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PTX > SEC Filings for PTX > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for PERNIX THERAPEUTICS HOLDINGS, INC.

Form 10-K for PERNIX THERAPEUTICS HOLDINGS, INC.


17-Mar-2014

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

We are a specialty pharmaceutical company that sells, markets, manufactures and develops a number of branded and generic pharmaceutical products primarily indicated for sleep, bacterial infections and cough and cold conditions. We intend to see continued growth through the promotion of our products to physicians, healthcare practitioners and consumers, as appropriate. Since inception, we have engaged in a number of acquisitions and licensing arrangements to expand our product offerings. As part of our ongoing expansion strategy, we plan to make strategic acquisitions of products and companies, as well as develop and in-license additional products, with the aim of adding chronic, non-seasonal, specialty products to our revenue base.

Our branded products include CEDAX®, an antibiotic for middle ear infections, and a family of prescription treatments for cough and cold (ZUTRIPRO®, REZIRA®, and VITUZ®). We also market SILENOR® (doxepin), which is approved for the treatment of insomnia characterized by difficulty with sleep maintenance and is not a controlled substance. We promote our branded products through our sales and marketing organization.

We also currently promote Omeclamox-Pak® through a License and Supply Agreement with GastroEntero-Logic, LLC. We recently entered into a promotion agreement with Cumberland Pharmaceuticals pursuant to which Cumberland began promoting Omeclamox-Pak to gastroenterologists as discussed further below.

We recently entered into an Exclusive License Agreement with Osmotica Pharmaceutical Corp. to promote its desvenlafaxine product, Khedezla™ Extended-Release Tablets, 50 and 100 mg as discussed further below.

We sell our generic products in the areas of cough and cold, pain, vitamins, dermatology, antibiotics and gastroenterology through our wholly-owned subsidiaries, Macoven Pharmaceuticals, LLC, or Macoven, and Cypress Pharmaceuticals, Inc., or Cypress.

Our wholly-owned subsidiary, Pernix Manufacturing, LLC, or Pernix Manufacturing, manufactures and packages products for the pharmaceutical industry in a range of dosage forms.

Exclusive License Agreement. On February 27, 2014, we entered into an exclusive license agreement with Osmotica Pharmaceutical Corporation to promote KHEDEZLA (desvenlafaxine) Extended-Release (ER) Tablets, 50 mg and 100 mg. The sales and marketing of KHEDEZLA will be supported by our team of approximately 90 sales professionals, promoting the product to high desvenlafaxine prescribing physicians. The New Drug Application (NDA) for KHEDEZLA Tablets was approved by the U.S. Food and Drug Administration pursuant to section 505(b)(2) of the Federal Food, Drug, and Cosmetic Act in July 2013. KHEDEZLA is indicated for the treatment of major depressive disorder (MDD). Pursuant to the agreement, we agreed to make an upfront payment for the license and Osmotica's existing inventory of Khedezla, certain milestone payments payable upon the achievement of certain cumulative sales milestones and royalty payments for sales achieved for promoting the product. Subject to certain earlier termination rights, the initial term of the agreement expires in February 2024, with two year automatic renewals.


Note Offering. On February 21, 2014, we issued $65 million aggregate principal amount of the Company's 8.00% Convertible Senior Notes due 2019 in accordance with each of the Securities Purchase Agreements dated February 4, 2014 by and between the Company and the investors party thereto and the related Indenture dated February 21, 2014, by and between the Company and the trustee named therein. See further discussion herein under the heading "Liquidity and Capital Resources."

MidCap Revolver Amendment. On February 21, 2014, we, together with our subsidiaries, entered into Amendment No. 1 to the Amended and Restated Credit Agreement with MidCap Funding IV, LLC, as Agent and as a lender, and the other lenders from time to time parties thereto. This Amendment No. 1 amends the Amended and Restated Credit Agreement that the Company and its subsidiaries entered into, effective May 8, 2013, with MidCap Financial, LLC, as Administrative Agent and as a lender, and the additional lenders from time to time parties thereto. See further discussion herein under the heading "Liquidity and Capital Resources."

Resignation of Directors. At the request of the Company, on February 21, 2014, each of Cooper C. Collins, James E. Smith, Jr. and Anthem Blanchard resigned as members of the Board of Directors of the Company. In addition, Mr. Collins also resigned as Chief Strategy Officer of the Company effective as of April 15, 2014. These resignations did not relate to any disagreements with the Board of Directors (the "Board") or management of the Company or disagreements with respect to matters related to the operations, policies or practices of the Company.

As a result of the Board resignations, the size of the Board was decreased to five directors, leaving two vacancies to be filled by the existing directors prior to the Company's 2014 annual meeting of shareholders. Funds managed by each of Athyrium Capital Management and Cetus Capital were given certain Board nomination rights.

As a result of the resignations of Messrs. Collins, Smith and Blanchard, the Company notified the Nasdaq Stock Market ("NASDAQ") on February 21, 2014, that it was not in compliance with the majority independent director and audit committee requirements under NASDAQ Listing Rule 5605. NASDAQ Listing Rule 5605(b)(1) requires that a majority of the board of directors be comprised of independent directors as defined in Rule 5605(a)(2). NASDAQ Listing Rule 5605(c)(2)(A) requires that a corporation's Audit Committee be comprised of at least three members, each of whom are independent directors. Currently, the Company's Board consists of one independent director and two non-independent directors and the Audit Committee is comprised of one member who is the current independent director. The Company is actively pursuing independent director candidates and expects to fill the vacancies created by these resignation as soon as practicable. The Company intends that these new independent directors will serve as members of the Audit Committee and the other applicable committees of the Board.

In accordance with NASDAQ Listing Rules 5605(b)(1)(A) and 5605(c)(4), the Company has a cure period during which it may regain compliance with the Listing Rules. In this case, the Company's cure period will expire upon its 2014 annual shareholders' meeting. The Company expects to regain compliance on a timely basis prior to its 2014 annual meeting of shareholders.

Settlement with Former Shareholders of Cypress. A Stipulation of Dismissal was filed with the United States District Court for the Southern District of Texas (Houston Division) on January 29, 2014 in connection with the settlement of all claims brought against the Company by the former shareholders (the "Plaintiff Shareholders") of Cypress and all claims brought against the Plaintiff Shareholders by Cypress in connection with the purchase of Cypress by the Company pursuant to the Securities Purchase Agreement by and among the Company, Cypress and the Plaintiff Shareholders (the "Purchase Agreement"). See further discussion herein under the heading "Liquidity and Capital Resources."

Texas Attorney General Medicaid Investigation. The Company reached an agreement with the Attorney General of the State of Texas to settle all claims arising from certain actions by Cypress under the Texas Medicaid Fraud Prevention Act prior to its acquisition by the Company in connection with a Civil Investigative Demand made on Cypress. See further discussion herein under the heading "Liquidity and Capital Resources."

Promotion Agreement for 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. On October 28, 2013, we entered into a promotion agreement with Cumberland Pharmaceuticals Inc. to promote Omeclamox-Pak. Pursuant to the agreement, Cumberland will promote Omeclamox-Pak to gastroenterologists in the United States, and we will continue to promote the product to certain primary care physicians. Cumberland paid an upfront payment of $4.0 million to us on October 29, 2013. There are also additional milestones at the first and second anniversary dates of the execution of the agreement totaling $4.0 million in the aggregate. Royalty payments ranging from 15% to 20% based on tiered levels of gross profits will be paid by Cumberland to the Company monthly.


Asset Dispositions. On September 11, 2013, the Company completed the sale of certain of its generic assets held by Cypress to Breckenridge. The acquisition was consummated pursuant to the terms of the Purchase Agreement, as amended. Breckenridge paid the Company $2,000,000 in cash upon execution of the Purchase Agreement, and $17,850,000, before customary closing costs of approximately $173,000, in cash at Closing, and issued two promissory notes, each in an amount of $4,850,000, with one due on the first anniversary after Closing and the other due on the second anniversary after Closing, for an aggregate purchase price of up to $29,550,000. See Note 5, Disposition of Certain Cypress Assets, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion.

Renegotiation of Natroba Co-Promotion Agreement. In September 2013, the Company amended the terms of our co-promotion agreement with ParaPRO. ParaPRO assumed responsibility for distribution of NATROBA and related activities, and the Company and its subsidiaries no longer purchase quantities of NATROBA at a discount for sale to customers. The Company continues to provide promotion services for NATROBA in its assigned territories for co-promotion fees based on prescriptions generated by its sales force. With respect to generic products covered by the agreement, the Company continues to provide distribution and co-promotion services for fees based on units distributed and prescriptions dispensed in defined territories. See Note 19, Other Revenue Sharing Arrangements, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion

U.S. License of Cough, Cold, Sinus & Allergy Intellectual Property. Effective August 30, 2013, the Company re-licensed all of our rights to these assets in the United States and licensed the Dr. Cocoa trademark and logo to infirst+ in exchange for a royalty of 5% of net sales in the United States through 2019 and 2.5% of net sales in the United States and Canada from 2020 through 2029. Our subsidiary, Pernix Manufacturing, entered into a supply agreement with infirst+ to supply certain of infirst+'s manufactured products in the United States. As a result of this transaction, the Company no longer has any rights to a royalty for products utilizing the intellectual property described above outside of the United States and Canada. See Note 11, Investment in Joint Venture, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion.

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. See Note 4, Business Combinations and Other Acquisitions, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion.

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. See Note 4, Business Combinations and Other Acquisitions, and Note 23, Subsequent Events, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion.

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. See Note 15, Debt, and Note 23, Subsequent Events, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion.

Acquisition of GSL. On July 2, 2012, we completed our acquisition of the business assets of Great Southern Laboratories, or 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, or PML. See Note 4, Business Combinations and Other Acquisitions, to our consolidated financial statements included in this Annual Report on Form 10-K for further discussion.


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.

For the years ended December 31, 2013, 2012 and 2011, our net sales were approximately $84,872,000, $61,313,000 and $60,607,000, respectively, and our net (loss) income before income taxes was approximately ($46,391,000), ($1,784,000) and $12,937,000, respectively.

Our net cash (used in) provided by operating activities for the years ended December 31, 2013, 2012 and 2011 was approximately ($6,532,000), ($1,926,000) and $9,397,000, respectively.

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 $4,329,000, $4,514,000 and $5,543,000 for the years ended December 31, 2013, 2012 and 2011, respectively. Manufacturing revenue from Pernix Manufacturing, acquired in July 2012 as discussed previously, was approximately $3,011,000 and $5,424,000 for the years ended December 31, 2013 and 2012, respectively. The following table sets forth a summary of Pernix's net sales revenue for the years ended December 31, 2013, 2012 and 2011.

                                                            Year Ended December 31,
                                                       2013          2012          2011
                                                                (in thousands)
Upper respiratory, allergy and antibiotic products   $  54,583     $  39,094     $  61,454
Gastroenterology                                         9,641         8,830           122
Dietary supplements and medical food products           29,112        11,964         4,509
Analgesics                                              21,946        14,007         7,889
Sleep maintenance                                       12,956             -             -
Dermatology products                                     5,417         7,211        11,865
Other products                                          11,400           958             -
Gross Product Sales                                    145,055        82,064        85,839
Sales Allowances                                       (67,523 )     (30,689 )     (30,775 )
Net Product Sales                                       77,522        51,375        55,064
Manufacturing revenue                                    3,011         5,424             -
Co-promotion and other revenue                           4,329         4,514         5,543
Net Sales Revenues                                   $  84,872     $  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, 2013:

                                                                      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
Allowances assumed in acquisition of Somaxon                776                479                   1,113
Post-closing opening balance sheet adjustments            1,374                391                     416
Allowances for certain co-promotion agreements (1)           58                110                     483
Reclass from contingent consideration                     3,934                  -                       -
Current provision:
Adjustments to provision for prior year sales             1,611               (921 )                  (300 )
Provision - current year sales                            9,394              6,335                  48,567
Payments and credits                                    (17,155 )           (9,495 )               (42,938 )
Balance at December 31, 2013                         $   12,049              3,936                  18,301

(1) Allowances for certain co-promotion agreements represent allowances for which the expense is the responsibility of the other party to the co-promotion agreement. However, since we are responsible for the remittance of the payment of these deduction items to the billing third party, these items are included in accrued allowances on our balance sheet.

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 10% of sales of branded products (may be higher for product launches or on sales of short dated product). 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, 2013, we recorded an additional returns allowance for the returns of certain recalled products of approximately $390,000 and reclassified approximately $300,000 in unrealized price adjustments and approximately $921,000 in unrealized Medicaid rebates on these recalled products due to the fact that they will now be returned instead of prescribed under Medicaid. We also reclassed approximately $3,943,000 from the contingent consideration liability to the returns allowance for the year ended December 31, 2013 as the result of the settlement of the litigation and related indemnification claims with the former Cypress shareholders. 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, 2013 would have affected pre-tax earnings by approximately $1,459,000.


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, 2013, a 1% difference in the provision assumptions based on utilization would have effected pre-tax earnings by approximately $572,000 and a 1% difference in the provisions based on reimbursement rates would have affected pre-tax earnings by approximately $135,000.

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, 2013, a 1% difference in the assumptions based on the applicable sales would have affected pre-tax earnings by approximately $2,073,000.

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 8% 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 . . .

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