FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2005
OR
[ ] 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 0-19777
DUSA PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
New Jersey 22-3103129
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Upton Drive
Wilmington, Massachusetts 01887
(Address of principal executive offices)
(Zip Code)
(978) 657-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 month (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 at the Exchange Act).
Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 at the Exchange Act).
Yes No X
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
16,937,697 shares as of November 4, 2005
PART I. FINANCIAL INFORMATION
ITEM 1. UNAUDITED FINANCIAL STATEMENTS.
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30,
2005 DECEMBER 31,
(UNAUDITED) 2004
------------- ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,001,402 $ 2,928,143
Marketable securities 33,262,314 46,222,969
Accrued interest receivable 421,627 641,797
Accounts receivable, net 703,863 711,016
Inventory, net 2,068,738 1,417,160
Prepaids and other current assets 1,442,233 830,895
------------ ------------
TOTAL CURRENT ASSETS 39,900,177 52,751,980
Restricted cash 143,353 140,764
Property, plant and equipment, net 3,168,314 3,481,888
Deferred charges and other assets 240,454 276,256
------------ ------------
TOTAL ASSETS $ 43,452,298 $ 56,650,888
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 565,614 $ 857,268
Accrued compensation 850,221 963,607
Other accrued expenses 1,835,182 1,901,841
Deferred revenue 419,415 230,715
------------ ------------
TOTAL CURRENT LIABILITIES 3,670,432 3,953,431
Other liabilities 202,706 190,439
------------ ------------
TOTAL LIABILITIES 3,873,138 4,143,870
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 10)
SHAREHOLDERS' EQUITY
Capital Stock
Authorized: 100,000,000 shares; 40,000,000 shares designated as common
stock, no par, and 60,000,000 shares issuable in series or classes; and
40,000 junior Series A preferred shares. Issued and outstanding:
16,936,697 and 16,876,822 shares of common stock, no par, at
September 30, 2005 and December 31, 2004, respectively. 124,930,094 124,698,059
Additional paid-in capital 2,035,783 2,016,339
Accumulated deficit (87,304,775) (74,538,761)
Accumulated other comprehensive (loss) income (81,942) 331,381
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 39,579,160 52,507,018
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 43,452,298 $ 56,650,888
============ ============
See the accompanying Notes to the Condensed Consolidated Financial Statements.
2
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
------------------------- ---------------------------
2005 2004 2005 2004
----------- ----------- ------------ ------------
REVENUES
Kerastick(R) Product Revenues, net $ 1,806,135 $ 1,498,514 $ 6,081,938 $ 3,697,612
BLU-U(R) Product Revenues, net 586,109 512,105 1,907,036 1,744,720
----------- ----------- ------------ ------------
PRODUCT REVENUES, NET $ 2,392,244 $ 2,010,619 $ 7,988,974 $ 5,442,332
Kerastick(R) Cost of Product Revenues
and Royalties 816,182 303,091 2,641,710 1,222,963
BLU-U(R) Cost of Product Revenues 491,251 415,077 2,139,879 1,389,921
----------- ----------- ------------ ------------
COST OF PRODUCT REVENUES AND ROYALTIES 1,307,433 718,168 4,781,589 2,612,884
TOTAL MARGIN $ 1,084,811 $ 1,292,451 $ 3,207,385 $ 2,829,448
OPERATING COSTS
Research and development 1,414,428 1,585,099 4,809,294 4,850,159
Marketing and sales 1,804,439 1,835,210 6,885,755 4,901,813
General and administrative 1,663,697 1,197,707 5,187,415 5,775,500
Restructuring 150,917 -- 150,917 --
----------- ----------- ------------ ------------
TOTAL OPERATING COSTS 5,033,481 4,618,016 17,033,381 15,527,472
----------- ----------- ------------ ------------
LOSS FROM OPERATIONS (3,948,670) (3,325,565) (13,825,996) (12,698,024)
OTHER INCOME
Interest income, net 340,389 350,573 1,059,982 1,125,291
----------- ----------- ------------ ------------
NET LOSS $(3,608,281) $(2,974,992) $(12,766,014) $(11,572,733)
=========== =========== ============ ============
BASIC AND DILUTED NET LOSS PER COMMON
SHARE $ (0.21) $ (0.18) $ (0.75) $ (0.72)
=========== =========== ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 16,930,746 16,855,504 16,920,220 16,131,017
=========== =========== ============ ============
See the accompanying Notes to the Condensed Consolidated Financial Statements.
3
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2005 2004
(UNAUDITED) (UNAUDITED)
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(12,766,014) $(11,572,733)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization of premiums and accretion of
discounts on marketable securities, net 401,221 93,582
Realized gain on sale of marketable securities (72,195)
Depreciation and amortization expense 755,593 1,190,605
Stock-based compensation 19,444 240,753
Changes in other assets and liabilities impacting
cash flows from operating
activities:
Accrued interest receivable 220,170 65,528
Accounts receivable 7,153 (162,250)
Inventory (651,578) (668,613)
Prepaids and other assets (611,338) (718,700)
Accounts payable (291,654) (743,765)
Accrued compensation and other accrued expenses (180,045) 671,224
Deferred revenue 188,700 164,532
Other liabilities-non current 12,267
------------ ------------
CASH USED IN OPERATING ACTIVITIES (12,968,276) (11,439,837)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of marketable securities (40,683,061) (30,767,026)
Proceeds from maturities and sales of marketable
securities 52,901,367 21,450,000
Restricted cash (2,589) (1,008)
Purchases of property, plant and equipment (406,217) (507,378)
------------ ------------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 11,809,500 (9,825,412)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock (net of stock offering
costs of $200,202) 28,262,298
Proceeds from exercise of stock options 232,035 719,319
Repayments of long-term debt (1,517,500)
------------ ------------
CASH PROVIDED BY FINANCING ACTIVITIES 232,035 27,464,117
------------ ------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (926,741) 6,198,868
------------ ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,928,143 4,294,482
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,001,402 $ 10,493,350
============ ============
On March 2, 2004, the Company issued 135,000 shares of its common stock in a
private placement at $11.00 per share as commission and non-refundable retainer
to the placement agent, and an additional 20,250 shares on April 14, 2004 with
respect to the exercise of the additional investment rights, for a total value
of $1,707,750.
See the accompanying Notes to the Condensed Consolidated Financial Statements.
4
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1) BASIS OF PRESENTATION
The Condensed Consolidated Balance Sheets as of September 30, 2005 and
December 31, 2004, Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 2005 and 2004, and Condensed Consolidated
Statements of Cash Flows for the nine months ended September 30, 2005 and 2004
of DUSA Pharmaceuticals, Inc. (the "Company" or "DUSA") have been prepared in
accordance with accounting principles generally accepted in the United States of
America. These condensed consolidated financial statements are unaudited but
include all normal recurring adjustments that management of the Company believes
to be necessary for fair presentation of the periods presented. The results of
the Company's operations for any interim period are not necessarily indicative
of the results of the Company's operations for any other interim period or for a
full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. These condensed
consolidated financial statements should be read in conjunction with the
Company's December 31, 2004 audited consolidated financial statements and notes
thereto. Certain amounts for 2004 have been reclassified to conform to the
current year presentation. The reclassifications of 2004 amounts include
separate presentation of the cost of product revenues and royalties for the
Company's two products, the Kerastick(R) and the BLU-U(R). Such
reclassifications had no impact on the net loss or shareholders' equity for any
period presented.
2) MARKETABLE SECURITIES
The Company's marketable securities consist of securities of the United
States government and its agencies and corporate bonds, all classified as
available-for-sale. As of September 30, 2005, current yields range from 2.54% to
7.25% and maturity dates range from October 6, 2005 to June 15, 2008. The
estimated fair value and cost of marketable securities at September 30, 2005 and
December 31, 2004 are as follows:
SEPTEMBER 30, 2005
(UNAUDITED)
------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED COST GAINS LOSSES FAIR VALUE
-------------- ---------- ---------- -----------
United States government securities $19,716,856 $102,158 $ (47,826) $19,771,188
Corporate securities 13,627,400 8,533 (144,807) 13,491,126
----------- --------- --------- -----------
Total marketable securities
available-for-sale $33,344,256 $110,691 $(192,633) $33,262,314
=========== ========= ========= ===========
5
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 2004
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
----------- ---------- ---------- -----------
United States government securities $27,266,271 $389,585 $(15,315) $27,640,541
Corporate securities 18,625,317 504 (43,393) 18,582,428
----------- -------- -------- -----------
Total marketable securities
available-for-sale $45,891,588 $390,089 $(58,708) $46,222,969
=========== ======== ======== ===========
3) CONCENTRATION OF CREDIT RISK
The Company is exposed to concentration of credit risk related to accounts
receivable that are generated from its distributors and other customers. To
manage credit risk, the Company performs regular credit evaluations of its
customers' financial condition and provides allowances for potential credit
losses, when applicable. Concentrations of credit risk in the Company's total
revenues for the three and nine months ended September 30, 2005 and 2004, and
accounts receivable as of September 30, 2005 and December 31, 2004 are as
follows:
% OF REVENUE % OF REVENUE % OF ACCOUNTS RECEIVABLE
THREE-MONTHS ENDED NINE-MONTHS ENDED AS OF
SEPTEMBER 30 SEPTEMBER 30 ---------------------------------
(UNAUDITED) (UNAUDITED) SEPTEMBER 30,
------------------ ---------------- 2005
2005 2004 2005 2004 (UNAUDITED) DECEMBER 31, 2004
---- ---- ---- ---- ------------- -----------------
Third-party distributor A 17% 30% 17% 30% 6% 27%
Third-party distributor B -- 17% -- 21% -- --
Third-party distributor C 13% 9% 14% 8% 40% 34%
4) INVENTORY
Inventory consisted of the following:
SEPTEMBER 30,
2005 DECEMBER 31,
(UNAUDITED) 2004
------------- ------------
Finished goods $1,266,278 $1,226,071
Work in process 387,719 85,910
Raw materials 414,741 105,179
---------- ----------
$2,068,738 $1,417,160
========== ==========
6
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5) RESTRUCTURING CHARGE
During the quarter ended September 30, 2005, the Company eliminated 14
staff positions, representing 16% of the workforce, to align headcount more
closely with management's assessment of its resource requirements at this time.
These workforce reductions were made across all functions of the Company. As a
result of these actions the Company recorded a restructuring charge of
approximately $150,000. As of September 30, 2005, the Company had paid an
aggregate of $136,000 and expects to pay the remainder of the charges by
December 31, 2005.
A summary of the restructuring charges and related activity is as follows:
SEPTEMBER 30, 2005
-----------------------------------
ACCRUED
RESTRUCTURING
CHARGES PAYMENTS BALANCE
-------- -------- -------------
Employee severance, benefits and related
costs $150,917 $136,093 $14,824
-------- -------- -------
Total $150,917 $136,093 $14,824
======== ======== =======
6) OTHER ACCRUED EXPENSES
Other accrued expenses consisted of the following:
SEPTEMBER 30,
2005 DECEMBER 31,
(UNAUDITED) 2004
------------- ------------
Research and development costs $ 343,809 $ 778,926
Marketing and sales costs 101,729 153,167
Product related costs 266,446 261,444
Legal and other professional fees 691,842 374,142
Employee benefits 338,869 229,304
Restructuring 14,824 --
Other expenses 77,663 104,858
---------- ----------
$1,835,182 $1,901,841
========== ==========
7) ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation for employee stock
option awards in accordance with Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," using the intrinsic value
method. Under APB Opinion 25, stock compensation expense is recognized for the
excess, if any, of intrinsic value of the award over the exercise price.
7
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In March 2005, the vesting period for 18,875 options to purchase shares of
common stock was extended beyond the original terms and the vesting of 1,250
options was accelerated upon an employee's termination. As a result of this
stock option modification, the Company recorded compensation expense of
approximately $19,000 during the nine months ended September 30, 2005. The
compensation expense was calculated using the intrinsic value method, which
compares the common stock option exercise price to the fair market value of the
underlying common stock on the date of modification. The stock compensation
expense was recorded as part of general and administrative costs in the
Condensed Consolidated Statement of Operations.
As described above, the Company uses the intrinsic value method to measure
compensation expense associated with grants of stock options to employees. Had
the Company used the fair value method to measure employee stock compensation,
the Company's pro forma net loss, and pro forma net loss per share for the three
and nine months ending September 30, 2005 and 2004 would have been as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
------------------------- ---------------------------
2005 2004 2005 2004
----------- ----------- ------------ ------------
NET LOSS
As reported $(3,608,281) $(2,974,992) $(12,766,014) $(11,572,733)
Add: stock-based compensation expense
included in reported net loss -- -- 19,444 --
Less: stock-based compensation expense
determined under the fair value method (339,471) (438,535) (1,439,514) (1,935,133)
----------- ----------- ------------ ------------
Pro forma $(3,947,752) $(3,413,527) $(14,186,084) $(13,507,866)
=========== =========== ============ ============
BASIC AND DILUTED NET LOSS PER COMMON SHARE
As reported $ (0.21) $ (0.18) $ (0.75) $ (0.72)
Effect on net loss per common share if fair (0.02) (0.02) (0.09) (0.12)
value method had been used
----------- ----------- ------------ ------------
Pro forma $ (0.23) $ (0.20) $ (0.84) $ (0.84)
=========== =========== ============ ============
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS Statement No. 123(R), "Share-Based Payment," ("123(R)") a revision of SFAS
Statement No. 123, which will impact the accounting for employee stock options
and other equity-based compensation. The standard requires companies to measure
and recognize compensation expense for all stock-based payments at fair value.
The adoption of SFAS No. 123(R) will not affect the Company's cash flows, but it
will affect the Company's net income (loss) and net income (loss) per share. As
this standard is effective for the Company on January 1, 2006, the Company will
8
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
recognize the expense attributable to stock awards that are granted or vest in
periods subsequent to December 31, 2005. As stock award grants are potentially
issued in each annual period, the increase or decrease in stock compensation
expense as a result of adoption of SFAS No. 123(R) cannot be predicted with
certainty.
8) BASIC AND DILUTED NET LOSS PER COMMON SHARE
Basic net loss per common share is based on the weighted-average number of
shares outstanding during each period. For the periods ended September 30, 2005,
and 2004, stock options, warrants and rights totaling approximately 3,396,000
and 3,043,000 shares, respectively, have been excluded from the computation of
diluted net loss per share as the effect would be antidilutive.
9) COMPREHENSIVE LOSS
For the three and nine months ended September 30, 2005 and 2004,
comprehensive loss consisted of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
------------------------- ---------------------------
2005 2004 2005 2004
----------- ----------- ------------ ------------
NET LOSS $(3,608,281) $(2,974,992) $(12,766,014) $(11,572,733)
Change in net unrealized gains and
losses on marketable securities
available-for-sale (166,714) (130,812) (413,323) (847,221)
----------- ----------- ------------ ------------
COMPREHENSIVE LOSS $(3,774,995) $(3,105,804) $(13,179,337) $(12,419,954)
=========== =========== ============ ============
Accumulated other comprehensive (loss) income consists of net unrealized
gains and losses on marketable securities available-for-sale, which is reported
as part of shareholders' equity in the Condensed Consolidated Balance Sheets.
10) COMMITMENTS AND CONTINGENCIES
Legal Matters - The Company continues to negotiate with PhotoCure ASA and
Galderma S.A. under the terms of a Mediation Agreement signed by the parties in
August 2004 in order to try to facilitate a settlement of our differences with
respect to certain of the Company's patents licensed to us by PARTEQ Research &
Development Innovations, the technology transfer arm of Queen's University at
Kingston, Ontario.
9
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In December 2004, the Company filed a lawsuit against New England
Compounding Pharmacy, Inc. of Framingham, Massachusetts alleging violations of
U.S. patent law in the United States District Court in Boston, Massachusetts. On
March 17, 2005, New England Compounding Pharmacy filed an answer against us,
including a defense that our patents are invalid and several counterclaims
against us, and we filed our response on April 5, 2005. The parties are now in
the discovery stage of this litigation and we are unable to predict the outcome
of this lawsuit at this time. A tentative trial date has been set by the Court
for January 2007. We are seeking injunctive relief, monetary damages and costs.
In January 2005, the Company filed a lawsuit against The Cosmetic Pharmacy of
Tucson, Arizona alleging violations of the Lanham Act for false advertising and
trademark infringement, and of U.S. patent law in the U.S. District Court for
the District of Arizona. A motion for default judgment was granted on July 25,
2005 in our favor for failure of The Cosmetic Pharmacy of Tucson to appear,
together with injunctive relief and attorney fees and costs in the amount of
approximately $20,000. While we believe that certain actions of these pharmacies
go beyond the activities which are permitted under the Food, Drug and Cosmetic
Act and have advised the FDA and local health authorities of our concerns, we
cannot be certain that our lawsuits will be successful in curbing the practices
of these pharmacies or that regulatory authorities will intervene to stop their
activities which we believe are having a negative impact on our business.
The Company has not accrued any amounts for these contingencies as of
September 30, 2005 as these amounts are neither probable nor estimable.
Termination of Distribution Agreement - In September 2005, the Company
exercised its right to terminate its distribution agreement with its
non-exclusive distributor of the Kerastick(R) in the United States. The
termination is scheduled to become effective on December 31, 2005. Following
termination, the Company plans to perform these activities using its existing
employees and infrastructure.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
DUSA is a pharmaceutical company engaged primarily in the research,
development, and marketing of a drug named 5-aminolevulinic acid, or ALA, which
is used in combination with appropriate light devices in order to detect or
treat a variety of medical conditions. The trademark for our brand of ALA is
Levulan(R). When Levulan(R) is used and followed with exposure to light to
produce a therapeutic effect, the technology is called photodynamic therapy, or
PDT. When Levulan(R) is used and followed with exposure to light to detect
medical conditions, the technology is called photodetection, or PD. Our products
are Levulan(R) 20% topical solution using our Kerastick(R) brand applicator, and
our BLU-U(R) brand light unit. Our products are used together to provide PDT for
the treatment of non-hyperkeratotic actinic keratoses, or AKs, of the face or
scalp. In addition, the BLU-U(R) is used without Levulan(R) for the treatment of
moderate inflammatory acne vulgaris and general dermatological conditions. Both
products have received approval or market clearance as required from the United
States Food and Drug Administration ("FDA") and regulatory approval from Health
Canada. We are currently conducting clinical trials to test whether our products
can be used to treat both photodamaged skin and acne with Levulan(R) PDT.
Kerastick(R) unit sales to end-users were 20,286 and 69,162 for the three
and nine month periods ended September 30, 2005, respectively, including 17,766
and 59,172, respectively, sold in the United States, and 2,520 and 9,990,
respectively, sold in Canada by Coherent-AMT, our Canadian marketing and
distribution partner. This represents an increase from 20,196 and 50,160
Kerastick(R) units sold in the three and nine-month periods ended September 30,
2004, respectively, including 18,870 and 46,926, respectively, sold in the
United States, and 1,326 and 3,234, respectively sold in Canada by Coherent-AMT.
During the quarter ended September 30, 2005, 818 customers in the United
States ordered 17,766 Kerastick(R) units, of which approximately 73% were
existing customers and 27% were new customers, as compared to approximately
1,600 customers in the United States who ordered product during all of 2004.
However, due to various factors, including, a price increase which had been
announced prior to its November 2004 effective date and certain volume discount
programs which had been in place for much of 2004, we believe that physicians
ordered more Kerastick(R) units than their usage necessitated at the end of
2004, which we believe has negatively impacted 2005 revenues. Approximately 39%
of our top 114 volume customers from 2004 have not yet reordered Kerastick(R)
units in 2005, and, in some cases, may still be working down their supplies
through the remainder of the year.
While overall Kerastick(R) unit sales for the quarter ended September 30,
2005 were relatively flat on a sequential basis, United States sales during the
quarter represented a 7.6% increase over the quarter ended June 30, 2005, driven
by a combination of new customers and orders by existing customers. We are
encouraged with this unit increase in light of the fact that
11
the summer months are traditionally slow periods in the dermatology market,
particularly with laser and light-based therapies.
During the quarter, we received FDA approval to manufacture our BLU-U(R) in
our Wilmington, Massachusetts facility. However, at this time, we expect to
utilize our own facility only as a back-up to our current third-party
manufacturer or for repairs. The net number of BLU-U(R) units placed in doctors'
offices during the three months ended September 30, 2005 was 98, including 22
placed in Canada. As of September 30, 2005 there were 1,215 units in doctor's
offices, consisting of 1,037 in the United States and 178 in Canada as compared
with 914 BLU-U(R) units in doctors' offices at December 31, 2004, consisting of
813 in the United States and 101 in Canada.
We have continued our efforts to penetrate the market by implementing
targeted sales efforts in key geographic locations. See section entitled
"Results of Operations - Marketing and Sales Costs." We are encouraged by the
increase in sales on a year-to-date basis, despite the circumstances outlined
above, as well as the positive feedback we continue to receive from physicians
across the country that believe Levulan PDT should become a routine part of
standard dermatological practice.
Historically, we devoted most of our resources to fund research and
development efforts in order to advance the Levulan(R) PDT/PD technology
platform. More recently, we have also devoted significant resources to our sales
and marketing efforts. As a result, we have experienced significant operating
losses. As of September 30, 2005, we had an accumulated deficit of approximately
$87,305,000. We expect to continue to incur operating losses until sales of our
products increase substantially. Achieving our goal of becoming a profitable
operating company is dependent upon greater acceptance of our therapy by the
medical and consumer constituencies, and our ability to develop and/or acquire
new profitable products.
We believe that issues related to reimbursement to physicians relative to
our products have negatively impacted the economic competitiveness of our
therapy with other AK therapies and have hindered its adoption in the past.
Effective January 1, 2005, the CMS average national reimbursement for the use of
Levulan(R) PDT for AKs was increased, reflecting the cost of additional medical
supplies that were not included in the original application. However, the effect
of this increase was partially offset by a simultaneous change in drug
reimbursement methodologies, which also became effective on January 1, 2005.
Drug reimbursement amounts are now based on 106% of a drug's average selling
price (ASP) rather than 85% of the drug's average wholesale price (AWP), which
was the previous standard. Reimbursement for the Kerastick(R) will vary from
quarter to quarter based on the ASP to the end-user during a prior quarter,
including all discounts. While we believe that 2005 reimbursement changes
related to treatment of AK are positive for physicians using our therapy, some
physicians still believe that even the new reimbursement levels do not fully
reflect the required efforts to routinely execute our therapy in their
practices, which we believe impacts adoption of our products and ultimately, our
revenues. We continue to support ongoing efforts that might lead to further
increases in
12
reimbursement and intend to support efforts to seek reimbursement for our
FDA-cleared use of the BLU-U(R) alone in the treatment of mild to moderate
inflammatory acne.
Several of the major private insurers have approved coverage for our AK
therapy. We continue to work to educate other private insurance carriers in an
attempt to gain more widespread coverage. We believe that these efforts, along
with our education and marketing programs, should result in an increased
adoption of our therapy over time.
We have been encouraged by the positive response from many physicians and
patients who have used our therapy, but we recognize that we have to continue to
demonstrate the clinical value of our unique therapy, and the related product
benefits as compared to other well-established conventional therapies, in order
for the medical community to accept our products on a large scale. While our
financial position is strong, we cannot predict when product sales may offset
the costs associated with these efforts. We are aware that physicians have been
using Levulan(R) with the BLU-U(R), and with light devices manufactured by other
companies, for uses other than our FDA-approved use. While we are not permitted
to market our products for so-called 'off-label' uses, we believe that these
activities are positively affecting the sales of our products.
We are also aware that some compounding pharmacies may be exceeding the
legal limits for their activities, including manufacturing and/or selling
quantities of ALA in circumstances which may be inducing purchasers to infringe
our intellectual property. We believe that these activities are negatively
impacting our sales growth. Therefore in December 2004 and in January 2005, we
filed lawsuits against two compounding pharmacies. See "Part II, Item 1,
Litigation."
As of September 30, 2005, our staff included 69 full-time employees and 2
part-time employees as compared to 65 full-time employees and 4 part-time
employees at the end of 2004. These include marketing and sales, production,
maintenance, customer support, and financial operations personnel, as well as
those who support research and development programs for dermatology and internal
indications. During the nine-month period ended September 30, 2005, we increased
the size of our sales force to 28 from 22 at the end of 2004. During the
three-month period ended September 30, 2005, we eliminated 14 positions,
representing 16% of our workforce, to align headcount more closely with our
assessment of our resource requirements at this time. These workforce reductions
were made across all functions of the Company. We anticipate that this reduction
in staff will reduce our future operating costs by $1,400,000 on an annualized
basis. We may add and/or replace employees during the balance of 2005 as
business circumstances deem necessary.
We believe that DUSA is now much better positioned to take advantage of the
market opportunities for Levulan(R) PDT in dermatology and other fields. With
our increased sales force, and a variety of educational and marketing
initiatives, we anticipate continued year-over-year increases in sales going
forward, although variability in quarterly growth rates at this early stage of
the adoption curve is still to be expected. Now that we have a specialty
dermatology sales force, we are also actively working on in-licensing and/or
developing additional dermatology
13
products; as well as continuing to work on out-licensing Levulan(R) PDT for
dermatology in territories outside of North America.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are disclosed in Note 2 to the Notes to the
Consolidated Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2004. Since all of these accounting policies do not require
management to make difficult, subjective or complex judgments or estimates, they
are not all considered critical accounting policies. We have discussed these
policies and the underlying estimates used in applying these accounting policies
with our audit committee. We consider the following policies and estimates to be
critical to our financial statements.
REVENUE RECOGNITION - Revenues on product sales are recognized when
persuasive evidence of an arrangement exists, the price is fixed and
determinable, delivery has occurred, and collection is probable. Product sales
made through distributors who have a general right of return of product have
been recorded as deferred revenue until the product is sold by our distributors
to the end user. Although we make every effort to assure the reasonableness of
our estimates, significant unanticipated changes in our estimates due to
business, economic, or industry events could have a material impact on our
results of operations.
INVENTORY - Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method. Inventories are continually
reviewed for slow moving, obsolete and excess items. Inventory items identified
as slow-moving are evaluated to determine if an adjustment is required.
Additionally, our industry is characterized by regular technological
developments that could result in obsolete inventory. Although we make every
effort to assure the reasonableness of our estimates, any significant
unanticipated changes in demand, technological development, or significant
changes to our business model could have a significant impact on the value of
our inventory and our results of operations. We use sales projections to
estimate the appropriate level of inventory reserves, if any, that are necessary
at each balance sheet date.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS - We review long-lived assets
for impairment whenever events or changes in business circumstances indicate
that the carrying amount of assets may not be fully recoverable or that the
useful lives of these assets are no longer appropriate. Factors that we consider
important which could trigger an impairment review include significant changes
relative to: (i) projected future operating results; (ii) the use of the assets
or the strategy for the overall business; (iii) business collaborations; and
(iv) industry, business, or economic trends and developments. Each impairment
test is based on a comparison of the undiscounted cash flow to the recorded
value of the asset. If it is determined that the carrying value of long-lived or
intangible assets may not be recoverable based upon the existence of one or more
of the above indicators of impairment, the asset is written down to its
estimated fair value on a discounted cash flow basis. At September 30, 2005, our
total property, plant and equipment had a carrying value of $3,168,000,
including $2,320,000 associated with our
14
manufacturing facility. As of September 30, 2005, we had intangible assets
totaling $162,000 recorded in deferred charges and other assets relating to the
unamortized balance of payments made in 2004 to National Biological Corporation
to amend our agreement to develop and manufacture light sources, and to Draxis
Health, Inc., our former parent, to reacquire our product rights in Canada.
STOCK-BASED COMPENSATION - We have elected to continue to use the intrinsic
value-based method to account for employee stock option awards under the
provisions of Accounting Principles Board Opinion No. 25, and to provide
disclosures based on the fair value method in the Notes to the Consolidated
Financial Statements as permitted by Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock Compensation," as amended by SFAS No.
148, "Accounting for Stock-Based Compensation, Transition and Disclosure". Stock
or other equity-based compensation for non-employees is accounted for under the
fair value-based method as required by SFAS No. 123 and Emerging Issues Task
Force ("EITF") No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services" and other related interpretations. Under this method, the equity-based
instrument is valued at either the fair value of the consideration received or
the equity instrument issued on the date of grant. The resulting compensation
cost is recognized and charged to operations over the service period, which, in
the case of stock options, is generally the vesting period.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123(R), "Share-Based Payment," a revision of SFAS No. 123, which will impact the
accounting for employee stock options and other equity-based compensation when
it becomes effective on January 1, 2006. The standard requires companies to
measure and recognize compensation expense for all stock-based payments at fair
value. The adoption of SFAS No. 123(R) will not affect our cash flow, but it
will affect our net income (loss) and net income (loss) per share. We will
recognize the expense attributable to stock options that are granted or vest in
periods subsequent to December 31, 2005. As stock award grants are potentially
issued in each annual period, the increase or decrease in stock compensation
expense as a result of the adoption of SFAS No. 123(R) cannot be predicted with
certainty.
RESULTS OF OPERATIONS
REVENUES - Total revenues for the three and nine-month periods ended
September 30, 2005 were $2,392,000 and $7,989,000, respectively, as compared to
$2,011,000 and $5,442,000 in the comparable periods in 2004, and were comprised
of the following:
15
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
------------------------------------ ------------------------------------
INCREASE/ INCREASE/
2005 2004 (DECREASE) 2005 2004 (DECREASE)
---------- ---------- ---------- ---------- ---------- ----------
KERASTICK(R) REVENUES
United States $1,630,000 $1,414,000 $216,000 $5,389,000 $3,513,000 $1,876,000
Canada 176,000 85,000 91,000 693,000 185,000 508,000
---------- ---------- -------- ---------- ---------- ----------
Total $1,806,000 $1,499,000 $307,000 $6,082,000 $3,698,000 $2,384,000
---------- ---------- -------- ---------- ---------- ----------
BLU-U(R) REVENUES
United States $ 462,000 $ 432,000 $ 30,000 $1,488,000 $1,481,000 $ 7,000
Canada 124,000 80,000 44,000 419,000 263,000 156,000
---------- ---------- -------- ---------- ---------- ----------
Total $ 586,000 $ 512,000 $ 74,000 $1,907,000 $1,744,000 $ 163,000
---------- ---------- -------- ---------- ---------- ----------
Total Revenues $2,392,000 $2,011,000 $381,000 $7,989,000 $5,442,000 $2,547,000
========== ========== ======== ========== ========== ==========
Kerastick(R) unit sales to end-users were 20,286 and 69,162 for the three
and nine month periods ended September 30, 2005, respectively, including 17,766
and 59,172, respectively, sold in the United States, and 2,520 and 9,990,
respectively, sold in Canada by Coherent-AMT, our Canadian marketing and
distribution partner. This represents an increase from 20,196 and 50,160
Kerastick(R) units sold in the three and nine-month periods ended September 30,
2004, respectively, including 18,870 and 46,926, respectively, sold in the
United States, and 1,326 and 3,234, respectively sold in Canada by Coherent-AMT.
The increase in Kerastick(R) revenues for the three months ended September 30,
2005 compared with the same 2004 period was driven mainly by an increase in our
average net selling price, which increased to $89.02 during the current quarter
from $74.20 for the third quarter of 2004. For the first nine months of 2005,
the increase in revenues is attributable to increased sales volumes, an increase
in our average unit selling price, increased levels of our direct distribution
to customers and a reduction in our overall sales volume discount programs. Our
average net selling price for the Kerastick(R) increased to $87.94 for the first
nine months of 2005 from $73.72 for the first nine months of 2004. Our average
net selling price for the Kerastick(R) includes sales made directly to our
end-user customers, as well as sales made to our distributors, both in the
United States and Canada.
While overall Kerastick(R) unit sales for the quarter ended September 30,
2005 were relatively flat on a sequential basis, United States sales during the
quarter represented a 7.6% increase over the quarter ended June 30, 2005, driven
by a combination of new customers and orders by existing customers. We are
encouraged with this unit increase in light of the fact that the summer months
are traditionally slow periods in the dermatology market. However, we also
believe that due to various factors mentioned above, that physicians ordered
more Kerastick(R) units in 2004 than their usage necessitated at that time. As a
result, approximately 39% of our top 114 volume customers from 2004 have not
ordered Kerastick(R) units during the first nine
16
months of 2005 and, in some cases, may still be working down their supplies
through the remainder of the year.
The increase in 2005 BLU-U(R) revenue on a year-to-date basis was driven by
an increase in our average selling price to $6,390 for the nine-month period
ended September 30, 2005 from $4,038 for the nine-month period ended September
30, 2004. In the three and nine-month periods ended September 30, 2005, there
were 82 and 294 units sold, respectively, versus 103 units and 432 units in the
comparable 2004 periods. The 2005 total consists of 219 units sold in the United
States and 75 sold in Canada by Coherent-AMT. The 2004 total consists of 355
sold in the United States and 77 sold in Canada. The decrease in BLU-U(R) units
sold in the three and nine-month periods ended September 30, 2005 compared to
the same periods in 2004 is due primarily to the implementation of a more
focused sales strategy aimed at increasing Kerastick(R) sales volumes in
existing accounts; as well as a decrease in BLU-U(R) discounting programs.
The increase of both Kerastick(R) and BLU-U(R) revenues during 2005 is a
result of the increased efforts of our sales force and related marketing and
sales activities. With respect to United States sales, we increased our average
selling prices, increased our direct selling and distribution efforts, while
still maintaining the services of one external distributor, and reduced our
overall sales volume discount programs, all of which have had a positive impact
on our average selling prices during 2005. Sales must increase significantly
from these levels in order for us to become profitable. We remain confident that
we are in a good position to exploit our therapy and that with a more focused
sales strategy, the on-going consumption of the Kerastick(R) by our customers,
the addition of new customers and the publication of positive results of
independent investigators' studies in peer reviewed journal articles, that sales
will continue to increase as we approach year end.
COST OF PRODUCT REVENUES AND ROYALTIES - Cost of product revenues and
royalties for the three and nine-month periods ended September 30, 2005 were
$1,307,000 and $4,782,000, respectively, as compared to $718,000 and $2,613,000
in the comparable periods in 2004. A summary of the components of cost of
product revenues and royalties is provided below:
THREE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
---------------------------------
INCREASE/
KERASTICK(R)COST OF PRODUCT REVENUES AND ROYALTIES 2005 2004 (DECREASE)
-------- --------- ----------
Direct Kerastick(R) Product costs $369,000 $ 390,000 $(21,000)
Other Kerastick(R) Product costs including internal costs
assigned to support products 354,000 (162,000) 516,000
Royalty and supply fees (1) 93,000 75,000 18,000
-------- --------- --------
Total Kerastick(R) cost of product revenues and
royalties $816,000 $ 303,000 $513,000
-------- --------- --------
17
INCREASE/
2005 2004 (DECREASE)
---------- -------- ---------
BLU-U(R) COST OF PRODUCT REVENUES
Direct BLU-U(R) Product costs (2) $ 284,000 $ -- $ 284,000
Other BLU-U(R) Product costs including internal costs
assigned to support products; as well as costs
incurred to ship, install and service the BLU-U(R)
in physicians offices 207,000 415,000 (208,000)
---------- -------- ---------
Total BLU-U(R) cost of product revenues $ 491,000 $415,000 $ 76,000
---------- -------- ---------
TOTAL COST OF PRODUCT REVENUES AND ROYALTIES $1,307,000 $718,000 $ 589,000
========== ======== =========
NINE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
------------------------------------
INCREASE/
2005 2004 (DECREASE)
---------- ---------- ----------
KERASTICK(R) COST OF PRODUCT REVENUES AND ROYALTIES
Direct Kerastick(R) Product costs $1,339,000 $ 969,000 $ 370,000
Other Kerastick(R) Product costs including internal
costs assigned to support products 985,000 79,000 906,000
Royalty and supply fees (1) 318,000 175,000 143,000
---------- ---------- ----------
Total Kerastick(R) cost of product revenues and
royalties $2,642,000 $1,223,000 $1,419,000
---------- ---------- ----------
INCREASE/
2005 2004 (DECREASE)
---------- ---------- ----------
BLU-U(R) COST OF PRODUCT REVENUES
Direct BLU-U(R) Product costs (2) $ 998,000 $ -- $ 998,000
Other BLU-U(R) Product costs including internal
costs assigned to support products; as well as
costs incurred to ship, install and service the
BLU-U(R) in physicians offices 1,142,000 1,390,000 (248,000)
---------- ---------- ----------
Total BLU-U(R) cost of product revenues $2,140,000 $1,390,000 $ 750,000
---------- ---------- ----------
TOTAL COST OF PRODUCT REVENUES AND ROYALTIES $4,782,000 $2,613,000 $2,169,000
========== ========== ==========
1) Royalty and supply fees reflect amounts paid to our licensor, PARTEQ
Research and Development Innovations, the licensing arm of Queen's
University, Kingston, Ontario, and amortization of an upfront fee and
ongoing royalties paid to Draxis, DUSA's former parent, on sales of the
Levulan(R) Kerastick(R) in Canada.
2) Although there were direct BLU-U(R) product revenues in 2004, there were no
related direct BLU-U(R) product costs as these units had a zero book value
due to inventory impairment charges recorded during 2002.
18
MARGINS - Total product margins for the three and nine-month periods ended
September 30, 2005 were $1,085,000 and $3,207,000, respectively, as compared to
$1,292,000 and $2,829,000 in the comparable periods in 2004, as shown below:
THREE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
-----------------------------------------------
INCREASE/
2005 2004 (DECREASE)
---------------- ---------------- ----------
Kerastick(R) $ 990,000 55% $1,195,000 80% $(205,000)
BLU-U(R) 95,000 16% 97,000 19% (2,000)
---------- ---------- ---------
Total Margin $1,085,000 45% $1,292,000 64% $(207,000)
========== ========== =========
NINE MONTHS ENDED SEPTEMBER 30,
(UNAUDITED)
-------------------------------------------------
INCREASE/
2005 2004 (DECREASE)
---------------- ---------------- ----------
Kerastick(R) $3,440,000 57% $2,474,000 67% $ 966,000
BLU-U(R) (233,000) (12)% 355,000 20% 588,000
---------- ---------- ----------
Total Margin $3,207,000 40% $2,829,000 52% $1,554,000
========== ========== ==========
Kerastick(R) margins for the three and nine months ended September 30, 2005
were 55% and 57%, respectively, versus 80% and 67% for the comparable 2004
periods. The decrease in the Kerastick(R) margins, in terms of both dollars and
percentages, for the three and nine months ended September 30, 2005 in
comparison to the comparable 2004 periods is due to favorable manufacturing
variances experienced during the quarter ended September 30, 2004 attributable
to elevated Kerastick(R) production during that quarter. This favorable
manufacturing variance resulted in Other Kerastick Product costs being negative
for the three-month period ended September 30, 2004. Despite the favorable
manufacturing variances experienced during the third quarter of 2004, in
general, we have been operating our Kerastick(R) manufacturing plant well below
capacity, resulting in underutilization charges, which have negatively impacted
margins. Due to this situation, we are realizing expected fluctuations in our
margins as a result of both the timing of production and unabsorbed expenses.
This has been somewhat offset by an increase in the overall selling price per
unit. Our long-term goal is to achieve much higher margins on Kerastick(R) sales
which will be significantly dependent on increased volume.
BLU-U(R) margins for the three and nine months ended September 30, 2005
were 16% and (12%), respectively, versus 19% and 20% for the comparable 2004
periods. The erosion on margin is directly attributable to the fact that in 2005
we sold newly purchased units with an associated production cost, whereas during
the comparable 2004 period, we sold units which had
19
a zero net book value due to inventory impairment charges recorded during 2002
following termination of an agreement with a marketing partner. The margin
erosion is somewhat offset by an increase in the overall selling price per unit
and a decrease in Other BLU-U(R) Product costs. Our short-term strategy is to
approach breakeven on device sales in an effort to drive Kerastick(R) sales
volumes. However, our longer term goal is to move towards a reasonable profit
margin on all device sales.
RESEARCH AND DEVELOPMENT COSTS - Research and development costs for the
three and nine-month periods ended September 30, 2005 were $1,414,000 and
$4,809,000, respectively, as compared to $1,585,000 and $4,850,000 in the
comparable periods in 2004. We have completed patient accrual to both the
efficacy phase of our Phase II photodamaged skin study and to our Phase II
multi-center moderate to severe inflammatory acne study. We now anticipate that
we will have preliminary efficacy and safety data for both of the Phase II
studies early in the first quarter of 2006. During September 2005, the FDA
issued draft guidance for the pharmaceutical industry regarding the development
of new drugs for acne vulgaris treatment. DUSA has studied these guidelines, and
in combination with positive new information learned from independent
investigator studies on acne, the Company now believes that additional Phase II
work is likely to be required before we commence Phase III acne trials. As our
Phase II clinical trials proceed, and especially at such time as we may commence
Phase III trials in these indications, research and development expenses are
expected to increase significantly. We have retained the services of a
regulatory consultant to assist us with seeking foreign marketing approvals for
our products, which could cause research and development expenses to increase.
On September 27, 2004, DUSA signed a clinical trial agreement with the
National Cancer Institute, Division of Cancer Prevention, or NCI DCP, for the
clinical development of Levulan(R) PDT for the treatment of high-grade dysplasia
within Barrett's Esophagus. In addition, to further our objectives concerning
treatment of internal indications using Levulan(R) photodynamic therapy ("PDT"),
on November 4, 2004 we signed an additional clinical trial agreement with the
NCI DCP for the treatment of oral cavity dysplasia. DUSA and the NCI DCP are
working together to prepare overall clinical development plans for Levulan(R)
PDT in these indications, starting with Phase II trials, and continuing through
Phase III studies, if appropriate. DUSA and the NCI DCP have prepared outlines
of clinical studies in both indications. The NCI DCP has solicited letters of
intent regarding these studies from its extramural expert clinical investigator
consortium, and is in the process of reviewing the letters it has received.
After the investigators are selected, DUSA and the NCI DCP will finalize the
clinical trial designs. The NCI DCP will use its resources to file its own
Investigational New Drug applications with the FDA. Our costs related to these
studies will be limited to providing Levulan(R), device(s) and the necessary
training for the investigators involved. All other costs of these studies will
be the responsibility of the NCI DCP. We will maintain full ownership of our
existing intellectual property, have options on new intellectual property and,
subject to successful Phase II and III clinical trial results, intend to seek
FDA approvals in due course. In preparation for new Phase II clinical trials for
the treatment of high-grade dysplasia associated Barrett's esophagus, our small
single-center pilot Phase II clinical trial using our new proprietary endoscopic
light delivery device is continuing.
20
MARKETING AND SALES COSTS - Marketing and sales costs for the three and
nine-month periods ended September 30, 2005 were $1,804,000 and $6,886,000,
respectively, as compared to $1,835,000 and $4,902,000 in the comparable periods
in 2004. These costs consist primarily of expenses such as salaries and benefits
for the marketing and sales staff, commissions, and related support expenses
such as travel, and telephone, totaling $1,566,000 and $5,256,000 for the three
and nine-month periods ended September 30, 2005, compared to $1,438,000 and
$3,731,000 in the comparable periods in 2004. These increases were mainly
attributable to the expansion of our sales force from 22 employees as of
September 30, 2004 to 28 employees as of September 30, 2005, including sales
management. The remaining expenses consist of tradeshows, miscellaneous
marketing and outside consultants totaling $238,000 and $1,630,000 for the three
and nine-month periods ended September 30, 2005, compared to $397,000 and
$1,171,000 for the comparable periods in 2004. We expect that our marketing and
sales costs for the remainder of 2005 will remain relatively flat for the
remainder of 2005.
GENERAL AND ADMINISTRATIVE COSTS - General and administrative costs for the
three and nine-month periods ended September 30, 2005 were $1,664,000 and
$5,187,000, respectively, as compared to $1,198,000 and $5,776,000 in the
comparable periods in 2004. The increase for the three month period is due to
increased legal and other professional fees, as well as increased general
corporate expenses in relation to the comparable 2004 period for the reason
described in this paragraph below. The decrease for the nine-month period is
mainly attributable to lower legal expenses of $1,551,000 as compared to
$2,822,000 in the comparable period in 2004, due to the absence of patent
litigation costs in Australia as the final hearing in the PhotoCure litigation
described below was held in April 2004. The savings related to the Australian
litigation is partially offset by the on-going negotiations with PhotoCure and
Galderma regarding settlement of patent issues, as well as litigation costs
against two compounding pharmacies, as described below. Additionally, general
corporate expenses, including increased personnel related costs, have increased
as our business has expanded.
We continue to negotiate with PhotoCure ASA and Galderma S.A. under the
terms of a Mediation Agreement signed by the parties in August 2004 in order to
try to facilitate a settlement of our differences with respect to certain of our
patents licensed to us by PARTEQ Research & Development Innovations, the
technology transfer arm of Queen's University at Kingston, Ontario.
In December 2004, we filed a lawsuit against New England Compounding
Pharmacy, Inc. of Framingham, Massachusetts alleging violations of United States
patent law in the U.S. District Court in Boston, Massachusetts. On March 17,
2005, New England Compounding Pharmacy filed an answer against us, including a
defense that our patents are invalid and counterclaims, and we filed our
response on April 5, 2005. The parties are now in the discovery stage of this
litigation and we are unable to predict the outcome of this lawsuit at this
time. A tentative trial date has been set by the court for January 2007. We are
seeking injunctive relief, monetary damages and costs. In January 2005, we filed
a lawsuit against The Cosmetic
21
Pharmacy of Tucson, Arizona alleging violations of the Lanham Act for false
advertising and trademark infringement, and of U.S. patent law in the U.S.
District Court for the District of Arizona. A motion for default judgment was
granted on July 25, 2005 in our favor for failure of The Cosmetic Pharmacy of
Tucson to appear, together with injunctive relief and attorney fees and costs in
the amount of approximately $20,000. While we also believe that certain actions
of these pharmacies go beyond the activities which are permitted under the Food,
Drug and Cosmetic Act and have advised the FDA and local health authorities of
our concerns, we cannot be certain that our lawsuits will be successful in
curbing the practices of these pharmacies or that regulatory authorities will
intervene to stop their activities which we believe are having a negative impact
on our business.
RESTRUCTURING CHARGE - During the quarter ended September 30, 2005, the
Company eliminated 14 staff positions, representing 16% of the workforce, to
align headcount more closely with management's assessment of its resource
requirements at this time. These workforce reductions were made across all
functions of the Company. As a result of these actions the Company recorded a
restructuring charge of $150,000. The Company expects that future operating
costs will be reduced by $1.4 million on an annualized basis as a result of
these actions. As of September 30, 2005, the Company had paid an aggregate of
$136,000 and expects to pay the remainder of the charges by December 31, 2005.
OTHER INCOME, NET - Other income for the three and nine-month periods ended
September 30, 2005 was $340,000 and $1,060,000, respectively, as compared to
$351,000 and $1,125,000 in the comparable 2004 periods. This decrease was
attributable to a reduction in our average investment balances as we used cash
to support our operating activities, offset in part by an increase in investment
yield due to higher interest rates during the period.
NET LOSSES - For the three and nine months ended September 30, 2005, we
incurred net losses of $(3,608,000), or $(0.21) per share, and $(12,766,000), or
$(0.75) per share, respectively, as compared to net losses of $(2,975,000), or
$(0.18) per share, and $(11,573,000), or $(0.72) per share, for the comparable
periods in 2004. Net losses are expected to continue until end-user sales offset
the cost of launching our sales force and marketing initiatives, and the costs
for other business support functions.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2005, we had approximately $35,264,000 of total liquid
resources comprised of $2,001,000 of cash and cash equivalents and marketable
securities available-for-sale totaling $33,263,000. As of September 30, 2005,
these available-for-sale securities had current yields ranging from 2.54% to
7.25% and maturity dates ranging from October 6, 2005 to June 15, 2008.
As of September 30, 2005, working capital (total current assets minus total
current liabilities) was $36,230,000 as compared to $48,799,000 as of December
31, 2004. Total current assets and total current liabilities decreased by
$12,852,000 and $283,000, respectively, during
22
the nine months ended September 30, 2005 due primarily to cash used in operating
activities of $12,968,000, offset in part by cash provided by investing
activities of $11,809,000.
We believe that based on current sales volumes and related expenses we have
sufficient resources to continue to fund our current programs for Levulan(R) PDT
and our operations and capital expenditures for approximately two years. We have
invested our funds in liquid investments, so that we will have ready access to
these investments, as needed.
We are actively seeking to expand or enhance our business by using
resources to acquire by license, purchase or other arrangements, businesses, new
technologies, or products. During 2005, we have focused primarily on increasing
the sales of the Levulan(R) Kerastick(R) and the BLU-U(R), and advancing our
Phase II studies for use of Levulan(R) PDT in photodamaged skin and acne.
DUSA has no off-balance sheet financing arrangements other than its
operating leases.
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS -
On July 29, 2005, the Company signed an amendment to its existing supply
agreement with Sochinaz S.A, the bulk supplier of the active ingredient in
Levulan(R). This amendment extends the agreement through December 31, 2009, with
an option to extend for an additional one year, and amends certain pricing and
purchasing terms.
On September 15, 2005, the Company exercised its right to terminate its
distribution agreement with its non-exclusive distributor of the Kerastick(R) in
the United States. The termination is scheduled to become effective on December
31, 2005. Following termination, we will perform these activities using our
existing employees and infrastructure.
INFLATION -
Although inflation rates have been comparatively low in recent years,
inflation is expected to apply upward pressure on our operating costs. We have
included an inflation factor in our cost estimates. However, the overall net
effect of inflation on our operations is expected to be minimal.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. Our investment policy specifies credit quality
standards for our investments and limits the
23
amount of credit exposure to any single issue, issuer or type of investment. Our
investments consist of United States government securities and high grade
corporate bonds. All investments are carried at market value, which approximates
cost.
As of September 30, 2005, the weighted average rate of return on our
investments was 4.41%. If market interest rates were to change immediately and
uniformly by 100 basis points from levels as of September 30, 2005, the fair
market value of the portfolio would change by $326,000. Declines in interest
rates could, over time, reduce our interest income.
ITEM 4. CONTROLS AND PROCEDURES.
We carried out an evaluation, under the direction of our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of September 30, 2005.
There have been no changes in our internal control over financial reporting
that occurred during the quarter ended September 30, 2005 that have materially
affected, or are reasonably likely to materially affect, DUSA's internal control
over financial reporting.
FORWARD-LOOKING STATEMENTS
This report, including the Management's Discussion and Analysis, contains
various "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 which represent our expectations or beliefs concerning
future events, including, but not limited to statements regarding management's
goal of becoming profitable, beliefs regarding adoption of our therapy by
physicians, expectations for continuing operating losses, expectations regarding
our position to take advantage of market opportunities and to exploit our
therapy, beliefs regarding increases in sales and revenue, estimates regarding
inventory levels and hiring goals, expectations regarding internal distribution
capabilities and the utilization of our facility for manufacturing and repairs,
estimates regarding the effects of so-called 'off-label' use of our products,
expectations for research and development expenses and the need for additional
clinical trials, beliefs regarding expenses and regulatory requirements
associated with seeking foreign marketing approvals for our products, beliefs
regarding development programs with respect to photodamaged skin and acne,
expectations regarding marketing and sales expenses, effects of unanticipated
changes in estimates, forecasts, demand, technological developments and our
business model, factors which could trigger impairment review, beliefs
concerning reimbursement and the effect on our revenue and the economic
competitiveness of our therapy, beliefs regarding our education and marketing
programs, expectations regarding the reduction of operating costs, expectations
concerning the operational impact and general effect of the ruling by the
Federal court of Australia regarding the Australian patent, beliefs regarding
the impact of the activities of compounding pharmacies on our business, beliefs
regarding our requirements of
24
cash resources to fund our current programs, operations and capital
expenditures, beliefs regarding the need for additional funds for development,
levels of interest income and net losses and the sufficiency of our capital
resources, expectations regarding accounting pronouncements, inflation, market
risks and controls and procedures. These forward-looking statements are further
qualified by important factors that could cause actual results to differ
materially from those in the forward-looking statements. These factors include,
without limitation, changing market and regulatory conditions, actual clinical
results of our trials, the potential need to hire additional personnel, the
impact of competitive products and pricing, the timely development, FDA
approval, and market acceptance of our products, the maintenance of our patent
portfolio, changes in our long and short term goals, the litigation process, the
ability to obtain competitive levels of reimbursement by third-party payors, and
other risks noted in our SEC filings from time to time, including our Form 10-K
for the period ending December 31, 2004, none of which can be assured.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On April 12, 2002, the Company received notice that one of the patents
licensed to the Company by PARTEQ Research & Development Innovations, the
technology transfer arm of Queen's University at Kingston, Ontario was being
challenged by PhotoCure ASA. PhotoCure ASA filed a lawsuit in Australia alleging
that Australian Patent No. 624985, which is one of the patents relating to the
Company's 5-aminolevulinic acid technology, is invalid. As a consequence of this
action, Queen's University assigned the Australian patent to the Company so that
DUSA could participate directly in this litigation. The Company filed a response
setting forth its defenses, and a related countersuit alleging that certain
activities of PhotoCure and its marketing partner, Galderma S.A., infringed the
patent. The final hearing in the Federal Court of Australia was held in April
2004. On April 6, 2005, the Federal Court of Australia ruled that the Australian
patent is valid and remains in full force and effect. However, the Court also
ruled that PhotoCure's product, Metvix, does not infringe the claims in the
Australian patent. Since these claims are unique to the Australian patent and
Australian law differs from patent law in other jurisdictions, the Company does
not expect this ruling to be determinative of the validity of any other patents
licensed by DUSA from Queen's University or of whether PhotoCure's product
infringes claims in such other patents, including the United States patent. As
DUSA does not have an active drug application in Australia, DUSA believes that
this ruling will have no operational impact on the Company. None of the parties
have appealed the decision and the date to do so has expired. The parties signed
a Mediation Agreement in August 2004 to attempt to settle their disputes and
those discussions are ongoing.
In December 2004, the Company filed a lawsuit against New England
Compounding Pharmacy, Inc. of Framingham, Massachusetts alleging violations of
U.S. patent law in the United States District Court in Boston, Massachusetts. On
March 17, 2005, New England Compounding Pharmacy filed an answer against us,
including a defense that our patents are invalid and several counterclaims
against us, and we filed our response on April 5, 2005. The parties are now in
the discovery stage of this litigation and we are unable to predict the outcome
of this lawsuit at this time. We have not reserved any funds for settlement or
damages at this time. A tentative trial date has been set by the court for
January 2007. We are seeking injunctive relief, monetary damages and costs. In
January 2005, we filed a lawsuit against The Cosmetic Pharmacy of Tucson,
Arizona alleging violations of the Lanham Act for false advertising and
trademark infringement, and of U.S. patent law in the U.S. District Court for
the District of Arizona. A motion for default judgment was granted on July 25,
2005 in our favor for failure of The Cosmetic Pharmacy of Tucson to appear,
together with injunctive relief and attorney fees and costs in the amount of
$20,668.12.
26
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
a) Exhibit 10.1 - Third Amendment to Supply Agreement, dated July 29,
2005, between DUSA Pharmaceuticals, Inc. and Sochinaz S.A., filed as
Exhibit 10.1 to the Registrant's Form 10-Q filed on August 3, 2005,
and is incorporated herein by reference, portions of which have been
omitted pursuant to a request for confidential treatment pursuant to
Rule 24b-2 of the Securities Exchange Act of 1934, as amended.
b) Exhibit 31(a) - Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer.
c) Exhibit 31(b) - Rule 13a-14(a)/15d-14(a) Certification of the Chief
Financial Officer.
d) Exhibit 32(a) - Certification of the Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
e) Exhibit 32(b) - Certification of 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.
f) Exhibit 99(a) - Press Release dated November 4, 2005.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DUSA Pharmaceuticals, Inc.
By: /s/ D. Geoffrey Shulman
------------------------------------
D. Geoffrey Shulman
Chairman and Chief Executive Officer
(principal executive officer)
Date: November 8, 2005 By: /s/ Richard C. Christopher
------------------------------------
Richard C. Christopher
Vice President, Finance and Chief
Financial Officer (principal
financial officer and principal
accounting officer)
28
EXHIBIT INDEX
10.1 Third Amendment to Supply Agreement, dated July 29, 2005, between DUSA
Pharmaceuticals, Inc. and Sochinaz S.A., filed as Exhibit 10.1 to the
Registrant's Form 10-Q filed on August 3, 2005, and is incorporated
herein by reference, portions of which have been omitted pursuant to a
request for confidential treatment pursuant to Rule 24b-2 of the
Securities Exchange Act of 1934, as amended.
31(a) Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer.
31(b) Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer.
32(a) Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32(b) Certification of 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.
99(a) Press Release dated November 4, 2005.