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PTX > SEC Filings for PTX > Form 10-K on 18-Mar-2013All Recent SEC Filings

Show all filings for PERNIX THERAPEUTICS HOLDINGS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for PERNIX THERAPEUTICS HOLDINGS, INC.


18-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of Pernix's consolidated financial condition and results of operations together with the consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K. In addition to historical information, the following discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Pernix's actual results may differ materially from those anticipated in these forward-looking statements as a result of many important factors, including, but not limited to, those set forth in "Item 1A - Risk Factors" of Part I of this Annual Report Form 10-K.

Overview

Pernix Therapeutics Holdings, Inc. ("Pernix", the "Company", "we" or "our") is a specialty pharmaceutical company focused on the sales, marketing, manufacturing and development of branded, generic and over-the-counter, which we refer to herein as OTC, pharmaceutical products for pediatric and adult indications in a variety of therapeutic areas. We expect to execute our growth strategy which includes the horizontal integration of our branded prescription, generic and OTC businesses. We also plan to continue to make strategic acquisitions of products and companies, as well as develop and in-license additional products. We manage a portfolio of branded and generic products. Our branded products for the pediatrics market include CEDAX®, an antibiotic for middle ear infections, NATROBA®, a topical treatment for head lice marketed under an exclusive co-promotion agreement with ParaPRO, LLC, and a family of prescription treatments for cough and cold (ZUTRIPRO®, REZIRA®, BROVEX®, ALDEX® and PEDIATEX®). Our branded products for gastroenterology include OMECLAMOX-PAK®, a 10-day treatment for H. pylori infection and duodenal ulcer disease, and REZYST®, a probiotic blend to promote dietary management. Through our wholly-owned subsidiary Pernix Sleep (formerly Somaxon Pharmaceuticals, Inc.), we market SILENOR® (doxepin), which is approved for the treatment of insomnia characterized by difficulty with sleep maintenance and is not a controlled substance. Through our license agreement with Pharmaceutical Associates, Inc., we market VERIPRED™, a prescription drug product indicated for the control of severe allergic conditions. In addition, a product candidate utilizing cough-related intellectual property is in development for the U.S. OTC market. We promote our branded pediatric and gastroenterology products through our sales force. We market our generic products in the areas of cough and cold, pain, vitamins, dermatology, antibiotics and gastroenterology through our wholly-owned subsidiaries, Macoven Pharmaceuticals and Cypress Pharmaceuticals. Our wholly-owned subsidiary, Pernix Manufacturing, manufactures and packages products for the pharmaceutical industry in a wide range of dosage forms.


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The Company promotes its branded, and certain of its generic products, through an established U.S. sales force of approximately 123 sales representatives, as of March 15, 2013, including approximately 65 sales representatives acquired in the acquisition of Cypress as discussed below, primarily in highly populated states, targeting pediatric and high-prescribing physicians that are in the top decile of physicians that prescribe our products. Approximately 18 of these sales representatives are dedicated exclusively to the gastroenterology market focusing on the promotion of OMECLAMOX-PAK®. Since January 2011, we have added 46 new sales reps at varying dates throughout the two-year period. Our current operating plan focuses on maximizing sales of our existing expanded product portfolio. In addition, we plan to accelerate growth by launching new products, line extensions, new formulations and acquiring and licensing approved products.

Merger with Somaxon. On March 6, 2013, the Company acquired all of the outstanding common stock of Somaxon Pharmaceuticals, Inc. pursuant to an agreement and plan of merger dated December 10, 2012. As a result of the merger, each outstanding share of Somaxon common stock was converted into the right to receive approximately 0.478 shares of the Company's common stock, with cash paid in lieu of fractional shares. As a result of the merger, the Company issued an aggregate of approximately 3,665,689 shares of its common stock to the former stockholders of Somaxon.

Acquisition of Cypress. On December 31, 2012, we completed the acquisition of a privately-owned, generic pharmaceutical company, Cypress Pharmaceuticals, Inc. and its branded pharmaceutical subsidiary Hawthorn Pharmaceuticals, Inc., which we refer to collectively herein as Cypress. Cypress offers a wide array of generic pharmaceutical products in the areas of cough and cold, nutritional supplements, analgesics, urinary tract, women's health, pre-natal vitamins and dental health, as well as allergy, respiratory, iron deficiency, nephrology and pain management. Hawthorn offers a broad portfolio of branded products including allergy, respiratory, iron deficiency, nephrology and pain management. We paid an aggregate purchase price of up to $102.3 million. This purchase price included $52 million in cash, 4,427,084 shares of our common stock having an aggregate market value equal to approximately $34.3 million based on the closing price per share of $7.75 as reported on the NYSE MKT LLC on December 31, 2012, up to $6.5 million in holdback and contingent payments, $4.5 million to be deposited in escrow on December 15, 2013, and $5.0 million in shares of our common stock contingent upon the occurrence of a milestone event.

As part of the funding for this acquisition, we entered into a $42 million credit facility on December 31, 2012 with Midcap Funding V, LLC, as administrative agent, as a lender and as co-bookrunner and sole lead arranger, Business Development Corporation of America, as co-bookrunner, and additional lenders from time to time party thereto. Subject to certain permitted liens, our obligations under this facility are secured by a first priority perfected security interest in substantially all of our assets and the assets of our subsidiaries. The proceeds from this facility were used to fund a portion of the cash consideration of the acquisition of Cypress. The MidCap Credit Agreement includes customary covenants for a secured credit facility, which include, among other things, (a) restrictions on (i) the incurrence of indebtedness, (ii) the creation of or existence of liens, (iii) the incurrence or existence of contingent obligations, (iv) making certain dividends or other distributions,
(v) certain consolidations, mergers or sales of assets, (vi) purchases of assets, investments and acquisitions and (vii) capital expenditures; and (b) requirements to deliver financial statements, reports and notices to the administrative agent and other lenders; provided that, the restrictions described in (a)(i)-(vii) above are subject to certain exceptions and permissions limited in scope and dollar value.

The MidCap Credit Agreement also contains certain financial covenants that require the Company not to permit: (1) the fixed charge coverage ratio for the twelve (12) month period ending on any date set forth below to be less than the ratio set forth below for such date (A) 1.15 to 1.00 on March 31, 2013; (B) 1.20 to 1.00 on June 30, 2013, September 30, 2013 and December 31, 2013; (C) 1.25 to 1.00 on March 31, 2014, June 30, 2014, September 30, 2014 and December 31, 2014; and (D) 1.30 to 1.00 from March 31, 2015 and the last day of each calendar quarter ending thereafter; and (2) a total debt to EBITDA ratio for the twelve
(12) month period ending on any date set forth below to exceed the ratio set forth below for such date: (A) 3.75 to 1.00 on March 31, 2013; (B) 3.60 to 1.00 on June 30, 2013; (C) 3.00 to 1.00 on September 30, 2013; (D) 2.50 to 1.00 on December 31, 2013, March 31, 2014, June 30, 2014, September 30, 2014 and December 31, 2014; (E) 2.00 to 1.00 on March 31, 2015 and June 30, 2015; (F) 1.75 to 1.00 on September 30, 2015 and December 31, 2015; (G) 1.50 to 1.00 on March 31, 2016; (H) 1.25 to 1.00 on June 30, 2016 and September 30, 2016; and
(I) 1.00 to 1.00 on December 31, 2016 and the last day of each calendar quarter ending thereafter.The MidCap Credit Agreement also contains customary representations and warranties and event of default provisions for a secured credit facility.

For additional information regarding our credit facility, see Note 13, Debt and Lines of Credit, to our Consolidated Financial Statements for the years ended December 31, 2012 and 2011. For additional information regarding our acquisition of Cypress, see Note 4, Business Combinations and Other Acquisitions, and Note 10, Intangible Assets and Goodwill, to our Consolidated Financial Statements for the years ended December 31, 2012 and 2011.


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Acquisition of New Product. In August 2012, the Company completed the purchase of a pediatric prescription product, including certain intellectual property rights, for a total purchase price of $1.35 million plus the assumption of certain liabilities. The Company paid $500,000 at the closing plus $250,000 on October 1, 2012, $600,000 on February 1, 2013, and assumed certain liabilities.

Amended and Restated Co-Promotion Agreement for NATROBA. We entered into an exclusive co-promotion agreement with ParaPRO for NATROBA in certain U.S. territories. In July 2012, the Company and ParaPRO replaced their then-existing co-promotion and supply agreements relating to NATROBA™ with a new agreement to restructure the terms for marketing and distributing NATROBA. Under the terms of the new agreement, the Company will no longer have the minimum purchase order commitments related to the marketing and promotion of NATROBA that were required under the previous agreements. If the Company fails to meet certain dispensed volumes, the Company or ParaPRO would have the option to either modify or terminate the new agreement. The previous options granted to ParaPRO under its services agreement with the Company were not impacted by this new agreement. The Company and ParaPRO currently co-promote and market NATROBA, as well as an authorized generic equivalent. The Company pays a co-promotion fee per unit prescribed which is recorded as co-promotion revenue. The cost that the Company pays for NATROBA is significantly higher than the direct manufacturing cost that the Company pays on the other products in our portfolio which impacts our gross profit margin.

Acquisition of GSL. On July 2, 2012, we completed our acquisition of the business assets of GSL, a pharmaceutical contract manufacturing company located in Houston, Texas. We closed on the related real estate on August 30, 2012. Upon the final closing, we paid an aggregate of approximately $4.6 million, net of the $300,000 escrow that was refunded to us subsequent to close, and assumed certain liabilities totaling approximately $5.9 million, for substantially all of GSL's assets, including the land and buildings in which GSL operates. GSL has an established manufacturing facility with an existing base of customers in the pharmaceutical industry, which provides us with additional income and potential cost savings. We acquired the GSL assets through our wholly owned subsidiary, Pernix Manufacturing, LLC. See Note 4, Business Combinations and Other Acquisitions, to our Consolidated Financial Statements for the years ended December 31, 2012 and 2011 for further discussion.

U.S. License of Cough, Cold, Sinus & Allergy Intellectual Property. On May 14, 2012, the Company acquired the exclusive rights from SEEK, its former joint venture partner, to commercialize and market products utilizing the joint venture's intellectual property (IP) in the areas of cough, cold, sinus and allergy in the United States and Canada for $5 million. The investment in the JV at termination was approximately $1,445,000 and there was approximately $2,687,000 arising from a deferred tax liability. The value of the license recorded was approximately $9,133,000. Under the terms of the agreement, Pernix will pay royalties to SEEK on sales of products utilizing the joint venture IP in the United States and Canada. Pernix will also receive royalties from SEEK product sales outside of the United States and Canada. As a result, we no longer share in the development costs outside the United States and Canada. See Note 9, Investment in Joint Venture, to our Consolidated Financial Statements for the years ended December 31, 2012 and 2011 for further discussion.

License of Gastroenterology Product. In January 2012, we entered into a license and supply agreement with a private company for OMECLAMOX-PAK, an FDA-approved prescription product to treat gastroenterology disease. Under the terms of the agreement, we obtained exclusive marketing rights to this product in the United States. We paid an up-front license fee of $2.0 million and an additional fee of $2.0 million upon commercial launch of the product in July 2012. In addition to these license fees, the agreement calls for us to pay royalties and milestone payments based on the sales of the product.

For the years ended December 31, 2012 and 2011, our net sales were approximately $61,313,000 and $60,607,000, respectively, and our net (loss) income before income taxes was approximately ($1,410,000) and $12,937,000, respectively.

Our net cash provided by (used in) operating activities for the years ended December 31, 2012 and 2011 was approximately ($1,926,000) and $9,397,000, respectively.

Financial Operations Overview

The discussion in this section describes our consolidated income statement categories. For a discussion of our consolidated results of operations, see "Results of Operations" below.

Net Revenues

Pernix's net revenues consist of net product sales, manufacturing revenue and revenue from co-promotion and other revenue sharing agreements. Pernix recognizes product sales net of estimated allowances for product returns, price adjustments (including customer rebates, service fees, chargebacks and other discounts), government program rebates (Medicaid, Medicare and other government sponsored programs) and prompt pay discounts. The primary factors that determine Pernix's net product sales are the level of demand for Pernix's products, unit sales prices, the applicable federal and supplemental government program rebates, contracted rebates, chargebacks and service fees and other discounts that Pernix may offer. In addition to our own product portfolio, from time to time we may enter into co-promotion or other revenue sharing arrangements pursuant to which we receive a percentage of revenue on sales of our products that they generate. Revenue from agreements pursuant to which contracted third parties market products to which we have rights and submit a specified profit share to us and other revenue such as sales of API (active pharmaceutical ingredients) was approximately $4,514,000 and $4,634,000 for the years ended December 31, 2012 and 2011, respectively. Manufacturing revenue from Pernix Manufacturing, acquired in July 2012 as discussed previously, was approximately $5,424,000 and 0 for the years ended December 31, 2012 and 2011.


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The following table sets forth a summary of Pernix's net sales revenue for the years ended December 31, 2012 and 2011.

                                                         Year Ended December 31,
                                                           2012             2011
                                                              (in thousands)
  Upper respiratory, allergy and antibiotic products   $     39,094       $  61,454
  ENT                                                           958               -
  Gastroenterology                                            5,896               -
  Dietary supplements and medical food products              11,964           4,509
  Dermatology products (including NATROBA)                    7,174          12,633
  Other generic products                                     16,978           8,152
    Gross Product Sales                                      82,064          86,748
    Sales Allowances                                        (30,689 )       (30,775 )
     Net Product Sales                                       51,375          55,973
  Manufacturing revenue                                       5,424               -
  Co-promotion and other revenue                              4,514           4,634
  Net Sales Revenues                                   $     61,313       $  60,607

Allowances for Prompt Pay Discounts, Product Returns, Price Adjustments, and
Medicaid Rebates

The following table sets forth a summary of our allowances for product returns,
government program rebates and price adjustments as of December 31, 2012:

                                                                       Government
                                                       Product          Program
                                                       Returns          Rebates          Price Adjustments
                                                                         (in thousands)
Balance at December 31, 2010                         $     4,313     $        4,432     $             1,744
Current provision:
  Adjustments to provision for prior year sales              498              1,137                     300
  Provision - current year sales                           4,784              9,969                  12,311
Payments and credits                                      (3,883 )           (9,695 )                (8,904 )
Balance at December 31, 2011                               5,712              5,843                   5,451
Allowances assumed in acquisition of Cypress               5,901              1,175                   4,586
Current provision:
  Adjustments to provision for prior year sales            1,840             (1,075 )                  (272 )
  Provision - current year sales                           5,426              7,689                  15,368
Payments and credits                                      (6,822 )           (6,595 )               (14,173 )
Balance at December 31, 2012                         $    12,057     $        7,037     $            10,960

Product Returns. Consistent with industry practice, we offer contractual return rights that allow our customers to return short-dated or expiring products within an 18-month period, commencing from six months prior to and up to twelve months subsequent to the product expiration date. Our products have a 15 to 36-month expiration period from the date of manufacture. We adjust our estimate of product returns if we become aware of other factors that we believe could significantly impact our expected returns. These factors include our estimate of inventory levels of our products in the distribution channel, the shelf life of the product shipped, review of consumer consumption data as reported by external information management companies, actual and historical return rates for expired lots, the forecast of future sales of the product, competitive issues such as new product entrants and other known changes in sales trends. We estimate returns at percentages up to 14% of sales of branded products (including a 14% return estimate applied to launch-year sales of Omeclaxom-Pak®). We estimate returns at percentages up to 10% on sales of generic products. The returns estimate on certain generic products was increased approximately 2% effective April 1, 2012 from prior periods due to the potential impact of changes in Medicaid coverage on certain products. Also, the returns estimate was increased 5% on a generic product that contributes approximately 16% of our gross revenue to consider higher than expected returns as a result of a shorter shelf-life than the rest of the generic products in our portfolio. Returns estimates are based upon historical data and other facts and circumstances that may impact future expected returns to derive an average return percentage for our products. In addition to the accrual on sales during the year ended December 31, 2012, we recorded an additional returns allowance of approximately $1,840,000 ($1,220,000 in the fourth quarter, $120,000 in the third quarter and $500,000 in the second quarter) as a result of higher than expected returns primarily on products that lost Medicaid coverage in 2012 and certain generic products launched in 2011. The returns reserve may be adjusted as we accumulate sales history and returns experience on our portfolio of products. We review and adjust these reserves quarterly. If estimates regarding product demand are inaccurate, if changes in the competitive environment effect demand for certain products, or if other unforeseen circumstances effect a product's salability, actual returns could differ and such differences could be material. For example, a 1% difference in our provision assumptions for the year ended December 31, 2012 would have affected pre-tax earnings by approximately $834,000.


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Government Program Rebates. The liability for government program rebates is estimated based on historical and current rebate redemption and utilization rates contractually submitted by each state's program administrator and assumptions regarding future government program utilization for each product sold. As we become aware of changing circumstances regarding the Medicaid and Medicare coverage of our products, we will continue to incorporate such changing circumstances into the estimates and assumptions that we use to calculate government program rebates. If our estimates and assumptions prove inaccurate, we may be subject to higher or lower government program rebates. For example, with respect to the provision for the year ended December 31, 2012, a 1% difference in the provision assumptions based on utilization would have effected pre-tax earnings by approximately $194,000 and a 1% difference in the provisions based on reimbursement rates would have affected pre-tax earnings by approximately $81,000.

Price Adjustments. Our estimates of price adjustments which include customer rebates, service fees, chargebacks and other discounts are based on our estimated mix of sales to various third-party payors who are entitled either contractually or statutorily to discounts from the listed prices of our products and contracted service fees with our wholesalers. In the event that the sales mix to third-party payors or the contract fees paid to the wholesalers are different from our estimates, we may be required to pay higher or lower total price adjustments than originally estimated. For example, for the year ended December 31, 2012, a 1% difference in the assumptions based on the applicable sales would have affected pre-tax earnings by approximately $1,387,000.

We, from time to time, offer certain promotional product-related incentives to our customers. These programs include sample cards to retail consumers, certain product incentives to pharmacy customers and other sales stocking allowances. For example, we have initiated coupon programs for certain of our promoted products whereby we offer a point-of-sale subsidy to retail consumers. We estimate our liabilities for these coupon programs based on redemption information provided by a third party claims processing organization. We account for the costs of these special promotional programs as a reduction of gross revenue when applicable products are sold to the wholesalers or other retailers. Any price adjustments that are not contractual but that are offered at the time of sale are recorded as a reduction of revenue when the sales order is recorded. These adjustments are not accrued as they are offered on a non-recurring basis at the time of sale and are recorded as an expense at the time of the sale. These allowances may be offered at varying times throughout the year or may be associated with specific events such as a new product launch or to reintroduce a product. Approximately 18% of the provision relates to point-of-sale discounts to the wholesaler.

Prompt Payment Discounts. We typically require our customers to remit payments within the first 30 days for branded products (60 to 120 days for generics, depending on the customer and the products purchased). We offer wholesale distributors a prompt payment discount if they make payments within these deadlines. This discount is generally 2% to 3%, but may be higher in some instances due to product launches and/or industry expectations. Because our wholesale distributors typically take advantage of the prompt pay discount, we accrue 100% of the prompt pay discounts, based on the gross amount of each invoice, at the time of our original sale, and apply earned discounts at the time of payment. This allowance is recorded as a reduction of accounts receivable and revenue. We adjust the accrual periodically to reflect actual experience. Historically, these adjustments have not been material. We do not anticipate that future changes to our estimates of prompt payment discounts will have a material impact on our net revenue. Prompt pay discounts were approximately $1,713,000 and $1,775,000 for the years ended December 31, 2012 and 2011, respectively.

Cost of Product Sales

Our cost of product sales is primarily comprised of the costs of manufacturing and distributing our pharmaceutical products and profit sharing and royalty expenses related to co-promotion and license agreements with third parties. In particular, cost of product sales includes manufacturing, packaging and distribution costs and the cost of active pharmaceutical ingredients. We partner with third parties to manufacture certain of our products and product candidates while some of our products are manufactured by Great Southern Laboratories, the manufacturing plant that we acquired in July 2012. We expect to utilize Pernix Manufacturing to manufacture more of our products moving forward which should result in a reduction of the cost of certain of our products.


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Most of our manufacturing arrangements with third party manufacturers are not subject to long-term agreements and generally may be terminated by either party without penalty at any time. Changes in the price of raw materials and manufacturing costs could adversely affect our gross margins on the sale of our products. Changes in our mix of products sold also affect our cost of product sales.

From time to time in the ordinary course of business, the Company enters into agreements regarding royalty payments or other profit sharing payments. Royalty expenses include the contractual amounts Pernix is required to pay licensors from which it has acquired the rights to certain of its marketed products. Royalty and profit sharing expenses will vary based on changes in product sales and/or product mix.

For further discussion of our agreements that are subject to a profit split arrangement or royalty, see Note 4, Business Combinations and Other Acquisitions, and Note 17, Other Revenue Sharing Arrangements, to our Consolidated Financial Statements for the years ended December 31, 2012 and 2011.

The cost of NATROBA is included in our cost of product sales from August 2011 (the month of launch) to present. We pay wholesale average cost less a nominal discount when we purchase NATROBA inventory. Under the original agreement with ParaPRO, we received a contracted cost of goods rebate per unit when the product was shipped to retailers in our specified territories. Under the renegotiated terms effective August 12, 2012, we receive a flat co-promotion fee on NATROBA per unit based on prescriptions in our specified territories. Because of the structure of the NATROBA agreement, we recognize significantly lower margins on . . .

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