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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 2002
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________ to ________
Commission file number 0-28748
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CLOSURE MEDICAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 56-1959623
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
5250 Greens Dairy Road
Raleigh, North Carolina 27616
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 876-7800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this Annual Report on Form 10-K or any amendment to
this Annual Report on Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
As of June 30, 2002 the aggregate market value of the voting and non-voting
Common Stock held by non-affiliates of the registrant was $94,306,758 based upon
the closing price of the Common Stock as reported on the Nasdaq National Market.
Shares of common stock held by each officer and director and by each person who
owns five percent or more of the outstanding common stock have been excluded
from this calculation as such persons may be considered to be affiliated with
the Company.
As of March 24, 2003, the number of shares of Common Stock outstanding was
13,569,486.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated by reference into this
report: Definitive Proxy Statement in connection with the 2003 Annual Meeting of
Shareholders
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TABLE OF CONTENTS
PART I ............................................................................................ 3
ITEM 1. BUSINESS ............................................................................... 3
ITEM 2. PROPERTIES ............................................................................. 19
ITEM 3. LEGAL PROCEEDINGS ...................................................................... 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .................................... 19
PART II ........................................................................................... 19
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS .................. 19
ITEM 6. SELECTED FINANCIAL DATA ................................................................ 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS .. 21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK .............................. 26
ITEM 8. FINANCIAL STATEMENTS ................................................................... 27
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES .. 27
PART III .......................................................................................... 27
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ..................................... 27
ITEM 11. EXECUTIVE COMPENSATION ................................................................. 27
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ......................... 27
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ......................................... 27
ITEM 14. CONTROLS AND PROCEDURES ................................................................ 28
PART IV ........................................................................................... 28
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ....................... 28
SIGNATURES ........................................................................................ 31
CERTIFICATIONS .................................................................................... 32
INDEX TO FINANCIAL STATEMENTS ..................................................................... F-1
Closure Medical Corporation(R) is a registered trademark of the registrant.
DERMABOND is a registered trademark of ETHICON, Inc.; BAND-AID(R) is a
registered trademark of Johnson & Johnson; SOOTHE-N-SEAL(R) is a registered
trademark of Colgate Oral Pharmaceuticals, Inc.; and NEXABAND(R) is a registered
trademark of Closure Medical Corporation.
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PART I
ITEM 1. BUSINESS.
FORWARD-LOOKING STATEMENTS
The statements set forth below that are not historical facts or statements of
current conditions are forward-looking statements. Such forward-looking
statements may be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "forecasts," "estimates," "plans,"
"continues," "may," "will," "should," "anticipates" or "intends" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy or intentions. These forward-looking statements, such as statements
regarding present or anticipated scientific progress, development of potential
products, future revenues, capital expenditures and research and development
expenditures, future financings and collaborations, management, manufacturing
development and capabilities, regulatory clearances and approvals, and other
statements regarding matters that are not historical facts, involve predictions.
Our actual results, performance or achievements could differ materially from the
results expressed in, or implied by, these forward-looking statements. Potential
risks and uncertainties that could affect Closure's actual results, performance
or achievements include, but are not limited to, the "Risk Factors" set forth in
Item 1 of this Annual Report. Given these uncertainties, current or prospective
investors are cautioned not to place undue reliance on any such forward-looking
statements. Furthermore, we disclaim any obligation or intent to update any such
factors or forward-looking statements to reflect future events or developments.
AVAILABLE INFORMATION
Closure Medical files annual, quarterly, and current reports, proxy statements,
and other documents with the SEC under the Securities Exchange Act of 1934. The
public can obtain any documents that we file with the SEC at http://www.sec.gov.
We make available free of charge through our website, www.closuremed.com, our
Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and all amendments to those reports as soon as reasonably practicable
after such material is electronically filed with or furnished to the Securities
and Exchange Commission. We are not including the information contained on our
Web site as a part of, or incorporating it by reference into, this Annual Report
on Form 10-K.
BUSINESS OVERVIEW
We develop, manufacture and commercialize medical tissue adhesive products for
wound care and wound closure for the professional healthcare, over-the-counter,
or OTC, and veterinary markets based on our proprietary medical grade
cyanoacrylate technology. To date, we have commercialized nonabsorbable products
for topical use and our research efforts include the development of internal
adhesive products.
Our leading product, DERMABOND adhesive, is sold to healthcare professionals and
can be used instead of sutures or staples to rapidly close, seal and protect
wounds and incisions from infection, and to stop leakage of blood and other body
fluids from injured tissue. This product allows natural healing to proceed by
closing and sealing injured tissue without the trauma caused by suturing or
stapling. We believe that using DERMABOND adhesive results in enhanced patient
and physician benefits such as lower overall procedure costs and is easier and
quicker to use than sutures or staples.
We have other products that are marketed in the OTC adhesive bandage and the OTC
oral pain relief markets. BAND-AID(R) Brand Liquid Bandage quickly seals,
protects and stops bleeding from minor cuts and scrapes. SOOTHE-N-SEAL(R)
adhesive provides a protective barrier that shields oral ulcers and sores from
irritation caused by eating and drinking while providing immediate and long-term
pain relief.
In addition, we have two veterinary products in our NEXABAND(R) product line
that are used in cat declaw procedures as well as spay and neuter procedures.
We have entered into marketing partnerships with third parties that distribute
and market our current products to professionals and consumers. Our partners
include Ethicon, Inc., a Johnson & Johnson company; Johnson & Johnson
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Consumer Products Company; Colgate Oral Pharmaceuticals, Inc.; Johnson & Johnson
Wound Management; and Abbott Laboratories, Inc.
TECHNOLOGY OVERVIEW
We have developed, manufactured and commercialized nonabsorbable medical tissue
adhesive products based on our proprietary medical grade cyanoacrylate
technology. Cyanoacrylates are a family of liquid monomers that react under a
variety of conditions to form polymer films with strong adhesive properties.
Industrial adhesives based on cyanoacrylates were first introduced in 1958 and
are widely used in the aerospace and automotive industries, as well as in
consumer products such as super glue. Our proprietary medical grade
cyanoacrylate technology allows us to customize the physical and chemical
properties of cyanoacrylates to meet specific market needs related to wound care
and wound closure. Such properties include, but are not limited to, viscosity,
flexibility, bond strength, stability, setting time, porosity and
biodegradation.
Our technology enables us to develop nonabsorbable formulations for topical use
and may enable us to develop internal adhesives for use inside the body.
Nonabsorbable formulations close and seal skin wounds and incisions for the
duration of healing, then slough off naturally as new skin cells are produced
and the wound heals. Results from product studies on some of our professional
and OTC topical products have shown that our cyanoacrylate technology provides a
barrier against bacteria that cause infections that does not exist when using
traditional wound care technologies. Internal adhesives may be used to close or
seal internal wounds and degrade, in a predictable, biocompatible manner, into
components that are eliminated from the body naturally.
We have developed applicator and packaging technology to deliver DERMABOND
adhesive and other products to wound sites to enhance the utility of our
products. For example, the current DERMABOND adhesive applicator contains a
catalyst that controls the rate of polymerization and allows the adhesive film
to be applied in multiple layers, which enhances bond strength. Our current
products perform consistently and reproducibly, do not require special
preparation or refrigeration and have shelf-lives of at least 12 to 24 months.
PRODUCTS CURRENTLY MARKETED
DERMABOND Topical Skin Adhesive
Our leading product, DERMABOND adhesive, is a nonabsorbable, topical tissue
adhesive that can be used to close wounds from skin lacerations, incisions,
minimally invasive surgery and plastic surgery. DERMABOND adhesive is used as an
alternative to topical sutures or staples, including as an adjunct to
subcuticular sutures or staples which are used for internal tissue closure.
Suturing and stapling involve puncturing healthy tissue in order to align and
close the wound. These procedures may allow leakage or cause additional scarring
at the puncture sites, require anesthetics, are time consuming in their
application, and generally require return patient visits and physician time to
remove the sutures or staples. DERMABOND adhesive may be applied quickly, may
not require anesthetics, does not induce trauma to surrounding tissues and may
not require return visits to the physician for removal. DERMABOND adhesive is
not intended for use on high skin tension areas such as the hands, feet or
across joints.
In January 2003, we received approval from the U.S. Food & Drug Administration,
or FDA, to market High Viscosity DERMABOND Topical Skin Adhesive. This new
formulation of DERMABOND adhesive is thicker which provides physicians greater
precision and control of application, especially when used on curved areas of
the body such as around the eyes and nose. The approval is based in part on the
findings of an 84-patient multicenter clinical study conducted at the Orlando
Regional Medical Center and Stony Brook University Hospital, Long Island, NY.
Our marketing partner, Ethicon, has been distributing this product in Europe
since late 2002 and launched the product in the United States during the first
quarter of 2003.
In 2002, we received approval from the FDA, to include in DERMABOND adhesive's
device labeling that it acts as a barrier to microbial penetration and protects
against the two most common bacteria that cause infection, staphylococcus and
pseudomonas. We believe that this is a significant benefit of using DERMABOND
adhesive as opposed to sutures and staples which have not been shown to protect
against microbial penetration. The unit cost of DERMABOND adhesive is greater
than sutures or staples, however we believe that the use of DERMABOND adhesive
results in lower overall procedure costs because it may reduce treatment time
and the need for anesthetics, simplify post-closure wound care and eliminate
suture or staple removal.
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In March 1996, we entered into an exclusive worldwide agreement with Ethicon to
market and distribute DERMABOND adhesive. In August 1998, we received premarket
approval to market DERMABOND adhesive in the United States and Ethicon launched
the product in September 1998. Additionally, Ethicon has been distributing
DERMABOND adhesive outside the United States since late 1997 and is currently
marketing DERMABOND adhesive in approximately 36 foreign countries and regions,
including Japan.
BAND-AID(R) Brand Liquid Bandage
In January 2001, we received FDA clearance to market our liquid bandage, which
is the first and only cyanoacrylate medical device approved by the FDA for the
OTC adhesive bandage market. Clinical trials demonstrated the effectiveness of
our proprietary nonabsorbable formulation as compared to traditional adhesive
bandages when applied to minor cuts and abrasions. In the clinical trials, it
was found that our liquid bandage speeds wound healing, provides a superior
barrier to bacteria that cause infections versus traditional adhesive bandages,
stops bleeding and can help to reduce the pain associated with minor cuts and
abrasions. Our liquid bandage utilizes the same proprietary technology as our
professional product, DERMABOND adhesive.
In May 2001, we entered into an agreement providing Johnson & Johnson Consumer
Products Company, or CPC, with worldwide supply, distribution and development
rights to our liquid bandage technology. The agreement includes rights to the
liquid bandage and certain future OTC products, excluding our SOOTHE-N-SEAL(R)
adhesive technology. During February 2002, CPC began the marketing and
distribution of our liquid bandage as BAND-AID(R) Brand Liquid Bandage and the
product is currently available in most major retail, food and drug outlets in
the United States. CPC conducted, as part of its product launch, a consumer
oriented marketing campaign that included television advertising, consumer
promotions, and trade promotions. Given the results of the initial product
launch, Closure and CPC plan to develop liquid bandage line extensions in the
future as well as broaden the distribution beyond the United States. During the
first quarter of 2003, CPC began distributing BAND-AID(R) Brand Liquid Bandage
in Canada.
SOOTHE-N-SEAL(R) canker sore relief
In 1999, we received FDA clearance to market SOOTHE-N-SEAL(R) adhesive, which
was the first cyanoacrylate adhesive approved by the FDA for the OTC consumer
market. In clinical trials, SOOTHE-N-SEAL(R) adhesive was found to provide
immediate and long-term pain relief associated with oral ulcers, as well as
providing a protective barrier that shields oral ulcers and mouth sores from
irritation due to eating and drinking. SOOTHE-N-SEAL(R) adhesive utilizes the
same proprietary technology as our professional product, DERMABOND adhesive.
In December 2000, we entered into an agreement providing Colgate Oral
Pharmaceuticals, Inc. with exclusive worldwide supply, distribution and
development rights to SOOTHE-N-SEAL(R) adhesive technology. Beginning in the
second quarter of 2001, Colgate began distributing SOOTHE-N-SEAL(R) adhesive to
Wal-Mart and several other national drug chains.
NEXABAND(R) adhesives
We have developed two topical tissue adhesive products under the NEXABAND(R)
trade name for use in veterinary wound closure and wound care. NEXABAND(R)
Liquid Topical Tissue Adhesive, designed for use in cat declaw surgeries,
reduces procedure time, seals exposed nerve endings and reduces leakage and
irritation. NEXABAND(R) S/C Topical Tissue Adhesive is indicated for the topical
closure and sealing of various surgical incisions, including those made during
spay and neuter procedures and provides an effective, flexible barrier against
fluids, dirt and contaminants.
In July 2001, we entered into an agreement providing Abbott Laboratories, Inc.
with worldwide supply, distribution and development rights to the NEXABAND(R)
product line. Abbott distributes our veterinary products in North America,
Australia, Switzerland and the United Kingdom. Prior to our distribution
agreement with Abbott, NEXABAND(R) products were marketed and distributed only
in North America.
PRODUCTS UNDER DEVELOPMENT
We continue to pursue modifications and improvements to our existing products to
enhance their effectiveness and expand their marketability. We are also
developing additional nonabsorbable and internal adhesive products. These
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future products require further development and are subject to clinical trials
and regulatory clearance or approval before commercialization.
Internal adhesives
In 1998, we established our Internal Products Development team, or IPD, which is
comprised of dedicated scientists with extensive surgical device development
experience. The IPD is developing biocompatible cyanoacrylate formulations,
including the synthesis, formulation design, analytical methods and in vitro and
in vivo testing, that may potentially be used for internal applications.
We are primarily focused on developing formulations for a vascular sealant to be
used as an adjunct to sutures. We have completed several animal models through
collaborations with leading research institutions and have ongoing studies
involving the finalization of formulations and the completion of additional
safety studies. We are also preparing the clinical strategy prior to filing an
Investigational Device Exemption, or IDE, with the FDA. The vascular sealant
formulation as well as future internal adhesive products require further
development and could be subject to stringent clinical trials and lengthy
regulatory premarket approvals prior to their commercialization.
Liquid Occlusive Dressing
We are currently developing a liquid occlusive dressing, or LOD, to treat
partial thickness wounds such as pressure ulcers and skin tears. The LOD
formulation is being developed to adhere directly to the wound tissue, allowing
the product to conform to various wound sizes and shapes, flex with the skin,
provide a barrier to infection and is transparent, thereby permitting enhanced
wound assessment. To date, we have completed animal research as well as a
10-patient human pilot clinical study for pressure ulcers. A second human pilot
clinical study is ongoing to define the durability and wound healing rates when
using LOD versus leading dressings in the category. Depending on the outcomes
from the pilot studies, we anticipate the initiation of a definitive,
multi-center, human clinical study allowing for FDA approval through the 510(k)
premarket clearance. In November 2001, distribution and development rights for
our professional wound management products, including LOD, were granted to
Johnson & Johnson Wound Management, a division of Ethicon, through an amendment
to the terms of our existing licensing and development agreement with Ethicon.
Endobronchial Lung Volume Reduction
In February 2001, we entered into a Cooperative Research and Development
Agreement with Walter Reed Army Medical Center and the Uniformed Services
University of the Health Sciences to conduct animal research related to the
development of a novel, minimally invasive treatment for emphysema called
Endobronchial Lung Volume Reduction, or ELVR. In performing ELVR, our
proprietary medical adhesive would be delivered using a bronchoscope and small
catheter to achieve bronchial occlusion without the need for open chest surgery.
Once occluded, dysfunctional lung tissue would collapse and allow for healthier
lung tissue to expand. To date, our research has demonstrated feasibility of the
device in safely creating segmental lung volume reduction in the animal model.
Future development activities include the completion of additional longer-term
safety and efficacy animal studies. Given positive results of the animal
studies, we would then seek FDA approval to enter a human pilot safety study,
followed by a pivotal effectiveness study.
MARKETING AGREEMENTS
We do not presently employ a sales force and our strategy for current products
has been to use marketing partners to promote, sell and distribute our products.
We are dependent on our marketing partners to market and distribute these
products in accordance with the terms of their respective arrangements. However,
we may decide to establish our own sales force for the distribution of products
for which we do not currently have marketing partners, such as future internal
adhesive products.
Ethicon, Inc.
In 1996, we entered into an eight-year supply and distribution agreement
providing Ethicon with exclusive worldwide rights to market, distribute and sell
DERMABOND adhesive. Upon execution of the agreement, Ethicon paid us $4,500,000,
which represented a $3,500,000 non-refundable licensing fee and a $1,000,000
payment that has been and will continue to be offset against either future
product purchases or royalties to be paid by Ethicon on product sales (as
described below). At December 31, 2002, $170,000 of the $1,000,000 payment
remained classified as deferred revenue on our balance sheet to offset future
product purchases. In 1996, Ethicon advanced us an additional $1,000,000 payment
related to the achievement of a milestone pursuant to our agreement, which was
fully credited against royalties owed by Ethicon from 1998 through 2000.
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The agreement requires Ethicon to make minimum purchases that increase annually
and to pay royalties based upon net sales. The agreement may be renewed after
the initial eight-year term for successive additional periods of one year by
Ethicon upon at least ninety days' notice prior to the expiration of the
contract period. The agreement is terminable upon specified events, including
material breach by either party and insolvency of either party. Upon certain
events of default by us, including failure to provide an adequate supply of
product, Ethicon may end its arrangement to purchase DERMABOND adhesive from us,
and may manufacture the product itself and pay us royalties based on sales. In
addition, the agreement allows for the joint collaboration and cost sharing of
continuing development activities.
Johnson & Johnson Consumer Products Company
In May 2001, we entered into an agreement providing CPC with exclusive worldwide
supply, distribution and development rights to BAND-AID(R) Brand Liquid Bandage
technology. Included in the agreement are rights to certain future OTC products
co-developed by the parties, excluding our SOOTHE-N-SEAL(R) adhesive technology.
The agreement requires CPC to purchase annual minimum quantities during each
contract year. The agreement will automatically renew each year for a period of
one year after the initial contract term expires unless either party notifies
the other at least six months prior of its intention not to renew. The agreement
is terminable upon specified events, including material breach by either party.
In addition, the agreement allows for the joint collaboration and cost sharing
of continuing development activities. Upon execution of the agreement and
achievement of certain milestones by Closure, CPC made payments to us in
recognition of our previous research and development expenditures. These
payments have been deferred and are being recognized ratably over the life of
the agreement. In accordance with the agreement, we may receive future milestone
payments, based on achievement of certain criteria.
Colgate Oral Pharmaceuticals, Inc.
In December 2000, we entered into an exclusive worldwide supply, distribution
and development rights agreement for SOOTHE-N-SEAL(R) adhesive with Colgate.
Under the agreement, Colgate acquired exclusive worldwide rights to market, sell
and distribute SOOTHE-N-SEAL(R) adhesive and future oral care products, based
upon our proprietary cyanoacrylate technology, to both professional and consumer
markets. Upon execution of the agreement, Colgate paid Closure a license fee and
consideration for all right, title and interest in the SOOTHE-N-SEAL(R) adhesive
trademark. These payments were deferred and are being recognized ratably over
the life of the agreement. The agreement requires Colgate to purchase annual
minimum quantities and, at the end of the seven-year term, may be renewed by
agreement of both parties for additional periods. The agreement is terminable
upon specified events, including material breach by either party. In addition,
the agreement allows for the joint collaboration and cost sharing of continuing
development activities.
Abbott Laboratories, Inc.
In July 2001, we entered into an agreement providing Abbott with exclusive
worldwide, supply, distribution and development rights to our veterinary
NEXABAND(R) product line. This agreement also grants Abbott rights to future
veterinary products co-developed through the collaboration of the parties,
including product improvements, line extensions and new veterinary products
based on the Company's cyanoacrylate technology. The agreement requires Abbott
to purchase a minimum dollar amount of product during each contract year. At the
end of the contract term, the agreement may be renewed for additional periods
with the consent of both parties. In addition, the agreement allows for the
joint collaboration and cost sharing of continuing development activities.
Johnson & Johnson Wound Management
We entered into an agreement with Johnson & Johnson Wound Management, a division
of Ethicon, in November 2001, which provides Johnson & Johnson Wound Management
with worldwide supply, distribution and development rights to our professional
wound management platform, including our liquid occlusive dressing for partial
thickness wounds which is currently under development. The agreement is in the
form of an amendment to the terms of our existing licensing and development
agreement with Ethicon. Upon execution of the agreement, Johnson & Johnson Wound
Management paid Closure a non-refundable fee in consideration of rights under
the agreement which was deferred and is being recognized ratably over the period
of the agreement. We may receive future milestone payments based on achievement
of certain criteria which will be deferred and recognized ratably over the
period of the agreement. In addition, the agreement allows for the joint
collaboration and cost sharing of continuing development activities.
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PATENTS, TRADE SECRETS AND PROPRIETARY RIGHTS
Our success depends in large part on our ability to obtain patents, maintain
trade secret protection and operate without infringing on the proprietary rights
of third parties. We have 41 issued United States patents with expiration dates
ranging from 2004 to 2020 of which the average remaining life is thirteen years.
Also, we have eleven issued foreign patents with expiration dates ranging from
2014 to 2019 of which the average remaining life is fourteen years. We also have
filed applications for 54 additional United States patents and 83 applications
for patents outside the United States. The issued and pending United States
patents relate to our tissue products, processes and delivery technology.
In addition to patent protection, we rely on unpatented trade secrets and
proprietary technological expertise. We rely on confidentiality agreements with
our marketing partners, employees, advisors, vendors and consultants to protect
our trade secrets and proprietary technological expertise.
GOVERNMENT REGULATIONS
Our products and operations are subject to substantial government regulation in
the United States and foreign countries.
FDA Regulation
Most medical devices, including our medical tissue adhesives for humans, are
subject to stringent government regulation in the United States by the FDA under
the Federal Food, Drug and Cosmetic Act, or the FDC Act, and, in many instances,
by foreign and state governments. The FDA regulates the preclinical and clinical
testing, manufacture, safety, labeling, sale, distribution and promotion of
medical devices. Included among these regulations are premarket clearance and
approval requirements and good manufacturing practices, or GMPs. Other statutory
and regulatory requirements include, among other things, establishment
registration and inspection, medical device listing, prohibitions against
misbranding and adulteration, labeling and postmarket reporting. The regulatory
process is lengthy, expensive and uncertain. Securing FDA approvals and
clearances may require the submission of extensive preclinical and clinical data
and supporting information to the FDA. Failure to comply with applicable
requirements can result in refusal to approve or clear new applications or
notifications, withdrawals of existing product approvals or clearances,
issuances of warning letters, application integrity proceedings, injunctions,
civil penalties, fines, recalls or seizures of products, total or partial
suspensions of production and criminal prosecution.
Under the FDC Act, medical devices are classified into one of three classes
(Class I, II or III) on the basis of the controls necessary to reasonably ensure
their safety and effectiveness. Before any new medical device may be introduced
to the market, the manufacturer generally must obtain either premarket clearance
through the 510(k) premarket notification process or premarket approval through
the lengthier premarket application, or PMA, process. A 510(k) premarket
notification will be granted if the submitted data establishes that the proposed
device is "substantially equivalent" to a legally marketed Class I or Class II
medical device, or to a Class III medical device for which the FDA has not
called for PMAs. Prior to making a substantial equivalence determination, the
FDA may request extensive data, including clinical trials of the device's safety
and effectiveness. It generally takes from three to nine months from submission
to obtain 510(k) premarket clearance. If our product is found to be not
substantially equivalent to a legally marketed Class I or II device, or if it is
a Class III device for which the FDA has called for PMAs, then we must file a
PMA application. DERMABOND adhesive, SOOTHE-N-SEAL(R) adhesive and BAND-AID(R)
Brand Liquid Bandage are Class III, II and I medical devices, respectively. A
PMA application must be supported by extensive data, including laboratory,
preclinical and clinical trial data, to demonstrate the safety and efficacy of
the device, as well as extensive manufacturing information. Before initiating
human clinical trials, the manufacturer often must first obtain an IDE for the
proposed medical device. Before granting a PMA, the FDA will generally conduct
an inspection of the manufacturer's facilities to ensure compliance with GMPs
and the FDA must approve final labeling. Approval of a PMA could take two or
more years from the date of submission of the application or petition. The PMA
process can be expensive, uncertain and lengthy, and there is no guarantee of
ultimate approval.
Modifications or enhancements to products that are either cleared through the
510(k) process or approved through the PMA process that could affect safety or
effectiveness or effect a major change in the intended use of the device
may require further FDA review through new 510(k) or PMA submissions.
Additionally, future modifications of our
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manufacturing facilities and processes may subject us to further FDA inspections
and review before implementation of such modifications.
In 2002, Congress enacted the Medical Device User Fee and Modernization Act,
which authorizes the FDA to assess and collect user fees for premarket
notifications and premarket approval applications filed on or after October 1,
2002. Fees for fiscal year 2003 range from $2,187 for premarket notifications to
$154,000 for premarket approval applications, although fee reductions are
available for companies qualifying as small businesses.
Companies that manufacture devices distributed in the United States must comply
with GMP requirements governing the design, manufacture, release, packaging, and
distribution of devices. Manufacturers must continue to expend time, money, and
effort in the area of production and quality control to ensure full technical
compliance with GMPs. Medical devices also are subject to postmarket reporting
requirements for certain adverse events and device malfunctions. Additionally,
the FDA actively enforces regulations prohibiting marketing of devices for
indications or uses that have not been cleared or approved by the FDA. If safety
or efficacy problems occur after the product reaches the market, the FDA may
take steps to prevent or limit further marketing of the product.
In August 1998, DERMABOND adhesive received premarket approval. SOOTHE-N-SEAL(R)
adhesive and BAND-AID(R) Brand Liquid Bandage received 510(k) clearances in
September 1999 and January 2001, respectively. DERMABOND adhesive,
SOOTHE-N-SEAL(R) adhesive and BAND-AID(R) Brand Liquid Bandage are subject to
GMP, postmarket reporting and other FDA requirements.
Foreign Regulatory Matters
In order for us to market our products in Europe, Australia, Canada and certain
other foreign jurisdictions, we must obtain required market authorizations and
otherwise comply with extensive regulations regarding safety, manufacturing
processes and quality. These regulations, including the requirements for
authorizations to market, may differ from the FDA regulatory scheme. The time
required to obtain authorization for marketing our products in foreign countries
may be longer or shorter than that required for FDA clearance or approval, and
the requirements may differ. In addition, there may be foreign regulatory
barriers other than market authorizations.
Pursuant to the FDC Act, a non-FDA approved medical device may be exported to
any country, provided that the device complies with the laws of that country and
has valid marketing authorization or the equivalent from the appropriate
authority in a "listed country." The listed countries include Australia, Canada,
Israel, Japan, New Zealand, Switzerland, South Africa and any member nation in
the European Union or the European Economic Area. Generally, export of
unapproved devices (i.e., those requiring a PMA in the United States) that do
not have marketing authorization in a listed country will continue to require
prior FDA export authorization.
Medical devices that are marketed or put into service within the European Union
are required to comply with Council Directive 93/42/EEC, the medical devices
directive, or MDD. As of June 14, 1998, compliance with the MDD requires that
manufacturers of devices covered by the MDD must obtain the right to display the
CE mark, which allows the device to be marketed, put into service and circulated
freely within the European Union. We received authorization to display the CE
mark in the European Union for DERMABOND adhesive and other topical and
ophthalmic tissue adhesive applications in August 1997. We plan to pursue the
right to display the CE mark on future products for human use that we may
develop.
Upon receipt of the CE mark, we must demonstrate every six months for two years
and annually thereafter, that our quality management system meets the
requirements of the MDD and our technical documentation for products displaying
the CE mark is accurate and reflects the current manufacturing process.
Environmental Regulations
Our activities involve the controlled use of hazardous materials and chemicals.
We are subject to federal, state and local laws and regulations governing the
use, manufacture, storage, handling and disposal of such material and certain
waste products. We believe that our safety procedures for handling and disposing
of such materials comply in all material respects with the standards prescribed
by such laws and regulations, but risk of accidental contamination or injury
from these materials cannot be completely eliminated. To help minimize these
risks, we utilize an outside professional services organization to help us
evaluate and monitor environmental regulations.
9
MANUFACTURING
We have devoted considerable resources to the development of manufacturing
processes and technologies capable of providing our products with clinical
efficacy, safety, ease of use and suitable shelf-life. We have developed a
manufacturing process designed to produce a highly purified base material which
is not achievable by other known methodologies. We rely heavily on internal
trade secrets and technological expertise and expect to keep our manufacturing
process in-house and, where applicable, seek patent protection for specific
manufacturing applications.
Since 1998, we have been manufacturing our products in a 50,000 square foot
facility in Raleigh, North Carolina. This facility integrates the production of
all of our product formulations as well as the filling, labeling and packaging
capabilities for certain products. In addition to full-time employees, we hire
filling and packaging employees as needed on a temporary basis. In addition,
third party vendors currently perform filling, labeling and sterilization for
certain products manufactured by Closure.
Over the next several years, we plan to expand our manufacturing capabilities to
include operations associated with the filling and packaging of current
products, as well as various new products. Although the expansion should provide
for sufficient capacity, some of our manufacturing processes will continue to be
completed by outside providers.
In 1997, in connection with our application for a CE mark to market DERMABOND
adhesive in the European Union, the British Standards Institution, or BSI,
registered us to certify that our quality management system complies with the
requirements of the ISO 9002 international quality assurance standard issued by
the International Organization of Standardization of Geneva, Switzerland. In
1998, BSI expanded the scope of our quality system certification to include
compliance with ISO 9001, a comprehensive international standard for
manufacturing and servicing firms for quality assurance in design, development,
production, installation and servicing.
COMPETITION AND TECHNOLOGICAL CHANGE
We compete with domestic and foreign competitors in various rapidly evolving and
technologically advanced fields in developing our technology and products,
including medical device and pharmaceutical companies.
In the worldwide wound closure market, DERMABOND adhesive competes with the
suture products of Ethicon as well as the staple products of Ethicon
Endo-Surgery, Inc., both subsidiaries of Johnson & Johnson. We also compete with
the suture and staple products of United States Surgical Corporation, a
subsidiary of Tyco International Ltd. In addition, there are currently three
other cyanoacrylate-based topical adhesives with which DERMABOND adhesive
competes, only one of which is approved for sale in the United States. In 2002,
United States Surgical, a division of Tyco Health Group, LP received FDA
approval to market Indermil(TM) Tissue Adhesive, a butyl cyanoacrylate. Tyco has
been marketing Indermil(TM) in the United Kingdom since 1996 and it is currently
available in many other countries. B. Braun GmbH markets Histoacryl(R) as a
topical closure adhesive for small lacerations and incisions in low skin tension
areas of the body. MedLogic Global Corporation markets LiquiBand(R) adhesive,
primarily in the United Kingdom, and has filed an IDE in the United States.
In the domestic OTC adhesive bandage market, BAND-AID(R) Brand Liquid Bandage
competes with the BAND-AID(R) Brand Adhesive Bandages of CPC as well as 3M(R)
brand adhesive bandages and Curad(R) brand adhesive bandages marketed by
Beiersdorf AG. These three products in total comprise approximately 80% of the
adhesive bandage market. In the domestic OTC oral pain relief market,
SOOTHE-N-SEAL(R) adhesive competes with the following four major products that
comprise approximately 75% of that category: Colgate Orabase(R) Gel marketed by
Colgate, Anbesol(R) Oral Anesthetic products marketed by American Home Products
Corporation, Orajel(R) products marketed by Del Laboratories and Zilactin(R)
products marketed by Zila Consumer Pharmaceuticals.
SCIENTIFIC ADVISORS
We have established a team of recognized scientific advisors who advise us about
present and long-term scientific planning, research and development. The
Scientific Advisors have recognized expertise in relevant sciences or clinical
medicine. These scientific advisors consist of independent professionals who
meet on an individual basis
10
with management when so requested. We retain their services under the terms of
consulting and confidentiality agreements.
EMPLOYEES
As of March 24, 2003, we had 101 full-time employees, up from 88 in March 2002,
of whom 82 were dedicated to research, development, manufacturing, quality
control and regulatory affairs, and 19 were dedicated to administrative
activities. Twelve members of our research, development and regulatory affairs
staff have doctoral or advanced degrees. Our employees are not represented by a
union, and we believe relationships with our employees are good.
EXECUTIVE OFFICERS
The table below sets forth the names, ages and positions of the persons who are
the executive officers as of March 24, 2003.
Name Age Position
Daniel A. Pelak 51 President and Chief Executive Officer and Director
Joe B. Barefoot 52 Vice President of Regulatory Affairs and Quality Assurance
Jeffrey G. Clark 49 Vice President of Research and Development
William M. Cotter 52 Vice President of Manufacturing and Operations
Jerry Y. Jonn 46 Vice President of Internal Products Development
Debra L. Pawl 50 Vice President and General Counsel
Benny Ward 39 Vice President of Finance and Chief Financial Officer
Daniel A. Pelak has served as President and Chief Executive Officer of Closure
since September 2002. Prior to joining Closure Medical, Mr. Pelak spent 26 years
with Medtronic, Inc. During his career he has held positions in Sales, Sales
Management, Marketing, and General Management. Immediately prior to joining
Closure, he was the Vice President and General Manager of Medtronic's Perfusion
Systems Division. From March 2000 until January 2002, he was the Vice President
and General Manager of Medtronic's Cardiac Surgery Technologies Division. From
1992 to 2000, Mr. Pelak managed progressively larger sales and marketing
operations within the Cardiovascular areas of Medtronic, including Vice
President Cardiovascular Marketing and Vice President U.S. Cardiac Surgery
Business. Prior to 1992, he held the position of Vice President and General
Manager of Medtronic's Nortech Division. Mr. Pelak holds a B.S. degree from
Pennsylvania State University.
Joe B. Barefoot has served as Vice President of Regulatory Affairs and Quality
Assurance of Closure since 1990. From 1986 to 1990, Mr. Barefoot managed the
quality assurance program and regulatory submissions for Sharpoint, Inc. and its
successor. From 1982 to 1986, he was a member of the quality assurance staff at
C.R. Bard, Inc. Before that time, he was a member of the quality assurance staff
at Becton, Dickinson & Co. Mr. Barefoot holds a B.S. degree in Microbiology from
Emporia State University.
Jeffrey G. Clark has served as Vice President of Research and Development of
Closure since 1990. Prior to that time, Mr. Clark spent seven years at
Sharpoint, Inc. where he developed bioabsorbable and polypropylene suture
technology. From 1977 to 1983, Mr. Clark worked at Extracorporeal, Inc., a
division of Johnson & Johnson. Mr. Clark holds a M.S. degree in Organic
Chemistry from Drexel University.
William M. Cotter has served as Vice President of Manufacturing and Operations
of Closure since June 1997. From 1989 to 1997, Mr. Cotter was Vice President of
Operations (North America) of Sanofi Diagnostics Pasteur, Inc., a company
involved in the design, manufacturing and marketing of in vitro diagnostics
instrumentation and biological reagents. From 1984 to 1988, he worked at Genetic
Systems Corporation, a subsidiary of Bristol Myers Company, where he was
involved in the commercialization of one of the first diagnostic test kits for
the HIV virus. Before that time, Mr. Cotter worked at Advanced Technology
Laboratories, Inc., a division of E.R. Squibb Company. Mr. Cotter holds a B.A.
degree from Ohio University.
11
Jerry Y. Jonn, Ph.D. has served as Vice President of Internal Products
Development since July 2001. Prior to that time Dr. Jonn served as Director,
Absorbable Products Research of the Company from May 1999. Prior to employment
with Closure Medical, Dr. Jonn spent seven years with U. S. Surgical in North
Haven, CT where he last served as the Director of U.S. Surgical's Research and
Development efforts. Dr. Jonn earned his M.S. and Ph.D. degrees in Polymer
Chemistry from Cornell University.
Debra L. Pawl has served as Vice President and General Counsel since 1998.
Previously, Ms. Pawl served as Patent Manager for the J.M. Huber Corporation and
practiced in the patent law departments of The BFGoodrich Company, Owens-Corning
Fiberglas Corporation, The Standard Oil Company (Ohio) and the Washington, D.C.
law firm of Cushman, Darby and Cushman. Prior to practicing law, Ms. Pawl worked
as a research chemist for the Diamond Shamrock Corporation and taught chemistry
and anatomy and physiology at Cuyahoga Community College. Ms. Pawl holds a J.D.
degree from the University of Toledo, College of Law, and a M.S. and a B.S.
degree in biology/chemistry from John Carroll University.
Benny Ward has served as Vice President of Finance and Chief Financial Officer
of Closure since April 2000. From 1996 until 2000, Mr. Ward served as Closure's
Controller. From 1993 to 1996, Mr. Ward served as a Senior Accountant with Price
Waterhouse LLP in Raleigh, North Carolina. From 1990 to 1993, he worked for
Alcatel Network Systems, N. A. Mr. Ward holds bachelor degrees in Accounting and
Political Science from East Carolina University and is a certified public
accountant.
RISK FACTORS
In addition to the other information in this Annual Report on Form 10-K, the
following risk factors should be carefully considered. The risks and
uncertainties described below are not the only ones facing us. Additional risks
and uncertainties not presently known to us or that we currently deem immaterial
may also impair our business, operating results and financial condition. The
occurrence of any of the following risks could adversely affect our business,
operating results and financial condition, as well as adversely affect the value
of an investment in our common stock.
Our products are in the early stage of product commercialization and if they are
not successful, our operating results and business may be substantially
impaired.
We received premarket approval from the FDA to market DERMABOND adhesive in the
United States in August 1998. We were granted 510(k) premarket clearance for
SOOTHE-N-SEAL(R) adhesive and BAND-AID(R) Brand Liquid Bandage in September 1999
and January 2001, respectively. We believe that our viability and growth will
depend in large part on sales of DERMABOND adhesive and BAND-AID(R) Brand Liquid
Bandage. There can be no assurance that we and our marketing partners will be
able to commercialize successfully or achieve market acceptance of our
technologies or products, or that our competitors will not develop technologies
that are less expensive or otherwise superior. The failure to develop and market
successfully our existing products as well as new products could have a material
adverse effect on our results of operations and financial condition.
If we are unable to develop new products based on our proprietary cyanoacrylate
technology, our future operating results may suffer.
In addition to the commercialization of our current products, our future success
depends on our ability to develop new products based on our core technology,
which could be expensive and time consuming. The successful development of new
products depends on a number of factors, including the following:
. obtaining regulatory clearances or approvals;
. acceptance of new products by the market;
. inherent developmental risks, including ineffectiveness or lack
of safety and unreliability;
. high commercial cost and preclusion or obsolescence resulting
from third parties' proprietary rights or superior or equivalent
products;
. our ability to enter into favorable marketing agreements;
. our ability to develop repeatable processes to manufacture new
products in sufficient quantities for commercial sales; and
. general economic conditions.
12
If any of these factors cannot be overcome, we may not be able to develop and
introduce new products in a timely or cost-effective manner, which could affect
our future growth and results of operations.
If we are unable to produce adequate quantities of our products, our operating
results may suffer.
Our future success is dependent on our ability to manufacture our products:
. in commercial quantities;
. in compliance with regulatory requirements; and
. at an acceptable cost.
We currently manufacture all of our products in a 50,000 square foot facility in
Raleigh, North Carolina, with the exception of certain processes completed by
third parties. Production of increased quantities may involve technical
challenges for us and may require significant scale-up expenses for additions to
facilities and personnel. There can be no assurance that we will be able to
achieve sufficient manufacturing capabilities to satisfy demand in a
cost-effective manner or to produce the quantities necessary for us to achieve
profitability.
If we are unable to meet our marketing partner's manufacturing requirements for
DERMABOND adhesive, revenues generated from DERMABOND adhesive will decrease.
If we are unable to meet the manufacturing requirements for DERMABOND adhesive
imposed by Ethicon, then Ethicon may itself manufacture DERMABOND adhesive and
pay us royalties on sales. The royalty payments we would receive would be
substantially less than the revenues currently generated by selling DERMABOND
adhesive to Ethicon.
If our products are not accepted by the medical community and consumers, the
commercial opportunities for our products would be limited.
The success of our existing products and products we develop in the future will
depend on continued and initial acceptance of these products by the medical
community as well as consumers. We cannot predict how quickly, if at all, the
medical community or consumers will accept our products or the extent to which
our products will be used. If the medical or consumer community does not accept
our products, our revenues would suffer.
We may face product liability claims that could result in costly litigation and
significant liabilities for which we may not have adequate insurance protection.
The manufacture and sale of medical products exposes us to an inherent risk of
product liability claims. The medical device industry in general has been
subject to significant product liability litigation. Any claims, with or without
merit, could result in costly litigation, reduced sales, significant liabilities
and diversion of our management's time, attention and resources. Based on our
experience, we believe that we maintain adequate product liability insurance to
cover any such litigation. However, we cannot be sure that our product liability
insurance coverage is adequate or that it will continue to be available to us on
acceptable terms, if at all. A successful product liability claim or series of
claims brought against us could require us to pay substantial amounts that would
decrease our profitability, if any.
Our products are subject to costly and extensive premarket clearances and
approvals. Any unanticipated costs or delays in these processes, or any failure
to obtain the necessary clearances or approvals, will affect our ability to
introduce and market new products.
The regulatory process is lengthy, expensive and uncertain and there can be no
assurance that we will obtain the necessary clearances or approvals to market
our products. Before any new medical device may be introduced to the market, the
manufacturer generally must obtain FDA clearance or approval through either the
510(k) process or the lengthier PMA, or premarket application, process. It
generally takes from three to nine months from submission to obtain 510(k)
premarket clearance, although it may take longer. Approval of a PMA could take
up to two or more years from the date of submission of the application. We
expect that some of our future products under development will be subject to the
lengthier PMA process. Securing FDA clearances and approvals may require the
submission of extensive preclinical and clinical data and supporting information
to the FDA, and there can be no guarantee of ultimate clearance or approval.
Failure to comply with applicable requirements can result in refusals to approve
or
13
clear new applications or notifications, withdrawals of existing product
approvals or clearances, issuances of warning letters, application integrity
proceedings, injunctions, civil penalties, fines, recalls or seizures of
products, total or partial suspensions of production and criminal prosecution.
Our medical tissue adhesives must receive regulatory clearances or approvals
from the FDA and, in many instances, from foreign and state governments, before
their sale. To obtain such clearances or approvals, medical tissue adhesives
must be shown to be efficacious and safe for use in humans. Our current and
future medical tissue adhesives for humans are subject to stringent government
regulation in the United States by the FDA under the Federal Food, Drug and
Cosmetic Act. The FDA regulates the preclinical and clinical testing,
manufacture, safety, labeling, sale, distribution and promotion of medical
devices. Included among these regulations are premarket notification and PMA
requirements. Other statutory and regulatory requirements include, among other
things, compliance with establishment registration and medical device listing,
GMP labeling, and promotional requirements.
Our products are subject to postmarket reporting requirements. If safety
problems occur after one of our products reaches the market, the FDA may take
steps to prevent or limit the further marketing of the product.
Our medical devices and medical tissue adhesives are also subject to postmarket
reporting requirements for certain adverse events and device malfunctions, and
correction and removal reporting and recordkeeping requirements for actions
taken with respect to distributed devices to reduce a risk to health.
Additionally, the FDA actively enforces regulations prohibiting marketing of
devices for indications or uses that have not been cleared or approved by the
FDA. If safety or efficacy problems occur after the product reaches the market,
the FDA may take steps to prevent or limit further marketing of the product.
Our products are subject to extensive governmental regulation that could make it
more expensive and time consuming for us to manufacture our products.
The manufacture of our products is subject to periodic inspection by regulatory
authorities and certain marketing partners, while manufacture of our products
for human use is subject to regulation and inspection from time to time by the
FDA for compliance with good manufacturing practices, or GMPs, as well as
equivalent requirements and inspections by state and foreign regulatory
authorities. There can be no assurance that we will continue to satisfy these
requirements for DERMABOND adhesive, SOOTHE-N-SEAL(R) adhesive and BAND-AID(R)
Brand Liquid Bandage. In addition, there can be no assurance that the FDA or
other authorities will not, during the course of an inspection of existing or
new facilities, identify what they consider to be deficiencies in GMPs or other
requirements and request, or seek, remedial action. Failure to comply with such
regulations or any delay in attaining compliance may adversely affect our
manufacturing activities and could result in, among other things, FDA refusal to
grant premarket approvals or clearances for pending or future products, warning
letters, injunctions, civil penalties, fines, recalls or seizures of products,
total or partial suspensions of production and criminal prosecution.
Additionally, future modifications of our manufacturing facilities and processes
may subject us to further FDA inspections and review before implementation of
such modifications. There can be no assurance that we will be able to obtain
necessary regulatory approvals or clearances on a timely basis, if at all.
Delays in receipt of or failure to receive such approvals or clearances or the
loss of previously received approvals or clearances will affect our ability to
timely manufacture our products.
Although we do not receive payments directly from third-party health care
payors, their reimbursement methods and policies impact demand for DERMABOND
adhesive and future products.
DERMABOND adhesive is subject to the reimbursement methods and policies used by
the government and other third-party health care payors. If physicians,
hospitals and other users of our products fail to obtain sufficient
reimbursement from healthcare payors for DERMABOND adhesive or procedures using
DERMABOND, or adverse changes occur in governmental and private third-party
payors' policies toward reimbursement for this product or these procedures, it
could negatively affect the demand for DERMABOND adhesive. If third-party payors
fail to provide appropriate levels of reimbursement for purchase and use of our
products it could have a material adverse effect on our results of operations.
Because of the uncertainty surrounding the reimbursement status of newly
approved health care products, we have no assurance that adequate or any
third-party coverage will be provided for new products introduced by Closure. If
our
14
new products do not receive adequate coverage and reimbursement, the market
acceptance of these products would be adversely affected, which would have a
material adverse effect on our results of operations.
If we do not comply with laws and regulations relating to our use of hazardous
materials, we may incur substantial liabilities.
We use hazardous materials and chemicals in our research and development
programs and in our manufacturing operations. We are required to comply with
increasingly rigorous laws and regulations governing environmental protection
and workplace safety, including requirements governing the handling, storage and
disposal of hazardous substances. Although, we believe that we handle, store and
dispose of these materials in a manner that complies with state and federal
regulations, the risk of accidental contamination or injury exists. In the event
of an accident, we could be held liable for decontamination costs, other
clean-up costs and related damages or liabilities. To help minimize these risks,
we utilize an outside professional services organization to help us evaluate and
monitor environmental regulations.
If we are unable to maintain our current arrangements with our marketing
partners, we may not be able to market or sell our current or future products
independently.
We have no experience in sales, marketing and distribution. Therefore, our
strategy for commercialization of our products has included entering into
agreements with other companies to market current and certain future products
incorporating our technology. There can be no assurance that we will be able to
enter into additional marketing agreements on terms favorable to us, if at all,
or that current or future agreements will ultimately be beneficial to us.
Certain agreements also permit our marketing partners to pursue existing or
alternative technologies in preference to our technology. There can be no
assurance that our interests will continue to coincide with those of our
marketing partners or that the marketing partners will not develop,
independently or with third parties, products which could compete with our
products, or that disagreements over rights or technology or other proprietary
interests will not occur. Furthermore, there can be no guarantee that one of our
marketing partners will not terminate their relationship with us and begin
marketing products of their own or of third parties. If we choose not to, or are
unable to, enter into future agreements with marketing partners, we would be
forced to commit increased capital to undertake the marketing and sale of our
current and future products, or we may not be able to market such products at
all. If we are unable to sell our products independently or identify alternative
marketing partners, our revenue and results of operations will be materially
adversely affected.
Our product sales for our nonabsorbable products are dependent upon the success
of our marketing partners in performing their responsibilities. If our marketing
partners fail to successfully perform their responsibilities, our products will
suffer.
We have no control over the amount and timing of resources which may be devoted
to our marketing partners' performances of their contractual responsibilities.
There can be no assurance that our marketing partners will perform their
obligations as expected or market any products under the marketing agreements,
or that we will derive any revenue from such arrangements. There can be no
assurance that products will be launched in the manner and on the timetable
expected by us as such determinations are entirely within the control of our
marketing partners. If our marketing partners do not successfully perform their
responsibilities, the revenues we derive from our relationships with them will
suffer.
We depend on a single qualified source supplier. If we are unable to obtain
adequate commercial quantities or develop alternative source suppliers meeting
regulatory, price and timing requirements, our ability to manufacture our
products, including DERMABOND adhesive, may be impaired.
We currently purchase cyanoacetate, the primary raw material used in
manufacturing our products, from a single qualified source. There can be no
assurance that we will be able to obtain adequate commercial quantities of
cyanoacetate to manufacture our products within a reasonable period of time or
at commercially reasonable rates. We may manufacture cyanoacetate ourselves,
however it may be more costly and we may not be able to produce commercial
quantities as needed. A lack of adequate commercial quantities of cyanoacetate,
or our inability to develop alternative sources meeting regulatory requirements
at similar prices and terms within a reasonable time, or any interruptions in
supply in the future could have a material adverse effect on our ability to
manufacture our products, including DERMABOND adhesive, and, consequently, could
have a material adverse effect on our results of operations and financial
condition.
15
In addition, there are a few other critical components that we obtain from a
single qualified source. We have plans to qualify a second source or establish
supply contracts which include catastrophe plans for each of these items.
If our suppliers and subcontractors cannot provide the components and services
that we require, we may be unable to manufacture our products.
We cannot be sure that our suppliers and subcontractors will furnish us with
required components when we need them. Relying on third parties exposes us to
potential interruptions in supply as well as damaged or non-conforming parts
which could affect our ability to ship our products to our customers on a timely
basis. These factors could make it more difficult to manage our inventory
effectively and manufacture our products which could have a material adverse
effect on our results of operations.
If we are unable to obtain new patents and maintain patent and trade secret
protection, our reputation and competitiveness in the marketplace may be
adversely affected.
The medical device industry places considerable importance on obtaining patent
and trade secret protection for technologies, products and processes. Our
success depends, in part, on whether we can obtain patents and maintain trade
secret protection. There can be no assurance that any pending patent
applications will be approved, that we will develop additional proprietary
products that are patentable or that any patents issued to us will provide us
with competitive advantages. Furthermore, there can be no assurance that others
will not independently develop similar products, duplicate any of our products
or design around our patents.
In addition to patent protection, we rely on unpatented trade secrets and
proprietary technological expertise. There can be no assurance that others will
not independently develop or otherwise acquire equivalent techniques, or
otherwise gain access to our trade secrets and proprietary technological
expertise or disclose such trade secrets. We rely, in part, on confidentiality
agreements with our marketing partners, employees, advisors, vendors and
consultants to protect our trade secrets and proprietary technological
expertise. There can be no assurance that these agreements will not be breached,
that we will have adequate remedies for any breach or that our unpatented trade
secrets and proprietary technological expertise will not otherwise become known
or be independently discovered by competitors. Failure to obtain or maintain
patent or trade secret protection, for any reason, could adversely effect our
competitiveness in the marketplace.
If we are accused of infringing upon the patents or proprietary rights of
others, we may be required to obtain commercially favorable licenses or be
forced to engage in costly and time-consuming litigation.
Our commercial success will depend, in part, on our ability to operate without
infringing on patents and other proprietary rights of third parties. Our patents
may be challenged by third parties and the patents of others may prevent the
commercialization of our products. If it is determined that we have been
infringing upon any third party's patent rights, we could be required to pay
damages, alter our products or processes, obtain licenses or cease certain
activities. If we are required to obtain any licenses, there can be no assurance
that we will be able to do so on commercially favorable terms, if at all. Our
failure to obtain a license to any necessary technology may result in our being
barred from manufacturing and selling our products.
We may also be forced to engage in litigation to enforce any patents issued or
licensed to us, or to determine the scope and validity of third party
proprietary rights. Moreover, if our competitors prepare and file patent
applications in the United States to claim technology that is also claimed by
us, we may be forced to participate in interference proceedings declared by the
U.S. Patent and Trademark Office to determine priority of invention. Such
litigation and participation in proceedings could result in substantial costs
and diversion of our efforts, even if the eventual outcome is favorable to us.
Litigation could also subject us to significant liabilities to third parties,
require disputed rights to be licensed from third parties or require us to cease
using certain technology.
If our competitors are successful in developing alternative technologies and
products that are more effective, easier to use or more economical, our
technology and products may be rendered obsolete and noncompetitive.
We compete with domestic and foreign competitors in various rapidly evolving and
technologically advanced fields in developing our technology and products,
including medical device and pharmaceutical companies. In the worldwide wound
closure market, DERMABOND adhesive competes with the suture products of Ethicon
as well as
16
the staple products of Ethicon Endo-Surgery, Inc., both subsidiaries of Johnson
& Johnson. We also compete with the suture and staple products of United States
Surgical Corporation, a subsidiary of Tyco International Ltd. In addition, there
are currently three other cyanoacrylate-based topical adhesives with which
DERMABOND adhesive competes, only one of which is approved for sale in the
United States. In 2002, United States Surgical, a division of Tyco Health Group,
LP received FDA approval to market Indermil(TM) Tissue Adhesive, a butyl
cyanoacrylate. Tyco has been marketing Indermil(TM) in the United Kingdom since
1996 and it is currently available in many other countries. B. Braun GmbH
markets Histoacryl(R) as a topical closure adhesive for small lacerations and
incisions in low skin tension areas of the body. MedLogic Global Corporation
markets LiquiBand(R) adhesive, primarily in the United Kingdom, and has filed an
IDE in the United States. In the domestic OTC adhesive bandage market,
BAND-AID(R) Brand Liquid Bandage competes with the BAND-AID(R) Brand Adhesive
Bandages of CPC as well as 3M(R) brand adhesive bandages and Curad(R) brand
adhesive bandages marketed by Beiersdorf AG. These three products in total
comprise approximately 80% of the adhesive bandage market. In the domestic OTC
oral pain relief market, SOOTHE-N-SEAL(R) adhesive competes with the following
four major products that comprise approximately 75% of that category: Colgate
Orabase(R) Gel marketed by Colgate, Anbesol(R) Oral Anesthetic products marketed
by American Home Products Corporation, Orajel(R) products marketed by Del
Laboratories and Zilactin(R) products marketed by Zila Consumer Pharmaceuticals.
There can be no assurance that our competitors will not succeed in developing
alternative technologies and products that are more effective, easier to use or
more economical than those which have been or are being developed by us or that
would render our technology and products obsolete and noncompetitive in these
fields. These competitors may also have greater experience in developing
products, conducting clinical trials, obtaining regulatory clearances or
approvals, and manufacturing and marketing such products. Certain competitors
may obtain patent protection, approval or clearance by the FDA or product
commercialization earlier than us. Finally, under the terms of our marketing
agreements, our marketing partners may pursue parallel development of other
technologies or products, which may result in a marketing partner developing
additional products that will compete with our products.
Our plans to market current and future products internationally are subject to
several risks and as a result, we may not be able to successfully commercialize
our current or future products in any foreign market.
We and our marketing partners intend to market current and future products in
Europe, Australia, Canada and certain other foreign jurisdictions outside of the
United States as well as domestically. A number of risks are inherent in
international transactions, including the following:
. our ability to obtain required market authorizations;
. our compliance with extensive safety, manufacturing and quality
regulations;
. differences from the FDA regulatory scheme;
. the influence of political instability, price controls, trade
restrictions and tariff modifications on our international sales;
and
. fluctuations in currency exchange rates.
There can be no assurance that we will obtain market authorizations in such
countries or that we will not be required to incur significant costs in
obtaining or maintaining our foreign market authorizations. Delays in receipt of
authorizations to market our products in foreign countries, failure to receive
such authorizations or the future loss of previously received authorizations
would delay or bar sales of our products in any such foreign country. Our
international sales and related royalties of DERMABOND adhesive are based on
sales in foreign currencies, but payable in U.S. dollars, and thus may be
adversely affected by fluctuations in currency exchange rates. Additionally,
fluctuations in currency exchange rates may adversely affect demand for our
products by increasing the price of our products in the currency of the
countries in which the products are sold. There can be no assurance that we will
be able to successfully commercialize our current or future products in any
foreign market.
We may need additional funding and may not have access to capital. If we are
unable to raise capital when needed, we may need to delay, reduce, eliminate or
license our product development and commercialization effort.
We have expended and expect to continue to expend substantial funds to complete
the research, development and clinical testing of our existing products and
future products in development and to increase our current scale of
manufacturing. We believe that existing cash and cash equivalents and
investments, which totaled $17.0 million as of December 31, 2002, will be
sufficient to finance our capital requirements for at least 12 months. There can
be no
17
assurance that we will not be required to seek additional capital to
finance our operations in the future. We currently have a $3.0 million line of
credit for working capital purposes. We currently have no commitments for any
additional financing, and there can be no assurance that adequate funds for our
operations from our revenues, financial markets, arrangements with marketing
partners or from other sources will be available when needed or on terms
attractive to us. The inability to obtain sufficient funds may require us to
delay, scale back or eliminate some or all of our research and product
development programs, manufacturing operations, clinical studies or regulatory
activities or to license third parties to commercialize products or technologies
that we would otherwise seek to develop ourselves.
Our stock price is volatile and could experience substantial declines.
The market price of our common stock has historically experienced and might
continue to experience volatility. The market price of our common stock may
fluctuate due to our operating results, changes in the economy or the financial
markets and other developments affecting us or our competitors. In addition, the
stock market has experienced significant price and volume fluctuations in recent
years, as well as significant decreases in value. This volatility and the recent
market decline have affected the market prices of securities issued by many
companies and might adversely affect the price of our common stock.
Our operations might be affected if there is a natural disaster or other
catastrophic event.
We depend on our manufacturing facility for the continued operation of our
business, as well as critical information systems. We currently have in place
contingency plans for catastrophic events and natural disasters. Although we
carry limited business interruption and other insurance policies, we might
suffer losses as a result of catastrophic events and natural disasters which
could have a material negative impact on our operating results.
Our failure to detect and prevent viruses and other malicious acts targeted at
our management information systems and controls could expose us to a breach in
security, rendering proprietary information available to outsiders and data
unreliable.
Unauthorized access, computer viruses, accidental or intentional actions and
other disruptions could occur with regard to our information systems. As a
result of accidental as well as intentional actions of Internet users or
"hackers", we may experience delays or interruptions in business due to a breach
in the security of confidential information. The costs required to mitigate the
risks from computer viruses and alleviate other security problems could be
significant and the efforts to address such problems could result in
interruptions and delays in our business, which could have a material adverse
effect on our results of operations. Furthermore, a breach in the security of
our management information systems could cause our trade secrets and other
proprietary information to enter the public domain, which could adversely effect
our competitive position in the market.
Our success depends on key personnel, the loss of whom could impair our research
and development efforts.
Our success partially depends upon the efforts and talents of our senior
management and scientific personnel. We have entered into employment agreements
with each member of our senior management. The loss of the services of one or
more of these key employees could adversely affect our ability to meet our
business objectives. In addition, our success depends on our ability to attract
and retain skilled personnel, especially in the areas of research and product
development. There is intense competition for such skilled personnel and we may
be unable to attract and retain these individuals. Our failure to do so would
have an adverse effect on our business.
Effective control by principal stockholders could allow for control of most
matters submitted to our stockholders.
Two principal stockholders, in the aggregate, beneficially own approximately 42%
of the outstanding common stock as of March 24, 2003. Currently, there are no
voting trusts or other agreements between these individuals to vote in concert,
however, such persons, acting together, could have the ability to control most
matters submitted to stockholders of Closure.
18
ITEM 2. PROPERTIES.
We lease a 50,000 square foot facility that houses manufacturing, research and
development and our executive offices in Raleigh, North Carolina. The lease
expires in July 2007 and includes an option to lease additional space adjacent
to our current facility if needed. We have the option to renew the lease upon
termination.
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We did not submit any matters to a vote of security holders during the fourth
quarter of fiscal year 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
Our Common Stock is quoted on the Nasdaq National Market under the symbol
"CLSR." The following table sets forth, for the periods indicated, the high and
low closing sale price per share of Common Stock, as reported on the Nasdaq
National Market, for 2001 and 2002.
Market Price Per Share
------------------------------------------
2001 2002
------------------- -------------------
High Low High Low
-------- ------- -------- -------
First Quarter ................... $34.88 $14.69 $24.30 $18.00
Second Quarter .................. 26.25 14.51 19.60 13.20
Third Quarter ................... 25.85 15.30 15.90 11.01
Fourth Quarter .................. 24.14 16.07 14.18 8.00
HOLDERS
As of March 24, 2002, there were approximately 259 holders of record of our
Common Stock. We have no preferred stock outstanding.
DIVIDEND INFORMATION
We have never declared or paid cash dividends on our Common Stock and do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to fund the development and growth of
our business. Any future determination to pay cash dividends will be at the
discretion of the Board of Directors and will be dependent upon our financial
condition, operating results, capital requirements and such other factors as the
Board of Directors deems relevant.
19
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data set forth below for each year in the five year
period ended December 31, 2002 have been derived from financial statements
audited by PricewaterhouseCoopers LLP, independent accountants. The balance
sheets as of December 31, 2001 and 2002 and the related statements of
operations, cash flows and stockholders' equity for the years ended December 31,
2000, 2001 and 2002 and notes thereto appear elsewhere in this Annual Report.
This data should be read in conjunction with "Item 7--Management's Discussion
and Analysis of Financial Condition and Results of Operations" and our financial
statements, including the notes thereto, and the other financial information
included elsewhere in this Annual Report. Certain prior year balances have been
reclassified to conform to the current year presentation.
Years ended December 31,
----------------------------------------------------------------------
1998 1999 2000 2001 2002
------------- ------------- -------------- ------------- -------------
(In thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Product sales $ 8,079 $ 13,370 $ 13,076 $ 18,405 $ 22,711
License and product development revenues (1) 1,500 -- 625 768 1,020
------------- ------------- -------------- ------------- -------------
Total revenues 9,579 13,370 13,701 19,173 23,731
Cost of products sold 3,480 4,722 3,841 5,450 6,496
------------- ------------- -------------- ------------- -------------
Gross profit 6,099 8,648 9,860 13,723 17,235
------------- ------------- -------------- ------------- -------------
Research, development and regulatory affairs expenses 6,297 6,296 5,853 5,622 6,436
General and administrative expenses 5,338 5,266 5,400 5,504 6,855
Special charge- voluntary packaging recall (2) -- -- -- 430 --
------------- ------------- -------------- ------------- -------------
Total operating expenses 11,635 11,562 11,253 11,556 13,291
------------- ------------- -------------- ------------- -------------
Income (loss) from operations (5,536) (2,914) (1,393) 2,167 3,944
Interest income, net 763 387 481 388 315
------------- ------------- -------------- ------------- -------------
Income (loss) before taxes (4,773) (2,527) (912) 2,555 4,259
Provision (benefit) for income taxes -- -- -- 21 (5,864)
------------- ------------- -------------- ------------- -------------
Net income (loss) before cumulative
effect of accounting change (4,773) (2,527) (912) 2,534 10,123
Cumulative effect of accounting change (1) -- -- (2,656) -- --
------------- ------------- -------------- ------------- -------------
Net income (loss) $ (4,773) $ (2,527) $ (3,568) $ 2,534 $ 10,123
============= ============= ============== ============= =============
Net income (loss) per common share before cumulative
effect of accounting change:
Basic $ (0.36) $ (0.19) $ (0.07) $ 0.19 $ 0.75
============= ============= ============== ============= =============
Diluted $ (0.36) $ (0.19) $ (0.07) $ 0.18 $ 0.73
============= ============= ============== ============= =============
Cumulative effect of accounting change per common
share-basic and diluted $ -- $ -- $ (0.20) $ -- $ --
============= ============= ============== ============= =============
Net income (loss) per common share:
Basic $ (0.36) $ (0.19) $ (0.27) $ 0.19 $ 0.75
============= ============= ============== ============= =============
Diluted $ (0.36) $ (0.19) $ (0.27) $ 0.18 $ 0.73
============= ============= ============== ============= =============
Shares used in computation of net income (loss) per
common share:
Basic 13,270 13,324 13,390 13,468 13,535
============= ============= ============== ============= =============
Diluted 13,270 13,324 13,390 13,852 13,783
============= ============= ============== ============= =============
Pro forma amounts are presented below assuming the
change in accounting principle adopted in fiscal 2000 is
applied retroactively (1):
Pro forma- Net income (loss) $ (5,320) $ (1,902) $ (912)
============= ============= ==============
Pro forma- Net income (loss) per common share:
Basic $ (0.40) $ (0.14) $ (0.07)
============= ============= ==============
Diluted $ (0.40) $ (0.14) $ (0.07)
============= ============= ==============
20
As of December 31,
----------------------------------------------------------------------
1998 1999 2000 2001 2002
------------- ------------- ---------------------------- -------------
(In thousands)
BALANCE SHEET DATA:
Cash and cash equivalents and investments $ 16,702 $ 11,322 $ 11,832 $ 12,958 $ 17,042
Working capital (3) 11,621 9,745 8,462 9,321 16,815
Total assets 27,420 22,511 22,139 25,340 36,747
Long-term debt and capital lease obligations, less
current portion 934 2,155 332 -- 336
Total stockholders' equity 18,250 16,625 13,907 17,247 29,190
___________
(1) In fiscal 2000, we adopted SEC Staff Accounting Bulletin No. 101 which
changed our method of accounting for revenue from license and product
development agreements. See note 3 of notes to financial statements for
further discussion.
(2) In fiscal 2001, we recalled three production lots of DERMABOND adhesive
due to a mechanized packaging problem. See note 4 of notes to financial
statements for further discussion.
(3) Working capital is calculated as current assets minus current liabilities.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The statements set forth below that are not historical facts or statements of
current conditions are forward-looking statements. Such forward-looking
statements may be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "forecasts," "estimates," "plans,"
"continues," "may," "will," "should," "anticipates" or "intends" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy or intentions. These forward-looking statements, such as statements
regarding present or anticipated scientific progress, development of potential
products, future revenues, capital expenditures and research and development
expenditures, future financings and collaborations, management, manufacturing
development and capabilities, regulatory clearances and approvals, and other
statements regarding matters that are not historical facts, involve predictions.
Closure's actual results, performance or achievements could differ materially
from the results expressed in, or implied by, these forward-looking statements.
Potential risks and uncertainties that could affect Closure's actual results,
performance or achievements include, but are not limited to, the "Risk Factors"
set forth in Item 1 of this Annual Report. Given these uncertainties, current or
prospective investors are cautioned not to place undue reliance on any such
forward-looking statements. Furthermore, we disclaim any obligation or intent to
update any such factors or forward-looking statements to reflect future events
or developments.
The following discussion should be read in conjunction with our financial
statements, including the notes thereto, included elsewhere in this Annual
Report.
OVERVIEW
Since our inception in 1990, we have focused our efforts on developing,
manufacturing and commercializing medical tissue adhesive products for use in
wound closure in humans and animals. In addition, our research efforts include
the development of internal adhesive products.
During 2002, DERMABOND adhesive continued to be our leading product. Early in
2002, we received FDA approval to include in our device labeling that DERMABOND
adhesive acts as a barrier to microbial penetration. Clinically, this provides
for the potential reduction of infection rates, as long as the adhesive remains
intact, when closing incisions and lacerations with DERMABOND adhesive versus
the traditional use of sutures and staples which have not been shown to protect
against microbial penetration. We believe that this claim has supported the
21
increased penetration of DERMABOND adhesive, particularly in the operating room.
In addition, we completed the enrollment and follow-up of an 84-patient
definitive clinical trial for a high-viscosity, or thicker, version of DERMABOND
adhesive. This version is our second product line extension and will allow for
more precise application without the "rundown" experienced with the less viscous
versions. We received approval from the U.S. Food & Drug Administration to
market the High Viscosity DERMABOND Topical Skin Adhesive in January 2003 as a
result of the effort during 2002. Also, during the summer of 2002, Ethicon
initiated a direct-to-consumer television and print campaign, the first time
ever for any of its products, to increase awareness and preference for DERMABOND
adhesive among consumers.
Also, our marketing partner, CPC, launched our liquid bandage under the name
BAND-AID(R) Brand Liquid Bandage during the spring of 2002. CPC executed a print
and television advertising campaign during the summer months to increase
consumer awareness of the liquid bandage. We believe the efforts of CPC were
effective in establishing BAND-AID(R) Brand Liquid Bandage in the consumer
bandage market. In addition, BAND-AID(R) Brand Liquid Bandage was one of only
seven products to receive a Good Housekeeping "Good Buy" Award for best new
household products introduced during 2002, and was the only personal healthcare
product to win the award.
During 2002, we continued the development of our internal adhesive and wound
management projects. Our vascular sealant product is based on our core
cyanoacrylate technology and is intended for use inside the human body. We plan
to file an Investigational Device Exemption with the FDA in 2003, with human
clinical trials to follow. We are continuing to evaluate other opportunities,
such as our ELVR product, to use our cyanoacrylate technology inside the body.
We have continued the development of our liquid occlusive dressing, or LOD, to
treat partial thickness wounds such as pressure ulcers and skin tears. To date,
we have completed animal research as well as a 10-patient human pilot clinical
study for pressure ulcers. A second pilot clinical study is ongoing to further
define the LOD wear time and wound healing rates versus leading dressings in the
category. Based on the outcomes from the pilot studies, we anticipate the
initiation of a definitive, multi-center, human clinical study allowing for FDA
approval through the 510(k) premarket clearance.
RESULTS OF OPERATIONS
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Revenues. Total revenues for 2002 were $23,731,000 compared to $19,173,000 for
2001. Product revenues increased by 23% which is primarily due to sales of
BAND-AID(R) Brand Liquid Bandage, launched in April by CPC as well as increased
shipments of DERMABOND adhesive. In 2002, DERMABOND adhesive continued to
represent the majority of total revenues, approximately 75%. License and product
development revenues increased during 2002 to $1,020,000 from $768,000 in 2001
as revenue previously deferred was recognized ratably over the lives of various
contracts with our marketing partners. In 2002 and 2001, 94% and 83% of product
sales were to one customer, respectively.
Cost of products sold. Cost of products sold for 2002 was $6,496,000 compared to
$5,450,000 for 2001. Cost of products sold as a percentage of revenues was
approximately 27% for 2002 and 29% for 2001. The decrease is attributable to
increased production volumes and cost containment. Also, our product sales mix
continues to be heavily weighted with the DERMABOND product, which has
significantly higher margins than our over-the-counter products. We expect that
future gross margins on product sales will fluctuate based on production volumes
and the relative proportion of professional and OTC products.
Operating expenses. Operating expenses were approximately $13,291,000 and
$11,556,000 for 2002 and 2001, respectively. Operating expenses consist of
research, development and regulatory affairs expenses and general and
administrative expenses. During 2002, research, development and regulatory
affairs expenses were primarily focused on the development of DERMABOND adhesive
line extensions, including the High-Viscosity clinical study, the development of
an internal vascular sealant and wound management products and basic research.
We expect these expenses will increase as we expand our product pipeline and
related development efforts and clinical trials for potential new products, in
particular our internal adhesives. Overall, general and administrative expenses
increased in 2002 primarily due to a charge of approximately $800,000 related to
the transition of the CEO position. The charge included approximately $600,000
related to transition services provided by our former CEO and his entering
22
into a non-competition agreement. The remainder primarily related to the taxes
and benefits on the transition services and recruitment costs associated with
the selection of a new CEO. In addition, general and administrative costs for
2002 increased due to additional outside professional services and personnel
costs over the 2001 period.
Interest income, net. Net interest income for 2002 decreased to $315,000 from
$388,000 for 2001. Total interest income decreased primarily due to lower
investment yields as a result of market interest rate changes during 2002.
Interest expense also declined due to the continued reduction of our term loan
balance and capital lease obligations through monthly principal payments coupled
with a decline in interest rates associated with those obligations. All capital
lease obligations were retired during 2002.
Income taxes. Prior to 2002, no deferred provision or benefit for income taxes
was recorded because we were in a net deferred tax asset position and a full
valuation allowance had been recorded. During the fourth quarter of 2002, we
re-evaluated the amount of valuation allowance required in light of numerous
factors including the profitability achieved in recent years and expected in
future years. As a result, we reduced the valuation allowance on deferred tax
assets to an amount that we believe is more likely than not of being realized
based on our assessment of the likelihood of near term operating income coupled
with uncertainties with respect to the impact of future market conditions. At
December 31, 2002, the valuation allowance primarily reflects uncertainties
involving the realization of state tax credits and loss carryforwards. The
valuation allowance was reduced by $8,419,000 during 2002, including $1,210,000
related to net operating losses generated by the exercise of stock options prior
to 2002. This portion of the reduction in the valuation allowance, along with
$48,000 in similar tax benefits from stock option exercises during 2002, was
credited to additional paid-in-capital. We estimate that we would need to
generate future taxable income of approximately $19.0 million to fully utilize
our federal net operating loss and tax credit carryforwards existing as of
December 31, 2002.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenues. Total revenues for 2001 were $19,173,000 compared to $13,701,000 for
2000. Product revenues increased by 40% which is primarily due to increased
shipments of DERMABOND adhesive. Also contributing to this increase was the
launch of SOOTHE-N-SEAL(R) adhesive, including a significant amount of samples,
into the consumer market in the second quarter of 2001 by Colgate. License and
product development revenues increased during 2001 to $768,000 from $625,000 in
2000 as revenue previously deferred was recognized ratably over the lives of
various contracts with our marketing partners, including those entered into
during 2001.
Cost of products sold. Cost of products sold for 2001 was $5,450,000 compared to
$3,841,000 for 2000. Cost of products sold as a percentage of product sales
remained fairly constant at approximately 29% for 2001 and 2000. Although 2001
sales volume increased, this percentage remained steady due to the mix of the
products during 2001 which included the lower margin SOOTHE-N-SEAL(R) adhesive
and related samples. We expect that future gross margins on product sales will
fluctuate based on production volumes and the relative proportion of
professional and OTC products.
Operating expenses. Operating expenses were approximately $11,556,000 and
$11,253,000 for 2001 and 2000, respectively. Operating expenses primarily
consist of research, development and regulatory affairs expenses and general and
administrative expenses and, in 2001, included expenses related to a voluntary
packaging recall. During 2001, research, development and regulatory affairs
expenses were primarily focused on the development of DERMABOND adhesive line
extensions, the development of a liquid occlusive dressing, other product
development and basic research. During 2001, we were not involved in any
clinical trials. During 2000, research, development and regulatory affairs
expenses were primarily focused on clinical trials for BAND-AID(R) Brand Liquid
Bandage, the development of DERMABOND adhesive line extensions, other product
development and basic research. We expect these expenses will increase as we
expand our product pipeline and related development efforts and clinical trials
for potential new products, in particular our internal adhesive products.
Overall, general and administrative expenses remained fairly consistent with the
exception of salary expenses which increased during the 2001 period due to
increased headcount.
Also in 2001, we recorded a special charge related to the voluntary packaging
recall of three production lots of DERMABOND adhesive due to blister packaging
seals that may have been compromised due to a mechanized packaging problem. The
related costs of this recall were estimated to be approximately $430,000 and
consist primarily of costs to notify customers, cost of replacement product and
shipping expenses.
23
Interest income, net. Net interest income for 2001 decreased to $388,000 from
$481,000 for 2000. Total interest income decreased primarily due to lower
investment yields as a result of market interest rate changes during 2001.
Interest expense also declined due to the continued reduction of our term loan
balance and capital lease obligations through monthly principal payments coupled
with a decline in interest rates associated with those obligations.
Income taxes. During 2001, tax expense was recorded for the first time by
Closure in the amount of $21,000. This amount represents alternative minimum
taxes that cannot be eliminated through the use of net operating loss
carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations to date primarily through the sale of equity
securities, borrowings from lenders, license and product development revenues
and product sales. Our principal sources of liquidity include cash, cash
equivalents and marketable investments, which totaled $17.0 million at December
31, 2002.
In May 2002, our equipment term loan and line of credit matured and the
outstanding balance of approximately $690,000 was refinanced as a borrowing
within our $3.0 million line of credit, which was simultaneously renewed for a
two-year period. The renewed agreement contains certain restrictive covenants
including, but not limited to, maintenance of certain levels of unencumbered
liquid assets and a minimum tangible net worth requirement. The agreement is
secured by certain trade accounts receivable, inventory and equipment. The
December 31, 2002 outstanding balance of $336,000 was classified as long-term
debt as the agreement does not require principal payments within the next 12
months. Although our current payment pattern will allow for extinguishment of
debt by June 30, 2003, we are not required to pay all outstanding principal plus
accrued and unpaid interest until maturity at May 31, 2004.
Future minimum lease payments under noncancellable operating leases are
approximately $2.5 million over the next five years. The majority of operating
lease obligations relate to our facility lease.
Capital Expenditures
There are no individually material capital expenditure commitments outstanding
as of December 31, 2002. However, we estimate that capital investments for 2003
could be at least $2.5 million to support manufacturing scale-up initiatives. We
believe that our balances of cash, cash equivalents, and investments together
with funds generated from operations and existing borrowing facilities will be
sufficient to meet our operating cash requirements and fund required capital
expenditures for the foreseeable future.
Research and Development
During 2002, Closure spent approximately $6.4 million in research, development
and regulatory affairs expenses compared to $5.6 million in 2001. The increase
was primarily due to development and regulatory expenses surrounding the
High-Viscosity DERMABOND clinical and regulatory approval process as well as
ongoing research related to the internal adhesive and liquid occlusive dressing
products. We continued to increase our research and development activities to
maintain a competitive advantage and we anticipate that research and development
expenses will increase for the next several years as we develop new products and
line extensions for existing products. We also expect that clinical trials
related to new products and line extensions will be costly and represent a
significant part of future expenses. Research, development and regulatory
affairs expenses consist of items related to personnel, costs of supplies,
clinical trials, facility costs and fees paid to consultants and outside
contractors and providers and are expensed as incurred. We have arrangements
with certain marketing partners in which we share certain research, development
and regulatory affairs expenses related to approved projects. During 2002, 2001
and 2000 we were reimbursed $905,000, $576,000 and $355,000, respectively, in
accordance with these cost sharing arrangements. We cannot estimate the costs to
complete our internal research and development projects due to uncertainties
regarding successful completion of projects, clinical trial outcomes, regulatory
approvals and cost sharing arrangements with partners. We believe that funds for
future research and development needs can be obtained from existing cash and
investment balances and from cash generated from operations. However, no
assurance can be given that we may not require additional funds to support the
completion of new product development, conduct clinical trials and obtain
regulatory approvals.
24
Cash Flows
Net cash provided by operating activities was $5,713,000 for 2002 compared to
$3,219,000 for 2001. The increase in cash provided by operations was primarily
due to the increase in net income during the 2002 period offset by the change in
deferred taxes.
Net cash used by investing activities was $7,590,000 during 2002 and $1,621,000
during the 2001 period. The increase in net cash used during 2002 primarily
related to the increased net investment in marketable securities whereas net
cash used in 2001 primarily related to purchases of fixed assets and the
investment in intangible assets.
Net cash used by financing activities was $371,000 during 2002 compared to
$66,000 for 2001. Our primary financing activities during both years were the
repayment of debt and capital lease obligations, offset by the proceeds from the
sale of stock under our stock option and other benefit plans.
Based on our current plans, we believe that existing cash, cash equivalents and
investments, which totaled $17.0 million at December 31, 2002, will be
sufficient to finance our operating and capital requirements for at least 12
months. We anticipate that our recurring operating expenses will increase for
the next several years, as we expect research, development and regulatory
affairs and general and administrative expenses to increase in order to develop
new products, manufacture in commercial quantities and fund additional clinical
trials. We also may invest in long-term assets such as intangible assets and
capital expenditures to expand our manufacturing capabilities.
Our future capital requirements, however, will depend on numerous factors,
including but not limited to the following:
. our ability to manufacture and commercialize successfully our existing
products, including DERMABOND adhesive and liquid bandage;
. the progress of our research and product development programs for
future nonabsorbable and internal adhesive products, including
clinical studies;
. the effectiveness of product commercialization activities and
marketing agreements for our future products, including the scale-up
of manufacturing capabilities for increased capacity in anticipation
of product commercialization and development as well as progress of
sales and marketing efforts;
. our ability to maintain existing marketing agreements, including our
agreement with Ethicon for DERMABOND adhesive, and establish and
maintain new marketing agreements;
. our ability to achieve product development milestones;
. the costs involved in preparing, filing, prosecuting, defending and
enforcing intellectual property rights and complying with regulatory
requirements;
. the effect of competing technological and market developments;
. timely receipt of regulatory clearances and approvals;
. general acceptance of our products by the medical community and
consumers; and
. general economic conditions.
We may be required to seek additional capital to finance our operations in the
future. If our currently available funds and internally generated cash flow are
not sufficient to satisfy our financing and operating needs, we will be required
to seek additional funding through bank borrowings, additional public or private
sales of our securities, including equity securities, or through other
arrangements with marketing partners. Other than our working capital line of
credit, we have no credit facility or other committed sources of capital. There
can be no assurance that additional funds, if required, will be available to us
on favorable terms, if at all.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This is not a comprehensive list of all of our accounting policies. Our
significant accounting policies are described in Note 2 to the consolidated
financial statements included in Item 8 of this Form 10-K. The preparation of
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues, expenses and related
disclosures. On an ongoing basis, our management re-evaluates its estimates and
judgments. We believe the following policies require the most significant
judgment and estimates used in the preparation of the consolidated financial
statements.
Revenue recognition. The sales price of DERMABOND adhesive and NEXABAND
adhesives is ultimately determined by the sales price of the product to the
ultimate customer. For these products, we recognize revenue at an
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agreed-upon amount per unit at the time these products are shipped. Our
marketing partners subsequently provide a summary of their quarterly sales, and
at that time, we recognize additional revenue in an amount derived from the
difference between the previously recognized amount at shipment and the average
sales price received by the marketing partners. In addition, we recognize
royalty revenue for DERMABOND adhesive. Revenues from our other products are
recognized upon shipment which is when title is transferred. Advance payments
received by us that relate to future sales of product or future royalties due on
these sales are deferred and recorded as revenue as they are earned over future
periods.
Non-refundable fees received upon the execution of marketing and distribution
agreements for which Closure has an ongoing commitment to provide product are
deferred and recognized ratably over the period of the related agreement
pursuant to SEC Staff Accounting Bulletin No. 101. Under these marketing and
distribution agreements, we may receive additional milestone payments after the
execution of the contract. Because these payments are based on events or
achievements that may be outside of our control, we are unable to reasonably
estimate the amount of revenue, if any, that we might receive in the future
under our agreements. However, potential payments under existing contracts could
total $2.7 million over the next two years assuming that all criteria are
achieved. The revenue related to these payments would be deferred and recognized
ratably over the remaining period of the related agreement, which could extend
as far out as 2011 for certain agreements.
Intangible assets. Intangible assets consist primarily of patents and licenses.
Costs incurred to secure patents and obtain licenses are capitalized until
either the related patent or license is issued or obtained, in which case they
are amortized over the shorter of their remaining economic or useful lives,
generally fifteen years for patents, or they are rejected or abandoned, in which
case they are written off. On an ongoing basis, we evaluate the adequacy of our
patents and licenses carrying values.
Inventories. Inventories are stated at the lower of cost (first-in, first-out)
or market. Closure evaluates its inventory for obsolescence on an ongoing basis.
Income taxes. Income taxes are computed using the asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in our
financial statements or tax returns. In estimating future tax consequences, we
generally consider all expected future events other than enactment of changes in
tax law or rates. A valuation allowance is recorded when based on available
evidence, it is more likely than not that some portion of a deferred tax asset
will not be realized. On a quarterly basis, we consider all positive and
negative evidence, including our earnings history and existing contracts and
partnerships, to determine whether it is more likely than not that certain
deferred