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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended SEPTEMBER 30, 1998,
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from_____________ to
____________
Commission file number: 000-24103
COHESION TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 94-3274368
(State or Other (I.R.S. Employer
Jurisdiction of Identification No.)
Incorporation or
Organization)
2500 FABER PLACE, PALO ALTO, CA 94303
(Address of Principal Executive Offices, including Zip Code)
Registrant's telephone number, including area code: (650) 354-4300
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
PREFERRED SHARE PURCHASE RIGHTS
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 month (or 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 [ ] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of October 31, 1998, Registrant had 8,647,488 shares of Common Stock
outstanding, exclusive of 200,100 shares held by the Registrant as treasury
stock.
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PART I
COHESION TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
PART I. Financial Information Page No.
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<S> <C>
Condensed Consolidated Balance Sheets -
September 30, 1998 and June 30, 1998 3
Condensed Consolidated Statements of Income -
Three months ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows -
Three months ended September 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6-10
Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-18
PART II. Other Information
Other Information 19
Signatures 20
</TABLE>
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COHESION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1998*
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................... $ 2,767 $ 591
Short-term investments .................................................. 1,038 1,016
Accounts receivable, net ................................................ 386 473
Inventories, net ........................................................ 87 81
Other current assets, net ............................................... 2,047 1,254
------------- -------------
Total current assets ............................................. 6,325 3,415
Property and equipment, net ............................................... 2,501 2,072
Intangible assets, net .................................................... 1,070 1,184
Investment in Boston Scientific Corporation ............................... 46,641 73,979
Receivable from equity collar investment .................................. 10,155 --
Other investments and assets, net ......................................... 15,217 15,003
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$ 81,909 $ 95,653
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LIABILITIES AND STOCKHOLDERS' AND PARENT COMPANY EQUITY
Current liabilities:
Accounts payable ........................................................ $ 644 $ 792
Accrued compensation .................................................... 2,321 953
Accrued liabilities ..................................................... 2,585 2,390
Income taxes payable .................................................... 1,307 300
Payable to Collagen Aesthetics, Inc. .................................... 241 880
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Total current liabilities ........................................ 7,098 5,315
Long-term liabilities ..................................................... 25,244 31,923
Commitments and contingencies
Stockholders' and parent company equity:
Preferred stock, $.001 par value, authorized: 5,000,000 shares,
issued and outstanding: no shares at September 30 and June 30, 1998 .. -- --
Common stock, $.001 par value, authorized: 15,000,000 shares,
issued and outstanding: 8,797,588 shares at September 30, 1998 and
8,861,040 shares at June 30, 1998 ..................................... 9 9
Additional paid-in capital .............................................. 14,778 9,612
Parent company equity ................................................... -- 4,961
Retained earnings (Since August 19, 1998) ............................... 895 --
Accumulated other comprehensive income .................................. 34,072 43,833
Treasury stock, at cost, 50,000 shares at September 30, 1998
(None at June 30, 1998) ............................................. (187) --
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Total stockholders' and parent company equity .................... 49,567 58,415
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$ 81,909 $ 95,653
============= =============
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
* Amounts derived from audited financial statements at the date indicated.
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COHESION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED
SEPTEMBER 30,
------------------------------
1998 1997
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<S> <C> <C>
Revenue-- product sales ............................... $ 396 $ 708
Costs and expenses:
Cost of sales ....................................... 183 413
Research and development ............................ 3,988 3,510
Selling, general and administrative ................. 1,689 1,344
Compensation expense related to
cancelled stock options ........................ 1,813 --
------------ ------------
Total costs and expenses .................... 7,673 5,267
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Loss from operations .................................. (7,277) (4,559)
Other income (expense):
Gain on investments, principally
Boston Scientific Corporation ................... 9,618 5,931
Equity in losses of other affiliates ................ -- (9)
Interest income ..................................... 57 237
------------ ------------
Income before provision for income taxes .............. 2,398 1,600
Provision for income taxes ............................ 1,007 --
------------ ------------
Net income ............................................ $ 1,391 $ 1,600
============ ============
Basic and diluted net income per share ................ $ .16 n/a
============ ============
Shares used in calculating basic and diluted per
share information ..................................... 8,838 n/a
============ ============
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
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COHESION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED
SEPTEMBER 30,
-------------------------------
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net income .................................................................. $ 1,391 $ 1,600
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization ............................................ 277 171
Equity in losses of affiliates ........................................... -- 9
Gains on investments ..................................................... (9,618) (5,931)
Decrease (increase) in assets:
Accounts receivable .................................................... 87 (256)
Inventories ............................................................ (6) (4)
Other .................................................................. (793) 357
Increase (decrease) in liabilities:
Accounts payable, accrued liabilities and other ........................ 472 (883)
Income taxes payable ................................................... 1,007 721
Other long-term liabilities ............................................ -- (30)
------------ ------------
Total adjustments ........................................................... (8,574) (5,846)
------------ ------------
Net cash used in operating activities .................................... (7,183) (4,246)
------------ ------------
Cash flows from investing activities:
Proceeds from sales of Boston Scientific
Corporation stock ........................................................ 9,626 6,216
Proceeds from sales of other affiliate stock ................................ 533 704
Purchases of short-term investments ......................................... (22) --
Expenditures for property and equipment ..................................... (591) (220)
------------ ------------
Net cash provided by investing activities ................................ 9,546 6,700
------------ ------------
Cash flows from financing activities:
Treasury stock purchase .................................................... (187) --
------------ ------------
Net cash used in financing activities .................................... (187) --
------------ ------------
Net increase in cash and cash equivalents ..................................... 2,176 2,454
Cash and cash equivalents at beginning of period .............................. 591 13,707
------------ ------------
Cash and cash equivalents at end of period .................................... $ 2,767 $ 16,161
============ ============
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
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COHESION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Cohesion Technologies, Inc. ("Cohesion" or the "Company") was organized as a
Delaware corporation and a wholly owned subsidiary of Collagen Aesthetics, Inc.
formerly known as Collagen Corporation ("Collagen") in June 1997. In October
1997, Collagen announced that it would proceed to separate its Aesthetic
Technologies Group and its Collagen Technologies Group ("CTG") into two
independent, publicly-traded companies. In connection with the separation of the
two groups, Collagen distributed as a dividend to its stockholders, one share of
the Company's Common Stock for each share of Collagen common stock outstanding
on August 18, 1998 (the "Distribution"). The Distribution was designed to
separate two distinct businesses with significant differences in their markets,
products, research needs, investment needs, employee retention and compensation
plans and plans for growth. Collagen's Board believed the separation into two
independent companies would enhance the ability of each to focus on strategic
initiatives and new business opportunities, improve cost structures and
operating efficiencies and create incentives that are more attractive and
appropriate for the recruitment and retention of key employees. As a
consequence, Collagen believed that investors would be able to evaluate better
the merits of the two groups of businesses and their future prospects.
In March 1998, the Board of Directors of Collagen approved certain agreements
between the Company and Collagen (collectively, the "Intercompany Agreements")
which (i) provided for the transfer, effective January 1, 1998, of certain
assets and liabilities relating to the businesses previously conducted by
Collagen's CTG to Cohesion, and (ii) established contractual arrangements
between Collagen and the Company. CTG's business activities focused on the
design, development, manufacture and commercialization of innovative resorbable
biomaterials, adhesive technologies, and delivery systems in the fields of
tissue repair and regeneration.
The condensed consolidated financial statements reflect the results of
operations, financial condition and cash flows of Cohesion as a component of
Collagen up through August 18, 1998 and as a separate stand-alone company
thereafter. The financial statements of Cohesion include the operating results
of Cohesion Corporation, a developer of proprietary products for hemostasis and
tissue adhesion, biosealants and adhesion barriers for surgical applications,
since the acquisition of Cohesion Corporation by Collagen in fiscal 1996.
Results prior to the distribution may not be indicative of the actual results of
operations and financial position of Cohesion under separate ownership. The
various assets, liabilities, revenues and expenses associated with CTG have been
allocated to the historical financial statements of Cohesion in a manner
consistent with the Intercompany Agreements. Management believes that the
consolidated statements of operations include a reasonable allocation of costs
incurred by Collagen which benefit Cohesion. These allocations of corporate
expenses include, in aggregate, approximately 30% to 35% of the general and
administrative expenses of Collagen for the periods presented, with the
exception of certain former Chief Executive Officer ("CEO") expenses in fiscal
1998. The CEO expenses have been allocated to Cohesion based on the CEO's level
of involvement in Cohesion during fiscal 1998. Costs and expenses associated
with cost of sales and research and development were generally allocated to
Cohesion on a specific identification basis.
In connection with the asset transfer discussed above, $10.9 million of cash,
cash equivalents and short-term investments remained with Collagen and the
remaining cash, cash equivalents and short-term investments were transferred to
the Company at December 31, 1997. Each debt security was
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allocated between the companies pro rata to the total allocation of such
investments. Substantially all investments in affiliates, including Boston
Scientific Corporation of Natick, Massachusetts ("Boston Scientific") and
Innovasive Devices, Inc. of Marlborough, Massachusetts ("Innovasive Devices")
were allocated to Cohesion. Trade receivables, notes receivable, loans to
officers and employees, fixed assets and employee related liabilities were
allocated based on specific identification. All equity accounts, with the
exception of the additional paid-in-capital related to Target Therapeutics,
Inc., remained with Collagen. For any assets or liabilities where it was not
practical to use the specific identification method, Cohesion was allocated 30%
of these assets and liabilities. The 30% allocation was based on a review of the
characteristics and activity of these assets and liabilities and business
objectives. The intercompany receivable/payable balances resulting from
Cohesion's participation in Collagen's central cash management system, after
consideration of the December 31, 1997 contribution of cash, cash equivalents
and short-term investments, is a component of parent company's contributed
capital on Cohesion's balance sheet. The officer separation agreement with
Collagen's former CEO and the costs associated with the agreement have been
allocated to Cohesion.
Under the terms of the services and supply agreements between Cohesion and
Collagen, Collagen will supply certain products to Cohesion for a fee. The cost
of sales amounts included in the financial statements are based on historical
costs for the periods presented through January 1, 1998. The Intercompany
Agreements provide for cost to be determined on a defined formula. If such
prospective arrangements had been in place during the periods presented, cost of
sales would have decreased by $30,000 in the prior year fiscal quarter.
Under the terms of the recombinant technology and development license
agreement between Cohesion and Collagen, Cohesion and Collagen will collaborate
to develop recombinant human collagen and will share the costs of the project
until certain milestones are met. The research and development ("R&D") expenses
included in the financial statements are based on historical costs for the
periods presented through January 1, 1998. The Intercompany Agreements provide
for costs to be equally shared. If such prospective arrangements had been in
place during the periods presented, R&D expenses, net of reimbursements from
Collagen, would have decreased by $400,000 in the quarter ended September 30,
1997.
The condensed consolidated financial statements include the accounts of
Cohesion and its wholly-owned and majority-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated. Cohesion operates
in one industry segment focusing on the development and sale of medical devices.
Investments in unconsolidated subsidiaries, and other equity investments in
which Cohesion has a 20% to 50% interest or otherwise has the ability to
exercise significant influence, are accounted for under the equity method.
Unrestricted available-for-sale equity securities in which Cohesion has a
less than 20% interest, which includes holdings in Boston Scientific and the
unrestricted portion of the Company's holdings in Innovasive Devices are carried
at fair value with the unrealized gains and losses, net of tax, reported as a
separate component of stockholders' equity. Restricted equity securities in
which Cohesion has less than a 20% interest are carried at cost or estimated
realizable value, if less, and are included in "other investments" in the
accompanying balance sheets. (See Note 2.) The cost of securities sold is based
on the specific identification method. The fair value of public equity
securities held is based upon quoted closing market prices. The fair value of
private equity securities held approximates the carrying value based on quoted
market prices for similar securities.
The condensed consolidated balance sheet as of September 30, 1998, the
condensed consolidated statements of income for the three months ended September
30, 1998 and 1997, and the condensed consolidated statements of cash flows for
the three months ended September 30, 1998 and 1997, have been prepared by the
Company and are unaudited. In the opinion of management, all necessary
adjustments (which include only normal recurring adjustments) have been made to
present fairly the financial position, results of operations, and cash flows at
September 30, 1998 and for all periods presented. Interim results are not
necessarily indicative of results for a full fiscal year. The
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consolidated balance sheet as of June 30, 1998 has been derived from the audited
consolidated financial statements at that date.
The financial statements for the prior fiscal period have been reclassified
to conform with the current year presentation. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted.
These condensed consolidated financial statements should be read in conjunction
with the audited consolidated financial statements and notes included in the
Company's Annual Report on Form 10-K for the year ended June 30, 1998.
New Accounting Standards
As of July 1, 1998, the Company adopted Financial Accounting Standard No. 130
("SFAS 130"), "Reporting Comprehensive Income". SFAS 130 establishes new rules
for the reporting and display of comprehensive income and its components;
however, the adoption of this statement had no impact on the Company's net
income or stockholders' equity. SFAS 130 requires unrealized gains or losses on
the Company's available-for-sale securities which prior to adoption were
reported separately in stockholders' equity to be included in other
comprehensive income. Prior year financial statements have been reclassified to
conform to the requirements of SFAS 130.
During the first quarter of fiscal 1999 and 1998, total comprehensive income
amounted to losses of $8.4 million and $3.0 million, respectively. The
components of comprehensive income (loss), net of related tax, for the
three-month periods ended September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
September 30,
------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Net income .................................. $ 1,391 $ 1,600
Unrealized gains (losses) on securities ..... (9,762) (4,639)
------------ ------------
Comprehensive income (loss) ................. $ (8,371) $ (3,039)
============ ============
</TABLE>
2. EQUITY INVESTMENTS
Boston Scientific Corporation
During the quarter ended September 30, 1998, Cohesion sold 125,000 shares of
Boston Scientific common stock for a pre-tax gain of approximately $9.1 million.
Boston Scientific is a leading manufacturer of catheter-based devices that can
be inserted through small body openings and are used in heart surgery and other
operations. Boston Scientific common stock is quoted on the New York Stock
Exchange under the symbol BSX. On September 30, 1998, the closing price of
Boston Scientific common stock was $51.38 per share.
Cohesion's shares of Boston Scientific common stock are classified as
available-for-sale and have been recorded at the estimated fair value. The
unrealized gains (estimated fair value less cost) on these available-for-sale
securities have been reported as a separate component of stockholders' equity,
net of tax. The following is a summary of the aggregate estimated fair value,
gross unrealized gains and amortized cost of the Company's investment in Boston
Scientific common stock:
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2. EQUITY INVESTMENTS (CONTINUED)
Boston Scientific Corporation
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1998
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Amortized Cost ............. $ 3,926 $ 4,468
Gross Unrealized Gains ..... 42,715 69,511
------------ ------------
Estimated Fair Value ....... $ 46,641 $ 73,979
============ ============
</TABLE>
To hedge against fluctuations in the market value of a portion of the Boston
Scientific common stock, Cohesion entered into costless collar instruments that
expire quarterly from August 1998 through May 2001 and will require settlement
in cash. At September 30, 1998, 800,000 shares were hedged under these collars.
The call options are collateralized by shares of Boston Scientific common stock
held by Cohesion. The receivable from the equity collar investment at September
30, 1998 was $10.2 million.
Innovasive Devices, Inc.
Prior to October 1996, Cohesion's 843,936 shares of common stock of
Innovasive Devices were valued at cost or $4.1 million due to restrictions which
prevented the sale of any of Cohesion's shares of common stock of Innovasive
Devices. At September 30, 1998, these restrictions were no longer applicable on
91,795 shares of Innovasive Devices common stock held by Cohesion. Cohesion
carries the portion of its investment in Innovasive Devices which can be sold
within one year, as an available-for-sale investment at market value, or
$482,000 at September 30, 1998, reflecting an unrealized gain of $40,000
($482,000 estimated fair value less $442,000 cost), which has been included in a
separate component of stockholders' equity, net of tax. The remaining 752,141
restricted shares of common stock continued to be valued at cost of $3.6
million. The investment in Innovasive Devices is included in "other investments"
in the accompanying balance sheets.
During the quarter ended September 30, 1998, Cohesion did not sell any of its
shares of common stock of Innovasive Devices. Innovasive Devices common stock is
quoted on The Nasdaq Stock Market under the symbol IDEA. The closing price of
Innovasive Devices' common stock at September 30, 1998, was $5.25 per share. At
September 30, 1998, Cohesion held approximately a 9% ownership position in
Innovasive Devices.
Pharming, B.V.
Prior to July 1998, Cohesion's investment in Pharming B.V. ("Pharming") was
valued at cost or $7.0 million. In July 1998, Pharming became a publicly traded
company, at which time the Company's shares were converted into 838,512 shares
of Pharming common stock. The Pharming common stock held by the Company will be
restricted from sale until December 31, 1998. Cohesion carries the portion of
its investment in Pharming which can be sold within one year, as an
available-for-sale investment at market value, or $1.8 million at September 30,
1998, reflecting an unrealized gain of $609,000 ($1.8 million estimated fair
value less $1.2 million cost), which has been included in a separate component
of stockholders' equity, net of tax. The remaining 695,579 restricted shares of
common stock continued to be valued at cost of $5.8 million. The investment in
Pharming is included in "other investments" in the accompanying balance sheets.
Pharming common stock is quoted on The EASDAQ Stock Market under the symbol
PHAR. The
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closing price of Pharming common stock at September 30, 1998, was $12.62 per
share. At September 30, 1998, Cohesion held approximately a 6% ownership
position in Pharming.
3. SHORT-TERM DEBT
In October 1998, the Company borrowed $500,000 for working capital purposes.
The interest rate on the demand loan is based on LIBOR + 1-1/8% and the debt is
collateralized by the Boston Scientific common stock.
4. STOCKHOLDERS' AND PARENT COMPANY EQUITY
Parent Company Equity
Cohesion's equity account with its parent company, Collagen, was closed out
to Additional Paid-in Capital as of the Distribution date. Retained earnings has
been established thereafter, and includes net income for the Company since
August 19, 1998.
Cohesion Corporation Stock Options
In September 1998, the Company's Board of Directors approved a program to
cancel options to purchase shares of the common stock of Cohesion Corporation, a
majority-owned subsidiary of the Company. In connection with such program, the
Company offered to pay each holder of these canceled options a per share amount
equal to the excess of $16.70 over the exercise price of the canceled option.
The Company will make this option payment ratably over the original vesting
period of the canceled option so long as the former holder thereof remains an
employee or consultant of the Company or Cohesion Corporation. The Company
recorded $1.8 million of compensation expense related to these canceled options
in the quarter ended September 30, 1998 and expects to records an additional
$3.9 million over fiscal years 1999 through 2001.
5. INCOME TAXES
The effective tax rate for the quarter ended September 30, 1998 was 42%.
There was no tax provision for the prior year quarter based on fiscal year 1998
projections at that time.
6. EARNINGS PER SHARE
Historical per share data for the quarter ended September 30, 1997 has not
been presented as no common shares were outstanding until June 25, 1998.
For the quarter ended September 30, 1997, basic and diluted pro forma net
income per share was $.18 per share based on 8,901,000 shares, assuming the
distribution of shares of the Company's Common Stock to Collagen's stockholders
had occurred on July 1, 1997 based on the number of Collagen common shares and
common equivalent shares outstanding for that period, assuming a one-for-one
exchange ratio in the Distribution.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following information should be read in conjunction with the Condensed
Consolidated Financial Statements and the notes thereto. This quarterly report
on Form 10-Q, and in particular the Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements regarding future events or the future performance of the Company that
involve certain risks and uncertainties including those discussed in "Factors
That May Affect Future Results of Operations" below and as more fully described
in "Risk Factors" in the Company's Form 10-K for the year ended June 30, 1998.
In this report, the words "anticipates", "believes", "expects", "future" and
similar expressions identify forward-looking statements. Actual events or the
actual future results of the Company may differ materially from any
forward-looking statements due to such risks and uncertainties. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Company undertakes no obligation to publicly release the
results of any revision to these forward-looking statements, which may be made
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. For a more detailed discussion of these and
other business risks, see "-- Factors That May Affect Future Results of
Operations."
The financial information of the Company set forth in this Form 10-Q is
theoretical in nature and not necessarily indicative of the future results of
operations or financial position of the Company or the results of operations and
financial position which would have resulted had the Company been a stand-alone
company during the periods presented.
OVERVIEW
Cohesion Technologies, Inc. ("Cohesion" or the "Company") was organized as a
Delaware corporation and wholly owned subsidiary of Collagen Aesthetics, Inc.,
formerly known as Collagen Corporation ("Collagen"), in June 1997. In October
1997, Collagen announced that it would proceed to separate its Aesthetic
Technologies Group and its Collagen Technologies Group ("CTG") into two
independent, publicly-traded companies. Effective January 1, 1998, Collagen
contributed its research and development programs for hemostatic devices,
biosealants, orthopedics products and programs, adhesion barriers and
recombinant human collagen and thrombin and other related businesses of CTG (the
"Transferred Businesses") to the Company. Collagen also contributed various
equity investments to the Company, including all of its holdings in Boston
Scientific Corporation ("Boston Scientific") and Innovasive Devices, Inc.
("Innovasive Devices"), which had an aggregate market value of $51.1 million at
September 30, 1998. In connection with the separation of the two groups,
Collagen distributed as a dividend to its stockholders on August 18, 1998, one
share of the Company's Common Stock for each share of Collagen common stock
outstanding (the "Distribution"). The Company and Collagen have entered into
various agreements (the "Intercompany Agreements") to provide for an orderly
transition of matters and to govern certain ongoing matters between the two
entities and provide a mechanism for transitioning license, supply,
distribution, research and development, tax, service and other agreements in
connection with the Distribution. A description of the assets and liabilities
contributed by Collagen to the Company is contained in Note 1 of Notes to
Condensed Consolidated Financial Statements.
The Company's historical financial position and results of operations reflect
the historical operations of the Transferred Businesses contributed by Collagen
to the Company. Prior to being contributed to the Company by Collagen, the
Transferred Businesses were part of the Collagen Technologies Group. In
particular, this Management's Discussion and Analysis of Financial Condition and
Results of Operations reflects the historical results of that operating group
for all periods presented through January 1, 1998, as if the contribution of the
Transferred Businesses by Collagen
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to the Company had occurred on July 1, 1997. (See Note 1 of Notes to Condensed
Consolidated Financial Statements.)
The Company is focused on developing and commercializing proprietary surgical
products, including bioresorbable hemostatic devices and biosealants for tissue
repair and regeneration. CoStasis surgical hemostat, the Company's lead
hemostatic product, is designed for use initially in cardiothoracic indications.
The Company completed a multi-site, randomized, pivotal clinical trial in Europe
and received European Community Certification ("CE Mark") for CoStasis in
September 1998. The Company anticipates to launch CoStasis in Europe in early
calendar 1999. The Company has received an Investigational Device Exemption
("IDE") from the United States Food and Drug Administration ("FDA") for CoStasis
and has commenced U.S. pivotal trials targeting cardiac, hepatic, orthopedic and
general surgery indications. CoSeal(TM) surgical sealant, the Company's lead
biosealant product designed for sealing organs and other tissues resulting from
surgical wounds and incisions, is expected to commence feasibility clinical
trials during fiscal 1999. The Company believes its surgical products will
provide several distinct advantages over currently available technologies,
including ease of preparation and use, novel delivery systems, improved safety
profiles and clinical effectiveness. The Company also sells Collagraft implant,
an orthopedic product, and has research and development programs in other
orthopedic areas and in recombinant human collagen and thrombin. The Company's
products and programs are based on a platform of proprietary technologies
centered around collagen and hydrophilic polymers that quickly polymerize
in-vivo and bind to tissue.
RESULTS OF OPERATIONS
Quarter Ended September 30, 1998 and 1997
Revenues were $396,000 and $708,000 for the quarter ended September 30, 1998
and 1997, respectively. Sales of Collagraft in the current fiscal quarter were
$276,000 compared to $542,000 in the prior year quarter. The decrease in sales
was due to lower sales of Collagraft by Zimmer, Inc. ("Zimmer") and the
consequent decrease in sales from the Company to Zimmer. The Company expects
sales of Collagraft in fiscal 1999 to be at levels slightly higher than those of
fiscal 1998 due to anticipated product launches by Zimmer in Japan and by the
Company in certain European countries.
A number of uncertainties exist surrounding the marketing and distribution of
Collagraft bone graft products. The Company's primary means of distribution for
the products is through Zimmer, a third party firm. The Company's business and
financial results could be adversely affected in the event that Zimmer is unable
to market the product effectively, anticipate customer demand accurately, or
effectively manage industry-wide pricing and cost containment pressures in
health care.
Cost of sales as a percentage of sales was 46% and 58% for the quarter ended
September 30, 1998 and 1997, respectively. The decrease in cost of sales as a
percentage of sales in fiscal 1999 is due to the pricing currently in effect for
fiscal 1999 for product purchases from Collagen. Cost of sales as a percentage
of sales for fiscal 1999 is expected to be lower as cost of sales will reflect a
full year's impact of the supply agreement with Collagen, which provides for
cost to be determined on a defined formula.
Research and development ("R&D") expenses were $4.0 million and $3.5 million
for the quarter ended September 30, 1998 and 1997, respectively. The 14%
increase in R&D spending primarily was due to clinical trial costs for the
tissue adhesive program and increased activity in the biosealant and recombinant
human collagen programs, including manufacturing startup costs for the CoStasis
product and contractual payments owed to Pharming, B.V. when program milestones
were met. R&D expense for the current fiscal quarter is reflected net of
reimbursement from Collagen (approximately $300,000) for the recombinant human
collagen program in accordance with the Intercompany Agreements. The Company
expects R&D spending in fiscal 1999 to be at levels higher than fiscal 1998 as a
result of increased activities in these programs.
12
<PAGE> 13
Selling, general and administrative ("SG&A") expenses were $1.7 million and
$1.3 million in the quarter ended September 30, 1998 and 1997, respectively.
SG&A expenses increased 26% over the prior year due to a ramp up of marketing
costs associated with the anticipated launch of CoStasis in Europe. SG&A costs
for the periods presented include expenses related to Collagen's former CEO, Mr.
Palefsky. The Company made cash payments of $575,000 to Mr. Palefsky in fiscal
1998, and will make cash payments to Mr. Palefsky during fiscal 1999 totaling
$233,000. The Company also agreed to forgive all indebtedness, aggregating $1.6
million, owed by Mr. Palefsky to Collagen (and assumed by the Company effective
January 1, 1998) subject to certain conditions. (See Note 1 of Notes to
Condensed Consolidated Financial Statements.) Such indebtedness was fully
reserved during fiscal 1997. SG&A expenses are expected to remain relatively
constant in fiscal 1999 due to reductions in costs associated with the
Distribution, and expenses associated with Mr. Palefsky, offset by anticipated
increased expenses associated with operating as a public company. Future levels
of SG&A spending will depend on various factors, including the level of product
sales.
During the current fiscal quarter, the Company recorded $1.8 million of
compensation expense in connection with the cancellation of the remaining stock
options of Cohesion Corporation. In September 1998, the Company's Board of
Directors approved a program to cancel options to purchase shares of the common
stock of Cohesion Corporation (the "Canceled Options"). In connection with such
program, the Company offered to pay each holder of Canceled Options a per share
amount equal to the excess of $16.70 over the exercise price of the Canceled
Option (the "Option Payment"). The Company will make this Option Payment ratably
over the original vesting period of the Canceled Option so long as the former
holder thereof remains an employee or consultant of the Company or Cohesion
Corporation. The Company expects to record an additional $3.9 million of
compensation expense to be recognized during fiscal years 1999 through 2001.
Gains on sales of investments were $9.6 million and $5.9 million for the
quarter ended September 30, 1998 and 1997, respectively. During the current
fiscal quarter, the Company sold 125,000 shares of Boston Scientific common
stock which provided cash proceeds of $9.6 million. The timing and number of
additional shares of Boston Scientific common stock sold will depend on market
conditions and the anticipated cash needs of the Company.
Interest income was $57,000 and $237,000 for the quarter ended September 30,
1998 and 1997, respectively. The decrease was due to lower average cash, cash
equivalent, and short-term investment balances in the current fiscal quarter.
The Company recorded a provision for income taxes of 42% for the current
fiscal quarter. There was no provision for income taxes recorded for the prior
year quarter based on projections at that time for the fiscal year 1998.
LIQUIDITY AND CAPITAL RESOURCES
On January 1, 1998, Collagen contributed to the Company, cash, cash
equivalents and short-term investments of $1.8 million, certain equity
investments, including Boston Scientific common stock and common stock of
Innovasive Devices as well as the agreement with Zimmer regarding the
distribution of Collagraft products. The Company expects to rely upon proceeds
from the sale of these investments, as well as revenues from the sale of
Collagraft, for future working capital, capital expenditures and other corporate
purposes.
At September 30, 1998, cash, cash equivalents and short-term investments were
$3.8 million compared to $1.6 million at June 30, 1998. Net cash used in
operating activities was $7.2 million and $4.2 million for September 30, 1998
and 1997, respectively. For the quarter ended September 30, 1998, cash provided
by investing activities of $9.5 million primarily related to proceeds of $9.6
million from the sale of 125,000 shares of Boston Scientific common stock and
proceeds of approximately $533,000 from the sale of shares in other investments,
partially offset by capital expenditures. For the quarter ended September 30,
1998, $187,000 was used in financing activities to purchase shares of
13
<PAGE> 14
the Company's common stock. The Company anticipates capital expenditures to be
approximately $6.0 million in fiscal 1999.
In September 1998, the Company's Board of Directors approved a stock
repurchase program to buyback up to 1.0 million shares of the Company's Common
Stock at a price of up to $4.25 per share. For the quarter ended September 30,
1998, the Company had repurchased 50,000 shares of Common Stock under this
program. In October 1998, the Company purchased an additional 150,100 shares of
its Common Stock.
The Company's principal sources of liquidity include sales of Boston
Scientific common stock and its cash, cash equivalents and short-term
investments. The Company anticipates that stock sales will be made from time to
time, with the objective of generating cash for, among other things, further
investments in both current and new affiliate companies. The Company may defer
sales of Boston Scientific common stock for tax planning purposes, although
decisions concerning prospective Boston Scientific common stock sales will also
be affected by the then-current market price of Boston Scientific common stock.
As another source of financing, the Company may in the near term establish a
credit facility, although there can be no assurance that a line of credit will
be available to the Company on acceptable terms, if at all. In October 1998, the
Company borrowed $500,000 for working capital purposes, which is collateralized
by the Boston Scientific common stock.
The Company's capital requirements will depend on numerous factors, including
the progress of the Company's clinical research and product development
programs, the extent to which the Company enters into collaborative
relationships with third parties and the scope of the Company's obligations in
such relationships, the receipt of, and the time required to obtain, regulatory
clearances and approvals, the resources required to protect the Company's
intellectual property and other factors. The timing and amount of such capital
requirements cannot be accurately predicted.
The Company believes that its current sources of liquidity should be adequate
to fund its anticipated capital requirements through at least the next two
fiscal years. However, during this period and thereafter, the Company may
require additional financing. The Company does not anticipate significant
capital expenditures in the near term other than what is noted above; however,
it may make investments in businesses and technologies that are necessary to
support its objectives. There can be no assurance that additional financing will
be available to the Company on acceptable terms, if at all. Furthermore, any
additional equity financing may be dilutive to stockholders and debt financing,
if available, may involve restrictive covenants.
YEAR 2000
The Year 2000 issue refers to problems that computer programs may have in
determining the correct century for the year, for example, time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could cause a system failure or miscalculations causing disruptions
of operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar business activity. Cohesion
has developed a plan to address potential exposures related to the Year 2000
issue and is taking reasonable steps to ensure that its systems, software and
equipment involving date-related information will continue to function properly
after December 31, 1999. The Company's plan encompasses compliance with
regulatory guidelines on the Year 2000 issue.
The Company has started its assessment of information technology business
systems, product, operating equipment, and third party interfaces, including
suppliers. To date, the Company has not identified any significant problems. The
Company plans to use Collagen's computer systems until June 30, 1999 under one
of the Intercompany Agreements. Some of Collagen's older computer programs were
written using two digits rather than four to define the applicable year.
Collagen has completed an assessment and has notified the Company that it will
modify or replace portions of its software so that its computer systems will
function properly with respect to dates in the year 2000 and
14
<PAGE> 15
thereafter. The Company will incur no costs related to ensuring that Collagen's
computer systems are year 2000 compliant. Accordingly, the Company estimates
that its costs associated with the year 2000 issue will be immaterial.
Subsequent to June 30, 1999, the Company expects to utilize its own recently
purchased computer system, which the Company believes is Year 2000 compliant.
The Company plans to implement this new business system during fiscal 1999.
With respect to third party interfaces, the Company has been and will
continue to confirm the Year 2000 readiness of those third parties through
January 1, 2000. However, the Company cannot reasonably estimate the potential
impact on its financial condition and operations if critical third parties do
not become Year 2000 ready on a timely basis.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
For a more complete discussion of risks and uncertainties involving the
Company's business, please see the risks factors described under the heading
"Risk Factors" set forth in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1998.
Uncertainties Related to Clinical Trials and Lack of Extensive Clinical Data
Although the Company received a CE Mark in Europe for its lead product
candidate, CoStasis, and is currently in clinical trials in the United States,
clinical data obtained to date has been insufficient to demonstrate the safety
and efficacy of any of the Company's product candidates under applicable FDA
regulatory guidelines. Significant additional clinical data will be required
prior to submission of a premarket approval ("PMA") application for any of such
prospective products in the United States. Such obstacles could delay progress
in the development and commercialization of the Company's current product
candidates. Adverse events related to the use of the Company's product
candidates may occur during clinical trials, and any such events may require
suspension or termination of clinical trials, and the filing of reports with the
FDA and other applicable U.S. and international regulatory authorities. Such
events could negatively impact the Company's ability to achieve successful
development and commercialization of its products.
Uncertainties Related to Development and Commercialization
The development and commercialization of new products, such as the Company's
surgical sealant CoSeal, are highly uncertain, as is the timing associated with
these activities. Among other things, potential products that may appear to the
Company to be promising may not reach the market for a number of reasons,
including the possibilities that the potential products will be found to be
ineffective or to cause harmful side effects during preclinical testing or
clinical trials, will fail to receive necessary regulatory approvals, will be
difficult to manufacture on a commercial scale, will be uneconomical, will fail
to achieve market acceptance or will be precluded from commercialization by the
proprietary rights of third parties. If any of the Company's development
programs are not successfully completed in a timely fashion, required regulatory
approvals are not obtained in a timely fashion, or products for which approvals
are obtained are not commercially successful, the Company's business, financial
condition and results of operations will be materially and adversely affected.
Uncertainties of Market Acceptance
There can be no assurance that the Company's products will gain commercial
acceptance among physicians, patients and health care payors, even if necessary
international and U.S. marketing approvals are obtained. The Company believes
that recommendations and endorsements by physicians will be essential for market
acceptance of its surgical products, and there can be no
15
<PAGE> 16
assurance that any such recommendations or endorsements will be obtained.
Acceptance among physicians may also depend upon the Company's ability to train
surgeons and other potential users of the Company's products in the application
of sprayable surgical products, which they typically have not used, and the
willingness of such users to learn these new techniques. Additional factors in
achieving market acceptance may include the Company's ability to address
competition from U.S. and international medical device, pharmaceutical and
biopharmaceutical companies, to develop a marketing and sales force, to form
strategic partnerships and to manufacture price- and cost-effective products.
Failure of the Company's products to achieve significant market acceptance will
have a material adverse effect on the Company's business, financial condition
and results of operations.
Intense Competition
The Company competes with many domestic and foreign medical device,
pharmaceutical and biopharmaceutical companies and organizations across each of
its product categories and areas in which it is conducting research and
development activities. In the hemostatic and biosealant areas, the Company
believes that it will face strong competition in the United States from existing
methodologies for controlling bleeding and sealing wounds resulting from
surgery, such as hemostatic powders and sponges, collagen-based hemostats and
traditional sutures and staples marketed by companies. In the United States,
there are several fibrin sealants under development, including a fibrin sealant
product which was recently approved by the FDA. In addition to conventional
fibrin sealants, there are a number of other products in late-stage development
using either collagen or polymer technologies, as well as another class of
sealants called cyanoacrylates. In the orthopedics area, the Company's
Collagraft bone graft products face competition from synthetic bone graft
substitutes.
Many of these companies and organizations have or will have substantially
greater financial, technological, research and development, regulatory and
clinical, marketing and sales and personnel resources than the Company. They may
also have greater experience in developing products, conducting clinical trials,
obtaining regulatory approvals, and manufacturing and marketing such products.
They may also develop alternative technologies and products that are more
effective, easier to use or more economical than those which have been or are
being developed by the Company or that render the Company's technology and
products obsolete and non-competitive. There can be no assurance that the
Company's current competitors or other parties will not succeed in developing
alternative technologies and products that are more effective, easier to use or
more economical than those which have been or are being developed by the Company
or that would render the Company's technology and products obsolete and
uncompetitive. Competitors may also obtain approval or clearance by the FDA or
foreign regulatory approval organizations, achieve product commercialization or
obtain patent protection earlier than the Company. Also, to the extent the
Company commences manufacturing activities, it will also face competition with
respect to manufacturing efficiency and marketing capabilities, areas in which
it currently has limited experience.
Uncertainty of Future Profitability
The Company's operating losses have resulted primarily from expenses incurred
in connection with the Company's research and development activities, including
preclinical and clinical trials, development of manufacturing processes and
general and administrative expenses and the Company expects that such expenses
will continue to increase for the foreseeable future. The Company's ability to
achieve and sustain operating profitability is highly dependent upon obtaining
in a timely and efficient fashion regulatory approval for and successfully
commercializing its products in development, particularly the CoStasis
atraumatic hemostatic device and the CoSeal surgical sealant and developing
sales and marketing capabilities for its product candidates, both in Europe, the
United States and other markets. There can be no assurance that the Company will
obtain required regulatory approvals in a timely fashion, if at all, or
successfully develop, manufacture, commercialize and market products or that the
Company will ever record significant product revenues or achieve operating
profitability. Operating profitability, if achieved, may not be sustained.
16
<PAGE> 17
Dependence on Boston Scientific Stock to Fund Operations
The Company has implemented a "protect" strategy based on purchases of put
options and sales of call options in combination, common known as an "equity
collar," covering 800,000 shares of its Boston Scientific stock holdings as of
September 30, 1998. While the strategy is designed to minimize downside risk of
loss should the stock price decline below approximately $63.00 and allow for
limited upside participation should the stock price rise above approximately
$98.00, there can be no assurance that the Company will be able to sell the
remaining unhedged shares of Boston Scientific stock at attractive prices if,
when and as needed. Failure to achieve such sales could jeopardize the Company's
ability to fund its operations and require it to engage in additional financing
alternatives, some of which might be dilutive. The market price of Boston
Scientific common stock is highly volatile and, as a medical device
manufacturer, the Company believes that Boston Scientific is subject to a number
of the same factors affecting its operations as the Company, as well as
additional factors not applicable to the Company. Any significant downward
fluctuation in the market price for Boston Scientific common stock could
adversely impact the Company's earnings due to lower amounts realized on any
sales by the Company of such stock.
No Assurance of Regulatory Approvals
The Company's existing and proposed products, research and development and
planned commercialization activities are subject to regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. Product development and approval within this
regulatory framework take a number of years and involve the expenditure of
substantial resources. Any failure by the Company to comply with applicable
regulatory requirements could result in the detention or seizure of products,
issuance of an enjoinment of future product activities and the assessment of
civil and criminal penalties against the Company, its officers and its
employees. Failure to comply with the regulatory requirements could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In order for the Company to market its products in Europe and other foreign
countries, the Company and/or its partners, if any, must obtain required
regulatory approvals and comply with extensive regulations governing safety,
quality and manufacturing processes. These regulations vary significantly from
country to country. The time required to obtain approval to market the Company's
products outside the United States may be longer or shorter than that required
in the United States. In order to market the products being developed by the
Company in the member countries of the European Union, the Company will be
required to obtain CE Mark certification.
The Company anticipates that its products currently in development will be
regulated as Class III medical devices and will require a PMA prior to being
marketed in the United States. There can be no assurance that the FDA will agree
that the clinical study results for CoSeal, once submitted, will have adequately
demonstrated the safety and effectiveness of the product.
Limited Manufacturing Capacity
Cohesion expects to manufacture and package the final product for CoStasis
and for CoSeal and that it will use outside contractors for other functions,
such as non-proprietary, high-volume processes. There can be no assurance that
the Company will be able to manufacture commercial quantities of its planned
products in a timely manner, or at all, and at commercially reasonable costs on
a timely basis. There can also be no assurance that the Company or its suppliers
or contract manufacturers will not experience materials shortages in the future.
Any of these factors could have an material adverse effect on the Company's
ability to develop and commercialize its products, which in turn would have a
material adverse effect on the Company's business, financial condition and
results of operations.
17
<PAGE> 18
The Company is required to register as a medical device manufacturer with the
FDA and to list its products with the FDA. In addition, prior to international
commercialization, the Company will be required to attain and maintain
compliance with ISO 9001 standards. Failure to either attain or maintain
compliance with the applicable regulatory requirements of various regulatory
agencies would have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has not yet undergone
an FDA quality system regulation ("QSR") inspection and does not anticipate that
it will undergo such an inspection until after submission of its initial PMA
application for its CoStasis hemostat product.
Lack of Marketing and Sales Capabilities
The Company currently has no experience in marketing or selling its products
under development and does not have a significant marketing and sales staff. In
order to achieve commercial success for any product approved by the FDA, the
Company must either develop a marketing and sales force or enter into
arrangements with third parties to market and sell its products. If the Company
develops its own marketing and sales capabilities, it will compete with other
companies that currently have experienced and well-funded marketing and sales
operations. To the extent that the Company enters into co-promotion or other
marketing and sales arrangements with other companies, any revenues to be
received by the Company will be dependent on the efforts of others, and there
can be no assurance that such efforts will be successful.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk, including changes to interest rates
and equity investment prices. The Company places its debt investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines. The Company does not expect any material
loss with respect to its debt investment portfolio. As part of its strategic
alliance efforts, the Company invests in equity instruments of biotechnology or
biomedical device companies that are subject to fluctuations in market value
from changes in stock prices and thus has material equity investments at
September 30, 1998 with related market risks. The Company believes that these
are viable investments that will eventually develop into marketable investments.
18
<PAGE> 19
PART II. OTHER INFORMATION
COHESION TECHNOLOGIES, INC.
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
Exhibit 27 Financial Data Schedule
B. Reports on Form 8-K
None
19
<PAGE> 20
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.
COHESION TECHNOLOGIES, INC.
Dated: November 16, 1998 /s/ David Foster
------------------------------------------
David Foster
Chief Executive Officer, and Director
(Principal Executive Officer)
Dated: November 16, 1998 /s/ Sharon Kokubun
------------------------------------------
Sharon Kokubun
Vice President, Financial Operations
(Principal Accounting Officer)
20
<PAGE> 21
COHESION TECHNOLOGIES, INC.
FORM 10-Q QUARTERLY REPORT FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX TO EXHIBITS
Sequentially
Exhibit Numbered
Number Exhibit Page
- ---------------------------------------------------------------------------
27 Financial Data Schedule (EDGAR version only)
21
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