Item 1. Business
Our website address is www.salix.com. We make available free of charge through our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.
Overview
We are a specialty pharmaceutical company dedicated to acquiring, developing and commercializing prescription drugs used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract. Our strategy is to:
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identify and acquire rights to products that we believe have potential for near-term regulatory approval or are already approved;
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apply our regulatory, product development, and sales and marketing expertise to commercialize these products; and
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use our approximately 100-member specialty sales and marketing team focused on high-prescribing U.S. gastroenterologists, who are doctors who specialize in gastrointestinal diseases, to sell our products.
Our current products demonstrate our ability to execute this strategy. These products are:
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balsalazide disodium, which we sell in the United States under the brand name Colazal® ;
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rifaximin, which was approved by the U.S. Food and Drug Administration, or FDA, in May 2004 and which we sell in the United States under the brand name Xifaxan™;
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three dosage strengths of azathioprine, an FDA-approved product licensed by us, two of which strengths we launched in the United States through our direct sales force in February 2004 under the brand name Azasan®;
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Anusol-HC® 2.5% (hydrocortisone Cream USP), Anusol-HC® 25 mg Suppository (Hydrocortisone Acetate);
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Proctocort® Cream (Hydrocortisone Cream USP) 1%, Proctocort® Suppositories (Hydrocortisone Acetate Rectal Suppositories, 30 mg); and
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a patented, granulated formulation of mesalamine, which, if approved by the FDA, we intend to sell in the United States to expand our range of treatment options for ulcerative colitis.
We currently market Colazal, Xifaxan, two dosage strengths of Azasan, and two formulations each of Anusol-HC and Proctocort, and intend, if approved by the FDA, to market future products to U.S. gastroenterologists through our own direct sales force, and enter into distribution relationships outside the United States and in markets where a larger sales organization is appropriate. Currently, our specialty sales and marketing team consists of approximately 100 persons. We believe our sales and marketing team should also position us to sell additional products.
PRODUCTS
Colazal® (balsalazide disodium) Capsules
Our first marketed product, Colazal, upon approval in July 2000 was the first new molecular entity approved in 10 years by the FDA for the treatment of mildly to moderately active ulcerative colitis and the first new oral therapy approved by the FDA for this indication in seven years. Ulcerative colitis is a chronic form of inflammatory bowel disease characterized by inflammation of the lining of the colon. Symptoms of active ulcerative colitis include rectal bleeding, abdominal pain, increased stool frequency, loss of appetite, fever and weight loss. This disease affects roughly 500,000 people in the United States, typically with onset under the age of 40. The cause of ulcerative colitis is unknown and no known cure exists except for the removal of the colon. Oral branded prescription products containing the active therapeutic agent 5-ASA are the first line of treatment and most frequently prescribed class of drugs for ulcerative colitis, with 2004 U.S. retail, mail order and non-retail sales of approximately $750 million. In terms of prescription dollar sales, the market for 5-ASA products has been growing at a 16% annual compound rate for the last 4 years. Colazal contains 5-ASA, as does Asacol®, the market-leading drug with retail, mail-order and non-retail sales of approximately $500 million in 2004.
In clinical trials, Colazal demonstrated at least comparable efficacy and had an improved safety profile as compared to some other oral 5-ASA products. Other 5-ASA products often do not deliver optimal doses of the active therapeutic agent to the colon. However, because Colazal’s proprietary formulation allows approximately 99% of the drug to reach the colon, it can work more quickly and effectively than comparable doses of other 5-ASA products that deliver less drug to the diseased area. In addition, some other 5-ASA products have historically been associated with side effects that cause up to 15-40% of patients to discontinue treatment.
We launched Colazal to physicians in the United States in January 2001 using our own sales force. We sold $14.1 million, $33.5 million, $55.8 million and $85.4 million worth of Colazal in the United States in the years ended December 31, 2001, 2002, 2003 and 2004, respectively. The number of prescriptions written in 2001, 2002, 2003 and 2004 for Colazal was approximately 68,000, 210,000, 314,000 and 374,000, respectively, making Colazal the fastest-growing oral 5-ASA product of its kind in the marketplace during that time period.
Xifaxan™ (rifaximin) tablets
Xifaxan is a gastrointestinal-specific oral antibiotic that was approved by the FDA in May 2004 for the treatment of patients twelve years of age and older with travelers’ diarrhea caused by noninvasive strains of E coli. According to the Centers for Disease Control, each year between 20% and 50% of international travelers, an estimated 10 million people, develop diarrhea, with approximately 80% of the cases caused by bacteria. Based upon recent data, approximately 6.4 million people sought treatment in the United States for infectious diarrhea in 2004 and approximately 4 million of those patients were prescribed a drug.
We believe the advantages of Xifaxan to treat these infections are two-fold: (1) site-targeted antibiotic delivery; and (2) improved tolerability compared to other treatments. Less than 0.5% of the drug is absorbed into the bloodstream when it is taken orally. In addition, the drug might also cause fewer side effects or discomforts such as nausea, headache or dizziness than observed with currently available, more highly-absorbed antibiotics. We believe Xifaxan is also less likely to cause harmful interaction with other drugs a patient is taking. Furthermore, we believe Xifaxan is unique because there is no other U.S.-approved oral antibiotic with its potential lack of systemic absorption and safety profile.
We launched Xifaxan in the United States in July 2004 using our own direct sales force. We sold $9.8 million worth of Xifaxan in the United States in the year ended December 31, 2004. We believe Xifaxan can potentially compete in an annual U.S. market in excess of $2 billion, comprised of over 12 million patients. By comparison, Colazal competes in an annual U.S. market of approximately $750 million, comprised of approximately 500,000 patients. While the potential market for Xifaxan is larger than that for Colazal, we expect to capture only a portion of each market and might not achieve the same success in the Xifaxan market as with Colazal due to competition, market acceptance and/or other factors. We are exploring potential additional indications, formulations, clinical trials and co-promotion arrangements to capitalize on the potential for Xifaxan.
Azasan® (azathioprine tablets)
In November 2003, we acquired from aaiPharma LLC the exclusive right to sell 25, 75 and 100 milligram dosage strengths of azathioprine tablets in North America under the brand name Azasan. Azasan is an FDA-approved drug that suppresses immune system responses and is indicated for preventing rejection of kidney transplants and treatment of severe arthritis. Azasan is commonly prescribed by gastroenterologists for treatment of Crohn’s disease and ulcerative colitis, even though the drug was not approved for these treatments. In February 2004, we launched the 75 and 100 milligram dosage strengths of Azasan in the United States. Product sales for Azasan were $2.3 million for 2004.
Anusol-HC® and Proctocort® (hydrocortisone creams and suppositories)
In June 2004, we acquired the exclusive right to sell Anusol-HC 2.5% (hydrocortisone Cream USP), Anusol-HC 25 mg Suppository (Hydrocortisone Acetate), Proctocort Cream (Hydrocortisone Cream USP) 1% and Proctocort Suppositories (Hydrocortisone Acetate Rectal Suppositories, 30 mg) from King Pharmaceuticals, Inc. The two cream products are topical corticosteroids indicated for relief of the inflammatory and pruritic, or itching, manifestations of corticosteroid-responsive dermatoses. The two suppository products are indicated for use in inflamed hemorrhoids and postirradiation proctitis, as well as an adjunct in the treatment of chronic ulcerative colitis and other inflammatory conditions.
Salix paid $13 million cash for the four products. The Company entered into a supply agreement for the suppository products and the Anusol-HC cream product with King Pharmaceuticals; an alternate supply arrangement with a contract manufacturer was put in place for the Proctocort cream product. Product sales for the Anusol-HC and Proctocort lines were $4.1 million in 2004.
Granulated Mesalamine
In July 2002 we acquired the exclusive development rights in the United States to a granulated mesalamine product from Dr. Falk Pharma GmbH, one of the most recognized companies worldwide in gastroenterology. As part of that transaction, we also received a right of first negotiation with respect to additional Falk products in the United States. The Falk granulated mesalamine product has already been approved in most of the principal markets of Europe. If approved in the United States, the Falk granulated mesalamine product’s unique prolonged release mechanism might allow us to expand the range of treatment options for ulcerative colitis. In February 2004, we initiated a study designed to determine the appropriate dose. In December 2004, we initiated two Phase III studies to investigate the product as a maintenance treatment for ulcerative colitis utilizing a dosing regimen that represents significant improvements in convenience over current therapies. The patent for the treatment of the intestinal tract with the granulated mesalamine product will expire in 2018.
Collaborative Agreements
We have and will continue to enter into various collaborations with licensors, licensees and others. To date, we have entered into the following agreements:
aaiPharma LLC
In November 2003, we acquired from aaiPharma LLC the exclusive right to sell 25, 75 and 100 milligram dosage strengths of azathioprine tablets in North America under the name Azasan. Under the terms of the agreement, we agreed to pay aaiPharma an upfront payment and ongoing royalties on net sales in exchange for supplying us with the drug product.
Alfa Wassermann S.P.A.
We in-licensed rifaximin from Alfa Wassermann, a privately held pharmaceutical company headquartered in Italy. Alfa Wassermann has developed several glycosaminoglycans, rifaximin and alpha-interferon from human leukocytes. Alfa Wassermann’s principal areas of therapeutic focus include anti-thrombotics, antibiotics, gastrointestinal products, NSAIDs, immunomodulators, anti-hypertensives and bronchopulmonary products.
Pursuant to our agreement, Alfa Wassermann granted us the exclusive right in the United States and Canada to develop, make, use and sell or have sold rifaximin for the treatment of gastrointestinal and respiratory tract diseases. Alfa Wassermann has agreed separately to supply the Company with bulk active ingredient rifaximin at a fixed price.
Pursuant to the license agreement, we agreed to pay Alfa Wassermann a net sales-based royalty, as well as certain milestone payments. Our obligation to pay royalties commences upon the commercial launch of the product and continues until the later of (1) the expiration of the period in which the manufacture, use or sale of the products by an unlicensed third party would constitute an infringement on the patent covering the product or (2) 10 years from commercial launch. Thereafter, the licenses granted to us shall continue as irrevocable royalty-free paid-up licenses. However, we would remain obligated to pay a net sales based royalty for use of the product trademark if we choose to continue using it after the other licenses expired.
The license agreement does not have a set term and continues until terminated in accordance with its terms. Either party to the agreement may terminate it following a material breach by the other party and the failure of the breaching party to remedy the breach within 60 days. In addition, Alfa Wassermann has the right to terminate the agreement on three months’ written notice in the event that we fail to use best efforts to develop the product in a timely manner, fail to effect commercial launch within six months of receipt of regulatory approval or fail to sell the product for a period of six consecutive months after commercial launch. In addition, Alfa Wassermann may terminate the agreement if we become involved in bankruptcy, liquidation or similar proceedings. We may terminate the agreement in respect of any indication or any part of the territory covered on 90 days’ notice, at which point our rights with respect to that indication or territory shall cease.
Altana Pharma US, Inc.
On March 2, 2005, we entered into a co-promotion agreement with Altana Pharma US, Inc. to promote Xifaxan. Altana will utilize one of its sales forces with approximately 250 representatives to promote Xifaxan.
Under the terms of the agreement, Altana will have the exclusive right to promote Xifaxan in the United States to physicians other than those already identified and called upon by Salix. Salix and Altana will jointly develop a marketing plan involving promotional materials, sales training and providing samples to Altana. Salix will pay Altana during the contract term a co-promotion fee based on the amount of Xifaxan sold as a result of Altana’s marketing efforts.
The agreement will terminate on December 31, 2006 unless earlier terminated. Each party may terminate upon 90 days written notice or upon breach of the other party.
Biorex Laboratories Limited
Biorex, a private, independent drug company headquartered in England, developed the new chemical entity balsalazide and completed limited Phase III clinical trials. We in-licensed balsalazide and all its salts, including our first product, balsalazide disodium, from Biorex. Under its agreements with us, Biorex will participate in future milestone revenues, royalties and profits from balsalazide.
Pursuant to an agreement entered into between us and Biorex in 1992, Biorex granted us the exclusive worldwide right (other than Japan, Taiwan, Korea and the United States) to develop, manufacture and sell balsalazide for all disease indications for a period of 15 years from the date of commercial launch, subject to early termination in certain circumstances, including upon the material breach by either party and, in the case of Biorex, in the event of our bankruptcy or if a sublicensee of ours terminates or becomes entitled to terminate its sublicense as a result of actions by us. Under a separate agreement, Biorex granted us the exclusive right to develop, manufacture and sell balsalazide for all disease indications in the United States for a period of nine years from the date of commercial launch or the term of the applicable patent, whichever is longer. Under these agreements, we paid Biorex fees upon entering into the agreements and are obligated to make additional milestone and royalty payments for the drug. The royalty payments to be made by us pursuant to the agreement governing the United States market are based on net sales, subject to minimum royalty payments for the first five years following commercial launch. Under the agreement governing territories other than the United States, we are obligated to
pay to Biorex a portion of any gross profit on sales of balsalazide outside the United States. Under these agreements, we undertook to complete preclinical testing, perform clinical trials and obtain regulatory approvals for balsalazide. During 2001, we acquired from Biorex the exclusive right and license to develop, manufacture and sell balsalazide in Japan, Korea and Taiwan. There were no fees paid to Biorex upon entering into this agreement, but we are obligated to pay Biorex a portion of any upfront payments, milestone payments and gross profit on sales of balsalazide in Japan, Korea and Taiwan as well.
Dr. Falk Pharma GmbH
In July 2002, we in-licensed rights to a granulated formulation of mesalamine under an agreement with Dr. Falk Pharma of Freiburg, Germany. The agreement gives us the exclusive rights to develop and market the product in the United States. In return we will make upfront, milestone and royalty payments to Falk. The agreement also provides us a right of first negotiation with respect to rights to develop and market certain additional Falk products in the United States.
King Pharmaceuticals, Inc.
In June 2004, we acquired the exclusive right to sell Anusol-HC® 2.5% (hydrocortisone Cream USP), Anusol-HC® 25 mg Suppository (Hydrocortisone Acetate), Proctocort® Cream (Hydrocortisone Cream USP) 1% and Proctocort® Suppositories (Hydrocortisone Acetate Rectal Suppositories, 30 mg) from King Pharmaceuticals, Inc. (NYSE:KG). We paid $13 million cash for the four products, and entered into a supply agreement for the suppository products and the Anusol-HC cream product with King Pharmaceuticals; an alternate supply arrangement with a contract manufacturer was put in place for the Proctocort cream product.
Menarini Pharmaceutical Industries S.R.L.
Menarini, headquartered in Italy, is the largest manufacturer and distributor of pharmaceuticals in Southern Europe. Menarini also has extensive experience developing and marketing therapies for gastrointestinal disease in its markets. Under our agreements with Menarini, we granted Menarini certain manufacturing rights and exclusive distribution rights with respect to balsalazide in Italy, Spain, Portugal and Greece. Through December 31, 2001, we had received revenues as partial contribution to research and development costs borne by us of approximately $1.2 million. The agreement calls for additional milestone revenues to be paid to us relating to European marketing approvals in the Menarini territories. During 2001, Menarini paid a $270,000 milestone payment to us related to receipt of marketing approval in Italy. Under the terms of the agreements, we will sell the bulk active ingredient balsalazide to Menarini for marketing and distribution in its territories at cost plus a sales-based royalty. During 2001, Menarini paid us approximately $1.2 million for bulk active ingredient balsalazide. Menarini did not purchase any bulk active ingredient balsalazide from us during 2002 or 2003. During 2004, Menarini paid us approximately $0.1 million related to balsalazide purchases.
Unless terminated sooner in accordance with its terms, the agreement with Menarini continues until the earlier of the expiration of (1) the patents relating to the product or (2) 15 years from the date of the agreement, provided however that in any case the agreement shall continue for a period of 10 years from the date of first launch. Either party may terminate the agreement upon a material breach by the other party and the failure to remedy such breach within 30 days in the case of a payment breach or 90 days in the case of any other material breach or if a party enters liquidation, bankruptcy or similar proceedings.
Shire Pharmaceuticals Group plc
In May 2000, we signed an agreement with Shire Pharmaceuticals Group under which Shire purchased from us the exclusive rights to balsalazide, for use as a treatment for ulcerative colitis for Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Republic of Ireland, Luxembourg, Norway, The Netherlands, Switzerland, Sweden and the United Kingdom. Under the agreement, Shire agreed to pay us up to a total of approximately $24.0 million, including approximately $12.1 million in up-front fees and up to $12.0 million upon the achievement of certain milestones. In accordance with our license arrangement with Biorex Laboratories Limited,
our licensor, we share a portion of these payments with Biorex. In May 2000, Shire paid us $9.6 million of cash and $2.5 million by way of the issue of 160,546 new Shire ordinary shares. In August 2000 Shire paid us $4.4 million in connection with the transfer to Shire of the United Kingdom product license for balsalazide. No such additional payments have been made to us by Shire since August 2000. During 2004, we recognized $3.5 million of deferred revenue related to this agreement. We do not anticipate any future revenues under this agreement.
Manufacturing
We own no manufacturing facilities. We have in the past used and will continue to use third-party manufacturers to produce material for use in clinical trials and for commercial product. This manufacturing strategy enables us to direct our financial resources to product in-licensing and acquisition, product development, and sales and marketing efforts, without devoting resources to the time and cost associated with building manufacturing plants.
Currently, we are using active pharmaceutical ingredient balsalazide manufactured for us by Omnichem s.a., a subsidiary of Ajinomoto in Belgium. Balsalazide is being encapsulated as Colazal drug product for us by Anabolic Laboratories in Irvine, California. In addition, we have qualified Noveon Pharma, GmbH in Raubling, Germany as an additional manufacturer of commercial quantities of the active pharmaceutical ingredient balsalazide and are in the process of qualifying an additional Colazal drug product manufacturer.
Under our supply agreement with Alfa Wasserman, Alfa Wassermann is obligated to supply us with bulk active ingredient rifaximin until July 2014 or introduction of a generic product, whichever occurs first. Currently, Alfa Wassermann manufactures rifaximin for the Italian and other European markets. Alfa Wasserman is in the process of securing additional sources of commercial quantities of the active pharmaceutical ingredient rifaximin. Rifaximin drug substance is being manufactured into Xifaxan drug product by Patheon, Inc. in Whitby, Ontario with whom we have long-term supply arrangements.
With respect to the granulated mesalamine product, we will be negotiating with the same manufacturers who supplied the drug substance and drug product for the Phase III clinical trial material for eventual commercial supply.
Under our supply agreement with aaiPharma, aaiPharma is obligated to supply us with finished product to meet all of our requirements for the 25, 75 and 100 milligram tablets of Azasan through November 2006.
Under our supply agreement with King Pharmaceuticals, King is obligated to supply us with finished product of Anusol-HC Cream, Anusol-HC Suppositories, and Proctocort Suppositories through June 2006. We are in the process of executing a Technical Transfer of these three products from King to an alternate manufacturing site with whom we are currently negotiating long-term supply arrangements. In addition, through prior supply arrangements between King and Crown Laboratories in Johnson City, Tennessee, Crown will also be supplying us with finished product of Proctocort Cream.
Sales and Marketing
We currently market Colazal, Xifaxan, Azasan, Anusol-HC and Proctocort and intend, if approved by the FDA, to market granulated mesalamine and other future products to U.S. gastroenterologists through our own direct sales force, and enter into distribution relationships outside the United States and in markets where a larger sales organization is appropriate. Currently, our sales and marketing staff consists of approximately 100 people. We believe our sales force should also position us to sell additional products, including the granulated mesalamine product.
PATENTS AND PROPRIETARY RIGHTS
General
The patents for the balsalazide composition of matter and method of treating ulcerative colitis with balsalazide expired in July 2001 in the United States; however, we have been granted an extension of such patent under the Waxman-Hatch Act through July 2006. We have also obtained patent extensions for the composition of balsalazide in Italy and the United Kingdom until July 2006. The patents for the rifaximin composition of matter (also covering a
process of making rifaximin and using rifaximin to treat gastrointestinal infectious diseases) expired in May 2001 in the United States and Canada. We have filed applications for patents for additional indications using balsalazide and related chemical substances. The patent for the treatment of the intestinal tract with the granulated mesalamine product will expire in 2018.
Data Exclusivity
In 2000, the FDA granted us five years of new chemical entity data exclusivity for balsalazide. This means that for five years from the date of approval of our NDA for balsalazide, the FDA will not approve an application for a competitive version of balsalazide which relies upon data included in our NDA. Therefore, unless an applicant for a competitive version of balsalazide were to develop its own data supporting approval of its NDA, this data exclusivity will have the effect of preventing generic competition for balsalazide until at least July 2005. This period has now been effectively extended to July 2006 by the grant of the balsalazide patent extension.
Because rifaximin is a new chemical entity, the FDA granted us similar 5 year exclusivity for it when it was approved in May 2004. Therefore, rifaximin has data exclusivity through May 2009.
Although the granulated mesalamine product is not a new chemical entity, it may be entitled to three years of exclusivity from the date of its approval if new clinical investigations are required for its approval. Such exclusivity would have the effect of preventing FDA from approving an NDA for a granulated mesalamine product which relied upon the new clinical investigation in our NDA for three years from the date of approval. We believe that the patent for the granulated mesalamine will nonetheless prevent any such approval until at least 2018.
Because Azasan and the Anusol-HC and Proctocort product lines are older products, there are no patents or exclusivity rights available.
Government Regulation
The research, testing, manufacture, marketing and distribution of drug products are extensively regulated by governmental authorities in the United States and other countries. In the United States, drugs are subject to rigorous regulation by the FDA. The Federal Food, Drug and Cosmetic Act, as amended, and the regulations promulgated thereunder, and other federal and state statutes and regulations, govern, among other things, the research, development, testing, manufacture, storage, record keeping, labeling, promotion and marketing and distribution of pharmaceutical products. Failure to comply with applicable regulatory requirements may subject a company to administrative sanctions or judicially imposed sanctions such as civil penalties, criminal prosecution, injunctions, product seizure or detention, product recalls, and total or partial suspension of product marketing and/or approvals. In addition, non-compliance may result in the FDA’s refusal to approve pending NDAs or supplements to approved NDAs or in the withdrawal of an NDA. Any such sanction could result in adverse publicity, which could have a material adverse effect on our business, financial conditions, and results of operation.
The steps ordinarily required before a new pharmaceutical product containing a new chemical entity may be marketed in the United States include: (1) preclinical laboratory tests, preclinical studies in animals and formulation studies; (2) the submission to the FDA of a notice of claimed investigational exemption for a new drug or antibiotic, which must become effective before clinical testing may commence; (3) adequate and well-controlled clinical human trials to establish the safety and efficacy of the drug for each indication; (4) the submission of an NDA to the FDA; and (5) FDA review and approval of the NDA prior to any commercial sale or shipment of the drug. Preclinical tests include laboratory evaluation of product chemistry and formulation, as well as animal studies to assess the potential safety and efficacy of the product. Preclinical tests must be conducted in compliance with Good Laboratory Practice regulations. The results of preclinical testing are submitted to the FDA as part of an IND. A 30-day waiting period after the filing of each IND is required prior to the commencement of clinical testing in humans. In addition, the FDA may, at any time during this 30-day period or at any time thereafter, impose a clinical hold on proposed or ongoing clinical trials. If the FDA imposes a clinical hold, clinical trials cannot commence or recommence without FDA authorization and then only under terms authorized by the FDA. In some instances, the IND application process can result in substantial delay and expense.
Clinical trials to support NDAs are typically conducted in three sequential phases, but the phases may overlap. In Phase I, the initial introduction of the drug into healthy human subjects or patients, the drug is tested to assess metabolism, pharmacokinetics and pharmacological actions and safety, including side effects associated with increasing doses. Phase II usually involves studies in a limited patient population to (1) assess the efficacy of the drug in specific, targeted indications, (2) assess dosage tolerance and optimal dosage and (3) identify possible adverse effects and safety risks. If a compound is found to be potentially effective and to have an acceptable safety profile in Phase II evaluations, Phase III trials are undertaken to further demonstrate clinical efficacy and to further test for safety within an expanded patient population at geographically dispersed clinical study sites. There can be no assurance that Phase I, Phase II or Phase III testing will be completed successfully within any specified time period, if at all, with respect to any of our products subject to such testing.
After successful completion of the required clinical testing, generally an NDA is submitted. FDA approval of the NDA is required before marketing may begin in the United States. The FDA reviews all NDAs submitted before it accepts them for filing and may request additional information rather than accepting an NDA for filing. In such an event, the NDA must be resubmitted with the additional information and, again, is subject to review before filing. Once the submission is accepted for filing, the FDA begins an in-depth review of the NDA. The FDA has 10 months in which to review the NDA and respond to the applicant. The review process is often significantly extended by FDA requests for additional information or clarification regarding information already provided in the submission. The FDA may refer the application to an appropriate advisory committee, typically a panel of clinicians, for review, evaluation and a recommendation as to whether the application should be approved. The FDA is not bound by the recommendation of an advisory committee. If FDA evaluations of the NDA and the manufacturing facilities are favorable, the FDA may issue either an approval letter or an approvable letter, which usually contains a number of conditions that must be met in order to secure final approval of the NDA. When and if those conditions have been met to the FDA’s satisfaction, the FDA will issue an approval letter, authorizing commercial marketing of the drug for certain indications. If the FDA’s evaluation of the NDA submission or manufacturing facilities is not favorable, the FDA may refuse to approve the NDA or issue a not approvable letter, outlining the deficiencies in the submission and often requiring additional testing or information. If regulatory approval of any product is granted, such approval will be limited to those disease states and conditions for which the product has been found by the FDA to be safe and effective, as demonstrated through well controlled clinical studies. Furthermore, approval may entail ongoing requirements for post-marketing studies. Even if such regulatory approval is obtained, a marketed product, its manufacturer and its manufacturing facilities are subject to continual review and periodic inspections. In addition, identification of certain side effects after a drug is on the market or the occurrence of manufacturing problems could cause subsequent withdrawal of approval, reformulation of the drug, additional preclinical testing or clinical trials and changes in labeling of the product.
Under the Orphan Drug Act, the FDA may designate a product as an orphan drug if it is a drug intended to treat a “rare disease or condition,” which is a disease or condition that affects populations of fewer than 200,000 individuals in the United States or a disease whose incidence rates number more than 200,000 where the sponsor establishes that it does not realistically anticipate that its product sales will be sufficient to recover its costs. The sponsor that obtains the first marketing approval for a designated orphan drug for a given rare disease is eligible to receive marketing exclusivity for use of that drug for the orphan indication for a period of seven years. We are currently exploring the potential to develop rifaximin as an orphan drug for the treatment of hepatic encephalopathy.
Drug manufacturing establishments are subject to periodic inspection by regulatory authorities and must comply with Good Manufacturing Practice regulations. Either we or our third party manufacturer must pass a preapproval inspection of our respective manufacturing facilities by the FDA before obtaining marketing approval of any products for sale in the United States. These manufacturers are also subject to periodic FDA inspections. In the event that violations of applicable standards are found, we may be required to cease distribution of some or all products and may be required to recall products already distributed.
Regulation of Drug Compounds Outside of the United States
Outside the United States, the ability to market a drug is contingent upon receiving marketing authorizations from the appropriate regulatory authorities. The requirements governing the conduct of clinical trials and marketing authorization vary widely from country to country. Currently, foreign marketing authorizations are applied for at a
national level, although within the European Union procedures are available to companies wishing to market a product in more than one European Union member state. The foreign regulatory approval process includes all of the risks associated with FDA approval set forth above.
To market our products in Europe, we or our distributors also must satisfy foreign regulatory requirements, implemented by foreign health authorities, governing human clinical trials and marketing approval. In the United Kingdom, the sale and marketing of new drugs is subject to the approval of the Medicines Control Agency, or MCA. As in the United States, a company seeking regulatory approval must submit an application requesting such approval, which is referred to as a Product License Application, or PLA. The PLA is submitted after completion of pre-clinical and clinical studies. The MCA may request additional clinical information on efficacy or safety before formally reviewing the application. Following a review of the PLA, the MCA makes a determination as to approval of the new drug compound. The review process in the United Kingdom is subject to many of the same uncertainties and risks associated with the approval of new drugs by the FDA in the United States. Furthermore, approval may entail ongoing requirements for post-marketing studies. Even if such regulatory approval is obtained, a marketed product and its manufacturer and its manufacturing facilities are subject to continual review and periodic inspections by the MCA.
Under a relatively new regulatory system in Europe, marketing authorizations, broadly speaking, may be submitted at a centralized, a decentralized or a national level. The centralized procedure is mandatory for the approval of biotechnology and high technology products and available at the applicant’s option for other products. The centralized procedure provides for the first time in the European Union for the grant of a single marketing authorization which is valid in all EU member states. Alternatively, a mutual recognition procedure implemented in January 1995 is available at the request of the applicant for all medicinal products that are not subject to the centralized procedure under the so-called “decentralized procedure”. The decentralized procedure, which began in January 1998, created a new system for mutual recognition of national approval decisions, made changes to then existing procedures for national approvals and established procedures for coordinated EU actions on products, suspensions and withdrawals.
If and when necessary, we will choose the appropriate route of European regulatory filing to accomplish the most rapid regulatory approvals. However, the chosen regulatory strategy might not secure regulatory approvals or approvals of our chosen product indications. Furthermore, we must obtain pricing approval in addition to regulatory approval prior to launching the product in the approving country. Failure to obtain pricing approval in a timely manner or approval of pricing which would support an adequate return on investment or generate a sufficient margin to justify the economic risk might delay or prohibit the commercial launch of the product in those countries.
Competition
Competition in our business is intense and characterized by extensive research efforts and rapid technological progress. Technological developments by competitors, earlier regulatory approval for marketing competitive products, or superior marketing capabilities possessed by competitors could adversely affect the commercial potential of our products and could have a material adverse effect on our revenue and results of operations. We believe that there are numerous pharmaceutical and biotechnology companies, including large well-known pharmaceutical companies, as well as academic research groups throughout the world, engaged in research and development efforts with respect to pharmaceutical products targeted at gastrointestinal diseases and conditions addressed by our current and potential products. In particular, we are aware of products in research or development by competitors that address the diseases being targeted by our products. Developments by others might render our current and potential products obsolete or non-competitive. Competitors might be able to complete the development and regulatory approval process sooner and, therefore, market their products earlier than us. Many of our competitors have substantially greater financial, marketing and personnel resources and development capabilities than we do.
For example, many large, well capitalized companies already offer products in the United States and Europe that target the indications for balsalazide, including mesalamine and the granulated mesalamine product (GlaxoSmithKline plc, Giuliani S.p.A., Axcan Pharma, Inc., Solvay S.A., The Procter & Gamble Company and Shire Pharmaceuticals Group plc), sulfasalazine (Pharmacia & Upjohn, Inc.), and olsalazine (Pharmacia & Upjohn, Inc.). Asacol, marketed by Proctor & Gamble, is currently the most prescribed product for the treatment of ulcerative colitis in the United States. The most frequently prescribed product for treatment of travelers’ diarrhea in the United States currently is
ciprofloxacin, commonly known as “Cipro®” and marketed by Bayer AG. The most frequently prescribed products that compete with Azasan are Imuran®, marketed by Prometheus Laboratories, Inc., and its various generics and Purinethol®, marketed by GATE Pharmaceuticals, and it’s various generics. The most frequently prescribed products that compete with Anusol-HC and Proctocort are AnaMantle HC, marketed by Bradley Pharmaceuticals; Analpram HC, marketed by Ferndale Laboratories; Proctofoam-HC and Proctocream-HC, marketed by Schwartz Pharma; Procto-Kit, marketed by Ranbaxy Pharmaceuticals; and various generics.
Employees
As of December 31, 2004, we had 150 full-time employees. We believe that our future success will depend in part on our continued ability to attract, hire, and retain qualified personnel. Competition for such personnel is intense, and there can be no assurance that we will be able to identify, attract, and retain such personnel in the future. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good.
Item 2.
Item 2. Properties
Our corporate headquarters are currently located at 8540 Colonnade Center Drive, Suite 501, Raleigh, North Carolina 27615, where we occupy approximately 26,000 square feet of office space under a lease expiring in August 2011. We have additional space in Palo Alto, California, where we occupy approximately 3,000 square feet under a lease expiring in February 2006. In mid-2005, we intend to move our corporate headquarters to 1700 Perimeter Park Drive, Morrisville, North Carolina 27560, where we will occupy approximately 77,000 square feet of office space under a lease expiring in 2015.
Item 3.
Item 3. Legal Proceedings
From time to time, we are party to various legal proceedings or claims, either asserted or unasserted, which arise in the ordinary course of business. Management has reviewed pending legal matters and believes that the resolution of such matters will not have a significant adverse effect on our financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of our stockholders during the fourth quarter of the year ended December 31, 2004.
Executive Officers of the Registrant
The following table sets forth certain information concerning our executive officers as of January 31, 2005:
Carolyn J. Logan has served as President and Chief Executive Officer and as a member of the Board of Directors since July 2002. She previously served as Senior Vice President, Sales and Marketing from June 2000 to July 2002. Prior to joining us, Ms. Logan served as Vice President, Sales and Marketing of the Oclassen Dermatologics division of Watson Pharmaceuticals, Inc. from May 1997 to June 2000, and as Vice President, Sales from February 1997 to May 1997. Prior to that date, she served as Director, Sales of Oclassen Pharmaceuticals, Inc. from January 1993 to February 1997. Prior to joining Oclassen, Ms. Logan held various sales and marketing positions with Galderma Laboratories, Ulmer Pharmacal and Westwood Pharmaceuticals. Ms. Logan received a B.S. degree in Biology and Dental Hygiene from the University of North Carolina at Chapel Hill.
Adam C. Derbyshire has served as Senior Vice President, Finance and Administration and Chief Financial Officer since June 2000. Prior to joining us, Mr. Derbyshire was Vice President, Corporate Controller and Secretary of Medco Research, Inc. (acquired by King Pharmaceuticals, Inc. in February 2000) from June 1999 to June 2000, Corporate Controller and Secretary of Medco from September 1995 to June 1999 and Assistant Controller of Medco from October 1993 to September 1995. Mr. Derbyshire received his B.S. degree from the University of North Carolina at Wilmington and his MBA from the University of North Carolina at Charlotte.
David N. Taylor joined Salix in September 2004 as Vice President, Medical and Safety and Chief Medical Officer. Dr. Taylor most recently served as Research Professor in the Department of International Health at Johns Hopkins School of Public Health. During his 22-year career with the United States Public Health Service and United States Army, Dr. Taylor served in a number of positions, including Acting Director of the Division of Communicable Diseases and Immunology at the Walter Reed Army Institute of Research (WRAIR); Clinical Director, Department of Enteric Infections, Division of Communicable Diseases and Immunology WRAIR; and Adjunct Professor of Preventative Medicine/Biometrics, Uniformed Services University of the Health Sciences. Dr. Taylor received his medical degree from Harvard Medical School. He is a certified Diplomate with the National Board of Medical Examiners and American Board of Internal Medicine, as well as a Fellow with the American College of Physicians and Infectious Diseases Society of America and Member of the American Society of Microbiology and American Epidemiological Society. Dr. Taylor serves on the peer review committee for numerous professional medical publications and has authored 190 publications.
William P. Forbes joined Salix in January 2005 as Vice President, Research and Development, and Chief Medical Officer. Prior to joining Salix, Dr. Forbes was Vice President, Clinical Development and Regulatory Affairs of Metabasis Therapeutics, Inc. from 2002 through 2004. He has also worked for Otsuka America Pharmaceutical, Inc. in a variety of roles of increasing responsibility from 1991 to 2002 and Glaxo, Inc. from 1989 through 1991. He has extensive experience in clinical development, regulatory affairs and project management. Dr. Forbes received his Doctor of Pharmacy degree from Creighton University.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq National Market under the symbol “SLXP.” The following table sets forth the high and low sales prices of our common stock, as reported on the Nasdaq National Market, with prices prior to our July 2004 3-for-2 stock split adjusted to reflect that split.
On December 31, 2004, the closing price for the common stock as reported on the Nasdaq National Market was $17.59. As of March 7, 2005, there were approximately 3,200 stockholders of record.
The securities markets have from time to time experienced significant price and volume fluctuations unrelated to the operating performance of particular companies. In addition, the market prices of the common stock of many publicly traded pharmaceutical and biotechnology companies have in the past and can in the future be expected to be especially volatile. Announcements of technological innovations or new products by us or our competitors, developments or disputes concerning proprietary rights, publicity regarding actual or potential medical results relating to products under development by us or our competitors, regulatory developments in both the United States and other countries, public concern as to the safety of pharmaceutical products and economic and other external factors, as well as period-to-period fluctuations in our financial results, might have a significant impact on the market price of our common stock.
Dividend Policy
We have never declared or paid cash dividends on our common stock. We currently expect to retain future earnings, if any, for use in the operation and expansion of business and do not anticipate paying any cash dividends in the foreseeable future.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and the Notes thereto included elsewhere in this report. The following selected financial data are derived from the consolidated financial statements of Salix Pharmaceuticals, Ltd. which have been audited by Ernst & Young LLP, independent registered accounting firm. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein.
Consolidated Statements of Operations Data:
(1)
See Note 2 of Notes to Consolidated Financial Statements for an explanation of shares used in computing net loss per share.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a specialty pharmaceutical company dedicated to acquiring, developing and commercializing prescription drugs used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract. Our strategy is to identify and acquire rights to products that we believe have potential for near-term regulatory approval or are already approved; apply our regulatory, product development, and sales and marketing expertise to commercialize these products; and use our 100-member specialty sales and marketing team focused on high-prescribing U.S. gastroenterologists to sell our products. We rely on distribution relationships with third parties to sell our products outside the United States.
We generate revenue primarily by selling our products, prescription drugs, to pharmaceutical wholesalers. These direct customers of ours resell and distribute our products to and through pharmacies to patients who have had our products prescribed by doctors. Because demand for our products originates with doctors, our sales force calls on high prescribing specialists, primarily gastroenterologists, and we monitor new and total prescriptions for our products as a key performance indicator for our business.
Prescriptions result in our products being used by patients, requiring our direct customers to purchase more products to replenish their inventory. However, our revenue might fluctuate from quarter to quarter due to other factors, such as increased buying by wholesalers in anticipation of a price increase. Revenue could be less than anticipated in subsequent quarters as wholesalers’ increased inventory is used up. We believe such increased buying occurred in 2004, and it could occur again.
In December 2000, we established our own field sales force to market Colazal in the United States. Currently, this sales force has approximately 70 sales representatives in the field. Although the creation of an independent sales organization involved substantial costs, we believe that the financial returns from Colazal, Xifaxan, Azasan and the Anusol-HC/Proctocort lines and other future products, if acquired and approved, will be more favorable to us than those from the indirect sale of product through marketing partners.
Critical Accounting Policies
General
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to sales of our products, bad debts, inventories, investments, intangible assets and legal issues. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results might differ materially from these estimates under different assumptions or conditions.
Methodologies used and assumptions selected by management in making these estimates, as well as the related disclosures, have been reviewed by and discussed with the Audit Committee of our Board of Directors.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Our product sales are recorded upon shipment of order and transfer of title. Reported product revenue is net of estimated contractual allowances related to managed care agreements, government rebates, customer returns and other discounts. We estimate allowances for revenue reducing items using a combination of relevant information including
market data, historical information and internal analyses that we perform. Provisions for these estimated costs are recorded at the time of sale and are periodically adjusted to reflect actual experiences. If our actual experience were greater than our estimates, we would record additional expenses in that period. Refer to “Schedule II - Valuation and Qualifying Accounts” for a roll forward of accruals for rebates and coupons and product returns.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB 104, “Revenue Recognition”, which clarifies conditions to be met in order to recognize revenue. SAB 101 requires companies to recognize up-front non-refundable fees over the term of the related agreement unless the fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process.
Due to the uniqueness of each of our licensing arrangements, we analyze each element of each contract, including milestone payments, to determine the appropriate revenue recognition. In accordance with SAB 101, we recognize revenue upon achievement of contractual milestones only when and to the extent we conclude that a separate earnings process has been culminated or the milestone is representative of the level of effort and progress toward completion of a long-term contract.
Investments
We consider all investments that have a maturity of greater than three months and less than one year to be short-term investments. All securities with maturities beyond one year are considered long-term investments. Our investments consist of government agency and high-grade corporate bonds. Our existing investments are classified as available-for-sale. All available-for-sale investments are classified as current, as we have the ability to use them for current operating and investing purposes.
Inventories
As of December 31, 2004, we had $26.7 million in inventories. Our inventories consisted of pharmaceutical products, comprised of $18.0 million of raw materials and $8.7 million of finished goods. At December 31, 2004, we had no inventories of unapproved products. Inventories are stated at the lower of cost (which approximates actual cost on a first-in, first-out cost method) or market. In evaluating whether inventory is stated at the lower of cost or market, management considers such factors as the amount of inventory on hand and in the distribution channel, estimated time required to sell such inventory, remaining shelf life, and current and expected market conditions, including levels of competition. As appropriate, provisions are made to reduce inventories to their net realizable value.
Intangible Assets
When we make product acquisitions that include license agreements, product rights and other identifiable intangible assets, we record the aggregate purchase price, along with the value of the product-related liabilities that we assume, as intangible assets. We allocate the purchase price to the fair value of the various intangible assets in order to amortize their cost as an expense in our statement of operations over the estimated economic useful life of the related assets. We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that the carrying value might not be recoverable. Some factors that we consider important which could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends.
In assessing the recoverability of our intangible assets, we must make assumptions regarding estimated future cash flows and other factors. If the estimated undiscounted future cash flows do not exceed the carrying value of the intangible assets we must determine the fair value of the intangible assets. If the fair value of the intangible assets is less than the carrying value, an impairment loss will be recognized in an amount equal to the difference. We review intangible assets for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
In June 2004, the Company acquired the exclusive U.S. rights to Anusol-HC 2.5% (hydrocortisone Cream USP), Anusol-HC 25 mg Suppository (Hydrocortisone Acetate), Proctocort Cream (Hydrocortisone Cream USP) 1% and Proctocort Suppositories (Hydrocortisone Acetate Rectal Suppositories, 30 mg) from King Pharmaceuticals, Inc. for $13.0 million. At December 31, 2004, other assets consisted primarily of intangible assets related to the Anusol-HC, Proctocort and Azasan product acquisitions. Amortization expense for the year-ended December 31, 2004 was $0.8 million. Amortization is calculated on a straight-line basis over the estimated useful life of the asset. No amortization expense was incurred during the years ended December 31, 2003 and 2002.
Allowance for Uncollectible Accounts
To date, we have not experienced any material accounts receivable collection issues. However, based on a review of specific customer balances, industry experience and the current economic environment, we currently reserve for specific accounts plus 1% of our outstanding trade accounts receivable balance as an allowance for uncollectible accounts, which at December 31, 2004 and December 31, 2003 was approximately $0.8 million and $0.3 million, respectively.
Allowance for Returns
To date, we have not experienced material product return issues. However, in 2004, we began selling several products that were either recently approved for marketing by the FDA or recently acquired by us. Based on a review of factors specific to each of these products we recorded an appropriate estimated allowance for returns. At December 31, 2004, the allowance for returns was $1.4 million.
Allowance for Rebates and Coupons
Based on contracts that allow for rebates and our estimate of revenue associated with those contracts, we currently reserve an allowance for rebate charges, which at December 31, 2004 and December 31, 2003 was $4.5 million and $2.1 million, respectively. Based on the number of available coupons and our estimate of redemption of available coupons from industry experience, we currently have reserved approximately $25,000 as an allowance for coupon redemption. Refer to “Schedule II - Valuation and Qualifying Accounts” for a roll forward of the accrual for rebates and coupons.
Results of Operations
Years Ended December 31, 2004, 2003 and 2002
Revenues totaled $105.5 million, $55.8 million and $33.5 million for 2004, 2003 and 2002, respectively. Revenues for the year ended December 31, 2004 included net product revenues of $101.7 million and revenues from collaborative agreements of $3.8 million. Revenues for the years ended December 31, 2003 and 2002 consisted solely of net product revenues. We expect that future revenues will consist solely or primarily of net product revenue. Net product revenue increases from 2002 to 2003 were due to increased sales of Colazal while net product revenue increases from 2003 to 2004 were due to increased sales of Colazal, the commercial launches of Xifaxan and Azasan and the acquisition of the Anusol-HC and Proctocort products during the year. Increases in revenue-reducing items from 2002 to 2003 were due primarily to increases in allowances for managed care agreements as a result of increased sales of Colazal. Increases in revenue-reducing items from 2003 to 2004 were due primarily to increases in allowances for managed care agreements as a result of increased product sales and the allowance for product returns associated with the commercial launch of Xifaxan. The $3.8 million of revenue from collaborative agreements recognized in 2004 was due primarily to our agreement with Shire. We do not anticipate any future revenues under that agreement.
Total costs and expenses were $98.8 million, $75.6 million, and $59.3 million for 2004, 2003 and 2002, respectively. The increase from 2002 to 2003 was primarily the result of increased research and development activity associated with rifaximin, as well as expansion of our commercialization infrastructure and marketing campaign for Colazal. The increase from 2003 to 2004 was primarily related to Xifaxan market research and commercial development activities, along with increased cost of product sold related to the corresponding increase in product revenue.
We recognized cost of products sold of $21.8 million, $13.2 million and $8.2 million for 2004, 2003 and 2002, respectively. The increases in cost of products sold in 2004 and 2003 were due primarily to increased sales of Colazal. License fees and costs related to collaborative agreements of $1.8 million, $0.1 million and $0.1 million in 2004, 2003 and 2002, respectively, related primarily to payments made to Biorex and Alfa Wassermann under the terms of the respective license agreements. The $1.8 million of expense recognized in 2004 was primarily the result of royalty expense associated with the recognition of revenue under our agreement with Shire. Cost of products sold does not include amortization of product rights. Refer to “Critical Accounting Policies for Intangible Assets” above.
Research and development expense was $20.4 million, $23.7 million and $18.0 million for 2004, 2003 and 2002, respectively. Our current major research and development projects are for additional potential indications for rifaximin and granulated mesalamine. The decrease in research and development expenses in 2004 from 2003 was due primarily to the rifaximin NDA amendment filing expenses occurring in 2003. The increase in research and development expenses in 2003 from 2002 was due primarily to costs associated with maintaining the rifaximin NDA and completion of studies to support it, as well as the completion of a multi-center study for rifaximin as a treatment for hepatic encephalopathy. To date, we have incurred research and development expenditures of approximately $20.8 million for balsalazide, $30.7 million for rifaximin and $8.9 million for granulated mesalamine. We expect research and development costs to increase as we pursue additional indications for balsalazide and rifaximin, pursue development of the granulated mesalamine product, and if and when we acquire new products.
Selling, general and administrative expenses were $54.1 million, $38.6 million and $33.0 million for 2004, 2003 and 2002, respectively. The increase in 2004 compared to 2003 was primarily the result of rifaximin market research and market development activities and the marketing campaign for all drugs sold during year. The increase in 2003 compared to 2002 was primarily the result of rifaximin market research and market development activities and the marketing campaign for Colazal.
Interest and other income (expense), net was $0.6 million in 2004, $(0.3) million in 2003 and $1.1 million in 2002. The increase in 2004 compared to 2003 and the decrease in 2003 compared to 2002 was primarily due to $1.7 million of expenses related to the attempted hostile takeover of our company by Axcan Pharma, Inc. in 2003.
Income tax expense was $0.4 million in 2004, our first profitable year. Our effective tax rate for 2004 was 5.6% due to the utilization of net operating loss carryforwards. We recognized no income tax expense in 2003 and 2002.
At December 31, 2004, we had U.S. federal net operating loss carryforwards of approximately $84.4 million. These carryforwards will expire on various dates beginning in 2004 through 2022 if not utilized. Utilization of the federal net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code. The annual limitation might result in the expiration of net operating losses and credits before utilization.
See Note 12 of Notes to Consolidated Financial Statements for a presentation of our quarterly results of operations for the years ended December 31, 2004 and 2003.
Liquidity and Capital Resources
Since inception, we have historically financed product development, operations and capital expenditures primarily from public and private sales of equity securities and funding arrangements with collaborative partners. Since launching Colazal in 2001, product revenue has been a growing source of cash, a trend that we expect to continue. As of December 31, 2004, we had approximately $52.1 million in cash, cash equivalents and investments compared to $64.8 million as of December 31, 2003.
Cash used in our operations was $5.0 million in 2004, $20.8 million in 2003 and $29.0 million in 2002. Negative operating cash flows during 2004, 2003 and 2002 were caused primarily by operating losses in earlier years and increases in inventory and other assets and accounts receivable as our business has grown.
Our capital expenditures were $0.4 million in 2004, $1.8 million in 2003 and $0.6 million in 2002, with the expenditures primarily attributable to the purchase of furniture and equipment. During 2004, we acquired the U.S. rights to Anusol-HC 2.5% (Hydrocortisone Cream USP), Anusol-HC 25 mg Suppository (Hydrocortisone Acetate), Proctocort Cream (Hydrocortisone Cream USP) 1% and Proctocort Suppositories (Hydrocortisone Acetate Rectal Suppositories, 30 mg) from King Pharmaceuticals, Inc. for $13.0 million. During 2004, $6.0 million of investments matured or were called by the issuers. During 2003, $27.2 million of investments matured or were called by the issuers. During 2002, we purchased $82.9 million of investments and had $45.7 million of investments that matured or were called by the issuer.
During 2004, cash provided by financing activities was $5.7 million due to the exercise of stock options. During 2003, cash provided by financing activities was $34.0 million due primarily to the completion of a private placement of common stock in November 2003. During 2002, cash provided from financing activities was $57.8 million due primarily to the public offering of common stock that we completed in March 2002.
During the third quarter of 2002, we entered into a $7.0 million revolving working capital line of credit, with borrowing capacity of up to 75% of our eligible accounts receivable under 90 days old from the date of invoice. We had no outstanding balance under this line as of December 31, 2004. On January 31, 2005 this line of credit expired.
As of December 31, 2004, we had non-cancelable purchase order commitments for inventory purchases of approximately $16.7 million. We anticipate significant expenditures in 2005 related to our continued sales, marketing, product launch and development efforts associated with Colazal, Xifaxan, Azasan, Anusol-HC, Proctocort and granulated mesalamine. To the extent we acquire rights to additional products, we will incur additional expenditures.
Our contractual commitments for non-cancelable purchase commitments of inventory and minimum lease obligations for all non-cancelable operating leases as of December 31, 2004 are as follows (in thousands):
As of December 31, 2004, we had an accumulated deficit of $83.9 million. We believe our cash and cash equivalent and investments balances should be sufficient to satisfy our cash requirements for the foreseeable future. However, our actual cash needs might vary materially from those now planned because of a number of factors, including our success selling products, the results of research and development activities, FDA and foreign regulatory processes, establishment of and change in collaborative relationships, technological advances by us and other pharmaceutical companies, the status of competitive products and whether we acquire rights to additional products. We might seek additional debt or equity financing or both to fund our operations or product acquisitions. If we incur debt, we might be restricted in our ability to raise additional capital and might be subject to financial and restrictive covenants. If we issued additional equity, our stockholders could suffer dilution. We might also enter into additional collaborative arrangements with corporate partners that could provide us with additional funding in the form of equity, debt, licensing, milestone and/or royalty payments. We might not be able to enter into such arrangements or raise any additional funds on terms favorable to us or at all.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123R, “Share-Based Payment”, which requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. This requirement represents a significant change because fixed-based stock option awards, a predominate form of stock compensation for us, were not recognized as compensation expense under APB 25. Statement 123R requires the cost of the award, as determined on the date of grant at fair value, be recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period. The grant-date fair value of the award will be estimated using option-pricing models. We are required to adopt Statement 123R no later than July 1, 2005 under one of three transition methods, including a prospective, retrospective and combination approach. We currently disclose the
effect of expensing stock options under a fair value approach using the Black-Scholes pricing model for 2004, 2003 and 2002. We are evaluating all of the provisions of Statement 123R and the expected effect on us including, among other items, reviewing compensation strategies related to stock-based awards, selecting an option pricing model and determining the transition method.
Cautionary Statement
We operate in a highly competitive environment that involves a number of risks, some of which are beyond our control. The following statement highlights some of these risks.
Statements contained in this Form 10-K that are not historical facts are or might constitute forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, our expectations might not be attained. Forward-looking statements involve known and unknown risks that could cause actual results to differ materially from expected results. Factors that could cause actual results to differ materially from our expectations expressed in the report include, among others: our dependence on our first six pharmaceutical products, Colazal, Xifaxan, Azasan, Anusol-HC, Proctocort and granulated mesalamine, and the uncertainty of market acceptance of those products; the high cost and uncertainty of the research, clinical trials and other development activities involving pharmaceutical products; the unpredictability of the duration and results of regulatory review of New Drug Applications and Investigational New Drug Applications; the uncertainty of obtaining, and our dependence on, third parties to manufacture and sell our products; intense competition; the possible impairment of, or inability to obtain, intellectual property rights and the costs of obtaining such rights from third parties; and results of future litigation and other risk factors detailed from time to time in our other SEC filings.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our purchases of raw materials and our product sales to our European distribution partners are denominated in Euros. Translation into our reporting currency, the U.S. dollar, has not historically had a material impact on our financial position. Additionally, our net assets denominated in currencies other than the U.S. dollar have not historically exposed us to material risk associated with fluctuations in currency rates. Given these facts, we have not considered it necessary to use foreign currency contracts or other derivative instruments to manage changes in currency rates.
Pursuant to our investment policy, we have invested a portion of our available cash in government agency and high-grade corporate bonds. Due to the nature and maturity terms of these investments, we do not believe these investments present significant market risk.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this Item is set forth in the Consolidated Financial Statements and Notes thereto beginning at page of this Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Control and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) are designed only to provide reasonable assurance that information to be disclosed in our Exchange Act Reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s and forms.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such terms are defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. A control system, no matter how well designed and operated, can only provide reasonable, not absolute, assurance that the objectives of the control system are met and must reflect the fact that there are resource constraints that require management to consider the benefits of internal controls relative to their costs. Because of these inherent limitations, management does not expect that our internal controls over financial reporting will prevent all error and all fraud. Under the supervision and with the participation of our management, including our CEO and our Senior VP, Finance and Administration and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as December 31, 2004.
Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004, has been audited by Ernst & Young LLP, and independent registered public accounting firm, as stated in their report which is included on page herein.
Changes in Internal Control Over Financial Reporting
There was no change in our internal controls over financial reporting during the fourth quarter of the period covered by this Annual Report that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
On January 28, 2005, the company amended its compensatory arrangement for non-employee directors to provide that the chair of each committee will receive $6,000 per year, each Audit Committee Member will receive $6,000 per year and Board meeting fees will be $2,000 if in person and $1,000 if telephonic. Other non-employee director compensation remained unchanged. A copy of the 2005 non-employee director compensation arrangement is attached to this report as Exhibit 10.49.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item concerning our directors is incorporated by reference from the section captioned “Election of Directors” contained in our proxy statement related to the 2005 Annual Meeting of Stockholders scheduled to be held on June 9, 2005, which we intend to file with the SEC within 120 days of the end of our fiscal year pursuant to General Instruction G(3) of Form 10-K.
The Board of Directors has determined that the members of the Audit Committee are independent as defined in Rule 4200(a)(15)of the National Association of Securities Dealers’ listing standards. The Board of Directors has also determined that Thomas W. D’Alonzo, Richard A. Franco and William P. Keane are “audit committee financial experts” as defined in Item 401(h) of Regulation S-K.
Our Board of Directors adopted a code of conduct that applies to all of our directors and employees. Our Board also adopted a separate code of ethics for our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Controller, or persons performing similar functions. We will provide copies of our code of conduct and code of ethics without charge upon request. To obtain a copy of our code of conduct and code of ethics, please send your written request to Salix Pharmaceuticals, Ltd., 8540 Colonnade Center Drive, Suite 501, Raleigh, NC 27615, Attn: General Counsel. In addition, you can find those codes on our website at www.salix.com/pdf/Salix_Code_Bus_Cond.pdf.
The information required by this Item concerning executive officers of the Registrant is set forth at the end of Part I of this report.
The information required by this Item concerning compliance with Section 16(a) of the United States Securities Exchange Act of 1934, as amended, is incorporated by reference from the section of the proxy statement captioned “Section 16(a) Beneficial Ownership Reporting Compliance.”
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference to the information under the sections captioned “Director Compensation”, “Executive Compensation and Other Matters”, “Report of the Compensation Committee of the Board of Directors on Executive Compensation”, “Salix Stock Price Performance Graph” and “Compensation Committee Interlocks and Insider Participation” contained in the proxy statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth the indicated information as of December 31, 2004 with respect to our equity compensation plans:
The other information required by this Item is incorporated by reference to the information under the section captioned “Security Ownership of Management and Certain Beneficial Owners” and “Equity Compensation Plan Information” contained in the proxy statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated by reference to the information under the section captioned “Certain Transactions” contained in the proxy statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to the information under the section captioned “Principal Accountant Fees and Services” contained in the proxy statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Financial Statements
The following statements are filed as part of this report:
Page
Report of Independent Registered Public Accounting Firm on Internal Control
Report of Independent Registered Public Accounting Firm on Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules
Schedule II-Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.
3. Exhibits
Exhibit
Number
Description of Document
Registrant’s
Form
Dated
Exhibit
Number
Filed
Herewith
2.1
Certificate of Domestication.
S-3
02/12/02
2.1
2.2*
Asset Purchase Agreement dated June 30, 2004 between King Pharmaceuticals, Inc., Monarch Pharmaceuticals, Inc., Parkedale Pharmaceuticals, Inc., Salix Pharmaceuticals, Inc. and Salix Pharmaceuticals, Ltd.
10-Q
08/09/04
2.2
3.1
Certificate of Incorporation, as amended.
S-3
02/12/02
3.1
3.2
Amended and Restated Bylaws.
S-4
11/20/01
3.2
10.2
Form of 1994 Stock Plan for Salix Holdings, Ltd. and form of Stock Option and Restricted Stock Purchase Agreements thereunder.
S-1
08/15/97
10.2
10.3
Form of 1996 Stock Plan for Salix Holdings, Ltd., as amended September 2000 and form of Notice of Stock Option Grant and Stock Option Agreement thereunder, as amended March 12, 2001.
10-Q
08/09/04
10.3
10.4*
Amendment Agreement effective as of September 17, 1992 by and among Glycyx Pharmaceuticals, Ltd., Salix Pharmaceuticals, Inc. and Biorex.
S-1
08/15/97
10.4
10.5*
License Agreement, dated September 17, 1992 between Biorex Laboratories Limited and Glycyx Pharmaceuticals, Ltd. and letter agreement amendments thereto.
S-1
08/15/97
10.5
10.6*
Research and Development Agreement dated September 21, 1992 between Glycyx Pharmaceuticals, Ltd. and AB Astra and letter agreement amendments thereto.
S-1
08/15/97
10.6
10.7*
Distribution Agreement dated September 21, 1992 between Glycyx Pharmaceuticals, Ltd. and AB Astra.
S-1
08/15/97
10.7
Exhibit
Number
Description of Document
Registrant’s
Form
Dated
Exhibit
Number
Filed
Herewith
10.8*
Amended and Restated License Agreement by and between Salix Pharmaceuticals, Inc. and Biorex Laboratories, Limited, dated April 16, 1993.
S-1
08/15/97
10.8
10.9*
Co-Participation Agreement, dated April 30, 1993 between Salix Pharmaceuticals, Inc. and AB Astra as amended by Amendment No. 1 thereto effective September 30, 1993.
S-1
08/15/97
10.9
10.9.1
Letter Agreement dated October 16, 1998 to Co-Participation Agreement dated April 30, 1993 by and between Salix Pharmaceuticals, Inc. and AB Astra.
10-Q
11/16/98
10.9.1
10.11*
Distribution Agreement, dated September 23, 1994 between Glycyx Pharmaceuticals, Ltd. and Menarini International Operations Luxembourg SA and amendments thereto.
S-1
08/15/97
10.11
10.12*
License Agreement, dated June 24, 1996, between Alfa Wassermann S.p.A. and Salix Pharmaceuticals, Ltd.
S-1
08/15/97
10.12
10.13*
Supply Agreement, dated June 24, 1996, between Alfa Wassermann S.p.A. and Salix Pharmaceuticals, Ltd.
S-1
08/15/97
10.13
10.14
Lease dated January 1, 1992 by and between Kontrabecki Mason Developers and Salix Pharmaceuticals, Inc., as amended.
S-1
08/15/97
10.14
10.22
Termination and Settlement Agreement dated as of December 22, 1999, by and between Astra AB and Salix Pharmaceuticals Inc. (a wholly owned subsidiary of Salix Pharmaceuticals, Ltd.).
8-K
12/28/99
10.22
10.23
Agreement dated December 22, 1999, between Glycyx Pharmaceuticals, Ltd. and Astra AB.
8-K
12/28/99
10.23
10.25*
Agreement dated May 17, 2000 between Glycyx Pharmaceuticals, Ltd. and Shire Pharmaceuticals Group plc.
10-Q
08/14/00
10.25
10.26*
Agreement dated May 17, 2000 between Biorex Laboratories Limited and Glycyx Pharmaceuticals, Ltd.
10-Q
08/14/00
10.26
10.28
Lease Agreement dated June 30, 2000 by and between Colonnade Development, LLC and Salix Pharmaceuticals, Inc.
10-Q
08/14/01
10.29
10.29*
License Agreement between Biorex Laboratories Limited and Glycyx Pharmaceuticals, Ltd. dated August 22, 2001.
10-Q
11/14/01
10.30
10.30
Form of Employment Agreement for executive officers.
10-Q
11/14/01
10.31
10.32*
License Agreement by and between Salix Pharmaceuticals, Inc. and Dr. Falk Pharma GmbH dated July 15, 2002.
10-Q
11/14/02
10.32
10.33
Loan and Security Agreement dated September 30, 2002 by and between RBC Centura Bank, Salix Pharmaceuticals, Ltd. and Salix Pharmaceuticals, Inc.
10-Q
11/14/02
10.33
10.34
Commercial Promissory Note Agreement dated September 30, 2002 issued to RBC Centura Bank by Salix Pharmaceuticals, Ltd. and Salix Pharmaceuticals, Inc.
10-Q
11/14/02
10.34
10.35
Negative Pledge Agreement dated September 30, 2002 between RBC Centura Bank, Salix Pharmaceuticals, Ltd. and Salix Pharmaceuticals, Inc.
10-Q
11/14/02
10.35
10.36
Rights Agreement, dated as of January 10, 2003, between Salix Pharmaceuticals, Ltd. and Computershare Investor Services LLC, as Rights Agent.
8-K
01/10/03
10.36
Exhibit
Number
Description of Document
Registrant’s
Form
Dated
Exhibit
Number
Filed
Herewith
10.37
Common Stock Purchase Agreement dated November 6, 2003 among Salix Pharmaceuticals, Ltd. and the investors listed therein.
8-K
11/10/03
10.37
10.38
Modification to Commercial Promissory Note Agreement dated September 29, 2003 between RBC Centura Bank, Salix Pharmaceuticals, Ltd. and Salix Pharmaceuticals, Inc.
10-Q
11/14/03
10.38
10.39*
License Agreement dated October 17, 2003, between Glycyx Pharmaceuticals, Ltd (a wholly owned subsidiary of Salix Pharmaceuticals, Ltd.) and Chong Kun Dang Pharmaceutical Corporation.
10-Q
11/14/03
10.39
10.40*
Amendment Agreement dated November 24, 2003 between Salix Pharmaceuticals, Inc. and Dr. Falk Pharma Gmbh.
10-K
03/12/04
10.40
10.41*
License Agreement dated October 31, 2003 between aaiPharma LLC, aaiPharma Inc. and Salix Pharmaceuticals, Ltd.
10-K
03/12/04
10.41
10.42
Modification to Commercial Promissory Note Agreement dated December 31, 2003 between RBC Centura Bank, Salix Pharmaceuticals, Ltd. and Salix Pharmaceuticals, Inc.
10-K
03/12/04
10.42
10.43
Modification to Commercial Promissory Note Agreement dated January 30, 2004 between RBC Centura Bank, Salix Pharmaceuticals, Ltd. and Salix Pharmaceuticals, Inc.
10-Q
05/10/04
10.43
10.44*
Supply Agreement dated June 30, 2004 between King Pharmaceuticals, Inc., Parkedale Pharmaceuticals, Inc., Salix Pharmaceuticals, Inc. and Salix Pharmaceuticals, Ltd. Certificate of Incorporation, as amended.
10-Q
08/09/04
10.44
10.45
License Assignment and Consent Agreement dated June 30, 2004 between Parkedale Pharmaceuticals, Inc., King Pharmaceuticals, Inc., Salix Pharmaceuticals, Inc., Salix Pharmaceuticals, Ltd., Warner-Lambert Company LLC and Parke, Davis & Company LLC.
10-Q
08/09/04
10.45
10.46
Assignment of Trademarks Agreement dated June 30, 2004 between Parkedale Pharmaceuticals, Inc. and Salix Pharmaceuticals, Inc.
10-Q
08/09/04
10.46
10.47
License Agreement dated June 30, 2004 between Monarch Pharmaceuticals, Inc., Parkedale Pharmaceuticals, Inc., King Pharmaceuticals, Inc., Salix Pharmaceuticals, Inc. and Salix Pharmaceuticals, Ltd.
10-Q
08/09/04
10.47
10.48
Office lease dated as of November 24, 2004 between Salix Pharmaceuticals, Ltd. And Duke Realty Limited Partnership
8-K
12/13/04
10.48
10.49
Non-employee director compensation summary
X
21.1
Subsidiaries of the Registrant.
S-4
11/20/01
21.1
23.1
Consent of Independent Registered Public Accounting Firm.
X
31.1
Certification by the Chief Executive Officer pursuant to Section 240.13a-14 or section 240.15d-14 of the Securities and Exchange Act of 1934, as amended.
X
31.2
Certification by the Chief Financial Officer pursuant to Section 240.13a-14 or section 240.15d-14 of the Securities and Exchange Act of 1934, as amended.
X
Exhibit
Number
Description of Document
Registrant’s
Form
Dated
Exhibit
Number
Filed
Herewith
32.1
Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
X
32.2
Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
X
*
The registrant has received confidential treatment with respect to certain portions of this exhibit. Such portions have been omitted from this exhibit and have been filed separately with the United States Securities and Exchange Commission.
(b) Exhibits
See Item 15(a)(3) above.
(c) Financial Statement Schedules
See Item 15(a)(1) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
SALIX PHARMACEUTICALS, LTD.
/S/ CAROLYN J. LOGAN
Carolyn J. Logan
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the Registrant and on the dates indicated.
Date: March 15, 2005
/s/ CAROLYN J. LOGAN
Carolyn J. Logan
President, Chief Executive Officer
(Principal Executive Officer) and Director
Date: March 15, 2005
/s/ ADAM C. DERBYSHIRE
Adam C. Derbyshire
Senior Vice President, Finance & Administration and
Chief Financial Officer (Principal
Financial and Accounting Officer)
Date: March 15, 2005
/s/ JOHN F. CHAPPELL
John F. Chappell
Chairman of the board
Date: March 15, 2005
/s/ THOMAS W. D’ALONZO
Thomas W. D’Alonzo
Director
Date: March 15, 2005
/s/ RICHARD A. FRANCO
Richard A. Franco
Director
Date: March 15, 2005
/s/ WILLIAM P. KEANE
William P. Keane
Director
SALIX PHARMACEUTICALS, LTD.
Index to Consolidated Financial Statements
PAGE
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm on Internal Control
Report of Independent Registered Public Accounting Firm on Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity.
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements.
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Schedule II-Valuation and Qualifying Accounts
REPORT OF INDEPENDENT REGISTERED PUBLIC AC COUNTING FIRM ON INTERNAL CONTROL
The Board of Directors and Shareholders of Salix Pharmaceuticals, Ltd.
We have audited management’s assessment that Salix Pharmaceuticals, Ltd. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Salix Pharmaceuticals, Ltd.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Salix Pharmaceuticals, Ltd. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Salix Pharmaceuticals, Ltd. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Salix Pharmaceuticals, Ltd. as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004 and our report dated March 11, 2005 expressed an unqualified opinion thereon.
Raleigh, North Carolina
March 11,
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENTS
The Board of Directors and Shareholders
Salix Pharmaceuticals, Ltd.
We have audited the accompanying consolidated balance sheets of Salix Pharmaceuticals, Ltd. as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Salix Pharmaceuticals, Ltd. at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Salix Pharmaceuticals, Ltd.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2005 expressed an unqualified opinion thereon.
Raleigh, North Carolina
March 11,
SALIX PH ARMACEUTICALS, LTD.
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
SALIX PHARMACEUTICALS, LTD.
Consolidated Statements of Operations
The accompanying notes are an integral part of these consolidated financial statements.
S ALIX PHARMACEUTICALS, LTD.
Consolidated Statements of Stockholders’ Equity
The accompanying notes are an integral part of these consolidated financial statements.
S ALIX PHARMACEUTICALS, LTD.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
SALIX PHARMACEUTICALS, LTD.
Notes to Consolidated Financial Statements
(1) ORGANIZATION AND BASIS OF PRESENTATION
Salix Pharmaceuticals, Ltd., a Delaware corporation (“Salix” or the “Company”), is a specialty pharmaceutical company dedicated to acquiring, developing and commercializing prescription drugs used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract.
These statements are stated in U.S. dollars and are prepared under accounting principles generally accepted in the United States. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.
Certain amounts in the 2003 financial statements have been reclassified to conform to the 2004 presentation. These reclassifications did not result in any changes to the net loss or stockholders’ equity as previously reported.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
Product sales are recorded upon shipment of order and transfer of title. Net product revenue is derived by reducing product sales by various allowances and other sales related deductions. Provision for these estimated costs are recorded at the time of sale and are periodically adjusted to reflect actual experiences.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB 104, “Revenue Recognition”, which clarifies conditions to be met in order to recognize revenue. SAB 101 requires companies to recognize up-front non-refundable fees over the term of the related agreement unless the fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process.
Research and Development
Research and development costs, both internal and externally contracted, are expensed as incurred. These costs include direct expenditures for goods and services, as well as indirect expenditures such as salaries, administrative expenses and various allocated costs.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities from date of purchase of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents in several different instruments with various banks and brokerage houses. This diversification of risk is consistent with Company policy to maintain liquidity and ensure the safety of principal.
Accounts Receivable
The Company extends credit on an uncollateralized basis primarily to wholesale drug distributors and retail pharmacy chains throughout the U.S. The Company is required to estimate the level of accounts receivable which ultimately will be uncollectible. The Company calculates this estimate based on a review of specific customer balances,
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
industry experience and the current economic environment. Currently, the Company reserves for specific accounts plus 1% of our outstanding trade accounts receivable balance as an allowance for uncollectible accounts. To date, the Company has not experienced significant credit losses on its accounts.
Investments
The Company considers all investments that have a maturity of greater than three months and less than one year to be short-term investments. The Company’s investments consist of government agency and high-grade corporate bonds. The Company classifies its existing investments as available-for-sale. All available-for-sale investments are classified as current, as the Company has the ability to use them for current operating and investing purposes.
Property and Equipment
Property and equipment are stated at cost and depreciated over the estimated useful lives of the assets, generally three to five years, using the straight-line method.
Inventories
Raw materials, work-in-process and finished goods inventories are stated at the lower of cost (which approximates actual cost on a first-in, first-out cost method) or market value. At December 31, 2004, inventories were comprised of $18.0 million of raw material and $8.7 million of finished goods. At December 31, 2003, inventories were comprised of $12.2 million of raw material and $3.9 million of finished goods. At December 31, 2004, the Company had an inventory allowance of $0.2 million compared to $0.1 million at December 31, 2003.
The Company may make scale-up and commercial quantities of products prior to receiving final FDA marketing approval. The production of these pre-launch inventories involves the risk that such products may not be approved for marketing on a timely basis, or ever. Pre-launch inventories are capitalized at a point where the Company believes that marketing approval is likely, a well-characterized manufacturing process is established and anticipated future sales support the carrying value of the inventory.
At December 31, 2003, the Company had approximately $6.4 million of raw material inventories of rifaximin which had not received FDA approval at that time. In May 2004, the Company received FDA marketing approval for Xifaxan. At December 31, 2004, the Company had no inventories of non-FDA approved products.
Intangible Assets
When the Company makes product acquisitions that include license agreements, product rights and other identifiable intangible assets, it records the aggregate purchase price, along with the value of the product related liabilities that it assumes, as intangible assets. The Company allocates the purchase price to the fair value of the various intangible assets in order to amortize their cost as an expense in its statement of operations over the estimated economic useful life of the related assets. The Company assesses the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors that the Company considers important which could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business, and significant negative industry or economic trends.
In assessing the recoverability of its intangible assets, the Company must make assumptions regarding estimated future cash flows and other factors. If the estimated undiscounted future cash flows do not exceed the carrying value of the intangible assets the Company must determine the fair value of the intangible assets. If the fair value of the
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
intangible assets is less than the carrying value, an impairment loss will be recognized in an amount equal to the difference. The Company reviews intangible assets for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
In November 2003, the Company acquired from aaiPharma LLC the exclusive right to sell 25, 75 and 100 milligram dosage strengths of azathioprine tablets in North America under the name Azasan for $2.0 million. The purchase price is being amortized over a period of ten years. Although Azasan does not have any patent protection, the Company believes ten years is an appropriate amortization period based on established product history and management experience. At December 31, 2004, accumulated amortization for Azasan was $0.2 million.
In June 2004, the Company acquired the exclusive U.S. rights to Anusol-HC 2.5% (hydrocortisone Cream USP), Anusol-HC 25 mg Suppository (Hydrocortisone Acetate), Proctocort Cream (Hydrocortisone Cream USP) 1% and Proctocort Suppositories (Hydrocortisone Acetate Rectal Suppositories, 30 mg) from King Pharmaceuticals, Inc. for $13.0 million. The purchase price is being amortized over a period of ten years. Although Anusol-HC and Proctocort do not have any patent protection, the Company believes ten years is an appropriate amortization period based on established product history and management experience. At December 31, 2004, accumulated amortization for the King products was $0.6 million.
Amortization expense is calculated on a straight-line basis over the estimated useful life of the asset. Amortization expense for the year-ended December 31, 2004 was $0.8 million. No amortization expense was incurred during the years ended December 31, 2003 and 2002. Estimated amortization expense for each of the succeeding five years is $1.5 million.
Asset Impairment
The Company periodically reviews the value of its long-lived assets to determine if an impairment has occurred. In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards, or SFAS, No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, if this review indicates that the assets will not be recoverable, based on an analysis of undiscounted cash flows over the remaining amortization period, the Company will reduce the carrying value of its long-lived assets accordingly.
Shipping and Handling Costs
The Company does not charge its customers for freight costs. The amounts of such costs are included in selling, general and administrative expenses and are not material.
Advertising Costs
Advertising costs are charged to expense as incurred. Advertising expenses were approximately $1.6 million, $1.3 million and $0.6 million for 2004, 2003 and 2002, respectively.
Foreign Currency Translation
The functional currency for the Company is the U.S. dollar. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. All income statement accounts were translated using the average exchange rates throughout the year. The gains and losses resulting from the changes in exchange rates from year to year were reported in other comprehensive loss. The effect on the consolidated statements of operations of transaction gains and losses is insignificant for all years presented.
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
Segment Reporting
The Company operates in a single industry acquiring, developing and commercializing prescription drugs used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract. Accordingly, the Company’s business is classified as a single reportable segment.
The following table presents net product revenues by product (in thousands):
Comprehensive Income (Loss)
The Company adopted SFAS No. 130, “Reporting Comprehensive Income” effective January 1, 1998. SFAS 130 requires that the Company display an amount representing comprehensive income (loss) for the year in a financial statement, which is displayed with the same prominence as other financial statements. The Company elected to present this information in the Statement of Stockholders’ Equity.
Stock-Based Compensation
The Company accounts for stock-based awards to employees under the intrinsic value method in accordance with Accounting Principles Board Opinion, or APB, No. 25, “Accounting for Stock Issued to Employees” and has adopted the disclosure-only alternative of SFAS No. 123, “Accounting for Stock-Based Compensation”. Under APB 25, the Company generally recognizes no compensation expense with respect to such awards.
In December 2002, SFAS No. 148, “Accounting for Stock Based Compensation-Transition and Disclosure an amendment of FASB Statement No. 123” was issued. This statement amended SFAS Statement No. 123 “Accounting for Stock Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock based employee compensation. In addition, this statement amended the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effects of the method used on reported results (see below). The provisions of SFAS No. 148 have been adopted herein.
Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company’s net loss and loss per share would have been increased to the pro forma amounts indicated below for the years ended December 31, 2004, 2003 and 2002.
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
Income Taxes
Income taxes are provided under the liability method in accordance with SFAS No. 109, “Accounting for Income Taxes”. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the consolidated financial statements. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize their benefit or if future deductibility is uncertain.
Net Income (Loss) Per Common Share
The Company computes net income (loss) per share in accordance with SFAS No. 128, “Earnings Per Share” (“SFAS 128”). Under the provisions of SFAS 128, basic net income (loss) per share (“Basic EPS”) is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted net income (loss) per share (“Diluted EPS”) is computed by dividing net income (loss) by the weighted average number of common shares and dilutive common share equivalents then outstanding. Common share equivalents consist of the incremental common shares issuable upon the exercise of stock options.
The following table reconciles the numerator and denominator used to calculate diluted net income (loss) per share:
The number of outstanding options, which are excluded from the above calculation as their impact would be anti-dilutive, are 648,631; 4,670,687 and 4,841,417 for the years ended December 31, 2004, 2003 and 2002, respectively.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123R, “Share-Based Payment”, which requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. This requirement
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
represents a significant change because fixed-based stock option awards, a predominate form of stock compensation for us, were not recognized as compensation expense under APB 25. Statement 123R requires the cost of the award, as determined on the date of grant at fair value, be recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period. The grant-date fair value of the award will be estimated using option-pricing models. We are required to adopt Statement 123R no later than July 1, 2005 under one of three transition methods, including a prospective, retrospective and combination approach. We currently disclose the effect of expensing stock options under a fair value approach using the Black-Scholes pricing model for 2004, 2003 and 2002. We are evaluating all of the provisions of Statement 123R and the expected effect on us including, among other items, reviewing compensation strategies related to stock-based awards, selecting an option pricing model and determining the transition method, thus the impact of adopting SFAS No. 123R cannot yet be determined.
(3) INVESTMENTS
The following is a summary as of December 31, 2004 of available-for-sale securities (in thousands):
At December 31, 2004, the Company’s available-for-sale securities consisted of a 28-day auction rate note with a maturity in excess of 10 years. The security is classified as a current asset based on the Company’s intent and ability to use the security as necessary to satisfy cash needs as they arise by redeeming the security at par within a 28-day period.
(4) PROPERTY AND EQUIPMENT
Depreciation expense was approximately $0.7 million, $0.5 million and $0.4 million for 2004, 2003 and 2002, respectively.
Property and equipment consisted of the following at December 31 (in thousands):
(5) ACCRUED LIABILITIES
Accrued liabilities consist of the following at December 31 (in thousands):
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
(6) REVENUE FROM COLLABORATIVE AGREEMENTS
In May 2000, the Company signed an agreement with Shire Pharmaceuticals Group under which Shire purchased from Salix the exclusive rights to balsalazide as a treatment for ulcerative colitis for Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Republic of Ireland, Luxembourg, Norway, The Netherlands, Switzerland, Sweden and the United Kingdom. Under the agreement, Shire agreed to pay Salix up to a total of approximately $24.0 million, including approximately $12.1 million in up-front fees and up to $12.0 million upon the achievement of milestones. In accordance with the Company’s license arrangement with Biorex Laboratories Limited, its licensor, Salix will share a portion of these payments, including all of the new Shire ordinary shares, with Biorex. In May 2000, Shire paid the Company $9.6 million of cash and $2.5 million by way of the issue of 160,546 new Shire ordinary shares. In August 2000 Shire paid the Company $4.4 million in connection with the transfer to Shire of the United Kingdom product license for balsalazide. During the year ended December 31, 2004, Shire notified the Company that Shire did not intend to pursue additional development activities for balsalazide. Accordingly, the Company recognized $3.5 million of deferred revenue related to the Shire agreement.
During the year ended December 31, 2004, the Company recognized $3.8 million of license fee income primarily related to the agreement with Shire.
(7) STOCKHOLDERS’ EQUITY
In June 2004, the Board of Directors approved a three-for-two stock split of the Company’s common stock, in the form of a stock dividend. As a result, stockholders received one additional common share for every two shares held on the record date of June 30, 2004. Statements or certificates were issued on or about July 12, 2004. All share and per share amounts have been retroactively adjusted to reflect the split for all periods presented.
Preferred Stock
A total of 5,000,000 shares of preferred stock are authorized and issuable. No shares of preferred stock were issued or outstanding as of December 31, 2004.
Common Stock
As of December 31, 2004 the Company was authorized to issue up to 80,000,000 shares of $0.001 par value common stock. As of December 31, 2004 and 2003, there were 36,514,648 and 35,579,732 shares of common stock issued and outstanding, respectively.
In November 2003, the Company completed a private placement of its common stock to a limited number of accredited investors. The Company raised approximately $29.0 million, net of offering costs, through the issuance of 2,550,000 shares of common stock.
In March 2002, the Company completed a public offering of its common stock. The Company raised approximately $57.4 million, net of offering costs, through the issuance of 6,900,000 shares of common stock.
Stockholder Rights Plan
On January 9, 2003, the Company’s Board of Directors adopted an updated stockholder rights plan. Consequently, the Board authorized the redemption, effective on January 20, 2003, of rights under its existing stockholder rights plan for $0.0001 per right. Pursuant to the updated plan, stock purchase rights were distributed to stockholders at the rate of one right with respect to each share of common stock held of record as of January 20, 2003. The rights plan is designed to enhance the Board’s ability to prevent an acquirer from depriving stockholders of the long-term value of their investment and to protect stockholders against attempts to acquire the Company by means of unfair or abusive takeover tactics. The rights become exercisable based upon certain limited conditions related to acquisitions of stock, tender offers and certain business combinations involving the Company.
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
Stock Option Plans
The Company’s 1994 Stock Plan (the “1994 Plan”) was adopted by the Board of Directors in March 1994 and approved by the stockholders in March 1995. The Company’s 1996 Stock Option Plan (the “1996 Plan”) was adopted by the Board of Directors and approved by the Company’s stockholders in February 1996. The options granted under the 1994 Plan and the 1996 Plan may be either incentive stock options or non-statutory stock options. Options granted expire no later than ten years from the date of grant.
The option price shall be at least 100% of the fair market value on the date of grant for incentive stock options, and no less than 85% of the fair market value for nonqualified stock options. If, at the time the Company grants an option, the optionee directly or by attribution owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Company, the exercise price for an incentive stock option shall be at least 110% of the fair market value and the option shall not be exercisable more than five years after the date of grant. The options generally become exercisable in increments of 1/48th per month over a period of 48 months from the date of grant. Options may be granted with different vesting terms as determined by the board of directors. Since inception of the Company’s 1994 and 1996 stock option plans the Company’s stock option grants were all at fair market value.
Aggregate option activity is as follows:
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
Exercise prices for options outstanding as of December 31, 2004 ranged from $0.54 to $22.19 per share.
At December 31, 2003, there were 1,785,180 exercisable options with a weighted average exercise price of $4.65. At December 31, 2002 there were 1,622,135 exercisable options with a weighted average exercise price of $4.91.
Stock-Based Compensation
The weighted-average fair value of options granted in 2004, 2003 and 2002 was $14.35, $6.77 and $4.01, respectively.
The fair value of the Company stock-based awards to employees was estimated using a Black-Scholes option pricing model. The fair value of the Company’s stock-based awards to employees was estimated assuming no expected dividends and the following weighted-average assumptions:
(8) INCOME TAXES
As of December 31, 2004, the Company had U.S. federal net operating loss carryforwards of approximately $84.4 million. These losses will expire on various dates from 2005 through 2024, if not utilized.
The following table presents the provision for income taxes for the years ended December 31 (in thousands):
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
Significant components of the Company’s deferred tax assets for federal and state income taxes were as follows at December 31 (in thousands):
Because of the Company’s history of net operating losses, the deferred tax asset has been fully reserved by a valuation allowance. The valuation allowance increased by approximately $4.2 million and $7.5 million during the years ended December 31, 2004 and 2003, respectively. The deferred tax asset includes certain net benefits from stock options, upon realization, such benefits will be credited to equity.
Utilization of the federal net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the change in ownership provisions of the Internal Revenue Code of 1986. If this limitation applies, the ultimate ability for the Company to use existing net operating loss carryovers and tax credit carryovers to offset future income may be limited.
A reconciliation of the statutory income tax rate to the effective income tax rate as recognized in the statements of operations is as follows for the years ended December 31:
(9) SIGNIFICANT CONCENTRATIONS
The Company operates in a single industry acquiring, developing and commercializing prescription drugs used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract. The Company’s principal financial instruments subject to potential concentration of credit risk are accounts receivable, which are unsecured.
The Company’s primary customers are wholesale pharmaceutical distributors and retail pharmacy chains in the U.S.
Total revenues from customers representing 10% or more of total revenues for the respective years, are summarized as follows:
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
Additionally, 70% and 28% of the Company’s accounts receivable balances were due from these three customers at December 31, 2004 and 2003, respectively.
Currently, the Company is using the active pharmaceutical ingredient balsalazide manufactured for the Company by Omnichem s.a., a subsidiary of Ajinomoto in Belgium. Balsalazide is being encapsulated as Colazal drug product for the Company by Anabolic Laboratories in Irvine, California. In addition, the Company has qualified Noveon in Raubling, Germany as an additional manufacturer of commercial quantities of the active pharmaceutical ingredient balsalazide and is in the process of qualifying an additional Colazal drug product manufacturer.
Under the Company’s supply agreement with Alfa Wasserman, Alfa Wassermann is obligated to supply the Company with bulk active ingredient rifaximin until July 2014 or introduction of a generic product, whichever occurs first. Currently, Alfa Wassermann manufactures rifaximin for the Italian and other European markets. Alfa Wasserman is in the process of securing additional sources of commercial quantities of the active pharmaceutical ingredient rifaximin. Rifaximin drug substance is being manufactured into Xifaxan drug product by Patheon in Whitby, Ontario with whom the Company has long term supply arrangements.
Under the Company’s supply agreement with aaiPharma, aaiPharma is obligated to supply the Company with finished product to meet all of its requirements for the 25, 75 and 100 milligram tablets of Azasan through November 2006.
Under the Company’s supply agreement with King Pharmaceuticals, King is obligated to supply the Company with finished product of Anusol-HC Cream, Anusol-HC Suppositories, and Proctocort Suppositories through June 2006. The Company is in the process of executing a Technical Transfer of these three products from King to an alternate manufacturing site with whom the Company is currently negotiating long term supply arrangements. In addition, through prior supply arrangements between King and Crown Laboratories in Johnson City, Tennessee, Crown will also be supplying the Company with finished product of Proctocort Cream.
(10) 401(K) PLAN
In 1996, the Company adopted the Salix Pharmaceuticals, Inc. 401(k) Retirement Plan. Eligible participants may elect to defer a percentage of their compensation. The Company matches up to 50% of participant deferrals, up to 6% of the participant’s compensation. The Company’s total matching contributions for all participants were approximately $351,000, $302,000 and $275,000 in 2004, 2003 and 2002, respectively. Additional discretionary employer contributions may be made on an annual basis.
(11) COMMITMENTS
The Company leases office facilities under various non-cancelable operating leases, the last of which expires on April 30, 2015. Certain of these leases contain future payment obligations that escalate over time. Rent expense was approximately $821,000, $813,000 and $776,000, for the years ended December 31, 2004, 2003 and 2002, respectively. In addition to the office space, the Company leases automobiles, for use by its direct sales force, under a three-year operating lease.
SALIX PHARMACEUTICALS, LTD.
Notes To Consolidated Financial Statements - Continued
As of December 31, 2004, future minimum payments for operating leases were as follows (in thousands):
At December 31, 2004, the Company had binding purchase order commitments for inventory purchases aggregating approximately $16.7 million throughout 2005.
During the third quarter of 2002, the Company entered into a $7.0 million revolving working capital line of credit, with borrowing capacity of up to 75% of its eligible accounts receivable under 90 days old from the date of invoice. The Company had no outstanding balance under this line as of December 31, 2004. On January 31, 2005, this line of credit expired.
(12) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2004 and 2003:
(1)
The sum of per share earnings by quarter may not equal earnings per share for the year due to the changes in average share calculations. This is in accordance with prescribed reporting requirements.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Allowance for Rebates and Coupons