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 June 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 [_]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 subsequent to the distribution of securities under a plan confirmed
by a court.
Yes [_] No [_]
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:
16,923,697 shares as of August 1, 2005
PART I. FINANCIAL INFORMATION
ITEM 1. UNAUDITED FINANCIAL STATEMENTS.
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
2005 2004
(UNAUDITED)
-------------- --------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,443,523 $ 2,928,143
Marketable securities 37,217,156 46,222,969
Accrued interest receivable 505,989 641,797
Accounts receivable, net 630,925 711,016
Inventory, net 2,384,575 1,417,160
Prepaids and other current assets 1,141,802 830,895
-------------- --------------
TOTAL CURRENT ASSETS 43,323,970 52,751,980
Restricted cash 140,989 140,764
Property, plant and equipment, net 3,374,667 3,481,888
Deferred charges and other assets 252,388 276,256
-------------- --------------
TOTAL ASSETS $ 47,092,014 $ 56,650,888
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 602,661 $ 857,268
Accrued compensation 884,722 963,607
Other accrued expenses 1,747,043 1,901,841
Deferred revenue 352,284 230,715
-------------- --------------
TOTAL CURRENT LIABILITIES 3,586,710 3,953,431
Other liabilities 198,617 190,439
-------------- --------------
TOTAL LIABILITIES 3,785,327 4,143,870
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTE 9)
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:
16,923,697 and 16,876,822 shares of common stock, no par, at June
30, 2005 and December 31, 2004, respectively 124,882,626 124,698,059
Additional paid-in capital 2,035,783 2,016,339
Accumulated deficit (83,696,494) (74,538,761)
Accumulated other comprehensive income 84,772 331,381
-------------- --------------
TOTAL SHAREHOLDERS' EQUITY 43,306,687 52,507,018
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 47,092,014 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
(UNAUDITED) (UNAUDITED)
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
REVENUES
Kerastick (R) Product Revenues, net $ 1,766,029 $ 1,303,833 $ 4,276,118 $ 2,199,098
BLU-U (R) Product Revenues, net 462,087 872,195 1,320,612 1,232,615
------------ ------------ ------------ ------------
PRODUCT REVENUES, NET $ 2,228,116 $ 2,176,028 $ 5,596,730 $ 3,431,713
KERASTICK (R) COST OF PRODUCT REVENUES AND ROYALTIES 846,285 489,241 1,825,528 919,871
BLU-U (R) COST OF PRODUCT REVENUES 624,243 579,470 1,648,628 974,845
------------ ------------ ------------ ------------
COST OF PRODUCT REVENUES AND ROYALTIES 1,470,528 1,068,711 3,474,156 1,894,716
TOTAL MARGIN 757,588 1,107,317 2,122,574 1,536,997
OPERATING COSTS
Research and development 1,799,149 1,577,294 3,394,866 3,265,060
Marketing and sales 2,295,914 1,699,145 5,081,316 3,066,603
General and administrative 1,841,239 2,402,546 3,523,718 4,577,793
------------ ------------ ------------ ------------
TOTAL OPERATING COSTS 5,936,302 5,678,985 11,999,900 10,909,456
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (5,178,714) (4,571,668) (9,877,326) (9,372,459)
OTHER INCOME
Interest income, net 352,596 375,581 719,593 774,718
------------ ------------ ------------ ------------
NET LOSS $ (4,826,118) $ (4,196,087) $ (9,157,733) $ (8,597,741)
============ ============ ============ ============
BASIC AND DILUTED NET LOSS PER
COMMON SHARE $ (0.29) $ (0.25) $ (0.54) $ (0.55)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 16,921,318 16,727,111 16,914,870 15,764,792
============ ============ ============ ============
See the accompanying Notes to the Condensed Consolidated Financial Statements.
3
DUSA PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30,
2005 2004
(UNAUDITED) (UNAUDITED)
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (9,157,733) $ (8,597,741)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of premiums and accretion of discounts on marketable 306,274 51,986
securities available-for-sale, net
Realized gain on sale of marketable securities available-for-sale (6,371)
Depreciation and amortization expense 522,308 896,372
Issuance of stock options to consultants 240,753
Stock-based compensation 19,444
Changes in other assets and liabilities impacting cash flows from operations:
Accrued interest receivable 135,808 89,659
Accounts receivable 80,091 (536,695)
Inventory (967,415) (178,449)
Prepaids and other current assets (310,907) (87,570)
Accounts payable (254,607) (445,619)
Accrued compensation and other accrued expenses (233,683) 218,314
Deferred revenue 121,569 194,039
Other liabilities-non current 8,178
-------------- --------------
CASH USED IN OPERATING ACTIVITIES (9,737,044) (8,154,951)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of marketable securities (24,095,511)
Proceeds from maturities and sales of marketable securities 32,554,812 7,000,000
Restricted cash (225) (634)
Purchases of property, plant and equipment (391,219) (417,465)
-------------- --------------
CASH PROVIDED BY INVESTING ACTIVITIES 8,067,857 6,581,901
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock (net of stock offering costs of $200,202) 28,262,298
Proceeds from exercise of options 184,567 591,076
Payments of long-term debt (1,517,500)
-------------- --------------
CASH PROVIDED BY FINANCING ACTIVITIES 184,567 27,335,874
-------------- --------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,484,620) 25,762,824
-------------- --------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,928,143 4,294,482
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,443,523 $ 30,057,306
============== ==============
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 June 30, 2005 and December
31, 2004, Condensed Consolidated Statements of Operations for the three and six
months ended June 30, 2005 and 2004, and Condensed Consolidated Statements of
Cash Flows for the six months ended June 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, which 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. 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 June 30, 2005, current yields range from 2.53% to
7.60% and maturity dates range from July 15, 2005 to June 15, 2008. The
estimated fair value and cost of marketable securities at June 30, 2005 and
December 31, 2004 are as follows:
JUNE 30, 2005
(UNAUDITED)
------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
-------------- -------------- -------------- --------------
United States government securities $ 22,002,290 $ 132,685 $ (23,288) $ 22,111,687
Corporate securities $ 15,130,094 $ 9,894 $ (34,519) $ 15,105,469
-------------- -------------- -------------- --------------
Total marketable securities
available-for-sale $ 37,132,384 $ 142,579 $ (57,807) $ 37,217,156
============== ============== ============== ==============
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
============== ============== ============== ==============
The change in net unrealized gains and losses on such securities for the
three and six months ended June 30, 2005 were $(18,793) and $(246,609),
respectively, as compared to $(568,750) and $(716,409) for the three and six
months ended June 30, 2004. These amounts have been recorded in accumulated
other comprehensive income, which is reported as part of shareholder's equity in
the Condensed Consolidated Balance Sheets.
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 six months ended June 30, 2005 and 2004, and accounts
receivable as of June 30, 2005 and December 31, 2004 are as follows:
% OF REVENUE % OF REVENUE % OF ACCOUNTS RECEIVABLE
------------------- ------------------- ----------------------------
THREE-MONTHS ENDED SIX-MONTHS ENDED
(UNAUDITED) (UNAUDITED) AS OF
------------------- ------------------- ----------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2005 DECEMBER 31,
2005 2004 2005 2004 (UNAUDITED) 2004
-------- -------- -------- -------- ------------- ------------
Third-party distributor A 19% 25% 16% 30% 8% 27%
Third-party distributor B - 19% - 23% - -
Third-party distributor C 17% 12% 15% 8% 44% 34%
6
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4) INVENTORY
Inventory consisted of the following:
JUNE 30, DECEMBER 31,
2005 2004
(UNAUDITED)
------------- -------------
Finished goods $ 1,686,690 $ 1,226,071
Work in process 284,654 85,910
Raw materials 413,231 105,179
------------- -------------
$ 2,384,575 $ 1,417,160
============= =============
5) OTHER ACCRUED EXPENSES
Other accrued expenses consisted of the following:
JUNE 30, DECEMBER 31,
2005 2004
(UNAUDITED)
------------- -------------
Research and development costs $ 501,475 $ 778,926
Marketing and sales costs 198,246 153,167
Product related costs 295,443 261,444
Legal and other professional fees 363,343 374,142
Employee benefits 290,891 229,304
Other expenses 97,645 104,858
------------- -------------
$ 1,747,043 $ 1,901,841
============= =============
6) ACCOUNTING FOR STOCK-BASED COMPENSATION
SFAS No. 123, as amended by SFAS No. 148, addresses the financial
accounting and reporting standards for stock or other equity-based compensation
arrangements. The Company has 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, "Accounting for Stock
Issued to Employees," and to provide disclosures based on the fair value method
in the Notes to the Consolidated Financial Statements as permitted by SFAS No.
123, as amended by SFAS No. 148. Under the intrinsic value method, compensation
expense, if any, is recognized for the difference between the exercise price of
the option and the fair value of the underlying common stock as of a measurement
date. The measurement date is the time when both the number of shares and the
exercise price is known. Stock or other equity-based compensation for
non-employees must be accounted for under the fair value-based method as
required by SFAS No. 123, as amended by SFAS No. 148, and EITF No. 96-18, 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 measurement date, which is generally the grant date.
The resulting compensation cost is recognized and charged to operations over the
service period, which is generally the vesting period.
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 six months ending June 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 compensation, the Company's
pro forma net loss, and pro forma net loss per share for the three and six
months ending June 30, 2005 and 2004 would have been as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(UNAUDITED) (UNAUDITED)
---------------------------------- ----------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
NET LOSS
As reported $ (4,826,118) $ (4,196,087) $ (9,157,733) $ (8,597,741)
Effect on net loss if fair value method had
been used (758,427) (779,453) (1,080,599) (1,496,598)
-------------- -------------- -------------- --------------
Pro forma $ (5,584,545) $ (4,975,540) $ (10,238,332) $ (10,094,339)
============== ============== ============== ==============
BASIC AND DILUTED NET LOSS PER COMMON SHARE
As reported $ (0.29) $ (0.25) $ (0.54) $ (0.55)
Effect on net loss per common share if fair
value method had been used (0.04) (0.05) (0.07) (0.09)
-------------- -------------- -------------- --------------
Pro forma $ (0.33) $ (0.30) $ (0.61) $ (0.64)
============== ============== ============== ==============
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. In
accordance with SFAS Statement No.123(R) and the Securities and Exchange
Commission's recent ruling that defers the required effective date of adoption,
the Company will recognize the expense attributable to stock awards that are
granted or vest in periods subsequent
8
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
to December 31, 2005. As noted above, had the Company expensed its employee
stock options under SFAS No. 123 for the three and six months ended June 30,
2005, net loss and net loss per share would have increased by approximately
$758,000, or $0.04 per share and $1,081,000, or $0.07 per share, respectively.
As stock award grants are determined throughout each year, the increase or
decrease in stock compensation expense as a result of adoption of SFAS No.
123(R) cannot be predicted with certainty.
7) 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 June 30, 2005, and
2004, stock options, warrants and rights totaling approximately 3,490,000 and
3,083,000 shares, respectively, have been excluded from the computation of
diluted net loss per share as the effect would be antidilutive.
8) COMPREHENSIVE LOSS
For the three and six months ended June 30, 2005 and 2004, comprehensive
loss consisted of the following:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(UNAUDITED) (UNAUDITED)
---------------------------------- ----------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
NET LOSS $ (4,826,118) $ (4,196,087) $ (9,157,733) $ (8,597,741)
Change in net unrealized gains and
losses on marketable securities
available-for-sale (18,793) (568,750) (246,609) (716,409)
-------------- -------------- -------------- --------------
COMPREHENSIVE LOSS $ (4,844,911) $ (4,764,837) $ (9,404,342) $ (9,314,150)
============== ============== ============== ==============
Accumulated other comprehensive 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.
9) COMMITMENTS AND CONTINGENCIES
Legal Matters - 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
9
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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. 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 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 may be having a negative impact on our
business.
The Company has not accrued any amounts for these contingencies as of June
30, 2005 as these amounts are neither probable nor estimable.
10) SUBSEQUENT EVENTS
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
10
DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
extends the agreement through December 31, 2009, with an option to extend for
an additional one year, and amends certain pricing and purchasing terms.
As a consequence of slower revenue growth than previously anticipated, the
Company reduced its corporate staff, across all departments, by 14 persons and
consolidated two sales territories, effective July 29, 2005.
11
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.
Since the October 2003 launch of our sales force, sales and revenues of
our products have increased substantially, although sales for the three months
ended June 30, 2005 were disappointing as compared to the preceding quarter
ended March 31, 2005 for reasons described below. Kerastick(R) unit sales to
end-users were 20,172 and 48,876 for the three and six-month periods ended June
30, 2005, respectively, including 3,666 and 7,470, respectively, sold by
Coherent-AMT, our Canadian marketing and distribution partner. This represents
an increase from 17,910 and 29,964 Kerastick(R) units sold in the three and
six-month periods ended June 30, 2004, respectively, including 1,908 sold by
Coherent-AMT all sold in the second quarter of 2004.
The net number of BLU-U(R) units placed in doctors' offices during the
three months ended June 30, 2005 was 72, including 24 placed in Canada. As of
June 30, 2005 there were 1,117 units in doctor's offices, consisting of 961 in
the United States and 156 in Canada. There were 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. As of June 30, 2005, our
direct sales force consisted of 31 employees, including representatives and
management, compared to 22 at the end of 2004. See section entitled "Results of
Operations - Marketing and Sales Costs." Despite our disappointment with sales
volumes for the quarter ended June 30, 2005, we are encouraged by both the
increases in sales on a year-to-date basis and the positive feedback we continue
to receive from doctors across the country that believe Levulan PDT should
become a routine part
12
of standard dermatological practice. During the quarter ended June 30, 2005, 738
customers in the United States ordered Kerastick(R) units, of which
approximately 70% were existing customers and 30% 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, but not
limited to 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 that time. We also experienced a disruption of the
sales force related to the addition of 11 new sales employees during the first 4
months of 2005 and the implementation of a more focused sales strategy from a
more opportunistic approach to selling. In addition, efforts by compounding
pharmacies may be having a negative impact on our sales. We believe that as a
result of these conditions approximately 45% 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.
Historically, we have primarily devoted our resources to fund research and
development efforts in order to advance the Levulan(R) PDT/PD technology
platform and, as a result, we have experienced significant operating losses. As
of June 30, 2005, we had an accumulated deficit of approximately $83,700,000. 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 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, a change in 2005 to the way the drug is
reimbursed, which is now based on the average selling price (ASP) rather than
the average wholesale price (AWP), caused a decrease in the amount reimbursed
for the Kerastick(R). Reimbursement for the Kerastick(R) will vary from quarter
to quarter, calculated as 106% of the ASP to the end-user during a prior
quarter, including all discounts. As we have decreased our Kerastick(R) volume
discount programs, reimbursement is expected to increase in future quarters.
While we believe that 2005 reimbursement changes related to treatment of AK are
positive overall for doctors 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. We continue to support
ongoing efforts that might lead to further increases in 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.
In addition, we continue to work to educate private insurance carriers so
that they will approve our therapy for coverage. Several of the major private
insurers have approved coverage for our AK therapy. We believe that due to these
efforts, along with our education and marketing programs, a more widespread
adoption of our therapy should occur over time.
13
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 estimate, based on
limited in-house survey data, that these activities are positively affecting the
sales of our products and may represent a greater percentage of our total sales
than the usage of our products for treatment of AKs.
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. These activities may be 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 June 30, 2005, our staff included 84 full-time employees and 4
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 six-month period ended June 30, 2005, we increased the
size of our sales force to 31 from 22 at the end of 2004. As a consequence of
slower revenue growth than previously anticipated, we reduced our corporate
staff, across all departments, by 14 persons and consolidated two sales
territories, effective July 29, 2005. As a result of these actions, we expect
that we will reduce operating costs by $1.4 million 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 strengthened management team, 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 products; while continuing
to work on out-licensing Levulan(R) PDT for dermatology in territories outside
of North America.
During the quarter, we also received the Notice of Final Determination
under the Hatch-Waxman Patent Term Extension Act, which will extend the term of
our patent claims in United States Patent No. 5,079,262 with respect to actinic
keratoses from July 2009 to September 2013.
14
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 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 June 30, 2005,
our total property, plant and equipment had a carrying value of $3,375,000,
including $2,500,000 associated with our manufacturing facility. As of June 30,
2005, we had intangible assets totaling $174,000 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
15
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. 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. In accordance with the revised statement and the Securities
and Exchange Commission's recent ruling that defers the required effective date
of adoption, we will recognize the expense attributable to stock options that
are granted or vest in periods subsequent to December 31, 2005. As described in
Note 6 to the Notes to the Condensed Consolidated Financial Statements, had the
Company expensed its employee stock options under SFAS No. 123 for the three and
six months ended June 30, 2005, net loss and net loss per share would have
increased by approximately $758,000, or $0.04 per share and $1,081,000, or $0.07
per share, respectively. As stock award grants are determined throughout each
year, the increase or decrease in stock compensation expense as a result of the
adoption of SFAS No. 123(R) cannot be predicted with certainty.
16
RESULTS OF OPERATIONS
REVENUES - Total revenues for the three and six-month periods ended June
30, 2005 were $2,228,000 and $5,597,000, respectively, as compared to $2,176,000
and $3,432,000 in the comparable periods in 2004, and were comprised of the
following:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(UNAUDITED) (UNAUDITED)
---------------------------------------------- ----------------------------------------------
INCREASE/ INCREASE/
2005 2004 (DECREASE) 2005 2004 (DECREASE)
------------ ------------ ------------ ------------ ------------ ------------
KERASTICK(R) REVENUES
United States $ 1,510,000 $ 1,204,000 $ 306,000 $ 3,759,000 $ 2,100,000 $ 1,659,000
Canada 256,000 100,000 156,000 517,000 100,000 417,000
------------ ------------ ------------ ------------ ------------ ------------
Total 1,766,000 1,304,000 462,000 4,276,000 2,200,000 2,076,000
BLU-U(R) REVENUES
United States $ 340,000 $ 720,000 $ (380,000) $ 1,026,000 $ 1,080,000 $ (54,000)
Canada 122,000 152,000 (30,000) 295,000 152,000 143,000
------------ ------------ ------------ ------------ ------------ ------------
Total 462,000 872,000 (410,000) 1,321,000 1,232,000 89,000
------------ ------------ ------------ ------------ ------------ ------------
Total Revenues $ 2,228,000 $ 2,176,000 $ 52,000 $ 5,597,000 $ 3,432,000 $ 2,165,000
============ ============ ============ ============ ============ ============
The increase in 2005 Kerastick(R) revenues was driven mainly by increased
sales volumes. Kerastick(R) unit sales to end-users were 20,172 and 48,876 for
the three and six-month periods ended June 30, 2005, respectively, including
3,666 and 7,470, respectively, sold by Coherent-AMT, our Canadian marketing and
distribution partner. This represents an increase from 17,910 and 29,964
Kerastick(R) units sold in the three and six-month periods ended June 30, 2004,
respectively, including 1,908 sold by Coherent-AMT all sold in the second
quarter of 2004. The increase in revenues in 2005 is also attributable to our
decision to increase our average unit selling price during the fourth quarter of
2004, increased levels of our direct distribution to customers by eliminating
one of our distributors, and a reduction in our overall sales volume discount
programs. In fact, our average net selling price for the Kerastick(R) increased
to $87.48 for the first six months of 2005 from $73.39 for the first six months
of 2004.
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 $6,187 for the six-month period
ended June 30, 2005 from $3,747 for the six-month period ended June 30, 2004. In
the three and six-month periods ended June 30, 2005, there were 69 and 212 units
sold, respectively, versus 220 units and 329 units in the comparable 2004
periods. The 2005 total consists of 159 units sold in the United States and 53
sold in Canada by Coherent-AMT. The 2004 total consists of 281 sold in the
United States and
17
48 sold in Canada. The decrease in BLU-U(R) units sold in the three and
six-month periods ended June 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 efforts of our sales force and related marketing and sales
activities. With respect to United States Kerastick(R) sales, we increased the
selling price in November 2004 and will continue to evaluate the market during
the year. We have increased our direct selling and distribution efforts, while
still maintaining the services of one external distributor, and we have reduced
our overall sales volume discount programs, all of which have had a positive
impact on our average selling prices during 2005. We also believe, however, that
due to various factors mentioned above, during 2004 physicians ordered more
Kerastick(R) units then their usage necessitated at that time. As a result,
approximately 45% of our top 114 volume customers from 2004 have not ordered
Kerastick(R) units during the first half of 2005 and, in some cases, may still
be working down their supplies through the remainder of the year. We also
experienced a disruption of the sales force related to the addition of 11 new
sales employees during the first 4 months of 2005 and the implementation of a
more focused sales strategy from a more opportunistic approach to selling.
Although the level of Kerastick(R) sales to end-users for 2005 is higher than
that in the prior year, sales volumes for three month period ended June 30, 2005
of 20,172 is lower than sales volumes for the preceding three month period ended
March 31, 2005 of 28,704. 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 we
will begin to deliver increasing revenue as we approach year end. For the
balance of 2005, we have retained the services of a specialty device firm, on a
commission basis, in order to increase sales of our products, in addition to the
other strategic decisions described above.
COST OF PRODUCT REVENUES AND ROYALTIES - Cost of product revenues and
royalties for the three and six-month periods ended June 30, 2005 were
$1,471,000 and $3,474,000, respectively, as compared to $1,069,000 and
$1,895,000 in the comparable periods in 2004. A summary of the components of
cost of product revenues and royalties is provided below:
THREE MONTHS ENDED JUNE 30,
(UNAUDITED)
----------------------------------------------
INCREASE/
KERASTICK(R) COST OF PRODUCT REVENUES AND ROYALTIES 2005 2004 (DECREASE)
------------ ------------ ------------
Direct Kerastick(R) Product costs $ 389,000 $ 346,000 $ 43,000
Other Kerastick(R) Product costs including internal costs
assigned to support products 359,000 79,000 280,000
Royalty and supply fees (1) 98,000 64,000 34,000
------------ ------------ ------------
Total Kerastick(R) cost of product revenues and royalties $ 846,000 $ 489,000 $ 357,000
------------ ------------ ------------
18
INCREASE/
2005 2004 (DECREASE)
------------ ------------ ------------
BLU-U(R) COST OF PRODUCT REVENUES
Direct BLU-U(R) Product costs (2) $ 238,000 $ - $ 238,000
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 387,000 580,000 (193,000)
------------ ------------ ------------
Total BLU-U(R) cost of product revenues 625,000 580,000 45,000
------------ ------------ ------------
TOTAL COST OF PRODUCT REVENUES AND ROYALTIES $ 1,471,000 $ 1,069,000 $ 402,000
============ ============ ============
SIX MONTHS ENDED JUNE 30,
(UNAUDITED)
----------------------------------------------
INCREASE/
2005 2004 (DECREASE)
------------ ------------ ------------
KERASTICK(R) COST OF PRODUCT REVENUES AND ROYALTIES
Direct Kerastick(R) Product costs $ 969,000 $ 579,000 $ 390,000
Other Kerastick(R) Product costs including internal costs
assigned to support products 630,000 241,000 389,000
Royalty and supply fees (1) 226,000 100,000 126,000
------------ ------------ ------------
Total Kerastick(R) cost of product revenues and royalties $ 1,825,000 $ 920,000 $ 905,000
------------ ------------ ------------
INCREASE/
2005 2004 (DECREASE)
------------ ------------ ------------
BLU-U(R) COST OF PRODUCT REVENUES
Direct BLU-U(R) Product costs (2) $ 714,000 $ - $ 714,000
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 935,000 975,000 (40,000)
------------ ------------ ------------
Total BLU-U(R) cost of product revenues 1,649,000 975,000 674,000
------------ ------------ ------------
TOTAL COST OF PRODUCT REVENUES AND ROYALTIES $ 3,474,000 $ 1,895,000 $ 1,579,000
============ ============ ============
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.
19
MARGIN - Total product margins for the three and six-month periods ended
June 30, 2005 were $758,000 and $2,123,000, respectively, as compared to
$1,107,000 and $1,537,000 in the comparable periods in 2004, as shown below:
THREE MONTHS ENDED JUNE 30,
(UNAUDITED)
------------------------------------------------
INCREASE/
2005 2004 (DECREASE)
---------- ---------- ----------
Kerastick(R) $ 920,000 52% $ 814,000 62% $ 106,000
BLU-U(R) (162,000) (35)% 293,000 34% (455,000)
---------- ---------- ----------
Total Margin $ 758,000 34% $1,107,000 51% $ (349,000)
========== ========== ==========
SIX MONTHS ENDED JUNE 30,
(UNAUDITED)
------------------------------------------------
INCREASE/
2005 2004 (DECREASE)
---------- ---------- ----------
Kerastick(R) $2,451,000 57% $1,279,000 58% $1,172,000
BLU-U(R) (328,000) (25)% 258,000 21% (586,000)
---------- ---------- ----------
Total Margin $2,123,000 38% $1,537,000 45% $ 586,000
========== ========== ==========
Kerastick(R) margins for the three and six months ended June 30, 2005 were
52% and 57%, respectively, versus 62% and 58% for the comparable 2004 periods.
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 six months ended June 30, 2005 were
(35%) and (25%), respectively, versus 34% and 21% for the comparable 2004
periods. The erosion on margin is directly attributable to the fact that in the
first half of 2005 we sold newly purchased units with an associated production
cost, whereas during the comparable 2004 period, we sold units which had 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.
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.
20
RESEARCH AND DEVELOPMENT COSTS -
Research and development costs for the three and six-month periods ended
June 30, 2005 were $1,799,000 and $3,395,000, respectively, as compared to
$1,577,000 and $3,265,000 in the comparable periods in 2004. We have commenced
the efficacy phase of our Phase II photodamaged skin study and completed
enrollment in the second of three cohorts of the Phase II multi-center acne
study. We anticipate that we will have preliminary efficacy and safety data for
both of the Phase II studies around year end 2005. 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.
We have also been following patients who completed Phase I/II studies in
the treatment of high-grade and low-grade dysplasia associated with Barrett's
esophagus. 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. The immediate plan is for
the NCI DCP to solicit clinical protocols from its extramural expert clinical
investigator consortium, after which time 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. We will provide Levulan(R),
device(s) and the necessary training for the investigators involved in the
studies. 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, we are carrying out a small
single-center pilot Phase II clinical trial using our new proprietary endoscopic
light delivery device.
MARKETING AND SALES COSTS -
Marketing and sales costs for the three and six-month periods ended June
30, 2005 were $2,296,000 and $5,081,000, respectively, as compared to $1,699,000
and $3,067,000 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 $1,853,000 and $3,690,000 for the three and six-month periods ended
June 30, 2005, compared to $1,277,000 and $2,292,000 in the comparable periods
in 2004. These increases were mainly attributable to the expansion of our sales
force from 16 employees as of June 30, 2004 to 31 employees as of June 30, 2005,
including sales
21
management. The remaining expenses consist of tradeshows, miscellaneous
marketing and outside consultants totaling $443,000 and $1,391,000 for the three
and six-month periods ended June 30, 2005, compared to $422,000 and $775,000 for
the comparable periods in 2004. We expect that our marketing and sales costs for
the remainder of 2005 will continue to show an increase over comparable 2004
periods, reflecting the expansion of our sales capacity year over year, offset
in part, by the resignation of our Vice President of Sales who we will not
replace at this time.
GENERAL AND ADMINISTRATIVE COSTS -
General and administrative costs for the three and six-month periods ended
June 30, 2005 were $1,841,000 and $3,524,000, respectively, as compared to
$2,403,000 and $4,578,000 in the comparable periods in 2004. This decrease is
mainly attributable to lower legal expenses of $619,000 and $1,038,000 incurred
for the three and six-month periods ended June 30, 2005 as compared to
$1,331,000 and $2,530,000 in the comparable periods 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 to try and settle remaining patent issues and litigation
costs against two compounding pharmacies also described below, as well as higher
levels of general corporate expenses to support our expanding business,
including an increase in personnel related costs.
On April 12, 2002, we received notice that one of the patents licensed to
DUSA 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 our 5-aminolevulinic acid
technology, is invalid. As a consequence of this action, Queen's University
assigned the Australian patent to us so that we could participate directly in
this litigation. We filed a response setting forth our defenses, and a related
countersuit alleging that certain activities of PhotoCure and its marketing
partner, Galderma S.A., infringe 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 our Australian patent is valid and so it 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. None of the
parties filed an appeal and the time period for doing so has now expired. 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, we believe that this ruling will have no
operational impact. We continue to negotiate with PhotoCure and Galderma 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 other patents licensed from PARTEQ.
22
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 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.
OTHER INCOME, NET -
Other income for the three and six-month periods ended June 30, 2005 were
$353,000 and $720,000, respectively, as compared to $376,000 and $775,000 in the
comparable periods in 2004. This decrease was attributable to a reduction in our
average investment balances as we used cash to support our operating activities.
NET LOSSES -
For the three and six months ended June 30, 2005, we incurred net losses
of $(4,826,000), or $(0.29) per share, and $(9,158,000), or $(0.54) per share,
respectively, as compared to net losses of $(4,196,000), or $(0.25) per share,
and $(8,598,000), or $(0.55) 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
DUSA is in a strong liquidity position. At June 30, 2005, we had
approximately $38,661,000 of total liquid resources comprised of $1,444,000 of
cash and cash equivalents and marketable securities available-for-sale totaling
$37,217,000. As of June 30, 2005, these available-for-sale securities had
current yields ranging from 2.53% to 7.60% and maturity dates ranging from July
15, 2005 to June 15, 2008.
23
As of June 30, 2005, working capital (total current assets minus total
current liabilities) was $39,737,000 as compared to $48,799,000 as of December
31, 2004. Total current assets and total current liabilities decreased by
$9,428,000 and $367,000, respectively, during the six months ended June 30, 2005
due primarily to cash used in operating activities of $9,737,000, offset in part
by cash provided by investing activities of $8,068,000.
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, for the funding of development
plans on a short-term and long-term basis.
We anticipate that marketing and sales expenses will level off for the
remainder of 2005 as we seek to focus our current sales force in key territories
and concentrate on potential high volume users. 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. For
2005, we are focusing 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.
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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS -
There have been no recently issued accounting pronouncements that have a
material impact on our financial reporting other than those presented in our
Annual Report on Form 10-K for the year ended December 31, 2004, other than SFAS
No. 123(R) discussed above.
24
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 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 June 30, 2005, the weighted average rate of return on our
investments was 4.82%. If market interest rates were to change immediately and
uniformly by 100 basis points from levels as of June 30, 2005, the fair market
value of the portfolio would change by $260,000. 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 June 30, 2005.
There have been no changes in our internal control over financial
reporting that occurred during the quarter ended June 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, impact
of the activities of compounding pharmacies on our business, expectations for
continuing operating losses, expectations regarding increases in sales and
adequate supply of inventory, expectations regarding internal distribution
capabilities, beliefs regarding physician Kerastick(R) orders, estimates
regarding the effects of so-called `off-label' use of our products, expectations
for research and development expenses and 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, technological developments and our business
model, beliefs regarding inventory levels, factors which could trigger
impairment review, beliefs concerning the effect of increased reimbursement (or
failure to achieve it), beliefs regarding our education and marketing programs
and potential
25
market opportunities, intentions to evaluate and pursue licensing and
acquisition opportunities, beliefs regarding the effects of staff reductions and
the consolidation of sales territories, 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, requirements of cash resources, potential impact on conversion of
government securities, need for additional funds for development, levels of
interest income and net losses, 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 impact of competitive products and pricing, the timely
development, FDA approval, and market acceptance of our products, the
maintenance of our patent portfolio and 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.
26
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.
27
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.
Matters submitted to a vote of security holders of the Corporation
at the Annual Meeting of Shareholders held June 16, 2005 included the
election of six (6) directors, and the ratification of the selection of
Deloitte & Touche LLP as the independent registered public accounting firm
for the Corporation for 2005.
a) The following persons were elected to serve as directors of the
Corporation:
Votes
Votes Cast Cast Broker
For Against Abstained Non-votes
---------- ------- --------- ---------
D. Geoffrey Shulman 15,503,784 28,430 -0- -0-
John H. Abeles 15,469,001 63,213 -0- -0-
David Bartash 15,161,980 370,234 -0- -0-
Jay Haft 15,503,734 28,480 -0- -0-
Richard C. Lufkin 15,468,999 63,215 -0- -0-
Magnus Moliteus 15,498,683 33,531 -0- -0-
b) Shareholders ratified the selection of Deloitte & Touche LLP as the
independent registered public accounting firm for the Corporation for 2005 as
follows:
Votes Cast Votes Cast Broker
For Against Abstained Non-votes
---------- ---------- --------- ---------
Deloitte & Touche LLP 15,510,427 19,304 2,483 -0-
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., 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.
28
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; and
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 August 3, 2005.
29
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: August 3, 2005 By: /s/ Richard C. Christopher
---------------------------
Richard C. Christopher
Vice President, Finance and
Chief Financial Officer (principal
financial officer and principal
accounting officer)
30
EXHIBIT INDEX
10.1 Third Amendment to Supply Agreement, dated July 29, 2005, between DUSA
Pharmaceuticals, Inc. and Sochinaz S.A., 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; and
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 August 3, 2005.