ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is a drug development and marketing company focused exclusively on
the pediatric market. The Company commenced operations in March 1989 and prior
to the quarter ended September 30, 1997 had been engaged primarily in developing
its products and product candidates and in organizational efforts, including
recruiting scientific and management personnel and raising capital. The Company
introduced its first product, Feverall, during the quarter ended September 30,
1997 and its second product, Pediamist, during the quarter ended December 31,
1997. During the quarter ended March 31, 1998, the Company began marketing
Duricef(R) (cefadroxil monohydrate) oral suspension to pediatricians in the
United States pursuant to a four-year co-promotion agreement with Bristol-Myers
Squibb (the "Duricef Agreement").
The Company has incurred net losses since its inception and expects to incur
additional operating losses at least through the next fiscal year as it
continues its product development programs, maintains its sales and marketing
organization and introduces products to the market. The Company expects
cumulative losses to increase over this period. The Company has incurred an
accumulated deficit since inception through September 30, 1998 of $46,485,000.
RESULTS OF OPERATIONS
Three and Nine Months Ended Sept. 30, 1998 Compared with Three and
Nine Months Ended Sept. 30, 1997.
Revenue. The Company had net revenue for the three and nine months ended
September 30, 1998 of $1,001,000 and $3,156,000, respectively, compared with
revenue of $933,000 in the comparable prior year periods. The increase in
revenue of $68,000 for the three months ended September 30, 1998 as compared
with the three months ended September 30, 1997 was primarily due to sales of
Pediamist nasal saline spray, which was not introduced until the fourth quarter
of 1997 and revenues under the Duricef Agreement. The increase in revenue of
$2,223,000 for the nine months ended September 30, 1998 as compared with the
nine months ended September 30, 1997 was primarily due to
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(i) the sales of Feverall products, which were not introduced until the third
quarter of 1997, (ii) the sales of Pediamist nasal saline spray, and (iii)
revenue under the Duricef agreement.
Cost of Sales. Cost of sales was $509,000 and $1,576,000 for the three and nine
months ended September 30, 1998, respectively, compared with $404,000 for each
of the comparable prior year periods. The increase in cost of sales of $105,000
for the three months ended September 30, 1998 as compared with the three months
ended September 30, 1997 was primarily attributable to $65,000 for the
manufacturing cost associated with the production of the Feverall and Pediamist
products and net realizable value adjustments for material carried in inventory
for one of the Company's products in development. In addition, during the
current quarter the Company's margin was affected by a marketing program that
included greater than customary discounts. The increase in cost of sales of
$1,172,000 for the nine months ended September 30, 1998 as compared with the
nine months ended September 30, 1997 was primarily attributable to (i) $783,000
for the manufacturing cost associated with the production of the Feverall and
Pediamist products, (ii) net realizable value adjustments for material carried
in inventory for one of the Company's products in development, and (iii) the of
amortization of $167,000 for the Feverall manufacturing agreement.
Selling, General and Administrative. The Company incurred selling, general and
administrative expenses for the three and nine months ended September 30, 1998
of $3,569,000 and $10,780,000, respectively, as compared to $2,068,000 and
$4,420,000 for the comparable periods in 1997.
Selling expenses were $2,242,000 and $7,149,000 for the three and nine months
ended September 30, 1998, respectively, compared with $1,350,000 and $2,399,000
for the comparable prior year periods. The increase of $892,000 for the three
months ended September 30, 1998 as compared with the three months ended
September 30, 1997 was primarily a result of (i) increased personnel expenses of
approximately $1,174,000 associated with the hiring of the Company's field sales
organization and (ii) decreased distribution and marketing expenses of $220,000
due to a corporate marketing program that was run during 1997 and was not
repeated in 1998. The increase of $4,750,000 for the nine months ended September
30, 1998 as compared with the nine months ended September 30, 1997 was primarily
a result of (i) increased personnel expenses of approximately $4,429,000
associated with the hiring of the Company's field sales organization, and (ii)
increased marketing and distribution expenses of $411,000 associated with the
introduction of the Company's first two product offerings, Feverall and
Pediamist.
General and administrative expenses were $1,327,000 and $3,631,000 for the three
and nine months ended September 30, 1998, respectively, compared with $718,000
and $2,021,000 for the comparable prior year periods. The increase of $609,000
for the three months ended September 30, 1998 as compared with the three months
ended September 30, 1997 was primarily a result of (i) increased support
personnel costs of $315,000 associated with the initial commercialization of the
company's first two products, and (ii) increased legal, accounting and investor
relations costs of $53,000 associated with being a public company. The increase
of $1,610,000 for the nine months ended September 30, 1998 as compared with the
nine months ended September 30, 1997 was primarily a result of (i) increased
amortization expenses for intangible assets of $204,000 related to the Feverall
acquisition, (ii) increased amortization expenses for debt issue costs of
$46,000, (iii) increased support personnel cost of $431,000 associated with the
initial commercialization of the company's first two products, (iv) increased
legal, accounting and investor relations costs of $222,000 associated with being
a publicly-traded company, and (v) increased insurance expenses of $180,000
related to product liability, automobile and directors' and officers' liability
insurance.
Research and Development. Research and development expenses were $773,000 and
$2,785,000 for the three and nine months ended September 30, 1998, respectively,
compared with $992,000 and $3,458,000 for the comparable prior year periods. The
decreases of $219,000 and $673,000 for the three and nine months ended September
30, 1998, respectively, primarily reflected the costs of clinical trials for the
Company's Feverall ER acetaminophen beaded product which were conducted during
the first nine months of 1997.
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Interest. Interest income was $103,000 and $321,000 for the three and nine
months ended September 30, 1998, respectively, as compared to $286,000 and
$527,000 for the comparable prior year periods. The decreases of $183,000 and
$206,000 for the three and nine months ended September 30, 1998, respectively,
were primarily attributable to a decrease in funds available for investment.
Interest expense was $192,000 and $1,861,000 for the three and nine months ended
September 30, 1998, respectively, as compared to $508,000 and $833,000 for the
comparable prior year periods. The decrease of $316,000 for the three months
ended September 30, 1998 as compared with the three months ended September 30,
1997 was primarily the result of a lower interest rate on the current
subordinated notes as compared to the notes outstanding during the prior year.
The increase of $1,028,000 for the nine months ended September 30, 1998 as
compared with the nine months ended September 30, 1997 was primarily a result of
acceleration of $842,000 of accretion to full value of the notes repaid in June
1998.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily from
private sales of capital stock, subordinated secured notes and related common
stock purchase warrants and from an initial public offering of shares of common
stock. As of September 30, 1998, the Company had raised approximately
$33,560,000 (net of issuance costs) from the sales of preferred stock and
related warrants, approximately $14,743,000 (net of issuance costs) from the
issuance of subordinated secured notes and related warrants and approximately
$17,529,000 (net of issuance costs) from the initial public offering of
2,240,000 shares of common stock. The Company has also financed its operations
through internally generated funds. In the second half of 1997, the Company
began shipping its first two products, Feverall acetaminophen suppositories and
Pediamist nasal saline spray and in March 1998 began promoting Duricef(R)
pursuant to the Duricef Agreement.
On July 10, 1997, the Company closed the acquisition of the Feverall line of
acetaminophen suppositories from Upsher-Smith for a purchase price of
$11,905,000. The Company issued a promissory note for $5.5 million as partial
payment for the purchase price, which promissory note was paid in full on
February 20, 1998.
In January and June 1997, the Company issued an aggregate of $7 million of
subordinated secured notes, resulting in net proceeds to the Company of
$6,404,000, which was recorded as a liability of $4,494,000 with $2,506,000 to
be accreted as interest expense over the term of the notes. On June 1, 1998, the
Company paid in full the remaining principal and interest due of approximately
$5,250,000 and $130,000, respectively.
On June 1, 1998, the Company issued and sold to funds affiliated with Furman
Selz Investments and BancBoston Ventures an aggregate of $7 million of Series G
convertible exchangeable preferred stock (the "Preferred Stock"), $9 million of
8% seven-year subordinated notes (the "Subordinated Notes") and seven-year
warrants to purchase 2,116,958 shares of common stock for an aggregate purchase
price of $16 million (the "1998 Financing"). The $9 million of Subordinated
Notes issued and sold was allocated to the fair value of the Subordinated Notes
of $8,652,515 and the fair value of the warrants of $347,485. Accordingly, the
Subordinated Notes will be accreted from $8,652,515 to the maturity amount of
$9,000,000 as interest expense over the term of the Subordinated Notes. Amounts
allocated to the warrants was included in additional paid in capital. The
Preferred Stock is convertible into common stock at a price of $4.75 per share,
which was above the fair market value of the Company's common stock at June 1,
1998, and the warrants are exercisable at a price of $4.75 per share. The
Preferred Stock is entitled to cumulative annual dividends equal to 8% (subject
to adjustment) of the liquidation preference of such stock ($1,000), payable
semiannually in June and December of each year, commencing December 1998, and
may be exchanged for 8% seven-year convertible subordinated notes (the
"Convertible Notes") having an aggregate principal amount equal to the aggregate
liquidation preference of the Preferred Stock solely at the option of the
Company any time within seven years of issuance of the Preferred Stock. The
Subordinated Notes and Convertible Notes (when and if issued upon exchange of
the Preferred Stock) (collectively, the "1998 Notes") bear interest at a rate of
8% per annum, payable semiannually in June and December of each year, commencing
December 1998. Forty percent of the
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interest due on the Subordinated Notes and fifty percent of the dividends due on
the Preferred Stock (or the interest due on the Convertible Notes if issued upon
exchange of the Preferred Stock) in each of December 1998, June 1999, December
1999 and June 2000 may be deferred by the Company for a period of three years.
In the event of a change in control or unaffiliated merger of the Company, the
Company may also redeem the Preferred Stock (or the Convertible Notes issuable
upon exchange of the Preferred Stock) at a price equal to the liquidation
preference on such stock ($1,000) plus accrued and unpaid dividends, although
the Company will be required to issue new Common Stock purchase warrants in
connection with such redemption. In the event of a change of control or
unaffiliated merger of the Company, the holders of the 1998 Notes may require
the Company to redeem the 1998 Notes at a price equal to the unpaid principal
plus accrued and unpaid interest on such notes. In connection with the
investment, a representative of Furman Selz Investments was added to the
Company's Board of Directors. The Company has used a portion of the net
proceeds, after fees and expense, of $14.7 million to repay the $5.3 million in
subordinated secured notes and intends to use the balance for working capital.
As a result of the early repayment of subordinated secured notes, the Company
accelerated the accretion of the discount of $842,000. In addition, $325,000 of
unamortized debt issue costs were written off.
The Company's future capital requirements will depend on many factors, including
the costs and margins on sales of its products and the success of its
commercialization activities and arrangements, particularly the level of product
sales, continued progress in its product development programs, the magnitude of
these programs, the results of pre-clinical studies and clinical trials, the
time and cost involved in obtaining regulatory approvals, the cost involved in
filing, prosecuting, enforcing and defending patent claims, competing
technological and market developments, the ability of the Company to maintain
and in the future, expand its sales and marketing capability and product
development, manufacturing and marketing relationships and the ability of the
Company to enter into and to maintain co-promotion agreements. The Company's
business strategy requires a significant commitment of funds to conduct clinical
testing of potential products, to pursue regulatory approval of such products
and maintain sales and marketing capabilities and manufacturing relationships
necessary to bring such products to market. The Company expects, based on its
current operating plan, that its existing capital and internally generated funds
should be adequate to satisfy its capital requirements through the middle of the
first quarter of 1999. Substantial additional funds will be required from
external sources to support the Company's operations beyond that time, and there
can be no assurance that additional funds will be available, or, if available,
that such funds will be available on acceptable terms.
The Company is seeking additional equity or debt financing to fund future
operations depending on the terms on which such financing may be available. The
Company also is seeking additional collaborative or commercialization
arrangements with third parties in order to fund future operations. There can
be no assurance that such financing or other arrangements will be available, or
if available, that they will be available on acceptable terms. The Company has
no committed external sources of capital. If the Company is unable to obtain
necessary additional funds, it would be required to delay, scale back or
eliminate one or more of its product development programs or product
commercialization efforts, obtain funds through arrangements with collaborative
partners or others that may require the Company to relinquish rights to certain
of its technologies, product candidates or products which the Company would
otherwise pursue on its own or significantly scale back or terminate
operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5
"Accounting for the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5
requires all costs of start-up activities (as defined by SOP 98-5) to be
expensed as incurred. The Company does not believe that SOP 98-5 will have a
significant impact on its financial statement disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities.
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The statement requires companies to recognize all derivatives as either assets
or liabilities, with the instruments measured at fair value. The accounting for
changes in fair value, gains or losses, depends on the intended use of the
derivative and its resulting designation. The statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. The Company does
not believe that SFAS 133 will have a significant impact on its financial
statement disclosures.
IMPACT OF YEAR 2000 ISSUES
The Year 2000 ("Y2K") issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Following
December 31, 1999, the Company's computer equipment and software that is time
sensitive, including equipment with embedded technology such as telephone
systems and facsimile machines, may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to engage in normal business activities.
The Company is in the process of assessing its computer systems, software and
operations infrastructure, including systems being developed to improve business
functionality, to identify computer hardware, software and process control
systems that are not Y2K compliant. To this end, during the third quarter of
fiscal 1998, the Company established an internal Y2K task force, comprised of
employees and members of management, for the purpose of evaluating the Y2K
compliance of its existing computer systems, software and operations
infrastructure and any Y2K issues of third parties of business importance to the
Company. The goal of the Company's Y2K task force is to minimize any disruptions
to the Company's business which could result from the Y2K problem and to
minimize liabilities which the Company might incur as a result of such
disruptions. The Company currently anticipates that its Y2K assessment efforts
will be completed by March 31, 1999.
The Company has also initiated communications with its significant suppliers and
service providers and certain strategic customers to determine the extent to
which such suppliers, providers or customers will be affected by any significant
Y2K issues. Although, as of November 1, 1998, the Company has not received a
significant number of responses to its inquiries, the Company believes that
these communications will permit the Company to determine the extent to which
the Company may be affected by the failure of these third parties to address
their own Y2K issues and may facilitate the coordination of Y2K solutions
between the Company and these third parties. There can be no guarantee, however,
that third parties of business importance to the Company will successfully and
timely evaluate and address their own Y2K issues. The failure of any of these
third parties to achieve Y2K compliance in a timely fashion could have a
material adverse effect on the Company's business, financial position, results
of operations or cash flows.
The costs of the Company's Y2K compliance efforts are being funded with cash
flows from operations. Although the Company has not completed the Y2K assessment
of its computer systems and software, based upon its assessment efforts to date,
the Company does not anticipate that the costs of becoming Y2K compliant will
have a material adverse effect upon the Company's business, financial position,
results of operations or cash flows. The Company does not expect that the costs
of replacing or modifying the computer equipment and software will be
substantially different, in the aggregate, from the normal, recurring costs
incurred by the Company for systems development, implementation and maintenance
in the ordinary course of business. In this regard, in the ordinary course of
replacing computer equipment and software, the Company attempts to obtain
replacements that are Y2K compliant. For example, the Company recently upgraded
its financial accounting software and received written representations that the
system was Y2K compliant. As of September 30, 1998, additional costs incurred by
the Company for the replacement of computer equipment and software that was not
Y2K compliant (i.e. the costs incurred in excess of the costs that would have
been incurred by the Company in the ordinary course of replacing computer
equipment and software) was less than $1,000. The Company expects to incur total
costs of less than $25,000 to become Y2K compliant.
The Company does not presently believe that the Y2K issue will pose significant
operational problems for the Company. However, if all Y2K issues are not
properly identified, or assessment, remediation and testing are
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not effected timely with respect to Y2K problems that are identified, there can
be no assurance that the Y2K issue will not have a material adverse effect on
the Company's business, financial position, results of operations or cash flows
or adversely affect the Company's relationships with customers, suppliers or
others.
The Company has not yet developed a contingency plan for dealing with the
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from failure by the Company and certain third
parties to achieve Y2K compliance on a timely basis. The Company currently plans
to complete its analysis of the problems and costs associated with the failure
to achieve Y2K compliance and to establish a contingency plan in the event of
such failure by December 31, 1999.
The foregoing assessment of the impact of the Y2K problem on the Company is
based on management's best estimates as of the date of this Quarterly Report,
which are based on numerous assumptions as to future events. There can be no
assurance that these estimates will prove accurate, and actual results could
differ materially from those estimated if these assumptions prove inaccurate.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
This quarterly report on Form 10-Q contains certain forward looking statements.
For this purpose any statements herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," "intends"
and similar expressions are intended to identify forward-looking statements.
There are a number of important factors that could cause the Company's actual
results to differ materially from those indicated by such forward-looking
statements. These factors include, without limitation, those set forth in "Item
7, Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Factors That May Affect Future Results" of the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1997 as filed
with the Securities and Exchange Commission, which are expressly incorporated by
reference herein.
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