Item 1B.
Unresolved Staff Comments
None.
We currently lease the following space:
We are actively marketing our space in Germantown, Maryland. We believe that our facilities are suitable and adequate to meet our current needs.
We are not a party to any material pending legal proceedings, other than ordinary routine litigation incidental to our business.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock has been traded on the NASDAQ Global Market under the symbol MBRK (previously, AVNC until June 29, 2007) since July 3, 2006. Upon completion of our initial public offering on October 17, 2003 and prior to the creation of the NASDAQ Global Market, our common stock was traded on the NASDAQ National Market. The following table sets forth the quarterly high and low sales prices per share of our common stock as reported by NASDAQ for each quarter during the last two fiscal years:
Holders
As of March 10, 2010, there were 104 holders of record of our common stock.
Dividends
We have never declared or paid any cash dividends on our common stock. We intend to retain our future earnings, if any, to finance our operations and potentially the further development and expansion of our business and do not intend to pay cash dividends for the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, restrictions contained in current or future financing instruments and such other factors as our board of directors deems relevant.
Corporate Performance Graph
The following performance graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
The following graph shows the cumulative total return resulting from a hypothetical $100 investment in our common stock on December 31, 2004 through December 31, 2009. MiddleBrook stock price performance over this period is compared to the same amount invested in the NASDAQ Stock Market (U.S.) Index and the NASDAQ Pharmaceutical Index over the same period (in each case, assuming reinvestment of dividends). While total stockholder return can be an important indicator of corporate performance, we believe it is not necessarily indicative of our company’s degree of success in executing our business plan, particularly over short periods.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information with respect to the equity securities that are authorized for issuance under our equity compensation plans as of December 31, 2009.
(1)
In September 2008, our board of directors approved the New Hire Stock Incentive Plan (the “New Hire Incentive Plan”) for use in making inducement grants of stock options to new employees pursuant to NASDAQ Marketplace Rule 5635(c)(4) as a material inducement for them to join MiddleBrook. The New Hire Incentive Plan was based upon and is substantially similar to our Stock Incentive Plan as approved by stockholders, except that eligible recipients are limited to prospective employees of MiddleBrook, consistent with its purpose as an employment inducement tool. The board of directors initially authorized 4,500,000 shares under the New Hire Incentive Plan, and as of December 31, 2009, we had issued options to purchase 1,905,968 shares of our common stock pursuant to this plan. As of January 1, 2010, our board of directors ceased issuing shares under our New Hire Incentive Plan. However, should the board of directors reinstitute this plan, 2,594,032 shares remain available for issuance. The board of directors may also increase shares available under the New Hire Incentive Plan in its discretion.
The following selected financial information as of December 31, 2009 and 2008 and for each of the years ended December 31, 2009, 2008 and 2007 has been derived from our audited consolidated financial statements included in this Annual Report on Form 10-K. The selected consolidated financial data presented below as of December 31, 2007, 2006 and 2005 and for each of the years ended December 31, 2006 and 2005 is derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The information below is not necessarily indicative of results of future operations and should be read in conjunction with Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements, the accuracy of which involves risks and uncertainties. As a result of many factors, including those set forth under “Forward-Looking Statements” and Part I, Item 1A. Risk Factors and elsewhere in this Annual Report on Form 10-K, our actual results may differ materially from those anticipated in these forward-looking statements. All tabular amounts are presented in thousands except per-share data.
Our Business
MiddleBrook Pharmaceuticals, Inc. was incorporated in Delaware in December 1999 and commenced operations on January 1, 2000. We are a pharmaceutical company focused on commercializing anti-infective drug products that fulfill unmet medical needs. We have developed a proprietary delivery technology called PULSYS, which enables the pulsatile delivery, or delivery in rapid bursts, of certain drugs. Our PULSYS technology may provide the prolonged release and absorption of a drug, which we believe can provide therapeutic advantages over current dosing regimens and therapies.
Our current PULSYS product, MOXATAG (amoxicillin extended-release) Tablets, 775 mg, received U.S. Food and Drug Administration, or FDA, approval for marketing on January 23, 2008, and is the first and only FDA-approved once-daily amoxicillin. It is approved for the treatment of pharyngitis/tonsillitis secondary to Streptococcus pyogenes, commonly known as strep throat, for adults and pediatric patients age 12 and older, and there is no AB-rated equivalent to MOXATAG. We have two additional PULSYS product candidates. The clinical development programs for these product candidates are currently delayed pending adequate financial resources and the successful commercialization of MOXATAG. We had previously announced our plans to start a Phase III clinical trial for our KEFLEX (Cephalexin) PULSYS product candidate for the treatment of skin and skin structure infections in 2010. We submitted a Special Protocol Assessment, or SPA, to the FDA in June 2009 for our KEFLEX PULSYS product candidate, and the FDA responded to our SPA on July 30, 2009. At this time, we have not gained agreement with the FDA regarding the non-inferiority design and planned analysis of the study as outlined in the SPA. Any future development is contingent upon the successful commercialization of MOXATAG, adequate financial resources and the FDA’s agreement with a revised study design. We also intend to conduct a Phase II trial to evaluate various dosing regimens of our amoxicillin pediatric PULSYS product candidate in a sprinkle formulation, for use in pediatric patients more than two years old with pharyngitis/tonsillitis secondary to Streptococcus pyogenes. Our Phase II trial for the pediatric PULSYS sprinkle product is currently delayed subject to the availability of additional funds and the successful commercialization of MOXATAG.
We also currently market certain drug products that do not utilize our PULSYS technology and are not protected by any patents. We acquired the U.S. rights to KEFLEX (Cephalexin, USP) capsules, the immediate-release brand of cephalexin, from Eli Lilly in 2004.
We have engaged Broadpoint Gleacher Securities Group, Inc., or Broadpoint, to assist us in identifying and evaluating strategic options, including a potential sale of the Company. Based on the current credit market turmoil and our financial condition, there can be no assurance that we will be able to identify and implement a strategic option that will be beneficial to our investors. If we are unable to consummate a strategic transaction in the near future, we may be unable to continue operations as a going concern and we may be forced to seek bankruptcy protection.
In order to more aggressively preserve our financial resources, on September 1, 2009 and December 3, 2009, we announced reductions of approximately 25% and 33%, respectively, in the number of our sales representatives and managers, as well as approximately 20% and 20%, respectively, in our corporate staff. Effective March 15, 2010, we eliminated our field sales force and significantly reduced our corporate staff to preserve our cash resources as we explore strategic options. As part of this reduction in force, our Chief Executive Officer announced his resignation as an officer and director, effective March 15, 2010, to further reduce expenses. As a result of our recurring operating losses and management’s substantial doubt about our ability to continue as a going concern for at least 12 months following the balance sheet date, our auditors included a going concern explanatory paragraph in their audit opinion for the year ended December 31, 2009. Our future operating results will depend largely on our ability to successfully commercialize our MOXATAG and KEFLEX 750 mg products as well as our ability to consummate a strategic transaction. The results of our operations vary significantly from year to year and quarter to quarter and depend on a number of factors, including risks related to our business, risks related to our industry, and other risks detailed in this Annual Report on Form 10-K. In addition, aminopenicillin antibiotics like MOXATAG experience seasonality, with prescriptions peaking between October and March, according to IMS Health, National Prescription Audit™. We do not believe that the cephalexin antibiotic market experiences any seasonality.
Management Overview of the Key Developments in 2009
The following is a summary of key events that occurred during 2009:
Focus for 2010
Our primary focus for 2010 is the pursuit of strategic alternatives and the preservation of cash, as well as the continued commercialization of our MOXATAG and KEFLEX products.
We are working to validate additional active pharmaceutical ingredient providers for our MOXATAG product and negotiating with a new third-party manufacturer for our KEFLEX products. We are working to validate production on a 10-count dose pack for MOXATAG.
Based on the FDA’s response to our SPA, we will need to evaluate the extent of the work to be performed on our KEFLEX PULSYS product candidate. The Phase III trial for this product candidate continues to be delayed in part because we have not gained agreement with the FDA regarding our non-inferiority design and planned analysis of the clinical trial, as outlined in the SPA that we submitted to the FDA in June. Any future development of the KEFLEX PULSYS product candidate is contingent upon the successful commercialization of MOXATAG, adequate financial resources, and the FDA’s agreement with a revised clinical trial design.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with generally accepted accounting principles, or GAAP, in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. On an ongoing basis, we evaluate our estimates and judgments, including those related to sales reserves and allowances, accrued expenses and fair valuation of stock related to stock-based compensation. We have based our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
In June 2009, the Financial Accounting Standards Board, or FASB, established the FASB Accounting Standards CodificationTM, which we refer to as the Codification, as the official single source of authoritative accounting principles recognized by the FASB in the preparation of financial statements in conformity with GAAP. All existing accounting standards are superseded by the Codification, and all other accounting guidance not included in the Codification are considered non-authoritative. The Codification also includes all relevant SEC guidance organized using the same topical structure in separate sections within the Codification.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.
Revenue Recognition
We recognize revenue for the sale of pharmaceutical products and for payments received, if any, under collaboration agreements for licensing, milestones, and reimbursement of development costs as follows:
Product Sales. Revenue from product sales, net of estimated provisions, is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably probable. Our customers consist primarily of large pharmaceutical wholesalers and retailers who sell directly into the retail channel. Provisions for sales discounts, and estimates for chargebacks, service fees, rebates, co-pay assistance programs and product returns are established as a reduction of product sales revenue at the time revenues are recognized, based on historical experience adjusted to reflect known changes in the factors that impact these reserves.
During the first quarter of 2009, we launched MOXATAG. Our MOXATAG customers are almost identical to those that purchase our KEFLEX product. Therefore, we have utilized much of our experience with KEFLEX to estimate provisions associated with sales of MOXATAG. We continue to monitor our estimates and assumptions to determine if a different pattern emerges with MOXATAG and will adjust our provisions accordingly in the period any change may be made.
Product Returns. In the pharmaceutical industry, customers are normally granted the right to return product for a refund if the product has not been used prior to its expiration date, which for our products is typically three years from the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window, from six months prior to the expiration date until 12 months after the expiration date.
As of December 31, 2009 and 2008, the liability for product returns was $1.7 million and $1.3 million, respectively, and was recorded within Accrued expenses and other current liabilities on our consolidated balance sheet. The increased liability balance is the result of increased sales in 2009 compared to 2008, associated with the launch of MOXATAG. We estimate the level of sales that will ultimately be returned pursuant to our return policy, and record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net revenues.
Our estimates take into consideration historical returns of our products, estimated product in the trade channel, remaining time until expiration and our future expectations. We periodically review the reserves established for returns and adjust the reserves and estimates based on actual experience. The amount of actual product returns could be either higher or lower than the amounts accrued by us. Changes in our estimates would be recorded in the income statement in the period of the change. If we over- or under-estimate the quantity of product that will ultimately be returned, it may have a material impact to our financial statements. Based on historical experience, we have estimated and accrued approximately 6% of gross product sales for KEFLEX 750 mg and 7% of gross product sales for all other KEFLEX strengths to cover future product returns. We have based our estimates for MOXATAG on the returns history of KEFLEX 750 mg. Changing our accrual rates by one percentage point would result in an approximately $245,000 impact to our net sales. We have not had reason to make any material changes to the assumptions utilized in our returns estimates.
Distribution Service Fees. Consistent with industry practice, we enter into distribution and inventory management agreements with our key wholesalers to provide incentives to effectively manage channel inventory and provide timely and accurate data with respect to inventory levels and data regarding sales activity.
The distribution service fees paid to each wholesaler are based on agreements unique to each wholesaler. Therefore, the reserve fluctuates based on the product mix and sales levels to each wholesaler. As of December 31, 2009 and 2008, the reserves for distribution service fees related to agreements with wholesalers were approximately $512,000 and $266,000, respectively, and were recorded as a reduction of gross accounts receivable. The increased reserve balance for 2009 compared to the prior year is the result of increased sales, combined with the timing of the deductions taken by wholesalers for the distribution service fee. The reserve is calculated and recorded as a reduction of gross sales at the time the product is sold, although the deduction is taken by the wholesaler against a future payment. Based on the unique formula to record these fees for each wholesaler, there have been minimal adjustments to these balances.
Chargebacks and Rebates. Chargebacks and rebates represent the difference between the prices at which we sell our products to our customers and the sales price ultimately paid under fixed price contracts by third-party payors, including governmental agencies. We record an estimate at the time of sale of the amount to be charged back to us or rebated to the end user.
As of December 31, 2009 and 2008, reserves for chargebacks were approximately $220,000 and $97,000, respectively, and recorded as a reduction of gross accounts receivable. The reserves for Medicaid rebates were approximately $195,000 and $67,000, respectively, for the same periods and were recorded within Accrued expenses and other current liabilities on the consolidated balance sheet. The increases in the reserve balance compared to the prior year is driven by increased sales in 2009 compared to 2008 from the launch of MOXATAG during the first quarter of 2009, combined with the timing of payment and deductions taken against the reserves.
We have recorded reserves for chargebacks and rebates based upon various factors, including current contract prices, historical trends, estimated inventory levels and our future expectations. The amount of actual chargebacks and rebates claimed could be either higher or lower than the amounts we have accrued. Changes in our estimates would be recorded in the statement of operations in the period of the change. The accrual rates for chargebacks and rebates are more predictable than for product returns because the amount of the chargeback or rebate is generally based on contracted dollar amounts or percentages. Additionally, chargebacks and Medicaid rebates are typically accrued and paid out (or deducted by customers) within one to three fiscal quarters, compared to product returns which could take up to three years subsequent to the date of sale. As a result of the more predictable nature of chargebacks and Medicaid rebates, we do not believe that the actual amounts claimed will be materially different than the amounts previously accrued and reflected in our financial statements.
Co-Pay Assistance Programs. Our co-pay assistance program has evolved from our coupon and check programs. The coupon and check redemptions are based on the specific terms of the coupon or check, and timing and quantity of distribution, combined with historical redemption rates. We launched our co-pay assistance program in July 2009, which we designed to keep a patient’s net out-of-pocket co-pay expense for a MOXATAG prescription at no more than $20. The co-pay voucher is available at doctors’ offices or through the MOXATAG website. Patients can redeem the voucher at the point-of-sale in conjunction with having a MOXATAG prescription filled. The estimated liability for the redemption of these vouchers is based on the estimated number of prescriptions that will be filled with a voucher compared to the number of prescriptions in the channel (i.e., inventory that we have sold to retailers and wholesalers but that has yet to be filled as prescriptions for an end-user patient). In addition to estimating the number of prescriptions to be filled, we also estimate the number of prescriptions remaining in the channel and the value for which each voucher will be redeemed to provide the $20 maximum co-pay benefit.
The liability for this co-pay assistance program was estimated based on redemptions of the vouchers to date, compared to prescriptions filled during the same period, to assist in determining the appropriate redemption rate for this program. We will continue to review and refine the estimates as additional information becomes available. The reserve for our co-pay assistance programs is $3.8 million at December 31, 2009 compared to $122,000 for our coupon redemptions as of December 31, 2008. This reserve is recorded as a liability within Other current liabilities on the consolidated balance sheet.
Other Sales Allowances and Reserves. We also record other sales allowances and reserves that reduce the total of our gross product revenue, including cash discounts and pricing discounts. We offer cash discounts for prompt payments from our customers, which we estimate based on customer payment terms and historical experience. Cash discount reserves are recorded as an allowance against accounts receivable. Pricing discounts are based on the specific terms of each discount and are recorded at the time of the sale of such discounted product.
The following table shows the balances of liabilities and accounts receivable valuation accounts resulting from sales reserves and allowances at each balance sheet date:
(1)
The co-pay assistance balance as of December 31, 2009 primarily consists of a liability for our co-pay assistance program associated with MOXATAG. The liability is based on estimated redemption rates for prescriptions in the channel and was initially recorded when the vouchers were available for physicians to distribute to their patients.
(2)
Accrued returns, rebates and other are reported within Accrued expenses and other current liabilities on the consolidated balance sheet.
(3)
Distribution fees, chargebacks and cash discounts are reported as valuation allowances against accounts receivable on the consolidated balance sheet.
The following table summarizes the activity of our sales allowances and reserves:
Inventories
Inventory is stated at the lower of cost or market, with cost determined under the first-in, first-out method. Inventory consists of MOXATAG tablets and KEFLEX finished capsules, as well as amoxicillin, the active pharmaceutical ingredient in MOXATAG. On at least a quarterly basis, we review our inventory levels and write down inventory that has become obsolete or has a cost basis in excess of its expected net realizable value or is in excess of expected requirements. Inventory levels are evaluated by management relative to product demand, remaining shelf life, future marketing plans and other factors, and reserves for obsolete and slow-moving inventories are recorded for amounts that may not be realizable.
Foreign Currency Exchange Forward Contracts
We had entered into foreign currency forward exchange contracts to hedge forecasted inventory and sample purchase transactions that are subject to foreign exchange exposure to either the euro or British pound sterling. These instruments were designated as cash flow hedges and were recorded in our consolidated balance sheet at fair value in either other current assets (for unrealized gains) or other current liabilities (for unrealized losses). There are no outstanding contracts as of December 31, 2009.
We formally documented our hedge relationships, including identifying the hedging instruments and the hedged items, as well as our risk management objectives and strategies for undertaking the hedge transaction. This process included identifying the designated derivative to forecasted transactions. We also formally assessed, both at inception and at least quarterly thereafter, whether the derivatives that were used in hedging transactions were highly effective in offsetting changes in the fair value of the hedged item. The maturities of the forward exchange contracts generally coincided with the settlement dates of the underlying exposure.
We do not use derivatives for trading purposes and restrict all derivative transactions to those intended for hedging purposes.
Intangible Assets
Acquired Intangible Assets. We originally acquired the U.S. rights to the KEFLEX brand of cephalexin in 2004. During November 2007, we sold these rights to Deerfield and then reacquired them in September 2008. When intangible assets are acquired, we review and identify the individual intangible assets acquired and record them based on their fair values. Each identifiable intangible asset is then reviewed to determine if it has a definite life or indefinite life, and definite-lived intangible assets are amortized over their estimated useful lives.
Impairment. We assess the impairment of identifiable intangible assets when events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important that could trigger an impairment review include significant underperformance compared to historical or projected future operating results, significant changes in our use of the acquired assets or the strategy for our overall business, or significant negative industry or economic trends. If we determine that the carrying value of intangible assets may not be recoverable based upon the existence of one or more of these factors, we first perform an assessment of the asset’s recoverability based on expected undiscounted future net cash flow, and if the amount is less than the asset’s value, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.
Accrued Expenses
As part of the process of preparing financial statements, we are required to estimate accrued expenses for services performed and liabilities incurred. This process involves identifying services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for such service as of each balance sheet date in our financial statements. The date on which certain services commence, the level of services performed on or before a given date and the cost of such services are often judgmental. We make these judgments in accordance with GAAP based upon the facts and circumstances known to us. We also make estimates for other liabilities incurred, including health insurance costs for our employees.
Stock-Based Compensation
We determine the value of stock option grants using the Black-Scholes option-pricing model. Our determination of fair value of share-based payment awards on the date of grant is affected by our stock price, as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and projected employee stock option exercise behaviors. This model requires that we estimate our future expected stock price volatility, as well as the period of time that we expect the share-based awards to remain outstanding.
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We estimate the expected term of share-based awards based on many factors, including historical experience, vesting period of awards, expected volatility and employee demographics. We have estimated the expected term to be 4.0 years, equal to the length of the vesting periods for most option grants. Previously, we elected to determine the expected term of share-based awards using a transition approach approved by GAAP, resulting in an expected term of 6.25 years for four-year grants with a ten-year contractual term. The change in the expected term occurred at the end of 2008. The shorter expected term results in lower compensation expense per award.
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To estimate expected future volatility, we use our historical volatility over a period equal to our estimated expected term of options, adjusted for certain unusual, one day fluctuations. We have no implied volatility data, as we have no publicly traded options or other financial instruments from which implied volatility can be derived. Late in 2008, we changed our volatility from 75% to 90% based on the updated expected term of the awards and our adjusted historical volatility and have maintained that estimated volatility throughout 2009. Historically, we based our estimate of expected future volatility upon a combination of our historical volatility together with the average volatility rates of comparable public companies. The higher volatility input to the Black-Scholes model results in a higher compensation expense for each award.
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The risk-free rate is based on U.S. Treasury yields in effect at the time of grant corresponding with the expected term of the options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.
We estimate forfeitures in calculating the expense related to share-based compensation, rather than recognizing forfeitures as a reduction in expense as they occur. To the extent actual forfeitures differ from our estimates, such amounts will be recorded as a cumulative adjustment in the period that the estimates are revised. We plan to refine our estimated forfeiture rate as we obtain more historical data.
Income Taxes
As part of the process of preparing our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We account for income taxes by the asset and liability method. Under this method, deferred income taxes are recognized for tax consequences in future years as differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on enacted laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Income tax expense or benefit for the year is allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income, and items charged or credited directly to shareholders equity. Pursuant to this intraperiod allocation requirement, $174,000 of tax expenses for 2009 has been allocated to loss from continuing operations and $174,000 of tax benefit has been allocated to the reduction in net unrealized gains that were recorded in other comprehensive income. We have not recorded any tax provision or benefit for the year ended December 31, 2007. We have provided a valuation allowance for the full amount of our net deferred tax assets because realization of any future benefit from deductible temporary differences and net operating loss carryforwards cannot presently be sufficiently assured. At December 31, 2009 and 2008, we had federal and state net operating loss carryforwards of approximately $236.2 million and $186.3 million, respectively, available to reduce future taxable income, which will begin to expire in 2020. Under the provisions of Sections 382 and 383 of the Internal Revenue Code, certain substantial changes in our ownership may result in a limitation on the amount of net operating loss and research and experimentation tax credit carryforwards that can be used in future years. During various years, we may have experienced such ownership changes.
Warrants
Management’s judgment is required in evaluating the terms of freestanding instruments, such as warrants, and the application of authoritative accounting literature. In November 2007, we issued 3.0 million warrants to affiliates of Deerfield in connection with the sale and license of certain non-PULSYS KEFLEX tangible and intangible assets. The warrant agreement contained provisions for cash settlement under certain conditions, including a major asset sale or acquisition in certain circumstances, which was available to the warrant holders at their option. As a result, management concluded that those warrants should be classified as a liability at their contractual fair value in our consolidated balance sheet. These warrants were redeemed for cash on September 4, 2008, in accordance with the Deerfield Agreement dated July 1, 2008. All other warrants, including those issued to EGI in September 2008, are classified as equity based on the provisions of such warrant agreements.
Registration Payment Arrangements
We view a registration rights agreement containing a liquidated damages provision as a separate freestanding contract with nominal value. Under this approach, the registration rights agreement is accounted for separately from the financial instrument. Should we conclude that it is more likely than not that a liability for liquidated damages will occur, we would record the estimated cash value of the liquidated damages liability at that time.
Consolidation of Variable Interest Entities
Variable interest entities are entities that are subject to consolidation because the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Management’s judgment is required in identifying potential variable interest entities and in evaluating the controlling financial interest to determine if the variable interest entity is consolidated. An entity is subject to consolidation if (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties; or (b) the equity investment holders lack (1) the direct or indirect ability to make decisions about an entity’s activities, (2) the obligation to absorb the expected losses of the entity, or (3) the right to receive the expected residual returns of the entity. If management concludes that an entity is a variable interest entity, an analysis must then be made to determine if there is a primary beneficiary, using either a qualitative or quantitative approach.
Our management evaluated whether the Deerfield affiliates, Kef and Lex, are variable interest entities and, if so, whether there is a primary beneficiary with a controlling financial interest. Because MiddleBrook made the material decisions with respect to the ongoing activities of the assets owned by Kef and Lex, the Kef and Lex entities were determined to be variable interest entities for this characteristic. Because we had a fixed price repurchase option, the equity holders in Kef and Lex did not have rights to all of the residual returns of the entities; accordingly Kef and Lex were determined to be variable interest entities for this characteristic. Management used a qualitative analysis to determine whether Deerfield or MiddleBrook was the primary beneficiary of the entities. MiddleBrook was determined to be the primary beneficiary, because it was the party exposed to the majority of the risks. Thus, we consolidated the financial condition and results of operations of Kef and Lex.
In connection with the September 2008 EGI Transaction, we repurchased those certain KEFLEX assets previously sold to Kef and Lex in November 2007 by purchasing all of the outstanding capital stock of both Kef and Lex. Accordingly, subsequent to September 4, 2008, we no longer eliminate the noncontrolling interest of Kef and Lex from our consolidated financial condition and results of operations. As of November 1, 2009, Kef and Lex were dissolved into MiddleBrook.
Recent Accounting Pronouncements
In December 2007, the FASB issued ASC 805, “Business Combinations,” which became effective for financial statements issued for fiscal years beginning on or after December 15, 2008. ASC 805 established principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and goodwill acquired in a business combination. ASC 805 also established disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The adoption of ASC 805 had no impact on our results of operations and financial condition and will be implemented prospectively, as circumstances require.
In December 2007, the FASB updated ASC 810, “Consolidation,” for noncontrolling interests in consolidated financial statements. ASC 810 addresses the accounting and reporting framework for minority interests by a parent company. ASC 810 also addresses disclosure requirements to distinguish between interests of the parent and interests of the noncontrolling owners of a subsidiary. We adopted the provisions of ASC 810, effective January 1, 2009, as required. As a result of the adoption, we adjusted the presentations and disclosures relating to noncontrolling interests during prior years when the noncontrolling interest existed.
In March 2008, the FASB updated ASC 815, “Derivatives and Hedging,” to amend previous guidance regarding disclosures about derivative instruments and hedging activities. ASC 815 requires additional disclosures regarding a company’s derivative instruments and hedging activities by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. We adopted ASC 815, effective January 1, 2009, as required.
In October 2008, the FASB updated ASC 820, “Fair Value Measurements and Disclosures,” to provide guidance for determining the fair value of a financial asset when the market for that asset is not active. ASC 820 amended previous guidance on this topic to include guidance on how to determine the fair value of a financial asset in an inactive market. This update of ASC 820 is effective immediately on issuance, including prior periods for which financial statements had not been issued. The implementation of ASC 820 did not have a material impact on our financial position and results of operations. The adoption of fair value measurements for nonfinancial assets and nonfinancial liabilities was effective for 2009 and did not have a material impact on our financial position and results of operations.
In May 2009, the FASB issued ASC 855, “Subsequent Events,” which is effective for interim or annual financial periods ending after June 15, 2009. ASC 855 established guidance regarding circumstances under which subsequent events must be recognized, the period during which to evaluate events subsequent to the financial statement date, and disclosures associated with those events.
In December 2009, the FASB issued ASU 2009-17, “Consolidations: Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” which codifies SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” issued in June 2009. ASU 2009-17 will amend certain provisions of ASC 810 related to the consolidation of variable interest entities, or VIE. ASU 2009-17 will replace the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses of the VIE or right to receive benefits from the VIE that could potentially be significant to the VIE. ASU 2009-17 will also require ongoing reassessments of whether an enterprise is the primary beneficiary. ASU 2009-17 will be effective for us beginning in 2010. We do not believe its adoption will have a material impact on our consolidated financial statements.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related expenses for personnel, fees paid to professional service providers in conjunction with independently monitoring our clinical trials and acquiring and evaluating data in conjunction with our clinical trials, development costs for contract manufacturing prior to FDA approval of products, costs of materials required to validate the manufacturing process and prepare for commercial launch, depreciation of capital resources used to develop our products, and other costs of facilities. We expense research and development costs as incurred. We believe that significant investment in product development is a competitive necessity and plan to continue these investments, assuming sufficient financial resources are available, in order to be in a position to realize the potential of our product candidates and proprietary technologies.
During the fourth quarter of 2009, we delayed our KEFLEX PULSYS clinical trial following our review of the FDA’s response to our SPA. Subsequent to this decision, we reviewed the work being performed by our internal research and development personnel and determined that the projects that they were working on no longer were primarily research and development related. As such, beginning with the fourth quarter of 2009, all internal research and development direct and indirect costs have been classified within Selling, general and administrative expense on our statement of operations.
Net Losses
We have a limited history of operations. We anticipate that our results of operations will fluctuate for the foreseeable future due to several factors, including the progress of our research and development efforts, the approval and commercial launch of new products, and the timing and outcome of regulatory approvals, all of which are currently on hold. Our limited operating history makes predictions of future operations difficult or impossible. Since our inception, we have incurred significant losses. As of December 31, 2009, we had an accumulated deficit of approximately $299.2 million. We anticipate incurring additional annual operating losses in 2010.
Results of Operations
Fiscal Year Ended December 31, 2009 Compared to Fiscal Year Ended December 31, 2008
Revenues. We recorded revenues of $14.8 million during the fiscal year ended December 31, 2009 compared to $8.8 million during the fiscal year ended December 31, 2008, comprised of the following product sales:
We began to sell MOXATAG during the first quarter of 2009 in anticipation of its marketing launch on March 16, 2009. Sales during 2009 include initial quantities to distribute the product to pharmacy shelves, as well as reorders. The net revenues from MOXATAG have been negatively impacted by a $5.2 million charge that reduced net revenues during the year. The charge is associated with our $20 maximum co-pay program for MOXATAG that we launched in the third quarter 2009, ahead of the strep throat season.
Net sales of our KEFLEX products decreased 26% during 2009 compared to 2008 primarily due to the focus and strategic alignment of our sales force on the successful launch and commercialization of MOXATAG during 2009.
Cost of Product Sales. Cost of product sales represents the purchase cost of our MOXATAG and KEFLEX products sold, depreciation on manufacturing equipment, royalties on the KEFLEX 750 mg product, and any provisions recorded for slow-moving or excess inventory that is not expected to be sold prior to reaching expiration. The following table discloses the major components of cost of product sales:
Cost of product sales increased from $1.6 million during 2008 to $2.3 million during 2009, primarily as the result of additional cost of products sold associated with our new product, MOXATAG, which was partially offset by a reduction in the royalties owed to Eli Lilly on the KEFLEX 750 mg product due to lower sales of the product in the comparable period.
Consignment and royalty payments we owed to Kef and Lex based on sales of KEFLEX are eliminated in the consolidated statement of operations. These payments approximated $1.0 million from January 1, 2008 through September 4, 2008, the portion of the periods presented during which we consolidated our former variable interest entities, Kef and Lex.
Research and Development Expenses. Research and development expenses decreased $13.8 million, or 72%, to $5.3 million for the fiscal year ended December 31, 2009 from $19.1 million for the fiscal year ended December 31, 2008. Research and development expenses consist of direct and indirect costs. Direct costs include expenses such as salaries and related costs of research and development personnel, and the costs of consultants, materials and supplies associated with research and development projects, as well as clinical studies and manufacturing validation in advance of our commercial launch of MOXATAG. Indirect research and development costs include facilities, depreciation, and other indirect overhead costs.
The decrease is primarily attributable to a decline in expenses associated with the development of MOXATAG manufacturing capacity at our contract manufacturer’s facility in Clonmel, Ireland, which was ongoing throughout 2008. The decrease in capacity expenses is partially offset by 2009 development work associated with the identification and validation of a secondary supplier for MOXATAG’s active pharmaceutical ingredient, combined with preliminary development work on an additional dose pack for MOXATAG and development of KEFLEX PULSYS.
During the fourth quarter of 2009, we put our KEFLEX PULSYS research on hold following our review of the FDA’s response to our SPA. Subsequent to this decision, we reclassified $1.2 million of fourth quarter 2009 expenses related to our employees in research and development to Selling, general and administrative expense on our statement of operations. We anticipate these internal costs to remain classified as Selling, general and administrative expenses on our statement of operations in 2010.
The following table discloses the components of research and development expenses reflecting our project expenses.
Insurance expenses associated with our research and development efforts were classified as an administrative cost during 2009 rather than partially allocated to research and development. The negative balance in patents and licensing is due to $1.1 million partial refund from the FDA received during 2009 as a result of the FDA’s grant of our request for a small business waiver at the time of our MOXATAG NDA application. The decrease in facility costs and depreciation and amortization compared to 2008 is due to our decision to vacate portions of our leased facilities in Maryland, which lowered costs and depreciation expense, subsequent to our write-down of Maryland leasehold improvements and sale of unused equipment at the end of 2008.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $45.5 million, or 187%, to $69.9 million for the year ended December 31, 2009 from $24.4 million for the year ended December 31, 2008, as detailed in the following table:
Selling, general and administrative expenses consist of salaries and related costs for executive, marketing, selling and other administrative personnel, selling and product distribution costs, professional fees and facility costs. Overall, costs increased by $45.5 million due to the commercial launch of MOXATAG during the first quarter of 2009. We hired additional sales and marketing personnel, including a field sales force, during the first quarter of 2009, which drove the increase in personnel-related expenses, marketing expenses, equipment-related costs and travel-related costs. The reduction in contract sales and distribution expense resulted from our elimination of the contract sales force during the fourth quarter of 2008 prior to hiring our internal field sales force. Both years included severance expenses associated with eliminated employees. During the second half of 2009 we strategically reduced and realigned our field sales force and eliminated corporate positions to more aggressively preserve our financial resources. In connection with this reduction in force, we recorded $2.3 million of severance expense and benefits, $1.9 million in Selling, general and administrative expense and $0.4 million in Research and development expense on our statement of operations. The 2008 severance amounts are associated with the change in management in connection with the EGI Transaction.
Additionally, beginning in the fourth quarter of 2009 following our decision to suspend our KEFLEX PULSYS research, all internal employees and related costs previously considered research and development began to be classified as Selling, general and administrative on our statement of operations, which contributed to the increased total in 2009 compared to 2008. Insurance expenses were all classified as administrative expenses during 2009 compared to being allocated between administrative and research and development expenses in 2008, resulting in a big increase in insurance expenses within selling, general and administrative in 2009.
Interest Income and (Expense). Interest income decreased $363,000, or 50%, for the year ended December 31, 2009 compared to interest income of $724,000 for the year ended December 31, 2008. The decrease is due to lower investment balances and decreased yields on the invested balances. Interest expense was $121,000 for the year ended December 31, 2009 compared to no expense for the prior year. The 2009 interest expense is primarily related to the accounting for leased vehicles as capital leases, which allocates a portion of the monthly payment to interest. We did not have any capital leases during 2008.
Our net interest income (expense) for the years ended December 31, 2009 and 2008 was:
Warrant Expense. Warrant expense in 2008 of $6.7 million resulted from recording the remaining portion of our total warrant liability of $8.8 million paid to Deerfield in connection with the re-acquisition of the KEFLEX intangible assets during the third quarter of 2008 in connection with the EGI Transaction. There were no warrants classified as liabilities during 2009.
Other Income. Other income of $161,000 in 2009 represents the gain on investments and the settlement of a hedging contract during 2009. We had no Other income amounts during 2008.
Noncontrolling Interest. Pursuant to the agreements that we entered into with Deerfield in November 2007, we consolidated the financial condition and results of operations of Kef and Lex until we acquired these entities in September 2008. Accordingly, during 2008, we deducted the losses of $0.5 million attributable to the noncontrolling interest (the losses of Kef and Lex) from our net loss in the consolidated statement of operations, and we also reduced the noncontrolling interest holders’ ownership interest in Kef and Lex in the consolidated balance sheet by the losses of Kef and Lex. This loss represents the loss from January 1, 2008 through the acquisition date of September 4, 2008. Subsequent to our acquisition of Kef and Lex, we fully consolidated them into our financial condition and result of operations without eliminating any associated losses.
Fiscal Year Ended December 31, 2008 Compared to Fiscal Year Ended December 31, 2007
Revenues. We recorded revenues of $8.8 million during the fiscal year ended December 31, 2008 compared to $10.5 million during the fiscal year ended December 31, 2007, composed of KEFLEX product sales as follows:
Net sales of KEFLEX decreased 15% during 2008 compared to 2007, while units sold decreased 24%. A price increase during October 2007 helped partially offset the impact of declining units sold on our net revenue. We believe decreased sales primarily resulted from fewer prescriptions as a result of our decision to detail KEFLEX 750 mg to fewer physicians. To reduce expenses, we decreased our contract sales force from 75 in 2007 to 30 during 2008. Our contract for the sales force was terminated in November 2008.
Cost of Product Sales. Cost of product sales represents the purchase cost of the KEFLEX products sold during the year, as well as provisions for obsolescence and royalties. The following table discloses the major components of cost of product sales:
The decrease in product manufacturing costs during 2008 reflects the decrease in units sold compared to 2007, partially offset by an increase in cost per unit across all products. The royalty to Eli Lilly also reflects the decrease in sales during 2008, as the royalty is calculated based on sales of KEFLEX 750 mg. The decrease in the obsolescence provision in 2008 resulted from a large provision recorded in 2007 to cover excess inventory of KEFLEX 750 mg after we lowered initial sales forecasts. Most of this excess inventory was destroyed in 2008. Obsolescence provisions result from projections of future sales compared to inventory levels and a determination that a portion of inventory may not be sold prior to expiration date.
Consignment and royalty payments we owed to Kef and Lex based on sales of KEFLEX are eliminated in the consolidated statement of operations. These payments approximated $1.0 million from January 1, 2008 through September 4, 2008, and $0.3 million for the period from November 8, 2007 through December 31, 2007, the periods during which we consolidated Kef and Lex.
Research and Development Expenses. Research and development expenses decreased $2.9 million, or 13%, to $19.1 million for the fiscal year ended December 31, 2008 from $22.0 million for the fiscal year ended December 31, 2007.
The following table discloses the components of research and development expenses reflecting our project expenses.
Personnel, benefits and related costs decreased $2.9 million, or 43%, during the year ended December 31, 2008 compared to 2007, as a result of lower headcount due to expense reductions. The lower headcount also drove lower stock-based compensation expense for the period.
Consultants, supplies, materials and other direct costs dropped from $6.5 million to $2.9 million, or 56%, due to reduced research and development activity as we prepared for the commercial launch of MOXATAG. The 2007 costs primarily related to our contract manufacturer’s facility modifications in Clonmel, Ireland, which were completed by the end of 2007. The 2008 costs relate to the manufacturing and validation activities to prepare for commercial supply of MOXATAG.
Indirect project costs increased by $4.0 million in 2008, primarily due to costs related to our decision to vacate parts of our Germantown, Maryland research facilities, including loss on sales of assets, impairment of leasehold improvements and accelerated expense associated with the lease. These additional expenses more than offset reductions in other indirect costs.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $1.7 million, or 6%, to $24.4 million for the year ended December 31, 2008 from $26.0 million for the year ended December 31, 2007, as detailed in the following table:
The decrease in Selling, general and administrative expenses is primarily driven by a reduction in our contract sales force from 75 representatives in 2007 to 30 representatives during most of 2008. We terminated our agreement with the contract sales force provider during the fourth quarter of 2008. Marketing expenses associated with the KEFLEX 750 mg product also decreased year over year. These reductions were partially offset by a severance charge recorded during the third quarter of 2008 associated with the departure of executives and other employees in connection with the EGI Transaction in September 2008, along with increased salaries, benefits and related costs associated with hiring additional employees as we began to prepare for the launch of MOXATAG in the first quarter of 2009.
Other expenses in 2008 increased 7% over the prior year, primarily reflecting increased activity in preparation for hiring our field sales force and other general expenses including, insurance, accounting, facility and equipment expenses.
Interest Income and (Expense). Net interest income was $724,000 for the year ended December 31, 2008 compared to net interest expense of $41,000 for the year ended December 31, 2007. The interest income increase of $765,000 in 2008 represents interest income on increased cash and short-term investment balances invested during the year, combined with no interest expense during the year, as we paid off our Merrill Lynch Capital term debt facility in November 2007.
Early Extinguishment of Debt. In connection with the payoff of the Merrill Lynch Capital debt facility in November 2007, we incurred expenses of $224,000. We did not have any similar expenses in 2008.
Warrant Expense. Warrant expense in 2008 of $6.7 million resulted from recording the remaining portion of our aggregate warrant liability of $8.8 million paid to Deerfield in connection with the re-acquisition of the KEFLEX intangible assets during the third quarter of 2008 with the proceeds from the EGI Transaction. As of December 31, 2007, we had already expensed $2.1 million of warrant liability.
Other Income. Other income of $75,000 in 2007 represents the forgiveness by Montgomery County, Maryland of our development loan. We had no Other income amounts during 2008.
Noncontrolling Interest. Pursuant to the agreements that we entered into with Deerfield in November 2007, we consolidated the financial condition and results of operations of Kef and Lex until we acquired these entities in September 2008. Accordingly, during 2008, we deducted the losses of $0.5 million attributable to the noncontrolling interest (the losses of Kef and Lex) from our net loss in the consolidated statement of operations, and we also reduced the noncontrolling interest holders’ ownership interest in Kef and Lex in the consolidated balance sheet by the losses of Kef and Lex. This loss represents the loss from January 1, 2008 through our acquisition of Kef and Lex on September 4, 2008. During 2007, we deducted losses associated with the noncontrolling interest of $162,000, representing the loss from when we entered into the agreements with Deerfield in November 2007 through December 2007. Subsequent to our acquisition of Kef and Lex, we fully consolidated them into our financial condition and result of operations without eliminating any associated losses.
Liquidity and Capital Resources
Prospective Information - Risks and Uncertainties related to Our Future Capital Requirements
We expect to incur a significant loss in 2010, as we expect that revenues from product sales will not be sufficient to fully fund our operating costs. We have experienced considerable losses since our inception in 2000, and as of December 31, 2009, we had an accumulated deficit of $299.2 million. The process of developing and commercializing our products requires significant research and development work, preclinical testing and clinical trials, as well as regulatory approvals, significant marketing and sales efforts, and manufacturing capabilities. We expect our commercialization and marketing activities for our current MOXATAG and KEFLEX products, together with our general and administrative expenses, to continue to result in significant operating losses for 2010. To minimize our cash requirements, we have implemented a program of cost reductions, including postponement of product development programs, reduction of headcount, elimination of our field sales force, and reduction of other discretionary spending. Nonetheless, the revenues we have recognized from our MOXATAG and KEFLEX products to date have not been sufficient for us to achieve or sustain profitability. Our product revenues are unpredictable in the near term and may fluctuate due to many factors, many of which we cannot control, including the market acceptance of our products.
We believe our existing cash resources will be sufficient to fund our operations through the second quarter of 2010 at our planned levels of sales and marketing activities, including the continued commercialization of MOXATAG. However, our net cash requirements for 2010 will depend on, among other things, the cash received from sales of MOXATAG and our existing KEFLEX products and the cash expended for (1) cost of products sold, including royalties due to Eli Lilly on KEFLEX 750 mg net revenues, (2) research and development, (3) sales and marketing expenses for KEFLEX 750 mg and MOXATAG, and (4) general and administrative expenses. Our cash receipts and cash expenditures assumptions for 2010 include the following: (1) continuation of KEFLEX 750 mg monthly prescriptions at the current 8,000 to 12,000 prescriptions per month rate (end-user demand), which assumes no generic competitive product enters the market in 2010, (2) market acceptance of MOXATAG and associated end-user demand, (3) the expenses associated with and impact of terminating our internal field sales force and managers, (4) marketing costs associated with the continued commercialization of MOXATAG through DoctorDirectory’s virtual marketing solution, IncreaseRx®, (5) the continued postponement of our research and development programs for PULSYS product candidates, and (6) expenses associated with identifying and evaluating strategic options. These 2010 estimates are forward-looking statements that involve risks and uncertainties, and actual results could vary materially.
Our estimates of our longer-term capital requirements are also uncertain and will depend on a number of factors, including cash received from sales of our immediate-release KEFLEX products and our MOXATAG product, the availability of financing, the progress of our research and development of product candidates, the timing and outcome of regulatory approvals, the amount of payments received or made under any future collaborative agreements, the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims and other intellectual property rights, the acquisition of licenses for new products or compounds, the status of competitive products, and our or our partners’ success in developing markets for our product candidates. Changes in our commercialization plans, partnering activities, regulatory activities and other developments may increase our rate of spending and decrease the period of time our available resources will fund our operations. Insufficient funds may require us to further delay, scale back or eliminate some or all of our research, development or commercialization programs, or may adversely affect our ability to operate as a going concern.
We have engaged Broadpoint to assist us in identifying and evaluating strategic options, including a potential sale of the Company. However, there can be no guarantee we will identify and implement a strategic option that will be beneficial to our investors. If we are unable to consummate a strategic transaction in the near future, we may be forced to seek bankruptcy protection.
General Sources of Capital
We have funded our operations principally with the proceeds of $54.5 million from a series of five preferred stock offerings and one issue of convertible notes over the period 2000 through 2003, the net proceeds of $54.3 million from our initial public offering in October 2003, and five private placements of common stock between April 2005 and September 2008.
In April 2005, we completed a private placement of 6.8 million shares of our common stock at a price of $3.98 per share, together with warrants to purchase a total of 2.4 million shares of common stock at an exercise price of $4.78 per share, resulting in net proceeds after commissions and expenses of $25.8 million. The warrants are exercisable for five years.
In December 2006, we completed a private placement of 6.0 million shares of our common stock at a price of $3.00 per share, resulting in net proceeds after commissions and expenses of $16.7 million. There were no warrants associated with the transaction.
In April 2007, we completed a private placement of 10.2 million shares of our common stock at a price of $2.36375 per share, together with warrants to purchase a total of 7.6 million shares of common stock at an exercise price of $2.27 per share, resulting in net proceeds after commissions and expenses of $22.4 million.
In January 2008, we completed a private placement of 8.8 million shares of our common stock, with warrants to purchase 3.5 million shares of common stock at a price of $3.00 per unit, resulting in net proceeds after commissions and expenses of $19.9 million.
In September 2008, we completed a private placement of 30.3 million shares of our common stock and a warrant to purchase 12.1 million shares of common stock at a price of $3.90 per share, resulting in net proceeds of $96.0 million.
In addition, we have received funding of $8.0 million and $28.3 million from GlaxoSmithKline and Par, respectively, as a result of now-terminated collaboration agreements for the development of new products.
We also received a $1.0 million advance payment in 2005 from a potential buyer of our KEFLEX brand, which we recognized in income in 2006, as the sale was not completed and the amount was not refundable. In the second quarter of 2006, we received proceeds of $6.9 million from a term loan, net of costs and the payoff of existing debt. In November 2007, we sold certain of our KEFLEX assets in exchange for $7.5 million (less a $0.5 million payment to the purchaser to cover its expenses related to the transaction), while retaining the right to continue operating the KEFLEX business, subject to certain royalty payments to the purchaser and the right to repurchase the assets at a future date at predetermined prices. These assets were re-purchased when we acquired Kef and Lex in September 2008.
Loan Agreement
On June 29, 2009, we entered into a Loan and Security Agreement, which we refer to as the Loan Agreement, with Silicon Valley Bank, or SVB, for a two-year $10.0 million revolving line of credit for working capital needs. Effective March 16, 2010, we terminated the Loan Agreement. No balances were outstanding during the term of the Loan Agreement.
Cash and Marketable Securities
At December 31, 2009, unrestricted cash, cash equivalents and marketable securities were $14.8 million compared to $74.8 million at December 31, 2008, as detailed in the following table:
Our cash and cash equivalents are highly-liquid investments with a maturity of 90 days or less at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financial institutions, and commercial paper of high-quality corporate issuers. Our marketable securities are highly-liquid investments and are classified as available-for-sale, as they can be utilized for current operations. Our investment policy requires the selection of high-quality issuers, with bond ratings of AAA to A1+/P1. We do not invest in auction rate securities. Due to our current liquidity needs, we do not anticipate holding any security with a maturity greater than 12 months, and at December 31, 2009 and 2008, we held no security with a maturity greater than 365 days from those dates.
Also, we maintain cash balances with financial institutions in excess of insured limits. We do not anticipate any losses with respect to such cash balances.
Cash Flow
The following table summarizes our sources and uses of cash and cash equivalents for fiscal years ended December 31, 2009, 2008 and 2007.
Operating Activities
Net cash used in operating activities increased significantly during 2009 compared to both 2008 and 2007, driven primarily by the launch and initial commercialization of MOXATAG during 2009. We incurred significantly greater expenses to support the increased employee-related expenses for our expanded office-based and new field-based sales force. We utilized cash to purchase increased levels of inventory and prepaid samples (classified within Other current assets) and incurred significant marketing expenses to support our commercialization of MOXATAG. The increased sales during 2009 compared to 2008 resulted in an increase to our accounts receivable balance, which is reflected as a use of cash.
Cash used in operating activities in 2008 was lower than 2007 because 2007 included payments to complete the buildout of our contract manufacturer’s manufacturing facility in Clonmel, Ireland for MOXATAG and a full year of marketing and sales force infrastructure costs to market KEFLEX 750 mg capsules and prepare a sales force for the eventual launch of MOXATAG. Cash used in operating activities in 2008 compared to 2007 reflects the impact of our expense reduction efforts and the completion of the development of MOXATAG. Cash paid for employee compensation decreased in 2008 as the result of an overall reduction in headcount as part of an expense reduction program as we weighed strategic alternatives before launching MOXATAG.
Investing Activities
Net cash provided by / used in investing activities for the three years ended December 31, 2009 has fluctuated significantly. The $44.0 million of net cash provided by investing activities during 2009 is primarily due to the sales and maturities of securities which we transferred to cash used to support operations. During 2008, we used $55.5 million in investing activities, driven by the purchase of $46.2 million of marketable securities and the repurchase of the KEFLEX assets from Deerfield. Net cash used in investing activities in 2008 was partially offset by the maturity of some securities and the sale of fixed assets that we were no longer utilizing. Net cash used in investing activities in 2007 was $0.8 million, which primarily offset purchases and sales of marketable securities and the purchase of fixed assets to be used in the manufacturing of MOXATAG.
The purchases of marketable securities in 2008 were driven by the additional funds received in conjunction with the EGI Transaction. The sale of fixed assets during 2008 related to funds received in asset auctions held during the year to sell laboratory equipment that we were no longer utilizing in our Maryland facilities. Additionally during 2008, we entered into a lease for office space in Westlake, Texas for which we made a deposit and acquired office equipment for new employees. We also repurchased the non-PULSYS KEFLEX intangible assets from Deerfield during the year from the proceeds of the EGI Transaction.
Property and equipment purchases in 2007 were made primarily to complete the buildout and equip our contract manfacturer’s manufacturing facility in Clonmel, Ireland for MOXATAG.
Financing Activities
We used net cash in financing activities for 2009, while financing activities provided cash during both 2008 and 2007.
During 2009, cash used in financing activities reflects the principal payments made on our capital lease obligations for our automobile leases for our field-based sales force, slightly offset by proceeds received from the exercise of stock options.
The major financing activities in 2008 included two private placements of common stock, the first in January, which generated net proceeds of $19.9 million, and the second in September, which generated net proceeds of $96.0 million. In connection with the September offering, we settled the outstanding warrant liability with Deerfield for $8.8 million, which partially offset the proceeds from the financing activities. Cash provided by financing activities in 2008 also included almost $1.0 million of proceeds received from the exercise of stock options and warrants.
The major financing activities in 2007 were a private placement of common stock that occurred in April and generated $22.4 million of net proceeds, and the November sale of our inventory and non-PULSYS KEFLEX intangibles to Deerfield, which generated $7.5 million of gross proceeds, excluding a $0.5 million payment to the purchaser to cover expenses related to the transaction. We used the proceeds from the Deerfield transaction to pay off the balance of our Merrill Lynch debt facility. Proceeds from the exercise of stock options also contributed to the cash provided by financing activities in 2007.
Contractual Obligations
During 2009, we entered into a master lease agreement to provide vehicles for our field-based sales employees and their managers. These leases range in length from 30 to 40 months and include up to 75,000 miles. The vehicles are accounted for as capital leases. As a result, we have recorded the present value of the minimum lease payments as an asset within property and equipment, with an offsetting liability split between other current and long-term liabilities. We are amortizing the value of the vehicle leases over the term of each lease and allocating the lease payments between a reduction of the outstanding obligation and interest expense. When we terminate leases, such as we did in the third and fourth quarters of 2009 as a result of the reduction and realignment of our field sales force, the remaining net book value of the terminated leases and associated liabilities are removed once the lease is settled with the lessor. Effective March 15, 2010, we eliminated our field sales force. As a result of this action, we will be terminating the remaining vehicle leases.
We continue to have commitments for leased facilities in Maryland that we no longer occupy. During 2009, we adjusted the anticipated loss we had recorded in 2008 for these unused facilities, based on the updated timing of anticipated cash flows mainly from a lease amendment entered into for a portion of one of the facilities. An additional charge of $1.0 million related to these commitments was recorded in Research and development expense during the second quarter of 2009. During January 2010, we vacated the remaining portion of our leased facility in Maryland. As a result of this action, we will be recording an expense during the first quarter 2010 of approximately $2.0 million associated with the anticipated loss of the remaining portion of the unused facility.
The following table summarizes our contractual obligations at December 31, 2009 and the effects such obligations are expected to have on our liquidity and cash flows in future periods.
Payments Due by Period
(1)
This table does not include potential royalty payments, at a rate of 10% of sales value, to Eli Lilly, which may be due on product line extensions of KEFLEX, including KEFLEX 750 mg. Any such royalties cannot be estimated at this time.
(2)
This table does not include a contingent liability to Par under our amoxicillin development and commercialization agreement that was terminated by Par in August 2005. Under certain circumstances, the termination clauses of the agreement may entitle Par to receive a share of future net profits, if any, up to one-half of Par’s total $23.25 million investment in the development of certain amoxicillin PULSYS products, should products covered by the agreement be successfully commercialized. Accordingly, we retained $11.625 million of deferred revenue in recognition of this contingent liability to Par.
(3)
Effective March 15, 2010, we eliminated our field sales force. As a result of this action, we will be terminating any remaining vehicle leases.
(4)
We expect to incur additional amounts under contractual arrangements. These amounts represent software license agreements for our field-based sales force, annual license fees for the FDA and purchase commitments for samples and insurance.
In addition to the minimum purchase commitments and contractual obligations in the above table, we may incur funding liabilities for additional obligations that we enter into on a discretionary basis. These discretionary obligations could include additional facilities or equipment, investments in new technologies or products, acquisitions, funding of clinical trials, or similar events.
As part of our FDA approval of MOXATAG in adults and pediatric patients 12 years and older and in accordance with the requirements of the Pediatric Research Equity Act, we received from the FDA a deferral to further evaluate our product candidate for pediatric patients with pharyngitis or tonsillitis as part of a post-marketing commitment. As part of this commitment, we agreed to submit a completed Phase III clinical trial report and data set for our pediatric amoxicillin product candidate in pediatric patients aged two to 11 years by March 2013. Should we obtain adequate financial resources and successfully commercialize MOXATAG, we intend to conduct a Phase II trial, and if the results of the Phase II trial support proceeding into Phase III, we would then plan to conduct a Phase III clinical trial in this population. If the results of the Phase II trial did not support proceeding into Phase III, we may file a request for a waiver for the further assessment of the safety and effectiveness of the product in this population. The funding for these trials is not included in the above table, as we cannot estimate the potential exposure at this time. Substantially all spending on research and development projects has been delayed pending the successful commercialization of MOXATAG and adequate financial resources. As a result, we are not currently pursuing the Phase II trial.
In connection with some of our private placements, we have registration rights agreements that generally require that we undertake to file a registration statement within a specified number of days, to have the SEC declare the registration statement effective within a specified number of days, and that we maintain the effectiveness of the registration statement for a period of time. These agreements also specify liquidated damages for each day we fail to comply with these obligations. We have met the required deadlines for filing and for achieving effectiveness of these private placements and have never had a period in which any of our registration statements was not continuously effective. If the registration statements are declared ineffective, the maximum potential liquidated damages for the private placements would be:
Off-Balance Sheet Arrangements
We have not entered into any transactions, agreements or other contractual arrangements that meet the definition of off-balance sheet arrangements, with the exception of our private placements of common stock and warrants in September 2008, January 2008, April 2007 and April 2005. The following outstanding warrants could be exercised by the warrant holder for additional shares in exchange for the pre-determined exercise price per share. In the September 2008 private placement, we issued a warrant to purchase 12.1 million shares of common stock at an exercise price of $3.90 per share. In the January 2008 private placement, we issued warrants to purchase 3.5 million shares of common stock at an exercise price of $3.00 per shares. In the April 2007 private placement, we issued warrants to purchase a total of 7.6 million shares of common stock at an exercise price of $2.27 per share. In the April 2005 private placement, we issued warrants to purchase a total of 2.4 million shares of common stock at an exercise price of $4.78 per share.
In August 2004, we leased additional space adjacent to our Germantown, Maryland, facility. We vacated this facility during the third quarter of 2007. Effective April 2008, another company leased approximately 40% of the facility directly from the landlord, with the landlord amending our lease to reflect a rent reduction for the amount of rent the landlord will receive each month from the other company. We remain contingently liable for the other company’s rental payments under a financial guarantee to the landlord.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Market Risk
Our exposure to market risk is currently confined to our cash, cash equivalents and restricted cash, which generally have maturities of less than one year. We currently do not hedge interest rate exposure. We have not used derivative financial instruments for speculation or trading purposes. Because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have any significant impact on the realized value of our investments.
Foreign Currency Risk
Most of our trade payable transactions are conducted in U.S. dollars, or USD, although purchases of our MOXATAG product are paid in euros, or EUR, for finished goods and British pound sterling, or GBP, for product samples. In order to manage the fluctuations in exchange rates between the USD and EUR and USD and GBP, we entered into several forward exchange contracts that lock in the exchange rate for which we utilized USD to buy the foreign currency and therefore our inventory. The contracts were designated as cash flow hedges of the variability of the cash flows due to changes in foreign exchange rates and were marked-to-market with the resulting gains or losses reflected in other comprehensive income (loss). Gains or losses are and will be included in Cost of products sold at the time the products are sold, generally within the next twelve months. There were no outstanding contracts as of December 31, 2009.
Inflation
Our most liquid assets are cash and cash equivalents. Because of their liquidity, these assets are not directly affected by inflation. We also believe that we have intangible assets in the value of our intellectual property. We have not capitalized the value of this intellectual property on our balance sheet. Due to the nature of this intellectual property, we believe that these intangible assets are not affected by inflation. Because we intend to retain and continue to use our equipment, furniture and fixtures and leasehold improvements, we believe that the incremental inflation related to replacement costs of such items will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and contract services, which could increase our level of expenses and the rate at which we use our resources.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The information required by this item is set forth on pages to.
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
Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management, including our principal executive and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2009. Based on that evaluation, our principal executive and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2009.
Changes in Internal Control over Financial Reporting during the Quarter
There have not been any changes in our internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act, during the fiscal quarter ended December 31, 2009 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal controls over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Our system of internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) 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.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, including our principal executive and principal financial officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework . Based on that assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2009.
The effectiveness of our internal controls over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers LLP, our independent registered public accounting firm, as stated in their report which appears on page of this Annual Report on Form 10-K.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
We incorporate herein by reference the information concerning directors and executive officers from the information under the headings “Proposals to be Voted on at the Annual Meeting-Proposal 1. Election of Directors”, and “Management” in our Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed within 120 days after the end of our fiscal year, which we refer to as the 2010 Proxy Statement.
We incorporate herein by reference the information regarding compliance with Section 16(a) of the Exchange Act from the information under the heading “Section 16(A) Beneficial Ownership Reporting Compliance” in the 2010 Proxy Statement.
We incorporate herein by reference the information with respect to corporate governance from the information under the heading “Corporate Governance and Related Matters” in the 2010 Proxy Statement.
Code of Ethics
Our Board of Directors has adopted a written code of ethics and business conduct that applies to our directors, officers and employees, a copy of which is available on our website at www.middlebrookpharma.com. Our code of ethics and business conduct, along with any other information that can be accessed from our website, is not incorporated by reference into this Annual Report on Form 10-K. Copies of our code of ethics and business conduct may also be requested in print by writing to Investor Relations at MiddleBrook Pharmaceuticals Inc., 7 West Village Circle, Suite 100 in Westlake, Texas 76262.
We incorporate herein by reference the information concerning executive compensation under the headings “Executive Compensation and Other Matters” and “Compensation Tables” in the 2010 Proxy Statement.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
We incorporate herein by reference the information concerning security ownership of certain beneficial owners and management contained under the heading “Security Ownership of Certain Beneficial Owners and Management” in the 2010 Proxy Statement.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
We incorporate herein by reference the information concerning certain relationships and related transactions from the information under the heading “Certain Relationships and Related Transactions” contained in the 2010 Proxy Statement.
We incorporate herein by reference the information regarding director independence under the heading “Corporate Governance and Related Matters” in the 2010 Proxy Statement.
Item 14.
Item 14.
Principal Accountant Fees and Services
We incorporate herein by reference the information concerning principal accountant fees and services and related pre-approval policies from the information under the heading “Audit and Non-Audit Fees” in the 2010 Proxy Statement.
PART IV
Item 15.
Item 15.
Exhibits and Consolidated Financial Statement Schedules
(a) The following documents are filed as part of this Annual Report on Form 10-K:
(1) Index to Financial Statements
(2) Financial Statement Schedule
The following schedule is filed as part of this Annual Report on Form 10-K:
Schedule II - Valuation and Qualifying Accounts for the Years Ended December 31, 2009, 2008, and 2007
(3) Exhibits

The Schedules and certain of the Exhibits to this Asset Purchase Agreement have been omitted in reliance upon the rules of the Securities and Exchange Commission. A copy will be delivered to the Securities and Exchange Commission upon request.
+
Confidential treatment requested for certain portions of this Exhibit pursuant to Rule 406 under the Securities Act, which portions are omitted and filed separately with the Securities and Exchange Commission.
*
Indicates a management contract or a compensatory plan.
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.
MIDDLEBROOK PHARMACEUTICALS, INC.
By: /s/ David Becker
David Becker
Executive Vice President, Chief Financial Officer, and
Acting President and Chief Executive Officer
Dated: March 16, 2010
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 the dates indicated:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
of MiddleBrook Pharmaceuticals, Inc.:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of MiddleBrook Pharmaceuticals, Inc. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting, appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated 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 financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the risk that existing cash resources will not be sufficient to fund operations
raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to this matter are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Dallas, Texas
March 16, 2010
MIDDLEBROOK PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
MIDDLEBROOK PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
MIDDLEBROOK PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)
(amounts in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MIDDLEBROOK PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000’s)
The accompanying notes are an integral part of these consolidated financial statements.
MIDDLEBROOK PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands except per share data)
1. Nature of the Business
Nature of Business
MiddleBrook Pharmaceuticals, Inc. (“MiddleBrook” or “we” or “us”) was incorporated in Delaware in December 1999 and commenced operations on January 1, 2000. We are a pharmaceutical company focused on commercializing anti-infective drug products that fulfill unmet medical needs. We have developed a proprietary delivery technology called PULSYS, which enables the pulsatile delivery, or delivery in rapid bursts, of certain drugs. Our PULSYS technology may provide the prolonged release and absorption of a drug, which we believe can provide therapeutic advantages over current dosing regimens and therapies. We currently have 25 U.S. issued patents and seven foreign patents covering our PULSYS technology which extend through 2020.
Our current PULSYS product, MOXATAG (amoxicillin extended-release) Tablets, 775 mg, received U.S. Food and Drug Administration (or “FDA”) approval for marketing on January 23, 2008, and is the first and only FDA-approved once-daily amoxicillin. It is approved for the treatment of pharyngitis/tonsillitis secondary to Streptococcus pyogenes, commonly known as strep throat, for adults and pediatric patients age 12 and older, and there is no AB-rated equivalent to MOXATAG.
Liquidity
We have experienced significant operating losses since our inception in 2000. As of December 31, 2009, we had an accumulated deficit of $299.2 million. The process of developing and commercializing our products requires significant research and development work, preclinical testing and clinical trials, as well as regulatory approvals, substantial marketing and sales efforts, and manufacturing capabilities. These activities including the commercialization of MOXATAG, together with our general and administrative expenses, require significant investments and are expected to continue to result in significant operating losses for 2010 and the foreseeable future. We began marketing MOXATAG on March 16, 2009. We have incurred, and will continue to incur, significant expenses associated with the commercialization of MOXATAG. To date, revenues recognized from the KEFLEX (immediate-release cephalexin) and MOXATAG products have been limited and have not been sufficient for us to achieve or sustain profitability. We believe our existing cash resources will be sufficient to fund our operations through the second quarter of 2010 at our planned levels of research, development, sales and marketing activities, including the commercialization of MOXATAG.
Our history of losses and negative cash flows from operations and our reliance on raising additional external funding raises substantial doubt about our ability to continue as a going concern. The accompanying consolidated financial statements have been prepared on a basis that contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might be necessary should we be unable to continue as a going concern.
We have engaged Broadpoint Gleacher Securities Group, Inc. to assist us in identifying and evaluating strategic options, including a potential sale of the Company. However, there can be no assurance that we will be able to identify and implement a strategic option that will be beneficial to our investors. If we are unable to consummate a strategic transaction in the near future, we may be unable to continue operations as a going concern and we may be forced to seek bankruptcy protection.
Our estimates of future capital requirements are uncertain and will depend on a number of factors, including the success of our commercialization of MOXATAG, the progress of our research and development of product candidates (which are currently delayed), the timing and outcome of regulatory approvals, cash received from sales of our products, payments received or made under any future collaborative agreements, the costs involved in enforcing patent claims and other intellectual property rights, the status of competitive products, the availability of financing, and our or our potential partners’ success in developing markets for our product candidates. Changes in our commercialization and development plans, partnering activities, regulatory activities and other developments may increase our rate of spending and decrease the period of time our available resources will fund our operations. Insufficient funds will require us to continue to delay, scale back or eliminate some or all of our research, development or commercialization programs, or may adversely affect our ability to operate as a going concern. We previously announced that we had planned to start our Phase III clinical trial for the KEFLEX PULSYS product candidate in 2010, contingent upon the successful commercialization of MOXATAG and FDA agreement with our clinical protocol. We submitted a Special Protocol Assessment (“SPA”) to the FDA in June 2009 for our KEFLEX PULSYS product candidate, and the FDA responded to our SPA on July 30, 2009. At this time, we have not gained agreement with the FDA regarding the non-inferiority design and planned analysis of the clinical trial as outlined in the SPA. Accordingly, we have delayed the development of our KEFLEX PULSYS product candidate and any future development is contingent upon the successful commercialization of MOXATAG, adequate financial resources and the FDA’s agreement with a revised clinical trial design.
2. Summary of Significant Accounting Policies
Financial Accounting Standards Codification™
In June 2009, the Financial Accounting Standards Board (“FASB”) established the FASB Accounting Standards CodificationTM (“Codification”) as the official single source of authoritative accounting principles recognized by the FASB in the preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (“GAAP”). All existing accounting standards are superseded by the Codification, and all other accounting guidance not included in the Codification are considered non-authoritative. The Codification also includes all relevant SEC guidance organized using the same topical structure in separate sections within the Codification.
Consolidation
The consolidated financial statements include our accounts, together with the accounts of Kef Pharmaceuticals, Inc. (“Kef”) and Lex Pharmaceuticals, Inc. (“Lex”), two variable interest entities for which we were the primary beneficiary. Kef and Lex were legal entities that were formed in November 2007 by Deerfield Management, one of our stockholders and affiliates at that time (“Deerfield”), which purchased certain non-PULSYS KEFLEX assets from us in 2007 including KEFLEX product inventories (collectively, Deerfield, Kef and Lex are hereinafter referred to as the “Deerfield Entities”). Additionally, we had assigned certain intellectual property rights, solely relating to our existing, non-PULSYS KEFLEX business to the Deerfield Entities. These agreements with Deerfield provided us with capital and were designed to provide us with financial flexibility. See Note 22- Noncontrolling Interest - Deerfield Transaction.
As the primary beneficiary of Kef and Lex, we consolidated the financial condition and results of operations of the Deerfield Entities. Accordingly, the losses of $485,000 and $162,000 attributable to the noncontrolling interest (the losses of Kef and Lex) for the years ended December 31, 2008 and 2007, respectively, have been deducted from the net loss in the consolidated statement of operations, and the noncontrolling interest holders’ ownership interest in the Deerfield Entities in our consolidated balance sheet was reduced by the losses of Kef and Lex prior to their acquisition by us.
All significant intercompany accounts and transactions between us and Kef and Lex have been eliminated through September 4, 2008. We repurchased the non-PULSYS KEFLEX assets from Deerfield on September 4, 2008 by purchasing all of the outstanding capital stock of both Kef and Lex pursuant to an agreement dated July 1, 2008 (the “Deerfield Agreement”), with Deerfield and certain of its affiliates, including Kef and Lex. After the repurchase of the non-PULSYS KEFLEX assets, the balances of those accounts remained fully consolidated as part of our consolidated financial statements.
Effective November 1, 2009, our wholly-owned subsidiaries Kef and Lex have been dissolved and merged into the parent company, MiddleBrook Pharmaceuticals, Inc. Any trademarks, copyrights or other assets or rights have been assigned to us, and we have assumed any and all liabilities or obligations of Kef and Lex.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition
Product sales revenue, net of estimated provisions, is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Provisions for sales discounts, and estimates for chargebacks, rebates, and product returns are established as a reduction of product sales revenue at the time revenues are recognized, based on historical experience adjusted to reflect known changes in the factors that impact these reserves. These factors include current contract prices and terms, estimated wholesaler inventory levels, remaining shelf life of product, and historical information for similar products in the same distribution channel.
Deferred contract revenue represents cash received in excess of revenue recognized. See Note 13 - “Deferred Contract Revenue” for discussion of deferred contract revenue related to the terminated collaboration with Par Pharmaceutical (“Par”).
Research and Development
We expense research and development costs as incurred. Research and development costs primarily consist of salaries and related expenses for personnel; fees paid to consultants and outside service providers, including clinical research organizations for the conduct of clinical trials; costs of materials used in clinical trials and research and development; development costs for contract manufacturing prior to FDA approval of products; depreciation of capital resources used to develop products; and costs of facilities, including costs to modify third-party facilities. Beginning in the fourth quarter of 2009, based on significant reductions in the focus of internal resources on research and development projects, all internal costs began to be classified as Selling, general and administrative expenses on our consolidated statement of operations.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of three months or less at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financial institutions, commercial paper and high-quality corporate bonds. At December 31, 2009, we maintained all of our cash and cash equivalents in one financial institution, while at December 31, 2008, our cash and cash equivalents were in three financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand, and we believe there is minimal risk of losses on such cash balances. At December 31, 2009 and 2008, we did not have any investments in auction-rate securities.
Restricted Cash
In conjunction with the lease of our research and development facilities in Maryland, we provided the landlord with letters of credit which were collateralized with restricted cash deposits totaling $0.9 million at December 31, 2009 and 2008 (see Note 20 - Commitments and Contingencies ). These deposits are recorded as noncurrent Restricted cash.
Marketable Securities
We classify all of our marketable securities as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported as a component of stockholders’ equity in Accumulated other comprehensive income. Marketable securities available for current operations are classified in the balance sheet as current assets; marketable securities held for long-term purposes are classified as noncurrent assets. Interest income, net of amortization of premiums on marketable securities, and realized gains and losses on securities are included in Interest income in the consolidated statements of operations.
Fair Value of Financial Instruments
The carrying amounts of our financial instruments, which include cash and cash equivalents, marketable securities, notes payable and line of credit borrowings, approximate their fair values, due to their short maturities. Warrants classified as liabilities were recorded at their fair value, based on the Black-Scholes option-pricing model.
Derivative Financial Instruments
We previously entered into foreign currency forward exchange contracts to hedge forecasted inventory and sample purchase transactions that are subject to foreign exchange exposure to either the euro or British pound sterling. These instruments were designated as cash flow hedges in accordance with GAAP and were recorded in the consolidated balance sheet at fair value in either Prepaid assets and other current assets (for unrealized gains) or Accrued expenses and other current liabilities (for unrealized losses).
For derivatives designated as a cash flow hedge, the effective portions of the changes in the fair value of the derivative are recorded in Accumulated other comprehensive income and are recognized in the statement of operations when the hedged item affects earnings, through Cost of goods sold for inventory and Selling, general and administrative for samples. Ineffective portions of changes in the fair value of cash flow hedges would be recognized in Other income (expense). Hedge effectiveness is measured by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item, both of which are based on forward rates. These contracts are highly effective in hedging the variability in future cash flows attributable to changes in currency exchange rates.
We formally document our hedge relationships, including identifying the hedging instruments and the hedged items, as well as our risk management objectives and strategies for undertaking the hedge transaction. This process includes identifying the designated derivative to forecasted transactions. We also formally assess, both at inception and at least quarterly thereafter, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the fair value of the hedged item. The maturities of the forward exchange contracts generally coincide with the settlement dates of the underlying exposure.
We do not use derivatives for trading purposes and restrict all derivative transactions to those intended for hedging purposes.
We had the following outstanding balances on foreign exchange forward contracts at December 31, 2008:
The fair value of these contracts is reported in the balance sheet as follows:
For additional information on the fair value measurements of the derivative instruments and other financial instruments, see Note 21 - “Fair Value Measurements”.
For the year ended December 31, 2009, we recognized $15,000 in Other expense due to hedge ineffectiveness. There were no amounts recognized for ineffectiveness during the years ended December 31, 2008 or 2007. There were no derivative contracts, and therefore no unrealized amounts, outstanding as of December 31, 2009 or 2007.
Accounts Receivable
Accounts receivable represent amounts due from trade customers for sales of pharmaceutical products. Allowances for estimated product discounts, wholesaler rebates and chargebacks are recorded as reductions to gross accounts receivable. Amounts due for returns, co-pay assistance programs and estimated rebates payable to third parties are included in Accrued expenses and other current liabilities.
Inventories
Inventories are stated at the lower of cost or market, which is determined on the first-in, first-out (FIFO) method. Reserves for obsolete or slow-moving inventory are recorded as reductions to inventory cost. We periodically review our product inventories on hand. Inventory levels are evaluated by management relative to product demand, remaining shelf life, future marketing plans and other factors, and reserves for obsolete and slow-moving inventories are recorded for amounts that may not be realizable.
Property and Equipment
Property and equipment are stated at cost and depreciated over their estimated useful lives using the straight-line method. Leasehold improvements are capitalized and amortized over the shorter of their economic life or the remaining lease term. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations. Repairs and maintenance costs are expensed as incurred.
Intangible Assets
Identifiable intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. We do not have identifiable intangible assets with indefinite lives. The KEFLEX brand name and other intangible assets were acquired for marketing purposes, and the related amortization is charged to selling expense. In November 2007, we sold our KEFLEX brand rights to affiliates of Deerfield. We retained the right to repurchase, at a predetermined price, the non-PULSYS KEFLEX intangible assets at a future date, as well as to continue to utilize the KEFLEX trademark and other intangible assets in order to continue to operate our KEFLEX business. As discussed above under “Consolidation,” we consolidated the variable interest entities that held the intangible assets, and there was no change in the accounting policies or basis for intangible assets.
We exercised our repurchase right and repurchased the non-PULSYS KEFLEX assets from Deerfield as of September 4, 2008 by purchasing all of the outstanding capital stock of both Kef and Lex with a portion of the proceeds from the EGI Transaction (see Note 23, “Equity Group Investments Transaction” for a description of the transaction). As a result of the repurchase, we had a new basis in the non-PULSYS KEFLEX intangible asset of $11.8 million, which we began to amortize over 12 years to coincide with the expiry date of certain of our patents that we intended to utilize for KEFLEX PULSYS.
Based on the FDA’s response to our SPA received on July 30, 2009, we have not gained agreement with the FDA regarding our non-inferiority design and planned analysis of the Phase III trial for our KEFLEX PULSYS product candidate as outlined in the SPA. Accordingly, we have indefinitely delayed the Phase III trial pending the successful commercialization of MOXATAG, adequate financial resources and the FDA’s agreement with a revised clinical trial design. Based on the FDA’s response, we performed an impairment analysis of the intangible asset and have determined that it is not impaired at this time. Based on the indefinite delay of the trial, we have reconsidered the life over which the asset is being amortized, and beginning in the fourth quarter of 2009, we have reduced the remaining life to four years, which better reflects the life of our estimated economic benefit without using our PULSYS technology. We will continue to monitor the value and life of the asset in relation to the status of the Phase III trial for KEFLEX PULSYS.
Patents are carried at cost less accumulated amortization, which is calculated on a straight-line basis over the estimated useful lives of the patents. We periodically review the carrying value of patents to determine whether the carrying amount of the patent is recoverable. For the years ended December 31, 2009, 2008 and 2007, there were no adjustments to the carrying values of patents. We amortized the cost of the patent applications over a period of 10 years. As of December 31, 2009, all patents are fully amortized.
Impairment of Long-Lived Assets
We review our long-lived assets, including property and equipment and intangible assets included in the consolidated balance sheet, for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. If this review indicates that the carrying value of the asset will not be recoverable based on the expected undiscounted net cash flows of the related asset, an impairment loss is recognized.
During 2009, following the FDA’s response to our SPA, we delayed any research on our KEFLEX PULSYS product candidate. The indefinite delay resulted in a triggering event that caused us to evaluate several of our assets for possible impairment. As discussed above under “Intangible Assets,” we determined that our KEFLEX intangible asset was not impaired but we determined that it was necessary to decrease the life of the asset. Additionally, we determined that there were research and development assets that were deemed impaired by the delay. We reviewed the carrying value of the assets compared to the fair value of the assets, which we determined utilizing an income approach based on level three inputs (see Note 21 - Fair Value Measurements for more information about the levels of determining fair value). As a result of the review, we recorded an impairment loss of $233,000 associated with those assets within Research and development in the fourth quarter of 2009.
During 2008, we exited certain portions of our leased laboratory space in our Maryland offices. In connection with vacating this space, we recognized a loss of $3.1 million in 2008 associated with the impairment of the leasehold improvements in the laboratories of the facilities that we would no longer be utilizing, and therefore would not have any value to us. There were no indications of impairment through December 31, 2007, and consequently there were no impairment losses recognized in 2007.
If we are not able to carry out our business plans, there is the potential that this will be an indicator of an event or change in circumstances that would require us to perform an impairment analysis and ultimately may result in further impairment of the long-lived assets.
Leases
We lease our office and laboratory facilities under operating leases. Lease agreements may contain provisions for rent holidays, rent escalation clauses or scheduled rent increases, and landlord lease concessions such as tenant improvement allowances. The effects of rent holidays and scheduled rent increases in an operating lease are recognized over the term of the lease, including the rent holiday period, so that rent expense is recognized on a straight-line basis. For lease concessions such as tenant improvement allowances, we recorded a deferred rent liability included in Deferred rent and credit on lease concession on the consolidated balance sheets and amortize the deferred liability on a straight-line basis as a reduction to rent expense over the term of the lease. The tenant improvements are capitalized as leasehold improvements and are amortized over the shorter of the economic life of the improvement or the remaining lease term (excluding optional renewal periods). Amortization of leasehold improvements is included in depreciation expense. Our leases do not include contingent rent provisions.
For leased facilities where we have ceased using a portion or all of the space, we accrue a loss if the cost of the leased space is in excess of reasonably attainable rates for potential sublease income. In the years ended December 31, 2009 and 2008, we accrued losses of $1.0 million and $3.3 million, respectively, for leased facility space no longer in use. The current portion of this loss is recorded in Accrued expenses and other current liabilities while the noncurrent portion is recorded in Other long-term liabilities on the consolidated balance sheets. The 2008 expense was partially offset by the reversal of the deferred rent and lease concessions associated with the exited portion of the facilities that had previously been recorded.
Leases - Capital
We lease vehicles for our field sales force to assist them in performing their responsibilities of calling on physicians and pharmacists. These vehicle leases are accounted for as capital leases. During 2009, we recorded a $5.0 million asset and an offsetting liability for the present value of the minimum lease payments at the inception of the leases. The asset is included within Property and equipment, net and is depreciated over the term of the leases. The liability is reduced as the monthly payments are made, with a portion applied to the obligation and the balance recorded as interest expense. During the third and fourth quarters of 2009, we completed reductions of our field sales force, which resulted in the termination of automobile leases with a net book value of $1.7 million. The net book value of the terminated automobile leases was removed from Property and equipment, net and the associated liabilities were removed from other current and long-term liabilities. As of December 31, 2009, the remaining net book value for ongoing leases is $1.6 million, which is included in Property and equipment, net. The associated liabilities of $1.0 million are included in Other current liabilities and $0.6 million are included in Other long-term liabilities.
Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred income taxes are recognized for tax consequences in future years as differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on enacted laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Warrant Liabilities
Warrants may be classified as assets or liabilities (derivative accounting), temporary equity, or permanent equity, depending on the terms of the specific warrant agreement. Financial instruments such as warrants that are classified as permanent or temporary equity are excluded from the definition of a derivative. Financial instruments, including warrants, that are classified as assets or liabilities are considered derivatives and are marked to market at each reporting date, with the change in fair value recorded in the statement of operations.
Based on a review of the provisions of our warrant agreements, we determined that the warrants we issued in November 2007 to Deerfield should be accounted for as liabilities and marked to market at each reporting date, while our remaining warrants should be classified as permanent equity. The warrants issued to Deerfield in November 2007 were repurchased as part of the EGI Transaction for $8.8 million.
Registration Payment Arrangements
We view a registration rights agreement containing a liquidated damages provision as a separate freestanding contract that has nominal value. Under this approach, the registration rights agreement is accounted for separately from the financial instrument. Registration payment arrangements are measured in accordance contingency accounting, meaning that if we conclude that it is more likely than not that a liability for liquidated damages will occur, we would record the estimated cash value of the liquidated damages liability at that time.
Comprehensive Loss
Comprehensive loss is composed of two components, net loss and other comprehensive income (loss), and 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 and is presented in the consolidated statements of stockholders’ equity. Other comprehensive (loss) income consists of unrealized gains and losses on available-for-sale marketable securities and foreign exchange forward contracts.
Earnings Per Share
Basic earnings per share is computed based on the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed based on the weighted-average shares outstanding adjusted for all potentially dilutive common shares. The dilutive impact, if any, of potential common shares outstanding during the period, including outstanding stock options, is measured by the treasury stock method. Potential common shares are not included in the computation of diluted earnings per share if they are antidilutive.
We incurred net losses for 2009, 2008 and 2007 and, accordingly, did not assume exercise of any of our outstanding stock options, or warrants, because to do so would be antidilutive.
The following are the securities that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the periods presented:
Segment and Geographic Information
We operate in one business segment and are organized along functional lines of responsibility. We do not utilize a product, divisional or regional organizational structure. We are managed and operate as one business. The entire business is managed by a single management team that reports to the chief executive officer.
We sell our products to a limited number of pharmaceutical wholesalers and retailers, and all product sales occur in the United States. Long-lived assets, consisting of property and equipment, are located both in the United States and Ireland as follows:
Recent Accounting Pronouncements
In December 2007, the FASB issued Accounting Standards Codification (“ASC”) 805, “Business Combinations,” which became effective for financial statements issued for fiscal years beginning on or after December 15, 2008. ASC 805 established principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and goodwill acquired in a business combination. ASC 805 also established disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The adoption of ASC 805 had no impact on our results of operations and financial condition and will be implemented prospectively, as circumstances require.
In December 2007, the FASB updated ASC 810, “Consolidation,” for noncontrolling interests in consolidated financial statements. ASC 810 addresses the accounting and reporting framework for minority interests by a parent company. ASC 810 also addresses disclosure requirements to distinguish between interests of the parent and interests of the noncontrolling owners of a subsidiary. We adopted the provisions of ASC 810 effective January 1, 2009, as required. As a result of the adoption, we adjusted the presentations and disclosures relating to noncontrolling interests during prior years when the noncontrolling interest existed.
In March 2008, the FASB updated ASC 815, “Derivatives and Hedging,” to amend previous guidance regarding disclosures about derivative instruments and hedging activities. ASC 815 requires additional disclosures regarding a company’s derivative instruments and hedging activities by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. We adopted ASC 815 effective January 1, 2009, as required.
In October 2008, the FASB updated ASC 820, “Fair Value Measurements and Disclosures,” to provide guidance of determining the fair value of a financial asset when the market for that asset is not active. ASC 820 amended previous guidance on this topic to include guidance on how to determine the fair value of a financial asset in an inactive market. This update of ASC 820 was effective immediately on issuance, including prior periods for which financial statements have not been issued. The implementation of ASC 820 did not have a material impact on our financial position and results of operations. The adoption of the fair value measurements for nonfinancial assets and nonfinancial liabilities was effective for 2009 and did not have a material impact on our financial position or results of operations.
In May 2009, the FASB issued ASC 855, “Subsequent Events,” which is effective for interim or annual financial periods ending after June 15, 2009. ASC 855 established guidance regarding circumstances under which subsequent events must be recognized, the period during which to evaluate events subsequent to the financial statement date, and disclosures associated with those events.
In December 2009, the FASB issued ASU 2009-17, “Consolidations: Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” which codifies SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” issued in June 2009. ASU 2009-17 will amend certain provisions of ASC 810 related to the consolidation of variable interest entities (“VIE”). ASU 2009-17 will replace the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses of the VIE or right to receive benefits from the VIE that could potentially be significant to the VIE. ASU 2009-17 will also require ongoing reassessments of whether an enterprise is the primary beneficiary. ASU 2009-17 will be effective for us beginning in 2010. We do not believe its adoption will have a material impact on our consolidated financial statements.
3. Revenue
We record revenue from sales of pharmaceutical products under the KEFLEX brand, and beginning in 2009, also under the MOXATAG brand. Our largest customers are large wholesalers and retailers of pharmaceutical products. Cardinal Health, McKesson, and CVS accounted for 36.9%, 33.2% and 12.7% of our gross revenues from product sales in the year ended December 31, 2009. Cardinal Health, McKesson, and AmerisourceBergen accounted for 50.3%, 33.6% and 10.6% of our gross revenues from product sales in the year ended December 31, 2008, and 49.3%, 33.3% and 10.9% of our gross revenues from product sales in the year ended December 31, 2007.
4. Marketable Securities
We held no marketable securities at December 31, 2009. Marketable securities, including accrued interest, at December 31, 2008 were as follows:
The above marketable debt securities consist of corporate and government agency bonds with contractual maturities less than six months. We classify our investments in marketable securities as “available for sale” and record them at their fair value, with any unrealized gains or losses reported in other comprehensive income. We recognized $63,000 of net realized gains in 2009 and did not realize any gains or losses on our investments during 2008 or 2007. Any gains or losses to be recognized by us upon the sale of a marketable security are specifically identified by investment.
5. Accounts Receivable
Accounts receivable, net, consists of the following:
Our largest customers are large wholesalers and retailers of pharmaceutical products. Our three largest customers accounted for 56.2%, 17.5% and 9.5% of our accounts receivable as of December 31, 2009 and 48.7%, 35.6% and 10.0% as of December 31, 2008.
6. Inventories
Inventories, net, consist of the following:
Inventories are primarily finished goods of our commercial products but, during 2009, we purchased active pharmaceutical ingredient to be utilized by our third-party contract manufacturer in our MOXATAG product. This inventory is recorded as raw materials within our inventory balance.
We periodically review product inventories on hand. Inventory levels are evaluated by management relative to various factors including product demand, remaining shelf life and future marketing plans; reserves for obsolete and slow-moving inventories are recorded for amounts that we believe may not be realizable. We recorded provisions for excess inventory of $414,000, $39,000 and $864,000 in the years ended December 31, 2009, 2008 and 2007, respectively.
On November 7, 2007, we entered into a transaction with Deerfield. As part of the transaction, we sold our entire inventory of KEFLEX products to Deerfield. Under the transaction agreements, which include an inventory consignment agreement, we continued to operate our KEFLEX business, and purchased consigned inventory from Deerfield as necessary to fulfill customer orders. We exercised our repurchase right and re-acquired all the inventories from Deerfield on September 4, 2008, in connection with the EGI Transaction. While the Deerfield Entities owned the KEFLEX assets, we consolidated them, and there was no change in the accounting policies or basis for inventories.
7. Prepaids and Other Current Assets
Prepaid expenses and other current assets consist of the following:
Some of the 2008 items were accounted for as Prepaid expenses and other current assets in anticipation of their utilization in the first quarter 2009 for training of new sales representatives in preparation for the launch of MOXATAG.
8. Property and Equipment
Property and equipment consist of the following:
After receipt of the FDA’s response to our SPA for KEFLEX PULSYS, we indefinitely delayed substantially all spending on our PULSYS projects pending the successful commercialization of MOXATAG and adequate financial resources. As a result of this delay, we performed a review of our research and development assets to evaluate the need for a possible impairment. We reviewed the carrying value of the assets compared to the fair value of the assets, which we determined utilizing an income approach based on level three inputs (see Note 21 - Fair Value Measurements for more information about the levels of determining fair value). Based upon this review, we determined a number of our research and development assets were deemed to be impaired and we recorded a $233,000 charge in Research and development expenses to account for the impairment in the fourth quarter of 2009.
During 2008, we auctioned numerous pieces of research and development equipment with a net book value of $2.3 million and received proceeds of $1.3 million, resulting in a loss of $1.0 million that is recorded in Research and development expenses on the consolidated statement of operations.
In connection with the disposal of the research and development equipment, combined with engaging a commercial real estate broker to assist with subleasing the vacant laboratory section of our Maryland facility, we performed a review to evaluate the need for a possible impairment of the Maryland facilities. As a result of the review, we determined that we would not be able to recover the costs associated with the leasehold improvements in the laboratory section of the facility upon entering a sublease. As such, the leasehold improvements specifically identified with that portion of the facility were deemed impaired and a $3.1 million charge was recorded in 2008 in Research and development expenses on the consolidated statements of operations.
For leased facilities where we have ceased use of a portion or all of the space, we accrue a loss if the cost of the leased space is in excess of reasonably attainable rates for potential sublease income. During 2009 and 2008, we accrued losses of $1.0 million and $3.3 million, respectively, for excess leased laboratory and office space in Maryland.
Depreciation expense for the years ended December 31, 2009, 2008 and 2007 was $3.0 million, $5.2 million and $3.2 million, respectively.
Following is a rollforward of our reserves associated with the vacated portions of our Maryland facility for the years ended December 31, 2009, 2008 and 2007:
9. Intangible Assets
Intangible assets at December 31, 2009 and 2008 consist of the following:
Identifiable intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. Since the reacquisition of the non-PULSYS KEFLEX intangible assets from Deerfield on September 4, 2008, the assets were being amortized over 12 years to coincide with patents associated with the PULSYS technology.
Based on the FDA’s response to our SPA received on July 30, 2009, we have not gained agreement with the FDA regarding our non-inferiority design and planned analysis of the Phase III trial for our KEFLEX PULSYS product candidate as outlined in the SPA. Accordingly, we have indefinitely delayed the Phase III trial pending the successful commercialization of MOXATAG, adequate financial resources and the FDA’s agreement with a revised clinical trial design. Based on the FDA’s response, we have performed an impairment analysis of the intangible asset and have determined that it is not impaired at this time. Based on the indefinite delay of the project, we have reconsidered the life over which the asset is being amortized and, beginning in the fourth quarter of 2009, we have reduced the life to four years to better reflect our estimated economic life without using our PULSYS technology. We will continue to monitor the value and life of the asset in relation to the status of the Phase III trial for KEFLEX PULSYS.
Amortization expense for acquired intangible assets with definite lives was $1.4 million, $1.1 million and $1.2 million for the years ended December 31, 2009, 2008 and 2007, respectively. The 2008 balance includes amortization expense that was recorded in the consolidated financial statements for the KEFLEX intangible assets while they were owned by the Deerfield Entities. The gross carrying amounts for these assets were eliminated from our balance sheet and replaced by the value at which they were repurchased from Deerfield on September 4, 2008. For the next four years, annual amortization expense for acquired intangible assets is expected to be approximately $2.5 million. At that time, all intangible assets will be fully amortized, with no additional amortization expense expected.
In November 2007, we sold our non-PULSYS KEFLEX intangible assets to affiliates of Deerfield. We retained the right to repurchase, at a predetermined price, the intangible assets sold at a future date, as well as to continue to utilize the KEFLEX trademark and other intangible assets in order to continue to operate our non-PULSYS KEFLEX business. As discussed in Note 2 under “Consolidation,” the Deerfield affiliates were consolidated in our financial statements, and there was no change in the accounting policies or basis for intangible assets at that time. We exercised our right to repurchase the non-PULSYS KEFLEX intangible and associated assets in conjunction with the EGI Transaction on September 4, 2008. See Note 23, “Equity Group Investments Transaction.”
10. Revolving Line of Credit
We entered into a Loan and Security Agreement, dated June 29, 2009 (the “Loan Agreement”), pursuant to which we obtained a working capital-based secured revolving line of credit (the “Revolving Line”) from Silicon Valley Bank (“SVB”) with borrowing availability up to $10.0 million.
As of December 31, 2009, we were in compliance with the covenants under the Loan Agreement, had $1.7 million in available borrowings to be borrowed under the Revolving Line, and had no amounts outstanding.
We had no obligations on borrowings as of December 31, 2009. Effective on March 16, 2010, we terminated the Loan Agreement.
11. Accrued Expenses
Accrued expenses and other current liabilities consist of the following:
Accrued Severance
During the second half of 2009, we strategically realigned our field sales force and eliminated corporate staff positions to more aggressively preserve our financial resources. We terminated 142 field-based and 16 office-based employees. All employees were notified and terminated within the period the associated expense was accrued. In connection with the reductions-in-force, we recorded $2.3 million of severance expense and benefits. Of the total expense, $1.9 million was recorded in Selling, general and administrative expenses, while the remaining $0.4 million was recorded within Research and development expenses. The liability was recorded in current accrued expenses, as all amounts are expected to be paid out within one year. The majority of the payments were made before December 31, 2009.
In 2008, we terminated several employees in connection with the EGI Transaction and change in executive management, including the former chief executive and chief financial officers. In connection with these terminations, we recorded a severance expense within Selling, general and administrative expenses of $2.1 million for severance and benefits. The majority of the severance was paid out during 2008, with the balance being paid out during the first half of 2009.
In 2007, we reduced our workforce to reduce our operating expenses and recorded a charge of $0.5 million for salaries and benefits.
The following table presents the expenses we recorded for severance and benefits in each of the years ended December 31, 2009, 2008 and 2007:
The following table summarizes the activity in our 2009, 2008 and 2007 liabilities for the cash portion of severance costs. All liability balances are included in Accrued expenses and other current liabilities.
12. Warrant Liability
In November 2007, we issued warrants for the purchase of 3.0 million shares of our common stock to Deerfield in connection with the sale of certain non-PULSYS KEFLEX tangible and intangible assets. The warrants were exercisable immediately upon issuance for a period of six years. The warrant agreement contained provisions for cash settlement under certain conditions, including a major asset sale or acquisition in certain circumstances, which was available to the warrant holders at their option. As a result, the warrants were classified as a liability at their contractual fair value in the consolidated balance sheet. Upon issuance of the warrants in November 2007, we recorded the warrant liability at its initial fair value of $2.6 million based on the Black-Scholes option-pricing model.
Equity derivatives not qualifying for permanent equity accounting are recorded at fair value and re-measured at each reporting date until the warrants are exercised or expire. Changes in the fair value of the warrants issued in November 2007 were reported in the consolidated statement of operations as non-operating income or expense.
As discussed in Note 23, “Equity Group Investments Transaction,” we settled the warrant liability for $8.8 million in 2008 in connection with the closing of the EGI Transaction discussed therein. At December 31, 2007, the aggregate fair value of these warrants decreased to $2.1 million, using the Black-Scholes option pricing model, from their initial fair value of $2.6 million at the issuance date of November 7, 2007, resulting in a noncash gain of $0.5 million and a corresponding reduction in the recorded value of the warrant liability as of December 31, 2007. The gain was attributable to a decrease in our stock price and a reduction in the remaining term of the warrants.
13. Deferred Contract Revenue
Collaboration with Par Pharmaceutical for Amoxicillin PULSYS.
In May 2004, we entered into an agreement with Par to collaborate on the further development and commercialization of PULSYS-based amoxicillin products. Under the terms of the agreement, we conducted the development program, including the manufacture of clinical supplies and the conduct of clinical trials, and were responsible for obtaining regulatory approval for the product. We were to own the product trademark and were to manufacture or arrange for supplies of the products for commercial sales. Par was to be the sole distributor of the products. Both parties were to share commercialization expenses, including pre-marketing costs and promotion costs, on an equal basis. Operating profits from sales of the products were also to be shared on an equal basis. Under the agreement, we received an upfront fee of $5.0 million and a commitment from Par to fund all further development expenses. Development expenses incurred by us were to be partially funded by quarterly payments aggregating $28 million over the period of July 2004 through October 2005, of which up to $14 million would have been contingently refundable.
Revenue related to the receipt of the quarterly payments from Par was recognized based on actual costs incurred as the work was performed, limited to the minimum amounts expected to be received under the agreement and excluding amounts contingent on future events or that were contingently refundable, with the balance of cash received in excess of revenue recognized recorded as deferred revenue. The excess of the development costs we incurred over the quarterly payments made by Par was to be funded subsequent to commercialization, by the distribution to us of Par’s share of operating profits until the excess amount had been reimbursed. We did not record any amounts as revenue on a current basis that were dependent on achievement of future operating profits.
On August 3, 2005, we were notified by Par that they had decided to terminate the companies’ amoxicillin PULSYS collaboration agreement. After termination of the agreement, we received from Par the $4.8 million development funding quarterly payment due in July 2005 and expect no further payments under the collaboration. Under certain circumstances, the termination clauses of the agreement may entitle Par to receive a share of net profits, as categorized in the agreement, up to one-half of their cumulative $23.3 million funding of the development costs of certain amoxicillin PULSYS products, should the products covered by the agreement be successfully commercialized. Accordingly, in 2005, we retained deferred revenue of $11.6 million related to the agreement, and accelerated the recognition into current revenue of the remaining balance of $2.4 million of deferred reimbursement revenue.
14. Preferred Stock - Undesignated
On October 22, 2003, our certificate of incorporation was amended to authorize the issuance of up to 25.0 million shares of undesignated preferred stock. Our Board of Directors, without any further action by our stockholders, is authorized to issue shares of undesignated preferred stock in one or more classes or series. The Board may fix the rights, preferences and privileges of the preferred stock. The preferred stock could have voting or conversion rights that could adversely affect the voting power or other rights of common stockholders. As of December 31, 2009 and 2008, no shares of preferred stock have been issued.
15. Common Stock and Warrants
Our certificate of incorporation has authorized 225.0 million shares of common stock.
Each share of common stock is entitled to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally available and when declared by the Board of Directors, subject to the prior rights of holders of all classes of stock outstanding.
Private Placements of Common Stock
In September 2008, we completed a private placement of 30.3 million shares of our common stock, par value $0.01 per share, and a warrant (the “EGI Warrant”) to purchase an aggregate of 12.1 million shares (the “Warrant Shares”) of our common stock for an aggregate purchase price of $100 million, with net proceeds of $96 million after expenses. The EGI Warrant has a term of five years and an exercise price of $3.90 per Warrant Share, subject to certain adjustments. Based on a review of the provisions of our warrant agreements, we have determined that the EGI Warrant should be classified as permanent equity. See Note 23 - “Equity Group Investments Transaction” for further detail about the private placement.
In January 2008, we closed a private placement of 8.8 million shares of our common stock and warrants to purchase 3.5 million shares of common stock, at a price of $2.40 per unit. Each unit consists of one share of our common stock and a warrant to purchase 0.40 shares of common stock. The transaction raised approximately $21.0 million in gross proceeds and $19.9 million in proceeds, net of expenses. The warrants have a five-year term beginning July 28, 2008 and an exercise price of $3.00 per share. Based on a review of the provisions of our warrant agreements, we have determined that the warrants we issued in January 2008 should be classified as permanent equity.
In April 2007, we closed a private placement of 10.2 million shares of our common stock and warrants to purchase 7.6 million shares of common stock, at a price of $2.36375 per unit. Each unit consists of one share of our common stock and a warrant to purchase 0.75 shares of common stock. The warrants have a five-year term and an exercise price of $2.27 per share. The transaction raised approximately $24.0 million in gross proceeds. We received net proceeds after deducting commissions and expenses of approximately $22.4 million.
We view the registration rights agreement containing the liquidated damages provision as a separate freestanding contract which has nominal value. Under this approach, the registration rights agreement is accounted for separately from the financial instrument. Accordingly, the classification of the warrants has been determined to be and accounted for as permanent equity. Registration payment arrangements are measured based on the probability that liquidated damages will occur. Should we conclude that it is more likely than not that a liability for liquidated damages will occur, we will record the estimated cash value of the liquidated damages liability at that time.
Our registration rights agreements generally require that we undertake to file a registration statement within a specified number of days, to have the SEC declare the registration statement effective within a specified number of days, and that we maintain the effectiveness of the registration statement for a period of time; for example, until the date as of which all investors as selling stockholders may sell the registered securities without restriction pursuant to Rule 144 (or any successor rule thereto) or the actual date that the securities have been sold. These agreements also specify liquidated damages for each day we fail to comply with these obligations. For each of the private placements we have completed, we have met the required deadlines for filing and for achieving effectiveness, and we have never had a period in which any of our registration statements was not continuously effective.
If we were to fail to remain effective under our registration statements, we have calculated the maximum possible liquidated damages that we might incur. In order to estimate that amount, the following assumptions have been made: (a) in addition to the original investment, all warrants are exercised for cash at the latest possible date before expiration; (b) no shares are sold during the entire period; and (c) the registration statements are not effective for the entire term of the agreement, including one year after the last potential warrant exercise (a total of six years for the private placements and seven years for the Deerfield Transaction). The April 2007 and January 2008 private placements have caps on maximum liquidated damages, and the caps have been used as the maximum potential liquidated damages for those two private placements. Our maximum potential liquidated damages under our private placements is approximately $55.4 million as of March 10, 2010. The Deerfield warrants issued in November 2007 were settled in conjunction with the EGI Transaction in September 2008; as a result, there are no potential liquidated damages associated with such warrants.
Warrants
We have granted warrants to purchase shares of common stock in connection with certain of our financing transactions, as well as the transaction with Deerfield. At December 31, 2009, the following warrants to purchase common stock were outstanding and exercisable:
Shares Reserved for Future Issuance
At December 31, 2009, common stock reserved for future issuance is as follows:
16. Stock Option Plans
We currently grant stock options under the Stock Incentive Plan (the “Plan”). An amendment to the Plan to increase the number of shares of common stock available for grant thereunder by 7.0 million shares (the “Plan Amendment”), was approved by the stockholders as of September 4, 2008, in conjunction with the EGI Transaction, and an additional 3.5 million shares were approved by stockholders in June 2009. In September 2008, our Board of Directors approved our New Hire Incentive Plan (the “New Hire Incentive Plan”), which provides for the issuance of up to 4.5 million non-qualified stock options to new hires as a material inducement for them to accept employment with us. As of January 1, 2010, our Board of Directors no longer issues shares under the New Hire Incentive Plan. The number of shares authorized for issuance under these plans is 24.3 million.
Options granted under the Plan may be incentive stock options or non-qualified stock options, while options granted under the New Hire Incentive Plan may only be non-qualified stock options. Stock purchase rights may also be granted under the Plan. Incentive stock options may only be granted to employees. The compensation committee of the Board of Directors determines the period over which options become exercisable. Options granted to employees and consultants normally vest over a four-year period. Options granted to directors, upon their initial appointment or election, vest monthly over periods of 36 or 48 months. Annual director and advisor grants vest monthly over 12 months. Director and advisor grants are exercisable on the date of grant but are restricted, subject to repurchase until vested. The exercise price of incentive stock options and non-qualified stock options shall be no less than 100% of the fair market value per share of our common stock on the grant date. The term of all options outstanding is 10 years. As of December 31, 2009 and 2008, there were 7.3 million and 2.6 million shares of common stock available for future option grants, respectively.
The following table summarizes the activity of the Plans for the year ended December 31, 2009:
The total intrinsic value of options exercised during the years ended December 31, 2009, 2008 and 2007 was $45,000, $1.4 million and $306,000, respectively. Cash received by us in the years ended December 31, 2009, 2008 and 2007 upon the issuance of shares from option exercises was $64,000, $772,000 and $167,000, respectively. Our policy is to issue new shares of common stock to satisfy stock option exercises.
A summary of our nonvested options for the year ended December 31, 2009 is presented below:
The fair value of options vested during the years ended December 31, 2009 and 2008 was $4.6 million and $1.9 million, respectively.
The following table summarizes information about stock options outstanding and exercisable at December 31, 2009:
17. Stock-Based Compensation
We have recorded stock-based compensation expense for the grant of stock options to employees and to nonemployees as follows:
Employees. We measure employee share-based compensation using a fair value method, with the resulting compensation cost being recognized in the financial statements. We estimate forfeitures in calculating the expense related to share-based compensation rather than recognizing forfeitures as a reduction in expense as they occur.
We record compensation expense on a straight-line basis over the requisite service period, which is equal to the vesting period. All share-based compensation costs are charged to expense and not capitalized.
As of December 31, 2009, the total unrecognized compensation cost related to nonvested stock awards was $7.7 million, and the related weighted-average period over which it is expected to be recognized is approximately 2.6 years.
The weighted average fair value of options granted to employees during 2009, 2008 and 2007 was $0.82, $1.28 and $1.79 per share, respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes options pricing model, with the following weighted-average assumptions for grants in 2009, 2008 and 2007:
We utilize many factors, including historical experience, vesting period of awards, expected volatility and employee demographics in determining the fair value of options granted and continually review our assumptions for reasonableness. In December 2008, we lowered our estimated expected term to 4.0 years, equal to the length of the vesting periods for most option grants. Previously, we elected to determine the expected term of share-based awards using the transition approach under which an expected term of 6.25 years may be used for four-year grants with a ten-year contractual term. A shorter expected term results in lower compensation expense. The shorter expected term continues to remain appropriate.
To estimate expected future volatility, we use our historical volatility over a period equal to our estimated expected term of options adjusted for certain unusual, one day fluctuations. We have no implied volatility data, as we have no publicly traded options or other financial instruments from which implied volatility can be derived. As of December 2008, we changed our volatility from 75% to 90%. Historically, we have based our estimate of expected future volatility upon a combination of our historical volatility together with the average of volatility rates of comparable public companies. Using a higher volatility input to the Black-Scholes model results in a higher compensation expense. The higher volatility remained appropriate during 2009.
The risk-free rate is based on U.S. Treasury yields in effect at the time of grant corresponding with the expected term of the options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.
In May 2007, we amended our Form of Incentive Stock Option Agreement and our Form of Non-Qualified Stock Option Agreement to provide that all outstanding unvested stock options will automatically become fully vested upon a Change in Control (as that term is defined in the Plan). This modification resulted in no additional compensation charge, as the modification to vesting did not change the assumptions underlying the fair value of the options granted.
Nonemployees. We have recorded stock-based compensation expense for options granted to nonemployees, including consultants, Scientific Advisory Board (“SAB”) members and contract sales representatives based on the fair value of the equity instruments issued. Stock-based compensation for options granted to nonemployees is periodically remeasured as the underlying options vest. We recognize an expense for such options throughout the performance period as the services are provided by the nonemployees, based on the fair value of the options at each reporting period. The options are valued using the Black-Scholes option pricing model. For graded-vesting options, a final measurement date occurs as each tranche vests. As of December 31, 2009, the balance of unamortized stock-based compensation for options granted to non-employees was approximately $216,000. This amount will be adjusted based on changes in the fair value of the options at the end of each reporting period. As of December 31, 2009, 142,084 options are outstanding and exercisable for nonemployees.
18. Income Taxes
Income tax expense or benefit for the year is allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income, and items charged or credited directly to shareholders equity. Pursuant to this intraperiod allocation requirement, $174,000 of tax expense has been allocated to loss from continuing operations. This entry has been reversed in 2009, as all items comprising Other comprehensive income have been realized. We have provided a valuation allowance for the full amount of our net deferred tax assets since realization of any future benefit from deductible temporary differences and net operating loss carryforwards cannot be sufficiently assured at December 31, 2009 and 2008.
The components of the benefit from income taxes are as follows:
Deferred tax assets (liabilities) consist of the following:
The effective tax rate differs from the U.S. federal statutory tax rate of 34% due to the following:
At December 31, 2009 and 2008, we had federal and state net operating loss carryforwards of approximately $236.2 million and $186.3 million, respectively, available to reduce future taxable income, which will begin to expire in 2020. At December 31, 2009, we had federal research and experimentation tax credit carryforwards of approximately $4.0 million, which begin to expire in 2021, and state tax credit carryforwards of $0.4 million, which begin to expire in 2018.
Under the provisions of Sections 382 and 383 of the Internal Revenue Code, certain substantial changes in our ownership may result in a limitation on the amount of net operating loss and research and experimentation tax credit carryforwards that can be utilized in future years. During various years we may have experienced such ownership changes.
We are primarily subject to U.S., Texas and Maryland state corporate income tax. All tax years from our inception in 2000 remain open to examination by U.S. federal and state authorities.
Our policy is to recognize interest related to income tax matters, if any, in interest expense and penalties related to income tax matters, if any, in operating expenses. As of December 31, 2009 and 2008, we had no accruals for interest or penalties related to uncertain tax positions or other income tax matters.
We are unaware of any positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months.
19. 401(k) Savings Plan and Employee Stock Purchase Plan
We have established a defined contribution savings plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. Our Board of Directors has discretion to match contributions made by our employees. To date, we have not made any matching contributions.
We have adopted an employee stock purchase plan which provides for the issuance of up to 100,000 shares of common stock. This plan, which is intended to qualify under Section 423 of the Internal Revenue Code, provides our employees with an opportunity to purchase shares of our common stock through payroll deductions. Options to purchase the common stock may be granted to each eligible employee periodically. The purchase price of each share of common stock will not be less than the lesser of 85% of the fair market value of the common stock at the beginning or end of the option period. Participation is limited so that the right to purchase stock under the purchase plan does not accrue at a rate which exceeds $25,000 of the fair market value of our common stock in any calendar year. To date, the plan has not been activated, and no shares have been issued under this plan.
20. Commitments and Contingencies
Leases
In September 2008, we entered into a five-year lease for corporate office space in Westlake, Texas, which is renewable for one period of five consecutive years at the end of the original term. We took possession of the leased space in November 2008. In conjunction with the execution of the lease agreement, we provided the landlord with a deposit of $0.4 million as of December 31, 2009 and 2008. The lease includes scheduled base rent increases over the term of the lease. The total amount of the base rent payments will be charged to expense on the straight-line method over the term of the lease (excluding renewal periods).
In August 2002, we entered into a 10-year lease for our corporate, research and development facility in Germantown, Maryland, which is renewable for two periods of five consecutive years each at the end of the term. We took possession of the lease space during 2003. In conjunction with the execution of the lease agreement, we provided the landlord with a letter of credit, which we collateralized with a restricted cash deposit in the amount of $0.6 million at December 31, 2009 and 2008 (see Note 2 - Summary of Significant Accounting Policies ). The lease includes scheduled base rent increases over the term of the lease. The total amount of the base rent payments will be charged to expense on the straight-line method over the term of the lease (excluding renewal periods). We received $0.9 million in cash from the landlord in connection with the build-out of the facility. These amounts were recorded as deferred rent and are being amortized on a straight-line basis as a reduction to rent expense over the term of the lease.
In August 2004, we leased additional space adjacent to our Germantown, Maryland facility. This lease, which includes a rent holiday and scheduled rent increases annually over its term, is being charged to expense on a straight-line basis over the entire term of the lease, which expires May 31, 2013. In conjunction with the execution of the lease agreement, we provided the landlord with a letter of credit, which we collateralized with a restricted cash deposit in the amount of $0.3 million at December 31, 2009 and 2008 (see Note 2 - Summary of Significant Accounting Policies ).
We vacated portions of the original Maryland lease during the fourth quarter of 2008. For leased facilities where we have ceased use for a portion or all of the space, we accrue a loss if the cost of the leased space is in excess of reasonably attainable sublease income.
During April 2009, we entered into a lease amendment for a portion of the adjacent space we had leased in Germantown in 2004. In this amendment, we have been removed from the lease for that portion of the building, but our rent for the remaining portion was adjusted to compensate the landlord for the reduced rents to be received on the newly leased spaced. Additionally, we also have a note payable with the landlord to cover the cost of tenant improvements that the landlord advanced for the new tenant on our behalf. In connection with the lease amendment, we reviewed and adjusted the liability for our previously exited leased space to include the change in rental payments and the note payable. These changes resulted in an additional charge of $1.0 million recorded in Research and development expenses during 2009.
In 2008, we accrued a loss for the cost of the leased space in excess of reasonably attainable sublease income in the amount of $1.8 million, which was partially offset by the reversal of the straight-line rent accrual for the unused portion of the facility in the amount of $0.5 million. Additionally, portions of the adjacent facility had been abandoned during the third quarter of 2007, and we accrued a loss for the cost of the leased space in excess of potential sublease income at that time. Effective April 2008, another company leased approximately 40 percent of the facility directly from the landlord, with the landlord amending our lease to reflect a rent reduction for the amount of rent the landlord will receive each month from the other company. We remain contingently liable for that other company’s rental payments under a financial guarantee to the landlord. The contingent rentals due under the financial guarantee have been included in the table of future minimum lease payments below. During 2008, we reassessed the original loss recorded during 2007 based upon updated potential sublease amounts and recorded an additional loss of $1.3 million, which is net of deferred rent amounts of $0.2 million.
Rent expense under all leases was $1.7 million, $4.1 million and $2.6 million for the years ended December 31, 2009, 2008 and 2007, respectively. As discussed above, the 2009 and 2008 rent expense includes the accelerated expense associated with unused leased space.
Future minimum lease payments under noncancelable operating leases at December 31, 2009 are as follows:
Capital Leases - Automobiles
In connection with hiring a field sales force during the first quarter of 2009, we entered into leases under a master lease agreement to provide vehicles for the sales force. These leases range in length from 30 to 40 months and include up to 75,000 miles. Based on the details of the leases, we are accounting for these leases as capital leases. As a result, we have recorded the present value of the minimum lease payments as an asset within property and equipment, with an offsetting liability split between other current and long-term liabilities. We are amortizing the value of the vehicle leases over the term of each lease and allocate the lease payments between a reduction of the outstanding obligation and interest expense.
We had recorded a total gross asset value of $5.0 million associated with all automobile leases. During 2009, we completed reductions of our field sales force, which resulted in the termination of automobile leases with a net book value of $1.7 million. The net book value associated with all terminated automobile leases, along with the remaining current and noncurrent liability balances, were removed from Property and equipment, net and other current and long-term liabilities on our consolidated balance sheet. As of December 31, 2009, $1.6 million of net book value of the automobiles remains in Property and equipment, net associated with the ongoing capital leases, and the associated liabilities of are $1.0 million are included in Other current liabilities and $0.6 million are included in Other long-term liabilities. For the year ended December 31, 2009, we paid $121,000 for imputed interest on capital leases.
Royalties
We originally acquired the U.S. rights to the KEFLEX brand of cephalexin from Eli Lilly and Company in June 2004. In the event we are able to develop and commercialize a PULSYS-based KEFLEX product, another cephalexin product relying on the acquired NDAs, or other pharmaceutical products using the acquired trademarks, Eli Lilly will be entitled to royalties on these new products. In 2006, we launched our KEFLEX 750 mg product, which is covered by the agreement with Eli Lilly and is subject to a royalty on net sales of 10 percent. Royalties are payable on a new product by new product basis for five years following the first commercial sale for each new product, up to a maximum aggregate royalty per calendar year. All royalty obligations with respect to any defined new product cease after the fifteenth anniversary of the first commercial sale of the first defined new product.
On November 7, 2007, we closed an agreement with Deerfield. We sold certain assets, and assigned certain intellectual property rights, relating only to our existing cephalexin business, excluding cephalexin PULSYS, to Deerfield for $7.5 million (less a $0.5 million payment to Deerfield). Pursuant to an inventory consignment agreement and license of those intellectual property rights back to us, we continued to operate our existing cephalexin business, subject to consignment and royalty payments to Deerfield of 20% of net sales. Regardless of the level of net sales, the minimum combined consignment and royalty payment was $0.4 million for each calendar quarter. Consignment and royalty payments due to affiliates of Deerfield from us were eliminated in the consolidated balance sheet and consolidated statement of operations. In conjunction with the EGI Transaction, we exercised our right to repurchase the KEFLEX intangible and associated assets from Deerfield. As part of the Deerfield Agreement, we repurchased the royalty stream from Deerfield.
Legal Proceedings
We are not a party to any material pending legal proceedings, other than ordinary routine litigation incidental to our business.
21. Fair Value Measurements
We have held certain assets that are required to be measured at fair value on a recurring basis. These assets consisted of high quality short-term commercial paper and government agency bonds, for which fair value is measured based on inputs that are derived principally from or corroborated by observable market data. We currently do not have non-financial assets that are required to be measured at fair value on a recurring basis.
GAAP has established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:
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Level 1 - defined as observable inputs such as quoted prices in active markets
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Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable
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Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions
As of December 31, 2009, we did not hold any assets that were required to be measured at fair value on a recurring basis. As of December 31, 2008, we held certain assets that are required to be measured at fair value on a recurring basis. These assets consisted of high quality short-term commercial paper and government agency bonds, for which fair value is measured based on inputs that are derived principally from or corroborated by observable market data.
As of December 31, 2009 and 2008, we did not hold any liabilities that were required to be measured at fair value on a recurring basis.
22. Noncontrolling Interest - Deerfield Transaction
On November 7, 2007, we entered into a series of agreements with Deerfield, which provided for a potential capital raise of up to $10 million in cash in two potential closings through the sale or assignment of certain of our non-PULSYS KEFLEX assets to two Deerfield affiliates, Kef and Lex.
A portion of the proceeds received from the EGI Transaction (see Note 23 - Equity Group Investments Transaction) was used to repurchase those certain non-PULSYS KEFLEX assets sold and assigned to Kef and Lex, by purchasing all of the outstanding capital stock of both Kef and Lex.
23. Equity Group Investments Transaction
On July 1, 2008, we entered into a securities purchase agreement with EGI, under which we agreed to sell, and EGI agreed to purchase, 30.3 million shares of our common stock, par value $0.01 per share, and the EGI Warrant to purchase an aggregate of 12.1 million Warrant Shares of our common stock for an aggregate purchase price of $100 million, with net proceeds of $96 million after expenses. The EGI Warrant has a term of five years and an exercise price of $3.90 per Warrant Share, subject to certain adjustments. Based on a review of the provisions of our warrant agreements, we have determined that the EGI Warrant should be classified as permanent equity.
The EGI Transaction received shareholder approval and closed on September 4, 2008.
In connection with the EGI Transaction, we also entered into the Deerfield Agreement, under which we agreed to repurchase, for approximately $11 million, our non-PULSYS KEFLEX assets previously sold to certain of the Deerfield Entities in November 2007, and to terminate our ongoing royalty obligations to certain Deerfield Entities. Additionally, each of the applicable Deerfield Entities agreed to irrevocably exercise its option to require us to redeem warrants to purchase 3.0 million of our common stock (the “Deerfield Warrants”), upon the occurrence of the closing of the EGI Transaction, for an aggregate redemption price of approximately $8.8 million. The Deerfield Agreement closed in conjunction with the closing of the EGI Transaction, and a portion of the proceeds received from EGI were used to repurchase the non-PULSYS KEFLEX assets and associated assets and to redeem the Deerfield Warrants.
Pursuant to a registration rights agreement with EGI, we registered the resale of 42.4 million shares of common stock, representing 30.3 million shares of common stock and the 12.1 million shares of common stock issuable upon exercise of the EGI Warrant. The registration rights agreement provides certain filing and effectiveness clauses for the initial registration statement, if we do not subsequently maintain the effectiveness of the initial registration statement or any additional registration statements, then in addition to any other rights EGI may have, we will be required to pay EGI liquidated damages, in cash, equal to 1.0 percent per month of the aggregate purchase price paid by EGI. Maximum aggregate liquidated damages payable to EGI are 20 percent of the aggregate amount paid by EGI. The registration statement on Form S-3 was filed on October 17, 2008 with the SEC and was declared effective as of November 24, 2008, which was within the effectiveness clauses of the agreement.
24. Related Party Transactions
Deerfield Transaction
On November 7, 2007, we entered into a series of agreements with Deerfield, a healthcare investment fund and one of our largest equity shareholders at that time. The agreements were terminated as of September 4, 2008. See Note 22 - Noncontrolling Interest - Deerfield Transaction and Note 23 - Equity Group Investments Transaction for further detail.
Consulting Arrangements
On October 17, 2008, our Board of Directors appointed Lord James Blyth to the Board of Directors and elected him as its vice chairman. In connection with his new appointment, we entered into a consulting agreement with Lord Blyth, pursuant to which Lord Blyth will provide strategic guidance in late-stage development and commercialization of our research and development efforts. The consulting agreement has a term of 36 months beginning on October 17, 2008. As compensation for his services under the consulting agreement, Lord Blyth received an option under the Plan to purchase 470,000 shares of our common stock with an exercise price of $1.34 per share, equal to the closing price of our common stock on the NASDAQ Global Market on October 16, 2008. The option has a term of three years and fully vests one month prior to the expiration of the consulting agreement. The Board may accelerate the vesting, or terminate the consulting agreement prior to the vesting of the option, at any time in the Board’s sole discretion based on a review of Lord Blyth’s contribution to us. Lord Blyth will not be eligible to participate in any benefit programs that we maintain for our employees. We will not reimburse Lord Blyth for any expenses except for reasonable travel expenses incurred in connection with his performance of consulting services, unless otherwise agreed by us. On November 24, 2009, the Board granted Lord Blyth an additional 500,000 shares with an exercise price of $0.70 per share, equal to the closing price of our common stock on the NASDAQ Global Market on November 23, 2009. The option term was set to coincide with his prior grant so all of Lord Blyth’s options will fully vest one month prior to the expiration on the consulting agreement.
Consulting Agreements with Edward M. Rudnic. On June 27, 2008, we entered into a Consulting Agreement with Dr. Edward M. Rudnic, the former chief executive officer, which became effective on September 5, 2008, for a term of 24 months, and is subject to renewal for additional 12-month periods by mutual agreement of the parties. Under the Consulting Agreement, Dr. Rudnic has agreed to be available on a mutually agreeable schedule to provide such consulting services with respect to the business of us as we reasonably request. The fees for the services of Dr. Rudnic under the Consulting Agreement shall be $3,000 per day or $1,500 per half-day, plus reasonable travel expenses. We also granted to Dr. Rudnic, on September 4, 2008, a stock option pursuant to the terms of the Plan to purchase 100,000 shares of common stock. The Option shall vest, in its entirety, upon expiration of the original term of the Consulting Agreement or, if earlier, upon a material breach of the Consulting Agreement by us. With respect to other stock options held by Dr. Rudnic as of September 4, 2008, Dr. Rudnic’s obligations to provide consulting services under the Consulting Agreement shall constitute continued “Service” with us (as described in the Plan and any applicable stock option agreement) so that (i) such prior options shall continue to vest during the term of the Consulting Agreement (including any additional terms following the original term), and (ii) the exercisability of such prior options shall be determined as if such service continued until the expiration of the term of the Consulting Agreement (including any additional terms following the original term).
The Consulting Agreement may be terminated (i) by a party to the Consulting Agreement upon a material breach by the other party; (ii) upon mutual written agreement of the parties; or (iii) automatically upon expiration of the original term or any renewed terms of the Consulting Agreement without additional renewal by the parties. As of December 31, 2009, $11,000 has been paid under this Consulting Agreement.
Consulting Agreements with Robert C. Low. On June 30, 2008, we entered into a Consulting Agreement with Mr. Robert C. Low, the former chief financial officer, which became effective on September 5, 2008 for a term of 24 months, subject to renewal for additional 12-month periods by mutual agreement of the parties. Under the Consulting Agreement, Mr. Low has agreed to be available to provide such consulting services with respect to our business as we reasonably request. The fees for the services of Mr. Low under the Consulting Agreement shall be $1,500 per day or $750 per half-day, plus reasonable travel expenses. With respect to prior stock options held by Mr. Low as of September 4, 2008, we have agreed that Mr. Low’s obligations to provide consulting services under the Consulting Agreement shall constitute continued “Service” with us (as described in the Plan and any applicable stock option agreement) so that (i) such prior options shall continue to vest during the term of the Consulting Agreement (including any additional terms following the original term), and (ii) the exercisability of such prior options shall be determined as if such service continued until the expiration of the term of the Consulting Agreement (including any additional terms following the original term).
The Consulting Agreement may be terminated by a party to the Consulting Agreement upon a material breach by the other party. As of December 31, 2009, no amounts have been paid under this Consulting Agreement.
25. Subsequent Events
On March 9, 2010, we engaged Broadpoint Gleacher Securities Group, Inc. as our financial advisor to assist the board of directors in identifying and evaluating strategic alternatives, including a possible merger or sale of the Company. The board of directors has not set a definitive timetable for the completion of its evaluation, and there can be no assurance that the process will result in a transaction. We do not intend to disclose developments regarding this process unless and until the board of directors has approved a specific transaction.
Effective March 15, 2010, we eliminated our field sales force and significantly reduced our corporate staff to preserve our cash resources as we explore our strategic options. As part of the reduction in force, John Thievon, our president and chief executive officer, announced his resignation as an officer and director to further reduce operating expenses. David Becker, our chief financial officer, has assumed the role of acting president and chief executive officer. In connection with this action, we will record an expense of approximately $3.9 million during the first quarter 2010. The restructuring charge will include non-recurring employee termination charges for severance payments and benefits and non-recurring exit costs primarily related to vehicle lease termination expenses and the write-off of the remaining net book value of laptop computers and associated software licenses.
Effective March 16, 2010, we terminated our Loan Agreement with Silicon Valley Bank.
In February 2010, we partnered with DoctorDirectory.com, Inc., or DoctorDirectory, to promote MOXATAG through DoctorDirectory’s virtual marketing solution, IncreaseRx®. IncreaseRx® utilizes web-based educational and promotional tactics to reach thousands of healthcare professionals with targeted sales and marketing messages. IncreaseRx® performs as a virtual contract sales organization, providing healthcare professionals with access to electronic sampling and online educational tools and information. We now rely entirely on IncreaseRx® to market MOXATAG. We also plan to market KEFLEX in the United States through a third party marketer.
In January 2010, we vacated the remaining portions of our leased space in Maryland. As a result, we will record approximately $2 million in expenses during the first quarter relating to the future rental expense and abandoned assets in the facility.
26. Quarterly Financial Data (Unaudited)
The following table presents our unaudited quarterly financial data. Our quarterly results of operations for these periods are not necessarily indicative of future results of operations.
SCHEDULE II
MIDDLEBROOK PHARMACEUTICALS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2009, 2008, and 2007
(1)
Deductions represent utilization of the allowances. For accounts receivable, these include the deduction by customers of prompt pay discounts from their payments, chargebacks made by wholesalers to us, wholesaler rebates and writeoffs of bad debts, if any.