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CPIX > SEC Filings for CPIX > Form 10-K on 11-Mar-2014All Recent SEC Filings

Show all filings for CUMBERLAND PHARMACEUTICALS INC

Form 10-K for CUMBERLAND PHARMACEUTICALS INC


11-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis of our financial position and results of operations should be read together with our audited consolidated financial statements and related notes appearing elsewhere in this Form 10-K. This discussion and analysis may contain forward-looking statements that involve risks and uncertainties - please refer to the section entitled, "Special Note Regarding Forward-Looking Statements," Contained in Part I, Item 1A, "Risk Factors," of this Form 10-K. You should review the "Risk Factors" section of this Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements described in the following discussion and analysis.
EXECUTIVE SUMMARY
We are a growing specialty pharmaceutical company focused on the acquisition, development and commercialization of branded prescription products. Our primary target markets are hospital acute care and gastroenterology. These markets are characterized by relatively concentrated prescriber bases that we believe can be penetrated effectively by small, targeted sales forces. Cumberland is dedicated to providing innovative products that improve quality of care for patients and address unmet or poorly met medical needs Our product portfolio includes Acetadote® (acetylcysteine) Injection for the treatment of acetaminophen poisoning, Caldolor® (ibuprofen) Injection, the first injectable treatment for pain and fever, Kristalose® (lactulose) for Oral Solution, a prescription laxative, Omeclamox®-Pak, triple therapy combination medication for Helicobacter pylori (H. pylori) infection and duodenal ulcer disease, and Hepatoren (ifetroban) Injection, a Phase II candidate for the treatment of critically ill hospitalized patients suffering from HRS. We market and sell our approved products through our hospital and field sales forces in the United States, which together comprised approximately 60 sales representatives and managers as of December 31, 2013.
We have both product development and commercial capabilities, and believe we can leverage our existing infrastructure to support our expected growth. Our management team consists of pharmaceutical industry veterans experienced in business development, product development, regulatory, manufacturing, sales, marketing and finance. Our business development team identifies, evaluates and negotiates product acquisition, in-licensing and out-licensing opportunities. Our product development team develops proprietary product formulations, manages our clinical trials, prepares all regulatory submissions and manages our medical call center. Our quality and manufacturing professionals oversee the manufacture and release of our products. Our marketing and sales professionals are responsible for our commercial activities, and we work closely with our distribution partners to ensure availability and delivery of our products. We were incorporated in 1999 and have been headquartered in Nashville, Tennessee since inception. During 2009, we completed an initial public offering of our common stock and listing on the NASDAQ exchange.
The following is a summary of our 2013 highlights and recent developments. For more information, please see Part I, Item I, Business, of this Form 10-K.
• In 2013, we added Omeclamox-Pak, a branded prescription product used for the treatment of Helicobacter pylori (H. pylori) infection and duodenal ulcer disease. This innovative product combines three well-known and widely prescribed medications: omeprazole, clarithromycin, and amoxicillin. Our involvement with Omeclamox-Pak was effective October 2013, including recognition of $1.0 million in product revenue during the fourth quarter of 2013, through an agreement with Pernix. We launched our promotion and distribution efforts to support Omeclamox-Pak in early 2014 and we are responsible for the marketing, sale and distribution of the product.

•         In June 2013, we announced that the FDA has approved updated labeling
          for Acetadote. The new labeling revises the product's indication and
          offers new dosing guidance for specific patient populations.


•         We continued our international expansion throughout 2013 by finalizing
          agreements to commercialize Caldolor in several new large markets
          including: India, Indonesia, the Pacific Rim, the Arabian Peninsula,
          Spain, Portugal and the majority of South America.


•         A poster with data from two Caldolor studies involving four hundred
          fifty patients was presented at the Annual Meeting of the American
          Society of Anesthesiologists in San Francisco in October 2013. The
          poster presentation included the safety and efficacy of a shortened
          infusion time of intravenous ibuprofen.


•         We obtained our second U.S. patent for Acetadote in March 2013. The
          claims of the 445 Acetadote Patent encompass the use of the 200 mg/ml
          Acetadote formulation to treat patients with acetaminophen overdose.
          The 445 Acetadote Patent will expire in August 2025. We are continuing
          to seek additional claims to protect our intellectual property
          associated with Acetadote.


•         We extended our relationship with our long-serving, third party
          distribution contractor, Cardinal Health through June 30, 2016. Since
          August 2002 they have exclusively handled U.S. product logistics
          efforts, including warehousing, shipping, customer billing and
          collections.

CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
Accounting Estimates and Judgments
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. We base our estimates on past experience and on other factors we deem reasonable given the circumstances. Past results help form the basis of our judgments about the carrying value of assets and liabilities that are not determined from other sources. Actual results could differ from these estimates. These estimates, judgments and assumptions are most critical with respect to our accounting for revenue recognition, marketable securities, inventory, intangible assets, research and development accounting, provision for income taxes and share-based payment. Revenue Recognition
We recognize revenue in accordance with the SEC's Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104 (together, SAB 101), and Topic 605-15 of the Accounting Standards Codification.
Our revenue is derived primarily from the product sales of Acetadote, Caldolor, Omeclamox-Pak and Kristalose. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable and collectibility is probable. Delivery is considered to have occurred upon either shipment of the product or arrival at its destination based on the shipping terms of the transaction. When these conditions are satisfied, we recognize gross product revenue, which is the price we charge generally to our wholesalers for a particular product. Other revenue, which is a component of net revenues, includes upfront payments under licensing agreements along with grant and rental income. Other income was less than 3 percent of net revenues in 2013, less than two percent in 2012, and less than one percent in 2011.
Our net product revenue reflects the reduction of gross product revenue at the time of initial sales recognition for estimated accounts receivable allowances for chargebacks, cash discounts and damaged product as well as provisions for sales related accruals of rebates, product returns and administrative fees and fee for services. Our financial statements reflect accounts receivable allowances of $0.6 million and $0.2 million at December 31, 2013 and 2012, respectively for chargebacks, discounts and allowances for product damaged in shipment.
The following table reflects our sales-related accrual activity for the periods indicated below:

                                                2013            2012            2011

Balance, January 1                          $ 3,371,863     $ 3,216,622     $ 2,626,313
Current provision                             4,181,403       6,000,830       4,719,231
Current provision for prior period sales              -        (367,060 )       380,235
Actual product returns and credits issued    (5,116,126 )    (5,478,529 )    (4,509,157 )
Balance, December 31                        $ 2,437,140     $ 3,371,863     $ 3,216,622

The allowances for chargebacks, discounts, and damaged products and sales related accruals for rebates and product returns are determined on a product-by-product basis and are established by management as our best estimate at the


time of sale based on each product's historical experience, adjusted to reflect known changes in the factors that impact such allowances and accruals. Additionally, these allowances and accruals are established based on the following:
• The contractual terms with customers;

• Analysis of historical levels of discounts, returns, chargebacks and rebates;

• Communications with customers;

•         Purchased information about the rate of prescriptions being written and
          the level of inventory remaining in the distribution channel, if known;
          and


•         Expectations about the market for each product, including any
          anticipated introduction of competitive products.

The allowances for chargebacks and accruals for rebates and product returns are the most significant estimates used in the recognition of our revenue from product sales. Of the accounts receivable allowances and our sales related accruals, our accrual for fee for services and product returns represents the majority of the balance. Sales related accrued liabilities for rebates, product returns, service fees, and administrative fees totaled $2.4 million, $3.4 million and $3.2 million as of December 31, 2013, 2012 and 2011, respectively. Of these amounts, our estimated liability for fee for services represented $0.5 million, $1.1 million and $1.0 million, respectively, while our accrual for product returns totaled $1.6 million, $1.8 million and $1.8 million, respectively. If the actual amount of cash discounts, chargebacks, rebates, and product returns differs from the amounts estimated by management, material differences may result from the amount of our revenue recognized from product sales. A change in our rebate estimate of one percentage point would have impacted net sales by approximately $0.1 million in each of the three years ended December 31, 2013. A change in our product return estimate of one percentage point would have impacted net sales by $0.3 million, $0.6 million and $0.6 million for the years ended December 31, 2013, 2012 and 2011, respectively. Fair Value of Marketable Securities
We invest in variable rate demand notes and a portfolio of government-backed securities (including U.S. Treasuries, government-sponsored enterprise debentures and government-sponsored adjustable rate mortgage-backed securities), in order to maximize our return on cash. We classify these investments as trading securities, and mark the investments to fair value at the end of each reporting period, with the adjustment being recognized in the statement of income as a component of interest income. These investments are generally valued using observable market prices by third-party pricing services, or are derived from such services' pricing models. The level of management judgment required in establishing fair value of financial instruments for which there is a quoted price in an active market is minimal. Similarly there is little subjectivity or judgment required for instruments valued using valuation models that are standard across the industry and where all parameter inputs are quoted in active markets. Inputs to the models may include, but are not limited to, reported trades, executable bid and ask prices, broker/dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security.
Inventories
We record amounts for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about remaining shelf life, future demand and market conditions. The estimated inventory obsolescence amounts are calculated based upon specific review of the inventory expiration dates and the quantity on-hand at December 31, 2013 in comparison to our expected inventory usage. The amount of actual inventory obsolescence and unmarketable inventory could differ (either higher or lower) in the near term from the estimated amounts. Changes in our estimates would be recorded in the income statement in the period of the change.
Income Taxes
We provide for deferred taxes using the asset and liability approach. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to operating loss and tax credit carry-forwards


and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Our principal differences are related to the timing of deductibility of certain items such as depreciation, amortization and expense for options issued to nonemployees. Deferred tax assets and liabilities are measured using management's estimate of tax rates expected to apply to taxable income in the years in which management believes those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in our results of operations in the period that includes the enactment date.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
The tax benefit associated with the exercise of nonqualified stock options is recognized when the benefit is used to offset income taxes payable. As of December 31, 2013, we have unrecognized federal net operating loss carryforwards associated with the exercise of nonqualified options of $43.4 million. In addition to these unrecognized federal net operating loss carryforwards, as of December 31, 2013, we have recognized federal Orphan Drug and Research and Development tax credits of $1.0 million that expire between 2021 and 2033. Share-Based Payments
We recognize compensation expense for all share-based payments based on the fair value of the award on the date of grant. In addition, incremental compensation expense is recognized upon the modification of equity awards.
During 2011, we began issuing restricted stock awards at no cost in lieu of stock options to employees, directors and consultants. Compensation expense for restricted stock granted to employees and directors is generally equal to the fair market value of the underlying common stock on the date of grant. If a sufficient disincentive for nonperformance does not exist at the date of grant, the compensation cost is remeasured at each reporting date at the then-current fair market value of the underlying common stock until the award vests. The fair value of stock options and warrants are calculated using the Black-Scholes option-pricing model on the date of grant. We estimate volatility in accordance with SAB No. 107, as amended by SAB No. 110. As there was no public market for our common stock prior to our initial public offering and, therefore, a lack of company-specific historical or implied volatility data, we have determined the share-price volatility based on an analysis of certain publicly-traded companies that we consider to be our peers. The comparable peer companies used for our estimated volatility are publicly-traded companies with operations which we believe to be similar to ours. When identifying companies as peers, we consider such characteristics as the type of industry, size and/or type of product(s), research and/or product development capabilities, and stock-based transactions. If we need to evaluate volatility in the future to value stock options, we intend to use our own historical volatility to the extent it is sufficient. We would supplement the estimate of our volatility using peer companies in the above manner until historical information regarding the volatility of our own shares is sufficient. We estimate the expected life of employee share options based on the simplified method allowed by SAB No. 107, as amended by SAB No. 110. Under this approach, the expected term is presumed to be the average between the weighted-average vesting period and the contractual term. The expected term for options granted to non-employees is generally the contractual term of the option. The risk-free interest rate is based on the U.S. Treasury Note, Stripped Principal, on the date of grant with a term substantially equal to the corresponding option's expected term. We have never declared or paid any cash dividends nor do we plan to pay cash dividends in the foreseeable future.
In the second quarter of 2012, we implemented an Option Exchange Program (the "Exchange Program") whereby certain outstanding stock options could be exchanged for shares of restricted stock. The Exchange Program was designed to provide a value-for-value exchange of equity instruments. The fair value of each exchanged option was determined on the date the Exchange Program commenced using the Black-Scholes option fair value model. The following assumptions were used in calculating the fair value of options exchanged in 2012 as part of the Exchange Program.


                                2012
                          Exchange Program

Dividend yield                   -
Expected term (years)        1.3 - 7.3
Expected volatility          37% - 78%
Risk-free interest rate    0.23% - 1.50%

Research and Development
We accrue for and expense research and development costs based on estimates of work performed, patient enrollment or fixed-fee-for-services. As work is performed and/or invoices are received, we adjust our estimates and accruals. To date, our accruals have been within our estimates. Total research and development costs are a function of studies being conducted and will increase or decrease based on the level of activity in any particular year. Intangible Assets
Intangible assets include product rights, license agreements and other identifiable intangible assets. We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate the carrying value may not be recoverable. In determining the recoverability of our intangible assets, we make assumptions regarding estimated future cash flows and other factors. If the estimated undiscounted future cash flows do not exceed the carrying value of the intangible assets, we must determine the fair value of the intangible assets. If the fair value of the intangible assets is less than the carrying value, an impairment loss will be recognized in an amount equal to the difference. Fair value is determined through various valuation techniques including quoted market prices, third-party independent appraisals and discounted cash flow models, as considered necessary.


RESULTS OF OPERATIONS
Year ended December 31, 2013 compared to year ended December 31, 2012 Net revenues. Net revenues in 2013 decreased approximately $16.8 million compared to 2012. The decline in net revenues was primarily attributable to decreases in Acetadote product revenue of $18.7 million. This decrease was partially offset by an increase in Caldolor product revenue of $1.1 million and revenue of $1.0 million generated from our new product, Omeclamox-Pak. The increase in Caldolor revenue was primarily due to increased volume associated with continued success in penetrating our target market. We have continued to focus more of our sales and marketing resources to driving pull-through use of Caldolor in facilities stocking the product.
The decrease in Acetadote net revenue was a result of decreased sales volume of the branded Acetadote product largely as a result of generic competition during 2013. Our Acetadote product revenue also included $9.2 million in sales of our authorized generic in 2013 and $0.3 million in 2012.
Other revenue. We recognized $0.9 million of other revenue in both 2013 and 2012, primarily as the result of upfront payments we received in connection with out-licensing agreements with international commercial partners.
Cost of products sold. As a percentage of net revenues, cost of products sold increased to 17.0% in 2013 compared to 10.3% in 2012. The increase in costs of sales as a percentage of revenue was attributable to a change in the sales mix along with the recognition of $0.9 million of inventory write-downs during 2013 for potentially obsolete inventory.
Selling and marketing. Selling and marketing expense for 2013 totaled $14.4 million, compared to $20.3 million for 2012. The $5.9 million decrease was driven primarily by decreased salaries, benefits and other selling expenses of $4.4 million along with $1.1 million in decreased travel, convention and promotion expense. These reductions were primarily a result of our new commercial strategy and sales force realignment that went into effect during the fourth quarter of 2012.
Research and development. Research and development costs for 2013 was $5.6 million, compared to $5.1 million in 2012, representing an increase of $0.5 million, or 10.2%. The increase was a result of increased product development and study costs in 2013 compared to 2012.
General and administrative. General and administrative expense totaled $9.5 million in 2013, representing an increase of $0.4 million, or 4.8%, over 2012. The increase was primarily due to several small cost increases including CET rent, stock-based compensation and retirement expense.
Amortization. Amortization expense is the ratable use of our capitalized intangible assets including product and license rights, patents, trademarks and patent defense costs. Amortization for 2013 totaled $0.9 million, representing an increase of approximately $0.4 million compared to 2012. The increase was primarily due to increased capitalized patents and capitalized patent defense costs.
Income taxes. Income tax benefit for 2013 was $1.5 million, representing a decrease in tax expense of $4.8 million from the $3.2 million of income tax expense in 2012. As a percentage of loss before income taxes, the income tax benefit was 41.4% for 2013 compared to expense of 35.8% of income before income taxes for 2012. The tax rate for 2013 was positively impacted by the reinstatement of the U.S. research and development tax credit during 2013. The tax rate percentage in 2012 was primarily due to the recognition of a deferred tax benefit associated with the exchange of certain incentive stock options. Year ended December 31, 2012 compared to year ended December 31, 2011 Net product revenues. Net product revenue decreased $2.9 million, or 6%, in 2012 as compared to 2011. The decrease was primarily due to a decrease in Acetadote revenue of $4.9 million, offset by the positive impact of both increased Kristalose revenue of $0.9 million and increased Caldolor revenue of $1.1 million.


The decrease in Acetadote revenue was primarily driven by lower volumes of Acetadote sales, especially in comparison to 2011 where we experienced a 13% increase over 2010 volumes. The increase in volumes during 2011 was due in part to our introduction of the new formulation of Acetadote. The formulation is free of EDTA and other stabilization and chelating agents and is also preservative-free. The new formulation of Acetadote has been well-received in the market, and continues to be the treatment of choice for acetaminophen overdose. Additionally, Acetadote revenue was positively impacted by the shortage of the oral form of n-acetylcysteine due to manufacturing delays. During 2012, the volume decline was partially offset by the impact of increases in the average selling price. During 2012, Acetadote product revenue was positively impacted by $0.3 million in sales under our product licensing agreement with Perrigo for our Authorized Generic product.
The increase in Kristalose net revenue was primarily due to an increase in the average selling price of the 10g and 20g packets, with a small increase in overall sales volumes.
The increase in Caldolor revenue was due to increased volume. Gross product revenue for Caldolor increased $1.1 million in 2012 as compared to 2011. The increase in revenue and gross revenue was primarily due to increased volume associated with continued success in penetrating our target market. We have continued to focus more of our sales and marketing resources to driving pull-through use of Caldolor in facilities stocking the product. In the fourth quarter of 2011, we notified our wholesalers that we discontinued the 400mg offering of Caldolor in the United States and concentrate our sales efforts on 800mg. As a result, during 2011, we recognized additional expense amounts for potential returns related to the 400mg product, of which a majority was related to sales in prior years.
Other revenue. Other revenue increased $0.7 million in 2012 as compared to 2011. The increase was primarily a result of an upfront payment we received in connection with an out-licensing agreement with our commercial partner in China, Harbin Gloria Pharmaceuticals.
Cost of products sold. Cost of products sold as a percentage of net revenues decreased from 10.5% in 2011 to 10.3% in 2012. The decrease is primarily due to a change in product mix.
Selling and marketing. Selling and marketing expense totaled $20.3 million in 2012, representing a decrease of $0.6 million, or 3%, as compared to 2011. The decrease was primarily due to decreases in royalty expenses and employee related expenses for recruitment, travel and training, partially offset by increased costs incurred as a result of the realignment of our sales force of $0.7 million.
Research and development. Research and development expense totaled $5.1 million in 2012, representing an increase of $0.1 million, or 1%, over 2011. The increase consisted of a $0.4 million increase in salaries and hiring expense due to the expansion of our research and development team, mostly offset by $0.3 million in decreased expenses for studies and lower consulting expenses. General and administrative. General and administrative expense totaled $9.1 . . .

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