information and historical purchase patterns,
this process is inherently imprecise. Rarely do wholesale customers provide us complete
inventory levels at regional distribution centers, or within their national distribution
systems. We rely wholly upon our wholesale and drug chain customers to effect the
distribution allocation of substantially all of our products. Based upon historically
consistent purchasing patterns of our major wholesale customers, we believe our estimates of
trade inventory levels of our products are reasonable. We further believe that inventories
of our products among wholesale customers, taken as a whole, are similar to those of other
specialty pharmaceutical companies, and that our trade practices, which periodically involve
volume discounts and early payment discounts, are typical of the industry.
We periodically offer promotions to wholesale and chain drugstore customers to
encourage dispensing of our prescription products, consistent with prescriptions written by
licensed health care providers. Because many of our prescription products compete in
multi-source markets, it is important for us to ensure the licensed health care providers
dispensing instructions are fulfilled with our branded products and are not substituted with
a generic product or another therapeutic alternative product which may be contrary to the
licensed health care providers recommended and prescribed Medicis brand. We believe that a
critical component of our brand protection program is maintenance of full product
availability at drugstore and wholesale customers. We believe such availability reduces the
probability of local and regional product substitutions, shortages and backorders, which
could result in lost sales. We expect to continue providing favorable terms to wholesale
and retail drug chain customers as may be necessary to ensure the fullest possible
distribution of our branded products within the pharmaceutical chain of commerce.
We cannot control or significantly influence the purchasing patterns of our wholesale
and retail drug chain customers. They are highly sophisticated customers that purchase
products in a manner consistent with their industry practices and, presumably, based upon
their projected demand levels. Purchases by any given customer, during any given period, may
be above or below actual prescription volumes of any of our products during the same period,
resulting in fluctuations of product inventory in the distribution channel.
Results of Operations
The following table sets forth certain data as a percentage of net revenues for the
periods indicated.
|
|
|
|
|
|
|
|
|
|
|
THREE MONTHS ENDED |
|
|
MARCH 31, |
|
MARCH 31, |
|
|
2007 (a) |
|
2006 (b) |
Net revenues |
|
|
100.0 |
% |
|
|
100.0 |
% |
Gross profit (c) |
|
|
89.0 |
|
|
|
83.8 |
|
Operating expenses |
|
|
79.6 |
|
|
|
205.3 |
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
9.4 |
|
|
|
(121.5 |
) |
Interest and investment income (expense), net |
|
|
6.7 |
|
|
|
5.8 |
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax expense |
|
|
16.1 |
|
|
|
(115.7 |
) |
Income tax expense |
|
|
6.3 |
|
|
|
2.1 |
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
9.8 |
% |
|
|
(117.8 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Included in operating expenses is $5.5 million (5.8% of net revenues) of
compensation expense related to stock options and restricted stock. |
|
(b) |
|
Included in operating expenses is $90.9 million (121.0% of net revenues)
related to our development and distribution agreement with Ipsen for the development of
RELOXIN®, $7.2 million (9.6% of net revenues) of compensation
expense related to stock options and restricted stock, $6.0 million (8.0% of net
revenues) related to a loss contingency for a legal matter and $1.8 million (2.4% of
net revenues) related to a settlement of a dispute related to our merger with Ascent. |
|
(c) |
|
Gross profit does not include amortization of the related intangibles as such
expense is included in operating expenses. |
21
Three Months Ended March 31, 2007 Compared to the Three Months Ended March 31, 2006
Net Revenues
The following table sets forth the net revenues for the three months ended March 31,
2007 (the first quarter of 2007) and March 31, 2006 (the first quarter of 2006), along
with the percentage of net revenues and percentage point change for each of our product
categories (dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
|
First Quarter |
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
$Change |
|
|
% Change |
|
Net product revenues |
|
$ |
92.4 |
|
|
$ |
71.1 |
|
|
$ |
21.3 |
|
|
|
29.9 |
% |
Net contract revenues |
|
$ |
2.7 |
|
|
$ |
4.1 |
|
|
$ |
(1.4 |
) |
|
|
(32.6 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
|
$ |
95.1 |
|
|
$ |
75.2 |
|
|
$ |
19.9 |
|
|
|
26.6. |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
First Quarter |
|
|
|
|
2007 |
|
2006 |
|
Change |
Acne and acne-related
dermatological products |
|
|
48.3 |
% |
|
|
18.6 |
% |
|
|
29.7 |
% |
Non-acne dermatological
products |
|
|
42.7 |
% |
|
|
67.3 |
% |
|
|
(24.6 |
)% |
Non-dermatological products |
|
|
9.0 |
% |
|
|
14.1 |
% |
|
|
(5.1 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our total net revenues increased during the first quarter of 2007 primarily as a result
of sales of SOLODYN®, which was approved by the FDA during the second quarter of
2006, and ZIANA, which was approved by the FDA during the fourth quarter of
2006. Net revenues associated with our acne and acne-related dermatological products
increased as a percentage of net revenues and increased in net dollars by 228.1% during the
first quarter of 2007 as compared to the first quarter of 2006 as a result of sales of
SOLODYN® and ZIANA, partially offset by decreases in sales of
DYNACIN® and TRIAZ® due to competitive pressures, including generic
competition. Net revenues associated with our non-acne dermatological products decreased as
a percentage of net revenues, and decreased in net dollars by 19.6% during the first quarter
of 2007, primarily due to a decrease in sales of RESTYLANE® due to the recent
introduction of several competitive products. Net revenues associated with our
non-dermatological products decreased as a percentage of net revenues, and decreased in net
dollars by 19.6% during the first quarter of 2007 as compared to the first quarter of 2006,
primarily due to a decrease in contract revenue.
Gross Profit
Gross profit represents our net revenues less our cost of product revenue. Our cost of
product revenue includes our acquisition cost for the products we purchase from our third
party manufacturers and royalty payments made to third parties. Amortization of intangible
assets related to products sold is not included in gross profit. Amortization expense
related to these intangibles for the first quarter of 2007 and 2006 was approximately $4.8
million and $5.1 million, respectively. Product mix plays a significant role in our
quarterly and annual gross profit as a percentage of net revenues. Different products
generate different gross profit margins, and the relative sales mix of higher gross profit
products and lower gross profit products can affect our total gross profit.
22
The following table sets forth our gross profit for the first quarter of 2007 and 2006,
along with the percentage of net revenues represented by such gross profit (dollar amounts
in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
First Quarter |
|
|
|
|
|
|
2007 |
|
2006 |
|
$Change |
|
% Change |
Gross profit |
|
$ |
84.6 |
|
|
$ |
63.0 |
|
|
$ |
21.6 |
|
|
|
34.4 |
% |
% of net revenues |
|
|
89.0 |
% |
|
|
83.8 |
% |
|
|
|
|
|
|
|
|
The increase in gross profit during the first quarter of 2007, compared to the first
quarter of 2006, was due to the increase in our net revenues, and the increase in gross
profit as a percentage of net revenues was primarily due to the different mix of products
sold during the first quarter of 2007 as compared to the first quarter of 2006. The launch
of SOLODYN®, a higher margin product, during the second quarter of 2006, was the
primary change in the mix of products sold during the comparable periods that affected gross
profit as a percentage of net revenues.
Selling, General and Administrative Expenses
The following table sets forth our selling, general and administrative expenses for the
first quarter of 2007 and 2006, along with the percentage of net revenues represented by
selling, general and administrative expenses (dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
First Quarter |
|
|
|
|
|
|
2007 |
|
2006 |
|
$Change |
|
% Change |
Selling, general and administrative |
|
$ |
62.3 |
|
|
$ |
51.2 |
|
|
$ |
11.1 |
|
|
|
21.5 |
% |
% of net revenues |
|
|
65.5 |
% |
|
|
68.2 |
% |
|
|
|
|
|
|
|
|
Share-based compensation expense
included in selling, general and
administrative |
|
$ |
5.4 |
|
|
$ |
6.6 |
|
|
$ |
(1.2 |
) |
|
|
(19.1 |
)% |
The increase in selling, general and administrative expenses during the first quarter
of 2007 from the first quarter of 2006 was attributable to approximately $6.2 million of
increased personnel costs, primarily related to an increase in the number of employees
increasing from 357 as of March 31, 2006 to 425 as of March 31, 2007 and the effect of the
annual salary increase that occurred during February 2007, $5.7 million of increased
promotional expense, primarily related to RESTYLANE®, SOLODYN® and
ZIANA, $3.4 million of increased professional and consulting expenses, including
costs related to the development and implementation of our new enterprise resource planning
(ERP) system, and $4.1 million of other additional selling, general and administrative costs
incurred during the first quarter of 2007. These increases were partially offset by certain
costs incurred during the first quarter of 2006 that were not incurred during the first
quarter of 2007, including $6.0 million related to a loss contingency for a legal matter,
approximately $1.8 million related to a settlement of a dispute related to our merger with
Ascent, approximately $0.5 million of professional fees related to our development and
distribution agreement with Ipsen for the development of RELOXIN®.
23
Research and Development Expenses
The following table sets forth our research and development expenses for the first
quarter of 2007 and 2006 (dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
First Quarter |
|
|
|
|
|
|
2007 |
|
2006 |
|
$Change |
|
% Change |
Research and development |
|
$ |
8.0 |
|
|
$ |
97.2 |
|
|
$ |
(89.2 |
) |
|
|
(91.8 |
)% |
Charges included in research
and development |
|
|
|
|
|
|
90.5 |
|
|
|
(90.5 |
) |
|
|
(100.0 |
)% |
Share-based compensation
expense included in
research and development |
|
|
0.1 |
|
|
|
0.5 |
|
|
$ |
(0.4 |
) |
|
|
(74.1 |
)% |
Included in research and development expenses for the first quarter of 2007 was
approximately $0.1 million of share-based compensation expense. Included in research and
development expenses for the first quarter of 2006 was $90.5 million related to the
development and distribution agreement with Ipsen for the development of RELOXIN®
(including $90.1 million paid to Ipsen) and approximately $0.5 million of share-based
compensation expense. During the first quarter of 2007, we incurred approximately $4.3
million of research and development costs related to the development of RELOXIN®.
We expect research and development expenses to continue to fluctuate from quarter to
quarter based on the timing of the achievement of development milestones under license and
development agreements, as well as the timing of other development projects and the funds
available to support these projects. We expect to incur significant research and
development expenses related to the development of RELOXIN® each quarter
throughout the development process. In accordance with our agreements with Q-Med AB, we
paid $29.1 million to Q-Med upon receipt of FDA approval of PERLANE®. This
milestone was achieved on May 2, 2007, and the $29.1 million is being capitalized as a
long-lived asset.
In accordance with our development and distribution agreement with Ipsen for the
development of RELOXIN®, we will pay Ipsen $26.5 million upon successful
completion of various clinical and regulatory milestones, which we will recognize as
research and development expense when incurred.
Depreciation and Amortization Expenses
Depreciation and amortization expenses during the first quarter of 2007 decreased $0.4
million, or 6.9%, to $5.5 million from $5.9 million during the first quarter of 2006. This
decrease was primarily due to the amount of intangible assets being amortized during the
first quarter of 2007 as compared to the first quarter of 2006, due to the write-down of
long-lived assets due to impairment during the three months ended September 30, 2006. The
remaining amortizable lives of these long-lived assets were also shortened. These
long-lived assets had an aggregate cost basis of approximately $76.6 million and were being
amortized at a rate of approximately $0.4 million per quarter. These long-lived assets were
written-down to an aggregate new cost basis of approximately $3.6 million, and are being
amortized at an aggregate rate of approximately $0.1 million per quarter.
Interest and Investment Income
Interest and investment income during the first quarter of 2007 increased $2.0 million,
or 28.3%, to $9.0 million from $7.0 million during the first quarter of 2006, due to an
increase in the funds available for investment and an increase in the interest rates
achieved by our invested funds during the first quarter of fiscal 2007.
Interest Expense
Interest expense during the first quarter of 2007 remained consistent with the first
quarter of 2006, at $2.7 million. Our interest expense during the first quarter of 2007 and
2006 consisted of interest expense on our Old Notes, which accrue interest at 2.5% per
annum, our New Notes, which accrue interest at 1.5% per annum,
and amortization of fees and other origination costs related to the issuance of the Old
Notes and New Notes.
24
See Note 8 in our accompanying condensed consolidated financial
statements for further discussion on the Old Notes and New Notes.
Income Tax Expense
Income taxes are determined using an annual effective tax rate, which generally differs
from the U.S. Federal statutory rate, primarily because of state and local income taxes,
enhanced charitable contribution deductions for inventory, tax credits available in the
U.S., the treatment of certain share-based payments under SFAS 123R that are not designed to
normally result in tax deductions, various expenses that are not deductible for tax
purposes, and differences in tax rates in certain non-U.S. jurisdictions. Our effective tax
rate may be subject to fluctuations during the year as new information is obtained which may
affect the assumptions we use to estimate our annual effective tax rate, including factors
such as our mix of pre-tax earnings in the various tax jurisdictions in which we operate,
changes in valuation allowances against deferred tax assets, reserves for tax audit issues
and settlements, utilization of tax credits and changes in tax laws in jurisdictions where
we conduct operations. We recognize deferred tax assets and liabilities for temporary
differences between the financial reporting basis and the tax basis of our assets and
liabilities, along with net operating losses and credit carryforwards. We record valuation
allowances against our deferred tax assets to reduce the net carrying values to amounts that
management believes is more likely than not to be realized.
Our effective tax rate for the first quarter of 2007 was 39.17% compared to our
effective tax rate of (1.8)% for the first quarter of 2006. The provision for
income taxes generally reflects managements estimate of the effective tax rate expected to be
applicable for the full fiscal year. However, during the first quarter of 2006, the
Companys effective tax rate of (1.8%) differed from the Companys estimate of the effective
tax rate for the full 2006 fiscal year. The Companys effective tax rate during the first
quarter of 2006 relates to the initial tax treatment of the $90.1 million paid to Ipsen
under the development and distribution agreement for the development of RELOXIN®.
The $90.1 million was incurred by Aesthetica Ltd., our wholly-owned subsidiary incorporated
and registered under the laws of Bermuda. Aesthetica Ltd. was initially treated as an
entity not subject to corporate income taxes. As such, we did not record tax benefit during
the first quarter of 2006 on the $90.1 million charge that was included in research and
development expenses.
25
Liquidity and Capital Resources
Overview
The following table highlights selected cash flow components for the first quarter of
2007 and 2006, and selected balance sheet components as of March 31, 2007 and December 31,
2006 (dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
First Quarter |
|
|
|
|
|
|
2007 |
|
2006 |
|
$Change |
|
% Change |
Cash provided by (used in): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating activities |
|
$ |
25.8 |
|
|
$ |
(111.5 |
) |
|
$ |
137.3 |
|
|
|
123.1 |
% |
Investing activities |
|
|
(153.9 |
) |
|
|
(88.6 |
) |
|
|
(65.3 |
) |
|
|
(73.7 |
)% |
Financing activities |
|
|
8.8 |
|
|
|
(1.1 |
) |
|
|
9.9 |
|
|
|
921.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mar. 31, 2007 |
|
Dec. 31, 2006 |
|
$Change |
|
% Change |
Cash, cash equivalents and
short-term investments |
|
$ |
644.5 |
|
|
$ |
554.3 |
|
|
$ |
90.2 |
|
|
|
16.3 |
% |
Working capital |
|
|
639.2 |
|
|
|
550.0 |
|
|
|
89.2 |
|
|
|
16.2 |
% |
Long-term investments |
|
|
73.6 |
|
|
|
130.3 |
|
|
|
(56.7 |
) |
|
|
(43.5 |
)% |
2.5% contingent convertible
senior notes due 2032 |
|
|
169.2 |
|
|
|
169.2 |
|
|
|
|
|
|
|
|
|
1.5% contingent convertible
senior notes due 2033 |
|
|
283.9 |
|
|
|
283.9 |
|
|
|
|
|
|
|
|
|
Working Capital
Working capital as of March 31, 2007 and December 31, 2006 consisted of the following
(dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mar. 31, 2007 |
|
|
Dec. 31, 2006 |
|
|
$Change |
|
|
% Change |
|
Cash, cash equivalents and
short-term investments |
|
$ |
644.5 |
|
|
$ |
554.3 |
|
|
$ |
90.2 |
|
|
|
16.3 |
% |
Accounts receivable, net |
|
|
18.0 |
|
|
|
36.4 |
|
|
|
(18.4 |
) |
|
|
(50.5 |
)% |
Inventories, net |
|
|
30.8 |
|
|
|
27.0 |
|
|
|
3.8 |
|
|
|
14.2 |
% |
Deferred tax assets, net |
|
|
20.9 |
|
|
|
23.0 |
|
|
|
(2.1 |
) |
|
|
(9.3 |
)% |
Other current assets |
|
|
22.8 |
|
|
|
16.0 |
|
|
|
6.8 |
|
|
|
42.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
737.0 |
|
|
|
656.7 |
|
|
|
80.3 |
|
|
|
12.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable |
|
|
51.4 |
|
|
|
47.5 |
|
|
|
3.9 |
|
|
|
8.2 |
% |
Income taxes payable |
|
|
0.0 |
|
|
|
11.3 |
|
|
|
(11.3 |
) |
|
|
(100.0 |
)% |
Other current liabilities |
|
|
46.4 |
|
|
|
47.9 |
|
|
|
(1.5 |
) |
|
|
(2.9 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
97.8 |
|
|
|
106.7 |
|
|
|
(8.9 |
) |
|
|
(8.3 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working capital |
|
$ |
639.2 |
|
|
$ |
550.0 |
|
|
$ |
89.2 |
|
|
|
16.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
We had cash, cash equivalents and short-term investments of $644.5 million and working
capital of $639.2 million at March 31, 2007, as compared to $554.3 million and $550.0
million, respectively, at December 31, 2006. The increases were primarily due to a net
transfer of $56.7 million of our long-term investments into cash and short-term investments,
the generation of $25.8 million of operating cash flow, and $9.6 million of cash received
from employees exercise of stock options during the first quarter of 2007.
Management believes existing cash and short-term investments, together with funds
generated from operations, should be sufficient to meet operating requirements for the
foreseeable future. Our cash and short-term investments are available for dividends,
strategic investments, acquisitions of companies or products complementary to our business,
the repayment of outstanding indebtedness, repurchases of our
outstanding securities and other potential large-scale needs. In addition, we may consider
incurring additional indebtedness and issuing additional debt or equity securities in the
future to fund potential
26
acquisitions or investments, to refinance existing debt or for
general corporate purposes. If a material acquisition or investment is completed, our
operating results and financial condition could change materially in future periods.
However, no assurance can be given that additional funds will be available on satisfactory
terms, or at all, to fund such activities.
During July 2006, we executed a lease agreement for new headquarter office space to
accommodate our expected long-term growth. The first phase is for approximately 150,000
square feet with the right to expand. Occupancy of the new headquarter office space, which
is located approximately one mile from our current headquarter office space in Scottsdale,
Arizona, is expected to occur in 2008.
During October 2006, we executed a lease agreement for additional headquarter office
space to accommodate our current needs and future growth. Approximately 21,000 square feet
of office space is being leased for a period of three years. Occupancy of the additional
headquarter office space, which is located approximately one mile from our current
headquarter office space in Scottsdale, Arizona, is expected to occur in May 2007.
During 2007 and 2008, we will be designing and implementing a new enterprise resource
planning (ERP) system to integrate and improve the financial and operational aspects of our
business. We have dedicated approximately 50 of our employees to various aspects of the
project, along with third party consultants. We expect this project will require an
aggregate investment of approximately $10 $12 million during 2007 and 2008.
Operating Activities
Net cash provided by operating activities during the first quarter of 2007 was
approximately $25.8 million, compared to cash used in operating activities of approximately
$111.5 million during the first quarter of 2006. The following is a summary of the primary
components of cash provided by (used in) operating activities during the first quarter of
2007 and 2006 (in millions):
|
|
|
|
|
|
|
|
|
|
|
First Quarter |
|
|
First Quarter |
|
|
|
2007 |
|
|
2006 |
|
Payments made to Ipsen related to development of RELOXIN® |
|
$ |
|
|
|
$ |
(90.1 |
) |
Payment of professional fees related to the agreement
with Ipsen for the development of RELOXIN® |
|
|
|
|
|
|
(0.5 |
) |
Payment of professional fees related to the termination of the
proposed merger with Inamed |
|
|
|
|
|
|
(16.7 |
) |
Payment of a development milestone related to a research and
development collaboration with Dow |
|
|
|
|
|
|
(4.0 |
) |
Income taxes paid |
|
|
(12.4 |
) |
|
|
(20.7 |
) |
Other cash provided by operating activities |
|
|
38.2 |
|
|
|
20.5 |
|
|
|
|
|
|
|
|
Cash provided by (used in) operating activities |
|
$ |
25.8 |
|
|
$ |
(111.5 |
) |
|
|
|
|
|
|
|
Investing Activities
Net cash used in investing activities during the first quarter of 2007 was
approximately $153.9 million, compared to net cash used in investing activities during the
first quarter of 2006 of $88.6 million. The change was primarily due to the net purchases
and sales of our short-term and long-term investments during the respective quarters. In
addition, approximately $27.4 million was paid during the first quarter of 2006 for
contingent payments related to our 2001 merger with Ascent.
On May 2, 2007, the FDA approved PERLANE®. In accordance with our
agreements with Q-Med AB, we paid $29.1 million to Q-Med upon achievement of this milestone.
27
Financing Activities
Net cash provided by financing activities during the first quarter of 2007 was $8.8
million, compared to net cash used in financing activities of $1.1 million during the first
quarter of 2006. This change is primarily due to the proceeds from the exercise of stock
options, which were $9.6 million during the first quarter of 2007 compared to $0.6 million
during the first quarter of 2006. Dividends paid during the first quarter of 2007 and the
first quarter of 2006 was $1.7 million and $1.6 million, respectively.
Contingent Convertible Senior Notes and Other Long-Term Commitments
On August 14, 2003, we exchanged $230.8 million in principal amount of our Old Notes
for $283.9 million in principal amount of our New Notes. Holders of Old Notes that accepted
the Companys exchange offer received $1,230 in principal amount of New Notes for each
$1,000 in principal amount of Old Notes. The terms of the New Notes are similar to the
terms of the Old Notes, but have a different interest rate, conversion rate and maturity
date. Holders of Old Notes that did not exchange will continue to be subject to the terms
of the Old Notes. See Note 8 of Notes to Condensed Consolidated Financial Statements for
further discussion.
The New Notes and the Old Notes are unsecured and do not contain any restrictions on
the incurrence of additional indebtedness or the repurchase of our securities, and do not
contain any financial covenants. The Old Notes do not contain any restrictions on the
payment of dividends. Holders of the Old Notes may require us to repurchase all or a
portion of their Old Notes on June 4, 2007. The New Notes require an adjustment to the
conversion price if the cumulative aggregate of all current and prior dividend increases
above $0.025 per share would result in at least a one percent (1%) increase in the
conversion price. This threshold has not been reached and no adjustment to the conversion
price has been made.
Except for the Old Notes, the New Notes and deferred tax liabilities, we have no
long-term liabilities and had $97.9 million of current liabilities at March 31, 2007. Our
other commitments and planned expenditures consist principally of payments we will make in
connection with strategic collaborations and research and development expenditures, and we
will continue to invest in sales and marketing infrastructure. In addition, we will be
implementing a new ERP system during 2007 and 2008, which will require financial
expenditures to complete.
We have made available to BioMarin Pharmaceutical Inc. (BioMarin) the ability to draw
down on a Convertible Note up to $25.0 million beginning July 1, 2005 (the Convertible
Note). The Convertible Note is convertible based on certain terms and conditions including
a change of control provision. Money advanced under the Convertible Note is convertible
into BioMarin shares at a strike price equal to the BioMarin average closing price for the
20 trading days prior to such advance. The Convertible Note matures on the option purchase
date in 2009 as defined in the Securities Purchase Agreement entered into on May 18, 2004
(the Securities Purchase Agreement) but may be repaid by BioMarin at any time prior to the
option purchase date. As of May 10, 2007, BioMarin has not requested any monies to be
advanced under the Convertible Note, and no amounts are outstanding.
In accordance with our development and distribution agreement with Ipsen for the
development of RELOXIN®, we will pay Ipsen $75.0 million upon FDA approval of
RELOXIN®. This payment will be capitalized as a long-lived asset.
Dividends
We do not have a dividend policy. Since July 2003, we have paid quarterly cash
dividends aggregating approximately $23.5 million on our common stock. In addition, on
March 14, 2007, we declared a cash dividend of $0.03 per issued and outstanding share of
common stock payable on April 30, 2007 to our stockholders of record at the close of
business on April 2, 2007. Prior to these dividends, we had not paid a cash dividend on our
common stock. Any future determinations to pay cash dividends will
be at the discretion of our Board of Directors and will be dependent upon our financial
condition, operating results, capital requirements and other factors that our Board of
Directors deems relevant.
28
Off-Balance Sheet Arrangements
As of March 31, 2007, we are not involved in any off-balance sheet arrangements, as
defined in Item 3(a)(4)(ii) of Securities and Exchange Commission (SEC) Regulation S-K.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are
based upon our condensed consolidated financial statements, which have been prepared in
conformity with U.S. generally accepted accounting principles. The preparation of the
condensed consolidated financial statements requires us to make estimates and assumptions
that affect the amounts reported in the condensed consolidated financial statements and
accompanying notes. On an ongoing basis, we evaluate our estimates related to sales
allowances, chargebacks, rebates, returns and other pricing adjustments, depreciation and
amortization and other contingencies and litigation. We base our estimates on historical
experience and various other factors related to each circumstance. Actual results could
differ from those estimates based upon future events, which could include, among other
risks, changes in the regulations governing the manner in which we sell our products,
changes in the health care environment and managed care consumption patterns. Our
significant accounting policies are described in Note 2 to the consolidated financial
statements included in our Form 10-K for the year ended December 31, 2006. We believe the
following critical accounting policies affect our most significant estimates and assumptions
used in the preparation of our condensed consolidated financial statements and are important
in understanding our financial condition and results of operations.
Revenue Recognition
Revenue from our product sales is recognized pursuant to Staff Accounting Bulletin No.
104 (SAB 104), Revenue Recognition in Financial Statements. Accordingly, revenue is
recognized when all four of the following criteria are met: (i) persuasive evidence that an
arrangement exists; (ii) delivery of the products has occurred; (iii) the selling price is
both fixed and determinable; and (iv) collectibility is reasonably assured.
Our customers consist primarily of large pharmaceutical wholesalers who sell directly
into the retail channel. We do not provide any material forms of price protection to our
wholesale customers and permit product returns if the product is damaged, or, depending on
the customer, if it is returned within six months prior to expiration or up to 12 months
after expiration. Our customers consist principally of financially viable wholesalers, and
depending on the customer, revenue is recognized based upon shipment (FOB shipping point)
or receipt (FOB destination), net of estimated provisions. As a general practice, we do
not ship product that has less than 15 months until its expiration date. We also authorize
returns for damaged products and credits for expired products in accordance with our
returned goods policy and procedures. The shelf life associated with our products is up to
36 months depending on the product. The majority of our products have a shelf life of
approximately 18-24 months.
We enter into licensing arrangements with other parties whereby we receive contract
revenue based on the terms of the agreement. The timing of revenue recognition is dependent
on the level of our continuing involvement in the manufacture and delivery of licensed
products. If we have continuing involvement, the revenue is deferred and recognized on a
straight-line basis over the period of continuing involvement. In addition, if our
licensing arrangements require no continuing involvement and payments are merely based on
the passage of time, we assess such payments for revenue recognition under the
collectibility criteria of SAB 104.
Items Deducted From Gross Revenue
Provisions for estimates for product returns and exchanges, sales discounts,
chargebacks, managed care and Medicaid rebates and other adjustments are established as a
reduction of product sales
revenues at the time such revenues are recognized. These deductions from gross revenue
are established by us as our best estimate at the time of sale based on historical
experience adjusted to reflect known changes in the factors that impact such reserves.
These deductions from gross revenue are generally reflected either as a direct reduction to
accounts receivable through an allowance, or as an addition to accrued expenses if the
payment is due to a party other than the wholesale or retail customer.
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Our accounting policies for revenue recognition have a significant impact on our
reported results and rely on certain estimates that require complex and subjective judgment
on the part of our management. If the levels of product returns and exchanges, cash
discounts, chargebacks, managed care and Medicaid rebates and other adjustments fluctuate
significantly and/or if our estimates do not adequately reserve for these reductions of
gross product revenues, our reported net product revenues could be negatively affected.
Product Returns
We account for returns of product by establishing an allowance based on our estimate of
revenues recorded for which the related products are expected to be returned in the future.
We estimate the rate of future product returns based on our historical experience, the
relative risk of return based on expiration date, and other qualitative factors that could
impact the level of future product returns, such as competitive developments, product
discontinuations and our introduction of new products. Historical experience and the other
qualitative factors are assessed on a product-specific basis as part of our compilation of
our estimate of future product returns. We also monitor inventories held by our
distributors, as well as prescription trends to help us assess the rate of return. Changes
due to our competitors price movements have not adversely affected us. We do not provide
incentives to our distributors to assume additional inventory levels beyond what is
customary in their ordinary course of business.
Returns for new products are more difficult to estimate than returns for established
products. We determine our estimates of the sales return accrual for new products primarily
based on our historical product returns experience of similar products, products that have
similar characteristics at various stages of their life cycle, and other available
information pertinent to the intended use and marketing of the new product.
Our actual experience and the qualitative factors that we use to determine the
necessary accrual for future product returns are susceptible to change based on unforeseen
events and uncertainties. We assess the trends that could affect our estimates and make
changes to the accrual quarterly.
Sales Discounts
We offer cash discounts to our customers as an incentive for prompt payment, generally
approximately 2% of the sales price. We account for cash discounts by establishing an
allowance reducing accounts receivable by the full amount of the discounts expected to be
taken by the customers. We consider payment performance and adjust the allowance to reflect
actual experience and our current expectations about future activity.
Contract Chargebacks
We have agreements for contract pricing with several entities, whereby pricing on
products is extended below wholesaler list price. These parties purchase products through
wholesalers at the lower contract price, and the wholesalers charge the difference between
their acquisition cost and the lower contract price back to us. We account for chargebacks
by establishing an allowance reducing accounts receivable based on our estimate of
chargeback claims attributable to a sale. We determine our estimate of chargebacks based on
historical experience and changes to current contract prices. We also consider our claim
processing lag time, and adjust the allowance periodically throughout each quarter to
reflect actual experience. Although we record an allowance for estimated chargebacks at the
time we record the sale (typically when we ship the product), the actual chargeback related
to that sale is not processed until the entities purchase the product from the wholesaler.
Managed Care and Medicaid Rebates
Rebates are contractual discounts offered to government programs and private health
plans that are eligible for such discounts at the time prescriptions are dispensed, subject
to various conditions. We record provisions for rebates by estimating these liabilities as
products are sold, based on factors such as timing and terms of plans under contract, time
to process rebates, product pricing, sales volumes, amount of inventory in the distribution
channel and prescription trends.
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Other
In addition to the significant items deducted from gross revenue described above, we
deduct other items from gross revenue. For example, we offer consumer rebates on many of
our products and a consumer loyalty program for our RESTYLANE® dermal filler
product. We generally account for these other items deducted from gross revenue by
establishing an accrual based on our estimate of the adjustments attributable to a sale. We
generally base our estimates for the accrual of these items deducted from gross sales on
historical experience and other relevant factors. We adjust our accruals periodically
throughout each quarter based on actual experience and changes in other factors, if any.
Use of Information from External Sources
We use information from external sources to estimate our significant items deducted
from gross revenues. Our estimates of inventory in the distribution channel are based on
historical shipment and return information from our accounting records and data on
prescriptions filled, which we purchase from IMS Health, Inc., one of the leading providers
of prescription-based information. We also utilize projected prescription demand for our
products, as well as, written and oral information obtained from certain wholesalers with
respect to their inventory levels and our internal information. We use the information from
IMS Health, Inc. to project the prescription demand for our products. Our estimates are
subject to inherent limitations pertaining to reliance on third-party information, as
certain third-party information is itself in the form of estimates.
Use of Estimates in Reserves
We believe that our allowances and accruals for items that are deducted from gross
revenues are reasonable and appropriate based on current facts and circumstances. It is
possible, however, that other parties applying reasonable judgment to the same facts and
circumstances could develop different allowance and accrual amounts for items that are
deducted from gross revenues. Additionally, changes in actual experience or changes in
other qualitative factors could cause our allowances and accruals to fluctuate, particularly
with newly launched products. We review the rates and amounts in our allowance and accrual
estimates on a quarterly basis. If future estimated rates and amounts are significantly
greater than those reflected in our recorded reserves, the resulting adjustments to those
reserves would decrease our reported net revenues; conversely, if actual returns, rebates
and chargebacks are significantly less than those reflected in our recorded reserves, the
resulting adjustments to those reserves would increase our reported net revenues. If we
changed our assumptions and estimates, our related reserves would change, which would impact
the net revenues we report. For example, if the 2006 prescription data used to estimate
inventory in the distribution channel changed by 1.0 percent and our historical returns
reserve percent were to change by 1.0 percentage point our sales returns reserve could be
impacted by approximately $1.1 million and corresponding revenue could be impacted by the
same amount.
Share-Based Compensation
As part of our adoption of SFAS No. 123R as of July 1, 2005, we were required to
recognize the fair value of share-based compensation awards as an expense. Determining the
appropriate fair-value model and calculating the fair value of share-based awards at the
date of grant requires judgment. We use the Black-Scholes option pricing model to estimate
the fair value of employee stock options. Option pricing models, including the
Black-Scholes model, also require the use of input assumptions, including
expected volatility, expected life, expected dividend rate and expected risk-free rate
of return. We use a blend of historical and implied volatility based on options freely
traded in the open market as we believe this is more reflective of market conditions and a
better indicator of expected volatility than using purely historical volatility. Increasing
the weighted average volatility by 2.5 percent (from 0.35 percent to 0.375 percent) would
have increased the fair value of stock options granted in the first quarter of 2007 to
$15.23 per share. Conversely, decreasing the weighted average volatility by 2.5 percent
(from 0.35 percent to 0.325 percent) would have decreased the fair value of stock options
granted in the first quarter of 2007 to $13.95 per share. The expected life of the awards
is based on historical and other economic data trended into the future. Increasing the
weighted average expected life by 0.5 years (from 7.0 years to 7.5 years) would have
increased the fair value of stock options granted during the first quarter of 2007 to $15.09
per
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share. Decreasing the weighted average expected life by 0.5 years (from 7.0 years to
6.5 years) would have decreased the fair value of stock options granted in the first quarter
of 2007 to $14.07 per share. The risk-free interest rate assumption is based on observed
interest rates appropriate for the terms of our awards. The dividend yield assumption is
based on our history and expectation of future dividend payouts.
The fair value of our restricted stock grants is based on the fair market value of our
common stock on the date of grant discounted for expected future dividends.
SFAS No. 123R requires us to develop an estimate of the number of share-based awards
which will be forfeited due to employee turnover. Quarterly changes in the estimated
forfeiture rate may have a significant effect on share-based compensation, as the effect of
adjusting the rate for all expense amortization after July 1, 2005 is recognized in the
period the forfeiture estimate is changed. If the actual forfeiture rate is higher than the
estimated forfeiture rate, then an adjustment is made to increase the estimated forfeiture
rate, which will result in a decrease to the expense recognized in the financial statements.
If the actual forfeiture rate is lower than the estimated forfeiture rate, then an
adjustment is made to decrease the estimated forfeiture rate, which will result in an
increase to the expense recognized in the financial statements. The effect of forfeiture
adjustments in the first quarter of 2007 was immaterial.
We evaluate the assumptions used to value our awards on a quarterly basis. If factors
change and we employ different assumptions, stock-based compensation expense may differ
significantly from what was recorded in the past. If there are any modifications or
cancellations of the underlying unvested securities, we may be required to accelerate,
increase or cancel any remaining unearned stock-based compensation expense. Future
stock-based compensation expense and unearned stock-based compensation will increase to the
extent that we grant additional equity awards to employees or we assume unvested equity
awards in connection with acquisitions.
Our estimates of these important assumptions are based on historical data and judgment
regarding market trends and factors. If actual results are not consistent with our
assumptions and judgments used in estimating these factors, we may be required to record
additional stock-based compensation expense or income tax expense, which could be material
to our results of operations.
Long-lived Assets
We assess the impairment of long-lived assets when events or changes in circumstances
indicate that the carrying value of the assets may not be recoverable. Factors that we
consider in deciding when to perform an impairment review include significant
under-performance of a product line in relation to expectations, significant negative
industry or economic trends, and significant changes or planned changes in our use of the
assets. Recoverability of assets that will continue to be used in our operations is
measured by comparing the carrying amount of the asset grouping to our estimate of the
related total future net cash flows. If an asset carrying value is not recoverable through
the related cash flows, the asset is considered to be impaired. The impairment is measured
by the difference between the asset groupings carrying amount and its fair value, based on
the best information available, including market prices or discounted cash flow analysis.
When we determine that the useful lives of assets are shorter than we had originally
estimated, and there are sufficient cash flows to support the carrying value of the assets,
we accelerate the rate of amortization charges in order to fully amortize the assets over
their new shorter useful lives.
During 2006 an impairment charge of $52.6 million was recognized related to our review
of long-lived assets, primarily related to long-lived assets associated with our
LOPROX® and ESOTERICA® products. In addition, the remaining useful
lives of these two long-lived assets were reduced. This process requires the use of
estimates and assumptions, which are subject to a high degree of judgment. If these
assumptions change in the future, we may be required to record additional impairment charges
for, and/or accelerate amortization of, long-lived assets.
32
Income Taxes
Income taxes are determined using an annual effective tax rate, which generally differs
from the U.S. Federal statutory rate because of state and local income taxes, tax-exempt
interest, charitable contribution deductions, nondeductible expenses and research and
development tax credits available in the U.S. Our effective tax rate may be subject to
fluctuations during the year as new information is obtained which may affect the assumptions
we use to estimate our annual effective tax rate, including factors such as our mix of
pre-tax earnings in the various tax jurisdictions in which we operate, valuation allowances
against deferred tax assets, reserves for tax audit issues and settlements, utilization of
research and development tax credits and changes in tax laws in jurisdictions where we
conduct operations. We recognize deferred tax assets and liabilities for temporary
differences between the financial reporting basis and the tax basis of our assets and
liabilities. We record valuation allowances against our deferred tax assets to reduce the
net carrying value to an amount that management believes is more likely than not to be
realized.
Based on our historical pre-tax earnings, management believes it is more likely than
not that we will realize the benefit of the existing net deferred tax assets at March 31,
2007. Management believes the existing net deductible temporary differences will reverse
during periods in which we generate net taxable income; however, there can be no assurance
that we will generate any earnings or any specific level of continuing earnings in future
years. Certain tax planning or other strategies could be implemented, if necessary, to
supplement income from operations to fully realize recorded tax benefits.
Effective
January 1, 2007, we adopted FASB Interpretation No. 48, Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement
No. 109 (FIN 48). We assess income tax positions and record tax
benefits for all years subject to examination based upon our
evaluation of the facts, circumstances, and information available at
the reporting date. For uncertain tax positions where it is more
likely than not that a tax benefit will be sustained, we record the
greatest amount of tax benefit that has a greater than 50 percent
probability of being realized upon effective settlement with a taxing
authority that has full knowledge of all relevant information. For
uncertain income tax positions where it is not more likely than
not
that a tax benefit will be sustained, no tax benefit is recognized in
the financial statements. Our policy is to recognize interest and
penalties that would be assessed in relation to the settlement value
of unrecognized tax benefits as a component of income tax expense.
Research and Development Costs and Accounting for Strategic Collaborations
All research and development costs, including payments related to products under
development and research consulting agreements, are expensed as incurred. We may continue
to make non-refundable payments to third parties for new technologies and for research and
development work that has been completed. These payments may be expensed at the time of
payment depending on the nature of the payment made.
Our policy on accounting for costs of strategic collaborations determines the timing of
our recognition of certain development costs. In addition, this policy determines whether
the cost is classified as development expense or capitalized as an asset. We are required
to form judgments with respect to the commercial status of such products in determining
whether development costs meet the criteria for immediate expense or capitalization. For
example, when we acquire certain products for which there is already an ANDA or NDA approval
related directly to the product, and there is net realizable value based on projected sales
for these products, we capitalize the amount paid as an intangible asset. In addition, if
we acquire product rights that are in the development phase and as to which we have no
assurance that the third party will successfully complete its developmental milestones or
that the product will gain regulatory approval, we expense such payments.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
clarifies the definition of fair value, establishes a framework for measuring fair value,
and expands the disclosures
about fair value measurements. SFAS No. 157 is effective for fiscal years beginning
after November 15, 2007. We are currently evaluating SFAS No. 157 and its impact, if any,
on our consolidated results of operations and financial condition.
Effective January 1, 2007, we adopted FIN 48, Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement No. 109. FIN No. 48 provides guidance for the
recognition threshold and measurement attributes for financial statement recognition and
measurement of a tax position taken, or expected to be taken, in a tax return. In
accordance with FIN No. 48, we recognized a cumulative-effect adjustment of approximately
$808,000, increasing our liability for unrecognized tax benefits, interest, and penalties
and reducing the January 1, 2007 balance of retained earnings.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Statements and Financial Liabilities, which provides companies with an option to report
selected financial assets and liabilities at fair value. SFAS No. 159 requires companies to
provide additional information that will help investors and other users of financial
statements to more easily understand the effect of the companys choice to use fair value on
its earnings. It also requires entities to display the fair value of those
33
assets and
liabilities for which the company has chosen to use fair value on the face of the balance
sheet. SFAS No. 159 does not eliminate disclosure requirements included in other accounting
standards, including requirements for disclosures about fair value measurements included in
FASB Statements No. 157, Fair Value Measurements, and No. 107, Disclosures about Fair Value
of Financial Instruments. We are currently evaluating SFAS No. 159 and its impact, if any,
on our consolidated results of operations and financial condition.
Forward Looking Statements
This Quarterly Report on Form 10-Q and other documents we file with the SEC include
forward-looking statements. These include statements relating to future actions,
prospective products or product approvals, future performance or results of current and
anticipated products, sales and marketing efforts, expenses, the outcome of contingencies,
such as legal proceedings, and financial results. From time to time, we also may make
forward-looking statements in press releases or written statements, or in our communications
and discussions with investors and analysts in the normal course of business through
meetings, webcasts, phone calls, and conference calls. All statements other than statements
of historical fact are, or may be deemed to be, 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 (the Exchange Act). These statements are
based on certain assumptions made by us based on our experience and perception of historical
trends, current conditions, expected future developments and other factors we believe are
appropriate in the circumstances. We caution you that actual outcomes and results may
differ materially from what is expressed, implied, or forecast by our forward-looking
statements. Such statements are subject to a number of assumptions, risks and
uncertainties, many of which are beyond our control. You can identify these statements by
the fact that they do not relate strictly to historical or current facts. They use words
such as anticipate, estimate, expect, project, intend, plan, believe, will,
should, outlook, could, target, and other words and terms of similar meaning in
connection with any discussion of future operations or financial performance. Among the
factors that could cause actual results to differ materially from our forward-looking
statements are the following:
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competitive developments affecting our products, such as the recent FDA approvals of
ARTEFILL®, RADIESSE®, a cosmetic tissue augmentation product
developed by Anika Therapeutics, Inc., JUVEDERM, HYLAFORM®,
HYLAFORM PLUS® and CAPTIQUE®, competitors to
RESTYLANE®, a generic form of our DYNACIN® Tablets
product, generic forms of our LOPROX® TS and LOPROX® Cream
products, and potential generic forms of our LOPROX® Shampoo,
LOPROX® Gel, TRIAZ® or PLEXION® products; |
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the success of research and development activities and the speed with which
regulatory authorizations and product launches may be achieved; |
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changes in the FDAs position on the safety or effectiveness of our products.
For example, in the August 29, 2006 Federal Register, the FDA issued a notice of
proposed rulemaking to categorically establish that over-the-counter skin bleaching
drug products are not generally recognized as safe and effective and are misbranded.
If the proposed rule is adopted, all manufacturers of skin bleaching products would be
required to remove their products from the market and obtain FDA approval prior to
re-entering the U.S. market. ESOTERICA® is an over-the-counter product line
sold by the Company that contains bleaching products that would be regulated by the
proposed rule and, if that occurs, the Company does not currently intend to invest in
obtaining an approved NDA in order to continue selling this product line. This product
accounted for $2.0 million and $0.4 million in net revenues during 2006 and the first
quarter of 2007, respectively; |
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changes in our product mix; |
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changes in prescription levels; |
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the effect of economic changes in hurricane-effected areas; |
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manufacturing or supply interruptions; |
34
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importation of other dermal filler products, including the unauthorized distribution
of products approved in countries neighboring the U.S.; |
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changes in the prescribing or procedural practices of dermatologists, podiatrists
and/or plastic surgeons; |
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the ability to successfully market both new and existing products; |
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difficulties or delays in manufacturing; |
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the ability to compete against generic and other branded products; |
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trends toward managed care and health care cost containment; |
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our ability to protect our patents and other intellectual property; |
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possible U.S. legislation or regulatory action affecting, among other things,
pharmaceutical pricing and reimbursement, including Medicaid and Medicare and
involuntary approval of prescription medicines for over-the-counter use; |
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legal defense costs, insurance expenses, settlement costs and the risk of an
adverse decision or settlement related to product liability, patent protection,
government investigations, and other legal proceedings (see Part II, Item 1, Legal
Proceedings); |
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changes in U.S. generally accepted accounting principles; |
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additional costs related to compliance with changing regulation of corporate
governance and public financial disclosure; |
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our ability to successfully design and implement our new enterprise resource
planning (ERP) system; |
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any changes in business, political and economic conditions due to the threat of
future terrorist activity in the U.S. and other parts of the world; |
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access to available and feasible financing on a timely basis; |
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the availability of product acquisition or in-licensing opportunities; |
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the risks and uncertainties normally incident to the pharmaceutical and medical
device industries, including product liability claims; |
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the risks and uncertainties associated with obtaining necessary FDA approvals; |
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the inability to obtain required regulatory approvals for any of our pipeline
products, such as RELOXIN®; |
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unexpected costs and expenses, or our ability to limit costs and expenses as our
business continues to grow; and |
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the impact of acquisitions, divestitures and other significant corporate
transactions. |
We undertake no obligation to publicly update forward-looking statements, whether as a
result of new information, future events or otherwise. You are advised, however, to review
any future disclosures contained in the reports that we file with the SEC. Our Annual
Report on Form 10-K for the year ended December 31, 2006 contains discussions of various
risks relating to our business that could cause actual results to differ materially from
expected and historical results, which is incorporated herein by reference and which you
should review. You should understand that it is not possible to predict or identify all
such risks. Consequently, you should not consider any such list or discussion to be a
complete set of all potential risks or uncertainties.
35
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of March 31, 2006, there were no material changes to the information previously
reported under Item 7A in our Annual Report on Form 10-K for the year ended December 31,
2006.
Item 4. Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Exchange Act) that are designed to ensure that information required to be
disclosed in reports filed by us under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the SECs rules and forms and that such
information is accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding
required disclosure. Our Chief Executive Officer and Chief Financial Officer, with the
participation of other members of management, evaluated the effectiveness of our disclosure
controls and procedures as of March 31, 2007 and have concluded that, as of such date, our
disclosure controls and procedures were effective to ensure that the information we are
required to disclose in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the SECs rules and
forms.
Although the management of the Company, including the Chief Executive Officer and the
Chief Financial Officer, believes that our disclosure controls and internal controls
currently provide reasonable assurance that our desired control objectives have been met,
management does not expect that our disclosure controls or internal controls will prevent
all errors and all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more people, or by management
override of the controls. The design of any system of controls is also based in part upon
certain assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential future
conditions.
During the three months ended March 31, 2007, there was no change in our internal
control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the
Exchange Act) that has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings
The government notified us on December 14, 2004, that it is investigating claims that
we violated the federal False Claims Act in connection with the alleged off-label marketing
and promotion of LOPROX® and LOPROX® TS products to pediatricians
during periods prior to our May 2004 disposition of our pediatric sales division. On April
25, 2007, we entered into a Settlement Agreement with the Justice Department, the Office of
Inspector General of the Department of Health and Human Services (OIG) and the TRICARE
Management Activity (collectively, the United States) and private complainants to settle
all outstanding federal and state civil suits against us in connection with claims related
to our alleged off-label marketing and promotion of LOPROX® (the Settlement Agreement).
The settlement is neither an admission of liability by us nor a concession by the United
States that its claims are not well founded. Pursuant to the Settlement Agreement, we will
pay approximately $10 million to settle the matter between the parties. The Settlement
Agreement provides that, upon full payment of the settlement fees and execution of a
Corporate Integrity Agreement, the United States releases us from the claims asserted by the
United States and will refrain from instituting action seeking exclusion from Medicare,
Medicaid, the TRICARE Program and other federal health care programs for the alleged
conduct. These releases relate
36
solely to the allegations related to us and do not cover
individuals. The Settlement Agreement also provides that the private complainants release
us and our officers, directors and employees from the asserted claims, and we release the
United States and the private complainants from asserted claims.
As part of the settlement, we have entered into a five-year Corporate Integrity
Agreement with the OIG to resolve any potential administrative claims the OIG may have
arising out of the governments investigation (the CIA). The CIA acknowledges the
existence of our comprehensive existing compliance program and provides for certain other
compliance-related activities during the term of the CIA, including the maintenance of a
compliance program that, among other things, is designed to ensure compliance with the CIA,
federal health care programs and FDA requirements. Pursuant to the CIA, we are required to
notify the OIG, in writing, of: (i) any ongoing government investigation or legal proceeding
involving an allegation that we have committed a crime or has engaged in fraudulent
activities; (ii) any other matter that a reasonable person would consider a probable
violation of applicable criminal, civil, or administrative laws; (iii) any written report,
correspondence, or communication to the FDA that materially discusses any unlawful or
improper promotion of our products; and (iv) any change in location, sale, closing,
purchase, or establishment of a new business unit or location related to items or services
that may be reimbursed by Federal health care programs. We are also subject to periodic
reporting and certification requirements attesting that the provisions of the CIA are being
implemented and followed, as well as certain document and record retention mandates. We
have hired a Chief Compliance Officer and created an enterprise-wide compliance function to
administer its obligations under the CIA.
On or about October 12, 2006, we and the United States Attorneys Office for the
District of Kansas entered into a Nonprosecution Agreement wherein the government agreed not
to prosecute us for any alleged criminal violations relating to the alleged off-label
marketing and promotion of LOPROX®. In exchange for the governments agreement
not to pursue any criminal charges against us, we have agreed to continue cooperating with
the government in its ongoing investigation into whether past and present employees and
officers may have violated federal criminal law regarding alleged off-label marketing and
promotion of LOPROX® to pediatricians. No individuals have been designated as
targets of the investigation. Any such claims, prosecutions or other proceedings, with
respect to our past and present employees and officers, the cost of their defense and fines
and penalties resulting therefrom could have a material impact on our reputation, business
and financial condition.
On October 27, 2005, we filed suit against Upsher-Smith Laboratories, Inc. of Plymouth,
Minnesota and against Prasco Laboratories of Cincinnati, Ohio for infringement of Patent No.
6,905,675 entitled Sulfur Containing Dermatological Compositions and Methods for Reducing
Malodors in Dermatological Compositions covering our sodium sulfacetamide/sulfur
technology. This intellectual property is related to our PLEXION® Cleanser
product. The suit was filed in the U.S. District Court for the District of Arizona, and
seeks an award of damages, as well as a preliminary and a permanent injunction. A hearing
on our preliminary injunction motion was heard on March 8 and March 9, 2006. On May 2,
2006, an order denying the motion for a preliminary injunction was received by Medicis. The
Court has entered an order staying the case until the conclusion of a patent reexamination
request submitted by Medicis.
On June 22, 2006, Medicis and Aventis-Sanofi (the manufacturer of LOPROX®
Gel), filed a complaint in the U.S. District Court for the District of Minnesota against
Paddock Laboratories, asserting that Paddocks proposed generic version of Medicis
LOPROX® Gel product will infringe one or more claims of one of the Companys
patents on LOPROX® Gel. Paddock filed an answer and counterclaims and later
amended these filings, denying infringement and seeking fees and costs. On December 7,
2006, plaintiffs served Paddock with a covenant not to sue for infringement of the 656
patent based on the products that are the subject of Paddocks current ANDA, and filed their
reply to Paddocks counterclaims, which included a denial of Paddocks allegations that the
337 patent claims are invalid, unenforceable and not infringed. On January 26, 2007, the
Court entered a stipulated Amended Pretrial Scheduling Order, extending all pre-trial and
discovery dates in the case by 30 days to allow the parties to
engage in discussions. On March 14, 2007, the Court entered a further
Order extending dates in the case to permit the parties to engage in
discussions.
In addition to the matters discussed above, we and certain of our subsidiaries are
parties to other actions and proceedings incident to our business, including litigation
regarding our intellectual property, challenges to the enforceability or validity of our
intellectual property and claims that our products infringe
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on the intellectual property
rights of others. We record contingent liabilities resulting from claims against us when it
is probable (as that word is defined in Statement of Financial Accounting Standards No. 5)
that a liability has been incurred and the amount of the loss is reasonably estimable. We
disclose material contingent liabilities when there is a reasonable possibility that the
ultimate loss will exceed the recorded liability. Estimating probable losses requires
analysis of multiple factors, in some cases including judgments about the potential actions
of third-party claimants and courts. Therefore, actual losses in any future period are
inherently uncertain. In all of the cases noted where we are the defendant, we believe we
have meritorious defenses to the claims in these actions and that resolution of these
matters will not have a material adverse effect on our business, financial condition, or
results of operations; however, the results of the proceedings are uncertain, and there can
be no assurance to that effect.
Item 1A. Risk Factors
There are no material changes from the risk factors previously disclosed in Part I of
Item 1A in our Annual Report on Form 10-K for the year period ended December 31, 2006.
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Item 6. Exhibits
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Exhibit 3.1
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Amended and Restated By-Laws of Medicis Pharmaceutical Corporation (1) |
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Exhibit 12+
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Computation of Ratios of Earnings to Fixed Charges |
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Exhibit 31.1+
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Certification by the Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 |
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Exhibit 31.2+
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Certification by the Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 |
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Exhibit 32.1+
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Certification by the Chief Executive Officer and the Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 |
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+ |
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Filed herewith |
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(1) |
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Incorporated by reference to the Companys Current Report on Form 8-K filed
with the SEC on April 16, 2007. |
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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MEDICIS PHARMACEUTICAL CORPORATION |
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Date: May 10, 2007
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By:
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/s/ Jonah Shacknai |
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Jonah Shacknai |
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Chairman of the Board and |
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Chief Executive Officer |
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(Principal Executive Officer) |
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Date: May 10, 2007
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By:
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/s/ Mark A. Prygocki, Sr. |
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Mark A. Prygocki, Sr. |
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Executive Vice President |
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Chief Financial Officer and Treasurer |
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(Principal Financial and Accounting |
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Officer) |
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