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SOMX > SEC Filings for SOMX > Form 10-Q on 10-May-2012All Recent SEC Filings

Show all filings for SOMAXON PHARMACEUTICALS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SOMAXON PHARMACEUTICALS, INC.


10-May-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The interim financial statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2011, and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2011. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011 and the caption "Risk Factors" in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2012.

Overview

Background

We are a specialty pharmaceutical company focused on the in-licensing, development and commercialization of proprietary branded products and product candidates to treat important medical conditions where there is an unmet medical need and/or high-level of patient dissatisfaction, currently in the central nervous system therapeutic area. In March 2010, the U.S. Food and Drug Administration, or FDA, approved our New Drug Application, or NDA, for Silenor 3 mg and 6 mg tablets for the treatment of insomnia characterized by difficulty with sleep maintenance. Silenor was made commercially available by prescription in the United States in September 2010.

Our principal focus is on commercial activities relating to Silenor. We commercially launched Silenor in September 2010 with 110 sales representatives provided to us on an exclusive basis under our contract sales agreement with Publicis, managed by our sales management personnel, and an additional 105 sales representatives provided to us under our co-promotion agreement with P&G. In February 2011, we amended our agreement with Publicis to have Publicis deploy for us an additional 35 sales representatives. Because we did not believe that the growth of Silenor revenues throughout 2011 was sufficient to support sales and marketing expenses at then-current levels, we terminated our agreements with Publicis and P&G in December 2011 in an effort to conserve cash, and effective January 3, 2012, we hired a reduced sales force to cover 25 sales territories to promote Silenor. The remainder of the Publicis sales force ceased promoting Silenor as of November 2, 2011. Our financial statements as of December 31, 2011 reflect all remaining contractual obligations owed to Publicis.

In June 2011, we entered into agreements with Paladin Labs Inc., or Paladin, under which Paladin has the right to commercialize Silenor in Canada, South America, the Caribbean and Africa, subject to the receipt of marketing approval in each such territory. In April 2012, we entered into agreements with CJ CheilJedang Corporation, or CJ CheilJedang, under which CJ CheilJedang has the right to commercialize Silenor in South Korea, subject to the receipt of marketing approval in South Korea.

Critical Accounting Policies and Estimates

Management's discussion and analysis of our financial condition and results of operations is based on our condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those estimates. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our condensed financial statements.

Revenue Recognition

Product Sales

We sell Silenor to wholesale pharmaceutical distributors. Our returned goods policy generally permits our customers to return products beginning six months before and up to twelve months after the expiration date of the product. We authorize returns for expired products in accordance with our returned goods policy and issue credit to our customers for expired returned product. We do not exchange product from inventory for returned product. Through March 31, 2012, the dollar amount of returns received since we commenced commercial shipments of Silenor (in August 2010) has been negligible.


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We recognize product revenue from product sales when it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) our price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) our price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid us, or the buyer is obligated to pay us and the obligation is not contingent on resale of the product, (3) the buyer's obligation to us would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by us, (5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated.

Prior to the second quarter of 2011, we were unable to reasonably estimate returns. We therefore deferred revenue recognition until the right of return no longer existed, which was the earlier of Silenor being dispensed through patient prescriptions or the expiration of the right of return. We estimated patient prescriptions dispensed using an analysis of third-party information. In order to develop a methodology to reliably estimate product returns and provide a basis for recognizing revenue on sales to customers at the time of product shipment, we analyzed many factors, including, without limitation, industry data regarding product return rates, and tracked the Silenor product return history, taking into account product expiration dating at the time of shipment and levels of inventory in the wholesale channel compared to prescription units dispensed and the sell-down of our launch inventory. During the second quarter of 2011, the sell-down of our launch inventory was completed, which we believe demonstrates sufficient market acceptance of our product for purposes of our revenue recognition analysis. In addition, since product launch, we have sold product to wholesale pharmaceutical distributors at standard commercial terms utilized in the industry. As a result, we believe we can analogize to industry data regarding product return rates. Based on the sell-down of our launch inventory and the industry and internal data gathered, we believe we have the information needed to reasonably estimate product returns. As a result, in the second quarter of 2011, we began recognizing revenue for Silenor sales at the time of delivery of the product to wholesale pharmaceutical distributors and our other customers.

License and Royalty Revenue

In June 2011, we entered into a license agreement with Paladin pursuant to which Paladin has the exclusive right to commercialize Silenor in Canada, South America, the Caribbean and Africa subject to the receipt of marketing approval in each such territory. We received an upfront payment of $500,000 in connection with the execution of this agreement. We recorded the upfront payment as deferred revenue and are recognizing the upfront payment as license revenue over the period of our significant involvement under the agreement, which we are estimating to be 15 years. As of March 31, 2012, the deferred revenue balance associated with the license agreement is $472,000, of which $439,000 is recorded as a non-current liability and the remainder is recorded as a current liability within accrued liabilities. We recognized $8,000 as revenue during the three months ended March 31, 2012, which is recorded in interest and other income.

If Silenor is commercialized in the licensed territories, we would be eligible to receive sales-based milestone payments of up to $128.5 million as well as a tiered double-digit percentage of net sales in the licensed territories. Due to the uncertainty surrounding the achievement of these future sales-based milestones and royalties, these potential payments will not be recognized as revenue until they are realized and earned.

Product Sales Discounts and Allowances

We record product sales discounts and allowances at the time of sale and report revenue net of such amounts in the same period that product sales are recorded. In determining the amount of product sales discounts and allowances, we must make significant judgments and estimates. If actual results vary from our estimates, we may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment. Our product sales discounts and allowances and the specific considerations we use in estimating these amounts include:


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Prompt Pay Discounts. As an incentive for prompt payment, we offer a 2% cash discount to customers. We calculate the discount based on the gross amount of each invoice as we expect that all customers will comply with the contractual terms to earn the discount. We record the discount as an allowance against accounts receivable and a corresponding reduction of revenue. At March 31, 2012 and December 31, 2011, the allowance for prompt pay discounts was $31,000 and $39,000, respectively.

Patient Discount Programs. We offer discount programs to patients of Silenor under which the patient receives a discount on his or her prescription. We reimburse pharmacies for these discounts through third-party vendors. We estimate the total amount that will be redeemed based on the dollar amount of the discounts, the timing and quantity of distribution and historical redemption rates. We accrue the discounts and recognize a corresponding reduction of revenue. At March 31, 2012 and December 31, 2011, the accrual for patient discount programs was $400,000 and $414,000, respectively.

Distribution Service Fees. We pay distribution services fees to each wholesaler for distribution and inventory management services. We accrue for these fees based on contractually defined terms with each wholesaler and recognize a corresponding reduction of revenue. At March 31, 2012 and December 31, 2011, the accrual for distribution service fees was $231,000 and $319,000, respectively.

Chargebacks. We provide discounts to federal government qualified entities with whom we have contracted. These federal entities purchase products from the wholesalers at a discounted price, and the wholesalers then charge back to us the difference between the current retail price and the contracted price the federal entity paid for the product. We accrue chargebacks based on contract prices and sell-through sales data obtained from third party information. At March 31, 2012 and December 31, 2011, the accrual for chargebacks was $28,000 and $24,000, respectively.

Rebates. We participate in certain rebate programs, which provide discounted prescriptions to qualified insured patients. Under these rebate programs, we pay a rebate to the third-party administrator of the program. We accrue rebates based on contract prices, estimated percentages of product sold to qualified patients and estimated levels of inventory in the distribution channel. Our accrual consists of: (1) the amount expected to be incurred based on the current quarter's product sold, (2) an accrual for unpaid rebates relating to prior quarters, and (3) an accrual for rebates relating to estimated inventory in the distribution channel. Our estimate of utilization is based on partial claims history data received, third-party data, and information about our expected patient population. At March 31, 2012 and December 31, 2011, the accrual for rebates was $1,761,000 and $1,896,000, respectively.

Product Returns. We estimate future product returns based upon actual returns history, product expiration dating analysis, estimated inventory levels in the distribution channel, and industry data regarding product return rates for similar products. There may be a significant time lag between the date we determine the estimated allowance and when we receive product returns and issue credits to customers. Due to this time lag, we may record adjustments to our estimated allowance over several periods, which would impact our operating results in those periods. At March 31, 2012 and December 31, 2011, the allowance for product returns was $380,000 and $255,000, respectively.

As we expand our managed care rebate programs and discount programs to offset patients' out of pocket costs, we expect product sales discounts and allowances to increase.

The following table summarizes the activity for the three months ended March 31, 2012 associated with product sales discounts and allowances, with amounts shown in thousands:

                                     Prompt          Patient                              Charge-
                                       Pay           Discount        Distribution        backs and        Product
                                    Discounts          Fees          Service Fees         Rebates         Returns       Total
Balance at January 1, 2012         $        39      $      414      $          319      $     1,920      $     255     $  2,947
Current period provision                    88             277                 297              865            125        1,652
Payments and other credits                 (96 )          (291 )              (385 )           (996 )           -        (1,768 )

Balance at March 31, 2012          $        31      $      400      $          231      $     1,789      $     380     $  2,831


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Cost of Sales

Cost of sales includes the costs to manufacture, package, and ship Silenor, including personnel costs associated with manufacturing oversight, as well as royalties and amortization of capitalized license fees associated with our license agreement with ProCom One, Inc., or ProCom.

Inventory

Our inventories are valued at the lower of weighted average cost or net realizable value. We analyze our inventory levels quarterly and write down inventory that has become obsolete, or has a cost basis in excess of its expected net realizable value, as well as any inventory quantities in excess of expected requirements. Expired inventory is disposed of and the related costs are written off. We did not record any significant write-downs of obsolete or excess inventory during the three months ended March 31, 2012.

Capitalized License Fees

License fees related to our intellectual property are capitalized once technological feasibility has been established. Determining when technological feasibility has been achieved, and determining the related amortization period for capitalized intellectual property, requires the use of estimates and subjective judgment. Costs incurred to in-license our product candidates subsequent to FDA approval of our NDA for Silenor have been capitalized and recorded as an intangible asset. Capitalized amounts are amortized on a straight line basis over approximately ten years.

Share-based Compensation

Share-based compensation expense for employees and directors is recognized in the statement of operations based on estimated amounts, including the grant date fair value, the probability of achieving performance conditions and the expected service period for awards with conditional vesting provisions. For stock options, we estimate the grant date fair value using the Black-Scholes valuation model which requires the use of multiple subjective inputs including an estimate of future volatility and the expected terms of the awards. Our stock did not have a readily available market prior to our initial public offering in December 2005, creating a relatively short history from which to obtain data to estimate volatility for our stock price. Consequently, we estimate our expected future volatility based on a combination of both comparable companies and our own stock price volatility to the extent such history is available. Our future volatility may differ from our estimated volatility at the grant date. We estimate the expected term of our options using guidance provided by the Securities and Exchange Commission, or SEC, in Staff Accounting Bulletin, or SAB, No. 107 and SAB No. 110. This guidance provides a formula-driven approach for determining the expected term. Share-based compensation recorded in our statement of operations is based on awards expected to ultimately vest and has been reduced for estimated forfeitures. Our estimated forfeiture rates may differ from actual forfeiture rates which would affect the amount of expense recognized during the period. Estimated forfeitures are adjusted to actual amounts as they become known.

We recognize the value of the portion of the awards that are expected to vest on a straight-line basis over the awards' requisite service periods. The requisite service period is generally the time over which our share-based awards vest. Some of our share-based awards vested upon achieving certain performance conditions, generally pertaining to the commercial performance of Silenor or the achievement of other strategic objectives. Share-based compensation expense for awards with performance conditions is recognized over the period from the date the performance condition is determined to be probable of occurring through the time the applicable condition is met. If the performance condition is not considered probable of being achieved, then no expense is recognized until such time the performance condition is considered probable of being met. At that time, expense is recognized over the period during which the performance condition is likely to be achieved. Determining the likelihood and timing of achieving performance conditions is a subjective judgment made by management which may affect the amount and timing of expense related to these share-based awards. Share-based compensation is adjusted to reflect the value of options which ultimately vest as such amounts become known in future periods. As a result of these subjective and forward-looking estimates, the actual value of our stock options realized upon exercise could differ significantly from those amounts recorded in our financial statements.


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Results of Operations

Comparisons of the Three Months Ended March 31, 2012 and 2011

Product Sales. Net product sales represent sales of Silenor for which we have
recognized revenue, and are summarized in the following table (in thousands).



                                         Three Months Ended
                                             March  31,                     Change
                                          2012          2011         Dollar        Percent
 Gross product sales                   $    4,393      $ 2,877      $  1,516             53 %
 Sales discounts and allowances
 Prompt pay discount                          (88 )        (55 )         (33 )           60 %
 Patient discount programs                   (277 )        (95 )        (182 )          192 %
 Distribution service fees                   (297 )       (204 )         (93 )           46 %
 Chargebacks and rebates                     (865 )        (14 )        (851 )         6079 %
 Product returns and other discounts         (125 )       (187 )          62            (33 %)

 Total discounts and allowances            (1,652 )       (555 )      (1,097 )          198 %

 Total net product sales               $    2,741      $ 2,322      $    419             18 %

We recognized net product sales of $2.7 million and $2.3 million for the three months ended March 31, 2012 and 2011, respectively. Sales discounts and allowances totaled $1.7 million for the three months ended March 31, 2012, compared to $0.6 million for the same period in 2011. As a percentage of gross sales, the discounts and allowances were 37.6% and 19.3% for the three months ended March 31, 2012 and 2011, respectively. The increases in gross product sales and sales discounts and allowances are due to growth of sales of Silenor since the commencement of Silenor sales in the third quarter of 2010. The increase in sales discounts as a percentage of gross product sales is primarily due to an expansion in our participation in payor rebate programs.

Cost of Sales. Cost of sales includes the costs to manufacture, package, and ship Silenor, including personnel costs associated with manufacturing oversight, as well as royalties and amortization of capitalized license fees associated with our license agreement. Cost of sales is summarized in the following table (in thousands).

Three Months Ended March 31, Change 2012 2011 Dollar Percent Cost of sales $ 274 $ 363 $ (89 ) (25 %)

We recognized cost of sales of $0.3 million and $0.4 million for the three months ended March 31, 2012 and 2011, respectively, relating to product with respect to which revenue was recognized. The decrease in cost of sales expense was due to a reduction in personnel and related costs resulting from cost reduction initiatives we implemented in the fourth quarter of 2011. Gross profit was $2.5 million and $2.0 million for the three months ended March 31, 2012 and 2011, respectively. Expressed as a percentage of net product sales, gross margin was 90.0% and 84.4% for the three months ended March 31, 2012 and 2011, respectively.

Selling, General and Administrative Expenses. Our selling, general and administrative expenses consist primarily of salaries, benefits, share-based compensation expense, the costs of our sales representatives, royalties paid to our co-promotion partner, personnel costs and other promotional spending and consulting costs, advertising and market research costs, insurance and facility costs, and professional fees related to our marketing, administrative, finance, human resources, legal and internal systems support functions. Selling, general and administrative expenses are summarized in the following table (in thousands, except percentages).


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                                                 Three Months Ended
                                                     March 31,                       Change
                                                2012            2011         Dollar          Percent
Sales and marketing                           $   1,812       $ 13,519      $ (11,707 )           (87 %)
General and administrative                        2,788          5,074         (2,286 )           (45 %)

Total selling, general and administrative
expense                                       $   4,600       $ 18,593      $ (13,993 )           (75 %)

Selling and marketing expenses totaled $1.8 million and $13.5 million for the three months ended March 31, 2012 and 2011, respectively. Of this, share-based compensation expense totaled $29,000 and $0.3 million for the three months ended March 31, 2012 and 2011, respectively. The decrease in our selling and marketing expenses of $11.7 million in comparison to the prior year was primarily due to the reduction in the scope of our commercial operations and marketing activities which we implemented during the fourth quarter of 2011. During the first quarter of 2012, we also negotiated reductions in amounts included in accounts payable at December 31, 2011 resulting in a $0.3 million reduction of selling and marketing expenses for the three months ended March 31, 2012.

General and administrative expenses totaled $2.8 million and $5.1 million for the three months ended March 31, 2012 and 2011, respectively. Of this, share-based compensation expense totaled $0.7 million and $0.8 million for the three months ended March 31, 2012 and 2011, respectively. The decrease in our general and administrative expenses of $2.3 million in comparison to the prior year was primarily due to the reduction in our headcount and other cost savings initiatives implemented by us during the fourth quarter of 2011.

Research and Development Expense. Research and development expenses are summarized in the following table (in thousands, except percentages).

                                           Three Months Ended
                                               March  31,                    Change
                                          2012           2011        Dollar        Percent
Personnel and other costs                $    -        $     273     $  (273 )         (100 )%
Share-based compensation expense              -              146        (146 )         (100 )%

Total research and development expense   $    -        $     419     $  (419 )         (100 )%

Our most significant research and development costs have typically consisted of salaries, benefits and share-based compensation expense related to our research and development personnel. In connection with our other cost reduction initiatives implemented during the fourth quarter of 2011, we discontinued all of our ongoing research and development activities. Previously, research and development costs were incurred in connection with ongoing process validation associated with Silenor.

Liquidity and Capital Resources

As of March 31, 2012, we had $7.8 million in cash and cash equivalents which consisted of cash on deposit at financial institutions and money market funds. We will need to obtain additional funds to finance our operations. Actual financial results for the period of time through which our financial resources will be adequate to support our operations could vary based upon many factors, including but not limited to Silenor sales performance, the actual cost of commercial activities and any potential litigation expenses we may incur.

Since inception, our operations have been financed primarily through the sale of equity securities and the proceeds from the exercise of warrants and stock options. We have incurred losses from operations and negative cash flows since our inception, and we expect to continue to incur losses and have negative cash flows from operations in the foreseeable future as we continue our commercial activities for Silenor, commercialize any other products to which we obtain rights and potentially pursue the development of other product candidates. Based on our recurring losses, negative cash flows from operations and working capital levels, we will need to raise substantial additional funds to finance our operations. If we are unable to maintain sufficient financial resources, including by raising additional funds when needed, our business, financial condition and results of operations will be materially and adversely affected. The report of our independent registered public accounting firm on our financial statements for the year ended December 31, 2011 contained an explanatory paragraph stating that our recurring losses raise substantial doubt about our ability to continue as a going concern.

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