<PAGE> 1
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 MARCH 31, 2000,
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) 320-5500
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
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 [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of April 30, 2000, the Registrant had 9,097,257 shares of Common Stock
outstanding, exclusive of 515,100 shares held by the Registrant as treasury
stock.
<PAGE> 2
COHESION TECHNOLOGIES, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. Financial Information Page No.
- --------------------------------- --------
<S> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
March 31, 2000 and June 30, 1999 3
Condensed Consolidated Statements of Operations -
Three and nine months ended March 31, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows -
Nine months ended March 31, 2000 and 1999 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 18
PART II. Other Information
- --------------------------------
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COHESION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
2000 1999*
---------- --------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................... $ 16,479 $ 4,239
Accounts receivable, net ..................... 370 895
Inventories .................................. 1,642 976
Other current assets ......................... 2,924 2,142
-------- --------
Total current assets .................. 21,415 8,252
Property and equipment, net .................... 6,418 6,705
Investment in Boston Scientific Corporation .... 19,133 41,632
Other investments and assets ................... 29,276 14,930
-------- --------
TOTAL ASSETS ................................... $ 76,242 $ 71,519
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................. $ 809 $ 1,035
Accrued compensation ......................... 952 1,172
Accrued liabilities .......................... 4,060 4,133
Income taxes payable ......................... 3,305 953
Obligation under capital lease ............... 733 --
-------- --------
Total current liabilities ............. 9,859 7,293
Long-term liabilities:
Obligation under capital lease ............... 2,854 --
Deferred income taxes ........................ 14,850 18,985
-------- --------
Total long-term liabilities ........... 17,704 18,985
Commitments and contingencies
Stockholders' equity:
Preferred stock .............................. -- --
Common stock ................................. 10 9
Additional paid-in capital ................... 18,549 15,193
Retained earnings ............................ 11,818 5,705
Accumulated other comprehensive income ....... 20,276 26,308
Treasury stock, at cost ...................... (1,974) (1,974)
-------- --------
Total stockholders' equity ............ 48,679 45,241
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ..... $ 76,242 $ 71,519
======== ========
</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.
3
<PAGE> 4
COHESION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------- ----------------------
2000 1999 2000 1999
------- ------- ------- --------
<S> <C> <C> <C> <C>
Revenue -- product sales .................................... $ 849 $ 428 $ 1,796 $ 1,651
Costs and expenses:
Cost of sales, including manufacturing start-up costs ..... 1,274 398 2,842 993
Research and development .................................. 3,422 3,724 9,582 11,182
Selling, general and administrative ....................... 1,515 1,712 5,094 4,931
Compensation expense related to
cancelled stock options .............................. 354 498 1,245 2,945
------- ------- ------- --------
Total costs and expenses .......................... 6,565 6,332 18,763 20,051
------- ------- ------- --------
Loss from operations ........................................ (5,716) (5,904) (16,967) (18,400)
Other income (expense):
Gain on sale of investments ............................... 1,511 13,220 26,532 27,191
Interest income ........................................... 307 2 576 72
Interest expense .......................................... (85) (8) (174) (11)
------- ------- ------- --------
Income (loss) before provision for income taxes
and minority interest ................................ (3,983) 7,310 9,967 8,852
Provision (benefit) for income taxes ........................ (1,593) 2,925 3,987 3,541
------- ------- ------- --------
Income (loss) before minority interest in
consolidated subsidiary .............................. (2,390) 4,385 5,980 5,311
Minority interest in net loss of
consolidated subsidiary .............................. (133) -- (133) --
------- ------- ------- --------
Net income (loss) ........................................... $(2,257) $ 4,385 $ 6,113 $ 5,311
======= ======= ======= ========
Earnings (loss) per common share - basic .................... $ (.25) $ .52 $ .71 $ .62
======= ======= ======= ========
Earnings (loss) per common share assuming dilution .......... $ (.25) $ .52 $ .66 $ .62
======= ======= ======= ========
Weighted average shares outstanding - basic ................. 8,900 8,399 8,584 8,607
======= ======= ======= ========
Weighted average shares outstanding assuming dilution ...... 8,900 8,399 9,311 8,607
======= ======= ======= ========
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4
<PAGE> 5
COHESION TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income .................................................. $ 6,113 $ 5,311
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation and amortization ............................ 1,315 876
Gain on investments ...................................... (26,532) (27,191)
Decrease (increase) in assets:
Accounts receivable .................................... 525 85
Inventories ............................................ (666) (1,064)
Other .................................................. 25 (175)
Increase (decrease) in liabilities:
Accounts payable, accrued liabilities and other ........ (520) 772
Income taxes payable ................................... 2,352 2,534
-------- --------
Net cash used in operating activities .................... (17,388) (18,852)
-------- --------
Cash flows from investing activities:
Proceeds from sales of Boston Scientific
Corporation stock ........................................ 12,614 25,020
Proceeds from sale of other investments ..................... 10,993 533
Purchase of investments ..................................... (4,342) --
Proceeds on maturity of equity collar, net .................. 4,085 2,769
Proceeds from maturities of short-term investments .......... -- 1,616
Expenditures for property and equipment ..................... (664) (4,803)
-------- --------
Net cash provided by investing activities ................ 22,686 25,135
-------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options and
from employee stock purchase plan ........................ 3,355 96
Proceeds from sale-leaseback of manufacturing facility ...... 4,188 --
Payment of capital lease obligation ......................... (601) --
Proceeds from short-term borrowings ......................... -- 3,250
Payment of short-term borrowings ............................ -- (3,250)
Treasury stock purchases .................................... -- (1,835)
-------- --------
Net cash provided by (used in) financing activities ...... 6,942 (1,739)
-------- --------
Net increase in cash and cash equivalents ..................... 12,240 4,544
Cash and cash equivalents at beginning of period .............. 4,239 591
-------- --------
Cash and cash equivalents at end of period .................... $ 16,479 $ 5,135
======== ========
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements are
an integral part of these statements.
5
<PAGE> 6
COHESION TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated balance sheet as of March 31, 2000, the
condensed consolidated statements of operations for the three and nine months
ended March 31, 2000 and 1999, and the condensed consolidated statements of cash
flows for the nine months ended March 31, 2000 and 1999, 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
March 31, 2000 and for all periods presented. Interim results are not
necessarily indicative of results for a full fiscal year. The consolidated
balance sheet as of June 30, 1999 has been derived from the audited consolidated
financial statements at that date.
Certain amounts in 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, 1999.
2. INVENTORIES
Inventories are comprised of the following:
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
2000 1999
------ ------
(IN THOUSANDS)
<S> <C> <C>
Raw materials ....... $ 356 $ 158
Work-in-process ..... 908 737
Finished goods ...... 378 81
------ ------
$1,642 $ 976
====== ======
</TABLE>
6
<PAGE> 7
3. EQUITY INVESTMENTS
The following is a summary of the aggregate cost, gross unrealized
gains, and estimated fair value of the Company's investments in common stock and
equity collars:
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
2000 1999
------- -------
(IN THOUSANDS)
<S> <C> <C>
BOSTON SCIENTIFIC CORPORATION
Cost .............................. $ 1,569 $ 2,229
Gross unrealized gains ............ 13,898 43,056
------- -------
15,467 45,285
Fair value of equity collar ....... 3,666 (3,653)
------- -------
Estimated fair value .............. $19,133 $41,632
======= =======
OTHER INVESTMENTS
Cost .............................. $ 8,324 $10,253
Gross unrealized gains ............ 16,618 3,516
------- -------
Estimated fair value .............. $24,942 $13,769
======= =======
Total estimated fair value ........ $44,075 $55,401
======= =======
</TABLE>
The Company determines the appropriate classification of marketable
securities at the time of purchase and re-evaluates such designation as of each
balance sheet date. All of the Company's investments in equity securities are
classified as available-for-sale, except for the Company's investment in
NeuColl, which is accounted for under the equity method as of March 31, 2000.
To hedge against fluctuations in the market value of a portion of the
Boston Scientific common stock, the Company entered into costless collar
instruments that expire quarterly through May 2001 and will require settlement
in cash. At March 31, 2000, 475,000 shares (65%) were hedged under these
collars. The put and call options are collateralized by the shares of Boston
Scientific common stock held by the Company.
4. NEUCOLL
In February 1999, the Company formed a new subsidiary, NeuColl, Inc., to
commercialize products in the orthopedics field, which include Collagraft and
NeuVisc(TM), a collagen-based intra-articular implant for the treatment of pain
related to osteoarthritis. During the quarter ended March 31, 2000, NeuColl
obtained a total of $4 million in financing from a third party, $2 million of
which was received in February 2000 and the remaining $2 million on March 31,
2000, reducing the Company's ownership from 100% to approximately 60% and 39%,
respectively. For the quarter ended March 31, 2000, the Company consolidated
NeuColl's operating loss in its results of operations and reported the related
minority interest of $133,000 for a two-month period. Upon receipt of the second
tranche of financing on March 31, 2000, the Company's voting interest in NeuColl
decreased below 50%. Accordingly, NeuColl is no longer consolidated as of that
date and the Company will begin to report its share of NeuColl's operating
results under the equity method of accounting. As of March 31, 2000, the
Company's receivable balance with NeuColl was approximately $553,000 and the
carrying value of the investment was $20,000. The Company holds a warrant to
purchase an additional 3.0 million shares of common stock in NeuColl, which
expires in February 2006.
7
<PAGE> 8
5. EARNINGS PER SHARE
Under Statement of Financial Accounting Standards No. 128, Earnings Per
Share ("SFAS 128"), basic earnings per share ("EPS") is calculated using the
weighted average number of common shares outstanding for the period. The
computation of diluted EPS includes the effects of stock options, warrants and
convertible preferred stock, if such effect is dilutive. Options that had an
exercise price greater than their market price during the three and nine months
ended March 31, 2000 and 1999 were excluded, as their inclusion would have been
anti-dilutive. Below is a reconciliation between the basic and diluted weighted
average common and common-equivalent shares for the three and nine months ended
March 31, 2000 and 1999:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------ ------------------
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Basic (weighted average common
shares outstanding) ................ 8,900 8,399 8,584 8,607
Weighted average dilutive common
stock options outstanding .......... -- -- 727 --
----- ----- ----- -----
Diluted weighted average shares
outstanding ........................ 8,900 8,399 9,311 8,607
===== ===== ===== =====
</TABLE>
6. CAPITAL LEASE OBLIGATION
The Company entered into a lease agreement that covers manufacturing
equipment and leasehold improvements. The lease finances expenditures up to $5.0
million in aggregate and has a term of 48 months with a one-year extension
option or a single cash payment of 20% of the lease line utilized. Rental
payments are based on a monthly equivalent rental payment factor of the lease
line utilized. Equipment and certain investments collateralize the lease.
The following is a schedule of future minimum lease payments as of March
31, 2000:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
Period Ending March 31,
2001 ........................ $ 788
2002 ........................ 1,050
2003 ........................ 1,050
2004 ........................ 1,216
-------
Total future minimum lease payments ........................ 4,104
Less: Amount representing interest ......................... (517)
-------
Present value of net minimum lease payments ................ 3,587
Current portion of capital lease obligation ................ 733
-------
Long-term portion of capital lease obligation .............. $ 2,854
=======
</TABLE>
8
<PAGE> 9
7. STOCKHOLDERS' EQUITY
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. 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. The Company recorded $354,000 and $1.2 million of compensation
expense related to these canceled options during the three and nine months ended
March 31, 2000, respectively. The Company expects to record an additional
$700,000 through 2001.
8. COMPREHENSIVE INCOME
The components of comprehensive income (loss), net of related income
tax, for the three and nine months ended March 31, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------- -------------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) ............................ $ (2,257) $ 4,385 $ 6,113 $ 5,311
Change in unrealized gains on securities ..... 5,571 (865) (6,032) (14,425)
-------- -------- -------- --------
Comprehensive income (loss) .................. $ 3,314 $ 3,520 $ 81 $ (9,114)
======== ======== ======== ========
</TABLE>
9
<PAGE> 10
9. SEGMENT INFORMATION
The Company develops proprietary surgical products, including
bioresorbable hemostatic devices and biosealants for tissue repair and
regeneration. The Company operates in two segments: 1) a surgical business and
2) an orthopedic business. In February 1999, the Company formed a new
subsidiary, NeuColl, Inc., to commercialize its products in the orthopedics
field, which include Collagraft and NeuVisc(TM). Both segments report to the
Chief Executive Officer ("CEO") of Cohesion who allocates resources to each
business. The CEO has been identified as the Chief Operating Decision Maker as
defined by Statement of Financial Accounting Standards No. 131, Disclosure about
Segments of an Enterprise and Related Information ("SFAS 131"). Effective March
31, 2000, the Company's voting interest in NeuColl decreased below 50% and
therefore, NeuColl will no longer be consolidated as of that date and the
Company will report its share of NeuColl's operating income or loss under the
equity method of accounting. See Note 4 - NeuColl.
Information on reportable segments for the three and nine months ended
March 31, 2000 is as follows (information for the three and nine months ended
March 31, 1999 is not available):
THREE MONTHS ENDED
MARCH 31, 2000
(IN THOUSANDS)
<TABLE>
<CAPTION>
SURGICAL ORTHOPEDIC TOTAL
-------- ---------- --------
<S> <C> <C> <C>
Revenue - product sales ........ $ 323 $ 526 $ 849
Loss from operations ........... $(5,099) $(617) $(5,716)
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31, 2000
(IN THOUSANDS)
SURGICAL ORTHOPEDIC TOTAL
-------- ---------- -----
<S> <C> <C> <C>
Revenue - product sales ............. $ 620 $ 1,176 $ 1,796
Loss from operations ................ $(15,302) $(1,665) $(16,967)
Total assets at March 31, 2000 ...... $ 76,241 $ -- $ 76,241
</TABLE>
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with the
Condensed Consolidated Financial Statements and notes thereto. Certain
statements in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations" are forward-looking. The forward-looking statements
contained herein are based on current expectations and entail various risks and
uncertainties that could cause actual results to differ materially from those
expressed in such forward-looking statements. These risks include, but are not
limited to, (i) significant unforeseen delays in the regulatory approval
process, (ii) determination by the FDA or foreign regulatory bodies that our
clinical data does not support the safety and efficacy of our products and (iii)
competitive products and technology. For a more detailed discussion on other
business risks see "Additional Factors That May Affect Future Results of
Operations."
We are focused on developing and commercializing proprietary surgical
products, including bioresorbable hemostatic devices and biosealants for tissue
repair and regeneration. CoStasis Surgical Hemostat, our lead hemostatic
product, is designed for use in cardiovascular, orthopedic and general surgery
indications. We received a CE Mark for CoStasis in September 1998 and commenced
sales and distribution of the product in Europe beginning in February 1999. We
completed a pivotal clinical trial in the U.S. during fiscal 1999, and filed a
PMA application with the FDA in June 1999. In November 1999, we announced an
agreement with U.S. Surgical for the marketing and distribution of CoStasis. The
U.S. Surgical territories include the U.S., European Union, Eastern Europe,
Latin America, Middle East, Australia, New Zealand and India. In February 2000,
we received approval for an investigational device exemption, or IDE, filed with
the FDA to begin clinical studies in the U.S. for CoSeal Surgical Sealant, our
lead biosealant product designed for sealing vascular grafts, and in March 2000,
we announced receipt of a CE mark for CoSeal in Europe. We believe that our
surgical products will provide several distinct advantages over currently
available technologies, including ease of preparation and use, better delivery
systems, improved safety profiles and clinical effectiveness. Our products and
programs are based on a platform of proprietary technologies centered around
collagen, thrombin and hydrophilic polymers that quickly polymerize in-vivo and
bind to tissue. We also have research and development programs in recombinant
human collagen and thrombin. We reported sales of Collagraft implant, an
orthopedic product, through our investment in NeuColl, Inc. which also has
research and development programs in NeuVisc(TM) and other orthopedic areas.
Cohesion was organized in June 1997 as a Delaware corporation and wholly
owned subsidiary of Collagen Aesthetics, Inc., formerly known as Collagen
Corporation (now McGhan Medical since acquired by Inamed Corporation). During
fiscal 1998, Collagen proceeded to separate its Aesthetic Technologies Group and
its Collagen Technologies Group 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 to Cohesion. Collagen also contributed various equity
investments to Cohesion, including all of its holdings in Boston Scientific
Corporation. On August 18, 1998, Collagen distributed as a dividend to its
stockholders, one share of Cohesion's Common Stock for each share of Collagen
common stock outstanding. Cohesion and Collagen entered into various 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 of Cohesion's common stock.
11
<PAGE> 12
In February 1999, we formed a new subsidiary, NeuColl, Inc., to
commercialize products in the orthopedics field, which include Collagraft and
NeuVisc(TM), a collagen-based intra-articular implant for the treatment of pain
related to osteoarthritis. In connection with the formation, we granted NeuColl
an exclusive license to certain patents relating to collagen and polymer
technology for orthopedic applications. During the current fiscal quarter,
NeuColl obtained a total of $4 million in financing from a third party, which
reduced our ownership from 100% to approximately 39% as of March 31, 2000. For
the quarter ended March 31, 2000, we consolidated NeuColl's operating loss in
our results of operations and reported the related minority interest for a
two-month period. Beginning March 31, 2000, we will no longer consolidate
NeuColl into our financial results and instead, report our share of NeuColl's
operating income or loss under the equity method of accounting.
RESULTS OF OPERATIONS
Three and Nine Months Ended March 31, 2000 and 1999
Revenues were $0.8 million and $1.8 million for the three and nine
months ended March 31, 2000, respectively, compared to $0.4 million and $1.7
million for the same periods in the prior year. Sales of Collagraft for the
three months ended March 31, 2000 and 1999 were $0.5 million and $0.3 million,
respectively, and $1.2 million for the nine months ended March 31, 2000 and
1999. The increase in Collagraft sales over the prior year quarter is primarily
due to timing of shipments to Zimmer, NeuColl's distribution partner in the U.S.
and Asia. While we will no longer include sales of Collagraft in our revenues
for future periods, we expect revenues to be higher in fiscal 2000 due to
anticipated CoStasis milestone payments from the agreement with U.S. Surgical,
and a full-year of CoStasis sales in Europe. A number of uncertainties exist
surrounding the marketing and distribution of our products where the primary
means of distribution is through third-party firms, such as U.S. Surgical. Our
business and financial results could be adversely affected in the future in the
event a third-party firm 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 158% and 61% for the nine
months ended March 31, 2000 and 1999, respectively. The increase in cost of
sales as a percentage of sales was primarily due to manufacturing startup costs
for the CoStasis product, which are expected to continue through fiscal 2000.
Research and development ("R&D") expenses were $3.4 million and $9.6
million for the three and nine months ended March 31, 2000, respectively,
compared to $3.7 million and $11.2 million for the comparable prior year
periods. The decrease in R&D spending was due primarily to lower spending in the
recombinant programs in the current fiscal year. R&D expense reflects
reimbursement for the recombinant human collagen program in accordance with
intercompany agreements entered into between Cohesion and Collagen (now McGhan
Medical). We expect R&D spending in fiscal 2000 to be at slightly lower levels
than in fiscal 1999.
Selling, general and administrative ("SG&A") expenses were $1.5 million
and $5.1 million during the three and nine months ended March 31, 2000,
respectively, compared to $1.7 million and $4.9 million for the same periods in
the prior fiscal year. SG&A expenses were slightly lower in the current fiscal
quarter due to corporate transaction costs incurred in the prior year quarter.
The slight increase in SG&A expenses for the nine months ended over the prior
fiscal year is due primarily to increased marketing costs associated with the
launch of CoStasis in Europe, which were offset in part by lower corporate
transaction costs. Future levels of SG&A spending will depend on various
factors, including the level of product sales and how future products are
distributed throughout the world.
During the three and nine months ended March 31, 2000, we recorded $0.4
million and $1.2 million, respectively of compensation expense in connection
with the cancellation of the remaining stock options of Cohesion Corporation.
Compensation expense for the same periods in the prior year
12
<PAGE> 13
was $0.5 million and $2.9 million, respectively. In September 1998, our board of
directors approved a program to cancel options to purchase shares of the common
stock of Cohesion Corporation. In connection with this cancellation, we 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. We 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.
We expect to record an additional $0.7 million of compensation expense with
respect to the cash-out of canceled options, which will be recognized through
2001.
Gains on sales of investments were $1.5 million and $26.5 million for
the three and nine months ended March 31, 2000, respectively. The gains in the
current fiscal quarter were due to proceeds from a portion of the equity collars
that matured. Gains on sale of investments were $13.2 million and $27.2 million,
respectively, for the same periods in the prior year. The timing of future sales
of investments and number of shares sold will depend on market conditions and
our anticipated cash needs.
Interest income was $307,000 and $576,000 for the three and nine months
ended March 31, 2000, respectively, compared to $2,000 and $72,000 for the same
periods in the prior year. The increase is primarily due to higher average cash
and cash equivalents balances.
Interest expense was $85,000 and $174,000 for the three and nine months
ended March 31, 2000, respectively. Interest expense was related to our
obligation under our capital lease.
Our effective tax rate for the nine months ended March 31, 2000 and 1999
was 40%.
Minority interest in net loss of consolidated subsidiary (NeuColl) was
$133,000 for the three and nine months ended March 31, 2000. We will report our
share of NeuColl's operating results under the equity method of accounting
beginning March 31, 2000. As at March 31, 2000, the carrying value of our
NeuColl investment is $20,000.
SEGMENT INFORMATION
We operate in two segments: 1) our surgical business and 2) our
orthopedics business. Our surgical segment develops proprietary surgical
products, including bioresorbable hemostatic devices and biosealants, such as
CoStasis and CoSeal, for tissue repair and regeneration. In February 1999, we
formed a new subsidiary, NeuColl, Inc., to commercialize products in the
orthopedics field, which include Collagraft(R) and NeuVisc(TM), a collagen-based
intra-articular implant for the treatment of pain related to osteoarthritis. For
a discussion of Collagraft sales, see revenue discussion in "Results of
Operations." Our ownership in NeuColl decreased from 100% to below 50% as of
March 31, 2000 due to financing received by NeuColl from a third party.
Beginning March 31, 2000, we will no longer consolidate NeuColl into our
financial results and instead, will report our share of NeuColl's operating
income or loss under the equity method of accounting.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2000, cash and investments were $60.6 million. Net cash
used in operating activities was $17.4 million for nine months ended March 31,
2000. For the nine months ended March 31, 2000, cash provided by investing
activities of $22.7 million was related to proceeds of approximately $12.6
million from the sale of Boston Scientific common stock and proceeds of
approximately $15.1 million from the sale of other investments and maturity of
our equity collars. The investment proceeds were offset by $4.2 million for the
purchase of investments and $664,000 for capital expenditures. We anticipate
capital expenditures to be approximately $1.5 million in fiscal 2000. Net cash
provided by financing activities for the nine month ended March 31, 2000 was
$6.9 million primarily due to
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<PAGE> 14
proceeds of $4.2 million from the sale-leaseback of our manufacturing facility
improvements and equipment and $3.4 million of proceeds from stock programs,
which were offset by payments of approximately $0.6 million on a capital lease
obligation.
Our principal sources of liquidity include our equity investments, cash,
and cash equivalents. We anticipate 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. We may defer sales of
equity investments for tax planning purposes or other reasons, although
decisions concerning prospective stock sales will also be affected by the
then-current market price of the common stock.
In September 1998, our Board of Directors approved a stock repurchase
program to buy back up to 1.0 million shares of common stock at a price of up to
$4.25 per share. As of March 31, 2000, we had repurchased 515,100 shares of
common stock under this program.
In September 1998, our Board of Directors approved a program to cancel
options to purchase shares of the common stock of Cohesion Corporation. We
recorded $1.2 million of compensation expense related to these canceled options
during the nine months ended March 31, 2000 and expect to record an additional
$0.7 million with respect to the cash-out of canceled options through 2001.
We believe that our current sources of liquidity should be adequate to
fund our anticipated capital requirements through at least the next two years.
However, during this period and thereafter, we may require additional financing.
Our capital requirements will depend on numerous factors, including the progress
of our clinical research and product development programs, the extent to which
we enter into collaborative relationships with third parties and the scope of
our obligations in such relationships, the receipt of, and the time required to
obtain, regulatory clearances and approvals, the resources required to protect
our intellectual property and other factors. We cannot accurately predict the
timing and amount of such capital requirements. Additional financing may not be
available to us on acceptable terms, if at all.
In February 1999, we formed a new subsidiary, NeuColl, Inc., in order to
commercialize products in the orthopedics field, which include Collagraft and
NeuVisc, a collagen-based intra-articular implant. We provided the initial
funding for NeuColl; however, during the current fiscal quarter, NeuColl
obtained a total of $4 million in financing from a third party, reducing our
ownership from 100% to below 50%. As of March 31, 2000, the carrying value of
our investment in NeuColl was $20,000. We hold a warrant to purchase an
additional 3.0 million shares of common stock in NeuColl, which expires in
February 2006.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
For a more complete discussion of other risks and uncertainties
involving our business, see "Business - Government Regulations" and "Business -
Competition" in our Annual Report on Form 10-K for the fiscal year ended June
30, 1999.
Cohesion has a history of operating losses and anticipates continued operating
losses
Prior to July 1, 1998, our historical results of operations reflect the
historical operations of the transferred businesses contributed by Collagen (now
McGhan Medical) to Cohesion. The financial statements, prior to July 1, 1998,
may not necessarily reflect the results of operations, financial position and
cash flows of the transferred businesses had Cohesion been operated as an
independent entity during the periods presented. The transferred businesses
incurred operating losses in each of the past five years, including operating
losses of $24.9 million, $31.5 million and $16.4 million in fiscal 1999, 1998
and 1997, respectively. Cohesion's operating losses have resulted primarily from
expenses incurred in connection with research and development activities,
including preclinical and
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<PAGE> 15
clinical trials, development of manufacturing processes and general and
administrative expenses, and we expect that such expenses will continue to
increase for the foreseeable future. While we had sales of Collagraft bone
products of $1.9 million, $1.5 million and $1.9 million for the years ended June
30, 1999, 1998 and 1997, respectively, such sales will not contribute to our
operating results after March 31, 2000 when our voting interest in NeuColl
decreased below 50%. Sales at their present levels, do not contribute in a
material way to our operating profitability. Our ability to achieve and sustain
operating profitability is highly dependent upon obtaining in a timely and
efficient fashion, regulatory approval for and successfully commercializing our
products in development, particularly CoStasis Surgical Hemostat and CoSeal
Surgical Sealant, and developing sales and marketing capabilities for our
products, both in Europe, the United States and other markets. There can be no
assurance that we will obtain required regulatory approvals in a timely fashion,
if at all, or successfully develop, manufacture, commercialize and market
products or that we will ever record significant product revenues or achieve
operating profitability.
We must develop and commercialize our products to generate revenues
Except for our line of collagen-based research material products, and
CoStasis and CoSeal in Europe, all of our products are in research or
preclinical or clinical development. We have not received marketing approval for
any of our products from the FDA. The development and commercialization of new
products are highly uncertain, as is the timing associated with these
activities. Among other things, potential products that may appear 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. We cannot assure you that any of our development programs will
be successfully completed, that clinical trials will generate anticipated
results or will commence or be completed as planned. Additionally, we cannot
assure you that we will be able to obtain a CE Mark in Europe, on a timely
basis, if at all, or that any PMA application will be accepted or ultimately
approved by the FDA on a timely basis, if at all, or that any products for which
approval is obtained will be commercially successful. If any of our 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, our business, financial condition
and results of operations will be materially and adversely affected.
Cohesion operates in an intensely competitive environment
We compete with many domestic and foreign medical device, pharmaceutical
and biopharmaceutical companies and organizations across each of our product
categories and areas in which we are conducting research and development
activities. In the hemostatic and biosealant areas, we believe in the United
States that we will face strong competition 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 such as Johnson & Johnson, United States
Surgical Corporation, American Home Products Corporation and Haemacure
Corporation. In addition, a fibrin sealant product is currently being marketed
by Baxter Healthcare Corporation. We face competition from more recent products
and technologies, such as those developed by Focal, Inc. and Fusion Medical
Technologies, Inc. Outside of the United States, other competitive products
currently being marketed include fibrin sealants and another class of sealants,
cyanoacrylates, which are sold in Europe and the Pacific Rim countries by Immuno
AG, Centeon L.L.C. and Cryolife. In the United States, there are several fibrin
sealants under development including those by the American Red Cross, Convatec,
a subsidiary of the Bristol-Myers Squibb Company, Haemacure Corporation and V.I.
Technologies, Inc. (Vitex). In addition to conventional fibrin sealants, there
are a number of other products in late-stage development using either collagen
or polymer technologies, made by Focal and Fusion, as well as cyanoacrylates.
Additionally, several
15
<PAGE> 16
companies and institutions are engaged in the development of collagen-based
materials, techniques, procedures and products for use in medical applications
we anticipate addressing with our current and proposed products and research
programs.
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
Cohesion. They may also have greater experience in developing products,
conducting clinical trials, obtaining regulatory approvals and manufacturing and
marketing such products. Recently developed technologies or procedures are, or
may in the future be, the basis of competitive products. There can be no
assurance that our 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
us or that would render our technology and products obsolete and noncompetitive.
In such an event, our business, financial condition and results of operations
would be materially and adversely affected. Competitors may also obtain approval
or clearance by the FDA or foreign regulatory approval organizations, achieve
product commercialization or obtain patent protection earlier than Cohesion.
Additionally, there can be no assurance that any marketing or other strategic
partners that we may engage will not pursue parallel development of technologies
or products relating to or competitive with our planned product portfolio. Also,
to the extent we commence manufacturing activities, we will also face
competition with respect to manufacturing efficiency and marketing capabilities,
areas in which we currently have limited experience. Failure to successfully
address the foregoing factors and circumstances could have a material adverse
impact on our business, financial condition and results of operations.
The market may not accept our products
CoStasis Surgical Hemostat is a device designed to control diffuse
capillary and small vein bleeding, and CoSeal Surgical Sealant is a device
designed to seal vascular grafts. There can be no assurance that either of these
products will gain commercial acceptance among physicians, patients and health
care payors, even if necessary international and U.S. regulatory marketing
approvals are obtained. We believe that recommendations and endorsements by
physicians will be essential for market acceptance of these surgical products,
and there can be no assurance that any such recommendations or endorsements will
be obtained. We believe that surgeons will not use our products unless they
determine, based on clinical data and other factors, that the products are an
effective means of controlling bleeding and sealing anastomoses and sites of
incision, and that the clinical benefits to the patient and cost savings
achieved through use of these systems outweigh their cost. Acceptance among
physicians may also depend upon our ability to train surgeons and other
potential users of our 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 our 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 our products to achieve
significant market acceptance will have a material adverse effect on our
business, financial condition and results of operations.
We have limited marketing and sales capabilities
We currently have limited experience in marketing and selling our
products under development and do not have a significant marketing and sales
staff. In order to achieve commercial success for any product approved by the
FDA, if any, we must either develop a marketing and sales force or enter into
arrangements with third parties to market and sell our products. If we develop
our own marketing and sales capabilities, we will be competing with other
companies that currently have experienced and well-funded marketing and sales
operations. To the extent that we enter into co-promotion or other marketing and
sales arrangements with other companies, any revenues we receive will be
dependent on the efforts of others, and there can be no assurance that such
efforts will be successful. Failure to
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<PAGE> 17
develop a sales and marketing force or enter into arrangements with other
companies will reduce our ability to generate revenues.
We depend on the sale of Boston Scientific stock and other equity investments to
fund operations
In connection with our spin-off from Collagen, Collagen transferred to
Cohesion, effective January 1, 1998, all of its equity interest in Boston
Scientific and other equity investments, including our investment in Pharming.
We have implemented a "protect" strategy based on purchases of put options and
sales of call options in combination, commonly known as an "equity collar,"
covering the substantial majority of our Boston Scientific holdings. While the
strategy is designed to minimize downside risk of loss should the stock price
decline below approximately $22.00 and allow for limited upside participation
should the stock price rise above approximately $49.00, there can be no
assurance that we will be able to sell any of the remaining unhedged shares of
Boston Scientific common stock at attractive prices if, when and as needed. As
of March 31, 2000, we have not hedged other equity investments in our portfolio.
The market prices of Boston Scientific common stock and other investments are
highly volatile and we believe that Boston Scientific, Pharming and other equity
investments are subject to a number of the same factors affecting their
operations as Cohesion, as well as additional factors not applicable to
Cohesion.
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<PAGE> 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Cohesion is exposed to financial market risks, including changes to
interest rates and equity security prices. To mitigate these risks, Cohesion
utilizes derivative financial instruments. Cohesion does not utilize derivative
financial instruments for speculative or trading purposes.
INTEREST RATE RISK
The primary objective of Cohesion's debt investment portfolio is to
preserve principal. Cohesion invests in debt instruments that meet high credit
quality standards and limits the amount of credit exposure to any one issue,
issuer or type of instrument. Cohesion also limits the maturity of debt
investments to 400 days or less. As of March 31, 2000, Cohesion held
approximately $16.3 million of interest rate sensitive investments in debt
securities. A hypothetical 1% increase in interest rates would result in a
decrease in the fair value of investments in debt securities of less than
$20,000 as of March 31, 2000. This estimate is based on sensitivity analyses
performed on Cohesion's financial positions at March 31, 2000. Actual results
may differ materially.
EQUITY SECURITY PRICE RISK
Cohesion is exposed to equity security price risks on investments in
Boston Scientific common stock and equity instruments of other biotechnology or
biomedical device companies. To hedge against fluctuations in the market value
of the Boston Scientific common stock, Cohesion entered into costless collar
instruments that expire quarterly through May 2001 and will require settlement
in cash. At March 31, 2000, 475,000 shares held by Cohesion were hedged using
these collars. The costless collar instruments are collateralized by shares of
Boston Scientific common stock held by Cohesion. Certain investments that are
restricted are carried at cost until the restrictions have lapsed.
<TABLE>
<CAPTION>
FAIR VALUE AT
EQUITY INVESTMENTS MARCH 31, 2000
- ------------------ --------------
(IN THOUSANDS)
<S> <C>
Boston Scientific $15,467
Equity collar 3,666
Innovasive 5,621
Pharming 19,321
------
Total portfolio $44,075
=======
</TABLE>
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<PAGE> 19
PART II. OTHER INFORMATION
COHESION TECHNOLOGIES, INC.
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
Exhibit 27.1 Financial Data Schedule
B. Reports on Form 8-K
None
19
<PAGE> 20
SIGNATURES
Pursuant to the requirements 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: May 15, 2000 /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 THREE MONTHS ENDED MARCH 31, 2000
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Exhibit Page
------- ------- ------------
<S> <C> <C>
27.1 Financial Data Schedule (EDGAR version only)
</TABLE>
21
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 3-MOS
<FISCAL-YEAR-END> JUN-30-2000 JUN-30-2000
<PERIOD-START> JUL-01-1999 JAN-01-2000
<PERIOD-END> MAR-31-2000 MAR-31-2000
<CASH> 16,479 0
<SECURITIES> 0 0
<RECEIVABLES> 370 0
<ALLOWANCES> 0 0
<INVENTORY> 1,642 0
<CURRENT-ASSETS> 21,415 0
<PP&E> 10,749 0
<DEPRECIATION> 4,331 0
<TOTAL-ASSETS> 76,242 0
<CURRENT-LIABILITIES> 9,859 0
<BONDS> 0 0
0 0
0 0
<COMMON> 10 0
<OTHER-SE> 48,669 0
<TOTAL-LIABILITY-AND-EQUITY> 76,242 0
<SALES> 1,796 849
<TOTAL-REVENUES> 1,796 849
<CGS> 2,842 1,274
<TOTAL-COSTS> 2,842 1,274
<OTHER-EXPENSES> 15,921 5,291
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 174 85
<INCOME-PRETAX> 9,967 (3,983)
<INCOME-TAX> 3,987 (1,593)
<INCOME-CONTINUING> 6,113 (2,257)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 6,113 (2,257)
<EPS-BASIC> .71 (.25)
<EPS-DILUTED> .66 (.25)
</TABLE>
