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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
Commission File Number 0-17254
NOVEN PHARMACEUTICALS, INC.
| Incorporated under the laws of the | I.R.S. Employer Identification Number | |
| State of Delaware | 59-2767632 |
11960 S.W. 144th Street, Miami, Florida 33186
305-253-5099
305-253-5099
Securities registered pursuant to Section 12(b) of the Act:
|
Common Stock, Par Value $.0001 | |
Name of exchange on which registered:
|
Nasdaq Stock Market | |
Securities registered pursuant to Section 12(g) of the Act:
|
None |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
The aggregate market value of the voting and non-voting common equity of the registrant held
by non-affiliates of the registrant was approximately $421 million (computed by reference to the
price at which the common equity was last sold on June 30, 2006, the last business day of the
registrant’s most recently completed second fiscal quarter).
As of March 1, 2007, there were 24,759,369 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III: Portions of registrant’s Proxy Statement for its 2007 Annual Meeting of
Shareholders.
NOVEN PHARMACEUTICALS, INC.
Annual Report on Form 10-K
for the year ended December 31, 2006
for the year ended December 31, 2006
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FORWARD-LOOKING INFORMATION
Statements in this report that are not descriptions of historical facts are
forward-looking statements provided under the “safe harbor” protection of the Private Securities
Litigation Reform Act of 1995. These statements are made to enable a better understanding of our
business, but because these statements are subject to many risks, uncertainties, future
developments and changes over time, actual results may differ materially from those expressed or
implied by such statements. Examples of forward-looking statements are statements about
anticipated financial or operating results, financial projections, business prospects, future
product performance, future research and development results, anticipated regulatory filings and
approvals, and other matters that are not historical facts. Such statements often include words
such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “could,”
“should,” “seeks,” “will,” “would” or similar expressions.
These forward-looking statements are based on the information that was available to us, and
the expectations and assumptions that were deemed reasonable by us, at the time the statements were
made. We do not undertake any obligation to update any forward-looking statements in this report
or in any of our other communications, except as required by law, and all such forward-looking
statements should be read as of the time the statements were made, and with the recognition that
these forward-looking statements may not be complete or accurate at a later date.
Many factors may cause or contribute to actual results or events being materially different
from those expressed or implied by forward-looking statements. Although it is not possible to
predict or identify all such factors, they include those set forth under “Risk Factors” beginning
on page 21 of this report.
PART I
Item 1. Business.
General
Noven Pharmaceuticals, Inc. (“we” or “Noven”) develops and manufactures advanced transdermal
patches utilizing our proprietary drug delivery technologies. Our principal commercialized
products are prescription transdermal patches for use in the treatment of Attention Deficit
Hyperactivity Disorder (“ADHD”) and in menopausal hormone therapy (“HT”). These products include:
| • | Daytrana™ (methylphenidate transdermal system), the first and only transdermal patch approved by the United States Food and Drug Administration (“FDA”) for the treatment of ADHD. | ||
| • | Vivelle-Dot® (estradiol transdermal system), the most prescribed transdermal estrogen therapy product in the United States and the smallest estrogen patch approved by the FDA. This product is marketed primarily under the brand name Estradot® outside the United States. |
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| • | CombiPatch® (estradiol/norethindrone acetate transdermal system), the first combination estrogen/progestin transdermal patch approved by the FDA. This product is marketed under the brand name Estalis® outside the United States. |
Our business strategy is focused on diversifying our product offerings (beyond ADHD and HT)
through strategic collaborations and new product development. Products under development may
include third-party proprietary and non-proprietary molecules, which are generally FDA-approved
compounds as opposed to new chemical entities, as well as generic versions of existing transdermal
products where we believe our proprietary technology may be beneficially applied.
We have established development collaborations with Shire plc (“Shire”), Endo Pharmaceuticals
Inc. (“Endo”) and other companies relating to the development of new transdermal products using our
technologies.
We have an active research and development program investigating a broad range of products and
therapeutic categories where we believe our technology may be beneficially applied. We are also
investigating ways to improve our existing technology and to acquire new technologies that we
believe will expand the range of molecules we can deliver through transdermal or other delivery
systems. Pre-clinical research is ongoing as we select new candidates for development.
We were incorporated in Delaware in 1987 as Noven Pharmaceuticals, Inc., and our principal
executive offices are located at 11960 S.W. 144th Street, Miami, Florida 33186; our
telephone number is (305) 253-5099 and our Internet website address is www.noven.com.
Novogyne Pharmaceuticals
Our menopausal hormone therapy products are marketed and sold in the United States
through Novogyne Pharmaceuticals (“Novogyne”), a joint venture that we formed with Novartis
Pharmaceuticals Corporation (“Novartis”) in 1998 to market and sell women’s prescription healthcare
products. We own a 49% equity interest in the joint venture company and Novartis owns the
remaining 51% equity interest. The joint venture company is a Delaware limited liability company
which is legally known as Vivelle Ventures LLC, but which does business under the Novogyne name.
We account for our interest in Novogyne using the equity method. For the past several years, our
equity in earnings of Novogyne, a non-cash item, represented substantially all of our income before
income taxes.
Novogyne presently markets our Vivelle-Dot®, Vivelle®, and
CombiPatch® products in the United States. Novogyne’s sales and marketing efforts have
caused Vivelle-Dot® to become the most prescribed product in the transdermal estrogen
therapy (“ET”) category, with a greater than 48% share of monthly total prescriptions written in
the United States as of December 2006.
Under the terms of the joint venture agreements, we manufacture and supply Novogyne with
Vivelle-Dot®, Vivelle® and CombiPatch®, perform
marketing, sales
and promotional activities, and receive royalties from Novogyne based on Novogyne’s sales of
Vivelle® and Vivelle-Dot®. Novartis distributes Vivelle-Dot®,
Vivelle® and CombiPatch® and provides certain other services to Novogyne,
including contracting with the managed care sector, and all regulatory, accounting and legal
services. In January 2006, the Novogyne sales force, formerly a contract sales force, became
direct employees of Noven. As is the case with other costs incurred by us on behalf of Novogyne,
we are reimbursed by Novogyne for costs associated with these sales force employees.
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Novogyne is managed by a committee (the “Management Committee”) of five members, three
appointed by Novartis and two appointed by Noven. The President of Novogyne is Robert C. Strauss,
who also serves as President, Chief Executive Officer and Chairman of the Board of Noven. Pursuant
to the joint venture agreements, certain significant actions require a supermajority vote of the
committee members, including approving or amending the annual operating and capital budgets of
Novogyne, incurring debt or guaranties in excess of $1.0 million, entering into new supply or
licensing arrangements, marketing new products and acquiring or disposing of material amounts of
Novogyne assets. Novogyne’s Management Committee has the authority to distribute cash to Novartis
and Noven based upon a contractual formula. In the years 2006, 2005 and 2004, Novogyne made cash
distributions of $26.4 million, $26.2 million and $18.1 million, respectively, to Noven. The
amount of cash we receive from Novogyne in any period may not be the same as the amount of income
we recognize from Novogyne for that period.
The joint venture agreements provide for an annual preferred return of $6.1 million to
Novartis and then an allocation of income between Novartis and Noven depending upon sales levels
attained. Our percentage share of income after Novartis’ preferred return increases as product
sales increase, subject to a maximum of 49%. In 2006, 2005 and 2004, our equity in earnings of
Novogyne, as reflected in our statements of operations, was $28.6 million, $24.7 million, and $17.6
million, respectively, representing 48.4%, 47.7% and 48.8% of Novogyne’s income after Novartis’
preferred returns for each of those years.
Novartis has the right to dissolve the joint venture in the event of a change in control of
Noven if the acquirer is one of the ten largest pharmaceutical companies (as measured by annual
dollar sales). Upon dissolution, Novartis would reacquire the rights to market
Vivelle-Dot® and Vivelle® under the terms of the license agreement in effect
prior to the formation of the Novogyne joint venture, and Novogyne’s other assets would be
liquidated and distributed to the parties in accordance with their capital account balances as
determined pursuant to the joint venture operating agreement.
The joint venture operating agreement includes a buy/sell provision that either Noven or
Novartis may trigger by notifying the other party of the price at which the triggering party would
be willing to acquire the other party’s entire interest in the joint venture. Upon receipt of this
notice, the non-triggering party has the option to either purchase the triggering party’s interest
in Novogyne or to sell its own interest in Novogyne to the triggering party at the price
established by the triggering party. If we are the purchaser, then we must also pay an additional
amount equal to the net present value of Novartis’ preferred return. This amount is calculated by
applying a specified discount rate and a period of 10 years to Novartis’ $6.1 million annual
preferred return. Novartis is a larger company with greater financial resources than us, and
therefore may be in a better position to be the purchaser if the buy/sell provision is triggered.
In addition, this buy/sell provision may have an anti-takeover effect on Noven since a potential
acquirer of Noven will face the possibility that Novartis could trigger this provision at any time
and thereby require any acquirer to either purchase Novartis’ entire interest in Novogyne or to
sell its entire interest in Novogyne to Novartis.
Growth Strategy
Our strategy for growth and continued profitability is to broaden the commercialized
applications for our proprietary transdermal drug delivery technologies to further our leadership
position in the transdermal drug delivery field. This strategy includes:
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| • | identifying and initiating development of new product opportunities that utilize our existing delivery technology; | ||
| • | seeking to license developmental products at various stages of development to strategic industry partners for completion of development and commercialization; | ||
| • | developing and/or acquiring new delivery technologies that we believe will permit us to expand the number of compounds that our products can deliver and the therapeutic areas our products can address; | ||
| • | identifying opportunities to market our own products (developed internally and/or acquired) through a specialty sales organization; and | ||
| • | seeking to enhance the opportunity presented by our collaboration with Novartis through Novogyne by licensing certain of our developmental women’s health products to Novogyne and by expanding Novogyne’s product range beyond transdermal HT products. |
Our strategy also includes continued internal efforts to improve production efficiencies and
facility utilization in order to improve the overall profitability of our manufacturing operations.
In pursuing our strategy, we intend to focus on developing products in a range of
therapeutic areas, including ADHD, hormone therapy, central nervous system conditions such as pain
management, and other areas where we believe transdermal therapies may be beneficial. Target areas
for new product development may include proprietary prescription products, generic prescription
products, or select over-the-counter product opportunities that we believe may offer attractive
financial returns. We generally seek to develop and commercialize products through agreements with
strategic industry partners. We believe that the introduction of our products in diverse
therapeutic categories with multiple partners will reduce our reliance on any particular product or
partner.
We regularly review our corporate strategies to evaluate the suitability and effectiveness of
these strategies in light of evolving business, industry, market and other conditions. No
assurance can be given that we will implement all or any part of our business or growth strategies,
that our strategies may not change from time to time or that any strategy we adopt will be
successful.
Transdermal Drug Delivery
Transdermal patches utilize an adhesive patch containing medication that is administered
through the skin and into the bloodstream over an extended period of time. Patches avoid first
pass liver metabolism and may offer significant advantages over conventional oral and parenteral
dosage forms, including non-invasive administration, controlled delivery, improved patient
compliance, flexible dose duration and avoidance of certain adverse side-effects.
Our most advanced patches utilize our patented DOT Matrix® patch technology. DOT
Matrix® is a highly efficient class of diffusion-based drug-in-adhesive patch technology
that can often deliver more drug through a smaller patch area than competitive patches, without
using irritating skin permeation enhancers and without compromising adhesion. We believe that
reduced
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patch size can have a beneficial effect on patient preference and provide a competitive
advantage over patches that deliver similar compounds through a larger patch. DOT
Matrix® technology may also permit us to develop patient-friendly patches in cases
where, due to the nature of the compound or the size of the required daily dose, competitors’
products would not be able to deliver a therapeutic dose without making the patch objectionably
large.
Patches incorporating our DOT Matrix® technology, such as Daytrana™,
Vivelle-Dot®, and CombiPatch®, are diffusion-based patches that use a
patented blend of silicone adhesive, acrylic adhesive and drug. This blend causes microscopic
pockets of concentrated drug to be formed and uniformly dispersed throughout the patch’s
drug/adhesive layer. The resulting high concentration gradient between each drug pocket and the
skin works to enhance the diffusion of drug from the patch, through the skin and into the
bloodstream. This inherent delivery efficiency reduces the need for skin permeation enhancers.
Precise ratios of silicone adhesive, acrylic adhesive and drug regulate the rate of drug delivery
and help assure therapeutic blood levels over the intended course of therapy.
We believe that our technology enables us to develop patient-friendly transdermal systems that
can reduce skin irritation sometimes associated with patches, improve adhesion, minimize patch size
and improve patch appearance. Our patches are capable of being modified to deliver a wide variety
of chemical entities.
ADHD Therapy
We have developed a once-daily transdermal methylphenidate patch called Daytrana™
for the treatment of ADHD. Daytrana™ is the first and only transdermal medication
approved to treat the symptoms of ADHD, and is approved for children aged six to twelve years.
Shire, the market leader in this therapeutic category, is the exclusive, global licensee of
Daytrana™. The FDA approved Daytrana™ in April 2006. The product combines
the active ingredient methylphenidate with our DOT Matrix® technology, and is designed
to provide continuous release of medication throughout the day.
ADHD is characterized by developmentally inappropriate levels of attention, concentration,
activity, distractibility, hyperactivity and impulsivity symptoms. The disorder typically causes
functional impairment that can limit success and create hardship in school, and in social and
familial relationships. As children age, the symptoms can lead to serious conduct disorders,
criminal behavior, substance abuse and accidental injuries.
Presently, all ADHD medications approved in the United States (other than
Daytrana™) are delivered orally. Stimulant therapies, including
methylphenidate, which is designated as a Schedule II controlled substance by the United
States Drug Enforcement Administration (“DEA”), are the most prescribed drug class for the
treatment of ADHD. We believe that Daytrana™ provides physicians and
parents with broad dosing flexibility, in that dosing can be discontinued by simply removing the
patch if a shorter duration of effect is desired or if late-day methylphenidate side effects
appear, and may offer other advantages as compared to certain oral ADHD medications.
In 2003, we licensed to Shire the exclusive global rights to market Daytrana™
for payments by Shire of up to $150.0 million and ongoing manufacturing revenues. In
consideration for the transaction Shire agreed to pay us as follows: (i) $25.0 million was paid
upon closing of the transaction in April 2003; (ii) $50.0 million was paid in April 2006 upon
receipt of final marketing approval by the FDA; and (iii) three installments of $25.0 million each
are payable upon Shire’s
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achievement of $25.0 million, $50.0 million and $75.0 million in annual
Daytrana™ net sales, respectively. For purposes of the sales milestones,
Shire’s annual net sales are measured quarterly on a trailing 12-month basis, with each milestone
payment due 45 days after the end of the first calendar quarter during which trailing 12-month
sales exceed the applicable threshold. We are currently deferring and recognizing approval and
sales milestones as license revenues on a straight-line basis, beginning on the date the milestone
is achieved through the first quarter of 2013. During 2006, we recognized $5.9 million in license
revenues related to the Shire collaboration. Shire’s net sales of Daytrana™ exceeded
the threshold for the first sales milestone in the fourth quarter of 2006 and, accordingly, we
received a $25 million payment from Shire in the first quarter of 2007.
Shire has agreed that it will not sell any other product containing methylphenidate as an
active ingredient until the earlier of (i) five years from the closing date or (ii) payment of all
sales milestones. Additionally, Shire is required to use reasonable commercial efforts to maximize
Daytrana™ product sales, and actively promote Daytrana™ as a strategic
product within Shire’s ADHD portfolio, until payment of all sales milestones. Upon the closing
date in April 2003, we also entered into a long-term supply agreement under which we manufacture
and supply Daytrana™ to Shire at a fixed price. In 2006, our product sales of
Daytrana™ to Shire were $8.6 million. The agreement gives Shire the right to qualify a
second manufacturing source and purchase a portion of its requirements from that source. If Shire
were to exercise this right, our revenues and profits from sales of Daytrana™ would be
adversely affected.
In June 2004, we entered into an agreement with Shire for the development of a transdermal
amphetamine patch for ADHD. The product entered Phase I clinical development in December 2006.
Our amphetamine patch project is discussed in additional detail under “Development Collaborations”
below.
Hormone Therapy Products
Overview
Our menopausal HT products consist of:
| • | Vivelle-Dot®/Estradot® — our advanced estrogen patch; | ||
| • | Vivelle®/Menorest/Femiest® — our original estrogen patch; and | ||
| • | CombiPatch®/Estalis® — our combination estrogen/progestin patch. |
We currently derive a significant portion of our revenues from our HT products. Our
total HT-related revenues were $42.7 million, $43.8 million and $39.8 million for 2006, 2005 and
2004, respectively, which represented 70%, 83% and 87% of our revenues in each of those years.
Our HT products are indicated for menopausal symptoms. Menopause begins when the ovaries
cease to produce estrogen, or when both ovaries are removed surgically prior to natural menopause.
The most common acute physical symptoms of natural or surgical menopause are hot flashes and night
sweats, which can occur in a substantial percentage of menopausal women. Another common symptom
associated with menopause is vaginal dryness. Moderate-to-severe menopausal symptoms can be
treated by replacing the estrogen that the body can no longer produce. Estrogen therapy can
effectively relieve hot flashes and night sweats, and can prevent drying and
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shrinking of the reproductive system. Our ET products are also indicated for the prevention
of osteoporosis, a progressive deterioration of the skeletal system through the loss of bone mass.
There are, however, other approved therapies for the prevention of osteoporosis, and our labeling
advises that ET should be used for this condition only in women who have a significant risk of
osteoporosis and for whom non-estrogen therapies are inappropriate.
HT Studies
In July 2002, the National Institutes of Health (“NIH”) released data from its Women’s Health
Initiative (“WHI”) study on the risks and benefits associated with use of oral combination HT by
healthy women. The NIH announced that it was discontinuing the arm of the study investigating the
use of oral estrogen/progestin after an average follow-up period of 5.2 years because the oral
combination HT product used in the study was shown to cause an increase in the risk of invasive
breast cancer. The study also found an increased risk of stroke, heart attacks and blood clots and
concluded that overall health risks exceeded benefits from use of the orally delivered combined
estrogen plus progestin product among healthy postmenopausal women. Also in July 2002, the
National Cancer Institute (“NCI”) published the results of an observational study in which it found
that postmenopausal women who used ET for 10 or more years had a higher risk of developing ovarian
cancer than women who never used HT. Since 2002, several other published studies have identified
increased risks from the use of HT, and statistical analysis announced in December 2006 indicated a
drop in breast cancer cases since the publication of the WHI study. As a result of the findings
from the WHI and other studies, the FDA has required that “black box” labeling be included on all
HT products marketed in the United States to warn, among other things, that these products have
been associated with increased risks for heart disease, heart attacks, strokes, and breast cancer
and that they are not approved for heart disease prevention. Since the July 2002 publication of
the WHI and NCI study data, total United States prescriptions have declined for substantially all
HT products, including our products in the aggregate. For a discussion of our prescription rates,
see “Management’s Discussion and Analysis of Financial Condition and Results of Operations –
Overview of Noven and our Novogyne Joint Venture.”
Researchers continue to analyze data from both arms of the WHI study and other studies. Other
studies evaluating HT are currently underway or in the planning stage. In particular, a private
foundation has commenced a five-year study aimed at determining whether ET use by women aged 42 to
58 reduces the risk of heart disease. The study also seeks to determine if transdermal estrogen
patches are more or less beneficial than an oral HT product. While our products are not being used
in the study, the market for our products could be adversely affected if this study finds that a
transdermal estrogen patch is less beneficial than other dosage forms, and we could be subject to
increased product liability risk if HT patch products are found to increase the risk of adverse
health consequences. Noven’s products have been named in lawsuits filed against Noven, Novogyne
and Novartis. See “Item 3 – Legal Proceedings.”
Advanced Transdermal Estrogen Patch
Utilizing our proprietary DOT Matrix® technology, our advanced transdermal estrogen
patch (marketed as Vivelle-Dot® and Estradot®) is one-third the area of our
original Vivelle® estrogen patch at any given dosage level, yet provides the same
delivery of drug over the same period. This system is more flexible and comfortable to wear than
the original product, with a lower potential for skin irritation. Vivelle-Dot® is the
most prescribed transdermal ET product in the United States. This product is currently available
in the United States in five dosage strengths. The lowest dosage
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strength is approved only for prevention of osteoporosis, and in light of the HT studies
described above and the label changes, many physicians may consider alternative treatments for the
prevention of osteoporosis which would adversely affect the market for that dosage strength.
Novogyne markets Vivelle-Dot® in the United States. In Canada,
Vivelle-Dot® is marketed as Estradot® by an affiliate of Novartis Pharma AG
(“Novartis Pharma”). Novartis Pharma holds the rights to market this product under the name
Estradot® in all countries other than the United States, Canada and Japan, and has
marketing rights in the same territories to any product improvements and future generations of
estrogen patches developed by us. Sanofi-aventis (“Aventis”) has marketing rights for
Vivelle-Dot® in Japan.
Under the terms of our license to Novartis Pharma, Novartis Pharma is responsible for seeking
approval to market Estradot® in its territories. The product has been approved for
marketing in over 30 foreign countries. Novartis Pharma has launched the product in the United
Kingdom, France, Germany, Spain (without the benefit of government reimbursement) and in a number
of smaller European countries. We cannot assure that Novartis Pharma will be successful in
launching Estradot® in these or other countries. The price of Estradot® and
our other products sold in the European Union may be negatively affected by parallel trade
practices whereby a licensed importer may take advantage of price disparity between markets by
purchasing our products in a market with a relatively lower price and then importing them into a
country with a relatively higher price. Novartis Pharma markets several other estrogen patches in
addition to our products and Novartis Pharma may derive higher gross margins on the sale of its
other products compared to ours. If pricing, government reimbursement and labeling issues are
resolved, we expect that the growth of Estradot® sales will depend, in part, on Novartis
Pharma’s willingness and ability to convert sales of its existing patches to Estradot®.
Pursuant to license and supply agreements with Novartis Pharma and Novogyne, we manufacture
the product for these parties and receive fees based on their sales of the product. The supply
agreement for the Estradot® product is a long-term agreement. The supply agreement for
Vivelle-Dot® and Vivelle® expired in January 2003. Since the expiration of
this agreement, the parties have continued to operate in accordance with its commercial terms. We
cannot assure that we will enter into a new supply agreement on satisfactory terms or at all. A
decision to discontinue operating in accordance with the supply agreement’s commercial terms could
have a material adverse effect on our business, results of operations and financial position.
Novogyne’s designation of a new supplier and approval of a new supply agreement would require the
affirmative vote of four of the five members of Novogyne’s Management Committee. Accordingly, both
Novartis and Noven must agree on Novogyne’s supplier. Due to our dependence on Novogyne as well as
Novartis’ greater financial and business resources, we may be unable to negotiate favorable
business terms with Novartis or resolve any dispute between us in a favorable manner.
Original Transdermal Estrogen Patch
Our original transdermal estrogen patch (marketed as Vivelle®, Menorest, and
Femiest®) is available by prescription and utilizes our adhesive matrix technology.
This product delivers estradiol, the primary estrogen produced by the ovaries, through a patch that
is applied twice weekly.
This product has been approved for marketing by the FDA, as well as by regulatory authorities
in many foreign countries, for the treatment of menopausal symptoms and the prevention of
osteoporosis. Marketing rights to this product are held by Novogyne in the United States, by
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Aventis in Japan, and by Novartis Pharma in all other territories. Novartis Pharma is
selling this product under the brand name Menorest in a number of foreign countries. Novogyne and
Novartis Pharma’s Canadian affiliate market this product under the brand name Vivelle®
in the United States and Canada, respectively, and Aventis markets this product under the brand
name Femiest® in Japan. This product is in the process of being discontinued in several
territories where our advanced Vivelle-Dot® ET patch has gained acceptance. We ceased
manufacturing of Vivelle® for the United States market at the end of 2006.
Pursuant to license and supply agreements with Novartis Pharma, Novogyne and Aventis, we
manufacture Vivelle®, Menorest and Femiest® for these parties and receive
fees based on their sales of the products. The supply agreements for Menorest and
Femiest® are long-term agreements. Vivelle® is supplied under the commercial
terms of the same agreement as Vivelle-Dot®. As discussed above, we cannot assure that
the United States supply agreement will be extended on satisfactory terms or at all.
Transdermal Combination Estrogen/Progestin Patch
We developed the first combination transdermal HT system approved for marketing by the FDA, a
combination patch containing estradiol and norethindrone acetate, a progestin. Although benefits
of ET include menopausal symptom control and osteoporosis prevention, estrogen-only therapy has
been associated with an increased risk of endometrial cancer for women who have an intact uterus
(non-hysterectomized). To address this situation, a combination therapy of estrogen and progestin
may be prescribed. Using both hormones together has been shown to reduce the risk of endometrial
cancer while continuing to produce the menopausal symptom control benefits of ET.
Novogyne acquired marketing rights to the product in 2001 from Aventis (which was then our
exclusive worldwide licensee for the product) and markets the product under the brand name
CombiPatch® in two dosage strengths in the United States. Novartis Pharma holds the
right to market this product outside of the United States and Japan and is marketing this product
under the brand name Estalis® in a number of foreign countries.
Pursuant to license and long-term supply agreements with Novartis Pharma, we manufacture the
combination product for Novartis Pharma and receive fees based on their sales of the product.
Sales to Novogyne are at an agreed-upon price pursuant to a supply agreement.
Transmucosal Product
Our first transmucosal delivery system, DentiPatch®, utilizes a patented,
proprietary technology consisting of a thin, solid state multi-laminate construction with a
drug-bearing bio-adhesive that delivers lidocaine through the buccal mucosa over time.
DentiPatch® was approved for marketing by the FDA in 1996 and was the first FDA-approved
oral transmucosal patch. We launched the product in the United States in 1997. The product is
indicated for the reduction of pain from oral injections and for the production of mild topical
anesthesia prior to superficial dental procedures. It is the first topical anesthetic clinically
proven to reduce pain when large needles are inserted to the bone. DentiPatch® is
currently marketed in the United States through a network of independent distributors. Sales of
DentiPatch® are not material to our results of operations.
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Development Collaborations
Shire
In addition to our agreements with Shire related to Daytrana™, in June 2004 we
entered into an agreement with Shire for the development of a transdermal amphetamine patch for
ADHD, and in July 2006, we amended this agreement with Shire. Under the amended agreement, Shire
paid us a non-refundable $1.0 million in August 2006 in exchange for the option of purchasing, for
an additional $5.9 million, the exclusive developmental rights to the product. The amended
agreement further provides that we will perform certain early-stage development activities which
were previously to be performed by Shire. Upon our completion of such development activities,
Shire has the option to pay us the $5.9 million to continue exclusive development of the product.
If Shire does not exercise this option, rights to further develop the product will revert to us.
The product entered Phase I clinical development by us in December 2006. The $1.0 million was
included in deferred contract revenues on our balance sheet as of December 31, 2006.
P&G Pharmaceuticals
In April 2003, we established a collaboration with Procter & Gamble Pharmaceuticals, Inc.
(“P&G Pharmaceuticals”) for the development of new prescription patches for Hypoactive Sexual
Desire Disorder (“HSDD”). The products under development explore follow-on product opportunities
for Intrinsa™, P&G Pharmaceuticals’ in-licensed investigational transdermal testosterone
patch designed to help restore sexual desire in menopausal women diagnosed with HSDD. In the U.S.,
P&G Pharmaceuticals withdrew its New Drug Application (“NDA”) for Intrinsa™ in December
2004 based on safety concerns expressed by an FDA Advisory Committee and other factors. P&G
Pharmaceuticals has indicated that work on Intrinsa™ for the U.S. market has been placed
on hold while they evaluate alternatives for the project. If P&G Pharmaceuticals is unable to
identify a practical strategy to complete development and commercialize the product in the U.S., or
if their evaluation of alternatives significantly delays the project, the prospects for our
collaboration with P&G Pharmaceuticals will be adversely affected.
Endo
In July 2003, we submitted an Abbreviated New Drug Application (“ANDA”) to the FDA seeking
approval to market a generic fentanyl patch. We entered into an agreement with Endo in the first
quarter of 2004 granting Endo the exclusive right to market our fentanyl patch in the United
States. We received an up-front payment of $8.0 million from Endo, of which $6.5 million was
allocated to license revenue for the fentanyl patch and the remaining $1.5 million was allocated
based on fair value to fund feasibility studies that seek to determine whether certain compounds
identified by the parties could be delivered through our transdermal technology. Our agreement
provides that Endo would fund and manage clinical development of those compounds proceeding into
clinical trials.
In July 2005, the FDA issued a public advisory that it is investigating reports of death and
other serious side effects from overdoses involving both the branded and generic fentanyl patches.
In September 2005, the FDA advised us that it did not expect to approve our ANDA and was
consequently ceasing its review of our ANDA, based on the FDA’s assessment of potential safety
concerns related to the higher drug content in our generic product versus the branded product. Due
to the FDA’s determination, Noven and Endo agreed in December 2005 to terminate the fentanyl
portion of the 2004 license agreement as well as the fentanyl supply agreement. Noven is currently
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evaluating the feasibility of reformulating the fentanyl patch to address the FDA’s concerns,
and has granted Endo a right of first negotiation with respect to any reformulated fentanyl patch
that it may develop. Noven’s decision to proceed with the fentanyl project is expected to depend
upon, among other things, the expense, timeline and risk of seeking FDA approval, and the size and
sustainability of the United States market opportunity at the time our product would be launched.
For a discussion of the effects of the FDA’s review of our ANDA, see “Management’s Discussion and
Analysis of Financial Condition and Results of Operations – Results of Operations.”
Noven and Endo continue to proceed with other areas of their development collaboration that
are unrelated to fentanyl.
Research and Development
Our research and development strategy is to identify drugs that can be delivered
transdermally and which we believe have substantial market potential, as well as those that we
believe can be improved by using our patented technologies. We typically seek to develop products
that use approved drugs that currently are being delivered to patients through means other than
transdermal delivery, but we may also explore new formulations or proprietary products where we
believe our technology may be beneficially applied. As part of our strategy, we seek to supplement
our research and development efforts by entering into research and development agreements, joint
ventures and other collaborative arrangements with other companies.
In addition to the development activities being conducted in connection with our Endo and
Shire collaborations, we entered into three development collaborations in 2005 and have entered
into a number of early stage feasibility and/or development agreements with other pharmaceutical
companies to determine the feasibility of transdermal delivery of various compounds.
For the years ended December 31, 2006, 2005 and 2004, we spent $11.5 million, $13.2 million
and $9.5 million, respectively, for research and development activities, which does not include
amounts expended on additional clinical studies for Daytrana™ in 2004 and 2005 because
those amounts were reimbursements to Shire and were recorded as a reduction of a portion of the
$25.0 million non-refundable deferred license revenue previously received from Shire. Our research
and development expense may vary significantly from quarter to quarter depending on product
development cycles, the timing of clinical studies and whether we or a third party are funding
development. We intend to focus on long-term growth prospects, and, therefore, may incur higher
than expected research and development expenses in a given period rather than delay clinical
activities. These variations in research and development spending may not be accurately
anticipated and may have a material effect on our results of operations.
Our long-term strategy is dependent upon the successful development of new products and their
successful commercialization. A project can fail or be delayed at any stage of development, even
if each prior stage was completed successfully, which could jeopardize our ability to recover our
investment in the product. Some of our development projects will not be completed successfully or
on schedule. Many of the factors which may cause a product in development to fail or be delayed
are beyond our control, such as difficulty in enrolling patients in clinical trials, the failure of
clinical trials, lack of sufficient supplies or raw materials, inability to supply the subject
product or technology on a commercial scale on an economical basis, and changes in regulations.
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Competition
The markets for our products are highly competitive. All drug delivery products that we are
developing may face competition from conventional forms of drug delivery (i.e., oral and
parenteral), from alternate forms of drug delivery, such as controlled release oral delivery,
liposomes, implants, gels and creams and possibly from alternate non-drug therapies. Some or all
of the products being marketed or developed by us face, or will face, competition from other
transdermal products that deliver the same drugs to treat the same indications. In addition,
medical science is constantly evolving. As developments in medicine are made, products may become
obsolete or fall out of favor with physicians.
Competition in drug delivery systems is generally based on a company’s marketing strength,
product performance characteristics (i.e., reliability, safety, patient convenience) and product
price. As a general matter, transdermal drug delivery systems are more expensive and difficult to
manufacture than oral formulations. Acceptance by physicians and other health care providers,
including managed care groups, is also critical to the success of a product. The first product on
the market in a particular therapeutic area typically is able to obtain and maintain a significant
market share for a period of time. In a highly competitive marketplace and with evolving
technology and medical science, there can be no assurance that additional product introductions or
medical developments by others will not render our products or technologies noncompetitive or
obsolete. We also compete with other drug delivery companies in the establishment of business
arrangements with large pharmaceutical companies to assist in the development or marketing of
products. It is also possible that Daytrana™, Vivelle-Dot® or our other
products could, prior to the expiration of the applicable patent periods, face competition from a
generic product if approved through the ANDA process or from a functionally-equivalent product that
avoids infringing our patents.
Daytrana ™ participates in a highly competitive market for
the treatment of ADHD, with a product mix that includes generic oral methylphenidate, long-acting
formulations, other stimulant medications, medications not containing Schedule II controlled
substances, and a variety of other drug types. Other products which may have improved safety and
efficacy profiles are also in development. Shire currently markets non-methylphenidate products
for the treatment of ADHD and in February 2007 received marketing approval for an amphetamine pro
drug for the treatment of ADHD. We cannot assure that Shire will continue to market Daytrana™ aggressively or effectively, or that Daytrana™ will compete effectively against
extended release oral formulations of methylphenidate and/or other ADHD medications, especially
those not involving controlled substances. Some of the companies marketing competitive ADHD
products are substantially larger and have greater financial resources than Shire, including
Johnson & Johnson, Novartis and Eli Lilly & Company
(“Lilly”).
In the market for HT products, Novogyne competes against Wyeth Pharmaceuticals, Watson
Pharmaceuticals, Inc., Mylan Pharmaceuticals, Inc., Berlex Laboratories, Esprit Pharma, Inc.,
Ascend Therapeutics, Inc., Barr Laboratories and others, including Novartis, Novartis Pharma and
their affiliates. We expect increased competition in the HT market as new and innovative products
continue to be introduced in this field, including products using alternative delivery systems such
as gels and creams, lower-dosage products, and products that may be used to treat menopause-related
symptoms that are not hormone-based or that may reduce the risks related to hormone-based products.
Most of our competitors are substantially larger and have greater resources and larger sales
forces than we do, as well as greater experience in developing and commercializing pharmaceutical
products.
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Dependence on Licensees and Joint Venture
During 2006, 44%, 25%, and 24% of our revenues were attributable to Novogyne, Novartis Pharma
(and its affiliates) and Shire, respectively, and substantially all of our income before income
taxes was attributable to our equity in Novogyne’s earnings, a non-cash item. Going forward, we
expect to be dependent on sales to Novartis Pharma, Novogyne, Shire and other collaboration
partners, as well as fees, milestone payments, profit sharing and royalties generated from their
sales of our transdermal delivery systems, for a significant portion of our expected revenues. No
assurance can be given regarding the amount and timing of such revenues. Failure of these parties
to successfully market our products would cause the quantity of products purchased from us and the
amount of manufacturing revenue, fees, milestone payments and royalties ultimately paid to us to be
reduced and would therefore have a material adverse effect on our business and results of
operations. We expect to be able to influence the marketing of Vivelle-Dot®,
Vivelle® and CombiPatch® in the United States through our participation in
the management of Novogyne, but the Management Committee of Novogyne is comprised of a majority of
Novartis representatives, and we will not be able to control those matters. Our agreements with
Shire require Shire to use reasonable commercial efforts to market Daytrana™, until
payment of all milestone payments, but Shire has no obligation to continue marketing
Daytrana™ thereafter. While our agreements with our marketing partners may impose
certain obligations on them, there can be no assurance that such agreements will provide us with
any meaningful level of protection or cause these companies to perform at a level that we deem
satisfactory. Further, these companies and their affiliates sell competing products, both in the
United States and abroad, and it is possible that they will promote their other competitive
products to our detriment. Any reduction in the level of support and promotion that these
companies provide to our products, whether as a result of their focus on other products or
otherwise, could have a material adverse effect on our business, results of operations, financial
condition and prospects.
Manufacturing
Our headquarters and manufacturing facility is located on a 15-acre site in Miami-Dade County,
Florida. On this site, we conduct our manufacturing operations in a single facility comprised of
two approximately 40,000 square foot buildings located on approximately 7 acres that we lease from
Aventis. This facility has been inspected by the FDA, the Medicines and Healthcare Products
Regulatory Agency of the United Kingdom, and by the Florida Department of Health and found to be in
compliance with applicable regulatory requirements. This facility has also been certified by the
DEA to manufacture products containing controlled substances. To bring new products to market as
quickly as possible, we will seek to have sufficient manufacturing capacity to produce the new
product prior to obtaining FDA approval and, in certain circumstances, to begin manufacturing the
new product prior to obtaining FDA approval. In addition, we have supplemented our manufacturing
facilities on our existing site with leased space located in close proximity to our existing site
for the storage, and, if necessary, the manufacture of new products. If FDA approval for products
under development is ultimately not obtained or if such products are not successfully
commercialized, we may be unable to fully recover our up-front costs to expand our manufacturing
capabilities. For products under development, unless our partner is responsible for pre-launch
inventories, we may be unable to recover our up-front costs for raw material and other costs
associated with manufacturing pre-launch supplies.
Some raw materials essential to our business are readily available from multiple sources.
Certain raw materials and components used in the manufacture of our products (including essential
polymer adhesives and other critical components) are, however, available from limited sources, and
in
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some cases, a single source. The NDA for Daytrana™ includes only one supplier of
the active pharmaceutical compound. In addition, the DEA controls access to controlled substances
(including methylphenidate, fentanyl and amphetamine), and we must receive authorization from the
DEA to obtain these substances. Any curtailment in the availability of such raw materials could
result in production or other delays, and, in the case of products for which only one raw material
supplier exists, could result in a material loss of sales, with consequent adverse effects on our
business and results of operations. In addition, because most raw material sources for transdermal
patches must generally be approved by regulatory authorities, changes in raw material suppliers may
result in production delays, higher raw material costs and loss of sales, customers and market
share. Some raw materials used in our products are supplied by companies that restrict certain
medical uses of their products. While our use is presently acceptable, there can be no assurance
that such companies will not expand their restrictions to include our applications.
Marketing & Sales
Our business strategy generally is to seek to establish a collaboration for a new product with
a third party who we believe has the clinical and regulatory resources and expertise necessary to
develop the product and the marketing and sales resources necessary to broadly commercialize the
product. We seek to retain manufacturing rights for ourselves, in part to help safeguard our
proprietary technology. Except for DentiPatch®, we have historically granted product
marketing rights to other pharmaceutical companies.
Our strategy, however, includes the possibility that we may retain the rights to a particular
new product and develop, market and sell it ourselves. We may also seek to commercialize products
ourselves through the acquisition of one or more products or the acquisition of a company with
marketed or marketable products. A decision to commercialize a product ourselves would be based
upon an analysis of, among other things, our financial resources and capabilities at the time, the
characteristics of the particular product and market, complementary products in our pipeline or
available to us, and the estimated costs associated with any clinical studies, sales, marketing and
distribution. A decision to develop and commercialize products ourselves could result in
substantial research, development, sales, marketing and acquisition and other expenses that could
adversely affect our results of operations over a period of years.
Under the Novogyne joint venture agreements, Novartis has responsibility for Novogyne’s
distribution function (including managing the relationships and agreements with wholesale drug
distributors and other trade customers) and its managed care strategy and relationships, while we
have responsibility for the day-to-day management of Novogyne’s marketing efforts and sales force.
Effective January 2006, the Novogyne sales force, formerly a contract sales force, became direct
employees of Noven. As is the case with other costs incurred by us on behalf of Novogyne, we are
reimbursed by Novogyne for costs associated with these sales force employees. In fulfilling the
marketing and sales function, we believe that we have established significant expertise
in this area. We believe this expertise has helped lead Vivelle-Dot® to become the most
prescribed transdermal estrogen therapy product in the United States. We also seek to
use this expertise more broadly to help us identify and evaluate the commercial potential of new
product development projects that may help advance our growth strategy.
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Patents and Proprietary Rights
We seek to obtain patent protection on our delivery systems and manufacturing processes
whenever possible. We have obtained 35 United States patents and over 315 foreign patents relating
to our transdermal and transmucosal delivery systems and manufacturing processes, and have over 154
pending patent applications worldwide.
As a result of changes in United States patent law under the General Agreement on Tariffs and
Trade and the accompanying agreement on Trade-Related Aspects of Intellectual Property Law, which
took effect in their entirety on January 1, 1996, the terms of some of our existing patents have
been extended beyond the original term of 17 years from the date of grant. Our patents filed after
June 7, 1995 will have a term of 20 years computed from the effective filing date.
We are unaware of any challenge to the validity of our patents or of any third party claim of
patent infringement with respect to any of our products, in either case that could have a material
adverse effect on our business or prospects.
Although there is a statutory presumption as to a patent’s validity, the issuance of a patent
is not conclusive as to such validity, or as to the enforceable scope of the claims of the patent.
We cannot assure that our patents or any future patents will prevent other companies from
developing similar or functionally equivalent products. We cannot assure that we would be
successful in any action to enforce our patent rights that we may elect to bring against an alleged
infringer. Likewise, we cannot assure that we would be successful in the defense of an
infringement action. Furthermore, we cannot assure that any of our future processes or products
will be patentable, that any pending or additional patents will be issued in any or all appropriate
jurisdictions or that our processes or products will not infringe upon the patents of third
parties. In addition, since our patents typically cover our product formulation rather than the
compound being delivered, competitors may seek to create functionally equivalent products (i.e.,
patches delivering the same compound over the same time period to treat the same indication) that
avoid our patents. In those cases, we may face competition from functionally equivalent products
even before our patents expire.
We also attempt to protect our proprietary information under trade secret and confidentiality
agreements. Generally, our agreements with each employee, licensing partner, consultant,
university, pharmaceutical company and agent contain provisions designed to protect the
confidentiality of our proprietary information. There can be no assurance that these agreements
will not be breached, that we will have adequate legal remedies as a result thereof, or that our
trade secrets will not otherwise become known or be independently developed by others.
Trademarks
The trademarks for the products and technologies referred to in this Form 10-K are registered
as follows:
| - | DOT Matrix® and DentiPatch® are registered trademarks of Noven; | ||
| - | Vivelle® is a registered trademark of Novartis Corporation; | ||
| - | Estradot® (foreign) and Vivelle-Dot® are registered trademarks of Novartis AG; | ||
| - | CombiPatch® and Estalis® (U.S.) are registered trademarks of Vivelle Ventures LLC; | ||
| - | Menorest is a trademark of Novartis AG; | ||
| - | Femiest® is a registered trademark of Aventis in Japan; |
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| - | Daytrana™ is a trademark of Shire Pharmaceuticals Ireland Limited; | ||
| - | Concerta® is a registered trademark of ALZA Corporation; | ||
| - | Intrinsa™ is a trademark of P&G Pharmaceuticals; | ||
| - | Vioxx® is a registered trademark of Merck & Co., Inc.; | ||
| - | Duragesic® is a registered trademark of Johnson & Johnson Corporation; | ||
| - | Ortho Evra® is a registered trademark of Ortho-McNeil Pharmaceutical, Inc.; | ||
| - | Vyvanse™ is a trademark of Shire LLC. |
Government Regulation
Our operations are subject to extensive regulation by governmental authorities in the United
States and other countries with respect to the development, testing, approval, manufacture,
labeling, marketing and sale of pharmaceutical products, and the possession and use of controlled
substances. We devote significant time, effort and expense to address the extensive government
regulations applicable to our business.
The marketing of pharmaceutical products requires the approval of the FDA in the United
States. The FDA has established regulations, guidelines and safety standards that apply to the
pre-clinical evaluation, clinical testing, manufacturing and marketing of pharmaceutical products.
The process of obtaining FDA approval for a new product may take several years or more and is
likely to involve the expenditure of substantial resources. The steps required before a product
can be produced and marketed for human use typically include: (i) pre-clinical studies; (ii)
submission to the FDA of an Investigational New Drug Application (“IND”), which must become
effective before human clinical trials may commence in the United States; (iii) adequate and well
controlled human clinical trials that demonstrate reasonable assurance of the safety and efficacy
of the product; (iv) submission to the FDA of an NDA; and (v) review and approval of the NDA by the
FDA. Approval of a product by the FDA does not guarantee the product’s safety or efficacy. In
light of widely publicized events surrounding HT products and other products such as COX-2
inhibitors (including Vioxx®) and certain antidepressants, during 2005 the FDA created
an independent Drug Safety Oversight Board comprised of FDA representatives, medical experts and
other third parties to oversee the management of drug safety issues. We believe these changes will
make drug development more lengthy, risky and expensive.
An NDA generally is required for products with new active ingredients, new indications, new
routes of administration, new dosage forms or new strengths. An NDA requires that complete
clinical studies of a product’s safety and efficacy be submitted to the FDA, the cost of which is
substantial. These costs can be reduced, however, for delivery systems that utilize already
approved drugs. In these cases, the company seeking approval may refer to safety and toxicity data
reviewed by the FDA in its approval process for the innovator product. In addition, a supplemental
NDA may be filed to add an indication or make product improvements to an already approved product.
An abbreviated approval process may be available for products that have, among other
requirements, the same active ingredient(s), indication, route of administration, dosage form and
dosage strength as an existing FDA-approved product covered by an NDA, if clinical studies have
demonstrated bio-equivalence of the new product to the FDA-approved product covered by an NDA. For
this abbreviated process, an ANDA is submitted to the FDA instead of an NDA. Under FDA ANDA
regulations, companies that seek to introduce an ANDA product must also certify that the product
does not infringe on any approved product’s patent listed with the FDA or that such patent has
expired. If the applicant certifies that its product does not infringe on the approved product’s
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patent or that such patent is invalid, the patent holder may institute legal action to
determine the relative rights of the parties and the application of the patent. Under the Drug
Price Competition and Patent Term Restoration Act of 1984 (the “Hatch-Waxman Act”), the FDA may not
finally approve the ANDA until the earlier of thirty months from the date of the legal action or a
final determination by a court that the applicable patent is invalid or would not be infringed by
the applicant’s product. We are developing products for which we or a licensee may file an ANDA.
There can be no assurance we will not be sued for patent infringement, that we would prevail in any
litigation or that the costs of any such litigation would not be prohibitive.
The Hatch-Waxman Act further provides for a period of 180 days of generic marketing
exclusivity for each ANDA applicant that is first to file an ANDA containing a certification of
invalidity, non-infringement or unenforceability related to a patent listed with respect to a
reference drug product, commonly referred to as a Paragraph IV certification. During this
exclusivity period, the FDA cannot grant final approval to any other Paragraph IV filer. If an
ANDA containing a Paragraph IV certification is successful, it generally results in higher initial
market share, net revenues and gross margin for that applicant. Even if we obtain FDA approval for
generic drug products, we may lose significant advantages to a competitor who was first to file an
ANDA containing a Paragraph IV certification. Disputes have arisen as to which of several ANDA
applicants is first to file, and thus potentially entitled to exclusivity. FDA administration of
its “first to file” policies has been the subject of unresolved litigation, and administrative and
legislative activity. Thus, we cannot assure that even if we are otherwise entitled to such
exclusivity, it will ultimately be awarded.
Pre-clinical studies are conducted to obtain preliminary information on a product’s safety.
The results of these studies are submitted to the FDA as part of the IND and are reviewed by the
FDA before human clinical trials can begin. Human clinical trials may commence 30 days after
receipt of the IND by the FDA, unless the FDA objects to the commencement of clinical trials.
Human clinical trials are typically conducted in three sequential phases prior to FDA
approval, but the phases may overlap. Phase I trials consist of testing the product primarily for
safety and dosage strength in healthy volunteers or a small number of patients at one or more
doses. In Phase II trials, the safety and efficacy of the product are evaluated in a patient
population somewhat larger than the Phase I trials, generally at differing dosages. Phase III
trials typically involve additional testing for safety and clinical efficacy in an expanded
population at a number of separate clinical test sites. Phase IV trials may be required after a
product is already approved and on the market to learn more about the product’s long-term risks,
benefits and optimal use, or to test the product in different populations of people, such as
children or adults. A clinical plan, or protocol, accompanied by information on the
investigator(s) conducting the trials, must be submitted to the FDA prior to commencement of each
phase of the clinical trials. The FDA may order the temporary or permanent discontinuation of a
clinical trial at any time, including, for example, if it finds unacceptable risks to the study
subjects.
The results of product development and pre-clinical and clinical studies are submitted to the
FDA as an NDA or ANDA for approval. If an application is submitted, there can be no assurance that
the FDA will complete its review and approve the NDA or ANDA in a timely manner. The FDA may deny
an NDA or ANDA if applicable regulatory criteria are not satisfied or it may require additional
clinical testing. Even if such data is submitted, the FDA may ultimately deny approval of the
product. Further, if there are modifications to the drug, including changes in indication, dosage,
manufacturing process, labeling, or a change in manufacturing facility, an NDA or ANDA
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notification may be required to be submitted to the FDA and FDA approval required prior to
implementation of the change.
The FDA may require testing and surveillance programs to monitor the effect of products that
have been commercialized, and has the power to prevent or limit further marketing of these products
based on the results of these post-marketing programs. Product approvals may be contingent on an
agreement to conduct specified post-marketing programs, and product approvals may be withdrawn
after the product reaches the market if compliance with regulatory standards is not maintained or
if problems occur regarding the safety or efficacy of the product. As the FDA’s approval process
comes under greater scrutiny by the government and the public, especially with regard to safety
issues, we expect that the scope and frequency of post-marketing programs required as a condition
of approval will increase. For example, the approval letter for Daytrana™ requires
post-marketing surveillance and post-marketing studies relating to the possibility of skin
sensitization.
The approval procedures for the marketing of our products in foreign countries vary from
country to country, and the time required for approval may be longer or shorter than that required
for FDA approval. Even after foreign approvals are obtained, further delays may be encountered
before products may be marketed. For example, many countries require additional governmental
approval for price reimbursement under national health insurance systems. Additional studies may
be required to obtain foreign regulatory approval. Further, some foreign regulatory agencies may
require additional studies involving patients located in their countries.
Manufacturing facilities are subject to periodic inspections for compliance with the FDA’s
good manufacturing practices regulations and each domestic drug manufacturing facility must be
registered with the FDA. Most foreign regulatory authorities have similar regulations. In
complying with standards set forth in these regulations, we must expend significant time, money and
effort in the area of quality assurance to ensure full technical compliance. Facilities handling
controlled substances, such as ours, also must be licensed by the DEA, and are subject to more
extensive regulatory requirements than those facilities not licensed to handle controlled
substances. We also require approval of the DEA to obtain and possess controlled substances,
including methylphenidate, amphetamine and fentanyl. We produce transdermal drug delivery products
in accordance with United States and international regulations for clinical trials, manufacturing
process validation studies and commercial sale. FDA approval to manufacture a drug product is site
specific. In the event our approved manufacturing facility becomes inoperable, obtaining the
required FDA approval to manufacture such drug at a different manufacturing site could result in
production delays, which could adversely affect our business and results of operations.
Failure to comply with governmental regulations may result in fines, warning letters,
unanticipated compliance expenditures, interruptions or suspension of production and resulting loss
of sales, product seizures or recalls, injunctions prohibiting further sales, withdrawal of
previously approved marketing applications and criminal prosecution.
The federal and state governments in the United States, as well as many foreign governments,
from time to time explore ways to reduce medical care costs through health care reform. Due to
uncertainties regarding the ultimate features of reform initiatives and their enactment and
implementation, we cannot predict what impact any reform proposal ultimately adopted may have on
the pharmaceutical industry or on our business or operating results.
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Our activities are subject to various federal, state and local laws and regulations regarding
occupational safety, sales practices, laboratory and manufacturing practices, environmental
protection and hazardous substance control, and may be subject to other present and possible future
local, state, federal and foreign regulations. Under certain of these laws, we could be liable for
substantial costs and penalties in the event that waste is disposed of improperly. While it is
impossible to accurately predict the future costs associated with environmental compliance and
potential remediation activities, compliance with environmental laws is not expected to require
significant capital expenditures and has not had, and is not presently expected to have, a material
adverse effect on our earnings or competitive position.
Backlogs
We had no material backlogs as of March 1, 2007 and March 1, 2006.
Employees
As of December 31, 2006, we had approximately 518 employees, approximately 259 of which were
engaged in manufacturing, process development, quality assurance and quality control, 28 in
research and development, 10 in clinical research and regulatory affairs, and 221 in marketing and
administration. No employee is represented by a union and we have never experienced a
labor-related work stoppage. We believe our employee relations are good. Novogyne’s sales force,
formerly a contract sales force, became direct employees of Noven in January 2006, increasing the
number of Noven employees by approximately 120 individuals.
Seasonality
Although our business is affected by the purchasing patterns of our partners and wholesale
drug distributors, there are no significant seasonal aspects to our existing business at this time.
We may experience some seasonality in the future with respect to our sales of Daytrana™
to Shire as ADHD products are generally prescribed more frequently during the school year than
during the summer months.
Available Information
Our Internet website address is www.noven.com. Our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are available
free of charge through our website, as soon as reasonably practicable after such material is
electronically filed with, or furnished to, the Securities and
Exchange Commission (“SEC”). We also make available on our website the
beneficial ownership reports (Form 3, Form 4 and Form 5) filed by Noven officers, directors and
other reporting persons under Section 16 of the Securities Exchange Act of 1934. Our Internet
website and the information contained therein or connected thereto are not incorporated into this
annual report on Form 10-K.
Item 1A. Risk Factors.
The following section summarizes certain risk factors that may cause our results to differ
from the “forward-looking statements” made in this report or otherwise made by or on our behalf.
The risks and uncertainties described below are not listed in order of priority and are not the
only ones we face. If any of the following risks actually occurs, our business, financial
condition and results of operations
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would suffer. Additional risks not presently known to us or other factors not perceived by us
to present significant risks to our business at this time also may impair our business operation.
We do not undertake to update any of these forward-looking statements or to announce the results of
any revisions to these forward-looking statements except as required by law.
Publication of negative results of studies or clinical trials may adversely impact our products.
From time to time, studies or clinical trials on various aspects of pharmaceutical products
are conducted by academics or others, including government agencies, the results of which, when
published, may have dramatic effects on the markets for the pharmaceutical products that are the
subject of the study and on other similar or related pharmaceutical products. The publication of
negative results of studies or clinical trials related to our products or the therapeutic areas in
which our products compete could adversely affect our sales, the prescription trends for our
products and the reputation of our products and could also cause us to be a target for product
liability or other lawsuits.
Currently, our liquidity, results of operations and business prospects are almost entirely
dependent on sales, license royalties and fees associated with transdermal HT products and to a
lesser extent, Daytrana™. The market for HT products has been negatively affected by
the WHI study and other studies that have found that the overall health risks from the use of
certain HT products exceed the benefits from the use of those products among healthy postmenopausal
women. For example, total prescriptions dispensed in the HT market in the United States declined
by 55% from the second quarter of 2002 (the quarter immediately preceding the WHI study) to the
fourth quarter of 2006. In addition, a private foundation has commenced a five-year study aimed at
determining whether ET use by women aged 42 to 58 reduces the risks of heart disease. The study
also seeks to determine if transdermal estrogen patches are more or less beneficial than an oral HT
product. The market for HT products, including ours, both in the United States and abroad, could
be further adversely impacted if this or other HT studies find unacceptable risks from HT use. Any
further adverse change in the market for HT products could have a material adverse impact on our
business, financial position and results of operations.
The FDA’s analysis of potential safety issues associated with certain patch products,
including Duragesic® and Ortho Evra®, and the resulting media coverage of
these issues, may adversely affect the public’s and the medical community’s perceptions of other
transdermal products, including our products, and could ultimately impair the commercial acceptance
of our current and future patch products.
A 2005 study by researchers at the M.D. Anderson Cancer Center found adverse chromosomal
effects on 12 children treated with oral methylphenidate. The FDA has announced that the National
Institutes of Health (“NIH”) and Duke University have or will undertake additional studies designed
to examine the chromosomal effects of oral methylphenidate. Additionally, ongoing FDA inquiries
into the possible cardiac, psychiatric and other side effects of ADHD medications have led the FDA
to require distribution of patient medication guides when ADHD medications are dispensed, and may
lead the FDA to require the addition of related “black-box” warnings to the labeling of ADHD
medications. We cannot predict what effect these events, as well as any other studies or FDA
actions that may occur as a result of the ongoing public debate in the United States regarding the
appropriateness of using methylphenidate and other medications to treat children with ADHD, will
have on our partner’s ability to successfully commercialize Daytrana™.
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If we cannot develop, license or acquire new products and commercialize them on a timely basis our
financial position and results of operations could be adversely affected.
Our long-term strategy is dependent upon the successful development of new products and their
successful commercialization. There can be no assurance that we will be able to identify
commercially promising products or technologies or additional indications to which our products and
technologies may be beneficially applied. The length of time necessary to complete clinical trials
and obtain marketing approval from regulatory authorities is considerable. No assurance can be
given that we will have the financial resources necessary to complete products under development,
that those projects to which we dedicate resources will be successfully completed, that we will be
able to obtain regulatory approval for any such product, or that any approved product can be
produced in commercial quantities, at reasonable costs, and be successfully marketed, either by us
or by a licensing partner. A project can fail or be delayed at any stage of development, even if
each prior stage was completed successfully, which could jeopardize our ability to recover our
investment in the product. Some of our development projects will not be completed successfully or
on schedule. Many of the factors which may cause a product in development to fail or be delayed,
such as difficulty in enrolling patients in clinical trials, the failure of clinical trials, lack
of sufficient supplies or raw materials, inability to supply the subject product or technology on a
commercial scale on an economical basis and changes in regulations, are beyond our control.
From time to time we may need to acquire licenses to patents and other intellectual property
of third parties to develop, manufacture and commercialize our products. There can be no assurance
that we will be able to acquire such licenses on commercially reasonable terms or at all. The
failure to obtain such a license could negatively affect our ability to develop, manufacture and
commercialize certain products. In some cases, we have begun and, in the future, may begin
developing a product with the expectation that a licensee will be identified to assist in
completing development and/or marketing. There can be no assurance that we will attract a business
partner for any particular product or will be able to negotiate an agreement on commercially
reasonable terms. If an agreement is not reached, our initial development investment in any such
product may not be recovered.
If we undertake an acquisition, we will incur a variety of costs, and we may never realize the
anticipated benefits of the acquisition.
One of our current growth strategies is to expand our product base, including through the
acquisition of new transdermal technologies that allow for the delivery of additional molecules
through the skin. We may seek to expand our product base through the acquisition of other
companies, the acquisition of rights to products, or through the license or purchase of rights to
new technologies. If we undertake an acquisition, the process of integrating the acquired
business, technology or product may result in unforeseen operating difficulties and expenditures
and may divert significant management attention from our ongoing business operations. We may
undertake an acquisition that initially results in dilution to our earnings per share. We may fail
to realize the anticipated benefits of any acquisition for a variety of reasons, such as an
acquired technology proving to not be safe or effective in later clinical trials or if the
technology is later found to infringe upon the intellectual property rights of another. It is
possible that we may fund any future acquisition by issuing equity or debt securities, which could
dilute the ownership percentage of current stockholders or limit our financial or operating
flexibility as a result of restrictive covenants related to new debt. Acquisition efforts can
consume significant management attention and require substantial expenditures, which could detract
from our other programs. In addition, we may devote time and resources to potential acquisitions
that are never completed.
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We depend on partners to obtain regulatory approval for, and to market and sell, certain of our
products. Our marketing partners sell products that compete with our products.
We depend upon collaborative agreements with other pharmaceutical companies to obtain
regulatory approval for and to market and sell certain of our products. To help alleviate the
up-front financial burden of seeking product approval and commercializing products we often seek
out strategic partners to whom we can license our products. Under the terms of the Novogyne joint
venture, Novartis is responsible for the distribution of Novogyne’s products, including
Vivelle-Dot®, and for selling Novogyne’s products to its trade customers. For
Daytrana™, we have granted the exclusive marketing rights to Shire. Failure of
Novartis, Shire or our other partners to adequately support our products would cause the quantity
of products purchased from us and the amount of fees and royalties ultimately paid to us to be
reduced and would therefore have a material adverse effect on our business and operations. Our
partners may have different and, sometimes, competing priorities from ours. Some of our partners,
including Novartis and Shire, market and sell products competitive with ours. Shire has a
portfolio of ADHD products and in February 2007 received marketing approval for an amphetamine pro
drug for the treatment of ADHD. Shire is likely to dedicate substantial resources to the promotion
of this product, which is expected to reduce the level of promotion related to
Daytrana™. In addition, Shire is only contractually obligated to use reasonable
commercial efforts to market Daytrana™ until payment of all sales milestones and has no
obligation to continue marketing Daytrana™ thereafter. The marketing organizations of
our partners may be unsuccessful, or those partners may assign a lower level of priority to the
marketing of our products. If one or more partners fails to pursue the marketing of our products
as planned, or if marketing of any of those products is otherwise delayed, our business, financial
position and results of operations may be negatively affected. Absent these marketing partners,
we do not presently have a significant direct marketing channel to health care providers for our
drug delivery technologies.
We do not control Novogyne and we may face additional risks because Novartis, our joint venture
partner, has significantly greater resources than we do.
Our equity in earnings of Novogyne contributed substantially all of our income before income
taxes in 2006, and Novogyne’s results will likely continue to be material to us in the future.
Because, among other things, we are much smaller than Novartis, and because Novartis and its
affiliates sell competing products outside of Novogyne, our interests may not always be aligned.
This may result in potential conflicts between Novartis and us on matters relating to Novogyne
which we may not be able to resolve on favorable terms or at all. Under the Novogyne joint venture
agreement, Novartis has the right to dissolve Novogyne under certain circumstances. Novogyne’s
Management Committee is comprised of a majority of representatives from Novartis. While certain
significant corporate actions require the supermajority vote of the committee members, we do not
control Novogyne. In addition, the joint venture operating agreement has a buy/sell provision that
either Noven or Novartis may trigger by notifying the other party of the price at which the
triggering party would be willing to acquire the other party’s entire interest in the joint
venture. Novartis is a larger company with greater financial resources than us, and therefore may
be in a better position to be the purchaser if the provision is triggered. If the buy/sell
provision is triggered and Novartis is the purchaser, there can be no assurance that we would be
able to reinvest the proceeds of the sale in a manner that would result in sufficient earnings to
offset the loss of earnings from Novogyne. If the provision is triggered and we are the purchaser,
there can be no assurance that we would be able to adequately perform the services currently being
provided by Novartis or that we would not be adversely affected
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by the changes in capital and/or debt structure that likely would be required to finance the
purchase transaction.
We depend on Novartis to perform all financial, accounting, regulatory, compliance, inventory,
sales deductions and other functions for Novogyne.
Under the Novogyne joint venture, Novartis is responsible for providing Novogyne with all
financial, accounting, legal and regulatory services, including monitoring inventory levels and
estimating and recording sales allowances and returns for Novogyne (which include reserves and
allowances related to product returns), and is primarily responsible for ensuring compliance with
applicable regulations relating to sales and marketing activities. Novartis is responsible for
internal controls over financial reporting for Novogyne, so our ability to assess their
effectiveness at maintaining those internal controls is necessarily limited. Failure by Novartis
to perform its obligations under the joint venture agreements could negatively affect the financial
position and results of operations of Novogyne and us.
Because Novartis maintains the relevant data, we may have limited ability to accurately
forecast the amount of sales allowances in any period. If Novartis materially changes the
assumptions it uses in determining the reserve, Novogyne may be required to record an additional
reserve allowance on its financial statements, which would adversely affect Novogyne’s operating
results during the period in which the determination or reserve were made, and would, consequently
also reduce our earnings attributable to our investment in Novogyne for that period. More
generally, any material errors by Novartis in performing its accounting functions for Novogyne
could lead to a subsequent restatement of Novogyne’s financial statements and in turn require us to
restate our financial statements as well.
We may be unable to obtain marketing approval for our new products on a timely basis or at all.
We are not able to market our products (including generic drug products) in the United States
or other jurisdictions without first obtaining marketing approval from the FDA or an equivalent
foreign agency. The process of obtaining FDA approval for a new product is expensive and may take
several years. The process is subject to the broad authority and discretion of the FDA.
We cannot assure that we will obtain the necessary regulatory approval for our products under
development or that any such approval will be free from unduly burdensome conditions or
limitations. In light of the WHI and other HT studies, it is possible that healthcare regulators
could delay the approval of HT products or require that any such new products be subject to more
extensive or more rigorous study and testing prior to being approved, or be subject to more
extensive conditions or limitations after approval.
As a result of the publicity surrounding COX-2 inhibitors, certain antidepressants, and the
publicity surrounding HT products, during 2005 the FDA created an independent Drug Safety Oversight
Board comprised of FDA representatives, medical experts and other third parties to oversee the
management of drug safety issues, and the FDA may impose more stringent standards in approving or
monitoring new products compared to the standards applied in the past. We believe these changes
will make drug development more lengthy, risky and expensive.
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Due to the diversity of proposals put forth, we cannot predict what effect future changes in
regulations or legal interpretations, if, when and as ultimately promulgated, may have on our
business.
Our approved products may not achieve the expected level of market acceptance.
Even if we are able to obtain regulatory approval for our new products, our success will
depend on their market acceptance. Substantially all of our revenues are generated through sales
of transdermal delivery systems, which generally are more expensive than oral formulations. Our
products are marketed primarily to physicians, some of whom are reluctant to prescribe a
transdermal delivery system when an alternative delivery system is available. We and our licensees
must demonstrate to prescribing physicians the benefits of transdermal delivery, especially with
respect to products such as Daytrana™, for which there is presently no transdermal
system on the market. The commercial success of our products is also based in part on patient
preference, and difficulties in obtaining patient acceptance of our transdermal delivery systems
may similarly impact our ability to market our products.
The market for Daytrana™ may be negatively affected by a number of factors. We
have received reports concerning difficulty removing the release liner from a small percentage of
Daytrana™ patches. Although the product meets specifications, during the first quarter
of 2007, we implemented enhancements intended to make Daytrana™ easier to use. If
Daytrana™ sales are materially impacted because of this issue, then Noven’s results of
operations and financial condition would likely be adversely affected. Further, the market for
Daytrana™ could be negatively affected by the outcome of ongoing FDA inquiries into the
possible cardiac, psychiatric and other side effects of ADHD medications which may lead the FDA to
require the addition of related “black-box” warnings to the labeling of ADHD medications, any
negative results from the post-marketing studies and surveillance that the FDA required in
connection with its approval of Daytrana™, as well as ongoing public debate in the
United States regarding the appropriateness of using methylphenidate and other medications to treat
children with ADHD. The outcome of this debate is uncertain, and we cannot predict what impact, if
any, the increased public attention will have on the market for products indicated for ADHD or for
Daytrana™. Because at least part of the stigma results from the fact that most of the
current products are Schedule II controlled substances, non-Schedule II products may benefit from
this controversy at the expense of the methylphenidate and amphetamine-based products on the
market.
Failure to comply with our supply agreements or otherwise adequately supply our products to our
licensees could negatively affect our financial position and results of operations.
Our supply agreements with our licensees impose strict obligations on us with respect to the
manufacture and supply of our products. Failure to comply with the terms of these supply
agreements may result in our being unable to supply product to our licensees, resulting in lost
revenues by us and potential responsibility for damages and losses suffered by our licensees. Our
supply agreement with Novogyne for Vivelle® and Vivelle-Dot® has expired.
Since the expiration of that supply agreement, the parties have continued to operate in accordance
with the supply agreement’s commercial terms. We cannot assure that we will enter into a new
supply agreement on satisfactory terms or at all. It is not clear that the non-commercial terms of
the supply agreement would be enforceable with respect to post-expiration events or occurrences.
Due to our dependence on Novogyne, we may be unable to negotiate favorable business terms with them
or resolve any dispute that we may be involved in with them in a favorable manner. Failure to
continue operating in
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accordance with the supply agreement’s commercial terms could have a material adverse effect
on our business, results of operations and financial position. Designation of a new supplier and
approval of a new supply agreement would require the affirmative vote of four of the five members
of Novogyne’s Management Committee. Accordingly, both Novartis and Noven must agree on Novogyne’s
supplier.
Our products may be recalled.
Product recalls or product field alerts may be initiated at the discretion of Noven (if we
have regulatory authority for the product), our partners (if they have regulatory authority for the
product as is the case for our lead products, Vivelle-Dot® and Daytrana™),
the FDA, other government agencies, or a combination of these parties. Our products may be
recalled for various reasons including the failure of our products to maintain their stability
through their expiration dates, manufacturing issues, quality claims, safety issues, disputed
labeling claims or other reasons. As a general matter, the manufacture of transdermal delivery
systems is more complex than for oral products, and special handling of the product may be required
after shipment by Noven, which may increase the risk of a recall of one of our products. We have
experienced a number of production issues, some of which have led to recalls in the past. We
cannot assure that there will not be recalls of our products in the future. We do not carry any
insurance to cover the risk of a potential product recall. A significant product recall could
materially affect our sales, the prescription trends for the products and our reputation and the
reputation of the product. In these cases, our business, results of operations and financial
condition could be materially and adversely affected.
Failure to comply with applicable regulations may result in product recalls and/or penalties.
Our operations are subject to extensive regulation by governmental authorities in the United
States and other countries with respect to the development, testing, approval, manufacture,
labeling, marketing and sale of pharmaceutical products. These regulations are wide-ranging and
govern, among other things: adverse drug experience reporting, product promotion, product pricing
and discounting, drug sample accountability, drug product stability, product manufacturing,
including good manufacturing practices, and product changes or modifications. In addition, our
facilities handle controlled substances, resulting in additional extensive regulatory requirements
and oversight. Compliance with the extensive government regulations applicable to our business
requires the allocation of significant time, effort and expense. Even if a product is approved by
a regulatory authority, product approvals may be withdrawn after the product reaches the market if
compliance with regulatory standards is not maintained or if problems occur regarding the safety or
efficacy of the product. Failure to comply with governmental regulations may result in fines,
warning letters or other negative written observations, unanticipated compliance expenditures,
interruptions or suspension of production and resulting loss of sales, product seizures or recalls,
injunctions prohibiting further sales, withdrawal of previously approved marketing applications,
and criminal prosecution. Under the terms of the Novogyne joint venture, Novartis is responsible
for providing regulatory services. There can be no assurance that Novartis will comply with these
regulations or that any violation by Novartis will not have an adverse effect on us.
We face scale-up risks in the manufacture of new products in commercial quantities.
Inefficiencies and other scale-up problems can occur in the process of manufacturing a new
product in commercial quantities. If we do not adequately and timely scale-up our manufacturing
processes for new products or otherwise meet supply requirements, the success of our new product
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launches, revenues and product gross margins could be adversely affected. Significant
scale-up or other manufacturing problems could also result in our collaboration partners, if
permitted under our agreements, relying more heavily on second manufacturing sources, thus reducing
the manufacturing revenues that we would otherwise realize. It could also jeopardize our ability
to obtain milestone payments under the applicable transaction. If we experience manufacturing
difficulties such as quality problems, yield deficiencies or similar issues, our overall
manufacturing costs may be higher than anticipated.
If we are unable to improve our margins on Daytrana™ our results of operations will be
adversely affected.
The price at which we sell Daytrana™ to Shire is determined in accordance with the
terms of our Toll Conversion and Supply Agreement with Shire. Because the price at which we sell
Daytrana™ to Shire is generally fixed, our margin on sales of Daytrana™ is
determined by the production costs we incur to produce the product. During the initial commercial
production of Daytrana™ during 2006, our gross margin on that product was negative (i.e.
the costs we incurred to produce the product were greater than the revenue we realized from the
sales of that product). The negative gross margin resulted primarily from start-up expenses
associated with the production of Daytrana™, and production inefficiencies including
lower than desired yields and increased costs associated with meeting launch timelines. Although
our gross margins on sales of this product began to improve in the third quarter of 2006, if we are
unable to continue to improve production yields and reduce our costs of production for
Daytrana™, we will be unable to further improve our margin on sales of the product and
our operating results will be adversely affected. Our ability to produce Daytrana™ and
improve the gross margins from the sale of this product is contingent on, among other things,
receiving a sufficient supply of the active methylphenidate ingredient from Shire as well as
sufficient quota from the DEA for this controlled substance. At any given time, we expect to have
applications pending with the DEA for annual or additional procurement quota that may be critical
to continued production. Any delay or stoppage in the supply of the active methylphenidate
ingredient could cause us to lose revenues or incur additional costs (including those related to
expedited production), which could have an adverse effect on our results of operations.
We rely on a single supplier or a limited number of suppliers for certain raw materials and
compounds used in our products.
Certain raw materials and components used in the manufacture of our products, including
essential polymer adhesives, are available from limited sources, and, in some cases, a single
source. Our NDA for Daytrana™ includes only one supplier of the active pharmaceutical
compound.
Without adequate approved supplies of raw materials or packaging supplies, our manufacturing
operations could be interrupted until another supplier is identified, our products approved and
trading terms with this new supplier negotiated. We may not be able to identify an alternative
supplier and any supplier that we do identify may not be able to obtain the requisite regulatory
approvals in a timely manner, or at all. Furthermore, we may not be able to negotiate favorable
terms with an alternative supplier. Any disruptions in our manufacturing operations from the loss
of an approved supplier may cause us to incur increased costs and lose revenues and may have an
adverse effect on our relationships with our partners and customers, any of which could have
adverse effects on our business and results of operations. Some raw materials used in our products
are supplied by companies that restrict certain medical uses of their products. While our use is
presently acceptable, there can be no assurance that such companies will not expand their
restrictions
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to include our applications. Our business also faces the risk that third party suppliers may
supply us with raw materials that do not meet required specifications, which, if undetected by us,
could cause our products to test out of specification and require us to recall the affected
product.
Our supply of methylphenidate and other controlled substances must be approved by the DEA.
Regulatory authorities must generally approve raw material sources for transdermal products,
and in the case of controlled substances, the DEA sets quotas for controlled substances, including
methylphenidate, fentanyl and amphetamine, and we must receive authorization from the DEA to handle
these substances. Similarly, the manufacturers who supply the controlled substances to us must
also receive authorization from the DEA to manufacture the substances. We cannot assure that we or
our suppliers will be granted sufficient DEA quota to meet our production requirements for
controlled substances. Previous grants of methylphenidate quota for Daytrana™ have been
less than originally requested and we have had to re-apply for additional quota. We expect that
this application and re-application process will continue with respect to future grants. We cannot
guarantee that the timing or quantity of future DEA awards of methylphenidate quota will be
sufficient for us to meet our production requirements for Daytrana™, and the timing and
quantity of any future award may impact our production costs and market penetration of
Daytrana™.
We face significant competition, which may result in others discovering, developing or
commercializing products before, or more successfully, than we do.
We face competition from a number of companies in the development of transdermal drug delivery
products as well as products using other drug delivery systems, and competition is expected to
intensify as more companies enter the field. Some of these companies are substantially larger than
we are and have greater resources than we do, as well as greater experience in developing and
commercializing pharmaceutical products. As a result, they may succeed before us in developing
competing technologies or obtaining governmental approvals for products. Our products compete with
other transdermal products as well as alternative dosage forms of the same or comparable chemical
entities, as well as non-drug therapies.
We face continued competition in the HT market as new and innovative products continue to be
introduced in this field, including products using alternative delivery systems such as gels and
creams, lower-dosage products, and products that may be used to treat menopause-related symptoms
that are not hormone-based or that may reduce the risks related to hormone-based products.
The ADHD market is highly competitive and our receipt of the sales-based milestones under the
Shire agreement depends on the sales levels achieved by Shire, which already markets
non-methylphenidate ADHD products. Other competitors marketing or developing ADHD products include
Johnson & Johnson, Novartis, Glaxo-Smithkline, Bristol-Myers Squibb, Abbott Laboratories, Celltech,
and Lilly. Johnson & Johnson markets Concerta®, the market-leading methylphenidate
product, and Novartis and Lilly market competitive ADHD products. If therapies in development by
other companies become recognized as therapeutically superior to stimulants, or are preferred by
physicians, parents and/or patients, the market for Daytrana™ would be adversely
affected. Shire has received marketing approval for Vyvanse™, an amphetamine pro drug
for the treatment of ADHD which, although a stimulant, may receive favorable scheduling from the
DEA, which could give that product a competitive advantage in the ADHD market. In addition, Shire
is likely to dedicate substantial resources to the promotion of Vyvanse™, which is
expected to reduce the level of promotion devoted to Daytrana™. These competitive
products, especially Vyvanse™ and those already marketed
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by Shire, may negatively impact Shire’s ability to gain market share for Daytrana™ and therefore may decrease the
likelihood that we will receive the sales-based milestone
payments.
We cannot assure that our products will compete successfully against competitive products or
that developments by others will not render our products obsolete or uncompetitive. If we cannot
maintain competitive products and technologies, our current and potential strategic partners may
choose to adopt the drug delivery technologies of our competitors or their own internally developed
technologies.
Competitors may use legal, regulatory and legislative strategies to prevent or delay our launch of
generic products.
The Hatch-Waxman Act provides for a period of 180 days of generic marketing exclusivity for
each ANDA applicant that is first to file an ANDA containing a certification of invalidity,
non-infringement or unenforceability related to a patent listed in the FDA “Orange Book” with
respect to a reference listed drug product, commonly referred to as a Paragraph IV certification.
During this exclusivity period, the FDA cannot grant final approval to any other Paragraph IV
filer. If an ANDA containing a Paragraph IV certification is successful, it generally results in
higher market share, net revenues and gross margin for that applicant for a period of time. Even
if we obtain FDA approval for generic drug products, we may have a significant disadvantage against
a competitor who was first to file an ANDA containing a Paragraph IV certification.
Competitors may also pursue legislative and other regulatory or litigation strategies to
prevent or delay our launch of a generic product. These strategies include, but are not limited
to: seeking to obtain new patents on drugs for which patent protection is about to expire,
changing the labeling for the branded product, filing a citizen petition with the FDA, pursuing
state legislative efforts to limit the substitution of generic versions of brand pharmaceuticals,
filing patent infringement lawsuits that automatically delay FDA approval of many generic products,
introducing a second generation product prior to the expiration of market exclusivity for the first
generation product, which may reduce demand for a generic first generation product, and obtaining
market exclusivity extensions by conducting pediatric trials of brand drugs.
The European market for our products may be limited due to pricing pressures and other matters.
Pharmaceutical prices, including prices for our products, in Europe and certain countries in
other regions are significantly lower than in the United States. Because our agreements with
Novartis Pharma provide for us to receive a percentage of Novartis Pharma’s net selling price
(subject to a minimum price), our gross margins are generally much lower for product sold to
Novartis Pharma for resale outside of the United States than for product sold to Novogyne for sale
in the United States. In addition, the lower prices restrict Novartis Pharma’s gross margin
realized from selling our products. Because our products compete for sales and marketing resources
with other Novartis Pharma products, including competitive HT products, there can be no assurance
that the relatively low gross margins generated from selling our products will not cause Novartis
Pharma to focus its resources on other products or even not launch our products in certain
countries. Novartis Pharma has launched Estradot® in the United Kingdom, France,
Germany, Spain (without the benefit of government reimbursement) and in a number of smaller
European countries. We cannot assure that Novartis Pharma will be successful in launching
Estradot® in other countries. The profitability of sales in Europe may be negatively
affected by parallel trade practices in the European Union
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whereby a licensed importer may take advantage of price disparity between markets by
purchasing our products in a market with a relatively lower price and then importing them into a
country with relatively higher price. Lack of government reimbursement for Estradot®
could also negatively impact the product’s profitability.
Our quarterly operating results are subject to significant fluctuations.
In 2006, we experienced significant fluctuations in our quarterly operating results and we
expect that revenues from product sales to our licensees as well as our research and development
expenditures will continue to fluctuate from quarter-to-quarter and year-to-year depending upon
various factors not in our control, including the purchasing patterns of wholesale drug
distributors, marketing efforts of each licensee, fluctuations in sales and returns allowances,
including those related to allowances for expiring product as well as product recalls, the
inventory requirements of each licensee, the impact of competitive products, the timing and scope
of Estradot® launches and commercialization efforts by Novartis Pharma, the impact of
the HT studies on prescriptions for our HT products, the product pricing of each licensee, the
timing of certain royalty reconciliations and payments under our license agreements, the timing of
FDA approval, any subsequent launch of new products, and the success of Shire’s commercialization
efforts. Our earnings may fluctuate because of, among other things, fluctuations in research and
development spending resulting from the timing of clinical trials. In addition, Novartis is
entitled to an annual $6.1 million preferred return over our interest in Novogyne, which has the
effect of reducing our share of Novogyne’s income in the first quarter of each year.
Our results of operations will be adversely affected if we or Novogyne fail to realize the full
value of our intangible assets.
Accounting principles generally accepted in the United States require Novogyne and us to test
the recoverability of our respective long-lived assets and certain identifiable intangible assets
whenever events or changes in circumstances indicate that those assets’ carrying amount may not be
recoverable. If the fair value is less than the carrying amount of the asset, a loss is recognized
for the difference. Novogyne recorded the acquisition of the CombiPatch® product
marketing rights at cost and tests this asset for impairment on a periodic basis. Any further
adverse change in the market for HT products or a recall of CombiPatch® could have a
material adverse impact on the ability of Novogyne to recover its investment in its
CombiPatch® marketing rights, which could require Novogyne to revalue that asset.
Impairment of that asset would adversely affect Novogyne’s, and consequently our, operating
results.
We cannot be certain of the protection or confidentiality of our patents and proprietary rights.
Our success will depend, in part, on our ability to obtain or license patents for our
products, processes and technologies. If we do not do so, our competitors may exploit our
innovations and deprive us of the ability to realize revenues from those innovations. There is no
assurance that we will be issued patents for any of our patent applications, that any existing or
future patents that we receive or license will provide competitive advantages for our products, or
that we will be able to enforce successfully our patent rights. Additionally, there can be no
assurance that our patents or any future patents will prevent other companies from developing
similar or functionally equivalent products, or challenging, invalidating or avoiding our patent
applications or any existing or future patents that we receive or license. Many of our patents are
formulation patents and would not preclude others from developing and marketing products that
deliver drugs transdermally or
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otherwise through non-infringing formulations. Furthermore, there is no assurance that any of
our future processes or products will be patentable, that any pending or additional patents will be
issued in any or all appropriate jurisdictions or that our processes or products will not infringe
upon the patents of third parties.
We also rely on trade secrets, unpatented proprietary know-how and continuing technological
innovation. We use confidentiality agreements with licensees, suppliers, employees and consultants
to protect our trade secrets, unpatented proprietary know-how and continuing technological
innovation, but there can be no assurance that these parties will not breach their agreements with
us or that we will be able to effectively enforce our rights under those agreements. We also
cannot be certain that we will have adequate remedies for any breach. Disputes may arise
concerning the ownership of intellectual property or the applicability of confidentiality
agreements. Furthermore, we cannot be sure that our trade secrets and proprietary technology will
not otherwise become known or that our competitors will not independently develop our trade secrets
and proprietary technology.
Third parties may claim that we infringe their proprietary rights, forcing us to expend substantial
resources in resulting litigation, the outcome of which is uncertain. Any unfavorable outcome
could negatively affect our financial position and results of operations.
Our success depends, in part, on our ability to operate without infringing the proprietary
rights of others, and there can be no assurance that our products and processes will not infringe
upon the patents of others. Third parties may also institute patent litigation against us for
competitive reasons unrelated to any infringement by us. If a third party asserts a claim of
infringement, we may have to seek licenses, defend infringement actions or challenge the validity
of those third-party patents in court. If we cannot obtain the required licenses, or are found
liable for infringement or are not able to have these patents declared invalid, we may be liable
for significant monetary damages, encounter significant delays in bringing products to market or be
precluded from participating in the manufacture, use or sale of products or methods of drug
delivery covered by the patents of others. There can be no assurance that we have identified, or
that in the future we will be able to identify, all U.S. and foreign patents that may pose a risk
of potential infringement claims.
We may experience reductions in the levels of reimbursement for our products by governmental
authorities, private health insurers and managed care organizations.
Our ability and our marketing partners’ ability to commercialize our products, including
Daytrana™, is dependent in part on obtaining reimbursement from government health
authorities, private health insurers and managed care organizations. The trend toward managed
healthcare in the United States and the prominence of health maintenance organizations (HMOs) and
similar entities could significantly influence the purchase of our products, resulting in lower
prices and lower demand. This is particularly true in a market that includes generic alternatives,
such as the ADHD market. In addition, managed care agreements established by Novartis could
adversely affect Novogyne’s financial results.
Health care reform or other changes in government regulation could harm our business.
The federal and state governments in the United States, as well as many foreign governments,
from time to time explore ways to reduce medical care costs through health care reform. In the
United States, some parties have advocated for the re-importation of prescription drugs from Canada
and other countries for re-sale in the United States at a discount to United States prices, as well
as
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requiring the government to negotiate directly with drug companies for lower prices in the
Medicare prescription drug plan. Due to the diverse range of proposals put forth from country to
country and the uncertainty of any proposal’s adoption, we cannot predict what impact any reform
proposal ultimately adopted may have on the pharmaceutical industry or on our business, financial
position or results of operations.
We may be exposed to product liability claims and there can be no assurance of adequate insurance.
Like all pharmaceutical companies, the testing, manufacturing and marketing of our products
may expose us to potential product liability and other claims resulting from their use. We have
been named as a defendant in six cases in which a plaintiff alleges personal injury from the use of
HT products which we manufacture and Novogyne distributes. In addition, Novartis has advised us
that Novartis has been named as a defendant in at least 31 additional lawsuits involving
approximately 33 plaintiffs that allege liability in connection with personal injury claims
allegedly arising from the use of HT patches distributed and sold by Novartis and Novogyne,
including our products, Vivelle-Dot®, Vivelle® and CombiPatch®.
Novogyne has been named as a defendant in one lawsuit in
addition to the lawsuits referenced above. If any such claims against us are successful, we
may be required to make significant payments and suffer the associated adverse publicity. Even
unsuccessful claims could result in the expenditure of funds in litigation and the diversion of
management time and resources. We and Novogyne maintain product liability insurance, but there can
be no assurance that such insurance will cover all future claims or that we and/or Novogyne will be
able to maintain existing coverage or obtain additional coverage at reasonable rates. Over the
past few years, the cost of product liability insurance policy has increased while providing
significantly less coverage and higher deductibles than in the past. If a claim is not covered or
if coverage is insufficient, we and/or Novogyne may incur significant liability payments that would
negatively affect our business, financial position and results of operations. Novogyne has a
claims-made insurance policy with a $10.0 million aggregate limit, and as of December 31, 2006,
Novogyne has recorded an insurance receivable of $7.3 million.
All of our products are manufactured at one location. An interruption of production at this
facility could negatively affect our business, financial position and results of operations.
All of our products are manufactured at a single facility in Miami, Florida. An interruption
of manufacturing resulting from regulatory issues, technical problems, casualty loss (including
hurricane) or other factors could result in our inability to meet production requirements, which
may cause us to lose revenues and which could have an adverse effect on our relationships with our
partners and customers, any of which could have a material adverse effect on our business,
financial position or results of operations. Without our existing production facility, we would
have no other means of manufacturing our products until we were able to restore the manufacturing
capability at our facility or develop an alternative manufacturing facility. Although we carry
business interruption insurance to cover lost revenues and profits resulting from casualty losses,
this insurance does not cover all possible situations and cannot cover all potential exposure and
there can be no assurance that any event of casualty to our facility would be covered by such
insurance. The amount of our coverage may not be sufficient to cover the full amount of a covered
loss. In addition, our business interruption insurance would not compensate us for the loss of
opportunity and potential adverse
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impact on relations with our existing partners and customers resulting from our inability to
produce products for them.
We use hazardous chemicals in our business. Potential claims relating to improper handling, storage
or disposal of these chemicals could be time consuming and costly.
Our research and development processes involve the controlled use of hazardous chemicals.
These hazardous chemicals are reagents and solvents typically found in a chemistry laboratory. Our
operations also produce hazardous waste products. Federal, state and local laws and regulations
govern the use, manufacture, storage, handling and disposal of hazardous materials. We cannot
eliminate all risk of accidental contamination from or discharge of hazardous materials and any
resultant injury. Compliance with environmental laws and regulations may be expensive. We might
have to pay civil damages in the event of an improper or unauthorized release of, or exposure of
individuals to, hazardous materials. We are not insured against these environmental risks.
Our operations could be disrupted if our information systems fail or if we are unsuccessful in
implementing necessary upgrades.
Our business depends on the efficient and uninterrupted operation of our computer and
communications software and hardware systems, and our other information technology. In the coming
years, we may have to implement significant upgrades to our information systems, including the
implementation and qualification of an upgrade to our business applications software. If our
systems were to fail or we are unable to successfully expand the capacity of these systems or to
integrate new technologies into our existing systems, our operations and financial results could
suffer.
Our insurance coverage may not be adequate and rising insurance premiums could negatively affect
our profitability.
We rely on insurance to protect us from many business risks, including product liability,
business interruption, property and casualty loss, employment practices liability and directors’
and officers’ liability. The cost of insurance has risen significantly in the last few years,
especially for property, business interruption and products liability coverage. These and other
types of coverage also have become less widely available and more difficult to obtain. In
response, we increased deductibles and decreased certain coverages to mitigate these costs while
still paying higher premiums. There can be no assurance that the insurance that we maintain and
intend to maintain will be adequate, or that the cost of insurance and limitations in coverage will
not adversely affect our business, financial position or results of operations. Furthermore, it is
possible that, in some cases, coverage may not be available at any price.
Our financial position and results of operations could be harmed if we are required to perform
under existing or future contractual indemnification provisions.
In the normal course of business, we enter into development, license, supply, employment and
other agreements that include indemnification provisions. The Novogyne joint venture operating
agreement contains an indemnification provision as do certain supply and license agreements between
and among us, Novartis and Novogyne. The various indemnification provisions in these agreements
are not uniform and, depending on the circumstances, may be subject to differing legal
interpretations. As a consequence, it may be difficult in certain circumstances for us to
determine or
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predict in advance what amounts we might be obligated to pay Novogyne or Novartis under these
indemnification provisions or, alternatively, what obligations may be owed to us by these parties,
including as they relate to potential damages, settlement amounts and defense costs associated with
the product liability lawsuits that relate to the use of products we manufacture and Novogyne
distributes. While insurance coverage may mitigate the costs of some of our obligations under our
indemnification provisions, our business, financial position and results of operations could be
harmed if we are required to perform under these indemnification provisions and there is no or
insufficient insurance coverage.
Our success depends on attracting and retaining our key employees.
Our success depends on our ability to attract and retain qualified, experienced personnel. We
face significant competition in recruiting talented personnel. In the past, our location in an
area with relatively few pharmaceutical companies has made recruitment more difficult, as many
candidates prefer to work in places with a broad pharmaceutical industry presence. The loss of key
personnel, or the inability to attract and retain additional, competent employees, could adversely
affect our business, financial position or results of operations.
Our stockholders’ rights plan, our charter documents, Delaware law and our joint venture with
Novartis may have an anti-takeover effect.
Our stockholders’ rights plan, our corporate charter documents, Delaware law and our joint
venture operating agreement with Novartis each include provisions that may discourage or prevent
parties from attempting to acquire us. These provisions may have the effect of depriving our
stockholders of the opportunity to sell their stock at a price in excess of prevailing market
prices in an acquisition of us. We have a stockholders’ rights plan, commonly referred to as a
“poison pill,” which is intended to cause substantial dilution to a person or group who attempts to
acquire us on terms that our Board of Directors has not approved. The existence of the
stockholders’ rights plan could make it more difficult for a third party to acquire a majority of
our common stock without the consent of our Board of Directors. Certain provisions of our
certificate of incorporation and bylaws could have the effect of making it more difficult for a
third party to acquire a majority of our outstanding voting common stock. These include provisions
that limit the ability of stockholders to bring matters before an annual meeting of stockholders,
call special meetings or nominate candidates to serve on our Board of Directors.
We are also subject to the provisions of Section 203 of the Delaware General Corporation Law,
which prohibits a publicly-held Delaware corporation from engaging in a “business combination” with
an “interested stockholder” for a period of three years after the date of the transaction in which
the person became an interested stockholder, unless the business combination is approved in a
prescribed manner. For purposes of Section 203, a “business combination” includes a merger, asset
sale or other transaction resulting in a financial benefit to the interested stockholder, and an
“interested stockholder” is a person who, either alone or together with affiliates and associates,
owns (or within the past three years, did own) 15% or more of the corporation’s voting stock.
The operating agreement for our joint venture with Novartis has a buy/sell provision that
either party may trigger by notifying the other party of the price at which the triggering party
would be willing to acquire the other party’s interest in the joint venture. As a result of the
buy/sell
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provision, any potential acquirer of us faces the possibility that Novartis could trigger this
provision at any time and thereby require the acquirer to either purchase for cash Novartis’
interest in Novogyne (which would include the net present value of Novartis’ $6.1 million annual
preferred return) or to sell its interest in Novogyne to Novartis. The existence of the buy/sell
provision and the uncertainty it may create could discourage an acquisition of us by a third party,
which could have an adverse effect on the market price for our common stock. In addition, the
operating agreement gives Novartis the right to dissolve the joint venture in the event of a change
in control of Noven if the acquirer is one of the ten largest pharmaceutical companies (as measured
by annual dollar sales). Upon dissolution, Novartis would reacquire the rights to market
Vivelle-Dot® and Vivelle® subject to the terms of Novartis’ prior arrangement
with us, and Novogyne’s other assets would be liquidated and distributed to the parties in
accordance with their capital account balances as determined pursuant to the joint venture
operating agreement. This dissolution provision could have an anti-takeover effect with respect to
a top ten pharmaceutical company.
The market price for our common stock is volatile.
The market price of our common stock is volatile. During 2006, our common stock traded as low
as $14.50 per share and as high as $26.22 per share. Any number of factors, including some over
which we have no control and some unrelated to our business or financial results, may have a
significant impact on the market price of our common stock, including: announcements by us or our
competitors of technological innovations or new commercial products, changes in governmental
regulation, receipt by us or one of our competitors of regulatory approvals or adverse regulatory
determinations, developments relating to our patents or proprietary rights of one of our
competitors, publicity regarding actual or potential medical results or risks for products that we
or one of our competitors market or has under development, and period-to-period changes in
financial results and the economy generally. We, like any other company with a volatile stock
price, may be subject to further securities litigation, which could have a material adverse effect
on our business and financial results.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2. Properties.
Our headquarters and manufacturing facility is located on a 15-acre site in Miami-Dade County,
Florida. On this site, we own an approximately 20,000 square foot building, which is used for
laboratory, office and administrative purposes. We also lease from Aventis, for $1.00 per year,
7.2 acres of the site and two approximately 40,000 square foot buildings located on this portion of
the site, which we use for manufacturing, engineering, administrative and warehousing purposes.
The lease expires upon the earlier of 2024 or the termination of our 1992 license agreement with
Aventis. We have an option to purchase the leased facilities and property at any time during the
term of the lease for Aventis’ book value ($0.7 million at December 31, 2006). Aventis may
terminate the lease prior to the expiration of its term upon termination or expiration of our 1992
license agreement with Aventis. The facility has been certified by the DEA to manufacture products
containing controlled substances.
We lease approximately 17,600 square feet of office space in a neighboring facility for
certain marketing and administrative functions and an additional 73,000 square feet of industrial
space for warehousing which, depending on need, may also be used for manufacturing new products.
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Our site includes 5 acres of vacant land that we own that we believe could accommodate new
buildings for a variety of manufacturing, warehousing and developmental purposes. We believe that
our facilities are in satisfactory condition, and are suitable for their intended use and have
adequate capacity for the manufacture of our HT products and Daytrana™.
Our sole manufacturing facility, our research and development activities, as well as our
corporate headquarters and other critical business functions, are located in an area subject to
hurricane casualty risk. Although we have certain limited protection afforded by insurance, our
business, earnings and competitive position could be materially adversely affected in the event of
a major windstorm or other casualty.
Item 3. Legal Proceedings.
In September 2005, Noven, Novogyne and Novartis were served with a summons and complaint from
an individual plaintiff in Superior Court of New Jersey Law Division, Atlantic County in which the
plaintiff claims personal injury allegedly arising from the use of HT products, including
Vivelle®. The plaintiff claims compensatory, punitive and other damages in an
unspecified amount. We do not expect any activity in this case in the near future, as
the court has entered an order to stay proceedings in all its pending and future HT cases, except
for cases where Wyeth Pharmaceuticals and its affiliates and Pfizer, Inc. are the defendants.
In April 2006, an individual plaintiff and her husband filed a complaint in the United States
District Court, District of Minnesota against Noven, Novogyne, Novartis, Wyeth Inc. and Wyeth
Pharmaceuticals, Inc. alleging liability in connection with personal injury claims allegedly
arising from the use of HT products, including our CombiPatch® product. The plaintiffs
claim compensatory and other damages in an unspecified amount.
In July 2006, four complaints were filed in the United States District Court, District of
Minnesota against Noven and other pharmaceutical companies by four separate individual plaintiffs,
each filing alone or with her husband. Three of the complaints also name Novartis as a defendant,
and of these, two name Novogyne as a defendant as well. Each complaint alleges liability in
connection with personal injury claims allegedly arising from the use of HT products, including
Vivelle® in one case and CombiPatch® in two of the cases. The plaintiffs in
each case claim compensatory and other damages in an unspecified amount.
We intend to defend all of the foregoing lawsuits vigorously, but the outcome of these product
liability lawsuits cannot ultimately be predicted.
Novartis has advised us that Novartis has been named as a defendant in at least 31 lawsuits
that include approximately 33 plaintiffs that allege liability in connection with personal injury
claims allegedly arising from the use of HT patches distributed and sold by Novartis and Novogyne,
including our Vivelle-Dot®, Vivelle®, and CombiPatch®
products. Novogyne has been named as a defendant in one lawsuit in
addition to the four lawsuits referenced above. Novartis has indicated that it will seek
indemnification from Noven and Novogyne to the extent permitted by the agreements between and among
Novartis, Novogyne and Noven.
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We are a party to other pending legal proceedings arising in the normal course of business,
none of which we believe is material to our financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
We did not submit any matters to a vote of stockholders during the quarter ended December 31,
2006.
Executive Officers of the Registrant
Set forth below is a list of the names, ages, positions held and business experience of the
persons serving as our executive officers as of March 1, 2007. Officers serve at the discretion of
the Board of Directors. There is no family relationship between any of the executive officers or
between any of the executive officers and any of our directors, and there is no arrangement or
understanding between any executive officer and any other person pursuant to which the executive
officer was selected.
Eduardo G. Abrao, M.D., Ph.D. Dr. Abrao, age 64, has been Vice President – Clinical
Development & Chief Medical Officer of Noven since September 2003. From March 2002 to October
2002, Dr. Abrao served as the Vice President, Regulatory Affairs and Drug Safety of Berlex
Laboratories, Inc. From 1996 to 2002, Dr. Abrao served Otsuka America Pharmaceutical, Inc. in a
variety of regulatory and operational positions, most recently as its President and Chief Operating
Officer. From 1989 to 1996, Dr. Abrao was Vice President, International Medical Department with
Marion Merrell Dow/Hoechst Marion Roussel.
Diane M. Barrett. Ms. Barrett, age 46, has been Vice President & Chief Financial
Officer of Noven since May 2003. From August 2000 to January 2001, she served as Treasurer and
Executive Director of Finance of Noven, and from January 2001 to May 2003 she served as Vice
President – Finance & Treasurer of Noven. From 1997 to 2000, Ms. Barrett served as Vice President
and Chief Financial Officer of BioNumerik Pharmaceuticals, Inc. and, from 1990 to 1997, served
Cordis Corporation in a variety of finance positions, most recently as Treasurer. Prior to joining
Cordis, Ms. Barrett was a manager with Arthur Andersen & Co.
Jeffrey F. Eisenberg. Mr. Eisenberg, age 41, has been with Noven since November 1998
and, since May 2005, has served as Senior Vice President – Strategic Alliances. From January 2001
to September 2001, he served as Noven’s Vice President, General Counsel & Corporate Secretary, and
from September 2001 to May 2005, he served as Noven’s Vice President – Strategic Alliances, General
Counsel & Corporate Secretary. From 1995 through 1998, Mr. Eisenberg served as Associate General
Counsel and then as Acting General Counsel of IVAX Corporation. Prior to joining IVAX, he was a
lawyer in the corporate securities department of the law firm of Steel Hector & Davis.
W. Neil Jones. Mr. Jones, age 54, has been with Noven since February 1997 and, since
November 2000, has served as Vice President – Marketing & Sales. From 1981 through 1997, he served
Ciba-Geigy Corporation in a variety of sales and marketing positions, most recently as Executive
Director of Marketing.
Juan A. Mantelle. Mr. Mantelle, age 48, has been with Noven since March 1990 and,
since June 2000, has served as Vice President & Chief Technical Officer. From 1986 to 1990, he
served
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Paco Research Corp. as Manager – Product Development. From 1983 to 1986, he served Key
Pharmaceuticals, Inc. as Senior Research Engineer.
Robert C. Strauss. Mr. Strauss, age 65, has been President, Chief Executive Officer &
Chairman of the Board of Noven since June 2001. From December 1997 to September 2000, he served as
President & Chief Executive Officer and as a Director of Noven, and from September 2000 to June
2001, he served as Co-Chairman of Noven. In 1997, he served as President and Chief Operating
Officer and as a Director of IVAX Corporation. From 1983 to 1997, he served in various executive
positions with Cordis Corporation, most recently as its Chairman of the Board, President and Chief
Executive Officer.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
Our Common Stock is listed on the Nasdaq Stock Market and is traded under the symbol NOVN. As
of March 1, 2007, we had 254 stockholders of record of our Common Stock. We have never paid a cash
dividend on our Common Stock and do not anticipate paying cash dividends in the foreseeable future.
The following table sets forth, for the periods indicated, the high and low sale prices for the
Common Stock as reported on the Nasdaq Stock Market.
| High Price | Low Price | |||||||
Fourth Quarter, 2006 |
$ | 26.22 | $ | 21.25 | ||||
Third Quarter, 2006 |
25.48 | 17.69 | ||||||
Second Quarter, 2006 |
19.10 | 16.30 | ||||||
First Quarter, 2006 |
18.17 | 14.50 | ||||||
Fourth Quarter, 2005 |
$ | 16.38 | $ | 10.44 | ||||
Third Quarter, 2005 |
18.23 | 12.14 | ||||||
Second Quarter, 2005 |
18.34 | 15.58 | ||||||
First Quarter, 2005 |
19.20 | 14.80 | ||||||
The following table provides information with respect to our stock repurchases during the
fourth quarter of 2006:
| Total Number of | ||||||||||||||||
| Shares | Approximate | |||||||||||||||
| Purchased as | Dollar Value | |||||||||||||||
| Part of | That May Yet | |||||||||||||||
| Total Number of | Average Price | Publicly | be Purchased | |||||||||||||
| Shares | Paid | Announced | under the | |||||||||||||
| Purchased | Per Share | Program | Program1 | |||||||||||||
October 1, 2006 to
October 31, 2006 |
— | — | — | $ | 23,711,040 | |||||||||||
November 1, 2006 to
November
30, 2006 |
— | — | — | $ | 23,711,040 | |||||||||||
December 1, 2006 to
December 31, 2006 |
— | — | — | $ | 23,711,040 | |||||||||||
Totals |
— | — | — | $ | 23,711,040 | |||||||||||
| 1 | In March 2003, we announced a stock repurchase program authorizing the buy back of up to $25.0 million of our Common Stock. There is no expiration date specified for this program. |
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Comparison of Five-Year Cumulative Total Return*
Noven Pharmaceuticals, Inc., Russell 2000 Index and Value Line Drugs Index
(Performance Results Through 12/31/06)
Noven Pharmaceuticals, Inc., Russell 2000 Index and Value Line Drugs Index
(Performance Results Through 12/31/06)
| 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | |||||||||||||||||||
Noven Pharmaceuticals |
$ | 100.00 | $ | 52.00 | $ | 85.69 | $ | 96.11 | $ | 85.24 | $ | 143.38 | ||||||||||||
Russell 2000 Index |
$ | 100.00 | $ | 78.42 | $ | 114.00 | $ | 133.38 | $ | 137.81 | $ | 161.24 | ||||||||||||
Value Line Drugs Index |
$ | 100.00 | $ | 82.59 | $ | 105.97 | $ | 105.02 | $ | 115.49 | $ | 133.02 | ||||||||||||
| * | Cumulative total return assumes reinvestment of dividends. |
Source: Value Line, Inc.
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Item 6. Selected Financial Data.
The selected financial data presented below is derived from our audited financial statements.
The data set forth below should be read in conjunction with “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and the Financial Statements and related notes
appearing elsewhere in this Form 10-K (all amounts in thousands, except per share amounts).
| Years Ended December 31, | ||||||||||||||||||||
| 20061 | 20052 | 2004 | 2003 | 2002 | ||||||||||||||||
Statement of Operations Data: |
||||||||||||||||||||
Net Revenues: |
||||||||||||||||||||
Product revenue |
$ | 48,326 | $ | 40,451 | $ | 36,871 | $ | 37,116 | $ | 50,199 | ||||||||||
Contract and license revenue |
12,363 | 12,081 | 9,020 | 6,050 | 5,173 | |||||||||||||||
Total net revenues |
60,689 | 52,532 | 45,891 | 43,166 | 55,372 | |||||||||||||||
Expenses: |
||||||||||||||||||||
Cost of products sold |
36,508 | 34,047 | 20,514 | 19,845 | 23,297 | |||||||||||||||
Research and development |
11,454 | 13,215 | 9,498 | 7,719 | 11,310 | |||||||||||||||
Marketing, general and
administrative |
21,701 | 16,915 | 17,271 | 15,858 | 14,257 | |||||||||||||||
Total expenses |
69,663 | 64,177 | 47,283 | 43,422 | 48,864 | |||||||||||||||
(Loss) income from operations |
(8,974 | ) | (11,645 | ) | (1,392 | ) | (256) | 6,508 | ||||||||||||
Equity in earnings of Novogyne |
28,632 | 24,655 | 17,641 | 17,094 | 14,368 | |||||||||||||||
Interest income, net |
4,272 | 2,242 | 999 | 659 | 822 | |||||||||||||||
Income before income taxes |
23,930 | 15,252 | 17,248 | 17,497 | 21,698 | |||||||||||||||
Income tax expense |
7,942 | 5,280 | 6,024 | 6,301 | 7,819 | |||||||||||||||
Net income |
$ | 15,988 | $ | 9,972 | $ | 11,224 | $ | 11,196 | $ | 13,879 | ||||||||||
Basic earnings per share |
$ | 0.67 | $ | 0.42 | $ | 0.48 | $ | 0.50 | $ | 0.62 | ||||||||||
Diluted earnings per share |
$ | 0.66 | $ | 0.42 | $ | 0.46 | $ | 0.49 | $ | 0.60 | ||||||||||
Balance Sheet Data: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 9,144 | $ | 66,964 | $ | 93,958 | $ | 83,381 | $ | 58,684 | ||||||||||
Short-term investments |
144,455 | 17,900 | — | — | — | |||||||||||||||
Total assets |
281,365 | 185,910 | 201,975 | 170,984 | 138,502 | |||||||||||||||
Capital lease obligation |
388 | 121 | 235 | — | 5 | |||||||||||||||
Deferred license revenue |
89,272 | 23,655 | 39,085 | 50,005 | 29,445 | |||||||||||||||
Stockholders’ equity |
176,675 | 140,621 | 129,039 | 108,823 | 96,741 | |||||||||||||||
| 1 | Our results for 2006 included $3.3 million in stock-based compensation expenses resulting from the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”. | |
| 2 | Our results for 2005 included $9.9 million in charges associated with the write-off of fentanyl inventories and associated destruction charges, and the recognition of $5.7 million in fentanyl deferred license revenues, resulting from the FDA’s decision not to approve our application for a generic fentanyl patch. |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
The following section addresses aspects of Noven’s financial condition and results of
operations. The contents of this section include:
| • | An executive summary of our 2006 results of operations; | ||
| • | An overview of Noven and our Novogyne joint venture; | ||
| • | A review of certain items that may affect the historical or future comparability of our results of operations; | ||
| • | An analysis of our results of operations and our liquidity and capital resources; | ||
| • | An outlook that includes our current financial guidance for 2007; | ||
| • | A discussion of how we apply our critical accounting estimates; and | ||
| • | A discussion of recently-issued accounting standards. |
This discussion should be read in conjunction with Noven and Novogyne’s 2006 financial
statements and the related notes thereto included in this Form 10-K.
Executive Summary
The following Executive Summary is qualified in its entirety by the more detailed discussion
and analysis of our financial condition and results of operations appearing in this Item 7 as well
as in our financial statements and related notes included in this Form 10-K.
For Noven, the highlights of the year ended December 31, 2006 included the approval and launch
of Daytrana™, the first transdermal therapy for ADHD and our first product
commercialized outside the HT category, as well as record financial results reported by our
Novogyne joint venture.
Daytrana™ was approved by the FDA in April 2006, triggering a $50 million approval
milestone payment from Shire. Our results for 2006 included the recognition of $5.9 million in
license revenues associated with Daytrana™ milestones, as well as $8.6 million in
Daytrana™ product sales to Shire. Primarily due to Daytrana™ product and
license revenues, our 2006 net revenues increased to $60.7 million, a 16% increase over 2005. In
2005, our net revenues benefited from the recognition of $6.0 million in deferred license revenues
in connection with our collaboration with Endo, of which $5.7 million (the “Fentanyl Revenues”) was
associated with the FDA’s decision to cease review of our application for a generic fentanyl patch.
Those same circumstances caused us to record in 2005 an aggregate $9.9 million in charges
associated with the write-off and destruction of our fentanyl inventories (the “Fentanyl Charges”).
Our gross margin percentage for 2006 was 24%, substantially lower than what our gross margin
in 2005 would have been but for the Fentanyl Charges. Our 2006 gross margin was adversely affected
by, among other things, startup costs and related inefficiencies associated with the scale-up and
expedited production of Daytrana™ launch quantities in the 2006 second quarter, as well
as increased overhead costs associated with facility expansion for new products and quality-related
improvements. Due in part to our continuing efforts to improve efficiencies and reduce costs,
including a 2006 third quarter cost reduction program, we reported improvements in gross margin
percentage in the second half of the year. Specifically, our overall gross margin percentage
increased from 11% in the second quarter to 30% in each of the third and fourth quarters of 2006.
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Research and development expenses for 2006 decreased $1.8 million, or 13%, to $11.5 million,
primarily due to reduced development expenses related to our developmental fentanyl patch and
Daytrana™. Marketing, general and administrative expenses increased $4.8 million, or
28%, to $21.7 million, primarily as a result of the recognition of $2.5 million in stock-based
compensation expenses due to the adoption of Statement of Financial Accounting Standards No. 123
(revised 2004), “Share-Based Payment” (“SFAS 123(R)”) in 2006, a $1.1 million increase in personnel
costs and a $0.6 million termination charge related to the 2006 third quarter cost reduction
program.
We recognized $28.6 million in earnings from Novogyne in 2006, an increase of 16% compared to
2005. Interest income for 2006 increased $2.0 million, or 91%, over 2005, largely reflecting a
higher average cash balance in 2006 resulting from the receipt of a $50.0 million approval
milestone payment from Shire. For 2006, we reported net income of $16.0 million ($0.66 diluted
earnings per share), compared to net income of $10.0 million ($0.42 diluted earnings per share)
reported in 2005. Net income in 2005 reflected the impact of both the Fentanyl Revenues and the
Fentanyl Charges.
Our Novogyne joint venture reported net revenues of $131.9 million, a 9% increase over 2005,
reflecting increased sales of Vivelle-Dot® (the market leading product in the
transdermal estrogen therapy category) partially offset by increased sales and returns allowances.
Novogyne’s selling, general and administrative expenses for 2006 increased 5% to $37.3 million,
primarily reflecting increased marketing, sample and promotional spending in support of
Vivelle-Dot®. Novogyne’s 2006 net income increased 13% to $65.3 million compared to
2005.
At December 31, 2006, Noven had an aggregate $153.6 million in cash and cash equivalents and
short-term investments, compared to $84.9 million at December 31, 2005. In February 2007, Shire
notified us that its net sales of Daytrana™ in 2006 were sufficient to trigger payment
of the first of three potential $25.0 million milestones to Noven. We received that payment in the
first quarter of 2007. For accounting purposes, we expect to defer the revenue associated with the
Daytrana™ sales milestones and recognize them as license revenues on a straight line
basis through the first quarter of 2013.
Prescription demand for our two lead products increased during 2006. Total prescriptions for
Vivelle-Dot® increased 6% in 2006 compared to 2005, and total prescriptions for
Novogyne’s products, taken as a whole, increased 3% for the same period. Total prescriptions for
Daytrana™ increased 69% in the fourth quarter of 2006 compared to the third quarter of
2006, which was the first complete quarter following the product’s launch. The increase in
Daytrana™ prescriptions reflects initial uptake of a newly-launched product and is not
indicative of the product’s ongoing growth rate.
Overview of Noven and our Novogyne Joint Venture
We develop and manufacture advanced transdermal patches, offering commercial products in both
the ADHD and HT categories. We presently derive a significant portion of our revenues, and an even
greater percentage of our profits, from sales of HT patches. In the United States, our HT products
are marketed and sold by Novogyne Pharmaceuticals, our joint venture with Novartis. Our business,
financial position and results of operations currently depend largely on Novogyne and its marketing
of our three principal HT products – Vivelle-Dot®, Vivelle® and
CombiPatch®– in the
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United States. A discussion of Novogyne’s results and their impact on our results can be
found under the caption “—Results of Operations—Equity in Earnings of Novogyne.”
In all countries other than the United States, Canada and Japan, we have licensed the
marketing rights to our HT products to Novartis Pharma, which is an affiliate of Novartis. In most
of these markets, Vivelle® is marketed under the brand name Menorest,
Vivelle-Dot® is marketed under the brand name Estradot® and
CombiPatch® is marketed under the brand name Estalis®.
We hold a 49% equity interest in Novogyne, and Novartis holds the remaining 51% equity
interest. Novartis is entitled to an annual $6.1 million preferred return over our interest in
Novogyne, which has the effect of reducing our share of Novogyne’s income in the first quarter of
each year. After the annual preferred return to Novartis, our share of Novogyne’s income
increases as product sales increase, subject to a maximum of 49%. Our share of Novogyne’s income
was $28.6 million, $24.7 million and $17.6 million in 2006, 2005 and 2004, respectively. The
income we recognize from Novogyne is a non-cash item. Any cash we receive from Novogyne with
respect to our equity in its earnings is in the form of cash distributions declared by Novogyne’s
Management Committee. Accordingly, the amount of cash distributions that we receive from Novogyne
in any period may not be the same as the amount of income we recognize from Novogyne for that
period. In 2006, 2005 and 2004, we received $26.4 million, $26.2 million and $18.1 million,
respectively, in cash distributions from Novogyne, which accounted for a substantial portion of our
net cash flows provided by operating activities for these periods.
The market for HT products, including transdermals, significantly declined in the years
following the July 2002 publication of the WHI study that found adverse health risks associated
with HT, and in current periods the market continues to decline. Comparing the fourth quarter of
2005 to the fourth quarter of 2006, total prescriptions dispensed in the HT market in the United
States decreased 3%. Comparing the same periods, aggregate prescriptions for our United States HT
products increased 3%. Total prescriptions in the estrogen segment of the HT market in the United
States decreased 4% comparing the same periods, while prescriptions for our Vivelle®
line of products increased 4%. Vivelle-Dot®, which represented 87% of our total United
States HT prescriptions in the fourth quarter of 2006, increased 5% from the fourth quarter of
2005. We believe that Vivelle-Dot® patch prescriptions have benefited from patient
conversions from the original Vivelle® product (the predecessor product to
Vivelle-Dot®), which represented 3% of our total United States prescriptions in the
fourth quarter of 2006. Vivelle® is in the process of being discontinued in several
jurisdictions where our advanced Vivelle-Dot® ET patch has gained acceptance. We ceased
manufacturing of Vivelle® for the United States market at the end of 2006.
United States prescriptions for our CombiPatch® product (which represented
approximately 10% of our total United States HT prescriptions in the fourth quarter of 2006)
decreased 11% from the fourth quarter of 2005 to the fourth quarter of 2006, while prescriptions
for the total United States market for fixed combination hormone therapy decreased 5%. The
combination therapy arm of the WHI studies involved an oral combination estrogen/progestin product
and, accordingly, the combination therapy segment of the HT market has experienced the most
significant decline. Further decreases above expectations for our CombiPatch® product
(whether as a result of the WHI studies, competition in the category or otherwise) could require
Novogyne (which holds the CombiPatch® marketing rights) to record an impairment loss
related to these marketing rights, which would adversely affect the results of operations of both
Noven and Novogyne. See “—Critical Accounting Estimates – Investment in Novogyne.”
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Certain Items that May Affect Historical or Future Comparability
Daytrana™
The DEA controls access to controlled substances, including methylphenidate, the active
ingredient in Daytrana™. Manufacturers of products containing controlled substances must
annually apply to the DEA for procurement quota in order to obtain these substances for
manufacturing. In 2006, we received an initial grant of methylphenidate quota from the DEA. We
submitted supplemental applications for additional quota to fulfill 2006 product orders received
from Shire. The DEA granted additional 2006 quota in November 2006, but less than we had
requested, and later than required to fulfill 2006 product orders. As a result, we ended the year
with $8.6 million in full-year Daytrana™ sales to Shire and approximately $1.0 million
in Daytrana™ product backorders that we fulfilled in the first quarter of 2007.
The reduction in Daytrana™ revenues negatively affected our gross margin in the
fourth quarter of 2006. Our ability to produce Daytrana™ and improve the gross margins
from the sale of this product is contingent on, among other things, receiving a sufficient supply
of the active methylphenidate ingredient from Shire as well as sufficient quota from the DEA for
this controlled substance. At any given time, we expect to have applications pending with the DEA
for annual or additional procurement quota that may be critical to continued production. Any delay
or stoppage in the supply of the active methylphenidate ingredient could cause us to lose revenues
or incur additional costs (including those related to expedited production), which could have an
adverse effect on our results of operations.
We have received reports concerning difficulty removing the release liner from a small
percentage of Daytrana™ patches. Although the product meets specifications, during the
first quarter of 2007, we implemented enhancements intended to make Daytrana™ easier to
use. If Daytrana™ sales are materially impacted because of this issue, then Noven’s
results of operations and financial condition would likely be adversely affected.
Stock-based Compensation Expense
Currently, our outstanding stock-based compensation consists of: (i) stock options; (ii)
stock-settled appreciation rights (“SSARs”); and (iii) for our non-employee directors, restricted
stock awards. Prior to January 1, 2006, all awards granted to employees under the 1999 Long-Term
Incentive Plan (the “1999 Plan”) were stock options. In 2006, we began granting SSARs to employees
and restricted stock to non-employee directors in lieu of stock options, and from time to time we
may consider or grant other forms of stock-based compensation.
Prior to 2006, stock-based compensation expense was not required to be recognized in our
statements of operations. On January 1, 2006, we adopted the provisions of, and accounted for
stock-based compensation in accordance with, SFAS 123(R), which requires us to expense the fair
value of stock-based compensation awards in our statement of operations. We elected the
modified-prospective method, under which prior periods are not revised for comparative purposes.
Total pre-tax stock-based compensation expense recognized in our statements of operations for 2006
was $3.3 million, of which $2.5 million was recognized in marketing, general and administrative and
$0.4 million was recognized in each of research and development and cost of products sold,
respectively. There were no stock-based compensation costs capitalized as part of inventory or
fixed assets for 2006.
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At December 31, 2006, the unamortized compensation expense that we expect to record in future
periods related to currently outstanding unvested stock options, SSARs and restricted stock, as
determined in accordance with SFAS 123(R), is approximately $8.3 million before the effect of
income taxes, of which $3.5 million, $2.4 million,
$1.6 million and $0.8 million is expected to be incurred
in 2007, 2008, 2009 and 2010, respectively. We will also incur additional expense in future years
related to new equity awards that may be granted in the future that cannot yet be quantified.
In order to eliminate some of the future compensation expense that we would otherwise have
recognized in our statements of operations under SFAS 123(R), during 2005, we accelerated the
vesting of certain stock options under the 1999 Plan. As a result of this action, options to
purchase approximately 1.1 million shares of our common stock became immediately exercisable,
including options held by our executive officers to purchase approximately 455,000 shares. As a
result of the acceleration, during 2005, we eliminated approximately $10.1 million of compensation
expense, net of applicable income taxes, from our future statements of operations, however, this
expense is included in the pro forma footnote disclosure for the year ended December 31, 2005.
Results of Operations
Revenues:
Total revenues are summarized as follows (dollar amounts in thousands):
| 2006 | % Change | 2005 | % Change | 2004 | ||||||||||||||||
Product revenues — Novogyne: |
||||||||||||||||||||
Product sales |
$ | 19,714 | (1 | %) | $ | 19,910 | 6 | % | $ | 18,798 | ||||||||||
Royalties |
6,845 | 6 | % | 6,444 | 24 | % | 5,204 | |||||||||||||
| 26,559 | 1 | % | 26,354 | 10 | % | 24,002 | ||||||||||||||
Product revenues — third parties: |
||||||||||||||||||||
Product sales |
21,422 | 55 | % | 13,779 | 12 | % | 12,327 | |||||||||||||
Royalties |
345 | 8 | % | 318 | (41 | %) | 542 | |||||||||||||
| 21,767 | 54 | % | 14,097 | 10 | % | 12,869 | ||||||||||||||
Total product revenues |
48,326 | 19 | % | 40,451 | 10 | % | 36,871 | |||||||||||||
Contract and license revenues: |
||||||||||||||||||||
Contract |
1,966 | (22 | %) | 2,528 | (50 | %) | 5,021 | |||||||||||||
License |
10,397 | 9 | % | 9,553 | 139 | % | 3,999 | |||||||||||||
| 12,363 | 2 | % | 12,081 | 34 | % | 9,020 | ||||||||||||||
Net revenues |
$ | 60,689 | 16 | % | $ | 52,532 | 14 | % | $ | 45,891 | ||||||||||
Net Revenues
As described in more detail below, the 16% increase in 2006 net revenues as compared to 2005
was primarily attributable to the launch of Daytrana™, which contributed $8.6 million to
our product revenues and $5.9 million to our license revenues in 2006.
The 14% increase in 2005 net revenues as compared to 2004 was attributable to an increase in
license revenues related to the recognition of $6.0 million of license revenue from our fentanyl
agreement with Endo which is described in more detail below. In addition, there was an aggregate
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increase in sales for our U.S. and international products and an increase in royalties as a
result of Novogyne’s higher sales of Vivelle-Dot®. These increases were partially
offset by a decline in contract revenues.
Product Revenues – Novogyne
Product revenues – Novogyne consists of our sales of Vivelle-Dot®,
Vivelle®, Estradot® for Canada and CombiPatch® to
Novogyne at a
fixed price for product sampling and resale by Novogyne primarily in the United States, as well as
the royalties we receive as a result of Novogyne’s sales of Vivelle-Dot® and
Vivelle®. For additional information on the components of product revenues – Novogyne as
well as our other sources of revenues, see “–Critical Accounting Estimates – Revenue Recognition.”
Revenues from Novogyne in 2006 were relatively consistent with 2005. The $2.4 million
increase in revenues from Novogyne for 2005 as compared to 2004 was primarily related to a $1.6
million increase in unit sales of Vivelle-Dot® and a $1.2 million increase in royalties.
This increase was offset by a $0.6 million decline in unit sales of Estradot® for
Canada. The increase in Vivelle-Dot® product sales and royalties was attributable to
higher sales at Novogyne due to increased prescription trends and price increases at Novogyne. The
decline in unit sales of
Estradot®
was primarily attributable to fulfilling orders in 2004
related to a planned transition from Vivelle® to Estradot® in Canada. Price
was not a contributing factor to the overall increase.
Product Revenues – Third Parties
Product revenues – third parties consists of sales of Estradot®,
Estalis® and Menorest to Novartis Pharma at a price based on a percentage of Novartis
Pharma’s net selling price (subject to certain minima) for resale primarily outside the United
States and Japan, together with royalties generated from Novartis Pharma’s sales of
Vivelle® and Estradot® in Canada. Product revenues – third parties also
includes sales of Femiest to Aventis for resale in Japan. Beginning in the second quarter of 2006,
product revenues – third parties also includes sales of Daytrana™ to Shire for resale in
the United States.
The $7.7 million increase in product revenues from third parties for 2006 as compared to 2005
was primarily related to $8.6 million in unit sales of Daytrana™, reflecting initial
product launch. This increase was partially offset by a $0.9 million decline in the recognition of
the price reconciliation payments received from Novartis Pharma. Noven records such payments from
time to time upon Novartis Pharma’s determination that its actual sales price of our product
entitles us to receive amounts in excess of the minimum transfer price at which we initially sold
the product to Novartis Pharma. Volume increases of $0.9 million and $0.2 million for
Estradot® and Femiest, respectively, were offset by volume declines of $0.7 million and
$0.4 million for Estalis® and Menorest, respectively. We believe the volume increases
and declines were all related to the timing of orders, except for the decline in Menorest, which
was attributable to the continued transition from Menorest to Estradot®.
The $1.2 million increase in product revenues from third parties for 2005 as compared to 2004
primarily related to $0.5 million increase in unit sales and a $0.7 million increase related to
pricing. The increase in unit sales was mostly attributable to $0.6 million in higher sales of
Estalis®. We believe this increase was attributable to the timing of orders due to the
re-stocking of inventory in launched countries and not to an increase in underlying demand. The
$0.7 million increase in
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revenue related to pricing was primarily due to the recognition of a higher price adjustment
payment received from Novartis Pharma in 2005 compared to 2004.
Contract and License Revenues
Contract
revenues consists of the recognition of payments received as work is performed on
research and development projects. The payments received may take the form of non-refundable
up-front payments, payments received upon the completion of certain phases of development work and
success milestone payments. License revenues consist of the recognition of non-refundable
up-front, milestone and similar payments under license agreements.
Contract revenues declined $0.6 million for 2006 as compared to 2005 due to a decline in
contract work performed. License revenue increased $0.8 million for 2006 as compared to 2005
primarily due to the recognition of $5.9 million in Daytrana™ license revenues and the
recognition of a $1.0 million one-time non-refundable payment from a third party for a license to
certain of our patents, partially offset by $6.0 million in license revenue recognized in 2005
related to our fentanyl agreement with Endo that did not recur in 2006. Included in the $6.0
million of license revenue in 2005 was $5.7 million that was recognized in the fourth quarter of
2005 due to the termination of our fentanyl agreement with Endo upon the FDA’s decision to cease
review of our fentanyl patch application.
The $2.5 million decline in contract revenues for 2005 as compared to 2004 was primarily
related to our recognition in 2004 of $4.4 million in product development milestones under our
collaboration with P&G Pharmaceuticals that did not recur in 2005. This decline was partially
offset by $1.9 million in contract revenues related to work performed in 2005 on development
contracts. The $5.6 million increase in license revenue is primarily attributable to the
recognition of the remaining deferred revenue balance related to our fentanyl agreement with Endo
as discussed above.
Gross Margin:
This section discusses our gross margin percentages relating to our product revenues (i)
across all of our products (“Overall Gross Margin”), (ii) on our product revenues from Novogyne
(“Gross Margin — Novogyne”), which for accounting purposes is considered a related party, and (iii)
on our product revenues from third parties (“Gross Margin – Third Parties”). Product revenues from
third parties primarily include HT product sales to Novartis Pharma for resale primarily outside the U.S. and
Japan, as well as Daytrana™ product sales to Shire.
This section includes a non-GAAP analysis of gross margins that excludes an aggregate $9.9
million charge to cost of products sold in 2005 relating to the write-off and destruction of
fentanyl pre-launch inventories (the “Fentanyl Charge”). We
took this charge following the FDA’s
decision in September 2005 to cease review of our fentanyl patch ANDA. We believe such a non-GAAP
analysis is useful to investors in order to meaningfully evaluate our ongoing, underlying business
and compare our 2005 financial results to other years. For the same reasons, management uses this
non-GAAP analysis to evaluate Noven’s ongoing, underlying business. This analysis should not be
considered an alternative to measures computed in accordance with GAAP, nor should it be considered
an indicator of our overall financial performance.
The allocation of overhead costs impacts our determination of gross margins for each of our
products. Overhead costs, which were in excess of $20.0 million in 2006, consist of salaries and
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benefits, supplies and tools, equipment costs, depreciation, and insurance costs and represent
a substantial portion of our inventory production costs. The allocation of overhead among our
various products requires us to make significant estimates that involve subjective and often
complex judgments. Using different estimates would likely result in materially different results
for Gross Margin – Novogyne and Gross Margin – Third Parties than are presented in the gross margin
table below.
Our gross margins are summarized as follows (dollar amounts in thousands):
| 2006 | 2005 | 2004 | ||||||||||
Overall Gross Margin: |
||||||||||||
Product revenues |
$ | 48,326 | $ | 40,451 | $ | 36,871 | ||||||
Cost of products sold |
36,508 | 34,047 | 20,514 | |||||||||
Gross profit (product revenues
less cost of products sold) |
11,818 | 6,404 | 16,357 | |||||||||
Gross margin (gross profit as a
percentage of product revenues) |
24 | % | 16 | % | 44 | % | ||||||
Fentanyl Charge |
— | 9,917 | — | |||||||||
Gross profit excluding Fentanyl Charge |
11,818 | 16,321 | 16,357 | |||||||||
Gross margin excluding Fentanyl Charge |
24 | % | 40 | % | 44 | % | ||||||
| 2006 | 2005 | 2004 | ||||||||||
Gross Margin Novogyne: |
||||||||||||
Product revenues |
$ | 26,559 | $ | 26,354 | $ | 24,002 | ||||||
Cost of products sold |
14,102 | 13,547 | 11,413 | |||||||||
Gross profit (product revenues
less cost of products sold) |
12,457 | 12,807 | 12,589 | |||||||||
Gross margin (gross profit as a
percentage of product revenues) |
47 | % | 49 | % | 52 | % | ||||||
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| 2006 | 2005 | 2004 | ||||||||||
Gross Margin Third Parties: |
||||||||||||
Product revenues |
$ | 21,767 | $ | 14,097 | $ | 12,869 | ||||||
Cost of products sold |
22,406 | 20,500 | 9,101 | |||||||||
Gross profit (loss) (product revenues
less cost of products sold) |
(639 | ) | (6,403) | 3,768 | ||||||||
Gross margin (gross profit (loss) as a
percentage of product revenues) |
(3 | %) | (45 | %) | 29 | % | ||||||
Fentanyl Charge |
— | 9,917 | — | |||||||||
Gross (loss) profit excluding Fentanyl Charge |
(639 | ) | 3,514 | 3,768 | ||||||||
Gross (loss) margin excluding Fentanyl Charge |
(3 | %) | 25 | % | 29 | % | ||||||
In general, our sales of HT products to Novogyne for resale in the U.S. have a higher
gross margin than our other products, reflecting favorable pricing, larger production orders and
other factors. Our sales of HT products to Novartis Pharma for resale in international markets
generally have a lower gross margin than sales of HT products sold to Novogyne due to, among other
things, unfavorable pricing environments in foreign markets, and smaller production orders. Our
gross margin on product sales of Daytrana™ to Shire has been negatively affected by,
among other things, costs and inefficiencies associated with the commencement of commercial
production of the product. As discussed below, we are working to improve the profitability of
Daytrana™ product sales, but we cannot assure that we will be successful.
During the years presented in the gross margin tables, we have expanded our facilities and
increased staffing for the production of fentanyl, Daytrana™, and other developmental
products (the “Expansion Activities”). We also have increased personnel and other resources
dedicated to quality control in our HT product line (“HT Quality Improvements”). Together, these
initiatives expanded and improved our production infrastructure, but they also increased overhead
and negatively affected our gross margins. Our ability to improve gross margins from current
levels is dependent in part on our ability to launch new commercial products that leverage this
infrastructure and assist in the absorption of overhead, as well as on our ability to control
and/or reduce costs. We cannot assure that we will be successful in improving our gross margins in
future periods.
We implemented a cost reduction program in the third quarter of 2006 to reduce costs and
improve efficiencies in our operations (the “Cost Reduction Program”). We believe this program
will result in annual pre-tax savings of up to $1.8 million, the majority of which will be
recognized in manufacturing costs. This program contributed to an improved Overall Gross Margin in
the second half of 2006.
We sell Daytrana™ finished product to Shire at a fixed cost, so our profit on
product sales of Daytrana™ depends on our ability to manufacture the product efficiently. Start-up
expenses and
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production inefficiencies associated with the commencement of Daytrana™ production,
including lower than desired yields and increased costs associated with meeting launch timelines
(together, the “Daytrana™ Launch Costs”), negatively affected Overall Gross Margin and
Gross Margin – Third Parties in 2006. In addition, the cost of the active methylphenidate
ingredient (“AMI”) used in the production of Daytrana™ is not included in our
Daytrana™ product revenues or in our cost of products sold. Shire supplies us with AMI
for production of Daytrana™, and retains title to the AMI. Under this arrangement, we
bear certain risks of manufacturing loss related to AMI and are obligated to reimburse Shire for
the cost of AMI if our production yields do not meet certain minimum levels. For 2006, our cost of
products sold included $0.4 million in AMI reimbursements to Shire which negatively affected
Overall Gross Margin and Gross Margin – Third Parties in 2006. For 2006, Daytrana™ product revenues were $8.6 million, and cost of products sold related to Daytrana™ was $10.5
million, primarily reflecting the impact of the Daytrana™ Launch Costs and the AMI
reimbursements.
Our Overall Gross Margin was 29%, 11%, 30% and 30% in the first, second, third and fourth
quarters of 2006, respectively. The decline in the 2006 second quarter primarily reflects the
Daytrana Launch Costs and AMI reimbursements. The improvement in the third and fourth quarters
primarily reflects improved efficiencies and yields in Daytrana™ production, as well as
cost savings associated with the third quarter Cost Reduction Program. We cannot assure that we
will be able to continue to improve Overall Gross Margin. Our expectations for gross margins in
future periods are addressed under “Outlook” below.
The decline in Overall Gross Margin in 2005 compared to 2004 (excluding the impact of the
Fentanyl Charge) was primarily related to costs associated with the Expansion Activities. The
decline in Gross Margin – Novogyne in 2005 compared to 2004 reflected costs associated with the HT
Quality Improvements. In addition, Gross Margin — Novogyne in 2004 benefited from a $0.6 million
reduction in allowances for returns that had been established in 2003, based upon our review and
analysis of historical and expected future returns. The decline in Gross Margin — Third Parties in
2005 compared to 2004 (excluding the impact of the Fentanyl Charge) was primarily related to higher
costs associated with the Expansion Activities, partially offset by a $0.7 million increase in
price adjustment payments in 2005.
Operating Expenses:
Operating expenses are summarized as follows (dollar amounts in thousands):
| 2006 | % Change | 2005 | % Change | 2004 | ||||||||||||||||
Research and development |
$ | 11,454 | (13 | %) | $ | 13,215 | 39 | % | $ | 9,498 | ||||||||||
Marketing, general and administrative |
21,701 | 28 | % | 16,915 | (2 | %) | 17,271 | |||||||||||||
Research and Development
Research and development expense includes costs associated with, among other things, product
formulation, pre-clinical testing, clinical studies, regulatory and medical affairs, production of
product for clinical and regulatory purposes, production-related development engineering for
developmental products, and the personnel associated with each of these functions.
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The
$1.8 million decrease in 2006 as compared to 2005 was primarily attributable to a $3.2
million decline in development engineering expenses related to our methylphenidate and fentanyl
patches, partially offset by a $0.4 million increase in stock-based compensation, a $0.4 million
increase in personnel costs and a $0.3 million increase in other costs associated with the
development of other products.
The $3.7 million increase in 2005 as compared to 2004 was primarily attributable to a $2.8
million increase in development engineering related to our methylphenidate and fentanyl patches, a
$0.4 million increase in clinical studies and a $0.3 million increase in personnel costs.
Marketing, General and Administrative
The $4.8 million increase in marketing, general and administrative expenses in 2006 as
compared to 2005 was primarily attributable to $2.5 million in stock-based compensation expenses
resulting from the adoption of SFAS 123(R) in 2006, a $1.1 million increase in compensation expense
primarily due to the addition of personnel in business development, strategic alliances and other
key areas and a $0.6 million charge associated with the elimination of employee positions as part
of the cost reduction program discussed in our gross margin section above. Consulting costs
increased $0.6 million due to the timing of work performed on projects related to our compliance
with the Sarbanes-Oxley Act of 2002 and to a lesser extent increased information management
compliance costs.
The $0.4 million decline in 2005 as compared to 2004 was primarily attributable to a $0.7
million reduction in professional fees related to compliance with the Sarbanes-Oxley Act of 2002
and other regulatory requirements and $0.5 million related to the reduction of our allowance for
costs related to product recalls established in 2004. These reductions were partially offset by a
$0.9 million increase in costs associated with expansion activities for anticipated new product
launches.
Other Income and Expenses:
Interest Income
Interest income increased $2.0 million, or 91%, in 2006 as compared to 2005 due to an increase
in the average cash balance, which was primarily attributable to the $50.0 million milestone
payment received from Shire in April 2006 in connection with the approval of our Daytrana™ product as well as $13.2 million received from the exercise of stock options. In
addition to
higher average cash balances, we invested a higher portion of our cash in short-term investments
which primarily consist of investment grade, asset backed, variable debt obligations and municipal
auction rate securities that yielded higher interest income. We also benefited from an increase in
interest rates in 2006 as compared to 2005.
Interest income increased $1.2 million, or 124%, in 2005 as compared to 2004 and was primarily
attributable to the investing of a portion of our cash into short-term investments, as described
above, that yielded higher interest income as well as an increase in interest rates.
Income Taxes
Our effective tax rate was 33% for 2006, and 35% for 2005 and 2004, respectively. The
decrease in our effective tax rate for 2006 as compared to the prior year relates primarily to
higher
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non-taxable interest income as a percentage of taxable income. This decreased tax rate was
partially offset by higher taxable income in 2006 as compared to 2005 primarily due to the Fentanyl
Charge in the prior year, non-deductible stock-based compensation expense related to incentive
stock options that began in 2006 and certain credits and reductions for reserves for Internal
Revenue Service audits that occurred in the prior period that did not recur in the current period.
The provision for income taxes is based on the Federal statutory and state income tax rates.
Net deferred income tax assets are measured using the average graduated tax rate for the
estimated amount of annual taxable income in the years that the asset is expected to be recovered.
The effect of adjusting the expected tax rate related to the net deferred income tax assets is
included in the provision for income taxes. As of December 31, 2006, we had a net deferred tax
asset of $12.7 million. Realization of this deferred tax asset depends upon the generation of
sufficient future taxable income. Although realization is not assured, we believe it is more
likely than not that the deferred income tax asset will be realized based upon estimated future
taxable income.
Equity in Earnings of Novogyne
We share in the earnings of Novogyne, after satisfaction of an annual preferred return of $6.1
million to Novartis, according to an established formula. Novogyne produced sufficient income in
each of 2006, 2005 and 2004 for us to recognize earnings from Novogyne under the formula. We
report our share of Novogyne’s earnings as “Equity in earnings of Novogyne” on our Statements of
Operations.
The financial results of Novogyne are summarized as follows (dollar amounts in thousands):
| 2006 | % Change | 2005 | % Change | 2004 | ||||||||||||||||
Gross revenues 1 |
$ | 154,901 | 13 | % | $ | 136,901 | 10 | % | $ | 124,791 | ||||||||||
Sales allowances |
17,226 | 20 | % | 14,408 | 10 | % | 13,154 | |||||||||||||
Sales returns allowances |
5,732 | N/M | 936 | N/M | 6,224 | |||||||||||||||
Sales and returns allowances |
22,958 | 50 | % | 15,344 | (21 | %) | 19,378 | |||||||||||||
Net revenues |
131,943 | 9 | % | 121,557 | 15 | % | 105,413 | |||||||||||||
Cost of sales |
30,149 | 5 | % | 28,696 | 3 | % | 27,755 | |||||||||||||
Gross profit |
101,794 | 10 | % | 92,861 | 20 | % | 77,658 | |||||||||||||
Gross margin percentage |
77 | % | 76 | % | 74 | % | ||||||||||||||
Selling, general and
administrative expenses |
37,318 | 5 | % | 35,568 | (0 | %) | 35,624 | |||||||||||||
Income from operations |
64,476 | 13 | % | 57,293 | 36 | % | 42,034 | |||||||||||||
Interest income |
841 | 82 | % | 461 | 141 | % | 191 | |||||||||||||
Net income |
$ | 65,317 | 13 | % | $ | 57,754 | 37 | % | $ | 42,225 | ||||||||||
Noven’s equity in earnings
of Novogyne |
$ | 28,632 | 16 | % | $ | 24,655 | 40 | % | $ | 17,641 | ||||||||||
| N/M – Not Meaningful | ||
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| 1 | Novogyne’s gross revenues, which are calculated by adding sales allowances and sales returns allowances to net revenues, are discussed in this section because Noven’s management believes it is a useful measure to evaluate and compare Novogyne’s total sales from period to period in light of the significant historic fluctuations in Novogyne’s sales allowances and returns. |
Novogyne Revenues
Novogyne sells its products to trade customers, including wholesalers, distributors and chain
pharmacies. As has historically been the case, the timing of purchases by trade customers is
driven by the inventory needs of each customer and other factors, and does not necessarily track
underlying prescription trends in any given period or coincide with Novogyne’s quarterly financial
reporting periods. As a result, the timing of orders by trade customers is difficult to predict
and can lead to significant variability in Novogyne’s results, especially when comparing quarterly
periods.
Novogyne’s gross revenues increased $18.0 million for 2006 as compared to 2005. By product,
the increase in Novogyne’s gross revenues reflects a $19.2 million increase in sales of
Vivelle-Dot®/Estradot®, partially offset by a $0.9 million and a $0.3 million
decline in sales of Vivelle® and CombiPatch®, respectively. The higher
Vivelle-Dot®/Estradot® sales were primarily attributable to a $11.2 million
increase in unit sales due to an increase in prescriptions as well as the timing of orders, and an
$8.0 million increase related to pricing. The decline in Vivelle®, our first generation
estrogen patch, is due to a $1.2 million decline in unit sales due to product maturity and the
planned discontinuation of the product, partially offset by a $0.3 million increase related to
pricing. The decline in CombiPatch® was due to a $1.2 million decline in unit sales as
a result of the continuing decline in the market for combination therapies as well as the impact
of a competitive product. This
CombiPatch® decline was partially offset by a $0.9
million increase related to pricing.
Novogyne’s gross revenues increased $12.1 million for 2005 as compared to 2004, primarily due
to a $15.6 million increase in sales of Vivelle-Dot®, partially offset by a $1.5 million
decline in sales of Vivelle®, a $1.3 million decline in unit sales of
Estradot® to an affiliate of Novartis Pharma in Canada (“Novartis Canada”), and a $0.7
million decline in sales of CombiPatch®. Approximately $8.4 million of the
Vivelle-Dot® increase was due to increased unit sales based on increased trade demand,
while the remaining $7.2 million increase related to pricing. The decline in Vivelle®,
our first generation estrogen patch, was mostly attributable to a decline in unit sales due to
product maturity. The decline in sales of Estradot® to Novartis Canada is primarily
attributable to the timing of orders, as 2004 sales benefited from Novartis Canada stocking
inventory as they transitioned from Vivelle® to Estradot®. The lower sales
of CombiPatch® were due to a continuing decline in the market for combination therapies
as well as the impact of a competitive product.
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The following table describes Novogyne’s sales and returns allowances for the years ended
December 31, 2006, 2005 and 2004 (dollar amounts in thousands):
| % of | % of | % of | ||||||||||||||||||||||
| gross | gross | gross | ||||||||||||||||||||||
| 2006 | revenues | 2005 | revenues | 2004 | revenues | |||||||||||||||||||
Gross revenues |
$ | 154,901 | $ | 136,901 | $ | 124,791 | ||||||||||||||||||
Managed health care rebates |
10,117 | 7 | % | 8,018 | 6 | % | 7,898 | 6 | % | |||||||||||||||
Cash discounts |
3,042 | 2 | % | 2,690 | 2 | % | 2,425 | 2 | % | |||||||||||||||
Medicaid, Medicare & State
program rebates and credits
including prescription
drug saving cards |
981 | 1 | % | 938 | 1 | % | 1,341 | 1 | % | |||||||||||||||
Chargebacks, including
hospital chargebacks |
1,032 | 1 | % | 970 | 1 | % | 861 | 1 | % | |||||||||||||||
Other discounts |
2,054 | 1 | % | 1,792 | 1 | % | 629 | 1 | % | |||||||||||||||
Sales allowances |
17,226 | 11 | % | 14,408 | 11 | % | 13,154 | 11 | % | |||||||||||||||
Sales returns allowances |
5,732 | 4 | % | 936 | 1 | % | 6,224 | 5 | % | |||||||||||||||
Sales and returns allowances |
22,958 | 15 | % | 15,344 | 11 | % | 19,378 | 16 | % | |||||||||||||||
Net revenues |
$ | 131,943 | $ | 121,557 | $ | 105,413 | ||||||||||||||||||
Sales returns allowances consist of: (i) changes in allowances for returns of expiring
product, and (ii) changes in allowances for returns for product recalls. The activity for sales
returns allowances for the years ended December 31, 2006, 2005 and 2004 was as follows (amounts in
thousands):
| 2006 | 2005 | 2004 | ||||||||||
Current year provisions for returns of expiring product |
$ | 4,342 | $ | 3,384 | $ | 8,342 | ||||||
Adjustment to prior year provisions for returns of
expiring product |
1,390 | (2,385 | ) | 1,227 | ||||||||
Benefits for returns for product recalls |
— | (63 | ) | (3,345 | ) | |||||||
Sales returns allowances |
$ | 5,732 | $ | 936 | $ | 6,224 | ||||||
Actual returns for expiring product |
(3,962 | ) | (3,897 | ) | (8,675 | ) | ||||||
Actual returns for product recalls |
— | (40 | ) | (2,620 | ) | |||||||
Total actual returns |
$ | (3,962 | ) | $ | (3,937 | ) | $ | (11,295 | ) | |||
The increase in sales returns allowances as a percentage of gross revenues for 2006 as
compared to 2005 was primarily due to higher than expected returns of Vivelle-Dot®
as well as higher than expected returns of CombiPatch®, which resulted in an
increase of prior year provisions for returns of $1.4 million. In addition, 2005 benefited from a
reduction in allowances of expiring product due to lower than expected returns as a result of a
decline in actual returns of Vivelle® at the time.
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The
decrease in sales returns allowances as a percentage of gross revenues for 2005 as compared to 2004 was primarily related to
lower than expected returns as a result of a decline in actual returns of Vivelle® and
Vivelle-Dot® in 2005. As a result
of this analysis, allowances related to prior years were reduced by $2.4 million.
Novogyne Gross Margin
Novogyne’s gross margin was consistent for 2006 as compared to 2005. The 2% gross margin
increase in 2005 as compared to 2004 was primarily related to lower sales returns allowances
attributable to lower than expected returns as described above as well as higher sales of
Vivelle-Dot®, which has a higher gross margin than other products sold by Novogyne, and
lower sales of Estradot®, which has a lower gross margin than other products sold by
Novogyne.
Novogyne Selling, General and Administrative
Novogyne’s selling, general and administrative expenses increased $1.7 million for 2006 as
compared to 2005, primarily due to a $1.2 million increase in marketing, advertising and promotion
expenses and a $0.7 million increase in sample expenses primarily attributable to the timing of
sample orders by Novogyne.
Novogyne’s selling, general and administrative expenses declined $0.1 million for 2005 as
compared to 2004, primarily due to a $0.9 million decline in sample expenses primarily attributable
to the timing of sample orders by Novogyne, and a $0.8 million decline in advertising and promotion
expenses. These declines were partially offset by a $0.6 million increase in sales force expenses.
In addition, 2004 benefited from a $0.9 million reduction in expenses associated with the
co-promotion of one of Novartis’ products.
Liquidity and Capital Resources:
As of December 31, 2006 and December 31, 2005, Noven had the following (amounts in thousands):
| December 31, 2006 | December 31, 2005 | |||||||
Cash and cash equivalents |
$ | 9,144 | $ | 66,964 | ||||
Short-term investments |
144,455 | 17,900 | ||||||
Working capital |
180,821 | 91,122 | ||||||
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Cash provided by (used in) operating, investing and financing activities is summarized as
follows (amounts in thousands):
| 2006 | 2005 | 2004 | ||||||||||
Cash flows: |
||||||||||||
Operating activities |
$ | 60,027 | $ | 3,885 | $ | 11,869 | ||||||
Investing activities |
(133,511 | ) | (32,055 | ) | (7,115 | ) | ||||||
Financing activities |
15,664 | 1,176 | 5,823 | |||||||||
Operating Activities:
Net cash provided by operating activities in 2006 primarily resulted from our receipt of $50.0
million from Shire related to the final marketing approval of Daytrana™ by the FDA and
$26.4 million in cash distributions from Novogyne. These receipts were offset by changes in
working capital due to the timing of certain payments, including reimbursement payments of $5.1
million to Shire for clinical trial costs incurred in connection with obtaining
Daytrana™ regulatory approval, $3.9 million for compensation and related liabilities and
$2.6 million related to insurance.
Net cash provided by operating activities in 2005 primarily resulted from the receipt of $26.2
million in distributions from Novogyne, partially offset by the timing of certain payments,
including reimbursement payments of $10.3 million to Shire for clinical trial costs incurred in
connection with obtaining Daytrana™ regulatory approval, $3.2 million for purchases of
fentanyl, $3.7 million for incentive compensation and related liabilities, and $2.5 million related
to insurance.
Net cash provided by operating activities in 2004 primarily resulted from the receipt of an
$8.0 million license payment upon the closing of the Endo transaction in February 2004 and $18.1
million in distributions from Novogyne. The increase was partially offset by changes in working
capital due to the timing of payments and receipts, specifically for payment of $5.4 million in
income taxes, $2.7 million for purchases of fentanyl, $2.9 million in clinical trial costs incurred
in connection with obtaining
Daytrana™
regulatory approval, $2.9 million for
compensation and related liabilities and $2.5 million related to insurance.
Investing Activities:
Net cash used in investing activities in 2006 was primarily attributable to $126.4 million in
net purchases of short-term investments, as well as the purchase of $6.3 million in fixed assets to
expand production capacity for future products. Beginning in the first quarter of 2005, Noven
invested a portion of its cash in short-term investments, which primarily consist of investment
grade, asset backed, variable rate debt obligations and municipal auction rate securities, which
are categorized as available-for-sale under the provisions of SFAS No. 115 “Accounting for Certain
Investments in Debt and Equity Securities”.
Net cash used in investing activities in 2005 was primarily attributable to $17.9
million in net purchases of short-term investments, as well as the purchase of $13.7 million in
fixed assets to expand production capacity for future products.
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Net cash used in investing activities in 2004 was primarily attributable to the purchase of
$6.5 million in fixed assets to expand production capacity for future products.
Financing Activities:
Net cash provided by financing activities in 2006, 2005 and 2004 was attributable to $13.2
million, $1.3 million and $5.9 million, respectively, received as the exercise price paid by the
option holders in connection with their exercise of stock options. In addition, 2006 benefited
from $2.6 million in excess tax deductions from the exercise of stock options, which prior to the
adoption of SFAS 123(R) was reported in operating activities.
Short-Term and Long-Term Liquidity:
Our principal sources of short-term liquidity are existing cash, cash generated from product
sales, fees and royalties under development and license agreements and distributions from Novogyne.
For the year ended December 31, 2006, a substantial portion of our income before income taxes was
comprised of equity in earnings of Novogyne, a non-cash item. Accordingly, our net income may not
be reflective of our operating cash flow or our short-term liquidity. Although we expect to
continue to receive distributions from Novogyne, there can be no assurance that Novogyne will have
sufficient profits or cash flow to pay distributions or that Novogyne’s Management Committee will
authorize such distributions.
Our short-term cash flow is dependent on sales, royalties, license fees and distributions
associated with transdermal products. Any decrease in sales of those products by us or our
licensees or any increase in returns of products to Novogyne (including any such changes resulting
from the HT studies), the further decline of the HT market, or the inability or failure of Novogyne
to pay distributions would have a material adverse effect on our short-term liquidity and require
us to rely on our existing cash balances and short-term investments or on borrowings to support our
operations and business.
In April 2006, Noven received a $50.0 million milestone payment from Shire as a result of the
final marketing approval of Daytrana™ by the FDA. Shire’s net sales of
Daytrana™ exceeded the threshold for the first sales milestone in the fourth quarter of
2006 and, accordingly, we received a $25.0 million payment from Shire in the first quarter of 2007.
Noven may also earn up to two additional $25.0 million milestone payments upon Shire’s achievement
of $50.0 million and $75.0 million in annual net sales of Daytrana™, respectively.
Shire commercially launched the product in June 2006. The majority of the income taxes related to
the $50.0 million milestone are expected to be paid in 2007 or early 2008 and the majority of
the income taxes related to the first $25.0 million milestone are expected to be paid in 2008
or early 2009.
Our liquidity in 2006 benefited from $13.2 million received as the exercise price paid by
option holders in connection with their exercise of employee stock options. This number can be
expected to fluctuate from year to year depending on the performance
of Noven’s stock and equity award
exercises.
Capital expenditures were $6.3 million in 2006 and we expect our capital expenditures for
full-year 2007 to be approximately in line with 2006 levels. We expect to fund anticipated capital
expenditures from our existing cash balances. As a general matter, we believe that we have
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sufficient liquidity available to meet our operating needs and anticipated short-term capital
requirements.
If our products under development are successful, we expect that our cash requirements will
increase to fund plant and equipment purchases to expand production capacity. For our long-term
operating needs, we intend to utilize funds derived from the above sources, as well as funds
generated through sales of products under development or products that we may license or acquire
from others. We expect that such funds will be comprised of payments received pursuant to future
development and licensing arrangements, as well as direct sales of our own products.
We cannot assure that we will successfully complete the development of such products, that we
will obtain regulatory approval for any such products, that any approved product may be produced in
commercial quantities, at reasonable costs, and be successfully marketed, or that we will
successfully negotiate future licensing or product acquisition arrangements. Because much of the
cost associated with product development and expansion of manufacturing facilities is incurred
prior to product launch, if we are unsuccessful in out-licensing, or if we are unable to launch
additional commercially-viable products that we develop or that we license or acquire from others,
we will have incurred the up-front costs associated with product development or acquisition without
the benefit of the liquidity generated by sales of those products, which could adversely affect our
long-term liquidity needs. Factors that could impact our ability to develop or acquire and launch
additional commercially-viable products are discussed under “Risk Factors.”
From time to time we may explore the acquisition of one or more technologies, products or
businesses that we believe may be complementary to our existing business. We expect to draw upon
our cash and short-term investments to fund all or a portion of such potential strategic
acquisitions. We may also consider issuing equity securities to fund potential acquisitions. To
the extent our existing cash and short-term investments are insufficient to fund any large-scale
acquisitions we may be required to seek debt financing or to issue equity or debt securities. If a
material acquisition is completed, our results of operations and financial condition could change
materially in future periods. If we finance all or any portion of an acquisition through debt
financing or debt securities we would be required to devote funds to service and ultimately repay
such debt and could be subject to financial or operational covenants that could limit or hinder our
ability to conduct our business.
In addition, although we have not repurchased any of our common stock since 2003, it is
possible that a portion of our cash and short-term investments could be used to repurchase Noven
common stock under our previously-announced stock repurchase program. Stock repurchases, if any,
may be made in the open market, including pursuant to a trading program under Rule 10b5-1
promulgated under the Securities Exchange Act of 1934.
To the extent that capital requirements exceed available capital, we will seek alternative
sources of financing to fund our operations. No assurance can be given that alternative financing
will be available, if at all, in a timely manner, or on favorable terms. If we are unable to
obtain satisfactory alternative financing, we may be required to delay or reduce our proposed
expenditures, including expenditures for research and development and plant and equipment, in order
to meet our future cash requirements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
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Aggregate Contractual Obligations
The table below lists our significant contractual obligations as of December 31, 2006
(amounts are in thousands):
| Less Than | 1 - 3 | 3 - 5 | More than | |||||||||||||||||
| Total | 1 year | years | years | 5 years | ||||||||||||||||
Operating Lease Obligations1 |
$ | 7,765 | $ | 1,050 | $ | 2,019 | $ | 1,845 | $ | 2,851 | ||||||||||
Capital Lease Obligation2 |
458 | 142 | 283 | 16 | 17 | |||||||||||||||
Deferred Compensation Obligation |
178 | — | 136 | — | 42 | |||||||||||||||
Purchase Obligations3 |
10,785 | 10,647 | 138 | — | — | |||||||||||||||
Total |
$ | 19,186 | $ | 11,839 | $ | 2,576 | $ | 1,861 | $ | 2,910 | ||||||||||
1 In the ordinary course of business, we enter into operating leases for
machinery, equipment, warehouse and office space. Total rental expense for operating leases was
$1.2 million, $1.1 million and $0.5 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
2 During 2006 and 2004, Noven entered into capital lease obligations totaling $0.4
million and $0.3 million for new equipment, respectively, of which $0.5 million (including
interest) remains outstanding as of December 31, 2006.
3 In the ordinary course of business, we enter into non-cancelable purchase
obligations to vendors to which we have submitted purchase orders, but have not yet received the
goods or services.
Outlook
A summary of our current financial guidance is provided below. This forward-looking
information is based on our current assumptions and expectations, many of which are beyond our
control to achieve. In particular, for purposes of this guidance we have assumed, among other
things, that during 2007 there will not be any material:
| • | acquisitions of products, companies, or technologies or other transactions; | ||
| • | changes in Noven’s or Novogyne’s accounting or accounting principles or any of the estimates or judgments underlying our critical accounting policies; | ||
| • | regulatory or technological developments; | ||
| • | changes in the supply of, demand for, or distribution of our products (including any changes resulting from competitive products, product recalls, or new study results); | ||
| • | negative actions with respect to our applications for methylphenidate quota or other disruptions in supplies of raw materials; | ||
| • | changes in our business relationships/collaborations; or | ||
| • | changes in the economy or the health care sector generally. |
Financial guidance is inherently uncertain. Accordingly, we cannot assure that we will achieve
results consistent with this guidance, and our actual financial results could differ materially
from the expected results discussed below. For a discussion of certain factors that may impact our
actual financial results for the periods referenced, readers should carefully consider the risks,
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uncertainties and cautionary factors discussed above under “Risk Factors” beginning on page 21 of
this report.
Daytrana™. As discussed above, during 2006 we received a $50.0 million milestone
payment from Shire relating to the final marketing approval of Daytrana™ by the FDA. In
the fourth quarter of 2006, the first of three potential $25.0 million Daytrana™ sales
milestones was triggered, resulting in the payment of $25.0 million from Shire to us in the first
quarter of 2007. We expect the second $25.0 million
milestone payment to trigger in 2007, and it is
possible that the third milestone will trigger in the same year, in each case depending on the
level of Shire’s commercial sales of the product. We expect to defer and recognize the approval
milestone and all sales milestones as license revenues on a straight-line basis, beginning on the
date the milestone is achieved through the first quarter of 2013, which is our current best
estimate of the end of the useful economic life of the product for accounting purposes. We expect
our
Daytrana™
product sales to Shire for full-year 2007 to be between $16.0 million and
$20.0 million, subject to, among other things, demand for the product and the availability and timing
of DEA quota.
HT Product Revenues. Given customer orders, prescription trends and other factors, we expect
Noven’s HT product revenues for full-year 2007 to approximate 2006 levels, with growth in our U.S.
HT product revenues expected to offset a decline in our international HT revenues.
Contract and License Revenues. We expect contract revenues in 2007 to approximate 2006
levels. We expect license revenues to increase substantially in 2007 compared to 2006, reflecting
higher Daytrana™ license revenues.
Gross Margin. Since the launch of Daytrana™ in the second quarter of 2006, we
have worked to reduce costs and improve yields, and we reported significant improvement in our
overall gross margin for the third and fourth quarters of 2006 compared to our overall gross margin
in the second quarter of 2006. For full-year 2007, we are targeting an overall gross margin in the
mid-30% range, subject to a variety of factors, some of which are not within our control. These
factors include the availability and timing of methylphenidate quota and our ability to effectively
coordinate production between Daytrana™ and our HT products to improve facility
utilization, and our ability to improve yields, and these same factors could cause our overall
gross margin in any particular quarter to vary significantly from other quarters in 2007.
Research and Development Expense. We expect our research and development expense in 2007 to
approach $16.0 million, depending on our ability to advance certain development projects into human
clinical studies during 2007.
Marketing, General and Administrative Expense. We expect our marketing, general and
administrative expense in 2007 to increase in the 5% range over 2006 levels.
Stock-Based Compensation Expenses. Based on the expense associated with stock-based
compensation previously awarded, and our estimate of the expense associated with such compensation
that may be awarded in the course of 2007, we estimate that our total stock-based compensation
expenses for full-year 2007 will be approximately $4.1 million, compared to $3.3 million for
full-year 2006. All other financial guidance provided in this Outlook includes the effect of our
anticipated stock-based compensation expenses.
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Novogyne. Based on current prescription trends and other factors, we expect Novogyne’s full
year 2007 net revenues to increase in the 5% range compared to 2006 levels, and we expect
Novogyne’s net income and profit contribution to Noven for 2007 to increase by close to 10%
compared to 2006 levels.
Tax Matters. We estimate that our effective tax rate for full-year 2007 will be in the 33% to
35% range, which is consistent with 2006 levels. In 2007 or early 2008, we expect to pay taxes in
the $18.0 million range associated with the $50.0 million cash milestone payment received from
Shire in 2006.
Capital Expenditures. We expect our capital expenditures for full-year 2007 to be
approximately in line with 2006 levels.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations are based
upon our financial statements, which have been prepared in accordance with accounting principles
generally accepted 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, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our estimates, including those related to revenue recognition and estimates related to
allowance for returns related to product recalls, the fair value of stock-based compensation
granted to employees and outside directors, the determination of the net realizable value of the
net deferred tax asset and our effective tax rate. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Many of our critical accounting
estimates are those which we believe require the most subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are inherently uncertain or
which involve factors that may be beyond our control. Using different assumptions could result in
materially different results. A discussion of our critical accounting estimates, the underlying
judgments and uncertainties affecting their application and the likelihood that materially
different amounts would be reported under different conditions or using different assumptions, is
as follows:
Revenue Recognition
We enter into certain contracts that have various terms and conditions that may have multiple
revenue characteristics, including license revenues, contract revenues, product sales, royalties
and manufacturing revenues. As prescribed by Emerging Issues Task Force 00-21 “Accounting for
Revenue Arrangements with Multiple Deliverables”(“EITF 00-21”), we analyze each contract in order
to separate each deliverable into separate units of accounting and then recognize revenues for
those separated units at their fair value as earned in accordance with SEC Staff Accounting
Bulletin Topic 13, “Revenue Recognition” (“Topic 13”) or other applicable revenue recognition
guidance. The analysis prescribed by EITF 00-21 requires us to make a number of
significant assumptions and judgments, including those related to: sales price, unit costs and
manufacturing profit; expected launch date of the product licensed and valuation of that licensed
product; and price, cost, and applicable profit of research and development work to be performed.
Changes in any of these assumptions and judgments could lead to a different conclusion on what the
separate units of
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accounting are and their applicable fair values, which may lead to material
changes to revenue recognition.
License revenues consist of up-front, milestone and similar payments under license agreements
and are not recognized until earned under the terms of the applicable agreements. In most cases,
license revenues are deferred and recognized over the estimated product life cycle, which is
management’s best estimate of the earning period. Estimates of product life cycles are inherently
uncertain as a result of regulatory, competitive or medical developments. We estimate product life
cycles based on our assessment of various factors, including the expected launch date of the
product licensed, the strength of the intellectual property protection of the product, and various
other competitive, developmental and regulatory issues, and contractual terms. Any change to the
actual or estimated product life could require us to change the recognition period. Management’s
best estimate of the end of the product life cycle for Daytrana™ extends through the
first quarter of 2013, which results in the annual recognition of approximately $7.1 million in
license revenues for the $50.0 million approval milestone payment we received from Shire in April
2006. If our estimate of the Daytrana™ product life cycle should change, we will be
required to change the license revenue recognition period on a prospective basis, which may
materially change the license revenues that we recognize in any given period. For example, with
respect to the $50.0 million approval milestone payment, we would have recognized $5.0 million and
$3.8 million in Daytrana™ license revenues on an annual basis had we determined that the
product life cycle ended in the first quarter of 2016 and 2019, respectively.
Contract revenues consist of contract payments related to research and development projects
performed for third parties. The work performed by us includes feasibility studies to determine if
a specific drug is amenable to transdermal drug delivery, the actual formulation of a specific drug
into a transdermal drug delivery system, studies to address the ongoing stability of the drug in a
transdermal drug delivery system and manufacturing of batches of product that can be used in human
clinical trials. We receive contract payments for the work we perform in the following forms:
| • | nonrefundable up-front payments prior to commencing the work (or certain phases of the work); | ||
| • | additional payments upon completion of additional phases; and | ||
| • | in some cases, success milestone payments based on achievement of specified performance criteria. |
For non-refundable up-front payments received prior to commencing work, we recognize revenue
based on the proportionate share (proportional performance method) of the work performed by us in
any given period based on the total hours we expect to incur on the project to deliver all our
obligations under the contract as we believe direct hours spent on the projects is the best
indicator of our delivery of the obligation and earning process for the contract. There are a
number of assumptions, estimates and judgments that are involved in determining the total hours we
expect to incur on the project, including personnel and time involved. Similar assumptions,
estimates and judgments are involved in determining the proportionate share of the work performed
by us in any given period in addition to estimates of hours remaining to complete the project. Any
changes in these assumptions, estimates and judgments may cause us to change the revenue
recognition for contracts.
Product revenues are net of an allowance for returns. We establish allowances for returns for
product that has been recalled or that we believe is probable of being recalled. The methodology
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used by us to estimate product recall returns is based on the distribution and expiration dates of
the affected product and overall trade inventory levels. These estimates are based on currently
available information, and the ultimate outcome may be significantly different than the amounts
estimated
given the subjective nature of the assumptions and complexities inherent in this area and in
the pharmaceutical industry. If our estimate concerning the amount of the product returns is
incorrect or if our partners should initiate further unexpected recalls, then our results of
operations could be materially different. For example, in 2003, Noven and Novogyne established
allowances for the return of recalled product, which had the effect of reducing Noven’s and
Novogyne’s net revenues by $1.4 million and $6.5 million, respectively, for the year ended December
31, 2003. Based on a review of available relevant information, including actual product returns and
future expected returns, Noven and Novogyne reduced these allowances during the year ended December
31, 2004, which had the effect of increasing net revenues for the year ended December 31, 2004 by
$0.6 million and $3.3 million for Noven and Novogyne, respectively. The effect on Noven of these
adjustments by Noven and Novogyne was to increase Noven’s income before income taxes by $2.2
million for the year ended December 31, 2004.
Stock-Based Compensation
On January 1, 2006, we adopted SFAS 123(R), which requires the measurement and recognition of
compensation expense for all share-based payment awards made to employees and directors based on
estimated fair values. Pre-tax stock-based compensation expense recognized under SFAS 123(R) in
2006 was $3.3 million.
We currently use the Black-Scholes option pricing model to determine the fair value of stock
options and SSARs. The determination of the fair value of stock-based payment awards on the date
of grant using an option-pricing model is affected by our stock price as well as assumptions
regarding a number of complex and subjective variables. These variables include our expected stock
price volatility over the term of the awards, actual and projected employee equity award exercise
behaviors, risk-free interest rate, expected forfeiture rates and expected dividends.
We estimate the expected term of options granted by taking the average of the vesting term and
the contractual term of the option, as described in SAB 107. We estimate the volatility of common
stock by using a combination of both historical and implied volatility based on an equal weighting
of each as management believes that marketplace participants would likely use the expected
volatility in determining an exchange price for an option. We are required to estimate forfeitures
at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ
from those estimates. We use historical data to estimate pre-vesting option forfeitures and record
stock-based compensation expense accordingly. If factors change and we employ different
assumptions for estimating stock-based compensation expense in future periods or if we decide to
use a different valuation model, the future periods may differ significantly from what we have
recorded in the current period and could materially affect our operating income, net income and net
income per share. The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully transferable,
characteristics not present in our option grants. Existing valuation models, including the
Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of
our stock-based compensation. Consequently, there is a risk that our estimates of the fair values
of our stock-based compensation awards on the grant dates may bear little resemblance to the actual
values realized upon the exercise, expiration, early termination or forfeiture of those stock-based
payments in the future. Stock options or SSARs may expire worthless or otherwise result in zero
intrinsic value as
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compared to the fair values originally estimated on the grant date and reported
in our financial statements. Alternatively, value may be realized from these instruments that are
significantly higher than the fair values originally estimated on the grant date and reported in
our financial statements.
There currently is no market-based mechanism or other practical application to verify the
reliability and accuracy of the estimates stemming from these valuation models, nor is there a
means to compare and adjust the estimates to actual values.
Inventories
Inventories consist primarily of raw materials, work in process and finished goods for our
commercial branded products and under certain circumstances may include pre-launch branded and
generic products. Inventory costs include material, labor and manufacturing overhead. Inventories
are stated at the lower of cost (first-in, first-out method, or FIFO) or market and as appropriate,
we reflect provisions necessary to reduce the carrying value of our inventories to net realizable
value.
We
use a standard costing system to estimate our actual FIFO cost of inventory at the end of each
reporting period. Historically, standard costs have been substantially consistent with actual
costs. In addition, the allocation of overhead costs impacts our estimate of the cost of
inventory. Total overhead costs, which were in excess of $20.0 million in 2006, consist of
salaries and benefits, supplies and tools, equipment costs, depreciation and insurance costs and
represent a substantial portion of our inventory production costs. The allocation of overhead to
inventory production costs and between and among our various products requires us to make
significant estimates that involve subjective and often complex judgments, including, among other
things, normal production capacity, the relationship between labor costs and overhead costs, the
extent of labor that goes into producing products and the amount of overhead costs absorbed in
manufacturing inventory. Any change in these assumptions could materially impact our recorded cost
of products sold and stated inventory balances.
Our net inventory balances were $8.7 million and $7.9 million as of December 31, 2006 and
2005, respectively. We determine the market value of our raw materials, finished product and
packaging inventories based upon references to current market prices for such items as of the end
of each reporting period and record a write-down of inventory standard cost to market, when
applicable. We periodically review our inventory for excess items, and we establish a valuation
write-down based upon the age of specific items in inventory and the expected recovery from the
disposition of the items. A provision is established for the estimated aged surplus, spoiled or
damaged products, and discontinued inventory items and components. The amount of the provision is
determined by analyzing inventory composition, expected usage, historical and projected sales
information, and other factors. Changes in sales volume due to unexpected economic or competitive
conditions are among the factors that could result in materially different amounts for provisions
we establish. If our provisions prove to be inadequate, our inventories could be overstated or
understated in any given period.
Pre-Launch Inventories
Pre-launch inventories consist primarily of our branded or generic product candidates prior to
the date that we anticipate that such products will receive FDA final marketing approval or the
satisfactory resolution of patent infringement litigation, or any other circumstances that will
make our product candidates commercially viable. We will capitalize pre-launch quantities into
inventories when we believe it is probable that (i) a future economic benefit will be derived from
the
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commercialization of the product and/or the risk of pre-launch inventories is transferred to
our collaborative partner, (ii) the FDA will approve the marketing of the product, (iii) we will
validate our process for manufacturing the product within the specifications that have been or will
be
approved by the FDA for such product and (iv) particularly in the case of a generic product,
we will prevail in any patent infringement litigation. In evaluating whether it is probable that
we will derive future economic benefits from our pre-launch inventories and whether the pre-launch
inventories are stated at the lower of cost or market, we consider, among other things, the
remaining shelf life of that inventory, the current and expected market conditions, the amount of
inventory on hand, the substance of communications with the FDA during the regulatory approval
process and the views of patent and/or litigation counsel.
The manufacture of pre-launch inventories involves the risk that the FDA may not approve such
product(s) for marketing on a timely basis or at all, that each approval may require additional or
different testing and/or specifications than what was performed in the manufacture of such
pre-launch inventory and/or that the results of related litigation may not be satisfactory. If any
of these risks were to materialize with respect to a given product or if the launch of such product
is significantly postponed, we may record additional provisions, which could be material. For
example, as a result of the FDA’s decision to cease its review of our fentanyl patch application in
September, 2005, we wrote off the entire fentanyl patch inventory of $14.0 million, with a charge
of $9.5 million to our cost of products sold, representing our portion of the costs of the
inventory as agreed with Endo. We had capitalized $10.8 million and $14.0 million of these
inventories as of December 31, 2004 and September 30, 2005, respectively, with the full belief that
the FDA would approve the product and it would be launched. Pre-launch inventories of $2.4 million
as of December 31, 2005 consisted of Noven’s Daytrana™ product, which received final
approval from the FDA in April 2006 and was commercially launched in June 2006. There were no
pre-launch inventories at December 31, 2006.
Income Taxes
Accounting principles generally accepted in the United States require that we not record a
valuation allowance against our net deferred tax asset if it is “more likely than not” that we will
be able to generate sufficient future taxable income to utilize our net deferred tax asset, which
was $12.7 million as of December 31, 2006. Although realization is not assured, we believe it is
more likely than not that the net deferred income tax asset will be realized based upon our
estimated future income and, accordingly, no valuation allowance for the net deferred income tax
asset was deemed necessary as of December 31, 2006. Subsequent revisions to the estimated net
realizable value of the net deferred tax asset could cause our provision for income taxes to vary
significantly from period to period and could affect our financial results.
Our future effective tax rate is based on estimates of expected income and enacted statutory
tax rates, as applied to our operations. Significant judgment is required in making these
determinations and the ultimate resolution of our tax return positions. Despite our belief that
our tax return positions are correct, our policy is to establish accruals for tax contingencies
that may result from examinations by tax authorities. Our tax accruals are analyzed periodically
and adjustments are made as events occur to warrant such adjustment. It is reasonably possible that
our effective tax rate and/or cash flows may be materially impacted by the ultimate resolution of
our tax positions. If we are assessed interest and/or penalties by governing jurisdictions, we
include those amounts in our tax provision. We estimated our effective tax rate for
2006 to be
33%, while our effective tax rate for
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2005 and 2004 was 35%, respectively. If our effective tax
rate was proven to be 35% or higher for 2006, our provision for income taxes would materially vary.
Investment in Novogyne
We entered into a joint venture (Novogyne) with Novartis, effective May 1, 1998, to market and
sell women’s prescription healthcare products in the United States and Canada. We account for our
49% investment in Novogyne under the equity method and report our share of Novogyne’s earnings as
“Equity in earnings of Novogyne” on our Statements of Operations. We defer the recognition of 49%
of our profit on products sold to Novogyne until the products are sold by Novogyne.
Novogyne Intangible Asset
As of December 31, 2006, Novogyne had a long-term intangible asset of $26.3 million related to
the acquisition of the marketing rights to CombiPatch®. The amortization of this asset
is included in cost of sales in Novogyne’s financial statements. In accordance with Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment of Disposal of Long-Lived
Assets (“SFAS 144”), the CombiPatch® marketing rights are assessed for impairments
whenever events or changes in circumstances indicate the carrying amount of the asset may not be
recoverable. The impairment testing involves comparing the carrying amount of the asset to the
forecasted undiscounted future net cash flows of the product. This analysis requires Novogyne to
make a number of significant assumptions and judgments involving prescription trends, sales price,
unit cost and product life cycle among many other factors. In the event the carrying value of the
asset exceeds the undiscounted future net cash flows of the product and the carrying value is not
considered recoverable, an impairment exists. An impairment loss is measured as the excess of the
asset’s carrying value over its fair value, calculated using a discounted future cash flow method.
An impairment loss would be recognized in net income in the period that the impairment occurs.
Events giving rise to impairments are an inherent risk in the pharmaceutical industry and cannot be
predicted. Further declines in CombiPatch® sales (whether as a result of the HT
studies, competition in the category or otherwise) could require Novogyne to record an impairment
loss related to these marketing rights. As a result of the significance of the CombiPatch®
marketing rights, any such impairment loss could have a material adverse impact on Novogyne’s
and Noven’s financial position and/or results of operations.
Novogyne Revenue Recognition
Revenues at Novogyne are recognized when all the risks and rewards of ownership have
transferred to the customer, which occurs at the time of shipment of products. Revenues are
reduced at the time of sale to reflect expected returns that are estimated based on historical
experience. Additionally, provisions are made at the time of sale for all discounts, rebates and
estimated sales allowances based on historical experience updated for changes in facts and
circumstances, as appropriate. Such provisions are recorded as a reduction of revenue.
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The following table describes the activity for the revenue deduction accruals by major
category for the year ended December 31, 2006 (amounts in thousands):
| Income Statement Charge (Reversal) | ||||||||||||||||||||
| Adjustments of | December | |||||||||||||||||||
| January 1, 2006 | Payments | prior years | Current Year | 31, 2006 | ||||||||||||||||
Medicaid, Medicare and
State program rebates &
credits including
prescription drug
savings cards |
$ | 555 | $ | (1,064 | ) | $ | (89 | ) | $ | 1,070 | $ | 472 | ||||||||
Managed health care
rebates |
4,135 | (9,561 | ) | 95 | 10,022 | 4,691 | ||||||||||||||
Chargebacks, including
hospital chargebacks |
82 | (1,016 | ) | — | 1,032 | 98 | ||||||||||||||
Cash discounts, direct
customer discounts &
other discounts |
817 | (5,242 | ) | (2 | ) | 5,098 | 671 | |||||||||||||
Sales returns allowances |
6,168 | (3,962 | ) | 1,390 | 4,342 | 7,938 | ||||||||||||||
Total |
$ | 11,757 | $ | (20,845 | ) | $ | 1,394 | $ | 21,564 | $ | 13,870 | |||||||||
These deductions represent estimates of the related obligations, requiring the use of
judgment when estimating the impact of these sales deductions on gross sales for a reporting
period. These estimates for revenue deductions are derived utilizing a combination of information
received from third parties, including market data, inventory reports from its major wholesale
customers, historical information and other analysis. Novogyne’s management believes that due to
Novartis’ extensive experience, it is able to reasonably estimate these sales deductions.
The following briefly describes the nature of each revenue deduction and how the related
accruals are estimated by Novogyne:
The United States Medicaid program is a state-government-administered program that uses state
and federal funds to provide assistance to certain vulnerable and needy individuals and families.
In 1990, the Medicaid Drug Rebate Program was established to reduce state and federal expenditures
for prescription drugs. Under the rebate program, rebates are paid to states based on drugs paid
for by those states. Provisions for estimating Medicaid rebates are calculated using a combination
of historical experience, product and population growth, price increases, the impact of contracting
strategies and specific terms in the individual state agreements. These provisions are then
adjusted based upon the established re-filing process with individual states. For Medicaid, the
calculation of rebates involves interpretation of relevant regulations, which are subject to
challenge or change in interpretative guidance by government authorities. Since Medicaid rebates
are typically billed up to six months after the product is dispensed, any rebate adjustments may
involve revisions of accruals for several quarters.
The products also participate in prescription drug savings programs that offer savings to
patients that are eligible participants under United States Medicare programs. These savings vary
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based on a patient’s current drug coverage and personal income levels. Provisions for the
obligations under these programs are based on historical experience, trend analysis and current
program terms.
On January 1, 2006, an additional prescription drug benefit was added to the United States
Medicare program which funds healthcare benefits to individuals over the age of 65. Individuals
that previously had dual Medicaid/Medicare drug benefit eligibility had their Medicaid prescription
drug coverage replaced on January 1, 2006, by the new Medicare Part D coverage provided through
private prescription drug plans. The change led to a significant shift of plan participants
between programs in which products participate. Provisions for Medicare Part D rebates are
estimated using a combination of specific terms of individual plan agreements, product and
population growth, price increases and the impact of contracting strategies. The estimated impact
of this shift that is related to 2005 sales has been reflected in Novogyne’s sales accruals at the
end of 2005 although the impact was relatively neutral to Novogyne’s products.
Wholesaler chargebacks relate to contractual arrangements with certain indirect customers to
sell products at prices that are lower than the list price charged to wholesalers. A wholesaler
chargeback represents the difference between the invoice price charged to the wholesaler and the
indirect customer’s contract discount price. Provisions for estimating chargebacks are calculated
using a combination of historical experience, product growth rates and the specific terms in each
agreement. Wholesaler chargebacks are generally settled within a few weeks of incurring the
liability.
Managed health care rebates are offered to key managed health care, group purchasing
organizations and other direct and indirect customers to sustain and increase product market share.
These rebate programs provide that the customer receive a rebate after attaining certain
performance parameters relating to product purchases, formulary status and/or pre-established
market share milestones relative to competitors. Since rebates are contractually agreed upon,
rebates are estimated based on the specific terms in each agreement, historical experience and
product growth rates. The sales performance of products subject to managed health care rebates and
other contract discounts and levels of inventory in the distribution channel are tracked, and
adjustments to the accrual are made periodically to reflect actual experience.
In order to evaluate adequacy of ending accrual balances, Novogyne uses both internal and
external estimates of the level of inventory in the distribution channel and the rebate claims
processing lag time. External data sources include periodic reports of wholesalers and purchased
third party market data. Management internally estimates the inventory level in the retail channel
and in transit.
It is customary in the pharmaceutical industry to allow returns of unused stocks with
remaining shelf lives of six months or less. Novogyne’s policy is that no product will be shipped
to customers with less than nine months of remaining shelf-life and Novogyne generally will accept
returns due to expiration within twelve months after the product has expired. An allowance for
estimated sales returns is recorded based on (i) the historical experience of actual product
returns and (ii) the estimated lag time between when an actual sale takes place in relation to when
the products are physically returned by a customer. The historical actual returns rate is then
applied to product sales during the estimated lag period to develop the returns estimate. Novogyne
also considers trends and expectations for future demand and trade inventory levels. These
policies cause a significant lag time between when a product is sold and the latest date on which a
return could occur. Novogyne believes this is a reasonable basis on which to estimate returns
exposure and incorporates the key
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factors that contribute to returns. In addition, Novogyne establishes sales returns
allowances for product that has been recalled or that it believes is probable of being recalled.
The methodology used to estimate product returns associated with recalls is based on the
distribution and expiration dates of the affected product and overall trade inventory levels.
These estimates are based on currently available information, and the ultimate outcome may be
different than the amounts estimated given the subjective nature and complexities inherent in this
area and in the pharmaceutical industry.
Novogyne’s product supply policy is to maintain inventories on a consistent level from year to
year based on the pattern of consumption. Wholesaler inventory levels are monitored monthly based
on gross sales volume, prescription volumes based on third party data and information received from
the key wholesalers. Based on this information, the inventories on hand at wholesalers and other
distribution channels were estimated to be approximately one month at December 31, 2006 and 2005. Novogyne believes the third party data sources of information are
sufficiently reliable; however its accuracy cannot be independently verified.
Cash discounts are offered to customers to encourage prompt payment. Cash discounts, which are
typically 2% of gross sales, are accrued at the time of sale.
Other sales discounts, such as consumer coupons and discount cards, are also offered. These
discounts are recorded at the time of sale and estimated utilizing historical experience and the
specific terms for each program.
Novartis controls and maintains the reserves associated with such sales allowances and returns
on behalf of Novogyne and pays all monies owed and issues credits to individual customers as deemed
necessary. The contracts that underlie these transactions are maintained by Novartis for its
business as a whole and those transactions relating to Novogyne are estimated by Novartis. Based
on an analysis of the underlying activity, the amounts recorded by Novogyne represent Novartis’
best estimate of charges that apply to sales by Novogyne. However, we can
not control Novartis’ analysis of the underlying activity or its application of that analysis to
Novogyne. If Novartis materially changes the assumptions it uses in determining the reserve,
Novogyne may be required to record an additional reserve allowance on its financial statements,
which would adversely affect Novogyne’s operating results during the period in which the
determination or reserve were made, and would consequently also reduce the earnings attributable to
our investment in Novogyne for that period.
Novogyne Loss Contingencies
Novogyne is required to establish accruals for certain loss contingencies related to
litigation, including product liability claims. Novogyne accrues estimated legal fees and
settlement costs in accordance with SFAS No. 5, “Accounting for Contingencies”. Accruals for
product liability claims are recorded by Novogyne, on an undiscounted basis, when it is probable
that a liability has been incurred and the amount of the liability can be reasonably estimated
based on existing information. Novogyne includes estimated legal fees in accruals for product
liability claims and makes adjustments as new information becomes available. Receivables for
insurance recoveries related to product liability claims under Novogyne’s third party insurance
policy are recorded, on an undiscounted basis, when it is probable that a recovery will be
realized. Novogyne’s accruals and related receivables for product liability claims and other
litigation accruals involve a high level of judgment, including estimates of incurred but not
reported claims, estimates of cost per claim for both reported and unreported claims, allocation of
cost between Noven, Novartis and Novogyne
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based on ownership dates and applicable indemnification and other agreements between them,
estimates of insurance recoveries and judgments as to the recoverability of insurance receivables
recorded. Since July 2004, Novartis, along with various other pharmaceutical companies, has been
named in a number of lawsuits involving Novogyne’s hormone replacement therapy products. Novogyne
has established reserves in the amount of $9.6 million as of December 31, 2006 for expected defense
and settlement expenses related to pending lawsuits as well as for estimated future cases alleging
use of Novogyne’s products. In addition, Novogyne has recorded an insurance receivable of $7.3
million, which is Novogyne’s best estimate of the insurance coverage for recovery of claims.
Novartis controls and maintains the accruals associated with such litigation on behalf of
Novogyne and pays all monies owed for legal fees and settlements, as well as collects any insurance
recovery from policies in the name of Novogyne. The litigation accruals and estimated insurance
recoveries are maintained by Novartis for its business as a whole and those accruals and recoveries
relating to Novogyne are estimated by Novartis (based on claims specifically attributable to
Novogyne’s products and Novogyne’s insurance policies). Based on an analysis of the underlying
data, the amounts recorded by Novogyne represent Novartis’ best estimate of litigation accruals and
estimated insurance recoveries relating to Novogyne. However, we can
not control
Novartis’ analysis of the underlying data or its application of that analysis to Novogyne.
Litigation and its outcome are inherently difficult to predict. Any change in the estimates of
number of cases, cost per case, allocation of cost between Noven, Novartis and Novogyne, insurance
recoveries and other assumptions could cause Novogyne’s and Noven’s financial results to
significantly vary. Furthermore, if actual liability and insurance recoveries ultimately differ
from that which has been recorded, Novogyne’s and Noven’s financial results in the period where the
liability becomes payable and the insurance is recoverable could be materially affected by the
adjustment of the liability and insurance recoveries. No insurance proceeds have been recovered by
Novartis on behalf of Novogyne as of December 31, 2006.
New Accounting Standards
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement
of Financial Accounting Standards No. 157, “Fair Value Measurements” (“FAS 157”). This standard
defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements. FAS 157 is effective
for financial statements issued for fiscal years beginning after November 15, 2007 and interim
periods within those fiscal years. The adoption of FAS 157 is not expected to have a material
impact on our results of operations or financial condition.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), which added
Section N to Topic 1, Financial Statements, of the Staff Accounting Bulletin Series effective for
fiscal years ending after November 15, 2006. Section N provides guidance on the consideration of
the effects of prior year misstatements when quantifying current year financial statement
misstatements for the purpose of materiality assessment. The SEC concluded in SAB 108 that a
registrant’s materiality evaluation of an identified unadjusted error should quantify the impact of
correcting all misstatements, including both the carryover and reversing effects of prior year
misstatements, on the current year financial statements. If either the carryover or reversing
effects of prior year misstatements is material, the misstatements should be corrected in the
current year. If correcting an error in the current year for prior year misstatements causes the
current year to be materially misstated, the prior year financial statements should be corrected,
even though such
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revision previously was and continues to be immaterial to the prior year financial statements.
SAB 108 was adopted on December 31, 2006 and its adoption did not have a material impact on our
results of operations or financial condition.
In July 2006, the FASB issued Interpretation No. 48 “Accounting for Uncertainty in Income
Taxes” (“FIN 48”) to clarify the accounting for uncertainties related to income taxes that are
recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 prescribes
a recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. This Interpretation
requires financial statement recognition of the impact of a tax position, if that position is more
likely than not to be sustained on examination, based on the technical merits of the position. FIN
48 is effective as of the beginning of the first annual reporting period that begins after December
15, 2006, with the cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48
on our results of operations and financial condition.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 8. Financial Statements and Supplementary Data.
See Index to Financial Statements at page 86 of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of
1934. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective in timely alerting them to
material information relating to Noven required to be included in our periodic Securities and
Exchange Commission filings. However, that conclusion should be considered in light of the various
limitations described below on the effectiveness of those controls and procedures, some of which
pertain to most if not all business enterprises, and some of which arise as a result of the nature
of our business. Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures will prevent all error and all
improper conduct. A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no
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evaluation of controls can provide absolute assurance that all control issues and instances of
improper conduct, if any, have been detected. These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur because of simple error
or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control. Further, the design of
any system of controls also is based in part upon assumptions about the likelihood of future
events, and there can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system, misstatements due to error
or fraud may occur and not be detected. Furthermore, our level of historical and current equity
participation in Novogyne may substantially impact the effectiveness of our disclosure controls and
procedures. Because we do not control Novogyne, and Novogyne’s financial, accounting, inventory,
sales and sales deductions functions are performed by Novartis, our disclosure controls and
procedures with respect to our equity investment in Novogyne are necessarily more limited than
those we maintain with respect to ourself.
Changes in Internal Control over Financial Reporting
No changes were made in our internal control over financial reporting subsequent
to the date of our Chief Executive Officer’s and Chief Financial Officer’s evaluation that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
Management’s Report on Internal Controls over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or
15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under
the supervision of, a company’s principal executive and principal financial officers and effected
by a company’s board of directors, management and other personnel, 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 and includes those
policies and procedures that:
| • | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; | ||
| • | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and | ||
| • | 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. |
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Because of its inherent limitations, and because it is required to provide only reasonable,
not absolute, assurance that its objectives are met, internal control over financial reporting may
not prevent or detect misstatements whether arising from fraud or simple error. Projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate over time because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Noven’s management assessed the effectiveness of the company’s internal control over financial
reporting as of December 31, 2006. In making this assessment, Noven’s management used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control—Integrated Framework.
Based on our assessment, Noven’s management believes that, as of December 31, 2006, Noven’s
internal control over financial reporting is effective based on those criteria.
Deloitte & Touche LLP, Noven’s independent registered public accounting firm, has issued an
audit report on Noven’s management’s assessment of the company’s internal control over financial
reporting. This report appears on page 76.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Noven Pharmaceuticals, Inc.:
Noven Pharmaceuticals, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on
Internal Controls over Financial Reporting, that Noven Pharmaceuticals, Inc. (the “Company”)
maintained effective internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Company’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on
management’s assessment and an opinion on the effectiveness of the Company’s internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over
financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on
the criteria established in Internal Control—Integrated Framework issued by the Committee of
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Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,
2006, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the financial statements as of and for the year ended December 31, 2006 of
the Company and our report dated March 12, 2007 expressed an unqualified opinion on those financial
statements and included an explanatory paragraph regarding the
Company’s adoption of Statement of Financial Accounting
Standards No. 123 Revised, “Share-Based Payment” on
January 1, 2006.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Certified Public Accountants
Miami, Florida
March 12, 2007
March 12, 2007
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Item 9B. Other Information.
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
The information concerning executive officers required by Item 10 is contained in the
discussion entitled “Executive Officers of the Registrant” in Part I hereof. All other information
required by Item 10 is incorporated by reference to our Proxy Statement for our 2007 Annual Meeting
of Stockholders.
Item 11. Executive Compensation.
The information required by Item 11 is incorporated by reference to our Proxy Statement for
our 2007 Annual Meeting of Stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The information required by Item 12 is incorporated by reference to our Proxy Statement for
our 2007 Annual Meeting of Stockholders.
Item 13. Certain Relationships and Related Transactions, and Director
Independence.
The information required by Item 13 is incorporated by reference to our Proxy Statement for
our 2007 Annual Meeting of Stockholders.
Item 14. Principal Accounting Fees and Services.
The information required by Item 14 is incorporated by reference to our Proxy Statement for
our 2007 Annual Meeting of Stockholders.
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements
See Index to Financial Statements at page 86 of this report.
(a)(2) Financial Statement Schedules
All schedules have been omitted because the required information is not applicable or the
information is included in the financial statements or the notes thereto.
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(a)(3) Exhibits
| Exhibit | |||||
| Number | Description | Method of Filing | |||
3.1
|
Noven’s Restated Certificate of Incorporation. | Incorporated by reference to Exhibit 3.1 of Noven’s Form 10-K for the year ended December 31, 1998 (File No. 0-17254). | |||
3.2
|
Noven’s Certificate of Amendment of Certificate of Incorporation dated June 5, 2001. | Incorporated by reference to Exhibit 3.1 of Noven’s Form 10-Q for the quarter ended June 30, 2001 (File No. 0-17254). | |||
3.3
|
Certificate of Designations of Series A Junior Participating Preferred Stock of Noven Pharmaceuticals, Inc. | Incorporated by reference to Exhibit 3.3 of Noven’s Form 10-K for the year ended December 31, 2001 (File No. 0-17254). | |||
3.4
|
Noven’s Bylaws, as amended and restated as of February 8, 2001. | Incorporated by reference to Exhibit 3.2 of Noven’s Form 10-K for the year ended December 31, 2000 (File No. 0-17254). | |||
4.1
|
Rights Agreement by and between Noven and American Stock Transfer & Trust Company dated November 6, 2001. | Incorporated by reference to Exhibit 4.1 of Noven’s Form 8-K dated November 6, 2001 (File No. 0-17254). | |||
10.1
|
Noven Pharmaceuticals, Inc. 1999 Long-Term Incentive Plan.* | Incorporated by reference to Noven’s definitive Proxy Statement dated April 12, 2004, for the Annual Meeting of Shareholders held on May 18, 2004. | |||
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| Exhibit | ||||
| Number | Description | Method of Filing | ||
10.2
|
Amended and Restated Employment Agreement between Noven and Robert C. Strauss dated as of November 5, 2003.* | Incorporated by reference to Exhibit 10.2 of Noven’s Form 10-Q for the quarter ended September 30, 2003 (File No. 0-17254). | ||
10.3
|
Form of Employment Agreement (Change of Control), between Noven and each of Eduardo G. Abrao, Diane M. Barrett, Jeffrey F. Eisenberg, W. Neil Jones and Juan A. Mantelle.* | Incorporated by reference to the Form of Employment Agreement (Change of Control) filed as Exhibit 10.1 of Noven’s Form 8-K dated November 15, 2005 (File No. 0-17254). | ||
10.4
|
Form of Indemnification Agreement for Directors and Officers. | Incorporated by reference to Exhibit 10.4 of Noven’s Form 10-K for the year ended December 31, 1998 (File No. 0-17254). | ||
10.5
|
License Agreement between Noven and Ciba-Geigy Corporation dated November 15, 1991 (with certain provisions omitted pursuant to Rule 406). | Incorporated by reference to Exhibit 10.9 of Amendment No. 1 to Noven’s Registration Statement on Form S-2 (File No. 33-45784). | ||
10.6
|
Industrial Lease between Rhône-Poulenc Rorer Pharmaceuticals Inc. and Noven dated March 23, 1993 and effective February 16, 1993 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.20 of Noven’s Form 10-K for the year ended December 31, 1993 (File No. 0-17254). | ||
10.7
|
Operating Agreement of Vivelle Ventures LLC (a Delaware limited liability company) dated as of May 1, 1998. | Incorporated by reference to Exhibit 10.33 to Noven’s Form 10-Q for the quarter ended March 31, 1998 (File No. 0-17254). | ||
10.8
|
Amendment to Operating Agreement between Novartis Pharmaceuticals Corporation and Noven dated March 29, 2001. | Incorporated by reference to Exhibit 10.7 to Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). | ||
10.9
|
Marketing and Promotional Services Agreement by and between Noven and Vivelle Ventures LLC dated as of May 1, 1998. | Incorporated by reference to Exhibit 10.4 to Noven’s Form 10-Q for the quarter ended March 31, 1998 (File No. 0-17254). |
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| Exhibit | ||||
| Number | Description | Method of Filing | ||
10.10
|
First Amendment to Marketing and Promotional Services Agreement between Vivelle Ventures LLC and Noven dated March 29, 2001. | Incorporated by reference to Exhibit 10.6 to Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). | ||
10.11
|
Sublicense Agreement by and among Novartis Pharmaceuticals Corporation, Noven and Vivelle Ventures LLC dated as of May 1, 1998. | Incorporated by reference to Exhibit 10.35 to Noven’s Form 10-Q for the quarter ended March 31, 1998 (File No. 0-17254). | ||
10.12
|
Amended and Restated License Agreement between Noven and Rhône-Poulenc Rorer Pharmaceuticals, Inc. dated September 30, 1999 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended September 30, 1999 (File No. 0-17254). | ||
10.13
|
Amended and Restated License Agreement between Noven and Rhône-Poulenc Rorer, Inc. dated September 30, 1999 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.2 of Noven’s Form 10-Q for the quarter ended September 30, 1999 (File No. 0-17254). | ||
10.14
|
Amendment No. 2 to Amended and Restated License Agreement between Rorer Pharmaceutical Products, Inc. and Noven Pharmaceuticals, Inc. dated March 29, 2001 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.2 of Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). | ||
10.15
|
License Agreement between Noven and Novartis Pharma AG dated as of November 3, 2000 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.2 of Noven’s Form 10-Q for the quarter ended September 30, 2000 (File No. 0-17254). | ||
10.16
|
License Agreement between Noven and Vivelle Ventures LLC dated March 29, 2001 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). | ||
10.17
|
Sublicense Agreement among Rorer Pharmaceutical Products, Inc., Rhône-Poulenc Rorer Inc., Aventis Pharmaceuticals Products Inc., Rhône-Poulenc Rorer International Holdings Inc., Novartis Pharma AG and Noven dated March 29, 2001 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.3 of Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). |
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| Exhibit | ||||
| Number | Description | Method of Filing | ||
10.18
|
Purchase Agreement among Rorer Pharmaceutical Products, Inc., Aventis Pharmaceuticals Products Inc. and Vivelle Ventures LLC dated March 29, 2001 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.4 of Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). | ||
10.19
|
Supply Agreement between Vivelle Ventures LLC and Noven dated March 29, 2001 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.5 of Noven’s Form 10-Q for the quarter ended March 31, 2001 (File No. 0-17254). | ||
10.20
|
Development Agreement between Novartis Pharma AG and Noven dated June 1, 2001. | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended June 30, 2001 (File No. 0-17254). | ||
10.21
|
Transaction Agreement among Shire US Inc., Shire Pharmaceuticals Group PLC and Noven, dated February 26, 2003 (with certain provisions omitted pursuant to Rule 24b-2).** | Incorporated by reference to Exhibit 10.25 of Noven’s Form 10-K for the year ended December 31, 2002 (File No. 0-17254). | ||
10.22
|
License Agreement among Shire US Inc., Shire Pharmaceuticals Group PLC and Noven, dated as April 7, 2003 (with certain provisions omitted pursuant to Rule 24b-2).** | Incorporated by reference to Exhibit 10.25 of Noven’s Form 10-K for the year ended December 31, 2002 (File No. 0-17254). | ||
10.23
|
Toll Conversion and Supply Agreement among Shire US Inc., Shire Pharmaceuticals Group PLC and Noven, dated as April 7, 2003 (with certain provisions omitted pursuant to Rule 24b-2).** | Incorporated by reference to Exhibit 10.25 of Noven’s Form 10-K for the year ended December 31, 2002 (File No. 0-17254). | ||
10.24
|
Agreement between Shire US Inc. and Noven, dated June 15, 2004 (with certain provisions omitted pursuant to Rule 24b-2).** | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended June 30, 2004 (File No. 0-17254). | ||
10.25
|
Agreement between Shire Pharmaceuticals Ireland Limited and Noven dated March 6, 2006.** | Incorporated by reference to Exhibit 10.27 of Noven’s Form 10-K for the year ended December 31, 2005 (File No. 0-17254). |
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| Exhibit | ||||
| Number | Description | Method of Filing | ||
10.26
|
Agreement between Noven and P&G Pharmaceuticals, Inc. dated April 28, 2003 (with certain provisions omitted pursuant to Rule 24b-2).** | Incorporated by reference to Exhibit 10.29 of Noven’s Form 10-K for the year ended September 30, 2003 (File No. 0-17254). | ||
10.27
|
License Agreement between Noven and Endo Pharmaceuticals Inc. dated February 25, 2004 (with certain provisions omitted pursuant to Rule 24b-2).** | Incorporated by reference to Exhibit 10.30 of Noven’s Form 10-K for the year ended December 31, 2003 (File No. 0-17254). | ||
10.28
|
Termination Agreement between Noven and Endo Pharmaceuticals Inc. effective as of December 31, 2005 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.30 of Noven’s Form 10-K for the year ended December 31, 2005 (File No. 0-17254). | ||
10.29
|
Form of Incentive Stock Option Agreement.* | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-17254). | ||
10.30
|
Form of Non-Qualified Stock Option Agreement.* | Incorporated by reference to Exhibit 10.2 of Noven’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-17254). | ||
10.31
|
Form of Non-Qualified Stock Option Agreement (Non-Employee Director).* | Incorporated by reference to Exhibit 10.3 of Noven’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-17254). | ||
10.32
|
Letter Agreement between Noven and Proctor & Gamble Pharmaceuticals, Inc., dated December 22, 2004 (with certain provisions omitted pursuant to Rule 24b-2). | Incorporated by reference to Exhibit 10.36 of Noven’s Form 10-K for the year ended December 31, 2004 (File No. 0-17254). | ||
10.33
|
Industrial Long-Term Lease, dated February 22, 2005, between Noven and Deerwood Commerce Center LLC.** | Incorporated by reference to Exhibit 10.37 of Noven’s Form 10-K for the year ended December 31, 2004 (File No. 0-17254). |
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| Exhibit | ||||
| Number | Description | Method of Filing | ||
10.34
|
Noven Pharmaceuticals, Inc. Nonqualified Deferred Compensation Plan, as amended and restated September 15, 2006.* | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended September 30, 2006 (File No. 0-17254). | ||
10.35
|
Form of Stock Appreciation Rights Agreement (Employee).* | Incorporated by reference to Exhibit 10.1 of Noven’s Form 10-Q for the quarter ended March 31, 2006 (File No. 0-17254). | ||
10.36
|
Form of Restricted Stock Agreement.* | Incorporated by reference to Exhibit 10.1 of Noven’s Form 8-K dated May 22, 2006 (File No. 0-17254). | ||
11
|
Computation of Earnings per Share. | Filed herewith. | ||
21
|
Subsidiaries of the Registrant. | Filed herewith. | ||
23.1
|
Consent of Deloitte & Touche LLP. | Filed herewith. | ||
23.2
|
Consent of PricewaterhouseCoopers LLP. | Filed herewith. | ||
31.1
|
Certification of Robert C. Strauss, President, Chief Executive Officer and Chairman of the Board, pursuant to Securities Exchange Act Rules 13a-15(c) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | Filed herewith. | ||
31.2
|
Certification of Diane M. Barrett, Vice President and Chief Financial Officer, pursuant to Securities Exchange Act Rules 13a-15(c) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | Filed herewith. | ||
32.1
|
Certification of Robert C. Strauss, President, Chief Executive Officer and Chairman of the Board, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*** | Furnished herewith. | ||
32.2
|
Certification of Diane M. Barrett, Vice President and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*** | Furnished herewith. |
| * | Compensation Plan or Agreement. | |
| ** | Certain exhibits and schedules to this document have not been filed. The Registrant agrees to furnish a copy of any omitted schedule or exhibit to the Securities and Exchange Commission upon request. | |
| *** | Pursuant to Item 601(b) (32) of Regulation S-K, this exhibit is furnished rather than filed with this Annual Report on Form 10-K. |
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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.
| Date: March 12, 2007 | NOVEN PHARMACEUTICALS, INC. |
|||
| By: | /s/ Robert C. Strauss | |||
| Robert C. Strauss | ||||
| President, Chief Executive Officer and Chairman of the Board | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
| Signature | Title | Date | ||||
By:
|
/s/ Robert C. Strauss | Principal Executive | March 12, 2007 | |||
| Robert C. Strauss | Officer and Chairman | |||||
| (President, CEO & Chairman of the Board) | of the Board | |||||
By:
|
/s/ Diane M. Barrett | Principal Financial | March 12, 2007 | |||
| Diane M. Barrett | and Accounting Officer | |||||
| (Vice President & Chief Financial Officer) |
||||||
By:
|
/s/ Sidney Braginsky | Director | March 12, 2007 | |||
| Sidney Braginsky | ||||||
By:
|
/s/ John G. Clarkson, M.D. | Director | March 12, 2007 | |||
| John G. Clarkson, M.D. | ||||||
By:
|
/s/ Donald A. Denkhaus | Director | March 12, 2007 | |||
| Donald A. Denkhaus | ||||||
By:
|
/s/ Pedro P. Granadillo | Director | March 12, 2007 | |||
| Pedro P. Granadillo | ||||||
By:
|
/s/ Robert G. Savage | Director | March 12, 2007 | |||
| Robert G. Savage | ||||||
By:
|
/s/ Wayne P. Yetter | Director | March 12, 2007 | |||
| Wayne P. Yetter | ||||||
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INDEX TO FINANCIAL STATEMENTS
| Page | ||||
NOVEN PHARMACEUTICALS, INC. |
||||
| 87 | ||||
FINANCIAL STATEMENTS |
||||
| 88 | ||||
| 89 | ||||
| 90 | ||||
| 91 | ||||
| 92 | ||||
VIVELLE VENTURES, LLC |
||||
(d/b/a NOVOGYNE PHARMACEUTICALS) |
||||
(a significant unconsolidated joint venture) |
||||
| 129 | ||||
FINANCIAL STATEMENTS |
||||
| 130 | ||||
| 131 | ||||
| 132 | ||||
| 133 | ||||
Notes to Financial Statements |
134 | |||
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Noven Pharmaceuticals, Inc.:
Noven Pharmaceuticals, Inc.:
We have audited the accompanying balance sheets of Noven Pharmaceuticals, Inc. (“Noven”) as of
December 31, 2006 and 2005, and the related statements of operations, stockholders’ equity, and
cash flows for each of the three years in the period ended December 31, 2006. These financial
statements are the responsibility of Noven’s management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the financial
statements of Vivelle Ventures LLC (d/b/a Novogyne Pharmaceuticals), Noven’s investment in which is
accounted for by use of the equity method, for the years ended December 31, 2006, 2005, and 2004.
Noven’s equity in Vivelle Ventures LLC of $23,296,000 and $23,243,000 at December 31, 2006 and
2005, respectively, and Noven’s share of that joint venture’s income of $28,632,000, $24,655,000
and $17,641,000 for the years ended December 31, 2006, 2005, 2004, respectively, are included in
the accompanying financial statements. Such financial statements of Vivelle Ventures LLC were
audited by other auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for such joint venture for 2006, 2005, and 2004, is based solely on
the report of such other auditors.
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 audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of the other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, such financial statements
present fairly, in all material respects, the financial position of Noven Pharmaceuticals, Inc. as
of December 31, 2006 and 2005 and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2006, in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 2 to the financial statements, Noven changed its method of accounting for
stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123
Revised, “Share-Based Payment” on January 1, 2006.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of the Company’s internal control over financial reporting
as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated
March 12, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of
the Company’s internal control over financial reporting and an unqualified opinion on the
effectiveness of the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
March 12, 2007
Certified Public Accountants
Miami, Florida
March 12, 2007
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NOVEN PHARMACEUTICALS, INC.
Balance Sheets
December 31, 2006 and 2005
(in thousands, except share data)
December 31, 2006 and 2005
(in thousands, except share data)
| 2006 | 2005 | |||||||
Assets |
||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | 9,144 | $ | 66,964 | ||||
Short-term investments available-for-sale, at fair value |
144,455 | 17,900 | ||||||
Trade receivable (less allowance for doubtful
accounts of $67 in 2006 and $53 in 2005) |
5,038 | 2,919 | ||||||
Milestone payment receivable — Shire |
25,000 | — | ||||||
Accounts receivable — Novogyne, net |
7,693 | 8,912 | ||||||
Inventories |
8,651 | 7,861 | ||||||
Net deferred income tax asset, current portion |
4,400 | 6,000 | ||||||
Prepaid income taxes |
3,416 | 7,697 | ||||||
Prepaid and other current assets |
2,410 | 1,357 | ||||||
| 210,207 | 119,610 | |||||||
Property, plant and equipment, net |
37,010 | 34,455 | ||||||
Other Assets: |
||||||||
Investment in Novogyne |
23,296 | 23,243 | ||||||
Net deferred income tax asset |
8,308 | 6,373 | ||||||
Patent development costs, net |
2,317 | 2,211 | ||||||
Deposits and other assets |
227 | 18 | ||||||
| 34,148 | 31,845 | |||||||
| $ | 281,365 | $ | 185,910 | |||||
Liabilities and Stockholders’ Equity |
||||||||
Current Liabilities: |
||||||||
Accounts payable and accrued expenses |
$ | 4,765 | $ | 5,812 | ||||
Capital lease obligation — current portion |
109 | 121 | ||||||
Accrued liability — Shire |
419 | 5,488 | ||||||
Accrued compensation and related liabilities |
5,308 | 5,771 | ||||||
Other accrued liabilities |
2,085 | 2,124 | ||||||
Deferred rent credit |
89 | 89 | ||||||
Deferred contract revenues |
1,527 | 1,481 | ||||||
Deferred license revenues — current portion |
15,084 | 7,602 | ||||||
| 29,386 | 28,488 | |||||||
Long-Term Liabilities: |
||||||||
Capital lease obligation |
279 | — | ||||||
Deferred rent credit |
659 | 748 | ||||||
Deferred license revenues |
74,188 | 16,053 | ||||||
Deferred compensation liability |
178 | — | ||||||
| 104,690 | 45,289 | |||||||
Commitments and Contingencies (Note 6 and 15) |
||||||||
Stockholders’ Equity: |
||||||||
Preferred stock — authorized 100,000 shares of $.01 par
value; no shares issued or outstanding |
— | — | ||||||
Common stock — authorized 80,000,000 shares,
par value $.0001 per share; issued and
outstanding 24,661,169 in 2006 and
23,617,221 in 2005 |
2 | 2 | ||||||
Additional paid-in capital |
109,912 | 89,846 | ||||||
Retained earnings |
66,761 | 50,773 | ||||||
| 176,675 | 140,621 | |||||||
| $ | 281,365 | $ | 185,910 | |||||
The accompanying notes are an integral part of these statements.
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NOVEN PHARMACEUTICALS, INC.
Statements of Operations
Years Ended December 31, 2006, 2005 and 2004
(in thousands, except per share amounts)
Years Ended December 31, 2006, 2005 and 2004
(in thousands, except per share amounts)
| 2006 | 2005 | 2004 | ||||||||||
Revenues: |
||||||||||||
Product revenues — Novogyne: |
||||||||||||
Product sales |
$ | 19,714 | $ | 19,910 | $ | 18,798 | ||||||
Royalties |
6,845 | 6,444 | 5,204 | |||||||||
Total product revenues — Novogyne |
26,559 | 26,354 | 24,002 | |||||||||
Product revenues — third parties |
21,767 | 14,097 | 12,869 | |||||||||
Total product revenues |
48,326 | 40,451 | 36,871 | |||||||||
Contract and license revenues: |
||||||||||||
Contract |
1,966 | 2,528 | 5,021 | |||||||||
License |
10,397 | 9,553 | 3,999 | |||||||||
Contract and license revenues |
12,363 | 12,081 | 9,020 | |||||||||
Net revenues |
60,689 | 52,532 | 45,891 | |||||||||
Expenses: |
||||||||||||
Cost of products sold — Novogyne |
14,102 | 13,547 | 11,413 | |||||||||
Cost of products sold — third parties |
22,406 | 20,500 | 9,101 | |||||||||
Research and development |
11,454 | 13,215 | 9,498 | |||||||||
Marketing, general and administrative |
21,701 | 16,915 | 17,271 | |||||||||
Total expenses |
69,663 | 64,177 | 47,283 | |||||||||
Loss from operations |
(8,974 | ) | (11,645 | ) | (1,392 | ) | ||||||
Equity in earnings of Novogyne |
28,632 | 24,655 | 17,641 | |||||||||
Interest income, net |
4,272 | 2,242 | 999 | |||||||||
Income before income taxes |
23,930 | 15,252 | 17,248 | |||||||||
Provision for income taxes |
7,942 | 5,280 | 6,024 | |||||||||
Net income |
$ | 15,988 | $ | 9,972 | $ | 11,224 | ||||||
Basic earnings per share |
$ | 0.67 | $ | 0.42 | $ | 0.48 | ||||||
Diluted earnings per share |
$ | 0.66 | $ | 0.42 | $ | 0.46 | ||||||
Weighted average number of common shares outstanding: |
||||||||||||
Basic |
23,807 | 23,566 | 23,332 | |||||||||
Diluted |
24,252 | 23,981 | 24,305 | |||||||||
The accompanying notes are an integral part of these statements.
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NOVEN PHARMACEUTICALS, INC.
Statements of Stockholders’ Equity
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
| Additional | ||||||||||||||||||||
| Common Stock | Paid-in | Retained | ||||||||||||||||||
| Shares | Amount | Capital | Earnings | Total | ||||||||||||||||
Balance at December 31, 2003 |
22,722 | $ | 2 | $ | 79,244 | $ | 29,577 | $ | 108,823 | |||||||||||
Issuance of shares pursuant to employee
equity plan, net |
757 | — | 5,924 | — | 5,924 | |||||||||||||||
Issuance of stock to outside
directors |
2 | — | 34 | — | 34 | |||||||||||||||
Tax benefit from exercise of employee
equity grants |
— | — | 3,034 | — | 3,034 | |||||||||||||||
Net income |
— | — | — | 11,224 | 11,224 | |||||||||||||||
Balance at December 31, 2004 |
23,481 | 2 | 88,236 | 40,801 | 129,039 | |||||||||||||||
Issuance of shares pursuant to employee
equity plan, net |
136 | — | 1,290 | — | 1,290 | |||||||||||||||
Tax benefit from exercise of employee
equity grants |
— | — | 281 | — | 281 | |||||||||||||||
Compensation expense related to
accelerated options |
— | — | 39 | — | 39 | |||||||||||||||
Net income |
— | — | — | 9,972 | 9,972 | |||||||||||||||
Balance at December 31, 2005 |
23,617 | 2 | 89,846 | 50,773 | 140,621 | |||||||||||||||
Issuance of shares pursuant to employee
equity plan, net |
1,040 | — | 13,224 | — | 13,224 | |||||||||||||||
Stock-based compensation expense and
issuance of shares to outside directors |
4 | — | 3,286 | — | 3,286 | |||||||||||||||
Tax benefit from exercise of employee
equity grants |
— | — | 3,556 | — | 3,556 | |||||||||||||||
Net income |
— | — | — | 15,988 | 15,988 | |||||||||||||||
Balance at December 31, 2006 |
24,661 | $ | 2 | $ | 109,912 | $ | 66,761 | $ | 176,675 | |||||||||||
The accompanying notes are an integral part of these statements.
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NOVEN PHARMACEUTICALS, INC.
Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
| 2006 | 2005 | 2004 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net income |
$ | 15,988 | $ | 9,972 | $ | 11,224 | ||||||
Adjustments to reconcile net income to net cash flows
provided by operating activities: |
||||||||||||
Depreciation, amortization and certain other noncash items |
4,429 | 3,126 | 3,222 | |||||||||
Write-off of fentanyl inventories deemed non-saleable |
— | 9,475 | — | |||||||||
Stock based compensation expense |
3,286 | — | — | |||||||||
Income tax benefits on exercise of stock options |
3,556 | 281 | 3,034 | |||||||||
Excess tax deduction from exercise of stock options |
(2,590 | ) | — | — | ||||||||
Deferred income tax (benefit) expense |
(335 | ) | 2,566 | 5,236 | ||||||||
Recognition of deferred license revenues |
(10,397 | ) | (9,553 | ) | (3,999 | ) | ||||||
Equity in earnings of Novogyne |
(28,632 | ) | (24,655 | ) | (17,641 | ) | ||||||
Distributions from Novogyne |
26,368 | 26,187 | 18,083 | |||||||||
Changes in operating assets and liabilities: |
||||||||||||
(Increase) decrease in trade receivable, net |
(2,119 | ) | 2,476 | (1,586 | ) | |||||||
Increase in milestone payment receivable — Shire |
(25,000 | ) | — | — | ||||||||
Decrease (increase) in accounts receivable – Novogyne, net |
1,219 | 1,186 | (3,778 | ) | ||||||||
Increase in inventories |
(790 | ) | (1,348 | ) | (10,788 | ) | ||||||
Decrease (increase) in prepaid income taxes |
6,492 | 3,105 | (5,497 | ) | ||||||||
Increase in prepaid and other current assets |
(1,053 | ) | (119 | ) | (173 | ) | ||||||
(Increase) decrease in deposits and other assets |
(15 | ) | 3 | (7 | ) | |||||||
(Decrease) increase in accounts payable and accrued expenses |
(1,047 | ) | (6,364 | ) | 8,206 | |||||||
(Decrease) increase in accrued liability — Shire |
(5,069 | ) | (5,099 | ) | 10,497 | |||||||
(Decrease) increase in accrued compensation and related liabilities |
(463 | ) | 9 | 2,028 | ||||||||
Decrease in other accrued liabilities |
(39 | ) | (891 | ) | (575 | ) | ||||||
Increase (decrease) in deferred contract revenue, net |
46 | (595 | ) | 1,304 | ||||||||
Increase in deferred license revenue |
76,000 | — | 6,500 | |||||||||
Increase in deferred compensation |
178 | — | — | |||||||||
Amounts reimbursable to Shire and offset against deferred
license revenue related to Daytrana™ approval |
14 | (5,877 | ) | (13,421 | ) | |||||||
Cash flows provided by operating activities |
60,027 | 3,885 | 11,869 | |||||||||
Cash flows from investing activities: |
||||||||||||
Purchases of property, plant and equipment, net |
(6,261 | ) | (13,669 | ) | (6,529 | ) | ||||||
Payments for patent development costs, net |
(616 | ) | (486 | ) | (586 | ) | ||||||
Purchase of company-owned life insurance |
(185 | ) | — | — | ||||||||
Purchases of short-term investments |
(1,298,424 | ) | (516,505 | ) | — | |||||||
Proceeds from sale of short-term investments |
1,171,975 | 498,605 | — | |||||||||
Cash flows used in investing activities |
(133,511 | ) | (32,055 | ) | (7,115 | ) | ||||||
Cash flows from financing activities: |
||||||||||||
Issuance of common stock from exercise of stock options |
13,224 | 1,290 | 5,924 | |||||||||
Excess tax benefit from exercise of stock options |
2,590 | — | — | |||||||||
Payments under capital leases |
(150 | ) | (114 | ) | (101 | ) | ||||||
Cash flows provided by financing activities |
15,664 | 1,176 | 5,823 | |||||||||
Net (decrease) increase in cash and cash equivalents |
(57,820 | ) | (26,994 | ) | 10,577 | |||||||
Cash and cash equivalents, beginning of year |
66,964 | 93,958 | 83,381 | |||||||||
Cash and cash equivalents, end of year |
$ | 9,144 | $ | 66,964 | $ | 93,958 | ||||||
The accompanying notes are an integral part of these statements.
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NOVEN PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS
| 1. | DESCRIPTION OF BUSINESS: | |
| Noven Pharmaceuticals, Inc. (“Noven”) was incorporated in Delaware in 1987 and is engaged in the research, development, manufacture and marketing of advanced transdermal drug delivery technologies and prescription transdermal products. | ||
| Noven and Novartis Pharmaceuticals Corporation (“Novartis”) entered into a joint venture, Vivelle Ventures LLC (d/b/a Novogyne Pharmaceuticals) (“Novogyne”), effective May 1, 1998, to market and sell women’s prescription healthcare products in the United States and Canada. These products include Noven’s transdermal hormone therapy products delivery systems marketed under the brand names Vivelle-Dot®, Vivelle® and CombiPatch®. Noven accounts for its 49% investment in Novogyne under the equity method and reports its share of Novogyne’s earnings as “Equity in earnings of Novogyne” on its Statements of Operations. Noven defers the recognition of 49% of its profit on products sold to Novogyne until the products are sold by Novogyne to third party customers. | ||
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: | |
| USE OF ESTIMATES: | ||
| The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of 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. | ||
| The most significant estimates made by management include: (i) revenue recognition, including specific estimates related to (a) separating deliverables related to collaborative agreements into separate units of accounting and then recognizing revenues for those separated units at their fair value as earned, (b) estimating when the license period begins and determining the period of recognition when revenues have been earned over estimated product life cycles or length of patents, (c) contract revenues consisting of development fees and milestone payments that require estimates of proportional performance of work completed, (d) estimating allowances for returns for product that has been recalled or that Noven believes is probable of being recalled, (ii) determination of the fair value of employee stock options to determine compensation expense, (iii) the valuation of inventories and the allocation of overhead expenses, (iv) whether or not to capitalize pre-launch inventories and (v) determination of the net realizable value of the net deferred tax asset, estimation of the effective tax rate and income and other tax accruals. |
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| The most significant estimates made by the management of Novogyne impacting Noven’s financial statements include: (i) Novogyne’s testing for impairment of the long-term intangible asset related to the acquisition of the marketing rights to CombiPatch®, (ii) Novogyne’s estimates related to sales allowances and returns at Novogyne and (iii) Novogyne’s provisions for product liability claims and anticipated recovery of insurance related receivables. | ||
| CASH AND CASH EQUIVALENTS: | ||
| Cash and cash equivalents includes all highly liquid investments with an original maturity of three months or less at the date of purchase. Cash and cash equivalents as of December 31, 2006 and 2005, consisted primarily of overnight money market accounts, time deposits, commercial paper and money market funds with original maturities of three months or less at the date of purchase. | ||
| INVESTMENTS AVAILABLE-FOR-SALE: | ||
| Beginning in the first quarter of 2005, Noven invested a portion of its cash in short-term investments, which primarily consist of investment grade, asset backed, variable rate debt obligations and municipal auction rate securities, which are categorized as available-for-sale under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115 “Accounting for Certain Investments in Debt and Equity Securities”. Although the contractual maturities of the auction rate securities and the variable rate demand bonds are greater than one year, they are classified as short-term investments available-for-sale due to the fact that interest rate auctions will occur periodically within the next year for the auction rate securities, and the variable rate demand bonds can be tendered for purchase at par whenever rates reset. Noven does not intend to hold these securities for longer than one year. The short-term investments are reported at fair value, with any related unrealized gains and losses included in comprehensive income as a separate component of stockholder’s equity, net of applicable taxes. As of December 31, 2006 and 2005, the cost of all short-term investments approximated fair value. No unrealized gains and losses have been recognized for the years ended December 31, 2006 and 2005, respectively. Realized gains and losses and interest and dividends are included in interest income or interest expense, as appropriate. |
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| As of December 31, 2006 and 2005, Noven’s short-term investments consisted of the following (amounts in thousands): |
| Fair Value | ||||||||
| 2006 | 2005 | |||||||
Short-Term: |
||||||||
Tax-exempt variable rate demand bonds |
$ | 60,360 | $ | 2,900 | ||||
Tax-exempt municipal auction rate
securities |
67,790 | 15,000 | ||||||
Taxable municipal auction rate securities |
2,900 | — | ||||||
Dividend preferred auction rate securities |
2,500 | — | ||||||
Commercial paper |
10,905 | — | ||||||
| $ | 144,455 | $ | 17,900 | |||||
| INVENTORIES: | ||
| Inventories consist primarily of raw materials, work in process and finished goods for Noven’s commercial branded products and under certain circumstances may include pre-launch branded and generic products. Inventory costs include material, labor and manufacturing overhead. As appropriate, Noven reflects provisions necessary to reduce the carrying value of its inventories to net realizable value. Certain raw materials and components used in the manufacture of its products (including essential polymer adhesives and other critical components) are available from limited sources, and in some cases, a single source. In addition, the Drug Enforcement Agency (“DEA”) controls access to controlled substances, including methylphenidate, the active ingredient in Daytrana™. Manufacturers of products containing controlled substances must annually apply to the DEA for procurement quota in order to obtain these substances for manufacturing. | ||
| Other than products produced for commercial sale or to meet the requirements for production of pre-launch inventories, Noven’s policy is to immediately recognize as expense all inventory purchased for research and development purposes. | ||
| Shire plc (“Shire”) retains title to the active methylphenidate ingredient (“AMI”) in Daytrana™. AMI is not included in Daytrana™ product revenues or in Noven’s cost of products sold. Noven records AMI maintained at its manufacturing facility as consignment inventory and bears certain manufacturing risks of loss related to the AMI. These risks include the contractual obligation of Noven to reimburse Shire for the cost of AMI if Noven does not meet certain minimum yields of the finished product. During 2006, Noven used $4.0 million of AMI in the finished product and reimbursed Shire approximately $0.4 million for excess AMI used in production, which amount is included in cost of products sold. Noven had $1.0 million of consignment AMI inventory on hand at December 31, 2006, which is not reflected in the table below. |
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| Commercial Inventories | ||
| Inventories are stated at the lower of cost (first-in, first-out method) or market. Noven evaluates lower of cost or market separately for commercial and pre-launch inventories. In evaluating whether inventory is stated at the lower of cost or market, management considers such factors as the amount of inventory on hand, remaining shelf life and current and expected orders from Noven’s collaboration partners based on market conditions, including levels of competition. | ||
| Pre-Launch Inventories | ||
| Pre-launch inventories consist primarily of Noven’s branded or generic product candidates prior to the date that Noven anticipates that such products will receive final marketing approval from the United States Food and Drug Administration (“FDA”) or the satisfactory resolution of patent infringement litigation, or any other circumstances that will make Noven’s product candidates commercially viable. Noven will capitalize pre-launch quantities into inventories when Noven believes it is probable that (i) a future economic benefit will be derived from the commercialization of the product and/or the risk of pre-launch inventories is transferred to Noven’s collaborative partner, (ii) the FDA will approve the marketing of the product, (iii) Noven will validate its process for manufacturing the product within the specifications that have been or will be approved by the FDA for such product and (iv) particularly in the case of a generic product, Noven will prevail in any patent infringement litigation. In evaluating whether it is probable that Noven will derive future economic benefits from its pre-launch inventories and whether the pre-launch inventories are stated at the lower of cost or market, Noven considers, among other things, the remaining shelf life of that inventory, the current and expected market conditions, the amount of inventory on hand, the substance of communications with the FDA during the regulatory approval process and the views of patent and/or litigation counsel. | ||
| In order to be able to launch the product promptly upon the receipt of FDA approval, Noven must commence the validation process well before the date Noven anticipates the product will be approved. This process may entail a “scale-up” process in which Noven evaluates and, as necessary, modifies the equipment and processes employed in the manufacture of the new product to efficiently manufacture the product. Noven expenses scale-up activities, including the raw material used in such activities. Noven capitalizes direct and indirect manufacturing costs incurred during the manufacture of validation lots that Noven anticipates will be permitted to be sold by the FDA as well as the manufacture of additional product to meet estimated launch demand. | ||
| The manufacture of pre-launch inventories involves the risk that the FDA may not approve such product(s) for marketing on a timely basis or at all, that each approval may require additional or different testing and/or specifications than what was performed in the manufacture of such pre-launch inventory and/or that the results of related litigation may not be satisfactory. If any of these risks were to materialize with respect to a given product or if |
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| the launch of such product is significantly postponed, Noven may record additional provisions, which could be material. Shelf lives of pre-launch inventories generally exceed one year. | ||
| The following are the major classes of inventories as of December 31, 2006 and 2005 (in thousands): |
| December 31, 2006 | December 31, 2005 | |||||||||||||||||||||||
| Commercial | Pre-Launch | Total | Commercial | Pre-Launch | Total | |||||||||||||||||||
Finished goods |
$ | 893 | $ | — | $ | 893 | $ | 760 | $ | — | $ | 760 | ||||||||||||
Work in progress |
2,851 | — | 2,851 | 1,278 | 1,004 | 2,282 | ||||||||||||||||||
Raw materials |
4,907 | — | 4,907 | 3,422 | 1,397 | 4,819 | ||||||||||||||||||
| $ | 8,651 | $ | — | $ | 8,651 | $ | 5,460 | $ | 2,401 | $ | 7,861 | |||||||||||||
| Pre-launch inventories as of December 31, 2005 consisted of Noven’s Daytrana™ product, which received final approval from the FDA in April 2006 and was commercially launched in June 2006. | ||
| COST OF PRODUCTS SOLD: | ||
| Direct and indirect costs of manufacturing are included in cost of products sold. Indirect costs include overhead costs, which consist of salaries and benefits, supplies and tools, equipment costs, depreciation and insurance costs and represent a substantial portion of Noven’s inventory production costs. Noven uses a standard costing system to estimate its actual FIFO cost of inventory at the end of each reporting period. Unallocated overhead costs are recognized as an expense in the period in which they are incurred. | ||
| PROPERTY, PLANT AND EQUIPMENT: | ||
| Property, plant and equipment consists of the following at December 31, 2006 and 2005 (in thousands, except estimated useful lives): |
| Estimated | ||||||||||||
| Useful Lives | ||||||||||||
| 2006 | 2005 | (in years) | ||||||||||
Land |
$ | 2,540 | $ | 2,540 | ||||||||
Building and improvements |
3,288 | 3,231 | 40 | |||||||||
Leased property and leasehold improvements |
21,529 | 19,231 | 10-31 | |||||||||
Manufacturing and other equipment |
24,036 | 21,628 | 3-10 | |||||||||
Furniture |
2,339 | 1,734 | 10 | |||||||||
Software and software development costs |
5,101 | 4,238 | 3 | |||||||||
| 58,833 | 52,602 | |||||||||||
Less accumulated depreciation and
amortization |
(21,823 | ) | (18,147 | ) | ||||||||
| $ | 37,010 | $ | 34,455 | |||||||||
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| Property, plant and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets ranging up to 40 years. Leasehold improvements are amortized over the life of the lease or the service life of the improvements, whichever is shorter. Major renewals and betterments are capitalized, while maintenance repairs and minor renewals are expensed as incurred. During 2006, 2005, and 2004 depreciation expense was $4.0 million, $2.7 million, and $2.3 million, respectively. | ||
| SOFTWARE AND DEVELOPMENT COSTS: | ||
| Noven capitalizes purchased software which is ready for service and development costs for marketable software incurred from the time the preliminary project stage is completed until the software is ready for use. Under the provisions of SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”, Noven capitalizes costs associated with software developed or obtained for internal use from the time the preliminary project stage is completed until the software is ready for use. Capitalized costs include only: (i) external direct costs of materials and services consumed in developing or obtaining internal-use software and (ii) payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal-use software project. Capitalization of such costs ceases no later than the point at which the project is substantially complete and ready for its intended purpose. For the years ended December 31, 2006 and 2005, approximately $0.9 million and $1.2 million, respectively, of these costs were capitalized. | ||
| Computer software maintenance costs related to software development are expensed as incurred. Software development costs are amortized using the straight-line method over three years, but not exceeding the expected life of the product. | ||
| IMPAIRMENT OF LONG-LIVED ASSETS: | ||
| Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the fair value is less than the carrying amount of the asset, a loss is recognized for the difference. Fair value is determined based on market quotes, if available, or is based on valuation techniques. | ||
| PATENT DEVELOPMENT COSTS: | ||
| Costs related to the development of patents, principally legal fees, are capitalized and amortized over the lesser of their estimated economic useful lives or their remaining legal lives and included in cost of products sold. Amortization expense was $0.5 million for 2006 and $0.4 million for each of 2005 and 2004. | ||
| INCOME TAXES: | ||
| Noven accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109 provides that income taxes are accounted for using an asset and liability method |
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| which requires the recognition of deferred income tax assets and liabilities for expected future tax consequences of temporary differences between tax bases and financial reporting carrying values of assets and liabilities. In addition, if Noven is assessed interest and/or penalties by governing jurisdictions, Noven includes those amounts in its tax provision. In July 2006, the FASB issued FIN 48 to clarify the accounting for uncertainties related to income taxes that are recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 is effective as of the beginning of the first annual reporting period that begins after December 15, 2006. Noven is evaluating the impact of adopting FIN 48 on Noven’s results of operations and financial condition (see Note 7). | ||
| COMMITMENTS AND CONTINGENCIES: | ||
| Noven accounts for commitments and contingencies in accordance with the provisions of SFAS No. 5, “Accounting for Contingencies”. SFAS 5 provides that accruals are to be established for contingencies that are probable and estimable. However, the estimation of the amount to accrue usually requires significant judgment. The establishment of allowances for returns related to product recalls requires Noven to make assumptions about future expected returns, actual returns, distribution and expiration dates of the affected product and overall trade inventory levels. Noven’s policy is to accrue for estimated legal fees and settlement costs related to litigation when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. Receivables for insurance recoveries related to litigation under Noven’s third party insurance policies are recorded when it is probable that recovery will be realized. Litigation accruals for estimated legal fees and settlement costs require Noven to make assumptions about the future outcome of each case based on current information and expected legal fees that will be incurred and expected insurance recovery, if any. Accruals for tax contingencies require Noven to make assumptions based upon management’s best estimate of possible assessments by taxing authorities and are adjusted, from time to time, based upon changing facts and circumstances (see Notes 7 and 15). | ||
| REVENUE RECOGNITION: | ||
| Substantially all of Noven’s product revenues were for sales to its licensees, Novogyne, Novartis Pharma AG and its affiliates (“Novartis Pharma”), Shire and sanofi-aventis (“Aventis”) (see Notes 4 and 5). Revenues from product sales are recognized at the time of shipment when both title and the risks and rewards of ownership have been transferred to the buyer. Certain of Noven’s license agreements provide that the ultimate supply price is based on a percentage of the licensee’s net selling price. Each of those agreements also establishes a fixed minimum supply price per unit that represents the lowest price Noven is entitled to receive on sales to the licensee. Noven receives the minimum price at the time of shipment with the possibility of an upward adjustment later when the licensee’s net selling price is known. Revenues under these agreements are recorded at the minimum price at the time of shipment. Noven records any upward adjustments to revenues at the time that the information necessary to make the determination is received from the licensee. If the upward adjustments |
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| are not determinable, Noven records the adjustments on a cash basis. These amounts are included in product revenues. | ||
| Royalty revenues consist of royalties payable by Novogyne and Novartis Pharma from sales of Vivelle® and Vivelle-Dot®/Estradot® in the United States and Canada. Noven accrues royalties from Novogyne’s and Novartis Pharma’s product sales each quarter based on Novogyne’s and Novartis Pharma’s net sales for that quarter. Royalties are included in product revenues. | ||
| Noven enters into certain contracts that have various terms and conditions that may have multiple revenue characteristics, including license revenues, contract revenues, product sales and manufacturing revenues. As prescribed by Emerging Issues Task Force 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”, Noven analyzes each contract in order to separate each deliverable into separate units of accounting and then recognize revenues for those separated units at their fair value as earned in accordance with the Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin Topic 13, “Revenue Recognition” (“SAB Topic 13”) or other applicable revenue recognition guidance. If each deliverable does not qualify as a separate unit of accounting, the deliverables are combined and the amounts under the contract are allocated to the combined deliverables. The appropriate recognition of revenue is then determined for the combined deliverables as a single unit of accounting. | ||
| License revenues consist of up-front, milestone and similar payments under license agreements and are not recognized until earned under the terms of the applicable agreements. In most cases, license revenues are deferred and recognized over the estimated product life cycle, which is management’s best estimate of the earning period. | ||
| Contract revenues consist of contract payments related to research and development projects performed for third parties. The work performed by Noven includes feasibility studies to determine if a specific drug is amenable to transdermal drug delivery, the actual formulation of a specific drug into a transdermal drug delivery system, studies to address the ongoing stability of the drug in a transdermal drug delivery system and manufacturing of batches of product that can be used in human clinical trials. Noven receives contract payments for the work it performs in the following forms: |
| • | nonrefundable up-front payments prior to commencing the work (or certain phases of the work); | ||
| • | additional payments upon completion of additional phases; and | ||
| • | in some cases, success milestone payments based on achievement of specified performance criteria. |
| For non-refundable up-front payments received prior to commencing work, Noven recognizes revenue based on the proportionate share of the work performed by Noven in any given period based on the total hours it expects to incur on the project to deliver all its obligations under the contract. Additional payments upon completion of additional phases and |
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| milestone payments are recorded when the specified performance criteria are achieved, as determined by the customer. The difference between the amount of the payments received and the amount recognized is recorded as deferred revenues until that amount is earned. | ||
| Product revenues are net of an allowance for returns, if any. Noven establishes allowances for returns for product that has been recalled or that it believes is probable of being recalled. The methodology used by Noven to estimate product recall returns is based on the distribution and expiration dates of the affected product and overall trade inventory levels. These estimates are based on currently available information, and the ultimate outcome may be significantly different than the amounts estimated given the subjective nature and complexities inherent in this area and in the pharmaceutical industry. | ||
| Noven believes that its revenue recognition policy is in compliance with the requirements of SEC Staff Accounting Bulletin Topic 13. | ||
| VENDOR DISCOUNTS: | ||
| Noven receives purchase-volume-related discounts and rebates from vendors in the normal course of business. Management uses projected purchase volumes to estimate accrual rates, validates those projections based on actual purchase trends and applies those rates to actual purchase volumes to determine the amount of funds accrued by Noven and receivable from the vendor. Amounts accrued could be impacted if actual purchase volumes differ from projected purchase volumes. Purchase-volume-related discounts or rebates are treated as a reduction of inventory cost or cost of products sold, depending on whether the related inventory is on-hand or has been previously sold. | ||
| RESEARCH AND DEVELOPMENT COSTS: | ||
| Research and development costs include costs of internally generated research and development activities and costs associated with work performed under agreements with third parties. Research and development costs are expensed as incurred and include direct and allocated expenses, which includes costs associated with, among other things, product formulation, pre-clinical testing, clinical studies, regulatory and medical affairs, production of product for clinical and regulatory purposes, production engineering for developmental products, and the personnel associated with each of these functions. | ||
| EARNINGS PER SHARE: | ||
| Noven computes its Earnings Per Share in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share”. Basic earnings per share excludes all dilution. It is based on income attributable to common stockholders and the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects an estimate of the potential dilution that would occur if securities or other contracts to issue common stock that Noven issues were exercised or converted into common stock. Common stock equivalents are not included in the diluted earnings per share calculation if the effect of |
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| their inclusion would be antidilutive. The total number of common stock equivalents not included in the diluted earnings per share calculation as of December 31, 2006, 2005 and 2004 was 421,813, 2,019,863, and 1,360,983 shares, respectively, which amounts represent out-of-the-money stock options. | ||
| COMPREHENSIVE INCOME: | ||
| For the years ended December 31, 2006, 2005 and 2004, total comprehensive income was equal to net income. | ||
| EMPLOYEE STOCK PLANS: | ||
| On January 1, 2006, Noven adopted the provisions of, and began accounting for stock-based compensation in accordance with, Statement of Financial Accounting Standards No. 123 Revised, “Share Based Payment” (“SFAS 123(R)”). Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. Noven elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123(R) apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the grant date fair value previously calculated for the SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) pro forma disclosures requisite. | ||
| Noven currently uses the Black-Scholes option pricing model to determine the fair value of stock options and stock-settled stock appreciation rights (“SSARs”). The grant date fair value of stock-based payment awards using an option-pricing model is affected by Noven’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include Noven’s expected stock price volatility over the expected term of the awards, actual and projected employee equity award exercise behaviors, risk-free interest rate, estimated forfeitures of awards and expected dividends. | ||
| Noven estimates the expected term of options granted by taking the average of the vesting term and the contractual term of the option, as described in the SEC’s Staff Accounting Bulletin Topic 14: Share-Based Payment (SAB 107) (“SAB 107”). Noven estimates the volatility of common stock by using a combination of both historical and implied volatility based on an equal weighting of each, as management believes it is the expected volatility that marketplace participants would likely use in determining an exchange price for an option. Noven bases the risk-free interest rate that Noven uses in the option valuation model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. Noven does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. Noven estimates forfeitures based on historical data at the time of grant and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. All stock-based payment |
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| awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. The fair value of each SSAR/option granted during 2006, 2005 and 2004 is estimated to be $10.94, $8.64 and $13.10, respectively, on the date of the grant using the Black-Scholes option-pricing model with the assumptions below: |
| 2006 | 2005 | 2004 | ||||||||||
Volatility |
49.2 | % | 69.0 | % | 69.0 | % | ||||||
Risk free interest rate |
4.67 | % | 4.30 | % | 3.49 | % | ||||||
Expected life (years) |
5 | 5 | 5 | |||||||||
| Total pre-tax stock-based compensation recognized in Noven’s statement of operations for the period ended December 31, 2006 was $3.3 million, of which $2.5 million was recognized in marketing, general and administrative and $0.4 million was recognized in each of research and development and cost of products sold, respectively. The tax benefit recognized related to compensation expense was $0.9 million. There were no stock-based compensation costs capitalized as part of inventory or fixed assets for the year ended December 31, 2006. | ||
| Prior to the adoption of SFAS 123(R), Noven presented all tax benefits for deductions resulting from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options as operating cash flows on its statement of cash flows. SFAS 123(R) requires the benefits of tax deductions in excess of those recognized in conjunction with compensation expense, to be reported as a financing cash flow, rather than as an operating cash flow. This requirement has the effect of reducing net operating cash flows and increasing net financing cash flows in periods in and after adoption. However, under this requirement, total cash flow remains unchanged from what would have been reported under prior accounting rules. Cash received from options exercised under all share-based payment arrangements for the period ended December 31, 2006, 2005 and 2004 was $13.2 million, $1.3 million and $5.9 million, respectively. The tax benefit realized on the tax deductions from option exercises under stock-based compensation arrangements totaled $3.6 million, $0.3 million and $3.0 million for the periods ended December 31, 2006, 2005 and 2004, respectively, of which $2.6 million was reported as a financing cash flow for the period ended December 31, 2006. There were no amounts reported as financing cash flow for the periods ended December 31, 2005 and 2004. The total intrinsic value of all option exercises for each of the years ended December 31, 2006, 2005 and 2004 were $10.5 million, $0.9 million and $9.8 million, respectively. | ||
| At December 31, 2006, the unamortized compensation expense that Noven expects to record in future periods related to currently outstanding unvested stock options, SSARs and nonvested shares (“restricted stock”), as determined in accordance with SFAS 123(R), is approximately $8.3 million before the effect of income taxes, of which $3.5 million, $2.4 million, $1.6 million and $0.8 million is expected to be incurred in 2007, 2008, 2009 and 2010, respectively. |
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| In accordance with the modified prospective transition method, Noven’s financial statements for prior periods have not been restated and do not include the impact of SFAS 123(R). Accordingly, no compensation expense related to stock option awards was recognized in 2005 or 2004, as all stock options granted had an exercise price equal to the fair market value of the underlying common stock on the date of grant. The following table shows the effect on net income and income per share as if the fair-value-based method of accounting had been applied to all outstanding and unvested stock option awards prior to adoption for SFAS 123(R) (in thousands, except per share amounts): |
| 2005 | 2004 | |||||||
Net income: |
||||||||
As reported |
$ | 9,972 | $ | 11,224 | ||||
Total stock-based employee
compensation expense determined
under fair value based method for
all
awards, net of related tax effects |
(14,145 | ) | (5,842 | ) | ||||
Pro forma |
$ | (4,173 | ) | $ | 5,382 | |||
Basic earnings per share: |
||||||||
As reported |
$ | 0.42 | $ | 0.48 | ||||
Pro forma |
$ | (0.18 | ) | $ | 0.23 | |||
Diluted earnings per share: |
||||||||
As reported |
$ | 0.42 | $ | 0.46 | ||||
Pro forma |
$ | (0.18 | ) | $ | 0.22 | |||
| In order to eliminate some of the future compensation expense that Noven would otherwise recognize in its statement of operations upon adoption of SFAS 123(R), during 2005 the Compensation Committee of the Board of Directors of Noven approved the acceleration of vesting of certain stock options under the Noven 1999 Long-Term Incentive Plan (the “1999 Plan”). As a result of this action, options to purchase approximately 1.1 million shares of Noven’s common stock became immediately exercisable, including options held by Noven’s executive officers to purchase approximately 455,000 shares. Noven recorded an immaterial charge to compensation expense during 2005 due to the acceleration of a nominal amount of in-the-money options. As a result of the acceleration, during 2005, approximately $10.1 million of future compensation expense, net of applicable income taxes, was eliminated from Noven’s future statement of operations and included in the pro forma footnote disclosure above for 2005. | ||
| SEGMENT INFORMATION: | ||
| Noven is engaged principally in one line of business – the development and commercialization of advanced transdermal drug delivery products and technologies and prescription transdermal products. See Note 13 for disclosures about geographic areas and |
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| major customers in accordance with Statement of Financial Accounting Standards No. 131, “Disclosure about Segments of an Enterprise and Related Information”. | ||
| FAIR VALUE OF FINANCIAL INSTRUMENTS: | ||
| The carrying amounts of financial instruments such as cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses reasonably approximate fair value because of the short term nature of these items. | ||
| CONCENTRATIONS OF CREDIT RISK: | ||
| Noven’s customers currently consist of Novogyne, Novartis Pharma, Shire and a limited number of other pharmaceutical companies with worldwide operations. Noven performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable. Noven maintains an allowance for doubtful accounts based on an assessment of the collectability of such accounts. | ||
| RECLASSIFICATION: | ||
| Certain reclassifications have been made to the prior years’ statement of cash flows to conform to the current year’s presentation. | ||
| RECENT ACCOUNTING PRONOUNCEMENTS: | ||
| In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of SFAS 157 is not expected to have a material impact on Noven’s results of operations or financial condition. | ||
| In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), which added Section N to Topic 1, Financial Statements, of the Staff Accounting Bulletin Series effective the fiscal year ending after November 15, 2006. Section N provides guidance on the consideration of the effects of prior year misstatements when quantifying current year financial statement misstatements for the purpose of materiality assessment. The SEC concluded in SAB 108 that a registrant’s materiality evaluation of an identified unadjusted error should quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements. If either the carryover or reversing effects of prior year misstatements is material, the misstatements should be corrected in the current year. If correcting an error in the current year for prior year misstatements causes the current year to be materially misstated, the prior year financial statements should be corrected, even though such revision previously was and |
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| continues to be immaterial to the prior year financial statements. SAB 108 was adopted on December 31, 2006 and its adoption did not have a material impact on Noven’s results of operations or financial condition. | ||
| In July 2006, the FASB issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”) to clarify the accounting for uncertainties related to income taxes that are recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation requires financial statement recognition of the impact of a tax position, if that position is more likely than not to be sustained on examination, based on the technical merits of the position. FIN 48 is effective as of the beginning of the first annual reporting period that begins after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. Noven is currently evaluating the impact of adopting FIN 48 on its results of operations and financial condition. | ||
| 3. | CASH FLOW INFORMATION: | |
| Cash payments for income taxes were $0.8 million, $1.6 million and $5.4 million in 2006, 2005, and 2004, respectively. Cash payments for interest were $15,000, $12,000, and $18,000 in 2006, 2005 and 2004, respectively. | ||
| Non-cash Operating Activities | ||
| In 2002, the State of New Jersey enacted legislation that requires Novogyne to remit estimated state income tax payments on behalf of its owners, Noven and Novartis. In April 2006, 2005 and 2004 Novogyne paid $2.2 million, $1.5 million and $1.7 million, respectively, to the New Jersey Department of Revenue, representing Noven’s portion of Novogyne’s estimated state income tax payments. These payments were deemed a distribution to Noven from Novogyne. | ||
| Noven recorded a $3.6 million, $0.3 million and $3.0 million income tax benefit to additional paid-in capital derived from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options in 2006, 2005 and 2004, respectively. | ||
| Non-cash Investing Activities | ||
| In 2006 and 2004, Noven entered into capital lease obligations totaling $0.4 and $0.3 million for new equipment, respectively. | ||
| In 2005 Noven recorded approximately $0.9 million in leasehold improvements as a deferred rent credit relating to landlord-funded leasehold improvements. See Note 6 – Operating and Capital Leases. |
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| 4. | CONTRACT AND LICENSE AGREEMENTS: | |
| HORMONE THERAPY COLLABORATIONS | ||
| Noven has license agreements relating to its hormone therapy products with Aventis, Novartis, Novartis Pharma and Novogyne. At the time of the formation of Novogyne, Novartis sublicensed its rights under its license agreement to Novogyne. Noven’s agreement with Novogyne grants Novogyne the right to market Noven’s transdermal estrogen delivery systems in the United States and Canada. Novartis’ Canadian affiliate markets Noven’s advanced estrogen delivery system in Canada. The agreement provides for royalty payments based on sales by Novogyne and Novartis’ Canadian affiliate. | ||
| Aventis Licenses | ||
| Noven has two license agreements with Aventis. These agreements grant Aventis the right to market Noven’s original transdermal estrogen delivery system worldwide except for the United States and Canada and to market Noven’s transdermal combination estrogen/progestin delivery system worldwide. The agreements also grant Aventis the right to market Noven’s advanced transdermal estrogen delivery system in Japan. In June 1992, as part of the license agreements, Aventis funded $7.0 million for the construction of a manufacturing facility for the production by Noven of transdermal drug delivery systems. Noven leases the facilities from Aventis for $1.00 per year for a term that expires upon the earlier of 2024 or the termination of Noven’s license agreement with Aventis. Noven has the right to purchase the facility at any time for Aventis’ book value ($0.7 million as of December 31, 2006), or when fully depreciated, for $1.00. Aventis may terminate the lease prior to the expiration of its term upon termination or expiration of Noven’s 1992 license agreement with Aventis. For accounting purposes, Noven treated the exchange of the funding of the facility for the license as a non-monetary exchange at fair value. Noven has determined that the fair market value of the license was $7.0 million, based on the amount Aventis paid for the construction of the manufacturing facility. Noven recorded both the facility and deferred license revenues at amounts equal to the funds advanced by Aventis, which are deferred and recognized as depreciation expense and license revenues over the life of the underlying lease, which expires in 2024. At December 31, 2006 and 2005, the carrying amount of the leased property and deferred revenues was $3.8 million and $4.1 million, respectively. | ||
| Novartis Pharma Sublicenses from Aventis | ||
| In October 1999, Novartis Pharma sublicensed Aventis’ rights to market (i) Noven’s combination estrogen/progestin transdermal delivery system in all countries other than the United States and Japan, and (ii) Noven’s original estrogen transdermal delivery system in all countries other than the United States, Canada and Japan. |
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| Novartis Pharma License of Estradot® | ||
| In November 2000, Noven entered into an exclusive license agreement with Novartis Pharma pursuant to which Noven granted Novartis Pharma the right to market Noven’s advanced transdermal estrogen delivery system under the name Estradot® in all countries other than the United States, Canada and Japan. The agreement also grants Novartis Pharma marketing rights in the same territories to any product improvements and future generations of estrogen patches developed by Noven. Noven received an up-front license payment of $20.0 million upon execution of the agreement. The up-front payment was deferred and is being recognized as license revenues over 10 years beginning in the fourth quarter of 2000, which is the estimated life of the product. Noven subsequently received a $5.0 million milestone payment in the fourth quarter of 2001 that is being recognized as license revenues beginning in the first quarter of 2002 through the fourth quarter of 2010. | ||
| Novogyne Marketing Rights of CombiPatch® | ||
| Novogyne acquired the exclusive United States marketing rights to CombiPatch® in March 2001 in a series of transactions involving Novogyne, Noven, Novartis and Aventis. Prior to the transaction, Aventis had been Noven’s exclusive licensee for CombiPatch® in the United States. The transaction was structured as (i) a direct purchase by Novogyne from Aventis of certain assets for $25.0 million, which was paid at closing, (ii) a grant-back by Aventis to Noven of certain intellectual property rights relating to CombiPatch®, and (iii) a simultaneous license by Noven to Novogyne of these intellectual property rights. The consideration that was paid by Noven to Aventis, and by Novogyne to Noven, was $40.0 million. Novogyne agreed to indemnify Noven against Noven’s obligation to Aventis. As a consequence of the transaction and under the terms of Noven’s existing license agreement with Aventis, Noven received $3.5 million from Aventis, which amount was deferred and is being recognized as license revenues over 10 years beginning in the first quarter of 2001, which is the estimated life of the product. In a related transaction, Novartis Pharma acquired from Aventis the development and marketing rights to future generations of Noven’s combination estrogen/progestin patch in all markets other than Japan. Due to current regulatory requirements in Europe, Novartis Pharma has elected not to complete development of a next generation combination estrogen/progestin patch. | ||
| ENDO COLLABORATION | ||
| In July 2003, Noven submitted an Abbreviated New Drug Application (“ANDA”) to the FDA seeking approval to market a generic fentanyl patch. Noven entered into an agreement with Endo in the first quarter of 2004 granting Endo the exclusive right to market Noven’s fentanyl patch in the United States. Noven received an up-front payment of $8.0 million from Endo, of which $6.5 million was allocated to license revenue for the fentanyl patch and the remaining $1.5 million was allocated based on fair value to fund feasibility studies that seek to determine whether certain compounds identified by the parties could be delivered through Noven’s transdermal technology. Noven’s agreement provides that Endo would fund and manage clinical development of those compounds proceeding into clinical trials. |
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| In July 2005, the FDA issued a public advisory that it is investigating reports of death and other serious side effects from overdoses involving both the branded and generic fentanyl patches. In September 2005, the FDA advised Noven that it did not expect to approve Noven’s ANDA and was consequently ceasing its review of Noven’s ANDA, based on the FDA’s assessment of potential safety concerns related to the higher drug content in Noven’s generic product versus the branded product. Due to the FDA’s determination, Noven and Endo agreed in December 2005 to terminate the fentanyl portion of the 2004 license agreement as well as the fentanyl supply agreement. In addition, Noven deemed the entire $14.0 million of fentanyl patch inventories on hand at that time to be non-saleable and recorded a $9.5 million charge to cost of products sold in the third quarter of 2005. This charge represents the portion of the cost of the existing fentanyl inventories and purchasing commitments for raw materials allocable to Noven under the contractual formula. Endo was responsible for the remaining $4.5 million of the fentanyl patch production costs, which they paid Noven in the fourth quarter of 2005 less $2.6 million Noven owed Endo for fentanyl raw materials. In addition, Noven incurred approximately $0.4 million in costs associated with disposal and destruction of fentanyl inventories in the fourth quarter of 2005, which was charged to costs of products sold in that quarter. | ||
| Noven is currently evaluating the feasibility of reformulating the fentanyl patch to address the FDA’s concerns, and has granted Endo a right of first negotiation with respect to any reformulated fentanyl patch that it may develop. Noven’s decision to proceed with the fentanyl project is expected to depend upon, among other things, the expense, the timeline and risk of seeking FDA approval, and the size and sustainability of the United States market opportunity at the time Noven’s product would be launched. As a result of the termination and the fact that Noven had no obligation to Endo and no continuing involvement related to the fentanyl license agreement, Noven earned the remaining $5.7 million of previously deferred license revenue and recognized it as license revenue in the fourth quarter of 2005. | ||
| Noven and Endo continue to proceed with other areas of their development collaboration that are unrelated to fentanyl. | ||
| SHIRE COLLABORATION | ||
| Noven has developed a once-daily transdermal methylphenidate patch for Attention Deficit Hyperactivity Disorder called Daytrana™. In the first quarter of 2003 Noven licensed to Shire the exclusive global rights to market Daytrana™ for payments by Shire of up to $150.0 million. In consideration for the transaction Shire agreed to pay Noven as follows: (i) $25.0 million was paid upon closing of the transaction in April 2003; (ii) $50.0 million was paid in April 2006 upon receipt of final marketing approval by the FDA; and (iii) three installments of $25.0 million each are payable upon Shire’s achievement of $25.0 million, $50.0 million and $75.0 million in annual Daytrana™ net sales, respectively. Shire launched the product in June 2006. Noven is currently deferring and recognizing approval and sales milestones as license revenues on a straight-line basis, beginning on the date the milestone is achieved through the first quarter of 2013, which is Noven’s current best estimate of the end of the useful economic life of the product. Shire’s net sales of Daytrana™ exceeded the threshold for the first sales |
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| milestone in the fourth quarter of 2006 and, accordingly, Noven received a $25.0 million payment from Shire in the first quarter of 2007. During 2006, Noven recognized $5.9 million in license revenues related to the Shire collaboration. Noven also manufactures and supplies finished product for Shire and during 2006, Noven’s product sales of Daytrana™ to Shire were $8.6 million. | ||
| In 2004 and 2005, Noven and Shire conducted additional clinical trials that were intended to address clinical issues raised in the not approvable letter Noven received from the FDA in April 2003 relating to Noven’s New Drug Application (“NDA”) for Daytrana™. Beginning in the fourth quarter of 2003, Noven recorded reimbursements to Shire for Shire’s direct costs and certain direct incremental costs incurred by Noven as requested by Shire in pursuit of Daytrana™ regulatory approval. These reimbursements were recorded as a reduction of a portion of the $25.0 million nonrefundable deferred license revenue previously received from Shire. Because Shire had made a significant investment related to licensing Daytrana™, Shire wanted to manage the development program in order to advance Daytrana™ toward approval. Therefore, Noven effectively agreed to reimburse Shire a portion of Shire’s non-refundable license payment for certain costs Shire incurred in pursuit of approval. Furthermore, due to the fact Shire requested that Noven incur certain direct incremental costs in pursuit of approval, Noven treated such costs as reimbursements as well. Such reimbursements and direct incremental costs did not impact Noven’s research and development expenses in 2006, 2005, or 2004, although the reimbursements or amounts reimbursable to Shire reduced Noven’s cash position and also reduced the amount of deferred revenues that Noven is currently recognizing related to the original $25.0 million up-front payment. Upon obtaining Daytrana™ regulatory approval in April 2006, $4.8 million remained in deferred license revenues of the original $25.0 million, which is currently being recognized on a straight-line basis as license revenue from the date of approval through the first quarter of 2013. | ||
| In addition to Noven’s agreements with Shire related to Daytrana™, in June 2004 Noven entered into an agreement with Shire for the development of a transdermal amphetamine patch for ADHD, and in July 2006, Noven and Shire amended this agreement. Under the amended agreement, Shire paid Noven a non-refundable $1.0 million in August 2006, in exchange for the option of purchasing, for an additional $5.9 million, the exclusive developmental rights to the product. The amended agreement further provides that Noven will perform certain early-stage development activities which were previously to be performed by Shire. Upon Noven’s completion of such development activities, Shire has the option to pay Noven the $5.9 million to continue exclusive development of the product. If Shire does not exercise this option, rights to further develop the product will revert to Noven. The product entered Phase I clinical development by Noven in December 2006. The $1.0 million was included in deferred contract revenues on Noven’s balance sheet as of December 31, 2006. | ||
| P&G PHARMACEUTICALS COLLABORATION | ||
| In April 2003, Noven established a collaboration with P&G Pharmaceuticals for the development of new prescription patches for Hypoactive Sexual Desire Disorder (“HSDD”). |
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| The products under development explore follow-on product opportunities for Intrinsa™, P&G Pharmaceuticals’ in-licensed investigational transdermal testosterone patch designed to help restore sexual desire in menopausal women diagnosed with HSDD. During 2006, 2005 and 2004, Noven earned $0.9 million, $0.1 million and $4.4 million under the P&G Pharmaceuticals collaboration, respectively. In the U.S., P&G Pharmaceuticals withdrew its NDA for Intrinsa™ in December 2004 based on safety concerns expressed by an FDA Advisory Committee and other factors. P&G Pharmaceuticals has indicated that work on Intrinsa™ for the U.S. market has been placed on hold while they evaluate alternatives for the project. If P&G Pharmaceuticals is unable to identify a practical strategy to complete development and commercialize the product in the U.S., or if their evaluation of alternatives significantly delays the project, the prospects for Noven’s collaboration with P&G Pharmaceuticals will be adversely affected. | ||
| OTHER AGREEMENTS | ||
| Noven has entered into other developmental agreements for feasibility of certain compounds. In 2006, 2005 and 2004 Noven received approximately $0.2 million, $1.7 million and $0.4 million, respectively, related to these agreements. During 2006, Noven also recognized a $1.0 million one-time payment from a third party for a license to certain Noven patents due to Noven having no continuing involvement nor Noven having any future economic benefit related to the license. Noven has also established additional collaborations with third parties relating to the development of transdermal products outside of the ADHD and HT categories. Details relating to these collaborations have not been disclosed for competitive, confidentiality and other reasons. | ||
| 5. | INVESTMENT IN VIVELLE VENTURES LLC (d/b/a NOVOGYNE): | |
| In 1998, Noven invested $7.5 million in return for a 49% equity interest in Novogyne. In return for a 51% equity interest in Novogyne, Novartis granted an exclusive sublicense to Novogyne of a license agreement with Noven (see Note 4). This sublicense assigned certain of Novartis’ rights and obligations under license and supply agreements with Noven, and granted an exclusive license to Novogyne of the Vivelle® trademark. |
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| The summarized Statements of Operations of Novogyne for the years ended December 31, 2006, 2005 and 2004 are as follows (in thousands): |
| 2006 | 2005 | 2004 | ||||||||||
Gross revenues |
$ | 154,901 | $ | 136,901 | $ | 124,791 | ||||||
Sales allowances |
17,226 | 14,408 | 13,154 | |||||||||
Sales returns allowances |
5,732 | 936 | 6,224 | |||||||||
Sales allowances and returns |
22,958 | 15,344 | 19,378 | |||||||||
Net revenues |
131,943 | 121,557 | 105,413 | |||||||||
Cost of sales |
30,149 | 28,696 | 27,755 | |||||||||
Selling, general and
administrative expenses |
37,318 | 35,568 | 35,624 | |||||||||
Income from operations |
64,476 | 57,293 | 42,034 | |||||||||
Interest income |
841 | 461 | 191 | |||||||||
Net income |
$ | 65,317 | $ | 57,754 | $ | 42,225 | ||||||
Noven’s equity in earnings of
Novogyne |
$ | 28,632 | $ | 24,655 | $ | 17,641 | ||||||
| The activity in the Investment in Novogyne account for the years ended December 31, 2006, 2005 and 2004 is as follows (in thousands): |
| 2006 | 2005 | 2004 | ||||||||||
Investment in Novogyne,
beginning of year |
$ | 23,243 | $ | 26,233 | $ | 28,368 | ||||||
Equity in earnings of Novogyne |
28,632 | 24,655 | 17,641 | |||||||||
Cash distributions from Novogyne |
(26,368 | ) | (26,187 | ) | (18,083 | ) | ||||||
Non-cash distribution from
Novogyne |
(2,211 | ) | (1,458 | ) | (1,693 | ) | ||||||
Investment in Novogyne,
end of year |
$ | 23,296 | $ | 23,243 | $ | 26,233 | ||||||
| Novogyne’s Management Committee has the authority to distribute cash to Novartis and Noven based upon a contractual formula. The joint venture agreements provide for an annual preferred return of $6.1 million to Novartis and then an allocation of income between Novartis and Noven depending upon sales levels attained. Noven’s share of income increases as product sales increase, subject to a maximum of 49%. The non-cash distribution from Novogyne reported above represented a $2.2 million, $1.5 million and $1.7 million tax payment in April 2006, 2005 and 2004, respectively, to the New Jersey Department of Revenue made by Novogyne on Noven’s behalf. As discussed in Note 3, such payment was deemed a distribution from Novogyne to Noven. |
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| The summarized Balance Sheets of Novogyne at December 31, 2006 and 2005 are as follows (in thousands): |
| 2006 | 2005 | |||||||
Current assets |
$ | 29,447 | $ | 22,313 | ||||
Insurance receivable |
7,299 | 3,511 | ||||||
Intangible assets |
26,263 | 32,442 | ||||||
Total long-term assets |
33,562 | 35,953 | ||||||
Total assets |
63,009 | 58,266 | ||||||
Product liability reserve |
9,629 | 4,945 | ||||||
Allowance for returns |
7,938 | 6,168 | ||||||
Other liabilities |
8,943 | 10,341 | ||||||
Total liabilities (all of which are current) |
26,510 | 21,454 | ||||||
Members’ capital |
$ | 36,499 | $ | 36,812 | ||||
| The activity for the allowance for returns for the three years ended December 31, 2006 is as follows in thousands): |
Balance January 1, 2004 |
$ | 14,240 | ||
Expense related to expired product-current year |
8,342 | |||
Expense related to expired product-prior year |
1,227 | |||
Expense related to product recalls |
(3,345 | ) | ||
Deductions |
(11,295 | ) | ||
Balance December 31, 2004 |
9,169 | |||
Expense related to expired product-current year |
3,384 | |||
Expense related to expired product-prior year |
(2,385 | ) | ||
Reductions in product recalls expense |
(63 | ) | ||
Deductions |
(3,937 | ) | ||
Balance December 31, 2005 |
6,168 | |||
Expense related to expired product-current year |
4,342 | |||
Expense related to expired product-prior year |
1,390 | |||
Deductions |
(3,962 | ) | ||
Balance December 31, 2006 |
$ | 7,938 | ||
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| In 2003, Noven’s product stability testing program revealed that certain lots of CombiPatch® and Vivelle-Dot® patches did not maintain required specifications throughout the products’ shelf lives, resulting in product recalls of certain lots. As a result of these recalls, Novogyne recorded a $6.5 million estimated returns reserve related to the recalls as of December 31, 2003. Novogyne reversed the remaining recall reserve of $3.3 million to income in 2004, as the FDA closed out the recall. | ||
| Under the terms of the joint venture agreements, Noven is responsible for the manufacture of the products, retention of samples and regulatory documentation, design and implementation of an overall marketing and sales program in the hospital and retail sales sectors of the market, including the preparation of marketing plans and sales force staffing and management, and the procurement of advertising services in connection with the marketing and promotion of the products. All other matters, including inventory control and distribution, management of marketing and sales programs for the managed care sector of the market, customer service support, regulatory affairs support, legal, accounting and other administrative services are provided by Novartis. | ||
| The joint venture operating agreement includes a buy/sell provision that either Noven or Novartis may trigger by notifying the other party of the price at which the triggering party would be willing to acquire 100% of the joint venture. Upon receipt of this notice, the non-triggering party has the option to either purchase the triggering party’s interest in Novogyne or to sell its own interest in Novogyne to the triggering party at the price established by the triggering party. If Noven is the purchaser, then Noven must pay an additional amount equal to the net present value of Novartis’ preferred return. This amount is calculated by applying a specified discount rate and a period of 10 years to Novartis’ $6.1 million annual preferred return. Novartis is a larger company with greater financial resources than Noven, and therefore, may be in a better position to be the purchaser if the buy/sell provision is triggered. In addition, this buy/sell provision may have an anti-takeover effect on Noven since a potential acquirer of Noven will face the possibility that Novartis could trigger this provision at any time and thereby require any acquirer to either purchase Novartis’ interest in Novogyne or to sell its interest in Novogyne to Novartis. | ||
| Novartis has the right to dissolve the joint venture in the event of a change in control of Noven if the acquirer is one of the ten largest pharmaceutical companies (as measured by annual dollar sales). Upon dissolution, Novartis would reacquire the rights to market Vivelle® and Vivelle-Dot® subject to the terms of Novartis’ prior arrangement with Noven, and Novogyne’s other assets would be liquidated and distributed to the parties in accordance with their capital account balances as determined pursuant to the joint venture operating agreement. |
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| During the years ended December 31, 2006, 2005 and 2004, Noven had the following transactions with Novogyne (in thousands): |
| 2006 | 2005 | 2004 | ||||||||||
Revenues: |
||||||||||||
Trade product |
$ | 17,013 | $ | 17,787 | $ | 15,216 | ||||||
Sample product and other |
2,701 | 2,123 | 3,582 | |||||||||
Royalties |
6,845 | 6,444 | 5,204 | |||||||||
| $ | 26,559 | $ | 26,354 | $ | 24,002 | |||||||
Reimbursed expenses: |
||||||||||||
Services |
$ | 20,926 | $ | 20,768 | $ | 20,014 | ||||||
Product specific marketing
expenses |
7,850 | 6,945 | 7,780 | |||||||||
Reimbursed expenses |
$ | 28,776 | $ | 27,713 | $ | 27,794 | ||||||
| As of December 31, 2006 and 2005, the Accounts Receivable – Novogyne, net is as follows (in thousands): |
| 2006 | 2005 | |||||||
Sales of product |
$ | 3,795 | $ | 4,126 | ||||
Services provided by Noven |
3,057 | 3,835 | ||||||
Royalty |
1,714 | 1,827 | ||||||
Deferred profit on Novogyne
inventory
and other |
(873 | ) | (876 | ) | ||||
| $ | 7,693 | $ | 8,912 | |||||
| 6. | OPERATING AND CAPITAL LEASES: | |
| Noven has various operating and capital leases for computers and equipment. Noven also leases office space and other in close proximity to its manufacturing facility in Miami, Florida. | ||
| In February 2005, Noven entered into an Industrial Long-Term Lease (the “Lease”) for approximately 73,000 square feet of newly constructed space located in close proximity to its manufacturing facility in Miami, Florida. Noven is using the leased space for the storage and, as needed, the manufacture of new product. The lease term is 10 years, which may be extended for up to an additional 21 years pursuant to four renewal options of five years each and a one-time option to renew for one year. The annual base rent is $6.40 per square foot. Noven is also paying a monthly management fee equal to 1.5% of the base rent. The rent for the first year is discounted to $3.20 per square foot. The base rent is subject to annual increases of 3% during the initial 10-year lease term. After the initial term, the rent will be 95% of the fair market rate of the leased space as determined under the Lease. Noven |
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| improved the leased space in order to prepare it for its intended use during 2005. The landlord was responsible for up to approximately $0.9 million of leasehold improvements, which were fully paid in 2005. Any amounts paid to the general contractor in excess of this amount and any other leasehold improvements are the responsibility of Noven. For accounting purposes, Noven is amortizing the total expected rental payments on a straight-line basis over the initial 10-year term of the Lease. The renewal terms have not been included for amortization purposes because Noven cannot reasonably estimate the rental payments after the initial term and Noven cannot assure that it will renew the Lease after the initial term. Leasehold improvements are recorded at cost and are amortized on a straight-line basis over the shorter of the estimated useful life of the improvements or the remaining initial 10-year lease term. Leasehold improvements to the leased space paid by the landlord were recorded by Noven as a deferred rent credit and are being amortized on a straight-line basis over the remaining initial 10-year lease term as a reduction of rent expense. Rent expense related to this Lease was $0.4 million for each of the years ended December 31, 2006 and 2005. | ||
| Lease expense under operating leases, including rent expense related to the Industrial Long-Term Lease described above, was approximately $1.2 million, $1.1 million and $0.5 million for the years ended December 31, 2006, 2005 and 2004, respectively. | ||
| The future minimum rental payments required under noncancelable operating and capital leases as of December 31, 2006 are as follows (in thousands): |
| Operating | Capital | |||||||
| Leases | Leases | |||||||
2007 |
$ | 1,050 | $ | 142 | ||||
2008 |
1,017 | 154 | ||||||
2009 |
1,002 | 129 | ||||||
2010 |
913 | 8 | ||||||
2011 |
932 | 8 | ||||||
Thereafter |
2,851 | 17 | ||||||
Total lease obligation |
$ | 7,765 | 458 | |||||
Less: portion representing interest |
(70 | ) | ||||||
Capital lease obligation |
388 | |||||||
Less: current portion |
(109 | ) | ||||||
Capital lease obligation, net of current portion |
$ | 279 | ||||||
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| 7. | INCOME TAXES: | |
| The provision (benefit) for income taxes in 2006, 2005 and 2004 consists of (in thousands): |
| 2006 | 2005 | 2004 | ||||||||||
Current income taxes: |
||||||||||||
Federal |
$ | 7,123 | $ | 2,347 | $ | 638 | ||||||
State |
1,154 | 367 | 150 | |||||||||
| 8,277 | 2,714 | 788 | ||||||||||
Deferred income tax
(benefit) expense: |
||||||||||||
Federal |
(241 | ) | 2,291 | 4,322 | ||||||||
State |
(94 | ) | 275 | 914 | ||||||||
| (335 | ) | 2,566 | 5,236 | |||||||||
Provision for income taxes |
$ | 7,942 | $ | 5,280 | $ | 6,024 | ||||||
| Deferred income taxes reflect the tax effects in future years for temporary differences between the tax bases of assets and liabilities and their financial reporting amounts. The following table summarizes the significant components of Noven’s net deferred tax asset (in thousands): |
| 2006 | 2005 | |||||||
Deferred income tax assets: |
||||||||
Deferred license revenue |
$ | 6,234 | $ | 7,732 | ||||
Joint venture interest |
3,451 | 2,499 | ||||||
Inventory adjustments and reserves |
2,153 | 2,268 | ||||||
Deferred profit on sales to Novogyne |
334 | 332 | ||||||
Deferred rent credit |
433 | — | ||||||
Non-qualified stock options |
712 | — | ||||||
Other |
585 | 467 | ||||||
Total deferred income tax assets |
13,902 | 13,298 | ||||||
Deferred income tax liabilities: |
||||||||
Basis difference in fixed assets |
(1,194 | ) | (925 | ) | ||||
Net deferred income tax asset |
$ | 12,708 | $ | 12,373 | ||||
| Realization of the net deferred income tax asset of $12.7 million and $12.4 million at December 31, 2006 and 2005, respectively, is dependent upon generating sufficient future taxable income. Although realization is not assured, management believes it is more likely than not that the net deferred income tax asset will be realized based upon estimated future income of Noven and, accordingly, no valuation allowance for the net deferred income tax asset was deemed necessary at December 31, 2006 and 2005. |
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| The income tax benefits derived from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options in excess of any amounts previously classified as a deferred tax asset, when realized, are credited to additional paid-in capital. For the years ended December 31, 2006, 2005 and 2004, Noven credited $3.6 million, $0.3 million and $3.0 million, respectively, to additional paid-in capital related to the excess tax benefits from the exercise of stock options. Of the $3.6 million credited to additional paid-in capital in 2006, $1.0 million was classified as cash provided by operating activities in the statement of cash flows, representing that portion of cash provided by operating activities computed as if FAS 123(R) had always been applied for recognition purposes, and the remaining $2.6 million was classified as cash provided by financing activities. | ||
| The difference between the income taxes resulting from applying the statutory federal income tax rate to pretax income and the total income tax expense is reconciled as follows (dollars in thousands): |
| 2006 | 2005 | 2004 | ||||||||||||||||||||||
| Amount | % | Amount | % | Amount | % | |||||||||||||||||||
Income taxes at statutory rate |
$ | 8,375 | 35.0 | $ | 5,338 | 35.0 | $ | 6,037 | 35.0 | |||||||||||||||
Increase (decrease) in taxes: |
||||||||||||||||||||||||
State income tax, net of federal
benefits |
690 | 2.9 | 323 | 2.1 | 691 | 4.0 | ||||||||||||||||||
Non-taxable interest income |
(1,323 | ) | (5.5 | ) | (385 | ) | (2.5 | ) | — | — | ||||||||||||||
Non-deductible incentive stock
option compensation
expense |
228 | 0.9 | — | — | — | — | ||||||||||||||||||
Extraterritorial income exclusion |
— | — | 122 | 0.8 | (179 | ) | (1.0 | ) | ||||||||||||||||
Research and development
expenditures credit |
— | — | (141 | ) | (0.9 | ) | (135 | ) | (0.8 | ) | ||||||||||||||
Increase (reduction) in IRS
audit and state tax
contingency accruals |
— | — | 1 | — | (400 | ) | (2.3 | ) | ||||||||||||||||
Other |
(28 | ) | (0.1 | ) | 22 | 0.1 | 10 | — | ||||||||||||||||
Income tax expense |
$ | 7,942 | 33.2 | $ | 5,280 | 34.6 | $ | 6,024 | 34.9 | |||||||||||||||
| Noven is periodically audited by federal and state taxing authorities. The outcome of these audits may result in Noven being assessed taxes in addition to amounts previously paid. Accordingly, Noven maintains tax contingency accruals for such potential assessments. The accruals are determined based upon Noven’s best estimate of possible assessments by the Internal Revenue Service (“IRS”) or other taxing authorities and are adjusted, from time to time, based upon changing facts and circumstances. The IRS audited Noven’s federal income tax returns for the years 2001 through 2003. Noven originally accrued $1.5 million based on its best estimate of possible assessment by the IRS at the time, and then reduced the accrual by $0.4 million in 2004 and an additional $0.1 million in 2005. In 2005 Noven paid the IRS for all amounts due, except for $0.1 million in interest charges, which were paid in January 2006. |
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| 8. | STOCKHOLDERS’ EQUITY: | |
| Noven established the 1999 Plan on June 8, 1999. The 1999 Plan replaced Noven’s 1997 Stock Option Plan (the “1997 Plan”) and no future stock option awards may be granted under the 1997 Plan. The 1999 Plan as amended in May 2004 provides for the granting of incentive and non-qualified stock options, stock awards (including restricted stock), and other permitted awards to selected individuals for up to 4,768,848 shares, including 2,768,848 shares that remained available under the 1997 Plan at the time of its termination. Prior to January 1, 2006, all awards granted to employees under the 1999 Plan were stock options, with the exception of unrestricted stock awards for a total of 4,534 shares that were granted in 2004. In 2006, Noven began granting SSARs to employees and restricted stock to non-employee directors in lieu of stock options. The terms and conditions of stock options (including price, vesting schedule, term and number of shares) and other permitted awards under the 1999 Plan are determined by the Compensation Committee, which administers the 1999 Plan. The per share exercise price of (i) non-qualified stock options cannot be less than the fair market value of the common stock on the date of grant, (ii) incentive stock options can not be less than the fair market value of the common stock on the date of grant and (iii) incentive stock options granted to employees owning in excess of 10% of Noven’s issued and outstanding common stock can not be less than 110% of the fair market value of the common stock on the date of grant. | ||
| Each equity award granted under the 1999 Plan is exercisable after the period(s) specified in the relevant agreement, and no equity award can be exercised after ten years from the date of grant (or five years from the date of grant in the case of a grantee of an incentive stock option holding more than 10% of the issued and outstanding Noven common stock). At December 31, 2006, there were 2,863,733 stock options and 411,306 SSARs issued and outstanding under the 1999 Plan. Historically, the equity awards granted by Noven vest over a period of four or five years, beginning one year after date of grant, and expire seven years after date of grant. As noted in the section “Recent Accounting Pronouncements”, effective January 1, 2006, Noven adopted SFAS 123(R), which requires compensation expense associated with equity awards to be recognized in Noven’s statement of operations, rather than as historically presented as a pro forma footnote disclosure in Noven’s financial statements. | ||
| The 1997 Plan, originally effective January 1, 1997, provided for the granting of up to 4,000,000 incentive and non-qualified stock options. At December 31, 2006, there were no stock options outstanding under the 1997 Plan. The 1997 Plan is also administered by the Compensation and Stock Option Committee, and the terms and conditions of the 1997 Plan are similar to those of the 1999 Plan. | ||
| In May 2006, Noven issued a total of 34,344 shares of restricted stock to its non-employee directors. The grants fall under the definition of nonvested shares under SFAS 123(R). The shares vest over each director’s one-year service period, quarterly, beginning with the quarter ended June 30, 2006. |
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| Stock option and SSARs transactions related to the plans are summarized as follows (options/SSARs and shares in thousands): |
| 2006 | 2005 | 2004 | ||||||||||||||||||||||
| Weighted | Weighted | Weighted | ||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||
| Options/ | Exercise | Exercise | Exercise | |||||||||||||||||||||
| SSARs | Price | Options | Price | Options | Price | |||||||||||||||||||
Outstanding at
beginning of year |
4,004 | $ | 17.23 | 3,739 | $ | 17.69 | 3,919 | $ | 14.51 | |||||||||||||||
Granted |
411 | 22.49 | 557 | 14.25 | 1,015 | 21.70 | ||||||||||||||||||
Exercised |
(1,045 | ) | 12.77 | (137 | ) | 9.52 | (769 | ) | 8.03 | |||||||||||||||
Canceled and expired |
(95 | ) | 18.86 | (155 | ) | 24.44 | (426 | ) | 15.52 | |||||||||||||||
Outstanding at end
of year |
3,275 | 19.26 | 4,004 | 17.23 | 3,739 | 17.69 | ||||||||||||||||||
Options exercisable
at end of year |
2,136 | 20.97 | 2,871 | 19.14 | 1,541 | 18.35 | ||||||||||||||||||
Shares of common
stock reserved |
3,428 | 4,504 | 4,644 | |||||||||||||||||||||
The following tables summarize information concerning outstanding and exercisable
options/SSARs at December 31, 2006 (options and aggregate intrinsic value in thousands):
| Options/SSARs Outstanding | ||||||||||||||||
| Weighted | Weighted | |||||||||||||||
| Range of | Number | Average | Average | Aggregate | ||||||||||||
| Exercise | Outstanding | Remaining | Exercise | Intrinsic | ||||||||||||
| Prices | at Year End | Contractual Life | Price | Value | ||||||||||||
$ 9.08 - 13.12 |
689 | 3.4 | $ | 11.53 | $ | 9,584 | ||||||||||
13.68 - 17.91 |
959 | 4.2 | 14.78 | 10,229 | ||||||||||||
18.00
- 24.17 |
1,214 | 5.4 | 22.33 | 3,791 | ||||||||||||
31.31 - 34.50 |
404 | 0.9 | 33.43 | — | ||||||||||||
36.24 - 41.81 |
9 | 1.1 | 38.34 | — | ||||||||||||
| 3,275 | $ | 23,604 | ||||||||||||||
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| Options/SSARs Exercisable | ||||||||||||
| Weighted | ||||||||||||
| Range of | Number | Average | Aggregate | |||||||||
| Exercise | Exercisable | Exercise | Intrinsic | |||||||||
| Prices | at Year End | Price | Value | |||||||||
$ 9.08 - 13.12 |
322 | $ | 11.90 | $ | 4,358 | |||||||
13.68 - 17.91 |
572 | 15.35 | 5,783 | |||||||||
18.00
- 24.17 |
829 | 22.10 | 2,780 | |||||||||
31.31 - 34.50 |
404 | 33.43 | — | |||||||||
36.24 - 41.81 |
9 | 38.34 | — | |||||||||
| 2,136 | $ | 12,921 | ||||||||||
| The total fair value of options that vested in each of the years 2006, 2005 and 2004 were $3.3 million, $21.2 million and $6.3 million, respectively. The year 2005 included the acceleration of options with a fair value of $10.1 million, which reduced future compensation expense by that amount. The following table summarizes the options outstanding, options vested or expected to vest, and options exercisable at December 31, 2006 (options and aggregate intrinsic value in thousands): |
| Weighted | Weighted | |||||||||||||||
| Average | Average | Aggregate | ||||||||||||||
| Exercise | Remaining | Intrinsic | ||||||||||||||
| Options | Price | Contractual Life | Value | |||||||||||||
Outstanding at end of
year |
3,275 | $ | 19.26 | 4.1 | $ | 23,604 | ||||||||||
Vested or expected to
vest at end of year |
2,871 | $ | 19.42 | 4.0 | $ | 20,115 | ||||||||||
Exercisable at end of
year |
2,136 | $ | 20.97 | 3.3 | $ | 12,921 | ||||||||||
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| The following table summarizes information concerning Noven’s restricted stock at December 31, 2006 (shares in thousands): |
| 2006 | ||||||||
| Weighted | ||||||||
| Average | ||||||||
| Grant-Date | ||||||||
| Shares | Fair Value | |||||||
Nonvested at
December 31, 2005 |
— | $ | — | |||||
Granted |
34 | 17.47 | ||||||
Vested |
(26 | ) | 17.47 | |||||
Forfeited |
— | — | ||||||
Nonvested at
December 31, 2006 |
8 | $ | 17.47 | |||||
| On November 6, 2001, Noven’s Board of Directors adopted a Stockholder Rights Plan under which Noven declared a dividend of one right for each share of common stock outstanding. Prior to the Distribution Date referred to below, the rights will be evidenced by, and trade with, the certificates for the common stock. After the Distribution Date, Noven will mail rights certificates to the stockholders and the rights will become transferable apart from the common stock. Rights will separate from the common stock and become exercisable following (a) the tenth day after a public announcement that a person or group acquired beneficial ownership of 15% or more of Noven’s common stock in a transaction or series of transactions not approved by Noven’s Board of Directors or (b) the tenth business day (or such later date as may be determined by a majority of the directors) after a person or group announces a tender or exchange offer (with respect to which the Board of Directors does not issue a favorable recommendation), the consummation of which would result in ownership by a person or group of 15% or more of Noven’s common stock (in either case, such date is referred to as the “Distribution Date”). After the Distribution Date, each right will entitle the holder to purchase for $110 a fraction of a share of Noven’s preferred stock with economic terms similar to that of one share of Noven’s common stock. In addition, upon the occurrence of certain events, holders of the rights (other than rights owned by an acquiring person or group) would be entitled to purchase either Noven’s preferred stock or shares in an “acquiring entity” at approximately half of market value. The rights will expire on November 6, 2011, and Noven generally will be entitled to redeem the rights at $0.01 per right at any time prior to the close of business on the tenth day after there has been a public announcement of the beneficial ownership by any person or group of 15% or more of Noven’s voting stock, subject to certain exceptions. The plan is intended to protect the interests of Noven’s stockholders against certain coercive tactics sometimes employed in takeover attempts. The adoption of the Stockholder Rights Plan could make it more difficult for a third party to acquire a majority of |
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| Noven’s common stock in a transaction that does not have the support of Noven’s Board of Directors. | ||
| 9. | DEFERRED COMPENSATION PLAN: | |
| Effective January 1, 2006, Noven established a deferred compensation plan (the “Plan”) available to Noven’s officers and members of its Board of Directors. The Plan permits participants to defer receipt of part of their current compensation to a later date as part of their personal retirement or financial planning. Participants may elect to defer, as applicable, portions of their director fees, base salary, bonus, long-term incentive plan awards, and/or restricted stock grants. Participants have an unsecured contractual commitment by Noven to pay amounts due under the Plan. Benefit security for the Plan is provided by a rabbi trust, which is intended to protect participants if Noven is unwilling to pay Plan benefits for any reason other than insolvency or bankruptcy. | ||
| The compensation withheld from Plan participants, together with investment income on the Plan, is reflected as a deferred compensation obligation to participants and is classified as a long-term liability in the accompanying balance sheet. The related assets, which are held in the rabbi trust in the form of a company-owned life insurance policy that names Noven as the beneficiary, are classified within other assets in the accompanying balance sheet and are reported at cash surrender value, which was approximately $0.2 million as of December 31, 2006. At December 31, 2006, the balance of the deferred compensation liability totaled $0.2 million. | ||
| 10. | SHARE REPURCHASE PROGRAM: | |
| In the first quarter of 2003, Noven’s Board of Directors authorized a share repurchase program under which Noven may acquire up to $25 million of its common stock. As of December 31, 2003, Noven had repurchased 105,000 shares of its common stock at an aggregate price of approximately $1.3 million. These shares were retired on March 31, 2003. No shares were repurchased during 2006, 2005 or 2004. | ||
| 11. | COST REDUCTION PROGRAM: | |
| Over the past two years, Noven expanded its facilities and increased staffing for the production of fentanyl, Daytrana™ and other developmental products. In September 2005, the FDA ceased review of Noven’s ANDA for its fentanyl product after informing Noven that it did not expect to approve the ANDA. In the third quarter of 2006, Noven implemented a program to reduce overhead associated with this expansion. This program included the elimination of certain employee positions. A pre-tax one-time termination charge of $0.6 million associated with the elimination of these positions was included in marketing, general and administrative expenses for the period ended December 31, 2006. In addition, Noven incurred an additional $0.1 million in pre-tax outplacement costs, which was included in marketing, general and administrative expenses in 2006. Noven does not expect any further workforce reductions in connection with this program. Payments made in connection with the |
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| $0.6 million one-time termination charge as of December 31, 2006 totaled $0.3 million. Amounts remaining to be paid as of December 31, 2006 totaled $0.3 million. | ||
| 12. | 401(k) SAVINGS PLAN: | |
| On January 1, 1997, Noven established a savings plan under section 401(k) of the Internal Revenue Code (the “401(k) Plan”) covering substantially all employees who have completed three months of service and have reached the age of twenty-one. This plan allows eligible participants to contribute from one to fifteen percent of their current compensation to the 401(k) Plan subject to the maximum permitted by law. Effective January 2001, the 401(k) Plan provided for employer matching of 50% of employee contributions up to the first 3% of the participants’ contributions. The employer matching of 50% of the employee contributions was increased to the first 6% of the participants’ contribution as of January 1, 2003. Noven contributed $656,000, $397,000 and $353,000 to the 401(k) Plan for the years ended December 31, 2006, 2005 and 2004, respectively. | ||
| 13. | SEGMENT, GEOGRAPHIC AND CUSTOMER DATA: | |
| Noven is engaged principally in one line of business, the research, development, manufacture and marketing of advanced transdermal drug delivery technologies and prescription transdermal products, which represents substantially all of its revenues and income. There were no intercompany sales or transactions between geographic areas. The following table presents information about Noven’s revenues by geographic area (in thousands): |
| 2006 | 2005 | 2004 | ||||||||||
United States |
$ | 43,628 | $ | 34,546 | $ | 28,923 | ||||||
Other countries |
17,061 | 17,986 | 16,968 | |||||||||
Net revenues |
$ | 60,689 | $ | 52,532 | $ | 45,891 | ||||||
| The following table presents information about Noven’s revenues by customer, including product, royalty, contract and license revenues (in thousands): |
| 2006 | 2005 | 2004 | ||||||||||
Novogyne |
$ | 26,559 | $ | 26,354 | $ | 24,002 | ||||||
Novartis Pharma/Novartis |
15,287 | 16,955 | 14,721 | |||||||||
Shire |
14,556 | — | — | |||||||||
Endo |
303 | 6,682 | 853 | |||||||||
Other |
3,984 | 2,541 | 6,315 | |||||||||
Net revenues |
$ | 60,689 | $ | 52,532 | $ | 45,891 | ||||||
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| 14. | UNAUDITED QUARTERLY CONDENSED FINANCIAL DATA: (in thousands, except per share amounts): |
| 2006 | First | Second | Third | Fourth | Full Year | |||||||||||||||
Net revenues |
$ | 10,192 | $ | 17,547 | $ | 15,708 | $ | 17,242 | $ | 60,689 | ||||||||||
Gross profit (product revenues
less cost of products sold) |
2,507 | 1,417 | 3,784 | 4,110 | 11,818 | |||||||||||||||
(Loss) income from operations |
(4,168 | ) | (2,868 | ) | (1,870 | ) | (68 | ) | (8,974 | ) | ||||||||||
Equity in earnings of
Novogyne1 |
4,327 | 6,762 | 8,234 | 9,309 | 28,632 | |||||||||||||||
Net income |
$ | 504 | $ | 3,333 | $ | 5,031 | $ | 7,120 | $ | 15,988 | ||||||||||
Basic earnings per share |
$ | 0.02 | $ | 0.14 | $ | 0.21 | $ | 0.30 | $ | 0.67 | ||||||||||
Diluted earnings per share |
$ | 0.02 | $ | 0.14 | $ | 0.20 | $ | 0.29 | $ | 0.66 | ||||||||||
| 2005 | First | Second | Third | Fourth | Full Year | |||||||||||||||
Net revenues2 |
$ | 11,736 | $ | 11,771 | $ | 12,240 | $ | 16,785 | $ | 52,532 | ||||||||||
Gross profit (loss) (product revenues
less cost of products sold)2 |
4,256 | 5,124 | (4,969 | ) | 1,993 | 6,404 | ||||||||||||||
(Loss) income from operations |
(1,086 | ) | (687 | ) | (11,239 | ) | 1,367 | (11,645 | ) | |||||||||||
Equity in earnings of Novogyne1 |
912 | 8,101 | 8,081 | 7,561 | 24,655 | |||||||||||||||
Net income (loss) |
$ | 211 | $ | 5,121 | $ | (1,422 | ) | $ | 6,062 | $ | 9,972 | |||||||||
Basic earnings (loss) per share |
$ | 0.01 | $ | 0.22 | $ | (0.06 | ) | $ | 0.26 | $ | 0.42 | |||||||||
Diluted earnings (loss) per share |
$ | 0.01 | $ | 0.21 | $ | (0.06 | ) | $ | 0.25 | $ | 0.42 | |||||||||
| 1 | Equity in earnings of Novogyne is typically lower in the first quarter of each year than any other quarter due to Novartis’ preferred return of $6.1 million, which must be distributed before any allocation of income between Novartis and Noven. | |
| 2 | Due to the FDA’s determination that Noven’s fentanyl ANDA was not approvable, Noven and Endo agreed to terminate the fentanyl portion of the license agreement, as well as the fentanyl supply agreement between the parties, resulting in Noven earning the remaining $5.7 million of previously deferred license revenue, which was recognized in the fourth quarter of 2005. In addition, cost of products sold in the third quarter of 2005 included a $9.5 million charge relating to the write-off of fentanyl inventories and the fourth quarter of 2005 included $0.4 million in charges relating to the destruction of fentanyl inventories. |
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| 15. | COMMITMENTS AND CONTINGENCIES: | |
| HT STUDIES: | ||
| In July 2002, the National Institutes of Health (“NIH”) released data from its Women’s Health Initiative (“WHI”) study on the risks and benefits associated with use of oral combination HT by healthy women. The NIH announced that it was discontinuing the arm of the study investigating the use of oral estrogen/progestin after an average follow-up period of 5.2 years because the oral combination HT product used in the study was shown to cause an increase in the risk of invasive breast cancer. The study also found an increased risk of stroke, heart attacks and blood clots and concluded that overall health risks exceeded benefits from use of the orally delivered combined estrogen plus progestin product among healthy postmenopausal women. Also in July 2002, the National Cancer Institute (“NCI”) published the results of an observational study in which it found that postmenopausal women who used ET for 10 or more years had a higher risk of developing ovarian cancer than women who never used HT. Since 2002, several other published studies have identified increased risks from the use of HT. As a result of the findings from the WHI and other studies, the FDA has required that “black box” labeling be included on all HT products marketed in the United States to warn, among other things, that these products have been associated with increased risks for heart disease, heart attacks, strokes, and breast cancer and that they are not approved for heart disease prevention. Since the July 2002 publication of the WHI and NCI study data, total United States prescriptions have declined for substantially all HT products, including Noven’s products in the aggregate. | ||
| Researchers continue to analyze data from both arms of the WHI study and other studies. Other studies evaluating HT are currently underway or in the planning stage. In particular, a private foundation has commenced a five-year study aimed at determining whether ET use by women aged 42 to 58 reduces the risk of heart disease. The study also seeks to determine if transdermal estrogen patches are more or less beneficial than an oral HT product. While Noven products are not being used in the study, the market for Noven’s products could be adversely affected if this study finds that a transdermal estrogen patch is less beneficial than other dosage forms, and Noven could be subject to increased product liability risk if HT patch products are found to increase the risk of adverse health consequences. Noven is currently named as a defendant in six product liability lawsuits involving its HT products and Noven may have liability with respect to other actions in which it has not, to date, been made a party. See “Litigation, Claims and Assessments” below for a further discussion on related product liability lawsuits. | ||
| These studies and others have caused the HT market, and the market for Noven’s products, to significantly decline. Prescriptions for CombiPatch®, Noven’s combination estrogen/progestin patch, continue to decline in the post-WHI environment. Novogyne recorded the acquisition of the marketing rights for Noven’s CombiPatch® product at cost and tests this asset for impairment on a periodic basis. Further adverse change in the market for HT products could have a material adverse impact on the ability of Novogyne to recover its investment in these rights, which could require Novogyne to record an impairment loss on the |
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| CombiPatch® intangible asset. Impairment of the CombiPatch® intangible asset would adversely affect Novogyne’s and Noven’s financial results. Management cannot predict whether these or other studies will have additional adverse effects on Noven’s liquidity and results of operations, or Novogyne’s ability to recover the net carrying value of the CombiPatch® intangible asset. | ||
| SUPPLY AGREEMENT: | ||
| Noven’s supply agreement with Novogyne for Vivelle® and Vivelle-Dot® patches expired in January 2003. Since expiration, the parties have continued to operate in accordance with the supply agreement’s commercial terms. There is no assurance that the agreement’s non-commercial terms would be enforceable with respect to post-expiration occurrences. A decision to discontinue operating in accordance with the agreement’s commercial terms could have a material adverse effect on Noven’s financial position, results of operations and cash flows. Novogyne’s designation of a new supplier and approval of a new supply agreement would require the affirmative vote of four of the five members of Novogyne’s Management Committee. Accordingly, both Novartis and Noven must agree on Novogyne’s supplier. | ||
| LITIGATION, CLAIMS AND ASSESSMENTS: | ||
| In September 2005, Noven, Novogyne and Novartis were served with a summons and complaint from an individual plaintiff in Superior Court of New Jersey Law Division, Atlantic County in which the plaintiff claims personal injury allegedly arising from the use of HT products, including Vivelle®. The plaintiff claims compensatory, punitive and other damages in an unspecified amount. Noven does not expect any activity in this case in the near future, as the court has entered an order to stay proceedings in all its pending and future HT cases except for cases where Wyeth Pharmaceuticals and its affiliates and Pfizer, Inc. are the defendants. | ||
| In April 2006, an individual plaintiff and her husband filed a complaint in the United States District Court, District of Minnesota against Noven, Novogyne, Novartis, Wyeth Inc. and Wyeth Pharmaceuticals, Inc. alleging liability in connection with personal injury claims allegedly arising from the use of HT products, including Noven’s CombiPatch® product. The plaintiffs claim compensatory and other damages in an unspecified amount. | ||
| In July 2006, four complaints were filed in the United States District Court, District of Minnesota against Noven and other pharmaceutical companies by four separate individual plaintiffs, each filing alone or with her husband. Three of the complaints also name Novartis as a defendant, and of these, two name Novogyne as a defendant as well. Each complaint alleges liability in connection with personal injury claims allegedly arising from the use of HT products, including Vivelle® in one case and CombiPatch® in two of the cases. The plaintiffs in each case claim compensatory and other damages in an unspecified amount. Noven has established an accrual for the expected legal fees related to the cases referenced above, although the amount is not material. |
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| Novartis has advised Noven that Novartis has been named as a defendant in at least 31 lawsuits that include approximately 33 plaintiffs that allege liability in connection with personal injury claims allegedly arising from the use of HT patches distributed and sold by Novartis and Novogyne, including Noven’s Vivelle-Dot®, Vivelle®, and CombiPatch® products. Novogyne has been named as a defendant in one lawsuit in addition to the four lawsuits referenced above. Novartis has indicated that it will seek indemnification from Noven and Novogyne to the extent permitted by the agreements between and among Novartis, Novogyne and Noven. Novogyne’s aggregate limit under its claims-made insurance policy as of December 31, 2006 was $10.0 million. Novogyne has established reserves in the amount of $9.6 million with an offsetting insurance recovery of $7.3 million for expected defense and settlement expenses as well as for estimated future cases alleging use of Noven’s HT products. This accrual represents Novartis management’s best estimate as of December 31, 2006. | ||
| We intend to defend all of the foregoing lawsuits vigorously, but the outcome of these product liability lawsuits cannot ultimately be predicted. | ||
| Noven is a party to other pending legal proceedings arising in the normal course of business, none of which Noven believes is material to its financial position, results of operations or cash flows. | ||
| CONTRACT AND LICENSE AGREEMENTS: | ||
| Noven is obligated to perform under its contract and license agreements. In certain circumstances, Noven is required to indemnify its licensees from damages caused by the products Noven manufactures as well as claims or losses related to patent infringement. | ||
| EMPLOYMENT AGREEMENT AND BONUS PLAN: | ||
| Noven has entered into an amended and restated employment agreement with Robert C. Strauss, its President, Chief Executive Officer and Chairman, that provides for a base salary subject to cost of living increases each year and other increases and bonuses. This agreement provides for annual commitments of approximately $0.5 million and has a term extending through 2007 subject to a one-year extension unless otherwise terminated by the parties. | ||
| Noven has a formula bonus plan that includes company and individual performance goals. Noven incurred $3.1 million, $3.6 million and $3.8 million of bonus expenses in 2006, 2005, and 2004, respectively. Under the plan, a fixed percentage of each employee’s base salary is set as a target incentive bonus award for such employee. To the extent that actual company performance is equal to, exceeds or is less than the company performance targets, an employee’s bonus award may be equal to, greater than or less than his target award. An employee’s non-financial goals are then considered in determining his or her final bonus award. In 2006 Noven’s performance was less than the company’s performance targets, and in |
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| accordance with the plan formula the bonus awards to employees were less than their initial target awards. In 2005 and 2004, Noven met or exceeded the plan’s performance goals, and in accordance with the plan formula the bonus awards to most employees were greater than their initial target awards. |
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Report of Independent Registered Public Accounting Firm
To the Management Committee of
Vivelle Ventures LLC d/b/a Novogyne Pharmaceuticals
Vivelle Ventures LLC d/b/a Novogyne Pharmaceuticals
In our opinion, the accompanying balance sheets and the related statements of operations, members’
capital and cash flows present fairly, in all material respects, the financial position of Vivelle
Ventures LLC at December 31, 2006 and 2005, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/
PRICEWATERHOUSECOOPERS LLP
Pricewaterhousecoopers LLP
Pricewaterhousecoopers LLP
Florham
Park, New Jersey
February 16, 2007
February 16, 2007
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
d/b/a Novogyne Pharmaceuticals
Balance Sheets
December 31, 2006 and 2005
December 31, 2006 and 2005
| 2006 | 2005 | |||||||
Assets |
||||||||
Current assets |
||||||||
Due from affiliate—Novartis Pharmaceuticals
Corporation (Note 6) |
$ | 23,688,751 | $ | 17,951,634 | ||||
Due from affiliate—Novartis
Pharmaceuticals Canada |
1,116,767 | — | ||||||
Finished goods inventory (net of
reserves of $13,225 and $31,977
as of December 31, 2006 and 2005) |
4,069,226 | 4,053,734 | ||||||
Other current assets |
572,733 | 307,475 | ||||||
Total current assets |
29,447,477 | 22,312,843 | ||||||
Long-term assets |
||||||||
Insurance receivable (Note 7) |
7,299,241 | 3,510,868 | ||||||
Intangible assets (Note 3) (net of amortization of
$35,531,923 and
$29,352,458 as of December 31,
2006 and 2005) |
26,262,722 | 32,442,187 | ||||||
Total long-term assets |
33,561,963 | 35,953,055 | ||||||
Total assets |
$ | 63,009,440 | $ | 58,265,898 | ||||
Liabilities and Members’ Capital |
||||||||
Current liabilities |
||||||||
Due to affiliate—Noven
Pharmaceuticals, Inc. (Note 6) |
$ | 8,566,562 | $ | 9,787,307 | ||||
Accrued liabilities |
376,877 | 554,342 | ||||||
Product liability reserve (Note 7) |
9,629,241 | 4,944,815 | ||||||
Allowance for returns (Note 4) |
7,937,905 | 6,167,605 | ||||||
Total current liabilities |
26,510,585 | 21,454,069 | ||||||
Commitments and contingencies (Note 7) |
||||||||
Members’ capital |
||||||||
Capital contributions |
32,857,909 | 32,857,909 | ||||||
Accumulated earnings |
3,640,946 | 3,953,920 | ||||||
Total members’ capital |
36,498,855 | 36,811,829 | ||||||
Total liabilities and
members’ capital |
$ | 63,009,440 | $ | 58,265,898 | ||||
The accompanying notes are an integral part of these financial statements.
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
d/b/a Novogyne Pharmaceuticals
Statements of Operations
Years Ended December 31, 2006, 2005 and 2004
Years Ended December 31, 2006, 2005 and 2004
| 2006 | 2005 | 2004 | ||||||||||
Net sales |
||||||||||||
Third parties |
$ | 128,973,730 | $ | 119,331,180 | $ | 101,834,528 | ||||||
Novartis Pharmaceuticals Canada, Inc. |
2,969,045 | 2,226,126 | 3,578,932 | |||||||||
| 131,942,775 | 121,557,306 | 105,413,460 | ||||||||||
Cost of sales |
||||||||||||
Sales to third parties |
15,886,720 | 15,148,711 | 14,882,911 | |||||||||
Sales to Novartis Pharmaceuticals Canada, Inc. |
1,237,620 | 923,604 | 1,489,292 | |||||||||
Noven royalties |
6,845,122 | 6,444,033 | 5,203,932 | |||||||||
Amortization of license/marketing rights |
6,179,465 | 6,179,465 | 6,179,465 | |||||||||
| 30,148,927 | 28,695,813 | 27,755,600 | ||||||||||
Gross profit |
101,793,848 | 92,861,493 | 77,657,860 | |||||||||
Operating expenses |
||||||||||||
Sales and marketing expenses |
32,928,299 | 31,657,682 | 31,364,085 | |||||||||
Administrative expenses |
3,494,020 | 3,377,400 | 3,359,684 | |||||||||
Product liability expenses, net of insurance receivable |
896,053 | 533,947 | 900,000 | |||||||||
Income from operations |
64,475,476 | 57,292,464 | 42,034,091 | |||||||||
Other income |
||||||||||||
Interest income |
841,564 | 461,294 | 191,287 | |||||||||
Net income |
$ | 65,317,040 | $ | 57,753,758 | $ | 42,225,378 | ||||||
The accompanying notes are an integral part of these financial statements.
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
d/b/a Novogyne Pharmaceuticals
Statements of Members’ Capital
Years Ended December 31, 2006, 2005 and 2004
Years Ended December 31, 2006, 2005 and 2004
| Total | ||||
Members’ capital at January 1, 2004 |
$ | 48,199,843 | ||
Net income |
42,225,378 | |||
Distributions to Novartis |
(28,363,294 | ) | ||
Distributions to Noven |
(19,775,736 | ) | ||
Members’ capital at December 31, 2004 |
42,286,191 | |||
Net income |
57,753,758 | |||
Distributions to Novartis |
(35,583,169 | ) | ||
Distributions to Noven |
(27,644,951 | ) | ||
Members’ capital at December 31, 2005 |
36,811,829 | |||
Net income |
65,317,040 | |||
Distributions to Novartis |
(37,050,205 | ) | ||
Distributions to Noven |
(28,579,809 | ) | ||
Members’ capital at December 31, 2006 |
$ | 36,498,855 | ||
The accompanying notes are an integral part of these financial statements.
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
d/b/a Novogyne Pharmaceuticals
Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
Years Ended December 31, 2006, 2005 and 2004
| 2006 | 2005 | 2004 | ||||||||||
Cash flows from operating activities |
||||||||||||
Net income |
$ | 65,317,040 | $ | 57,753,758 | $ | 42,225,378 | ||||||
Adjustments to reconcile net income to net cash provided
by operating activities |
||||||||||||
Amortization of license/marketing rights |
6,179,465 | 6,179,465 | 6,179,465 | |||||||||
Obsolescence reserve |
(18,752 | ) | 31,977 | — | ||||||||
Changes in assets and liabilities |
||||||||||||
(Increase) decrease in due from affiliate—Novartis
Pharmaceuticals Corporation |
(5,737,117 | ) | 5,179,494 | (1,798,501 | ) | |||||||
(Increase) decrease in due from affiliate—Novartis
Pharmaceuticals Canada, Inc. |
(1,116,767 | ) | — | 696,620 | ||||||||
Decrease (increase) in finished goods inventory |
3,260 | (1,908,275 | ) | 504,677 | ||||||||
Increase in other current assets |
(265,258 | ) | (16,976 | ) | (24,978 | ) | ||||||
Increase in insurance receivable |
(3,788,373 | ) | (2,810,868 | ) | (700,000 | ) | ||||||
(Decrease) increase in due to affiliate—Noven
Pharmaceuticals, Inc. |
(1,220,745 | ) | (895,425 | ) | 3,518,108 | |||||||
(Decrease) increase in accrued liabilities |
(177,465 | ) | (628,594 | ) | 1,009,686 | |||||||
Increase in product liability reserve |
4,684,426 | 3,344,815 | 1,600,000 | |||||||||
(Decrease) increase in allowance for returns |
1,770,300 | (3,001,251 | ) | (5,071,425 | ) | |||||||
Net cash provided by operating activities |
65,630,014 | 63,228,120 | 48,139,030 | |||||||||
Cash flows from financing activities |
||||||||||||
Distributions to members (Note 5) |
(65,630,014 | ) | (63,228,120 | ) | (48,139,030 | ) | ||||||
Net cash used in financing activities |
(65,630,014 | ) | (63,228,120 | ) | (48,139,030 | ) | ||||||
Net change in cash |
— | — | — | |||||||||
Cash and cash equivalents |
||||||||||||
Beginning of year |
— | — | — | |||||||||
End of year |
$ | — | $ | — | $ | — | ||||||
The accompanying notes are an integral part of these financial statements.
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| 1. | Organization and Business | |
| Vivelle Ventures LLC (the “Company”) was organized to maintain and grow a franchise in women’s health in the United States of America focusing initially on the marketing and sale of an estradiol transdermal patch product under the trademark “Vivelle®”. During 1999, the Company began doing business under the name “Novogyne Pharmaceuticals”. | ||
| The Company is a limited liability company between Novartis Pharmaceuticals Corporation (“Novartis”) and Noven Pharmaceuticals, Inc. (“Noven”) (collectively referred to as the “Members”), pursuant to a Formation Agreement dated as of May 1, 1998 (date of inception). On May 1, 1998, Novartis granted an exclusive sublicense to the Company of the license agreement between Noven and Novartis, assigned the Company certain of its rights and obligations under a supply agreement between Noven and Novartis, and granted an exclusive license to the Company of the Vivelle® trademark as its contribution of capital to the Company. These assets, with a value of $7,800,000 as agreed to by the Members, have been recorded by the Company at Novartis’ carryover basis of zero. Noven contributed $7,500,000 in cash to the Company. Pursuant to the Formation Agreement, the initial capital interests of the Company were owned 51% by Novartis and 49% by Noven. | ||
| The Company commenced selling its second generation transdermal estrogen delivery system “Vivelle-Dot®” in 1999. The patent rights and know-how for Vivelle-Dot® have been transferred to the Company by means of the original sublicense granted by Novartis for Vivelle® as discussed above. | ||
| On March 30, 2001, the Company acquired the exclusive United States marketing rights to CombiPatch® (estradiol/norethindrone acetate transdermal system) in a series of transactions involving the Company, Noven, Novartis and sanofi-aventis as successor in interest of Aventis Pharmaceuticals (“sanofi-aventis”) (Note 3). | ||
| Novartis is responsible for providing distribution, administrative and marketing services to the Company, pursuant to certain other agreements, as amended. Noven is responsible for supplying products to the Company and for providing marketing and promotional services pursuant to certain other agreements, as amended. The Company does not have any employees. The Company relies on Novartis and Noven to perform all services (Notes 5 and 6). | ||
| 2. | Summary of Significant Accounting Policies | |
| Basis of Presentation | ||
| The preparation of the financial statements are in conformity with accounting principles generally accepted in the United States of America. | ||
| Use of Estimates | ||
| The preparation of financial statements require the use of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| during the reporting period. The most significant assumptions are employed in estimates used in the deductions from gross sales for allowances, rebates, returns, and discounts, provisions for product liability, anticipated recovery of insurance related receivables, and assumptions for cash flows when testing assets for impairment. Actual results could differ from the estimated results. | ||
| Cash and Cash Equivalents | ||
| The Company does not have cash accounts. Novartis administers cash collections and disbursements on behalf of the Company. The statement of cash flows for the year ended December 31, 2006, 2005, and 2004 are based on the cash accounts Novartis administers on behalf of the Company. | ||
| Inventory | ||
| Inventory is stated at the lower of cost or market value utilizing the first-in, first-out method. Inventory provisions are recorded in the normal course of business, and relate primarily to product that is within nine months of expiration as of the balance sheet dates. | ||
| Revenue Recognition | ||
| The Company recognizes revenue when all the risks and rewards of ownership have transferred to the customer, which occurs at the time of shipment of products. Revenues are reduced at the time of sale to reflect expected returns that are estimated based on historical experience. Additionally, provisions are made at the time of sale for all discounts, rebates and estimated sales allowances based on historical experience updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as reductions of revenue. | ||
| Sales Allowances | ||
| Novartis records the Company’s sales net of sales allowances for chargebacks, Medicare Part D rebates, Medicaid rebates, managed healthcare rebates, cash discounts and other allowances that are established in the same period the related revenue is recognized, resulting in a reduction to sales and the Due from affiliate — Novartis. Novartis maintains the reserves associated with such sales allowances on behalf of the Company, excluding the sales returns accrual that is maintained and recorded by the Company. Novartis is responsible for paying rebates and processing returns on behalf of the Company. The contracts that underlie these transactions are maintained by Novartis for its business as a whole and allocated to the Company for its products. Based on an analysis of the underlying activity, the amounts recorded by the Company represent Novartis’ best estimate of these charges that apply to sales of the Company. | ||
| The following table sets forth the reconciliation of the Company’s third party gross sales to third party net sales by each significant category of sales allowances: |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| Years Ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Gross sales |
$ | 151,931,653 | $ | 134,675,279 | $ | 121,212,227 | ||||||
Sales returns |
$ | 5,732,390 | $ | 935,912 | $ | 6,224,072 | ||||||
Managed health care rebates |
10,117,301 | 8,018,050 | 7,898,343 | |||||||||
Cash discounts |
3,041,805 | 2,690,058 | 2,425,331 | |||||||||
Medicaid and Medicare Part D rebates including
prescription drug savings cards |
980,498 | 938,423 | 1,340,483 | |||||||||
Chargebacks |
1,032,093 | 969,492 | 860,412 | |||||||||
Other discounts |
2,053,836 | 1,792,164 | 629,058 | |||||||||
Total sales allowances |
22,957,923 | 15,344,099 | 19,377,699 | |||||||||
Net sales to third parties |
$ | 128,973,730 | $ | 119,331,180 | $ | 101,834,528 | ||||||
| Advertising Costs | ||
| Advertising costs are expensed as incurred. | ||
| Shipping and Handling Costs | ||
| The Company does not charge customers for shipping and handling costs. Shipping and handling costs are included in sales and marketing expenses and were $126,128, $146,322, and $118,936 for 2006, 2005, and 2004, respectively. | ||
| Income Taxes | ||
| The Company’s income, gains, losses and tax credits are passed to its Members who report their share of such items on their respective income tax returns. Accordingly, income taxes have not been provided. | ||
| Impairment of Long Lived Assets | ||
| The Company evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance may not be recoverable. When factors indicate that an asset should be evaluated for possible impairment, the Company reviews such long lived asset to assess recoverability from future operations using undiscounted cash flows. Impairments would be recognized in earnings to the extent that carrying value exceeds fair value. To date, no impairment has been identified (Note 3). | ||
| Product Liability | ||
| Accruals for product liability claims are recorded, on an undiscounted basis, when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. The Company includes legal fees in accruals for product liability claims. The accruals are adjusted as new information becomes available. Receivables for insurance recoveries related to product liability claims under the Company’s third party insurance policy are recorded, on an undiscounted basis, when it is probable that a recovery will be realized. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| Product liability claims which cover years in which the products were sold by the Company and years in which the products were sold by Novartis have been allocated between the Company and Novartis based on the ownership of the product during the period in which the injury is alleged to have occurred. | ||
| 3. | Acquisition of CombiPatch® Marketing Rights and Inventory | |
| On March 30, 2001, the Company acquired the exclusive United States marketing rights to CombiPatch® in a series of transactions involving the Company, Noven, Novartis and sanofi-aventis. The transactions were structured as (a) a direct purchase by the Company from sanofi-aventis of certain assets for $25,000,000, which was paid at closing, (b) a grant-back by sanofi-aventis to Noven of certain intellectual property rights relating to CombiPatch®, and (c) a simultaneous license by Noven to the Company of these intellectual property rights. The consideration payable by Noven to sanofi-aventis, and by the Company to Noven, was $40,000,000. The Company also incurred and capitalized $271,912 of legal services related to the acquisition. | ||
| The Company allocated $3,477,267 to the value of the inventory and the remaining $61,794,645 to an intangible asset representing license and marketing rights. This intangible asset is being amortized over a period of ten years, which is the estimated useful life. The accumulated amortization for this intangible asset was $35,531,923 and $29,352,458 as of December 31, 2006 and 2005. Amortization expense is $6,179,465 per year and is included in Cost of Sales. | ||
| The HT studies (Note 7) led to a triggering event in 2002 and as such, the Company completed an impairment test of the intangible asset using projected undiscounted net cash flows applicable to CombiPatch®. Based on this test, the Company determined that there was no impairment. | ||
| Based on continued declining sales and the fact that further adverse changes in the market for hormone therapy products could have a material adverse impact on the ability of the Company to recover its investment, the Company continues to complete an annual impairment test of the intangible asset using projected undiscounted net cash flows applicable to CombiPatch®. Based on this test, the Company determined that there was no impairment as of December 31, 2006 and 2005. Further, evaluations may be required if additional declines in the market for CombiPatch® develop due to the HT studies or other factors. | ||
| 4. | Allowance for Returns and Product Recalls | |
| The methodology used by the Company to estimate product returns related to expired product is based on (a) historical experience of actual product returns and (b) the estimated lag time between when an actual sale takes place in relation to when the products are physically returned by a customer. The historical actual returns rate is then applied to product sales during the estimated lag period to develop the returns estimate. | ||
| The activity for the allowances for returns, including product recalls, for the years ended December 31, 2006, 2005 and 2004 is as follows: |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
Balance January 1, 2004 |
$ | 14,240,281 | ||
Current year provision |
4,997,001 | |||
Prior year adjustment |
1,227,071 | |||
Deduction—returns processed |
(11,295,497 | ) | ||
Balance December 31, 2004 |
9,168,856 | |||
Current year provision |
3,320,440 | |||
Prior year adjustment |
(2,384,528 | ) | ||
Deduction—returns processed |
(3,937,163 | ) | ||
Balance December 31, 2005 |
6,167,605 | |||
Current year provision |
4,342,016 | |||
Prior year adjustment |
1,390,374 | |||
Deduction—returns processed |
(3,962,090 | ) | ||
Balance December 31, 2006 |
$ | 7,937,905 |
| Product Recall |
| In October 2003, product stability testing revealed that certain CombiPatch® and Vivelle-Dot® products did not maintain the required specifications, resulting in a product recall. As a result, in 2003, the Company recorded a $6,500,000 estimated returns reserve related to the announced recall. In 2004, $3,155,101 of actual CombiPatch® and Vivelle-Dot® returns associated with the recall were processed. The remaining recall reserve of $3,344,899 was reversed to sales in 2004, as the United States Food and Drug Administration (the “FDA”) closed out the recall. In addition to the returns reserve, the Company recorded $432,661 in inventory provisions in 2003 related to product that was affected by the recall. The inventory related to the recall provision of $432,661 was destroyed in 2004 and the inventory provision was reduced to zero. There are no remaining allowances for the 2003 recalls as of December 31, 2006, 2005 and 2004. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| affects more product than Noven’s current testing and analysis suggests, additional recalls may be required, which could have a material and adverse effect on the Company’s results of operations and prospects. | ||
| 5. | Operating Agreement | |
| The Company’s Operating Agreement provides, among other things, for the following: | ||
| Management Committee | ||
| The Operating Agreement, as amended, provides for the formation of a Management Committee. The Members act on any matters to be determined by them through their representatives on the Management Committee. The Management Committee has general management powers with respect to the management and operation of the business and affairs of the Company and is responsible for policy setting and approval of the overall direction of the Company. The Management Committee consists of five individuals of whom three are designated by Novartis and two by Noven. A decision by the Management Committee is made by the affirmative vote of a majority of the Committee members. The Operating Agreement, as amended, also provides for certain actions or decisions to require the vote of at least four of the five members of the Management Committee. Those actions or decisions include but are not limited to approval of material amendments to the annual operating and capital budget for activities outside normal business, amendments to the documents concerning the formation of the Company, incurrence of indebtedness in excess of $1 million, admitting a new member, acquiring or disposing of assets with a value in excess of $500,000 or settlement of litigation in excess of $1 million. The Members have further agreed that the approval of both Members is required to adopt or materially amend the annual sales and marketing plan or to enter into any contract with a third party sales force. | ||
| Allocation of Net Income and Loss | ||
| Net income is allocated at the end of each fiscal year in accordance with the accounting method followed by the Company for federal income tax purposes in the following order of priority: | ||
| First, to Novartis until the cumulative amount of net income allocated under the relevant provisions of the Operating Agreement equals $6,100,000 annually, for the current and all prior fiscal years. | ||
| Second, any remaining net income attributable to sales of Vivelle® for each fiscal year is to be allocated 70% to Novartis and 30% to Noven until the cumulative amount of such net income equals the product of $30,000,000 multiplied by a fraction, the numerator of which is the aggregate net income from sales of Vivelle® and the denominator of which is the aggregate net sales of Vivelle® in that period. | ||
| Third, any remaining net income attributable to sales of Vivelle® for each fiscal year is to be allocated 60% to Novartis and 40% to Noven until the cumulative amount of such net income equals the product of $10,000,000 multiplied by a fraction, the numerator of which is the aggregate net income from sales of Vivelle® and the denominator of which is the aggregate net sales of Vivelle® in that period. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| Lastly, all remaining net income attributable to Vivelle® and all other net income, including net income attributable to Vivelle-Dot® and CombiPatch®, are to be allocated to the members in proportion to their respective percentage interests. | ||
| Net loss for any fiscal year is to be allocated between the Members in proportion to their respective percentage interests, with the exception of any net loss resulting from the termination of any license or know-how which would be allocated to the Member to whom such license or know-how reverts upon termination. | ||
| Distributions | ||
| Distributable funds are equal to the Company’s Net Cash Flow during the period, as defined in the Operating Agreement, less reserves for working capital and other purposes of $3,000,000 or as determined by the Management Committee. | ||
| Distributable funds are payable to the Members quarterly or as determined by the Management Committee. Distributions are made to the Members based on taxable income. Commencing in 2002, the state of New Jersey enacted legislation that requires the Company to remit estimated tax payments on behalf of its owners, Novartis and Noven. Included in the 2006 distributions to Novartis and Noven of $37,050,205 and $28,579,809, respectively, are payments related to New Jersey state taxes of $2,970,908 and $2,212,070, respectively. Included in the 2005 distributions to Novartis and Noven of $35,583,169 and $27,644,951, respectively, are payments related to New Jersey state taxes of $2,076,945 and $1,458,356, respectively. Included in the 2004 distributions to Novartis and Noven of $28,363,294 and $19,775,736, respectively, are payments to New Jersey for state taxes of $2,497,347 and $1,692,966, respectively. | ||
| Buy/Sell and Dissolution Provisions | ||
| The joint venture operating agreement includes a buy/sell provision that either Noven or Novartis may trigger by notifying the other party of the price at which the triggering party would be willing to acquire 100% of the joint venture. Upon receipt of this notice, the other member has the option to either purchase the triggering party’s interest in the Company or to sell its own interest in the Company to the triggering party at the price established by the triggering party. If Noven is the purchaser, then Noven must pay an additional amount equal to the net present value of Novartis’ preferred profit return. This amount is calculated by applying a specified discount rate and a period of ten years to Novartis’ $6.1 million annual preferred return. Either party may dissolve the Company in the event that the Company does not achieve certain financial results. | ||
| Novartis has the right to dissolve the joint venture in the event of a change in control of Noven if the acquirer is one of the ten largest pharmaceutical companies (as measured by annual dollar sales). Upon dissolution, Novartis would reacquire the rights to market Vivelle® and Vivelle-Dot® subject to the terms of the prior arrangement between Noven and Novartis, and the Company’s other assets would be liquidated and distributed to the parties in accordance with their capital account balances as determined pursuant to the joint venture operating agreement. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| 6. | Transactions with Affiliates | |
| Services | ||
| The Company relies on Novartis and Noven for providing certain services as follows: | ||
| Novartis is responsible for providing the following services: |
| • | Shipment of the products, fulfillment of product orders, inventory control and distribution, processing of invoices and cash management. | ||
| • | Management of the overall marketing and sales program for the products in the managed care sector of the market, including but not limited to all corporate, institutional and government accounts. | ||
| • | Customer service support and assistance for the products. | ||
| • | Regulatory affairs support and assistance for the products. | ||
| • | Bookkeeping and accounting, administrative functions relating to the distribution and sale of the products, and assistance with tax matters, insurance coverage and treasury services. | ||
| • | Legal services. |
| Charges for these services are based upon predetermined budgeted amounts that are ratified by the Management Committee of the Company on an annual basis. The Company believes this method is a reasonable basis for determining those charges. | ||
| During the years ended December 31, 2006, 2005 and 2004, Novartis charged the Company $3,555,410, $3,133,136 and $2,796,760, respectively, for these services. | ||
| Bookkeeping, Accounting and Treasury | ||
| The books and records of the Company are maintained by Novartis. The Company’s transactions are initially recorded in Novartis’ general ledger and are transferred to the Company’s ledger on a monthly basis with the corresponding entry being recorded as an amount Due to or from affiliate — Novartis Pharmaceuticals Corporation. The balances in this account of $23,688,751 and $17,951,634, as of December 31, 2006 and 2005, respectively, represent the net balance of these transactions for the period from commencement of the Company to those dates. | ||
| The Company received interest on amounts due from Novartis during the year ended December 31, 2006, 2005 and 2004 at an average annual rate of 5.25%, 3.6% and 1.4%, respectively. During these periods, interest of $841,564, $461,294 and $191,287, respectively, was earned and is reflected in the amount Due from affiliate—Novartis Pharmaceuticals Corporation. | ||
| The Members have agreed that Novartis is responsible for managing the receivables balances and Novartis bears the risk of the balances not being recovered in full. However, the Company records |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| receivables for sales to Novartis Pharmaceuticals Canada, Inc. and retains the risk related to these balances. These receivables are reflected in the amount Due from affiliate - Novartis Pharmaceuticals Canada. | ||
| The following summarizes the transactions processed through the Due from affiliate — Novartis account: |
| Years Ended December 31, | ||||||||
| 2006 | 2005 | |||||||
Balance at the beginning of the period |
$ | 17,951,634 | $ | 23,131,128 | ||||
Net sales—third parties (excluding returns) |
134,706,120 | 120,267,092 | ||||||
Sales returns processed |
(3,962,090 | ) | (3,937,163 | ) | ||||
Interest income on cash balances |
841,564 | 461,294 | ||||||
Distributions to members |
(65,630,014 | ) | (63,228,120 | ) | ||||
Payment to Noven for marketing services, inventory
purchases and royalties |
(56,699,396 | ) | (55,134,309 | ) | ||||
Disbursements made on behalf of the Company |
(1,815,935 | ) | (2,752,411 | ) | ||||
Novartis service charges |
(3,555,410 | ) | (3,133,136 | ) | ||||
Cash received from Novartis Canada |
1,852,278 | 2,226,126 | ||||||
Other |
— | 51,133 | ||||||
Total |
$ | 23,688,751 | $ | 17,951,634 | ||||
| Noven is responsible for providing the following services: |
| • | Manufacturing and packaging products for distribution by Novartis. | ||
| • | Retention of samples and regulatory documentation of the products. | ||
| • | Design and implementation of an overall marketing and sales program for the products in the retail sales and hospital sectors of the market, including the preparation of annual and quarterly marketing plans and managing the field sales force. | ||
| • | Quality control and quality assurance testing of finished goods prior to shipment to Novartis. |
| During the years ended December 31, 2006, 2005 and 2004, Noven charged the Company $20,926,359, $20,768,126, and $20,014,190, respectively, for field sales force staffing and marketing. | ||
| Noven also provides advertising and other services in connection with the marketing and promotion of the products. Such costs charged during the years ended December 31, 2006, 2005 and 2004 were $10,551,108, $8,970,238, and $10,663,298, respectively. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| These costs for field sales force staffing and marketing and advertising and other services in connection with the marketing and promotion of the products are included in the sales and marketing expenses line on the statement of operations. | ||
| Royalties
Royalties are payable to Noven by the Company on the sale of Vivelle® and Vivelle-Dot® in the United States of America. The royalty formula is based upon a percentage of the products’ net sales. In addition, a minimum annual royalty formula is specified. Included in the cost of sales are royalty expenses of $6,845,122, $6,444,033 and $5,203,932 for the years ended December 31, 2006, 2005 and 2004, respectively. |
||
| Inventory Purchases
Vivelle®, Vivelle-Dot® and CombiPatch® are manufactured by Noven and sold to the Company at an agreed upon price. Noven has ceased manufacturing of Vivelle for the Company at the end of 2006. During the years ended December 31, 2006, 2005 and 2004, the Company purchased products from Noven in the amounts of $17,012,690, $17,787,186 and $15,216,288, respectively. |
||
| Research and Development Noven assumes responsibility for research and development costs associated with the development of Vivelle®, Vivelle-Dot®, CombiPatch® and all future generation products (Note 7). |
||
| Due to Affiliate-Noven Pharmaceuticals, Inc. The following represents the amounts payable to Noven related to: |
| December 31, | ||||||||
| 2006 | 2005 | |||||||
Purchases of inventory |
$ | 3,795,409 | $ | 4,125,516 | ||||
Services provided by Noven |
3,056,883 | 3,835,010 | ||||||
Royalties |
1,714,270 | 1,826,781 | ||||||
| $ | 8,566,562 | $ | 9,787,307 | |||||
| 7. | Commitments and Contingencies | |
| Litigation, Claims and Assessments As of December 31, 2006, there have been 42 lawsuits that include 56 plaintiffs that allege personal injury liability arising from the use of hormone therapy (“HT”) products sold by the Company, including Vivelle®, Vivelle-Dot® and CombiPatch®. Of the 42 lawsuits filed, 5 lawsuits have been dismissed and 1 lawsuit has been settled for a nominal amount. For the remaining 36 pending lawsuits, 4 of these pending lawsuits name the Company, Noven and Novartis. Another of these pending lawsuits names Noven and Novartis, but not the Company, and another only names the Company. The remainder of the 36 lawsuits only name Novartis. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| The Company’s operating agreements contain a number of indemnification provisions in which the joint venture has indemnified the members relating to product liability losses. Novartis and Noven will seek indemnification and defense from the Company for any expenses and damages, including attorneys’ fees, incurred related to the aforementioned lawsuits and to any future lawsuits based on product liability theories related to Vivelle®, Vivelle-Dot® and/or CombiPatch® to the extent that indemnification is permitted by the agreements between and among Novartis, Noven and the Company. | ||
| Although it is not possible to predict the ultimate outcome of its litigation or the indemnification provisions at this time, the Company established reserves in the amount of $9,629,241 and $4,944,815 as of December 31, 2006 and 2005, respectively, for expected defense and settlement expenses as well as for estimated future cases alleging use of the Company’s products. These reserves represent management’s best estimates at this time based on all available information relating to the pending claims and historical experience, including that of Novartis. | ||
| To the extent insurance coverage provides for recovery of claims, the Company has recorded an insurance receivable, using estimates consistent with those used to develop the liability. The Company recorded an insurance receivable of $7,299,241 and $3,510,868 as of December 31, 2006 and 2005, respectively. Currently, although the Company’s insurance carrier has sent the Company a reservation of rights letter, the coverage is not in dispute. | ||
| The Company plans to pursue having these claims treated as a serial loss. As of December 31, 2006, the Company’s insurance carrier has not determined these claims to be a serial loss. Therefore, the Company has recorded a reserve for the deductible amount for each reported and incurred but not reported claim. | ||
| Additionally, with respect to CombiPatch® claims only, the Company purchased the right to that product pursuant to an asset purchase agreement (Note 3) which provides that the seller retains all product liabilities associated with the use, sale or disposal of CombiPatch® products on or before March 30, 2001, and the Company will seek to enforce this provision in cases to which it applies. At present no receivable has been recorded for this provision as the portion of the liability that can be attributed to the seller cannot be determined. | ||
| The Company, Novartis and Noven intend to vigorously defend themselves in the HT litigation. Given the unpredictable nature of litigation, no assurance can be given that the Company’s actual liability with respect to HT litigation will not exceed the reserved amounts and, there is a risk that additional claims may be filed against the Company. The Company’s financial condition, results of operations and/or cash flows could be materially and adversely affected if and to the extent that the Company’s estimate of the HT litigation liability proves incorrect or the Company is unable to recover payments under its product liability insurance policy. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| For the year ended December 31, 2004 the Company had a claims-made insurance policy with a $50,000 deductible per claim and a $10,000,000 aggregate limit, including defense costs. The Company also purchased the optional 5 Year Extended Reporting Period Endorsement which permits coverage for an occurrence prior to the expiration of the current policy term (January 1, 2005) to be reported under the 2004 policy during the next five years, as long as policy limits have not been eroded by prior claims. The premium in the amount of $965,909 for this coverage was recognized in administrative expenses as of December 31, 2004. In addition, the 2005 limited exclusion (as discussed above) would not apply for occurrences prior to policy expiration, but reported within the extended reporting period of 5 years. | ||
| The Company obtained a claims-made insurance policy for 2005 with a $150,000 deductible per claim and a $5,000,000 aggregate limit, including defense costs. This policy contains a limited HT exclusion providing no coverage for claims reported after January 1, 2005 for products which do not have the “new” labeling required by the FDA. | ||
| The Company is subject to legal proceedings, including product liability claims, related to its normal course of business. With the exception of the matters discussed above, the Company is not currently a party to any pending litigation which, if decided adversely to the Company, could have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company. | ||
| Supply Agreement | ||
| The Company has a supply agreement with Noven for the purchase of the Vivelle® and Vivelle-Dot® products which expired in January 2003. Since expiration, the parties have continued to operate in accordance with the supply agreement’s original commercial terms. A decision to discontinue operating in accordance with the Supply Agreement could have a material adverse impact on the Company’s financial position, results of operations and cash flows. | ||
| HT Studies | ||
| In July 2002, the National Institutes of Health (“NIH”) released data from its Women’s Health Initiative (“WHI”) study on the risks and benefits associated with use of oral combination HT by healthy women. The NIH announced that it was discontinuing the arm of the study investigating the use of oral estrogen/progestin after an average follow-up period of 5.2 years because the oral combination HT product used in the study was shown to cause an increase in the risk of invasive breast cancer. The study also found an increased risk of stroke, heart attacks and blood clots and concluded that overall health risks exceeded benefits from use of the orally delivered combined estrogen plus progestin product among healthy postmenopausal women. Also in July 2002, the National Cancer Institute published the results of an observational study in which it found that postmenopausal women who used estrogen therapy (“ET”) for 10 or more years had a higher risk of developing ovarian cancer than women who had never used HT. Since 2002, several other published studies have identified increased risks from the use of HT. As a result of the findings from the WHI and other studies, the FDA has required that “black box” labeling be included on all HT products marketed in the United States to warn, among other things, that these products have been associated with increased risks for heart disease, heart attacks, strokes, and breast cancer and that they are not approved for heart disease prevention. |
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Vivelle Ventures LLC
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
d/b/a Novogyne Pharmaceuticals
Notes to Financial Statements
December 31, 2006
| Researchers continue to analyze data from both arms of the WHI study and other studies. Other studies evaluating HT are currently underway or in the planning stage, including a new five-year study aimed at determining whether ET used by women aged 42 to 58 reduces the risk of heart disease. This study also seeks to determine if transdermal estrogen patches are more or less beneficial than an oral HT product. Although the Company’s Vivelle-Dot® product is not being used in the study, among other risks related to this study, the market for Vivelle-Dot® would likely be adversely affected if this study finds that a transdermal estrogen patch is less beneficial than other dosage forms, and the Company could be subject to an increased risk of product liability claims if HT patch products are found to increase the risk of adverse health consequences. | ||
| These studies and others have caused the HT market, and the market for the Company’s products, to significantly decline. Prescriptions for CombiPatch®, the Company’s combination estrogen/progestin patch, continue to decline in the post-WHI environment. The Company recorded the acquisition of CombiPatch® marketing rights at cost and tests this asset for impairment on a periodic basis. Further adverse change in the market for HT products could have a material adverse impact on the ability of the Company to recover its investment in these rights, which could require the Company to record an impairment loss on the CombiPatch® intangible asset. Impairment of the CombiPatch® intangible asset would adversely affect the Company’s financial results. The Members can not predict whether these or other studies will have additional adverse effects on the Company’s liquidity and results of operations, or the Company’s ability to recover the carrying value of the CombiPatch® intangible asset. | ||
| 8. | Significant Concentrations | |
| The Company considers there to be a concentration risk for all customers that represent 10% or more of the Company’s total sales. Sales to the Company’s top three distributors accounted for 38%, 37% and 20% in 2006, 35%, 37% and 21% in 2005, and 40%, 24% and 20% in 2004. |
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