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KOSP > SEC Filings for KOSP > Form 10-Q on 14-Sep-2006All Recent SEC Filings

Show all filings for KOS PHARMACEUTICALS INC

Form 10-Q for KOS PHARMACEUTICALS INC


14-Sep-2006

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Executive Overview
Kos is a fully-integrated specialty pharmaceutical company engaged in the development and commercialization of proprietary prescription products for the treatment of chronic cardiovascular, metabolic and respiratory diseases. Kos manufactures its lead products, Niaspan® and Advicor®, and currently markets them directly through its own sales force and co-promotion partners in the United States, through its commercialization partner in Canada and, with respect to Niaspan only, through its commercialization partner and license arrangements outside of the United States, Canada and Japan.
On March 8, 2004, the Company announced that it had entered into a product acquisition agreement with Aventis Pharmaceuticals Holdings Inc. (the "Azmacort Acquisition Agreement") and a finished product supply agreement (the "Azmacort Supply Agreement" and together with the AzmacortAcquisition Agreement, the "Aventis Agreements") with Aventis Pharmaceuticals Inc. (collectively with Aventis Pharmaceutical Holdings Inc., "Aventis") to acquire global rights to the Azmacort® (triamcinolone acetonide) inhalation aerosol franchise. The transaction was completed on March 31, 2004. Accordingly, Kos began recording revenue for all sales related to the Azmacort product beginning April 1, 2004.
On April 12, 2005, the Company entered into a co-promotion agreement (the "Duramed Co-promotion Agreement"), a licensing and manufacturing agreement (the "Barr License and Manufacturing Agreement"), and a settlement and license agreement (the "Barr Settlement and License Agreement", and collectively, the "Barr Agreements") with Barr Laboratories, Inc. and certain of its affiliates ("Barr"), contemporaneous to the resolution of the patent litigation involving the Company's Niaspan products. Under the Barr License and Manufacturing Agreement, Barr stands ready to supply Kos Life Sciences, Inc. ("KLS"), a wholly-owned subsidiary of Kos, certain quantities of Niaspan and Advicor tablets, under or pursuant to Barr's Abbreviated New Drug Applications ("ANDAs"), as and when approved, and granted KLS a license to use, market and sell, at a future date, Barr's versions of the Company's Niaspan and Advicor products, as and when approved, in the United States. Barr received an initial license fee and receives quarterly payments to remain compliant with the United States Food and Drug Administration ("FDA") current Good Manufacturing Practices ("cGMP") and to stand ready to meet the Company's manufacturing requirements on short notice.
The Barr Settlement and License Agreement sets forth the terms of the settlement of the litigation between Kos and Barr. It permits Barr to launch a generic version of Niaspan and Advicor, as well as future dosage formulations, strengths or modified versions of the products, under terms of an exclusive license commencing on September 20, 2013, approximately four years earlier than the last-to-expire KLS patent. Pursuant to the Duramed Co-promotion Agreement, Duramed Pharmaceuticals, Inc. ("Duramed"), an affiliate of Barr, promotes the Company's Niaspan and Advicorproducts to physicians who mostly specialize in women's healthcare. In consideration of Duramed's performance of its co-promotion obligations, the Company pays Duramed royalties subject to certain sales caps.


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On May 2, 2005, KLS entered into a strategic commercialization and research and development alliance with Biovail Corporation and certain of its affiliates ("Biovail") in the area of cardiovascular disease (the "Biovail Agreements"). Pursuant to the Biovail Agreements, Kos acquired the rights to the Teveten®
(eprosartan mesylate) and Teveten HCT (eprosartan mesylate/hydrochlorothiazide)
products (collectively, the "Teveten Products"), and obtained exclusive sales and marketing rights to the Cardizem® LA (diltiazem hydrochloride) product in the United States. The Company began recording revenue for sales related to the TevetenProducts and Cardizem LA in May 2005.
On July 7, 2005, the Company received notice from Biovail that Andrx Corporation had filed with the FDA an ANDA that would, if approved, allow Andrx Corporation to market a generic version of the Cardizem LA product. On August 10, 2005, a lawsuit alleging patent infringement against Andrx Pharmaceuticals, L.L.C. and Andrx Corporation (collectively "Andrx") in Biovail's name was commenced in the United States District Court for the District of Delaware ("Delaware District Court"). Upon receiving a second Paragraph IV certification from Andrx Pharmaceuticals, L.L.C. directed to additional Cardizem LA tablet strengths of 120, 180, 240, 300, and 360 mg added by amendment to Andrx's ANDA, on October 14, 2005, a second complaint alleging additional patent infringement was filed in Biovail's name in the Delaware District Court. These two civil actions have been consolidated by the Court for all purposes. Under the current case schedule, fact and expert discovery is scheduled to close on October 13, 2006, and the trial is scheduled for April 9, 2007. These dates, however, may change.
On November 6, 2005, KLS entered into an exclusive Collaboration and License Agreement (the "Jerini Agreement") with Jerini US, Inc. ("Jerini"), a subsidiary of Jerini AG, for the development, marketing and distribution of Jerini's compound, Icatibant, a peptidomimetic bradykinin B2 receptor antagonist, in the United States and Canada. In connection with the Jerini Agreement, KLS paid an upfront licensing payment of $14.2 million (the "Jerini Licensing Payment") to Jerini. Additionally, Kos consummated an equity investment in Jerini AG by purchasing 3,125,000 shares of Jerini AG for $11.8 million (the "Jerini Investment").
On May 5, 2006, KLS and Jagotec AG ("Jagotec"), a subsidiary of SkyePharma PLC, entered into an exclusive agreement which granted KLS the marketing and distribution rights in the United States of Jagotec's Flutiform product (the "Flutiform Agreement"). Flutiform is a formoterol and fluticasone fixed-dose combination in a HydroFluroAlkane metered dose inhaler. In connection with the Flutiform Agreement, KLS made an upfront licensing payment of $25.0 million, which is included in the accompanying condensed consolidated statements of income as "Research and development" expense for the three and six months ended June 30, 2006. Under the terms of the Flutiform Agreement, there may be additional payments to Jagotec upon the completion of specific milestones, which, if achieved, could result in Jagotec receiving up to an additional $14.0 million.
The Company's cardiovascular products under development consist of controlled-release, oral solid dosage formulations, and the Company's respiratory products under development consist of aerosolized inhalation formulations to be used primarily with Kos' proprietary inhalation devices.
The Company's core business strategy is based primarily upon developing drugs that are reformulations of existing approved prescription pharmaceutical products, but which offer certain safety or patient compliance advantages compared with existing formulations of such products. Kos has also begun to gradually broaden its business strategy by making measured investments and applying greater focus on the research and development of new chemical entities, with an initial focus in the area of modulators of HDL cholesterol and treatments for atherosclerosis.


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The core elements of Kos' current business strategy are as follows:
(i) develop or acquire products with unrealized commercial potential where safety or patient compliance may be improved or where greater utilization of a product could be attained through increasing the awareness of the product's features and benefits;

(ii) focus on the large, rapidly growing cardiovascular, metabolic and respiratory markets, which include many chronic diseases requiring long-term therapy;

(iii) develop proprietary formulations of currently approved pharmaceutical compounds;

(iv) make measured investments in new chemical entity research through sponsored research programs, scientific in-licensing and corporate development activities;

(v) manage internally the clinical development of its products, or where necessary or prudent, using contract research organizations;

(vi) manufacture its products internally, or where necessary or prudent, through its partners or using a third party manufacturer;

(vii) market its products directly through the Company's sales forces, which Kos may supplement with one or more contract sales organizations or other partners and through co-promotion and other strategic alliances, to extend the marketing reach of the Company to new patients; and

(viii) leverage its core competencies through corporate and academic alliances.

In measuring the Company's results of operations, management's primary focus has been on revenue growth of Niaspan, Advicor, Azmacort, Cardizem LA, and the Teveten Products, as well as net income growth. Net sales of the Company's Niaspan and Advicor products increased to $288.2 million for the six months ended June 30, 2006, from $256.7 million in 2005 . While experiencing growth from increased prescription demand and increased prices for Niaspan and Advicor, revenues during the 2006 six-month period were also impacted by the Company's Inventory Management Agreements ("IMAs") which resulted in an estimated $20.4 million inventory reduction ($15.7 million for Niaspan and $4.7 million for Advicor) - see discussion of IMAs in the Results of Operations section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. Azmacort net sales for the six months ended June 30, 2006, totaled $42.3 million, compared to $53.2 million for the 2005 period. The decrease in Azmacort net sales for the six months ended June 30, 2006 included the impact of an estimated $7.0 million reduction in inventory associated with Company's IMAs. As mentioned above, the Company began recording Cardizem LA, Teveten and Teveten HCT revenue in May 2005. Cardizem LA, Teveten and Teveten HCT net sales for the six months ended June 30, 2006, totaled $61.3 million. Net income for the six months ended June 30, 2006, was $11.1 million compared to net income of $53.2 million for the same period in 2005.


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Because Kos' current business strategy is principally dependent on the reformulation of existing compounds or the development or acquisition of synergistic products with unrealized market potential, the Company's business could be subject to significant competitive pressures by other products and therapies in the growing markets for cardiovascular, metabolic and respiratory treatments. As such, Kos' critical success factors include its ability to continue to increase the amount of revenue generated by Niaspan, Advicor, Azmacort, Cardizem LA, and the Teveten Products and its ability to successfully develop and/or acquire new products or drugs. The Company's ability to continue to increase revenue is primarily dependent on its ability to increase prescriptions for its marketed products, and to maintain a competitive product pricing and differentiation strategy. In addition, the Company's ability to complete new drug and product acquisitions on favorable terms will be a critical factor in the Company's ability to increase revenues in future periods. Protection of the Company's intellectual property rights will also be critical to the Company's success in future periods, including its ability to obtain and maintain patents, enforce those patents, preserve trade secrets, and operate without infringing the proprietary rights of third parties. General
A predecessor corporation to the Company was formed in July 1988, under the name of Kos Pharmaceuticals, Inc. principally to conduct research and development on new formulations of existing prescription pharmaceutical products. In June 1993, Aeropharm Technology, Inc., now Aeropharm Technology, LLC ("Aeropharm"), a then majority-owned subsidiary of the Company, was formed to conduct research and development activities on aerosolized products, dispensed in metered-dosed inhalers, for the treatment of respiratory diseases. During June 1996, this predecessor corporation acquired the outstanding minority interest in Aeropharm; changed its name to Kos Holdings, Inc. ("Holdings"); established the Company as a wholly-owned subsidiary under the name of Kos Pharmaceuticals, Inc.; and, effective as of June 30, 1996, transferred all of its existing assets, liabilities, and intellectual property, other than certain net operating loss carryforwards ("NOLs"), to the Company. Accordingly, all references in this Form 10-Q filing to the Company's business include the business and operations of Holdings until June 30, 1996.
On March 12, 1997, the Company completed an initial public offering ("IPO") of its Common Stock. From inception through the IPO, the Company had not recorded any significant revenues; and the Company had funded its operations exclusively through equity contributions and loans from its majority shareholder. Through June 30, 2006, the Company had retained earnings from operations of approximately $24.6 million. In connection with the transfer of operations from Holdings to the Company on June 30, 1996, NOLs amounting to approximately $51.0 million and related tax benefits were retained by Holdings and not transferred to the Company. Consequently, as of June 30, 2006, the Company had approximately $26.1 million of NOLs.
On July 28, 1997, Kos received clearance from the FDA to market the Niaspan product for the treatment of mixed lipid disorders. Niaspan is a once-a-day prescription formulation of a niacin product approved by the FDA for the treatment of mixed lipid disorders. The Company and a co-promotion partner, Takeda Pharmaceuticals North America, Inc. ("Takeda"), currently market Niaspan in the United States directly to physicians who specialize in treating patients with coronary heart disease and/or who are among the leading prescribers of lipid-altering medications. The Company recently notified Takeda that it does not intend to extend the co-promotion arrangement with Takeda upon its expiration on December 31, 2006. Rather, the Company has made a strategic decision to increase the size of the Kos sales force to fully maximize the commercial opportunities available to the Company. In addition, another co-promotion partner, Duramed, also markets Niaspanand Advicor in the United States directly to physicians and healthcare professionals who specialize in women's health.


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On December 17, 2001, Kos received clearance from the FDA to market the Advicor product (extended-release niacin/lovastatin tablets). The approval of the Advicor product marked the first time that the FDA had approved a combination product for the safe and efficacious treatment of cholesterol disorders. The Company began detailing the Advicor product to physicians on January 28, 2002. As with Niaspan, Kos and Takeda market Advicor directly to physicians who specialize in treating patients with coronary heart disease and/or who are among the leading prescribers of lipid-altering medications. Duramed also markets Advicor to physicians and healthcare professionals specializing in women's health.
On March 31, 2004, the Company completed the acquisition of the Azmacort product from Aventis. The Azmacort product is an inhaled corticosteroid that alleviates inflammation in the lungs and is used as prophylactic therapy for the maintenance treatment of asthma. Under the terms of the Azmacort Supply Agreement, Aventis Pharmaceuticals Inc. agreed to a five-year supply agreement beginning on March 31, 2004. On March 31, 2005, Inyx, Inc. ("Inyx") acquired the assets and business of the Aventis affiliate responsible for manufacturing Azmacort, and agreed, among other things, to produce and supply Azmacort for a period of ten years. The purchase price allocation resulted in the recording of intangible assets of $154.4 million for developed and core technology value, $38.0 million for the value of in-process research and development, $7.0 million for the value of inventory, and $6.7 million for the value of certain other intangibles. Except for the Azmacort in-process research and development, which was expensed in 2004, the intangible assets acquired from Aventis are being amortized over their estimated lives, ranging from 5 to 22 years. The Company began detailing the Azmacort product in August 2004 and currently markets the Azmacortproduct in the United States directly to specialist physicians, such as pulmonologists and allergists and to selected primary care physicians.
The Azmacort in-process research and development was determined by identifying the specific in-process research and development projects that would be continued and for which (a) technological feasibility has not been established as of the acquisition date, (b) there was no alternative future use, and (c) the fair value was estimable with reasonable reliability.
The acquired in-process research and development represents a single project, the hydrofluoroalkane ("HFA") formulation of Azmacort. The HFA formulation of Azmacort does not use a chlorofluorocarbon ("CFC")-based propellant and, consequently, to the knowledge of the Company, should not contribute to the depletion of the Earth's Ozone Layer. The Montreal Protocol on Substances that Deplete the Ozone Layer (the "Protocol") is an international treaty under which the production and consumption of ozone-depleting substances is being phased out worldwide. Under the Protocol, codified by the United States Congress into law in Title VI of the Clean Air Act, the production of CFCs in the United States was banned as of January 1, 1996, unless a specific exemption is approved annually by the international parties to the Protocol. In order to comply with the Clean Air Act and the Montreal Protocol, the United States will eventually need to phase out CFC-propelled Metered Dose Inhalers.
Although Azmacort HFA had previously received an "approvable" letter from the FDA, the Azmacort HFA formulation had not achieved technological feasibility as of the date of the Aventis Agreements. Among the technological matters to be resolved are manufacturing controls and evidence of dose proportionality between the 75 µg and 225 µg dosage formulations.


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The Company believes it may need to invest approximately $29 million during the 2006-2009 period to achieve technological feasibility of the Azmacort HFA formulation. If the technological and regulatory challenges are overcome, approval of the Azmacort HFA formulation by the FDA could occur as early as late 2009. There can be no assurance that the Company will be able to obtain technological feasibility for the Azmacort HFA formulation prior to an FDA decision to phase out Azmacort CFC as of a particular date in the future. Failure to obtain FDA approval and bring Azmacort HFA to market prior to the FDA's phase out of Azmacort CFC in the United States could have a material adverse effect on the Company's business, operating results and financial condition.
On February 1, 2005, the Company made $4.0 million of a proposed aggregate $8.0 million investment in Triad Pharmaceuticals, Inc., which later changed its name to Arisaph Pharmaceuticals, Inc. ("Arisaph"), through the purchase of shares of a new series of convertible preferred stock of Arisaph (the "Series F Preferred Stock"). On August 1, 2006, the Company purchased an additional $4.0 million of Series F Preferred Stock - refer to the Recent Developments section of this Management's Discussion and Analysis of Financial Condition and Results of Operations for further information regarding the additional $4.0 million purchase of Arisaph Series F Preferred Stock by the Company. Upon completion of the additional $4.0 million investment and after taking into consideration the recent increase in the size of the Arisaph stock option plan, Kos owns approximately 24% fully diluted ownership interest in Arisaph. Additionally, the principal stockholder of Arisaph, which is a limited partnership (the "Arisaph Limited Partnership") formed by Mary Jaharis, the wife of Michael Jaharis, the principal stockholder and Chairman Emeritus of Kos invested an additional $8.0 million on similar terms and conditions as the Kos investment as part of a $16.0 million round of financing for Arisaph. The Arisaph Limited Partnership currently owns or has the right to vote approximately 42% of the outstanding common stock of Arisaph on a fully diluted basis. Under the agreements related to the investment, the Company is entitled to designate three persons, and the Arisaph Limited Partnership is entitled to designate seven persons, to Arisaph's 13-member Board of Directors. Adrian Adams, the President and Chief Executive Officer of the Company, has been appointed by the Company to the Arisaph Board of Directors and has been elected by the directors of Arisaph as Chairman. The Company has appointed Dr. Ralf Rosskamp, the Company's Executive Vice President, Research and Development and Dr. Marvin F. Blanford, the Company's Senior Vice President, Drug Regulatory, Safety and Compliance to the Arisaph Board. Michael Jaharis, Steven Jaharis, Robert E. Baldini, and Kevin T. Ferro, all directors of Kos, have been appointed by the Arisaph Limited Partnership to the Arisaph Board of Directors. In connection with the closing of the initial investment in Arisaph, Christopher P. Kiritsy, Kos' former Executive Vice President, Corporate Development and Chief Financial Officer, accepted the position of President and Chief Executive Officer of Arisaph and resigned as Executive Vice President, Corporate Development and Chief Financial Officer of Kos effective on May 20, 2005.
After considering the provisions of Financial Accounting Standards Board Interpretation No. 46 "Consolidation of Variable Interest Entities on Interpretation of ARB No. 51", the Company concluded that Arisaph does not constitute a variable interest entity that is required to be consolidated by Kos as of June 30, 2006. Instead, the Company accounts for its investment in Arisaph under the equity method of accounting. Further, in accordance with the guidance offered by the American Institute of Certified Public Accountants' Practice Aid "Assets Acquired in a Business Combination to be Used in Research and Development Activities: A Focus on Software, Electronic Devices, and Pharmaceutical Industries", which establishes that the value related to an investor's proportionate interest in assets acquired to be used in research and development activities that have no alternative future use should be charged to income in the period that the acquiring company makes its equity investment in common stock, Kos wrote-off its $4.0 million investment in Arisaph (the "Arisaph Write-off") as a research and development expense during the six months ended June 30, 2005.


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As described previously, on April 12, 2005, the Company entered into the Duramed Co-promotion Agreement, the Barr License and Manufacturing Agreement, and the Barr Settlement and License Agreement with Barr. The Barr Settlement and License Agreement resolved the patent litigation involving the Company's Niaspan products. The United States District Court for the Southern District of New York subsequently entered into a Consent Dismissal Without Prejudice dismissing the litigation between the Company and Barr.
The Duramed Co-promotion Agreement provides that the Company and Duramed, a subsidiary of Barr, will co-promote the current Niaspan and Advicor products, as well as future dosage formulations, strengths or modified versions of those products (the "Products"), to obstetricians, gynecologists and other practitioners with a focus on women's healthcare in the United States using a Duramed specialty sales force. Under the terms of the seven-year agreement (with renewal rights), the Company trained a Duramed specialty sales force, which is promoting the Products. In consideration of the co-promotion, the Company pays Duramed royalties based on quarterly and yearly net sales of the Products, subject to certain maximum sales levels.
Pursuant to the Barr License and Manufacturing Agreement, Barr agreed to stand ready to supply KLS quantities of Niaspan 500 mg, 750 mg and 1000 mg extended-release niacin tablets and Advicor500 mg/20 mg, 750 mg/20 mg and 1000 mg/20 mg extended-release niacin/lovastatin tablets, under or pursuant to the approval of Barr's ANDAs, as and when approved. Under the terms of the Barr License and Manufacturing Agreement, Barr granted Kos a license to use, market and sell Barr's versions of the Company's current Niaspan and Advicor products as and when approved in the United States. Barr received an initial license fee and will receive quarterly payments to remain compliant with FDA cGMP and to stand ready to meet the Company's manufacturing requirements on short notice. In addition, if the Company engages Barr to manufacture these products, the Company will purchase such products at an agreed-upon supply price.
The Barr Settlement and License Agreement sets forth the terms of the settlement of the litigation between Kos and Barr. It permits Barr to launch generic versions of Niaspan and Advicor, as well as future dosage formulations, strengths or modified versions of the Products, under terms of an exclusive license commencing on September 20, 2013, approximately four years earlier than the last-to-expire KLS patent. Upon such future launch, Barr would pay the Company a royalty equal to a portion of profits generated from the sales of generic versions of the Products. As part of the settlement, Barr stipulated that the Company's Niaspan patents in suit are valid and enforceable and that Barr infringed those patents.
As previously described, on May 2, 2005, pursuant to the Biovail Agreements, the Company acquired the rights to the Teveten (eprosartan mesylate) and Teveten HCT (eprosartan mesylate/hydrochlorothiazide) products, and obtained exclusive sales and marketing rights to the Cardizem LA (diltiazem hydrochloride) product in the United States. The preliminary purchase price allocation resulted in the recording of intangible assets of $44.4 million for the value of the Teveten Products developed and core technology, $4.2 million for the value of the Teveten trade name, $49.0 million for the value of the Cardizem LA product, $2.3 million of goodwill, $2.8 million for the value of a proposed Cardizem LA with enalapril combination product currently in development (the "Cardizem Combination Product") and $3.3 million for the value of inventory. Except for the value associated with the Cardizem Combination Product, which was expensed during the second quarter of 2005, the intangible assets acquired from Biovail are being amortized over their estimated lives, ranging from 9 to 17 years. The Company began detailing the Cardizem LA, Teveten, and Teveten HCT products in June 2005 and currently markets such products in the United States directly to specialist and primary care physicians.


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The value of the Cardizem Combination Product in-process research and . . .

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