Item 1. Business
This Annual Report on Form 10-K contains forward-looking statements concerning future events and performance of our Company. When used in this report, the words “intend,” “estimate,” “anticipate,” “believe,” “plan,” “goal” and “expect” and similar expressions as they relate to Avanir Pharmaceuticals, Inc. are included to identify forward-looking statements. These forward-looking statements are based on our current expectations and assumptions and many factors could cause our actual results to differ materially from those indicated in these forward-looking statements. Risks that could cause actual results to differ significantly from our forward-looking statements include, but are not limited to, risks relating to our product sales, capital resources, commercial market estimates, safety of NUEDEXTA, future development efforts, patent protection, effects of healthcare reform, reliance on third parties, and other risks set forth below under Item 1A, “Risk Factors.” We disclaim any intent to update or announce revisions to any forward-looking statements to reflect actual events or developments.
References in this report to Avanir, the Company, we, our and us refer to Avanir Pharmaceuticals, Inc. and its subsidiaries, on a consolidated basis. “Avanir” and “NUEDEXTA” are registered trademarks of Avanir Pharmaceuticals, Inc. or its subsidiaries in the U.S. and/or other countries. Other trademarks or service marks appearing in this report may be trademarks or service marks of other owners.
EXECUTIVE OVERVIEW
Avanir is a pharmaceutical company focused on acquiring, developing and commercializing novel therapeutic products for the treatment of central nervous system disorders. In October 2010, the U.S. Food and Drug Administration (“FDA”) approved NUEDEXTA® (referred to as AVP-923 during clinical development), a unique proprietary combination of dextromethorphan (“DM”) and low-dose quinidine (“Q”), for the treatment of pseudobulbar affect (“PBA”). We commenced promotion of NUEDEXTA in the United States in February 2011 and we are currently pursuing approval of NUEDEXTA in Europe.
We are also studying AVP-923 for use in different types of neuropathic pain. We have filed an Investigational New Drug application (“IND”) with the FDA and have initiated a large Phase II clinical trial of AVP-923 for the treatment of central neuropathic pain in patients with multiple sclerosis. In addition, we are pursuing planned studies to assess behavioral disturbances related to emotional lability, such as agitation, in patients with Alzheimer’s disease.
AVP-923 has also successfully completed a Phase III trial for the treatment of patients with diabetic peripheral neuropathic pain. Additional phase III trials with a modified formulation would need to be completed for approval of this indication.
In addition to our focus on products for the central nervous system, we also have partnered programs in other therapeutic areas that may generate future revenue for us. Our first commercialized product, docosanol 10% cream (sold in the United States and Canada as Abreva® by our marketing partner GlaxoSmithKline Consumer Healthcare), is the only over-the-counter treatment for cold sores that has been approved by the FDA. In 2008, we out-licensed all of our monoclonal antibodies and we remain eligible to receive milestone payments and royalties related to the sale of these assets.
Avanir was incorporated in California in August 1988 and was reincorporated in Delaware in March 2009.
DRUG CANDIDATES AND MARKETED PRODUCTS
NUEDEXTA for the Treatment of PBA
NUEDEXTA is the first and only FDA-approved treatment for PBA. PBA occurs secondary to a variety of otherwise unrelated neurological conditions, and is characterized by involuntary, sudden, and frequent episodes of laughing and/or crying. PBA episodes typically occur out of proportion or incongruent to the patient’s underlying emotional state.
NUEDEXTA is an innovative combination of two well-characterized components: dextromethorphan hydrobromide (20 mg), the ingredient that is pharmacologically active in the central nervous system, and quinidine sulfate (10 mg), a metabolic inhibitor enabling dextromethorphan to reach therapeutic plasma concentrations. NUEDEXTA acts on sigma-1 and N-Methyl-D-aspartic acid, or NMDA, receptors in the brain, although the mechanism by which NUEDEXTA exerts therapeutic effects in patients with PBA is unknown.
Studies to support the effectiveness of NUEDEXTA were performed in patients with PBA and underlying amyotrophic lateral sclerosis, or ALS, and multiple sclerosis. The primary outcome measure, the number of laughing and crying episodes, was significantly lower in the NUEDEXTA cohort compared with placebo. The secondary outcome measure, the Center for Neurologic Studies Lability Scale (CNS-LS), demonstrated a significantly greater mean decrease in CNS-LS score from baseline for the NUEDEXTA cohort compared with placebo. NUEDEXTA has not been shown to be safe and effective in other types of emotional lability that can commonly occur, for example, in Alzheimer’s disease and other dementias.
NUEDEXTA safety information
NUEDEXTA can interact with other medications causing significant changes in blood levels of those medications and/or NUEDEXTA. NUEDEXTA is contraindicated in patients receiving drugs that both prolong QT interval and are metabolized by CYP2D6 (e.g., thioridazine and pimozide) and should not be used concomitantly with other drugs containing quinidine, quinine, or mefloquine. NUEDEXTA is contraindicated in patients taking monoamine oxidase inhibitors (MAOIs) or in patients who have taken MAOIs within the preceding 14 days. NUEDEXTA is contraindicated in patients with a known hypersensitivity to its components.
NUEDEXTA may cause serious side effects, including possible changes in heart rhythm. NUEDEXTA is contraindicated in patients with a prolonged QT interval, congenital long QT syndrome or a history suggestive of torsades de pointes, in patients with heart failure as well as patients with, or at risk of, complete atrioventricular (AV) block, unless the patient has an implanted pacemaker. NUEDEXTA causes dose-dependent QTc prolongation. When initiating NUEDEXTA in patients at risk of QT prolongation and torsades de pointes, electrocardiographic (ECG) evaluation of QT interval should be conducted at baseline and 3-4 hours after the first dose.
The most common adverse reactions in patients taking NUEDEXTA are diarrhea, dizziness, cough, vomiting, weakness, swelling of feet and ankles, urinary tract infection, flu, elevated liver enzymes, and flatulence.
NUEDEXTA may cause dizziness. Precautions to reduce the risk of falls should be taken, particularly for patients with motor impairment affecting gait or a history of falls.
Patients should take NUEDEXTA exactly as prescribed. Patients should not take more than 2 capsules in a 24-hour period, make sure that there is an approximate 12-hour interval between doses, and not take a double dose after they miss a dose.
These are not all the risks from use of NUEDEXTA. For additional important safety information about NUEDEXTA, please see the full Prescribing Information at www.NUEDEXTA.com.
PBA indication and market
PBA is a distinct neurologic syndrome that is characterized by a loss of control of emotional expression, typically involving episodes of involuntary or exaggerated motor expression of emotion such as laughing, crying or other emotional displays.
There are an estimated 18 to 20 million people in the United States who suffer from the underlying neurologic conditions that can give rise to PBA. These underlying neurologic conditions include but are not limited to ALS, MS, Alzheimer’s disease, Parkinson’s disease, stroke and traumatic brain injury. Extrapolating from the epidemiologic medical literature, physician estimates and an Avanir-sponsored patient survey, which surveyed a total of 2,464 patients and caregivers of patients with underlying neurologic conditions associated with PBA (including ALS, Alzheimer’s disease/dementias, MS, Parkinson’s disease, stroke and traumatic brain injury), we estimate that approximately 10% of people in the United States who suffer from neurological disease or injury suffer from moderate to severe PBA, with many more suffering from mild PBA.
Other than NUEDEXTA, there are no approved therapies indicated to treat PBA. Currently, some physicians treat PBA using a range of drugs off-label, including: selective serotonin reuptake inhibitors/serotonin-norepinephrine reuptake inhibitors, or SSRIs/SNRIs, antidepressants and atypical antipsychotics. According to our market research, physicians are generally only moderately satisfied with these off-label therapies as a treatment for PBA. We conducted this market research through an Internet-based survey of 215 physicians, consisting of Neurologists, Internal Medicine/Geriatrics, Psychiatrists and Physical Medicine and Rehabilitation specialists.
We believe that NUEDEXTA represents a more attractive treatment option for patients suffering from PBA. In our Phase III STAR trial that was completed in 2009, patients treated with NUEDEXTA reported an average 80% reduction in episodes at the end of the 12-week study compared to baseline, with an average 50% reduction in episodes in the first week of treatment. Over the course of the 12-week study, patients receiving NUEDEXTA experienced significantly lower PBA episode rates versus placebo (P<0.0001). Over the final two weeks of the STAR trial, one-half of patients treated with NUEDEXTA achieved episode-free remission.
NUEDEXTA Commercialization Strategy
We currently market NUEDEXTA to approximately 10,000 physicians and other healthcare providers who specialize in psychiatry, neurology or geriatric medicine and practice in outpatient or long-term care settings. Our commercial strategy for NUEDEXTA includes the following objectives: increase awareness and diagnosis of PBA, expand adoption of NUEDEXTA, minimize barriers to patient access, and motivate patients and caregivers to request and adhere to NUEDEXTA therapy.
AVP-923 for the Potential Treatment of Neuropathic Pain
AVP-923 for the Treatment of MS Pain
Multiple Sclerosis (“MS”) is one of the most frequent chronic neurologic disease causing significant disability in young adults. Among the many neurological complications of MS, chronic pain has a significant impact on the daily life of patients with this disease.
Several distinct pain conditions associated with MS have been characterized in various literature, including optic neuritis, headache, musculoskeletal pain (which includes painful tonic spasms, back pain and muscle spasms) and central neuropathic pain (which includes extremity pain, trigeminal neuralgia and Lhermitte’s sign). While the specific pain mechanisms associated with each condition have not been fully identified, it is believed that neuropathic pain results from neurologic damage caused by demyelinating lesions. Pain is a common symptom experienced by many MS patients and, in particular, approximately 30% of MS patients experience central neuropathic pain during the course of the disease.
In September 2009, we reported on secondary efficacy endpoints from the double-blind phase of the AVP-923 STAR trial in PBA, including an endpoint measuring reduction of MS-related pain. AVP-923 30/10 mg demonstrated statistically significant decrease in pain scores compared to placebo in the subset of MS patients with moderate-to-severe pain. Based on these results, we filed an IND application with the FDA to begin a Phase II clinical trial of AVP-923 for the treatment of central neuropathic pain in patients with MS. The FDA accepted the proposed clinical investigational plan included in the submission and we enrolled the first patient in November 2011.
The objectives of the study are to evaluate the safety, tolerability, and efficacy of three dose levels of AVP-923 capsules for the treatment of central neuropathic pain in a population of patients with MS. The trial is a multicenter, randomized, double-blind, placebo-controlled, 4-arm parallel group study. Eligible patients will be randomized to receive one of the three dose levels of AVP-923 containing either 45mg DM/10mg Q, 30mg DM/10mg Q, 20mg DM/10mg Q or placebo, daily for 12 weeks. The primary efficacy endpoint is the Pain Rating Scale obtained from daily patient diaries. Secondary endpoints include measure of fatigue, impact of MS on daily life, sleep quality, cognition and depression. Safety will be assessed by monitoring adverse events, clinical laboratory tests, electrocardiograms, physical examinations, and vital signs. We expect to enroll approximately 400 patients both in the U.S. and internationally.
AVP-923 for the treatment of diabetic neuropathic pain
Diabetic peripheral neuropathic pain (“DPN pain”), which arises from nerve injury, can result in a chronic and debilitating form of pain that has historically been poorly diagnosed and treated. It is often described as burning, tingling, stabbing, or pins and needles in the feet, legs, hands or arms. An estimated 3.5 million people in the United States experience DPN pain according to the American Diabetes Association. DPN pain currently is most commonly treated with antidepressants, anticonvulsants, opioid analgesics and local anesthetics. Most of these treatments have limited effectiveness or undesirable side effects resulting in a high degree of unmet medical need. The neuropathic pain market is continuing to grow rapidly, and in 2006, was estimated to be worth $2.6 billion in sales among the seven largest markets, consisting of the United States, Japan, France, Germany, Italy, Spain and the United Kingdom.
Avanir has successfully completed a Phase III clinical trial for AVP-923 in the treatment of patients with DPN pain. In April 2007, we announced positive top-line data from our first Phase III clinical trial of AVP-923 for the treatment of patients with DPN pain. The most commonly reported adverse events from this Phase III study were dizziness, nausea, diarrhea, fatigue and somnolence, which were mild to moderate in nature. We are continuing to evaluate our options for this program and next steps.
Other Programs
Docosanol 10% cream - cold sore treatment
Docosanol 10% cream is a topical treatment for cold sores. In 2000, we received FDA approval for marketing docosanol 10% cream as an over-the-counter product. Since that time, docosanol 10% cream has been approved by regulatory agencies in Asia, North America, and Europe. In March 2000, we granted a subsidiary of GlaxoSmithKline, SB Pharmco Puerto Rico, Inc. (“GSK”), the exclusive rights under a license to market docosanol 10% cream in the United States and Canada (“GSK License Agreement”). GSK markets the product under the name Abreva® in these markets. Under the terms of the GSK License Agreement, GSK is responsible for all sales and marketing activities and the manufacturing and distribution of docosanol 10% cream. Under the GSK license agreement, the Company received a total of $25 million in milestone payments from GSK and the Company was entitled to receive an 8% royalty on net sales of Abreva by GSK.
In November 2002, the Company sold to Drug Royalty USA an undivided interest in the Company’s rights to receive future Abreva royalties under the GSK License Agreement for $24.1 million (the “Drug Royalty Agreement”). Under the Drug Royalty Agreement, Drug Royalty USA has the right to receive royalties from GSK on sales of Abreva until December 2013. The Company retained the right to receive 50% of all royalties (a net of 4%) under the GSK License Agreement for annual net sales of Abreva in the U.S. and Canada in excess of $62 million. From the effective date of the GSK License Agreement up to the 2002 sale of the Company’s royalty rights to Drug Royalty USA, Inc., the Company received a total of approximately $5.9 million in royalty payments from GSK attributed to the 8% royalty on net sales by GSK.
Under the terms of our docosanol license agreements, our partners are generally responsible for all regulatory approvals, sales and marketing activities, and manufacturing and distribution of the product in the licensed territories. The terms of the license agreements typically provide for us to receive a data transfer fee, potential milestone payments and royalties on product sales. We purchase the active pharmaceutical ingredient (“API”), docosanol, from a large supplier in Western Europe and have, on occasion, sold material to our licensees. We currently store our API in the United States. Any material disruption in manufacturing could cause a delay in shipments and possible loss of sales.
Competition
The pharmaceutical industry is characterized by rapidly evolving technology and intense competition. A large number of companies of all sizes, including major pharmaceutical companies and specialized biotechnology companies, engage in activities similar to our activities. Many of our competitors have substantially greater financial and other resources available to them. In addition, colleges, universities, governmental agencies and other public and private research organizations continue to conduct research and are becoming more active in seeking
patent protection and licensing arrangements to collect royalties for use of technologies that they have developed. Some of our competitors’ products and technologies are in direct competition with ours. We also must compete with these institutions in recruiting highly qualified personnel.
NUEDEXTA for Pseudobulbar Affect. Although NUEDEXTA is the first product to be marketed for the treatment of PBA, we are aware that physicians may prescribe other products in an off-label manner for the treatment of this disorder. For example, NUEDEXTA may face competition from the following products:
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Antidepressants, including Prozac®, Celexa®, Zoloft®, Paxil®, Elavil® and Pamelor® and others;
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Atypical antipsychotic agents, including Zyprexa®, Risperdal®, Seroquel, Abilify®, Geodon® and others; and
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Miscellaneous agents, including Symmetrel®, Lithium and others.
While it is also possible that compounding pharmacies could combine the components of NUEDEXTA in an unauthorized fashion that is in violation of our patents, it is inconsistent with the policies of the Pharmacy Compounding Accreditation Board.
Manufacturing
We currently have no manufacturing or production facilities and, accordingly, rely on third parties for clinical production of our products and product candidates. We obtain the API for NUEDEXTA from a sole supplier who is one of several available commercial suppliers. (See Item 1A, “Risk Factors”). Further, we licensed to various pharmaceutical companies the exclusive rights to manufacture and distribute docosanol 10% cream.
Intellectual Property Rights
Patents
We own and have licensed a number of our patents relating to our products, which in the aggregate are believed to be of material importance to us in the operation of our business. See Item 1A, “Risk Factors.”
In December 2010, we filed applications for patent term extension for NUEDEXTA under the Hatch-Waxman law that allows for up to five additional years of patent protection based on the development timeline of a drug. Although we applied to extend two Nuedexta patents listed in the FDA Orange Book, if both are granted extensions, we will need to select only one patent for extension. Without extension, these patents currently expire on March 27, 2012 and January 26, 2016, respectively.
Trademarks and Other Intellectual Property Rights
We have made a practice of selling our products under trademarks and of obtaining protection for these trademarks by all available means. These trademarks are protected by registration in the United States and other countries where such products are marketed. We consider these trademarks in the aggregate to be of material importance in the operation of our business.
Our intellectual property also includes copyrights, confidential and trade secret information.
Government Regulations
The FDA and comparable regulatory agencies in foreign countries extensively regulate the manufacture and sale of the pharmaceutical products that we have developed or are currently developing. The FDA has established guidelines and safety standards that are applicable to the nonclinical evaluation and clinical investigation of therapeutic products and stringent regulations that govern the manufacture and sale of these products. The process of obtaining regulatory approval for a new therapeutic product usually requires a significant amount of time and substantial resources. The steps typically required before a product can be tested in humans include:
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Animal pharmacology studies to obtain preliminary information on the safety and efficacy of a drug; and
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Nonclinical evaluation in vitro and in vivo including extensive toxicology studies.
The results of these nonclinical studies may be submitted to the FDA as part of an IND application. The sponsor of an IND application may commence human testing of the compound 30 days after submission of the IND, unless notified to the contrary by the FDA.
The clinical testing program for a new drug typically involves three phases:
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Phase I investigations are generally conducted in healthy subjects. In certain instances, subjects with a life-threatening disease, such as cancer, may participate in Phase I studies that determine the maximum tolerated dose and initial safety of the product;
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Phase II studies are conducted in limited numbers of subjects with the disease or condition to be treated and are aimed at determining the most effective dose and schedule of administration, evaluating both safety and whether the product demonstrates therapeutic effectiveness against the disease; and
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Phase III studies involve large, well-controlled investigations in diseased subjects and are aimed at verifying the safety and effectiveness of the drug.
Data from all clinical studies, as well as all nonclinical studies and evidence of product quality, typically are submitted to the FDA in a NDA. Although the FDA’s requirements for clinical trials are well established and we believe that we have planned and conducted our clinical trials in accordance with the FDA’s applicable regulations and guidelines, these requirements, including requirements relating to testing the safety of drug candidates, may be subject to change or new interpretation. Additionally, we could be required to conduct additional trials beyond what we had planned due to the FDA’s safety and/or efficacy concerns or due to differing interpretations of the meaning of our clinical data. (See Item 1A, “Risk Factors”).
The FDA’s Center for Drug Evaluation and Research must approve a NDA for a drug before it may be marketed in the U.S. If we begin to market our proposed products for commercial sale in the U.S., any manufacturing operations that may be established in or outside the U.S. will also be subject to rigorous regulation, including compliance with current good manufacturing practices. We also may be subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substance Control Act, the Export Control Act and other present and future laws of general application.
Regulatory obligations continue post-approval, and include the reporting of adverse events when a drug is utilized in the broader commercial population. Promotion and marketing of drugs is also strictly regulated, with penalties imposed for violations of FDA regulations, the Lanham Act (trademark statute), and other federal and state laws, including the federal anti-kickback statute.
We currently intend to continue to seek, directly or through our partners, approval to market our products and product candidates in foreign countries, which may have regulatory processes that differ materially from those of the FDA. We anticipate that we will rely upon pharmaceutical or biotechnology companies to license our proposed products or independent consultants to seek approvals to market our proposed products in foreign countries. We cannot assure you that approvals to market any of our proposed products can be obtained in any country. Approval to market a product in any one foreign country does not necessarily indicate that approval can be obtained in other countries.
Product Liability Insurance
We maintain product liability insurance on our products and clinical trials that provides coverage in the amount of $10 million per incident and $10 million in the aggregate.
Executive Officers and Key Employees of the Registrant
Information concerning our executive officers and key employees, including their names, ages and certain biographical information can be found in Part III, Item 10 under the caption, “Executive Officers and Key Employees of the Registrant.” This information is incorporated by reference into Part I of this report.
Employees
As of December 1, 2011, we employed 188 persons, including 25 engaged in research and development activities, including clinical development, medical and regulatory affairs, and 163 in selling, general and administrative functions such as human resources, finance, accounting, business development, sales, marketing, and investor relations. Of the selling, general and administrative positions, approximately 129 are field based.
Financial Information about Segments
We operate in a single accounting segment - the development and commercialization of novel treatments that target the central nervous system. Refer to Note 14, “Segment Information” in the Notes to the Consolidated Financial Statements.
General Information
Our principal executive offices are located at 20 Enterprise, Suite 200, Aliso Viejo, California 92656. Our telephone number is (949) 389-6700 and our e-mail address is info@avanir.com. Our Internet website address is www.avanir.com. No portion of our website is incorporated by reference into this Annual Report on Form 10-K.
You are advised to read this Annual Report on Form 10-K in conjunction with other reports and documents that we file from time to time with the Securities and Exchange Commission (“SEC”). In particular, please read our definitive proxy statement, which will be filed with the SEC in connection with our 2012 Annual Meeting of Stockholders, our Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K that we may file from time to time. You may obtain copies of these reports after the date of this annual report directly from us or from the SEC at the SEC’s Public Reference Room at 100 F Street, N.E. Washington, D.C. 20549. In addition, the SEC maintains information for electronic filers (including Avanir) at its website at www.sec.gov. The public may obtain information regarding the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We make our periodic and current reports available on our internet website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.
Item 1A.
Item 1A. Risk Factors
This Annual Report on Form 10-K contains forward-looking information based on our current expectations. Because our actual results may differ materially from any forward-looking statements that we make or that are made on our behalf, this section includes a discussion of important factors that could affect our actual future results, including, but not limited to, our product sales, capital resources, commercial market estimates, safety of NUEDEXTA, future development efforts, patent protection, effects of healthcare reform, reliance on third parties, and other risks set forth below. We disclaim any intent to update forward-looking statements to reflect subsequent developments or actual results.
Risks Relating to Our Business
Our near-term prospects are dependent on NUEDEXTA. If we are unable to successfully commercialize NUEDEXTA, including raising PBA awareness, driving higher rates of physician adoption and obtaining reimbursement and third party payor coverage, we will not be able to commercialize NUEDEXTA effectively and our ability to generate significant revenue or achieve profitability will be adversely affected.
Although NUEDEXTA has been approved for marketing, our current ability to generate significant revenue is entirely dependent upon our ability to successfully commercialize NUEDEXTA. To be successful we must continue to:
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establish and maintain successful sales, marketing and education programs for our targeted physicians;
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raise physician awareness of PBA and encourage physicians to screen patients for the condition;
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obtain adequate reimbursement for NUEDEXTA from a broad range of payors; and
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maintain and defend our patent protection and maintain regulatory exclusivity for NUEDEXTA.
Supplying the market for NUEDEXTA requires us to manage relationships with an increasing number of collaborative partners, suppliers and third-party contractors. If we are unable to successfully establish and maintain the required sales and marketing infrastructure, as well as successfully manage an increasing number of relationships, including with suppliers, manufacturers, distributors, insurance carriers and prescribers, we will have difficulty growing our business. In addition, pharmacies, institutions and prescribers may rely on third-party medical information systems to interpret the NUEDEXTA approved product label and guide utilization of NUEDEXTA. If these information systems load incorrect information or misinterpret the approved product label, it may result in lower adoption or utilization than expected. For example, because NUEDEXTA contains quinidine, which is a known pro-arrhythmic drug at antiarrhythmic doses exceeding 600 mg per day, it is possible that medical information systems may incorrectly identify NUEDEXTA as contraindicated or otherwise inappropriate for a patient, even in situations where the risks are substantially less than perceived.
In addition, we may enter into co-promotion or out-licensing arrangements with other pharmaceutical or biotechnology partners where necessary to reach customers in domestic or foreign market segments and when deemed strategically and economically advisable. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold NUEDEXTA, and some or all of the revenues we receive will depend upon the efforts of third parties, which may not be successful. If we are unable to accomplish any of these key objectives, we may not be able to generate significant product revenue or become profitable.
We have a history of net losses and an accumulated deficit, and we may be unable to generate sufficient revenue to achieve or maintain profitability in the future.
We have experienced significant net losses and negative cash flows from operations and we expect our negative cash flow from operations to continue until we are able to generate significant revenues from sales of NUEDEXTA. As of September 30, 2011, we had an accumulated deficit of approximately $365.3 million. We have incurred these losses principally from costs incurred in funding the research, development and clinical testing of our drug candidates, from our general and administrative expenses and from our efforts to commercialize NUEDEXTA. We may continue incurring net losses for the foreseeable future and we expect our operating losses to continue for at least the short term as we continue to market NUEDEXTA.
Our ability to generate revenue and achieve profitability is dependent on our ability, alone or with partners, to successfully manufacture and market NUEDEXTA for the treatment of patients with PBA. We expect to continue to spend substantial amounts on the ongoing marketing of NUEDEXTA for PBA domestically, as well as seeking regulatory approvals for use of NUEDEXTA in other geographic markets and indications. As a result, we may never generate sufficient revenue from product sales to become profitable or generate positive cash flows.
Certain of our key issued patents are currently being challenged and our pending patent applications may be denied. An adverse outcome in either case would adversely affect our ability to generate significant product revenue or become profitable.
We have invested in an extensive patent portfolio and we rely substantially on the protection of our intellectual property through our ownership or control of issued patents and patent applications. The degree of patent protection that will ultimately be afforded to us in the U.S. and in other important markets remains uncertain and is dependent upon the scope of protection decided upon by the patent offices, courts and lawmakers in these countries. If we cannot prevent others from exploiting claims in our patent portfolio, we will not derive the benefit from it that we currently expect. Further, we may incur substantial expense from litigation to protect our patent portfolio.
The validity, enforceability and scope of our core patents covering NUEDEXTA are currently being challenged as a result of recent abbreviated new drug application (“ANDA”) filings from generic drug companies. The outcome of the current or any future challenges to the validity, enforceability or scope of our patent portfolio could significantly reduce revenues from NUEDEXTA and any future products. More broadly speaking, investors should be aware that the biopharmaceutical industry is highly competitive. Our ability to compete in this space involves various risks relating to our intellectual property, including:
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our patents covering NUEDEXTA may be found to be invalid and unenforceable or insufficiently broad to block the introduction of a generic form of NUEDEXTA;
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the claims in any of our pending patent applications may not be allowed and our patent applications may not be granted;
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competitors may develop similar or superior technologies independently, duplicate our technologies, or design around the patented aspects of our technologies;
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any of our issued patents may not provide us with significant competitive advantages; and
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we may not be able to secure additional worldwide intellectual property protection for our NUEDEXTA patent portfolio.
An adverse outcome with respect to any of these risks could adversely affect our ability to generate significant product revenue or become profitable.
We have received notice of four ANDA filings for NUEDEXTA submitted by generic drug companies. These ANDA filings assert that a generic form of NUEDEXTA would not infringe on our issued patents. As a result of these filings, we have commenced litigation to defend our patent rights, which is expected to be costly and time-consuming and, depending on the outcome of the litigation, we may face competition from lower cost generic or follow-on products in the near term.
NUEDEXTA is approved under the provisions of the Federal Food, Drug and Cosmetic Act (“FDCA”), which renders it susceptible to potential competition from generic manufacturers via the Hatch-Waxman Act and ANDA process. Generic manufacturers pursuing ANDA approval are not required to conduct costly and time-consuming clinical trials to establish the safety and efficacy of their products; rather, they are permitted to rely on the innovator’s data regarding safety and efficacy. Additionally, generic drug companies generally do not expend significant sums on sales and marketing activities, instead relying on physicians or payors to substitute the generic form of a drug for the branded form. Thus, generic manufacturers can sell their products at prices much lower than those charged by the innovative pharmaceutical or biotechnology companies who have incurred substantial expenses associated with the research and development of the drug product and who must spend significant sums marketing a new drug.
The ANDA procedure includes provisions allowing generic manufacturers to challenge the innovator’s patent protection by submitting “Paragraph IV” certifications to the FDA in which the generic manufacturer claims that the innovator’s patent is invalid, unenforceable and/or will not be infringed by the manufacture, use, or sale of the generic product. A patent owner who receives a Paragraph IV certification may choose to sue the generic applicant for patent infringement. In recent years, generic manufacturers have used Paragraph IV certifications extensively to challenge the applicability of patents listed in the FDA’s Approved Drug Products List with Therapeutic Equivalence Evaluations, commonly referred to as the Orange Book, on a wide array of innovative therapeutic products. We expect this trend to continue and to implicate drug products with even relatively modest revenues.
We have received Paragraph IV certification notices from four separate companies contending that our patents listed in the Orange Book (U.S. Patents 7,659,282 and RE 38,115, which expire in August 2026 and January 2016, respectively) are invalid, unenforceable and/or will not be infringed by the manufacture, use, or sale of a generic form of NUEDEXTA. In response to these notices, we have filed suit against all four of the generic drug companies to defend our patent rights.
Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of the ANDAs submitted by the Defendants can occur no earlier than October 29, 2013. Further, as a result of the 30-month stay associated with the filing of the ANDA Actions, the FDA cannot grant final approval to any ANDA before December 30, 2013, unless there is an earlier court decision holding that the ’282 and ‘115 patents are not infringed and/or are invalid.
Although we intend to vigorously enforce our intellectual property rights relating to NUEDEXTA, there can be no assurance that we will prevail in our defense of our patent rights. Our existing patents could be invalidated, found unenforceable or found not to cover a generic form of NUEDEXTA. If an ANDA filer were to receive approval to sell a generic version of NUEDEXTA and/or prevail in any patent litigation, NUEDEXTA would become subject to increased competition and our revenue would be adversely affected.
PBA is a new market and estimates vary significantly over the potential market size and our anticipated revenues over the near and long term.
NUEDEXTA is being made available to patients to treat PBA, an indication for which there is no established pharmaceutical market. Industry sources and equity research analysts have a wide divergence of estimates for the near- and long-term market potential of our product. A variety of assumptions directly impact the estimates for our drug’s market potential, including estimates of underlying neurologic condition prevalence, severity of PBA prevalence among these conditions, and rates of physician adoption of our drug for treatment of PBA among these populations, drug pricing assumptions, and patient adherence and compliance rates within each underlying neurologic condition. Small differences in these assumptions can lead to widely divergent estimates of the market potential of our product. Additionally, although our approved product label is indicated to treat PBA, without regard for the underlying neurological condition, it is possible that physicians, the FDA’s Office of Prescription Drug Promotion (“OPDP”) or others may interpret the label more narrowly than the FDA’s approving division’s approval for a broad PBA label and believe that PBA secondary to certain conditions, such as Alzheimer’s disease, is not an indicated use. If such interpretations are widespread, the actual market size may be smaller than we have estimated. Accordingly, investors are cautioned not to place undue reliance on any particular estimates of equity research analysts or industry sources.
Significant safety or drug interaction problems could arise with respect to NUEDEXTA, which could result in restrictions in NUEDEXTA’s label, recalls, withdrawal of NUEDEXTA from the market, an adverse impact on potential sales of NUEDEXTA, or cause us to alter or terminate current or future NUEDEXTA clinical development programs, any of which would adversely impact our future business prospects.
Discovery of previously unknown safety or drug interaction problems with an approved product may result in a variety of adverse regulatory actions. This risk may be increased as physicians, at their own discretion, may prescribe NUEDEXTA for off-label uses which may result in unknown safety or drug interactions. Under the Food and Drug Administration Amendments Act of 2007, the FDA has broad authority to force drug manufacturers to take any number of actions if previously unknown safety or drug interaction problems arise, including, but not limited to: (i) requiring manufacturers to conduct post-approval clinical studies to assess known risks or signals of serious risks, or to identify unexpected serious risks; (ii) mandating labeling changes to a product based on new safety information; or (iii) requiring manufacturers to implement a Risk Evaluation Mitigation Strategy, or REMS, where necessary to assure safe use of the drug. In addition, previously unknown safety or drug interaction problems could result in product recalls, restrictions on the product’s permissible uses, or withdrawal of the product from the market.
The combination of dextromethorphan and quinidine has never been marketed for the treatment of any condition until the approval of NUEDEXTA. NUEDEXTA has only been studied in a limited number of patients in clinical studies and the data submitted to the FDA as part of our New Drug Application was obtained in controlled clinical trials of limited duration. In connection with the approval of NUEDEXTA, the FDA has required that we conduct certain post-approval studies, which include both non-clinical studies and a pediatric development plan. New safety or drug interaction issues may arise from these studies or as NUEDEXTA is used over longer periods of time by a wider group of patients. In addition, as we conduct other clinical trials for AVP-923 in other indications, new safety problems may be identified which could negatively impact both our ability to successfully complete these studies and the use and/or regulatory status of NUEDEXTA for the treatment of PBA. New safety or drug interaction issues may result in product liability lawsuits and may require us to, among other things, provide additional warnings and/or restrictions on the NUEDEXTA prescribing information, including a boxed warning, directly alert healthcare providers of new safety information, narrow our approved indications, or alter or terminate current or planned trials for additional uses of AVP-923, any of which could have a significant adverse impact on potential sales of NUEDEXTA.
In addition, if we are required to conduct additional post-approval clinical studies, implement a REMS, or take other similar actions, such requirements or restrictions could have a material adverse impact on our ability to generate revenues from sales of NUEDEXTA, and/or require us to expend significant additional funds.
We have limited capital resources and may need to raise additional funds to support our operations.
We have experienced significant operating losses in funding the research, development, clinical testing and commercialization of NUEDEXTA and our drug candidates. We expect to continue to incur substantial operating losses for the foreseeable future as we continue the commercial launch of NUEDEXTA. Although we had approximately $81.8 million in cash and cash equivalents and restricted investments in marketable securities as of September 30, 2011, we currently do not have sufficient revenue from NUEDEXTA or other sources of recurring revenue or cash flow from operations to sustain our operations on a profitable basis and it is possible that we may not be able to achieve profitability with our current capital resources.
In light of our substantial long-term capital needs, we may need to partner our rights to NUEDEXTA (either in the U.S. or outside the U.S.) or raise additional capital in the future to finance our long-term operations, until we expect to be able to generate meaningful amounts of revenue from product sales. Based on our current loss rate and existing capital resources as of the date of this report, we estimate that we have sufficient funds to sustain our operations at their current and anticipated levels into the fourth quarter of calendar 2012, which includes the costs associated with the ongoing marketing of NUEDEXTA for PBA. Although we expect to be able to raise additional capital if needed, there can be no assurance that we will be able to do so or that the available terms of any financing would be acceptable to us. If we are unable to raise additional capital to fund future operations, then we may be unable to fully execute our development and commercialization plans for NUEDEXTA. This may result in significant delays or cutbacks in the commercialization of NUEDEXTA and may force us to further curtail our operations or seek to raise additional capital.
If we raise additional capital, we may do so through various financing alternatives, including licensing or sales of our technologies, drugs and/or drug candidates, selling shares of common or preferred stock, through the acquisition of other companies, or through the issuance of debt securities. Each of these financing alternatives carries certain risks. Raising capital through the issuance of common stock may depress the market price of our stock. Any such financing will dilute our existing stockholders and, if our stock price is relatively depressed at the time of any such offering, the levels of dilution would be greater. In addition, debt financing, to the extent available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as making capital expenditures or entering into licensing transactions. If we seek to raise capital through licensing transactions or sales of one or more of our technologies, drugs or drug candidates, as we have previously done with certain investigational compounds and docosanol 10% cream, then we will likely need to share a significant portion of future revenues from these drug candidates with our licensees. Additionally, the development of any drug candidates licensed or sold to third parties will no longer be in our control and thus we may not realize the full value of any such relationships.
We have licensed or sold most of our non-core drug development programs and related assets and these and other possible future dispositions carry certain risks.
We have entered into agreements for the licensing or sale of our non-core assets, including FazaClo, our anthrax antibody program, and other antibodies in our infectious disease program, as well as docosanol in the U.S. and other markets worldwide. As a result, we do not currently have a diversified pipeline of product candidates and our long-term success is currently dependent on NUEDEXTA. From time to time, we have been and will continue to be engaged in discussions with potential licensing or development partners for NUEDEXTA for PBA and/or AVP-923 for other indications and we may choose to pursue a partnership or license involving NUEDEXTA, if the terms are attractive. However, these transactions involve numerous risks, including:
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diversion of management’s attention from normal daily operations of the business;
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disputes over earn-outs, working capital adjustments or contingent payment obligations;
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insufficient proceeds to offset expenses associated with the transactions; and
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the potential loss of key employees following such a transaction.
Transactions such as these carry significant risks where a large portion of the total consideration is contingent upon post-closing events, such as commercialization or sales milestones. We may not exercise control over whether
these milestones are met and, if they are not met, then a potentially large portion of the value of the transaction may not be realized. Disputes may also develop over these and other terms, such as representations and warranties, indemnities, earn-outs, and other provisions in the transaction agreements. If disputes are resolved unfavorably, our financial condition and results of operations may be adversely affected and we may not realize the anticipated benefits from the transactions.
Disputes relating to these transactions can lead to expensive and time-consuming litigation and may subject us to unanticipated liabilities or risks, disrupt our operations, divert management’s attention from day-to-day operations, and increase our operating expenses. See Item 3 “Legal Proceedings” for further discussion relating to a lawsuit filed by Neal R. Cutler, M.D., founder of Alamo Pharmaceuticals, LLC.
The FDA’s safety concerns regarding our prior formulation of NUEDEXTA, known as AVP-923, for the treatment of PBA extend to other clinical indications that we have been pursuing, including DPN pain. Due to these concerns, any future development of AVP-923 for other indications, including central neuropathic pain in patients with MS, is expected to use an alternative lower-dose quinidine formulation, which may negatively affect efficacy.
We have successfully completed a single Phase III trial for AVP-923 in the treatment of DPN pain. In communications regarding the continued development of AVP-923 for this indication, the FDA has expressed that the safety concerns and questions raised in the PBA approvable letter necessitate the testing of a low-dose quinidine formulation in the DPN pain indication as well. Additionally, based on feedback we have received from the FDA on the proposed continued development of AVP-923 for this indication, we believe it is likely that two large well-controlled Phase III trials would be needed to support a supplemental NDA filing for this indication. Due to our limited capital resources, we do not expect that we will be able to conduct the trials needed for this indication without additional capital or a development partner for NUEDEXTA. Moreover, although we achieved positive results in our initial Phase III trial, an alternative low-dose quinidine formulation may not yield the same levels of efficacy as seen in the earlier trials or as predicted based on our subsequent pharmacokinetic study. Any decrease in efficacy may be so great that the drug does not demonstrate a statistically significant improvement over placebo or an active comparator. Additionally, any alternative low-dose quinidine formulation that we develop may not sufficiently satisfy the FDA’s safety concerns. If this were to happen, we may not be able to pursue the development of AVP-923 for other indications, including central neuropathic pain in patients with MS, behavioral disturbances related to emotional lability in patients with Alzheimer’s disease, or may need to undertake significant additional clinical trials, which would be costly and cause potentially substantial delays.
If our products infringe the intellectual property rights of others, we may incur damages and be required to incur the expense of obtaining a license.
Even if we successfully secure our intellectual property rights, third parties, including other biotechnology or pharmaceutical companies, may allege that our technology infringes on their rights. Intellectual property litigation is costly, and even if we were to prevail in such a dispute, the cost of litigation could adversely affect our business, financial condition, and results of operations. Litigation is also time consuming and could divert management’s attention and resources away from our operations and other activities. If we were to lose any litigation, in addition to any damages we would have to pay, we could be required to stop the infringing activity or obtain a license. Any required license might not be available to us on acceptable terms, or at all. Some licenses might be non-exclusive, and our competitors could have access to the same technology licensed to us. If we were to fail to obtain a required license or were unable to design around a competitor’s patent, we would be unable to sell or continue to develop some of our products, which would have a material adverse effect on our business, financial condition and results of operations.
We rely on market research to evaluate the potential commercial acceptance of NUEDEXTA.
Based on the results of our market research, we believe that physicians are likely to continue to support the use and adoption of NUEDEXTA for the treatment of PBA. We conduct market research in accordance with Good Marketing Research Practices; however, research findings may not be indicative of the response we might receive from a broader sample of physicians. Moreover, these results are based on physicians’ impressions formed from a description of the product, and not actual results from having prescribed the product, which could result in different responses from those same or other physicians.
It is unclear whether we would be eligible for patent-term restoration in the U.S. under applicable law and we therefore do not know whether our patent-term can be extended.
Some of our U.S. patents may be eligible for limited patent term extension under the Drug Price Competition and Patent Term Restoration Act of 1984, referred to as the Hatch-Waxman Amendments. Due to receipt of approval for NUEDEXTA, the Hatch-Waxman Amendments permit a patent restoration term of up to five years for one of our patents covering NUEDEXTA as compensation for the patent term lost during product development and the regulatory review process. The patent term restoration period is generally one-half the time between the effective date of an IND and the submission date of an NDA, plus the time between the submission date of an NDA and the approval of that application with a maximum of five years. In addition, the patent term restoration cannot extend the remaining term of a patent beyond a total of 14 years after the product’s approval date. Because NUEDEXTA is not a new chemical entity, but is a combination of two previously approved products, it is uncertain whether NUEDEXTA will be granted any patent term restoration under the U.S. Patent and Trademark Office guidelines.
Market exclusivity provisions under the FDCA, may also delay the submission or the approval of certain applications for competing product candidates. The FDCA provides three years of non-patent marketing exclusivity for an NDA if new clinical investigations, other than bioavailability studies, that were conducted or sponsored by the applicant are deemed by the FDA to be essential to the approval of the application. This three-year exclusivity covers only the conditions associated with the new clinical investigations and does not prohibit the FDA from approving abbreviated NDAs (ANDA) for drugs containing the original active agent.
Once the three-year FDCA exclusivity period has passed and after the patents (including the patent restoration term, if any) that cover NUEDEXTA expire or have been invalidated, generic drug companies would be able to introduce competing versions of the drug. If we are unsuccessful in defending our patents against generic competition, our long-term revenues from NUEDEXTA sales may be less than expected, we may have greater difficulty finding a development partner or licensee for NUEDEXTA and the costs to defend the patents would be significant.
We may be unable to protect our unpatented proprietary technology and information.
In addition to our patented intellectual property, we also rely on trade secrets and confidential information. We may be unable to effectively protect our rights to such proprietary technology or information. Other parties may independently develop or gain access to equivalent technologies or information and disclose it for others to use. Disputes may arise about inventorship and corresponding rights to know-how and inventions resulting from the joint creation or use of intellectual property by us and our corporate partners, licensees, scientific and academic collaborators and consultants. In addition, confidentiality agreements and material transfer agreements we have entered into with these parties and with employees and advisors may not provide effective protection of our proprietary technology or information or, in the event of unauthorized use or disclosure, may not provide adequate remedies.
If we fail to obtain regulatory approval in foreign jurisdictions, we would not be able to market our products abroad and our revenue prospects would be limited.
We are seeking to have our products or product candidates, including NUEDEXTA, marketed outside the United States. In order to market our products in the European Union and many other foreign jurisdictions, we must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and jurisdictions and can involve additional testing. The time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval processes may include all of the risks associated with obtaining FDA approval. We may not obtain foreign regulatory approvals on a timely basis, if at all, and may not qualify or be accepted for accelerated review in foreign countries. For example, our development partner in Japan encountered significant difficulty in seeking approval of docosanol in that country and was forced to abandon efforts to seek approval in that country. Approval by the FDA does not ensure approval by regulatory authorities in other countries or jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictions or by the FDA. We may not
be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market. The failure to obtain these approvals could materially adversely affect our business, financial condition and results of operations.
We face challenges recruiting and retaining members of management and other key personnel.
The industry in which we compete has a high level of employee mobility and aggressive recruiting of skilled employees. This type of environment creates intense competition for qualified personnel, particularly in commercial, clinical and regulatory affairs, research and development and accounting and finance. Because we have a relatively small management team, the loss of any executive officers, including the Chief Executive Officer, key members of senior management or other key employees, could adversely affect our operations.
Future business development activity could disrupt our business and harm our financial condition.
In order to augment our product pipeline or otherwise strengthen our business, we may decide to acquire additional businesses, products and technologies. As we have limited experience in evaluating and completing acquisitions, our ability as an organization to make such acquisitions is unproven. Acquisitions could require significant capital infusions and could involve many risks, including, but not limited to, the following:
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we may have to issue debt or equity securities to complete business development activities, which would dilute our stockholders and could adversely affect the market price of our common stock, and we may issue securities or rights with contingent payment obligations, which could have variable accounting treatment and negative accounting consequences;
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business development activity may negatively impact our results of operations because it may require us to amortize or write down amounts related to goodwill and other intangible assets, or incur or assume substantial debt or liabilities, or it may cause adverse tax or accounting consequences, substantial depreciation or deferred compensation charges;
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we may encounter difficulties in assimilating and integrating the business, products, technologies, personnel or operations of companies that we acquire;
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certain business development activities may impact our relationship with existing or potential partners who are competitive with the acquired business, products or technologies;
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business development activities may require significant capital infusions and the acquired businesses, products or technologies may not generate sufficient value to justify acquisition costs;
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business development activity may disrupt our ongoing business, divert resources, increase our expenses and distract our management;
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business development activities may involve the entry into a geographic or business market in which we have little or no prior experience; and
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key personnel of an acquired company may decide not to work for us.
If any of these risks occurred, it could adversely affect our business, financial condition and operating results. We cannot assure you that we will be able to identify or consummate any future acquisitions on acceptable terms, or at all. If we do pursue any acquisitions, it is possible that we may not realize the anticipated benefits from such acquisitions or that the market will not view such acquisitions positively.
Our operations might be interrupted by the occurrence of a natural disaster or other catastrophic event.
Our principal operations are located in Aliso Viejo, California. We depend on our facilities and on our partners, contractors and vendors for the continued operation of our business. Natural disasters or other catastrophic events, interruptions in the supply of natural resources, political and governmental changes, wildfires and other fires, floods, explosions, actions of animal rights activists, earthquakes and civil unrest could disrupt our operations or those of our partners, contractors and vendors. Even though we believe we carry commercially reasonable business interruption and liability insurance, and our contractors may carry liability insurance that protect us in certain events, we might suffer losses as a result of business interruptions that exceed the coverage available under
our and our contractors’ insurance policies or for which we or our contractors do not have coverage. Any natural disaster or catastrophic event could have a significant negative impact on our operations and financial results. However, we have a disaster recovery plan in place for our information technology infrastructure that generally allows us to have our systems operational in as little as four hours of triggering the disaster recovery plan, depending on the severity of the disaster. Moreover, any such event could impact the commercialization of NUEDEXTA and our research and development programs.
Risks Relating to Our Industry
The pharmaceutical industry is highly competitive and most of our competitors have larger operations and have greater resources. As a result, we face significant competitive hurdles.
The pharmaceutical and biotechnology industries are highly competitive and subject to significant and rapid technological change. We compete with hundreds of companies that develop and market products and technologies in areas similar to those in which we are performing our research. For example, we expect that NUEDEXTA will face competition from antidepressants, atypical anti-psychotic agents and other agents in the treatment of PBA. Additionally, NUEDEXTA is currently facing challenges from “generic” drug companies, as described above.
Our competitors may have specific expertise and development technologies that are better than ours and many of these companies, which include large pharmaceutical companies, either alone or together with their research partners, have substantially greater financial resources, larger research and development capabilities and substantially greater experience than we do. Accordingly, our competitors may successfully develop competing products. We are also competing with other companies and their products with respect to manufacturing efficiencies and marketing capabilities, areas where we have limited or no direct experience.
If we fail to comply with regulatory requirements, regulatory agencies may take action against us, which could significantly harm our business.
Marketed products, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for these products, are subject to continual requirements and review by the FDA and other regulatory bodies. In addition, regulatory authorities subject a marketed product, its manufacturer and the manufacturing facilities to ongoing review and periodic inspections. We will be subject to ongoing FDA requirements, including required submissions of safety and other post-market information and reports, registration requirements, current Good Manufacturing Practices (“cGMP”) regulations, requirements regarding the distribution of samples to physicians and recordkeeping requirements.
The cGMP regulations also include requirements relating to quality control and quality assurance, as well as the corresponding maintenance of records and documentation. We rely on the compliance by our contract manufacturers with cGMP regulations and other regulatory requirements relating to the manufacture of products. We are also subject to state laws and registration requirements covering the distribution of our products. Regulatory agencies may change existing requirements or adopt new requirements or policies. We may be slow to adapt or may not be able to adapt to these changes or new requirements.
We face uncertainty related to healthcare reform, pricing and reimbursement, which could reduce our revenue.
In the United States, President Obama signed in March 2010 the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act (collectively, “PPACA”), which is expected to substantially change the way health care is financed by both governmental and private payors. PPACA provides for changes to extend medical benefits to those who currently lack insurance coverage, encourages improvements in the quality of health care items and services, and significantly impacts the U.S. pharmaceutical industry in a number of ways, further listed below. By extending coverage to a larger population, PPACA may substantially change the structure of the health insurance system and the methodology for reimbursing medical services, drugs and devices. These structural changes, as well as other changes that may be made as part of deficit and debt reduction efforts in Congress, could entail modifications to the existing system of private payors and government programs, such as Medicare, Medicaid and State Children’s Health Insurance Program, as well as the creation of a government-sponsored healthcare insurance source, or some combination of both. Such restructuring
of the coverage of medical care in the United States could impact the extent of reimbursement for prescribed drugs, including our product candidates, biopharmaceuticals, and medical devices. Some of the specific PPACA provisions, among other things:
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Establish annual, non-deductible fees on any entity that manufactures or imports certain branded prescription drugs and biologics;
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Increase minimum Medicaid rebates owed by manufacturers under the Medicaid Drug Rebate Program;
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Extend manufacturers’ Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations;
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Establish a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research;
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Require manufacturers to participate in a coverage gap discount program, under which they must agree to offer 50 percent point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for the manufacturer’s outpatient drugs to be covered under Medicare Part D; and
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Increase the number of entities eligible for discounts under the Public Health Service pharmaceutical pricing program.
If future reimbursement for NUEDEXTA or any other approved product candidates, if any, is substantially less than we project, or rebate obligations associated with them are substantially increased, our business could be materially and adversely impacted.
Sales of NUEDEXTA for treatment of patients with PBA will depend in part on the availability of coverage and reimbursement from third-party payors such as government insurance programs, including Medicare and Medicaid, private health insurers, health maintenance organizations and other health care related organizations. Accordingly, coverage and reimbursement may be uncertain. Adoption of NUEDEXTA by the medical community may be limited if third-party payors will not offer coverage. Cost control initiatives may decrease coverage and payment levels for NUEDEXTA and, in turn, the price that we will be able to charge. We are unable to predict all changes to the coverage or reimbursement methodologies that will be applied by private or government payors to NUEDEXTA. Any denial of private or government payor coverage or inadequate reimbursement for procedures performed using NUEDEXTA could harm our business and reduce our revenue.
In addition, both the federal and state governments in the United States and foreign governments continue to propose and pass new legislation affecting coverage and reimbursement policies, which are designed to contain or reduce the cost of health care, as well as hold public hearings on these matters, which has resulted in certain private companies dropping the prices of their drugs. Further federal and state proposals and healthcare reforms are likely, which could limit the prices that can be charged for the product candidates that we develop and may further limit our commercial opportunity. There may be future changes that result in reductions in current coverage and reimbursement levels for our products, if commercialized, and we cannot predict the scope of any future changes or the impact that those changes would have on our operations.
We rely on insurance companies to mitigate our exposure for business activities, including developing and marketing pharmaceutical products for human use.
The conduct of our business, including the testing, marketing and sale of pharmaceutical products, involves the risk of liability claims by consumers, stockholders, and other third parties. Although we maintain various types of insurance, including product liability and director and officer liability, claims can be high and our insurance may not sufficiently cover our actual liabilities. If liability claims were made against us, it is possible that our insurance carriers may deny, or attempt to deny, coverage in certain instances. If a lawsuit against us is successful, then the lack or insufficiency of insurance coverage could materially and adversely affect our business and financial condition. Furthermore, various distributors of pharmaceutical products require minimum product liability insurance coverage before their purchase or acceptance of products for distribution. Failure to satisfy these insurance requirements could impede our ability to achieve broad distribution of our proposed products and the imposition of
higher insurance requirements could impose additional costs on us. Additionally, we are potentially at risk if our insurance carriers become insolvent. Although we have historically obtained coverage through highly rated and capitalized firms, the ongoing financial crisis may affect our ability to obtain coverage under existing policies or purchase insurance under new policies at reasonable rates.
If we market products in a manner that violates health care fraud and abuse laws, we may be subject to civil or criminal penalties.
We are also subject to healthcare fraud and abuse regulation and enforcement by both the federal government and the states in which we conduct our business. The laws that may affect our ability to operate include:
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the federal healthcare programs’ Anti-Kickback Law, which prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs;
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federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent;
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the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters; and
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state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers.
If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from governmental health care programs, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Further, the recently enacted PPACA, among other things, amends the intent requirement of the federal anti-kickback and criminal health care fraud statutes. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim including items or services resulting from a violation of the federal anti-kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes. Moreover, some states, such as California, Massachusetts and Vermont, mandate implementation of commercial compliance programs to ensure compliance with these laws. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.
In addition, there has been a recent trend of increased federal and state regulation of payments made to physicians for marketing, including the tracking and reporting of gifts, compensation, and other remuneration to physicians. The shifting commercial compliance environment and the need to build and maintain robust and expandable systems to comply with multiple jurisdictions with different compliance and/or reporting requirements increases the possibility that a healthcare company may run afoul of one or more of the requirements.
The PPACA also imposes new reporting and disclosure requirements on drug manufacturers for any “transfer of value” made or distributed to prescribers and other healthcare providers, effective March 31, 2013. Such information will be made publicly available in a searchable format beginning September 30, 2013. In addition, drug manufacturers will also be required to report and disclose any investment interests held by physicians and their immediate family members during the preceding calendar year. Failure to submit required information may result in civil monetary penalties of up to an aggregate of $150,000 per year (and up to an aggregate of $1 million per year for “knowing failures”), for all payments, transfers of value or ownership or investment interests not reported in an
annual submission. Finally, under PPACA, effective April 1, 2012, pharmaceutical manufacturers and distributors must provide the U.S. Department of Health and Human Services with an annual report on the drug samples they provide to physicians.
We may incur significant liability if it is determined that we are promoting the “off-label” use of drugs.
Companies may not promote drugs for “off-label” uses - that is, uses that are not described in the product’s labeling and that differ from those approved by the FDA, Therapeutic Products Directorate, or TPD, or other applicable regulatory agencies. Physicians may prescribe drug products for off-label uses, and such off-label uses are common across medical specialties. Although the FDA, TPD and other regulatory agencies do not regulate a physician’s choice of treatments, the FDA, TPD and other regulatory agencies do restrict communications by pharmaceutical companies or their sales representatives on the subject of off-label use. The FDA, TPD and other regulatory agencies actively enforce regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance has not been obtained. A company that is found to have improperly promoted off-label uses may be subject to significant liability, including civil and administrative remedies as well as criminal sanctions. Notwithstanding the regulatory restrictions on off-label promotion, the FDA, TPD and other regulatory authorities allow companies to engage in truthful, non-misleading, and non-promotional speech concerning their products. The Company has taken numerous steps to ensure compliance is a high priority throughout the organization and we believe that all of our communications regarding all of our products are in compliance with the relevant regulatory requirements, however, the FDA, TPD or another regulatory authority may disagree, and we may be subject to significant liability, including civil and administrative remedies, as well as criminal sanctions. In addition, management’s attention could be diverted from our business operations and our reputation could be damaged. Our distribution partners may also be the subject of regulatory investigations involving, or remedies or sanctions for, off-label uses of products we have licensed to them, which may have an adverse impact on sales of such licensed products, which may, in turn, have a material adverse effect on our business, financial condition and results of operations and could cause the market value of our common shares to decline.
There are a number of difficulties and risks associated with clinical trials and our trials may not yield the expected results.
There are a number of difficulties and risks associated with conducting clinical trials. For instance, we may discover that a product candidate does not exhibit the expected therapeutic results, may cause harmful side effects or have other unexpected characteristics that may delay or preclude regulatory approval or limit commercial use if approved. It typically takes several years to complete a late-stage clinical trial and a clinical trial can fail at any stage of testing. If clinical trial difficulties or failures arise, our product candidates may never be approved for sale or become commercially viable.
In addition, the possibility exists that:
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the results from earlier clinical trials may not be predictive of results that will be obtained from subsequent clinical trials, particularly larger trials;
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institutional review boards or regulators, including the FDA, may hold, suspend or terminate our clinical research or the clinical trials of our product candidates for various reasons, including noncompliance with regulatory requirements or if, in their opinion, the participating subjects are being exposed to unacceptable health risks;
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subjects may drop out of our clinical trials;
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our preclinical studies or clinical trials may produce negative, inconsistent or inconclusive results, and we may decide, or regulators may require us, to conduct additional preclinical studies or clinical trials;
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trial results derived from top-line data, which is based on a preliminary analysis of efficacy and safety data related to primary and secondary endpoints, may change following a more comprehensive review of the complete data set derived from a particular clinical trial or may change due to FDA requests to analyze the data differently; and
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the cost of our clinical trials may be greater than we currently anticipate.
It is possible that earlier clinical and pre-clinical trial results may not be predictive of the results of subsequent clinical trials. If earlier clinical and/or pre-clinical trial results cannot be replicated or are inconsistent with subsequent results, our development programs may be cancelled or deferred. In addition, the results of these prior clinical trials may not be acceptable to the FDA or similar foreign regulatory authorities because the data may be incomplete, outdated or not otherwise acceptable for inclusion in our submissions for regulatory approval.
Additionally, the FDA has substantial discretion in the approval process and may reject our data or disagree with our interpretations of regulations or draw different conclusions from our clinical trial data or ask for additional information at any time during their review.
Although we would work to be able to fully address any such FDA concerns, we may not be able to resolve all such matters favorably, if at all. Disputes that are not resolved favorably could result in one or more of the following:
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delays in our ability to submit an NDA;
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the refusal by the FDA to accept for filing any NDA we may submit;
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requests for additional studies or data;
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delays in obtaining an approval;
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the rejection of an application; or
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the approval of the drug, but with adverse labeling claims that could adversely affect the commercial market.
If we do not receive regulatory approval to sell our product candidates or cannot successfully commercialize our product candidates, we would not be able to generate meaningful levels of sustainable revenues.
Risks Related to Reliance on Third Parties
We depend on third parties to manufacture, package and distribute compounds for our drugs and drug candidates. The failure of these third parties to perform successfully could harm our business.
We have utilized, and intend to continue utilizing, third parties to manufacture, package and distribute NUEDEXTA and the API for docosanol 10% cream and to provide clinical supplies of our drug candidates. We have no experience in manufacturing and do not have any manufacturing facilities. Currently, we have sole suppliers for the API for docosanol and NUEDEXTA, and a sole manufacturer for the finished form of NUEDEXTA. In addition, these materials are custom and available from only a limited number of sources. In particular, there may be a limited supply source for APIs in NUEDEXTA. Although we maintain a significant supply of APIs on hand, any sustained disruption in this supply could adversely affect our operations and revenues. Any material disruption in manufacturing could cause a delay in shipments and possible loss of sales. We do not have any long-term agreements in place with our current docosanol supplier or NUEDEXTA API suppliers. If we are required to change manufacturers, we may experience delays associated with finding an alternate manufacturer that is properly qualified to produce supplies of our products and product candidates in accordance with FDA requirements and our specifications. Any delays or difficulties in obtaining APIs or in manufacturing, packaging or distributing NUEDEXTA could negatively affect our sales revenues, as well as delay our clinical trials of this product candidate for DPN pain, MS-related pain or other potential indications. The third parties we rely on for manufacturing and packaging are also subject to regulatory review, and any regulatory compliance problems with these third parties could significantly delay or disrupt our commercialization activities. Additionally, the ongoing economic crisis creates risk for us if any of these third parties suffer liquidity or operational problems. If a key third party vendor becomes insolvent or is forced to lay off workers assisting with our projects, our results and development timing could suffer.
Because we depend on clinical research centers and other contractors for clinical testing and for certain research and development activities, the results of our clinical trials and such research activities are, to a certain extent, beyond our control.
The nature of clinical trials and our business strategy of outsourcing a substantial portion of our research require that we rely on clinical research centers and other contractors to assist us with research and development,
clinical testing activities, patient enrollment and regulatory submissions to the FDA. As a result, our success depends partially on the success of these third parties in performing their responsibilities. Although we pre-qualify our contractors and we believe that they are fully capable of performing their contractual obligations, we cannot directly control the adequacy and timeliness of the resources and expertise that they apply to these activities. Additionally, the current global economic slowdown may affect our development partners and vendors, which could adversely affect their ability to timely perform their tasks. If our contractors do not perform their obligations in an adequate and timely manner, the pace of clinical development, regulatory approval and commercialization of our drug candidates could be significantly delayed and our prospects could be adversely affected.
We generally do not control the development of compounds licensed to third parties and, as a result, we may not realize a significant portion of the potential value of any such license arrangements.
Under our typical license arrangement we have no direct control over the development of drug candidates and have only limited, if any, input on the direction of development efforts. These development efforts are made by our licensing partner, and if the results of their development efforts are negative or inconclusive, it is possible that our licensing partner could elect to defer or abandon further development of these programs. We similarly rely on licensing partners to obtain regulatory approval for docosanol in foreign jurisdictions. Because much of the potential value of these license arrangements is contingent upon the successful development and commercialization of the licensed technology, the ultimate value of these licenses will depend on the efforts of licensing partners. If our licensing partners do not succeed in developing the licensed technology for whatever reason, or elect to discontinue the development of these programs, we may be unable to realize the potential value of these arrangements. If we were to license NUEDEXTA to a third party or a development partner, it is likely that much of the long-term success of that drug will similarly depend on the efforts of the licensee.
We expect to rely entirely on third parties for international registration, sales and marketing efforts.
In the event that we attempt to enter into international markets, in some instances we expect to rely on collaborative partners to obtain regulatory approvals and to market and sell our product(s) in those markets. We have not yet entered into any collaborative arrangement with respect to marketing or selling NUEDEXTA, with the exception of one such agreement relating to Israel. We may be unable to enter into any other arrangements on terms favorable to us, or at all, and even if we are able to enter into sales and marketing arrangements with collaborative partners, we cannot assure you that their sales and marketing efforts will be successful. If we are unable to enter into favorable collaborative arrangements with respect to marketing or selling NUEDEXTA in international markets, or if our collaborators’ efforts are unsuccessful, our ability to generate revenues from international product sales will suffer.
Risks Relating to Our Stock
Our stock price has historically been volatile and we expect that this volatility will continue for the foreseeable future.
The market price of our common stock has been, and is likely to continue to be, highly volatile. This volatility can be attributed to many factors independent of our operating results, including the following:
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comments made by securities analysts, including changes in their recommendations;
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short selling activity by certain investors, including any failures to timely settle short sale transactions;
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announcements by us of financing transactions and/or future sales of equity or debt securities;
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sales of our common stock by our directors, officers or significant stockholders, including sales effected pursuant to predetermined trading plans adopted under the safe-harbor afforded by Rule 10b5-1;
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regulatory developments in the U.S. and foreign countries, including the passage of laws, rules or regulations relating to healthcare and reimbursement or the public announcement of inquiries relating to these subjects;
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lack of volume of stock trading leading to low liquidity; and
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market and economic conditions.
If a substantial number of shares are sold into the market at any given time, particularly following any significant announcements or large swings in our stock price (whether sales are under our existing “shelf” registration statements, from an existing stockholder, or the result of warrant or stock options exercised), there may not be sufficient demand in the market to purchase the shares without a decline in the market price for our common stock. Moreover, continuous sales into the market of a number of shares in excess of the typical trading volume for our common stock, or even the availability of such a large number of shares, could depress the trading market for our common stock over an extended period of time.
Additionally, our stock price has been volatile as a result of announcements of regulatory actions and decisions relating to NUEDEXTA, and periodic variations in our operating results. We expect that our operating results will continue to vary from quarter to quarter, particularly as we continue to market NUEDEXTA and report initial sales results. Our operating results and prospects may also vary depending on the status of our partnering arrangements.
As a result of these factors, we expect that our stock price may continue to be volatile and investors may be unable to sell their shares at a price equal to, or above, the price paid. Additionally, any significant drops in our stock price could give rise to stockholder lawsuits, which are costly and time consuming to defend against and which may adversely affect our ability to raise capital while the suits are pending, even if the suits are ultimately resolved in favor of the Company. We have, from time to time, been a party to such suits and although none have been material to date, there can be no assurance that any such suit will not have an adverse effect on the Company.
If our internal controls over financial reporting are not considered effective, our business and stock price could be adversely affected.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal controls over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal controls over financial reporting in our annual report on Form 10-K for that fiscal year. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management’s assessment of our internal controls over financial reporting, and we again became subject to these requirements starting with the year ended September 30, 2010.
Our management, including our chief executive officer and principal financial officer, does not expect that our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud involving a company have been, or will be, detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become ineffective because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal controls in the future. A material weakness in our internal controls over financial reporting would require management and our independent registered public accounting firm to consider our internal controls as ineffective. If our internal controls over financial reporting are not considered effective, we may experience a loss of public confidence, which could have an adverse effect on our business and on the market price of our common stock.
Because we do not expect to pay dividends in the foreseeable future, you must rely on stock appreciation for any return on your investment.
We have paid no cash dividends on our common stock to date, and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future, and payment of cash dividends, if any, will also depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of
directors. Furthermore, we may in the future become subject to contractual restrictions on, or prohibitions against, the payment of dividends. Accordingly, the success of your investment in our common stock will likely depend entirely upon any future appreciation. There is no guarantee that our common stock will appreciate in value or even maintain the price at which you purchased your shares, and you may not realize a return on your investment in our common stock.
Our corporate governance documents, rights agreement and Delaware law may delay or prevent an acquisition of us that stockholders may consider favorable, which could decrease the value of our common stock.
Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions include restrictions on the ability of our stockholders to remove directors and supermajority voting requirements for stockholders to amend our organizational documents and a classified board of directors. In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Delaware law, for instance, also imposes some restrictions on mergers and other business combinations between any holder of 15% or more of our outstanding common stock and us. Although we believe these provisions protect our stockholders from coercive or otherwise unfair takeover tactics and thereby provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders. We have also adopted a stockholder rights agreement intended to deter hostile or coercive attempts to acquire us. Under the agreement, if a person becomes an “acquiring person,” each holder of a right (other than the acquiring person) will be entitled to purchase, at the then-current exercise price, such number of shares of our preferred stock which are equivalent to shares of common stock having twice the exercise price of the right. If we are acquired in a merger or other business combination transaction after any such event, each holder of a right will then be entitled to purchase, at the then-current exercise price, shares of the acquiring company’s common stock having a value of twice the exercise price of the right. Our stockholder rights agreement could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, us or a large block of our common stock without the support of our board of directors. Therefore, the agreement makes an acquisition much more costly to a potential acquirer.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our headquarters and commercial and administrative offices are located in Aliso Viejo, California, where we currently occupy approximately 30,000 square feet. The Aliso Viejo office lease expires in November 2016.
We lease approximately 30,370 square feet in two buildings in San Diego. The terms of the leases for the San Diego facilities end in January 2013. The San Diego buildings are sublet through January 2013.
Item 3.
Item 3. Legal Proceedings
NUEDEXTA ANDA Litigation
In June and July 2011, we received Paragraph IV certification notices from four separate companies contending that certain of our patents listed in the FDA Orange Book (U.S. Patents 7,659,282 (“’282 Patent”) and RE 38,115 (“’115 Patent”), which expire in August 2026 and January 2016, respectively) are invalid, unenforceable and/or will not be infringed by the manufacture, use, sale or offer for sale of a generic form of NUEDEXTA as described in those companies’ ANDAs. In August 2011, we filed lawsuits in the U.S District Court for the District of Delaware against Par Pharmaceutical, Inc. and Par Pharmaceutical Companies, Inc. (collectively “Par”), Actavis South Atlantic LLC and Actavis, Inc. (collectively “Actavis”), Wockhardt USA, LLC and Wockhardt, Ltd. (collectively, “Wockhardt”), and Impax Laboratories, Inc. (“Impax”) (Par, Actavis, Wockhardt and Impax, collectively the “Defendants”). All four lawsuits (collectively, the “ANDA Actions”) were filed on the basis that the
Defendants’ submissions of their respective ANDAs to obtain approval to manufacture, use, sell, or offer for sale generic versions of NUEDEXTA prior to the expiration of the ‘282 Patent and the ‘115 Patent listed in the FDA Orange Book constitute infringement of one or more claims of those patents.
Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of the ANDAs submitted by the Defendants can occur no earlier than October 29, 2013. Further, as a result of the 30-month stay associated with the filing of the ANDA Actions, the FDA cannot grant final approval to any ANDA before December 30, 2013, unless there is an earlier court decision holding that the ‘282 and ‘115 patents are not infringed and/or are invalid. We intend to vigorously enforce our intellectual property rights relating to NUEDEXTA, but we cannot predict the outcome of these matters.
Alamo and Azur Litigation
In October 2011, Neal R. Cutler, M.D., the founder of Alamo Pharmaceuticals, LLC (“Alamo”), filed a lawsuit in California Superior Court against AzurPharma International III Limited and AzurPharma Limited (collectively, “Azur”) and Avanir (the “Cutler Action”). We purchased Alamo in 2006 to acquire rights to FazaClo, an approved anti-psychotic drug. In connection with this acquisition of Alamo, we agreed to provide the Alamo equity holders, including Dr. Cutler, with milestone payments tied to the aggregate net revenues of FazaClo. In 2007, we sold FazaClo and its related assets and operations to Azur. In connection with this sale, Azur agreed to assume the milestone payment obligations due to Dr. Cutler under the Alamo purchase agreement, although we may remain liable for these payments if Azur defaults on these obligations. In the Cutler Action, Dr. Cutler alleges that Azur has failed to make certain sales information available to Dr. Cutler and has withheld payments to which Dr. Cutler is entitled. Dr. Cutler alleges that Avanir has acquiesced in this conduct, and Dr. Cutler seeks to hold both Azur and Avanir liable for these actions. We maintain that we have not acquiesced. Dr. Cutler is seeking damages in an amount that may exceed $35 million, as well as attorneys’ fees. As of September 30, 2011, we believe there is a low likelihood of an outcome adverse to us, and as such, we have not recorded any liability related to any potential legal settlement that may be assessed against us. However, we will continue to evaluate the need for any such liability in the future.
In the ordinary course of business, we may face various claims brought by third parties and we may, from time to time, make claims or take legal actions to assert our rights, including intellectual property rights as well as claims relating to employment matters and the safety or efficacy of our products. Any of these claims could subject us to costly litigation and, while we generally believe that we have adequate insurance to cover many different types of liabilities, our insurance carriers may deny coverage, may be inadequately capitalized to pay on valid claims, or our policy limits may be inadequate to fully satisfy any damage awards or settlements. If this were to happen, the payment of any such awards could have a material adverse effect on our consolidated operations, cash flows and financial position. Additionally, any such claims, whether or not successful, could damage our reputation and business. Management believes the outcome of currently pending claims or lawsuits will not likely have a material effect on our operations or financial position.
Item 4.
Item 4. Removed and Reserved
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The following table sets forth the high and low prices for our common stock in each of the quarters over the past two fiscal years, as quoted on the NASDAQ Global Market.
On December 1, 2011, the closing sales price of our common stock was $2.33 per share.
As of December 5, 2011, we had approximately 27,738 stockholders, including 373 holders of record and an estimated 27,365 beneficial owners. We have not paid any dividends on our common stock since our inception and do not expect to pay dividends on our common stock in the foreseeable future.
The following graph compares the cumulative 5-year return provided stockholders on Avanir Pharmaceuticals, Inc.’s common stock relative to the cumulative total returns of the NASDAQ Composite index and the NASDAQ Biotechnology index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each of the indexes on October 1, 2006 and its relative performance is tracked through September 30, 2011.
Information About Our Equity Compensation Plans
Information regarding our equity compensation plans is incorporated by reference to Item 12 of Part III of this annual report on Form 10-K.
Item 6.
Item 6. Selected Financial Data
The selected consolidated financial data set forth below at September 30, 2011 and 2010, and for the fiscal years ended September 30, 2011, 2010, and 2009, are derived from our audited consolidated financial statements included elsewhere in this report. This information should be read in conjunction with those consolidated financial statements, the notes thereto, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data set forth below at September 30, 2009, 2008 and 2007, and for the years ended September 30, 2008 and 2007, are derived from our audited consolidated financial statements that are contained in reports previously filed with the SEC, not included herein. The quarterly consolidated financial data are derived from unaudited consolidated financial statements included in our Quarterly Reports on Form 10-Q.
The following tables include selected consolidated financial data for each of our last five fiscal years and quarterly data for the last two fiscal years and include adjustments to reflect the classification of our FazaClo Business as discontinued operations.
Summary Financial Information
(1) In accordance with Staff Accounting Bulletin 108, in the fourth quarter of fiscal 2010, the Company recorded a cumulative non-cash adjustment to correct an immaterial error related to previously recorded deferred royalty revenue related to the GSK license agreement. The total cumulative non-cash adjustment recorded in the fourth quarter was a decrease in revenue of $797,000 which resulted in net revenues of ($71,000) in the fourth fiscal quarter of 2010 and $2.9 million for fiscal 2010.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report on Form 10-K contains forward-looking statements concerning future events and performance of our Company. When used in this report, the words “intend,” “estimate,” “anticipate,” “believe,” “plan,” “goal” and “expect” and similar expressions as they relate to Avanir Pharmaceuticals, Inc. are included to identify forward-looking statements. These forward-looking statements are based on our current expectations and assumptions and many factors could cause our actual results to differ materially from those indicated in these forward-looking statements. Risks that could cause actual results to differ significantly from our forward-looking statements include, but are not limited to, risks relating to our product sales, capital resources, commercial market estimates, safety of NUEDEXTA, future development efforts, patent protection, effects of healthcare reform, reliance on third parties, and other risks set forth below under Item 1A, “Risk Factors.” We disclaim any intent to update or announce revisions to any forward-looking statements to reflect actual events or developments. Except as otherwise indicated herein, all dates referred to in this report represent periods or dates fixed with reference to the calendar year, rather than our fiscal year ending September 30.
Executive Overview
We are a pharmaceutical company focused on acquiring, developing and commercializing novel therapeutic products for the treatment of central nervous system disorders. In October 2010, the U.S. Food and Drug Administration (“FDA”) approved NUEDEXTA (referred to as AVP-923 during clinical development), a unique proprietary combination of dextromethorphan and low-dose quinidine, for the treatment of pseudobulbar affect (“PBA”). We commenced promotion of NUEDEXTA in the United States in February 2011 and are currently pursuing approval of NUEDEXTA in Europe.
We are also studying AVP-923 for use in different types of neuropathic pain. We have filed an Investigational New Drug application (“IND”) with the FDA and have initiated a large Phase II clinical trial of AVP-923 for the treatment of central neuropathic pain in patients with multiple sclerosis.
AVP-923 has also successfully completed a Phase III trial for the treatment of patients with diabetic peripheral neuropathic pain (“DPN pain”). Additional phase III trials with a modified formulation would need to be completed for approval of this indication.
In addition to our focus on products for the central nervous system, we also have a number of partnered programs in other therapeutic areas which may generate future revenue for us. Our first commercialized product, docosanol 10% cream, (sold in the United States and Canada as Abreva® by our marketing partner GlaxoSmithKline Consumer Healthcare) is the only over-the-counter treatment for cold sores that has been approved by the FDA. In 2008, we out-licensed all of our monoclonal antibodies and we remain eligible to receive milestone payments and royalties related to the sale of these assets. Avanir was incorporated in California in August 1988 and was reincorporated in Delaware in March 2009.
The following is a summary of significant accomplishments in fiscal 2011 and subsequent to the end of fiscal 2011 through the date of this filing that have materially affected our operations, financial condition and prospects:
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On October 29, 2010, we announced that the FDA approved NUEDEXTA as the first treatment for PBA.
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On November 22, 2010, we completed an underwritten public offering of 20,000,000 shares of our common stock. Gross offering proceeds resulting from the offering were approximately $88,000,000, before deducting underwriting discounts, commissions and offering expenses.
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On January 31, 2011, we announced that NUEDEXTA was available by prescription in the United States and we commenced promotion of NUEDEXTA in February 2011.
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On April 4, 2011, we filed an Investigational New Drug application with the FDA to begin a large Phase II clinical trial of AVP-923, an investigational drug for the treatment of central neuropathic pain in patients with multiple sclerosis.
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On May 4, 2011, we announced the PRISM registry, the first patient registry to further quantify the prevalence and quality of life impact of PBA in patients with a variety of underlying neurologic conditions.
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In November 2011, we enrolled the first patient in our Phase II clinical trial of AVP-923, an investigational drug for the treatment of central neuropathic pain in patients with multiple sclerosis.
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In November 2011, the European Medicines Agency (“EMA”) accepted the filing of the Marketing Authorization Application (MAA) for NUEDEXTA for the treatment of PBA. The MAA acceptance triggers the initiation of the EMA’s scientific assessment and opinion review period which will take a minimum of 210 calendar days.
Our principal focus is on the commercialization of NUEDEXTA for the PBA indication. We believe that cash and cash equivalents and restricted investments of approximately $81.8 million at September 30, 2011, together with funds generated from sales of NUEDEXTA, will be sufficient to fund our operations, for at least the next 15 months. In addition, we received approximately $7.8 million from the exercise of approximately 5.4 million warrants in December 2011. For additional information about the risks and uncertainties that may affect our business and prospects, please see Item 1A, “Risk Factors.”
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make a number of assumptions and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates and assumptions are required in the determination of revenue recognition in certain royalties. Significant estimates and assumptions are also required in the appropriateness of
amounts recognized for inventories, income taxes, contingencies and stock-based compensation. We base our estimates on historical experience and various other assumptions that are available at that time and that we believe to be reasonable under the circumstances. Some of these judgments can be subjective and complex. For any given individual estimate or assumption made by us, there may also be other estimates or assumptions that are reasonable. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.
Revenue Recognition
We have historically generated revenues from product sales, collaborative research and development arrangements, and other commercial arrangements such as royalties, the sale of royalty rights and sales of technology rights. Payments received under such arrangements may include non-refundable fees at the inception of the arrangements, milestone payments for specific achievements designated in the agreements, royalties on sales of products resulting from collaborative arrangements, and payments for the sale of rights to future royalties.
We recognize revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) our price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. Certain product sales are subject to rights of return. For products sold where the buyer has the right to return the product, we recognize revenue at the time of sale only if (1) our price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid us, or the buyer is obligated to pay us and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to us would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by us, (5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated. We recognize such product revenues on the earlier of when we have met all the above criteria, including the ability to reasonably estimate future returns, when we can reasonably estimate that the return privilege has substantially expired, or when the return privilege has substantially expired.
Product Sales - NUEDEXTA. NUEDEXTA is sold primarily to third-party wholesalers that, in turn, sell this product to retail pharmacies, hospitals, and other dispensing organizations. We have entered into agreements with wholesale customers, certain medical institutions and third-party payors throughout the United States. These agreements frequently contain commercial terms, which may include favorable product pricing and discounts and rebates payable upon dispensing the product to patients. Additionally, these agreements customarily provide the customer with rights to return the product, subject to the terms of each contract. Consistent with pharmaceutical industry practice, wholesale customers can return purchased product during an 18-month period that begins six months prior to the product’s expiration date and ends 12 months after the expiration date.
At the present time, we are unable to reasonably estimate future returns due to the lack of sufficient historical returns data for NUEDEXTA. Accordingly, we invoice the wholesaler, record deferred revenue at gross invoice sales price less estimated cash discounts and distribution fees, and classify the inventory shipped as inventories subject to return. We currently defer recognition of revenue and the related cost of product sales on shipments of NUEDEXTA until the right of return no longer exists, i.e. when we receive evidence that the products have been dispensed to patients. We estimate patient prescriptions dispensed using an analysis of third-party information. In the future, we plan to recognize product sales upon shipment to the customer when we believe we have sufficient data to develop reasonable estimates of expected returns based upon historical returns.
Our net product sales represent gross product sales less allowances for customer credits, including estimated discounts, rebates, chargebacks and co-pay assistance. These allowances provided by us to a customer are presumed to be a reduction of the selling prices of our products or services and, therefore, are characterized as a reduction of revenue when recognized in our statement of operations. Allowances for discounts, rebates, chargebacks and co-pay assistance are estimated based on contractual terms with customers and sell-through data purchased from third parties. Product shipping and handling costs are included in cost of product sales.
Product Sales - Active Pharmaceutical Ingredient docosanol (“docosanol”). Revenue from sales of docosanol is recorded when title and risk of loss have passed to the buyer provided that the criteria for revenue recognition are met. We sell docosanol to various licensees upon receipt of a written order for the materials. Shipments generally occur fewer than three times a year. Our contracts for sales of docosanol include buyer acceptance provisions that give buyers the right of replacement if the delivered product does not meet specified criteria. That right requires that they give us notice within 30 days after receipt of the product. We have the option to refund or replace any such defective materials; however, we have historically demonstrated that the materials shipped from the same pre-inspected lot have consistently met the specified criteria and no buyer has rejected any of our shipments from the same pre-inspected lot to date. Therefore, we recognize revenue at the time of delivery without providing any returns reserve.
Multiple Element Arrangements. We have, in the past, entered into arrangements whereby we deliver to the customer multiple elements including technology and/or services. Such arrangements have included some combination of the following: antibody generation services; licensed rights to technology, patented products, compounds, data and other intellectual property; and research and development services. At the inception of the arrangement, we analyze the multiple element arrangements to determine whether the elements can be separated. If a product or service is not separable, the combined deliverables will be accounted for as a single unit of accounting.
A delivered element can be separated from other elements when it meets both of the following criteria: (1) the delivered item has value to the customer on a standalone basis; and (2) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in our control. If an element can be separated, we allocate amounts based upon the selling price of each element. We determine the selling price of a separate deliverable using the price we charge other customers when we sell that product or service separately; however, if we do not sell the product or service separately, we use third-party evidence of selling price of a similar product or service to a similar situated customer. We consider licensed rights or technology to have standalone value to our customers if we or others have sold such rights or technology separately or our customers can sell such rights or technology separately without the need for our continuing involvement. We have not entered into any multiple element arrangements during fiscal 2011, 2010 or 2009, that require us to estimate selling prices.
License Arrangements. License arrangements may consist of non-refundable upfront license fees, data transfer fees, research reimbursement payments, exclusive licensed rights to patented or patent pending compounds, technology access fees, and various performance or sales milestones. These arrangements are often multiple element arrangements.
Non-refundable, up-front fees that are not contingent on any future performance by us, and require no consequential continuing involvement on our part, are recognized as revenue when the license term commences and the licensed data, technology and/or compound is delivered. Such deliverables may include physical quantities of compounds, design of the compounds and structure-activity relationships, the conceptual framework and mechanism of action, and rights to the patents or patents pending for such compounds. We defer recognition of non-refundable upfront fees if we have continuing performance obligations without which the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee that is separate and independent of our performance under the other elements of the arrangement. In addition, if we have required continuing involvement through research and development services that are related to our proprietary know-how and expertise of the delivered technology, or can only be performed by us, then such up-front fees are deferred and recognized over the period of continuing involvement.
Payments related to substantive, performance-based milestones in a research and development arrangement are recognized as revenues upon the achievement of the milestones as specified in the underlying agreements when they represent the culmination of the earnings process.
Royalty Arrangements. We recognize royalty revenues from licensed products when earned in accordance with the terms of the license agreements. Net sales amounts generally required to be used for calculating royalties include deductions for returned product, pricing allowances, cash discounts, freight and warehousing. These arrangements are often multiple element arrangements.
Certain royalty arrangements require that royalties are earned only if a sales threshold is exceeded. Under these types of arrangements, the threshold is typically based on annual sales. For royalty revenue generated from the license agreement with GlaxoSmithKline (“GSK”), we recognize royalty revenue in the period in which the threshold is exceeded.
When we sell our rights to future royalties under license agreements and also maintain continuing involvement in earning such royalties, we defer recognition of any upfront payments and recognize them as revenues over the life of the license agreement. We recognize revenues for the sale of an undivided interest of our Abreva® license agreement to Drug Royalty USA under the “units-of-revenue method.” Under this method, the amount of deferred revenues to be recognized in each period is calculated by multiplying the ratio of the royalty payments due to Drug Royalty USA by GSK for the period to the total remaining royalties the Company expects GSK will pay Drug Royalty USA over the remaining term of the agreement by the unamortized deferred revenues.
Cost of Product Sales
Cost of revenues includes third-party royalties, costs to provide research and development services, and direct and indirect costs to manufacture product sold, including packaging, storage, shipping and handling costs and the write-off of obsolete inventory.
Share-Based Compensation
We grant options, restricted stock units and restricted stock awards to purchase our common stock to our employees, directors and consultants under our stock option plans. The benefits provided under these plans are share-based payments that we account for using the fair value method.
The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option pricing model (“Black-Scholes model”) that uses assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Expected volatilities are based on historical volatility of our common stock and other factors. The expected terms of options granted are based on analyses of historical employee termination rates and option exercises. The risk-free interest rates are based on the U.S. Treasury yield in effect at the time of the grant. Since we do not expect to pay dividends on our common stock in the foreseeable future, we estimated the dividend yield to be 0%.
If factors change and we employ different assumptions in calculating the fair value in future periods, the compensation expense that we record may differ significantly from what we have recorded in the current period. There is a high degree of subjectivity involved when using option pricing models to estimate share-based compensation. Because changes in the subjective input assumptions can materially affect our estimates of fair values of our share-based compensation, in our opinion, existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements.
Alternatively, values may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. There is no current market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of employee share-based awards is determined using an option-pricing model, the value derived from that model may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
The application of the fair value method of accounting for share-based compensation may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a
possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimate of share-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.
Theoretical valuation models and market-based methods are evolving and may result in lower or higher fair value estimates for share-based compensation. The timing, readiness, adoption, general acceptance, reliability and testing of these methods is uncertain. Sophisticated mathematical models may require voluminous historical information, modeling expertise, financial analyses, correlation analyses, integrated software and databases, consulting fees, customization and testing for adequacy of internal controls. Market-based methods are emerging that, if employed by us, may dilute our earnings per share and involve significant transaction fees and ongoing administrative expenses. The uncertainties and costs of these extensive valuation efforts may outweigh the benefits to investors.
Share-based compensation expense recognized during a period is based on the value of the portion of share-based payment awards that is ultimately expected to vest amortized using the straight-line attribution method. As share-based compensation expense recognized in the consolidated statements of operations for fiscal 2011, 2010, and 2009 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The fair value method requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We estimate forfeitures based on our historical experience. Changes to the estimated forfeiture rate are accounted for as a cumulative effect of change in the period the change occurred. During fiscal 2011, we reduced our estimated forfeitures from 12.6% to 7.0% resulting in an increase in share-based compensation expense of approximately $40,000. During fiscal 2010, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 12.6% to zero percent, as we expect all the awards to vest. This change in the estimated forfeiture rates resulted in an increase in share-based compensation expense of approximately $93,000 with no effect on loss per share for fiscal 2010. In the fourth quarter of fiscal 2009, we reviewed our estimated forfeiture rate considering then recent actual data resulting in a reduction to our estimated forfeiture rate from 30.0% to 12.6% in fiscal 2009. Additionally, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 30.0% to zero percent, as we expected all the awards to vest. These changes in the estimated forfeiture rates during fiscal 2009 resulted in an increase in share-based compensation expense of $935,000 and an increase to the diluted loss per share of $0.01 for fiscal 2009.
Recognition of Expenses in Outsourced Contracts
Pursuant to our assessment of the services that have been performed on clinical trials and other contracts, we recognize expense as the services are provided. Our assessments include, but are not limited to: (1) an evaluation by the project manager of the work that has been completed during the period, (2) measurement of progress prepared internally and/or provided by the third-party service provider, (3) analyses of data that justify the progress, and (4) management’s judgment. Several of our contracts extend across multiple reporting periods, including our largest contract, representing an $11.9 million Phase II clinical trial contract that was entered into during fiscal 2011.
Research and Development Expenses
Research and development expenses consist of expenses incurred in performing research and development activities including salaries and benefits, facilities and other overhead expenses, clinical trials, contract services and other outside expenses. Research and development expenses are charged to operations as they are incurred. Up-front payments to collaborators made in exchange for the avoidance of potential future milestone and royalty payments on licensed technology are also charged to research and development expense when the drug is still in the development stage, has not been approved by the FDA for commercialization and concurrently has no alternative uses.
We assess our obligations to make milestone payments that may become due under licensed or acquired technology to determine whether the payments should be expensed or capitalized. We charge milestone payments to research and development expense when:
•
The technology is in the early stage of development and has no alternative uses;
•
There is substantial uncertainty regarding the future success of the technology or product;
•
There will be difficulty in completing the remaining development; and
•
There is substantial cost to complete the work.
Acquired contractual rights. Payments to acquire contractual rights to a licensed technology or drug candidate are expensed as incurred when there is uncertainty in receiving future economic benefits from the acquired contractual rights. We consider the future economic benefits from the acquired contractual rights to a drug candidate to be uncertain until such drug candidate is approved by the FDA or when other significant risk factors are abated.
Effects of Inflation
We believe the impact of inflation and changing prices on net revenues and on operations has been minimal during the past three years.
Results of Operations
We operate our business on the basis of a single reportable segment, which is the business of development, acquisition and commercialization of novel therapeutics for chronic diseases. Our chief operating decision-maker is the Chief Executive Officer, who evaluates our company as a single operating segment.
We categorize revenues by type of revenue in five different categories: 1) product sales, 2) royalties and royalty rights, 3) licensing, 4) government research grant services and 5) research and development services.
All long-lived assets for fiscal 2011 and 2010 are located in the United States.
Comparison of Fiscal 2011 and 2010
Revenues
Total net revenues were $10.5 million for the fiscal year ended September 30, 2011 compared to $2.9 million for the fiscal year ended September 30, 2010. The increase in net revenues of approximately $7.6 million was primarily attributed to NUEDEXTA product sales of $6.1 million, for which we began commercial promotion in February 2011. In addition, annual royalty revenue from our license agreement with GSK increased approximately $599,000 and in fiscal 2010, we recorded a non-recurring non-cash adjustment that reduced GSK royalty revenue by $797,000.
Potential revenue-generating contracts that remained active as of September 30, 2011 include licensing revenue from our agreement with GSK, potential royalties from our agreements with Azur Pharma and Emergent Biosolutions, Inc. and modest revenue generated from various other licensing agreements. Partnering, licensing and research collaborations have been, and may continue to be, an important part of our business development strategy. We may continue to seek partnerships with pharmaceutical companies that can help fund our operations in exchange for sharing in the success of any licensed compounds or technologies. See Note 11, “Research, License, Supply and other Agreements,” and Note 14, “Segment Information,” in the Notes to Consolidated Financial Statements.
Cost of Product Sales
In fiscal 2011, cost of product sales was $446,000 compared to $198,000 in fiscal 2010. The increase in cost of product sales is attributable to the sales of NUEDEXTA for which we began commercial promotion in February 2011.
Operating Expenses
Research and Development Expenses
Research and development expenses increased by approximately $1.9 million for the fiscal year ended September 30, 2011 compared to the fiscal year ended September 30, 2010. The increase is primarily due to increased spending of $3.6 million in medical affairs activities and $1.6 million in expense related to the clinical study for the treatment of central neuropathic pain in patients with MS which started in fiscal 2011, partially offset by a $3.1 million reduction in clinical expenses resulting from costs incurred in support of the complete response to the FDA approvable letter in fiscal 2010. We expect expenditures for research and development expenses to increase from fiscal 2011 levels as we continue to execute on our regulatory filing plan for NUEDEXTA in Europe and continue development of AVP-923 for treatment of central neuropathic pain in patients with MS and planned studies to assess behavioral disturbances related to emotional lability, such as agitation, in patients with Alzheimer’s disease.
Selling and Marketing Expenses
Selling and marketing expenses increased by approximately $32.4 million for the fiscal year ended September 30, 2011, compared to the fiscal year ended September 30, 2010. The increase is primarily attributed to costs associated with preparation and execution of the commercial launch of NUEDEXTA, including increased personnel costs of approximately $18.9 million resulting from the hiring of a sales force and other key corporate and commercial headcount resulting in an increase of over 100 employees; increased marketing and market research costs of approximately $12.5 million; and increased other costs of approximately $1.0 million. Selling and marketing expenses are expected to increase as we continue the ongoing marketing of NUEDEXTA.
General and Administrative Expenses
General and administrative expenses increased by approximately $6.5 million for the fiscal year ended September 30, 2011, compared to the fiscal year ended September 30, 2010. The increase is primarily attributed to increased personnel costs of approximately $3.5 million resulting from the hiring of key corporate headcount to support the commercialization of NUEDEXTA; increased legal expense of approximately $1.1 million primarily due to the enforcement of our intellectual property rights; and increased other corporate costs of approximately $1.9 million. General and administrative expenses are expected to increase as we enforce our intellectual property rights relating to NUEDEXTA.
Share-Based Compensation
The Company re-examines forfeiture rates as they apply to stock-based compensation on an annual basis. We estimate forfeitures based on our historical experience. Changes to the estimated forfeiture rate are accounted for as a cumulative effect of change in the period the change occurred. During fiscal 2010, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 12.6% to zero percent, as we expected all the awards to vest. This change in the estimated forfeiture rates resulted in an increase in share-based compensation expense of approximately $93,000 with no effect on loss per share for fiscal 2010. Future estimates may differ substantially from management’s current estimates.
Total compensation expense for our share-based payments in the fiscal years ended September 30, 2011 and 2010 was approximately $3.8 million and $2.7 million, respectively. Research and development expense in the fiscal years ended September 30, 2011 and 2010 includes share-based compensation expense of approximately $644,000 and $578,000, respectively. Selling and marketing expense in the fiscal years ended September 30, 2011 and 2010 includes share-based compensation expense of approximately $600,000 and $58,000, respectively. General and administrative expense in the fiscal years ended September 30, 2011 and 2010 includes share-based compensation expense of approximately $2.5 million and $2.1 million, respectively. As of September 30, 2011, approximately $10.4 million of total unrecognized compensation costs related to unvested awards is expected to be recognized over a weighted average period of 2.5 years. See Note 10, “Stockholders’ Equity - Employee Equity Incentive Plans,” in the Notes to Consolidated Financial Statements for further discussion.
Interest Income
For the fiscal year ended September 30, 2011, interest income was approximately $39,000, compared to approximately $15,000 for the prior fiscal year. The increase is due to a higher average cash balance in fiscal 2011 as compared to the prior fiscal year.
Other, net
Other, net was approximately $38,000 of expense in fiscal 2011 compared to income of approximately $391,000 in fiscal 2010. In fiscal year 2010, the Company recorded approximately $390,000 as Other, net under Other Income (Expense) in connection with a legal settlement. (See Note 9, “Commitments and Contingencies,” in the Notes to Consolidated Financial Statements).
Net Loss
Net loss was approximately $60.6 million, or $0.51 per share, for the fiscal year ended September 30, 2011, compared to a net loss of approximately $26.7 million, or $0.30 per share for the fiscal year ended September 30, 2010. The increase in net loss is primarily attributed to costs incurred for the commercial launch of NUEDEXTA.
Comparison of Fiscal 2010 and 2009
Revenues and Cost of Revenues
Revenues
Revenues were $2.9 million for the fiscal year ended September 30, 2010 compared to $4.2 million for the fiscal year ended September 30, 2009. The decrease in revenues of approximately $1.3 million was primarily attributed to a decrease in the recognition of deferred royalty revenue, as well as a decrease in licensing revenue related to the license agreement with Kobayashi Pharmaceutical Co. Ltd. which was terminated in fiscal 2009.
In the fourth quarter of fiscal 2010, the Company recorded a cumulative non-cash adjustment to correct an immaterial error related to previously recorded deferred royalty revenue related to the GSK license agreement. The total cumulative non-cash adjustment recorded in the fourth quarter was a decrease in revenue of $797,000 which resulted in net revenues of ($71,000) in the fourth fiscal quarter of 2010 and $2.9 million for fiscal 2010.
For the fiscal years ended September 30, 2010 and 2009, we generated no product revenue from the sale of the active pharmaceutical ingredient docosanol.
Cost of Revenues
In fiscal 2010, cost of revenues was $198,000 compared to $83,000 in fiscal 2009. The increase in cost of revenues was attributed to an increase in our inventory obsolescence reserve for docosanol.
Operating Expenses
Research and Development Expenses
Research and development expenses decreased by approximately $2.5 million for the fiscal year ended September 30, 2010 compared to the fiscal year ended September 30, 2009. The decrease is primarily due to a reduction in clinical expenses resulting from the completion of the STAR trial in fiscal 2009, partially offset by costs incurred in support of the complete response to the FDA approvable letter for NUEDEXTA and other regulatory activities. The complete response was submitted to the FDA in the third fiscal quarter of 2010.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by approximately $6.3 million for the fiscal year ended September 30, 2010, compared to the fiscal year ended September 30, 2009. The increase is primarily attributed to costs associated with preparation for commercial readiness for the launch of NUEDEXTA.
Share-Based Compensation
The Company re-examines forfeiture rates as they apply to stock-based compensation on an annual basis. We estimate forfeitures based on our historical experience. Changes to the estimated forfeiture rate are accounted for as a cumulative effect of change in the period the change occurred. During fiscal 2010, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 12.6% to zero percent, as we expect all the awards to vest. This change in the estimated forfeiture rates resulted in an increase in share-based compensation expense of approximately $93,000 with no effect on loss per share for fiscal 2010. In the fourth quarter of fiscal 2009, we reviewed our estimated forfeiture rate considering then recent actual data resulting in a reduction to our estimated forfeiture rate from 30.0% to 12.6% in fiscal 2009. Additionally, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 30.0% to zero percent, as we expected all the awards to vest. These changes in the estimated forfeiture rates during fiscal 2009 resulted in an increase in share-based compensation expense of $935,000 and an increase to loss per share of $0.01 for fiscal 2009. Future estimates may differ substantially from management’s current estimates.
Total compensation expense for our share-based payments in the fiscal years ended September 30, 2010 and 2009 was approximately $2.7 million and $2.9 million, respectively. Selling, general and administrative expense in the fiscal years ended September 30, 2010 and 2009 includes share-based compensation expense of approximately $2.2 million for each period. Research and development expense in the fiscal years ended September 30, 2010 and 2009 includes share-based compensation expense of approximately $578,000 and $664,000, respectively. See Note 11, “Stockholders’ Equity - Employee Equity Incentive Plans,” in the Notes to Consolidated Financial Statements for further discussion.
Interest Expense and Interest Income
We had no interest expense for the fiscal year ended September 30, 2010, compared to a nominal amount of $517 for the prior fiscal year.
For the fiscal year ended September 30, 2010, interest income was approximately $15,000, compared to approximately $204,000 for the prior fiscal year. The decrease is due to a lower investment yield in fiscal 2010 as compared to the prior fiscal year.
Other, net
Other, net was approximately $391,000 of income in fiscal 2010 compared to expense of approximately $272,000 in fiscal 2009. In fiscal 2010, the Company recorded approximately $390,000 as Other, net under Other Income (Expense) in connection with a legal settlement. (See Note 9, “Commitments and Contingencies” in the Notes to Consolidated Financial Statements). In fiscal 2009, the Company recognized a loss on disposal of fixed assets of approximately $266,000.
Net Loss
Net loss was approximately $26.7 million, or $0.30 per share, for the fiscal year ended September 30, 2010, compared to a net loss of approximately $22.0 million, or $0.28 per share for the fiscal year ended September 30, 2009. The increase in net loss is primarily attributed to costs incurred in preparation for the commercial launch of NUEDEXTA and regulatory costs associated with the complete response to the approvable letter and other regulatory activities.
Liquidity and Capital Resources
We assess our liquidity based on our ability to generate cash to fund future operations. Key factors in the management of our liquidity are: cash required to fund operating activities including expected operating losses and the levels of inventories, accounts payable and capital expenditures; the timing and extent of cash received from milestone payments under license agreements; adequate credit facilities; and financial flexibility to attract long-term equity capital on favorable terms. Historically, cash required to fund on-going business operations has been provided by financing activities and used to fund operations, working capital requirements and investing activities.
Cash, cash equivalents and restricted investments, as well as net cash provided by or used in operating, investing and financing activities, are summarized in the table below.
Operating activities. Net cash used in operating activities was approximately $56.5 million in fiscal 2011 compared to approximately $23.8 million in fiscal 2010. The increase is primarily due to expenses related to the commercial launch of NUEDEXTA and the Company’s regulatory activities. Net cash used in operating activities was approximately $20.3 million in fiscal 2009. The increase from fiscal 2009 to fiscal 2010 was primarily due to expenses related to the Company’s regulatory and commercial readiness activities.
Investing activities. Net cash used in investing activities was approximately $3.5 million in fiscal 2011, compared to approximately $346,000 in fiscal 2010. The increase is primarily related to the increase in purchases of property and equipment in support of our commercial launch of NUEDEXTA and investments in securities. In fiscal 2010, cash used in investing activities was primarily due to the purchase of property and equipment in support of our commercial readiness activities and investments in securities. Net cash provided by investing activities in fiscal 2009 was approximately $357,000. In fiscal 2009, cash provided by investing activities arose primarily from sales and maturities of investments.
Financing activities. Net cash provided by financing activities was approximately $100.8 million in fiscal 2011 compared to approximately $31.4 million in fiscal 2010. In fiscal 2011, we raised approximately $96.7 million in gross proceeds (approximately $91.4 million net of offering costs and commissions) from the sale of common stock and approximately $9.3 million from the exercise of warrants and stock options. In fiscal 2010, we raised approximately $32.7 million in gross proceeds (approximately $31.6 million net of offering costs and commissions) from sales of common stock. Net cash provided by financing activities was approximately $10.0 million in fiscal year 2009. In fiscal 2009, we raised approximately $10.8 million in gross proceeds (approximately $10.2 million net of offering costs and commissions) from sale of common stock.
In April 2009, we filed with the SEC a shelf registration statement on Form S-3 to sell an aggregate of up to $35.0 million in common stock, preferred stock, debt securities and warrants. On May 6, 2009, the registration statement was declared effective. On July 30, 2009 we entered into a financing facility with Cantor Fitzgerald & Co., providing for the sale of up to 12,500,000 shares of our common stock from time to time into the open market at prevailing prices. As of December 1, 2011, 9.8 million shares of common stock had been sold for total gross proceeds of $27.9 million through this facility under our registration statement. Approximately $7.1 million remains on this shelf registration statement. We may or may not sell additional shares under this facility, depending on the volume and price of our common stock, as well as our capital needs and potential alternative sources of capital, such as a development partner for NUEDEXTA.
In September 2009, we filed with the SEC a shelf registration statement on Form S-3 to sell an aggregate of up to $75.0 million in common stock, preferred stock, debt securities and warrants. On September 23, 2009, the registration statement was declared effective. In May 2010, we sold an aggregate of 10,000,000 shares of our common stock in an underwritten offering at a public offering price of $2.75 per share, resulting in $27.5 million in gross offering proceeds and approximately $26.6 million in net proceeds to us, after deducting underwriting discounts, commissions and estimated offering expenses.
In September 2010, we filed with the SEC a shelf registration statement on Form S-3 to sell an aggregate of up to $75.0 million in common stock, preferred stock, debt securities and warrants. In November 2010, we completed an underwritten public offering of 20,000,000 shares of our common stock offered at a public offering price of $4.40 per share. Gross offering proceeds resulting from the offering were approximately $88,000,000, with net proceeds of approximately $83.0 million, after deducting offering discounts, costs and commissions.
As of December 1, 2011, approximately $34.5 million of the September 2009 shelf registration statement remains available and there are no funds remaining on the September 2010 shelf registration statement.
As of September 30, 2011, we have contractual obligations for trade expenses and operating lease obligations, as summarized in the table that follows. We have no off-balance sheet arrangements.
(1) Operating lease obligations are exclusive of payments we expect to receive under sublease agreements.
(2) Purchase obligations consist of the total of trade accounts payable and trade related accrued expenses at September 30, 2011, which approximates our contractual commitments for goods and services in the normal course of our business.
In connection with our acquisition of Alamo in May 2006, we agreed to pay up to an additional $39,450,000 in revenue-based earn-out payments, based on future sales of FazaClo. These earn-out payments are based on FazaClo sales in the U.S. from the closing date of the acquisition through December 31, 2018 (the “Contingent Payment Period”). We sold the FazaClo product line to Azur in August 2007. Our future earn-out obligations that would have been payable to the prior owner of Alamo Pharmaceuticals upon the achievement of certain milestones were assumed by Azur, although we may remain liable for these payments if Azur defaults on these obligations. See Item 3, “Legal Proceedings - Alamo and Azur Litigation.”
NUEDEXTA License Milestone Payments. We hold the exclusive worldwide marketing rights to NUEDEXTA for certain indications pursuant to an exclusive license agreement with the Center for Neurologic Study (“CNS”).
We paid a $75,000 milestone upon FDA approval of NUEDEXTA for the treatment of PBA in fiscal 2011. In addition, we are obligated to pay CNS a royalty ranging from approximately 5% to 8% of net GAAP revenue generated by sales of NUEDEXTA. During fiscal 2011, we recorded royalties of approximately $389,000 related to NUEDEXTA product shipments. Of this amount, approximately $309,000 is recorded to cost of product sales in the consolidated statements of operations for fiscal 2011, and the remaining $80,000 represents deferred cost of product sales and is recorded to other current assets in the consolidated balance sheet at September 30, 2011. Under certain circumstances, we may have the obligation to pay CNS a portion of net revenues received if we sublicense NUEDEXTA to a third party.
Under the agreement with CNS, we are required to make payments on achievements of up to a maximum of ten milestones, based upon five specific clinical indications. Maximum payments for these milestone payments could total approximately $1.1 million if we pursued the development of NUEDEXTA for all five of the licensed indications. In general, individual milestones range from $75,000 to $125,000 for each accepted new drug application (“NDA”) and a similar amount for each approved NDA in addition to the royalty discussed above on net GAAP revenues. We are not obligated to develop additional indications under the CNS license agreement.
Management Outlook
We believe that cash, cash equivalents and restricted investments of approximately $81.8 million at September 30, 2011, together with funds generated from sales of NUEDEXTA, will be sufficient to sustain our planned level of operations for at least the next 15 months. In addition, we received approximately $7.8 million from the exercise of approximately 5.4 million warrants in December 2011. However, we cannot provide assurances that our plans will not change, or that changed circumstances will not result in the depletion of capital resources more rapidly than anticipated.
For information regarding the risks associated with our need to raise capital to fund our ongoing and planned operations, please see Item 1A, “Risk Factors.”
Recent Authoritative Guidance
See Note 2, “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for a discussion of recently issued authoritative guidance and its effect, if any, on us.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
As described below, we are exposed to market risks related to changes in interest rates. Because substantially all of our revenue, expenses, and capital purchasing activities are transacted in U.S. dollars, our exposure to foreign currency exchange rates is immaterial. However, in the future we could face increasing exposure to foreign currency exchange rates if we obtain EMA approval to market NUEDEXTA and distribute internationally, expand international distribution of docosanol 10% cream and purchase additional services from outside the U.S. Until such time as we are faced with material amounts of foreign currency exchange rate risks, we do not plan to use derivative financial instruments, which can be used to hedge such risks. We will evaluate the use of derivative financial instruments to hedge our exposure as the needs and risks should arise.
Interest Rate Sensitivity
Our investment portfolio consists primarily of cash equivalent fixed income instruments invested in government money market funds. The primary objective of our investments in these securities is to preserve principal. We classify our restricted investments, which are primarily certificates of deposit, as of September 30, 2011 as held-to-maturity. These held-to-maturity securities are subject to interest rate risk. Based on the average duration of our investments in interest-bearing accounts as of September 30, 2011, an increase of one percentage point in the interest rates for these interest-bearing accounts would have resulted in increases in interest income of approximately $22,000.
As of September 30, 2011, $38.4 million of our cash and cash equivalents were maintained in three separate money market mutual funds, and approximately $41.1 million of our cash and cash equivalents were maintained at three major financial institutions in the United States. At times, deposits held with financial institutions may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation. At September 30, 2011, such uninsured deposits totaled approximately $78.0 million. Generally, these deposits may be redeemed upon demand and, therefore, bear minimal risk.
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. Our cash and cash equivalents are placed at various money market mutual funds and financial institutions of high credit standing.
We perform ongoing credit evaluations of our customers’ financial conditions and would limit the amount of credit extended if deemed necessary but usually we have required no collateral.
Item 8.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements are annexed to this report beginning on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Vice President, Finance, of the effectiveness of our “disclosure controls and procedures” as of the end of the period covered by this report, pursuant to Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934, as amended.
In connection with that evaluation, our CEO and Vice President, Finance concluded that our disclosure controls and procedures were effective and designed to provide reasonable assurance that the information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms as of September 30, 2011. For the purpose of this review, disclosure controls and procedures means controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit is accumulated and communicated to management, including our principal executive officer, principal financial officer and principal accounting officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
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 Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal 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 (COSO) and related COSO guidance. Based on our evaluation under this framework, our management concluded that our internal control over financial reporting was effective as of September 30, 2011.
Our assessment of the effectiveness of our internal control over financial reporting as of September 30, 2011 has been audited by KMJ Corbin & Company LLP, an independent registered public accounting firm, as stated in their report, which is set forth at.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during our fourth fiscal quarter ended September 30, 2011, that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information relating to our directors that is required by this item is incorporated by reference from the information under the captions “Election of Directors,” “Corporate Governance,” “Board of Directors and Committees” and “Executive Officers” contained in our definitive proxy statement (the “Proxy Statement”), which will be filed with the Securities and Exchange Commission in connection with our 2012 Annual Meeting of Stockholders.
Additionally, information relating to reporting of insider transactions in Company securities is incorporated by reference from the information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement.
Executive Officers and Key Employees of the Registrant
The names of our executive officers and other key employees and their ages as of December 1, 2011 are set forth below. Officers are elected annually by the Board of Directors and hold office until their respective successors are qualified and appointed or until their resignation, removal or disqualification.
Keith A. Katkin
President and Chief Executive Officer
Gregory J. Flesher
Senior Vice President and Chief Business Officer
Randall E. Kaye, M.D.
Senior Vice President, Chief Medical Officer
Joao Siffert, M.D.
Senior Vice President, Research and Development
Eric S. Benevich
Vice President, Marketing
Adrian Hepner, M.D.
Vice President, Clinical Research
Elona Kogan
Vice President, Legal
Michael McFadden
Vice President, U.S. Sales and Managed Markets
Christine G. Ocampo, CPA
Vice President, Finance, Secretary
Keith Katkin. Mr. Katkin joined Avanir in July of 2005 as Senior Vice President of Sales and Marketing. In March 2007, Mr. Katkin was appointed President and Chief Executive Officer and was elected as a member of the Board of Directors. Prior to joining Avanir, Mr. Katkin previously served as Vice President, Commercial Development for Peninsula Pharmaceuticals, playing a key role in the management and sale of the company to Johnson & Johnson in 2005. Additionally, Mr. Katkin’s employment experience includes leadership roles at InterMune, Inc., Amgen, Inc., and Abbott Laboratories. Mr. Katkin also served as strategic advisor to Cerexa, a pharmaceutical company that was sold to Forest Laboratories in 2007. Mr. Katkin received a B.S. degree in Business and Accounting from Indiana University and an M.B.A. degree in Finance from the Anderson School of Management at UCLA, graduating with honors. Mr. Katkin became a licensed Certified Public Accountant in 1995.
Gregory J. Flesher. Mr. Flesher joined Avanir in June 2006 as Senior Director of Commercial Strategy and in November 2006 assumed the additional responsibility for Business Development and Portfolio Planning. In August 2007 he was promoted to Vice President of Business Development and in February 2011 he was promoted to Senior Vice President and Chief Business Officer. Prior to joining Avanir, he served as a Sales Director from 2004 to 2006 and as Director of Pulmonary & Infectious Disease Marketing from 2002 to 2004 at InterMune, Inc., a biopharmaceutical company. Prior to his tenure at InterMune, Mr. Flesher held Oncology and Nephrology marketing positions with Amgen Inc., a global biotechnology company. Mr. Flesher also held roles in global marketing and clinical development at Eli Lilly and Company. Mr. Flesher graduated from Purdue University with a degree in Biology and has completed his doctorate coursework in Biochemistry and Molecular Biology at Indiana University School of Medicine.
Randall E. Kaye, M.D. Dr. Kaye joined Avanir in January 2006 as Vice President of Clinical and Medical Affairs and assumed the role of Senior Vice President Clinical Research and Medical Affairs and Chief Medical Officer in February 2007. Immediately prior to joining Avanir, from 2004 to 2006, Dr. Kaye was the Vice President of Medical Affairs for Scios Inc., a division of Johnson & Johnson. From 2002 to 2004, Dr. Kaye recruited and managed the Medical Affairs department for InterMune Inc. Previously, Dr. Kaye served for nearly a decade in a variety of Medical Affairs and Marketing positions for Pfizer Inc. Dr. Kaye earned his Doctor of Medicine, Masters in Public Health and Bachelor of Science degrees at George Washington University in Washington, D.C. and was a Research Fellow in Allergy and Immunology at Harvard Medical School.
Joao Siffert, M.D. Dr. Siffert joined Avanir in August 2011 as Senior Vice President, Research and Development. Dr. Siffert previously served as Vice President and Chief Medical Officer at Ceregene, Inc., a biotechnology company focused on the development of neurotrophic gene therapies for Alzheimer’s and Parkinson’s diseases, from September 2007 to August 2011. Prior to his work at Ceregene, Dr. Siffert served as the Chief Medical Officer at Avera Pharmaceuticals, a CNS specialty pharmaceutical company, from May 2005 to September 2007. Prior to joining Avera, Dr. Siffert held positions with Pfizer from February 2002 to May 2005, first as a medical director for Relpax and subsequently as the worldwide medical team leader of Lyrica and
Neurontin focusing in areas of pain and epilepsy. Prior to Pfizer, Dr. Siffert held academic positions at Beth Israel Medical Center, where he served as director of the Adult Neuro-Oncology program, and Albert Einstein College of Medicine, where he was assistant professor of neurology. Dr. Siffert completed residencies in pediatrics at New York University School of Medicine and in neurology at Harvard Medical School. Dr. Siffert was certified by the American Board of Neurology and Psychiatry in 1996. He holds an M.D. degree from the University of Sao Paulo School of Medicine as well as an M.B.A. degree from Columbia University Business School.
Eric S. Benevich. Mr. Benevich joined Avanir in July 2005 as Senior Director of Marketing. In August 2007, he was promoted to Vice President of Marketing. Prior to joining Avanir, Mr. Benevich previously served as the Senior Director of Marketing for Peninsula Pharmaceuticals. Prior to his tenure at Peninsula Pharmaceuticals, Mr. Benevich held several Marketing positions with Amgen Inc., a global biotechnology company. In addition, Mr. Benevich held several commercial roles at Astra Merck in Sales, Market Research and Brand Marketing. Mr. Benevich graduated from Washington State University with a degree in International Business.
Adrian Hepner, M.D. Dr. Hepner joined Avanir in 2006 as Senior Director of Clinical Research and Medical Affairs. Dr. Hepner has over 20 years of U.S. and international experience in clinical studies and has been involved in filing of multiple INDs and NDAs. Dr. Hepner trained first as a physician and later as a neuropsychiatrist at the University of Buenos Aires School of Medicine. He also spent a number of years as a post-doctoral fellow in neuropsychopharmacology at the University of Ottawa. Following his post-doctoral fellowship Dr. Hepner was a clinical consultant to a number of pharmaceutical companies and a leading clinical investigator in Latin America. In 2001, he joined IVAX Research where he was director of new drug development. Prior to joining Avanir he was director of innovative R&D at TEVA Pharmaceuticals. Dr. Hepner has over 30 published papers and has also received an award from the National Academy of Medicine in Argentina for his research work in dementias.
Elona Kogan. Ms. Kogan joined Avanir in the role of Vice President of the Legal Affairs Department in May 2011. Ms. Kogan is responsible for Avanir’s legal affairs, as well as providing counsel to the chairman and chief executive officer and its Board of Directors. Prior to joining Avanir, Ms. Kogan was Associate General Counsel and Privacy Officer at King Pharmaceuticals, Inc., a publicly traded pharmaceutical company. In addition to providing counsel to the chief commercial officer, and helping shape company commercial strategy, Ms. Kogan worked on a variety of legal issues, including, regulatory compliance, patient assistance programs, privacy issues, contracting, litigation and corporate governance. Prior to joining King Pharmaceuticals, Ms. Kogan worked at Bristol-Myers Squibb, Bergen Brunswick, and Epstein, Becker & Green. Ms. Kogan earned a B.A. degree, cum laude from Columbia University, and a Juris Doctor degree from the Southwestern University School of Law.
Michael McFadden. Mr. McFadden joined Avanir in May 2010 as Vice President of U.S. Sales and Managed Markets. Mr. McFadden’s 20 years of pharmaceutical commercial experience includes the selling and marketing of several successful prescription products. Prior to joining Avanir, Mr. McFadden served in various leadership roles in sales and managed care at Amylin Pharmaceuticals where he was responsible for building and leading sales and managed markets teams and launching two first-in-class diabetes products. Prior to his tenure at Amylin, Mr. McFadden held commercial roles at Pharmacia and Eli Lilly and Company. Mr. McFadden graduated from University of Louisiana at Monroe with a degree in Business Administration.
Christine G. Ocampo, CPA. Ms. Ocampo joined Avanir in March 2007 as Corporate Controller and was promoted to Vice President, Finance in February 2008. Prior to joining Avanir, Ms. Ocampo served as Senior Vice President, Chief Financial Officer, Chief Accounting Officer, Treasurer and Secretary of Cardiogenesis Corporation from November 2003 until April 2006. From 2001 to November 2003, Ms. Ocampo served in the role of Vice President and Corporate Controller at Cardiogenesis. Prior to first joining Cardiogenesis in April 1997, Ms. Ocampo held a management position in Finance at Mills-Peninsula Health Systems in Burlingame, CA, and spent three years as an auditor for Ernst & Young LLP. Ms. Ocampo graduated with a Bachelors of Science degree in Accounting from Seattle University and became a licensed Certified Public Accountant in 1996.
Code of Ethics
We have adopted a code of Business Conduct and Ethics for directors, officers (including our principal executive officer, principal financial officer, and principal accounting officer and controller), and employees. This
code is available on our website at www.avanir.com. Any waivers from or amendments to the code of ethics will be filed with the SEC on Form 8-K. You may also request a printed copy of our code of ethics, without charge, by writing to us at 20 Enterprise, Suite 200, Aliso Viejo, California 92656, Attn: Investor Relations.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated by reference to the information under the captions “Executive Compensation” and “Compensation Committee Interlocks and Insider Participation” and “Director Compensation” contained in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference to the information under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” contained in the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this item is incorporated by reference to the information under the captions “Certain Relationships and Related Party Transactions,” “Director Independence” and “Board Committees” contained in the Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item is incorporated by reference to the information under the caption “Fees for Independent Registered Public Accounting Firm” contained in the Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Financial Statements and Schedules
See index to the financial statements on page.
(b) Exhibits
The following exhibits are incorporated by reference or filed as part of this report.
Exhibit
Number
Description
Incorporated by Reference Herein
Form
Date
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
Filed herewith
101.DEF
XBRL Taxonomy Definition Linkbase Document 
Filed herewith
* Confidential treatment has been granted with respect to portions of this exhibit pursuant to an application requesting confidential treatment under Rule 24b-2 of the Securities Exchange Act of 1934. A complete copy of this exhibit, including the redacted terms, has been separately filed with the Securities and Exchange Commission.
 The XBRL information is deemed furnished and not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities and Exchange Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise is not subject to liability under these Sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AVANIR PHARMACEUTICALS, INC.
By:
/S/ KEITH A. KATKIN
Keith A. Katkin
President and Chief Executive Officer
Date: December 13, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
Avanir Pharmaceuticals, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedules:
Financial statement schedules have been omitted for the reason that the required information is presented in the consolidated financial statements or notes thereto, the amounts involved are not significant or the schedules are not applicable.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Avanir Pharmaceuticals, Inc.
We have audited the accompanying consolidated balance sheets of Avanir Pharmaceuticals, Inc. and subsidiaries (the “Company”) as of September 30, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended September 30, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Avanir Pharmaceuticals, Inc. and subsidiaries as of September 30, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2011, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated December 13, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
December 13, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
To the Board of Directors and Stockholders of
Avanir Pharmaceuticals, Inc.
We have audited the internal control over financial reporting of Avanir Pharmaceuticals, Inc. and subsidiaries (the “Company”) as of September 30, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’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, included in the accompanying Management’s Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to express 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 of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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 accounting principles generally accepted in the United States of America. 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 accounting principles generally accepted in the United States of America, 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 of the internal control over financial reporting 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, Avanir Pharmaceuticals, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of September 30, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Avanir Pharmaceuticals, Inc. and subsidiaries as of September 30, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended September 30, 2011 and our report dated December 13, 2011 expressed an unqualified opinion on those consolidated financial statements.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
December 13, 2011
Avanir Pharmaceuticals, Inc.
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
Avanir Pharmaceuticals, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to consolidated financial statements.
Avanir Pharmaceuticals, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See notes to consolidated financial statements.
Avanir Pharmaceuticals, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
Avanir Pharmaceuticals, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
Avanir Pharmaceuticals, Inc. and subsidiaries (“Avanir”, the “Company” or “we”) is a pharmaceutical company focused on acquiring, developing and commercializing novel therapeutic products for the treatment of central nervous system disorders. In October 2010, the U.S. Food and Drug Administration (“FDA”) approved NUEDEXTA® (referred to as AVP-923 during clinical development), a unique proprietary combination of dextromethorphan and low-dose quinidine, for the treatment of pseudobulbar affect (“PBA”). The Company commenced promotion of NUEDEXTA in the United States in February 2011 and is currently pursuing approval of NUEDEXTA in Europe.
The Company is also studying AVP-923 for use in different types of neuropathic pain. The Company has filed an Investigational New Drug application (“IND”) with the FDA and has initiated a large Phase II clinical trial of AVP-923 for the treatment of central neuropathic pain in patients with multiple sclerosis.
AVP-923 has also successfully completed a Phase III trial for the treatment of patients with diabetic peripheral neuropathic pain (“DPN pain”). Additional phase III trials with a modified formulation would need to be completed for approval of this indication.
In addition to the Company’s focus on products for the central nervous system, the Company also has partnered programs in other therapeutic areas which may generate future income. The Company’s first commercialized product, docosanol 10% cream, (sold in the United States and Canada as Abreva® by our marketing partner GlaxoSmithKline Consumer Healthcare) is the only over-the-counter treatment for cold sores that has been approved by the FDA. In 2008, the Company licensed all of our monoclonal antibodies and remains eligible to receive milestone payments and royalties related to the sale of these assets.
The Company’s operations are subject to certain risks and uncertainties frequently encountered by companies in the early stages of operations, particularly in the evolving market for small biotech and specialty pharmaceuticals companies. Such risks and uncertainties include, but are not limited to, the occurrence of adverse safety events with NUEDEXTA; that NUEDEXTA may not gain acceptance by the medical field or that the indicated use may not be clearly understood; the Company’s dependence on third parties for manufacturing and distribution of NUEDEXTA; that the Company may not adequately build or maintain the necessary sales, marketing, supply chain management and reimbursement capabilities on its own or enter into arrangements with third parties to perform these functions in a timely manner or on acceptable terms; the ability to successfully defend our intellectual property rights relating to NUEDEXTA; timing and uncertainty of achieving milestones in clinical trials; and obtaining approvals by the FDA and regulatory agencies in other countries. The Company’s ability to generate revenues in the future may depend on market acceptance of NUEDEXTA for the treatment of PBA and the timing and success of reaching clinical development milestones and obtaining regulatory approvals for other formulations for NUEDEXTA (referred to as “AVP-923”). The Company’s operating expenses depend substantially on the level of expenditures for the ongoing marketing of NUEDEXTA, clinical development activities for NUEDEXTA as well as AVP-923 and the rate of progress being made on such activities.
Avanir was incorporated in California in August 1988 and was reincorporated in Delaware in March 2009.
2. Summary of Significant Accounting Policies
Basis of presentation
The consolidated financial statements include the accounts of Avanir Pharmaceuticals, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The Company’s fiscal year ends on September 30 of each year. The years ended September 30, 2011, 2010, and 2009 are herein referred to as fiscal 2011, fiscal 2010 and fiscal 2009, respectively.
Avanir Pharmaceuticals, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company has evaluated subsequent events through the filing date of this Form 10-K, and determined that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes thereto other than as discussed in the accompanying notes. See Note 15, “Subsequent Events” and Note 9, “Commitments and Contingencies - Alamo and Azur litigation”.
On March 27, 2009, the Company effected a change of domicile from California to Delaware. In the change of domicile, Avanir Pharmaceuticals, a California corporation (“Avanir California”), merged with and into Avanir Pharmaceuticals, Inc., a Delaware corporation (“Avanir Delaware”) and a wholly-owned subsidiary of Avanir California. As a result of the merger, Avanir Delaware succeeded to the assets and liabilities of Avanir California. In the merger, each share of Avanir California Class A common stock, no par value, was converted into one share of Avanir Delaware common stock, $0.0001 par value, and all options, warrants and purchase rights issued by Avanir California and outstanding at the time of the merger were assumed by Avanir Delaware. Due to the change in the par value of the Company’s common stock, the Company attributed $7,824 to stockholders’ equity for common stock as of March 31, 2009, which amount is equal to the aggregate par value of the shares of common stock issued and outstanding on that date, and reclassified the balance of $285,814,402 as additional paid-in capital as of that date. No change was made to stockholders’ equity for preferred stock as no shares were outstanding as of March 31, 2009. The reclassifications had no effect on total stockholders’ equity.
Management estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates made by management include, among others, provisions for uncollectible receivables, valuation of inventories and investments, recoverability of long-lived assets, recognition of deferred revenue, share-based compensation expense, determination of expenses in outsourced contracts, and realization of deferred tax assets.
Cash and cash equivalents
Cash and cash equivalents consist of cash and highly liquid investments with maturities of three months or less at the date of acquisition.
Concentration of credit risk and sources of supply
As of September 30, 2011, $38.4 million of the Company’s cash and cash equivalents were maintained in three separate money market mutual funds, and approximately $41.1 million of the Company’s cash and cash equivalents were maintained at three major financial institutions in the United States. At times, deposits held with financial institutions often exceed the amount of insurance provided by the Federal Deposit Insurance Corporation (“FDIC”), which provides basic deposit coverage with limits up to $250,000 per owner. In addition to the basic insurance deposit coverage, the FDIC is providing temporary unlimited coverage for noninterest-bearing transaction accounts from December 31, 2010 through December 31, 2012. At September 30, 2011, such uninsured deposits totaled approximately $78.0 million of the $81.8 million of total cash and cash equivalents and restricted investments. Generally, these deposits may be redeemed upon demand and, therefore, are believed to bear minimal risk.
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and trade receivables. The Company’s cash and cash equivalents are placed in various money market mutual funds and at financial institutions of high credit standing. The Company performs ongoing credit evaluations of customers’ financial condition and would limit the amount of credit extended if necessary; however, the Company has historically required no collateral.
Avanir Pharmaceuticals, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company currently has sole suppliers for the active pharmaceutical ingredients (“APIs”) for NUEDEXTA and a sole manufacturer for the finished form of NUEDEXTA. In addition, these materials are custom and available from only a limited number of sources. Any material disruption in manufacturing could cause a delay in shipments and possible loss of revenue. If the Company is required to change manufacturers, the Company may experience delays associated with finding an alternative manufacturer that is properly qualified to produce NUEDEXTA in accordance with FDA requirements and the Company’s specifications.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out (“FIFO”) basis. The Company evaluates the carrying value of inventories on a regular basis, based on the price expected to be obtained for products in their respective markets compared with historical cost. Write-downs of inventories are considered to be permanent reductions in the cost basis of inventories.
The Company also regularly evaluates its inventories for excess quantities and obsolescence (expiration), taking into account such factors as historical and anticipated future sales or use in production compared to quantities on hand and the remaining shelf life of products and active pharmaceutical ingredients on hand. The Company establishes reserves for excess and obsolete inventories as required based on its analyses.
Property and equipment
Property and equipment, net, is stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful life of the asset. Computer equipment and related software are depreciated over three to five years. Office equipment, furniture and fixtures are depreciated over five years. Leasehold improvements are amortized over the useful life or remaining lease term, whichever is shorter.
Valuation of long-lived assets
Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If the review indicates that a long-lived asset is not recoverable (i.e. the carrying amount is less than the future projected undiscounted cash flows), its carrying amount would be reduced to fair value. Factors management considers important that could trigger an impairment review include the following:
•
A significant underperformance relative to expected historical or projected future operating results;
•
A significant change in the manner of our use of the acquired asset or the strategy for our overall business; and/or
•
A significant negative industry or economic trend.
Based on its analysis, the Company’s management believes that no impairment of the carrying value of its long-lived assets existed at September 30, 2011 or 2010.
Deferred rent
The Company accounts for rent expense related to operating leases (excluding leases related to exit activities) by determining total minimum rent payments on the leases over their respective periods and recognizing the rent expense on a straight-line basis. The difference between the actual amount paid and the amount recorded as rent expense in each fiscal year is recorded as an adjustment to deferred rent. Deferred rent as of September 30, 2011 and 2010 was $173,360 and $12,148, respectively, and is included in accrued expenses and other liabilities in the accompanying consolidated balance sheets.
Avanir Pharmaceuticals, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Fair value of financial instruments
At September 30, 2011 and 2010, the Company’s financial instruments include cash and cash equivalents, trade receivables, restricted investments in marketable securities, accounts payable, accrued expenses and other liabilities, and accrued compensation and payroll taxes. The carrying amount of cash and cash equivalents, trade receivables, accounts payable, accrued expenses and other liabilities, and accrued compensation and payroll taxes approximates fair value due to the short-term maturities of these instruments. The Company’s short- and long-term restricted investments in marketable securities are carried at amortized cost which approximates fair value.
Revenue recognition
The Company has historically generated revenues from product sales, collaborative research and development arrangements, and other commercial arrangements such as royalties, the sale of royalty rights and sales of technology rights. Payments received under such arrangements may include non-refundable fees at the inception of the arrangements, milestone payments for specific achievements designated in the agreements, royalties on sales of products resulting from collaborative arrangements, and payments for the sale of rights to future royalties.
The Company recognizes revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the Company’s price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. Certain product sales are subject to rights of return. For products sold where the buyer has the right to return the product, the Company recognizes revenue at the time of sale only if (1) the Company’s price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid the Company, or is obligated to pay the Company and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller, (5) the Company does not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated. The Company recognizes such product revenues when either it has met all the above criteria, including the ability to reasonably estimate future returns, when it can reasonably estimate that the return privilege has substantially expired, or when the return privilege has substantially expired, whichever occurs first.
Product Sales - NUEDEXTA. NUEDEXTA is sold primarily to third-party wholesalers that, in turn, sell this product to retail pharmacies, hospitals, and other dispensing organizations. The Company has entered into agreements with wholesale customers, certain medical institutions and third-party payors throughout the United States. These agreements frequently contain commercial terms, which may include favorable product pricing and discounts and rebates payable upon dispensing the product to patients. Additionally, these agreements customarily provide the customer with rights to return the product, subject to the terms of each contract. Consistent with pharmaceutical industry practice, wholesale customers can return purchased product during an 18-month period that begins six months prior to the product’s expiration date and ends 12 months after the expiration date.
At the present time, the Company is unable to reasonably estimate future returns due to the lack of sufficient historical returns data for NUEDEXTA. Accordingly, the Company invoices the wholesaler, records deferred revenue at gross invoice sales price less estimated cash discounts and distribution fees, and classifies the inventory shipped as inventories subject to return. The Company currently defers recognition of revenue and the related cost of product sales on shipments of NUEDEXTA until the right of return no longer exists, i.e. when the Company receives evidence that the products have been dispensed to patients. The Company estimates patient prescriptions dispensed using an analysis of third-party information. In the future, the Company plans to recognize product sales upon shipment to the customer when it believes it has sufficient data to develop reasonable estimates of expected returns based upon historical returns.
The Company’s net product sales represent gross product sales less allowances for customer credits, including estimated discounts, rebates, chargebacks and co-pay assistance. These allowances provided by the Company to a
Avanir Pharmaceuticals, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
customer are presumed to be a reduction of the selling prices of the Company’s products or services and, therefore, are characterized as a reduction of revenue when recognized in the Company’s statement of operations. Allowances for discounts, rebates, chargebacks and co-pay assistance are estimated based on contractual terms with customers and sell-through data purchased from third parties. Product shipping and handling costs are included in cost of product sales.
Product Sales - Active Pharmaceutical Ingredient docosanol (“docosanol”). Revenue from sales of the Company’s docosanol is recorded when title and risk of loss have passed to the buyer and provided the criteria for revenue recognition are met. The Company sells the docosanol to various licensees upon receipt of a written order for the materials. Shipments generally occur fewer than three times a year. The Company’s contracts for sales of the docosanol include buyer acceptance provisions that give the Company’s buyers the right of replacement if the delivered product does not meet specified criteria. That right requires that they give the Company notice within 30 days after receipt of the product. The Company has the option to refund or replace any such defective materials; however, it has historically demonstrated that the materials shipped from the same pre-inspected lot have consistently met the specified criteria and no buyer has rejected any of the Company’s shipments from the same pre-inspected lot to date. Therefore, the Company recognizes revenue at the time of delivery without providing any returns reserve.
Multiple Element Arrangements. The Company has, in the past, entered into arrangements whereby it delivers to the customer multiple elements including technology and/or services. Such arrangements have included some combination of the following: antibody generation services; licensed rights to technology, patented products, compounds, data and other intellectual property; and research and development services. At the inception of the arrangement, the Company analyzes its multiple element arrangements to determine whether the elements can be separated. If a product or service is not separable, the combined deliverables will be accounted for as a single unit of accounting.
A delivered element can be separated from other elements when it meets both of the following criteria: (1) the delivered item has value to the customer on a standalone basis; and (2) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the Company’s control. If an element can be separated, the Company allocates amounts based upon the selling price of each element. The Company determines the selling price of a separate deliverable using the price it charges other customers when it sells that product or service separately; however, if the Company does not sell the product or service separately, it uses third-party evidence of selling price of a similar product or service to a similar situated customer. The Company considers licensed rights or technology to have standalone value to its customers if it or others have sold such rights or technology separately or its customers can sell such rights or technology separately without the need for the Company’s continuing involvement. The Company has not entered into any multiple element arrangements during fiscal 2011, 2010 or 2009, which required the Company to estimate selling prices.
License Arrangements. License arrangements may consist of non-refundable upfront license fees, data transfer fees, research reimbursement payments, exclusive licensed rights to patented or patent pending compounds, technology access fees, and various performance or sales milestones. These arrangements are often multiple element arrangements.
Non-refundable, up-front fees that are not contingent on any future performance by the Company, and require no consequential continuing involvement on its part, are recognized as revenue when the license term commences and the licensed data, technology and/or compound is delivered. Such deliverables may include physical quantities of compounds, design of the compounds and structure-activity relationships, the conceptual framework and mechanism of action, and rights to the patents or patents pending for such compounds. The Company defers recognition of non-refundable upfront fees if it has continuing performance obligations without which the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the
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licensee that is separate and independent of the Company’s performance under the other elements of the arrangement. In addition, if the Company has required continuing involvement through research and development services that are related to its proprietary know-how and expertise of the delivered technology, or can only be performed by the Company, then such up-front fees are deferred and recognized over the period of continuing involvement.
Payments related to substantive, performance-based milestones in a research and development arrangement are recognized as revenues upon the achievement of the milestones as specified in the underlying agreements when they represent the culmination of the earnings process.
Royalty Arrangements. The Company recognizes royalty revenues from licensed products when earned in accordance with the terms of the license agreements. Net sales amounts generally required to be used for calculating royalties include deductions for returned product, pricing allowances, cash discounts, freight and warehousing. These arrangements are often multiple element arrangements.
Certain royalty arrangements require that royalties are earned only if a sales threshold is exceeded. Under these types of arrangements, the threshold is typically based on annual sales. For royalty revenue generated from the license agreement with GlaxoSmithKline (“GSK”), the Company recognizes royalty revenue in the period in which the threshold is exceeded.
When the Company sells its rights to future royalties under license agreements and also maintains continuing involvement in earning such royalties, it defers recognition of any upfront payments and recognizes them as revenues over the life of the license agreement. The Company recognizes revenues for the sale of an undivided interest of its Abreva® license agreement to Drug Royalty USA under the “units-of-revenue method.” Under this method, the amount of deferred revenues to be recognized in each period is calculated by multiplying the ratio of the royalty payments due to Drug Royalty USA by GSK for the period to the total remaining royalties the Company expects GSK will pay Drug Royalty USA over the remaining term of the agreement by the unamortized deferred revenues.
Cost of product revenues
Cost of product revenues includes third-party royalties and direct and indirect costs to manufacture product sold, including packaging, storage, shipping and handling costs and the write-off of obsolete inventory.
Recognition of expenses in outsourced contracts
Pursuant to management’s assessment of the services that have been performed on clinical trials and other contracts, the Company recognizes expense as the services are provided. Such management assessments include, but are not limited to: (1) an evaluation by the project manager of the work that has been completed during the period, (2) measurement of progress prepared internally and/or provided by the third-party service provider, (3) analyses of data that justify the progress, and (4) management’s judgment. Several of the Company’s contracts extend across multiple reporting periods.
Research and development expenses
Research and development expenses consist of expenses incurred in performing research and development activities including salaries and benefits, facilities and other overhead expenses, clinical trials, contract services and outsource contracts. Research and development expenses are charged to operations as they are incurred. Up-front payments to collaborators made in exchange for the avoidance of potential future milestone and royalty payments on licensed technology are also charged to research and development expense when the drug is still in the development stage, has not been approved by the FDA for commercialization and currently has no alternative uses.
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The Company assesses its obligations to make milestone payments that may become due under licensed or acquired technology to determine whether the payments should be expensed or capitalized. The Company charges milestone payments to research and development expense when:
•
The technology is in the early stage of development and has no alternative uses;
•
There is substantial uncertainty regarding the future success of the technology or product;
•
There will be difficulty in completing the remaining development; and
•
There is substantial cost to complete the work.
Acquired contractual rights. Payments to acquire contractual rights to a licensed technology or drug candidate are expensed as incurred when there is uncertainty in receiving future economic benefits from the acquired contractual rights. The Company considers the future economic benefits from the acquired contractual rights to a drug candidate to be uncertain until such drug candidate is approved by the FDA or when other significant risk factors are abated.
Share-based compensation
The Company grants options, restricted stock units and restricted stock awards to purchase the Company’s common stock to employees, directors and consultants under stock option plans. The benefits provided under these plans are share-based payments that the Company accounts for using the fair value method.
The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option pricing model (“Black-Scholes model”) that uses assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, expected stock price volatility, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Expected volatilities are based on historical volatility of common stock and other factors. The expected terms of options granted are based on analyses of historical employee termination rates and option exercises. The risk-free interest rates are based on the U.S. Treasury yield in effect at the time of the grant. Since the Company does not expect to pay dividends on common stock in the foreseeable future, it estimated the dividend yield to be 0%.
Share-based compensation expense recognized during a period is based on the value of the portion of share-based payment awards that is ultimately expected to vest amortized under the straight-line attribution method. As share-based compensation expense recognized in the consolidated statements of operations for fiscal 2011, 2010, and 2009 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The fair value method requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company estimates forfeitures based on historical experience. Changes to the estimated forfeiture rate are accounted for as a cumulative effect of change in the period the change occurred.
During fiscal 2011, the Company reduced the estimated forfeiture rate from 12.6% to 7.0%. This change in the estimated forfeiture rates resulted in an increase in share-based compensation expense of approximately $40,000 with no effect on loss per share for fiscal 2011.
During fiscal 2010, the Company reduced the estimated forfeiture rate on certain restricted stock unit awards from 12.6% to zero percent, as management expected all the awards to vest. This change in the estimated forfeiture rate resulted in an increase in share-based compensation expense of approximately $93,000 with no effect on loss per share for fiscal 2010.
In the fourth quarter of fiscal 2009, the Company reviewed the estimated forfeiture rate considering then recent actual data resulting in a reduction to our estimated forfeiture rate from 30.0% to 12.6% in fiscal 2009. Additionally, the Company reduced the estimated forfeiture rate on certain restricted stock unit awards from 30.0% to zero
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percent, as management expected all the awards to vest. These changes in the estimated forfeiture rates during fiscal 2009 resulted in an increase in share-based compensation expense of $935,000 and an increase to loss per share of $0.01 for fiscal 2009.
Total compensation expense related to all of the Company’s share-based awards for fiscal 2011, 2010 and 2009 was comprised of the following:
Since the Company has a net operating loss carry-forward as of September 30, 2011, 2010, and 2009, no excess tax benefits for the tax deductions related to share-based awards were recognized in the consolidated statements of operations. Additionally, no incremental tax benefits were recognized from stock options exercised in fiscal 2011, 2010, and 2009 that would have resulted in a reclassification from cash flows from operating activities to cash flows from financing activities.
Restructuring expense
The Company records costs and liabilities associated with exit and disposal activities at fair value in the period the liability is incurred. In periods subsequent to initial measurement, changes to a liability are measured using the credit-adjusted risk-free rate applied in the initial period. In fiscal 2009, the Company recorded costs and liabilities for exit and disposal activities related to a relocation plan that was implemented in 2006. Refer to Note 7, “Accrued Expenses and Other Liabilities,” for further information.
Advertising expenses
Advertising costs are expensed as incurred, and these costs are included in both research and development expenses as related to clinical trials, and selling, general and administrative expenses, which include promotional materials for physicians. Advertising costs were approximately $5.7 million, $1.2 million and $336,000 for fiscal 2011, 2010, and 2009, respectively.
Income taxes
The Company accounts for income taxes and the related accounts under the liability method. Deferred tax assets and liabilities are determined based on the differences between the consolidated financial statement carrying amounts and the income tax bases of assets and liabilities. A valuation allowance is applied against any net deferred tax asset if, based on available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
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The Company recognizes any uncertain income tax positions on income tax returns at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.
The total unrecognized tax benefit resulting in a decrease in deferred tax assets and corresponding decrease in the valuation allowance at September 30, 2011 is $3.3 million. There are no unrecognized tax benefits included in the consolidated balance sheet that would, if recognized, affect the effective tax rate.
The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had $0 accrued for interest and penalties on the Company’s consolidated balance sheets at September 30, 2011 and 2010.
The Company is subject to taxation in the U.S. and various state jurisdictions. The Company’s tax years for 1994 and forward are subject to examination by the U.S. and California tax authorities due to the carryforward of unutilized net operating losses and research and development credits.
The Company does not foresee material changes to its gross uncertain income tax position liability within the next twelve months.
In July 2010, the Company applied for the Qualifying Therapeutic Discovery Project tax credit (“Therapeutic Credit”). The Therapeutic Credit allows qualifying businesses to claim a credit for 50% of their qualified investment in qualifying projects for tax years 2010 and 2009. In November 2010, the Company received notification from the Internal Revenue Service that it was granted a credit of approximately $244,000 related to the Therapeutic Credit. The Company elected to receive a cash grant in lieu of the credit which it received in May 2011. The cash grant is recorded as an offset to research and development expenses in the accompanying consolidated statement of operations for fiscal 2011.
Comprehensive Gain (Loss)
Comprehensive gain (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on marketable securities. The Company has incurred no comprehensive gains or losses during fiscal years 2011, 2010 and 2009.
Computation of net loss per common share
Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is computed by dividing net loss by the weighted-average number of common and dilutive common equivalent shares outstanding during the period. In the loss periods, the shares of common stock issuable upon exercise of stock options and warrants are excluded from the computation of diluted net loss per share, as their effect is anti-dilutive. There were no restricted shares with right of repurchase excluded from the computation of net loss per share in fiscal 2011, 2010, and 2009.
For fiscal 2011, 2010, and 2009, the following options and warrants to purchase shares of common stock, restricted stock awards and restricted stock units were excluded from the computation of diluted net loss per share, as the inclusion of such shares would be anti-dilutive:
(1) Includes 1,413,481, 1,158,138, and 692,448 shares of restricted stock in fiscal 2011, 2010, and 2009, respectively, awarded to directors that have vested but are still restricted until the directors resign.
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Recent authoritative guidance
Proposed Amendments to Current Accounting Standards. The Financial Accounting Standard Board (“FASB”) is currently working on amendments to existing accounting standards governing a number of areas including, but not limited to, revenue recognition and lease accounting.
In June 2010, the FASB issued an exposure draft, Revenue from Contracts with Customers, which would supersede most of the existing guidance on revenue recognition in Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition. In November 2011, the FASB re-exposed this draft. As the standard-setting process is still ongoing, the Company is unable to determine the impact this proposed change in accounting will have in the Company’s consolidated financial statements at this time.
In August 2010, the FASB issued an exposure draft, Leases, which would result in significant changes to the accounting requirements for both lessees and lessors in ASC Topic 840, Leases. In July 2011, the FASB announced its intention to re-expose the draft which is currently scheduled to re-expose in the first half of 2012. As the standard-setting process is still ongoing, the Company is unable to determine the impact this proposed change in accounting will have in the Company’s consolidated financial statements at this time.
Fair Value Measurement. In May 2011, the FASB issued Accounting Standards Update No. 2011-04, “Fair Value Measurement (Topic 820): Amendment to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU No. 2011-04”). ASU No. 2011-04 amends the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and disclosing information about fair value measurements. The amendments in this update achieve the objective of developing common fair value measurement and disclosure requirements, as well as improving consistency and understandability. Some of the requirements clarify the FASB’s intent about the application of existing fair value measurement requirements while other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this ASU are effective prospectively for interim and annual periods beginning after December 15, 2011, with no early adoption permitted. The Company is required to adopt ASU No. 2011-04 effective its second quarter fiscal 2012. The Company is currently evaluating the effect that this guidance will have on its consolidated financial position, results of operations and cash flows.
Fees Paid to the Federal Government by Pharmaceutical Manufacturers. In December 2010, the FASB ratified a consensus of the Emerging Issues Task Force (“EITF”) related to an annual fee to be paid to the federal government by pharmaceutical manufacturers as mandated by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act. This consensus requires the liability related to the annual fee to be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense generally using a straight-line method of allocation over the calendar year that it is payable. This guidance is effective for calendar years beginning after December 31, 2010, when the fee initially became effective. The Company adopted this guidance effective January 1, 2011. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
Milestone Method of Revenue Recognition. In March 2010, the FASB ratified a consensus of the EITF related to the milestone method of revenue recognition. The consensus codifies a method of revenue recognition that has been common practice. Under this method, contingent consideration from research and development activities that is earned upon the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved. This guidance is effective for annual periods beginning on or after June 15, 2010 but may be early adopted as of the beginning of an annual period. The Company adopted this guidance effective October 1, 2010. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
Multiple-Deliverable Revenue Arrangements. In September 2009, the FASB issued authoritative guidance regarding multiple-deliverable revenue arrangements. This guidance addresses how to measure and allocate
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consideration to one or more units of accounting. Specifically, the guidance requires that consideration be allocated among multiple deliverables based on relative selling prices. The guidance establishes a selling price hierarchy of (1) vendor-specific objective evidence, (2) third-party evidence and (3) estimated selling price. This guidance is effective for annual periods beginning on or after June 15, 2010 but may be early adopted as of the beginning of an annual period. The Company adopted this guidance effective October 1, 2010. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
3. Fair Value of Financial Instruments
The Company measures the fair value of certain of its financial assets on a recurring basis. A fair value hierarchy is used to rank the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
•
Level 1-Quoted prices in active markets for identical assets and liabilities.
•
Level 2-Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets and liabilities, quoted prices in the markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•
Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
As of September 30, 2011 and 2010, the Company’s cash equivalents held in money market mutual funds of approximately $38.4 million and $25.2 million, respectively, are all valued using quoted prices generated by market transactions involving identical assets, or Level 1 as defined by the fair value hierarchy noted above.
4. Restricted Investments in Marketable Securities
Restricted investments in marketable securities at September 30, 2011 and 2010 consist of certificates of deposit, which are classified as held-to-maturity. At September 30, 2011 and 2010, the fair value of these investments approximated their cost basis.
At September 30, 2011, restricted investments in marketable securities totaling approximately $1.6 million, classified as non-current assets, consist of three certificates of deposit that relate to irrevocable standby letters of credit connected to fleet rentals and two office leases with expiration dates in 2013 and 2016. The certificates of deposit related to fleet rentals and the office lease expiring in 2016 automatically renew annually and the certificate of deposit related to the office lease that expires in 2013 renews automatically every 30 days.
Restricted investments in marketable securities also consist of two certificates of deposit totaling approximately $618,300, classified as current assets, that relate to the Company’s corporate credit card agreement and an irrevocable standby letter of credit connected to the short-term portion of an office lease with an expiration date in 2013. The certificate of deposit related to the Company’s credit card agreement automatically renews every three months and the certificate of deposit related to the office lease renews automatically every 30 days.
At September 30, 2010, restricted investments in marketable securities totaling $401,550, classified as a non-current asset, consisted of an investment certificate of deposit that automatically renewed every 30 days that related to a letter of credit connected to an office lease with an expiration date in 2013 and was classified as a non-current asset. Restricted investments in marketable securities also consisted of a $200,000 certificate of deposit that renewed every three months and was related to the Company’s corporate credit card agreement and was classified as a current asset.
Restricted investments of $66,925 matured in fiscal 2010. No restricted investments matured in fiscal 2011.
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5. Inventories
Inventories are comprised of NUEDEXTA finished goods and the active pharmaceutical ingredients of NUEDEXTA, dextromethorphan (“DM”) and quinidine (“Q”), as well as the active pharmaceutical ingredient docosanol.
The composition of inventories as of September 30, 2011 and 2010 is as follows:
The amount classified as non-current inventories is comprised of the raw material components for NUEDEXTA, dextromethorphan and quinidine, which will be used in the manufacture of NUEDEXTA capsules in the future. Included in finished goods inventory is NUEDEXTA that was manufactured in 2010 to obtain FDA approval. This product is currently being sold to wholesalers and is scheduled to expire in 2012. Wholesalers generally will not purchase product that is within 12 months of expiration. As such, the Company recorded an inventory write-down of approximately $82,000 in fiscal 2011 for the estimated amount of NUEDEXTA that may not be shipped due to short-dating. In fiscal 2010, the Company recorded an inventory reserve of approximately $198,000 for docosanol inventory based on estimated usage. In fiscal 2009, the Company recorded an inventory reserve of approximately $456,000 which is primarily comprised of $383,000 for DM and Q supplies that were scheduled to expire in fiscal 2011 and an additional inventory reserve of approximately $69,000 for docosanol inventory.
As of September 30, 2011 and 2010, raw materials represent gross raw materials of approximately $1.5 million and $1.3 million, respectively, offset by inventory reserves of approximately $695,000 and $699,000, respectively. Inventory write-downs may be taken in the future as the Company continues to assess inventory on a periodic basis and due to potential changes in the operating procedures of our contract manufacturers.
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The following table presents the activity in inventory reserves for the last three fiscal years:
6. Property and Equipment
Property and equipment as of September 30, 2011 and 2010 consist of the following:
Depreciation and amortization expense associated with property and equipment was approximately $438,000, $205,000, and $261,000 for fiscal 2011, 2010, and 2009, respectively. In fiscal 2011, approximately $574,426 of
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office equipment was disposed of as it was determined to no longer be in use. The loss on disposal related to the net book value of approximately $9,000 is included in “other, net” on the accompanying consolidated statements of operations. In fiscal 2009, manufacturing equipment with a net book value of approximately $262,000 was disposed as it was determined the equipment was not likely to be used in the packaging process of NUEDEXTA.
7. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities at September 30, 2011 and 2010 are as follows:
(1) In fiscal 2006, the Company relocated all operations other than research and development from San Diego, California to Aliso Viejo, California. In fiscal 2007, the Company subleased a total of approximately 49,000 square feet of laboratory and office space in San Diego and relocated remaining personnel and clinical trial support functions to the Company’s offices in Aliso Viejo, California. Restructuring expenses included recognition of the estimated loss due to the exit of the Company’s leases of approximately $2.1 million. No further costs were incurred related to these restructuring events in fiscal 2008. In April 2009, the Company entered into a sublease for office space in San Diego, California. Sublease rental payments commenced in September 2009 pursuant to this sublease. In September 2009, the Company recognized a loss of approximately $172,000 related to a lease restructuring liability resulting from a sublease entered into in April 2009 for office buildings subleased in San Diego, California. The lease restructuring loss is included in rent expense in fiscal 2009.
The following table presents the restructuring activities in fiscal 2011:
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The following table presents the restructuring activities in fiscal 2010:
8. Deferred Revenues/Sale of Licenses
The following table sets forth as of September 30, 2011 and 2010 the net deferred revenue balances for NUEDEXTA product shipments and the Company’s sale of future Abreva® royalty rights to Drug Royalty USA.
(1) The amount that ultimately will be recognized as net product sales may be different due to other discounts and allowances, including, but not limited to, wholesaler fees based on wholesaler shipments, rebates, chargebacks and co-pay assistance.
NUEDEXTA Product - The amount of deferred revenue from NUEDEXTA product shipments is shown net of estimated prompt-pay discounts and wholesaler fees based on wholesaler purchases. The amount that ultimately will be recognized as net product sales in the Company’s consolidated financial statements may be different due to other
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discounts and allowances, including, but not limited to, wholesaler fees based on wholesaler shipments, rebates, chargebacks and co-pay assistance. See Note 2, “Summary of Significant Accounting Policies - Revenue recognition - Product Sales - NUEDEXTA,” for further discussion.
Drug Royalty Agreement - In November 2002, the Company sold to Drug Royalty USA an undivided interest in the Company’s rights to receive future Abreva royalties under the license agreement with GlaxoSmithKline for $24.1 million (the “Drug Royalty Agreement” and the “GSK License Agreement,” respectively). Under the Drug Royalty Agreement, Drug Royalty USA has the right to receive royalties from GlaxoSmithKline on sales of Abreva until December 2013. The Company retained the right to receive 50% of all royalties (a net of 4%) under the GSK License Agreement for annual net sales of Abreva in the U.S. and Canada in excess of $62 million. In fiscal 2011, 2010, and 2009, the Company recognized royalties related to the annual net Abreva sales in excess of $62 million in the amount of approximately $1.5 million, $942,000 and $951,000, respectively, which is included in the consolidated statements of operations as revenues from royalties and royalty rights.
In the fourth quarter of fiscal 2010, the Company recorded a cumulative non-cash adjustment to correct an immaterial error related to previously recorded deferred royalty revenue related to the GSK license agreement. The total cumulative non-cash adjustment recorded in the fourth quarter was a decrease in revenue of $797,000 which resulted in net revenues of ($71,000) in the fourth fiscal quarter of 2010 and $2.9 million for fiscal 2010.
Revenues are recognized when earned, collection is reasonably assured and no additional performance of services is required. The Company classified the proceeds received from Drug Royalty USA as deferred revenue, and is recognizing the revenue over the life of the license agreement because of the Company’s continuing involvement over the term of the Drug Royalty Agreement. Such continuing involvement includes overseeing the performance of GlaxoSmithKline and its compliance with the covenants in the GSK License Agreement, monitoring patent infringement, adverse claims or litigation involving Abreva, and undertaking to find a new license partner in the event that GlaxoSmithKline terminates the agreement. The Drug Royalty Agreement contains both covenants and events of default that require such performance on the Company’s part. Therefore, nonperformance on the Company’s part could result in default of the arrangement, and could give rise to additional rights in favor of Drug Royalty USA under a separate security agreement with Drug Royalty USA, which could result in loss of the Company’s rights to share in future Abreva royalties if wholesale sales by GlaxoSmithKline exceed $62 million a year. The deferred revenue is being recognized as revenue using the “units-of-revenue method” over the life of the license agreement. Based on a review of the Company’s continuing involvement, the Company concluded that the sale proceeds did not meet any of the rebuttable presumptions that would require classification of the proceeds as debt.
Kobayashi Docosanol License Agreement - In January 2006, the Company signed an exclusive license agreement with Kobayashi Pharmaceutical Co., Ltd. (“Kobayashi”), a Japanese corporation, to allow Kobayashi to market in Japan medical products that are curative of episodic outbreaks of herpes simplex or herpes labialis and that contain a therapeutic concentration of the Company’s docosanol 10% cream.
In April 2009, the license agreement with Kobayashi was terminated and no termination fees were incurred. In the third quarter of fiscal 2009, the Company recognized approximately $170,000 in revenue which was previously deferred relating to the approximately $860,000 data transfer fee received in March 2006 upon initiation of the agreement.
During fiscal 2009, the Company recognized total revenues of approximately $284,000 related to the Kobayashi agreement.
Emergent Biosolutions License Agreement - In March 2008, the Company entered into an Asset Purchase and License Agreement with Emergent Biosolutions (“Emergent”) for the sale of the Company’s anthrax antibodies and license to use its proprietary Xenerex Technology platform. Under the terms of the definitive agreement, the Company received upfront payments totaling $500,000, of which $250,000 was deferred and recognized in the
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fourth quarter of fiscal 2008 upon delivery of all materials to Emergent. The Company has the potential to receive up to $1.25 million in milestone payments, as well as royalties on annual net sales if the product is commercialized. Milestone payments of $250,000 are included in the consolidated statements of operations as revenues from license agreements in fiscal 2009. No revenue was received from this agreement in fiscal 2011 and 2010.
In October 2010, AVP-21D9 for the treatment of inhalation anthrax was granted Orphan Drug Designation and Fast Track Designation. Emergent has initiated a Phase I clinical trial for AVP-21D9.
9. Commitments and Contingencies
Operating lease commitments. The Company leases approximately 30,000 square feet of office space in Aliso Viejo, California. The lease has scheduled rent increases each year and expires in 2016. As of September 30, 2011, the financial commitment for the remainder of the term of the lease is approximately $3.8 million.
The Company leases approximately 30,370 square feet of office and lab space in San Diego, California. The lease has scheduled rent increases each year and expires in 2013. All 30,370 square feet of office and lab space is subleased through January 14, 2013. The sublease has scheduled rent increases each year. As of September 30, 2011, the financial commitment for the remainder of the term of the lease is approximately $1.6 million (excluding the benefit of approximately $1.3 million of payments to be received from the subleases). The Company delivered an irrevocable standby letter of credit to the lessor in the amount of approximately $402,000, to secure the Company’s performance under the lease (see Note 4).
Rent expense, excluding common area charges and other costs, was approximately $1.9 million, $1.6 million and $1.5 million in fiscal 2011, 2010, and 2009, respectively. Sublease rent income totaled approximately $961,000, $889,000 and $907,000 in fiscal 2011, 2010 and 2009, respectively. Future minimum rental payments under non-cancelable operating lease commitments as of September 30, 2011 areas follows:
Legal contingencies.
NUEDEXTA ANDA Litigation
In June and July 2011, the Company received Paragraph IV certification notices from four separate companies contending that certain of its patents listed in the FDA Orange Book (U.S. Patents 7,659,282 (“’282 Patent”) and RE 38,115 (“’115 Patent”), which expire in August 2026 and January 2016, respectively) are invalid, unenforceable and/or will not be infringed by the manufacture, use, sale or offer for sale of a generic form of NUEDEXTA as described in those companies’ abbreviated new drug applications (“ANDA”). In August 2011, the Company filed lawsuits in the U.S District Court for the District of Delaware against Par Pharmaceutical, Inc. and Par Pharmaceutical Companies, Inc. (collectively “Par”), Actavis South Atlantic LLC and Actavis, Inc. (collectively “Actavis”), Wockhardt USA, LLC and Wockhardt, Ltd. (collectively, “Wockhardt”), and Impax Laboratories, Inc. (“Impax”) (Par, Actavis, Wockhardt and Impax, collectively the “Defendants”). All four lawsuits (collectively, the
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“ANDA Actions”) were filed on the basis that the Defendants’ submissions of their respective ANDAs to obtain approval to manufacture, use, sell, or offer for sale generic versions of NUEDEXTA prior to the expiration of the ‘282 Patent and the ‘115 Patent listed in the FDA Orange Book constitute infringement of one or more claims of those patents.
Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of the ANDAs submitted by the Defendants can occur no earlier than October 29, 2013. Further, as a result of the 30-month stay associated with the filing of the ANDA Actions, the FDA cannot grant final approval to any ANDA before December 30, 2013, unless there is an earlier court decision holding that the ‘282 and ‘115 patents are not infringed and/or are invalid. The Company intends to vigorously enforce its intellectual property rights relating to NUEDEXTA, but the Company cannot predict the outcome of these matters.
Alamo and Azur Litigation
In October 2011, Neal R. Cutler, M.D., the founder of Alamo Pharmaceuticals, LLC (“Alamo”), filed a lawsuit in California Superior Court against AzurPharma International III Limited and AzurPharma Limited (collectively, “Azur”) and Avanir (the “Cutler Action”). The Company purchased Alamo in 2006 to acquire rights to FazaClo, an approved anti-psychotic drug. In connection with this acquisition of Alamo, the Company agreed to provide the Alamo equity holders, including Dr. Cutler, with milestone payments tied to the aggregate net revenues of FazaClo. In 2007, the Company sold FazaClo and its related assets and operations to Azur. In connection with this sale, Azur agreed to assume the milestone payment obligations due to Dr. Cutler under the Alamo purchase agreement, although the Company may remain liable for these payments if Azur defaults on these obligations. In the Cutler Action, Dr. Cutler alleges that Azur has failed to make certain information reasonably available to Dr. Cutler and has withheld payments to which Dr. Cutler is entitled. Dr. Cutler alleges that Avanir has acquiesced in this conduct, and Dr. Cutler seeks to hold both Azur and Avanir liable for these actions. Dr. Cutler is seeking damages in an amount that may exceed $35.0 million, as well as attorneys’ fees. As of September 30, 2011, the Company has not recorded any liability related to any potential legal settlement that may be assessed against it. However, the Company will continue to evaluate the need for any such liability in the future.
General and Other
In the ordinary course of business, the Company may face various claims brought by third parties and the Company may, from time to time, make claims or take legal actions to assert the Company’s rights, including intellectual property rights as well as claims relating to employment and the safety or efficacy of products. Any of these claims could subject the Company to costly litigation and, while the Company generally believes that the Company has adequate insurance to cover many different types of liabilities, the Company’s insurance carriers may deny coverage or policy limits may be inadequate to fully satisfy any damage awards or settlements. If this were to happen, the payment of any such awards could have a material adverse effect on the Company’s consolidated operations, cash flows and financial position. Additionally, any such claims, whether or not successful, could damage the Company’s reputation and business. Management believes the outcomes of currently pending claims and lawsuits will not likely have a material effect on the Company’s consolidated operations or financial position.
In May 2010, the Company received proceeds from a legal settlement in the amount of approximately $390,000. The proceeds were recorded as Other, net under Other Income (Expense) in the consolidated statement of operations in fiscal 2010.
In addition, it is possible that the Company could incur termination fees and penalties if it elected to terminate contracts with certain vendors, including clinical research organizations.
Guarantees and Indemnities. The Company indemnifies its directors and officers to the maximum extent permitted under the laws of the State of Delaware, and various lessors in connection with facility leases for certain claims arising from such facilities or leases. Additionally, the Company periodically enters into contracts that
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contain indemnification obligations, including contracts for the purchase and sale of assets, wholesale distribution agreements, clinical trials, pre-clinical development work and securities offerings. These indemnification obligations provide the contracting parties with the contractual right to have Avanir pay for the costs associated with the defense and settlement of claims, typically in circumstances where Avanir has failed to meet its contractual performance obligations in some fashion.
The maximum amount of potential future payments under such indemnifications is not determinable. The Company has not incurred significant costs related to these guarantees and indemnifications, and no liability has been recorded in the consolidated financial statements for guarantees and indemnifications as of September 30, 2011 and 2010.
Center for Neurologic Study (“CNS”) - The Company holds the exclusive worldwide marketing rights to NUEDEXTA for certain indications pursuant to an exclusive license agreement with CNS.
We paid a $75,000 milestone upon FDA approval of NUEDEXTA for the treatment of PBA in fiscal 2011. In addition, we are obligated to pay CNS a royalty ranging from approximately 5% to 8% of net GAAP revenue generated by sales of NUEDEXTA. Under certain circumstances, we may have the obligation to pay CNS a portion of net revenues received if we sublicense NUEDEXTA to a third party.
Under the agreement with CNS, we are required to make payments on achievements of up to a maximum of ten milestones, based upon five specific clinical indications. Maximum payments for these milestone payments could total approximately $1.1 million if we pursued the development of NUEDEXTA for all five of the licensed indications. In general, individual milestones range from $75,000 to $125,000 for each accepted new drug application (“NDA”) and a similar amount for each approved NDA in addition to the royalty discussed above on net GAAP revenues. We do not have the obligation to develop additional indications under the CNS license agreement.
10. Stockholders’ Equity
Preferred Stock
In March 2009, the Board of Directors approved a stockholder rights plan (the “Plan”) that provides for the issuance of Series A junior participating preferred stock to each stockholder of record under certain circumstances. None of the Series A junior participating preferred stock was outstanding on September 30, 2011 and 2010. The Plan provided for a dividend distribution of one preferred share purchase right (the “Right”) on each outstanding share of common stock, payable on shares outstanding as of March 20, 2009 (the “Record Date”). All shares of common stock issued by the Company after the Record Date have been issued with such Rights attached. Subject to limited exceptions, the Rights would become exercisable if a person or group acquires 20% or more of the Company’s common stock or announces a tender offer for 20% or more of the Company’s common stock (a “Trigger Event”).
If and when the Rights become exercisable, each Right will entitle stockholders, excluding the person or group causing the Trigger Event (an “Acquiring Person”), to buy a fraction of a share of Series A junior participating preferred stock at a fixed price. In certain circumstances following a Trigger Event, each Right will entitle its owner, who is not an Acquiring Person, to purchase at the Right’s then current exercise price, a number of shares of common stock having a market value equal to twice the Right’s exercise price. Rights held by any Acquiring Person would become void and not be exercisable to purchase shares at the discounted purchase price.
The Board of Directors may redeem the Rights at $0.0001 per Right at any time before a person has acquired 20% or more of the outstanding common stock. The Rights will expire on March 20, 2019, subject to a periodic review of the Plan by a committee of independent directors.
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Common stock
Fiscal 2011. In November 2010, the Company completed a common stock offering raising $88.0 million in gross proceeds and approximately $83.0 million in net proceeds to the Company after deducting underwriting discounts, commissions and offering expenses. In connection with the offering, 20 million shares of common stock were sold at a public offering price of $4.40 per share. The Company intends to use the net proceeds for operating expenses. In addition, the net proceeds may be used for further clinical, regulatory and commercial development of AVP-923, as well as business development activities.
On July 30, 2009, the Company entered into a Controlled Equity Offering Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co. (“Cantor”), providing for the sale of up to 12,500,000 shares of common stock from time to time into the open market at prevailing prices. Pursuant to the Sales Agreement, sales of common stock are made in such quantities and on such minimum price terms as the Company may set from time to time. During fiscal 2011, 2,147,000 shares of common stock were sold under the Sales Agreement at an average price of $3.78 per share raising proceeds of $8.1 million ($7.9 million after offering expenses, including commissions). The Company issued an additional 180,000 shares, in connection with the Sales Agreement, that were recorded as a stock subscription receivable at September 30, 2010. The proceeds were received in fiscal 2011. As of September 30, 2011, a total of 8,686,510 shares of common stock were sold under the Sales Agreement at an average price of $2.84 per share raising gross proceeds of $24.7 million ($23.7 million after offering expenses, including commissions).
During fiscal 2011, the Company issued 252,941 shares of common stock in connection with the vesting of restricted stock units. In connection with the vesting, an officer exercised his option to pay for minimum required withholding taxes associated with the vesting of restricted stock by surrendering 1,446 shares of common stock at an average market price of $3.92 per share.
Also during fiscal 2011, the Company issued 814,454 shares of common stock upon the exercise of outstanding options.
Fiscal 2010. In May 2010, the Company closed an underwritten securities offering raising $27.5 million in gross proceeds and approximately $26.6 million in net proceeds to the Company after deducting underwriting discounts, commissions and offering expenses. In connection with the offering, 10 million shares of common stock were sold at a public offering price of $2.75 per share.
During fiscal 2010, 1,926,160 shares of common stock were sold under the Sales Agreement at an average price of $3.00 per share raising proceeds of $5.8 million ($5.6 million after offering expenses, including commissions). At September 30, 2010, the Company had not issued 180,000 shares sold in connection with the Sales Agreement. The Company recorded a stock subscription receivable of approximately $581,000 at September 30, 2010 related to the net proceeds in consideration for the 180,000 shares sold.
During fiscal 2010, the Company issued 1,185,258 shares of common stock in connection with the vesting of restricted stock units. In connection with the vesting, two officers and three employees exercised their option to pay for minimum required withholding taxes associated with the vesting of restricted stock by surrendering 90,606 and 15,258 shares of common stock, respectively, at an average market price of $2.02 and $1.97 per share, respectively.
Also during fiscal 2010, the Company issued 55,836 shares of common stock upon the exercise of outstanding options.
Fiscal 2009. During fiscal 2009, 4,613,350 shares of common stock were issued under the Sales Agreement at an average price of $2.34 per share raising gross proceeds of $10.8 million ($10.2 million after offering expenses, including commissions).
During fiscal 2009, the Company issued 346,294 shares of common stock in connection with the vesting of restricted stock units. In connection with the vesting, two officers and three employees exercised their option to pay
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for minimum required withholding taxes associated with the vesting of restricted stock by surrendering 77,046 and 12,402 shares of common stock, respectively, at an average market price of $2.08 and $2.13 per share, respectively.
Warrants
During fiscal 2011, the Company received proceeds of approximately $8.7 million from the exercise of warrants to purchase 6,085,267 shares of the Company’s common stock. The warrants had been issued in connection with the Company’s registered securities offering in April 2008 at an exercise price of $1.43 per share. As of September 30, 2011, warrants to purchase 6,155,170 shares of the Company’s common stock at a weighted-average exercise price per share of $1.43 remained outstanding, all of which are exercisable. The warrants expire in April 2013. The warrants outstanding at September 30, 2011 are callable by the Company when the Company’s stock price reaches 400% of the warrant’s exercisable price for at least twenty trading days during any consecutive sixty day period.
A summary of common stock issued for fiscal 2011, 2010, and 2009 is shown in the table below:
(1) Amount received represents the amount before the cost of financing and underwriter’s discount.
(2) Average price per share has been rounded to two decimal places.
Employee Equity Incentive Plans
The Company currently has five equity incentive plans (the “Plans”): the 2005 Equity Incentive Plan (the “2005 Plan”), the 2003 Equity Incentive Plan (the “2003 Plan”), the 2000 Stock Option Plan (the “2000 Plan”), the 1998 Stock Option Plan (the “1998 Plan”) and the 1994 Stock Option Plan (the “1994 Plan”), which are described
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below. The 1994 Plan, 1998 Plan and 2000 Plan are expired and the Company no longer grants share-based awards from these plans. All of the Plans were approved by the stockholders, except for the 2003 Plan, which was approved solely by the Board of Directors. Share-based awards are subject to terms and conditions established by the Compensation Committee of the Company’s Board of Directors. The Company’s policy is to issue new common shares upon the exercise of stock options, conversion of share units or purchase of restricted stock.
During fiscal 2011, 2010, and 2009, the Company granted share-based awards under both the 2003 Plan and the 2005 Plan. Under the 2003 Plan and 2005 Plan, options to purchase shares, restricted stock units, restricted stock and other share-based awards may be granted to the Company’s directors, employees and consultants. Under the Plans, as of September 30, 2011, the Company had an aggregate of 18,014,271 shares of common stock reserved for issuance. Of those shares, 9,882,109 were subject to outstanding options and other awards and 8,132,162 shares were available for future grants of share-based awards. The Company may also issue share-based awards outside of the Plans. As of September 30, 2011, there were no options to purchase shares of common stock that were issued outside of the Plans (inducement option grants). None of the share-based awards is classified as a liability as of September 30, 2011.
2005 Equity Incentive Plan. On March 17, 2005, the Company’s stockholders approved the adoption of the 2005 Plan that initially provided for the issuance of up to 500,000 shares of common stock, plus an annual increase beginning in fiscal 2006 equal to the lesser of (a) 1% of the shares of common stock outstanding on the last day of the immediately preceding fiscal year, (b) 325,000 shares of common stock, or (c) such lesser number of shares of common stock as the Board of Directors shall determine. Pursuant to the provisions of annual increases, the number of authorized shares of common stock for issuance under the 2005 Plan increased by 273,417 shares effective November 16, 2005, 317,084 shares effective November 30, 2006, and an additional 325,000 shares effective for each date of December 4, 2007, November 6, 2008, November 11, 2009 and November 10, 2010 to a total of 2,390,501 shares. In February 2006, the Company’s stockholders eliminated the limitation on the number of shares of common stock that may be issued as restricted stock under the 2005 Plan. The 2005 Plan allows the Company to grant options, restricted stock awards and stock appreciation rights to the Company’s directors, officers, employees and consultants. As of September 30, 2011, 574,382 shares of common stock remained available for issuance under the 2005 Plan.
2003 Equity Incentive Plan. On March 13, 2003, the Board of Directors approved the adoption of the 2003 Plan that provides for the issuance of up to 625,000 shares of common stock, plus an annual increase beginning January 2004 equal to the lesser of (a) 5% of the number of shares of common stock outstanding on the immediately preceding December 31, or (b) a number of shares of common stock set by the board of directors. Pursuant to the provisions of annual increases, the number of authorized shares of common stock for issuance under the 2003 Plan increased by 1,528,474 shares effective November 30, 2005, 1,857,928 shares effective August 3, 2007, 2,158,220 shares effective February 21, 2008, 3,911,352 shares effective February 19, 2009, 4,158,905 shares effective February 18, 2010, and an additional 4,255,003 shares effective February 7, 2011 to a total of 18,494,882 shares. Of the additional 3,911,352 shares effective February 19, 2009, the Board of Directors provided that no more than 2,346,811 shares would be available to grant in calendar 2009. The 2003 Plan allows the Company to grant options, restricted stock awards and stock appreciation rights to the Company’s directors, officers, employees and consultants. As of September 30, 2011, 7,557,780 shares of common stock remained available for issuance under the 2003 Plan.
Stock Options. Stock options are granted with an exercise price equal to the current market price of the Company’s common stock at the grant date and have 10-year contractual terms. Options awards typically vest in accordance with one of the following schedules:
a. 25% of the option shares vest and become exercisable on the first anniversary of the grant date and the remaining 75% of the option shares vest and become exercisable quarterly in equal installments thereafter over three years;
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b. One-third of the option shares vest and become exercisable on the first anniversary of the grant date and the remaining two-thirds of the option shares vest and become exercisable daily or quarterly in equal installments thereafter over two years;
c. 6.25% vest upon obtainment of a performance target and the remaining option shares vest and become exercisable quarterly in equal installments thereafter over 3.75 years; or
d. Options fully vest and become exercisable at the date of grant.
Certain option awards provide for accelerated vesting if there is a change in control (as defined in the Plans). Summaries of stock options outstanding and changes during fiscal 2011 are presented below.
The weighted average grant-date fair values of options granted during fiscal 2011, 2010, and 2009 were $3.18, $1.56 and $0.40 per share, respectively. The total intrinsic value of options exercised during fiscal 2011 and 2010 was $2.5 million and $116,000, respectively, based on the differences in market prices on the dates of exercise and the option exercise prices. There were no stock options exercised in fiscal 2009. As of September 30, 2011, the total unrecognized compensation cost related to options was approximately $9.6 million, which is expected to be recognized over a weighted-average period of 2.6 years, based on the vesting schedules.
The fair value of each option award is estimated on the date of grant using the Black-Scholes model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Company’s common stock and other factors. The expected term of options granted is based on analyses of historical employee termination rates and option exercises. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant.
Assumptions used in the Black-Scholes model for options granted during fiscal 2011, 2010, and 2009 were as follows:
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The following table summarizes information concerning outstanding and exercisable stock options as of September 30, 2011:
Restricted stock units (“RSU”). RSUs generally vest based on three years of continuous service and may not be sold or transferred until the awardee’s termination of service. The following table summarizes the RSU activities for fiscal 2011:
The weighted average grant-date fair value of RSUs granted during fiscal 2011, 2010, and 2009 was $4.12, $2.00 and $0.44 per unit, respectively. The fair value of RSUs vested during fiscal 2011, 2010, and 2009 was approximately $1.1 million, $2.2 million and $1.1 million, respectively. As of September 30, 2011, the total unrecognized compensation cost related to unvested stock units was approximately $784,000, which is expected to be recognized over a weighted-average period of 0.8 years, based on the vesting schedules and assuming no forfeitures.
At September 30, 2011, there were 1,413,481 shares of restricted stock with a weighted-average grant date fair value of $1.78 per share awarded to directors that have vested but are still restricted until the directors resign. In fiscal 2011, 2010, and 2009, 255,343, 465,689 and 519,062 shares of restricted stock, respectively, vested but remained restricted.
During fiscal 2011, the Company awarded performance-based RSUs (“Performance RSUs”) to purchase up to 166,813 shares of the Company’s common stock. The grant date fair value of these awards was $4.18 per share. The RSUs have a performance goal that determines the actual number of shares to be awarded. If the goal is met by the target date, no shares are forfeited. If the goal is met within two months after the target date, 25% of the shares will be forfeited and if the goal is not met within two months after the target date, all shares will be forfeited. As of September 30, 2011, the performance goal had been achieved and no shares were forfeited. The shares vest 50% on the first anniversary of the grant date and the remaining 50% on the second anniversary of the grant date.
During fiscal 2010, the Company awarded an RSU representing the right to acquire a total of 120,000 shares of common stock to a non-employee. The grant date fair value of this award was $2.08 per share. The restricted stock units vest on the earlier of October 15, 2011 or the completion of a performance target, and are re-measured at each balance sheet date until vested.
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In November 2009, the Company’s compensation committee approved a modification to the vesting schedule of RSUs originally granted on December 4, 2007 (“12/4/2007 Modified Awards”). The 12/4/2007 Modified Awards originally were to vest 50% upon the earlier of the completion of a Company milestone or December 4, 2010, and the remaining 50% on December 4, 2010. The awards’ vesting was modified to vest equally over two specified dates, March 15, 2010 and December 4, 2010. The 12/4/2007 Modified Awards are for an aggregate of 480,785 RSUs held by eight employees, including officers. The modification did not change the probability of vesting and did not result in any incremental share-based compensation. At the date of modification, no RSUs were vested and the remaining unamortized share-based compensation expense was amortized over the remaining vesting periods of the 12/4/2007 Modified Awards.
In June 2009, the Company’s compensation committee approved a modification to the vesting schedule of RSUs originally granted on March 21, 2007 (“3/21/2007 Modified Awards”). The 3/21/2007 Modified Awards originally were to vest 50% upon the earlier of the completion of a Company milestone or March 21, 2010, and the remaining 50% on March 21, 2010. The awards’ vesting was modified to vest equally over four specified dates through August 31, 2010. The 3/21/2007 Modified Awards were for an aggregate of 1,200,708 RSUs held by eight grantees, including officers and employees. The modification did not change the probability of vesting and did not result in any incremental share-based compensation. At the date of modification, no RSUs were vested and the remaining unamortized share-based compensation expense was amortized over the remaining vesting periods of the 3/21/2007 Modified Awards.
11. Research, License, Supply and other Agreements
Center for Neurologic Study (“CNS”) - The Company holds the exclusive worldwide marketing rights to NUEDEXTA for certain indications pursuant to an exclusive license agreement with CNS.
We paid a $75,000 milestone upon FDA approval of NUEDEXTA for the treatment of PBA in fiscal 2011. In addition, we are obligated to pay CNS a royalty ranging from approximately 5% to 8% of net GAAP revenue generated by sales of NUEDEXTA. During fiscal 2011, we recorded royalties of approximately $389,000 related to NUEDEXTA product shipments. Of this amount, approximately $309,000 is recorded to cost of product sales in the condensed consolidated statements of operations for fiscal 2011, and the remaining $80,000 represents deferred cost of product sales and is recorded in other current assets in the consolidated balance sheet at September 30, 2011. Under certain circumstances, we may have the obligation to pay CNS a portion of net revenues received if we sublicense NUEDEXTA to a third party.
Under the agreement with CNS, we are required to make payments on achievements of up to a maximum of ten milestones, based upon five specific clinical indications. Maximum payments for these milestone payments could total approximately $1.1 million if we pursued the development of NUEDEXTA for all five of the licensed indications. In general, individual milestones range from $75,000 to $125,000 for each accepted NDA and a similar amount for each approved NDA in addition to the royalty discussed above on net GAAP revenues. We do not have the obligation to develop additional indications under the CNS license agreement.
HBI Docosanol License Agreement - In July 2006, the Company entered into an exclusive license agreement with Healthcare Brands International, pursuant to which the Company granted to HBI the exclusive rights to develop and commercialize docosanol 10% in the following countries: Austria, Belgium, Czech Republic, Estonia, France, Germany, Hungary, Ireland, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal, Russia, Slovakia, Slovenia, Spain, Ukraine and the United Kingdom. The HBI License Agreement automatically expires on a country-by-country basis upon the later to occur of (a) the 15th anniversary of the first commercial sale in each respective country in the Licensed Territory or (b) the date the last claim of any patent licensed under the HBI License Agreement expires or is invalidated that covers sales of licensed products in each such country in the Licensed Territory. The Company did not receive any payments under the HBI License Agreement during fiscal 2011, 2010 or 2009.
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Kobayashi Docosanol License Agreement - In January 2006, the Company signed an exclusive license agreement with Kobayashi Pharmaceutical Co., Ltd. (“Kobayashi”), a Japanese corporation, to allow Kobayashi to market in Japan medical products that are curative of episodic outbreaks of herpes simplex or herpes labialis and that contain a therapeutic concentration of the Company’s docosanol 10% cream.
In April 2009, the license agreement with Kobayashi was terminated and no termination fees were incurred. In fiscal 2009, the Company recognized approximately $170,000 in revenue which was previously deferred relating to the $860,000 data transfer fee received in March 2006 upon initiation of the agreement.
During fiscal 2009, the Company recognized total revenues of approximately $284,000 related to the Kobayashi agreement. The Company did not recognize any revenue related to the Kobayashi agreement during fiscal 2011 or 2010.
GlaxoSmithKline Subsidiary, SB Pharmco Puerto Rico, Inc. (“GSK”). On March 31, 2000, the Company signed an exclusive license agreement with GSK for rights to manufacture and sell Abreva (docosanol 10% cream) as an over-the-counter product in the United States and Canada as a treatment for recurrent oral-facial herpes. Under the terms of the license agreement, GSK Consumer Healthcare is responsible for all sales and marketing activities and the manufacturing and distribution of Abreva in the U.S. and Canada. The terms of the license agreement provide for the Company to earn royalties on product sales. In October 2000 and August 2005, GSK launched Abreva in the United States and Canada, respectively. All milestones under the agreement were earned and paid prior to fiscal 2003. During fiscal 2003, the Company sold an undivided interest in the GSK license agreement to Drug Royalty with a term until the later of December 13, 2013 or until the expiration of the patent for Abreva. (See Note 8, “Deferred Revenues/Sale of Licenses.”)
Azur Pharma. In August 2007, the Company entered into a license agreement with Azur Pharma , where the Company could receive up to $2.0 million in royalties, based on 3% of annualized net product revenues in excess of $17.0 million. During fiscal 2011, 2010 and 2009, the Company recorded royalty revenues of approximately $527,000, $516,000 and $395,000 in connection with this agreement.
P.N. Gerolymatos SA. (“Gerolymatos”). In May 2004, the Company signed an exclusive agreement with Gerolymatos giving them the rights to manufacture and sell docosanol 10% cream as a treatment for cold sores in Greece, Cyprus, Turkey and Romania. Under the terms of the agreement, Gerolymatos will be responsible for all sales and marketing activities, as well as manufacturing and distribution of the product. The terms of the agreement provide for the Company to receive a license fee, royalties on product sales and milestones related to product approvals in Greece, Cyprus, Turkey and Romania. This agreement will continue until the latest of the 12th anniversary of the first commercial sale in each of those respective countries, or the date that the patent expires, or the last date of the expiration of any period of data exclusivity in those countries. Gerolymatos is also responsible for regulatory submissions to obtain marketing approval of the product in the licensed territories. Less than $1,000 was recognized in royalty revenue from this agreement in fiscal 2011. In fiscal 2010 and 2009, the Company recognized royalty revenue from product sales of approximately $1,800 and $6,000, respectively.
Emergent Biosolutions. In March 2008, the Company entered into an Asset Purchase and License Agreement with Emergent Biosolutions for the sale of the Company’s anthrax antibodies and license to use the Company’s proprietary Xenerex Technology platform which was used to generate fully human antibodies to target antigens. Under the terms of the Agreement, the Company completed the remaining work under an NIH/NIAID grant and transferred all materials to Emergent. Under the terms of the agreement, the Company is eligible to receive milestone payments and royalties on any product sales generated from this program. The Company did not earn anything in milestone payments in fiscal 2011 and 2010. The Company earned $250,000 in milestone payments in fiscal 2009.
Non-anthrax related antibodies. In September 2008, the Company entered into an Asset Purchase Agreement with a San Diego based biotechnology company for the sale of non-anthrax related antibodies as well as the remaining equipment and supplies associated with the Xenerex Technology platform. No licensing revenue was recorded in fiscal 2011, 2010 and 2009 associated with this agreement.
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12. Income Taxes
Components of the income tax provision are as follows for the fiscal years ended September 30, 2011, 2010 and 2009:
Deferred income taxes reflect the income tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s net deferred income tax balance are as follows:
The Company has provided a full valuation allowance against the net deferred income tax assets recorded as of September 30, 2011, 2010 and 2009 as the Company concluded that they are unlikely to be realized. As of September 30, 2011 the Company had federal and state net operating loss carryforwards of $307,000,000 and $242,800,000, respectively. As of September 30, 2011 the Company had federal and California research and development credits of $7,300,000 and $6,400,000, respectively. The net operating loss and research credit carryforwards will expire on various dates through 2029, unless previously utilized. We also have foreign tax credit
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carryforwards of $600,000 which begin to expire in 2011, unless previously utilized. In the event of certain ownership changes, the Tax Reform Act of 1986 imposes certain restrictions on the amount of net operating loss and credit carryforwards that the Company may use in any year.
A reconciliation of the federal statutory income tax rate and the effective income tax rate is as follows for the fiscal years ended September 30:
13. Employee Savings Plan
The Company has established an employee savings plan pursuant to Section 401(k) of the Internal Revenue Code. The plan allows participating employees to deposit into tax deferred investment accounts up to 50% of their salary, subject to annual limits. The Company is not required to make matching contributions under the plan. However, the Company voluntarily contributed approximately $204,000, $58,000 and $39,000 in fiscal 2011, 2010, and 2009, respectively, to the plan.
14. Segment Information
The Company operates the business on the basis of a single reportable segment, which is the business of discovery, development and commercialization of novel therapeutics for chronic diseases. The Company’s chief operating decision-maker is the Chief Executive Officer, who evaluates the company as a single operating segment.
The Company categorizes revenues by geographic area based on selling location. All operations are currently located in the United States; therefore, total revenues for fiscal 2011, 2010, and 2009 are attributed to the United States. All long-lived assets at September 30, 2011 and 2010 are located in the United States.
Approximately 37%, 82%, and 78% of the Company’s total revenues in fiscal 2011, 2010, and 2009, respectively, were derived from a license agreement with GSK and the sale of rights to royalties under that agreement. Royalties from Azur totaled approximately 18% of total revenue in fiscal 2010 and were less than 10% of total revenues in fiscal 2011 and 2009.
15. Subsequent Events
From October 1, 2011 through December 9, 2011, 5,445,061 shares were issued pursuant to the exercise of warrants that were outstanding at September 30, 2011, resulting in proceeds of approximately $7.8 million to the Company.
From October 1, 2011 through December 9, 2011, 1,085,000 shares of common stock were sold under the at-the-market facility with Cantor at an average price of $2.94 per share, resulting in net proceeds of $3.1 million.
From October 1, 2011 through December 9, 2011, 310,275 shares were issued pursuant to exercises of stock options that were outstanding at September 30, 2011, resulting in proceeds of approximately $235,000 to the Company.
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From October 1, 2011 through December 9, 2011, 164,688 shares were issued pursuant to the vesting of restricted stock units that were outstanding at September 30, 2011.
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