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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
. . . . . . . . . . . . . . . . . . . .
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended June 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 0-18443
MEDICIS PHARMACEUTICAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 52-1574808
(State of other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
4343 East Camelback Road, Suite 250, Phoenix, AZ 85018-2700
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (602) 808-8800
Securities registered pursuant to Class A Common Stock, $0.014 par value
Section 12(b) of the Act: Preference Share Purchase Rights
(Title of each Class)
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form or any amendment
to this Form 10-K [ ].
The aggregate market value of the voting stock held on September 21, 1998 by
non-affiliates of the registrant was $581,148,692 (calculated by excluding all
shares held by executive officers, directors and holders known to the registrant
of five percent or more of the voting power of the registrant's Common Stock,
without conceding that such persons are "affiliates" of the Registrant for
purposes of the federal securities laws).
As of September 21, 1998, there were outstanding 18,496,377 shares of Class A
Common Stock $0.014 par value and 281,974 shares of Class B Common Stock $0.014
par value. Documents incorporated by reference:
Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of
Stockholders are incorporated herein by reference in Part III of this Form 10-K
to the extent stated herein.
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PART I
This Annual Report on Form 10-K ("Form 10K") contains forward-looking
statements which involve risks and uncertainties. The actual results of Medicis
Pharmaceutical Corporation (together with its wholly-owned subsidiaries, the
"Company" or "Medicis") could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth in this Annual Report on Form 10-K and the Company's other Securities and
Exchange Commission filings. See "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operation."
ITEM 1. BUSINESS
THE COMPANY
Medicis is the leading independent pharmaceutical company in the United
States focusing exclusively on the treatment of dermatological conditions. The
Company offers prescription, over-the-counter ("OTC") and physician-dispensed
dermatology products, emphasizing the clinical effectiveness, quality,
affordability and cosmetic elegance of its products. Medicis has achieved a
leading position in branded products for the treatment of acne, acne-related
conditions, psoriatic conditions and pruritic conditions, while also offering
the leading OTC topical analgesic containing capsaicin and the leading OTC fade
cream product in the United States. The Company has built its business through
successfully introducing prescription products such as DYNACIN(R) and TRIAZ(R)
for the treatment of acne, LUSTRA(TM) for the treatment of skin discolorations
and photoaging, as well as marketing OTC products such as the ESOTERICA(R) fade
cream product line. In addition, Medicis has acquired the LIDEX(R) and
SYNALAR(R) corticosteroid product lines from Syntex USA, Inc., ("Syntex") and
the entire product line from GenDerm Corporation and subsidiary ("GenDerm")
including ZOSTRIX(R) topical analgesic and NOVACET(R) acne rosacea treatments.
Medicis has also formed a business unit to market non-prescription cosmetic
dermatology treatments for sale directly to dermatologists in the United States
for administering and dispensing to patients.
PRINCIPAL PRODUCTS AND PRODUCT LINES
The Company currently offers products in the following areas of
dermatology: acne, acne rosacea, pruritis, inflammatory and hyperproliferative
skin conditions, dry skin, dandruff, warts, hyperpigmentation, dyschromia and
cosmetic dermatology. The Company addresses these areas with a range of
prescription products, OTC products and physician-dispensed dermatology
products.
PRESCRIPTION PHARMACEUTICALS
Prescription pharmaceuticals accounted for 77.0% of the Company's net
sales in the fiscal year ended June 30, 1998 ("fiscal 1998"). The Company
currently focuses its prescription pharmaceutical efforts primarily on treating
acne, acne-related conditions, and inflammatory and hyperproliferative skin
diseases, including eczema, psoriasis, hyperpigmentation, dyschromia and topical
dermatitis. The Company's principal branded pharmaceuticals are as follows:
DYNACIN(R) is an oral, systemic antibiotic prescribed for the treatment
of moderate to severe acne vulgaris, the most common form of acne. Acne related
conditions resulted in over 10 million visits to dermatologists in the United
States in 1995. The most commonly prescribed systemic acne treatments are
tetracycline and its derivatives, doxycycline and minocycline. Minocycline, the
active ingredient in DYNACIN(R) products, is widely prescribed for the treatment
of acne for several reasons. It has a more convenient schedule of one or two
doses per day as compared to other forms of tetracycline, which can require up
to four doses per day. Other forms of tetracycline require ingestion on an empty
stomach and often increase patient sensitivity to sunlight, creating a greater
risk of sunburn. Moreover, the other forms of tetracycline, including
doxycycline, often cause gastric irritation. In addition, resistance to several
commonly used antibiotics, including erythromycin, clindamycin,
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doxycycline and tetracycline, by the primary bacterial organism responsible for
acne has been documented. Studies suggest that bacterial resistance to
erythromycin exceeds 60%, and resistance to doxycycline and tetracycline exceeds
40%, while the bacteria showed virtually no resistance to minocycline. Thus,
although more expensive than other forms of branded tetracycline and many times
more expensive than generic tetracycline, minocycline is documented to have
clinical performance that is superior to other forms of tetracycline, while
avoiding many of its disadvantages. The Company believes the retail price of
DYNACIN(R) is approximately 30% lower than the average reported retail price of
another branded minocycline product, Minocin, while selling at approximately 25%
to 30% higher than the average reported retail price of generic minocycline.
DYNACIN(R) is at least comparable in performance to Minocin and is believed by
the Company to enjoy certain performance characteristics that favorably
distinguish it from generic minocycline. DYNACIN(R) was launched in the second
quarter of the fiscal year ended June 30, 1993. There can be no assurance that
DYNACIN(R) will not lose significant market share in the future, that it will
remain a competitive product, or that the Company will be able to compete
successfully in the acne treatment market through the sale of DYNACIN(R) or any
other product. The Company has entered into a manufacturing and supply agreement
with Schein Pharmaceutical, Inc. ("Schein") for the supply of DYNACIN(R)
products. See "-- Manufacturing."
TRIAZ(R) is an internally developed, patented, topical therapy
prescribed for the treatment of all forms and varying degrees of acne, and is
available as a gel or cleanser in two concentrations. The combined sales of
topically applied prescription acne products were in excess of $500 million in
the United States in 1996. The most frequently prescribed topical acne
treatments include Cleocin-T, generic topical clindamycin, and Benzamycin. While
these therapies are generally effective, TRIAZ(R) offers advantages over each
product, including improved stability, greater convenience of use, reduced cost
and fewer side effects. Benzamycin requires refrigeration and mixing by a
pharmacist and has a relatively short shelf life of three months. In contrast,
TRIAZ(R) comes in a ready-mixed gel that does not require refrigeration and has
a two-year shelf life. In addition, TRIAZ(R) is aesthetically pleasing and
minimizes the extreme drying and scaling of skin often caused by competing
brands. The Company believes the average reported retail price of TRIAZ(R) is
less than that of either Cleocin-T or Benzamycin. TRIAZ(R) products are
manufactured using the active ingredient benzoyl peroxide in a vehicle
containing glycolic acid and zinc lactate. Studies conducted by third parties
have shown that benzoyl peroxide is the most efficacious agent available for
eradicating the bacteria that cause acne with no reported resistance. Glycolic
acid is believed by the Company to enhance the effectiveness of benzoyl peroxide
by exfoliating the outer layer of the skin, thereby providing direct access to
the bacteria, and zinc lactate is believed by the Company to act to reduce the
appearance of inflammation and irritation often associated with acne. TRIAZ(R)
was developed by the Company and introduced in the second quarter of the fiscal
year ended June 30, 1996. TRIAZ(R) is currently the leading benzoyl peroxide
product in dermatology. There can be no assurance that TRIAZ(R) will not lose
significant market share in the future, that it will remain a competitive
product or that the Company will be able to compete successfully in the acne
treatment market through the sale of TRIAZ(R) or any other product. The Company
has patents and certain licensed patent rights covering varying aspects of
TRIAZ(R). TRIAZ(R) products are manufactured to the Company's specifications on
a purchase order basis by Paco Laboratories, Inc., ("Paco") and Accupac, Inc.,
("Accupac") See "--Manufacturing," "--Trademarks" and "--Patents and Proprietary
Rights."
LIDEX(R) is a high-potency topical corticosteroid brand prescribed for
the treatment of inflammatory and hyperproliferative skin diseases such as
eczema, psoriasis, atopic dermatitis, poison ivy, and other inflammatory skin
conditions. Competing steroid brands in the high potency category include Halog,
Elocon, and Cyclocort. LIDEX(R) was introduced more than 20 years ago and the
Company believes it is among the most widely-accepted, efficacious and safe
topical steroid treatments available. Topical corticosteroid treatments
represented sales of approximately $480 million in 1996 in the United States.
The active ingredient in LIDEX(R), fluocinonide, works to alleviate
inflammations of the skin by reducing swelling and pain, relieving itching and
constricting blood vessels in the skin. In a controlled clinical study sponsored
by Syntex, LIDEX(R) was shown to be therapeutically superior to a generic
preparation containing the same active ingredients. In addition, in a controlled
clinical study sponsored by the Company in 1997, LIDEX(R) was shown to be more
chemically stable than a generic preparation containing the same active
ingredients. The LIDEX(R) product line consists of various strengths and
cosmetically elegant formulations, including gels, ointments, creams, solutions
and emollient creams. This broad product line allows dermatologists to prescribe
the most appropriate product based on the severity and location of a patient's
condition, as well as the thickness of a patient's skin. The various forms of
LIDEX(R) are preservative-free, and the active
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ingredient is fully dissolved in the vehicle of the medication, with the
exception of the LIDEX(R)-E Cream, resulting in better absorption of the
medication into the skin. In addition, certain competing products have a time
limitation on their usage, whereas there are no restrictions on the length of
treatment with LIDEX(R). The Company believes LIDEX(R) is priced comparably to
other branded corticosteroid products, but significantly higher than the average
reported retail price of generics containing fluocinonide. The Company acquired
the rights to LIDEX(R) in the United States and Canada from Syntex in the third
quarter of the fiscal year ending June 30, 1997. There can be no assurance that
the Company will be able to successfully market the LIDEX(R) product line, that
LIDEX(R) will not lose significant market share in the future, that it will
remain a competitive product or that the Company will be able to compete
successfully in the topical corticosteroid market through the sale of LIDEX(R)
or any other product. The Company has a manufacturing and supply agreement with
Patheon, Inc., ("Patheon") for the production of LIDEX(R). See
"--Manufacturing," "--Trademarks" and "Patents and Proprietary Rights."
SYNALAR(R) is a mid- to low-potency topical corticosteroid brand
prescribed for the treatment of less severe forms of inflammatory and
hyperproliferative skin diseases such as eczema, psoriasis, poison ivy, atopic
dermatitis and other inflammatory skin conditions. The active ingredient in
SYNALAR(R), fluocinolone acetonide, works to alleviate inflammations of the skin
by reducing swelling and pain, relieving itching and constricting blood vessels
in the skin. The SYNALAR(R) product line consists of various strengths and
cosmetically elegant formulations, including ointments, creams, emollient creams
and solutions. This flexibility allows dermatologists to prescribe the most
appropriate product based on the severity and location of a patient's condition,
as well as the thickness of skin. Competing steroid brands in the mid- and
low-potency categories include Aristocort, Cutivate, and Valisone. There can be
no assurance that the Company will be able to successfully market the SYNALAR(R)
product line or that the SYNALAR(R) product line will achieve or retain market
acceptance. SYNALAR(R) is priced comparably to other branded corticosteroid
products. The Company has a manufacturing and supply agreement with Patheon,
Inc., for the production of SYNALAR(R). See "-- Manufacturing," "-- Trademarks,"
and "Patents and Proprietary Rights."
LUSTRA(TM) is a topical therapy prescribed for the treatment of
ultra-violet induced skin discolorations and hyperpigmentation usually
associated with the use of oral contraceptives, pregnancy, hormone replacement
therapy and superficial trauma. LUSTRA(TM) contains 4% hydroquinone in a vehicle
containing glycolic acid in an anti-oxidant complex. In controlled clinical
trials sponsored by the Company in 1998, LUSTRA(TM) demonstrated a reduction in
pigmented lesions in a two week period with statistically significant
performance over competing brands Solaquin and Melanex. In another clinical
trial sponsored by the Company in 1997, LUSTRA(TM) demonstrated a statistically
significant reduction of sunburned skin cells when exposed to cumulative
ultra-violet radiation as compared with no treatment. Such sunburned cells are a
measure of ultra-violet induced skin damage. The Company started shipping
LUSTRA(TM) to wholesalers in February 1998. LUSTRA(TM) is manufactured on a
purchase-order basis by Contract Pharmaceuticals Limited. There can be no
assurance that the Company will be able to successfully market LUSTRA(TM) or
that the product will achieve market acceptance. See "--Manufacturing."
NOVACET(R) is a topical vanishing cream prescribed for the treatment of
acne rosacea, a chronic inflammatory skin disorder resembling acne, and
seborrheic dermatitis. The active ingredients in NOVACET(R) are sodium
sulfacetamide and sulfur. Sales of products to treat acne rosacea in the United
States in 1996 were approximately $50.0 million. NOVACET(R) was introduced by
GenDerm in 1993 and competes with other topical acne rosacea treatments such as
Sulfacet-R, MetroGel, MetroCream and generic treatments, as well as various
forms of erythromycin, clindamycin and oral metronidazole, which also are used
from time to time to treat acne rosacea. In a controlled clinical study
sponsored by GenDerm, NOVACET(R) was shown to reduce the severity of redness and
inflammation resulting from acne rosacea by 83% over an eight week period. By
week eight of the study, 98% of the patients in the study showed significant
improvements in their condition. The Company believes NOVACET(R) is priced
comparably to the competing brands. The Company acquired NOVACET(R) in December
1997 via the acquisition of all the common stock of GenDerm and assumed the
marketing of this brand in the United States and Canada. There can be no
assurance that the Company will be able to successfully market the NOVACET(R)
product line or that the NOVACET(R) product line will achieve or maintain market
acceptance. The Company has a manufacturing and supply agreement with DPT
Laboratories, Ltd. ("DPT") for the production of NOVACET(R). See "--
Manufacturing."
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The Company's other prescription products include, among others:
BENZASHAVE(R), a prescription shaving product used for the treatment of
pseudofolliculitis barbae ("PFB") and acne associated with shaving; THERMYCIN
Z(R), a topical antibiotic therapy for the treatment of acne; and ZONALON(R), a
topical anti-pruritic cream.
NON-PRESCRIPTION PRODUCTS
The Company's non-prescription products consist of OTC pharmaceutical
products and physician-dispensed dermatology products.
OTC and physician-dispensed pharmaceutical products accounted for 23.0%
of the Company's net sales in fiscal 1998. The Company markets a variety of OTC
and physician-dispensed skin care products to treat hyperpigmentation, warts,
dandruff, acne, dry skin, the texture and appearance of the skin, and certain
inflammatory skin conditions as well as a topical analgesic to treat arthritic
pain. The Company's principal OTC products are as follows:
ESOTERICA(R) is a line of topical creams used to treat minor skin
discoloration problems such as age spots, uneven skin tones, dark patches,
blotches and freckles. ESOTERICA(R) is the leading line of fade creams in the
United States. ESOTERICA(R) is available in five formulations, consisting of
four creams containing various concentrations of the active ingredient
hydroquinone and a body lotion. Hydroquinone is the only agent proven to reduce
hyperpigmentation and the only product legally sold in the United States for
this purpose. Competing OTC products used to treat minor skin discoloration
include Porcelana and AMBI, which are sold in a variety of creams, gels and
lotions. There can be no assurance that the Company will be able to successfully
market the ESOTERICA(R) product line, that it will not lose significant market
share in the future, that it will remain a competitive product or that the
Company will be able to compete successfully in the OTC fade cream market
through the sale of ESOTERICA(R) or any other product. The Company has a
manufacturing agreement for the ESOTERICA(R) products with Contract
Pharmaceuticals Limited on a purchase order basis. See "-- Manufacturing."
ZOSTRIX(R) is a line of topical analgesic creams for the treatment of
arthritic pain. The active ingredient in ZOSTRIX(R) is capsaicin, a chemical
derived from chili peppers, which is believed to work by decreasing the presence
of a neurotransmitter in the body called substance P, which can cause pain and
inflammation. ZOSTRIX(R) is the leading line of topical capsaicin creams in the
United States, comprising approximately 56% of the capsaicin market. ZOSTRIX(R)
primarily competes with other topical analgesics including: Capzacin,
Aspercreme, Sportscreme, Icy Hot, Flexall, Bengay and other private label
capsaicins and hot/cold rubs. The Company acquired ZOSTRIX(R) in December 1997
via the acquisition of GenDerm and assumed the marketing of this brand in the
United States and Canada. The Company has granted to Bioglan Laboratories,
Limited ("Bioglan") an exclusive license to the Company's rights with regard to
pharmaceutical topical preparations containing capsaicin in Belgium, France,
Germany, Greece, Italy, Luxembourg, The Netherlands and Portugal, in
consideration for the payment by Bioglan of certain royalties ("The Bioglan
Agreement"). The Bioglan Agreement will expire upon the later of January 31,
2008 or the tenth anniversary of the date of first commercial sales of the
licensed products in such territory. Upon the expiration of the term of The
Bioglan Agreement, Bioglan will have a fully paid, exclusive, perpetual license
for such rights in such countries. There can be no assurance that the Company
will be able to successfully market the ZOSTRIX(R) product line, that ZOSTRIX(R)
will not lose significant market share in the future, that it will remain a
competitive product or that the Company will be able to compete successfully in
the topical analgesics market through the sale of ZOSTRIX(R) or any other
product. The Company has a manufacturing and supply agreement with DPT for the
production of ZOSTRIX(R). See "-- Manufacturing," "-- Certain License and
Royalty Agreements."and "-- Patents and Proprietary Rights"
The Company's other OTC products include, among others: THERAPLEX(R), a
line of moisturizers used for the treatment of dry skin or certain inflammatory
skin conditions; OCCLUSAL-HP(R), a topical wart therapy; PENTRAX(R), a shampoo
containing the active ingredient fractar, an extract of coal tar, used for the
treatment of dandruff, seborrheic dermatitis and psoriasis of the scalp; and
SALAC(R), a cleanser used for the topical treatment of acne vulgaris.
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PRODUCTS IN DEVELOPMENT
The Company has developed and obtained rights to certain pharmaceutical
agents in various stages of development. The Company has a variety of products
under development, ranging from existing product line extensions to new products
to reformulations of existing products. Medicis' strategy involves the rapid
evaluation and formulation of new therapeutics by obtaining preclinical safety
and efficacy data, when possible, followed by rapid safety and efficacy testing
in humans. While development periods may vary, the Company generally selects
products for development with the objective of proceeding from formulation to
product launch within a two-year period.
The Company directs the efforts of contract laboratory research
facilities to perform formulation and research work on active ingredients as
well as to conduct preclinical studies and clinical trials. All products and
technologies under development require significant commitments of personnel and
financial resources. Several products require extensive clinical evaluation and
premarketing clearance by the United Stated Food and Drug Administration ("FDA")
and comparable agencies in other countries prior to commercial sale. Certain of
the products and technologies under development have been licensed from third
parties. The failure of the Company to meet its obligations under one or more of
these agreements could result in the termination of the Company's rights under
such agreements. In addition, the Company regularly reevaluates its product
development efforts. On the basis of these reevaluations, the Company has in the
past, and may in the future, abandon development efforts for particular
products. There can be no assurance that any product or technology under
development will result in the successful introduction of any new product.
Failure of the Company to introduce and market new products, whether internally
developed or acquired from third parties, could have a material adverse effect
on the Company's business, financial condition or results of operation.
The Company's research and development costs for Company-sponsored and
unreimbursed co-sponsored pharmaceutical projects for the fiscal year ended June
30, 1998 ("fiscal 1998"), the fiscal year ended June 30, 1997 ("fiscal 1997"),
and the fiscal year ended June 30, 1996 ("fiscal 1996") were $2,885,000,
$1,450,000, and $952,000, respectively. The Company has in the past
supplemented, and may in the future supplement, its research and development
efforts by entering into research and development agreements with other
pharmaceutical companies in order to defray the cost of product development.
There can be no assurance that the Company will be able to enter into research
and development agreements acceptable to the Company, or at all.
In July 1997, the Company entered into an agreement with Abbott
Laboratories, ("Abbott") for the development, manufacture and marketing of a
branded dermatologic product. Abbott will be responsible for the development and
eventual manufacture of the product, which the Company will market exclusively
to dermatologists. The Company has agreed to pay certain development expenses
estimated to be approximately $1,000,000. There can be no assurance that this
collaboration will result in the successful introduction of any new product or
technology.
In October 1997, the Company signed a letter of intent with Miravant
Medical Technologies, Inc. ("Miravant") for the development and
commercialization of Miravant's PhotoPoint technology for dermatology
applications. PhotoPoint technology is a proprietary procedure that uses
light-activated drugs to destroy targeted cells. The Company and Miravant will
collaborate on the development of photo sensitizers, subsequent clinical trials
and future marketing activities. Treatment of psoriasis and certain skin cancers
are among the planned co-development project areas. Under the preliminary
agreement, Miravant will bear the costs associated with product development and
the Company shall be responsible for all marketing, sales and distribution
expenses following regulatory approval of the technology. The Company expects to
enter into an agreement incorporating these terms. However, there can be no
assurance that the Company will enter into a final agreement incorporating these
terms or that this collaboration, if agreed upon, will result in the successful
introduction of any new product or technology.
In December 1997, the Company acquired 100% of the common stock of
GenDerm. The acquisition also included several in-process research and
development projects. Although the Company intends to continue such development
projects, there can be no assurance that any product or technology previously
under development by
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GenDerm will result in the successful introduction of any new product or that
the Company will continue the development of any such projects in the future.
MARKETING AND SALES
The Company believes that its prescription pharmaceutical marketing and
sales organization is one of the most productive in the dermatology sector. The
marketing effort is focused on assessing and meeting the needs of
dermatologists. The Company's prescription sales team, consisting of 59 members
at July 31, 1998, regularly calls on dermatologists, focusing on the
approximately 3,200 dermatologists who are responsible for 80% of all
prescriptions written by dermatologists in the United States. The Company's
sales team also calls on high-volume dermatologists who are actively engaged in
dispensing cosmetic products directly to patients and who perform cosmetic
procedures in their offices. Medicis representatives conduct in-depth product
demonstrations and training, assist physicians and their office staffs with
merchandising, and provide consulting services to dermatologists new to the
dispensing business. The Company has created an incentive program based on
aggressive goals in market share growth and believes its highest performing
sales representatives to be well compensated. The Company focuses on cultivating
a relationship of trust and confidence with dermatologists themselves. In
addition, the Company also uses a variety of marketing techniques to promote its
products, including sampling, journal advertising, promotional material,
specialty publications, rebate coupons, product guarantees, a leadership
position in educational conferences and exposure of its products on the
Internet.
The Company's OTC products are promoted to retailers and wholesalers by
manufacturers' representatives who also support a substantial number of products
of other manufacturers. The Company also markets its OTC products through trade
promotions, radio and print advertising, couponing and consumer awareness.
WAREHOUSING AND DISTRIBUTION
The Company utilizes an independent national warehousing corporation to
store and distribute its products from three central warehousing locations in
Nevada, Georgia and Maryland. Upon the receipt of a purchase order through
electronic data input ("EDI"), phone, mail or facsimile, the order is processed
into the Company's inventory systems, at which time an inventory picking sheet
is automatically placed via EDI to the most efficient warehouse location for
shipment, usually within 24 hours, to the customer placing the order. Upon
shipment, the warehouse sends back to the Company via EDI the necessary
information to automatically process the invoice in a timely manner.
CUSTOMERS
The Company's customers include the nation's leading wholesale
pharmaceutical distributors, such as McKesson Drug Company ("McKesson"), Bergen
Brunswig Drug Company, ("Bergen Brunswig"), Cardinal Health Inc., ("Cardinal"),
and other major drug chains. In fiscal 1998, McKesson, Bergen Brunswig, and
Cardinal, accounted for approximately 16.9%, 13.2% and 12.6% respectively, of
the Company's sales. In fiscal 1997, McKesson, Cardinal and Bergen Brunswig
accounted for approximately 20.6%, 16.3% and 10.9%, respectively, of the
Company's sales. In fiscal 1996, McKesson, Bergen Brunswig and Cardinal,
accounted for approximately 15.5%, 12.2% and 11.8%, respectively, of the
Company's sales. The distribution network for pharmaceutical products has, in
recent years, been subject to increasing consolidation. As a result, a few large
wholesale distributors control a significant share of the market. In addition,
the number of independent drug stores and small chains has decreased as retail
consolidation has occurred. Further consolidation among, or any financial
difficulties of, distributors or retailers could result in the combination or
elimination of warehouses which may result in product returns to the Company,
cause a reduction in the inventory levels of distributors and retailers, or
otherwise result in reductions in purchases of the Company's products, any of
which could have a material adverse impact upon the Company's business,
financial condition and results of operations. The loss of, or deterioration in,
any of these customer accounts would have a material adverse effect on the
Company's business, financial condition and results of operations.
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MANUFACTURING
The Company currently contracts for all of its manufacturing needs and
is required by the FDA to contract only with manufacturers that comply with
current Good Manufacturing Practices ("cGMP") regulations and other applicable
laws and regulations. The Company typically does not enter into long-term
manufacturing contracts with third-party manufacturers. Whether or not such
contracts exist, there can be no assurance that the Company will be able to
obtain adequate supplies of its products in a timely fashion, on acceptable
terms, or at all.
The Company's DYNACIN(R) products are manufactured by Schein in
compliance with the Company's specifications and quality standards pursuant to a
supply agreement. Under the agreement, Schein manufactures minocycline for sale
in the branded market exclusively for the Company, but may manufacture and sell
minocycline for itself or others as a generic product. Schein currently
manufactures minocycline for the generic market under its own label. The supply
agreement expires in December 2003, but is subject to automatic renewal for
successive two-year periods if neither party gives timely notice of termination.
It may also be terminated by either party without cause upon twelve months
notice. Schein may also terminate the exclusivity portion of the agreement if
its profit margin on sales of DYNACIN(R) products falls below a specified level.
The agreement also provides that the Company will purchase all of its
requirements for minocycline from Schein but may purchase some of its
requirements from another manufacturer if Schein fails to meet certain cost
standards or fails to provide the Company with all of its requirements for two
of four consecutive quarters. In addition, the Company may use alternative
sources if Schein terminates the Company's exclusive rights to purchase branded
minocycline based upon the Company's failure to meet the specified profit
margins, as defined. Either party may terminate the agreement in the event that
one party cannot perform under the agreement for a period of three months or
longer for certain reasons beyond its control. The Company believes that it has
alternative sources of supply and that it would be able to use these alternative
sources to preserve an adequate supply of DYNACIN(R). However, the inability of
Schein to fulfill the Company's supply requirements for DYNACIN(R), one of the
Company's largest-selling products, in a timely fashion, would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The majority of the Company's LIDEX(R) products are manufactured
primarily by Patheon, Inc., ("Patheon") in accordance with a manufacturing and
supply agreement assumed by the Company in connection with the acquisition of
the LIDEX(R) and SYNALAR(R) products. Under the terms of an agreement with the
Company, F. Hoffman-La Roche, Ltd. ("Roche") supplies, at cost, active
ingredients necessary for manufacturing the LIDEX(R) and SYNALAR(R) products.
The Patheon manufacture and supply agreement expires in January 1999, but is
subject to one-year automatic renewals if neither party gives timely notice of
termination. The inability of Patheon to fulfill the Company's supply
requirements for LIDEX(R) and SYNALAR(R) in a timely fashion could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company's ZOSTRIX(R), OCCLUSAL-HP(R), PENTRAX(R), SALAC(R),
NOVACET(R) and ZONALON(R) products, among others, are manufactured for
distribution in the United States primarily by DPT and in Canada by Patheon in
accordance with manufacturing and supply agreements assumed by the Company
concurrent with the acquisition of GenDerm. The Company is currently seeking
additional sources to manufacture these products. Under the agreement, the
Company is required to purchase at least 90% of its annual sales requirements
from DPT. The DPT manufacturing agreement expires in December 2003. Either party
may terminate the agreement upon two-years notice by the Company and three-years
notice by DPT. Such termination period becomes 60 days if either party fails to
perform, without cure, its obligations under the DPT manufacturing agreement.
The Company's ESOTERICA(R), LUSTRA(TM), TRIAZ(R), and THERAPLEX(R)
HYDROLOTION products are manufactured by Contract Pharmaceuticals Limited
pursuant to manufacturing agreements expiring in July 2001.
The Company's AFIRM(TM) and BETA-LIFTx(R) products are manufactured by
Advanced Polymer Systems, Inc. ("APS") pursuant to a license and supply
agreement that expires on the later of the expiration date of the last-to-expire
patent relating to the AFIRM(TM) and BETA-LIFTx(R) products, or in October 2006,
the tenth anniversary of the effective date. Under the terms of the agreement,
the Company is limited to promoting the products exclusively
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to dermatologists in the United States. In the event that APS fails to supply
the Company's requirements for either product, the Company is permitted to
purchase its requirements from third parties.
The Company purchases THERAMYCIN Z(R) and BENZASHAVE(R) products
exclusively from IVAX Corporation ("IVAX"), pursuant to a manufacturing
agreement expiring in July 2000. If IVAX is unable to supply the Company's
requirements of either product, the Company is permitted to purchase the
unsatisfied requirements from third parties.
The remainder of the Company's products are produced on a purchase
order basis only: THERAPLEX(R) EMOLLIENT products, manufactured by ViFor, SA.
("Vifor"); THERAPLEX(R) CLEARLOTION products, manufactured by Accupac, Inc.;
THERAPLEX(R) HYDROLOTION products, manufactured by BeautiControl Cosmetics,
Inc.; TRIAZ(R) products, manufactured by Paco and Accupac; and one LIDEX(R)
product manufactured by Paco.
There can be no assurance that the manufacturers of the Company's
products will continue to meet the FDA's regulations or the Company's product
specifications and standards for the indicated products or that they can
continue to meet product demand on a consistent and timely basis. The Company
derives a majority of its revenue from sales of DYNACIN(R), TRIAZ(R) and
LIDEX(R) products and expects the newly acquired line of ZOSTRIX(R) products to
also be a significant contributor to revenues (the "Key Products"). Schein,
IVAX, ViFor and DPT are currently the sole manufacturers of DYNACIN(R) products,
THERAMYCIN Z(R) products, THERAPLEX(R) EMOLLIENT products and ZONALON(R)
products, respectively. Patheon is currently the manufacturer of the LIDEX(R)
and SYNALAR(R) products. Because of the FDA requirement for cGMP validation of
manufacturing facilities for particular products, validation of a new facility
to serve as a replacement source of manufacturing requires a substantial period
of time. The Company believes that alternative sources of manufacturing are
available for all of its products. However, any loss of a manufacturer or other
difficulty relating to the manufacturing of the Company's products, especially
the Key Products, could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company faces the risk that, upon expiration of the term of any third-party
manufacturing agreement, it may not be able to renew or extend the agreement
with the third-party manufacturer, to obtain an alternative manufacturing source
from other third parties or to develop internal manufacturing capabilities on
commercially viable terms, if at all. The Company has obtained business
interruption insurance to insure against the loss of income for up to twelve
months due to the interruption of manufacturing of the Company's Key Products
due to certain causes. While the Company believes that the policy provides
substantial protection against the covered events, there can be no assurance
that the policy will cover all manufacturing interruptions or that the amount of
such insurance will be adequate to fully protect the Company for losses
associated with such interruptions. Any loss in excess of coverage limits, or
not covered by such policies, could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company's third-party manufacturers rely on certain suppliers of
key raw materials. Certain of those materials are purchased from single sources
and others may only be available from single sources in the future. Any
disruption in supplies, including delays due to the inability of the Company or
its manufacturers to procure raw materials, could have a material adverse effect
on the Company's business, financial condition and results of operations.
To manage its resources effectively, the Company attempts to retain
inventory levels that are no greater than necessary to meet the currently
projected needs of its customers. Any interruptions in the supply of any of the
Company's products due to shortages in raw materials, changes in manufacturing
sources, regulatory changes or other causes could delay or eliminate the
Company's ability to supply such products. There can be no assurance that the
Company will not suffer future supply insufficiencies or interruptions or that
it will be able to obtain adequate supplies of its products in a timely fashion,
or at all. While the Company believes that its inventory levels are generally
adequate, the loss of a manufacturer, the failure to obtain or validate a
replacement manufacturer on a timely basis, other manufacturing problems or any
interruption of supply could have a material adverse effect on the Company's
business, financial condition and results of operations.
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CERTAIN LICENSE AND ROYALTY AGREEMENTS
The Company has acquired rights to manufacture, use or market certain
of its products, as well as many of its other proposed products and
technologies, pursuant to license agreements with third parties. Such agreements
contain provisions requiring the Company to use its best efforts or otherwise
exercise diligence in pursuing market development for such products in order to
maintain the rights granted under the agreements and may be canceled upon the
Company's failure to perform its payment or other obligations. In addition, the
Company has also entered into agreements to license certain rights to
manufacture, use and sell certain of its technology outside the United States
and Canada to various licensees, including the ZOSTRIX(R) product line.
In December 1997, in connection with the GenDerm acquisition, in
addition to various license agreements relating to GenDerm's products, the
Company acquired an exclusive worldwide license agreement, on a
country-by-country basis, to market the ZOSTRIX(R) product line from Dr. Joel E.
Bernstein. The term of the license is for the life of the patents, the last of
which expires in June 2003, with royalties payable to Dr. Bernstein until 2002.
The Company has granted such rights to the ZOSTRIX(R) product line in Belgium,
France, Germany, Greece, Italy, Luxembourg, The Netherlands and Portugal to
Bioglan.
The Company's licensing agreement for the exclusive rights to market
the THERAPLEX(R) line of products will terminate in October 1999 with the
expiration of the related patent.
There can be no assurance that the Company will fulfill its obligations
under its license agreements due to insufficient resources, lack of successful
product development, lack of product acceptance or other reasons. The failure to
satisfy the requirements of any such agreements may result in the loss of the
Company's rights under that agreement or under related agreements. The inability
of the Company to continue to license these products or to license other
necessary products for use with its products or substantial increases in royalty
payments under third party licenses could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the effective implementation of the Company's strategy depends on the successful
integration of these licensed products with the Company's products, and
therefore any flaws or limitations of such licensed products may prevent or
impair the Company's ability to market and sell the Company's products, delay
new product introductions, and/or adversely affect the Company's reputation.
Such problems could have a material adverse effect on the Company's business,
financial condition and results of operations.
TRADEMARKS
The Company believes that trademark protection is an important part of
establishing product recognition. The Company owns more than 100 federally
registered trademarks and trademark applications. United States federal
registrations for trademarks remain in force for 10 years and may be renewed
every 10 years after issuance provided the mark is still being used in commerce.
There can be no assurance that any such trademark or service mark registrations
will afford the Company adequate protection, or that the Company will have the
financial resources to enforce its rights under any such trademark and service
mark registrations. The inability of the Company to protect its trademarks or
service marks from infringement could result in the impairment of any goodwill
which may be developed in such trademarks or service marks. Moreover, the
Company's inability to use one or more of its trademarks or service marks
because of successful third-party claims to such marks could have a material
adverse effect on the Company's business, financial condition and results of
operations.
From time to time, the Company receives communications from parties who
allege that their trademark or service mark interests may be damaged either by
the Company's use of a particular trademark or service mark or its registration
of such trademark or service mark, and, on occasion, the Company also sends such
communications to third parties. In general, the Company seeks to resolve such
conflicts before an actual opposition to registration or suit for infringement
is filed. There can, however, be no assurance that such actions will not be
filed or that, if filed, they will not have a material adverse effect upon the
Company's business, financial condition or results of operations. See "Risk
Factors -- Uncertainty of Enforceability of Trademarks, Patents and Proprietary
Rights" at Item 7 of this Report.
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PATENTS AND PROPRIETARY RIGHTS
The Company is pursuing several United States patent applications.
There can be no assurance that patents will be issued with respect to any of
these applications. The Company has acquired rights under certain patents and
patent applications from third-party licensors. The Company has licensed rights
to products covered by certain United States patents directed to aspects of the
ZOSTRIX(R), THERAPLEX(R), BENZASHAVE(R), AFIRM(TM) and BETA-LIFTx(R) compounds
or formulations. The Company has obtained patents directed to aspects of several
other compounds, including a United States patent expiring in October 2015
covering various formulations of its TRIAZ(R) product line, a United States
patent and foreign patents covering its ZONALON(R) product line, and a United
States patent and foreign patents covering its OCCLUSAL-HP(R) product line. A
patent licensed to the Company relating to the ZOSTRIX(R) product line was
recently reexamined by the United States Patent and Trademark Office. This
reexamination concluded with a decision that confirmed the validity of the
patent's claims. The Company has recently acquired from certain of its
consultants and principals an assignment of their rights to certain United
States patents or patent applications. Certain of such patents and patent
applications may be subject to claims of rights by third parties by reason of
existing relationships with the party who filed such patents or patent
applications. There can be no assurance that the Company will be able to obtain
any rights under such patents or patent applications as a result of such
conflicting claims, or that any rights which the Company may obtain will be
sufficient for the Company to market products which may be the subject of such
patents or patent applications. The Company may be required to obtain licenses
and/or pay royalties to obtain the rights it acquires under such patents or
patent applications, and there can be no assurance that the Company will be able
to obtain rights under such patents or patent applications on terms acceptable
to the Company, or at all.
The Company believes that its success will depend in part on its
ability to obtain and maintain patent protection for its own inventions, and to
obtain and maintain licenses for the use of patents licensed or sublicensed by
third parties. There can be no assurance that any patent issued to, or licensed
by, the Company will provide protection that has commercial significance. In
this regard, the patent position of pharmaceutical compounds is particularly
uncertain. There can be no assurance that challenges will be not be instituted
against the validity or enforceability of any patent owned by or licensed to the
Company or, if instituted, that such challenges will not be successful. The cost
of litigation to uphold the validity and prevent infringement of patents can be
substantial and require a significant commitment of management's time.
Furthermore, there can be no assurance that others will not independently
develop similar technologies or duplicate the technology owned by or licensed to
the Company or design around the patented aspects of such technology. The
Company only conducts complete searches to determine whether its products
infringe upon any existing patents as it deems appropriate. There can be no
assurance that the products and technologies the Company currently markets, or
may seek to market in the future, will not infringe patents or other rights
owned by others.
The Company believes that obtaining foreign patents may be more
difficult than obtaining domestic patents because of differences in patent laws,
and recognizes that its patent position, therefore, may be stronger in the
United States than in Europe or elsewhere. In addition, the protection provided
by foreign patents once they are obtained may be weaker than that provided by
domestic patents.
The Company relies and expects to continue to rely upon unpatented
proprietary know-how and continuing technological innovation in the development
and manufacture of many of its principal products. The Company's policy is to
require all its employees, consultants and advisors to enter into
confidentiality agreements with the Company. There can be no assurance, however,
that these agreements will provide meaningful protection for the Company's trade
secrets or proprietary know-how in the event of any unauthorized use or
disclosure of such know-how. In addition, there can be no assurance that others
will not obtain access to or independently develop similar or equivalent trade
secrets or know-how. See "Risk Factors -- Uncertainty of Enforceability of
Trademarks, Patents and Proprietary Rights" and "-- Risks Associated with
GenDerm Acquisition" in Item 7 of the Report.
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COMPETITION
The pharmaceutical industry is characterized by intense competition,
rapid product development and technological change. Competition is intense among
manufacturers of prescription pharmaceuticals, such as the DYNACIN(R), LIDEX(R),
SYNALAR(R), TRIAZ(R), NOVACET(R), ZONALON(R), THERAMYCIN Z(R), BENZASHAVE(R) and
LUSTRA(TM) products for the treatment of dermatological diseases, in the OTC
market for products such as the ESOTERICA(R), ZOSTRIX(R), OCCLUSAL-HP(R),
PENTRAX(R), SALAC(R) and THERAPLEX(R) product lines, and in the
physician-dispensed dermatology market for products such as AFIRM(TM) and
BETA-LIFTx(R), as well as other products which the Company may develop and
market in the future. Most of the Company's competitors are large,
well-established pharmaceutical, chemical, cosmetic or health care companies
with considerably greater financial, marketing, sales and technical resources
than available to the Company. Additionally, many of the Company's present and
potential competitors have research and development capabilities that may allow
such competitors to develop new or improved products that may compete with the
Company's product lines. The Company's products could be rendered obsolete or
made uneconomical by the development of new products to treat the conditions
addressed by the Company's products, technological advances affecting the cost
of production, or marketing or pricing actions by one or more of the Company's
competitors. The Company's business, financial condition and results of
operations could be materially adversely affected by any one or more of such
developments. Each of the Company's products competes for a share of the
existing market with numerous products which have become standard treatments
recommended or prescribed by dermatologists. There can be no assurance that the
Company will be able to compete successfully against current or future
competitors or that competition will not have a material adverse effect on the
Company's business, financial condition and results of operations.
DYNACIN(R) competes with Minocin, a branded minocycline product
marketed by American Home Products Corporation ("AHP"), Vectrin, marketed by
Warner-Chilcott Laboratories, Inc. ("Warner-Chilcott") and generic minocycline
products marketed by Schein, BioCraft Laboratories, Inc. ("BioCraft") and Barr
Laboratories, Inc. ("Barr Labs"). Other oral antibiotics utilized for the
treatment of acne include erythromycin, doxycycline and tetracycline marketed in
branded and generic form by a variety of companies. LIDEX(R) and SYNALAR(R)
compete with a number of corticosteroid brands in the super-, high-, mid-, and
low-potency categories for the treatment of inflammatory and hyperproliferative
skin conditions. Competing brands include Halog and Ultravate, marketed by
Westwood-Squibb Pharmaceuticals, Inc.; Elocon, Diprolene, Diprosone and
Valisone, marketed by Schering-Plough Corporation; Cyclocort, marketed by
Fujisawa Pharmaceuticals Co., Ltd.; Temovate and Cutivate, marketed by Glaxo
Wellcome plc; Psorcon, marketed by Rhone-Poulenc Rorer Pharmaceuticals Inc.
("Rhone"); and Aristocort, marketed by AHP. The Company believes that TRIAZ(R)
competes with Benzamycin, marketed by a subsidiary of Rhone; Cleocin-T and a
generic topical clindamycin, marketed by Pharmacia & Upjohn Co, Inc.; and
Benzac, marketed by a subsidiary of L'Oreal ("Galderma"). The Company believes
that LUSTRA(TM) primarily competes with Solaquin Forte and Melanex that is
marketed by ICN Pharmaceuticals, Inc. ESOTERICA(R) primarily competes with
Porcelana, marketed by Dep Corp. and AMBI, marketed by Kiwi Brands, a division
of Sara Lee Brands Corporation. ZOSTRIX(R) primarily competes with other topical
analgesics including Capzacin, Aspercream and Sportscream, marketed by Thomson
Medical Co.; Icy Hot and Flexall, marketed by Chattem, Inc.; Bengay, marketed by
Pfizer Inc., and other private label capsaicins and hot/cold rubs. In the
category of cosmetic dermatology products, AFIRM(TM) and BETA-LIFTx(R) compete
with various brands and private-label products, as well as compounds which some
dermatologists formulate themselves in small quantities for their patients.
Examples of competing brands include the Glytone line, marketed by C & M
Pharmacal; the M.D. Formulations, M.D. Forte and Aqua Glycolic lines, marketed
by Allergan Inc.; as well as various product lines marketed by NeoStrata
Company, the Gly Derm division of ICN Pharmaceuticals, Inc., the Nova Skin Care
Division of Glaxo Wellcome plc and Cellex-C Distribution Company.
Several of the Company's products, including DYNACIN(R) and LIDEX(R),
compete with generic (non-branded) pharmaceuticals which claim to offer
equivalent therapeutic benefits at a lower cost. In some cases, insurers and
other third-party payors seek to encourage the use of generic products making
branded products less attractive, from a cost perspective, to buyers. In
addition, certain of the Company's OTC products, including ZOSTRIX(R), compete
with private label products. The aggressive pricing activities of the Company's
generic and private label competitors and the payment and reimbursement policies
of third-party payors, could have a material
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adverse effect on the Company's business, financial condition and results of
operations. See "Risk Factors -- Intense Competition; Uncertainty of
Technological Change in Item 7 of this Report."
GOVERNMENT REGULATION
DRUG AND COSMETIC REGULATION
The manufacture and sale of cosmetics and drugs are subject to
regulation principally by the FDA and state and local authorities in the United
States, and by comparable agencies in certain foreign countries. The FTC and
state and local authorities regulate the advertising of OTC drugs and cosmetics.
The Food and Drug Act and the regulations promulgated thereunder, and other
federal and state statutes and regulations, govern, among other things, the
testing, manufacture, safety, effectiveness, labeling, storage, recordkeeping,
approval, advertising and promotion of the Company's products. In general,
products falling within the FDA's definition of "new drugs" require premarketing
clearance by the FDA. Products falling within the FDA's definition of
"cosmetics" or of "drugs" that are not "new drugs" and that are generally
recognized as "safe and effective" do not require premarketing clearance.
The steps required before a "new drug" may be marketed in the United
States include (i) preclinical laboratory and animal testing, (ii) submission to
the FDA of an Investigational New Drug ("IND") application, which must become
effective before clinical trials may commence, (iii) adequate and
well-controlled clinical trials to establish the safety and efficacy of the
drug, (iv) submission to the FDA of a New Drug Application ("NDA") and (v) FDA
approval of the NDA prior to any commercial sale or shipment of the drug. In
addition to obtaining FDA approval for each product, each domestic drug
manufacturing establishment must be registered with, and approved by, the FDA.
Drug product manufacturing establishments located in California also must be
licensed by the State of California in compliance with separate regulatory
requirements.
Preclinical testing is generally conducted in laboratory animals to
evaluate the potential safety and the efficacy of a drug. The results of these
studies are submitted to the FDA as a part of an IND, which must be approved
before clinical trials in humans can begin. Typically, clinical evaluation
involves a time consuming and costly three-phase process. In Phase I, clinical
trials are conducted with a small number of subjects to determine the early
safety profile, the pattern of drug distribution and metabolism. In Phase II,
clinical trials are conducted with groups of patients afflicted with a specific
disease in order to determine preliminary efficacy, optimal dosages and expanded
evidence of safety. In Phase III, large-scale, multi-center, comparative trials
are conducted with patients afflicted with a target disease in order to provide
enough data to demonstrate the efficacy and safety required by the FDA. The FDA
closely monitors the progress of each of the three phases of clinical trials and
may, at its discretion, re-evaluate, alter, suspend or terminate the testing
based upon the data which have been accumulated to that point and its assessment
of the risk/benefit ratio to the patient.
In general, FDA approval is required before a new drug product may be
marketed in the United States. However, most OTC drugs are exempt from the FDA's
premarketing approval requirements. In 1972, the FDA instituted the ongoing OTC
Drug Review to evaluate the safety and effectiveness of OTC drug ingredients
then in the market. Through this process, the FDA issues monographs that set
forth the specific active ingredients, dosages, indications and labeling
statements for OTC drug ingredients that the FDA will consider generally
recognized as safe and effective and therefore not subject to premarket
approval. OTC drug ingredients are classified by the FDA in one of three
categories: Category I ingredients, which are deemed "safe and effective for OTC
use," Category II ingredients, which are deemed "not generally recognized as
safe and effective for OTC use," and Category III ingredients, which are deemed
"possibly safe and effective with studies ongoing." Based upon the results of
these ongoing studies, the FDA may reclassify all Category III ingredients as
Category I or Category II ingredients. For certain categories of OTC drugs not
yet subject to a final monograph, the FDA usually permits such drugs to continue
to be marketed until a final monograph becomes effective unless the drug will
pose a potential health hazard to consumers. Drugs subject to final monographs,
as well as drugs that are subject only to proposed monographs, are subject to
various FDA regulations concerning, for example, cGMP, general and specific OTC
labeling requirements, prohibitions against promotion for conditions other than
those stated in the labeling, and
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requirement that OTC drugs contain only suitable inactive ingredients. OTC drug
manufacturing facilities are subject to FDA inspection, and failure to comply
with applicable regulatory requirements may lead to administrative or judicially
imposed penalties.
The active ingredient in DYNACIN(R) products, minocycline, and the
active ingredients in LIDEX(R) and SYNALAR(R), fluocinonide and fluocinolone
acetonide, respectively, have been approved by the FDA under a NDA. The active
ingredient in ZOSTRIX(R), capsaicin, is classified currently by the FDA as a
category I ingredient. The active ingredient in TRIAZ(R) and BENZASHAVE(R)
products has been classified as a Category III ingredient under a tentative
final FDA monograph for OTC use in treatment of labeled conditions. The FDA has
requested, and a task force of the Non-Prescription Drug Manufacturers
Association ("NDMA"), a trade association of OTC drug manufacturers, has
undertaken further studies to confirm that benzoyl peroxide, an active
ingredient in TRIAZ(R) and BENZASHAVE(R) products, is not a tumor promoter when
tested in conjunction with UV light exposure. TRIAZ(R) and BENZASHAVE(R)
products, which the Company sells on a prescription basis, have the same
ingredients at the same dosage levels as the OTC products. When the FDA issues
the final monograph, the Company may be required by the FDA to sell TRIAZ(R) as
an OTC drug unless the Company files an NDA covering such product. In addition,
there can be no assurance as to the results of these studies or any FDA action
to reclassify benzoyl peroxide. In addition, there can be no assurance that
adverse test results would not result in withdrawal of TRIAZ(R) from marketing.
An adverse decision by the FDA with respect to the safety of benzoyl peroxide
could result in the assertion of product liability claims against the Company
and could have a material adverse effect on the Company's business, financial
condition and results of operations.
Certain ESOTERICA(R) products contain the active ingredient
hydroquinone at a 2% concentration, currently a Category I ingredient.
Independent expert dermatologists have formally expressed the view that
hydroquinone at a 2% concentration used for ESOTERICA(R) is generally recognized
as safe and effective for its intended use. In 1992, with the concurrence of the
FDA, the industry initiated dermatological metabolism and toxicity studies to
fully support hydroquinone's continued Category I status. Notwithstanding the
pendency or results of these tests, which may take up to three years to
complete, the FDA may elect to classify hydroquinone as a Category III
ingredient. The Company, in conjunction with the NDMA and other manufacturers,
is responsible for 50% of the costs associated with these studies. An adverse
decision by the FDA on the safety of hydroquinone could result in the assertion
of product liability claims against the Company. Moreover, if hydroquinone is
not maintained as a Category I or Category III ingredient, the Company would be
required to cease marketing ESOTERICA(R) and LUSTRA(TM) products containing
hydroquinone. An adverse decision by the FDA on the safety of hydroquinone could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Risk Factors -- Potential Product Liability;
Limited Insurance Coverage in Item 7 of this Report."
The ESOTERICA(R), TRIAZ(R), BENZASHAVE(R) and LUSTRA(TM) products must
meet the composition and labeling requirements established by the FDA for
products containing their respective basic ingredients. The Company believes
that compliance with those established standards avoids the requirement for
premarketing clearance of these products. There can be no assurance that the FDA
will not take a contrary position.
The active ingredient in ZOSTRIX(R), capsaicin, is classified currently
by the FDA as a Category I ingredient. The active ingredient in OCCLUSAL-HP(R)
and SALAC(R), salicylic acid, is classified currently by the FDA as a Category I
ingredient. The active ingredient in PENTRAX(R), an extract of coal tar called
Fractar, also is classified currently by the FDA as a Category I ingredient.
NOVACET(R), containing the active ingredients sodium sulfacetamide and sulfur,
is marketed under the FDA compliance policy entitled "Prescription Drugs
Marketed Without an NDA." ZONALON(R), containing the active ingredient doxepin
hydrochloride, has been approved by the FDA under an NDA with labeling limited
to adult use.
The Company believes its three THERAPLEX(R) moisturizers and the
AFIRM(TM) and BETA-LIFTx(R) products, as they are promoted and intended by the
Company for use, fall within the FDA's definition of "cosmetics" and therefore
do not require premarketing clearance. There can be no assurance that the FDA
will not take a contrary position in the future or that an adverse determination
by the FDA would not result in withdrawal of the THERAPLEX(R) moisturizers or
the AFIRM(TM) and BETA-LIFTx(R) products from the market. The Company believes
that such products are subject to regulations governing product safety, use of
ingredients, labeling and
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promotion, and methods of manufacture. See "Risk Factors -- Uncertainty of
Government Regulation" in Item 7 of this Report.
CERTAIN FACTORS AFFECTING THE COMPANY'S PRODUCTS
The Company believes that certain of its products, as they are promoted
and intended by the Company for use, are exempt from being considered "new
drugs" based on the date of introduction of their active ingredients and
therefore do not require premarketing clearance. There can be no assurance that
the FDA will not take a contrary position. If the FDA were to do so, the Company
may be required to seek FDA approval for such products, market such products as
OTC products or withdraw such products from the market. The Company believes
that such products are subject to regulations governing product safety, use of
ingredients, labeling and promotion and methods of manufacture.
Clinical trials and the marketing and manufacturing of pharmaceutical
products are subject to the rigorous testing and approval processes of the FDA
and foreign regulatory authorities. The process of obtaining FDA and other
required regulatory approvals is lengthy and expensive. There can be no
assurance that the Company will be able to obtain the necessary approvals to
conduct clinical trials or to manufacture and market such products, that all
necessary clearances will be granted to the Company or its licensors for future
products on a timely basis, or at all, or that FDA review or other actions will
not cause delays adversely affecting the marketing and sale of the Company's
products. In addition, the testing and approval process with respect to certain
new products which the Company may develop or seek to introduce is likely to
take a substantial number of years and involve the expenditure of substantial
resources. There can be no assurance that pharmaceutical products currently in
development, or those products acquired or licensed by the Company, will be
cleared for marketing by the FDA. Failure to obtain any necessary approvals or
failure to comply with applicable regulatory requirements could have a material
adverse effect on the Company's business, financial condition and results of
operations. Further, future government regulation could prevent or delay
regulatory approval of the Company's products.
There can be no assurance that any approval will be granted on a timely
basis, or at all; that the FDA will not require post-marketing testing and
surveillance to monitor the product and continued compliance with regulatory
requirements; that the FDA will not require the submission of any lot of any
product for inspection and will not restrict the release of any lot that does
not comply with FDA standards; that the FDA will not otherwise order the
suspension of manufacturing, recall or seizure of products; or that the FDA will
not withdraw its marketing clearance of any product if compliance with
regulatory standards is not maintained or if problems concerning safety or
efficacy of the product are discovered following approval.
From time to time, the FDA has issued correspondence to pharmaceutical
companies, including the Company, alleging that their advertising or promotional
practices are false, misleading or deceptive. The Company has resolved all such
complaints without any further adverse findings by the FDA and without incurring
substantial expense. However, there can be no assurance that the Company will
not receive such correspondence from the FDA in the future, or that, if such
notices are received, they will not result in substantial cost or disruption,
including fines and penalties, in material changes to the manner in which the
Company promotes its products, in loss of sales of the Company's products or
other material adverse effects on the Company's business, financial condition
and results of operations.
For both currently marketed and future products, failure to comply with
the applicable regulatory requirements could, among other things, result in
fines, suspensions of regulatory approvals, product recalls, operating
restrictions, criminal prosecution, relabeling costs, delays in product
distribution, marketing and sales, or seizure or cessation of manufacture of the
products and the imposition of civil or criminal sanctions. There can be no
assurance that the FDA will not change its position with regard to the safety or
effectiveness of the Company's current or future products or that the FDA will
agree with the Company's position regarding the regulatory status of its
products. In the event that the FDA takes a contrary position regarding any of
the Company's current or future products, the Company may be required to change
its labeling or formulation or cease manufacturing and marketing such products.
In addition, even prior to any formal regulatory action, the Company could
decide voluntarily to cease distribution and sale or to recall any of its
products if concern about the safety or efficacy of any of its
-15-
<PAGE> 16
products were to develop. Any such action could have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company also will be subject to foreign regulatory authorities
governing clinical trials and pharmaceutical sales if it seeks to market its
products outside the United States. Whether or not FDA approval has been
obtained, approval of a product by the comparable regulatory authorities of
foreign countries must be obtained prior to the commencement of marketing of the
product in those countries. The approval process varies from country to country
and the time required may be longer or shorter than that required for FDA
approval. There can be no assurance that any foreign regulatory agency will
approve any product submitted for review by the Company.
THIRD-PARTY REIMBURSEMENT
The operating results of the Company will depend in part on the
availability of adequate reimbursement for the Company's products from
third-party payors, such as government entities, private health insurers and
managed care organizations. Third-party payors increasingly are seeking to
negotiate the pricing of medical services and products and to promote the use of
generic, non-branded pharmaceuticals through payor-based reimbursement policies
designed to encourage their use. In some cases, third-party payors will pay or
reimburse a user or supplier of a prescription drug product only a portion of
the purchase price of the product. In the case of the Company's prescription
products, payment or reimbursement by third-party payors of only a portion of
the cost of such products could make such products less attractive, from a cost
perspective, to users, suppliers and prescribing physicians. There can be no
assurance that reimbursement, if available, will be adequate. Moreover, certain
of the Company's products are not of a type generally eligible for third-party
reimbursement. If adequate reimbursement levels are not provided by government
entities or other third-party payors for the Company's products, or if those
reimbursement policies increasingly favor the use of generic products, the
Company's business, financial condition and results of operations would be
materially adversely affected. In addition, managed care initiatives to control
costs have influenced primary care physicians to refer fewer patients to
dermatologists, resulting in a declining target market for the Company. Further
reductions in referrals to dermatologists could have a material adverse impact
upon the Company's business, financial condition and results of operations.
A number of legislative and regulatory proposals aimed at changing the
United States' health care system have been proposed in recent years. While the
Company cannot predict whether any such proposals will be adopted, or the effect
that any such proposal may have on its business, such proposals, if enacted,
could have a material adverse effect on the Company's business, financial
condition and results of operations.
PRODUCT LIABILITY INSURANCE
The Company faces an inherent risk of exposure to product liability
claims in the event that the use of its products is alleged to have resulted in
adverse effects. Such risk exists even with respect to those products that are
manufactured in licensed and regulated facilities or that otherwise received
regulatory approval for commercial sale. There can be no assurance that the
Company will not be subject to significant product liability claims. The Company
currently has product liability insurance in the amount of $5.0 million per
claim and $5.0 million in the aggregate on a claims-made basis. Many of the
Company's customers require the Company to maintain product liability insurance
coverage as a condition to their conducting business with the Company. As the
loss of such insurance coverage could result in a loss of such customers, the
Company intends to take all reasonable steps necessary to maintain such
insurance coverage. There can be no assurance that insurance coverage will be
available in the future on commercially reasonable terms, or at all, or that
such insurance will be adequate to cover potential product liability claims, or
that the loss of insurance coverage or the assertion of a product liability
claim or claims would not materially adversely affect the Company's business,
financial condition and results of operations.
EMPLOYEES
As of June 30, 1998, the Company had 125 full-time employees. The
Company believes its relationship with its employees is good. The Company
intends to hire additional personnel as needed during the next 12 months.
-16-
<PAGE> 17
ITEM 2: PROPERTIES
The Company presently occupies approximately 22,400 square feet of
office space for its headquarters in Phoenix, Arizona, under a lease agreement
which expires in May 2005. The Company believes that these facilities will be
adequate to meet its needs for the presently foreseeable future.
Medicis Canada, Inc., a wholly-owned subsidiary of the Company's
GenDerm subsidiary, presently leases approximately 7,500 square feet of office
and warehouse space in St-Laurent, Quebec, Canada, under a lease agreement which
expires on April 30, 1999.
ITEM 3: LEGAL PROCEEDINGS
The Company and certain of its subsidiaries are parties to actions and
proceedings incident to their business, including certain litigation assumed in
connection with the GenDerm acquisition. The Company believes liability in the
event of final adverse determinations in any of these matters is either covered
by the indemnification provided to the Company under the GenDerm acquisition
agreement, insurance and/or established reserves, or, will not, in the
aggregate, have a material adverse effect on the business, financial position or
results of operations of the Company. There can be no assurance that an adverse
determination on any action or proceeding will not have a material adverse
effect on the business, financial condition and results of operations of the
Company, or that the Company will be able to realize the full amount of any
indemnification obligation that any person may have to the Company under the
GenDerm acquisition agreement.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the
Company during the fourth quarter of fiscal 1998.
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
DIVIDEND POLICY
The Company declared a 3-for-2 stock split in the form of a 50% stock
dividend paid on August 2, 1996 to holders of record on July 22, 1996. The
Company declared a 3-for-2 stock split in the form of a 50% stock dividend paid
on March 28, 1997 to holders of record on March 17, 1997. The Company has never
declared a cash dividend. The Company intends to retain any earnings to fund
future growth and the operation of its business and, therefore, does not
anticipate paying any cash dividends in the foreseeable future.
PRICE RANGE OF COMMON STOCK
The Company's Class A Common Stock for fiscal 1998 was traded on the
Nasdaq National Market under the symbol "MDRX." The following table sets forth
for the fiscal periods indicated, the range of high and low sales prices for the
Class A Common Stock of the Company on the Nasdaq National Market, as adjusted
to reflect (i) the 1-for-14 reverse stock split of the Company's Common Stock
effected on October 23, 1995, as adjusted to the
-17-
<PAGE> 18
nearest 1/16, (ii) the 3-for-2 stock split in the form of a 50% stock dividend
paid on August 2, 1996 to holders of record as of July 22, 1996, and (iii) the
3-for-2 stock split in the form of a 50% stock dividend paid on March 28, 1997
to holders of record as of March 17, 1997.
HIGH LOW
FISCAL YEAR ENDED JUNE 30, 1998
First Quarter..................... $ 55-1/2 $ 37-1/2
Second Quarter.................... 56 40
Third Quarter..................... 51-1/8 38-1/2
Fourth Quarter.................... 48-3/8 33-1/4
FISCAL YEAR ENDED JUNE 30, 1997
First Quarter..................... $ 33-1/2 $ 16-1/2
Second Quarter.................... 40-3/16 26-2/3
Third Quarter..................... 47-1/3 28
Fourth Quarter.................... 51 23-1/4
FISCAL YEAR ENDED JUNE 30, 1996
First Quarter..................... $ 3-1/2 $ 1-1/2
Second Quarter.................... 7-1/16 3
Third Quarter..................... 14-1/16 6-1/16
Fourth Quarter.................... 21 10-1/3
On September 21, 1998, the last reported sale price on the Nasdaq
National Market for the Company's Class A Common Stock was $40.88 per share. As
of such date, there were approximately 319 holders of record of Class A Common
Stock. As of September 24, 1998, the Company began trading on the New York Stock
Exchange ("NYSE"). The Company is trading on the NYSE under the trading symbol
MRX.
-18-
<PAGE> 19
ITEM 6: SELECTED FINANCIAL DATA
The following selected financial data have been derived from the
consolidated financial statements of Medicis Pharmaceutical Corporation for the
fiscal years 1998, 1997, 1996, 1995 and 1994. Gross profit does not include
amortization of the related intangibles.
<TABLE>
<CAPTION>
JUNE 30,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994(1)
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales $ 77,571 $ 41,159 $ 25,310 $ 19,132 $ 17,059
Gross profit 63,592 31,797 18,354 13,282 11,239
Operating expenses:
Selling, general and administrative 27,424 16,484 10,868 10,330 8,786
Research and development expenses 2,885 1,450 952 770 1,572
In-process research and
development 35,400 -- -- -- --
Depreciation and amortization 2,903 999 559 522 653
-------- -------- -------- -------- --------
Total operating expenses 68,612 18,933 12,379 11,622 11,011
-------- -------- -------- -------- --------
Operating (loss) income (5,020) 12,864 5,975 1,660 228
Other:
Minority share of losses of Dyad -- -- -- -- 677
Gain on disposition of Dyad -- -- -- 107 --
Net interest income (expense) 7,037 3,787 79 (94) (249)
Income tax (expense) benefit (14,424) 694 1,826 (60) --
-------- -------- -------- -------- --------
Net (loss) income ($12,407) $ 17,345 $ 7,880 $ 1,613 $ 656
======== ======== ======== ======== ========
Basic net (loss) income per common share (2) $ (0.77) $ 1.31 $ 0.77 $ 0.16 $ 0.07
======== ======== ======== ======== ========
Diluted net (loss) income per common share (2) $ (0.77) $ 1.24 $ 0.72 $ 0.16 $ 0.07
======== ======== ======== ======== ========
Number of shares used in computing basic net
(loss) income per common share (2) 16,067 13,191 10,255 9,890 9,455
======== ======== ======== ======== ========
Number of shares used in computing diluted
net (loss) income per common share (2) 16,067 14,039 10,891 9,890 9,455
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
BALANCE SHEET DATA: JUNE 30,
------------------------------------------------------------------------
1998 1997 1996 1995 1994(1)
---- ---- ---- ---- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and short-term
investments $237,921 $ 85,132 $ 7,956 $ 953 $ 775
Working capital (deficiency) 262,956 94,803 12,401 619 (1,978)
Total assets 352,350 140,537 26,313 13,850 12,726
Long-term debt 95 111 117 694 899
Stockholders' equity 324,495 131,565 19,460 7,387 5,263
</TABLE>
(1) Fiscal 1994 includes the operations of Dyad Pharmaceutical Corporation
("Dyad"), which were divested in Fiscal 1995.
(2) In 1997, the Financial Accounting Standards Board issued SFAS No. 128
replacing the previously reported primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excluded any dilutive effects of
options, warrants, and convertible securities. Diluted earnings per share
is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented,
and where necessary, restated to conform to the SFAS No. 128 requirements.
-19-
<PAGE> 20
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Medicis was founded in 1987 to develop and market prescription and OTC
products to treat dermatological conditions. Innovative Therapeutics, Inc. (the
predecessor of the Company) was incorporated under the laws of the District of
Columbia on July 1, 1987, subsequently changed its name to Medicis Corporation
and was merged with and into Medicis Corporation, which was incorporated on July
29, 1988 under the laws of Delaware, pursuant to an Agreement of Merger dated
July 29, 1988. Medicis Corporation subsequently changed its name to Medicis
Pharmaceutical Corporation.
Medicis is the leading independent pharmaceutical company in the United
States focusing exclusively on the treatment of dermatological conditions. The
Company offers prescription, OTC, and physician-dispensed dermatology products,
emphasizing the clinical effectiveness, quality, affordability and cosmetic
elegance of its products. Medicis has achieved a leading position in branded
products for the treatment of acne, acne-related conditions, psoriatic
conditions, and pruritic conditions, while also offering the leading OTC topical
analgesic containing capsaicin and the leading OTC fade cream product in the
United States. The Company has built its business through successfully
introducing prescription products such as DYNACIN(R) and TRIAZ(R) for the
treatment of acne, LUSTRA(TM) for the treatment of skin discolorations and
photoaging, as well as marketing OTC products such as the ESOTERICA(R) fade
cream product line. In addition, Medicis has acquired the LIDEX(R) and
SYNALAR(R) corticosteroid product lines from Syntex and the entire product line
from GenDerm, including ZOSTRIX(R) topical analgesic and NOVACET(R) acne rosacea
treatments. Medicis has also formed a business unit to market non-prescription
cosmetic dermatology treatments for sale directly to dermatologists in the
United States for administering and dispensing to patients.
Prescription pharmaceuticals accounted for 77.0%, 86.5%, and 83.2% of
net sales in the fiscal years ended fiscal 1998, fiscal 1997, fiscal 1996,
respectively. The Company believes, that as a result of the GenDerm acquisition,
OTC products will account for a greater percentage of the Company's total sales
in future quarters with minimal impact on the Company's gross profit margins.
The Company derives a majority of its revenue from sales of the Key
Products. The Company believes that sales of the Key Products will constitute
the majority of net sales for the foreseeable future. Accordingly, any factor
adversely affecting the sale of the Key Products, individually or collectively,
would have a material adverse effect on the Company's business, financial
condition and results of operations. Each of the Key Products could be rendered
obsolete or uneconomical by regulatory or competitive changes. The sale of Key
Products could also be adversely affected by other factors, including
manufacturing or supply interruptions, the development of new competitive
pharmaceuticals to treat the conditions addressed by the Key Products,
technological advances, factors affecting the cost of production, marketing or
pricing actions by one or more of the Company's competitors, changes in the
prescribing practices of dermatologists, changes in the reimbursement policies
of third-party payors, product liability claims, the outcome of disputes
relating to trademarks, patents and other rights or other factors.
The Company's results of operations may vary from period to period due
to a variety of factors, including expenditures incurred to acquire, license and
promote pharmaceuticals; expenditures and timing relating to the acquisition and
integration of businesses; changes in the prescribing practices of
dermatologists; the introduction of new products by the Company or its
competitors; cost increases from third-party manufacturers; manufacturing and
supply interruptions; the availability and cost of raw materials; the mix of
products sold by the Company; changes in marketing and sales expenditures;
market acceptance of the Company's products; competitive pricing pressures; the
outcome of disputes relating to trademarks, patents and other rights; general
economic and industry conditions that affect customer demand; and the Company's
level of research and development activities. In addition, the Company's
business has historically been subject to seasonal fluctuations, with lower
sales generally being experienced in the first quarter of each fiscal year. As a
result of customer buying patterns, a substantial portion of the Company's
revenues has been in the last month of each quarter. The Company schedules its
inventory purchases
-20-
<PAGE> 21
to meet anticipated customer demand. As a result, relatively small delays in the
receipt of manufactured products by the Company could result in revenues being
deferred or lost. The Company's operating expenses are based on anticipated
sales levels, and a high percentage of the Company's operating expenses are
relatively fixed in the short term. Consequently, variations in the timing of
recognition of revenue could cause significant fluctuations in operating results
from period to period and may result in unanticipated earnings shortfalls or
losses. There can be no assurance that the Company will maintain or increase
revenues or profitability or avoid losses in any future period.
In December 1997, the Company acquired 100% of the common stock of
GenDerm for approximately $60.0 million and the Company could pay an additional
sum not to exceed $20.0 million if sales of GenDerm products, as defined in the
acquisition agreement, are in excess of $31.0 million during calendar 1999 and
certain other conditions are met (the "GenDerm Earnout Amount"). A significant
portion of the purchase price was identified in an independent valuation, using
proven valuation procedures and techniques, as intangible assets. These
intangible assets included $35.4 million for acquired in-process research and
development ("in-process R&D") for projects in development for which there is no
alternative future use. This allocation represents the estimated fair market
value based on projected cash flows related to the in-process R&D projects. At
the date of the acquisition, the development of these projects was not yet
completed and the in-process R&D had no alternative future uses. Accordingly,
these costs were expensed in the fiscal quarter ended December 31, 1997. The
Company estimates that approximately $6.7 million will be incurred to complete
the acquired in-process R&D projects over the four years subsequent to the
acquisition.
Products acquired in the GenDerm transaction include, among others, the
prescription brands NOVACET(R) and ZONALON(R), as well as the OTC brands
ZOSTRIX(R), OCCLUSAL-HP(R), PENTRAX(R), and SALAC(R). Prior to the acquisition,
the Company did not market any products in the topical acne rosacea treatment,
anti-itch medication, topical analgesic or wart treatment markets, and the
Company has no experience marketing such products. Successful integration of
these products by the Company is important to maintaining growth of sales of
these products. There can be no assurance that the Company will be able to
successfully integrate, market and sell the products acquired from GenDerm, or
that such products will be accepted by the market at levels previously achieved
by GenDerm, or sufficient to maintain growth. The failure of the Company to
successfully integrate, market and sell these products would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The acquisition involves a number of risks that could adversely affect
the Company's operating results, including the assumption of liabilities and
obligations of GenDerm, including the liabilities and obligations which may not
have been adequately disclosed to the Company, the diversion of management's
attention, the assimilation of the acquired operations into the Company's
business, and the valuation of acquired intangible assets. The agreement
governing the terms of the acquisition limits the Company's remedies for any
losses incurred by the Company in connection with the acquisition to the
indemnification rights specifically provided to the Company under the agreement
governing the acquisition. The indemnification rights are limited to a maximum
of $11.0 million subject to certain adjustments together with the GenDerm
Earnout Amount and any interest thereon. Any claims for indemnification must be
made prior to August 1, 2000, in accordance with the terms of the agreement
governing the acquisition. There can be no assurance that the acquisition of
GenDerm by the Company will not materially and adversely affect the Company or
that such acquisition will enhance the Company's business.
The Company recognizes revenues from sales upon shipment to its
customers. At the time of sale, the Company records reserves for returns based
on estimates using historical experience. Sales are reported net of actual and
estimated product returns and net of pricing adjustments and/or discounts. The
Company applies royalty obligations to the cost of sales in the period the
corresponding sales are recognized.
Medicis customers include the nation's leading wholesale pharmaceutical
distributors, such as McKesson, Bergen Brunswig, Cardinal, Bindley Western Drug
Company and other major drug chains. During fiscal 1998, McKesson, Bergen
Brunswig, and Cardinal, accounted for 16.9%, 13.2% and 12.6% respectively, of
the Company's sales. During fiscal 1997, McKesson, Cardinal, and Bergen Brunswig
accounted for 20.6%, 16.3% and 10.9% respectively, of the Company's sales.
During fiscal 1996, McKesson, Bergen Brunswig and Cardinal accounted for
-21-
<PAGE> 22
15.5%, 12.2% and 11.8%, respectively, of the Company's sales. The loss of any of
these customer's accounts could have a material adverse effect upon the
Company's business, financial condition or results of operations.
The Company plans to spend substantial amounts of capital to continue
the research and development of its pharmaceutical products. Actual expenditures
will depend upon the Company's financial condition, as well as the results of
clinical testing, delays or changes in government-required testing and approval
procedures, technological and competitive developments and strategic marketing
decisions. The Company may increase total expenditures for research and
development and expects that research and development expenditures as a
percentage of net sales will fluctuate from period to period. The Company can
give no assurance that the research and development projects will provide
technologies or products that will be patentable, commercially feasible or
acceptable to government agencies whose approval may be necessary.
The Company intends to seek additional acquisitions of dermatology
products to leverage its existing distribution channels and marketing
infrastructure, and to aggressively market formulations of existing products.
The success of the Company's efforts is subject to a number of risks and
uncertainties including dependence on sales of Key Products and integration of
new product acquisitions, risks associated with the GenDerm acquisition,
reliance upon third-party manufacturers to produce certain Key Products, the
ability to effectively manage a changing business, uncertainties related to
pharmaceutical pricing and reimbursement and the uncertainty of competitive
forces within the pharmaceutical industry which affect both the market for its
products and the availability of product lines for acquisitions which meet the
Company's acquisition criteria. The future results of operations, both annually
and from quarter to quarter, are subject to a variety of factors applicable to
the Company and to the industries and markets in which it operates.
To enable Medicis to focus on its core marketing and sales activities,
the Company selectively out-sources certain non-sales and non-marketing
functions, such as laboratory research, manufacturing and warehousing. As the
Company expands its activities in these areas, additional financial resources
are expected to be utilized. The Company typically does not enter into long-term
manufacturing contracts with third-party manufacturers. Whether or not such
contracts exist, there can be no assurance that the Company will be able to
obtain adequate supplies of its products in a timely fashion, on acceptable
terms, or at all.
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Consolidated Financial Statements and Notes to Consolidated Financial
Statements contained elsewhere herein. The following table sets forth certain
data as a percentage of net sales for the periods indicated.
PERCENTAGE OF SALES
<TABLE>
<CAPTION>
JUNE 30,
------------------------------------
1998* 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Gross profit 82.0 77.3 72.5
Operating expenses 42.8 46.0 48.9
Operating income 39.2 31.3 23.6
Interest income, net 9.0 9.2 0.3
Income tax (expense) benefit (18.6) 1.6 7.2
------- ------- -------
Net income 29.6% 42.1% 31.1%
======= ======= =======
</TABLE>
*Absent special charge for in-process research and development.
The following table reflects certain selected unaudited quarterly
operating results of the Company for each of the past eight quarters through the
quarter ended June 30, 1998. The Company believes that all necessary adjustments
have been included to present fairly the quarterly information. The operating
results for any quarter are
-22-
<PAGE> 23
not necessarily indicative of the results for any future period. Gross profit
does not include amortization of the related intangibles.
<TABLE>
<CAPTION>
FISCAL 1998 FISCAL 1997
------------------------------------- ------------------------------------
SEPT. DEC.* MARCH JUNE SEPT. DEC. MARCH JUNE
----- ----- ----- ---- ----- ---- ----- ----
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales $13,911 $16,928 $22,527 $24,205 $ 7,268 $ 8,508 $10,976 $14,407
Gross profit 11,365 13,924 18,535 19,768 5,313 6,255 8,499 11,730
Operating expenses 6,403 7,718 9,871 9,220 3,718 3,956 5,045 6,214
Operating income 4,962 6,206 8,664 10,548 1,595 2,299 3,454 5,516
Net income 3,751 4,349 6,434 8,459 3,604 3,251 4,337 6,153
Net income per
common share:
Basic $ 0.26 $ 0.30 $ 0.38 $ 0.45 $ 0.34 $ 0.24 $ 0.31 $ 0.43
Diluted $ 0.25 $ 0.29 $ 0.37 $ 0.44 $ 0.32 $ 0.22 $ 0.29 $ 0.41
Shares used in
computing net
income per common share:
Basic 14,313 14,367 16,883 18,750 10,581 13,818 14,159 14,239
Diluted 15,022 15,087 17,554 19,377 11,389 14,703 14,944 14,932
</TABLE>
*Absent special charge for in-process research and development
Quarterly results may vary from period to period due to a variety of
factors, including expenditures incurred to acquire, license and promote
pharmaceuticals; expenditures and timing relating to acquisition and integration
of businesses; changes in the prescribing practices of dermatologists; the
introduction of new products by the Company or its competitors; cost increases
from third-party manufacturers; supply interruptions; the availability and cost
of raw materials; the mix of products sold by the Company; changes in marketing
and sales expenditures; market acceptance of the Company's products; competitive
pricing pressures; the outcome of disputes relating to trademarks, patents and
other rights; general economic and industry conditions that affect customer
demand; and the Company's level of research and development activities. There
can be no assurance that the Company will maintain or increase revenues or
profitability or avoid losses in any future period.
YEARS ENDED JUNE 30, 1998 AND 1997
NET SALES
Net sales for fiscal 1998 increased 88.5%, or $36.4 million, to $77.6
million from $41.2 million for fiscal 1997. The Company's net sales increased in
fiscal 1998 primarily as a result of both unit and dollar sales growth
associated with an increase in market share of the existing prescription
products, the launch of the Company's internally developed LUSTRA(TM) product,
and the acquisition of GenDerm in December 1997. The Company's prescription
products accounted for 77.0% of net sales in fiscal 1998 and 86.5% in fiscal
1997. Net sales of the Company's prescription products grew 67.7%, or $24.1
million, to $59.7 million in 1998 from $35.6 million in fiscal 1997, primarily
due to the continued growth of the TRIAZ(R) products, a full year of sales of
the LIDEX(R) and SYNALAR(R) products acquired in February 1997, the purchase of
the prescription products from GenDerm and the launch of the Company's
LUSTRA(TM) product which was introduced in the third quarter of fiscal 1998. The
Company's OTC products and physician-dispensed division accounted for 23.0% of
net sales for fiscal 1998 and 13.5% in fiscal 1997. OTC sales increased
approximately 222.2%, primarily due to the acquisition of the OTC products from
GenDerm in the second quarter of fiscal 1998.
GROSS PROFIT
Gross profit during fiscal 1998 increased 100.0%, or $31.8 million, to
$63.6 million from $31.8 million in fiscal 1997. As a percentage of net sales,
gross profit grew to 82.0% in fiscal 1998 from 77.3% in fiscal 1997,
-23-
<PAGE> 24
primarily as a result of a full year of sales of the LIDEX(R) and SYNALAR(R)
products, the increase in sales of TRIAZ(R) products, sales of NOVACET(R) and
ZONALON(R) products which were acquired in the GenDerm acquisition, and sales of
LUSTRA(TM), which was launched by the Company in the third quarter of fiscal
1998, all of which enjoy margins in excess of the aggregate corporate gross
profits.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses in fiscal 1998 increased
66.4%, or $10.9 million, to $27.4 million from $16.5 million in fiscal 1997.
This increase was primarily attributable to an increase in promotional costs
associated with the sampling and advertising of the Company's products,
promotional costs associated with the launch of LUSTRA(TM), an internally
developed prescription product, and variable costs commensurate with increased
sales volumes. The increase in personnel costs is attributable to an increase in
the number of employees to 125 in fiscal 1998 from 85 in fiscal 1997 and yearly
salary escalation for existing employees. Selling, general and administrative
expenses as a percentage of net sales in fiscal 1998 decreased 4.7 percentage
points to 35.4% from 40.1% in fiscal 1997.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses in fiscal 1998 increased 99.0%, or
$1.4 million, to $2.9 million from $1.5 million in fiscal 1997, primarily due to
development efforts relating to the Company's newest product, LUSTRA(TM), and
new products and expenses associated with the clinical support of the Company's
existing products.
DEPRECIATION AND AMORTIZATION EXPENSES
Depreciation and amortization expenses in fiscal 1998 increased 190.6%,
or $1.9 million, to $2.9 million from $1.0 million in fiscal 1997. This increase
is primarily attributable to the amortization of a full year of the purchase
price of the LIDEX(R) and SYNALAR(R) products purchased by the Company in
February 1997. The Company is amortizing this purchase price over a 25-year
period. The Company's depreciation and amortization also increased due to the
amortization of the intangible assets acquired in connection with the
acquisition of GenDerm in December 1997.
IN-PROCESS RESEARCH AND DEVELOPMENT
The Company recorded $35.4 million as in-process research and
development during the second quarter of fiscal 1998 as part of the allocated
purchase price of GenDerm. The amount allocated to in-process research and
development was based on an independent appraisal of GenDerm's completed and
in-process technologies. The in-process research and development of $35.4
million was charged to operations as required under generally accepted
accounting principles with the recording of the purchase price allocation (see
"Overview"). No such amount was recorded in fiscal 1997.
OPERATING (LOSS) INCOME
Operating income for fiscal 1998 decreased 139.0%, or $17.9 million to
a $5.0 million operating loss from $12.9 million in income in fiscal 1997. This
decrease is a result of a $35.4 million in-process research and development
charge relating to the Company's purchase of GenDerm in December 1997. Absent
this special charge, operating income in fiscal 1998 increased 136.2%, or $17.5
million, to $30.4 million from $12.9 million in fiscal 1997 as a result of
higher sales volume, coupled with a 4.7 percentage point increase in the
Company's gross profit as a percentage of net sales and a decrease of 4.7
percentage points in selling, general and administrative expenses as a
percentage of sales offset by an increase in research and development and
depreciation and amortization expenses.
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NET INTEREST INCOME (EXPENSE)
Interest income in fiscal 1998 increased $3.2 million, to $7.0 million
from $3.8 million in fiscal 1997, primarily due to higher cash, cash equivalent
and short-term investment balances during fiscal 1998, attributable to the
Company's public offering of its common stock in February 1998, which resulted
in offering proceeds of $209.4 million before related expenses or $197.9 million
net of related expenses. Interest expense in fiscal 1998 decreased 13.8%, or
$3,800, to $23,600 from $27,400 in fiscal 1997.
INCOME TAX (EXPENSE) BENEFIT
Income tax expense during fiscal 1998 increased $15.1 million to an
expense of $14.4 from a benefit of $0.7 million in fiscal 1997. The Company's
tax provision is recorded at an effective tax rate of 39%. No income tax benefit
is associated with the charge for in-process research and development. The
income tax benefit for fiscal 1997 is a result of management reducing the
valuation allowance required to reduce deferred tax assets in accordance with
Statement of Financial Accounting Standard No. 109, "Accounting for Income
Taxes" ("SFAS No. 109") to an amount the Company believes appropriate.
NET (LOSS) INCOME
Net income during fiscal 1998 decreased approximately 171.5%, or $29.7
million, to a $12.4 million loss from $17.3 million in income for fiscal 1997.
This decrease is the result of a special charge for in-process research and
development relating to the Company's purchase of GenDerm in December 1997.
Absent this special charge, net income for fiscal 1998 increased 32.6%, or $5.7
million, to $23.0 million from $17.3 million in fiscal 1997 as a result of an
increase in sales volume, an increase in gross profit as a percentage of net
sales, a decrease in selling, general and administrative costs as a percentage
of net sales and an increase in net interest income offset by an increase in
income taxes and research and development expenses as a percentage of net sales.
YEARS ENDED JUNE 30, 1997 AND 1996
NET SALES
Net sales for fiscal 1997 increased 62.6%, or $15.9 million, to $41.2
million from $25.3 million for fiscal 1996. The Company's net sales increased in
fiscal 1997 primarily as a result of both unit and dollar sales growth
associated with an increase in market share of the existing prescription and OTC
products and the acquisition of a new prescription product line in February
1997. The Company's prescription products accounted for 86.5% of net sales in
fiscal 1997 and 83.2% in fiscal 1996. Net sales of the Company's prescription
products grew 68.9%, or $14.5 million, to $35.6 million in 1997 from $21.1
million in fiscal 1996, primarily due to the Company's acquisition of the
LIDEX(R) and SYNALAR(R) products in February 1997 and the continued growth in
units and dollars of the Company's DYNACIN(R) and TRIAZ(R) products. The
Company's OTC products and cosmetic division accounted for 13.5% of net sales
for fiscal 1997 and 16.8% in fiscal 1996. OTC sales increased approximately
27.7%, primarily due to an increase in units and dollars of the Company's
ESOTERICA(R) products.
GROSS PROFIT
Gross profit during fiscal 1997 increased 73.2%, or $13.4 million, to
$31.8 million from $18.4 million in fiscal 1996. As a percentage of net sales,
gross profit grew to 77.3% in fiscal 1997 from 72.5% in fiscal 1996, primarily
as a result of the acquisition of the LIDEX(R) and SYNALAR(R) products, which
enjoy higher profits than the Company's other products, the increase in sales of
TRIAZ(R) products, which also enjoy profits in excess of aggregate corporate
gross profit percentages, manufacturing cost reductions for DYNACIN(R) products
and a change in sales mix toward the Company's prescription products, which have
higher gross profits.
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses in fiscal 1997 increased
51.7%, or $5.6 million, to $16.5 million from $10.9 million in fiscal 1996. This
increase was primarily attributable to an increase in promotional costs
attributable to the sampling and advertising of the Company's products, variable
costs commensurate with increased sales volumes, and an increase in personnel
costs attributable to an increase in the number of employees to 85 in fiscal
1997 from 58 in fiscal 1996 and yearly salary escalations for existing
employees. Selling, general and administrative expenses as a percentage of net
sales in fiscal 1997 decreased 2.8 percentage points to 40.1% from 42.9% in
fiscal 1996.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses in fiscal 1997 increased 52.3%, or
$0.5 million, to $1.5 million from $1.0 million in fiscal 1996, primarily due to
development efforts relating to new products and expenses associated with the
clinical support of the Company's existing products.
DEPRECIATION AND AMORTIZATION EXPENSES
Depreciation and amortization expenses in fiscal 1997 increased 78.8%,
or $0.4 million, to $1.0 million from $0.6 million in fiscal 1996. This increase
is primarily attributable to the amortization of the purchase price of the
LIDEX(R) and SYNALAR(R) products purchased by the Company in February 1997. The
Company is amortizing this purchase price over a 25-year period.
OPERATING INCOME
Operating income during fiscal 1997 increased 115.3%, or $6.9 million,
to $12.9 million from $6.0 million in fiscal 1996 and increased as a percentage
of net sales to 31.3% from 23.6% in fiscal 1996. This increase was primarily a
result of higher sales volume, coupled with an increase in the Company's gross
profit and the reduction in operating expenses as a percentage of net sales.
NET INTEREST INCOME (EXPENSE)
Interest income in fiscal 1997 increased $3.6 million, to $3.8 million
from $0.2 million in fiscal 1996, primarily due to higher cash, cash equivalent
and short-term investment balances during fiscal 1997, attributable to the
public offering completed by the Company in October 1996, raising $95.7 million
before related expenses, or $90.1 million net of related expenses. Interest
expense in fiscal 1997 decreased 63.8%, or $48,000, to $27,000 from $76,000 in
fiscal 1996.
INCOME TAX BENEFIT
Income tax benefit, net, during fiscal 1997 decreased $1.1 million to a
benefit of $0.7 million from a benefit of $1.8 million in fiscal 1996. During
the fourth quarter of fiscal 1996 and the first quarter of fiscal 1997, the
Company reevaluated the estimated amount of valuation allowance required to
reduce deferred tax assets in accordance with Statement of Financial Accounting
Standard No. 109, "Accounting for Income Taxes" ("SFAS No. 109") to an amount
the Company believed appropriate. Accordingly, a credit to deferred income tax
benefit of $1.9 million in fiscal 1996 and $2.0 million in fiscal 1997 was
reflected in the consolidated income statement. The amount of net deferred tax
assets estimated to be recoverable was based upon the Company's assessment of
the likelihood of near term operating income coupled with uncertainties with
respect to the impact of future competitive and market conditions.
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NET INCOME
Net income during fiscal 1997 increased approximately 120.1%, or $9.4
million, to $17.3 million from $7.9 million in fiscal 1996. The increase was
primarily attributable to an increase in sales volume, an increase in gross
profit as a percentage of net sales, and a reduction of operating expenses as a
percentage of net sales.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998 and June 30, 1997, the Company had cash, cash
equivalents and short-term investments of approximately $237.9 million and $85.1
million, respectively. The Company's working capital was $263.0 million at June
30, 1998, and $94.8 million at June 30, 1997.
In fiscal 1998, the Company increased its cash position through a
public offering of common stock yielding $209.4 million before related expenses,
$14.7 million cash provided by operations and $1.0 million generated from the
exercise of stock options. During fiscal 1998, the Company paid $60.0 million
for the purchase of 100% of the outstanding common stock of GenDerm.
At June 30, 1998 and June 30, 1997, the Company had net accounts
receivable of $18.9 million and $6.4 million, respectively. The increase in the
Company's accounts receivable balances is related primarily to a 68.0% increase
in sales volume in the fourth quarter of fiscal 1998 as compared to the quarter
ended June 30, 1997, coupled with an increase in accounts receivable as a result
of a joint venture with IMX Pharmaceutical Corporation established in June 1998
(the "IMX Joint Venture"), which the Company is required to consolidate on its
balance sheet.
At June 30, 1998 and June 30, 1997 the Company had inventories of $9.2
million and $3.0 million, respectively. The increase in the Company's inventory
balances is related primarily to an increase in the number of stock keeping
units ("SKU") acquired and inventory purchase commitments assumed in the GenDerm
acquisition and the IMX Joint Venture.
OTHER MATTERS
In February 1997, the Company acquired the United States and Canadian
dermatology assets of Syntex, from various affiliates of Syntex and its parent
company, F. Hoffman-LaRoche, Ltd. The Company, using cash reserves, paid $28
million, and must pay an additional $3 million, in $1 million installments, on
the anniversary of the purchase for each of the subsequent three years unless
certain market conditions are not obtained. Medicis paid the first of three
installments in January 1998. Medicis entered into four separate Asset Purchase
Agreements with various Roche affiliates (the "Purchase Agreements") for the
acquisition of the intellectual property rights, know-how, and all finished
goods inventory specifically associated with Syntex's topical corticosteroid
dermatology products (the "Purchased Products") in the United States and Canada.
The Purchased Products include the prescription topical steroid brands LIDEX(R)
and SYNALAR(R). These topical corticosteroids combat inflammatory and
hyperproliferative skin diseases by reducing swelling and pain, relieving
itching, and constricting blood vessels in the skin.
During June 1997, the Company entered into a joint product development
and distribution agreement with an unrelated third party whereby the Company
will pay certain costs with respect to certain product approvals estimated to be
approximately $1 million.
In December 1997, the Company acquired 100% of the common stock of
GenDerm as more fully discussed in "Overview" above.
Inflation did not have a significant impact upon the results of the
Company during fiscal 1998, 1997 or 1996.
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<PAGE> 28
The Year 2000 issue results from the inability of some computer
programs to identify the year 2000 properly, potentially leading to errors or
system failure. A company's business may be adversely affected if it, or any of
its suppliers and customers or others with whom it transacts business (including
its banks and governmental agencies), have not timely resolved the year 2000
issue. In response to its rapid growth, the Company selected a new management
information system in fiscal 1997, which was implemented in fiscal 1998 that is
expected to meet its presently anticipated needs. In selecting a system, Year
2000 compliance was one of the criteria. The Company is reviewing the areas
within its business and operations which could be adversely affected by Year
2000 issues and evaluating the costs associated with modifying and testing its
systems for the Year 2000. Although the Company is not yet able to estimate its
incremental cost for the Year 2000 issues, within its internal information
systems, based on its preliminary review to date, the Company does not believe
Year 2000 issues, will have a material adverse effect on the Company's business,
financial condition and results of operations. The Company is currently working
with critical third parties to determine the impact of Year 2000 issues on their
business and operations and its collateral impact on the business and operations
of the Company and plans to remediate Year 2000 issues where their systems
interface with the Company's systems. The assessment and necessary modification
for the Year 2000 issue are estimated to be completed in late 1999.
Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements which involve risk and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
set forth below under "Risk Factors."
RISK FACTORS
This Company's Form 10K contains forward-looking statements which
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth in the following risk
factors and elsewhere in this Form 10K.
DEPENDENCE ON SALES OF KEY PRODUCTS
The Company derives a majority of its revenue from sales of DYNACIN(R),
TRIAZ(R) and LIDEX(R) products and expects the newly acquired line of ZOSTRIX(R)
products to also be a significant contributor to revenues (the "Key Products").
The Company believes that sales of the Key Products will constitute the majority
of net sales for the foreseeable future. Accordingly, any factor adversely
affecting the sale of the Key Products individually or collectively would have a
material adverse effect on the Company's business, financial condition and
results of operations. Each of the Key Products could be rendered obsolete or
uneconomical by regulatory or competitive changes. The sale of Key Products
could also be adversely affected by other factors, including manufacturing or
supply interruptions, the development of new competitive pharmaceuticals to
treat the conditions addressed by the Key Products, technological advances,
factors affecting the cost of production, marketing or pricing actions by one or
more of the Company's competitors, changes in the prescribing practices of
dermatologists, changes in the reimbursement policies of third-party payors,
product liability claims or other factors. See "Item 1. Business -- Products in
Development," "-- Manufacturing," "-- Certain License and Royalty Agreements,"
"-- Competition" and "-- Government Regulation."
UNCERTAINTY OF FUTURE FINANCIAL RESULTS; FLUCTUATIONS IN OPERATING RESULTS
The Company's results of operations may vary from period to period due
to a variety of factors, including expenditures incurred to acquire, license and
promote pharmaceuticals, expenditures and timing relating to acquisition and
integration of businesses, changes in the prescribing practices of
dermatologists, the introduction of new products by the Company or its
competitors, cost increases from third-party manufacturers, manufacturing or
supply interruptions, the availability and cost of raw materials, the mix of
products sold by the Company, changes in marketing and sales expenditures,
market acceptance of the Company's products, competitive pricing pressures,
general economic and industry conditions that affect customer demand, and the
Company's level of research and development activities. In addition, the
Company's business has historically been subject to seasonal fluctuations, with
lower sales generally being experienced in the first quarter of each fiscal
year. As a result of customer buying
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<PAGE> 29
patterns, a substantial portion of the Company's revenues has been in the last
month of each quarter. The Company schedules its inventory purchases to meet
anticipated customer demand. As a result, relatively small delays in the receipt
of manufactured products by the Company could result in revenues being deferred
or lost. The Company's operating expenses are based on anticipated sales levels,
and a high percentage of the Company's operating expenses are relatively fixed
in the short term. Consequently, variations in the timing of recognition of
revenue could cause significant fluctuations in operating results from period to
period and may result in unanticipated earnings shortfalls or losses. There can
be no assurance that the Company will maintain or increase revenues or
profitability or avoid losses in any future period. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Overview."
DEPENDENCE ON ACQUISITION STRATEGY AND NEW PRODUCT INTRODUCTIONS
The Company's strategy for growth is substantially dependent upon its
continued ability to acquire products targeted at the dermatology market. The
Company engages in limited proprietary research and development of new products
and must rely upon the willingness of other companies to sell or license product
lines. Other companies, including those with substantially greater financial,
marketing and sales resources, compete with the Company to acquire such
products. There can be no assurance that the Company will be able to acquire
rights to additional products on acceptable terms, or at all. The failure of the
Company to acquire additional products or successfully introduce new products
could have a material adverse effect on the Company's business, financial
condition and results of operations. Further, any new internally developed or
acquired products may have different distribution channels and may face
different pricing pressures and levels of competition than the Company's current
products. Consequently, there can be no assurance that the Company will be able
to compete favorably and attain market acceptance in any new product category or
successfully integrate any acquired products or businesses. In addition, any
such products may require the Company to significantly increase its sales force
and incur commensurate expenses in anticipation of a new product introduction.
Failure of the Company to successfully introduce and market new products,
whether internally developed or acquired from third parties, would have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview."
RISKS ASSOCIATED WITH GENDERM ACQUISITION
In December 1997, the Company acquired 100% of the common stock of
GenDerm for approximately $60.0 million; and the Company could pay an additional
sum not to exceed $20.0 million if sales of GenDerm products, as defined in the
acquisition agreement, are in excess of $31.0 million during calendar 1999 and
certain other conditions are met (the "GenDerm Earnout Amount"). Products
acquired in the transaction include, among others, the prescription brands
NOVACET(R) and ZONALON(R), as well as the OTC brands ZOSTRIX(R), OCCLUSAL-HP(R),
PENTRAX(R), and SALAC(R). Prior to the acquisition, the Company did not market
any products in the topical acne rosacea treatment, anti-itch medication,
topical analgesic or wart treatment markets, and the Company has no experience
marketing such products. Successful integration of these products by the Company
is important to maintaining growth of sales of these products. The historical
net sales of GenDerm, prior to its acquisition by Medicis, are based upon
GenDerm's sales practices which the Company believes may have included discounts
and sales incentives to increase GenDerm's sales above historic consumption
levels. Due to these selling practices, there can be no assurance that the
Company can attain similar sales levels of the GenDerm products. There can be no
assurance that the Company will be able to successfully integrate, market and
sell the products acquired from GenDerm, or that such products will be accepted
by the market at levels previously achieved by GenDerm, or sufficient to
maintain growth. The failure of the Company to successfully integrate, market
and sell these products would have a material adverse effect on the Company's
business, financial condition and results of operations.
The acquisition involves a number of risks that could adversely affect
the Company's operating results, including the assumption of liabilities and
obligations of GenDerm, including the liabilities and obligations which may not
have been adequately disclosed to the Company, the diversion of management's
attention, and the assimilation of the acquired operations into the Company's
business, and the valuation of acquired intangible assets. The agreement
governing the terms of the acquisition limits the Company's remedies for any
losses incurred by the Company in connection with the acquisition to the
indemnification rights specifically provided to the Company
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<PAGE> 30
under the agreement governing the acquisition. The indemnification rights are
limited to a maximum of $11.0 million, subject to certain adjustments, together
with the GenDerm Earnout Amount, and any interest thereon. Any claims for
indemnification must be made prior to August 1, 2000 in accordance with the
terms of the agreement governing the acquisition. There can be no assurance that
the acquisition of GenDerm by the Company will not materially and adversely
affect the Company or that such acquisition will enhance the Company's business.
See "Management Discussion and Analysis of Financial Condition and Results of
Operations."
INTENSE COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE
The pharmaceutical industry is characterized by intense competition,
rapid product development and technological change. Most of the Company's
competitors are large, well-established pharmaceutical, chemical, cosmetic or
health care companies with considerably greater financial, marketing, sales,
development and technical resources than those available to the Company.
Additionally, many of the Company's present and potential competitors have
research and development capabilities that may allow such competitors to develop
new or improved products that may compete with the Company's product lines. The
Company's products could be rendered obsolete or made uneconomical by the
development of new or improved products to treat the conditions addressed by the
Company's products, technological advances affecting the cost of production, or
marketing or pricing actions by one or more of the Company's competitors. The
Company's business, financial condition and results of operations could be
materially adversely affected by any one or more of such developments.
DYNACIN(R) competes with Minocin, a branded minocycline product
marketed by AHP, Vectrin, marketed by Warner-Chilcott and generic minocycline
products marketed by Schein, BioCraft, and Barr Labs. Other oral antibiotics
utilized for the treatment of acne include erythromycin, doxycycline and
tetracycline marketed in branded and generic form by a variety of companies.
LIDEX(R) competes with a number of corticosteroid brands in the super-, high-,
mid-, and low-potency categories for the treatment of inflammatory and
hyperproliferative skin conditions. Competing brands include Halog, marketed by
Westwood-Squibb Pharmaceuticals, Inc.; Elocon, Diprolene, Diprosone and
Valisone, marketed by Schering-Plough Corporation.; Cyclocort, marketed by
Fujisawa Pharmaceuticals Co., Ltd.; Temovate and Cutivate, marketed by Glaxo
Wellcome plc; Psorcon, marketed by Rhone; and Aristocort, marketed by AHP. The
Company believes that TRIAZ(R) competes with Benzamycin, marketed by a
subsidiary of Rhone; Benzac, marketed by Galderma; and Cleocin-T and a generic
topical clindamycin, marketed by Pharmacia & Upjohn Co, Inc. ZOSTRIX(R)
primarily competes with other topical analgesics, including Capzasin, Aspercreme
and Sportscreme marketed by Thompson Medical Company, Inc.; Icy Hot and Flexall,
marketed by Chattem Inc.; Bengay, marketed by Pfizer Inc. and other private
label capsaicins and hot/cold rubs. In addition, the Company's other products,
including the OTC and cosmetic dermatology products, also compete with various
brands and private-label products, as well as with compounds which some
dermatologists formulate themselves in small quantities for their patients.
Several of the Company's products, including DYNACIN(R) and LIDEX(R),
compete with generic (non-branded) pharmaceuticals which claim to offer
equivalent therapeutic benefits at a lower cost. In some cases, insurers and
other third-party payors seek to encourage the use of generic products by making
branded products less attractive, from a cost perspective, to buyers. In
addition, certain of the Company's OTC products, including ZOSTRIX(R), compete
with private label products. The aggressive pricing activities of the Company's
generic and private label competitors and the payment and reimbursement policies
of third-party payors could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1. Business
- -- Competition."
UNCERTAINTY OF MANAGING GROWTH
The Company has recently experienced a period of significant expansion
of its operations that has placed a significant strain upon its management
system and resources. The Company's ability to compete effectively and to manage
future growth, if any, will require the Company to continue to improve its
financial and management controls, reporting systems and procedures on a timely
basis and expand, train and manage an increasing number of employees. The
Company's failure to do so would have a material adverse effect on the Company's
business, financial condition and results of operations.
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The Company's business strategy includes potential acquisitions of
products and businesses and introductions of new products. The Company
anticipates that the integration of additional new businesses or potential
products, if any, would require significant expense and management time and
attention. Failure to manage growth effectively would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations," and "-- Products in Development."
RELIANCE ON THIRD-PARTY MANUFACTURERS AND SOLE-SOURCE SUPPLIERS
The Company currently contracts for all of its manufacturing needs and
is required by the FDA to contract only with manufacturers that comply with the
FDA's cGMP regulations and other applicable laws and regulations. The Company
typically does not enter into long-term manufacturing contracts with third-party
manufacturers. Whether or not such contracts exist, there can be no assurance
that the Company will be able to obtain adequate supplies of its products in a
timely fashion, on acceptable terms, or at all.
The Company's DYNACIN(R) products are manufactured solely by Schein in
compliance with the Company's specifications and quality standards pursuant to a
supply agreement. Under the agreement, Schein manufactures minocycline for sale
in the branded market exclusively for the Company, but may manufacture and sell
minocycline for itself or others as a generic product. Schein currently
manufactures minocycline for the generic market under its own label. The supply
agreement expires in December 2003, but is subject to automatic renewal for
successive two-year periods if neither party gives timely notice of termination.
It may also be terminated by either party without cause upon 12-months notice.
Schein may terminate the exclusivity portion of the agreement if its gross
profit on sales of DYNACIN(R) products falls below a specified level. The
agreement also provides that the Company will purchase all of its requirements
for minocycline from Schein but may purchase some of its requirements from
another manufacturer if Schein fails to meet certain cost standards or fails to
provide the Company with all of its requirements for two of four consecutive
quarters. Either party may terminate the agreement in the event that the other
party cannot perform under the agreement for a period of three months or longer
for certain reasons beyond its control. The inability of Schein to fulfill the
Company's supply requirements for DYNACIN(R), one of the Company's
largest-selling products, in a timely fashion would have a material adverse
effect on the Company's business, financial condition and results of operations.
The majority of the Company's LIDEX(R) products are manufactured by
Patheon in accordance with a manufacturing and supply agreement. Under the terms
of the agreement, Roche supplies, at cost, active ingredients necessary for
manufacturing the LIDEX(R) products. The Patheon manufacture and supply
agreement expires in January 1999, but is subject to one-year automatic renewals
if neither party gives timely notice of termination. The inability of Patheon to
fulfill the Company's supply requirements for LIDEX(R) in a timely fashion would
have a material adverse effect on the Company's business, financial condition
and results of operations.
The Company's ZOSTRIX(R) products, among others, are manufactured for
distribution in the United States primarily by DPT in accordance with a
manufacturing and supply agreement and in Canada by Patheon on a purchase order
basis. Under the DPT agreement assumed by the Company in connection with the
acquisition of GenDerm, the Company is required to purchase at least 90% of its
annual sales requirements from DPT. The DPT manufacturing agreement expires in
December 2003. Either party may terminate the agreement upon two years notice by
the Company and three years notice by DPT. The notice period is reduced to 60
days if either party fails to perform, without cure, its obligations under the
DPT manufacturing agreement.
The Company has entered into manufacturing and supply agreements with
third parties for certain of its other products. Certain of the Company's
products, including TRIAZ(R) products, are produced on a purchase order basis
only from various manufacturers.
There can be no assurance that the manufacturers of the Company's
products will continue to meet the FDA's regulations or the Company's product
specifications and standards for the indicated products or that they can
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continue to meet product demand on a consistent and timely basis. Certain of the
Company's products, including the DYNACIN(R) products, are manufactured by a
sole manufacturer. Because of the FDA requirement for cGMP validation of
manufacturing facilities for particular products, validation of a new facility
to serve as a replacement source of manufacturing requires a substantial period
of time. Any loss of a manufacturer or any difficulty relating to the
manufacturing of the Company's products, especially the Key Products, could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company faces the risk that, upon
expiration of the term of any third-party manufacturing agreement, it may not be
able to renew or extend the agreement with the third-party manufacturer, to
obtain an alternative manufacturing source from other third parties or to
develop internal manufacturing capabilities on commercially viable terms, if at
all. The Company has obtained business interruption insurance against the loss
of income for up to 12 months due to the interruption of manufacturing of the
Company's Key Products due to certain causes. There can be no assurance that the
policy will cover all manufacturing interruptions or that the amount of such
insurance will be adequate to fully protect the Company for losses associated
with such interruptions. Any loss in excess of coverage limits could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company's third-party manufacturers rely on certain suppliers of
key raw materials. Certain of those materials are purchased from single sources
and others may be purchased from single sources in the future. Any disruption in
supplies, including delays due to the inability of the Company or its
manufacturers to procure raw materials, could have a material adverse effect on
the Company's business, financial condition and results of operations.
To manage its resources effectively, the Company attempts to maintain
inventory levels that are no greater than necessary to meet the currently
projected needs of its customers. Any interruptions in the supply of any of the
Company's products due to shortages in raw materials, changes in manufacturing
sources, regulatory changes or other causes could delay or eliminate the
Company's ability to distribute such products. There can be no assurance that
the Company will not suffer supply insufficiencies or interruptions or that it
will be able to obtain adequate supplies of its products in a timely fashion, or
at all. The loss of a manufacturer, the failure to obtain or validate a
replacement manufacturer on a timely basis, other manufacturing problems or any
interruption of supply could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1. Business
- -- Manufacturing."
UNCERTAINTY OF PRODUCT DEVELOPMENT
The Company has developed and obtained rights to certain pharmaceutical
agents in various stages of development. The Company has a variety of products
under development, ranging from existing product line extensions to new products
to reformulations of existing products. All products and technologies under
development require significant commitment of personnel and financial resources.
Several products require extensive clinical evaluation and premarketing
clearance by the FDA and comparable agencies in other countries prior to
commercial sale. There can be no assurance that any of these products under
development will be successfully introduced. Certain of the products and
technologies under development have been licensed from third parties. The
failure of the Company to meet its obligations under one or more of these
agreements could result in the termination of the Company's rights under such
agreements. In addition, the Company regularly reevaluates its product
development efforts. On the basis of these reevaluations, the Company has in the
past, and may in the future, abandon development efforts for particular
products. There can be no assurance that any product or technology under
development will result in the successful introduction of any new product. The
failure to introduce new products into the market on a timely basis could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 1. Business -- Products in Development" and "--
Government Regulation."
The Company has in the past supplemented, and may in the future
supplement, its research and development efforts by entering into research and
development agreements with other pharmaceutical companies in order to defray
the cost of product development. There can be no assurance that the Company will
be able to enter into additional research and development agreements acceptable
to the Company, or at all. See "Item 1. Business -- Products in Development" and
"-- Certain Licenses and Royalty Agreements."
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<PAGE> 33
UNCERTAINTY OF GOVERNMENT REGULATION
The manufacture and sale of cosmetics and drugs is subject to
regulation principally by the FDA and state and local authorities in the United
States, and by comparable agencies in certain foreign countries. The Federal
Trade Commission ("FTC") and state and local authorities regulate the
advertising of OTC drugs and cosmetics. The Federal Food, Drug, and Cosmetic
Act, as amended (the "Food and Drug Act"), and the regulations promulgated
thereunder, and other federal and state statutes and regulations, govern, among
other things, the testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of the Company's
products. In general, products falling within the FDA's definition of "new
drugs" require premarketing clearance by the FDA. Products falling within the
FDA's definition of "cosmetics" or of "drugs" that are not "new drugs" and that
are generally recognized as "safe and effective" do not require premarketing
clearance.
In general, FDA approval is required before a new drug product may be
marketed in the United States. However, most OTC drugs are exempt from the FDA's
premarketing approval requirements. The FDA issues monographs that set forth the
specific active ingredients, dosages, indications and labeling statements for
OTC drug ingredients that the FDA will consider generally recognized as safe and
effective and, therefore, not subject to pre-market approval. OTC drug
ingredients are classified by the FDA in one of three categories: Category I
ingredients, which are deemed "safe and effective for OTC use," Category II
ingredients, which are deemed "not generally recognized as safe and effective
for OTC use," and Category III ingredients, which are deemed "possibly safe and
effective with studies ongoing." Based upon the results of these ongoing
studies, the FDA may reclassify all Category III ingredients as Category I or
Category II ingredients. OTC drug manufacturing facilities are subject to FDA
inspection, and failure to comply with applicable regulatory requirements may
lead to administrative or judicially imposed penalties.
The active ingredient in DYNACIN(R) products, minocycline, and the
active ingredient in LIDEX(R), fluocinonide, have been approved by the FDA under
an NDA. The active ingredient in ZOSTRIX(R), capsaicin, is classified currently
by the FDA as a Category I ingredient. The active ingredient in TRIAZ(R)
products has been classified as a Category III ingredient under a tentative
final FDA monograph for OTC use in treatment of labeled conditions. The FDA has
requested, and a task force of the NDMA, a trade association of OTC drug
manufacturers, has undertaken further studies to confirm that benzoyl peroxide,
an active ingredient in TRIAZ(R) products, is not a tumor promoter when tested
in conjunction with UV light exposure. TRIAZ(R) products, which the Company
sells on a prescription basis, have the same ingredients at the same dosage
levels as the OTC products. When the FDA issues the final monograph, the Company
may be required by the FDA to sell TRIAZ(R) as an OTC drug unless the Company
files an NDA covering such product. In addition, there can be no assurance as to
the results of these studies or any FDA action to reclassify benzoyl peroxide.
In addition, there can be no assurance that adverse test results would not
result in withdrawal of TRIAZ(R) from the market. An adverse decision by the FDA
with respect to the safety of benzoyl peroxide could result in the assertion of
product liability claims against the Company and could otherwise have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company believes that certain of its products, as they are promoted
and intended by the Company for use, are exempt from being considered "new
drugs" based on the date of introduction of their active ingredients and
therefore do not require pre-marketing clearance. There can be no assurance that
the FDA will not take a contrary position. If the FDA were to do so, the Company
may be required to seek FDA approval for such products, market such products as
OTC products, or withdraw such products from the market. The Company believes
that such products are subject to regulations governing product safety, use of
ingredients, labeling and promotion, and methods of manufacture.
Clinical trials and the marketing and manufacturing of pharmaceutical
products are subject to the rigorous testing and approval processes of the FDA
and foreign regulatory authorities. The process of obtaining FDA and other
required regulatory approvals is lengthy and expensive. There can be no
assurance that the Company will be able to obtain the necessary approvals to
conduct clinical trials or to manufacture and market such products, that all
necessary clearances will be granted to the Company or its licensors for future
products on a timely basis, or at all,
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<PAGE> 34
or that FDA review or other actions will not cause delays adversely affecting
the marketing and sale of the Company's products. In addition, the testing and
approval process with respect to certain new products which the Company may
develop or seek to introduce is likely to take a substantial number of years and
involve the expenditure of substantial resources. There can be no assurance that
pharmaceutical products currently in development, or those products acquired or
licensed by the Company, will be cleared for marketing by the FDA. Failure to
obtain any necessary approvals or failure to comply with applicable regulatory
requirements could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, future government
regulation could prevent or delay regulatory approval of the Company's products.
There can be no assurance that any approval will be granted on a timely
basis, or at all; that the FDA will not require post-marketing testing and
surveillance to monitor the product and continued compliance with regulatory
requirements; that the FDA will not require the submission of any lot of any
product for inspection and will not restrict the release of any lot that does
not comply with FDA standards; that the FDA will not otherwise order the
suspension of manufacturing, recall or seizure of products; or that the FDA will
not withdraw its marketing clearance of any product if compliance with
regulatory standards is not maintained or if problems concerning safety or
efficacy of the product are discovered following approval.
From time to time, the FDA has issued correspondence to pharmaceutical
companies, including the Company, alleging that their advertising or promotional
practices are false, misleading or deceptive. There can be no assurance that the
Company will not receive such correspondence from the FDA in the future, or
that, if such notices are received, they will not result in substantial cost or
disruption, including fines and penalties, material changes to the manner in
which the Company promotes its products, loss of sales of the Company's products
or other material adverse effects on the Company's business, financial condition
and results of operations.
For both currently marketed and future products, failure to comply with
the applicable regulatory requirements could, among other things, result in
fines, suspensions of regulatory approvals, product recalls, operating
restrictions, criminal prosecution, relabeling costs, delays in product
distribution, marketing and sales, or seizure or cessation of manufacture of the
products and the imposition of civil or criminal sanctions. There can be no
assurance that the FDA will not change its position with regard to the safety or
effectiveness of the Company's current or future products or that the FDA will
agree with the Company's position regarding the regulatory status of its
products. In the event that the FDA takes a contrary position regarding any of
the Company's current or future products, the Company may be required to change
its labeling or formulation or cease the manufacture and marketing of such
products. In addition, even prior to any formal regulatory action, the Company
could decide voluntarily to cease distribution and sale or to recall any of its
products if concern about the safety or efficacy of any of its products were to
develop. Any such action could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company also will be subject to foreign regulatory authorities
governing clinical trials and pharmaceutical sales if it seeks to market its
products outside the United States. Whether or not FDA approval has been
obtained, approval of a product by the comparable regulatory authorities of
foreign countries must be obtained prior to the commencement of marketing of the
product in those countries. The approval process varies from country to country
and the time required may be longer or shorter than that required for FDA
approval. There can be no assurance that any foreign regulatory agency will
approve any product submitted for review by the Company. See "Item 1. Business
- -- Government Regulation."
UNCERTAINTY OF ENFORCEABILITY OF TRADEMARKS, PATENTS AND PROPRIETARY RIGHTS
The Company believes that trademark and service mark protection is an
important factor in establishing product recognition. There can be no assurance
that any such trademarks or service mark registrations will afford the Company
adequate protection, or that the Company will have the financial resources to
enforce its rights under any such trademarks or service mark registrations. The
inability of the Company to protect its trademarks or service marks from
infringement could result in impairment to any goodwill which may be developed
in such trademarks and service marks. Moreover, the Company's inability to use
one or more of its trademarks or service marks because of successful third-party
claims could have a material adverse effect on the Company's business, financial
condition
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<PAGE> 35
and results of operations. From time to time, the Company receives
communications from parties who allege that their interests may be damaged
either by the Company's use of a particular trademark or service mark or its
registration of such trademark or service mark. There can be no assurance that
such oppositions will not be filed or that, if filed, they will not have a
material adverse effect upon the Company's business, financial condition and
results of operations.
The Company is pursuing several United States patent applications.
There can be no assurance that patents will be issued with respect to any of
these applications. The Company has acquired rights under certain patents and
patent applications from third-party licensors. The Company has also acquired
from certain of its consultants and principals an assignment of their rights to
certain United States patents or patent applications. Certain of such patents
and patent applications may be subject to claims of rights by third parties, by
reason of existing relationships with the party who filed such patents or patent
applications. There can be no assurance that the Company will be able to obtain
any rights under such patents or patent applications as a result of any such
conflicting claims, or that any rights which the Company may obtain will be
sufficient for the Company to market products that may be the subject of such
patents or patent applications.
The Company believes that its success will depend in part on its
ability to obtain and maintain patent protection for its own inventions, and to
obtain and maintain licenses for the use of patents, licensed or sublicensed, by
third parties. There can be no assurance that any patent issued to, or licensed
by, the Company will provide protection that has commercial significance. In
this regard, the patent position of pharmaceutical compounds is particularly
uncertain. There can be no assurance that challenges will be not be instituted
against the validity or enforceability of any patent owned by or licensed to the
Company or, if instituted, that such challenges will not be successful. The cost
of litigation to uphold the validity and prevent infringement of patents can be
substantial and such litigation can require a substantial commitment of
management's time. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate the technology owned by
or licensed to the Company or design around the patented aspects of such
technology. The Company only conducts complete searches to determine whether its
products infringe upon any existing patents as it deems appropriate. There can
be no assurance that the products and technologies the Company currently
markets, or may seek to market in the future, will not infringe patents or other
rights owned by others. In the event of an adverse outcome of any dispute with
respect to patents or other rights, the Company may be required to license such
disputed rights or to cease sales of the affected products or modify those
products to avoid infringement of those rights. There can be no assurance that a
license would be available on terms acceptable to the Company, or at all.
The Company relies and expects to continue to rely upon unpatented
proprietary know-how and continuing technological innovation in the development
and manufacture of many of its principal products. The Company's policy is to
require all its employees, consultants, and advisors to enter into
confidentiality agreements with the Company. There can be no assurance, however,
that these agreements will provide meaningful protection for the Company's trade
secrets or proprietary know-how in the event of any unauthorized use or
disclosure of such know-how. In addition, there can be no assurance that others
will not obtain access to or independently develop similar or equivalent trade
secrets or know-how. See "Item 1. Business -- Certain License and Royalty
Agreements," "-- Trademarks," " -- Patents and Proprietary Rights."
CUSTOMER CONCENTRATION; CONSOLIDATION OF DISTRIBUTION NETWORK
The distribution network for pharmaceutical products has, in recent
years, been subject to increasing consolidation. As a result, a few very large
wholesale distributors control a significant share of the market. In addition,
the number of independent drug stores and small chains has decreased as retail
consolidation has occurred. Further consolidation among, or any financial
difficulties of, distributors or retailers could result in the combination or
elimination of warehouses which may result in product returns to the Company,
cause a reduction in the inventory levels of distributors or retailers, or
otherwise reduce purchases of the Company's products, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Medicis' customers include the leading wholesale pharmaceutical
distributors in the United States, such as McKesson, Bergen Brunswig, Cardinal,
Bindley and other major drug chains. In fiscal 1998, McKesson, Bergen Brunswig,
and Cardinal accounted for approximately 16.9%, 13.2% and 12.6%, respectively of
the Company's
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<PAGE> 36
sales. In fiscal 1997, McKesson, Cardinal and Bergen Brunswig accounted for
approximately 20.6%, 16.3% and 10.9%, respectively, of the Company's sales. In
fiscal 1996, McKesson, Bergen Brunswig and Cardinal accounted for approximately
15.5%, 12.2% and 11.8%, respectively, of the Company's sales. The loss of, or
deterioration in, any of these customer accounts would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Item 1. Business -- Customers."
UNCERTAINTIES RELATING TO PHARMACEUTICAL PRICING, THIRD-PARTY REIMBURSEMENT AND
HEALTH CARE REFORM
The operating results of the Company will depend in part on the
availability of adequate reimbursement for the Company's products from
third-party payors, such as government entities, private health insurers and
managed care organizations. Third-party payors are increasingly seeking to
negotiate the pricing of medical services and products and to promote the use of
generic, non-branded pharmaceuticals through payor-based reimbursement policies
designed to encourage their use. In some cases, third-party payors will pay or
reimburse a user or supplier of a prescription drug product for only a portion
of the purchase price of the product. In the case of the Company's prescription
products, payment or reimbursement by third-party payors of only a portion of
the cost of such products could make such products less attractive, from a cost
perspective, to users, suppliers and prescribing physicians. There can be no
assurance that reimbursement, if available, will be adequate. Moreover, certain
of the Company's products are not of a type generally eligible for third-party
reimbursement. If adequate reimbursement levels are not provided by government
entities or other third-party payors for the Company's products, or if those
reimbursement policies increasingly favor the use of generic products, the
Company's business, financial condition and results of operations would be
materially adversely affected. In addition, managed care initiatives to control
costs have influenced primary care physicians to refer fewer patients to
dermatologists, resulting in a declining target market for the Company. Further
reductions in referrals to dermatologists would have a material adverse effect
upon the Company's business, financial condition and results of operation. In
addition, a number of legislative and regulatory proposals aimed at changing the
United States health care system have been proposed in recent years. While the
Company cannot predict whether any such proposals will be adopted, or the effect
that any such proposal may have on its business, such proposals, if enacted,
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Item 1. Business -- Third Party
Reimbursement."
POTENTIAL PRODUCT LIABILITY; LIMITED INSURANCE COVERAGE
The Company faces an inherent risk of exposure to product liability
claims in the event that the use of its products is alleged to have resulted in
adverse effects. Such risk exists even with respect to those products that are
manufactured in licensed and regulated facilities or that otherwise have
received regulatory approval for commercial sale. There can be no assurance that
the Company will not be subject to significant product liability claims. The
Company currently has product liability insurance in the amount of $5.0 million
per claim and $5.0 million in the aggregate on a claims-made basis. Many of the
Company's customers require the Company to maintain product liability insurance
as a condition to their conducting business with the Company. There can be no
assurance that insurance coverage will be available in the future on
commercially reasonable terms, or at all, that such insurance will be adequate
to cover potential product liability claims, or that a loss of insurance
coverage or the assertion of a product liability claim or claims would not
materially adversely affect the Company's business, financial condition and
results of operations. See "Item 1. Business -- Government Regulation" and " --
Product Liability Insurance."
DEPENDENCE ON LICENSES FROM OTHERS
The Company has acquired rights to manufacture, use or market certain
of its products, including certain of its Key Products, as well as many of its
other proposed products and technologies, pursuant to license agreements with
third parties. Such agreements contain provisions requiring the Company to use
its best efforts or otherwise exercise diligence in pursuing market development
for such products in order to maintain the rights granted under the agreements
and may be canceled upon the Company's failure to perform its payment or other
obligations. There can be no assurance that the Company will fulfill its
obligations under one or more of such agreements due to insufficient resources,
lack of successful product development, lack of product acceptance or other
reasons. The
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<PAGE> 37
failure to satisfy the requirements of any such agreements may result in the
loss of the Company's rights under that agreement or under related agreements.
The inability of the Company to continue to license these products or to license
other necessary products for use with its products or substantial increases in
royalty payments under third party licenses could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, the effective implementation of the Company's strategy depends on the
successful integration of these licensed products with the Company's products,
and therefore any flaws or limitations of such licensed products may impair the
Company's ability to market and sell its products, delay new product
introductions, and/or adversely affect the Company's reputation. Such problems
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company's license agreement with Dr.
Joel Bernstein for the exclusive rights to market the ZOSTRIX(R) product line
will terminate in June 2003 with the expiration of the related patent. The
license agreement for certain of the Company's other products will also
terminate upon the expiration of any such underlying patents. See "Item 1.
Business -- Manufacturing," "--Certain License and Royalty Agreements," "--
Trademarks" and "-- Patents and Proprietary Rights."
RISK OF PRODUCT RECALL AND PRODUCT RETURNS
Product recalls may be issued at the discretion of the Company, the FDA
or other government agencies having regulatory authority for product sales and
may occur due to disputed labeling claims, manufacturing issues, quality defects
or other reasons. There can be no assurance that product recalls will not occur
in the future. Any product recall, especially one of the Company's Key Products,
could materially adversely affect the Company's business, financial condition
and results of operations. The Company's policy is to accept for return only
damaged or out of date products. However, the Company's customers have in the
past sought, and may in the future seek, exceptions to that policy. There can be
no assurance that the Company will not grant such exceptions in the future. The
Company maintains financial reserves for the anticipated amount of product
returns based upon historical experience. There can be no assurance that future
recalls or returns would not exceed reserves or otherwise have a material
adverse effect upon the Company's business, financial condition and results of
operations.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent on certain management personnel for the
operation and development of its business. The Company has entered into an
Employment Agreement providing for full-time services with Mr. Jonah Shacknai,
the founder, Chairman of the Board and Chief Executive Officer of the Company.
The current term of the Employment Agreement expires on June 30, 2001, subject
to automatic renewal for periods of five years unless either party gives timely
notice of an intention not to renew the Employment Agreement. Mr. Shacknai may
also terminate the Employment Agreement prior to the end of the term. Subject to
the control and oversight of the Company's Board of Directors, Mr. Shacknai
exercises control over substantially all policy making functions of the Company.
In addition, the Company is dependent upon its scientific consultants,
particularly with respect to the commercial development of discoveries and
technologies as to which they have special expertise. Certain of such
consultants are employed on a full-time basis by employers other than the
Company, and some have consulting or other advisory arrangements with other
entities which may conflict with their obligations to the Company. The loss of
any key person, or a reduction in the amount of time Mr. Shacknai devotes to the
Company, could have an adverse effect on the Company's business, financial
condition and results of operations.
UNCERTAINTY OF ACCESS TO CAPITAL
The Company may need to raise additional funds to acquire or license
additional formulations, technologies, products or businesses, to expand its
sales force, to support the marketing and sales of additional products, and
possibly to expand its facilities to accommodate an expanded sales force or to
expand manufacturing capabilities and capacity. The Company may seek additional
funding through public and private financings, including equity financings.
Adequate funds for these purposes, whether through the financial markets or from
other sources, may not be available when needed or on terms acceptable to the
Company. Insufficient funds may cause the Company to delay, scale back, or
abandon some or all of its acquisition and licensing opportunities, marketing,
research and product development programs and manufacturing opportunities. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources."
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<PAGE> 38
LACK OF CASH DIVIDENDS
The Company has never declared or paid any cash dividends on its
capital stock and does not anticipate that any cash dividends will be declared
or paid in the foreseeable future. See "Dividend Policy."
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the risk of loss arising from adverse changes
in market valuation which arise from equity price risk, interest rate risk,
foreign currency exchange rate risk, and commodity price risk. The Company's
primary market risk is equity price risk.
INTEREST RATE RISK
The Company faces minimal interest rate risk exposure in relation to
its outstanding debt of $105,920 at June 30, 1998. A hypothetical 10 percent
change in interest rates applied to the fair value of the debt would not have a
material impact on earnings or cash flows of the Company.
CURRENCY RISK
The Company faces transactional currency exposures that arise when its
Canadian subsidiary or the Company itself enters into transactions denominated
in the Canadian dollar. The Company also faces currency risk exposure that
arises from translating the results of its Canada operations to the U.S. dollar.
The currency risk exposure is not material as the Canadian subsidiary's
operations do not have a material impact on the Company's earnings.
COMMODITY PRICE RISK
The Company does not take commodity risk.
EQUITY PRICE RISK
The Company maintains a portfolio of available-for-sale securities
which subjects the Company to equity pricing risks. The change in fair values of
equity securities represents instantaneous changes in all equity prices. The
following are changes in the fair value of the Company's available for sale
securities at June 30, 1998 based on hypothetical percentage changes in fair
value. Equity price risk is managed through industry diversification. Actual
future price appreciation or depreciation may be different from the changes
identified in the table below.
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<PAGE> 39
AVAILABLE-FOR-SALE SECURITIES
FAIR VALUE AT JUNE 30, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
PERCENT
CHANGE IN DUE IN ONE DUE AFTER ONE YEAR DUE AFTER
FAIR VALUE YEAR OR LESS THROUGH TWO YEARS TWO YEARS
---------- ------------ ----------------- ---------
<S> <C> <C> <C>
20.00% $43,294 $62,054 $3,264
10.00% $39,686 $56,883 $2,992
0.00% $36,078 $51,712 $2,720
(10.00)% $32,470 $46,541 $2,448
(20.00)% $28,862 $41,370 $2,176
</TABLE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements and schedule at June 30, 1998 and
1997 and for each of the three years in the period ending June 30, 1998 and the
Independent Auditors' Report thereon are contained on pages F-1 through F-19 and
S-1 of this Form 10-K.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11: EXECUTIVE COMPENSATION
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Items 10, 11, 12 and 13 are incorporated
by reference to the Company's definitive proxy statement for the 1998 Annual
Meeting of Stockholders to be filed pursuant to Regulation 14A.
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<PAGE> 40
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
PAGE
(a) Documents filed as a part of this Report
(1) Financial Statements:
Index to Consolidated Financial Statements........................ F-1
Report of Ernst & Young LLP, Independent Auditors................. F-2
Consolidated balance sheets at June 30, 1998 and 1997............. F-3
Consolidated statements of income (loss) for the years ended
June 30, 1998, 1997 and 1996...................................... F-5
Consolidated statements of stockholders' equity for the years
ended June 30, 1998, 1997 and 1996................................ F-6
Consolidated statements of cash flows for the years ended June 30,
1998, 1997 and 1996............................................... F-7
Notes to consolidated financial statements........................ F-8
(2) Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts................... S-1
The financial statement schedule should be read in conjunction
with the consolidated financial statements. Financial statement
schedules not included in this Annual Report on Form 10-K have been
omitted because they are not applicable or the required information
is shown in the financial statements or notes thereto.
(3) Exhibits filed as part of this Report:
EXHIBIT NO. DESCRIPTION
2.1 - Agreement of Merger by and between Medicis Pharmaceutical
Corporation, a Delaware corporation, Medicis Acquisition
Corporation, a Delaware corporation, and GenDerm
Corporation, a Delaware corporation, dated November 28, 1997
(18)
3.1 - Certificate of Incorporation of the Company, as amended (11)
3.3 - By-Laws of the Company (1)
4.1 - Rights Agreement dated as of August 17, 1995 between the
Company and American Stock Transfer & Trust Company, as
Rights Agent (11)
4.1b - Amendment No. 2 to Rights Agreement dated as of March 17,
1997 between the Company and Norwest Bank Minnesota N.A.
(16)
4.3 - Form of specimen certificate representing Class A Common
Stock (2)
10.1 - License Agreement among Euromerican Trade Resources, Inc.,
Dr. H. R. Suess and H. R. Suess A.G. dated as of September
24, 1987 (3)
10.2 - Modification to License Agreement among the Company,
Euromerican Trade Resources, Inc., Dr. H. R. Suess and H. R.
Suess A.G. dated as of April 6, 1989 (3)
10.3 - Letter Agreement between the Company and Euromerican Trade
Resources, Inc. dated as of April 6, 1989, relating to
Modification to License Agreement among the Company,
Euromerican Trade Resources, Inc., Dr. H. R. Suess and H. R.
Suess A.G. dated as of April 6, 1989 (3)
10.8 - Medicis Pharmaceutical Corporation 1995 Stock Option Plan
(incorporated by reference to Exhibit C to the definitive
Proxy Statement for the 1995 Annual Meeting of Stockholders
previously filed with the SEC, File No. 0-18443)
10.9 - Employment Agreement between the Company and Jonah Shacknai
dated as of July 24, 1996 (15)
10.10 - Medicis Pharmaceutical Corporation 1988 Stock Option Plan,
as amended (4)
10.12 - License Agreement between the Company and Dr. H. R. Suess
dated March 1, 1990 (3)
10.13 - License Agreement between Syosset Laboratories, Inc. and
Medicis Dermatologics, Inc., dated as of July 25, 1990, and
the Guaranty of the Company (5)
10.14 - Non-Exclusive License Agreement between Syosset
Laboratories, Inc. and Medicis
-40-
<PAGE> 41
Dermatologics, Inc., dated as of July 25, 1990, and the
Guaranty of the Company (5)
10.15 - Manufacturing Agreement between Syosset Laboratories, Inc.
and Medicis Dermatologics, Inc., dated as of July 25, 1990,
and the Guaranty of the Company (5)
10.16 - Sales Agency Agreement between Syosset Laboratories, Inc.
and Medicis Dermatologics, Inc., dated as of July 25, 1990,
and the Guaranty of the Company (5)
10.18 - Medicis Pharmaceutical Corporation 1990 Stock Option Plan,
as amended (4)
10.49 - Option to Purchase Class A Common Stock granted to Stephen
B. Booke (4)
10.50 - Option to Purchase Class A Common Stock granted to Gerald
Amato (4)
10.58 - Medicis Pharmaceutical Corporation 1992 Stock Option Plan
(8)
10.59 - Supply Agreement, dated as of October 21, 1992 between
Schein and the Company (7)
10.70 - Amendment to Manufacturing and Supply Agreement, dated March
2, 1993 between Schein and the Company (10)
10.72(a) - Credit and Security Agreement, dated as of August 3, 1995
between the Company and Norwest Business Credit, Inc. (12)
10.72(b) - First Amendment to Credit and Security Agreement, dated as
of May 29, 1996 between the Company and Norwest Bank
Arizona, N.A. (15)
10.72(c) - Second Amendment to Credit and Security Agreement dated
November 22, 1996 by and between the Company and Norwest
Bank Arizona, N.A. as successor-in-interest to Norwest
Business Credit, Inc. (17)
10.73(a) - Patent Collateral Assignment and Security Agreement, dated
as of August 3, 1995 by the Company to Norwest Business
Credit, Inc. (13)
10.73(b) - First Amendment to Patent Collateral Assignment and Security
Agreement, dated as of May 29, 1996 by the Company to
Norwest Bank Arizona, N.A. (15)
10.74(a) - Trademark Collateral Assignment and Security Agreement,
dated as of August 3, 1995 by the Company to Norwest
Business Credit, Inc. (14)
10.74(b) - First Amendment to Trademark Collateral Assignment and
Security Agreement, dated as of May 29, 1996 by the Company
to Norwest Bank Arizona, N.A. (15)
10.75 - Assignment and Assumption of Loan Documents, dated as of May
29, 1996 from Norwest Business Credit, Inc., to and by
Norwest Bank Arizona, N.A. (15)
10.76 - Multiple Advance Note, dated May 29, 1996 from the Company
to Norwest Bank Arizona, N.A. (15)
10.77 - Securities Account Pledge and Security Agreement dated
November 22, 1996 by and between the Company and Norwest
Bank Arizona, N.A. (17)
10.78 - Acknowledgment of Control of Pledged Securities Account
dated November 22, 1996 by and among Norwest Bank Arizona
and the Company and Norwest Bank Minnesota (17)
10.79 - Asset Purchase Agreement dated January 21, 1997 between the
Company and Syntex (U.S.A.) Inc. (16)
10.80 - Asset Purchase Agreement dated January 21, 1997 between the
Company and Syntex (U.S.A.), Inc. (16)
10.81 - Asset Purchase Agreement dated January 21, 1997 between the
Company and F. Hoffman-La Roche Limited (16)
10.82 - Asset Purchase Agreement dated January 21, 1997 between the
Company and Syntex Pharmaceuticals International Limited
(16)
10.83 - Transition Services Agreement dated January 21, 1997 between
the Company and F. Hoffman-La Roche, Inc. (16)
10.84 - Transition Services Agreement dated January 21, 1997 between
the Company and F. Hoffman-La Roche Limited (16)
10.85 - Supply Agreement (Fluocinolone Acetonide and Fluocinonide)
dated January 21, 1997 between the Company and Syntex
Pharmaceuticals International Limited (16)
10.86 - License Agreement dated March 28, 1997 between the Company
and Platinum(R) Software Corporation (16)
10.87 - Master Software License Agreement dated March 28, 1997
between the Company and FocusSoft, Inc. (16)
21.1 - Subsidiaries (19)
23.1 - Consent of Ernst & Young LLP, Independent Auditors (19)
24.1 - Power of Attorney (19) See signature page(s)
27.1 - Financial Data Schedule (19)
-41-
<PAGE> 42
(1) Incorporated by reference to the exhibit with the same number in the
Company's Quarterly Report on Form 10-Q for the quarter ended December
31, 1992, File No. 0-18443, previously filed with the Securities and
Exchange Commission (the "SEC")
(2) Incorporated by reference to the exhibit with the same number in the
Registration Statement on Form S-1 of the Registrant, File No.
33-32918, filed with the SEC on January 16, 1990
(3) Incorporated by reference to the exhibit with the same number in
Amendment No. 1 to the Registration Statement on Form S-1 of the
Company, File No. 33-32918, filed with the SEC on March 6, 1990
(4) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1992, as amended, File No. 0-18443 previously filed with the SEC
(5) Incorporated by reference to the exhibit with the same number in
Amendment No. 2 to the Registration Statement on Form S-1 of the
Company, File No. 33-34041, filed with the SEC on August 2, 1990
(6) Incorporated by reference to the exhibit with the same number in
Amendment No. 1 to the Registration Statement on Form S-1 of the
Company, File No. 33-46913, filed with the SEC on April 29, 1992
(7) Incorporated by reference to the exhibit with the same number in
Registration Statement on Form S-1 of the Company, File No. 33-54276,
filed with the SEC on June 11, 1993
(8) Incorporated by reference to Exhibit B to the Company's definitive
Proxy Statement for its 1992 Annual Meeting of Stockholders, previously
filed with the SEC, File No. 0-18443
(9) Incorporated by reference to the exhibit with the same number in
Amendment No. 1 to the Registration Statement on Form S-1 of the
Company, File No. 33-54276, filed with the SEC on May 25, 1993
(10) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1993, File No. 0-18443, filed with the SEC on October 13, 1993
(11) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1995, File No. 0-18443, filed with the SEC on September 27, 1995 ("1995
Form 10-K")
(12) Incorporated by reference to exhibit number 4.2 in the 1996 Form 10-K
(13) Incorporated by reference to exhibit number 4.4 in the 1996 Form 10-K
(14) Incorporated by reference to exhibit number 4.5 in the 1996 Form 10-K
(15) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1996, File No. 0-18443, filed with the SEC on September 24, 1996
(16) Incorporated by reference to the exhibit with the same number in the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997, File No. 0-18443, previously filed with the SEC
(17) Incorporated by reference to the exhibit with the same number in the
Company's Quarterly Report on Form 10-Q for the quarter ended December
31, 1996, File No. 0-18443, previously filed with the SEC
(18) Incorporated by reference to the exhibit with the same number in the
Company's Current Report on Form 8-K filed with the SEC on December 15,
1997
(19) Filed herewith
(b) No reports on Form 8-K were filed with the SEC for the quarter end June 30,
1998.
(c) The exhibits to this Form 10-K follow the Company's Financial Statement
Schedule included in this Form 10-K.
(d) The Financial Statement Schedule to this Form 10-K appears on page S-1 of
this Form 10-K.
-42-
<PAGE> 43
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Jonah Shacknai and Mark A. Prygocki, Sr.,
or either of them, as his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-K and any documents related to this report and filed
pursuant to the Securities and Exchange Act of 1934, and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: September 28, 1998
MEDICIS PHARMACEUTICAL CORPORATION
By: /s/ JONAH SHACKNAI
-------------------------------------
Jonah Shacknai
Chairman of the Board of Directors
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ JONAH SHACKNAI Chairman of the Board of Directors September 28, 1998
- ----------------------------- and Chief Executive Officer
Jonah Shacknai (Principal Executive Officer)
/s/ MARK A. PRYGOCKI, SR. Chief Financial Officer September 28, 1998
- ----------------------------- (Principal Financial and Accounting Officer)
Mark A. Prygocki, Sr.
Director
- -----------------------------
Arthur G. Altschul, Jr.
/s/ RICHARD L. DOBSON, M.D. Director September 28, 1998
- -----------------------------
Richard L. Dobson, M.D.
/s/ PETER S. KNIGHT, ESQ. Director September 28, 1998
- -----------------------------
Peter S. Knight, Esq.
/s/ MICHAEL A. PIETRANGELO Director September 28, 1998
- -----------------------------
Michael A. Pietrangelo
/s/ PHILIP S. SCHEIN, M.D. Director September 28, 1998
- -----------------------------
Philip S. Schein, M.D.
/s/ LOTTIE SHACKELFORD Director September 28, 1998
- -----------------------------
Lottie Shackelford
</TABLE>
-43-
<PAGE> 44
MEDICIS PHARMACEUTICAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Income (Loss)................................... F-5
Consolidated Statements of Stockholders' Equity............................ F-6
Consolidated Statements of Cash Flows...................................... F-7
Notes to Consolidated Financial Statements................................. F-8
F-1
<PAGE> 45
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of
Medicis Pharmaceutical Corporation
We have audited the accompanying consolidated balance sheets of Medicis
Pharmaceutical Corporation and subsidiaries as of June 30, 1998 and 1997, and
the related consolidated statements of income (loss), stockholders' equity, and
cash flows for each of the three years in the period ended June 30, 1998. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial condition of
Medicis Pharmaceutical Corporation and subsidiaries at June 30, 1998 and 1997,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended June 30, 1998, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ ERNST & YOUNG LLP
Phoenix, Arizona
August 7, 1998
F-2
<PAGE> 46
MEDICIS PHARMACEUTICAL CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JUNE 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ..................... $147,411,127 $ 33,623,397
Short-term investments ........................ 90,510,029 51,508,611
Accounts receivable, less allowances:
1998: $2,826,000; 1997: $1,150,000 .......... 18,899,868 6,352,840
Inventories ................................... 9,208,384 2,981,877
Deferred tax assets ........................... 3,300,000 6,257,000
Other current assets .......................... 8,800,434 2,818,505
------------ ------------
Total current assets ..................... 278,129,842 103,542,230
Property and equipment, net ....................... 1,343,603 712,141
Intangible assets:
Intangible assets related to product acquisitions 70,386,665 36,999,644
Other intangible assets ......................... 6,874,626 1,608,762
------------ ------------
77,261,291 38,608,406
Less accumulated amortization ................... 5,977,399 3,325,621
------------ ------------
Net intangible assets .................... 71,283,892 35,282,785
Other non-current assets .......................... 1,592,907 1,000,000
------------ ------------
$352,350,244 $140,537,156
============ ============
</TABLE>
See accompanying notes.
F-3
<PAGE> 47
MEDICIS PHARMACEUTICAL CORPORATION
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
JUNE 30,
-------------------------------
1998 1997
------------- -------------
<S> <C> <C>
LIABILITIES
Current liabilities:
Accounts payable ................................................... $ 5,496,526 $ 4,128,370
Accrued royalties .................................................. 1,040,993 712,432
Notes payable ...................................................... 11,364 5,245
Other accrued liabilities .......................................... 8,624,789 3,893,196
------------- -------------
Total current liabilities ..................................... 15,173,672 8,739,243
Long-term liabilities:
Notes payable ...................................................... 94,556 111,335
Other non-current liabilities ...................................... 124,115 121,761
Deferred tax liability ............................................. 10,502,416 --
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST ...................................................... 1,960,000 --
STOCKHOLDERS' EQUITY
Preferred Stock, $0.01 par value; shares authorized: 5,000,000;
no shares issued ..................................................... -- --
Class A Common Stock, $0.014 par value; shares authorized: 50,000,000;
issued and outstanding: 18,474,256 and 13,978,714 at June 30, 1998 and
1997, respectively ................................................... 258,640 195,702
Class B Common Stock, $0.014 par value; shares authorized: 1,000,000;
issued and outstanding: 281,974 at June 30, 1998 and 1997 ............ 3,948 3,948
Additional paid-in capital ............................................. 344,107,350 138,973,208
Accumulated deficit .................................................... (19,874,453) (7,608,041)
------------- -------------
Total stockholders' equity .................................... 324,495,485 131,564,817
------------- -------------
$ 352,350,244 $ 140,537,156
============= =============
</TABLE>
See accompanying notes.
F-4
<PAGE> 48
MEDICIS PHARMACEUTICAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
<TABLE>
<CAPTION>
JUNE 30,
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales ................................................. $ 77,571,419 $ 41,158,860 $ 25,309,743
Operating costs and expenses:
Cost of sales ............................................ 13,979,793 9,361,383 6,955,685
Selling, general and administrative ...................... 27,423,574 16,484,329 10,867,979
Research and development ................................. 2,884,479 1,449,620 951,888
In-process research and development ...................... 35,400,000 -- --
Depreciation and amortization ............................ 2,903,423 999,113 558,802
------------ ------------ ------------
Operating costs and expenses .......................... 82,591,269 28,294,445 19,334,354
------------ ------------ ------------
Operating (loss) income ................................... (5,019,850) 12,864,415 5,975,389
Interest income ........................................... 7,060,354 3,814,435 154,023
Interest expense .......................................... (23,635) (27,403) (75,670)
------------ ------------ ------------
Income before taxes ....................................... 2,016,869 16,651,447 6,053,742
Income tax (expense) benefit .............................. (14,424,045) 693,467 1,826,000
------------ ------------ ------------
Net (loss) income ......................................... $(12,407,176) $ 17,344,914 $ 7,879,742
============ ============ ============
Basic net (loss) income per common share ..................
$ (0.77) $ 1.31 $ 0.77
============ ============ ============
Diluted net (loss) income per common share ................
$ (0.77) $ 1.24 $ 0.72
============ ============ ============
Shares used in computing basic net (loss) income per common
share ..................................................... 16,066,840 13,190,889 10,254,668
============ ============ ============
Shares used in computing diluted net (loss) income per
common share .............................................. 16,066,840 14,038,676 10,890,643
============ ============ ============
</TABLE>
See accompanying notes.
F-5
<PAGE> 49
MEDICIS PHARMACEUTICAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CLASS A CLASS B ADDITIONAL
COMMON STOCK COMMON STOCK PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- -------- ------- ------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1995 .... 9,748,265 $136,476 281,974 $3,948 $ 40,016,192 $(32,769,622) $ 7,386,994
Exercise of stock options
and warrants, net ........ 476,212 6,667 -- -- 3,099,249 -- 3,105,916
Tax effect of stock options
exercised ................ -- -- -- -- 1,067,000 -- 1,067,000
Options issued in lieu of
payment for services
rendered ................. -- -- -- -- 20,000 -- 20,000
Net income ................. -- -- -- -- -- 7,879,742 7,879,742
---------- -------- ------- ------ ------------ ------------ -------------
Balance at June 30, 1996 .... 10,224,477 143,143 281,974 3,948 44,202,441 (24,889,880) 19,459,652
Exercise of stock options .. 563,681 7,892 -- -- 3,482,765 -- 3,490,657
Tax effect of stock
options exercised ........ -- -- -- -- 1,165,000 -- 1,165,000
Options issued in lieu of
payment for services
rendered ................. -- -- -- -- 59,500 -- 59,500
Public offering ............. 3,190,556 44,667 -- -- 90,063,502 -- 90,108,169
Net unrealized losses on
available-for-sale
securities ................ -- -- -- -- -- (63,075) (63,075)
Net income .................. -- -- -- -- -- 17,344,914 17,344,914
---------- -------- ------- ------ ------------ ------------ -------------
Balance at June 30, 1997 .... 13,978,714 195,702 281,974 3,948 138,973,208 (7,608,041) 131,564,817
Exercise of stock options ... 155,542 2,178 -- -- 955,384 -- 957,562
Tax effect of stock options
exercised ................. -- -- -- -- 6,305,311 -- 6,305,311
Options issued in lieu of
payment for services
rendered .................. -- -- -- -- 57,500 -- 57,500
Public offering ............. 4,340,000 60,760 -- -- 197,815,947 -- 197,876,707
Net unrealized gains on
available-for-sale
securities ................ -- -- -- -- -- 140,764 140,764
Net loss .................... -- -- -- -- -- (12,407,176) (12,407,176)
---------- -------- ------- ------ ------------ ------------ -------------
Balance at June 30, 1998 .... 18,474,256 $258,640 281,974 $3,948 $344,107,350 $(19,874,453) $ 324,495,485
========== ======== ======= ====== ============ ============ =============
</TABLE>
See accompanying notes.
F-6
<PAGE> 50
MEDICIS PHARMACEUTICAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
JUNE 30,
--------------------------------------------
1998 1997 1996
------------- ------------ -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net (loss) income ....................................... $ (12,407,176) $ 17,344,914 $ 7,879,742
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
In-process research and development .................. 35,400,000 -- --
Depreciation and amortization ........................ 2,903,423 999,113 558,802
Gain on sale of available-for-sale investments ....... (50,931) (37,591) --
Non-cash interest .................................... -- -- 13,100
Other non-cash expenses .............................. 57,500 59,500 20,000
Deferred income tax (benefit) expense ................ 13,787,173 (2,092,000) (1,933,000)
Provision for doubtful accounts and returns .......... 460,000 470,000 160,000
Accretion of discount on investments ................. (344,454) (422,032) --
Changes in operating assets and liabilities:
Accounts receivable ................................ (10,944,095) (1,612,136) (1,156,280)
Inventories ........................................ (4,772,069) (901,863) (1,281,058)
Other current assets ............................... (5,353,132) (1,579,594) (487,825)
Accounts payable ................................... 35,575 757,186 144,011
Accrued officer's salaries ......................... -- (204,750) --
Accrued royalties .................................. 328,561 159,480 84,770
Accrued incentives ................................. 115,289 486,992 552,880
Other accrued liabilities .......................... (4,470,648) 359,959 334,891
------------- ------------ -----------
Net cash provided by operating activities 14,745,016 13,787,178 4,890,033
INVESTING ACTIVITIES:
Purchase of property and equipment ...................... (833,111) (430,691) (181,911)
Purchase of common stock of GenDerm,
net of cash acquired ..................... (54,982,386) -- --
Payments for intangible assets .......................... (5,012,483) (28,636,227) --
Purchase of available-for-sale investments .............. (147,656,185) (75,297,924) --
Sale of available-for-sale investments .................. 74,690,916 9,685,861 --
Maturity of available-for-sale investments .............. 34,500,000 14,500,000 --
Change in other assets .................................. (490,000) (1,500,000) (71,772)
------------- ------------ -----------
Net cash used in investing activities .... (99,783,249) (81,678,981) (253,683)
FINANCING ACTIVITIES:
Proceeds from the sale of common equity securities, net . 197,876,707 90,108,169 --
Proceeds from issuance of note payable .................. -- -- 9,143
Payment of notes payable ................................ (10,660) (10,000) (748,797)
Decrease in other non-current liabilities ............... 2,354 (29,676) --
Proceeds from the exercise of options/warrants .......... 957,562 3,490,657 3,105,916
------------- ------------ -----------
Net cash provided by financing activities 198,825,963 93,559,150 2,366,262
------------- ------------ -----------
Net increase in cash and cash equivalents ............... 113,787,730 25,667,347 7,002,612
Cash and cash equivalents at beginning of year .......... 33,623,397 7,956,050 953,438
------------- ------------ -----------
Cash and cash equivalents at end of year ................ $ 147,411,127 $ 33,623,397 $ 7,956,050
============= ============ ===========
</TABLE>
See accompanying notes.
F-7
<PAGE> 51
MEDICIS PHARMACEUTICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
NOTE 1. FORMATION AND DEVELOPMENT OF THE COMPANY
Medicis Pharmaceutical Corporation and its wholly owned subsidiaries
("Medicis" or the "Company") is an independent pharmaceutical company in the
United States offering prescription and over-the-counter ("OTC") products
exclusively to treat dermatological conditions. The Company has acquired rights
to manufacture and sell certain of its dermatological products pursuant to
several license and asset purchase agreements. The Company sells these products
for use in various segments of the dermatological market, including acne,
inflammatory skin conditions, therapeutic emollients and moisturizers,
pigmentation disorders and cosmetic dermatology.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of Medicis and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. Certain prior period amounts
have been reclassified to conform to the current period presentation. The
company records minority interest to the extent the subsidiary is not wholly
owned.
CASH AND CASH EQUIVALENTS
At June 30, 1998, cash and cash equivalents include highly liquid
investments invested in money market accounts consisting of government
securities and high-grade commercial paper. These investments are stated at cost
which approximates fair value. The Company considers all highly liquid
investments purchased with a remaining maturity of three months or less to be
cash equivalents.
INVESTMENTS
The Company accounts for investments under Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The Company's debt securities are classified as
available-for-sale. Available-for-sale securities are carried at fair value with
the unrealized gains and losses reported in stockholders' equity. The amortized
cost of debt securities in this category is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Realized gains and losses, interest, and dividends on
securities are included in interest income. The cost of securities sold is based
on the specific identification method.
INVENTORIES
The Company utilizes third parties to manufacture and package
inventories held for sale, and warehouses such goods until packaged for final
distribution and sale. Inventories consist of salable dermatological products
held at the Company's warehouses as well as at the manufacturers' facilities and
are valued at the lower of cost or market using the first-in, first-out method.
F-8
<PAGE> 52
Inventories are as follows:
<TABLE>
<CAPTION>
JUNE 30,
-------------------------------
1998 1997
---------- ----------
<S> <C> <C>
Raw materials ........................ $1,086,585 $ 557,520
Finished goods ....................... 8,121,799 2,424,357
---------- ----------
Total inventories .................... $9,208,384 $2,981,877
========== ==========
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated
on the straight-line basis over the estimated useful lives of property and
equipment (three to five years). Leasehold improvements are amortized over the
shorter of their estimated useful lives or the remaining lease term.
INTANGIBLE ASSETS
Intangible assets resulting from product acquisitions principally
consist of the excess of the fair value attributed to the related developed
products and are being amortized on a straight-line basis over a ten to
twenty-five year period. The Company assesses the recoverability of intangible
assets resulting from these acquisitions based upon expected future undiscounted
cash flows on a product line basis along with other relevant information.
OTHER CURRENT LIABILITIES
Other current liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Accrued incentives ........................... $1,786,392 $1,671,103
Accrued contract costs ....................... -- 600,000
Payable to affiliate ......................... 1,366,846 --
Marketing allowance .......................... 1,141,000 325,000
Other accrued expenses ....................... 4,330,551 1,297,093
---------- ----------
$8,624,789 $3,893,196
========== ==========
</TABLE>
REVENUE RECOGNITION
Revenue from product sales are recognized upon shipment net of
discounts, rebates and estimated allowances for chargebacks and returns. The
Company principally authorizes returns for damaged and expired products in
accordance with its Return Goods Policy and Procedures. The Company has not
experienced significant returns of damaged or expired products.
ADVERTISING
The Company expenses advertising as incurred. Advertising expenses for
the fiscal years ended June 30, 1998 ("fiscal 1998"), June 30, 1997 ("fiscal
1997") and June 30, 1996 ("fiscal 1996") were approximately $8,347,000,
$3,806,000 and $1,887,000, respectively.
STOCK BASED COMPENSATION
The Company grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
date of grant. The Company accounts for stock option grants to employees in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25").
F-9
<PAGE> 53
RESEARCH AND DEVELOPMENT COSTS
All research and development costs, including payments related to
products under development and research consulting agreements, are expensed as
incurred.
INCOME TAXES
Income taxes have been provided using the liability method in
accordance with SFAS No. 109.
INCOME (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board issued SFAS
No. 128, "Earnings per Share" ("SFAS No. 128"). SFAS No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. Earnings per share amounts for all
periods have been presented, and where appropriate, restated to conform to the
requirements of SFAS No. 128. The effect of dilutive securities is computed
using the treasury stock method.
STATEMENTS OF CASH FLOWS
Non-cash investing and financing activities were as follows:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Tax benefit of stock options exercised................. $ 6,305,311 $ 1,165,000 $1,067,000
Intangibles acquired under accrued contract costs...... -- 600,000 --
</TABLE>
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates based upon future events, which could include, among other
risks, changes in the regulations governing the manner in which the Company
sells its products, changes in the health care environment and the reliance on
contract manufacturing services.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, short-term
investments, accounts receivable, accounts payable, and long-term debt reported
in the consolidated balance sheets approximate their fair value.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This Statement established standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. This Statement is
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes is
required. This Statement, requiring only additional informational disclosures is
effective for the Company's fiscal year ending June 30, 1999.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." This Statement established standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that enterprises report
selected information
F-10
<PAGE> 54
about operating segments in interim financial reports issued to stockholders.
This Statement is effective for fiscal years beginning after December 15, 1997.
In the initial year of application, comparative information for earlier years is
to be restated. This Statement, requiring only additional informational
disclosures, is effective for the Company's fiscal year ending June 30, 1999.
NOTE 3. ACQUISITIONS
On December 3, 1997, the Company acquired 100% of the common stock of
GenDerm Corporation and subsidiary ("GenDerm") for net cash of approximately
$55.0 million and the Company could pay an additional sum not to exceed $20.0
million if sales of GenDerm products, as defined in the acquisition agreement,
are in excess of $31.0 million during calendar 1999 and certain other conditions
are met. GenDerm marketed products including the prescription brands NOVACET(R)
and ZONALON(R), as well as the OTC brands ZOSTRIX(R), OCCLUSAL-HP(R),
PENTRAX(R), and SALAC(R).
The purchase price was allocated to the assets and liabilities, based on fair
market value, as follows:
<TABLE>
<S> <C>
Accounts receivable trade, net .......................... $ 1,554,220
Inventories ............................................. 1,963,147
Prepaid expenses and other assets ....................... 781,704
Deferred tax assets ..................................... 6,268,446
In-process research and development ..................... 35,400,000
Intangible assets ....................................... 31,400,000
Goodwill ................................................ 880,402
Accounts payable ........................................ (1,332,581)
Accrued liabilities, including costs of
acquisition .......................................... (9,686,952)
Deferred tax liability .................................. (12,246,000)
------------
Purchase price .......................................... $ 54,982,386
============
</TABLE>
The acquisition was accounted for using the purchase method of
accounting in accordance with Accounting Principles Board Opinion No. 16,
"Business Combinations" ("APB 16"). Under APB 16, purchase price allocations
were made to the assets acquired and the liabilities assumed based upon their
respective fair values. The operations of GenDerm, including revenues, costs and
expenses, have been included in the statements of income (loss), as of the
acquisition date. In conjunction with the acquisition, the Company recorded a
charge to operations of $35.4 million, based upon independent valuation,
relating to acquired in-process research and development for projects in
development for which there is no alternative future use. The $35.4 million
charge, relating to in-process research and development, is not deductible for
tax purposes.
Unaudited pro forma operating results for the Company, assuming the
acquisition of GenDerm occurred on July 1, 1996, are as follows:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Net sales $ 89,615,074 $ 69,625,259
Net (loss) income (13,171,189) 12,698,944
Basic net (loss) income per common share $ (0.82) $ 0.96
Diluted net (loss) income per common share $ (0.82) $ 0.90
</TABLE>
For purposes of these pro forma operating results, the charge for
in-process research and development is presented in the year ended June 30,
1998, the year the charge was incurred. The pro forma information does not
necessarily represent the actual results that would have occurred had the
acquisition taken place on July 1, 1996, given the manner in which the Company
has assimilated the GenDerm products into its business.
F-11
<PAGE> 55
On June 25, 1998 the Company entered into a joint venture arrangement
with IMX Pharmaceuticals, Inc. ("IMX") of Boca Raton, Florida for the purpose
of, among other things, jointly distributing the EXOREX(TM) product line for the
treatment of psoriasis and eczema. Medicis paid $4.0 million for 51.0% ownership
in the joint venture which Medicis will consolidate for financial reporting
purposes.
The Company has also purchased 400,000 shares of IMX Common Stock,
Symbol IMXN, for $2.50 per share. Medicis is holding the IMX Common Stock as an
investment on its Balance Sheet.
In February 1997, the Company acquired the products LIDEX(R), and
SYNALAR(R) from a third party for $28.0 million, and may pay an additional $3.0
million, in $1.0 million installments, on the anniversary of the purchase for
each of the next three years if certain market conditions are met. Medicis paid
the first installment of $1.0 million in February 1998.
NOTE 4. DEBT
Upon the Company's relocation to Arizona, the Company entered into a
note from the Commerce and Economic Development Commission in the amount of
approximately $131,000, bearing interest at a rate of 6.5%, due in installments
through June 2, 2000. At June 30, 1998, $105,920 was outstanding on the note.
The Company has a revolving line of credit facility of up to $25
million from Norwest Bank Arizona, N.A. The facility may be drawn upon by the
Company at its discretion and is secured by principal assets of the Company. The
outstanding balance of the credit facility bears interest at a floating rate of
150 basis points in excess of the 30-day London Interbank Offered Rate, and
expires in November 1998. The agreement requires the Company to comply with
certain covenants, including covenants relating to the Company's financial
condition and results of operation. The Company has not drawn on this credit
facility.
NOTE 5. SHORT-TERM INVESTMENTS
The Company's short-term investments are intended to establish a high
quality portfolio which preserves principal, meets liquidity needs, avoids
inappropriate concentrations and delivers an appropriate yield in relationship
to the Company's investment guidelines and market conditions.
The following is a summary of available-for-sale securities:
<TABLE>
<CAPTION>
JUNE 30, 1998
--------------------------------------------------------
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
U.S. corporate securities $46,070,979 $ 42,348 $ 10,209 $46,103,118
Other debt securities 44,298,286 109,686 1,061 44,406,911
----------- ----------- ----------- -----------
Total debt securities $90,369,265 $ 152,034 $ 11,270 $90,510,029
=========== =========== =========== ===========
<CAPTION>
JUNE 30, 1997
--------------------------------------------------------
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
U.S. corporate securities $22,542,389 $ 1,811 $ 22,188 $22,522,012
U.S. Treasury securities and obligations
of U.S. government agencies 19,030,792 494 38,626 18,992,660
Other debt securities 9,998,505 -- 4,566 9,993,939
----------- ----------- ----------- -----------
Total debt securities $51,571,686 $ 2,305 $ 65,380 $51,508,611
=========== =========== =========== ===========
</TABLE>
During the years ended June 30, 1998 and 1997, the gross realized gains
on sales of available-for-sale securities totaled $63,602 and $64,361
respectively, and the gross realized losses totaled $12,671 and $26,770
F-12
<PAGE> 56
respectively. The net adjustment to unrealized gains (losses) on
available-for-sale securities included in stockholders' equity totaled $140,764
and $(63,075), respectively. The amortized cost and estimated fair value of the
available-for-sale securities at June 30, 1998, by maturity, are shown below.
Expected maturities will differ from contractual maturities because the issuers
of the securities may have the right to prepay obligations without prepayment
penalties, and the Company views its available-for-sale securities as available
for current operations.
<TABLE>
<CAPTION>
ESTIMATED
COST FAIR VALUE
----------- -----------
<S> <C> <C>
AVAILABLE-FOR-SALE
Due in one year or less .................... $36,085,689 $36,077,581
Due after one year through two years ....... 51,586,526 51,712,448
Due after two years ........................ 2,697,050 2,720,000
----------- -----------
$90,369,265 $90,510,029
=========== ===========
</TABLE>
NOTE 6. COMMITMENTS AND CONTINGENCIES
OCCUPANCY ARRANGEMENTS
The Company presently occupies approximately 22,400 square feet of
office space, at an average annual expense of $404,941, under a lease agreement
which expires in May 2005. The lease contains certain rent escalation clauses
and upon expiration, can be renewed for a period of five years. Rent expense was
approximately $350,000, $203,000 and $207,000 for fiscal 1998, 1997 and 1996,
respectively.
RESEARCH AND DEVELOPMENT AND CONSULTING CONTRACTS
The Company has in the past and may in the future enter into agreements
with various research organizations and individuals under which the Company
acquires certain patent and marketing rights for therapeutics developed under
such agreements in exchange for providing funding for collaborative research. It
is also anticipated that, before any commercial marketing can be commenced, the
Company will be required to secure certain regulatory approvals on the
technological processes involved.
The Company has various consulting agreements with certain scientists
in exchange for the assignment of certain rights and consulting services. In
addition, the Company has granted options to purchase shares of Class A Common
Stock which are included in the stock option plan described in Note 9. These
options vest annually over the commitment periods. At June 30, 1998, the Company
had approximately $843,300 (solely attributable to the Chairman of the Central
Research Committee of the Company) of commitments payable over the remaining
five years under an agreement, which is cancelable by either party under certain
conditions.
LICENSING, MARKETING AND MANUFACTURING AGREEMENTS
The Company has entered into licensing and marketing agreements under
which it has obtained rights to market certain existing and future
pharmaceutical products. Generally, the terms of such agreements vary, but range
from ten to twenty years from the date of the first sale of the related product
or until the expiration of the patent applicable to the product. The agreements
provide for varying royalties with certain stated minimum annual amounts, which
vary by agreement from $17,500 to, for one such agreement, $55,000. Total
minimum royalties required to be paid on products currently being sold are
approximately $122,500 per year.
In July 1998, the Company entered into a joint product development and
distribution agreement with an unrelated third party whereby the Company will
pay certain costs with respect to certain product approvals estimated to be
approximately $1,000,000.
F-13
<PAGE> 57
OTHER
The Company and certain of its subsidiaries are parties to other
actions and proceedings incident to their business. Liability in the event of
final adverse determinations in any of these matters is either covered by
insurance and/or established reserves, or, in the opinion of management, after
consultation with counsel, should not, in the aggregate, have a material adverse
effect on the consolidated financial condition or results of operations of the
Company.
NOTE 7. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------------------------------------
1998 1997
---------------------------- --------------------------
Deferred tax assets: CURRENT LONG-TERM CURRENT LONG-TERM
------------ ------------ ------------ ---------
<S> <C> <C> <C> <C>
Net operating loss carryforwards ...... $ -- $ 599,000 $ 4,550,000 $ --
Reserves and liabilities .............. 3,300,000 -- 1,497,000 --
Research and development credits ...... -- 1,137,000 580,000 --
Alternative minimum tax credits ....... -- 129,584 325,000 --
------------ ------------ ------------ ---------
3,300,000 1,865,584 6,952,000 --
Excess of net book value over tax basis
of tangible assets .................... -- (12,368,000) (695,000) --
------------ ------------ ------------
Deferred tax assets (liabilities) ....... $ 3,300,000 $(10,502,416) $ 6,257,000 $ --
============ ============ ============ =========
</TABLE>
The valuation allowance decreased by $8,600,000 during fiscal 1997. The
decrease related to changes in estimate with respect to deferred tax assets that
management believes are more likely than not expected to be recovered through
future income.
During fiscal 1998, the Company acquired all of the outstanding stock
of GenDerm in a taxable stock acquisition. As a result of the GenDerm
acquisition, net deferred tax liabilities and current taxes payable were
recorded. The deferred tax liability related to acquired intangible assets that
have no tax basis. The deferred tax assets acquired related to reserves,
acquired net operating loss carryovers, research and experimentation credits and
other tax credits. All of the net operating losses and tax credits acquired are
limited for tax purposes under both the separate return limitation year rules
and Internal Revenue Code sections 382 and 383 which limit the annual
utilization of net operating losses and tax credits.
At June 30, 1998, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $1,500,000 and research and
experimentation credits of approximately $1,137,000 which begin expiring in
varying amounts in the years 2003 through 2012 if not previously utilized. At
June 30, 1998, the Company has approximately $130,000 of alternative minimum tax
credits which do not expire. All of the net operating loss and tax credit
carryforwards are attributable to the Company's acquisition of GenDerm. As such,
they are limited for tax purposes under both the separate return limitation year
rules and Internal Revenue Code sections 382 and 383 which limit the annual
utilization of net operating losses and tax credits.
F-14
<PAGE> 58
During fiscal 1998, 1997, and 1996, the Company made tax payments of
$1,874,000, $1,133,000 and $132,000, respectively:
Components of the provision for income taxes (benefit) are as follows:
<TABLE>
<CAPTION>
JUNE 30,
--------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Current
Federal ............. $ 3,221,629 $ 272,000 $ 70,000
State ............... 1,570,000 1,126,533 37,000
------------ ------------ ------------
4,791,629 1,398,533 107,000
------------ ------------ ------------
Deferred
Federal ............. 8,644,416 (1,830,000) (1,500,000)
State ............... 988,000 (262,000) (433,000)
------------ ------------ ------------
9,632,416 (2,092,000) (1,933,000)
------------ ------------ ------------
Total ........ $ 14,424,045 $ (693,467) $ (1,826,000)
============ ============ ============
</TABLE>
Income tax expense (benefit) for the three years ended June 30, 1998,
1997, and 1996 differs from the amount computed applying the federal statutory
rates as follows:
<TABLE>
<CAPTION>
JUNE 30,
------------------------------
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Statutory federal income tax rate ......... 35.0% 35.0% 34.0%
State tax rate ............................ 4.0 5.0 6.0
Change in valuation allowance ............. -- (44.2) (70.0)
In-process research and development ....... 684.5 -- --
Tax-exempt interest ....................... (14.4) -- --
Other ..................................... 6.0 -- --
----- ----- -----
715.1% (4.2%) (30.0%)
===== ===== =====
</TABLE>
NOTE 8. STOCK TRANSACTIONS
Class A Common Stock has one vote per share and Class B Common Stock
has ten votes per share. Each share of Class B Common Stock may be converted
into one share of Class A Common Stock at the option of the holder or, in some
circumstances, may automatically be converted upon a vote of the Board of
Directors and the majority of the Class B Common Stockholders.
On August 17, 1995, the Board of Directors adopted a Preferred Stock
Purchase Rights plan and declared a dividend of one preference share purchase
right for each outstanding share of Class A Common Stock and Class B Common
Stock. Under certain circumstances, after a person has acquired beneficial
ownership of 15% of the Class A Common Stock, each Preference Stock Purchase
Right will entitle the holder to purchase, at the Right's then-current exercise
price, stock of the Company or its successor at a discount.
On July 23, 1996, the Board of Directors declared a three-for-two stock
split effected in the form of a 50% stock dividend payable August 2, 1996, to
common shareholders of record at the close of business on July 22, 1996. Per
share amounts and the weighted average number of shares outstanding at that date
have been retroactively revised for all periods presented.
On October 2, 1996, the Company completed a public offering for
approximately 2,800,000 primary shares of the Company's Class A Common Stock at
a price of $30.00 per share. The underwriters also exercised the over-allotment
option of approximately 400,000 primary shares at a price of $30.00 per share.
Gross proceeds from the offering before related expenses totaled approximately
$95.7 million. The Company is using the proceeds for marketing expenses
associated with new product introductions, the licensing or acquisition of
formulations,
F-15
<PAGE> 59
technologies, products or businesses, research and development, expansion of
marketing and sales capabilities, and general corporate purposes.
On March 7, 1997, the Board of Directors declared a three-for-two stock
split effected in the form of a 50% stock dividend payable March 28, 1997 to
common shareholders of record at the close of business on March 17, 1997. Per
share amounts and the weighted average number of shares outstanding have been
retroactively revised for all periods presented.
In February 1998, the Company completed a public offering for 4,000,000
primary shares of the Company's Class A Common Stock at a price of $48.25 per
share. The underwriters also exercised the over allotment option of 340,000
primary shares at a price of $48.25 per share. Gross proceeds from the offering
before related expenses totaled $209,405,000.
NOTE 9. STOCK OPTION PLANS
The Company has five Stock Option Plans (the 1996, 1995, 1992, 1990,
and 1988 Plans or, collectively, the "Plans"). The 1996, 1995, 1992, 1990, and
1988 Plans have the following options outstanding: 760,683, 370,335, 354,674,
38,181, and 178,778, respectively. The Plans allow the Company to designate
options as qualified incentive or non-qualified on an as-needed basis. Qualified
and non-qualified stock options vest over a period determined at the time the
options are granted ranging from one to five years. Options are granted at the
fair market value on the grant date. Options outstanding at June 30, 1998, vary
in price from $1.55 to $54.00, with a weighted average of $23.86 outlined in the
chart below:
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE AVERAGE WEIGHTED AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ---- ----- ----- -----------
<S> <C> <C> <C> <C> <C>
$ 1.55 - $ 2.33 140,038 1.37 $ 1.96 89,237 $ 1.96
$ 2.36 - $ 3.50 408,781 2.27 $ 2.88 368,696 $ 2.90
$ 3.67 - $ 4.22 9,158 .30 $ 4.03 8,512 $ 4.05
$ 6.22 - $ 9.33 29,875 3.16 $ 6.23 29,712 $ 6.22
$10.14 - $13.66 25,950 6.04 $12.66 16,970 $12.81
$18.16 - $31.44 359,616 8.10 $20.16 94,089 $22.94
$31.66 - $44.63 590,433 9.09 $42.04 29,749 $32.62
$45.44 - $54.00 138,800 9.25 $47.16 90 $46.25
</TABLE>
The weighted average fair value of options granted during fiscal 1998
and 1997 was $24.41 and $13.79, respectively.
F-16
<PAGE> 60
A summary of stock option activity granted within the Plans and related
information for the years ended June 30, 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
QUALIFIED NON-QUALIFIED TOTAL PRICE
---------- ---------- ---------- ------
<S> <C> <C> <C> <C>
Balance at June 30, 1995 . 412,890 868,199 1,281,089 $ 6.12
Granted .................. 316,827 447,992 764,819 $ 3.48
Exercised ................ (38,503) (176,815) (215,318) $13.38
Terminated/expired ....... (197,938) (332,960) (530,898) $ 6.98
---------- ---------- ----------
Balance at June 30, 1996 . 493,276 806,416 1,299,692 $ 4.32
Granted .................. 284,593 168,427 453,020 $21.99
Exercised ................ (157,622) (341,607) (499,229) $ 5.62
Terminated/expired ....... (40,974) (4,821) (45,795) $ 9.44
---------- ---------- ----------
Balance at June 30, 1997 . 579,273 628,415 1,207,688 $10.22
Granted .................. 377,753 330,369 708,122 $43.64
Exercised ................ (58,289) (97,253) (155,542) $ 6.16
Terminated/expired ....... (55,763) (1,854) (57,617) $29.95
---------- ---------- ----------
Balance at June 30,1998 .. 842,974 859,677 1,702,651 $23.86
========== ========== ==========
</TABLE>
Options exercisable under the Company's Stock Option Plans at June 30,
1998 was 637,055 with an average exercise price of $7.55. An additional 6,250
non-qualified stock options not subject to the Plans are issued and outstanding
to outside parties at June 30, 1998, with an exercise price of $9.71.
The Company elected the adoption of the disclosure-only provisions of
SFAS No. 123 in fiscal 1998. In accordance with the provisions of SFAS No. 123,
the Company applies APB 25 and related interpretations in accounting for option
grants to employees under its stock option plans. If the Company had elected to
recognize compensation cost based on the fair value of the options granted at
grant date as prescribed by SFAS No. 123, operating results would have changed
to the pro forma amounts indicated in the table below:
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Net (Loss) Income - As Reported $(12,407,176) $ 17,344,914
Net (Loss) Income - Pro Forma $(15,346,543) $ 15,742,000
Diluted Earnings Per Share - As Reported $ (0.77) $ 1.24
Diluted Earnings Per Share - Pro Forma $ (0.96) $ 1.12
</TABLE>
Pro forma results disclosed are based on the provisions of SFAS No. 123
using the Black-Scholes option pricing model and are not likely to be
representative of the effect on pro forma net income for future years. The
Black-Scholes option pricing model was developed for use in estimating the fair
value of traded options which, unlike options granted by the Company, have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected stock price volatility. Because the Company's stock options have
characteristics significantly different from options traded on an exchange, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options.
The fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:
F-17
<PAGE> 61
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Expected Dividend Yield 0.0% 0.0%
Expected Stock Price Volatility 0.50 0.70
Risk-Free Interest Rate 5.5% 5.7%
Expected Life of Options 5 Years 5 Years
</TABLE>
NOTE 10. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Numerator
Net (loss) income ............................. $(12,407,176) $ 17,344,914 $ 7,879,742
------------ ------------ ------------
Denominator for basic net (loss) income per common
share ......................................... 16,066,840 13,190,889 10,254,668
Effect of dilutive securities:
Stock options ................................. -- 847,787 635,975
------------ ------------ ------------
Denominator for diluted net (loss) income per common
share ......................................... 16,066,840 14,038,676 10,890,643
============ ============ ============
Basic net (loss) income per common share ........... $ (0.77) $ 1.31 $ 0.77
============ ============ ============
Diluted net (loss) income per common share ......... $ (0.77) $ 1.24 $ 0.72
============ ============ ============
</TABLE>
Options that are anti-dilutive because the exercise price was greater
than the average market price of the common shares are not included in the
computation of diluted earnings per share. There were no dilutive securities in
1998 given that the Company had a net loss.
NOTE 11. SIGNIFICANT CUSTOMERS
For fiscal 1998, three customers accounted for approximately 16.9%,
13.2%, and 12.6% of sales. For fiscal 1997, three customers accounted for
approximately 20.6%, 16.3%, and 10.9% of sales. For fiscal 1996, three customers
accounted for approximately 15.5%, 12.2%, and 11.8% of sales.
NOTE 12. FINANCIAL INSTRUMENTS -- CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
significant concentrations of credit risk consist principally of cash, cash
equivalents, short-term investments and accounts receivable.
The Company maintains cash, cash equivalents and short-term investments
primarily with two financial institutions that invest funds in short-term,
interest bearing, investment grade, marketable securities. The Company performs
periodic evaluations of the relative credit standing of these financial
institutions.
At June 30, 1998 and 1997, three customers, comprised approximately
46.9% and 50.0%, respectively, of accounts receivable. The Company does not
require collateral from its customers but performs periodic credit evaluations
of its customers' financial condition. Management does not believe a significant
credit risk exists at June 30, 1998.
F-18
<PAGE> 62
NOTE 13. DEFINED CONTRIBUTION PLAN
The Company has a defined contribution plan (the "Contribution Plan")
that is intended to qualify under Section 401(k) of the Internal Revenue Code.
All employees, except those who have not attained the age of 21, are eligible to
participate in the Contribution Plan. Participants may contribute, through
payroll deductions, up to 20% of their basic compensation, not to exceed
Internal Revenue Code limitations. Although the Contribution Plan provides for
profit sharing contributions by the Company, the Company has not made any such
contributions since its inception.
NOTE 14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
In the table below is the quarterly financial information for fiscal
1998 and 1997. All figures are in thousands except per share data, and certain
amounts do not total to the annual amounts due to rounding.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30, 1998
(FOR THE QUARTERS ENDED)
SEPTEMBER 30, 1997 DECEMBER 31, 1997 MARCH 31, 1998 JUNE 30, 1998
------------------ ----------------- -------------- -------------
<S> <C> <C> <C> <C>
Net sales ............. $ 13,911 $ 16,928 $ 22,527 $ 24,205
Gross profit .......... 11,365 13,924 18,535 19,768
Net income (loss) ..... 3,751 (31,051) 6,434 8,459
Basic net income (loss)
per common share .... $ 0.26 $ (2.16) $ 0.38 $ 0.45
Diluted net income
(loss) per common
share ............... $ 0.25 $ (2.16) $ 0.37 $ 0.44
<CAPTION>
FISCAL YEAR ENDED JUNE 30, 1997
(FOR THE QUARTERS ENDED)
SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 JUNE 30, 1997
------------------ ----------------- -------------- -------------
<S> <C> <C> <C> <C>
Net sales ............. $ 7,268 $ 8,508 $ 10,976 $ 14,407
Gross profit .......... 5,313 6,255 8,499 11,730
Net income ............ 3,604 3,251 4,337 6,153
Basic net income (loss)
per common share .... $ 0.34 $ 0.24 $ 0.31 $ 0.43
Diluted net income
(loss) per common
share ............... $ 0.32 $ 0.22 $ 0.29 $ 0.41
</TABLE>
The quarterly net income per share data disclosed above does not agree
with the amounts reported in the Company's Quarterly Reports on Form 10-Q filed
with the Securities and Exchange Commission, as the amounts have been revised to
reflect the stock splits discussed in Note 8, and the effect of SFAS No. 128
related to basic and diluted earnings per share. Gross profit does not include
amortization of the related intangibles.
F-19
<PAGE> 63
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND CHARGED TO BALANCE AT
DESCRIPTION YEAR EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF YEAR
----------- ---- -------- -------------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Year Ended June 30, 1998
Deducted from Asset Accounts:
Accounts Receivable:
Allowances ................ $ 1,150,000 $ 460,000 $ 1,216,000(1) $ -- $ 2,826,000
Year Ended June 30, 1997
Deducted from Asset Accounts:
Accounts Receivable:
Allowances ................ 680,000 470,000 -- -- 1,150,000
Deferred tax assets:
Valuation allowance ....... 8,600,000 (8,600,000) -- -- --
Year Ended June 30, 1996
Deducted from Asset Accounts:
Accounts Receivable:
Allowances ................ 520,000 160,000 -- -- 680,000
Deferred tax assets:
Valuation allowance ....... $13,960,000 $(5,360,000) $ -- $ -- $ 8,600,000
</TABLE>
(1) Allowance related to acquisition of GenDerm.
S-1
<PAGE> 64
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
2.1 - Agreement of Merger by and between Medicis Pharmaceutical
Corporation, a Delaware corporation, Medicis Acquisition
Corporation, a Delaware corporation, and GenDerm
Corporation, a Delaware corporation, dated November 28, 1997
(18)
3.1 - Certificate of Incorporation of the Company, as amended (11)
3.3 - By-Laws of the Company (1)
4.1 - Rights Agreement dated as of August 17, 1995 between the
Company and American Stock Transfer & Trust Company, as
Rights Agent (11)
4.1b - Amendment No. 2 to Rights Agreement dated as of March 17,
1997 between the Company and Norwest Bank Minnesota N.A.
(16)
4.3 - Form of specimen certificate representing Class A Common
Stock (2)
10.1 - License Agreement among Euromerican Trade Resources, Inc.,
Dr. H. R. Suess and H. R. Suess A.G. dated as of September
24, 1987 (3)
10.2 - Modification to License Agreement among the Company,
Euromerican Trade Resources, Inc., Dr. H. R. Suess and H. R.
Suess A.G. dated as of April 6, 1989 (3)
10.3 - Letter Agreement between the Company and Euromerican Trade
Resources, Inc. dated as of April 6, 1989, relating to
Modification to License Agreement among the Company,
Euromerican Trade Resources, Inc., Dr. H. R. Suess and H. R.
Suess A.G. dated as of April 6, 1989 (3)
10.8 - Medicis Pharmaceutical Corporation 1995 Stock Option Plan
(incorporated by reference to Exhibit C to the definitive
Proxy Statement for the 1995 Annual Meeting of Stockholders
previously filed with the SEC, File No. 0-18443)
10.9 - Employment Agreement between the Company and Jonah Shacknai
dated as of July 24, 1996 (15)
10.10 - Medicis Pharmaceutical Corporation 1988 Stock Option Plan,
as amended (4)
10.12 - License Agreement between the Company and Dr. H. R. Suess
dated March 1, 1990 (3)
10.13 - License Agreement between Syosset Laboratories, Inc. and
Medicis Dermatologics, Inc., dated as of July 25, 1990, and
the Guaranty of the Company (5)
10.14 - Non-Exclusive License Agreement between Syosset
Laboratories, Inc. and Medicis
<PAGE> 65
Dermatologics, Inc., dated as of July 25, 1990, and the
Guaranty of the Company (5)
10.15 - Manufacturing Agreement between Syosset Laboratories, Inc.
and Medicis Dermatologics, Inc., dated as of July 25, 1990,
and the Guaranty of the Company (5)
10.16 - Sales Agency Agreement between Syosset Laboratories, Inc.
and Medicis Dermatologics, Inc., dated as of July 25, 1990,
and the Guaranty of the Company (5)
10.18 - Medicis Pharmaceutical Corporation 1990 Stock Option Plan,
as amended (4)
10.49 - Option to Purchase Class A Common Stock granted to Stephen
B. Booke (4)
10.50 - Option to Purchase Class A Common Stock granted to Gerald
Amato (4)
10.58 - Medicis Pharmaceutical Corporation 1992 Stock Option Plan
(8)
10.59 - Supply Agreement, dated as of October 21, 1992 between
Schein and the Company (7)
10.70 - Amendment to Manufacturing and Supply Agreement, dated March
2, 1993 between Schein and the Company (10)
10.72(a) - Credit and Security Agreement, dated as of August 3, 1995
between the Company and Norwest Business Credit, Inc. (12)
10.72(b) - First Amendment to Credit and Security Agreement, dated as
of May 29, 1996 between the Company and Norwest Bank
Arizona, N.A. (15)
10.72(c) - Second Amendment to Credit and Security Agreement dated
November 22, 1996 by and between the Company and Norwest
Bank Arizona, N.A. as successor-in-interest to Norwest
Business Credit, Inc. (17)
10.73(a) - Patent Collateral Assignment and Security Agreement, dated
as of August 3, 1995 by the Company to Norwest Business
Credit, Inc. (13)
10.73(b) - First Amendment to Patent Collateral Assignment and Security
Agreement, dated as of May 29, 1996 by the Company to
Norwest Bank Arizona, N.A. (15)
10.74(a) - Trademark Collateral Assignment and Security Agreement,
dated as of August 3, 1995 by the Company to Norwest
Business Credit, Inc. (14)
10.74(b) - First Amendment to Trademark Collateral Assignment and
Security Agreement, dated as of May 29, 1996 by the Company
to Norwest Bank Arizona, N.A. (15)
10.75 - Assignment and Assumption of Loan Documents, dated as of May
29, 1996 from Norwest Business Credit, Inc., to and by
Norwest Bank Arizona, N.A. (15)
10.76 - Multiple Advance Note, dated May 29, 1996 from the Company
to Norwest Bank Arizona, N.A. (15)
10.77 - Securities Account Pledge and Security Agreement dated
November 22, 1996 by and between the Company and Norwest
Bank Arizona, N.A. (17)
10.78 - Acknowledgment of Control of Pledged Securities Account
dated November 22, 1996 by and among Norwest Bank Arizona
and the Company and Norwest Bank Minnesota (17)
10.79 - Asset Purchase Agreement dated January 21, 1997 between the
Company and Syntex (U.S.A.) Inc. (16)
10.80 - Asset Purchase Agreement dated January 21, 1997 between the
Company and Syntex (U.S.A.), Inc. (16)
10.81 - Asset Purchase Agreement dated January 21, 1997 between the
Company and F. Hoffman-La Roche Limited (16)
10.82 - Asset Purchase Agreement dated January 21, 1997 between the
Company and Syntex Pharmaceuticals International Limited
(16)
10.83 - Transition Services Agreement dated January 21, 1997 between
the Company and F. Hoffman-La Roche, Inc. (16)
10.84 - Transition Services Agreement dated January 21, 1997 between
the Company and F. Hoffman-La Roche Limited (16)
10.85 - Supply Agreement (Fluocinolone Acetonide and Fluocinonide)
dated January 21, 1997 between the Company and Syntex
Pharmaceuticals International Limited (16)
10.86 - License Agreement dated March 28, 1997 between the Company
and Platinum(R) Software Corporation (16)
10.87 - Master Software License Agreement dated March 28, 1997
between the Company and FocusSoft, Inc. (16)
21.1 - Subsidiaries (19)
23.1 - Consent of Ernst & Young LLP, Independent Auditors (19)
24.1 - Power of Attorney (19) See signature page(s)
27.1 - Financial Data Schedule (19)
<PAGE> 66
(1) Incorporated by reference to the exhibit with the same number in the
Company's Quarterly Report on Form 10-Q for the quarter ended December
31, 1992, File No. 0-18443, previously filed with the Securities and
Exchange Commission (the "SEC")
(2) Incorporated by reference to the exhibit with the same number in the
Registration Statement on Form S-1 of the Registrant, File No.
33-32918, filed with the SEC on January 16, 1990
(3) Incorporated by reference to the exhibit with the same number in
Amendment No. 1 to the Registration Statement on Form S-1 of the
Company, File No. 33-32918, filed with the SEC on March 6, 1990
(4) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1992, as amended, File No. 0-18443 previously filed with the SEC
(5) Incorporated by reference to the exhibit with the same number in
Amendment No. 2 to the Registration Statement on Form S-1 of the
Company, File No. 33-34041, filed with the SEC on August 2, 1990
(6) Incorporated by reference to the exhibit with the same number in
Amendment No. 1 to the Registration Statement on Form S-1 of the
Company, File No. 33-46913, filed with the SEC on April 29, 1992
(7) Incorporated by reference to the exhibit with the same number in
Registration Statement on Form S-1 of the Company, File No. 33-54276,
filed with the SEC on June 11, 1993
(8) Incorporated by reference to Exhibit B to the Company's definitive
Proxy Statement for its 1992 Annual Meeting of Stockholders, previously
filed with the SEC, File No. 0-18443
(9) Incorporated by reference to the exhibit with the same number in
Amendment No. 1 to the Registration Statement on Form S-1 of the
Company, File No. 33-54276, filed with the SEC on May 25, 1993
(10) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1993, File No. 0-18443, filed with the SEC on October 13, 1993
(11) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1995, File No. 0-18443, filed with the SEC on September 27, 1995 ("1995
Form 10-K")
(12) Incorporated by reference to exhibit number 4.2 in the 1996 Form 10-K
(13) Incorporated by reference to exhibit number 4.4 in the 1996 Form 10-K
(14) Incorporated by reference to exhibit number 4.5 in the 1996 Form 10-K
(15) Incorporated by reference to the exhibit with the same number in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1996, File No. 0-18443, filed with the SEC on September 24, 1996
(16) Incorporated by reference to the exhibit with the same number in the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997, File No. 0-18443, previously filed with the SEC
(17) Incorporated by reference to the exhibit with the same number in the
Company's Quarterly Report on Form 10-Q for the quarter ended December
31, 1996, File No. 0-18443, previously filed with the SEC
(18) Incorporated by reference to the exhibit with the same number in the
Company's Current Report on Form 8-K filed with the SEC on December 15,
1997.
(19) Filed herewith
(b) No reports on Form 8-K were filed with the SEC for the quarter end June 30,
1998.
(c) The exhibits to this Form 10-K follow the Company's Financial Statement
Schedule included in this Form 10-K.
(d) The Financial Statement Schedule to this Form 10-K appears on page S-1 of
this Form 10-K.
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES
- - Medicis, The Dermatology Company
- - Medicis Dermatologics, Inc.
- - Dermavest, Inc.
- - Advanced Pharmaceutical Research
- - Medicis Acquisition Corporation
- - Medicis Manufacturing Corporation
- - Medicis Partners, Inc.
- - Medicis Consumer Products Company, LLC
- - GenDerm, Inc.
- - Medicis Canada, Ltd.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 33-45573) pertaining to the 1988 and 1990 Stock Option
Plans, in the Registration Statement (Form S-8 No. 33-88590) pertaining to the
1992 Stock Option Plan, in the Registration Statement (Form S-8 No. 33-311419)
pertaining to the 1995 Stock Option Plan, and in the Registration Statement
(Form S-8 No. 33-333647) pertaining to the 1996 Stock Option Plan of Medicis
Pharmaceutical Corporation of our report dated August 7, 1998 with respect to
the consolidated financial statements and schedule of Medicis Pharmaceutical
Corporation included in the Annual Report (Form 10-K) for the year ended June
30, 1998.
/s/ ERNST & YOUNG, LLP
Phoenix, Arizona
September 23, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE MEDICIS
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME (LOSS) FOR THE
TWELVE MONTHS ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FORM 10-K.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 147,411,127
<SECURITIES> 90,510,029
<RECEIVABLES> 18,899,868
<ALLOWANCES> 0
<INVENTORY> 9,208,384
<CURRENT-ASSETS> 278,129,842
<PP&E> 1,704,317
<DEPRECIATION> 360,714
<TOTAL-ASSETS> 352,350,244
<CURRENT-LIABILITIES> 15,173,672
<BONDS> 0
0
0
<COMMON> 262,588
<OTHER-SE> 324,232,897
<TOTAL-LIABILITY-AND-EQUITY> 352,350,244
<SALES> 77,571,419
<TOTAL-REVENUES> 77,571,419
<CGS> 13,979,793
<TOTAL-COSTS> 68,611,476
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (7,036,719)
<INCOME-PRETAX> 2,016,869
<INCOME-TAX> 14,424,045
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,407,176)
<EPS-PRIMARY> (0.77)
<EPS-DILUTED> (0.77)
</TABLE>
