<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _____________
COMMISSION FILE NUMBER 0-20096
GLIATECH INC.
(Exact name of registrant as specified in its charter)
DELAWARE 34-1587242
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
23420 COMMERCE PARK ROAD
CLEVELAND, OHIO 44122
(Address of principal executive offices) (Zip Code)
(216) 831-3200
(Registrant's telephone number, including area code)
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
-----
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR
VALUE PER SHARE, AS OF NOVEMBER 8, 2000 WAS 9,642,637 SHARES.
<PAGE> 2
GLIATECH INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
Item 1 Financial Statements: (unaudited)
Consolidated Balance Sheets -
September 30, 2000 and December 31, 1999 1
Consolidated Statements of Operations - for the three month and
nine month periods ended September 30, 2000 and 1999 2
Consolidated Statements of Cash Flows -
for the nine month periods ended September 30, 2000 and 1999 3
Notes to Consolidated Financial Statements 4
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk 17
PART II. OTHER INFORMATION
Item 1 Legal Proceedings 18
Item 6 Exhibits and Reports on Form 8-K 20
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GLIATECH INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 445,318 $ 3,350,245
Short-term investments 10,302,786 15,750,620
Accounts receivable, net 3,675,455 899,696
Government grants receivable 222,053 413,608
Inventories, net 4,739,000 5,353,696
Prepaid expenses and other 707,757 824,720
------------ ------------
Total current assets 20,092,369 26,592,585
Long term investments 1,727,940 1,712,790
Property and equipment, net 3,261,456 3,232,712
Other assets, net 1,049,559 845,668
------------ ------------
TOTAL ASSETS $ 26,131,324 $ 32,383,755
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 618,241 $ 1,129,470
Accrued expenses 3,013,284 2,084,490
Accrued research contracts 113,889 485,470
Accrued compensation 244,871 207,558
Accrued clinical trial costs 895,706 2,085,011
------------ ------------
Total current liabilities 4,885,991 5,991,999
Stockholders' equity:
Common stock 96,427 95,536
Additional paid-in capital 74,117,494 73,967,823
Treasury stock at cost, 0 and 75,000 shares at
September 30, 2000 and December 31, 1999, respectively (1,448,950)
Accumulated other comprehensive loss (11,107) (54,839)
Accumulated deficit (52,957,481) (46,167,814)
------------ ------------
Total stockholders' equity 21,245,333 26,391,756
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 26,131,324 $ 32,383,755
============ ============
</TABLE>
See notes to consolidated financial statements
1
<PAGE> 4
GLIATECH INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES
Product sales $ 6,087,473 $ 8,053,567 $ 19,954,354 $ 23,738,922
Research contracts 514,194
Government grants 56,831 245,168 542,335 676,019
------------ ------------ ------------ ------------
Total revenues 6,144,304 8,298,735 20,496,689 24,929,135
OPERATING COSTS AND EXPENSES
Cost of products sold 2,386,114 1,344,457 4,753,175 3,639,112
Research and development 1,563,930 3,004,345 7,196,181 10,304,896
Selling, general and administrative 2,319,996 3,227,935 8,603,986 9,398,601
Merger related and severance costs 6,817,338 7,541,128
------------ ------------ ------------ ------------
Total operating costs and expenses 13,087,378 7,576,737 28,094,470 23,342,609
------------ ------------ ------------ ------------
Operating (loss) income (6,943,074) 721,998 (7,597,781) 1,586,526
Interest income, net 266,138 384,438 808,114 944,524
------------ ------------ ------------ ------------
NET (LOSS) INCOME $ (6,676,936) $ 1,106,436 $ (6,789,667) $ 2,531,050
============ ============ ============ ============
(Loss) Earnings per share
Basic $ (0.70) $ 0.12 $ (0.71) $ 0.27
============ ============ ============ ============
Diluted $ (0.70) $ 0.11 $ (0.71) $ 0.25
============ ============ ============ ============
Average shares outstanding
Basic 9,597,912 9,497,342 9,536,819 9,470,748
============ ============ ============ ============
Diluted 9,597,912 9,997,521 9,536,819 10,080,993
============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
2
<PAGE> 5
GLIATECH INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
2000 1999
------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (6,789,667) $ 2,531,050
Adjustments to reconcile net (loss) income to net cash used in
operating activities:
Depreciation and amortization 540,384 448,901
Patent cost write-off 178,122
Provision (credit) for losses on accounts receivable 16,666 (229,926)
Compensation from issuance of stock and stock options 131,475 242,156
Gain on sale of investments (21,509)
Changes in operating assets and liabilities:
Accounts receivable (2,792,425) (619,967)
Inventories 614,696 (3,438,547)
Government grants receivable and other assets 308,518 462,623
Accounts payable and other accrued expenses 454,878 (368,867)
Other liabilities (1,560,886) 97,336
------------ ------------
Net cash used in operating activities (9,097,870) (697,119)
INVESTING ACTIVITIES
Sale of investments 17,397,415 25,222,845
Purchase of investments (11,899,490) (23,668,393)
Payment for patent rights and trademarks (216,981) (154,085)
Purchase of property and equipment (556,037) (2,009,193)
------------ ------------
Net cash provided by (used in) investing activities 4,724,907 (608,826)
FINANCING ACTIVITIES
Proceeds from exercise of stock options 1,468,036 462,803
Purchase of treasury stock (1,448,950)
------------ ------------
Net cash provided by (used in) financing activities 1,468,036 (986,147)
------------ ------------
Decrease in cash and cash equivalents (2,904,927) (2,292,092)
Cash and cash equivalents at beginning of period 3,350,245 4,731,814
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 445,318 $ 2,439,722
============ ============
</TABLE>
See notes to consolidated financial statements
3
<PAGE> 6
GLIATECH INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine month period ended September 30,
2000 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000. These financial statements should be read in
conjunction with the consolidated financial statements and footnotes thereto
included in the Annual Report on Form 10-K of Gliatech Inc. for the fiscal year
ended December 31, 1999 filed with the Securities and Exchange Commission.
Note 2. Investments
Short-term and long-term investments at September 30, 2000 and December 31, 1999
are as follows:
<TABLE>
<CAPTION>
Gross Unrealized
Amortized Cost Holding Gain Holding Loss Fair Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
September 30, 2000 Available-for-sale:
Corporate debt securities $ 9,841,833 $ 10,044 $ (3,651) $ 9,848,226
U.S. Treasury securities 2,200,000 0 (17,500) 2,182,500
------------ ------------ ------------ ------------
$ 12,041,833 $ 10,044 $ (21,151) $ 12,030,726
============ ============ ============ ============
December 31, 1999 Available-for-sale:
Corporate debt securities $ 14,822,004 $ 1,880 $ (18,657) $ 14,805,227
U.S. Treasury securities 2,696,245 0 (38,062) 2,658,183
------------ ------------ ------------ ------------
$ 17,518,249 $ 1,880 $ (56,719) $ 17,463,410
============ ============ ============ ============
</TABLE>
4
<PAGE> 7
All of the Company's investments are classified as available-for-sale. Such
investments are stated at fair value with unrealized holding gains and losses
charged or credited to stockholders' equity.
Realized gains and losses on available-for-sale securities are determined on a
specific identification basis. Any decline in market value below cost that is
determined to be other than temporary is an impairment that would result in a
reduction in the carrying amount to fair value. Such impairment, if any, is
charged to current earnings, and an adjusted cost for the security is
established.
Investments with maturity dates of less than one year are classified as
short-term; investments with maturity dates of more than one year are classified
as long-term.
Maturities of short-term and long-term investments classified as
available-for-sale securities at September 30, 2000 were as follows:
<TABLE>
<CAPTION>
Amortized Cost Fair Value
-------------- ----------
<S> <C> <C>
September 30, 2000 Available-for-sale:
Due in 1 year or less $10,301,265 $10,302,786
Due in 1-3 years 1,740,618 1,727,940
----------- -----------
$12,041,833 $12,030,726
=========== ===========
</TABLE>
Note 3. Inventories
At September 30, 2000 and December 31, 1999, inventories, net of reserves
consisted of:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Raw material $2,863,734 $4,549,976
Work in process 1,156,548 205,007
Finished goods 718,718 598,713
---------- ----------
$4,739,000 $5,353,696
========== ==========
</TABLE>
The Company records reserves for obsolete and impaired inventory when items are
identified that will not meet either the Company's quality or regulatory
validation requirements.
5
<PAGE> 8
Note 4. Other Assets
At September 30, 2000 and December 31, 1999, other assets consisted of:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Patent rights, net of accumulated amortization of $134,064
at September 30, 2000 and $124,722 at December 31, 1999 $ 997,791 $ 791,139
Trademark cost, net of accumulated amortization of $28,750
at September 30, 2000 and $25,000 at December 31, 1999 38,576 40,241
Other 13,192 14,288
---------- ----------
$1,049,559 $ 845,668
========== ==========
</TABLE>
Patent rights are amortized on the straight-line basis over the shorter of the
estimated useful life of the patented technology or seventeen years, beginning
at the time the patent is granted. The Company reviews its patents to determine
if the expected future operating cash flows to be derived from the patents are
less than the carrying value and, if an impairment has occurred, the patent is
written-down to its expected future cash flows or, if abandoned, it is
written-off in its entirety. Patent expense due to impairments or abandonments
was $0 and $178,122 for the nine month periods ended September 30, 2000 and
1999, respectively.
Trademark costs are amortized on the straight-line basis over the shorter of the
estimated useful life of the trademark or ten years beginning at the time the
trademark is granted.
Note 5. Business Segment
The Company operates in one business segment. The Company is engaged in the
discovery and development of biosurgical and therapeutic products to improve
surgical outcomes and to treat neurological disorders. The Company's principal
products are the ADCON(R) family of products, which are medical devices designed
to inhibit excess scarring and adhesion following surgery. The Company sells
ADCON(R) products through independent medical device distributors in
approximately 30 countries outside the United States and directly to hospitals
in the United States. The Company does not have foreign facilities and therefore
does not measure operating profit or loss from foreign sales.
Domestic and foreign product sales are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Domestic $ 4,997,226 $ 7,012,309 $16,709,697 $20,929,423
Foreign 1,090,247 1,041,258 3,244,657 2,809,499
----------- ----------- ----------- -----------
Total $ 6,087,473 $ 8,053,567 $19,954,354 $23,738,922
=========== =========== =========== ===========
</TABLE>
6
<PAGE> 9
Note 6. Merger Related and Severance Costs
On May 30, 2000 Guilford Pharmaceuticals Inc. ("Guilford") and the Company
announced that they had entered into a definitive Merger Agreement.
Subsequently, the Company announced on August 28, 2000 that the two parties had
agreed to a mutual termination of the Merger Agreement. The Company incurred
$1.1 million and $1.8 million in the third quarter and first nine months of
2000, respectively, of costs associated with the merger and subsequent
termination of the Merger Agreement.
Guilford informed the Company that the decision to terminate the Merger
Agreement was based primarily on the issuance by the Food and Drug
Administration ("FDA") of inspectional observations contained in a Form FDA 483.
The FDA report was issued to the Company on August 23, 2000 after an audit by
the FDA of a post-approval clinical trial of ADCON(R)-L, in which certain
observations identified that good clinical practices had not been uniformly
followed.
On August 29, 2000 the Company announced an investigation by an internal task
force comprised of members of the Company's executive and clinical personnel who
were not involved in the U.S. ADCON(R)-L clinical study. In addition, the
Company's Board of Directors commissioned an external investigation.
On September 25, 2000 the Board of Directors announced that Thomas O.
Oesterling, Ph.D., retired as President and Chief Executive Officer. In
addition, as of such date, Michael A. Zupon, Ph.D., Executive Vice President
of Research and Development, and Raymond Silkaitis, Ph.D., Vice President of
Regulatory Affairs, resigned. The Company incurred approximately $1.2 million in
severance costs associated with these former employees.
7
<PAGE> 10
Note 7. Litigation
In June 2000, Cartech Company, LTD. filed a lawsuit against Gliatech and
Guilford alleging breach of and interference with Gliatech's build-to-suit lease
agreement with Cartech. The parties subsequently entered into a Settlement
Agreement to resolve the litigation. Pursuant to the settlement agreement,
Guilford agreed to pay Cartech $4.5 million within seven days after the merger
closed or, if the Merger Agreement terminated prior to closing or if the merger
did not close by December 1, 2000, Gliatech would pay Cartech $4.5 million. In
the event that Gliatech made the payment to Cartech and upon Gliatech's written
request, Gliatech and Cartech would enter into good faith negotiations for a new
build-to-suit lease and Gliatech would receive a credit against the cost of the
new lease of up to $2,187,000 for up to six months after payment. As a result
of the execution of the settlement agreement, the lawsuit was dismissed by
Cartech without prejudice. The parties agreed to a full mutual release of
claims and termination of the existing build-to-suit lease and Cartech also
agreed to abstain from further legal action against Gliatech or Guilford. In
accordance with the terms of the Settlement Agreement, Gliatech paid Cartech
on September 6, 2000, after the termination of the Merger Agreement with
Guilford.
To date, ten class action lawsuits against the Company and certain of its
officers have been filed in the United States District Court for the Northern
District of Ohio alleging violation of the federal securities laws. These
complaints allege that the Company and certain officers failed to disclose
material facts in connection with the termination of the Merger Agreement that
had been entered into with Guilford Pharmaceuticals, Inc. and from certain
inspectional observations by the FDA contained in a Form FDA 483. These
complaints seek compensatory damages in an unspecific amount, fees and expenses
related to such class action and the granting of extraordinary equitable and/or
injunctive relief, including, without limitation, rescission.
8
<PAGE> 11
The Company and certain officers filed a motion to consolidate these actions and
certain plaintiffs have moved for the appointment of lead plaintiff and lead
counsel. The Company has been granted leave to respond to the complaints until
after appointment of lead plaintiff. These motions are currently pending in the
United States District Court for the Northern District of Ohio.
Note 8. Comprehensive Income (Loss)
The components of comprehensive income (loss) are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net (loss) income $(6,676,936) $ 1,106,436 $(6,789,667) $ 2,531,050
Unrealized gain (loss) on investments 38,315 (45,590) 43,732 (45,590)
----------- ----------- ----------- -----------
Total comprehensive (loss) income $(6,638,621) $ 1,060,846 $(6,745,935) $ 2,485,460
=========== =========== =========== ===========
</TABLE>
Accumulated other comprehensive loss, which is shown as a separate charge to
stockholders' equity, was $(11,107) and $(54,839) at September 30, 2000 and
December 31, 1999, respectively, and consists entirely of unrealized losses on
investments.
Note 9. Earnings Per Share Calculation
The following table sets forth the computation of basic and diluted earnings per
share
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic Earnings Per Share Computation
Net (Loss) Income $(6,676,936) $ 1,106,436 $ (6,789,667) $ 2,531,050
=========== ============== ============== ===========
Average Common
Shares outstanding 9,597,912 9,497,342 9,536,819 9,470,748
=========== ============== ============== ===========
Basic (Loss) Earnings Per Share $ (0.70) $ 0.12 $ (0.71) $ 0.27
=========== ============== ============== ===========
Diluted Earnings Per Share Computation
Net (Loss) Income $(6,676,936) $ 1,106,436 $ (6,789,667) $ 2,531,050
=========== ============== ============== ===========
Basic Shares Outstanding 9,597,912 9,497,342 9,536,819 9,470,748
Stock Options Calculated Under
the Treasury Stock Method 500,179 610,245
----------- -------------- -------------- -----------
Total Shares 9,597,912 9,997,521 9,536,819 10,080,993
=========== ============== ============== ===========
Diluted (Loss) Earnings Per Share $ (0.70) $ 0.11 $ (0.71) $ 0.25
=========== ============== ============== ===========
</TABLE>
9
<PAGE> 12
Securities that could potentially dilute earnings per share in future periods
totaled 484,330 and 454,278 for the three and nine month periods ended September
30, 2000, respectively. Such shares were not included in the computation of
diluted earnings per share for those periods because to do so would have been
antidilutive.
Note 10. Stock-Based Compensation to Employees and Non-employees
The Company accounts for stock-based compensation related to employees in
accordance with Accounting Principles Board Opinion ("APBO") No. 25, "Accounting
for stock issued to Employees" and the FASB issued FASB Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock Compensation and
Interpretations of APB Opinion No. 25." No compensation cost has been
recognized for the three or nine month periods ended September 30, 2000 or
1999 for fixed stock options issued to employees or directors.
The Company accounts for stock-based compensation related to non-employees in
accordance with Emerging Issues Task Force Issue No. 96-18, "Accounting for
Equity Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." Accordingly, the Company
recognized compensation expense related to stock options issued to non-employee
consultants of $28,200 and $131,477 for the three and nine month periods ended
September 30, 2000, respectively, and $54,756 and $242,156 for the three and
nine month periods ended September 30, 1999, respectively.
Note 11. Accounting Pronouncements
The Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued in June 1998 and subsequently amended in June
2000, to provide guidance on its implementation. Statement No. 133 requires
derivatives to be recorded on the balance sheet at fair value and establishes
accounting for three different types of hedges: hedges of changes in fair value
of assets, liabilities, or firm commitments; hedges of the variable cash flows
of forecasted transactions; and hedges of foreign currency exposures of net
investments in foreign operations. Statement No. 133 is effective for years
beginning after June 15, 2000 and is not expected to have a significant impact
on the Company's financial position or results of operations.
In December 1999, the staff of the Securities and Exchange Commission ("SEC")
issued Staff Accounting Bulletin ("SAB") 101 "Revenue Recognition in Financial
Statement and subsequently, in October 2000, issued "Frequently Asked Questions
and Answers related to SAB 101." SAB 101 outlines the basic criteria that
must be met to recognize revenue, and provides guidelines for disclosure related
to revenue recognition policies. This guidance is required to be implemented in
the fourth quarter of 2000, and is not expected to have a significant impact on
the Company's financial position or results of operations.
10
<PAGE> 13
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is engaged in the discovery and development of biosurgical and
therapeutic products to improve surgical outcomes and to treat neurological
disorders. The biosurgical products include the ADCON family of products, which
are proprietary, resorbable, carbohydrate polymer medical devices designed to
inhibit surgical scarring and adhesions. The Company is also pursuing the
development of other biosurgical products and small molecule drug candidates for
the treatment of several neurological disorders, including Attention Deficit
Hyperactive Disorder ("ADHD"), sleep disorders, anxiety, schizophrenia and
Alzheimer Disease ("AD"). The Company anticipates that a significant portion of
revenue from product sales will be derived from its ADCON family of products,
primarily ADCON(R)-L. Based on European pivotal clinical studies and other
compliance efforts and submission of data, the Company obtained regulatory
clearance to affix CE Marking on ADCON(R)-L and ADCON-T/N in August 1995 and
January 1996, respectively, thereby allowing ADCON(R)-L and ADCON-T/N to be
marketed in the 19 European countries which recognize CE Marking for lumbar disc
surgery and tendon and peripheral nerve surgeries, respectively. The Company is
currently marketing ADCON(R)-L and ADCON-T/N through independent medical device
distributors in approximately 30 countries outside the United States, including
the major countries in the European Union pursuant to its CE Marking. The
Company also commenced sales of ADCON(R)-L in the United States in June 1998. In
addition, the Company signed a development and exclusive license agreement in
December 1996 with Chugai for the sale of ADCON(R)-L and ADCON-T/N in Japan,
subject to regulatory approval.
In October 1994, the Company entered into a strategic alliance with Janssen to
collaborate on the discovery and development of therapeutic models to treat AD.
In May 1999, Janssen ceased funding this endeavor. The Company believes that
Janssen does not intend to select a lead compound from the identified compounds
or pursue clinical trials relating to any such compound. The Company expects to
continue discussion with Janssen to transfer development rights of these
compounds to the Company. There can be no assurance that the Company will be
successful in obtaining such development rights from Janssen or, if the Company
is successful, that such rights will be obtained on favorable terms. In
addition, the Company receives revenues from various government grants awarded
to the Company. The Company recognizes revenues from government grants in the
periods in which the associated costs are incurred.
In September 1999, the Food and Drug Administration ("FDA") issued the Company's
contract manufacturing firm, European Medical Contract Manufacturing B.V.
("EMCM"), a warning letter. In connection with the warning letter, the FDA
issued an import alert relating to ADCON(R)-L. In December 1999, the Company
announced that the FDA completed a re-inspection of EMCM and removed them from
the automatic detention list for the production of ADCON(R)-L. The Company
resumed shipments of ADCON(R)-L to the U.S. in the first quarter of 2000.
11
<PAGE> 14
On May 30, 2000 Guilford and the Company announced that they had entered into a
definitive Merger Agreement. Subsequently, the Company announced on August 28,
2000 that the two parties had agreed to a mutual termination of the Merger
Agreement. The Company incurred $1.1 million and $1.8 million in the third
quarter and first nine months of 2000, respectively, of costs associated with
the merger and subsequent termination of the Merger Agreement.
Guilford informed the Company that the decision to terminate the Merger
Agreement was based primarily on the issuance by the FDA of inspectional
observations contained in a Form FDA 483. The FDA report was issued to the
Company on August 23, 2000 after an audit by the FDA of a post-approval clinical
trial of ADCON(R)-L, in which certain observations identified that good clinical
practices had not been uniformly followed.
On August 29, 2000 the Company announced an investigation by an internal task
force comprised of members of the Company's executive and clinical personnel who
were not involved in the U.S. ADCON(R)-L clinical study. In addition, the
Company's Board of Directors commissioned an external investigation.
RESULTS OF OPERATIONS
For the three month and nine month periods ended September 30, 2000 and 1999.
REVENUES
Total revenues decreased 26.0% to $6.1 million in the third quarter of 2000
compared to $8.3 million in the third quarter of 1999 and decreased 17.8% to
$20.5 million in the first nine months of 2000 compared to $24.9 million in the
first nine months of 1999. The decrease in total revenues is primarily the
result of a decrease in product sales, which decreased to $6.1 million in the
third quarter of 2000 compared to $8.1 million in the third quarter of 1999 and
decreased to $20.0 million in the first nine months of 2000 compared to $23.7
million in the first nine months of 1999. Although the Company experienced
continued growth in international sales of ADCON(R)-L of 4.7% and 15.5% in three
and nine month periods ended September 30, 2000, respectively, sales of
ADCON(R)-L in the U.S. primarily decreased due to: (i) the announcement of the
merger and subsequent termination; and (ii) the issuance by the FDA of its Form
FDA 483.
12
<PAGE> 15
These factors contributed to the disruption of business within the Company and
for customers and independent sales representatives, as well as a temporary lack
of momentum in the market penetration of ADCON(R)-L.
There were no research contract revenues during fiscal 2000, as Janssen
terminated the collaboration efforts and related funding with the Company in May
1999.
Revenues from government grants decreased 76.8% to $56,831 in the third quarter
of 2000 compared to $245,168 in the third quarter of 1999 and decreased 19.8% to
$542,335 for the first nine months of 2000 compared to $676,019 for the first
nine months of 1999. The Company recognized grant revenue over the first nine
months of 2000 as the related costs for the two Phase II Small Business
Innovation Research ("SBIR") grants were incurred during that period. The
Company does not anticipate recognizing any grant revenue in the fourth quarter
of 2000 as the SBIR grants have been used in their entirety and the Company has
not received any new grants.
OPERATING COSTS AND EXPENSES
Total operating costs increased by $5.5 million to $13.1 million in the third
quarter of 2000 and increased by $4.8 million to $28.1 million in the first nine
months of 2000. Excluding merger related and severance costs, total operating
expenses decreased 17.2% to $6.3 million in the third quarter of 2000, compared
to $7.6 million in the third quarter of 1999 and decreased 11.9% to $20.6
million in the first nine months of 2000 compared to $23.3 million in the first
nine months of 1999. Cost of products sold increased to $2.4 million or 39.2% of
product sales in the third quarter of 2000 compared to $1.3 million or 16.7% of
product sales in the third quarter of 1999. The cost of products sold increased
to $4.8 million or 23.8% of product sales in the first nine months of 2000
compared to $3.6 million or 15.3% of product sales in the first nine months of
1999. The increase in cost of products sold in the third quarter and first nine
months of 2000 as a percentage of product sales is due to start-up costs
associated with the Company's new manufacturing plant in Solon, Ohio, which is
undergoing validation testing for sales within the U.S., and other manufacturing
inefficiencies incurred as a result of reduced production volumes. Start-up
costs for the Solon manufacturing plant increased to $833,000 for the first nine
months of 2000 compared to $450,000 for the first nine months of 1999 as the
Company increased validation testing and related production in 2000.
Research and development expenses decreased 47.9% to $1.6 million in the third
quarter of 2000 compared to $3.0 million in the third quarter of 1999 and
decreased 30.2% to $7.2 million in the first nine months of 2000 compared to
$10.3 million in the first nine months of 1999. This decrease was primarily due
to a reduction in clinical development costs due to: (i) the Perceptin Phase II
clinical trial having a slower than anticipated enrollment during the first nine
months of 2000 and (ii) the pilot studies for ADCON(R)-A (for inhibition of
postsurgical scarring and adhesion following abdominal or colorectal surgeries)
and ADCON(R)-L gel (for inhibition of postsurgical scarring and adhesion
following breast augmentation surgery) were fully enrolled and expensed by the
end of fiscal 1999 with limited new enrollment in follow-on studies in 2000.
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<PAGE> 16
Write-offs of abandoned patents totaled $0 and $178,122 for the nine month
periods ended September 30, 2000 and 1999, respectively. These patent costs were
expensed in 1999 as the Company determined it would be more cost beneficial to
pursue alternative patent technology.
Selling, general and administrative expenses decreased 28.1% to $2.3 million in
the third quarter of 2000 compared to $3.2 million in the third quarter of 1999
and decreased 8.5% to $8.6 million in the first nine months of 2000 compared to
$9.4 million in the first nine months of 1999 primarily due to reduced
commission expense as a result of lower U.S. product sales.
MERGER RELATED AND SEVERANCE COSTS
Merger related and severance costs were $6.8 million and $7.5 million in the
third quarter and first nine months of 2000, respectively. The $7.5 million of
non-recurring expenses included: (i) a $4.5 million settlement of a lawsuit
relating to a lease entered into by the Company for a new headquarters building;
(ii) $1.8 million of costs associated with the merger and subsequent termination
of the agreement; (iii) $1.2 million of expenses related to the retirement of a
senior executive and the resignation of two other executives from the Company.
INTEREST INCOME
Interest income, net, decreased 30.1% to $266,138 in the third quarter of 2000
compared to $384,438 in the third quarter of 1999 and decreased 14.4% to
$808,114 in the first nine months of 2000 compared to $944,524 in the first nine
months of 1999 primarily due to the cash outflow for payments for the settlement
of a lawsuit and other merger related costs.
NET INCOME
Net income decreased by $7.8 million to a net loss of $6.7 million in the third
quarter of 2000 and by $9.3 million to a net loss of $6.8 million for the first
nine months of 2000. Excluding merger related and severance costs, net income
and diluted net income per share would have been $140,402 or $0.01 per diluted
share and $751,461 or $0.08 per diluted share for the third quarter and first
nine months of 2000, respectively, compared to $1.1 million or $0.11 per diluted
share and $2.5 million or $0.25 per diluted share for the third quarter and
first nine months of 1999, respectively. Excluding merger related and severance
costs, the decrease in net income was primarily due to lower U.S. sales of
ADCON(R)-L and increased costs of products sold.
CONSOLIDATED BALANCE SHEETS
Short term investments decreased to $10.3 million at September 30, 2000
compared to $15.8 million at December 31, 1999, due primarily to the payment of
a settlement of a lawsuit and certain accrued clinical trial costs. Accounts
receivable increased $2.8 million to $3.7 million at September 30, 2000,
compared to $.9 million at December 31, 1999. Raw material inventory decreased
to $2.9 million at September 30, 2000 compared to $4.5 million at December 31,
1999 because the Company has not made similar bulk purchases in 2000 as were
made in 1999 to take advantage of certain volume discounts. Total work in
process and finished goods inventory increased to $1.9 million at September 30,
2000 from $.8 million at December 31, 1999. The increase in accounts receivable
and work in process and finished goods inventory were due to the Company
resuming shipments and production of ADCON(R)-L in the
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<PAGE> 17
United States in January 2000 after the temporary embargo was lifted. The
Company is currently producing ADCON(R)-L at its Solon, Ohio facility and
shipping the product for sale outside of the U.S. Accrued expenses increased
approximately $900,000 to $3.0 million at September 30, 2000 compared to $2.1
million at December 31, 1999 due to increased legal and consulting fees related
to the merger, the Form FDA 483 report and certain litigation.
LIQUIDITY AND CAPITAL RESOURCES
In order to preserve principal and maintain liquidity, the Company's funds are
invested primarily in commercial paper and US Treasury Securities. As of
September 30, 2000 and December 31, 1999, the Company's cash and cash
equivalents and investments totaled $12.5 million and $20.8 million,
respectively. The Company expects that its existing capital resources, interest
earned thereon, and product sales will enable the Company to maintain its
planned operations for the foreseeable future.
Prior to the commercialization of ADCON(R)-L in the United States, the Company
historically financed its operations primarily through the private placement and
public offering of its equity securities, research contract licensing fees, and,
to a lesser extent, through federally sponsored research grants. The Company
also has established a $1.5 million line of credit with a bank. As of September
30, 2000, the Company had no borrowings against the line of credit.
In the second quarter of 1999 the Company was awarded a third Phase II SBIR
Program grant from the National Cancer Institute ("NCI"), a division of the NIH,
for the research of inhibition of postoperative gynecological adhesions. In
September 1998, the Company was awarded a Phase II SBIR Program grant from the
NINDS for research evaluating H (3) agonists. Each of these Phase II grants had
a two-year term and provided approximately $750,000 in funding. In February 1997
the Company was awarded a two-year Phase II SBIR Program grant from NINDS for
research evaluating histamine H (3) receptor antagonists to treat ADHD, which
provided approximately $750,000 in funding. If the Company is successful in
other Phase I research, additional Phase II awards may be sought for funding to
aid in further development of pharmaceutical compounds, however, there is no
assurance that such Phase I research will be successful or that additional
funding will be obtained. The Company does not anticipate receiving any
additional funding from grants in the fourth quarter of 2000.
The Company may need to raise substantial additional capital to fund its
operations. The Company's future capital requirements will depend on, and could
increase as a result of many factors, including, but not limited to, the cost
for commercialization of ADCON(R)-L, the commercialization success of its ADCON
family of products, the progress of the Company's research and development,
including the costs related to its Cognition Modulation, Perceptin, AD,
schizophrenia and other neurological disorders programs, the scope, timing and
results of preclinical studies and clinical trials, the cost and timing of
obtaining regulatory approvals, the Company's success in obtaining the strategic
alliances required to fund certain of its programs, the rate of technological
advances, determinations as to the commercial potential of certain of the
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<PAGE> 18
Company's product candidates, the status of competitive products and the
establishment of additional manufacturing capacity.
The Company from time to time is involved in various stages of discussion or
negotiation regarding acquisitions or mergers and from time to time other
strategic alternatives. As of the date hereof, the Company has not entered into
any definitive agreement with respect to any such transaction or other strategic
alternative.
EURO CONVERSION
On January 1, 1999, eleven of the fifteen countries (the "Participating
Countries") that are members of the European Union established a new uniform
currency known as the "Euro." The currencies existing prior to such date in the
Participating Countries will be phased out during the transition period
commencing January 1, 1999 and ending January 1, 2002. During such transition
period both the Euro and the existing currencies will be available in the
Participating Countries. Although certain of the Company's products are being
sold in the Participating Countries through independent distributors, the
Company receives revenues from such sales in U.S. dollars. As a result, the
Company does not anticipate that the introduction and use of the Euro will
materially affect the Company's business, prospects, results of operations or
financial condition
FORWARD-LOOKING STATEMENTS. Certain statements in this Quarterly Report on Form
10-Q constitute "forward-looking statements." When used in this Form 10-Q, the
words "believes," "anticipates," "expects," "intends" and other predictive,
interpretive and similar expressions are intended to identify such
forward-looking statements. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual results
of the Company to be different from expectations expressed or implied by such
forward-looking statements. Such factors included, but are not limited to,
commercial uncertainty of market acceptance of the Company's ADCON(R) family of
products, including the timing and content of decisions made by the FDA, delays
in product development of additional ADCON(R) products, uncertainty of outcomes
of current and future FDA audits and inspections, uncertainty due to the early
stage of development for the neurological disorder programs, the productivity of
distributors of the ADCON(R) products, the uncertainty of shortages of supply of
ADCON(R) products from the Company's sole manufacturer, the ability of the
Company to commence manufacturing of its ADCON(R) products at its manufacturing
facility located in the United States, the lack of supply of raw materials for
the Company's products, uncertainty of future profitability, uncertainties
related to the Company's proprietary rights in its products and technological
change. These statements are based on certain assumptions and analysis made by
the Company in light of its experience and its perception of historical trends,
current conditions, expected future developments and other factors it believes
are appropriate in the circumstances. Such statements are subject to a number of
other assumptions, risks, uncertainties, general economic and business
conditions, and the business opportunities (or lack thereof) that may be
presented to and pursued by the Company. Prospective investors are cautioned
that any such statements are not guarantees of future performance and that
actual results or developments may differ materially from those projected in the
forward-looking statements.
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<PAGE> 19
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The Company does not enter into derivative financial instruments. The Company
primarily invests in commercial paper and corporate bonds that have short-term
maturities. The Company has no outstanding debt. Exposure to foreign currency
has been minimal because the Company's foreign product sales are in U.S.
currency. As a result, the Company believes that its market risk exposure is not
material to the Company's financial position, liquidity or results of
operations.
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<PAGE> 20
PART II
OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
In June 2000, Cartech Company, LTD. filed a lawsuit against Gliatech and
Guilford alleging breach of and interference with Gliatech's build-to-suit lease
agreement with Cartech. The parties subsequently entered into a Settlement
Agreement to resolve the litigation. Pursuant to the settlement agreement,
Guilford agreed to pay Cartech $4.5 million within seven days after the merger
closed or, if the Merger Agreement terminated prior to closing or if the merger
did not close by December 1, 2000, Gliatech would pay Cartech $4.5 million. In
the event that Gliatech made the payment to Cartech and upon Gliatech's written
request, Gliatech and Cartech would enter into good faith negotiations for a new
build-to-suit lease and Gliatech would receive a credit against the cost of the
new lease of up to $2,187,000 for up to six months after payment. As a result
of the execution of the Settlement Agreement, the lawsuit was dismissed by
Cartech without prejudice. The parties agreed to a full mutual release of
claims and termination of the existing build-to-suit lease and Cartech also
agreed to abstain from further legal action against Gliatech or Guilford. In
accordance with the terms of the Settlement Agreement, Gliatech paid Cartech
$4.5 million on September 6, 2000 after the termination of the Merger Agreement
with Guilford.
A complaint was filed by Vance Carter, who was administered ADCON(R)-L during
lumbar disc surgery, against the Company on August 18, 1999 in the Fourth
Judicial District Court of Louisiana, alleging, certain product liability claims
as a result of the use of ADCON(R)-L in the surgery. The Company settled this
suit for $50,000 in October 2000.
To date, the following plaintiffs, on behalf of each such party and all other
persons similarly situated, have filed ten class action lawsuits against the
Company and certain of its officers in the United States District Court for the
Northern District of Ohio alleging violation of the federal securities laws.
These complaints allege that the Company and certain officers failed to disclose
material facts in connection with the termination of the Merger Agreement that
had been entered into with Guilford Pharmaceuticals, Inc. and from certain
inspectional observations by the FDA contained in a Form FDA 483. These
complaints seek compensatory damages in an unspecific amount, fees and expenses
related to such class action and the granting of extraordinary equitable and/or
injunctive relief, including, without limitation, rescission. For each of these
class actions, the date each complaint was filed and the name of the plaintiff
is as follows:
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<PAGE> 21
Date Plaintiff
---- ---------
September 5, 2000 Avrom Gart
September 7, 2000 Jason Raker
September 12, 2000 Jon Burgermeister
September 13, 2000 Carl L. Evans
September 27, 2000 WPG Merger Arbitrage Fund, L.P. and WPG Merger
Arbitrage Overseas Fund, Ltd.
October 4, 2000 Eric Ford
October 5, 2000 Steven R. Graupner
October 19, 2000 James Berman
October 20, 2000 Atul Verma
November 1, 2000 Daniel Triefler
The Company and certain officers filed a motion to consolidate these actions and
certain plaintiffs have moved for the appointment of lead plaintiff and lead
counsel. The Company has been granted leave to respond to the complaints until
after appointment of lead plaintiff. These motions are currently pending in the
United States District Court for the Northern District of Ohio.
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ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Agreement, dated as of September 25, 2000 entered into by and between
the Company and Thomas O. Oesterling, Ph.D.
10.2 Agreement, dated as of September 25, 2000 entered into by and between
the Company and Michael A. Zupon, Ph.D.
10.3 Agreement, dated as of September 25, 2000 entered into by and between
the Company and Raymond Silkaitis, Ph.D.
27.1 Financial data schedule
(b) Reports on Form 8-K
Although the Company did not file a Current Report on Form 8-K (the "Form 8-K")
during the quarterly period covered by this Quarterly Report on Form 10-Q, it
did file a Form 8-K on October 16, 2000 regarding the Company's response to the
Form FDA 483.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2000 GLIATECH INC.
By: /s/Rodney E. Dausch
-------------------------------------------
Rodney E. Dausch, Chief Operating Officer
and Secretary
(Duly Authorized Officer)
/s/Thomas F. Barnish
-------------------------------------------
Thomas F. Barnish, Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
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<PAGE> 24
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit Page Number
----------- ---------------------- -----------
<S> <C> <C>
10.1 Agreement, dated as of September 25, 2000 entered into by Thomas O. Oesterling,
Ph.D. and the Company
10.2 Agreement, dated as of September 25, 2000 entered into by Michael A. Zupon, Ph.D.
and the Company
10.3 Agreement, dated as of September 25, 2000 entered into by Raymond Silkaitis, Ph.D.
and the Company
27.1 Financial Data Schedule
</TABLE>
